SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended January 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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)
Securities registered pursuant to Section 12(b) of the Act:
6 1/4% Convertible Subordinated
Debentures Due July 1, 2006
(Title of class)
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
registrants was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrant's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
All of the voting stock of registrant is held by WEI Holdings, Inc., a
Delaware corporation ("WEI"). All of the voting stock of WEI Holdings, Inc. is
held by affiliates. All officers, directors and more than 5% stockholders of
WEI Holdings, Inc. are deemed "affiliates" of WEI Holdings, Inc. for the purpose
of determining the foregoing. The registrant, however, does not represent that
such persons, or any of them, would be deemed "affiliates" of the registrant for
any other purpose under the Securities Exchange Act of 1934 or the Securities
Act of 1933.
As of January 31, 1996, 2,360,729 shares of WEI's common stock and 10
shares of registrant's common stock were issued and outstanding.
PART I
Item 1. BUSINESS
Wherehouse Entertainment, Inc. (the "Company" or "Wherehouse") is, based
upon published and other information available to its management, in terms of
both revenues and store count, one of the largest retailers of prerecorded music
and videocassettes rentals in the western U.S. Founded in 1970 as a music
retailer, Wherehouse has evolved into a diversified entertainment retailer with
a broad range of prerecorded music, videocassettes and other products. As the
Company has grown, its product lines and product mix have been adapted to
changes in electronics technology and consumer tastes.
PETITION FOR RELIEF UNDER CHAPTER 11
On August 2, 1995 (the "Petition Date"), Wherehouse Entertainment, Inc. and
WEI Holdings, Inc. ("WEI"), the Company's parent, filed a voluntary petition for
relief under Chapter 11 of Title 11 of the United States Code in the United
States Bankruptcy Court for the District of Delaware in Wilmington, seeking to
reorganize under Chapter 11. In Chapter 11, the Company and WEI will continue
to manage their respective affairs and operate their businesses as
debtors-in-possession while they attempt to develop a reorganization plan
that will restructure and allow their emergence from Chapter 11. As
debtors-in-possession in Chapter 11, neither the Company nor WEI may engage
in transactions outside of the ordinary course of business without approval,
after notice and hearing, of the Bankruptcy Court.
As of the Petition Date, payment of pre-petition liabilities to the senior
lenders, bondholders and unsecured creditors of the Company and WEI, and pending
litigation against the Company and/ or WEI are stayed while they continue their
business operations as debtors-in-possession.
As a result of the bankruptcy filing and other events, the Company, and,
as applicable, WEI, are each currently in default under various agreements
governing the Revolving Line of Credit, Variable Rate Term Note, 13% Senior
Subordinated Notes and 6 1/4% Convertible Subordinated Debentures. As a
result, all unpaid principal of, and accrued pre-petition interest on, such
debt has become "Liabilities Subject to Compromise" and has been classified
as such on the Company's balance sheet. The payment of such debt and accrued
but unpaid interest thereon is prohibited during the pendency of the
Company's Chapter 11 case other than pursuant to a court order.
As of January 31, 1996, the total principal and accrued interest related to
the above debt was $207.5 million and $8.5 million, respectively. The ultimate
outcome of the aforementioned debt will be determined during the bankruptcy
case.
As a result of the filing, the accrual of interest on the Revolving Line of
Credit, Variable Rate Term Note, 13% Senior Subordinated Notes and 6 1/4%
Convertible Subordinated Debentures was suspended effective August 1, 1995.
Interest expense on the above debt would have been $13.1 million higher had it
continued to accrue from the period of August 2, 1995 through January 31, 1996.
In accordance with the Bankruptcy Code, the Company can seek court approval
for the rejection of pre-petition executory contracts, including real property
leases. Any such rejection may give rise to a pre-petition claim for damages
pursuant to the Bankruptcy Code. In connection with the Chapter 11 proceedings,
the Company reviewed all of its store operating results and as a consequence of
that process, the Company requested and received approval to reject 45 real
property leases (44 store leases and one office lease). In addition, six other
stores have been closed since the filing. Other real property leases and
certain executory contracts may be rejected in the future subject to Bankruptcy
Court approval.
Subsequent to January 31, 1996 the Company received Court approval to
reject an additional 17 store leases. In addition, 2 stores were sold during
the month of March, 1996. Costs related to the closing of 49 stores during the
period subsequent to the bankruptcy filing, and 19 stores either closed or sold
in fiscal year 1997 were $6.2 million, of which $5.2 million was related to the
write off of the remaining value of assets connected with those closed stores.
Since the filing, the Company has also obtained lease concessions,
primarily reductions in base rent and other charges, for a number of its
leases. Based upon these reductions, the Company sought and obtained court
approval for the assumption of 23 renegotiated store leases on February 27,
1996. In addition, 2 other store leases were assumed prior to the sale of
those stores in March 1996. Other real property leases and certain executory
contracts may be assumed in the future subject to Bankruptcy Court approval.
In connection with the Company's Chapter 11 case, the United States trustee
has appointed a committee for the Company's bondholders and other general
unsecured creditors.
As a result of the reorganization proceedings, the Company may sell or
otherwise realize assets and liquidate or settle liabilities for amounts other
than those reflected in the financial statements. Further, a plan of
reorganization could materially change the amounts currently recorded in the
financial statements. Except as noted, the financial statements do not give
effect to any adjustments to the carrying value of assets, or amounts and
classification of liabilities that might be necessary as a consequence of these
matters.
On the first day of the filing, the Company sought and received
authorization from the Bankruptcy Court to continue certain employee and
customer related policies which the Company deemed necessary for its survival.
These included its policies related to employees wages, benefits and
out-of-pocket business expenses. They also included its customer benefit
programs, including the Company's frequent renter program, its gift and rental
certificate programs and its merchandise return program. To date, and except
for loss of business which may have resulted from the reduction in the
breadth of the Company's inventory as a result of the matters discussed below,
the Company does not believe that it has experienced any material negative
impact from its customers or employees because of the filing.
On September 25, 1995, the Company completed negotiations with Bankers
Trust Company, as Agent, for a debtor-in-possession ("DIP") financing facility.
The DIP facility provides a borrowing capacity of up to $30.0 million in
revolving loans and letters of credit, subject to borrowing base limitations
based upon, among other things, the value of merchandise inventory. The DIP
facility also requires that the Company maintain certain financial covenants and
provide certain financial information on a periodic basis. A final order
authorizing borrowing on the DIP financing facility was approved by the
Bankruptcy Court on October 19, 1995.
Since the filing, most of the Company's vendors including the six major
distributors (Polygram Group Distribution, Inc. ("PGD"), Warner/Elektra/Atlantic
Corporation ("WEA"), Uni Distribution Corp. ("UNI"), EMI Music Distribution
("EMI") formerly ("CEMA"), Sony Music, ("SONY"), BMG Distribution ("BMG")) have
continued to ship merchandise to the Company. However, most of the Company's
vendors have requested changes in the trade credit terms offered to the
Company. Where previously the Company was paying for most vendor shipments
on an average of 60-75 days, it now finds that it is being required to make
payment on a cash-in-advance basis for most of its shipments. The Company is
currently involved in negotiations with its vendors to set up normal terms for
post-petition shipments and services.
Under certain circumstances, the court has allowed the Company to enter
into post-petition vendor agreements which permit returns of inventory for
credit against pre-petition indebtedness in exchange for the granting of normal
terms on a post-petition basis. On October 12, 1995, the Company signed such an
agreement with WEA which provides for a credit facility of up to $4.5 million.
The agreement also requires returns of inventory to WEA of $2.2 million for
credit against pre-petition indebtedness. Similar agreements have since been
signed with EMI, PGD and Alliance Entertainment Corporation which provide for
credit facilities of $1.1 million to $4.5 million and require returns of
inventory for credit against pre-petition claims of $0.3 million to $2.3
million. As a result of these and other agreements, the Company has secured
approximately $15.8 million in post-petition trade credit. The above agreements
are binding and effective until a plan of reorganization is confirmed by the
Court, or the original Order is reversed, stayed or set aside. The agreements
also may be terminated by the vendor in the case of certain defined events of
default. Changes in credit terms have had a material impact on the Company's
liquidity, and there can be no assurance as to the effect which any future
changes in trade credit terms imposed by the Company's vendors could have on the
Company's liquidity or its operations.
The Board of Directors has authorized Jefferies & Company, the Company's
financial advisor, to develop and implement a process (the "M & A Process") to
solicit interest relating to the potential sale of all or part of the Company's
assets or stock by merger, tender offer, exchange offer, plan of reorganization,
other acquisition of debt or securities, or otherwise. Since the commencement
of the M & A Process, the Company has negotiated and entered into
confidentiality agreements with several potentially interested buyers.
On April 29, 1996 the Company filed a Plan of Reorganization (the Plan)
with the Bankruptcy Court. Following is a summary of the proposed treatment in
the Plan of each of the major classes of creditors and shareholders recorded on
the Company's January 31, 1996 balance sheet:
PRE-PETITION LENDERS
Pre-petition Lenders include the variable rate term note and
revolving line of credit. If the Plan is accepted by the
Pre-petition Lenders, the Pre-petition Lenders will receive
approximately 4.2 million shares of new common stock for the
amount of their pre-petition secured claim (estimated for
purposes of a consensual Plan to be $35.0 million less
adequate protection payments of $1.7 million) and
approximately $14.7 million of new notes and 2.2 million
shares of new common stock for their deficiency claim. If
the Plan is not accepted by the Pre-petition Lenders, the
Pre-petition Lenders will receive new notes in an amount not
to exceed $20.0 million for the amount of their pre-petition
secured claim (subject to determination by the Bankruptcy
Court pursuant to a valuation hearing) and 15.748 shares of
new common stock for each $1,000 of their allowed deficiency
claim.
PRE-PETITION SUPPLIER CLAIMANTS
Pre-petition Supplier Claimants include trade and other
miscellaneous claims and lease rejection claims. If the
Plan is accepted by the Pre-petition Lenders, the Pre-
petition Supplier Claimants will receive approximately $3.9
million of new notes and approximately 728,000 shares of new
common stock. If the Plan is not accepted by the Pre-
petition Lenders, the Pre-petition Supplier Claimants will
receive 15.748 shares of new common stock for each $1,000 of
their allowed claim.
13% SENIOR SUBORDINATED NOTES
13% Senior Subordinated Note Claimants include the holders
of the 13% senior subordinated notes. If the Plan is
accepted by the Pre-petition Lenders, the 13% Senior
Subordinated Note Claimants will receive approximately
615,000 shares of new common stock. If the Plan is not
accepted by the Pre-petition Lenders, the 13% Senior
Subordinated Note Claimants will receive 15.748 shares of
new common stock for each $1,000 of their allowed claim.
CONVERTIBLE SUBORDINATED DEBENTURES:
The Convertible Subordinated Debentures and related accrued
interest will be canceled, with the holders thereof
receiving no distribution.
CURRENT COMMON SHAREHOLDERS:
The current common stock will be canceled, with the common
shareholders receiving no distribution.
There can be no assurance that the Plan will be confirmed by the Bankruptcy
Court in exactly the form submitted. In addition, the Company has until June
27, 1996 to solicit acceptances from its creditors; however, the Company has
filed a motion for a 60-day extension.
GENERAL
Wherehouse operated 297 stores at January 31, 1996 in 8 states under the
names "The Wherehouse," "Wherehouse Entertainment," "Record Shop," "Rocky
Mountain Records," "Leopolds" and "Odyssey." All but 6 of the Company's stores
operate under "The Wherehouse" or "Wherehouse Entertainment" names. The "Record
Shop" and "Rocky Mountain Records" names were acquired with the acquisitions of
those stores between 1992 and 1994, and 4 of the stores continue to operate
under those names at this time.
The Company sells prerecorded music and videocassettes, video games,
personal electronics (including personal stereos, portable stereos, headphones
and related merchandise), blank audiocassettes and videocassettes, and
accessories. Approximately 81% of the Company's stores also rent both
videocassettes and video games. The Company believes that this combination
entertainment store format offers competitive advantages relative to those
competitors that operate stores offering only merchandise products for sale or
products for rent. The merchandise sale and video rental lines complement one
another and offer cross-selling opportunities. A video rental customer visits a
store at least once, and possibly twice, for each transaction and is presented
each time with the Company's merchandise offerings.
In the fiscal year ended January 31, 1996 ("fiscal 1996"), sales of
prerecorded music, videocassettes, video games, and accessories accounted for
80.9% of revenues, and rentals of videocassettes, video games, and other
products accounted for 19.1% of revenues.
Of the 297 stores operating as of January 31, 1996, 248 stores were located
in strip centers or freestanding buildings and 49 were located in malls.
Approximately 92% of the Company's stores are concentrated in ten major
marketing areas (Los Angeles, San Francisco, San Diego, Sacramento, Seattle,
Phoenix, Fresno, Las Vegas, Denver and Salt Lake City) and approximately 84% of
the stores are located in California. The Company has focused its operations on
its ten major marketing areas in order to create competitive advantages in
operations, advertising and marketing, and distribution.
Currently, WEI conducts no independent operations and has no significant
assets other than the capital stock of the Company.
MERCHANDISE SALE PRODUCTS AND SUPPLY
Wherehouse stores generally sell a broad array of entertainment products,
including prerecorded music and videocassettes, video game software, accessories
and personal electronics. The table at the end of this section summarizes the
Company's dollar volume of sale revenue by merchandise category from fiscal 1992
through fiscal 1996. The percentage of total revenues contributed by
merchandise sales has risen from 78.4% in 1992 to 80.9% in 1996. The number of
different music titles per store ranges from approximately 6,000 to 70,000,
representing a range of 12,000 to 140,000 individual stock-keeping units in
inventory per store.
The Company's most important product strategy is to ensure constant
availability of the most popular music and video titles while maximizing the
selection of catalog titles of lasting popularity. With input from store
management and a product allocation team, Wherehouse's inventory management
systems tailor each store's product selections and merchandise mix to local
market demand and maximize the availability of the most popular items at each
store, subject to store size constraints. The Company's stores have been
designed to facilitate quick service and to accommodate changes in industry
trends and product offerings.
The Company also buys and sells used products, principally used CD's, in
the majority of its stores. The sale of used CDs was first tested in certain of
the Company's stores in fiscal 1993. Based upon strong consumer acceptance, the
Company began buying used CDs from customers and expanded upon its used product
business significantly in fiscal 1994, 1995 and 1996.
Prerecorded videocassettes (feature films, music videos, and
self-improvement programming) represented, after music, the Company's second
largest sale product category in fiscal 1995 and fiscal 1996. As box-office
"hit" motion pictures continue to be released to the videocassette sell-through
market at reduced prices, industry-wide sales of this category have increased.
The Company's revenues from the sales of videocassettes, however, decreased from
fiscal 1991 through 1994 with the proliferation of competitors' outlets selling
videocassettes and the highly competitive pricing of the product, particularly
from discounters and mass merchandisers.
The Company sells video game hardware and software, blank audio and
videocassette tapes, music and tape care products, carrying cases, storage
units, and personal electronics. The Company also collects commissions on event
tickets sold under affiliations with Bay Area Seating Service (BASS) and
Ticketmaster.
Sales and Rental Revenue By
Merchandise Category
(dollars in millions)
Fiscal Years Ended January 31,
---------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
Merchandise Sales
Compact discs
(including
used CDs) $219.5 $239.7 $203.7 $174.3 $161.0
Cassettes and
other music 72.7 94.2 101.9 112.7 124.5
------ ------ ------ ------ ------
Total music 292.2 333.9 305.6 287.0 285.5
New videocassettes 24.1 25.8 24.3 26.9 33.4
Video game software
and hardware,
general merchan-
dise, accessories,
ticket commis-
sions, and
other 34.4 49.8 50.3 40.6 39.7
------ ------ ------ ------ ------
Total merchandise
sales $350.7 $409.5 $380.2 $354.5 $358.6
====== ====== ====== ====== ======
Video and other
product rentals 82.5 90.1 91.6 94.0 98.8
------ ------ ------ ------ ------
TOTAL REVENUE $433.2 $499.6 $471.8 $448.5 $457.4
====== ====== ====== ====== ======
VIDEO AND OTHER PRODUCT RENTALS
The Company's other principal revenue source is the rental
of prerecorded videocassettes and other products, chiefly feature films.
Although most videocassette rentals are feature films,
approximately 10% of Wherehouse's rentals in fiscal 1996 were
nontheatrical titles, such as children's videos, adult videos, workout videos,
music videos, educational videos, and do-it-yourself videos. Audiocassette
books, video game players and laser discs are also offered for rent in a few
select stores. As of January 31, 1996, 241 of Wherehouse's 297 stores offered
videocassettes and other products for rent. On average, stores that rent
videocassettes carry approximately 6,700 units, and can range from as few as
2,200 to as many as 18,000 units, representing from approximately 3,000 to 9,000
individual titles.
Wherehouse purchases prerecorded videocassettes from a
variety of distributors and other suppliers. As with recording
companies, the film studios, or their videocassette distribution
operations, each controls a certain portion of available titles
and seeks to promote those titles. The Company's leading suppliers of
prerecorded videocassettes are Warner Home Video, Video Product Distribution,
Baker & Taylor Video, UNI and Fox Video. The Company has not experienced, and
does not anticipate having in the future, any material problems obtaining its
products.
The Company believes that an important element of efficient
video operations is the disposition of used rental videocassettes to maximize
the productivity of its inventory. Wherehouse's systems enable the Company to
effectively monitor the rental efficiency of its inventory on an individual
title and unit basis. As a title's efficiency declines, used rental
videocassettes are sold on a clearance basis in the Company's stores, and, where
appropriate, the Company may sell excess used video inventory to third-party
distributors.
ADVERTISING AND PROMOTION
The Company employs advertising, promotion, pricing, and
presentation in a coordinated manner to generate customer awareness of its
breadth of product and value pricing on selected items and to induce trial and
repeat purchase of its products and video rental services. Wherehouse
advertises on a regular and
frequent basis in a variety of broadcast and print media, including radio,
newspaper, direct mail, freestanding inserts, magazines, and television.
Advertising generally emphasizes immediate availability of hit product at
reduced prices, as well as access to a broad array of catalog product. The
Company believes its strategy of clustering its stores in major markets allows
it to optimize the use of its advertising expenditures.
Wherehouse seeks to maximize cooperative advertising
payments from suppliers, which are generally available to the
industry. Music and video companies generally provide funds on a
title-by-title basis to promote new releases and, occasionally,
on a label-wide basis. When the Company runs pre-authorized
advertising that contains reference to a specific title or label,
the related supplier will generally reimburse 100% of the pro
rata cost of that advertising.
The Company has not experienced, and does not anticipate having in the
future, any material problems obtaining cooperative advertising due to the
bankruptcy filing.
TRADE CUSTOMS AND PRACTICES
Most of the Company's music purchases are protected by return policies
offered by major manufacturers. The return privilege generally exists for each
music title as long as that title remains in the current music catalog of a
manufacturer. Catalog changes are generally made only after advance notice,
allowing the Company to return excess inventory before a title is discontinued.
Most of the Company's major pre-recorded music suppliers provide unlimited
returns of unopened items, but generally charge return penalties of varying
amounts. The above-mentioned major suppliers do not accept returns of opened
merchandise on the same basis as unopened items, but do generally provide the
Company with certain additional allowances. Returns to vendors were suspended
following the bankruptcy filing but were reinstated several months later for
most of the Company's vendors. Pricing and return policies of the Company's
major distributors are subject to change.
Trade terms for many of the Company's vendors have changed since the
bankruptcy filing. Further information on this topic is available under the
heading "Petition for Relief Under Chapter 11."
STORE ADDITIONS AND SITE SELECTION
The table below sets forth store openings, closings, total number of
stores, and aggregate square footage under lease for the last five fiscal years:
Aggregate
Total Stores Stores Total Stores Square
Fiscal at Beginning _____________ at End Footage at End
Year of Period Opened Closed of Period of Period
______ ____________ ______ ______ ___________ ______________
1996 347 3 53 297 1,994,000
1995 347 4 4 347 2,159,000
1994 313 49 15 347 2,117,000
1993 301 15 3 313 2,011,000
1992 283 21 3 301 1,932,000
During the fiscal year ended January 31, 1996, the Company's new store
openings ranged in size from 2,018 to 17,500 square feet. Initial cash
investment (before landlord's contribution) in leasehold improvements, fixtures
and equipment for these new stores ranged from approximately $192,000 to
$994,000.
The Company's strategy of clustering stores in marketing areas has led to
the achievement of important economies of scale and scope in several business
functions, including advertising, personnel, management and distribution.
During the years prior to the bankruptcy filing, the Company pursued growth
opportunities in existing marketing areas and selectively grew through
acquisition if such growth was consistent with the Company's strategies. The
Company will continue to take advantage of opportunities to consolidate or close
stores in areas where the market has become less favorable.
STORE OPERATIONS AND DISTRIBUTION
STORE LOCATION. As of January 31, 1996, the Company had 248 stores located
in strip centers or freestanding buildings and 49 stores located in malls. The
standard size of strip center or freestanding locations is approximately 6,500
square feet, with an approximate range of 3,000 to 25,000 square feet. Mall
stores range in size from 1,500 to 10,000 square feet of space, and most do not
offer video rental service due to the importance of convenience in the video
rental business.
RETAIL PRESENTATION. The Company has developed a contemporary store design
approach that employs light interior colors, attractive lighting, modified
exterior signage and a minimum of fixed interior walls. The design maximizes
flexibility in lighting and use of floor space (e.g., to accommodate changes in
product format) and focuses customer attention primarily on the products. The
Company maintains an active store remodeling program to keep older stores up to
date.
DISTRIBUTION. Central to Wherehouse's strategy of providing
broad merchandise selection to its customers (i.e. multiple copies of hits,
select copies of catalog product, and high
quality in-stock condition) is its ability to distribute product
quickly and cost-effectively to its stores. The Company's
central distribution system achieves this result by filling
orders to all stores twice a week. Inventory at the Company's distribution
center (located in Carson, California) is automatically sorted based on
individual store demand data generated by its store-level inventory systems.
Approximately 25% of the Company's inventory is shipped to
store locations directly from manufacturers and distributors
(chiefly in the case of new releases), and the remainder is
shipped from the Company's distribution center. The Company uses common
carriers for deliveries from its distribution center.
COMPETITION
Both the prerecorded music and the video rental markets
are highly competitive. In the prerecorded music market, the Company competes
with other chain retailers who specialize in prerecorded music, discounters and
other mass merchandisers, direct mail programs such as record clubs, and local
operators. The video rental market is a more fragmented industry, with many
small operators and one significant competitor, Blockbuster Entertainment
Corporation. Grocery and convenience stores also account for a portion of the
video rental market. In the Company's judgment, small operators may be well
located, but usually have significant disadvantages in inventory selection and
cost relative to chain retailers. Additionally, the Company's combination
entertainment store format gives the Company cross-selling opportunities in
music and rental video which most of its competition does not have.
Nevertheless, in both the music and rental markets, there has been a trend
towards consolidation, and several large regional retail chains -- many similar
to or direct competitors of the Company -- have been acquired by large national
retail chains. In addition, several major retail chains, including Best Buy,
Blockbuster Entertainment, Hollywood Entertainment and Virgin Megastores, have
recently opened stores or expanded their retail store presence in the Company's
markets. Several have announced plans to continue that expansion. Accordingly,
it can be expected that the Company will in future periods experience increased
competition from companies with greater financial resources than the Company,
and that such competition may result in continued pressure on revenues and gross
profit margins.
The Company also competes with cable television and DSS (Digital Satellite
Systems), which includes pay-per-view television. Currently, pay-per-view
provides less viewing flexibility to the consumer than videocassette rentals,
and at a higher cost. Also, under current entertainment industry distribution
practices, movies are generally available on videocassette prior to appearing on
pay-per-view. However, viewing flexibility may increase with improved
technology which could negatively impact the retail store delivery of home video
and the Company's business. Notwithstanding potential technological advances,
the Company believes that video rental should, in the near future, continue to
be the first source of filmed in-the-home entertainment, before pay-per-view,
and a primary source of filmed entertainment for the consumer.
Several major companies have announced that they are developing other
technologies which, if successful, could constitute significant competition.
These include technologies which would provide movies or interactive games "on
demand" over fiber optic telephone or cable lines, other in-the-home
entertainment which may some day be provided over the "information
superhighway", and in-store kiosks that would provide on-site transcription of
compact discs. While none of these technologies is yet commercially available,
and it appears that significant technical, economic, and other obstacles to
their introduction remain to be resolved, if and when these or other new
technologies are introduced, it can be anticipated that the Company's business
could be significantly impacted; and the Company may need to develop and
implement new marketing strategies in order for its business to remain viable.
The Company is one of the largest retailers of prerecorded music and
videocassette rentals in the western U.S. The Company believes that its major
competitive advantages lie in its convenient store locations and in its ability
to offer a wider and more up-to-date selection of inventory and to provide
better customer service.
ORGANIZATION AND EMPLOYEES
The Company's corporate offices are located in Torrance,
California. The Company maintains offices for its operating divisions within
the corporate offices and in Redwood City, California. The Company's
distribution center is in Carson, California.
As of January 31, 1996, the Company employed approximately 7,100 persons.
Approximately 29% were full-time employees and approximately 71% were part-time
employees. The Company's labor complement depends on seasonal requirements,
with up to 600 additional store and distribution center employees added during
the peak holiday season. The Company's headquarters staff, which numbers
approximately 190, is responsible for executive and general operating
management, buying, merchandising, advertising, finance, accounting, information
systems and real estate.
TRADEMARKS
All but 6 of the Company's stores operate under the name "The Wherehouse"
or "Wherehouse Entertainment." The Company owns and maintains registrations for
"The Wherehouse" trademark and variations thereof in the United States, the
United Kingdom, and Mexico, and has filed trademark registrations in Japan,
Korea, Thailand, and Taiwan. The Company monitors the status of its trademark
registrations to maintain them in force and to renew them as required.
SEASONALITY
The Company's business is seasonal, and, as is typical for
most retailers, its revenues peak during the Christmas holiday
season. Revenues in the fourth quarter of fiscal 1996 were slightly more than
30% of total annual revenues.
Item 2. PROPERTIES
The Company's executive offices, which are located in
Torrance, California, are governed by a lease covering 72,708
square feet of space at a current annual base rent of approximately $697,992.
The lease expires on May 31, 1999.
The Company owns a 110,000 square foot warehouse in Gardena, California,
which is subject to a mortgage in the original principal amount of $2.8 million
which matures in December 1996. The majority of the space in this facility is
leased until March 31, 1997 for an annual rental of $192,000. This lease is
subject to a renewal option for an additional term of three years.
The Company operates a 200,000 square foot distribution center in Carson,
California. The lease for this property expires on April 30, 2002, subject to
two five-year renewal options. The base rent for fiscal 1996 was $731,808; rent
is subject to periodic adjustment.
All 3 stores opened through internal development during fiscal 1996 were
located in leased properties. As of January 31, 1996, the Company had not
signed any lease commitments to open new stores. During February of 1996, the
Company entered into four short-term leases with the Lucky's Division of
American Stores, Inc. to operate sale and rental businesses within Lucky's
supermarkets, under the "Wherehouse" name.
As of January 31, 1996, the Company owned 1 of its retail
locations and leased space for the remaining 296 stores. Lease
terms generally range from 10 to 25 years including renewal
options. If no leased stores' renewal options were exercised, excluding the 19
leases related to the stores closed in February and March 1996, 32 leases would
expire on or before January 31, 1997, 100 would expire between February 1, 1997
and January 31, 2001, and the remainder would expire between February 1, 2001
and January 31, 2013. The Company does not depend on the continued existence of
any one or several of its lease agreements or store locations for the operation
of its business.
Item 3. LEGAL PROCEEDINGS
(i) Bankruptcy filing
On August 2, 1995 (the "Petition Date"), the Company and WEI, the
Company's parent, each filed a voluntary petition for relief under the Chapter
11 of title 11 of the United States Code in the United States Bankruptcy Court
for the District of Delaware. Since the Petition Date, the Company and WEI have
continued to manage their respective affairs and operate their business as
debtors-in-possession. As debtors-in-possession, neither the Company nor WEI
may engage in transactions outside of the ordinary course of business without
approval, after notice and hearing, of the Bankruptcy Court.
On the Petition Date, the Company sought and received authorization
from the Bankruptcy Court to, among other things, retain certain legal and
financial professionals for the bankruptcy estates, use cash collateral on an
interim basis and honor its prepetition obligations under its employee and
customer-related policies which the Company deemed necessary for its survival.
On or about September 21, 1995, the Bankruptcy Court gave interim
approval for the Company to obtain debtor-in-possession financing in the form of
a revolving credit facility of up to $30 million, subject to borrowing base
limitations, in unsecured credit on an administrative superiority basis (the
"DIP Facility"). On or about October 19, 1995, the Bankruptcy Court gave final
authorization for the Company to enter into the DIP Facility.
On or about October 19, 1995, the Bankruptcy Court authorized the
Company to enter into agreements with its vendors under section 546(g)* of the
U.S. Bankruptcy Code. Section 546(g)* permits a consensual return of goods
shipped to Wherehouse by a creditor prior to the Petition Date and provides for
an offset of such creditor's prepetition claim in the amount of the purchase
price of such returned goods. The Bankruptcy Court order authorizing the
Company's entry into such agreements imposed certain additional requirements and
limitations, including the requirement that any vendor entering into such
agreement must commit or re-establish trade credit with Wherehouse on normal
terms.
In late November, 1995, the Company and its financial advisor,
Jefferies & Company, Inc. ("Jefferies") commenced a process to determine and
assess systematically and definitively the Company's various strategic options,
including a sale or merger of all or substantially all of the Company's business
and a sale of post-reorganization equity to a new investor (the "M&A Process").
On December 29, 1995, the Bankruptcy Court approved the supplemental terms of
Jefferies' retention with respect to the M&A Process.
Since the Petition Date, the Bankruptcy Court has approved the
rejection by the Company of 62 of its real property leases (covering 61 stores
and one administrative office) and the assumption by the Company of 25 of its
store leases, two of which were assigned upon the subsequent sale of the
underlying stores to a purchaser.
On April 29, 1996, the Company and WEI filed their Chapter 11 Plan of
Reorganization ("Plan") with the Bankruptcy Court. By order of the Bankruptcy
Court, the disclosure statement for the Plan is due on May 15, 1996. The
Company and WEI currently have until June 27, 1996 to solicit acceptances of the
Plan from their creditors.
(ii) Banker's Trust Litigation
IN RE WHEREHOUSE ENTERTAINMENT, INC., AND WEI HOLDINGS, INC.;
WHEREHOUSE ENTERTAINMENT, INC., AND WEI HOLDINGS, INC. V. BANKERS TRUST COMPANY,
United States Bankruptcy Court for the District of Delaware, Case No. 95-911
(HSB); Adv. Pro. No. A-95-105. On November 9, 1995, the Company filed an
adversary proceeding in the Bankruptcy Court against Bankers Trust Company, one
of the Company's secured creditors. The Company seeks a declaration that
certain collateral in which Bankers Trust has a security interest does not
extend to the Company's "merchandise (or sale) inventory." Bankers Trust has
filed a motion for judgment on the pleadings seeking to dismiss the Company's
complaint, and the Company has filed a motion seeking leave of the Court to file
a First Amended Complaint against Bankers Trust. The Bankruptcy Court granted
the Company's motion, and the Company filed its First Amended Complaint on April
19, 1996. In the First Amended Complaint, the Company seeks relief in addition
to a declaration that Bankers Trust's collateral does not include merchandise
(sale) inventory. Among others, the Company asserts claims against Bankers
Trust for reformation of the security agreement between the Company and Bankers
Trust to provide that Bankers Trust's security interest does not extend to the
Company's merchandise (sale) inventory and/or equitable subordination of Bankers
Trust's entire security interest to that of other creditors. On April 30, 1996,
Wherehouse and Bankers Trust stipulated to a moratorium on discovery effective
immediately, and the Bankruptcy Court approved the moratorium on May 7, 1996.
The moratorium can be terminated by either party by providing the other party
with seven days notice of termination. Under the stipulation, the parties
further agreed that, if and when the moratorium period is terminated, the
pretrial dates set forth in the Court's January 17, 1996, Scheduling Order would
be reset so that the discovery cutoff date and the due date for case or issue
dispositive motions would be the corresponding dates in the Scheduling Order
plus the number of days that the moratorium period (including the seven day
notice) was in effect. None of the other provisions of the Scheduling Order,
including any other dates set in that Order, will be affected by the
stipulation.
(iii) McMahan and Related Actions.
In January 1988, holders (the "Debentureholders") of approximately $17
million in principal amount of the Company's
6-1/4% Convertible Subordinated Debentures (the "Debentures") commenced the
action McMahan & Company, et al. v. Wherehouse Entertainment, Inc., et al., 88
Civ. 0321 (S.D.N.Y.). Defendants are the Company, six of its former directors,
Furman Selz, Adler & Shaykin, the former controlling shareholder of the Company
("A&S"), WEI Acquisition Corp. ("WAC"), a corporation formed by A&S for the
purpose of acquiring the Company, and WEI.
An indenture between the Company and Bank of America National Trust
and Savings Association (the "Debenture Indenture"), which sets forth the
contractual rights of the Debentureholders, provides that under certain
circumstances (defined as "triggering events") the Debentureholders will have
the right to have their Debentures redeemed by the Company at a specified
redemption price. One of the triggering events is a merger of the Company with
another company that is not approved by a majority of the "Independent
Directors" (as defined in the Debenture Indenture). The claims in this action
arose from the 1988 acquisition of the Company by A&S, pursuant to a merger
agreement (the "1988 Acquisition Agreement") that was approved by the board of
directors of the Company, including a majority of the Independent Directors. At
that time, there were 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 Indenture because of the alleged implicit
requirement in the Debenture Indenture that the Independent Directors would not
approve any merger agreement unless the approval was in the best interests of
the Debentureholders. Count II alleges that the board of directors' approval of
the 1988 Acquisition Agreement violated the directors' contractual duty of good
faith and fair dealing to the Debentureholders. Count III alleges that
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
Debentureholders. Count IV, brought solely on behalf of Froley, Revy Investment
Co. ("Froley Revy"), alleges that representatives of Furman Selz violated
Section 12(2) of the Securities Act by making material misstatements to Froley
Revy to the effect that the optional redemption provision was a "special
protection" and a "protective covenant" for Debentureholders, without disclosing
that the directors retained the power, in their discretion, to approve a
transaction and thereby prevent any right to redemption from arising. Count V
alleges that the prospectus issued by the Company and Furman Selz in connection
with the offering of the Debentures, as well as the oral 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 descriptions 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 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.
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 Commission 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.
On September 13, 1995, the Second Circuit Court of Appeals issued an
opinion reversing in part and affirming in part the District Court's order
denying defendants' motion for summary judgement on plaintiffs' federal
securities law claims. The Court of Appeals held that the District Court's
refusal to dismiss plaintiffs' claim for an alleged violation of Section 11 of
the Securities Act was based on an incorrect application of the law and directed
the District Court to address evidence submitted by defendants in support of
their motion for summary judgement on plaintiffs' Section 11 claim. With
respect to plaintiffs' claim for an alleged violation of Section 10(b) of the
Exchange Act, the Court held that plaintiffs may seek to recover a
"benefit-of-the-bargain" measure of damages. The Court denied plaintiffs'
cross-petition to appeal from the District Court's order dismissing their
state law claims. On September 27, 1995, defendants filed a petition for a
rehearing requesting that the Court of Appeals vacate its ruling on
plaintiffs' Section 10(b) claim. On December 15, 1995, defendants' petition
for a rehearing was denied. On December 19, 1995, the District Court entered
an order dismissing plaintiffs' Section 11 claim with prejudice. On March 14,
1996, defendants filed a petition for certiorari in The United States
Supreme Court requesting that the court reverse the Second Circuit's ruling
that plaintiffs may seek to recover benefit-of-the-bargain damages under
Section 10(b) of the Exchange Act.
The McMahan case and the related Don Thompson case are scheduled for
trial on August 5, 1996. The Company believes that this action is without merit
and is vigorously defending it.
$5.3 million principal amount of the Debentures remained outstanding
as of January 31, 1996.
An action entitled Don Thompson v. Wherehouse Entertainment, 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 consolidated with
the McMahan action.
(iv) 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. Wherehouse 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 $19.3 million.
(v) Other.
The Company is a party to various other claims, legal actions and
complaints arising in the ordinary course of its business. In the opinion of
management, all such matters are without merit or involve such amounts that
unfavorable disposition will not have a material impact on the financial
position and results of operations of the Company.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
MARKET INFORMATION
The Company has only one class of common equity outstanding,
all of which is owned by WEI. WEI has only one class of common equity
outstanding, which is owned exclusively by affiliates of MLCP and certain
members of management of the Company. See Item 12 - "Security Ownership of
Certain Beneficial Owners and Management". There is no established public
trading market for the common equity of WEI.
HOLDERS
As of January 31, 1996, there was one holder of the Company's common stock
and there were 14 holders of common stock, par value $.10 per share of WEI.
DIVIDENDS
WEI has paid no dividends to its stockholders in either of the last three
fiscal years. Dividends in the amount of $184,511 were paid by the Company to
WEI in fiscal year 1995 solely for the purpose of providing funds to enable WEI
to purchase shares from former members of management pursuant to the
Stockholder's Agreement described in Item 13. The Company's Bank Credit
Agreement among Wherehouse, as borrower, WEI as guarantor, Bankers Trust
Company, as Agent, and the Indenture relating to the Company's 13% Senior
Subordinated Notes Due 2002, Series B, restrict the ability of WEI and the
Company to pay dividends. See Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operation." There are no plans by the
Company or WEI to pay cash dividends on its common stock in the foreseeable
future.
Item 6. 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.
The selected financial data should be read in conjunction with the discussion
under Item 7 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and with the financial statements, including the notes
thereto, included elsewhere in this report.
(Dollar amounts in millions)
-----------------------------------------------------------------
Company Predecessor(1)
------------------------------------------- --------------------
8 Months 4 Months Year
Year Ended Ended Ended Ended
January 31, Jan. 31, May 30, Jan. 31,
1996 1995 1994 1993 1992 1992
--------- --------- --------- --------- --------- ---------
Income statement data
- ---------------------
Revenue:
Sales $350.7 $409.5 $380.2 $249.1 $105.3 $358.6
Rental 82.5 90.1 91.6 64.3 29.8 98.8
--------- --------- --------- --------- --------- ---------
433.2 499.6 471.8 313.4 135.1 457.4
Cost and expenses:
Cost of sales 230.4 262.6 248.0 155.2 66.9 225.5
Cost of rentals
including
amortization 40.0 35.0 50.8 24.8 7.3 30.9
Selling, general and
administrative
expenses 167.2 188.7 196.6 122.9 59.9 179.1
Restructuring charges(2) --- --- 14.3 --- --- ---
Write-down of long-
lived assets 1.5 139.5 --- --- --- ---
Interest expense, net
of interest income 14.7 23.0 23.2 15.6 4.8 17.9
--------- --------- --------- --------- --------- ---------
453.8 648.8 532.9 318.5 138.9 453.4
--------- --------- --------- --------- --------- ---------
(Loss) income before
reorganization items
and income taxes (20.6) (149.2) (61.1) (5.1) (3.8) 3.9
Reorganization items (2) 23.2 --- --- --- --- ---
--------- --------- --------- --------- --------- ---------
(Loss) income
before income taxes (43.8) (149.2) (61.1) (5.1) (3.8) 3.9
(Benefit) provision
for income taxes 0.0 13.0 (19.1) (1.3) (1.9) 1.0
--------- --------- --------- --------- --------- ---------
(Loss) income before
extraordinary item(3) (43.8) (162.2) (42.1) (3.8) (2.0) 2.9
Extraordinary item(4) --- --- --- --- (4.5) ---
--------- --------- --------- --------- --------- ---------
Net (loss) income(3) ($43.8) ($162.2) ($42.1) ($3.8) ($6.5) $2.9
Balance sheet data
- ------------------
Working capital
(deficiency)/excess excl.
Liabilities subject to
compromise in 1996(5) 83.7 ($13.2) $4.9 ($0.5) ($30.7)
Total assets(5) 168.5 197.7 351.4 374.4 225.7
Liabilities subject to
Compromise 278.9 --- --- --- ---
Long-term debt
(including current
portion, excluding long-
term debt deemed subject
to compromise)(5)(6) 4.2 167.4 175.1 185.1 110.0
Total shareholder's
(deficit)/equity (7) (156.3) (112.4) 50.0 62.5 3.7
Other information
- -----------------
Ratio of earnings to
fixed charges(8) (9) (9) (9) 0.80x 0.60x 1.11x
(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) See Item 7 "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Results of Operations."
(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 reclassified to conform to current
classifications.
(6) Includes convertible subordinated debentures for all fiscal years through
1995. For fiscal year 1996, convertible subordinated debentures are
included in liabilities subject to compromise.
(7) There were no cash dividends declared during any of the periods presented
above, except for cash dividends in the amount of $.2 million, $.5 million
and $.3 million paid to WEI, the Company's sole stockholder, in fiscal
years 1995, 1994 and 1992, 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) A ratio of earnings to fixed charges is not presented as the pre-tax
loss, exclusive of fixed charges, was $(7.3) million, $(111.1) million
and $(23.1) million in fiscal year 1996, 1995 and 1994, respectively.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Year Ended January 31, 1996 Compared to Year Ended January 31, 1995
Revenues were $433.2 million and $499.6 million for the fiscal years ended
January 31, 1996 and January 31, 1995, respectively. This decrease of $66.4
million was principally due to a 12.2% decrease in same-store revenues (stores
open for at least 13 months) and the closing of 53 stores during the year.
Merchandise sales were $350.7 million and $409.5 million during the fiscal
years ended January 31, 1996 and 1995, respectively, representing an aggregate
decrease of 14.4% and a decrease of 13.0% on a same-store basis. (See table in
Item 1 -- "Business - Merchandise Products and Supply.") The decrease in
same-store merchandise sales was principally due to decreased customer
traffic caused by a lack of new, "hit" release music product, continued
competitive and economic pressures in certain of the Company's markets and
in the opinion of the Company, a shift in consumer spending from traditional
entertainment products to home computer hardware and software products.
Rental revenue includes the rental of videocassettes, video games and game
players, audiocassette books and laser discs. At January 31, 1996 approximately
81% of the Company's stores offered videocassettes and other products for rent
versus approximately 76% at January 31, 1995. Rental revenue for the fiscal
year ended January 31, 1996 was $82.5 million, a decrease of 8.4% from the
previous fiscal year and a decrease of 8.7% on a same-store basis. The Company
believes that decreases in both total and same-store rental income are
attributable to a number of factors, including the difficulties resulting from
the Company's liquidity problems in attempting to purchase large quantities of
certain "hit" titles, a lack of "hit" releases in all rental categories,
continued competition and a general softening in rental consumer spending
nationwide.
The Company believes that in the future its business and same-store
revenues may be impacted by various competitive and economic factors, including,
but not limited to, consumer tastes, new releases of music, videocassette and
video game titles available for sale or rental, and general economic trends
impacting retailers and consumers. In addition, in recent years the Company's
merchandise sales and rental revenues have been impacted by increased
competition from other music and video specialty retail chains, as well as
discounters and mass merchandisers. Further, future revenues may be reduced as
a result of the closure of 53 stores in fiscal 1996 and 19 stores in fiscal
1997, and as a result of the closure of any additional stores that may be
approved by the court during the remainder of the bankruptcy case.
The Company's business is seasonal, and as is typical for most retailers,
its revenues tend to peak during the Christmas holiday season. See
"Seasonality", below.
Cost of sales decreased $32.3 million to $230.3 million for the fiscal year
ended January 31, 1996, as compared with $262.6 million for the fiscal year
ended January 31, 1995. As a percentage of merchandise sales revenues, cost of
sales increased 1.6% to 65.7% for the fiscal year ended January 31, 1996 versus
64.1% for the fiscal year ended January 31, 1995. The gross profit percentage
for merchandise sale product was 34.3% and 35.9% for the fiscal years ended
January 31, 1996 and 1995, respectively. The 1.6% increase in cost of sales as
a percentage of merchandise sales revenues was principally due to increased
costs attributable to merchandise returns and inventory shrink, and decreased
prompt payment discounts on merchandise inventory purchases as a result of the
bankruptcy filing.
Cost of rentals, including amortization, increased $5.0 million to $40.0
million for the fiscal year ended January 31, 1996, as compared with $35.0
million for the fiscal year ended January 31, 1995. As a percentage of
rental revenue, cost of rentals increased to 48.5% for the fiscal year ended
January 31, 1996 from 38.8% for the fiscal year ended January 31, 1995, an
increase of 9.7%. The gross profit percentage for rental revenue was 51.5%
and 61.2% for the fiscal years ended January 31, 1996 and 1995, respectively.
The 9.7% increase in cost of rentals, including amortization, is primarily
attributable to costs related to increased sales of used rental inventory and
to a lesser extent, higher rental inventory shrinkage. Sales of used rental
inventory increased over last year as a byproduct of the Company's strategy
of carrying more rental "hit" titles. The sale of used rental product yields
lower margins than the rental of such product.
Merchandise sales, as a percentage of aggregate net revenues, decreased
from 82.0% in the fiscal year ended January 31, 1995 to 81.0% in the fiscal year
ended January 31, 1996. Should the shift in product mix from lower margin
merchandise sales to higher margin rental revenue continue, it can be expected
that the change in the mix of revenue contribution could have an impact on
profitability.
Several major retail chains, including Best Buy, Blockbuster Entertainment,
Hollywood Entertainment and Virgin Megastores increased their retail store
presence in the Company's markets. This trend is expected to continue and it is
anticipated that the Company will in future periods experience increased
competition from companies with greater financial resources than its own, and
that such competition may result in continued pressure on revenues and gross
profit margins.
Selling, general and administrative expenses, excluding amortization of
purchase price adjustments resulting from acquisitions, were $167.9 million and
$185.3 million for the fiscal years ended January 31, 1996 and 1995,
respectively, a decrease of $17.4 million, or 9.4%. As a percentage of
aggregate net revenues, selling, general and administrative expenses, excluding
amortization of purchase price adjustments, were 38.8% and 37.1% for the fiscal
years ended January 31, 1996 and 1995, respectively, an increase of 1.7%. The
change was primarily due to increases as a percentage of revenue, in rent and
other occupancy costs, and to a lesser extent, payroll and advertising expense.
Reductions in absolute dollars may occur in rent and occupancy costs during the
bankruptcy case as a result of the rejection of certain real property leases.
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 the net assets acquired
(or "goodwill") due to an impairment in the carrying value. Accordingly,
no goodwill amortization has been included in selling, general and
administrative expenses during the year ended January 31, 1996
while $3.7 million has been included during the year ended January 31, 1995.
The Company has evaluated the ongoing value of its equipment and
improvements on a store-by-store basis during fiscal year 1996 as required by
Statement No. 121 above. Based on this evaluation, the Company determined that
store equipment and improvements with a carrying amount of $1.8 million were
impaired and wrote them down by $1.5 million to their fair value. Fair value
was based on estimated future cash flows to be generated by the individual
stores, discounted at a market rate of interest.
The loss from operations was $5.9 million for the fiscal year ended January
31, 1996, as compared with a loss of $126.2 million for the fiscal year ended
January 31, 1995. The decrease in the operating loss resulted primarily from a
decrease in the amount of write-down of long-lived assets of $138.0 million.
Excluding the effect of the write-down of long-lived assets in both fiscal
years, loss from operations would have been $4.4 million for fiscal year ended
January 31, 1996 as compared to income from operations of $13.3 million for
fiscal year ended January 31, 1995, a decrease of $17.7 million.
Interest expense (net of interest income) decreased $8.3 million to $14.7
million for the year ended January 31, 1996 versus $23.0 million for the
year-ended January 31, 1995. The decrease was primarily due to the
suspension of the accrual of interest on the Revolving Line of Credit,
Variable Rate Term Note, 13% Subordinated Notes and 6 1/4% Convertible
Subordinated Debentures following the filing of Chapter 11.
Reorganization items include costs related to the bankruptcy case including
professional fees for legal and financial advisors, costs related to the closing
of stores, and the estimated cost associated with the rejection of certain
executory contracts. For the year, the Company reported total reorganization
items of $23.2 million which is comprised of $2.5 million of professional fees,
$6.2 million related to the closing of stores, $6.0 million associated with the
rejection of certain executory contracts and $8.5 million connected with the
write off of financing costs and debt discounts. Reorganization items are
expected to continue in the future periods as a result of the bankruptcy case.
The Company recorded a small income tax provision of $17 thousand for year
ended January 31, 1996 versus a tax provision of $13.0 million for year ended
January 31, 1995. While the Company experienced a pre-tax loss in fiscal 1996,
it was unable to record a tax benefit because of an offsetting increase in the
valuation allowance for deferred tax assets. Although such tax assets are
available to reduce taxes payable, historical losses in fiscal years 1995 and
1996 and a projected tax loss for fiscal year 1997 necessitated the increase in
the reserve allowance.
Based upon the current operations of the Company, and other factors, the
Company anticipates that net pre-tax losses, if any, which may be realized
during the fiscal year ending January 31, 1997 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
reduce any future taxes payable under applicable Internal Revenue Service and
state regulations should the Company generate future taxable income.
The Company is currently under audit by the Internal Revenue Service for
tax years January 31, 1993, 1994 and 1995, and by the California Franchise Tax
Board for tax years January 31, 1992, 1993 and 1994. The Company believes that
it has made adequate provision in the financial statements for these two audits.
Year Ended January 31, 1995 Compared to Year Ended January 31, 1994
Net revenues were $499.6 million and $471.8 million for the fiscal years
ended January 31, 1995 and January 31, 1994, respectively. This increase of
$27.8 million was principally due to a 3.4% increase in same-store revenues
(stores open for at least 13 months) and the full year of revenues in fiscal
year 1995 from the stores acquired in fiscal year 1994 from The Record Shop,
Inc. and from Pegasus Music and Video, Inc. During the fiscal year ended
January 31, 1995, the Company opened 4 new stores, expanded or remodeled 95
stores and closed 4 stores.
Merchandise sales were $409.5 million and $380.2 million during the fiscal
years ended January 31, 1995 and 1994, respectively, representing an aggregate
increase of 7.7% and an increase of 4.2% on a same-store basis. (See table in
Item 1 -- "Business - Merchandise Products and Supply.") The increase in
same-store merchandise sales resulted principally from increased sales of
compact discs, used compact discs and videocassettes. 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.
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 videocassettes and other products for rent.
Rental revenue for the fiscal year ended January 31, 1995 was $90.1 million, a
decrease of 1.6% from the previous fiscal year but an increase of .2% on a
same-store basis. Decreases in the rental of videocassettes and games were
partially offset by increases in the sales of previously viewed rental
inventory. Same-store rental revenue increased 6.0% in the quarter ended
January 31, 1995 as compared to the quarter ended January 31, 1994, largely due
to a price increase implemented in December 1994 as well as the maintenance of a
higher inventory of "hit" videocassettes.
Cost of sales increased $14.6 million to $262.6 million for the fiscal year
ended January 31, 1995, as compared with $248.0 million for the fiscal year
ended January 31, 1994. As a percentage of merchandise sales revenues, cost of
sales decreased 1.1% to 64.1% for the fiscal year ended January 31, 1995 versus
65.2% for the fiscal year ended January 31, 1994. The gross profit percentage
for merchandise sale product was 35.9% and 34.8% for the fiscal years ended
January 31, 1995 and 1994, respectively. The 1.1% decrease in cost of sales as
a percentage of merchandise sales revenues resulted principally from decreased
costs associated with inventory shrinkage and other book-to-physical
adjustments, and decreased costs attributable to merchandise returns.
Cost of rentals, including amortization, decreased $15.8 million to $35.0
million for the fiscal year ended January 31, 1995, as compared with $50.8
million for the fiscal year ended January 31, 1994. As a percentage of rental
revenue, cost of rentals decreased to 38.8% for the fiscal year ended January
31, 1995 from 55.5% for the fiscal year ended January 31, 1994, a decrease of
16.7%. The gross profit percentage for rental revenue was 61.2% and 44.5% for
the fiscal years ended January 31, 1995 and 1994, respectively. The 16.7%
decrease in cost of rentals, including amortization, as a percentage of rental
revenues was principally due to a change in accounting estimate for amortizing
the cost of video rental inventory that was implemented in the fiscal year 1994
that resulted in a $20.3 million charge (22.2% of rental revenue) to reduce the
net carrying value of existing rental inventory at January 31, 1994, and to a
lesser extent decreased shrinkage and obsolescence in fiscal year 1995.
Offsetting these decreases were increased amortization, as a percentage of
rental revenue, of 5.2%, due to increased videocassette purchases to support
higher rental revenues and an increase in the write-off of net book value of
rental dispositions resulting from the sale of older rental inventory.
Merchandise sales, as a percentage of aggregate net revenues, increased
from 80.6% in the fiscal year ended January 31, 1994 to 82.0% in the fiscal year
ended January 31, 1995.
Selling, general and administrative expenses, excluding $3.4 million and
$8.9 million for the amortization of purchase price adjustments resulting from
acquisitions, were $185.3 million and $187.7 million for the fiscal years ended
January 31, 1995 and 1994, respectively, a decrease of $2.4 million, or 1.3%.
As a percentage of aggregate net revenues, selling, general and administrative
expenses, excluding amortization of purchase price adjustments, were 37.1% and
39.8% for the fiscal years ended January 31, 1995 and 1994, respectively, a
decrease of 2.7%. The 2.7% decrease was principally due to reductions in
payroll expense, depreciation expense and occupancy costs. The decrease in
occupancy costs was primarily due to decreases in the non-cash provisions for
the straight-line effect of scheduled future rent increases.
In connection with the adoption of 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), the Company evaluated
the carrying value of the excess cost over the fair value of net assets acquired
(or "goodwill") and fixed assets. Significant adverse changes in the Company's
business climate became apparent at the end of fiscal year 1995 and continued to
be evidenced by increased competition and erosion of revenues and gross margins
subsequent to year-end, which led to recent operating results and forecasted
future results that were less than previously planned. These factors led to the
conclusion that there was a potential impairment in the recorded value of
goodwill and fixed assets. Accordingly, the Company wrote off the remaining
goodwill balance of $139.5 million at January 31, 1995 as an impairment in
carrying value. The annual amortization of goodwill included in selling,
general and administrative expenses was $3.7 million and $3.6 million in fiscal
years 1995 and 1994, respectively.
The loss from operations was $126.2 million for the fiscal year ended
January 31, 1995, as compared with a loss of $37.9 million for the fiscal year
ended January 31, 1994. The increase in operating loss resulted primarily from
the above described write-off of goodwill. Excluding the non-cash effects of
purchase accounting in both fiscal years and excluding both the change in
estimate for amortizing video rental inventory and the restructuring charges
(described below) in the fiscal year ended January 31, 1994 and the goodwill
impairment in the fiscal year ended January 31, 1995, income from operations
would have been $16.7 million for the fiscal year ended January 31, 1995
compared to $8.4 million for the fiscal year ended January 31, 1994, an increase
of $8.3 million.
Interest expense (net) decreased $0.2 million to $23.0 million, as compared
with $23.2 million, for the fiscal years ended January 31, 1995 and 1994,
respectively. The decrease resulted primarily from lower overall debt levels
offset by higher interest rates on floating rate debt. Included in interest
expense are $1.9 million and $1.7 million attributable to the amortization of
acquisition financing costs during the fiscal years ended January 31, 1995 and
1994, respectively.
The tax provision recorded by the Company on its loss before income taxes
was $13.0 million, or 8.7% of its loss before income taxes, in fiscal year 1995
versus an effective tax benefit of $19.1 million, or 31.2% of its loss before
income taxes in fiscal year 1994. The increase in tax expense resulted
primarily from an increase in the valuation allowance for deferred tax assets.
While such tax assets are available to reduce future taxes payable, historical
tax losses in fiscal years 1994 and 1995 and a projected tax loss for fiscal
year 1996 necessitated the increase in the reserve allowance. As a result of
available net operating loss carrybacks, the Company received a $1.3 million
federal income tax refund during the third quarter of the year ended January 31,
1996.
LIQUIDITY AND CAPITAL RESOURCES
During the fiscal year ended January 31, 1996, the Company's net cash
provided by operating activities declined by $21.7 million (from $11.1
million provided in fiscal year ended 1995 to $10.6 million used in fiscal
year ended 1996) after giving consideration to a reduction in accounts
payable, accrued expenses and other liabilities not separately identified of
$22.0 million. In addition, as a result of the change in vendor terms during
the year, the Company recorded prepaid inventory deposits at January 31, 1996
of $10.9 million which also contributed to the decrease in cash provided by
operating activities. Offsetting the above items was a reduction of $26.7
million and changes in certain other items of $15.5 million.
It should be noted that the payment of a number of obligations has been
deferred as a result of the bankruptcy filing.
Cash used in investing activities totaled $10.7 million as compared to
$16.1 million for the fiscal years ended January 31, 1996 and January 31, 1995,
respectively. Acquisitions of property, equipment and improvements were $10.3
million during the fiscal year ended January 31, 1996 as compared to $15.7
million in 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 year 1995, the acquisition of new
point-of-sale platforms for the stores.
Cash provided by financing activities increased by $22.9 million to $26.7
million during the year ended January 31, 1996 from $3.8 million during the year
ended January 31, 1995 principally due to increased short-term borrowings under
the Company's $45.0 million revolving line of credit. The increased borrowings
were primarily the result of decreased revenues and margins and changes in
credit terms prior to the bankruptcy filing.
The Company's institutional indebtedness currently includes the following:
i) the Revolving Line of Credit, Variable Rate Term Note, 13% Senior
Subordinated Notes and 6 1/4% Convertible Subordinated Debentures.
As a result of the bankruptcy filing and other events, the Company,
and, as applicable, WEI, are each currently in default under various agreements
governing the above debt. As a result, all unpaid principal of, and accrued
pre-petition interest on, such debt has become "Subject to Compromise" and has
been classified as such on the Company's balance sheet. The payment of such
debt and accrued but unpaid interest thereon is prohibited during the pendency
of the Company's Chapter 11 case other than pursuant to a court order.
As of January 31, 1996, the total principal and interest related to the
above debt was $207.5 million and $8.5 million, respectively. The ultimate
outcome of the aforementioned debt will be determined during the bankruptcy
case.
ii) revolving line of credit (DIP facility) in the amount of $30.0
million, which includes a letter of credit subfacility of $10.0 million.
Borrowings under the facility bear interest at the Company's option, at
either: (a) the Base Rate (defined as the higher of the Prime Rate or the
Federal Funds Effective Rate plus 1/2%) plus 1%; or (b) the Eurodollar Rate
plus 2.75%. The Company had no outstanding borrowings against the DIP
facility at January 31, 1996. At January 31, 1996, the Company had $0.4
million of letters of credit outstanding. The Company is subject to various
financial and other covenants under the terms of the DIP facility including,
among other things, minimum EBITDAV (as defined) and limitations on
indebtedness, investments, payments of indebtedness and capital expenditures.
As of January 31, 1996, the Company was in compliance with all financial
covenants required by this facility or had obtained appropriate waivers. The
facility is available through the earlier of September 1, 1997 or the
effective date of a plan of reorganization.
Management believes that the current DIP borrowing facility is adequate to
support the upcoming fiscal year. However, there can be no assurance as to the
effect which any future changes in the Company's operations or results could
have on its liquidity.
SEASONALITY
The Company's business is seasonal, and revenues and operating income are
highest during the fourth quarter. Working capital deficiencies and related
bank borrowings 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 expenditures for new stores and the building of inventory for
the holiday season.
INFLATION
The Company believes that inflation has not had a material effect on its
results of operations and its internal and external sources of liquidity and
working capital. However, interest rate increases, beyond current levels, could
have an impact on the Company's operations.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Index to Financial Statements and Financial Statement Schedules
appearing on page F-0 of this report.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth certain information concerning
the persons who are directors and executive officers of the
Company:
Age at
April 30,
Name Position 1996
- ----------------- --------------------------------- -----
Jerry E. Goldress Chief Executive Officer, Chairman 65
of the Board and Director
Barbara C. Brown Senior Vice President, Sales and 44
Operations
Stephen P. Brown Senior Vice President, General 38
Merchandise Manager
Henry Del Castillo Senior Vice President, Chief 57
Financial Officer and Secretary
Michael T. Buskey Vice President, Regional Manager 47
James J. Burke, Jr. Director 44
Gerald S. Armstrong Director 52
Rupinder S. Sidhu Director 39
Bradley J. Hoecker Director 34
Jerry E. Goldress, Chief Executive Officer, Chairman of the Board and
Director of the Company and WEI. Mr. Goldress originally joined the Company in
February 1988. Mr. Goldress was Chairman of the Board of the Company from
February 1988 to June 1992 and Chief Executive Officer of the Company from
February 1988 to March 1990. Mr. Goldress was a Director of the Company from
January 1988 to June 1992. Mr. Goldress returned to the Company in August 1993
as President and Chief Operating Officer. In June 1994, Mr. Goldress assumed
the position of Acting Chief Financial Officer. On March 1, 1995, Mr. Goldress
was elected Chief Executive Officer, Chairman of the Board and Director of the
Company and WEI. Mr. Goldress is currently Chairman of Grisanti, Galef &
Goldress, Inc. (a management consulting firm) and has been employed by that
company since 1973. All positions with the Company which have been, and which
currently are, held by Mr. Goldress have been pursuant to consulting agreements
with Grisanti, Galef & Goldress, Inc. Mr. Goldress has been a general partner
of A&S since 1987. He is a Director of Dreco Energy Services Ltd., Applied
Magnetics, Inc., and K2, Inc. As a management consultant, Mr. Goldress provides
assistance to businesses in financial difficulty and, in the course of providing
such assistance, is frequently appointed a director and an executive officer of
such businesses. Often such businesses are involved in bankruptcy or other
reorganization proceedings.
----------------
Barbara C. Brown, Senior Vice President, Sales and Operations
of the Company. Ms. Brown joined the Company in 1973.
She became Vice President, Sales and Operations in 1986 and was
promoted to Senior Vice President in 1991. Prior to 1986, Ms.
Brown served in a variety of store operations positions including
Store Manager, District Manager, Assistant Vice President, Store
Operations, and Associate Vice President, Store Operations. Ms. Brown is the
spouse of Mr. Stephen P. Brown, Senior Vice President, General Merchandise
Manager.
----------------
Stephen P. Brown, Senior Vice President, General Merchandise Manager of the
Company. Mr. Brown joined the Company in 1980. He became Vice President,
Merchandise Allocation and Distribution in 1993 and was promoted to Senior Vice
President, General Merchandise Manager in 1994. Prior to 1993, Mr. Brown served
in a variety of store operations positions including Store Manager, District
Manager, Regional Manager, and Assistant Vice President, Store Operations. Mr.
Brown is the spouse of Ms. Barbara C. Brown, Senior Vice President, Sales and
Operations.
----------------
Henry Del Castillo, Senior Vice President, Chief Financial Officer and
Secretary of the Company. Mr. Del Castillo joined the Company in August 1995,
following a twenty year career as a financial executive and Chief Financial
Officer of Powerine Oil Company. Previously, he served as Chief Financial
Officer of Carte Blanche Corporation, an international credit card and travel
services provider.
----------------
Michael T. Buskey, Vice President, Regional Manager for the Company. Mr.
Buskey joined the Company in 1993. Prior to his current position he was General
Manager for Circuit City Stores, Inc.
----------------
James J. Burke, Jr., Director of the Company and WEI since June 1992. Mr.
Burke has been Managing Partner and Director of Stonington Partners, Inc.
("SPI") since 1993, and is a consultant to MLCP. Mr. Burke has also been a
Director of MLCP since 1987 and was a Managing Partner of MLCP from 1993 to
1994, and President of MLCP from 1987 to 1994. Mr. Burke was a Vice President
of Merrill Lynch Pierce Fenner & Smith Incorporated ("MLPF&S") from 1983 until
1988 and was a First Vice President from 1988 to July 1994 and a Managing
Director of MLPF&S from 1985 to July 1994. Mr. Burke is a director of Amstar
Corporation, Borg-Warner Security Corporation, Supermarkets General Holdings
Corporation, AnnTaylor Stores Corporation, Pathmark Stores, Inc., and United
Artists Theater Circuit, Inc.
Gerald S. Armstrong, Director of the Company and WEI since April 1993. Mr.
Armstrong has been a Partner and Director of SPI since 1993 and is a consultant
to MLCP. Mr. Armstrong has been a Director of MLCP since 1988, and was an
Executive Vice President of MLCP from 1988 until 1993, and a Partner of MLCP
from 1993 to July 1994. Mr. Armstrong was a Managing Director of the Investment
Banking Division of MLPF&S from November 1988 to July 1994. From January to
November 1988, he was President and Chief Executive Officer of Printing Finance
Company, Inc., a printing company, and from March 1985 to January 1988, he was
Executive Vice President and Chief Operating Officer of PACE Industries, Inc., a
manufacturing and printing company. Mr. Armstrong is also a Director of
AnnTaylor Stores Corporation, Beatrice Foods, Inc., First USA, Inc., Blue Bird
Corporation, and World Color Press, Inc.
Rupinder S. Sidhu, Director of the Company and WEI. Mr. Sidhu has been a
partner of SPI since 1993 and is a consultant to MLCP. Mr. Sidhu has also been
a Director of MLCP since 1987, was a Senior Vice President of MLCP from 1987
until 1993 and was a Partner of MLCP from 1993 to July 1994. Mr. Sidhu was a
Managing Director of MLPF&S from 1989 to July 1994, and was a Vice President of
MLPF&S from 1984 until 1988. Mr. Sidhu is a Director of Eckerd Corporation,
Clinton Mills, Inc., First USA Bank, First USA, Inc. and First USA Paymentech,
Inc.
Bradley J. Hoecker, Director of the Company and WEI. Mr. Hoecker has been
a Principal of SPI since 1993 and is a consultant to MLCP. Mr. Hoecker was a
Principal of MLCP from 1993 to July 1994. Mr. Hoecker was an Associate of MLCP
from 1989 to 1993 and of MLPF&S from 1989 to July 1994. From 1984 to 1987, Mr.
Hoecker was employed by Bankers Trust Company.
Each director of the Company and WEI is elected annually and
serves until the next annual meeting or until his successor is
duly elected and qualified. Messrs. Armstrong, Sidhu, and Hoecker serve as
members of the audit committees and Messrs. Burke, Armstrong and Sidhu serve as
members of the compensation committees of the board of directors of the Company
and WEI. Each executive officer of the Company and WEI serves at the discretion
of the board of directors of the Company and WEI, respectively.
Under the Stockholders' Agreement (See Item 13 of this Annual Report), if
any of the directors are unwilling or unable to serve, or otherwise cease to
serve, as directors of WEI, then the shareholders of WEI controlled by or
affiliated with MLCP or one of its affiliates (the "ML Investors") will be
entitled to fill the resulting vacancies on the board. In addition, the
Stockholders' Agreement provides that the ML Investors are entitled to nominate
successors to all WEI directors and that the stockholders of WEI will cooperate
in any removal of directors proposed by the ML Investors.
Item 11. EXECUTIVE COMPENSATION.
SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION
The following table sets forth, for the fiscal years ended
January 31, 1996, January 31, 1995, and January 31, 1994, the
cash compensation paid by WEI and its subsidiaries, as well as
certain other compensation paid or accrued for each such fiscal
year, to each of the five most highly compensated executive
officers of WEI who were officers on January 31, 1996 (collectively, the "named
executive officers") in all capacities in which they served. All compensation
with respect to Mr. Goldress was paid to Grisanti, Galef & Goldress, Inc., a
management consulting firm in which Mr. Goldress is a principal.
SUMMARY COMPENSATION TABLE
Long-Term
Annual Compensation Compensation
--------------------------------- -------------
Other Annual No. of Sec. All Other
Name and Fiscal Salary Bonus Compensation Underlying Compensation
Principal Position Year ($) ($) ($) (f) Options ($)
- ----------------------------------------------------------------------------------------------
Jerry E. Goldress (a) 1996 445,883 50,000 --- --- ---
Chairman, Chief 1995 375,000 --- --- --- ---
Executive Officer 1994 100,000 --- --- --- 150,000 (g)
Barbara C. Brown 1996 171,538 16,000 7,200 (f) --- 6,847 (h)
Senior Vice President, 1995 165,000 11,257 (b) 7,200 (f) --- 7,212 (I)
Sales and Operations 1994 155,625 11,257 (c) 7,200 (f) --- 23,191 (j)
Stephen P. Brown 1996 159,808 16,000 7,200 (f) --- 4,613 (k)
Senior Vice President, 1995 114,615 1,499 (d) 7,200 (f) --- 4,242 (l)
General Merchandise 1994 84,629 1,499 (e) 2,492 (f) --- 15,219 (m)
Manager
Henry Del Castillo 1996 80,769 0 3,321 (f) 0 18,375 (n)
Senior Vice President, 1995 0 0 0 0 0
Chief Financial 1994 0 0 0 0 0
Officer and Secretary
Michael T. Buskey 1996 132,685 1,154 7,200 (f) 0 2,470 (o)
Vice President, 1995 106,962 21,962 7,200 (f) 0 1,930 (p)
General Manager - 1994 102,846 25,000 7,200 (f) 0 1,283 (q)
Los Angeles Division
(a) Mr. Goldress was elected Chairman and Chief Executive Officer on March 1,
1995. During all of fiscal 1995 and until March 1, 1995, he served as
President and Chief Operating Officer. From June 1994 until March 1, 1995,
he served as Acting Chief Financial Officer.
(b) Includes an $11,257 bonus to cover interest expense on Ms. Brown's
Management Note (see Item 13, below), with a "gross-up" to cover income
taxes related to the bonus.
(c) Includes an $11,257 bonus to cover interest expense on Ms. Brown's
Management Note (see Item 13, below), with a "gross-up" to cover income
taxes related to the bonus.
(d) Includes a $1,499 bonus to cover interest expense on Mr. Brown's Management
Note (see Item 13, below), with a "gross-up" to cover income taxes related
to the bonus.
(e) Includes a $1,499 bonus to cover interest expense on Mr. Brown's Management
Note (see Item 13, below), with a "gross-up" to cover income taxes related
to the bonus.
(f) Includes payment of an auto allowance to the named executive officer at a
rate of $600 per month.
(g) Includes payments made to Mr. Goldress's consulting company for services
related to the 1994 Re-engineering Plan.
(h) Includes $3,236 paid on behalf of Ms. Brown and her family for medical
expenses not covered by the Company's group medical insurance plan. Also
included are $1,828 of premiums paid for term life insurance and $1,783 for
matching contributions to the Company's 401(k) plan made on behalf of Ms.
Brown.
(i) Includes $3,622 paid on behalf of Ms. Brown and her family for medical
expenses not covered by the Company's group medical insurance plan. Also
included are $1,828 of premiums paid for term life insurance and $1,763 for
matching contributions to the Company's 401(k) plan made on behalf of Ms.
Brown.
(j) Includes $19,685 paid on behalf of Ms. Brown and her family for medical
expenses not covered by the Company's group medical insurance plan. Also
included are $1,828 of premiums paid for term life insurance and $1,678 for
matching contributions to the Company's 401(k) plan made on behalf of Ms.
Brown.
(k) Includes $179 paid on behalf of Mr. Brown and his family for medical
expenses not covered by the Company's group medical insurance plan. Also
included are $2,772 of premiums paid for term life insurance and $1,661 for
matching contributions to the Company's 401(k) plan made on behalf of Mr.
Brown.
(l) Includes $1,032 paid on behalf of Mr. Brown and his family for medical
expenses not covered by the Company's group medical insurance plan. Also
included are $2,079 of premiums paid for term life insurance and $1,131 for
matching contributions to the Company's 401(k) plan made on behalf of Mr.
Brown.
(m) Includes $14,273 paid on behalf of Mr. Brown and his family for medical
expenses not covered by the Company's group medical insurance plan. Also
included is $945 for matching contributions to the Company's 401(k) plan
made on behalf of Mr. Brown.
(n) Included is $18,375 of premiums paid for term life insurance made on
behalf of Mr. Del Castillo.
(o) Includes $1,091 paid on behalf of Mr. Buskey and his family for medical
expenses and $1,379 for matching contributions to the Company's 401(k) plan
made on behalf of Mr. Buskey.
(p) Includes $826 paid on behalf of Mr. Buskey and his family for medical
expenses not covered by the Company's group and $1,104 for matching
contributions to the Company's 401(k) plan made on behalf of Mr. Buskey.
(q) Includes $791 paid on behalf of Mr. Buskey and his family for medical
expenses not covered by the Company's group medical insurance plan and $492
for matching contributions to the Company's 401(k) plan made on behalf of
Mr. Buskey.
STOCK OPTIONS AND STOCK APPRECIATION RIGHTS
No Stock Options or Stock Appreciation Rights were granted in fiscal year
1996.
FISCAL YEAR-END OPTION VALUES
No options were exercised by any of the named executive officers during
fiscal 1996. The following table sets forth certain information with respect to
the named executive officers concerning the number of shares covered by both
exercisable and unexercisable stock options held as of January 31, 1996. No
market exists for WEI's Common Stock. The Company believes that at January 31,
1996, none of these options were "in-the-money options."
FISCAL YEAR-END OPTION VALUES
Number of Securities
Underlying
Unexercised Options
at Fiscal Year End
Name Exercisable Unexercisable
- --------------------------------------------------
Jerry E. Goldress 30,000 ---
Barbara C. Brown 9,900 3,600
Stephen P. Brown 1,213 522
Henry Del Castillo 0 0
Mike Buskey 0 0
COMPENSATION OF DIRECTORS
The directors of the Company and WEI do not receive compen-sation for their
services as directors or as members of the committees of the boards of directors
of the Company and WEI.
EMPLOYMENT AGREEMENTS
Jerry E. Goldress serves as Chairman of the Board, President and Chief
Executive Officer of the Debtors pursuant to an agreement dated May 11, 1994, as
amended on April 5, 1995 and on December 13, 1995, between Wherehouse and GGG,
Inc. (The "GGG Management Agreement"). Under the GGG Management Agreement, GGG
Inc. currently receives $450,000 annually as compensation for Mr. Goldress'
services which is guaranteed through October 31, 1997. In consultation with the
Official Committee, the Informal Committee and Bankers Trust, as agent,
Wherehouse amended the GGG Management Agreement on December 13, 1995 to, among
other things, provide a bonus to GGG, Inc. in the amount of $250,000 if a plan
is confirmed in the Chapter 11 Case prior to October 1, 1996.
In order to retain its key management employees during the period of
deteriorating financial condition and instability prior to the Filing Date, in
July of 1995, Wherehouse entered into agreements with 13 of its officers that
provide certain security in the event of a "Change of Control" and the
subsequent termination of such employee's employment or a significant reduction
in such employee's responsibilities (the "Change of Control Agreements"). Since
the Filing Date, Wherehouse has entered into Change of Control Agreements with
five additional officers. The Change of Control Agreements were approved by the
Bankruptcy Court on December 1, 1995. The above agreements call for payments of
up to $2.2 million should certain events (as defined) occur.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of the compensation committees of the Company's and WEI's
boards of directors are currently Messrs. Burke, Armstrong, and Sidhu.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.
THE COMPANY
The common stock of the Company is the only outstanding class of its voting
securities. WEI owns 10 shares, which represent 100% of the issued and
outstanding shares of the Company's common stock. WEI's only business interest
is its ownership of the Company. WEI's principal executive offices are located
at c/o Wherehouse Entertainment, Inc., 19701 Hamilton Avenue, Torrance,
California 90502-1334.
WEI
The Common Stock, par value $0.01 per share of WEI (the "WEI Common Stock")
is the only outstanding class of its voting securities. The following table
sets forth, as of January 31, 1996, the number and percentage of shares of WEI
Common Stock beneficially owned by (i) each person known to WEI to be the
beneficial owner of more than 5% of the outstanding shares of WEI Common Stock,
(ii) each director of the Company and WEI, (iii) each named executive officer,
and (iv) all directors and executive officers of the Company and WEI as a
group. Unless otherwise indicated in a footnote, each person listed below
possesses sole voting and investment power with respect to the shares
indicated as beneficially owned by them, subject to community property
laws where applicable.
[Need to Update]
Shares of Percentage
Name and Address WEI Common Of
of Beneficial Owner Stock Ownership
- ----------------------------------------------------------------------------------
Merrill Lynch Capital Partners, Inc.(1)(2) 1,820,458 77.1%
767 Fifth Avenue
New York, New York 10153
Merrill Lynch & Co., Inc.(1)(3) 452,269 19.2%
250 Vesey Street
North Tower - World Financial Center
New York, New York 10281
Jerry E. Goldress(4) 30,000 1.3%
Wherehouse Entertainment, Inc.
19701 Hamilton Avenue
Torrance, California 90502-1334
Barbara C. Brown(5) 21,147 0.9%
Wherehouse Entertainment, Inc.
19701 Hamilton Avenue
Torrance, California 90502-1334
Stephen P. Brown(6) 1,909 0.1%
Wherehouse Entertainment, Inc.
19701 Hamilton Avenue
Torrance, California 90502-1334
Henry Del Castillo(7) --- 0.0%
Wherehouse Entertainment, Inc.
19701 Hamilton Avenue
Torrance, California 90502-1334
Michael T. Buskey(7) --- 0.0%
Wherehouse Entertainment, Inc.
19701 Hamilton Avenue
Torrance, California 90502-1334
James J. Burke, Jr.(8) --- 0.0%
c/o Stonington Partners, Inc.
767 Fifth Avenue
New York, New York 10153
Gerald S. Armstrong(8) --- 0.0%
c/o Stonington Partners, Inc.
767 Fifth Avenue
New York, New York 10153
Rupinder S. Sidhu(8) --- 0.0%
c/o Stonington Partners, Inc.
767 Fifth Avenue
New York, New York 10153
Bradley J. Hoecker(8) --- 0.0%
c/o Stonington Partners, Inc.
767 Fifth Avenue
New York, New York 10153
All directors and executive officers
as a group(9) (13 persons) 202,829 8.2%
(1) Entities affiliated with Merrill Lynch & Co., Inc., including MLCP,
beneficially own an aggregate of 2,272,727 shares, which represents
approximately 96% of the outstanding WEI Common Stock at January 31, 1996.
(2) MLCP is a subsidiary of Merrill Lynch Group, Inc. which is wholly-owned by
Merrill Lynch & Co., both of which are affiliates of MLPF&S. Shares of WEI
Common Stock are beneficially owned by MLCP and owned of record (and
beneficially) as follows: 1,103,219 (46.6% of outstanding WEI Common Stock)
by Merrill Lynch Capital Appreciation Partnership No. B-XXI, L.P.; 699,062
(29%) by ML Offshore LBO Partnership No. B-XXI; and 18,177 (0.8%) by MLCP
Associates L.P. No. II. MLCP is the indirect managing general partner of
Merrill Lynch Capital Appreciation Partnership No. B-XXI, L.P. and ML
Offshore LBO Partnership No. B-XXI and the general partner of MLCP
Associates L.P. No. II. The address for Merrill Lynch Capital Appreciation
Partnership No. B-XXI, L.P. and MLCP Associates L.P. No. II is c/o MLCP,
767 Fifth Avenue, New York, New York 10153. The address for ML Offshore
LBO Partnership No. B-XXI is P. O. Box 25, Roseneath, The Grange, St. Peter
Port, Guernsey Channel Island, British Isles.
(3) Shares of WEI Common Stock beneficially owned by Merrill Lynch & Co., Inc.,
excluding shares beneficially owned by MLCP as set forth in note (2) above,
are owned of record (and beneficially) as follows: 429,542 (18.2% of
outstanding WEI Common Stock) by ML IBK Positions, Inc.; and 22,727 (1%) by
Merrill Lynch KECALP L.P. 1991. The address for each such record holder is
250 Vesey Street, North Tower - World Financial Center, New York, New York
10281.
(4) Mr. Goldress' options have been granted pursuant to an agreement dated
January 17, 1995 by and between Mr. Goldress and WEI. The options are non-
qualified and have not been issued pursuant to the WEI Management Stock
Option Plan. Mr. Goldress' options are fully vested and exercisable, and
the term of the options expire on October 1, 2003.
(5) Includes 9,900 shares subject to vested options under the WEI Management
Stock Option Plan which are currently exercisable. Also includes 1,990
shares which are referred to as "Unvested WEI Common Stock" in Item 13 of
this Annual Report and 2,274 shares pledged to WEI as security for Ms.
Brown's Management Note (see Item 13 of this Annual Report).
(6) Includes 1,213 shares subject to vested options under the WEI Management
Stock Option Plan which are currently exercisable. Also includes 134
shares which are referred to as "Unvested WEI Common Stock" in Item 13 of
this Annual Report and 302 shares pledged to WEI as security for Mr.
Brown's Management Note (see Item 13 of this Annual Report).
(7) Messrs. Buskey and Del Castillo are officers of the Company and WEI and do
not own any shares of WEI Common Stock.
(8) Messrs. Burke, Armstrong, Sidhu and Hoecker are directors of the Company
and WEI. Messrs. Burke, Armstrong and Sidhu are each directors of MLCP and
may be deemed to beneficially own all of the 1,820,458 shares of Common
Stock beneficially owned by MLCP. Furthermore, MLCP is part of a group of
affiliates of Merrill Lynch & Co. that beneficially owns 2,272,727 shares
of the Company's common stock. Messrs. Burke, Armstrong, and Sidhu each
disclaim beneficial ownership of these shares.
(9) Includes 84,827 shares subject to vested options under the WEI Management
Stock Option Plan which are currently exercisable, and 30,000 shares
subject to non-qualified vested options which are currently exercisable.
Includes 15,078 shares which are referred to as "Unvested WEI Common Stock"
in Item 13 of this Annual Report, and 15,008 shares pledged to WEI as
security for Management Notes.
Certain common stock and stock options mentioned above in regards to
current executive officers and directors may not have any value in the future as
a result of the bankruptcy filing. The ultimate outcome of the above-mentioned
items will be determined during the bankruptcy case.
PLEDGE OF COMMON STOCK AND ASSETS OF THE COMPANY
As security for the term facility and the revolving credit facility under
the Bank Credit Agreement (see Item 7 of this Annual Report), the lenders
thereunder have been granted (i) a first priority pledge by WEI of the capital
stock of the Company and (ii) a first priority lien on all or substantially all
of WEI's and the Company's assets other than sale inventory, except that
mortgages on the real property and leaseholds owned, directly or indirectly, by
the Company have not been granted and will be granted by the Company only as
requested by Agent and Requisite Lenders (as defined in the Bank Credit
Agreement). In addition, the Company is prohibited from granting a security
interest on any of its unencumbered assets.
Bankers Trust has asserted that their lien extends to sale inventory. The
Company denies this assertion and has filed an adversary proceeding seeking a
determination on this issue. See (i) of Item 3, Part I.
If the Company fails to repay any of its outstanding indebtedness to the
lenders under the Bank Credit Agreement or if any other event of default should
occur under the Bank Credit Agreement, the Banks may, among other things,
foreclose on their security interest in the Company's capital stock and acquire
control of the Company.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
In connection with the Acquisition described in Item 1 of this Annual
Report, certain members of management (the "Management Investors") executed new
non-recourse notes in exchange for notes originally executed by them in
connection with their purchases of shares of WEI prior to the Acquisition. The
following table sets forth the outstanding principal balance of the notes of
each of the named executive officers (the "Management Notes"), which amounts
have remained unchanged since the beginning of the last fiscal year. The
Management Notes bear interest at the rate of 7% per annum:
Name Principal Balance
Barbara C. Brown 99,867
Stephen P. Brown 13,300
To secure repayment of the Management Notes, each maker pledged to WEI the
number of shares of WEI Common Stock purchased by such maker with an original
purchase price greater than or equal to 100% of the original principal amount of
such maker's Management Note.
Under a Stockholders' Agreement among WEI, certain Management Investors and
certain other shareholders of the Company, a portion of the WEI Common Stock
owned by the Management Investors is deemed to be "unvested" (the "Unvested WEI
Common Stock"), and is currently held by WEI in trust for the benefit of the
Management Investors.
In connection with the Acquisition, approximately $18.75 million of the
Merger consideration was deferred, and is subject to reduction to the extent
that the Company incurs certain litigation costs, including costs relating to
the McMahan, Thompson and Silverman actions described in Item 3 of this Annual
Report. Currently, the balance of this deferred account (including interest
thereon), net of costs incurred to date, approximates $19.3 million. Under the
Stockholders' Agreement, "vesting" of the Unvested WEI Common stock will be
based upon the percentage of such deferred amount which is actually paid to the
selling parties in the Merger.
The Stockholders' Agreement provides that any shares of Unvested WEI Common
Stock remaining after the remaining deferred amounts have been fully distributed
will be cancelled, and each Management Investor who would otherwise be entitled
to such shares of Unvested WEI Common Stock (assuming they had vested) will have
the right, exercisable within 90 days after the date of such cancellation, to
purchase a number of shares of WEI Common Stock equal to the number of shares of
Unvested WEI Common Stock so canceled, at a cash purchase price of $44 per
share.
Pursuant to the terms of the Stockholders' Agreement, all shares of WEI
Common Stock purchased in connection with the Acquisition by the Management
Investors or issued upon exercise of options are subject to certain restrictions
on transfer and certain put and call arrangements in the event that the holder
of such shares terminates his or her employment with WEI or any of its
subsidiaries.
Management Investors have the right to put their shares and options to WEI
in the event of death, disability, retirement or termination without cause for a
"fair value price" determined in good faith by the board of directors of WEI,
less the applicable per share exercise price, in the case of options. WEI has
the right to call shares and options held by a Management Investor if such
Management Investor's employment terminates. In the event of termination
without cause, death, disability or retirement, such call shall be exercisable
at a price equal to the fair value price of the stock or options determined in
good faith by the board of directors of WEI, less the applicable per share
exercise price, in the case of options. In the event of termination for cause
or voluntary resignation, such call shall be exercisable at a price equal to the
lower of (i) the fair value price of the stock or options determined in good
faith by the board of directors of WEI and (ii) $44 per share (the initial cost
of such shares) plus interest thereon at 6.5% per annum, provided that the board
of directors of WEI will consider increasing such call price (but not in excess
of the fair value price of such stock or options, determined in good faith by
the board of directors of WEI) in the case of voluntary resignation, depending
on the circumstances. Payments under the puts and calls are limited under the
Bank Credit Agreement and the Indenture, as applicable. Under certain
circumstances, WEI may issue junior subordinated notes in payment for all or a
portion of the shares acquired under exercise of a put or call.
Certain common stock, stock options and management notes mentioned above in
regards to current executive officers may not have any value in the future as a
result of the bankruptcy filing. The ultimate outcome of the above-mentioned
items will be determined during the bankruptcy case.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K.
(a) Documents filed as part of this report.
1. Financial statements.
See Index to Financial Statements and Financial Statement
Schedules.
2. Financial statement schedules.
See Index to Financial Statements and Financial Statement
Schedules.
All other schedules are omitted as the required information
is inapplicable or the information is presented in the consolidated financial
statements or related notes.
3. Exhibits
2.1 Merger Agreement, dated as of May 5, 1992, by and among
Grammy Corp., WEI, the Company and A&S. Incorporated by
reference to Exhibit 1 of the Company's Current Report on
Form 8-K dated May 6, 1992.
3.1 Restated Certificate of Incorporation of the Company.
Incorporated by reference to Exhibit 3.1 of the Company's
Annual Report on Form 10-K for the year ended January 31,
1988 (the "1988 Report").
3.2 By-laws of the Company. Incorporated by reference to
Exhibit 3.2 of the 1988 Report.
3.3 Restated Certificate of Incorporation of WEI. Incorporated
by reference to Exhibit 2.2 of the Company's Registration
statement on Form S-1, Registration No. 335166 (the
"Registration Statement").
3.4 By-laws of WEI. Incorporated by reference to Exhibit 3.4 of
the Registration Statement.
4.1 Indenture, dated as of June 15, 1986, between the Company
and Bank of America National Trust and Savings Association.
Incorporated by reference to Exhibit 4(a) of the Company's
Registration Statement on Form S-2, Registration No.
33-6485.
4.2 First Supplemental Indenture, dated as of February 11, 1988,
between the Company and Bank of America National Trust and
Savings Association. Incorporated by reference to Exhibit
4.2 of the 1988 Report.
4.3 Specimen of 13% Senior Subordinated Notes due 2002, Series
B. Incorporated by reference to Exhibit 4.3 of the
Registration Statement.
4.4 Indenture, dated as of June 11, 1992, among Grammy Corp.,
the Company and the Trustee relating to the Notes.
Incorporated by reference to Exhibit 4(e) of the Company's
Quarterly Report on Form 10-Q for the quarter ended April
30, 1992 (the "1992 10-Q").
4.5 Supplemental Indenture, dated as of June 11, 1992, among the
Company, WEI and the Trustee relating to the Notes.
Incorporated by reference to Exhibit 4.5 of the Registration
Statement.
4.6 Securities Purchase Agreement, dated as of June 11, 1992,
among Grammy Corp., the Company and the purchasers of the
Old Notes. Incorporated by reference to Exhibit 4(f) of the
1992 10-Q.
4.7 Securities Purchase Assumption Agreement, dated as of June
11, 1992, executed by the Company and WEI. Incorporated by
reference to Exhibit 4.7 of the Registration Statement.
4.8 Registration Rights Agreement, dated as of June 11, 1992,
among Grammy Corp., the Company and the purchasers of the
Old Notes. Incorporated by reference to Exhibit 4(g) of the
1992 10-Q.
4.9 Registration Rights Assumption Agreement, dated as of June
11, 1992, executed by the Company and WEI relating to the
Old Notes. Incorporated by reference to Exhibit 4.9 of the
Registration Statement.
10.1 Office lease dated as of October 23, 1985, by and between
the Company, as lessee, and Patrician Associates, Inc. and
OMA Harbor Tech H. Associates, as lessors. Incorporated by
reference to Exhibit 10(u) of the Company's Report on Form
10-K for the seven months ended January 31, 1986.
10.2 Single Tenant Industrial Lease, dated November 5, 1991, by
and between Watson Land Company, as lessor, and the Company,
as lessee. Incorporated by reference to Exhibit 10.6 of the
1992 Report.
10.3* WEI Holdings, Inc. 1988 Employee Stock Purchase and Option
Plan. Incorporated by reference to Exhibit 10.33 of the
Annual Report on Form 10-K for the year ended January 31,
1989.
10.4* WEI Holdings, Inc. 1990 Employee Stock Purchase and Option
Plan. Incorporated by reference to Exhibit 10.37 of the
1991 Report.
10.5 Escrow Agreement, dated June 11, 1992, among A&S, as
Representative, WEI and Chase Manhattan Bank, N.A., as
Escrow Agent. Incorporated by reference to Exhibit 10.24 of
the Registration Statement.
10.6 ML Stock Subscription Agreement, dated as of June 11, 1992,
among Grammy Corp. and the ML Investors listed in Schedule I
thereto. Incorporated by reference to Exhibit 10.25 of the
Registration Statement.
10.7* Management Stock Subscription Agreement, dated as of June
11, 1992, among Grammy Corp. and the Management Investors
listed on the signature pages thereto. Incorporated by
reference to Exhibit 10.26 of the Registration Statement.
10.8 Form of Management Note. Incorporated by reference to
Exhibit 10.27 of the Registration Statement.
10.9 Form of Stock Pledge Agreement. Incorporated by reference to
Exhibit 10.28 of the Registration Statement.
10.10* Stockholders' Agreement, dated as of June 11, 1992, among
WEI, the Management Investors listed in Schedule I thereto
and the ML Investors listed in Schedule II thereto.
Incorporated by reference to Exhibit 10.29 of the
Registration Statement.
10.11* WEI Management Stock Option Plan, effective June 11, 1992.
Incorporated by reference to Exhibit 10.30 of the
Registration Statement.
10.12* Form of Incentive Option Agreement. Incorporated by
reference to Exhibit 10.31 of the Registration Statement.
10.13* Form of Performance Option Agreement. Incorporated by
reference to Exhibit 10.32 of the Registration Statement.
10.14 Bank Credit Agreement, dated as of June 11, 1992, among the
Company, WEI and Bankers Trust Company, as Agent and Heller
Financial, Inc. as Co-Agent, including all exhibits thereto.
Incorporated by reference to Exhibit 4(a) of the 1992 10-Q.
10.15 Borrower Security Agreement, dated as of June 11, 1992, by
and between the Company and Bankers Trust Company, as
collateral agent for and representative of the Lenders.
Incorporated by reference to Exhibit 4(b) of the 1992 10-Q.
10.16 Holdings Security Agreement, dated as of June 11, 1992, by
and between WEI and Bankers Trust Company, as collateral
agent for and representative of the Lenders. Incorporated
by reference to Exhibit 4(c) of the 1992 10-Q.
10.17 Holdings Pledge Agreement, dated as of June 11, 1992, by and
between WEI and Bankers Trust Company, as collateral agent
for a representative of the Lenders. Incorporated by
reference to Exhibit 4(d) of the 1992 10-Q.
10.18 First Amendment to Credit Agreement dated November 17, 1992,
between the Company, WEI, Bankers Trust Company,
Individually and as Agent, Heller Financial, Inc., United
States National Bank of Oregon, and Allstate Prime Income
Trust. Incorporated by reference to Exhibit 10.40 of the
1993 Report.
10.19 Second Amendment to Credit Agreement dated August 17, 1993,
between the Company, WEI, Bankers Trust Company,
Individually and as Agent, Heller Financial, Inc., United
States National Bank of Oregon, and Allstate Prime Income
Trust. Incorporated by reference to Exhibit 10.44 of the
Company's Quarterly Report on Form 10-Q for the quarter
ended July 31, 1993 (the "1993 10-Q").
10.20 Third Amendment to Credit Agreement dated January 27, 1994,
between the Company, WEI, Bankers Trust Company,
Individually and as Agent, Heller Financial, Inc., United
States National Bank of Oregon, and Allstate Prime Income
Trust. Incorporated by reference to Exhibit 10.27 of the
Company's Annual Report on Form 10-K for the year ended
January 31, 1994 (the "1994 Report").
10.21* Fiscal 1993 Corporate Incentive Compensation Plan.
Incorporated by reference to Exhibit 10.41 of the 1993
Report.
10.22 Master Lease Agreement dated October 13, 1992, between
United States Leasing Corporation, as Lessor, and the
Company, as Lessee. Incorporated by reference to Exhibit
10.42 of the 1993 Report.
10.23 Equipment Lease Agreement dated December 21, 1992, between
General Electric Capital Corporation, as Lessor, and the
Company, as Lessee. Incorporated by reference to Exhibit
10.43 of the 1993 Report.
10.24* Fiscal 1994 Corporate Incentive Compensation Plan.
Incorporated by reference to Exhibit 10.39 of the 1994
Report.
10.25 Letter agreement, dated May 11, 1994, between the Company
and GGG, Inc. Incorporated by reference to Exhibit 10.40 of
the Company's Quarterly Report on Form 10-Q for the quarter
ended April 30, 1994 (the "1994 10-Q").
10.26 Amendment to consulting agreement, dated April 5, 1995,
between the Company and Grisanti, Galef & Goldress, Inc.
Incorporated by reference to Exhibit 10.34 of the 1995
Report.
10.27 Amendment to WEI Management Stock Option Plan, dated January
18, 1995. Incorporated by reference to Exhibit 10.35 of the
1995 Report.
10.28 Limited Waiver Regarding Maximum Permitted Leverage Ratio,
dated April 12, 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. Incorporated by reference to Exhibit 10.36 of
the 1995 Report.
10.29 Agreement dated July 1, 1994, between The Future Now, Inc.
and the Company. Incorporated by reference to Exhibit 10.37
of the 1995 Report.
10.30 Fifth Amendment to Lease dated December 23, 1994, by and
between the Company, as lessee, and Patrician Associates,
Inc. and OMA Harbor Tech H. Associates, as lessors.
Incorporated by reference to Exhibit 10.38 of the 1995
Report.
10.31 Fiscal 1995 Corporate Incentive Compensation Plan.
Incorporated by reference to Exhibit 10.39 of the 1995
Report.
10.32 Non-Qualified Stock Options Agreement dated January 17,
1995, between WEI and Jerry E. Goldress. Incorporated by
reference to Exhibit to 10.40 of the 1995 Report.
10.33 Limited Waiver, dated May 11, 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. Incorporated by reference
to Exhibit 10.41 of the 1995 Report.
10.34 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. Incorporated by
reference to Exhibit 10.42 of the Company's Quarterly Report
on Form 10-Q for the quarter ended April 30, 1995.
10.35 Letter, dated June 16 1995, to Bank America National Trust
and Savings, from Bankers Trust Company regarding Indenture
dated as of June 15, 1986 between Wherehouse Entertainment,
Inc. and Bank of America National Trust and Savings
Association Incorporated by reference to Exhibit 10.43 of
the Company's Quarterly Report on Form 10-Q for the quarter
ended April 30, 1995.
10.36 Change of Control Agreements, dated as of July 10, 1995,
between Registrant and each of its executive officers, with
schedule required by instruction (2) to item 601(a) of
Regulation S-K identifying the parties thereto and certain
other details. Incorporated by reference to Exhibit 10.1 of
the Company's Quarterly Report on Form 10-Q for the quarter
ended July 31, 1995.
10.37 Debtor-In-Possession Credit Agreement, dated as of September
25, 1995, among the Company, WEI and Bankers Trust, as
Agent, including all exhibits thereto. Incorporated by
reference to Exhibit 10.2 of the Company's Quarterly Report
on Form 10-Q for the quarter ended October 31, 1995.
12.1** Computation of ratio of earnings to fixed charges.
21.1 Subsidiaries of the Company and WEI.
27.0** Financial Data Schedule.
(b) Current Reports on Form 8-K.
- ---------------
* Management contract or compensatory plan or arrangement
** Filed herewith
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrants has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
WHEREHOUSE ENTERTAINMENT, INC.
Date: May 15, 1996 By: /s/ Jerry E. Goldress
------------------------------
Jerry E. Goldress
Chairman of the Board,
Chief Executive Officer
and Director
(Principal Executive
Officer)
Pursuant to the requirements of the Securities Exchange Act
of 1934, this report has been signed below by the following persons on behalf of
the Registrants and in the capacities and on the dates indicated:
WHEREHOUSE ENTERTAINMENT, INC.
Signature Title Date
- --------- ----- ----
/s/ Jerry E. Goldress Chairman of the Board, May 15, 1996
- ------------------------ Chief Executive Officer
Jerry E. Goldress and Director
(Principal Executive
(Officer)
/s/ Henry Del Castillo Senior Vice President, May 15, 1996
- ------------------------ Chief Financial Officer
Henry Del Castillo and Secretary
(Principal Financial
and Accounting Officer)
/s/ James J. Burke, Jr. Director May 15, 1996
- ------------------------
James J. Burke, Jr.
/s/ Gerald S. Armstrong Director May 15, 1996
- ------------------------
Gerald S. Armstrong
/s/ Rupinder S. Sidhu Director May 15, 1996
- ------------------------
Rupinder S. Sidhu
/s/ Bradley J. Hoecker Director May 15, 1996
- ------------------------
Bradley J. Hoecker
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO
SECTION 15(d) OF THE ACT BY REGISTRANT WHICH HAS NOT REGISTERED SECURITIES
PURSUANT TO SECTION 12 OF THE ACT.
No annual report or proxy material has been sent to the security holders of
the registrant.
FINANCIAL STATEMENTS
WHEREHOUSE ENTERTAINMENT, INC.
JANUARY 31, 1996
WITH REPORT OF INDEPENDENT AUDITORS
WHEREHOUSE ENTERTAINMENT, INC.
INDEX TO FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
JANUARY 31, 1996
CONTENTS
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . F-1
Financial Statements
Balance Sheets at January 31, 1996 and 1995. . . . . . . . . . . . . . . . . F-3
Statements of Operations for each of the three years in the period ended
January 31, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-5
Statements of Changes in Shareholder's (Deficit) Equity for each of the
three years in the period ended January 31, 1996 . . . . . . . . . . . . . F-6
Statements of Cash Flows for each of the three years in the period ended
January 31, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-7
Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . F-9
Financial Statement Schedule for each of the three years ended
January 31, 1996
VIII Valuation and Qualifying Accounts. . . . . . . . . . . . . . . . . . .F-34
All other schedules have been omitted because they are not required under the
related instructions or are inapplicable, or because the required information is
included elsewhere in the financial statements.
1784/W-18 5/13/96
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Wherehouse Entertainment, Inc.
We have audited the accompanying balance sheets of Wherehouse
Entertainment, Inc. as of January 31, 1996 and 1995 and the related statements
of operations, shareholder's (deficit) equity, and cash flows for each of the
three years in the period ended January 31, 1996. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Wherehouse Entertainment, Inc.
at January 31, 1996 and 1995, and the results of its operations and its cash
flows for each of the three years in the period ended January 31, 1996, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
The accompanying financial statements and financial statement schedule have been
prepared assuming that Wherehouse Entertainment, Inc. will continue as a going
concern. As more fully described in Note 1, the Company and its parent company
have filed voluntary petitions for reorganization under Chapter 11 of the United
States Bankruptcy Code in the United States Bankruptcy Court for the District of
Delaware (the Bankruptcy Court). This event and circumstances relating to this
event, including the Company's highly leveraged financial structure and
recurring losses from operations resulting in cumulative shareholder's deficit,
raise substantial doubt about its ability to continue as a
F-1
going concern. Although the Company is currently operating the business as
debtors-in-possession under the jurisdiction of the Bankruptcy Court, the
continuation of the business as a going concern is contingent upon, among other
things, the ability to (a) formulate a plan of reorganization which will gain
approval of the creditors and shareholders and confirmation by the Bankruptcy
Court, (b) maintain compliance with all debt covenants under the debtor-in-
possession financing agreement, and (c) achieve satisfactory levels of future
operating profit. The financial statements and financial statement schedule do
not include any adjustments to reflect the possible future effects on the
classification and realization of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
As discussed on Note 2 to the financial statements, in 1995 the Company changed
its method of accounting for the impairment of long-lived assets.
Los Angeles, California
May 1, 1996
F-2
WHEREHOUSE ENTERTAINMENT, INC.
BALANCE SHEETS
JANUARY 31
1996 1995
------------------------------
ASSETS (NOTES 1 AND 5)
Current assets:
Cash $ 7,353,000 $ 1,962,000
Receivables 1,583,000 3,155,000
Taxes receivable - 1,500,000
Prepaid inventory deposits 10,880,000 -
Merchandise inventory 90,951,000 115,639,000
Other current assets 4,628,000 2,743,000
------------ ------------
Total current assets 115,395,000 124,999,000
Rental inventory, net of accumulated amortization
of $38,906,000 (1996) and $40,984,000 (1995) (NOTE 2) 14,004,000 16,093,000
Equipment and improvements, at cost (NOTES 5 AND 11):
Leasehold improvements 24,908,000 29,911,000
Data processing equipment and software 26,289,000 22,368,000
Store and office fixtures and equipment 13,969,000 22,207,000
Buildings and improvements 1,590,000 1,492,000
Land 683,000 683,000
------------ ------------
67,439,000 76,661,000
Accumulated depreciation and amortization 29,752,000 29,126,000
------------ ------------
37,687,000 47,535,000
Financing costs and leasehold interests, net of accumulated
amortization of $11,263,000 (1996) and $2,815,000
(1995) (NOTE 2) 641,000 8,317,000
Other assets 800,000 736,000
------------ ------------
Total assets $168,527,000 $197,680,000
------------ ------------
------------ ------------
SEE ACCOMPANYING NOTES.
F-3
JANUARY 31
1996 1995
-------------------------------
LIABILITIES AND SHAREHOLDER'S DEFICIT
Current liabilities:
Short-term borrowings (NOTE 5) $ - $ 15,800,000
Accounts payable and bank overdraft 8,099,000 74,984,000
Interest payable 17,000 7,772,000
Sales taxes payable 2,332,000 3,004,000
Other accrued expenses (NOTE 9) 18,592,000 26,778,000
Current portion of capital lease obligations and long-
term debt, secured (NOTES 5 AND 11) 2,655,000 9,811,000
Long-term debt classified as current (NOTE 5) - 150,000,000
------------- -------------
Total current liabilities 31,695,000 288,149,000
Capital lease obligations and long-term debt, secured
(NOTES 5 AND 11) 1,498,000 3,892,000
Other long-term liabilities 9,494,000 10,895,000
Convertible subordinated debentures (NOTE 7) - 3,716,000
Liabilities subject to compromise (NOTES 1 AND 8) 278,857,000 -
Deferred income taxes (NOTE 10) 3,270,000 3,477,000
Commitments and contingencies (NOTES 11, 12 AND 13)
Shareholder's deficit:
Common stock, $.01 par value, 1,000 shares
authorized, 10 issued and outstanding - -
Additional paid-in capital 95,671,000 95,671,000
Accumulated deficit (251,958,000) (208,120,000)
------------- -------------
Total shareholder's deficit (156,287,000) (112,449,000)
------------- -------------
Total liabilities and shareholder's deficit $ 168,527,000 $ 197,680,000
------------- -------------
------------- -------------
SEE ACCOMPANYING NOTES.
F-4
WHEREHOUSE ENTERTAINMENT, INC.
STATEMENTS OF OPERATIONS
YEAR ENDED JANUARY 31
1996 1995 1994
-----------------------------------------------------
Sales $ 350,646,000 $ 409,484,000 $ 380,202,000
Rental revenue 82,547,000 90,141,000 91,584,000
-----------------------------------------------------
433,193,000 499,625,000 471,786,000
Cost of sales 230,347,000 262,616,000 247,997,000
Cost of rentals, including amortization 40,049,000 34,973,000 50,837,000
-----------------------------------------------------
270,396,000 297,589,000 298,834,000
Selling, general and administrative expenses 167,161,000 188,740,000 196,622,000
Restructuring charges (NOTE 3) - - 14,259,000
Write-down of long-lived assets (NOTE 2) 1,476,000 139,493,000 -
Interest expense (contractual interest for the year ended
January 31, 1996 of $28,135,000) (NOTES 1 AND 5) 15,045,000 23,194,000 23,525,000
Other income (283,000) (153,000) (318,000)
-----------------------------------------------------
Loss before reorganization items and income taxes (20,602,000) (149,238,000) (61,136,000)
Reorganization items (NOTES 1 AND 2):
Professional fees 2,470,000 - -
Write-off of financing costs and debt discount 8,512,000 - -
Provision for store closing costs 6,237,000 - -
Provision for rejected executory contracts 6,000,000 - -
-----------------------------------------------------
23,219,000 - -
-----------------------------------------------------
Loss before income taxes (43,821,000) (149,238,000) (61,136,000)
Provision (benefit) for income taxes (NOTE 10) 17,000 13,007,000 (19,077,000)
-----------------------------------------------------
Net loss $ (43,838,000) $(162,245,000) $ (42,059,000)
-----------------------------------------------------
-----------------------------------------------------
SEE ACCOMPANYING NOTES.
F-5
WHEREHOUSE ENTERTAINMENT, INC.
STATEMENTS OF CHANGES IN SHAREHOLDER'S (DEFICIT) EQUITY
Common Stock Additional
$.01 Par Value Paid-in Accumulated
Shares Amount Capital Deficit Total
------------------------------------------------------------------------
Balance, January 31, 1993 10 $ - $ 66,346,000 $ (3,816,000) $ 62,530,000
Capital contribution - - 30,000,000 - 30,000,000
Dividend - - (491,000) - (491,000)
Net loss - - - (42,059,000) (42,059,000)
------------------------------------------------------------------------
Balance, January 31, 1994 10 - 95,855,000 (45,875,000) 49,980,000
Dividend - - (184,000) - (184,000)
Net loss - - - (162,245,000) (162,245,000)
------------------------------------------------------------------------
Balance, January 31, 1995 10 - 95,671,000 (208,120,000) (112,449,000)
Net loss - - - (43,838,000) (43,838,000)
------------------------------------------------------------------------
Balance, January 31, 1996 10 $ - $ 95,671,000 $(251,958,000) $(156,287,000)
------------------------------------------------------------------------
------------------------------------------------------------------------
SEE ACCOMPANYING NOTES.
F-6
WHEREHOUSE ENTERTAINMENT, INC.
STATEMENTS OF CASH FLOWS
YEAR ENDED JANUARY 31
1996 1995 1994
------------------------------------------------
OPERATING ACTIVITIES
Net loss $(43,838,000) $(162,245,000) $(42,059,000)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization 41,403,000 47,142,000 70,530,000
Book value of rental inventory dispositions 14,448,000 8,866,000 6,983,000
Noncash portion of restructuring charges - - 13,590,000
Write-down of long-lived assets 1,476,000 139,493,000 -
Other - (3,000) 32,000
Deferred taxes (207,000) 14,653,000 (14,667,000)
Changes in operating assets and liabilities:
Receivables 1,572,000 (353,000) 1,087,000
Taxes receivable 1,500,000 3,500,000 (4,555,000)
Prepaid inventory deposits (10,880,000) - -
Merchandise inventory 24,688,000 (2,047,000) (3,135,000)
Other current assets (1,885,000) (170,000) (750,000)
Accounts payable, accrued expenses and other
liabilities not separately identified (20,528,000) 1,497,000 10,279,000
Rental inventory purchases (37,962,000) (39,201,000) (30,222,000)
Changes due to reorganization activities:
Accrued professional fees (668,000) - -
Write-off of financing costs and debt discount 8,512,000 - -
Provision for store closing costs 5,743,000 - -
Provision for rejected executory contracts 6,000,000 - -
-----------------------------------------------
Net cash (used in) provided by operating activities (10,626,000) 11,132,000 7,113,000
INVESTING ACTIVITIES
Proceeds from sale of assets - 4,000 1,042,000
Acquisition of property, equipment and improvements (10,252,000) (15,667,000) (11,784,000)
Purchase of certain assets of The Record Shop, Inc. - (735,000) (6,745,000)
Purchase of certain assets of Pegasus Music and Video, Inc. - - (5,502,000)
Decrease (increase) in other assets and intangibles (415,000) 262,000 (1,844,000)
-----------------------------------------------
Net cash used in investing activities (10,667,000) (16,136,000) (24,833,000)
FINANCING ACTIVITIES
Short-term borrowings (payments), net 29,020,000 11,800,000 (2,550,000)
Principal payments on capital lease obligations and
long-term debt (2,336,000) (7,769,000) (10,582,000)
Equity contribution - - 30,000,000
Dividend paid to WEI Holdings, Inc. - (185,000) (490,000)
-----------------------------------------------
Net cash provided by financing activities 26,684,000 3,846,000 16,378,000
F-7
WHEREHOUSE ENTERTAINMENT, INC.
STATEMENTS OF CASH FLOWS (CONTINUED)
YEAR ENDED JANUARY 31
1996 1995 1994
---------------------------------------------------
REORGANIZATION ACTIVITIES
Reclassification of liabilities subject to compromise $ 278,857,000 $ - $ -
Decrease in accounts payable, accrued expenses and
other liabilities (71,343,000) - -
Reduction of debt (207,514,000) - -
---------------------------------------------------
Net cash effect of reorganization activities - - -
---------------------------------------------------
Net increase (decrease) in cash 5,391,000 (1,158,000) (1,342,000)
Cash at beginning of period 1,962,000 3,120,000 4,462,000
---------------------------------------------------
Cash at end of period $ 7,353,000 $ 1,962,000 $ 3,120,000
---------------------------------------------------
---------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid (received) during the period for:
Interest $ 11,993,000 $ 20,554,000 $ 22,448,000
Income taxes (1,276,000) (5,146,000) 164,000
Reorganization items 2,297,000 - -
Supplemental disclosure of noncash investing and financing activities:
Capital lease obligations of $483,000 in the twelve months ended January 31,
1994 were incurred when the Company entered into leases for equipment.
SEE ACCOMPANYING NOTES.
F-8
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1996
1. REORGANIZATION UNDER CHAPTER 11
On August 2, 1995 (the "petition date"), Wherehouse Entertainment, Inc.
(hereafter referred to as Wherehouse or the Company) and WEI Holdings, Inc.
(WEI), the Company's parent, filed voluntary petitions for reorganization under
Chapter 11 of the United States Bankruptcy Code (Chapter 11 or the Bankruptcy
Code) in the United States Bankruptcy Court for the District of Delaware (the
Bankruptcy Court). The Chapter 11 proceedings are being jointly administered,
with the Company managing the business in the ordinary course as debtor-in-
possession subject to the control and supervision of the Bankruptcy Court.
Under Chapter 11 proceedings, litigation and actions by creditors to collect
certain claims in existence at the petition date (pre-petition) are stayed,
absent specific Bankruptcy Court authorization to pay such claims. The Company
believes that appropriate provisions have been made in the accompanying
financial statements for the pre-petition claims that could be estimated at the
date of these financial statements. Such claims are reflected in the January 31,
1996 balance sheet as "liabilities subject to compromise." Additional claims
(liabilities subject to compromise) may arise subsequent to the filing date
resulting from the rejection of executory contracts, including leases, and from
the determination of the court (or agreed to by parties-in-interest) of allowed
claims for contingencies and disputed amounts. Claims secured against the
Company's assets (secured claims) are stayed, although holders of such claims
have the right to move the court for relief from the stay. Secured claims are
secured by all of the Company's assets except merchandise inventory (see
discussion on adversary proceeding pending with the Bankruptcy Court in Note 12)
and by a pledge by WEI of all the Company's capital stock. Under the Bankruptcy
Code, a creditor's claim is treated as secured only to the extent of the value
of such creditor's collateral, and the balance of such creditor's claim is
treated as unsecured.
The Company received approval from the Bankruptcy Court to pay or otherwise
honor employee wages and benefits and certain other pre-petition obligations
necessary for the continuing existence of the Company prior to a plan of
reorganization. Generally, unsecured debt does not accrue interest after the
petition date. In addition, the Company has determined that there is
insufficient collateral to cover the interest portion of scheduled payments on
most pre-petition debt obligations. Therefore, the Company has discontinued
accruing interest on these obligations. Contractual interest on those
obligations amounts to $28,135,000, which is $13,090,000 in excess of reported
interest expense. Refer to Note 5 for a discussion of the credit arrangements
entered into subsequent to the Chapter 11 filings.
F-9
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. REORGANIZATION UNDER CHAPTER 11 (CONTINUED)
As debtor-in-possession, the Company has the right, subject to Bankruptcy Court
approval and certain other limitations, to assume or reject certain executory
contracts, including unexpired leases. In this context, "assumption" means that
the Company agrees to perform its obligations and cure certain existing defaults
under the contract or lease, and "rejection" means that the Company is relieved
from its obligations to perform further under the contract or lease and is
subject only to a claim for damages for the breach thereof. Any claim for
damages resulting from the rejection of an executory contract or an unexpired
lease is treated as a general unsecured claim in the Chapter 11 proceedings. The
Company has been reviewing its executory contracts and has affirmed 25 leases
and rejected 62 leases to date. An estimate of the allowed claims related to the
rejected leases of $6,000,000 has been provided for and included in liabilities
subject to compromise.
The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates continuity of operations, realization of
assets and liquidation of liabilities in the ordinary course of business.
However, as a result of the Chapter 11 filings, such realization of assets and
liquidation of liabilities is subject to uncertainty. While under the protection
of Chapter 11, in the normal course of business, the Company may sell or
otherwise dispose of assets and liquidate or settle liabilities for amounts
other than those reflected in the consolidated financial statements. Further, a
plan of reorganization could materially change the amounts and classifications
reported in the consolidated historical financial statements, which do not give
effect to any adjustments to the carrying value of assets or amounts of
liabilities that might be necessary as a consequence of a plan of
reorganization. The propriety of using the going concern basis is dependent
upon, among other things, confirmation of a plan of reorganization which will be
approved by the creditors and confirmed by the Bankruptcy Court and its ability
to meet its business plan and generate sufficient cash flows from operations and
financing sources.
At this time an official committee of unsecured creditors (Official Committee)
and an unofficial committee of certain general unsecured claim holders (Trade
Committee) have been formed and are acting in the Chapter 11 proceedings. The
Official Committee has the right to review and object to certain business
transactions and to any proposed plan of reorganization. Pursuant to the order
of the Bankruptcy Court, each committee has retained counsel and other
professionals, in the case of the Official Committee at the expense of the
Company.
F-10
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. REORGANIZATION UNDER CHAPTER 11 (CONTINUED)
On April 29, 1996 the Company filed a Plan of Reorganization (the Plan) with the
Bankruptcy Court. The Company has until June 27, 1996 to solicit acceptances
from its creditors; however, the Company has filed a motion for a 60-day
extension.
While there can be no assurance that the Plan will be confirmed by the
Bankruptcy Court in exactly the form submitted, the confirmation and
consummation of the Plan would result in a substantially different capital
structure for the Company. Such Plan contemplates the issuance of: (a) an
aggregate of $20,000,000 in principal amount of 8% unsecured notes due January
31, 2004 (the New Notes) and (b) an aggregate of 8,000,000 shares of $.01 par
value new common stock (New Common Stock) in settlement of certain pre-petition
claims. Following is a summary of the proposed treatment in the Plan of each of
the major classes of creditors and shareholder recorded on the Company's January
31, 1996 balance sheet:
PRE-PETITION LENDERS
Pre-petition Lenders include the variable rate term note and revolving line of
credit, and related interest of $1,121,000, discussed in Note 5. If the Plan is
accepted by the Pre-petition Lenders, the Pre-petition Lenders will receive
approximately 4,231,000 shares of New Common Stock for the amount of their pre-
petition secured claim (estimated for purposes of a consensual Plan to be
$35,000,000 less adequate protection payments of $1,675,000) and approximately
$14,724,000 of New Notes and 2,160,000 shares of New Common Stock for their
deficiency claim. If the Plan is not accepted by the Pre-petition Lenders, the
Pre-petition Lenders will receive New Notes in an amount not to exceed
$20,000,000 for the amount of their pre-petition secured claim (subject to
determination by the Bankruptcy Court pursuant to a valuation hearing) and
15.748 shares of New Common Stock for each $1,000 of their allowed deficiency
claim. See discussion on adversary proceeding pending with the Bankruptcy Court
in Note 12.
F-11
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. REORGANIZATION UNDER CHAPTER 11 (CONTINUED)
PRE-PETITION SUPPLIER CLAIMANTS
Pre-petition Supplier Claimants include trade and other miscellaneous claims and
lease rejection claims (see Note 8). If the Plan is accepted by the Pre-petition
Lenders, the Pre-petition Supplier Claimants will receive approximately
$3,865,000 of New Notes and approximately 728,000 shares of New Common Stock. If
the Plan is not accepted by the Pre-petition Lenders, the Pre-petition Supplier
Claimants will receive 15.748 shares of New Common Stock for each $1,000 of
their allowed claim.
13% SENIOR SUBORDINATED NOTES
13% Senior Subordinated Note Claimants include the holders of the 13% senior
subordinated notes discussed in Note 5, and related accrued interest of
$7,190,000. If the Plan is accepted by the Pre-petition Lenders, the 13% Senior
Subordinated Note Claimants will receive approximately 615,000 shares of New
Common Stock. If the Plan is not accepted by the Pre-petition Lenders, the 13%
Senior Subordinated Note Claimants will receive 15.748 shares of New Common
Stock for each $1,000 of their allowed claim.
CONVERTIBLE SUBORDINATED DEBENTURES:
The Convertible Subordinated Debentures and related accrued interest (see
Note 7) will be canceled, with the holders thereof receiving no distribution.
CURRENT COMMON SHAREHOLDERS:
The current common stock will be canceled, with the common shareholders
receiving no distribution.
Under the provisions of Statement of Position 90-7, Financial Reporting by
Entities in Reorganization under the Bankruptcy Code, issued in November 1990 by
the American Institute of Certified Public Accountants, the Company has prepared
the following unaudited pro forma balance sheet as of January 31, 1996 on the
basis of "fresh start" reporting since the reorganization value, as defined, was
less than the total of all
F-12
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. REORGANIZATION UNDER CHAPTER 11 (CONTINUED)
postpetition liabilities and pre-petition claims, and holders of voting shares
immediately before confirmation of the Plan would receive less than fifty
percent of the voting shares of the emerging entity. Under this concept, all
assets and liabilities are restated to reflect the reorganization value of the
reorganized entity, which approximates its fair value at the date of
reorganization.
To determine an estimate of its reorganization value, the Company will have the
assets and liabilities of the reorganized entity appraised. Such appraisal will
determine the reorganization value (i.e. fair value) of the assets and
liabilities of the successor company. In addition, the accumulated deficit of
the Company will be eliminated and its capital structure recast in conformity
with the proposed Plan. As such, the accompanying unaudited pro forma balance
sheet as of January 31, 1996 gives effect to the terms of the Plan and the
adoption of fresh start accounting. Therefore, it represents the financial
position of a successor company which, in effect, is a new entity with assets,
liabilities and a capital structure having carrying values not comparable with
prior periods and with no beginning retained earnings or deficit.
The following unaudited pro forma balance sheet as of January 31, 1996 is
presented as if the Plan were confirmed and became effective as of January 31,
1996.
Current assets: Current liabilities:
Cash $ 4,470,000 Accounts payable and
Receivables 1,583,000 bank overdraft $ 8,099,000
Prepaid inventory deposits 10,880,000 Accrued expenses 20,941,000
Merchandise inventory 90,951,000 Current portion of capital
Other current assets 4,628,000 lease obligations and
------------ long-term debt 2,655,000
Total current assets 112,512,000 Deferred income taxes 35,000,000
------------
Total current liabilities 66,695,000
Rental inventory, net 17,194,000
Long-term debt 20,000,000
Equipment and Capital lease obligations
improvements, net 58,195,000 and long-term debt 1,498,000
Other long-term liabilities 9,494,000
Deferred income taxes 28,000,000
Other assets 800,000
Shareholders' equity 63,014,000
------------ ------------
$188,701,000 $188,701,000
------------ ------------
------------ ------------
F-13
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
COMPANY OPERATIONS
Wherehouse is a retailer of prerecorded music, videocassette rentals and other
entertainment oriented products. At January 31, 1996, the Company operated 297
locations in 8 states. Approximately 92% of the Company's stores are
concentrated in 10 major marketing areas (Los Angeles, San Francisco, San Diego,
Sacramento, Fresno, Seattle, Phoenix, Las Vegas, Denver and Salt Lake City) and
approximately 84% of the stores are located in California.
BASIS OF PRESENTATION
WEI holds all of the capital stock of the Company and, in turn, is owned by
affiliates of Merrill Lynch Capital Partners, Inc. (MLCP) (91.8%) and certain
members of management (8.2%) on a fully diluted basis at January 31, 1996. The
current equity structure is the result of the purchase of all of WEI's ownership
interest in the Company's predecessor by certain affiliates of MLCP on June 11,
1992 (the Acquisition). Currently, WEI conducts no independent operations and
has no significant assets other than the capital stock of the Company.
INVENTORY
Inventories are carried at the lower of cost or market using the first-in,
first-out (FIFO) method. Inventory consists primarily of resaleable prerecorded
music, videocassettes, video games and other products.
RENTAL INVENTORY
In the fourth quarter of fiscal 1994, the Company accelerated the amortization
of rental inventory by switching to a more accelerated method which eliminated
the use of the half-year convention and salvage values. Rental inventory
continues to be amortized over a period of two years for video games and three
years for videocassettes. In adopting the more accelerated amortization, the
Company recorded a charge of $20,268,000 in 1994 to reduce the carrying value of
existing rental inventory. The charge was accounted for as a change in estimate
and was recorded as additional amortization expense included in "cost of
rentals" on the accompanying statement of operations. In addition, the Company
sells
F-14
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
RENTAL INVENTORY (CONTINUED)
rental cassettes and games in excess of ongoing needs after the initial rental
period at prices which are often less than net book value. The sell-through of
such rental inventory in the year purchased results in additional amortization,
which is included in the cost of rentals. Although rental inventory generates a
portion of the Company's current revenue and cash flow, the rental inventory is
classified as a noncurrent asset because not all inventory is expected to be
realized as cash or sold in the normal business cycle.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization of equipment and leasehold improvements is
computed on the straight-line method over the following periods:
Years
---------
Leasehold improvements 2 - 10*
Data processing equipment and software 5
Store and office fixtures and equipment 5 - 10
Buildings and improvements 5 - 30
*Amortization over related lease periods
LEASEHOLD INTERESTS
Leasehold interests and over-market leasehold liabilities are amortized on the
straight-line method over the estimated remaining lease terms of the related
store operating leases which vary from 2 to 10 years.
FAIR VALUE OF LONG-LIVED ASSETS
The Company adopted Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets,
to be Disposed Of" in the year ended January 31, 1995. Accordingly, the Company
records impairment losses on long-lived assets used in operations, and the
related goodwill, when events and circumstances indicate that the assets might
be impaired and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of those assets.
F-15
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
FAIR VALUE OF LONG-LIVED ASSETS (CONTINUED)
Management identified significant adverse changes in the Company's business
climate late in the fourth quarter of the year ended January 31, 1995 that
persisted subsequent to year end. These changes were largely due to increasing
competition in the Company's marketplace, which led to operating results and
forecasted future results that were less than previously planned. These factors
led to the conclusion that there was a potential impairment in the recorded
value of goodwill and fixed assets. Accordingly, management reviewed the
recoverability of the carrying value of long-lived assets, primarily goodwill
and fixed assets, based upon a 20-year cash flow analysis. While goodwill was
being amortized on a straight-line basis over 40 years, management's estimate of
undiscounted cash flows over the reduced life amounted to less than the recorded
value of goodwill, indicating impairment of the goodwill under the provisions of
Statement No. 121. Management's estimate, however, indicated that the carrying
value of fixed assets at January 31, 1995, was recoverable over their remaining
useful lives.
An impairment loss of $139,493,000 is included in the accompanying 1995
statement of operations, representing the difference between the estimated
discounted cash flows (at 11.5% per year) and the recorded value of goodwill.
The discount rate of 11.5% represents the Company's weighted average interest
rate in effect on the revolving line of credit, variable rate term note, and the
13% senior subordinated notes at January 31, 1995.
As a result of the Company's financial performance and the Chapter 11
proceedings, the Company closed 53 locations during 1996 and 19 additional
locations subsequent to year end. In addition, the Company has evaluated the
ongoing value of its equipment and improvements on a store-by-store basis. Based
on this evaluation, the Company determined that store equipment and improvements
with a carrying amount of $1,843,000 were impaired and wrote them down by
$1,476,000 to their fair value. Fair value was based on estimated future cash
flows to be generated by the individual stores, discounted at a market rate of
interest.
The remaining carrying amount of equipment and improvements are expected to be
recovered based on the Company's estimates of undiscounted cash flows on a
store-by-store basis. However, it is reasonably possible that such estimates may
change in the near term resulting in the need to write-down additional assets to
fair value.
F-16
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FINANCING COSTS
Financing costs were being amortized using the effective interest rate method
over the terms of the related financing which varied with the terms of the
related agreement.
As a result of the Chapter 11 proceedings, the net book value of the financing
costs were written off during the year ended January 31, 1996 in accordance with
Statement of Position 90-7.
ADVERTISING COSTS
The Company expenses nonreimbursable advertising costs as costs are incurred.
The amount charged to advertising expense during the years ended January 31,
1996, 1995 and 1994 was $5,596,000, $5,704,000 and $5,743,000, respectively.
PRE-OPENING COSTS
Expenditures associated with opening new stores are charged to expense as
incurred.
REORGANIZATION ITEMS
Reorganization items include: (a) professional fees relating to legal,
accounting and consulting services provided in connection with the Chapter 11
proceedings, (b) costs and expenses associated with the closing of locations,
including an estimated accrual for the expected allowed claims related to
rejected executory contracts, and (c) the write off of unamortized financing
costs and debt discount in order to record debt subject to the Chapter 11
proceedings at par value.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. See discussion in Note 1
concerning uncertainties due to Chapter 11 proceedings.
F-17
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company utilizes the liability method of accounting for income taxes. Under
the liability method, deferred taxes are determined based on the difference
between the financial statement and tax basis of assets and liabilities and are
measured at the enacted tax rates that will be in effect when these differences
reverse.
EARNINGS PER SHARE
Earnings per share are omitted for the Company since it is a wholly-owned
subsidiary of WEI.
3. RESTRUCTURING CHARGES
In response to an increasingly competitive retail environment, the Company began
a "re-engineering" project during fiscal 1994 in order to lower costs and
provide greater value at lower prices to customers. As part of this project, the
Company identified required changes in systems and operations and, therefore,
assessed the realizable value of certain assets and the cost of restructuring
measures. As a result, in the fourth quarter of fiscal 1994, $14,259,000 in
restructuring charges were recorded that included the write off of $8,167,000 in
equipment, property and improvements, $3,472,000 in beneficial leasehold
interests and $721,000 in other assets as well as the recognition of $1,899,000
for severance payments for employees terminated before January 31, 1994,
consultants' fees and other costs related to re-engineering.
4. ACQUISITIONS
During June 1993 and January 1994, the Company agreed to acquire a maximum of 31
store locations (17 at the initial closing) and related assets of The Record
Shop, Inc. (Record Shop) and 15 retail stores from Pegasus Music & Video, Inc.
(Pegasus) (15 at the initial closing), respectively. The aggregate consideration
for transferred assets during fiscal 1994, without inventory, was approximately
$6,745,000 for Record Shop and $5,502,000 for Pegasus. The Company accounted for
the transactions using the purchase method of accounting. Included in the
statement of operations for the Company are the results of all Record Shop and
Pegasus stores acquired, effective June 24, 1993 and
F-18
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. ACQUISITIONS (CONTINUED)
January 14, 1994, respectively, as well as additional stores operated under
management contract for the benefit of the Company. The purchase price of each
acquisition was allocated to property and equipment, beneficial leaseholds, and
store trade name, with the remainder ($4,722,000 - Record Shop and $4,532,000 -
Pegasus) recorded as excess cost over fair value of net assets acquired
(goodwill). The goodwill balances at January 31, 1995 related to these
acquisitions were included in the goodwill impairment loss recognized in the
year ended January 31, 1995 as described in Note 1. Aggregate 1994 revenues of
the acquired companies from the date of acquisition were $11,768,000. The net
effect of the consolidated operations was not significant to the year ended
January 31, 1994.
5. FINANCING
As a result of the Chapter 11 proceedings, the unpaid principal of, and interest
on, all of the indebtedness of the Company as of the petition date became
immediately due and payable in accordance with the terms of the instruments
governing such indebtedness.
While the Chapter 11 proceedings are pending, however, the Company is prohibited
from making any payments of obligations owing as of the petition date, except as
permitted by the Bankruptcy Court and contractual terms of debt obligations have
been suspended subject to settlement. Furthermore, the Company is not able to
borrow additional funds under any of its pre-petition credit arrangements.
The Company has obtained debtor-in-possession financing with a syndicate of
financial institutions whereby a $30,000,000 revolving credit facility (DIP
facility), which includes a letter of credit subfacility of $10,000,000, is
available to fund working capital, issue letters of credit and make certain
other payments during the Chapter 11 proceedings. The DIP facility is available
through the earlier of September 1, 1997 or the effective date of a plan of
reorganization. The maximum amount available under the DIP facility is subject
to a borrowing base limitation equal to 50% of eligible inventory (as defined)
and is reduced by any outstanding letters of credit. Borrowings under the DIP
facility bear interest, at the Company's option, at either: (a) the Base Rate
(defined as the higher of the Prime Rate or the Federal Funds Effective Rate
plus 1/2%) plus 1% (9.5% at January 31, 1996); or (b) the Eurodollar Rate
(defined as the rate to first-class banks for dollar deposits in the Eurodollar
Market) plus 2.75% (8.125% at January 31, 1996). Interest on
F-19
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. FINANCING (CONTINUED)
Base Rate loans is payable monthly in arrears. Interest on Eurodollar Rate loans
is payable at the end of a one, two or three month interest period, at the
Company's option. The Company may convert all or part of the individual loans
from Base Rate loans to Eurodollar Rate loans and vice versa, with certain
limitations as to timing. The Company pays a commitment fee of 1/2% on the
average daily unused portion of the DIP facility. The Company had no outstanding
borrowings against the DIP facility at January 31, 1996. At January 31, 1996,
the Company had $400,000 of letters of credit outstanding.
Short-term borrowings at January 31, 1995 consisted of amounts borrowed under a
$45,000,000 revolving line of credit (with the same lenders that provided the
variable rate term note described below) which, prior to the Chapter 11
proceedings, was to expire on January 31, 1998, was subject to the same
covenants as the term note and was collateralized by all of the Company's assets
except merchandise inventory (see discussion on adversary proceeding pending
with the Bankruptcy Court in Note 12) and by a pledge by WEI of all the
Company's capital stock. Borrowings bore interest at the rates and terms
described for the term note. The Company was also subject to a commitment fee of
1/2% on used borrowings under the line. The weighted average interest rates for
the years ended January 31, 1996, 1995 and 1994 were 10.03%, 7.65% and 6.28%,
respectively. Borrowings outstanding at January 31, 1996 of $44,820,000, and
related accrued interest and commitment fees of $581,000, have been classified
as liabilities subject to compromise as there is insufficient collateral to
cover the full principal amount outstanding.
Long-term debt, in accordance with its contracted terms, is summarized as
follows:
DESCRIPTIONS 1996 1995
---------------------------------------------------------------------------------------
10-5/8% promissory note $ 1,847,000 $ 1,890,000
Variable rate term note 47,350,000 49,000,000
13% senior subordinated notes 110,000,000 110,000,000
Other 426,000 195,000
Capital lease obligations (NOTE 10) 1,880,000 2,618,000
--------------------------------
161,503,000 163,703,000
Less current portion:
Scheduled repayments (2,655,000) (9,811,000)
Long-term debt classified as current - (150,000,000)
Less amount included as liabilities subject to
compromise (157,350,000) -
--------------------------------
$ 1,498,000 $ 3,892,000
--------------------------------
--------------------------------
F-20
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. FINANCING (CONTINUED)
As a result of the uncertainties relating to the Chapter 11 proceedings, future
minimum repayments of long-term debt have not been presented.
Currently, the Company is making principal and interest payments on the DIP
facility and on certain pre-petition debt pursuant to Section 1110 of the
Bankruptcy Code. No other principal or interest may be paid without the approval
of the Bankruptcy Court. The Company accrued interest on its unsecured and
undersecured obligations through the petition date; however, due to the
uncertainties relating to a final plan of reorganization, the Company ceased
accruing interest on such obligations effective on the petition date.
Set forth in the following paragraphs is a description of the terms of the
Company's various long-term debt agreements as in effect on the petition date.
Such provisions do not necessarily presently govern the respective rights of the
Company and the various lenders. Instead, the rights of the parties will likely
be determined in connection with the Chapter 11 proceedings currently pending in
the Bankruptcy Court.
10-5/8% PROMISSORY NOTE: The original amount of $2,800,000 was payable in
monthly installments of $20,000 (including principal and interest) through
December 1, 1996, at which time the remaining principal balance was due. The
note is collateralized by a deed of trust on land and building with a net book
value of approximately $3,035,000 at January 31, 1996 and is assumed to be fully
secured.
VARIABLE RATE TERM NOTE: The Company's credit agreement, resulting from the
Acquisition, provided for a variable rate term note which was bearing interest
at prime rate plus 1-1/2% or Eurodollar Rate plus 3%. These interest rates were
subject to a discount based on the Company's ability to maintain certain
leverage ratios. Interest on the term note was payable quarterly. At January 31,
1995, the Company had an interest rate protection agreement with a major
financial institution covering approximately 40% of the outstanding balance of
the term note which limited net interest costs to the Company to a ceiling of 9-
1/8% with respect to the balances covered by the agreement. The interest rate
protection agreement expired during the year ended January 31, 1996.
The credit agreement was amended on January 27, 1994 to revise certain financial
covenants and provide the Company with additional flexibility. In connection
with this amendment, MLCP received a fee of $300,000.
F-21
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. FINANCING (CONTINUED)
This note is collateralized by all of the Company's assets except merchandise
inventory (see discussion on adversary proceeding pending with the Bankruptcy
Court in Note 12) and by a pledge by WEI of all the Company's capital stock.
Principal payments were due in quarterly installments in the following aggregate
annual amounts: $9,000,000 in fiscal 1996, $17,000,000 in fiscal 1997 and
$23,000,000 in fiscal 1998. However, only $1,650,000 in principal payments were
actually made during 1996 due to the Company's financial condition and to the
Chapter 11 proceedings ($750,000 of cash collateral usage payments made
subsequent to the petition date and approved by the Bankruptcy Court have been
reflected as a reduction of the principal balance). Borrowings outstanding at
January 31, 1996 of $47,350,000, and related accrued interest of $540,000, have
been classified as liabilities subject to compromise because the principal
balance is undersecured.
13% SENIOR SUBORDINATED NOTES: The notes were due August 2002 with interest
payable semiannually. The notes were noncallable prior to August 1, 1997 and
required sinking fund payments of $27,500,000 in August 2000 and 2001. The
outstanding principal balance of $110,000,000, and related accrued interest of
$7,190,000, have been included in liabilities subject to compromise due to their
unsecured nature.
WEI and MLCP are affiliates of Merrill Lynch, Pierce, Fenner & Smith
Incorporated (MLPF&S). In connection with the original sale of the senior
subordinated notes as part of the Acquisition, MLPF&S received a fee of
$3,850,000 with respect to its activities as placement agent. In addition, in
connection with the Acquisition, MLCP received a fee of $2,500,000 plus
reimbursement of expenses of $135,000 from the Company.
FINANCIAL COVENANTS
The Company's various pre-petition loan agreements had covenants which, among
other things, required the maintenance of certain financial ratios such as
minimum consolidated adjusted EBITDAV (as defined), maximum leverage and minimum
fixed charge coverage. In addition, the covenants placed limitations on
dividends, capital expenditures, transactions with affiliates, capital lease
borrowings and other indebtedness. However, as a result of the automatic stay
resulting from the Chapter 11 proceedings, the Company's lenders may not enforce
any rights, exercise any remedies or realize on any claims in the event that the
Company fails to comply with any of the covenants contained in the various pre-
petition loan agreements.
F-22
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. FINANCING (CONTINUED)
FINANCIAL COVENANTS (CONTINUED)
As of January 31, 1995, $150,000,000 of debt covered by the terms of the loan
agreements was reclassified as a current liability due to the violation of a
loan covenant and anticipated future violations under loan agreements.
The Company is subject to various financial and other covenants under the terms
of the DIP facility including, among other things, minimum EBITDAV (as defined)
and limitations on indebtedness, investments, payments of indebtedness and
capital expenditures. The Company is in compliance with the DIP facility
covenants at January 31, 1996 or has obtained appropriate waivers.
6. FAIR MARKET VALUE
It was not practicable to estimate the fair market value of the Company's pre-
petition debt obligations as the Company is currently in Chapter 11 proceedings.
The ultimate plan of reorganization could significantly impact the estimated
fair value of these obligations. The fair market values of the DIP financing as
of January 31, 1996, is estimated to be the same as the amounts reported for
such debt in the Company's balance sheet at that date.
7. CONVERTIBLE SUBORDINATED DEBENTURES
In 1986, the Company's predecessor issued $50,000,000 of 6-1/4% convertible
subordinated debentures due in 2006.
In conjunction with a prior acquisition of the Company's predecessor in 1988,
the Company's predecessor and its Trustee for the convertible subordinated
debentures entered into a First Supplemental Indenture, which provides that
convertible subordinated debenture holders may convert their debentures into
cash and have no other rights under the indenture to convert their debentures
into common stock of the Company. As a result of the 1988 acquisition of the
Company's predecessor, the subordinated debentures were discounted to fair
value. No adjustment was made to the carrying value as a result of the June 1992
Acquisition. The remaining discount was being amortized by the interest
F-23
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. CONVERTIBLE SUBORDINATED DEBENTURES (CONTINUED)
method over the term of the debentures. During 1996, $322,000 (undiscounted
value) of convertible subordinated debentures were redeemed. There were no
redemptions in fiscal years 1995 or 1994. At January 31, 1996, the remaining
discount was reversed due to the Chapter 11 proceedings and the gross
outstanding amount of $5,344,000, and related accrued interest of $196,000, are
included with liabilities subject to compromise due to their unsecured nature.
Refer to Note 12 for a discussion of litigation associated with these
convertible subordinated debentures.
8. LIABILITIES SUBJECT TO COMPROMISE
Liabilities subject to compromise at January 31, 1996 include the following:
13% senior subordinated notes $110,000,000
Variable rate term note and revolving line of credit 92,170,000
Accrued interest 8,507,000
Lease rejection claims 6,000,000
Convertible subordinated debentures 5,344,000
Trade and other miscellaneous claims 56,836,000
------------
$278,857,000
------------
------------
Liabilities subject to compromise under the Chapter 11 proceedings include
substantially all current and long-term debt and trade and other payables as of
the petition date. As discussed in Note 1, payment of these liabilities,
including the maturity of debt obligations, are stayed while the Company
continues to operate as a debtor-in-possession.
As part of the Chapter 11 proceedings, the Company has notified all known or
potential claimants for the purpose of identifying all pre-petition claims
against the Company. The Bankruptcy Court entered an order setting Mary 15, 1996
as the bar date (the Bar Date) for submission of proofs of claim in the Chapter
11 proceedings. With certain exceptions, a creditor who fails to submit on or
before the Bar Date a proof of claim in respect of a claim against the Company
is forever barred from asserting such claim against the Company. Additional
bankruptcy claims and pre-petition liabilities may arise by termination of
various contractual obligations and as certain contingent and/or potentially
disputed bankruptcy claims are settled for amounts which differ from those shown
on the balance sheet.
F-24
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. OTHER ACCRUED EXPENSES
Other accrued expenses consists of the following:
1996 1995
--------------------------
Gift certificate liability $ 5,138,000 $ 5,018,000
Payroll and related costs 4,799,000 6,125,000
Store closing costs 1,780,000 501,000
Frequent renter program liability 167,000 3,283,000
Other 6,708,000 11,851,000
--------------------------
$18,592,000 $26,778,000
--------------------------
--------------------------
10. INCOME TAXES
The provision (benefit) for income taxes includes:
YEAR ENDED JANUARY 31
1996 1995 1994
-------------------------------------------
Current:
Federal $ - $(1,500,000) $ (4,390,000)
State 17,000 - (20,000)
-------------------------------------------
17,000 (1,500,000) (4,410,000)
Deferred:
Federal (14,187,000) (5,057,000) (14,164,000)
State (2,695,000) (2,249,000) (4,114,000)
Valuation allowance 16,882,000 21,813,000 3,611,000
-------------------------------------------
- 14,507,000 (14,667,000)
-------------------------------------------
$17,000 $13,007,000 $(19,077,000)
-------------------------------------------
-------------------------------------------
F-25
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
A reconciliation of the difference between the federal statutory rate and the
effective tax rate is summarized as follows:
YEAR ENDED JANUARY 31
1996 1995 1994
-------------------------------
Statutory tax rate (34.0)% (34.0)% (34.0)%
Permanent tax differences for
deductions (primarily amortization
of excess of cost over fair value of
net assets acquired) - 30.5 2.5
Job tax credits - (2.1) (1.5)
State taxes, net of federal benefit - (1.0) (4.0)
Other - 0.7 (0.1)
Valuation allowance 34.0 14.6 5.9
-------------------------------
- 8.7% (31.2)%
-------------------------------
-------------------------------
The components of net deferred income taxes at January 31, 1996 are as follows:
Net current deferred income tax assets (liabilities):
Merchandise inventory $ 3,596,000
Vacation liability 894,000
Other accrued liabilities 115,000
Prepaid expenses (143,000)
------------
4,462,000
Net long-term deferred income tax assets (liabilities):
Video rental inventory 1,312,000
Equipment and improvements 3,251,000
Store closure liability 717,000
Average rent liability 3,810,000
Federal/state operating loss carryovers 11,651,000
Federal/state credit carryovers 8,588,000
Deferred compensation 564,000
Other accrued liabilities (4,147,000)
Capital leases 469,000
Goodwill 3,243,000
Loan fees 2,708,000
Rejected executory contracts 2,408,000
------------
34,574,000
------------
39,036,000
Valuation allowance for deferred tax assets (42,306,000)
------------
Net deferred income tax liability $ (3,270,000)
------------
------------
F-26
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
The Company has a carryover benefit for job tax and alternative minimum tax
credits of $8,588,000 which will expire starting in 2010 and federal net
operating loss carryovers of $10,333,000 which expire starting in 2010. For
financial reporting purposes, the benefit has been included as a deferred tax
asset at January 31, 1996.
During the year ended January 31, 1996, the valuation allowance for deferred tax
assets increased by $16,882,000 from $25,424,000 at January 31, 1995 to
$46,453,000 at January 31, 1996.
The Company is currently undergoing audits by the Internal Revenue Service for
the years ended January 31, 1993, 1994 and 1995 and by the State of California
for the years ended January 31, 1992, 1993 and 1994. Management believes that it
has made adequate provision in the accompanying financial statements for these
audits. Additionally, assessments resulting from the audit will be submitted as
claims in the Chapter 11 case.
11. COMMITMENTS
LEASES
The Company leases substantially all of its data processing equipment, retail
stores and other facilities. The capital and operating lease agreements expire
on various dates through 2013 with renewal options for certain leases. Certain
leases provide for payment of real estate taxes and additional rents based on a
percentage of sales. The Company has until the earlier of the confirmation of a
plan of reorganization or May 30, 1996 to affirm or reject these leases. The
Company is in the process of negotiating lease term revisions with its landlords
and evaluating each lease in terms of its ongoing operations. To date 25 leases
have been affirmed and 62 have been rejected.
F-27
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. COMMITMENTS (CONTINUED)
LEASES (CONTINUED)
Future minimum annual lease payments under capital and operating leases at
January 31, 1996 (including any modifications due to leases rejected and
affirmed), which are subject to further modification in the Chapter 11
proceedings, are payable as follows:
CAPITAL OPERATING
LEASES LEASES
----------------------------
1997 $ 879,000 $ 34,938,000
1998 776,000 33,725,000
1999 255,000 31,678,000
2000 123,000 27,868,000
2001 - 25,848,000
Thereafter - 105,805,000
----------------------------
Total future minimum lease payments 2,033,000 $259,862,000
------------
------------
Less amounts representing interest 152,000
-----------
Present value of future minimum lease payments 1,881,000
Less current portion 785,000
-----------
Long-term obligations under capital leases $1,096,000
-----------
-----------
Rental expense charged to operations was approximately $38,892,000 in fiscal
1996, $43,331,000 in fiscal 1995 and $42,285,000 in fiscal 1994. In addition,
real estate taxes and additional rents based on percentage of sales were
approximately $2,871,000 in fiscal 1996, $3,158,000 in fiscal 1995 and
$2,881,000 in fiscal 1994. The Company subleases a portion of its warehouse in
Gardena, California, for an annual rent of $192,000 through March 31, 1997.
Included in equipment and improvements are assets held under capital leases with
an original cost to the Company of $4,067,000 at January 31, 1996 and 1995.
Capital lease obligations are assumed to be fully secured by the value of the
related equipment and improvements.
F-28
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. COMMITMENTS (CONTINUED)
MANAGEMENT CONSULTING AGREEMENTS
As part of the re-engineering project begun in June 1993, the Company entered
into a management consulting agreement with a company whose chairman provided
services first by leading the re-engineering project and then as Chairman of the
Board and Chief Executive Officer of the Company. The current agreement, as
amended on December 31, 1995 and effective as of March 1, 1995, specifies
monthly payments of $37,500 and is effective through October 1, 1997. Amounts
paid under this agreement were $496,000, $375,000 and $250,000 during fiscal
1996, 1995 and 1994, respectively. Upon signing the amendment, an additional
$50,000 was paid.
12. CONTINGENCIES
The Company's contingencies are generally subject to the effects of the Chapter
11 proceedings, which are discussed in Note 1. The following discussion does not
purport to reflect or provide for all the consequences of the ongoing Chapter 11
proceedings. Primarily due to the uncertainty concerning the ultimate outcome of
the Chapter 11 proceedings, the ultimate liability and effect on the financial
statements from such matters cannot currently be determined.
The Company, certain of its former directors, WEI and its investment bankers are
defendants in three class action lawsuits; two lawsuits relate to the
subordinated debentures outstanding at the time of the acquisition of the
Company's predecessor in 1988 and one relates to a pre-1988 potential
acquisition of the Company's predecessor, which lawsuit was settled for $350,000
and paid out of the deferred merger consideration discussed below. The lawsuits,
among other claims, request unspecified damages. Based upon discovery
proceedings to date and the Company's discussions with its trial lawyers, the
Company believes that these actions are without merit and they are vigorously
defending them.
As part of the Acquisition, approximately $18,750,000 of the merger
consideration was deferred and is subject to reduction to the extent the Company
incurs certain litigation costs related to the aforementioned class action
lawsuits. The fund has a current balance, including accrued interest of
$19,300,000.
F-29
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. CONTINGENCIES (CONTINUED)
Based on management's discussions with its trial lawyers, the Company does not
currently believe that any of the foregoing class action lawsuits will have a
material adverse effect on the Company. However, if any of these matters were to
be determined adversely by a court of law, such determination could have a
material adverse effect on the Company.
On November 9, 1995, the Company filed an adversary proceeding with the
Bankruptcy Court against one of its secured creditors seeking a declaration that
certain collateral in which the creditor has a security interest does not extend
to the Company's merchandise inventory. The secured creditor has filed a motion
to dismiss the Company's complaint. The Bankruptcy Court has not yet decided on
the motions, and discovery has been stayed pending conclusion of negotiations on
the Plan. As the Company does not believe it is probable that the creditor's
security interest will include merchandise inventory, such creditor's claims
have, therefore, been classified as liabilities subject to compromise in the
balance sheet as they are undersecured. In the event the Bankruptcy Court found
that merchandise inventory did collateralize the creditor's claims, such claims
would become fully secured claims.
The Company is a party to various other claims, legal actions and complaints
arising in the ordinary course of its business. In the opinion of management,
all such matters are without merit or involve such amounts that unfavorable
disposition will not have a material impact on the financial position or results
of operations of the Company.
13. EMPLOYEE BENEFITS
EXECUTIVE OFFICERS' RETIREMENT PLAN: The Company provides life insurance for the
executive officers of the Company, with face values of such policies ranging
from $250,000 to $500,000. Upon retirement at the normal retirement age of 65,
covered executives are entitled to receive annual payments equal to 10% of the
face amount of their life insurance policies for each of the 15 years following
retirement. The Company recognized $60,000 of expense in 1996, $27,000 in fiscal
1995 and $20,000 in 1994, under this plan.
F-30
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
13. EMPLOYEE BENEFITS (CONTINUED)
EMPLOYEES' SAVINGS RETIREMENT PLAN: In March 1992, the Company established a tax
qualified 401(k) Savings Retirement Plan (401(k) Plan). All employees who have
completed one year of service and at least 1,000 hours of service in that year
with the Company are eligible to join the 401(k) Plan on the first day of each
calendar quarter. All eligible employees may contribute from 1% to 10% of their
annual compensation on a pre-tax basis. The Company makes a matching
contribution in an amount equal to 50% of the employees' contributions of 1% to
3% of their annual compensation and 25% of the employees' contributions of 4% to
5% of their annual compensation. Matching contributions made by the Company vest
25% per year beginning with the employee's second year of employment. The
Company recognized $305,000 in 1996, $381,000 in 1995 and $477,000 in 1994 for
matching costs and administrative costs under the 401(k) Plan.
SEVERANCE AGREEMENTS: In order to retain certain key management employees prior
to and during the Chapter 11 proceedings, the Company has established severance
agreements with such employees. These agreements would take effect in
the event of a change in control of the Company (as defined), which would
result in such employees' termination of employment or in a significant
reduction in such employees' responsibilities. If such an event occurred, the
Company would be liable for payments of up to $2,159,000 under the various
severance agreements. In addition, the salary of the Chairman of the Board
and Chief Executive Officer of the Company is guaranteed through
October 1, 1997.
F-31
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information (unaudited) is as follows (in thousands):
NET REVENUE GROSS PROFIT NET LOSS
--------------------------------------------
1996 - QUARTER ENDED
April 30 $103,976 $ 43,106 $ (7,438)
July 31 105,036 41,076 (10,151)
October 31 93,100 34,823 (12,048)
January 31 131,081 43,792 (14,201)
1995 - QUARTER ENDED
April 30 $113,863 $ 46,505 $ (5,648)
July 31 114,324 47,904 (3,729)
October 31 112,651 45,919 (6,052)
January 31 158,787 61,708 (146,816)
F-32
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
15. SUMMARY FINANCIAL INFORMATION OF WEI HOLDINGS, INC.
Unconsolidated summary financial information of the Company's parent, WEI
Holdings, Inc. is as follows:
JANUARY 31
1996 1995
---------------------------
(IN THOUSANDS)
Current assets $ 38 $ 64
Total assets 38 64
Current liabilities 76 76
Deficiency in investment in the Company 156,287 112,449
Total liabilities 156,363 112,525
Redeemable common stock 3,872 3,872
Notes receivable from shareholders (660) (660)
Contingent shares (663) (663)
Net income (loss) (exclusive of the net
loss of the Company) (28) 37
WEI has no material assets apart from its ownership of all of the outstanding
capital stock of Wherehouse Entertainment, Inc. WEI does not have income from
operations.
F-33
WHEREHOUSE ENTERTAINMENT, INC.
SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
BALANCE AT CHARGED TO
BEGINNING COSTS AND BALANCE AT
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS(1) END OF PERIOD
- -----------------------------------------------------------------------------------------------------
Accumulated amortization deducted
from video rental inventory:
Company:
Year ended January 31, 1996 $40,984,000 $24,213,000 $26,291,000 $38,906,000
Year ended January 31, 1995 38,966,000 26,831,000 24,813,000 40,984,000
Year ended January 31, 1994 14,703,000 41,392,000 17,129,000 38,966,000
- -------------------------
(1) Accumulated amortization on disposition of video rental tapes.
F-34