<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the period ended September 30, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________________ to ___________________.
Commission File Number 000-21887
CD WAREHOUSE, INC.
------------------
(Exact name of registrant as specified in its charter)
DELAWARE 73-1504999
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1204 Sovereign Row, Oklahoma City, Oklahoma 73108
- ------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (405) 949-2422
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
------ ------
The number of shares outstanding of the Issuer's Common Stock, $.01 par value,
as of August 11, 1999 was 3,660,295.
Transitional Small Business Disclosure Format (check one): Yes No X
--- ---
<PAGE>
FORM 10-QSB
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
PART I. FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - December 31, 1998 and
September 30, 1999 (unaudited)........................................... 3
Condensed Consolidated Statements of Operations - Three months
and nine months ended September 30, 1998 and 1999 (unaudited)............ 4
Condensed Consolidated Statements of Cash Flows - Nine months
ended September 30, 1998 and 1999 (unaudited)............................ 5
Notes to Condensed Consolidated Financial Statements (unaudited)......... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................ 9
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K......................................... 17
Signatures....................................................................... 18
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Information at September 30, 1999 is unaudited)
ASSETS
<TABLE>
<CAPTION>
December 31, 1998 September 30, 1999
----------------- ------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 4,442,454 $ 707,956
Accounts receivable, net 976,438 822,940
Notes receivable 81,501 90,928
Merchandise inventory 4,366,422 9,167,074
Prepaid expenses and other 121,261 176,192
Refundable income taxes - 487,140
------------ ------------
Total current assets 9,988,076 11,452,230
Furniture, fixtures and equipment, net 2,285,209 5,091,219
Notes receivable, due after one year 129,465 69,254
Intangible and other assets, net 10,908,418 11,947,917
------------ ------------
$ 23,311,168 $ 28,560,620
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 640,019 $ 2,306,376
Accrued liabilities 313,250 478,584
Advances and deposits 93,000 138,000
Current portion of long-term debt - 1,490,120
Income taxes payable 398,385 -
------------ ------------
Total current liabilities 1,444,654 4,413,080
Long-term debt - 1,599,272
Deferred income taxes 98,000 98,000
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized, none issued - -
Common stock, $.01 par value; 10,000,000
shares authorized, 3,550,550 and 3,660,295
issued and outstanding at December 31, 1998
and September 30, 1999, respectively 35,506 36,603
Additional paid-in-capital 20,571,755 21,758,158
Retained earnings 1,161,253 655,507
------------ ------------
Total stockholders' equity 21,768,514 22,450,268
------------ ------------
$ 23,311,168 $ 28,560,620
============ ============
</TABLE>
(See accompanying notes)
3
<PAGE>
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
-------------------------------- ---------------------------------
September 30, September 30, September 30, September 30,
1998 1999 1998 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Company operations:
Retail store sales $ 2,335,937 $ 6,978,882 $ 5,823,712 $ 18,913,660
Wholesale merchandise sales 580,064 141,454 2,046,592 365,437
Software income, net 3,051 14,271 29,700 61,940
Franchise operations:
Royalty income 883,400 948,634 1,840,442 2,810,718
Management fees 18,725 - 56,175 -
Franchise and development fees 47,000 51,000 124,500 104,000
------------ ------------ ------------ ------------
Total revenues 3,868,177 8,134,241 9,921,121 22,255,755
Operating costs and expenses:
Cost of sales - retail store sales 1,360,731 4,209,442 3,386,956 11,100,892
Cost of sales - wholesale merchandise sales 511,957 120,981 1,850,932 244,994
Retail store operating expenses 841,579 2,921,459 2,052,327 7,187,992
General and administrative 670,860 1,114,422 1,704,496 3,386,925
Depreciation and amortization 206,428 387,835 360,010 1,062,090
------------ ------------ ------------ ------------
Total operating costs and expenses 3,591,555 8,754,139 9,354,721 22,982,893
------------ ------------ ------------ ------------
Operating income (loss) 276,622 (619,898) 566,400 (727,138)
Other income (expense), net 94,721 (68,332) 182,188 (83,008)
------------ ------------ ------------ ------------
Income (loss) before income taxes 371,343 (688,230) 748,588 (810,146)
Provision (credit) for income taxes 139,650 (257,700) 281,150 (304,400)
------------ ------------ ------------ ------------
Net income (loss) $ 231,693 (430,530) $ 467,438 $ (505,746)
============ ============ ============ ============
Net income (loss) per share-basic and diluted $ .06 $ (.12) $ .16 $ (.14)
============ ============ ============ ============
Weighted average diluted common shares $ 3,859,697 $ 3,660,295 $ 2,910,014 $ 3,636,425
============ ============ ============ ============
</TABLE>
(See accompanying notes)
4
<PAGE>
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
----------------------------------------------------
September 30, 1998 September 30,1999
------------------ --------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITES:
Net income (loss) $ 467,438 $ (505,746)
Adjustments to reconcile net income to net cash
Used for operating activities:
Depreciation and amortization 360,010 1,062,090
Loss on disposal of assets 6,892 27,529
Changes in operating assets and liabilities:
Accounts receivable, net (393,107) 163,278
Inventories (700,611) (1,743,674)
Prepaid expenses and other (38,067) (51,166)
Refundable income taxes - (487,140)
Investment in partnership (66,872) -
Other assets (2,989) (91,057)
Accounts payable (517,833) 1,666,357
Accrued liabilities 39,785 165,334
Advances and deposits (25,500) 45,000
Income taxes payable 81,535 (398,385)
Minority interests (14,484) -
------------ ------------
Total adjustments (1,271,241) 358,166
------------ ------------
Net cash used by operating activities (803,803) (147,580)
CASH FLOW FROM INVESTING ACTIVITIES:
Notes receivable
Advances - (10,000)
Collections - 60,784
Purchase of furniture, fixtures and equipment (497,825) (3,014,053)
Proceeds from disposal of assets 115,030 -
Acquisition of businesses:
Cost in excess of net assets of companies acquired, net (7,025,542) (1,558,101)
Accounts receivable (85,000) (9,780)
Inventory (635,428) (2,056,978)
Prepaid expenses and other (10,000) (3,765)
Furniture, fixtures and equipment (155,700) (243,352)
Other assets (14,300) (28,565)
Advances and deposits 100,000 -
------------ ------------
(7,825,970) (3,900,541)
------------ ------------
Net cash used for investing activities (8,208,765) (6,863,810)
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net:
Proceeds from exercise of stock options - 187,500
Private placement 14,854,580 -
Collection of stock subscription 23,438 -
Notes payable
Advances - 3,500,000
Repayments - (410,608)
------------ ------------
Net cash provided by financing activities 14,878,018 3,276,892
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,865,450 (3,734,498)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,122,233 4,442,454
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 6,987,683 $ 707,956
============ ============
</TABLE>
5
<PAGE>
CD WAREHOUSE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(unaudited)
Supplemental Cash Flow Information:
For the nine months ending September 30, 1998 and 1999, the Company had the
following noncash investing and financing activities:
In 1998, the Company purchased partnership interests of a Company
franchisee for cash of $173,471 and 100,000 shares of the Company's common stock
valued at $3.625 per share. The noncash portion of this transaction is as
follows:
<TABLE>
<S> <C>
Costs in excess of net assets acquired, net $ 281,412
Inventory 221,208
Furniture, fixtures and equipment 70,080
Other assets 10,616
Accounts payable and accrued liabilities (47,345)
-------------------
535,971
Less cash paid (173,471)
-------------------
$ 362,500
===================
</TABLE>
In 1999, the Company acquired the assets of Music Trader, Inc. for cash of
$3,000,000 and 84,745 shares of the Company's common stock valued at $11.80 per
share. The non-cash portion of this transaction is as follows:
<TABLE>
<S> <C>
Costs in excess of net assets acquired, net $ 966,880
Prepaid expenses and other 9,780
Inventory 2,837,312
Furniture, fixtures and equipment 160,000
Other assets 26,028
-------------------
4,000,000
Less cash paid (3,000,000)
-------------------
$ 1,000,000
===================
</TABLE>
6
<PAGE>
CD WAREHOUSE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The condensed consolidated financial statements as of December 31, 1998 and
September 30, 1999 and for the nine months ended September 30, 1998 and 1999,
include the accounts of CD Warehouse, Inc. (the "Company"), its wholly owned
subsidiaries, Compact Discs Management, Inc. ("CDM"), and CD Warehouse Finance
Company ("CDF"). All material intercompany accounts and transactions have been
eliminated in consolidation.
The accompanying interim condensed consolidated financial statements of the
Company are unaudited; however, in the opinion of management, all adjustments
necessary for a fair presentation of such condensed consolidated financial
statements have been reflected in the interim periods presented. Such
adjustments consisted only of normal recurring items. The results of operations
for the nine months ended September 30, 1999 are not necessarily indicative of
the results to be expected for the full year ending December 31, 1999. The
significant accounting policies and certain financial information which are
normally included in financial statements prepared in accordance with generally
accepted accounting principles, but which are not required for interim reporting
purposes, have been condensed or omitted. The accompanying condensed
consolidated financial statements of the Company should be read in conjunction
with the consolidated financial statements and related notes included in the
Company's Form 10-KSB.
NOTE 2. PRIVATE PLACEMENT OFFERING AND BUSINESS ACQUISITIONS
In May 1998, the Company completed a private placement ("Placement") of
1,624,300 shares of common stock at $10.00 per share. Proceeds from the
Placement, after deducting the placement discount and placement expenses, were
approximately $14.8 million. The net proceeds from the Placement were used for
acquisitions, expansion, provision of financing to franchisees, and working
capital. The Company effected a Registration Statement on Form S-3 related to
such shares in September 1998.
In January 1998, the Company purchased five CD Warehouse stores from a
franchisee ("ZDTMAC") for cash of $173,471 and 100,000 shares of common stock
valued at $3.625 per share for a total purchase price of $535,971. The
acquisition was recorded under the purchase method of accounting and resulted in
an allocation of excess of purchase price over net assets acquired of $281,412
which is amortized on a straight-line basis over ten years.
In June 1998, the Company acquired the assets of three retail stores and
franchise rights for 134 franchisees of Disc Go Round ("DGR"), a competing
retailer of new and preowned compact discs, for cash of $7 million and
assumption of liabilities of $100,000. The acquisition was accounted for under
the purchase method of accounting and resulted in an allocation of excess of
purchase price over net assets acquired of $6,830,992 which is amortized on a
straight-line basis over fifteen years.
In October 1998, the Company acquired, for cash of $1,737,867, the assets
and liabilities of three partnerships: Compact Disc Investments II, Ltd.,
Compact Disc Investment V, Ltd., and Compact Disc Associates, L.L.C. which
collectively owned 16 CD Warehouse stores. The Company, through its wholly-
owned subsidiary, CDM, previously owned a majority or minority interest in these
partnerships. Upon the acquisition of these assets and liabilities, the related
partnerships were dissolved. The acquisition was accounted for under the
purchase method of accounting and resulted in an allocation of excess of
purchase price over net assets acquired of $629,245, which is amortized on a
straight-line basis over ten years.
7
<PAGE>
CD WAREHOUSE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
In February 1999, the Company acquired the assets of Music Trader, Inc., a
16-store retail music chain based in Southern California for cash of $3,000,000
and 84,745 shares for the Company's common stock for a total purchase price of
approximately $4,000,000. The acquisition was recorded under the purchase
method of accounting and resulted in an allocation of excess of purchase price
over net assets acquired for $966,880 which is amortized on a straight-line
basis over ten years.
The acquisitions described above were accounted for by the purchase method
of accounting for business combinations. Accordingly, the accompanying
consolidated statements of income do not include any revenues or expenses
related to these acquisitions prior to the respective closing dates. The cash
portions of the acquisitions were financed through proceeds from the Company's
private placement of common stock, operating cash flows and bank borrowings.
Following are the Company's unaudited pro forma results for the nine months
ended September 30, 1998 and 1999 assuming the acquisitions and the private
placement occurred on January 1, 1998 (in thousands, except for per share data):
<TABLE>
<CAPTION>
1998 1999
----------------------------------------
<S> <C> <C>
Total revenues $ 20,489,057 $ 23,308,705
Net income (loss) $ 840,149 $ (428,608)
Net income (loss) per share-basic and diluted $ .22 $ (.12)
Weighted average diluted common shares 3,833,671 3,652,877
</TABLE>
These unaudited pro forma results have been prepared for comparative
purposes only and include certain adjustments, including amortization of
goodwill as a result of the acquisitions, and do not purport to be indicative of
the results of operations which would have actually resulted had the
combinations been in effect on January 1, 1998, or of future results of
operations.
NOTE 3. EARNINGS PER SHARE
Shares used in the computation of diluted earnings per share include
dilutive outstanding stock options and warrants after giving effect to the
treasury stock method for assumed exercise.
8
<PAGE>
Item 2. Management's Discussion and Analysis or Plan of Operation.
This Report includes "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933, as amended (the "Act"), and Section 21E of
the Securities Exchange Act of 1934, as amended. All statements other than
statements of historical facts included in this Report, including, without
limitation, statements regarding the Company's future financial position,
business strategy, budgets, projected costs and plans and objectives of
Management for future operations, are forward-looking statements. In addition,
forward-looking statements generally can be identified by the use of forward-
looking terminology such as "may," "will," "expect," "intend," "estimate,"
"anticipate" or "believe" or the negative thereof or variations thereon or
similar terminology. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such expectations will prove to have been correct. Such
statements are based upon numerous assumptions about future conditions, which
may ultimately prove to be inaccurate and actual events, and results may
materially differ from anticipated results described in such statements.
Important factors that could actual results to differ materially from the
Company's expectations ("cautionary statements") include the risks inherent
generally in the retail and franchising industries, the impact of competition
and pricing, changing market conditions, the risks disclosed under "Item 2-
Management's Discussion and Analysis or Plan of Operation" and elsewhere in this
Report. All subsequent written and oral forward-looking statements attributable
to the Company, or persons acting on its behalf, are expressly qualified in
their entirety by the cautionary statements. The Company assumes no duty to
update or revise its forward-looking statements based on changes in internal
estimates or expectations or otherwise. As a result, the reader is cautioned
not to place reliance on these forward-looking statements. Further, there can
be no assurance that the historical level of the Company's revenues and net
income will continue to be achieved in the future. As used in herein, the word
"Company" means CD Warehouse, Inc. and its wholly owned subsidiaries, Compact
Discs Management, Inc., and CD Warehouse Finance Company, unless the context
indicates otherwise.
Overview
The Company was formed in September 1996 to acquire the franchise
operations of Compact Discs International, Ltd., a Texas limited partnership,
which franchised and operated stores throughout the United States and England
under the name "CD Warehouse." The first CD Warehouse store was opened in 1992.
Under the CD Warehouse name, as of September 30, 1999, there were 235 domestic
units operating in 34 states and the District of Columbia, and 11 international
units operating in England, Canada, France, Guatemala and Venezuela.
On June 26, 1998 the Company completed the acquisition, from Grow Biz
International, Inc. ("Grow Biz"), of the franchise rights to 134 Disc Go Round
retail music stores, as well as the acquisition of the assets of three Disc Go
Round stores owned and operated by Grow Biz, for an aggregate purchase price of
approximately $7 million. The Company has continued to operate the Disc Go
Round stores as a separate franchise system. As of September 30, 1999, the
Company's CD Warehouse and Disc Go Round franchise systems had a total of 336
stores operating in 40 states and the District of Columbia domestically and in
five different countries internationally.
Results of Operations
The Company derives its revenues primarily from retail sales of its
company-owned stores, wholesale merchandise sales to franchisees of the Company
and royalty fees from franchisees. The Company also receives revenues from
initial franchise fees, area development fees and software income. Retail store
cost of sales and operating expenses relate directly to company-owned retail
store sales. Wholesale merchandise sales and associated cost of sales relate to
the Company's franchising operations. Other expenses, such as depreciation,
amortization, and general and administrative expenses, relate to company-owned
store operations, as well as the Company's franchising operations. The number
and sales volumes of company-owned retail stores directly affect the Company's
revenues and expenses. The Company's revenues and, to a lesser extent,
expenses, also are affected by the number and sales volumes of franchise stores.
Initial franchise fees are directly affected by the number of franchised store
openings.
9
<PAGE>
The following table sets forth the percentage relationship to total revenues,
unless otherwise indicated, of certain items included in the Company's statement
of operations.
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1998 1999 1998 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Retail store sales 60.4% 85.8% 58.7% 85.0%
Wholesale merchandise sales 15.0 1.7 20.6 1.6
Software income, net .1 .2 .3 .3
Royalty income 22.8 11.7 18.5 12.6
Management fees .5 -- .6 --
Franchise and development fees 1.2 .6 1.3 .5
----------- ----------- ----------- -----------
100.0% 100.0% 100.0% 100.0%
=========== =========== =========== ===========
Operating costs and expenses:
Cost of sales-retail stores sales (1) 58.3% 60.3% 58.2% 58.7%
Cost of sales-wholesale merchandise sales (2) 88.3 85.5 90.4 67.0
Retail store operating expenses (1) 36.0 41.9 35.2 38.0
General and administrative 17.3 13.7 17.2 15.2
Depreciation and amortization 5.3 4.7 3.6 4.8
Operating income (loss) 7.2 (7.6) 5.7 (3.3)
Other income (expense), net 2.4 (.8) 1.8 (.4)
Net income (loss) 6.0% (5.3)% 4.7% (2.3)%
(1) As percentage of retail store sales.
(2) As percentage of wholesale merchandise sales.
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1998 1999 1998 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales Data:
System wide sales
CD Warehouse $13,751,762 $20,567,700 $37,939,457 $56,247,335
Disc Go Round $ 8,142,969 $ 6,299,566 $ ( C ) $21,624,817
Percentage increase (A)
CD Warehouse 46% 50% 51% 48%
=========== =========== =========== ===========
Disc Go Round ( C ) (23)% ( C ) ( C )
Average monthly sales per store
CD Warehouse $ 28,909 $ 30,518 $ 27,673 $ 30,111
=========== =========== =========== ===========
Disc Go Round $ 21,317 $ 23,370 $ ( C ) $ 22,271
=========== =========== ============ ===========
Change in comparable retail store sales (B)
CD Warehouse 14% 8% 16% 13%
=========== =========== =========== ===========
Disc Go Round ( C ) 6% ( C ) ( C )
===========
(A) Represents percentage increase from comparable period in prior year.
(B) Represents percentage increase for stores open in both periods reported.
(C) Acquired Disc Go Round June, 1998 - Data unavailable for computation.
</TABLE>
10
<PAGE>
The following table sets forth the number of stores opened and closed
throughout the CD Warehouse System during fiscal 1999:
<TABLE>
<CAPTION>
December 31, Open Close Transfer September 30,
1998 1999
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Franchise Stores
Domestic - CD Warehouse 128 15 (6) 22 159
Domestic - Disc Go Round 120 -- (9) ( 27) 84
------------ ------------ ------------ ------------ ------------
248 15 (15) (5) 243
International - CD Warehouse 7 2 -- 2 11
International - Disc Go Round 8 -- -- (2) 6
------------ ------------ ------------ ------------ ------------
15 2 -- -- 17
Company-owned Stores
Domestic - CD Warehouse 51 24 (4) 5 76
Domestic - Disc Go Round -- -- -- -- --
------------ ------------ ------------ ------------ ------------
51 24 (4) 5 76
------------ ------------ ------------ ------------ ------------
Total 314 41 (19) -- 336
============ ============ ============ ============ ============
</TABLE>
Three Months Ended September 30, 1999 compared to Three Months Ended September
30, 1998 (all numbers rounded to the nearest thousand).
Revenues
Retail store sales increased $4,643,000 to $6,979,000 for the three months
ended September 30, 1999, compared to $2,336,000 for the three months ended
September 30, 1998. The 199% increase in retail store sales is the result of
having 76 company stores in operation during the three months ended September
30, 1999, compared to only 28 company stores during the same period in 1998.
Wholesale merchandise sales were $141,000 for the three months ended
September 30, 1999, compared to $580,000 for the same period in 1998, a decrease
of $439,000, or 75%. The decrease reflects the Company's continued phasing out
of its "one-stop" warehouse operations since 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 $66,000 to $949,000 for the three months ended
September 30, 1999, compared to $883,000 for the same period in 1998. Same
store sales for stores operating as CD Warehouse increased by 8% for the three
months ended September 30, 1999, with monthly average sales for all CD Warehouse
stores increasing from $28,909 for the three months ended September 30, 1998 to
$30,518 for the same period in 1999. Same store sales for stores operating as
Disc Go Round increased by 6% for the three months ended September 30, 1999,
with monthly average sales for all Disc Go Round stores increasing from $21,317
for the three months ended September 30, 1998 to $23,370 for the same period in
1999.
Costs and Expenses
Cost of sales for retail store sales increased $2,849,000, or 209%, for the
three months ended September 30, 1999 compared to the same period in 1998. This
increase is consistent with the increase of retail store revenue discussed
above. However, cost of sales as a percentage of sales increased to 60% of
sales for the three months
11
<PAGE>
ended September 30, 1999 compared to 58% of sales for the three months ended
September 30, 1998. The increase is primarily due to the change in sales mix
between used product and new product, which has a greater cost of sales.
Costs of sales for wholesale merchandise decreased 76% to $121,000 for the
three months ended September 30, 1999, compared to $512,000 in 1998. The
decrease is consistent with the decrease in wholesale merchandise sales. Cost
of sales was 86% of sales for the three months ended September 30, 1999,
compared to 88% for the comparable period in 1998.
Retail store operating expenses increased $2,079,000 to $2,921,000 for the
three months ended September 30, 1999, compared to $842,000 for the three months
ended September 30, 1998. Although the increase is due primarily to the
increase of company-owned stores discussed above, retail store operating expense
was 42% of retail store revenue for the three months ended September 30, 1999,
compared to 36% of retail store revenue for the same period in 1998. The
increase in retail store operating expense as a percentage of retail store
revenue is attributable principally to (i) expenses associated with the
Company's new advertising campaign, aimed to aggressively position itself
against its competitors, who have also recently launched marketing blitzes, (ii)
increased payroll costs associated with retail store preparation to upload the
stores' used inventory for sale on the Company's E-Commerce website, and (iii)
severe weather in certain company store markets, which resulted in unexpected
store closings due to the weather conditions. The Company anticipates that
retail store operating expense as a percentage of retail store revenue will
decrease from the level experienced during the three months ended September 30,
1999.
General and administrative expenses increased by $443,000 to $1,114,000 for
the three months ended September 30, 1999, compared to $671,000 for the three
months ended September 30, 1998. This increase resulted from the continued
growth in company-owned stores (increase of 48 stores). The three months ended
September 30, 1999 also included costs associated with operating two separate
franchise concepts, certain non-recurring legal and administrative expenses and
implementing operations of the Company's E-Commerce site in all company stores.
Depreciation and Amortization
Depreciation and amortization increased $182,000 to $388,000 for the three
months ended September 30, 1999, compared to $206,000 for the same period in
1998. This is due to the addition of 48 company-owned stores, costs associated
with E-Commerce and the amortization of goodwill associated with various
acquisitions (discussed in the financial statements) effected during 1998 and
1999.
Net Income (loss)
The Company experienced a net loss of $431,000 for the three months ended
September 30, 1999, compared to net income of $232,000 for the three months
ended September 30, 1998. The net loss is due primarily to the increase in cost
of sales, retail operating expenses and general and administrative cost
described above. Net loss was also affected by the decrease in other income of
$163,000. This was caused by the reduction of interest income of approximately
$80,000 combined with increase of interest expense of $65,000. The remaining
difference relates to costs associated with closing three company stores.
Nine Months Ended September 30, 1999 compared to Nine Months Ended September 30,
1998 (all numbers rounded to the nearest thousand).
Revenues
Retail store sales increased $13,090,000 to $18,914,000 for the nine months
ended September 30, 1999, compared to $5,824,000 for the nine months ended
September 30, 1998. The 224% increase in retail store sales is the result of
having 76 company stores in operation during the nine months ended September 30,
1999, compared to only 28 during the same period in 1998.
Wholesale merchandise sales decreased 82% to $365,000 for the nine months
ended September 30, 1999, compared to $2,047,000 for the same period in 1998.
The decrease is due to the Company discontinuing its "one-
12
<PAGE>
stop" warehouse operations in May 1998, which acquired new CD releases from the
major record labels and sold them to the franchise system with minimal mark up.
The Company has determined to focus its efforts on warehousing used product to
open new stores and eventually sell used product to the franchise system.
Royalty income increased $971,000 to $2,811,000 for the nine months ended
September 30, 1999, compared to $1,840,000 for the same period in 1998. A
substantial portion of the increase is attributable to the inclusion of the Disc
Go Round franchise stores to the Company's operations in July 1998, which
contributed approximately $725,000 of royalty income during the first six months
of 1999. Additionally, same store sales for stores operating as CD Warehouse
increased by 13% for the nine months ended September 30, 1999, with monthly
average sales for all CD Warehouse stores increasing from $27,673 for the nine
months ended September 30, 1998 to $30,111 for the same period in 1999. No same
store sales information is available for Disc Go Round stores for the period
preceding the Company's acquisition of the Disc Go Round franchise system in
June 1998.
Costs and Expenses
Cost of sales for retail store sales increased $7,714,000 for the nine
months ended September 30, 1999, compared to the same period in 1998. This 228%
increase is consistent with the increase of retail store revenue discussed
above. However, cost of sales as a percentage of sales remained fairly constant
at 58% of sales for both the nine months ended September 30, 1999 and September
30, 1998.
Costs of sales for wholesale merchandise decreased $1,606,000 to $245,000
for the nine months ended September 30, 1999, compared to $1,851,000 in 1998.
The 86% decrease is consistent with the decrease in wholesale merchandise sales.
Cost of sales was 67% of sales for the nine months ended September 30, 1999
compared to 90% for the comparable period in 1998.
Retail store operating expenses increased $5,136,000 to $7,188,000 for the
nine months ended September 30, 1999, compared to $2,052,000 for the nine months
ended September 30, 1998. The 260% increase is due to the increase of company-
owned stores discussed above. Retail store operating expense was 38% of retail
store revenue for the nine months ended September 30, 1999, compared to 35% of
retail store revenue for the same period in 1998. The increase relates to costs
associated with absorbing the acquisition of the 16 Music Trader stores late in
the first quarter of 1999, as well as the factors discussed above relating to
the increase in retail store operating expense for the three months ended
September 30, 1999.
General and administrative expenses increased by $1,683,000 to $3,387,000
for the nine months ended September 30, 1999, compared to $1,704,000 for the
nine months ended September 30, 1998. This increase resulted from the continued
growth in company-owned stores (increase of 48 stores). The nine months ended
September 30, 1999 also included costs associated with operating two separate
franchise concepts, certain non-recurring legal and administrative expenses and
implementing operations of the Company's E-Commerce site in all company stores.
Depreciation and Amortization
Depreciation and amortization increased $702,000 to $1,062,000 for the nine
months ended September 30, 1999 compared to $360,000 for the same period in
1998. This is due to the addition of 48 company-owned stores, costs associated
with E-Commerce and the amortization of goodwill associated with various
acquisitions (discussed in the financial statements) effected during 1998 and
1999.
Net Income (loss)
The Company experienced a net loss of $506,000 for the nine months ended
September 30, 1999, compared to net income of $467,000 during the same period in
1998. The net loss is due primarily to the increase in cost of sales, retail
operating expenses and general and administrative cost described above. Net loss
was also affected by the decrease in other income of $265,000. This was caused
by the reduction of interest income of approximately $160,000 combined with
increase of interest expense of $145,000. The remaining difference relates to
costs associated with closing three company stores.
13
<PAGE>
Liquidity and Capital Resources
At September 30, 1999 the Company had working capital of $7,039,000 and
cash and cash equivalents aggregating $708,000, compared to working capital of
$8,543,000 and cash and cash equivalents of $4,442,000 at December 31, 1998.
Net cash used by operating activities was $148,000 for the nine months ended
September 30, 1999, compared to net cash used for operating activities of
$804,000 for the nine months ended September 30, 1998. The net cash used by
operations for the nine months ended September 30, 1999 relates principally to
an increase in inventory of $1,744,000, resulting from both an increase in
company stores as well as continued planned growth of per store inventory
quantities. This increase was offset by an increase in accounts payable of
$1,666,000 consisting primarily of amounts due to E-Commerce related vendors.
The net cash used for operating activities for the nine months ended September
30, 1998 was due principally to the reduction of amounts due the major labels
because of the company's decision to discontinue its warehouse operations
relating to new CDs and increase in retail store inventory.
Net cash used for investing activities was $6,864,000 for the nine months
ended September 30, 1999, compared to $8,209,000 for the same period in 1998.
The significant uses of cash for investing activities in 1999 relate to the
acquisition of Music Trader, Inc. in February 1999, development costs relating
to E-Commerce, and continued company store growth. The use in 1998 related
primarily to the acquisition of Disc Go Round in June 1998.
Net cash provided from financing activities was $3,277,000 for the nine
months ended September 30, 1999, compared to $14,878,000 for the same period in
1998. The net cash provided from financing in 1999 relates to bank debt of
$3,500,000 used to acquire Music Trader, Inc. and open new company stores, as
well as proceeds from the exercise of stock warrants issued in connection with
the Company's initial public offering. The net cash provided from financing in
1998 relates primarily to the proceeds of the private placement of 1,624,300
shares of common stock in May 1998.
In October 1998 the Company formed a wholly owned subsidiary, CD Warehouse
Finance Company, to finance the growth of qualified franchisees. As of
September 30, 1999, the financing subsidiary had funded $228,000 for the
development or remodel of three new franchised stores. The Company expects the
subsidiary's activity to increase in the future, although the level of such
activity cannot be predicted with any certainty and is dependent on the
availability of working capital.
The Company is continuing the implementation of its Internet E-Commerce
website (http://www.cdwarehouse.com/). The website "went live" in December 1998
----------------------------
and offers both new and used CDs. To date, the Company has incurred costs in
excess of $2,000,000 in development of the website, and it is expected that
additional costs will be incurred in further project development. As previously
reported, the Company has experienced difficulties in the process of expanding
its Internet website to include all used inventory of its company stores. The
Company's principal E-Commerce partner and project developer has worked with the
Company to resolve these difficulties, and the majority of the company stores
have now uploaded their used inventory on-line. Additionally, the Company
anticipates that the website will also be available for participation by
franchised stores by year-end. A significant portion of the Company's accounts
payable at September 30, 1999 related to amounts owed to its principal E-
Commerce vendors. Pending the outcome of alternative sources of financing
currently being sought by the Company, as described below, the Company may seek
a restructuring of the amounts due with such vendors.
In addition to the working capital at September 30, 1999, the Company has a
$7,000,000 credit facility with Bank One Oklahoma, N. A. The credit facility
consists of a $2,000,000 line of credit maturing in April 2000 and a $5,000,000
term loan portion maturing in April 2002. Amounts borrowed under the credit
facility bear an interest rate equal to Bank One's prime rate. As of the date
of this Report, $3,000,000 of the term loan portion of the facility had been
utilized to acquire Music Trader's 16 retail music stores in San Diego,
California and $1,000,000 of the line of credit had been advanced for company
store growth. The credit facility provides for the maintenance by the Company
of certain financial and financial ratio covenants. For the nine months ended
14
<PAGE>
September 30, 1999, increased capital expenditures by the Company, relating
primarily to E-Commerce development, caused the Company to exceed the
limitations on capital expenditures imposed by the credit facility, which in
turn caused the fixed coverage ratio to fall below the requirement imposed by
the credit facility. Additionally, the net loss for the period caused the
Company to be out of compliance at September 30, 1999 with the credit facility's
tangible net worth requirement. The lender has granted waivers of the Company's
noncompliance with these financial covenants.
The Company has engaged the services of an investment banker to assist it
in securing financing of up to $20 million, which will be used by the Company
(i) to make acquisitions which come within its strategic parameters, and (ii)
for such other purposes as may be designated in accordance with the terms of any
such financing. If the Company does not obtain the financing, or does not
obtain the total amount sought, it will not be able to fully implement its
business plan, which includes ongoing acquisitions as a major component of its
business strategy. However, it is the Company's opinion that the current
working capital at September 30, 1999, combined with available funds under its
existing credit facility, will be sufficient to support ongoing activities of
the Company for the foreseeable future, excluding consideration of (i) any
acquisitions in furtherance of its long-term business plan, or (ii) amounts
owing to the Company's principal E-Commerce vendors.
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 during the Fall of
1999, and that such efforts will be completed prior to any currently anticipated
impact on its computer equipment and software. The Company estimates that as of
September 30, 1999, it had completed approximately 95% 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 5% of the initiatives are in process and expected to be completed on
or about November 30, 1999.
The Company has also mailed letters or verbally communicated with its
significant vendors and service providers to determine the extent to which
interfaces with such entities are vulnerable to Year 2000 issues and whether the
products and services purchased from such entities are Year 2000 compliant. As
of September 30, 1999, the Company had received responses from a majority of
such third parties, and substantially all of the companies that have responded
have provided written assurances that they expect to address all their
significant Year 2000 issues on a timely basis. The Company will continue to
make follow-up mailings to significant vendors and service providers that have
not responded, or whose responses have been deemed unsatisfactory by the
Company.
15
<PAGE>
The cost of its Year 2000 identification, assessment, remediation and
testing efforts, as well as currently anticipated costs to be incurred by the
Company with respect to Year 2000 issues of third parties, are not currently
expected to have a material adverse impact on the Company's financial position,
results of operations or cash flows in future periods. As of September 30,
1999, the Company had incurred minimal costs related to its Year 2000
identification, assessment, remediation and testing efforts. Other non-Year
2000 IT efforts have not been materially delayed or impacted by Year 2000
initiatives. The Company presently believes that the Year 2000 issue will not
pose significant operational problems for the Company. However, if all Year
2000 issues are not properly identified, or assessment, remediation and testing
are not effected timely with respect to Year 2000 problems that are identified,
there can be no assurance that the Year 2000 issue will not materially adversely
impact the Company's results of operations or adversely affect the Company's
relationships with customers, vendors, or others. Additionally, there can be no
assurance that the Year 2000 issues of other entities will not have a material
adverse impact on the Company's systems or results of operations.
The Company has begun, but not yet completed, a comprehensive analysis of
the operational problems and costs (including loss of revenues) that would be
reasonably likely to result from the failure by the Company and certain third
parties to complete efforts necessary to achieve Year 2000 compliance on a
timely basis. A contingency plan has not been developed for dealing with the
most reasonably likely worst case scenario, as such scenario has not yet been
clearly identified. The Company expects that it will complete such analysis and
contingency planning before December 31, 1999.
The costs of the Company's Year 2000 identification, assessment,
remediation and testing efforts and the dates on which the Company believes it
will complete such efforts are based upon management's best estimates, which
were derived using numerous assumptions regarding future events, including the
continued availability of certain resources, third-party remediation plans, and
other factors. There can be no assurance that these estimates will prove to be
accurate, and actual results could differ materially from those currently
anticipated. Specific factors that could cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in Year 2000 issues, the ability to identify, assess, remediate and test all
relevant computer codes and embedded technology, and similar uncertainties. In
addition, variability of definitions of "compliance with Year 2000" and the
myriad of different products and services, and combinations thereof, sold by the
Company may lead to claims whose impact on the Company is not currently
estimable. No assurance can be given that the aggregate cost of defending and
resolving such claims, if any, will not materially adversely affect the
Company's results of operations. Although some of the Company's agreements with
manufacturers and others from whom it purchases products for resale contain
provisions requiring such parties to indemnify the Company under some
circumstances, there can be no assurance that such indemnification arrangements
will cover all of the Company's liabilities and costs related to claims by third
parties related to the Year 2000 issue.
16
<PAGE>
PART II-OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Exhibit
------- ---------------------------------
27.1* Financial Data Schedule
* Filed electronically herewith
(b) Reports on Form 8-K
A report on Form 8-K was filed October 8, reporting that the
Company and CD Plus.com Ltd., a Canadian public company, had
executed a letter of intent to merge the operations of the two
companies. No financial statements were filed as a part of the
report.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CD WAREHOUSE, INC.,
a Delaware corporation
Date: November 11, 1999 /s/ Jerry W. Grizzle
--------------------
Jerry W. Grizzle
Chairman of the Board of Directors;
President and Chief Executive Officer
Date: November 11, 1999 /s/ Doyle E. Motley
-------------------
Doyle E. Motley
Senior Vice-President and Chief
Financial Officer
18
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Page number
at which exhibit
appears in
Exhibit sequentially
Number Name of Exhibit numbered pages
------ --------------- --------------
<S> <C> <C>
27.1* Financial Data Schedule 20
</TABLE>
* Filed electronically herewith
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONATAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-QSB
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1999
<PERIOD-START> JUL-01-1999 JAN-01-1999
<PERIOD-END> SEP-30-1999 SEP-30-1999
<CASH> 707,956 207,956
<SECURITIES> 0 0
<RECEIVABLES> 913,868 913,868
<ALLOWANCES> 0 0
<INVENTORY> 9,167,074 9,167,074
<CURRENT-ASSETS> 11,452,230 11,452,230
<PP&E> 5,091,219 5,091,219
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 28,560,620 28,560,620
<CURRENT-LIABILITIES> 4,413,080 4,413,080
<BONDS> 0 0
0 0
0 0
<COMMON> 36,603 36,603
<OTHER-SE> 22,413,665 22,413,665
<TOTAL-LIABILITY-AND-EQUITY> 28,560,620 28,560,620
<SALES> 7,134,607 19,341,037
<TOTAL-REVENUES> 8,134,241 22,255,755
<CGS> 4,330,423 11,345,886
<TOTAL-COSTS> 8,754,139 22,982,893
<OTHER-EXPENSES> 68,332 83,008
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> (688,230) (810,146)
<INCOME-TAX> (257,700) (304,400)
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (430,530) (505,746)
<EPS-BASIC> (0.12) (0.14)
<EPS-DILUTED> (0.12) (0.14)
</TABLE>
