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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED APRIL 30, 1999
[ ] 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 [ ]
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,
10,704,710 shares outstanding as of June 11, 1999
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2
INDEX
WHEREHOUSE ENTERTAINMENT, INC.
PAGE
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FORWARD-LOOKING STATEMENTS.......................................... 3
PART I. FINANCIAL INFORMATION
Item
1. Financial Statements........................................ 4
Consolidated Condensed Balance Sheets --
April 30, 1999 (Unaudited) and January 31, 1999........... 4
Consolidated Condensed Statements of Operations --
Three Months ended April 30, 1999 and 1998 (Unaudited).... 5
Consolidated Condensed Statements of Cash Flows --
Three Months ended April 30, 1999 and 1998 (Unaudited).... 6
Notes to Consolidated Condensed Financial Statements........ 7
Item Management's Discussion and Analysis of Financial Condition
2. and Results of Operations................................. 9
PART II. OTHER INFORMATION
Item
1. Legal Proceedings........................................... 15
Item
6. Exhibits and Reports on Form 8-K............................ 15
SIGNATURES.......................................................... 16
2
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 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) possible delays and
difficulties in integrating the operations of the Acquired Business (as defined
herein) with those of Wherehouse; (b) the ability to retain the customers of the
Acquired Business; (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 Internet 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 sells and rents; (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 legislation; (h) changes in the general economic conditions in the
United States including, but not limited to, consumer sentiment about the
economy in general; (i) regulatory changes, including the investigation of
minimum advertised pricing guidelines by the Federal Trade Commission, which may
adversely affect the business in which we are engaged; (j) the ability to
attract and retain key personnel; and (k) 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.
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4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
WHEREHOUSE ENTERTAINMENT, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
ASSETS
APRIL 30, JANUARY 31,
1999 1999
------------ ------------
(UNAUDITED)
Current assets:
Cash and cash equivalents................................. $ 9,489,000 $ 15,009,000
Receivables, net.......................................... 4,440,000 5,207,000
Inventories, net.......................................... 223,142,000 226,648,000
Other current assets...................................... 2,854,000 2,807,000
Deferred taxes............................................ 14,003,000 14,003,000
------------ ------------
Total current assets.............................. 253,928,000 263,674,000
Property, equipment, and improvements, net.................. 68,531,000 68,531,000
Deferred taxes.............................................. 12,409,000 12,409,000
Intangible assets, net...................................... 40,400,000 41,282,000
Other assets, net........................................... 1,833,000 1,845,000
------------ ------------
Total assets...................................... $377,101,000 $387,741,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and net uncleared checks................. $102,600,000 $114,480,000
Accrued expenses.......................................... 30,053,000 43,590,000
Store closing reserves.................................... 18,993,000 25,205,000
Reorganization liabilities................................ 2,078,000 2,109,000
Current portion of leases in excess of fair market
value.................................................. 3,271,000 3,271,000
Current portion of capital lease obligations.............. 4,081,000 4,207,000
------------ ------------
Total current liabilities......................... 161,076,000 192,862,000
Line of credit.............................................. 64,483,000 37,349,000
Long-term debt.............................................. 3,970,000 3,837,000
Capital lease obligations................................... 22,339,000 23,546,000
Leases in excess of fair market value....................... 25,111,000 25,929,000
Deferred rent and other long-term liabilities............... 6,058,000 6,040,000
------------ ------------
Total liabilities................................. 283,037,000 289,563,000
------------ ------------
Shareholders' equity:
Preferred stock, $.01 par value, 3,000,000 shares
authorized, none issued................................ -- --
Common stock, $.01 par value, 24,000,000 shares
authorized, 10,729,710 and 10,729,710 issued at April
30, 1999 and at January 31, 1999, respectively......... 108,000 108,000
Additional paid-in-capital................................ 89,400,000 89,400,000
Retained earnings......................................... 11,073,000 14,758,000
Treasury stock, 25,000 shares............................. (338,000)
Notes receivable.......................................... (6,179,000) (6,088,000)
------------ ------------
Total shareholders' equity........................ 94,064,000 98,178,000
------------ ------------
Total liabilities and shareholders' equity........ $377,101,000 $387,741,000
============ ============
See Accompanying Notes to Consolidated Condensed Financial Statements.
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WHEREHOUSE ENTERTAINMENT, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
---------------------------
APRIL 30, APRIL 30,
1999 1998
------------ -----------
Sale merchandise revenue.................................... $173,042,000 $61,274,000
Rental revenue.............................................. 5,352,000 9,258,000
------------ -----------
Total revenues............................................ 178,394,000 70,532,000
------------ -----------
Cost of sale merchandise revenue............................ 115,551,000 38,153,000
Cost of rentals, including amortization..................... 2,491,000 4,772,000
------------ -----------
Total cost of revenues.................................... 118,042,000 42,925,000
------------ -----------
Gross profit...................................... 60,352,000 27,607,000
Selling, general and administrative expenses................ 59,063,000 23,626,000
Depreciation and amortization............................... 5,915,000 1,643,000
------------ -----------
(Loss) income from operations............................. (4,626,000) 2,338,000
Interest expense............................................ 1,625,000 94,000
Interest income............................................. (109,000) (697,000)
------------ -----------
(Loss) income before income taxes......................... (6,142,000) 2,941,000
(Benefit) provision for income taxes........................ (2,457,000) 1,214,000
------------ -----------
Net (loss) income......................................... $ (3,685,000) $ 1,727,000
============ ===========
Net (loss) income per common share:
Basic..................................................... $ (0.34) $ 0.16
============ ===========
Diluted................................................... $ (0.34) $ 0.15
============ ===========
Weighted average common shares outstanding -- Basic......... 10,715,384 10,624,500
============ ===========
Weighted average common shares and common equivalent shares
outstanding -- Diluted.................................... 10,715,384 11,209,545
============ ===========
See Accompanying Notes to Consolidated Condensed Financial Statements.
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WHEREHOUSE ENTERTAINMENT, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
----------------------------
APRIL 30, APRIL 30,
1999 1998
------------ ------------
OPERATING ACTIVITIES:
Net (loss) income........................................... $ (3,685,000) $ 1,727,000
Adjustments to reconcile net (loss) income to net cash
provided by (used in) operating activities:
Depreciation and amortization............................. 5,915,000 1,643,000
Rental amortization included in cost of rentals........... 1,427,000 3,760,000
Book value of rental inventory dispositions, included in
cost of rentals........................................ 372,000 937,000
Changes in operating assets and liabilities:
Receivables, net....................................... 767,000 426,000
Inventories, net....................................... 3,547,000 (4,211,000)
Rental inventory purchases............................. (1,885,000) (4,163,000)
Other current assets................................... (47,000) (31,000)
Accounts payable, accrued expenses and other current
liabilities.......................................... (26,246,000) (9,778,000)
Store closure reserves................................. (6,212,000)
Other long-term liabilities............................ 14,000
------------ ------------
Net cash used in operating activities............. (26,033,000) (9,690,000)
------------ ------------
INVESTING ACTIVITIES:
Purchase of property, equipment and improvements............ (5,004,000) (203,000)
Increase (decrease) in other assets......................... 12,000 (103,000)
------------ ------------
Net cash used in investing activities............. (4,992,000) (306,000)
------------ ------------
FINANCING ACTIVITIES:
Net borrowings under line of credit......................... 27,134,000
Payments on capital lease obligations and long-term debt.... (1,200,000) (35,000)
Purchase of common stock.................................... (338,000)
Interest on notes receivable................................ (91,000) (92,000)
------------ ------------
Net cash provided by (used in) financing
activities...................................... 25,505,000 (127,000)
------------ ------------
Net decrease in cash........................................ (5,520,000) (10,123,000)
Cash and cash equivalents at beginning of the period........ 15,009,000 54,720,000
------------ ------------
Cash and cash equivalents at end of the period.............. $ 9,489,000 $ 44,597,000
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest............................................... $ 1,458,000 $ 16,000
Income taxes........................................... $ 4,908,000 $ 6,879,000
See Accompanying Notes to Consolidated Condensed Financial Statements.
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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. All material intercompany balances and transactions have been
eliminated in consolidation. Wherehouse Entertainment, Inc. and all of its
subsidiaries are collectively referred to as the "Company."
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, therefore, operating results for the three-month period ended April
30, 1999 are not necessarily indicative of the results that may be expected for
the Company's fiscal year ending January 31, 2000 ("Fiscal 2000"). Certain
reclassifications of balances have been made to the results for the Company's
fiscal year ended January 31, 1999 ("Fiscal 1999") to conform to the Fiscal 2000
presentation. For further information, refer to the financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-K for
Fiscal 1999.
2. ACQUISITION
On October 26, 1998, pursuant to a Stock Purchase Agreement dated as of
August 10, 1998 (the "Purchase Agreement"), the Company acquired (the
"Acquisition") from Viacom International Inc. (the "Seller") all of the capital
stock of certain retail music subsidiaries of Seller (the "Acquired Business").
The Acquired Business, which operated under the name "Blockbuster Music,"
consisted of 378 stores (the "Acquired Stores") in 33 States. The Company is in
the process of integrating the Acquired Stores into the Wherehouse systems and
changing the trade name under which the Acquired Stores operate to "Wherehouse
Music."
The purchase price for the Acquisition, which is subject to final
adjustment as discussed below, was $127,873,000, including direct acquisition
costs. The Purchase Agreement contains a purchase price adjustment mechanism
based on working capital. The Company has delivered to Seller its Notice of
Disagreement as to Seller's calculation of the working capital adjustment and
final purchase price and is currently negotiating with Seller to resolve the
difference. The ultimate purchase price may be lower as a result.
The Acquisition was accounted for under the purchase method of accounting.
Accordingly, the purchase price has been allocated to the assets acquired and
liabilities assumed based upon their respective fair values at the Acquisition
date based on valuations and other studies. The results of operations of the
Acquired Business are reflected in the accompanying unaudited consolidated
condensed financial statements for the quarter ended April 30, 1999.
Upon the consummation of the Acquisition, the Company's senior management
began formulating its plan to close certain stores which, due to the
Acquisition, competed in the same trade areas as other stores (the "Store
Closure Plan"). The major action steps of the Store Closure Plan, which was
finalized during January 1999, include, among other things, (1) the
identification of stores for closure, (2) the immediate initiation of lease
settlement negotiations, and (3) the establishment of an exit plan for each of
those stores. The Store Closure Plan includes the closing of 70 stores (51
Acquired Stores and 19 existing Wherehouse stores) located in 17 states. The
Company has closed 44 of these stores (32 Acquired Stores and 12 existing
Wherehouse stores) as of April 30, 1999, and nine additional Acquired Stores
stores as of June 11, 1999. The Company is negotiating with landlords to
terminate the leases on the remaining 17 stores.
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WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
During Fiscal 1999, the Company recorded accruals in the purchase price
allocation for store closure reserve -- Acquired Stores and leases in excess of
fair market value. The following is a rollforward of the activity of these
reserves:
ACCRUAL AS OF CHARGES
JANUARY 31, AGAINST BALANCE AS OF
1999 RESERVE APRIL 30, 1999
------------- ---------- --------------
Store closure reserve -- Acquired Stores(1).......... $22,612,000 $5,366,000 $17,246,000
Leases in excess of fair market value................ 29,200,000 818,000 28,382,000
----------- ---------- -----------
Total...................................... $51,812,000 $6,184,000 $45,628,000
=========== ========== ===========
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(1) Consists substantially of lease termination costs.
During Fiscal 1999, the Company recorded accruals related to the planned
closing of 19 Wherehouse stores. As of April 30, 1999, the Company had closed 12
of these stores. The following is a rollforward of the activity of the store
closure reserve -- existing stores:
ACCRUAL AS OF CHARGES BALANCE AS OF
JANUARY 31, AGAINST APRIL 30,
1999 RESERVE 1999
------------- -------- -------------
Store closure reserve -- Existing Stores(1)............. $2,593,000 $846,000 $1,747,000
========== ======== ==========
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(1) Consists substantially of lease termination costs.
3. EARNINGS PER SHARE
Basic earnings per share are based on weighted average common shares
outstanding and diluted shares are based on weighted average common shares
outstanding adjusted for the dilutive effect of potentially issuable common
shares outstanding.
4. REORGANIZATION UNDER CHAPTER 11
The Plan of Reorganization for the Company's predecessors (the
"Reorganization Plan") was confirmed by an order of the United States Bankruptcy
Court for the District of Delaware (the "Bankruptcy Court") entered on January
7, 1997. The effective date of the Reorganization 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.
A more comprehensive summary of the Reorganization Plan is contained in the
Company's Annual Report on Form 10-K for Fiscal 1999.
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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 1999.
The results of operations for the quarter ended April 30, 1998 do not
include the operating results of the Acquired Stores.
RESULTS OF OPERATIONS
FOR THE QUARTERS ENDED APRIL 30, 1999 AND APRIL 30, 1998
Revenues
Net revenues were $178.4 million and $70.5 million for the quarters ended
April 30, 1999 (the first quarter of Fiscal 2000) and April 30, 1998 (the first
quarter of Fiscal 1999), respectively. The increase of $107.9 million was
primarily attributable to the addition of the Acquired Stores, which contributed
$107.0 million in net revenues during the first quarter of Fiscal 2000.
Excluding the Acquired Stores, net revenues increased to $71.4 million
during the first quarter of Fiscal 2000 from $70.5 million during the first
quarter of Fiscal 1999. The increase was comprised of an increase in sale
merchandise revenue (defined below) of $4.8 million which was partially offset
by a decrease in rental revenue of $3.9 million.
A summary of total sale merchandise and rental revenues by category is
provided below:
SALE MERCHANDISE AND RENTAL REVENUES BY CATEGORY
(DOLLARS IN MILLIONS)
QUARTER ENDED
APRIL 30,
---------------
1999* 1998
------ -----
Sale merchandise revenue:
Music..................................................... $153.4 $53.8
Other, principally sales of new videocassettes, DVDs,
video game software and hardware, general merchandise
and ticket commissions................................. 19.6 7.5
------ -----
Total sale merchandise revenue.................... 173.0 61.3
Videocassette and other rental revenues**................... 5.4 9.2
------ -----
Total revenue..................................... $178.4 $70.5
====== =====
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* Includes revenue of the Acquired Business from February 1, 1999 to April 30,
1999
** Includes sales of previously viewed videocassettes
A. Sale merchandise revenue. Sales of prerecorded music, new
videocassettes, DVDs, video game software and hardware and general merchandise
(collectively referred to as "sale merchandise") continue to represent the
greatest portion of the Company's revenues. For the first quarter of Fiscal
2000, sale merchandise revenue represented 97.0% of aggregate revenues, compared
to 86.9% during the first quarter of Fiscal 1999, an increase of 10.1%. This
increase results from the combined impact of the additional sale merchandise
revenue derived from the Acquired Business and a decrease in the number of
stores engaged in the rental business.
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10
Sale merchandise revenue was $173.0 million in the first quarter of Fiscal
2000 compared to $61.3 million in the first quarter of Fiscal 1999. This
increase in sale merchandise revenue was primarily attributable to the addition
of the Acquired Stores.
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 Acquired Stores, sale merchandise revenue, increased by 9.5% during the
first quarter of Fiscal 2000 as compared to the first quarter of Fiscal 1999.
Management believes that the increase in same-store sale merchandise revenue was
principally the result of improvements in music catalog inventory management,
new initiatives such as an expanded DVD selection, and re-merchandising
activities which occurred in certain stores. Management estimates that, on a
same-store basis, sale merchandise revenue for the Acquired Stores decreased by
3.8% during the first quarter of Fiscal 2000 compared to the same period in
Fiscal 1999. This decrease is principally due to the negative impact on revenues
of activities associated with the integration of the Acquired Stores. Such
integration activities included conversions to the Company's point-of-sale
("POS") system and other systems integration as well as the implementation of a
name change from "Blockbuster Music" to "Wherehouse Music" for the Acquired
Stores.
B. Rental revenue. Rental revenue includes proceeds from the rental of
videocassettes, DVDs, video games and game players, and audiocassette books, and
from the sale of previously viewed videocassettes and previously played video
games. As of April 30, 1999, 113 of the Company's stores offered rental
products, with approximately 98 of those stores offering DVDs for rental. The
Acquired Stores generally are not engaged in the rental business. The Company's
license of the Blockbuster Music trademark from Seller prohibits the Company
from renting videos in the Acquired Stores during the time they operate under
the Blockbuster Music name. Once the Acquired Stores commence operations under
the Wherehouse name, they may rent videos.
Rental revenue was $5.4 million in the first quarter of Fiscal 2000 and
$9.2 million in the first quarter of Fiscal 1999, representing a decrease of
$3.8 million or 41.3%. Management believes that, on a same-store basis, rental
revenue, excluding the Acquired Stores, decreased approximately 34.3% during the
first quarter of Fiscal 2000 as compared to the same period last year. This
decrease in same-store rental revenue was primarily attributable to an
increasingly competitive rental market.
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, including, but not limited to, consumer
tastes, new releases of music, videocassette and video game titles available for
sale or rental, the Internet, and technological developments such as digital
downloading, 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, discounters and mass merchandisers. Historically, the
margin on rentals has been higher than the margin on sale merchandise. Should
the Company's product mix continue to shift to lower margin sale merchandise
from higher margin rental revenue, the change in the mix of revenue contribution
could have a negative impact on profitability.
Cost of Revenue
Cost of sale merchandise revenue was $115.5 million for the first quarter
of Fiscal 2000, as compared with $38.2 million for the same period last year, an
increase of $77.3 million which was principally due to the addition of the
Acquired Stores. As a percentage of sale merchandise revenue, cost of sale
merchandise revenue was 66.8% for the first quarter of Fiscal 2000 as compared
with 62.3% for the first quarter of Fiscal 1999. Such costs were negatively
impacted by approximately $2.2 million due to the incremental costs associated
with the use of a third-party distributor to handle music and sale video
replenishment and other transition-related costs. These incremental distribution
costs resulted from the Seller's inability to support the fulfillment of music
product from its distribution facility. These incremental costs are expected to
discontinue by July 31, 1999, once all the Acquired Stores are converted to the
Company's POS system and the expansion of the Company's distribution facility is
expected to be completed.
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11
Excluding the impact of the $2.2 million incremental costs, cost of sale
merchandise revenue, as a percentage of sale merchandise revenue, would have
been 65.5% for the first quarter of Fiscal 2000 as compared with 62.3% for the
first quarter of Fiscal 1999, an increase of 3.2%. Such increase is entirely
attributable to higher cost of sale merchandise revenue incurred by the Acquired
Stores which, in turn, is attributable to higher shrinkage accruals for the
Acquired Stores, as well as higher unit costs for the Acquired Stores prior to
the conversion to the Company's POS system.
Cost of rentals on a consolidated basis, including amortization, was $2.5
million for the first quarter of Fiscal 2000 as compared with $4.8 million for
the first quarter of Fiscal 1999, a decrease of $2.3 million. As a percentage of
rental revenue, cost of rentals decreased to 46.3% for the first quarter of
Fiscal 2000 from 51.5% for the first quarter of Fiscal 1999, a decrease of 5.2%.
The 5.2% decrease in cost of rentals as a percentage of revenue was primarily
due to the favorable impact of an increase in revenue sharing programs and
improved rental efficiencies.
Operating Expenses
Selling, general and administrative ("SG&A") expenses, on a consolidated
basis, for the first quarter of Fiscal 2000 were $59.1 million, compared to
$23.6 million for the first quarter of Fiscal 1999, an increase of $35.5
million. The increase was principally related to the operating expenses of the
Acquired Stores, partially offset by lower store payroll and other store
expenses in the existing Wherehouse stores.
SG&A expenses were 33.1% of revenue in the first quarter of Fiscal 2000,
compared to 33.5% of revenue in the first quarter of Fiscal 1999, a decrease of
0.4%. During the first quarter of Fiscal 2000, the Company incurred integration
costs of approximately $2.9 million related to the Acquisition. Such costs were
principally related to the name change of the Acquired Stores and the conversion
of those stores to the Company's POS system. The Company expects the name change
and POS conversion of the Acquired Stores to be completed by July 31, 1999.
Excluding the integration costs of approximately $2.9 million, SG&A
expenses would have been 31.5% of revenue in the first quarter of Fiscal 2000,
compared to 33.5% of revenue in the first quarter of Fiscal 1999, a decrease of
2.0%. Such 2.0% decrease in SG&A expenses as a percentage of revenues is due
primarily to lower corporate overhead and distribution expense as a percentage
of revenue.
Depreciation and amortization expense was $5.9 million in the first quarter
of Fiscal 2000 compared to $1.6 million in the first quarter of Fiscal 1999, an
increase of $4.3 million. The increase is principally related to depreciation
and amortization expense for the Acquired Stores of $2.8 million.
Loss From Operations
During the first quarter of Fiscal 2000, the Company recorded a loss from
operations of $4.6 million, as compared to income from operations of $2.3
million for the first quarter of Fiscal 1999. The $6.9 million decrease was
principally due to non-recurring costs related to the integration of the
Acquired Stores totaling $5.1 million and the decrease in gross profit resulting
from the decline in rental revenue. The non-recurring costs of $5.1 million
include incremental distribution costs of approximately $2.2 million and
integration costs related to the Acquisition of $2.9 million. Excluding these
non-recurring costs, income from operations would have been $0.5 million.
Interest Expense
Interest expense for the first quarter of Fiscal 2000 was $1.6 million,
compared to $0.1 million for the first quarter of Fiscal 1999, an increase of
$1.5 million. The $1.5 million increase was primarily attributable to interest
expense of $1.0 million incurred due to borrowings under the Company's revolving
line of credit with Congress Financial Corporation (Western) (the "Congress
Facility"). Such borrowings were used mainly to finance a portion of the cost of
the Acquisition.
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Interest Income
Interest income for the first quarter of Fiscal 2000 was $0.1 million, as
compared to $0.7 million for the first quarter of Fiscal 1999. The decrease of
$0.6 million was the result of a decline in short-term investments of excess
cash. Such excess cash was used mainly to finance a portion of the cost of the
Acquisition.
Income Taxes
The Company recorded a tax benefit of $2.5 million for the first quarter of
Fiscal 2000 compared to a tax provision of $1.2 million for the first quarter of
Fiscal 1999. The tax benefit for the first quarter of Fiscal 2000 represents an
effective rate of 40.0%, which the Company estimates will be its effective rate
for Fiscal 2000.
EBITDA
EBITDA represents income (loss) 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 to evaluate operating
performance and to determine the Company's ability to service debt.
Adjusted EBITDA for the first quarter of Fiscal 2000 was $1.2 million
compared to $4.1 million for the first quarter of Fiscal 1999. During the first
quarter of Fiscal 2000, the Company incurred certain incremental and
non-recurring costs related to the Acquisition. Excluding the incremental
distribution costs of $2.2 million and integration costs of $2.9 million,
Adjusted EBITDA would have been $6.3 million.
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 GAAP measurements such as net income or cash flow
from operations. Rather it is presented as supplementary information.
LIQUIDITY AND CAPITAL RESOURCES
During the first quarter of Fiscal 2000, the Company's net cash used in
operating activities was $26.0 million, as compared to $9.7 million net cash
used in operating activities during the first quarter of Fiscal 1999, an
increase of $16.3 million. The increase in cash flow used in operations was
primarily due to a reduction in accounts payable, accrued expenses, and other
store closing reserves, as well as the loss from operations, partially offset by
a decrease in inventory resulting from the Company's inventory reduction
activities.
Net cash used in investing activities increased to $5.0 million during the
first quarter of Fiscal 2000 from $0.3 million during the first quarter of
Fiscal 1999, an increase of $4.7 million. The increase in cash used in investing
activities was primarily due to capital expenditures totaling $5.0 million
related mainly to the acquisition of property, equipment and improvements to
support the POS systems conversion, name change and re-merchandising activities
related to the Acquired Stores. Financing of capital expenditures has generally
been provided by cash from operations and borrowings under the Congress
Facility.
Net cash provided by financing activities was $25.5 million for the first
quarter of Fiscal 2000, as compared to cash used for financing activities of
$0.1 million for the first quarter of Fiscal 1999. The increase of $25.6 million
was primarily due to net borrowings under the Congress Facility of $27.1
million, partially offset by $1.2 million in payments on capital lease
obligations and long-term debt.
The Company believes that cash on hand, cash flow from operations 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 2000.
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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 cumulative capital expenditures for new stores 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 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, and in January 1999 the Company
created a Y2K Project Committee. This committee established guidelines for and
directs the Y2K efforts. The primary objective of this committee is to ensure
the Company's ability to operate with its internal systems in the Year 2000. The
secondary objective is 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 POS systems. All the new systems purchased have
been confirmed to be Y2K compliant. The projects to implement these new systems
are underway. Implementation of these new systems will likely occur in the
second and third quarters of Fiscal 2000. 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, which the Company expects
will be completed in the third quarter of Fiscal 2000. The Company expects to
complete the conversion of the Acquired Stores to the Wherehouse POS system in
the first half of Fiscal 2000.
External Vendors -- The Company is aware of significant Y2K remediation
work being performed by its major vendors. The Y2K Project Committee initiated
communication with the Company's significant suppliers in the first three months
of Fiscal 2000 regarding their Y2K readiness. The Company intends to focus
extensively on the second tier suppliers in the second and third quarters of
Fiscal 2000.
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 because 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. Costs relating to
the remediation, performed as a contingency measure, of approximately $1.8
million were recorded in Fiscal 1999. The Company's internal personnel and other
resources performed the POS software remediation. The Wherehouse POS hardware
operating system upgrade is expected to cost between $1.5 million and $2.0
million, principally for new POS related hardware. The Company's internal
personnel will handle all other projects.
3) The Risks of the Company's Year 2000 Issues
The Company has completed a detailed risk assessment of its major systems.
The Y2K Project Committee is scheduled to complete a detailed risk assessment,
addressing other Y2K concerns in the second quarter of Fiscal 2000.
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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 contracted with an
outside firm to remediate the existing corporate merchandising system.
Installation of the remediated corporate merchandising system is scheduled to
begin during the second quarter of Fiscal 2000. The Company has a contingency
plan to remediate the current warehouse management system software in the event
that installation of the newly acquired warehouse management system fails. The
Company is in the process of preparing a contingency plan in the event the
installation of the new financial system, which is widely used by retailers, is
delayed.
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 2000 as
compared to the rate at April 30, 1999, the Company's interest expense for
Fiscal 2000 would increase $0.6 million based on the outstanding balance of the
Congress Facility at April 30, 1999. The Company does not hold any derivative
instruments and does not engage in hedging activities.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a party to various claims, legal actions and complaints
arising in the ordinary course of its business. In the opinion of management,
all such matters are without merit or involve such amounts that unfavorable
disposition will not have a material impact on the financial position and
results of operations of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
27.0 Financial Data Schedule
(b) Reports on Form 8-K
None.
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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: June 14, 1999 /s/ ANTONIO C. ALVAREZ, II
--------------------------------------
ANTONIO C. ALVAREZ, II
Chairman of the Board and Chief
Executive Officer, and Director
(Principal Executive Officer)
Date: June 14, 1999 /s/ ROBERT S. KELLEHER
--------------------------------------
ROBERT S. KELLEHER
Executive Vice President and
Chief Financial Officer
Date: June 14, 1999 /s/ MEHDI MAHDAVI
--------------------------------------
MEHDI MAHDAVI
Vice President, Controller
(Principal Accounting Officer)
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