<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 June 30, 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 731504999
-------- ---------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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 August 11, 1999 was 3,660,295.
Transitional Small Business Disclosure Format (check one): Yes No X
---- ----
<PAGE>
FORM 10QSB
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - December 31,
1998 and June 30, 1999 (unaudited)............................... 3
Condensed Consolidated Statements of Operations - Three months
and six months ended June 30, 1998 and 1999 (unaudited).......... 4
Condensed Consolidated Statements of Cash Flows Six months
ended June 30, 1998 and 1999 (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.............. 16
Item 6. Exhibits and Reports on Form 8-K................................. 16
Signatures............................................................... 18
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Information at June 30, 1999 is unaudited)
<TABLE>
<CAPTION>
ASSETS
December 31, 1998 June 30, 1999
----------------- --------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 4,442,454 $ 2,613,376
Accounts receivable, net 976,438 1,029,508
Notes receivable 81,501 88,413
Merchandise inventory 4,366,422 8,464,925
Prepaid expenses and other 121,261 242,555
Refundable income taxes - 229,440
------------ ------------
Total current assets 9,988,076 12,668,217
Furniture, fixtures and equipment, net 2,285,209 4,768,712
Notes receivable, due after one year 129,465 92,822
Intangible and other assets, net 10,908,418 11,646,456
------------ ------------
$ 23,311,168 $ 29,176,207
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 640,019 $ 2,325,596
Accrued liabilities 313,250 472,431
Advances and deposits 93,000 145,500
Current portion of long-term debt - 1,481,418
Income taxes payable 398,385 -
------------ ------------
Total current liabilities 1,444,654 4,424,945
Long-term debt - 1,772,464
Deferred income taxes 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 June 30, 1999, respectively 35,506 36,603
Additional paid-in-capital 20,571,755 21,758,158
Retained earnings 1,161,253 1,086,037
------------ ------------
Total stockholders' equity 21,768,514 22,880,798
------------ ------------
$ 23,311,168 $ 29,176,207
============ ============
</TABLE>
(See accompanying notes)
3
<PAGE>
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------------------ ---------------------------------
June 30, 1998 June 30, 1999 June 30, 1998 June 30, 1999
------------ ------------ ---------------------------------
<S> <C> <C> <C> <C>
Revenues:
Company operations:
Retail store sales $ 1,832,074 $ 6,613,670 $ 3,487,775 $ 11,934,778
Wholesale merchandise sales 397,010 83,667 1,466,528 223,983
Software income, net 18,054 20,948 26,649 47,668
Franchise operations:
Royalty income 478,502 936,325 957,042 1,862,084
Management fees 18,725 - 37,450 -
Franchise and development fees 44,500 30,000 77,500 53,000
---------- ---------- ---------- -----------
Total revenues 2,788,865 7,684,610 6,052,944 14,121,513
Operating costs and expenses:
Cost of sales - retail store sales 1,063,990 3,840,942 2,026,225 6,891,450
Cost of sales - wholesale merchandise sales 372,434 34,500 1,338,975 124,013
Retail store operating expenses 641,768 2,561,780 1,210,748 4,266,533
General and administrative 590,284 1,113,683 1,033,636 2,272,503
Depreciation and amortization 80,467 357,187 153,582 674,255
---------- ---------- ---------- -----------
2,748,943 7,908,092 5,763,166 14,228,754
---------- ---------- ---------- -----------
Operating income (loss) 39,922 (223,482) 289,778 (107,241)
Other income (expense), net 80,531 (8,906) 87,467 (14,675)
---------- ---------- ---------- -----------
Income (loss) before income taxes 120,453 (232,388) 377,245 (121,916)
Provision (credit) for income taxes 45,500 (88,300) 141,500 (46,700)
---------- ---------- ---------- -----------
Net income (loss) $ 74,953 $ (144,088) $ 235,745 $ (75,216)
========== ========== ========== ===========
Net income (loss) per share-basic and diluted $ .03 $ (.04) $ .10 $ (.02)
========== ========== ========== ===========
Weighted average diluted common shares 2,879,363 3,660,295 2,429,158 3,624,292
========== ========== ========== ===========
</TABLE>
(See accompanying notes)
4
<PAGE>
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
--------------------------------------------
June 30, 1998 June 30,1999
--------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITES:
<S> <C> <C>
Net income (loss) $ 235,745 $ (75,216)
Adjustments to reconcile net income to net cash
Used for operating activities:
Depreciation and amortization 153,582 674,255
Loss on disposal of assets 1,031 -
Changes in operating assets and liabilities:
Accounts receivable, net (158,784) (43,290)
Inventories (106,241) (1,152,225)
Prepaid expenses and other (46,896) (117,529)
Refundable income taxes - (229,440)
Investment in partnership (61,396) -
Other assets 18,021 (38,610)
Accounts payable (875,983) 1,685,577
Accrued liabilities 75,175 159,181
Advances and deposits (500) 52,500
Income taxes payable (58,115) (398,385)
Minority interests (19,791) -
----------- ----------
Total adjustments (1,079,897) 592,034
----------- ----------
Net cash provided (used) by operating activities (844,152) 516,818
CASH FLOW FROM INVESTING ACTIVITIES:
Notes receivable
Advances - (10,000)
Collections - 39,731
Purchase of furniture, fixtures and equipment (246,763) (2,516,468)
Proceeds from disposal of assets 115,030 -
Acquisition of businesses:
Cost in excess of net assets of companies acquired, net (6,845,785) (1,086,401)
Accounts receivable (85,000) (9,780)
Inventory (441,529) (1,946,278)
Prepaid expenses and other (10,000) (3,765)
Furniture, fixtures and equipment (134,500) (225,752)
Other assets (7,500) (28,565)
Advances and deposits 100,000 -
----------- ----------
(7,424,314) (3,300,541)
----------- ----------
Net cash used for investing activities (7,556,047) (5,787,278)
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net:
Proceeds from exercise of stock options - 187,500
Private placement 14,858,560 -
Collection of stock subscription 23,438 -
Notes payable
Advances - 3,500,000
Repayments - (246,118)
------------- -----------
Net cash provided by financing activities 14,881,998 3,441,382
------------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 6,481,799 (1,829,078)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,122,233 4,442,454
------------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,604,032 $ 2,613,376
============= ===========
</TABLE>
5
<PAGE>
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(unaudited)
Supplemental Cash Flow Information:
For the six months ending June 30, 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:
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
===================
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:
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
=================
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
June 30, 1999 and for the six months ended June 30, 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 six months ended June 30, 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. PRIVATE PLACEMENT 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
franchise rights for 134 franchisees 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>
CD WAREHOUSE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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 for 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 for $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 Company's
private placement of common stock, operating cash flows and bank borrowings.
Following are the Company's unaudited pro forma results for the six months ended
June 30, 1998 and 1999 assuming the acquisitions and the private placement
occurred on January 1, 1998 (in thousands, except for per share data):
1998 1999
----------------------------------
Total revenues $ 13,562,068 $ 15,174,463
Net income $ 516,271 $ 1,922
Net income per common share:
Basic $ .14 $ .00
Diluted $ .14 $ .00
Weighted average common shares:
Basic 3,635,295 3,649,107
Diluted 3,779,223 3,861,613
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 Compact Discs International, Ltd., 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 June 30, 1999, there were 208 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 June 30, 1999, the Company's
CD Warehouse and Disc Go Round franchise systems had a total of 333 stores
operating in 40 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 relates 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 operations.
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
-------------------------------------- --------------------------------------
1998 1999 1998 1999
--------------- ----------------- ---------------- -----------------
<S> <C> <C> <C> <C>
Revenues:
Retail store sales 65.7% 86.0% 57.6% 84.5%
Wholesale merchandise sales 14.2 1.1 24.2 1.6
Software income, net .6 .3 .5 .3
Royalty income 17.2 12.2 15.8 13.2
Management fees .7 -- .6 --
Franchise and development fees 1.6 .4 1.3 .4
----------- ----------- ----------- -----------
100.0% 100.0% 100.0% 100.0%
=========== =========== =========== ===========
Operating costs and expenses:
Cost of sales-retail stores sales (1) 58.1% 58.1% 58.1% 57.7%
Cost of sales-wholesale merchandise sales (2) 93.8 41.2 91.3 55.4
Retail store operating expenses (1) 35.0 38.7 34.7 35.7
General and administrative 21.2 14.5 17.1 16.1
Depreciation and amortization 2.9 4.6 2.5 4.8
Operating Income (loss) 1.1 (2.9) 4.5 ( .8)
Other income (expense), net 3.2 ( .1) 1.7 ( .1)
Net income (loss) 2.7% (1.9)% 3.9% ( .5)%
(1) As percentage of retail store sales.
(2) As percentage of wholesale merchandise sales.
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------- --------------------------------------
1998 1999 1998 1999
--------------- ----------------- ---------------- -----------------
Sales Data:
System wide sales $12,306,441 $18,789,515 $24,187,695 $35,679,635
Percentage increase (1) 49% 53% 54% 48%
=========== =========== =========== ===========
Average monthly sales per store $ 26,984 $ 30,598 $ 27,025 $ 29,933
=========== =========== =========== ===========
Change in comparable retail store sales (2) 15% 17% 18% 16%
=========== =========== =========== ===========
</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 June 30,
31. 1998 Open Close Transfer 1999
--------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Franchise Stores
Domestic CD Warehouse 128 11 (3) 1 137
Domestic Disc Go Round 120 -- (5) (5) 110
--- --- --- --- ---
248 11 (8) (4) 247
International CD Warehouse 7 -- -- -- 7
International Disc Go Round 8 -- -- -- 8
--- --- --- --- ---
15 -- -- -- 15
Company-owned Stores
Domestic CD Warehouse 51 18 (2) 4 71
Domestic Disc Go Round -- -- -- -- --
--- --- --- --- ---
51 18 (2) 4 71
--- --- --- --- ---
Total 314 29 (10) -- 333
=== === === === ===
</TABLE>
Three Months Ended June 30, 1999 compared to Three Months Ended June 30, 1998
(all numbers rounded to the nearest thousand).
Revenues
Retail store sales increased $4,782,000 to $6,614,000 for the three months
ended June 30, 1999 compared to $1,832,000 for the three months ended June 30,
1998. The increase in retail store sales is the result of having 71 company
stores in operation during the three months ended June 30, 1999, compared to
only 25 during the same period in 1998.
Wholesale merchandise sales decreased $313,000, or 78% to $84,000, for the
three months ended June 30, 1999 compared to $397,000 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 $457,000 to $936,000 for the three months ended
June 30, 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
$351,000 of royalty income during the three months ended June 30, 1999.
Additionally, stores operating as CD Warehouse increased their same store sales
by 17% for the three months ended June 30, 1999 with monthly average sales for
these stores increasing from $26,984 for the three months ended June 30, 1998 to
$30,598 for the same period in 1999.
Costs and Expenses
Cost of sales for retail store sales increased $2,777,000 for the three
months ended June 30, 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 58%
of sales for both the three months ended June 30, 1999 and June 30, 1998.
11
<PAGE>
Costs of sales for wholesale merchandise decreased $337,000, or 91% to
$35,000, for the three months ended June 30, 1999 compared to $372,000 in 1998.
The decrease is consistent with the decrease in wholesale merchandise sales.
Cost of sales was 41% of sales for the three months ended June 30, 1999,
compared to 94% for the comparable period in 1998.
Retail store operating expenses increased $1,920,000 to $2,562,000 for the
three months ended June 30, 1999, compared to $642,000 for the three months
ended June 30, 1998. The increase is due to the increase of company-owned
stores discussed above. Retail store operating expense was 38.7% of retail
store revenue for the three months ended June 30, 1999, compared to 35% of
retail store revenue for the same period in 1998. The increase relates to costs
associated with absorbing the acquisition of the 16 Music Trader stores late in
the first quarter of 1999 and an aggressive advertising campaign in certain
company store markets.
General and administrative expenses increased by $524,000 to $1,114,000 for
the three months ended June 30, 1999, compared to $590,000 for the three months
ended June 30, 1998. This increase resulted from the continued growth in
company-owned stores (increase of 46 stores). The three months ended June 30,
1999 also included costs associated with operating two separate franchise
concepts and implementing operations of the Company's E-Commerce site.
Depreciation and Amortization
Depreciation and amortization increased $277,000 to $357,000 for the three
months ended June 30, 1999 compared to $80,000 for the same period in 1998.
This is due to the addition of 46 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 (loss)
The Company experienced a net loss of $144,000 for the three months ended
June 30, 1999, compared to net income of $75,000 for the three months ended June
30, 1998. The net loss is due primarily to the increase in general and
administrative cost described above.
Six Months Ended June 30, 1999 compared to Six Months Ended June 30, 1998 (all
numbers rounded to the nearest thousand).
Revenues
Retail store sales increased $8,447,000 to $11,935,000 for the six months
ended June 30, 1999, compared to $3,488,000 for the six months ended June 30,
1998. The increase in retail store sales is the result of having 71 company
stores in operation during the six months ended June 30, 1999 compared to only
25 during the same period in 1998.
Wholesale merchandise sales decreased $1,243,000, or 84% to $224,000 for
the six months ended June 30, 1999 compared to $1,467,000 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 $910,000 to $1,867,000 for the six months ended
June 30, 1999, compared to $957,000 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
$725,000 of royalty income during the six months ended June 30, 1999.
Additionally, stores operating as CD Warehouse increased their same store sales
by 14% for the six months ended June 30, 1999 with monthly average sales for
these stores increasing from $27,025 for the six months ended June 30, 1998 to
$29,933 for the same period in 1999.
12
<PAGE>
Costs and Expenses
Cost of sales for retail store sales increased $4,865,000 for the six
months ended June 30, 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 58%
of sales for both the six months ended June 30, 1999 and June 30, 1998.
Costs of sales for wholesale merchandise decreased $1,215,000 or 90% to
$124,000 for the six months ended June 30, 1999 compared to $1,339,000 in 1998.
The decrease is consistent with the decrease in wholesale merchandise sales.
Cost of sales was 55% of sales for the six months ended June 30, 1999 compared
to 91% for the comparable period in 1998.
Retail store operating expenses increased $3,056,000 to $4,267,000 for the
six months ended June 30, 1999, compared to $1,211,000 for the six months ended
June 30, 1998. The increase is due to the increase of company-owned stores
discussed above. Retail store operating expense was 36% of retail store revenue
for the six months ended June 30, 1999 compared to 35% of retail store revenue
for the same period in 1998. The increase relates to costs associated with
absorbing the acquisition of the 16 Music Trader stores late in the first
quarter of 1999 and an aggressive advertising campaign in certain company store
markets.
General and administrative expenses increased by $1,239,000 to $2,273,000
for the six months ended June 30, 1999, compared to $1,034,000 for the six
months ended June 30, 1998. This increase resulted from the continued growth in
company-owned stores (increase of 46 stores). The six months ended June 30,
1999 also included costs associated with operating two separate franchise
concepts and implementing operations of the Company's E-Commerce site.
Depreciation and Amortization
Depreciation and amortization increased $520,000 to $674,000 for the six
months ended June 30, 1999 compared to $154,000 for the same period in 1998.
This is due to the addition of 46 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 (loss)
The Company experienced a net loss of $75,000 for the six months ended June
30, 1999, compared to net income of $236,000 during the same period in 1998.
The net loss is due primarily to the increase in general and administrative cost
described above, as well as interest expense on bank borrowings used to acquire
Music Trader, Inc. in February 1999.
Liquidity and Capital Resources
At June 30, 1999 the Company had working capital of $8,243,000 and cash and
cash equivalents aggregating $2,613,000, compared to working capital of
$8,543,000 and cash and cash equivalents of $4,442,000 at December 31, 1998.
Net cash provided by operating activities was $517,000 for the six months ended
June 30, 1999, compared to net cash used for operating activities of $844,000
for the six months ended June 30, 1998. The net cash provided by operations for
the six months ended June 30, 1999 includes an increase in accounts payable of
$1,686,000, consisting primarily of amounts due to E-Commerce related vendors.
The increase in cash provided by operating activities during the six months
ended June 30, 1999 was reduced in part by increased inventory purchases during
the period, resulting from the increase in company stores, as well as the
continued planned growth of per store inventory quantities. The net cash used
for operating activities for the six months ended June 30, 1998 was due
principally to the reduction of amounts due the major labels because of the
company's decision to discontinue its warehouse operations relating to new CDs.
13
<PAGE>
Net cash used for investing activities was $5,787,000 for the six months
ended June 30, 1999, compared to $7,556,000 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 and development costs
relating to E-Commerce. The use in 1998 relates to the acquisition of Disc Go
Round in June 1998.
Net cash provided from financing activities was $3,441,000 for the six
months ended June 30, 1999, compared to $14,882,000 for the same period in 1998.
The net cash provided from financing in 1999 relates to bank debt of $3,500,000
used to acquire Music Trader, Inc. and open new company stores, as well as
proceeds from the exercise of stock warrants issued in connection with the
Company's initial public offering. The net cash provided from financing in 1998
relates primarily to the proceeds of the private placement of 1,624,300 shares
of common stock in May 1998.
In October 1998 the Company formed a wholly owned subsidiary, CD Warehouse
Finance Company, to finance the growth of qualified franchisees. As of June 30,
1999, the financing subsidiary had funded $228,000 for the development or
remodel of three 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.
The Company is continuing the development of its Internet E-Commerce
website (http://www.cdwarehouse.com/), which became operational in December 1998
and offers both new and used CDs. To date, the Company has incurred costs in
excess of $2,000,000 in development of the website, and it is expected that
additional costs will be incurred in further project development. The Company
has experienced difficulties in the process of expanding its Internet website to
include all used inventory of its company stores. The Company's principal E-
Commerce partner and project developer has worked with the Company to resolve
these difficulties. The Company currently has several of its company stores'
used inventory on-line and expects that substantially all company-owned stores
should be on-line by the end of the third quarter. Additionally, the Company
anticipates that the website will also be available for participation by
franchised stores by year-end. A significant portion of the Company's accounts
payable at June 30, 1999 related to amounts owed to its principal E-Commerce
vendors. Pending the outcome of alternative sources of financing currently
being sought by the Company, as described below, the Company may seek a
restructuring of the amounts due with such vendors.
In addition to the working capital at June 30, 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 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 had been
utilized to acquire Music Trader's 16 retail music stores in San Diego,
California and $500,000 of the line of credit had been advanced for company
store growth. The credit facility provides for the maintenance by the Company
of certain financial and financial ratio covenants. For the six months ended
June 30, 1999, increased capital expenditures by the Company, relating primarily
to E-Commerce development, caused the Company to exceed the limitations on
capital expenditures imposed by the credit facility, which in turn caused the
fixed coverage ratio to fall below the requirement imposed by the credit
facility. The lender has granted waivers of the Company's noncompliance with
these two financial covenants.
The Company has engaged the services of an investment banker to assist it
in securing financing of up to $20 million, which will be used by the Company to
make acquisitions which come within its strategic parameters. If the Company
does not obtain the financing, or does not obtain the total amount sought, it
will not be able to fully implement its business plan, which includes ongoing
acquisitions as a major component of its business strategy. However, it is the
Company's opinion that the current working capital at June 30, 1999, combined
with available funds under the credit facility, will be sufficient to support
ongoing activities of the Company for the foreseeable future, excluding
consideration of (i) any acquisitions in furtherance of its long-term business
plan, or (ii) amounts owing to the Company's principal E-Commerce vendors.
14
<PAGE>
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 the Fall of 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
June 30, 1999, it had completed approximately 85% 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
15% of the initiatives are in process and expected to be completed on or about
November 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 June 30, 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.
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 June 30, 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.
15
<PAGE>
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.
PART II OTHER INFORMATION
Item 4. Submission of Matters to Vote of Security Holders
The Company held its annual stockholders' meeting on May 7, 1999. Two
proposals were voted on by the Company's stockholders: 1) election of directors,
and 2) ratification of the appointment of Ernst & Young LLP as independent
auditors. All proposals were approved by a majority of the votes cast at the
meeting, as follows:
(a) Two directors were elected to each serve three year terms:
Robert O. McDonald was elected as a Class 3 director for a term expiring
at the 2002 annual meeting, with 2,224,225 shares voted in favor and 0
voted against and 14,852 abstained; Christopher M. Salyer was elected as
a Class 3 director for a term expiring at the 2002 annual meeting, with
2,224,225 voted in favor, 0 voted against and 14,852 abstained. Jerry W.
Grizzle and Gary D. Johnson who are Class 1 directors with a terms
expiring at the 2000 annual meeting, and Ronald V. Perry, who is a Class
2 director with a term expiring at the 2001 annual meeting, were not up
for reelection and continued on as directors.
(b) Ratification of the appointment of Ernst & Young LLP as independent
auditors:
In favor: 2,237,085
Against: 380
Abstain: 1,612
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Exhibit
----------- --------------------------------------
27.1* Financial Data Schedule
* Filed electronically herewith
16
<PAGE>
(b) Reports on Form 8-K
On April 16, 1999, the Company filed a Form 8-K reporting the
termination of a worldwide area development agreement and certain domestic
franchise development agreements pursuant to the terms of a settlement
agreement between the Company, Compact Discs International, Ltd. and Mark
E. Kane signed by the parties on April 9, 1999.
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: August 11, 1999 /s/ Jerry W. Grizzle
--------------------------------------
Jerry W. Grizzle
Chairman of the Board of Directors;
President and Chief Executive Officer
Date: August 11, 1999 /s/ Doyle E. Motley
--------------------------------------
Doyle E. Motley
Senior Vice-President and Chief
Financial Officer
18
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<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1999
<PERIOD-START> APR-01-1999 JAN-01-1999
<PERIOD-END> JUN-30-1999 JUN-30-1999
<CASH> 2,613,376 2,613,376
<SECURITIES> 0 0
<RECEIVABLES> 1,029,508 1,029,508
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<CURRENT-ASSETS> 12,668,217 12,668,217
<PP&E> 4,768,712 4,768,712
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<TOTAL-ASSETS> 29,176,207 29,176,207
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<TOTAL-REVENUES> 7,684,610 14,121,513
<CGS> 3,875,442 7,015,463
<TOTAL-COSTS> 7,908,092 14,228,754
<OTHER-EXPENSES> 8,906 14,675
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> (232,388) (121,916)
<INCOME-TAX> (88,300) (46,700)
<INCOME-CONTINUING> (144,088) (75,216)
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