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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 $ (3,884) $ (3,501) $ (3,238)
------------------------- ---------------------- ----------------------
Gross deferred tax liabilities (3,884) (3,501) (3,238)
------------------------- ---------------------- ----------------------
Covenants not to compete -- 1,851 4,318
Zero Coupon debt discount 19,838 14,041 9,885
Other 4,474 3,558 2,479
Net operating loss carryforward 32,255 50,072 49,217
------------------------- ---------------------- ----------------------
Gross deferred tax assets 56,567 69,522 65,899
------------------------- ---------------------- ----------------------
Net deferred tax assets 52,683 66,021 62,661
Valuation allowance (52,683) (66,021) (62,661)
------------------------- ---------------------- ----------------------
$ --- $ --- $ ---
========================= ====================== ======================
The Company deducted for income tax purposes for the period September 25
to December 31, 1992 approximately $88 million of payments made to former
partners of Duane Reade (the "Retirement Payments"). Approximately $22.2
million of the valuation allowance relates to the Retirement Payments.
The Retirement Payments and other current tax deductions resulted in an
available net operating loss of approximately $68.6 million which may be
used to offset future taxable income of the Company through 2012. Due to
the nature of the Retirement Payments, future reductions in that portion
of the valuation allowance related to the Retirement Payments will be
credited to goodwill. Further, due to the change in ownership arising as a
result of the recapitalization, certain income tax law provisions apply
which limit the ability of the Company to utilize the available net
operating loss carryforwards. It is estimated that the annual limitation
will be $5.1 million.
-38-
The provision for income taxes for the 52 weeks ended December 27, 1997,
December 28, 1996 and December 30, 1995 differs from the amounts of income
tax determined by applying the applicable U.S. statutory federal income
tax rate to pretax loss as a result of the following (in thousands):
52 WEEKS ENDED 52 WEEKS ENDED 52 WEEKS ENDED
DECEMBER 27, 1997 DECEMBER 28, 1996 DECEMBER 30, 1995
---------------------------- ---------------------------- ----------------------------
Pretax accounting loss $ (14,714) 100.0% $ (17,854) 100.0% $ (18,058) 100.0%
================= ========== ================ ========== ================ ==========
Statutory rate (5,150) (35.0) (6,249) (35.0) (6,320) (35.0)
State and local taxes, net
of federal tax (332) (2.3) (1,201) (6.7) (1,233) (6.8)
Goodwill amortization 1,218 8.3 1,218 6.8 1,218 6.7
Net operating losses
not utilized 1,530 10.4 5,534 31.0 5,828 32.3
Nondeductible
interest expense 796 5.4 684 3.8 585 3.2
Nondeductible recapitalization 1,915 13.0 0 0.0 0 0.0
Other 23 0.2 14 0.1 (78) (0.4)
----------------- ---------- ---------------- ---------- ---------------- ----------
Effective tax rate $ --- --% $ --- ---% $ --- ---%
================= ========== ================ ========== ================ ==========
7. STORE PRE-OPENING EXPENSES
Duane Reade opened seven new store locations during the 52 weeks ended
December 27, 1997, one new store location during the 52 weeks ended
December 28, 1996 and eight new store locations during the 52 weeks ended
December 30, 1995.
8. COMMITMENTS AND CONTINGENCIES
LEASES
Duane Reade leases all of its store facilities under operating lease
agreements expiring on various dates through the year 2022. In addition
to minimum rentals, certain leases provide for annual increases based
upon real estate tax increases, maintenance cost increases and inflation.
Rent expense for the 52 weeks ended December 27, 1997, December 28, 1996
and December 30, 1995 was $26,587,000, $24,420,000 and $22,703,000,
respectively.
-39-
Minimum annual rentals at December 27, 1997 (including obligations under
new store leases entered into but not opened as of December 27, 1997) are
as follows (in thousands):
1998............................ $ 28,899
1999............................ 29,300
2000............................ 28,512
2001............................ 28,204
2002............................ 27,682
Remaining lease terms .......... 155,071
----------------
Total........................... $ 297,668
================
LITIGATION
The Company from time to time is involved in routine legal matters
incidental to its business. In the opinion of management, the ultimate
resolution of such matters will not have a material adverse effect on the
Company's financial position, results of operations or liquidity.
MANAGEMENT AGREEMENTS
The Company has employment agreements with several of its executives
providing, among other things, for employment terms of up to three years.
Pursuant to the terms of such employment and related agreements, the
Company and various executives entered into agreements pursuant to which
(i) executives' salary and bonuses were established and (ii) executives
purchased shares of common stock. In the event of employment termination,
all of the stock may be repurchased by the Company. As a result of the
recapitalization and the reverse stock split (Note 10), all outstanding
shares were converted into common stock. As of December 27, 1997, an
aggregate 287,578 shares of common stock are held by employees and former
employees.
COMMITMENTS
The Company has established a Supplemental Executive Retirement Plan
("SERP") which presently covers only its Chairman. Such SERP provides
for vesting over a twenty year period. However, if the Chairman's
employment is terminated without cause, as defined, or if the Chairman
resigns with cause, as defined, such vesting becomes immediate, in which
event the Company would be liable to the Chairman (in addition to amounts
accrued in the financial statements) in the amount of approximately
$700,000.
The Company is subject to a loan agreement between the Company, certain of
the DLJMB Entities and an executive of the Company whereby the Company
has an obligation to assume a $1 million loan made to said executive,
should certain of the DLJMB Entities elect. At December 27, 1997, the
such DLJMB Entities have not exercised such election.
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9. EMPLOYEE BENEFIT PLANS
On October 12, 1992, the Company adopted the 1992 Stock Option Plan of
Duane Reade Holding Corp. (the "Plan"). Under the Plan, a committee
designated by the Board of Directors to administer the Plan (the
"Committee") may grant, to executive and other key employees of the
Company, nonqualified stock options to purchase up to an aggregate of
510,757 (adjusted for the recapitalization--See Note 10--and the reverse
stock split--see Note 15) shares of common stock of the Company at an
exercise price fixed by the Committee. The options are exercisable at such
time or times as the Committee determines at or subsequent to grant. The
term of the options set by the Committee shall not exceed 10 years.
At December 27, 1997, there were outstanding nonqualified stock options to
purchase up to an aggregate of 635,207 (adjusted for the recapitalization
and the reverse stock split, Note 10) shares of common stock (including
options granted outside the Plan), all of which are vested.
Changes in options outstanding (including options granted outside the
Plan) during 1997 and 1996 are summarized as follows:
OPTION PRICE PER SHARE
------------------------------------------------- Total
$.58 $7.34-$12.77 $29.37 $40.86 Options
---- ------------ ------ ------ -------
Options outstanding, December 30, 1995 40,110 40,109 40,109 40,109 160,437
Options granted 723,662 2,745 2,745 2,745 731,897
Options canceled (13,728) (13,726) (13,726) (13,726) (54,906)
-------- -------- -------- -------- --------
Options outstanding, December 28, 1996 750,044 29,128 29,128 29,128 837,428
Options granted 851 68,953 851 851 71,506
Options exercised (2,745) --- --- --- (2,745)
Options canceled (262,747) (2,745) (2,745) (2,745) (270,982)
-------- -------- -------- -------- --------
Options outstanding, December 27, 1997 485,403 95,336 27,234 27,234 635,207
======== ======== ======== ======== ========
Weighted average remaining life on
outstanding options 8.2 years 8.3 years 6.2 years 6.2 years 8.1 years
During the second quarter of 1997, the Company adopted an Equity
Participation Plan under which options for a total of 1,321,181 (adjusted
for the recapitalization and the reverse stock split, Note 10) shares of
common stock of the Company may be granted to employees, consultants and
non-employee directors of the Company if the Company meets specific
performance targets. At December 27, 1997, options for 1,019,284 shares
have been granted to employees.
-41-
Changes in options outstanding under the Equity Participation Plan during
the 52 weeks ended December 27, 1997 are summarized as follows:
Number
of Options Option Price
------------------------------ -----------------------
Options outstanding, December 28, 1996 -- --
Options granted 1,019,284 $ 8.33
------------------------------ -----------------------
Options outstanding, December 27, 1997 1,019,284 $ 8.33
============================== =======================
As permitted, the Company applies Accounting Principles Board Opinion No.
25 and related Interpretations in accounting for its stock-based
compensation plan. Had compensation cost for the Company's stock-based
compensation plan been determined based on the fair value at the grant
dates for awards under the Plan, consistent with the alternative method of
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," the proforma effect on the Company's net loss
for the 52 weeks ended December 27, 1997 and December 28, 1996 would have
been less than $100,000 and $200,000, respectively. The proforma
compensation expense for stock options has been estimated using the
Black-Scholes option pricing model with the following assumptions:
dividend yield of 0.0%, expected volatility of 60.0%, risk free interest
rate of 6.0% and an expected term of 8 years. These proforma disclosures
may not be representative of the effects on reported net income for future
years since options vest over several years and options granted prior to
1995 are not considered.
The Company maintains an employee savings plan pursuant to Section 401(k)
(the "401(k) Plan") of the Internal Revenue Code ("IRC") which covers
substantially all non-union employees other than key employees as defined
by IRC. Eligible participating employees may contribute up to 10% of their
pretax salaries, subject to certain IRC limitations. The 401(k) Plan, as
amended, provides for employer matching provisions at the discretion of
the Company (to a maximum of 1% of pretax salaries) and has a feature
under which the Company may contribute additional amounts for all eligible
employees. The Company's policy is to fund such costs under the 401(k)
Plan as accrued. For the 52 weeks ended December 27, 1997 and December 28,
1996, there were no employer contributions to the 401(k) Plan. For the 52
weeks ended December 30, 1995, employer contributions to the 401(k) Plan
were $166,000.
Duane Reade is under contract with local unions to contribute to
multi-employer pension and welfare benefit plans for certain of its
employees. For the 52 weeks ended December 27, 1997, December 28, 1996 and
December 30, 1995, contributions to such plans were $6,751,000, $5,783,000
and $5,200,000, respectively.
10. RECAPITALIZATION
During June 1997, the Company entered into a recapitalization agreement
(the "Agreement") with its stockholders ("Stockholders") and certain
investors ("Investors"). The Agreement provided for (i) the purchase by
Investors from the Stockholders of substantially all their stock holdings
in the Company, (ii) a conversion of all of the outstanding shares of the
Company into a newly authorized class of Class B Common stock and (iii)
the creation of a new authorized class of preferred stock which will carry
the rights and preferences granted by the Company's Board of Directors
when issued.
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Shares were converted as follows:
Approximate
Prior Class Conversion Rate
----------- ----------------
Common and Common Class A ......................... 28/1
Common Class P and Common Class P-1 ................ 355/1
In addition, because of the change in control, the Company was obligated
to and made offers to repurchase all outstanding Senior Notes and Zero
Coupon Notes at 101% of the principal amount or accreted value thereof,
respectively. Such offers expired on September 12, 1997. The Company
repurchased an aggregate of $107,000 principal amount of Senior Notes and
$9,000 of Zero Coupon Notes pursuant to the offers.
These financial statements do not reflect any adjustments as a result of
the June 1997 change in control.
On January 14, 1998, the Company effected an 8.326 reverse stock split of
its common stock. All references to common stock amounts, shares and per
share data included herein have been adjusted to give retroactive effect
to such reverse stock split.
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11. NONRECURRING CHARGES
During the first quarter of 1997, the Company considered a public offering
of its common stock and took certain steps in connection with these plans.
Such plans were abandoned upon consummation of the transaction discussed
in Note 10.
Costs and expenses incurred in connection with the abandoned public
offering, the recapitalization and the exchange offers referred to in Note
10 aggregated approximately $12.7 million, including investment banking
fees of $7.7 million (including $3.5 million to an affiliate of the
Investors and $0.6 million to the Stockholders), write-off of unamortized
deferred financing costs relating to the old credit agreement of $1.8
million, legal and accounting fees of $1.6 million, stand-by commitment
fees relating to the exchange offers of $1.2 million to an affiliate of
the Investors, and other costs of $0.4 million. The Company has treated
these expenses as non-recurring because such expenses related to financing
activities in connection with the Recapitalization and related events,
which the Company does not expect to repeat.
12. RELATED PARTY TRANSACTIONS
In 1992, the Company and the then principal stockholder of the Company
(who has subsequently sold most of its shares, Note 10) entered into a
professional services agreement whereby consulting, advisory, financial
and other services were provided at the Company's request, for a five year
term. During the 52 weeks ended December 28, 1996 and December 30, 1995,
such fees aggregated approximately $1.0 million.
In addition, the Investors paid an executive approximately $0.8 million
for advisory services rendered and a former executive approximately $1.6
million for the repurchase and cancellation of exercisable stock options.
The accompanying financial statements do not reflect such payments.
Costs incurred in connection with the Old Credit Agreement aggregated
approximately $2.7 million (including a funding fee of $2.4 million to
an affiliate of the DLJMB Entities).
13. SUBSEQUENT EVENTS
On February 13, 1998, the Company issued 6,700,000 shares of common stock
in an initial public offering for net proceeds of approximately $101.8
million. In addition to the issuance of common stock, the Company entered
into the Existing Credit Agreement which provides for borrowings of up to
approximately $160 million and issued $80 million of new Senior Notes. The
net proceeds of the common stock and the sale of the Senior Notes and
borrowings under the Existing Credit Agreement were used for the (i)
redemption of all of the Zero Coupon Notes for $99.8 million (including a
redemption premium of $7.0 million), (ii) redemption of all the Senior
Notes for $93.9 million (including a redemption premium of $4.0 million),
(iii) repayment of the outstanding term loan indebtedness of $65.3
million, (iv) repayment of outstanding revolving indebtedness of $27.5
million and (v) payment of fees and expenses in connection with the
Company's refinancing plan.
The early payment of the Zero Coupon and Senior Notes will result in an
extraordinary loss of approximately $23.6 million in the first quarter of
1998.
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14. SELECTED QUARTERLY INFORMATION (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- -------------------------------------------------------------------------------
QUARTER 1997 1996 1995
SALES
First $ 99,740 $ 90,594 $ 77,985
Second 107,423 96,438 84,141
Third 106,633 94,061 84,157
Fourth 116,020 100,373 90,639
================ ================= ==================
Year $ 429,816 $ 381,466 $ 336,922
================ ================= ==================
GROSS PROFIT
First $ 23,837 $ 19,965 $ 19,007
Second 25,941 22,723 21,073
Third 27,605 22,608 19,775
Fourth 30,093 27,665 17,240
---------------- ----------------- ------------------
Year $ 107,476 $ 92,961 $ 77,095
================ ================= ==================
NET LOSS
First $ (2,165) $ (5,135) $ (3,436)
Second (10,192) (3,225) (3,783)
Third (1,808) (4,125) (4,669)
Fourth (549) (5,369) (6,170)
---------------- ----------------- ------------------
Year $ (14,714) $ (17,854) $ (18,058)
================ ================= ==================
NET LOSS PER COMMON SHARE (BASIC
AND DILUTED)
First $ (.21) $ (.50) $ (.34)
Second (1.01) (.32) (.37)
Third (.18) (.41) (.46)
Fourth (.05) (.54) (.60)
---------------- ----------------- ------------------
Year $ (1.45) $ (1.77) $ (1.77)
================ ================= ==================
-45-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
-46-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS AND OFFICERS
The following table sets forth the directors and executive
officers of the Company:
Name Age Position
---- --- ---------
Anthony J. Cuti.............................52 Chairman, Chief Executive Officer and President
William Tennant.............................50 Senior Vice President and Chief Financial Officer
Gary Charboneau.............................53 Senior Vice President - Sales and Merchandising
Jerry M. Ray................................50 Senior Vice President - Store Operations
Nicole S. Arnaboldi.........................39 Director
David L. Jaffe..............................39 Director
Andrew J. Nathanson.........................40 Director
Kevin Roberg................................46 Director
David W. Johnson............................65 Director
ANTHONY J. CUTI has been Chairman and Chief Executive Officer
of the Company since April 1996. Prior to joining the Company, Mr. Cuti served
as President and as a member of the Board of Directors of Supermarkets General
and Pathmark from 1993 to 1996 and, prior to being named President of
Supermarkets General and Pathmark, Mr. Cuti was Executive Vice President and
Chief Financial Officer of Supermarkets Generals. From 1984 to 1990, he was the
Chief Financial Officer of the Bristol-Myers International Group of the
Bristol-Myers Company and prior to that was employed by the Revlon Corporation.
WILLIAM TENNANT has been Senior Vice President and Chief
Financial Officer of the Company since February 1997. Prior to joining the
Company, Mr. Tennant was Senior Vice President and Chief Financial Officer of
Tops Appliance City, a consumer electronics retailer, from 1993 to 1996. From
1986 to 1993, Mr. Tennant served as Vice President and Controller for the Great
Atlantic & Pacific Tea Company.
GARY CHARBONEAU has been Senior Vice President in charge of
Sales and Merchandising of the Company since February 1993. Prior to joining
the Company, Mr. Charboneau held various positions at CVS, a retail drugstore
chain, from 1978 to February 1993, most recently as Executive Vice President.
JERRY M. RAY has been Senior Vice President in charge of Store
Operations since July 1996 and served as Vice President of Pharmacy Operations
from April 1995 to June 1996. From 1991 to 1994, Mr. Ray served as President
and CEO of Begley Drugstores, Inc.
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NICOLE S. ARNABOLDI has been a Director of the Company since
June 1997. Ms. Arnaboldi is a Managing Director of DLJMB. She joined the DLJ
Merchant Banking Group in March 1993 after six years with The Sprout Group,
DLJ's venture capital affiliate.
DAVID L. JAFFE has been a Director of the Company since June
1997. Mr. Jaffe is a Managing Director of DLJMB. Mr. Jaffe joined DLJ Merchant
Banking in 1984 and became a Managing Director in 1995. He currently sits on
the Board of Directors of each of EZ Buy and EZ Sell Recycler Corporation, OHA
Financial, Inc., OSF, Inc., Terra Nova Group, Pharmaceutical Fine Chemicals SA
and Brand Scaffold Services, Inc.
ANDREW J. NATHANSON has been a Director of the Company since
June 1997. Mr. Nathanson is a Managing Director of DLJ. Mr. Nathanson joined
DLJ in 1989 from Drexel Burnham Lambert, and has been a Managing Director of
DLJ since 1991. Mr. Nathanson also serves on the Board of Directors of
Specialty Foods, Inc.
KEVIN ROBERG has been a Director of the Company since February
1998. Mr. Roberg currently serves as Chief Executive Officer and President of
ValueRx. Prior to serving in this position, Mr. Roberg served as Chief
Executive Officer and President of Medintell Systems Corporation during 1995
and as President - Western Health Plans and President - PRIMExtra, Inc. for EBP
Health Plans, Inc. from 1994 to 1995. Mr. Roberg served as President-Self
Funded and Private Label Division from 1993 to 1993 for Diversified
Pharmaceutical Services (a subsidiary of United HealthCare Corporation)
("Diversified") and prior to that served as Chief Operating Officer of
Diversified.
DAVID W. JOHNSON has been a Director of the Company since
February 1998. Since 1993, Mr. Johnson has served as Chairman of the Board of
Campbell Soup Company. Prior to holding this position, Mr. Johnson served as
President and Chief Executive Officer of Campbell Soup Company. Mr. Johnson
also serves on the Board of Directors of Colgate Palmolive Company.
COMMITTEES OF THE BOARD OF DIRECTORS
The members of the Compensation Committee are Messrs. Jaffe and
Johnson. The duties of the Compensation Committee are to provide a general
review of the Company's compensation and benefit plans to ensure that they meet
corporate objectives. In addition, the Compensation Committee will review
management's recommendations on (i) compensation of all officers of the Company
and (ii) adopting and changing major Company compensation policies and
practices, and report its recommendations to the entire Board of Directors for
approval and authorization. The Compensation Committee will administer the
Company's stock plans.
The Board of Directors may also establish other committees to
assist in the discharge of its responsibilities.
-48-
ITEM 11.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table summarizes the principal components of
compensation of the Chief Executive Officer and the other four highest
compensated executive officers of the Company (the "Named Executive Officers")
for the fiscal year ended December 27, 1997. The compensation set forth below
fully reflects compensation for services performed on behalf of the Company and
its subsidiaries.
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
------------------------------------- -------------
SECURITIES
NAME AND FISCAL OTHER ANNUAL UNDERLYING ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS(#) COMPENSATION
Anthony J. Cuti..................1997 $386,000 $475,000 $-- 496,569 $--
Chief Executive Officer
Gary Charboneau..................1997 243,000 121,600 -- 141,877 --
Senior Vice President-Sales
and Merchandising
Jerry M. Ray`....................1997 200,000 100,000 -- 118,231 --
Senior Vice President-Store
Operations
William J. Tennant...............1997 151,000(1) 61,300 -- 115,393 --
Senior Vice President-Chief
Financial Officer
Joseph S. Lacko..................1997 150,000 52,500 -- 11,823 --
Vice President-Management
Information Systems
- ----------------
(1) Reflects Mr. Tennant's salary for the partial year from February 18,
1997 (when he joined the Company) through December 27, 1997.
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OPTION GRANTS IN LAST FISCAL YEAR
The following table discloses options granted during fiscal
year 1997 to the Named Executive Officers.
INDIVIDUAL GRANTS
--------------------------------------------------------
NUMBER OF % OF TOTAL POTENTIAL REALIZABLE VALUE AT
SECURITIES OPTIONS ASSUMED RATES OF STOCK PRICE
UNDERLYING GRANTED TO EXERCISE OR APPRECIATION FOR OPTION TERM(2)
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION -------------------------------
GRANTED(1) FISCAL YEAR PER SHARE DATE 5% 10&
Anthony J. Cuti.......... 496,569 45.5% $8.33 6/18/07 $2,602,022 $6,594,436
Gary Charboneau(3)....... 141,877 13.0 8.33 6/18/07 743,435 1,884,127
Jerry M. Ray(3).......... 118,231 10.8 8.33 6/18/07 619,530 1,570,081
William J. Tennant(4).... 115,393 10.6 7.34-8.33 2/18/07-6/18/07 561,964(5) 1,425,104(5)
Joseph S. Lacko ......... 11,823 1.1 8.33 6/18/07 61,953 157,009
- ------------------
(1) Except for 68,101 options grated to Mr. Tennant under a separate
program, all of such options vest fully on the eighth anniversary of the
grant date and may vet sooner based on the Company's achievement of
certain specified targets.
(2) Amounts reflect certain assumed rates of appreciation for the term of
the option as set forth in the executive compensation disclosure rules
of the Securities and Exchange Commission and are not intended to
forecast future appreciation of the Common Stock. Actual gains, if any,
on stock option exercises depend on future performance of the Company's
stock and overall market conditions. For each Named Executive Officer
other than Mr. Tennant, at an annual rate of appreciation of 5% per year
for the option term, the price of the Common Stock would be
approximately $13.57 per share as of the expiration date, and for Mr.
Tennant such price would be approximately $12.62 per share. For each
Named Executive Officer other than Mr. Tennant, at an annual rate of
appreciation of 10% per year for the option term, the price of the
Common Stock would be approximately $21.61 per share as of the
expiration date, and for Mr. Tennant such price would be approximately
$20.10 per share.
(3) All of such options were granted under the Equity Plan (as defined
below). The options granted under such plan are subject to repurchase
provisions upon termination of employment. See "-- Stock Options."
(4) 68,101 of Mr. Tennant's options were granted pursuant to a separate
program with the Company, and the remaining 47,292 options were granted
pursuant to the Equity Plan.
(5) Amounts for Mr. Tennant are calculated based on a weighted average exercise price of $7.75 per share.
-50-
FISCAL YEAR END OPTION VALUES
The following table summarizes the number and value of all
unexercised options held by the Named Executive Officers at the end of 1997.
There were no options exercised in the Company's last fiscal year.
NUMBER OF
SECURITIES
UNDERLYING
UNEXERCISED VALUE OF UNEXERCISED
SHARES OPTIONS IN-THE-MONEY OPTIONS
NAME ACQUIRED VALUE REALIZED FISCAL YEAR END AT FISCAL YEAR END ($)(1)
- ---- -------- -------------- --------------- -------------------------
EXERCISABLE/ EXERCISABLE/
UNEXERCISABLE UNEXERCISABLE
Anthony J. Cuti............ -- -- 409,931/451,168 $2,825,108/0
Gary Charboneau............ -- -- 68,985/128,905 306,443/0
Jerry M. Ray............... -- -- 55,842/107,421 285,161/0
William J. Tennant......... -- -- 72,425/42,968 67,420/0
Joseph S. Lacko............ -- -- 18,917/9,931 131,944/0
- -----------------
(1) Assumes the value of the Common Stock as of December 27, 1997 is equal
to $8.33 per share.
Mr. Barry Weston, the Company's former Chief Executive Officer,
resigned from the Company effective as of February 28, 1997. In connection with
Mr. Weston's severance from the Company and the Recapitalization, Mr. Weston
received approximately $1.6 million from DLJMB and all of his unexercised
options were effectively canceled. In addition, Mr. Weston received
approximately $412,000 from the Company during 1997, a portion of which was
attributable to his 1995 and 1996 bonus and the remainder of which was
attributable to severance payments.
COMPENSATION OF DIRECTORS
Directors of the Company who are employees of the Company, DLJ
or DLJMB or their respective subsidiaries are not compensated for serving as
directors. As of the date of their election to the Board of Directors, each of
Messrs. Roberg and Johnson received 5,000 options to purchase Common Stock at
$21.5625 per share. The Company plans to compensate future Directors who are
not employees of the Company, DLJ or DLJMB ("Non-Employee Directors") with
option grants for serving in such capacity and for serving on committees of the
Board of Directors and to reimburse Non-Employee Directors for out-of-pocket
expenses incurred in such capacity.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to the consummation of its initial public offering, the Company
did not have a compensation committee. Instead, compensation decisions
regarding the Company's executive officers were made by the Board of Directors.
Each executive officer of the Company has an
-51-
employment agreement with the Company that establishes his annual compensation.
See "--Employment Agreements."
EMPLOYMENT AGREEMENTS
Effective June 18, 1997, the Company entered into an employment
agreement with Anthony J. Cuti (the "Cuti Employment Agreement"). Pursuant to
the Cuti Employment Agreement, Mr. Cuti serves as Chairman, President and Chief
Executive Officer of the Company. The Cuti Employment Agreement provides for
(i) a base salary of $425,000 per year, which will increase to $500,000 in 1998
and $550,000 in 1999 if certain EBITDA targets (as defined in the Cuti
Employment Agreement) are met and will increase every 18 months commencing July
1, 2001 by not less than the percentage increase in a designated consumer price
index for such 18-month period, (ii) an annual incentive bonus of up to 200% of
base salary based on certain EBITDA targets and (iii) participation in all
benefit plans generally available to executive officers of the Company.
Pursuant to the Cuti Employment Agreement and the Equity Plan
described below, on June 18, 1997, Mr. Cuti was granted non-qualified stock
options to purchase an aggregate of 496,569 shares of Common Stock at an
exercise price of $8.33 per share. Subject to Mr. Cuti's continued employment
with the Company, the options generally will become 100% vested on the eighth
anniversary of the date of grant, but may vest sooner based on the Company's
achievement of certain specified financial targets. Furthermore, the vesting of
options will accelerate upon the occurrence of a sale of the Company (as
defined in the Cuti Employment Agreement) on or prior to December 30, 2001,
based on the Company's achievement of specified financial targets prior to the
date of any such sale of the Company.
The Cuti Employment Agreement provides that Mr. Cuti may generally
only transfer up to 10% of his shares of Common Stock in each calendar year
while he is an employee of the Company, except pursuant to certain rights and
obligations (i) to transfer ("put") his shares to the Company upon termination
of employment and (ii) to transfer shares in connection with certain transfers
of Common Stock by DLJMBPII. The Cuti Employment Agreement also provides that
Mr. Cuti will be given the opportunity to invest additional amounts in stock
of the Company in the event that DLJMBPII invests new equity in the Company
or creates an instrument that may be dilutive to Mr. Cuti's equity position
relative to DLJMBPII.
Mr. Cuti's initial term of employment is for three years and, unless
terminated by notice of non-renewal by either the Company or Mr. Cuti, will
continue thereafter for successive one-year periods. Pursuant to the Cuti
Employment Agreement, if the Company terminates Mr. Cuti without "cause" (as
defined in the Cuti Employment Agreement) or by notice of non-renewal or Mr.
Cuti resigns with "good reason" (as defined in the Cuti Employment Agreement),
Mr. Cuti will be entitled to continued base salary and incentive bonus payments
(at the rate of two times base salary and bonus for the year prior to
termination, which can be increased to three times base salary and bonus upon
the occurrence of certain events, including a sale of
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the Company) and employee benefits for a two year period, which, under certain
circumstances, including Mr. Cuti's termination of employment prior to June 18,
2003 and within one year following a Sale of the Company, may be extended by
one year. Additionally, the vesting of Mr. Cuti's options may accelerate upon
such a termination of employment, based on the Company's financial performance
prior to such termination and whether a Sale of the Company has occurred. The
Cuti Employment Agreement also contains certain non-compete, non-solicitation
and confidentiality provisions. See also "Certain Relationships and Related
Transaction-Cuti Loan Agreement."
The Company has also entered into agreements with Messrs. Charboneau
and Ray and certain other executives that provide for their initial base salary
as well as annual incentive bonuses based on certain EBITDA targets. Mr.
Charboneau's employment agreement provides for an annual base salary of
$220,000 and for additional increases from time to time as the Company may
determine. Mr. Ray's employment agreement provides for an annual base salary of
$150,000 and for additional increases from time to time as the Company may
determine. Each of Messrs. Charboneau and Ray are entitled to severance
payments equalling 12 months of their respective salaries if they are
terminated without "cause" (as respectively defined in the agreements).
The Company's agreement with Mr. Lacko provides for payment of an
annual base salary of $150,000 as well as for payment of annual incentive
bonuses based upon achievement of certain corporate and financial objectives.
Mr. Lacko's agreement also provides for the grant of stock options to acquire
an aggregate of 6,805 shares of Common Stock. These options vested on June 18,
1997 and have an exercise price of $8.33 per share. In addition, Mr. Lacko's
agreement provides for 12 months of salary continuation in the event Mr. Lacko
is terminated without cause.
The Company's agreement with Mr. Tennant provides for payment of an
annual base salary of $175,000 per year as well as for payment of annual
incentive bonuses based upon achievements of certain financial targets. Mr.
Tennant's agreement also provides for the grant of stock options to acquire an
aggregate of 68,101 shares of Common Stock at an exercise price of $7.34 per
share. These options vested on June 18, 1997. The agreement also provides for
12 months of salary continuation in the event Mr. Tennant is terminated without
cause.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
The Company has established the Supplemental Executive Retirement Plan
("SERP"), an unfunded retirement plan that provides a lump sum benefit equal to
the actuarial present value of a life annuity commencing at the later of age 65
or termination of employment for any reason other than for "cause." The SERP
benefit is calculated as a percentage of a participant's Final Average Earnings
(defined as the average base salary and bonus for the five years which produce
the greatest amount multiplied by the participant's years of services with the
Company). Currently, Mr. Cuti is the only SERP participant. Mr. Cuti's
estimated SERP benefit, based on his annualized 1996 includable compensation
and upon discount rates effective for termination of employment in December
1997, is estimated to be $619,000, if termination of employment occurs after 10
years when Mr. Cuti will be age 60 1/2, or $1,263,000 if termination of
employment occurs after 14 1/2 years, when Mr. Cuti will be age 65. Pursuant to
the Cuti
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Employment Agreement, the Company is required to set aside funds in a "rabbi
trust" to pay Mr. Cuti's SERP benefit in specified circumstances, including a
sale of the Company, termination without "cause" and resignation for "good
reason" (as respectively defined in the Cuti Employment Agreement).
Furthermore, in the event of his termination without "cause" or by reason of
the Company's non-renewal, his resignation for "good reason," or his death or
disability, Mr. Cuti's SERP benefit will be calculated on the basis of 20 years
of employment regardless of his actual number of years of employment with the
Company (the present value of which was approximately $700,000 as of December
27, 1997).
STOCK OPTIONS
1992 STOCK OPTION PLAN. The Board of Directors adopted and the
Company's stockholders approved the 1992 Stock Option Plan (the "1992 Plan") in
September 1992. Under the 1992 Plan, the Board of Directors may grant to
executive and other key employees of the Company nonqualified stock options to
purchase up to an aggregate of 510,757 shares of Common Stock of the Company at
exercise prices and terms specified by the Board of Directors.
At December 27, 1997, there were outstanding nonqualified stock
options issued under the 1992 Plan to purchase up to an aggregate of 281,657
shares of Common Stock of the Company at exercise prices ranging from $0.58 to
$40.88 per share. The 1992 Plan was frozen as to the future grants following
the initial public offering of the Company's Common Stock. All options issued
under the 1992 Plan are 100% vested.
1997 EQUITY PARTICIPATION PLAN. As of June 18, 1997, the Board of
Directors and stockholders of the Company approved the 1997 Equity
Participation Plan (the "Equity Plan"). Since consummation of the initial
public offering of the Company's Common Stock, the Equity Plan has been
administered by the Compensation Committee. The Board of Directors is
authorized under the Equity Plan to select the individuals to whom awards will
be made (the "Participants") and determine the terms and conditions of the
awards under the Equity Plan. The Equity Plan provides that the Board of
Directors may grant or issue stock options, stock appreciation rights,
restricted stock, deferred stock, dividend equivalents, performance awards,
stock payments and other stock related benefits, or any combination thereof,
to any eligible employee or consultant. Each such award will be set forth in a
separate a agreement with the person receiving the award and will indicate the
type, terms, and conditions of the award. An aggregate of 1,321,181 shares of
Common Stock of the Company have been reserved for issuance under the Equity
Plan, subject to certain adjustments reflecting changes in the Company's
capitalization. The Equity Plan provides that no Participant may receive awards
relating to more than 480,429 shares of Common Stock per year.
SECTION 162(M) LIMITATION. In general, under Section 162(m) of the
Code ("Section 162(m)"), income tax deductions of publicly-held corporations
may be limited to the extent total compensation including base salary, annual
bonus, stock option exercises and non-qualified benefits for certain executive
officers exceeds $1 million (less the amount of any "excess parachute payments"
as defined in Section 280G of the Code) in any one year. Under a Section 162(m)
transition rule for compensation plans of corporations which are privately held
and which
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become publicly held in an initial public offering, the Equity Plan will not be
subject to Section 162(m) until the "Transition Date" which is defined as the
earliest of (i) the material modification of the Equity Plan; (ii) the issuance
of all Common Stock and other compensation that has been allocated under the
Equity Plan; and (iii) the first meeting of stockholders at which directors are
to be elected that occurs after December 31, 2001. After the Transition Date,
rights and awards granted under the Equity Plan will not qualify as
"performance-based compensation" for purposes of Section 162(m) unless such
rights and awards are granted by an independent compensation committee, and
such awards are granted or vest upon pre-established objective performance
goals, the material terms of which are disclosed to and approved by the
stockholders of the Company. The transition rule will also apply to base salary
and bonus payments made pursuant to employment agreements in effect at the time
of the initial public offering of the Company's Common Stock.
The Board of Directors generally will have the power and authority to
amend the equity Plan at any time without approval of the Company's
stockholders, subject to applicable federal securities and tax law limitations
(including rules and regulations of the New York Stock Exchange).
-55-
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to the
beneficial ownership (as defined by the regulations of the Securities and
Exchange Commission) of the Company's Common Stock (which constitutes the only
class of voting capital stock of the Company) by (i) each person known to the
Company to be the beneficial owner of 5% or more of the Common Stock, (ii) each
director, (iii) each Named Executive Officer and (iv) all executive officers
and directors as a group, based on data as of March 15, 1998.
SHARES BENEFICIALLY OWNED (1)
-----------------------------
NAME NO OF SHARES PERCENT
- ---- ------------ -------
DLJ Merchant Banking Partners II, L.P. and related
investors(2).............................. 8,292,162 48.9%
Anthony J. Cuti............................. 409,931 2.4%
David L. Jaffe(3)........................... __ __
Nicole S. Arnaboldi(3)...................... __ __
Andrew J. Nathanson(3)...................... __ __
Gary Charboneau............................. 272,436 1.6%
Jerry M. Ray................................ 96,532 *
William J. Tennant.......................... 72,425 *
Joseph S. Lacko............................. 18,917 *
Kevin Roberg................................ 5,000 *
David W. Johnson............................ 5,000 *
All executive officers and directors as a group
(10 persons)(3)........................... 861,324 4.9
- --------------------
* Less than one percent
(1) For purposes of this table, a person is deemed to have "beneficial
ownership" of any shares that such person has the right to acquire within 60
days after the date of this Prospectus. For purposes of calculating the
percentage of outstanding shares held by each person named above, any shares
that such person has the right to acquire within 60 days after the date of this
prospectus are deemed to be outstanding, but not for the purposes of
calculating the percentage ownership of any other person.
(2) Consists of shares held directly by the following related investors,
each of whom is affiliated with DLJ: DLJ Merchant Banking Partners II, L.P.
("DLJMBPII"), 5,223,192 shares; DLJ Merchant Banking Partners II-A, L.P.
("DLJMBPII-A"), 208,012 shares; DLJ Offshore Partners II, C.V. ("DLJOPII"),
256,849 shares; DLJ
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Diversified Partners, L.P. ("DLJ"), 305,371 shares; DLJ Diversified Partners-A,
L.P. ("DLJDPA"), 113,405 shares; DLJMB Funding II, Inc. ("DLJMBFII"), 927,352
shares; DLJ Millennium Partners, L.P. ("Millennium"), 84,453 shares; DLJ
Millennium-A, L.P. :("Millennium-A"), 16,471 shares; DLJ EAB Partners, L.P.
("DLJEAB"), 23,452 shares; UK Investment Plan 1997 Partners ("UK Investment"),
138,196 shares; and DLJ First ESC L.P. ("DLJ ESC" and, collectively with the
aforementioned entities, the "DLJMBPII Entities") 995,009 shares. See "Certain
Relationships and Related Transactions--DLJMB Relationships." The address of
each DLJMBPII, DLJMBIIA, DLJDP, DLJDPA, DLJMBFII, Millennium, Millennium-A,
DLJEAB, and DLJ ESC is 277 Park Avenue, New York, New York 10172. The address
of DLJOPII is c/o John B. Gorsiraweg, 14 Willemstad, Curacao, Netherlands
Antilles. The address of UK Investment is 2121 Avenue of the Stars, Fox Plaza,
Suite 3000, Los Angeles, California 90067. As a general partner of each of
DLJMBPII, DLJMBIIA, DLJOPII, DLJDP, DLJDPA, DLJEAB, Millennium and
Millennium-A, DLJMB may be deemed to beneficially own indirectly all of the
shares held directly by DLJMBPII, DLJMBIIA, DLJOPII, DLJDP, DLJDPA, DLJEAB,
Millennium and Millennium-A, and as the parent of each of DLJMB, DLJMBFII and
DLJLBO Plans Management Corporation (the General partner of DLJ ESC and UK
Investment), Donaldson, Lufkin & Jenrette Inc., the parent of DLJ ("DLJ Inc.")
may be deemed to beneficially own indirectly all of the shares held by
DLJMBPII, DLJMBIIA, DLJOPII, DLJDP, DLJDPA, DLJEAB, Millennium, Millennium-A,
DLJMBFII, DLJESC and UK investment. The address of DLJ Merchant Banking, Inc.
is 277 Park Avenue, New York, New York 10172.
(3) Mr. Nathanson is a Managing Director of DLJ and, as a result may be
deemed to beneficially own the shares of Common Stock held by the DLJMBPII
Entities. Mr. Nathanson expressly disclaims beneficial ownership of such shares
of Common Stock. Ms. Arnaboldi and Mr. Jaffe are managing directors of DLJMB
and DLJ Diversified Partners, Inc. ("DLJDPI"). DLJMB is the managing general
partner of DLJMBII, DLJMBIIA, DLJOPII, Millennium and Millennium-A. DLJDPI is
the managing general partner of DLJDP and DLJDPA. As a result, Ms. Arnaboldi
and Mr. Jaffe may be deemed to beneficially own the shares of Common Stock held
by each of DLJMBPII, DLJMBIIA, DLJOPII, DLJDP, DLJDPA, Millennium,
Millennium-A. Ms. Arnaboldi and Mr. Jaffe expressly disclaim beneficial
ownership of such shares of Common Stock.
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ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
DLJMB RELATIONSHIPS
In connection with the Recapitalization, DLJMBPII and certain
of its affiliates (the "DLJ Entities") purchased an aggregate of 9, 383,420
shares of Common Stock, certain members of management retained an aggregate of
284,832 shares of Common Stock and certain other stockholders retained an
aggregate of 589,577 shares of Common Stock. The aggregate purchase price for
the shares acquired by the DLJ Entities was approximately $78.7 million or
approximately $8.33 per share. Each of these shareholders other than members of
management signed the Stockholders and Registration Rights Agreement. See
"--Stockholders and Registration Rights Agreement." Mr. Jaffe and Ms.
Arnaboldi, directors of the Company, are managing Directors of DLJMB, and Mr.
Nathanson, also a director of the Company, is a Managing Director of DLJ.
On September 30, 1997, the Company entered into a credit
agreement (the "Old Existing Credit Agreement") in which DLJ Capital Funding,
Inc., an affiliate of DLJMBPII, ("DLJ Funding") acted as the arranger and
syndication agent. In connection with the Old Credit Agreement, DLJ Funding
received a customary funding fee of approximately $2.4 million. On February 13,
1998, the Company entered into its existing credit agreement (the "Existing
Credit Agreement") for which DLJ Funding acted as the manager and syndication
agent. In connection with the Existing Credit Agreement, DLJ Funding received a
customary funding fee of approximately $1.9 million.
DLJ (an affiliate of DLJMBPII) acted as financial advisor to the
Company in connection with the structuring of the Recapitalization and received
customary fees for such services of approximately $3.5 million and
reimbursement for reasonable out-of-pocket expenses and affiliates of DLJ
received standby commitment fees of approximately $1.2 million in connection
with change of control offers for the Zero Coupon Notes and the Senior Notes,
which were required as a result of the Recapitalization. The Company agreed to
indemnify DLJ in connection with its acting as financial advisor. In addition,
DLJ received its pro rata portion of the underwriters compensation
(approximately $4.258 million) in connection with its services as lead
underwriter in the initial public offering of the Company's Common Stock that
was consummated on February 13, 1998. DLJ also served as sole underwriter in
connection with the offering of the Company's 9 1/4% Senior Subordinated Notes
due 2008 that was consummated on February 13, 1998, for which DLJ received
$2.4 million of underwriting compensation payable in connection therewith and
$50,000 in connection with services relating to the defeasance of the Zero
Coupon Notes and the Senior Notes. In addition, the DLJ Entities received
$16.75 million from the sale of 1,091,658 shares of Common Stock in connection
with the exercise by the Underwriters of their overallotment option in
connection with the initial public offering of the Company's Common Stock.
-58-
CUTI LOAN AGREEMENT
Pursuant to the terms of the Cuti Employment Agreement and a
Secured Loan Agreement and related agreements among Mr. Cuti, the Company and
DLJ (the "Loan Documents"), on November 20, 1997, Mr. Cuti borrowed $1 million
from DLJ (the "Loan"). The Loan is secured by Mr. Cuti's pledge to DLJ of his
options granted under the equity Plan and his option to purchase 496,569 shares
of Common Stock, and all Common Stock and other proceeds payable upon exercise
or other disposition thereof (the "Pledged Security"). The Loan is subject to
interest at the Federal Mid-Term Rate as in effect from time to time and is
generally payable in five equal installments commencing within 30 days after
Mr. Cuti has the ability to receive cash in exchange for any of the Pledged
Security. In addition, the Company may apply any amounts to which Mr. Cuti is
entitled upon termination of employment to repayment of the Loan. The Cuti
Employment Agreement and the Loan Documents further provide that in the event
of termination of Mr. Cuti's employment by reason of termination by the Company
without "cause" or the Company's non-renewal or his resignation with "good
reason" (as such terms are defined in the Cuti Employment Agreement), the
Company will reimburse Mr. Cuti for all interest accrued as of the date of such
termination if the Company has achieved certain specified financial targets for
the year prior to termination and the year of such termination. The Loan
Documents permits DLJ to assign the Loan to certain of its affiliates,
including the Company, and the Company is obligated pursuant to the Cuti
Employment Agreement to assume the Loan from DLJ as soon as practicable after
the Company and DLJ agree that the Company may do so. At December 27, 1997, the
DLJ Investors had not exercised such election.
OTHER RELATIONSHIPS
The Company incurred aggregate fees owing to Credit Suisse First
Boston for financial services rendered from March 1995 through the consummation
of the Recapitalization in the aggregate among of $3.6 million, of which $1.4
million was paid upon consummation of the Recapitalization and the remaining
$2.2 million was paid in connection with the consummation of the initial public
offering of the Company's Common Stock.
STOCKHOLDERS AND REGISTRATION RIGHTS AGREEMENT
In connection with the Recapitalization, certain of the shareholders
of the Company (the "Initial Shareholders") entered into a Stockholders and
Registration Rights Agreement, pursuant to which the Company has granted the
Initial Shareholders the right to cause the Company to register shares of
Common Stock (the "registrable securities") under the Securities Act. Upon
consummation of the Offering, 9,395,278 outstanding shares of Common Stock will
constitute registrable securities and therefore will be eligible for
registration pursuant to the Stockholders and Registration Rights Agreement.
Under the terms of the Stockholders and Registration Rights Agreement, at any
time after the one year anniversary date of the Offering, (i) the holders of at
least a majority of the registrable securities held by the DLJ Entities can
require the Company, subject to certain limitations, to file a registration
statement under the Securities Act covering all or part of the registrable
securities held by the DLJ Entities and (ii) the remaining
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Initial Shareholders can require the Company, subject to certain limitations,
to file a registration statement covering all or part of the registrable
securities held by such Initial Shareholders (each, a "demand registration").
The Company is obligated to pay all registration expenses (other than
underwriting discounts and commissions and subject to certain limitations)
incurred in connection with the demand registrations. In addition, the
Stockholders and Registration Rights Agreement provides the Initial
Shareholders with "piggyback" registration rights, subject to certain
limitations, whenever the Company files a registration statement on a
registration form that cam be used to register securities held by such Initial
Shareholders.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this
report:
(i) Financial Statements
(ii) Exhibits:
EXHIBIT NO. DESCRIPTION
3.1(i) Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1(i) to the Common Stock
S-1).
3.1(ii) Form of Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.1(i) to the Common Stock S-1).
3.2(i) Certificate of Incorporation of DRI I Inc. (incorporated by
reference to Exhibit 3.2(i) to the S-1 with respect to the
Company's 9 1/4% Senior Subordinated Notes due 2008 (the "Notes
S-1")).
3.2(ii) By-laws of DRI I Inc. (incorporated by reference to Exhibit 3.2(ii)
of the Notes S-1)
3.3 Second Amended and Restated Partnership Agreement of Duane Reade.
(incorporated by reference to Exhibit 3.3 of the Notes S-1)
4.1 Form of Indenture. (incorporated by reference to Exhibit 4.1 of the
Notes S-1)
10.1 Duane Reade Inc. 1997 Equity Participation Plan (incorporated by
reference to Exhibit 10.1 to the Company's Form S-1 registration
Statement (File No. 333-41239), the "Common Stock S-1").
10.2 Duane Read Inc. Holding Corp. 1992 Stock Incentive Plan
(incorporated by reference to Exhibit 10.2 to the Common Stock
S-1).
10.3 Employment Agreement, dated as of October 27, 1997, between the
Company and Anthony J. Cuti (incorporated by reference to Exhibit
10.3 to the Common Stock S-1).
10.4 Employment Agreement, dated as of February 22, 1993, as amended,
between the Company and Gary Charboneau (incorporated by reference
to Exhibit 10.4 to the Common Stock S-1).
10.5 Employment Agreement, dated as of April 10, 1995, as amended,
between Duane Reade and Jerry M. Ray (incorporated by reference to
Exhibit 10.5 to the Common Stock S-1).
10.6 Employment Letter Agreement, dated as of October 9, 1996, between
Duane Read and Joseph Lacko (incorporated by reference to Exhibit
10.6 to the Common Stock S-1).
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10.7 Employment Letter Agreement, dated as of February 12, 1997, between
the Company and William Tennant (incorporated by reference to
Exhibit 10.7 to the Common Stock S-1).
10.8 Agreement, dated as of November 22, 1996 between Duane Reade and
Drug, Chemical, Cosmetic, Plastics and Affiliated Industries
Warehouse Employees Local 815 (incorporated by reference to Exhibit
10.8 to the Common Stock S-1).
10.9 Agreement, dated July 16, 1992, as amended, between Duane Reade and
Allied Trades Council (incorporated by reference to Exhibit 10.9 to
the Common Stock S-1).
10.10 Agreement, dated February 4, 1997, as amended between Duane Reade
and The Pharmacy fund, Inc. (incorporated by reference to Exhibit
10.10 to the Common Stock S-1).
10.11 Stockholders and Registration Rights Agreement, dated as of June
18, 1997, among the Company, DLJMB Funding II, Inc., DLJ Merchant
Banking Partners II, L.P., DLJ Diversified Partners, L.P., DLJ
First ESC L.L.C., DLJ Offshore Partners, II, C.V., DLJ EAB
Partners, L.P., UK Investment Plan 1997 Partners, Bankers Trust New
York Corporation, Conac & Co., Muico & Co., Roton & Co. , Putnam
high Yield Trust, PaineWebber Managed Investment Trust on behalf of
PaineWebber High Income Fund, USL Capital Corporation, Pearlman
Family Partners, The Marion Trust, Bruce L. Weitz, BCIP Associates,
BCIP Trust Associates, L.P., Tyler Capital fund L.P., Tyler
International, L.P.-II, and Tyler Massachusetts, L.P. (incorporated
by reference to Exhibit 10.13 to the Common Stock S-1).
10.12* Credit Agreement, dated as of February 13, 1998, among Duane Reade,
as the Borrower, Duane Reade Inc. and DRI I Inc., as the Parent
Guarantors, Various Financial Institutions set forth therein, as
the Lenders, DLJ Capital Funding, Inc., as the Syndication Agent
for the Lenders, Fleet National Bank, as the Administrative Agent
for the Lenders and Credit Lyonnais New York Branch, as the
Documentation Agent for the Lenders.
10.13* Partnership Security Agreement, dated as of February 13, 1998,
among Duane Reade Inc. and DRI I Inc. and Fleet National Bank, as
Administrative Agent.
10.14* Borrower Security Agreement, dated as of February 13, 1998 between
Duane Reade and Fleet National Bank as Administrative Agent.
10.15* Holdings Pledge Agreement, dated as of February 13, 1997, among
Duane Reade Inc. and Fleet National Bank, as Administrative Agent.
10.16 Form of Irrevocable Trust Agreement with respect to Senior Notes
and Zero Coupon Notes between the Company and State Street Bank and
Trust, as trustee.
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21.1 Subsidiaries of the Company (incorporated by reference to Exhibit
3.1(i) to the Common Stock S-1).
27.1* Financial Data Schedule.
* Filed herewith.
(b) Reports on Form 8-K. None.
(c) Financial Statement Schedules: None
Schedules for which provision is made in the applicable accounting regulations
of the Commission are either not required under the related instructions, are
in applicable or not material, or the information called for thereby is
otherwise included in the financial statements and therefore has been omitted.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Dated: March 27, 1998
DUANE READE INC.
(Registrant)
By: /s/ William J. Tennant
------------------------------
Name: William J. Tennant
Title: Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on March 27, 1998:
SIGNATURES TITLES
---------- ------
/s/ Anthony J. Cuti
- ------------------------ President and Chief Executive Officer and Director
Anthony J. Cuti (Principal Executive Officer)
/s/ William J. Tennant
- ------------------------ Senior Vice President, Chief Financial Officer
William J. Tennant (Principal Financial Officer; Principal Accounting
Officer)
/s/ Nicole S. Arnaboldi Director
- ------------------------
Nicole S. Arnaboldi
/s/ David L. Jaffe Director
- ------------------------
David L. Jaffe
Director
- ------------------------
David W. Johnson
/s/ Andrew J. Nathanson Director
- ------------------------
Andrew J. Nathanson
Director
- ------------------------
Kevin Roberg
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SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 27, 1998
DRI I Inc.
By: /s/ William J. Tennant
------------------------------
Name: William J. Tennant
Title: Senior Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below on March 27, 1998 by the following persons
in the capacities indicated with respect to DRI I Inc.:
SIGNATURE CAPACITY
--------- --------
/s/ Anthony J. Cuti
- ------------------------ President and Chief Executive Officer and Director
Anthony J. Cuti (Principal Executive Officer)
/s/ William J. Tennant
- ------------------------ Vice President,
William J. Tennant (principal accounting and financial officer)
/s/ Nicole S. Arnaboldi Director
- ------------------------
Nicole S. Arnaboldi
/s/ David L. Jaffe Director
- ------------------------
David L. Jaffe
/s/ Andrew J. Nathanson Director
- ------------------------
Andrew J. Nathanson
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Dated: March 27, 1998
DUANE READE INC.
By: DRI I Inc., a general partner By: Duane Reade Inc.
By: /s/ William J. Tennant By: /s/ William J. Tennant
--------------------------- ------------------------------
Name: William J. Tennant Name: William J. Tennant
Title: Senior Vice President and Title: Senior Vice President and
Chief Financial Officer Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below on March 27, 1998 by the following persons
in the capacities indicated with respect to Duane Reade Inc. and DRI I Inc.,
the general partners of Duane Reade, on behalf of Duane Reade:
SIGNATURE CAPACITY
--------- --------
/s/ Anthony J. Cuti
- ------------------------ President and Chief Executive Officer and Director
Anthony J. Cuti (Principal Executive Officer)
/s/ William J. Tennant
- ------------------------ Senior Vice President, Chief Financial Officer
William J. Tennant (principal accounting and financial officer)
/s/ Nicole S. Arnaboldi Director
- ------------------------
Nicole S. Arnaboldi
/s/ David L. Jaffe Director
- ------------------------
David L. Jaffe
Director*
- ------------------------
Kevin Roberg
/s/ Andrew J. Nathanson Director
- ------------------------
Andrew J. Nathanson
Director*
- ------------------------
David W. Johnson
*Duane Reade Inc. only.
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