PROSPECTUS
OFFER TO EXCHANGE UP TO $80,000,000 OF 10 1/4% SENIOR NOTES DUE 2004, SERIES B
OF COMMUNITY DISTRIBUTORS, INC., WHICH HAVE BEEN REGISTERED
UNDER THE SECURITIES ACT OF 1933, AS AMENDED, FOR ANY AND ALL
OF ITS OUTSTANDING 10 1/4% SENIOR NOTES DUE 2004
Community Distributors, Inc.
CDI Group, Inc.
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M.,
NEW YORK CITY TIME, ON MARCH 13, 1998, UNLESS EXTENDED
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Community Distributors, Inc. (the "Company") hereby offers, upon the terms
and subject to the conditions set forth in this Prospectus and the accompanying
letter of transmittal (the "Letter of Transmittal," and together with this
Prospectus, the "Exchange Offer"), to exchange up to an aggregate amount of
$80,000,000 of the Company's 10 1/4% Senior Notes Due 2004, Series B (the "New
Notes"), which have been registered under the Securities Act of 1933, as
amended (the "Securities Act"), pursuant to a Registration Statement of which
this Prospectus is a part, which New Notes shall be guaranteed (the "New
Guarantee") by CDI Group, Inc. (the "Holding Company"), and any future
subsidiaries of the Company (collectively, the "Guarantors") for a like
principal amount of the Company's outstanding 10 1/4% Senior Notes due 2004 (the
"Existing Notes"), of which $80,000,000 in aggregate principal amount is
outstanding as of the date hereof, which Existing Notes have been guaranteed by
the Holding Company (the "Existing Guarantee" and, together with the New
Guarantee, the "Guarantees"). The terms of the New Notes and the New Guarantee
are identical in all material respects to the terms of the Existing Notes and
the Existing Guarantee, except for certain transfer restrictions and
registration rights relating to the Existing Notes. The New Notes will be
issued pursuant to, and entitled to the benefits of, the Indenture, dated as of
October 16, 1997, between the Company and the Holding Company and The Bank of
New York, as trustee, governing the Existing Notes. The New Notes and the
Existing Notes are hereinafter sometimes collectively referred to as the
"Notes."
The New Notes will constitute unsecured obligations of the Company and rank
pari passu in right of payment with all present and future senior indebtedness
of the Company. Although the New Notes are titled "senior", they will be
effectively subordinated to borrowings under the Company's New Credit Facility
to the extent of the value of the assets securing such indebtedness and to any
additional secured indebtedness of the Company permitted under the indenture
governing the Notes. As of December 31, 1997, the aggregate amount of secured
indebtedness of the Company, to which the Notes are effectively subordinated,
was approximately $0.2 million, the aggregate amount of the Company's
outstanding indebtedness ranking pari passu with the Notes (consisting of trade
accounts payable) was approximately $14.3 million, and the Company had not
issued (and had no commitments to issue) any indebtedness that is or will be
expressly subordinated to the Notes. The Notes are fully and unconditionally
guaranteed on a senior unsecured basis by the Holding Company and the Company's
future subsidiaries, if any. The Guarantees are effectively subordinated in
right of payment to all existing and future secured indebtedness of the
Guarantors to the extent of the value of the assets securing such indebtedness.
As of December 31, 1997, the Holding Company had no secured indebtedness, no
indebtedness ranking pari passu in right of payment to the Guarantees, and
approximately $17.7 million of indebtedness (consisting of the Holding Company's
outstanding Subordinated Notes due 2005), including accrued interest, that was
expressly subordinated to the Guarantees.
The Company will accept for exchange any and all Existing Notes that are
validly tendered on or prior to 5:00 p.m., New York City time, on the date the
Exchange Offer expires, which will be March 13, 1998, unless the Exchange Offer
is extended (the "Expiration Date"). Tenders of Existing Notes may be withdrawn
at any time prior to 5:00 p.m., New York City time, on the business day prior to
the Expiration Date. The Exchange Offer is not conditioned upon any minimum
principal amount of Existing Notes being tendered for exchange. However, the
Exchange Offer is subject to certain conditions which may be waived by the
Company and to the terms and provisions of the Notes Registration Rights
Agreement (as defined herein). See "Exchange Offer." The Company has agreed to
pay the expenses of the Exchange Offer.
Holders of Existing Notes whose notes are not tendered and accepted in the
Exchange Offer will continue to hold such Existing Notes. Following
consummation of the Exchange Offer, the holders of Existing Notes will continue
to be subject to the existing restrictions upon transfer thereof and, except as
provided herein, the Company and the Holding Company will have no further
obligation to such holders to provide for the registration under the Securities
Act of the Existing Notes held by them or the Existing Guarantee.
SEE "RISK FACTORS" BEGINNING ON PAGE 16 FOR A DISCUSSION OF CERTAIN RISKS
THAT SHOULD BE CONSIDERED BY HOLDERS OF EXISTING NOTES AND PROSPECTIVE
PURCHASERS OF NEW NOTES.
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The Company will not receive any proceeds from this Exchange Offer and no
underwriter is being utilized in connection with this Exchange Offer.
THE SECURITIES OFFERED HEREBY HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR
HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE
---------------
The date of this Prospectus is February 13, 1998.
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PROSPECTIVE INVESTORS ARE NOT TO CONSTRUE THE CONTENTS OF THIS PROSPECTUS
AS INVESTMENT, LEGAL OR TAX ADVICE. EACH INVESTOR SHOULD CONSULT ITS OWN
COUNSEL, ACCOUNTANT AND OTHER ADVISORS AS TO LEGAL, TAX, BUSINESS, FINANCIAL
AND RELATED ASPECTS OF A PURCHASE OF THE NOTES. NEITHER THE COMPANY NOR THE
INITIAL PURCHASERS ARE MAKING ANY REPRESENTATION TO ANY OFFEREE OR PURCHASER OF
THE NOTES REGARDING THE LEGALITY OF AN INVESTMENT THEREIN BY SUCH OFFEREE OR
PURCHASER UNDER APPROPRIATE LEGAL INVESTMENT OR SIMILAR LAWS. IN MAKING AN
INVESTMENT DECISION REGARDING THE EXCHANGE NOTES OFFERED HEREBY, PROSPECTIVE
INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF THE COMPANY AND THE TERMS OF
THE EXCHANGE OFFER, INCLUDING THE MERITS AND RISKS INVOLVED. THE EXCHANGE OFFER
IS BEING MADE ON THE BASIS OF THIS PROSPECTUS. ANY DECISION TO EXCHANGE NOTES
IN THE EXCHANGE OFFER MUST BE BASED ON THE INFORMATION CONTAINED HEREIN. EACH
PROSPECTIVE PURCHASER OF THE EXCHANGE NOTES MUST COMPLY WITH ALL APPLICABLE
LAWS AND REGULATIONS IN FORCE IN ANY JURISDICTION IN WHICH IT PURCHASES, OFFERS
OR SELLS THE EXCHANGE NOTES OR POSSESSES OR DISTRIBUTES THIS PROSPECTUS AND
MUST OBTAIN ANY CONSENT, APPROVAL OR PERMISSION REQUIRED BY IT FOR THE
PURCHASE, OFFER OR SALE BY IT OF THE EXCHANGE NOTES UNDER THE LAWS AND
REGULATIONS IN FORCE IN ANY JURISDICTION TO WHICH IT IS SUBJECT OR IN WHICH IT
MAKES SUCH PURCHASES, OFFERS OR SALES, AND NEITHER THE COMPANY NOR THE INITIAL
PURCHASERS SHALL HAVE ANY RESPONSIBILITY THEREFOR. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE
NOTES TO ANY PERSON IN ANY JURISDICTION WHERE IT IS UNLAWFUL TO MAKE SUCH AN
OFFER OR SOLICITATION.
UPON REQUEST OF THE INITIAL PURCHASERS OR THE COMPANY, PROSPECTIVE
INVESTORS MAY OBTAIN SUCH ADDITIONAL INFORMATION AS THEY MAY REASONABLY REQUEST
IN CONNECTION WITH THE DECISION TO PURCHASE ANY OF THE NOTES.
NOTICE TO NEW HAMPSHIRE RESIDENTS
NEITHER THE FACT THAT A REGISTRATION STATEMENT OR AN APPLICATION FOR A LICENSE
HAS BEEN FILED UNDER RSA 421-B WITH THE STATE OF NEW HAMPSHIRE NOR THE FACT
THAT A SECURITY IS EFFECTIVELY REGISTERED OR A PERSON IS LICENSED IN THE STATE
OF NEW HAMPSHIRE CONSTITUTES A FINDING BY THE SECRETARY OF STATE THAT ANY
DOCUMENT FILED UNDER RSA 421-B IS TRUE, COMPLETE AND NOT MISLEADING. NEITHER
ANY SUCH FACT NOR THE FACT THAT ANY EXEMPTION OR EXCEPTION IS AVAILABLE FOR A
SECURITY OR A TRANSACTION MEANS THAT THE SECRETARY OF STATE OF THE STATE OF NEW
HAMPSHIRE HAS PASSED IN ANY WAY UPON THE MERITS OR QUALIFICATION OF, OR
RECOMMENDED OR GIVEN APPROVAL TO, ANY PERSON, SECURITY OR TRANSACTION. IT IS
UNLAWFUL TO MAKE, OR CAUSE TO BE MADE, TO ANY PROSPECTIVE PURCHASER, CUSTOMER
OR CLIENT ANY REPRESENTATION INCONSISTENT WITH THE PROVISIONS OF THIS
PARAGRAPH.
THE INITIAL PURCHASERS WHO PARTICIPATED IN THE OFFERING OF THE INITIAL NOTES
MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE
PRICE OF THE NOTES. SPECIFICALLY, THE INITIAL PURCHASERS MAY BID FOR AND
PURCHASE INITIAL NOTES AND EXCHANGE NOTES IN THE OPEN MARKET.
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PROSPECTUS SUMMARY
The following is a summary of certain information contained elsewhere in
this Prospectus and is qualified in its entirety by the more detailed
information and financial statements and the related notes thereto appearing
elsewhere in this Prospectus. As used in this Prospectus, the terms "fiscal
1993," "fiscal 1994," "fiscal 1996," "fiscal 1997," "fiscal 1998" and "fiscal
1999" refer to the fiscal years ended or ending July 25, 1993, July 31, 1994,
July 28, 1996, July 26, 1997, July 25, 1998 and July 31, 1999, respectively, of
the Predecessor Company, the Company or the Holding Company, as applicable. All
references to the twelve months ended July 30, 1995 are to the 52 weeks ended
July 30, 1995, and all information presented for this period represents the
mathematical addition of the results of operations of the Company for the six
months immediately prior to the acquisition of the Company by the Holding
Company on January 30, 1995 and the results of operations of the Company for
the six months ended July 30, 1995.
THE COMPANY AND THE HOLDING COMPANY
The Company is among the largest regional drugstore chains in the United
States and the only regional chain focused primarily on the densely populated
northern and central New Jersey markets, although several national and other
regional drugstore chains have operations in this area. The Holding Company is
the owner of all of the outstanding capital stock of the Company. The Company
operates a chain of 43 drug and general merchandise stores under two separate
formats, Drug Fair and Cost Cutters, and ranks as the number two or three
competitor in its primary market areas based on sales of similar merchandise.
Of the Company's 43 stores, 18 have been opened since 1989 and all but one of
the remaining stores have been refurbished since 1991. The Company has been
consistently profitable and each of the Company's mature stores (those open for
more than 24 months) is profitable on an operating basis prior to the
allocation of certain corporate overhead. The Company's revenues, net income,
Adjusted EBITDA (as defined) and income before incomes taxes were $231.0
million, $4.6 million, $18.7 million and $9.8 million, respectively, in fiscal
1997. Adjusted EBITDA is calculated as net income plus depreciation and
amortization, income taxes, net interest expense, changes in LIFO inventory
reserves and non-cash rental expense. The calculation of Adjusted EBITDA
differs from the calculation of income before income taxes in that it adds back
to net income certain expenses that do not impact the Company's cash flows. The
Company believes that, while Adjusted EBITDA should not be used as a substitute
for other measures of financial performance determined under generally accepted
accounting principles, the presentation of Adjusted EBITDA is meaningful to
holders of Existing Notes and possible purchasers of New Notes because EBITDA
is commonly used by certain investors and analysts to analyze and compare
companies on the basis of operating performance, leverage and liquidity and to
determine a company's ability to service debt. See "Summary Financial and Other
Data" and "Selected Financial Data of the Company."
Drug Fair. Drug Fair is a chain of 26 large-format drugstores with an
average store size of approximately 17,000 square feet. All of the stores
contain a pharmacy in the rear of the store, which is the focal point of the
store layout. In fiscal 1997, the Company's pharmacies (including four at Cost
Cutters locations) filled over 1.5 million prescriptions, an average weekly
volume of approximately 1,000 scripts per pharmacy, and pharmacy sales
increased 16.3% over fiscal 1996. Currently, approximately 72% of the Company's
prescription sales are made to participants in managed health care plans and
other third-party payer plans ("Third-Party Plans"). Drug Fair's strategy is to
utilize large-format stores to capitalize on the increased customer traffic
associated with its growing pharmacy business to increase sales of higher
margin non-pharmacy merchandise, including health and beauty care items,
housewares, greeting cards, stationery, candy and seasonal items. General
merchandise accounted for approximately 61% of Drug Fair revenues in fiscal
1997, higher than the average of other large drugstore chains. The Company
believes that its broad selection of non-pharmacy merchandise is a significant
competitive strength that has enabled it to increase its overall gross margins
from 27.3% in fiscal 1993 to 29.4% in fiscal 1997. Drug Fair stores are
primarily located in neighborhood shopping centers that are easily accessible
and generate significant customer traffic.
Cost Cutters. Cost Cutters is a 17-store general merchandise chain with an
average store size of approximately 29,000 square feet. Cost Cutters stimulates
customer traffic by offering a non-pharmacy merchandise mix similar to Drug
Fair, a high-impact merchandise presentation and an everyday low price
strategy, with prices generally 10%-15% lower than Drug Fair. Cost Cutters
offers a broader selection of products than Drug Fair while still focusing on
health and beauty care items, housewares, greeting cards, stationery, candy and
seasonal items. Currently, four locations have pharmacies, two within the store
and two as separate Drug Fair storefronts adjacent
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to the store, and the Company believes there is an opportunity to open Drug
Fair pharmacies at certain additional Cost Cutters locations. Cost Cutters
stores are primarily located near major highways, drawing customers from a
wider area than a typical drugstore and emphasizing their destination-store
orientation.
Since 1990, the Company has experienced significant growth led by Frank
Marfino, the Company's Chief Executive Officer. During this period, the Company
expanded its store base by 12 stores, with revenues increasing from $168.4
million in fiscal 1993 to $231.0 million in fiscal 1997 and Adjusted EBITDA and
income before income taxes increasing from $10.4 million and $8.6 million in
fiscal 1993 to $18.7 million and $9.8 million, respectively, in fiscal 1997.
Net income decreased from $7.7 million in fiscal 1993 to $4.6 million in fiscal
1997, primarily as a result of debt-related expense and goodwill amortization
incurred by the Company in connection with its Acquisition by the Holding
Company in January 1995 (the "Acquisition.") During this period, the Company
also increased its Adjusted EBITDA margin (which is calculated as the ratio of
Adjusted EBITDA to net sales) from 6.2% to 8.1% of sales. This improved
operating performance and growth have resulted primarily from rationalization
and expansion of the store base, improved centralized controls over purchasing,
effective merchandising, pricing and loss-prevention strategies, increased
pharmacy business with Third-Party Plan participants and cost control measures.
The Company was acquired in January 1995 (the "Acquisition") by the
Holding Company, whose shareholders include a group of investors led by
BancBoston Ventures Inc. ("BancBoston"), Harvest Technology Partners, L.P.
("Harvest") and affiliates, and management. Since the Acquisition, the Company
has placed increased emphasis on growing its pharmacy sales to Third-Party Plan
participants and, as a result, has grown its pharmacy sales by 40.4% from
fiscal 1994 to fiscal 1997. During the same period, the Company's net income
decreased from $10.5 million to $4.6 million, primarily as a result of
debt-related expense and goodwill amortization incurred by the Company in
connection with the Acquisition. Similarly, improved non-pharmacy merchandising
and pricing strategies, combined with increased customer traffic resulting from
higher pharmacy sales, have enabled the Company to increase its gross margin
from 27.9% in fiscal 1994 to 29.4% in fiscal 1997. This increase occurred
despite continued pharmacy margin erosion resulting from increased sales to
Third-Party Plan participants.
According to Drug Store News, the U.S. drugstore industry accounted for
$91 billion of retail sales in 1996 and has grown by 70.1% since 1987. During
this period, sales at chain drugstores, such as those operated by the Company,
grew by 106.0%, as independent drugstores lost significant market share to the
larger and more efficient national and regional chains, such as the Company.
During 1996, pharmacy sales at chain drugstores increased by approximately
17.4% to $30.3 billion, representing 61% of the $49.4 billion pharmacy market,
while pharmacy sales at independent drugstores grew less than 4% in 1996, to an
estimated $19.1 billion, a 39% market share. During fiscal 1996 and fiscal
1997, the Company's pharmacy sales increased by approximately 10.8% and 16.3%,
respectively. Industry revenues are expected to continue to grow at similar
rates due to the aging of the U.S. population, greater participation in Third-
Party Plans and continued growth in new pharmaceutical products. According to
industry sources, households headed by persons aged 55 to 64 and 65 to 74 spend
approximately 20% more and 105% more, respectively, on prescriptions than the
average household. According to the United States Bureau of the Census, people
55 years of age and over represent the fastest growing segment of the U.S.
population and are expected to grow from 55.8 million in 1997 to 74.7 million
in 2010, an increase of 33.9%. In addition, the percentage of prescriptions
purchased through Third-Party Plans has increased from 50% in 1993 to 67% in
1996 and is expected to continue to increase. As pharmacy sales at national and
regional chains have grown, sales of other higher-margin non-pharmacy
merchandise offered in chain drugstores have also experienced positive growth
as a result of increased customer traffic. The Company's non-pharmacy sales
increased from $168.0 million in fiscal 1996 to $175.5 million in fiscal 1997,
a 4.5% increase. The Company's net income was $3.7 million in fiscal 1996 and
$4.6 million in fiscal 1997.
COMPETITIVE STRENGTHS
The Company attributes its success in the marketplace to the following
competitive strengths:
Strong Market Position in Attractive Regional Market. As the largest
drugstore chain focused primarily on the densely populated northern and central
New Jersey markets, the Company's operations serve an estimated population of
over 5.7 million. New Jersey offers a highly attractive customer base, with
among the highest income per capita in the United States. The Company has
operated in these markets for its entire 43-year history and has profitably
managed its operations through changing economic conditions and an environment
of increasing competition. Since 1990, a period
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of significant incremental competition, management has successfully expanded
its store base, increased same-store sales each year, and increased its
Adjusted EBITDA margin and gross margin from 6.2% and 27.3% in fiscal 1993 to
8.1% and 29.4%, respectively, in fiscal 1997. The State of New Jersey has
adopted "Freedom of Choice" and "Any Willing Provider" legislation, which
together effectively allow any prescription provider to service Third-Party
Plan participants on terms identical to those offered to other providers.
Management believes this results in a "level playing field" in New Jersey for
regional drugstore chains such as the Company and positions it to benefit from
the continued growth in pharmacy sales.
Favorable Store Locations. The Company has generally located its stores in
convenient locations under favorable leases, many of which include attractive
long-term renewal rates. The Company's Drug Fair stores are primarily located
in neighborhood shopping centers that are easily accessible and generate
significant customer traffic. The Company's Cost Cutters stores are primarily
located near major highways, drawing customers from a wider area than a typical
drugstore and emphasizing their destination-store orientation. The Company
believes that the accessibility and manageable size of its stores appeal to
consumers at a time when other discount merchandisers continue to open larger
and more complex stores that customers may find less convenient. The close
proximity of the Company's stores to its executive offices and distribution
centers also results in distribution and inventory management efficiencies and
permits close management supervision of store operations.
Successful Merchandising and Pricing Strategy. The Company believes that
its focus on consistent execution of its purchasing, pricing and merchandising
strategies has been instrumental to its success. Excluding pharmacy, Drug Fair
and Cost Cutters offer a similar merchandise mix, with over 90% of merchandise
common to both chains. The Company believes that its broader selection of
front-end merchandise is a significant competitive strength which enabled it to
realize an overall increase in its margins between fiscal 1993 and fiscal 1997.
The Company also believes that by operating both chains it is able to purchase
most of its products at competitive prices by purchasing products in truck-load
or container quantities. The Company employs a promotional pricing strategy at
Drug Fair and a modified everyday low price strategy at Cost Cutters, each
targeted towards the customers it seeks to attract. In addition, the Company's
comprehensive and integrated inventory management system and electronic
point-of-sale system record all sales data by scanner at the time of sale and
permit the Company to maintain in-stock positions in all key lines of
merchandise, promote higher inventory turns and provide the ability to monitor
sales and profitability by store location.
Well-Maintained Store Base. Of the Company's 43 stores, 18 have been
opened since 1989 and all but one of the 25 remaining stores have been
refurbished since 1991. As a result, the Company does not expect to incur an
extraordinary level of capital expenditures for store maintenance in the near
term. Furthermore, since 1991 the Company has rationalized its store base and
closed four underperforming stores. As a result of this rationalization and the
other operating improvements implemented by management, each of the Company's
38 mature stores is profitable on an operating basis prior to the allocation of
certain corporate overhead and management believes that the Company's Adjusted
EBITDA margin exceeds the industry average.
OPERATING AND GROWTH STRATEGY
The Company's operating and growth strategy consists of four principal
elements: (i) capitalize on favorable pharmacy trends, (ii) increase customer
traffic, (iii) further optimize retail execution and (iv) selectively expand
its store base.
Capitalize on Favorable Pharmacy Trends. The pharmacy business contributes
significantly to the Company's growth by increasing sales of non-pharmacy
merchandise, enhancing customer loyalty and generating customer traffic.
Primarily as a result of increasing sales to Third-Party Plan participants, the
Company's pharmacy sales have increased by 9.0%, 10.8% and 16.3% in the twelve
months ended July 30, 1995, fiscal 1996 and fiscal 1997, respectively.
Management expects favorable pharmacy sales trends to continue, and believes
that the Company is well-positioned to increase its higher margin non-pharmacy
merchandise sales by capitalizing on the increased customer traffic generated
by its pharmacies.
Increase Customer Traffic. With favorable pharmacy sales and resulting
customer traffic trends expected to continue, the Company believes that there
are opportunities to further improve customer traffic by providing various
products and services that increase consumer conveniences or otherwise attract
customers to the Company's stores, including offering on-site one-hour
photofinishing labs in a number of locations and increasing offerings of
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convenience foods and seasonal merchandise. The Company is also offering new
products and services such as lottery ticket sales and automated teller
machines (ATMs) in selected stores to enhance customer traffic. The Company
also builds customer loyalty and encourages repeat customer traffic by keeping
its stores orderly and clean and maintaining in-stock positions in
substantially all of its merchandise.
Further Optimize Retail Execution. The Company's non-pharmacy
merchandising strategies are designed to improve customer satisfaction,
selection and convenience and establish its stores as a destination for a
growing number of front-end merchandise categories. The Company believes that
effective merchandise management increases customer satisfaction and has
contributed significantly to increases in its gross margin. The Company will
continue to refine its merchandising and buying practices with the goal of
increasing sales of higher-margin items and improving inventory turnover. For
example, the Company is exploring opportunities to expand sales of over-
the-counter ("OTC") drugs, health and beauty care items, and private label
merchandise.
Selectively Expand Store Base. The Company expects to selectively expand
its store base as favorable market locations become available. The Company
believes that store expansion will increase sales and cash flow, strengthen its
market position and result in economies of scale in marketing and distribution
by leveraging its existing infrastructure. In addition, the Company believes
that increased sales volume may enable it to purchase inventory at better
prices. Management plans to expand its Drug Fair store base, as these stores
generally offer shorter payback periods and higher returns on investment and
better position the Company to capitalize on favorable trends affecting the
drugstore industry. The Company estimates that the average new store investment
is between $0.3 million and $0.6 million, not including inventory costs which
may range from $0.4 million to $0.5 million, and that the average investment
required to open a Drug Fair pharmacy at a Cost Cutters location is between
$75,000 and $100,000, not including inventory costs which may range from
$50,000 to $75,000. Such costs may be slightly higher in the event that the
Company elects to purchase prescription customer files from existing drugstores
in the area in which such stores are opened. In addition, since fiscal 1993,
new Drug Fair stores have not been profitable on an operating basis (that is,
prior to the allocation of corporate overhead) until 32 months after opening,
on average. To the extent that capital is committed to new store openings or
funding initial operations, such funds will be unavailable for other purposes
such as the payment of interest or principal on the Notes. The Company expects
to open four new Drug Fair locations before the end of fiscal 1998 and,
depending on the availability of favorable locations, intends to open an
average of three to four new Drug Fair stores annually over the next several
years.
THE EXCHANGE OFFER
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Securities Offered .................... Up to $80,000,000 aggregate principal amount of 10 1/4% Senior Notes
due 2004, Series B of the Company (the "New Notes"), together with
a guarantee hereof by the Holding Company (the "New Guarantee"),
in exchange for up to $80,000,000 aggregate principal amount of
outstanding 10 1/4% Senior Notes due 2004 of the Company (together
with a guarantee thereof by the Holding Company, referred to
hereinafter as the "Existing Guaranty," and together with the New
Guaranty, the "Guarantees"). The terms of the New Notes and the
New Guarantee and those of the Existing Notes and the Existing
Guarantee are identical in all material respects, except for certain
transfer restrictions relating to the Existing Notes. See "Description
of the Notes."
Registration Rights Agreement ......... The Existing Notes were issued on October 16, 1997 to Donaldson,
Lufkin & Jenrette Securities Corporation and Bear, Stearns & Co. Inc.
(the "Initial Purchasers"). The Initial Purchasers resold the Existing
Notes to certain qualified institutional buyers in reliance on, and
subject to the restrictions imposed pursuant to, Rule 144A under the
Securities Act. In connection therewith, the Company, the Holding
Company and the Initial Purchasers entered into the Registration
Rights Agreement, dated as of October 16, 1997 (the "Registration
Rights Agreement"), providing, among other things, for the Exchange
Offer. See "The Exchange Offer."
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Resale of New Notes ......... Based on interpretations by the Staff of the Commission as set forth
in no-action letters issued to third parties, the Company believes that
the New Notes issued pursuant to the Exchange Offer may be offered
for resale, resold or otherwise transferred by any holder thereof (other
than any such holder that is a broker-dealer or an "affiliate" of the
Company within the meaning of Rule 405 under the Securities Act)
without compliance with the registration and prospectus delivery
provisions of the Securities Act, provided that (i) such New Notes are
acquired in the ordinary course of business, (ii) at the time of the
commencement of the Exchange Offer such holder has no
arrangement or understanding with any person to participate in a
distribution of the New Notes and (iii) such holder is not engaged in,
and does not intend to engage in, a distribution of the New Notes. By
tendering Existing Notes in exchange for New Notes, each holder will
represent to the Company that; (i) it is not such an affiliate of the
Company, (ii) at the time of the commencement of the Exchange Offer
it had no arrangement with any person to participate in a distribution
of the New Notes and, if such holder is not a broker-dealer, it is not
engaged in, and does not intend to engage in, a distribution of New
Notes and (iii) any New Notes to be received by it will be acquired
in the ordinary course of business. If a holder of Existing Notes is
unable to make the foregoing representations, such holder may not
rely on the applicable interpretations of the Staff of the Commission
as set forth in such no-action letters, and must comply with the
registration and prospectus delivery requirement of the Securities Act
in connection with any secondary resale transaction.
Each broker-dealer that receives New Notes for its own account
pursuant to the Exchange Offer in exchange for Existing Notes, where
such Existing Notes were acquired by such broker-dealer as a result
of market-making activities or other activities, must acknowledge that
it will deliver a prospectus meeting the requirements of the Securities
act and that it has not entered into any arrangement or understanding
with the Company or an affiliate of the Company to distribute the New
Notes in connection with any resale of such New Notes. The Letter
of Transmittal states that by so acknowledging and by delivering a
prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act. This
Prospectus, as it may be amended or supplemented from time to time,
may be used by a broker-dealer in connection with resales of New
Notes where such Existing Notes were acquired by such broker-dealer
as a result of market-making activities or other trading activities. The
Company has agreed that, starting on the Expiration Date, and ending
on the close of business 180 days after the Expiration Date, it will
make this Prospectus available to any participating broker dealer for
use in connection with any such resale. See "Plan of Distribution."
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To comply with the securities laws of certain jurisdictions, it may
be necessary to qualify for sale or register the New Notes prior to
offering or selling such New Notes in such jurisdictions. The
Company has agreed, pursuant to the Registration Rights
Agreement and subject to certain specified limitations therein, to
register or qualify the New Notes for offer or sale under the
securities or "blue sky" laws of such jurisdictions as may be
necessary to permit the holders of New Notes to trade in New Notes
without any material restrictions or limitations under the securities
laws of the several states of the United States.
The Exchange Offer ................... The New Notes are being offered in exchange for a like principal
amount of Existing Notes. Existing Notes may be exchanged only
in existing multiples of $1,000. The issuance of the New Notes is
intended to satisfy obligations of the Company under the
Registration Rights Agreement. For a description of the procedures
for tendering, see "Exchange Offer--Procedures for Tendering
Existing Notes."
Expiration Date; Withdrawal .......... The Exchange Offer will expire at 5:00 p.m., New York City time, on
March 13, 1998, or such later date and time to which it may be
extended in the sole discretion of the Company (the "Expiration
Date"). The tender of Existing Notes pursuant to the Exchange Offer
may be withdrawn at any time prior to any time prior to 5:00 p.m.,
New York City time, on the business day prior to the Expiration Date.
Any Existing Notes not accepted for exchange for any reason will be
returned without expense to the tendering holders thereof as promptly
as practicable after the expiration or termination of the Exchange
Offer. See "Exchange Offer--Expiration Date; Extensions;
Termination; Amendments; and Withdrawal Rights."
Conditions to Exchange Offer ......... The Exchange Offer is subject to certain conditions. See "Exchange
Offer--Certain Conditions to the Exchange Offer."
Procedures for Tendering Each holder of Existing Notes wishing to accept the Exchange Offer
Existing Notes ...................... must complete, sign and date a Letter of Transmittal, or a facsimile
thereof, in accordance with the instructions contained herein and
therein, and mail or otherwise deliver such Letter of Transmittal, or
such facsimile, together with such Existing Notes and any other
required documents, to the Exchange Agent (as defined) at the address
set forth herein. See "Exchange Offer--Procedures for Tendering
Existing Notes."
Use of Proceeds ...................... There will be no proceeds to the Company or the Holding Company
from the exchange of Notes pursuant to the Exchange Offer.
Certain Federal Income Tax The exchange pursuant to the Exchange Offer should not be a
Consideration ....................... taxable event to the holder for federal income tax purposes, and the
holder should not recognize any taxable gain or loss as a result of
such exchange. See "Certain Federal Income Tax Considerations."
</TABLE>
6
<PAGE>
<TABLE>
<S> <C>
Untendered Existing Notes ......... Upon consummation of the Exchange Offer, the holders of Existing
Notes, if any, will have no further rights under the Registration Rights
Agreement, except as provided herein. Holders of Existing Notes
whose Existing Notes are not tendered or are tendered but not accepted
in the Exchange Offer will continue to hold such Existing Notes and
will be entitled to all the rights and preferences and subject to the
limitations applicable thereto. Following consummation of the
Exchange Offer, the holders of Existing Notes will continue to be
subject to the existing restrictions upon transfer thereof and, except as
provided herein, the Company will have no further obligation to such
holders to provide for the registration under the Securities Act of the
Existing Notes held by them. To the extent that Existing Notes are
tendered and accepted in the Exchange Offer, the trading market for
untendered and tendered by unaccepted Existing Notes could be
adversely affected.
Exchange Agent .................... The Bank of New York is serving as the Exchange Agent in
connection with the Exchange Offer.
</TABLE>
TERMS OF THE NOTES
Except as otherwise indicated, the following description relates both to
the Existing Notes issued pursuant to the Offering and to the New Notes to be
issued in exchange for Existing Notes in connection with the Exchange Offer.
The New Notes will be obligations of the Company evidencing the same
indebtedness as the Existing Notes, and will be entitled to the benefits of the
same Indenture. The form and terms of the New Notes are the same as the form
and terms of the Existing Notes, except that the New Notes have been registered
under the Securities Act and therefore will not bear legends restricting the
transfer thereof. For a more complete description of the Notes see "Description
of Notes." Throughout this Prospectus, references to the "Notes" refer to the
New Notes and the Existing Notes collectively.
<TABLE>
<S> <C>
Issuer ......................... Community Distributors, Inc.
Securities Offered ............. $80,000,000 aggregate principal amount of 10 1/4% Senior Notes
due 2004, Series B.
Maturity Date .................. October 15, 2004.
Interest on the Notes .......... The Existing Notes accrue interest at a rate of 10 1/4% per annum
from the Issue Date. The New Notes will accrue interest at a rate
of 10 1/4% per annum from the Issue Date or from the most recent
date to which interest had been paid on the Existing Notes.
Interest Payment Dates ......... April 15 and October 15, commencing on April 15, 1998.
</TABLE>
7
<PAGE>
<TABLE>
<S> <C>
Optional Redemption ......... The Notes will be redeemable at the option of the Company, in
whole or in part, on or after October 15, 2001, at the redemption
prices set forth herein, plus accrued and unpaid interest, if any, to
the date of redemption. Notwithstanding the foregoing, prior to
October 15, 2000, the Company may redeem from time to time up
to 35% of the aggregate principal amount of the Notes originally
outstanding at a redemption price equal to 110.25% of the principal
amount thereof, plus accrued and unpaid interest, if any, to the
redemption date, with the net proceeds of one or more Equity
Offerings (as defined herein); provided that at least 65% of the
aggregate principal amount of the Notes originally outstanding
remain outstanding immediately after the occurrence of such
redemption. See "Description of Notes--Optional Redemption."
Guarantees .................. The Notes are fully and unconditionally guaranteed on a senior
unsecured basis by the Holding Company and the Company's
future subsidiaries, if any (such future subsidiaries are collectively
referred to as the "Subsidiary Guarantors" and, together with the
Holding Company, as the "Guarantors").
Ranking ..................... The Notes and the Guarantees constitute unsecured obligations of the
Company and the Guarantors, respectively, and rank pari passu with
all present and future unsecured senior indebtedness of the
Company and the Guarantors, as applicable. Although the Notes
are titled "senior," the Notes and the Guarantees will be effectively
subordinated to borrowings under the Company's New Credit
Facility to the extent of the value of the assets securing such
indebtedness and to any additional secured indebtedness of the
Company and the Guarantors, respectively, permitted under the
indenture governing the Notes (the "Indenture"). As of December
31, 1997, the aggregate amount of secured indebtedness of the
Company, to which the Notes are effectively subordinated, was
approximately $0.2 million, and the Company had not issued (and
had no commitments to issue) any indebtedness that is or will be
expressly subordinated to the Notes. As of December 31, 1997, the
Holding Company had no secured indebtedness, no indebtedness
ranking pari passu in right of payment to the Guarantees, and
approximately $17.7 million of indebtedness (consisting of the
Holding Company's outstanding Subordinated Notes due 2005),
including accrued interest, that was expressly subordinated to the
Guarantees. See "Description of Notes--General" and
"Description of New Credit Facility and Certain Other
Indebtedness."
</TABLE>
8
<PAGE>
<TABLE>
<S> <C>
Change of Control Offer ......... Upon a Change of Control (as defined), the Company will be
required to offer to repurchase all outstanding Notes at 101% of the
aggregate principal amount thereof, plus accrued and unpaid
interest, if any, to the date of repurchase. Because the Company's
obligation to make an offer to repurchase Notes upon a "Change
of Control" arises only upon transactions that fit within the
definition of such term, it is possible that other transactions, such
as certain types of highly leveraged transactions, which could result
in an effective change in the control of the Company or the Holding
Company could occur that are not covered by such definition and,
accordingly, would not cause this repurchase obligation to arise. In
such an event, the holders of the Notes could be denied the benefits
of the provision of the Indenture described under the caption
"Description of Notes--Certain Covenants--Repurchase of Notes
at the Option of the Holder Upon a Change of Control." See
"Description of Notes--Certain Covenants--Repurchase of Notes
at the Option of the Holder Upon a Change of Control."
Certain Covenants ............... The Indenture contains certain covenants with respect to the Company
and any subsidiaries that limit the ability of the Company and any
subsidiaries to, among other things, (i) incur additional Indebtedness
(as defined herein), (ii) pay dividends or make other distributions, (iii)
make certain investments, (iv) create certain liens, (v) sell certain
assets, (vi) enter into certain transactions with affiliates and (vii) enter
into certain mergers or consolidations involving the Company or its
subsidiaries. See "Description of Notes--Certain Covenants."
</TABLE>
COMPARISON OF NEW NOTES WITH EXISTING NOTES
<TABLE>
<S> <C>
Freely Transferable ......... Generally, the New Notes will be freely transferable under the
Securities act by holders thereof other than any holder that is either
an affiliate of the Company or a broker-dealer that purchased the Notes
from the Company to resell pursuant to Rule 144A or any other
available exemption. The New Notes otherwise will be substantially
identical in all material respects (including interest rate and maturity)
to the Existing Notes. See "Exchange Offer."
Registration Rights ......... The holders of Existing Notes currently are entitled to certain
registration rights pursuant to the Registration Rights Agreement (the
"Registration Rights Agreement"), dated as of October 16, 1997,
among the Company, the Holding Company and the Initial
Purchasers. However, upon consummation of the Exchange Offer,
subject to certain exceptions, holders of Existing Notes who do not
exchange their Existing Notes for New Notes in the Exchange Offer
will no longer be entitled to registration rights and will not be able to
offer or sell their Existing Notes, unless such Existing Notes are
subsequently registered under the Securities Act (which, subject to
certain limited exceptions, the Company will have no obligation to
do), except pursuant to an exemption from, or in a transaction not
subject to, the Securities Act and applicable state securities laws. See
"Risk Factors--Adverse Consequences of Failure to Adhere to
Exchange Offer Procedures."
</TABLE>
9
<PAGE>
<TABLE>
<S> <C>
Absence of a Public Market for the The New Notes are new securities and there is currently no
New Notes ....................... established market for the New Notes. Accordingly, there can be
no assurance as to the development or liquidity of any market for
the New Notes. The Company does not intend to apply for listing
on a securities exchange of the New Notes.
</TABLE>
For more complete information regarding the Existing Notes and the New
Notes, including the definitions of certain capitalized terms used above, see
"Description of the Notes."
Risk Factors
Holders of Existing Notes and prospective purchasers of New Notes should
consider carefully the information set forth under the caption "Risk Factors,"
and all other information set forth in this Prospectus, in connection with the
Exchange Offer.
10
<PAGE>
SUMMARY FINANCIAL AND OPERATING DATA
The Company
The following summary financial data, operating data and pro forma data
for the periods and dates indicated set forth below have been derived from the
audited annual financial statements, unaudited interim and pro forma financial
statements of the Company and the audited financial statements of the
Predecessor Company (as defined below) and the related notes thereto included
elsewhere herein. The financial statements of the Predecessor Company for the
six months ended January 29, 1995, have been audited by Arthur Andersen LLP,
and the financial statements of the Company for the six months ended July 30,
1995, fiscal 1996 and fiscal 1997 have been audited by Coopers & Lybrand L.L.P.
The Company was acquired by the Holding Company on January 30, 1995, and is
referred to below with respect to periods prior to that date as the
"Predecessor Company," and with respect to periods after that date as the
"Company." The summary financial and operating data of the Company presented
below under the caption "Statement of Operations Data" and "Balance Sheet Data"
for the three months ended October 25, 1997 and October 26, 1996, and the data
presented below under the caption "Pro Forma Data" and "Other Data" for all
periods presented, are unaudited and are not necessarily indicative of the
Company's results for the full fiscal year. The unaudited summary pro forma
financial and operating data of the Company for the twelve months ended July
26, 1997 and three months ended October 25, 1997 do not necessarily reflect the
results of operations or financial position of the Company that would have
actually resulted had the events referred to in the notes to the unaudited pro
forma financial information been consummated as of the dates indicated and are
not intended to project the Company's financial position or results of
operations for any future period.
The summary financial data, operating data and pro forma data presented
below should be read in conjunction with the audited annual financial
statements and notes thereto of the Company for the six months ended July 30,
1995, fiscal 1996 and fiscal 1997, the audited financial statements of the
Predecessor Company for the six months ended January 29, 1995, and the
unaudited interim financial statements of the Company for the three months
ended October 26, 1996 and October 25, 1997, and the pro forma financial
statements included elsewhere in this Prospectus. For additional information,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
Predecessor The
Company Company
------------- --------------------------------------------------------------
Twelve Months Three Months
Six Months Six Months Ended Ended
Ended Ended --------------------- ---------------------------
January 29, July 30, July 28, July 26, Oct. 26, Oct. 25,
1995 1995 1996 1997 1996 1997
(unaudited) (unaudited)
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales ........................ $101,687 $96,171 $215,731 $231,033 $52,073 $54,722
Cost of sales .................... 72,469 67,686 152,645 163,157 38,072 39,671
-------- ------- -------- -------- ------- -------
Gross profit .................... 29,218 28,485 63,086 67,876 14,001 15,051
Selling, general and
administrative expense ......... 21,468 21,635 47,487 50,831 11,752 12,678
Other income, net ................ 595 205 353 401 95 105
Administrative fees .............. 0 125 250 250 63 63
Depreciation and
amortization (2) ............... 884 1,980 4,341 4,399 1,116 1,467
-------- ------- -------- -------- ------- -------
Operating income ................ 7,461 4,950 11,361 12,797 1,165 948
Interest expense, net ............ 0 2,284 3,998 3,018 826 718
-------- ------- -------- -------- ------- -------
Income (loss) before
income taxes ................... 7,461 2,666 7,363 9,779 339 230
Provision for income taxes
(3) ............................ 186 1,598 3,659 5,216 393 349
-------- ------- -------- -------- ------- -------
Net income (loss) ............... $ 7,275 $ 1,068 $ 3,704 $ 4,563 $ (54) $ (119)
======== ======= ======== ======== ======= =======
<CAPTION>
The Company Pro Forma (1)
-----------------------------
Twelve Months Three Months
Ended Ended
July 26, October 25,
1997 1997
(unaudited) (unaudited)
<S> <C> <C>
Statement of Operations Data:
Net sales ........................ $231,033 $54,722
Cost of sales .................... 163,157 39,671
-------- -------
Gross profit .................... 67,876 15,051
Selling, general and
administrative expense ......... 50,831 12,678
Other income, net ................ 401 105
Administrative fees .............. 250 63
Depreciation and
amortization (2) ............... 4,720 1,200
-------- -------
Operating income ................ 12,476 1,215
Interest expense, net ............ 8,170 2,025
-------- -------
Income (loss) before
income taxes ................... 4,306 $ (810)
Provision for income taxes
(3) ............................ 2,282 (430)
-------- -------
Net income (loss) ............... $ 2,024 $ (380)
======== =======
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
As of October 25, 1997
------------------------
(unaudited)
(dollars in thousands)
<S> <C>
Balance Sheet Data:
Working capital ........................ $ 18,083
Total assets ........................... 91,041
Total debt ............................. 80,197
Stockholder's equity (deficit) ......... (17,542)
</TABLE>
<TABLE>
<CAPTION>
Twelve Months Three Months
Ended Ended
--------------- -----------------
July 26, 1997 October 25, 1997
--------------- -----------------
(unaudited)
(dollars in thousands)
<S> <C> <C>
Additional Pro Forma Data (1):
Adjusted EBITDA (4) .......................................... $18,696 $ 2,834
Pro forma cash interest expense, net (5) ..................... 8,170 2,025
Ratio of pro forma income before income taxes to pro forma
cash interest expense, net (5) .............................. 0.5x 0.4x
Ratio of Adjusted EBITDA to pro forma cash interest expense,
net (6) ..................................................... 2.3x 1.4x
Pro forma total debt ......................................... $80,198 $80,198
Ratio of pro forma total debt to pro forma income before
income taxes ................................................ 17.8x 99.0x
Ratio of pro forma total debt to Adjusted EBITDA (7) ......... 4.3x 28.3x
</TABLE>
<TABLE>
<CAPTION>
Predecessor The
Company Company
------------------ --------------------------------------------------------
Twelve Months Ended Three Months
Six Months Ended Six Months Ended ----------------------- Ended
January 29, July 30, July 28, July 26, October 25,
1995 1995 1996 1997 1997
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Other Data (unaudited):
Ratio of earnings to fixed
charges (8) ...................... 8.1x 1.7x 2.1x 2.7x 1.2x
Adjusted EBITDA (4) ................ $9,682 $7,714 $16,913 $18,695 $2,834
Gross Margin ....................... 28.7 29.6 29.2 29.4 27.5%
Adjusted EBITDA margin (9) ......... 9.5% 8.0% 7.8% 8.1% 5.2%
Capital expenditures ............... $1,313 $1,070 $ 2,887 $ 1,287 $ 663
Pharmacy sales growth .............. 7.8% 10.1% 10.8% 16.3% 12.2%
Pharmacy sales as a % of total ..... 19.6 22.6 22.1 24.1 26.3
Third-Party Plan sales as a % of
pharmacy sales ................... 47.2 50.9 61.5 70.1 72.5
Store data:
Number of stores at end of
period:
Drug Fair ....................... 22 22 25 26 26
Cost Cutters .................... 15 16 17 17 17
------ ------ ------- ------- ------
Total ......................... 37 38 42 43 43
====== ====== ======= ======= ======
Same-store sales growth (10):
Drug Fair ....................... 4.0% 6.6% 3.5% 6.7% 5.9%
Cost Cutters .................... 4.0 4.3 0.9 2.7 2.9
------ ------ ------- ------- ------
Total ......................... 4.0% 5.6% 2.4% 4.8% 4.6%
====== ====== ======= ======= ======
</TABLE>
12
<PAGE>
- ------------
(1) Gives pro forma effect to the sale of the Existing Notes and the
application of the net proceeds therefrom as described under the caption
"Use of Proceeds" as of July 29, 1996.
(2) Depreciation and amortization amounts for the six month period ended July
30, 1995 and for the twelve months ended July 28, 1996, the twelve months
ended July 26, 1997 and the three months ended October 25, 1997 include
amortization of goodwill, beneficial leasehold intangibles and deferred
financing costs recorded in connection with the Acquisition in January
1995.
(3) Prior to its acquisition by the Holding Company on January 30, 1995, the
Predecessor Company was treated as a Subchapter S corporation for both
federal and state income tax purposes. Accordingly, the provision for
income taxes for the six months ended January 29, 1995 and all prior
periods is substantially less than that recorded for the Company for the
six months ended July 30, 1995 and each subsequent period. If the
Predecessor Company had been treated as a C corporation for federal and
state income tax purposes for the six month period ended January 29, 1995,
the Predecessor Company's provision for income taxes for such period would
have been approximately $3,000 and its net income for such period would
have been approximately $4,461.
(4) Adjusted EBITDA represents net income plus depreciation and amortization,
income taxes, net interest expense, changes in LIFO inventory reserves and
non-cash rental expense. Changes in LIFO inventory reserves and non-cash
rental expense are included in Adjusted EBITDA because they reflect
non-cash expenses that do not directly impact the ability of the Company
to service its debt obligations, including under the Notes. Changes in
LIFO inventory reserves and non-cash rental expense aggregated $1,337,
$784, $1,211, and $1,500 for the six months ended January 29, 1995 and
July 30, 1995, and the twelve months ended July 28, 1996 and July 26,
1997, respectively. While Adjusted EBITDA should not be construed as a
substitute for income from operations, net income, income before income
taxes or cash flows from operating activities (as defined by generally
accepted accounting principles), or other measures defined by generally
accepted accounting principles, in analyzing the Company's operating
performance, financial position or cash flows, the Company has included
Adjusted EBITDA because management understands that it is commonly used by
certain investors and analysts to analyze and compare companies on the
basis of operating performance, leverage and liquidity and to determine a
company's ability to service debt. Unlike net income or EBITDA, Adjusted
EBITDA may not be a measure of the ultimate profitability of a company,
and may not be as meaningful to other investors or analysts. In addition,
investors should note that the method of calculating Adjusted EBITDA set
forth above may be different from calculations of EBITDA employed by other
companies and, accordingly, may not be directly comparable to such other
calculations.
The Adjusted EBITDA calculations for the periods presented are as follows:
<TABLE>
<CAPTION>
Predecessor
Company The Company
------------------ ----------------------------------------------------------------------
Six Months Ended Six Months Ended Twelve Months Ended Three Months Ended
January 29, 1995 July 30, 1995 July 28, 1996 July 26, 1997 October 25, 1997
(unaudited)
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Net Income (loss) ................. $7,275 $1,068 $ 3,704 $ 4,563 $ (119)
Provision for income taxes ....... 186 1,598 3,659 5,216 349
Interest expense, net ............ 0 2,284 3,998 3,018 718
Depreciation and amortization..... 884 1,980 4,341 4,399 1,467
Non-cash rent expense ............ 0 217 552 413 119
Change in LIFO reserve ........... 1,337 567 659 1,086 300
Adjusted EBITDA ................... 9,682 7,714 16,913 18,695 2,834
</TABLE>
(5) The pro forma cash interest expense calculation reflects the elimination of
interest expense of $3,048 and $743 on the term loans under the Old Credit
Facility for fiscal 1997 and the three months ended October 25, 1997,
respectively, and the inclusion of interest of $8,200 and $2,050,
respectively, on the Notes for such periods. Also reflects the pro forma
elimination of deferred financing cost amortization incurred in connection
with the Old Credit Facility (as defined below) in the amounts of $108 and
$374 for fiscal 1997 and the three month period ended October 25, 1997,
respectively, and the inclusion of deferred financing cost amortization
associated with issuance of the Notes in the amounts of $429 and $107,
respectively, for such periods.
(6) The ratio of Adjusted EBITDA to pro forma cash interest expense, net is
calculated as the amount of pro forma cash interest expense, net for a
period divided by the Adjusted EBITDA for such period. The Company
believes that the presentation of the ratio of Adjusted EBITDA to pro
forma cash interest expense, net is meaningful to an understanding of the
Company's financial position and results of operations because it is a
more direct measurement of the Company's ability to service its debt
obligations out of cash flow than other measures determined under
generally accepted accounting principles.
(7) The ratio of pro forma total debt to Adjusted EBITDA is calculated as the
amount of pro forma total debt as of the end of a period divided by the
Adjusted EBITDA for such period. The Company believes that the
presentation of the ratio of pro forma total debt to Adjusted EBITDA is
meaningful because it is a more direct measurement of the Company's
ability to service its debt obligations out of cash flow than other
measures determined under generally accepted accounting principles.
13
<PAGE>
(8) Ratio of earnings to fixed charges is computed by adding fixed charges
(interest and one-third of rental expenses, which the Company believes is
representative of that portion of rental expenses attributable to
interest) to income before income taxes and dividing that sum by the sum
of the fixed charges. Assuming that all amounts outstanding under the Old
Credit Facility were repaid as of July 29, 1996, the ratios of earnings to
fixed charges for fiscal 1997 and the three months ended October 25, 1997
would have been 1.3x and 0.7x, respectively.
(9) Adjusted EBITDA margin is calculated as the amount of Adjusted EBITDA for a
period divided by net sales for such period. While Adjusted EBITDA margin
should not be construed as a substitute for gross margin (as defined by
generally accepted accounting principles), or other measurements
determined by generally accepted accounting principles, in analyzing the
Company's operating performance, financial position or cash flows, the
Company has included presentation of Adjusted EBITDA because Management
believes it is commonly used by certain investors and analysts to analyze
and compare companies on the basis of operating performance, leverage and
liquidity and to determine a company's ability to service debt. Management
believes that Adjusted EBITDA margin is a meaningful supplement to gross
margin because it measures the Company's profitability on a cash flow
basis, which is material to a determination of the Company's ability to
service its debt.
(10) Same-store sales growth is calculated based on net sales for stores open
for the whole of the indicated period and the previous period.
14
<PAGE>
The Holding Company
The following summary financial data and operating data for the periods
and dates indicated set forth below have been derived from the financial
statements of the Holding Company. The Holding Company was formed in January,
1995. The summary financial and operating data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Holding Company's audited annual financial statements,
unaudited interim financial statements and pro forma financial statements and
related notes thereto, included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
Holding Company
----------------------------------------------------------------
Twelve Months
Six Months Ended Three Months Three Months
Ended --------------------- Ended Ended
July 30, July 28, July 26, October 26, October 25,
1995 1996 1997 1996 1997
(unaudited) (unaudited)
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales .......................... $96,171 $215,731 $231,033 $52,073 $54,722
Cost of sales ...................... 67,686 152,645 163,157 38,072 39,671
------- -------- -------- ------- -------
Gross profit ...................... 28,485 63,086 67,876 14,001 15,051
Selling, general and
administrative expense ........... 21,635 47,487 50,831 11,752 12,678
Other income, net .................. 205 353 401 95 105
Administrative fees ................ 125 250 250 63 63
Depreciation and amortization
(2) .............................. 1,980 4,341 4,399 1,116 1,467
------- -------- -------- ------- -------
Operating income .................. 4,950 11,361 12,797 1,165 948
Interest expense, net .............. 2,946 5,326 4,586 1,151 1,241
------- -------- -------- ------- -------
Income (loss) before income
taxes ............................ 2,004 6,035 8,211 14 (293)
Provision for income taxes ......... 1,366 3,442 4,433 279 166
------- -------- -------- ------- -------
Net income (loss) ................. $ 638 $ 2,593 $ 3,778 $ (265) $ (459)
======= ======== ======== ======= =======
<CAPTION>
Holding Company
Pro Forma (1)
-----------------------------
Twelve Months Three Months
Ended Ended
July 26, October 25,
1997 1997
(unaudited) (unaudited)
<S> <C> <C>
Statement of Operations Data:
Net sales .......................... $231,033 $ 54,722
Cost of sales ...................... 163,157 39,671
-------- --------
Gross profit ...................... 67,876 15,051
Selling, general and
administrative expense ........... 50,831 12,678
Other income, net .................. 401 105
Administrative fees ................ 250 63
Depreciation and amortization
(2) .............................. 4,720 1,200
-------- --------
Operating income .................. 12,476 1,215
Interest expense, net .............. 9,738 2,548
-------- --------
Income (loss) before income
taxes ............................ 2,318 (1,333)
Provision for income taxes ......... 1,451 (706)
-------- --------
Net income (loss) ................. $ 1,287 $ (627)
======== ========
</TABLE>
<TABLE>
<CAPTION>
As of October 25, 1997
-----------------------
(unaudited)
(dollars in thousands)
<S> <C>
Balance Sheet Data:
Working capital ............................... $ 18,829
Total assets .................................. 91,055
Total debt .................................... 97,558
Redeemable Preferred and Common Stock ......... 1,278
Stockholder's equity (deficit) ................ (34,604)
</TABLE>
- ------------
(1) Gives pro forma effect to the sale of the Existing Notes and the
application of the net proceeds therefrom as described under the caption
"Use of Proceeds" as of July 29, 1996, the first day of the stated period.
(2) Depreciation and amortization amounts include amortization of goodwill,
beneficial leasehold intangibles and deferred financing costs recorded in
connection with the Acquisition in January 1995.
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RISK FACTORS
Holders of Existing Notes and prospective purchasers of New Notes should
consider carefully the following risk factors in addition to the other
information set forth in this Prospectus before tendering their Existing Notes
for New Notes. Holders of Existing Notes should consider carefully the
following factors, which are generally applicable to the Existing Notes and the
New Notes. Certain of the statements in this Prospectus are forward-looking in
nature and, accordingly, are subject to risks and uncertainties. The actual
results that the Company and the Holding Company achieve may differ materially
from any forward-looking statements in this Prospectus. Factors that could
cause or contribute to such differences include, but are not limited to, those
discussed below and those contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations," "Business" and "Special Note
Regarding Forward-Looking Statements," as well as those discussed elsewhere in
this Prospectus.
Risks of Significant Leverage; Potential Inability to Service Indebtedness
In connection with the Offering, the Company incurred a significant amount
of indebtedness and used a significant portion of the proceeds from the sale of
such indebtedness to pay a dividend to securityholders of the Holding Company.
As a result, the Company is highly leveraged and has substantial repayment
obligations, as well as significantly increased interest expense, with the
portion of the net proceeds used to pay such dividend unavailable to service
such obligations and expenses or any other Company obligation. As of October
25, 1997, the Company's total indebtedness was approximately $80.2 million and
the Company had a stockholder's deficit of approximately $17.5 million. In
addition, subject to the restrictions in the New Credit Facility and the
Indenture, the Company and the Holding Company may incur additional
indebtedness from time to time to finance expansion or capital expenditures or
for other purposes.
The Company's ability to make scheduled payments of principal or interest
on, or to refinance, its indebtedness will depend on future operating
performance and cash flow, which are subject to prevailing economic conditions,
prevailing interest rates and financial, competitive, business and other
factors beyond its control. The degree to which the Company is leveraged could
have important consequences to holders of the Notes, including the following:
(i) the Company's ability to obtain additional financing for working capital,
capital expenditures, acquisitions or general corporate purposes may be
impaired; (ii) a substantial portion of the Company's cash flow from operations
must be dedicated to the payment of interest on the Notes and interest on its
other existing indebtedness, thereby reducing the funds available to the
Company for other purposes; (iii) the agreements governing the Company's
long-term indebtedness impose certain restrictive financial and operating
covenants on the Company; (iv) all of the indebtedness under the New Credit
Facility are at a variable rate of interest, which causes the Company to be
adversely affected by increases in interest rates; (v) all of the indebtedness
outstanding under the New Credit Facility is secured by all inventory and
accounts receivable of the Company and will become due prior to the time the
principal on the Notes will become due; (vi) the Company is substantially more
leveraged than certain of its competitors, which might place the Company at a
competitive disadvantage; (vii) the Company may be hindered in its ability to
adjust rapidly to changing market conditions; (viii) certain vendors'
willingness to give the Company favorable payment terms and certain landlords'
willingness to enter into store leases with the Company may be affected; and
(ix) the Company may be more vulnerable in the event of a downturn in general
economic conditions or in its business. See "Description of New Credit Facility
and Certain Other Indebtedness."
The Company believes that, based upon anticipated levels of operations, it
should be able to meet its debt service obligations, including interest
payments on the Notes, when due. If, however, the Company cannot generate
sufficient cash flow from operations to meet its obligations, the Company might
be required to refinance its debt or to dispose of assets to obtain funds for
such purpose. There is no assurance that refinancing or asset dispositions
could be effected on satisfactory terms, if at all, or would be permitted by
the terms of the New Credit Facility or the Indenture pursuant to which the
Notes were issued. Failure by the Company to refinance the New Credit Facility
or the Notes or raise funds through asset sales, sales of equity or otherwise,
if required, could have a material adverse effect on the Company's financial
condition and results of operations and its ability to pay principal of and
interest on the Notes.
The Company's obligations under the Notes is guaranteed on a senior,
unsecured basis by the Holding Company and any future subsidiaries of the
Company. Because the operations of the Company provide all of the cash flow of
the Holding Company, the Holding Company's ability to perform under its
Guarantee is currently entirely dependent upon the operations and financial
position of the Company.
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Risks Associated with Effective Subordination of the Notes and the Holding
Company Guarantee
The Indenture and the Holding Company's Guarantee permit the Company and
the Holding Company to incur additional senior indebtedness, provided certain
financial or other conditions are met. The Notes and the Holding Company's
Guarantee are senior unsecured obligations and rank pari passu in right of
payment with all existing and future senior unsecured indebtedness of the
Company and the Holding Company, respectively. As of December 31, 1997, the
aggregate amount of secured indebtedness of the Company, to which the Notes are
effectively subordinated, would have been approximately $0.2 million and the
aggregate amount of the Company's outstanding indebtedness ranking pari passu
with the Notes (consisting of trade accounts payable) was approximately $14.3
million. Holders of existing or future secured indebtedness of the Company
permitted under the Indenture, including the New Credit Facility, will have
claims with respect to the assets constituting collateral that are prior to the
claims of holders of the Notes. See "Description of Notes--Ranking."
In addition, any indebtedness that is incurred by any of the Guarantors
will be effectively senior to the claims of the holders of the Notes with
respect to the assets of such Guarantors, except to the extent that the holders
of the Notes may be creditors of a Guarantor pursuant to a Guarantee. Any such
claim by the holders of the Notes with respect to the assets of any Guarantor
will be effectively subordinated to secured indebtedness of such Guarantor with
respect to the assets securing such indebtedness. The rights of the Company and
its creditors, including holders of the Notes, to realize the assets of any
Guarantor upon such Guarantor's liquidation or reorganization (and the
consequent rights of holders of the Notes to participate in those assets) will
be subject to the prior claims of such Guarantor's creditors, except to the
extent that the Company may itself be a creditor with recognized claims against
such Guarantor or to the extent that the holders of the Notes may be creditors
with recognized claims against such Guarantor pursuant to the terms of a
Guarantee (subject, however, to the prior claims of creditors holding secured
indebtedness of any such Guarantor with respect to the assets securing such
indebtedness). As of December 31, 1997, the Holding Company had no secured
indebtedness, no indebtedness ranking pari passu with the Guarantee of the
Holding Company and the aggregate amount of the Holding Company's outstanding
indebtedness ranking expressly subordinate to the Guarantee of the Holding
Company (consisting of the Holding Company's outstanding Subordinated Notes due
2005) is approximately $17.7 million, including accrued interest.
Fraudulent Conveyance Risks
Various fraudulent conveyance laws have been enacted for the protection of
creditors and may be utilized by a court to subordinate or void the Notes and
the Guarantees in favor of other existing or future creditors of the Company
and the Guarantors.
Proceeds from the sale of the Existing Notes were used, in part, to make a
cash distribution to the Company's sole stockholder, the Holding Company, which
distributed these proceeds to its securityholders. If a court in a lawsuit on
behalf of any unpaid creditor of the Company or a representative of the
creditors of the Company were to find that, at the time the Company issued the
Existing Notes, the Company (x) intended to hinder, delay or defraud any
existing or future creditor or contemplated insolvency with a design to prefer
one or more creditors to the exclusion in whole or in part of others or (y) did
not receive fair consideration in good faith or reasonably equivalent value for
issuing the Existing Notes, and the Company (i) was insolvent, (ii) was
rendered insolvent by reason of such distribution, (iii) was engaged or about
to engage in business or transactions for which its remaining assets
constituted unreasonably small capital to carry on its business, or (iv)
intended to incur, or believed that it would incur, debts beyond its ability to
pay such debts as they matured, such court could void the Notes and void such
transactions. Alternatively, in such event, claims of the holders of Notes
could be subordinated to claims of other creditors of the Company. The Company
may be viewed as insolvent at the time of or as a result of the sale of the
Existing Notes if the fair market value of its assets does not exceed its
probable liabilities at the time of, or following, the sale of the Existing
Notes. The Company's obligations under the Notes are guaranteed by the
Guarantors, and the Guarantees may also be subject to review under federal and
state fraudulent transfer laws. If a court were to determine that at the time a
Guarantor became liable under its Guarantee, it satisfied either of clauses (x)
or (y) above, the court could void the Guarantee and direct the repayment of
amounts paid thereunder.
Based upon financial and other information currently available to it,
management of the Company believes that the Notes and the Holding Company's
Guarantee were incurred for proper purposes and in good faith. Certain courts
have held, however, that a company's purchase of its own capital stock does not
constitute reasonably
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equivalent value or fair consideration for incurring indebtedness. By
extension, the sale of the Existing Notes and the use of the net proceeds of
the sale of the Existing Notes as described above may also be viewed as not
constituting reasonably equivalent value or fair consideration to the Company.
The Company believes that based upon forecasts and other financial
information, including the pro forma information reflecting the consummation of
the sale of the Existing Notes and the application of the net proceeds
therefrom as described under the caption "Use of Proceeds," the Company is and
will continue to be solvent, that it will have sufficient capital to carry on
its business and will be and will continue to be able to pay its debts as they
mature. In addition, in connection with the closing of the sale of the Existing
Notes, the Company received a solvency opinion from an investment bank that the
payment of the dividend described under the caption "Use of Proceeds" upon
consummation of the sale of the Existing Notes would not render the Company
insolvent, leave the Company with inadequate or unreasonably small capital or
result in the Company incurring debt beyond its ability to repay such debt as
it matures. There can be no assurance, however, that a court considering such
issues would agree with such conclusions or opinion.
Additionally, under federal bankruptcy or applicable state solvency law,
if a bankruptcy or insolvency were initiated by or against the Company within
90 days after any payment by the Company with respect to the Notes or by any
Guarantor with respect to a Guarantee, or within one year after any payment to
any insider of the Company (which will include the dividend paid by the Company
to the Holding Company), or if the Company or such Guarantor anticipated
becoming insolvent at the time of any such payment, all or a portion of the
payment could be voided as a preferential transfer and the recipient of such
payment could be required to return such payment. In rendering its opinion on
the validity of the Notes, neither counsel for the Company, nor counsel for the
Initial Purchasers, nor any other counsel, expressed any opinion as to federal
or state laws relating to fraudulent transfers, which means the holders of the
Notes have no independent legal verification that the Notes or the Guarantees
or payments on the Notes or the Guarantees will not be treated as a fraudulent
conveyance or preferential transfer, respectively, by a court if the Company
were to become insolvent. The obligations of each Guarantor under its
Guarantee, however, are limited in a manner intended to avoid it being deemed a
fraudulent conveyance under applicable law. See "Description of Notes."
Risks Associated with Restrictions Imposed by Terms of the Company's
Indebtedness
The Indenture and the New Credit Facility impose upon the Company certain
financial and operating covenants, including, among others, requirements that
the Company maintain certain financial ratios and satisfy certain financial
tests, limitations on capital expenditures, and restrictions on the ability of
the Company to incur debt, pay dividends, or take certain other corporate
actions, all of which may restrict the Company's ability to pursue its business
strategies. Changes in economic or business conditions, results of operations
or other factors could in the future cause a violation of one or more covenants
in the Company's debt instruments. See "Description of Notes--Certain
Covenants" and "Description of New Credit Facility and Certain Other
Indebtedness."
Risks Associated with Dependence on "Freedom of Choice" and "Any Willing
Provider" Legislation; Impact of Possible Repeal
In July 1994, the State of New Jersey adopted "Freedom of Choice"
legislation that requires Third-Party Plans to allow their customers to
purchase prescription drugs from the provider of their choice as long as the
provider meets uniformly established requirements, and "Any Willing Provider"
legislation that requires that any Third-Party Plan that has entered into an
agreement with a prescription provider must permit any other licensed provider
to participate in such Third-Party Plan as a preferred or contracting provider,
if such provider is willing to accept the terms of such agreement. Management
believes this results in a "level playing field" for regional drugstore chains
such as the Company. Although the Company is not aware of any pending
legislation which seeks to repeal or otherwise render ineffective the "Freedom
of Choice" or "Any Willing Provider" legislation, in the event of any repeal or
other termination of this legislation, larger national drugstore chains or
other distribution channels with which the Company competes could enter into
exclusive contracts with Third-Party Plans, similar to those in effect in other
states, pursuant to which such Third-Party Plans would require their members to
purchase their reimbursable prescriptions from such drugstore chains or other
distribution channels. Any such contracts could effectively prevent the Company
from competing for reimbursable prescription sales to participants in such
Third-Party Plans, which could impact the sales of all of the Company's
products by reducing customer traffic at the Company's stores. Furthermore,
other than Delaware, none of the states surrounding New Jersey has enacted
similar "Freedom of
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Choice" or "Any Willing Provider" legislation. Accordingly, in the event that
the Company determines to pursue expansion into surrounding states, it will
have to compete with larger drugstore chains or other distribution channels
that may have aligned themselves with certain Third-Party Plans in such states.
There can be no assurance that any repeal or other termination or amendment of
the "Freedom of Choice" or "Any Willing Provider" legislation in New Jersey
would not have a material adverse effect on the Company's financial condition
and results of operations and its ability to pay principal of and interest on
the Notes and the New Credit Facility, or that the Company would be able to
compete successfully with larger drugstore chains or other distribution
channels in the event it determines to expand into states that do not have
"Freedom of Choice" or "Any Willing Provider" legislation. See "Business--The
Drugstore Industry."
Risk of Extensive Competition
The industries in which the Company operates are highly competitive. The
Company competes in most of its markets with several national, regional and
local drugstore chains, large grocery stores and supermarkets, membership
clubs, deep discount drugstores, combination food and drugstores, discount
general merchandise stores, mass merchandisers, independent drugstores and
local merchants. In addition to competition from the foregoing, the Company's
pharmacy departments also compete with hospitals, health maintenance
organizations and mail order providers. Many of the Company's competitors have
substantially greater financial resources than the Company. See
"Business--Competition."
Reliance on Trade Names, Service Marks and Trademarks; Risks Associated with
Possible Loss of Use of Trade Names
The Company uses various trade names, service marks and trademarks,
including "Drug Fair" and "Cost Cutters," in the conduct of its business.
Historically, the Company has relied on common law protection of its trade
names, service marks and trademarks. Common law provides the Company with
limited protection for its trade names, service marks and trademarks within its
product lines and in its geographic market areas. While the Company has filed a
federal service mark registration application for the service mark "Drug Fair,"
there can be no assurance that a federal service mark registration for the mark
"Drug Fair" will be issued to the Company. A third party presently owns an
issued federal service mark registration for the name "Cost Cutters," but does
not currently operate in the Company's market areas. However, there can be no
assurance that such third party will not commence operations in the Company's
geographic market areas or license the use of the name to a third party other
than the Company in such areas. In such an event, the Company may be required
to seek a license from the holder of the registration, and there can be no
assurance that such a license would be available on acceptable terms, if at
all. If the Company is unable to so license this service mark, it may be
required to cease using the "Cost Cutters" name. In addition, there can be no
assurance that the Company's use of the names "Drug Fair" and "Cost Cutters,"
or any other trade names, service marks or trademarks, will not otherwise be
challenged, invalidated, prevented or circumvented in the future, or that any
such challenge, invalidation, prevention or circumvention will not have a
material adverse effect on the Company's financial condition and results of
operations and its ability to pay principal and interest on the Notes and the
New Credit Facility. See "Business--Trade Names, Service Marks and Trademarks."
Risk of Changes in Economic Conditions and Regional Concentration
All of the Company's stores are located in northern and central New
Jersey. As a result, the Company is sensitive to economic, competitive, and
regulatory conditions in that region. The success of the Company's future
operations will be substantially affected by its ability to compete effectively
in New Jersey, and no prediction can be made as to economic conditions in that
state.
Risk that Change of Control May Cause Defaults
Upon the occurrence of a Change of Control (as defined in the Indenture),
the Company will be required to make an offer to purchase all of the
outstanding Notes at a price equal to 101% of the principal amount thereof at
the date of purchase plus accrued and unpaid interest, if any, to the date of
purchase. The occurrence of certain of the events that would constitute a
Change of Control may constitute a default under the New Credit Facility and
might constitute a default under other indebtedness of the Company. In
addition, the New Credit Facility may prohibit the purchase of the Notes by the
Company in the event of a Change of Control, unless and until such time as the
indebtedness under the New Credit Facility is repaid in full. The Company's
failure to purchase the Notes in such instance would result in a default under
the Indenture and possibly under the New Credit Facility. The
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inability to repay the indebtedness under the New Credit Facility, if
accelerated, could have material adverse consequences to the Company and to the
holders of the Notes. Future indebtedness of the Company may also contain
prohibitions of certain events or transactions that could constitute a Change
of Control or require such indebtedness to be repurchased upon a Change of
Control. See "Description of New Credit Facility and Certain Other
Indebtedness" and "Description of Notes--Certain Covenants--Repurchase of Notes
at the Option of the Holder Upon a Change of Control." In the event of a Change
of Control, there can be no assurance that the Company would have sufficient
assets to satisfy all of its obligations under the Notes and the New Credit
Facility.
Risks Associated with the Uncertainty of Lease Renewals on the Company's Stores
All of the Company's stores are leased, with the leases expiring at
various dates from December 31, 1997 to April 30, 2039 (assuming renewal
options are exercised). Four leases representing stores which generated 11.4%
of the Company's net sales in fiscal 1997 are scheduled to expire before the
end of 1999. Although the Company has historically been successful in renewing
its most important store leases when they have expired, there can be no
assurance that the Company will continue to be able to do so. The Company's
substantial leverage after the Offering may adversely impact certain landlords'
willingness to enter into store leases with the Company. If the Company is
unable to renew the leases for some of the Company's more successful store
locations, or find other favorable locations at acceptable lease rates, there
can be no assurance that such failures will not have a material adverse effect
on the Company's financial condition and results of operations or that its
ability to pay principal of and interest on the Notes and the New Credit
Facility would not be adversely affected. See "Business--Properties."
Risks Associated with a Potential Disruption of Operations as the Company Moves
to a New Facility
The Company intends to consolidate its two existing distribution centers
and corporate offices in a single new facility when its current distribution
center leases expire in 1998. In connection with the consolidation, the Company
plans to install a new MIS system at the new facility. While the Company
believes this consolidation effort may reduce the Company's warehousing and
distribution costs, there can be no assurance that this effort will result in
improved operating margins, or that the move to the new facility, the
commencement of operations at such facility, and the implementation of the new
MIS system to be installed at the new facility will not have a disruptive
effect on the Company's operations. A significant, unexpected disruption during
the course of this consolidation program could have a material adverse effect
on the Company's financial condition and results of operations and its ability
to pay principal of and interest on the Notes and the New Credit Facility. See
"Business--Properties."
Risks Associated with Changes in the Health Care Industry
Pharmacy sales accounted for approximately 22.1% of the Company's total
sales for fiscal 1996 and 24.1% for fiscal 1997. Pharmacy sales to Third-Party
Plan participants accounted for approximately 61.5% and 70.1% of the Company's
total prescription drug sales for fiscal 1996 and fiscal 1997, respectively.
The efforts of Third-Party Plans to contain costs have placed downward pressure
on gross profit margins from sales of prescription drugs. However, management
believes that, to date, such lower margins have been substantially offset by
the higher volume of pharmacy sales to Third-Party Plan participants and
therefore actively seeks to increase its business with these plans. The Company
expects that the rate of Third-Party Plan sales as a percentage of total
pharmacy sales will continue to increase, creating further downward pressure on
gross profit margins from prescription drug sales. There can be no assurance
that the Company will be able to offset these margin declines by continued
increased sales of pharmacy and non-pharmacy merchandise and by higher gross
profit margins from non-pharmacy merchandise. Furthermore, if the Company were
not able to generate higher volumes of pharmacy sales to Third-Party Plan
participants to offset this downward pressure on gross margins, it could have a
material adverse effect on the Company's gross profits and results of
operations. The Company's revenues from prescription drug sales may also be
affected by health care reform initiatives of federal and state governments,
including proposals designed to significantly reduce spending on Medicare,
Medicaid and other government programs, changes in programs providing for
reimbursement for the cost of prescription drugs by Third-Party Plans, and
regulatory changes relating to the approval process for prescription drugs.
Such initiatives could lead to the enactment of federal and state regulations
that may adversely impact the Company's prescription drug sales and,
accordingly, could have a material adverse effect on the Company's financial
condition and results of operations and its ability to pay principal of and
interest on the Notes and the New Credit Facility. See "Business--Government
Regulation."
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Risks Associated with Control of the Company by Insiders
The Holding Company owns all of the outstanding capital stock of the
Company. The existing stockholders of the Holding Company, which include the
Company's President and Chief Executive Officer, certain entities affiliated
with the other directors of the Company, and other officers and employees of
the Company, own 100% of the issued and outstanding common stock of the Holding
Company on a fully-diluted basis. Accordingly, such stockholders indirectly
control the Company and have the power to appoint new management and approve
any action requiring the approval of the holders of the capital stock of the
Company, including adopting amendments to the Company's certificate of
incorporation and approving mergers or sales of substantially all of the
Company's assets. There can be no assurance that the interests of the holders
of the capital stock of the Holding Company will not conflict with the
interests of the holders of the Notes. See "Management" and "Certain
Relationships and Related Transactions."
Risks Attendant to Potential Growth and Expansion Related Risks
The Company has grown in recent years by opening new stores, remodeling
and relocating existing stores and refining the product mix in existing stores.
There can be no assurance that the Company will continue to be able to maintain
or expand its market presence in its current locations or to successfully enter
other markets. The ability of the Company to continue to grow in the future
will depend on a number of factors including existing and emerging competition,
the availability of working capital to support such growth, the Company's
ability to manage costs and maintain margins in the face of pricing pressures,
and the ability to recruit and train additional qualified personnel. Because
the Company intends to continue its practice of leasing its stores, any delays
or other difficulties in the negotiation of satisfactory store leases or the
inability on the part of prospective landlords to obtain financing for new
store buildings may delay or interfere with such new store openings. In
addition, there can be no assurance that the sites which the Company identifies
for new store locations will actually be available to the Company, and various
zoning, site acquisition, environmental, traffic, construction, and other
contingencies may also delay or prevent the opening of a new store in a
particular location. There can be no assurance that any new stores that the
Company may open will be profitable. Failure by the Company to maintain its
growth could have a material adverse effect on the Company's financial
condition and results of operations and its ability to pay principal of and
interest on the Notes and the New Credit Facility.
Risks Associated with Government Regulation and Reimbursement Programs
The Company is subject to numerous federal, state, and local licensing and
registration regulations with respect to, among other things, its pharmacy
operations. The Company seeks to comply with all such licensing and
registration requirements and continues to actively monitor its compliance with
such requirements. However, violations of any such regulations could result in
various penalties, including suspension or revocation of the Company's licenses
or registrations or monetary fines, which could have a material adverse effect
on the Company's financial condition and results of operations and its ability
to pay principal of and interest on the Notes and the New Credit Facility.
New Jersey Regulation
In addition, pursuant to the Omnibus Budget Reconciliation Act of 1990 and
comparable New Jersey regulations, the Company's pharmacists are required to
offer counseling, without additional charge, to their customers about
medication, dosage, delivery systems, common side effects and other information
deemed significant by the pharmacists and may have a duty to warn customers
regarding any potential adverse effects of a prescription drug if the warning
could reduce or negate such effects. In addition, the Company's pharmacists are
required to conduct a prospective drug review before any new prescriptions are
dispensed, and may conduct a similar review prior to refilling any
prescriptions if they deem it warranted. Further, New Jersey closely regulates
the dispensing by pharmacists of over-the-counter controlled dangerous
substances, imposing requirements as to: (i) filling and refilling of
prescriptions, (ii) labeling of prescriptions, and (iii) monitoring the use of
Schedule V over-the-counter controlled dangerous substances to determine, in a
pharmacist's professional judgment, whether the substance has or will be used
for unauthorized or illicit consumption or distribution. The drug review
program and other programs created by subsequent legislation could result in
increased costs to the Company that could impact adversely its gross profit
margin on prescription drug sales.
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Medicaid and Medicare
A portion of the Company's services are reimbursed by government sponsored
programs, principally Medicaid and to a lesser extent Medicare, with the
remainder being reimbursed by individual patients or Third-Party Plans. The
failure, even if inadvertent, of the Company to comply with applicable
reimbursement regulations could adversely affect the Company's business.
Furthermore, changes in such reimbursement programs or in regulations related
thereto, such as reductions in coverage or allowable reimbursement levels,
modifications in the timing or processing of payments and other changes
intended to limit or decrease the growth of Medicaid and Medicare expenditures,
could adversely affect the Company's business. The Company is also subject to
federal and state laws prohibiting the submission of false or fraudulent claims
and certain financial relationships between health care providers that are
intended to induce or encourage the referral of patients, or the
recommendations of particular items or services. Violation of these laws can
result in loss of licensure, civil and criminal penalties, and exclusion from
federal health care programs.
Employment Regulation
The Company is also subject to laws governing its relationship with
employees, including minimum wage requirements, overtime and working
conditions. An increase in the minimum wage rate, employee benefit costs, or
other costs associated with employees could adversely affect the Company. See
"Business--Government Regulation."
Risks Associated with the Company's Dependence on Key Personnel
The success of the Company depends upon the efforts, abilities and
expertise of its executive officers and other key employees, including its
Chief Executive Officer and President. The loss of the services of such
individual or any other key employees could have a material adverse effect on
the Company's financial condition and results of operations. See "Management."
Risk of Adverse Consequences of Potential Failure to Adhere to Exchange Offer
Procedures
Issuance of the New Notes in exchange for the Existing Notes pursuant to
the Exchange Offer will be made only after a timely receipt by the Company of
such Existing Notes, a properly completed and duly executed Letter of
Transmittal and all other required documents. All questions as to the validity,
form, eligibility (including time of receipt) and acceptance of the Existing
Notes tendered for exchange will be determined by the Company in its sole
discretion, which determination will be final and binding on all parties.
Holders of the Existing Notes desiring to tender such Existing Notes in
exchange for New Notes should allow sufficient time to ensure timely delivery.
The Company is under no duty to give notification of defects or irregularities
with respect to the tenders of the Existing Notes for exchange. Existing Notes
that are not tendered or are tendered but not accepted will, following the
consummation of the Exchange Offer, continue to be subject to the existing
restrictions upon transfer thereof and, except as provided herein, the Company
will have no further obligations to provide for the registration under the
Securities Act of such Existing Notes. To the extent that Existing Notes are
tendered and accepted in the Exchange Offer, the trading market for untendered
and tendered but unaccepted Existing Notes could be adversely affected. See
"Exchange Offer."
Risks Associated with the Lack of a Public Market for the Notes
There can be no assurance regarding the future development of a market for
any of the Notes, or the ability of holders of any of the Notes to sell their
Notes, or the price at which such holders may be able to sell such Notes. If
such a market were to develop, the Notes could trade at prices that may be
lower than the initial offering price depending on many factors, including
prevailing interest rates, the Company's operating results and the market for
similar securities. The Initial Purchasers have advised the Company that they
currently intend to make a market in the Notes. The Initial Purchasers are not
obligated to do so, however, and any market-making activity with respect to the
Notes may be discontinued at any time without notice. Therefore, there can be
no assurance as to the liquidity of any trading market for the Notes, or that
an active public market for the New Notes will develop. In addition, such
market-making activity will be subject to the limitations imposed by the
Securities Act and the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and may be limited during the Exchange Offer. The Company does
not intend to apply for listing or quotation of the New Notes on any securities
exchange or stock market; however, the Existing Notes are eligible for trading
in the PORTAL market of the National Association of Securities Dealers, Inc.
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To the extent that Existing Notes are tendered and accepted in the
Exchange Offer, the trading market for the remaining untendered or tendered but
not accepted Existing Notes could be adversely affected. Because the Company
anticipates that most holders of the Existing Notes will elect to exchange such
Existing Notes for New Notes due to the absence of restrictions on the resale
of New Notes under the Securities Act, the Company anticipates that the
liquidity of the market for any Existing Notes remaining after the consummation
of the Exchange Offer may be substantially limited.
23
<PAGE>
USE OF PROCEEDS
No proceeds will be received by the Company or the Holding Company from
the Exchange Offer. The net proceeds of the sale of the Existing Notes were
approximately $77.0 million, after deducting discounts and commissions and
expenses related to the sale of the Existing Notes. The Company used $29.3
million of the net proceeds to refinance substantially all existing
indebtedness of the Company and $45.0 million of the net proceeds to pay a
dividend to the Holding Company, which distributed these proceeds to its
securityholders. The balance will be used for general corporate purposes.
The following table summarizes the sources and uses of funds for the sale
of the Existing Notes:
<TABLE>
<CAPTION>
(in millions)
<S> <C>
Sources:
10 1/4% Senior Notes due 2004 ................................................ $ 80.0
=======
Uses:
Repayment of Old Credit Facility (including accrued interest and premium) (1) $ 29.3
Dividend to the Holding Company (2) .......................................... 45.0
Transaction fees and expenses ................................................ 3.0
Excess working capital ....................................................... 2.7
-------
Total uses .................................................................. $ 80.0
=======
</TABLE>
- ------------
(1) In connection with the Acquisition, the Company and the Holding Company
entered into a Credit Agreement, dated as of January 30, 1995 (the "Old
Credit Facility"), with Banque Paribas as Agent, providing for two term
loans aggregating $45.0 million in principal amount (the "Term Loans"), a
revolving loan in the aggregate principal amount of $13.0 million (the
"Revolving Loan") and a letter of credit facility. The Term Loans bore
interest at rates ranging from 7.7% per annum to 8.6% per annum, and were
scheduled to mature on January 31, 2002, and the Revolving Loan bore
interest at a rate of 9.5% and was scheduled to mature on January 30,
2000. All of the amounts outstanding under the Old Credit Facility were
repaid upon the closing of the sale of the Existing Notes, and the Old
Credit Facility was terminated.
(2) The Holding Company paid a dividend (the "Dividend") in the same amount to
its securityholders, including BancBoston, Harvest and members of
management. See "Certain Relationships and Related Transactions."
24
<PAGE>
CAPITALIZATION
The Company
The following table sets forth the capitalization of the Company as of
October 25, 1997. This table should be read in conjunction with "Selected
Financial Data," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Company's financial statements and the
related notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
As of
October 25, 1997
-----------------
(unaudited)
(dollars
in thousands)
<S> <C>
Cash and cash equivalents ..................................... $ 1,139
=========
Long-term debt (including current portion) (1):
New Credit Facility .......................................... --
10 1/4% Senior Notes due 2004 ................................ 80,000
Capitalized lease obligations and other indebtedness ......... 197
---------
Total long-term debt (including current portion) ............ 80,197
Stockholder's equity (deficit) ................................ (17,542)
---------
Total capitalization ......................................... $ 62,655
=========
</TABLE>
- ------------
(1) Upon the closing of the sale of the Existing Notes, the Company repaid all
borrowings under the Old Credit Facility, terminated the Old Credit
Facility and entered into the New Credit Facility. See "Use of Proceeds"
and "Description of New Credit Facility and Certain Other Indebtedness."
The Holding Company
The following table sets forth the consolidated capitalization of the
Holding Company as of October 25, 1997. This table should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Holding Company's financial statements and
the related notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
As of
October 25, 1997
-----------------
(unaudited)
(dollars
in thousands)
<S> <C>
Cash and cash equivalents ..................................... $ 1,139
=========
Long-term debt (including current portion):
10 1/4% Senior Notes due 2004 ................................ 80,000
Capitalized lease obligations and other indebtedness ......... 197
Subordinated notes due January 30, 2005 ...................... 17,361
---------
Total long-term debt (including current portion) ............ 97,558
Redeemable Preferred and Common Stock ......................... 1,278
Stockholder's equity (deficit) ................................ (34,604)
---------
Total capitalization ......................................... $ 64,232
=========
</TABLE>
25
<PAGE>
SELECTED FINANCIAL DATA OF THE COMPANY
The selected financial data presented below under the captions "Statement
of Operations Data" and "Balance Sheet Data" as of and for each of the periods
in the five-year period ended July 26, 1997 and for the three month periods
ended October 26, 1996 and October 25, 1997, are derived from the audited
financial statements of the Company and the Predecessor Company (as defined
below), and the unaudited financial statements of the Company. The financial
statements of the Predecessor Company for fiscal 1993, fiscal 1994 and the six
months ended January 29, 1995 have been audited by Arthur Andersen LLP, and the
financial statements for the six months ended July 30, 1995, fiscal 1996 and
fiscal 1997 have been audited by Coopers & Lybrand L.L.P. The Company was
acquired by the Holding Company on January 30, 1995, and is referred to below
with respect to periods prior to that date as the "Predecessor Company" and
with respect to periods after that date as the "Company." The selected
financial data presented below under the captions "Statement of Operations
Data" and "Balance Sheet Data (End of Period)" below for the three months ended
October 26, 1996 and October 25, 1997, and the selected financial and other
data presented below under the caption "Other Data" as of and for all of the
periods presented, are unaudited and are not necessarily indicative of the
Company's results for the full fiscal year. The unaudited financial data
reflects all adjustments (consisting of normal, recurring adjustments) which
are, in the opinion of management, necessary for a fair presentation of the
Company's financial position, results of operations and cash flows for and as
of the end of the periods presented.
The selected financial data presented below should be read in conjunction
with the audited financial statements and the related notes thereto of the
Predecessor Company for the six months ended January 29, 1995, and the Company
for the six months ended July 30, 1995, fiscal 1996 and fiscal 1997, the
unaudited financial statements of the Company for the three months ended
October 26, 1996 and October 25, 1997, and the pro forma financial data of the
Company for fiscal 1997 and the three months ended October 25, 1997, and the
related notes thereto included elsewhere in this Prospectus. For additional
information, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
<TABLE>
<CAPTION>
Predecessor Company The Company
----------------------------------------- ----------------------------------------
Twelve Twelve
Months Six Six Months
Ended Months Months Ended
--------------------------- Ended Ended ---------------------------
July 25, July 31, Jan. 29, July 30, July 28, July 26,
1993 1994 1995 1995 1996 1997
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales ............................ $ 168,416 $ 180,206 $ 101,687 $ 96,171 $ 215,731 $ 231,033
Cost of sales ........................ 122,433 129,856 72,469 67,686 152,645 163,157
--------- --------- --------- -------- --------- ---------
Gross profit ........................ 45,983 50,350 29,218 28,485 63,086 67,876
Selling, general and
administrative expense ............. 36,286 38,494 21,468 21,635 47,487 50,831
Other income, net .................... 610 803 595 205 353 401
Administrative fees .................. 0 0 0 125 250 250
Depreciation and Amortization
(2) ................................ 1,703 1,674 884 1,980 4,341 4,399
--------- --------- --------- -------- --------- ---------
Operating income .................... 8,604 10,985 7,461 4,950 11,361 12,797
Interest expense, net ................ 0 0 0 2,284 3,998 3,018
--------- --------- --------- -------- --------- ---------
Income (loss) before income
taxes (3) .......................... 8,604 10,985 7,461 2,666 7,363 9,779
Provision for income taxes ........... 862 474 186 1,598 3,659 5,216
--------- --------- --------- -------- --------- ---------
Net income (loss) ................... $ 7,742 $ 10,511 $ 7,275 $ 1,068 $ 3,704 $ 4,563
========= ========= ========= ======== ========= =========
Balance Sheet Data (End of
Period):
Working capital (unaudited) .......... $ 21,059 $ 25,950 $ 29,457 $ 10,645 $ 11,196 $ 9,875
Total assets ......................... 42,775 52,163 53,176 86,079 84,931 81,256
Total debt ........................... 0 0 0 45,000 39,360 29,467
Stockholder's equity (deficit) ....... 29,250 33,645 36,033 19,068 22,772 27,335
Other Data (unaudited):
Ratio of earnings to fixed charges
(4) ................................ 5.8x 6.7x 8.1x 1.7x 2.1x 2.7x
Adjusted EBITDA (5) .................. $ 10,411 $ 11,536 $ 9,682 $ 7,714 $ 16,913 $ 18,695
Gross margin ......................... 27.3% 27.9% 28.7% 29.6% 29.2% 29.4%
Adjusted EBITDA margin (6) ........... 6.2% 6.4% 9.5% 8.0% 7.8% 8.1%
Capital expenditures ................. $ 2,379 $ 2,308 $ 1,313 $ 1,070 $ 2,887 $ 1,287
Pharmacy sales growth ................ 4.0% 8.7% 7.8% 10.1% 10.8% 16.3%
Pharmacy sales as a % of total ....... 21.6 22.0 19.6 22.6 22.1 24.1
<CAPTION>
The Company Pro Forma (1)
Three -------------------------
Months Twelve Three
Ended Months Months
------------------------ Ended Ended
Oct. 26, Oct. 25, July 26, October 25,
1996 1997 1997 1997
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Statement of Operations Data:
Net sales ............................ $52,073 $ 54,722 $ 231,033 $ 54,722
Cost of sales ........................ 38,072 39,671 163,157 39,671
------- --------- --------- ----------
Gross profit ........................ 14,001 15,051 67,876 15,051
Selling, general and
administrative expense ............. 11,752 12,678 50,831 12,678
Other income, net .................... 95 105 401 105
Administrative fees .................. 63 63 250 63
Depreciation and Amortization
(2) ................................ 1,116 1,467 4,720 1,200
------- --------- --------- ----------
Operating income .................... 1,165 948 12,476 1,215
Interest expense, net ................ 826 718 8,170 2,025
------- --------- --------- ----------
Income (loss) before income
taxes (3) .......................... 339 230 4,306 $ (810)
Provision for income taxes ........... 393 349 2,282 (430)
------- --------- --------- ----------
Net income (loss) ................... $ (54) $ (119) $ 2,024 $ (380)
======= ========= ========= ==========
Balance Sheet Data (End of
Period):
Working capital (unaudited) .......... $10,238 $ 18,083 $ 15,138 $ 17,555
Total assets ......................... 81,256 91,041 85,150 92,051
Total debt ........................... 29,446 80,197 80,198 80,197
Stockholder's equity (deficit) ....... 27,698 (17,542) (20,668) (17,803)
Other Data (unaudited):
Ratio of earnings to fixed charges
(4) ................................ 1.2x 1.2x 2.7x 1.2x
Adjusted EBITDA (5) .................. $ 2,667 $ 2,834 $ 18,695 $ 2,834
Gross margin ......................... 26.9% 27.5% 29.4% 27.5%
Adjusted EBITDA margin (6) ........... 5.1% 5.2% 8.1% 5.2%
Capital expenditures ................. $ 506 $ 663 $ 1,287 $ 663
Pharmacy sales growth ................ 17.7% 12.5% 16.3% 12.2%
Pharmacy sales as a % of total ....... 24.7 26.3 24.1 26.3
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
Predecessor Company The Company
-------------------------------- --------------------------------
Six Six
Months Months Year
Year Ended Ended Ended Ended
--------------------- ---------- ---------- ---------------------
July 25, July 31, Jan. 29, July 30, July 28, July 26,
1993 1994 1995 1995 1996 1997
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Other Data (unaudited)
Third-Party Plan sales as
a % of pharmacy
sales ................... 36.0% 40.6% 47.2% 50.9% 61.5% 70.1%
Store data:
Number of stores at
end of period: .........
Drug Fair .............. 22 21 22 22 25 26
Cost Cutters ........... 13 14 15 16 17 17
---- ---- ---- ---- ---- ----
Total ................ 35 35 37 38 42 43
==== ==== ==== ==== ==== ====
Same-store sales growth
(7):
Drug Fair .............. 3.9% 5.7% 4.0% 6.6% 3.5% 6.7%
Cost Cutters ........... 4.6 1.1 4.0 4.3 0.9 2.7
---- ---- ---- ---- ---- ----
Total ................ 4.1% 3.7% 4.0% 5.6% 2.4% 4.8%
==== ==== ==== ==== ==== ====
<CAPTION>
The Company Pro Forma (1)
-------------------------
Three Twelve Three
Months Months Months
Ended Ended Ended
--------------------- ---------- ------------
Oct. 26, Oct. 25, July 26, October 25,
1996 1997 1997 1997
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Other Data (unaudited)
Third-Party Plan sales as
a % of pharmacy
sales ................... 65.3% 72.5% 70.1% 72.5%
Store data:
Number of stores at
end of period: .........
Drug Fair .............. 26 26 26 26
Cost Cutters ........... 17 17 17 17
---- ---- ---- ----
Total ................ 43 43 43 43
==== ==== ==== ====
Same-store sales growth
(7):
Drug Fair .............. 9.7% 5.9% 6.7% 5.9%
Cost Cutters ........... 4.9 2.9 2.7 2.9
---- ---- ---- ----
Total ................ 7.4% 4.6% 4.8% 4.6%
==== ==== ==== ====
</TABLE>
- ------------
(1) Gives pro forma effect to the sale of the Existing Notes and the
application of the net proceeds therefrom as described under the caption
"Use of Proceeds" as of July 26, 1996.
(2) Depreciation and amortization amounts for the periods set forth under the
captions "The Company" and "Company Pro Forma" include amortization of
goodwill, beneficial leasehold intangibles and deferred financing costs
incurred in connection with the Acquisition in January 1995.
(3) Prior to its acquisition by the Holding Company on January 30, 1995, the
Predecessor Company was treated as a Subchapter S corporation for both
federal and state income tax purposes. Accordingly, the provision for
income taxes for the six months ended January 29, 1995 and all prior
periods is substantially less than that recorded for the Company for the
six months ended July 30, 1995 and each subsequent period. If the
Predecessor Company had been treated as a C corporation for federal and
state income tax purposes for the six month period ended January 29, 1995,
and for the year ended July 31, 1994 and July 25, 1993, respectively, the
Predecessor Company's provision for income taxes for such periods would
have been approximately $3,000, $4,426 and $3,473, respectively, and its
net income for such periods would have been approximately $4,461, $6,559
and $5,131, respectively.
(4) The ratio of earnings to fixed charges is computed by adding fixed charges
(interest and one-third of rental expenses, which the Company believes is
representative of that portion of rental expenses attributable to
interest) to income before income taxes and dividing that sum by the sum
of the fixed charges.
(5) Adjusted EBITDA represents net income plus depreciation and amortization,
income taxes, net interest expense, non-cash LIFO reserves against
inventory and non-cash rental expense. Changes in LIFO inventory reserves
and non-cash rental expense are included in Adjusted EBITDA because they
reflect non-cash expense that do not directly impact the ability of the
Company to service its debt obligations, including under the Notes.
Changes in LIFO inventory reserves and non-cash rental expense aggregated
$104, $(1,123), $1,337, $784, $1,211 and $1,500 during fiscal 1993, fiscal
1994, the six months ended on each of January 29, 1995 and July 30, 1995,
fiscal 1996 and fiscal 1997, respectively. While Adjusted EBITDA should
not be construed as a substitute for income from operations, net income or
cash flows from operating activities (as defined by generally accepted
accounting principles), or other measurements determined by generally
accepted accounting principles, in analyzing the Company's operating
performance, financial position or cash flows, the Company has included
Adjusted EBITDA because management understands that it is commonly used by
certain investors and analysts to analyze and compare companies on the
basis of operating performance, leverage and liquidity and to determine a
company's ability to service debt. Unlike net income or EBITDA, Adjusted
EBITDA may not be a measure of the ultimate profitability of a company,
and may not be as meaningful to other investors or analysts. In addition,
the method of calculating Adjusted EBITDA set forth above may be different
from calculations of Adjusted EBITDA employed by other companies and,
accordingly, may not be directly comparable to such other calculations.
27
<PAGE>
The Adjusted EBITDA calculations for the periods presented are as follows:
<TABLE>
<CAPTION>
Predecessor
Company
---------------------------------------------
Twelve Months Ended Six Months
------------------------------- Ended
January 29,
July 25, 1993 July 31, 1994 1995
--------------- --------------- -------------
(unaudited)
(dollars in thousands)
<S> <C> <C> <C>
Net Income ....................... $ 7,742 $ 10,511 $7,275
Provision for income taxes ...... 862 474 186
Interest expense, net ........... 0 0 0
Depreciation & amortization ..... 1,703 1,674 884
Non-cash rent expense ........... 0 0 0
Change in LIFO reserve .......... 104 (1,123) 1,337
------- -------- ------
Adjusted EBITDA .................. $10,411 $ 11,536 $9,682
======= ======== ======
<CAPTION>
The
Company
----------------------------------------------------------
Six Months Twelve Months Three Months
Ended Ended Ended
July 30, ------------------------------- October 25,
1995 July 28, 1996 July 26, 1997 1997
------------ --------------- --------------- -------------
(unaudited)
(dollars in thousands)
<S> <C> <C> <C> <C>
Net Income ....................... $1,068 $ 3,704 $ 4,563 $ (119)
Provision for income taxes ...... 1,598 3,659 5,216 349
Interest expense, net ........... 2,284 3,998 3,018 718
Depreciation & amortization ..... 1,980 4,341 4,399 1,467
Non-cash rent expense ........... 217 552 413 119
Change in LIFO reserve .......... 567 659 1,086 300
------ ------- ------- ------
Adjusted EBITDA .................. $7,714 $16,913 $18,695 $2,834
====== ======= ======= ======
</TABLE>
(6) Adjusted EBITDA margin is calculated as the amount of Adjusted EBITDA for a
period divided by net sales for such period. While Adjusted EBITDA margin
should not be construed as a substitute for gross margin (as defined by
generally accepted accounting principles), or other measurements
determined by generally accepted accounting principles, in analyzing the
Company's operating performance, financial position or cash flows, the
Company has included presentation of Adjusted EBITDA margin because
management believes it is commonly used by certain investors and analysts
to analyze and compare companies on the basis of operating performance,
leverage and liquidity and to determine a company's ability to service
debt. Management believes that Adjusted EBITDA margin is a meaningful
supplement to gross margin because it measures the Company's profitability
on a cash flow basis, which is material to a determination of the
Company's ability to service its debt.
(7) Same-store sales growth is calculated based on net sales for stores open
for the whole of the indicated and the previous period.
28
<PAGE>
UNAUDITED PRO FORMA CONDENSED STATEMENTS OF OPERATIONS
The following unaudited pro forma condensed statements of operations for
the Company and the Holding Company present the results of operations of the
Company and the Holding Company for fiscal 1997, and the three months ended
October 25, 1997 as if the sale of the Existing Notes had occurred as of July
29, 1996, the first day of fiscal 1997. The unaudited pro forma condensed
statements of operations for the periods presented have been prepared by the
Company's management and are not necessarily indicative of the Company's
results of operations had the issuance of the Existing Notes actually occurred
as of the assumed date, nor are they necessarily indicative of the Company's
financial position or results of operations for any future period. The
unaudited pro forma condensed consolidated financial data should be read in
conjunction with the "Selected Financial Data of the Company," the audited
financial statements of the Predecessor Company for the six months ended
January 30, 1995, the audited financial statements of the Company for the six
months ended July 30, 1995, and the twelve months ended on July 28, 1996 and
July 26, 1997, the unuaudited financial statements of the Company for the three
months ended October 26, 1996 and October 25, 1997, the audited financial
statements of the Holding Company for the six months ended July 30, 1995, and
the twelve months ended on July 28, 1996 and July 26, 1997, and the unaudited
financial statements of the Holding Company for the three months ended October
26, 1996 and October 25, 1997, included elsewhere in this Prospectus. For
additional information, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
<TABLE>
<CAPTION>
The Company (unaudited) The Holding Company (unaudited)
---------------------------------- ---------------------------------
Twelve Months Three Months Twelve Months Three Months
Ended Ended Ended Ended
July 26, 1997 October 25, 1997 July 26, 1997 October 25, 1997
<S> <C> <C> <C> <C>
Statement of Operations Data:
Net Sales ................................. $231,033 $54,722 $231,033 $54,722
Cost of Sales ............................. $163,157 $39,671 $163,157 $39,671
-------- ------- -------- -------
Gross profit ............................. $ 67,876 $15,051 $ 67,876 $15,051
Selling, general and administrative
expense ................................. $ 50,831 $12,678 $ 50,831 $12,678
Other income, net ......................... $ 401 $ 105 $ 401 $ 105
Administrative fees ....................... $ 250 $ 63 $ 250 $ 63
Depreciation and amortization (2) ......... $ 4,720 $ 1,200 $ 4,720 $ 1,200
-------- ------- -------- -------
Operating income ......................... $ 12,476 $ 1,215 $ 12,476 $ 1,215
Interest expense, net (1) ................. $ 8,170 $ 2,025 $ 9,738 $ 2,548
-------- ------- -------- -------
Income (loss) before income taxes ......... $ 4,306 $ (810) $ 2,738 ($ 1,333)
Provision for income taxes (3) ............ $ 2,282 $ (430) $ 1,451 $ (706)
======== ======= ======== =======
Net income (loss) ......................... $ 2,024 $ (380) $ 1,287 ($ 627)
======== ======= ======== =======
</TABLE>
- ------------
The unaudited pro forma condensed financial data presented above have been
prepared by applying the following adjustments to the respective historical
financial statements of the Company and the Holding Company included elsewhere
herein:
(1) Reflects the pro forma elimination of interest expense of $3,048 and $743
on the term loans under the Old Credit Facility for fiscal 1997 and for
the three months ended October 25, 1997, respectively, and the inclusion
of interest expense of $8,200 and $2,050, respectively, on the Notes for
such periods.
(2) Reflects the pro forma elimination of deferred financing cost amortization
incurred in connection with the Old Credit Facility in the amounts of $108
and $374 for fiscal 1997 and the three month period ended October 25,
1997, respectively, and the inclusion of deferred financing cost
amortization associated with issuance of the Notes in the amounts of $429
and $107, respectively, for such periods. The deferred financing costs of
the Notes is approximately $3.0 million and is being amortized over the 7
year term of the Notes.
(3) Reflects the tax effects of the adjustments noted in notes (1) and (2)
above at applicable tax rates.
29
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Company was founded in 1954 and until 1990 was managed primarily by
its founders. The Holding Company is the owner of all of the outstanding
capital stock of the Company. Since 1990, the Company has experienced
significant growth led by Frank Marfino, the Company's current Chief Executive
Officer. The Company currently operates a chain of 43 drug and general
merchandise stores, with 26 drugstores operating under the "Drug Fair" name and
17 general merchandise stores operating under the "Cost Cutters" name. Each of
the Company's 38 mature stores (those open for more than 24 months) is
profitable on an operating basis.
Since 1990, the Company expanded its store base by 12 stores, with
revenues increasing from $168.4 million in fiscal 1993 to $231.0 million in
fiscal 1997 and Adjusted EBITDA and income before taxes increasing from $10.4
million and $8.6 million in fiscal 1993 to $18.7 million and $9.8 million,
respectively, in fiscal 1997. Net income decreased from $7.7 million in fiscal
1993 to $4.6 million in fiscal 1997. During this period, the Company also
increased its Adjusted EBITDA margin from 6.2% to 8.1% of sales. Adjusted
EBITDA is calculated as net income plus depreciation and amortization, income
taxes, net interest expense, changes in LIFO inventory reserves and non-cash
rental expense. The calculation of Adjusted EBITDA differs from the calculation
of income before income taxes in that it adds back to net income certain
expenses that do not impact the Company's cash flows. The Company believes
that, while Adjusted EBITDA should not be used as a substitute for other
measures of financial performance determined under generally accepted
accounting principles, the presentation of Adjusted EBITDA is meaningful to
holders of Existing Notes and possible purchasers of New Notes because EBITDA
is commonly used by certain investors and analysts to analyze and compare
companies on the basis of operating performance, leverage and liquidity and to
determine a company's ability to service debt. This improved operating
performance and growth have resulted primarily from rationalization and
expansion of the store base, improved centralized controls over purchasing,
effective merchandising, pricing and loss-prevention strategies, increased
pharmacy business with Third-Party Plan participants and cost control measures.
The Company was acquired in January 1995 by the Holding Company, whose
shareholders include a group of investors led by BancBoston, Harvest and
management. Since the Acquisition, the Company has placed emphasis on growing
its pharmacy sales to Third-Party Plan participants and, as a result, has grown
its pharmacy sales by 40.4% from fiscal 1994 to fiscal 1997. During the same
period, the Company's net income decreased from $10.5 million to $4.6 million,
primarily as a result of debt-related expense and goodwill amortization
incurred by the Company in connection with the Acquisition. Similarly, improved
non-pharmacy merchandising and pricing strategies, combined with increased
customer traffic resulting from higher pharmacy sales, have enabled the Company
to increase its gross margin from 27.9% in fiscal 1994 to 29.4% in fiscal 1997.
This increase occurred despite pharmacy margin erosion resulting from increased
sales to Third-Party Plan participants.
Since fiscal 1994, the Company's pharmacy sales have increased by 40.4%,
primarily as a result of the growth in prescription sales to Third-Party Plan
participants. In fiscal 1997, the Company's pharmacies filled over 1.5 million
prescriptions (an average weekly volume of approximately 1,000 scripts per
pharmacy), and pharmacy sales increased 16.3% over fiscal 1996. Currently,
approximately 72% of prescription sales results from sales to Third-Party Plan
participants. Although pharmacy sales to Third-Party Plan participants
typically have lower margins than cash pharmacy sales, resulting in a decline
in the Company's pharmacy gross margins, the higher pharmacy sales volume has
resulted in an overall increase in gross profit. Although management expects
that Third-Party Plan sales as a percentage of total pharmacy sales will
continue to increase, management believes that as this rate of increase slows,
margins will stabilize, resulting in pharmacy gross profit growth more closely
approximating pharmacy sales growth rates. Additionally, the Company believes
that this margin pressure has had less of an impact on its overall margin than
on margins of retailers for which prescriptions represent a higher percentage
of total sales. To compensate for declining pharmacy gross margins and to
capitalize on the increased customer traffic resulting from the growth in
Third-Party Plan sales, the Company has aggressively managed its non-pharmacy
operations through effective merchandising and purchasing strategies. As a
result of these initiatives, the Company has raised its non-pharmacy gross
margins from 27.8% in 1994 to 31.4% in fiscal 1997. There can be no assurance
that the Company will be able to continue to offset declines in pharmacy gross
margins resulting from increases in Third-Party Plan sales as a percentage of
total pharmacy sales by continued increased sales of pharmacy and non-pharmacy
merchandise and by higher gross profit margins from non-pharmacy merchandise.
30
<PAGE>
The Company has expanded its store base by 12 stores since 1990, with no
stores, three stores, four stores and one store having been opened in fiscal
1994, the twelve months ended July 30, 1995, fiscal 1996 and fiscal 1997,
respectively. The Company has signed four new leases for Drug Fair locations,
with all of these stores expected to open before the end of fiscal 1998. The
Company has purchased prescription customer files from existing independent
drugstores, at an average cost of $120,000 per store, for two of these new
locations. This strategy, which the Company had not employed in connection with
prior store openings, is intended to reduce the amount of time before a new
store becomes profitable. The Company will close one of its Drug Fair stores,
located in Ridgewood, New Jersey, when its lease expires in the third quarter
of fiscal 1998. This lease did not provide for an extension past its expiration
date, and the landlord and the Company were not able to come to mutually
acceptable terms for renewal of the lease. The Company does not believe that
this store closing will have a material effect on the Company's revenues or
gross profit. The Company intends to continue to opportunistically expand its
store base, primarily focused on Drug Fair stores, as favorable market
locations become available. While pharmacy is not the main focus of the Cost
Cutters chain, two Cost Cutters locations contain their own pharmacies and the
Company has recently added Drug Fair pharmacies adjacent to two of its Cost
Cutters locations. The Company believes there is an opportunity to add Drug
Fair pharmacies to certain additional Cost Cutters stores depending on factors
such as location, store size, layout and competition. Five of the eight stores
opened between fiscal 1995 and fiscal 1997 (none of which are mature stores) do
not currently contribute to the Company's operating profit.
Results of Operations
The following discussion should be read in conjunction with the audited
financial statements and the related notes thereto of the Predecessor Company
and the Company for the six months ended January 29, 1995, the six months ended
July 30, 1995, fiscal 1996 and fiscal 1997, and the unaudited financial
statements of the Company for the three month periods ended October 25, 1997
and October 26, 1996 included elsewhere in this Prospectus. The amounts
presented below for the Company for the twelve month period ended July 30, 1995
represent the mathematical addition of the historical amounts for the
Predecessor Company and the Company for purposes of the discussion below only.
The following table sets forth the Company's operating results for the periods
indicated expressed as a percentage of sales and the net number of new stores
opened during the periods indicated.
<TABLE>
<CAPTION>
Twelve Months Ended Three Months Ended
------------------------------------ ----------------------------
July 30, July 28, July 26, October 25, October 26,
1995 1996 1997 1997 1996
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales ........................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Gross profit ........................................ 29.2 29.2 29.4 27.5 26.9
Selling, general and administrative expense ......... 21.8 22.0 22.0 23.2 22.6
Administrative fees ................................. 0.1 0.1 0.1 0.1 0.1
Depreciation and amortization ....................... 1.4 2.0 1.9 2.7 2.1
Other income, net ................................... 0.4 0.2 0.2 0.2 0.2
----- ----- ----- ----- -----
Operating income ................................. 6.3 5.3 5.6 1.7 2.2
Interest expense, net ............................... 1.2 1.9 1.3 1.3 1.6
----- ----- ----- ----- -----
Income before income taxes .......................... 5.1 3.4 4.3 0.4 0.7
Provision for income taxes .......................... 0.9 1.7 2.3 0.6 0.8
----- ----- ----- ----- -----
Net income ....................................... 4.2 1.7 2.0 (0.2) (0.1)
===== ===== ===== ===== =====
Other Data (unaudited):
Adjusted EBITDA ..................................... 8.8% 7.8% 8.1% 5.2% 5.1%
Number of new stores (net) .......................... 3 4 1 0 1
</TABLE>
Comparison of the Three Months Ended October 25, 1997 (the "1998 Period")
with the Three Months Ended October 26, 1996 (the "1997 Period").
Net sales for the 1998 Period were $54.7 million as compared to $52.0
million for the 1997 Period, an increase of $2.7 million or 5.2%. This increase
was primarily due to a 4.6% increase in same-store sales, driven by a 12.5%
increase in pharmacy sales from $12.8 million to $14.4 million which includes a
24.4% increase in pharmacy sales to Third-Party Plans from $8.6 million to
$10.7 million. The Company believes that the increase in pharmacy sales
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<PAGE>
to Third Party Plans during this period was primarily driven by the increase in
the volume of pharmacy products sold to Third Party Plan customers and to
pricing increases on such products. The number of prescriptions filled for Third
Party Plan customers increased to approximately 280,000 prescriptions for the
1998 Period, as opposed to 240,000 prescriptions for the 1997 Period, an
increase of 16.7%, as compared to the 24.1% increase in pharmacy sales to Third
Party Plans over the same period. The Company believes that pricing increases on
pharmacy products of between 4% and 6% annually have been common during the past
several years and is the primary reason for the higher rate of increase in
pharmacy sales to Third Party Plans as compared to the rate of increase in
prescriptions filled for Third Party Plan customers. Gross profit on pharmacy
sales to Third Party Plan customers increased from $1.6 million in the 1997
Period to $1.7 million in the 1998 Period, primarily as a result of the increase
in volume of pharmacy sales to Third Party Plan customers in the 1998 Period.
Pharmacy sales to non-Third Party Plan customers decreased from $4.2 million in
the 1997 Period to $3.7 million in the 1998 Period, primarily as a result of the
increased participation of the Company's customers in Third Party Plans and a
decrease in the volume of pharmacy products sold to non-Third Party Plan
customers as prescriptions filled for such customers decreased from
approximately 125,000 in the 1997 Period to approximately 99,000 in the 1998
Period. Gross profit on sales of pharmacy products to non-Third Party Plan
customers decreased from approximately $1.4 million in the 1997 Period to
approximately $1.3 million in the 1998 Period, primarily as a result of the
volume decrease described above. The Company believes that its pharmacy sales to
participants in Medicaid and Medicare do not represent a material percentage of
its total net sales.
Gross profit was $15.1 million for the 1998 Period, as compared to $14.0
million for the 1997 Period, an increase of 7.9%. Gross profit as a percentage
of net sales was 27.5% for the 1998 Period as compared to 26.9% for the 1997
Period. This 0.6% increase was due primarily to the increase in the gross
margin on general merchandise sales, offset by a decrease in the overall gross
margin on pharmacy sales caused by an increase in Third-Party Plan prescription
sales as a percentage of total pharmacy sales. Although management expects that
Third Party Plan sales as a percentage of total pharmacy sales will continue to
increase, management believes that as this rate of increase slows, margins will
stabilize, resulting in pharmacy gross profit growth more closely approximating
pharmacy sales growth rates. Management believes that the rate of increase in
Third Party Plan prescription sales as a percentage of total pharmacy sales
will slow because the current growth rates, if continued, would quickly reach
the point at which almost all members of the population who may be eligible for
enrollment in Third Party Plans will be so covered, although management
believes there will always be some pharmacy customers who do not enroll in
Third Party Plans. Because of the lower margins on prescription sales to Third
Party Plan participants, management believes that the increase in Third Party
Plan prescription sales as a percentage of total pharmacy sales will negatively
impact profitablility, although this may be partly or wholly offset by the
increases in pharmacy sales that have accompanied the increase in Third Party
Plan prescription sales as a percentage of total pharmacy sales.
Gross profit on total pharmacy sales (including sales to Third Party
Plans) was $3.0 million for each of the 1998 Period and the 1997 Period.
Net sales of non-pharmacy products were $40.3 million in the 1998 Period,
as compared to $39.2 in the 1997 Period, an increase of 2.8%. Gross profit on
non-pharmacy sales was $12.1 million for the 1998 Period, as compared to $11.0
million for the 1997 Period, an increase of 10.0%. The Company attributes these
increases in net sales of non-pharmacy products and gross profit on
non-pharmacy sales to increased customer traffic in the Company's stores
associated with an increase in total pharmacy sales, as well as the
implementation of the Company's merchandising and purchasing strategies.
Selling, general and administrative expense as a percentage of net sales
was 23.2% for the 1998 Period as compared to 22.6% for the 1997 Period. This
increase was primarily the result of pre-opening costs incurred related to two
new stores that opened immediately after the end of the 1998 Period as compared
to one new store that opened during the 1997 Period, as well as the greater
number of Drug Fair stores as compared to Cost Cutters stores in the Company's
store mix. The Company's Drug Fair stores typically take a longer time to
mature than the Company's Cost Cutters stores and carry a higher rate of
selling, general and administrative expense as a percentage of net sales. In
the event that the Company is successful in opening additional stores in future
periods, the Company anticipates that these costs may be higher.
32
<PAGE>
Depreciation and amortization was $1.5 million during the 1998 Period as
compared to $1.1 million during the 1997 Period, an increase of 36.3%. This
increase was due to the one-time write-off of deferred financing costs of $0.4
million related to the repayment of the Company's previous credit facility (the
"Old Credit Facility"), which was repaid-with a portion of the proceeds of the
sale of the Existing Notes.
Interest expense for the Company was $0.7 million during the 1998 Period
as compared to $0.8 million during the 1997 Period, a decline of $0.1 million.
This decrease was the result of lower interest costs incurred on the Old Credit
Facility during the 1998 Period as compared to the 1997 Period, due to a lower
average principal balance outstanding. The higher rate of interest cost
incurred as a result of the issuance of the Existing Notes did not have a
significant impact on total interest expense as such notes were only
outstanding for 9 days during the 1998 Period. Interest expense for the Parent
was $0.5 million during the 1998 Period as compared to $0.3 million during the
1997 Period, an increase of $0.2 million. This increase was the result of the
compounding of the interest on the Parent's Subordinated Notes due 2005. The
Company expects interest expense to increase in future periods as a result of
the issuance of the Notes.
The Company incurred a net loss of $0.1 million in each of the 1998 Period
and 1997 Period. The net loss for the 1998 Period was partially due to the
one-time write-off of deferred financing costs of $0.4 million on the Old
Credit Facility during such Period. The net loss for the Parent for the 1998
Period was $0.5 million as compared to $0.3 million. The increase in the net
loss incurred by the Parent was the result of the factors described above in
addition to a higher level of interest accruing during the 1998 Period on the
Parent's Subordinated Notes, as interest on such notes is compounding.
Comparison of fiscal 1997 to fiscal 1996
Net sales for fiscal 1997 were $231.0 million as compared to $215.7
million for fiscal 1996, an increase of $15.3 million or 7.1%. This increase was
due primarily to a 4.8% increase in same-store sales, driven by a 16.3% increase
in total pharmacy sales (including sales to Third Party Plans), from $47.8
million to $55.6 million, and a 34.5% increase in pharmacy sales to Third-Party
Plans from $29.3 million to $39.4 million. The Company believes that the
increase in pharmacy sales to Third Party Plans during this period was primarily
driven by the increase in the volume of pharmacy products sold to Third Party
Plan customers and pricing increases on such products. The number of
prescriptions filled for Third Party Plan customers increased to approximately
1.1 million prescriptions for fiscal 1997, as compared to approximately 840,000
prescriptions in fiscal 1996, an increase of approximately 31.0%, as compared to
the 34.1% increase in pharmacy sales to Third Party Plans over the same period.
The Company believes that pricing increases on pharmacy products of between 4%
and 6% annually have been common during the past several years and is the
primary reason for the higher rate of increase in pharmacy sales to Third Party
Plans as compared to the rate of increase in prescriptions filled for Third
Party Plan customers. Gross profit on pharmacy sales to Third Party Plan
customers increased from approximately $5.7 million in fiscal 1996 to
approximately $7.0 million in fiscal 1997, primarily as a result of the increase
in volume. Pharmacy sales to non-Third Party Plan customers decreased from $18.4
million in fiscal 1996 to $16.2 million in fiscal 1997, primarily as a result of
the increased participation of the Company's customers in Third Party Plans and
a decrease in the volume of pharmacy products sold to non-Third Party Plan
customers as prescriptions filled for such customers decreased from
approximately 560,000 in fiscal 1996 to approximately 472,000 in fiscal 1997.
Gross profit on sales of pharmacy products to non-Third Party Plan customers
decreased from approximately $6.0 million in fiscal 1996 to approximately $5.8
million in fiscal 1997, primarily as a result of the volume decrease described
above.
Gross profit was $67.9 million for fiscal 1997, as compared to $63.1
million for fiscal 1996, an increase of 7.6%. Gross profit as a percentage of
net sales was 29.4% for fiscal 1997 as compared to 29.2% for fiscal 1996. This
0.2% increase was due primarily to the increase in the gross margin on general
merchandise sales, particularly at Cost Cutters, and the increase in the amount
of cash advances from certain of the Company's suppliers recognized during
fiscal 1997. These cash advances ("Supplier Advances") are made by a supplier
at the beginning of a supply contract and are recognized by the Company, on a
pro rata basis, as a reduction of cost of goods sold over the term of the
contract as the Company attains certain purchase levels of the supplier's
products or satisfies other criteria provided in the agreement. The increase in
gross margin on general merchandise sales and the recognition of
33
<PAGE>
Supplier Advances was partially offset by a decrease in the overall gross
margin on pharmacy sales caused by an increase in Third-Party Plan prescription
sales as a percentage of total pharmacy sales.
Gross profit on total pharmacy sales (including sales to Third Party
Plans) was approximately $12.8 million for fiscal 1997, as compared to $11.8
million for fiscal 1996, an increase of 8.5%. Gross profit on pharmacy sales to
Third Party Plans was approximately $7.0 million for fiscal 1997, as compared
to $5.7 million for fiscal 1996, an increase of 22.8%. The Company attributes
the increases in gross profit on total pharmacy sales and pharmacy sales to
Third Party Plans to the overall increases in the total volume of pharmacy
sales and pharmacy sales to Third Party Plans.
Net sales of non-pharmacy products were $175.5 million in fiscal 1997, as
compared to $168.0 million in fiscal 1996, an increase of 4.5%. Gross profit on
non-pharmacy sales was $55.1 million for fiscal 1997, as compared to $51.3
million for fiscal 1996, an increase of 7.4%. The Company attributes these
increases in net sales of non-pharmacy products and gross profit on
non-pharmacy sales to increased customer traffic in the Company's stores
associated with an increase in total pharmacy sales, as well as the
implementation of the Company's merchandising and purchasing strategies.
Selling, general and administrative expense as a percentage of net sales
was 22.0% in each of fiscal 1996 and fiscal 1997. This percentage remained
stable as an increase in advertising expenses as a percentage of sales from
0.8% in fiscal 1996 to 1.1% in fiscal 1997, which resulted from an upgrade by
the Company of the quality of its direct mail circulars in order to increase
sales and a lower amount of co-op advertising rebates from its suppliers during
fiscal 1997, was offset by increased sales volume.
Net income for the Company for fiscal 1997 was $4.6 million as compared to
$3.7 million for fiscal 1996, an increase of 24.3%, as a result of the factors
described above. Net income for the Holding Company for fiscal 1997 was $3.8
million as compared to $2.6 million for fiscal 1996, an increase of 46.2%, as a
result of the factors described above which were partially offset by interest
expense of $1.6 million at the Holding Company level attributable to interest
accruing on the Holding Company's Subordinated Notes.
Comparison of fiscal 1996 to the Twelve Months Ended July 30, 1995 (the
"1995 Period")
Net sales for fiscal 1996 were $215.7 million as compared to $197.9 million
for the 1995 Period, an increase of $17.8 million or 9.0%. This increase was
primarily due to the addition of four new stores (including one Cost Cutters
store) in 1996, which generated $9.1 million in additional revenue, and a 2.4%
same-store sales increase, driven by a 10.8% increase in overall pharmacy sales
from $43.1 million to $47.8 million, including an increase in pharmacy sales to
Third Party Plans from $21.2 million to $29.3 million. The Company believes that
the increase in pharmacy sales to Third Party Plans during this period was
primarily driven by the increase in the volume of pharmacy products sold to
Third Party Plan customers, in addition to pricing increases on such products.
The number of prescriptions filled for Third Party Plan customers increased to
approximately 840,000 prescriptions for Fiscal 1996, as opposed to 610,000
prescriptions for the 1995 Period, an increase of 37.7%, as compared to the
38.2% increase in pharmacy sales to Third Party Plans over the same period.
Gross profit on pharmacy sales to Third Party Plan customers increased from
approximately $4.4 million in the 1995 Period to approximately $5.7 million in
fiscal 1996, primarily as a result of the increase in volume. Pharmacy sales to
non-Third Party Plan customers decreased from $22.0 million in the 1995 Period
to $18.4 million in fiscal 1996, primarily as a result of the increased
participation of the Company's customers in Third Party Plans and a decrease in
the volume of pharmacy products sold to non-Third Party Plan customers as
prescriptions filled for such customers decreased from approximately 734,000 in
the 1995 Period to approximately 560,000 in fiscal 1996. Gross profit on sales
of pharmacy products to non-Third Party Plan customers decreased from
approximately $7.0 million in the 1995 Period to approximately $6.0 million in
fiscal 1996 primarily as a result of the volume decrease described above.
Gross profit was $63.1 million for fiscal 1996, as compared to $57.7
million for the 1995 Period, an increase of 9.4%. Gross profit as a percentage
of net sales was 29.2% for fiscal 1996 as well as the 1995 Period. For the 1995
Period, Third-Party Plan prescription sales represented 49.1% of total
prescription sales, or $21.1 million, while Third-Party Plan prescription sales
represented 60.1% of total prescription sales for fiscal 1996, or $29.3
million. The decline in the gross margin on prescription sales was partially
offset by an increase in the gross margin on general merchandise and the
recognition of $1.5 million of Supplier Advances in fiscal 1996.
34
<PAGE>
Gross profit on total pharmacy sales (including sales to Third Party
Plans) was approximately $11.8 million for fiscal 1996, as compared to $11.5
million for the 1995 Period, an increase of 2.8%. Gross profit on pharmacy
sales to Third Party Plans was approximately $5.7 million for fiscal 1996, as
compared to $4.4 million for the 1995 Period, an increase of 29.6%. The Company
attributes the increases in gross profit on total pharmacy sales and pharmacy
sales to Third Party Plans to the overall increases in the total volume of
pharmacy sales and pharmacy sales to Third Party Plans.
Net sales of non-pharmacy products were $168.0 million in fiscal 1996, as
compared to $155.0 million in the 1995 Period, an increase of 8.4%. Gross
profit on non-pharmacy sales was $51.3 million for fiscal 1996, as compared to
$46.2 million for the 1995 Period, an increase of 11.0%. The Company attributes
these increases in net sales of non-pharmacy products and gross profit on
non-pharmacy sales to increased customer traffic in the Company's stores
associated with an increase in total pharmacy sales, as well as the
implementation of the Company's merchandising and purchasing strategies.
Selling, general and administrative expense as a percentage of net sales
was 22.0% for fiscal 1996 as compared to 21.8% for the 1995 Period. This 0.2%
increase was due primarily to the relatively large numbers of stores opened in
the 1995 Period (3 stores opened) and fiscal 1996 (4 stores opened) and the
higher level of expenses incurred by these stores, which is typical for new
stores in their first few years of operations. In addition, in order to improve
the quality of its direct mail advertising program, the Company increased its
net advertising expenditures from approximately $0.7 million in the 1995 Period
to $1.6 million in fiscal 1996.
Depreciation and amortization expense increased to $4.3 million for fiscal
1996 compared to $2.9 million for the 1995 Period, an increase of 48.3%, as a
result of amortization of intangibles and deferred financing costs recorded in
connection with the Acquisition for all of fiscal 1996 as compared to only the
last six months of the 1995 Period. Prior to the Acquisition, the Company
incurred no amortization of goodwill, beneficial leasehold interests or
deferred financing costs. Amortization of goodwill and beneficial leasehold
interests and deferred financing costs aggregated $2.6 million for fiscal 1996.
Net income for the Company for fiscal 1996 was $3.7 million as compared to
$8.3 million for the 1995 Period, a decrease of 55.4%, as a result of the
factors described above. The Holding Company had no operations until the
Acquisition on January 30, 1995. Net income for the Holding Company for fiscal
1996 was $2.6 million as compared to $0.6 million for the 1995 Period, an
increase of 333.3%, as a result of the fact that fiscal 1996 included a full
year of operations, as well as the other factors described above which were
partially offset by interest expense of $1.328 million at the Holding Company
level attributable to interest accruing on the Subordinated Notes.
Liquidity and Capital Resources
General
The Company
In the 1998 Period cash used in operations was $3.0 million as compared to
$0.5 million for the 1997 Period. This increased use of cash in operations was
the result of a higher level of inventory investment during the 1998 Period as
compared to the 1997 Period, a greater amount of cash being used to take
advantage of vendor cash discounts during the 1998 Period, and the expenses
associated with the two store openings that occurred during the 1998 Period as
compared to the one new store opening that occurred during the 1997 Period.
Cash used in investing activities was $0.7 million for the 1998 Period as
compared to $0.5 million for the 1997 Period. This increased use of cash was
the result of investments made for the opening of two new store locations in
the 1998 Period as compared to one new store opening in the 1997 Period. Cash
provided from financing activities was $2.9 million in 1998 as compared to a
use of cash of $1.9 million in the 1997 Period. The cash provided from
financing activities in the 1998 Period was provided from the issuance of the
Existing Notes as compared to the regularly scheduled and additional principal
payments which were made on the Old Credit Facility during the 1997 Period.
During fiscal 1997, cash provided from operations was $9.4 million, as
compared to $10.5 million for fiscal 1996. This decrease of $1.1 million was
primarily the result of an increase in deferred tax liability and income taxes
payable resulting from larger estimated tax payments during fiscal 1997, which
was partially offset by higher net income. Cash used in investing activities
was $1.3 million for fiscal 1997, as compared to $2.9 million for fiscal 1996.
This $1.6 million decrease was due to decreased capital expenditures in the
subsequent period as a result
35
<PAGE>
of a decrease in store openings. Cash used in financing activities was $9.9
million for fiscal 1997, as compared to $5.8 million for fiscal 1996. This $4.1
million increase was due to increased principal payments made on the Old Credit
Facility.
During fiscal 1996, cash provided from operations was $10.5 million
compared to $10.9 million for the 1995 Period. This $0.4 million decrease was
due primarily to increases in Third-Party Plan prescription receivables and
inventory acquisitions for new stores. Cash used in investing activities was
$2.9 million in fiscal 1996 as compared to $2.3 million in the 1995 Period,
excluding the Acquisition. Cash used in financing activities, primarily the
payment of principal under the Old Credit Facility, for fiscal 1996 was $5.8
million as compared to $4.9 million for the 1995 Period.
Historically, cash flows from operations, augmented when necessary by
borrowings under the Revolving Loan under the Old Credit Facility, have been
sufficient to fund working capital needs, investing activities (consisting
primarily of capital expenditures) and financing activities (normal debt
service consisting of interest payments and repayments of term and revolving
loans outstanding). Working capital was $18.1 million, $9.8 million, $11.2
million and $10.6 million on October 25, 1997, July 26, 1997, July 28, 1996 and
July 30, 1995, respectively.
In the last few years, the Company's capital requirements primarily
resulted from opening and stocking new stores, remodeling and refurbishing
existing stores and continuing development of new management information
systems. The Company has opened 16 new stores since 1990, and has signed four
leases for new Drug Fair locations, with all of these stores expected to open
before the end of fiscal 1998. The Company estimates that the average initial
new store investment is between $0.3 million and $0.6 million, not including
inventory costs which may range from $0.4 million to $0.5 million. Such costs
may be slightly higher in the event that the Company elects to purchase
prescription customer files from existing drugstores in the area in which such
stores are opened. Depending on the availability of suitable locations, the
Company intends to open an average of three to four new Drug Fair stores
annually over the next several years, and may open additional Drug Fair
storefronts at Cost Cutters locations. In the event that the Company is
successful in opening four new stores in each of the next several years, the
Company could incur opening expenses of between approximately $2.8 million and
approximately $4.4 million (including inventory costs). Since fiscal 1993, new
Drug Fair stores have not been profitable on an operating basis (that is, prior
to the allocation of corporate overhead) until 32 months after opening, on
average.
Of the Company's 43 stores, 18 have been opened since 1989 and all but one
of the remaining 25 stores have been refurbished since 1991. The total cost of
this refurbishment program was approximately $3.0 million or approximately
$125,000 per store. The Company anticipates that over the next few years it
will remodel and refurbish approximately four stores per year at a cost of
approximately $0.4 million per year. The Company also spends approximately $0.5
million annually to update its POS network and other management information
systems and, as part of this effort, the Company expects to complete the
installation of a comprehensive processing system from JDA Software, Inc. prior
to June 30, 1998. Working capital is also required to support inventory for the
Company's existing stores.
The Company expects that it will pay one-time performance-related bonuses
to Mr. Frank Marfino, its President and Chief Executive Officer, and Mr. Todd
Pluymers, its Chief Financial Officer in the aggregate amount of approximately
$1.4 million, in one or more installments over the next nine months.
The Company intends to consolidate its two existing distribution centers
and corporate offices into a single new facility when its current distribution
center leases expire in 1998. The Company intends to lease this new facility,
which it anticipates will be approximately 200,000 square feet in size. The
Company anticipates that incremental annual rent and related expenses will be
approximately $0.4 million. The Company's obligations under its existing leases
total approximately $8.6 million for fiscal 1998 and approximately $8.4 million
for fiscal 1999. In the event that the Company is successful in opening
additional stores in fiscal 1998 and fiscal 1999, the Company expects its lease
obligations to be proportionately greater.
In November 1997, the Company entered into a Receivables Purchase
Agreement with The Pharmacy Fund, Inc. pursuant to which the Company has agreed
to factor all of its Third Party Plan prescription receivables. Under the terms
of this agreement, the Company accelerates its collection of these receivables
by selling them to The Pharmacy Fund, Inc. two days after they are created,
rather than waiting to collect them in the ordinary course.
36
<PAGE>
In addition, the Company avoids the collection risk as the receivables are sold
without recourse, although the Company believes that the financing cost of
factoring these receivables, while not material to the Company's gross profit
or net income, may be higher than the average collection loss rate on these
receivables.
The Company has no current long-term debt outstanding other than the
Notes. The Company's interest obligations under the Notes will aggregate $4.1
million in fiscal 1998 and $8.2 million in fiscal 1999 and each fiscal year
thereafter until maturity of the Notes.
After the issuance of the Existing Notes, the Company's total debt
increased from approximately $29.5 million to approximately $80.2 million, as
of October 25, 1997, resulting in a corresponding increase in the Company's
interest expense obligations. Because $45.0 million of the proceeds of the sale
of the Existing Notes was paid to the Holding Company on October 16, 1997 in
the form of a dividend (the "Holding Company Dividend"), and most of the rest
of the proceeds from such sale were used to repay the Old Credit Facility
($29.3 million), and pay transaction fees and expenses ($3.0 million), only
$2.7 million of the proceeds are available to pay interest on the Notes and the
Company's other indebtedness or for other corporate purposes. Accordingly, the
Company expects to use cash from operations and borrowings under the New Credit
Facility to meet most of its cash requirements. Prior to the payment of the
Holding Company Dividend on October 16, 1997, the Company had paid no dividends
on its capital stock although the Predecessor Company, which was treated as a
Subchapter S corporation for federal and state income tax purposes, made
payments to its shareholders from time to time to cover tax liabilities. The
Holding Company has paid no dividends other than the Dividend since its
organization.
The Company believes that, based on anticipated levels of operations, it
will be able to meet its debt service obligations, including interest payments
on the Notes, when due and to fund anticipated capital expenditures and working
capital requirements, and to comply with the terms of its debt agreements
during the remainder of fiscal 1998 and fiscal 1999. The Company's ability to
make scheduled payments of principal or interest on, or to refinance, its
indebtedness will depend on future operating performance and cash flow, which
are subject to prevailing economic conditions, prevailing interest rates and
financial, competitive, business and other factors beyond its control. Although
the Company's cash flow and borrowings under the New Credit Facility are
intended to cover the Company's debt service obligations and working capital
requirements over the near term, the Company's New Credit Facility does not
mature until October 2002, and the Notes do not mature until October 2004.
Accordingly, the Company's principal financing expenses over the near term are
expected to relate to the payment of interest on such indebtedness. The Company
expects that substantially all of its borrowings under the New Credit Facility
will bear interest at floating rates; therefore, the Company's financial
condition will be affected by any changes in prevailing interest rates. Because
(i) the Company has not guaranteed the obligations of the Holding Company under
its outstanding Subordinated Notes, (ii) no interest is payable on the
Subordinated Notes until their maturity, and (iii) the maturity date of the
Subordinated Notes is subsequent to the maturity date of the Notes, the Company
does not believe that its liquidity will be materially affected by the Holding
Company's obligations under the Subordinated Notes, during the term of the
Notes.
The Company entered into the $20.0 million New Credit Facility
simultaneously with the consummation of the sale of the Existing Notes. As of
December 31, 1997, the Company had made no borrowings under the New Credit
Facility. In addition, the Company believes that as of December 31, 1997, the
Company's borrowing base (as defined under the New Credit Facility) was
sufficient to support borrowings of the entire amount committed under the New
Credit Facility. See "Description of New Credit Facility and Certain Other
Indebtedness" for a description of the terms of the New Credit Facility. The
New Credit Facility will be used primarily for working capital purposes.
The Holding Company
Although the Holding Company does not conduct operations separate from the
Company, the Holding Company has issued $13.25 million (not including accrued
interest) in Senior Subordinated Notes due 2005. Interest on these Subordinated
Notes is not currently payable, but accrues at a rate of 10% per annum. In
addition, the Holding Company has issued a Guarantee of the Notes. Because the
Holding Company does not conduct operations separate from the Company, it is
dependent entirely on cash flow generated, and borrowings made, by the Company.
Furthermore, the Holding Company has nominal, if any, liquid assets. The
Company's ability to make distributions of funds to the Holding Company is
limited by the terms of the Indenture governing the Notes and the New Credit
Facility. Under the terms of the Indenture, any payments by the Company to the
Holding Company (other than
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<PAGE>
payments specifically made to satisfy tax obligations of the Holding Company,
payments made to satisfy the Holding Company's obligations under the management
fee agreements currently in place with BancBoston and Harvest, payments of up
to $250,000 per year to provide for the operating expenses of the Holding
Company and certain payments not to exceed $500,000 in any fiscal year for the
repurchase of equity from departing or deceased directors, officers or
employees), must satisfy the conditions set forth in the covenant in the
Indenture titled "Limitation on Restricted Payments", including conditions that
the Company be able to incur at least $1.00 of additional indebtedness under
the Debt Incurrence Ratio described in "Description of the Notes--Limitation on
the Incurrence of Additional Indebtedness and Disqualified Capital Stock" and
that the aggregate amount of all such restricted payments not exceed an amount
equal to 50% of the aggregate Consolidated Net Income of the Company after the
Issue Date of the Existing Notes (minus 100% of any loss for such period). See
"Description of the Notes--Certain Covenants--Limitation on Restricted
Payments." Under the terms of the New Credit Facility, the Company is
prohibited from paying dividends to the Holding Company in excess of (i)
payments to the Holding Company in an amount, not to exceed $250,000 in the
aggregate per fiscal year, sufficent to pay reasonable and necessary operating
expenses and other general corporate expenses, and (ii) cash dividends to the
Holding Company to the extent necessary to permit the Holding Company to
repurchase equity securities of the Holding Company held by departing or
deceased directors, officers or employees of the Holding Company or the
Company, subject to a maximum on such repurchases of $500,000 in the aggregate
in any fiscal year and a maximum of $2,000,000 in the aggregate during the
period from the date of the New Credit Facility through October 16, 2002. The
only financial results reported by the Company or the Holding Company that have
included periods after the issue date of the Existing Notes (the results for
the three months ended October 25, 1997) have included net losses for both the
Company and the Holding Company for such fiscal periods. The Holding Company
believes that, based on anticipated levels of operations of the Company,
distributions from the Company will be sufficient to permit the Holding Company
to meet its obligations under the Subordinated Notes and its Guarantee of the
Notes when and if they become due. Because the Company will be restricted in
making distributions to the Holding Company in the event that it is unable to
fulfill its obligations under the Notes, in the event of such a default it is
unlikely that the Holding Company will be able to fulfill its obligations under
its Guarantee of the Notes. The Holding Company's ability to make scheduled
payments of principal and interest on, or to refinance the Subordinated Notes,
will depend on the future operating performance and cash flow of the Company,
which are subject to prevailing economic conditions, prevailing interest rates
and financial, competitive, business and other factors beyond the control of
the Company and the Holding Company.
Seasonality
The business of the Company is seasonal in nature. Historically, the
Company's revenues and income are highest during its second and fourth fiscal
quarters, with the second quarter being the highest due to the holiday season.
Inflation
The Company believes that inflation has not had a material impact on
results of operations for the Company during the three year period ended
October 25, 1997.
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BUSINESS
General
The Company is among the largest regional drugstore chains in the United
States and the only regional chain focused primarily on the densely populated
northern and central New Jersey markets, although several national and other
regional drugstore chains have operations in this area. The Holding Company is
the owner of all of the outstanding capital stock of the Company. The Company
operates a chain of 43 drug and general merchandise stores under two separate
formats, Drug Fair and Cost Cutters, and ranks as the number two or three
competitor in its primary market areas based on sales of similar merchandise.
Of the Company's 43 stores, 18 have been opened since 1989 and all but one of
the remaining stores have been refurbished since 1991. The Company has been
consistently profitable and each of the Company's 38 mature stores (those open
for more than 24 months) is profitable on an operating basis prior to the
allocation of certain corporate overhead. The Company's revenues, net income,
Adjusted EBITDA and income before income taxes were $231.0 million, $4.6
million, $18.7 million and $9.8 million, respectively, in fiscal 1997. Adjusted
EBITDA is calculated as net income plus depreciation and amortization, income
taxes, net interest expense, changes in LIFO inventory reserves and non-cash
rental expense. The calculation of Adjusted EBITDA differs from the calculation
of income before income taxes in that it adds back to net income certain
expenses that do not impact the Company's cash flows. The Company believes
that, while Adjusted EBITDA should not be used as a substitute for other
measures of financial performance determined under generally accepted
accounting principles, the presentation of Adjusted EBITDA is meaningful to
holders of Existing Notes and possible purchasers of New Notes because EBITDA
is commonly used by certain investors and analysts to analyze and compare
companies on the basis of operating performance, leverage and liquidity and to
determine a company's ability to service debt. See "Summary Financial and Other
Data" and "Selected Financial Data of the Company."
Drug Fair. Drug Fair is a chain of 26 large-format drugstores with an
average store size of approximately 17,000 square feet. All of the stores
contain a pharmacy in the rear of the store, which is the focal point of the
store layout. In fiscal 1997, the Company's pharmacies (including four at Cost
Cutters locations) filled over 1.5 million prescriptions, an average weekly
volume of approximately 1,000 scripts per pharmacy, and pharmacy sales
increased 16.3% over fiscal 1996. Currently, approximately 72% of the Company's
prescription sales are to Third-Party Plan participants. Drug Fair's strategy
is to utilize large-format stores to capitalize on the increased customer
traffic associated with its growing pharmacy business to increase sales of
higher margin non-pharmacy merchandise, including health and beauty care items,
housewares, greeting cards, stationery, candy and seasonal items. General
merchandise accounted for approximately 61% of Drug Fair revenues in fiscal
1997, higher than the average of other large drugstore chains. The Company
believes that its broad selection of non-pharmacy merchandise is a significant
competitive strength that has enabled it to increase its overall gross margins
from 27.3% in fiscal 1993 to 29.4% in fiscal 1997. Drug Fair stores are
primarily located in neighborhood shopping centers that are easily accessible
and generate significant customer traffic.
Cost Cutters. Cost Cutters is a 17-store general merchandise chain with an
average store size of approximately 29,000 square feet. Cost Cutters stimulates
customer traffic by offering a non-pharmacy merchandise mix similar to Drug
Fair, a high-impact merchandise presentation and an everyday low price
strategy, with prices generally 10%-15% lower than Drug Fair. Cost Cutters
offers a broader selection of products than Drug Fair while still focusing on
health and beauty care items, housewares, greeting cards, stationery, candy and
seasonal items. Currently, four locations have pharmacies, two within the store
and two as separate Drug Fair storefronts adjacent to the store, and the
Company believes there is an opportunity to open Drug Fair pharmacies at
certain additional Cost Cutters locations. Cost Cutters stores are primarily
located near major highways, drawing customers from a wider area than a typical
drugstore and emphasizing their destination-store orientation.
Since 1990, the Company has experienced significant growth led by Frank
Marfino, the Company's Chief Executive Officer. During this period, the Company
expanded its store base by 12 stores, with revenues increasing from $168.4
million in fiscal 1993 to $231.0 million in fiscal 1997 and Adjusted EBITDA and
income before income taxes increasing from $10.4 million and $8.6 million in
fiscal 1993 to $18.7 million and $9.8 million, respectively, in fiscal 1997.
During this period, the Company also increased its Adjusted EBITDA margin from
6.2% to 8.1% of sales. This improved operating performance and growth have
resulted primarily from rationalization and expansion of the store base,
improved centralized controls over purchasing, effective merchandising, pricing
and loss-prevention strategies, increased pharmacy business with Third-Party
Plan participants and cost control measures.
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The Company was acquired in January 1995 by the Holding Company, whose
shareholders include a group of investors led by BancBoston, Harvest and
management. Since the Acquisition, the Company has placed increased emphasis on
growing its pharmacy sales to Third-Party Plan participants and, as a result,
has grown its pharmacy sales by 40.4% from fiscal 1994 to fiscal 1997. During
the same period, the Company's net income decreased from $10.5 million to $4.6
million, primarily as a result of debt-related expense and goodwill
amortization incurred by the Company in connection with the Acquisition.
Similarly, improved non-pharmacy merchandising and pricing strategies, combined
with increased customer traffic resulting from higher pharmacy sales, have
enabled the Company to increase its gross margin from 27.9% in fiscal 1994 to
29.4% in fiscal 1997. This increase occurred despite continued pharmacy margin
erosion resulting from increased sales to Third-Party Plan participants.
Each of the Company and the Holding Company is incorporated in Delaware,
and their executive offices are located at 251 Industrial Parkway, Branchburg
Township, Somerville, NJ 08876. The telephone number for the Company and the
Holding Company at these executive offices is (908) 722-8700.
The Drugstore Industry
According to Drug Store News, the U.S. drugstore industry accounted for
$91 billion of retail sales in 1996 and has grown by 70.1% since 1987. During
this period, sales at chain drugstores have grown by 106.0%, as independent
drugstores lost significant market share to the larger and more efficient
national and regional chains, such as the Company. Industry revenues are
expected to continue to grow at similar rates due to the aging of the U.S.
population, greater participation in Third-Party Plans and continued growth in
new pharmaceutical products. As pharmacy sales at national and regional chains
continue to grow, sales of other higher margin non-pharmacy merchandise offered
in chain drugstores are expected to experience positive growth through
increased customer traffic.
According to industry sources, households headed by persons aged 55 to 64
and 65 to 74 spend approximately 20% more, and 105% more, respectively, on
prescriptions than the average household. According to the United States Bureau
of the Census, people 55 years of age and over represent the fastest growing
segment of the population, with expected growth from 55.8 million in 1997 to
74.7 million in 2010, an increase of 33.9%.
In addition to these positive demographic trends, the growth in
Third-Party Plan participation is increasing overall prescription drug usage.
The percentage of prescriptions purchased through Third-Party Plans has
increased from 50% in 1993 to 67% in 1996 and is expected to reach 85% to 90%
in the next two to three years. Third-Party Plans encourage participants to use
lower cost drug therapies over alternative treatment methods such as surgery or
hospital treatment. Additionally, by reducing the out-of-pocket expense to the
consumer, Third-Party Plans have caused consumers to increase the number of
prescriptions filled.
Although pharmacy sales to Third-Party Plan participants typically have
lower margins than cash pharmacy sales, resulting in a decline in pharmacy
gross margins, this decline has been partially offset by a higher volume of
pharmacy sales. Management expects that as sales to Third-Party Plan
participants as a percentage of total pharmacy sales slows, margins will
stabilize, resulting in pharmacy gross profit growth more closely approximating
pharmacy sales growth rates. The drugstore industry, including the Company, has
also capitalized on the customer traffic created by the growth in Third-Party
Plan sales to increase sales of higher margin non-pharmacy merchandise.
Another factor expected to increase industry revenues is the introduction
of new prescription drugs and drug therapies. According to industry sources,
pharmaceutical manufacturers will spend an estimated $19.0 billion in 1997 on
research and development to develop new drugs which could result in incremental
pharmacy sales. In 1996, 53 new drugs were approved by the United States Food
and Drug Administration ("FDA"), an increase of 102% over the average for the
previous five years. In addition, the FDA is approving an increasing number of
prescription products for sale over-the-counter. Such drugs that are approved
for over-the-counter distribution have historically shown significantly
increased sales.
As a result of the economies of scale available to larger drugstore chains
as well as the Third-Party Plan payment trend, during the past ten years
national and regional chain drugstores have increased their share of the total
retail drug market at the expense of independent drugstores and smaller
drugstore chains. During 1996, pharmacy sales at chain drugstores grew by an
estimated 17.4% to $30.3 billion, representing approximately 61% of the $49.4
billion drugstore pharmacy market, while pharmacy sales at independent
drugstores grew less than
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4% in 1996, to an estimated $19.1 billion, a 39% market share. The number of
independent drugstores and smaller drugstore chains has decreased from
approximately 35,000 in 1985 to approximately 22,000 in 1996, as many of such
retailers have been acquired by larger drugstore chains. The Company believes
that independent retail drugstores will continue to lose market share to the
larger and more efficient drugstore chains principally because larger chains
such as the Company are better positioned to handle the increased volume of
sales to Third-Party Plan participants, are able to purchase inventory on more
favorable terms, and are able to achieve other economies of scale with respect
to their marketing, advertising, distribution and other expenditures.
In July 1994, the State of New Jersey adopted "Freedom of Choice" and "Any
Willing Provider" legislation, which the Company believes results in a "level
playing field" in New Jersey for regional drugstore chains such as the Company.
The "Freedom of Choice" legislation permits Third-Party Plan participants to
purchase prescription drugs from the provider of their choice if the provider
meets uniformly established requirements. In states which have not adopted
similar legislation, many Third-Party Plans align themselves by agreement with
particular drugstore chains under arrangements whereby members of a Third-Party
Plan are required to purchase their drugs at a particular drugstore chain in
order for most or all of the cost to be paid by the Third-Party Plan. As a
result, other drugstore chains and independent drugstores are in effect
precluded from selling prescription drugs to the applicable members. The "Any
Willing Provider" legislation requires that any Third-Party Plan that has
entered into an agreement with a prescription provider must also permit any
other licensed provider to participate in such Third-Party Plan as a preferred
or contracting provider, provided that such provider is willing to accept the
terms of such agreement.
Competitive Strengths
The Company attributes its success in the marketplace to the following
competitive strengths:
Strong Market Position in Attractive Regional Market. As the largest
drugstore chain focused primarily on the densely populated northern and central
New Jersey markets, the Company's operations serve an estimated population of
over 5.7 million. New Jersey offers a highly attractive customer base, with
among the highest personal income per capita in the United States. The Company
has operated in these markets for its entire 43-year history and has profitably
managed its operations through changing economic conditions and an environment
of increasing competition. Since 1990, a period of significant incremental
competition, management has successfully expanded its store base, increased
same-store sales each year and increased its Adjusted EBITDA margin and gross
margin from 6.2% and 27.3% in fiscal 1993 to 8.1% and 29.4%, respectively, in
fiscal 1997. In July 1994, the State of New Jersey adopted "Freedom of Choice"
and "Any Willing Provider" legislation, which together effectively allow any
prescription provider to service Third-Party Plan participants on terms
identical to those afforded to other providers. Management believes this
results in a "level playing field" in New Jersey for regional drugstore chains
such as the Company and positions it to benefit from the continued growth in
pharmacy sales.
Favorable Store Locations. The Company has generally located its stores in
convenient locations under favorable leases, many of which include attractive
long-term renewal rates. The Company's Drug Fair stores are primarily located
in neighborhood shopping centers that are easily accessible and generate
significant customer traffic. The Company's Cost Cutters stores are primarily
located near major highways, drawing customers from a wider area than a typical
drugstore and emphasizing their destination-store orientation. The Company
believes that the accessibility and manageable size of its stores appeal to
consumers at a time when other discount merchandisers continue to open larger
and more complex stores that customers may find less convenient. The close
proximity of the Company's stores to its executive offices and distribution
centers also results in distribution and inventory management efficiencies and
permits close management supervision of store operations.
Successful Merchandising and Pricing Strategy. The Company believes that
its focus on consistent execution of its purchasing, pricing and merchandising
strategies has been instrumental to its success. Excluding pharmacy, Drug Fair
and Cost Cutters offer a similar merchandise mix, with over 90% of merchandise
common to both chains. The Company believes that its broader selection of
front-end merchandise is a significant competitive strength which enabled it to
realize an overall increase in its margins between fiscal 1991 and fiscal 1997.
The Company also believes that by operating both chains it is able to purchase
most of its products at competitive prices by purchasing products in truck-load
or container quantities. The Company employs a promotional pricing strategy at
Drug Fair and a modified everyday low price strategy at Cost Cutters, each
targeted towards the customers it seeks to attract. In addition, the Company's
comprehensive and integrated inventory management system and electronic
point-of-
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sale system record all sales data by scanner at the time of sale and permit the
Company to maintain in-stock positions in all key lines of merchandise, promote
higher inventory turns and provide the ability to monitor sales and
profitability by store location.
Well-Maintained Store Base. Of the Company's 43 stores, 18 have been
opened since 1989 and all but one of the remaining stores have been refurbished
since 1991. As a result, the Company does not expect to incur an extraordinary
level of capital expenditures for maintenance in the near term. Furthermore,
since 1991 the Company has rationalized its store base and closed four
underperforming stores. As a result of this rationalization and the other
operating improvements implemented by management, each of the Company's 38
mature stores is profitable on an operating basis prior to the allocation of
certain corporate overhead, and management believes that the Company's Adjusted
EBITDA margin exceeds the industry average.
Operating and Growth Strategy
The Company's operating and growth strategy consists of four principal
elements: (i) capitalize on favorable pharmacy trends, (ii) increase customer
traffic, (iii) further optimize retail execution and (iv) selectively expand
its store base.
Capitalize on Favorable Pharmacy Trends. The pharmacy business contributes
significantly to the Company's growth by increasing sales of non-pharmacy
merchandise, enhancing customer loyalty and generating customer traffic.
Primarily as a result of increasing sales to Third-Party Plan participants, the
Company's pharmacy sales have increased by 9.0%, 10.8% and 16.3% in the twelve
months ended July 30, 1995, fiscal 1996 and fiscal 1997, respectively.
Management expects favorable pharmacy sales trends to continue, and believes
that the Company is well-positioned to increase its higher margin non-pharmacy
merchandise sales by capitalizing on the increased customer traffic generated
by its pharmacies.
Increase Customer Traffic. With favorable pharmacy sales and resulting
customer traffic trends expected to continue, the Company believes that there
are opportunities to further improve customer traffic by providing various
products and services that increase consumer conveniences or otherwise attract
customers to the Company's stores, including offering on-site one-hour
photofinishing labs in a number of locations and increasing offerings of
convenience foods and seasonal merchandise. The Company is also offering new
products and services such as lottery ticket sales and ATMs in selected stores
to enhance customer traffic. The Company also builds customer loyalty and
encourages repeat customer traffic by keeping its stores orderly and clean and
maintaining in-stock positions in substantially all of its merchandise.
Further Optimize Retail Execution. The Company's non-pharmacy
merchandising strategies are designed to improve customer satisfaction,
selection and convenience and establish its stores as a destination for a
growing number of front-end merchandise categories. The Company believes that
effective merchandise management increases customer satisfaction and has
contributed significantly to increases in the Company's gross margin. The
Company will continue to refine its merchandising and buying practices with the
goal of increasing sales of higher-margin items and improving inventory
turnover. For example, the Company is exploring opportunities to expand sales
of OTC drugs, health and beauty care items, and private label merchandise.
Selectively Expand Store Base. The Company expects to selectively expand
its store base as favorable market locations become available. The Company
believes that store expansion will increase sales and cash flow, strengthen its
market position and result in economies of scale in marketing and distribution
by leveraging its existing infrastructure. In addition, the Company believes
that increased sales volume may enable it to purchase inventory at better
prices. Management plans to expand its Drug Fair store base, as these stores
generally offer shorter payback periods and higher returns on investment and
better position the Company to capitalize on favorable trends affecting the
drugstore industry. The Company estimates that the average new store investment
is between $0.3 million and $0.6 million, not including inventory costs which
may range from $0.4 million to $0.5 million, and that the average investment
required to open a Drug Fair pharmacy at a Cost Cutters location is between
$75,000 and $100,000, not including inventory costs which may range from
$50,000 to $75,000. Such costs may be slightly higher in the event that the
Company elects to purchase prescription customer files from existing drugstores
in the area in which such stores are opened. In addition, since fiscal 1993,
new Drug Fair stores have not been profitable on an operating basis (that is,
prior to the allocation of corporate overhead) until 32 months after opening,
on average. To the extent that capital is committed to new store openings or
funding initial operations, such funds will be unavailable for other purposes
such as the payment of interest or principal on the Notes. The Company expects
to open four new
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Drug Fair locations before the end of fiscal 1998 and, depending on the
availability of favorable locations, intends to open an average of three to
four new Drug Fair stores annually over the next several years.
Store Operations
The Company's stores are operated under two separate formats, Drug Fair
and Cost Cutters, with each of the 38 mature stores profitable on an operating
basis prior to the allocation of certain corporate overhead. The Company
employs different pricing strategies for Drug Fair and Cost Cutters, each
targeted towards the customers it seeks to attract. Drug Fair uses a more
traditional promotional pricing strategy, with a limited number of discounted
items; however, management believes that its regular pricing is somewhat lower
than that of its retail drugstore competitors. In contrast, Cost Cutters relies
on an everyday low price strategy by offering lower prices on most items on a
regular basis, which management believes is consistent with its
destination-store orientation.
The following table sets forth the approximate percentage of revenues
attributable to each major product category at Drug Fair and Cost Cutters
stores during fiscal 1997:
<TABLE>
<CAPTION>
Percentage of Fiscal 1997
Sales by Category
-------------------------
Category: Drug Fair Cost Cutters
<S> <C> <C>
Pharmacy .............................. 38.9% 5.6%
Health and Beauty Care ................ 12.5 19.1
Other Merchandise ..................... 12.3 13.1
Housewares ............................ 8.0 17.6
Stationery and Greeting Cards ......... 7.1 13.3
Candy, Food and Beverage .............. 6.2 10.0
Seasonal and Promotional .............. 6.0 10.3
OTC Pharmaceuticals ................... 4.9 5.0
Cosmetics ............................. 4.1 6.0
----- -----
100.0% 100.0%
===== =====
</TABLE>
Excluding revenue generated by stores that were open less than twelve
months before the beginning of each period, the Company's stores generated net
sales of $211.2 million in fiscal 1996 (from 39 stores), and $221.3 million in
fiscal 1997 (from 39 stores), an increase of 4.8%. The Company attributes this
growth in same store sales to increased pharmacy sales as well as increased
sales of non-pharmacy merchandise generated by increased customer traffic, as
well as the successful implementation of the Company's merchandising
strategies.
Drug Fair
Drug Fair is a 26 store chain of larger sized traditional drugstores
primarily located in easily accessible neighborhood shopping centers. Drug Fair
has built a base of loyal customers by offering a broader range of non-pharmacy
merchandise within this larger format, including an expanded selection of
health and beauty care items, housewares, greeting cards, stationery and
seasonal items, in a convenient setting with attractive prices. Drug Fair's
strategy is to emphasize its broad selection of merchandise and offer
competitive prices relative to its competition. In particular, the Company
believes that its broader selection of front-end merchandise is a significant
competitive strength that has enabled it to increase overall gross margin from
27.3% in fiscal 1993 to 29.4% in fiscal 1997. The Company's long-standing
philosophy of customer service has made Drug Fair a leader in local pharmacy
services in its markets.
The first Drug Fair store was opened in 1954 in Scotch Plains, New Jersey
and the Company's current Drug Fair locations average approximately 17,000
square feet, ranging between 11,200 and 23,400 square feet. The Company
believes that its store size and locations are important factors to store
profitability. Most Drug Fair stores are contained in neighborhood shopping
centers that are easily accessible and generate significant customer traffic.
All stores are open seven days a week, from 9:00 a.m. to 9:30 p.m., Monday
through Friday, with slightly reduced hours on weekends, totaling approximately
83 hours per week.
Pharmacy. In fiscal 1997, the Company's pharmacies filled over 1.5 million
prescriptions, representing an average weekly volume of approximately 1,000
scripts per pharmacy, and pharmacy sales increased 16.3% over fiscal 1996.
Currently, approximately 72% of prescription volume results from sales to
Third-Party Plan participants. The Company offers discounts on prescriptions to
senior citizens, who accounted for approximately 14.2% of prescription sales
volume in fiscal 1997.
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All Drug Fair stores contain a pharmacy in the rear of the store, each
staffed by two full-time registered pharmacists. The pharmacy is the focal
point of the store layout, which is also designed to promote optimal customer
flow and shopping convenience. New and remodeled stores typically have
enhancements such as pharmacy waiting and consultation areas. In addition, for
the past four years Drug Fair stores have featured free home delivery of
prescriptions. The Company believes that this delivery service represents an
attractive alternative to the drive-through pharmacy service offered by some of
its competitors while avoiding the significant capital expenditures required to
remodel stores to accommodate drive-through services.
General Merchandise. As a customer-oriented, lower-cost retail drugstore,
Drug Fair strives to compete on the bases of cost and maintaining a
high-quality image with the consumer. General merchandise is an important
component of Drug Fair's revenues, comprising approximately 61% of Drug Fair
revenues in fiscal 1997. General merchandise products are well stocked and
displayed on shelves within easy reach of consumers. With its convenient
merchandise layout and large selection, Drug Fair retains its small-store
atmosphere while offering a variety of merchandise selections typically seen in
larger retail stores. Drug Fair offers a similar selection of general
merchandise as that of its drugstore competitors but, due to its above average
size, is able to expand its selection of items and offer a wider assortment of
higher margin non-pharmacy merchandise. For example, seasonal items have been a
key contributor to Drug Fair's success, comprising 6.0% of divisional revenues
in fiscal 1997. Seasonal items are prominently displayed along the entrance,
providing a varied product mix and generating impulse buying. With nearly
58,000 non-pharmacy stock keeping units ("SKUs") including seasonal items, Drug
Fair also offers expanded greeting card and household item sections to the
consumer.
In addition to its general merchandise offerings, the Company seeks to
attract customers by offering ancillary conveniences and services, such as
ATMs, lottery tickets, convenience food sections and film processing in many of
its stores, including its own on-site one-hour photofinishing labs in 13 Drug
Fair locations. Management believes that it offers the lowest prices for
one-hour film developing in its markets. The Company intends to continue to
experiment with new products and services designed to increase customer traffic
and enhance convenience.
Cost Cutters
Cost Cutters is a 17-store general merchandise chain focused on the
product areas of health and beauty care, housewares, greeting cards,
stationery, candy and seasonal items. The stores are self-service oriented, and
feature a similar non-pharmacy merchandise mix to Drug Fair, with more than a
90% overlap in general merchandise, at prices generally 10%-15% lower than at
Drug Fair. Currently, two Cost Cutters locations house their own pharmacies,
and the Company has added Drug Fair pharmacies adjacent to two of its Cost
Cutters locations. The Company believes there is an opportunity to open Drug
Fair pharmacies in certain additional Cost Cutters locations. Cost Cutters is
unique in its merchandising strategy in its markets and provides a much broader
product variety and deeper discounts than other local stores, while
successfully competing with mass merchandise stores.
The Company opened its first Cost Cutters store in 1983 in Norwood, New
Jersey and the Company's Cost Cutters stores average approximately 29,000
square feet in size, ranging from 20,000 to 36,000 square feet. In expanding to
new sites, the Company has opportunistically negotiated favorable lease terms,
typically from grocery stores that are relocating, rather than paying higher
prices for new real estate. Most of the stores are located in shopping centers,
near highways in easily accessible locations for surrounding communities. By
comparison, larger discount department chains, such as WalMart, Caldor and
K-Mart, typically build new stores in excess of 100,000 square feet and focus
more on higher-priced products such as apparel, sporting goods, electronics and
appliances. The Company believes that the accessibility and manageable size of
a Cost Cutters store is attractive to consumers at a time when larger discount
merchandisers continue to open larger and more complex stores that many
customers may find less convenient. All stores are open seven days a week, from
9:00 a.m. to 9:30 p.m., Monday through Friday, with slightly reduced hours on
weekends, totaling approximately 83 hours per week.
Pharmacy. While pharmacy is not the main focus of the Cost Cutters chain,
two Cost Cutters locations house their own pharmacies and the Company has
recently added Drug Fair pharmacies as separate storefronts adjacent to two of
its Cost Cutters locations with a pass-through between the two stores. The
Company believes there is an opportunity to add Drug Fair pharmacies to certain
additional Cost Cutters stores depending on factors such as location, store
size, layout and competition. The Company estimates that it costs $75,000 to
$100,000 to install a Drug Fair pharmacy next to an existing Cost Cutters
location (assuming construction of a new storefront is required), excluding
costs of staffing and inventory.
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<PAGE>
General Merchandise. With over 59,000 non-pharmacy SKUs, including
seasonal items, and substantial overlap in merchandise with Drug Fair, Cost
Cutters distinguishes itself through its merchandise presentation, pricing
strategy, assortment of items targeted to impulse purchases and a strong
merchandising position in greeting cards, stationery, seasonal items and
household products. In addition to traditional retail drugstore merchandise
such as health and beauty care items, OTC pharmaceuticals, candy and seasonal
items, Cost Cutters also sells luggage, kitchenware and an extended selection
of houseware products and automotive-related goods. One of the Company's
merchandising strategies is a high-impact merchandise presentation based on
well-stocked shelves that are highly visible to the customer, promoting a value
superstore image. Seven Cost Cutters locations contain on-site one-hour
photofinishing labs.
Cost Cutters is less promotional than most other discount stores because
it utilizes an everyday low price strategy. Competitors such as Caldor and
Bradlees generally employ what is known as a "high-low" pricing strategy, in
which everyday prices are generally higher than at Cost Cutters but are reduced
below Cost Cutters' prices during periodic store-wide sales. The Company
believes that Cost Cutters' pricing strategy is more attractive to consumers
than alternative pricing strategies for the majority of its product offerings,
including health and beauty care products that are typically purchased when
needed as opposed to when offered on sale.
Advertising and Promotion
The Company aggressively advertises its Drug Fair and Cost Cutters chains
through extensive use of colorful, high-quality direct mail circulars
distributed to its neighborhood markets. Approximately 22 Drug Fair circular
programs are distributed annually, with each circular typically containing a
selection of approximately 200 specially priced items chosen to build customer
traffic. Cost Cutters distributes approximately 17 circular programs annually,
each containing approximately 200 items, of which 10% to 15% have been reduced
in price. The circulars often contain coupons good for item discounts and
advertise "Special" and "Bonus" buys. "Special" buys are items that are carried
at reduced prices while supplies last. "Bonus" buys are items carried every day
that include an additional amount of the same product or another product for no
extra cost. In some cases the body of the circulars for both chains are
identical, with different outside covers or "wraps," which allows the Company
to save advertising costs. In such cases, the products advertised in the body
generally represent regular everyday low prices for Cost Cutters and discounted
prices for Drug Fair. The Company estimates the average circular program costs
$140,000 to produce and distribute to approximately 600,000 recipients,
although in some cases the cost is partially offset by co-op advertising
rebates received from featured suppliers. The Company is also experimenting
with "marriage-mailing" its circulars with circulars from other merchandisers
to further save on advertising costs.
Purchasing and Distribution
By operating both Drug Fair and Cost Cutters chains, the Company believes
that it is able to take advantage of economies of scale available to larger
chains in purchasing merchandise and maintaining up-to-date systems and
technology. Although the Company utilizes two separate retail formats, the 43
stores are operated as one company through centralized purchasing and
distribution and use complementary marketing strategies. The Company believes
that its focus on consistent execution of its purchasing, pricing and
merchandising strategies has been instrumental in its success to date.
The Company maintains centralized budgeting, pricing, purchasing,
warehousing and inventory control functions at its corporate offices. Products
are purchased for both store chains by merchandise managers, each of whom is
responsible for a distinct product category (for example, cosmetics or
housewares) and reports directly to the Company's Chief Executive Officer.
Approximately 55% of all non-prescription purchases are received at the
Company's central warehouse and distribution center in Somerville, New Jersey.
These products are delivered to the stores by the Company's eight owned trucks.
The balance of general merchandise is shipped directly to the stores by
manufacturers and distributors. All prescription drugs are shipped directly to
the individual stores by wholesale drug distributors on a daily basis. The
Company has a supply agreement with Cardinal Health, Inc. ("Cardinal") that
requires it to purchase at least 90% of its pharmacy products from Cardinal.
The initial term of the Company's supply agreement with Cardinal expires in
January 2000. Pursuant to the terms of the Cardinal Agreement, the Company
purchases pharmacy products at a specified discount to Cardinal's Cost (as
defined in the Cardinal Agreement). The Company believes that Cardinal's Cost
(as defined in the Cardinal Agreement) is higher than Cardinal's actual cost
for the pharmaceutical products it supplies because it does not reflect all
discounts that may be available to Cardinal from
45
<PAGE>
its suppliers. Neuman Distributors, Inc. serves as a secondary supplier for
products that are not routinely carried by or are out of stock at Cardinal, and
the Company believes that its pharmacy products are readily available from
numerous other wholesale suppliers of pharmacy products that would be able to
supply the Company's requirements on substantially similar terms in the event
that Cardinal and Neuman Distributors, Inc. were unable to do so. The Cardinal
Agreement does not provide for specific penalties in the event of a breach by
either party. Management believes that by operating both chains it is able to
purchase most of its products at competitive prices by purchasing products in
truck-load or container quantities. Seasonal merchandise is warehoused and
distributed independently of general merchandise.
The Company buys products from more than 1,600 suppliers and manufacturers
and seeks to purchase its merchandise directly from manufacturers in order to
take advantage of promotional programs offered only to retailers, including
co-op advertising allowances, promotional displays and materials and price
promotions. The Company believes that its relationships with its vendors are
good. The Company often utilizes prompt cash payments to obtain additional
merchandise discounts. None of the Company's suppliers or manufacturers
represented more than 10% of the Company's total non-pharmacy purchases during
fiscal 1997.
Management Information Systems
The Company operates an in-house data processing system in connection with
the operation and management control functions of its business. This system
incorporates both proprietary and commercially available software, including
E-3 buying systems and Lawson Associates payroll systems, and is designed to
integrate the key retailing functions of merchandise planning, purchase order
management, sales capture, merchandise distribution, receiving, order entry,
inventory control and replenishment. Management believes its systems enable the
Company to maintain a virtually constant "in-stock" position in all key lines
of merchandise. In anticipation of continued growth, the Company is
implementing a new comprehensive processing system developed by JDA Software,
Inc., which it expects to integrate by June 30, 1998.
The Company monitors inventories and sales at its 43 stores through a
point-of-sale network, utilizing IBM Chain Drug software and hardware, which
links store terminals to a central computer located at the Company's
headquarters. The Company uses this system to replenish store inventories from
its central warehouses and to provide management with detailed information on
individual store operations on a daily basis.
All sales data is recorded by cashiers, utilizing scanners, in each store
at the time of sale. Sales data is transmitted to the central computer where it
is compiled to produce daily, weekly and monthly management reports. Reports
are organized by line of merchandise, class, item and store, and enable
management to monitor sales and profitability by location. Based upon this
information, management makes merchandising decisions as required, including
reorders, special promotions and changes in buying programs. As a means of
further inventory verification, physical inventories are taken twice a year at
all stores and the warehouses. The Company also employs Telxon and Symbol
Technologies radio frequency equipment in order to constantly monitor and
update inventory, shelf labels and prices.
The Company expects to install a new warehouse management system including
bar-code scanning and radio frequency technologies at its new distribution
center into which it expects to move its distribution operations in 1998.
Although the Company believes that the majority of its computer software
applications and systems will not be affected by the "year 2000" dating
problem, a small portion of such computer software applications and systems
will have to be modified, upgraded or replaced to accommodate the "year 2000"
dating changes necessary to permit correct recording of year dates for 2000 and
later years. The Company does not expect that the cost of its planned year 2000
compliance program will be material to its financial condition or results of
operations. The Company believes that it will be able to achieve compliance by
the end of 1999, and does not currently anticipate any material disruption in
its operations. In the event that any of the Company's significant suppliers
does not successfully and timely achieve year 2000 compliance, the Company's
business or operations could be adversely affected.
All of the Company's stores contain Sensormatic Electronic Article
Surveillance Systems designed to minimize theft. Since its installation four
years ago, this system has contributed to reducing overall shrinkage to
approximately 1.5% of sales, which management believes is below the industry
average.
Properties
The Company's current stores by location, year opened, year refurbished
and size are as follows:
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<PAGE>
Drug Fair
<TABLE>
<CAPTION>
Square
Location Opened/Refurbished Footage
<S> <C> <C>
South Plainfield 1959/1994 21,250
Manville 1965/1991 20,000
Old Bridge 1969/1992 16,527
Edison 1970/1992 15,000
Freehold 1970/1994 16,000
Westfield 1972/1991 23,424
Aberdeen 1974/1993 11,620
Fairfield 1976/1991 19,600
Hazlet 1976/1991 12,000
Berkeley Heights 1977/1993 16,800
Milburn 1977/1992 21,112
Warren 1978/1991 15,000
Ridgewood 1981/-- 20,800
Wyckoff 1981/1995 15,960
Rahway 1983/1993 13,900
Isellin 1985/1993 16,265
Englewood 1988/1992 13,440
Cranford 1989/-- 13,661
Oakland 1989/-- 20,205
Middlesex 1991/-- 23,000
Stirling 1993/-- 15,777
Verona 1995/-- 17,200
Clifton 1996/-- 11,200
Ramsey 1996/-- 17,000
Somerset 1996/-- 18,050
Plainfield 1997/-- 18,000
Hillside 1998/-- 17,600
Florham Park 1998/-- 12,750
</TABLE>
Cost Cutters
<TABLE>
<CAPTION>
Square
Location Open/Refurbished Footage
<S> <C> <C>
Norwood 1983/1992 24,630
Bricktown 1984/1993 26,878
Manalapan 1984/1992 24,450
Middletown 1984/1993 27,988
Hamilton 1985/1993 33,300
Union 1985/1994 35,217
West Long Branch 1986/1996 27,113
Wall 1987/1993 30,000
Hillsborough 1990/1994 20,600
Parsippany 1991/-- 29,575
Lacey 1992/-- 34,000
Wayne 1992/-- 29,000
Ocean 1993/-- 36,890
Toms River 1994/-- 34,000
Chatham 1995/-- 20,800
Elizabeth 1995/-- 25,000
Lincoln Park 1995/-- 30,100
</TABLE>
All the Company's stores are leased pursuant to long-term leases
containing generally favorable terms. The current leases expire between
December 31, 1997 and April 30, 2039 (assuming renewal options are exercised),
with an average of 15 years remaining on lease terms. Eight of these leases
will expire by the end of 2000, 18 leases will expire between 2001-2015 and 17
leases will expire after 2015. The Company expects to close its Ridgewood, New
Jersey store when its lease expires in the third quarter of fiscal 1998. This
lease did not provide for an extension past its expiration date, and the
landlord and the Company were not able to come to mutually acceptable terms for
renewal of the lease. Management does not expect that the Company will incur
material costs in connection with the closing of this store.
The Company is committed to keeping its stores modern through continual
upgrades and refurbishments. Over the past six years, the Company has remodeled
and refurbished all but one store opened prior to 1989, at a cost of
approximately $125,000 per store. The Company works closely with an interior
design firm to develop updated interior concepts. The Company believes that the
size of its stores is sufficient for their current format.
The Company's leases for its corporate office and warehouse facilities
expire in 1998 and, although the Company believes its current facility is
sufficient for its purposes, the Company intends to consolidate its corporate
offices and two warehousing operations at a single new facility close to its
existing corporate headquarters. The Company is seeking a suitable location and
anticipates that this facility will be approximately 200,000 square feet in
size. The Company intends to lease this facility and believes that the facility
will improve operating efficiencies in several areas, particularly distribution
and inventory control.
Competition
The Company competes in its markets with several national, regional and
local drugstore chains, large grocery stores and supermarkets, membership
clubs, deep discount drugstores, combination food and drugstores, discount
general merchandise stores, mass merchandisers, independent drugstores and
local merchants. Historically,
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<PAGE>
consumers were faced with few alternatives for filling their prescriptions.
Today's customer has a number of options including independent or chain
drugstores, food retailers, mass merchants (including discounters and deep
discounters) and "mail-order" pharmacies, as well as supermarkets, combination
food and drugstores, hospitals and HMOs. The Company's on-site one-hour
photofinishing labs also compete with a variety of mini-lab photo-processors
and photo-specialty shops.
The Company believes that the primary elements of competition in its
industries include pricing, store location and design, product selection,
customer service and convenience. The Company believes that it competes
successfully because of its pricing policies, reputation for reliability,
convenient store locations, superior pharmacy services, broad selection of
merchandise and effective sales techniques. However, the competitive
environment is often affected by factors beyond a particular retailer's
control, such as shifts in consumer preferences, economic conditions and
population and traffic patterns. The Company believes that in the future the
ability to compete effectively will be increasingly dependent on quality
merchandising and customer service, the effectiveness of cost containment
measures, especially with respect to pharmacy services, and advanced
information systems.
Government Regulation
Pharmacies are subject to extensive federal, state and local regulation.
These regulations cover required qualifications, day-to-day operations,
reimbursement and documentation of activities.
Licenses and Regulation. The Company's pharmacists are required to be
licensed by the New Jersey Board of Pharmacy. All stores with pharmacies and
the Company's distribution centers are also registered with the Federal Drug
Enforcement Administration, although no pharmaceuticals are stored in the
distribution centers. Various other federal and state licenses (including state
licenses required to sell cigarettes) are required for the conduct of the
Company's business as presently conducted. The Company seeks to comply with all
such licensing and registration requirements and continues to actively monitor
its compliance with such requirements. By virtue of these licenses and
registration requirements, the Company will be obligated to observe certain
rules and regulations, and a violation of such rules and regulations could
result in a suspension or revocation of one or more licenses or registrations
and/or monetary penalties or fines. The sale of pharmaceutical products at new
stores requires the issuance of additional licenses, with respect to which the
licensing authorities may conduct investigations.
In 1990, the United States Congress enacted the Omnibus Budget
Reconciliation Act of 1990 (OBRA), which required states to implement
pharmaceutical drug use review programs for Medicaid beneficiaries by January
1, 1993. Under OBRA, pharmacists are required to offer counseling, without
additional charge, to customers covered by Medicaid about medication, dosage,
delivery systems, common side effects and other information deemed significant
by the pharmacists. The State of New Jersey enacted broader regulations that
require pharmacists to provide such counseling to all customers, regardless of
whether they are covered by Medicaid. As a result, the Company's pharmacists
must provide counseling to customers and have a duty to warn customers
regarding any potential adverse effects of a prescription drug if the warning
could reduce or negate such effects. In addition, the Company's pharmacists are
required to conduct a prospective drug review before any new prescriptions are
dispensed, and may conduct a similar review prior to refilling any
prescriptions if considered appropriate. Such reviews include screening for
potential drug therapy problems due to (i) therapeutic duplication, (ii)
drug-disease contraindications, (iii) drug-drug interactions, (iv) incorrect
drug dosage or duration of drug treatment, (v) drug-allergy interactions, and
(vi) clinical abuse or misuse. Further, New Jersey closely regulates the
dispensing by pharmacists of over-the-counter controlled dangerous substances,
imposing requirements as to: (i) filling and refilling of prescriptions, (ii)
labeling of prescriptions, and (iii) monitoring the use of Schedule V
over-the-counter controlled dangerous substances to determine, in a
pharmacist's professional judgment, whether the substance has or will be used
for unauthorized or illicit consumption or distribution. The Company believes
its series of training programs for pharmacy personnel and its pharmacy
computer network are designed to ensure that these requirements are satisfied,
but violations of these regulations could have an adverse impact on the
Company.
State Laws Affecting Access to Services. In July 1994, the State of New
Jersey adopted "Freedom of Choice" and "Any Willing Provider" legislation,
which the Company believes results in a "level playing field" in New Jersey for
regional drugstore chains such as the Company. The "Freedom of Choice"
legislation permits Third-Party Plan participants to purchase prescription
drugs from the provider of their choice if the provider meets uniformly
established requirements. In states which have not adopted similar legislation,
many Third-Party Plans align themselves by agreement with particular drugstore
chains under arrangements whereby members of a Third-Party Plan are required to
purchase their drugs at a particular drugstore chain in order for most or all
of the cost to be
48
<PAGE>
paid by the Third-Party Plan. As a result, other drugstore chains and
independent drugstores are in effect precluded from selling prescription drugs
to the applicable members. The "Any Willing Provider" legislation requires that
any Third-Party Plan that has entered into an agreement with a prescription
provider must permit any other licensed provider to participate in such
Third-Party Plan as a preferred or contracting provider if it is willing to
accept the terms of such agreement. Such legislation may increase competition
for the Company's pharmacies.
Medicare and Medicaid. The pharmacy business has long operated under
regulatory and cost containment pressures from state and federal legislation
primarily affecting Medicaid and, to a lesser extent, Medicare.
The Medicaid program is a cooperative federal-state program designed to
enable states to provide medical assistance to aged, blind, or disabled
individuals, or members of families with dependent children whose income and
resources are insufficient to meet the costs of necessary medical services.
Federal laws and regulations contain a variety of requirements relating to
the furnishing of prescription drugs under Medicaid. First, states are given
authority, subject to certain standards, to limit or specify conditions to the
coverage of particular drugs. Second, federal Medicaid law establishes
standards affecting pharmacy practice, such as the OBRA counseling and drug
utilization review requirements described above. Third, federal regulations
impose certain requirements relating to the reimbursement for prescription
drugs furnished to Medicaid recipients. Among other things, federal regulations
establish "upper limits" on payment levels. In addition to requirements imposed
by federal law, states have substantial discretion to determine administrative,
coverage, eligibility and payment policies under their state Medicaid programs
which may affect the Company's operations.
The Medicare program is a federally funded and administered health
insurance program for individuals age 65 and older or who are disabled.
Medicare covers a limited number of specifically designated prescription drugs.
As part of the Balanced Budget Act of 1997, reimbursement for these products is
generally limited to 95% of the published average wholesale price for such
products. An increasing number of Medicare beneficiaries are being served
through health maintenance organizations. In addition to the limited Medicare
coverage for specified products described above, some health maintenance
organizations providing health care benefits to Medicare beneficiaries may
offer expanded drug coverage.
The Medicare and Medicaid programs are subject to statutory and regulatory
changes, retroactive and prospective rate adjustments, administrative rulings
and freezes and funding restrictions, all of which may adversely affect the
Company's business. There can be no assurance that payments for pharmaceutical
supplies and services under governmental reimbursement programs will continue
to be based on the current methodology or remain comparable to present levels.
In this regard, the Company may be subject to rate reductions as a result of
federal budgetary legislation related to the Medicare and Medicaid programs. In
addition, various Medicaid programs periodically experience budgetary
shortfalls which may result in Medicaid payment delays.
Fraud and Abuse. The Company is subject to federal and state laws
prohibiting the submission of false or fraudulent claims and governing its
billing relationships and financial and other arrangements between health care
providers. These laws include the federal anti-kickback statute, which
prohibits, among other things, knowingly and willfully soliciting, receiving,
offering or paying any remuneration directly or indirectly to induce or in
return for the referral of an individual to a person for the furnishing of any
item or service for which payment may be made in whole or in part under federal
health care programs. Many states have enacted similar statutes which are not
necessarily limited to items and services for which payment is made by federal
health care programs. New Jersey, for example, enacted the "Healthcare Cost
Reduction Act" in 1991. Federal and state courts have interpreted these laws
broadly. Violations of these laws may result in fines, imprisonment, civil
money penalties and exclusion from the federal and state funded health care
programs.
The Department of Health and Human Services Office of Inspector General
has issued a "Special Fraud Alert" concerning prescription drug marketing
practices that could potentially violate the federal anti-kickback statute.
According to the Special Fraud Alert, examples of practices that may implicate
the statute include certain arrangements under which remuneration is made to
pharmacists to recommend the use of a particular pharmaceutical product.
In addition, a number of states have undertaken enforcement actions
against pharmaceutical manufacturers involving pharmaceutical marketing
programs, including programs containing incentives to pharmacists to dispense
one particular product rather than another. These enforcement actions arose
under state consumer protection laws which generally prohibit false
advertising, deceptive trade practices, and the like.
49
<PAGE>
The Company seeks to maintain its contract arrangements with other health
care providers, its pharmaceutical suppliers and its pharmacy practices in
compliance with these laws. There can be no assurance that such laws will not,
however, be interpreted in the future in a manner inconsistent with the
Company's interpretation and application.
Health Care Legislation. Prescription drug sales have represented a
significant portion of the Company's revenues. These revenues may be affected
by changes within the health care industry, including changes in programs
providing for reimbursement of the cost of prescription drugs by Third-Party
Plans, regulatory changes relating to the approval process for prescription
drugs and proposals to reduce significantly projected increases in federal
spending on Medicare, Medicaid and other governmental programs.
In recent years, a number of legislative proposals have been introduced in
Congress to reform the health care system, including proposals in the context
of federal budget legislation. In addition, a number of states have enacted and
are considering various health care reforms. For example, several state
Medicaid programs have established mandatory statewide managed care programs
for Medicaid beneficiaries to control costs through negotiated or capitated
rates, as opposed to traditional cost based reimbursement for Medicaid
services, and proposed to use savings achieved through these programs to expand
coverage to those not previously eligible for Medicaid. Also, legislation to
reform the FDA, if enacted, could expressly permit pharmacy drug compounding
under certain conditions for individual patients. This could maintain and
increase the range of services provided by the Company. The Company cannot
predict whether or in what form health care legislation may be adopted in the
future, at the federal or state level, or the impact of any such legislation on
the Company's financial position or results of operations. However, to the
extent health care legislation expands the number of persons receiving health
care benefits covering the purchase of prescription drugs (such as through
government-sponsored managed care initiatives), it could result in increased
purchases of such drugs and could thereby have a favorable impact on both the
Company and the retail drug industry in general. Nevertheless, there can be no
assurance that any such legislation will be enacted or, if enacted, that such
legislation will not have an adverse effect on the Company.
Labor Laws. The Company is subject to laws governing its relationship with
employees, including minimum wage requirements, overtime and working
conditions. An increase in the minimum wage rate, employee benefit costs or
other costs associated with employees could adversely affect the Company.
Trade Names, Service Marks and Trademarks
The Company uses various trade names, service marks and trademarks,
including "Drug Fair" and "Cost Cutters," in the conduct of its business.
Historically, the Company has relied on common law protection of its trade
names, service marks and trademarks. Common law provides the Company with
limited protection for its trade names, service marks and trademarks within its
product lines and in its geographic market areas. Although the Company recently
filed a federal service mark registration application for the service mark
"Drug Fair," a third party which does not currently operate in the Company's
geographic markets owns an issued federal service mark registration for the
name "Cost Cutters." See "Risk Factors--Reliance on Trade Names, Service Marks
and Trademarks."
Employees
As of December 31, 1997, the Company had approximately 1,550 employees of
which approximately 43% were full-time and 57% were part-time. None of such
employees are covered by collective bargaining agreements or represented by
unions. The Company has not experienced any material business interruption as a
result of labor disputes and the Company considers its employee relations to be
good.
Litigation and Environmental Matters
The Company is from time to time involved in routine litigation incidental
to the conduct of its business. The Company believes that no current pending
litigation to which it is a party will, individually or in the aggregate, have
a material adverse effect on its financial position or results of operations or
cash flows. The Company has not been required to expend in the past, and does
not expect to be required to expend in the future, any significant amounts for
investigation of environmental conditions, remediation of environmental
conditions or other similar matters.
50
<PAGE>
MANAGEMENT
Directors, Executive Officers and Key Employees
The following table sets forth certain information with respect to the
directors, executive officers and key employees of the Holding Company and the
Company:
<TABLE>
<CAPTION>
Years with
Name Age Title Company
- ------------------------- ----- ---------------------------------------------------- -----------
<S> <C> <C> <C>
Frank Marfino 54 President, Chief Executive Officer and Director of 15
the Holding Company and the Company
Lynn L. Shallcross 56 President--Cost Cutters Division of the Company 25
Todd H. Pluymers 33 Chief Financial Officer of the Holding Company 6
and the Company
Barrie Levine 52 Vice President--Pharmacy Operations of the 5
Company
William F. Gilligan 55 Vice President--Distribution of the Company 12
Kevin Marron 40 Director--MIS of the Company 11
Alan J. Kirschner 43 Director--Loss Prevention of the Company 6
Mark H. DeBlois 41 Director of the Holding Company and the Company 2
Harvey P. Mallement 57 Director of the Holding Company and the Company 2
</TABLE>
Mr. Marfino has been a Director and the President and Chief Executive
Officer of the Holding Company and the Company since February 1995. Prior to
February 1995, Mr. Marfino had served as the Chief Operating Officer of the
Company beginning in 1990 after having served as Vice President in charge of
Operations and Merchandising. Prior to joining the Company in 1982, Mr. Marfino
held senior positions, including Regional Manager and Director of
Administrative Operations with Two Guys Discount Stores/Vorando, Inc. over a 19
year period. Mr. Marfino has 30 years of experience in the retail industry.
Mr. Shallcross has been President of the Cost Cutters division since 1984.
Mr. Shallcross joined the Company in 1971 and has held numerous positions in
management including pharmacist, pharmacist-manager, and district manager. Mr.
Shallcross is a graduate of Rutgers College of Pharmacy and has been a licensed
pharmacist since 1964.
Mr. Pluymers joined the Company in April 1991 as Chief Financial Officer
and was appointed Chief Financial Officer of the Holding Company in January
1995. Prior to joining the Company, Mr. Pluymers was employed by Arthur
Andersen & Co. from 1986 through 1991, most recently as an Audit Manager. Mr.
Pluymers is a graduate of Westminster College with a degree in Business
Administration/Accounting and is a Certified Public Accountant.
Mr. Levine joined the Company as Vice President--Pharmacy Operations in
1993. Prior to joining the Company, Mr. Levine was employed by Supermarkets
General (Pathmark) since 1971. At Pathmark, Mr. Levine held various positions,
including Regional Pharmacy and Regional Front-End Supervisor, Regional
Non-Food Product Manager, and Manager of Pharmacy Services. Mr. Levine is a
graduate of Brooklyn College of Pharmacy and a licensed pharmacist in several
states.
Mr. Gilligan has been Vice President--Distribution since 1985 after
serving as General Manager for 11 years with Atlantic Distribution Center in
Jersey City, New Jersey and 11 years with Wakefern Food Corporation, parent
company of Shop-Rite supermarkets. Trained in distribution management at Ohio
State University and Rutgers University, Mr. Gilligan is responsible for the
daily management of the distribution center, transportation logistics, property
management and the administrative staff. Mr. Gilligan has over 30 years of
experience in Distribution-Warehouse Management.
Mr. Marron has been Director--Management Information Systems for the
Company since 1986. Mr. Marron's work experience includes six years with
Arthur's Catalog Showroom and six years with MIS Software Corporation prior to
joining the Company. Mr. Marron has been instrumental in the creation of
several proprietary software
51
<PAGE>
applications for the Company, including inventory management, sales, marketing,
distribution, warehouse management, shelf labeling and point-of-sale in store
applications.
Mr. Kirschner joined the Company as Director--Loss Prevention in 1991.
Prior to 1991, Mr. Kirschner held a similar position with NBO Menswear and
Rickel Home Centers, Inc. Mr. Kirschner is a graduate of Jersey City State
College.
Mr. DeBlois has been a Director of the Holding Company and the Company
since 1995. Since 1990, Mr. DeBlois has been employed as an officer, most
recently as a Managing Director, of BancBoston Ventures Inc., a private equity
investment firm with committed capital in excess of $750 million that provides
private equity and mezzanine financing to middle market companies for
management-led buyouts, acquisitions and growth capital. Mr. DeBlois is a
graduate of Boston College.
Mr. Mallement has been a Director of the Holding Company and the Company
since 1995. Since 1981, Mr. Mallement has been Managing General Partner of
Harvest Partners, Inc., a private equity investment and growth financing firm
with committed capital in excess of $250 million that provides equity
investment financing that focuses on the acquisition of medium sized companies
and financing of growth businesses. Mr. Mallement is also a director of Symbol
Technologies, Inc. and is a graduate of the City College of New York with a
masters degree in Business Administration.
Pursuant to a Stockholder Agreement entered into as of January 30, 1995,
as amended, the holders of a substantial majority of the outstanding common
stock of the Holding Company (the "Common Stock"), including BancBoston
Ventures, Inc. and Harvest Partners International, L.P., and their affiliates,
as well as the Holding Company, Banque Paribas, Paribas Principal, Inc., TA
Holding, Inc., Jon Tietbohl and Frank Marfino, have agreed that each of the
Holding Company and the Company will have a Board of Directors comprised of up
to five members. The stockholders party to the Stockholder Agreement have
agreed to vote for the following persons as directors: (i) up to two
individuals designated by the holders of a majority of the outstanding shares
of Common Stock purchased by BancBoston in 1995 (the "BBV Stock"); (ii) up to
two individuals designated by the holders of a majority of the outstanding
shares of Common Stock purchased by Harvest and its affiliates in 1995 (the
"Harvest Stock"); and (iii) Frank Marfino, so long as he continues to be
employed by the Holding Company as President and Chief Executive Officer, and
thereafter, his successor as President and Chief Executive Officer. Mr. DeBlois
has been designated for election to the Board of Directors of the Holding
Company and the Company by the holders of a majority of the BBV Stock, and Mr.
Mallement has been designated for election to the Board of Directors of the
Holding Company and the Company by the holders of a majority of the Harvest
Stock.
Executive officers of the Holding Company and the Company are appointed by
their respective Boards of Directors on an annual basis and serve until their
successors have been duly elected and qualified. There are no family
relationships among any of the executive officers and directors of the Holding
Company and the Company.
Compensation of Directors
Directors of the Holding Company and the Company do not receive
compensation from the Holding Company or the Company for their service in such
capacities.
During fiscal 1997 the Company paid $20,000 each to two outside directors
of the Company and the Holding Company for their services as directors during
such period. Each of these individuals resigned as directors of the Company and
the Holding Company prior to the issuance of the Existing Notes.
Executive Compensation
The following table sets forth the aggregate compensation paid by the
Company for services rendered during fiscal 1997 to the Company's Chief
Executive Officer and four other most highly-compensated executive officers.
52
<PAGE>
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation for Fiscal 1997
---------------------------------------------
All Other
Name and Principal Position Salary Bonus (1) Compensation (2)
<S> <C> <C> <C>
Frank Marfino
President and Chief Executive Officer $431,692 $228,680 $3,748
Lynn L. Shallcross
President--Cost Cutters Division $167,135 $ 50,000 $2,586
Todd H. Pluymers
Chief Financial Officer $133,606 $ 26,000 $ 741
Barrie Levine
Vice President--Pharmacy Operations $124,423 $ 12,200 $1,620
William F. Gilligan
Vice President--Distribution $107,231 $ 17,500 $1,738
</TABLE>
- ------------
(1) Reflects bonuses paid during fiscal 1997 with respect to the achievement of
certain performance goals relating to fiscal 1996. The amounts of annual
bonuses that may be paid to the named executive officers for fiscal 1997
have not yet been determined. In addition, it is expected that the Company
will pay one-time performance-related bonuses to Mr. Marfino and Mr.
Pluymers aggregating approximately $1.4 million. It is expected that these
bonuses will be paid in one or more installments over the next nine
months. See "Certain Relationships and Related Transactions."
(2) Amounts include the values of the personal use of company cars equal to
$1,300, $520, $520, $520 and $520 for each of Messrs. Marfino, Shallcross,
Pluymers, Levine and Gilligan, respectively, as well as the incremental
cost of additional life insurance premiums in the amounts of $2,448,
$2,066, $221, $1,100 and $1,218, for each of Messrs. Marfino, Shallcross,
Pluymers, Levine and Gilligan, respectively.
The following table sets forth the number of options to purchase Common
Stock held by the Company's Chief Executive Officer as of the end of fiscal
1997. None of the Company's four other most highly-compensated executive
officers held any options to purchase Common Stock as of the end of fiscal
1997, and there were no options to purchase Common Stock granted during fiscal
1997.
Fiscal Year End Option Values
<TABLE>
<CAPTION>
Number of Securities
underlying unexercised Value of unexercised
Options at Fiscal Year In-the-Money Options
End (#) at Fiscal Year-End ($)
Exercisable/Unexercisable Exercisable/Unexercisable(1)
--------------------------- -----------------------------
<S> <C> <C>
Frank Marfino ......... 21,334/21,001 $179,206/$176,408
</TABLE>
- ------------
(1) The value of unexercised in-the-money options (each of which was granted in
January 1995) is determined by determining the difference between the book
value of the Common Stock underlying the options at the end of fiscal 1997
($18.40) and the option exercise price. The Common Stock was not publicly
traded at the end of fiscal 1997.
53
<PAGE>
Employment Agreements
In connection with the acquisition of the Company by the Holding Company
in 1995, the Company entered into Employment Agreements with each of Messrs.
Marfino, Shallcross, Pluymers, Levine and Gilligan. Each of these Employment
Agreements contains customary confidential information and inventions
assignment provisions and provides for a one-year non-competition period upon
termination.
Mr. Marfino's Employment Agreement, which expires in January 2001,
provides for Mr. Marfino to receive an annual base salary of $450,000 (subject
to annual increases based on a consumer price index), and an incentive bonus
based on the financial performance of the Company. Mr. Marfino is not entitled
to receive a bonus for any fiscal year in which the Company's Actual EBITDA (as
defined in the Employment Agreement) is less than 90% of a forecasted EBITDA.
In the event that Actual EBITDA is more than 90% of forecasted EBITDA, Mr.
Marfino will receive a bonus calculated with respect to the amount by which
Actual EBITDA exceeds forecasted EBITDA, of which $50,000 is guaranteed. In the
event that Mr. Marfino's employment is terminated by the Company prior to the
end of the term of the Employment Agreement or any extension thereof, or he
resigns under circumstances in which he is deemed to have terminated his
employment for Good Reason (as defined therein), Mr. Marfino is entitled to
receive his base salary through the end of the initial term of his Employment
Agreement or any extension term and a pro rated minimum bonus and incentive
bonus. In the event that Mr. Marfino's employment is terminated as a result of
death or disability, Mr. Marfino or his estate is entitled to severance pay of
one year of base salary and a pro rated minimum bonus and incentive bonus. In
the event that Mr. Marfino's employment is terminated upon the expiration of
the term of the Employment Agreement or any extension term, Mr. Marfino shall
be entitled only to receive a pro rated minimum bonus and incentive bonus.
The Employment Agreements for Messrs. Shallcross, Pluymers, Levine and
Gilligan, each of which expires in January or February of 1998, currently
provide for base salaries of $168,000, $137,500, $125,000 and $108,000,
respectively. In the event that the employment of any of these officers is
terminated during the respective terms of their Employment Agreements for
death, disability, resignation or termination by the Company other than for
"cause," the relevant officer will receive severance pay of his base salary for
one year after termination. No severance pay is payable under any of the
Employment Agreements in the event of termination for "cause."
Compensation Committee Interlocks and Insider Participation
Neither the Board of Directors of the Company, nor the Board of Directors
of the Holding Company, has ever maintained a compensation committee. Executive
compensation decisions are considered and decided by all of the directors of the
Company. All executive compensation decisions relating to fiscal 1997 were
decided by Mark DeBlois, Harvey Mallement, Robert Zimmerman, Peter Gould and
Frank Marfino, each of whom was a director of the Company during all of fiscal
1997. Messrs. Zimmerman and Gould are no longer directors of the Company or the
Holding Company. No officers or employees of the Company or the Holding Company
other than Mr. Marfino, the President and Chief Executive Officer of the Company
and the Holding Company, participated in any discussions of the Board of
Directors of either company regarding executive compensation.
Indebtedness of Management
During fiscal 1997, Mr. Frank Marfino, the President and Chief Executive
Officer of the Holding Company and the Company, and a director of the Holding
Company and the Company, had an outstanding loan from the Company which was
incurred by Mr. Marfino in connection with his purchase of shares of capital
stock of the Company concurrently with the acquisition of the Company by the
Holding Company in January 1995. In connection with this loan, Mr. Marfino
executed a full-recourse promissory note to the Company which required Mr.
Marfino to pay cash interest at a rate of 8% per annum. The largest amount of
this loan that was outstanding during fiscal 1997 was $173,334, and this loan
was repaid in October 1997. See "Certain Relationships and Related
Transactions."
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In January 1995, the Holding Company, which was formed for purposes of
acquiring the Company by BancBoston, Harvest and certain other investors,
including certain members of the Company's management, acquired the Company
through a merger of a wholly-owned subsidiary of the Holding Company with and
into the Company in which the old stockholders of the Company received cash for
their shares of stock of the Company.
In connection with the acquisition of the Company in 1995, the following
officers, directors and holders of five percent or more of the Common Stock of
the Holding Company paid the following amounts set forth below for their
interests in the Holding Company. In addition, the Holding Company paid
transaction-related fees of $500,000 each to each of Harvest and First Capital
Corporation, an affiliate of BancBoston.
54
<PAGE>
Consideration Paid in Connection with Acquisition
<TABLE>
<CAPTION>
Shareholder Consideration
- -------------------------------------------------------- --------------
<S> <C>
BancBoston ............................................. $2,301,110
Harvest ................................................ 781,871
Harvest Technology Partners, L.P. ...................... 252,901
European Development Capital Corporation N.V. .......... 227,611
DBG Auslands--Holding GmbH ............................. 1,038,727
Frank Marfino .......................................... 50,000
Paribas Principal, Inc. ................................ 400,000
</TABLE>
The total consideration paid by the Holding Company to the former owners
of the Company in connection with the acquisition of the Company by the Holding
Company was approximately $85.0 million. The other investors in this
transaction included The Alexander Fund, TA Holding, Inc. and Jon Tietbohl.
In connection with the acquisition of the Company by the Holding Company,
the Company entered into Employment Agreements with each of Mr. Frank Marfino,
the President and Chief Executive Officer of the Company, Mr. Todd Pluymers,
the Chief Financial Officer of the Company, Mr. Lynn Shallcross, the President
of the Cost Cutters division of the Company, Mr. William Gilligan, the Vice
President--Distribution of the Company and Mr. Barrie Levine, the Vice
President--Pharmacy Operations of the Company. See "Management--Employment
Agreements."
The holders of a substantial majority of the outstanding Common Stock have
also entered into a Stockholder Agreement pursuant to which such stockholders
agreed (i) to vote their shares of Common Stock in favor of a specified size
and composition of the respective Boards of Directors of the Holding Company
and the Company, (ii) not to transfer shares of Common Stock in violation of
such Stockholder Agreement, (iii) to consent to and participate in certain
sales of the Holding Company approved by the Board of Directors of the Holding
Company and holders of a majority of the Common Stock held by each of
BancBoston and Harvest and certain transferees and (iv) not to vote in favor
of, or permit the Board of Directors of the Holding Company to vote in favor
of, certain actions relating to corporate governance, including the borrowing
of money, the payment of dividends and the making of any guarantees of
obligations of other persons, not approved by BancBoston and Harvest. See
"Management--Directors, Executive Officers and Key Employees."
The Company is also bound by Management Fee Agreements each dated as of
January 30, 1995 (as amended, the "Management Fee Agreements"), pursuant to
which the Company is required to pay an annual fee of $125,000 to each of
BancBoston and Harvest Partners, Inc. in consideration for certain management
services provided by such entities in connection with the administration of the
Company's business. These services include providing advice and administrative
oversight with respect to the Company's business direction and policy in the
promotion, development and operation of the Company's business. The Company's
obligations under the respective Management Fee Agreements shall continue so
long as BancBoston or Harvest, as the case may be, owns any shares of capital
stock of the Holding Company. Payments under the Management Agreements will
constitute "Permitted Payments" under the Indenture. See "Description of
Notes."
Banque Paribas, the agent for the Old Credit Facility, holds a presently
exercisable warrant (the "Paribas Warrant") to purchase 16,667 shares of Common
Stock and Paribas Principal, Inc. ("Paribas Principal"), an affiliate of Banque
Paribas, holds 40,000 shares of Common Stock. The Company repaid all amounts
outstanding under the Old Credit Facility with a portion of the proceeds of the
Offering and terminated the Old Credit Facility simultaneously with the closing
of the Offering. After the consummation of the Offering, Paribas Principal
continues to hold 40,000 shares of Common Stock, and the Paribas Warrant
remains outstanding. In connection with the payment of the Dividend, Banque
Paribas and Paribas Principal received approximately $1.66 million and $4.0
million, respectively.
The Holding Company, BancBoston, Harvest, Banque Paribas, Paribas
Principal, Harvest Technology Partners, L.P., European Development Capital
Corporation N.V., Deutsche Beteiligungsgesellschaft mbH, Frank Marfino and
certain other stockholders of the Holding Company are party to a Registration
Rights Agreement, dated as of January 30, 1995, pursuant to which the Holding
Company granted the other parties thereto piggy-back registration rights with
respect to their shares of Common Stock subject to certain limitations in the
event of an underwritten offering, and certain demand registration rights which
are exercisable during certain periods after the initial public offering of
55
<PAGE>
the Common Stock. In addition, if the Holding Company has not completed an
initial public offering of its Common Stock prior to January 30, 2003, the
holders of a majority of the securities initially issued to Banque Paribas and
Paribas Principal are permitted to cause the Holding Company to effect such an
initial public offering pursuant to the terms of the Registration Rights
Agreement.
The Company paid a dividend of approximately $45.0 million to the Holding
Company out of the proceeds of the Offering. The Holding Company paid the
Dividend to its shareholders, including management and certain employees of the
Company, BancBoston and Harvest. Messrs. Marfino, Shallcross, Pluymers,
Gilligan and Levine received approximately $3.6 million, $578,000, $442,000,
$436,000 and $142,000, respectively, and BancBoston, Harvest, Harvest
Technology Partners, L.P. and European Development Capital Corporation N.V.
received approximately $15.9 million, $5.2 million, $1.8 million and $1.4
million, respectively, from the Dividend.
The Company leases the location for its Westfield, New Jersey store from
Jules and Arlene Siegel, the former majority stockholders of the Company,
pursuant to a lease which expires on September 30, 1998. Under the terms of
this lease, the Company is required to pay a monthly rent of $16,592. For the
six months ended July 29, 1995, fiscal 1996 and fiscal 1997, total payments
under this lease aggregated $100,000, $199,000 and $199,000, respectively. The
lessors sold all of their interests in the Company to the Holding Company in
January 1995.
The Company expects to pay one-time performance-related bonuses of
approximately $1.2 million and $200,000 to Mr. Marfino and Mr. Pluymers,
respectively, in one or more installments over the next nine months. These
bonuses will be paid pursuant to a committment made by the Board of Directors
of the Company in October 1997 to grant bonuses to these officers in such
amounts in consideration of the contributions made by such officers to the
growth and success of the Company over the period since its acquisition in
January 1995. The payment of these bonuses will constitute "Exempted Affiliate
Transactions" under the Indenture for purposes of the "Limitation on
Transactions with Affiliates" covenant. See "Description of Notes--Certain
Definitions."
On October 16, 1997, the Holding Company amended all of the Subordinated
Notes to the holders thereof in the same principal amounts in connection with
the issuance of the Existing Notes and the Existing Guarantee. These
Subordinated Notes were reissued in order to expressly provide for the
subordination of the Holding Company's obligations thereunder to the
obligations of the Holding Company under the Indenture, including the
Guarantees. No officers or directors of the Company or the Holding Company hold
any Subordinated Notes, although the following 5% or greater shareholders of
the Holding Company hold Subordinated Notes in the following original principal
amounts:
<TABLE>
<CAPTION>
Noteholder: Principal Amount:
<S> <C>
BancBoston .............................................. $5,753,890
Harvest ................................................. 1,889,970
Harvest Technology Partners, L.P. ....................... 643,210
European Development Capital Corporation, N.V. .......... 505,286
DBG Auslands-Holding GmbH ............................... 2,641,821
Paribas Principal ....................................... 1,400,000
</TABLE>
BENEFICIAL OWNERSHIP
The Holding Company is the beneficial owner, with sole voting power and
investment power, of 100% of the outstanding capital stock of the Company.
The following table sets forth certain information regarding beneficial
ownership of the Common Stock(1) and Preferred Stock(2) of the Holding Company
(i) by each person known to the Company to own beneficially more than 5% of
each class of outstanding voting capital stock of the Holding Company, (ii) by
each director of the Company and the Holding Company, (iii) by each of the
executive officers of the Company and the Holding Company named in the "Summary
Compensation Table," and (iv) by all directors and executive officers of the
Company and the Holding Company as a group, as of December 31, 1997.
56
<PAGE>
<TABLE>
<CAPTION>
Class A Common Stock Preferred Stock
------------------------------------ -----------------------------------
Amount and Nature of Percent Amount and Nature of Percent
Name and Address Beneficial Ownership(3) of Class Beneficial Ownership(3) of Class
<S> <C> <C> <C> <C>
BancBoston Ventures Inc.
175 Federal St.
Boston, MA 02110 ............................ 159,389(4) 43.2% -- --
Mark H. DeBlois
c/o BancBoston Ventures Inc.
175 Federal St.
Boston, MA 02110 ............................ 159,389(5) 43.2% -- --
Harvest Partners International, L.P.
c/o Harvest Partners, Inc.
767 Third Avenue
New York, NY 10017 .......................... 51,851(6) 20.4% -- --
Harvey P. Mallement
c/o Harvest Partners, L.P.
767 Third Avenue
New York, NY 10017 .......................... 83,816(7) 32.9% -- --
Paribas Principal, Inc.
787 Seventh Avenue
New York, NY 10017 .......................... 40,000(8) 15.7% -- --
DBG Auslands-Holding GmbH
Emil-von-Behring-Strasse 2
D-60439 Frankfurt-am-Main
Germany ..................................... 73,525(9) 28.9% -- --
Harvest Technology Partners, L.P.
c/o Harvest Partners, Inc.
767 Third Avenue
New York, NY 10017 .......................... 17,901(6) 7.0% -- --
Banque Paribas
787 Seventh Avenue
New York, NY 10019 .......................... 16,667(8) 6.1% -- --
European Development Capital Corporation N.V.
c/o Harvest Partners, Inc.
767 Third Avenue
New York, NY 10017 .......................... 14,064(6) 5.5% -- --
Frank Marfino ............................... 37,333(10) 14.6% 4,000 50.9%
Lynn L. Shallcross .......................... 8,211(11) 3.2% 1,073 13.6%
Todd H. Pluymers ............................ 6,781(11) 2.7% 715 9.1%
William F. Gilligan ......................... 6,781(11) 2.7% 715 9.1%
Barrie Levine ............................... 2,927(11) 1.1% 143 1.8%
All Directors and Executive Officers as a
Group (7 persons) ........................... 305,238(12) 82.4% 6,646 84.5%
</TABLE>
- ------------
(1) The Common Stock is comprised of Class A Voting Common Stock, $.00001 par
value per share ("Class A Common Stock"), and Class B Non-Voting Common
Stock, $.00001 par value per share ("Class B Common Stock"), each having
the same rights and privileges, other than with respect to voting rights
and
57
<PAGE>
powers. Holders of shares of Class A Common Stock have full voting rights
and powers as to all matters submitted to the stockholders of the Holding
Company for vote, consent or approval. Shares of Class A Common Stock are
convertible into shares of Class B Common Stock. Shares of Class B Common
Stock are convertible into shares of Class A Common Stock, except in the
event that the holder is a bank holding company or subsidiary thereof and
such holder is restricted by applicable banking laws from holding any (or
any additional) shares with voting rights.
(2) The Preferred Stock of the Holding Company, $1.00 par value per share (the
"Preferred Stock"), has a liquidation value of $100 per share and is
mandatorily redeemable by the Holding Company on January 31, 2005, or
optionally redeemable by the Holding Company at any time, in either case
at the liquidation value thereof. Holders of Preferred Stock have no
voting rights with respect to such shares.
(3) As used in this table, "beneficial ownership" means the sole or shared
power to vote or direct the voting of a security, or the sole or shared
investment power with respect to a security. A person is deemed as of any
date to have "beneficial ownership" of any security that such person has
the right to acquire within 60 days after such date. For purposes of
computing the percentage of outstanding shares held by each person named
above, any security that such person has the right to acquire within 60
days of the date of calculation is deemed to be outstanding, but is not
deemed to be outstanding for purposes of computing the percentage
ownership of any other person.
(4) Includes 114,397 shares of Class B Common Stock.
(5) The shares shown as beneficially owned by Mr. DeBlois represent 159,389
shares owned of record by BancBoston. Mr. DeBlois is a Managing Director
of BancBoston and may be deemed to control BancBoston, and accordingly may
be deemed to control the voting and disposition of the shares of Class A
Common Stock owned by BancBoston. As such, Mr. DeBlois may be deemed to
have shared voting and investment power with respect to all shares held by
BancBoston. However, Mr. DeBlois disclaims beneficial ownership of the
securities held by BancBoston.
(6) Harvest Partners International, L.P. ("Harvest Partners") is affiliated
with Harvest Technology Partners, L.P. ("Harvest") and European
Development Capital Corporation N.V. ("European Development"). In the
aggregate, Harvest Partners, Harvest and European Development hold 83,816
shares of Class A Common Stock, representing 32.9% of the shares
outstanding. Harvest Partners, Harvest and European each disclaim
beneficial ownership of all shares held by the others.
(7) The shares shown as beneficially owned by Mr. Mallement represent 51,851
shares owned of record by Harvest Partners, 17,901 shares owned of record
by Harvest and 14,064 shares owned of record by European Development. Mr.
Mallement either directly (whether through ownership interest or position)
or through one or more intermediaries, may be deemed to control the voting
and disposition of the Class A Common Stock owned by each of Harvest
Partners, Harvest and European Development, and accordingly may be deemed
to have shared voting and investment power with respect to all shares held
by each of Harvest Partners, Harvest and European Development. However,
Mr. Mallement disclaims beneficial ownership of the securities held by
each of Harvest Partners, Harvest and European Development except to the
extent of his pecuniary interests therein.
(8) Paribas Principal, Inc. is affiliated with Banque Paribas, which holds a
presently exercisable warrant to purchase 16,667 shares of Class A Common
Stock, representing 6.1% of the shares of Class A Common Stock outstanding
on a fully diluted basis. In the aggregate, on a fully diluted basis,
Paribas Principal and Banque Paribas would hold, upon exercise of all such
warrants, 56,667 shares of Class A Common Stock, representing 20.9% of the
shares outstanding. Paribas Principal and Banque Paribas each disclaim
beneficial ownership of all shares held by the other.
(9) Includes 73,525 shares of Class B Common Stock.
(10) Includes 1,334 shares subject to exercisable options. In addition, all of
such shares are subject to repurchase by the Holding Company upon
termination of employment under certain circumstances.
(11) All of such shares are subject to repurchase by the Holding Company upon
termination of employment under certain circumstances.
(12) Includes 1,334 shares subject to exercisable options. In addition, 60,699
shares are subject to repurchase by the Holding Company upon termination
of employment under certain circumstances. Except as noted above, the
Company believes that the beneficial holders listed in the table above
have sole voting power and investment power over the shares described as
being beneficially owned by them.
58
<PAGE>
DESCRIPTION OF NEW CREDIT FACILITY AND CERTAIN OTHER INDEBTEDNESS
New Credit Facility
The Company entered into a five-year revolving credit facility (the "New
Credit Facility") simultaneous with the closing of the Offering with PNC Bank,
National Association (the "Lender") providing for up to $20.0 million of
credit, including a sublimit of $5.0 million for letter of credit
accommodations. Borrowings under the New Credit Facility are limited to a
borrowing base comprised of 85% of eligible accounts receivable and 65% of
eligible inventory, and bear interest, at the option of the Company, at either
(i) the Lender's "Prime Rate," as announced from time to time or (ii) the
"Euro-Rate plus Applicable Margin" ("Eurodollar Loans"). "Euro-Rate" means the
rate (grossed up for maximum statutory reserve requirements for eurocurrency
liabilities) determined by the Lender in accordance with its usual procedures
to be the Eurodollar rate for one, two, three or six month periods (as selected
by the Company), and the Applicable Margin on Eurodollar Loans is 1.75%.
The proceeds of the New Credit Facility will be used to provide for the
working capital requirements of the Company and for other general corporate
purposes. As of October 31, 1997, the Company had not made any borrowings under
the New Credit Facility. See "Use of Proceeds."
The New Credit Facility is secured by first priority security interests in
all of the tangible and intangible assets of the Company.
The New Credit Facility contains certain financial and operating
covenants, including a minimum fixed charge coverage ratio. In addition, the
Company is limited in the amount of annual capital expenditures and its ability
to redeem, repurchase or make any payments of principal on account of the
Notes.
The operating covenants of the New Credit Facility include limitations on
the ability of the Company to (i) incur additional indebtedness, other than
certain permitted indebtedness, (ii) sell or lease assets of the Company, other
than the sale of inventory and the retirement of other assets in the ordinary
course of business; (iii) permit additional liens or encumbrances, other than
permitted liens, (iv) make any loans to or investments in other persons, other
than trade credit advanced in the ordinary course of business and certain
permitted investments, (v) become obligated with respect to contingent
obligations relating to third parties, and (vi) make any dividend or
distribution (including by way of redemption of stock) with respect to any
share of stock, other than certain permitted distributions. The operating
covenants include restrictions on certain specified fundamental changes, such
as mergers and asset sales, transactions with shareholders and affiliates, the
transfer of instruments payable to the Company and amending the Company's
governing documents.
If for any reason the Company is unable to comply with the terms of the
New Credit Facility, including the covenants included therein, such
noncompliance could result in an event of default under the New Credit Facility
and could result in the acceleration of payment of the indebtedness under the
New Credit Facility. The acceleration of the indebtedness of the Company under
the New Credit Facility as a result of a default under the New Credit Facility
will constitute an Event of Default under the Indenture. See "Description of
Notes--Events of Default and Remedies." In addition, an Event of Default under
the Indenture will constitute an event of default under the New Credit
Facility.
Senior Subordinated Notes
On October 16, 1997, the Holding Company issued Amended and Restated
Senior Subordinated Notes due 2005 (the "Subordinated Notes") in the aggregate
principal amount of $13.25 million to certain of the Holding Company's
shareholders. The Subordinated Notes constitute the amendment and restatement
of certain predecessor subordinated notes issued by the Holding Company
pursuant to several subscription agreements, each dated as of January 30, 1995,
between the Company and the purchasers of such notes.
The entire principal amount, together with interest on the unpaid amount
outstanding, of each of the Subordinated Notes becomes payable on January 31,
2005. Each of the Subordinated Notes bears interest, at a rate equal to 10% per
annum compounded annually, with interest accruing from January 30, 1995, the
date on which the original senior subordinated notes due 2005 were issued. Each
of the Subordinated Notes is subordinate and junior in right of payment to all
Obligations (as defined therein) of the Holding Company under the Indenture.
59
<PAGE>
EXCHANGE OFFER
General
The Company hereby offers, upon the terms and subject to the conditions
set forth in this Prospectus and in the accompanying Letter of Transmittal
(which together constitute the Exchange Offer), to exchange up to $80.0 million
aggregate principal amount of New Notes for a like aggregate principal amount
of Existing Notes properly tendered on or prior to the Expiration Date and not
withdrawn as permitted pursuant to the procedures described below. The Exchange
Offer is being made with respect to all of the Existing Notes; the total
aggregate principal amount of Existing Notes and New Notes will in no event
exceed $80.0 million.
The summary herein of certain provisions of the Registration Rights
Agreement does not purport to be complete and is subject to, and is qualified
in its entirety by reference to, all the provisions of the Registration Rights
Agreement, a copy of which will be made available upon request of the Company.
Purpose of the Exchange Offer
On October 16, 1997, the Company issued $80.0 million aggregate principal
amount of Existing Notes. The issuance of the Existing Notes was not registered
under the Securities Act in reliance upon the exemption provided in Section
4(2) of the Securities Act.
The Company, the Holding Company and the Initial Purchasers entered into
the Registration Rights Agreement on the Closing Date. Pursuant to the
Registration Rights Agreement, the Company and the Holding Company agreed to
use their respective reasonable best efforts to file with the Commission the
Exchange Offer Registration Statement on the appropriate form under the
Securities Act with respect to the Exchange Notes. Upon the effectiveness of
the Exchange Offer Registration Statement, the Company and the Holding Company
will offer notes of the Company which will have terms substantially identical
in all material respects to the Notes, including the Existing Guarantee (the
"Exchange Notes") (except that the Exchange Notes will not contain terms with
respect to transfer restrictions) pursuant to the Exchange Offer in exchange
for properly tendered Transfer Restricted Securities to the Holders of Transfer
Restricted Securities who are able to make certain representations. If (i) the
Company is not required to file the Exchange Offer Registration Statement or
permitted to consummate the Exchange Offer because the Exchange Offer is not
permitted by applicable law or Commission policy or (ii) any Holder of Transfer
Restricted Securities notifies the Company prior to the 20th day following
consummation of the Exchange Offer that (A) it is prohibited by law or
Commission policy from participating in the Exchange Offer or (B) that it may
not resell the Exchange Notes acquired by it in the Exchange Offer to the
public without delivering a prospectus and the prospectus contained in the
Exchange Offer Registration Statement is not appropriate or available for such
resales or (C) that it is a broker-dealer and owns Notes acquired directly from
the Company or an affiliate of the Company, the Company and the Holding Company
will use their respective reasonable best efforts to file with the Commission a
Shelf Registration Statement covering resales of the Notes by the Holders
thereof who satisfy certain conditions relating to the provision of information
in connection with the Shelf Registration Statement. The Company and the
Holding Company will use their respective reasonable best efforts to cause the
applicable registration statement to be declared effective by the Commission
under the Securities Act on or prior to 90 days after the Company becomes
required to file the Shelf Registration Statement. For purposes of the
foregoing, "Transfer Restricted Securities" means each Note until the earliest
of (i) the date on which such Note is exchanged in the Exchange Offer and is
entitled to be resold to the public by the holder thereof without complying
with the prospectus delivery requirements of the Securities Act, (ii) the date
on which such Note has been disposed of in accordance with a Shelf Registration
Statement, (iii) the date on which such Note is disposed of by a broker-dealer
pursuant to the plan of distribution contemplated by the "Plan of Distribution"
section of this prospectus (including delivery of a copy of this prospectus),
or (iv) the date on which such Note is distributed to the public pursuant to
Rule 144 under the Act.
The Registration Rights Agreement provides that (i) the Company and the
Holding Company will use their respective reasonable best efforts to file an
Exchange Offer Registration Statement with the Commission as soon as
practicable after the Closing Date, but in no event later than 45 days after
the Closing Date, (ii) the Company and the Holding Company will use their
reasonable best efforts to have the Exchange Offer Registration Statement
declared effective by the Commission at the earliest possible time, but in no
event later than 120 days after the Closing Date, (iii) unless the Exchange
Offer would not be permitted by applicable law or Commission policy, the
Company will commence the Exchange Offer and use its reasonable best efforts to
issue on or prior to 30 business days after the date on which the Exchange
Offer Registration Statement was declared effective by the Commission,
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Exchange Notes in exchange for all Notes tendered prior thereto in the Exchange
Offer and (iv) if obligated to file the Shelf Registration Statement, the
Company and the Holding Company will use their respective reasonable best
efforts to file the Shelf Registration Statement with the Commission on or
prior to 30 days after such filing obligation arises and to cause the Shelf
Registration to be declared effective by the Commission on or prior to 90 days
after such obligation arises. The Company will be entitled to suspend the use
of a prospectus under the Exchange Offer Registration Statement or any Shelf
Registration Statement for certain limited periods under certain prescribed
circumstances. If (a) the Company and the Holding Company fail to file any of
the Registration Statements required by the Registration Rights Agreement on or
before the date specified for such filing; (b) any of such Registration
Statements is not declared effective by the Commission on or prior to the date
specified for such effectiveness (the "Effectiveness Target Date"); (c) an
Exchange Offer Registration Statement becomes effective but the Company and the
Holding Company fail to consummate the Exchange Offer within 30 business days
of the Effectiveness Target Date with respect to the Exchange Offer
Registration Statement; or (d) subject to certain exceptions, the Shelf
Registration Statement or the Exchange Offer Registration Statement is declared
effective but thereafter ceases to be effective or usable in connection with
resales of Transfer Restricted Securities during the periods specified in the
Registration Rights Agreement without being succeeded immediately by a
post-effective amendment to such Registration Statement that cures such failure
and that is itself declared effective immediately (each such event referred to
in clauses (a) through (d) above a "Registration Default"), then the Company
will pay Liquidated Damages to each Holder of the Notes, with respect to the
first 90-day period immediately following the occurrence of the first
Registration Default in an amount equal to $.05 per week per $1,000 principal
amount of Notes held by such Holder. The amount of Liquidated Damages will
increase by an additional $.05 per week per $1,000 principal amount of Notes
with respect to each subsequent 90-day period until all Registration Defaults
have been cured, up to a maximum amount of Liquidated Damages of $.50 per week
per $1,000 principal amount of Notes. All accrued Liquidated Damages will be
paid by the Company on each Interest Payment Date to the Holders of Global
Notes by wire transfer of immediately available funds or by federal funds check
and to Holders of Certificated Securities at the office or agency of the
Company maintained for such purpose in the Borough of Manhattan, The City of
New York or by mailing checks to their registered addresses. Following the cure
of all Registration Defaults, the accrual of Liquidated Damages will cease.
Holders of Notes will be required to make certain representations to the
Company and the Holding Company (as described in the Registration Rights
Agreement) in order to participate in the Exchange Offer and will be required
to deliver information to be used in connection with the Shelf Registration
Statement within the time periods set forth in the Registration Rights
Agreement in order to have their Notes included in the Shelf Registration
Statement and benefit from the provisions regarding Liquidated Damages set
forth above.
Expiration Date; Extensions; Termination; Amendments
The Exchange Offer will expire at 5:00 P.M., New York City time, on March
13, 1998, unless the Company, in its sole discretion, has extended the period of
time (as described below) for which the Exchange Offer is open (such date, as
it may be extended, is referred to herein as the "Expiration Date"). The
Expiration Date will be at least 30 days after the commencement of the Exchange
Offer (or longer if required by applicable law). The Company expressly reserves
the right, at any time or from time to time, to extend the period of time
during which the Exchange Offer is open, and thereby delay acceptance for
exchange of any Existing Notes by giving oral notice (confirmed in writing) or
written notice to the Exchange Agent (as defined herein) and by giving written
notice of such extension to the holders thereof or by timely public
announcement communicated, unless otherwise required by applicable law or
regulation, by making a release through the Dow Jones News Service, in each
case, no later than 9:00 A.M. New York City time, on the next business day
after the previously scheduled Expiration Date. Such announcement may state
that the Company is extending the Exchange Offer for a specified period of
time. During any such extension, all Existing Notes previously tendered will
remain subject to the Exchange Offer.
In addition, the Company expressly reserves the right to terminate or
amend the Exchange Offer and not to accept for exchange any Existing Notes not
theretofore accepted for exchange upon the occurrence of any of the events
specified below under "--Certain Conditions to the Exchange Offer." If any such
termination or amendment occurs, the Company will notify the Exchange Agent and
will either issue a press release or give oral or written notice to the holders
of the Existing Notes as promptly as practicable.
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Procedures for Tendering Existing Notes
The tender to the Company of Existing Notes by a holder thereof as set
forth below and the acceptance thereof by the Company will constitute a binding
agreement between the tendering holder and the Company upon the terms and
subject to the conditions set forth in this Prospectus and in the accompanying
Letter of Transmittal.
A holder of Existing Notes may tender the same by (i) properly completing
and signing the Letter of Transmittal or a facsimile thereof (all references in
this Prospectus to the Letter of Transmittal shall be deemed to include a
facsimile thereof) and delivering the same, together with the certificate or
certificates representing the Existing Notes being tendered, if any, and any
required signature guarantees, to the Exchange Agent at its address set forth
below on or prior to 5:00 p.m., New York City time, on the Expiration Date (or
complying with the procedure for book-entry transfer described below) or (ii)
complying with the guaranteed delivery procedures described below.
THE METHOD OF DELIVERY OF EXISTING NOTES, LETTERS OF TRANSMITTAL AND ALL
OTHER REQUIRED DOCUMENTS IS AT THE ELECTION AND RISK OF THE HOLDERS. IF SUCH
DELIVERY IS BY MAIL, IT IS RECOMMENDED THAT REGISTERED MAIL PROPERLY INSURED,
WITH RETURN RECEIPT REQUESTED, OR AN OVERNIGHT OR HAND DELIVERY SERVICE, BE
USED. IN ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO INSURE TIMELY
DELIVERY. NO EXISTING NOTES OR LETTERS OF TRANSMITTAL SHOULD BE SENT TO THE
COMPANY.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the
case may be, must be guaranteed unless the Existing Notes surrendered for
exchange pursuant thereto are tendered (i) by a registered holder of the
Existing Notes who has not completed the box entitled "Special Issuance
Instructions" or "Special Delivery Instructions" on the Letter of Transmittal
or (ii) for the account of an Eligible Institution (as defined herein). In the
event that signatures on a Letter of Transmittal or a notice of withdrawal, as
the case may be, are required to be guaranteed, such guarantee must be by a
firm which is a member of a registered national securities exchange or a member
of the National Association of Securities Dealers, Inc. or by a commercial bank
or trust company having an office or correspondent in the United States (each
an "Eligible Institution"). If Existing Notes are registered in the name of a
person other than a signer of the Letter of Transmittal, the Existing Notes
surrendered for exchange must be endorsed by, or be accompanied by a written
instrument or instruments of transfer or exchange, in satisfactory form as
determined by the Company in its sole discretion, duly executed by the
registered holder with the signature thereon guaranteed by an Eligible
Institution.
The Exchange Agent will make a request promptly after the date of this
Prospectus to establish accounts with respect to the Existing Notes at the
book-entry transfer facility, The Depository Trust Company, for the purpose of
facilitating the Exchange Offer, and subject to the establishment thereof, any
financial institution that is a participant in the book-entry transfer
facility's system may make book-entry delivery of Existing Notes by causing
such book-entry transfer facility to transfer such Existing Notes into the
Exchange Agent's account with respect to the Existing Notes in accordance with
the book-entry transfer facility's procedures for such transfer. Although
delivery of Existing Notes may be effected through book-entry transfer in the
Exchange Agent's account at the book-entry transfer facility, an appropriate
Letter of Transmittal with any required signature guarantee and other required
documents must in each case be transmitted to and received or confirmed by the
Exchange Agent at its address set forth below on or prior to the Expiration
Date, or, if the guaranteed delivery procedures described below are complied
with, within the time period provided under such procedures.
If a holder desires to accept the Exchange Offer and time will not permit
a Letter of Transmittal or Existing Notes to reach the Exchange Agent before
the Expiration Date or the procedure for book-entry transfer cannot be
completed on a timely basis, a tender may be effected if the Exchange Agent has
received at its address or facsimile number set forth below on or prior to the
Expiration Date a letter, telegram or facsimile from an Eligible Institution
setting forth the name and address of the tendering holder, the name in which
the Existing Notes are registered and, if possible, the certificate number or
numbers of the Certificate or certificates representing the Existing Notes to
be tendered, and stating that the tender is being made thereby and guaranteeing
that within three business days after the Expiration Date the Existing Notes in
proper form for transfer (or a confirmation of book-entry transfer of such
Existing Notes into the Exchange Agent's account at the book-entry transfer
facility), will be delivered by such Eligible Institution together with a
properly completed and duly executed Letter of Transmittal (and any other
required documents). Unless Existing Notes being tendered by the
above-described method are deposited with the Exchange Agent within the time
period set forth above (accompanied or preceded by a properly completed Letter
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of Transmittal and any other required documents), the Company may, at its
option, reject the tender. Copies of a Notice of Guaranteed Delivery which may
be used by an Eligible Institution for the purposes described in this paragraph
are available from the Exchange Agent.
A tender will be deemed to have been received as of the date when (i) the
tendering holder's properly completed and duly signed Letter of Transmittal
accompanied by the Existing Notes (or a confirmation of book-entry transfer of
such Existing Notes into the Exchange Agent's account at the book-entry
transfer facility) is received by the Exchange Agent, or (ii) a Notice of
Guaranteed Delivery or letter, telegram or facsimile to similar effect (as
provided above) from an Eligible Institution is received by the Exchange Agent.
Issuances of New Notes in exchange for Existing Notes tendered pursuant to a
Notice of Guaranteed Delivery or letter, telegram or facsimile to similar
effect (as provided above) by an Eligible Institution will be made only against
deposit of the Letter of Transmittal (and any other required documents) and the
tendered Existing Notes.
All questions as to the validity, form, eligibility (including time of
receipt) and acceptance of Existing Notes tendered for exchange will be
determined by the Company in its sole discretion, which determination will be
final and binding on all parties. The Company reserves the right to reject any
and all tenders of any particular Existing Notes not properly tendered or
reject any particular shares of Existing Notes the acceptance of which might,
in the judgment of the Company or its counsel, be unlawful. The Company also
reserves the absolute right to waive any defects or irregularities or condition
of the Exchange Offer as to any particular Existing Notes either before or
after the Expiration Date (including the right to waive the ineligibility of
any holder who seeks to tender Existing Notes in the Exchange Offer). The
interpretation of the terms and conditions of the Exchange Offer (including the
Letter of Transmittal and the instructions thereto) by the Company shall be
final and binding on all parties. Unless waived, any defects or irregularities
in connection with tenders of Existing Notes for exchange must be cured within
such time as the Company shall determine. Neither the Company nor any other
person shall be under any duty to give notification of defects or
irregularities with respect to tenders of Existing Notes for exchange, nor
shall any of them incur any liability for failure to give such notification.
If the Letter of Transmittal or any Existing Notes or powers of attorney
are signed by trustees, executors, administrators, guardians,
attorneys-in-fact, officers of corporations or others acting in a fiduciary or
representative capacity, such persons should so indicate when signing, and
unless waived by the Company, proper evidence satisfactory to the Company of
their authority to so act must be submitted.
By tendering, each holder that is not a broker-dealer or is a
broker-dealer but is not receiving New Notes for its own account will represent
to the Company that, among other things, the New Notes acquired pursuant to the
Exchange Offer are being obtained in the ordinary course of such holder's
business, that such holder has no arrangement or understanding with any person
to participate in the distribution of such New Notes and that such holder is
not an "affiliate" of the Company as defined in Rule 405 under the Securities
Act or, if it is an affiliate, such holder will comply with the registration
and prospectus delivery requirements of the Securities Act, to the extent
applicable. Each broker-dealer that is receiving New Notes for its own account
in exchange for Existing Notes that were acquired as a result of market-making
or other trading activities will represent to the Company that it will deliver
a prospectus in connection with any resale of such Existing Notes.
In addition, the Company reserves the right in its sole discretion to (a)
purchase or make offers for any Existing Notes that remain outstanding
subsequent to the Expiration Date, or, as set forth under "--Certain Conditions
to the Exchange Offer," to terminate the Exchange Offer and (b) to the extent
permitted by applicable law, purchase Existing Notes in the open market, in
privately negotiated transactions or otherwise. The terms of any such purchases
or offers may differ from the terms of the Exchange Offer.
Withdrawal Rights
Tenders of Existing Notes may be withdrawn at any time prior to 5:00 p.m.,
New York City time, on the business day prior to the Expiration Date. For a
withdrawal to be effective, a written notice of withdrawal sent by letter,
telegram or facsimile must be received by the Exchange Agent at any time prior
to 5:00 p.m., New York City time, on the business day prior to the Expiration
Date at its address or facsimile number set forth below. Any such notice of
withdrawal must (i) specify the name of the person having tendered the Existing
Notes to be withdrawn (the "Depositor"), (ii) identify the Existing Notes to be
withdrawn (including the certificate number or numbers of the certificate or
certificates representing such Existing Notes and the aggregate principal
amount of such Existing Notes), (iii) be signed by the holder in the same
manner as the original signature on the Letter of Transmittal by
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which such Existing Notes were tendered (including any required signature
guarantees) or be accompanied by documents of transfer sufficient to permit the
Transfer Agent with respect to the Existing Notes to register the transfer of
such Existing Notes into the name of the person withdrawing the tender and (iv)
specify the name in which any such Existing Notes are to be registered, if
different from that of the Depositor. All questions as to the validity, form
and eligibility (including time of receipt) of such withdrawal notices will be
determined by the Company in its sole discretion, which determination will be
final and binding on all parties. Any Existing Notes so withdrawn will be
deemed not to have been validly tendered for purposes of the Exchange Offer and
no New Notes will be issued with respect thereto unless the Existing Notes so
withdrawn are validly retendered. Any Existing Notes which have been tendered
but which are withdrawn will be returned to the holder thereof without cost to
such holder as soon as practicable after such withdrawal. Properly withdrawn
Existing Notes may be retendered by following one of the procedures described
above under "--Procedures for Tendering Existing Notes" at any time prior to
the Expiration Date.
Acceptance of Existing Notes for Exchange; Delivery of New Notes
Upon satisfaction or waiver of all of the conditions to the Exchange
Offer, the Company will accept, promptly after the Expiration Date, all
Existing Notes properly tendered and will issue the New Notes promptly after
acceptance of the Exchange Offer. See "--Certain Conditions to the Exchange
Offer" below. For purposes of the Exchange Offer, the Company will be deemed to
have accepted properly tendered Existing Notes for exchange when the Company
has given oral or written notice thereof to the Exchange Agent.
In all cases, issuance of the New Notes in exchange for Existing Notes
pursuant to the Exchange Offer will be made only after timely receipt by the
Company of such Existing Notes, a properly completed and duly executed Letter
of Transmittal and all other required documents. If any tendered Existing Notes
are not accepted for exchange for any reason set forth in the terms and
conditions of the Exchange Offer, such unaccepted Existing Notes will be
returned without expense to the tendering holder thereof as promptly as
practicable after the rejection of such tender or the expiration or termination
of the Exchange Offer.
Untendered Existing Notes
Holders of Existing Notes whose Existing Notes are not tendered or are
tendered but not accepted in the Exchange Offer will continue to hold such
Existing Notes and will be entitled to all the rights and preferences and
subject to the limitations applicable thereto. Following consummation of the
Exchange Offer, the holders of Existing Notes will continue to be subject to
the existing restrictions upon transfer thereof and, except as provided herein,
the Company will have no further obligation to such holders to provide for the
registration under the Securities Act of the Existing Notes held by them. To
the extent that Existing Notes are tendered and accepted in the Exchange Offer,
the trading market for untendered and tendered but unaccepted Existing Notes
could be adversely affected.
Certain Conditions to the Exchange Offer
Notwithstanding any other term of the Exchange Offer, the Company will not
be required to accept for exchange, or issue New Notes in exchange for, any
Existing Notes, and may terminate or amend the Exchange Offer, if at any time
before the acceptance of such Existing Notes for exchange, any of the following
events shall occur:
(A) an injunction, order or decree shall have been issued by any court or
governmental agency that would prohibit, prevent or otherwise materially
impair the ability of the Company to proceed with the Exchange Offer; or
(B) there shall occur a change in the current interpretation of the staff
of the Commission which current interpretation permits the New Notes issued
pursuant to the Exchange Offer in exchange for the Existing Notes to be
offered for resale, resold and otherwise transferred by holders thereof
(other than (i) a broker-dealer who purchases such New Notes directly from
the Company to resell pursuant to Rule 144A or any other available
exemption under the Securities Act or (ii) a person that is an affiliate of
the Company within the meaning of Rule 405 under the Securities Act),
without compliance with the registration and prospectus delivery provisions
of the Securities Act provided that such New Notes are acquired in the
ordinary course of such holders' business and such holders have no
arrangement with any person to participate in the distribution of New
Notes.
The foregoing conditions are for the sole benefit of the Company and may
be asserted by the Company regardless of the circumstances giving rise to any
such condition or may be waived by the Company in whole or
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in part at any time and from time to time in its sole discretion. The failure
by the Company at any time to exercise any of the foregoing rights shall not be
deemed a waiver of any such right and each such right shall be deemed an
ongoing right which may be asserted at any time and from time to time.
If the Company determines that it may terminate the Exchange Offer, as set
forth above, the Company may (i) refuse to accept any Existing Notes and return
any Existing Notes that have been tendered to the holders thereof, (ii) extend
the Exchange Offer and retain all Existing Notes tendered prior to the
Expiration Date, subject to the rights of such holders of tendered shares of
Existing Notes to withdraw their tendered Existing Notes, or (iii) waive such
termination event with respect to the Exchange Offer and accept all properly
tendered Existing Notes that have not been withdrawn. If such waiver
constitutes a material change in the Exchange Offer, the Company will disclose
such change by means of a supplement to this Prospectus that will be
distributed to each registered holder of Existing Notes, and the Company will
extend the Exchange Offer for a period of five to ten business days, depending
upon the significance of the waiver and the manner of disclosure to the
registered holders of the Existing Notes, if the Exchange Offer would otherwise
expire during such period.
In addition, the Company will not accept for exchange any Existing Notes
tendered, and no New Notes will be issued in exchange for any such Existing
Notes, if at any time any stop order shall be threatened by the Commission or
in effect with respect to the Registration Statement.
The Exchange Offer is not conditioned on any minimum principal amount of
Existing Notes being tendered for exchange.
Exchange Agent
The Bank of New York has been appointed as Exchange Agent for the Exchange
Offer. Questions regarding Exchange Offer procedures and requests for
additional copies of this Prospectus or the Letter of Transmittal should be
directed to the Exchange Agent addressed as follows:
<TABLE>
<S> <C>
By Mail: By Hand or Overnight Delivery:
The Bank of New York The Bank of New York
101 Barclay Street, 7E 101 Barclay Street
New York, New York 10286 Corporate Trust Services Window
Attention: Reorganization Section, Ground Level
Ms. Theresa Gass New York, New York 10286
Attention: Reorganization Section,
Ms. Theresa Gass
By Facsimile:
(212) 815-6339
Confirm by Telephone:
(212) 815-5942
</TABLE>
The Bank of New York is also the Transfer Agent for the Existing Notes and
New Notes.
Solicitation of Tenders; Fees and Expenses
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers or other
persons soliciting acceptance of the Exchange Offer. The Company, however, will
pay the Exchange Agent reasonable and customary fees for its services and will
reimburse the Exchange Agent for its reasonable out-of-pocket expenses in
connection therewith. The cash expenses to be incurred by the Company in
connection with the Exchange Offer will be paid by the Company.
No person has been authorized to give any information or to make any
representation in connection with the Exchange Offer other than those contained
in this Prospectus. If given or made, such information or representations
should not be relied upon as having been authorized by the Company. Neither the
delivery of this Prospectus nor any exchange made hereunder shall, under any
circumstances, create any implication that there has been no change in the
affairs of the Company since the respective dates as of which information is
given herein. The Exchange Offer is not being made to (nor will tenders be
accepted from or on behalf of) holders of Existing Notes in any jurisdiction in
which the making of the Exchange Offer or the acceptance thereof would not be
in compliance with the laws of such jurisdiction.
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Transfer Taxes
The Company will pay all transfer taxes, if any, applicable to the
exchange of Existing Notes pursuant to the Exchange Offer. If, however,
certificates representing New Notes or Existing Notes not tendered or accepted
for exchange are to be delivered to, or are to be registered or issued in the
name of, any person other than the registered holder of the Existing Notes
tendered, or if tendered Existing Notes are registered in the name of any
person other than the person signing the Letter of Transmittal, or if a
transfer tax is imposed for any reason other than the exchange of New Notes
pursuant to the Exchange Offer, then the amount of any such transfer taxes
(whether imposed on the registered holder or any other persons) will be payable
by the tendering holder. If satisfactory evidence of payment of such taxes or
exemption therefrom is not submitted with the Letter of Transmittal, the amount
of such transfer taxes will be billed directly to such tendering holders.
Accounting Treatment
No gain or loss for accounting purposes will be recognized by the Company
upon the consummation of the Exchange Offer. Expenses incurred in connection
with the issuance of the New Notes will be amortized by the Company over the
term of the New Notes under generally accepted accounting principles.
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PLAN OF DISTRIBUTION
Based on no action letters issued by the staff of the Commission to third
parties, the Company believes that the New Notes issued pursuant to the
Exchange Offer in exchange for Existing Notes may be offered for resale, resold
and otherwise transferred by holders thereof (other than (i) a broker-dealer
who purchases such New Notes directly from the Company to resell pursuant to
Rule 144A or any other available exemption under the Securities Act or (ii) a
person that is an affiliate of the Company within the meaning of Rule 405 under
the Securities Act), without compliance with the registration and prospectus
delivery requirements of the Securities Act provided that New Notes are
acquired in the ordinary course of such holders' business and such holders have
no arrangement with any person to participate in the distribution of such New
Notes. Any holder of Existing Notes who tenders in the Exchange Offer for the
purpose of participating in a distribution of the New Notes could not rely on
such interpretation by the staff of the Commission and must comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with any resale transaction. Thus, any New Notes acquired by such
holders will not be freely transferable except in compliance with the
Securities Act.
Each broker-dealer that receives New Notes for its own account in exchange
for Existing Notes acquired as a result of market-making or other trading
activities must acknowledge that it will deliver a prospectus in connection
with any resale of such New Notes. For a period of 180 days after the
Expiration Date, this Prospectus, as it may be amended or supplemented from
time to time, may be used by a broker-dealer in connection with resales of such
New Notes. During such 180-day period, the Company will use its reasonable best
efforts to make this Prospectus available to any broker-dealer for use in
connection with such resale, provided that such broker-dealer indicates in the
Letter of Transmittal that it is a broker-dealer.
The Company will not receive any proceeds from any sale of New Notes by
broker-dealers. New Notes received by broker-dealers for their own account
pursuant to the Exchange Offer may be sold from time to time in one or more
transactions in the over-the-counter market, in negotiated transactions,
through the writing of options on the New Notes or a combination of such
methods of resale, at market prices prevailing at the time of resale, at prices
related to such prevailing market prices or negotiated prices. Any such resale
may be made directly to purchasers or to or through broker-dealers who may
receive compensation in the form of commissions or concessions from any such
broker-dealer and/or the purchasers of any such New Notes. Any broker-dealer
that resells New Notes that were received by it for its own account pursuant to
the Exchange Offer and any person that participates in the distribution of such
New Notes may be deemed to be an "underwriter" within the meaning of the
Securities Act and any profit on any such resale of New Notes and any
commissions or concessions received by any such broker-dealers may be deemed to
be underwriting compensation under the Securities Act. The Letter of
Transmittal states that a broker-dealer, by acknowledging that it will deliver
and by delivering a prospectus, will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act.
The Company will indemnify the holders of the New Notes (including any
broker-dealers) against certain liabilities, including liabilities under the
Securities Act.
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DESCRIPTION OF NOTES
Except as otherwise indicated, the following description relates both to
the Existing Notes issued in the Offering and the New Notes, together with the
New Guarantees, to be issued in exchange for the Existing Notes in the Exchange
Offer. The form and terms of the New Notes are the same as the form and terms
of the Existing Notes, except that the New Notes have been registered under the
Securities Act and therefore will not bear legends restricting the transfer
thereof. The New Notes will be obligations of the Company evidencing the same
indebtedness as the Existing Notes. The Existing Notes were issued, and the New
Notes offered hereby will be issued, pursuant to an indenture (the "Indenture")
dated as of October 16, 1997 by and among Community Distributors, Inc. (the
"Company"), CDI Group, Inc. (the "Holding Company"), and The Bank of New York,
as trustee (the "Trustee"). The following summaries of certain provisions of
the Notes, the Indenture and the Registration Rights Agreement are summaries
only, do not purport to be complete and are qualified in their entirety by
reference to all of the provisions of the respective documents. The Indenture
and the Registration Rights Agreement have been filed as exhibits to the
registration statement of which this prospectus forms a part. Capitalized terms
used herein and not otherwise defined shall have the meanings assigned to them
in the Indenture or the Registration Rights Agreement, as applicable. Wherever
particular provisions of the Indenture are referred to in this summary, such
provisions are incorporated by reference as a part of the statements made and
such statements are qualified in their entirety by such reference.
General
The Notes are senior unsecured, general obligations of the Company,
limited in aggregate principal amount to $80 million. The Notes will be issued
only in fully registered form, without coupons, in denominations of $l,000 and
integral multiples thereof.
Maturity, Interest and Principal
The Notes will mature on October 15, 2004. The Notes will bear interest at
the rate per annum stated on the cover page hereof from the date of issuance or
from the most recent Interest Payment Date to which interest has been paid or
provided for, payable semi-annually on April 15 and October 15 of each year,
commencing April 15, 1998, to the persons in whose names such Notes are
registered at the close of business on the April 1 or October 1 immediately
preceding such Interest Payment Date. Interest will be calculated on the basis
of a 360-day year consisting of twelve 30-day months.
Principal of, premium, if any, and interest on the Notes will be payable,
and the Notes may be presented for registration of transfer or exchange, at the
office or agency of the Company maintained for such purpose, which office or
agency shall be maintained in the Borough of Manhattan, The City of New York.
At the option of the Company, payment of interest may be made by check mailed
to the Holders of the Notes at the addresses set forth upon the registry books
of the Company. No service charge will be made for any registration of transfer
or exchange of Notes, but the Company may require payment of a sum sufficient
to cover any tax or other governmental charge payable in connection therewith.
Until otherwise designated by the Company, the Company's office or agency will
be the corporate trust office of the Trustee presently located at The Bank of
New York, 101 Barclay St., Floor 21W, N.Y., N.Y. 10286 Attn: Corporate Trust,
Trustee Administrator.
The Indenture will not contain provisions which would afford Holders of
the Notes protection in the event of a decline in the Company's credit quality
resulting from highly leveraged or other similar transactions involving the
Company or the Guarantors.
Ranking
The indebtedness of the Company evidenced by the Notes ranks senior in
right of payment to all existing and future subordinated indebtedness of the
Company and pari passu in right of payment with all other existing or future
unsubordinated indebtedness of the Company, including indebtedness under the
New Credit Facility. The Notes, however, are effectively subordinated to
secured Indebtedness of the Company and the Guarantors (including Indebtedness
under the New Credit Facility) with respect to the assets securing such
Indebtedness.
Guarantees
The Notes are fully and unconditionally guaranteed (the "Guarantees"),
jointly and severally, on a senior unsecured basis by each of the Company's
future Subsidiaries (the "Subsidiary Guarantors") and the Holding
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Company (together with the Subsidiary Guarantors, the "Guarantors"). The
obligations of each Guarantor under its Guarantee, however, will be limited in
a manner intended to avoid it being deemed a fraudulent conveyance under
applicable law. See "--Certain Bankruptcy Limitations" below.
Any right of the Company to receive the assets of any Subsidiary Guarantor
upon such Subsidiary Guarantor's liquidation or reorganization (and the
consequent right of the Holders of the Notes to participate in the distribution
of the proceeds of those assets) will be in effect subordinated by operation of
law to the claims of such Subsidiary Guarantor's creditors (including trade
creditors) and holders of its preferred stock, except to the extent that the
Company is itself recognized as a creditor or preferred stockholder of such
subsidiary.
Certain Bankruptcy Limitations
Holders of the Notes will be direct creditors of each Guarantor by virtue
of its Guarantee. Nonetheless, in the event of the bankruptcy or financial
difficulty of a Guarantor, such Guarantor's obligations under its Guarantee may
be subject to review and avoidance under state and federal fraudulent transfer
laws. Among other things, such obligations may be avoided if a court concludes
that such obligations were incurred for less than reasonably equivalent value
or fair consideration at a time when the Guarantor was insolvent, was rendered
insolvent, or was left with inadequate capital to conduct its business. A court
would likely conclude that a Guarantor did not receive reasonably equivalent
value or fair consideration to the extent that the aggregate amount of its
liability on its Guarantee exceeds the economic benefits it receives in the
Offering. The obligations of each Guarantor under its Guarantee will be limited
in a manner intended to cause it not to be a fraudulent conveyance under
applicable law, although no assurance can be given that a court would give the
holder the benefit of such provision. See "Risk Factors--Fraudulent Conveyance
Risks."
If the obligations of a Guarantor under its Guarantee were avoided,
Holders of Notes would have to look to the assets of any remaining Guarantors
for payment. There can be no assurance in that event that such assets would
suffice to pay the outstanding principal and interest on the Notes.
Optional Redemption
The Company will not have the right to redeem any Notes prior to October
15, 2001, except as provided in the immediately following paragraph. The Notes
will be redeemable at the option of the Company, in whole or in part, at any
time on or after October 15, 2001, upon not less than 30 days nor more than 60
days notice to each Holder of Notes, at the following redemption prices
(expressed as percentages of the principal amount) if redeemed during the
12-month period commencing October 15 of the years indicated below, in each
case (subject to the right of Holders of record on a Record Date to receive
interest due on an Interest Payment Date that is on or prior to such Redemption
Date) together with accrued and unpaid interest thereon to the Redemption Date:
<TABLE>
<CAPTION>
Year Percentage
- --------------------------------- -------------
<S> <C>
2001 105.125%
2002 102.562%
2003 and thereafter 100.000%
</TABLE>
Notwithstanding the foregoing, prior to October 15, 2000, the Company may
redeem up to 35% of the aggregate principal amount of the Notes originally
outstanding at a redemption price of 110.25% of the principal amount thereof
(subject to the right of Holders of record on a Record Date to receive interest
due on an Interest Payment Date that is on or prior to such Redemption Date),
plus accrued and unpaid interest thereon, if any, to the Redemption Date, with
the net cash proceeds of one or more Equity Offerings; provided, that at least
65% of the aggregate principal amount of the Notes originally outstanding
remains outstanding immediately after the occurrence of such redemption;
provided, further, that such notice of redemption shall be sent within 30 days
after the date of closing of any such Equity Offering, and such redemption
shall occur within 60 days after the date such notice is sent.
In the case of a partial redemption, the Trustee shall select the Notes or
portions thereof for redemption on a pro rata basis, by lot or in such other
manner it deems appropriate and fair. The Notes may be redeemed in part in
multiples of $1,000 only.
The Notes will not have the benefit of any sinking fund.
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Notice of any redemption will be sent, by first class mail, at least 30
days and not more than 60 days prior to the date fixed for redemption to the
Holder of each Note to be redeemed to such Holder's last address as then shown
upon the registry books of the Registrar. Any notice which relates to a Note to
be redeemed in part only must state the portion of the principal amount equal
to the unredeemed portion thereof and must state that on and after the date of
redemption, upon surrender of such Note, a new Note or Notes in a principal
amount equal to the unredeemed portion thereof will be issued. On and after the
date of redemption, interest will cease to accrue on the Notes or portions
thereof called for redemption, unless the Company defaults in the payment
thereof.
Certain Covenants
Repurchase of Notes at the Option of the Holder Upon a Change of Control
The Indenture provides that in the event that a Change of Control has
occurred, each Holder of Notes will have the right, at such Holder's option,
pursuant to an irrevocable and unconditional offer by the Company (the "Change
of Control Offer"), to require the Company to repurchase all or any part of
such Holder's Notes (provided, that the principal amount of such Notes must be
$1,000 or an integral multiple thereof) on a date (the "Change of Control
Purchase Date") that is no later than 45 Business Days after the occurrence of
such Change of Control, at a cash price (the "Change of Control Purchase
Price") equal to 101% of the principal amount thereof, together with accrued
interest to the Change of Control Purchase Date. The Change of Control Offer
shall be made within 15 Business Days following a Change of Control and shall
remain open for 20 Business Days following its commencement (the "Change of
Control Offer Period"). Upon expiration of the Change of Control Offer Period,
the Company promptly shall purchase all Notes properly tendered in response to
the Change of Control Offer.
As used herein, a "Change of Control" means (i) any merger or
consolidation of the Company or the Holding Company with or into any person or
any sale, transfer or other conveyance, whether direct or indirect, of all or
substantially all of the assets of either of the Company or the Holding Company
on a consolidated basis, in one transaction or a series of related
transactions, if, immediately after giving effect to such transactions, any
"person" or "group" (as such terms are used for purposes of Sections 13(d) and
14(d) of the Exchange Act, whether or not applicable) (other than an Excluded
Person) is or becomes the Beneficial Owner, directly or indirectly, of more
than 50% of the total voting power in the aggregate normally entitled to vote
in the election of directors, managers, or trustees, as applicable, of the
transferees or surviving entity or entities, (ii) any "person" or "group" (as
such terms are used for purposes of Sections 13(d) and 14(d) of the Exchange
Act, whether or not applicable) (other than an Excluded Person or the Holding
Company) is or becomes the Beneficial Owner, directly or indirectly, of more
than 50% of the total voting power in the aggregate of all classes of Capital
Stock of either of the Company or the Holding Company then outstanding normally
entitled to vote in elections of directors, or (iii) during any period of 12
consecutive months after the Issue Date, individuals who at the beginning of
any such 12-month period constituted the Board of Directors of the Company or
the Holding Company (together, in each case, with any new directors whose
election by such Board or whose nomination for election by the shareholders of
the Company or the Holding Company, as applicable, was approved by a vote of a
majority of the directors then still in office who were either directors at the
beginning of such period or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority of the
Board of Directors of the Company or the Holding Company then in office, as
applicable.
On or before the Change of Control Purchase Date, the Company will (i)
accept for payment Notes or portions thereof properly tendered pursuant to the
Change of Control Offer, (ii) deposit with the Paying Agent cash sufficient to
pay the Change of Control Purchase Price (together with accrued and unpaid
interest) of all Notes so tendered and (iii) deliver to the Trustee Notes so
accepted together with an Officers' Certificate listing the Notes or portions
thereof being purchased by the Company. The Paying Agent will promptly deliver
to the Holders of Notes so accepted payment in an amount equal to the Change of
Control Purchase Price (together with accrued and unpaid interest), and the
Trustee will promptly authenticate and mail or deliver to such Holders a new
Note equal in principal amount to any unpurchased portion of the Note
surrendered. Any Notes not so accepted will be promptly mailed or delivered by
the Company to the Holder thereof. The Company will publicly announce the
results of the Change of Control Offer on or as soon as practicable after the
Change of Control Purchase Date.
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The Change of Control purchase feature of the Notes may make it more
difficult or discourage a takeover of the Company or the Holding Company, and,
thus, the removal of incumbent management. The Change of Control purchase
feature resulted from negotiations between the Company, the Holding Company and
the Initial Purchasers and is not the result of any intention on the part of
the Company or the Holding Company, or their respective management, to
discourage the acquisition of the Company or the Holding Company.
The phrase "all or substantially all" of the assets of the Company or the
Holding Company will likely be interpreted under applicable state law and will
be dependent upon particular facts and circumstances. As a result, there may be
a degree of uncertainty in ascertaining whether a sale or transfer of "all or
substantially all" of the assets of the Company or the Holding Company has
occurred. In addition, because the Company's obligation to make an offer to
repurchase Notes upon a "Change of Control" arises only upon transactions that
fit within the definition of such term, it is possible that other transactions
such as highly-leveraged transactions, which could result in an effective
change in the control of the Company or the Holding Company, could occur that
are not covered by such definition and, accordingly, would not cause this
repurchase obligation to arise. In such an event, the holders of the Notes
could be denied the benefits of the provision of the Indenture described above.
The New Credit Facility contains provisions that would prohibit the
purchase of the Notes in response to a Change of Control, unless all
indebtedness thereunder has been paid in full. Furthermore, certain events that
would constitute a Change of Control may constitute an event of default under
the New Credit Facility. In addition, no assurances can be given that the
Company or the Holding Company will have sufficient funds to, or otherwise be
able to, acquire Notes tendered upon the occurrence of a Change of Control.
Nevertheless, the Company's failure to make a Change of Control Offer or to
purchase all Notes properly tendered pursuant to such a Change of Control Offer
will constitute an Event of Default under the Indenture.
Any Change of Control Offer will be made in compliance with all applicable
laws, rules and regulations, including, if applicable, Regulation 14E under the
Exchange Act and the rules thereunder and all other applicable Federal and
state securities laws.
Limitation on Incurrence of Additional Indebtedness and Disqualified
Capital Stock
The Indenture provides that the Company will not, and will not permit any
of its Subsidiaries to, directly or indirectly, issue, assume, guaranty, incur,
become directly or indirectly liable with respect to (including as a result of
an Acquisition), or otherwise become responsible for, contingently or otherwise
(individually and collectively, to "incur" or, as appropriate, an
"incurrence"), any Indebtedness or any Disqualified Capital Stock (including
Acquired Indebtedness), except for Permitted Indebtedness.
Notwithstanding the foregoing, if (i) no Default or Event of Default shall
have occurred and be continuing at the time of, or would occur after giving
effect to, such incurrence of Indebtedness or Disqualified Capital Stock and
(ii) on the date of such incurrence (the "Incurrence Date"), the Consolidated
Interest Coverage Ratio of the Company for the Reference Period immediately
preceding the Incurrence Date, after giving effect on a pro forma basis to such
incurrence of such Indebtedness or Disqualified Capital Stock and, to the
extent set forth in the definition of Consolidated Interest Coverage Ratio, the
use of proceeds thereof, would be at least 2.0 to 1 (the "Debt Incurrence
Ratio"), then the Company and its Subsidiaries may incur such Indebtedness or
Disqualified Capital Stock.
Indebtedness of any person which is outstanding at the time such person
becomes a Subsidiary of the Company or is merged with or into or consolidated
with the Company or a Subsidiary of the Company shall be deemed to have been
incurred at the time such person becomes such a Subsidiary of the Company or is
merged with or into or consolidated with the Company or a Subsidiary of the
Company, as applicable.
Limitation on Restricted Payments
The Indenture provides that the Company will not, and will not permit any
of its Subsidiaries to, directly or indirectly, make any Restricted Payment if,
after giving effect to such Restricted Payment on a pro forma basis, (l) a
Default or an Event of Default shall have occurred and be continuing, (2) the
Company is not permitted to incur at least $1.00 of additional Indebtedness
pursuant to the Debt Incurrence Ratio in the second paragraph of the covenant
"Limitation on Incurrence of Additional Indebtedness and Disqualified Capital
Stock," or (3) the aggregate amount of all Restricted Payments made by the
Company and its Subsidiaries, including after giving effect to such proposed
Restricted Payment, from and after the Issue Date, would exceed the sum of (a)
50% of
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the aggregate Consolidated Net Income of the Company and its consolidated
Subsidiaries for the period (taken as one accounting period), commencing on the
first day after the Issue Date, to and including the last day of the fiscal
quarter ended immediately prior to the date of each such calculation (or, in
the event Consolidated Net Income for such period is a deficit, then minus 100%
of such deficit), plus (b) the aggregate Net Cash Proceeds received by the
Company from the sale of its Qualified Capital Stock (other than (i) to a
Subsidiary of the Company, and (ii) to the extent applied in connection with a
Qualified Exchange after the Issue Date), plus (c) the aggregate of cash
capital contributions in the form of common equity made to the Company by the
Holding Company. The foregoing clauses (2) and (3), however, will not prohibit
Permitted Payments.
The foregoing paragraph shall not prevent payments to the Holding Company
to enable the Holding Company to pay federal, state or local tax liabilities,
not to exceed the aggregate amount of (1) the amount of such tax liabilities
that would be due from the Company or the Subsidiary Guarantors to the
appropriate taxing authority if they were separate taxable entities to the
extent that the Holding Company has an obligation to satisfy such federal,
state or local tax liabilities relating to the operations, assets or capital of
the Company or the Subsidiary Guarantors, plus (2) the amount of such tax
liabilities that are due from the Holding Company with respect to the Holding
Company's ownership of the Company's Capital Stock, as applicable; provided
such payment shall either be used by the Holding Company to pay such federal,
state or local tax liabilities within 90 days of its receipt of such payment or
refunded to the payee. In addition, the Indenture specifically permitted the
payment by the Company of the cash dividend on the Issue Date to the Holding
Company in an amount of $45.0 million to enable it to pay the cash distribution
to the securityholders of the Holding Company as stated under "Use of
Proceeds."
Limitation on Dividends and Other Payment Restrictions Affecting
Subsidiaries
The Indenture provides that the Company will not, and will not permit any
of its Subsidiaries to, directly or indirectly, create, assume or suffer to
exist any consensual restriction on the ability of any Subsidiary of the
Company to pay dividends or make other distributions to or on behalf of, or to
pay any obligation to or on behalf of, or otherwise to transfer assets or
property to or on behalf of, or make or pay loans or advances to or on behalf
of, the Company or any Subsidiary of the Company, except (a) restrictions
imposed by the Notes or the Indenture, (b) restrictions imposed by applicable
law, (c) existing restrictions under specified Indebtedness outstanding on the
Issue Date or under any Acquired Indebtedness not incurred in violation of the
Indenture or under any agreement relating to any property, asset, or business
acquired by the Company or any of its Subsidiaries, which restrictions in each
case existed at the time of acquisition, were not put in place in connection
with or in anticipation of such acquisition and are not applicable to any
person, other than the person acquired, or to any property, asset or business,
other than the property, assets and business so acquired, (d) any such
restriction or requirement imposed by Indebtedness incurred under clause (b)
under the definition of "Permitted Indebtedness," provided such restriction or
requirement is no more restrictive than that imposed by the Credit Agreement as
of the Issue Date, (e) restrictions with respect solely to a Subsidiary of the
Company imposed pursuant to a binding agreement which has been entered into for
the sale or disposition of all or substantially all of the Capital Stock or
assets of such Subsidiary, provided such restrictions apply solely to the
Capital Stock or assets of such Subsidiary that are being sold and only to the
extent such Subsidiary is so sold within 180 days of such event, (f)
restrictions on transfer contained in Purchase Money Indebtedness, provided
such restrictions relate only to the transfer of the property acquired with the
proceeds of such Purchase Money Indebtedness, (g) customary restrictions
imposed on the transfer of copyrighted or patented materials and customary
provisions in agreements (other than agreements relating to Indebtedness) that
restrict the assignment of such agreements or any rights thereunder, and (h) in
connection with and pursuant to permitted Refinancings, replacements of
restrictions imposed pursuant to clause (c) of this paragraph that are not more
restrictive than those being replaced and do not apply to any other person or
assets than those that would have been covered by the restrictions in the
Indebtedness so refinanced. Notwithstanding the foregoing, neither (a)
customary provisions restricting subletting or assignment of any lease entered
into in the ordinary course of business, consistent with industry practice, nor
(b) Liens permitted under the terms of the Indenture, shall in and of
themselves be considered a restriction on the ability of the applicable
Subsidiary to transfer such agreement or assets, as the case may be.
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Liens
The Indenture provides that the Company will not, and will not permit any
of its Subsidiaries to, create, incur, assume or suffer to exist, any Lien of
any kind, other than Permitted Liens, upon any of their respective assets now
owned or acquired on or after the date of the Indenture or upon any income or
profits therefrom unless the Company or such Subsidiary provides, concurrently
therewith, that the Notes are equally and ratably secured, provided that, if
such Lien is to secure Subordinated Indebtedness, the Lien securing such
Subordinated Indebtedness shall be subordinate and junior to the Lien securing
the Notes or the applicable Guarantee, as applicable, with the same relative
priority as such Subordinated Indebtedness shall have with respect to the Notes
or the Guarantee, as applicable; provided, further, that in the case of a
Subsidiary, if such Subsidiary shall cease to be a Subsidiary Guarantor in
accordance with the terms of the Indenture, such equal and ratable Lien shall,
without any further action, cease to exist.
Limitation on Sale of Assets and Subsidiary Stock
The Indenture provides that the Company will not, and will not permit any
of its Subsidiaries to, in one transaction or a series of related transactions,
convey, sell, transfer, assign or otherwise dispose of, directly or indirectly,
any of their respective property, business or assets, including by merger or
consolidation (in the case of a Subsidiary of the Company), and including any
sale or other transfer or issuance of any Capital Stock of any Subsidiary of
the Company, whether by the Company or a Subsidiary of either or through the
issuance, sale or transfer of Capital Stock by a Subsidiary of the Company (an
"Asset Sale"), unless (l)(a) within 180 days after the date of such Asset Sale,
the Net Cash Proceeds therefrom (the "Asset Sale Offer Amount") are applied to
the optional redemption of the Notes in accordance with the terms of the
Indenture or to the repurchase of the Notes pursuant to an irrevocable,
unconditional cash offer (the "Asset Sale Offer") to repurchase Notes at a
purchase price (the "Asset Sale Offer Price") of 100% of the principal amount
thereof, plus accrued interest to the date of payment, made within 180 days of
such Asset Sale or (b) within 180 days following such Asset Sale, the Asset
Sale Offer Amount is (i) invested in fixed assets and property (other than
notes, bonds, obligations and securities) which in the good faith reasonable
judgment of the Board will immediately constitute or be a part of a Related
Business of the Company or such Subsidiary (if it continues to be a Subsidiary)
immediately following such transaction or (ii) used to retire any Indebtedness
ranking at least pari passu with the Notes and the Guarantees and to
permanently reduce the amount of such Indebtedness (including that in the case
of a revolver or similar arrangement that makes credit available, such
commitment is so permanently reduced by such amount), (2) at least 75% of the
consideration for such Asset Sale consists of cash or Cash Equivalents, (3) no
Default or Event of Default shall have occurred and be continuing at the time
of, or would occur after giving effect to, such Asset Sale, and (4) in the case
of any Asset Sale resulting in Net Cash Proceeds in excess of $500,000, the
Board of Directors of the Company determines in good faith that the Company or
such Subsidiary, as applicable, receives fair market value for such Asset Sale.
The Indenture provides that an Asset Sale Offer may be deferred until the
accumulated Net Cash Proceeds from Asset Sales not applied to the uses set
forth in (l)(b) above (the "Excess Proceeds") exceeds $3.0 million and that
each Asset Sale Offer shall remain open for 20 Business Days following its
commencement and no longer (the "Asset Sale Offer Period"). Upon expiration of
the Asset Sale Offer Period, the Company shall apply the Asset Sale Offer
Amount plus an amount equal to accrued and unpaid interest to the purchase of
all Notes properly tendered (on a pro rata basis if the Asset Sale Offer Amount
is insufficient to purchase all Notes so tendered) at the Asset Sale Offer
Price (together with accrued interest). To the extent that the aggregate amount
of Notes tendered pursuant to an Asset Sale Offer is less than the Asset Sale
Offer Amount, the Company may use any remaining Net Cash Proceeds for general
corporate purposes as otherwise permitted by the Indenture and following each
Asset Sale Offer the Excess Proceeds amount shall be reset to zero.
Notwithstanding the foregoing provisions of the prior two paragraphs:
(i) the Company and its Subsidiaries may in the ordinary course of
business, convey, sell, lease, transfer, assign or otherwise dispose of
inventory acquired and held for resale in the ordinary course of business;
(ii) the Company and its Subsidiaries may convey, sell, lease, transfer,
assign or otherwise dispose of assets pursuant to and in accordance with the
limitation on mergers, sales or consolidations provisions in the Indenture;
(iii) the Company and its Subsidiaries may convey, sell, lease, transfer,
assign or otherwise dispose of assets to the Company or any of its
Subsidiaries;
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(iv) the Company and its Subsidiaries may in the ordinary course of
business sell, transfer, convey or otherwise dispose of Third Party Plan
Receivables in customary factoring arrangements; and
(v) the Company and its Subsidiaries may consummate any sale or series of
related sales of assets or properties of the Company and its Subsidiaries
having an aggregate Fair Market Value of less than $1.0 million in any fiscal
year.
Any Asset Sale Offer shall be made in compliance with all applicable laws,
rules, and regulations, including, if applicable, Regulation 14E of the
Exchange Act and the rules and regulations thereunder and all other applicable
Federal and state securities laws.
Limitation on Transactions with Affiliates
The Indenture provides that neither the Company nor any of its
Subsidiaries will be permitted after the Issue Date to enter into any contract,
agreement, arrangement or transaction with any Affiliate (an "Affiliate
Transaction"), or any series of related Affiliate Transactions (other than
Exempted Affiliate Transactions), unless such Affiliate Transaction is made in
good faith, the terms of such Affiliate Transaction are fair and reasonable to
the Company or such Subsidiary, as the case may be, and are no less favorable
than the terms which could be obtained by the Company or such Subsidiary, as
the case may be, in a comparable transaction made on an arm's-length basis with
persons who are not Affiliates.
Without limiting the foregoing, any Affiliate Transaction or series of
related Affiliate Transactions (other than Exempted Affiliate Transactions) (1)
involving consideration to either party in excess of $1.0 million, must be
evidenced by an Officers' Certificate addressed and delivered to the Trustee
stating that the terms of such Affiliate Transaction are fair and reasonable to
the Company or such Subsidiary, and no less favorable to the Company or such
Subsidiary, than could have been obtained in an arm's length transaction with a
non-Affiliate, and (2) involving consideration to either party in excess of
$5.0 million, unless in addition the Company, prior to the consummation
thereof, obtains a written favorable opinion as to the fairness of such
transaction to the Company or such Subsidiary from a financial point of view
from an independent investment banking firm of national reputation.
The foregoing provisions shall not apply to any Restricted Payment that is
made in compliance with or exempt from the provisions described in the first
paragraph under the heading "Limitation on Restricted Payments."
Limitation on Merger, Sale or Consolidation
The Indenture provides that the Company will not, directly or indirectly,
consolidate with or merge with or into another person or sell, lease, convey or
transfer all or substantially all of its assets (computed on a consolidated
basis), whether in a single transaction or a series of related transactions, to
another person or group of affiliated persons or adopt a Plan of Liquidation,
unless (i) either (a) the Company is the continuing entity or (b) the
resulting, surviving or transferee entity or, in the case of a Plan of
Liquidation, the entity which receives the greatest value from such Plan of
Liquidation, is a corporation organized under the laws of the United States,
any state thereof or the District of Columbia and expressly assumes by
supplemental indenture all of the obligations of the Company in connection with
the Notes and the Indenture; (ii) no Default or Event of Default shall exist or
shall occur immediately after giving effect to such transaction; (iii)
immediately after giving effect to such transaction on a pro forma basis, the
Consolidated Net Worth of the consolidated surviving or transferee entity or,
in the case of a Plan of Liquidation, the entity which receives the greatest
value from such Plan of Liquidation, is at least equal to the Consolidated Net
Worth of the Company immediately prior to such transaction; and (iv)
immediately after giving effect to such transaction on a pro forma basis, the
consolidated resulting, surviving or transferee entity or, in the case of a
Plan of Liquidation, the entity which receives the greatest value from such
Plan of Liquidation, would immediately thereafter be permitted to incur at
least $1.00 of additional Indebtedness pursuant to the Debt Incurrence Ratio
set forth in the second paragraph under the heading "Limitation on Incurrence
of Additional Indebtedness and Disqualified Capital Stock."
Upon any consolidation or merger or any transfer of all or substantially
all of the assets of the Company or consummation of a Plan of Liquidation in
accordance with the foregoing, the successor corporation formed by such
consolidation or into which the Company is merged or to which such transfer is
made or, in the case of a Plan of Liquidation, the entity which receives the
greatest value from such Plan of Liquidation, shall succeed to, and be
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substituted for, and may exercise every right and power of, the Company under
the Indenture with the same effect as if such successor corporation had been
named therein as the Company, and the Company shall be released from the
obligations under the Notes and the Indenture.
For purposes of the foregoing, the transfer (by lease, assignment, sale or
otherwise) of all or substantially all of the properties and assets of one or
more Subsidiaries, the Capital Stock of which constitutes all or substantially
all of the properties and assets of the Company, shall be deemed to be the
transfer of all or substantially all of the properties and assets of the
Company.
Each Subsidiary will not, and the Company will not cause or permit any
Subsidiary to, directly or indirectly, consolidate with or merge with or into
another person or sell, lease, convey or transfer all or substantially all of
its assets (computed on a consolidated basis), whether in a single transaction
or a series of related transactions, to another person or group of affiliated
persons or adopt a Plan of Liquidation, unless (i) either (a) the Subsidiary is
the continuing entity or (b) the resulting, surviving or transferee entity or,
in the case of a Plan of Liquidation, the entity which receives the greatest
value from such Plan of Liquidation, is a corporation organized under the laws
of the United States, any state thereof or the District of Columbia and
expressly assumes by supplemental indenture all of the obligations of the
Subsidiary in connection with its Guarantee; (ii) no Default or Event of
Default shall exist or shall occur immediately after giving effect to such
transaction; (iii) immediately after giving effect to such transaction on a pro
forma basis, the Consolidated Net Worth of the Company is at least equal to the
Consolidated Net Worth of the Company immediately prior to such transaction;
and (iv) immediately after giving effect to such transaction on a pro forma
basis, the Company would immediately thereafter be permitted to incur at least
$1.00 of additional Indebtedness pursuant to the Debt Incurrence Ratio
described in the second paragraph under the heading "Limitation on Incurrence
of Additional Indebtedness and Disqualified Capital Stock." Any such
transaction with and into the Company (with the Company being the surviving
entity) or another Subsidiary that is a Wholly owned Subsidiary of the Company
need not comply with this covenant. Notwithstanding the foregoing provisions of
this paragraph, upon the sale or disposition (whether by merger, stock
purchase, asset sale or otherwise) of a Subsidiary or all or substantially all
of the assets of such Subsidiary to an entity which is not a Subsidiary of the
Company, which transaction complies with the provisions of the covenant
described under "Limitation on Sale of Assets and Subsidiary Stock," such sale
or disposition shall be permitted under the Indenture and such Subsidiary shall
be deemed released from all of its obligations under its Guarantee of the Notes
without complying with the provisions of this paragraph.
Limitation on Lines of Business
The Indenture provides that neither the Company nor any of its
Subsidiaries shall directly or indirectly engage to any substantial extent in
any line or lines of business activity other than that which, in the reasonable
good faith judgment of the Board of Directors of the Company, is a Related
Business.
Restriction on Sale and Issuance of Subsidiary Stock
The Indenture provides that the Company will not issue or sell, and will
not permit any of its Subsidiaries to issue or sell, any shares of Capital
Stock of any Subsidiary of the Company to any person other than the Company or
a Wholly owned Subsidiary of the Company, except for shares of common stock
with no preferences or special rights or privileges and with no redemption or
prepayment provisions.
Future Subsidiary Guarantors
The Indenture provides that all present and future Subsidiaries of the
Company jointly and severally will guarantee irrevocably and unconditionally
all principal, premium, if any, and interest on the Notes on a senior basis.
Limitation on Status as Investment Company
The Indenture prohibits the Company and its Subsidiaries from being
required to register as an "investment company" (as that term is defined in the
Investment Company Act of 1940, as amended), or from otherwise becoming subject
to regulation under the Investment Company Act.
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Reports
The Indenture provides that whether or not the Company is subject to the
reporting requirements of Section 13 or 15(d) of the Exchange Act, the Company
shall deliver to the Trustee and, to each Holder and to prospective purchasers
of Notes identified to the Company by an Initial Purchaser, within 15 days
after it is or would have been (if it were subject to such reporting
obligations) required to file such with the Commission, annual and quarterly
financial statements substantially equivalent to financial statements that
would have been included in reports filed with the Commission, if the Company
were subject to the requirements of Section 13 or 15(d) of the Exchange Act,
including, with respect to annual information only, a report thereon by the
Company's certified independent public accountants as such would be required in
such reports to the Commission, and, in each case, together with a management's
discussion and analysis of financial condition and results of operations which
would be so required. In addition, whether or not required by the rules and
regulations of the Commission, the Company will file a copy of all such
information and reports with the Commission for public availability (unless the
Commission will not accept such a filing) and make such information available
to securities analysts and prospective investors upon request.
Events of Default and Remedies
The Indenture defines an Event of Default as (i) the failure by the
Company to pay any installment of interest on the Notes as and when the same
becomes due and payable and the continuance of any such failure for 30 days,
(ii) the failure by the Company to pay all or any part of the principal, or
premium, if any, on the Notes when and as the same becomes due and payable at
maturity, redemption, by acceleration or otherwise, including, without
limitation, payment of the Change of Control Purchase Price or the Asset Sale
Offer Price, (iii) the failure by the Company or any Guarantor to observe or
perform any other covenant or agreement contained in the Notes, the Guarantees
or the Indenture and, subject to certain exceptions, the continuance of such
failure for a period of 30 days after written notice is given to the Company by
the Trustee or to the Company and the Trustee by the Holders of at least 25% in
aggregate principal amount of the Notes then outstanding, (iv) certain events
of bankruptcy, insolvency or reorganization in respect of the Company or any of
its Significant Subsidiaries, (v) a default in any Indebtedness of the Company
or any of its Subsidiaries with an aggregate principal amount in excess of $2.0
million (a) resulting from the failure to pay principal at maturity or (b) as a
result of which the maturity of such Indebtedness has been accelerated prior to
its stated maturity, (vi) final unsatisfied judgments not covered by insurance
aggregating in excess of $2.0 million, at any one time rendered against the
Company or any of its Subsidiaries and not stayed, bonded or discharged within
60 days and (vii) except for any release of a Guarantee in accordance with the
covenant "Limitation on Merger, Sale or Consolidation," any Guarantee ceases to
be in full force and effect or is declared null and void or any Guarantor
denies that it has any further liability under any Guarantee, or gives notice
to such effect (other than by reason of the termination of the Indenture or the
release of any such Guarantee in accordance with the terms of the Indenture).
The Indenture provides that if an Event of Default occurs and is continuing,
generally the Trustee must, within 90 days after the occurrence of such
default, give to the Holders notice of such Event of Default.
If an Event of Default occurs and is continuing (other than an Event of
Default specified in clause (iv) above, relating to the Company or any
Significant Subsidiary) then in every such case, unless the principal of all of
the Notes shall have already become due and payable, either the Trustee or the
Holders of 25% in aggregate principal amount of the Notes then outstanding, by
notice in writing to the Company (and to the Trustee if given by Holders) (an
"Acceleration Notice"), may declare all principal and accrued interest thereon
to be due and payable immediately. If an Event of Default specified in clause
(iv) above, relating to the Company or any Significant Subsidiary occurs, all
principal and accrued interest thereon will be immediately due and payable on
all outstanding Notes without any declaration or other act on the part of the
Trustee or the Holders. The Holders of a majority in aggregate principal amount
of the Notes then outstanding generally are authorized to rescind such
acceleration if all existing Events of Default (other than the non-payment of
the principal of, premium, if any, and interest on the Notes which have become
due solely by such acceleration) have been cured or waived, except a default
with respect to any provision which cannot be modified or amended by majority
approval.
Prior to the declaration of acceleration of the maturity of the Notes, the
Holders of a majority in aggregate principal amount of the Notes at the time
outstanding may waive on behalf of all of the Holders any default, except a
default with respect to any provision requiring supermajority approval to
amend, which default may only be waived by such supermajority, and except a
default in the payment of principal of, premium on, or interest on any Note not
yet cured or a default with respect to any covenant or provision which cannot
be modified or amended
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without the consent of the Holder of each outstanding Note affected. Subject to
the provisions of the Indenture relating to the duties of the Trustee, the
Trustee will be under no obligation to exercise any of its rights or powers
under the Indenture at the request, order or direction of any of the Holders,
unless such Holders have offered to the Trustee reasonable security or
indemnity. Subject to all provisions of the Indenture and applicable law, the
Holders of a majority in aggregate principal amount of the Notes at the time
outstanding will have the right to direct the time, method and place of
conducting any proceeding for any remedy available to the Trustee, or
exercising any trust or power conferred on the Trustee.
Legal Defeasance and Covenant Defeasance
The Indenture provides that the Company may, at its option and at any
time, elect to have its obligations and the obligations of the Guarantors
discharged with respect to the outstanding Notes ("Legal Defeasance"). Such
Legal Defeasance means that the Company shall be deemed to have paid and
discharged the entire Indebtedness represented by, and the Indenture shall
cease to be of further effect as to, all outstanding Notes and Guarantees,
except as to (i) rights of Holders to receive payments in respect of the
principal of, premium, if any, and interest on such Notes when such payments
are due from the trust funds; (ii) the Company's obligations with respect to
such Notes concerning issuing temporary Notes, registration of Notes,
mutilated, destroyed, lost or stolen Notes, and the maintenance of an office or
agency for payment and money for security payments held in trust; (iii) the
rights, powers, trust, duties, and immunities of the Trustee, and the Company's
and the Guarantors' obligations in connection therewith; and (iv) the Legal
Defeasance provisions of the Indenture. In addition, the Company may, at its
option and at any time, elect to have the obligations of the Company and the
Guarantors released with respect to certain covenants that are described in the
Indenture ("Covenant Defeasance") and thereafter any omission to comply with
such obligations shall not constitute a Default or Event of Default with
respect to the Notes. In the event Covenant Defeasance occurs, certain events
(not including non-payment, bankruptcy, receivership, rehabilitation and other
insolvency events) described under "Events of Default" will no longer
constitute an Event of Default with respect to the Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance, (i)
the Company must irrevocably deposit with the Trustee, in trust, for the
benefit of the Holders of the Notes, U.S. legal tender, U.S. Government
Obligations or a combination thereof, in such amounts as will be sufficient, in
the opinion of a nationally recognized firm of independent public accountants,
to pay the principal of, premium, if any, and interest on such Notes on the
stated date for payment thereof or on the redemption date of such principal or
installment of principal of, premium, if any, or interest on such Notes, and
the Trustee, for the exclusive benefit of the Holders of the Notes, must have a
valid, perfected, exclusive security interest in such trust; (ii) in the case
of Legal Defeasance before the date that is one year prior to the Stated
Maturity, the Company shall have delivered to the Trustee an opinion of counsel
in the United States reasonably acceptable to the Trustee confirming that (A)
the Company has received from, or there has been published by, the Internal
Revenue Service, a ruling or (B) since the date of the Indenture, there has
been a change in the applicable federal income tax law, in either case to the
effect that, and based thereon such opinion of counsel shall confirm that, the
Holders of such Notes will not recognize income, gain or loss for federal
income tax purposes as a result of such Legal Defeasance and will be subject to
federal income tax on the same amounts, in the same manner and at the same
times as would have been the case if such Legal Defeasance had not occurred;
(iii) in the case of Covenant Defeasance before the date that is one year prior
to the Stated Maturity, the Company shall have delivered to the Trustee an
opinion of counsel in the United States reasonably acceptable to such Trustee
confirming that the Holders of such Notes will not recognize income, gain or
loss for federal income tax purposes as a result of such Covenant Defeasance
and will be subject to federal income tax on the same amounts, in the same
manner and at the same times as would have been the case if such Covenant
Defeasance had not occurred; (iv) no Default or Event of Default shall have
occurred and be continuing on the date of such deposit or, insofar as Events of
Default from bankruptcy or insolvency events are concerned, at any time in the
period ending on the 91st day after the date of deposit; (v) such Legal
Defeasance or Covenant Defeasance shall not result in a breach or violation of,
or constitute a default under the Indenture or any other material agreement or
instrument to which the Company or any of its Subsidiaries is a party or by
which the Company or any of its Subsidiaries is bound; (vi) the Company shall
have delivered to the Trustee an Officers' Certificate stating that the deposit
was not made by the Company with the intent of preferring the Holders of such
Notes over any other creditors of the Company or with the intent of defeating,
hindering, delaying or defrauding any other creditors of the Company or others;
and (vii) the Company shall have delivered to the Trustee an Officers'
Certificate and an opinion of counsel, each stating that the conditions
precedent provided for in, in the case of the Officers' Certificate, clauses
(i) through (vi)
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and, in the case of the opinion of counsel, clauses (i), (with respect to the
validity and perfection of the security interest), (ii), (iii) and (v) of this
paragraph have been complied with.
If the funds deposited with the Trustee to effect Legal Defeasance or
Covenant Defeasance are insufficient to pay the principal of premium, if any,
and interest on the Notes when due, then the obligations of the Company and the
Guarantors under the Indenture will be revived and no such defeasance will be
deemed to have occurred.
Amendments and Supplements
The Indenture contains provisions permitting the Company, the Guarantors
and the Trustee to enter into a supplemental indenture for certain limited
purposes without the consent of the Holders. With the consent of the Holders of
not less than a majority in aggregate principal amount of the Notes at the time
outstanding, the Company, the Guarantors and the Trustee are permitted to amend
or supplement the Indenture or any supplemental indenture or modify the rights
of the Holders; except that any amendments or supplements to the provisions
relating to the provisions described under the heading "Repurchase of Notes at
the Option of the Holder Upon a Change of Control" in a manner adverse to the
Holders shall require the consent of Holders of not less than 66-2/3% of the
aggregate principal amount of Notes at the time outstanding; provided, further,
that no such modification may, without the consent of each Holder affected
thereby: (i) change the Stated Maturity on any Note, or reduce the principal
amount thereof or the rate (or extend the time for payment) of interest thereon
or any premium payable upon the redemption thereof, or change the place of
payment where, or the coin or currency in which, any Note or any premium or the
interest thereon is payable, or impair the right to institute suit for the
enforcement of any such payment on or after the Stated Maturity thereof (or, in
the case of redemption, on or after the Redemption Date), or reduce the Change
of Control Purchase Price or Asset Sale Offer Price or alter the redemption
provisions of the Indenture in a manner adverse to the Holders, (ii) reduce the
percentage in principal amount of the outstanding Notes, the consent of whose
Holders is required for any such amendment, supplemental indenture or waiver
provided for in the Indenture, (iii) modify any of the waiver provisions,
except to increase any required percentage or to provide that certain other
provisions of the Indenture cannot be modified or waived without the consent of
the Holder of each outstanding Note affected thereby or (iv) cause the Notes or
any Guarantee to become subordinate in right of payment to any other
Indebtedness.
No Personal Liability of Partners, Stockholders, Officers, Directors
The Indenture provides that no direct or indirect stockholder, employee,
officer or director, as such, past, present or future of the Company, the
Guarantors or any successor entity shall have any personal liability in respect
of the obligations of the Company or the Guarantors under the Indenture or the
Notes by reason of his or its status as such stockholder, employee, officer or
director, except to the extent such person is the Company or a Guarantor.
Certain Definitions
"Acquired Indebtedness" means Indebtedness or Disqualified Capital Stock
of any person existing at the time such person becomes a Subsidiary of the
Company or is merged or consolidated into or with the Company or one of its
Subsidiaries.
"Acquisition" means the purchase or other acquisition of any person or
substantially all the assets of any person by any other person, whether by
purchase, stock purchase, merger, consolidation, or other transfer, and whether
or not for consideration.
"Affiliate" means any person directly or indirectly controlling or
controlled by or under direct or indirect common control with the Company. For
purposes of this definition, the term "control" means the power to direct the
management and policies of a person, directly or through one or more
intermediaries, whether through the ownership of voting securities, by
contract, or otherwise, provided, that, a Beneficial Owner of 10% or more of
the total voting power normally entitled to vote in the election of directors,
managers or trustees, as applicable, shall for such purposes be deemed to
constitute control.
"Average Life" means, as of the date of determination, with respect to any
security or instrument, the quotient obtained by dividing (i) the sum of (a)
the product of the number of years from the date of determination to the date
or dates of each successive scheduled principal (or redemption) payment of such
security or instrument and (b) the amount of each such respective principal (or
redemption) payment by (ii) the sum of all such principal (or redemption)
payments.
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"Beneficial Owner" has the meaning attributed to it in Rules 13d-3 and
13d-5 under the Exchange Act (as in effect on the Issue Date), whether or not
applicable, except that a "person" shall be deemed to have "beneficial
ownership" of all shares that any such person has the right to acquire, whether
such right is exercisable immediately or only after the passage of time.
"Business Day" means each Monday, Tuesday, Wednesday, Thursday and Friday
which is not a day on which banking institutions in New York, New York are
authorized or obligated by law or executive order to close.
"Capital Stock" means, (i) with respect to any corporation, any and all
shares, interests, rights to purchase (other than convertible or exchangeable
Indebtedness that is not itself otherwise Capital Stock), warrants, options,
participations or other equivalents of or interests (however designated) in
stock issued by that corporation, (ii) in the case of an association or
business entity, any and all shares, interests, participations, rights or other
equivalents (however designated) of corporate stock, (iii) in the case of a
partnership, partnership interests (whether general or limited), and (iv) any
other interest or participation that confers on a person the right to receive a
share of the profits and losses of, or distributions of assets of, the issuing
person.
"Capitalized Lease Obligation" means rental obligations under a lease that
are required to be capitalized for financial reporting purposes in accordance
with GAAP, and the amount of Indebtedness represented by such obligations shall
be the capitalized amount of such obligations, as determined in accordance with
GAAP.
"Cash Equivalent" means (i) securities issued or directly and fully
guaranteed or insured by the United States of America or any agency or
instrumentality thereof (provided that the full faith and credit of the United
States of America is pledged in support thereof) or (ii) time deposits and
certificates of deposit and commercial paper issued by the parent corporation
of any domestic commercial bank of recognized standing having capital and
surplus in excess of $500 million and commercial paper issued by any other
issuer which is rated at least A-1 or the equivalent thereof by Standard &
Poor's Corporation or at least P-1 or the equivalent thereof by Moody's
Investors Service, Inc. and in each case maturing within one year after the
date of acquisition.
"Consolidated Cash Flow" means, with respect to any person, for any
period, the Consolidated Net Income of such person for such period adjusted to
add thereto (to the extent deducted from net revenues in determining
Consolidated Net Income), without duplication, the sum of (i) consolidated
income tax expense, (ii) consolidated depreciation and amortization expense,
provided that consolidated depreciation and amortization of a Subsidiary that
is less than wholly owned shall only be added to the extent of the equity
interest of the Company in such Subsidiary, and (iii) Consolidated Interest
Expense.
"Consolidated Interest Coverage Ratio" of any person on any date of
determination (the "Transaction Date") means the ratio, on a pro forma basis,
of (a) the aggregate amount of Consolidated Cash Flow of such person
attributable to continuing operations and businesses (exclusive of amounts
attributable to operations and businesses that would in accordance with GAAP be
deemed to be discontinued operations) for the Reference Period to (b) the
aggregate Consolidated Interest Expense of such person (exclusive of amounts
attributable to operations and businesses permanently discontinued or disposed
of, but only to the extent that the obligations giving rise to such
Consolidated Interest Expense would no longer be obligations contributing to
such person's Consolidated Interest Expense subsequent to the Transaction Date)
during the Reference Period; provided, that for purposes of such calculation,
(i) Acquisitions which occurred during the Reference Period or subsequent to
the Reference Period and on or prior to the Transaction Date shall be assumed
to have occurred on the first day of the Reference Period, (ii) transactions
giving rise to the need to calculate the Consolidated Interest Coverage Ratio
shall be assumed to have occurred on the first day of the Reference Period,
(iii) the incurrence of any Indebtedness or issuance of any Disqualified
Capital Stock during the Reference Period or subsequent to the Reference Period
and on or prior to the Transaction Date (and the application of the proceeds
therefrom to the extent used to refinance or retire other Indebtedness) shall
be assumed to have occurred on the first day of such Reference Period, and (iv)
the Consolidated Interest Expense of such person attributable to interest on
any Indebtedness or dividends on any Disqualified Capital Stock bearing a
floating interest (or dividend) rate shall be computed on a pro forma basis as
if the average rate in effect from the beginning of the Reference Period to the
Transaction Date had been the applicable rate for the entire period, unless
such person or any of its Subsidiaries is a party to an Interest Swap or
Hedging Obligation (which shall remain in effect for the 12-month period
immediately following the Transaction Date) that has the effect of fixing the
interest rate on the date of computation, in which case such rate (whether
higher or lower) shall be used. If any Indebtedness that is being given pro
forma effect was incurred under a revolving credit facility,
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the interest expense on such Indebtedness shall be computed based upon the
average daily balance of such Indebtedness during the applicable period.
"Consolidated Interest Expense" of any person means, for any period, the
aggregate amount (without duplication and determined in each case in accordance
with GAAP) of (a) interest expensed or capitalized, paid, accrued, or scheduled
to be paid or accrued (including, in accordance with the following sentence,
interest attributable to Capitalized Lease Obligations) of such person and its
Consolidated Subsidiaries during such period, including (i) original issue
discount and non-cash interest payments or accruals on any Indebtedness, (ii)
the interest portion of all deferred payment obligations, and (iii) all
commissions, discounts and other fees and charges owed with respect to bankers'
acceptances and letters of credit financings and currency and Interest Swap and
Hedging Obligations, in each case to the extent attributable to such period,
and (b) the amount of dividends accrued or payable (or guaranteed) by such
person or any of its Consolidated Subsidiaries in respect of Preferred Stock
(other than by Subsidiaries of such person to such person or such person's
wholly owned Subsidiaries). For purposes of this definition, (x) interest on a
Capitalized Lease Obligation shall be deemed to accrue at an interest rate
reasonably determined in good faith by the Company to be the rate of interest
implicit in such Capitalized Lease Obligation in accordance with GAAP, and (y)
interest expense attributable to any Indebtedness represented by the guarantee
by such person or a Subsidiary of such person of an obligation of another
person shall be deemed to be the interest expense attributable to the
Indebtedness guaranteed.
"Consolidated Net Income" means, with respect to any person for any
period, the net income (or loss) of such person and its Consolidated
Subsidiaries (determined on a consolidated basis in accordance with GAAP) for
such period, adjusted to exclude (only to the extent included in computing such
net income (or loss) and without duplication): (a) (i) in calculating
Consolidated Net Income for the purposes of the Debt Incurrence Ratio covenant
described in the second paragraph under the heading "Limitation on Incurrence
of Additional Indebtedness and Disqualified Capital Stock, " all gains and
losses and (ii) in calculating Consolidated Net Income for the purposes of the
covenant described under the heading "Limitation on Restricted Payments," all
gains but not losses, in each case which are either extraordinary (as
determined in accordance with GAAP) or are either unusual or nonrecurring
(including any gain or loss, as applicable, from the sale or other disposition
of assets outside the ordinary course of business or from the issuance or sale
of any Capital Stock), (b) the net income, if positive, of any person, other
than a Consolidated Subsidiary, in which such person or any of its Consolidated
Subsidiaries has an interest, except to the extent of the amount of any
dividends or distributions actually paid in cash to such person or a wholly
owned Consolidated Subsidiary of such person during such period, but in any
case not in excess of such person's pro rata share of such person's net income
for such period, (c) the net income or loss of any person acquired in a pooling
of interests transaction for any period prior to the date of such acquisition,
(d) the net income, if positive, of any of such person's Consolidated
Subsidiaries in the event and solely to the extent that the declaration or
payment of dividends or similar distributions is not at the time permitted by
operation of the terms of its charter or bylaws or any other agreement,
instrument, judgment, decree, order, statute, rule or governmental regulation
applicable to such Consolidated Subsidiary, and (e) the effects of changes in
accounting principles.
"Consolidated Net Worth" of any person at any date means the aggregate
consolidated stockholders' equity of such person (plus amounts of equity
attributable to preferred stock) and its Consolidated Subsidiaries, as would be
shown on the consolidated balance sheet of such person prepared in accordance
with GAAP, adjusted to exclude (to the extent included in calculating such
equity), (a) the amount of any such stockholders' equity attributable to
Disqualified Capital Stock or treasury stock of such person and its
Consolidated Subsidiaries, (b) all upward revaluations and other write-ups in
the book value of any asset of such person or a Consolidated Subsidiary of such
person resulting from or in connection with the transaction or series of
related transactions giving rise to the calculation of the Consolidated Net
Worth of such person at such date, and (c) all investments in Subsidiaries that
are not Consolidated Subsidiaries and in persons that are not Subsidiaries.
"Consolidated Subsidiary" means, for any person, each Subsidiary of such
person (whether now existing or hereafter created or acquired) the financial
statements of which are consolidated for financial statement reporting purposes
with the financial statements of such person in accordance with GAAP.
"Credit Agreement" means the Credit Agreement described under "Description
of New Credit Facility and Certain Other Indebtedness," including any related
notes, guarantees, collateral documents, instruments and agreements executed in
connection therewith, as such credit agreement and/or related documents may be
amended, restated, supplemented, renewed, replaced or otherwise modified from
time to time whether or not with the same
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agent, trustee, representative, lenders or holders, and, subject to the proviso
to the next succeeding sentence, irrespective of any changes in the terms and
conditions thereof. Without limiting the generality of the foregoing, the term
"Credit Agreement" shall include any amendment, amendment and restatement,
renewal, extension, restructuring, supplement or modification to such credit
agreement and all refundings, refinancings and replacements of such credit
agreement, including any agreement (i) extending the maturity of any
Indebtedness incurred thereunder or contemplated thereby, (ii) adding or
deleting borrowers or guarantors thereunder, so long as borrowers and issuers
include one or more of the Company and its Subsidiaries and their respective
successors and assigns, (iii) increasing the amount of Indebtedness incurred
thereunder or available to be borrowed thereunder, provided that on the date
such additional Indebtedness is incurred it would not be prohibited by the
covenant described under the heading "Limitation on Incurrence of Additional
Indebtedness and Disqualified Capital Stock," or (iv) otherwise altering the
terms and conditions thereof in a manner not prohibited by the terms hereof.
"Disqualified Capital Stock" means (a) except as set forth in clause (b)
of this paragraph, with respect to any person, Capital Stock of such person
that, by its terms or by the terms of any security into which it is then
convertible, exercisable or exchangeable, is, or upon the happening of an event
or the passage of time would be, required to be redeemed or repurchased
(including at the option of the holder thereof) by such person or any of its
Subsidiaries, in whole or in part, on or prior to the Stated Maturity of the
Notes and (b) with respect to any Subsidiary of such person (including with
respect to any Subsidiary of the Company), any Capital Stock other than any
common stock with no preference, privileges, or redemption or repayment
provisions.
"Equity Offering" means an underwritten public offering pursuant to a
registration statement filed with the SEC in accordance with the Securities Act
the consequence of which is that the common stock of either the Company or the
Holding Company is listed on a national securities exchange or quoted on the
national market system of NASDAQ and, in the case of an Equity Offering of the
Common Stock of the Holding Company, all the net proceeds (after payment of
related transaction costs) of such Equity Offering are contributed as common
equity to the Company.
"Excluded Person" means collectively or individually BancBoston Ventures
Inc. and Harvest Partners, Inc. and all Related Persons of such person.
"Exempted Affiliate Transaction" means (a) customary employee or director
compensation arrangements approved by a majority of independent (as to such
transactions) members of the Board of Directors of the Company or its
Subsidiary, as applicable, (b) dividends permitted under the terms of the
covenant discussed above under "Limitation on Restricted Payments" and payable,
in form and amount, on a pro rata basis to all holders of Common Stock of the
Company (after taking into account the exercise of one or more outstanding
options or warrants), (c) transactions solely between the Company and any of
its Wholly owned Subsidiaries or solely among Wholly owned Subsidiaries of the
Company, (d) transactions set forth in clauses (i) or (iii) of the definition
of "Permitted Payments" and (e) the payment to Mr. Frank Marfino and Mr. Todd
Pluymers of performance related bonuses in an aggregate amount not to exceed
$1.4 million to be paid no later than the first anniversary of the Issue Date.
"GAAP" means United States generally accepted accounting principles set
forth in the opinions and pronouncements of the Accounting Principles Board of
the American Institute of Certified Public Accountants and statements and
pronouncements of the Financial Accounting Standards Board or in such other
statements by such other entity as approved by a significant segment of the
accounting profession in the United States as in effect on the Issue Date.
"Indebtedness" of any person means, without duplication, (a) all
liabilities and obligations, contingent or otherwise, of any such person, (i)
in respect of borrowed money (whether or not the recourse of the lender is to
the whole of the assets of such person or only to a portion thereof), (ii)
evidenced by bonds, notes, debentures or similar instruments, (iii)
representing the balance deferred and unpaid of the purchase price of any
property or services, except (other than accounts payable or other obligations
to trade creditors which have remained unpaid for greater than 90 days past
their original due date) those incurred in the ordinary course of its business
that would constitute ordinarily a trade payable to trade creditors, (iv)
evidenced by bankers' acceptances or similar instruments issued or accepted by
banks, (v) for the payment of money relating to a Capitalized Lease Obligation,
or (vi) evidenced by a letter of credit or a reimbursement obligation of such
person with respect to any letter of credit; (b) all net obligations of such
person under Interest Swap and Hedging Obligations; (c) all liabilities and
obligations of others of the kind described in the preceding clause (a) or (b)
that such person has guaranteed or that is otherwise
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its legal liability or which are secured by any assets or property of such
person and all obligations to purchase, redeem or acquire any Capital Stock;
and (d) any and all deferrals, renewals, extensions, refinancing and refundings
(whether direct or indirect) of, or amendments, modifications or supplements
to, any liability of the kind described in any of the preceding clauses (a),
(b) or (c), or this clause (d), whether or not between or among the same
parties. Indebtedness shall not include obligations of any person resulting
from the endorsement of negotiable instruments for collection in the ordinary
course of business and consistent with past business practices.
"Interest Swap and Hedging Obligation" means any obligation of any person
pursuant to any interest rate swap agreement, interest rate cap agreement,
interest rate collar agreement, interest rate exchange agreement, currency
exchange agreement or any other agreement or arrangement designed to protect
against fluctuations in interest rates or currency values, including, without
limitation, any arrangement whereby, directly or indirectly, such person is
entitled to receive from time to time periodic payments calculated by applying
either a fixed or floating rate of interest on a stated notional amount in
exchange for periodic payments made by such person calculated by applying a
fixed or floating rate of interest on the same notional amount.
"Investment" by any person in any other person means (without duplication)
(a) the acquisition (whether by purchase, merger, consolidation or otherwise)
by such person (whether for cash, property, services, securities or otherwise)
of Capital Stock, bonds, notes, debentures, partnership or other ownership
interests or other securities, including any options or warrants, of such other
person or any agreement to make any such acquisition; (b) the making by such
person of any deposit with, or advance, loan or other extension of credit to,
such other person (including the purchase of property from another person
subject to an understanding or agreement, contingent or otherwise, to resell
such property to such other person) or any commitment to make any such advance,
loan or extension (but excluding accounts receivable, endorsements for
collection or deposits arising in the ordinary course of business); (c) other
than guarantees of Indebtedness of the Company or any Subsidiary to the extent
permitted by the covenant described under the heading "Limitation on Incurrence
of Additional Indebtedness and Disqualified Capital Stock," the entering into
by such person of any guarantee of, or other credit support or contingent
obligation with respect to, Indebtedness or other liability of such other
person; and (d) the making of any capital contribution by such person to such
other person.
"Issue Date" means the date of first issuance of the Notes under the
Indenture.
"Lien" means any mortgage, charge, pledge, lien (statutory or otherwise),
privilege, security interest, hypothecation or other encumbrance upon or with
respect to any property of any kind, real or personal, movable or immovable,
now owned or hereafter acquired (including any conditional sale or other title
retention agreement and any lease deemed to constitute a security interest and
any option or other agreement to give any security interest).
"Management Fee Agreements" means the Management Fee Agreements, dated as
of January 30, 1995, as amended, between the Company and BancBoston Ventures
Inc. and Harvest Partners Inc., respectively, each substantially as in effect
on the Issue Date.
"Net Cash Proceeds" means the aggregate amount of cash or Cash Equivalents
received by the Company in the case of a sale of Qualified Capital Stock and by
the Company and its Subsidiaries in respect of an Asset Sale plus, in the case
of an issuance of Qualified Capital Stock upon any exercise, exchange or
conversion of securities (including options, warrants, rights and convertible
or exchangeable debt) of the Company that were issued for cash on or after the
Issue Date, the amount of cash originally received by the Company upon the
issuance of such securities (including options, warrants, rights and
convertible or exchangeable debt) less, in each case, the sum of all payments,
fees, commissions and (in the case of Asset Sales, reasonable and customary)
expenses (including, without limitation, the fees and expenses of legal counsel
and investment banking fees and expenses) incurred in connection with such
Asset Sale or sale of Qualified Capital Stock, and, in the case of an Asset
Sale only, less the amount (estimated reasonably and in good faith by the
Company) of income, franchise, sales and other applicable taxes required to be
paid by the Company or any of its respective Subsidiaries in connection with
such Asset Sale.
"Permitted Indebtedness" means, without duplication (a) Indebtedness
evidenced by the Notes and represented by the Indenture up to the amounts
specified therein as of the date thereof; (b) Indebtedness of the Company and
its Subsidiaries incurred under or in respect of the Credit Agreement up to an
aggregate amount outstanding (including any Indebtedness issued to refinance,
refund or replace such Indebtedness in whole or in part) at any time of $20.0
million, minus the amount of any such Indebtedness retired with Net Cash
Proceeds from any Asset Sale or assumed by a transferee in an Asset Sale; (c)
Refinancing Indebtedness incurred by the Company
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and its Subsidiaries, as applicable, with respect to any Indebtedness or
Disqualified Capital Stock, as applicable, described in clauses (a) and (b)
above, incurred pursuant to the second paragraph under the covenant "Limitation
on Incurrence of Additional Indebtedness and Disqualified Capital Stock" or
which is outstanding on the Issue Date; (d) Indebtedness incurred by the
Company or its Subsidiaries in an aggregate amount outstanding at any time
(including any Indebtedness issued to refinance, replace, or refund such
Indebtedness in whole or in part) of up to $5.0 million, minus the amount of
any such Indebtedness retired with Net Cash Proceeds from any Asset Sale or
assumed by a transferee in an Asset Sale; and (e) Indebtedness incurred by the
Company to any of its Subsidiaries, and Indebtedness incurred by any Subsidiary
to any other Subsidiary or to the Company; provided, that, in the case of
Indebtedness of the Company, such obligations shall be unsecured and
subordinated in all respects to the Company's obligations pursuant to the
Notes.
"Permitted Lien" means any of the following:
(a) Liens existing on the Issue Date;
(b) Liens imposed by governmental authorities for taxes, assessments or
other charges not yet subject to penalty or which are being contested in good
faith and by appropriate proceedings, if adequate reserves with respect thereto
are maintained on the books of the Company in accordance with GAAP;
(c) statutory liens of carriers, warehousemen, mechanics, materialmen,
landlords, repairmen or other like Liens arising by operation of law in the
ordinary course of business provided that (i) the underlying obligations are
not overdue for a period of more than 30 days, or (ii) such Liens are being
contested in good faith and by appropriate proceedings and adequate reserves
with respect thereto are maintained on the books of the Company in accordance
with GAAP;
(d) Liens securing the performance of bids, trade contracts (other than
borrowed money), leases, statutory obligations, surety and appeal bonds,
performance bonds and other obligations of a like nature incurred in the
ordinary course of business;
(e) easements, rights-of-way, zoning, similar restrictions and other
similar encumbrances or title defects which, singly or in the aggregate, do not
in any case materially detract from the value of the property subject thereto
(as such property is used by the Company or any of its Subsidiaries) or
interfere with the ordinary conduct of the business of the Company or any of
its Subsidiaries;
(f) Liens arising by operation of law in connection with judgments, only
to the extent, for an amount and for a period not resulting in an Event of
Default with respect thereto;
(g) pledges or deposits made in the ordinary course of business in
connection with workers' compensation, unemployment insurance and other types
of social security legislation;
(h) Liens securing the Notes;
(i) Liens securing Indebtedness of a person existing at the time such
person becomes a Subsidiary or is merged with or into the Company or a
Subsidiary or Liens securing Indebtedness incurred in connection with an
Acquisition, provided in each case that such Liens were in existence prior to
the date of such acquisition, merger or consolidation, were not incurred in
anticipation thereof, and do not extend to any other assets;
(j) Liens securing Refinancing Indebtedness incurred to refinance any
Indebtedness that was previously so secured in a manner no more adverse to the
Holders of the Notes than the terms of the Liens securing such refinanced
Indebtedness provided that the Indebtedness secured is not increased and the
lien is not extended to any additional assets of property;
(k) Liens consisting of customary restrictions on assignment or transfer
in any lease or other agreement not relating to Indebtedness;
(l) Liens on the applicable accounts receivables, proceeds and contract
rights securing the Company's obligations with respect to a customary factoring
arrangement of Third Party Plan Receivables; and
(m) Liens securing Permitted Indebtedness of the type referred to in
clauses (b) and (d) of the definition of Permitted Indebtedness, and any
Refinancing Indebtedness with respect to such Indebtedness.
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"Permitted Payments" means (i) (a) payments to the Holding Company in an
amount not to exceed $250,000 in the aggregate in any fiscal year sufficient to
permit the Holding Company to pay reasonable and necessary operating expenses
and other general corporate expenses (including any reasonable professional
fees and expenses) and (b) cash dividends to the Holding Company to the extent
necessary to permit the Holding Company to repurchase common stock, stock
options and stock equivalents or other equity securities of the Holding Company
held by departing or deceased directors, officers or employees of the Holding
Company, the Company or any Subsidiary Guarantor ("Management Holders"),
provided that the aggregate amount of all such repurchases shall not exceed
$500,000 during any fiscal year or $2,000,000 during the term of the Notes
(plus the net cash proceeds received by the Company after the Issue Date as a
capital contribution in the form of common equity from the sale to Management
Holders of such equity securities of the Holding Company); (ii) a Qualified
Exchange; (iii) payments made pursuant to the Management Fee Agreements; or
(iv) the payment of any dividend on Qualified Capital Stock within 60 days
after the date of its declaration if such dividend could have been made on the
date of such declaration in compliance with the foregoing provisions. The full
amount of any Permitted Payment made pursuant to the foregoing clause (iv) (but
not pursuant to clauses (i), (ii) and (iii)) of the immediately preceding
sentence, however, will be deducted in the calculation of the aggregate amount
of Restricted Payments available to be made referred to in clause (3) of the
covenant described under the heading "Limitation on Restricted Payments."
"Purchase Money Indebtedness" means any Indebtedness of such person to any
seller or other person incurred to finance the acquisition (including in the
case of a Capitalized Lease Obligation, the lease) of any after acquired real
or personal tangible property, which, in the reasonable good faith judgment of
the Board of Directors of the Company, is directly related to a Related
Business of the Company and which is incurred concurrently with such
acquisition and is secured only by the assets so financed.
"Qualified Capital Stock" means any Capital Stock of the Company that is
not Disqualified Capital Stock.
"Qualified Exchange" means any legal defeasance, redemption, retirement,
repurchase or other acquisition of Capital Stock or Indebtedness of the Company
issued on or after the Issue Date with the Net Cash Proceeds received by the
Company from the substantially concurrent sale of Qualified Capital Stock or
any exchange of Qualified Capital Stock for any Capital Stock or Indebtedness
of the Company issued on or after the Issue Date.
"Reference Period" with regard to any person means the four full fiscal
quarters (or such lesser period during which such person has been in existence)
ended immediately preceding any date upon which any determination is to be made
pursuant to the terms of the Notes or the Indenture.
"Refinancing Indebtedness" means Indebtedness or Disqualified Capital
Stock (a) issued in exchange for, or the proceeds from the issuance and sale of
which are used substantially concurrently to repay, redeem, defease, refund,
refinance, discharge or otherwise retire for value, in whole or in part, or (b)
constituting an amendment, modification or supplement to, or a deferral or
renewal of ((a) and (b) above are, collectively, a "Refinancing"), any
Indebtedness or Disqualified Capital Stock in a principal amount or, in the
case of Disqualified Capital Stock, liquidation preference, not to exceed
(after deduction of reasonable and customary fees and expenses incurred in
connection with the Refinancing plus the amount of premium paid in connection
with such Refinancing in accordance with the terms of the documents governing
the Indebtedness Refinanced) the lesser of (i) the principal amount or, in the
case of Disqualified Capital Stock, liquidation preference, of the Indebtedness
or Disqualified Capital Stock so Refinanced and (ii) if such Indebtedness being
Refinanced was issued with an original issue discount, the accreted value
thereof (as determined in accordance with GAAP) at the time of such
Refinancing; provided, that (A) such Refinancing Indebtedness of any Subsidiary
of the Company shall only be used to Refinance outstanding Indebtedness or
Disqualified Capital Stock of such Subsidiary, (B) such Refinancing
Indebtedness shall (x) not have an Average Life shorter than the Indebtedness
or Disqualified Capital Stock to be so refinanced at the time of such
Refinancing and (y) in all respects, be no less subordinated or junior, if
applicable, to the rights of Holders of the Notes than was the Indebtedness or
Disqualified Capital Stock to be refinanced and (C) such Refinancing
Indebtedness shall have no installment of principal (or redemption payment)
scheduled to come due earlier than the scheduled maturity of any installment of
principal of the Indebtedness or Disqualified Capital Stock to be so refinanced
which was scheduled to come due prior to the Stated Maturity or a final stated
maturity or redemption date, as applicable, no earlier than the final stated
maturity or redemption date, as applicable, of the Indebtedness or Disqualified
Capital Stock to be so refinanced.
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"Related Business" means the business conducted (or proposed to be
conducted) by the Company and its Subsidiaries as of the Issue Date and any and
all businesses that in the good faith judgment of the Board of Directors of the
Company are materially related businesses.
"Related Person" means any person who controls, is controlled by or is
under common control with an Excluded Person; provided that for purposes of
this definition "control" means the beneficial ownership of more than 50% of
the total voting power of a person normally entitled to vote in the election of
directors, managers or trustees, as applicable of a person.
"Restricted Investment" means, in one or a series of related transactions,
any Investment, other than investments in (a) Cash Equivalents, and (b) the
Company or a Wholly owned Subsidiary that is engaged in a Related Business;
provided, however, that a merger of another person with or into the Company or
any of its Subsidiaries shall not be deemed to be a Restricted Investment so
long as the surviving entity is the Company or a direct Wholly owned
Subsidiary.
"Restricted Payment" means, with respect to any person, (a) the
declaration or payment of any dividend or other distribution in respect of
Capital Stock of such person or any parent or Subsidiary of such person, (b)
any payment on account of the purchase, redemption or other acquisition or
retirement for value of Capital Stock of such person or any parent or
Subsidiary of such person, (c) other than with the proceeds from the
substantially concurrent sale of, or in exchange for, Refinancing Indebtedness,
any purchase, redemption, or other acquisition or retirement for value of, any
payment in respect of any amendment of the terms of or any defeasance of, any
Subordinated Indebtedness, directly or indirectly, by such person or a parent
or Subsidiary of such person prior to the scheduled maturity, any scheduled
repayment of principal, or scheduled sinking fund payment, as the case may be,
of such Indebtedness and (d) any Restricted Investment by such person;
provided, however, that the term "Restricted Payment" does not include (i) any
dividend, distribution or other payment on or with respect to Capital Stock of
an issuer to the extent payable solely in shares of Qualified Capital Stock of
such issuer; or (ii) any dividend, distribution or other payment to the
Company, or to any of its Wholly owned Subsidiaries, by the Company or any of
its Subsidiaries.
"Significant Subsidiary" means any Subsidiary of the Company that would be
a "significant subsidiary" of the Company as defined in Rule 1-02 of Regulation
S-X under the Securities Act and the Exchange Act, as such Rule is in effect on
the Issue Date.
"Stated Maturity," when used with respect to any Note, means October 15,
2004.
"Subordinated Indebtedness" means Indebtedness of the Company or a
Guarantor that is subordinated in right of payment to the Notes or such
Guarantee, as applicable, in any respect.
"Subsidiary," with respect to any person, means (i) a corporation a
majority of whose Capital Stock with voting power, under ordinary
circumstances, to elect directors is at the time, directly or indirectly, owned
by such person, by such person and one or more Subsidiaries of such person or
by one or more Subsidiaries of such person, (ii) any other person (other than a
corporation) in which such person, one or more Subsidiaries of such person, or
such person and one or more Subsidiaries of such person, directly or
indirectly, at the date of determination thereof has at least majority
ownership interest, or (iii) a partnership in which such person or a Subsidiary
of such person is, at the time, a general partner and in which such person,
directly or indirectly, at the date of determination thereof has at least a
majority ownership interest.
"Third Party Plan Receivable" means a right to receive payment from a
managed health care provider or other third party payer (a "Third Party Plan")
resulting from a sale to customers associated with a Third Party Plan of
pharmacy goods or services by a person pursuant to an arrangement with such
Third Party Plan under which such Third Party Plan is obligated to pay for such
goods or services under terms that permit the purchase of such goods or
services on credit.
"U.S. Government Obligations" means direct non-callable obligations of, or
non-callable obligations guaranteed by, the United States of America for the
payment of which obligation or guarantee the full faith and credit of the
United States of America is pledged.
"Wholly owned Subsidiary" means a Subsidiary all the Capital Stock of
which is owned by the Company or one or more Wholly owned Subsidiaries of the
Company.
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Book-Entry; Delivery; Form and Transfer
Except as set forth below, the New Notes will initially be issued in the
form of one or more registered New Notes in global form (the "Global Notes").
Each Global Note representing New Notes will be deposited on the date of the
closing of the Exchange Offer (the "Closing Date") with, or on behalf of, The
Depository Trust Company (the "Depositary") and registered in the name of Cede
& Co., as nominee of the Depositary. Interests in Global Notes will be
available for purchase only by "qualified institutional buyers," as defined in
Rule 144A under the Securities Act ("QIBs").
Notes that are (i) originally issued to or transferred to institutional
"accredited investors," as defined in Rule 501(a)(1), (2), (3) or (7) under the
Securities Act, who are not QIBs or to any other person who are not QIBs or
(ii) issued as described below under "Certificated Securities," will be issued
in registered form without coupons (the "Certificated Securities"). Upon the
transfer to a QIB of Certificated Securities, such Certificated Securities
will, unless the Global Note has previously been exchanged for Certificated
Securities, be exchanged for an interest in the Global Note representing the
principal amount of New Notes being transferred.
The Depository has advised the Company that it is (i) a limited-purpose
trust company organized under the laws of the State of New York, (ii) a member
of the Federal Reserve System, (iii) a "clearing corporation" within the
meaning of the Uniform Commercial Code, as amended, and (iv) a "Clearing
Agency" registered pursuant to Section 17A of the Exchange Act. The Depositary
was created to hold securities for its participating organizations
(collectively, the "Participants") and to facilitate the clearance and
settlement of transactions in such securities between Participants through
electronic book-entry changes in accounts of its Participants. The Depositary's
Participants include securities brokers and dealers (including the Initial
Purchasers), banks and trust companies, clearing corporations and certain other
organizations. Access to the Depositary's system is also available to other
entities such as banks, brokers, dealers and trust companies (collectively, the
"Indirect Participants") that clear through or maintain a custodial
relationship with a Participant, either directly or indirectly. QIBs may elect
to hold New Notes purchased by them through the Depositary. QIBs who are not
Participants may beneficially own securities held by or on behalf of the
Depositary only through Participants or Indirect Participants. Persons that are
not QIBs may not hold New Notes through the Depositary.
The Company expects that pursuant to procedures established by the
Depositary (i) upon deposit of the Global Note, the Depositary will credit the
accounts of Participants designated by the Initial Purchasers with an interest
in the Global Note and (ii) ownership of the New Notes will be shown on, and
the transfer of ownership thereof will be effected only through, records
maintained by the Depositary (with respect to the interests of Participants),
the Participants and the Indirect Participants. The laws of some states require
that certain persons take physical delivery in definitive form of securities
that they own and that security interests in negotiable instruments can only be
perfected by delivery of certificates representing the instruments.
Consequently, the ability to transfer New Notes or to pledge the New Notes as
collateral will be limited to such extent. The New Notes will be subject to
certain other restrictions on transferability.
So long as the Depositary or its nominee is the registered owner of a
Global Note, the Depositary or such nominee, as the case may be, will be
considered the sole owner or holder of the New Notes represented by the Global
Note for all purposes under the Indenture. Except as provided below, owners of
beneficial interests in a Global Note will not be entitled to have New Notes
represented by such Global Note registered in their names, will not receive or
be entitled to receive physical delivery of Certificated Securities, and will
not be considered the owners or holders thereof under the Indenture for any
purpose, including with respect to the giving of any directions, instructions
or approvals to the Trustee thereunder. As a result, the ability of a person
having a beneficial interest in New Notes represented by a Global Note to
pledge such interest to persons or entities that do not participate in the
Depositary's system, or to otherwise take actions with respect to such
interest, may be affected by the lack of a physical certificate evidencing such
interest.
Accordingly, each QIB owning a beneficial interest in a Global Note must
rely on the procedures of the Depositary and, if such QIB is not a Participant
or an Indirect Participant, on the procedures of the Participant through which
such QIB owns its interests, to exercise any rights of a holder under the
Indenture or such Global Note. The Company understands that under existing
industry practice, in the event the Company requests any action of holders of
New Notes or a QIB that is an owner of a beneficial interest in a Global Note
desires to take any action that the Depositary, as the holder of such Global
Note, is entitled to take, the Depositary would authorize the Participants to
take such action and the Participants would authorize QIBs owning through such
Participants
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to take such action or would otherwise act upon the instructions of such QIBs.
Neither the Company nor the Trustee will have any responsibility or liability
for any aspect of the records relating to or payments made on account of New
Notes by the Depositary, or for maintaining, supervising or reviewing any
records of the Depositary relating to such New Notes.
Payments with respect to the principal of, premium, if any, and interest
on any New Notes represented by a Global Note registered in the name of the
Depositary or its nominee on the applicable record date will be payable by the
Trustee to or at the direction of the Depositary or its nominee in its capacity
as the registered holder of the Global Note representing such new Notes under
the Indenture. Under the terms of the Indenture, the Company and the Trustee
may treat the persons in whose names the New Notes, including the Global Notes,
are registered as the owners thereof for the purpose of receiving such payments
and for any and all other purposes whatsoever. Consequently, neither the
Company nor the Trustee has or will have any responsibility or liability for
the payment of such amounts to beneficial owners of New Notes (including
principal, premium, if any, and interest), or to immediately credit the
accounts of the relevant participants with such payment, in amounts
proportionate to their respective holdings in principal amount of beneficial
interest in the Global Note as shown on the records of the Depositary. Payments
by the Participants and the Indirect Participants to the beneficial owners of
New Notes will be governed by standing instructions and customary practice and
will be the responsibility of the Participants or the Indirect Participants.
Certificated Securities
If (i) the Company notifies the Trustee in writing that the Depositary is
no longer willing or able to act as a depository and the Company is unable to
locate a qualified successor within 90 days (ii) the Company, at its option,
notifies the Trustee in writing that it elects to cause the issuance of New
Notes in definitive form under the Indenture, or (iii) there shall have
occurred and be continuing a Default or Event of Default with respect to the
Notes, then, upon surrender by the Depositary of its Global Note or Global
Notes, Certificated Securities will be issued to each person that the
Depositary identifies as the beneficial owner of the New Notes represented by
the Global Note. In addition, subject to certain conditions, any person having
a beneficial interest in a Global Note may, upon request to the Trustee,
exchange such beneficial interest for Certificated Securities. Upon any such
issuance, the Trustee is required to register such Certificated Securities in
the name of such person or persons (or the nominee of any thereof), and cause
the same to be delivered thereto.
Neither the Company nor the Trustee shall be liable for any delay by the
Depositary or any Participant or Indirect Participant in identifying the
beneficial owners of the related New Note and such person may conclusively rely
on, and shall be protected in relying on instructions from the Depositary for
all purposes (including with respect to the registration and delivery, and the
respective principal amounts, of the New Notes to be issued).
The information in this section concerning DTC and DTC's book-entry system
has been obtained from sources that the Company believes to be reliable. The
Company will have no responsibility for the performance by DTC or its
Participants of their respective obligations as described hereunder or under
the rules and procedures governing their respective operations.
Same Day Settlement and Payment
The Indenture requires that payments in respect of the Notes represented
by the Global Notes (including principal, premium, if any, interest and
Liquidated Damages, if any) be made by wire transfer of immediately available
same day funds to the accounts specified by the holder of interests in such
Global Note. With respect to Certificated Notes, the Company will make all
payments of principal, premium, if any, interest and Liquidated Damages, if
any, by wire transfer of immediately available same day funds to the accounts
specified by the holders thereof or, if no such account is specified, by
mailing a check to each such holder's registered address. The Company expects
that secondary trading in the Certificated Notes will also be settled in
immediately available funds.
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CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following discussion of certain of the anticipated federal income tax
consequences of an exchange of the Existing Notes for New Notes and of the
purchase, ownership, and disposition of the New Notes is based upon the
provisions of the Internal Revenue Code of 1986, as amended (the "Code"), the
final, temporary, and proposed regulations promulgated thereunder, and
administrative rulings and judicial decisions now in effect, all of which are
subject to change (possibly with retroactive effect) or different
interpretations. The following summary is not binding on the Internal Revenue
Service ("IRS") and there can be no assurance that the IRS will take a similar
view with respect to the tax consequences described below. No ruling has been
or will be requested by the Company from the IRS on any tax matters relating to
the New Notes or the Exchange Offer. This summary does not purport to deal with
all aspects of federal income taxation that may be relevant to a particular
investor, nor any tax consequences arising under the laws of any state,
locality, or foreign jurisdiction, and it is not intended to be applicable to
all categories of investors, some of which, such as dealers in securities,
banks, insurance companies, tax-exempt organizations, foreign persons, persons
that hold New Notes as part of a straddle or conversion transactions or holders
subject to the alternative minimum tax, may be subject to special rules. In
addition, the summary is limited to persons that will hold the New Notes as
"capital assets" (generally, property held for investment) within the meaning
of Section 1221 of the Code. ALL INVESTORS ARE ADVISED TO CONSULT THEIR OWN TAX
ADVISERS REGARDING THE FEDERAL, STATE, LOCAL, AND FOREIGN TAX CONSEQUENCES OF
THE EXCHANGE AND THE OWNERSHIP AND DISPOSITION OF NEW NOTES.
Taxation of Holders on Exchange
Subject to the limitations set forth above, an exchange of Existing Notes
for New Notes will not be a taxable event to holders of Existing Notes, and
holders will not recognize any taxable gain or loss as a result of such an
exchange. Accordingly, subject to the limitations set forth above, a holder
will have the same adjusted basis and holding period in the New Notes as it had
in the Existing Notes immediately before the exchange and the tax consequences
of ownership and disposition of any New Notes will be the same as the tax
consequences of ownership and disposition of Existing Notes.
Market Discount
If a holder purchases a Note for an amount that is less than its principal
amount, the amount of the difference will be treated as "market discount" for
federal income tax purposes, unless such difference is less than a specified de
minimis amount. Under the market discount rules, a holder will be required to
treat any principal payment on, or any gain on the sale, exchange, retirement
or other disposition of, a Note as ordinary income to the extent of the market
discount which has not previously been included in income and is treated as
having accrued on such a Note at the time of such payment or disposition. In
addition, the holder may be required to defer, until the maturity of the Note
or its earlier disposition in a taxable transaction, the deduction of all or a
portion of the interest expense on any indebtedness incurred or continued to
purchase or carry such Note.
Any market discount will be considered to accrue ratably during the period
from the date of acquisition to the maturity date of the Note, unless the
holder elects to accrue on a constant interest method. A holder of a Note may
elect to include market discount in income currently as it accrues (on either a
ratable or constant interest method), in which case the rule described above
regarding deferral of interest deductions will not apply. This election to
include market discount in income currently, once made, applies to all market
discount obligations acquired on or after the first taxable year to which the
election applies and may not be revoked without the consent of the IRS.
Amortizable Bond Premium
A holder that purchases a Note for an amount in excess of the sum of its
principal amount will be considered to have purchased the Note at a "premium."
A holder generally may elect to amortize the premium over the remaining term of
the Note on a constant yield method. The amount amortized in any year will be
treated as a reduction of the holder's interest income from the Note. Bond
premium on a Note held by a holder that does not make such an election will
decrease the gain or increase the loss otherwise recognized on disposition of
the Note. The election to amortize premium on a constant yield method once made
applies to all debt obligations held or subsequently acquired by the electing
holder on or after the first day of the first taxable year to which the
election applies and may not be revoked without the consent of the IRS.
88
<PAGE>
Sale, Exchange and Retirement of Notes
A holder's tax basis in a Note will, in general, be the holder's cost
therefor, increased by market discount previously included in income by the
holder and reduced by any amortized premium. Upon the sale, exchange or
retirement of a Note, a holder will recognize gain or loss equal to the
difference between the amount realized upon the sale, exchange or retirement
(less any accrued interest, which will be taxable as such) and the adjusted tax
basis of the Note. Except as described above with respect to market discount,
such gain or loss will be capital gain or loss and will, as a general rule, be
long-term capital gain or loss if at the time of sale, exchange or retirement
the Note has been held for more than eighteen months. Under current law,
long-term capital gains of individuals are, under certain circumstances, taxed
at lower rates than items of ordinary income. The deductibility of capital
losses is subject to limitations.
Backup Withholding
In general, information reporting requirements will apply to certain
payments of principal, interest and premium paid on Notes and to the proceeds
of sale of a Note made to holders other than certain exempt recipients (such as
corporations). A 31% backup withholding tax will apply to such payments if the
holder fails to provide a taxpayer identification number or certification of
foreign or other exempt status or fails to report in full dividend and interest
income.
Any amounts withheld under the backup withholding rules will be allowed as
a refund or a credit against such holder's U.S. federal income tax liability
provided the required information is furnished to the IRS.
THE UNITED STATES FEDERAL TAX DISCUSSION SET FORTH ABOVE IS INCLUDED FOR
GENERAL INFORMATION ONLY AND MAY OR MAY NOT BE APPLICABLE DEPENDING UPON A
HOLDER'S PARTICULAR SITUATION. HOLDERS SHOULD CONSULT THEIR TAX ADVISERS WITH
RESPECT TO THE TAX CONSEQUENCES TO THEM OF THE EXCHANGE OF EXISTING NOTES FOR
NEW NOTES AND OF THE OWNERSHIP AND DISPOSITION OF THE NEW NOTES, INCLUDING THE
TAX CONSEQUENCES UNDER STATE, LOCAL, FOREIGN AND OTHER TAX LAWS AND THE
POSSIBLE EFFECTS OF CHANGES IN FEDERAL OR OTHER TAX LAWS.
INDEPENDENT PUBLIC ACCOUNTANTS
The financial statements of the Company as of July 26, 1997, July 28, 1996
and July 30, 1995 and for the fiscal years ended July 26, 1997 and July 28,
1996 and the six month period ended July 30, 1995 included in this Prospectus
have been audited by Coopers & Lybrand L.L.P., independent accountants, as
stated in their report appearing herein. The financial statements of the
Predecessor Company for the six month period ended January 29, 1995, included
in this Prospectus have been audited by Arthur Andersen LLP, independent
accountants, as stated in their report appearing herein. The consolidated
financial statements of the Holding Company as of July 26, 1997, July 28, 1996
and July 30, 1995 and for the fiscal years ended July 26, 1997 and July 28,
1996 and the six month period ended July 30, 1995 included in this Prospectus
have been audited by Coopers & Lybrand L.L.P., independent accountants, as
stated in their report appearing herein.
LEGAL MATTERS
The validity of the Exchange Notes will be passed upon for the Company by
Bingham Dana LLP, Boston, Massachusetts.
AVAILABLE INFORMATION
The Company has agreed that whether or not the Company is subject to the
reporting requirements of Section 13 or 15(d) of the Exchange Act, the Company
shall deliver to the Trustee and to each holder of the Notes and to prospective
purchasers of the Notes identified to the Company by an Initial Purchaser,
within 15 days after it is or would have been required to file such with the
Commission, annual and quarterly financial statements substantially equivalent
to financial statements that would have been included in reports filed with the
Commission, if the Company were subject to the requirements of Section 13 or
15(d) of the Exchange Act, including, with respect to annual information only,
a report thereon by the Company's certified independent public accountants as
such would be required in such reports to the Commission, and, in each case,
together with a management's discussion and analysis of financial condition and
results of operations which would be so required. In addition, from and after
89
<PAGE>
the effectiveness of the registration statement of which this prospectus is a
part of the Shelf Registration Statement, whether or not required by the rules
and regulations of the Commission, the Company will file a copy of all such
information and reports with the Commission for public availability (unless the
Commission will not accept such a filing) and make such information available
to securities analysts and prospective investors upon request.
Once the Registration Statement has been declared effective by the
Commission, the Company and the Holding Company will become subject to the
informational requirements of the Exchange Act and in accordance therewith will
be required to file reports and other information with the Commission. When
filed, the Registration Statement and the exhibits thereto, as well as such
reports and other information to be filed by the Company and the Holding
Company with the Commission, may be inspected, without charge, at the public
reference facilities maintained by the Commission at 450 Fifth Street, N.W.,
Room 1024, Washington, D.C. 20549, as well as the regional offices of the
Commission at the Northwest Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661 and 7 World Trade Center, 13th Floor, New York, New
York 10048. Copies of such documents can be obtained from the Public Reference
Section of the Commission at 450 Fifth Street, N.W., Room 1024, Washington,
D.C. 20549, at prescribed rates. In addition, the Company and the Holding
Company will be required to file electronic versions of these documents with
the Commission through the Commission's Electronic Data Gathering, Analysis,
and Retrieval (EDGAR) system. The Commission maintains a World Wide Web site,
located at http://www.sec.gov that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the Commission.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus contains certain statements that may be considered
"forward-looking." Such forward-looking statements include, among other things,
management's expectations about industry trends including, without limitation,
industry revenue and profit growth rates, the rates of public participation in
Third-Party Plans and the impact of such participation on margins, sales and
profitability, the correlation of sales of non-pharmacy merchandise with sales
of pharmaceutical products, the correlation of sales rates with the aging of
the population and introduction of new drugs, and projections of such rates and
correlations, and the impact of various factors on market shares of independent
drugstore chains, national chains, and regional chains. Forward-looking
statements are also made concerning the Company's expectations regarding
increased customer traffic, the Company's expectations regarding future
regulatory developments and health care reform, the relationship between the
Company's margins and its purchasing practices, product mix and inventory
controls, the Company's business strategy and expectations concerning possible
expansion by the Company, including the opening of new Drug Fair stores or
pharmacies in Cost Cutters locations, the Company's ability to obtain adequate
supplies of pharmaceuticals and general merchandise, the Company's ability to
maintain its gross profit margins in the face of pressure on pharmaceutical
profit margins as a result of an increase in Third-Party Plan pharmaceutical
sales, the Company's ability to minimize store maintenance expenses, the
Company's ability to decrease the amount of time necessary for a new store to
become profitable through the purchase of prescription customer files, the
Company's ability to cost-effectively consolidate its administrative and
distribution functions in a single new location and integrate a new MIS system
at that facility and accommodate any "Year 2000" problems, the Company's
ability to extend leases for current store locations, or find new leases for
attractive store locations at favorable rates, the Company's ability to
generate cash flow or make borrowings sufficient to pay interest and principal
on the Notes, and the Company's ability to meet its debt service obligations
when due, fund anticipated capital expenditures and working capital
requirements, and comply with the terms of its debt agreements for a specified
period of time. Such forward-looking statements involve known and unknown
risks, uncertainties and other factors that may cause the actual results,
performance or achievements of the Company to be materially different from any
future results, performance or achievements of the Company expressed or implied
by such forward-looking statements. Prospective investors in the Notes offered
hereby are cautioned that although the Company believes that the assumptions on
which the forward-looking statements contained herein are based are reasonable,
any of those assumptions could prove to be inaccurate and, as a result, the
forward-looking statements based on those assumptions also could be materially
incorrect. The uncertainties in this regard include, but are not limited to,
those identified in the section of this Prospectus entitled "Risk Factors." In
light of these and other uncertainties, the inclusion of a forward-looking
statement herein should not be regarded as a representation by the Company that
the Company's plans and objectives will be achieved and prospective investors
in the Notes should not place undue reliance on such forward-looking
statements. The Company disclaims any obligation to publicly announce the
result of any revisions to any of the forward-looking statements contained
herein to reflect future events or developments.
90
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
-----
<S> <C>
The Predecessor Company
Report of Independent Public Accountants ................................................. F-3
Statements of Income and Undistributed Earnings for the Six Months Ended January 29, 1995 F-4
Statement of Cash Flows for the Six Months Ended January 29, 1995 ........................ F-5
Notes to Financial Statements for the Six Months Ended January 29, 1995 .................. F-6
The Company
Report of Independent Accountants ........................................................ F-9
Balance Sheets as of July 28, 1996 and July 26, 1997 ..................................... F-10
Statements of Income for the Six Months Ended July 30, 1995 and the Years Ended
July 28, 1996 and July 26, 1997 ......................................................... F-11
Statements of Cash Flows for the Six Months Ended July 30, 1995 and the Years Ended
July 28, 1996 and July 26, 1997 ......................................................... F-12
Statements of Stockholder's Equity for the Six Months Ended July 30, 1995, and the
Years Ended July 28, 1996 and July 26, 1997 ............................................. F-13
Notes to Financial Statements ............................................................ F-14
The Holding Company
Report of Independent Accountants ........................................................ F-22
Consolidated Balance Sheets as of July 28, 1996 and as of July 26, 1997 .................. F-23
Consolidated Statements of Income for the Six Months Ended July 30, 1995 and
the Years Ended July 28, 1996, and July 26, 1997 ........................................ F-24
Consolidated Statements of Cash Flows for the Six Months Ended July 30, 1995 and
the Years Ended July 28, 1996 and July 26, 1997 ......................................... F-25
Consolidated Statements of Stockholders' Equity for the Six Months Ended July 30, 1995,
and the Years Ended July 28, 1996 and July 26, 1997 ..................................... F-26
Notes to Consolidated Financial Statements ....................................... F-27-F-36
The Company (Unaudited)
Condensed Consolidated Statements of Operations--Three Months Ended October 25, 1997
and October 26, 1996 .................................................................... F-37
Condensed Balance Sheets--As of July 26, 1997 and October 25, 1997 ....................... F-38
Condensed Statements of Cash Flows--Three Months Ended October 25, 1997
and October 26, 1996 .................................................................... F-39
Notes to Condensed Financial Statements .................................................. F-40
The Holding Company (Unaudited)
Condensed Consolidated Statements of Operations--Three Months Ended October 25, 1997
and October 26, 1996 .................................................................... F-41
Condensed Consolidated Balance Sheets--As of July 26, 1997 and October 25, 1997 .......... F-42
Condensed Consolidated Statements of Cash Flows--Three Months Ended October 25, 1997
and October 26, 1996 .................................................................... F-43
Notes to Condensed Consolidated Financial Statements ..................................... F-44
</TABLE>
F-1
<PAGE>
<TABLE>
<CAPTION>
Page
-----
<S> <C>
Financial Statement Schedules
Report of Independent Accountants ...................................................... F-45
Schedule II--Summary of Valuation and Qualifying Accounts--Community Distributors, Inc. F-46
Report of Independent Accountants ...................................................... F-47
Schedule II--Summary of Valuation and Qualifying Accounts--CDI Group, Inc. ............. F-48
</TABLE>
F-2
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Community Distributors, Inc.:
We have audited the accompanying statements of income and undistributed
earnings and cash flows of Community Distributors, Inc. (a Delaware
corporation) for the six months ended January 29, 1995. 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 audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations of Community Distributors,
Inc. and its cash flows for the six month period ended January 29, 1995 in
conformity with generally accepted accounting principles.
Roseland, New Jersey ARTHUR ANDERSEN LLP
March 10, 1995
F-3
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
THE PREDECESSOR COMPANY
STATEMENTS OF INCOME AND UNDISTRIBUTED EARNINGS
FOR THE SIX MONTHS ENDED JANUARY 29, 1995
<TABLE>
<CAPTION>
Six Months
Ended
January 29,
1995
---------------
<S> <C>
NET SALES ............................................................. $101,687,000
COST OF SALES ......................................................... 72,469,000
------------
Gross profit ....................................................... 29,218,000
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE ........................... 22,352,000
------------
Operating income ................................................... 6,866,000
OTHER INCOME, net ..................................................... 595,000
------------
Income before provision for state income taxes ..................... 7,461,000
PROVISION FOR STATE INCOME TAXES ...................................... 186,000
------------
Net income ......................................................... 7,275,000
UNDISTRIBUTED EARNINGS ("S" Corporation), beginning of period ......... 19,550,000
DISTRIBUTIONS TO STOCKHOLDERS ......................................... (4,887,000)
------------
UNDISTRIBUTED EARNINGS ("S" Corporation), end of period ............... $ 21,938,000
============
</TABLE>
The accompanying notes to financial statements are an integral part of this
statement.
F-4
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
THE PREDECESSOR COMPANY
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JANUARY 29, 1995
<TABLE>
<CAPTION>
Six Months
Ended
January 29,
1995
--------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................... $ 7,275,000
Adjustments to reconcile net income to net cash provided by
operating activities--
Depreciation and amortization ......................................... 884,000
LIFO provision ........................................................ 1,337,000
Cash received from supplier advances .................................. 140,000
Revenue recognized from supplier advances ............................. (623,000)
Changes in operating assets and liabilities--
Receivables ......................................................... (554,000)
Inventories ......................................................... (2,280,000)
Prepaid expenses .................................................... 81,000
Due from affiliates ................................................. 33,000
Other assets ........................................................ 306,000
Accounts payable, accrued liabilities and state income taxes payable (883,000)
Other liabilities ................................................... (9,000)
------------
Net cash provided by operating activities ........................ 5,707,000
CASH FLOWS USED IN INVESTING ACTIVITIES--
Capital expenditures ..................................................... (1,313,000)
CASH FLOWS USED IN FINANCING ACTIVITIES--
Distributions to stockholders ............................................ (4,887,000)
------------
Net decrease in cash and short-term investments .................. (493,000)
CASH AND SHORT-TERM INVESTMENTS AT BEGINNING OF FISCAL YEAR ............... 17,296,000
------------
CASH AND SHORT-TERM INVESTMENTS AT END OF FISCAL YEAR ..................... $ 16,803,000
============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the fiscal year for--
Income taxes ........................................................... $ 110,000
Interest ............................................................... 0
</TABLE>
The accompanying notes to financial statements are an integral part of this
statement.
F-5
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
THE PREDECESSOR COMPANY
NOTES TO FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Company Business-Community Distributors, Inc. (the Company) owns and
operates a chain of specialty drug stores under the name "Drug Fair" and
deep discount general merchandise stores under the name "Cost Cutters."
Accounting Year-
The Company maintains its accounts on a 52-53 week year ending on the last
Sunday in July. The fiscal period ended January 29, 1995 included 26 weeks.
Use of Estimates-
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these
estimates.
Cash and Short-Term Investments-
Cash and short-term investments include cash on deposit with banks and
investments having a maturity of three months or less.
Inventories-
Store and warehouse inventories are stated at the lower of cost, using the
last-in, first-out method (LIFO), or market. If the first-in, first-out
method (FIFO) of inventory accounting had been used, inventories would have
been $6,893,000 higher than reported at January 29, 1995.
Depreciation and Amortization-
Property and equipment are stated at cost and depreciation is provided
using the straight-line method over the expected useful lives of the
applicable assets. Leasehold improvements are amortized over the expected
useful life of the improvement or the life of the lease, whichever is
shorter.
Supplier Advances-
Included in the accompanying balance sheet at January 29, 1995 is
$4,637,000 representing advances received related to inventory supply
agreements. Such amounts are being amortized as a reduction of cost of
sales over the term of the applicable supply agreements (periods ranging
from three to five years).
S Corporation Election-
The Company and its stockholders elected to be taxed as an S Corporation
for fiscal years beginning after July 26, 1987, under the provisions of
Subchapter S of the Internal Revenue Code. As such, the taxable income or
losses of the Company are included in the individual tax returns of the
stockholders for Federal income tax purposes. Effective with the fiscal
year beginning July 26, 1993, the Company and its stockholders elected to
be taxed as an S Corporation under the provisions of the tax regulations
for the State of New Jersey. Accordingly, the tax rate used by the Company
in determining its provision for state income taxes was 2.350% for the six
months ended January 29, 1995. Effective with this change, the taxable
income or losses of the Company are included in the individual state income
tax returns of the stockholders. Deferred income taxes are provided on
transactions recorded for financial statement purposes in periods different
from that in which such transactions are recorded for tax purposes. The
differences relate primarily to liabilities for supplier advances which are
reflected as income when the advances are received and the use of
accelerated methods of depreciation and amortization for income tax
purposes. Deferred taxes totaling approximately $146,000 as of January 29,
1995 and are included in other assets in the accompanying balance sheet.
F-6
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
THE PREDECESSOR COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)
(2) FINANCING ARRANGEMENT:
The Company has a short-term line of credit totaling $7,500,000. This line of
credit bears interest at the bank's prime rate (8.50% at January 29, 1995).
Borrowings under the line of credit are unsecured. There were no borrowings
outstanding under the line of credit at January 29, 1995. Under the line of
credit agreement the Company may use up to $2,500,000 to secure letters of
credit. The Company was committed to $705,000 in outstanding letters of credit
at January 29, 1995.
(3) COMMITMENTS:
Litigation-
The Company is party to various legal actions arising in the normal course
of its business. The Company believes that the disposition of such actions,
individually or in the aggregate, will not have a material adverse effect
on the financial position or results of operations of the Company.
Leases-
The Company conducts all of its warehousing and retailing operations from
leased facilities. These leases, which may be renewed for periods ranging
from five to thirty years, generally provide that the Company pay
insurance, maintenance costs and property taxes. These additional charges
are subject to escalation for increases in the related costs. Minimum
rental commitments under long-term noncancelable operating leases are as
follows-
<TABLE>
<CAPTION>
Related
Party (Note 4) Third Party Total
---------------- ------------- -------------
Fiscal years ending January-
<S> <C> <C> <C>
1996 ................... $ 401,000 $ 6,224,000 $ 6,625,000
1997 ................... 401,000 6,240,000 6,641,000
1998 ................... 401,000 6,158,000 6,559,000
1999 ................... 183,000 5,915,000 6,098,000
2000 ................... 0 5,808,000 5,808,000
Thereafter ............. 0 25,704,000 25,704,000
---------- ----------- -----------
$1,386,000 $56,049,000 $57,435,000
========== =========== ===========
</TABLE>
Rental expense for all leases aggregated $3,172,000 for the six months
ended January 29, 1995.
(4) RELATED PARTY TRANSACTIONS:
The Company is a guarantor of a loan from a bank to a real estate holding
company owned by the stockholders of the Company. The loan amounted to
$607,000 at January 29, 1995. This real estate company owns the buildings in
which the Company conducts its warehousing and one of its retailing
operations. Rents paid to the real estate company were approximately $201,000
during the six months ended January 29, 1995. In connection with the sale of
the Company (Note 5) on January 30, 1995, the Company was relieved of its
obligation to guarantee the loan.
During fiscal 1991, the Company entered into a line of credit agreement with
the real estate company to finance the construction of an addition to the
facility it rents to the Company and the construction of an additional
facility at the same location. During fiscal 1992, the balance outstanding
(approximately $2 million) was converted into a 15 year mortgage agreement.
The mortgage was originally scheduled to mature in April 2007 and bore
interest at 8.5% per annum. In connection with the sale of the Company (Note
5) on January 30, 1995, the balance due under this mortgage agreement was paid
in full and, accordingly, has been included as a current asset in the
accompanying balance sheet.
F-7
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
THE PREDECESSOR COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)
(5) SALE OF THE COMPANY:
On January 30, 1995, the Company's stockholders sold their shares in the
Company to Newrxco, Inc., a newly formed acquisition company, for
approximately $75,000,000. The accompanying balance sheet does not give effect
to this sale, which will be accounted for under the purchase method of
accounting.
As a result of the sale, the Company will no longer qualify to be taxed as an
S Corporation for either Federal or New Jersey State income tax purposes.
Without giving effect to adjustments to allocate the purchase price for this
sale, the effect of terminating the S Corporation tax treatment would be to
increase deferred tax assets and stockholders' equity by approximately $2.3
million as of January 29, 1995, and to recognize Federal and state income tax
benefits associated with temporary differences (primarily supplier advances).
This adjustment has not been reflected in the accompanying balance sheet.
F-8
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholder of
Community Distributors, Inc.:
We have audited the accompanying balance sheets of Community Distributors,
Inc. (a Delaware corporation) as of July 26, 1997 and July 28, 1996, and the
related statements of income, cash flows and stockholder's equity for the
fiscal years then ended and for the six months ended July 30, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Community Distributors,
Inc. as of July 26, 1997 and July 28, 1996, and the results of its operations
and its cash flows for the fiscal years then ended, and for the six months
ended July 30, 1995, in conformity with generally accepted accounting
principles.
Parsippany, New Jersey COOPERS & LYBRAND L.L.P.
October 9, 1997, except for Note 9 for
which the date is October 16, 1997.
F-9
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
As of As of
July 28, 1996 July 26, 1997
--------------- --------------
<S> <C> <C>
ASSETS:
CURRENT ASSETS:
Cash and cash equivalents ................................... $ 3,623 $ 1,870
Accounts receivable ......................................... 3,270 2,614
Inventory ................................................... 28,196 30,233
Prepaid expenses and other current assets ................... 740 1,085
-------- --------
Total current assets .................................... 35,829 35,802
PROPERTY AND EQUIPMENT:
Leasehold improvements ...................................... 5,084 5,217
Furniture, fixtures and equipment ........................... 6,220 7,195
Automobiles and trucks ...................................... 410 551
-------- --------
11,714 12,963
Less: Accumulated depreciation and amortization ............. (2,381) (4,314)
-------- --------
Property and equipment, net ............................. 9,333 8,649
Beneficial leaseholds, net .................................. 2,704 2,127
Other assets ................................................ 63 91
Deferred financing costs, net ............................... 464 356
Deferred tax assets ......................................... 1,104 712
Goodwill, net ............................................... 35,434 33,519
-------- --------
Total assets ............................................ $ 84,931 $ 81,256
======== ========
LIABILITIES:
CURRENT LIABILITIES:
Current portion of long-term debt ........................... $ 4,675 $ 4,750
Accounts payable ............................................ 11,698 14,796
Accrued liabilities ......................................... 3,563 3,587
Deferred tax liabilities .................................... 1,746 391
Current portion of supplier advances ........................ 1,340 1,900
Income taxes payable ........................................ 1,611 503
-------- --------
Total current liabilities ............................... 24,633 25,927
LONG-TERM DEBT ................................................ 34,490 24,519
SUPPLIER ADVANCES, net of current portion ..................... 1,965 1,353
OTHER LIABILITIES ............................................. 1,037 1,402
DUE TO PARENT ................................................. 34 720
-------- --------
Total liabilities ....................................... 62,159 53,921
COMMITMENTS AND CONTINGENCIES
STOCKHOLDER'S EQUITY:
Common stock, $.01 par value, 1,000 shares authorized, issued
and outstanding ............................................ -- --
Additional paid-in capital .................................. 18,000 18,000
Retained earnings ........................................... 4,772 9,335
-------- --------
Total stockholder's equity .............................. 22,772 27,335
-------- --------
Total liabilities and stockholder's equity .............. $ 84,931 $ 81,256
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-10
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
For the Six For the For the
Months Ended Year Ended Year Ended
July 30, 1995 July 28, 1996 July 26, 1997
--------------- --------------- --------------
<S> <C> <C> <C>
Net sales ............................................ $96,171 $215,731 $231,033
Cost of sales ........................................ 67,686 152,645 163,157
------- -------- --------
Gross profit ...................................... 28,485 63,086 67,876
Selling, general and administrative expenses ......... 21,635 47,487 50,831
Administrative fees .................................. 125 250 250
Depreciation and amortization ........................ 1,980 4,341 4,399
Other income, net .................................... 205 353 401
------- -------- --------
Operating income .................................. 4,950 11,361 12,797
Interest expense, net ................................ 2,284 3,998 3,018
------- -------- --------
Income before income taxes ........................ 2,666 7,363 9,779
Provision for income taxes ........................... 1,598 3,659 5,216
------- -------- --------
Net income ........................................ $ 1,068 $ 3,704 $ 4,563
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-11
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
For the Six For the For the
Months Ended Year Ended Year Ended
July 30, 1995 July 28, 1996 July 26, 1997
--------------- --------------- --------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income ......................................... $ 1,068 $ 3,704 $ 4,563
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ................... 1,926 4,233 4,443
Deferred financing costs ........................ 54 108 108
Non-cash rent expense ........................... 217 552 414
LIFO provision .................................. 567 659 1,086
(Gain) loss on sale of assets ................... (9) -- 7
Changes in operating assets and liabilities
Accounts receivable ........................... (250) (865) 656
Inventory ..................................... (394) (1,792) (3,123)
Prepaid expenses and other current assets ..... 237 1,002 (345)
Other non-current assets ...................... (617) -- (28)
Deferred tax asset ............................ -- 134 392
Due to Parent ................................. -- 34 686
Deferred tax liability ........................ 376 (134) (1,355)
Accounts payable and accrued liabilities ...... 2,469 56 3,122
Income taxes payable .......................... -- 3,740 (1,108)
Supplier advances ............................. (417) (915) (52)
Other ......................................... (46) 1 (48)
---------- -------- --------
Net cash provided by operating
activities ................................. 5,181 10,517 9,418
Cash flows used in investing activities:
Acquisition of business, net of cash acquired ...... (68,143) --
Capital expenditures ............................... (1,070) (2,887) (1,287)
Proceeds from sale of assets ....................... 74 20 12
---------- -------- --------
Net cash used in investing activities ........ (69,139) (2,867) (1,275)
Cash flows provided by (used in) financing
activities:
Proceeds from issuance of common stock ............. 18,000 -- --
Proceeds from borrowings on long-term debt ......... 45,000 -- --
Debt issuance costs ................................ (590) -- --
Proceeds from revolver borrowings .................. 5,733 4,700 7,550
Payments made on revolver borrowings ............... (5,733) (4,700) (7,550)
Payments made on long-term debt .................... -- (5,835) (9,896)
---------- -------- --------
Net cash provided by (used in)
financing activities ....................... 62,410 (5,835) (9,896)
---------- -------- --------
Net (decrease) increase in cash and cash
equivalents .................................. (1,548) 1,815 (1,753)
Cash and cash equivalents beginning of period ...... 3,356 1,808 3,623
---------- -------- --------
Cash and cash equivalents end of period ............ $ 1,808 $ 3,623 $ 1,870
========== ======== ========
Supplemental disclosures of cash information:
Cash paid during the period:
Income taxes ..................................... $ 1,001 $ 2,255 $ 6,605
========== ======== ========
Interest ......................................... $ 2,018 $ 4,088 $ 3,160
========== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-12
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
STATEMENTS OF STOCKHOLDER'S EQUITY
(DOLLARS IN THOUSANDS--EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Total
Paid-in Retained Stockholder's
Shares Amount Capital Earnings Equity
----------- -------- ----------- ------------ --------------
<S> <C> <C> <C> <C> <C>
Balance at January 29, 1995 as previously
reported by predecessor company ............. 1,000 $ -- $ 100 $ 35,933 $ 36,033
Repurchase and elimination of predecessor
company equity .............................. (1,000) -- (100) (35,933) (36,033)
Issuance of successor company shares ......... 1,000 -- 18,000 -- 18,000
------ ------ ------- --------- ---------
Balance at January 30, 1995 for successor
company ..................................... 1,000 -- 18,000 -- 18,000
Net income ................................... -- -- -- 1,068 1,068
------ ------ ------- --------- ---------
Balance at July 30, 1995 ..................... 1,000 -- 18,000 1,068 19,068
Net income ................................... -- -- -- 3,704 3,704
------ ------ ------- --------- ---------
Balance at July 28, 1996 ..................... 1,000 -- 18,000 4,772 22,772
Net income ................................... -- -- -- 4,563 4,563
------ ------ ------- --------- ---------
Balance at July 26, 1997 ..................... 1,000 $ -- $18,000 $ 9,335 $ 27,335
====== ====== ======= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-13
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
(1) ORGANIZATION:
On January 30, 1995 (the "acquisition date"), all of the outstanding capital
stock of Community Distributors, Inc. (the "Company") was acquired by Newrxco,
Inc. a newly formed acquisition company, wholly owned by CDI Group, Inc. (the
"Parent"), for approximately $68 million, net of cash acquired and certain
liabilities assumed. Concurrent with the acquisition of the Company by
Newrxco, Inc., Newrxco, Inc. was merged into the Company so that Newrxco, Inc.
ceased to exist and the Company became the sole subsidiary of the Parent. This
acquisition has been accounted for by the purchase method of accounting at the
date of the acquisition, and accordingly, the purchase price has been "pushed
down" and allocated to the assets acquired and liabilities assumed based on
the estimated fair market values at the date of acquisition. The purchase
price exceeded the fair market value of the net assets acquired by
approximately $38 million. The resulting goodwill is being amortized on a
straight-line basis over 20 years.
On January 30, 1995, the Parent issued $13,250 in senior subordinated notes
which are due January 31, 2005. The ability of the Parent to pay these notes
is currently reliant upon the operations and financial position of the
Company.
The Company owns and operates in the State of New Jersey a chain of drug and
general merchandise stores under the name "Drug Fair" and general merchandise
stores under the name "Cost Cutters." Community Distributors, Inc. is a wholly
owned subsidiary of CDI Group, Inc. and under the principles of consolidation
would be considered part of the consolidated results of CDI Group, Inc. These
separate company financial statements and notes to financial statements solely
represent the financial position and results of operations of Community
Distributors, Inc.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Accounting Year
The Company maintained its accounts on a 52-53 week fiscal year ending with
the last Sunday in July through fiscal 1996 and the last Saturday in July
for fiscal 1997. The six months ended July 30, 1995 included 26 weeks, and
the years ended July 28, 1996 and July 26, 1997 each contained 52 weeks.
Revenue Recognition
Sales are net of returns and exclude sales tax. Revenues include sales
from all stores operating during the period.
Cash and Cash Equivalents
Cash and cash equivalents are considered by the Company to be financial
instruments with original maturities of three months or less, and are
presented at cost which approximates fair value.
Inventories
Store and warehouse inventories are stated at the lower of cost or market,
using the dollar-value, double extension last-in, first-out (LIFO) method.
If the first-in, first-out (FIFO) method of inventory accounting had been
used, inventories would have been approximately $1,296 and $2,382 higher
than reported at July 28, 1996 and July 26, 1997, respectively. Management
believes inventory on a FIFO basis approximates current replacement costs
of such inventory. Inventories are reflected net of reserves for
excess/obsolete/damaged inventories in the amounts of $109 and $113 at July
28, 1996 and July 26, 1997, respectively.
Property and Equipment
Property and equipment, including computer software costs, are recorded at
cost and are depreciated on a straight-line basis over the estimated useful
lives of the assets, which range from three to seven years. Leasehold
improvements are amortized over the expected useful life of the improvement
or the life of the lease, whichever is shorter. Depreciation expense
recorded for the six months ended July 30, 1995 and the fiscal years ended
July 28, 1996 and July 26, 1997 was $674, $1,743 and $1,952, respectively.
The cost and related accumulated depreciation of assets retired or sold are
removed from the respective accounts and any gain or loss is recognized in
operations.
F-14
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
Beneficial Leaseholds
Beneficial leasehold rights existing at the acquisition date have been
recorded for acquired leases based on differences between contractual rents
under the respective lease agreements and prevailing market rents on the
acquisition date. Beneficial leaseholds are amortized over the lease term
using the straight-line method. Accumulated amortization as of July 28,
1996 and July 26, 1997 was $865 and $1,441, respectively.
Goodwill
Goodwill, which represents the excess of the Parent's purchase price of
acquired assets over the fair market value of net assets of the Company acquired
on January 30, 1995, is being amortized using the straight-line method over
twenty years. The Company evaluates the recoverability of goodwill on an annual
basis, or earlier, if circumstances indicate that such an evaluation is
necessary. The Company's assessment of recoverability considers current and
future profitability, estimated undiscounted future cash flows from operations,
and any other events or changes in circumstances which indicate that the
carrying amount of goodwill may not be recoverable. In the event an impairment
of goodwill, or related asset, is indicated to have occurred, the Company's
policy is to allocate goodwill to long lived assets on a pro rata basis using
the relative fair value of those assets at the date the goodwill arose. The
Company has incurred no impairment of goodwill, or related assets, since its
inception. Accumulated amortization as of July 28, 1996 and July 26, 1997 was
$2,873 and $4,793, respectively.
Deferred Financing Costs
Deferred financing costs are amortized utilizing the interest method over
the term of the respective borrowings, approximately 6 years.
Supplier Advances
Included in the accompanying balance sheets are $3,305 and $3,253 of
advances received related to various inventory supply agreements at July 28,
1996 and July 26, 1997, respectively. Such amounts are being recorded as a
reduction of cost of sales as the Company's supply agreement obligations are
fulfilled (generally ranging from three to five years from the point that the
supplier advance received). The Company's obligations under the supply
agreements are fulfilled through the passage of time for those supply agreements
that are for a specific period of time and by the purchasing of inventory for
those supply agreements that stipulate the purchasing of a specific amount of
inventory. The Company is currently committed to approximately $31,000 of
additional purchases under the inventory supply agreements as of July 26, 1997.
In the event the Company does not fulfill its obligations under the inventory
supply agreements, a pro rata portion of the advance will be required to be
repaid, approximating the amounts presented in the financial statements as
Supplier Advances as of July 26, 1997. The amount presented as the current
portion of the supplier advances is estimated by the Company as the amount
related to the passage of time and the estimated inventory purchases to be made
during the twelve months following July 26, 1997, as applicable to the specific
inventory supply agreements.
Preopening and Advertising Costs
Costs associated with new stores prior to opening and advertising costs are
expensed as incurred. Net advertising expense was approximately $481,
$1,638 and $1,941 for the six months ended July 30, 1995 and the fiscal
years ended July 28, 1996 and July 26, 1997, respectively.
Interest Expense (Net)
Interest expense recorded for the six months ended July 30, 1995 and fiscal
years ended July 28, 1996 and July 26, 1997 has been recorded net of
interest income was:
<TABLE>
<CAPTION>
For the Six For the For the
Months Ended Year Ended Year Ended
July 30, 1995 July 28, 1996 July 26, 1997
--------------- --------------- --------------
<S> <C> <C> <C>
Interest expense ............... $2,293 $4,061 $3,160
Interest income ................ (9) (63) (142)
-------- ------ ------
Interest expense (net) ......... $2,284 $3,998 $3,018
======= ====== ======
</TABLE>
Income Taxes
The Company provides for income taxes on a separate tax return basis and in
accordance with Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" ("SFAS" No. 109"). To the extent the separate
return current tax liability recorded by the Company differs from tax
payments made by the
F-15
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
consolidated group, such difference is classified as due to Parent in these
financial statements. SFAS No. 109 requires recognition of deferred tax
liabilities and assets for the expected future tax consequences of events
that have been included in the financial statements or tax returns. Under
this method, deferred tax liabilities and assets are determined on the
basis of the differences between the financial statement and tax bases of
assets and liabilities ("temporary differences") at enacted tax rates in
effect for the years in which the temporary differences are expected to
reverse.
Deferred Lease Liabilities
The Company recognizes rental expense for leases with scheduled rent
increases on the straight-line basis. During the six month period ended
July 30, 1995 and the years ended July 28, 1996 and July 26, 1997, the
Company recognized rent expense in excess of amounts paid of approximately
$217, $552 and $411, respectively.
Concentrations of Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk are cash and cash equivalents. Such amounts
are primarily held in a single commercial bank. The Company holds no
collateral for these financial instruments.
All of the Company's stores are located in northern and central New Jersey.
As a result, the Company is sensitive to economic, competitive, and
regulatory conditions in that region. The success of the Company's future
operations will be substantially affected by its ability to compete
effectively in New Jersey, and no prediction can be made as to economic
conditions in that region.
The Company is party to a supply agreement with Cardinal Health, Inc.
pursuant to which the Company is required to purchase at least 90% of its
pharmacy products from such supplier.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make significant
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 and
expenses during the reporting period. Actual results could differ from
those estimates.
Accounting for the Impairment of Long-Lived Assets
In the current fiscal year, the Company adopted Statement of Financial
Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of", ("SFAS 121"). SFAS No.
121 prescribes the accounting for the impairment of long-lived assets, such
as property, plant and equipment and intangible assets, as well as the
accounting for long-lived assets that are held for disposal. The statement
requires that the carrying value of such assets be reviewed when events or
circumstances indicate that an impairment might exist. The implementation
of SFAS No. 121 in the fiscal year ended July 26, 1997 did not have a
material effect on the results of operations or financial position of the
Company.
Recently Issued Accounting Standard
During February 1997, the Financial Accounting Standards Board issued
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No.
128"). SFAS No. 128 will require the Company to replace the current
presentation of the per share data with "basic" and "diluted" per share
data. SFAS No. 128 will be adopted by the Company for periods ending after
July 25, 1998, and "basic" and "diluted" per share data for all periods
presented by the Company will be provided. Based on management's current
estimates, the future adoption of SFAS 128 is not expected to have a
material impact on per share data.
F-16
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS)
(3) LONG-TERM DEBT:
Long-term debt consists of the following (dollars in thousands):
<TABLE>
<CAPTION>
As of As of
July 28, 1996 July 26, 1997
--------------- --------------
<S> <C> <C>
Term loan A--due last business day in January, 2000, principal
and interest payable in quarterly installments ............. $16,501 $11,003
Term loan B--due last business day in January, 2002, principal
and interest payable in quarterly installments ............. 22,664 18,266
------- -------
39,165 29,269
Less, current portion due within one year .................. 4,675 4,750
------- -------
Long-term portion ............................................ $34,490 $24,519
======= =======
</TABLE>
On January 30, 1995, the Company entered into a $58,000 Credit Agreement (the
"Credit Agreement") with a consortium of banks (the "Banks"). The Credit
Agreement provides for a Revolving Credit facility not to exceed $13,000 based
on trade accounts receivable and inventory as defined in the agreement, a
letter of credit facility for up to $3,500 of the unused portion of the
Revolving Credit facility, and a $45,000 term loan facility. The Revolving
Credit facility has a term ending January 30, 2000, which may be extended to
January 30, 2002, upon written request by the Company. The Company must pay a
commitment fee of 1/2 of 1.00% per annum on the daily average unutilized
Revolving Credit facility commitment. For the six month period ended July 30,
1995 and for the years ended July 28, 1996 and July 26, 1997, the Company
incurred approximately $25, $60 and $70, respectively, of commitment fees and
letter of credit fees.
The A Term Loan and Revolving Loan bear interest at a rate equal to 2.00% plus
the base rate, and the B Term Loan bears interest at a rate equal to 2.50%
plus the base rate. The base rate is the greater of (i) 1/2 of 1.00% in excess
of the Federal Funds Rate and (ii) the Chase Manhattan Bank, N.A. Prime
Lending Rate. The A Term Loan, Revolving Loan, and B Term Loan are
collectively termed Base Rate Loans. The Credit Agreement allows the Company
to temporarily convert all or a portion of the Base Rate Loans, with certain
restrictions, to Eurodollar Loans for periods of one, three, or six months.
Eurodollar Loans bear interest at the lead bank's Eurodollar rate, as defined
in the Credit Agreement, plus 3.00% in the case of the A Term Loan and
Revolving Loan and 3.50% in the case of the B Term Loan.
At July 28, 1996, the Company had converted Base Rate Loans to Eurodollar
loans which are summarized as follows:
<TABLE>
<CAPTION>
Conversion Period
- --------------------------------------
Begin End Amount Interest Rate
- ----------------- ------------------ ---------- --------------
<S> <C> <C> <C>
Term Loan A
July 24, 1996 January 24, 1997 $10,000 8.8750%
July 26, 1996 August 26, 1996 6,501 8.4375%
Term Loan B
May 20, 1996 August 20, 1996 10,000 9.0000%
July 24, 1996 January 24, 1997 10,000 9.3750%
July 26, 1996 August 26, 1996 2,664 8.9375%
</TABLE>
F-17
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS)
(3) LONG-TERM DEBT: (Continued)
At July 26, 1997, the Company had converted Base Rate Loans to Eurodollar
Loans which are summarized as follows:
<TABLE>
<CAPTION>
Conversion Period
- -------------------------------------
Begin End Amount Interest Rate
- ----------------- ----------------- --------- --------------
<S> <C> <C> <C>
Term Loan A
July 24, 1997 August 26, 1997 $ 8,603 7.69%
June 30, 1997 July 31, 1997 2,400 7.69%
Term Loan B
May 20, 1997 August 20, 1997 10,000 8.56%
July 24, 1997 August 26, 1997 8,266 8.56%
</TABLE>
The Parent has pledged all of the issued and outstanding shares of capital
stock of the Company and the Company has pledged substantially all of its
assets as collateral under the Credit Agreement. The Company is required to
make mandatory repayments or commitment reductions for a percentage of excess
cash flows and for certain supplier advances, as defined by the Credit
Agreement.
The Credit Agreement contains various covenants, including among other things,
limitations on capital expenditures and restrictions on: additional
indebtedness; issuance of capital stock; payment of any cash dividends; and
the purchase or sale of assets. The Company is also required to achieve
certain earnings levels and maintain various leverage and interest coverage
ratios.
On February 13, 1995, the First Amendment to the Credit Agreement was executed
requiring the Company to obtain interest rate protection acceptable to the
banks for at least 50% of the outstanding Term Loans for a period of two years
from the initial borrowing date. In conjunction with this amendment, on
February 16, 1995, the Company entered into an interest rate cap agreement
with a bank. This agreement relates to a $22,500 notional amount of debt and
provides for payments to be received by the Company based exclusively on the
three month London Interbank Offered Rate with a cap of 9%. The purchase price
of the cap has been capitalized and amortized over the term of the agreement.
The cap was purchased for approximately $50 and expired February 16, 1997.
Aggregate debt maturities as of July 26, 1997 are as follows:
<TABLE>
<CAPTION>
Amount Due
Fiscal Year Ending -----------
<S> <C>
1998 .......... $ 4,750
1999 .......... 5,750
2000 .......... 6,750
2001 .......... 9,000
2002 .......... 3,019
-------
$29,269
=======
</TABLE>
The carrying amount of the Company's debt approximates fair value as of July
28, 1996 and July 26, 1997 based upon market conditions and the terms and
conditions of the Company's debt.
See footnote 9 "Subsequent Events" regarding various financing activities
occurring after July 26, 1997.
(4) COMMITMENTS:
Leases
The Company conducts all of its warehousing and retailing operations from
leased facilities. Annual store rent is composed of a fixed minimum amount,
and for certain stores, contingent rent based upon a percentage of sales
exceeding a stipulated amount. The leases, which may be renewed for periods
ranging from five to thirty
F-18
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS)
(4) COMMITMENTS: (Continued)
years, generally provide that the Company pay insurance, maintenance costs
and property taxes. These additional charges are subject to escalation for
increases in the related costs. Minimum rental commitments under long-term
noncancelable operating leases are as follows at July 26, 1997:
<TABLE>
<CAPTION>
Amount Due
Fiscal Year -----------
<S> <C>
1998 ................ $ 8,582
1999 ................ 8,243
2000 ................ 7,327
2001 ................ 5,862
2002 ................ 5,317
Thereafter .......... 40,959
-------
$76,290
=======
</TABLE>
Annual Rent expense is comprised of a fixed minimum amount, plus contingent
rent based on a percentage of sales exceeding a stipulated amount. For the
six months ended July 30, 1995 and for the twelve months ended July 28,
1996 and July 26, 1997, total rent expense included:
<TABLE>
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Fixed Minimum Rent .......... $3,266 $7,696 $8,261
Contingent Rent ............. 89 178 180
------ ------ ------
Total Rent Expense .......... $3,355 $7,874 $8,441
====== ====== ======
</TABLE>
Letter of Credit
Outstanding letters of credit, guaranteeing certain contingent purchase
commitments which are not reflected in the accompanying financial
statements, aggregate approximately $1,031 and $1,135 at July 28, 1996 and
July 26, 1997.
(5) INCOME TAXES:
The provision for income taxes for the six month period ended July 30, 1995
and for the years ended July 28, 1996 and July 26, 1997 consist of the
following:
<TABLE>
<CAPTION>
July 30, July 28, July 26,
1995 1996 1997
---------- ---------- ---------
<S> <C> <C> <C>
Current ............ $1,222 $3,659 $6,179
Deferred ........... 376 -- (963)
------ ------ ------
$1,598 $3,659 $5,216
====== ====== ======
</TABLE>
The components of deferred taxes as of July 28, 1996 and July 26, 1997 are
summarized as follows:
<TABLE>
<CAPTION>
July 28, July 26,
1996 1997
---------- -----------
<S> <C> <C>
Supplier advances, current ............................. $ 536 $ 620
Inventory .............................................. 136 169
Accruals and reserves .................................. 627 658
Inventory (LIFO reserve) ............................... (2,916) (2,094)
-------- --------
Depreciation ........................................... (129) 256
Net deferred income tax liability--current ......... (1,746) (391)
======== ========
Accruals and reserves .................................. 318 482
Supplier advances, non-current ......................... 786 230
-------- --------
Net deferred income tax asset--long-term ............... $ 1,104 $ 712
======== ========
</TABLE>
F-19
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS)
(5) INCOME TAXES: (Continued)
The following table accounts for the differences between the actual provision
and the amounts obtained by applying the statutory U.S. Federal income tax
rate of 34% to the income before provision for income taxes:
<TABLE>
<CAPTION>
For the For the For the
six months twelve months twelve months
ended ended ended
July 30, 1995 July 28, 1996 July 26, 1997
--------------- --------------- --------------
<S> <C> <C> <C>
Federal statutory tax rate ...................... 34% 34% 34%
State and local income taxes, net of federal tax
benefit ...................................... 6% 6% 8%
Goodwill amortization ........................... 19% 12% 9%
Other ........................................... 1% (2%) 2%
-- -- --
60% 50% 53%
== == ==
</TABLE>
(6) RELATED PARTY TRANSACTIONS:
Included in the Company's statements of income for the six month period ended
July 30, 1995 and for the years ended July 28, 1996 and July 26, 1997 are
administrative fees of $125, $250 and $250, respectively. The Company has
entered into administrative fee agreements with certain shareholders of CDI
Group, Inc., whereby these shareholders will provide, advisory and consulting
services to the Company. These administrative fee agreements require the
Company to pay $250 of administrative fees annually.
Under a lease dated September 30, 1983, the former majority stockholders of
the Company lease the building housing the Company's Westfield Drug Fair store
to the Company. Under this lease, which has a term of 15 years and expires on
September 30, 1998, the Company pays $17 per month in rent.
Under a letter agreement dated as of January 30, 1995 between the Company and
a corporation owned by the former majority stockholders of the Company, the
corporation pays to the Company $3 per month in rent for the use of
approximately 6,000 sq. feet of storage space at the Company's Somerville, NJ
warehouse. This letter agreement was terminated in July 1996.
(7) LITIGATION:
The Company is a defendant in various lawsuits arising in the ordinary course
of business. In the opinion of management, the disposition of these lawsuits
should not have a material impact on the Company's results of operations,
financial position, and cash flows.
(8) EMPLOYEE BENEFIT PLAN:
On July 1, 1995, the Company implemented a 401(k) salary deferral plan (the
"Plan") which is available to eligible employees, as defined. The Plan
provides for the Company to make discretionary contributions, however, the
Company elected not to make contributions for all periods through July 26,
1997.
(9) SUBSEQUENT EVENT:
On October 16, 1997 the Company issued $80,000 of 10 1/4% senior notes due 2004
which are guaranteed by the Parent. The net proceeds of such debt issuance was
approximately $77,000. The Company used $29,000 of such net proceeds to
refinance substantially all of its then existing indebtedness and $45,000 of
net proceeds was used to pay a dividend to the Parent which then paid a
dividend of the same amount to the stockholders of the Parent. Under the
relevant debt agreements, in the event of a change in control, as defined, the
Company is required to repurchase all such outstanding notes.
F-20
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS)
(9) SUBSEQUENT EVENT: (Continued)
On October 16, 1997, the Company also replaced its then existing credit
facility with a $20,000 five year revolving credit facility concurrent with
the issuance of the $80,000 of senior notes. This facility bears interest at
either prime rate or LIBOR plus 1.75% and is secured by the Company's eligible
accounts receivable and inventory balances, as defined. The new facility
contains certain financial and operating covenants, including a minimum fixed
charge ratio. Additionally, the Company cannot make any dividend or other
distributions with respect to any share of stock other than in certain limited
circumstances.
The following unaudited proforma data reflects the Long Term Debt and
Securities of the Company at July 26, 1997 after giving effect to the issuance
of the notes and use of proceeds.
<TABLE>
<CAPTION>
(Unaudited)
<S> <C>
Long Term Debt, including current maturities ......... $ 80,198
Stockholders' Deficit ................................ (19,269)
</TABLE>
F-21
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders of
CDI Group, Inc. and Subsidiary:
We have audited the accompanying consolidated balance sheets of CDI Group,
Inc. and Subsidiary (a Delaware corporation) as of July 26, 1997 and July 28,
1996, and the related consolidated statements of income, cash flows and
stockholders' equity for the fiscal years then ended and for the six months
ended July 30, 1995. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of CDI Group,
Inc. and Subsidiary as of July 26, 1997 and July 28, 1996, and the consolidated
results of their operations and their cash flows for the fiscal years then
ended and for the six months ended July 30, 1995 in conformity with generally
accepted accounting principles.
Parsippany, New Jersey COOPERS & LYBRAND L.L.P.
October 9, 1997, except for Note 11
for which the date is October 16, 1997.
F-22
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
As of As of
July 28, 1996 July 26, 1997
--------------- --------------
<S> <C> <C>
ASSETS:
CURRENT ASSETS:
Cash and cash equivalents ................................................ $ 3,623 $ 1,870
Accounts receivable ...................................................... 3,289 2,644
Inventory ................................................................ 28,196 30,233
Prepaid expenses and other current assets ................................ 740 1,131
-------- --------
Total current assets ................................................. 35,848 35,878
PROPERTY AND EQUIPMENT:
Leasehold improvements ................................................... 5,084 5,217
Furniture, fixtures and equipment ........................................ 6,220 7,195
Automobiles and trucks ................................................... 410 551
-------- --------
11,714 12,963
Less: Accumulated depreciation and amortization .......................... (2,381) (4,314)
-------- --------
Property and equipment, net .......................................... 9,333 8,649
Beneficial leaseholds, net ............................................... 2,704 2,127
Other assets ............................................................. 63 91
Deferred financing costs, net ............................................ 464 356
Deferred tax assets ...................................................... 1,104 712
Goodwill, net ............................................................ 35,434 33,519
-------- --------
Total assets ......................................................... $ 84,950 $ 81,332
======== ========
LIABILITIES:
CURRENT LIABILITIES:
Current portion of long-term debt ........................................ $ 4,675 $ 4,836
Accounts payable ......................................................... 11,698 14,796
Accrued liabilities ...................................................... 3,574 3,592
Deferred tax liabilities ................................................. 1,746 391
Current portion of supplier advances ..................................... 1,340 1,900
Income taxes payable ..................................................... 1,159 --
-------- --------
Total current liabilities ............................................ 24,192 25,515
LONG-TERM DEBT ............................................................. 34,490 24,519
SUBORDINATED DEBT .......................................................... 15,422 16,834
SUPPLIER ADVANCES, net of current portion .................................. 1,965 1,353
OTHER LIABILITIES .......................................................... 1,037 1,402
-------- --------
Total liabilities .................................................... 77,106 69,623
COMMITMENTS AND CONTINGENCIES
Redeemable preferred stock, $1.00 par value, 7,862 authorized, issued and
outstanding at July 28, 1996, and July 26, 1997 redemption value $100
per share ................................................................ 666 726
Redeemable shares of class A voting common stock, 33,726 shares issued and
outstanding at July 28, 1996 and July 26, 1997 at net redemption value ... 101 128
STOCKHOLDERS' EQUITY:
Class A voting common stock, $.00001 par value, authorized 600,000 shares,
196,632 issued and outstanding at July 28, 1996 and July 26, 1997
Class B non-voting common stock, $.00001 par value, authorized 600,000
shares, 187,922 issued and outstanding at July 28, 1996 and July 26, 1997 -- --
Additional paid-in capital ............................................... 3,846 3,846
Retained earnings ........................................................ 3,231 7,009
-------- --------
Total stockholders' equity ........................................... 7,077 10,855
-------- --------
Total liabilities and stockholders' equity ........................... $ 84,950 $ 81,332
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-23
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS--EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
For the Six For the For the
Months Ended Year Ended Year Ended
July 30, 1995 July 28, 1996 July 26, 1997
--------------- --------------- --------------
<S> <C> <C> <C>
Net sales ............................................ $ 96,171 $ 215,731 $ 231,033
Cost of sales ........................................ 67,686 152,645 163,157
-------- --------- ---------
Gross profit ...................................... 28,485 63,086 67,876
Selling, general and administrative expenses ......... 21,635 47,487 50,831
Administrative fees .................................. 125 250 250
Depreciation and amortization ........................ 1,980 4,341 4,399
Other income, net .................................... 205 353 401
-------- --------- ---------
Operating income .................................. 4,950 11,361 12,797
Interest expense, net ................................ 2,946 5,326 4,586
-------- --------- ---------
Income before income taxes ........................ 2,004 6,035 8,211
Provision for income taxes ........................... 1,366 3,442 4,433
-------- --------- ---------
Net income ........................................ $ 638 $ 2,593 $ 3,778
======== ========= =========
Per share data:
Net income per common share ....................... $ 1.56 $ 5.88 $ 8.22
======== ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-24
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
For the Six For the For the
Months Ended Year Ended Year Ended
July 30, 1995 July 28, 1996 July 26, 1997
--------------- --------------- --------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income .................................................. $ 638 $ 2,593 $ 3,778
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization ............................ 1,926 4,233 4,443
Deferred financing costs ................................. 54 108 108
Non-cash rent expense .................................... 217 552 414
Non-cash interest expense ................................ 662 1,347 1,585
LIFO provision ........................................... 567 659 1,086
(Gain) Loss on sale of assets ............................ (9) -- 7
Changes in operating assets and liabilities
Accounts receivable .................................... (250) (884) 645
Inventory .............................................. (394) (1,792) (3,123)
Prepaid expenses and other current assets .............. (372) 1,028 (391)
Other non-current assets ............................... (617) 2,351 (28)
Deferred tax asset ..................................... -- 134 392
Deferred tax liability ................................. 376 (134) (1,355)
Accounts payable and accrued liabilities ............... 2,885 (175) 3,116
Income taxes payable ................................... -- 1,159 (1,159)
Supplier advances ...................................... (417) (915) (52)
Other .................................................. (85) 227 (48)
---------- -------- --------
Net cash provided by operating activities ............. 5,181 10,491 9,418
---------- -------- --------
Cash flows used in investing activities:
Acquisition of business, net of cash acquired ............... (68,143) -- --
Capital expenditures ........................................ (1,070) (2,887) (1,287)
Proceeds from sale of assets ................................ 74 20 12
---------- -------- --------
Net cash used in investing activities ................. (69,139) (2,867) (1,275)
---------- -------- --------
Cash flows provided by financing activities:
Proceeds from borrowings on long-term debt .................. 45,000 -- --
Debt issuance costs ......................................... (590) -- --
Proceeds from issuance of common stock ...................... 4,000 226 --
Payments for the redemption of common stock ................. -- (300) --
Proceeds from issuance of preferred stock ................... 750 564 --
Payments for the redemption of preferred stock .............. -- (714) --
Proceeds from repayment of loans to Directors and
Officers .................................................. -- 87 87
Proceeds from issuance of senior subordinated notes ......... 13,250 163 --
Proceeds from revolver borrowings ........................... 5,733 4,700 7,550
Payments made on revolver borrowings ........................ (5,733) (4,700) (7,550)
Payments made on long-term debt ............................. -- (5,835) (9,896)
Payments on subordinated debt ............................... -- -- (87)
---------- -------- --------
Net cash provided by (used in) financing
activities .......................................... 62,410 (5,809) (9,896)
---------- -------- --------
Net (decrease) increase in cash and
cash equivalents .................................... (1,548) 1,815 (1,753)
---------- -------- --------
Cash and cash equivalents beginning of period ................ 3,356 1,808 3,623
---------- -------- --------
Cash and cash equivalents end of period ...................... $ 1,808 $ 3,623 $ 1,870
========== ======== ========
Supplemental disclosures of cash information:
Cash paid during the period:
Income taxes .............................................. $ 1,001 $ 2,255 $ 6,605
========== ======== ========
Interest .................................................. $ 2,018 $ 4,088 $ 3,160
========== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-25
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Common Stock
-------------------------------
Additional Total
Class A Class B Paid-in Retained Stockholders'
Shares Shares Amount Capital Earnings Equity
------------ --------- -------- ------------ ---------- --------------
<S> <C> <C> <C> <C> <C> <C>
Initial issuance of shares ............ 212,078 187,922 $ -- $4,000 $ -- $ 4,000
Net income ............................ -- -- -- -- 638 638
------- ------- ----- ------ ------ -------
Balance, July 30, 1995 ................ 212,078 187,922 $ -- $4,000 $ 638 4,638
Repurchase of Shares .................. (30,016) (300) (300)
Sales of Shares to Management ......... 14,570 -- -- 146 -- 146
Net income ............................ -- -- -- -- 2,593 2,593
------- ------- ----- ------ ------ -------
Balance, July 28, 1996 ................ 196,632 187,922 $ -- $3,846 $3,231 7,077
Net income ............................ -- -- -- -- 3,778 3,778
------- ------- ----- ------ ------ -------
Balance, July 26, 1997 ................ 196,632 187,922 $ -- $3,846 $7,009 $10,855
======= ======= ===== ====== ====== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-26
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) ORGANIZATION:
CDI Group, Inc. (the "Parent") was formed in January 1995. On January 30, 1995
(the "acquisition date"), all of the outstanding capital stock of Community
Distributors, Inc. (the "Subsidiary") was acquired by Newrxco, Inc. a newly
formed acquisition company, wholly owned by CDI Group, Inc., for approximately
$68 million, net of cash acquired, and certain liabilities assumed. Concurrent
with the acquisition of the Company by Newrxco, Inc., Newrxco, Inc. was merged
into the Subsidiary so that Newrxco, Inc. ceased to exist. This acquisition
has been accounted for by the purchase method of accounting at the date of the
acquisition, and accordingly, the purchase price has been allocated to the
assets acquired and liabilities assumed based on the estimated fair market
values at the date of acquisition. The purchase price exceeded the fair market
value of the net assets acquired by approximately $38 million. The resulting
goodwill is being amortized on a straight-line basis over 20 years.
CDI Group, Inc. and Subsidiary (the "Company") owns and operates in the State
of New Jersey a chain of drug and general merchandise stores under the name
"Drug Fair" and general merchandise stores under the name "Cost Cutters".
The accompanying consolidated financial statements include the accounts of
CDI Group, Inc. and its wholly-owned subsidiary, Community Distributors, Inc.
All significant intercompany accounts and transactions have been eliminated in
consolidation.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Accounting Year
The Company maintains its accounts on a 52-53 week year ending with the
last Sunday in July through Fiscal 1996 and the last Saturday in July for
fiscal 1997. The six months ended July 30, 1995 included 26 weeks and the
years ended July 28, 1996 and July 26, 1997 each contained 52 weeks.
Revenue Recognition
Sales are net of returns and exclude sales tax. Revenues include sales
from all stores operating during the period.
Cash and Cash Equivalents
Cash and cash equivalents are considered by the Company to be financial
instruments with original maturities of three months or less, and are
presented at cost which approximates fair value.
Inventories
Store and warehouse inventories are stated at the lower of cost or market,
using the dollar-value, double extension last-in, first-out (LIFO) method.
If the first-in, first-out (FIFO) method of inventory accounting had been
used, inventories would have been approximately $1,296 and $2,382 higher
than reported at July 28, 1996 and July 26, 1997, respectively. Management
believes inventory on a FIFO basis approximates current replacement costs
of such inventory. Inventories are reflected net of reserves for
excess/obsolete/damaged inventories in the amounts of $109 and $113 at July
28, 1996 and July 26, 1997, respectively.
Property and Equipment
Property and equipment, including computer software costs, are recorded at
cost and are depreciated on a straight-line basis over the estimated useful
lives of the assets, which range from three to seven years. Leasehold
improvements are amortized over the expected useful life of the improvement
or the life of the lease, whichever is shorter. Depreciation expense
recorded for the six months ended July 30, 1995 and the fiscal years ended
July 28, 1996 and July 26, 1997 was $674, $1,743 and $1,952, respectively.
The cost and related accumulated depreciation of assets retired or sold are
removed from the respective accounts and any gain or loss is recognized in
operations.
Beneficial Leaseholds
Beneficial leasehold rights existing at the acquisition date have been
recorded for acquired leases based on differences between contractual rents
under the respective lease agreements and prevailing market rents on
F-27
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
the acquisition date. Beneficial leaseholds are amortized over the lease
term using the straight-line method. Accumulated amortization as of July
28, 1996 and July 26, 1997 was $865 and $1,441, respectively.
Goodwill
Goodwill, which represents the excess of the Parent's purchase price of
acquired assets over the fair market value of net assets of the Company acquired
on January 30, 1995, is being amortized using the straight-line method over
twenty years. The Company evaluates the recoverability of goodwill on an annual
basis, or earlier, if circumstances indicate that such an evaluation is
necessary. The Company's assessment of recoverability considers current and
future profitability, estimated undiscounted future cash flows from operations,
and any other events or changes in circumstances which indicate that the
carrying amount of goodwill may not be recoverable. In the event an impairment
of goodwill, or related asset, is indicated to have occurred, the Company's
policy is to allocate goodwill to long lived assets on a pro rata basis using
the relative fair value of those assets at the date the goodwill arose. The
Company has incurred no impairment of goodwill, or related assets, since its
inception. Accumulated amortization as of July 28, 1996 and July 26, 1997 was
$2,873 and $4,793, respectively.
Deferred Financing Costs
Deferred financing costs are amortized utilizing the interest method over
the term of the respective borrowings, approximately 6 years.
Supplier Advances
Included in the accompanying balance sheets are $3,305 and $3,253 of
advances received related to various inventory supply agreements at July 28,
1996 and July 26, 1997, respectively. Such amounts are being recorded as a
reduction of cost of sales as the Company's supply agreement obligations are
fulfilled (generally ranging from three to five years from the point that the
supplier advance received). The Company's obligations under the supply
agreements are fulfilled through the passage of time for those supply agreements
that are for a specific period of time and by the purchasing of inventory for
those supply agreements that stipulate the purchasing of a specific amount of
inventory. The Company is currently committed to approximately $31,000 of
additional purchases under the inventory supply agreements as of July 26, 1997.
In the event the Company does not fulfill its obligations under the inventory
supply agreements, a pro rata portion of the advance will be required to be
repaid, approximating the amounts presented in the financial statements as
Supplier Advances as of July 26, 1997. The amount presented as the current
portion of the supplier advances is estimated by the Company as the amount
related to the passage of time and the estimated inventory purchases to be made
during the twelve months following July 26, 1997, as applicable to the specific
inventory supply agreements.
Preopening and Advertising Costs
Costs associated with new stores prior to opening and advertising costs are
expensed as incurred. Net advertising expense was approximately $481,
$1,638 and $1,941 for the six-month period ending July 30, 1995 and the
fiscal years ended July 28, 1996 and July 26, 1997, respectively.
Interest Expense (Net)
Interest expense recorded for the six months ended July 30, 1995 and the
fiscal years ended July 26, 1996 and July 26, 1997, net of interest income
was:
<TABLE>
<CAPTION>
For the Six For the Year For the Year
Months Ended Ended Ended
July 30, 1995 July 28, 1996 July 26, 1997
--------------- --------------- --------------
<S> <C> <C> <C>
Interest expense ............... $2,955 $5,389 $4,755
Interest income ................ (9) (63) (169)
-------- ------ ------
Interest expense (net) ......... $2,946 $5,326 $4,586
======= ====== ======
</TABLE>
Reclassifications
Certain reclassifications have been made to the prior year financial
statements to conform to the fiscal 1997 presentation.
Income Taxes
The Company provides for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes"
("SFAS" No. 109). SFAS No. 109 requires recognition of deferred tax
liabilities and assets for the expected future tax consequences of events
that have been included in the financial
F-28
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
statements or tax returns. Under this method, deferred tax liabilities and
assets are determined on the basis of the differences between the financial
statement and tax bases of assets and liabilities ("temporary differences")
at enacted tax rates in effect for the years in which the temporary
differences are expected to reverse.
Deferred Lease Liabilities
The Company recognizes rental expense for leases with scheduled rent
increases on the straight-line basis. During the six month period ended
July 30, 1995 and the years ended July 28, 1996 and July 26, 1997, the
Company recognized rent expense in excess of amounts paid of $217, $552 and
$411, respectively.
Concentrations of Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk are cash and cash equivalents. Such amounts
are primarily held in a single commercial bank. The Company holds no
collateral for these financial instruments.
All of the Company's stores are located in northern and central New Jersey.
As a result, the Company is sensitive to economic, competitive, and
regulatory conditions in that region. The success of the Company's future
operations will be substantially affected by its ability to compete
effectively in New Jersey, and no prediction can be made as to economic
conditions in that region.
The Company is party to a supply agreement with Cardinal Health, Inc.
pursuant to which the Company is required to purchase at least 90% of its
pharmacy products from such supplier.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make significant
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 and
expenses during the reporting period. Actual results could differ from
those estimates.
Earnings per Share
Net income per share is computed using the weighted average number of
common and common equivalent shares outstanding during the period. The
weighted average number of common and common equivalent shares outstanding
for the periods ended July 30, 1995, July 28, 1996 and July 26, 1997 was
409,283, 441,037, and 459,673, respectively.
Stock Options
In the current fiscal year, the Company adopted Statement of Financial
Accounting Standards No. 123 "Accounting for Stock Based Compensation"
("SFAS 123"). SFAS 123 prescribes the accounting for stock options and
requires that options be valued at their fair market value, as defined in
the statement, on the date of grant. SFAS 123 allows companies to either
fully adopt its requirements or to elect to only disclose the impact that
the requirements would have. The Company has adopted SFAS 123 for
disclosure purposes only and will continue to account for its stock options
under APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Accounting for the Impairment of Long-Lived Assets
In the current fiscal year, the Company adopted Statement of Financial
Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of", "SFAS No. 121". SFAS
No. 121 prescribes the accounting for the impairment of long-lived assets,
such as property, plant and equipment and intangible assets, as well as the
accounting for long-lived assets that are held for disposal. The statement
requires that the carrying value of such assets be reviewed when events or
circumstances indicate
F-29
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (Continued)
that an impairment might exist. The implementation of SFAS No. 121 in the
fiscal year ending July 26, 1997 did not have a material effect on the
results of operations or financial position of the Company.
Recently Issued Accounting Standard
During February 1997, the Financial Accounting Standards Board issued
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No.
128"). SFAS No. 128 will require the Company to replace the current
presentation of the per share data with "basic" and "diluted" per share
data. SFAS No. 128 will be adopted by the Company for periods ending after
July 25, 1998, and "basic" and "diluted" per share data for all periods
presented by the Company will be provided. Based on management's current
estimates, the future adoption of SFAS No. 128 is not expected to have a
material impact on per share data.
(3) LONG-TERM DEBT:
Long-term debt consists of the following (dollars in thousands):
<TABLE>
<CAPTION>
As of As of
July 28, 1996 July 26, 1997
--------------- --------------
<S> <C> <C>
Term loan A--due last business day in January, 2000, principal and
interest payable in quarterly installments ............................ $16,501 $11,003
Term loan B--due last business day in January, 2002, principal and
interest payable in quarterly installments ............................ 22,664 18,266
Senior subordinated notes--due January 31, 2005, principal plus interest
at a rate of 10% per annum payable upon maturity ...................... 15,249 16,834
Subordinated notes--due December 31, 1997 principal plus interest at a
rate of 8% per annum payable upon maturity ............................ 173 86
------- -------
Total ............................................................... 54,587 46,189
Less, current portion due within one year ........................... 4,675 4,836
------- -------
Long-term portion ...................................................... $49,912 $41,353
======= =======
</TABLE>
On January 30, 1995, the Subsidiary entered into a $58,000 Credit Agreement
(the "Credit Agreement") with a consortium of banks (the "Banks"). The Credit
Agreement provided for a Revolving Credit facility not to exceed $13,000 based
on trade accounts receivable and inventory balances as defined in the
agreement, a letter of credit facility for up to $3,500 of the unused portion
of the revolving credit facility, and a $45,000 term loan facility. The
Revolving Credit facility had a term ending January 30, 2000, which may have
been extended to January 30, 2002, upon written request by the Subsidiary. The
Subsidiary was required to pay a commitment fee of 1/2 of 1.00% per annum on
the daily average unutilized revolving credit facility commitment. For the six
month period ended July 30, 1995 and for the years ended July 28, 1996 and
July 26, 1997, the Subsidiary incurred approximately $25, $60 and $70, of
commitment fees and letter of credit fees, respectively.
On January 30, 1995, the Parent issued $13,250 in senior subordinated notes
which are due January 31, 2005. Principal on the notes was payable upon
maturity plus interest at a rate of 10% per annum. Payment of principal and
interest on the notes was subordinated to the prior payment in full of all of
the Company's obligations under the Credit Agreement.
On January 30, 1995, the Parent issued $260 in subordinated notes which are
due December 31, 1997. Principal on the notes was payable upon maturity plus
interest at a rate of 8% per annum.
The A Term Loan and Revolving Loan bear interest at a rate equal to 2.00% plus
the base rate, and the B Term Loan bears interest at a rate equal to 2.50%
plus the base rate. The base rate was the greater of (i) 1/2 of 1.00% in
excess of the Federal Funds Rate and (ii) the Chase Manhattan Bank, N.A. Prime
Lending Rate. The A Term, Revolving Loan, and B Term loans are collectively
termed Base Rate Loans. The Credit Agreement allowed the
F-30
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(3) LONG-TERM DEBT: (Continued)
Subsidiary to temporarily convert all or a portion of the Base Rate Loans,
with certain restrictions, to Eurodollar Loans for periods of one, three, or
six months. Eurodollar Loans bear interest at the lead bank's Eurodollar rate,
as defined in the Credit Agreement, plus 3.00% in the case of the A Term Loan
and Revolving Loan and 3.50% in the case of the B Term Loan.
At July 28, 1996, the Subsidiary had converted Base Rate Loans to Eurodollar
loans which are summarized as follows:
<TABLE>
<CAPTION>
Conversion Period
- ---------------------------------------
Begin End Amount Interest Rate
- ------------------ ------------------ ---------- --------------
<S> <C> <C> <C>
Term Loan A
July 24, 1996 January 24, 1997 $10,000 8.8750%
July 26, 1996 August 26, 1996 6,501 8.4375%
Term Loan B
May 20, 1996 August 20, 1996 10,000 9.0000%
July 24, 1996 January 24, 1997 10,000 9.3750%
July 26, 1996 August 26, 1996 2,664 8.9375%
</TABLE>
At July 26, 1997, the Subsidiary had converted Base Rate Loans to Eurodollar
loans which are summarized as follows:
<TABLE>
<CAPTION>
Conversion Period
- --------------------------------------
Begin End Amount Interest Rate
- ------------------ ----------------- ---------- --------------
<S> <C> <C> <C>
Term Loan A
July 24, 1997 August 26, 1997 $ 8,603 7.69%
June 30, 1997 July 31, 1997 2,400 7.69%
Term Loan B
May 20, 1997 August 20, 1997 10,000 8.56%
July 24, 1997 August 26, 1997 8,266 8.56%
</TABLE>
The Parent had pledged all of the issued and outstanding shares of its capital
stock and the Subsidiary had pledged substantially all its assets as
collateral under the Credit Agreement. The Subsidiary was required to make
mandatory repayments or commitment reductions for a percentage of excess cash
flows and for certain supplier advances, as defined by the Credit Agreement.
The Credit Agreement contained various covenants, including among other
things, limitations on capital expenditures and restrictions on: additional
indebtedness; issuance of capital stock; payment of no cash dividends; and the
purchase or sale of assets. The Subsidiary was also required to achieve
certain earnings levels and maintain various leverage and interest coverage
ratios.
On February 13, 1995, the First Amendment to the Credit Agreement was executed
requiring the Subsidiary to obtain interest rate protection acceptable to the
banks for at least 50% of the outstanding Term Loans for a period of two years
from the initial borrowing date. In conjunction with this amendment, on
February 16, 1995, the Subsidiary entered into an interest rate cap agreement
with a bank. This agreement related to a $22,500 notional amount of debt and
provided for payments to be received by the Subsidiary based exclusively on
the three month London Interbank Offered Rate with a cap of 9%. The purchase
price of the cap had been capitalized and amortized over the term of the
agreement. The cap was purchased for approximately $50 and expired February
16, 1997.
F-31
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(3) LONG-TERM DEBT: (Continued)
Aggregate debt maturities as of July 26, 1997 are as follows:
<TABLE>
<CAPTION>
Amount Due
Fiscal Year -----------
(in 000's)
<S> <C>
1998 ............... $ 4,836
1999 5,750
2000 6,750
2001 9,000
2002 3,019
Thereafter ......... 16,834
-------
$46,189
=======
</TABLE>
The carrying amount of the Company's debt approximates fair value as of July
28, 1996 and July 26, 1997 based upon market conditions and the terms and
conditions of the Company's debt.
See footnote 11 "Subsequent Events" regarding various financing activities
occurring after July 26, 1997.
(4) COMMITMENTS:
Leases
The Company conducts all of its warehousing and retailing operations from
leased facilities. Annual store rent is composed of a fixed minimum amount,
and for certain stores, contingent rent is based upon a percentage of sales
exceeding a stipulated amount. The leases, which may be renewed for periods
ranging from five to thirty years, generally provide that the Company pay
insurance, maintenance costs and property taxes. These additional charges
are subject to escalation for increases in the related costs. Minimum
rental commitments under long-term noncancelable operating leases are as
follows at July 26, 1997:
<TABLE>
<CAPTION>
(in 000's)
Fiscal Year -----------
<S> <C>
1998 ................ $ 8,582
1999 8,243
2000 7,327
2001 5,862
2002 5,317
Thereafter .......... 40,959
-------
$76,290
=======
</TABLE>
Annual Rent expense is comprised of a fixed minimum amount, plus contingent
rent based on a percentage of sales exceeding a stipulated amount. For the
six months ended July 30, 1995 and for the twelve months ended July 28,
1996 and July 26, 1997, total rent expense included:
<TABLE>
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Fixed Minimum Rent .......... $3,266 $7,696 $8,261
Contingent Rent ............. 89 178 180
------ ------ ------
Total Rent Expense .......... $3,355 $7,874 $8,441
====== ====== ======
</TABLE>
Letter of Credit
Outstanding letters of credit, guaranteeing certain contingent purchase
commitments which are not reflected in the accompanying financial
statements, aggregate approximately $1,031 and $1,135 at July 28, 1996 and
July 26, 1997.
F-32
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(5) INCOME TAXES:
The provision for income taxes for the six month period ended July 30, 1995
and for the years ended July 28, 1996 and July 26, 1997 consist of the
following:
<TABLE>
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Current ........... $ 990 $3,442 $5,396
Deferred .......... 376 -- (963)
------ ------ ------
$1,366 $3,442 $4,433
====== ====== ======
</TABLE>
The components of deferred taxes as of July 28, 1996 and July 26, 1997 are
summarized as follows:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Supplier advances, current ............................. $ 536 $ 620
Inventory .............................................. 136 169
Other assets
Accruals and reserves .................................. 627 658
Inventory (LIFO reserve) ............................... (2,916) (2,094)
Depreciation ........................................... (129) 256
-------- --------
Net deferred income tax liability--current .......... $ (1,746) $ (391)
======== ========
Accruals and reserves .................................. 318 482
Supplier advances, non-current ......................... 786 230
-------- --------
Net deferred income tax asset--long-term ............ $ 1,104 $ 712
======== ========
</TABLE>
The following table accounts for the differences between the actual provision
and the amounts obtained by applying the statutory U.S. Federal income tax
rate of 34% to the income before income taxes:
<TABLE>
<CAPTION>
For the
six months For the For the
ended year ended year ended
July 30, 1995 July 28, 1996 July 26, 1997
--------------- --------------- --------------
<S> <C> <C> <C>
Federal statutory tax rate ....................................... 34% 34% 34%
State and local income taxes, net of federal tax benefit ......... 6% 6% 6%
Goodwill amortization ............................................ 26% 15% 12%
Other ............................................................ 2% 2% 2%
-- -- --
68% 57% 54%
== == ==
</TABLE>
F-33
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(6) RELATED PARTY TRANSACTIONS:
Included in the Company's consolidated statements of income for the six month
period ended July 30, 1995 and for the years ended July 28, 1996 and July 26,
1997 are administrative fees of $125, $250 and $250, respectively. The Company
has entered into administrative fee agreements with certain shareholders of
CDI Group, Inc., whereby these shareholders will provide advisory and
consulting services to the Board of Directors. These administrative fee
agreements require the Company to pay $250 of administrative fees annually.
Under a lease dated May 1, 1983, the former majority stockholders of the
Company Leased to the Company the building housing the company's warehouse and
office. Under this lease, which expires on December 31, 1998, the Company pays
$17 per month in rent. Under a lease dated September 30, 1983, the former
majority stockholders of the Company leased to the Company the building
housing the Company's Westfield Drug Fair store. Under this lease, which
expires on September 30, 1998, the Company pays $16 per month in rent.
Under a letter agreement dated as of January 30, 1995 (the "Letter Agreement")
between the Company and a corporation owned by the former majority
stockholders of the Company, the corporation pays to the Company $3 per month
in rent for the use of approximately 6,000 square feet of storage space at the
Company's Somerville, NJ warehouse. This letter agreement was terminated in
July 1996.
(7) REDEEMABLE STOCK:
Redeemable Preferred
On January 30, 1995, 7,500 shares of $1.00 par value Preferred Stock were
issued for $100 per share, for an aggregate consideration of $750. On
October 31, 1995, 7,143 shares of $1.00 par value Preferred Stock were
redeemed by the Company from the stockholders and were sold to certain
members of Management of the Company at the redemption price of $100 per
share. At the same time, the Management of the Company purchased an
additional 362 of the $1.00 par value Preferred Stock shares at the same
price as the initial consideration paid on January 30, 1995. The Company's
Preferred Stock is redeemable at the option of the Company at any time,
unless prohibited by the terms of any credit or other financing agreement
with any lender to the Company, at a price equal to $100 per share, subject
to appropriate adjustment in the event of any stock dividend, stock split,
combination or other similar recapitalization affecting the Preferred Stock
("Liquidation Value"). On January 31, 2005, unless prohibited by the terms
of any credit or other financing agreement with any lender to the Company,
the Company will redeem all of the Preferred Stock outstanding at a price
per share equal to the Liquidation Value. Upon any voluntary or involuntary
liquidation, dissolution or winding up of the Company, the holders of
Preferred Stock shall be entitled to be paid the Liquidation Value of the
Preferred Stock before any payments could be made to holders of Common
Stock.
Redeemable Common
Under certain circumstances defined in the respective stock purchase
agreements, up to 33,726 shares of Class A Common Stock can be put back to
the Company with a redemption price to be determined under the stock
purchase agreement. Such redemption price cannot exceed the original issue
price which was ten dollars per share.
Loans to Officers and Directors
On October 31, 1995, the Company issued 33,726 shares of Class A Common
Stock and 3,643 of Preferred Stock to certain directors and officers of the
Company in consideration for a note signed by each director and officer.
These notes bear interest at 8.0% and are due on various dates through
January 31, 2005. All such shares are pledged as collateral toward these
notes.
The outstanding balance of the notes due from certain directors and
officers at July 26, 1997 and July 28, 1996 of $269 and $356, respectively,
has been reflected as a reduction of the redemption value of the related
redeemable Preferred and Common Stock.
F-34
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(8) STOCKHOLDERS' EQUITY:
Common Stock
On January 30, 1995, 212,078 shares of Class A Common Stock and 187,922
shares of Class B Common Stock were issued for consideration of $4 million
(average of $10.00 per share). Class A Common Stock ("Class A") and Class B
Common Stock ("Class B") stockholders have the same rights and privileges
with the exception that each holder of record of Class A stock is entitled
to one vote per share so held, while Class B stockholders have no voting
rights. Class A and Class B stockholders are entitled to convert any or all
such shares into an equivalent number of Class B and Class A shares,
respectively, except in the event that the holder of Class B is a bank
holding company or subsidiary thereof and such holder is restricted by
applicable banking laws from holding any (or any additional) shares with
voting rights. The conversion feature of the Class A and Class B shares
only affects the voting status of such shareholders, and the exercise of
such feature by all of the holders of the Class B shares would not trigger
a change in control event as defined in the Company's debt agreements.
On October 31, 1995, 30,016 shares of Class A Common Stock were redeemed by
the Company from the stockholders and 14,570 shares of Class A Common Stock
were sold to Management at the repurchase price of $10 per share, which
approximated fair market value at the original issue date of January 30,
1995 and at the repurchase date of October 31, 1995.
Stock Options and Warrants
On January 30, 1995, the Board of Directors approved the 1995 Stock Option
Plan (the "Plan"), which provides for the issuance of up to 65,882 shares
of Class A Voting Common Stock to employees and consultants of the Company
and its affiliates. The Plan is intended to be an incentive stock option
plan within the meaning of Section 422 of the Internal Revenue Service Code
of 1986. The option price under each incentive option shall be not less
than 100% of the fair market value of the Stock on the grant date. On
January 30, 1995, the Company issued options to purchase 37,649 shares of
Class A Common Stock, at a price of $10 per share, to a senior executive
the Company pursuant to the Plan. The options expire on January 31, 2005
and expiration may be accelerated due to termination of employment of the
senior executive as well as various other reasons as stipulated in the
Option Agreement. These options vest as follows:
<TABLE>
<CAPTION>
Number of
Options Vested Date Vested
- ---------------------- -----------------
<S> <C>
10,667 ......... January 30, 1996
10,667 ......... January 30, 1997
10,667 ......... January 30, 1998
2,824 ......... January 30, 1999
2,824 ......... January 30, 2000
</TABLE>
On January 30, 1995, Non-Plan options to acquire 4,706 shares of Class A
Common Stock at $10 per share were issued to a senior executive of the
Company. These options are exercisable immediately after any disposition event
as defined by the Option Agreement.
On January 30, 1995, the Company issued a warrant to purchase 16,667 shares of
Class A Common Stock, at a price of $.001 per share, to its' principal bank.
The holder of the Warrant may exercise the rights represented by the Warrant
in whole or in part at any time through January 30, 2005.
F-35
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(8) STOCKHOLDERS' EQUITY: (Continued)
A summary of stock option transactions follows:
<TABLE>
<CAPTION>
Fiscal 1995 Fiscal 1996 Fiscal 1997
------------- ------------- ------------
<S> <C> <C> <C>
Options outstanding at beginning of period ............... -- 67,473 67,079
Options granted .......................................... 67,473 -- --
Options exercised ........................................ -- -- --
Options canceled ......................................... -- (394) --
Options outstanding at end of period ..................... 67,473 67,079 67,079
Options available for grant at end of period ............. 3,115 3,115 3,115
Options vested and outstanding at end of period .......... -- 15,299 30,989
Option price per share for outstanding options ........... $ 10.00 $ 10.00 $ 10.00
</TABLE>
(9) LITIGATION:
The Company is a defendant in various lawsuits arising in the ordinary course
of business. In the opinion of management, the disposition of these lawsuits
should not have a material impact on the Company's consolidated results of
operations, financial position, and cash flows.
(10) EMPLOYEE BENEFIT PLAN:
On July 1, 1995, the Company implemented a 401(K) salary deferral plan (the
"Plan") which is available to eligible employees, as defined. The Plan
provides for the Company to make discretionary contributions, however, the
Company elected not to make contributions for all periods through July 26,
1997.
(11) SUBSEQUENT EVENT:
On October 16, 1997 the Subsidiary issued $80,000 of 10 1/4% senior notes due
2004 which are guaranteed by the Parent. The net proceeds of such debt
issuance was approximately $77,000. The Subsidiary used $29,000 of such net
proceeds to refinance substantially all of its then existing indebtedness and
$45,000 of net proceeds was used to pay a dividend to the Parent which then
paid a dividend of the same amount to the stockholders of the Parent. Under
the relevant debt agreements, in the event of a change in control, as defined,
the Company is required to repurchase all such outstanding notes.
On October 16, 1997, the Company also replaced its then existing credit
facility with a $20,000 five year revolving credit facility concurrent with
the issuance of the $80,000 of senior notes. This facility bears interest at
either prime rate or LIBOR plus 1.75% and is secured by the Company's eligible
accounts receivable and inventory balances, as defined. The new facility
contains certain financial and operating covenants, including a minimum fixed
charge ratio. Additionally, the Company cannot make any dividend or other
distributions with respect to any share of stock other than in certain limited
circumstances.
The following unaudited proforma data reflects the Long Term Debt and
Securities of the company at July 26, 1997 after giving effect to the issuance
of the notes and use of proceeds.
<TABLE>
<CAPTION>
(Unaudited)
<S> <C>
Long Term Debt, including current maturities ......... $ 97,118
Redeemable Preferred and Common Stock ................ 854
Stockholders' Deficit ................................ (36,817)
</TABLE>
F-36
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
October 25, October 26,
1997 1996
------------- ------------
(Amounts in thousands)
<S> <C> <C>
Net sales ............................................ $54,722 $52,073
Cost of sales ........................................ 39,671 38,072
------- -------
Gross profit ....................................... 15,051 14,001
Selling, general and administrative expenses ......... 12,678 11,752
Administrative fees .................................. 63 63
Depreciation and amortization ........................ 1,467 1,116
Other income, net .................................... 105 95
------- -------
Operating income ................................... 948 1,165
Interest expense, net ................................ 718 826
------- -------
Income before income taxes ......................... 230 339
Provision for income taxes ........................... 349 393
------- -------
Net loss ........................................... $ (119) $ (54)
======= =======
</TABLE>
See accompanying notes to condensed financial statements.
F-37
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
CONDENSED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
As of As of
October 25, 1997 July 26, 1997
------------------ --------------
(Amounts in thousands)
<S> <C> <C>
ASSETS:
Cash and cash equivalents ................................... $ 1,139 $ 1,870
Accounts receivable ......................................... 2,595 2,614
Inventory ................................................... 38,403 30,233
Prepaid expenses and other current assets ................... 1,155 1,085
--------- -------
TOTAL CURRENT ASSETS .................................... 43,292 35,802
Property and equipment, net ................................. 8,810 8,649
Deferred charges and other assets ........................... 5,899 3,286
Goodwill, net ............................................... 33,040 33,519
--------- -------
TOTAL ASSETS .................................................. $ 91,041 $81,256
========= =======
LIABILITIES:
Revolver borrowings ......................................... $ -- $ --
Current portion of long-term debt ........................... -- 4,750
Accounts payable ............................................ 19,314 14,796
Accrued expenses and other current liabilities .............. 3,995 4,118
Current portion of supplier advances ........................ 1,900 1,900
--------- -------
TOTAL CURRENT LIABILITIES ............................... 25,209 25,564
LONG-TERM DEBT ................................................ 80,000 24,519
SUPPLIER ADVANCES, NET OF CURRENT PORTION ..................... 1,032 1,353
OTHER LONG-TERM LIABILITIES ................................... 2,342 2,122
STOCKHOLDER'S EQUITY (DEFICIT):
Common stock, $.01 par value, 1,000 shares authorized, issued
and outstanding ............................................ -- --
Additional paid-in capital .................................. 18,242 18,000
Retained earnings/(accumulated deficit) ..................... (35,784) 9,698
--------- -------
TOTAL STOCKHOLDER'S EQUITY (DEFICIT) .................... (17,542) 27,698
--------- -------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY
(DEFICIT) $ 91,041 $81,256
========= =======
</TABLE>
See accompanying notes to condensed financial statements.
F-38
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
October 25, October 26,
1997 1996
------------- ------------
(Dollars in thousands)
<S> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net income ............................................. $ (119) $ (54)
Depreciation and amortization .......................... 1,500 1,116
Non-cash rent expense .................................. 119 86
LIFO provision ......................................... 300 300
Changes in operating assets and liabilities ............ (4,755) (1,923)
--------- --------
NET CASH USED IN OPERATING ACTIVITIES .................... (2,955) (475)
CASH FLOWS USED IN INVESTING ACTIVITIES
Capital expenditures ................................... (663) (506)
--------- --------
NET CASH USED IN INVESTING ACTIVITIES: (663) (506)
CASH FLOWS PROVIDED BY (USED IN) FINANCING
ACTIVITIES:
Payments made on long-term debt ........................ (29,269) (1,909)
Proceeds from issuance of Senior Notes ................. 80,000 --
Transaction fees paid .................................. (3,086) --
Dividend paid to parent ................................ (45,000) --
Additional capital received from parent ................ 242 --
--------- --------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES ............................................. 2,887 (1,909)
Net decrease in cash and cash equivalents ................ (731) (2,890)
Cash and cash equivalents at beginning of period ......... 1,870 3,623
--------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............... $ 1,139 $ 733
========= ========
</TABLE>
See accompanying notes to condensed financial statements.
F-39
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
(1) BASIS OF PRESENTATION:
The accompanying financial statements should be read in conjunction with the
audited financial statements of Community Distributors, Inc. (the "Company"),
and the notes thereto contained elsewhere herein. The Company, a wholly owned
subsidiary of CDI Group, Inc. (the "Parent"), is engaged in the operation of
retail stores throughout New Jersey. These interim financial statements are
unaudited but, in the opinion of management, include all adjustments,
consisting only of normal recurring items, necessary to fairly present the
financial position and operating results for the interim periods. Results for
interim periods are not necessarily indicative of results for the full year.
The year end balance sheet data was derived from audited financial statements
but does not include all disclosures required by generally accepted accounting
principles.
(2) CONTINGENCIES:
The Company is a defendant in various lawsuits arising in the ordinary course
of business. In the opinion of management, the disposition of these lawsuits
should not have a material impact on the Company's results of operations,
financial position, and cash flows.
(3) DEBT OFFERING:
On October 16, 1997, the Company issued $80.0 million of its 10 1/4% senior
notes due 2004 which are guaranteed by the Parent. The net proceeds of such
debt issuance was approximately $77.0 million. The Company used approximately
$29.0 million of such net proceeds to repay substantially all of its then
existing indebtedness at its carrying value, exclusive of deferred financing
charges of $400,000 associated with the repaid debt, which was written off at
that time. Approximately $45.0 million of the net proceeds was used to pay
a dividend to the Parent which was then distributed in the same amount to
the stockholders of the Parent. Under the relevant debt agreements, in the
event of a change in control, as defined, the Company is required to
repurchase all such outstanding notes.
On October 16, 1997, The Company also replaced its then existing credit
facility with a $20.0 million five year revolving credit facility (the
"Facility") concurrent with the issuance of the $80.0 million of senior notes.
At October 25, 1997, there were no borrowings under the Facility. This
Facility bears interest at either prime rate or LIBOR plus 1.75% and is
collateralized by the Company's eligible accounts receivable and inventory
balances, as defined. The Facility contains certain financial and operating
covenants, including a minimum fixed charge ratio. Additionally, the Company
cannot make any dividend or other distributions with respect to any share of
stock other than in certain limited circumstances.
(4) INVENTORY COSTING METHOD:
Inventory at interim periods is valued on a last-in, first-out (LIFO) basis
which is determined based on estimates of gross profit rate, inflation rates
and inventory levels, and is adjusted for the results of physical inventories
which are taken twice a year. The results of the last physical inventory that
was taken on July 26, 1997 did not have a material impact on the results of
operations.
(5) ESTIMATES:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make significant 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 and expenses during the
reporting period. Actual results could differ from those estimates.
F-40
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
October 25, October 26,
1997 1996
------------- ------------
(Dollars in thousands,
except per share data)
<S> <C> <C>
Net sales ............................................ $ 54,722 $ 52,073
Cost of sales ........................................ 39,671 38,072
-------- --------
Gross profit ....................................... 15,051 14,001
Selling, general and administrative expenses ......... 12,678 11,752
Administrative fees .................................. 63 63
Depreciation and amortization ........................ 1,467 1,116
Other income, net .................................... 105 95
-------- --------
Operating income ................................... 948 1,165
Interest expense, net ................................ 1,241 1,151
-------- --------
Income (loss) before income taxes .................. (293) 14
Provision for income taxes ........................... 166 279
-------- --------
Net loss ........................................... $ (459) $ (265)
======== ========
Per share data:
Net loss per common share .......................... $ (1.09) $ (0.63)
======== ========
Weighted average shares outstanding ................ 420,677 418,280
======== ========
</TABLE>
See accompanying notes to condensed financial statements.
F-41
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
As of As of
October 25, 1997 July 26, 1997
------------------ --------------
(Amounts in thousands)
<S> <C> <C>
ASSETS:
Cash and cash equivalents ...................................... $ 1,139 $ 1,870
Accounts receivable ............................................ 2,609 2,644
Inventory ...................................................... 38,403 30,233
Prepaid expenses and other current assets ...................... 1,155 1,131
--------- -------
TOTAL CURRENT ASSETS ........................................ 43,306 35,878
Property and equipment, net .................................... 8,810 8,649
Deferred charges and other assets .............................. 5,899 3,286
Goodwill, net .................................................. 33,040 33,519
--------- -------
TOTAL ASSETS ..................................................... $ 91,055 $81,332
========= =======
LIABILITIES:
Revolver borrowings ............................................ $ -- $ --
Current portion of long-term debt .............................. -- 4,836
Accounts payable ............................................... 19,314 14,796
Accrued expenses and other current liabilities ................. 3,263 3,620
Current portion of supplier advances ........................... 1,900 1,900
--------- -------
TOTAL CURRENT LIABILITIES ................................... 24,477 25,152
LONG-TERM DEBT ................................................... 80,000 24,519
SUBORDINATED DEBT ................................................ 17,361 16,834
SUPPLIER ADVANCES, NET OF CURRENT PORTION ........................ 1,032 1,353
OTHER LONG-TERM LIABILITIES ...................................... 1,511 1,402
COMMITMENTS AND CONTINGENCIES:
Redeemable preferred stock, $1.00 par value, 7,862 authorized,
issued and outstanding, redemption value $100 per share......... 786 726
Redeemable shares of Class A voting common stock, 57,963 and
33,726 shares issued and outstanding at net redemption value at
October 25, 1997 and July 26, 1997, respectively ............... 492 128
STOCKHOLDERS' EQUITY (DEFICIT):
Class A voting common stock, $.00001 par value, authorized
600,000 shares, 196,632 issued and outstanding at October 25,
1997 and July 26, 1997 ........................................ -- --
Class B non-voting common stock, $.00001 par value, authorized
600,000 shares, 187,922 issued and outstanding at October 25,
1997 and July 26, 1997 ........................................ -- --
Additional paid-in capital ..................................... 3,846 3,846
Retained earnings/(accumulated deficit) ........................ (38,450) 7,372
--------- -------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) ............................. (34,604) 11,218
--------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT) $ 91,055 $81,332
========= =======
</TABLE>
See accompanying notes to condensed financial statements.
F-42
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
October 25, October 26,
1997 1996
------------- ------------
(Dollars in thousands)
<S> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net income ............................................. $ (459) $ (265)
Depreciation and amortization .......................... 1,500 1,116
Non-cash rent expense .................................. 119 86
LIFO provision ......................................... 300 300
Non-cash interest expense .............................. 527 332
Changes in operating assets and liabilities ............ (5,037) (2,044)
--------- --------
NET CASH USED IN OPERATING ACTIVITIES .................... (3,050) (475)
CASH FLOWS USED IN INVESTING ACTIVITIES:
Capital expenditures ................................... (663) (506)
--------- --------
NET CASH USED IN INVESTING ACTIVITIES .................... (663) (506)
CASH FLOWS PROVIDED BY (USED IN) FINANCING
ACTIVITIES:
Payments made on long-term debt ........................ (29,269) (1,909)
Proceeds from issuance of Senior Notes ................. 80,000 --
Transaction fees paid .................................. (3,086) --
Dividend paid to stockholders .......................... (45,000) --
Proceeds from exercise of stock options ................ 242 --
Proceeds from loans to officers and directors .......... 182 --
Payments of subordinated debt .......................... (87) --
--------- --------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES ............................................. 2,982 (1,909)
Net decrease in cash and cash equivalents ................ (731) (2,890)
Cash and cash equivalents at beginning of period ......... 1,870 3,623
--------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............... $ 1,139 $ 733
========= ========
</TABLE>
See accompanying notes to condensed financial statements.
F-43
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) BASIS OF PRESENTATION:
The accompanying consolidated financial statements should be read in
conjunction with the audited consolidated financial statements of CDI Group,
Inc. and Subsidiary, (the "Company") and the notes thereto contained elsewhere
herein. The Company consists of an operating entity, Community Distributors,
Inc. (the "Subsidiary") which is engaged in the operation of retail stores
throughout New Jersey, and a holding company, CDI Group, Inc. (the "Parent")
which principally owns all of the outstanding shares of the Subsidiary. These
interim consolidated financial statements are unaudited but, in the opinion of
the management, include all adjustments, consisting only of normal recurring
items, necessary to fairly present the financial position and operating
results for the interim periods. Results for interim periods are not
necessarily indicative of results for the full year. The year end balance
sheet data was derived from audited financial statements but does not include
all disclosures required by generally accepted accounting principles.
(2) CONTINGENCIES:
The Company is a defendant in various lawsuits arising in the ordinary course
of business. In the opinion of management, the disposition of these lawsuits
should not have a material impact on the Company's consolidated results of
operations, financial position, and cash flows.
(3) DEBT OFFERING:
On October 16, 1997, the Subsidiary issued $80.0 million of its 10 1/4% senior
notes due 2004 which are guaranteed by the Parent. The net proceeds of such
debt issuance was approximately $77,000. The Subsidiary used approximately
$29.0 million of such net proceeds to repay substantially all of its then
existing indebtedness at its carrying value, exclusive of deferred financing
charges of $400,000 associated with the repaid debt, which was written off
at that time. Approximately $45.0 million of net proceeds was used to pay
a dividend to the Parent which was then distributed in the same amount to
the stockholders of the Parent. Under the relevant debt agreements, in the
event of a change in control, as defined, the Parent is required to repurchase
all such outstanding notes.
On October 16, 1997, the Subsidiary also replaced its then existing credit
facility with a $20.0 million five year revolving credit facility (the
"Facility") concurrent with the issuance of the $80.0 million of senior notes.
At October 25, 1997, there were no borrowings under the Facility. This
Facility bears interest at either prime rate or LIBOR plus 1.75% and is
collateralized by the Subsidiary's eligible accounts receivable and inventory
balances, as defined. The Facility contains certain financial and operating
covenants, including a minimum fixed charge ratio. Additionally, the
Subsidiary cannot make any dividend or other distributions with respect to any
share of stock other than in certain limited circumstances.
In addition to the $80.0 million of senior notes issued by the Subsidiary, at
October 25, 1997, the Parent had outstanding long term debt consisting of
approximately $17,268,000 of senior subordinated notes due January 31, 2005,
including current maturities and accrued interest.
(4) INVENTORY COSTING METHOD:
Inventory at interim periods is valued on a last-in, first-out (LIFO) basis
which is determined based on estimates of gross profit rate, inflation rates
and inventory levels, and is adjusted for the results of physical inventories
which are taken twice a year. The results of the last physical inventory that
was taken on July 26, 1997 did not have a material impact on the results of
operations.
(5) ESTIMATES:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make significant 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 and expenses during the
reporting period. Actual results could differ from those estimates.
F-44
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Our report on the financial statements of Community Distributors, Inc. is
included on page F-9 of this Form S-4. In connection with our audits of such
financial statements, we have also audited the related financial statement
schedule listed in the index on page F-2 of this Form S-4.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
Parsippany, New Jersey COOPERS & LYBRAND L.L.P.
October 9, 1997
F-45
<PAGE>
Schedule II
Community Distributors, Inc.
Summary of Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Inventory Beginning End
Reserves of Year Additions Reductions of Year
- -------------------------------------------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Fiscal 1997 ................................ $108,779 $ 4,441 $ 0 $113,220
Fiscal 1996 ................................ $ 61,233 $47,547 $ 0 $108,779
Six Months Ended July 30, 1995 (1) ......... $100,757 $ 0 $ (39,525) $ 61,233
</TABLE>
Note (1) Includes results as of the origination of the Company beginning
January 30, 1995.
Note The Company has the demonstrated ability, based upon its contractual and
other relationships with its vendors, to recover virtually all of the
costs of excess, obsolete and damaged inventory upon return of such
inventory to its vendors.
F-46
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Our report on the consolidated financial statements of CDI Group, Inc. and
Subsidiary is included on page F-22 of this Form S-4. In connection with our
audits of such financial statements, we have also audited the related financial
statement schedule listed in the index on page F-2 of this Form S-4.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
Parsippany, New Jersey COOPERS & LYBRAND L.L.P.
October 9, 1997
F-47
<PAGE>
Schedule II
CDI Group, Inc.
Summary of Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Inventory Beginning End
Reserves of Year Additions Reductions of Year
- -------------------------------------------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Fiscal 1997 ................................ $108,779 $ 4,441 $ 0 $113,220
Fiscal 1996 ................................ $ 61,233 $47,547 $ 0 $108,779
Six Months Ended July 30, 1995 (1) ......... $100,757 $ 0 $ (39,525) $ 61,233
</TABLE>
Note (1) Includes results as of the origination of the Company beginning
January 30, 1995.
Note The Company has the demonstrated ability, based upon its contractual and
other relationships with its vendors, to recover virtually all of the
costs of excess, obsolete and damaged inventory upon return of such
inventory to its vendors.
F-48
<PAGE>
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No dealer, salesperson or other person is authorized in connection with any
offering made hereby to give any information or to make any representation not
contained in this Prospectus, and, if given or made, such information or
representations must not be relied upon as having been authorized by the
Company or by the Initial Purchasers. This Prospectus does not constitute an
offer to sell or a solicitation of an offer to buy any security other than the
securities offered hereby, nor does it constitute an offer to sell or a
solicitation of an offer to buy any of the securities offered hereby to any
person in any jurisdiction in which it is unlawful to make such an offer or
solicitation to such person. Neither the delivery of this Prospectus nor any
sale made hereunder shall under any circumstance create any implication that
the information contained herein is correct as of any date subsequent to the
date hereof.
Until May 26, 1998 all dealers effecting transactions in the registered
securities, whether or not participating in this distribution, may be required
to deliver a prospectus. This is in addition to the obligation of dealers to
deliver a prospectus when acting as underwriters and with respect to their
unsold allotments or subscriptions.
------------------------
TABLE OF CONTENTS
<TABLE>
<S> <C>
Page
Prospectus Summary ..................................... 1
Risk Factors ........................................... 16
Use of Proceeds ........................................ 24
Capitalization ......................................... 25
Selected Financial Data of the Company ................. 26
Unaudited Pro Forma Condensed Financial Data 29
Management's Discussion and Analysis of
Financial Condition and Results of Operations 30
Business ............................................... 39
Management ............................................. 51
Certain Relationships and Related Transactions ......... 54
Beneficial Ownership ................................... 56
Description of New Credit Facility and Certain
Other Indebtedness .................................. 59
Exchange Offer ......................................... 60
Plan of Distribution ................................... 67
Description of Notes ................................... 68
Certain Federal Income Tax Considerations .............. 88
Independent Public Accountants ......................... 89
Legal Matters .......................................... 89
Available Information .................................. 89
Special Note Regarding Forward-Looking
Statements .......................................... 90
Index to Financial Statements .......................... F-1
</TABLE>
Community Distributors, Inc.
CDI Group, Inc.
Offer to Exchange up to
$80,000,000 of 10 1/4%
Senior Notes Due 2004
Which Have Been Registered
Under the Securities Act of 1933,
as Amended, For Any and All of its
Outstanding 10 1/4% Senior Notes
Due 2004, of which $80,000,000 in
Principal Amount is Outstanding on the
Date Hereof
--------------------------------------------------------
PROSPECTUS
--------------------------------------------------------
February 13, 1998
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