<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the period ended March 31, 1999
[_] 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 May 14, 1999 was 3,660,295.
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, 1998
and March 31, 1999 (unaudited) 3
Condensed Consolidated Statements of Income - Three months
ended March 31, 1998 and 1999 (unaudited) 4
Condensed Consolidated Statements of Cash Flows Three months
ended March 31, 1998 and 1999 (unaudited) 5
Notes to Condensed Consolidated Financial Statements
(unaudited) 7
Item 2. Management's Discussion and Analysis or Plan of Operation 9
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 15
2
<PAGE>
PART I. FINANCIAL INFORMATION
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Information at March 31, 1999 is unaudited)
<TABLE>
<CAPTION>
ASSETS
December 31, March 31,
1998 1999
----------------- ----------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 4,442,454 $ 3,764,095
Accounts receivable, net 976,438 835,033
Notes receivable 81,501 83,566
Merchandise inventory 4,366,422 7,789,594
Prepaid expenses and other 121,261 277,654
Refundable income taxes - 27,715
----------------- ----------------
Total current assets 9,988,076 12,777,657
Furniture, fixtures and equipment, net 2,285,209 2,933,634
Note receivable, due after one year 129,465 107,783
Intangible and other assets, net 10,908,418 11,841,950
----------------- ----------------
$23,311,168 $27,661,024
================= ================
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current
Accounts payable $ 640,019 $ 958,320
Accrued liabilities 313,250 469,318
Advances and deposits 93,000 110,500
Current portion of long-term debt - 844,079
Income taxes payable 398,385 -
----------------- ----------------
Total current liabilities 1,444,654 2,382,217
Long-term debt - 2,155,921
Deferred income tax 98,000 98,000
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized, none issued - -
Common stock, $.01 par value; 10,000,000 shares
authorized, 3,550,550 and 3,660,295 issued and
outstanding at December 31, 1998 and March 31, 1999,
respectively 35,506 36,603
Additional paid-in-capital 20,571,755 21,758,158
Retained earnings 1,161,253 1,230,125
----------------- ----------------
Total stockholders' equity 21,768,514 23,024,886
----------------- ----------------
$23,311,168 $27,661,024
================= ================
</TABLE>
(See accompanying notes)
3
<PAGE>
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------
March 31, March 31,
1998 1999
----------- -----------
<S> <C> <C>
Revenues:
Company Operations:
Retail store sales $1,655,701 $5,321,108
Wholesale merchandise sales 1,069,518 140,316
Software income, net 8,595 26,720
Franchise operations:
Royalty income 478,540 925,759
Management fees 18,725 -
Franchise and development fees 33,000 23,000
----------- -----------
Total revenues 3,264,079 6,436,903
Operating costs and expenses:
Cost of sales - retail stores sales 962,235 3,050,508
Cost of sales - wholesale merchandise sales 966,541 89,513
Retail store operating expenses 568,980 1,704,753
General and administrative 443,352 1,158,821
Depreciation and amortization 73,115 317,068
----------- -----------
Total operating costs and expenses 3,014,223 6,320,663
Operating income 249,856 116,240
Other income (expense), net 6,936 (5,768)
Income before income taxes 256,792 110,472
Provision for income taxes 96,000 41,600
----------- -----------
Net income $ 160,792 $ 68,872
=========== ===========
Net income per share-basic and diluted
Basic $ .09 $ .02
=========== ===========
Diluted $ .08 $ .02
=========== ===========
Shares used in computations:
Basic 1,887,778 3,587,890
=========== ===========
Diluted 1,917,448 3,836,948
=========== ===========
</TABLE>
(See accompanying notes)
4
<PAGE>
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------
March 31, March 31,
1998 1999
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 160,792 $ 68,872
Adjustments to reconcile net income to net cash
used for operating activities:
Depreciation and amortization 73,115 317,068
Loss on disposal of assets 2,909 -
Changes in operating assets and liabilities:
Accounts receivable, net 39,339 151,185
Inventories (211,650) (476,894)
Prepaid expenses and other (31,074) (152,628)
Refundable income taxes - (27,715)
Investment in partnership (55,926) -
Other assets 6,172 (21,101)
Accounts payable (3,758) 318,301
Accrued liabilities 44,365 156,068
Advances and deposits 17,052 17,500
Income taxes payable (103,615) (398,385)
Minority interests (28,985) -
------------- -----------
Total adjustments (252,056) (116,601)
------------- -----------
Net cash used for operating activities (91,264) (47,729)
CASH FLOW FROM INVESTING ACTIVITIES:
Note receivable - collections - 19,617
Purchase of furniture, fixtures and equipment (127,351) (537,206)
Proceeds from disposal of assets 86,030 -
Acquisition of businesses:
Cost in excess of net assets of companies acquired, net - (1,086,401)
Accounts receivable - (9,780)
Inventory (173,472) (1,946,278)
Prepaid expenses and other - (3,765)
Furniture, fixtures and equipment - (225,752)
Other assets - (28,565)
------------- -----------
(173,472) (3,300,541)
------------- -----------
Net cash used for investing activities (214,793) (3,818,130)
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options - 187,500
Proceeds from long-term debt - 3,000,000
------------- -----------
Net cash provided by financing activities - 3,187,500
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (306,057) (678,359)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,122,233 4,442,454
------------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 816,176 $ 3,764,095
============= ===========
</TABLE>
5
<PAGE>
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(unaudited)
Supplemental Cash Flow Information:
For the three months ending March 31, 1998 and 1999, the Company had the
following noncash investing and financing activities:
In 1998, the Company purchased partnership interests of a Company
franchisee for cash of $173,471 and 100,000 shares of the Company's common stock
valued at $3.625 per share. The noncash portion of this transaction is as
follows:
<TABLE>
<S> <C>
Costs in excess of net assets acquired, net $ 281,412
Inventory 221,208
Furniture, fixtures and equipment 70,080
Other assets 10,616
Accounts payable and accrued liabilities (47,345)
-----------
535,971
Less cash paid (173,471)
-----------
362,500
===========
</TABLE>
In 1999, the Company acquired the assets of Music Trader, Inc. for cash of
$3,000,000 and 84,745 shares of the Company's common stock valued at $11.80 per
share. The non cash portion of this transaction is as follows:
<TABLE>
<S> <C>
Costs in excess of net assets acquired, net $ 966,880
Prepaid expenses and other 9,780
Inventory 2,837,312
Furniture, fixtures and equipment 160,000
Other assets 26,028
-----------
4,000,000
Less cash paid (3,000,000)
-----------
$ 1,000,000
===========
</TABLE>
6
<PAGE>
CD WAREHOUSE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The condensed consolidated financial statements as of December 31, 1998 and
March 31, 1999 and for the three months ended March 31, 1998 and 1999, include
the accounts of CD Warehouse, Inc. (the "Company"), its wholly owned
subsidiaries, Compact Discs Management, Inc. ("CDM"), and CD Warehouse Finance
Company ("CDF"). 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 three months ended March 31, 1999 are not necessarily indicative of the
results to be expected for the full year ending December 31, 1999. 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. PUBLIC OFFERING AND BUSINESS ACQUISITIONS
In May 1998, the Company completed a private placement ("Placement")
of 1,624,300 shares of common stock at $10.00 per share. Proceeds from the
Placement, after deducting the placement discount and placement expenses, were
approximately $14.8 million. The net proceeds from the Placement were used for
acquisitions, expansion, provision of financing to franchisees, and working
capital. The Company effected a Registration Statement on Form S-3 related to
such shares in September 1998.
In January 1998, the Company purchased five CD Warehouse stores from a
franchisee ("ZDTMAC") for cash of $173,471 and 100,000 shares of common stock
valued at $3.625 per share for a total purchase price of $535,971. The
acquisition was recorded under the purchase method of accounting and resulted in
an allocation of excess of purchase price over net assets acquired of $281,412,
which is amortized on a straight-line basis over ten years.
In June 1998, the Company acquired the assets of three retail stores
and the franchise rights related to 134 franchise stores of Disc Go Round
("DGR"), a competing retailer of new and preowned compact discs, for cash of $7
million and assumption of liabilities of $100,000. The acquisition was accounted
for under the purchase method of accounting and resulted in an allocation of
excess of purchase price over net assets acquired of $6,830,992, which is
amortized on a straight-line basis over fifteen years.
In October 1998, the Company acquired, for cash of $1,737,867, the
assets and liabilities of three partnerships: Compact Disc Investments II, Ltd.,
Compact Disc Investment V, Ltd., and Compact Disc Associates, L.L.C., which
collectively owned 16 CD Warehouse stores. The Company, through its wholly-owned
subsidiary, CDM, previously owned a majority or minority interest in these
partnerships. Upon the acquisition of these assets and liabilities, the related
partnerships were dissolved. The acquisition was accounted for under the
purchase method of accounting and resulted in an allocation of excess of
purchase price over net assets acquired of $629,245, which is amortized on a
straight-line basis over ten years.
7
<PAGE>
In February 1999, the Company acquired the assets of Music Trader, Inc., a
16-store retail music chain based in Southern California, for cash of $3,000,000
and 84,745 shares of the Company's common stock for a total purchase price of
approximately $4,000,000. The acquisition was recorded under the purchase
method of accounting and resulted in an allocation of excess of purchase price
over net assets acquired of $966,880, which is amortized on a straight-line
basis over ten years.
The acquisitions described above were accounted for by the purchase method
of accounting for business combinations. Accordingly, the accompanying
consolidated statements of income do not include any revenues or expenses
related to these acquisitions prior to the respective closing dates. The cash
portions of the acquisitions were financed through proceeds from the Placement
and operating cash flows. Following are the Company's unaudited pro forma
results for the three months ended March 31, 1998 and 1999 assuming the
acquisitions and the private placement occurred on January 1, 1998 (in
thousands, except for per share data):
<TABLE>
<CAPTION>
1998 1999
-----------------------------
<S> <C> <C>
Total revenues $7,018,641 $7,489,853
Net income $ 301,054 $ 146,010
Net income per common share:
Basic $ .08 $ .04
Diluted $ .08 $ .04
Weighted average common shares:
Basic 3,635,295 3,637,795
Diluted 3,664,965 3,886,853
</TABLE>
These unaudited pro forma results have been prepared for comparative
purposes only and include certain adjustments, including amortization of
goodwill as a result of the acquisitions and do not purport to be indicative of
the results of operations which would have actually resulted had the
combinations been in effect on January 1, 1998, or of future results of
operations.
NOTE 3. EARNINGS PER SHARE
Shares used in the computation of diluted earnings per share include
dilutive outstanding stock options and warrants after giving effect to the
treasury stock method for assumed exercise.
8
<PAGE>
Item 2. Management's Discussion and Analysis or Plan of Operation.
This Report includes "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933, as amended (the "Act"), and Section 21E of
the Securities Exchange Act of 1934, as amended. All statements other than
statements of historical facts included in this Report, including, without
limitation, statements regarding the Company's future financial position,
business strategy, budgets, projected costs and plans and objectives of
Management for future operations, are forward-looking statements. In addition,
forward-looking statements generally can be identified by the use of forward-
looking terminology such as "may," "will," "expect," "intend," "estimate,"
"anticipate" or "believe" or the negative thereof or variations thereon or
similar terminology. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such expectations will prove to have been correct. Such
statements 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. Important factors
that could actual results to differ materially from the Company's expectations
("cautionary statements") include the risks inherent generally in the retail and
franchising industries, the impact of competition and pricing, changing market
conditions, the risks disclosed under "Item 2Management's Discussion and
Analysis or Plan of Operation" and elsewhere in this Report. All subsequent
written and oral forward-looking statements attributable to the Company, or
persons acting on its behalf, are expressly qualified in their entirety by the
cautionary statements. The Company assumes no duty to update or revise its
forward-looking statements based on changes in internal estimates or
expectations or otherwise. As a result, the reader is cautioned not to place
reliance on these forward-looking statements. Further, there can be no
assurance that the historical level of the Company's revenues and net income
will continue to be achieved in the future. As used in herein, the word
"Company" means CD Warehouse, Inc. and its wholly owned subsidiaries, Compact
Discs Management, Inc., and CD Warehouse Finance Company, 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 March 31, 1999, there were 204 domestic units operating in 34 states and the
District of Columbia, and 7 international units operating in England, France,
Guatemala and Venezuela.
On June 26, 1998 the Company completed the acquisition, from Grow Biz
International, Inc. ("Grow Biz"), of the franchise rights to 134 Disc Go Round
retail music stores, as well as the acquisition of the assets of three Disc Go
Round stores owned and operated by Grow Biz, for an aggregate purchase price of
approximately $7 million. The Company has continued to operate the Disc Go
Round stores as a separate franchise system. As of March 31, 1999, the
Company's CD Warehouse and Disc Go Round franchise systems had a total of 331
stores operating in 41 states and the District of Columbia domestically and in
five different countries internationally.
Results of Operations
The Company derives its revenues primarily from retail sales of its
company-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 and software income. Retail store
cost of sales and operating expenses relate directly to company-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-owned
store operations, as well as the Company's franchising operations. The number
and sales volumes of company-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.
9
<PAGE>
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:
<TABLE>
<CAPTION>
Three months ended March 31,
---------------------------
1998 1999
-------- -------
<S> <C> <C>
Revenues:
Retail store sales 50.7 % 82.7 %
Wholesale merchandise sales 32.8 % 2.2 %
Software income, net .3 % .4 %
Royalty income 14.6 % 14.4 %
Management fees .6 % - %
Franchise and development fees 1.0 % .3 %
----- -----
Total revenue 100.0 % 100.0 %
Cost and expenses:
Cost of sales retail store sales (1) 58.1 % 57.3 %
Cost of sales wholesale merchandise sales (2) 90.4 % 63.6 %
Retail store operating expenses (1) 34.4 % 32.0 %
General and administrative 13.6 % 18.0 %
Depreciation and amortization 2.2 % 4.9 %
Operating income 7.7 % 1.8 %
Net income 4.9 % 1.1 %
</TABLE>
________________
(1) As a percentage of retail store sales.
(2) As a percentage of wholesale merchandise sales.
<TABLE>
<CAPTION>
Three months ended March 31,
-------------------------------------------
CD Warehouse stores only: 1998 1999
----------- -----------
<S> <C> <C>
Sales Data:
System wide sales $11,881,254 $16,890,120
Percentage increase (1) 59% 42%
Average monthly sales per store $ 27,064 $ 29,222
=========== ===========
Change in comparable retail store sales (2) 21% 14%
=========== ===========
</TABLE>
(1) Represents percentage increase from comparable period in prior year.
(2) Represents percentage increase for stores open in both periods reported
10
<PAGE>
The following table sets forth the number of stores opened and closed
throughout the CD Warehouse System during fiscal 1999:
<TABLE>
<CAPTION>
December 31, Opened Closed Transfers March 31,
1998 1999
----------------- -------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
Franchised Stores
DomesticCD Warehouse 128 6 (2) 1 133
DomesticDisc Go Round 120 -- (3) (5) 112
----------------- -------------- -------------- -------------- ---------------
248 6 (5) (4) 245
InternationalCD Warehouse 7 -- -- -- 7
InternationalDisc Go Round 8 -- -- -- 8
----------------- -------------- -------------- -------------- ---------------
15 -- -- -- 15
Company-owned Stores
DomesticCD Warehouse 51 16 -- 4 71
DomesticDisc Go Round -- -- -- -- --
51 16 (5) 4 71
-----------------
Total 314 22 (5) -- 331
================= ============== ============== ============== ===============
</TABLE>
Three Months Ended March 31, 1999 compared to Three Months Ended March 31, 1998
(all numbers rounded to the nearest thousand).
Revenues
Retail store sales increased $3,665,000 to $5,321,000 for the three months
ended March 31, 1999 compared to $1,656,000 for the three months ended March 31,
1998. The increase in retail store sales is the result of having 71 company
stores in operation during the three months ended March 31, 1999 compared to
only 20 during the same period in 1998.
Wholesale merchandise sales decreased $930,000, or 87% to $140,000 for the
three months ended March 31, 1999 compared to $1,070,000 for the same period in
1998. 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 $447,000 to $926,000 for the three months ended
March 31, 1999, compared to $479,000 for the same period in 1998. A substantial
portion of the increase is attributable to the inclusion of the Disc Go Round
franchise stores to the Company's operations, which contributed approximately
$374,000 of royalty income during the three months ended March 31, 1999.
Additionally, stores operating as CD Warehouse increased their same store sales
by 14% for the three months ended March 31, 1999 with monthly average sales for
these stores increasing from $27,064 for the three months ended March 31, 1998
to $29,222 for the same period in 1999.
Costs and Expenses
Cost of sales for retail store sales increased $2,089,000 for the three
months ended March 31, 1999 compared to the same period in 1998. This increase
is consistent with the increase of retail store revenue discussed above.
However, cost of sales as a percentage of sales remained fairly constant at 57%
of sales for the three months ended March 31, 1999, compared to 58% for the
three months ended March 31, 1998.
11
<PAGE>
Costs of sales for wholesale merchandise decreased $878,000 or 91% to
$89,000 for the three months ended March 31, 1999 compared to $967,000 in 1998.
The decrease is consistent with the decrease in wholesale merchandise sales.
Cost of sales was 64% of sales for the three months ended March 31, 1999
compared to 90% for the comparable period in 1998.
Retail store operating expenses increased $1,136,000 to $1,705,000 for the
three months ended March 31, 1999, compared to $569,000 for the three months
ended March 31, 1998. The increase is due to the increase of company-owned
stores discussed above. Retail store operating expense was 32% of retail store
revenue for the three months ended March 31, 1999 compared to 34% of retail
store revenue for the same period in 1998. The decrease resulted from better
operating results of company-owned stores that began operations during 1998.
General and administrative expenses increased by $716,000 to $1,159,000 for
the three months ended March 31, 1999 compared to $443,000 for the three months
ended March 31, 1998. This increase resulted from the continued growth in both
company-owned stores (increase of 51 stores) and franchised stores (increase of
124 stores). The three months ended March 31, 1999 also included costs
associated with operating two separate franchise concepts, implementing
operations of the Company's E-Commerce site, acquiring the worldwide franchise
development rights from CD Warehouse's founder and application fees for listing
on the NASDAQ National Market System.
Depreciation and Amortization
Depreciation and amortization increased $244,000 to $317,000 for the three
months ended March 31, 1999 compared to $73,000 for the same period in 1998.
This is due to the addition of 51 company-owned stores, costs associated with E-
Commerce and the amortization of goodwill associated with various acquisitions
(discussed in the financial statements) effected during 1998 and 1999.
Net Income
Net income decreased $92,000 to $69,000 for the three months ended March
31, 1999 compared to $161,000 for the same period in 1998. The decrease in net
income is due primarily to the increase in general and administrative cost
described above, which were offset by improved retail store operations, as
indicated by reduced percentages of cost of sales and operating expenses,
increased royalties generated by the increased number of franchise stores, and
an increase in same store sales.
Liquidity and Capital Resources
At March 31, 1999 the Company had working capital of $10,395,000 and cash
and cash equivalents aggregating $3,764,000, compared to working capital of
$8,543,000 and cash and cash equivalents of $4,442,000 at December 31, 1998.
Net cash used for operating activities was $48,000 for the three months ended
March 31, 1999, compared to net cash used for operating activities of $91,000
for the three months ended March 31, 1998. The use of cash by operating
activities for the three months ended March 31, 1999 and March 31, 1998 relates
to the continued growth in both company-owned and franchised stores.
Net cash used for investing activities was $3,818,000 for the three months
ended March 31, 1999, compared to $215,000 for the same period in 1998. The
significant use of cash for investing activities in 1999 relates to the
acquisition of Music Trader, Inc. in February 1999. The use in 1998 relates to
the purchase of five CD Warehouse stores from a franchisee in January 1998.
Net cash provided from financing activities was $3,187,500 for the three
months ended March 31, 1999 compared to zero for the same period in 1998. The
net cash provided from financing in 1999 relates to bank debt of $3,000,000 used
to acquire Music Trader, Inc. and the exercise stock warrants issued in
connection with the Company's initial public offering.
12
<PAGE>
The Company is continuing to develop an internet site which will offer both
new and used CDs. Although this site became operational in December 1998, the
total cost associated with the development of the E-Commerce site has not yet
been realized 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 formed a wholly owned subsidiary, CD Warehouse
Finance Company, to finance the growth of qualified franchisees. As of March
31, 1999, the financing subsidiary had funded $218,000 for the development of
two new franchised stores. The Company expects the subsidiary's activity to
increase in the future and expects to fund its activities with existing
operational funds.
In addition to the working capital at March 31, 1999, the Company has a
$7,000,000 credit facility with Bank One Oklahoma, N. A. The credit facility
consists of a $2,000,000 line of credit maturing in April 2000 and a $5,000,000
term loan portion maturing in April 2002. Amounts borrowed under the credit
facility will bear an interest rate equal to Bank One's prime rate. As of the
date of this Report, $3,000,000 of the term loan portion of the facility has
been utilized to acquire Music Trader's 16 retail music stores in San Diego,
California. It is the Company's opinion that the current working capital at
March 31, 1999, combined with available funds under the credit facility, will be
sufficient to support ongoing activities of the Company 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 March 31,
1999, it had completed approximately 75% 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 25% 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 March 31, 1999, 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 will continue to make follow-up
mailings to significant vendors and service providers that have not responded,
or whose responses have been deemed unsatisfactory by the Company.
13
<PAGE>
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 March 31, 1999,
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.
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, as such scenario has not yet been
clearly identified. The Company expects that it will complete such analysis and
contingency planning before 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.
14
<PAGE>
Part II - Other Information
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
On February 24, 1999, the Company filed a Form 8-K reporting the
following matters:
(i) The Company's execution, on February 17, 1999, of a credit
agreement with Bank One, Oklahoma N.A., providing for a $7
million credit facility; and
(ii) The Company's acquisition, on February 22, 1999, of 16 retail
music stores in San Diego, California, from Music Trader,
Inc.
No financial statements were filed as a part of the Report on Form
8-K.
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: May 14, 1999 /s/ Jerry W. Grizzle
--------------------
Jerry W. Grizzle
Chairman of the Board of Directors;
President and Chief Executive Officer
Date: May 14, 1999 /s/ Doyle E. Motley
--------------------
Doyle E. Motley
Senior Vice-President and Chief Financial
Officer
15
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