1
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 31,1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-22289
WHEREHOUSE ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of
incorporation or organization)
95-4608339
(IRS Employer Identification Number)
19701 HAMILTON AVENUE, TORRANCE, CA 90502-1311 (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 registrant
was 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 whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15 (d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under the plan
confirmed by a court. Yes [X] No [ ]
As of October 31, 1998, 10,750,474 shares of the registrant's common stock were
issued and outstanding and approximately 77,897 additional shares are expected
to be issued pursuant to the bankruptcy plan of reorganization discussed in Item
1 below.
2
INDEX
WHEREHOUSE ENTERTAINMENT, INC.
Page
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FORWARD LOOKING STATEMENTS 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Balance Sheets -
October 31, 1998 (Unaudited) and January 31, 1998 4
Consolidated Condensed Statements of Income -
Three Months ended October 31, 1998 and 1997 (Unaudited)
and Nine Months ended October 31, 1998 and 1997 (Unaudited) 5
Consolidated Condensed Statements of Cash Flows -
Nine Months ended October 31, 1998 and 1997 (Unaudited) 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operation 12
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURES 22
3
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes certain statements that may
be deemed to be forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. The sections of this report containing
such forward-looking statements include "Management's Discussion and Analysis of
Financial Condition and Results of Operation," under Item 2 of Part I below.
Statements in this Report that address activities, events or developments that
the registrant expects or anticipates will or may occur in the future, including
such things as the future issuance of shares, future capital expenditures
(including the amount and nature thereof), expansion and other developments and
technological trends of industry segments in which the registrant is active,
business strategies, growth of the registrant's and its competitor's business
and operations and other such matters are forward-looking statements. Although
the registrant believes the expectations expressed in such forward-looking
statements are based on reasonable assumptions within the bounds of its
knowledge of its business, a number of factors could cause actual results to
differ materially from those expressed in any forward-looking statements,
whether oral or written, made by or on behalf of the registrant.
The registrant's operations are subject to factors outside its control.
Any one, or a combination, of these factors could materially affect the results
of the registrant's operations. These factors include: (a) possible delays and
difficulties in integrating the Blockbuster Music operations with Wherehouse's
(b) the ability to retain Blockbuster Music's suppliers and customers (c)
changes in levels of competition from current competitors and potential new
competition from both retail stores and alternative methods or channels of
distribution such as electronic and telephone shopping services and mail order;
(d) loss of a significant vendor or prolonged disruption of product supply; (e)
the presence or absence of popular new releases and products in the product
categories the registrant represents; (f) changes in levels of consumer
spending, especially during seasonally significant periods; (g) changes in
Federal and state income tax rules and regulations or interpretations of
existing periods; (h) changes in the general economic conditions in the United
States including, but not limited to consumer sentiment about the economy in
general; (i) the ability to attract and retain key personnel and (j) adverse
results in significant litigation matters. The foregoing should not be construed
as an exhaustive list of all factors which could cause actual results to differ
materially from those expressed in forward-looking statements made by the
registrant. Forward-looking statements made by or on behalf of the registrant
are based on a knowledge of its business and the environment in which it
operates, but because of the factors listed above, actual results may differ
from those anticipated results described in those forward-looking statements.
Consequently, all of the forward-looking statements made are qualified by these
cautionary statements and there can be no assurance that the actual results or
developments anticipated by the registrant will be realized or, even if
substantially realized, that they will have the expected consequences to or
effects on the registrant or its business or operations.
4
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
WHEREHOUSE ENTERTAINMENT, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
ASSETS
October 31, January 31,
1998 1998
------------ ------------
(Unaudited)
Current Assets
Cash $ 28,875,000 $ 54,720,000
Receivables 11,584,000 1,296,000
Merchandise inventory 272,343,000 62,472,000
Rental inventory, net 2,477,000 4,278,000
Other current assets 3,220,000 1,237,000
Deferred taxes 10,915,000 1,799,000
------------ ------------
Total current assets 329,414,000 125,802,000
Property, equipment and improvements, net 69,653,000 17,627,000
Reorganization value in excess of amounts allocable to
identifiable assets, net 13,161,000 14,358,000
Goodwill for new acquisition 16,050,000
Deferred taxes 17,208,000 2,952,000
Other assets 989,000 255,000
------------ ------------
Total assets $446,475,000 $160,994,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued expenses $143,851,000 $ 60,339,000
Acquired store leases in excess of fair
market value 5,748,000
Acquired store closure and other related reserves 20,095,000
Current portion of capital lease obligations-stores 5,709,000 193,000
Deferred taxes 10,138,000
------------ ------------
Total current liabilities 185,541,000 60,532,000
Line of credit borrowings 97,823,000
Long-term debt and other long term liabilities 9,458,000 4,648,000
Acquired store leases in excess of fair
market value 27,340,000
Capital lease obligations-stores 26,119,000 294,000
Notes payable 4,142,000 4,048,000
Deferred taxes 1,437,000
Shareholders' equity
Common stock, $.01 par value, 24,000,000
authorized, 10,750,474 and 10,619,201 issued and
outstanding at October 31, 1998 and January 31,
1998, respectively 108,000 106,000
Additional paid-in capital 89,400,000 89,377,000
Retained earnings 11,100,000 7,702,000
Notes receivable (5,993,000) (5,713,000)
------------ ------------
Total shareholders' equity 94,615,000 91,472,000
------------ ------------
Total liabilities and shareholders' equity $446,475,000 $160,994,000
============ ============
See accompanying notes to consolidated condensed financial statements
5
WHEREHOUSE ENTERTAINMENT, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (LOSS)
(Unaudited)
Three Months Ended Nine Months Ended
------------------------------- -------------------------------
October 31, October 31, October 31, October 31,
1998 1997 1998 1997
------------ ------------ ------------ ------------
Sales merchandise revenue $ 70,496,000 $ 60,762,000 $197,857,000 $184,342,000
Rental revenue 7,042,000 11,199,000 25,098,000 38,682,000
------------ ------------ ------------ ------------
Total revenues 77,538,000 71,961,000 222,955,000 223,024,000
------------ ------------ ------------ ------------
Cost of sales merchandise revenue 44,845,000 37,903,000 125,037,000 117,656,000
Costs of rentals, including amortization 3,693,000 6,008,000 13,046,000 21,728,000
------------ ------------ ------------ ------------
Total cost of revenues 48,538,000 43,911,000 138,083,000 139,384,000
------------ ------------ ------------ ------------
Selling, general and administrative expense 26,907,000 25,195,000 74,476,000 77,302,000
Depreciation and amortization 1,780,000 1,616,000 5,072,000 4,849,000
------------ ------------ ------------ ------------
Income from operations 313,000 1,239,000 5,324,000 1,489,000
Interest expense 1,199,000 115,000 1,418,000 337,000
Interest income (527,000) (494,000) (1,888,000) (1,032,000)
------------ ------------ ------------ ------------
Income (loss) before income taxes (359,000) 1,618,000 5,794,000 2,184,000
Provision (benefit) for income taxes (141,000) 648,000 2,397,000 913,000
------------ ------------ ------------ ------------
Net income (loss) $ (218,000) $ 970,000 $ 3,397,000 $ 1,271,000
============ ============ ============ ============
Basic net income (loss) per share $ (0.02) $ 0.09 $ 0.32 $ 0.12
============ ============ ============ ============
Diluted net income (loss) per share $ (0.02) $ 0.09 $ 0.29 $ 0.12
============ ============ ============ ============
Weighted average number of common shares
Outstanding -Basic 10,744,108 10,546,258 10,673,265 10,371,725
============ ============ ============ ============
Weighted average number of common shares and
common equivalent share outstanding-Diluted 10,744,108 10,972,123 11,517,902 10,821,155
============ ============ ============ ============
See accompanying notes to consolidated condensed financial statements.
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WHEREHOUSE ENTERTAINMENT, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
-------------------------------------
October 31, October 31,
1998 1997
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Operating activities:
Net income $ 3,398,000 $ 1,271,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,072,000 4,849,000
Rental amortization included in cost of rental 9,167,000 16,901,000
Book value of rental inventory dispositions, included
in cost of rental 1,565,000 3,300,000
Deferred taxes (105,000) (3,000,000)
Changes in operating assets and liabilities:
Receivables (4,198,000) 1,389,000
Prepaid inventory deposits - 4,486,000
Merchandise inventory (23,491,000) (3,013,000)
Accounts payable and accrued expenses 18,742,000 18,357,000
Other current assets (613,000) -
Rental inventory purchases (9,531,000) (16,773,000)
------------- -------------
Net cash provided by operating activities 6,000 27,767,000
Investing activities:
Acquisition of property, equipment and improvements (5,142,000) (2,930,000)
Other assets (544,000) 538,000
Cash paid in business acquisition, net of cash acquired (117,564,000) -
------------- -------------
Net cash used in investing activities (123,250,000) (2,392,000)
Financing activities:
Interest on note receivable (280,000) (280,000)
Payments on capital lease obligations and long-term debt (169,000) (553,000)
Issuance of new stock from warrants 25,000 -
Line of credit borrowings 97,823,000 -
------------- -------------
Net cash provided by (used in) financing activities 97,399,000 (833,000)
------------- -------------
Net (decrease) increase in cash (25,845,000) 24,542,000
Cash at beginning of the period 54,720,000 6,178,000
------------- -------------
Cash at end of the period $ 28,875,000 $ 30,720,000
============= =============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 991,000 $ 82,042
Income taxes $ 1,362,000 $ 1,710,000
Noncash investing and financing activities
Purchase of Blockbuster Music
Fair value of assets acquired 289,134,000
Cash paid 117,564,000
-------------
Liabilities assumed $ 171,570,000
=============
See accompanying notes to consolidated condensed financial statements
7
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial
statements have been prepared in accordance with the instructions to
Form 10-Q of the Securities and Exchange Commission. Accordingly, they
do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation
have been included. Operating results for the nine-month period ended
October 31, 1998 are not necessarily indicative of the results that may
be expected for the year ended January 31, 1999. Certain
reclassifications of balances have been made to the 1997 amounts to
conform to the 1998 presentation. For further information, refer to the
financial statements and footnotes thereto included in the Company's
reports on Form 10-K for the year ended January 31, 1998.
2. ACQUISITION
Pursuant to a Stock Purchase Agreement dated as of August 10,
1998, the Company, on October 26, 1998, acquired from Viacom
International Inc. ("Seller"), all of the capital stock of certain
retail music subsidiaries of Seller (collectively, "Blockbuster Music")
for a purchase price of approximately $121.2 million (including an
estimated $3.7 million of direct transaction costs), subject to certain
adjustments. Pursuant to the Stock Purchase Agreement, the purchase
price paid by the Company is to be adjusted by the difference, if any,
between the adjusted working capital (as defined) of Blockbuster Music
as of the closing date, and the adjusted working capital (as defined) as
of March 31, 1998. The Stock Purchase Agreement sets forth certain
mechanisms for calculating any such working capital adjustments. The
price the Company paid at closing included Seller's preliminary estimate
of this working capital adjustment. The Stock Purchase Agreement
provides a mechanism for resolution of the final working capital
adjustment, which the Company expects will occur in 1999. The
acquisition involved 378 Blockbuster Music Stores in 33 states.
The acquisition was funded with a combination of excess cash and
the proceeds of a loan made pursuant to an amended loan agreement
entered into with Congress Financial Corporation (Western), the
Company's lender (See Note 4). Pursuant to a Transition License
Agreement between Seller and the Company, the Company may continue to
use certain trade names, trademarks and service marks in the conduct of
the Blockbuster Music business for a limited time. During that time, the
Company will change the name of the stores to the Wherehouse name. In
addition, pursuant to a Transition Services Agreement, the Company may
utilize certain services and facilities of Seller for a transition
period of up to one year from the date of the acquisition.
8
The acquisition was accounted for under the purchase method of
accounting. Based on preliminary analyses, the Company recorded the
acquired assets and liabilities assumed at their estimated fair values
at the date of acquisition based on preliminary valuations and other
studies that have not yet been finalized. A preliminary allocation of
the purchase price has been made to major categories of assets and
liabilities based on the Company's estimates. The preliminary
allocation of the purchase price includes, among other things, capital
lease obligations for real estate leases of the acquired stores, store
leases in excess of fair market value, and acquired store closing and
other reserves of approximately $31.8 million, $33.1 million, and $20.1
million, respectively. The actual allocation of purchase price and the
resulting effect on income from operations may differ significantly from
the preliminary estimates. The excess purchase price over the net assets
acquired has been assigned to goodwill.
The financial results of Blockbuster Music have been
consolidated with Wherehouse Entertainment, Inc. effective October 26,
1998. The following unaudited pro forma financial information combines
the Blockbuster Music results of operations with those of Wherehouse
Entertainment, Inc. as if the acquisition occurred on February 1, 1997,
and is not necessarily indicative of future operating results of the
Company.
Prior to being acquired by the Company, Blockbuster Music
operated as a component of Blockbuster Entertainment Group, and separate
financial statements were not prepared; accordingly, no such financial
statements are readily available. The historical financial information
included herein was obtained from Blockbuster Music store operating
statements and other internal financial information that included
corporate overhead allocations. Details supporting the overhead and
corporate expense allocations made to Blockbuster Music were not readily
available.
The pro forma adjustments are based upon the available
information and certain assumptions that the Company believes are
reasonable. The pro forma financial information does not include any
efficiencies that may be realized due to synergies resulting from the
acquisition.
CERTAIN PRO FORMA FINANCIAL INFORMATION
NINE MONTHS ENDED
-------------------------
(in millions, except per share data) October 31,
-------------------------
(unaudited)
1998 1997
------- -------
Net Sales $574.7 $571.8
Net Loss(a) $ (5.0) $ (8.8)
Basic and Diluted Net Loss
Per Share $(0.47) $(0.85)
9
Pro forma adjustments include the recording of (1) interest
expense related to the loan to finance the acquisition,
(2) depreciation and amortization of property and equipment based on
their estimated fair market value, (3) preliminary estimates of goodwill
amortization and (4) the Company's estimates of reasonable distribution
center costs and overhead allocations.
(a) EBITDA is defined as income from operations, plus depreciation
and amortization. Management believes that due to the Company's combined
format of rental product and sale merchandise, a more appropriate
calculation of EBITDA (hereafter referred to as Adjusted EBITDA) should
include the net difference between rental amortization plus the book
value of rental dispositions, versus rental inventory purchased during
the period. The Company has included certain information concerning pro
forma unaudited Adjusted EBITDA because management believes it would be
useful information for certain investors and analysts to analyze
operating performance and to determine the Company's ability to service
debt. Pro forma unaudited Adjusted EBITDA excludes the non-cash impact
of store rent expense accrued to recognize minimum rents in a
straight-line basis over the term of the lease. Pro forma unaudited
Adjusted EBITDA for the period ended October 31, 1997 includes a
non-recurring cash benefit of $2.0 million resulting from the impact of
one-time credits received from landlord concessions. The method of
calculating Adjusted EBITDA set forth above may be different from
calculations of EBITDA employed by other companies and, accordingly may
not be directly comparable to such other computations. Adjusted EBITDA
should not be viewed as a substitute for Generally Accepted Accounting
Principles (GAAP) measurements such as net income or cash flow from
operations. Rather, it is presented as supplementary information. Pro
forma unaudited Adjusted EBITDA for the nine months ended October 31,
1998 was $8.1 million compared to $2.7 million for the nine months ended
October 31, 1997.
3. REORGANIZATION UNDER CHAPTER 11
The Plan of Reorganization for the Company's predecessors (the
"Plan") was confirmed by an order of the Bankruptcy Court entered on
January 7, 1997. The effective date of the Plan occurred on January 31,
1997 (the "Effective Date").
Since the Effective Date, the Bankruptcy Court has retained
jurisdiction over certain claims and other matters relating to the
bankruptcy estates of the Company's predecessors, but the Company has
been and is free to carry out its business without oversight by the
Bankruptcy Court.
For a summary of the Plan of Reorganization, reference is made to
the Company's Annual Report on Form 10-K for the year ended January 31,
1998.
On January 31, 1997, the Company implemented the recommended
accounting principles for entities emerging from Chapter 11 set forth in
the American Institute of Certified Public Accountants Statement of
Position 90-7 on Financial Reporting by Entities in Reorganization under
the Bankruptcy Code (SOP 90-7). This resulted in
10
the use of fresh start reporting, since the reorganization value, as
defined, was less than the total of all post-petition liabilities and
pre-petition claims, and holders of voting shares immediately before
confirmation of the Plan received less than fifty percent of the voting
shares of the emerging entity. Under this concept, all assets and
liabilities were restated to reflect the reorganization value of the
reorganized entity, which approximated its fair value at the date of
reorganization. In addition, the accumulated deficit of the Company was
eliminated and its capital structure was recast in conformity with the
Plan.
4. REVOLVING CREDIT FACILITY
In connection with the Blockbuster Music acquisition, the Company
entered into an amended loan agreement with Congress Financial
Corporation (Western) that provides a revolving credit line of up to
$165,000,000 including a letter of credit subfacility of $10,000,000
(the "Congress Facility"). The revolving line of credit under the
Congress Facility is divided into two tranches, Tranche A and Tranche B.
The Company may borrow up to $155,000,000 under Tranche A. Tranche A
loans bear an interest rate of prime plus 0.5%, or at the Company's
election, an adjusted Eurodollar rate plus 1.75%. The Company's ability
to make Tranche A borrowings is subject to borrowing base limitations
based upon, among other things, the value of certain eligible
merchandise inventory. If there is no availability under the Tranche A
line, the Company may borrow up to $10.0 million under the Tranche B
line. Tranche B loans bear an interest rate (i) on the first $5.0
million, of prime plus 3.75% or an adjusted Eurodollar rate plus 5.0%,
and (ii) at an interest rate on the next $5.0 million of prime plus
4.75% or an adjusted Eurodollar rate plus 6.0%.
As of October 31, 1998, there was an outstanding loan balance of
$97,823,000 and there were no outstanding letters of credit under the
Congress Facility.
5. NET INCOME PER SHARE
During the fiscal year ended January 31, 1998, the Company
adopted Statements of Financial Accounting Standard No. 128 ("SFAS
128"), "Earnings Per Share". In accordance with SFAS 128, primary
earnings per share has been replaced with basic earnings per share, and
fully diluted earnings per share have been replaced with diluted
earnings per share, which includes potentially dilutive securities such
as outstanding options. Prior periods have been presented to conform to
SFAS 128. There is no established trading market for the voting stock of
the Company. In order to arrive at an average market price for the
diluted earnings per share computation, the Company obtains market data
of stock transactions through public beneficial ownership reports filed
by its directors and large holders, and occasionally receives
information regarding trades from an independent stockbroker, including
the number of shares and the bid or asked price of the shares during the
period.
The weighted average number of common shares and common equivalent
shares includes outstanding stock options granted on April 7, 1998 and
September 22, 1998 pursuant to the Wherehouse Entertainment, Inc. 1998
Stock Incentive Plan (the "Stock
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Incentive Plan"), which was approved by the shareholders at the Annual
Meeting of the Shareholders on October 21, 1998. The weighted average
number of common shares and common equivalent shares also includes
options issued in connection with the Non-Transferable Stock Option
Agreement (the "Option Agreement") between the Company and A&M
Investment Associates #3 LLC ("A&M #3"). The Option Agreement provides
for interim adjustments to the number and exercise price of the options
granted to A&M#3 based upon the final distributions and settlements
under the Plan. On December 10, 1998, the Company approved an interim
adjustment, as called for in the Option Agreement, for all distributions
and settlements that occurred on or before September 30, 1998.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL
CONDITION AND RESULTS OF OPERATION
INTRODUCTION
This discussion should be read in conjunction with the financial
statements, related notes and Management's Discussion and Analysis of Financial
Condition and Results of Operation contained in the Company's Annual Report on
Form 10-K for the year ended January 31, 1998.
The operating results of Blockbuster Music for the six days beginning
October 26, 1998 through October 31, 1998 are included in the results of the
three-month period and the nine-month period ended October 31, 1998.
RESULTS OF OPERATIONS
FOR THE QUARTERS ENDED OCTOBER 31, 1998 AND OCTOBER 31, 1997
Revenues
Net revenues were $77.5 million and $71.9 million for the quarters ended
October 31, 1998 and October 31, 1997, respectively. The increase of $5.6
million, or 7.8%, is primarily attributable to an increase in sale merchandise
revenue for the Wherehouse stores of $3.1 million, and sale merchandise revenue
for the Blockbuster Music stores for the period October 26, 1998 through October
31, 1998 of $6.7 million, and partially offset by a decrease in rental revenue
of $4.2 million. The Company believes the decrease in rental revenue is
primarily attributable to an increasingly competitive rental market and a
reduction in the number of Company stores offering rental product.
A summary of total sale merchandise and rental revenues, by product
category, is provided below:
SALE MERCHANDISE AND RENTAL REVENUES
BY MERCHANDISE CATEGORY
(DOLLAR AMOUNTS IN MILLIONS)
Quarter Ended
October 31,
-----------------
1998 1997
------ ------
Sale Merchandise Revenue:
Music $60.4 $53.0
Other, principally sales of new videocassettes,
video game software and hardware,
general merchandise and ticket commissions 10.1 7.7
------ ------
Total sale merchandise revenue $70.5 $60.7
------ ------
Videocassette and other rental revenue 7.0 11.2
------- -------
Total revenues $ 77.5 $ 71.9
------- -------
13
Pre-recorded music, new videocassettes, digital versatile disks
("DVD's"), video game software and hardware and general merchandise,
(collectively referred to as "sale merchandise") continues to represent the
greatest portion of the Company's revenues. For the quarter ended October 31,
1998, sale merchandise revenue represented 90.9% of aggregate revenues, versus
84.4% of aggregate revenues in the prior year, an increase of 6.5%. Sale
merchandise revenue was $70.5 million versus $60.7 million, for the quarters
ended October 31, 1998 and October 31, 1997, respectively, representing an
overall increase of 16.0%. On a same store basis, sale merchandise revenue
increased by 9.3% during the quarter ended October 31, 1998 as compared to the
quarter ended October 31, 1997. Management believes that the increase of 9.3%
for same store sale merchandise revenue was principally the result of a stronger
new release schedule than last year, favorable customer response to several new
merchandising initiatives and, to a lesser extent, the favorable impact of
competitors' store closures.
Rental revenue includes the rental of video cassettes, DVD's, video
games and game players and audio-cassette books, and sales of previously viewed
videocassettes and previously played video games. As of October 31, 1998, 129 of
the Company's stores offered rental products, with 50 of those stores offering
DVD's for rental, versus 170 stores offering video rental product last year and
none offering DVD last year. Rental revenue was $7.0 million versus $11.2
million during the quarters ended October 31, 1998 and October 31, 1997,
respectively, representing a decrease of $4.2 million or 37.1%. On a same store
basis, rental revenue decreased approximately 38.1% as compared to the prior
year. The Company believes that the decrease in same store rental revenue was
primarily attributable to an increasingly competitive rental market.
Costs of Revenue
Costs of sale merchandise revenue increased $6.9 million to $44.8
million for the quarter ended October 31, 1998 versus $37.9 million for the
quarter ended October 31, 1997, representing an increase of 18.3%. As a
percentage of sale merchandise revenue, costs of sale merchandise revenue
increased 1.2% to 63.6% during the quarter ended October 31, 1998 versus 62.4%
during the quarter ended October 31, 1997. New releases of music product are
typically introduced at lower selling prices ("Promotional Price") and result in
lower gross margin rates. The 1.2% increase in costs of sale merchandise revenue
as a percentage of sale merchandise revenue was principally due to a higher
proportion of Promotional Price sales in the quarter ended October 31, 1998
compared to the corresponding quarter of last year.
Costs of rentals, including amortization, decreased to $3.7 million
during the quarter ended October 31, 1998, a decrease of $2.3 million or 38.5%,
versus $6.0 million during the quarter ended October 31, 1997. As a percentage
of rental revenue, costs of rentals decreased to 52.4% during the quarter ended
October 31, 1998, versus 53.6% during the quarter ended October 31, 1997,
representing a decrease of 1.2%. During the quarter ended October 31, 1998, in
response to the decline in rental revenues, the reduction in the number of
stores offering rentals, and an increase in revenue sharing programs, the
Company decreased its purchases of video rental product by $2.5 million or 44.1%
versus the same quarter of the prior year.
14
Operating Expenses
Selling, general and administrative ("SG&A") expenses, were $26.5
million, versus $25.2 million for the quarters ended October 31, 1998 and
October 31, 1997, respectively, an increase of $1.3 million or 5.0%. As a
percentage of net revenues, SG&A expenses, were 34.1% during the quarter ended
October 31, 1998 versus 35.0% during the quarter ended October 31, 1997,
representing a decrease of 0.9%. The 0.9% decrease as a percentage of net
revenue was principally due to improved efficiencies in store payroll and
reductions in corporate, distribution and other store expenses.
Income From Operations
Income from operations for the quarter ended October 31, 1998 was $0.3
million, versus $1.2 million for the quarter ended October 31, 1997, a decrease
of $0.9 million. The decrease in income from operations was primarily the result
of a decrease in rental revenue and a lower gross profit percentage on sale
merchandise revenue, which were partially offset by an increase in sale
merchandise revenue and lower SG&A expenses. During the quarter ended October
31, 1998, the Company closed 1 store, opened 5 stores and acquired 378 stores.
As of October 31, 1998, the Company operated 598 stores in thirty-three states.
Interest Expense
Interest expense for the quarter ended October 31, 1998 was $1.2
million, versus $0.1 million for the quarter ended October 31, 1997, an increase
of $1.1 million. The $1.1 million is primarily the result of a onetime fee of
$0.9 million which the Company paid Cerberus Capital Management, L.P., for a
commitment to provide a bridge loan to finance the acquisition of Blockbuster
Music in the event that permanent financing was not in place at the time of the
acquisition. Additionally, the Company incurred interest expense of $0.2 million
under the Congress Facility for the six days ending October 31, 1998.
Income Taxes
The Company recorded a tax benefit of $0.1 million for the quarter ended
October 31, 1998 versus a tax provision of $0.6 million for the quarter ended
October 31, 1997. The provision represents an effective tax rate of 41.3%, which
the Company estimates will be its effective tax rate for the year ended January
31, 1999.
The Company is currently under audit by the California Franchise Tax
Board ("FTB") for tax years ended January 31, 1992, 1993, and 1994. The Company
believes it has made adequate provision in the consolidated condensed financial
statements for this audit.
Net Income (Loss)
The Company had a net loss of $0.2 million for the quarter ended
October 31, 1998, compared to net income of $0.97 million for the quarter ended
October 31, 1997. The net loss is primarily attributable to the bridge loan
commitment fee associated with the financing of the Blockbuster Music
acquisition as described above. Excluding such one-time fee, the net income for
the period would have been $0.35 million, compared to a net income of $0.97
million, a $0.62 million decrease. This $0.62 decrease is principally due to a
decrease in rental revenue and a lower gross profit percentage on sale
merchandise revenue, which were partially offset by an increase in sale
merchandise revenue and lower SG&A expenses.
EBITDA
EBITDA represents income from operations, plus depreciation and
amortization. Management believes that, due to the combined format of rental
product and sale merchandise, a more appropriate calculation of EBITDA
(hereafter referred to as Adjusted EBITDA) should include the net difference
between rental amortization plus the book value of rental dispositions, versus
rental inventory purchased during the period. The Company has included certain
information concerning Adjusted EBITDA because management believes it would be
15
useful information for certain investors and analysts in analyzing operating
performance and in determining the Company's ability to service debt. Adjusted
EBITDA for the period ended October 31, 1998 was $2.9 million, versus $4.3
million for the period ended October 31, 1997. Adjusted EBITDA excludes the
non-cash impact of store rent expense accrued to recognize minimum rents on a
straight-line basis over the term of the lease. The decrease versus last year
results primarily from the decrease in rental revenue and a lower gross profit
percentage on sale merchandise revenue, which were partially offset by increases
in sale merchandise revenue and lower SG&A, expenses, as well as the effect of
the non-recurring cash benefit of $1.2 million for rent credits from landlords
which had a favorable impact on Adjusted EBITDA for the period ended October 31,
1997. The method of calculating Adjusted EBITDA set forth above may be different
from calculations of EBITDA employed by other companies and, accordingly, may
not be directly comparable to such other computations. Adjusted EBITDA should
not be viewed as a substitute for Generally Accepted Accounting Principles
(GAAP) measurements such as net income or cash flow from operations. Rather, it
is presented as supplementary information.
FOR THE NINE MONTHS ENDED OCTOBER 31, 1998 AND OCTOBER 31, 1997
Revenues
Total revenues were $223.0 million and $223.1 million for the nine
months ended October 31, 1998 and October 31, 1997, respectively. The decrease
of $0.1 million or 0.03% in total revenue resulted from an increase in sale
merchandise revenue of $13.5 million, comprised of $6.8 million from the
Wherehouse stores, plus sale merchandise revenue from the Blockbuster Music
stores for the period October 26, 1998 through October 31, 1998 of $6.7 million,
offset by a decrease in rental revenue of $13.6 million. The Company believes
that the decrease in rental revenue was primarily attributable to an
increasingly competitive rental market and a reduction in the number of Company
stores offering rental product.
A summary of total sale merchandise and rental revenues, by product
category, is provided below:
SALE MERCHANDISE AND RENTAL REVENUES
BY MERCHANDISE CATEGORY
(DOLLAR AMOUNTS IN MILLIONS)
Nine Months Ended
October 31,
---------------------
1998 1997
------ ------
Sale Merchandise Revenue:
Music $171.6 $161.4
Other, principally sales of new videocassettes,
video game software and hardware,
general merchandise and ticket commissions. 26.3 23.0
------ ------
Total sale merchandise revenue $197.9 $184.4
------ ------
Videocassette and other rental revenue 25.1 38.7
------ ------
Total revenues $223.0 $223.1
------ ------
16
Sale merchandise revenue continues to represent the largest portion of
the Company's revenues. For the nine months ended October 31, 1998, sale
merchandise revenue represented 88.7% of aggregate revenues, an increase of 6.1%
from 82.6% during the nine months ended October 31, 1997. Sale merchandise
revenue was $197.9 million versus $184.4 million for the nine months ended
October 31, 1998 and October 31, 1997, respectively, representing an overall
increase of 7.3%. On a same store basis, sale merchandise revenue increased by
7.6% during the nine months ended October 31, 1998, as compared to the nine
months ended October 31, 1997. Management believes that the increase of 7.6% was
principally the result of a stronger new release schedule than last year,
favorable customer response to several new merchandising initiatives and, to a
lesser extent, the favorable impact of competitors' store closures.
Rental revenue includes the rental of video cassettes, DVD's, video
games and game players, and audio cassette books, and sales of previously viewed
video cassettes and previously played video games. As of October 31, 1998, 129
of the Company's stores offered rental products, with 50 of the stores offering
DVD's for rental. Rental revenue was $25.1 million versus $38.7 million during
the nine months ended October 31, 1998 and October 31, 1997, respectively,
representing a decrease of $13.6 million or 35.1%. On a same-store basis, rental
revenue decreased approximately 30.9% as compared to the prior year. The Company
believes that the decrease in same store rental revenue was primarily
attributable to a strong competitive environment.
Costs of Revenue
Costs of sale merchandise revenue increased $7.4 million to $125.0
million for the nine months ended October 31, 1998 versus $117.7 million for the
nine months ended October 31, 1997, representing an increase of 6.3%. As a
percentage of sale merchandise revenue, costs of sale merchandise revenue
decreased 0.6% to 63.2% during the nine months ended October 31, 1998 versus
63.8% during the nine months ended October 31, 1997. The 0.6% decrease in costs
of sale merchandise revenue as a percentage of sale merchandise revenue was
principally due to lower obsolescence and other costs of sale revenue resulting
from improved inventory efficiencies, which were partially offset by lower gross
profit due to a higher proportion of Promotional Price sales.
Costs of rentals, including amortization, decreased to $13.0 million
during the nine months ended October 31, 1998, a decrease of $8.7 million or
40.0%, versus $21.7 million during the nine months ended October 31, 1997. As a
percentage of rental revenue, costs of rentals decreased to 52.0% during the
nine months ended October 31, 1998, versus 56.2%
17
during the nine months ended October 31, 1997, representing a decrease of 4.2%.
During the nine months ended October 31, 1998, in response to the decline in
rental revenues, the reduction in the number of stores offering rentals, and an
increase in revenue sharing programs, the Company decreased its purchases of
video rental product by $7.2 million or 37.8% versus the same nine months of the
prior year.
Operating Expenses
SG&A expenses were $74.0 million versus $77.3 million during the nine
months ended October 31, 1998 and October 31, 1997, respectively, representing a
decrease of $3.3 million or 4.2%. As a percentage of net revenues, SG&A expenses
were 33.2% of net revenues during the nine months ended October 31, 1998 versus
34.7% of net revenues during the nine months ended October 31, 1997,
representing a decrease of 1.5%. The 1.5% decrease was principally due to
efficiencies in store payroll and decreases in corporate, distribution and other
store expenses.
Income From Operations
Income from operations for the nine months ended October 31, 1998 was
$5.3 million as compared to $1.5 million for the nine months October 31, 1997,
representing an improvement of $3.8 million. The improvement in income from
operations was primarily the result of higher sale merchandise revenue, a higher
gross profit percentage on sale merchandise revenue, higher gross profit on
rental revenue, and lower SG&A expense, all of which were partially offset by a
decline in rental revenue. During the nine months ended October 31, 1998 the
Company closed 5 stores, opened 6 stores and acquired 378 stores. As of October
31, 1998 the Company operated 598 stores in thirty-three states.
Interest Expense
Interest expense for the nine months ended October 31, 1998 was $1.4
million, versus $0.3 million for the nine months ended October 31, 1997, an
increase of $1.1 million. The $1.1 million increase is primarily the result of a
one-time fee of $0.9 million, which the Company paid to Cerberus Capital
Partners, L.P. for a commitment to provide a bridge loan to finance the
acquisition of Blockbuster Music if the permanent financing was not in place at
the time of the acquisition. Additionally, the Company incurred interest expense
of $0.2 million under the Congress Facility revolving line of credit for the six
days ending October 31, 1998.
Income Taxes
The Company recorded a tax provision of $2.4 million for the nine months
ended October 31, 1998 versus a tax provision of $0.9 million for the period
ended October 31, 1997. The tax provision represents an effective tax rate of
41.4%, which the Company estimates will be its effective tax rate for the year
ended January 31, 1999.
EBITDA
EBITDA represents income from operations, plus depreciation and
amortization. Management believes that, due to the combined format of rental
product and sale merchandise, a more appropriate calculation of EBITDA
(hereafter referred to as Adjusted EBITDA) should include the net difference
between rental amortization plus the book value of rental dispositions, versus
rental inventory purchased during the period. The Company has included certain
information concerning Adjusted EBITDA because management believes it would be
useful information for certain investors and analysts in analyzing operating
performance and in determining the Company's ability to service debt. Adjusted
EBITDA for the period ended October 31, 1998 was $12.1 million versus $10.3
million for the period ended October 31,
18
1997. The increase in Adjusted EBITDA was primarily the result of higher sale
merchandise revenue, a higher gross profit percentage on sale merchandise
revenue, higher gross profit on rental revenue, and lower SG&A expense, all of
which were partially offset by a decline in rental revenue. Adjusted EBITDA
excludes the non-cash impact of store rent expense accrued to recognize minimum
rents on a straight-line basis over the term of the lease. Adjusted EBITDA for
the period ended October 31, 1997, includes a non-recurring cash benefit of $2.0
million resulting from the impact of one-time credits received from landlord
concessions. The method of calculating Adjusted EBITDA set forth above may be
different from calculations of EBITDA employed by other companies and,
accordingly, may not be directly comparable to such other computations. Adjusted
EBITDA should not be viewed as a substitute for Generally Accepted Accounting
Principles (GAAP) measurements such as net income or cash flow from operations.
Rather, it is presented as supplementary information.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended October 31, 1998, the Company's net cash
provided by operating activities was $6.0 thousand, as compared to $27.8 million
provided by operations for the corresponding nine months of the prior fiscal
year, primarily due to an increase in inventory and receivables. The increase
in inventory and receivables is a result of normal seasonal patterns coupled
with increases required to support higher sale merchandise revenue.
Cash used in investing activities was $126.9 million for the nine months
ended October 31, 1998, as compared to $2.4 million for the nine months ended
October 31, 1997. The increase was primarily due to the cash paid for the
Blockbuster Music acquisition of $117.6 million. In addition, the Company
increased its acquisition of property, equipment and improvements due to the
opening of six new stores and to support its new merchandising initiatives.
Cash provided from financing activities was $97.4 million for the nine
months ended October 31, 1998 as compared to $0.8 million used for the nine
months ended October 31, 1997. The increase of $98.2 million was primarily due
to the loan under the Congress Facility, used to finance the acquisition of
Blockbuster Music.
The Company believes that the current borrowing facility (see Note 4
under Notes to Consolidated Condensed Financial Statements) is adequate to
support the existing operations and the planned capital expenditures of the
Company and its subsidiaries that operate the Blockbuster Music stores for the
next twelve month period.
The Company expects to make additional payments to creditors,
professionals and others of up to $1.4 million through the end of the fiscal
year under the Plan of Reorganization.
As of October 31, 1998, the Company had signed 2 new lease commitments
to open new stores during the next twelve months.
19
SEASONALITY
The Company's business is seasonal, and revenues and operating income
are highest during the fourth quarter.
The Company believes that, except for changes in the minimum wage
mandated by the Federal government, inflation has not had a material effect on
its operations and its internal and external source of liquidity and working
capital.
IMPACT OF THE YEAR 2000
The Company has been actively addressing the internal system concerns
related to the Year 2000 ("Y2K") problem. The Company will create a Y2K Project
Committee in January 1999. This committee, to be comprised of several
executives, will establish guidelines and direct the Y2K efforts. The primary
objective of this committee will be to ensure the Company's ability to operate
with its internal systems in the year 2000. The secondary objective will be to
assess all non-Information Technology ("IT") departments and external Vendors'
state-of-readiness and Y2K compliance.
1) The Company's State of Readiness
Internal IT Systems - The Company has purchased new merchandising, financial
and distribution center management systems to replace all its major corporate
systems, except for Point-Of-Sales (POS). All the new systems purchased are Y2K
compliant. The projects to implement these new systems are underway.
Implementation of these new systems will likely occur in the second quarter of
fiscal 1999. The existing POS application software has been remediated,
installed at all the current Wherehouse stores and is now Y2K compliant. The
existing POS hardware operating system is not Y2K compliant. The Company has
approved project funds and identified potential vendors to perform the POS
hardware operating system upgrade. This project will start in the first quarter
of fiscal 1999 and the Company expects it will be completed in the second
quarter of fiscal 1999. The Company intends to convert the Blockbuster Music
stores to the Wherehouse POS system in the first half of fiscal 1999.
External Vendors - The Company is aware of significant Y2K remediation work
being performed by its major vendors. The Y2K Project Committee will initiate
formal communication with the Company's significant suppliers in the first
quarter of 1999 regarding their Y2K readiness. The Company intends to focus
extensively on the second tier suppliers in the first half of 1999.
20
2) The Costs to Address the Company's Year 2000 Issues
The Company does not consider the replacement of its corporate systems as a Y2K
expense. Installation of the new major corporate systems is required to address
additional business functionality. The remediation of the existing mainframe-
based corporate system is a Y2K contingency measure, and will cost between $1.5
million and $2.0 million. The distribution system will cost between $30,000 and
$60,000. Internal resources performed the POS software remediation. The
Wherehouse POS hardware operating system remediation will cost between $400,000
and $600,000. The Company has estimated approximately $1.0 million for other
hardware and software requirements. Internal resources will handle all other
projects.
3) The Risks of the Company's Year 2000 Issues
The Company has not finalized a detailed risk assessment. The Y2K Project
Committee will likely complete the detailed risk analysis in the first quarter
of fiscal 1999.
4) The Company's Contingency Plans
The Company has developed contingency plans for the merchandising,
financial, distribution center management, and POS hardware operating systems.
New application software will replace the merchandising, financial, and
distribution center management systems, and remediation will be done on the POS
hardware operating system. As a contingency plan, the Company has contracted
with an outside firm to remediate the existing corporate merchandising system.
As an additional contingency plan, the current distribution center management
system may also be remediated in the first quarter of fiscal 1999 by the
software supplier.
21
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Stockholders (the "Meeting") on
October 21, 1998, at which the Company's stockholders voted: (1) to elect the
nominated slate of five directors, each to serve until the next meeting and
until his or her successor has been duly elected and qualified: Antonio C.
Alvarez, II, Robert C. Davenport, Jonathan Gallen, Joseph J. Radecki, Jr., and
Joseph B. Smith: (2) to approve the Company's 1998 Stock Incentive Plan; and (3)
to ratify the appointment of Deloitte & Touche LLP as the Company's independent
public accountants and auditors for the fiscal year ending January 31, 1999.
Holders of record of the Company's common stock as of September 18, 1998
were entitled to vote at the Meeting. On September 18, 1998, there were
10,744,829 shares of common stock outstanding and entitled to vote and 9,779,879
of such shares were represented at the Meeting. Each of the directors received
91.02% of the shares cast in favor of his or her election. For each director,
9,779,833 shares were cast for the director's election and 46 shares were
withheld. With respect to the 1998 Stock Incentive Plan, the shares cast were
8,179,690 shares for, 2,080 shares against, 396 shares in abstention, and
1,597,713 broker non-votes. With respect to the ratification of Deloitte &
Touche LLP, the shares cast were 9,774,274 shares for, 0 shares against, and 605
in abstention.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
27.0 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on September 25, 1998, reporting
a change in the Company's Accountant. No other reports on Form 8-K were filed
during the quarter ended October 31, 1998.
22
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.
Date: December 21, 1998
ANTONIO C. ALVAREZ, II
Chairman of the Board and Chief
Executive Officer, and Director
(Principal Executive Officer)
Date: December 21, 1998
ROBERT S. KELLEHER
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer)