<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE PERIOD ENDED SEPTEMBER 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________ to _________________ .
COMMISSION FILE NUMBER 000-21887
CD WAREHOUSE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 73-1504999
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1204 SOVEREIGN ROW, OKLAHOMA CITY, OKLAHOMA 73108
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (405) 949-2422
CHECK WHETHER THE ISSUER (1) FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PAST 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
----- -----
The number of shares outstanding of the Issuer's Common Stock, $.01 par value,
as of November 10, 1998 was 3,550,550.
Transitional Small Business Disclosure Format (check one): YES NO X
----- -----
<PAGE>
FORM 10-QSB
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - December 31,
1997 and September 30, 1998 (unaudited)...........................3
Condensed Consolidated Statements of Income - Three
months and nine months ended September 30, 1997
and 1998 (unaudited)........................................... 4
Condensed Consolidated Statements of Cash Flows - Nine
months ended September 30, 1997 and 1998 (unaudited)........... 5
Notes to Condensed Consolidated Financial Statements
(unaudited).................................................... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 9
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders............ 17
Item 6. Exhibits and Reports on Form 8-K............................... 17
Signatures............................................................... 18
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(INFORMATION AT SEPTEMBER 30, 1998 IS UNAUDITED)
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31, 1997 SEPTEMBER 30, 1998
----------------- ------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,122,233 $ 6,987,683
Accounts receivable, net 517,248 995,355
Merchandise inventory 1,725,699 3,109,474
Prepaid expenses and other 53,816 101,883
----------- -----------
Total current assets 3,418,996 11,194,395
Furniture, fixtures and equipment, net 499,845 1,116,573
Investment in unconsolidated partnerships 6,009 8,917
Intangible and other assets, net 3,438,299 10,462,068
----------- -----------
$ 7,363,149 $22,781,953
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,107,669 $ 586,399
Accrued liabilities 85,438 176,005
Advances and deposits 90,000 164,500
Income taxes payable 205,000 286,535
----------- -----------
Total current liabilities 1,488,107 1,213,439
Deferred income taxes 25,000 25,000
Minority interest 97,398 82,914
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized, none issued -- --
Common stock, $.01 par value; 10,000,000 shares
authorized, 1,820,000 and 3,550,550 issued and
outstanding at December 31, 1997 and
September 30, 1998, respectively 18,200 35,506
Additional paid-in-capital 5,348,543 20,571,755
Retained earnings 385,901 853,339
----------- -----------
Total stockholders' equity 5,752,644 21,460,600
----------- -----------
$ 7,363,149 $22,781,953
=========== ===========
</TABLE>
(See accompanying notes)
3
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CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------------- ---------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1997 1998 1997 1998
-------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Company operations:
Retail store sales $ 1,099,985 $ 2,335,937 $ 2,130,054 $ 5,823,712
Wholesale merchandise sales 876,913 580,064 3,035,367 2,046,592
Software income, net 18,418 3,051 33,850 29,700
Franchise operations:
Royalty income 352,102 883,400 928,982 1,840,442
Management fees 23,648 18,725 85,140 56,175
Franchise and development fees 55,000 47,000 105,000 124,500
-------------- ------------- ------------- -------------
Total revenues 2,426,066 3,868,177 6,318,393 9,921,121
Operating costs and expenses:
Cost of sales - retail store sales 653,200 1,360,731 1,271,833 3,386,956
Cost of sales - wholesale merchandise sales 777,392 511,957 2,753,819 1,850,932
Retail store operating expenses 421,364 841,579 830,041 2,052,327
General and administrative 376,648 670,860 1,032,303 1,704,496
Depreciation and amortization 65,317 206,428 161,086 360,010
Minority interest in partnership income 12,827 5,309 28,400 23,382
-------------- ------------- ------------- -------------
Total operating costs and expenses 2,306,748 3,596,864 6,077,482 9,378,103
-------------- ------------- ------------- -------------
Operating income 119,318 271,313 240,911 543,018
Other income:
Equity in income of unconsolidated partnerships 60,359 12,585 92,679 42,825
Other income (expense) (921) 87,445 3,165 162,745
-------------- ------------- ------------- -------------
59,438 100,030 95,844 205,570
-------------- ------------- ------------- -------------
Income before income taxes 178,756 371,343 336,755 748,588
Provision for income taxes 60,250 139,650 114,000 281,150
-------------- ------------- ------------- -------------
Net income $ 118,506 $ 231,693 $ 222,755 $ 467,438
============== ============= ============= =============
Net income per share - basic $ 0.07 $ 0.07 $ 0.13 $ 0.17
============== ============= ============= =============
Net income per share - diluted $ 0.07 $ 0.06 $ 0.13 $ 0.16
============== ============= ============= =============
Shares used in computation - basic 1,820,000 3,550,550 1,674,432 2,711,638
============== ============= ============= =============
Shares used in computation - diluted 1,820,000 3,859,697 1,674,432 2,910,014
============== ============= ============= =============
</TABLE>
(See accompanying notes)
4
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CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
------------------------------------------
SEPTEMBER 30, 1997 SEPTEMBER 30, 1998
-------------------- --------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITES:
Net income $ 222,755 $ 467,438
Adjustments to reconcile net income to net cash
used for operating activities:
Depreciation and amortization 161,086 360,010
Loss on disposal of assets 30,778 6,892
Changes in operating assets and liabilities:
Accounts receivable, net (394,190) (393,107)
Inventories (1,275,445) (700,611)
Prepaid expenses and other (56,153) (38,067)
Investment in partnership 7,086 (66,872)
Other assets (48,239) (2,989)
Accounts payable 116,992 (517,833)
Accrued liabilities 55,759 39,785
Advances and deposits 149,890 (25,500)
Income taxes payable 114,000 81,535
Minority interests 97,536 (14,484)
------------- -------------
Total adjustments (1,040,900) (1,271,241)
------------- -------------
Net cash used for operating activities (818,145) (803,803)
CASH FLOW FROM INVESTING ACTIVITIES:
Purchase of furniture, fixtures and equipment (483,470) (497,825)
Proceeds from disposal of assets -- 115,030
Acquisition of businesses:
Cost in excess of net assets acquired, net (3,145,525) (7,025,542)
Accounts receivable (72,739) (85,000)
Inventory (398,346) (635,428)
Prepaid expenses and other -- (10,000)
Furniture, fixtures and equipment (50,514) (155,700)
Investment in partnerships (21,452) --
Other assets (931) (14,300)
Accounts payable 543,229 --
Accrued liabilities 1,673 --
Advances and deposits -- 100,000
Minority interest 12,980 --
------------- -------------
(3,131,625) (7,825,970)
------------- -------------
Net cash used for investing activities (3,615,095) (8,208,765)
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net:
Initial public offering 4,478,738 --
Private placement -- 14,854,580
Collection of stock subscription 350,000 23,438
------------- -------------
Net cash provided by financing activities 4,828,738 14,878,018
------------- -------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 395,498 5,865,450
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 15,431 1,122,233
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 410,929 $ 6,987,683
============= =============
</TABLE>
5
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CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
SUPPLEMENTAL CASH FLOW INFORMATION:
For the nine month period ending September 30, 1998 the Company had the
following non-cash investing and financing activities:
Purchased assets of a franchisee for $573,530 which was paid $211,030 in
cash and $362,500 in restricted common stock of the Company, valued for
purposes of the acquisition at $3.625 per share, which represented the
market value of the stock on the acquisition date. The following table
outlines the non-cash portion of this transaction:
Cost in excess of net assets acquired, net $ 281,412
Inventory 47,737
Furniture, fixtures and equipment 70,080
Other assets 10,616
Accounts payable 3,437
Accrued liabilities (50,782)
-----------
$ 362,500
===========
6
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CD WAREHOUSE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The condensed consolidated financial statements as of December 31, 1997
and September 30, 1998 and for the nine months ended September 30, 1997 and
1998, include the accounts of CD Warehouse, Inc. (the "Company"), its wholly
owned subsidiary, Compact Discs Management, Inc. ("CDM"), and majority owned
retail stores. All material intercompany accounts and transactions have been
eliminated in consolidation.
The accompanying interim condensed consolidated financial statements of
the Company are unaudited; however, in the opinion of management, all
adjustments necessary for a fair presentation of such condensed consolidated
financial statements have been reflected in the interim periods presented. Such
adjustments consisted only of normal recurring items. The results of operations
for the nine months ended September 30, 1998 are not necessarily indicative of
the results to be expected for the full year ending December 31, 1998. The
significant accounting policies and certain financial information which are
normally included in financial statements prepared in accordance with generally
accepted accounting principles, but which are not required for interim reporting
purposes, have been condensed or omitted. The accompanying condensed
consolidated financial statements of the Company should be read in conjunction
with the consolidated financial statements and related notes included in the
Company's Form 10-KSB.
NOTE 2. INITIAL PUBLIC OFFERING AND BUSINESS ACQUISITIONS
On January 27, 1997, the Company completed an initial public offering
(the "Initial Public Offering") for 1,000,000 shares of its common stock at a
price of $5 per share. On March 6, 1997, the underwriters exercised an
over-allotment option and purchased an additional 40,000 shares of common stock
at $5 per share. The proceeds of the Initial Public Offering, after deducting
underwriting discounts and offering expenses, were approximately $4.5 million.
Simultaneously with the closing of the Initial Public Offering, the
Company purchased the assets of Compact Disc International, LTD. ("CDIL") for
$3.2 million. Prior to the acquisition, CDIL franchised and operated stores
throughout the United States and England under the name "CD Warehouse." In
connection with its franchise operations, CDIL also sold new and preowned
compact discs to its franchisees.
In a related transaction, which also was effected simultaneously with the
closing of the Initial Public Offering, the Company and CDM purchased all of the
franchise interests of the largest CDIL franchisee in exchange for 80,000 shares
of the Company's common stock ("MacDonald Acquisition") valued at the initial
public offering price of $5 per share.
The acquisitions were recorded under the purchase method of accounting
and resulted in an excess of purchase price over net assets acquired of
approximately $3.5 million which is amortized on a straight-line basis over 20
years.
NOTE 3. PRIVATE PLACEMENT OFFERING AND BUSINESS ACQUISITION
On May 25, 1998, the Company closed an offering of 1,624,300 shares of
the Company's common stock at a price of $10 per share. The proceeds of the
offering (which were effected pursuant to Regulation D and Regulation S of the
Securities Act of 1933), after deducting discounts and offering expenses, were
approximately $14.9 million. In August 1998, the Company registered 1,595,300 of
the 1,624,300 shares (as well as 125,000 additional shares of common stock
issued or issuable under section 4(2) of the Securities Act) pursuant to a
Registration Statement on Form S-3.
On June 26, 1998, the Company completed the acquisition of the franchise
rights for 134 Disc Go Round(R) retail music stores, as well as the assets of 3
Disc Go Round(R) stores owned and operated by its parent company, from Grow Biz
International, Inc. (NASDAQ: GBIZ) for $7.0 million.
7
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CD WAREHOUSE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The following unaudited pro forma combined information presents a summary
of the consolidated results of operations of the Company and the acquired
business for the nine months ended September 30, 1997 and 1998, as if the
acquisition and the private placement by the Company had occurred January 1,
1997:
1997 1998
----------- ------------
Revenues $ 8,064,792 $ 11,312,621
Net income $ 341,880 $ 562,788
Net income per share-basic and diluted $ .10 $ .15
Shares used in computation-diluted 3,298,732 3,745,538
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion is qualified in its entirety by the more
detailed information in the Company's 1997 Annual Report to Stockholders (which
includes its Form 10-KSB for the fiscal year ended December 31, 1997 and the
financial statements contained therein, including the notes thereto), and the
Company's other periodic reports and all Current Reports on Form 8-K filed with
the Securities and Exchange Commission since December 31, 1997 (collectively are
referred to as the "Disclosure Documents"). Certain forward-looking statements
contained herein and in such Disclosure Documents regarding the Company's
business and prospects are based upon numerous assumptions about future
conditions which may ultimately prove to be inaccurate and actual events and
results may materially differ from anticipated results described in such
statements. The Company's ability to achieve such results is subject to certain
risks and uncertainties, such as those inherent generally in the retail and
franchising industries, the impact of competition and pricing, changing market
conditions, and other risks. Any forward-looking statements contained herein
represent the Company's judgment as of the date hereof. The Company disclaims,
however, any intent or obligation to update these forward-looking statements. As
a result, the reader is cautioned not to place undue reliance on these
forward-looking statements. As used in herein, the word "Company" means CD
Warehouse, Inc. and its wholly owned subsidiary, Compact Discs Management, Inc.,
unless the context indicates otherwise.
OVERVIEW
The Company was formed in September 1996 to acquire the franchise
operations of CDIL, a Texas limited partnership which franchised and operated
stores throughout the United States and England under the name "CD Warehouse."
The first CD Warehouse store was opened in 1992. Under the CD Warehouse name, as
of September 30, 1998, there were 163 domestic units operating in 31 states and
7 international units operating in England, France, Guatemala and Venezuela.
Simultaneously with the closing of the Initial Public Offering on January
27, 1997, the Company acquired the assets of CDIL, consisting primarily of
CDIL's rights as franchisor in the various franchise agreements to which it was
a party, for a purchase price of $3.2 million. In a related transaction (the
"MacDonald Acquisition"), which also occurred simultaneously with the closing of
the Offering, the Company acquired the equity interest of MacDonald, the then
largest CD Warehouse franchisee, in 36 franchised CD Warehouse stores. Pursuant
to the MacDonald Acquisition, the Company acquired 100% ownership of one store
and minority equity interests (including MacDonald's interest as a managing
general partner or limited liability company manager) in the other 35 franchised
stores in which MacDonald had an interest. Effective December 30, 1997, the
Company sold back to MacDonald the Company's various ownership interests in nine
partnerships, for an aggregate consideration of $169,807. The partnerships,
which act as franchisees of the Company, operate nine CD Warehouse stores.
Pursuant to the sale, MacDonald assumed the Company's interest in the
partnerships, which continue to operate as CD Warehouse franchisees.
On June 26, 1998 the Company completed the acquisition, for an aggregate
purchase price of $7 million, of the franchise rights to 134 Disc Go Round(R)
retail music stores from Grow Biz International, Inc. ("Grow Biz"), as well as
the acquisition of the assets of three Disc Go Round(R) stores owned and
operated by Grow Biz. Considering the above acquisition, as of September 30,
1998, the Company had 302 stores operating in 40 states domestically and in 5
different countries.
RESULTS OF OPERATION
The Company derives its revenues primarily from retail sales by Company
and majority-owned stores, wholesale merchandise sales to franchisees of the
Company and royalty fees from franchisees. The Company also receives revenues
from initial franchise fees, area development fees, management fees and software
income. Retail store cost of sales and operating expenses relate directly to
Company and majority-owned retail store sales. Wholesale merchandise sales and
associated cost of sales relate to the Company's franchising operations. Other
expenses, such as depreciation, amortization, and general and administrative
expenses, relate to Company and
9
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majority-owned store operations, as well as the Company's franchising
operations. The number and sales volumes of Company and majority-owned retail
stores directly affect the Company's revenues and expenses. The Company's
revenues and, to a lesser extent, expenses also are affected by the number and
sales volumes of franchise stores. Initial franchise fees are directly affected
by the number of franchised store openings.
The following table sets forth the percentage relationship to total
revenues, unless otherwise indicated, of certain items included in the Company's
statement of income.
PERCENTAGE RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ -------------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Retail store sales 45.3% 60.4% 33.7% 58.7%
Wholesale merchandise sales 36.1 15.0 48.0 20.6
Software income, net .8 .1 .5 .3
Royalty income 14.5 22.8 14.7 18.5
Management fees 1.0 .5 1.4 .6
Franchise and development fees 2.3 1.2 1.7 1.3
------------- ------------- ------------- -------------
100.0% 100.0% 100.0% 100.0%
============= ============= ============= =============
Operating costs and expenses:
Cost of sales-retail stores sales (1) 59.4% 58.3% 59.7% 58.2%
Cost of sales-wholesale merchandise sales (2) 88.7 88.3 90.7 90.4
Retail store operating expenses (1) 38.3 36.0 39.0 35.2
General and administrative 15.5 17.3 16.3 17.2
Depreciation and amortization 2.7 5.3 2.5 3.6
Minority interest in partnership income .5 .1 .4 .2
Operating Income 4.9 7.0 3.8 5.5
Other income net 2.4 2.6 1.5 2.1
Net income 4.9% 6.0% 3.5% 4.7%
</TABLE>
(1) As percentage of retail store sales.
(2) As percentage of wholesale merchandise sales.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ -------------------------------
<S> <C> <C> <C> <C>
CD Warehouse stores only: 1997 1998 1997 1998
------------- ------------- ------------- -------------
Sales Data:
System wide sales $ 9,395,693 $ 13,751,762 $ 25,100,872 $ 37,939,457
Percentage increase (1) 38% 46% 28% 51%
Average monthly sales per store $ 26,114 $ 28,909 $ 24,370 $ 27,673
============= ============= ============= =============
Change in comparable retail store sales (2) 19% 14% 12% 16%
------------- ------------- ------------- -------------
</TABLE>
(1) Represents percentage increase from comparable period in prior year.
(2) Represents percentage increase for stores open in both periods reported.
10
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STORE COUNT
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 OPEN CLOSE TRANSFER 1998
------------ -------- --------- -------- -------------
<S> <C> <C> <C> <C> <C>
Franchise
Domestic - CDW 131 17 (3) (10) 135
Domestic - DGR -- 128* (4) -- 124
------------ -------- --------- -------- -------------
131 145 (7) (10) 259
International - CDW 6 1 -- -- 7
International - DGR -- 8* -- -- 8
------------ -------- --------- -------- -------------
6 9 -- -- 15
Company
Domestic - CDW 13 4 (2) 13 28
Domestic - DGR -- 3* -- (3) 0
------------ -------- --------- -------- -------------
13 7 (2) 10 28
------------ -------- --------- -------- -------------
Total 150 161 (9) -- 302
============ ======== ========= ======== =============
</TABLE>
CDW - CD Warehouse
DGR - Disc Go Round(R)
* Acquired 126 domestic franchise stores, 8 International franchise stores and
3 company owned stores on June 26, 1998
RESULTS OF OPERATION
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
Revenues
Retail store sales increased $1,236,000 to $2,336,000 for the three
months ended September 30, 1998, compared to $1,100,000 for the three months
ended September 30, 1997. The increase in retail store sales is the result of
having thirty stores (twenty-eight Company and two majority-owned) in operation
by September 30, 1998 compared to only fifteen stores at September 30, 1997.
Wholesale merchandise sales decreased $297,000, or 34%, to $580,000 for
the three months ended September 30, 1998, compared to $877,000 for the same
period in 1997. The decrease is due to the Company discontinuing its "one-stop"
warehouse operations in May 1998, which acquired new CD releases from the major
record labels and sold them to the franchise system with minimal mark up. The
Company has determined to focus its efforts on warehousing used product to open
new stores and eventually sell used product to the franchise system.
Royalty income increased $531,000 to $883,000 for the three months ended
September 30, 1998, compared to $352,000 for the same period in 1997. The
increase is due to the greater number of CD Warehouse franchise stores in
operation at September 30, 1998 (142) compared to the number operating at
September 30, 1997 (115). Also, as a result of the acquisition of 134 Disc Go
Round(R) franchise stores on June 26, 1998, approximately $352,000 of royalty
income relating to these stores was recognized for the three months ended
September 30, 1998. Additionally, stores operating as CD Warehouse increased
their same store sales by 14% for the three months ended September 30, 1998 with
monthly average sales for these stores increasing from $26,114 for the three
months ended September 30, 1997 to $28,909 for the same period in 1998.
11
<PAGE>
Costs and Expenses
Cost of sales for retail store sales increased $708,000 for the three
months ended September 30, 1998, compared to the same period in 1997. This
increase is consistent with the increase of retail store revenue discussed
above. Cost of sales was 58% of sales for the three months ended September 30,
1998, compared to 59% for the three months ended September 30, 1997.
Cost of sales for wholesale merchandise decreased $265,000, or 34%, to
$512,000 for the three months ended September 30, 1998, compared to $777,000 in
1997. This decrease is consistent with the decrease in sales discussed above.
Cost of sales was 88% of sales for the three months ended September 30, 1998
compared to 89% for the same period in 1997.
Retail store operating expenses increased $420,000 to $842,000 for the
three months ended September 30, 1998, compared to the comparable period in
1997. The increase was due to the increased number of Company-owned and
majority-owned stores discussed above. However, retail store operating expense
was 36% of retail store revenue for the three months ended September 30, 1998,
while such operating expense was 38% of retail store revenue for the three
months ended September 30, 1997. This decrease resulted from better operating
results of Company-owned and majority-owned stores, which began operations
during 1997.
General and administrative expenses increased by $294,000 to $671,000 for
the three months ended September 30, 1998, compared to $377,000 for the three
months ended September 30, 1997. This increase resulted from the continued
growth of the Company in both Company stores (increase of 15 stores) and
franchise stores (increase of 27 stores). The three months ended September 30,
1998 also included costs (travel, personnel, support, etc.) associated with
absorbing the operations of 134 Disc Go Round(R) franchise stores discussed
above.
Depreciation and Amortization
Depreciation and Amortization increased $141,000 to $206,000 for the
three months ended September 30, 1998 compared to $65,000 for the comparable
period in 1997. This is due partially to the increase of fifteen Company stores
in 1998 compared to 1997. In addition, the three months ended September 30, 1998
include amortization of goodwill of $114,000 relating to the acquisition of the
franchise rights to 134 Disc Go Round(R) retail music stores on June 26, 1998.
Other Income
Other income increased $41,000 to $100,000 for the three months ended
September 30, 1998 compared to $59,000 for comparable period in 1997. This is
primarily due to interest earned of approximately $90,000 on the net proceeds of
the private placement completed in May 1998. The above increase is offset by a
reduction of equity income of unconsolidated partnerships of $48,000. This
reduction is due to the sale (in December 1997 and January 1998) of the
Company's ownership in 18 of the 34 stores originally acquired in January 1997.
Net Income
Net income increased $113,000 to $232,000 for the three months ended
September 30, 1998, compared to $119,000 for the same period ended September 30,
1997. The increase in net income is due to improved retail store operations, as
indicated by reduced percentages of cost of sales and operating expenses, an
increase in royalties generated by the increased number of franchise stores, an
increase in same store sales and the addition of 134 Disc Go Round(R) franchise
stores, offset by the increase in general and administrative expense.
12
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1997.
Revenues
Retail store sales increased $3,694,000 to $5,824,000 for the nine months
ended September 30, 1998 compared to $2,130,000 for the nine months ended
September 30, 1997. The increase in retail store sales is the result of having
twenty-eight Company and two majority owned stores in operations during the nine
months ended September 30, 1998 compared to only fifteen during the same period
in 1997.
Wholesale merchandise sales decreased $988,000, or 33% to $2,047,000 for
the nine months ended September 30, 1998 compared to $3,035,000 for the same
period in 1997. The decrease is due to the Company discontinuing its "one-stop"
warehouse operations is May 1998 which acquired new CD releases from the major
record labels and sold them to the franchise system with minimal mark up. The
Company has determined to focus its efforts on warehousing used product to open
new stores and eventually sell used product to the franchise system.
Royalty income increased $911,000 to $1,840,000 for the nine months ended
September 30, 1998 compared to $929,000 for the same period in 1997. Again, the
increase is due to the greater number of franchise CD Warehouse franchise stores
in operation at September 30, 1998 (142) compared to the number operating at
September 30, 1997 (115). Also, as a result of the acquisition of 134 Disc Go
Round(R) franchise stores on June 26, 1998, approximately $352,000 of royalty
income has been recognized as of September 30, 1998. Additionally, stores
operating as CD Warehouse increased their same store sales by 16% for the nine
months ended September 30, 1998 with monthly average sales for these stores
increasing from $24,370 for the nine months ended September 30, 1997 to $27,673
for the same period in 1998.
Costs and Expenses
Cost of sales for retail store sales increased $2,115,000 for the nine
months ended September 30, 1998 compared to the same period in 1997. This
increase is consistent with the increase of retail store revenue discussed
above. Cost of sales was 58% of sales for the nine months ended September 30,
1998 compared to 60% for the nine months ended September 30, 1997.
Costs of sales for wholesale merchandise decreased $903,000 or 33% to
$1,851,000 for the nine months ended September 30, 1998 compared to $2,754,000
in 1997. The decrease is consistent with the decrease in sales. Cost of sales
was 90% of sales for the nine months ended September 30, 1998 compared to 91%
for the comparable period in 1997.
Retail store operating expenses increased $1,222,000 to $2,052,000 for
the nine months ended September 30, 1998, compared to $830,000 for the nine
months ended September 30, 1997. The increase is due to the increase of Company
stores discussed above. Retail store operating expense was 35% of retail store
revenue for the nine months ended September 30, 1998 compared to 39% of retail
store revenue for the same period in 1997. The decrease resulted from better
operating results of Company and majority owned stores that began operations
during 1997. The result for nine months ended September 30, 1997 includes start
up costs relating to nine new Company stores compared to seven Company stores
for the same period in 1998.
General and administrative expenses increased by $672,000 to $1,704,000
for the nine months ended September 30, 1998 compared to $1,032,000 for the nine
months ended September 30, 1997. This increase resulted from the continued
growth of the Company in both Company stores (increase of 15 stores) and
franchise stores (increase of 27 stores). The nine months ended September 30,
1998 also included costs (travel, personnel, support, etc) associated with
absorbing the operations of 134 Disc Go Round(R) franchise stores discussed
above.
13
<PAGE>
Depreciation and Amortization
Depreciation and amortization increased $199,000 to $360,000 for the nine
months ended September 30, 1998 compared to $161,000 for the same period in
1997. This is due to the addition of 15 Company owned stores and the
amortization of goodwill associated with the acquisition of the franchise rights
to 134 Disc Go Round(R) retail music stores on June 26, 1998 (approximately
$38,000 per month).
Other Income
Other income increased $110,000 to $206,000 for the nine months ended
September 30, 1998 compared to $96,000 for the comparable period in 1997. This
is primarily due to interest earned of approximately $157,000 on the net
proceeds of the private placement completed in May 1998. The above increase is
offset by a reduction of equity income of unconsolidated partnerships of
$50,000. This reduction is due to the sale (in December 1997 and January 1998)
of the Company ownership interest in 18 of the 34 stores originally acquired in
January 1997.
Net Income
Net income increased $244,000 to $467,000 for the nine months ended
September 30, 1998 compared to $223,000 for the same period ended September 30,
1997. The increase in net income is due to improved retail store operations, as
indicated by reduced percentages of cost of sales and operating expenses, an
increase in royalties generated by the increase number of franchise stores, an
increase in same store sales and the addition of 134 Disc Go Round(R) franchise
stores, offset by the increase in general and administrative expenses.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998 the Company had working capital of $9,981,000 and
cash and cash equivalents aggregating $6,988,000, compared to working capital of
$1,931,000 and cash and cash equivalents of $1,122,000 at December 31, 1997. Net
cash used for operating activities was $804,000 for the nine months ended
September 30, 1998, compared to net cash used for operating activities of
$818,000 for the nine months ended September 30, 1997. The use of cash by
operating activities for the nine months ended September 30, 1998 and September
30, 1997 relates to the continued growth in both Company owned and franchise
stores.
Net cash used for investing activities was $8,209,000 for the nine months
ended September 30, 1998, compared to $3,615,000 for the same period in 1997.
The significant use of cash for investing activities in 1998 and 1997 relates to
the acquisition of Disc Go Round(R) in June 1998 and the acquisition of the
assets of CDIL in January 1997 combined with opening of Company stores.
Net cash provided from financing activities was $14,878,000 for the nine
months ended September 30, 1998 compared to $4,829,000 for the same period in
1997. The net cash provided from financing in 1998 relates primarily to the
private placement of 1,624,300 shares of common stock in May 1998. The net cash
provided from financing in 1997 relates to the initial public offering and
collection of a stock subscription in the amount of $350,000.
The Company is in process of developing an internet site which will offer
both new and used CDs. This site should be operational in December 1998. The
total cost associated with developing the internet commerce site has not yet
been quantified by the Company. Although such costs may be significant, the
Company believes it has sufficient funds to cover this project.
In October 1998 the Company capitalized a wholly owned subsidiary, CD
Warehouse Finance Company, to finance the growth of qualified franchisees. The
financing subsidiary has not yet commenced operations, but the Company expects
to fund its activities with a portion of the proceeds of the May 1998 private
placement.
In addition to the working capital at September 30, 1998, the Company
has a $500,000 Line of Credit and $500,000 Term Loan Agreement ("Credit
Facilities") with Merrill Lynch Business Financial Services, Inc. Amounts
14
<PAGE>
borrowed under the Credit Facilities will bear an interest rate equal to the sum
of 3.1% and the thirty-day Commercial Paper Rate. As of the date of this Report,
no balance is outstanding under these Credit Facilities. It is the Company's
opinion that the current working capital at September 30, 1998, combined with
the Credit Facilities will be sufficient to support the ongoing activities of
the business for the foreseeable future.
YEAR 2000 ISSUES
The Year 2000 problem is the result of computer programs being written
using two digits (rather than four) to define the applicable year. The Company's
computer equipment and software and devices with imbedded technology that are
time-sensitive may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.
The Company has undertaken various initiatives intended to ensure that
its computer equipment and software will function properly with respect to dates
in the Year 2000 and thereafter. For this purpose, the term "computer equipment
and software" includes systems that are commonly thought of as IT systems,
including accounting, data processing, and telephone/PBX systems, cash
registers, hand-held terminals, scanning equipment, and other miscellaneous
systems, as well as systems that are not commonly thought of as IT systems, such
as alarm systems, fax machines, or other miscellaneous systems. Both IT and
non-IT systems may contain imbedded technology, which complicates the Company's
Year 2000 identification, assessment, remediation, and testing efforts. Based
upon its identification and assessment efforts to date, the Company believes
that certain of the computer equipment and software it currently uses will
require replacement or modification. In addition, in the ordinary course of
replacing computer equipment and software, the Company attempts to obtain
replacements that are Year 2000 compliant. Utilizing both internal and external
resources to identify and assess needed Year 2000 remediation, the Company
currently anticipates that its Year 2000 identification, assessment, remediation
and testing efforts, which began in 1998, will be completed by June 1999, and
that such efforts will be completed prior to any currently anticipated impact on
its computer equipment and software. The Company estimates that as of September
30, 1998, it had completed approximately 50% of the initiatives that it believes
will be necessary to fully address potential Year 2000 issues relating to its
computer equipment and software. The projects comprising the remaining 50% of
the initiatives are in process and expected to be completed on or about June 30,
1999.
The Company has also mailed letters or verbally communicated with its
significant vendors and service providers to determine the extent to which
interfaces with such entities are vulnerable to Year 2000 issues and whether the
products and services purchased from such entities are Year 2000 compliant. As
of September 30, 1998, the Company had received responses from a majority of
such third parties, and substantially all of the companies that have responded
have provided written assurances that they expect to address all their
significant Year 2000 issues on a timely basis. The Company plans to make a
follow-up mailing to significant vendors and service providers that did not
initially respond, or whose responses were deemed unsatisfactory by the Company.
The cost of its Year 2000 identification, assessment, remediation and
testing efforts, as well as currently anticipated costs to be incurred by the
Company with respect to Year 2000 issues of third parties, are not currently
expected to have a material adverse impact on the Company's financial position,
results of operations or cash flows in future periods. As of September 30, 1998,
the Company had incurred minimal costs related to its Year 2000 identification,
assessment, remediation and testing efforts. Other non-Year 2000 IT efforts have
not been materially delayed or impacted by Year 2000 initiatives. The Company
presently believes that the Year 2000 issue will not pose significant
operational problems for the Company. However, if all Year 2000 issues are not
properly identified, or assessment, remediation and testing are not effected
timely with respect to Year 2000 problems that are identified, there can be no
assurance that the Year 2000 issue will not materially adversely impact the
Company's results of operations or adversely affect the Company's relationships
with customers, vendors, or others. Additionally, there can be no assurance that
the Year 2000 issues of other entities will not have a material adverse impact
on the Company's systems or results of operations.
15
<PAGE>
The Company has begun, but not yet completed, a comprehensive analysis
of the operational problems and costs (including loss of revenues) that would be
reasonably likely to result from the failure by the Company and certain third
parties to complete efforts necessary to achieve Year 2000 compliance on a
timely basis. A contingency plan has not been developed for dealing with the
most reasonably likely worst case scenario, and such scenario has not yet been
clearly identified. The Company currently plans to complete such analysis and
contingency planning by December 31, 1999.
The costs of the Company's Year 2000 identification, assessment,
remediation and testing efforts and the dates on which the Company believes it
will complete such efforts are based upon management's best estimates, which
were derived using numerous assumptions regarding future events, including the
continued availability of certain resources, third-party remediation plans, and
other factors. There can be no assurance that these estimates will prove to be
accurate, and actual results could differ materially from those currently
anticipated. Specific factors that could cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in Year 2000 issues, the ability to identify, assess, remediate and test all
relevant computer codes and embedded technology, and similar uncertainties. In
addition, variability of definitions of "compliance with Year 2000" and the
myriad of different products and services, and combinations thereof, sold by the
Company may lead to claims whose impact on the Company is not currently
estimable. No assurance can be given that the aggregate cost of defending and
resolving such claims, if any, will not materially adversely affect the
Company's results of operations. Although some of the Company's agreements with
manufacturers and others from whom it purchases products for resale contain
provisions requiring such parties to indemnify the Company under some
circumstances, there can be no assurance that such indemnification arrangements
will cover all of the Company's liabilities and costs related to claims by third
parties related to the Year 2000 issue.
16
<PAGE>
PART II-OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the three
months ended September 30, 1998.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Exhibit
------- ------------------------------------------------
27.1* Financial Data Schedule
- --------------------
*Filed electronically herewith
(b) Reports on Form 8-K
The Company filed on August 21, 1998 a Form 8-K disclosing the
dismissal of all causes of action and claims related to the litigation between
the Company and Grow Biz International, Inc. filed by the Company on September
15, 1997.
The Form 8-K also included as an Exhibit a "Letter to Shareholders"
which discussed the Company's internet strategy.
17
<PAGE>
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.
CD WAREHOUSE, INC.,
a Delaware corporation
Date: November 10, 1998 /s/ Jerry W. Grizzle
--------------------
Jerry W. Grizzle
Chairman of the Board of Directors;
President and Chief Executive Officer
Date: November 10, 1998 /s/ Doyle E. Motley
-------------------
Doyle E. Motley
Senior Vice-President and Chief Financial Officer
(Chief Accounting Officer)
18
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<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> JUL-01-1998 JAN-01-1998
<PERIOD-END> SEP-30-1998 SEP-30-1998
<CASH> 6,987,683 6,987,683
<SECURITIES> 0 0
<RECEIVABLES> 995,355 995,355
<ALLOWANCES> 0 0
<INVENTORY> 3,109,474 3,109,474
<CURRENT-ASSETS> 11,194,395 11,194,395
<PP&E> 1,116,573 1,116,573
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 22,781,953 22,781,953
<CURRENT-LIABILITIES> 1,213,439 1,213,439
<BONDS> 0 0
0 0
0 0
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<OTHER-SE> 21,425,094 21,425,094
<TOTAL-LIABILITY-AND-EQUITY> 22,781,953 22,781,953
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<TOTAL-REVENUES> 3,868,177 9,921,121
<CGS> 1,872,688 5,237,888
<TOTAL-COSTS> 3,596,864 9,378,103
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
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<INCOME-PRETAX> 371,343 748,588
<INCOME-TAX> 139,650 281,150
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<NET-INCOME> 231,693 467,438
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