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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------

                                   FORM 10-K
                            ------------------------

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
      ACT OF 1934

                   FOR THE FISCAL YEAR ENDED JANUARY 31, 2001

[ ]   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)

<TABLE>
<S>                                                       <C>
                        DELAWARE                                                 95-4608339
             (STATE OR OTHER JURISDICTION OF                                  (I.R.S. EMPLOYER
             INCORPORATION OR ORGANIZATION)                                IDENTIFICATION NUMBER)
</TABLE>

                             19701 HAMILTON AVENUE
                        TORRANCE, CALIFORNIA 90502-1334
          (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)

                                 (310) 965-8300
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                         COMMON STOCK, $0.01 PAR VALUE

     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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [ ]

     As of April 20, 2001, the aggregate book value of the estimated voting and
non-voting stock held by non-affiliates of the registrant was $14,326,803.(1)

     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 April 20, 2001, 11,026,421 shares of the registrant's common stock
were issued and outstanding and approximately 26,300 additional shares were
expected to be issued pursuant to a bankruptcy plan of reorganization (see Item
1 -- "Business -- Reorganization Under Chapter 11" below) and a related
anti-dilution provision of a stock subscription agreement with A&M Investment
Associates #3, LLC.
---------------
(1) There is no established trading market for the voting stock of the
    registrant. Accordingly, the registrant has utilized book value per share
    for purposes of the foregoing calculations concerning voting and non-voting
    stock held by non-affiliates. This calculation of book value per share is
    not intended to represent the price at which those shares trade. As of April
    20, 2001, 11,026,421 shares of the registrant's voting stock were issued and
    outstanding. All but 1,329,236 of those shares were issued pursuant to a
    bankruptcy plan of reorganization. See Item 1 -- "Business -- Reorganization
    Under Chapter 11" below. At April 20, 2001, the registrant estimates that
    approximately 26,300 additional shares of its voting stock may be issued
    pursuant to the plan of reorganization and a related anti-dilution provision
    of a stock subscription agreement with A&M Investment Associates #3, LLC,
    after which a total of approximately 11,052,721 shares of the registrant's
    voting stock will be issued and outstanding. The registrant estimates that
    of the number of total outstanding shares, approximately 1,993,284 shares
    will be held by non-affiliates of the registrant. The book value of voting
    and non-voting stock held by non-affiliates of the registrant specified
    above assumes the issuance of all 11,052,721 shares.

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<PAGE>   2

                             FORWARD-LOOKING STATEMENTS

     This Annual Report on Form 10-K 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 Annual Report on
Form 10-K containing such forward-looking statements include "Business --
Acquisition of Blockbuster Music", "Business -- Reorganization Under Chapter
11", "Business -- Merchandise Sale Products", "Business -- Video and Other
Product Rentals", "Business -- Industry Competitive Environment" under Item 1
below; "Holders" under Item 5 below; and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" under Item 7 below. Statements
in this Annual Report on Form 10-K which address activities, events or
developments that the registrant expects or anticipates will or may occur in the
future, including such things as 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 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 Annual Report on Form 10-K. 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 Company'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 we are 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 Annual Report or to reflect the
occurrence of unanticipated events.

                                        2
<PAGE>   3

                                     PART I

ITEM 1. BUSINESS

     The registrant, Wherehouse Entertainment, Inc. ("New Wherehouse") was
incorporated under the laws of the State of Delaware on November 15, 1996 as WEI
Acquisition Co. On January 31, 1997, New Wherehouse acquired substantially all
the assets of Wherehouse Dissolution Co. ("Old Wherehouse"), a Delaware
corporation, and Old Wherehouse's parent company, WEI Holdings, Inc., a Delaware
corporation ("WEI"), pursuant to a Chapter 11 plan of reorganization (as
described in "Reorganization Under Chapter 11" below). Prior to such
acquisition, Old Wherehouse was known as "Wherehouse Entertainment, Inc.", and,
after such acquisition, Old Wherehouse changed its name to "Wherehouse
Dissolution Co". After acquiring substantially all the assets of Old Wherehouse,
New Wherehouse changed its name to "Wherehouse Entertainment, Inc.", and, as the
successor to Old Wherehouse, has undertaken to continue the obligations of Old
Wherehouse to file all reports under Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended. Except as expressly indicated or unless the
context otherwise requires, the "Company", "Wherehouse", "we", "our", or "us"
means Wherehouse Entertainment, Inc. and its subsidiaries and, where the
discussion relates to the continuing business operations of Old Wherehouse and
New Wherehouse and its subsidiaries, New Wherehouse and Old Wherehouse,
collectively.

     The Company's fiscal year ends on January 31. References to "Fiscal 2001",
"Fiscal 2000" and "Fiscal 1999" refer to the fiscal years ended January 31,
2001, January 31, 2000, and January 31, 1999, respectively.

ACQUISITION OF BLOCKBUSTER MUSIC

     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. ("Seller") all of the capital
stock of certain retail music subsidiaries of Seller (the "Acquired Business").
The Acquired Business operated under the name "Blockbuster Music" and is
referred to as "Blockbuster Music" throughout this Report on Form 10-K. The
Acquired Business consisted of 378 Blockbuster Music stores (the "Acquired
Stores") in 33 states. In June 1999, the Company completed the systems
integration of the Acquired Stores, and all of the Acquired Stores are currently
operating under the "Wherehouse Music" name. The initial purchase price was
subject to a purchase price adjustment mechanism based on working capital as set
forth in the Purchase Agreement. On September 8, 1999, the Company reached an
agreement with the Seller with respect to this purchase price adjustment based
on working capital plus a settlement of certain other issues. The final purchase
price was $122.3 million, including direct acquisition costs of $4.7 million.

     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 on their respective fair values at the Acquisition
date based on valuations and other studies. The results of operations of the
Acquired Business from October 26, 1998 are reflected in the accompanying
consolidated financial statements.

GENERAL

     With the Acquisition of the Blockbuster Music stores, Wherehouse expanded,
in terms of both revenues and store count, to become one of the largest
retailers of prerecorded music in the United States.

     As of January 31, 2001, Wherehouse operated 497 stores in 28 states. Since
January 31, 2001, the Company closed thirteen (13) stores. All but 14 of
Wherehouse's stores operate under the name "The Wherehouse", "Wherehouse Music"
or "Wherehouse Entertainment". The remaining stores operate under the names "Tu
Musica", "Xchange", Wherehouse Outlet" and "Odyssey".

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<PAGE>   4

     Wherehouse sells prerecorded music, videocassettes, DVDs, video games,
personal electronics (including personal stereos, portable stereos, headphones
and related merchandise), blank audiocassettes and videocassettes, and
accessories. In Fiscal 2001 on a consolidated basis, sales of prerecorded music,
videocassettes, DVDs, video games, accessories and personal electronics
accounted for 98.7% of the Company's revenues.

                      SALES AND RENTAL REVENUE BY CATEGORY
                             (DOLLARS IN MILLIONS)

<TABLE>
<CAPTION>
                                                               FISCAL YEARS ENDED JANUARY 31,
                                                              --------------------------------
                                                               2001*       2000*       1999**
                                                              --------    --------    --------
<S>                                                           <C>         <C>         <C>
Sale Merchandise Revenue:
  Music.....................................................   $593.5      $663.2      $422.1
  Other, principally sales of new videocassettes, DVDs,
     video game software and hardware, general merchandise
     and ticket commissions.................................    107.1        92.9        42.4
                                                               ------      ------      ------
          Total sale merchandise revenue....................    700.6       756.1       464.5
Videocassette and other rental revenues, net***.............      5.8         9.8        16.0
                                                               ------      ------      ------
          Total Revenue.....................................   $706.4      $765.9      $480.5
                                                               ======      ======      ======
</TABLE>

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  * Includes revenue of the Acquired Business.

 ** Includes revenue of the Acquired Business commencing October 26, 1998.

*** Includes sales of previously viewed videocassettes.

MERCHANDISE SALE PRODUCTS

     Wherehouse's primary revenue source is the sale of merchandise. Wherehouse
stores generally sell a broad array of entertainment products, including
prerecorded music, videocassettes, DVDs, video games, accessories and personal
electronics. The table above summarizes Wherehouse's dollar volume of sale
revenue by merchandise category for Fiscal 1999 through Fiscal 2001. The
percentage of total revenue contributed by merchandise sales has risen from
96.7% in Fiscal 1999 to 99.2% in Fiscal 2001. 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.

     With input from store management and a product allocation team,
Wherehouse's inventory management systems are intended to tailor each store's
product selections and merchandise mix to local market demand and maximize the
availability of the most popular titles at each store, subject to store size
constraints. Wherehouse's stores have been designed to facilitate quick service
and to accommodate changes in industry trends and product offerings. Each
product line is monitored for profitability.

     The Company sells used products, principally used CDs, in the majority of
its stores. Prior to the Acquisition, the Blockbuster Music stores did not sell
used CDs. During Fiscal 2000, the Company expanded the used CD product line to
most of the non-mall Blockbuster Music stores.

     Prerecorded videocassettes and DVDs (feature films, music videos, and
self-improvement programming) represented, after music, Wherehouse's second
largest sale product category in Fiscal 1999, Fiscal 2000 and Fiscal 2001. As of
January 31, 2001, all but one of the Company's stores sold DVDs. As box-office
"hit" motion pictures continue to be released to the videocassette and DVD
sell-through market at reduced prices, industry-wide sales of this category have
increased. Excluding the Acquired Stores, Wherehouse's revenues from the sales
of videocassettes and DVDs increased by 44% in Fiscal 2001 over the prior year.

     Wherehouse sells video game hardware and software, blank audio and
videocassette tapes, music and video maintenance care products, carrying cases,
storage units, and personal electronics. Wherehouse also collects commissions on
event tickets sold under an affiliation with Ticketmaster.

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<PAGE>   5

VIDEO AND OTHER PRODUCT RENTALS

     Wherehouse's other revenue source is the rental of prerecorded
videocassettes, DVDs and other products, chiefly feature films. Video game
players are also offered for rent in certain stores. As of January 31, 2001, 74
of Wherehouse's 497 stores offered videocassettes, DVDs and other products for
rent, a decrease of 19 stores from January 31, 2000.

ADVERTISING AND PROMOTION

     Wherehouse employs advertising, promotion, pricing, and presentation in a
coordinated manner to generate customer awareness of its breadth of product and
value pricing on selected items, and to induce trial and repeat purchases of its
products and video rental services. Wherehouse advertises on a regular and
frequent basis in a variety of broadcast and print media, including radio,
newspaper, direct mail and freestanding inserts. The advertising generally
emphasizes immediate availability of hit products at competitive prices, as well
as access to a broad array of catalog products. With its current operations
covering 28 states, the Company continues to expand its marketing relationships
to pursue national promotional opportunities.

     Wherehouse also seeks to take advantage of cooperative advertising payments
from suppliers, which are generally available to the industry. Music and video
companies generally provide funds on a title-by-title basis and, occasionally,
on a label-wide basis to promote new releases. When Wherehouse runs
pre-authorized advertising that contains reference to a specific title or label,
the related supplier generally reimburses 100% of the pro rata cost of that
advertising.

TRADE CUSTOMS AND PRACTICES

     Most of the Company's music purchases are protected by return policies
offered by major manufacturers. The return privilege generally exists for each
music title as long as that title remains in the current music catalog of a
manufacturer. Catalog changes are generally made only after advance notice,
allowing the Company to return excess inventory before a title is discontinued.
Most of the Company's major pre-recorded music suppliers provide unlimited
returns of unopened items, but generally charge return penalties of varying
amounts. The major suppliers do not accept returns of opened merchandise on the
same basis as unopened items, but do generally provide the Company with certain
additional return allowances. As of January 31, 2001, the Company enjoyed normal
return privileges with all of its vendors. Pricing and return policies of the
Company's major distributors are subject to change.

STORE AND SITE SELECTION

     As of January 31, 2001, the Company operated 497 stores in 28 states. The
table below sets forth store openings, store acquisitions, store closings and
the total number of the Company's stores for the last three fiscal years:

<TABLE>
<CAPTION>
                                          TOTAL STORES               STORES
                                          AT BEGINNING    ----------------------------    STORES AT END
     FISCAL YEAR ENDED JANUARY 31,         OF PERIOD      OPENED    ACQUIRED    CLOSED      OF PERIOD
     -----------------------------        ------------    ------    --------    ------    -------------
<S>                                       <C>             <C>       <C>         <C>       <C>
2001....................................      529           3           0         35           497
2000....................................      579           1           0         51           529
1999....................................      223           8         378         30           579
</TABLE>

     The Company evaluates growth opportunities within the context of its
strategies and evaluates future store closing decisions, principally at lease
expiration, based upon individual store performance.

     As of January 31, 2001, the Company operated 497 stores comprising
approximately 3,846,400 square feet, a decrease of approximately 211,100 square
feet compared to January 31, 2000.

                                        5
<PAGE>   6

STORE OPERATIONS AND DISTRIBUTION

     STORE LOCATION. As of January 31, 2001, the Company had 393 stores located
in strip centers or freestanding buildings and 104 stores located in malls.
Strip center and freestanding locations range in size from 1,200 to 24,600
square feet and mall stores range in size from 700 to 10,200 square feet.

     RETAIL PRESENTATION. Prior to the Acquisition, the Company had updated its
retail presentation through the use of new in-store signage, expansion of
several product categories and, in certain stores, the introduction of new
product lines.

     Subsequent to the Acquisition, and as an integral part of the process of
converting the former Blockbuster Music stores into Wherehouse stores, the
Company introduced a new logo, Wherehouse Music. This change is a part of the
Company's brand awareness program, which has been introduced in all markets.

     DISTRIBUTION. Central to Wherehouse's strategy of providing a broad
merchandise selection to its customers (e.g., multiple copies of hits, select
copies of catalog products, and high quality in-stock condition) is its ability
to distribute product quickly and cost-effectively to its stores. Approximately
25% of the Company's inventory is shipped to store locations directly from
manufacturers and distributors (primarily in the case of new releases), while
the remaining 75% is delivered from the Company's distribution center. The
Company generally uses common carriers for deliveries from its distribution
center. Generally, the Company's centralized distribution system fills orders to
all stores at least once a week. Inventory at the Company's distribution center
is automatically sorted based on individual store demand data generated by the
Company's store-level inventory systems. Such data is captured by the Company's
point-of-sale ("POS") system and forwarded to the distribution center for
fulfillment. At its distribution center, the Company continues to enhance the
new distribution system that was installed in Fiscal 2000.

E-COMMERCE

     In response to the growth in electronic commerce for prerecorded music and
video product, the Company launched its own Internet commerce site,
"Wherehousemusic.com," on May 10, 1999. On November 16, 1999, the Company agreed
to enter into an equity investment and strategic partnership relationship (the
"CheckOut Agreement") with CheckOut.com, LLC ("CheckOut.com"), an Internet
content provider and e-commerce retailer of new and used music, as well as new
movies and games. The CheckOut Agreement was finalized on February 16, 2000. In
exchange for a 49% equity interest in CheckOut.com, the Company contributed $9.8
million to CheckOut.com in February 2000. The Company also agreed to contribute
an additional $1.568 million per month to CheckOut.com for a total investment of
approximately $20.0 million. Under the terms of the CheckOut Agreement,
CheckOut.com received various promotional benefits from Wherehouse and was
Wherehouse's exclusive Internet website partner for music, movies and games. As
a result, the Company merged the operation of its own Internet website,
Wherehousemusic.com, with that of CheckOut.com.

     Subsequent to February 2000, CheckOut.com experienced significant operating
losses and ceased operations of its Internet site in February 2001. For the year
ended January 31, 2001, a $20.6 million loss on investment in joint venture was
recorded and includes $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. To maintain its own online
retail presence, the Company is currently preparing to re-launch its Internet
e-commerce site, "Wherehousemusic.com". It is anticipated that the new
Wherehousemusic.com Internet site will provide its customers with the same
online retail offering that was previously provided by CheckOut.com.

INDUSTRY AND COMPETITIVE ENVIRONMENT

     The retail home entertainment industry is highly competitive. The Company
competes with other brick-and-mortar retailers and a growing number of
direct-to-consumer alternatives.

     Brick-and-Mortar Retailers. The Company competes with large, established
music and video chains, such as those operated by Trans World Entertainment
Corporation, Musicland and Tower Records; consumer

                                        6
<PAGE>   7

electronics superstores, such as Best Buy and Circuit City; mass merchants, such
as Wal-Mart, Kmart and Target and other specialty retail stores, such as Barnes
& Noble and Borders. Some of these competitors may have greater financial or
other resources than the Company. In addition, the Company also faces
competition from video rental stores, variety discounters and warehouse clubs.

     Direct-to-Consumer. The Internet has become an established avenue for
retailing. The purchase of music and video, in particular, through the Internet
is increasing in popularity with consumers. The Company's e-commerce competitors
include Amazon.com, CDnow.com, Barnesandnoble.com, mp3.com and others, most of
which have one or more marketing alliances. In addition to the Internet,
consumers receive television and mail order offers and have access to mail order
clubs. The largest mail order clubs are affiliated with major manufacturers of
prerecorded music and video and may have advantageous marketing relationships
with their affiliates. Consumers also have access to cable television and
digital satellite systems, including pay-per-view television. Many retailers as
well as certain distributors, are testing technology that allows for the
purchase of music through a digital download via the Internet. Although reported
sales to date have been relatively small, consumer interest in this form of
distribution is increasing as the technology improves and the assortment of
titles available for download widens.

     Consolidation continues to occur in the home entertainment industry.
Musicland recently agreed to be acquired by Best Buy, both competitors of the
Company. Time Warner Inc. was acquired by America Online, Inc. Vivendi acquired
Seagram Co. Ltd. which included the Universal Music Group, another major
supplier to the Company. Bertelsmann AG, also a major supplier to the Company,
acquired an interest in Napster. The Company continues to study these industry
developments in developing its own business strategies.

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. Revenues in the
fourth quarter of Fiscal 2001 were approximately 30.3% of total annual revenues.
Working capital and related bank borrowings in prior years were usually lowest
during the period beginning with the end of the Christmas holiday 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 and the building of
inventory for the holiday season.

     The Company believes that, except for changes in the minimum wage mandated
by regulators, inflation has not had a material effect on its operations and its
internal and external sources of liquidity and working capital.

ORGANIZATION AND EMPLOYEES

     As of January 31, 2001, Wherehouse employed approximately 6,330 persons.
Approximately 35% were full-time employees, and approximately 65% were part-time
employees. The Company's labor requirements vary based on seasonal business
fluctuations, with between 1,500 and 2,000 additional store and distribution
center employees added during the peak holiday season. Wherehouse's corporate
office staff, which consists of approximately 237 employees, is responsible for
executive and general operating management, buying, merchandising, advertising,
finance, accounting, human resources, legal, information systems and real
estate.

TRADEMARKS

     The Company owns and maintains registrations for "The Wherehouse" trademark
and variations thereof in the United States, Mexico, Taiwan, Thailand, Hong
Kong, and Korea and has filed trademark applications in China. The Company also
owns and maintains registrations in the United States and Mexico for the name
"Tu Musica". Trademark applications have been filed and are pending in the
United States for the names "Wherehouse Music", "Wherehouse.com",
"Wherehousemusic.com", "XChange", ".com by Wherehouse", "Earmail", "Songmail",
"Bandography", and "GameSpace".

                                        7
<PAGE>   8

REORGANIZATION UNDER CHAPTER 11

     On August 2, 1995, WEI and Old Wherehouse filed voluntary petitions for
relief under Chapter 11 of Title 11 of the United States Code ("Chapter 11") in
the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court"), seeking to reorganize under Chapter 11. Old Wherehouse and WEI
continued to manage their respective affairs and operate their businesses as
debtors-in-possession while they worked to develop a reorganization plan that
would restructure their businesses and allow their emergence from Chapter 11.

     The Plan of Reorganization for the Company's predecessors (the
"Reorganization Plan") was confirmed by an order of 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 New
Wherehouse has been and is free to carry out its business without oversight by
the Bankruptcy Court.

     On January 31, 1997, the Company implemented the accounting principles for
entities emerging from Chapter 11 set forth in the American Institute of
Certified Public Accountants' Statement of Position 90-7 "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 Reorganization Plan received less than fifty percent of the
voting shares of the emerging entity. All assets and liabilities were restated
to reflect the reorganization value of the reorganized entity, which
approximated its fair value at the Effective Date. In addition, the accumulated
deficit of the Company was eliminated and its capital structure was recast in
conformity with the Reorganization Plan.

ITEM 2. PROPERTIES

     The Company's executive offices, which are located in Torrance, California,
are subject to a lease covering 66,775 square feet of space at a current annual
base rent of approximately $584,000, which is subject to periodic adjustment.
The executive office lease expires on January 31, 2004. The Company has the
right to terminate its executive office lease on June 30, 2001 by paying to its
landlord an early termination fee in accordance with certain conditions in the
lease. The Company also maintains regional offices for its field managers within
existing store locations or in separate office facilities.

     The Company operates a 198,292 square-foot distribution center in Carson,
California. The lease for this property expires on April 30, 2002, subject to
two 5-year renewal options. The annual base rent for Fiscal 2001 was
approximately $809,000, although the rent is subject to periodic adjustment.

     As of January 31, 2001, the Company owned one of its stores and leased
space for the remaining 496 stores. Since January 31, 2001, the Company has
closed 13 of these 497 stores. Lease terms generally range from month-to-month
to 30 years, including renewal options. If no leased stores' renewal options
were exercised, 94 leases would expire on or before January 31, 2002, 59 would
expire between February 1, 2002 and January 31, 2003, 84 would expire between
February 1, 2003 and January 31, 2004, and the remainder would expire subsequent
to February 1, 2004. The Company has the right to terminate a number of its
store leases prior to the lease termination date, depending upon certain
conditions, as defined in each lease. The Company does not depend on the
continued existence of any one or several of its lease agreements or store
locations for the operation of its business.

ITEM 3. LEGAL PROCEEDINGS

(i) Bankruptcy filing

     See Item 1 -- "Business -- Reorganization Under Chapter 11" above for a
description of the bankruptcy filing of Old Wherehouse and WEI.

                                        8
<PAGE>   9

(ii) Other

     In January 2001, the Company was sued in the Los Angeles Superior Court by
a former employee, claiming alleged failure to pay overtime wages to herself and
all salaried store employees similarly situated. The Complaint does not specify
any amount of the claims, either individually or on behalf of the class. The
Company has moved to dismiss some of the claims and intends to vigorously
dispute not only Plaintiff's individual and class claims but the suitability of
her claim that she should be able to pursue this as a purported or
representative action.

     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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     None.

                                    PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

     The Company has one class of common equity outstanding, its Common Stock.
See Item 12 -- "Security Ownership of 5% Holders, Directors and Executive
Officers". There is no established public trading market for the Common Stock.

HOLDERS

     As of January 31, 1997, after the effective date of the Reorganization
Plan, there were eight holders of Common Stock, seven of whom were senior
lenders under Old Wherehouse's bank credit agreement (the "Senior Lenders"), led
by Cerberus Partners, L.P. as the agent for the Senior Lenders. As of April 20,
2001, the Company had issued 11,026,421 shares of Common Stock, and there were
859 holders of record of the Common Stock. The Company estimates that
approximately 26,300 additional shares of Common Stock will be distributed among
holders of general unsecured claims in the Bankruptcy Case as their claims are
allowed by the Bankruptcy Court and A&M Investment Associates #3, LLC ("A&M #3")
under the provisions of a Stock Subscription Agreement dated as of January 31,
1997 (the "Stock Subscription Agreement"). Included in the Common Stock issued
and outstanding as of April 20, 2001 are 250,000 shares of Common Stock the
Company issued on February 16, 2000 as part of its strategic alliance with
CheckOut.com (see Item 1 -- "Business -- E-Commerce" above).

DIVIDENDS

     No dividends have been paid to the holders of the Common Stock since its
issuance. The Company's amended loan agreement with Congress Financial
Corporation (Western) restricts the ability of Wherehouse to pay dividends. See
Item 7 -- "Management's Discussion and Analysis of Financial Condition and
Results of Operation -- Liquidity and Capital Resources" and Note 6 to the
financial statements included elsewhere in this report. There are no plans by
Wherehouse to pay cash dividends on the Common Stock in the foreseeable future.

                                        9
<PAGE>   10

ITEM 6. SELECTED FINANCIAL DATA

     Set forth below are selected financial data as of and for the periods
indicated below. The financial data are derived from financial statements of Old
Wherehouse and New Wherehouse. The selected financial data should be read in
conjunction with the discussion under Item 7 -- "Management's Discussion and
Analysis of Financial Condition and Results of Operation" and with the financial
statements, including the notes thereto, included elsewhere in this report.

<TABLE>
<CAPTION>
                                                              YEARS ENDED JANUARY 31 ,
                                         ------------------------------------------------------------------
                                                                                                    OLD
                                                            NEW WHEREHOUSE                       WHEREHOUSE
                                         -----------------------------------------------------   ----------
                                            2001          2000          1999          1998          1997
                                         -----------   -----------   -----------   -----------   ----------
                                                            (DOLLAR AMOUNTS IN MILLIONS)
<S>                                      <C>           <C>           <C>           <C>           <C>
INCOME STATEMENT DATA:
Revenue:
  Sale merchandise revenue.............  $     700.6   $     756.1   $     464.5   $     276.1     $295.5
  Rental revenue, net..................          5.8           9.8          16.0          23.9       36.0
                                         -----------   -----------   -----------   -----------     ------
         Total revenues................        706.4         765.9         480.5         300.0      331.5
Cost of sale merchandise revenue(1)....        457.8         495.6         309.7         176.1      195.5
Selling, general and administrative
  expenses.............................        219.5         237.7         140.1         104.7      134.0
Depreciation and amortization..........         31.1          25.5          11.8           7.1       11.4
System integration costs(2)............                                      0.8
Store closure costs -- existing
  stores(3)............................                                      2.9
Year 2000 remediation costs(4).........                        0.2           1.8
Other costs............................          2.3           0.2
                                         -----------   -----------   -----------   -----------     ------
  Income (loss) from operations........         (4.3)          6.7          13.3          12.0       (9.4)
Interest (income) expense, net.........          8.1           7.3           1.2          (1.1)       0.7
                                         -----------   -----------   -----------   -----------     ------
  Income (loss) before Loss on
    investment in joint venture,
    reorganization items, income taxes
    and extraordinary item.............        (12.4)         (0.6)         12.1          13.1      (10.1)
  Loss on investment in joint
    venture............................         20.6
Reorganization items...................                                                              19.9
                                         -----------   -----------   -----------   -----------     ------
  Income (loss) before income taxes....        (33.0)         (0.6)         12.1          13.1      (30.0)
Provision (benefit) for income taxes...        (11.4)          0.6           5.0           5.4
                                         -----------   -----------   -----------   -----------     ------
  Income (loss) before extraordinary
    item...............................        (21.6)         (1.2)          7.1           7.7      (30.0)
Extraordinary item(5)..................                                                             173.7
                                         -----------   -----------   -----------   -----------     ------
  Net income (loss)....................  $     (21.6)  $      (1.2)  $       7.1   $       7.7     $143.7
                                         ===========   ===========   ===========   ===========     ======
Net income (loss) per common share(6):
  Basic................................  $     (1.97)  $     (0.11)  $      0.66   $      0.74
  Diluted..............................  $     (1.97)  $     (0.11)  $      0.61   $      0.71
Weighted average shares outstanding:
  Basic................................   10,988,782    10,749,986    10,689,580    10,420,557
  Diluted..............................   10,988,782    10,749,986    11,551,798    10,894,862
Other data
  Adjusted EBITDA(7)...................  $      29.8   $      45.2   $      34.8   $      24.3     $  1.6
  Cash flows provided by operating
    activities.........................         28.5          33.4          55.0          59.9       15.9
  Cash flows used in investing
    activities.........................        (31.8)        (30.8)       (128.7)         (4.6)      (1.3)
  Cash flows (used in) provided by
    financing activities...............  $       1.2   $     (13.1)  $      34.0   $      (6.7)    $(15.8)
BALANCE SHEET DATA:
Working capital........................  $      31.8   $      47.7   $      70.8   $      65.3     $ 59.4
Total assets...........................        341.7         413.7         387.7         161.0      131.7
Line of credit.........................         35.1          32.0          37.3
Capital lease obligations and long-term
  debt (including current
  portion)(8)..........................         26.4          31.5          31.6           4.5        5.4
Total shareholders' equity(9)..........  $      79.3   $      96.3   $      98.2   $      91.5     $ 84.1
</TABLE>

                                        10
<PAGE>   11

---------------
(1) The Company incurred incremental cost of sales of approximately $2.5 million
    and $2.7 million for the fiscal years ended January 31, 2000 and 1999,
    respectively, relating to third-party distribution costs for music
    replenishment from one of its suppliers. These incremental costs resulted
    from the Seller's inability to support fulfillment of music product from its
    distribution facility. These incremental costs were discontinued by July
    1999.

(2) System integration costs relate to the Acquisition.

(3) The charge for Store closure costs-existing stores in Fiscal 1999 represents
    costs related to the closure of 19 Wherehouse stores that operated in the
    same trade areas as acquired Blockbuster Music stores.

(4) The Company recorded charges of $0.2 million and $1.8 million during Fiscal
    2000 and 1999, respectively, in connection with the Year 2000 remediation of
    its computer systems.

(5) The extraordinary item in Fiscal 1997 represents a gain from the
    extinguishment of debt pursuant to the Company's Reorganization Plan.

(6) Net income per common share is omitted for the Company for the fiscal year
    ended January 31, 1997 because that year relates to Old Wherehouse, which
    had a different capital structure.

(7) EBITDA represents income (loss) from operations plus depreciation and
    amortization. Management believes that, due to the combined format of rental
    product and sale merchandise and certain non-recurring costs, a more
    appropriate calculation of EBITDA (hereafter referred to as "Adjusted
    EBITDA") should include an adjustment for such non-recurring costs and the
    net difference between rental amortization plus the book value of rental
    dispositions less 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. The method of calculating Adjusted EBITDA set forth
    above may be different from calculations of EBITDA employed by other
    companies and, accordingly, may not be directly comparable to such other
    computations. Adjusted EBITDA should not be viewed as a substitute for
    Generally Accepted Accounting Principles (GAAP) measurements such as net
    income or cash flow from operations, and is presented as supplementary
    information.

         Adjusted EBITDA for Fiscal 2001 excludes other costs of $2.3 million.

         Adjusted EBITDA for Fiscal 2000 excludes certain incremental costs
    related to the Acquired Stores and costs associated with the remediation of
    its computer systems to comply with Y2K readiness requirement as follows:
    incremental non-recurring distribution costs of approximately $4.6 million;
    non-recurring integration costs of approximately $5.5 million (including
    $2.5 million of replenishment costs in cost of sale merchandise revenue);
    and $0.2 million of Y2K remediation costs. Also, Adjusted EBITDA excludes
    Internet related costs of $2.3 million, which are included in SG&A expenses.

         Adjusted EBITDA for Fiscal 1999 excludes certain incremental costs
    related to the Acquired Stores and costs associated with the remediation of
    its computer systems to comply with Y2K readiness requirements, as follows:
    costs related to the closure of existing stores of $2.9 million;
    non-recurring merchandise replenishment costs of $2.7 million included in
    cost of sale merchandise revenue; Y2K remediation costs of $1.8 million; and
    systems integration costs of $0.8 million.

         Adjusted EBITDA for Fiscal 1998 includes a non-recurring cash benefit
    of $1.7 million resulting from the impact of one-time credits received from
    landlord concessions.

(8) Includes $22.4 million, $27.4 million and $27.6 million of capital lease
    obligations in Fiscal 2001, 2000 and 1999, respectively that are real estate
    leases related to the Acquisition ($18.5 million, $22.0 million and $25.8
    million, respectively) and equipment leases ($3.9 million, $5.4 million and
    $1.8 million, respectively).

(9) There were no cash dividends declared during any of the periods presented
    above.

                                        11
<PAGE>   12

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

  FORWARD-LOOKING STATEMENTS

     Certain statements contained in Management's Discussion and Analysis of
Financial Condition and Results of Operations, particularly in the paragraph
entitled "Liquidity and Capital Resources", and elsewhere in this Annual Report
on Form 10-K are forward-looking statements. These statements discuss, among
other things, expected growth, future revenues and future performance. You can
find many of these statements by looking for words like "believes", "expects",
"anticipates", or similar expressions in this Annual Report on Form 10-K.
Although the Company 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 Company.

     The Company'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 Company'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 we are 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 Company. 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 Annual Report or to reflect the
occurrence of unanticipated events.

  YEAR ENDED JANUARY 31, 2001 COMPARED TO YEAR ENDED JANUARY 31, 2000

     Total revenues were $706.4 million and $765.9 million for the fiscal years
ended January 31, 2001 and January 31, 2000, respectively. The decrease of $59.5
million was primarily attributable to decreases in net revenues of $36.9 million
due to store closures since January 31, 1999, same-store sale decreases of $18.6
million and the reduction of net rental revenue of $4.0 million.

                                        12
<PAGE>   13

     A summary of total sale merchandise and rental revenue by category is
provided below:

                SALE MERCHANDISE AND RENTAL REVENUES BY CATEGORY
                             (DOLLARS IN MILLIONS)

<TABLE>
<CAPTION>
                                                              FISCAL YEARS ENDED
                                                                 JANUARY 31,
                                                              ------------------
                                                               2001       2000
                                                              -------    -------
<S>                                                           <C>        <C>
Sale merchandise revenue:
  Music.....................................................  $593.5     $663.2
  Other, principally sales of new videocassettes, DVDs,
     video game software and hardware, general merchandise
     and ticket commissions.................................   107.1       92.9
                                                              ------     ------
          Total sale merchandise revenue....................   700.6      756.1
Rental revenue, net.........................................     5.8        9.8
                                                              ------     ------
          Total revenue.....................................  $706.4     $765.9
                                                              ======     ======
</TABLE>

     A. Sale merchandise revenue. Sales of prerecorded music, new
videocassettes, DVDs, video game software and hardware (collectively referred to
as "sale merchandise") continue to represent the greatest portion of the Company
revenues. For Fiscal 2001, sale merchandise revenue represented 99.2% of
aggregate revenues, compared to 98.7% during Fiscal 2000, an increase of 0.5%.
This increase resulted from the continuing decline in rental revenue, net
discussed below. Negatively impacting revenues were the decline in same store
sales, also discussed below, and the closure of 35 stores since January 31,
2000.

     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 35 stores closed and the three stores opened during Fiscal 2001, sale
merchandise revenue decreased by approximately 2.6% as compared to Fiscal 2000.
The primary reasons for this decrease were a weak new release schedule for new
music products in Fiscal 2001, the favorable sales impact of grand opening
promotions, which took place at all of the Acquired Stores during the second
quarter of Fiscal 2000, and certain "big box" retailers selling selected new
music releases at or below cost. Partially offsetting these decreases were
improvements in music category inventory management, re-merchandising activities
which occurred in certain stores and 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 $5.8 million in Fiscal 2001 and $9.8
million in Fiscal 2000, representing a decrease of $4.0 million or 40.8% due to
increased competition in the rental market and fewer of the Company's stores
offering rental products.

     Cost of Sale Merchandise Revenue

     Cost of sale merchandise revenue was $457.8 million for Fiscal 2001 as
compared with $495.6 million for Fiscal 2000, a decrease of $37.8 million. As a
percentage of sale merchandise revenue, cost of sale merchandise revenue, or
gross profit margins, stayed approximately the same in Fiscal 2001 as compared
to Fiscal 2000. Cost of sale merchandise revenue was 65.3% for Fiscal 2001 as
compared to 65.5% for Fiscal 2000. Sales of higher margin new music product as a
percentage of total revenues decreased in Fiscal 2001, while sales of lower
gross profit margin DVD product increased in Fiscal 2001. In addition, increases
in unit costs for various music products and decreases in DVD sales prices were
offset principally by decreases in Fiscal 2001 in slow moving and obsolete
inventory provisions and inventory shrinkage.

     Operating Expenses

     SG&A expenses for Fiscal 2001 were $219.5 million, compared to $237.7
million in Fiscal 2000. The decrease includes a reduction of $9.8 million in
operating expenses at the Company's stores due to store closures. The decrease
is also due to certain non-recurring costs incurred in the prior year including
$7.6 million related to the integration of the Acquired Stores and certain other
non-recurring incremental

                                        13
<PAGE>   14

distribution costs and $2.3 million of Internet related expenses. In addition,
increases in distribution payroll costs were partially offset by a reduction in
other variable expenses due to the decline in sales merchandise revenue in
Fiscal 2001. SG&A expenses were 31.1% of total revenue in Fiscal 2001, compared
to 31.0% of total revenue for the same period last year.

     Other costs of $2.3 million during the year ended January 31, 2001 include
$0.9 million related to the write-off of system development costs for computer
software no longer utilized by the Company and $1.4 million related principally
to additional store closure expenses.

     Depreciation and amortization expense was $31.1 million in Fiscal 2001
compared to $25.5 million in Fiscal 2000, an increase of $5.6 million. The
increase is principally related to capital expenditures over the last two years
for the acquisition of property, equipment and systems improvements.

     Interest Expense

     Interest expense for Fiscal 2001 was $8.5 million, compared to $7.8 million
for Fiscal 2000, an increase of $0.7 million. This increase was primarily
attributable to interest expense incurred due to borrowings under the Company's
revolving line of credit agreement with Congress Financial Corporation (Western)
(the "Congress Facility"). Such borrowings were used for the funding of working
capital and, in Fiscal 2001, to fund the investment in CheckOut.com.

     Interest Income

     Interest income for Fiscal 2001 was $0.4 million, as compared to $0.5
million for Fiscal 2000. Interest income is related to short-term investments of
excess cash. Such cash is used mainly to pay down the Company's borrowings under
the Congress Facility.

     Loss on Investment in Joint Venture

     Subsequent to February 2000, CheckOut.com experienced significant operating
losses and ceased operations of its Internet site in February 2001. For the year
ended January 31, 2001, the $20.6 million loss on investment in joint venture
includes $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.

     Income Taxes

     The Company recorded a tax benefit of $11.4 million for Fiscal 2001
compared to a tax provision of $0.6 million for Fiscal 2000. The tax benefit is
commensurate with the decrease in income (loss) before income tax.

  YEAR ENDED JANUARY 31, 2000 COMPARED TO YEAR ENDED JANUARY 31, 1999

     Revenues

     Total revenues were $765.9 million and $480.5 million for the fiscal years
ended January 31, 2000 and January 31, 1999, respectively. The increase of
$285.4 million was attributable to the addition of the Acquired Stores, which
contributed $458.7 million in revenues during Fiscal 2000 compared to $173.7
million for Fiscal 1999, partially offset by a decrease of $6.2 million in net
rental revenues.

     Excluding the Acquired Stores, total revenues increased to $307.2 million
during Fiscal 2000 from $306.9 million during Fiscal 1999.

                                        14
<PAGE>   15

     A summary of total sale merchandise and rental revenue by category is
provided below:

                SALE MERCHANDISE AND RENTAL REVENUES BY CATEGORY
                             (DOLLARS IN MILLIONS)

<TABLE>
<CAPTION>
                                                              FISCAL YEARS ENDED
                                                                 JANUARY 31,
                                                              ------------------
                                                               2000       1999
                                                              -------    -------
<S>                                                           <C>        <C>
Sale merchandise revenue:
  Music.....................................................  $663.2     $422.1
  Other, principally sales of new videocassettes, DVDs,
     video game software and hardware, general merchandise
     and ticket commissions.................................    92.9       42.4
                                                              ------     ------
          Total sale merchandise revenue....................   756.1      464.5
Rental revenue, net.........................................     9.8       16.0
                                                              ------     ------
          Total revenue.....................................  $765.9     $480.5
                                                              ======     ======
</TABLE>

     A. Sale merchandise revenue. For Fiscal 2000, sale merchandise revenue
represented 98.7% of aggregate revenues, compared to 96.7% during Fiscal 1999,
an increase of 2.0%. 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.

     Sale merchandise revenue was $756.1 million in Fiscal 2000 compared to
$464.5 million in Fiscal 1999. This increase in sale merchandise revenue was
attributable to the addition of the Acquired Stores.

     On a same-store basis, excluding the 11 Wherehouse stores closed during
Fiscal 2000 and the Acquired Stores, sale merchandise revenue increased by
approximately 5.3% during Fiscal 2000 as compared to Fiscal 1999. Management
believes that the increase in same-store sale merchandise revenue was
principally the result of continuing 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 4.3% during Fiscal 2000 compared to Fiscal 1999. This
decrease is principally due to the negative impact on revenues of activities
associated with the integration of the Acquired Stores, including the
implementation of a name change from "Blockbuster Music" to "Wherehouse Music"
in the markets where the Wherehouse brand was not previously known.

     B. Rental revenue, net. Rental revenue, net was $9.8 million in Fiscal 2000
and $16.0 million in Fiscal 1999, representing a decrease of $6.2 million or
38.8% due to increased competition in the rental market and fewer of the
Company's stores offering rental products.

     Cost of Sale Merchandise Revenue

     Cost of sale merchandise revenue was $495.6 million for Fiscal 2000, as
compared with $309.7 million for Fiscal 1999, an increase of $185.9 million,
which was principally due to the Acquired Stores. As a percentage of sale
merchandise revenue, cost of sale merchandise revenue was 65.5% for Fiscal 2000
as compared with 66.7% for Fiscal 1999. Such decrease was caused principally by
a change in product mix as used music merchandise, which is sold at a higher
gross profit margin, was added to the Acquired Stores, partially offset by
vendor price increases on new CDs. In addition, less inventory shrinkage
occurred in Fiscal 2000, offset by increased inventory markdowns. Costs were
also negatively impacted by approximately $2.5 million in Fiscal 2000 and $2.7
million in Fiscal 1999 of incremental costs associated with the use of a
third-party distributor to handle music and sales video replenishment and other
transition-related costs in connection with the Acquisition. These incremental
distribution costs resulted from the Seller's inability to support the
fulfillment of music product from its distribution facility. These incremental
costs were discontinued by July of 2000, when all the Acquired Stores were
converted to the Company's POS system and expansion of the Company's
distribution facility was completed.

                                        15
<PAGE>   16

     Operating Expenses

     Selling, general and administrative ("SG&A") expenses for Fiscal 2000 were
$237.7 million, compared to $140.1 million for Fiscal 1999, an increase of $97.6
million. The increase was principally related to the operating expenses of the
Acquired Stores.

     SG&A expenses were 31.0% of total revenues in Fiscal 2000, compared to
29.2% of total revenues in Fiscal 1999, an increase of 1.8%. During Fiscal 2000,
the Company incurred non-recurring SG&A costs of $7.6 million related to the
integration of the Acquired Stores and certain other non-recurring incremental
distribution costs. These costs related principally to the name change of the
Acquired Stores, the conversion of those stores to the Company's POS system, and
additional freight charges to accommodate the Acquired Stores. During Fiscal
2000, SG&A costs include $2.3 million of Internet related expenses. The
additional increase in SG&A expenses as a percentage of total revenues is due
principally to the occupancy costs and payroll related expenses of the Acquired
Stores which are greater as a percentage of total revenues than the Company's
existing stores.

     Depreciation and amortization expense was $25.5 million in Fiscal 2000
compared to $11.8 million in Fiscal 1999, an increase of $13.7 million. The
increase is principally related to depreciation expense of the Acquired Stores
and amortization expense of intangible assets related to the Acquisition.

     Interest Expense

     Interest expense for Fiscal 2000 was $7.8 million, compared to $3.5 million
for Fiscal 1999, an increase of $4.3 million. This increase was primarily
attributable to interest expense incurred due to borrowings under the Congress
Facility. Such borrowings were used mainly for the funding of working capital
requirements.

     Interest Income

     Interest income for Fiscal 2000 was $0.5 million, as compared to $2.3
million for Fiscal 1999. The decrease of $1.8 million was the result of a
decline in short-term investments of excess cash. Such excess cash was used
mainly to pay down the Company's borrowings under the Congress Facility.

     Income Taxes

     The Company recorded a tax provision of $0.6 million for Fiscal 2000
compared to $5.0 million for Fiscal 1999. The tax provision is commensurate with
the decrease in income (loss) before income taxes. The increase in the Company's
effective tax rate relates principally to non-deductible goodwill amortization.

     Adjusted EBITDA

     See Selected Financial Data for a discussion regarding the computation of
Adjusted EBITDA.

     Recently Issued Financial Standards

     In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement, as amended, establishes
accounting and reporting standards for derivative instruments and for hedging
activities and will be effective for the Company's fiscal year ending January
31, 2002. The Company does not believe that the adoption of SFAS No. 133, as
amended, will have a material impact on its results of operations or financial
position.

LIQUIDITY AND CAPITAL RESOURCES

     During Fiscal 2001 and 2000, the Company's net cash provided by operating
activities was $28.5 million and $33.4 million respectively. The most
significant use of cash during Fiscal 2001 was related to the reduction of
accounts payable, accrued expenses and other liabilities of $47.6 million which
was offset by a reduction in inventories, net of $50.1 million. Seasonal
inventory purchases typically begin during the third quarter and continue into
the fourth quarter, while payment is typically due near the beginning of the
following year. Non-

                                        16
<PAGE>   17

seasonal inventory purchases are made throughout the year and fluctuate with the
timing and strength of new releases.

     Net cash used in investing activities during Fiscal 2001 was $31.8 million
due to capital expenditures totaling $13.3 million for the acquisition of
property, equipment and improvements, the $19.0 million invested in
CheckOut.com, partially offset by a $0.5 million reduction in other assets.
Financing of capital expenditures has generally been provided by cash from
operations and borrowings under the Congress Facility. Net cash used in
investing activities in Fiscal 2000 was $30.8 million primarily due to capital
expenditures to support the POS system conversion, distribution facility
improvements and the name change and re-merchandising activities related to the
Acquired Stores.

     Net cash provided by financing activities for Fiscal 2001 was $1.2 million
primarily due to net borrowings under the Congress Facility of $3.1 million and
$5.0 million received from the proceeds of sale of common stock to affiliates of
Wherehouse's partner in CheckOut.com, offset by payments of $6.6 million on
capital lease obligations and long-term debt. Net cash used in financing
activities for Fiscal 2000 of $13.1 million was primarily due to a reduction of
borrowings under the Congress Facility and payments on capital lease obligations
and long-term debt.

     As of January 31, 2001, the Company's amended loan agreement with Congress
Financial Corporation (Western) provides a revolving credit line of up to $165.0
million including a letter of credit subfacility of $10.0 million. The revolving
line of credit under the Congress Facility is divided into two tranches, Tranche
A and Tranche B. The Company may borrow up to $155.0 million under Tranche A.
Tranche A loans bear an interest rate of prime plus 0.5%, or at the Company's
election, an adjusted Eurodollar rate plus 1.75%. The Company's ability to make
Tranche A borrowings is subject to borrowing base limitations based upon, among
other things, the value of certain eligible merchandise inventory. If there is
no availability under the Tranche A line, the Company may borrow up to $10.0
million under the Tranche B line. Tranche B loans bear an interest rate (i) on
the first $5.0 million, of prime plus 3.75% or an adjusted Eurodollar rate plus
5.0%, and (ii) on the next $5.0 million, of prime plus 4.75% or an adjusted
Eurodollar rate plus 6.0%. In addition to the interest payable, the Company pays
an Unused Line Fee. The fee is 0.375% per annum calculated upon the amount by
which $120.0 million exceeds the average daily principal balance of the
outstanding Tranche A loans and letter of credit during the immediately
preceding month, along with 0.5% per annum calculated upon the amount by which
$10.0 million exceeds the average daily balance of the outstanding Tranche B
loans. The Congress Facility also required the Company to pay various other
fees, including a closing fee ($775,000 for Tranche A and $100,000 for Tranche
B), a syndication fee ($387,000), and includes an annual commitment fee on the
Tranche B line ($50,000) and a loan servicing fee ($3,000 per month, plus
reasonable out-of-pocket costs and expenses). As of January 31, 2001, there was
an outstanding loan balance of $35.1 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 January 31, 2001 was $82.7
million.

     On December 6, 2000, the Fifth Amendment to the Amended and Restated Loan
and Security Agreement ("Fifth Amendment") was entered into between the Company
and its subsidiaries and Congress Financial Corporation (Western). The Fifth
Amendment, among other things, extended the maturity of the Congress Facility to
October 31, 2003. The Fifth Amendment also permits the Company to include used
merchandise held for retail sale in the determination of amount of revolving
loans available to the Company and, effective October 26, 2001, eliminates the
$10.0 million Tranche B loan facility, which the Company has never utilized. On
January 10, 2001, the Fifth Amendment was amended and restated to, among other
things, delete the provision excluding the inclusion of Eligible Used Inventory
from the calculation of Excess Availability under the Adjusted Net Worth test as
such terms are defined in the Loan Agreement and amendments to the Loan
Agreement.

     The Company believes that cash on hand, cash flow from operations,
including planned inventory reductions during 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.

                                        17
<PAGE>   18

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 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 7A. 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 January 31, 2001, the Company's interest expense for
Fiscal 2002 would increase $0.4 million based on the outstanding balance of the
Congress Facility at January 31, 2001. The Company does not hold any derivative
instruments and does not engage in hedging activities. Information about the
fair value of financial instruments is included in note 3 of the Notes to
Consolidated Financial Statements.

     The Company believes that, except for changes in the minimum wage mandated
by regulators, inflation has not had a material effect on its operations and its
internal and external sources of liquidity and working capital.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     See Index to Financial Statements appearing on page F-1 of this report.

ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
       DISCLOSURE

     Not applicable.

                                        18
<PAGE>   19

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The following table sets forth certain information concerning the persons
who were directors and executive officers of Wherehouse as of April 25, 2001:

<TABLE>
<CAPTION>
                                                                                              AGE AT
               NAME                                       POSITION                        APRIL 25, 2001
               ----                                       --------                        --------------
<S>                                 <C>                                                   <C>
Antonio C. Alvarez, II............  Chief Executive Officer, Chairman of the Board and          52
                                    Director
Hugh G. Hilton....................  President                                                   50
Mark A. Velarde...................  Executive Vice President, Chief Financial Officer           44
                                    and Assistant Secretary
Mark D. Alvarez...................  Executive Vice President, Operations and                    33
                                    Administration
Larry C. Gaines...................  Executive Vice President and Chief Operating Officer        53
Barbara C. Brown..................  Senior Vice President, Store Operations                     49
Robert C. Davenport...............  Director                                                    34
Jonathan Gallen...................  Director                                                    41
Joseph B. Smith...................  Director                                                    73
Joseph J. Radecki, Jr. ...........  Director                                                    43
</TABLE>

     ANTONIO C. ALVAREZ, II, Chief Executive Officer, Chairman of the Board and
Director of Wherehouse since January 30, 1997. Mr. Alvarez is a principal of
Alvarez & Marsal, Inc., a New York based management consulting company "A&M").
Mr. Alvarez's experience includes acting as adviser to the bank lenders to
Camelot Music, Inc., a mall-based music retailer with over 300 stores. Mr.
Alvarez served as Phar-Mor, Inc.'s President and Chief Operating Officer from
September 1992 through February 1993, as acting Chief Financial Officer from
August 1992 to December 1992, and as Chief Executive Officer from February 1993
through Phar-Mor's emergence from Chapter 11 bankruptcy in October 1995. Mr.
Alvarez serves as the Chief Executive Officer, Chairman of the Board and
Director of Wherehouse pursuant to a Management Services Agreement, dated as of
January 31, 1997, as amended February 1, 1998, April 30, 1998, May 13, 1999, and
April 13, 2000 (the "Management Services Agreement"), among Wherehouse, A&M,
Antonio C. Alvarez, II, the Support Employees described therein, A&M #3, and
Cerberus Partners, L.P. See Item 11 -- "Executive Compensation -- Description of
Employment Contracts, Termination of Employment and Change in Control
Arrangements" below.

     HUGH G. HILTON, President. Mr. Hilton commenced serving as President of
Wherehouse in January 2000. He served as Chief Operating Officer from January
1998 to March 1999. He was appointed Executive Vice President in March 1999,
overseeing the Company's Special Projects and Development, including the
Company's Internet commerce site which was operated through Wherehouse.com,
Inc., Mr. Hilton is a Managing Director of A&M which he joined in June 1992. Mr.
Hilton's most recent experience while at A&M, Inc. includes serving as Chief
Executive Officer at Fedco between April 1996 and April 1997. Prior to joining
A&M., Mr. Hilton was President of HVK, Inc., a California-based real estate
consulting and investment advisory firm which he founded. Prior to founding HVK,
Inc., he served as President of Karsten Institutional Realty Advisors (a
subsidiary of First Interstate Bancorp), a pension fund advisory firm with $1.2
billion in real estate assets under management.

     MARK D. ALVAREZ, Executive Vice President, Operations and Administration.
During the past four and a half years, Mr. Alvarez has been working with
Wherehouse management taking senior roles in the areas of Store Operations, Real
Estate, Construction, Maintenance, Finance, Inventory Control, and
Merchandising, and Human Resources. Mr. Alvarez also led the due diligence
effort and transition effort in the successful acquisition of Blockbuster Music
Stores. Prior to joining Wherehouse, Mr. Alvarez has been consulting on several
assignments for A&M with London Fog/Pacific Trail, Phar-Mor, Inc., Fedco,
California Mart, Cherokee, and Integrated Resources in the areas of finance,
operations and real estate. Prior to joining A&M, he was an Associate in the
Structured Finance Group at Citibank. During this period he assisted in
negotiating

                                        19
<PAGE>   20

and structuring bank refinancings of middle-tier companies. Prior to that
assignment, he was an Associate in the Business Planning and Financial Analysis
Group at the American Express Company, where his responsibilities included
reviewing of business plans, preparing financial projections and performing
financial analysis and modeling of various subsidiary business units.

     LARRY C. GAINES, Executive Vice President and Chief Operating Officer. Mr.
Gaines joined Wherehouse in October 1998 with the Acquisition of Blockbuster
Music. He was appointed Executive Vice President and Chief Operating Officer of
Wherehouse in March 1999. From January 1998 through October 1998, Mr. Gaines
served as President of Blockbuster Music. From 1981 through 1997, Mr. Gaines was
with the Musicland Group, serving in several senior management positions, most
recently as President of Media Play, a 90-store, big box, full media chain.
Previously he was with Cole National Corporation. Mr. Gaines is a member of the
board of directors for the National Association of Recording Merchants (NARM).

     MARK A. VELARDE, Executive Vice President, Chief Financial Officer and
Assistant Secretary. On October 1, 1999, Mr. Velarde became Chief Financial
Officer of Wherehouse. Prior to joining Wherehouse, Mr. Velarde was a managing
director of A&M, Inc. which he joined in 1992. Mr. Velarde served as Chief
Financial Officer and Chief Operating Officer, of Telegroup, Inc., a publicly
traded telecommunications company from 1998 to 1999. From 1994 to 1998, he
served in the capacities of Chief Financial Officer and Acting Chief Operating
Officer of Anthony Manufacturing Company, Inc., a privately held manufacturer of
commercial refrigeration components. During 1992 and 1993, Mr. Velarde was
Acting Chief Executive Officer of Affiliated Medical Enterprises, a
debtor-in-possession which owned and operated a chain of acute care hospitals.
From 1988 to 1992, he was cofounder and Executive Vice President of HVK, Inc., a
California-based real estate consulting and investment advisory firm. Prior to
HVK, he was Senior Vice President -- Acquisitions of the pension fund advisory
arm of First Interstate Bancorp, where he worked in acquisitions for 5 years.

     BARBARA C. BROWN, Senior Vice President, Store Operations. Ms. Brown joined
Old Wherehouse in 1973. She became Vice President, Sales and Operations and in
1986, was promoted to Senior Vice President in 1991. Prior to 1986, Ms. Brown
served in a variety of store operations positions including Store Manager,
District Manager, Assistant Vice President, Store Operations, and Associate Vice
President, Store Operations.

     ROBERT C. DAVENPORT, Director since November 15, 1996. Mr. Davenport is a
Managing Director of Cerberus Capital Management, L.P., a New York based
investment fund management firm, a position he has held since February 1996.
From March 1994 until February 1996, he was a private investor. From 1990
through 1994, he was with Vestar Capital Partners, Inc. ("Vestar"), an
investment fund, where he served as a vice president. Prior to joining Vestar in
1990, Mr. Davenport was an analyst in the Mergers and Acquisitions Group at
Drexel Burnham Lambert in New York.

     JONATHAN GALLEN, Director since January 30, 1997. Mr. Gallen is the sole
managing member of Pequod LLC, the general partner of Pequod Investments, L.P.
Pequod Investments, L.P. is a distressed securities fund which invests in
publicly traded debt, private debt, trade claims, large and middle-market bank
loans, distressed real estate and public and private equity. Mr. Gallen has
served as a member of the Board of Directors of Harvest Foods and Fruehauf
Trailer Corporation.

     JOSEPH B. SMITH, Director since January 30, 1997. Mr. Smith is currently
the Chairman of Unison Productions, a consulting and production company, a
position he has held since April 1994. Mr. Smith served as President and Chief
Executive Officer of Capitol Industries-EMI Music, Inc. from 1987 until 1993.
Mr. Smith also serves as a director of Westwood One, Inc.

     JOSEPH J. RADECKI JR., Director since February 20, 1997. Mr. Radecki is a
Managing Director of CIBC Oppenheimer Corp., an investment bank. From 1990 to
1998, Mr. Radecki was an Executive Vice President and Director of Financial
Restructurings of Jefferies & Company, Inc. From 1983 until 1990, Mr. Radecki
was First Vice President in the International Capital Markets Group at Drexel
Burnham Lambert, Inc., where he specialized in financial restructurings and
recapitalizations. Mr. Radecki has also served as a member of the Board of
Directors of Service America Corporation, Bucyrus International, Inc. and
ECO-Net.

                                        20
<PAGE>   21

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

     Under the securities laws of the United States, the Company's directors,
its executive officers, and persons holding more than 10% of the Common Stock
are required to report their initial ownership of Common Stock and any
subsequent changes in that ownership to the Securities and Exchange Commission
(the "Commission"). Specific due dates for these reports have been established
and the Company is required to disclose any failure to file by these dates. All
of these filing requirements were satisfied during Fiscal 2000.

ITEM 11. EXECUTIVE COMPENSATION

SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION

     The following table sets forth, for Fiscal 2001, certain compensation paid
by Wherehouse or accrued for such fiscal year, to the Chief Executive Officer
and the four next most highly compensated executive officers of the Company (the
"Named Executive Officers"). All cash compensation with respect to Antonio C.
Alvarez, II was paid to A&M, a consulting firm of which Antonio C. Alvarez, II
is a principal. All other compensation paid with respect to Antonio C. Alvarez,
II was paid to A&M #3, an affiliate of A&M.

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                                  TERM
                                                                              COMPENSATION
                                                                                 AWARDS
                                                                              ------------
                                                 ANNUAL COMPENSATION              LONG
                                          ---------------------------------    SECURITIES
                            FISCAL YEAR                        OTHER ANNUAL    UNDERLYING     ALL OTHER
                               ENDED      SALARY      BONUS    COMPENSATION     OPTIONS      COMPENSATION
NAME & PRINCIPAL POSITION   JANUARY 31,     ($)        ($)        ($)(1)          (#)            ($)
-------------------------   -----------   -------    -------   ------------   ------------   ------------
<S>                         <C>           <C>        <C>       <C>            <C>            <C>
Antonio C. Alvarez, II....     2001            --         --     600,000(2)          --          1,948(3)
  Chairman, Chief              2000            --         --     600,000(2)          --             --
  Executive Officer            1999            --         --     600,000(2)          --             --
Hugh G. Hilton............     2001       275,000      4,583          --             --          9,601(4)
  President and Chief          2000        15,866(5)      --            (6)            (7)         754(8)
  Operating Officer            1999            --         --            (7)            (7)          --
Larry C. Gaines...........     2001       286,139     10,807          --                        11,077(9)
  Executive Vice President     2000       280,000    112,000          --             --          3,796(10)
  and Chief Operating          1999            --         --          --             --             --
  Officer
Mark A. Velarde...........     2001       227,219      3,722                                    22,674(11)
  Executive Vice
  President,                   2000            --         --          --             --             --
  Chief Financial Officer      1999            --         --          --             --             --
  and Assistant Secretary
Barbara C. Brown..........     2001       183,946      8,090          --             --         21,968(12)
  Senior Vice President,       2000       178,654     54,000          --             --         22,575(13)
  Store Operations             1999       175,000     75,000          --         28,000         22,334(14)
</TABLE>

---------------
 (1) In accordance with Commission rules, the compensation described in this
     table does not include medical, group life insurance or other benefits
     received by the Named Executive Officers which are available generally to
     all salaried employees of the Company, and certain perquisites and other
     personal benefits received by the Named Executive Officers that do not in
     the aggregate exceed the lesser of $50,000 or 10% of any such officer's
     salary and bonus disclosed in this table.

 (2) Mr. Alvarez commenced serving as Chairman of the Board and Chief Executive
     Officer of Wherehouse in January, 1997 pursuant to the Management Services
     Agreement dated as of January 31, 1997. The present term of the Management
     Services Agreement will expire on October 14, 2001 pursuant to an extension
     and amendment thereof dated as of June 30, 2000.

 (3) Includes $1,948 paid on behalf of Mr. Alvarez and his family for medical
     expenses not covered by the Company's group medical insurance plan.

                                        21
<PAGE>   22

 (4) Includes $1,780 paid on behalf of Mr. Hilton and his family for medical
     expenses not covered by the Company's group medical insurance plan. Also
     included are a $7,200 automobile allowance and $621 of premiums paid for
     term life insurance.

 (5) Pursuant to an amendment to the Management Services Agreement (see note 5
     below), Mr. Hilton was excluded from the personnel supplied to the Company
     by A&M and he was made an employee of the Company effective January 3,
     2000.

 (6) Mr. Hilton served the Company under the Management Services Agreement with
     Alvarez & Marsal, Inc. until January 2000. In January, 1998, Mr. Hilton was
     appointed Chief Operating Officer by the Board of Directors, and in March,
     1999, Mr. Hilton was appointed Executive Vice President, Special Projects
     and Development. In January 2000, he was appointed President. The Company
     did not pay any separate compensation for Mr. Hilton to Alvarez & Marsal,
     Inc. for Fiscal 1998. Effective February 1, 1998, the Company agreed,
     pursuant to an amendment to the Management Services Agreement, to
     compensate Alvarez & Marsal, Inc. separately for Mr. Hilton's services. See
     Item 13 -- "Certain Relationships and Related Transactions."

 (7) In connection with the Management Services Agreement, Wherehouse issued
     options to purchase 993,380 shares of Common Stock, subject to adjustment,
     to A&M #3, (an affiliate of A&M) of which Mr. Alvarez is a principal,
     pursuant to a Non-Transferable Stock Option Agreement dated as of January
     31, 1997, as amended the "Option Agreement". Mr. Hilton possesses a
     pecuniary interest in A&M #3, LLC. On April 30, 1998, the Option Agreement
     was amended to conform the Agreement to the intent of the parties. Pursuant
     to the Option Agreement, as amended, and based upon distributions and cash
     settlements pursuant to the Reorganization Plan, on December 10, 1998 the
     number of options granted to A&M #3 was adjusted to 1,199,151. See "Stock
     Options" under this Item 11 below.

 (8) Includes $303 paid on behalf of Mr. Hilton and his family for medical
     expenses not covered by the Company's group medical insurance plan. Also
     included are a $415 automobile allowance and $36 of premiums paid for term
     life insurance.

 (9) Includes $1,895 paid on behalf of Mr. Gaines and his family for medical
     expenses not covered by the Company's group medical insurance plan. Also
     included are a $7,200 automobile allowance, $651 of premiums paid for term
     life insurance and $1,331 for matching contributions to the Company's
     401(k) plan.

(10) Includes $673 paid on behalf of Mr. Gaines and his family for medical
     expenses not covered by the Company's group medical insurance plan. Also
     included are a $2,492 automobile allowance and $631 of premiums paid for
     term life insurance.

(11) Includes $13,782 paid on behalf of Mr. Velarde and his family for medical
     expenses not covered by the Company's group medical insurance plan. Also
     included are a $7,200 automobile allowance, $222 of premiums paid for term
     life insurance, and $1,470 for matching contributions to the Company's
     401(k) plan.

(12) Includes $3,467 paid on behalf of Ms. Brown and her family for medical
     expenses not covered by the Company's group medical insurance plan. Also
     included are a $7,200 automobile allowance, $7,353 of premiums paid for
     term life insurance and $3,948 for matching contributions to the Company's
     401(k) plan.

(13) Includes $4,415 paid on behalf of Ms. Brown and her family for medical
     expenses not covered by the Company's group medical insurance plan. Also
     included are a $7,200 automobile allowance, $7,387 of premiums paid for
     term life insurance and $3,573 for matching contributions to the Company's
     401(k) plan.

(14) Includes $4,415 paid on behalf of Ms. Brown and her family for medical
     expenses not covered by the Company's group medical insurance plan. Also
     included are a $7,200 automobile allowance, $7,405 of premiums paid for
     term life insurance and $3,215 for matching contributions to the Company's
     401(k) plan.

                                        22
<PAGE>   23

STOCK OPTIONS

     In connection with the Management Services Agreement and consummation of
the Reorganization Plan, Wherehouse entered into the Option Agreement (amended
on April 30, 1998 to conform the agreement to the intention of the parties) with
A&M #3, an affiliate of A&M, of which Antonio C. Alvarez, II is a principal. The
Option Agreement provides for the grant to A&M #3 of options (the "A&M #3
Options") representing in the aggregate the right to purchase 10% of (i) the
shares of Common Stock issued under the Reorganization Plan, (ii) certain shares
purchased by A&M #3, and (iii) the shares underlying these options. The A&M #3
Options vested monthly in equal installments through October 31, 1998, and all
unexercised A&M #3 Options expire on January 31, 2003, subject to prior
termination as set forth in the Management Services Agreement. The exact number
of shares underlying these options and the exercise prices will depend on the
final resolution of claims under the Reorganization Plan. The Option Agreement
provides that such adjustments will be made periodically as deemed practicable.
An interim adjustment was made on December 10, 1998 to reflect the resolution of
claims as of September 30, 1998. After such adjustment, the A&M #3 Options
consisted of (i) options to acquire 399,717 shares at an exercise price of
$8.80, (ii) options to acquire 399,717 shares at an exercise price of $10.66,
and (iii) options to acquire 399,717 shares at an exercise price of $12.97. The
Company presently estimates that after all adjustments, the A&M #3 Options will
consist of (i) options to acquire 407,667 shares at an exercise price of $8.63
per share, (ii) options to acquire 407,667 shares at an exercise price of $10.45
per share, and (iii) options to acquire 407,667 shares at an exercise price of
$12.72 per share.

     On April 7, 1998 and on September 18 and 22, 1998, the Company's
Compensation Committee granted, and the entire Board of Directors approved
grants of Nonqualified Stock Options under the Wherehouse 1998 Stock Incentive
Plan for a total of 339,500 shares of Common Stock. Additional grants of
Non-Qualified Stock Options totaling 197,000 and 254,500 were made during Fiscal
2001 and Fiscal 2000, respectively. On April 13, 2000, the Board of Directors
authorized the granting of an additional 264,500 options. As of April 25, 2001,
net of forfeitures, there were 521,000 options outstanding under the Wherehouse
1998 Stock Incentive Plan. [See "Option/SAR Grants in Last Fiscal Year" below.]

FISCAL YEAR-END OPTION VALUES

     No options were exercised by any of the Named Executive Officers during
Fiscal 2001. The following table sets forth certain information with respect to
the Named Executive Officers of the Company concerning the number of shares
covered by both exercisable and unexercisable stock options held as of January
31, 2001. None of the Named Executive Officers held any stock appreciation
rights at such time. No established trading market exists for the Common Stock.
As of January 31, 2001, the Company calculated the book value of each share of
Common Stock to be $7.19. This book value of $7.19 per share is utilized to
calculate the value of unexercised in-the-money options in the table below. The
value used is not intended to represent the price at which shares of the Common
Stock trade.

                         FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
                                             NUMBER OF SECURITIES         VALUE OF UNEXERCISED
                                            UNDERLYING UNEXERCISED        IN-THE-MONEY OPTIONS
                                             OPTIONS AT FY-END(#)            AT FY-END($)(1)
                  NAME                     EXERCISABLE/UNEXERCISABLE    EXERCISABLE/UNEXERCISABLE
                  ----                     -------------------------    -------------------------
<S>                                        <C>                          <C>
Antonio Alvarez, II......................         1,199,151/0(2)                  $0/0(2)
Hugh G. Hilton...........................                    (3)                   0/0
Larry C. Gaines..........................       20,000/30,000(4)                   0/0
Mark A. Velarde..........................            0/50,000(3)/(4)               0/0
Barbara C. Brown.........................       16,800/11,200(4)                   0/0
</TABLE>

---------------

(1) As noted above, book value was used to calculate the value of unexercised
    in-the-money options. If a higher stock value were used to calculate the
    value of unexercised options at fiscal year-end, the value of

                                        23
<PAGE>   24

    unexercised options would be higher, as (i) more options would be
    "in-the-money", and (ii) each in-the-money option would have a higher value.

(2) Wherehouse entered into the Option Agreement with A&M #3, an affiliate of
    A&M, of which Antonio C. Alvarez, II is a principal. Pursuant to the terms
    of the Option Agreement, on January 31, 1997, Wherehouse granted to A&M #3
    three tranches of options to acquire, in the aggregate, 993,380 shares of
    Common Stock, subject to adjustment upon certain events. On April 30, 1998,
    the Option Agreement was amended to conform the agreement to the intent of
    the parties. Pursuant to the Option Agreement, as amended, and based upon
    distributions and cash settlements pursuant to the Reorganization Plan, on
    December 10, 1998, the number of options granted to A&M #3 was adjusted such
    that the total shares subject to such options was 1,199,151, comprised of:
    (i) options to acquire 399,717 shares at an exercise price of $8.80, (ii)
    options to acquire 399,717 shares at an exercise price of $10.66, and (iii)
    options to acquire 399,717 shares at an exercise price of $12.97. See
    "Certain Relationships and Related Transactions" under Item 13 below.

(3) In connection with the Management Services Agreement, as amended, Wherehouse
    issued options to purchase 993,380 shares, subject to adjustment and
    subsequently increased to 1,199,151 shares as described in Note 2 above, of
    Common Stock to A&M #3 pursuant to the Option Agreement. Both Mr. Hilton and
    Mr. Velarde possess a pecuniary interest in A&M #3. See Item 13 -- "Certain
    Relationships and Related Transactions."

(4) These ten year options vest, subject to acceleration in certain
    circumstances, in five equal annual installments beginning on April 7, 1999
    and have an exercise price of $12.00 per share.

                     OPTION/SAR GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
                               INDIVIDUAL GRANTS                                          POTENTIAL REALIZABLE
                       ---------------------------------                                    VALUE AT ASSUMED
                         NUMBER OF      PERCENT OF TOTAL                                  ANNUAL RATES OF STOCK
                        SECURITIES        OPTIONS/SARS                                   PRICE APPRECIATION FOR
                        UNDERLYING         GRANTED TO       EXERCISE OR                      OPTION TERM(1)
                       OPTIONS/SARS       EMPLOYEES IN      BASE PRICE     EXPIRATION    -----------------------
        NAME           GRANTED(2)(3)      FISCAL YEAR        ($/SHARE)        DATE         5%($)        10%($)
        ----           -------------    ----------------    -----------    ----------    ---------    ----------
<S>                    <C>              <C>                 <C>            <C>           <C>          <C>
Mark A. Velarde......     50,000              25.4%           $18.00       4/13/2010      67,563       640,683
</TABLE>

---------------
(1) The amounts under the columns labeled "5%" and "10%" are included pursuant
    to certain rules promulgated by the Commission and are not intended to
    forecast future appreciation, if any, in the price of the Company's Common
    Stock. The amounts are calculated by using the fair market value of $11.88
    per share of Common Stock which was the fair market value on the April 7,
    1998 initial grant date of options under the Wherehouse 1998 Stock Incentive
    Plan (as determined by an appraisal obtained by the Company) and assume
    annual compounded stock appreciation rates of 5% and 10% over the full
    10-year term of the options.

     The appreciation shown are net of the option exercise price, but do not
     include deductions for taxes or other expenses associated with the exercise
     of the options or the sale of the underlying shares. As set forth in note 2
     below, the option grants vest equally over a 5-year period, and the
     reported amounts are based on the assumption that the named persons hold
     the options granted for their full 10-year term. The actual value of the
     options will vary in accordance with the market price of the Company's
     Common Stock.

(2) Stock options were granted under the Wherehouse 1998 Stock Incentive Plan at
    exercise prices deemed not to be less than the fair market value at the time
    of the grant. All options described in this table were to vest in five equal
    annual installments on the anniversary of the grant date over a 5-year
    period. Vested but unexercised options expire 6 months after a termination
    of employment due to retirement, death or total disability; immediately upon
    any termination of the individual's employment "for cause"; and 30 days
    after a termination of employment for any other reason. Generally, upon a
    "Change in Control Event", each option will become immediately exercisable.
    A "Change in Control Event" under the Wherehouse 1998 Stock Incentive Plan
    generally includes (subject to certain exceptions) (i) a more than 50%
    change in ownership of the Company; (ii) certain changes in a majority of
    the Board of Directors; (iii) certain mergers or consolidations approved by
    the Company's stockholders; or (iv) stockholder approval of a liquidation of
    the Company or sale of substantially all of the Company's

                                        24
<PAGE>   25

    assets. A "Change in Control Event" could also be triggered if any new
    person acquires greater than 30% ownership of the Company's stock, and
    certain 5% owners (see Item 12 -- "Security Ownership of 5% Holders,
    Directors and Executive Officers" below) do not retain at least 30%.

(3) This table does not include the adjustment to the number of shares subject
    to the options granted to A&M #3 pursuant to the adjustment provisions of
    the Option Agreement, as amended. See "Item 13 -- Certain Relationships and
    Related Transactions" below.

COMPENSATION OF DIRECTORS

     Two non-employee members of the Board of Directors, Messrs. Radecki and
Smith, each received a fee of $5,000 per attended meeting for his services and
were reimbursed for reasonable expenses incurred in connection with their
attendance at Board meetings. Messrs. Alvarez, Gallen and Davenport were not
paid any additional compensation for their services as directors.

DESCRIPTION OF EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE IN
CONTROL ARRANGEMENTS

     As of January 31, 2001, Antonio C. Alvarez, II serves as Chairman of the
Board and Chief Executive Officer pursuant to the Management Services Agreement.
Under the Management Services Agreement, A&M currently receives $600,000
annually as compensation for the services of Antonio C. Alvarez, II and the
services of other personnel supplied by A&M as needed. A&M is also eligible to
receive a discretionary incentive bonus for the services of certain individuals.
The Management Services Agreement, as amended, now provides that it will expire
on October 14, 2001, subject to further extension or earlier termination under
certain conditions.

     Prior to the effective date of the Reorganization Plan, Antonio C. Alvarez,
II served as a consultant to the Senior Lenders pursuant to at letter agreement
dated as of October 14, 1996 between A&M, Antonio C. Alvarez, II and the Senior
Lenders (the "Interim Agreement"). Pursuant to the Interim Agreement, the Senior
Lenders agreed to pay A&M a consulting fee of $50,000 per month plus the hourly
fees of the employees of A&M providing assistance to Antonio C. Alvarez, II in
the performance of his consulting responsibilities. The Senior Lenders paid
$389,452 to A&M pursuant to the Interim Agreement prior to January 31, 1997.
Under the Management Services Agreement, New Wherehouse agreed to reimburse, and
has reimbursed, the Senior Lenders for the amounts paid by the Senior Lenders to
A&M pursuant to the Interim Agreement.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     The Company's Compensation Committee consists of Messrs. Davenport,
Radecki, and Smith. None of the members of the Compensation Committee is or has
been an officer or employee of the Company. Mr. Radecki is currently Managing
Director of CIBC Oppenheimer Corp., an investment bank. CIBC Oppenheimer Corp.
acted as a financial advisor to the Company during 1998 with respect to the
Acquisition of Blockbuster Music, and, pursuant to an engagement letter dated
September 22, 1998, received a fee of $600,000, plus expenses, upon completion
of the Acquisition.

     Mr. Davenport is a Managing Director of Cerberus Capital Management, L.P.
In 1998, the Company paid a one-time fee of $0.9 million to Cerberus Capital
Management, L.P., an affiliate of Cerberus Partners, L.P., for a commitment to
provide a bridge loan to finance the acquisition of Blockbuster Music in the
event that permanent financing was not in place at the time of the Acquisition.

ITEM 12. SECURITY OWNERSHIP OF 5% HOLDERS, DIRECTORS AND EXECUTIVE OFFICERS

     The Common Stock is the only outstanding class of voting securities of the
Company. The following table sets forth, as of April 20, 2001, the number and
percentage of shares of Common Stock beneficially owned by (i) each person known
to Wherehouse to be the beneficial owner of more than 5% of the outstanding
shares of Common Stock, (ii) each director of Wherehouse, (iii) each Named
Executive Officer, and (iv) all directors and executive officers of Wherehouse
as a group. Unless otherwise indicated in a footnote, each person listed

                                        25
<PAGE>   26

below possesses sole voting and investment power with respect to the shares
indicated as beneficially owned by him or her, subject to community property
laws where applicable. The percentage of ownership in the following table does
not include the additional estimated 23,850 shares that may be issued to A&M #3
pursuant to the Stock Subscription Agreement.

<TABLE>
<CAPTION>
                                                                                PERCENTAGE
                                                         NUMBER OF SHARES         OF ALL
                                                           BENEFICIALLY        COMMON STOCK
                         NAME                              OWNED(1)(2)        OUTSTANDING(3)
                         ----                           ------------------    --------------
<S>                                                     <C>                   <C>
Stephen Feinberg......................................      7,099,282(4)           54.2%
  450 Park Avenue, 28th Floor
  New York, New York 10022
Antonio C. Alvarez, II................................               (5)
  c/o Wherehouse Entertainment, Inc.
  19701 Hamilton Avenue
  Torrance, California 90502-1334
AND
Bryan Marsal..........................................               (6)
  c/o Alvarez & Marsal, Inc.
  599 Lexington Avenue, Suite #2700
  New York, New York 10022-4802
A&M Investment Associates #3, LLC.....................      2,278,387(7)           17.4%
  c/o Alvarez & Marsal, Inc.
  599 Lexington Avenue, Suite #2700
  New York, New York 10022-4802
A&M Investment Associates #4, LLC.....................        385,542(8)            2.9%
A&M Investment Associates #8, LLC.....................         16,000(9)              *
                                                            ---------              ----
          Total for Antonio C. Alvarez, II and Bryan
            Marsal....................................      2,679,929(5)(6)        21.0%
Robert C. Davenport...................................              0(10)             0
Jonathan Gallen.......................................        435,195(11)           3.3%
Joseph B. Smith.......................................              0                 0
Joseph J. Radecki, Jr. ...............................              0                 0
Hugh G. Hilton........................................              0(7)              0
Larry Gaines..........................................         20,000(12)             *
Mark A. Velarde.......................................         10,000(13)
Barbara C. Brown......................................         16,800(14)             *
All Directors and Executive Officers, as a group (9
  persons)............................................      3,136,324              24.1%
</TABLE>

---------------
  *  Less than 1%.

 (1) Beneficial ownership is determined in accordance with the rules of the
     Commission and generally includes sole or shared voting or investment power
     with respect to securities. Except as otherwise noted below and subject to
     community property laws where applicable, each person named reportedly has
     sole voting and dispositive power with respect to all shares of Common
     Stock shown as beneficially owned by such person. On April 20, 2001, there
     were 11,026,421 shares of Common Stock outstanding.

                                        26
<PAGE>   27

 (2) The number of shares listed as beneficially owned by each named person (and
     the directors and executive officers as a group) includes shares of Common
     Stock underlying options, warrants and rights (including conversion rights)
     exercisable as of or within 60 days after April 20, 2001, as follows:

<TABLE>
<S>                                                         <C>
A&M Investment Associates #3, LLC.........................  1,199,151
  Antonio C. Alvarez, II, Bryan Marsal
Jonathan Gallen...........................................    161,666
Stephen Feinberg..........................................     72,687
Larry C. Gaines...........................................     20,000
Mark A. Velarde...........................................     10,000
Barbara C. Brown..........................................     16,800
                                                            ---------
All Directors and Executive Officers as a Group (9
  persons)................................................  1,480,304
</TABLE>

 (3) The percent of Common Stock outstanding is based upon (i) the 11,026,421
     shares of Common Stock issued and outstanding at April 20, 2001, plus (ii)
     the 776,000 warrants issued under the Reorganization Plan, plus (iii) the
     1,199,151 shares underlying the A&M Options, plus (iv) all employee stock
     options that are exercisable within 60 days of April 20, 2001. In
     connection with the Reorganization Plan, holders of Old Wherehouse's Senior
     Subordinated Notes received three tranches of warrants to purchase shares
     of Common Stock (the "Warrants"). The Tranche A Warrants represent the
     right to purchase 576,000 shares of Common Stock at an exercise price of
     $2.38 per share and have a five year maturity. The Tranche B Warrants
     represent the right to purchase 100,000 shares of Common Stock at an
     exercise price of $9.00 per share and have a seven year maturity. The
     Tranche C Warrants represent the right to purchase 100,000 shares of Common
     Stock at an exercise price of $11.00 per share and have a seven year
     maturity. Each Warrant is exercisable for one share of the Common Stock.

 (4) This information was obtained from a Schedule 13D-Amendment No. 2 filed
     with the Commission regarding Mr. Feinberg's beneficial ownership as of
     September 29, 1998. Ownership is described as follows: Cerberus Partners,
     L.P., a Delaware limited partnership, owns 1,670,222 shares of Common Stock
     and 4,959 Warrants; Cerberus International, Ltd., a corporation organized
     under the laws of the Bahamas, owns 1,962,182 shares of Common Stock and
     32,280 Warrants; Ultra Cerberus Fund, Ltd., a corporation organized under
     the laws of the Bahamas, owns 156,583 shares of Common Stock and 7,291
     Warrants, all over which Mr. Feinberg possesses sole voting and dispositive
     power. Various other private investment funds for which Mr. Feinberg
     possesses dispositive authority over the securities of the Company own in
     the aggregate 3,237,608 shares of the Common Stock and 28,157 Warrants.

 (5) As disclosed on a Schedule 13D -- Amendment No. 2 filed with the Commission
     on April 13, 1999, and on a Form 5 filed with the Commission on March 17,
     1999, Antonio C. Alvarez, II is a managing member of A&M #3, A&M #4 (as
     defined below), and A&M #8 (as defined below), and therefore may be deemed
     to be the beneficial owner of Common Stock held by any one or more of these
     entities. Mr. Alvarez disclaims beneficial ownership of the shares held by
     A&M #3, A&M #4, and A&M #8, except to the extent of his pecuniary interest
     therein.

 (6) As disclosed on a Schedule 13D -- Amendment No. 2 filed with the Commission
     on April 13, 1999, and on a Form 5 filed with the Commission on March 17,
     1999, Bryan Marsal is a managing member of A&M #3, A&M #4 (as defined
     below), and A&M #8 (as defined below), and therefore may be deemed to be
     the beneficial owner of Common Stock held by any one or more of these
     entities. Mr. Marsal disclaims beneficial ownership of the shares held by
     A&M #3, A&M #4, and A&M #8, except to the extent of his pecuniary interest
     therein.

 (7) A&M #3 is a Delaware limited liability company. The share total includes
     A&M #3 Options to purchase 1,199,151 shares of Common Stock, exercisable
     within 60 days of April 20, 2001. The A&M #3 Options are subject to
     adjustment. Pursuant to the adjustment provisions of the Option Agreement,
     on December 10, 1998, an interim adjustment was made as is described in
     Item 13 -- "Certain Relationships and Related Transactions" below. Mr.
     Hilton possesses a pecuniary interest in A&M #3. Mr. Hilton disclaims
     beneficial ownership of shares of Common Stock held by A&M #3, except to
     the extent of his pecuniary interest therein.

                                        27
<PAGE>   28

 (8) A&M Investment Associates #4, LLC is a Delaware limited liability Company
     ("A&M #4").

 (9) A&M Investment Associates #8, LLC is a Delaware limited liability Company
     ("A&M #8").

(10) Mr. Davenport is a managing director of Cerberus Capital Management, L.P.,
     an affiliate of Cerberus Partners, L.P,. and may be deemed to be the
     beneficial owner of all of the shares of Common Stock held by Cerberus
     Partners, L.P. Mr. Davenport disclaims any beneficial ownership in the
     shares of Common Stock held by Cerberus Partners, L.P.

(11) Mr. Gallen is the managing member of Pequod LLC, the general partner of
     Pequod Investments, L.P., which beneficially owns 217,596 shares of Common
     Stock, including 80,832 Warrants. Mr. Gallen is also President of Ahab
     Capital Management, Inc., which is an investment advisor to Pequod
     International, Ltd. Pequod International, Ltd. is the beneficial owner of
     217,599 shares of Common Stock, which total includes 80,834 Warrants. As
     such, Mr. Gallen may be deemed to be the beneficial owner of the shares of
     Common Stock and Warrants held by Pequod Investments, L.P. and Pequod
     International, Ltd. Mr. Gallen has sole voting and investment power over
     Common Stock owned by Pequod Investments, L.P. and Pequod International,
     Ltd. Mr. Gallen disclaims beneficial ownership in the shares of Common
     Stock held by Pequod Investments, L.P. and Pequod International, Ltd.,
     except to the extent of his pecuniary interest therein.

(12) Mr. Gaines has a right to acquire 20,000 shares of Common Stock pursuant to
     stock options exercisable as of or within 60 days after April 20, 2001 that
     were issued pursuant to the Wherehouse Entertainment, Inc. 1998 Stock
     Incentive Plan.

(13) Mr. Velarde has a right to acquire 10,000 shares of Common Stock pursuant
     to stock options exercisable as of or within 60 days after April 20, 2001
     that were issued pursuant to the Wherehouse Entertainment, Inc. 1998 Stock
     Incentive plan.

(14) Ms. Brown has a right to acquire 16,800 shares of Common Stock pursuant to
     stock options exercisable as of or within 60 days after April 20, 2001 that
     were issued pursuant to the Wherehouse Entertainment, Inc. 1998 Stock
     Incentive Plan.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Antonio C. Alvarez, II serves as Chairman of the Board and Chief Executive
Officer pursuant to the Management Services Agreement. Under the Management
Services Agreement, A&M currently receives $600,000 annually as compensation for
the services of Antonio C. Alvarez, II and the services of other personnel
supplied by A&M as needed. A&M is also eligible to receive a discretionary
incentive bonus for the services of certain individuals. The Management Services
Agreement, as amended, now provides that it will expire on October 14, 2001,
subject to further extension or earlier termination under certain conditions.

     Pursuant to the Management Services Agreement and a Stock Subscription
Agreement dated as of January 31, 1997 (the "Stock Subscription Agreement"),
Wherehouse agreed to sell, and A&M #3 agreed to buy at a purchase price of
$6,340,000 ($1,000,000 in cash from A&M #3's funds, plus a secured recourse
promissory note in the principal amount of $335,000 and a secured non-recourse
promissory note in the amount of $5,005,000 (collectively, the "Promissory
Notes")) 1,100,000 shares of the Common Stock (the "A&M Shares") (subject to
adjustment upward or downward to represent 10% of the sum of (i) the shares of
Common Stock ultimately issued under the Reorganization Plan plus (ii) the
number of shares of Common Stock issued to A&M #3). The Management Services
Agreement provides that the number of A&M Shares are to be adjusted
periodically, as practicable, based on the shares issued under the
Reorganization Plan. An interim adjustment was made on December 10, 1998 to
reflect the issuance of shares under the Reorganization Plan based on the
resolution of claims as of September 30, 1998. Based on this interim adjustment,
the number of A&M Shares was reduced to 1,079,236. The Company estimates that
approximately 23,850 additional A&M Shares will be issued in the future based on
the adjustment formula. The Promissory Notes bear interest at 7% per annum
during the first four years and 11% per annum during the fifth through seventh
years, mature on January 31, 2004 and have no scheduled interest or principal
amortization until their maturity date. The Promissory Notes are secured by a
first-priority pledge of the A&M Shares pursuant to a Stock Pledge Agreement
dated as of January 31, 1997.

                                        28
<PAGE>   29

     In addition, in connection with the Management Services Agreement and
consummation of the Reorganization Plan, Wherehouse entered into the Option
Agreement, amended on April 30, 1998 (to conform the agreement to the intention
of the parties) with A&M #3, an affiliate of Alvarez & Marsal, Inc., of which
Antonio C. Alvarez, II is a principal. The Option Agreement provides for the
grant to A&M #3 of options representing in the aggregate the right to purchase
10% of (i) the shares of Common Stock issued under the Reorganization Plan, (ii)
the A&M #3 Shares, and (iii) the shares underlying these options. The A&M #3
Options vested monthly in equal installments through October 31, 1998, and all
unexercised A&M #3 Options expire on January 31, 2003, subject to prior
termination as set forth in the Management Services Agreement. The exact number
of shares underlying the A&M Options and the exercise price will depend on the
final resolution of claims under the Reorganization Plan. The Option Agreement
provides that such adjustments will be made periodically as deemed practicable.
An interim adjustment was made on December 10, 1998 to reflect the resolution of
claims as of September 30, 1998. After such adjustment, the A&M #3 Options
consisted of (i) options to acquire 399,717 shares at an exercise price of
$8.80, (ii) options to acquire 399,717 shares at an exercise price of $10.66,
and (iii) options to acquire 399,717 shares at an exercise price of $12.97. The
Company presently estimates that after all adjustments, the A&M #3 Options will
consist of (i) options to acquire 407,667 shares at an exercise price of $8.63
per share, (ii) options to acquire 407,667 shares at an exercise price of $10.45
per share, and (iii) options to acquire 407,667 shares at an exercise price of
$12.72 per share.

     Wherehouse also granted certain registration rights to A&M #3 with respect
to the A&M Shares pursuant to a Registration Rights Agreement dated as of
January 31, 1997 (the "A&M Registration Rights Agreement"). Under the A&M
Registration Rights Agreement, A&M #3 has the right to make one demand
registration and two piggyback registrations in respect of the A&M Shares and
shares subject to the A&M #3 Options.

     Jefferies & Company, Inc., of which Mr. Radecki was an Executive Vice
President and Director of Financial Restructurings, served as the financial
consultant to Old Wherehouse in the Bankruptcy Case, and, prior to Mr. Radecki
leaving Jefferies & Company, Inc., it also served as financial advisor to New
Wherehouse. Mr. Radecki is currently Managing Director of CIBC Oppenheimer
Corp., an investment bank. CIBC Oppenheimer Corp. acted as a financial advisor
to the Company during 1998 with respect to the Acquisition of Blockbuster Music,
and, pursuant to an engagement letter dated September 22, 1998, received a fee
of $600,000, plus expenses, upon completion of the Acquisition.

     In 1998, the Company paid a one-time fee of $0.9 million to Cerberus
Capital Management, L.P. for a commitment to provide a bridge loan to finance
the acquisition of Blockbuster Music in the event that permanent financing was
not in place at the time of the Acquisition. Cerberus Capital Management, L.P.
is a limited partnership controlled by Mr. Feinberg, who is a beneficial owner
of greater than 5% of the Common Stock of Wherehouse. Mr. Davenport, a Managing
Director of Cerberus Capital Management, L.P., is a director of Wherehouse.

     Madeleine LLC, a Delaware limited liability company ("Madeleine"), has
entered into a participation agreement with Congress Financial Corporation
(Western), pursuant to which Madeleine has agreed to purchase a 100% undivided
interest in all of Congress Financial Corporation (Western)'s right, title and
interest in and to any Tranche B loans under the Congress Facility. On October
26, 1998, Madeleine received $100,000 of the closing fee for the Congress
Facility. Madeleine will receive up to $100,000 annually from Congress Financial
Corporation (Western) as its portion of the annual commitment fee and unused
line fee for Tranche B. Stephen Feinberg is the managing member of Madeleine and
the general partner of Cerberus Partners, L.P.

                                        29
<PAGE>   30

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) Financial statements and financial statement schedule

     Financial statements are submitted as a separate section of this Annual
Report on Form 10-K beginning on page F-1.

     All other schedules are omitted as the required information is inapplicable
or the information is presented in the consolidated financial statements or
related notes.

(b) Current Reports on Form 8-K.

     None

(c) Exhibits

     The following exhibits are filed as part of, or are incorporated by
reference into, this Annual Report on Form 10-K:

<TABLE>
    <C>      <S>
     2.1     Debtors' First Amended Chapter 11 Plan, as Revised for
             Technical Corrections dated October 4, 1996 and Supplemental
             Amendments on December 2, 1996 and December 13, 1996.
             (Incorporated by reference to Exhibits A, B and C of Exhibit
             3.1 of Old Wherehouse's Current Report on Form 8-K dated
             January 22, 1997.)
     2.2     Asset Purchase Agreement dated as of January 31, 1997 among
             Old Wherehouse, WEI and New Wherehouse. (Incorporated by
             reference to Exhibit 1.4 of Old Wherehouse's Current Report
             on Form 8-K dated February 12, 1997.)
     2.3     Stock Purchase Agreement dated as of August 10, 1998 by and
             among New Wherehouse and Viacom International Inc.
             (Incorporated herein by reference to Exhibit 2 of New
             Wherehouse's Quarterly Report on Form 10-Q dated September
             14, 1998).
     3.1     Certificate of Incorporation of New Wherehouse filed with
             the Delaware Secretary of State on November 15, 1997.
             (Incorporated by reference to Exhibit C of Exhibit A of
             Exhibit 3.1 of Old Wherehouse's Current Report on Form 8-K
             dated January 22, 1997.)
     3.2     Certificate of Amendment of Certificate of Incorporation of
             New Wherehouse filed with the Delaware Secretary of State on
             January 31, 1997. (Incorporated by reference to Exhibit 1.3
             of Old Wherehouse's Current Report on Form 8-K dated
             February 12, 1997.)
     3.3     Certificate of Amendment of Certificate of Incorporation of
             Old Wherehouse filed with the Delaware Secretary of State on
             January 31, 1997. (Incorporated by reference to Exhibit 1.2
             of Old Wherehouse's Current Report on Form 8-K dated
             February 12, 1997.)
     3.4     By-laws of New Wherehouse. (Incorporated by reference to
             Exhibit B of Exhibit A of Exhibit 3.1 of Old Wherehouse's
             Current Report on Form 8-K dated January 22, 1997.)
     3.5     Amendment to By-laws of New Wherehouse adopted January 30,
             1997, adopted by Unanimous Written Consent of the Sole
             Director of New Wherehouse. (Incorporated by reference to
             Exhibit 3.5 of New Wherehouse's Annual Report on Form 10-K
             dated May 16, 1997.)
     4.1     Tranche A Warrant Agreement dated as of January 31, 1997
             between New Wherehouse and United States Trust Company of
             New York, as the Warrant Agent. (Incorporated by reference
             to Exhibit 4.1 of New Wherehouse's Annual Report on Form
             10-K dated May 16, 1997.)
     4.2     Tranche B Warrant Agreement dated as of January 31, 1997
             between New Wherehouse and United States Trust Company of
             New York, as the Warrant Agent. (Incorporated by reference
             to Exhibit 4.2 of New Wherehouse's Annual Report on Form
             10-K dated May 16, 1997.)
     4.3     Tranche C Warrant Agreement dated as of January 31, 1997
             between New Wherehouse and United States Trust Company of
             New York, as the Warrant Agent. (Incorporated by reference
             to Exhibit 4.3 of New Wherehouse's Annual Report on Form
             10-K dated May 16, 1997.)
</TABLE>

                                        30
<PAGE>   31
<TABLE>
    <C>      <S>
     4.4     Registration Rights Agreement dated as of January 31, 1997
             among New Wherehouse, Cerberus Partners, L.P., CS First
             Boston Securities Corporation and Bank of America, Illinois.
             (Incorporated by reference to Exhibit 1.14 of Old
             Wherehouse's Current Report on Form 8-K dated February 12,
             1997.)
    10.1     Single Tenant Industrial Lease, dated November 5, 1991, by
             and between Watson Land Company, as lessor, and Old
             Wherehouse, as lessee. (Incorporated by reference to Exhibit
             10.6 of the Old Wherehouse's Annual Report on Form 10-K for
             the fiscal year ended January 31, 1992.)
    10.2     Management Services Agreement dated as of January 31, 1997
             among New Wherehouse Alvarez & Marsal, Inc., Antonio C.
             Alvarez II, A&M #3, Cerberus Partners, L.P. and the Support
             Employees. (Incorporated by reference to Exhibit 1.5 of Old
             Wherehouse's Current Report on Form 8-K dated February 12,
             1997.)
    10.3     Extension and Amendment to Management Services Agreement
             dated as of February 1, 1998 among New Wherehouse, Alvarez &
             Marsal, Inc., Antonio C. Alvarez, II and A&M #3.
             (Incorporated by reference to Exhibit 10.3 of New
             Wherehouse's Annual Report on Form 10-K dated May 1, 1998.)
    10.4     Second Amendment to Management Services Agreement dated as
             of April 30, 1998 among New Wherehouse, Alvarez & Marsal,
             Inc., Antonio C. Alvarez, II and A&M #3. (Incorporated by
             reference to Exhibit 10.4 of New Wherehouse's Annual Report
             on Form 10-K dated May 1, 1998.)
    10.5     Secured Recourse Promissory Note dated January 31, 1997 by
             A&M #3 in favor of New Wherehouse in the principal amount of
             $335,000. (Incorporated by reference to Exhibit 1.6 of Old
             Wherehouse's Current Report on Form 8-K dated February 12,
             1997.)
    10.6     Secured Non-Recourse Promissory Note dated January 31, 1997
             by A&M #3 in favor of New Wherehouse in the principal amount
             of $5,005,000. (Incorporated by reference to Exhibit 1.7 of
             Old Wherehouse's Current Report on Form 8-K dated February
             12, 1997.)
    10.7     Stock Pledge Agreement dated as of January 31, 1997 between
             A&M #3 and New Wherehouse. (Incorporated by reference to
             Exhibit 1.8 of Old Wherehouse's Current Report on Form 8-K
             dated February 12, 1997.)
    10.8     Stock Subscription Agreement dated as of January 31, 1997
             between New Wherehouse and A&M #3. (Incorporated by
             reference to Exhibit 1.9 of Old Wherehouse's Current Report
             on Form 8-K dated February 12, 1997.)
    10.9     Non-Transferable Stock Option Agreement dated as of January
             31, 1997 between New Wherehouse and A&M #3. (Incorporated by
             reference to Exhibit 1.10 of Old Wherehouse's Current Report
             on Form 8-K dated February 12, 1997.)
    10.10    First Amendment to Non-Transferable Stock Option Agreement
             dated as of April 30, 1998 between New Wherehouse and A&M
             #3. (Incorporated by reference to Exhibit 10.10 of New
             Wherehouse's Annual Report on Form 10-K dated May 1, 1998.)
    10.11    Registration Rights Agreement dated as of January 31, 1997
             between New Wherehouse and A&M #3. (Incorporated by
             reference to Exhibit 1.12 of Old Wherehouse's Current Report
             on Form 8-K dated February 12, 1997.)
    10.12    Letter agreement dated as of October 14, 1996 among Cerberus
             Partners, L.P., CS First Boston Securities Corporation and
             Bank of America, Illinois regarding fees to be paid to
             Alvarez & Marsal, Inc. (Incorporated by reference to Exhibit
             1.13 of Old Wherehouse's Current Report on Form 8-K dated
             February 12, 1997.
    10.13    Letter agreement dated as of January 31, 1997 between New
             Wherehouse and Cerberus Partners, L.P. regarding the
             reimbursement of fees paid by Cerberus on behalf of the
             senior lenders to Alvarez & Marsal, Inc. (Incorporated by
             reference to Exhibit 1.11 of Old Wherehouse's Current Report
             on Form 8-K dated February 12, 1997.)
</TABLE>

                                        31
<PAGE>   32
<TABLE>
    <C>      <S>
    10.14    Loan and Security Agreement dated as of January 31, 1997
             between New Wherehouse and Congress Financial Corporation
             (Western). (Incorporated by reference to Exhibit 1.15 of Old
             Wherehouse's Current Report on Form 8-K dated February 12,
             1997.)
    10.15    Security Agreement dated as of January 31, 1997 between New
             Wherehouse and United States Trust Company of New York, as
             Collateral Agent for certain trade creditors. (Incorporated
             by reference to Exhibit 1.16 of Old Wherehouse's Current
             Report on Form 8-K dated February 12, 1997.)
    10.16    Intercreditor and Collateral Agency Agreement dated as of
             January 31, 1997 among New Wherehouse, the Trade Creditors
             named therein and United States Trust Company of New York,
             as Collateral Agent. (Incorporated by reference to Exhibit
             1.17 of Old Wherehouse's Current Report on Form 8-K dated
             February 12, 1997.)
    10.17    Intercreditor and Subordination Agreement dated as of
             January 31, 1997 among the Trade Creditors named therein,
             United States Trust Company of New York, as Collateral Agent
             for the Trade Creditors and Congress Financial Corporation
             (Western). (Incorporated by reference to Exhibit 1.18 of Old
             Wherehouse's Current Report on Form 8-K dated February 12,
             1997.)
    10.18    Security Agreement dated as of January 20, 1997, by and
             between Mellon US Leasing, a division of Mellon Leasing
             Corporation, successor to United States Leasing Corporation,
             as Secured Party, and Reorganized Wherehouse. (Incorporated
             by reference to Exhibit 10.15 of New Wherehouse's Annual
             Report on Form 10-K dated May 16, 1997.)
    10.19    Change of Control Agreements, dated as of July 10, 1995,
             between Old Wherehouse and each of its executive officers,
             with schedule required by instruction (2) to item 601(a) of
             Regulation S-K identifying the parties thereto and certain
             other details. (Incorporated by reference to Exhibit 10.1 of
             Old Wherehouse's Quarterly Report on Form 10-Q for the
             quarter ended July 31, 1995.)
    10.20    Transition License Agreement dated as of October 26, 1998
             between Wherehouse Entertainment, Inc., the Blockbuster
             Music subsidiaries, and Blockbuster Entertainment Inc.
             (Incorporated by reference to Exhibit 2.2 of New
             Wherehouse's Current Report on Form 8-K dated November 10,
             1998.)
    10.21    Transition Services Agreement dated as of August 10, 1998
             between Wherehouse Entertainment, Inc. and Viacom
             International Inc. (Incorporated by reference to Exhibit 2.3
             of New Wherehouse's Current Report on Form 8-K dated
             November 10, 1998.)
    10.22    Amended and Restated Loan and Security Agreement dated as of
             October 26, 1998 between New Wherehouse and its subsidiaries
             and Congress Financial Corporation (Western). (Incorporated
             by reference to Exhibit 10.22 of New Wherehouse's Annual
             Report on Form 10-K dated May 17, 1999.)
    10.23    Intercreditor and Subordination Agreement dated as of
             October 26, 1998 among the Trade Creditors named therein,
             United States Trust Company of New York, as Collateral Agent
             for the Trade Creditors, and Congress Financial Corporation
             (Western). (Incorporated by reference to Exhibit 10.23 of
             New Wherehouse's Annual Report on Form 10-K dated May 17,
             1999.)
    10.24    Security Agreement dated as of October 26, 1998 between New
             Wherehouse and United States Trust Company of New York, as
             Collateral Agent for certain trade creditors. (Incorporated
             by reference to Exhibit 10.24 of New Wherehouse's Annual
             Report on Form 10-K dated May 17, 1999.)
    10.25    Intercreditor and Collateral Agency Agreement dated as of
             October 26, 1998 among certain subsidiaries of New
             Wherehouse, the Trade Creditors named therein and United
             States Trust Company of New York, as Collateral Agent.
             (Incorporated by reference to Exhibit 10.25 of New
             Wherehouse's Annual Report on Form 10-K dated May 17, 1999.)
</TABLE>

                                        32
<PAGE>   33
<TABLE>
    <C>      <S>
    10.26    Wherehouse Entertainment, Inc. 1998 Stock Incentive Plan.
             (Incorporated by reference to Appendix A of the Company's
             definitive proxy statement dated September 25, 1998.)
             (Incorporated by reference to Exhibit 10.26 of New
             Wherehouse's Annual Report on Form 10-K dated May 17, 1999.)
    10.27    First Amendment to the Amended and Restated Loan and
             Security Agreement dated as of November 30, 1998 between New
             Wherehouse and its subsidiaries and Congress Financial
             Corporation (Western). (Incorporated by reference to Exhibit
             10.27 of New Wherehouse's Annual Report on Form 10-K dated
             May 17, 1999.)
    10.28    Extension and Third Amendment to Management Services
             Agreement dated as of May 13, 1999 among Wherehouse, Alvarez
             & Marsal, Inc., Antonio C. Alvarez II and A&M #3.
             (Incorporated by reference to Exhibit 10.28 of New
             Wherehouse's Annual Report on Form 10-K dated May 17, 1999.)
    10.29    Second Amendment to the Amended and Restated Loan and
             Security Agreement dated as of May 14, 1999 between
             Wherehouse and its subsidiaries and Congress Financial
             Corporation (Western). (Incorporated by reference to Exhibit
             10.29 of New Wherehouse's Annual Report on Form 10-K dated
             May 17, 1999.)
    10.30    Third Amendment to the Amended and Restated Loan and
             Security Agreement dated as of August 31, 1999 between
             Wherehouse and its subsidiaries and Congress Financial
             Corporation (Western). (Incorporated by reference to Exhibit
             10.1 of New Wherehouse's Quarterly Report on Form 10-Q for
             the quarter ended July 31, 1999.)
    10.31    Fourth Amendment to the Amended and Restated Loan and
             Security Agreement dated as of August 31, 1999 between
             Wherehouse and its subsidiaries and Congress Financial
             Corporation (Western). (Incorporated by reference to Exhibit
             10.1 of New Wherehouse's Quarterly Report on Form 10-Q for
             the quarter ended October 31, 1999.)
    10.32    Fourth Amendment to Management Services Agreement dated as
             of April 13, 1999 among Wherehouse, Alvarez & Marsal, Inc.,
             Antonio C. Alvarez II and A&M #3. (Incorporated by reference
             to Exhibit 10.32 of New Wherehouse's Annual Report on Form
             10-K dated May 1, 2000.)
    10.33    Contribution Agreement dated as of November 16, 1999,
             between CheckOut.com, LLC and Wherehouse. (Incorporated by
             reference to Exhibit 10.33 of New Wherehouse's Annual Report
             on Form 10-K dated May 1, 2000.)
    10.34    Fifth Amendment to the Amended and Restated Loan and
             Security Agreement dated as of December 6, 2000 between
             Wherehouse and its subsidiaries and Congress Financial
             Corporation (Western). (Incorporated by reference to Exhibit
             10.1 of New Wherehouse's Quarterly Report on Form 10-Q for
             the quarter ended October 31, 2000.)
    10.35*   Fifth Amendment to Management Services Agreement dated as of
             June 30, 2000 among Wherehouse, Alvarez & Marsal, Inc.,
             Antonio C. Alvarez II and A&M #3.
    10.36*   Amended and Restated Fifth Amendment to the Amended and
             Restated Loan and Security Agreement dated as of January 10,
             2001 between Wherehouse and its subsidiaries and Congress
             Financial Corporation (Western).
</TABLE>

---------------

 * Filed herewith

                                        33
<PAGE>   34

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) 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.

Date: April 26, 2001                      WHEREHOUSE ENTERTAINMENT, INC.

                                          By:  /s/ ANTONIO C. ALVAREZ, II
                                            ------------------------------------
                                                   Antonio C. Alvarez, II
                                                   Chairman of the Board,
                                            Chief Executive Officer and Director
                                               (Principal Executive Officer)

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
                      SIGNATURE                                     TITLE                     DATE
                      ---------                                     -----                     ----
<C>                                                      <C>                             <S>

             /s/ ANTONIO C. ALVAREZ, II                     Chairman of the Board,       April 26, 2001
-----------------------------------------------------      Chief Executive Officer
               Antonio C. Alvarez, II

                 /s/ MARK A. VELARDE                      Executive Vice President,      April 26, 2001
-----------------------------------------------------      Chief Financial Officer
                   Mark A. Velarde

                  /s/ MEHDI MAHDAVI                       Vice President, Controller     April 26, 2001
-----------------------------------------------------       (Principal Accounting
                    Mehdi Mahdavi                                  Officer)

               /s/ ROBERT C. DAVENPORT                             Director              April 26, 2001
-----------------------------------------------------
                 Robert C. Davenport

                 /s/ JONATHAN GALLEN                               Director              April 26, 2001
-----------------------------------------------------
                   Jonathan Gallen

                /s/ JOSEPH J. RADECKI                              Director              April 26, 2001
-----------------------------------------------------
                  Joseph J. Radecki

                 /s/ JOSEPH B. SMITH                               Director              April 26, 2001
-----------------------------------------------------
                   Joseph B. Smith
</TABLE>

                                        34
<PAGE>   35

                         WHEREHOUSE ENTERTAINMENT, INC.

                         INDEX TO FINANCIAL STATEMENTS

                                    CONTENTS

<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Independent Auditors' Report -- Deloitte & Touche LLP.......  F-2
Financial Statements:
  Consolidated Balance Sheets at January 31, 2001 and
     2000...................................................  F-3
  Consolidated Statements of Operations for the years ended
     January 31, 2001, 2000 and 1999........................  F-4
  Consolidated Statements of Changes in Shareholders' Equity
     for the years ended January 31, 2001, 2000 and 1999....  F-5
  Consolidated Statements of Cash Flows for the years ended
     January 31, 2001, 2000 and 1999........................  F-6
Notes to Consolidated Financial Statements..................  F-7
</TABLE>

     All schedules have been omitted because they are not required under the
related instructions, are inapplicable or because the required information is
included elsewhere in the consolidated financial statements.

                                       F-1
<PAGE>   36

                          INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholders of
Wherehouse Entertainment, Inc.:

     We have audited the accompanying consolidated balance sheets of Wherehouse
Entertainment, Inc. and subsidiaries as of January 31, 2001 and 2000, and the
related consolidated statements of operations, changes in shareholders' equity,
and cash flows for each of the three years in the period ended January 31, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.

     We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

     In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Wherehouse Entertainment, Inc.
and subsidiaries at January 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
January 31, 2001 in conformity with accounting principles generally accepted in
the United States of America.

DELOITTE & TOUCHE LLP

Los Angeles, California
April 26, 2001

                                       F-2
<PAGE>   37

                         WHEREHOUSE ENTERTAINMENT, INC.

                          CONSOLIDATED BALANCE SHEETS

                                     ASSETS

<TABLE>
<CAPTION>
                                                                      JANUARY 31,
                                                              ----------------------------
                                                                  2001            2000
                                                              ------------    ------------
<S>                                                           <C>             <C>
Current assets (Note 6):
  Cash and cash equivalents.................................  $  2,457,000    $  4,531,000
  Receivables, net..........................................     1,343,000       7,794,000
  Inventories, net..........................................   197,147,000     247,800,000
  Income taxes receivable...................................     9,825,000       2,348,000
  Other current assets......................................     2,401,000       2,306,000
  Deferred taxes (Note 7)...................................     5,983,000      15,932,000
                                                              ------------    ------------
     Total current assets...................................   219,156,000     280,711,000
  Property, equipment and improvements, net (Notes 4 and
     6).....................................................    67,132,000      82,250,000
  Deferred taxes (Note 7)...................................    19,886,000      10,573,000
  Intangible assets, net (Notes 1, 2, 3 and 6)..............    34,510,000      38,075,000
  Other assets, net.........................................     1,007,000       2,074,000
                                                              ------------    ------------
          Total assets......................................  $341,691,000    $413,683,000
                                                              ============    ============
                           LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable and bank overdraft.......................  $129,042,000    $177,158,000
  Accrued expenses (Note 5).................................    31,675,000      30,067,000
  Sales taxes payable.......................................     3,793,000       4,015,000
  Store closure reserve -- Acquired stores (Note 1).........     7,539,000       9,746,000
  Store closure reserve -- Existing stores (Note 1).........       882,000       1,446,000
  Reorganization liabilities (Note 2).......................     1,242,000       1,567,000
  Current portion of long-term debt (Note 2)................     3,836,000          58,000
  Current portion of leases in excess of fair market value
     (Note 1)...............................................     3,270,000       3,278,000
  Current portion of capital lease obligations (Notes 4 and
     9).....................................................     6,090,000       5,633,000
                                                              ------------    ------------
     Total current liabilities..............................   187,369,000     232,968,000
  Line of credit (Note 6)...................................    35,123,000      31,983,000
  Long-term debt (Note 2)...................................       224,000       4,060,000
  Capital lease obligations (Notes 4 and 9).................    16,293,000      21,770,000
  Leases in excess of fair market value (Note 1)............    18,195,000      21,463,000
  Deferred rent and other long-term liabilities (Note 3)....     5,181,000       5,168,000
                                                              ------------    ------------
          Total liabilities.................................   262,385,000     317,412,000
                                                              ------------    ------------
Commitments and contingencies (Notes 9 and 10)
Shareholders' equity (Note 10):
  Preferred stock
  Common stock..............................................       110,000         108,000
  Additional paid-in-capital................................    94,453,000      89,400,000
  Retained earnings (deficit)...............................    (8,084,000)     13,562,000
  Treasury stock............................................      (338,000)       (338,000)
  Notes receivable..........................................    (6,835,000)     (6,461,000)
                                                              ------------    ------------
          Total shareholders' equity........................    79,306,000      96,271,000
                                                              ------------    ------------
          Total liabilities and shareholders' equity........  $341,691,000    $413,683,000
                                                              ============    ============
</TABLE>

          See accompanying notes to consolidated financial statements.
                                       F-3
<PAGE>   38

                         WHEREHOUSE ENTERTAINMENT, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                             YEARS ENDED JANUARY 31,
                                                   --------------------------------------------
                                                       2001            2000            1999
                                                   ------------    ------------    ------------
<S>                                                <C>             <C>             <C>
Sale merchandise revenue.........................  $700,614,000    $756,055,000    $464,475,000
Rental revenue, net..............................     5,797,000       9,836,000      15,984,000
                                                   ------------    ------------    ------------
     Total revenues..............................   706,411,000     765,891,000     480,459,000
Cost of sale merchandise revenue.................   457,775,000     495,596,000     309,687,000
                                                   ------------    ------------    ------------
     Gross profit................................   248,636,000     270,295,000     170,772,000
Selling, general and administrative expenses.....   219,465,000     237,749,000     140,135,000
System integration costs (Note 1)................                                       827,000
Store closure costs -- Existing stores (Note
  1).............................................                                     2,869,000
Year 2000 remediation costs (Note 12)............                       176,000       1,842,000
Other costs (Note 4).............................     2,335,000         153,000
Depreciation and amortization....................    31,101,000      25,506,000      11,769,000
                                                   ------------    ------------    ------------
  Income (loss) from operations..................    (4,265,000)      6,711,000      13,330,000
Interest expense.................................     8,563,000       7,796,000       3,503,000
Interest income..................................      (414,000)       (526,000)     (2,258,000)
Loss on investment in joint venture (Note 1).....    20,594,000
                                                   ------------    ------------    ------------
  Income (loss) before income taxes..............   (33,008,000)       (559,000)     12,085,000
Provision (benefit) for income taxes.............   (11,362,000)        637,000       5,029,000
                                                   ------------    ------------    ------------
  Net income (loss)..............................  $(21,646,000)   $ (1,196,000)   $  7,056,000
                                                   ============    ============    ============

Net income (loss) per common share (Note 8):
  Basic..........................................  $      (1.97)   $      (0.11)   $       0.66
                                                   ============    ============    ============
  Diluted........................................  $      (1.97)   $      (0.11)   $       0.61
                                                   ============    ============    ============
</TABLE>

          See accompanying notes to consolidated financial statements.
                                       F-4
<PAGE>   39

                         WHEREHOUSE ENTERTAINMENT, INC.

           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                 COMMON STOCK        ADDITIONAL      RETAINED
                             ---------------------     PAID-IN       EARNINGS     TREASURY       NOTES
                               SHARES      AMOUNT      CAPITAL      (DEFICIT)       STOCK     RECEIVABLE       TOTAL
                             ----------   --------   -----------   ------------   ---------   -----------   ------------
<S>                          <C>          <C>        <C>           <C>            <C>         <C>           <C>
Balance, January 31,
  1998.....................  10,619,201   $106,000   $89,377,000   $  7,702,000               $(5,713,000)  $ 91,472,000
Adjustment of common stock
  (Note 10)................     (20,764)
Issuance of common stock...     125,628      1,000        (1,000)
Exercise of warrants.......       5,645      1,000        24,000                                                  25,000
Interest on notes
  receivable...............                                                                      (375,000)      (375,000)
Net income.................                                           7,056,000                                7,056,000
                             ----------   --------   -----------   ------------   ---------   -----------   ------------
Balance, January 31,
  1999.....................  10,729,710    108,000    89,400,000     14,758,000                (6,088,000)    98,178,000
Issuance of common stock...      31,096
Purchase of treasury
  stock....................                                                       $(338,000)                    (338,000)
Interest on notes
  receivable...............                                                                      (373,000)      (373,000)
Net loss...................                                          (1,196,000)                              (1,196,000)
                             ----------   --------   -----------   ------------   ---------   -----------   ------------
Balance, January 31,
  2000.....................  10,760,806    108,000    89,400,000     13,562,000    (338,000)   (6,461,000)    96,271,000
Issuance of common stock...     265,615      2,000     4,998,000                                               5,000,000
Interest on notes
  receivable...............                                                                      (374,000)      (374,000)
Stock option
  compensation.............                               55,000                                                  55,000
Net loss...................                                         (21,646,000)                             (21,646,000)
                             ----------   --------   -----------   ------------   ---------   -----------   ------------
Balance, January 31,
  2001.....................  11,026,421   $110,000   $94,453,000   $ (8,084,000)  $(338,000)  $(6,835,000)  $ 79,306,000
                             ==========   ========   ===========   ============   =========   ===========   ============
</TABLE>

          See accompanying notes to consolidated financial statements.
                                       F-5
<PAGE>   40

                         WHEREHOUSE ENTERTAINMENT, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                       YEARS ENDED JANUARY 31,
                                                            ---------------------------------------------
                                                                2001            2000            1999
                                                            ------------    ------------    -------------
<S>                                                         <C>             <C>             <C>
OPERATING ACTIVITIES:
Net income (loss).........................................  $(21,646,000)   $ (1,196,000)   $   7,056,000
Adjustments to reconcile net income to net cash provided
  by operating activities:
  Depreciation and amortization...........................    31,101,000      25,506,000       11,769,000
  Other costs.............................................     2,335,000         153,000
  Store closure reserves -- existing stores...............                                      2,869,000
  Rental amortization included in rental revenue, net.....     3,624,000       5,435,000       11,190,000
  Book value of rental inventory dispositions, included in
    rental revenue, net...................................       682,000         949,000        2,044,000
  Loss on investment in joint venture.....................    20,594,000
  Stock option compensation...............................        55,000
  Interest on notes receivable............................      (374,000)       (373,000)        (375,000)
  Deferred taxes..........................................       636,000         432,000       (2,327,000)
  Changes in operating assets and liabilities:
    Receivables, net......................................     6,451,000      (1,518,000)      (3,911,000)
    Inventories, net......................................    50,065,000     (28,029,000)      21,742,000
    Other current assets..................................      (105,000)        501,000          181,000
    Accounts payable, accrued expenses and other
      liabilities.........................................   (47,640,000)     56,909,000       19,905,000
    Income taxes receivable/payable.......................    (7,477,000)     (6,955,000)      (1,705,000)
    Rental inventory purchases............................    (3,718,000)     (6,105,000)     (11,502,000)
    Other long-term liabilities...........................        13,000      (1,373,000)         617,000
    Store closure reserve -- Existing stores..............      (564,000)       (767,000)        (276,000)
    Store closure and leases in excess of FMV reserves --
      Acquired stores.....................................    (5,483,000)    (10,120,000)      (2,295,000)
                                                            ------------    ------------    -------------
      Net cash provided by operating activities...........    28,549,000      33,449,000       54,982,000
                                                            ------------    ------------    -------------
INVESTING ACTIVITIES:
Purchase of property, equipment and improvements..........   (13,267,000)    (30,617,000)     (11,241,000)
Investment in joint venture...............................   (19,033,000)
Decrease (Increase) in other assets.......................       496,000        (229,000)        (908,000)
Purchase of Blockbuster Music, net of cash acquired.......                                   (116,535,000)
                                                            ------------    ------------    -------------
      Net cash used in investing activities...............   (31,804,000)    (30,846,000)    (128,684,000)
                                                            ------------    ------------    -------------
FINANCING ACTIVITIES:
Net borrowings under line of credit.......................     3,140,000      (5,366,000)      37,349,000
Payments on capital lease obligations and long-term
  debt....................................................    (6,634,000)     (6,835,000)      (1,237,000)
Exercise of warrants......................................                                         25,000
Purchase of treasury stock................................                      (338,000)
Proceeds from sale of common stock........................     5,000,000
Settlement of pre-petition claims.........................      (325,000)       (542,000)      (2,146,000)
                                                            ------------    ------------    -------------
      Net cash provided by (used in) financing
         activities.......................................     1,181,000     (13,081,000)      33,991,000
                                                            ------------    ------------    -------------
Net decrease in cash and cash equivalents.................    (2,074,000)    (10,478,000)     (39,711,000)
Cash and cash equivalents, beginning of year..............     4,531,000      15,009,000       54,720,000
                                                            ------------    ------------    -------------
Cash and cash equivalents, end of year....................  $  2,457,000    $  4,531,000    $  15,009,000
                                                            ============    ============    =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid (received) during the year for:
  Interest................................................  $  7,921,000    $  6,815,000    $   2,760,000
  Income taxes, net.......................................  $ (4,824,000)   $  7,465,000    $   9,089,000
</TABLE>

NONCASH INVESTING AND FINANCING ACTIVITIES:
    The Company incurred capital lease obligations of $1,556,000, $6,518,000 and
$1,863,000 for the purchase of certain equipment during the years ended January
31, 2001, 2000 and 1999, respectively.
    During 1999, the Company accrued $775,000 of deferred financing costs
incurred in connection with the Revolving Credit Facility (See Note 6).

          See accompanying notes to consolidated financial statements.
                                       F-6
<PAGE>   41

                         WHEREHOUSE ENTERTAINMENT, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 1. BASIS OF PRESENTATION AND ACQUISITION

BASIS OF PRESENTATION

     The consolidated financial statements include the accounts of Wherehouse
Entertainment, Inc. and its wholly owned subsidiaries. All intercompany balances
and transactions have been eliminated. Wherehouse Entertainment, Inc. and all of
its subsidiaries are collectively referred to as the Company.

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. ("Seller") all of the capital
stock of certain retail music subsidiaries of the Seller (the "Acquired
Business"). The Acquired Business operated under the name "Blockbuster Music"
and is referred to as "Blockbuster Music". The Acquired Business consisted of
378 Blockbuster Music stores in 33 states. In June 1999, the Company completed
the systems integration of the Acquired Stores, and all of the Acquired Stores
are currently operating under the "Wherehouse Music" name. The initial purchase
price was subject to a purchase price adjustment mechanism based on working
capital as set forth in the Purchase Agreement.

     On September 8, 1999, the Company reached an agreement with the Seller with
respect to a purchase price adjustment based on working capital plus a
settlement of certain other issues. The final purchase price was $122.3 million,
including direct acquisition costs of $4.7 million.

     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 following is a summary of the
acquired assets and liabilities:

<TABLE>
<S>                                                      <C>
Current assets.........................................  $189,180,000
Property, equipment & improvements.....................    45,982,000
Deferred tax assets, net...............................    19,861,000
Goodwill...............................................    29,361,000
Accounts payable and accrued expenses..................   (87,015,000)
Store closure and other reserves.......................   (20,042,000)
Capital lease obligations..............................   (26,430,000)
Leases in excess of fair market value..................   (28,551,000)
                                                         ------------
          Total consideration..........................  $122,346,000
                                                         ============
</TABLE>

     The results of operations of the Acquisition are reflected in the
accompanying consolidated financial statements from October 26, 1998. Goodwill
arising out of the Acquisition is being amortized over 15 years.

     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 Store Closure Plan, which was finalized during January 1999,
anticipated the closing of 70 stores (51 Acquired Stores and 19 existing
Wherehouse stores) located in 17 states. The Company has closed 63 of these
stores (45 Acquired Stores and 18 existing Wherehouse stores) as of January 31,
2001. The Company is negotiating with landlords to terminate the leases on the
remaining 7 stores.

                                       F-7
<PAGE>   42
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     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:

<TABLE>
<CAPTION>
                         BALANCE                    BALANCE                                  BALANCE                    BALANCE
                          AS OF       CHARGES        AS OF        CHARGES                     AS OF       CHARGES        AS OF
                       OCTOBER 26,    AGAINST     JANUARY 31,     AGAINST     ADJUSTMENT   JANUARY 31,    AGAINST     JANUARY 31,
                          1998        RESERVES       1999        RESERVES        (2)          2000        RESERVES       2001
                       -----------   ----------   -----------   -----------   ----------   -----------   ----------   -----------
<S>                    <C>           <C>          <C>           <C>           <C>          <C>           <C>          <C>
Store closure
  reserve -- Acquired
  stores(1)..........  $24,126,000   $1,514,000   $22,612,000   $ 8,782,000   $4,084,000   $ 9,746,000   $2,207,000   $ 7,539,000
Leases in excess of
  fair market
  value..............   29,981,000      781,000    29,200,000     3,029,000    1,430,000    24,741,000    3,276,000    21,465,000
                       -----------   ----------   -----------   -----------   ----------   -----------   ----------   -----------
        Total........  $54,107,000   $2,295,000   $51,812,000   $11,811,000   $5,514,000   $34,487,000   $5,483,000   $29,004,000
                       ===========   ==========   ===========   ===========   ==========   ===========   ==========   ===========
</TABLE>

---------------
(1) Consists substantially of lease termination costs.

(2) Adjustments relate primarily to the finalization of certain lease settlement
    costs.

     During Fiscal 1999, the Company recorded accruals related to the planned
closing of 19 existing Wherehouse stores. The following is a rollforward of the
activity of the store closure reserve -- existing stores:

<TABLE>
<S>                                                        <C>
Balance at October 26, 1998(1)...........................  $2,869,000
Charges against reserve..................................     276,000
                                                           ----------
Balance at January 31, 1999..............................   2,593,000
Charges against reserve..................................   1,147,000
                                                           ----------
Balance at January 31, 2000..............................   1,446,000
Charges against reserve..................................     564,000
                                                           ----------
Balance at January 31, 2001..............................  $  882,000
                                                           ==========
</TABLE>

---------------
(1) Consists substantially of lease termination costs.

     The following unaudited pro forma financial information for the Company
gives effect to certain adjustments, including depreciation expense,
amortization of goodwill, corporate overhead allocations, interest expense and
the related income tax effect of the foregoing adjustments as if the Acquisition
had occurred at February 1, 1998:

<TABLE>
<CAPTION>
                                                          YEAR ENDED
                                                         JANUARY 31,
                                                             1999
                                                         ------------
<S>                                                      <C>
Net revenues...........................................  $857,504,000
Net loss...............................................  $(14,234,000)
Basic and diluted net loss per share...................  $      (1.33)
</TABLE>

     The unaudited pro forma results have been prepared for comparative purposes
only and do not purport to represent what the Company's actual results of
operations would have been had the Acquisition occurred as of the beginning of
the period presented and are not intended to be a projection of future results
or trends.

     In connection with the integration of the Acquired Business, the Company
incurred consulting and systems integration costs of $827,000 during 1999. These
amounts are included in system integration costs in the accompanying
consolidated statement of operations.

E-COMMERCE

     In response to the growth in electronic commerce for prerecorded music and
video product, the Company launched its own Internet commerce site,
"Wherehousemusic.com," on May 10, 1999. In November of 1999, the Company agreed
to enter into an equity investment and strategic partnership agreement (the
"Agree-

                                       F-8
<PAGE>   43
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

ment") with CheckOut.com, LLC ("CheckOut.com"), an Internet content provider and
e-commerce retailer of music, movies and games. This Agreement was finalized on
February 16, 2000. In exchange for a 49% interest in CheckOut.com, the Company
contributed $9.8 million in February of 2000. In addition, commencing March
2000, $1.568 million per month was contributed for a total investment of
approximately $20.0 million. Under the terms of the Agreement, CheckOut.com was
the exclusive Internet website partner for music, movies and games for
Wherehouse Music. As a result, the Company merged the operation of its own
Internet website, Wherehousemusic.com, with that of CheckOut.com. CheckOut.com
was integrated into all of the Company's marketing and advertising associated
with the Company's stores nationwide. As a part of the CheckOut.com transaction,
the Company sold 250,000 shares of its common stock to affiliates of its partner
in CheckOut.com for $5.0 million in cash. In addition, during the year ended
January 31, 2000 the Company loaned CheckOut.com $5.0 million which is included
in accounts receivable in the accompanying balance sheet at January 31, 2000.
The loan was paid by CheckOut.com in Fiscal 2001.

     Subsequent to February 2000, CheckOut.com experienced significant operating
losses and ceased operations of its Internet site in February 2001. For the year
ended January 31, 2001, the $20.6 million loss on investment in joint venture
includes $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.

 2. REORGANIZATION UNDER CHAPTER 11

     Wherehouse Entertainment, Inc. ("New Wherehouse" also the Company) was
incorporated under the laws of the state of Delaware on November 15, 1996, as
WEI Acquisition Co. On January 31, 1997, New Wherehouse acquired substantially
all of the assets of Wherehouse Dissolution Co. ("Old Wherehouse"), a Delaware
corporation, and its parent company, WEI Holdings, Inc., a Delaware corporation
(WEI, and together with Old Wherehouse, the "Debtor"), pursuant to a Chapter 11
plan of reorganization (the "Reorganization").

     On August 2, 1995 (the "Petition Date"), the Debtor filed voluntary
petitions for relief under Chapter 11 of Title 11 of the United States Code in
the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court"), seeking to reorganize under Chapter 11 (the "Bankruptcy Case"). Old
Wherehouse and WEI continued to manage their respective affairs and operate
their businesses as debtors-in-possession while they worked to develop a
reorganization plan that would restructure their businesses and allow their
emergence from Chapter 11.

     The Plan of Reorganization for the Company's predecessors (the
"Reorganization Plan") was confirmed by an order of 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 New
Wherehouse has been and is free to carry out its business without oversight by
the Bankruptcy Court.

     Several state and local taxing authorities received promissory notes for
their claims, due generally six years after the tax assessment date together
with interest at 5%. The promissory notes, which amounted to $3,812,000 and
$3,846,000 at January 31, 2001 and 2000, respectively, are included in long-term
debt and current portion of long-term debt in the accompanying consolidated
balance sheets.

 3. SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF BUSINESS

     The Company is a national specialty retailer of pre-recorded music, video
and other entertainment-related products. Certain of the Company's stores offer
video and other products for rental. At January 31,

                                       F-9
<PAGE>   44
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2001, the Company operated 497 stores in 28 states. The Company is supported by
centralized corporate services and the stores have similar economic
characteristics, products, customers and retail distribution methods, and as
such are reported as a single segment.

FISCAL YEAR

     The Company's fiscal year ends on January 31. References made to 2001,
2000, and 1999 are to the fiscal years ended January 31, 2001, 2000 and 1999,
respectively.

USE OF ACCOUNTING ESTIMATES

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.

CASH AND CASH EQUIVALENTS

     Cash and cash equivalents consist of highly liquid investments with a
maturity of three months or less when purchased.

FINANCIAL INSTRUMENTS

     The carrying amounts of cash and cash equivalents, accounts receivable, and
accounts payable approximate fair value because of the short-term maturities of
these instruments. The fair value of the Revolving Credit Facility is
$35,123,000 based on debt with similar terms.

CONCENTRATION OF CREDIT RISK

     Financial instruments, which potentially expose the Company to
concentrations of credit risk, consist primarily of cash and cash equivalents.
It is the Company's practice to place its cash equivalents in high quality
securities with a financial institution.

INVENTORY

     Wherehouse carries inventory at the lower of cost or market using the
last-in, first-out (LIFO) method. Inventory consists primarily of resaleable
pre-recorded music, videocassettes, DVDs, video games and other products. At
January 31, 2001 and 2000, inventory valued using LIFO is $1,977,000 and
$3,110,000, respectively, less than the value of the inventory if valued using
the first-in, first-out method.

RENTAL INVENTORY

     The Company amortizes video rental inventory using the straight-line method
over a three-month period with a $3 salvage value. Rental inventory has been
classified as a current asset in the accompanying consolidated balance sheets as
substantially all revenue and cash flow from rentals on hand is expected to be
derived within a one-year period. The sell-through of such rental inventory in
the year purchased results in additional amortization, which is included in
rental revenue, net.

                                       F-10
<PAGE>   45
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DEPRECIATION AND AMORTIZATION

     Fixed assets are stated at cost less accumulated depreciation and
amortization, which includes the amortization of assets recorded under capital
leases. Fixed assets purchased under capital leases are amortized on a
straight-line basis over the lesser of the estimated useful life of the asset or
the lease term. Depreciation and amortization of equipment and leasehold
improvements is computed on the straight-line method over the following periods:

<TABLE>
<CAPTION>
                                                              YEARS
                                                              ------
<S>                                                           <C>
Leasehold improvements......................................  2 - 10
Data processing equipment and software......................  3 - 5
Store and office fixtures and equipment.....................  1 - 10
Buildings and improvements..................................  5 - 30
</TABLE>

INTANGIBLE ASSETS

     Goodwill of $29,361,000, resulting from the Acquisition (see Note 1), is
being amortized on a straight-line basis over 15 years. Accumulated amortization
was $4,423,000 and $2,453,000 at January 31, 2001 and 2000, respectively.
Reorganization value in excess of amounts allocable to identifiable assets
resulting from the Reorganization (see Note 2) is being amortized on a
straight-line basis over a period of 10 years.

     Reorganization goodwill consisted of the following at January 31, 2001 and
January 31, 2000:

<TABLE>
<CAPTION>
                                               2001           2000
                                            -----------    -----------
<S>                                         <C>            <C>
Original value............................  $15,953,000    $15,953,000
Accumulated amortization..................   (6,381,000)    (4,786,000)
                                            -----------    -----------
Net.......................................  $ 9,572,000    $11,167,000
                                            ===========    ===========
</TABLE>

DEFERRED FINANCING COSTS

     In connection with the Acquisition, the Company incurred $1,263,000 of
costs related to the Revolving Credit Facility (see Note 6). Such costs are
being amortized on a basis that approximates the interest method over the term
of the related debt. Accumulated amortization at January 31, 2001 and 2000 was
$955,000 and $534,000, respectively.

DEFERRED RENT

     The Company recognizes rent expense on a straight-line basis over the life
of the leases. At January 31, 2001 and 2000, deferred rent of $3,181,000 and
$3,062,000, respectively, is included in the accompanying consolidated balance
sheets.

IMPAIRMENT OF LONG-LIVED ASSETS

     The Company follows the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of." Long-lived assets are reviewed for
impairment, based on undiscounted cash flows, whenever events or changes in
circumstances indicate that the carrying amount of such assets may not be
recoverable from cash flows.

STORE PRE-OPENING AND ADVERTISING COSTS

     Store pre-opening and advertising costs are charged to expense as they are
incurred.

                                       F-11
<PAGE>   46
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

EARNINGS PER SHARE

     Basic net income per share is based on the weighted average number of
shares of common stock outstanding. Diluted net income per share is based on the
weighted average number of shares of common stock outstanding and dilutive
potential common shares from stock options and warrants (using the treasury
stock method).

STOCK-BASED COMPENSATION

     The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25), which requires
compensation expense for stock options to be recognized when the market price of
the underlying security exceeds the exercise price on the date of grant. SFAS
No. 123, "Accounting for Stock-Based Compensation," permits companies to apply
the principles of APB 25 and to additionally provide pro forma disclosures of
net income and earnings per share as if the fair value method, as defined in
SFAS No. 123, had been applied.

INCOME TAXES

     The Company accounts for income taxes under an asset and liability approach
that requires the recognition of deferred income tax assets and liabilities for
the expected future consequences of events that have been recognized in the
Company's consolidated financial statements or income tax returns. Management
provides a valuation allowance for deferred income tax assets when it is more
likely than not that a portion of such deferred income tax assets will not be
realized.

NEW ACCOUNTING STANDARDS

     In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement, as amended, establishes
accounting and reporting standards for derivative instruments and for hedging
activities and will be effective for the Company's fiscal year ending January
31, 2002. The Company does not believe that the adoption of SFAS No. 133, as
amended, will have a material impact on its results of operations or financial
position.

 4. PROPERTY, EQUIPMENT AND IMPROVEMENTS

     Property, equipment and improvements consist of the following at January
31, 2001 and 2000:

<TABLE>
<CAPTION>
                                                      2001            2000
                                                  ------------    ------------
<S>                                               <C>             <C>
Land............................................  $    141,000    $    141,000
Buildings and improvements......................       131,000         131,000
Leasehold improvements..........................    24,047,000      20,490,000
Store and office fixtures and equipment.........    47,599,000      43,879,000
Data processing equipment and software..........    25,776,000      23,944,000
Capital leases..................................    29,391,000      27,836,000
                                                  ------------    ------------
                                                   127,085,000     116,421,000
Less accumulated depreciation and
  amortization..................................    59,953,000      34,171,000
                                                  ------------    ------------
Property and equipment, net.....................  $ 67,132,000    $ 82,250,000
                                                  ============    ============
</TABLE>

     Accumulated amortization related to capital lease assets amounted to
$12,072,000 and $5,818,000 at January 31, 2001 and 2000, respectively.

                                       F-12
<PAGE>   47
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     Other costs of $2,335,000 during the year ended January 31, 2001, include
$931,000 related to the write-off of system development costs for computer
software no longer utilized by the Company and $1,404,000 related principally to
additional store closure expenses of which $848,000 has been paid and $556,000
is expected to be paid during Fiscal 2002.

 5. ACCRUED EXPENSES

     Accrued expenses consists of the following at January 31, 2001 and 2000:

<TABLE>
<CAPTION>
                                                       2001           2000
                                                    -----------    -----------
<S>                                                 <C>            <C>
Gift certificate and credit slips liability.......  $18,552,000    $14,804,000
Payroll and related costs.........................    7,488,000      9,000,000
Accrued property taxes............................    1,844,000      2,420,000
Other.............................................    3,791,000      3,843,000
                                                    -----------    -----------
                                                    $31,675,000    $30,067,000
                                                    ===========    ===========
</TABLE>

 6. REVOLVING CREDIT FACILITY

     The Company maintains a financing agreement (the "Facility") with a
financial institution which provides for a revolving credit line of up to
$165,000,000, including a letter of credit subfacility of $10,000,000, expiring
on October 31, 2003, with a year to year renewal thereafter. The revolving line
of credit under the Facility is divided into two tranches, Tranche A and Tranche
B. The Company may borrow up to $155,000,000 under Tranche A. Tranche A loans
bear interest at the prime rate (9.5% at January 31, 2001) plus 0.5%, or at the
Company's election, an adjusted Eurodollar rate (5.805% at January 31, 2001)
plus 1.75%. The Company's ability to make Tranche A borrowings is subject to
borrowing base limitations based upon, among other things, the value of certain
eligible merchandise inventory. If there is no availability under the Tranche A
line, the Company may borrow up to $10,000,000 under the Tranche B line. Tranche
B loans bear interest (i) on the first $5,000,000, at the prime rate plus 3.75%
or an adjusted Eurodollar rate plus 5.0%, and (ii) on the next $5,000,000, at
the prime rate plus 4.75% or an adjusted Eurodollar rate plus 6.0%. In addition,
the Company pays an unused line fee of 0.375% per annum calculated upon the
amount by which $120,000,000 exceeds the average daily principal balance of the
outstanding Tranche A loans and letters of credit outstanding during the
immediately preceding month, along with 0.5% per annum calculated upon the
amount by which $10,000,000 exceeds the average daily principal balance of the
outstanding Tranche B loans. As of January 31, 2001, there was an outstanding
loan balance of $35,123,000 and there were no outstanding letters of credit.

     The Company also pays an annual commitment fee on the Tranche B line of
$50,000, payable in advance for each year during which the line is available.

     The Facility contains certain financial covenants, including the
maintenance of minimum adjusted net worth (as defined) and debt service coverage
ratios, and is collateralized by substantially all of the assets of the Company.

     Under the Facility, dividends may only be paid if, after the dividend
payment, the sum of (i) the Company's cash and (ii) availability under the
Tranche A line, less outstanding and unpaid obligations and certain trade
payables, exceeds $20,000,000.

     On December 6, 2000, the Company amended the Facility to include used
merchandise held for retail sale in the determination of the amount of revolving
loans available to the Company and, effective October 26, 2001, eliminated the
$10.0 million Tranche B loan facility, which the Company has never utilized. On
January 10, 2001, the Facility was amended and restated to, among other things,
delete the provision

                                       F-13
<PAGE>   48
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

excluding the inclusion of Eligible Used Inventory from the calculation of
Excess Availability under the Adjusted Net Worth test as such terms are defined.

 7. INCOME TAXES

     The provision (benefit) for income taxes is summarized as follows:

<TABLE>
<CAPTION>
                                                       YEAR ENDED JANUARY 31,
                                               ---------------------------------------
                                                   2001          2000         1999
                                               ------------    --------    -----------
<S>                                            <C>             <C>         <C>
Current:
  Federal....................................  $(12,350,000)   $ 45,000    $ 5,667,000
  State......................................       352,000     160,000      1,689,000
                                               ------------    --------    -----------
          Total current......................   (11,998,000)    205,000      7,356,000
                                               ------------    --------    -----------
Deferred:
  Federal....................................     1,998,000     459,000     (1,668,000)
  State......................................    (1,362,000)    (27,000)      (659,000)
                                               ------------    --------    -----------
          Total deferred.....................       636,000     432,000     (2,327,000)
                                               ------------    --------    -----------
          Total..............................  $(11,362,000)   $637,000    $ 5,029,000
                                               ============    ========    ===========
</TABLE>

     A reconciliation of the difference between the federal statutory tax rate
and the effective tax rate is summarized as follows:

<TABLE>
<CAPTION>
                                                              YEAR ENDED JANUARY 31,
                                                              ----------------------
                                                              2001     2000     1999
                                                              -----    -----    ----
<S>                                                           <C>      <C>      <C>
Statutory tax rate..........................................  (35.0)%  (35.0)%  35.0%
Non-deductible goodwill amortization........................    2.1    123.0     1.4
Other permanent tax differences.............................    0.5     11.0    (0.6)
State taxes, net of federal benefit.........................   (2.0)    14.9     5.8
                                                              -----    -----    ----
                                                              (34.4)%  113.9%   41.6%
                                                              =====    =====    ====
</TABLE>

                                       F-14
<PAGE>   49
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     The components of net deferred income taxes at January 31, 2001 and 2000
are as follows:

<TABLE>
<CAPTION>
                                                               2001           2000
                                                            -----------    -----------
<S>                                                         <C>            <C>
Net current deferred income tax assets (liabilities):
  Merchandise inventory...................................  $(1,095,000)   $ 8,431,000
  Losses from equity investment...........................    3,723,000
  Other accrued liabilities...............................      679,000      2,742,000
  Other...................................................   (1,434,000)    (1,699,000)
  Business Acquisition....................................    4,110,000      6,458,000
                                                            -----------    -----------
          Total current...................................    5,983,000     15,932,000
                                                            -----------    -----------
Net long-term deferred income tax assets (liabilities):
  Reorganization value....................................    1,854,000      1,500,000
  Deferred rent...........................................    1,279,000      1,239,000
  Property, equipment and improvements....................    5,422,000     (1,202,000)
  Business acquisition....................................    5,890,000      9,036,000
  Net operating loss......................................    5,441,000
                                                            -----------    -----------
          Total long-term.................................   19,886,000     10,573,000
                                                            -----------    -----------
          Total net deferred tax assets...................  $25,869,000    $26,505,000
                                                            ===========    ===========
</TABLE>

     The Company is currently undergoing an audit by the Internal Revenue
Service for Fiscal 1998. Management believes that it has made adequate provision
in the accompanying consolidated financial statements for this audit and
required adjustments, if any, would not have a significant impact on the
consolidated financial statements included.

     The Company has approximately $9.0 million of federal net operating losses
which can be carried forward to offset future federal taxable income. The
ability to use these loss carryforwards will expire in Fiscal 2022. The Company
has various state net operating losses that can be carried forward to offset
future state taxable income. The ability to use these state loss carryforwards
will begin to expire at various times depending upon specific state law.

                                       F-15
<PAGE>   50
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

 8. EARNINGS PER SHARE

     The following table is a reconciliation of the basic and diluted earnings
per share computations:

<TABLE>
<CAPTION>
                                                               YEAR ENDED JANUARY 31,
                                                     ------------------------------------------
                                                         2001           2000           1999
                                                     ------------    -----------    -----------
<S>                                                  <C>             <C>            <C>
Basic EPS Computation:
  Numerator........................................  $(21,646,000)   $(1,196,000)   $ 7,056,000
  Denominator:
     Weighted average common shares outstanding....    10,989,000     10,750,000     10,690,000
                                                     ------------    -----------    -----------
Basic EPS..........................................  $      (1.97)   $     (0.11)   $      0.66
                                                     ============    ===========    ===========
Diluted EPS Computation:
  Numerator........................................  $(21,646,000)   $(1,196,000)   $ 7,056,000
  Denominator:
     Weighted average common shares outstanding....    10,989,000     10,750,000     10,690,000
     Incremental shares from assumed exercise of
       warrants....................................             0              0        537,000
     Incremental shares from assumed exercise of
       options.....................................             0              0        325,000
                                                     ------------    -----------    -----------
          Total shares.............................    10,989,000     10,750,000     11,552,000
                                                     ------------    -----------    -----------
Diluted EPS........................................  $      (1.97)   $     (0.11)   $      0.61
                                                     ============    ===========    ===========
</TABLE>

     Options and warrants were not included in the computation of diluted
earnings per share during the years ended January 31, 2001 and 2000 because
there was a net loss and therefore, all options and warrants would be
antidilutive. Options to purchase 86,000 shares of common stock outstanding
during January 31, 1999 were not included in the computation of diluted earnings
per share because the options' exercise price was greater than the average
market price of the common shares and, therefore, the effect would be
antidilutive.

 9. COMMITMENTS AND CONTINGENCIES

LEASES

     The Company leases all of its retail stores and other facilities under
non-cancelable lease agreements that expire on various dates and provide for
renewal options. Certain of these leases have scheduled rent increases or
require rent escalations based on the consumer price index and/or provide for
payment of the real estate taxes and additional rents based on a percentage of
sales. Leases related to certain stores acquired (see Note 1) are reflected as
capital leases in the accompanying consolidated balance sheet at January 31,
2001 and 2000. In addition, the Company leases certain equipment under capital
lease agreements.

                                       F-16
<PAGE>   51
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     Future minimum annual lease payments under operating and capital leases at
January 31, 2001 are payable as follows:

<TABLE>
<CAPTION>
                       YEAR ENDED
                       JANUARY 31,                          OPERATING        CAPITAL
                       -----------                         ------------    -----------
<S>                                                        <C>             <C>
2002.....................................................  $ 56,515,000    $ 7,408,000
2003.....................................................    48,475,000      5,675,000
2004.....................................................    42,609,000      3,725,000
2005.....................................................    30,277,000      3,260,000
2006.....................................................    17,476,000      2,429,000
Thereafter...............................................    34,073,000      4,077,000
                                                           ------------    -----------
          Total minimum lease payments...................  $229,425,000     26,574,000
                                                           ============
  Less amounts representing interest.....................                    4,191,000
                                                                           -----------
  Present value of minimum lease payments................                  $22,383,000
                                                                           ===========
</TABLE>

     Rental expense charged to operations was $58,257,000, $59,205,000, and
$35,961,000 during 2001, 2000 and 1999, respectively. In addition, real estate
taxes and additional rents based on percentage of sales were $7,751,000,
$8,272,000, and $4,388,000 during Fiscal 2001, 2000, and 1999, respectively.

OTHER

     In January 2001, the Company was sued in the Los Angeles Superior Court by
a former employee, claiming alleged failure to pay overtime wages to herself and
all salaried store employees similarly situated. The Complaint does not specify
any amount of the claims, either individually or on behalf of the class. The
Company has moved to dismiss some of the claims and intends to vigorously
dispute not only Plaintiff's individual and class claims but the suitability of
her claim that she should be able to pursue this as a purported or
representative action. Although this matter is in the early stages of discovery,
management does not believe an adverse judgement against the Company would
result in a material impact to the consolidated financial statements.

     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.

10. SHAREHOLDERS' EQUITY

     The Company has the following classes of stock:

     Preferred Stock -- $.01 par value; 3,000,000 shares authorized; none
issued.

     Common Stock -- $.01 par value; 24,000,000 shares authorized; 11,026,421
and 10,760,806 shares issued; and 11,001,421 and 10,735,806 shares outstanding
at January 31, 2001 and 2000, respectively.

     Pursuant to a Management Services Agreement dated as of January 31, 1997
and as subsequently amended (the "Management Services Agreement"), and a Stock
Subscription Agreement dated as of January 31, 1997 (the "Stock Subscription
Agreement"), the Company agreed to sell, and A&M Investment Associates #3, LLC
("A&M #3"), an affiliate of Alvarez and Marsal, Inc. agreed to buy at a purchase
price of $6,340,000 ($1,000,000 in cash from A&M #3's funds, plus a secured
recourse promissory note in the principal amount of $335,000 and a secured
non-recourse promissory note in the amount of $5,005,000 (collectively, the
Promissory Notes), 1,100,000 shares of the common stock (the A&M Shares)
(subject to adjustment upward or downward to represent 10% of the sum of (i) the
shares of common stock ultimately

                                       F-17
<PAGE>   52
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

issued under the Reorganization Plan plus (ii) the number of shares of common
stock issued to A&M #3). On December 10, 1998, the A&M Shares were adjusted
downward by 20,764, which reduced the total shares to A&M as of January 31, 1999
to 1,079,236. The Promissory Notes bear interest at 7% per annum during the
first four years and 11% per annum during the fifth through seventh years,
mature on January 31, 2004, and have no scheduled interest and principal
amortization until their maturity date. The Promissory Notes are secured by a
first priority pledge of the A&M Shares pursuant to a Pledge Agreement dated as
of January 31, 1997.

     In addition, New Wherehouse and A&M #3 entered into a Non-Transferable
Stock Option Agreement dated as of January 31, 1997, (as amended, the Stock
Option Agreement), pursuant to which the Company issued to A&M #3 three tranches
of options to purchase shares of common stock (the A&M Options; and, together
with the A&M Shares, the A&M Securities) representing in the aggregate the right
to purchase an additional 10% of the shares of common stock issued under the
Reorganization Plan. The first tranche of options represents the right to
purchase 399,717 shares of common stock at an exercise price of $8.80. The
second tranche of options represents the right to purchase 399,717 shares of
common stock at an exercise price of $10.66. The third tranche of options
represents the right to purchase 399,717 shares of common stock at an exercise
price of $12.97. The A&M Options are fully vested and all unexercised A&M
Options expire on January 31, 2003, subject to prior vesting or termination as
set forth in the Management Services Agreement. The A&M Options are subject to
upward adjustment on a quarterly basis as additional shares of common stock
related to the Reorganization are issued and are entitled to certain other
anti-dilution provisions as set forth in the Stock Option Agreement. The above
option amounts and exercise prices have been adjusted for anti-dilution effects
through January 31, 2001.

     Under the Reorganization Plan, the Company issued three Tranches of
warrants to purchase shares of common stock (the "Warrants"). The Tranche A
warrants represent the right to purchase 576,000 shares of common stock at an
exercise price of $2.38 per share and have a five year maturity. The Tranche B
warrants represent the right to purchase 100,000 shares of common stock at an
exercise price of $9.00 per share and have a seven year maturity. The Tranche C
warrants represent the right to purchase 100,000 shares of common stock at an
exercise price of $11.00 per share and have a seven year maturity.

     During April 1998, the Board of Directors adopted the Wherehouse 1998 Stock
Incentive Plan ("Stock Incentive Plan"), which was amended on September 22, 1998
and April 13, 2000 to increase the number of shares available to 600,000 and
800,000, respectively. Under the provisions of the plan, the Company may grant
incentive and non-qualified stock options and stock appreciation rights (SARs)
to employees, officers and directors at the discretion of the Board of
Directors. Options granted under the plan vest ratably over a five year period
and expire ten years from the date of the grant.

     Non-qualified options are granted at an exercise price of no less than 85%
of fair market value at the date of the grant. Incentive options are granted at
no less than 100% (110% for holders of more than 10% of the voting stock) of the
fair market value at the date of the grant. During 2001, the Company granted
197,000 options to purchase shares of common stock to officers and employees at
$18 per share, an amount that was less than the $20 per share price paid by
affiliates of the Company's partner in CheckOut.com (See Note 1).

                                       F-18
<PAGE>   53
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Accordingly, the difference will be recorded as compensation expense over the
vesting period of the options. There were no SARs granted during 2001. A summary
of activity in the Stock Incentive Plan is as follows:

<TABLE>
<CAPTION>
                                                                        WEIGHTED AVERAGE
                                                             SHARES      EXERCISE PRICE
                                                            --------    ----------------
<S>                                                         <C>         <C>
Options outstanding at February 1, 1998
Options granted at $12.00 - $18.00 per share..............   339,500         $13.60
                                                            --------
Options outstanding at January 31, 1999...................   339,500         $13.60
Options granted at $18.00 per share.......................   254,500         $18.00
Options cancelled.........................................  (182,000)        $15.51
                                                            --------
Options outstanding at January 31, 2000...................   412,000         $15.52
Options granted at $18.00 per share.......................   197,000         $18.00
Options cancelled.........................................   (83,000)        $17.49
                                                            --------
Options outstanding at January 31, 2001...................   526,000         $16.11
                                                            ========
</TABLE>

     At January 31, 2001 there were 114,600 options exercisable under the Stock
Incentive Plan.

     Had compensation expense for grants under the Stock Incentive Plan been
determined based on the fair value method of SFAS 123, using the assumptions
described below, the Company's net income and earnings per share would not have
been materially different.

     The pro forma compensation expense related to the fair value of options
issued was estimated using the Black-Scholes model with the following
assumptions: expected volatility -- none (minimum value method); risk
free-interest rate -- 5.510%; average life -- 6 years and expected
dividends -- none.

11. EMPLOYEE BENEFITS

     Employees' Savings Retirement Plan: All employees who have completed one
year of service and at least 1,000 hours of service in that year with the
Company are eligible to join the tax qualified 401(k) Savings Retirement Plan
(the "401(k) Plan") on the first day of each calendar quarter. All eligible
employees may contribute from 1% to 10% of their annual compensation, up to
defined limitations, on a pre-tax basis. The Company contributes to the 401(k)
Plan based upon employee contributions. Matching contributions made by the
Company vest 25% per year beginning with the employee's second year of
employment. The Company recognized expense of $376,000 in 2001, $386,000 in
2000, and $223,000 in 1999 for matching costs and administrative costs under the
401(k) Plan.

     Employment Agreements: In connection with the Management Services Agreement
(see Note 10), certain specified executive services are provided to the Company
in exchange for annual fees, plus incentive fees up to $230,000, if certain
financial targets are achieved. Expenses, including incentives, amounted to
$670,000, $1,495,000, and $1,364,000 during the years ended January 31, 2001,
2000 and 1999, respectively.

     In the event that the Company's Chairman of the Board and Chief Executive
Officer, under the Management Services Agreement, is terminated other than for
cause (as defined in the Management Services Agreement), prior to October 14,
2001, the Management Services Agreement provides that (i) A&M #3 will have the
right to require the Company to purchase the shares of common stock and options
(whether or not vested), owned by A&M #3, and (ii) the Company will pay A&M cash
in a lump sum amount equal to $50,000 multiplied by the number of months
remaining from the time of termination to October 14, 2001. The price to be paid
by the Company in purchasing the shares of common stock and options to acquire
common stock owned by A&M #3 will depend on the fair market value (as defined in
the Management Services Agreement) of the common stock at the time of purchase.
Any payments made to A&M #3 in purchasing the shares of common stock and options
to acquire common stock from A&M #3 are required to be applied to reduce the
outstanding amounts under the Promissory Notes.

                                       F-19
<PAGE>   54
                         WHEREHOUSE ENTERTAINMENT, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

12. YEAR 2000 REMEDIATION COSTS

     Non-recurring costs of $176,000 and $1,842,000 relating to the Company's
remediation of its computer systems to comply with Year 2000 readiness
requirements were recorded during 2000 and 1999, respectively.

13. RELATED PARTIES

     The Company paid a onetime fee of $938,000 to Cerberus Capital Management,
L.P., the beneficial owner of approximately 65% of the Company's common stock,
for a commitment to provide a bridge loan to finance the Acquisition (See Note
1) in the event that permanent financing was not in place at the time of the
Acquisition. This fee is included in interest expense in the 1999 consolidated
statement of operations.

14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

     The following is a summary of the quarterly results of operations for the
years ended January 31, 2001 and 2000 (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                                   QUARTER ENDED
                                                  ------------------------------------------------
                                                  APRIL 30    JULY 31     OCTOBER 31    JANUARY 31
                                                  --------    --------    ----------    ----------
<S>                                               <C>         <C>         <C>           <C>
2001
Total revenues..................................  $176,767    $166,588     $148,796      $214,260
Gross profit....................................    63,485      58,322       54,914        71,915
Income (loss) from operations...................    (2,506)     (4,223)      (7,425)        9,889
Net loss........................................    (4,668)     (5,436)      (7,583)       (3,959)
Net loss per common share:
  Basic.........................................      (.43)       (.49)        (.69)         (.36)
  Diluted.......................................      (.43)       (.49)        (.69)         (.36)
Weighted average shares outstanding:
  Basic.........................................    10,950      11,001       11,001        11,001
  Diluted.......................................    10,950      11,001       11,001        11,001

2000
Total revenues..................................  $175,903    $183,501     $165,466      $241,021
Gross profit....................................    60,352      66,924       63,727        79,292
Income (loss) from operations...................    (4,626)        621       (2,081)       12,797
Net income (loss)...............................    (3,685)       (891)      (2,426)        5,806
Net income (loss) per common share:
  Basic.........................................     (0.34)      (0.08)       (0.23)         0.54
  Diluted.......................................     (0.34)      (0.08)       (0.23)         0.52
Weighted average shares outstanding:
  Basic.........................................    10,715      10,731       10,757        10,761
  Diluted.......................................    10,715      10,731       10,757        11,069
</TABLE>

                                       F-20