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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
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FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934
For the fiscal year ended December 27, 1997. Commission file number 333-41239
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DUANE READE INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3164702
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(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
DRI I Inc.* Delaware 04-3166107
Duane Reade* New York 11-2731721
*Guarantors with respect to the Company's 9 1/4% Senior Subordinated Notes due
2008
440 Ninth Avenue
New York, New York 10001
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(Address of principal executive offices) (Zip Code)
(212) 273-5700
(Registrant's telephone number, including area code)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE ON WHICH
TITLE OF EACH CLASS REGISTERED
-------------------------------- --------------------------------
Common Stock, $.01 par value per share New York Stock Exchange, Inc.
9 1/4% Senior Subordinated Notes due 2008 None.
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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 [ ]No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The only class of voting securities of Duane Reade Inc. is its Common
Stock, par value $.01 per share (the "Common Stock"). On March 23, 1998, the
aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $224.8 million.
-----------------------------
The number of shares of the Common Stock outstanding as of March 23,
1998: 16,960,577
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DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits as listed on the Exhibit Index and filed with
registrant's registration statements on Form S-1 (Nos. 333-41239 and 333-43313)
under the Securities Act of 1933, as amended, are incorporated by reference
into Part IV of this Form 10-K.
INDEX
Page
PART I
ITEM 1 Business........................................................4
ITEM 2. Properties......................................................12
ITEM 3. Legal Proceedings...............................................13
ITEM 4. Submission of Matters to a Vote of Security Holders.............13
PART II
ITEM 5. Market for Registrant's Common Equity
and Related Stockholder Matters.................................14
ITEM 6. Selected Financial Data.........................................15
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................17
ITEM 8. Financial Statements and Supplementary Data.....................25
ITEM 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.............................46
PART III
ITEM 10. Directors and Executive Officers of the Registrant..............47
ITEM 11. Executive Compensation..........................................49
ITEM 12. Security Ownership of Certain Beneficial Owners and Management..56
ITEM 13. Certain Relationships and Related Transactions..................58
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.............................................61
SIGNATURES.................................................................64
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PART I
ITEM 1. BUSINESS.
GENERAL
Duane Reade is the largest drugstore chain in New York City,
based on sales volume, with 58 of its 67 stores located in Manhattan's
high-traffic business and residential districts. The Company operates almost
twice as many stores in Manhattan as its next largest competitor. Since opening
its first store in 1960, the Company has successfully executed a marketing and
operating strategy tailored to the unique characteristics of New York City, the
largest and most densely populated market in the United States. According to
Drug Store News, Duane Reade is the leading drugstore chain in the United
States in terms of sales per square foot, at $1,010 per square foot in 1997,
which was more than two times the national average for drugstore chains. For
the fiscal year ended December 27, 1997, the Company had sales of $429.8
million and EBITDA of $43.1 million, increases of 12.7% and 22.0%,
respectively, over the 1996 fiscal year. For the fiscal year ended December 27,
1997, the Company had a net loss of $14.7 million.
The Company enjoys strong brand name recognition in New York
City, which it believes results from the Company's many locations in
high-traffic areas of Manhattan and the 30 million shopping bags with the
distinctive Duane Reade logo that the Company distributes annually. An
independent survey conducted in 1996 indicated that approximately 84% of the
people who live or work in Manhattan recognize the Duane Reade name, and seven
out of ten shopped at a Duane Reade store in the past twelve months. The
Company was also recently named "Regional Drug Store Chain of the Year" for
1997 by Drug Store News.
The Company has developed an operating strategy designed to
capitalize on the unique characteristics of the New York City market, which
include high-traffic volume, complex distribution logistics and high costs of
occupancy, media advertising and personnel. The key elements of the Company's
operating strategy are (i) everyday low price format and broad product
offering, (ii) low cost operating structure supported by its high volume stores
and low advertising and distribution costs and (iii) ability to design and
operate its stores in a wide variety of sizes and layouts.
The Company believes that its everyday low price format and
broad product offerings provide value and convenience for its customers and
build customer loyalty. The Company's everyday low price format results in
prices that the Company believes are lower, on average, than the prices offered
by its competitors.
The Company is able to keep its operating costs relatively low
due to its high per store sales volume, relatively low warehouse and
distribution costs and relatively low advertising expenditures. The Company's
high volume stores allow it to effectively leverage occupancy costs, payroll
and other store operating expenses. The Company's two primary distribution
facilities are located within five miles of all but one of its 67 stores and,
combined with the rapid
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turnover of inventory in Duane Reade's stores, result in relatively low
warehouse and distribution costs. The Company plans to move all of its
distribution facilities to another, recently leased warehouse in mid-1998. See
"--Company Operations." The Company's strong brand name recognition in New York
City and everyday low price format allow the Company to minimize its use of
costly media and print advertising and to rely instead on in-window displays
and other less expensive promotional activities.
The Company has demonstrated its ability to successfully
operate stores using a wide variety of store configurations and sizes, which
the Company believes is necessary to succeed in the New York City market. For
example, the size of the Company's stores ranges from 2,600 to 12,300 square
feet, and it operates 29 bi-level stores. The Company believes that its
flexibility in configuring stores provides it with a competitive advantage in
securing locations for its new stores, as many of its competitors target more
standardized spaces for their stores, which are more difficult to find in New
York City. In addition, the Company's management team has extensive experience
and knowledge of the New York City real estate market, allowing it to pursue
attractive real estate opportunities.
The Company's predecessor was founded in 1960. In 1992, Bain
Capital acquired the Company from its founders and, in June 1997, investment
funds affiliated with DLJMBPII (as defined) acquired approximately 91.5% of the
outstanding capital stock of the Company from Bain Capital and certain other
selling securityholders. Since the 1992 acquisition, the Company has incurred
net losses in each fiscal year.
In 1994 and 1995, the Company experienced rapid expansion,
growing from 40 stores to 59 stores. However, as a result of liquidity
constraints and the need for improved inventory controls, the Company was
forced to suspend its store expansion program in late 1995. In early 1996, a
strengthened management team led by Anthony Cuti, the Company's new Chairman
and Chief Executive Officer, took several measures to improve operations,
including improving inventory controls and decreasing out-of-stock occurrences,
creating a loss prevention function to control inventory shrink and continuing
to invest in MIS. In 1997, the Company resumed its store expansion program,
opening seven stores. During Mr. Cuti's tenure at the Company, EBITDA has
increased by 60.2% from $26.9 million for the 52 weeks ended March 29, 1996 to
$43.1 million for the fiscal year ended December 27, 1997, and the Company
experienced net losses of $19.8 million and $14.7 million for the 52 weeks
ended March 29, 1996 and the fiscal year ended December 27, 1997, respectively.
Net loss before non-recurring charges for the fiscal year ended December 27,
1997 was $2.0 million.
COMPANY OPERATIONS
Merchandising. Duane Reade's overall merchandising strategy is
to provide the broadest selection of branded and private label drugstore
products available in Manhattan and to sell them at everyday low prices. To
further enhance customer service and loyalty, the Company attempts to maintain
a consistent in-stock position in all merchandise categories. In addition to
prescription and OTC drugs, the Company offers health and beauty aids, food and
beverage items, tobacco products, cosmetics, housewares, hosiery, greeting
cards, photofinishing, photo
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supplies, seasonal merchandise and other products. Health and beauty care
products, including OTC drugs, represent the largest of the Company's product
categories. Duane Reade drugstores offer a wide variety of brand name and
private label products, including oral, skin and hair care products, bath
supplies, vitamins and nutritional supplements, feminine hygiene products,
family planning products and baby care products. Popular brands of health and
beauty aids are given ample shelf space, and large sizes are offered, which the
Company believes appeals to the value consciousness of many Manhattan
consumers. Convenience items such as candy, snacks and seasonal goods are
positioned near the check out registers to provide optimum convenience and
stimulate impulse purchases for the customers while allowing the store
employees to monitor those product categories that are particularly susceptible
to inventory shrink.
In addition to the wide array of brand products offered in its
stores, the Company offers its own private label products. Private label
products provide customers with high-quality, lower priced alternatives to name
brand products while generating higher gross profit margins than name brand
products. These offerings also enhance Duane Reade's reputation as a
value-oriented store. the Company currently offers approximately 400 private
label products. In 1997, these private label products accounted for
approximately 4.6% of non-pharmacy sales. The Company believes that its strong
brand image, reputation for quality and reliability in the New York City
market, and its economies of scale in purchasing allow it to aggressively
promote private label goods.
The Company has recently made efforts to increase the sales of
certain high-margin items, such as cosmetics, greeting cards and
photofinishing. Other merchandising initiatives completed during 1996 and 1997
include an expanded selection of seasonal merchandise, vitamins, nutrition
products and baby accessories, particularly in stores located in residential
areas. The Company believes there are additional opportunities to continue to
refine and improve the merchandise mix in its stores.
The Company also offers same-day photofinishing services in all
of its stores and has recently introduced one-hour photofinishing in three
stores. In 1998, the Company expects to introduce one-hour photofinishing in
seven to ten additional stores. Management believes that photofinishing
services contribute significantly to sales of other merchandise categories
because of customer traffic increases that result from the customer visiting a
store twice, in order to drop off film and pick up the processed photos.
Pharmacy. The Company believes that its pharmacy business will
continue to contribute significantly to the Company's growth. Management also
believes that a larger and stronger pharmacy business will enhance customer
loyalty and generate incremental customer traffic, which is expected to
increase sales of Duane Reade's wide variety of OTC drugs and other
non-pharmacy merchandise. Duane Reade's prescription drug sales (as reflected
by same store pharmacy sales) grew by 24.6% in 1997 compared to 1996. Sales of
prescription and OTC drugs represented approximately 40% of total sales in 1997
as compared with 35% of total sales in 1996. Although the average number of
prescriptions filled by Duane Reade per store per week has increased from 640
in 1994 to 863 during 1997, the Company's average remains well below the
industry chain store average of approximately 1,200, providing significant
opportunity for
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continued pharmacy growth. The Company believes that the average number of
prescriptions filled per week by it lags behind the industry average because of
(i) the historically low penetration of Third Party Plans in the New York City
area and (ii) the Company's concentration of stores in business areas, rather
than residential areas. The Company believes continued pharmacy growth will
also increase overall customer traffic and benefits its non-pharmacy sales.
The Company generally locates the pharmacy at the rear of the
store in order to maximize the pharmacy customer's exposure to other categories
of merchandise in the front of the store. Each pharmacy is staffed with a
registered pharmacist and drug clerk at all times to ensure quick and high
quality service. Each store carries a complete line of both branded and generic
prescription drugs. In 1996, the Company began a program to upgrade the quality
of its pharmacy service. The Company believes that this initiative has
contributed to its strong growth in pharmacy sales and should continue to
benefit the Company as customer loyalty builds in response to improved service
levels.
In addition to customer service initiatives in its pharmacy
business, the Company has remodeled or redesigned 16 of its pharmacies since
the beginning of 1996. This remodeling, which has primarily involved updating
the pharmacy counter area to allow pharmacists and customers to have more
direct contact and providing a consultation and waiting area for customers, has
not resulted in any significant reduction in total retail selling space. By
improving the store layout and accessibility of the pharmacist and pharmacy
area, the stores that have been remodeled have achieved strong growth in their
pharmacy business. All stores opened since 1995 have the new pharmacy counter
area design. The Company currently operates 24 such stores. The Company has
also launched pharmacy marketing initiatives, such as home delivery and
prescription-by-fax services, which it believes have contributed to the
increased sales and customer loyalty of the pharmacy business.
The Company believes that its extensive network of conveniently
located stores, strong local market position, pricing policies and reputation
for high quality health care products and services provide it with a
competitive advantage in attracting pharmacy business from individual customers
as well as Third Party Plans. The percentage of the Company's total
prescription drug sales attributable to Third Party Plans increased to
approximately 74% in 1997 from approximately 64% in 1996. Although gross
margins on sales to Third Party Plans are generally lower than other
prescription drug sales because of the highly competitive nature of pricing for
this business and the purchasing power of Third Party Plans, management
believes that the lower gross profit margins are offset by the higher volume of
pharmacy sales to Third Party Plan customers allowing the Company to leverage
other fixed store operating expenses. In addition, the Company believes that
Third Party Plans generate additional general merchandise sales by increasing
customer traffic in the stores. As of December 27, 1997, the Company had
contracts with over 100 Third Party Plans, including every major Third Party
Plan in the Company market areas.
Another important component of the Company's pharmacy growth
strategy is the continued acquisition of prescription files from independent
pharmacies in market areas currently served by existing Company stores. In
1997, the Company purchased the prescription files of
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eight independent pharmacies for an aggregate total of $830,000, which
generated approximately $7 million in revenues on an annualized basis.
Independent pharmacists tend to have a higher proportion of customers that are
not Third Party Plans, which provide the Company with incremental revenue and
higher margin contribution. When appropriate, the Company will retain the
services of the pharmacist, whose personal relationship with the customers
generally maximizes the retention rate of the purchased file. Since 1995, the
Company has experienced an estimated 80% customer retention rate with respect
to prescription files acquired. Presently, there are approximately 1,400
independent pharmacies in New York City, and the Company believes that these
stores will provide additional acquisition opportunities in the future.
The Company's pharmacies employ computer systems that link all
of the Company's pharmacies and enable them to provide customers with a broad
range of services. The Company's pharmacy computer network profiles customer
medical and other relevant information, supplies customers with information
concerning their drug purchases for income tax and insurance purposes and
prepares prescription labels and receipts. The computer network also expedites
transactions with Third Party Plans by electronically transmitting prescription
information directly to the Third Party Plan and providing on-line
adjudication, which confirms at the time of sale customer eligibility,
prescription coverage and pricing and co-payment requirements and automatically
bills the respective plan. On-line adjudication reduces losses from rejected
claims and eliminates a portion of the Company's paperwork for billing and
collection of receivables and costs associated therewith.
Store Operations. The majority of the Company's stores are
located in the business and residential areas of Manhattan, the most densely
populated area in the United States. The Company's operations have been
tailored to handle high-volume customer traffic. During 1997, an average Duane
Reade store served approximately 2,500 customers per weekday, and 700 customers
during each of the peak lunch and commuting periods of the day. Some of the
Company's stores may operate up to 25 registers during peak demand periods.
Duane Reade stores range in size from 2,600 to 12,300 square
feet, with an average of 6,900 square feet. The Company's stores are designed
to facilitate customer movement and to minimize inventory shrink. The Company
believes that its wide, straight aisles and well-stocked shelves allow
customers to find merchandise easily and allow the store's employees (managers,
security guards, cashiers and stock clerks) to effectively monitor customer
behavior. The Company attempts to group merchandise logically in order to
enable customers to locate items quickly and to stimulate impulse purchases.
In 1996, the Company began planogramming its stores by using a
computerized space management system to design each store's layout and product
displays. The system seeks to maximize productivity per square foot of selling
space, maintain consistency in merchandising and reduce inventory levels. To
date, 52 stores have been designed by the system. Management believes that the
Company's remaining stores will be planogrammed by the end of the second
quarter of 1998. As a result, the Company believes that it has yet to realize
the full benefits from this system.
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The Company establishes each store's hours of operation in an
attempt to best serve customer traffic patterns and purchase habits and to
optimize store labor productivity. Stores in Manhattan's business districts are
generally open five days a week. In residential and appropriate
business/shopping districts, stores are open six or seven days a week with a
heavy emphasis on convenient, early morning and late evening openings. In 1997,
the Company had seven stores which were open 24 hours a day, 365 days a year.
The Company intends to continue to identify stores in which extended operating
hours would improve customer service and convenience and contribute to the
Company's profitability. Each store is supervised by one store manager and one
or more assistant store managers. Stores are supplied by deliveries from the
Company's warehouses in Queens an average of three times a week, allowing the
stores to maintain a high in-stock position, maximize store selling space and
minimize inventory required to be held on hand.
The Company attempts to mitigate inventory shrink through (i)
the employment of full time security guards in each store, (ii) use of a
state-of-the-art Electronic Article Surveillance ("EAS") system that detects
unremoved EAS tags on valuable or easily concealed merchandise and (iii)
merchandise delivery and stocking during non-peak hours. Additionally, all
store and warehouse employees are trained to monitor inventory shrink, and the
Company uses outside consulting services to monitor employee behavior.
Recently, the Company hired a full-time team of loss prevention professionals
and established an anonymous call-in line to allow employees to report
instances of theft. The Company also instituted ongoing audits of warehouse
picking and receiving and an anonymous reward line for the reporting of theft.
The Company believes that these programs have enabled it to control inventory
shrink and will enable it to continue to do so.
Purchasing and Distribution. The Company purchases
approximately 82% of its merchandise directly from manufacturers. The Company
distributes approximately 84% of its merchandise through the Company's
warehouses and receives direct-to-store deliveries for approximately 16% of its
purchases. Direct-to-store deliveries are made for some pharmaceuticals,
greeting cards, photofinishing, convenience foods and beverages. The Company
purchases from over 1,000 vendors. The Company believes that there are ample
sources of supply for the merchandise currently sold in its stores. The
Company manages its purchasing through a combination of forward buying,
national buying and vendor discount ("deal") buying in ways in which it
believes maximizes its buying power. For example, the Company uses a
computerized forecasting and investment program that is designed to determine
optimal forward buying quantities before an announced or anticipated price
increase has been implemented. By forward buying, the Company stocks up on
regularly carried items when manufacturers temporarily reduce the cost of
goods or when a price increase has been announced or is anticipated.
The Company currently operates two warehouses, which are
located within five miles of all but one of its stores. The Company's primary
warehouse contains approximately 150,000 square feet devoted to inventory. The
Company believes that the close proximity of the warehouses to the stores
allows the Company to supply the stores frequently, thereby minimizing
inventory and maximizing distribution economies. The Company also owns a fleet
of trucks and vans, which it uses for all deliveries from the warehouses to the
stores.
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In March 1998, the Company entered into a new long-term lease
for a 300,000 square foot distribution center in Long Island City, New York.
The facility will approximately double in the Company's distribution capacity
and is one mile away from the Company's current center. The new facility is
scheduled to open in mid-year 1998 and will replace the existing warehouses.
ADVERTISING AND PROMOTION
The Company regularly promotes key items at reduced retail
prices during four-week promotional periods. Store windows and in-store signs
are utilized to communicate savings and value to shoppers. Additionally, over
30 million bags with the highly recognizable Duane Reade logo are used by its
customers each year, helping to promote the Company's name throughout New York
City. The Company also utilizes full color circulars to announce new stores and
heavily circulates them in local areas to attract customers. Typically, a new
store sells one to two times its regular volume during a grand opening
promotion, which generally lasts two to three weeks. The Company generally does
not rely heavily on the use of print or broadcast media to promote its stores.
Rather, because of its many high-traffic locations, the Company typically
relies on in-window displays as its primary method of advertising. In 1997, the
Company began using radio advertising. The radio advertising focuses on the
Company's pharmacy business, highlighting services enhanced by the modern
pharmacy computer system, pharmacist accessibility and enhanced convenience
MANAGEMENT INFORMATION SYSTEMS
The Company currently has modern pharmacy and inventory
management information systems. In 1996, the Company completed the installation
of a host-based, modern pharmacy information system. The pharmacy system (PDX)
has reduced the processing time for electronic reimbursement approval for
prescriptions from Third Party Plan providers from 50 seconds to 7 seconds, and
the inventory management systems (JDA merchandising and E3 replenishment) have
allowed the Company to increase turns in the warehouse from 11 to 13 per year.
In early 1997, the Company began the process of installing its point of sale
(POS) systems in its stores,. The Company believes that these systems will
better allow the Company to better control pricing, inventory and shrink, while
maximizing the benefits derived from the other parts of its systems
installation program. POS will also provide sales analysis that will enable the
Company to improve labor scheduling, and will help optimize planogram design by
allowing detailed analysis of stock-keeping unit sales. The installation of the
Company's POS systems was completed in December 1997. Additionally, the Company
has upgraded its financial reporting systems and installed local and wide area
networks to facilitate the transfer of data between systems and from the stores
to headquarters.
The Company has several computer software systems which will
require modification or upgrading to accommodate the year 2000 and thereafter.
The Company believes that all systems can be changed by the end of 1999 and
does not expect the cost of all the changes to be material to the Company's
financial condition or results of operations.
COMPETITION
The Company's stores compete on the basis of, among other
things, convenience of location and store layout, product mix, selection,
customer service and price. The New York
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City drugstore market is highly fragmented due to the complexities and costs of
doing business in the most densely populated area of the country. The diverse
labor pool, local customer needs and complex real estate market in New York
City all favor regional chains and independents that are familiar with the
market. Duane Reade's store format is tailored to meet all of these
requirements and has proven successful in both the business and residential
neighborhoods of Manhattan.
Because of the difficulties of operating in densely populated
areas, the New York City drugstore market remains under-penetrated by national
chains as compared to the rest of the country. Nationwide, approximately 74% of
the drugstore market is controlled by chains, while in New York City that
number is approximately 50%. There can be no assurance that such
underpenetration will continue.
Duane Reade believes that it has significant competitive
advantages over the approximately 1,400 independent drugstores in New York
City, including purchasing economies of scale, centrally located warehouses
that minimize store inventory and maximize selling space, a full line of in
stock, brand name merchandise and a convenient store format. Major chain
competitors in the New York City market include Rite-Aid, Genovese and CVS.
GOVERNMENT REGULATION
Duane Reade's stores and its distribution facility are
registered with the federal U.S. Drug Enforcement Agency and are subject to
various state and local licensing requirements. Each of Duane Reade's
pharmacies and pharmacists located in New York are licensed by the State of
New York. The pharmacy and pharmacists employed at Duane Reade's store in
Newark, New Jersey are licensed by the State of New Jersey. In addition, Duane
Reade has been granted cigarette tax stamping licenses from the State of
New York and from the City of New York which permit Duane Reade to buy
cigarettes directly from the manufacturers and stamp the cigarettes themselves.
Duane Reade's stores possess cigarette tax retail dealers licenses issued by
the State of New York, the City of New York and the State of New Jersey.
EMPLOYEES
As of December 27, 1997, Duane Reade had approximately 2,000
employees, almost all of whom were full-time. Approximately 1,800 of the
Company's 2,000 employees are represented by unions. Non-union employees
include employees at corporate headquarters, employees at Duane Reade's
personnel office and store management. The distribution facility employees are
represented by the International Brotherhood of Teamsters, Chauffeurs and
Warehousemen and Helpers of America, Local 815, and all store employees are
represented by the Allied Trade Council. Duane Reade's three year contracts
with these two unions expire on August 31, 1999 and August 31, 1998,
respectively. Duane Reade believes that its relations with its employees are
good.
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TRADEMARKS
The name "Duane Reade" and the "DR" logo are registered trademarks.
The Company believes that it has developed strong brand awareness within the
New York City area. As a result, the Company regards the Duane Reade logo as a
valuable asset.
The foregoing information contains certain forward-looking statements
that involve a number of risks and uncertainties. A number of factors could
cause actual results, performance, achievements of the Company, or industry
results to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. These
factors include, but are not limited to, the competitive environment in the
drugstore industry in general and in the Company's 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 the Company's business; liability
and other claims asserted against the Company; changes in operating strategy
or development plans; the ability to attract and retain qualified personnel;
the significant indebtedness of the Company; labor disturbances; changes in
the Company's acquisition and capital expenditure plans; and other factors
referenced herein. In addition, such 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 herein 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
thereof, or other variations thereon or comparable terminology, or by
discussions of strategy or intentions. Given these uncertainties, prospective
investors are cautioned not to place undue reliance on such forward-looking
statements. The Company disclaims any obligations to update any such factors
or to publicly announce the results of any revisions to any of the forward-
looking statements contained herein to reflect future events or developments.
ITEM 2.
PROPERTIES.
As of December 27, 1997, the Company is operating stores in the
following locations:
NO. OF STORES
Manhattan, NY 58
Brooklyn, NY 4
Bronx, NY 2
Queens, NY 2
Newark, NJ 1
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Total: 67
Store leases are generally for 15 year terms. The average year
of expiration for all the Company's leases is 2006. Lease rates are generally
subject only to increases based on inflation, real estate tax increases or
maintenance cost increases. The following table sets forth the lease expiration
dates of the Company's leased stores over each of the next five years and
thereafter. Of the stores with leases expiring in the next five years, six have
renewal options.
YEAR
1998...............................................2
1999...............................................1
2000...............................................4
2001...............................................0
2002...............................................9
Thereafter.........................................51
The Company owns a distribution facility and related land in
Long Island City, New York. The building contains approximately 150,000 square
feet of space, all of which is used for warehousing and distribution. The
Company also leases a 50,000 square foot distribution facility in Maspeth, New
York, which is approximately one mile from the Long Island City facility. In
addition, the Company recently entered into a new long-term lease for a
distribution facility in Long Island City, New York. The Company plans to
dispose of its owned warehouse once operations are moved to the new facility in
mid - 1998.
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The Company leases space for its corporate headquarters, which
is located in Manhattan, New York.
ITEM 3.
LEGAL PROCEEDINGS.
The Company is a party to certain legal actions arising in the
ordinary course of business. Based on information presently available to the
Company, the Company believes that it has 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 the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On November 24, 1997, a majority of the security holders of the
Company approved the initial public offering of the Company's Common Stock, a
change of the Company's name from Duane Reade Holding Corp. to Duane Reade Inc.
and Anthony J. Cuti's Employment Agreement and Option Agreement (effective June
18, 1997) by written consent in lieu of a meeting. On December 23, 1997, a
majority of the security holders of the Company approved and ratified all
employee stock options granted pursuant to the 1997 Equity Participation Plan
by written consent in lieu of a meeting.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
MARKET PRICE RANGE OF COMMON STOCK
Duane Reade's Common Stock is listed on the New York Stock
Exchange under the symbol: "DRD". At March 23, 1998 there were 85 recordholders
of the Common Stock. The Company's Common Stock was not publicly traded in 1997
and the Company paid no dividends.
-14-
ITEM 6. SELECTED FINANCIAL DATA.
(in thousands, except per share amounts, percentages
and store data)
Fiscal Year
------------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
STATEMENT OF OPERATIONS DATA:
Net sales.................................... $429,816 $381,466 $336,922 $281,103 $241,474
Cost of sales................................ 322,340 288,505 259,827 209,678 181,566
Gross profit................................. 107,476 92,961 77,095 71,425 59,908
Selling, general and administrative
expenses................................... 65,414 59,048 50,326 39,741 29,666
Amortization................................. 5,303 16,217 11,579 18,238 27,432
Depreciation................................. 3,507 3,015 1,929 1,184 729
Store pre-opening expenses................... 767 139 1,095 1,220 300
Nonrecurring charges (1) .................... 12,726 -- -- -- --
-------- -------- -------- -------- --------
Operating income............................. 19,759 14,542 12,166 11,042 1,781
Net interest expense......................... 34,473 32,396 30,224 27,480 26,199
-------- -------- -------- -------- --------
Loss before taxes............................ (14,714) (17,854) (18,058) (16,438) (24,418)
Provision for taxes.......................... -- -- -- -- --
-------- -------- -------- -------- --------
Net loss..................................... $(14,714) $(17,854) $(18,058) $(16,438) $(24,418)
======== ======== ======== ======== ========
Net loss per common share-basic.............. $(1.45) $(1.77) $(1.77) $(1.62) $(2.45)
======== ======== ======== ======== ========
Weighted average common shares
outstanding-basic.......................... 10,161 10,103 10,178 10,161 9,976
======== ======== ======== ======== ========
OPERATING AND OTHER DATA:
EBITDA (2)................................... $43,056 $35,300 $27,443 $31,188 $29,975
EBITDA as a percentage of sales.............. 10.0% 9.3% 8.2% 11.1% 12.4%
Number of stores at end of period............ 67 60 59 51 40
Same store sales growth (3) ................. 7.6% 8.3% (3.5)% 1.6% 3.3%
Pharmacy same store sales
growth (3)(5).............................. 24.6% 25.5% 7.0% 14.2% --
Average store size (square feet) at
end of period.............................. 6,910 6,733 6,712 6,596 6,172
Sales per square foot (4).................... $1,010 $956 $898 $970 $1,022
Pharmacy sales as a % of net sales 25.1% 21.8% 19.0% 17.6% 16.6%
Third-Party Plan sales as of % of
pharmacy sales (5)......................... 74.2% 64.4% 58.2% 45.7% --
Capital expenditures......................... $13,493 $1,247 $6,868 $9,947 $1,838
BALANCE SHEET DATA (AT END OF
PERIOD):
Working capital.............................. $37,494 $9,917 $13,699 $20,152 $14,285
Total assets................................. 249,521 222,476 235,860 229,699 234,430
Total debt and capital lease
obligations................................ 278,085 245,657 244,104 228,764 223,422
Stockholders' deficiency..................... (74,109) (59,396) (41,196) (23,170) (6,757)
(1) Refer to Note 12 of Consolidated Financial Statements.
(2) As used herein, "EBITDA" means net loss plus nonrecurring charges,
interest, income taxes, depreciation, amortization and other non-cash
items (primarily deferred rents). Management believes that EBITDA, as
presented, represents a useful measure of assessing the performance of
the Company's ongoing operating activities as it reflects the earnings
trends of the Company without the impact of certain non-cash charges.
Targets and positive trends in EBITDA are used as the performance
measure for determining management's bonus compensation; EBITDA is
also utilized by the Company's creditors in assessing debt covenant
compliance. The Company understands that, while EBITDA is frequently
used by security analysis in the evaluation of companies, it is not
necessarily comparable to other similarly titled captions of other
companies due to potential inconsistencies in the method of
calculation. EBITDA is not intended as an alternative to cash flow
from operating activities as a measure of liquidity, nor an
alternative to net income as an indicator of the Company's operating
performance nor any other measure of performance in conformity with
GAAP.
-15-
A reconciliation of net loss to EBITDA for each period included above is set
forth below (dollars in thousands):
Fiscal Year
------------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
Net loss..................................... $(14,714) $(17,854) $(18,058) $(16,438) $(24,418)
Net interest expense......................... 34,473 32,396 30,224 27,480 26,199
Amortization................................. 5,303 16,217 11,579 18,238 27,432
Depreciation................................. 3,507 3,015 1,929 1,184 729
Nonrecurring charges......................... 12,726 -- -- -- --
Other non-cash items......................... 1,761 1,526 1,769 724 33
-------- -------- -------- -------- --------
EBITDA....................................... $43,056 $35,300 $27,443 $31,188 $29,975
======== ======== ======== ======== ========
(3) Same store sales figures include stores that have been in operation
for at least 13 months.
(4) The Company experienced a decline in sales per square foot from 1993
through 1995 as a result of the opening of additional stores in
connection with the Company's expansion. The opening of such
additional stores resulted in a decline in sales per square foot
principally because (i) the average square footage for the new stores
was greater than that of the existing store base and (ii) new stores
generally take some time to reach a mature level of sales. See
"Management's Discussion and Analysis of Financial Condition and
Results of Operations--General."
(5) Prior to fiscal year 1994, the Company's pharmacy system did not separately
track third-party sales.
-16-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following should be read in connection with the consolidated
financial statements of the Company and the notes thereto included elsewhere in
this document.
GENERAL
The Company generates revenues primarily through sales of OTC drugs
and prescription pharmaceutical products, health and beauty aids, food and
beverage items, tobacco products, cosmetics, housewares, hosiery, greeting
cards, photofinishing, photo supplies and seasonal merchandise. Health and
beauty products, including OTC drugs, represent the largest of the Company's
product categories. The Company's primary costs and expenses consist of (i)
inventory costs, (ii) labor expenses and (iii) occupancy costs.
In 1994 and 1995, the Company experienced rapid expansion, growing
from 40 stores to 59 stores. However, as a result of liquidity constraints and
the need for improved inventory controls, the Company was forced to suspend its
store expansion program in late 1995. In early 1996, a strengthened management
team led by Anthony Cuti, the Company's new Chairman and Chief Executive
Officer, took several measures to improve operations such as decreasing out-of
stock occurrences, creating a loss prevention function to control inventory
shrink and continuing to invest in MIS.
The Company had sales per square foot of $956 and $1,010 in fiscal
1996 and fiscal 1997, respectively. The Company believes that sales per square
foot are a useful measure of comparing the Company's performance to that of its
competitors because it is a measure of a store's sales productivity. The
Company experienced a decline in sales per square foot from 1993 through 1995
as a result of the opening of additional stores in connection with the
Company's expansion plans during that period. The opening of such additional
stores resulted in a decline in sales per square foot principally because (i)
the average square footage for the new stores was greater than that of the
existing store base and (ii) new stores generally take some time to reach a
mature level of sales. The Company currently expects that its sales per square
foot may decline as it embarks on its plan to increase new store openings
during 1998 and 1999. The Company believes that its competitors in the industry
experience increases and decreases in sales per square foot for similar
reasons.
In 1997, the Company resumed its store expansion program, opening
seven stores. Generally a new Duane Reade store requires an investment of
approximately $1.1 million in capital expenditures and working capital. Since
1993, all of the Company's new stores have become profitable on an operating
basis within the first full year of operation. Over the next two years, the
Company plans to open approximately 30 to 40 stores, primarily in New York
City.
Over the past two years, Third Party Plans, including managed care
providers and insurance companies, have comprised an increasing percentage of
the Company's pharmacy business as the health care industry shifts to managed
care. While sales to customers covered by
-17-
Third Party Plans results in lower gross profit rates due to competitive
pricing, the Company believes that such lower rates are offset by increased
volume of pharmacy sales and the opportunity to leverage fixed expenses.
The Company includes stores that have been in operation for at least
13 months for purposes of calculating comparable store sales figures.
The Company's predecessor was founded in 1960. In 1992, Bain Capital
formed the Company to acquire the Company's predecessor from its founders
through a leveraged buyout, financed primarily with the proceeds from the Zero
Coupon Notes and the Senior Notes. In June 1997, investment funds affiliated
with DLJMBPII (the "DLJMB Entities"), an affiliate of DLJ, acquired
approximately 91.5% of the outstanding capital stock of the Company from Bain
Capital and certain other selling securityholders, for approximately $78.7
million in cash, pursuant to a Recapitalization Agreement, dated June 18, 1997
(the "Recapitalization Agreement"). Upon consummation of such purchase, the
Company reclassified all of its outstanding capital stock (then consisting of
four classes) into one class of common stock, $0.01 par value per share.
Prior to the consummation of the Offering in February 1998, the
Company's primary asset was all of the outstanding common stock of Daboco,
Inc., a New York corporation ("Daboco"), with Daboco and DRI I, Inc. ("DRI"), a
direct wholly-owned subsidiary of Daboco, together owning all of the
outstanding partnership interest of Duane Reade, a New York general partnership
("Duane Reade") (Daboco owns a 99% partnership interest and DRI owns the
remaining 1% partnership interest). Substantially all of the operations of the
Company are conducted through Duane Reade. Concurrently with the consummation
of the Offering, Daboco was merged with and into the Company (the "Merger"),
resulting in the Company directly owning 99% of the partnership interests of
Duane Reade (the "Partnership Interests") and DRI continuing to own a 1%
partnership interest. Following the consummation of the Merger, the primary
assets of the Company are the Partnership Interest and 100% of the outstanding
common stock of DRI.
RESULTS OF OPERATIONS
The following sets forth the results of operations as a percentage of
sales for the periods indicated.
Fiscal Year
--------------------------------------------------
1997 1996 1995
Net Sales..................... 100.0% 100.0% 100.0%
Cost of Sales................. 75.0 75.6 77.1
---- ---- ----
Gross profit.................. 25.0 24.4 22.9
---- ---- ----
Selling, general and
administrative expenses.... 15.2 15.5 14.9
Amortization.................. 1.2 4.3 3.5
Depreciation.................. 0.8 0.8 0.6
Store pre-opening expenses.... 0.2 0.0 0.3
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Nonrecurring charges.......... 3.0 -- --
--- -- --
Operating income.............. 4.6 3.8 3.6
Net interest expense.......... 8.0 8.5 9.0
--- --- ---
Net loss...................... (3.4)% (4.7)% (5.4)%
====== ====== ======
FISCAL 1997 COMPARED TO FISCAL 1996
Net sales in 1997 were $429.8 million, an increase of 12.7% over 1996
net sales of $381.5 million. The increase was attributable to increased
comparable store sales of 7.6% and the inclusion of one new store opened during
1996 for the entire 1997 period and seven new stores opened in 1997.
Cost of sales as a percentage of net sales decreased to 75.0% for 1997
from 75.6% for 1996, resulting in an increase in gross profit margin to 25.0%
for 1997 from 24.4% during 1996. The increase in gross margin resulted from a
number of factors including (i) increased contribution from the sale of higher
margin merchandise such as cosmetics, vitamins, general merchandise, generic
drugs and private label products, (ii) higher promotional allowances received
from venders and (iii) occupancy costs that increased at a lesser rate than the
rate at which sales increased.
Selling, general and administrative expenses were $65.4 million
or 15.2% of net sales and $59.0 million or 15.5% of net sales in 1997 and 1996,
respectively. The percentage decrease in 1997 compared to 1996 resulted
principally from lower general and administrative expense as a percentage of
net sales including the elimination of agreements requiring the annual payment
of $1.0 million in management fees to Bain Capital, partially offset by higher
selling expenses related to higher store salaries as a percentage of net sales
(principally from new stores during the early months of operation). The Company
believes, that as the Company's new stores mature, salaries will increase at a
lesser rate than store sales.
Amortization of goodwill and other intangibles in 1997 and
1996 was $5.3 million and $16.2 million, respectively. The decrease in
amortization is principally a result of the completion in 1996 of amortization
of covenants not to compete and the related write-off of the balance of such
amounts during the fourth quarter of 1996.
Depreciation was $3.5 million and $3.0 million in 1997 and
1996, respectively.
Store pre-opening expenses increased to $0.8 million in 1997
from $0.1 in 1996 due to the opening of seven new store locations in 1997
compared to one in 1996.
Net interest expense was $34.5 million in 1997 compared to
$32.4 million in 1996. The increase in interest expense was principally due to
(i) higher non-cash accretion of the Zero Coupon Notes, (ii) interest related
to financing of third party accounts receivable and (iii) increased interest on
borrowings under the revolving credit facility, partially offset by (a) reduced
interest on term loan borrowings caused by the decrease in average balance from
$72.0 million for 1996 to $67.4 million for 1997 and a decrease in the average
interest rate from 9.1% to 8.7% and (b) reduced interest on capital lease
obligations.
-19-
The net loss for the Company decreased by $3.2 million from
$17.9 million in 1996 to $14.7 million in 1997 primarily as a result of an
increase in sales and gross profit margin and a reduction in amortization
expense, partially offset by nonrecurring charges (see Note 12 of Notes to
Consolidated Financial Statements). The Company's EBITDA improved by $7.8
million or 22.0% to $43.1 million in 1997 compared to $35.3 million in 1996.
EBITDA as a percentage of sales increased to 10.0% in 1997 from 9.3% in 1996.
FISCAL 1996 COMPARED TO FISCAL 1995
Net sales in 1996 were $381.5 million, an increase of 13.2%
over 1995 net sales of $336.9 million. The increase was due to increased
comparable store sales of 8.3% and the inclusion of eight stores opened during
1995 for the entire 1996 period and of one store opened in 1996. The increase
in comparable store sales was primarily attributable to increased pharmacy
sales, which increased to 21.8% of total sales in 1996 compared to 19.0% of
total sales in 1995.
Cost of sales as a percentage of net sales decreased to 75.6%
for 1996 from 77.1% for 1995, resulting in an increase in gross profit margin
to 24.4% for 1996 from 22.9% for 1995. The increase in gross margin resulted
from a number of factors including (i) lower inventory shrink losses, (ii)
increased contribution from the sale of generic drugs and private label
products, (iii) less promotional activity and (iv) lower rent-to-sales ratios
in stores opened during 1995 and 1994. The increases were partially offset by
lower gross margins resulting from sales to customers covered by Third Party
Plans.
Selling, general and administrative expenses were $59.0
million or 15.5% of net sales and $50.3 million or 14.9% of net sales in 1996
and 1995, respectively. The percentage increase in 1996 compared to 1995
resulted principally from higher administrative expenses, including (i)
operating costs related to the Company's management information systems
department, (ii) administrative salaries and one time executive search and
severance expenses and (iii) professional and consulting fees principally for
the warehouse and loss prevention areas. The increases were partially offset by
lower store operating expenses as a percentage of net sales primarily due to a
higher volume of pharmacy sales, which allows the Company to leverage other
fixed store operating expenses.
Amortization of goodwill and other intangibles in 1995 and
1996 was $11.6 million and $16.2 million, respectively. The increase in
amortization was caused by an increase in the amortization of covenants not to
compete from $8.1 million in 1995 to $11.4 million in 1996 and amortization of
systems installation and integration costs in an amount of $1.4 million in
1996. The increase in amortization of covenants not to compete was caused by
the write-off of the balance of such intangibles in 1996 resulting from the
termination of the related agreements. Amortization of systems installation and
integration costs began in 1996.
The increase in depreciation from $1.9 million in 1995 to
$3.0 million in 1996 resulted principally from (i) depreciation of data
processing equipment which began in 1996 and (ii) a full year's depreciation in
1996 of assets of eight stores that were opened in 1995.
-20-
Store pre-opening expenses decreased from $1.1 million in
1995 to $0.1 million in 1996 due to the opening of one new store in 1996
compared to eight in 1995.
Net interest expense increased 7.2% to $32.4 million in 1996
from $30.2 million in 1995. The increase in interest expense was principally
due to the higher non-cash accretion of the Zero Coupon Notes offset, in part,
by reduced interest on term loan borrowings resulting from the decrease in
average outstanding balance from $75.1 million to $72.0 million and a decrease
in the average interest rate from 9.5% to 9.1%.
The net loss for the Company decreased by $0.2 million or
1.1% from $18.1 million in 1995 to $17.9 million in 1996 primarily as a result
of increased sales and gross profit margin offset, in part, by increases in
selling, general and administrative expenses and amortization of intangibles.
The Company's EBITDA increased by $7.9 million or 28.6% to $35.3 million in
1996 compared to $27.4 million in 1995. EBITDA as a percentage of sales
increased to 9.3% in 1996 from 8.2% in 1995.
LIQUIDITY AND CAPITAL RESOURCES
On September 30, 1997, the Company entered into the Old
Credit Agreement, which provided for, among other things, $65.5 million
of term loans and up to $30.0 million of revolving loans. As of December 27,
1997, outstanding balances thereunder totaled $89.8 million. The Company
utilizes cash flow from operations, together with borrowings under the
revolving portion of the Old Credit Agreement, to fund working capital
needs, investing activities (consisting primarily of capital expenditures) and
financing activities (normal debt service requirements, interest payments and
repayment of term and revolving loans outstanding).
In February 1998, the Company successfully completed an
initial public offering of its stock which was part of a plan to refinance all
of the Company's existing indebtedness (the "Refinancing Plan") in order to
enhance the Company's financial flexibility to pursue growth opportunities and
implement capital improvements. The Refinancing Plan resulted in a reduction in
the Company's overall indebtedness, a simplification of the Company's capital
structure and access to additional borrowings. The principal components of the
Refinancing Plan were; (i) the sale by the Company of 6.7 million shares of
common stock for net proceeds of approximately $102 million; (ii) the execution
of a new secured credit agreement (the "Existing Credit Agreement") which
provides for borrowings up to approximately $160 million ($130 million of term
loans and up to $30 million of revolving loans); (iii) the issuance of $80
million aggregate principal amount of the Company's 9 1/4% Senior Subordinated
Notes due 2008 (the "Senior Notes") for net proceeds of approximately
$77 million; (iv) the repayment of all outstanding borrowings under the
Old Credit Agreement, the outstanding principal amount of which was
$89.8 million as of December 27, 1997; (v) the redemption of the
Company's outstanding Zero Coupon Notes; (vi) the redemption of the Company's
outstanding 12% Senior Notes due 2002; and the (vii) Merger of Daboco with and
into the Company. The Company believes the Refinancing Plan will result in a
reduction in overall interest expense because total interest expense associated
with the Existing Credit Agreement and the New Senior
-21-
Subordinated Notes will be less than the total interest expense associated with
the 12% Senior Notes due 2002 and the Zero Coupon Notes. The interest rates
under the Existing Credit Agreement will be approximately the same as interest
rates under the Old Existing Credit Agreement.
Working capital was $37.5 million and $9.9 million as of
December 27, 1997 and December 28, 1996, respectively The increase is primarily
due to the Company's investing in forward-buy inventory and increases in
inventory related to the opening of additional stores in the first quarter or
1998. The Company's capital requirements primarily result from opening and
stocking new stores and from the continuing development of new MIS. The
Company's ability to open stores in 1996 was limited to a certain degree by
liquidity considerations. The Company believes that there are significant
opportunities to open additional stores, and currently plans to open 30 to 40
stores in the next two years. The Company expects to spend approximately $16
million in 1998 on capital expenditures primarily for new and replacement
stores. Working capital is also required to support inventory for the Company's
existing stores. Historically, the Company has been able to lease its store
locations The Company has experienced a significant increase in accounts
receivable due to increased pharmacy sales in connection with Third Party
Plans, as compared to non-Third Party Plan sales which are generally paid by
cash or credit card. However, the Company believes that it has adequately
provided for liquidity by entering into a non-recourse factoring arrangement
whereby the Company resells accounts receivable associated with Third Party
Plans.
For the fiscal year ended December 28, 1996, net cash
provided by operating activities was $12.6 million, compared to $6.7 million
for the fiscal year ended December 30, 1995. The primary reasons for this
increase relate to an increase in operating earnings before the amortization of
goodwill and other intangibles, depreciation and amortization of property and
equipment and interest expenses, partially offset by a decrease in working
capital primarily due to a decrease in accounts payable. For the fiscal year
ended December 28, 1996, net cash used in investing activities was $3.8
million, compared to $12.8 million for the fiscal year ended December 30,1995.
This reduction primarily resulted form a decrease in capital expenditures and
decreases in systems development costs. For the fiscal year ended December 28,
1996, net cash used in financing activities was $10.7 million, compared to $4.8
million provided by financing activities for the fiscal year ended December 30,
1995. This reduction primarily resulted from decreased borrowings under the
Company's then existing credit facility and a decrease in capital lease
financing.
For the fiscal year ended December 27, 1997, net cash used in
operating activities was $3.8 million, compared to $12.6 million provided by
operating activities during the fiscal year ended December 28, 1996. The
primary reasons for this decrease are (i) an increase in inventory and (ii) an
increase in accounts receivable due to increased pharmacy sales in connection
with Third Party Plans. The Company's significant increase in inventory
resulted from management's decision to take advantage of a number of forward
purchasing opportunities, accumulate inventory in advance of additional store
openings and seasonal inventory buildup during 1997. The Company believes that
the activities did not and will not materially adversely affect its liquidity.
For the fiscal year ended December 27, 1997, net cash used in investing
-22-
activities was $12.4 million, compared to $3.8 million for the fiscal year
ended December 28, 1996. This increase primarily resulted from an increase in
capital expenditures during 1997 partially offset by a decrease in systems
development costs. For the fiscal year ended December 27, 1997, net cash
provided by financing activities was $16.2 million, compared to $10.7 million
used in financing activities for the fiscal year ended December 28, 1996. This
increase primarily resulted from borrowings under the Old Credit Agreement
which provided for a term loan of $65.5 million and borrowings of
$24.5 million on a revolving credit facility of $30 million. These proceeds
were used to repay the outstanding term loan balance of $69.5 million and
the revolving loan balance of $2.5 million.
Leases for seven of the Company's stores that generated
approximately 10.7% of the Company's net sales for the fiscal year ended
December 27, 1997 are scheduled to expire before the end of the year 2000. The
Company believes that it will be able to renew such leases on economically
favorable terms or, alternatively, find other economically attractive locations
to lease.
As of December 27, 1997, approximately 1,800 of the Company's
approximately 2,000 employees were represented by various labor unions and were
covered by collective bargaining agreements. Pursuant to the terms of such
collectively bargaining agreements, the Company is required to pay certain
annual increases in salary and benefits to such employees. The Company does not
believe that such increases will have a material impact on the Company's
liquidity or results of operations.
Following the implementation of the Refinancing Plan, the
Company believes that, based on current levels of operations and anticipated
growth, cash flow from operations, together with other available sources of
funds, including borrowings under the Existing Credit Agreement, will be
adequate for at least the next two years to make required payments of
principal and interest on the Company's indebtedness, to fund anticipated
capital expenditures and working capital requirements and to comply with the
terms of its debt agreements. The ability of the Company to meet its debt
service obligations and reduce its total debt will be dependent upon the future
performance of the Company and its subsidiaries which, in turn, will be subject
to general economic, financial, business, competitive, legislative, regulatory
and other conditions, many of which are beyond the Company's control. In
addition, there can be no assurance that the Company's operating results, cash
flow and capital resources will be sufficient for repayment of its indebtedness
in the future. Substantially all of the Company's borrowings under the Existing
Credit Agreement bear interest at floating rates; therefore, the Company's
financial condition will be affected by the changes in prevailing interest
rates. The Company expects to enter into interest rate protection agreements to
minimize the impact from a rise in interest rates.
TAX BENEFITS FROM NET OPERATING LOSSES
-23-
At December 27, 1997, the Company had net operating loss
carryforwards ("NOLs") of approximately $71.0 million, which are due to expire
in the years 2007 through 2012. These NOLs may be used to offset future taxable
income through 2012 and thereby reduce or eliminate the Company's federal
income taxes otherwise payable. The Internal Revenue Code of 1986, as amended
(the "Code"), imposes significant limitations on the utilization of NOLs in the
event of an "ownership change," as defined in Section 382 of the Code (the
"Section 382 Limitation"). The 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 certain 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. The
Recapitalization caused the Company to experience an ownership change. As a
result, the Company currently is subject to an annual Section 382 Limitation of
approximately $5.0 million on the amount of NOLs generated prior to the
Recapitalization that the Company may utilize to offset future taxable income.
In addition, the Company believes that it will generate approximately $42.0
million of NOLs in connection with the Refinancing Plan. Such NOLs will not be
subject to the Section 382 Limitation and may be utilized to offset future
taxable income. However, there can be no assurance that any NOLs will be able
to be utilized by the Company to offset future taxable income or that such NOLs
will not become subject to limitation due to future ownership changes
YEAR 2000 COMPLIANCE
The Company has several computer software systems which will
require modification or upgrading to accommodate the year 2000 and thereafter.
The Company believes that all systems can be changed by the end of 1999 and
does not expect the cost of the changes to be material to the Company's
financial condition or results of operations.
SEASONALITY
In general, sales of drugstores items such as prescription
drugs, OTC 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 seasonable products. In view of the Company's recent expansion of seasonal
merchandising, the Company expects slightly greater revenue sensitivity
relating to seasonality in the future.
INFLATION
The Company believes that inflation has not had a material
impact on results of operations for the Company during the three years ended
December 27 1997.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
-24-
In February 1997, the Financial Accounting Standards Board
issued SFAS No. 128, "Earnings per Share," which requires the presentation of
basic and diluted earnings per share in a company's financial statements for
reporting periods ending subsequent to December 15, 1997. As of December 27,
1997, there were outstanding options to purchase an aggregate of 1.65 million
shares of Common Stock, which shares are not included in the
calculation of earnings per share for the 52 weeks ended December 27, 1997
and would not be included in such calculation under the guidance prescribed
by SFAS No. 128 because of the anit-dilutive nature of these instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
-25-
REPORT OF INDEPENDENT ACCOUNTS
To the Board of Directors and
Stockholders of Duane Reade Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity/(deficiency) and
cash flows present fairly, in all material respects, the financial position of
Duane Reade Inc. (formerly known as Duane Reade Holding Corp.) and its
subsidiaries at December 27, 1997 and December 28, 1996 and the results of
their operations and their cash flows for each of the 52 week periods ended
December 27, 1997, December 28, 1996 and December 30, 1995 in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP
New York, New York
March 6, 1998
-26-
DUANE READE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
FOR THE 52 WEEKS ENDED
----------------------------------------------------------------
DECEMBER 27, DECEMBER 28, DECEMBER 30,
1997 1996 1995
-------------------- ------------------ ------------------
Net sales $ 429,816 $ 381,466 $ 336,922
Cost of sales 322,340 288,505 259,827
-------------------- ------------------ ------------------
Gross profit 107,476 92,961 77,095
-------------------- ------------------ ------------------
Selling, general & administrative expenses 65,414 59,048 50,326
Amortization 5,303 16,217 11,579
Depreciation 3,507 3,015 1,929
Store pre-opening expenses 767 139 1,095
Nonrecurring charges 12,726 - -
-------------------- ------------------ ------------------
87,717 78,419 64,929
-------------------- ------------------ ------------------
Operating income 19,759 14,542 12,166
Interest expense, net 34,473 32,396 30,224
-------------------- ------------------ ------------------
Loss before income taxes (14,714) (17,854) (18,058)
Income taxes - - -
-------------------- ------------------ ------------------
Net loss $ (14,714) $ (17,854) $ (18,058)
==================== ================== ==================
Net loss per common share:
Basic $ (1.45) $ (1.77) $ (1.77)
==================== ================== ==================
Diluted $ (1.45) $ (1.77) $ (1.77)
==================== ================== ==================
Weighted average common shares outstanding:
Basic 10,161 10,103 10,178
==================== ================== ==================
Diluted 10,161 10,103 10,178
==================== ================== ==================
The accompanying notes are an integral part of these financial statements.
-27-
DUANE READE INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
- -------------------------------------------------------------------------------
DECEMBER 27, DECEMBER 28,
1997 1996
------------------ ------------------
ASSETS
Current assets
Cash $ 261 $ 216
Receivables 9,592 7,171
Inventories 66,665 47,914
Prepaid expenses 2,556 1,165
------------------ ------------------
TOTAL CURRENT ASSETS 79,074 56,466
Property and equipment, net 32,557 23,065
Goodwill, net of accumulated amortization $18,264 and 120,890 124,369
$14,785
Other assets 17,000 18,576
------------------ ------------------
TOTAL ASSETS $ 249,521 $ 222,476
================== ==================
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities
Accounts payable $ 23,510 $ 20,015
Accrued interest 4,634 3,873
Other accrued expenses 10,873 8,157
Current portion of long-term debt 660 12,000
Current portion of capital lease obligations 1,903 2,504
------------------ ------------------
TOTAL CURRENT LIABILITIES 41,580 46,549
Senior debt, less current portion 179,043 149,975
Subordinated zero coupon debt, net of unamortized discount of
$30,827 and $43,899 92,553 79,481
Capital lease obligations, less current portion 3,926 1,697
Other non-current liabilities 6,528 4,170
------------------ ------------------
TOTAL LIABILITIES 323,630 281,872
------------------ ------------------
COMMITMENTS AND CONTINGENCIES (NOTE 8)
Stockholders' deficiency
Common stock, $0.01 par; authorized 30,000,000 shares; issued
and outstanding 10,260,577 and 10,062,497 shares 103 101
Paid-in capital 24,563 24,564
Accumulated deficit (98,775) (84,061)
------------------ ------------------
TOTAL STOCKHOLDERS' DEFICIENCY (74,109) (59,396)
------------------ ------------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY $ 249,521 $ 222,476
================== ==================
The accompanying notes are an integral part of these financial statements.
-28-
DUANE READE INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
- -------------------------------------------------------------------------------
COMMON STOCK
--------------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------------- ---------- ------------ ---------------- -------------
Balance, December 31, 1994 10,164,214 $ 102 $ 24,877 $ (48,149) $ (23,170)
Sale of common stock to executives 40,692 - 100 - 100
Repurchase of common stock (20,341) - (68) - (68)
Net loss - - - (18,058) (18,058)
------------- ---------- ------------ ---------------- -------------
Balance, December 30, 1995 10,184,565 102 24,909 (66,207) (41,196)
Repurchase of common stock (122,068) (1) (345) - (346)
Net loss - - - (17,854) (17,854)
------------- ---------- ------------ ---------------- -------------
Balance, December 28, 1996 10,062,497 101 24,564 (84,061) (59,396)
Issuance of common stock 198,080 2 (1) - 1
Net loss - - - (14,714) (14,714)
------------- ---------- ------------ ---------------- -------------
Balance, December 27, 1997 10,260,577 $ 103 $ 24,563 $ (98,775) $ (74,109)
============= ========== ============ ================ =============
The accompanying notes are an integral part of these financial statements.
-29-
DUANE READE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
- -------------------------------------------------------------------------------
FOR THE 52 WEEKS ENDED
-------------------------------------------------------------
DECEMBER 27, DECEMBER 28, DECEMBER 30,
1997 1996 1995
----------------- ----------------- ------------------
Cash flows from operating activities:
Net loss $ (14,714) $ (17,854) $ (18,058)
Adjustments to reconcile net loss to
net cash provided by operating activities:
Depreciation and amortization of property
and equipment 3,507 3,015 1,929
Amortization of goodwill and other
intangibles 9,542 18,897 13,940
Accretion of principal of zero coupon debt 13,081 11,249 9,628
Other 1,761 1,526 1,769
Changes in operating assets and liabilities:
Receivables (2,421) (1,431) (1,962)
Inventories (18,751) (4,767) (6,745)
Accounts payable 3,495 (412) 7,382
Prepaid and accrued expenses 2,086 2,321 (658)
Increase in other (liabilities) assets - net (1,392) 51 (491)
----------------- ----------------- ------------------
NET CASH (USED IN) PROVIDED BY OPERATING
ACTIVITIES (3,806) 12,595 6,734
----------------- ----------------- ------------------
Cash flows from investing activities:
Proceeds from sales of capital assets 1,075 - -
Capital expenditures (13,493) (1,247) (6,868)
Systems development costs - (2,566) (6,268)
Sale of government securities -net - 44 382
----------------- ----------------- ------------------
NET CASH USED IN INVESTING ACTIVITIES (12,418) (3,769) (12,754)
----------------- ----------------- ------------------
Cash flows from financing activities:
Proceeds from new term loan 65,475 - -
Borrowings from new revolving credit
facility 24,500 - -
Repayments of old term loan (69,475) (5,625) (15,000)
Net borrowings (repayments) - old revolving
credit facility (2,500) (1,500) 4,000
Repayments of other long-term borrowings (116) - -
Financing costs (3,079) (952) (885)
Repayments of new term loan (165) - -
Proceeds from issuance of long-term debt - - 15,000
Proceeds from issuance of stock 1 - 25
Repurchase of stock - (95) (68)
Capital lease financing 4,133 274 4,329
Repayments of capital lease obligations (2,505) (2,845) (2,617)
----------------- ----------------- ------------------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 16,269 (10,743) 4,784
----------------- ----------------- ------------------
Net increase (decrease) in cash 45 (1,917) (1,236)
Cash at beginning of year 216 2,133 3,369
----------------- ----------------- ------------------
CASH AT END OF YEAR $ 261 $ 216 $ 2,133
================= ================= ==================
Supplementary disclosures of cash flow information:
Cash paid for interest $ 17,601 $ 18,391 $ 18,298
================= ================= ==================
The accompanying notes are an integral part of these financial statements.
-30-
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Duane Reade Inc. (the "Company") was formed on June 16, 1992 for the
purpose of acquiring Daboco, Inc. ("Daboco"). The acquisition took place
on September 25, 1992. Daboco and Duane Reade Inc. ("DR Inc."), a
subsidiary of Daboco, are general partners in Duane Reade, which operates
a chain of retail drug stores (67 at December 27, 1997) in the New York
City area.
Also in June 1997 the Company entered into a recapitalization agreement
(Note 10).
Significant accounting policies followed in the preparation of the
consolidated financial statements are as follows:
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of the Company and its subsidiaries. All intercompany
transactions and balances have been eliminated. Certain prior period
amounts have been reclassified to conform with the current presentation.
REPORTING YEAR: The fiscal year for the Company is the 52/53 week
reporting period ending on the last Saturday in December.
RECEIVABLES: Receivables consist primarily of amounts due from various
insurance companies and governmental agencies under third party payment
plans for prescription sales and amounts due from vendors, a majority of
which relate to promotional programs. The Company has not provided an
allowance for doubtful accounts as its historical write-offs have been
immaterial. The Company reflects promotional allowances from vendors as
income when such allowances are earned. The carrying value of the
Company's receivables approximate fair value given the short-term maturity
of these financial instruments.
INVENTORIES AND COST OF SALES: Substantially all inventories are stated at
the lower of cost, determined pursuant to the last-in, first-out retail
dollar value method (LIFO), or market. When appropriate, provision is made
for obsolete, slow-moving or damaged inventory. If current cost had been
used, inventories at December 27, 1997 and December 28, 1996 would not be
materially different from the amounts reflected on the accompanying
balance sheets.
Cost of sales includes distribution and occupancy costs.
PROPERTY AND EQUIPMENT: Property and equipment are stated at cost.
Depreciation and amortization are provided using the straight-line method
over estimated useful lives of assets as follows:
Buildings and improvements ...........30 years
Furniture, fixtures and equipment ....5-10 years
Leasehold improvements ...............Life of lease or, if shorter, asset
Property under capital leases ........7 years
OTHER ASSETS: Deferred financing costs arose in connection with borrowings
under the Term Loan and with the issuance of the Senior Subordinated
Notes and the Zero Coupon Notes and are amortized using the straight-line
method, the results of which are not materially different from the
interest method, over the term of the respective debt issue. Deferred
financing costs which arose in connection with the September 30, 1997
credit agreement are amortized utilizing the interest method, over the
term of the debt. Deferred financing costs which arose in connection
with the Old Credit Agreement are amortized utilizing the interest
method over the term of the debt.
-31-
Systems development costs, consisting principally of costs relating to the
new management information systems, are amortized using the straight-line
method commencing in 1996 over a period of seven years.
INTANGIBLE ASSETS: In September 1992, Holdings and Duane Reade entered
into agreements with certain former members of management of Duane Reade,
former shareholders of Daboco and shareholders of former partners of Duane
Reade (collectively, the "Group") precluding such persons from competing
with the operations of Duane Reade for a period of five years. The
covenants not to compete were recorded at acquisition cost and were being
amortized over the period of benefit using an accelerated method. During
the first quarter of 1997, Holdings and Duane Reade entered into
agreements in which the Company received consideration from the Group to
terminate the non-compete agreements. In accordance with APB Opinion No.
17, Intangible Assets, the remaining carrying value of the non-compete
agreements of $4.86 million as of December 28, 1996 was written off and
has been included in the accompanying consolidated statement of operations
as amortization expense.
Goodwill is amortized on the straight-line method over 40 years. The
carrying value of goodwill is periodically reviewed and evaluated by the
Company based principally on its expected future undiscounted operating
cash flows. Should such evaluation result in the Company concluding that
the carrying amount of goodwill has been impaired, an appropriate
write-down would be made.
PRE-OPENING EXPENSES: Store pre-opening costs, other than capital
expenditures, are expensed when incurred.
INCOME TAXES: Income taxes are accounted for under the liability method
prescribed by Statement of Financial Accounting Standards No. 109.
RECENTLY ISSUED ACCOUNTING STANDARDS: The Financial Accounting Standards
Board (FASB) has issued several accounting pronouncements which the
company will be required to adopt in future periods.
FASB Statement No. 130 "Reporting Comprehensive Income," which the Company
will adopt during the first quarter of 1998, establishes standards for
reporting and display of comprehensive income and its components in
financial statements. Comprehensive income generally represents all
changes in shareholders' equity except those resulting from investments by
or distributions to shareholders. With the exception of net earnings, such
changes are generally not significant to the Company and the adoption of
Statement No. 130, including the required comparative presentation for
prior periods, is not expected to have a material impact on the
consolidated financial statements.
FASB Statement No. 131 "Disclosures about Segments of an Enterprise and
Related Information" requires that a publicly-held company report
financial and descriptive information about its operating segments in the
consolidated financial statements issued to shareholders for interim and
annual periods. In addition, the Statement also requires additional
disclosures with respect to products and services, geographic areas of
operation, and major customers which have not previously been presented in
the consolidated financial statements and related notes. The Company will
adopt Statement No. 131 in 1998.
-32-
ACCOUNTING ESTIMATES: The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues, costs and expenses during the reporting period.
Actual results could differ from those estimates.
NET LOSS PER COMMON SHARE: Net loss per common share is based on the
weighted average shares outstanding during each period (10,160,851 for the
52 weeks ended December 27, 1997; 10,103,186 for the 52 weeks ended
December 28, 1996 and 10,177,782 for the 52 weeks ended December 30,
1995). The Company adopted the provisions of FASB Statement No. 128
"Earnings per Share" in 1997. 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. Potential common shares
include shares issuable upon exercise of the Company's stock options.
Potential common shares relating to options to purchase common stock were
not included in the weighted average number of shares for the fiscal years
1997, 1996 and 1995 because their effect would have been anti-dilutive.
2. PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows (in thousands):
DECEMBER 27, DECEMBER 28,
1997 1996
----------------------- ----------------------
Land...................................................... $ 312 $ 489
Buildings and building improvements ...................... 4,323 4,523
Furniture, fixtures and equipment ........................ 11,367 6,881
Leasehold improvements.................................... 17,620 13,134
Property under capital leases............................. 9,410 5,063
----------------------- ----------------------
43,032 30,090
Less--Accumulated depreciation and amortization .......... 10,475 7,025
----------------------- ----------------------
$ 32,557 $ 23,065
======================= ======================
-33-
3. OTHER ASSETS
Other assets are summarized as follows (in thousands):
DECEMBER 27, DECEMBER 28, 1996
1997
----------------------- -----------------------
Deferred financing costs (net of accumulated amortization of $4,117
and $10,417) ....................................................... $ 6,651 $ 7,811
Systems and integration costs (net of accumulated amortization
of $3,009 and $1,461) .............................................. 8,231 9,798
Other............................................................... 2,118 967
----------------------- -----------------------
$ 17,000 $ 18,576
======================= =======================
Included in other assets are notes receivable from executives in the amount of
$237,000 at December 27, 1997 and $381,000 at December 28, 1996.
4. DEBT
Long-term debt consists of the following (in thousands):
DECEMBER 27, DECEMBER 28,
1997 1996
------------------ -----------------------
Senior debt
Term loan facility (A)................................ $ 65,310 $ 69,475
Notes payable bank--revolving credit (A) ............. 24,500 2,500
12% Senior Notes due September 15, 2002 (B) .......... 89,893 90,000
Subordinated debt
15% Senior Subordinated Zero Coupon Notes due
September 15, 2004 (C)................................ 92,553 79,481
------------------ -----------------------
272,256 241,456
Less--Current portion ................................ 660 12,000
------------------ -----------------------
$ 271,596 $ 229,456
================== =======================
Amounts presented above are classified based upon their scheduled
maturity dates. As noted below, all amounts were repaid during the first
quarter of 1998 in connection with the Company's Existing Credit Agreement and
the issuance of Common Stock and Senior Notes.
-34-
(A) Outstanding balances under a credit agreement dated as of
September 24, 1992, as amended, with a syndicate of lending
institutions bear interest at floating rates, which at December
27, 1997 averaged 8.9%. On September 30, 1997, the Company
entered into a credit agreement (the "Old Credit Agreement")
with an affiliate of the DLJMB Entities and various financial
institutions providing for a term loan of $65.5 million and
a revolving credit facility of $30 million. Proceeds of the
term loan were used to repay outstanding term loans
($63.5 million) and revolving loans ($2 million).
The term loan is payable in quarterly installments of $165,000
from December 1997 through March 2001, with additional payments
as outlined in schedule below. The balance of the term loan at
December 27, 1997 of $65.3 million reflects the above amount less
the first quarterly payment made in December. As of December 27,
1997, the borrowings outstanding under the revolving credit
facility were $24.5 million (classified as a noncurrent
liability); in addition, $285,000 in letters of credit had been
issued.
At December 27, 1997, the aggregate principal amount of the term
loan matures as follows (in thousands):
1998.............................. $ 660
1999.............................. 660
2000.............................. 660
2001.............................. 31,495
2002.............................. 31,835
------------------
$ 65,310
==================
Subject to certain conditions, voluntary prepayments of the Term
Loan are permitted without premium or penalty. Mandatory
prepayments are required with respect to asset sales, permitted
issuance of debt or equity and 75% of excess cash flows, as
defined in the Credit Agreement, as amended.
Obligations under the Old Credit Agreement are secured by a
pledge of all of Duane Reade's tangible and intangible assets
and are guaranteed by the Company, which has pledged 100% of
its partnership interests in support of such guarantees. The
guarantees are joint and several and full and unconditional.
The Old Credit Agreement contains restrictions on indebtedness,
asset sales, dividends and other distributions, capital
expenditures, transactions with affiliates and other unrelated
business activities. Financial performance covenants include
interest coverage, leverage ratio, minimum net worth and
fixed charge coverage. At December 27, 1997, the Company is in
compliance with all of the covenants in the Old Credit Agreement.
-35-
(B) On September 25, 1992, Duane Reade issued $90,000,000 aggregate
principal amount of 12% Senior Notes due September 15, 2002, at
face value. Interest is payable at 12% semiannually. The Senior
Notes are guaranteed by Daboco and DR Inc. All of Daboco's assets
are pledged to secure indebtedness under the Credit Agreement
discussed in (A) above. As a result, such indebtedness will have
claim on those assets that is prior to the claim of holders of
the Senior Notes. To the extent that the amount of senior
indebtedness exceeds the value of the collateral securing such
indebtedness, the Senior Notes will rank pari passu with the Term
Loans.
Duane Reade is required to make a sinking fund payment on
September 15, 2001 sufficient to retire 50% of the aggregate
principal amount of Senior Notes originally issued. The Senior
Notes are subject to redemption at the option of the issuer at
104.5% of par, plus accrued interest, at the end of 1997,
declining to par, plus accrued interest, at the end of 2000. In
the event of a change in control, Duane Reade shall be obligated
to make an offer to purchase all outstanding Senior Notes at a
repurchase price of 101% of the principal amount.
(C) On September 25, 1992, Holdings issued $123,380,000 aggregate
principal amount of 15% Senior Subordinated Zero Coupon Notes due
September 15, 2004 (the "Zero Coupon Notes"), net of an
$81,909,000 discount. The discount accretes through the Final
Accretion Date of September 15, 1999. Thereafter, cash interest
is payable at 15% semi-annually through maturity. Interest
expense is determined using the effective interest method, which
applies a constant yield to carrying value over the life of the
Zero Coupon Notes.
The Credit Agreement and the Senior Note Indenture referred to in
(A) and (B) above provide for subordination of Holdings' debt to
partnership debt.
The notes are redeemable at the option of the issuer, in whole or
in part, at 107.5% of Accreted Value (as defined in the Zero
Coupon Note Indenture), plus accrued interest, at the end of 1997
declining to par, plus accrued interest, at the end of 2002. In
the event of a change in control, Holdings shall be obligated to
make an offer to purchase all outstanding Zero Coupon Notes at a
repurchase price of 101% of Accreted Value (as defined in the
Indenture) or principal amount, as applicable. The Accreted Value
of the Zero Coupon Notes was $96,400,000 at December 27, 1997.
Purchasers of the Zero Coupon Notes received 15% of the fully
diluted common stock of the Company, with registration rights,
for aggregate consideration of $3,529,000.
The Indentures governing the Zero Coupon Notes and the Senior
Notes include certain restrictive covenants. Subject to certain
exceptions, the Indentures restrict transactions with affiliates,
the incurrence of additional indebtedness, the payment of
dividends, the creation of liens, certain asset sales, mergers
and consolidations and certain other payments.
The Company's debt is thinly traded in the market place.
Accordingly, management is unable to determine fair market values
for such debt at December 27, 1997.
-36-
The Zero Coupon Notes and the Senior Notes were issued pursuant
to Registration Rights Agreements under which Holdings and Duane
Reade consummated registered exchange offers pursuant to which
Holdings and Duane Reade exchanged the Zero Coupon Notes and the
Senior Notes, respectively, for identical notes which have been
registered under the Securities Act of 1933, as amended.
In connection with the Company's new Credit Agreement (the "Existing
Credit Agreement") issuance of common stock and Senior Notes in
February 1998, all outstanding amounts under (A), (B) and (C) above
were repaid in full (see Note 15).
5. CAPITAL LEASE OBLIGATIONS
As of December 27, 1997, the present value of capital lease obligations
was $5.8 million (of which $1.9 million was payable during the next twelve
months). Such obligations are payable in monthly installments over three
to five year periods and bear interest at an average rate of 12.8%.
6. INCOME TAXES
-37-
Deferred tax assets and liabilities are determined based on the difference
between book and tax bases of the respective assets and liabilities at
December 27, 1997, December 28, 1996 and December 30, 1995 and are
comprised of (in thousands):
DECEMBER 27, DECEMBER 28, DECEMBER 30,
1997 1996 1995
------------------------- ---------------------- ----------------------
Inventories