Wherehouse hits sour note over debt-service problems.

Retailer may be near Chapter 11, analysts reckon

Wherehouse Entertainment Inc. could be on the verge of seeking Chapter 11 bankruptcy protection, according to analysts reviewing a public document recently filed by the music and video retailer.

"There's more than a 50 percent chance (Wherehouse) will file for bankruptcy," said Filippe Goossens, a senior analyst with New York-based Moody's Investors Service, a debt-rating service.

"Most investors are resigned to the fact that there is going to be some restructuring (by Wherehouse) that involves bankruptcy," added an analyst who wished to remain anonymous. The filing is likely to take place within the next month, the analyst added.

Torrance-based Wherehouse plans to do a restructuring, but company officials do not yet know what form it will take, said Wherehouse Chief Financial Officer Kathy Ford.

The company may be nearing Chapter 11, analysts said, because its latest filing with the Securities and Exchange Commission states it may not be able to meet its debt obligations. It also states that its lenders, in exchange for extending payment deadlines, are requiring the company to restructure its capital.

Wherehouse has $207 million in debt. It is not generating enough cash flow to service its debt because it is being pummeled by larger, more diversified competitors, analysts said.

And if the company does file Chapter 11, the bankruptcy would likely be a prepackaged one, the anonymous analyst said. In such a case, all of the parties involved would agree to a restructuring plan before Wherehouse declares Chapter 11.

Wherehouse sells music and videos. It operates about 350 stores in 11 states. A large concentration of its stores are in Southern California.

Its latest 10-K filing states that "recent developments ... have led to uncertainties as to the company's ability to continue operations as a going concern."

It was unable to make payments due Jan. 31 to its senior lenders, and received waivers that have been extended through June 30, the document states.

"In connection with the extension, the lenders required that the company ... use their best efforts to develop and implement a plan for the restructuring of their capital structure," it states.

The plan must be in place by June 30, according to the waiver document.

Furthermore, in order to pay off the debt in general, "the company will be required to generate substantial operating cash flow," the document states.

In the red

Wherehouse has been losing money. It lost $162.2 million during fiscal 1995, ended Jan. 31, compared with a loss of $42 million a year earlier. Sales were $409.5 million vs. $380.2 million a year earlier.

It also reported an 8.9 percent decline in same-store sales during the fiscal first quarter ended April 30, the document states.

"Any further significant decreases in revenues or any significant decline in gross margins will cause the company to default on the loan agreement covenants in fiscal year 1996," the document states.

Wherehouse is also trying to obtain additional waivers for the same bank agreement through its fiscal 1996 year. "If the company is unable to obtain such waivers or amendments ... the lenders could suspend or terminate the loan agreement," the document states.

Following the 10-K filing, both Moody's and New York-based Standard & Poor's downgraded Wherehouse's bonds.

Standard & Poor's lowered its rating on the company's subordinated debt, about $110 million worth, from CCC-plus to CCC-minus. A rating in the CCC range indicates the bonds are vulnerable to default.

Wariness grows

"The downgrade is based on Standard & Poor's growing doubt that the company will have sufficient liquidity to meet its debt obligations," according to an S&P statement.

Moody's, meanwhile, downgraded the subordinated debt from Caa to Ca. The new rating indicates the belief there is more than a 50 percent chance Wherehouse will default on the bond payments in the near term, Goossens said.

Moody's and Standard & Poor's needed to downgrade the bonds because of the uncertainties depicted in the 10-K, Wherehouse's Ford said.

The bonds are currently trading at about 30 cents on the dollar, Goossens added.

If it comes, a Chapter 11 filing will probably be prepackaged, the anonymous analyst said.

A company can only go the pre-packaged route if it files a voluntary petition, with creditors abstaining from forcing it into Chapter 11 involuntarily, the analyst explained. And Wherehouse's frankness in its 10-K indicates it is making creditors aware of its situation so they will work with it on a pre-packaged solution, the analyst said.

Would a buyer go for it?

However, if Wherehouse does declare Chapter 11, "I'm not convinced there is somebody out there who would be willing to acquire the company as a going concern," Goossens said.

The actual "franchise value" of the business, such as its name recognition, locations and ability to attract repeat customers may not be strong enough to attract a single buyer, he explained.

Instead, it would make more sense for several investors to divvy up pieces of the business, such as buying stores in different regions, Goossens said.

Wherehouse's sales and profits have been sliding because it is being pummeled by its bigger rivals, such as Blockbuster Entertainment and Best Buy Co. Its cumbersome debt obligations limit its ability to competitively cut prices, the anonymous analyst said.

Meanwhile, the giants are able to negotiate better deals with suppliers, and then pass along the savings in lower store prices, the analyst said.

They also have an advantage because they are more diversified. Best Buy, for instance, sells consumer electronics as well as compact discs. It lowers CD prices to bring in customers who might end up buying compact disc players, for instance, the analyst said.