SOUTHERN CALIFORNIA ENTERPRISE : Looking for a Groove : Wherehouse Hopes Restructuring Puts It Back on Track

Walk into one of the 347 Wherehouse record stores nationwide and you’re likely to be greeted by the sound of upbeat music. Shoppers will be flipping through bins of shiny compact discs and perusing walls of movies for rent. It’s even likely there’ll be a line at the checkout counter.

But that picture belies the behind-the-scenes machinations going on at the company’s headquarters in Torrance, where the Wherehouse Entertainment Inc. management team is laboring to put together a financial restructuring plan. The 25-year-old music retailer is mired in debt and faces the prospect of filing for bankruptcy if a suitable restructuring agreement cannot be reached with creditors by summer’s end.

The financial problems for Wherehouse Entertainment--which until last year considered itself the dominant music retailer on the West Coast--stem mainly from the 1992 takeover by Wherehouse management and Merrill Lynch Capital Partners, analysts say. Management and the partners bought parent company WEI from Adler & Shaykin, a New York leveraged buyout specialist that took Wherehouse private in 1988. Both deals were highly leveraged and left the company saddled with debt.

Then the chain began to face formidable competition just as the California economy turned soft.

“It’s like all the stars were aligned against Wherehouse,” said Mitch Julis, managing partner of Canyon Partners, a holder of Wherehouse bonds and an investment bank that has helped restructure bankrupt companies.

Or, in the words of Wherehouse Chief Executive Jerry E. Goldress: “What happened was the whole marketplace changed after the buyout.”

Indeed, industry players and analysts alike attribute Wherehouse’s poor performance to a variety of factors, some of them beyond the company’s control. Primary among them was stepped-up competition, ranging from other chains such as Blockbuster Music to super-retailers such as Target, Kmart and Best Buy, which often sell compact discs and cassettes at discount prices.

“There’s been a retail explosion,” said Stan Goman, senior vice president of Tower Records, a longtime competitor of Wherehouse based in Sacramento. But “the pie isn’t growing, so the slices are shrinking.”

He and others report that while the retail space devoted to recorded music has increased at least 25% over the past several years, the increase in sales can be measured in single digits. Between 1990 and ‘94, the record stores’ share of the market fell from nearly 70% to barely 50%, with discount retailers and mail-order record clubs luring away customers.

Since ‘91, Wherehouse has added 84 outlets. It has operated its branches as “neighborhood stores,” emphasizing location, convenience and customer service. Goldress says Wherehouse has 4% of the national market and 20% of the market in the Los Angeles area, and he concedes that his competitors are gaining. Although the super-sized stores are winning a larger piece of the market, Goldress says he remains committed to the neighborhood-store emphasis.

In recent years, Goman points out, stores selling recorded music have experienced slower growth because their products have become more expensive. Teen-agers, who traditionally have driven sales, can more easily afford singles and cassettes, but manufacturers have emphasized more expensive compact discs. A lack of broadly popular hit records--such as the Beatles made in the ‘60s and Bruce Springsteen did in the ‘70s --has also hurt record stores, he said.

This year, Wherehouse was also hurt by wet weather in California during the first quarter that kept shoppers away from all kinds of stores, Julis said.

Wherehouse lost more than $162 million for the fiscal year ending Jan. 31--almost four times the $42.1 million the company lost for the previous year--despite the fact that revenue climbed 5.8% to nearly $500 million. In the first quarter of this year, the company saw its revenue fall 8.7% and losses soar by a third over the first quarter of the previous year.

Analysts place most of the blame for the mounting losses on the company’s staggering debt load. Wherehouse had more than $167 million in long-term debt at the end of fiscal 1995, plus an additional $93.8 million in other obligations and $110 million in outstanding 13% senior subordinated notes. The company spends $14 million a year just to pay the interest on its massive debt, and so far it has made little progress in paying down the principal, Goldress said.

Still, Goldress says, “I think we have a high probability of success.”

That tone is in marked contrast to what the company says in its latest annual report. It concedes that there are “uncertainties as to the Company’s ability to continue operations as a going concern” beyond the current fiscal year.

Goldress says such a statement merely represents the worst-case scenario, something the company is legally bound to present, and he insists that its prospects are actually quite good. But things are probably going to get worse before they get better.

Last Wednesday, the New York rating agency Standard & Poor’s downgraded Wherehouse’s $110 million 13% subordinated bonds from “CCC-” to “C”--junk bond status--and plans to lower the rating to “D” in August if, as is expected, the company fails to make a scheduled interest payment.

Wherehouse Entertainment has been out of compliance with its loan covenants, and Goldress has managed to get a series of waivers from his creditors. The most recent extension was granted June 16, and it in effect gives Goldress until Sept. 30 to come up with a plan to restructure the company. In the meantime, the creditors have agreed that they will not call in their loans.

“Clearly, we think it’s a good franchise, but it’s over-leveraged and it needs to be restructured,” said Russ Belinsky, managing director of Chanin & Co., a financial adviser to a group that holds three-quarters of Wherehouse’s bonds. “On a restructured basis, this company can be viable and can prosper.”

Times staff writer Nancy Rivera Brooks contributed to this report.

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Wherehouse in the Red

Wherehouse Entertainment has seen its competition grow faster than demand for recorded music on compact discs, cassettes and records. By industry estimates, the amount of retail space devoted to selling music has increased at least 25% over the last several years, yet sales during that period have risen only about 1%. The growth has not been enough to help Wherehouse pay off its heavy debt load--left over from a highly leveraged takeover in June, 1992--or to pull the company out of the red.

Total unit sales of albums and singles throughout industry, in millions:

Year Compact discs Cassettes LPs Total 1994 379.6 329.7 4.26 713.7 1993 313.0 365.9 4.30 683.2 1992 255.1 398.6 1.46 655.2

Revenue, profit and long-term debt for Wherehouse Entertainment Inc. (for fiscal years ended Jan. 31), in millions of dollars:

Year Sales and rental revenue Profit (loss) Long-term debt 1995 $499.6 ($162.2) $167.4 1994 471.8 (42.1) 175.1 1993 448.5 (10.3) 185.1 1992 457.4 2.9 110.0 1991 452.1 (1.2) 120.5

Music Sales Diversify

The percentage of music sales made by record stores has declined steadily since 1990 as other retail outlets have expanded their music selections and record clubs have increased their efforts to gain market share.

1990 Sales: Record store: 69.8% Other store: 18.5% Record club: 8.9% Mail order: 2.5*%

1994 Sales: Record store: 53.3% Other store: 26.7% Record club: 15.1% Mail order: 3.4*%

* Numbers may not add up to 100% because of rounding.

Source: Recording Industry of America, SoundScan Inc., Wherehouse Entertainment Inc.