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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________.
For the Fiscal Year Ended December 31, 1998 Commission File Number 000-21887
CD WAREHOUSE, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 73-1504999
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1204 Sovereign Row, Oklahoma City, Oklahoma 73108
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (405) 949-2422
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value per share
(Title of Class)
Check whether the registrant (1) has filed all reports required by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 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
--- ---
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained in this form, and will not be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. _______
Registrant's revenues for its most recent fiscal year were $15,261,903.
As of March 8, 1999, the aggregate market value of the voting stock held by non-
affiliates computed by reference to the price at which the stock was sold, or
the average bid and asked prices of such stock, was $39,183,855.
As of March 8, 1999, there were 3,635,295 shares of Common Stock outstanding.
Transitional Small Business Disclosure Format (check one): Yes No X
--- ---
DOCUMENTS INCORPORATED BY REFERENCE: Registrant's Proxy Statement for the 1999
Annual Meeting of Stockholders is incorporated by reference in Part III, Items 9
through 12, of this Form 10-KSB.
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FORM 10-KSB
TABLE OF CONTENTS
Item PART I Page
1. Description of Business 1
2. Description of Property 14
3. Legal Proceedings 14
4. Submission of Matters to a Vote of Security Holders 15
PART II
5. Market for Common Equity and Related Stockholder Matters 15
6. Management's Discussion and Analysis or Plan of Operation 16
7. Financial Statements 22
8. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure 22
PART III
9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act 22
10. Executive Compensation 22
11. Security Ownership of Certain Beneficial Owners and Management 23
12. Certain Relationships and Related Transactions 23
13. Exhibits and Reports on Form 8-K 23
Signatures 25
Financial Information Appendix A
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DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
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 6Management'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.
PART I
Item 1. Description of Business.
General
CD Warehouse, Inc. (together with its wholly owned subsidiaries, the
"Company") is engaged in the franchising and ownership of music stores offering
new and pre-owned compact discs ("CD's") and related products under two similar
but distinct franchise systems, "CD Warehouse" and "Disc Go Round." The term
"CD Warehouse System" encompasses the two franchise systems and their respective
stores, which variously operate under the trade names "CD Warehouse," "Disc Go
Round" and "CD Exchange." Since its initial public offering in January 1997
(the "IPO"), the Company has engaged in a program of expansion to achieve strong
market recognition in the retail music industry. This expansion has been
accomplished primarily through the sale of new franchises and the acquisition
and conversion of independently owned retail music stores to company-owned
stores, as well as the acquisition by the Company of existing franchised stores.
During 1998, the most significant factors contributing to the Company's store
and revenue growth were (i) the acquisition of the Disc Go Round franchise
system from Grow Biz International, Inc. ("Grow Biz"), consisting of the
franchise rights for 134 Disc Go Round retail music stores and the assets of
three company-owned Disc Go Round stores, and (ii) the acquisition, as company-
owned stores, of 21 CD Warehouse franchised stores. At December 31, 1998, the
CD Warehouse System had an aggregate 314 stores in 40 states and the District of
Columbia., Canada, England, France, Guatemala and Venezuela, with 135 franchised
stores and 51 company-owned stores operating under the CD Warehouse concept
(utilizing either the CD Warehouse or CD Exchange trade name) and 128 franchised
stores operating under the Disc Go Round concept (utilizing either the Disc Go
Round or CD Exchange trade name). The term "CD Warehouse" encompasses the CD
Warehouse and CD Exchange stores operating within the CD Warehouse franchise
system, and the term "Disc Go Round" encompasses the Disc Go Round and CD
Exchange stores operating within the Disc Go Round franchise system.
CD Warehouse and Disc Go Round stores sell their products to the
general public in the market area where the respective store is located. A
typical store, located in a high traffic strip shopping center, will occupy
between 1,200 and 2,500 square feet and offer between 10,000 and 16,000
selections, with approximately 65% of the dollar sales volume being pre-owned
selections and the balance being new releases from the major music categories.
At each CD Warehouse and Disc Go Round store, a customer selects from a number
of new and pre-owned CD's and may listen to pre-owned CD's
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before purchase. CD Warehouse and Disc Go Round stores sell CD's, take
customers' CD's in trade or buy customers' CD's for cash. Typically, each store
carries the majority of the Billboard Top 100 selections as "new" inventory,
filling out its inventory selection with pre-owned CD's which are purchased for
$1 to $4 and remarketed for $6 to $9.
During the year ended December 31, 1998, the Company had total
revenues of approximately $15,262,000, and net income of approximately $775,000.
The Company's expansion strategy for 1999 is to open 30 franchised stores and
open or acquire 35 company-owned stores. The Company also plans to further
develop and market its internet site, http://www.cdwarehouse.com, launched in
December 1998, which offers both new and used CDs. See "ITEM 1Description of
BusinessCompetition."
History
The Company was formed in September 1996 to acquire the assets of
Compact Discs International, Ltd. ("CDIL"), a Texas limited partnership which
franchised stores throughout the United States and England under the name "CD
Warehouse." A portion of the proceeds of the Company's IPO was used to fund the
$3.2 million acquisition (the "CDIL Acquisition"), which was consummated
simultaneously with the closing of the IPO. See Item 12--Certain Relationships
and Related Transactions. In a related transaction (the "MacDonald
Acquisition"), which also occurred simultaneously with the closing of the IPO,
the Company acquired the equity interests of Bruce D. MacDonald (together with
his affiliates, "MacDonald") in various partnerships or other entities which
were franchisees of an aggregate 36 franchised CD Warehouse stores. See Item
12Certain Relationships and Related Transactions. As a result of the CDIL
Acquisition and the MacDonald Acquisition, the Company acquired the rights to
the CD Warehouse name, assumed CDIL's role as franchisor under the franchise
agreements to which CDIL was a party and acquired interests in the CD Warehouse
stores in which MacDonald had an interest.
Recent Events
. Effective January 1, 1998, the Company purchased the assets of a
franchisee, ZDTMAC, a general partnership. The aggregate purchase
price of $535,971 was paid $173,471 in cash and $362,500 in shares
of the Company's common stock, par value $.01 per share (the
"Common Stock"), valued for purposes of the acquisition at $3.625
per share. Pursuant to the acquisition, the five CD Warehouse
stores operated by ZDTMAC became company-owned stores.
. On May 28, 1998, the Company closed a private placement of an
aggregate 1,624,300 shares of the Company's Common Stock. The
Company received gross proceeds of $16,243,000 for the shares,
which were sold for a purchase price of $10.00 per share. The
shares were sold in the United States to certain "accredited
investors" (as such term is defined in Regulation D of the
Securities Act) in reliance on Rule 506 of Regulation D of the
Act, and outside the United States to certain non-U.S. persons
(who also were accredited investors) in reliance on Regulation S
of the Act. Pursuant to certain registration rights afforded the
purchasers of the shares, in September 1998 the Company effected a
registration under the Securities Act of 1933, as amended, of
substantially all such securities.
. In June 1998, the Company completed the acquisition of Disc Go
Round, a 137-store retail music franchise system. The acquisition
consisted of the franchise rights for 134 Disc Go Round retail
music stores and the assets of three company-owned Disc Go Round
stores, for an aggregate cash purchase price of approximately $7
million.
. During October 1998 and through November 6, 1998, Compact Discs
Management, Inc., ("CD Management"), a wholly owned subsidiary of
the Company, made purchases of 93 partnership and limited
liability company units from the owners of such units, paying an
aggregate cash purchase price of $1,737,867. The units acquired
represented the equity interests of the sellers in three entities
which owned and operated 16 CD Warehouse franchised stores in the
states of Arkansas, Kansas, Louisiana, Missouri, Nebraska,
Oklahoma and Texas. As a result of these individual purchases, CD
Management acquired 100% of these 16 stores, which are operated
under the CD Warehouse system concept as company-owned stores.
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. On February 22, 1999, the Company completed the purchase of a 16-
store retail music chain located in San Diego, California and
surrounding areas and operating under the name "Music Trader." The
Company intends to operate the 16 stores as company-owned stores
under the CD Warehouse concept. The total purchase price for the
transaction, which was structured as an acquisition of the assets
relating to the 16 stores, was $4,000,000, comprised of $3,000,000
in cash and $1,000,000 in Common Stock of the Company, valued for
purposes of the acquisition at $11.80 per share.
Business Strategy
The Company's business strategy of offering a mix of both new and pre-
owned CD's is based on its belief that there is a growing consumer willingness
to purchase pre-owned CD's, which is providing an expanding market niche in the
retail music industry for CD resellers. The Company's business strategy is to
establish itself as the recognized industry leader in the domestic buy-sell-
trade retail CD marketplace by pursuing a three-fold approach: (1) offering
quality, pre-owned CD's at exceptional value; (2) offering to accept as a trade,
or buy for cash, selected CD's from customers; and (3) selling new releases at
competitive prices.
According to the Recording Industry Association of America (the
"RIAA"), annual CD sales in the United States for 1998 were $11.4 billion in
1998, which represented a 15.1% increase from 1997 domestic CD sales of $9.9
billion. The lack of any audible difference between new and pre-owned CD's,
durability of the medium, cost savings and the accumulating stock of available
CDs for resale, suggest the possibility for rapid market growth in the pre-owned
CD market. Because the CD is encased in plastic and read by a laser, the playing
of CD's, and even the occasional careless handling of CDs, rarely cause damage
that will impair performance or result in any degradation of sound quality. In
the absence of pronounced abuse, CD's may reasonably be expected to last for
decades; premium (gold-plated) CD's may last for centuries. Such extraordinary
durability, coupled with the standard error-correction circuitry in CD players,
means that pre-owned CDs are essentially indistinguishable from new CDs in terms
of audible performance. By offering quality pre-owned CD's at substantial
savings and responding to consumers' desire to recycle merchandise they no
longer want or use but which has intrinsic value, the CD Warehouse remarketing
concept emphasizes consumer value.
Management believes that, in addition to the Company, Hastings
Entertainment, Inc. and The Wherehouse are the only national chains selling pre-
owned CD's on any significant scale, and that the market for CD remarketers is
fragmented and underserved. Accordingly, the Company believes that it can
increase its market share by expanding the CD Warehouse System in targeted
markets. The Company's expansion strategy for 1999 is to open 30 franchised
stores and open or acquire 35 company-owned stores. To accomplish this
objective, the Company employs a business strategy that includes the following
elements:
Inventory Management System. The Company considers its inventory
management system, which is a proprietary software program, to be essential to
the success of its business strategy and the CD Warehouse concept. The program,
which has a database in excess of 270,000 titles and includes catalogs from all
the major record labels, assists each store in selectively procuring pre-owned
CD's by supplying buying directions for every CD offered. The ability to access
this data instantly gives store operators the capability to make an informed
decision on every CD presented by a customer for purchase or trade, by reviewing
the title's historic sales data, as well as the recommended purchase price that
the CD has been assigned by the Company. By scanning each CD (utilizing bar
coding capability), the program also includes point-of-sale recording of all
transactions, including customer profiles with which mailing lists may be
created. Additionally, as each transaction is entered, the program provides for
the printing of customer receipts which concurrently compiles inventory by
title, including respective costs, selling price and gross profit results.
Accordingly, the program can generate reports of comprehensive data for any
selected period or any facet of store operations, including sales by title,
sales by dollar volume, inventory by title, individual transaction summaries,
acquisitions for any period, system adjustments, cash register reconciliation
and virtually any other pertinent financial information.
The Company believes that its inventory management system contributes
to more efficient system-wide management of inventory by reducing the need to
purchase new titles from music distributors for new store inventories and
affording existing stores the opportunity to sell excess inventory. As new
stores are developed, opening packages of inventory are assembled by the Company
and sold to the franchisees. The demand for inventory by new stores allows
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existing stores to sell excess inventory. If, for example, it is determined that
a store may be overstocked on a particular selection, the Company may purchase
the selection and resell it to another unit or as part of the opening inventory
of a new store. The Company believes that this is a significant advantage in
comparison to its competitors, since the Company can review all titles available
and source its own system for inventory. Management anticipates as much as 75%
of the opening inventory for a new store can be purchased from system stores.
This constant inventory turnover allows existing stores to make a reasonable
profit and provide a source of capital while providing an opportunity for the
Company to acquire quality inventory to open new stores or update an existing
location's inventory.
The Company currently is developing enhancements of its proprietary
software system. These enhancements will include such features as (i) a
communication upgrade that will allow all stores to communicate with the Company
and with each other, and (ii) an accounting package that will produce a profit
and loss statement from the information captured by a store's point-of-sale
register. The Company expects to introduce the software upgrade to all CD
Warehouse stores during the third quarter of 1999. Disc Go Round stores utilize
an inventory and point-of-sale software that offers comparable management
reporting capability but lacks the CD Warehouse database.
Customer Service. The Company emphasizes excellent customer service
and seeks to employ, and to sell franchises to, motivated and energetic people.
The Company also seeks to foster enthusiasm for its customer service philosophy
and its franchise concepts through annual franchise conventions, regional
meetings and other frequent contacts with its franchisees and store managers.
Targeted Expansion. The Company believes that its existing core and
developing markets offer significant growth opportunity for both company-owned
and franchised store development. The Company concentrates its expansion of
stores in markets where it can cluster stores, thereby expanding consumer
awareness and creating significant operating, distribution and advertising
efficiencies. To increase its penetration of core markets, the Company co-
develops markets with franchisees, divides markets among franchisees or divides
markets among the Company and franchisees. The Company also clusters its
company-owned stores and franchised stores through the use of area development
agreements and its site selection approval process. The Company believes that
this approach has contributed to increased average store sales.
Store Locations
The table below shows the location, as of December 31, 1998, of all CD
Warehouse and Disc Go Round stores (which also includes, for each franchise
system, stores operating under the trade name "CD Exchange") in the United
States, Canada, England, France, Guatemala and Venezuela:
DOMESTIC
ALABAMA ARKANSAS DELAWARE
Daphne++ Fort Smith++ Newark+
Homewood++ Little Rock * Wilmington+
Hoover++ North Little Rock*
Huntsville* FLORIDA
Huntsville++ CALIFORNIA Bradenton++
Mobile++ Huntington Beach+ Coral Gables*
Palm Desert+ Davie++
Daytona Beach*
ARIZONA COLORADO Deland*
Mesa+ Arvada+ Fern Park*
Scottsdale* Colorado Springs++ Ft. Lauderdale (2)++
Ft. Collins* Ft. Myers++
Littelton+ Gainesville++
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FLORIDA (cont'd) IOWA MINNESOTA
Jacksonville+ Ames+ Bemidji+
Jacksonville (2)* Cedar Rapids++ Blaine+
Lake Park++ Cedar Rapids+ Brooklyn Center+
Naples++ Clive+ Burnsville+
Neptune Beach* Davenport++ Duluth+
North Miami* Davenport+ Eden Prairie*
Orange Park* Des Moines (2)++ Edina+
Orlando* Des Moines+ Maple Grove+
Orlando+ Sioux City++ Maplewood+
Ormond Beach* Waterloo++ Minneapolis(2)+
Palm Harbor* Waterloo+ Minnetonka*
Port Charlotte++ Roseville+
Sarasota++ KANSAS St. Cloud+
Sanford* Overland Park*
Tallahassee(2)++ Shawnee* MISSOURI
Tampa+ Wichita++ Arnold++
Venice++ Ballwin++
KENTUCKY Cape Girardeau++
GEORGIA Lexington+ Gladstone*
Atanta(3)+ Louisville(2)+ Independence*
Augusta+ Paducah++ Lee Summit*
Duluth+ Richmond+ O'Fallon++
Marietta+ Springfield*
Marietta++ LOUISIANA St. Louis++
Martinez++ Baton Rouge*
Morrow+ Baton Rouge++ MONTANA
Lafayette* Bozeman++
IDAHO Metarie* Great Falls++
Idaho Falls++ New Orleans++
Shreveport++ NEBRASKA
ILLINOIS Shreveport+ Lincoln+
Burbank+ Omaha*
Carbondale++ MARYLAND
Chicago(2)+ Elkridge++ NEVADA
Harwood Heights+ Frederick+ Las Vegas(2)+
Moline+ Laurel++
North Riverside+ NEW JERSEY
Palatine++ MICHIGAN Belleville++
Sterling+ Ann Arbor+ Denville+
Streamwood++ East Lansing++ Freehold+
Grand Rapids(2)+ Laurel Springs++
INDIANA Holland+ Northfield++
Bloomington+ Kalamazoo++ Voorhees+
Indianapolis++
Indianapolis(3)+
Mishawaka+
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NEW YORK PENNSYLVANIA Houston (5)*
Endicott+ Allentown+ Houston+
Guilderland+ Conshohocken+ Hurst++
Huntington Station++ Easton+ Irving++
Rockville Center++ Erie+ Lewisville++
Wantaugh++ Greensburg+ Lubbock++
White Plains++ Harrisburg+ Mesquite++
Mechanicsburg+ Midland*
NORTH CAROLINA Monroeville+ North Richland Hills++
Cary+ Philadelphia+ Plano++
Charlotte++ Pittsburgh++ Rockwall++
Charlotte+ Pittsburg+ Round Rock++
Durham+ State College+ San Angelo++
Fayettville+ West Mifflin++ San Antonio (6)++
Goldsboro++ San Marcos++
Raleigh+ SOUTH CAROLINA Sherman++
Wilmington+ Columbia+ Texarkana++
Greenville++ Waco*
NORTH DAKOTA Greenville+ Webster*
Fargo+ Wichita Falls*
SOUTH DAKOTA
OHIO Sioux Falls+ UTAH
Beavercreek+ Provo++
Boardman++ TENNESSEE Provo+
Brooklyn+ Antioch+ Salt Lake City+
Canton++ Bartlett+ St. George++
Centerville+ Clarksville++ Taylorsville++
Cincinnati(2)+ Jackson++
Cleveland Heights++ Madison+ VERMONT
Columbus (3)++ Memphis* Burlington+
Holland++ Murfreesboro++
Mayfield Heights++ Nashville++ VIRGINIA
Miamisburg++ Alexandria++
Parma Heights++ TEXAS
Toledo++ Abilene* WASHINGTON
Youngstown+ Arlington (2)++ Belleville++
Austin (3)++ Bremerton+
OKLAHOMA Austin+ Kennewick+
Edmond* Carrollton++ Linwood+
Norman* College Station+ Seattle ++
Oklahoma City - North May* Corpus Christi++ Seattle(3)+
Oklahoma City-NW Expressway* Corpus Christi+
Shawnee* Dallas - Montfort* WISCONSIN
Stillwater* Dallas (7)++ Appleton++
Tulsa* Denton ++ Appleton+
Tulsa++ Duncanville++ Brookfield++
El Paso* Brookfield+
OREGON Ft. Worth (2) ++ East Milwaukee+
Beaverton+ Garland* Green Bay+
Portland+ Grand Prairie++ Greenfield+
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WISCONSIN (cont'd) INTERNATIONAL London++
Greenfield++ Watford++
Janesville+ CANADA
Kenosha++ Charlottetown/PE+ FRANCE
Madison(3)+ Dartmouth/NS+ Caen++
Madison++ Halifax/NS+
Racine++ Ottawa/ON+ GUATEMALA
Thunder Bay/ON+ Guatemala City++
WYOMING Winnipeg/MB (3)+
Casper+ VENEZUELA
ENGLAND Caracus++
DISTICT OF COLUMBIA Ealing++
Washington++ Leeds++
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* Indicates company-owned store.
++ Indicates CD Warehouse store.
+ Indicates Disc Go Round store.
Expansion Strategy
The first CD Warehouse store opened in Dallas, Texas in August 1992
and, as of December 31, 1998, the CD Warehouse System had an aggregate stores
314 stores in 40 states and the District of Columbia, Canada, England, France,
Guatemala and Venezuela, with 135 franchised stores and 51 company-owned stores
operating under the CD Warehouse concept and 128 franchised stores operating
under the Disc Go Round concept. Key elements of the Company's expansion
strategy include:
Aggressive, Balanced Growth. The Company's expansion strategy is to
increase the number of franchised stores by selective utilization of Company-
owned stores in a particular market area. The Company believes that, in many
cases, the Company will be able to take advantage of a promising new location by
establishing a Company-owned store when a delay in finding a qualified
franchisee might jeopardize the Company's ability to secure the site. Company-
owned stores also provide a training ground for Company-owned store and district
managers and a controllable testing ground for new products and promotions,
operating and training methods and merchandising techniques. However, the
cornerstone of the Company's expansion strategy remains the addition of new
franchised stores in the system, which enables the Company to expand its system
more quickly with no capital investment.
Name Recognition and New Market Penetration. The Company believes the
visibility of its stores at high traffic, Class A, strip shopping centers has
generated good name recognition in the areas in which stores currently are
located. The Company's expansion strategy involves the building-out of existing
markets and the further penetration of developing markets through the clustering
of both company-owned and franchised stores. This expansion strategy is
designed to take advantage of operational and advertising efficiencies through
store clustering within television and other advertising markets, thereby
increasing market penetration and consumer awareness. To accelerate penetration
of larger markets, the Company intends to continue to co-develop markets with
franchisees or divide markets among franchisees, and intends to utilize market
co-development where appropriate. In determining which new markets to develop,
the Company considers many factors, including the size of the market,
demographics, cost of media, population trends, competition and real estate
availability and pricing.
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International Franchise Expansion. There are seven CD Warehouse
franchised stores and eight Disc Go Round franchised stores currently operating
in Canada, England, France, Guatemala and Venezuela. In January 1997, the
Company entered into a master franchise agreement (the "Worldwide Area
Development Agreement") with Mark E. Kane, the founder of CDIL. The Worldwide
Area Development Agreement provides for a period of ten years for development of
franchise operations worldwide, excluding the United States, Canada and Mexico,
and includes a provision which allows the Company, at its option, to purchase
Mr. Kane's interest in any franchised operations developed pursuant to the
Worldwide Area Development Agreement. The development schedule under the
agreement requires that Mr. Kane open 100 stores over the ten-year period. The
agreement provides that Mr. Kane will pay the Company an amount to be jointly
determined between the Company and Mr. Kane on a country-by-country basis,
provided that the Company will receive a franchise fee of not less than $3,000
per store, a minimum royalty of 1% of gross sales based on individual store
sales volume and 20% of the total fee received from each subfranchisee by Mr.
Kane. In June 1998, the Company filed an arbitration claim against Mr. Kane,
alleging breach of the Worldwide Area Development Agreement and seeking
cancellation of the agreement. See Item 3--Legal Proceedings and Item 12--
Certain Relationships and Related Transactions.
Consideration of Acquisitions. During 1998, the most significant
factors attributable to the Company's store and revenue growth were (i) the
acquisition of the Disc Go Round franchise system from Grow Biz, consisting of
the franchise rights for 134 Disc Go Round retail music stores and the assets of
three company-owned Disc Go Round stores, and (ii) the acquisition, as company-
owned stores, of 21 CD Warehouse franchised stores. The Company intends to
pursue the acquisition of other local and regional pre-owned music retailers to
implement its strategy of building out current markets and establishing itself
in new target markets that may be concurrently developed by the Company as well
as franchised stores. Consistent with this strategy, on February 22, 1999, the
Company completed the purchase of a 16-store retail music chain located in San
Diego, California and surrounding areas and operating under the name "Music
Trader."
New Store Concept. During 1998, the Company investigated the need for
a new, consistent appearance, both externally and internally, for stores
operating under the CD Warehouse concept. A prototype unit, which was a company-
owned store, opened in March 1998 in Norman, Oklahoma. The prototype carries
slightly more inventory (18,000 titles) than is currently carried by existing CD
Warehouse stores (10,000 to 16,000 titles), and utilizes updated decor and
lighting schemes. The Company believes that it can derive greater profits by
offering a larger variety in both new and pre-owned CD titles. Based on the
success of the prototype, modifications were made and a uniform, low cost
remodel plan has been devised for CD Warehouse franchisees. The Company is in
the process of converting all company-owned stores to the new design, and all
new CD Warehouse franchised stores will be required to conform to such design.
Operations
Acquisition of Pre-owned CD's. A key component of the two franchise
concepts within the CD Warehouse System is the purchase or trade of selected
CD's from customers; accordingly, the Company obtains a significant portion of
its pre-owned CD inventory primarily from within the system itself.
Additionally, utilizing its inventory management system, which is a proprietary
program, the Company affords existing stores the opportunity to sell excess
inventory. As new stores are developed, opening packages of inventory are
assembled by the Company and sold to the franchisees. The demand for inventory
by new stores allows existing stores to sell excess inventory. If, for example,
it is determined that a store may be overstocked on a particular selection, the
Company may purchase the selection and resell it as part of the opening
inventory of a new store. The Company believes that this is a significant
advantage in comparison to its competitors since the Company can review all
titles available and source its own system for inventory. As much as 75% of the
opening inventory for a new store can be purchased from system stores. This
constant inventory turnover allows existing stores to make a reasonable profit
and provide a source of capital while providing an opportunity for the Company
to acquire quality inventory to open new stores or update an existing location's
inventory.
Purchasing of New CD's, Other Point-of-Sale Items and Store Fixtures.
For new music releases, the Company contracts with outside third-party
distributors. The Company negotiates with vendors on behalf of the system for
inventory display racks, lighting and related products which are then shipped
directly from the manufacturers to the individual stores.
As the system grows, the Company believes that additional quantity
discounts can be negotiated with the respective equipment and product suppliers.
The Company maintains its own distribution facility to provide its franchised
and Company-owned stores with supplies and related materials.
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Marketing and Advertising
CD Warehouse Stores. The Company provides new stores with certain pre-
opening items and point-of-sale materials. Additional point-of-sales materials
are available to all stores at no cost from the record companies. Pursuant to
the franchise agreement, which provides for each store to spend 2.5% of sales
specifically on advertising, each CD Warehouse franchisee currently conducts its
own marketing and advertising activities independently through newspapers and
radio. In May 1997, the Company was instrumental in the formation of an
advertising co-op in Dallas, Texas. All CD Warehouse stores in the Dallas, Texas
trade area formed the co-op and agreed to contribute to the co-op 1.25% of sales
on a monthly basis. The co-op meets monthly to determine how the co-op funds
will be utilized to promote the sales of music in the Dallas market area. In
July 1998, the Company activated a concept-wide advertising fund (the "SAF").
The Company did not require franchisees to participate in the SAF until there
was an aggregate of 200 stores, including company-owned stores, operating under
the CD Warehouse concept. With the acquisition of the 16 Music Trader stores in
February 1999, the number of franchised and company-owned stores operating under
the CDWI concept exceeded 200, and SAF participation is now mandatory. The
Company expects that the SAF will become the primary creative and production
vehicle for all marketing efforts respecting the CD Warehouse concept.
Disc Go Round Stores. Disc Go Round franchisees under existing
franchise agreements are required to spend 5% of their gross sales on approved
advertising and marketing. In addition, all Disc Go Round franchisees are
required to pay the Company an annual advertising production fee of $500.
Under the current form of Disc Go Round franchise agreement,
applicable for renewals, Disc Go Round franchisees are pay required to spend
during each calendar quarter 2.5% of the store's gross sales to advertise and
promote the store, of which 1 3/4% is spent directly by the store in local
market advertising, and 3/4% is paid to the Company to be deposited into a
concept-wide advertising fund to market the Disc Go Round concept.
Franchising Program
CD Warehouse
General. As of December 31, 1998, there were a total of 179 CD
Warehouse stores in 32 states and the District of Columbia, and seven CD
Warehouse stores in England, France, Guatemala and Venezuela. The Company
expects to open 30 new CD Warehouse franchised stores by the end of 1999.
However, there can be no assurance that all of these stores will be opened or
that the development schedule set forth in each area development agreement will
be achieved. Pursuant to the terms of existing area development agreements, a
total of 54 stores are committed to be opened over the next two years.
The CD Warehouse franchise agreement provides the franchisee the right
to use or be provided, as the case may be, the Company's trade names, service
marks and trademarks; design plans, color schemes, signs and fixtures for store
premises; buying and selling guidelines; computerized inventory management
system; initial inventory, operations and financial control guidelines; initial
management training; and advertising assistance.
Franchise Sourcing and Selection. The majority of new franchises are
individuals responding to advertisements in national publications such as
Entrepreneur Magazine and The Franchise Handbook. Various publications also
publish articles or rankings of top-selling franchises (e.g., in February 1999,
Entrepreneur Magazine ranked the Company 20th in its list of 101 fastest-growing
franchises and 57th in its 20th Annual Franchise 500), which also elicit
inquiries from potential franchisees. Franchisees are approved by the Company
on the basis of the applicant's net worth and liquidity, together with an
assessment of work ethic and personality compatibility with the Company's
operating philosophy.
Franchise Marketing Program. The Company's franchise marketing program
seeks to attract prospective franchisees with management experience, a minimum
level of net worth and strong interest in the retail music business. The Company
markets its franchise opportunities by advertising in selected business
magazines and franchise-oriented publications. Each inquiry is responded to and
an initial determination is made as to the prospect's qualifications to become a
CD Warehouse franchisee. Once an inquiry is received, the prospect is mailed the
Company's brochure and marketing materials. The inquiry is then followed up on
within a period of two weeks.
9
<PAGE>
The Company has established a home page via the Internet (World Wide
Web) that will provide detail on the franchise opportunities presented by
operating a CD Warehouse store. The Company's homepage can be accessed at
http://www/cdwi.com/.
Training and Support. The Company's philosophy is one of service and
commitment to its system. Each franchise owner/operator and each company store
manager is required to complete a comprehensive training program in store
operation and management. Topics covered in the training course include the
Company's philosophy of store operation and management, customer service,
merchandising, marketing, pricing, inventory and cost control, record keeping,
labor scheduling and personnel management. Training is based on standard
operating policies and procedures contained in an operations manual provided to
all franchisees, which the franchisee is required to follow by terms of the
franchise agreement. Additionally, trainees are provided with a complete
orientation to Company operations by meeting with members of the senior
management of the Company. Training continues through the opening of the store,
where Company field personnel assist and guide the franchisee in all areas of
operation.
The Franchise Agreement; Terms and Conditions. The domestic offer and
sale of CD Warehouse franchises is made by its Uniform Franchise Offering
Circular prepared in accordance with federal and state laws and regulations.
States that regulate the sale and operation of franchises require a franchisor
to register or file certain notices with the state authorities prior to offering
and selling franchises in those states.
Under the current form of domestic franchise agreement, CD Warehouse
franchisees generally pay the Company (i) an initial franchise fee of $15,000,
(ii) royalties equal to 5% of monthly gross sales and (iii) a marketing fee
equal to 2.5% of monthly gross sales. CD Warehouse franchisees existing prior
to January 27, 1997 (the date of the CDIL Acquisition), who enter into a
franchise agreement for a new location on or prior to December 31, 1998, will
pay the Company (i) an initial franchise fee of $6,000; (ii) royalties equal to
5% of monthly gross sales and (iii) a marketing fee equal to 2% of monthly gross
sales. Franchisees are generally granted exclusive territory with respect to
the operation of CD Warehouse stores only in the immediate vicinity of their
stores.
The franchise agreement requires franchisees to purchase from the
Company certain proprietary software and the store's initial inventory, and to
comply with the Company's procedures of operation, to permit inspections and
audits by the Company and to remodel stores to conform with standards in effect
from time to time for the CD Warehouse system. The Company may terminate the
franchise agreement upon the failure of the franchisee to comply with the
conditions of the agreement and upon the occurrence of certain events, such as
insolvency or bankruptcy of the franchisee or the commission by the franchisee
of any unlawful or deceptive practice which in the judgment of the Company is
likely to adversely affect the CD Warehouse system. The Company's ability to
terminate franchise agreements pursuant to such provisions is subject to
applicable bankruptcy and state laws and regulations.
The franchise agreement prohibits the transfer or assignment of any
interest in a franchise without the prior written consent of the Company. The
franchise agreement also gives the Company a right of first refusal to purchase
any interest in a franchise if a proposed transfer would result in a change of
control of that franchise. The refusal right, if exercised, would allow the
Company to purchase the interest proposed to be transferred under the same terms
and conditions and for the same price as offered by the proposed transferee.
The term of each franchise agreement is ten years, and franchisees
generally have the right to renew for an additional ten-year term. All of the
franchise agreements assigned to the Company in connection with the CDIL
Acquisition will expire between 2002 and 2006.
10
<PAGE>
Unit Economics. The Company believes that future CD Warehouse stores
can be opened for an initial investment of $123,300 to $150,300. The estimated
initial investment is comprised of the following:
Minimum Maximum
------- -------
Franchise Fee......................... $ 15,000 $ 15,000
Inventory............................. 40,000 50,000
Leasehold Improve..................... 18,000 22,000
Contractor............................ 11,000 15,000
Computer Hardware..................... 7,100 7,100
Proprietary Software.................. 1,500 1,500
Signage (exterior and interior)....... 7,200 7,200
Fixtures and equipment................ 17,000 19,500
Lease and utility deposits............ 1,500 3,000
Initial working capital............... 5,000 10,000
-------- --------
Total.......................... $123,300 $150,300
======== ========
Management believes that a key indicator of the success of a franchise
location is the sales to capitalization ratio. That ratio is defined as the
annual sales revenue generated by the business divided by the capitalization
costs to open the business. For the year ended December 31, 1998, average unit
sales on a comparable basis were $348,000. Based on an average initial
estimated capitalization of $136,800, the sales to capitalization ratio to open
a new CD Warehouse store is 2.54 to 1.
Franchise Financing. Typically, franchisees obtain their own sources
of financing and do not require the Company's assistance. However, the Company
provides inventory and equipment financing through CD Warehouse Finance Company,
a wholly owned subsidiary of the Company.
Disc Go Round
General. As of December 31, 1998, there were a total of 120 Disc Go
Round stores in 32 states and eight Disc Go Round stores in Canada. The Company
has determined that it will not sell or offer for sale any additional Disc Go
Round franchises. Additionally, while the Company will honor its ongoing
obligations as the franchisor under the Disc Go Round franchise agreements that
it acquired, it intends to encourage the existing Disc Go Round franchisees to
become CD Warehouse franchisees and to convert their Disc Go Round stores to CD
Warehouse stores.
The Franchise Agreement; Terms and Conditions. The domestic renewal of
Disc Go Round franchises is made by a Uniform Franchise Offering Circular
prepared in accordance with federal and state laws and regulations.
Generally, the form of franchise agreement under which substantially
all of the existing Disc Go Round franchises currently operate provides that
Disc Go Round franchisees pay the Company (i) royalties equal to 5% of weekly
gross sales, (ii) an annual marketing fee of $500 and (iii) a marketing fee
equal to 5% of gross sales, with the Company having the option to increase the
advertising expenditure to 6% of the franchisee's gross sales, of which up to 2%
would be paid to the Company as an advertising fee for deposit into a system-
wide advertising fund.
Under the form of domestic franchise agreement applicable to renewing
Disc Go Round franchisees, franchisees generally will pay the Company (i) a
renewal franchise fee of $5,000, (ii) royalties equal to 5% of monthly gross
sales and (iii) a marketing fee equal to 2.5% of monthly gross sales.
Franchisees are generally granted exclusive territory with respect to the
operation of Disc Go Round stores only in the immediate vicinity of their
stores.
The Disc Go Round franchise agreement requires franchisees to comply
with the Company's procedures of operation, to permit inspections and audits by
the Company and to remodel stores to conform with standards in effect from time
to time for the Disc Go Round system. The Company may terminate the franchise
agreement upon the failure of the franchisee to comply with the conditions of
the agreement and upon the occurrence of certain events, such as insolvency or
bankruptcy of the franchisee or the commission by the franchisee of any unlawful
or deceptive practice which in the
11
<PAGE>
judgment of the Company is likely to adversely affect the Disc Go Round system.
The Company's ability to terminate franchise agreements pursuant to such
provisions is subject to applicable bankruptcy and state laws and regulations.
The franchise agreement prohibits the transfer or assignment of any
interest in a franchise without the prior written consent of the Company. The
franchise agreement also gives the Company a right of first refusal to purchase
any interest in a franchise if a proposed transfer would result in a change of
control of that franchise. The refusal right, if exercised, would allow the
Company to purchase the interest proposed to be transferred under the same terms
and conditions and for the same price as offered by the proposed transferee.
Existing Disc Go Round franchises may be renewed for a renewal term of
five years; however, franchisees will not have the right to a subsequent term of
renewal. The Company's ability to not renew franchise agreements pursuant to
such provision is subject to applicable state laws and regulations.
Company Store Program
Company-owned stores permit market penetration, or seeding, in the
absence of an immediately viable multi-location franchise operator. Company
stores provide an opportunity to continually refine the Company's standard store
model in order to respond to market dynamics. Variations in inventory mix,
ancillary product offerings, and marketing and sales techniques can be tested
and refined before implementation throughout the system.
Managers of Company-owned stores are required to comply with all
Company operating standards and undergo training and receive support from the
Company similar to the training and support provided to franchisees. See Item
1Description of Business. The Company's Director of Company Store Operations and
his staff regularly visit company-owned stores to ensure compliance with Company
standards and procedures and to provide advice and support.
The following table sets forth the number of stores opened and closed
throughout the CD Warehouse System during fiscal 1998:
<TABLE>
<CAPTION>
December 31, December 31,
1997 Opened Closed Transfers 1998
------------ ---------- ---------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Franchised Stores
Domestic-CD Warehouse 131 32 (7) (28) 128
Domestic-Disc Go Round -- 128* (6) (2) 120
--- --- --- --- ---
131 160 (13) (30) 248
International-CD Warehouse 6 1 -- -- 7
International-Disc Go Round -- 8* -- -- 8
--- --- --- --- ---
6 9 -- -- 15
Company-owned Stores
Domestic-CD Warehouse 13 7 (2) 33 51
Domestic-Disc Go Round -- 3* -- (3) --
--- --- --- --- ---
13 10 (2) 30 51
Total 150 179 (15) -- 314
=== === === === ===
</TABLE>
* In June 1998, the Company completed the acquisition of the Disc Go Round
franchise system from Grow Biz, consisting of the franchise rights for 134
Disc Go Round retail music stores (126 domestic and 8 international) and
the assets of three company-owned Disc Go Round stores.
12
<PAGE>
Governmental Regulation
The Company is subject to various federal, state and local laws
affecting its business. Each of the Company's stores is subject to licensing and
regulation by a number of governmental authorities, which include taxing, zoning
and building agencies in the state or municipality in which the store is
located. Difficulties in obtaining or failures to obtain required licenses or
approvals could delay or prevent the opening a new store in a particular area.
The Company is subject to Federal Trade Commission ("FTC") regulation
and various state laws that regulate the offer and sale of franchises. The FTC
has adopted a rule that requires franchisors to make certain disclosures to
prospective franchise owners prior to the offer or sale of franchises. This rule
requires the disclosure of information necessary for a franchise owner to make
an informed decision as to whether to enter into a franchise relationship and
delineates the circumstances in which franchisors may make predictions on future
sales, income and profits. Failure to comply with this rule constitutes an
unfair or deceptive act or practice under the Federal Trade Commission Act.
Additionally, numerous states have in recent years adopted laws regulating
franchise operations and the franchisor-franchisee relationship, and similar
legislation is pending in Congress and several other states. Existing laws and
pending proposals vary from filing and disclosure requirements in the offer and
sale of franchises to the application of statutory standards regulating the
establishment and termination of franchise relationships. These laws generally
apply to both area and individual franchises. Although the foregoing matters may
result in some modification in the Company's franchising activities and some
delays or failures in enforcing certain of its rights and remedies under certain
area or individual franchise agreements, such modifications, delays or failures
have not had a material adverse effect on the Company's operations or business.
However, the law applicable to franchise operations and relationships is still
developing, and the Company is unable to predict the effect, if any, on its
operations of additional requirements or restrictions that may be enacted or
promulgated or of court decisions that may be adverse to the franchise industry.
While it is difficult to assess potential effects of federal and state
legislation in the U.S. or new international laws that may impact the industry,
the Company does not anticipate any material adverse effects from such
legislation or laws at this time.
The Company's operations are also subject to federal and state laws
governing such matters as wages, working conditions and overtime.
Competition
The Company competes in the retail music industry, which is highly
competitive in price, selection, service and location and is often affected by
changes in consumer trends, economic conditions, demographics, traffic patterns
and technological innovations. The following profile provides an overview and
comparison of how the retail "new release" CD industry and the emerging retail
"remarketing" or "buy-sell-trade" CD industry are currently structured and
segmented.
According to the RIAA, CD sales in the United States were over $11.4
billion in 1998. The Company has various competitors in the industry which sell
new recordings and music related merchandise. These companies vary from those
who are specialty music stores in malls (such as Musicland and Camelot), those
who utilize freestanding buildings (such as Blockbuster Music, Wherehouse
Records, and Hastings Entertainment) and those who sell via the internet (such
as CDNow and Amazon.com). Empirical studies conducted by the Company indicate
that companies in mall locations typically charge $15.99 to $17.99 for their
front-line CD products. Those in freestanding buildings generally have much
larger facilities (between 12,000 to 20,000 square feet). Their selling price
for front-line items range between $13.99 and $15.99, with the latest top 20
releases on sale for $11.99 to $13.99 per CD. None of these "superstores" sell
pre-owned music except for Wherehouse Records and Hastings Entertainment, which
have generally offered an inventory of pre-owned CDs in less than 500 square
feet of space with limited selections.
Other retailers offering music include major national discount stores,
including Wal-Mart, K-Mart and Target stores. These national discounters
maintain a very small number of new music titles while offering no pre-owned
music. Their pricing will typically vary from $11.99 to $13.99 per item in
approximately 1,000 square feet of space. In another category are the multi-
media electronic stores (such as Best Buy and Circuit City), which have
generally utilized approximately 1,000 square feet of space and discount their
new releases from $9.99 to $12.99 per item.
The Company also competes on the internet with retailers which sell
new and used CD's online. The Company's retail website,
http://www.cdwarehouse.com, commenced operations in December 1998. The online
commerce market
13
<PAGE>
is new, rapidly evolving and intensely competitive, and the Company expects that
competition will further intensify in the future. Barriers to entry are minimal,
and current and new competitors can launch new sites at a relatively low cost.
The Company believes that CD Warehouse stores compete favorably with
its competition in the pre-owned CD market in terms of price, selection, service
and location.
The Company also competes in the franchise industry for prospective
franchisees. With respect to the only franchisor known to the Company to engage
in a business similar to that of the Company, the Company believes that it
competes favorably.
Trademarks and Service Marks
The names "CD Warehouse," "Disc Go Round," "CD Exchange" are
registered with the United States Patent and Trademark Office. The Company also
has registered its copyright on its proprietary software system and has made
application for the service marks for the phrases "The Future of Music" and "A
New Spin on Music." The Company believes that its trademarks, service marks and
copyright have significant value and are important to its marketing efforts.
Employees
The Company as of March 15, 1999 employs 250 full-time and 150 part-
time employees. None of the Company's employees are represented by a labor union
and the Company believes that its relations with its employees are good.
Item 2. Description of Property.
The Company's principal executive offices are located at 1204
Sovereign Row, Oklahoma City, OK 73108. The total facility is approximately
11,000 square feet and is held under a 60-month lease with a monthly lease
payment of $6,420. The expiration date of the lease is August 31, 2002.
Approximately 6,500 square feet is used for administrative purposes and the
balance of the space is utilized as a warehouse.
The Company leases space for its 51 company-owned retail stores,
typically for a fixed monthly rental and operating costs. Rental expense under
these store leases totaled $724,160 for 1998. Total rental amounts of $2,693,626
under these noncancelable leases are due as follows: 1999--$1,009,722; 2000--
$793,692; 2001--$523,363; 2002--$268,651; 2003--$94,245; and thereafter--$3,953.
Item 3. Legal Proceedings.
On November 9, 1998, Jimick Products, Inc. ("Jimick") filed a petition
for a temporary injunction in the District Court of Oklahoma County, State of
Oklahoma against the Company, alleging that the Company breached an Area Wide
Development Agreement and certain franchise agreements entered into between
Jimick and the Company in May 1997. Jimick alleged, inter alia, that certain of
the Disc Go Round franchised stores acquired by the Company in June 1998 and
located in Jimick's development area encroached upon Jimick's development area
in violation of its agreements with the Company. The petition sought a temporary
injunction to disallow the conversion of Disc Go Round stores that were located
in Jimick's development area to CD Warehouse stores and to prevent the Company
from providing proprietary information regarding the CD Warehouse concept from
being disclosed to the Disc Go Round franchisees. On November 20, 1998, the
Court issued an order denying Jimick's request for a temporary injunction.
On November 9, 1998, Jimick also filed a demand for arbitration with
the American Arbitration Association ("AAA") based on the same allegations set
forth above. The demand for arbitration seeks restitution for an unspecified
amount of damages and injunctive relief together with costs of the action and
attorneys' fees. The Company believes this action is without merit and intends
to fight it vigorously.
On June 24, 1998, the Company filed a demand for arbitration with the
AAA against Mark E. Kane ("Kane"), alleging that Kane had breached a Worldwide
Area Development Agreement entered into between the Company and Kane on October
1, 1996, based on Kane's failure to perform pursuant to the terms and conditions
of the agreement including his failure to pay franchise and royalty fees due
thereunder. The Company seeks, in part, the cancellation of
14
<PAGE>
the exclusive worldwide franchise arrangement with Kane, a determination that
the agreement be terminated and the award of damages for unpaid franchise and
royalty fees.
On January 26, 1999, the Company filed a demand for arbitration with
the AAA against Kane and Compact Disc International, Ltd. ("CDIL"), alleging
anticipatory breach of Kane's covenant not to compete contained in the Asset
Purchase Agreement entered into between the Company, Kane and CDIL on October 1,
1996. The Company seeks, as damages for such breach, the 300,000 shares of
Company stock owned by Kane and held in escrow to collateralize Kane's
indemnification obligations under the agreement.
From time to time, the Company additionally may be involved in
litigation relating to claims arising out of its normal business operation. The
Company believes that any such litigation should not have a material adverse
effect on the Company's financial position.
Item 4. Submission of Matters to Vote of Security Holders.
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year covered by this report.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
Market for Common Equity
The Company's Common Stock began trading on the NASDAQ Small Cap
Market System on January 22, 1997, under the symbol "CDWI." The following table
sets forth, for the periods indicated, the high and low sale price per share for
the Company's Common Stock:
<TABLE>
<CAPTION>
1998 1997
-------------------------------- ---------------------------------
High Low High Low
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
First Quarter..................... $ 7 11/16 $ 3 1/2 $5 1/2 $3 5/8
Second Quarter.................... $ 16 3/4 $7 13/16 $4 1/2 $2 1/2
Third Quarter..................... $24 15/16 $ 6 3/4 $4 3/8 $2 3/4
Fourth Quarter.................... $ 23 5/8 $ 5 $ 5 $3 5/8
</TABLE>
At March 10, 1999, there were approximately 84 registered holders of
record of the Common Stock.
The Company has not paid cash dividends on its Common Stock since its
inception and intends to retain earnings for the continued expansion of its
business.
Recent Sales of Unregistered Securities
The following sets forth certain information regarding recent sales of
the Company's securities which were not registered under the Securities Act.
Pursuant to an Asset Purchase Agreement between CD Management and
Music Trader, Inc. ("Music Trader"), Jeffrey D. Clark and Debbi McGill-Clark,
dated February 22, 1999, the Company purchased substantially all of the assets
related to Music Trader's retail music business. One million dollars of the
$4,000,000 purchase price was paid by the issuance to Music Trader of 84,745
shares of restricted Common Stock of the Company, calculated by dividing
$1,000,000 by the average of the closing prices of the common stock, as quoted
by Nasdaq, for the five trading days preceding the closing. Pursuant to the
terms of the Asset Purchase Agreement, Music Trader was granted certain
"piggyback" registration rights with respect to the 84,745 shares issued in
connection with the transaction.
No sales commissions were paid in connection with the above stock
issuance. The securities were issued in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act.
15
<PAGE>
Item 6. Management's Discussion and Analysis or Plan of Operation.
Certain forward-looking statements contained herein 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 subsidiaries, Compact Discs Management, Inc., and CD
Warehouse Finance Company unless the context indicates otherwise.
Statements of Operations
The following table sets forth the Company's results of operations for
the year ended December 31, 1998 and 1997. The information should be read in
conjunction with the historical Financial Statements included elsewhere in this
document.
<TABLE>
<CAPTION>
Years Ended
December 31,
--------------------------
1998 1997
----------- -------------
(in thousands except share data)
<S> <C> <C>
Revenues:
Retail store sales..................................... $ 9,966 $ 3,352
Wholesale merchandise sales........................ 2,127 3,903
Software income, net............................... 92 61
Royalty income..................................... 2,827 1,394
Management fees.................................... 62 116
Franchise and development fees..................... 188 263
------- -------
Total revenues................................... 15,262 9,089
Operating costs and expenses:
Cost of sales retail store sales.................. 5,902 1,998
Cost of sales wholesale merchandise sales......... 1,915 3,608
Retail store operating expenses.................... 3,307 1,226
General and administrative......................... 2,512 1,510
Depreciation and amortization...................... 617 239
------- -------
Total costs and expenses................................ 14,253 8,581
------- -------
Operating income........................................ 1,009 508
Other income, net....................................... 232 108
------- -------
Income before provision for income taxes............... 1,241 616
Provision for income taxes.............................. 466 230
------- -------
Net income.............................................. $ 775 $ 386
======= =======
Net income per share-basic.............................. $ .27 $ .23
======= =======
Net income per share-diluted............................ $ .25 $ .23
======= =======
Shares used in computation-basic........................ 2,923,090 1,714,790
========= =========
Shares used in computation-diluted..................... 3,136,485 1,714,790
========= =========
</TABLE>
16
<PAGE>
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 December 31, 1998, there were 179 domestic units operating in 32 states and
the District of Columbia, and 7 international units operating in England,
France, Guatemala and Venezuela.
Simultaneously with the closing of the IPO 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 approximately $7 million, of the franchise rights to
134 Disc Go Round retail music stores from Grow Biz, as well as the acquisition
of the assets of three Disc Go Round stores owned and operated by Grow Biz.
Considering the above acquisition, as of December 31, 1998, the Company had 314
stores operating in 40 states and the District of Columbia domestically and in
five different countries.
[The balance of this page intentionally left blank]
17
<PAGE>
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, management 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.
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:
Years Ended December 31,
------------------------
1998 1997
---------- ----------
Revenues:
Retail store sales................................ 65.3% 36.9%
Wholesale merchandise sales................... 14.0% 42.9%
Software income, net.......................... .6% .7%
Royalty income................................ 18.5% 15.3%
Management fees............................... .4% 1.3%
Franchise and development fees................ 1.2% 2.9%
----- -----
Total revenues.............................. 100.0% 100.0%
Cost and expenses:
Cost of sales retail store sales (1)......... 59.2% 59.6%
Cost of sales wholesale merchandise sales(2). 90.0% 92.5%
Retail store operating expenses (1)........... 33.2% 36.6%
General and administrative.................... 16.5% 16.6%
Depreciation and amortization................. 4.0% 2.6%
Operating income................................... 6.6% 5.6%
Net income......................................... 5.1% 4.2%
_____________________
(1) As a percentage of retail store sales.
(2) As a percentage of wholesale merchandise sales.
Year Ended December 31,
-----------------------
CD Warehouse stores only: 1998 1997
---- ----
Sales Data:
System wide sales $54,845,432 $36,494,857
Percentage increase (1) 50% 34%
Average monthly sales per store $ 28,973 $ 25,467
=========== ===========
Change in comparable retail store sales (2) 16% 14%
=========== ===========
(1) Represents percentage increase from comparable period in prior year.
(2) Represents percentage increase for stores open in both periods reported
18
<PAGE>
Year Ended December 31, 1998 compared to Year Ended December 31, 1997.
Revenues
Retail store sales increased $6,614,000 to $9,966,000 for the year
ended December 31, 1998 compared to $3,352,000 for the year ended December 31,
1997. The increase in retail store sales is the result of having 51 company or
majority owned stores in operation during the year ended December 31, 1998
compared to only 16 during the same period in 1997.
Wholesale merchandise sales decreased $1,776,000, or 46% to $2,127,000
the year ended December 31, 1998 compared to $3,903,000 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 $1,433,000 to $2,827,000 for the year ended
December 31, 1998 compared to $1,394,000 for the same period in 1997. As a
result of the acquisition of 134 Disc Go Round franchise stores on June 26,
1998, approximately $737,000 of additional royalty income has been recognized as
of December 31, 1998. Additionally, stores operating as CD Warehouse increased
their same store sales by 16% for the year ended December 31, 1998 with monthly
average sales for these stores increasing from $25,467 for the year ended
December 31, 1997 to $28,973 for the same period in 1998.
Costs and Expenses
Cost of sales for retail store sales increased $3,904,000 for the year
ended December 31, 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 59% of sales for the year ended December 31, 1998 compared to 60% for
the year ended December 31, 1997.
Costs of sales for wholesale merchandise decreased $1,693,000 or 47%
to $1,915,000 for the year ended December 31, 1998 compared to $3,608,000 in
1997. The decrease is consistent with the decrease in sales. Cost of sales was
90% of sales for the year ended December 31, 1998 compared to 92% for the
comparable period in 1997.
Retail store operating expenses increased $2,081,000 to $3,307,000 for
the year ended December 31, 1998, compared to $1,226,000 for the year ended
December 31, 1997. The increase is due to the increase of company-owned stores
discussed above. Retail store operating expense was 33% of retail store revenue
for the year ended December 31, 1998 compared to 37% of retail store revenue for
the same period in 1997. The decrease resulted from better operating results of
company-owned and majority-owned stores that began operations during 1997. The
results for the year ended December 31, 1997 includes start up costs relating to
twelve new company stores compared to eight company stores in 1998.
General and administrative expenses increased by $1,002,000 to
$2,512,000 for the year ended December 31, 1998 compared to $1,510,000 for the
year ended December 31, 1997. This increase resulted from the continued growth
in both company-owned stores (increase of 38 stores) and franchised stores
(increase of 126 stores). The year ended December 31, 1998 also included costs
(travel, personnel, support, etc) associated with absorbing the operations of
134 Disc Go Round franchise stores discussed above.
Depreciation and Amortization
Depreciation and amortization increased $378,000 to $617,000 for the
year ended December 31, 1998 compared to $239,000 for the same period in 1997.
This is due to the addition of 38 company-owned stores and the amortization of
goodwill associated with the acquisition of the franchise rights to 134 Disc Go
Round retail music stores on June 26, 1998 (approximately $38,000 per month).
19
<PAGE>
Other Income
Other income increased $124,000 to $232,000 for the year ended
December 31, 1998 compared to $108,000 for the comparable period in 1997. This
is primarily due to interest earned of approximately $224,000 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
$74,000. This reduction is due to the sale (in December 1997, January 1998 and
October, 1998) of the Company ownership interest in the 34 stores originally
acquired in January 1997.
Net Income
Net income increased $389,000 to $775,000 for the year ended December
31, 1998 compared to $386,000 for the same period in 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 franchise stores, offset by the
increase in general and administrative expenses.
Liquidity and Capital Resources
At December 31, 1998 the Company had working capital of $8,543,000 and
cash and cash equivalents aggregating $4,442,000, 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 $325,000 in 1998, compared to net cash
used for operating activities of $129,000 in 1997. The use of cash by operating
activities for the years ended December 31, 1998 and December 31, 1997 relates
to the continued growth in both company-owned and franchised stores.
Net cash used for investing activities was $11,233,000 for the year
ended December 31, 1998, compared to $3,482,000 for the same period in 1997. The
significant use of cash for investing activities in 1998 relates to the
acquisition of Disc Go Round in June 1998 and the purchase of 16 stores in
October 1998. The increase in 1997 relates to the acquisition of the assets of
CDIL in January 1997. Both 1998 and 1997 also includes opening of company
stores.
Net cash provided from financing activities was $14,878,000 for the
year ended December 31, 1998 compared to $4,718,000 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 IPO and collection of a stock subscription
in the amount of $350,000.
The Company is in the process of developing an internet site which
will offer both new and used CDs. Although this site began operations 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 formed a wholly owned subsidiary, CD
Warehouse Finance Company, to finance the growth of qualified franchisees. As of
December 31, 1998, the financing subsidiary has funded $218,000 for the
development of two new franchised stores. The Company expects the activity to
increase in the future and expects to fund its activities with a portion of the
proceeds of the May 1998 private placement.
In addition to the working capital at December 31, 1998, the Company
finalized a $7,000,000 credit facility in February 1999 consisting of a
$2,000,000 line of credit and a $5,000,000 Term Loan Agreement with Bank One
Oklahoma, N. A. 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 has been utilized to acquire 16 retail music stores operating
as Music Trader in San Diego, California on February 22, 1999. It is the
Company's opinion that the current working capital at December 31, 1998,
combined with the balance of the credit facility, will be sufficient to support
ongoing activities of the Company for the foreseeable future.
20
<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 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 December 31,
1998, it had completed approximately 60% 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 40% 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 December 31, 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 December 31, 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.
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 by December 31, 1999.
21
<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.
Item 7. Financial Statements.
The consolidated financial statements of the Company are incorporated
by reference from pages F-1 through F-21 of the attached Appendix, and include
the following:
Consolidated Financial Statements of CD Warehouse, Inc.
(1) Report of Independent Auditors
(2) Consolidated Balance Sheet at December 31, 1998
(3) Consolidated Statements of Income for the years ended
December 31, 1998 and December 31, 1997
(4) Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1998 and December 31, 1997
(5) Consolidated Statement of Cash Flows for the years ended
December 31, 1998 and December 31, 1997
(6) Notes to Consolidated Financial Statements
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
There have been no material disagreements between the Company and its
independent accountants on accounting and financial disclosure matters which are
required to be reported under this Item for the period for which this Report is
filed.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With 16(a) of the Exchange Act
The information required will be contained in the Company's Proxy
Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.
Item 10. Executive Compensation.
The information required will be contained in the Company's Proxy
Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.
22
<PAGE>
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The information required will be contained in the Company's Proxy
Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.
Item 12. Certain Relationships and Related Transactions.
The information required will be contained in the Company's Proxy
Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.
Item 13. Exhibits and Reports on Form 8-K.
(a) The following documents are filed as part of this report:
(1) Financial Statements are attached hereto as Appendix A and
included herein on pages F-1 through F-21.
(2) The exhibits set forth on the following Exhibit Index are filed
with this Report or are incorporated by reference as set forth
therein:
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Index Page
------- ------------- ----
<S> <C>
3.1 Amended and Restated Certificate of Incorporation (filed as Exhibit
3.1 to the Company's Registration Statement on Form SB-2, file number
333-15139 and incorporated herein by reference) #
3.2 Amended and Restated Bylaws (filed as Exhibit 3.2 to the Company's
Registration Statement on Form SB-2, file number 333-15139 and
incorporated herein by reference) #
4.1 Specimen Certificate of the Common Stock (filed as Exhibit 4.1 to the
Company's Registration Statement on Form SB-2, file number 333-15139
and incorporated herein by reference) #
4.2 See Articles IV and VIII of the Company's Certificate of Incorporation
and Article II of the Company's Bylaws (filed as Exhibit 4.2 to the
Company's Registration Statement on Form SB-2, file number 333-15139
and incorporated herein by reference) #
4.3 Form of Warrant Agreement between the Company and the Underwriters
(filed as Exhibit 4.3 to the Company's Registration Statement on Form
SB-2, file number 333-15139 and incorporated herein by reference) #
*4.4 Warrant Agreement dated May 22, 1998, by and among the Company,
Comvest Partners, Inc. and Capital West Securities 50
4.5 Amended 1996 Stock Option Plan (filed as Exhibit 4.4 to the Company's
Registration Statement on Form S-8 dated February 19, 1999, file
number 333-72651 and incorporated herein by reference) #
10.1 Employment Agreement by and between the Company and Grizzle (filed as
Exhibit 10.1 to the Company's Registration Statement on Form SB-2,
file number 333-15139 and incorporated herein by reference) #
10.2 Employment Agreement by and between the Company and Johnson (filed as
Exhibit 10.2 to the Company's Registration Statement on Form SB-2,
file number 333-15139 and incorporated herein by reference) #
10.3 Employment Agreement by and between the Company and Motley (filed as
Exhibit 10.4 to the Company's Registration Statement on Form SB-2,
file number 333-15139 and incorporated herein by reference) #
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Name of Exhibit Page
------- --------------- ----
<S> <C> <C>
10.4 Asset Purchase Agreement, dated as of June 16, 1998, by and between
the Company and the Grow Biz International, Inc. (filed as Exhibit
10.1 to the Company's Form 8-K dated June 26, 1998 and incorporated
herein by reference) #
10.5 Asset Purchase Agreement dated as of January 1, 1998, by and among CD
Warehouse, Inc.; ZDTMAC; Compact Discs Management, Inc.; Texas ZDT
Management, Ltd.; and the general and limited partners of Texas ZDT
Management, Ltd. (filed as Exhibit 10.2 to the Company's Form 8-K
dated January 1, 1998 and incorporated herein by reference) #
10.6 Form of Franchise Agreement (filed as Exhibit 10.10 to the Company's
Registration Statement on Form SB-2, file number 333-15139 and
incorporated herein by reference) #
10.7 Form of Lockup Agreement (filed as Exhibit 10.11 to the Company's
Registration Statement on Form SB-2, file number 333-15139 and
incorporated herein by reference) #
10.8 Form of Development Agreement (filed as Exhibit 10.13 to the Company's
Registration Statement on Form SB-2, file number 333-15139 and
incorporated herein by reference) #
10.9 Lease Agreement dated April 17, 1997 by and between Will Rogers
Service Center Phase IV Associates and CD Warehouse, Inc. (filed as
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
Quarter ended June 30, 1998 and incorporated herein by reference) #
10.10 WCMA(R) Note, Loan and Security Agreement dated as of December 4,
1997, between the Company and Merrill Lynch Business Financial
Services Inc. (filed as Exhibit 10.1 to the Company's Form 8-K dated
February 10, 1998 and incorporated herein by reference) #
10.11 Term WCMA(R) Loan and Security Agreement dated as of November 28,
1997, between the Company and Merrill Lynch Business Financial
Services Inc. (filed as Exhibit 10.2 to the Company's Form 8-K dated
February 10, 1998 and incorporated herein by reference) #
10.12 Loan Agreement, dated February 17, 1999, between the Company and Bank
One, Oklahoma, N.A. (filed as Exhibit 5.1 to the Company's Form 8-K
dated February 24, 1999 and incorporated herein by reference) #
*21.1 List of subsidiaries 56
*23.1 Consent of Ernst & Young LLP 57
*27.1 Financial Data Schedule 58
* Filed herewith.
# Incorporated by reference.
</TABLE>
(b) A report on Form 8-K was filed by the Company on November 11, 1998,
reporting under "ITEM 5OTHER EVENTS" the Company's acquisition of 100% of
the equity interests in three entities which own and operate 16 CD
Warehouse franchised stores in the states of Arkansas, Kansas, Louisiana,
Missouri, Nebraska, Oklahoma and Texas. No financial statements were filed
as part of the Report.
24
<PAGE>
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.
March 16, 1999 CD WAREHOUSE, INC.,
a Delaware corporation
/s/ Jerry W. Grizzle
------------------------------
Jerry W. Grizzle
Chairman of the Board of Directors;
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
NAME AND TITLE DATE
-------------- ----
/s/ Jerry W. Grizzle March 16, 1999
- ------------------------------
Jerry W. Grizzle
Chairman of the Board of Directors;
President and Chief Executive Officer
/s/ Gary D. Johnson March 16, 1999
- ------------------------------
Gary D. Johnson
Executive Vice President; Chief Operating
Officer; Director
/s/ Doyle E. Motley March 16, 1999
- ------------------------------
Doyle E. Motley
Sr. Vice President, Chief Financial Officer,
Secretary and Treasurer
(Principal Accounting Officer)
/s/ Robert O. McDonald March 16, 1999
- ------------------------------
Robert O. McDonald
Director
/s/ Christopher M. Salyer March 16, 1999
- ------------------------------
Christopher M. Salyer
Director
25
<PAGE>
APPENDIX A
Consolidated Financial Statements
CD Warehouse, Inc.
Years ended December 31, 1998 and 1997
with Report of Independent Auditors
<PAGE>
CD Warehouse, Inc.
Consolidated Financial Statements
Years ended December 31, 1998 and 1997
Contents
Report of Independent Auditors.......................................... F-2
Consolidated Financial Statements
Consolidated Balance Sheet.............................................. F-3
Consolidated Statements of Income....................................... F-4
Consolidated Statements of Stockholders' Equity......................... F-5
Consolidated Statements of Cash Flows................................... F-6
Notes to Consolidated Financial Statements.............................. F-8
F-1
<PAGE>
Report of Independent Auditors
The Board of Directors and Stockholders
CD Warehouse, Inc.
We have audited the accompanying consolidated balance sheet of CD Warehouse,
Inc. as of December 31, 1998 and the related consolidated statements of income,
stockholders' equity and cash flows for each of the two years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits of the financial statements provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of CD
Warehouse, Inc. at December 31, 1998 and the consolidated results of its
operations and its cash flows for each of the two years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Oklahoma City, Oklahoma
February 19, 1999
F-2
<PAGE>
CD Warehouse, Inc.
Consolidated Balance Sheet
December 31, 1998
<TABLE>
<S> <C>
Assets
Current assets:
Cash and cash equivalents $ 4,442,454
Accounts receivable, net of allowance for doubtful accounts of $111,049 976,438
Notes receivable (Note 4) 81,501
Merchandise inventory 4,366,422
Prepaid expenses and other 121,261
-----------
Total current assets 9,988,076
Furniture, fixtures and equipment, net (Note 5) 2,285,209
Notes receivable, due after one year (Note 4) 129,465
Intangibles and other assets, net (Note 6) 10,908,418
-----------
Total assets $23,311,168
===========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 640,019
Accrued liabilities 313,250
Advances and deposits 93,000
Income taxes payable 398,385
-----------
Total current liabilities 1,444,654
Deferred income taxes (Note 7) 98,000
Commitments and contingencies (Note 9)
Stockholders' equity (Note 8):
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 shares issued and outstanding 35,506
Additional paid-in capital 20,571,755
Retained earnings 1,161,253
-----------
Total stockholders' equity 21,768,514
-----------
Total liabilities and stockholders' equity $23,311,168
===========
</TABLE>
See accompanying notes.
F-3
<PAGE>
CD Warehouse, Inc.
Consolidated Statements of Income
YEAR ENDED DECEMBER 31,
1998 1997
----------- -----------
Revenues:
Company operations:
Retail store sales $ 9,965,694 $ 3,352,433
Wholesale merchandise sales 2,127,025 3,902,729
Software income, net 92,062 60,939
Franchise operations:
Royalty income 2,827,205 1,393,717
Franchise and development fees 187,500 263,500
Management fees 62,417 115,728
----------- -----------
Total revenues 15,261,903 9,089,046
Operating costs and expenses:
Cost of sales--retail store sales 5,901,735 1,998,536
Cost of sales--wholesale merchandise sales 1,914,723 3,608,480
Retail store operating expenses 3,307,424 1,225,987
General and administrative 2,511,436 1,509,672
Depreciation and amortization 617,250 238,600
----------- -----------
Total costs and expenses 14,252,568 8,581,275
----------- -----------
Operating income 1,009,335 507,771
Other income:
Interest income 210,635 29,037
Other, net 21,382 79,391
----------- -----------
232,017 108,428
----------- -----------
Income before income taxes 1,241,352 616,199
Provision for income taxes (Note 7) 466,000 230,000
----------- -----------
Net income $ 775,352 $ 386,199
=========== ===========
Net income per share--basic and diluted:
Basic $ 0.27 $ 0.23
=========== ===========
Diluted $ 0.25 $ 0.23
=========== ===========
Shares used in computations:
Basic 2,923,090 1,714,790
=========== ===========
Diluted 3,136,485 1,714,790
=========== ===========
See accompanying notes.
F-4
<PAGE>
CD Warehouse, Inc.
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Common Stock Additional
-------------------------- Paid-in Retained
Shares Amount Capital Earnings
-----------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1996 350,000 $ 3,500 $ 346,500 $ (298)
Exercise of stock subscription 350,000 3,500 346,500 --
Sale of common stock (net of offering
costs) 1,040,000 10,400 4,256,343 --
Issuance of common stock in exchange for
partnership interests 80,000 800 399,200 --
Net income -- -- -- 386,199
---------- ----------- ----------- -----------
Balance at December 31, 1997 1,820,000 18,200 5,348,543 385,901
Exercise of stock options 6,250 63 23,375 --
Sale of common stock (net of offering
costs) 1,624,300 16,243 14,838,337 --
Issuance of common stock in exchange for
partnership interests 100,000 1,000 361,500 --
Net income -- -- -- 775,352
---------- ----------- ----------- -----------
Balance at December 31, 1998 3,550,550 $ 35,506 $20,571,755 $ 1,161,253
========== =========== =========== ===========
</TABLE>
See accompanying notes.
F-5
<PAGE>
CD Warehouse, Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 775,352 $ 386,199
Adjustments to reconcile net income to net cash used for operating
activities:
Depreciation and amortization 617,250 238,600
Deferred income taxes 73,000 25,000
Gain on disposal of assets, net 19,588 (21,432)
Net changes in operating assets and liabilities, exclusive of
business acquisitions:
Accounts receivable, net (404,450) (444,509)
Inventories (849,087) (1,287,056)
Prepaid expenses and other (57,446) (53,816)
Investment in partnerships (57,955) 52,953
Other assets (4,366) (52,731)
Accounts payable (552,103) 564,440
Accrued liabilities 116,343 83,765
Advances and deposits (97,000) 90,000
Income taxes payable 193,385 205,000
Minority interest (97,398) 84,418
----------- -----------
Total adjustments (1,100,239) (515,368)
----------- -----------
Net cash used for operating activities (324,887) (129,169)
</TABLE>
(Continued on following page)
F-6
<PAGE>
CD Warehouse, Inc.
Consolidated Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Notes receivable:
Advances $ (218,000) $ --
Collections 7,034 --
Purchases of furniture, fixtures and equipment (1,434,360) (535,426)
Proceeds from disposal of assets 115,030 179,012
Organizational costs -- (775)
Acquisition of businesses:
Excess of purchase price over assets acquired (7,631,259) (3,138,756)
Accounts receivable (54,740) (72,739)
Inventory (1,743,899) (398,346)
Prepaid and other (10,000) --
Furniture, fixtures and equipment (449,315) (50,514)
Investment in partnerships -- (21,452)
Other assets (61,978) (931)
Accounts payable 87,890 543,229
Accrued liabilities 60,687 1,673
Advances and deposits 100,000 --
Minority interest -- 12,980
------------ ------------
Net cash used for investing activities (11,232,910) (3,482,045)
CASH FLOWS FROM FINANCING ACTIVITIES
Notes payable:
Advances 280,938 --
Repayments (280,938) --
Proceeds from sale of common stock, net 14,854,580 4,368,016
Exercise of stock options 23,438 --
Exercise of stock subscription -- 350,000
------------ ------------
Net cash provided by financing activities 14,878,018 4,718,016
------------ ------------
Net increase in cash and cash equivalents 3,320,221 1,106,802
Cash and cash equivalents at beginning of year 1,122,233 15,431
------------ ------------
Cash and cash equivalents at end of year $ 4,442,454 $ 1,122,233
============ ============
</TABLE>
See accompanying notes.
F-7
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements
December 31, 1998
1. Summary of Significant Accounting Policies
Organization and Operations
CD Warehouse, Inc. and its wholly-owned subsidiaries, Compact Discs Management,
Inc. and CD Warehouse Finance Company (together the "Company") are engaged in
the franchising and ownership of retail music stores offering new and preowned
compact discs ("CDs") and related products. The Company was formed in Delaware
on September 5, 1996 and had only limited operations prior to its Initial Public
Offering and simultaneous business acquisition in January 1997. At December 31,
1998, the Company owns and operates 51 retail music stores located throughout
the United States and has 248 franchised stores throughout the United States,
and 15 stores located in Canada, England, France, Guatemala and Venezuela.
In December 1998, the Company established an internet website which will provide
a worldwide electronic store front for the sale of new and preowned CDs, related
music products, and concert and event tickets.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of CD
Warehouse, Inc. and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Cash Equivalents
Cash equivalents include money-market investments and investments in commercial
paper with maturities of three months or less when purchased.
F-8
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value.
The carrying amounts of cash and cash equivalents, trade receivables, and trade
accounts payable approximate fair value because of the short maturity of those
instruments. The Company's notes receivable from franchisees are at terms
consistent with market rate for the length of the note and risk of the borrower.
As such, the carrying amount for notes receivable approximates fair value.
Inventory
Inventory consists of new and preowned compact discs and is recorded at the
lower of average cost or market.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment, including leasehold improvements, are
recorded at cost and are depreciated on a straight-line basis over the estimated
useful lives of the assets which range from five to ten years.
Intangibles
Intangible assets relate principally to the excess cost over net assets acquired
of business and store acquisitions. Amortization of such costs are for periods
ranging from ten to twenty years.
Long-Lived Assets
In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," long-lived assets held and used by the Company are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. For purposes of evaluating
the recoverability of long-lived assets, the recoverability test is performed
using undiscounted net cash flows of the individual stores for long-lived assets
identified with individual stores, undiscounted net cash flows for acquired
franchises, and consolidated undiscounted net cash flows for long-lived assets,
not otherwise identifiable. No significant impairments were identified in 1998
or 1997.
F-9
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Franchise Fees and Royalties
Initial franchise fees are nonrefundable and are recognized in income when all
material services or conditions relating to the sale of the franchise have been
substantially performed or satisfied by the Company. Area development fees are
nonrefundable and are recognized in income on a pro rata basis when the
conditions for revenue recognition under the individual development agreements
are met. Royalties from franchise operations are recognized in income as earned.
Advertising Costs
Costs incurred in connection with advertising and promotion of the Company's
products are expensed as incurred. Such costs amounted to approximately $392,000
and $131,000 in 1998 and 1997, respectively.
Stock Options
The Company accounts for employee stock-based compensation using the intrinsic
value method prescribed by Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations. No
compensation expense is recorded with respect to stock options granted at prices
equal to the market value of the Company's common stock at the date of grant.
Upon exercise, the excess of the proceeds over the par value of the shares
issued is credited to additional paid-in capital.
Advertising Fund
The Company operates an Advertising Fund which receives contributions from
franchisees and the Company based on sales. These funds are used to provide and
support national advertising for the CD Warehouse brand. These funds and the
related expenditures are not included in the accompanying consolidated financial
statements.
F-10
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Net Income Per Share
The Company accounts for earnings per share in accordance with Statement of
Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share." SFAS
128 requires the disclosure of Basic and Diluted Earnings per Share ("EPS").
Basic EPS is calculated using income available to common shareowners divided by
the weighted average of common shares outstanding during the year. Diluted EPS
is similar to Basic EPS except that the weighted average of common shares
outstanding is increased to include the number of additional common shares that
would have been outstanding if the dilutive potential common shares, such as
options, had been issued. The treasury stock method is used to calculate
dilutive shares which reduces the gross number of dilutive shares by the number
of shares purchasable from the proceeds of the options assumed to be exercised
(Note 8).
Supplemental Cash Flow Information
For the years ending December 31, 1998 and 1997, 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
=========
F-11
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
Supplemental Cash Flow Information (continued)
In 1997, the Company purchased franchise interests of a Company franchisee
for 80,000 shares of the Company's common stock valued at the initial
public offering price of $5.00 per share:
Costs in excess of net assets acquired, net $301,806
Inventory 40,297
Furniture, fixtures and equipment 18,800
Investment in partnerships 37,510
Other assets 1,587
--------
$400,000
========
Income taxes paid in 1998 totaled $199,615. Interest paid in 1998 totaled
$2,374. There was no interest or income taxes paid in 1997.
2. Public Offerings
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 1997, the Company completed an Initial Public Offering ("Offering")
for 1,000,000 shares of its common stock at a price of $5 per share. In March
1997, the underwriters exercised an overallotment option and purchased an
additional 40,000 shares of common stock at $5 per share. The proceeds of the
Offering, after deducting the underwriting discount and offering expenses were
approximately $4.3 million.
F-12
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
3. Business Acquisitions
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,
CD Management, Inc., 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.
The 1998 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
F-13
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
3. Business Acquisitions (continued)
Company's private placement of common stock and operating cash flows. Following
are the Company's unaudited pro forma results for 1998 and 1997 assuming the
acquisitions occurred on January 1, 1997 (in thousands, except for per share
data):
<TABLE>
<CAPTION>
1998 1997
--------------------------
<S> <C> <C>
Total revenues $20,658,280 $16,893,947
Net income $1,068,014 $748,302
Net income per common share:
Basic $.30 $.21
Diluted $.28 $.21
Weighted average common shares:
Basic 3,550,550 3,550,550
Diluted 3,763,945 3,550,550
</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, 1997, or of future results of operations.
In January 1997, simultaneously with the closing of the Offering (Note 2), the
Company purchased substantially all of the assets of Compact Discs
International, Ltd. ("CDIL") for $3.2 million. Prior to the acquisition, CDIL
was engaged principally in the business of selling new and preowned audio
compact discs to its franchisees. Also in January 1997, the Company purchased
all of the franchise interests of the largest CDIL franchisee in exchange for
80,000 shares of the Company's common stock. These acquisitions were recorded in
January 1997 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 twenty years.
F-14
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
4. Notes Receivable
During 1998, the Company formed CD Warehouse Finance Company to provide
financing to new and existing franchisees. The financing is provided in the form
of notes receivable, secured by store assets and guarantees of the franchisees.
The notes generally require monthly payments of principal and interest, have a
two to four year term, and bear interest at 10.05%. Amounts outstanding under
these notes totaled $210,966 at December 31, 1998.
5. Furniture, Fixtures and Equipment
At December 31, 1998, furniture, fixtures and equipment, including leasehold
improvements, were comprised of the following:
Furniture, fixtures and equipment located at:
Corporate headquarters $ 405,052
Retail stores 1,421,996
Internet website development in progress 659,732
-----------
2,486,780
Accumulated depreciation (201,571)
-----------
$ 2,285,209
===========
Depreciation expense totaled $162,667 and $63,185 for 1998 and 1997,
respectively.
6. Intangibles and Other Assets
Intangibles and other assets consist of the following at December 31, 1998:
Excess of purchase price over net assets acquired
in business acquisitions $ 11,389,967
Deposits and other 132,209
------------
11,522,176
Accumulated amortization (613,758)
------------
$ 10,908,418
============
Amortization of goodwill totaled $454,583 and $175,415 in 1998 and 1997,
respectively.
F-15
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
7. Income Taxes
The significant components of income tax expense for the years ended December
31, 1998 and 1997 are as follows:
1998 1997
-------------------------------
Current tax expense:
Federal $ 339,000 $ 180,000
State 54,000 25,000
---------- ----------
393,000 205,000
Deferred tax expense:
Federal 62,000 22,000
State 11,000 3,000
---------- ----------
73,000 25,000
---------- ----------
$ 466,000 $ 230,000
===============================
The provision for income taxes differs from the computed "expected" income tax
provision using federal statutory rates on income before income taxes for the
following reasons:
Year ended December 31,
1998 1997
----------------------------
Computed "expected" income tax $ 422,059 $ 209,508
Increases in taxes resulting from:
State income taxes, net of federal benefit 43,013 18,488
Other 928 2,004
----------------------------
$ 466,000 $ 230,000
============================
Deferred income taxes and deferred tax liability at December 31, 1998 result
from differences in amortization of intangibles and depreciation of furniture
and fixtures for financial and tax purposes.
F-16
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
8. Stockholders' Equity
Earnings Per Share
1998 1997
-------------------------------
Income:
Income available to common shareowners $ 775,352 $ 386,199
===============================
Weighted average shares:
Outstanding 2,923,090 1,714,790
Dilutive shares assuming:
Exercise of stock options 276,750 --
Exercise of warrants 262,430 --
Less: Shares purchasable with proceeds (325,785) --
-------------- --------------
Total shares 3,136,485 1,714,790
===============================
Basic EPS $ 0.27 $ 0.23
===============================
Diluted EPS $ 0.25 $ 0.23
===============================
Options to purchase 261,000 shares of common stock at a range of $3.13 to $5.00
and warrants to purchase 100,000 shares of common stock at $7.50 per share were
outstanding during 1997 but were not included in the computation of the diluted
EPS because the exercise price was greater than the average market price of the
common shares.
Stock Option Plan
In December 1996, the Company adopted the 1996 Stock Option Plan which, as
amended, provides for grants of up to 600,000 shares of common stock to certain
employees, officers, directors and others. Generally, the purchase price of
stock issuable upon exercise of the options will be at least equal to the fair
market value of the stock on the dates of grant. Generally, options are
exercisable no longer than ten years from the dates of grant. The Company has
agreed to grant options to purchase 10,000 shares annually to each director. No
options were granted through December 31, 1996. In 1998 and 1997, options to
acquire 107,000 and 261,000 common shares, respectively, were granted at option
prices equal to the fair market value of the common stock on the date of grant.
No expense related to options granted was recorded in 1998 and 1997.
F-17
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
8. Stockholders' Equity (continued)
Stock option transactions for 1998 and 1997 are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
-------------------------- --------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
-------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 261,000 $ 3.84
Granted 107,000 $ 11.18 261,000 $ 3.84
Exercised (6,250) $ 3.75 --
Canceled, forfeited, or expired -- --
---------- -----------
Outstanding at end of year 361,750 $ 6.01 261,000 $ 3.84
========== ===========
Exercisable at end of year 88,042 $ 3.84 --
========== ===========
Weighted average fair value of options
granted during year $ 4.34 $ 2.18
========== ===========
</TABLE>
Outstanding options to acquire 361,750 shares of stock at December 31, 1998 had
exercise prices ranging from $3.13 to $12.88 per share and had a weighted
average remaining contractual life of 9 years.
The following pro forma information, as required by Statement of Financial
Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS
123"), presents net income and earnings per share information as if the Company
had accounted for stock options issued in 1998 and 1997 using the fair value
method prescribed by the Statement. The fair value of issued stock options was
estimated at the date of grant using a Black-Scholes option pricing model with
the following assumptions for 1998 and 1997, respectively: weighted average
risk-free interest rate of 5.49% and 5.81%; no dividends over the option term;
stock price volatility factor of .363 and .599, and a weighted average expected
option life of five years. For the purpose of the following pro forma
information, the estimated fair value as determined by the model was amortized
to expense over the respective vesting period. The SFAS 123 pro forma
information presented below is not necessarily indicative of the pro forma
effects to be presented in future periods.
F-18
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
8. Stockholders' Equity (continued)
The SFAS 123 pro forma information is as follows:
Year ended December 31,
1998 1997
-----------------------------
Net income:
As reported $ 775,352 $ 386,199
Pro forma $ 471,769 $ 348,951
Basic earnings per share:
As reported $ .27 $ .23
Pro forma $ .16 $ .20
Diluted earnings per share:
As reported $ .25 $ .23
Pro forma $ .15 $ .20
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of fair value of its stock options.
Warrants
In connection with the Offering, the Company sold to the underwriters, for a
price of $.001 per warrant, warrants to purchase 100,000 shares of common stock.
The underwriters' warrants are exercisable at $7.50 per share through January
2002.
In connection with the Placement, the placement agents were granted warrants to
purchase 162,430 shares of common stock exercisable at $10.00 per share through
2003.
F-19
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
9. Commitments and Contingencies
The Company has entered into employment agreements with three officers of the
Company. The employment agreements are for terms of one and five years with
renewal options of one and five years and total $380,000 annually for the three
individuals.
The Company has entered into operating leases primarily for its retail store
locations and corporate facilities. Rental expense under these leases totaled
$801,200 and $301,621 for 1998 and 1997, respectively. Total rental amounts of
$2,976,106 under these noncancelable leases are due as follows: 1999--
$1,086,762, 2000--$870,732, 2001--$600,403, 2002--$320,011, 2003--$94,245, and
thereafter--$3,953.
The Company is also involved in legal proceedings and litigation arising in the
ordinary course of business. In the opinion of management, the outcome of such
proceedings and litigation currently pending will not materially affect the
Company's consolidated financial statements.
10. Related Party Transactions
Pursuant to the purchase agreement with a predecessor franchisee (Note 3), the
franchisee served as an officer of the Company in 1997 and continued to provide
accounting services for the acquired franchise interests. The Company
compensated the officer for these accounting services and reimbursed certain
agreed upon office expenses. Amounts paid under this agreement totaled $109,288
in 1997. In December 1997, the individual resigned his position with the Company
and repurchased certain franchise interests from the Company. Total proceeds of
this sale amounted to $170,000 which approximated book value at the time of
sale. Additionally, the Company entered into a consulting arrangement with the
individual, which expired in March 1998, and provided for consideration of
$30,000.
The aforementioned reacquisition (Note 3) resulted in the Company entering into
an area development agreement (the "ADA") with the principal owner of CDIL (also
a stockholder of the Company). The ADA provides for the right to develop
franchise operations worldwide, except for the United States, Canada and Mexico.
The Company has the right, during a specified period of time, to cancel the ADA
and to acquire any franchise developed under the ADA at a specified multiple of
earnings. In addition, the Company has agreed to grant to the individual (1) ten
domestic franchises with no initial franchise fee and royalties of 2% of net
sales and (2) two renewal franchises with no franchise fee or royalty payments.
Except as provided for in the above mentioned franchise agreements, CDIL and the
individual have also entered into covenants not to compete with the Company for
a period of ten years.
F-20
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
11. Business Segment Information
The Company is engaged principally in one line of business--the sale of
prerecorded music compact discs and related products in Company and franchisee
owned retail stores--which represents approximately 98% of consolidated
revenues. There are no material amounts of sales among geographic areas,
individual foreign countries, or individual customers. All of the Company's
long-lived assets are located within the domestic United States.
12. Subsequent Events (unaudited)
In February 1999, the Company acquired the assets of Music Traders, 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.
In February 1999, the Company finalized a $7,000,000 credit facility consisting
of a $2,000,000 Line of Credit and a $5,000,000 Term Loan Agreement
("Agreement") with Bank One. Amounts borrowed under the Line of Credit or Term
Loan will bear an interest rate equal to the Bank One prime rate. This Agreement
replaced a credit facility with another financial institution which existed, but
was unused, as of December 31, 1998.
F-21
<PAGE>
EXHIBIT 4.4
CD WAREHOUSE, INC.
(a Delaware corporation)
WARRANT AGREEMENT
May 22, 1998
COMVEST PARTNERS, INC.
CAPITAL WEST SECURITIES, INC.
c/o COMVEST PARTNERS, INC.
8235 Douglas Avenue, Suite 525
Dallas, Texas 75225
Ladies/Gentlemen:
CD Warehouse, Inc., a Delaware corporation (the "Company"), agrees to issue
to you warrants (the "Warrants") to purchase the number of shares of common
stock, par value $0.01 per share (the "Common Stock"), of the Company set forth
herein, subject to the terms and conditions contained herein.
1. Issuance of Warrants; Exercise Price. The Warrants, which shall be
certificated in the form attached hereto as Exhibit A, shall be issued to you
concurrently with the execution hereof in consideration of the private placement
of a minimum of 1,400,000 shares (the "Minimum Offering") and a maximum of
1,800,000 shares (the "Maximum Offering") of the Company's Common Stock at a
price per share of $10 per share pursuant to that certain offering memorandum
dated May 4, 1998. The Warrant shall provide that you, or such other holder or
holders of the Warrants to whom transfer is authorized in accordance with the
terms of this Agreement, shall have the right to purchase an aggregate of one
(1) share of Common Stock for every 10 shares of Common Stock sold for an
exercise price equal to $10 per share (the "Exercise Price"); provided, however,
that the Minimum Offering has been sold.
2. Exercise of Warrants. At any time and from time to time on and after
the first anniversary of the date hereof and expiring on the fifth anniversary
of the effective date of this Agreement at 5:00 p.m., Central Standard Time,
Warrants may be exercised as to all or any portion of the whole number of shares
of Common Stock covered by the Warrants by the holder thereof by surrender of
the Warrants, accompanied by a subscription for shares to be purchased in the
form attached hereto as Exhibit B and by a check payable to the order of the
Company in the amount required for purchase of the shares as to which the
Warrant is being exercised, delivered to the Company at its principal office at
1204 Sovereign Row, Oklahoma City, Oklahoma, 73108, Attention: President.
Warrants may also be exercised from time to time, without any payment required
for the purchase of the shares as to which the Warrant is being exercised, as to
all or any portion of the number of shares of Common Stock covered by the
Warrant(s) by the holder thereof by surrender of the Warrants, accompanied by a
subscription for shares, pursuant to which the holder thereof will be entitled
to receive upon such surrender of the Warrant(s) (and without any further
payment) that number of shares of Common Stock equal to the product of the
number of shares of Common Stock obtainable upon exercise of the Warrant(s) (or
the portion thereof as to which the exercise relates ) multiplied by a fraction:
(i) the numerator of which shall be the difference between the then Current
Value (as hereinafter defined) of one full share of Common
<PAGE>
Stock on the date of exercise and the Exercise Price, and (ii) the denominator
of which shall be the Current Value of one full share of Common Stock on the
date of exercise. Upon the exercise of a Warrant in whole or in part, the
Company will within five (5) days thereafter, at its expense (including the
payment by the Company of any applicable issue or transfer taxes), cause to be
issued in the name of and delivered to the Warrant holder a certificate or
certificates for the number of fully paid and non-assessable shares of Common
Stock to which such holder is entitled upon exercise of the Warrant. In the
event such holder is entitled to a fractional share, in lieu thereof such holder
shall be paid a cash amount equal to such fraction, multiplied by the Current
Value of one full share of Common Stock on the date of exercise. Certificates
for shares of Common Stock issuable by reason of the exercise of the Warrant or
Warrants shall be dated and shall be effective as the date of the surrendering
of the certificates for the shares so purchased. In the event a Warrant is
exercised, as to less than the aggregate amount of all shares of Common Stock
issuable upon exercise of all Warrants held by such person, the Company shall
issue a new Warrant to the holder of the Warrant so exercised covering the
aggregate number of shares of Common Stock as to which Warrants remain
unexercised.
For purposes of this section, Current Value is defined (i) in the case for
which a public market exists for the Common Stock at the time of such exercise,
the average of the daily closing prices of the Common Stock for 20 consecutive
business days commencing 30 business days before the date of exercise, and (ii)
in the case no public market exists at the time of such exercise, at the
Appraised Value. For the purposes of this Agreement, "Appraised Value" is the
value determined in accordance with the following procedures. For a period of
five (5) days after the date of an event (a "Valuation Event") requiring
determination of Current Value at a time when no public market exists for the
Common Stock (the "Negotiation Period"), each party to this Agreement agrees to
negotiate in good faith to reach agreement upon the Appraised Value of the
securities or property at issue, as of the date of the Valuation Event, which
will be the fair market value of such securities or property, without premium
for control or discount for minority interests, illiquidity or restrictions on
transfer. In the event that the parties are unable to agree upon the Appraised
Value of such securities or other property by the end of the Negotiation Period,
then the Appraised Value of such securities or property will be determined for
purposes of this Agreement by a recognized appraisal or investment banking firm
mutually agreeable to the holders of the Warrants and the Company (the
"Appraiser"). If the holders of the Warrants and the Company cannot agree on an
Appraiser within two (2) business days after the end of the Negotiation Period,
the Company, on the one hand, and the holders of the Warrants, on the other
hand, will each select an Appraiser within ten (10) business days after the end
of the Negotiation Period and those two Appraisers will select ten (10) days
after the end of the Negotiation Period an independent Appraiser to determine
the fair market value of such securities or property, without premium for
control or discount for minority interests. Such independent Appraiser will be
directed to determine fair market value of such securities as soon as
practicable, but in no event later that thirty (30) days from the date of its
selection. The determination by an Appraiser of the fair market value will be
conclusive and binding on all parities to this Agreement. Appraised Value of
each share of Common stock at a time when (i) the Company is not a reporting
company under the Exchange Act and (ii) the Common Stock is not traded in the
organized securities markets, will, in all cases, be calculated by determining
the Appraised Value of the entire Company taken as a whole and dividing that
value by the number of shares of Common Stock then outstanding, without premium
for control or discount for minority interests, illiquidity or restrictions on
transfer. The costs of the Appraiser will be borne by the Company. In no event
will the Appraised Value of the Common Stock be less than the per share
consideration received or receivable with respect to the Common Stock or
securities or property of the same class in connection with a pending
transaction involving a sale, merger, recapitalization, reorganization,
consolidation, or share exchange, dissolution of the Company, sale or transfer
of all or a majority of its assets or revenue or income generating capacity, or
similar transaction.
2
<PAGE>
3. Indemnification; Contribution.
(a) The Company will indemnify and hold harmless each holder and each
affiliate thereof of Common Stock registered pursuant to this Agreement with the
Commission, or under any Blue Sky Law or regulation against any losses, claims,
damages, or liabilities, joint or several, to which such holder may become
subject under the Act or otherwise, insofar as such losses, claims, damages, or
liabilities (or actions in respect thereof) arise out of or are based upon an
untrue statement or alleged untrue statement of a material fact contained in any
Offering Memorandum or any amendment or supplement thereto, or arise out of or
are based upon the omission or alleged omission to state therein a material fact
required to be stated therein or necessary to make the statements therein not
misleading, and will reimburse each such holder and affiliate for any legal or
other expenses reasonably incurred by such holder in connection with
investigating or defending any such action or claim regardless of the negligence
of any such holder or affiliate; provided, however, that the Company shall not
be liable in any such case to the extent that any such loss, claim, damage, or
liability arises out of or is based upon an untrue statement or alleged untrue
statement or omission or alleged omission made in any preliminary Offering
Memorandum, or any such amendment or supplement thereto, in reliance upon and in
conformity with written information furnished to the Company by any such holder
expressly for use therein.
(b) Each holder of Common Stock registered pursuant to this Agreement
will indemnify and hold harmless the Company against any losses, claims,
damages, or liabilities to which the Company may become subject, under the Act
or otherwise, insofar as such losses, claims, damages, or liabilities (or
actions in respect thereof) arise out of or are based upon an untrue statement
or alleged untrue statement of a material fact contained in any Offering
Memorandum, or any amendment or supplement thereto, or arise out of or are based
upon the omission or alleged omission to state therein a material fact required
to be stated therein or necessary to make the statements therein not misleading,
in each case to the extent, but only to the extent, that such untrue statement
or alleged untrue statement or omission or alleged omission was made in any
Offering Memorandum, or any amendment or supplement thereto, in reliance upon
and in conformity with written information furnished to the Company by such
holder expressly for use herein.
(c) Promptly after receipt by an indemnified party under Sections
3(a) and (b) above of the commencement of any action, such indemnified party
shall, if a claim in respect thereof is to be made against the indemnifying
party under either such subsection, notify the indemnifying party in writing of
the commencement thereof; but the omission so to notify the indemnifying party
shall not relieve it from any liability that it may otherwise have to any
indemnified party. In case any such action shall be brought against any
indemnified party and it shall notify the indemnifying party of the commencement
thereof the indemnifying party shall be entitled to assume the defense thereof
by notice in writing to the indemnified party. After notice from the
indemnifying party to such indemnified party of its election to assume the
defense thereof, the indemnifying party shall not be liable to such indemnified
party under either of such subsections of any legal expenses of other counsel or
any other expense, in each case subsequently incurred by such indemnified party,
in connection with the defense thereof other than reasonable costs of
investigation incurred prior to the assumption by the indemnifying party, unless
such expenses have been specifically authorized in writing by the indemnifying
party, the indemnifying party has failed to assume the defense or employ
counsel, or the named parties to any such action include both the indemnified
party and the indemnifying party, as appropriate, and such indemnified party has
been advised by counsel that the representation of such indemnified party has
been advised by counsel that the representation of such indemnified party and
the indemnifying party by the same counsel that the representation of such
indemnified party and the indemnifying party by the same counsel would be
inappropriate due to actual or potential differing interests between them, in
each of which cases the fees of counsel for the indemnified party will be paid
by the indemnifying party.
3
<PAGE>
(d) If the indemnification provided for in this Section 3 is
unavailable or insufficient to hold harmless an indemnified party under Section
3(a) or (b) in respect of any losses, claims, damages, or liabilities (or action
in respect thereof) referred to therein, then each indemnifying party shall
contribute to the amount paid or payable by such indemnified party as a result
of such losses, claims, damages, or liabilities (or actions in respect thereof)
in such proportion as is appropriate to reflect the relative benefits received
by the Company and the holder or holders from this Agreement and from the
offering of the shares of Common Stock. If, however, the allocation provided by
the immediately preceding sentence is not permitted by applicable law, then each
indemnifying party shall contribute to such amount paid or payable by such
indemnified party in such proportion as is appropriate to reflect not only such
relative benefits but also the relative fault of the Company and the holders in
connection with the statement or omissions that resulted in such losses, claims,
damages, or liabilities (or actions in respect thereof), as well as any other
relevant equitable considerations. The relative fault shall be determined by
reference to, among other things, whether the untrue or alleged untrue statement
of a material fact or the omission or alleged omission to the state a material
fact related to information supplied by the Company or the holder and the
parties' relative intent, knowledge, access to information and opportunity to
correct or prevent such statement or omission. The Company and the holders agree
that it would not be just and equitable if contribution pursuant to this Section
3(d) were determined by pro rata allocation (even if the holders were treated as
one entity for such purpose) or by any other method of allocation that does not
take into account the equitable considerations referred to above in this
subsection (d). Except as provided in Section 8(c), the amount paid or payable
by an indemnified party as a result of the losses, claims, damages, or
liabilities (or actions in respect thereof) referred to above in this Section
8(d) shall be deemed to include any legal or other expenses reasonably incurred
by such indemnified party in connection with investigation or defending any such
action or claim. No person guilty of fraudulent misrepresentation (within the
meaning of Section 11(f) of the Act) shall be entitled to contribution from any
person who was not guilty of such fraudulent misrepresentation. Notwithstanding
any provision in this Section 8(d) to the contrary, no holder shall be liable
for any amount, in the aggregate, in excess of the net proceeds to such holder
from the sale of such holder's shares (obtained upon exercise of Warrants)
giving rise to such losses, claims, damages, or liabilities.
(e) The obligations of the Company under this Section 3 shall be in
addition to any liability that the Company may otherwise have and shall extend,
upon the same terms and conditions, to each person, if any, who controls any
holder of Warrants within the meaning of the Act. The obligations of the holders
of Common Stock under this Section 3 shall be in addition to any liability that
such holders may otherwise have and shall extend, upon the same terms and
conditions to each person, if any, who controls the Company within the meaning
of the Act.
4. Specific Performance. The Company stipulates that remedies at law, in
money damages, available to the holder of a Warrant, or of a holder of Common
Stock issued pursuant to exercise of a Warrant, in the event of any default or
threatened default by the Company in the performance of or compliance with any
of the terms of the Agreement are not and will not be adequate. Therefore, the
Company agrees that the terms of this Agreement may be specifically enforced by
a decree for the specific performance of any agreement contained herein or by an
injunction against a violation of any of the terms hereof or otherwise.
5. Successors and Assigns; Binding Effect. This Agreement shall be
binding upon and insure to the benefit of you and the Company and their
respective successors and permitted assigns.
6. Notices. Any notice hereunder shall be given by registered or
certified mail, if to the Company, at its principal office, and, if to the
holders, to the respective addresses shown in the Warrant ledger of the Company,
provided that any holder may at any time on three (3) days' written notice to
the
4
<PAGE>
Company designate or substitute another address where notice is to be given.
Notice shall be deemed given and received after a certified or registered
letter, properly addressed with postage prepaid, is deposited in the U.S. mail.
7. Severability. Every provision of this Agreement is intended to be
severable. If any term or provision hereof is illegal or invalid for any reason
whatsoever, such illegality or invalidity shall not affect the remainder of this
Agreement.
8. Assignment; Replacement of Warrants. If the Warrant or Warrants are
assigned, in whole or in part, the Warrants shall be surrendered at the
principal office of the company, and thereupon, in the case of a partial
assignment, a new Warrant shall be issued to the holder thereof covering the
number of shares not assigned, and the assignee shall be entitled to receive a
new Warrant covering the number of shares so assigned. Upon receipt of evidence
reasonably satisfactory to the Company of the loss, theft, destruction, or
mutilation of any Warrant and appropriate bond or indemnification protection,
the Company shall issue a new Warrant of like tenor. The Warrants will not be
transferred, sold, or otherwise hypothecated by you or any other person and the
Warrants will be nontransferable, except to (I) one or more persons, each of
which on the date of transfer is an officer, shareholder, or employee of you;
(ii) a partnership or partnerships, the partners of which are you and one or
more persons, each of whom on the date of transfer is an officer of you; (iii) a
successor to you in merger or consolidation; (iv) a purchaser of all or
substantially all of your assets; or (v) a person that receives a Warrant upon
death of a holder pursuant to will, trust, or the laws of intestate succession.
9. Governing Law. This Agreement shall be governed and construed in
accordance with the laws of the State of Texas without giving effect to the
principles of choice of laws thereof.
10. Definition. All references to the word "you," and to "Capital West
Securities, Inc." and "ComVest Partners, Inc." in this Agreement shall be deemed
to apply with equal effect to any persons or entities to whom Warrants have been
transferred in accordance with the terms hereof, and, where appropriate, to any
persons or entities holding shares of Common Stock issuable upon exercise of
Warrants.
11. Headings. The headings herein are for purposes of reference only and
shall not limited or otherwise affect the meaning of any of the provisions
hereof.
12. Counterparts. This Agreement may be signed in several counterparts,
each of which will constitute an original.
Very truly yours,
CD WAREHOUSE, INC.
By: /s/ Doyle E. Motley
--------------------------------------
Doyle E. Motley, Senior Vice President
and Chief Financial Officer
5
<PAGE>
Accepted as of the 22nd day of May, 1998
COMVEST PARTNERS, INC.
By: /s/ Andrew May
--------------------------------------
Andrew May, President
CAPITAL WEST SECURITIES, INC.
By: /s/ Robert O. McDonald
--------------------------------------
Robert O. McDonald, Chairman
6
<PAGE>
EXHIBIT 21.1
LIST OF SUBSIDIARIES AS OF
DECEMBER 31, 1998
(1) Compact Discs Management, Inc., a Delaware Corporation.
(2) CD Warehouse Finance Company, a Nevada Corporation.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement Form
S-8 No. 333-72651 pertaining to the CD Warehouse, Inc. Amended 1996 Stock Option
Plan, the Registration Statement Form S-3 No. 333-58451 for the registration of
2,036,730 shares of common stock and the Registration Statement Form S-3 No.
333-72755 for the registration of 316,430 shares of common stock, and the
related Prospectuses of our report dated February 19, 1999, with respect to
the consolidated financial statements of CD Warehouse, Inc. included in the
Annual Report Form 10-KSB for the year ended December 31, 1998.
/s/ ERNST & YOUNG LLP
Oklahoma City, Oklahoma
March 15, 1999
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
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<SECURITIES> 0
<RECEIVABLES> 1,057,939
<ALLOWANCES> 0
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<CURRENT-ASSETS> 9,988,076
<PP&E> 2,285,209
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<TOTAL-ASSETS> 23,311,168
<CURRENT-LIABILITIES> 1,444,654
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0
0
<COMMON> 35,506
<OTHER-SE> 21,733,008
<TOTAL-LIABILITY-AND-EQUITY> 23,311,168
<SALES> 12,184,781
<TOTAL-REVENUES> 15,261,903
<CGS> 7,816,458
<TOTAL-COSTS> 14,252,568
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