UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended OCTOBER 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________
to _______________
Commission File Number 1-8281
Wherehouse Entertainment, Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
95-2647555
(I.R.S. Employer Identification Number)
19701 Hamilton Avenue
Torrance, California 90502-1334
(Address of principal executive offices including ZIP code)
(310) 538-2314
(Registrant's telephone number, including area code)
Indicate by check mark whether the 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 were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Outstanding at
Class October 31, 1996
----- ----------------
Common Stock, $.01 Par Value 10
Total of 27 Pages
INDEX
WHEREHOUSE ENTERTAINMENT, INC.
Page
----
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets -
October 31, 1996 (Unaudited) and January 31, 1996 3
Condensed Statements of Operations -
Three Months Ended October 31, 1996 and 1995 (Unaudited)
Nine Months Ended October 31, 1996 and 1995 (Unaudited) 4
Condensed Statements of Cash Flows -
Nine Months Ended October 31, 1996 and 1995 (Unaudited) 5
Notes to Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 27
2
PART I.
FINANCIAL INFORMATION
WHEREHOUSE ENTERTAINMENT, INC.
CONDENSED BALANCE SHEETS
October 31 January 31
1996 1996
----------------- ----------------
(Unaudited) Note 1
ASSETS
Current Assets
Cash $ 1,428,000 $ 7,353,000
Receivables 1,483,000 1,583,000
Prepaid inventory deposits 5,797,000 10,880,000
Merchandise inventory 97,852,000 90,951,000
Other current assets 3,831,000 4,628,000
---------------- --------------
Total current assets 110,391,000 115,395,000
Rental inventory, net 11,987,000 14,004,000
Equipment and improvements, net 27,862,000 37,687,000
Financing costs and leasehold interest, net 1,019,000 641,000
Other assets 484,000 800,000
---------------- --------------
Total assets $ 151,743,000 $ 168,527,000
---------------- --------------
---------------- --------------
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Revolver-post petition $ 7,000,000 $ 0
Accounts payable and accrued expenses 24,799,000 28,232,000
Current maturities of capital lease obligations
and long-term debt 2,661,000 2,655,000
---------------- --------------
Total current liabilities 34,460,000 30,887,000
Capital lease obligations & long-term debt 874,000 1,498,000
Other long-term liabilities 10,583,000 9,494,000
Liabilities subject to compromise (Note 3) 276,575,000 279,665,000
Deferred income taxes 3,270,000 3,270,000
Shareholder's equity
Common stock, $.01 par value, 1,000
authorized, 10 issued and outstanding --- ---
Additional paid-in capital 95,671,000 95,671,000
Accumulated deficit (269,690,000) (251,958,000)
---------------- --------------
Total shareholder's deficit (174,019,000) (156,287,000)
---------------- --------------
Total liabilities and
shareholder's equity 151,743,000 $168,527,000
---------------- --------------
---------------- --------------
See accompanying notes to Condensed Financial Statements
3
WHEREHOUSE ENTERTAINMENT, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Three Nine Nine
Months Ended Months Ended Months Ended Months Ended
Oct 31, 1996 Oct 31, 1995 Oct 31, 1996 Oct 31, 1995
---------------- ----------------- ---------------- ----------------
Sales $ 63,184,000 $ 74,817,000 $ 200,894,000 $ 239,057,000
Rental Revenue 14,960,000 18,283,000 52,409,000 63,053,000
--------------- ---------------- --------------- ---------------
78,144,000 93,100,000 253,303,000 302,110,000
Cost of sales 40,029,000 46,997,000 129,967,000 153,065,000
Cost of rentals, including amortization 9,392,000 11,280,000 27,309,000 30,041,000
--------------- ---------------- --------------- ---------------
49,421,000 58,277,000 157,276,000 183,106,000
Selling, general and administrative expenses 35,120,000 42,485,000 109,562,000 131,345,000
--------------- ---------------- --------------- ---------------
Loss from operations (6,397,000) (7,662,000) (13,535,000) (12,341,000)
Interest expense 281,000 1,088,000 594,000 14,127,000
Other income (122,000) (64,000) (216,000) (194,000)
--------------- ---------------- --------------- ---------------
Loss before reorganization items & income taxes (6,556,000) (8,686,000) (13,913,000) (26,274,000)
Reorganization items:
Professional fees 900,000 1,676,000 2,686,000 1,676,000
Provision for store closing costs 0 1,687,000 1,134,000 1,687,000
--------------- ---------------- --------------- ---------------
900,000 3,363,000 3,820,000 3,363,000
--------------- ---------------- --------------- ---------------
Loss before income taxes (7,456,000) (12,049,000) (17,733,000) (29,637,000)
Benefit for income taxes 0 0 0 0
--------------- ---------------- --------------- ---------------
Net loss $ (7,456,000) $ (12,049,000) $ (17,733,000) $ (29,637,000)
--------------- ---------------- --------------- ---------------
--------------- ---------------- --------------- ---------------
See accompanying notes to Condensed Financial Statements
4
WHEREHOUSE ENTERTAINMENT, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Nine
Months Ended Months Ended
Oct 31, 1996 Oct 31, 1995
---------------- ----------------
Operating activities:
Net loss $ (17,733,000) $ (29,637,000)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Depreciation and amortization 29,053,000 32,831,000
Book value of rental inventory dispositions 7,893,000 9,672,000
Loss (gain) on disposal of fixed assets 0 1,597,000
Changes in operating assets and liabilities:
Receivables 100,000 1,886,000
Tax receivable 0 1,293,000
Prepaid inventory deposits 5,083,000 0
Merchandise inventory (8,925,000) (420,000)
Other current assets 797,000 (1,254,000)
Accounts payable, accrued expenses and
other liabilities 135,000 (25,063,000)
Rental inventory purchases (25,292,000) (27,585,000)
-------------- -------------
Net cash used in operating activities (8,889,000) (36,680,000)
Investing activities:
Acquisition of property, equipment and improvements (1,934,000) (7,734,000)
Decrease in other assets and intangibles (418,000) (478,000)
-------------- -------------
Net cash used in investing activities (2,352,000) (8,212,000)
Financing activities:
Short-term borrowings 0 29,320,000
Short-term borrowings-Post 7,000,000 18,000,000
Subordinated debenture redemptions 0 (169,000)
Liabilities subject to compromise (1,066,000) (300,000)
Principal payments on capital lease obligations
and long-term debt (618,000) (1,543,000)
-------------- -------------
Net cash provided by financing
activities 5,316,000 45,308,000
-------------- -------------
Net increase (decrease) in cash (5,925,000) 416,000
Cash at beginning of the period 7,353,000 1,962,000
-------------- -------------
Cash at end of the period $ 1,428,000 $ 2,378,000
-------------- -------------
-------------- -------------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 516,000 $ 11,456,000
Net income taxes 25,000 (1,276,000)
Reorganization items 2,815,000 0
See accompanying notes to Condensed Financial Statements
5
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying condensed financial statements of Wherehouse
Entertainment, Inc. (the "Company") have been prepared by the Company without
audit. The condensed balance sheet at January 31, 1996 has been derived from
the Company's audited financial statements at that date. Certain footnote
disclosures, including significant accounting policies, normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. The Company believes that the
accompanying condensed financial statements include all adjustments (consisting
only of normal, recurring adjustments) which are considered necessary for a fair
presentation. The results of operations for any interim period may not be
indicative of the results of the entire year.
It is suggested that the accompanying unaudited condensed financial
statements be read in conjunction with the financial statements and notes
included in the Company's Annual Report on Form 10-K for the year ended January
31, 1996 and Quarterly Reports on Form 10-Q for the quarters ended April 30,
1996 and July 31, 1996.
2. 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. These claims are reflected in the October
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
6
petition the court for relief from the stay.
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 approval of 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 would have been
$19.5 million higher had the Company continued to accrue interest on these
obligations from February 1, 1996 through October 31, 1996.
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. 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 obtained debtor-in-possession financing from 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 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 Company pays a commitment fee of 1/2% on the average daily
unused portion of the DIP facility. The Company had outstanding borrowings of
$7.0 million against the DIP facility at October 31, 1996. At October 31, 1996,
the Company had $400,000 of letters of credit outstanding.
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, the Company, in the normal course of business, 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 must
be approved by the creditors and confirmed by the Bankruptcy Court, and the
Company's ability to meet its business plan and generate sufficient cash flows
from operations and financial sources.
On September 26, 1996 the Company filed with the Bankruptcy Court, an
Amended Plan of Reorganization (the "Plan"), as revised for technical
corrections on October 4, 1996, and amended on December 2, 1996, and further
amended on the record at a Confirmation hearing held on December 13, 1996.
The Bankruptcy Court orally confirmed the Plan at that hearing.
7
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
October 31, 1996 balance sheet. Capitalized terms are defined in the Plan, a
copy of which has been filed as an exhibit to the Report. The following is
subject to, and qualified by, reference to the Plan:
SENIOR LENDERS
Seniors Lender Claims are claims arising under or in respect of the
Company's 1992 credit agreement and related documents. Under the Plan,
the secured portion of such claims is compromised at $35 million. On
account of such secured portion, the Senior Lenders will receive (i)
approximately $11.61 million in cash, subject to adjustment to effectuate
an exchange for new common stock with Eligible Suppliers who exercise
the Exchange Option, and (ii) approximately 24% of the new common stock
(prior to dilution for warrants or management stock), assuming an $11.61
million cash distribution.
The Senior Lenders will also receive a distribution of 31.92 shares of
new common stock per $1,000 in Allowed amount of the deficiency portion
of their claims. The Company estimates that the Senior Lenders will
receive approximately 19% of the new common stock (prior to dilution for
warrants or management stock) on account of their deficiency claims.
The Senior Lenders will also receive shares of new common stock (which
would otherwise be distributed to holders of Senior Subordinated Note
Claims) in accordance with, and in enforcement of, the subordination
provisions of the Senior Subordinated Note Indenture. The Company esti-
mates that approximately 37% of the new common stock (prior to dilution
for warrants or management stock) will be distributed to the Senior Len-
ders on account of the enforcement of these subordination provisions.
The total percentage of shares to be distributed to the Senior Lenders
depends on a number of variables, including how many Eligible Suppliers
elect the cash-out option described below and the total unsecured claims
that are ultimately allowed. Assuming that all Eligible Suppliers elect
the exchange option and based on the Company's estimate of the claims that
will be allowed, the Company estimates that the Senior Lenders will re-
ceive approximately 94.5% of the new common stock prior to dilution and
approximately 81% of the new common stock after dilution for the warrants
and management stock.
GENERAL UNSECURED CREDITORS
All holders of General Unsecured Claims (including trade suppliers,
landlords with rejection damages, and other miscellaneous unsecured
creditors) will receive a distribution of 31.92 shares of new common
stock per $1,000 in Allowed amount of claim, the same distribution ratio
as applicable to the distribution on account of Senior Lenders' deficiency
claims.
In addition, the Plan provides for a voluntary exchange between the
Senior Lenders and ongoing suppliers of copyrighted music, film or other
entertainment products. If such supplier commits to supply to Reorgan-
ized Wherehouse goods on normal credit terms which are substantially com-
parable to those offered from time to time to other similarly situated
customers, such supplier will have an option to exchange the new common
stock received under the Plan for cash distributed to the Senior Lenders
on account of their secured claims. Such cash option is exercisable at
a ratio equal to $0.27 for every dollar of such supplier's Allowed amount
of general unsecured claim.
SENIOR SUBORDINATED NOTE HOLDERS
At the confirmation hearing on December 13, 1996, the Debtors' First
Amended Chapter 11 Plan was amended so that the distribution to Senior
Subordinate Noteholders is as follows:
1. The distribution to the Class 7 Senior Subordinated Note-
holders will consist of: (a) a cash payment of $3,900,000 to be funded
from two sources: $2,350,000 from the Wherehouse estates and $1,550,000
through a separate settlement involving the 1992 acquisition fund re-
cipients, the principal of which is Adler & Shaykin and (b) warrants to
purchase 776,000 shares of new common stock which shall be issued in three
branches as follows: (i) 576,000 shares at an exercise price of $2.38
with a five year maturity, (ii) 100,000 shares at an exercise price of
$9.00 with a seven year maturity and (iii) 100,000 shares at an exercise
price of $11.00 with a seven year maturity.
2. The warrants shall have customary anti-dilution protection (such
anti-dilution protections shall not apply to the issuance of any manage-
ment stock and options to Alvarez & Marsal, Inc. as set forth in the dis-
closure statement to the Plan). The warrants will also have tag-along
rights which will expire on the earlier of (i) 3 years from the issuance
of the warrants or (ii) the consummation of an initial public offering
for Reorganized Wherehouse. Such tag-along rights shall only be applic-
able to a transaction or series of related transactions for the sale of
an amount greater than 750,000 shares of Reorganized Wherehouse held by
Cerberus Partners, L.P.
3. Whether or not obligated by law, Reorganized Wherehouse will
agree to be a reporting company under the Securities Exchange Act of
1934 for a period of no less than three years from the Effective Date.
DC-2 SECURED CLAIM
The Plan provided that the holder of the DC-2 Secured Claim would receive
either
8
full payment in cash or, if the DC-2 Property was abandoned to such
holder, a general unsecured claim for any deficiency. The DC-2 Property
was sold in December 1996 and the proceeds thereof were applied to the
payment in full of the DC-2 Secured Claim.
MISCELLANEOUS SECURED AND PRIORITY CLAIMS
Under the Plan, holders of Miscellaneous Secured Claims and Miscellaneous
Priority Claims will not be impaired.
CONVERTIBLE SUBORDINATED DEBENTURES
Under the Plan, the holders of Convertible Subordinated Debenture Claims
receive no distribution.
EQUITY HOLDERS
Under the Plan, the holders of equity interests receive no distribution.
RELEASES
The Plan was also modified to expand the releases related to the 1992
acquisition of the Company to include a release of the selling share-
holders, the principal of which was Adler & Shaykin. In return,
Adler & Shaykin agreed to fund a portion of the distribution to the
Senior Subordinated Noteholders.
The consummation and effectiveness of the Plan is subject to the satis-
faction of certain post-confirmation conditions (including the closing of
a new working capital facility and the execution and delivery of the Asset
Purchase Agreement, the Warrant Agreements and all required documents
thereunder) and the entry of a confirmation order by the Bankruptcy Court
that is unstayed.
9
3. LIABILITIES SUBJECT TO COMPROMISE
Liabilities subject to compromise include the following:
October 31, January 31,
1996 1996
------------ ------------
13% senior subordinated notes $110,000,000 $110,000,000
Variable rate term note and revolving
line of credit 90,262,000 92,170,000
Accrued interest 9,192,000 8,507,000
Lease rejection claims 6,000,000 6,000,000
Convertible subordinated debentures 5,344,000 5,344,000
Trade and other miscellaneous claims 55,777,000 57,644,000
------------ ------------
$276,575,000 $279,665,000
------------ ------------
4. SUMMARY OF FINANCIAL INFORMATION OF WEI HOLDINGS, INC.
Unconsolidated summary financial information of the Company's parent, WEI
Holdings, Inc., is as follows:
October 31, January 31,
1996 1996
------------ ------------
(In Thousands)
Current assets $ 38 $ 38
Total assets 38 38
Current liabilities 76 76
Deficiency in investment in the Company 174,019 156,287
Total liabilities 174,095 156,363
Redeemable common stock 3,872 3,872
Notes receivable from shareholders (660) (660)
Contingent shares (663) (663)
For the Nine Months Ended
October 31, October 31,
1996 1995
------------ ------------
(In Thousands)
Net Income $ 0 $ 10
10
WEI holds all of the capital stock of the Company and, in turn, is currently
owned by affiliates of Merrill Lynch Capital Partners, Inc. ("MLCP") (91.8% on a
fully diluted basis) and certain members of management (8.2% on a fully diluted
basis). Currently, WEI conducts no independent operations and has no
significant assets apart from its investment in the capital stock of the
Company.
On August 2, 1995, WEI filed a voluntary Petition for relief under Chapter
11 of Title 11 of the United States Code. See Note 2 above.
11
WHEREHOUSE ENTERTAINMENT, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion contains "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
statements consist of any statement other than a recitation of historical fact
and can be identified by the use of forward-looking terminology such as "may,"
"expect," "anticipate," "estimate," or "continue" or the negative thereof or
other variations thereon or comparable terminology. The reader is cautioned
that all forward-looking statements are necessarily speculative and there are
certain risks and uncertainties that could cause actual events or results to
differ materially from those referred to in such forward-looking statements.
The results for the nine months ended October 31, 1996 are not necessarily
indicative of the results that may be expected for the entire year. The risks
highlighted in this Report should not be assumed to be the only things that
could affect future performance of the Company. The Company does not have a
policy of updating or revising forward-looking statements and thus it should not
be assumed that silence by management of the Company over time means that actual
events are bearing out as estimated in such forward-looking statements.
This discussion should be read in conjunction with the financial statements,
related notes and Management's Discussion and Analysis of Financial Condition
and Results of Operations contained in the Company's Annual Report on Form 10-K
for the year ended January 31, 1996, and Quarterly Reports on Form 10-Q for
the quarters ended April 30, 1996 and July 31, 1996.
PETITION FOR RELIEF UNDER CHAPTER 11
On August 2, 1995 (the "Petition Date"), the Company and 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-
12
in-possession.
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 $19.5 million higher had it
continued to accrue from the period of February 1, 1996 through October 31,
1996. The above debt has also become "Subject to Compromise" and has been
classified as such on the Company's balance sheet.
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
approximately 85 real property leases. The Company also requested approval
to reject an additional 29 property leases.
The Company has obtained lease concessions, primarily reductions in base
rent and other charges, for a number of its leases. Based upon these
reductions, the Company has obtained Court approval for the assumption of
approximately 27 store leases since the filing. The Company has also
requested approval to assume an additional 196 property leases and 44
executory contracts.
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 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. As of July 30, 1996, the DIP financing facility was amended
to modify certain financial covenants contained therein. The Company was in
compliance with all DIP facility covenants, as amended, at October 31, 1996, or
had obtained appropriate waivers.
The Company is currently involved in negotiations with a potential lender
for a post-
13
bankruptcy financing facility. The Company is seeking a facility which 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 the merchandise inventory. It is anticipated that any such
facility will require that the Company maintain certain financial covenants and
provide certain financial information on a periodic basis. Any agreement that
is reached between the Company and a potential lender will be subject to
approval by the Bankruptcy Court.
On September 26, 1996 the Company filed with the Bankruptcy Court, an
Amended Plan of Reorganization (the "Plan"), as revised for technical
corrections on October 4, 1996, and amended on December 2, 1996, and further
amended on the record at a Confirmation hearing held on December 13, 1996.
See Note 2 to Notes to Condensed Financial Statements, above, for a summary
of the proposed treatment of creditor claims. The Bankruptcy Court orally
confirmed the Plan at the above hearing.
Since the filing, the Company has closed 90 stores (49 stores during fiscal
year 1996 and 41 stores during the nine months ended October 31, 1996). Total
store count at October 31, 1996 was 265.
14
RESULTS OF OPERATIONS
FOR THE QUARTERS ENDED OCTOBER 31, 1996 AND OCTOBER 31, 1995
Net revenues were $78.1 million and $93.1 million for the quarters ended
October 31, 1996 and 1995, respectively. The decrease of $15.0 million, or
16.1%, was principally due to the closing of 49 stores during fiscal year 1996
and 41 stores during the first nine months of fiscal year 1997, following the
bankruptcy filing, as well as continued competitive and economic pressures in
certain of the Company's markets.
A summary of total net revenues, by product category, is provided below:
NET REVENUES
BY PRODUCT CATEGORY
(DOLLAR AMOUNTS IN MILLIONS)
Quarter Ended
October 31,
1996 1995
----- -----
Net Merchandise Sales:
Compact discs (including used compact discs) $43.9 $46.6
Cassettes and other music 10.9 16.1
----- -----
Total music 54.8 62.7
Sales of new videocassettes 3.6 4.5
Video game software and hardware, general
merchandise, accessories, ticket commissions
and other 4.8 7.6
----- -----
Total merchandise sales 63.2 74.8
Videocassette and other rental income 14.9 18.3
----- -----
Total revenues $78.1 $93.1
----- -----
----- -----
Net merchandise sales were $63.2 million versus $74.8 million for the
quarters ended October 31, 1996 and 1995, respectively, representing an overall
decrease of 15.5%. On a same-store basis, however, net merchandise sales
declined by 2.6% during the quarter ended October 31, 1996 as compared to the
quarter ended October 31, 1995. These decreases in total and same-store net
merchandise sales are primarily attributable to the competitive and other
factors described above. Total net sales of music products, video games and
software, and accessories decreased in virtually all of the principal categories
of these products that are carried by the Company, except for sales of used
products which increased.
Rental income includes the rental of videocassettes, video games and game
players, audiocassette books, and laserdiscs; and sales of previously viewed
videocassettes and previously
15
played video games. Approximately 224 of the Company's stores currently
offer rental products. Rental income was $15.0 million versus $18.3 million
during the quarters ended October 31, 1996 and 1995, respectively,
representing a decrease of $3.3 million or 18.0%. On a same-store basis,
rental income decreased approximately 8.0% as compared to the prior year.
The Company believes that the decrease in same-store rental income was
attributable to continued competition and general softening in rental
consumer spending nationwide. During the quarter ended October 31, 1996, the
Company decreased its purchases of video rental product by $0.7 million or
8.5% versus the same quarter of the prior year.
The Company believes that in the future its business will continue to be
impacted by various competitive and economic factors, including, but not limited
to, consumer tastes, new releases of music, videocassette and video game titles
available for sale or rental, and general economic trends impacting retailers
and consumers. In addition, in more recent years the Company's revenues have
been impacted by increased competition from other music and video specialty
retail chains, as well as discounters and mass merchandisers. Further, future
revenues may be reduced as a result of the closure of 90 stores since the
bankruptcy filing, 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.
Cost of sales decreased $7.0 million to $40.0 million for the quarter ended
October 31, 1996 versus $47.0 million for the quarter ended October 31, 1995,
representing a decrease of 14.9%. As a percentage of net merchandise sales,
costs of sales increased 0.6% to 63.4% during the quarter ended October 31, 1996
versus 62.8% during the quarter ended October 31, 1995. The 0.6% increase in
cost of sales as a percentage of net merchandise sales was principally due to
increased merchandise return costs and an increase in the provision for
obsolescence, offset by decreases in the cost of product sold and higher prompt
payment discounts.
Cost of rentals, including amortization, decreased to $9.4 million during
the quarter ended October 31, 1996, a decrease of $1.9 million or 16.8%, versus
$11.3 million during the quarter ended October 31, 1995. As a percentage of
rental income, cost of rentals increased to 62.8% during the quarter ended
October 31, 1996 versus 61.7% during the quarter ended October 31, 1995,
representing an increase of 1.1%. The 1.1% increase in cost of rentals,
including amortization, is primarily attributable to higher amortization and
lower recapture of amortization on video inventory returns, offset by decreases
in shrink and costs related to the sale and liquidation of used rental
inventory.
Merchandise sales as a percentage of aggregate net revenues increased 0.5%
to 80.9% during the quarter ended October 31, 1996 versus 80.4% during the
quarter ended October 31, 1995.
Several major retail chains, including Best Buy, Blockbuster Entertainment,
Hollywood Entertainment and Virgin Megastores, over the past two years have
increased their retail store presence in the Company's markets. This trend may
continue and it is anticipated the Company will in future periods experience
increased competition from companies with greater financial resources than its
own, and that such competition will result in continued pressure on revenues
16
and gross profit margins.
Selling, general and administrative expenses, were $35.1 million versus
$42.5 million for the quarters ended October 31, 1996 and 1995, respectively, a
decrease of $7.4 million or 17.4%. As a percentage of net revenues, selling,
general and administrative expenses, were 44.9% during the quarter ended October
31, 1996 versus 45.6% during the quarter ended October 31, 1995, representing a
decrease of 0.7%. The 0.7% reduction was principally due to decreases as a
percentage of revenue in semi-variable expense and rent and other occupancy
costs offset by increases in payroll, advertising and other variable expense.
During the quarter, rent and occupancy costs declined in absolute dollars by
$3.5 million. Further decreases may be experienced as a result of the rejection
of additional real property leases during the bankruptcy case.
Interest expense (net of interest income) decreased $0.8 million to $0.2
million for the quarter ended October 31, 1996 versus $1.0 million for the
quarter ended October 31, 1995. The decrease was primarily attributable to a
reduction in the amount of borrowings on the DIP facility at October 31, 1996 as
compared to October 31, 1995.
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 quarter, the Company reported total reorganization
items of $0.9 million which was entirely comprised of professional fees.
Reorganization items are expected to continue in future periods as a result of
the bankruptcy case.
Based upon current operations of the Company and other factors, the Company
did not record an income tax benefit for the quarters ended October 31, 1996 and
1995, and does not anticipate doing so for the remainder of the current fiscal
year. The Company anticipates that pre-tax losses, if any, which may be
realized during the fiscal year ending January 31, 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 may be available
to the Company to reduce any future taxes payable under applicable Internal
Revenue Service and state regulations should the Company generate future taxable
income. Under certain circumstances, the Company could incur significant tax
liabilities from the forgiveness of indebtedness as a result of the bankruptcy
case, the eventual outcome of which is unknown at this time.
The Company is currently under audit by the California Franchise Tax Board
("FTB") for tax years January 31, 1992, 1993 and 1994. The Company believes
that it has made adequate provision in the financial statements for this audit.
In conjunction with the above-mentioned audit, the FTB has filed a proof of
claim in the bankruptcy court in the amount of $10.6 million for allegedly
unpaid income taxes during the years under audit. This claim, if allowed, would
become a pre-petition claim and as such would be paid out at the end of the
bankruptcy case. While the Company believes that the ultimate allowed amount of
this claim will constitute a small fraction of the claimed amount, there can be
17
no assurance as to the final outcome of this claim.
FOR NINE MONTHS ENDED OCTOBER 31, 1996 AND OCTOBER 31, 1995
Net revenues were $253.3 million and $302.1 million for the nine months
ended October 31, 1996 and 1995, respectively. The decrease of $48.8 million,
or 16.2%, was principally due to the closing of 90 stores subsequent to the
bankruptcy filing, as well as continued competitive and economic pressures in
certain of the Company's markets.
A summary of total net revenues, by product category, is provided below:
NET REVENUES
BY PRODUCT CATEGORY
(DOLLAR AMOUNTS IN MILLIONS)
Nine Months Ended
October 31,
1996 1995
----- -----
Net Merchandise Sales:
Compact discs (including used compact discs) $131.8 $146.0
Cassettes and other music 40.7 53.7
----- -----
Total music 172.5 199.7
Sales of new videocassettes 15.0 14.9
Video game software and hardware, general
merchandise, accessories, ticket commissions
and other 13.4 24.4
------ ------
Total merchandise sales 200.9 239.0
Videocassette and other rental income 52.4 63.1
----- -----
Total revenues $253.3 $302.1
------ ------
Net merchandise sales were $200.9 million versus $239.1 million for the nine
months ended October 31, 1996 and 1995, respectively, representing an overall
decrease of 16.0%. On a same-store basis, however, net merchandise sales
declined by 5.5% during the nine months ended October 31, 1996 as compared to
the nine months ended October 31, 1995. These decreases in total and same-store
net merchandise sales are primarily attributable to the competitive and other
factors described above. Total net sales of music products, video games and
software, and accessories decreased in virtually all of the principal categories
of these products that are carried by the Company, except for sales of used
products which increased.
Rental income was $52.4 million versus $63.1 million during the nine months
ended October 31, 1996 and 1995, respectively, representing a decrease of $10.7
million or 17.0%. On a same-store basis, rental income decreased approximately
10.7% as compared to the prior year. The Company believes that the decrease in
same-store rental income was attributable to
18
continued competition and general softening in rental consumer spending
nationwide. During the nine months ended October 31, 1996, the Company
decreased its purchases of video rental product by $2.8 million, or 10% versus
the same nine months of the prior year.
Cost of sales decreased $23.1 million to $130.0 million for the nine months
ended October 31, 1996 versus $153.1 million for the nine months ended October
31, 1995, representing a decrease of 15.1%. As a percentage of net merchandise
sales, costs of sales increased 0.7% to 64.7% during the nine months ended
October 31, 1996 versus 64.0% during the nine months ended October 31, 1995.
The 0.7% increase in cost of sales as a percentage of net merchandise sales was
principally due to increased merchandise return costs and lower prompt payment
discounts on merchandise inventory purchases.
Cost of rentals, including amortization, decreased to $27.3 million during
the nine months ended October 31, 1996, a decrease of $2.7 million or 9%, versus
$30.0 million during the nine months ended October 31, 1995. As a percentage of
rental income, cost of rentals increased to 52.1% during the nine months ended
October 31, 1996 versus 47.6% during the nine months ended October 31, 1995,
representing an increase of 4.5%. The 4.5% increase in cost of rentals,
including amortization, is primarily attributable to higher amortization,
shrinkage and costs related to an increased liquidation of used rental
inventory.
Merchandise sales as a percentage of aggregate net revenues increased by
0.2% from 79.1% for the period ended October 31, 1995, to 79.3% for the period
ended October 31, 1996.
Selling, general and administrative expenses, were $109.6 million versus
$131.3 million for the nine months ended October 31, 1996 and 1995,
respectively, a decrease of $21.7 million or 16.5%. As a percentage of net
revenues, selling, general and administrative expenses were 43.3% during the
nine months ended October 31, 1996 versus 43.5% during the nine months ended
October 31, 1995 representing a decrease of 0.2%. The 0.2% decrease was
principally due to decreases as a percentage of revenue in semi-variable expense
and rent and other occupancy costs offset by increases in payroll and other
variable expense. During the nine months, rent and other occupancy costs
decreased in absolute dollars by $8.7 million. Further decreases may be
experienced as a result of the rejection of additional real property leases
during the bankruptcy case.
Interest expense (net of interest income) decreased $13.5 million to $0.4
million for the nine months ended October 31, 1996 versus $13.9 million for the
nine months ended October 31, 1995. The decrease was primarily attributable to
the suspension of the accrual of interest following the filing of bankruptcy on
August 2, 1995, as noted previously.
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 nine months, the Company reported total
reorganization items of $3.8 million which was comprised of professional fees of
$2.7 million and store closing costs of $1.1 million. Reorganization items are
expected to continue in future periods as a result of the bankruptcy case.
19
Based upon current operations of the Company and other factors, the Company
did not record an income tax benefit for the nine months ended October 31, 1996
and 1995, and does not anticipate doing so for the remainder of the current
fiscal year. The Company anticipates that pre-tax losses, if any, which may be
realized during the fiscal year ending January 31, 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 the Company to reduce any future taxes payable under applicable Internal
Revenue Service and state regulations should the Company generate future taxable
income. Under certain circumstances, the Company could incur significant tax
liabilities from the forgiveness of indebtedness as a result of the bankruptcy
case, the eventual outcome of which is unknown at this time.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended October 31, 1996, the Company's net cash used
by operating activities decreased by $27.8 million to cash used of $8.9 million
from cash used during the nine months ended October 31, 1995 of $36.7 million.
The decrease of $27.8 million was due to lower decreases in accounts payable,
accrued expenses and other liabilities of $25.2 million, a cash increase
resulting from lower prepaid inventory deposits of $5.1 million and other
factors ($6.4 million), offset by lower decreases in merchandise inventory of
$8.9 million.
Cash used in investing activities decreased by $5.8 million to $2.4 million
during the nine months ended October 31, 1996 from $8.2 million during the nine
months ended July 31, 1995, principally due to decreased acquisitions of
property, equipment and improvements. While at the present time the Company
does not have any plans that materially alter the level of its planned capital
spending, such capital spending will be subject to future availability of funds
and other liquidity concerns.
Cash provided by financing activities decreased by $40.0 million from $45.3
million provided during the nine months ended October 31, 1995 to $5.3 million
provided in the nine months ended October 31, 1996 principally due to decreased
short-term borrowings.
While the Company believes that the current DIP borrowing facility (see Note
2 under Notes to Condensed Financial Statements) is adequate to support
operations for the remainder of the current fiscal year, there can be no
assurance as to the effect which any future changes in the Company's operations
(such as closed stores, material changes in interest rates, or its possible
emergence from bankruptcy) may have on its liquidity.
The Company has filed an Amended Plan of Reorganization with the Bankruptcy
Court (see Note 2 under Notes to Condensed Financial Statements). This Plan
requires the Company to make certain payments to creditors and others.
As of October 31, 1996 the Company has not signed any lease commitments to
open new stores during the next twelve months, or any other material commitments
outside those referenced
20
earlier.
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
operations and it's 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.
21
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
(i) Bankruptcy filing.
For a further description of developments with respect to the
Bankruptcy filing see the Company's Reports on Form 10-K and 10-Q for the year
ended January 31, 1996 and the quarters ended April 30, 1996 and July 31, 1996,
respectively.
On September 26, 1996, the Company and its parent Company, WEI Holdings,
Inc. (together, the "Debtors") filed the Debtors' First Amended Chapter 11
Plan. On October 4, 1996, the Debtors filed their First Amended Chapter 11
Plan, as revised for technical corrections (the "Plan") and the accompanying
disclosure statement. The deadline for filing objections to the adequacy of
the disclosure statement was October 31, 1996.
On November 4, 1996, the hearing on the adequacy of the disclosure
statement was held. The Bankruptcy Court approved the disclosure statement,
as amended by the Debtors prior to the hearing and as further amended on the
record at the hearing. The Bankruptcy Court ordered, among other things, that
the deadline for voting on the Plan would be December 9, 1996 and for filing
an objection to the Plan would be December 3, 1996.
On December 3, 1996, the Debtors filed certain documents required under
the Plan, including a schedule of certain non-residential real property
leases and executory contracts to be assumed at the confirmation hearing on
the Plan and the exhibits to the Plan. On December 6, 1996, the Debtor's
senior lenders filed a Schedule of Initial Members of the Board of Directors
of Reorganized Wherehouse.
On December 13, 1996, the confirmation hearing on the Plan was held.
Objections to the Plan had been filed by, among other entities, the Official
Committee of Unsecured Creditors and U.S. Trust Company of New York, as
indenture trustee for holders of the Company's Senior Subordinated Notes. On
December 13, 1996, a settlement was reached among the Debtors, the Company's
senior lenders, these objecting parties and a third party. As a result of
such settlement, these objections were withdrawn. All other objections filed
against the Plan were either resolved and withdrawn or overruled by the
Bankruptcy Court. The Bankruptcy Court orally confirmed the Plan, as amended
on the record at the hearing.
During the three month period ended October 31, 1996, the Bankruptcy
Court entered various other orders, including orders approving the assumption
of certain non-residential real property leases, approving the rejection of
certain non-residential real property leases and executory contracts,
approving a settlement agreement with one of the Company's worker's
compensation insurance companies, approving an amendment to the Debtor's
debtor-in-
22
possession credit agreement, supplementing the retention and employment of
Ernst & Young LLP as real estate consultants, extending the time to assume or
reject non-residential real property leases, and extending the Debtors'
exclusivity periods.
In November 1996, the Bankruptcy Court's orders included extending the
time for the Debtors to assume or reject their unexpired non-residential real
property leases through January 31, 1997, approving the sale of property that
formerly contained the Debtors' distribution center and the assumption and
assignment of the lease covering such property, and approving the payment of
deposits required in connection with the Debtors' efforts to obtain a
post-confirmation working capital facility. On December 13, 1996, the
Bankruptcy Court approved a further extension of the Debtors' exclusivity
periods through January 31, 1997.
Currently pending before the Bankruptcy Court is a motion to amend the
employment contract of Bruce Ogilvie, the Company's current President and
Chief Executive Officer, to provide for the termination of such contract on
the effective date of the Plan and for certain payments to be made in
connection with the confirmation of the Plan. Also pending before the
Bankruptcy Court is a motion to assume or reject the remaining
non-residential real property leases and executory contracts of the Debtors.
(ii) McMahan and Related Actions.
For a description of the prior history and background of McMahan v.
Wherehouse Entertainment, Inc., et al. and a related action, Don Thompson v.
Wherehouse Entertainment, Inc. et al., see the Company's Annual Report on
Form 10-K for the year ended January 31, 1996 and Quarterly Report on Form
10-Q for the quarter ended July 31, 1996.
(iii) 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, see Item 1 of Part II of the Company's Quarterly
Report on Form 10-Q for the quarter ended July 31, 1996. The Plan provides
that on its effective date, this adversary proceeding will be dismissed with
prejudice.
(iv) Declaratory Relief Action
In October 1996, the Official Committee and U.S. Trust filed an
adversary proceeding entitled United States Trust Company of New York and
the Official Committee of Unsecured Creditors of Wherehouse Entertainment,
Inc. and WEI Holdings, Inc. v. Cerberus Partners, L.P., individually and as
agent for the beneficial holders of Senior Lenders Claims. John Does
1-10,fi-ctitiously named parties whose true names are presently unknown, the
parties intended being the beneficial holders of Senior Lender Claims,
Wherehouse Entertainment, Inc., and WEI Holdings, Inc., Adversary Proceeding
No. A-96-183, in the United States Bankruptcy Court for the District of
Delaware. This proceeding sought declaratory relief relating to the
subordination provisions of the Senior Subordinated Note Indenture. In light
of the Court's oral confirmation of the Plan at the confirmation hearing,
this proceeding will be dismissed as moot.
(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 3. DEFAULTS UPON SENIOR SECURITIES
As a result, among other things, of the bankruptcy filing, the Company
is currently in default under the indentures governing the 13% Senior
Subordinated Notes ($117.2 million in principal and accrued interest as of
August 2, 1995) and 6 1/4% Convertible Subordinated Debentures ($5.6 million in
principal and accrued interest as of August 2, 1995). The Company is also in
default under various agreements governing the Revolving Line of Credit and
Variable Rate Term Note ($93.8 million in principal and accrued interest as of
August 2, 1995.)
23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.38 Letter Agreement dated June 14, 1996 between the
Company and GGG, Inc.
10.39 Letter Agreement dated June 14, 1996 between the
Company and Bruce Ogilvie
27.0 Financial Data Schedule
(b) Current Reports on Form 8-K
None.
10.40 Amendment No. 1 to Debtor-In-Possession Credit
Agreement dated July 30, 1996 between the Company and
Bankers Trust Company.
10.41 Debtors First Amended Chapter 11 Plan as Revised for
Technical Corrections on October 4, 1996.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WHEREHOUSE ENTERTAINMENT, INC.
(Registrant)
Date: December 20, 1996 /s/ Bruce Ogilvie
----------------------------
BRUCE OGILVIE
President and Chief Executive Officer
(Principal Executive Officer)
Date: December 20, 1996 /s/ Henry Del Castillo
------------------------------------
HENRY DEL CASTILLO
Vice President, Chief Financial Officer
and Secretary (Principal Financial
and Accounting Officer)
25