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 quarter period ended October 31, 1997
[ ] 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
(I.R.S. Employer Identification Number)
19701 Hamilton Avenue
Torrance, California 90502-1334
(Address of principal executive
offices including ZIP code)
(310) 538-2314
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark 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 a plan
confirmed by a court. Yes [ X ] No [ ]
As of October 31, 1997, 10,546,256 shares of the registrant's common stock
were issued and outstanding and 619,388 additional shares are expected to be
issued pursuant to the bankruptcy plan of reorganization discussed in Item 1
below.
INDEX
WHEREHOUSE ENTERTAINMENT, INC.
Page
----
FORWARD LOOKING STATEMENTS 3
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets -
October 31, 1997 (Unaudited) and
January 31, 1997 4
Condensed Statements of Operations -
Three Months Ended October 31, 1997
(New Wherehouse) and 1996 (Old
Wherehouse) (Unaudited) 5
Nine Months Ended October 31, 1997 (New
Wherehouse) and 1996 (Old Wherehouse)
(Unaudited) 5
Condensed Statements of Cash Flows -
Nine Months Ended October 31, 1997
(New Wherehouse) and 1996 (Old
Wherehouse) (Unaudited) 6
Notes to Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operation 10
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 2. Changes in Securities 18
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote of
Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
2
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 which 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
competitors' 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) 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; (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 the Federal and state
income tax rules and regulations or interpretations of existing legislation; (f)
changes in the general economic conditions in the United States, and in
particular the eight major markets served by the registrant, including, but not
limited to consumer sentiment about the economy in general; (g) changes in
availability or terms of working capital financing from vendors and lending
institutions; (h) adverse results in significant litigation matters; and (i) the
ability to attract and retain key personnel. 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.
3
PART I.
FINANCIAL INFORMATION
ITEM 1.
WHEREHOUSE ENTERTAINMENT, INC.
CONDENSED BALANCE SHEETS
October 31, January 31,
1997 1997
------------- -------------
(Unaudited)
ASSETS
Current Assets
Cash $ 30,720,000 $ 6,178,000
Receivables 823,000 1,932,000
Prepaid inventory deposits ------ 4,486,000
Merchandise inventory 78,813,000 75,800,000
Other current assets 1,786,000 2,259,000
Rental inventory, net (Note 5) 7,016,000 9,686,000
------------- -------------
Total current assets 119,158,000 100,341,000
Equipment and improvements, net 19,418,000 21,337,000
Reorganization value in excess of amounts allocable to
identifiable assets, net 8,995,000 9,724,000
Deferred taxes 3,000,000 -----
Other assets 275,000 340,000
------------- -------------
Total assets $ 150,846,000 $ 131,742,000
------------- -------------
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued expenses $ 56,905,000 $ 40,168,000
Current maturities of capital lease obligations
and long-term debt 306,000 729,000
------------- -------------
Total current liabilities 57,211,000 40,897,000
------------- -------------
Capital lease obligations and long-term debt 637,000 722,000
Notes payable 3,935,000 3,980,000
Other long-term liabilities 3,929,000 2,000,000
------------- -------------
Shareholders' equity
Common stock, $.01 par value, 24,000,000 authorized,
10,546,256 and 10,257,808 issued and outstanding
at October 31, 1997 and January 31, 1997, respectively 105,000 103,000
Additional paid-in capital 89,378,000 89,380,000
Retained earnings 1,271,000 -----
Notes receivable (5,620,000) (5,340,000)
------------- -------------
Total shareholders' equity 85,134,000 84,143,000
------------- -------------
Total liabilities and shareholders' equity $ 150,846,000 $ 131,742,000
------------- -------------
------------- -------------
See accompanying notes to Condensed Financial Statements
4
WHEREHOUSE ENTERTAINMENT, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
New Old New Old
Wherehouse Wherehouse Wherehouse Wherehouse
---------------- ---------------- ---------------- ----------------
Three Three Nine Nine
Months Ended Months Ended Months Ended Months Ended
October 31, 1997 October 31, 1996 October 31, 1997 October 31, 1996
---------------- ---------------- ---------------- ----------------
Sales $ 60,762,000 $ 63,184,000 $ 184,342,000 $ 200,894,000
Rental revenue 11,199,000 14,960,000 38,682,000 52,409,000
---------------- ---------------- ---------------- ----------------
71,961,000 78,144,000 223,024,000 253,303,000
Cost of sales 37,903,000 40,029,000 117,656,000 129,967,000
Costs of rentals, including amortization 6,008,000 9,392,000 21,728,000 27,309,000
---------------- ---------------- ---------------- ----------------
43,911,000 49,421,000 139,384,000 157,276,000
Selling, general and administrative expenses 25,195,000 32,510,000 77,302,000 100,279,000
Depreciation & amortization 1,616,000 2,610,000 4,849,000 9,283,000
---------------- ---------------- ---------------- ----------------
Income (loss) from operations 1,239,000 (6,397,000) 1,489,000 (13,535,000)
Interest expense 115,000 281,000 337,000 594,000
Interest income (494,000) (122,000) (1,032,000) (216,000)
---------------- ---------------- ---------------- ----------------
Income (loss) before reorganization items & income taxes 1,618,000 (6,556,000) 2,184,000 (13,913,000)
Reorganization items:
Professional fees ----- 900,000 ----- 2,686,000
Provision for store closing costs ----- ----- ----- 1,134,000
---------------- ---------------- ---------------- ----------------
----- 900,000 ----- 3,820,000
---------------- ---------------- ---------------- ----------------
Income (loss) before income taxes 1,618,000 (7,456,000) 2,184,000 (17,733,000)
---------------- ---------------- ---------------- ----------------
Provision for income taxes 648,000 ----- 913,000 -----
Net income (loss) $ 970,000 $ (7,456,000) $ 1,271,000 $ (17,733,000)
---------------- ---------------- ---------------- ----------------
---------------- ---------------- ---------------- ----------------
Net income (loss) per share $ 0.09 $ 0.12
---------------- ----------------
---------------- ----------------
Weighted average shares outstanding 10,969,938 10,666,193
---------------- ----------------
---------------- ----------------
Number of stores at end of period 230 265 230 265
---------------- ---------------- ---------------- ----------------
See accompanying notes to Condensed Financial Statements
5
WHEREHOUSE ENTERTAINMENT, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
New Old
Wherehouse Wherehouse
---------------- ----------------
Nine Nine
Months Ended Months Ended
October 31, 1997 October 31, 1996
---------------- ----------------
OPERATING ACTIVITIES:
Net income (loss) $ 1,271,000 $ (17,733,000)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 4,849,000 9,637,000
Rental amortization included in cost of rental 16,901,000 19,416,000
Book value of rental inventory dispositions, included in cost of rental 3,300,000 7,893,000
Deferred tax (3,000,000) -----
Changes in operating assets and liabilities:
Receivables 1,389,000 100,000
Prepaid inventory deposits 4,486,000 5,083,000
Merchandise inventory (3,013,000) (8,925,000)
Other current assets 473,000 797,000
Accounts payable, accrued expenses and other liabilities 18,077,000 135,000
Rental inventory purchases (16,773,000) (25,292,000)
---------------- ----------------
Net cash provided by (used in) operating activities 27,960,000 (8,889,000)
INVESTING ACTIVITIES:
Acquisition of property, equipment and improvements (2,930,000) (1,934,000)
Decrease (increase) in other assets and intangibles 65,000 (418,000)
---------------- ----------------
Net cash used in investing activities (2,865,000) (2,352,000)
FINANCING ACTIVITIES:
Principal payments on capital lease obligations
and long-term debt (553,000) (618,000)
Short term borrowings ----- 5,934,000
---------------- ----------------
Net cash provided by (used in) financing activities (553,000) 5,316,000
---------------- ----------------
Net increase (decrease) in cash 24,542,000 (5,925,000)
Cash at beginning of the period 6,178,000 7,353,000
---------------- ----------------
Cash at end of the period $ 30,720,000 $ 1,428,000
---------------- ----------------
---------------- ----------------
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 82,042 $ 516,000
Income taxes 1,710,000 25,000
Reorganization items 9,850,000 2,815,000
See accompanying notes to Condensed Financial Statements
6
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. 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,
1997 are not necessarily indicative of the results that may be expected for the
year ended January 31, 1998. Certain reclassifications of balances have been
made to the 1996 amounts to conform to the 1997 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, 1997.
2. REORGANIZATION UNDER CHAPTER 11
The Company's Plan of Reorganization, (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.
Pursuant to the Plan, Wherehouse Entertainment, Inc. (New Wherehouse) was
incorporated on November 15, 1996, as WEI Acquisition Co. On January 31, 1997,
New Wherehouse acquired (the Acquisition) substantially all the assets of
Wherehouse Dissolution Co. (Old Wherehouse), and its parent company, WEI
Holdings, Inc. Prior to the Acquisition, Old Wherehouse was known as
"Wherehouse Entertainment, Inc.," and after the Acquisition, Old Wherehouse
changed its name to "Wherehouse Dissolution Co." After the Acquisition, New
Wherehouse changed its name to "Wherehouse Entertainment, Inc." New Wherehouse
and Old Wherehouse are collectively referred to as the Company or Wherehouse
where the discussion relates to the continuing business operations of Old
Wherehouse and New Wherehouse.
Since the Plan Effective Date, the Bankruptcy Court has retained
jurisdiction over certain claims and other matters relating to the Debtors'
Bankruptcy estates, 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, reference is made to the Company's Annual Report
on Form 10-K for the year ended January 31, 1997.
7
3. FRESH START REPORTING
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 (SOP 90-7) on
Financial Reporting by Entities in Reorganization under the Bankruptcy Code (SOP
90-7). This resulted in 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 SOP, 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. As such, the accompanying Company balance
sheet as of January 31, 1997, represents that of a successor company which, in
effect, is a new entity with assets, liabilities and a capital structure having
carrying values not comparable with prior periods and with no beginning retained
earnings or deficit. In addition, the Company selected certain accounting
policies adopted at New Wherehouse's inception which are not consistent with
those used by Old Wherehouse. Accordingly, the results of operations of New
Wherehouse may not be comparable to those of Old Wherehouse. During the quarter
ending January 31, 1998, the Company expects to record reclassification
adjustments on the initial allocation of reorganization valuation as of January
31, 1997, based on final analysis and appraisals being obtained.
4. REVOLVING CREDIT FACILITY
Pursuant to the Plan, the Company entered into a loan and security
agreement with Congress Financial Corporation (Western) (the Congress Facility),
which provides a borrowing capacity of up to $30,000,000 with a letter of credit
subfacility of $10,000,000, subject to borrowing base limitations based upon,
among other things, the value of certain eligible merchandise inventory. The
Congress Facility prohibits the Company from declaring or paying dividends on
its classes of capital stock, including the common stock, in excess of an
aggregate of $6.0 million, unless certain financial performance targets set
forth in the Congress Facility are met. As of October 31, 1997, there were no
borrowings outstanding under the Congress Facility, although $700,000 of letters
of credit were outstanding.
5. RENTAL INVENTORY AMORTIZATION
On January 31, 1997, the Company adopted a more accelerated method of
amortization under which rental inventory is amortized using the straight-line
method over a three-month period with a salvage value of $3.00 per unit. The
previous method amortized rental inventory over a three year period for video
cassettes and a two year period for video games.
8
6. RESTATEMENT OF PRIOR QUARTERS
The Company will be amending its previously issued reports on Form 10-Q for
quarters ended April 30, 1997 and July 31, 1997 to reflect adjustments primarily
to depreciation and amortization expense resulting from changes in the initial
allocation of assets related to the Company's fresh start reporting. These
changes were based on analysis and appraisals received by the Company, during
the third quarter.
The impact on the first two quarters of fiscal year ending January 31, 1998 were
as follows:
3 MONTHS ENDING 3 MONTHS ENDING
APRIL 30, 1997 JULY 31, 1997
--------------- ---------------
Previously Previously
Reported Restated Reported Restated
------------ ---------- ---------- ---------
Income (loss) from operations $(1,430,000) $(524,000) $ 177,000 $ 774,000
Net income (loss) (830,000) (286,000) (230,000) 588,000
Net income (loss) per share $ (.08) $ (.03) $ (.02) $ .06
9
WHEREHOUSE ENTERTAINMENT, INC.
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 Reports on Form
10-K for the year ended January 31, 1997.
RESULTS OF OPERATIONS
FOR THE QUARTERS ENDED OCTOBER 31, 1997 AND OCTOBER 31, 1996
Net revenues were $71.9 million and $78.1 million for the quarters ended
October 31, 1997 and October 31, 1996, respectively. The Company believes that
the decrease of $6.2 million, or 7.9%, was principally due to the closure of
underperforming stores during the fiscal year ended January 31, 1997, as well as
continued competitive and economic pressures in certain of the Company's
markets.
A summary of total net merchandise sales and rental revenues, by product
category, is provided below:
NET MERCHANDISE SALES AND RENTAL REVENUES
BY MERCHANDISE CATEGORY
(Dollar Amounts in Millions)
Quarter Ended
October 31,
1997 1996
---- ----
Net Merchandise Sales:
Music $ 53.0 $ 54.8
Other, principally sales of new video
cassettes, video game software and hardware,
general merchandise and ticket commissions. 7.7 8.4
----- -----
Total merchandise sales $ 60.7 $ 63.2
------ ------
Rental Revenue
Video cassette and other rental revenue $ 11.2 $ 14.9
----- -----
Total rental revenue $ 11.2 $ 14.9
----- -----
Total revenues $ 71.9 $ 78.1
----- -----
----- -----
The sale of pre-recorded music, new video cassettes, video game software
and hardware and general merchandise continue to represent the greatest portion
of the Company's revenues.
10
For the quarter ended October 31, 1997, net merchandise sales represented 84.5%
of aggregate revenues. On a same-store basis, net merchandise sales increased
by 6.6% during the quarter ended October 31, 1997, as compared to the quarter
ended October 31, 1996. Net merchandise sales were $60.7 million versus $63.2
million for the quarters ended October 31, 1997 and October 31, 1996,
respectively, representing an overall decrease of 4.0%. The decrease of 4.0%
was largely the result of the closure of underperforming stores during the
fiscal year ended January 31, 1997.
Rental revenue includes the revenues from the rental of video cassettes,
video games, game players and audio cassette books and revenues from the sale of
previously used video cassettes and video games. Approximately 170 of the
Company's stores currently offer rental products. Rental revenue was $11.2
million versus $14.9 million during the quarters ended October 31, 1997 and
October 31, 1996, respectively, representing a decrease of $3.7 million or
24.8%. On a same-store basis, rental revenue decreased approximately 20.0% as
compared to the prior year. The Company believes that the decrease in
same-store rental revenue was primarily attributable to continued competition
and a general softening in rental video spending nationwide. During the
quarter ended October 31, 1997, the Company decreased its purchases of video
rental product by $2.7 million or 39.3% versus the same quarter of the prior
year.
Cost of sales decreased $2.1 million to $37.9 million for the quarter ended
October 31, 1997 versus $40.0 million for the quarter ended October 31, 1996,
representing a decrease of 5.3%. As a percentage of net merchandise sales,
costs of sales decreased 1.0% to 62.4% during the quarter ended October 31, 1997
versus 63.4% during the quarter ended October 31, 1996. The 1.0% decrease in
cost of sales as a percentage of net merchandise sales was primarily due to
lower obsolescence provisions resulting from improved inventory management.
Cost of rentals, including amortization, decreased to $6.0 million during
the quarter ended October 31, 1997, a decrease of $3.4 million or 36.0%, versus
$9.4 million during the quarter ended October 31, 1996. As a percentage of
rental revenue, cost of rentals decreased to 53.6% during the quarter ended
October 31, 1997 versus 62.8% during the quarter ended October 31, 1996,
representing a decrease of 9.2%. The 9.2% decrease in cost of rentals is the
result of a higher than normal charge for excess video liquidation in the prior
year, which more than offsets the current year impact of the adoption of a more
accelerated method of amortization of rental product. If Old Wherehouse had
adopted this accelerated method of amortization as of January 31, 1996, cost of
rentals during the quarter ended October 31, 1996 would have been lower (and
gross profit higher, because the cost associated with the write down of excess
video rental product last year would have been incurred as part of the
accounting changes, for the fiscal year ending January 31, 1966) by
approximately $1.7 million, since a significant portion of the charge taken in
that quarter would have been recognized as of January 31, 1996, as a result of
the change in method.
Merchandise sales as a percentage of aggregate net revenues increased 3.5%
to 84.4% during the quarter ended October 31, 1997 versus 80.9% during the
quarter ended October 31, 1996.
11
Selling, general and administrative expenses, were $25.2 million versus
$32.5 million for the quarters ended October 31, 1997 and October 31, 1996,
respectively, a decrease of $7.3 million or 22.5%. As a percentage of net
revenues, selling, general and administrative expenses, were 35.0% during the
quarter ended October 31, 1997 versus 41.6% during the quarter ended October 31,
1996, representing a decrease of 6.6%. The 6.6% decrease was principally due to
reductions in rent and occupancy costs through landlord concessions, decreases
in non-music advertising spending and decreases in other corporate and store
expense categories.
Income from operations for the quarter ended October 31, 1997 was $1.2
million as compared to a loss from operations of $6.4 million for the quarter
ended October 31, 1996, an improvement of $7.6 million. As mentioned
previously, the Company adopted an accelerated method of amortization for rental
inventory at January 31, 1997. If the Company had adopted the accelerated
method at January 31, 1996, loss from operations for the quarter ended October
31, 1996 would have been $1.7 million lower than reported. Including the impact
of the change in the method of amortization of rental inventory, if it had been
adopted by Old Wherehouse at January 31, 1996, income from operations for the
period ended October 31, 1997 was $5.9 million higher than that experienced for
the period ended October 31, 1996. The improvement in income from operations
was primarily the result of the closure of underperforming stores during the
fiscal year ended January 31,1997, reductions in rent and occupancy costs
through landlord concessions, decreases in non-music advertising expense, and
increased merchandise sales that more than offset the decline in rental revenue.
Management believes that EBITDA (Earnings Before Interest, Taxes,
Depreciation and Amortization) is a measurement tool commonly used among
retailers to evaluate, for internal purposes, the relative earning power of the
business. The merchandising format employed by the Company includes merchandise
offered for sale, as well as the rental of video cassettes, video games and game
players. Product purchased for rental purposes is recorded as an asset and is
amortized over a three month period, using a half-month convention in the month
of acquisition. Rental product amortization is included in cost of rental in
the Company's income statement. Management believes that the difference between
the cost of rental amortization of current rental inventory and book value of
rental dispositions, versus the rental product purchases during the period, is
an additional indicator that should be taken into account in assessing the
earning power of the Company. It is management's belief that due to the
combined format of rental product and sale merchandise, a more appropriate
calculation of EBITDA (hereinafter referred to as Adjusted EBITDA) should
include the net difference between rental amortization and book value of rental
dispositions, versus rental inventory purchased during the period. The schedule
below shows the results of this calculation. This measurement is not intended
to replace the Balance Sheet, Statement of Operations and Statement of Cash Flow
included in this document. Rather, it is presented as supplementary
information.
12
ADJUSTED EBITDA
THREE MONTHS ENDED
OCTOBER 31, 1997
-------------------
Income from Operations $1,239,000
Add back:
Depreciation on equipment and
amortization on improvements $1,616,000
----------
Subtotal $2,855,000
Add:
Book value of rental dispositions (excluding
dispositions outside the normal course
of operations) $ 445,000
Rental amortization in cost of rental $4,725,000
Less:
Costs of rental inventory purchases $4,105,000
----------
Adjusted EBITDA $3,920,000
----------
----------
Reorganization items include costs related to the bankruptcy case
including professional fees for legal and financial advisors, costs related to
the closing of stores, and the estimated cost associated with the rejection of
certain executory contracts. For the quarter ended October 31, 1996, the
Company reported total reorganization items of $.9 million.
The Company recorded a tax provision of $0.7 million for the
quarter ended October 31, 1997, but did not record any tax benefit for the
quarter ended October 31, 1996. The provision represents an effective tax rate
of 40% which the Company estimates will be its effective tax rate for the year
ended January 31, 1998.
The Company is currently under audit by the California Franchise
Tax Board ("FTB") for tax years January 31, 1992, 1993 and 1994. The Company
believes that it has made adequate provision in the financial statements for the
outcome of this audit.
FOR NINE MONTHS ENDED OCTOBER 31, 1997 AND OCTOBER 31, 1996
Net revenues were $223.1 million and $253.3 million for the nine
months ended October 31, 1997 and October 31, 1996, respectively. The Company
believes that the decrease of $30.2 million, or 11.9%, was principally due to
the closure of underperforming stores during the fiscal year ended January 31,
1997 as well as continued competitive and economic pressures in certain of the
Company's markets.
13
A summary of total net merchandise sales and rental revenues, by
product category, is provided below:
NET MERCHANDISE SALES AND RENTAL REVENUES
BY MERCHANDISE CATEGORY
(Dollar Amounts in Millions)
Nine Months Ended
October 31,
1997 1996
---- ----
Net Merchandise Sales:
Music $ 160.6 $ 172.5
Other, principally sales of new video cassettes,
video game software and hardware, general
merchandise and ticket commissions 23.0 28.4
------- -------
Total merchandise sales $ 184.4 $ 200.9
------- -------
Rental Revenue
Video cassette and other rental revenue $ 37.3 $ 52.4
Video cassette liquidation 1.4 0.0
------- -------
Total rental revenue $ 38.7 52.4
------- -------
Total revenues $ 223.1 $ 253.3
------- -------
------- -------
The sale of pre-recorded music, new video cassettes, video game software
and hardware and general merchandise continue to represent the greatest portion
of the Company's revenues. Net merchandise sales were $184.4 million versus
$200.9 million for the nine months ended October 31, 1997 and October 31, 1996,
respectively, representing an overall decrease of 8.2%. The decrease of 8.2%
was largely the result of the closure of underperforming stores during the
fiscal year ended January 31, 1997. For the nine months ended October 31, 1997,
net merchandise sales represented 82.7% of aggregate revenues. On a same-store
basis, net merchandise sales increased by 5.0% during the nine months ended
October 31, 1997, as compared to the nine months ended October 31, 1996.
Rental revenue includes the revenues from the rental of video cassettes,
video games, game players and audio cassette books and revenues from the sale of
previously used videocassettes and video games. Approximately 170 of the
Company's stores currently offer rental products. Rental revenue was $38.7
million versus $52.4 million during the nine months ended October 31, 1997 and
October 31, 1996, respectively, representing a decrease of $13.7 million or
26.2%. On a same-store basis rental revenue for the nine months ended October
31, 1997 decreased approximately 23.0%. The Company believes that the decrease
in same-store rental revenue was primarily attributable to continued competition
and a general softening in rental video spending nationwide. During the nine
months ended October 31, 1997, the Company decreased its purchases of video
rental product by $8.5 million or 33.7% versus the same nine months of the prior
year.
14
Included in rental revenue for the nine months ended October 31, 1997 was
approximately $1.4 million of revenue from the liquidation of excess video
catalog inventory (outside the normal course of operations). The Company may
experience continued excess video liquidations during the remainder of the
current fiscal year. The Company believes it has adequately provided for the
costs resulting from this liquidation.
Cost of sales decreased $12.3 million to $117.7 million for the nine months
ended October 31, 1997, versus $130.0 million for the nine months ended October
31, 1996, representing a decrease of 9.5%. As a percentage of net merchandise
sales, cost of sales decreased 0.9% to 63.8% during the nine months ended
October 31, 1997 versus 64.7% during the nine months ended October 31, 1996.
The 0.9% decrease in cost of sales as a percentage of net merchandise sales was
principally due to lower obsolescence provisions resulting from improvements in
inventory management and higher discounts.
Cost of rentals, including amortization, decreased to $21.7 million during
the nine months ended October 31, 1997, a decrease of $5.6 million or 21.0%,
versus $27.3 million during the nine months ended October 31, 1996. As a
percentage of rental revenue, cost of rentals increased to 56.2% during the nine
months ended October 31, 1997 versus 52.1% during the nine months ended October
31, 1996, representing an increase of 4.1%. The 4.1% increase in cost of
rentals is primarily due to the impact of the revenue shortfall. If Old
Wherehouse had adopted this accelerated method of amortization as of January 31,
1996, cost of rentals during the nine months ended October 31, 1996 would have
been higher (and gross profit lower) by approximately $0.2 million.
Merchandise sales as a percentage of aggregate net revenues increased 3.2%
to 82.5% during the nine months ended October 31, 1997 versus 79.3% during the
nine months ended October 31, 1996.
Selling, general and administrative expenses, were $77.3 million versus
$100.3 million for the nine months ended October 31, 1997 and October 31, 1996,
respectively, a decrease of $23.0 million or 22.9%. As a percentage of net
revenues, selling, general and administrative expenses, were 34.7% during the
nine months ended October 31, 1997 versus 39.6% during the nine months ended
October 31, 1996, representing a decrease of 4.9%. The 4.9% decrease was
principally due to the closure of underperforming stores during the fiscal year
ended January 31, 1997, reductions in rent and occupancy costs through landlord
concessions, decreases in non-music advertising spending and other decreases in
corporate and store expense categories.
Income from operations for the nine months ended October 31, 1997 was $1.5
million as compared to a loss from operations of $13.5 million for October 31,
1996, an improvement of $15.0 million. As mentioned previously, the Company
adopted an accelerated method of amortization for rental inventory at January
31, 1997. If the Company had adopted the accelerated method at January 31,
1996, the loss from operations for the nine months ended October 31, 1996 would
have been $13.8 million. Including the impact of the change in the method of
amortization of rental inventory, if it had been adopted by Old Wherehouse at
January 31, 1996 income from operations for the nine months ended October 31,
1997 was $14.7 million higher than that
15
experienced for the nine months ended October 31, 1996. The improvement in
income from operations was primarily the result of the closure of
underperforming stores during the fiscal year ended January 31, 1997, reductions
in rent and occupancy costs through landlord concessions, decreases in non-music
advertising expense, and increased merchandise sales that more than offset the
decline in rental revenue.
Management believes that EBITDA (Earnings Before Interest, Taxes,
Depreciation and Amortization) is a measurement tool commonly used among
retailers to evaluate, for internal purposes, the relative earning power of the
business. The merchandising format employed by the Company includes merchandise
offered for sale, as well as the rental of video cassettes, video games and game
players. Product purchased for rental purposes is recorded as an asset and is
amortized over a three month period, using a half-month convention in the month
of acquisition. Rental product amortization is included in cost of rental in
the Company's income statement. Management believes that the difference between
the cost of rental amortization of current rental inventory and the book value
of rental dispositions, versus the rental product purchases during the period,
is an additional indicator that should be taken into account in assessing the
earning power of the Company. It is management's belief that due to the
combined format of rental product and sale merchandise, a more appropriate
calculation of EBITDA (hereinafter referred to as Adjusted EBITDA) should
include the net difference between rental amortization and the book value of
rental dispositions, versus rental inventory purchased during the period. The
schedule below shows the results of this calculation. This measurement is not
intended to replace the Balance Sheet, Statement of Operations and Statement of
Cash Flow included in this document.
ADJUSTED EBITDA
NINE MONTHS ENDED
OCTOBER 31, 1997
-----------------
Income from Operations $1,489,000
Add back:
Depreciation on equipment and
amortization on improvements $4,849,000
----------
Subtotal $6,338,000
Add:
Book value of rental dispositions (excluding
dispositions outside the normal course
of operations) $1,879,000
Rental amortization in cost of rental $16,901,000
Less:
Costs of rental inventory purchases $16,773,000
-----------
Adjusted EBITDA $8,345,000
----------
----------
16
Reorganization items in 1996 include costs related to the bankruptcy case,
including professional fees for legal and financial advisors, costs related to
the closing of stores, and the estimated costs associated with the rejection of
certain executory contracts.
The Company recorded a tax provision of $0.9 million for the nine months
ended October 31, 1997 but did not record any tax benefit for nine months ended
October 31, 1996. The tax provision benefit represents an effective tax rate of
40% which the Company estimates will be its effective tax rate for the year
ended January 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended October 31, 1997, the Company's net cash
provided by operating activities increased by $36.9 million to $28.0 million.
The $36.9 million increase in cash from operating activities, was primarily due
to improvements in operating performance as well as increased payables and
accrued expenses and reductions in prepaids and other current assets.
Cash used in investing activities increased by $0.5 million to $2.9 million
during the nine months ended October 31, 1997 from $2.4 million during the nine
months ended October 31, 1996, principally due to increased acquisitions of
property, equipment and improvements.
The Company believes that the combined impact of the current borrowing
facility (see Note 4 under Notes to Condensed Financial Statements), existing
cash on hand and net cash provided by operations is adequate to support existing
operations for the next twelve months.
The Company expects to make additional payments to creditors, professionals
and others of up to $3.5 million through the end of the current fiscal year
under its Plan of Reorganization.
As of October 31, 1997 the Company has renewed six leases for existing
stores and did not sign any lease commitments to open new stores during the next
twelve months. The Company has plans to close seven stores at the end of the
quarter ending January 31, 1998, and is evaluating as many as six additional
stores which may be closed if the Company is unable to reach mutually acceptable
lease terms with landlords. Of the seven stores planned to close, three are the
result of lease expiration, and four are the result of the exercise of
previously negotiated right to terminate provisions.
The Company has assessed its information systems compliance with year 2000
requirements and anticipates the need for future commitments in order to be in
full compliance.
SEASONALITY
The Company's business is seasonal, and revenues and operating income are
highest during the fourth quarter.
17
PART II
OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is a party to various other claims, legal actions and
complaints arising in the ordinary course of its business. In the opinion of
management, all such matters are without merit or involve such amounts that
unfavorable disposition will not have a material impact on the financial
position and results of operations of the Company.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.0 Financial Data Schedule
(b) Current 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: December 22, 1997 /s/ Antonio C. Alvarez
-----------------------------
ANTONIO C. ALVAREZ
Chairman of the Board and Chief
Executive Officer, and Director
(Principal Executive Officer)
Date: December 22, 1997 /s/ Robert S. Kelleher
-----------------------------
ROBERT S. KELLEHER
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer)
19