SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934
For the quarterly period ended March 31, 2001. Commission file number 333-41239
------------------------------
DUANE READE INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 04-3164702
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (IRS EMPLOYER ID NUMBER)
DRI I INC.* DELAWARE 04-3166107
DUANE READE* NEW YORK 11-2731721
DUANE READE REALTY, INC.* DELAWARE 13-4074383
DUANE READE INTERNATIONAL, INC.* DELAWARE 22-3672347
* Guarantors with respect to the Company's 9 1/4% Senior Subordinated Notes due 2008
440 NINTH AVENUE
NEW YORK, NEW YORK 10001
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(212) 273-5700
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
-----------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
Common Stock, $.01 par value per share New York Stock Exchange, Inc.
9 1/4% Senior Subordinated Notes due 2008 None
----------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT:
None.
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed 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 |_|
The number of shares of the Common Stock outstanding as of May 9, 2001:
18,543,970
----------
==============================================================================
INDEX
PAGE
PART I
ITEM 1. - FINANCIAL STATEMENTS
Consolidated Statements of Operations (Unaudited) -
For the 13 Weeks Ended March 31, 2001 and March 25, 2000 3
Consolidated Balance Sheets
As of March 31, 2001 (Unaudited) and December 30, 2000 4
Consolidated Statements of Cash Flows (Unaudited) -
For the 13 Weeks Ended March 31, 2001 and March 25, 2000 5
Notes to Consolidated Financial Statements 6
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 8
PART II - OTHER INFORMATION 12
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DUANE READE INC.
Consolidated Statements of Operations (Unaudited)
(In thousands, except per share amounts)
For the 13 Weeks Ended
-----------------------------
March 31, March 25,
2001 2000
------------- -----------
Net sales $ 271,738 $ 226,275
Cost of sales 206,969 171,629
------------- -----------
Gross profit 64,769 54,646
------------- -----------
Selling, general & administrative expenses 44,545 36,748
Depreciation & amortization 6,475 5,914
Store pre-opening expenses 495 305
------------- -----------
51,515 42,967
------------- -----------
Operating income 13,254 11,679
Interest expense, net 8,664 8,238
------------- -----------
Income before income taxes 4,590 3,441
Income taxes 1,969 1,515
------------- -----------
Net income $ 2,621 $ 1,926
============= ===========
Per Common Share - Basic
Net income $ 0.14 $ 0.11
============= ===========
Weighted Average Common Shares Outstanding 18,315 17,404
============= ===========
Per Common Share - Diluted
Net income $ 0.14 $ 0.11
============= ===========
Weighted Average Common Shares Outstanding 19,184 18,103
============= ===========
The accompanying notes are an integral part of these financial statements.
3
DUANE READE INC.
Consolidated Balance Sheets
(In thousands, except share amounts)
March 31, December 30,
2001 2000
----------- ------------
(Unaudited)
ASSETS
Current Assets
Cash $ 992 $ 979
Receivables 46,434 48,953
Inventories 190,801 172,568
Deferred income taxes 11,791 13,023
Prepaid expenses 6,099 8,770
----------- ------------
TOTAL CURRENT ASSETS 256,117 244,293
Property and equipment, net 114,134 107,883
Goodwill, net of accumulated amortization of
$32,123 and $31,020 152,348 152,951
Deferred income taxes 8,845 8,852
Other assets 59,211 56,951
----------- ------------
TOTAL ASSETS $ 590,655 $ 570,930
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 51,614 $ 47,575
Accrued interest 5,836 8,394
Other accrued expenses 20,626 19,830
Current portion of long-term debt 12,250 12,325
Current portion of capital lease obligations 1,311 1,703
----------- ------------
TOTAL CURRENT LIABILITIES 91,637 89,827
Long-term debt, less current portion 343,350 337,913
Capital lease obligations, less current portion 957 1,060
Other noncurrent liabilities 32,598 27,633
----------- ------------
TOTAL LIABILITIES 468,542 456,433
----------- ------------
Stockholders' equity
Preferred stock, $0.01 par; authorized 5,000,000 shares;
issued and outstanding: none - -
Common stock, $0.01 par; authorized 75,000,000 shares;
issued and outstanding 18,478,684 and 18,232,339 shares 185 182
Paid-in capital 161,260 154,536
Accumulated other comprehensive income (1,731) -
Accumulated deficit (37,601) (40,221)
----------- ------------
TOTAL STOCKHOLDERS' EQUITY 122,113 114,497
----------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 590,655 $ 570,930
=========== ============
The accompanying notes are an integral part of these financial statements.
4
DUANE READE INC.
Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
For the 13 Weeks Ended
---------------------------
March 31, March 25,
2001 2000
----------- ------------
Cash flows from operating activities:
Net income $ 2,621 $ 1,926
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 3,700 3,372
Amortization of goodwill and other intangibles 3,261 2,940
Deferred tax provision 1,968 1,015
Other 1,390 1,250
Changes in operating assets and liabilities (net of the effect of acquisitions):
Receivables 2,414 751
Inventories (17,533) 178
Accounts payable 4,039 (9,277)
Prepaid and accrued expenses 2,031 (5,141)
Other assets and liabilities, net (239) (666)
----------- ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 3,652 (3,652)
----------- ------------
Cash flows from investing activities:
Capital expenditures (9,063) (5,788)
Lease acquisition and other costs (409) (220)
----------- ------------
NET CASH USED IN INVESTING ACTIVITIES (9,472) (6,008)
----------- ------------
Cash flows from financing activities:
Net borrowings (repayments) - term loans (3,138) 7,537
Net borrowings - revolving credit facility 8,500 3,500
Exercise of stock options 966 327
Financing costs - (1,139)
Repayments of capital lease obligations (495) (462)
----------- ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 5,833 9,763
----------- ------------
Net increase in cash 13 103
Cash at beginning of period 979 1,013
----------- ------------
Cash at end of period $ 992 $ 1,116
=========== ============
The accompanying notes are an integral part of these financial statements.
5
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The Unaudited Consolidated Financial Statements included herein reflect all
adjustments (consisting of normal recurring items) which, in the opinion of
management, are necessary to present fairly the results of operations and
financial position of Duane Reade Inc. (the "Company"), and have been prepared,
in all material respects, in accordance with the same accounting principles
followed in the preparation of the Company's annual financial statements for the
year ended December 30, 2000. These financial statements should be read in
conjunction with the Company's financial statements included in its Annual
Report on Form 10-K for the year ended December 30, 2000. The Unaudited
Consolidated Financial Statements include the accounts of the Company and its
subsidiaries. All significant intercompany transactions and balances have been
eliminated. Certain prior year amounts have been reclassified to conform to the
current year presentation. The results for the interim periods presented are not
necessarily indicative of the results expected for the full year.
The Company has no assets or operations other than its investment in its
subsidiary guarantors. Accordingly, the Unaudited Consolidated Financial
Statements present the combined assets and operations of the subsidiary
guarantors.
2. NET INCOME PER COMMON SHARE
Net income per common share is based on the weighted average shares outstanding
during each period in accordance with the provisions of FASB Statement No. 128
"Earnings Per Share." Basic earnings per share is computed based on the weighted
average number of common shares outstanding during the period. Diluted earnings
per share gives effect to all dilutive potential common shares outstanding
during the period. Dilutive potential common shares include shares issuable upon
exercise of the Company's stock options. Options to purchase 55,156 shares at
March 31, 2001 and 694,934 shares at March 25, 2000 were not included in the
computation of diluted earnings per share because the options' exercise prices
were greater than the average market price of the common shares.
3. INCOME TAXES
Income taxes are recorded based on the estimated effective tax rate expected to
be applicable for the full fiscal year. The effective tax rate is greater than
the statutory rate, principally reflecting the impact of non-deductible
goodwill.
4. ACQUISITIONS
During the first quarter of 2001, the Company acquired certain assets of five
separate independently owned pharmacy establishments. The total cost of these
acquisitions was $5.7 million, paid for by the issuance of common stock and was
allocated as follows: customer lists ($2.1 million), lease acquisition costs
($1.3 million), property and equipment ($0.9 million), inventory ($0.7 million),
goodwill ($0.5 million) and other assets ($0.3 million) net of accruals for
expenses and liabilities assumed ($0.1 million). The operations of the acquired
stores have been included in the consolidated financial statements from the
dates of the acquisitions. The pro forma impact of these acquisitions was not
material to sales or results of operations of the Company for the period ended
March 31, 2001.
6
5. INCOME PER COMMON SHARE
The following table sets forth the computation of income per common share for
the periods presented (in thousands, except per share amounts):
For the 13 Weeks Ended
----------------------------------
March 31, 2001 March 25, 2000
-------------- --------------
Net Income $ 2,621 $ 1,926
Weighted average number of common shares outstanding
during the period - basic 18,315 17,404
Potential dilutive shares 869 699
-------------- --------------
Weighted average number of shares outstanding - diluted 19,184 18,103
============== ==============
Per common share - basic -------------- --------------
Net Income $ 0.14 $ 0.11
============== ==============
Per common share - diluted -------------- --------------
Net Income $ 0.14 $ 0.11
============== ==============
6. NEWLY IMPLEMENTED ACCOUNTING POLICIES
Financial Accounting Standards Board Pronouncement No. 133 (FAS 133),
"Accounting for Derivative Instruments and Hedging Activities," requires
companies to disclose the nature and substance of derivative instrument
transactions in which they may engage and to record in their financial
statements the fair value of assets and liabilities and the gain or loss in
comprehensive income which arises from these transactions. At March 31, 2001,
the Company has reflected a tax affected loss on the swap transaction of $1.7
million in the "Accumulated other comprehensive income" component of
Shareholders' Equity.
The Company maintains an interest rate risk management strategy that allows for
the use of derivative instruments to minimize significant, unanticipated
earnings fluctuations caused by interest rate volatility. The Company's specific
goals are (1) to manage interest rate sensitivity by modifying the maturity
characteristics of certain of its debt instruments and (2) to lower (where
possible) the cost of borrowed funds. Interest rate fluctuations create an
unrealized appreciation or depreciation in the market value of the Company's
fixed rate debt when compared to cost. The effect of this unrealized
appreciation or depreciation in market value, however, will generally be offset
by income or loss on derivative instruments that are linked to the debt. The
Company uses interest rate swaps to convert a portion of its variable rate debt
to fixed rates. The resulting cost of funds is lower than it would have been had
fixed rate borrowings been issued directly. The level of fixed rate debt, after
the effects of the interest rate swaps have been considered, is maintained
between 50 and 75 percent of term debt.
The 1998 refinancing of the Company's debt resulted in a heavily leveraged
entity, whose primary source of capital is composed of a mixture of floating
rate term and revolving credit financing. The interest rates associated with
these borrowings are based on prevailing LIBOR rates plus an applicable margin
as defined in the Company's credit agreement. At March 31, 2001, the Company had
a total of $275,600 of outstanding floating rate debt, composed of $254,600 of
term loans and $21,000 of revolving credit borrowings.
Due to the volatile nature of short-term interest rates, the credit agreement
allows for some latitude with respect to the Company's ability to engage in
transactions aimed at minimizing a portion of the risk associated with the
fluctuation in short-term interest rates. In November 1998, the Company entered
into an interest rate protection agreement which capped the LIBOR rate on $65.0
million of floating rate term debt at 6.50%. Following the expiration of this
agreement in November 2000, the Company purchased a two-year interest rate swap
agreement with a notional amount of $150.0 million of floating rate term loan
borrowings. This swap agreement, which became effective on January 12, 2001,
effectively served to convert this floating rate component of the Company's debt
structure to a fixed rate of 5.8075% plus the applicable margins as defined in
the Company's credit agreement. It is likely that the Company may continue to
engage in transactions involving
7
swaps, hedges and other types of derivative instruments in a continuing effort
to moderate and minimize the effects of upward changes in short-term interest
rates.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOREGOING INFORMATION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE
A NUMBER OF RISKS AND UNCERTAINTIES. A NUMBER OF FACTORS COULD CAUSE OUR ACTUAL
RESULTS, PERFORMANCE, ACHIEVEMENTS, OR INDUSTRY RESULTS, TO BE MATERIALLY
DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR
IMPLIED BY THESE FORWARD-LOOKING STATEMENTS. THESE FACTORS INCLUDE, BUT ARE NOT
LIMITED TO, THE COMPETITIVE ENVIRONMENT IN THE DRUGSTORE INDUSTRY IN GENERAL AND
IN OUR SPECIFIC MARKET AREA; INFLATION; CHANGES IN COSTS OF GOODS AND SERVICES;
ECONOMIC CONDITIONS IN GENERAL AND IN THE COMPANY'S SPECIFIC MARKET AREAS;
DEMOGRAPHIC CHANGES; CHANGES IN PREVAILING INTEREST RATES AND THE AVAILABILITY
OF AND TERMS OF FINANCING TO FUND THE ANTICIPATED GROWTH OF OUR BUSINESS;
LIABILITY AND OTHER CLAIMS ASSERTED AGAINST US; CHANGES IN OPERATING STRATEGY OR
DEVELOPMENT PLANS; THE ABILITY TO ATTRACT AND RETAIN QUALIFIED PERSONNEL; OUR
SIGNIFICANT INDEBTEDNESS; LABOR DISTURBANCES; CHANGES IN OUR ACQUISITION AND
CAPITAL EXPENDITURE PLANS AND OTHER FACTORS REFERENCED IN THIS REPORT. IN
ADDITION, THESE FORWARD-LOOKING STATEMENTS ARE NECESSARILY DEPENDENT UPON
ASSUMPTIONS, ESTIMATES AND DATES THAT MAY BE INCORRECT OR IMPRECISE AND INVOLVE
KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS. ACCORDINGLY, ANY
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT DO NOT PURPORT TO BE
PREDICTIONS OF FUTURE EVENTS OR CIRCUMSTANCES AND MAY NOT BE REALIZED.
FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY, AMONG OTHER THINGS, THE USE OF
FORWARD-LOOKING TERMINOLOGY SUCH AS "BELIEVES," "EXPECTS," "MAY," "WILL,"
"SHOULD," "SEEKS," "PRO FORMA," "ANTICIPATES," "INTENDS" OR THE NEGATIVE OF ANY
OF THESE TERMS, OR OTHER VARIATIONS ON THESE TERMS OR COMPARABLE TERMINOLOGY, OR
BY DISCUSSIONS OF STRATEGY OR INTENTIONS. GIVEN THESE UNCERTAINTIES, WE CAUTION
INVESTORS NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS. WE
DISCLAIM ANY OBLIGATION TO UPDATE ANY OF THESE FACTORS OR TO PUBLICLY ANNOUNCE
THE RESULTS OF ANY REVISIONS TO ANY OF THE FORWARD-LOOKING STATEMENTS CONTAINED
IN THIS REPORT TO REFLECT FUTURE EVENTS OR DEVELOPMENTS.
RESULTS OF OPERATIONS
The following sets forth the results of operations as a percentage of net sales
for the periods indicated.
For the 13 Weeks Ended
--------------------------
March 31, March 25,
2001 2000
------------ -----------
Net sales 100.0 % 100.0 %
Cost of sales 76.2 75.8
------------ -----------
Gross profit 23.8 24.2
Selling, general and administrative expenses 16.4 16.2
Depreciation & amortization 2.4 2.7
Store pre-opening expenses 0.2 0.1
------------ -----------
Operating income 4.8 5.2
Interest expense, net 3.2 3.7
------------ -----------
Income before income taxes 1.6 1.5
Income taxes 0.7 0.6
------------ -----------
Net income 0.9 % 0.9 %
============ ===========
THIRTEEN WEEKS ENDED MARCH 31, 2001 VERSUS THIRTEEN WEEKS ENDED MARCH 25, 2000
Net sales were $271.7 million in the first quarter of 2001, an increase of 20.1%
over net sales of $226.3 million for the first quarter of 2000. Pharmacy sales
increased 30.0% and represented 37.5% of total sales, while front-end sales
8
increased 14.8% and represented 62.5% of total sales. For the first quarter of
2001, third party pharmacy sales represented 85.9% of total pharmacy sales, as
compared to 83.7% in the first quarter of 2000. The increase in total sales over
last year was attributable to increased comparable store sales of 8.5%,
including increases in pharmacy and front-end same store sales of 16.9% and
4.0%, respectively, combined with the full quarterly impact of four stores
opened during the first quarter of 2000 and sales from 27 net new stores opened
since the first quarter of 2000. We opened eight stores during the first quarter
of 2001, compared to four store openings during the first quarter of 2000. At
March 31, 2001, we operated 180 stores, versus 153 at March 25, 2000.
Cost of sales as a percentage of net sales increased to 76.2% for the first
quarter of 2001 from 75.8% for the first quarter of 2000, resulting in a
decrease in gross profit margin to 23.8% for the first quarter of 2001 from
24.2% for the first quarter of 2000. This decrease is primarily attributable to
an increased proportion of lower margin pharmacy and third-party reimbursed
pharmacy sales in relation to front-end sales, along with the impact of a milder
flu season experienced in the first quarter of 2001, resulting in fewer sales of
higher-margin flu-related prescriptions.
Selling, general and administrative expenses were $44.6 million, or 16.4% of net
sales, and $36.7 million, or 16.2% of net sales in the first quarters of 2001
and 2000, respectively. The increase in these expenses as a percentage of sales
resulted principally from increased advertising and promotional costs to support
new store openings, combined with higher than normal seasonal maintenance costs
associated with adverse winter weather experienced throughout our trading areas.
Depreciation and amortization of intangibles in the first quarters of 2001 and
2000 were $6.5 million and $5.9 million, respectively. This increase resulted
primarily from increases in the amortization of pharmacy customer lists and
lease acquisition costs for pharmacy acquisitions completed since the first
quarter of 2000, combined with incremental depreciation expenses related to
capital expenditures in 2000 and 2001.
We incurred store pre-opening expenses of $0.5 million during the first quarter
of 2001 related to the opening of eight stores. Store pre-opening expenses of
$0.3 million incurred during the first quarter of 2000 were attributable to the
opening of four stores.
Net interest expense increased 5.2% to $8.7 million in the first quarter of 2001
from $8.2 million in the first quarter of 2000. This increase is attributable to
several factors, including additional term and other borrowings incurred after
the first quarter of 2000 in support of our store expansion program, partially
offset by a decrease in short-term interest rates that favorably affected the
interest rates on our floating rate term and revolving loans.
Our income before income taxes in the first quarter of 2001 increased 33.4% to
$4.6 million from $3.4 million in the first quarter of 2000, reflecting
increased sales and related gross profit dollars, partially offset by increases
in selling, general, administrative and interest expenses.
In the first quarter of 2001, we recorded an income tax provision of $2.0
million, reflecting an estimated annual effective tax rate of 42.9%. The current
year's estimated effective rate includes the anticipated benefits of certain
employment-related tax credits. In the comparable period last year, the income
tax provision of $1.5 million reflected an estimated effective tax rate of
44.0%.
Our net income was $2.6 million in the first quarter of 2001, compared to $1.9
million in the first quarter of 2000, reflecting a $1.2 million improvement in
pre-tax income, partially offset by the incremental tax provision of $0.5
million described above.
LIQUIDITY AND CAPITAL RESOURCES
Working capital was $164.5 million as of March 31, 2001 and $154.5 million as of
December 30, 2000. The increase is primarily due to increases in inventory
related to the opening of eight additional stores during the first quarter of
2001
9
as well as seasonal and forward buy inventory purchases, partially offset by
reductions in prepaid expenses and receivables and an increase in accounts
payable related to the additional inventory purchased during the quarter.
For the first quarter of 2001, net cash provided by operating activities was
$3.7 million, as compared to net cash used by operating activities of $3.7
million in the first quarter of 2000.
Our EBITDA increased by 12.1% to $21.1 million in the first quarter of 2001,
compared to $18.8 million in the first quarter of 2000. EBITDA as a percentage
of sales was 7.8% in the first quarter of 2001, compared to 8.3% of sales in the
first quarter of 2000.
Net cash used in investing activities was $9.5 million during the first quarter
of 2001, compared to $6.0 million during the first quarter of 2000. In the first
quarter of 2001, capital expenditures, primarily related to new store openings
and the remodeling of existing locations, amounted to $9.1 million. Lease
acquisition costs accounted for $0.4 million of cash used in investing
activities. In the first quarter of 2000, $5.8 million was spent on capital
expenditures and $0.2 million on lease acquisition costs.
Net cash provided by financing activities was $5.8 million for the first quarter
of 2001, compared to $9.8 million for the first quarter of 2000. The decrease
reflects the timing of new store, seasonal and forward buy inventory purchases
as well as an increased level of earnings in the current year.
Our capital requirements primarily result from opening and stocking new stores,
remodeling and renovating existing retail locations and from the continuing
development of management information systems. We believe that there are
significant opportunities to open additional stores, and currently plan to open
approximately 50 to 60 stores through year-end 2002, including the eight stores
opened during the first quarter of 2001. We expect to spend approximately $30
million in 2001 on capital expenditures, primarily for new and replacement
stores and an additional $7 million for lease and pharmacy file acquisition
costs. We also require working capital to support inventory for our existing
stores. Historically, we have been able to lease our store locations.
We believe that, based on current levels of operations and anticipated growth,
cash flow from operations, together with other available sources of funds,
including revolving and term loan borrowings under our senior credit agreement,
will be adequate for at least the next two years to make required payments of
principal and interest on our indebtedness, to fund anticipated capital
expenditures and working capital requirements, and to comply with the terms of
our debt agreements. As of March 31, 2001, we had borrowed $21.0 million under
the revolving portion of our senior credit agreement and had $33.2 million of
remaining availability. Our ability to meet our debt service obligations and
reduce our total debt will be dependent upon our future performance which, in
turn, will be subject to general economic, financial, business, competitive,
legislative, regulatory and other conditions, many of which are beyond our
control. In addition, we cannot assure you that our operating results, cash flow
and capital resources will be sufficient to repay our indebtedness in the
future. Substantially all of our revolving and term loan borrowings under our
senior credit agreement bear interest at floating rates. There was approximately
$275.6 million of floating rate debt outstanding on March 31, 2001. Therefore,
our financial condition will be affected by changes in prevailing interest
rates. On December 20, 2000, we entered into a two-year interest rate swap in
the notional amount of $150.0 million. This swap had an effective date of
January 12, 2001, and represented a hedging transaction whereby we would receive
interest at a floating rate and pay interest at a fixed LIBOR rate. The effect
of this swap is to fix our interest obligations on $150.0 million of floating
rate debt for two years at a LIBOR rate of 5.8075% plus the applicable margins
as defined in the senior credit agreement. See "--Market Risk."
The senior credit agreement and the indenture relating to our senior
subordinated notes contain various covenants that limit or restrict, among other
things, subject to specified exceptions, our ability to make capital
expenditures, incur indebtedness, permit liens on our property, enter into
transactions with affiliates, make restricted payments, investments or
acquisitions, enter into mergers, consolidations or dissolutions, conduct assets
sales, pay dividends or distributions and enter into other specified
transactions and business activities.
Financial performance covenants included in our senior credit agreement include
interest coverage, leverage ratios, minimum net worth requirements and fixed
charge coverage requirements. At March 31, 2001, we were in compliance with all
financial performance covenants.
10
TAX BENEFITS FROM NET OPERATING LOSSES
At December 30, 2000, we had net operating loss carryforwards, or NOLs, of
approximately $23 million, which are due to expire in the years 2007 through
2018. These NOLs may be used to offset future taxable income through 2018 and
thereby reduce or eliminate our federal income taxes otherwise payable. The
Internal Revenue Code of 1986, as amended, imposes significant limitations on
the utilization of NOLs in the event of an "ownership change," as defined in
Section 382 of the Code. This Section 382 limitation is an annual limitation on
the amount of pre-ownership change NOLs that a corporation may use to offset its
post-ownership change income. The Section 382 limitation is calculated by
multiplying the value of a corporation's stock immediately before an ownership
change by the long-term tax-exempt rate (as published by the Internal Revenue
Service). Generally, an ownership change occurs with respect to a corporation if
the aggregate increase in the percentage of stock ownership by value of that
corporation by one or more 5% shareholders, including specified groups of
shareholders who in the aggregate own at least 5% of that corporation's stock,
exceeds 50 percentage points over a three-year testing period. Our
recapitalization in 1997 caused us to experience an ownership change. As a
result, we are currently subject to an annual Section 382 limitation of
approximately $8.5 million in 2001 and approximately $5.1 million from 2002 to
2007 on the amount of NOLs generated prior to the recapitalization that we may
use to offset future taxable income. At December 30, 2000, all of the existing
NOLs were subject to this limitation. We cannot assure you that we will be able
to use any NOLs to offset future taxable income or that the NOLs will not become
subject to limitation due to future ownership changes. Based on our recent and
projected performance, however, management believes that it is more likely than
not that the full value of the NOLs will be realized.
SEASONALITY
In general, sales of drugstore items such as prescription drugs,
over-the-counter drugs and health and beauty care products exhibit limited
seasonality in the aggregate, but do vary by product category. Quarterly results
are primarily affected by the timing of new store openings and the sale of
seasonal products, with the Christmas holiday season generating a higher
proportion of sales and earnings than other periods.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
FASB Statement No. 133 "Accounting for Derivative Instruments and Hedging
Activities" requires that derivative instruments such as interest rate swaps be
recorded as assets and liabilities at fair value and provides guidance for
recognition of changes in fair value depending on the reason for holding the
derivative. As discussed in "Newly Implemented Accounting Policies" on page 7,
we adopted Statement No. 133 during the first quarter of 2001, but this action
did not have a material impact on our consolidated financial statements.
MARKET RISK
Our financial results are subject to risk from interest rate fluctuations on
debt which carries variable interest rates. Variable rate debt outstanding under
our credit agreement was approximately $275.6 million at March 31, 2001. During
1998, in connection with senior credit agreement requirements, we entered into
an interest rate protection agreement, which capped the LIBOR rate at 6.5% on
$65 million of our floating rate debt. This agreement expired in November 2000.
On December 20, 2000, we purchased a two-year interest rate swap in the notional
amount of $150.0 million. This swap had an effective date of January 12, 2001,
and represented a hedging transaction to effectively convert $150.0 million of
floating rate debt to a fixed rate. This fixed rate is equivalent to a LIBOR
rate of 5.8075% plus the applicable margins described in our senior credit
agreement. At March 31, 2001, the 90-day LIBOR rate in effect on the $125.6
million balance of the floating rate term debt was 5.6875%. A 0.50% change in
interest rates applied to the $125.6 million balance of floating rate debt would
affect pre-tax annual results of operations by approximately $0.6 million. We
also have $80 million of senior subordinated notes outstanding at March 31,
2001, which bear interest payable semi-annually at a fixed rate of 9.25%, and
are therefore not subject to risk from interest rate fluctuations.
The principal objective of our investment management activities is to maintain
acceptable levels of interest rate and liquidity risk to facilitate our funding
needs. As part of our risk management, we may use additional derivative
financial products such as interest rate hedges and interest rate swaps in the
future.
11
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are a party to legal actions arising in the ordinary course of
business. Based on information presently available to us, we believe that we
have adequate legal defenses or insurance coverage for these actions and that
the ultimate outcome of these actions will not have a material adverse effect
on us.
In addition, we are currently party to arbitration proceedings
arising out of disputes over the purchase price with respect to the Rock
Bottom acquisition. In this arbitration, RB Holdings Corporation (formerly
known as Rock Bottom Stores, Inc.) claims that it is owed approximately $1.2
million for rent and other proration payments allegedly made by RB Holdings
prior to the closing. We have not disputed this claim, but we have filed
counterclaims against RB Holdings seeking to recover in excess of $42 million
based on an assertion of several breaches by RB Holdings of the asset
purchase agreement for the acquisition and tortious interference with a
business relationship by RB Holdings. In RB Holdings' reply to our
counterclaims, RB Holdings has asserted that it is entitled to recover
unspecified amounts from us in connection with certain trade payables owed to
our vendors. An arbitrator has been overseeing this matter and is expected to
render its decision in the near future. We believe that the ultimate outcome
of this action will not have a material adverse effect on our financial
position or results of operations.
Also in connection with the Rock Bottom acquisition, we were awarded
a purchase price adjustment of approximately $2.15 million with respect to an
inventory shortfall at the closing.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
AMENDMENT TO MR. CUTI'S EMPLOYMENT AGREEMENT
On May 1, 2001, we entered into an amendment to Mr. Cuti's existing
employment agreement to provide, in certain circumstances, for the forgiveness
of a $2.0 million loan extended to Mr. Cuti by us in November 1998 and our
payment on behalf of Mr. Cuti, or assumption of his obligations under a $1.0
million loan extended to Mr. Cuti by Donaldson, Lufkin & Jenrette, or DLJ, in
November 1997.
Under the amendment, if prior to December 31, 2001, Mr. Cuti's
employment is terminated without "cause," as a result of Mr. Cuti's death or
"disability or by Mr. Cuti with "good reason," or if a "sale of the company"
occurs, as these terms are defined in the amendment, we will forgive 50% of
the outstanding interest and principal balance of our $2.0 million loan, and
we will pay or assume 50% of the outstanding interest and principal balance
of the $1.0 million loan from DLJ. If any of these events occur after
December 31, 2001, we will forgive the outstanding interest and principal
balance of our $2.0 million loan and pay or assume the outstanding interest
and principal balance of $1.0 million loan from DLJ in their entirety.
In addition, the amendment provides for certain changes with respect
to the funding of Mr. Cuti's Supplemental Executive Retirement Plan, or SERP,
such that we will either, at Mr. Cuti's option, establish a "rabbi trust" and
fully fund his SERP in an amount that will be calculated on the basis of 20
years of employment regardless of his actual number of years of employment
with us, the present value of which was approximately $1,837,000 as of
December 30, 2000, or implement another arrangement that does not result in a
total after-tax economic impact to us that is materially greater than the
first alternative, upon the occurrence of any of the events described above
with respect to Mr. Cuti's loans or upon his 65th birthday.
ITEM 6. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
(a) The following documents are filed as a part of this report:
(i) Financial Statements
(ii) Exhibits:
3.1(i) Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.1(i) to the
Common Stock S-1).
3.1(ii) Form of Amended and Restated By-laws of the Company
(incorporated by reference to Exhibit 3.1(i) to the Common
Stock S-1).
3.2(i) Certificate of Incorporation of DRI I Inc. (incorporated by
reference to Exhibit 3.2(i) to the Notes S-1).
3.2(ii) By-laws of DRI I Inc. (incorporated by reference to Exhibit
3.2(ii) to the Notes S-1).
3.3 Second Amended and Restated Partnership Agreement of Duane
Reade (incorporated by reference to Exhibit 3.3 to the Notes
S-1).
3.4(i) Certificate of Incorporation of Duane Reade International,
Inc. (incorporated by reference to Exhibit 3.4(i) to the 1999
10-K).
3.4(ii) By-laws of Duane Reade International, Inc. (incorporated by
reference to exhibit 3.4(ii) to the 1999 10-K).
3.5(i) Certificate of Incorporation of Duane Reade Realty, Inc.
(incorporated by reference to Exhibit 3.5(i) to the 1999
10-K).
3.5(ii) By-laws of Duane Reade Realty, Inc. (incorporated by reference
to Exhibit 3.5(ii) to the 1999 10-K).
4.1 Form of Indenture (incorporated by reference to Exhibit 4.1 to
the Notes S-1).
12
10.1 Duane Reade Inc. 1997 Equity Participation Plan (incorporated
by reference to Exhibit 10.1 to the Common Stock S-1).
10.2 Duane Reade Inc. Holding Corp. 1992 Stock Incentive Plan
(incorporated by reference to Exhibit 10.2 to the Common Stock
S-1).
10.3 Employment Agreement, dated as of October 27, 1997, between
the Company and Anthony J. Cuti (incorporated by reference to
Exhibit 10.3 to the Common Stock S-1).
10.4 Employment Agreement, dated as of February 22, 1993, as
amended, between the Company and Gary Charboneau (incorporated
by reference to Exhibit 10.4 to the Common Stock S-1).
10.4 10.4 Employment Agreement, dated as of April 10, 1995, as
amended, between Duane Reade and Jerry M. Ray (incorporated by
reference to Exhibit 10.5 to the Common Stock S-1).
10.6 Employment Letter Agreement, dated as of October 9, 1996,
between Duane Reade and Joseph Lacko (incorporated by
reference to Exhibit 10.6 to the Common Stock S-1).
10.7 Employment Letter Agreement, dated as of February 12, 1997,
between the Company and William Tennant (incorporated by
reference to Exhibit 10.7 to the Common Stock S-1).
10.8 Agreement, dated as of November 22, 1996, as amended, between
Duane Reade and Drug, Chemical, Cosmetic, Plastics and
Affiliated Industries Warehouse Employees Local 815
(incorporated by reference to Exhibit 10.8 to the Common Stock
S-1).
10.9 Agreement, dated July 16, 1992, as amended, between Duane
Reade and Allied Trades Council (incorporated by reference to
Exhibit 10.9 to the Common Stock S-1).
10.10 Stockholders and Registration Rights Agreement, dated as of
June 18, 1997, among the Company, DLJMB Funding II, Inc., DLJ
Merchant Banking Partners II, L.P., DLJ Diversified Partners,
L.P., DLJ First ESC L.L.C., DLJ Offshore Partners, II, C.V.,
DLJ EAB Partners, L.P., UK Investment Plan 1997 Partners,
Bankers Trust New York Corporation, Conac & Co., Muico & Co.,
Roton & Co., Putnam High Yield Trust, PaineWebber Managed
Investment Trust on behalf of PaineWebber High Income Fund,
USL Capital Corporation, Pearlman Family Partners, The Marion
Trust, Bruce L. Weitz, BCIP Associates, BCIP Trust Associates,
L.P., Tyler Capital Fund L.P., Tyler International, L.P.-II,
and Tyler Massachusetts, L.P. (incorporated by reference to
Exhibit 10.13 to the Common Stock S-1).
10.11 Amended and Restated Partnership Security Agreement, dated as
of September 11, 1998, among Duane Reade Inc. and DRI I Inc.
and Fleet National Bank, as Administrative Agent (incorporated
by reference to Exhibit 10.15 to the Company's Current Report
on Form 8-K dated September 24, 1998).
10.12 Amended and Restated Borrower Security Agreement, dated as of
September 11, 1998, between Duane Reade and Fleet National
Bank as Administrative Agent (incorporated by reference to
Exhibit 10.16 to the Company's Current Report on Form 8-K
dated September 24, 1998).
10.13 Amended and Restated Holdings Pledge Agreement, dated as of
September 11, 1998, among Duane Reade Inc. and Fleet National
Bank, as Administrative Agent (incorporated by reference to
Exhibit 10.17 to the Company's Current Report on Form 8-K
dated September 24, 1998).
10.14 Promissory Note, dated as of November 9, 1998, between the
Company and Anthony J. Cuti (incorporated by reference to
Exhibit 10.16 to the 1998 10-K).
10.15 Employment Letter, dated June 10, 1999, between the Company
and John K. Henry (incorporated by reference to Exhibit 10.18
to the 1999 10-K).
10.16 Promissory Note, dated as of June 7, 1999, between the Company
and Anthony J. Cuti (incorporated by reference to Exhibit
10.19 to the 1999 10-K).
10.17 Promissory Note, dated as of December 30, 1999, between the
Company and Anthony J. Cuti (incorporated by reference to
Exhibit 10.20 to the 1999 10-K).
10.18 Third Amended and Restated Credit Agreement, dated as of March
17, 2000, among Duane Reade, as the Borrower, Duane Reade Inc.
and DRI I Inc., as the Parent Guarantors, Various Financial
Institutions set forth therein, as the Lenders, DLJ Capital
Funding, Inc., as the Syndication Agent for the Lenders, and
Credit Lyonnais New York Branch, as the Documentation Agent
for the Lenders (incorporated by reference to Exhibit 10.21 to
the 1999 10-K).
13
10.19 Amendment Agreement to Credit Agreement, dated as of March 17,
2000 among Duane Reade, Duane Reade Inc., DRI I Inc., Various
Financial Institutions as Lenders, DLJ Capital Funding, Inc.
as Syndication Agent, Fleet National Bank as Administrative
Agent and Credit Lyonnais New York Branch as Documentation
Agent (incorporated by reference to Exhibit 10.22 to the 1999
10-K).
10.20 First Amendment to Employment Agreement, dated March 13, 2000,
between the Company and Anthony J. Cuti. (incorporated by
reference to Exhibit 10.23 to the 1999 10-K).
10.21 Agreement, dated April 1, 1999, between Duane Reade and Local
340A/340B, New York (incorporated by reference to Exhibit
10.21 to the Company's Quarterly Report on Form 10-Q for the
period ended September 23, 2000).
10.22 First Amendment to the Third Amended and Restated Credit
Agreement, dated as of September 5, 2000, by and among Duane
Reade, each designated Guarantor, Duane Reade Inc., DRI I,
Inc., DLJ Capital Funding, Inc. as Syndication Agent and Fleet
National Bank as Administrative Agent (incorporated by
reference to Exhibit 10.22 to the Company's Quarterly Report
on Form 10-Q for the period ended September 23, 2000).
10.23 Second Amendment to the Third Amended and Restated Credit
Agreement, dated as of October 31, 2000, among Duane Reade,
Duane Reade Inc., DRI I, Inc., Various Financial Institutions
as Lenders, DLJ Capital Funding, Inc. as Syndication Agent,
Fleet National Bank as Administrative Agent and Credit
Lyonnais New York Branch as Documentation Agent (incorporated
by reference to Exhibit 10.23 to the Company's Quarterly
Report on Form 10-Q for the period ended September 23, 2000).
10.24 Promissory Note, dated as of January 10, 2001, between the
Company and Anthony J. Cuti (incorporated by reference to
Exhibit 10.24 to the 2000 10-K).
10.25* Second Amendment to Employment Agreement, dated May 1, 2001,
between the Company and Anthony J. Cuti.
21.1 Subsidiaries of the Company (incorporated by reference to
Exhibit 21.1 to the 1999 10-K).
---------
* filed herewith
(b) Reports on Form 8-K: None
(c) Financial Statement Schedules: None
Schedules for which provision is made in the applicable accounting regulations
of the Commission are either not required under the related instructions, are
inapplicable or immaterial, or the information called for thereby is otherwise
included in the financial statements and therefore has been omitted.
14
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.
Dated: May 10, 2001
DUANE READE, INC.
(Registrant)
By: /s/ John K. Henry
--------------------------------
Name: John K. Henry
Title: Senior Vice President and Chief Financial
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 in the capacities indicated on May 10, 2001.
SIGNATURES TITLES
/s/ Anthony J. Cuti President and Chief Executive Officer and Director
------------------------------------ (Principal Executive Officer)
Anthony J. Cuti
/s/ John K. Henry Senior Vice President and Chief Financial Officer
------------------------------------ (Principal Accounting and Financial Officer)
John K. Henry
15
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.
Dated: May 10, 2001
DRI I INC.
By: /s/ John K. Henry
-----------------------------------------
Name: John K. Henry
Title: Senior Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed on May 10, 2001 by:
SIGNATURES TITLES
/S/ Anthony J. Cuti President and Chief Executive Officer and Director
----------------------------------- (Principal Executive Officer)
Anthony J. Cuti
/s/ John K. Henry Senior Vice President and Chief Financial Officer
------------------------------------ (Principal Accounting and Financial Officer)
John K. Henry
16
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.
Dated: May 10, 2001
DUANE READE
By: DRI I Inc., a general partner By: Duane Reade Inc., a general partner
By: /s/ John K. Henry By: /s/ John K. Henry
-------------------------------------------- --------------------------------------------
Name: John K. Henry Name: John K. Henry
Title: Senior Vice President and Chief Financial Title: Senior Vice President and Chief Financial
Officer Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below on May 10, 2001 by the following
persons in the capacities indicated with respect to Duane Reade Inc. and DRI
I Inc., the general partners of Duane Reade, on behalf of Duane Reade (except
as otherwise indicated):
SIGNATURES TITLES
---------- ------
/s/ Anthony J. Cuti President and Chief Executive Officer and Director
----------------------------------- (Principal Executive Officer)
Anthony J. Cuti
/s/ John K. Henry Senior Vice President and Chief Financial Officer
----------------------------------- (Principal Accounting and Financial Officer)
John K. Henry
17
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.
Dated: May 10, 2001
DUANE READE REALTY, INC.
By: /s/ John K. Henry
-----------------------------------------
Name: John K. Henry
Title: Senior Vice President and Chief Financial
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed on May 10, 2001 by:
SIGNATURES TITLES
---------- ------
/s/ Anthony J. Cuti President and Chief Executive Officer and Director
----------------------------------- (Principal Executive Officer)
Anthony J. Cuti
/s/ John K. Henry Senior Vice President and Chief Financial Officer
------------------------------------ (Principal Accounting and Financial Officer)
John K. Henry
18
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.
Dated: May 10, 2001
DUANE READE INTERNATIONAL, INC.
By: /s/ John K. Henry
-----------------------------------------
Name: John K. Henry
Title: Senior Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed on May 10, 2001 by:
SIGNATURES TITLES
---------- ------
/s/ Anthony J. Cuti President and Chief Executive Officer and Director
----------------------------------- (Principal Executive Officer)
Anthony J. Cuti
/s/ John K. Henry Senior Vice President and Chief Financial Officer
------------------------------------ (Principal Accounting and Financial Officer)
John K. Henry
19