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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
---------------------
<Table>
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
</Table>
COMMISSION FILE NUMBER 0-22289
WHEREHOUSE ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
<Table>
<Caption>
DELAWARE 95-4608339
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
</Table>
19701 HAMILTON AVENUE, TORRANCE, CA 90502-1311
(Address of principal executive offices, including ZIP code)
(310) 965-8300
(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 [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date:
COMMON STOCK, $.01 PAR VALUE,
11,001,421 SHARES OUTSTANDING AS OF DECEMBER 10, 2001
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WHEREHOUSE ENTERTAINMENT, INC.
INDEX
<Table>
<Caption>
PAGE
----
FORWARD-LOOKING STATEMENTS........................................... 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Condensed Balance Sheets -- October 31, 2001
(Unaudited) and January 31, 2001............................ 3
Consolidated Condensed Statements of Operations -- Three
Months Ended October 31, 2001 and 2000 (Unaudited) and Nine
Months Ended October 31, 2001 and 2000 (Unaudited).......... 4
Consolidated Condensed Statements of Cash Flows -- Nine
Months Ended October 31, 2001 and 2000 (Unaudited).......... 5
Notes to Consolidated Condensed Financial Statements
(Unaudited)................................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition 8
and Results of Operations...................................
Item 3. Quantitative and Qualitative Disclosures About Market 12
Risk........................................................
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 13
Item 5. Other Information........................................... 13
Item 6. Exhibits and Reports on Form 8-K............................ 13
SIGNATURES........................................................... 14
</Table>
1
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 Quarterly Report
on Form 10-Q containing such forward-looking statements include "Management's
Discussion and Analysis of Financial Condition and Results of Operations" under
Item 2 of Part I below. Statements in this Quarterly Report on Form 10-Q which
address activities, events or developments that the registrant expects or
anticipates will or may occur in the future, including such things as future
issuances 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 strategy,
expansion and growth of the registrant's and its competitors' business and
operations and other such matters are forward-looking statements. You can find
many of these statements by looking for words like "believes", "expects",
"anticipates", or similar expressions in this Quarterly Report on Form 10-Q.
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 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) changes in levels of
competition from current competitors and potential new competition from both
non-traditional retailers of the registrant's products and alternative methods
or channels of distribution such as Internet and telephone shopping services and
mail order; (b) loss of a significant vendor or prolonged disruption of product
supply; (c) the presence or absence of popular new releases and products in the
product categories the registrant represents; (d) changes in levels of consumer
spending, especially during seasonally significant periods; (e) changes in
Federal and state income tax rules and regulations or interpretations of
existing legislation; (f) changes in the general economic conditions in the
United States including, but not limited to, consumer sentiment about the
economy in general; (g) regulatory changes which may adversely affect the
business in which the registrant is engaged; (h) the ability to attract and
retain key personnel; and (i) 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. You should consider the
cautionary statements contained in this section when evaluating any
forward-looking statements that we may make. We do not have any obligation to
publicly release any revisions to these forward-looking statements to reflect
events or circumstances after the date of this Quarterly Report on Form 10-Q or
to reflect the occurrence of unanticipated events.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
WHEREHOUSE ENTERTAINMENT, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
<Table>
<Caption>
OCTOBER 31, JANUARY 31,
2001 2001
------------ ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 1,130,000 $ 2,457,000
Receivables, net.......................................... 4,951,000 1,343,000
Inventories, net.......................................... 193,695,000 197,147,000
Income taxes receivable................................... 1,568,000 9,825,000
Other current assets...................................... 1,650,000 2,401,000
Deferred taxes............................................ 1,429,000 5,983,000
------------ ------------
Total current assets.............................. 204,423,000 219,156,000
Property, equipment and improvements, net................... 49,473,000 67,132,000
Deferred income taxes....................................... 19,886,000
Intangible assets, net...................................... 28,571,000 34,510,000
Other assets, net........................................... 4,735,000 1,007,000
------------ ------------
Total assets...................................... $287,202,000 $341,691,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and bank overdraft....................... $124,334,000 $129,042,000
Accrued expenses.......................................... 32,548,000 35,468,000
Store closure reserves.................................... 7,624,000 8,421,000
Reorganization liabilities................................ 1,202,000 1,242,000
Current portion of long-term debt......................... 3,634,000 3,836,000
Current portion of leases in excess of fair market
value.................................................. 3,270,000 3,270,000
Current portion of capital lease obligations.............. 4,986,000 6,090,000
------------ ------------
Total current liabilities......................... 177,598,000 187,369,000
Line of credit.............................................. 57,228,000 35,123,000
Long-term debt.............................................. 202,000 224,000
Capital lease obligations................................... 12,311,000 16,293,000
Leases in excess of fair market value....................... 15,234,000 18,195,000
Deferred rent and other long-term liabilities............... 4,405,000 5,181,000
------------ ------------
Total liabilities................................. 266,978,000 262,385,000
------------ ------------
Shareholders' equity:
Preferred stock, $.01 par value; shares authorized,
3,000,000; shares issued, none
Common stock, $.01 par value; shares authorized,
24,000,000; shares issued, 11,026,421; shares
outstanding, 11,001,421................................ 110,000 110,000
Additional paid-in-capital................................ 94,510,000 94,453,000
Retained earnings (deficit)............................... (66,943,000) (8,084,000)
Treasury stock, 25,000 shares............................. (338,000) (338,000)
Notes receivable.......................................... (7,115,000) (6,835,000)
------------ ------------
Total shareholders' equity........................ 20,224,000 79,306,000
------------ ------------
Total liabilities and shareholders' equity........ $287,202,000 $341,691,000
============ ============
</Table>
See Accompanying Notes to Unaudited Consolidated Condensed Financial Statements.
3
WHEREHOUSE ENTERTAINMENT, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
OCTOBER 31, OCTOBER 31, OCTOBER 31, OCTOBER 31,
2001 2000 2001 2000
------------ ------------ ------------ ------------
(UNAUDITED)
Sale merchandise revenue............. $128,554,000 $147,454,000 $427,519,000 $487,753,000
Rental revenue, net.................. 853,000 1,342,000 3,233,000 4,398,000
------------ ------------ ------------ ------------
Total revenues..................... 129,407,000 148,796,000 430,752,000 492,151,000
Cost of sale merchandise revenue..... 85,002,000 93,882,000 281,694,000 315,430,000
------------ ------------ ------------ ------------
Gross profit....................... 44,405,000 54,914,000 149,058,000 176,721,000
Selling, general and administrative
expenses........................... 48,180,000 54,677,000 152,958,000 167,677,000
Depreciation and amortization........ 7,366,000 7,554,000 22,977,000 22,425,000
Loss on disposition of assets........ 3,261,000 108,000 3,411,000 773,000
------------ ------------ ------------ ------------
Loss from operations............... (14,402,000) (7,425,000) (30,288,000) (14,154,000)
Interest expense..................... 1,217,000 2,250,000 4,455,000 6,592,000
Interest income...................... (209,000) (95,000) (405,000) (313,000)
Equity in loss from unconsolidated
joint venture...................... 3,100,000 9,143,000
------------ ------------ ------------ ------------
Loss before income taxes........... (15,410,000) (12,680,000) (34,338,000) (29,576,000)
Income tax (expense) benefit......... (32,092,000) 5,097,000 (24,521,000) 11,889,000
------------ ------------ ------------ ------------
Net loss........................... $(47,502,000) $ (7,583,000) $(58,859,000) $(17,687,000)
============ ============ ============ ============
Net loss per common share:
Basic.............................. $ (4.32) $ (0.69) $ (5.35) $ (1.61)
============ ============ ============ ============
Diluted............................ $ (4.32) $ (0.69) $ (5.35) $ (1.61)
============ ============ ============ ============
Weighted average common shares
outstanding -- Basic............... 11,001,421 11,001,421 11,001,421 10,984,538
============ ============ ============ ============
Weighted average common shares and
common equivalent shares
outstanding -- Diluted............. 11,001,421 11,001,421 11,001,421 10,984,538
============ ============ ============ ============
</Table>
See Accompanying Notes to Unaudited Consolidated Condensed Financial Statements.
4
WHEREHOUSE ENTERTAINMENT, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
NINE MONTHS ENDED
---------------------------
OCTOBER 31, OCTOBER 31,
2001 2000
------------ ------------
(UNAUDITED)
OPERATING ACTIVITIES:
Net loss.................................................... $(58,859,000) $(17,687,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 22,977,000 22,425,000
Loss on disposition of assets............................. 3,411,000 773,000
Rental amortization included in cost of rentals........... 2,717,000 2,688,000
Book value of rental inventory dispositions, included in
cost of rentals......................................... 314,000 477,000
Loss on investment in joint venture....................... 9,143,000
Stock option compensation................................. 57,000 37,000
Interest on notes receivable.............................. (280,000) (280,000)
Deferred income taxes..................................... 24,440,000 (12,681,000)
Changes in operating assets and liabilities:
Receivables, net........................................ (250,000) 6,372,000
Inventories, net........................................ (18,932,000) (10,257,000)
Rental inventory purchases.............................. (2,777,000) (2,967,000)
Income taxes receivable/payable......................... 8,257,000
Other current assets.................................... 731,000 270,000
Accounts payable, accrued expenses and other current
liabilities............................................ (7,656,000) (6,696,000)
Store closure and leases in excess of FMV reserves...... (3,241,000) (4,633,000)
Other long-term liabilities............................. (776,000) (5,000)
------------ ------------
Net cash used in operating activities................. (29,867,000) (13,021,000)
------------ ------------
INVESTING ACTIVITIES:
Purchase of property, equipment and improvements............ (6,659,000) (10,120,000)
Proceeds from sale of stores................................ 18,236,000
Investment in joint venture................................. (17,826,000)
Decrease (increase) in other assets......................... 4,000 115,000
------------ ------------
Net cash provided by (used in) investing activities... 11,581,000 (27,831,000)
------------ ------------
FINANCING ACTIVITIES:
Net borrowings under line of credit......................... 22,105,000 40,959,000
Payments on capital lease obligations and long-term debt.... (5,106,000) (4,379,000)
Proceeds from sale of common stock.......................... 5,000,000
Settlement of pre-petition claims........................... (40,000) (311,000)
------------ ------------
Net cash provided by financing activities............. 16,959,000 41,269,000
------------ ------------
Net (decrease) increase in cash and cash equivalents........ (1,327,000) 417,000
Cash and cash equivalents at beginning of the period........ 2,457,000 4,531,000
------------ ------------
Cash and cash equivalents at end of the period.............. $ 1,130,000 $ 4,948,000
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest................................................ $ 4,059,000 $ 6,450,000
Income taxes, net....................................... $ (7,937,000) $ 367,000
</Table>
Non-cash investing and financing activities:
The Company incurred capital lease obligations of $377,000 and $853,000 for
the purchase of certain equipment during the nine months ended October 31,
2001 and October 31, 2000, respectively.
The Company recorded notes receivable which totaled $6,075,000 in connection
with the sale of 64 Wherehouse Music stores during the nine months ended
October 31, 2001.
See Accompanying Notes to Unaudited Consolidated Condensed Financial Statements.
5
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements
include the accounts of Wherehouse Entertainment, Inc. and its wholly owned
subsidiaries (collectively referred to as the "Company"). All material
intercompany balances and transactions have been eliminated in consolidation.
The interim unaudited consolidated condensed financial statements of the
Company 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 ("GAAP") 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. The Company's business is
seasonal, so operating results for the nine months ended October 31, 2001 are
not necessarily indicative of the results that may be expected for the Company's
fiscal year ending January 31, 2002 ("Fiscal 2002"). For further information,
refer to the financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the Company's fiscal year ended January
31, 2001 ("Fiscal 2001").
2. DISPOSITION OF STORES
On August 9, 2001, the Company completed the sale of sixty-four (64)
Wherehouse Music stores to The Music Network ("TMN") for approximately $25.9
million which was comprised of $19.8 million in cash and $6.1 million in notes
receivable less approximately $0.6 million in costs to complete the transaction.
Approximately $0.9 million of the cash proceeds were in escrow and were received
subsequent to October 31, 2001. In addition, the Company received warrants to
purchase 90,440 shares or approximately 1.75% of TMN for $0.01 per share.
Management has valued these warrants at a de minimus amount. The majority of the
stores sold to TMN are located in Florida, North Carolina, South Carolina and
Tennessee, with a few located in Georgia and Alabama. As part of the
transaction, the Company also granted the rights to the Turtle's Music trade
brand to TMN. The subject stores accounted for $63.6 million in total revenues
for the fiscal year ended January 31, 2001 and $26.8 million in total revenues
for the nine months ended October 31, 2001. The net tangible book value of the
assets sold amounted to approximately $25.3 million. In addition, the Company
also wrote off approximately $3.3 million of goodwill which was attributable to
the sold stores. The Company is also obligated to fulfill lease commitments
should TMN default on certain obligations.
3. E-COMMERCE
For the nine-month period ended October 31, 2000, the Company recognized a
loss of $9.1 million related to its equity investment in Checkout.com, an
Internet content provider and e-commerce retailer of music, movies and games. As
of October 31, 2000, the Company's investment in the joint venture amounted to
$17.8 million. As a result of significant operating losses experienced by
CheckOut.com, CheckOut.com ceased operation of its Internet site in February,
2001. For Fiscal 2001, a $20.6 million loss on investment in joint venture was
recorded by the Company which included $11.1 million representing the Company's
share in the joint venture's operating losses and $9.5 million representing a
loss due to the impairment in value of the remaining investment. During November
2001, the Company re-launched its Internet e-commerce site,
"Wherehousemusic.com".
4. INCOME TAXES
During the quarter ended October 31, 2001, the Company recorded a valuation
allowance for a significant portion of its total deferred income tax assets in
the amount of $32.1 million as a result of recurring losses from operations.
Such valuation allowance will be reversed when the Company returns to
profitability at levels sufficient to realize such deferred income tax assets.
6
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
5. LITIGATION
In January, 2001, the Company was sued in the Los Angeles Superior Court by
a former store manager, claiming alleged failure to pay overtime wages to
herself and all similarly situated salaried store employees. The Complaint does
not specify any amount of the claims, either individually or on behalf of the
class. Thereafter, the Complaint was amended to add three additional named
plaintiffs. The amended Complaint seeks relief on behalf of both store managers
and assistant managers going back to 1997. The Company's motions to strike the
class action allegations have been denied. A limited amount of discovery has
been conducted to date.
In October, 2001, a second class action suit was filed with respect to
store managers and assistant managers by different named plaintiffs and
different lawyers. It also seeks overtime pay and, in addition, asserts claims
for meal break and rest break penalties. No case activity has taken place in the
second case to date. The Company believes the allegations in both suits are
without merit and intends to vigorously defend itself in these matters. However,
no assurance can be provided as to its outcome. Management does not believe an
adverse judgment against the Company would result in a material impact to the
consolidated financial statements.
On July 18, 2001, the Santa Clara County, California Superior Court entered
a $7.6 million judgment against the Company in a personal injury lawsuit
encaptioned Peterson, et al. v. Shapell Industries (the "Peterson Lawsuit").
While the Company was insured for this judgment, its insurer, Reliance Insurance
Company, was ordered liquidated by the State of Pennsylvania on October 3, 2001.
As such, it is unknown at present whether, and to what extent, assets of the
insurer will be available to the Company subsequent to a formal liquidation
proceeding. Pending this outcome, California's Insurance Guarantee Fund ("CIGA")
has engaged appellate counsel on behalf of the Company. CIGA has also
facilitated the posting of an appellate bond to stay execution of the Peterson
judgment pending the outcome of the Company's appeal. The Company was required
by the bonding company to provide an $11.4 million letter of credit as security
for the appellate bond. Management, based on the advice of legal counsel,
believes that it is reasonably possible that it will either prevail on appeal or
be successful in an alternative legal strategy and accordingly has not recorded
a liability for the judgment in the accompanying financial statements.
In addition, the Company is a party to various other claims, legal actions
and complaints arising in the ordinary course of its business. In the opinion of
management, all such matters are without merit or involve such amounts that
unfavorable disposition will not have a material impact on the financial
position or results of operations of the Company.
6. ACCOUNTING POLICY CHANGE
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that all
business combinations initiated after June 30, 2001 be accounted for under the
purchase method of accounting and addresses the initial recognition and
measurement of goodwill and other intangible assets acquired in a business
combination. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired in a business combination and the accounting for
goodwill and other intangible assets subsequent to their acquisition. SFAS No.
142 provides that intangible assets with finite useful lives be amortized and
that goodwill and intangible assets with indefinite lives will not be amortized,
but will be tested at least annually for impairment. The Company is required to
implement SFAS No. 142 on February 1, 2002 and, at that time, will stop
amortizing goodwill that resulted from business combinations completed prior to
the adoption of SFAS No. 141. Goodwill is currently being amortized at
approximately $3.3 million annually. The Company is currently evaluating the
provisions of SFAS No. 142 and has not yet determined any additional effects
that adoption of these standards will have on its financial statements.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
This discussion should be read in conjunction with the financial
statements, related notes and Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company's Annual Report on
Form 10-K for Fiscal 2001.
RESULTS OF OPERATIONS
FOR THE QUARTERS ENDED OCTOBER 31, 2001 AND OCTOBER 31, 2000
Revenues
Total revenues were $129.4 million and $148.8 million for the quarters
ended October 31, 2001 (the third quarter of Fiscal 2002) and October 31, 2000
(the third quarter of Fiscal 2001), respectively. The decrease of $19.4 million
was primarily attributable to decreases in net revenues of $17.2 million due to
the closure of 34 stores since August 1, 2000 and the sale of 64 stores sold
during the three months ended October 31, 2001, same store sales decreases in
net revenues of $1.9 million and the reduction of net rental revenue of $0.5
million.
A summary of total sale merchandise and rental revenue by category is
provided below:
SALE MERCHANDISE AND RENTAL REVENUES
BY CATEGORY
<Table>
<Caption>
QUARTER ENDED
OCTOBER 31,
---------------------
2001 2000
--------- ---------
(DOLLARS IN MILLIONS)
Sale merchandise revenue:
Music..................................................... $105.2 $125.6
Other, principally sales of new videocassettes, DVDs,
video game software and hardware, general merchandise
and ticket commissions................................. 23.4 21.9
------ ------
Total sale merchandise revenue.................... 128.6 147.5
Rental revenue, net......................................... 0.8 1.3
------ ------
Total revenue..................................... $129.4 $148.8
====== ======
</Table>
A. Sale merchandise revenue. Sale merchandise revenue includes
prerecorded music, new videocassettes, DVDs, and video game software and
hardware (collectively referred to as "sale merchandise"). Management defines
same-store sales as sales from stores that were open for the full period in both
periods of comparison. On a same-store basis, excluding the 34 stores closed
since August 1, 2000 and the 64 stores sold during the three months ended
October 31, 2001, sale merchandise revenue decreased by approximately 1.5%
during the third quarter of Fiscal 2002 as compared to the third quarter of
Fiscal 2001. Same-store sales for the three months ended October 31, 2001 were
trending positively prior to the events of September 11, 2001. Since September
11, 2001, sales have been adversely impacted by the general economic downturn.
Also contributing to the decrease in same-store sales is continuing competition
from certain "big-box" retailers selling selected new music releases at or below
cost. Partially offsetting these decreases were increased sales of DVD and used
music.
B. Rental revenue, net. Rental revenue, net includes the proceeds from
the rental of videocassettes, DVDs, video games and game players, and from the
sale of previously viewed videocassettes and previously played video games, net
of cost of rentals. Rental revenue, net was $0.8 million in the third quarter of
Fiscal 2002 and $1.3 million in the third quarter of Fiscal 2001, representing a
decrease due to the Company's de-emphasis of the rental portion of its business.
8
C. Competition and Economic Factors. The Company believes that, in the
future, its business and same-store revenues may be impacted by various
competitive and economic factors. These factors include, but are not limited to,
consumer tastes, new releases of music, DVD, videocassette and video game titles
available for sale or rental, the increasing popularity of the Internet as an
avenue for retailing and other direct-to-consumer alternatives, and
technological developments such as digital downloading and the use of CD
"burners" to copy, as well as general economic trends impacting retailers and
consumers. In addition, in recent years the Company's sale merchandise and
rental revenues have been impacted by increased competition from other music and
video specialty chains, consumer electronics superstores, discounters and mass
merchandisers. Consolidation continues to occur in the home entertainment
industry and the Company continues to study industry developments in developing
its own strategies.
Cost of Sale Merchandise Revenue
Cost of sale merchandise revenue was $85.0 million for the third quarter of
Fiscal 2002, as compared with $93.9 million for the same period last year, a
decrease of $8.9 million. As a percentage of sale merchandise revenue, cost of
sale merchandise revenue was 66.1% for the third quarter of Fiscal 2002 as
compared with 63.7% for the third quarter of Fiscal 2001. As a percentage of
total revenues for the third quarter of Fiscal 2002, sales of higher margin new
music product continued to decrease and sales of lower margin DVD product
continued to increase, which offset the benefit from an increase of higher
margin used music product. In addition, decreases in sales prices related to
several mid-line new music promotional events also caused downward pressure on
gross profit margins.
Operating Expenses
Selling, general and administrative ("SG&A") expenses for the third quarter
of Fiscal 2002 were $48.2 million, compared to $54.7 million for the third
quarter of Fiscal 2001, a decrease of $6.5 million. The decrease is primarily
attributable to a reduction of $8.0 million in operating expenses at the
Company's stores due to the sale of 64 stores. In addition, improvements in
operating efficiencies and expense reductions partially offset cost of living
increases in payroll, CPI increases in occupancy costs and similar inflationary
increases in utility and other costs. SG&A expenses were 37.2% of revenue in the
third quarter of Fiscal 2002, compared to 36.8% of revenue in the third quarter
of Fiscal 2001, an increase of 0.4%.
Depreciation and amortization expense was $7.4 million in the third quarter
of Fiscal 2002 compared to $7.6 million in the third quarter of Fiscal 2001, an
decrease of $0.2 million. The decrease is principally related to the sale of
certain assets to TMN (see Note 2 to Item 1 above).
Interest Expense
Interest expense for the third quarter of Fiscal 2002 was $1.2 million,
compared to $2.3 million for the third quarter of Fiscal 2001, a decrease of
$1.1 million. This decrease was primarily attributable to a reduction in the
average interest rates paid by the Company on its borrowings under the Company's
revolving line of credit with Congress Financial Corporation (Western) (the
"Congress Facility") of approximately 340 basis points in the third quarter of
Fiscal 2002 as compared to the third quarter of Fiscal 2001. Also contributing
to the decline was lower average borrowings under the Congress Facility during
the third quarter of Fiscal 2002. Borrowings under the Congress Facility were
used mainly for the funding of working capital and, in the third quarter of
Fiscal 2001, to fund the investment in CheckOut.com.
Interest Income
Interest income for the third quarter of Fiscal 2002 was $0.2 compared to
$0.1 for the third quarter of Fiscal 2001. The increase in interest income is
attributable to the notes receivable related to the sale of certain assets to
TMN. Interest income also includes notes receivable from shareholders.
9
Loss from Investment in Joint Venture
The Company had a 49% interest in the CheckOut.com joint venture and
accounted for this investment under the equity method of accounting. For the
third quarter of Fiscal 2001, the Company recognized a $3.1 million loss related
to its share of the losses of CheckOut.com. CheckOut.com continued to experience
significant operating losses and ceased operations of its Internet site in
February 2001.
Income Taxes
The income tax expense of $32.1 million for the quarter ended October 31,
2001, represents the valuation allowance provided against a significant portion
of the Company's deferred income tax assets due to recurring losses from the
Company's operations. Such valuation allowance will be reversed when the Company
returns to profitability at levels sufficient to realize such deferred income
tax assets.
FOR THE NINE MONTHS ENDED OCTOBER 31, 2001 AND OCTOBER 31, 2000
Revenues
Total revenues were $430.8 million and $492.2 million for the nine months
ended October 31, 2001 and October 31, 2000, respectively. The decrease of $61.4
million was primarily attributable to decreases in net revenues of $34.9 million
due to the closure of 54 stores since February 1, 2000 and the sale of 64 stores
during the three months ended October 31, 2001, same store sales decreases in
net revenues of $26.3 million and the reduction of net rental revenue of $1.2
million
A summary of total sale merchandise and rental revenue by category is
provided below:
SALE MERCHANDISE AND RENTAL REVENUES
BY CATEGORY
<Table>
<Caption>
NINE MONTHS ENDED
OCTOBER 31,
---------------------
2001 2000
-------- --------
(DOLLARS IN MILLIONS)
Sale merchandise revenue:
Music..................................................... $354.4 $420.6
Other, principally sales of new videocassettes, DVDs,
video game software and hardware, general merchandise
and ticket commissions................................. 73.1 67.2
------ ------
Total sale merchandise revenue.................... 427.5 487.8
Rental revenue, net......................................... 3.2 4.4
------ ------
Total revenue..................................... $430.8 $492.2
====== ======
</Table>
A. Sale merchandise revenue. On a same-store basis, excluding the 54
stores closed since February 1, 2000 and the 64 stores sold during the during
the three months ended October 31, 2001, sale merchandise revenue decreased by
approximately 6.2% during the nine months ended October 31, 2001 as compared to
the same period last year. The primary reasons for the decrease were a weak new
release schedule for music products that continued during most of the nine month
period ended October 31, 2001, and competition from certain "big-box" retailers
selling selected new music releases at or below cost. Partially offsetting these
decreases were increased sales of DVD and used music.
B. Rental revenue, net. Rental revenue, net was $3.2 million in the nine
months ended October 31, 2001 and $4.4 million in the nine months ended October
31, 2000, representing a decrease of $1.2 million or 27.3% due to the Company's
de-emphasis of the rental portion of its business.
10
Cost of Sale Merchandise Revenue
Cost of sale merchandise revenue was $281.7 million for the nine months
ended October 31, 2001, as compared with $315.4 million for the same period last
year, a decrease of $33.7 million. As a percentage of sale merchandise revenue,
cost of sale merchandise revenue was 65.9% for the nine months ended October 31,
2001 as compared with 64.7% for the nine months ended October 31, 2000. As a
percentage of total revenues for the nine months ended October 31, 2001, sales
of higher margin new music product continued to decrease and sales of lower
margin DVD product continued to increase, which offset the benefit from an
increase of higher margin used music product In addition, decreases in sales
prices related to several mid-line new music promotional events also caused
pressure on gross profit margins.
Operating Expenses
SG&A expenses for the nine months ended October 31, 2001 were $153.0
million, compared to $167.7 million for the nine months ended October 31, 2000,
a decrease of $14.7 million. The decrease includes a reduction of $12.9 million
in operating expenses at the Company's stores due to store closures and the sale
of 64 of the Company's stores. In addition, cost of living increases in payroll,
CPI increases in occupancy costs and similar inflationary increases in utility
and other costs were more than offset by improvements in operating efficiencies
and expense reductions. SG&A expenses were 35.5% of revenue in the nine months
ended October 31, 2001, compared to 34.1% of revenue in the nine months ended
October 31, 2000, an increase of 1.4%.
Depreciation and amortization expense was $23.0 million in the nine months
ended October 31, 2001 compared to $22.4 million in the nine months ended
October 31, 2000, an increase of $0.6 million. The increase is principally
related to capital expenditures over the last twelve months for the acquisition
of property, equipment and system improvements.
Interest Expense
Interest expense for the nine months ended October 31, 2001 was $4.5
million, compared to $6.6 million for the nine months ended October 31, 2000, a
decrease of $2.1 million. This decrease was partially attributable to lower
average borrowings under the Congress Facility. Also contributing to the decline
was a reduction in the average interest rates paid by the Company on its
borrowings under the Congress Facility of approximately 210 basis points in the
nine months ended October 31, 2001 as compared to the nine months ended October
31, 2000.
Interest Income
Interest income for the nine months ended October 31, 2001 was $0.4
compared to $0.3 for the nine months ended October 31, 2000. The increase in
interest income is attributable to the notes receivable related to the sale of
certain assets to TMN.
Loss from Investment in Joint Venture
For the nine months ended October 31, 2000, the Company recognized a $9.1
million loss related to its share of the losses of CheckOut.com. CheckOut.com
continued to experience significant operating losses and ceased operations of
its Internet site in February 2001.
Income Taxes
The income tax expense of $24.5 million for the nine months ended October
31, 2001, reflects the $32.1 valuation allowance provided against a significant
portion of the Company's deferred income tax assets due to losses from the
Company's operations in the quarter ended October 31, 2001. Such valuation
allowance will be reversed when the Company returns to profitability at levels
sufficient to realize such deferred income tax assets.
11
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended October 31, 2001 and the nine months ended
October 31, 2000, the Company's net cash used in operating activities was $29.9
million and $13.0 million, respectively. The most significant use of cash during
this period was related to seasonal and non-seasonal inventory purchases as
evidenced by higher inventory levels, $18.9 million and a decrease in accounts
payable, accrued expenses and other current liabilities, $7.7 million. Seasonal
inventory purchases typically begin during the third quarter and continue into
the fourth quarter, while payment is typically due in the first quarter of the
fiscal year. Non-seasonal inventory purchases are made throughout the year and
fluctuate with the timing and strength of new releases.
Net cash provided by investing activities during the nine months ended
October 31, 2001 was $11.6 million primarily due to $18.2 million in proceeds
received from the sale of assets to TMN, partially offset by capital
expenditures totaling $6.7 million for the acquisition of property, equipment
and improvements. Financing of capital expenditures has generally been provided
by cash by operations and borrowings under the Congress Facility. During the
nine months ended October 31, 2000, net cash used in investing activities
included $17.8 million invested in the Company's joint venture with
CheckOut.com.
Net cash provided by financing activities for the nine months ended October
31, 2001 was $17.0 million due to net borrowings under the Congress Facility of
$22.1 million, offset partially by payments of $5.1 million on capital lease
obligations and long-term debt.
As of October 31, 2001, there was an outstanding loan balance of $57.2
million and there were no outstanding letters of credit under the Congress
Facility. The Company estimates that its availability under its revolving line
of credit at October 31, 2001 was $51.2 million. On November 29, 2001, the
Company was required to post a letter of credit of $11.4 million as security for
an appellate bond issued to stay execution of the judgment in the Peterson
Lawsuit, discussed above, pending the outcome of the Company's appeal. As of
December 17, 2001, the Company estimates that its availability under its
revolving line of credit was $63.0 after giving effect to the $11.4 million
letter of credit.
The Company believes that cash on hand, cash flow from operations,
including planned inventory reductions during Fiscal 2002, and the availability
of lease financing, together with borrowings available under the Congress
Facility, will be adequate to support existing operations and the planned
capital expenditures of the Company for Fiscal 2002.
SEASONALITY AND INFLATION
The Company's business is seasonal, and revenues and operating income are
highest during the fourth quarter of the Company's fiscal year. Working capital
and related bank borrowings in prior years were usually lowest during the period
beginning with the end of the Christmas holiday season and ending with the close
of the Company's fiscal year. Beginning in February, working capital and related
bank borrowings have historically trended upward during the year until the
fourth quarter. Borrowings have historically been highest in October and
November due to capital expenditures and the building of inventory for the
holiday season. 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 sources of liquidity and working
capital.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to risks resulting from interest rate fluctuations
since interest on the Company's borrowings under the Congress Facility are based
on variable rates. If the Eurodollar rate were to increase 1% in Fiscal 2002 as
compared to the rate at October 31, 2001, the Company's interest expense for
Fiscal 2002 would increase $0.6 million based on the outstanding balance of the
Congress Facility at October 31, 2001. The Company does not hold any derivative
instruments and does not engage in hedging activities.
12
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As discussed above, in January, 2001, the Company was sued in the Los
Angeles Superior Court by a former store manager, claiming alleged failure to
pay overtime wages to herself and all similarly situated salaried store
employees. The Complaint does not specify any amount of the claims, either
individually or on behalf of the class. Thereafter, the Complaint was amended to
add three additional named plaintiffs. The amended Complaint seeks relief on
behalf of both store managers and assistant managers going back to 1997. The
Company's motions to strike the class action allegations have been denied. A
limited amount of discovery has been conducted to date.
In October 2001, a second class action suit was filed with respect to store
managers and assistant managers by different named plaintiffs and lawyers. It
also seeks overtime pay and, in addition, asserts claims for meal break and rest
break penalties. No case activity has taken place in the second case to date.
The Company believes the allegations in both suits are without merit and intends
to vigorously defend itself in these matters. However, no assurance can be
provided as to its outcome. Management does not believe an adverse judgment
against the Company would result in a material impact to the consolidated
financial statements.
On July 18, 2001, the Santa Clara County, California Superior Court entered
a $7.6 million judgment against the Company in a personal injury lawsuit
encaptioned Peterson, et al. v. Shapell Industries (the "Peterson Lawsuit").
While the Company was insured for this judgment, its insurer, Reliance Insurance
Company, was ordered liquidated by the State of Pennsylvania on October 3, 2001.
As such, it is unknown at present whether, and to what extent, assets of the
insurer will be available to the Company subsequent to a formal liquidation
proceeding. Pending this outcome, California's Insurance Guarantee Fund ("CIGA")
has engaged appellate counsel on behalf of the Company. CIGA has also
facilitated the posting of an appellate bond to stay execution of the Peterson
judgment pending the outcome of the Company's appeal. The Company was required
by the bonding company to provide an $11.4 million letter of credit as security
for the appellate bond. Management, based on the advice of legal counsel,
believes that it is reasonably possible that it will either prevail on appeal or
be successful in an alternative legal strategy and accordingly has not recorded
a liability for the judgment in the accompanying financial statements.
In addition, the Company is a party to various other claims, legal actions
and complaints arising in the ordinary course of its business. In the opinion of
management, all such matters are without merit or involve such amounts that
unfavorable disposition will not have a material impact on the financial
position or results of operations of the Company.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None.
(b) Reports on Form 8-K
None.
13
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.
/s/ ANTONIO C. ALVAREZ, II
--------------------------------------
Antonio C. Alvarez, II
Chairman of the Board and Chief
Executive Officer, and Director
(Principal Executive Officer)
Date: December 21, 2001
/s/ MARK A. VELARDE
--------------------------------------
Mark A. Velarde
Executive Vice President,
Chief Financial Officer and
Chief Administrative Officer
(Principal Financial Officer)
Date: December 21, 2001
/s/ MEHDI MAHDAVI
--------------------------------------
Mehdi Mahdavi
Vice President, Controller
(Principal Accounting Officer)
Date: December 21, 2001
14