<PAGE>
Filed Pursuant to Rule 424(b)(1)
Registration File No.: 333-43313
PROSPECTUS
FEBRUARY 9, 1998
$80,000,000
[DUANE READE INC LOGO]
9 1/4% SENIOR SUBORDINATED NOTES DUE 2008
The 9 1/4% Senior Subordinated Notes due 2008 (the "New Senior
Subordinated Notes") offered hereby (the "Offering") by Duane Reade Inc., a
Delaware corporation (the "Company") were originally issued by the Company as
part of the Refinancing Plan (as defined herein) of the Company. See
"Prospectus Summary--Refinancing Plan" and "Use of Proceeds."
The New Senior Subordinated Notes will mature on February 15, 2008.
Interest on the New Senior Subordinated Notes will be payable semi-annually
in arrears on February 15 and August 15 of each year, commencing on August
15, 1998. The New Senior Subordinated Notes will be redeemable at the option
of the Company, in whole or in part, at any time on or after February 15,
2003, in cash at the redemption prices set forth herein, plus accrued and
unpaid interest, if any, thereon to the redemption date. In addition, at any
time prior to February 15, 2001, the Company may, at its option, redeem up to
35% of the aggregate principal amount of the New Senior Subordinated Notes
originally issued at a redemption price equal to 109.25% of the aggregate
principal amount thereof, plus accrued and unpaid interest, if any, thereon
to the redemption date, with the net proceeds of offerings of equity
securities of the Company; provided that at least 65% of the original
aggregate principal amount of the New Senior Subordinated Notes will remain
outstanding immediately following such redemption. Upon the occurrence of a
Change of Control (as defined herein), each holder of New Senior Subordinated
Notes will have the right to require the Company to repurchase such holder's
New Senior Subordinated Notes at a price in cash equal to 101% of the
aggregate principal amount thereof, plus accrued and unpaid interest, if any,
thereon to the date of repurchase. See "Description of New Senior
Subordinated Notes--Repurchase at the Option of the Holders--Change of
Control."
The New Senior Subordinated Notes will be general unsecured obligations of
the Company and will be subordinated in right of payment to all existing and
future Senior Debt (as defined herein) of the Company, including indebtedness
pursuant to the New Credit Agreement (as defined herein). The New Senior
Subordinated Notes will rank pari passu with any future senior subordinated
indebtedness of the Company and will rank senior to all subordinated
indebtedness of the Company. The New Senior Subordinated Notes will be
guaranteed (the "Subsidiary Guarantees"), jointly and severally, on a senior
subordinated basis by all of the Company's subsidiaries (the "Subsidiary
Guarantors"). The Subsidiary Guarantees will be subordinated in right of
payment to all existing and future Senior Debt (including the guarantees
under the New Credit Agreement) of the Subsidiary Guarantors. On a pro forma
basis after giving effect to the Refinancing Plan, including consummation of
the Offering and the Common Stock Offering (as defined herein) and the
application of the proceeds thereof, as of September 27, 1997, the Company
would have had outstanding approximately $130.0 million of Senior Debt and
the Company and its subsidiaries would have had approximately $262.6 million
of aggregate outstanding liabilities, including trade payables and the New
Senior Subordinated Notes.
Consummation of the Offering occurred concurrently with consummation of
the Refinancing Plan. As part of the Refinancing Plan, the Company offered
(the "Common Stock Offering") 6,700,000 shares of its common stock, par value
$.01 per share (the "Common Stock"), for estimated net proceeds to the
Company of $101.8 million. See "Prospectus Summary--Refinancing Plan" and
"Use of Proceeds."
SEE "RISK FACTORS," BEGINNING ON PAGE 11, FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED IN EVALUATING AN INVESTMENT IN THE NEW
SENIOR SUBORDINATED NOTES.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR 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.
This Prospectus has been prepared for use by Donaldson, Lufkin & Jenrette
Securities Corporation ("DLJ") in connection with offers and sales of the New
Senior Subordinated Notes that may be made by it from time to time in
market-making transactions at negotiated prices relating to prevailing market
prices at the time of sale. There is currently no public market for the New
Senior Subordinated Notes. The Company has been advised by DLJ that it
intends to make a market for the New Senior Subordinated Notes, however, DLJ
is not obligated to do so. Any market-making may be discontinued at any time,
and there is no assurance that an active public market for the New Senior
Subordinated Notes will develop or, that if such market develops, that it
will continue. DLJ may act as principal agent in any such transaction. See
"Plan of Distribution."
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
<PAGE>
[PICTURES]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE NEW SENIOR
SUBORDINATED NOTES, INCLUDING STABILIZING TRANSACTIONS, SYNDICATE COVERING
TRANSACTIONS, AND THE IMPOSITION OF PENALTY BIDS. SPECIFICALLY, THE
UNDERWRITER MAY OVERALLOT IN CONNECTION WITH THE OFFERING AND MAY BID FOR AND
PURCHASE THE NEW SENIOR SUBORDINATED NOTES IN THE OPEN MARKET. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
2
<PAGE>
[DUANE READE INC. LOGO]
[PHOTO]
With 58 drugstores in Manhattan, four in Brooklyn, two in the Bronx, two
in Queens, and one in Newark, Duane Reade enjoys the largest share of drugstore
sale in the New York metropolitan market.
FLAGS APPROXIMATE STORE LOCATIONS.
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements and notes thereto included elsewhere in
this Prospectus. The share data set forth in this Prospectus reflects a
reclassification of the Company's capital stock, pursuant to which each
holder of shares of class B common stock, $.01 par value per share ("Class B
Common Stock"), is entitled to receive one share of Common Stock for
approximately 8.326 shares of Class B Common Stock (the "Reclassification").
Unless otherwise stated in this Prospectus, references to the "Company" or
"Duane Reade" shall mean Duane Reade Inc. (formerly known as Duane Reade
Holding Corp.), its consolidated subsidiaries and their respective
predecessors. The fiscal year of the Company ends on the last Saturday in
December. Fiscal years 1992 through 1996 each consisted of 52 weeks. All data
regarding the number of the Company's stores is as of November 25, 1997,
unless otherwise specified.
THE COMPANY
Duane Reade is the largest drugstore chain in New York City, based on
sales volume, with 58 of its 67 stores located in Manhattan's high-traffic
business and residential districts. The Company operates almost twice as many
stores in Manhattan as its next largest competitor. Since opening its first
store in 1960, the Company has successfully executed a marketing and
operating strategy tailored to the unique characteristics of New York City,
the largest and most densely populated market in the United States. According
to Drug Store News, Duane Reade is the leading drugstore chain in the United
States in terms of sales per square foot, at $956 per square foot in 1996,
which was more than two times the national average for drugstore chains. For
the fiscal year ended December 28, 1996, the Company had sales of $381.5
million and EBITDA (as defined herein) of $35.3 million, increases of 13.2%
and 28.6%, respectively, over the 1995 fiscal year. For the 39 weeks ended
September 27, 1997, the Company had sales of $313.8 million and EBITDA of
$29.7 million, increases of 11.6% and 24.9%, respectively, over the
comparable 1996 period. For the fiscal year ended December 28, 1996 and the
39 week period ended September 27, 1997, the Company had net losses of $17.9
million and $14.2 million, respectively, and, on a pro forma basis, after
giving effect to the Offering and the Refinancing Plan, the Company would
have had net losses of $5.3 million and $3.8 million, respectively, for such
periods.
The Company enjoys strong brand name recognition in New York City, which
it believes results from the Company's many locations in high-traffic areas
of Manhattan and the 30 million shopping bags with the distinctive Duane
Reade logo that the Company distributes annually. Independent surveys
conducted in 1996 indicated that approximately 84% of the people who live or
work in Manhattan recognize the Duane Reade name, and seven out of ten
shopped at a Duane Reade store in the past twelve months. The Company was
also recently named "Regional Drug Store Chain of the Year" for 1997 by Drug
Store News.
The Company has developed an operating strategy designed to capitalize on
the unique characteristics of the New York City market, which include
high-traffic volume, complex distribution logistics and high costs of
occupancy, media advertising and personnel. The key elements of the Company's
operating strategy are its (i) everyday low price format and broad product
offering, (ii) low cost operating structure supported by its high volume
stores and low advertising and distribution costs and (iii) ability to design
and operate its stores in a wide variety of sizes and layouts.
The Company believes that its everyday low price format and broad product
offerings provide value and convenience for its customers and build customer
loyalty. The Company's everyday low price format results in prices that the
Company believes are, on average, lower than the prices offered by its
competitors.
The Company is able to keep its operating costs relatively low due to its
high per store sales volume, low warehouse and distribution costs and low
advertising expenditures. The Company's high volume stores allow it to
effectively leverage occupancy costs, payroll and other store operating
expenses. The Company's two primary distribution facilities are located
within five miles of all but one of its 67 stores and, combined with the
rapid turnover of inventory in Duane Reade's stores, result in relatively low
3
<PAGE>
warehouse and distribution costs. The Company's strong brand name recognition
in New York City and everyday low price format allow the Company to minimize
its use of costly media and print advertising and to rely instead on
in-window displays and other less expensive promotional activities.
The Company has demonstrated its ability to successfully operate stores
using a wide variety of store configurations and sizes, which the Company
believes is necessary to succeed in the New York City market. For example,
the size of the Company's stores ranges from 2,600 to 12,300 square feet, and
it operates 29 bi-level stores. The Company believes that its flexibility in
configuring stores provides it with a competitive advantage in securing
locations for its new stores, as many of its competitors target more
standarized spaces for their stores, which are more difficult to find in New
York City. In addition, the Company's management team has extensive
experience and knowledge of the New York City real estate market, allowing it
to aggressively pursue attractive real estate opportunities.
The Company was founded in 1960. In 1992, Bain Capital acquired the
Company from its founders and, in June 1997, investment funds affiliated with
DLJ Merchant Banking Partners II, L.P. ("DLJMBPII") acquired approximately
91.5% of the outstanding capital stock of the Company from Bain Capital and
certain other selling securityholders (the "Recapitalization"). Since the
1992 acquisition, the Company has incurred net losses in each fiscal year.
In 1994 and 1995, the Company experienced rapid expansion, growing from 40
stores to 59 stores. However, as a result of liquidity constraints and the
need for improved inventory controls, the Company was forced to suspend its
store expansion program in late 1995. In early 1996, a strengthened
management team led by Anthony Cuti, the Company's new Chairman and Chief
Executive Officer, took several measures to improve operations, including
improving inventory controls and decreasing out-of-stock occurrences,
creating a loss prevention function to control inventory shrink and
continuing to invest in management information systems ("MIS"). In 1997, the
Company resumed its store expansion program, opening seven stores. During Mr.
Cuti's tenure at the Company, EBITDA has increased by 53.2% from $26.9
million for the 52 weeks ended March 29, 1996 to $41.2 million for the 52
weeks ended September 27, 1997.
The Company was incorporated in Delaware in 1992. The Company's principal
executive offices are located at 440 Ninth Avenue, New York, New York 10001,
and its phone number is (212) 273-5700.
GROWTH STRATEGY
The Company believes that, as a result of its successful operating history
and market position in New York City, it is well positioned to capitalize on
the growth opportunities in its market. The Company's strategy for continued
growth is to (i) open additional stores in Manhattan and the surrounding
boroughs, (ii) continue to capitalize on favorable pharmacy trends, (iii)
make opportunistic acquisitions of independent drugstores and pharmacy files
and (iv) continue to implement merchandising initiatives in non-pharmacy
areas.
OPEN ADDITIONAL STORES. The Company believes that the New York City
drugstore market remains underpenetrated by drugstore chains, with only 50%
of the estimated $2.65 billion in annual drugstore-related sales controlled
by chains, compared to approximately 74% controlled by chains nationally.
This provides significant opportunities for the Company to open additional
stores in Manhattan as well as in the densely populated areas of the
surrounding boroughs. Some of the Company's most successful stores have been
opened in areas new to the Company, such as the residential areas of the
Upper East and West sides of Manhattan, Brooklyn, the Bronx and Queens. The
Company believes that its long-standing presence in, and knowledge of, the
New York City real estate market, combined with the use of a proprietary site
selection model that considers numerous demographic and traffic flow
variables, have allowed it to identify attractive store locations. Since
1993, all of the Company's new stores have become profitable on an operating
basis (i.e., prior to allocation of corporate expenses, goodwill
amortization, interest expense and income taxes) within the first full year
of operation. Over the next two years, the Company plans to open
approximately 30 to 40 stores, primarily in New York City.
CONTINUE TO CAPITALIZE ON FAVORABLE PHARMACY TRENDS. Sales of prescription
and over-the-counter ("OTC") drugs have been growing rapidly throughout the
drugstore industry. The Company expects
4
<PAGE>
demographic trends, such as the aging of the U.S. population, and industry
changes, such as growth of managed care organizations, insurance companies,
employers and other third-party payors (collectively, "Third Party Plans"),
to continue to drive increases in the prescription and OTC drug businesses.
Since 1994, the Company has focused on increasing its pharmacy sales by
entering into agreements to service Third Party Plans and by upgrading the
appearance and service level of its store pharmacies. While sales to
customers covered by Third Party Plans generally result in lower gross profit
margins due to competitive pricing, the Company believes that such lower
margins are offset by the increased volume of pharmacy sales and the
opportunity to leverage fixed expenses. The Company believes that its
initiatives, which are designed to capitalize on industry trends, have
resulted in the Company's pharmacy sales growing at an annual rate of
approximately 30% since 1994. Although these initiatives have helped increase
the average number of prescriptions filled by Duane Reade per store per week
from 640 in 1994 to 865 during 1997, the Company's average remains well below
the national industry chain store average of approximately 1,200, providing
significant opportunity for continued pharmacy growth. The Company believes
that continued pharmacy growth will increase overall customer traffic,
thereby also benefitting its non-pharmacy sales.
MAKE OPPORTUNISTIC ACQUISITIONS OF INDEPENDENT DRUGSTORES AND PHARMACY
FILES. The Company believes that the growth of Third Party Plans and the
continued penetration of chain drugstores such as Duane Reade have put
increasing pressure on the approximately 1,400 independent drugstores in New
York City. When appropriate, the Company considers acquiring small local
chains or independent drugstores. The Company also pursues the purchase of
pharmacy files of independent drugstores when such purchases are economically
attractive to the Company. The pharmacy files of independent pharmacists tend
to have a higher proportion of prescriptions not covered by Third Party
Plans, which generate incremental revenue and higher margins. When
appropriate, the Company retains the services of the pharmacist, whose
personal relationship with the customers generally maximizes the retention
rate of the purchased file. In 1997, the Company acquired one independent
drugstore and seven such pharmacy files and intends to aggressively pursue
additional purchases.
CONTINUE TO IMPLEMENT MERCHANDISING INITIATIVES IN NON-PHARMACY
AREAS. Management has recently undertaken a number of merchandising
initiatives, including the expansion of certain high-margin categories such
as greeting cards, cosmetics, vitamins, photofinishing and photo supplies and
an expanded seasonal merchandising program. The Company also continues to
focus on category management, which it believes will improve gross margins
and increase non-pharmacy sales. For example, in 1997 the Company introduced
one-hour photofinishing service in three of its stores and intends to
introduce one-hour photofinishing service in approximately seven to ten
additional stores in 1998. The Company has also increased its emphasis on the
sale of its own private label products, which it believes provide a
high-quality, lower priced alternative to name brand products while
generating higher gross profit margins than name brand products. In addition,
in the fourth quarter of 1997, Duane Reade completed installation of Point of
Sale ("POS") scanners in all of its stores and, by the end of the first
quarter of 1998, will have completed its "planogramming" (space management
system) initiative in all of its stores. These systems and initiatives will
allow the Company to better analyze sales trends and merchandise its stores
more effectively, which the Company believes will ultimately increase its
sales and profitability.
The success of the Company's growth strategy is dependent on a number of
factors, many of which are beyond the Company's control. The Company's
ability to continue to successfully execute its new store opening program is
subject to a number of factors, including the availability and cost of
attractive new store locations, continued favorable retail and pharmacy
trends, competition, the general economic environment and the ability of
management to successfully oversee the Company's expanded operations. Due to
the above factors, there can be no assurance that the Company will be
successful in implementing the above growth strategy.
RECENT DEVELOPMENTS
The Company's 1997 fiscal year ended on December 27, 1997. While the final
results for the year ended December 27, 1997 are not yet available, the
Company currently estimates that net sales for the full 1997 fiscal year were
approximately $429.8 million, including approximately $107.8 million from
pharmacy sales.
5
<PAGE>
The information above is preliminary in nature only, and is subject in all
respects to completion of various internal analyses and procedures necessary
to finalize the Company's financial statements and to completion of the audit
of the Company's financial statements for the fiscal year ended December 27,
1997.
REFINANCING PLAN
The Offering is part of a plan to refinance all of the Company's existing
indebtedness (the "Refinancing Plan") in order to enhance the Company's
financial flexibility to pursue growth opportunities and implement capital
improvements. The successful consummation of the Refinancing Plan will reduce
the Company's overall indebtedness, simplify the Company's capital structure
and provide access to additional borrowings. The principal components of the
Refinancing Plan are: (i) the sale by the Company of 6,700,000 shares of
Common Stock in the Common Stock Offering for estimated net proceeds of
$101.8 million; (ii) the execution of a new secured credit agreement (the
"New Credit Agreement"), which will provide for borrowings of up to
approximately $160.0 million; (iii) the issuance of the New Senior
Subordinated Notes for estimated net proceeds of $77.1 million; (iv) the
repayment of all outstanding borrowings under the Company's existing credit
agreement (the "Existing Credit Agreement"), the outstanding principal amount
of which was $89.8 million as of December 27, 1997; (v) the redemption of the
Company's outstanding 15% Senior Subordinated Zero Coupon Notes due 2004 (the
"Zero Coupon Notes") for $99.8 million (including a redemption premium of
$7.0 million); (vi) the redemption of the Company's outstanding 12% Senior
Notes due 2002 (the "Senior Notes") for $93.9 million (including a redemption
premium of $4.0 million); and (vii) the merger of Daboco, Inc., a direct
wholly-owned subsidiary of the Company, with and into the Company (the
"Merger"). The Company believes that the Refinancing Plan will result in a
reduction in overall interest expense because total interest expense
associated with the New Credit Agreement and the Offering will be less than
the total interest expense currently associated with the Senior Notes and the
Zero Coupon Notes. See "Selected Consolidated Historical Financial and
Operating Data." The Company expects that interest rates under the New Credit
Agreement will be approximately the same as interest rates under the Existing
Credit Agreement. See "Description of Certain Indebtedness--New Credit
Agreement." The Company expects that total fees and expenses associated with
the Refinancing Plan will be approximately $14.4 million. See "Use of
Proceeds." The consummation of the Offering will be conditional upon the
other components of the Refinancing Plan.
THE OFFERING
Securities Offered ............ $80.0 million aggregate principal amount of
9 1/4% Senior Subordinated Notes due 2008.
Maturity Date ................. February 15, 2008.
Interest Payment Dates ........ February 15 and August 15, commencing August
15, 1998.
Mandatory Redemption .......... The Company will not be required to make
mandatory redemption of, or sinking fund
payments with respect to, the New Senior
Subordinated Notes except as described below
under "--Change of Control" and in the case
of certain Asset Sales. See "Description of
New Senior Subordinated Notes--Repurchase at
the Option of Holders--Assets Sales."
Optional Redemption ........... The New Senior Subordinated Notes will be
redeemable, in whole or in part, at any time
on or after February 15, 2003, in cash at
the redemption prices set forth herein, plus
accrued and unpaid interest, if any, thereon
to the redemption date. In
6
<PAGE>
addition, at any time on or prior to
February 15, 2001, the Company may, at its
option, redeem up to 35% of the aggregate
principal amount of the New Senior
Subordinated Notes originally issued at a
redemption price equal to 109.25% of the
aggregate principal amount thereof, plus
accrued and unpaid interest, if any, thereon
to the redemption date, with the net
proceeds from offerings of Equity Interests
(other than Disqualified Stock) of the
Company; provided that at least 65% of the
original aggregate principal amount of the
New Senior Subordinated Notes will remain
outstanding immediately following each
redemption. See "Description of New Senior
Subordinated Notes--Optional Redemption."
Change of Control ............. Upon the occurrence of a Change of Control,
each holder of New Senior Subordinated Notes
will have the right to require the Company
to offer to repurchase such holder's New
Senior Subordinated Notes in cash at a price
equal to 101% of the aggregate principal
amount thereof, plus accrued and unpaid
interest, if any, thereon to the date of
repurchase. The New Credit Agreement will
prohibit the Company from purchasing the New
Senior Subordinated Notes and will also
provide that certain change of control
events with respect to the Company will
constitute a default thereunder. Any future
credit agreements or other agreements
relating to Senior Debt to which the Company
becomes a party may contain similar
restrictions and provisions. In the event a
Change of Control occurs at a time when the
Company is prohibited from purchasing the
New Senior Subordinated Notes, the Company
could seek the consent of its lenders to the
purchase of the New Senior Subordinated
Notes or could attempt to refinance the
borrowings that contain such prohibition. If
the Company does not obtain such consent or
repay such borrowings, the Company will
remain prohibited from purchasing the New
Senior Subordinated Notes by the relevant
Senior Debt. In such case, the Company's
failure to purchase the tendered New Senior
Subordinated Notes would constitute an Event
of Default under the indenture pursuant to
which the New Senior Subordinated Notes will
be issued (the "New Senior Subordinated Note
Indenture"), which would, in turn,
constitute a default under the New Credit
Agreement and could constitute a default
under other Senior Debt. In such
circumstances, the subordination provisions
in the New Senior Subordinated Note
Indenture would likely restrict the payments
to the holders of the New Senior
Subordinated Notes. Furthermore, no
assurance can be given that the Company will
have sufficient resources to satisfy its
repurchase obligation with respect to the
New Senior Subordinated Notes following a
Change of Control. In addition, the
definition of Change of Control only
provides protection to the holders of New
Senior Subordinated Notes in the event of
certain changes in the equity ownership
and/or the composition of the board of
directors of the Company and, as a result,
the Company may, under certain
circumstances, incur substantial additional
indebt-
7
<PAGE>
edness or undergo restructuring or other
corporate changes without triggering a
Change of Control. See "Risk
Factors--Possible Inability to Repurchase
New Senior Subordinated Notes upon a Change
of Control" and "Description of New Senior
Subordinated Notes--Redemption at the Option
of Holders--Change of Control."
Ranking ....................... The New Senior Subordinated Notes will be
general unsecured obligations of the Company
and will be subordinated in right of payment
to all existing and future Senior Debt of
the Company, including indebtedness pursuant
to the New Credit Agreement. The New Senior
Subordinated Notes will rank pari passu with
any future senior subordinated indebtedness
of the Company and will rank senior to all
subordinated indebtedness of the Company.
The New Senior Subordinated Notes will be
guaranteed, jointly and severally, on a
senior subordinated basis by the Subsidiary
Guarantors. The Subsidiary Guarantees will
be subordinated in right of payment to all
existing and future Senior Debt (including
the guarantees under the New Credit
Agreement) of the Subsidiary Guarantors. On
a pro forma basis after giving effect to the
Refinancing Plan and the application of the
proceeds therefrom, as of September 27,
1997, the Company would have had outstanding
approximately $130.0 million of Senior Debt,
and the Company's and its subsidiaries would
have had approximately $262.6 million of
outstanding liabilities, including trade
payables and the New Senior Subordinated
Notes.
Subsidiary Guarantees ......... The New Senior Subordinated Notes will be
guaranteed, jointly and severally, on a
senior subordinated basis by each of the
Subsidiary Guarantors. The Subsidiary
Guarantees will be subordinated in right of
payment to all existing and future Senior
Debt of the Subsidiary Guarantors, including
the New Credit Agreement.
Certain Covenants ............. The New Senior Subordinated Note Indenture
will contain certain covenants that, among
other things, limit the ability of the
Company to: incur indebtedness and issue
preferred stock, repurchase Capital Stock
(as defined) and subordinated indebtedness,
engage in transactions with affiliates,
engage in sale and leaseback transactions,
incur or suffer to exist certain liens, pay
dividends or other distributions, make
investments, sell assets and engage in
certain mergers and consolidations.
Use of Proceeds ............... The net proceeds from the Offering, together
with borrowings under the New Credit
Agreement and the net proceeds from the
Common Stock Offering, will be used to
complete the Refinancing Plan. See
"Prospectus Summary--Refinancing Plan" and
"Use of Proceeds."
8
<PAGE>
SUMMARY HISTORICAL
FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT PERCENTAGES AND STORE DATA)
The following table sets forth summary consolidated historical financial
data for the fiscal years ended December 31, 1994, December 30, 1995 and
December 28, 1996 and for the 39 week periods ended September 28, 1996 and
September 27, 1997. This data should be read in conjunction with the
consolidated historical financial statements of the Company, together with
the notes thereto, included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
FISCAL YEAR 39 WEEKS ENDED
------------------------------------------------------------------
SEPTEMBER 28, SEPTEMBER 27,
1994 1995 1996 1996 1997
---------- ---------- ---------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales ................................. $281,103 $336,922 $381,466 $281,093 $313,796
Gross profit .............................. 71,425 77,095 92,961 65,296 77,383
Nonrecurring charges (1) .................. -- -- -- -- 10,887
Operating income .......................... 11,042 12,166 14,542 11,849 11,268
Net interest expense ...................... 27,480 30,224 32,396 24,334 25,433
Net loss .................................. (16,438) (18,058) (17,854) (12,485) (14,165)
OPERATING AND OTHER DATA:
EBITDA (2)................................. $ 31,188 $ 27,443 $ 35,300 $ 23,814 $ 29,747
EBITDA as a percentage of net sales ...... 11.1% 8.2% 9.3% 8.5% 9.5%
Capital expenditures....................... $ 9,947 $ 6,868 $ 1,247 $ 913 $ 4,931
Number of stores at end of period ........ 51 59 60 60 65
Same store sales growth (3) ............... 1.6% (3.5)% 8.3% 7.8% 7.9%
Pharmacy same store sales growth (3) ..... 14.2% 7.0% 25.5% 25.1% 25.4%
Average store size (square feet) at end of
period ................................... 6,596 6,712 6,733 6,733 6,832
Sales per square foot (4).................. $ 970 $ 898 $ 956 $ 708 $ 751
Pharmacy sales as a % of net sales ....... 17.6% 19.0% 21.8% 21.5% 24.8%
Third-Party Plan sales as a % of pharmacy
sales .................................... 45.7% 58.2% 64.4% 63.3% 72.9%
PRO FORMA DATA:
Cash interest expense (net)(5)............. $ 18,825 $ 12,263 $ 12,483
Ratio of EBITDA to cash interest expense .. 1.9x 1.9x 2.4x
Ratio of net debt to EBITDA (6)(7) ....... 4.5x
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF
DECEMBER 28, 1996 SEPTEMBER 27, 1997
----------------- -----------------------------
(ACTUAL) (AS ADJUSTED)(8)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital .......................... $ 9,917 $ 29,849 $ 56,187
Total assets ............................. 222,476 239,520 266,910
Total debt and capital lease obligations 245,657 262,649 212,187
Stockholders' equity (deficiency) ........ (59,396) (73,561) 4,316
</TABLE>
(footnotes on next page)
9
<PAGE>
(footnotes to Summary Historical Financial and Operating Data appearing on
the preceding page)
- ------------
(1) During the first quarter of fiscal 1997, the Company considered a
public offering of its common stock and took certain steps in
connection with these plans. Such plans were abandoned upon
consummation of the Recapitalization discussed in Note 10 of the Notes
to Consolidated Financial Statements (Unaudited) for the 39 weeks ended
September 27, 1997. Costs and expenses incurred in connection with the
abandoned public offering, the Recapitalization and the repurchase
offers referred to in Note 10 of the Notes to Consolidated Financial
Statements (Unaudited) aggregated approximately $10.9 million,
including investment banking fees of $7.7 million (including $3.5
million to an affiliate of DLJMBPII and $0.6 million to certain
affiliates of Bain Capital), legal and accounting fees of $1.6 million,
stand-by commitment fees relating to certain change of control offers
of $1.2 million to an affiliate of DLJMBPII, and other costs of $0.4
million, which the Company has treated as a non-recurring expense
because such expenses are related to financing activities in connection
with the Recapitalization and related events, which the Company does
not expect to repeat.
(2) As used herein, "EBITDA" means net income (loss) plus nonrecurring
costs, interest, income taxes, depreciation, amortization and other
non-cash items (primarily deferred rents). Management believes that
EBITDA, as presented, represents a useful measure of assessing the
performance of the Company's ongoing operating activities as it
reflects the earnings trends of the Company without the impact of
certain non-cash charges. Targets and positive trends in EBITDA are
used as the performance measure for determining management's bonus
compensation; EBITDA is also utilized by the Company's creditors in
assessing debt covenant compliance. The Company understands that, while
EBITDA is frequently used by security analysts in the evaluation of
companies, it is not necessarily comparable to other similarly titled
captions of other companies due to potential inconsistencies in the
method of calculation. EBITDA is not intended as an alternative to cash
flow from operating activities as a measure of liquidity, nor an
alternative to net income as an indicator of the Company's operating
performance nor any other measure of performance in conformity with
generally accepted accounting principles ("GAAP").
A reconciliation of net loss to EBITDA for each period included above is
set forth below (dollars in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR 39 WEEKS ENDED
---------------------------------------------------------------------
SEPTEMBER 28, SEPTEMBER 27,
1994 1995 1996 1996 1997
----------- ----------- ----------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Net loss ............. $(16,438) $(18,058) $(17,854) $(12,485) $(14,165)
Net interest expense 27,480 30,224 32,396 24,334 25,433
Amortization ......... 18,238 11,579 16,217 8,514 3,826
Depreciation ......... 1,184 1,929 3,015 2,295 2,584
Nonrecurring charges -- -- -- -- 10,887
Other non-cash item . 724 1,769 1,526 1,156 1,182
----------- ----------- ----------- --------------- ---------------
EBITDA ............... $ 31,188 $ 27,443 $ 35,300 $ 23,814 $ 29,747
=========== =========== =========== =============== ===============
</TABLE>
(3) Same store sales figures include stores that have been in operation for
at least 13 months.
(4) The Company experienced a decline in sales per square foot from 1993
through 1995 as a result of the opening of additional stores in
connection with the Company's expansion. The opening of such additional
stores resulted in a decline in sales per square foot principally
because (i) the average square footage for the new stores was greater
than that of the existing store base and (ii) new stores generally take
some time to reach a mature level of sales. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--General."
(5) Cash interest expense (net) represents net interest expense less
amortization of deferred financing costs and other non-cash interest
charges for the year ended December 28, 1996 and the 39 week periods
ended September 28, 1996 and September 27, 1997 on a pro forma basis
giving effect to the Refinancing Plan, including the consummation of
the Offering, the Common Stock Offering and the application of the net
proceeds therefrom as set forth under "Use of Proceeds," as if such
transactions had occurred at December 31, 1995.
(6) Net debt represents total debt and capital lease obligations less cash,
on a pro forma basis after giving effect to the Offering, the Common
Stock Offering and the application of the net proceeds therefrom.
(7) For purposes of this ratio, EBITDA represents historical EBITDA for the
52 weeks ended September 27, 1997, which was approximately $41,233.
(8) Adjusted to give effect to (i) the Refinancing Plan, including the
consummation of the Offering, and the Common Stock Offering and the
application of the net proceeds therefrom as set forth under "Use of
Proceeds," as if all such transactions had occurred at September 27,
1997, (ii) a provision of $75,000 for compensation expense related to
previously issued stock options and (iii) an extraordinary loss of
$23.6 million for the 39 weeks ended September 27, 1997 arising from
the redemption of the Senior Notes and the Zero Coupon Notes and the
write-off of the related unamortized deferred financing fees, as if all
such transactions had occurred at September 27, 1997. See "Use of
Proceeds" and "Capitalization."
10
<PAGE>
RISK FACTORS
In addition to the other information contained in this Prospectus,
prospective investors should carefully consider the following risk factors
before making an investment in the New Senior Subordinated Notes offered
hereby.
RISKS ASSOCIATED WITH SUBSTANTIAL INDEBTEDNESS
After the Offering, the Company will have a substantial amount of
outstanding indebtedness. As of September 27, 1997, on a pro forma basis
giving effect to the Refinancing Plan, including the Offering and the Common
Stock Offering and the application of the net proceeds therefrom, the
consolidated indebtedness of the Company would have been approximately $212.2
million (excluding trade payables, accrued expenses and other non-current
liabilities). In addition, the Company's earnings have historically been
insufficient to cover fixed charges and were insufficient by $17.9 million
and $14.2 million for the fiscal year ended December 28, 1996 and the 39 week
period ended September 27, 1997, respectively. Subject to certain limitations
contained in its outstanding debt instruments, the Company or its
subsidiaries may incur additional indebtedness to finance working capital,
capital expenditures or acquisitions or for general corporate purposes. The
Company's level of indebtedness could have important consequences to the
holders of New Senior Subordinated Notes, including the following: (i) the
Company's ability to obtain additional capital for acquisitions, capital
expenditures, working capital or general corporate or other purposes may be
limited and (ii) the Company's level of indebtedness may reduce the Company's
flexibility to respond to changing business and economic conditions.
Substantially all of the Company's indebtedness under the New Credit
Agreement is expected to be subject to variable interest rates that fluctuate
in accordance with changes in the market rate to be specified in the New
Credit Agreement. Fluctuations in such interest rates may occur at any time
in response to changing economic conditions and other factors beyond the
Company's control, and there can be no assurance with respect to how long
such rates will remain at their current levels. Although the Company expects
to enter into hedging agreements to limit its exposure to interest rate
fluctuations, a significant rise in interest rates could have a material
adverse effect on the Company. To date, the Company has not entered into any
such hedging arrangements. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."
The Company's ability to pay principal of and interest on the New Senior
Subordinated Notes and to service its remaining indebtedness will be
dependent on its future performance, which will be affected by prevailing
economic, financial, business, competitive, legislative, regulatory and other
conditions, certain of which are beyond the Company's control. The Company
believes that, based upon current levels of operations and anticipated
growth, it should be able to meet its debt service obligations when due for
the foreseeable future. If, however, the Company becomes unable to service
its indebtedness, it will be forced to pursue one or more alternative
strategies such as selling assets, restructuring or refinancing its
indebtedness or seeking additional equity capital, which actions are
restricted, to some extent, under the terms of the New Credit Agreement and
the New Senior Subordinated Notes. There can be no assurance that any of
these strategies could be effected on satisfactory terms, if at all.
The New Senior Subordinated Note Indenture will contain certain covenants
which, among other things, will restrict the ability of the Company and its
subsidiaries to incur additional indebtedness and issue preferred stock, pay
dividends or make other distributions, make certain restricted payments,
create certain liens, sell assets, enter into certain transactions with
affiliates, enter into certain mergers or consolidations or sell or issue
capital stock of the Company's subsidiaries. In addition, the New Credit
Agreement contains other and more restrictive covenants, including those
requiring the Company to maintain specified financial ratios and satisfy
certain tests relating to its financial condition, and prohibits the Company
from repaying its other indebtedness (including the New Senior Subordinated
Notes) prior to the maturity of the New Credit Agreement. The Company's
ability to comply with the covenants in the New Credit Agreement and/or the
New Senior Subordinated Note Indenture may be affected by events beyond its
control, including prevailing economic, financial, business, competitive,
legislative, regulatory and other conditions. The breach of any such
covenants or restrictions could result in a default under the New Credit
Agreement and/or the New Senior Subordinated Note Indenture. Upon the
occurrence of an
11
<PAGE>
event of default under the New Credit Agreement, the lenders thereunder could
elect to declare all amounts borrowed thereunder to be immediately due and
payable, together with accrued and unpaid interest, and terminate the
commitments of the lenders to make further extensions of credit under the New
Credit Agreement. If the Company were unable to repay its indebtedness to its
lenders under the New Credit Agreement, such lenders could proceed against
any or all of the collateral securing the indebtedness under the New Credit
Agreement, which collateral is expected to consist of substantially all of
the assets of the Company and the capital stock and substantially all of the
assets of its subsidiaries. See "Description of Certain Indebtedness."
SUBORDINATION
The New Senior Subordinated Notes will be general unsecured obligations of
the Company and will be subordinated in right of payment to all existing and
future Senior Debt of the Company, including indebtedness under the New
Credit Agreement. Furthermore, any payment with respect to a Subsidiary
Guarantee also will be subordinated to the payment of Senior Debt of that
Subsidiary Guarantor, including such Subsidiary Guarantor's obligations under
the New Credit Agreement. As of September 27, 1997, on a pro forma basis
after giving effect to the Refinancing Plan, including consummation of the
Offering and the Common Stock Offering and the application of the net
proceeds thereof, the Company would have had approximately $130.0 million of
Senior Debt, all of which would have been secured borrowings under the New
Credit Agreement. By reason of such subordination, in the event of the
insolvency, liquidation, reorganization, dissolution or other winding-up of
the Company or upon a default in payment with respect to, or the acceleration
of, any Senior Debt, the holders of such Senior Debt and any other creditors
who are holders of Senior Debt or creditors of subsidiaries must be paid in
full before the holders of the New Senior Subordinated Notes may be paid. If
the Company incurs an additional pari passu debt, the holders of such debt
would be entitled to share ratably with the holders of the New Senior
Subordinated Notes in any proceeds distributed in connection with any
insolvency, liquidation, reorganization, dissolution or other winding-up of
the Company. This may have the effect of reducing the amount of proceeds paid
to holders of the New Senior Subordinated Notes. In addition, no cash
payments may be made with respect to the New Senior Subordinated Notes during
the continuance of a payment default with respect to Senior Debt and, under
certain circumstances, no payments may be made with respect to the New Senior
Subordinated Notes for a period of up to 179 days if a non-payment default
exists with respect to Senior Debt. In addition, holders of indebtedness and
other liabilities of the Company's subsidiaries will have claims that are
effectively senior to the New Senior Subordinated Notes, except to the extent
of the Subsidiary Guarantees. See "--Enforceability of Subsidiary Guarantees"
and "Description of New Senior Subordinated Notes--Subordination."
HOLDING COMPANY STRUCTURE
The Company is a holding company and does not have any material operations
or assets other than ownership of the 99% of the general partnership interest
of Duane Reade, a New York general partnership ("DR"), and 100% of the
outstanding common stock of DRI I Inc. ("DRI"). DRI owns the remaining 1%
general partnership interest in DR. The Company is dependent on the cash flow
of its subsidiaries and distributions from its subsidiaries in order to meet
its debt service obligations.
Any right of the Company to participate in any distribution of the assets
of any of its subsidiaries upon liquidation, reorganization or insolvency of
any such subsidiary (and the consequent right of the holders of the New
Senior Subordinated Notes to participate in distribution of those assets)
will be subject to the prior claims of such subsidiary's creditors. All
obligations of DR under the New Credit Agreement will be secured by
substantially all of the assets of the Company, DRI and DR.
COMPETITION
The markets in which the Company operates are highly competitive. In the
New York City area, the Company competes against national, regional and local
drugstore chains, discount drugstores, supermarkets, combination food and
drugstores, discount general merchandise stores, mass merchandisers,
independent drugstores and local merchants. Major chain competitors in the
New York City market
12
<PAGE>
include Rite-Aid, Genovese and CVS. Many of the Company's competitors are
larger and have greater financial resources than the Company. In addition to
competition from the foregoing, the Company's pharmacy departments also
compete with hospitals, health maintenance organizations ("HMOs") and mail
order prescription drug providers. The Company's drugstores compete, among
other things, on the basis of convenience of location and store layout,
product mix, selection, customer service and price. There can be no assurance
that such competition will not adversely affect the Company's results of
operations or financial condition. See "Business--Competition."
NET LOSSES; INTANGIBLE ASSETS
The Company has experienced net losses of $24.4 million, $16.4 million,
$18.1 million, $17.9 million and $14.2 million for the prior four fiscal
years and the 39 weeks ended September 27, 1997, respectively. The net
proceeds from the Offering, the Common Stock Offering and the New Credit
Agreement will be used to reduce overall indebtedness of the Company and
associated interest expense. The Company's results of operations will
continue to be affected by events and conditions both within and beyond its
control, including the successful implementation of the Company's growth
strategy, continued performance of existing stores, competition and economic,
financial, business and other conditions. Therefore, there can be no
assurance that the Company will not continue to incur net losses in the
future. The Company also expects to realize an extraordinary loss of
approximately $23.6 million in the first quarter of 1998 as a result of the
early retirement of the Senior Notes, the Zero Coupon Notes and the Existing
Credit Agreement.
Of the Company's total assets at December 28, 1996, approximately $142.4
million (or 64.0% of total assets) represented goodwill, net of amortization
and other intangible assets arising principally from the acquisition of the
Company's predecessor by Bain Capital in 1992. It is possible that no cash
would be recoverable from the voluntary or involuntary sale of the intangible
assets of the Company, including its goodwill.
ECONOMIC CONDITIONS AND REGIONAL CONCENTRATION
Substantially all of the Company's stores are located in the New York City
area. As a result, the Company is sensitive to economic and competitive
conditions, the regulatory environment and the availability of labor in that
area. The success of the Company's future operations will be substantially
affected by its ability to compete effectively in the New York City area, and
no prediction can be made as to economic conditions in this region.
UNCERTAINTY OF LEASE RENEWALS
All of the Company's stores are leased, with the leases expiring at
various dates from May 1998 to December 2022 (assuming renewal options are
exercised). Leases for eight stores that generated approximately 12.8% of the
Company's net sales for the 39 week period ended September 27, 1997 are
scheduled to expire before the end of 2000. Although the Company has
historically been successful in renewing most of its store leases when they
have expired, there can be no assurance that the Company will continue to be
able to do so on acceptable terms or at all. If the Company is unable to
renew the leases for the Company's store locations as they expire, 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. See
"Business--Properties; Leases."
RISKS ASSOCIATED WITH FUTURE GROWTH
The Company is experiencing a period of rapid expansion, which the Company
believes will continue for the foreseeable future. The operating complexity
of the Company's business, as well as the responsibilities of management
personnel, have increased as a result of this expansion. The Company's
ability to manage such growth effectively will require it to continue to
expand and improve its operating and financial systems and to expand, train
and manage its employee base. In addition, as the Company opens new stores,
there can be no assurance that a sufficient number of qualified personnel
will be
13
<PAGE>
available to manage such expanded operations or that such operations will be
successfully integrated into the Company. The Company's inability to manage
its expansion effectively, including the hiring of additional personnel,
could have a material adverse effect on its business and results of
operations. The Company's expansion prospects are also dependent on a number
of other factors, including, among other things, economic conditions,
competition, consumer preferences, financing and working capital needs, the
ability of the Company to negotiate store leases on favorable terms and the
availability of additional warehouse space and new store locations. In
addition, as the Company continues with its plans to open additional stores
in the New York City area, sales at existing stores may decrease as customers
shop at the Company's newer stores. There can be no assurance that the
Company will be able to effectively realize its plans for future expansion.
See "Business."
RISKS ASSOCIATED WITH REGULATORY AND OTHER CHANGES IN THE HEALTH CARE
INDUSTRY
Pharmacy sales accounted for approximately 22% of the Company's total
sales for 1996 and 25% of the Company's total sales for the 39 week period
ended September 27, 1997. Pharmacy sales to Third Party Plans accounted for
approximately 64% of the Company's total pharmacy sales for 1996 and
approximately 73% of the Company's total pharmacy sales for the 39 week
period ended September 27, 1997. The efforts of Third Party Plans to contain
costs have placed downward pressures on gross profit margins from sales of
prescription drugs. However, management believes that the penetration of
Third Party Plans in the New York City market will continue, and the
resulting increase in volume should help to mitigate the decrease in gross
profit margins. See "Business--The Drugstore Industry."
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,
its results of operations.
REGULATORY MATTERS
The Company's business is subject to various federal and state
regulations. For example, pursuant to the Omnibus Budget Reconciliation Act
of 1990 ("OBRA") and comparable state 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. The Company is also
subject to federal, state and local licensing and registration regulations
with respect to, among other things, its pharmacy operations. The Company
believes that it has satisfied all of its 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 adversely effect the
Company's operations. Additionally, the Company is subject to federal Drug
Enforcement Agency ("DEA") regulations relative to its pharmacy operations,
including purchasing, storing and dispensing of controlled substances.
The Company is also subject to laws governing its relationship with
employees, including minimum wage requirements, overtime and working
conditions. Increases in the federal minimum wage rate, employee benefit
costs or other costs associated with employees could adversely affect the
Company's results of operations.
DEPENDENCE ON KEY PERSONNEL
The success of the Company depends to a large extent on its executive
management team. Although the Company has entered into employment agreements
with each of the Company's executive officers, it
14
<PAGE>
is possible that members of executive management may leave the Company, and
such departures could have a negative impact on the business of the Company.
The Company does not maintain key-man life insurance on any of its executive
officers. See "Management."
CONTINUED INFLUENCE OF PRINCIPAL STOCKHOLDERS
Upon consummation of the Common Stock Offering, investment funds
affiliated with DLJMPBII, an affiliate of Donaldson, Lufkin & Jenrette
Securities Corporation ("DLJ"), the Underwriter for the Offering, and certain
of its affiliates will beneficially own an aggregate of approximately 52.4%
of the fully diluted outstanding Common Stock (46.3% if the overallotment
option granted to the underwriters in the Common Stock Offering is exercised
in full). In addition, two of the Company's four directors are Managing
Directors of DLJ Merchant Banking II, Inc. ("DLJMB"), a general partner of
DLJMBPII, and one director is a Managing Director of DLJ. In connection with
the consummation of the Offering and the Common Stock Offering, the Company
expects to add two independent directors to the Board of Directors. See
"Management" and "Principal Stockholders." Under Delaware law and the
Company's Amended and Restated Certificate of Incorporation, owners of a
majority of the Company's outstanding Common Stock are able to elect all of
the Company's directors and approve significant corporate transactions
without the approval or consent of the other shareholders. As a result,
DLJMBPII will continue to have the ability (either alone or together with a
small percentage of other shareholders) to elect all of the Company's
directors and to control the vote on all matters submitted to a vote of the
holders of the Common Stock, including any going private transaction, merger,
consolidation or sale of all or substantially all of the Company's assets.
The Company's Amended and Restated Certificate of Incorporation provides that
any action that can be taken by a meeting of the shareholders may be taken by
written consent in lieu of a meeting.
COLLECTIVE BARGAINING AGREEMENTS
As of September 27, 1997, approximately 1,800 of the Company's
approximately 2,000 employees were represented by various labor unions and
were covered by collective bargaining agreements. The Company's distribution
facility employees are represented by the International Brotherhood of
Teamsters, Chauffeurs and Warehousemen and Helpers of America, Local 815, and
all store employees are represented by the Allied Trade Council. The
Company's three-year contracts with these two unions expire on August 31,
1999 and August 31, 1998, respectively. The Company has not experienced any
material business interruption as a result of labor disputes within the past
15 years, and the Company considers its employee relations to be good.
However, there can be no assurance that, upon the expiration of any of the
Company's collective bargaining agreements, the Company will be able to
negotiate new collective bargaining agreements on terms favorable to the
Company or that the Company's business operations will not be interrupted as
a result of labor disputes or difficulties or delays in the process of
renegotiating its collective bargaining agreements. In such events, the
Company's results of operations could be materially adversely affected. See
"Business--Employees."
POSSIBLE INABILITY TO REPURCHASE NEW SENIOR SUBORDINATED NOTES UPON CHANGE OF
CONTROL
The New Credit Agreement will prohibit the Company from purchasing the New
Senior Subordinated Notes and will also provide that certain change of
control events with respect to the Company will constitute a default
thereunder. Any future credit agreements or other agreements relating to
Senior Debt to which the Company becomes a party may contain similar
restrictions and provisions. In the event that a Change of Control occurs at
a time when the Company is prohibited from purchasing the New Senior
Subordinated Notes, the Company could seek the consent of its lenders to the
purchase of the New Senior Subordinated Notes or could attempt to refinance
the borrowings that contain such prohibition. If the Company does not obtain
such consent or repay such borrowings, the Company will remain prohibited
from purchasing the New Senior Subordinated Notes by the relevant Senior
Debt. In such case, the Company's failure to purchase the tendered New Senior
Subordinated Notes would constitute an event of default under the New Senior
Subordinated Note Indenture which would, in turn, constitute a default under
the New Credit Agreement and could constitute a default under other Senior
Debt. In such
15
<PAGE>
circumstances, the subordination provisions in the New Senior Subordinated
Note Indenture would likely restrict payments to the holders of the New
Senior Subordinated Notes. Furthermore, no assurance can be given that the
Company will have sufficient resources to satisfy its repurchase obligations
with respect to the New Senior Subordinated Notes following a Change of
Control.
FRAUDULENT TRANSFER CONSIDERATIONS
The incurrence by the Company of indebtedness such as the New Senior
Subordinated Notes to effect the Refinancing Plan may be subject to review
under relevant state and federal fraudulent conveyance laws if a bankruptcy
case or lawsuit is commenced by or on behalf of unpaid creditors of the
Company. The Company believes that the indebtedness represented by the New
Senior Subordinated Notes is being incurred for proper purposes and in good
faith and that, based on forecasts, asset valuations and other financial
information, the Company, after giving effect to the Refinancing Plan,
including the consummation of the Offering and the Common Stock Offering,
will be solvent, will have sufficient capital for carrying on its business
and will be able to pay its debts as they mature. Notwithstanding the
Company's belief, however, if a court of competent jurisdiction in a suit by
an unpaid creditor or representative of creditors (such as a trustee in
bankruptcy or debtor-in-possession) were to find that, at the time of the
issuance of the New Senior Subordinated Notes, the Company was insolvent, was
rendered insolvent by reason of such incurrence, was engaged in a business or
transaction for which its remaining assets constituted unreasonably small
capital, intended to incur, or believed that it would incur, debts beyond its
ability to pay such debts as they mature, or intended to hinder, delay or
defraud its creditors, and that the indebtedness was incurred for less than
reasonably equivalent value, then such court could, among other things: (i)
void all or a portion of the Company's obligations to the holders of the New
Senior Subordinated Notes, the effect of which would be that the holders of
the New Senior Subordinated Notes may not be repaid in full or at all, and/or
(ii) subordinate the Company's obligations to the holders of the New Senior
Subordinated Notes to other existing and future indebtedness of the Company,
the effect of which would be to entitle such other creditors to be paid in
full before any payment could be made on the New Senior Subordinated Notes.
ENFORCEABILITY OF SUBSIDIARY GUARANTEES
The Company's obligations under the New Senior Subordinated Notes will be
guaranteed, jointly and severally, on a senior subordinated basis by each of
the Subsidiary Guarantors. The Company believes that the Subsidiary
Guarantees are being incurred for proper purposes and in good faith and that,
based on forecasts, asset valuations and other financial information, the
Subsidiary Guarantors, after giving effect to the Refinancing Plan, including
the consummation of the Offering and the Common Stock Offering, will be
solvent, will have sufficient capital for carrying on their respective
businesses and will be able to pay their debts as they mature.
Notwithstanding the Company's belief however, if a court of competent
jurisdiction in a suit by an unpaid creditor or representative of creditors
(such as a trustee in bankruptcy or debtor-in-possession) were to find that,
at the time of incurrence of a Subsidiary Guarantee, a Subsidiary Guarantor
was insolvent, was rendered insolvent by reason of such issuance, was engaged
in a business or transaction for which its remaining assets constituted
unreasonably small capital, intended to incur, or believed that it would
incur, debts beyond its ability to pay such debts as they matured, or
intended to hinder, delay or defraud its creditors, and that the indebtedness
was incurred for less than reasonably equivalent value, then such court
could, among other things: (i) void all or a portion of such Subsidiary
Guarantor's obligations to the holders of the New Senior Subordinated Notes,
the effect of which would be that the holders of the New Senior Subordinated
Notes may not be repaid in full or at all, and/or (ii) subordinate such
Subsidiary Guarantor's obligations to the holders of the New Senior
Subordinated Notes to other existing and future indebtedness of such
Subsidiary Guarantor, the effect of which would be to entitle such other
creditors to be paid in full before any payment could be made on the New
Senior Subordinated Notes. Among other things, a legal challenge of a
Subsidiary Guarantee on fraudulent conveyance grounds may focus on the
benefits, if any, realized by the Subsidiary Guarantor as a result of the
issuance by the Company of the New Senior Subordinated Notes.
16
<PAGE>
TRADING MARKET FOR THE NOTES
The New Senior Subordinated Notes are not listed for trading on any
securities exchange or on any automated dealer quotation system. The Company
has been advised by DLJ that it intends to make a market in the New Senior
Subordinated Notes; however, DLJ is not obligated to do so. Any market-making
may be discontinued at any time, and there is no assurance that an active
public market for the New Senior Subordinated Notes will develop or, that if
such market develops, that it will continue. Further, the liquidity of, and
trading market for the New Senior Subordinated Notes may be adversely
affected by declines and volatility in the market for high yield securities
generally. The liquidity of and trading market for the New Senior
Subordinated Notes may be adversely affected by any changes in the Company's
financial performance or prospects.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
The information herein contains forward-looking statements that involve a
number of risks and uncertainties. A number of factors could cause actual
results, performance, achievements of the Company, or industry results to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. These factors
include, but are not limited to, the competitive environment in the drugstore
industry in general and in the Company's specific market area; inflation;
changes in costs of goods and services; economic conditions in general and in
the Company's specific market areas; demographic changes; changes in
prevailing interest rates and the availability of and terms of financing to
fund the anticipated growth of the Company's business; liability and other
claims asserted against the Company; changes in operating strategy or
development plans; the ability to attract and retain qualified personnel; the
significant indebtedness of the Company; labor disturbances; changes in the
Company's acquisition and capital expenditure plans; and other factors
referenced herein. In addition, such forward-looking statements are
necessarily dependent upon assumptions, estimates and dates that may be
incorrect or imprecise and involve known and unknown risks, uncertainties and
other factors. Accordingly, any forward-looking statements included herein do
not purport to be predictions of future events or circumstances and may not
be realized. Forward-looking statements can be identified by, among other
things, the use of forward-looking terminology such as "believes," "expects,"
"may," "will," "should," "seeks," "pro forma," "anticipates," "intends" or
the negative of any thereof, or other variations thereon or comparable
terminology, or by discussions of strategy or intentions. Given these
uncertainties, prospective investors are cautioned not to place undue
reliance on such forward-looking statements. The Company disclaims any
obligations to update any such factors or to publicly announce the results of
any revisions to any of the forward-looking statements contained herein to
reflect future events or developments.
17
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the Offering (after deducting the
underwriting discount and estimated general offering expenses) were
approximately $77.1 million. Such net proceeds were used, together with net
proceeds from the Common Stock Offering of $101.8 million and borrowings
under the New Credit Agreement, to complete the Refinancing Plan, which
consisted of: (i) the redemption of all of the Zero Coupon Notes for $99.8
million (including a redemption premium of $7.0 million), (ii) the redemption
of all of the Senior Notes for $93.9 million (including a redemption premium
of $4.0 million), (iii) the repayment of all outstanding term loan
indebtedness under the Existing Credit Agreement, the outstanding principal
amount of which was $65.3 million as of December 27, 1997, (iv) the repayment
of all outstanding revolving indebtedness under the Existing Credit
Agreement, the outstanding principal amount of which was $24.5 million as of
December 27, 1997, and (v) the payment of fees and expenses incurred in
connection with the Refinancing Plan. The Company intends to use the proceeds
of the Offering, the Common Stock Offering and a portion of the proceeds from
the New Credit Agreement to fund the redemption of the Zero Coupon Notes and
the Senior Notes. Accordingly, the proceeds from the Offering and the Common
Stock Offering were used to defease the Zero Coupon Notes and the Senior
Notes pending such redemptions, which the Company currently expects to occur
approximately 30 days after the closing of the Offering.
18
<PAGE>
CAPITALIZATION
The following table sets forth the total capitalization of the Company as
of September 27, 1997 and the pro forma capitalization as adjusted to give
effect to the Refinancing Plan (assuming consummation of the redemption of
the Senior Notes and the Zero Coupon Notes), including the sale by the
Company of the New Senior Subordinated Notes offered hereby. See "Use of
Proceeds." This table should be read in conjunction with the unaudited
consolidated financial statements of the Company, including the notes
thereto, appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 27, 1997
--------------------------
ACTUAL AS ADJUSTED(1)
---------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Long-term debt (including current portion):
Credit agreement(2) ......................... $ 81,475 $ --
New Credit Agreement(3) ..................... -- 130,000
Senior Notes(4) ............................. 89,893 --
Zero Coupon Notes(5) ........................ 89,094 --
9 1/4% New Senior Subordinated Notes ........ -- 80,000
Capital lease obligations ................... 2,187 2,187
---------- --------------
Total long-term debt ...................... 262,649 212,187
---------- --------------
Stockholders' equity (deficiency):
Common stock and additional paid-in capital 24,665 126,215
Preferred stock.............................. -- --
Accumulated deficit ......................... (98,226) (121,899)
---------- --------------
Total stockholders' equity (deficiency) .. (73,561) 4,316
---------- --------------
Total capitalization .......................... $189,088 $ 216,503
========== ==============
</TABLE>
- ------------
(1) Gives pro forma effect to the Refinancing Plan, including the
consummation of the Offering and the Common Stock Offering and the
application of the net proceeds therefrom as set forth under "Use of
Proceeds," as if all such transactions had occurred at September 27,
1997.
(2) Reflects outstanding balance under the Company's credit agreement in
effect on September 27, 1997, which was replaced in the Existing Credit
Agreement on September 30, 1997.
(3) Does not include $30.0 million of borrowing availability under the
revolving portion of the New Credit Agreement.
(4) Pursuant to the terms of the Indenture relating to the Senior Notes,
the Company has the right to call the Senior Notes at a price equal to
104.5% of the principal amount thereof (a premium of approximately $4.0
million). Concurrently with closing of the Offering and the Common
Stock Offering, the Company will call the Senior Notes (the "Senior
Notes Redemption") and currently expects that the Senior Notes
Redemption will occur approximately 30 days after the closing of the
Offering.
(5) Pursuant to the terms of the Indenture relating to the Zero Coupon
Notes, the Company has the right to call the Zero Coupon Notes at a
price equal to 107.5% of the accreted value thereof (a premium of
approximately $7.0 million). Concurrently with the closing of the
Offering and the Common Stock Offering, the Company will call the Zero
Coupon Notes (the "Zero Coupon Notes Redemption") and currently expects
that the Zero Coupon Notes Redemption will occur approximately 30 days
after the closing of the Offering.
19
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following unaudited pro forma condensed consolidated financial
statements are based on the unaudited consolidated financial statements
included elsewhere in this Prospectus, adjusted to give effect to the
Refinancing Plan.
The unaudited pro forma statements of operations data are derived from the
consolidated statements of operations for the fiscal year ended December 28,
1996 and the 39 week period ended September 27, 1997, included elsewhere in
this Prospectus, and assume that the Refinancing Plan was consummated as of
December 31, 1995. The unaudited pro forma condensed consolidated balance
sheet data are derived from the unaudited consolidated balance sheet of the
Company as of September 27, 1997, included elsewhere in this Prospectus, and
assume that the Refinancing Plan was consummated on September 27, 1997. The
unaudited pro forma condensed consolidated financial statements should be
read in conjunction with the consolidated financial statements of the
Company, included elsewhere in this Prospectus.
The unaudited pro forma condensed consolidated financial statements do not
purport to be indicative of the results that would actually have been
obtained if the Refinancing Plan had occurred on the dates indicated or of
the results that may be obtained in the future. The unaudited pro forma
condensed consolidated financial statements are presented for comparative
purposes only. The pro forma adjustments, as described in the accompanying
data, are based on available information and certain assumptions that
management believes are reasonable.
20
<PAGE>
DUANE READE INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
SEPTEMBER 27, 1997
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL ADJUSTMENTS PRO FORMA
------------ ------------- -----------
<S> <C> <C> <C>
ASSETS
Current assets
Cash........................................................ $ 218 $ 28,128 (1) $ 28,346
Receivables................................................. 9,084 9,084
Inventories................................................. 65,872 65,872
Prepaid expense ............................................ 1,371 1,371
------------ ------------- -----------
TOTAL CURRENT ASSETS ...................................... 76,545 28,128 104,673
Property and equipment, net ................................. 24,918 24,918
Goodwill, net ............................................... 121,757 121,757
Other assets, net............................................ 16,300 2,506 (1) 15,562
2,900 (1)
2,700 (2)
(8,844)(5)
------------ ------------- -----------
Total assets .............................................. $239,520 $ 27,390 $ 266,910
============ ============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities
Accounts payable ........................................... $ 30,710 $ $ 30,710
Accrued interest ........................................... 623 (600)(1) 23
Accrued expenses ........................................... 13,193 (2,200)(1) 13,693
2,700 (2)
Current portion of senior debt ............................. 660 2,550 (1) 2,550
(660)(1)
Current portion of capital lease obligations................ 1,510 1,510
------------ ------------- -----------
TOTAL CURRENT LIABILITIES ................................. 46,696 1,790 48,486
Senior debt, less current portion ........................... 170,708 127,450 (1) 207,450
80,000 (1)
(80,815)(1)
(93,938)(1)
4,045 (4)
Zero Coupon Notes, net....................................... 89,094 (99,803)(1) --
3,746 (3)
6,963 (4)
Capital lease obligations less current portion............... 677 677
Other non-current liabilities................................ 5,906 75 (6) 5,981
------------ ------------- -----------
TOTAL LIABILITIES ......................................... 313,081 (50,487) 262,594
------------ ------------- -----------
Stockholders' deficiency: 103 67 (1) 170
Common stock, $0.01 par; authorized 30,000,000 shares;
issued and outstanding 10,257,832 shares and 16,957,832
shares, respectively .......................................
Paid-in capital............................................. 24,562 110,483 (1) 126,045
(9,000)(1)
Accumulated deficit ........................................ (98,226) (3,746)(3) (121,899)
(11,008)(4)
(8,844)(5)
(75)(6)
------------ ------------- -----------
TOTAL STOCKHOLDERS' EQUITY (DEFICIENCY) ................... (73,561) 77,877 4,316
------------ ------------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) .. $239,520 $ 27,390 $ 266,910
============ ============= ===========
</TABLE>
See Notes to Unaudited Pro Forma Condensed Consolidated Balance Sheet.
21
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
(1) The net effect on cash of the transactions and the application of
proceeds thereof, as of September 27, 1997, is as follows:
<TABLE>
<CAPTION>
<S> <C>
TOTAL SOURCES:
Proceeds to the Company from the Common Stock Offering $110,550
New Credit Agreement:
Current portion........................................ 2,550
Non-current portion.................................... 127,450
New Senior Subordinated Notes........................... 80,000
----------
Total sources......................................... $320,550
==========
TOTAL USES:
Existing Credit Agreement
Current portion........................................ $ 660
Non-current portion.................................... 80,815
Senior Notes, including redemption premium.............. 93,938
Zero Coupon Notes, including redemption premium ........ 99,803
Offering fees and expenses.............................. 9,000
New Credit Agreement fees and expenses.................. 2,506
New Senior Subordinated Notes fees and expenses ........ 2,900
Accelerated payment of previously incurred liability ... 2,200
Accrued interest........................................ 600
Cash.................................................... 28,128
----------
Total uses............................................ $320,550
==========
</TABLE>
(2) Represents fees and expenses related to the Existing Credit Agreement.
(3) Represents adjustment of the Zero Coupon Notes to accreted value in
accordance with the Zero Coupon Notes Indenture.
(4) Represents accrual of redemption premiums on the Senior Notes and the
Zero Coupon Notes.
(5) Represents a write-off of unamortized deferred financing costs related
to the Company's previously outstanding debt, including (i) $6,144
relating to the bank credit agreement of the Company that existed prior
to the Existing Credit Agreement, the Senior Notes and the Zero Coupon
Notes and (ii) $2,700 relating to the Existing Credit Agreement.
(6) Represents compensation expense in connection with stock options
granted.
22
<PAGE>
DUANE READE INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE 39 WEEKS ENDED SEPTEMBER 27, 1997
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL ADJUSTMENTS PRO FORMA
------------ ------------- ------------
<S> <C> <C> <C>
Net sales .................................... $313,796 $ $313,796
Cost of sales................................. 236,413 236,413
------------ ------------- ------------
Gross profit.................................. 77,383 -- 77,383
------------ ------------- ------------
Selling, general and administrative expenses 48,218 75 (2) 48,293
Amortization ................................. 3,826 3,826
Depreciation ................................. 2,584 2,584
Store pre-opening expenses.................... 600 600
Nonrecurring charges.......................... 10,887 10,887
------------ ------------- ------------
66,115 75 66,190
------------ ------------- ------------
Operating income ............................. 11,268 (75) 11,193
Interest expense, net ........................ 25,433 (10,408)(1) 15,025
------------ ------------- ------------
Loss before income taxes...................... (14,165) 10,333 (3,832) (3)
Income taxes.................................. -- -- --
------------ ------------- ------------
Net loss..................................... $(14,165) $ 10,333 $ (3,832)
============ ============= ============
Net loss per common share.................... $ (1.34) $ (0.22)
============ ============
Weighted average common shares outstanding .. 10,600 17,300
============ ============= ============
</TABLE>
FOR THE 52 WEEKS ENDED DECEMBER 28, 1996
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL ADJUSTMENTS PRO FORMA
------------ ------------- -----------
<S> <C> <C> <C>
Net sales..................................... $381,466 $ $381,466
Cost of sales ................................ 288,505 288,505
------------ ------------- -----------
Gross profit ................................. 92,961 -- 92,961
------------ ------------- -----------
Selling, general and administrative expenses 59,048 59,048
Amortization.................................. 16,217 16,217
Depreciation.................................. 3,015 3,015
Store pre-opening expenses ................... 139 139
------------ ------------- -----------
78,419 -- 78,419
------------ ------------- -----------
Operating income.............................. 14,542 -- 14,542
Interest expense, net......................... 32,396 (12,527)(4) 19,869
------------ ------------- -----------
Loss before income taxes...................... (17,854) 12,527 (5,327)
Income taxes.................................. -- -- --
------------ ------------- -----------
Net loss..................................... $(17,854) $ 12,527 $ (5,327)
============ ============= ===========
Net loss per common share.................... $ (1.69) $ (0.31)
============ ===========
Weighted average common shares outstanding ... 10,575 17,275
============ ===========
</TABLE>
See notes to Unaudited Pro Forma Condensed Consolidated Statements of
Operations.
23
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
The Unaudited Pro Forma Condensed Consolidated Statements of Operations
reflect the following as if all transactions had occurred on December 31,
1995:
(1) For the 39 weeks ended September 27, 1997:
<TABLE>
<CAPTION>
<S> <C>
Interest expense related to the New Senior Subordinated Notes (at
an interest rate of 9.25%)(a) ..................................... $ 5,550
Interest expense related to the New Credit Agreement (b) .......... 8,072
Amortization of deferred financing costs related to the New Credit
Agreement and New Senior Subordinated Notes ....................... 658
Elimination of interest expense and amortization of deferred
financing costs related to the Company's previously outstanding
debt .............................................................. (24,688)
----------
$(10,408)
==========
</TABLE>
(2) Reflects a provision for compensation expense in connection with stock
options issued.
(3) Upon the early retirement of the Senior Notes, the Zero Coupon Notes
and the Existing Credit Agreement as a consequence of the consummation
of the Refinancing Plan, the Company expects to realize an
extraordinary loss, which on a pro forma basis for the 39 weeks ended
September 27, 1997 would be approximately $23,598, comprised of:
<TABLE>
<CAPTION>
<S> <C>
Redemption premium on Senior Notes.............................. $ 4,045
Redemption premium on Zero Coupon Notes......................... 6,963
Adjustment of Zero Coupon Notes to accreted value in accordance
with the Zero Coupon Note Indenture............................ 3,746
Write-off of unamortized deferred financing costs related to
the Company's previously outstanding debt...................... 8,844
--------
Pro forma extraordinary loss (tax effect: none)................. $23,598
========
</TABLE>
(4) For the 52 weeks ended December 28, 1996:
<TABLE>
<CAPTION>
<S> <C>
Interest expense related to the New Senior Subordinated Notes (at
an interest rate of 9.25%)(a)...................................... $ 7,400
Interest expense related to the New Credit Agreement (c) .......... 10,763
Amortization of deferred financing costs related to the New Credit
Agreement and New Senior Subordinated Notes ....................... 1,012
Elimination of interest expense and amortization of deferred
financing costs related to the Company's previously outstanding
debt .............................................................. (31,702)
----------
$(12,527)
==========
</TABLE>
- ------------
(a) A 25 basis point (0.25%) increase or decrease in the assumed interest
rate would result in a change in interest expense of $150 for the 39
weeks ended September 27, 1997 and $200 for the 52 weeks ended
December 28, 1996.
(b) Interest expense is calculated as follows: (i) assuming an
outstanding principal balance on the New Credit Agreement of $130.0
million for the applicable period and (ii) using an interest rate of
8.3%, which is calculated in accordance with the New Credit
Agreement, which provides for the payment of interest on $50.0
million of outstanding Tranche A loans at LIBOR plus 2.5% and on
$80.0 million of outstanding Tranche B loans at LIBOR plus 2.75%.
Based on the current LIBOR rate, as of February 6, 1998 of 5.625%,
the average interest rate on such borrowings is 8.3%. A 25 basis
point (0.25%) increase or decrease in the assumed interest rate would
result in a $243 change in interest expense.
(c) Interest expense is calculated as follows: (i) assuming an
outstanding principal balance on the New Credit Agreement of $130.0
million for the applicable period and (ii) using an interest rate of
8.3%, which is calculated in accordance with the New Credit
Agreement, which provides for the payment of interest on $50.0
million of outstanding Tranche A loans at LIBOR plus 2.5% and on
$80.0 million of outstanding Tranche B loans at LIBOR plus 2.75%.
Based on the current LIBOR rate, as of February 6, 1998 of 5.625%,
the average interest rate on such borrowings is 8.3%. A 25 basis
point (0.25%) increase or decrease in the assumed interest rate would
result in a $325 change in interest expense.
24
<PAGE>
SELECTED CONSOLIDATED HISTORICAL
FINANCIAL AND OPERATING DATA
(In thousands, except per share amounts, percentages and store data)
The data set forth below as of December 31, 1992 and for the period
September 26, 1992 through December 31, 1992, and as of January 1, 1994,
December 31, 1994, December 30, 1995, December 28, 1996 and for each of the
52 week periods then ended was derived from the consolidated financial
statements of the Company. As used below, the term "Predecessor" refers to
the operations of Duane Reade prior to the acquisition thereof by Bain
Capital in September 1992. The basis of accounting as of September 25, 1992
and for the period January 1, 1992 through September 25, 1992 reflects the
historical basis of accounting of the Predecessor prior to the acquisition
thereof by Bain Capital and such data was derived from the consolidated
financial statements of the Predecessor. The data presented below for the 39
weeks ended September 28, 1996 and September 27, 1997 and as of September 27,
1997 have been derived from the Company's unaudited consolidated financial
statements and, in the opinion of the Company's management, reflect and
include all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of such results. The results of operations
for the 39 weeks ended September 27, 1997 are not necessarily indicative of
the results that may be expected for a full fiscal year. This information
should be read in conjunction with the historical consolidated financial
statements of the Company, including the notes thereto, included elsewhere in
this Prospectus.
<TABLE>
<CAPTION>
PREDECESSOR
-------------
PERIOD
JANUARY 1
TO
SEPTEMBER 25,
1992
<S> <C>
STATEMENT OF OPERATIONS DATA:
Net sales ............................. $167,634
Cost of sales ......................... 124,637
-------------
Gross profit .......................... 42,997
Selling, general and administrative
expenses ............................. 22,636
Amortization .......................... 0
Depreciation .......................... 723
Store pre-opening expenses ............ --
Nonrecurring charges (1) .............. --
-------------
Operating income (loss) ............... 19,638
Net interest expense .................. 3,298
-------------
Income (loss) before income tax ...... 16,340
Provision for taxes ................... 620
-------------
Net income (loss) ..................... $ 15,720
=============
Earnings (loss) per common share .....
Ratio of earnings to fixed charges
(2)................................... 3.4x
Deficiency of earnings to fixed
charges (2)........................... $ --
Pro forma (deficiency) of earnings to
fixed charges (3) ....................
CONSOLIDATED CASH FLOWS DATA:
Net cash provided by operations ....... 22,505
Net cash (used in) provided by
investing activities.................. (114)
Net cash (used in) provided by
financing activities.................. (21,618)
OPERATING AND OTHER DATA:
EBITDA (4) ............................ $ 20,380
EBITDA as a percentage of sales ...... 12.2%
Number of stores at end of period .... 37
Same store sales growth (5) ........... --
Pharmacy same store sales
growth (5)(8).........................
Average store size (square feet) at
end of period......................... --
Sales per square foot (7) ............. --
Pharmacy sales as a % of net sales
(8)................................... --
Third-Party Plan sales as a % of
pharmacy sales (9) ...................
Capital expenditures .................. $ 114
BALANCE SHEET DATA (AT END OF PERIOD):
Working capital ....................... $ 13,943
Total assets .......................... 264,355
Total debt and capital lease
obligations (10) ..................... 221,471
Stockholders' equity (deficiency) .... (35,622)
</TABLE>
(RESTUBBED TABLE CONTINUED FROM ABOVE)
<TABLE>
<CAPTION>
COMPANY
------------------------------------------------------------------------------------
PERIOD 39 WEEKS ENDED
SEPTEMBER 26
TO FISCAL YEAR ----------------------------
DECEMBER 31, ----------------------------------------- SEPTEMBER 28, SEPTEMBER 27,
1992 1993 1994 1995 1996 1996 1997
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales ............................. $60,785 $241,474 $281,103 $336,922 $381,466 $281,093 $313,796
Cost of sales ......................... 45,560 181,566 209,678 259,827 288,505 215,797 236,413
------------ --------- --------- --------- --------- ------------- -------------
Gross profit .......................... 15,225 59,908 71,425 77,095 92,961 65,296 77,383
Selling, general and administrative
expenses ............................. 8,019 29,666 39,741 50,326 59,048 42,499 48,218
Amortization .......................... 7,344 27,432 18,238 11,579 16,217 8,514 3,826
Depreciation .......................... 166 729 1,184 1,929 3,015 2,295 2,584
Store pre-opening expenses ............ -- 300 1,220 1,095 139 139 600
Nonrecurring charges (1) .............. -- -- -- -- -- -- 10,887
------------ --------- --------- --------- --------- ------------- -------------
Operating income (loss) ............... (304) 1,781 11,042 12,166 14,542 11,849 11,268
Net interest expense .................. 6,989 26,199 27,480 30,224 32,396 24,334 25,433
------------ --------- --------- --------- --------- ------------- -------------
Income (loss) before income tax ...... (7,293) (24,418) (16,438) (18,058) (17,854) (12,485) (14,165)
Provision for taxes ................... -- -- -- -- -- -- --
------------ --------- --------- --------- --------- ------------- -------------
Net income (loss) ..................... $(7,293) $(24,418) $(16,438) $(18,058) $(17,854) $(12,485) $(14,165)
============ ========= ========= ========= ========= ============= =============
Earnings (loss) per common share ..... $ (0.73) $ (2.34) $ (1.55) $ (1.70) $ (1.69) $ (1.18) $ (1.34)
============ ========= ========= ========= ========= ============= =============
Ratio of earnings to fixed charges
(2)................................... -- -- -- -- -- -- --
Deficiency of earnings to fixed
charges (2)........................... $ (7,293) $(24,418) $(16,630) $(18,905) $(17,854) $(12,485) $(14,165)
Pro forma (deficiency) of earnings to
fixed charges (3) .................... (5,327) (3,832)
CONSOLIDATED CASH FLOWS DATA:
Net cash provided by operations ....... 1,532 7,021 15,297 6,734 12,595 6,656 (3,203)
Net cash (used in) provided by
investing activities.................. (174,825) (874) (11,238) (12,754) (3,769) (2,937) (3,856)
Net cash (used in) provided by
financing activities.................. 175,534 (6,138) (2,940) 4,784 (10,743) (5,609) 7,061
OPERATING AND OTHER DATA:
EBITDA (4) ............................ $ 7,206 $ 29,975 $ 31,188 $ 27,443 $ 35,300 $ 23,814 $ 29,747
EBITDA as a percentage of sales ...... 11.9% 12.4% 11.1% 8.2% 9.3% 8.5% 9.5%
Number of stores at end of period .... 37 40 51 59 60 60 65
Same store sales growth (5) ........... 2.4%(6) 3.3% 1.6% (3.5)% 8.3% 7.8% 7.9%
Pharmacy same store sales
growth (5)(8)......................... -- -- 14.2% 7.0% 25.5% 25.1% 25.4%
Average store size (square feet) at
end of period......................... 6,166(6) 6,172 6,596 6,712 6,733 6,733 6,832
Sales per square foot (7) ............. $ 1,001(6)$ 1,022 $ 970 $ 898 $ 956 $ 708 $ 751
Pharmacy sales as a % of net sales
(8)................................... -- 16.6% 17.6% 19.0% 21.8% 21.5% 24.8%
Third-Party Plan sales as a % of
pharmacy sales (9) ................... 45.7% 58.2% 64.4% 63.3% 72.9%
Capital expenditures .................. $ 950 $ 1,838 $ 9,947 $ 6,868 $ 1,247 $ 913 $ 4,931
BALANCE SHEET DATA (AT END OF PERIOD):
Working capital ....................... $ 13,722 $ 14,285 $ 20,152 $ 13,699 $ 9,917 $ 8,220 $ 29,849
Total assets .......................... 260,674 234,430 229,699 235,860 222,476 226,060 239,520
Total debt and capital lease
obligations (10) ..................... 221,815 223,422 228,764 244,104 245,657 247,570 262,649
Stockholders' equity (deficiency) .... 16,236 (6,757) (23,170) (41,196) (59,396) (54,027) (73,561)
</TABLE>
25
<PAGE>
- ------------
(1) During the first quarter of fiscal 1997, the Company considered a
public offering of its common stock and took certain steps in
connection with these plans. Such plans were abandoned upon
consummation of the Recapitalization discussed in Note 10 of the Notes
to Consolidated Financial Statements (Unaudited) for the 39 weeks ended
September 27, 1997. Costs and expenses incurred in connection with the
abandoned public offering, the Recapitalization and the exchange offers
referred to in Note 10 of the Notes to Consolidated Financial
Statements (Unaudited) aggregated approximately $10.9 million,
including investment banking fees of $7.7 million (including $3.5
million to an affiliate of DLJMBPII and $0.6 million to certain
affiliates of Bain Capital), legal and accounting fees of $1.6 million,
stand-by commitment fees relating to certain change of control offers
of $1.2 million to an affiliate of DLJMBPII, and other costs of $0.4
million, which the Company has treated as a non-recurring expense
because such expenses related to financing activities in connection
with the Recapitalization and related events, which the Company does
not expect to repeat.
(2) The ratio of earnings to fixed charges is computed by dividing (i)
income (loss) before interest expense, other fixed charges and
extraordinary items by (ii) fixed charges, including capitalized
interest, interest expense, amortization of deferred financing costs
and the portion of rent expense which represents interest (assumed to
be one-third). For the period September 26, 1992 to December 31, 1992,
fiscal years 1993, 1994, 1995 and 1996 and the 39 weeks ended September
28, 1996 and September 27, 1997, earnings were insufficient to cover
fixed charges. Included in the loss before extraordinary items for the
39 weeks ended September 27, 1997 was a nonrecurring charge of $10,887,
as disclosed in Note 11 to the Company's consolidated financial
statements. If such charge had not been incurred, earnings would have
been insufficient to cover fixed charges by $3,278.
(3) On a pro forma basis, after giving effect to the Offering, earnings for
fiscal year 1996 and the 39 weeks ended September 27, 1997 would have
been insufficient to cover fixed charges. Included in the loss before
extraordinary items for the 39 weeks ended September 27, 1997 was a
nonrecurring charge of $10,887 as disclosed in Note 11 to the Company's
consolidated financial statements. If such charge had not been
incurred, on a pro forma basis, after giving effect to the Offering,
the ratio of earnings to fixed charges would have been 1.3x.
(4) As used herein, "EBITDA" means net income (loss) plus nonrecurring
charges, interest, income taxes, depreciation, amortization and other
non-cash items (primarily deferred rents). Management believes that
EBITDA, as presented, represents a useful measure of assessing the
performance of the Company's ongoing operating activities as it
reflects the earnings trends of the Company without the impact of
certain non-cash charges. Targets and positive trends in EBITDA are
used as the performance measure for determining management's bonus
compensation; EBITDA is also utilized by the Company's creditors in
assessing debt covenant compliance. The Company understands that, while
EBITDA is frequently used by security analysts in the evaluation of
companies, it is not necessarily comparable to other similarly titled
captions of other companies due to potential inconsistencies in the
method of calculation. EBITDA is not intended as an alternative to cash
flow from operating activities as a measure of liquidity, nor an
alternative to net income as an indicator of the Company's operating
performance nor any other measure of performance in conformity with
GAAP.
A reconciliation of net income (loss) to EBITDA for each period
included above is set forth below (dollars in thousands):
<TABLE>
<CAPTION>
JAN. 1 SEPT. 26 FISCAL YEAR 39 WEEKS ENDED
TO TO ------------------------------------------------- ------------------------
SEPT. 25, DEC. 31, SEPT. 28, SEPT. 27,
1992 1992 1993 1994 1995 1996 1996 1997
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net income (loss) .... $15,720 $(7,293) $(24,418) $(16,438) $(18,058) $(17,854) $(12,485) $(14,165)
Net interest expense 3,298 6,989 26,199 27,480 30,224 32,396 24,334 25,433
Amortization ......... -- 7,344 27,432 18,238 11,579 16,217 8,514 3,826
Depreciation ......... 723 166 729 1,184 1,929 3,015 2,295 2,584
Nonrecurring charges -- -- -- -- -- -- -- 10,887
Other non-cash items 639 -- 33 724 1,769 1,526 1,156 1,182
----------- ---------- ----------- ----------- ----------- ----------- ----------- -----------
EBITDA ............... $20,380 $ 7,206 $ 29,975 $ 31,188 $ 27,443 $ 35,300 $ 23,814 $ 29,747
=========== ========== =========== =========== =========== =========== =========== ===========
</TABLE>
(5) Same store sales figures include stores that have been in operation for
at least 13 months.
(6) For the year ended December 31, 1992.
(7) The Company experienced a decline in sales per square foot from 1993
through 1995 as a result of the opening of additional stores in
connection with the Company's expansion. The opening of such additional
stores resulted in a decline in sales per square foot principally
because (i) the average square footage for the new stores was greater
than that of the existing store base and (ii) new stores generally take
some time to reach a mature level of sales. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--General."
(8) Prior to 1993, the Company did not separately track pharmacy sales.
(9) Prior to fiscal year 1994, the Company's pharmacy system did not
separately track third-party sales.
(10) Excludes deferred rent obligations of approximately $4.0 million and
$5.4 million at December 28, 1996 and at September 27, 1997,
respectively.
26
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following should be read in connection with the consolidated financial
statements of the Company and the notes thereto included elsewhere in this
Prospectus.
GENERAL
The Company generates revenues primarily through sales of OTC drugs and
prescription pharmaceutical products, health and beauty aids, food and
beverage items, tobacco products, cosmetics, housewares, hosiery, greeting
cards, photofinishing, photo supplies and seasonal merchandise. Health and
beauty products, including OTC drugs, represent the largest of the Company's
product categories. The Company's primary costs and expenses consist of (i)
inventory costs, (ii) labor expenses and (iii) occupancy costs.
In 1994 and 1995, the Company experienced rapid expansion, growing from 40
stores to 59 stores. However, as a result of liquidity constraints and the
need for improved inventory controls, the Company was forced to suspend its
store expansion program in late 1995. In early 1996, a strengthened
management team led by Anthony Cuti, the Company's new Chairman and Chief
Executive Officer, took several measures to improve operations such as
decreasing out-of-stock occurrences, creating a loss prevention function to
control inventory shrink and continuing to invest in MIS.
The Company had sales per square foot of $956 and approximately $1,054 in
fiscal 1996 and fiscal 1997, respectively. The Company believes that sales
per square foot are a useful measure of comparing the Company's performance
to that of its competitors because it is a measure of a store's sales
productivity. The Company experienced a decline in sales per square foot from
1993 through 1995 as a result of the opening of additional stores in
connection with the Company's expansion plans during that period. The opening
of such additional stores resulted in a decline in sales per square foot
principally because (i) the average square footage for the new stores was
greater than that of the existing store based and (ii) new stores generally
take some time to reach a mature level of sales. The Company currently
expects that its sales per square foot may decline as it embarks on its plan
to increase new store openings during 1998 and 1999. The Company believes
that its competitors in the industry experience increases and decreases in
sales per square foot for similar reasons.
In 1997, the Company resumed its store expansion program, opening seven
stores in 1997. Generally a new Duane Reade store requires an initial
investment of approximately $1.1 million in capital expenditures and working
capital. Since 1993, all of the Company's new stores have become profitable
on an operating basis within the first full year of operation. Over the next
two years, the Company plans to open approximately 30 to 40 stores, primarily
in New York City.
Over the past two years, Third Party Plans, including managed care
providers and insurance companies, have comprised an increasing percentage of
the Company's pharmacy business as the health care industry shifts to managed
care. While sales to customers covered by Third Party Plans result in lower
gross profit rates due to competitive pricing, the Company believes that such
lower rates are offset by increased volume of pharmacy sales and the
opportunity to leverage fixed expenses.
The Company includes stores that have been in operation for at least 13
months for purposes of calculating comparable store sales figures.
The Company's predecessor was founded in 1960. In 1992, Bain Capital
formed the Company to acquire the Company's predecessor from its founders
through a leveraged buyout, financed primarily with the proceeds from the
Zero Coupon Notes and the Senior Notes. In June 1997, investment funds
affiliated with DLJMBPII (the "DLJMB Entities"), an affiliate of DLJ, the
Underwriter, acquired approximately 91.5% of the outstanding capital stock of
the Company from Bain Capital and certain other selling securityholders, for
approximately $78.7 million in cash, pursuant to a Recapitalization
Agreement, dated June 18, 1997 (the "Recapitalization Agreement"). Upon
consummation of such purchase, the Company reclassified all of its
outstanding capital stock (then consisting of four classes) into one class of
common stock, $0.01 par value per share. Upon consummation of the Common
Stock Offering, assuming no
27
<PAGE>
exercise of the underwriters' overallotment option, the DLJMB Entities will
hold approximately 52.4% of the Common Stock on a fully diluted basis. See
"Principal Stockholders."
Prior to the consummation of the Offering, the Company's primary asset is
all of the outstanding common stock of Daboco, Inc., a New York corporation
("Daboco"), with Daboco and DRI, a direct wholly-owned subsidiary of Daboco,
together owning all of the outstanding partnership interests of Duane Reade,
a New York general partnership ("DR") (Daboco owns a 99% partnership interest
and DRI owns the remaining 1% partnership interest). Substantially all of the
operations of the Company are conducted through DR. Concurrently with the
consummation of the Offering, Daboco will be merged with and into the Company
(the "Merger"), resulting in the Company directly owning 99% of the
partnership interests of DR (the "Partnership Interest") and DRI continuing
to own a 1% partnership interest. Following the consummation of the Merger,
the primary assets of the Company will be the Partnership Interest and 100%
of the outstanding common stock of DRI.
RESULTS OF OPERATIONS
The following sets forth the results of operations as a percentage of
sales for the periods indicated.
<TABLE>
<CAPTION>
39 WEEKS ENDED
--------------------------------
FISCAL YEAR SEPTEMBER 28, SEPTEMBER 27,
----------------------------
1994 1995 1996 1996 1997
<S> <C> <C> <C> <C> <C>
Net sales .................. 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales .............. 74.6 77.1 75.6 76.8 75.3
-------- -------- -------- --------------- ---------------
Gross profit ............... 25.4 22.9 24.4 23.2 24.7
-------- -------- -------- --------------- ---------------
Selling, general and
administrative expenses .. 14.1 14.9 15.5 15.1 15.4
Amortization ............... 6.5 3.5 4.3 3.0 1.2
Depreciation ............... 0.4 0.6 0.8 0.8 0.8
Store pre-opening expenses 0.4 0.3 0.0 0.1 0.2
Nonrecurring charges ....... -- -- -- -- 3.5
-------- -------- -------- --------------- ---------------
Operating income ........... 4.0 3.6 3.8 4.2 3.6
Net interest expense ....... 9.8 9.0 8.5 8.6 8.1
-------- -------- -------- --------------- ---------------
Net loss ................... (5.8)% (5.4)% (4.7)% (4.4)% (4.5)%
======== ======== ======== =============== ===============
</TABLE>
39 WEEKS ENDED SEPTEMBER 27, 1997 COMPARED TO 39 WEEKS ENDED SEPTEMBER 28,
1996
Net sales in the 39 weeks ended September 27, 1997 were $313.8 million, an
increase of 11.6% over net sales of $281.1 million for the 39 weeks ended
September 28, 1996. The increase was attributable to increased comparable
store sales of 7.9% and the inclusion of one new store opened during the 39
weeks ended September 28, 1996 for the entire 1997 period and five new stores
opened in 1997.
Cost of sales as a percentage of net sales decreased to 75.3% for the 39
weeks ended September 27, 1997 from 76.8% for the 39 weeks ended September
28, 1996, resulting in an increase in gross profit margin to 24.7% for the
1997 period from 23.2% during the same period in 1996. The increase in gross
margin resulted from a number of factors including (i) increased contribution
from the sale of higher margin merchandise such as cosmetics, vitamins,
general merchandise, generic drugs and private label products, (ii) higher
promotional allowances received from vendors and (iii) lower occupancy costs
that increased at a lesser rate than the rate at which sales increased.
Selling, general and administrative expenses represented 15.4% and 15.1%
of net sales in the 39 weeks ended September 27, 1997 and September 28, 1996,
respectively. The percentage increase in 1997 compared to 1996 resulted
principally from higher selling and administrative expenses including (i)
higher store salaries as a percentage of net sales (principally from new
stores during the early months of
28
<PAGE>
operation) and (ii) operating costs related to the Company's management
information systems department, partially offset by elimination of agreements
requiring the annual payment of $1.0 million in management fees to Bain
Capital. Such agreements were terminated as a result of the Recapitalization.
The Company believes that as the Company's new stores mature, salaries will
increase at a lesser rate than store sales.
Amortization of goodwill and other intangibles in the 39 weeks ended
September 27, 1997 and September 28, 1996 was $3.8 million and $8.5 million,
respectively. The decrease in amortization is principally a result of the
completion in 1996 of amortization of covenants not to compete and the
related write-off of the balance of such amounts during the fourth quarter of
1996.
Depreciation was $2.6 million and $2.3 million in the 39 weeks ended
September 27, 1997 and September 28, 1996, respectively.
Store pre-opening expenses increased from $0.1 million in the 39 weeks
ended September 28, 1996 to $0.6 million in the 39 weeks ended September 27,
1997 due to the opening of five new store locations in 1997 compared to one
in 1996.
Net interest expense was $25.4 million in the 39 weeks ended September 27,
1997 compared to $24.3 million in the 39 weeks ended September 28, 1996. The
increase in interest expense was principally due to (i) higher non-cash
accretion of the Zero Coupon Notes, (ii) interest related to financing of
third party accounts receivable and (iii) increased interest on borrowings
under the revolving credit facility, partially offset by (a) reduced interest
on term loan borrowings caused by the decrease in average balance from $72.8
million for the 39 weeks ended September 28, 1996 to $66.5 million for the 39
weeks ended September 27, 1997 and a decrease in the average interest rate
from 9.1% for the 39 weeks ended September 28, 1996 to 8.8% for the 39 weeks
ended September 27, 1997 and (b) reduced interest on capital lease
obligations.
The net loss for the Company increased by $1.7 million from $12.5 million
in the 39 weeks ended September 28, 1996 to $14.2 million in the 39 weeks
ended September 27, 1997 primarily as a result of nonrecurring charges (see
Note 11 of Notes to Consolidated Financial Statements (Unaudited)) and
increases in selling, general and administrative expenses and interest
expense, partially offset by increased sales and gross profit margin and
lower amortization of intangibles. The Company's EBITDA improved by $5.9
million or 24.9% to $29.7 million in the 39 weeks ended September 27, 1997
compared to $23.8 million in the 39 weeks ended September 28, 1996. EBITDA as
a percentage of sales increased to 9.5% in the 39 weeks ended September 27,
1997 from 8.5% in the 39 weeks ended September 28, 1996.
FISCAL 1996 COMPARED TO FISCAL 1995
Net sales in 1996 were $381.5 million, an increase of 13.2% over 1995 net
sales of $336.9 million. The increase was due to increased comparable store
sales of 8.3% and the inclusion of eight stores opened during 1995 for the
entire 1996 period and of one store opened in 1996. The increase in
comparable store sales was primarily attributable to increased pharmacy
sales, which increased to 21.8% of total sales in 1996 compared to 19.0% of
total sales in 1995.
Cost of sales as a percentage of net sales decreased to 75.6% for 1996
from 77.1% for 1995, resulting in an increase in gross profit margin to 24.4%
for 1996 from 22.9% for 1995. The increase in gross margin resulted from a
number of factors including (i) lower inventory shrink losses, (ii) increased
contributions from the sale of generic drugs and private label products,
(iii) less promotional activity and (iv) lower rent-to-sales ratios in stores
opened during 1995 and 1994. The increases were partially offset by lower
gross margins resulting from sales to customers covered by Third Party Plans.
Selling, general and administrative expenses were $59.0 million or 15.5%
of net sales and $50.3 million or 14.9% of net sales in 1996 and 1995,
respectively. The percentage increase in 1996 compared to 1995 resulted
principally from higher administrative expenses, including (i) operating
costs related to the Company's management information systems department,
(ii) administrative salaries and one time executive search and severance
expenses and (iii) professional and consulting fees principally for the
warehouse and loss prevention areas. The increases were partially offset by
lower store operating
29
<PAGE>
expenses as a percentage of net sales primarily due to a higher volume of
pharmacy sales, which allows the Company to leverage other fixed store
operating expenses.
Amortization of goodwill and other intangibles in 1995 and 1996 was $11.6
million and $16.2 million, respectively. The increase in amortization was
caused by an increase in the amortization of covenants not to compete from
$8.1 million in 1995 to $11.4 million in 1996 and amortization of systems
installation and integration costs in an amount of $1.4 million in 1996. The
increase in amortization of covenants not to compete was caused by the
write-off of the balance of such intangibles in 1996 resulting from the
termination of the related agreements. Amortization of systems installation
and integration costs began in 1996.
The increase in depreciation from $1.9 million in 1995 to $3.0 million in
1996 resulted principally from (i) depreciation of data processing equipment
which began in 1996 and (ii) a full year's depreciation in 1996 of assets of
eight stores that were opened in 1995.
Store pre-opening expenses decreased from $1.1 million in 1995 to $0.1
million in 1996 due to the opening of one new store location in 1996 compared
to eight in 1995.
Net interest expense increased 7.2% to $32.4 million in 1996 from $30.2
million in 1995. The increase in interest expense was principally due to the
higher non-cash accretion of the Zero Coupon Notes offset, in part, by
reduced interest on term loan borrowings resulting from the decrease in
average outstanding balance from $75.1 million to $72.0 million and a
decrease in the average interest rate from 9.5% to 9.1%.
The net loss for the Company decreased by $0.2 million or 1.1% from $18.1
million in 1995 to $17.9 million in 1996 primarily as a result of increased
sales and gross profit margin offset, in part, by increases in selling,
general and administrative expenses and amortization of intangibles. The
Company's EBITDA increased by $7.9 million or 28.6% to $35.3 million in 1996
compared to $27.4 million in 1995. EBITDA as a percentage of sales increased
to 9.3% in 1996 from 8.2% in 1995.
FISCAL 1995 COMPARED TO FISCAL 1994
Net sales in 1995 were $336.9 million, an increase of 19.9% over 1994 net
sales of $281.1 million. The increase was primarily due to the inclusion of
11 new stores opened during 1994 for the entire 1995 period and of eight
stores opened during 1995, partially offset by a decrease in comparable store
sales of 3.5%.
Cost of sales as a percentage of net sales increased to 77.1% for 1995
from 74.6% for 1994. The increase in cost of sales resulted from a number of
factors, including: (i) increased inventory losses arising from inventory
shrink and from difficulties encountered in implementing new warehousing and
merchandising systems, (ii) delays in implementation of normal price
increases, (iii) increased promotional activity, primarily in the last
quarter of 1995, and (iv) increased occupancy expense as a percentage of
sales in 1995 as compared with 1994. These changes were partially offset by a
decline in amortization of certain acquisition costs, which amortization was
completed in the third quarter of 1994.
Selling, general and administrative expenses for 1995 increased to $50.3
million from $39.7 million for 1994, representing 14.9% and 14.1% of sales in
1995 and 1994, respectively. Such percentage increase in 1995 resulted
principally from additional costs from operating new stores and the
implementation of new MIS.
Amortization of goodwill and other intangibles decreased from $18.2
million in 1994 to $11.6 million in 1995. This decrease was primarily
attributable to a decrease in amortization of covenants not to compete from
$13.0 million in 1994 to $8.1 million in 1995. The decrease in amortization
of covenants not to compete in 1995 as compared to 1994 is a result of the
double declining balance method of amortization for such intangibles.
Amortization of customer files in connection with the acquisition of the
Company by Bain Capital in September 1992, which amounted to $1.7 million in
1994, was completed in the third quarter of 1994.
Depreciation charges in 1995 and 1994 were $1.9 million and $1.2 million,
respectively. The increase in 1995 resulted principally from (i) depreciation
in 1995 of assets of eight new store locations opened and (ii) a full year's
depreciation in 1995 of assets of 11 store locations that were opened in 1994
as compared to one-half year's depreciation of such assets in 1994.
30
<PAGE>
Store pre-opening expenses of $1.1 million and $1.2 million in 1995 and
1994, respectively, relate principally to eight new store locations opened in
1995 and 11 new store locations opened in 1994.
Net interest expense increased from $27.5 million in 1994 to $30.2 million
in 1995. This increase was principally due to an increase in the non-cash
accretion of the Zero Coupon Notes of $1.2 million and higher interest on
term loan borrowings resulting from a higher average interest rate of 9.5%
for 1995 as compared to 7.8% for 1994.
The net loss for the Company increased by $1.6 million or 9.8% from $16.4
million in 1994 to $18.1 million in 1995 primarily as a result of a decrease
in gross profit and an increase in selling, general and administrative
expenses offset, in part, by a decrease in amortization expense. The
Company's EBITDA decreased by $3.8 million or 12.2% to $27.4 million in 1995
compared to $31.2 million in 1994. EBITDA as a percentage of sales declined
to 8.2% in 1995 from 11.1% in 1994.
LIQUIDITY AND CAPITAL RESOURCES
On September 30, 1997, the Company entered into the Existing Credit
Agreement, which provides for, among other things, $65.5 million of term
loans and up to $30.0 million of revolving loans. As of October 25, 1997,
outstanding balances thereunder totaled $91.5 million. The Company utilizes
cash flow from operations, together with borrowings under the revolving
portion of the Existing Credit Agreement, to fund working capital needs,
investing activities (consisting primarily of capital expenditures) and
financing activities (normal debt service requirements, interest payments and
repayment of term and revolving loans outstanding). Concurrently with the
consummation of the Refinancing Plan, the Company expects to refinance and
replace the Existing Credit Agreement with the New Credit Agreement. See
"Description of Certain Indebtedness--New Credit Agreement."
Working capital was $9.9 million and $13.7 million as of December 28, 1996
and December 30, 1995, respectively, and $29.8 million on September 27, 1997.
The Company's capital requirements primarily result from opening and stocking
new stores and from the continuing development of new MIS. The Company's
ability to open stores in 1996 was limited to a certain degree by liquidity
considerations. The Company believes that there are significant opportunities
to open additional stores, and currently plans to open 30 to 40 stores in the
next two years. The Company expects to spend approximately $16 million in
1998 on capital expenditures primarily for new and replacement stores.
Working capital is also required to support inventory for the Company's
existing stores. Historically, the Company has been able to lease its store
locations. The Company has experienced a significant increase in accounts
receivable due to increased pharmacy sales in connection with Third Party
Plans, as compared to non-Third Party Plan sales which are generally paid by
cash or credit card. However, the Company believes that it has adequately
provided for liquidity by entering into a non-recourse factoring arrangement
whereby the Company sells accounts receivable associated with Third Party
Plans.
For the fiscal year ended December 28, 1996, net cash provided by
operating activities was $12.6 million, compared to $6.7 million for the
fiscal year ended December 30, 1995. The primary reasons for this increase
relate to an increase in operating earnings before the amortization of
goodwill and other intangibles, depreciation and amortization of property and
equipment and interest expense, partially offset by a decrease in working
capital primarily due to a decrease in accounts payable. For the fiscal year
ended December 28, 1996, net cash used in investing activities was $3.8
million, compared to $12.8 million for the fiscal year ended December 30,
1995. This reduction primarily resulted from a decrease in capital
expenditures and a decrease in systems development costs. For the fiscal year
ended December 28, 1996, net cash used in financing activities was $10.7
million, compared to $4.8 million provided by financing activities for the
fiscal year ended December 30, 1995. This reduction primarily resulted from
decreased borrowings under the Company's then existing credit facility and a
decrease in capital lease financing.
For the 39 weeks ended September 27, 1997 net cash used in operating
activities was $3.2 million, compared to $6.7 million provided by operating
activities during the 39 weeks ended September 28, 1996. The primary reasons
for this decrease are (i) an increase in inventory and accounts payable
during the 1997 period, partially offset by an increase in operating
earnings. The Company's significant increase in inventory resulted from
management's decision to take advantage of a number of
31
<PAGE>
forward purchasing opportunities, accumulate inventory in advance of
additional store openings and seasonal inventory buildup during the 1997
period. The Company believes that the activities did not and will not
materially adversely affect the Company's liquidity. For the 39 weeks ended
September 27, 1997, net cash used in investing activities was $3.9 million,
compared to $2.9 million for the 39 weeks ended September 28, 1996. This
increase primarily resulted from an increase in capital expenditures during
the 1997 period, partially offset by a decrease in the capitalization of
systems development costs. For the 39 weeks ended September 27, 1997, net
cash provided by financing activities was $7.1 million, compared to $5.6
million used in financing activities for the 39 weeks ended September 28,
1996. This increase primarily resulted from increased borrowings under the
revolving portion of the Existing Credit Agreement.
Leases for eight of the Company's stores that generated approximately
12.8% of the Company's net sales for the 39 week period ended September 27,
1997 are scheduled to expire before the end of the year 2000. The Company
believes that it will be able to renew such leases on economically favorable
terms or, alternatively, find other economically attractive locations to
lease. See "Risk Factors--Uncertainty of Lease Renewals."
As of September 27, 1997, approximately 1,800 of the Company's
approximately 2,000 employees were represented by various labor unions and
were covered by collective bargaining agreements. Pursuant to the terms of
such collective bargaining agreements, the Company is required to pay certain
annual increases in salary and benefits to such employees. The Company does
not believe that such increases will have a material impact on the Company's
liquidity or results of operations. See "Risk Factors--Collective Bargaining
Agreements" and "Business--Employees."
The net proceeds received by the Company from the Offering, together with
the net proceeds received by the Company from the Common Stock Offering and
borrowings under the New Credit Agreement, will be used to complete the
Refinancing Plan. See "Use of Proceeds." The Refinancing Plan is designed to
enhance the Company's financial flexibility and enable it to pursue growth
opportunities and implement capital improvements. The Company expects that
the Refinancing Plan will reduce the Company's overall level of indebtedness,
simplify the Company's capital structure and provide it with access to
additional borrowings. See "Prospectus Summary--Refinancing Plan."
Following the implementation of the Refinancing Plan, the Company believes
that, based on current levels of operations and anticipated growth, cash flow
from operations, together with other available sources of funds, including
borrowings under the New Credit Agreement, will be adequate for at least the
next two years to make required payments of principal and interest on the
Company's indebtedness (including the New Senior Subordinated Notes), to fund
anticipated capital expenditures and working capital requirements and to
comply with the terms of its debt agreements. The ability of the Company to
meet its debt service obligations and reduce its total debt will be dependent
upon the future performance of the Company and its subsidiaries which, in
turn, will be subject to general economic, financial, business, competitive,
legislative, regulatory and other conditions, certain of which are beyond the
Company's control. In addition, there can be no assurance that the Company's
operating results, cash flow and capital resources will be sufficient for
payment of its indebtedness in the future. The Company expects that
substantially all of its borrowings under the New Credit Agreement will bear
interest at floating rates; therefore, the Company's financial condition will
be affected by the changes in prevailing interest rates. The Company expects
to enter into interest rate protection agreements to minimize the impact from
a rise in interest rates. See "Risk Factors--Risks Associated with
Substantial Indebtedness."
TAX BENEFITS FROM NET OPERATING LOSSES
At September 27, 1997, the Company had net operating loss carryforwards
("NOLs") of approximately $71.0 million, which are due to expire in the years
2007 through 2012. These NOLs may be used to offset future taxable income
through 2012 and thereby reduce or eliminate the Company's federal income
taxes otherwise payable. The Internal Revenue Code of 1986, as amended (the
"Code"), imposes significant limitations on the utilization of NOLs in the
event of an "ownership change," as defined in section 382 of the Code (the
"Section 382 Limitation"). The Section 382 Limitation is an annual limitation
on the amount of pre-ownership change NOLs that a corporation may use to
offset its post-ownership change income. The Section 382 Limitation is
calculated by multiplying the value of a corporation's stock
32
<PAGE>
immediately before an ownership change by the long-term tax-exempt rate (as
published by the Internal Revenue Service). Generally, an ownership change
occurs with respect to a corporation if the aggregate increase in the
percentage of stock ownership (by value) of that corporation by one or more
5% shareholders (including certain groups of shareholders who in the
aggregate own at least 5% of that corporation's stock) exceeds 50 percentage
points over a three-year testing period. The Recapitalization caused the
Company to experience an ownership change. As a result, the Company currently
is subject to an annual Section 382 Limitation of approximately $5.0 million
on the amount of NOLs generated prior to the Recapitalization that the
Company may utilize to offset future taxable income. In addition, the Company
believes that it will generate approximately $42.0 million of NOLs in
connection with the Refinancing Plan. Such NOLs will not be subject to the
Section 382 Limitation and may be utilized to offset future taxable income.
However, there can be no assurance that any NOLs will be able to be utilized
by the Company to offset future taxable income or that such NOLs will not
become subject to limitation due to future ownership changes. The Company
does not believe that the Common Stock Offering will result in an ownership
change.
YEAR 2000 COMPLIANCE
The Company has several computer software systems which will require
modification or upgrading to accomodate the year 2000 and thereafter. The
Company believes that all systems can be changed by the end of 1999 and does
not expect the cost of the changes to be material to the Company's financial
condition or results of operations.
SEASONALITY
In general, sales of drugstore items such as prescription drugs, OTC drugs
and health and beauty care products exhibit limited seasonality in the
aggregate, but do vary by product category. Quarterly results are primarily
affected by the timing of new store openings and the sale of seasonal
products. In view of the Company's recent expansion of seasonal
merchandising, the Company expects slightly greater revenue sensitivity
relating to seasonality in the future.
INFLATION
The Company believes that inflation has not had a material impact on
results of operations for the Company during the three years ended December
28, 1996 and the 39 weeks ended September 27, 1997.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings per Share," which requires the presentation of basic and
diluted earnings per share in a company's financial statements for reporting
periods ending subsequent to December 15, 1997. Early adoption of SFAS No.
128 is not permitted. The adoption of SFAS No. 128 is not expected to have a
material impact on the Company's consolidated financial statements.
As of September 27, 1997, there were outstanding options to purchase an
aggregate of 1,126,731 shares of Common Stock, which shares are not included
in the calculation of earnings per share for the 39 weeks ended September 27,
1997 and would not be included in such calculation under the guidance
prescribed by SFAS No. 128 because of the anti-dilutive nature of these
instruments.
33
<PAGE>
BUSINESS
THE DRUGSTORE INDUSTRY
The U.S. drugstore industry generated approximately $91 billion of retail
sales in 1996 according to Drug Store News. The industry has experienced
strong and steady growth, having expanded at a 6.2% compound annual rate over
the ten years through 1996. The industry is expected to continue to grow as
the aging of the population drives long-term demand growth for prescription
drugs. The Company believes that prescription drug use generally rises with
age. In addition to these positive demographic trends, the shift to
increasing use of Third Party Plans is increasing overall prescription drug
usage. Third Party Plans tend to favor lower cost drug therapies over
alternative treatment methods such as surgery or in-hospital treatment.
Additionally, by reducing the out-of-pocket expense to the consumer and by
improving patients' compliance for prescription drug use, Third Party Plans
have helped increase unit growth in prescription drugs.
In recent years, the drugstore industry has experienced significant
consolidation, as national chains have gained market share from independent
operators. According to Drug Store News, the number of drugstores has fallen
from approximately 54,000 in 1990 to approximately 40,000 in 1996. The share
of industry sales represented by independent drugstores (i.e., operators of
less than four stores) has fallen from 35% in 1991 to 24% in 1996. Over the
last ten years, sales at chain drugstores such as Duane Reade have grown at a
compound annual rate of 8.4% compared to the industry average of 6.2%.
The increased role of Third Party Plans has contributed significantly to
industry consolidation. According to IMS America, pharmacy business
attributable to Third Party Plans as a percentage of total pharmacy sales has
risen to 67% in 1996 from 37% in 1990. Third Party Plans typically require
drugstores to enter into contracts with third party payors (such as insurance
plans, HMOs, preferred-provider organizations ("PPOs") and other managed care
providers) to provide prescription drugs at specified rates of reimbursement
for their membership. Although sales to customers covered by Third Party
Plans typically result in lower gross margins compared to cash sales,
management believes that the lower gross margins are offset by the increased
volume of pharmacy sales generated by such Third Party Plans. Drugstore
chains such as the Company, which have high penetration within their markets
and are able to handle the payment processing of such Third Party Plans, are
better able to service the customers of the Third Party Plans and are
therefore gaining market share in the sale of prescription drugs from
independent drugstores and small chains.
Third Party Plans typically seek to form alliances with drugstore chains
in order to benefit from the chains' multiple locations and to take advantage
of on-line management information systems that facilitate claims processing.
Management believes that penetration of Third Party Plans in Manhattan has
historically lagged behind the penetration of such Third Party Plans in the
rest of the United States because until 1994, neither Duane Reade nor most of
Manhattan's independent drugstores aggressively pursued alliances with Third
Party Plans. The Company believes that its extensive network of conveniently
located stores, strong local market position, pricing policies and reputation
for high quality health care products and services provide Duane Reade with a
competitive advantage in attracting business from individual customers as
well as Third Party Plans. While management believes that Third Party Plans
have grown significantly in Manhattan since 1994, it still remains relatively
less penetrated than the rest of the country. The Company believes that as
Third Party Plans continue to penetrate the Manhattan market, the number of
independent drugstores will decline due to competitive pressures.
GENERAL
Duane Reade is the largest drugstore chain in New York City, based on
sales volume, with 58 of its 67 stores located in Manhattan's high-traffic
business and residential districts. The Company operates almost twice as many
stores in Manhattan as its next largest competitor. Since opening its first
store in 1960, the Company has successfully executed a marketing and
operating strategy tailored to the unique characteristics of New York City,
the largest and most densely populated market in the United States. According
to Drug Store News, Duane Reade is the leading drugstore chain in the United
States in terms
34
<PAGE>
of sales per square foot, at $956 per square foot in 1996, which was more
than two times the national average for drugstore chains. For the fiscal year
ended December 28, 1996, the Company had sales of $381.5 million and EBITDA
of $35.3 million, increases of 13.2% and 28.6%, respectively, over the 1995
fiscal year. For the 39 weeks ended September 27, 1997, the Company had sales
of $313.8 million and EBITDA of $29.7 million, increases of 11.6% and 24.9%,
respectively, over the comparable 1996 period. For the fiscal year ended
December 28, 1996 and the 39 week period ended September 27, 1997, the
Company had net losses of $17.9 million and $14.2 million, respectively and,
on a pro forma basis, after giving effect to the Offering and the Refinancing
Plan, would have had net losses of $5.3 million and $3.8 million,
respectively, for such periods.
The Company enjoys strong brand name recognition in New York City, which
it believes results from the Company's many locations in high-traffic areas
of Manhattan and the 30 million shopping bags with the distinctive Duane
Reade logo that the Company distributes annually. An independent survey
conducted in 1996 indicated that approximately 84% of the people who live or
work in Manhattan recognize the Duane Reade name, and seven out of ten
shopped at a Duane Reade store in the past twelve months. The Company was
also recently named "Regional Drug Store Chain of the Year" for 1997 by Drug
Store News.
The Company has developed an operating strategy designed to capitalize on
the unique characteristics of the New York City market, which include
high-traffic volume, complex distribution logistics and high costs of
occupancy, media advertising and personnel. The key elements of the Company's
operating strategy are its (i) everyday low price format and broad product
offering, (ii) low cost operating structure supported by its high volume
stores and low advertising and distribution costs and (iii) ability to design
and operate its stores in a wide variety of sizes and layouts.
The Company believes that its everyday low price format and broad product
offerings provide value and convenience for its customers and build customer
loyalty. The Company's everyday low price format results in prices that the
Company believes are, on average, lower than the prices offered by its
competitors.
The Company is able to keep its operating costs relatively low due to its
high per store sales volume, low warehouse and distribution costs and low
advertising expenditures. The Company's high volume stores allow it to
effectively leverage occupancy costs, payroll and other store operating
expenses. The Company's two primary distribution facilities are located
within five miles of all but one of its 67 stores and, combined with the
rapid turnover of inventory in Duane Reade's stores, result in relatively low
warehouse and distribution costs. The Company's strong brand name recognition
in New York City and everyday low price format allow the Company to minimize
its use of costly media and print advertising and to rely instead on
in-window displays and other less expensive promotional activities.
The Company has demonstrated its ability to successfully operate stores
using a wide variety of store configurations and sizes, which the Company
believes is necessary to succeed in the New York City market. For example,
the size of the Company's stores ranges from 2,600 to 12,300 square feet, and
it operates 29 bi-level stores. The Company believes that its flexibility in
configuring stores provides it with a competitive advantage in securing
locations for its new stores, as many of its competitors target more
standarized spaces for their stores, which are more difficult to find in New
York City. In addition, the Company's management team has extensive
experience and knowledge of the New York City real estate market, allowing it
to aggressively pursue attractive real estate opportunities.
The Company's predecessor was founded in 1960. In 1992, Bain Capital
acquired the Company from its founders and, in June 1997, investment funds
affiliated with DLJMBPII acquired approximately 91.5% of the outstanding
capital stock of the Company from Bain Capital and certain other selling
securityholders. Since the 1992 acquisition, the Company has incurred net
losses in each fiscal year.
In 1994 and 1995 the Company experienced rapid expansion, growing from 40
stores to 59 stores. However, as a result of liquidity constraints and the
need for improved inventory controls, the Company was forced to suspend its
store expansion program in late 1995. In early 1996, a strengthened
management team led by Anthony Cuti, the Company's new Chairman and Chief
Executive Officer, took several
35
<PAGE>
measures to improve operations, including improving inventory controls and
decreasing out-of-stock occurrences, creating a loss prevention function to
control inventory shrink and continuing to invest in MIS. In 1997, the
Company resumed its store expansion program, opening seven stores in 1997.
During Mr. Cuti's tenure at the Company, EBITDA has increased by 53.2% from
$26.9 million for the 52 weeks ended March 29, 1996 to $41.2 million for the
52 weeks ended September 27, 1997, and the Company experienced net losses of
$19.8 million and $19.5 million the 52 weeks ended March 29, 1996 and the 52
weeks ended September 27, 1997, respectively. Net loss before non-recurring
charges for the 52 weeks ended September 27, 1997 was $8.6 million.
GROWTH STRATEGY
The Company believes that, as a result of its successful operating history
and market position in New York City, it is well positioned to capitalize on
the growth opportunities in its market. The Company's strategy for continued
growth is to (i) open additional stores in Manhattan and the surrounding
boroughs, (ii) continue to capitalize on favorable pharmacy trends, (iii)
make opportunistic acquisitions of independent drugstores and pharmacy files
and (iv) continue to implement merchandising initiatives in non-pharmacy
areas.
Open Additional Stores. The Company believes that the Manhattan drugstore
market remains underpenetrated by drugstore chains, with only 50% of the
estimated $2.65 billion in annual drugstore-related sales controlled by
regional or national chains, compared to approximately 74% controlled by
chains nationally. This provides significant opportunities for the Company to
open additional stores in Manhattan as well as in the densely populated areas
of the surrounding boroughs. Some of the Company's most successful stores
have been opened in areas new to the Company, such as the residential areas
of the Upper East and West sides of Manhattan, Brooklyn, the Bronx and
Queens. The Company believes that its long-standing presence in, and
knowledge of, the New York City real estate market, combined with the use of
a proprietary site selection model that considers numerous demographic and
traffic flow variables, have allowed it to identify attractive store
locations. Since 1993, all of the Company's new stores have become profitable
on an operating basis (i.e., prior to allocation of corporate expenses,
goodwill amortization, interest expense and income taxes) within the first
full year of operation. Over the next two years, the Company plans to open
approximately 30 to 40 stores, primarily in New York City. See "Risk
Factors--Risks Associated with Future Growth."
Continue to Capitalize on Favorable Pharmacy Trends. Sales of prescription
and OTC drugs have been growing rapidly throughout the drugstore industry.
The Company expects demographic trends, such as the aging of the U.S.
population, and industry changes, such as growth of Third Party Plans, to
continue to drive increases in the prescription and OTC drug businesses.
Since 1994, the Company has focused on increasing its pharmacy sales by
entering into agreements to service Third Party Plans and by upgrading the
appearance and service level of its store pharmacies. While sales to
customers covered by Third Party Plans result in lower gross profit margins
due to competitive pricing, the Company believes that such lower margins are
offset by the increased volume of pharmacy sales and the opportunity to
leverage fixed expenses. The Company believes that its initiatives, which are
designed to capitalize on industry trends, have resulted in the Company's
pharmacy sales growing at an annual rate of approximately 30% since 1994.
Although these initiatives have helped increase the average number of
prescriptions filled by Duane Reade per store per week from 640 in 1994 to
865 during 1997, the Company's average remains well below the national
industry chain store average of approximately 1,200, providing significant
opportunity for continued pharmacy growth. The Company believes that
continued pharmacy growth will increase overall customer traffic, thereby
also benefitting its non-pharmacy sales.
Make Opportunistic Acquisitions of Independent Drugstores and Pharmacy
Files. The Company believes that the growth of Third Party Plans and the
continued penetration of chain drugstores such as Duane Reade have put
increasing pressure on the approximately 1,400 independent drugstores in New
York City. When appropriate, the Company considers acquiring small local
chains or independent drugstores. The Company also pursues the purchase of
pharmacy files of independent drugstores when such purchases are economically
attractive to the Company. The pharmacy files of independent pharmacists tend
to have a higher proportion of prescriptions not covered by Third Party
Plans, which
36
<PAGE>
generate incremental revenue and higher margins. When appropriate, the
Company retains the services of the pharmacist, whose personal relationship
with the customers generally maximizes the retention rate of the purchased
file. In 1997, the Company acquired one independent drugstore and seven such
pharmacy files and intends to aggressively pursue additional purchases.
Continue to Implement Merchandising Initiatives in Non-Pharmacy
Areas. Management has recently undertaken a number of merchandising
initiatives, including the expansion of certain high-margin categories such
as greeting cards, cosmetics, vitamins, photofinishing and photo supplies and
an expanded seasonal merchandising program. The Company also continues to
focus on category management, which it believes will improve gross margins
and increase non-pharmacy sales. For example, in 1997 the Company introduced
one-hour photofinishing service in three of its stores and intends to
introduce one-hour photofinishing service in approximately seven to ten
additional stores in 1998. The Company has also increased its emphasis on the
sale of its own private label products, which it believes provide a
high-quality, lower priced alternative to name brand products while
generating higher gross profit margins than name brand products. In addition,
in the fourth quarter of 1997, Duane Reade completed its installation of POS
scanners in all of its stores and, by the end of the first quarter of 1998,
will have completed its planogramming initiative in all of its stores. These
systems and initiatives will allow the Company to better analyze sales trends
and merchandise its stores more effectively, which the Company believes will
ultimately increase its sales and profitability.
COMPANY OPERATIONS
Merchandising. Duane Reade's overall merchandising strategy is to provide
the broadest selection of branded and private label drugstore products
available in Manhattan and to sell them at everyday low prices. To further
enhance customer service and loyalty, the Company attempts to maintain a
consistent in-stock position in all merchandise categories. In addition to
prescription and OTC drugs, the Company offers health and beauty aids, food
and beverage items, tobacco products, cosmetics, housewares, hosiery,
greeting cards, photofinishing, photo supplies, seasonal merchandise and
other products. Health and beauty care products, including OTC drugs,
represent the largest of the Company's product categories. Duane Reade
drugstores offer a wide variety of brand name and private label products,
including oral, skin and hair care products, bath supplies, vitamins and
nutritional supplements, feminine hygiene products, family planning products
and baby care products. Popular brands of health and beauty aids are given
ample shelf space, and large sizes are offered, which the Company believes
appeals to the value consciousness of many Manhattan consumers. Convenience
items such as candy, snacks and seasonal goods are positioned near the check
out registers to provide optimum convenience and stimulate impulse purchases
for the customers while allowing the store employees to monitor those product
categories that are particularly susceptible to inventory shrink.
In addition to the wide array of name brand products offered in its
stores, the Company offers its own private label products. Private label
products provide customers with high-quality, lower priced alternatives to
name brand products while generating higher gross profit margins than name
brand products. These offerings also enhance Duane Reade's reputation as a
value-oriented store. The Company currently offers approximately 400 private
label products. In 1996, these private label products accounted for
approximately 4.6% of non-pharmacy sales. The Company believes that its
strong brand image, reputation for quality and reliability in the New York
City market, and its economies of scale in purchasing allow it to
aggressively promote private label goods.
The Company has recently made efforts to increase the sales of certain
high-margin items, such as cosmetics, greeting cards and photofinishing. In
1996, the Company completed the remodeling of the cosmetics sections in 19
stores, which resulted in an approximately 23% increase in cosmetic sales in
those stores with no increase in linear footage. In the greeting cards
category, the Company increased seasonal selection and reformatted the card
section in many of its stores, resulting in a 26% increase in greeting card
sales in 1996 compared to 1995. Other merchandising initiatives completed
during 1996 include an expanded selection of seasonal merchandise, vitamins,
nutrition products and baby accessories, particularly in stores located in
residential areas. The Company believes there are additional opportunities to
continue to refine and improve the merchandise mix in its stores.
37
<PAGE>
The Company also offers same-day photofinishing services in all of its
stores and has recently introduced one-hour photofinishing in three stores.
In 1998, the Company expects to introduce one-hour photofinishing in seven to
ten additional stores. Management believes that photofinishing services
contribute significantly to sales of other merchandise categories because of
customer traffic increases that result from the customer visiting a store
twice, in order to drop off film and pick up the processed photos.
Pharmacy. The Company believes that its pharmacy business will continue to
contribute significantly to the Company's growth. Management also believes
that a larger and stronger pharmacy business will enhance customer loyalty
and generate incremental customer traffic, which is expected to increase
sales of Duane Reade's wide variety of OTC drugs and other non-pharmacy
merchandise. Duane Reade significantly grew its prescription drug sales in
1996 as reflected by its same-store pharmacy sales increase of 25.5% during
1996 compared to 1995 and an increase of 25.4% for the 39 week period ended
September 27, 1997 compared to the same period in 1996. Sales of prescription
and OTC drugs represented approximately 35% of total sales in 1996 as
compared with 33% of total sales in 1995 and approximately 38% of total sales
for the 39 week period ended September 27, 1997. Although the average number
of prescriptions filled by Duane Reade per store per week has increased from
640 in 1994 to 865 during 1997, the Company's average remains well below the
industry chain store average of approximately 1,200, providing significant
opportunity for continued pharmacy growth. The Company believes that the
average number of prescriptions filled per week by it lags behind the
industry average because of (i) the historically low penetration of Third
Party Plans in the New York City area and (ii) the Company's concentration of
stores in business areas, rather than residential areas. The Company believes
continued pharmacy growth will also increase overall customer traffic and
benefit its non-pharmacy sales.
The Company generally locates the pharmacy at the rear of the store in
order to maximize the pharmacy customer's exposure to other categories of
merchandise in the front of the store. Each pharmacy is staffed with a
registered pharmacist and a drug clerk at all times to ensure quick and high
quality service. Each store carries a complete line of both branded and
generic prescription drugs. In 1996, the Company began a program to upgrade
the quality of its pharmacy service. The Company believes that this
initiative has contributed to its strong growth in pharmacy sales and should
continue to benefit the Company as customer loyalty builds in response to
improved service levels.
In addition to customer service initiatives in its pharmacy business, the
Company has remodeled or redesigned 16 of its pharmacies since the beginning
of 1996. This remodeling, which has primarily involved updating the pharmacy
counter area to allow pharmacists and customers to have more direct contact
and providing a consultation and waiting area for customers, has not resulted
in any significant reduction in total retail selling space. By improving the
store layout and accessibility of the pharmacist and pharmacy area, the
stores that have been remodeled have achieved strong growth in their pharmacy
business. All stores opened since 1995 have the new pharmacy counter area
design. The Company currently operates 24 such stores. The Company has also
launched pharmacy marketing initiatives, such as home delivery and
prescription-by-fax services, which it believes have contributed to the
increased sales and customer loyalty of the pharmacy business.
The Company believes that its extensive network of conveniently located
stores, strong local market position, pricing policies and reputation for
high quality health care products and services provide it with a competitive
advantage in attracting pharmacy business from individual customers as well
as Third Party Plans. The percentage of the Company's total prescription drug
sales attributable to Third Party Plans increased to approximately 64% in
1996 from approximately 58% in 1995, and to approximately 73% for the 39 week
period ended September 27, 1997. Although gross margins on sales to Third
Party Plans are generally lower than other prescription drug sales because of
the highly competitive nature of pricing for this business and the purchasing
power of Third Party Plans, management believes that the lower gross profit
margins are offset by the higher volume of pharmacy sales to Third Party Plan
customers allowing the Company to leverage other fixed store operating
expenses. In addition, the Company believes that Third Party Plans generate
additional general merchandise sales by increasing customer traffic in the
stores. As of September 27, 1997, the Company had contracts with over 100
Third-Party Plans, including every major Third Party Plan in the Company's
market areas.
38
<PAGE>
Another important component of the Company's pharmacy growth strategy is
the continued acquisition of prescription files from independent pharmacies
in market areas currently served by existing Company stores. In 1997, the
Company purchased the prescription files of eight independent pharmacies for
an aggregate total of $830,000, which generated approximately $7 million in
revenues on an annualized basis. Independent pharmacists tend to have a
higher proportion of customers that are not Third Party Plans, which provide
the Company with incremental revenue and higher margin contribution. When
appropriate, the Company will retain the services of the pharmacist, whose
personal relationship with the customers generally maximizes the retention
rate of the purchased file. Since 1995, the Company has experienced an
estimated 80% customer retention rate with respect to prescription files
acquired. Presently, there are approximately 1,400 independent pharmacies in
New York City, and the Company believes that these stores will provide
additional acquisition opportunities in the future.
The Company's pharmacies employ computer systems that link all of the
Company's pharmacies and enable them to provide customers with a broad range
of services. The Company's pharmacy computer network profiles customer
medical and other relevant information, supplies customers with information
concerning their drug purchases for income tax and insurance purposes and
prepares prescription labels and receipts. The computer network also
expedites transactions with Third Party Plans by electronically transmitting
prescription information directly to the Third Party Plan and providing
on-line adjudication, which confirms at the time of sale customer
eligibility, prescription coverage and pricing and co-payment requirements
and automatically bills the respective plan. On-line adjudication reduces
losses from rejected claims and eliminates a portion of the Company's
paperwork for billing and collection of receivables and costs associated
therewith.
Store Operations. The majority of the Company's stores are located in the
business and residential areas of Manhattan, the most densely populated area
in the United States. The Company's operations have been tailored to handle
high-volume customer traffic. During 1996, an average Duane Reade store
served approximately 2,500 customers per weekday, and 700 customers during
each of the peak lunch and commuting periods of the day. Some of the
Company's stores may operate up to 25 registers during peak demand periods.
Duane Reade stores range in size from 2,600 to 12,300 square feet, with an
average of 6,800 square feet. The Company's stores are designed to facilitate
customer movement and to minimize inventory shrink. The Company believes that
its wide, straight aisles and well-stocked shelves allow customers to find
merchandise easily and allow the store's employees (managers, security
guards, cashiers and stock clerks) to effectively monitor customer behavior.
The Company attempts to group merchandise logically in order to enable
customers to locate items quickly and to stimulate impulse purchases.
In 1996, the Company began planogramming its stores by using a
computerized space management system to design each store's layout and
product displays. The system seeks to maximize productivity per square foot
of selling space, maintain consistency in merchandising and reduce inventory
levels. To date, 34 stores have been designed by the system. Management
believes that the Company's remaining stores will be planogrammed by the end
of the first quarter of 1998. As a result, the Company believes that it has
yet to realize the full benefits from this system.
The Company establishes each store's hours of operations in an attempt to
best serve customer traffic patterns and purchase habits and to optimize
store labor productivity. Stores in Manhattan's business districts are
generally open five days a week. In residential and appropriate
business/shopping districts, stores are open six or seven days a week with a
heavy emphasis on convenient, early morning and late evening openings. In
1997, the Company had seven stores which were open 24 hours a day, 365 days a
year. The Company intends to continue to identify stores in which extended
operating hours would improve customer service and convenience and contribute
to the Company's profitability. Each store is supervised by one store manager
and one or more assistant store managers. Stores are supplied by deliveries
from the Company's warehouses in Queens an average of three times a week,
allowing the stores to maintain a high in-stock position, maximize store
selling space and minimize inventory required to be held on hand.
39
<PAGE>
The Company attempts to mitigate inventory shrink through (i) the
employment of full time security guards in each store, (ii) the use of a
state-of-the-art Electronic Article Surveillance ("EAS") system that detects
unremoved EAS tags on valuable or easily concealed merchandise and (iii)
merchandise delivery and stocking during non-peak hours. Additionally, all
store and warehouse employees are trained to monitor inventory shrink, and
the Company uses outside consulting services to monitor employee behavior.
Recently, the Company hired a full-time team of loss prevention professionals
and established an anonymous call-in line to allow employees to report
instances of theft. The Company also instituted ongoing audits of warehouse
picking and receiving and an anonymous reward line for the reporting of
theft. The Company believes that these programs have enabled it to control
inventory shrink and will enable it to continue to do so.
Purchasing and Distribution. The Company purchases approximately 82% of
its merchandise directly from manufacturers. The Company distributes
approximately 84% of its merchandise through the Company's warehouses and
receives direct-to-store deliveries for approximately 16% of its purchases.
Direct-to-store deliveries are made for pharmaceuticals, greeting cards,
photofinishing, convenience foods and beverages. The Company purchases from
over 1,000 vendors. The Company believes that there are ample sources of
supply for the merchandise currently sold in its stores. The Company manages
its purchasing through a combination of forward buying, national buying and
vendor discount ("deal") buying in ways in which it believes maximizes its
buying power. For example, the Company uses a computerized forecasting and
investment program that is designed to determine optimal forward buying
quantities before an announced or anticipated price increase has been
implemented. By forward buying, the Company stocks up on regularly carried
items when manufacturers temporarily reduce the cost of goods or when a price
increase has been announced or is anticipated.
The Company operates two warehouses, which are located within five miles
of all but one of its stores. The Company's primary warehouse contains
approximately 150,000 square feet devoted to inventory. The Company believes
that the close proximity of the warehouses to the stores allows the Company
to supply the stores frequently, thereby minimizing inventory and maximizing
distribution economies. The Company also owns a fleet of trucks and vans,
which it uses for all deliveries from the warehouses to the stores.
ADVERTISING AND PROMOTION
The Company regularly promotes key items at reduced retail prices during
four-week promotional periods. Store windows and in-store signs are utilized
to communicate savings and value to shoppers. Additionally, over 30 million
bags with the highly recognizable Duane Reade logo are used by its customers
each year, helping to promote the Company's name throughout New York City.
The Company also utilizes full color circulars to announce new stores and
heavily circulates them in local areas to attract customers. Typically, a new
store sells one to two times its regular volume during a grand opening
promotion, which generally lasts two to three weeks. The Company generally
does not rely heavily on the use of print or broadcast media to promote its
stores. Rather, because of its many high-traffic locations, the Company
typically relies on in-window displays as its primary method of advertising.
In 1997, the Company began using radio advertising. The radio advertising
focuses on the Company's pharmacy business, highlighting services enhanced by
the modern pharmacy computer system, pharmacist accessibility and enhanced
convenience.
40
<PAGE>
PROPERTIES; LEASES
As of November 25, 1997, the Company is operating stores in the following
locations:
<TABLE>
<CAPTION>
LOCATION TOTAL
<S> <C>
Manhattan, NY ..... 58
Brooklyn, NY ...... 4
Bronx, NY ......... 2
Queens, NY ........ 2
Newark, NJ ........ 1
---------
Total ........... 67
</TABLE>
Store leases are generally for 15 year terms. The average year of
expiration for all the Company's leases is 2006. Lease rates are generally
subject only to increases based on inflation, real estate tax increases or
maintenance cost increases. The following table sets forth the lease
expiration dates of the Company's leased stores over each of the next five
years and thereafter. Of the stores with leases expiring in the next five
years, four have renewal options. See "Risk Factors--Uncertainty of Lease
Renewals."
<TABLE>
<CAPTION>
NUMBER OF
YEAR LEASES EXPIRING
<S> <C>
1997 ........... 0
1998 ........... 3
1999 ........... 1
2000 ........... 4
2001 ........... 0
Thereafter ..... 59
</TABLE>
The Company owns a distribution facility and related land in Long Island
City, New York. The building contains approximately 150,000 square feet of
space, all of which is used for warehousing and distribution. The Company
also leases a 50,000 square foot distribution facility in Maspeth, New York,
which is only one mile from the Long Island City facility. The Company leases
space for its corporate headquarters, which is located in Manhattan.
MANAGEMENT INFORMATION SYSTEMS
The Company currently has modern pharmacy and inventory management
information systems. In 1996, the Company completed the installation of a
host-based, modern pharmacy information system. The pharmacy information
system (PDX) has reduced the processing time for electronic reimbursement
approval for prescriptions from Third Party Plan providers from 50 seconds to
seven seconds, and the inventory management information systems (JDA
merchandising and E3 replenishment) have allowed the Company to increase
inventory turns in the warehouses from 11 to 13 per year. In early 1997, the
Company began the process of installing POS systems in its stores. The
Company believes that these systems will allow the Company to better control
pricing, inventory and shrink, while maximizing the benefits derived from the
other parts of its systems installation program. POS will also provide sales
analysis that will enable the Company to improve labor scheduling, and will
help optimize planogram design by allowing detailed analysis of
stock-keeping-unit ("SKU") sales. The installation of the Company's POS
systems was completed in December 1997. Additionally, the Company has
upgraded its financial reporting systems and installed local and wide area
networks to facilitate the transfer of data between systems and from the
stores to headquarters.
COMPETITION
The Company's stores compete on the basis of, among other things,
convenience of location and store layout, product mix, selection, customer
service and price. The New York City drugstore market is highly fragmented
due to the complexities and costs of doing business in the most densely
populated area of the country. The diverse labor pool, local customer needs
and complex real estate market in New York City
41
<PAGE>
all favor regional chains and independent drugstores that are familiar with
the market. Duane Reade's store format is designed to meet the unique needs
of the New York City market and has proven successful in both the business
and residential neighborhoods of Manhattan.
Because of the difficulties of operating in a densely populated area, the
New York City drugstore market remains under-penetrated by national chains as
compared to the rest of the country. According to industry sources,
approximately 74% of the nationwide drugstore market was controlled by
chains, while in New York City that number was approximately 50%. There can
be no assurance that such underpenetration will continue.
Duane Reade believes that it has significant competitive advantages over
the approximately 1,400 independent drugstores in New York City, including
purchasing economies of scale, centrally located warehouses that minimize
store inventory and maximize selling space, a full line of in stock, brand
name merchandise and a convenient store format. Major chain competitors in
the New York City market include Rite-Aid, Genovese and CVS. See "Risk
Factors--Competition."
GOVERNMENT REGULATION
Duane Reade's stores and its distribution facilities are registered with
the federal DEA and are subject to various state and local licensing
requirements. Each of Duane Reade's pharmacies and pharmacists located in New
York are licensed by the State of New York. The pharmacy and pharmacists
employed at Duane Reade's store in Newark, New Jersey are licensed by the
State of New Jersey. In addition, Duane Reade has been granted cigarette tax
stamping licenses from the State of New York and from the City of New York,
which permit Duane Reade to buy cigarettes directly from the manufacturers
and stamp the cigarettes themselves. Duane Reade's stores possess cigarette
tax retail dealers licenses issued by the State of New York, the City of New
York and the State of New Jersey. See "Risk Factors--Regulatory Matters."
EMPLOYEES
As of September 27, 1997, Duane Reade had approximately 2,000 employees,
almost all of whom were full-time. Approximately 1,800 of the Company's 2,000
employees are represented by unions. Non-union employees include employees at
corporate headquarters and store management. The Company's distribution
facility employees are represented by the International Brotherhood of
Teamsters, Chauffeurs and Warehousemen and Helpers of America, Local 815, and
all store employees are represented by the Allied Trade Council. Duane
Reade's three year contracts with these two unions expire on August 31, 1999
and August 31, 1998, respectively. Duane Reade believes that its relations
with its employees are good. See "Risk Factors--Collective Bargaining
Agreements."
TRADEMARKS
The name "Duane Reade" and the "DR" logo are registered trademarks. The
Company believes that it has developed strong brand awareness within the New
York City area. As a result, the Company regards the Duane Reade logo as a
valuable asset.
LEGAL PROCEEDINGS
The Company is a party to certain legal actions arising in the ordinary
course of business. Based on information presently available to the Company,
the Company believes that it has adequate legal defenses or insurance
coverage for these actions and that the ultimate outcome of these actions
will not have a material adverse effect on the Company.
42
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth the directors and executive officers of the
Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
<S> <C> <C>
Anthony J. Cuti .... 51 Chairman, Chief Executive Officer and President
William Tennant .... 50 Senior Vice President and Chief Financial Officer
Gary Charboneau .... 53 Senior Vice President--Sales and Merchandising
Jerry M. Ray ........ 50 Senior Vice President--Store Operations
Nicole S. Arnaboldi 39 Director
David L. Jaffe....... 39 Director
Andrew J. Nathanson . 40 Director
</TABLE>
Two additional directors will be elected by the Board of Directors
following the completion of the Offering.
ANTHONY J. CUTI has been Chairman and Chief Executive Officer of the
Company since April 1996. Prior to joining the Company, Mr. Cuti served as
President and as a member of the Board of Directors of Supermarkets General
and Pathmark from 1993 to 1996 and, prior to being named President of
Supermarkets General and Pathmark, Mr. Cuti was Executive Vice President and
Chief Financial Officer of Supermarkets General. From 1984 to 1990, he was
the Chief Financial Officer of the Bristol-Myers International Group of the
Bristol-Myers Company and prior to that was employed by the Revlon
Corporation.
WILLIAM TENNANT has been Senior Vice President and Chief Financial Officer
of the Company since February 1997. Prior to joining the Company, Mr. Tennant
was Senior Vice President and Chief Financial Officer of Tops Appliance City,
a consumer electronics retailer, from 1993 to 1996. From 1986 to 1993, Mr.
Tennant served as Vice President and Controller for the Great Atlantic &
Pacific Tea Company.
GARY CHARBONEAU has been Senior Vice President in charge of Sales and
Merchandising of the Company since February 1993. Prior to joining the
Company, Mr. Charboneau held various positions at CVS, a retail drugstore
chain, from 1978 to February 1993, most recently as Executive Vice President.
JERRY M. RAY has been Senior Vice President in charge of Store Operations
since July 1996 and served as Vice President of Pharmacy Operations from
April 1995 to June 1996. From 1991 to 1994, Mr. Ray served as President and
CEO of Begley Drugstores, Inc.
NICOLE S. ARNABOLDI has been a Director of the Company since June 1997.
Ms. Arnaboldi is a Managing Director of DLJMB. She joined the DLJ Merchant
Banking Group in March 1993 after six years with The Sprout Group, DLJ's
venture capital affiliate.
DAVID L. JAFFE has been a Director of the Company since June 1997. Mr.
Jaffe is a Managing Director of DLJMB. Mr. Jaffe joined DLJ Merchant Banking
in 1984 and became a Managing Director in 1995. He currently sits on the
Board of Directors of each of EZ Buy and EZ Sell Recycler Corporation, OHA
Financial, Inc., OSF, Inc., Terra Nova Group, Pharmaceutical Fine Chemicals
SA and Brand Scaffold Services, Inc.
ANDREW J. NATHANSON has been a Director of the Company since June 1997.
Mr. Nathanson is a Managing Director of DLJ. Mr. Nathanson joined DLJ in 1989
from Drexel Burnham Lambert, and has been a Managing Director of DLJ since
1991. Mr. Nathanson also serves on the Board of Directors of Specialty Foods,
Inc.
Directors of the Company are currently elected annually by its
stockholders to serve during the ensuing year or until their respective
successors are elected and qualified. Executive officers of the Company are
elected by the Board of Directors to serve until their respective successors
are elected and qualified.
43
<PAGE>
COMMITTEES OF THE BOARD OF DIRECTORS
Prior to the Offering, the Board of Directors had no formal committees. In
connection with the completion of the Common Stock Offering, the Board of
Directors will establish two committees: (i) an Audit Committee and (ii) a
Compensation Committee.
The Audit Committee will make recommendations to the Board of Directors
regarding the Company's independent auditors, approve the scope of the annual
audit activities of the independent auditors and review audit results. It is
expected that a majority of the directors comprising the Audit Committee will
be directors not otherwise affiliated with the Company or its principal
stockholders.
The duties of the Compensation Committee will be to provide a general
review of the Company's compensation and benefit plans to ensure that they
meet corporate objectives. In addition, the Compensation Committee will
review management's recommendations on (i) compensation of all officers of
the Company and (ii) adopting and changing major Company compensation
policies and practices, and report its recommendations to the entire Board of
Directors for approval and authorization. The Compensation Committee will
administer the Company's stock plans. The Board of Directors may also
establish other committees to assist in the discharge of its
responsibilities.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table summarizes the principal components of compensation of
the Chief Executive Officer and the other four highest compensated executive
officers of the Company (the "Named Executive Officers") for the fiscal year
ended December 27, 1997. The compensation set forth below fully reflects
compensation for services performed on behalf of the Company and its
subsidiaries.
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
-------------------------------------- --------------
SECURITIES
NAME AND FISCAL OTHER ANNUAL UNDERLYING ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS(1) COMPENSATION OPTIONS (#) COMPENSATION
<S> <C> <C> <C> <C> <C> <C>
Anthony J. Cuti............. 1997 $386,000 $ -- $ -- 496,569 $ --
Chief Executive Officer
Gary Charboneau............. 1997 243,000 -- -- 141,877 --
Senior Vice
President--Sales and
Merchandising
Jerry M. Ray................ 1997 200,000 -- -- 118,231 --
Senior Vice
President--Store
Operations
William J. Tennant.......... 1997 151,000(2) -- -- 115,393 --
Senior Vice
President--Chief Financial
Officer
Joseph S. Lacko............. 1997 150,000 -- -- 11,823 --
Vice President--Management
Information Systems
</TABLE>
- ------------
(1) Bonuses for 1997 have not yet been determined. Messrs. Cuti,
Charboneau, Ray and Lacko received bonuses in fiscal 1996 of $340,000,
$120,000, $100,000 and $25,000, respectively.
(2) Reflects Mr. Tennant's salary for the partial year from February 18,
1997 (when he joined the Company) through December 27, 1997.
44
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table discloses options granted during 1997 to the Named
Executive Officers.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-----------------------------------------------------------
NUMBER OF % OF TOTAL
SECURITIES OPTIONS POTENTIAL REALIZABLE VALUE AT
UNDERLYING GRANTED TO EXERCISE OR ASSUMED RATES OF STOCK PRICE
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION APPRECIATION FOR OPTION TERM(2)
NAME GRANTED(1) FISCAL YEAR PER SHARE DATE 5% 10%
<S> <C> <C> <C> <C> <C> <C>
Anthony J. Cuti........ 496,569 45.5% $ 8.33 6/18/07 $2,602,022 $6,594,436
Gary Charboneau (3) .. 141,877 13.0 8.33 6/18/07 743,435 1,884,127
Jerry M. Ray (3) ...... 118,231 10.8 8.33 6/18/07 619,530 1,570,081
William J. Tennant
(4)................... 115,393 10.6 7.34-8.33 2/18/07-6/18/07 561,964(5) 1,425,104(5)
Joseph L. Lacko ....... 11,823 1.1 8.33 6/18/07 61,953 157,009
</TABLE>
- ------------
(1) All of such options vest fully on the eighth anniversary of the grant
date and may vest sooner based on the Company's achievement of certain
specified financial targets.
(2) Amounts reflect certain assumed rates of appreciation for the term of
the option as set forth in the executive compensation disclosure rules
of the Securities and Exchange Commission and are not intended to
forecast future appreciation of the Common Stock. Actual gains, if any,
on stock option exercises depend on future performance of the Company's
stock and overall market conditions. For each Named Executive Officer
other than Mr. Tennant, at an annual rate of appreciation of 5% per
year for the option term, the price of the Common Stock would be
approximately $13.57 per share as of the expiration date, and for Mr.
Tennant such price would be approximately $12.62 per share. For each
Named Executive Officer other than Mr. Tennant, at an annual rate of
appreciation of 10% per year for the option term, the price of the
Common Stock would be approximately $21.61 per share as of the
expiration date, and for Mr. Tennant such price would be approximately
$20.10 per share.
(3) All of such options were granted under the Company's Equity Plan (as
defined below). The options granted under such plan are subject to
repurchase provisions upon termination of employment. See "--Stock
Options."
(4) 68,101 of Mr. Tennant's options were granted pursuant to a separate
agreement with the Company, and the remaining 47,292 options were
granted pursuant to the Equity Plan.
(5) Amounts for Mr. Tennant are calculated based on a weighted average
exercise price of $7.75 per share.
FISCAL YEAR END OPTION VALUES
The following table summarizes the number and value of all unexercised
options held by the Named Executive Officers at the end of 1997. There were
no options exercised in the Company's last fiscal year.
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES
UNDERLYING VALUE OF UNEXERCISED
SHARES UNEXERCISED IN-THE-MONEY OPTIONS
ACQUIRED ON OPTIONS AT AT FISCAL YEAR END
NAME EXERCISE VALUE REALIZED FISCAL YEAR END ($)(1)
- ------------------- ------------- -------------- --------------- ---------------------
EXERCISABLE/ EXERCISABLE/
UNEXERCISABLE UNEXERCISABLE
<S> <C> <C> <C> <C>
Anthony J. Cuti..... -- -- 364,530/496,569 2,825,108/0
Gary Charboneau..... -- -- 56,013/141,877 306,443/0
Jerry M. Ray........ -- -- 45,032/118,231 285,161/0
William J. Tennant -- -- 68,101/47,292 67,420/0
Joseph S. Lacko ... -- -- 17,025/11,823 131,944/0
</TABLE>
- ------------
(1) Assumes the value of the Common Stock as of December 27, 1997 is equal
to $8.33 per share.
45
<PAGE>
Mr. Weston, the Company's former Chief Executive Officer, resigned from
the Company effective as of February 28, 1997. In connection with Mr.
Weston's severance from the Company and the Recapitalization, Mr. Weston
received approximately $1.6 million from DLJMB and all of his unexercised
options were effectively cancelled. In addition, Mr. Weston received
approximately $412,000 from the Company during 1997, a portion of which was
attributable to his 1995 and 1996 bonus and the remainder of which was
attributable to severance payments.
COMPENSATION OF DIRECTORS
Directors of the Company who are employees of the Company, DLJ or DLJMB or
their respective subsidiaries are not compensated for serving as directors.
Presently, the Company does not have directors who are not employees of the
Company, DLJ or DLJMB ("Non-Employee Directors"). However, the Company plans
to compensate future Non-Employee Directors with option grants for serving in
such capacity and for serving on committees of the Board of Directors and to
reimburse Non-Employee Directors for out-of-pocket expenses incurred in such
capacity.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to the Offering, the Company did not have a compensation committee.
Instead, compensation decisions regarding the Company's executive officers
were made by the Board of Directors. Each executive officer of the Company
has an employment agreement with the Company that establishes his annual
compensation. See "--Employment Agreements."
EMPLOYMENT AGREEMENTS
Effective June 18, 1997, the Company entered into an employment agreement
with Anthony J. Cuti (the "Cuti Employment Agreement"). Pursuant to the Cuti
Employment Agreement, Mr. Cuti serves as Chairman, President and Chief
Executive Officer of the Company. The Cuti Employment Agreement provides for
(i) a base salary of $425,000 per year, which will increase to $500,000 in
1998 and $550,000 in 1999 if certain EBITDA targets (as defined in the Cuti
Employment Agreement) are met and will increase every 18 months commencing
July 1, 2001 by not less than the percentage increase in a designated
consumer price index for such 18-month period, (ii) an annual incentive bonus
of up to 200% of base salary based on certain EBITDA targets and (iii)
participation in all benefit plans generally available to executive officers
of the Company.
Pursuant to the Cuti Employment Agreement and the Equity Plan described
below, on June 18, 1997, Mr. Cuti was granted non-qualified stock options to
purchase an aggregate of 496,569 shares of Common Stock at an exercise price
of $8.33 per share. Subject to Mr. Cuti's continued employment with the
Company, the options generally will become 100% vested on the eighth
anniversary of the date of grant, but may vest sooner based on the Company's
achievement of certain specified financial targets. Furthermore, the vesting
of options will accelerate upon the occurrence of a Sale of the Company (as
defined in the Cuti Employment Agreement) on or prior to December 30, 2001,
based on the Company's achievement of specified financial targets prior to
the date of any such Sale of the Company.
The Cuti Employment Agreement provides that following the Offering, Mr.
Cuti may generally only transfer up to 10% of his shares of Common Stock in
each calendar year while he is an employee of the Company, except pursuant to
certain rights and obligations (i) to transfer ("put") his shares to the
Company upon termination of employment and (ii) to transfer shares in
connection with certain transfers of Common Stock by DLJMBPII. The Cuti
Employment Agreement also provides that Mr. Cuti will be given the
opportunity to invest additional amounts in stock of the Company in the event
that DLJMBPII invests new equity in the Company or creates an intrument that
may be dilutive to Mr. Cuti's equity position relative to DLJMBPII.
Mr. Cuti's initial term of employment is for three years and, unless
terminated by notice of non-renewal by either the Company or Mr. Cuti, will
continue thereafter for successive one-year periods. Pursuant to the Cuti
Employment Agreement, if the Company terminates Mr. Cuti without "cause" (as
defined in the Cuti Employment Agreement) or by notice of non-renewal or Mr.
Cuti resigns with "good
46
<PAGE>
reason" (as defined in the Cuti Employment Agreement), Mr. Cuti will be
entitled to continued base salary and incentive bonus payments (at the rate
of two times base salary and bonus for the year prior to termination, which
can be increased to three times base salary and bonus upon the occurrence of
certain events, including a Sale of the Company) and employee benefits for a
two year period, which, under certain circumstances, including Mr. Cuti's
termination of employment prior to June 18, 2003 and within one year
following a Sale of the Company, may be extended by one year. Additionally,
the vesting of Mr. Cuti's options may accelerate upon such a termination of
employment, based on the Company's financial performance prior to such
termination and whether a Sale of the Company has occurred. The Cuti
Employment Agreement also contains certain non-compete, non-solicitation and
confidentiality provisions. See also "Certain Relationships and Related
Transactions--Cuti Loan Agreement."
The Company has also entered into agreements with Messrs. Charboneau and
Ray and certain other executives that provide for their initial base salary
as well as annual incentive bonuses based on certain EBITDA targets. Mr.
Charboneau's employment agreement provides for an annual base salary of
$220,000 and for additional increases from time to time as the Company may
determine. Mr. Ray's employment agreement provides for an annual base salary
of $150,000 and for additional increases from time to time as the Company may
determine. Each of Messrs. Charboneau and Ray are entitled to severance
payments equalling 12 months of their respective salaries if they are
terminated without "cause" (as respectively defined in the agreements).
The Company's agreement with Mr. Lacko provides for payment of an annual
base salary of $150,000 as well as for payment of annual incentive bonuses
based upon achievement of certain corporate and financial objectives. Mr.
Lacko's agreement also provides for the grant of stock options to acquire an
aggregate of 6,805 shares of Common Stock. These options vested on June 18,
1997 and have an exercise price of $8.33 per share. In addition, Mr. Lacko's
agreement provides for 12 months of salary continuation in the event Mr.
Lacko is terminated without cause.
The Company's agreement with Mr. Tennant provides for payment of an annual
base salary of $175,000 per year as well as for payment of annual incentive
bonuses based upon achievement of certain financial targets. Mr. Tennant's
agreement also provides for the grant of stock options to acquire an
aggregate of 68,101 shares of Common Stock at an exercise price of $7.34 per
share and for 12 months of salary continuation in the event Mr. Tennant is
terminated without cause.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
The Company has established the Supplemental Executive Retirement Plan
("SERP"), an unfunded retirement plan that provides a lump sum benefit equal
to the actuarial present value of a life annuity commencing at the later of
age 65 or termination of employment for any reason other than for "cause."
The SERP benefit is calculated as a percentage of a participant's Final
Average Earnings (defined as the average base salary and bonus for the five
years which produce the greatest amount multiplied by the participant's years
of services with the Company). Currently, Mr. Cuti is the only SERP
participant. Mr. Cuti's estimated SERP benefit, based on his annualized 1996
includable compensation and upon discount rates effective for termination of
employment in December 1997, is estimated to be $619,000, if termination of
employment occurs after 10 years when Mr. Cuti will be age 60 1/2, or
$1,263,000 if termination of employment occurs after 14 1/2 years, when Mr.
Cuti will be age 65. Pursuant to the Cuti Employment Agreement, the Company
is required to set aside funds in a "rabbi trust" to pay Mr. Cuti's SERP
benefit in specified circumstances, including a Sale of the Company,
termination without "cause" and resignation for "good reason" (as
respectively defined in the Cuti Employment Agreement). Furthermore, in the
event of his termination without "cause" or by reason of the Company's
non-renewal, his resignation for "good reason," or his death or disability,
Mr. Cuti's SERP benefit will be calculated on the basis of 20 years of
employment regardless of his actual number of years of employment with the
Company (the present value of which was approximately $680,000 as of
September 27, 1997).
STOCK OPTIONS
1992 STOCK OPTION PLAN. The Board of Directors adopted and the Company's
stockholders approved the 1992 Stock Option Plan (the "1992 Plan") in
September 1992. Under the 1992 Plan, the
47
<PAGE>
Board of Directors may grant to executive and other key employees of the
Company nonqualified stock options to purchase up to an aggregate of 510,757
shares of Common Stock of the Company at exercise prices and terms specified
by the Board of Directors.
At September 27, 1997, there were outstanding nonqualified stock options
issued under the 1992 Plan to purchase up to an aggregate of 281,657 shares
of Common Stock of the Company at exercise prices ranging from $0.58 to
$40.88 per share. The 1992 Plan will be frozen as to the future grants
following the Offering. All options issued under the 1992 Plan are 100%
vested.
1997 EQUITY PARTICIPATION PLAN. As of June 18, 1997, the Board of
Directors and stockholders of the Company approved the 1997 Equity
Participation Plan (the "Equity Plan"). The Equity Plan has been administered
by the Board of Directors and, following consummation of the Offering, will
be administered by the Compensation Committee. The Board of Directors is
authorized under the Equity Plan to select the individuals to whom awards
will be made (the "Participants") and determine the terms and conditions of
the awards under the Equity Plan. The Equity Plan provides that the Board of
Directors may grant or issue stock options, stock appreciation rights,
restricted stock, deferred stock, dividend equivalents, performance awards,
stock payments, and other stock related benefits, or any combination thereof,
to any eligible employee or consultant. Each such award will be set forth in
a separate agreement with the person receiving the award and will indicate
the type, terms and conditions of the award. An aggregate of 1,321,181 shares
of Common Stock of the Company have been reserved for issuance under the
Equity Plan, subject to certain adjustments reflecting changes in the
Company's capitalization. The Equity Plan provides that no Participant may
receive awards relating to more than 480,429 shares of Common Stock per year.
SECTION 162(M) LIMITATION. In general, under Section 162(m) of the Code
("Section 162(m)"), income tax deductions of publicly-held corporations may
be limited to the extent total compensation (including base salary, annual
bonus, stock option exercises and non-qualified benefits) for certain
executive officers exceeds $1 million (less the amount of any "excess
parachute payments" as defined in Section 280G of the Code) in any one year.
Under a Section 162(m) transition rule for compensation plans of corporations
which are privately held and which become publicly held in an initial public
offering, the Equity Plan will not be subject to Section 162(m) until the
"Transition Date" which is defined as the earliest of (i) the material
modification of the Equity Plan; (ii) the issuance of all Common Stock and
other compensation that has been allocated under the Equity Plan; and (iii)
the first meeting of stockholders at which directors are to be elected that
occurs after December 31, 2001. After the Transition Date, rights and awards
granted under the Equity Plan will not qualify as "performance-based
compensation" for purposes of Section 162(m) unless such rights and awards
are granted by an independent compensation committee, and such awards are
granted or vest upon pre-established objective performance goals, the
material terms of which are disclosed to and approved by the stockholders of
the Company. The transition rule will also apply to base salary and bonus
payments made pursuant to employment agreements in effect at the time of the
Offering.
The Board of Directors generally will have the power and authority to
amend the Equity Plan at any time without approval of the Company's
stockholders, subject to applicable federal securities and tax law
limitations (including rules and regulations of the New York Stock Exchange).
48
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
DLJMB RELATIONSHIPS
In connection with the Recapitalization, DLJMBPII and certain of its
affiliates (the "DLJ Entities") purchased an aggregate of 9,383,420 shares of
Common Stock, certain members of management retained an aggregate of 284,832
shares of Common Stock and certain other stockholders retained an aggregate
of 589,577 shares of Common Stock The aggregate purchase price for the shares
acquired by the DLJ Entities was approximately $78.7 million or approximately
$8.33 per share. Each of these shareholders other than members of management
signed the Stockholders and Registration Rights Agreement. See
"--Stockholders and Registration Rights Agreement." Mr. Jaffe and Ms.
Arnaboldi, directors of the Company, are Managing Directors of DLJMB, and Mr.
Nathanson, also a director of the Company, is a Managing Director of DLJ.
On September 30, 1997, the Company entered into the Existing Credit
Agreement in which DLJ Capital Funding, Inc., an affiliate of DLJMBPII, acted
as the arranger and syndication agent. In connection with the Existing Credit
Agreement, DLJ Capital Funding, Inc. received a customary funding fee of
approximately $2.4 million.
DLJ (the Underwriter and an affiliate of DLJMBPII) acted as financial
advisor to the Company in connection with the structuring of the
Recapitalization and received customary fees for such services of
approximately $3.5 million and reimbursement for reasonable out-of-pocket
expenses and affiliates of DLJ received stand-by commitment fees of
approximately $1.2 million in connection with the change of control offers
for Zero Coupon Notes and the Senior Notes, which were required as a result
of the Recapitalization. The Company agreed to indemnify DLJ in connection
with its acting as financial advisor. In addition, DLJ will receive the
underwriting compensation set forth on the cover page of this Prospectus. DLJ
is also serving as lead underwriter in connection with the Common Stock
Offering and will receive its pro rata portion of the underwriting
compensation payable in connection therewith. In addition, the DLJ Entities
have granted an option to the underwriters in the Common Stock Offering,
exercisable for 30 days after the date on the prospectus relating to the
Common Stock Offering (the "Common Stock Prospectus"), to purchase an
aggregate of up to 1,091,658 additional shares of Common Stock solely to
cover over-allotments, if any. If such over-allotment option is exercised in
full, the total net proceeds to such DLJ Entities will be approximately $16.8
million.
CUTI LOAN AGREEMENT
Pursuant to the terms of the Cuti Employment Agreement and a Secured Loan
Agreement and related agreements among Mr. Cuti, the Company and DLJ (the
"Loan Documents"), on November 20, 1997, Mr. Cuti borrowed $1 million from
DLJ (the "Loan"). The Loan is secured by Mr. Cuti's pledge to DLJ of his
options granted under the Equity Plan and his option to purchase 496,569
shares of Common Stock, and all Common Stock and other proceeds payable upon
exercise or other disposition thereof (the "Pledged Security"). The Loan is
subject to interest at the Federal Mid-Term Rate as in effect from time to
time and is generally payable in five equal installments commencing within 30
days after Mr. Cuti has the ability to receive cash in exchange for any of
the Pledged Security. In addition, the Company may apply any amounts to which
Mr. Cuti is entitled upon termination of employment to repayment of the Loan.
The Cuti Employment Agreement and the Loan Documents further provide that in
the event of termination of Mr. Cuti's employment by reason of termination by
the Company without "cause" or the Company's non-renewal or his resignation
with "good reason" (as such terms are defined in the Cuti Employment
Agreement), the Company will reimburse Mr. Cuti for all interest accrued as
of the date of such termination if the Company has achieved certain specified
financial targets for the year prior to termination and the year of such
termination. The Loan Documents permit DLJ to assign the Loan to certain of
its affiliates, including the Company, and the Company is obligated pursuant
to the Cuti Employment Agreement to assume the Loan from DLJ as soon as
practicable after the Company and DLJ agree that the Company may do so.
49
<PAGE>
OTHER RELATIONSHIPS
The Company incurred aggregate fees owing to Credit Suisse First Boston
for financial services rendered from March 1995 through the consummation of
the Recapitalization in the aggregate amount of $3.6 million, of which $1.4
million was paid upon consummation of the Recapitalization and the remaining
$2.2 million will become payable upon consummation of the Common Stock
Offering.
STOCKHOLDERS AND REGISTRATION RIGHTS AGREEMENT
In connection with the Recapitalization, certain of the shareholders of
the Company (the "Initial Shareholders") entered into a Stockholders and
Registration Rights Agreement, pursuant to which the Company has granted the
Initial Shareholders the right to cause the Company to register shares of
Common Stock (the "registrable securities") under the Securities Act. Upon
consummation of the Common Stock Offering, 9,395,278 outstanding shares of
Common Stock will constitute registrable securities and therefore will be
eligible for registration pursuant to the Stockholders and Registration
Rights Agreement. Under the terms of the Stockholders and Registration Rights
Agreement, at any time after the one year anniversary date of the Common
Stock Offering, (i) the holders of at least a majority of the registrable
securities held by the DLJ Entities can require the Company, subject to
certain limitations, to file a registration statement under the Securities
Act covering all or part of the registrable securities held by the DLJ
Entities and (ii) the remaining Initial Shareholders can require the Company,
subject to certain limitations, to file a registration statement covering all
or part of the registrable securities held by such Initial Shareholders
(each, a "demand registration"). The Company is obligated to pay all
registration expenses (other than underwriting discounts and commissions and
subject to certain limitations) incurred in connection with the demand
registrations. In addition, the Stockholders and Registration Rights
Agreement provides the Initial Shareholders with "piggyback" registration
rights, subject to certain limitations, whenever the Company files a
registration statement on a registration form that can be used to register
securities held by such Initial Shareholders.
50
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership (as defined by the regulations of the Securities and
Exchange Commission) of the Company's Common Stock (which constitutes the
only class of voting capital stock of the Company) by (i) each person known
to the Company to be the beneficial owner of 5% or more of the Common Stock,
(ii) each director, (iii) each Named Executive Officer and (iv) all executive
officers and directors as a group, based on data as of January 15, 1998.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED(1)
-------------------------------------------
% OF CLASS % OF CLASS
PRIOR TO AFTER
COMMON STOCK COMMON STOCK
NAME SHARES OFFERING OFFERING
- -------------------------------------------------- ----------- -------------- --------------
<S> <C> <C> <C>
DLJ Merchant Banking Partners II, L.P. and related
investors(2)(3)................................... 9,383,420 91.5% 55.32%
Anthony Cuti....................................... 364,530 3.6% 2.1
David Jaffe(4) .................................... -- -- --
Nicole S. Arnaboldi(4)............................. -- -- --
Andrew J. Nathanson(4) ............................ -- -- --
Gary Charboneau ................................... 259,464 2.5% 1.6
Jerry M. Ray ...................................... 85,722 * *
William J. Tennant................................. 68,001 * *
Joseph S. Lacko.................................... 17,025 * *
All executive officers and directors as a group
(11 persons)(4) .................................. 815,996 8.0% 4.9%
</TABLE>
- ------------
* Less than one percent
(1) For purposes of this table, a person is deemed to have "beneficial
ownership" of any shares that such person has the right to acquire
within 60 days after the date of this Prospectus. For purposes of
calculating the percentage of outstanding shares held by each person
named above, any shares that such person has the right to acquire
within 60 days after the date of this Prospectus are deemed to be
outstanding, but not for the purpose of calculating the percentage
ownership of any other person.
(2) Consists of 9,383,420 shares held directly by the following related
investors, each of whom is affiliated with DLJ: DLJ Merchant Banking
Partners II, L.P. ("DLJMBPII"), 5,910,855 shares; DLJ Merchant Banking
Partners II-A, L.P. ("DLJMBIIA"), 235,398 shares; DLJ Offshore Partners
II, C.V. ("DLJOPII"), 290,665 shares; DLJ Diversified Partners, L.P.
("DLJDP"), 345,575 shares; DLJ Diversified Partners-A, L.P. ("DLJDPA"),
128,335 shares; DLJMB Funding II, Inc. ("DLJMBFII"), 1,049,442 shares;
DLJ Millennium Partners, L.P. ("Millennium"), 95,572 shares; DLJ
Millennium-A, L.P. ("Millennium-A"), 18,640 shares; DLJ EAB Partners,
L.P. ("DLJEAB"), 26,539 shares; UK Investment Plan 1997 Partners ("UK
Investment"), 156,390 shares; and DLJ First ESC L.P. ("DLJ ESC," and
collectively, the "DLJMBPII Entities"), 1,126,010 shares. See "Certain
Relationships and Related Transactions--DLJMB Relationships." The
address of each of DLJMBPII, DLJMBIIA, DLJDP, DLJDPA, DLJMBFII,
Millennium, Millennium-A, DLJEAB, and DLJ ESC is 277 Park Avenue, New
York, New York 10172. The address of DLJOPII is c/o John B. Gorsiraweg,
14 Willemstad, Curacao, Netherlands Antilles. The address of UK
Investment is 2121 Avenue of the Stars, Fox Plaza, Suite 3000, Los
Angeles, California 90067. As a general partner of each of DLJMBPII,
DLJMBIIA, DLJOPII, DLJDP, DLJDPA, DLJEAB, Millennium and Millennium-A,
DLJMB may be deemed to beneficially own indirectly all of the shares
held directly by DLJMBPII, DLJMBIIA, DLJOPII, DLJDP, DLJDPA, DLJEAB,
Millennium and Millennium-A, and as the parent of each of DLJMB,
DLJMBFII and DLJ LBO Plans Management Corporation (the general partner
of DLJ ESC and UK Investment), Donaldson, Lufkin & Jenrette Inc., the
parent of DLJ ("DLJ Inc.") may be deemed to beneficially own indirectly
all of the shares held by DLJMBPII, DLJMBIIA, DLJOPII, DLJDP, DLJDPA,
DLJEAB, Millennium, Millennium-A, DLJMBFII, DLJ ESC and UK Investment.
The address of DLJ Merchant Banking, Inc. is 277 Park Avenue, New York,
New York 10172.
(3) In the event that the overallotment option granted to the underwriters
in the Common Stock Offering is exercised, DLJMBPII Entities will be
selling stockholders in the Common Stock Offering. In the event that
the DLJMBPII Entities sell all of the shares eligible to be sold by
them pursuant the overallotment option, such entities will own
approximately 48.9% of the Common Stock outstanding after the Offering.
(4) Mr. Nathanson is a Managing Director of DLJ and, as a result may be
deemed to beneficially own the shares of Common Stock owned by the
DLJMBPII Entities. Mr. Nathanson expressly disclaims beneficial
ownership of such shares of Common Stock. Nicole Arnaboldi and David
Jaffe are managing directors of DLJMB and DLJ Diversified Partners,
Inc. ("DLJDPI"). DLJMB is the managing general partner of DLJMBPII,
DLJMBIIA, DLJOPII, Millennium and Millennium-A. DLJDPI is the managing
general partner of DLJDP and DLJDPA. As a result, Ms. Arnaboldi and Mr.
Jaffe may be deemed to beneficially own the shares of Common Stock held
by each of DLJMBPII, DLJMBIIA, DLJOPII, DLJDP, DLJDPA, Millennium,
Millennium-A. Ms. Arnaboldi and Mr. Jaffe expressly disclaim beneficial
ownership of such shares of Common Stock.
51
<PAGE>
DESCRIPTION OF NEW SENIOR SUBORDINATED NOTES
GENERAL
The New Senior Subordinated Notes will be issued pursuant to an indenture
(the "New Senior Subordinated Note Indenture") among the Company, the
Subsidiary Guarantors and State Street Bank and Trust Company, as trustee
(the "Trustee"). The terms of the New Senior Subordinated Notes include those
stated in the New Senior Subordinated Note Indenture and those made part of
the New Senior Subordinated Note Indenture by reference to the Trust
Indenture Act of 1939, as amended (the "Trust Indenture Act"). The New Senior
Subordinated Notes are subject to all such terms, and prospective investors
are referred to the New Senior Subordinated Note Indenture and the Trust
Indenture Act for a statement thereof. The following summary of certain
provisions of the New Senior Subordinated Note Indenture does not purport to
be complete. A copy of the New Senior Subordinated Note Indenture has been
filed as an exhibit to the Registration Statement of which this Prospectus
forms a part. The definitions of certain terms used in this Description of
New Senior Subordinated Notes are set forth below under "--Certain
Definitions."
The New Senior Subordinated Notes will be general unsecured obligations of
the Company and will be subordinated in right of payment to all current and
future Senior Debt. In addition, the New Senior Subordinated Notes will be
effectively subordinated to indebtedness of the Company's Subsidiaries. See
"Risk Factors--Holding Company Structure." At September 27, 1997, on a pro
forma basis giving effect to the Offering, the Common Stock Offering and the
consummation of the Refinancing Plan, the Company would have had an aggregate
of $130.0 million of Senior Debt outstanding and the Company and its
Subsidiaries would have had approximately $262.6 million of aggregate
outstanding liabilities, including trade payables and the New Senior
Subordinated Notes. The New Senior Subordinated Note Indenture will permit
the incurrence of additional Senior Debt in the future, subject to certain
conditions.
PRINCIPAL, MATURITY AND INTEREST
The New Senior Subordinated Notes will be limited in aggregate principal
amount to $80.0 million, and will mature on February 15, 2008. Interest on
the New Senior Subordinated Notes will accrue at the rate of 9 1/4% per annum
and will be payable semi-annually in arrears on February 15 and August 15
(each, an "Interest Payment Date"), commencing on August 15, 1998, to holders
of record on the immediately preceding February 1 and August 1, respectively.
Interest on the New Senior Subordinated Notes will accrue from the most
recent date to which interest has been paid or, if no interest has been paid,
from the date of original issuance. Interest will be computed on the basis of
a 360-day year comprised of twelve 30-day months. Principal of, and interest
and premium (if any) on, the New Senior Subordinated Notes will be payable at
the office or agency of the Company maintained for such purpose or, at the
option of the Company, payment may be made by check mailed to holders of the
New Senior Subordinated Notes at their respective addresses set forth in the
register of holders; provided, however, that all payments with respect to New
Senior Subordinated Notes the holders of which have given wire transfer
instructions to the Company will be required to be made by wire transfer of
immediately available funds to the accounts specified by the holders thereof.
Until otherwise designated by the Company, the Company's office or agency
will be the office of the Trustee maintained for such purpose. The New Senior
Subordinated Notes will be issued in denominations of $1,000 and integral
multiples thereof.
SUBORDINATION
The payment of principal of, and premium (if any) and interest on the New
Senior Subordinated Notes will be subordinated in right of payment, as set
forth in the New Senior Subordinated Note Indenture, to the prior payment in
full of all Senior Debt, whether outstanding on the date of the New Senior
Subordinated Note Indenture or thereafter incurred. For purposes hereof,
"payment in full," as used with respect to Senior Debt, means payment of
cash.
Upon any distribution to creditors of the Company in a liquidation or
dissolution of the Company or in a bankruptcy, reorganization, insolvency,
receivership or similar proceeding relating to the Company or
52
<PAGE>
its property, an assignment for the benefit of creditors or any marshalling
of the Company's assets and liabilities, the holders of Senior Debt will be
entitled to receive payment in full of all Obligations due in respect of such
Senior Debt (including interest after the commencement of any such proceeding
at the rate specified in the applicable Senior Debt) before the holders of
New Senior Subordinated Notes will be entitled to receive any payment or
distribution of cash, securities or other property with respect to
Obligations due in respect of the New Senior Subordinated Notes and, until
all Obligations with respect to Senior Debt are paid in full, any payment,
distribution, or other transfer of assets of the Company or any Subsidiary
Guarantor of any kind or character, whether direct or indirect, by set-off or
otherwise, and whether in cash, securities or property, to which the holders
of New Senior Subordinated Notes would be entitled shall be made to the
holders of Senior Debt (except that holders of New Senior Subordinated Notes
may receive Permitted Junior Securities and payments made from the trust
described under "--Legal Defeasance and Covenant Defeasance").
The Company also may not make any payment upon or in respect of the New
Senior Subordinated Notes (except in Permitted Junior Securities or from the
trust described under "--Legal Defeasance and Covenant Defeasance") if (i) a
default in the payment of the principal of or premium if any, or interest on,
any Designated Senior Debt occurs and is continuing beyond any applicable
period of grace, if any, or (ii) any other default occurs and is continuing
with respect to any Designated Senior Debt that permits holders of the
Designated Senior Debt as to which such default relates to accelerate its
maturity and the Trustee receives a written notice of such default (a
"Payment Blockage Notice") from the Company or the holders of such Designated
Senior Debt (or their representative). Payments on the New Senior
Subordinated Notes may and shall be resumed (a) in the case of a payment
default, upon the date on which such default is cured or waived and (b) in
case of a nonpayment default, the earlier of the date on which such
nonpayment default is cured or waived or 179 days after the date on which the
applicable Payment Blockage Notice is received, unless the maturity of any
Designated Senior Debt has been accelerated. No new period of payment
blockage may be commenced unless and until 360 days have elapsed since the
effectiveness of the immediately prior Payment Blockage Notice. No nonpayment
default that existed or was continuing on the date of delivery of any Payment
Blockage Notice to the Trustee shall be, or be made, the basis for a
subsequent Payment Blockage Notice unless such default shall have been cured
or waived for a period of not less than 90 days.
The New Senior Subordinated Note Indenture will further require that the
Company promptly notify holders of Senior Debt (or their representatives) if
payment of the New Senior Subordinated Notes is accelerated because of an
Event of Default.
As a result of the subordination provisions described above, in the event
of a liquidation or insolvency, holders of New Senior Subordinated Notes may
recover less ratably than creditors of the Company who are holders of Senior
Debt. As of September 27, 1997, after giving pro forma effect to the
Offering, the Common Stock Offering and consummation of the Refinancing Plan,
the Company would have had approximately $130.0 million of Senior Debt
outstanding. The New Senior Subordinated Note Indenture will limit, subject
to certain conditions, the amount of additional Indebtedness, including
Senior Debt, that the Company and its Subsidiaries can incur. See "Certain
Covenants--Incurrence of Indebtedness and Issuance of Preferred Stock."
SUBSIDIARY GUARANTEES
The Company's payment obligations under the New Senior Subordinated Notes
will be jointly and severally guaranteed (the "Subsidiary Guarantees") on a
senior subordinated basis by all of the Company's present and future
Subsidiaries (the "Subsidiary Guarantors"). The Subsidiary Guarantee of each
Subsidiary Guarantor will be subordinated to the prior payment in full of all
Senior Debt and any amounts for which such Subsidiary Guarantor will be
liable under guarantees issued from time to time with respect to Senior Debt.
The obligations of each Subsidiary Guarantor under its Subsidiary Guarantee
will be limited to the maximum amount that may be paid thereunder without
resulting in such Subsidiary Guarantee being deemed to constitute a
fraudulent conveyance or a fraudulent transfer under applicable law. See
"Risk Factors--Enforceability of Subsidiary Guarantees."
53
<PAGE>
The New Senior Subordinated Note Indenture will provide that no Subsidiary
Guarantor may consolidate with or merge with or into (whether or not such
Subsidiary Guarantor is the surviving Person), or sell all or substantially
all of its assets to, another corporation, Person or entity, whether or not
affiliated with such Subsidiary Guarantor unless (a) subject to the
provisions of the following paragraph, the Person formed by or surviving any
such consolidation or merger (if other than such Subsidiary Guarantor)
assumes all of the obligations of such Subsidiary Guarantor, pursuant to a
supplemental indenture in form and substance reasonably satisfactory to the
Trustee, under the Subsidiary Guarantee of such Subsidiary Guarantor and the
New Senior Subordinated Note Indenture; (b) immediately after giving effect
to such transaction, no Default or Event of Default exists; and (c) the
Company would be permitted, immediately after giving effect to such
transaction, to incur at least $1.00 of additional Indebtedness pursuant to
the Fixed Charge Coverage Ratio test set forth in the first paragraph of the
covenant described under the caption "--Certain Covenants--Incurrence of
Indebtedness and Issuance of Preferred Stock." Notwithstanding the foregoing
provisions of this paragraph, the New Senior Subordinated Note Indenture will
not prohibit the merger of two of the Subsidiary Guarantors or the merger of
a Subsidiary Guarantor into the Company.
The New Senior Subordinated Note Indenture will provide that, in the event
of a sale or other disposition of all of the equity interests of any
Subsidiary Guarantor (including by way of merger or consolidation) or all or
substantially all of the assets of such Subsidiary Guarantor, then such
Subsidiary Guarantor (in the event of a sale or other disposition of all of
the capital stock of such Subsidiary Guarantor) or the corporation acquiring
the property (in the event of a sale or other disposition of all or
substantially all of the assets of such Subsidiary Guarantor) will be
released and relieved of any obligations under its Subsidiary Guarantee;
provided that the Net Proceeds of such sale or other disposition are applied
in accordance with the applicable provisions of the New Senior Subordinated
Note Indenture. See "--Repurchase at Option of Holders--Asset Sales."
OPTIONAL REDEMPTION
The New Senior Subordinated Notes will not be redeemable at the Company's
option prior to February 15, 2003. Thereafter, the New Senior Subordinated
Notes will be subject to redemption at any time at the option of the Company,
in whole or in part, upon not less than 30 nor more than 60 days prior
notice, at the redemption prices (expressed as percentages of principal
amount) set forth below, plus accrued and unpaid interest, if any, thereon to
the applicable redemption date, if redeemed during the 12-month period
beginning on February 15 of the years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
- -------------------- ------------
<S> <C>
2003 ................ 104.625%
2004 ................ 103.084%
2005 ................ 101.542%
2006 and thereafter 100.000%
</TABLE>
Notwithstanding the foregoing, on or prior to February 15, 2001, the
Company may redeem up to 35% in aggregate principal amount of New Senior
Subordinated Notes at a redemption price of 109.25% of the principal amount
thereof, plus accrued and unpaid interest, if any, thereon to the redemption
date, with the net proceeds of one or more Qualified Offerings of the
Company; provided that at least 65% in aggregate principal amount of the New
Senior Subordinated Notes originally issued under the New Senior Subordinated
Note Indenture remain outstanding immediately after the occurrence of such
redemption; and provided, further, that such redemption shall occur within 90
days of the date of the closing of such Qualified Offering.
SELECTION AND NOTICE
If less than all of the New Senior Subordinated Notes are to be redeemed
at any time, selection of New Senior Subordinated Notes for redemption will
be made by the Trustee in compliance with the requirements of the principal
national securities exchange, if any, on which the New Senior Subordinated
54
<PAGE>
Notes are listed, or, if the New Senior Subordinated Notes are not so listed,
on a pro rata basis, by lot or by such method as the Trustee shall deem fair
and appropriate; provided, however, that no New Senior Subordinated Note
shall be redeemed in a principal amount that is less than $1,000. Notices of
redemption shall be mailed by first class mail at least 30 but not more than
60 days before the redemption date to each holder of New Senior Subordinated
Notes to be redeemed at its registered address. Notices of redemption may not
be conditional. If any New Senior Subordinated Note is to be redeemed in part
only, the notice of redemption that relates to such New Senior Subordinated
Note shall state the portion of the principal amount thereof to be redeemed
and a new note in principal amount equal to the unredeemed portion of the
original New Senior Subordinated Note shall be issued in the name of the
holder thereof upon cancellation of the original New Senior Subordinated
Note. New Senior Subordinated Notes called for redemption become due on the
date fixed for redemption. On and after the redemption date, interest ceases
to accrue on New Senior Subordinated Notes or portions of them called for
redemption.
MANDATORY REDEMPTION
Except as set forth below under "--Repurchase at the Option of Holders,"
the Company is not required to make any mandatory redemption of, or sinking
fund payments with respect to, the New Senior Subordinated Notes.
REPURCHASE AT THE OPTION OF HOLDERS
Change of Control
Upon the occurrence of a Change of Control, the Company will be required
to make an offer (a "Change of Control Offer") to repurchase all or any part
(equal to $1,000 or an integral multiple thereof) of each holder's New Senior
Subordinated Notes at an offer price in cash equal to 101% of the aggregate
principal amount thereof, plus accrued and unpaid interest, if any, thereon
to the date of repurchase (the "Change of Control Payment"). Within 15 days
following a Change of Control, the Company will (or will cause the Trustee
to) mail a notice to each holder of New Senior Subordinated Notes describing
the transaction that constitutes the Change of Control and offering to
repurchase New Senior Subordinated Notes on the date specified in such
notice, which date shall be no earlier than 30 days and no later than 60 days
from the date such notice is mailed (the "Change of Control Payment Date"),
pursuant to the procedures required by the New Senior Subordinated Note
Indenture and described in such notice. The Company will comply with the
requirements of Rule 14e-1 under the Exchange Act and any other securities
laws and regulations thereunder to the extent such laws and regulations are
applicable in connection with the repurchase of New Senior Subordinated Notes
as a result of a Change of Control.
On or before the Change of Control Payment Date, the Company will, to the
extent lawful, (a) accept for payment all New Senior Subordinated Notes or
portions thereof properly tendered pursuant to the Change of Control Offer,
(b) deposit with the Paying Agent an amount equal to the Change of Control
Payment in respect of all New Senior Subordinated Notes or portions thereof
so tendered and (c) deliver or cause to be delivered to the Trustee the New
Senior Subordinated Notes so accepted together with an officer's certificate
stating the aggregate principal amount of New Senior Subordinated Notes or
portions thereof being purchased by the Company. The Paying Agent will
promptly mail to each holder of New Senior Subordinated Notes so tendered the
Change of Control Payment for such New Senior Subordinated Notes, and the
Trustee will promptly authenticate and mail (or cause to be transferred by
book entry) to each holder a new note equal in principal amount to any
unpurchased portion of the New Senior Subordinated Notes surrendered, if any;
provided, however, that each such new note will be in a principal amount of
$1,000 or an integral multiple 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 Payment Date.
Except as described above with respect to a Change of Control, the New
Senior Subordinated Note Indenture does not contain provisions that permit
the holders of the New Senior Subordinated Notes to require that the Company
repurchase or redeem the New Senior Subordinated Notes in the event of a
takeover, recapitalization or similar transaction. In addition, the Company
could enter into certain
55
<PAGE>
transactions, including acquisitions, refinancings or other
recapitalizations, that could affect the Company's capital structure or the
value of the New Senior Subordinated Notes, but that would not constitute a
Change of Control. The New Credit Agreement will prohibit the Company from
purchasing the New Senior Subordinated Notes (except in certain limited
amounts) and will also provide that certain change of control events with
respect to the Company will constitute a default thereunder. Any future
credit agreements or other agreements relating to Senior Debt to which the
Company becomes a party may contain similar restrictions and provisions. In
the event a Change of Control occurs at a time when the Company is prohibited
from purchasing the New Senior Subordinated Notes, the Company could seek the
consent of its lenders to the purchase of the New Senior Subordinated Notes
or could attempt to refinance the borrowings that contain such prohibition.
If the Company does not obtain such consent or repay such borrowings, the
Company will remain prohibited from purchasing the New Senior Subordinated
Notes by the relevant Senior Debt. In such case, the Company's failure to
purchase the tendered New Senior Subordinated Notes would constitute an event
of default under the New Senior Subordinated Note Indenture which would, in
turn, constitute a default under the New Credit Agreement and could
constitute a default under other Senior Debt. In such circumstances, the
subordination provisions in the New Senior Subordinated Note Indenture would
likely restrict payments to the holders of the New Senior Subordinated Notes.
Furthermore, no assurance can be given that the Company will have sufficient
resources to satisfy its repurchase obligation with respect to the New Senior
Subordinated Notes following a Change of Control. In addition, the Company's
ability to repurchase New Senior Subordinated Notes following a Change of
Control may also be limited by the Company's then existing financial
resources. Moreover, the definition of Change of Control only provides
protection to the holders of New Senior Subordinated Notes in the event of
certain changes in the equity ownership and/or the composition of the board
of directors of the Company and, as a result, the Company may, under certain
circumstances, incur substantial additional indebtedness or undergo
restructuring or other corporate changes without triggering a Change of
Control Offer.
The Company will not be required to make a Change of Control Offer
following a Change of Control if a third party makes the Change of Control
Offer in the manner, at the times and otherwise in compliance with the
requirements set forth in the New Senior Subordinated Note Indenture
applicable to a Change of Control Offer made by the Company and purchases all
New Senior Subordinated Notes validly tendered and not withdrawn under such
Change of Control Offer.
A "Change of Control" will be deemed to have occurred upon the occurrence
of any of the following: (a) the sale, lease, transfer, conveyance or other
disposition (other than by way of merger or consolidation), in one or a
series of related transactions, of all or substantially all of the assets of
the Company and its Subsidiaries, taken as a whole, to any "person" or
"group" (as such terms are used in Section 13(d) of the Exchange Act) other
than the Principals, (b) the adoption of a plan relating to the liquidation
or dissolution of the Company, (c) the consummation of any transaction
(including, without limitation, any merger or consolidation) the result of
which is that any "person" or "group" (as such terms are used in Section
13(d) of the Exchange Act) other than the Principals becomes the "beneficial
owner" (as such term is defined in Rule 13d-3 and Rule 13d-5 under the
Exchange Act), directly or indirectly through one or more intermediaries, of
more than 50% of the voting power of the outstanding voting stock of the
Company, or (d) the first day on which more than a majority of the members of
the Board of Directors of the Company are not Continuing Directors.
The definition of Change of Control includes a phrase relating to the
sale, lease, transfer, conveyance or other disposition of "all or
substantially all" of the assets of the Company and its Subsidiaries taken as
a whole. Although there is a developing body of case law interpreting the
phrase "substantially all," there is no precise established definition of the
phrase under applicable law. Accordingly, the ability of a holder of New
Senior Subordinated Notes to require the Company to repurchase such New
Senior Subordinated Notes as a result of a sale, lease transfer, conveyance
or other disposition of less than all of the assets of the Company and its
Subsidiaries taken as a whole to another Person or group may be uncertain.
"Continuing Directors" means, as of any date of determination, any member
of the Board of Directors of the Company who (a) was a member of the Board of
Directors of the Company on the date
56
<PAGE>
of original issuance of the New Senior Subordinated Notes or (b) was
nominated for election to the Board of Directors of the Company with the
approval of, or whose election to the Board of Directors of the Company was
ratified by, at least a majority of the Continuing Directors who were members
of the Board of Directors of the Company at the time of such nomination or
election.
Asset Sales
The New Senior Subordinated Note Indenture will provide that the Company
will not, and will not permit any of its Subsidiaries to, consummate an Asset
Sale unless (a) the Company or such Subsidiary, as the case may be, receives
consideration at the time of such Asset Sale at least equal to the fair
market value (evidenced by a resolution of the Board of Directors of the
Company set forth in an officer's certificate delivered to the Trustee) of
the assets or Equity Interests issued or sold or otherwise disposed of and
(b) at least 75% of the consideration therefor received by the Company or
such Subsidiary is in the form of (I) Cash Equivalents or (II) property or
assets that are used or useful in a Permitted Business, or the Capital Stock
of any Person engaged in a Permitted Business if, as a result of the
acquisition by the Company or any Subsidiary thereof, such Person becomes a
Subsidiary Guarantor; provided, however, that the amount of (i) any
liabilities (as shown on the Company's or such Subsidiary's most recent
balance sheet) of the Company or such Subsidiary (other than contingent
liabilities and liabilities that are by their terms subordinated to the New
Senior Subordinated Notes or any Subsidiary Guarantees) that are assumed by
the transferee of any such assets pursuant to a customary novation agreement
that releases the Company or such Subsidiary from further liability and (ii)
any securities, notes or other obligations received by the Company or such
Subsidiary from such transferee that are immediately converted by the Company
or such Subsidiary into cash (to the extent of the cash received) shall be
deemed to be cash for purposes of this provision; provided further, that the
75% limitation referred to in clause (b) will not apply to any Asset Sale in
which the Cash Equivalent portion of the consideration received therefrom,
determined in accordance with the foregoing proviso, is equal to or greater
than what the after-tax proceeds would have been had such Asset Sale complied
with the aforementioned 75% limitation.
Within 270 days after the receipt of any Net Proceeds from an Asset Sale,
the Company or any such Subsidiary shall apply such Net Proceeds at its
option (or to the extent the Company is required to apply such Net Proceeds
pursuant to the terms of the New Credit Agreement), to (a) repay Senior Debt
(and to correspondingly reduce commitments with respect thereto in the case
of revolving borrowings) or (b) repay pari passu Indebtedness of the Company
or any Subsidiary Guarantor (and to correspondingly reduce commitments with
respect thereto), provided that if the Company or any Subsidiary Guarantor
shall so repay pari passu Indebtedness, it will equally and ratably reduce
Indebtedness under the New Senior Subordinated Notes if the New Senior
Subordinated Notes are then redeemable, or if the New Senior Subordinated
Notes may not then be redeemed, the Company shall make an offer (in
accordance with the procedures set forth below for an Asset Sale Offer) to
all holders of New Senior Subordinated Notes to purchase at a price equal to
100% of the principal amount thereof the amount of New Senior Subordinated
Notes that would otherwise be redeemed or (c) an investment in property, the
making of a capital expenditure or the acquisition of other long-term assets,
in each case, of or from an entity that is engaged in a Permitted Business,
and in accordance with the terms of the New Senior Subordinated Note
Indenture. Pending the final application of any such Net Proceeds, the
Company may temporarily reduce Designated Senior Debt or otherwise invest
such Net Proceeds in any manner that is not prohibited by the New Senior
Subordinated Note Indenture. Any Net Proceeds from Asset Sales that are not
applied or invested as provided in the first sentence of this paragraph will
be deemed to constitute "Excess Proceeds." When the aggregate amount of
Excess Proceeds exceeds $10.0 million, the Company will be required to make
an offer to all holders of New Senior Subordinated Notes (an "Asset Sale
Offer") to purchase the maximum principal amount of New Senior Subordinated
Notes that may be purchased out of the Excess Proceeds at an offer price in
cash in an amount equal to 100% of the principal amount thereof plus accrued
and unpaid interest, if any, thereon to the date of purchase, in accordance
with the procedures set forth in the New Senior Subordinated Note Indenture.
To the extent that the aggregate principal amount of New Senior Subordinated
Notes tendered pursuant to an Asset Sale Offer is less than the Excess
Proceeds, the Company may use any remaining Excess Proceeds for general
corporate purposes. If the aggregate principal amount of New Senior
Subordinated Notes surrendered by holders
57
<PAGE>
thereof exceeds the amount of Excess Proceeds, the Trustee shall select the
New Senior Subordinated Notes to be purchased as set forth under "--Selection
and Notice." Upon completion of such offer to purchase, the amount of Excess
Proceeds shall be reset at zero.
CERTAIN COVENANTS
Restricted Payments
The New Senior Subordinated Note Indenture will provide that the Company
will not, and will not permit any of its Subsidiaries to, directly or
indirectly, (a) declare or pay any dividend or make any other payment or
distribution on account of the Company's or any of its Subsidiaries' Equity
Interests (other than dividends or distributions payable in Equity Interests
(other than Disqualified Stock) of the Company or dividends or distributions
payable to the Company or any Wholly Owned Subsidiary of the Company); (b)
purchase, redeem or otherwise acquire or retire for value any Equity
Interests of the Company (other than any such Equity Interests owned by the
Company or any Wholly Owned Subsidiary of the Company); (c) make any payment
on or with respect to, or purchase, redeem, defease or otherwise acquire or
retire for value, any Indebtedness that is subordinated to the New Senior
Subordinated Notes, except a payment of interest or principal at Stated
Maturity; or (d) make any Restricted Investment (all such payments and other
actions set forth in clauses (a) through (d) above being collectively
referred to as "Restricted Payments"), unless, at the time of and after
giving effect to such Restricted Payment:
(i) no Default or Event of Default shall have occurred and be continuing
or would occur as a consequence thereof;
(ii) the Company would, at the time of such Restricted Payment and after
giving pro forma effect thereto as if such Restricted Payment had been
made at the beginning of the applicable four-quarter period, have been
permitted to incur at least $1.00 of additional Indebtedness pursuant to
the Fixed Charge Coverage Ratio test set forth in the first paragraph of
the covenant described under the caption "--Incurrence of Indebtedness and
Issuance of Preferred Stock"; and
(iii) such Restricted Payment, together with the aggregate amount of all
other Restricted Payments made by the Company and its Subsidiaries after
the date of the New Senior Subordinated Note Indenture, is less than the
sum of (A) 50% of the Consolidated Net Income of the Company for the
period (taken as one accounting period) after the date of the New Senior
Subordinated Note Indenture to the end of the Company's most recently
ended fiscal quarter for which internal financial statements are available
at the time of such Restricted Payment (or, if such Consolidated Net
Income for such period is a deficit, less 100% of such deficit); plus (B)
100% of the aggregate net cash proceeds received by the Company from the
issue or sale since the date of the New Senior Subordinated Note Indenture
of Equity Interests of the Company (other than Disqualified Stock) or of
Disqualified Stock or debt securities of the Company to the extent that
they have been converted into such Equity Interests (other than any such
Equity Interests, Disqualified Stock or convertible debt securities sold
to a Subsidiary of the Company and other than Disqualified Stock or
convertible debt securities that have been converted into Disqualified
Stock).
The foregoing provisions will not prohibit (a) the payment of any dividend
within 60 days after the date of declaration thereof, if at said date of
declaration such payment would have complied with the provisions of the New
Senior Subordinated Note Indenture; (b) the redemption, repurchase,
retirement, defeasance or other acquisition of any pari passu or subordinated
Indebtedness or Equity Interests of the Company in exchange for, or out of
the net cash proceeds of the substantially concurrent sale (other than to a
Subsidiary of the Company) of, other Equity Interests of the Company (other
than any Disqualified Stock); provided that the amount of any such net cash
proceeds that are utilized for any such redemption, repurchase, retirement,
defeasance or other acquisition shall be excluded from clause (iii) (B) of
the preceding paragraph; (c) the defeasance, redemption, repurchase,
retirement or other acquisition of subordinated Indebtedness with the net
cash proceeds from an incurrence of, or in exchange for, Permitted
Refinancing Indebtedness; (d) the repurchase, redemption or other acquisition
or retirement for value of any Equity Interests of the Company or any
Subsidiary of the Company held by any member
58
<PAGE>
of the Company's management pursuant to any management equity subscription
agreement or stock option agreement in effect as of the date of the New
Senior Subordinated Note Indenture; provided, however, that (i) the aggregate
price paid for all such repurchased, redeemed, acquired or retired Equity
Interests shall not exceed $2.0 million in any twelve-month period plus the
aggregate cash proceeds received by the Company during such twelve-month
period from any reissuance of Equity Interests by the Company to members of
management of the Company and its Subsidiaries and (ii) no Default or Event
of Default shall have occurred and be continuing immediately after such
transaction; (e) payments and transactions in connection with the Refinancing
Plan, the New Credit Agreement (including commitment, syndication and
arrangement fees payable thereunder), the Offering and the Common Stock
Offering (including underwriting discounts and commissions in connection
therewith) and the application of the proceeds thereof, and the payment of
the fees and expenses with respect thereto and (f) the declaration and
payment of dividends to holders of any class or series of preferred stock
(other than Disqualified Stock) issued after the date of the New Senior
Subordinated Note Indenture; provided, however, that at the time of such
issuance, after giving effect to such issuance on a pro forma basis, the
Fixed Charge Coverage Ratio for the Company for the most recently ended four
full fiscal quarters for which internal financial statements are available
immediately preceding the date of such issuance would have been no less than
2.0 to 1.
The amount of all Restricted Payments (other than cash) shall be the fair
market value on the date of the Restricted Payment of the asset(s) or
securities proposed to be transferred or issued by the Company or such
Subsidiary, as the case may be, pursuant to the Restricted Payment. The fair
market value of any non-cash Restricted Payment shall be determined by the
Board of Directors of the Company whose resolution with respect thereto shall
be delivered to the Trustee. Not later than the date of making any Restricted
Payment, the Company shall deliver to the Trustee an officer's certificate
stating that such Restricted Payment is permitted and setting forth the basis
upon which the calculations required by the covenant described in this
section were computed.
Incurrence of Indebtedness and Issuance of Preferred Stock
The New Senior Subordinated Note Indenture will provide that (i) the
Company will not, and will not permit any of its Subsidiaries to, directly or
indirectly, create, incur, issue, assume, guarantee or otherwise become
directly or indirectly liable, contingently or otherwise, with respect to
(collectively, "incur") any Indebtedness (including Acquired Indebtedness),
(ii) the Company will not permit any of its Subsidiaries to issue any shares
of Disqualified Stock and (iii) the Company will not permit any of its
Subsidiaries that are not Subsidiary Guarantors to issue any shares of
preferred stock; provided, however, that the Company and any Subsidiary
Guarantor may incur Indebtedness (including Acquired Debt) or issue shares of
Disqualified Stock if the Fixed Charge Coverage Ratio for the Company's most
recently ended four full fiscal quarters for which internal financial
statements are available immediately preceding the date on which such
additional Indebtedness is incurred or such shares of Disqualified Stock are
issued would have been at least 2.0 to 1 determined on a consolidated pro
forma basis (including a pro forma application of the net proceeds
therefrom), as if the additional Indebtedness had been incurred, or the
Disqualified Stock had been issued, as the case may be, at the beginning of
such four-quarter period.
Notwithstanding the foregoing, the Company and, to the extent set forth
below, its Subsidiaries may incur the following:
(a) Indebtedness of the Company under the New Senior Subordinated Notes
and the New Senior Subordinated Note Indenture and Indebtedness of
Subsidiaries under the Subsidiary Guarantees;
(b) Indebtedness under the New Credit Agreement in an aggregate principal
amount not to exceed $160.0 million outstanding at any time;
(c) Existing Indebtedness;
(d) Capital Expenditure Indebtedness, Capitalized Lease Obligations and
purchase money Indebtedness of the Company and its Subsidiaries in an
aggregate principal amount not to exceed $20.0 million at any time
outstanding;
59
<PAGE>
(e) the incurrence by the Company or any of its Subsidiaries of Hedging
Obligations that are incurred for the purpose of fixing or hedging
interest rate risk with respect to any floating rate Indebtedness that is
permitted by the terms of the New Senior Subordinated Note Indenture to be
outstanding;
(f) Indebtedness of the Company representing guarantees of Indebtedness
incurred by one of its Subsidiaries pursuant to, and in compliance with,
another provision of this covenant;
(g) the incurrence by the Company or any of its Subsidiaries of
intercompany Indebtedness between or among the Company and any of its
Wholly Owned Subsidiaries; provided, however, that (i) if the Company is
the obligor on such Indebtedness, such Indebtedness is expressly
subordinated to the prior payment in full in cash of all obligations with
respect to the New Senior Subordinated Notes and (ii) (A) any subsequent
issuance or transfer of Equity Interests that results in any such
Indebtedness being held by a Person other than the Company or a Wholly
Owned Subsidiary and (B) any sale or other transfer of any such
Indebtedness to a Person that is not either the Company or a Wholly Owned
Subsidiary shall be deemed, in each case, to constitute an incurrence of
such Indebtedness by the Company or such Subsidiary, as the case may be;
(h) any Permitted Refinancing Indebtedness representing a replacement,
renewal, refinancing or extension of Indebtedness permitted under the
first paragraph and clause (c) of this covenant;
(i) Indebtedness arising from agreements of the Company or any
Subsidiary Guarantor providing for indemnification, adjustment of purchase
price or similar obligations, in each case, incurred or assumed in
connection with the disposition of any business, assets or a Subsidiary,
other than guarantees of Indebtedness incurred by any Person acquiring all
or any portion of such business, assets or Subsidiary for the purpose of
financing such acquisition; provided however, that (1) such Indebtedness
is not reflected on the balance sheet of the Company or any Subsidiary
Guarantor (contingent obligations referred to in a footnote or footnotes
to financial statements and not otherwise reflected on the balance sheet
will not be deemed to be reflected on such balance sheet for purposes of
this clause (1)) and (2) the maximum assumable liability in respect of
such Indebtedness shall at no time exceed the gross proceeds including
noncash proceeds (the fair market value of such noncash proceeds being
measured at the time received and without giving effect to any subsequent
changes in value) actually received by the Company and/or the Subsidiary
Guarantors in connection with such disposition; and
(j) additional Indebtedness of the Company and its Subsidiaries in an
aggregate principal amount not to exceed $30.0 million at any time
outstanding.
Liens
The New Senior Subordinated Note Indenture will provide that the Company
will not, and will not permit any of its Subsidiaries to, directly or
indirectly, create, incur, assume or suffer to exist any Lien that secures
obligations under any pari passu Indebtedness or subordinated Indebtedness on
any asset or property now owned or hereafter acquired by the Company or any
of its Subsidiaries, or any income or profits therefrom or assign or convey
any right to receive income therefrom, unless the New Senior Subordinated
Notes or the Subsidiary Guarantees, as applicable, are equally and ratably
secured with the obligations so secured until such time as such obligations
are not longer secured by a Lien; provided, that in any case involving a Lien
securing subordinated Indebtedness, such Lien is subordinated to the Lien
securing the New Senior Subordinated Notes or the Subsidiary Guarantees, as
applicable, to the same extent that such subordinated Indebtedness is
subordinated to the New Senior Subordinated Notes or the Subsidiary
Guarantees, as applicable.
Dividend and Other Payment Restrictions Affecting Subsidiaries
The New Senior Subordinated Note Indenture will provide that the Company
will not, and will not permit any of its Subsidiaries to, directly or
indirectly, create or otherwise cause or suffer to exist or become effective
any encumbrance or restriction on the ability of any Subsidiary to (a)(i) pay
dividends
60
<PAGE>
or make any other distributions to the Company or any of its Subsidiaries on
its Capital Stock or with respect to any other interest or participation in,
or measured by, its profits, or (ii) pay any Indebtedness owed to the Company
or any of its Subsidiaries, (b) make loans or advances to the Company or any
of its Subsidiaries or (c) transfer any of its properties or assets to the
Company or any of its Subsidiaries, except for such encumbrances or
restrictions existing under or by reason of (i) Existing Indebtedness as in
effect on the date of the New Senior Subordinated Note Indenture, (ii) the
New Credit Agreement as in effect on the date of the New Senior Subordinated
Note Indenture and any refinancings, amendments, restatements, renewals or
replacements thereof, provided, however, that the agreements governing such
refinancings, amendments, restatements, renewals or replacements contain
restrictions are not more restrictive in the aggregate than those contained
in the New Credit Agreement as in effect on the date of the New Senior
Subordinated Note Indenture, (iii) the New Senior Subordinated Note
Indenture, the New Senior Subordinated Notes and the Subsidiary Guarantees,
(iv) applicable law or any applicable rule, regulation or order, (v) any
agreement or other instrument governing Indebtedness or Capital Stock of a
Person acquired by the Company or any of its Subsidiaries as in effect at the
time of such acquisition (except to the extent such Indebtedness was incurred
in connection with or in contemplation of such acquisition), which
encumbrance or restriction is not applicable to any Person, or the properties
or assets of any Person, other than the Person, or the property or assets of
the Person, so acquired, provided that, in the case of Indebtedness, such
Indebtedness was permitted by the terms of the New Senior Subordinated Note
Indenture to be incurred, (vi) by reason of customary non-assignment
provisions in leases entered into in the ordinary course of business and
consistent with past practices, (vii) purchase money obligations for property
acquired in the ordinary course of business that impose restrictions of the
nature described in clause (c) above on the property so acquired, (viii)
customary provisions in bona fide contracts for the sale of property or
assets, or (ix) Permitted Refinancing Indebtedness, provided that the
restrictions contained in the agreements governing such Permitted Refinancing
Indebtedness are not more restrictive in the aggregate than those contained
in the agreements governing the Indebtedness being refinanced.
Merger, Consolidation or Sale of Assets
The New Senior Subordinated Note Indenture will provide that the Company
may not consolidate or merge with or into (whether or not the Company is the
surviving corporation), or sell, assign, transfer, lease, convey or otherwise
dispose of all or substantially all of its properties or assets in one or
more related transactions, to another corporation, Person or entity unless
(a) the Company is the surviving corporation or the entity or the Person
formed by or surviving any such consolidation or merger (if other than the
Company) or to which such sale, assignment, transfer, lease, conveyance or
other disposition shall have been made is a corporation organized or existing
under the laws of the United States, any state thereof or the District of
Columbia, (b) the entity or Person formed by or surviving any such
consolidation or merger (if other than the Company) or the entity or Person
to which such sale, assignment, transfer, lease, conveyance or other
disposition shall have been made assumes all the obligations of the Company
under the New Senior Subordinated Notes and the New Senior Subordinated Note
Indenture pursuant to a supplemental indenture in a form reasonably
satisfactory to the Trustee, (c) immediately after such transaction no
Default or Event of Default exists, and (d) except in the case of a merger of
the Company with or into a Wholly Owned Subsidiary of the Company, the
Company or the entity or Person formed by or surviving any such consolidation
or merger (if other than the Company), or to which such sale, assignment,
transfer, lease, conveyance or other disposition shall have been made will,
at the time of such transaction and after giving pro forma effect thereto as
if such transaction had occurred at the beginning of the applicable
four-quarter period, be permitted to incur at least $1.00 of additional
Indebtedness pursuant to the Fixed Charge Coverage Ratio test set forth in
the first paragraph of the covenant described above under the caption
"--Incurrence of Indebtedness and Issuance of Preferred Stock."
Transactions with Affiliates
The New Senior Subordinated Note Indenture will provide that the Company
will not, and will not permit any of its Subsidiaries to, make any payment
to, or sell, lease, transfer or otherwise dispose of any of its properties or
assets to, or purchase any property or assets from, or enter into or make or
amend any
61
<PAGE>
transaction, contract, agreement, understanding, loan, advance or guarantee
with, or for the benefit of, any Affiliate of the Company (each of the
foregoing, an "Affiliate Transaction"), unless (a) such Affiliate Transaction
is on terms that are no less favorable to the Company or the relevant
Subsidiary than those that would have been obtained in a comparable
transaction by the Company or such Subsidiary with an unrelated Person, and
(b) the Company delivers to the Trustee (i) with respect to any Affiliate
Transaction or series of related Affiliate Transactions involving aggregate
consideration in excess of $1.0 million, either (A) a resolution of the Board
of Directors of the Company set forth in an officer's certificate certifying
that such Affiliate Transaction complies with clause (a) above and that such
Affiliate Transaction has been approved by a majority of the disinterested
members of the Board of Directors of the Company and (ii) with respect to any
Affiliate Transaction or series of related Affiliate Transactions involving
aggregate consideration in excess of $5.0 million, an opinion as to the
fairness to the Company of such Affiliate Transaction from a financial point
of view issued by an accounting, appraisal or investment banking firm of
national standing; provided, however, that the following shall be deemed not
to be Affiliate Transactions: (i) customary directors' fees, indemnification
or similar arrangements or any employment agreement or other compensation
plan or arrangement entered into by the Company or any of its Subsidiaries in
the ordinary course of business (including ordinary course loans to employees
not to exceed (A) $3.0 million outstanding in the aggregate at any time and
(B) $1.5 million to any one employee) consistent with the past practice of
the Company or such Subsidiary; (ii) transactions between or among the
Company and/or its Wholly Owned Subsidiaries; (iii) transactions permitted by
the provisions of the New Senior Subordinated Note Indenture described above
under the caption "--Restricted Payments;" (iv) payments of customary fees by
the Company or any of its Subsidiaries to DLJMB and its Affiliates made for
any financial advisory, financing, underwriting or placement services or in
respect of other investment banking activities, including, without
limitation, in connection with acquisitions or divestitures which are
approved by a majority of the Board of Directors of the Company in good
faith; (v) any agreement as in effect on the date of the New Senior
Subordinated Note Indenture or any amendment thereto (so long as such
amendment is not disadvantageous to the holders of the New Senior
Subordinated Notes in any material respect) or any transaction contemplated
thereby; (vi) the existence of, or the performance by the Company of any of
its Subsidiaries of its obligations under the terms of, any stockholders
agreement (including any registration rights agreement or purchase agreement
related thereto) to which it is a party as of the date of the New Senior
Subordinated Note Indenture and any similar agreements which it may enter
into thereafter so long as such similar agreements contain only terms that
are customary of stockholders and registration rights agreements; and (vii)
payments and transactions in connection with the Refinancing Plan, the New
Credit Agreement (including commitment, syndication and arrangement fees
payable thereunder), the Offering and the Common Stock Offering (including
underwriting discounts and commissions in connection therewith) and the
application of the proceeds thereof, and the payment of the fees and expenses
with respect thereto.
Sale and Leaseback Transactions
The New Senior Subordinated Note Indenture will provide that the Company
will not, and will not permit any of its Subsidiaries to, enter into any sale
and leaseback transaction; provided, however, that the Company or any
Subsidiary may enter into a sale and leaseback transaction if (a) the Company
could have (i) incurred Indebtedness in an amount equal to the Attributable
Indebtedness relating to such sale and leaseback transaction pursuant to the
Fixed Charge Coverage Ratio test set forth in the first paragraph of the
covenant described under the heading "--Incurrence of Indebtedness and
Issuance of Preferred Stock" and (ii) incurred a Lien to secure such
Indebtedness pursuant to the covenant described above under the heading
"--Liens," (b) the gross cash proceeds of such sale and leaseback transaction
are at least equal to the fair market value (as determined in good faith by
the Board of Directors of the Company and set forth in an officer's
certificate delivered to the Trustee) of the property that is the subject of
such sale and leaseback transaction and (c) the transfer of assets in such
sale and leaseback transaction is permitted by, and the Company applies the
proceeds of such transaction in compliance with, the covenant described under
the heading "--Repurchase at the Option of Holders--Asset Sales."
Issuances and Sales of Capital Stock of Wholly-Owned Subsidiaries
The New Senior Subordinated Note Indenture will provide that the Company
(a) will not permit any Wholly Owned Subsidiary of the Company to issue any
of its Equity Interests to any Person other than
62
<PAGE>
to the Company or a Wholly Owned Subsidiary of the Company, and (b) will not,
and will not permit any Wholly Owned Subsidiary of the Company to, transfer,
convey, sell, lease or otherwise dispose of any Capital Stock of any Wholly
Owned Subsidiary of the Company to any Person (other than the Company or any
Wholly Owned Subsidiary of the Company) unless (i) such transfer, conveyance,
sale, lease or other disposition is of all of the Capital Stock of such
Wholly Owned Subsidiary and (ii) the Net Proceeds from such transfer,
conveyance, sale, lease or other disposition are applied in accordance with
the covenant described under the caption "--Repurchase at the Option of
Holders--Asset Sales"; provided that this clause (b) shall not apply to any
pledge of Capital Stock of any Wholly Owned Subsidiary of the Company
securing Indebtedness under the New Credit Agreement.
Additional Subsidiary Guarantees
The New Senior Subordinated Note Indenture will provide that if the
Company or any of its Subsidiaries shall, after the date of the New Senior
Subordinated Note Indenture, acquire or create another Subsidiary, then such
newly acquired, created or designated Subsidiary shall execute a Subsidiary
Guarantee and deliver an opinion of counsel in accordance with the terms of
the New Senior Subordinated Note Indenture.
No Senior Subordinated Debt
The New Senior Subordinated Note Indenture will provide that the Company
will not incur, create, issue, assume, guarantee or otherwise become liable
for any Indebtedness that is subordinate or junior in right of payment to any
Senior Debt and senior in any respect in right of payment to the New Senior
Subordinated Notes.
Reports
The New Senior Subordinated Note Indenture will provide that, whether or
not the Company is required to do so by the rules and regulations of the
Commission, the Company will file with the Commission (unless the Commission
will not accept such a filing) and, within 15 days of filing, or attempting
to file, the same with the Commission, furnish to the holders of the New
Senior Subordinated Notes (a) all quarterly and annual financial and other
information with respect to the Company and its Subsidiaries that would be
required to be contained in a filing with the Commission on Forms 10-Q and
10-K if the Company were required to file such forms, including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and, with respect to the annual information only, a report
thereon by the Company's certified independent accountants, and (b) all
current reports that would be required to be filed with the Commission on
Form 8-K if the Company were required to file such reports.
EVENTS OF DEFAULT AND REMEDIES
The New Senior Subordinated Note Indenture will provide that each of the
following constitutes an Event of Default: (a) default for 30 days in the
payment when due of interest on the New Senior Subordinated Notes (whether or
not prohibited by the subordination provisions of the New Senior Subordinated
Note Indenture); (b) default in payment when due of the principal of or
premium (if any) on the New Senior Subordinated Notes (whether or not
prohibited by the subordination provisions of the New Senior Subordinated
Note Indenture); (c) failure by the Company to comply with the provisions
described under the captions "--Repurchase at the Option of Holders--Change
of Control," "--Repurchase at the Option of Holders--Asset Sales," "--Certain
Covenants--Restricted Payments," "--Certain Covenants--Incurrence of
Indebtedness and Issuance of Preferred Stock" or "--Certain
Covenants--Merger, Consolidation or Sale of Assets;" (d) failure by the
Company for 60 days after notice to comply with any of its other agreements
in the New Senior Subordinated Note Indenture or the New Senior Subordinated
Notes; (e) default under any mortgage, indenture or instrument under which
there may be issued or by which there may be secured or evidenced any
Indebtedness for money borrowed by the Company or any of its Subsidiaries (or
the payment of which is guaranteed by the Company or any of its
Subsidiaries), whether such Indebtedness or guarantee now exists or is
created after the date of the
63
<PAGE>
New Senior Subordinated Note Indenture, which default (i) is caused by a
failure to pay principal of or premium (if any) or interest on such
Indebtedness at its final stated maturity prior to the expiration of any
grace period provided in such Indebtedness (a "Payment Default") or (ii)
results in the acceleration of such Indebtedness prior to its express
maturity and, in each case, the principal amount of any such Indebtedness,
together with the principal amount of any other such Indebtedness under which
there has been a Payment Default or the maturity of which has been so
accelerated, aggregates $5.0 million or more; (f) failure by the Company or
any of its Subsidiaries to pay final judgments aggregating in excess of $5.0
million, which judgments are not paid, discharged or stayed for a period of
60 days; (g) failure by any Subsidiary Guarantor to perform any covenant set
forth in its Subsidiary Guarantee, or the repudiation by any Subsidiary
Guarantor of its obligations under its Subsidiary Guarantee or the
unenforceability of any Subsidiary Guarantee against a Subsidiary Guarantor
for any reason, unless, in each such case, such Subsidiary Guarantor and its
Subsidiaries have no Indebtedness outstanding at such time or at any time
thereafter; and (h) certain events of bankruptcy or insolvency with respect
to the Company or any of its Significant Subsidiaries.
If any Event of Default occurs and is continuing, the Trustee or the
holders of at least 25% in principal amount of the then outstanding New
Senior Subordinated Notes may declare all the New Senior Subordinated Notes
to be due and payable immediately; provided, that so long as any Indebtedness
permitted to be incurred pursuant to the New Credit Agreement shall be
outstanding, such acceleration shall not be effective until the earlier of
(a) any acceleration of any such Indebtedness under the New Credit Agreement
and (b) five business days after receipt by the Company of written notice of
such acceleration. Notwithstanding the foregoing, in the case of an Event of
Default arising from certain events of bankruptcy or insolvency with respect
to the Company, any Significant Subsidiary or any group of Subsidiaries that,
taken together, would constitute a Significant Subsidiary, all outstanding
New Senior Subordinated Notes will become due and payable without further
action or notice. Holders of the New Senior Subordinated Notes may not
enforce the New Senior Subordinated Note Indenture or the New Senior
Subordinated Notes except as provided in the New Senior Subordinated Note
Indenture. In the event of a declaration of acceleration of the New Senior
Subordinated Notes because an Event of Default has occurred and is continuing
as a result of the acceleration of any Indebtedness described in clause (e)
of the preceding paragraph, the declaration of acceleration of the New Senior
Subordinated Notes shall be automatically annulled if the holders of any
Indebtedness described in clause (e) have rescinded the declaration of
acceleration in respect of such Indebtedness within 30 days of the date of
such declaration and if (i) the annulment of the acceleration of the New
Senior Subordinated Notes would not conflict with any judgment or decree of a
court of competent jurisdiction, and (ii) all existing Events of Default,
except nonpayment of principal or interest on the New Senior Subordinated
Notes that became due solely because of the acceleration of the New Senior
Subordinated Notes, have been cured or waived.
Subject to certain limitations, holders of a majority in principal amount
of the then outstanding New Senior Subordinated Notes may direct the Trustee
in its exercise of any trust or power. The Trustee may withhold from holders
of the New Senior Subordinated Notes notice of any continuing Default or
Event of Default (except a Default or Event of Default relating to the
payment of principal or interest) if it determines that withholding notice is
in their interest.
In the case of any Event of Default occurring by reason of any willful
action (or inaction) taken (or not taken) by or on behalf of the Company with
the intention of avoiding payment of the premium that the Company would have
had to pay if the Company then had elected to redeem the New Senior
Subordinated Notes pursuant to the optional redemption provisions of the New
Senior Subordinated Note Indenture, an equivalent premium shall also become
and be immediately due and payable to the extent permitted by law upon the
acceleration of the New Senior Subordinated Notes. If an Event of Default
occurs prior to February 15, 2003 by reason of any willful action (or
inaction) taken (or not taken) by or on behalf of the Company with the
intention of avoiding the prohibition on redemption of the New Senior
Subordinated Notes prior to such date, then the premium specified in the New
Senior Subordinated Note Indenture shall also become immediately due and
payable to the extent permitted by law upon the acceleration of the New
Senior Subordinated Notes.
64
<PAGE>
The holders of a majority in aggregate principal amount of the New Senior
Subordinated Notes then outstanding by notice to the Trustee may on behalf of
the holders of all of the New Senior Subordinated Notes waive any existing
Default or Event of Default and its consequences under the New Senior
Subordinated Note Indenture except a continuing Default or Event of Default
in the payment of the principal of or interest on the New Senior Subordinated
Notes.
The Company is required to deliver to the Trustee annually a statement
regarding compliance with the New Senior Subordinated Note Indenture, and the
Company is required upon becoming aware of any Default or Event of Default to
deliver to the Trustee a statement specifying such Default or Event of
Default.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Company
or any Subsidiary Guarantor, as such, shall have any liability for any
obligations of the Company or any Subsidiary Guarantor under the New Senior
Subordinated Notes, the Subsidiary Guarantees or the New Senior Subordinated
Note Indenture or for any claim based on, in respect of, or by reason of,
such obligations or their creation. Each holder of New Senior Subordinated
Notes by accepting a New Senior Subordinated Note waives and releases all
such liability. The waiver and release are part of the consideration for
issuance of the New Senior Subordinated Notes. Such waiver may not be
effective to waive liabilities under the federal securities laws and it is
the view of the Commission that such a waiver is against public policy.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have all of its
obligations discharged with respect to the outstanding New Senior
Subordinated Notes and have each Subsidiary Guarantor's obligations
discharged with respect to its Subsidiary Guarantee ("Legal Defeasance")
except for (a) the rights of holders of outstanding New Senior Subordinated
Notes to receive payments in respect of the principal of and premium (if any)
and interest on such New Senior Subordinated Notes when such payments are due
from the trust referred to below, (b) the Company's obligations with respect
to the New Senior Subordinated Notes concerning issuing temporary New Senior
Subordinated Notes, registration of New Senior Subordinated Notes, mutilated,
destroyed, lost or stolen New Senior Subordinated Notes and the maintenance
of an office or agency for payment and money for security payments held in
trust, (c) the rights, powers, trusts, duties and immunities of the Trustee,
and the Company's obligations in connection therewith and (d) the Legal
Defeasance provisions of the New Senior Subordinated Note Indenture. In
addition, the Company may, at its option and at any time, elect to have the
obligations of the Company and each Subsidiary Guarantor released with
respect to certain covenants that are described in the New Senior
Subordinated Note 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 New Senior Subordinated Notes. In the
event Covenant Defeasance occurs, certain events (not including non-payment,
bankruptcy, receivership, rehabilitation and insolvency events) described
under "--Events of Default and Remedies" will no longer constitute an Event
of Default with respect to the New Senior Subordinated 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 New Senior Subordinated Notes, cash in U.S.
dollars, non-callable Government Securities, 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 and premium
(if any) and interest on the outstanding New Senior Subordinated Notes on the
stated maturity or on the applicable redemption date, as the case may be, and
the Company must specify whether the New Senior Subordinated Notes are being
defeased to maturity or to a particular redemption date, (ii) in the case of
Legal Defeasance, 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 New Senior Subordinated Note Indenture, there has been a change
65
<PAGE>
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
the outstanding New Senior Subordinated 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, the
Company shall have delivered to the Trustee an opinion of counsel in the
United States reasonably acceptable to the Trustee confirming that the
holders of the outstanding New Senior Subordinated 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
(other than a Default or Event of Default resulting from the borrowing of
funds to be applied to such deposit), (v) such Legal Defeasance or Covenant
Defeasance will not result in a breach or violation of, or constitute a
default under, any material agreement or instrument (other than the New
Senior Subordinated Note Indenture) 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 must have delivered to the Trustee an opinion of
counsel to the effect that the trust funds will not be subject to the effect
of any applicable bankruptcy, insolvency, reorganization or similar laws
affecting creditors' rights generally, (vii) the Company must deliver to the
Trustee an officer's certificate stating that the deposit was not made by the
Company with the intent of preferring the holders of New Senior Subordinated
Notes over the other creditors of the Company with the intent of defeating,
hindering, delaying or defrauding creditors of the Company or others and
(viii) the Company must deliver to the Trustee an officer's certificate and
an opinion of counsel, each stating that all conditions precedent provided
for relating to the Legal Defeasance or the Covenant Defeasance have been
complied with.
TRANSFER AND EXCHANGE
A holder of New Senior Subordinated Notes may transfer or exchange New
Senior Subordinated Notes in accordance with the New Senior Subordinated Note
Indenture. The registrar and the Trustee may require a holder, among other
things, to furnish appropriate endorsements and transfer documents and the
Company may require a holder to pay any taxes and fees required by law or
permitted by the New Senior Subordinated Note Indenture. The Company is not
required to transfer or exchange any New Senior Subordinated Note selected
for redemption. Also, the Company is not required to transfer or exchange any
New Senior Subordinated Note for a period of 15 days before a selection of
New Senior Subordinated Notes to be redeemed.
The registered holder of a New Senior Subordinated Note will be treated as
the owner of it for all purposes.
AMENDMENT, SUPPLEMENT AND WAIVER
Except as provided in the next two succeeding paragraphs, the New Senior
Subordinated Note Indenture, the New Senior Subordinated Notes or the
Subsidiary Guarantees may be amended or supplemented with the consent of the
holders of at least a majority in principal amount of the New Senior
Subordinated Notes then outstanding (including, without limitation, consents
obtained in connection with a purchase of, or tender offer or exchange offer
for, New Senior Subordinated Notes), and any existing default or compliance
with any provision of the New Senior Subordinated Note Indenture, the New
Senior Subordinated Notes or the Subsidiary Guarantees may be waived with the
consent of the holders of a majority in principal amount of the then
outstanding New Senior Subordinated Notes (including consents obtained in
connection with a tender offer or exchange offer for New Senior Subordinated
Notes).
Without the consent of each holder affected, an amendment or waiver may
not (with respect to any New Senior Subordinated Notes held by a
non-consenting holder): (a) reduce the principal amount of New Senior
Subordinated Notes whose holders must consent to an amendment, supplement or
waiver, (b) reduce the principal of or change the fixed maturity of any New
Senior Subordinated Note or alter the
66
<PAGE>
provisions with respect to the redemption of the New Senior Subordinated
Notes (including as described under the caption "--Repurchase at the Option
of Holders"), (c) reduce the rate of or change the time for payment of
interest on any New Senior Subordinated Note, (d) waive a Default or Event of
Default in the payment of principal of or premium (if any) or interest on the
New Senior Subordinated Notes (except a rescission of acceleration of the New
Senior Subordinated Notes by the holders of at least a majority in aggregate
principal amount of the New Senior Subordinated Notes and a waiver of the
payment default that resulted from such acceleration), (e) make any New
Senior Subordinated Note payable in money other than that stated in the New
Senior Subordinated Notes, (f) make any change in the provisions of the New
Senior Subordinated Note Indenture relating to waivers of past Defaults or
the rights of holders of New Senior Subordinated Notes to receive payments of
principal of and premium (if any) and interest on the New Senior Subordinated
Notes, (g) waive a redemption payment with respect to any New Senior
Subordinated Note (including a payment as described under the caption
"--Repurchase at the Option of Holders"), (h) except as provided under the
caption "--Legal Defeasance and Covenant Defesance" or in accordance with the
terms of any Subsidiary Guarantee, release a Subsidiary Guarantor from its
obligations under its Subsidiary Guarantee or make any change in a Subsidiary
Guarantee that would adversely affect the holders of the New Senior
Subordinated Notes and (i) make any change in the foregoing amendment and
waiver provisions. Notwithstanding the foregoing, any amendment to the
provisions of the Subsidiary Guarantees relating to subordination or Article
10 of the New Senior Subordinated Note Indenture (which relates to
subordination) will require the consent of the holders of at least 75% in
aggregate principal amount of the New Senior Subordinated Notes then
outstanding if such amendment would adversely affect the rights of holders of
New Senior Subordinated Notes.
Notwithstanding the foregoing, without the consent of any holder of New
Senior Subordinated Notes, the Company, a Subsidiary Guarantor (with respect
to a Subsidiary Guarantee or the New Senior Subordinated Note Indenture to
which it is a party) and the Trustee may amend or supplement the New Senior
Subordinated Note Indenture, the New Senior Subordinated Notes or the
Subsidiary Guarantees to cure any ambiguity, defect or inconsistency, to
provide for uncertificated New Senior Subordinated Notes in addition to or in
place of certificated New Senior Subordinated Notes, to provide for the
assumption of the Company's or the Subsidiary Guarantor's obligations to
holders of New Senior Subordinated Notes in the case of a merger or
consolidation, to make any change that would provide any additional rights or
benefits to the holders of New Senior Subordinated Notes or that does not
adversely affect the legal rights under the New Senior Subordinated Note
Indenture of any such holder, or to comply with requirements of the
Commission in order to effect or maintain the qualification of the New Senior
Subordinated Note Indenture under the Trust Indenture Act or to allow any
Subsidiary Guarantor to guarantee the New Senior Subordinated Notes.
CONCERNING THE TRUSTEE
The New Senior Subordinated Note Indenture contains certain limitations on
the rights of the Trustee, should it become a creditor of the Company, to
obtain payment of claims in certain cases, or to realize on certain property
received in respect of any such claim as security or otherwise. The Trustee
will be permitted to engage in other transactions; however, if it acquires
any conflicting interest it must eliminate such conflict within 90 days and
apply to the Commission for permission to continue or resign.
The holders of a majority in principal amount of the then outstanding New
Senior Subordinated Notes will have the right to direct the time, method and
place of conducting any proceeding for exercising any remedy available to the
Trustee, subject to certain exceptions. The New Senior Subordinated Note
Indenture provides that in case an Event of Default shall occur (which shall
not be cured), the Trustee will be required, in the exercise of its power, to
use the degree of care of a prudent man in the conduct of his own affairs.
Subject to such provisions, the Trustee will be under no obligation to
exercise any of its rights or powers under the New Senior Subordinated Note
Indenture at the request of any holder of New Senior Subordinated Notes,
unless such holder shall have offered to the Trustee security and indemnity
satisfactory to it against any loss, liability or expense.
CERTAIN DEFINITIONS
Set forth below are certain defined terms used in the New Senior
Subordinated Note Indenture. Reference is made to the New Senior Subordinated
Note Indenture for a full disclosure of all such terms, as well as any other
capitalized terms used herein for which no definition is provided.
67
<PAGE>
"Acquired Indebtedness" means, with respect to any specified Person, (i)
Indebtedness of any other Person existing at the time such other Person is
merged with or into or became a Subsidiary of such specified Person,
including, without limitation, Indebtedness incurred in connection with, or
in contemplation of, such other Person merging with or into or becoming a
Subsidiary of such specified Person, and (ii) Indebtedness secured by a Lien
encumbering an asset acquired by such specified Person at the time such asset
is acquired by such specified Person.
"Affiliate" of any specified Person means any other Person which, directly
or indirectly, controls, is controlled by or is under direct or indirect
common control with, such specified Person. For purposes of this definition,
"control" when used with respect to any Person means the power to direct the
management and policies of such Person, directly or indirectly, whether
through the ownership of voting securities, by contract or otherwise;
provided that beneficial ownership of 10% or more of the voting securities of
a Person shall be deemed to be control, and the terms "controlling" and
"controlled" have meanings correlative to the foregoing.
"Asset Sale" means (a) the sale, lease, conveyance, disposition or other
transfer (a "disposition") of any properties, assets or rights (including,
without limitation, a sale and leaseback transaction) or (b) the issuance,
sale or transfer by the Company of Equity Interests of a Subsidiary, and in
the case of either clause (a) or (b), whether in a single transaction or a
series of related transactions for Net Proceeds in excess of $1.0 million;
provided, however, that the following transactions will be deemed not to be
Asset Sales: (i) sales of inventory in the ordinary course of business; (ii)
a disposition of assets by the Company to a Wholly Owned Subsidiary or by a
Wholly Owned Subsidiary of the Company to the Company or to another Wholly
Owned Subsidiary of the Company; (iii) a disposition of Equity Interests by a
Wholly Owned Subsidiary of the Company to the Company or to another Wholly
Owned Subsidiary of the Company; (iv) the sale and leaseback of any assets
within 90 days of the acquisition of such assets; and (v) a Permitted
Investment or Restricted Payment that is permitted by the New Senior
Subordinated Note Indenture.
"Attributable Indebtedness" in respect of a sale and leaseback transaction
means, at the time of determination, the present value (discounted at the
rate of interest implicit in such transaction, determined in accordance with
GAAP) of the obligation of the lessee for net rental payments during the
remaining term of the lease included in such sale and leaseback transaction
(including any period for which such lease has been extended or may, at the
option of the lessor, be extended).
"Capital Expenditure Indebtedness" means Indebtedness incurred by any
Person to finance the purchase or construction of any property or assets
acquired or constructed by such Person which have a useful life of more than
one year so long as (a) the purchase or construction price for such property
or assets is included in "addition to property, plant or equipment" in
accordance with GAAP, (b) the acquisition or construction of such property or
assets is not part of any acquisition of a Person or line of business and (c)
such Indebtedness is incurred within 90 days of the acquisition or completion
of construction of such property or assets.
"Capital Lease Obligation" means, at the time any determination thereof is
to be made, the amount of the liability in respect of a capital lease that
would at such time be required to be capitalized on a balance sheet in
accordance with GAAP.
"Capital Stock" means (a) in the case of a corporation, corporate stock,
(b) in the case of an association or business entity, any and all shares,
interests, participations, rights or other equivalents (however designated)
of corporate stock, (c) in the case of a partnership or limited liability
company, partnership or membership interests (whether general or limited),
and (d) 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.
"Cash Equivalents" means (a) United States dollars, (b) securities issued
or directly and fully guaranteed or insured by the United States government
or any agency or instrumentality thereof having maturities of not more than
six months from the date of acquisition, (c) certificates of deposit and
eurodollar time deposits with maturities of six months or less from the date
of acquisition, bankers' acceptances with maturities not exceeding six months
and overnight bank deposits, in each case with any
68
<PAGE>
domestic commercial bank having capital and surplus in excess of $500.0
million, (d) repurchase obligations with a term of not more than seven days
for underlying securities of the types described in clauses (b) and (c) above
entered into with any financial institution meeting the qualifications
specified in clause (c) above, (e) commercial paper having the highest rating
obtainable from Moody's Investors Service, Inc. or Standard & Poor's Rating
Service and in each case maturing within six months after the date of
acquisition and (f) any fund investing exclusively in investments of the
types described in clauses (a) through (e) above.
"Consolidated Cash Flow" means, with respect to any Person for any period,
the Consolidated Net Income of such Person for such period plus (a) an amount
equal to any extraordinary loss plus any net loss realized in connection with
an Asset Sale (to the extent such losses were deducted in computing such
Consolidated Net Income), plus (b) provision for taxes based on income or
profits of such Person and its Subsidiaries for such period, to the extent
that such provision for taxes was included in computing such Consolidated Net
Income, plus (c) consolidated interest expense of such Person and its
Subsidiaries for such period, whether paid or accrued and whether or not
capitalized (including, without limitation, amortization of debt issuance
costs and original issue discount, non-cash interest payments, the interest
component of any deferred payment obligations, the interest component of all
payments associated with Capital Lease Obligations, commissions, discounts
and other fees and charges incurred in respect of letter of credit or
bankers' acceptance financings, and net payments (if any) pursuant to Hedging
Obligations), to the extent that any such expense was deducted in computing
such Consolidated Net Income, plus (d) depreciation, amortization (including
amortization of goodwill and other intangibles but excluding amortization of
prepaid cash expenses (other than deferred rental expense) that were paid in
a prior period) and other non-cash expenses (excluding any such non-cash
expense to the extent that it represents an accrual of or reserve for cash
expenses in any future period or amortization of a prepaid cash expense that
was paid in a prior period) of such Person and its Subsidiaries for such
period to the extent that such depreciation, amortization and other non-cash
expenses were deducted in computing such Consolidated Net Income.
"Consolidated Net Income" means, with respect to any Person for any
period, the aggregate of the Net Income of such Person and its Subsidiaries
for such period, on a consolidated basis, determined in accordance with GAAP;
provided that (a) the Net Income (but not loss) of any Person that is not a
Subsidiary or that is accounted for by the equity method of accounting shall
be included only to the extent of the amount of dividends or distributions
paid in cash to the referent Person or a Wholly Owned Subsidiary thereof, (b)
the Net Income of any Subsidiary shall be excluded to the extent that the
declaration or payment of dividends or similar distributions by that
Subsidiary of that Net Income is not at the date of determination permitted
without any prior governmental approval (that has not been obtained) or,
directly or indirectly, by operation of the terms of its charter or any
agreement, instrument, judgment, decree, order, statute, rule or governmental
regulation applicable to that Subsidiary or its stockholders, (c) the Net
Income of any Person acquired in a pooling of interests transaction for any
period prior to the date of such acquisition shall be excluded, and (d) the
cumulative effect of a change in accounting principles shall be excluded.
"Default" means any event that is or with the passage of time or the
giving of notice or both would be an Event of Default.
"Designated Senior Debt" means, with respect to any Person, (i) any
Indebtedness of such Person outstanding under the New Credit Agreement and
thereafter (ii) any other Senior Debt of such Person permitted under the New
Senior Subordinated Note Indenture the principal amount of which is $25
million or more and that has been designated by such Person as "Designated
Senior Debt."
"Disqualified Stock" means any Capital Stock that, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable), or upon the happening of any event, matures or is mandatorily
redeemable, pursuant to a sinking fund obligation or otherwise is
exchangeable for Indebtedness (except to the extent exchangeable at the
option of such Person subject to the terms of any debt instrument to which
such Person is a party) or redeemable at the option of the holder thereof, in
whole or in part, on or prior to the date that is 91 days after the date on
which the New Senior Subordinated Notes mature; provided, however, that any
Capital Stock that would constitute Disqualified
69
<PAGE>
Stock solely because the holders thereof have the right to require the
Company to repurchase such Capital Stock upon the occurrence of a Change of
Control or an Asset Sale shall not constitute Disqualified Stock if the terms
of such Capital Stock provide that the Company may not repurchase or redeem
any such Capital Stock pursuant to such provisions unless such repurchase or
redemption complies with the covenant described above under the caption
"--Certain Covenants--Restricted Payments."
"DLJMB" means DLJ Merchant Banking Partners II, L.P. and its Affiliates.
"Equity Interests" means Capital Stock and all warrants, options or other
rights to acquire Capital Stock (but excluding any debt security that is
convertible into, or exchangeable for, Capital Stock).
"Existing Indebtedness" means Indebtedness of the Company and its
Subsidiaries (other than Indebtedness under the New Credit Agreement) in
existence on the date of the New Senior Subordinated Note Indenture, until
such amounts are repaid.
"Fixed Charges" means, with respect to any Person for any period, the sum
of (a) consolidated interest expense of such Person and its Subsidiaries for
such period, whether paid or accrued (including, without limitation,
amortization of debt issuance costs and original issue discount, non-cash
interest payments, the interest component of any deferred payment
obligations, the interest component of all payments associated with Capital
Lease Obligations and net payments (if any) pursuant to Hedging Obligations),
and (b) commissions, discounts and other fees and charges incurred with
respect to letters of credit and bankers' acceptances financing, and (c) any
interest expense on Indebtedness of another Person that is guaranteed by such
Person or secured by a Lien on assets of such Person and (d) the product of
(i) all dividend payments on any series of preferred stock of such Person
(other than dividends payable solely in Equity Interests that are not
Disqualified Stock), times (ii) a fraction, the numerator or of which is one
and the denominator of which is one minus the then current combined federal,
state and local statutory tax rate of such Person, expressed as decimal, in
each case, on a consolidated basis and in accordance with GAAP.
"Fixed Charge Coverage Ratio" means with respect to any Person for any
period, the ratio of the Consolidated Cash Flow of such Person and its
Subsidiaries for such period (exclusive of amounts attributable to
discontinued operations, as determined in accordance with GAAP, or operations
and businesses disposed of prior to the Calculation Date (as defined below))
to the Fixed Charges of such Person for such period (exclusive of amounts
attributable to discontinued operations, as determined in accordance with
GAAP, or operations and businesses disposed of prior to the Calculation Date,
but only to the extent that the obligations giving rise to such Fixed Charges
would no longer be obligations contributing to such Person's Fixed Charges
subsequent to the Calculation Date). In the event that the Company or any of
its Subsidiaries incurs, assumes, guarantees or redeems any Indebtedness
(other than revolving credit borrowings) or issues preferred stock subsequent
to the commencement of the period for which the Fixed Charge Coverage Ratio
is being calculated but prior to the date on which the event for which the
calculation of the Fixed Charge Coverage Ratio is made (the "Calculation
Date"), then the Fixed Charge Coverage Ratio shall be calculated giving pro
forma effect to such incurrence, assumption, guarantee or redemption of
Indebtedness, or such issuance or redemption of preferred stock, as if the
same had occurred at the beginning of the applicable four-quarter reference
period. For purposes of making the computation referred to above,
acquisitions that have been made by the Company or any of its Subsidiaries,
including all mergers and consolidations and any related financing
transactions, during the four-quarter reference period or subsequent to such
reference period and on or prior to the Calculation Date shall be calculated
on a pro forma basis and shall be deemed to have occurred on the first day of
such four-quarter reference period and Consolidated Cash Flow for such
reference period shall be calculated to include the Consolidated Cash Flow of
the acquired entities (adjusted to exclude (x) the cost of any compensation,
remuneration or other benefit paid or provided to any employee, consultant,
Affiliate or equity owner of the acquired entities to the extent such costs
are eliminated and not replaced and (y) the amount of any reduction in
general, administrative or overhead costs of the acquired entities, in each
case, as determined in good faith by an officer of the Company) without
giving effect to clause (c) of the proviso set forth in the definition of
Consolidated Net Income.
70
<PAGE>
"GAAP" means 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 have been approved by a significant
segment of the accounting profession, which are in effect as of the date of
the New Senior Subordinated Note Indenture.
"guarantee" means a guarantee (other than by endorsement of negotiable
instruments for collection in the ordinary course of business), direct or
indirect, in any manner (including, without limitation, letters of credit and
reimbursement agreements in respect thereof), of all or any part of any
Indebtedness.
"Hedging Obligations" means, with respect to any Person, the obligations
of such Person under interest rate swap agreements, interest rate cap
agreements, interest rate collar agreements and other agreements or
arrangements designed to protect such Person against fluctuations in interest
rates.
"Indebtedness" means, with respect to any Person, any indebtedness of such
Person, whether or not contingent, in respect of borrowed money or evidenced
by bonds, notes, debentures or similar instruments or letters of credit (or
reimbursement agreements in respect thereof) or bankers' acceptances or
representing Capital Lease Obligations or the balance deferred and unpaid of
the purchase price of any property or representing any Hedging Obligations,
except any such balance that constitutes an accrued expense or trade payable,
if and to the extent any of the foregoing indebtedness (other than letters of
credit and Hedging Obligations) would appear as a liability upon a balance
sheet of such Person prepared in accordance with GAAP, as well as
Indebtedness of others secured by a Lien on any asset of such Person (whether
or not such Indebtedness is assumed by such Person) and, to the extent not
otherwise included, the guarantee by such Person of any Indebtedness of any
other Person. The amount of any Indebtedness outstanding as of any date shall
be (a) the accreted value thereof (together with any interest thereon that is
more than 30 days past due), in the case of any Indebtedness that does not
require current payments of interest, and (b) the principal amount thereof,
in the case of any other Indebtedness.
"Investments" means, with respect to any Person, all investments by such
Person in other Persons (including Affiliates) in the forms of direct or
indirect loans (including guarantees by the referent Person of, and Liens on
any assets of the referent Person securing, Indebtedness or other obligations
of other Persons), advances or capital contributions (excluding commission,
travel and similar advances to officers and employees made in the ordinary
course of business), purchases or other acquisitions for consideration of
Indebtedness, Equity Interests or other securities, together with all items
that are or would be classified as investments on a balance sheet prepared in
accordance with GAAP. If the Company or any Subsidiary of the Company sells
or otherwise disposes of any Equity Interests of any direct or indirect
Subsidiary of the Company such that, after giving effect to any such sale or
disposition, such Person is no longer a Subsidiary of the Company, the
Company shall be deemed to have made an Investment on the date of any such
sale or disposition equal to the fair market value of the Equity Interests of
such Subsidiary not sold or disposed of in an amount determined as provided
in the final paragraph of the covenant described above under the caption
"--Certain Covenants--Restricted Payments."
"Lien" means, with respect to any asset, any mortgage, lien, pledge,
charge, security interest or encumbrance of any kind in respect of such
asset, whether or not filed, recorded or otherwise perfected under applicable
law (including any conditional sale or other title retention agreement, any
lease in the nature thereof, any option or other agreement to sell or give a
security interest in and any filing of or agreement to give any financing
statement under the Uniform Commercial Code (or equivalent statutes) of any
jurisdiction).
"Net Income" means, with respect to any Person, the net income (loss) of
such Person, determined in accordance with GAAP and before any reduction in
respect of preferred stock dividends, excluding, however, (a) any gain (but
not loss), together with any related provision for taxes on such gain (but
not loss), realized in connection with (i) any Asset Sale (including, without
limitation, dispositions pursuant to sale and leaseback transactions) or (ii)
the disposition of any securities by such Person or any of its Subsidiaries
or the extinguishment of any Indebtedness of such Person or any of its
Subsidiaries, and (b) any extraordinary or nonrecurring gain (but not loss),
together with any related provision for taxes on such extraordinary or
nonrecurring gain (but not loss).
71
<PAGE>
"Net Proceeds" means the aggregate cash proceeds received by the Company
or any of its Subsidiaries in respect of any Asset Sale (including, without
limitation, any cash received upon the sale or other disposition of any
non-cash consideration received in any Asset Sale), net of (without
duplication) (a) the direct costs relating to such Asset Sale (including,
without limitation, legal, accounting and investment banking fees, sales
commissions, recording fees, title transfer fees, and appraiser fees) and any
relocation expenses incurred as a result thereof, (b) taxes paid or estimated
to be payable as a result thereof (after taking into account any available
tax credits or deductions and any tax sharing arrangements), (c) amounts
required to be applied to the repayment of Indebtedness (other than revolving
credit Indebtedness incurred pursuant to the New Credit Agreement) secured by
a Lien on the asset or assets that were the subject of such Asset Sale, and
(d) any reserve established in accordance with GAAP or any amount placed in
escrow, in either case for adjustment in respect of the sale price of such
asset or assets, until such time as such reserve is reversed or such escrow
arrangement is terminated, in which case Net Proceeds shall include only the
amount of the reserve so reversed or the amount returned to the Company or
its Subsidiaries from such escrow arrangement, as the case may be.
"New Credit Agreement" means the New Credit Agreement, including any
related notes, guarantees, collateral and security documents, instruments and
agreements executed in connection therewith, and in each case as amended,
modified, renewed, refunded, replaced or refinanced from time to time,
subject to the terms thereof and of the New Senior Subordinated Note
Indenture.
"Obligations" means any principal, interest, premium, penalties, fees,
indemnification, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.
"Permitted Business" means any business in which the Company or the
Subsidiary Guarantors are engaged on the date of the New Senior Subordinated
Note Indenture or any business reasonably related, incidental or ancillary
thereto.
"Permitted Investments" means (a) any Investment in the Company or in a
Wholly Owned Subsidiary of the Company, (b) any Investment in cash or Cash
Equivalents, (c) any Investment by the Company or any Subsidiary of the
Company in a Person that is engaged in a Permitted Business if as a result of
such Investment (i) such Person becomes a Wholly Owned Subsidiary of the
Company and a Subsidiary Guarantor or (ii) such Person is merged,
consolidated or amalgamated with or into, or transfers or conveys
substantially all of its assets to, or is liquidated into, the Company or a
Wholly Owned Subsidiary of the Company, (d) any Investment made as a result
of the receipt of non-cash consideration from an Asset Sale that was made
pursuant to and in compliance with the covenant described above under the
caption "--Repurchase at the Option of Holders--Asset Sales," (e) any
Investment acquired solely in exchange for Equity Interests (other than
Disqualified Stock) of the Company, and (f) other Investments in any Person
that is engaged in a Permitted Business which Investment has a fair market
value (as determined by a resolution of the Board of Directors of the Company
and set forth in an officer's certificate delivered to the Trustee), when
taken together with all other Investments made pursuant to this clause (f)
that are at the time outstanding, not to exceed $10.0 million.
"Permitted Junior Securities" means Equity Interests in the Company or a
Subsidiary Guarantor or debt securities of the Company or a Subsidiary
Guarantor that are subordinated to all Senior Debt (and any debt securities
issued in exchange for Senior Debt) to substantially the same extent as, or
to a greater extent than, the New Senior Subordinated Notes are subordinated
to Senior Debt.
"Permitted Refinancing Indebtedness" means any Indebtedness of the Company
or any of its Subsidiaries issued in exchange for, or the net proceeds of
which are used to extend, refinance, renew, replace, defease or refund other
Indebtedness of the Company or any of its Subsidiaries; provided that (a) the
principal amount (or accreted value, if applicable) of such Permitted
Refinancing Indebtedness does not exceed the principal amount of (or accreted
value, if applicable), plus premium, if any, and accrued interest on, the
Indebtedness so extended, refinanced, renewed, replaced, defeased or refunded
(plus the amount of reasonable expenses incurred in connection therewith),
(b) such Permitted Refinancing Indebtedness has a final maturity date no
earlier than the final maturity date of, and has a Weighted Average Life to
Maturity equal to or greater than the Weighted Average Life to Maturity of,
the Indebtedness being extended, refinanced, renewed, replaced, defeased or
refunded, (c) if the Indebtedness being extended, refinanced, renewed,
replaced, defeased or refunded is subordinated in right of
72
<PAGE>
payment to the New Senior Subordinated Notes, such Permitted Refinancing
Indebtedness is subordinated in right of payment to the New Senior
Subordinated Notes on terms at least as favorable, taken as a whole, to the
holders of New Senior Subordinated Notes as those contained in the
documentation governing the Indebtedness being extended, refinanced, renewed,
replaced, defeased or refunded, and (d) such Indebtedness is incurred either
by the Company or by the Subsidiary who is the obligor on the Indebtedness
being extended, refinanced, renewed, replaced, defeased or refunded.
"Principals" means DLJMB.
"Qualified Offering" means (i) any issuance of common stock or preferred
stock by the Company (excluding Disqualified Stock) that is registered
pursuant to the Securities Act, other than issuance registered on Form S-8
and issuances registered on Form S-4, and (ii) any private issuance of common
stock or preferred stock of the Company (excluding Disqualified Stock), other
than issuances of common stock pursuant to employee benefit plans of the
Company or otherwise as compensation of employees of the Company.
"Restricted Investment" means an Investment other than a Permitted
Investment.
"Senior Debt" means, with respect to any Person, (a) all Obligations of
such Person outstanding under the New Credit Agreement and all Hedging
Obligations payable to a lender or an Affiliate thereof or to a Person that
was a lender or an Affiliate thereof at the time the contract was entered
into under the New Credit Agreement or any of its Affiliates, including,
without limitation, interest accruing subsequent to the filing of, or which
would have accrued but for the filing of, a petition for bankruptcy, whether
or not such interest is an allowable claim in such bankruptcy proceeding, (b)
any other Indebtedness of such Person unless the instrument under which such
Indebtedness is incurred expressly provides that it is subordinated in right
of payment to any other Senior Debt of such Person, and (c) all Obligations
with respect to the foregoing. Notwithstanding anything to the contrary in
the foregoing, Senior Debt will not include (i) any liability for federal,
state, local or other taxes, (ii) any Indebtedness of such Person to any of
its Subsidiaries, (iii) any trade payables or (iv) any Indebtedness that is
incurred in violation of the New Senior Subordinated Note Indenture.
"Significant Subsidiary" means any Subsidiary that would be a "significant
subsidiary" as defined in Article 1, Rule 1-02 of Regulation S-X, promulgated
pursuant to the Securities Act, as such Regulation is in effect on the date
hereof.
"Stated Maturity" means, with respect to any installment of interest or
principal on any series of Indebtedness, the date on which such payment of
interest or principal was scheduled to be paid in the original documentation
governing such Indebtedness, and shall not include any contingent obligations
to repay, redeem or repurchase any such interest or principal prior to the
date originally scheduled for the payment thereof.
"Subsidiary" means, with respect to any Person, (a) any corporation,
association or other business entity of which more than 50% of the total
voting power of shares of Capital Stock entitled (without regard to the
occurrence of any contingency) to vote in the election of directors, managers
or trustees thereof is at the time owned or controlled, directly or
indirectly, by such Person or one or more of the other Subsidiaries of that
Person (or a combination thereof) and (b) any partnership (i) the sole
general partner or the managing general partner of which is such Person or a
Subsidiary of such Person or (ii) the only general partners of which are such
Person or of one or more Subsidiaries of such Person (or any combination
thereof).
"Weighted Average Life to Maturity" means, when applied to any
Indebtedness at any date, the number of years obtained by dividing (a) the
sum of the products obtained by multiplying (i) the amount of each then
remaining installment, sinking fund, serial maturity or other required
payments of principal, including payment at final maturity, in respect
thereof, by (ii) the number of years (calculated to the nearest one-twelfth)
that will elapse between such date and the making of such payment, by (b) the
then outstanding principal amount of such Indebtedness.
"Wholly Owned Subsidiary" of any Person means a Subsidiary of such Person
all of the outstanding Capital Stock or other ownership interests of which
(other than directors' qualifying shares) shall at the time be owned by such
Person or by one or more Wholly Owned Subsidiaries of such Person.
73
<PAGE>
DESCRIPTION OF CERTAIN INDEBTEDNESS
NEW CREDIT AGREEMENT
In connection with the Refinancing Plan, the Company will enter into the
New Credit Agreement pursuant to which DLJ Capital Funding, Inc., an
affiliate of DLJ, will act as an arranger and syndication agent, and Fleet
National Bank N.A., as administrative agent. The New Credit Agreement is
expected to provide for total lending commitments of up to $160.0 million.
The New Credit Agreement will be comprised of (i) a Revolving Credit Facility
of up to $30.0 million, which includes borrowing capacity available for
letters of credit and for same-day notice swingline loans, (ii) Tranche A
Term Loans of up to $50.0 million and (iii) Tranche B Term Loans of up to
$80.0 million. Borrowings under the New Credit Agreement, together with the
proceeds of the Offering and the Common Stock Offering, will be used to repay
the Company's existing indebtedness as described under "Use of Proceeds." The
proceeds of loans under the New Credit Agreement may also be used to fund the
Company's working capital needs, capital expenditures and other general
corporate purposes, including the issuance of letters of credit.
Borrowings under the New Credit Agreement, like the Company's Existing
Credit Agreement, will bear interest annually, at the Company's option, at
the rate based on either (i) an "Alternate Base Rate" (defined as, generally,
the higher of the Federal Funds Rate, as published by the Federal Reserve
Bank of New York, plus 0.5%, or the administrative agent's prime lending
rate) plus (a) in the case of Tranche A Term Loans or revolving credit loans,
1.5% or (b) in the case of Tranche B Term Loans, 1.75% or (ii) a
reserve-adjusted "LIBO" rate, plus (x) in the case of Tranche A Term Loans or
revolving credit loans, 2.5% or (y) in the case of Tranche B Term Loans,
2.75%. Margins set forth for Tranche A Term Loans and revolving credit loans
will be subject to certain performance-based reductions occurring not earlier
than six months from the closing date of the New Credit Agreement. In
addition, the Company must pay a fee on the face amount of each letter of
credit outstanding at a rate equal to the LIBO margin.
It is expected that borrowings under the New Credit Agreement will be
guaranteed by, and secured by a pledge of all of the capital stock and assets
of, the Company's subsidiaries.
The New Credit Agreement will contain various covenants that limit or
restrict, among other things, subject to certain exceptions, the incurrence
of indebtedness, the creation of liens, transactions with affiliates,
restricted payments, investments and acquisitions, mergers, consolidations,
dissolutions, asset sales, dividends, distributions, and certain other
transactions and business activities by the Company.
74
<PAGE>
PLAN OF DISTRIBUTION
This Prospectus has been prepared for use by DLJ in connection with offers
and sales of the New Senior Subordinated Notes in market-making transactions
at negotiated prices related to prevailing market prices at the time of the
sale. DLJ may act as principal or agent in such transactions. The Company has
been advised by DLJ that it intends to make a market in the New Senior
Subordinated Notes; however, DLJ is not obligated to do so. Any market-making
may be discontinued at any time, and there is no assurance that an active
public market for the New Senior Subordinated Notes will develop or, that if
such market develops, that it will continue. DLJ served as the underwriter in
the Offering and received total underwriting discounts and commissions of
$3.0 million in connection therewith.
DLJ also acted as one of the underwriters in connection with the Common
Stock Offering and received customary discounts and commissions in connection
therewith. DLJ Capital Funding, Inc. is one of the lenders under the Existing
Credit Agreement. The proceeds of the Offering, together with the proceeds
from the Common Stock Offering and the New Credit Agreement, are being used
to effect the Refinancing Plan, including the repayment of the Existing
Credit Agreement. DLJ Capital Funding, Inc., an affiliate of DLJ, is the
syndication agent and a lender under the New Credit Agreement. From time to
time, DLJ provides investment banking services to the Company, for which it
receives customary compensation. See "Certain Relationships and Related
Transactions."
LEGAL MATTERS
The validity of the New Senior Subordinated Notes being offered hereby was
passed upon for the Company by Latham & Watkins, New York, New York. Latham &
Watkins also represented DLJMBPII in connection with the Recapitalization.
EXPERTS
The consolidated financial statements of the Company as of December 30,
1995 and December 28, 1996 and for each of the 52 week periods ended December
31, 1994, December 30, 1995 and December 28, 1996 included in this Prospectus
have been so included in reliance on the report of Price Waterhouse LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
ADDITIONAL INFORMATION
The Company has filed the Registration Statement on Form S-1 with respect
to the New Senior Subordinated Notes being offered hereby with the Commission
under the Securities Act. This Prospectus, which constitutes a part of the
Registration Statement, does not contain all the information set forth in the
Registration Statement, certain items of which are omitted in accordance with
the rules and regulations of the Commission. Statements contained in this
Prospectus concerning the provisions of documents filed with the Registration
Statement as exhibits are necessarily summaries of such documents, and each
such statement is qualified in its entirety by reference to the copy of the
applicable document filed as an exhibit to the Registration Statement. The
Registration Statement may be inspected and copied at the public reference
facilities maintained by the Commission at 450 Fifth Street, N.W., Room 1024,
Washington, D.C. 20549; at its Chicago Regional Office, Citicorp Center, 500
West Madison Street, Suite 1400, Chicago, Illinois 60661-2511; and at its New
York Regional Office, Seven World Trade Center, Suite 1300, New York, New
York 10048. Copies of such material can be obtained from the public reference
section of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates. The Commission also maintains a website on the Internet at
http://www.sec.gov that contains reports, proxy statements and other
information with respect to companies that file documents electronically with
the Commission. For further information pertaining to the Company and the New
Senior Subordinated Notes being offered hereby, reference is made to the
Registration Statement, including the exhibits thereto and the financial
statements, notes and schedules filed as a part thereof.
75
<PAGE>
INDEX TO FINANCIAL STATEMENTS
DUANE READE HOLDING CORP. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of Independent Accountants ....................................................... F-2
Consolidated Balance Sheets as of December 30, 1995 and December 28, 1996 .............. F-3
Consolidated Statements of Operations for each of the 52 weeks ended December 31, 1994,
December 30, 1995 and December 28, 1996................................................. F-4
Consolidated Statements of Stockholders' Equity (Deficiency) for each of the 52 weeks
ended December 31, 1994, December 30, 1995 and December 28, 1996........................ F-5
Consolidated Statements of Cash Flows for each of the 52 weeks ended December 31, 1994,
December 30, 1995 and December 28, 1996................................................. F-6
Notes to Consolidated Financial Statements .............................................. F-7
Consolidated Balance Sheet as of September 27, 1997 (Unaudited).......................... F-16
Consolidated Statements of Operations for each of the 39 weeks ended September 28, 1996
and September 27, 1997 (Unaudited)...................................................... F-17
Consolidated Statement of Stockholders' Equity (Deficiency) for the 39 weeks ended
September 27, 1997 (Unaudited).......................................................... F-18
Consolidated Statements of Cash Flows for the 39 weeks ended September 28, 1996 and
September 27, 1997 (Unaudited).......................................................... F-19
Notes to Consolidated Financial Statements (Unaudited) .................................. F-20
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Duane Reade Holding Corp.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity (deficiency) and
cash flows present fairly, in all material respects, the financial position
of Duane Reade Holding Corp. ("Holdings") and its subsidiaries at December
30, 1995 and December 28, 1996 and the results of their operations and their
cash flows for each of the 52 week periods ended December 31, 1994, December
30, 1995 and December 28, 1996 in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
Holdings' management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management and evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP
New York, New York
February 18, 1997, except as to the recapitalization and reverse stock split
described in Note 12 and net loss per common share described in Note 1 which
are as of January 14, 1998
F-2
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 30, DECEMBER 28,
1995 1996
-------------- --------------
<S> <C> <C>
ASSETS
Current assets
Cash................................................................ $ 2,133 $ 216
Government securities .............................................. 44 --
Receivables ........................................................ 5,740 7,171
Inventories ........................................................ 43,147 47,914
Prepaid expenses ................................................... 1,355 1,165
-------------- --------------
TOTAL CURRENT ASSETS ............................................... 52,419 56,466
Property and equipment, net ......................................... 24,832 23,065
Goodwill, net of accumulated amortization of $11,306 and $14,785 ... 127,848 124,369
Covenants not to compete, net of accumulated amortization of $48,660
and $60,000 ........................................................ 11,340 --
Other assets ........................................................ 19,421 18,576
-------------- --------------
TOTAL ASSETS ...................................................... $235,860 $222,476
============== ==============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities
Accounts payable.................................................... $ 20,427 $ 20,015
Accrued interest ................................................... 3,797 3,873
Other accrued expenses ............................................. 6,102 8,157
Current portion of long-term debt .................................. 5,625 12,000
Current portion of capital lease obligations ....................... 2,769 2,504
-------------- --------------
TOTAL CURRENT LIABILITIES ......................................... 38,720 46,549
Senior debt, less current portion ................................... 163,475 149,975
Subordinated zero coupon debt, net of unamortized discount of
$55,148 and $43,899 ................................................ 68,232 79,481
Capital lease obligations, less current portion ..................... 4,003 1,697
Other non-current liabilities ....................................... 2,626 4,170
-------------- --------------
TOTAL LIABILITIES ................................................. 277,056 281,872
-------------- --------------
Commitments and Contingencies (Note 8)
Stockholders' deficiency
Common stock, $0.01 par; authorized 30,000,000 shares; issued and
outstanding 10,184,565 and 10,062,497 shares ...................... 102 101
Paid-in-capital .................................................... 24,909 24,564
Accumulated deficit ................................................ (66,207) (84,061)
-------------- --------------
TOTAL STOCKHOLDERS' DEFICIENCY .................................... (41,196) (59,396)
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY .................... $235,860 $222,476
============== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE 52 WEEKS ENDED
----------------------------------------------
DECEMBER 31, DECEMBER 30, DECEMBER 28,
1994 1995 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Net sales .................................... $281,103 $336,922 $381,466
Cost of sales ................................ 209,678 259,827 288,505
-------------- -------------- --------------
Gross profit ................................. 71,425 77,095 92,961
-------------- -------------- --------------
Selling, general and administrative expenses 39,741 50,326 59,048
Amortization ................................. 18,238 11,579 16,217
Depreciation ................................. 1,184 1,929 3,015
Store pre-opening expenses ................... 1,220 1,095 139
-------------- -------------- --------------
60,383 64,929 78,419
-------------- -------------- --------------
Operating income ............................. 11,042 12,166 14,542
Interest expense, net ........................ 27,480 30,224 32,396
-------------- -------------- --------------
Loss before income taxes ..................... (16,438) (18,058) (17,854)
Income taxes ................................. -- -- --
-------------- -------------- --------------
NET LOSS..................................... $(16,438) $(18,058) $(17,854)
============== ============== ==============
NET LOSS PER COMMON SHARE.................... $ (1.55) $ (1.70) $ (1.69)
============== ============== ==============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING................................. 10,633 10,650 10,575
============== ============== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
COMMON STOCK
---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------------ -------- --------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Balance , January 1, 1994 . 10,154,041 $102 $24,852 $(31,711) $ (6,757)
Sale of common stock to
executives ................ 10,173 -- 25 -- 25
Net loss ................... -- -- -- (16,438) (16,438)
------------ -------- --------- ------------- ----------
Balance, December 31, 1994 10,164,214 102 24,877 (48,149) (23,170)
Sale of common stock to
executives ................ 40,692 -- 100 -- 100
Repurchase of common stock (20,341) -- (68) -- (68)
Net loss ................... -- -- -- (18,058) (18,058)
------------ -------- --------- ------------- ----------
Balance, December 30, 1995 10,184,565 102 24,909 (66,207) (41,196)
Repurchase of common stock (122,068) (1) (345) -- (346)
Net loss ................... -- -- -- (17,854) (17,854)
------------ -------- --------- ------------- ----------
Balance, December 28, 1996 10,062,497 $101 $24,564 $(84,061) $(59,396)
============ ======== ========= ============= ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE 52 WEEKS ENDED
----------------------------------------------
DECEMBER 31, DECEMBER 30, DECEMBER 28,
1994 1995 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss..................................... $(16,438) $(18,058) $(17,854)
Adjustments to reconcile net loss to net
cash provided by operating activities .....
Depreciation and amortization of property
and equipment ............................ 1,184 1,929 3,015
Amortization of goodwill and other
intangibles .............................. 20,646 13,940 18,897
Accretion of principal of zero coupon debt 8,282 9,628 11,249
Other ..................................... 724 1,769 1,526
Changes in operating assets and liabilities
Receivables ............................... (225) (1,962) (1,431)
Inventories ............................... (4,838) (6,745) (4,767)
Accounts payable .......................... 5,716 7,382 (412)
Prepaid and accrued expenses .............. (110) (658) 2,321
Increase in other assets (liabilities)--net 356 (491) 51
-------------- -------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES . 15,297 6,734 12,595
-------------- -------------- --------------
Cash flows from investing activities:
Capital expenditures ........................ (9,947) (6,868) (1,247)
Systems development costs ................... (2,425) (6,268) (2,566)
Sale of government securities--net ......... 1,134 382 44
-------------- -------------- --------------
NET CASH USED IN INVESTING ACTIVITIES ..... (11,238) (12,754) (3,769)
-------------- -------------- --------------
Cash flows from financing activities:
Financing costs ............................. -- (885) (952)
Repayments of term loan ..................... (8,000) (15,000) (5,625)
Proceeds from issuance of long-term debt ... -- 15,000 --
Net (repayments) borrowings--Revolving
credit ..................................... -- 4,000 (1,500)
Proceeds from issuance of stock ............. -- 25 --
Repurchase of stock ......................... -- (68) (95)
Capital lease financing ..................... 5,492 4,329 274
Repayments of capital lease obligations .... (432) (2,617) (2,845)
-------------- -------------- --------------
NET CASH (USED IN) PROVIDED BY FINANCING
ACTIVITIES ................................ (2,940) 4,784 (10,743)
-------------- -------------- --------------
Net increase (decrease) in cash ............. 1,119 (1,236) (1,917)
Cash at beginning of year ................... 2,250 3,369 2,133
-------------- -------------- --------------
Cash at end of year.......................... $ 3,369 $ 2,133 $ 216
============== ============== ==============
Supplementary disclosures of cash flow
information ................................
Cash paid for interest...................... $ 16,969 $ 18,298 $ 18,391
============== ============== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Duane Reade Holding Corp. ("Holdings") was formed on June 16, 1992 for the
purpose of acquiring Daboco, Inc. ("Daboco"). The acquisition took place on
September 25, 1992. Daboco and Duane Reade Inc. ("DR Inc."), a subsidiary of
Daboco, are general partners in Duane Reade, which operates a chain of retail
drug stores (60 at December 28, 1996) in the New York City area.
Significant accounting policies followed in the preparation of the
consolidated financial statements are as follows:
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of Holdings, Daboco, DR Inc. and Duane Reade (collectively, the
"Company"). All intercompany transactions and balances have been eliminated.
Certain prior period amounts have been reclassified to conform with the
current presentation.
REPORTING YEAR: The fiscal year for the Company is the 52/53 week
reporting period ending on the last Saturday in December.
RECEIVABLES: Receivables consist primarily of amounts due from various
insurance companies and governmental agencies under third party payment plans
for prescription sales and amounts due from vendors, a majority of which
relate to promotional programs. The Company has not provided an allowance for
doubtful accounts as its historical write-offs have been immaterial. The
Company reflects promotional allowances from vendors as income when such
allowances are earned.
INVENTORIES AND COST OF SALES: Substantially all inventories are stated at
the lower of cost, determined pursuant to the last-in, first-out retail
dollar value method (LIFO), or market. When appropriate, provision is made
for obsolete, slow-moving or damaged inventory. If current cost had been
used, inventories at December 30, 1995 and December 28, 1996 would not be
materially different from the amounts reflected on the accompanying balance
sheets. Cost of sales includes distribution and occupancy costs.
PROPERTY AND EQUIPMENT: Property and equipment are stated at cost.
Depreciation and amortization are provided using the straight-line method
over estimated useful lives of assets as follows:
<TABLE>
<CAPTION>
<S> <C>
Buildings and improvements ............ 30 years
Furniture, fixtures and equipment .... 5-10 years
Leasehold improvements ................ Life of lease or, if shorter, asset
Property under capital leases.......... 7 years
</TABLE>
OTHER ASSETS: Deferred financing costs arose in connection with borrowings
under the Term Loan and with the issuance of the Senior Notes and the Zero
Coupon Notes and are amortized using the straight-line method, the results of
which are not materially different from the interest method, over the term of
the respective debt issue.
Systems development costs, consisting principally of costs relating to the
new management information systems, are amortized using the straight-line
method commencing in 1996 over a period of seven years.
INTANGIBLE ASSETS: In September 1992, Holdings and Duane Reade entered
into agreements with certain former members of management of Duane Reade,
former shareholders of Daboco and shareholders of former partners of Duane
Reade (collectively, the "Group") precluding such persons from competing with
the operations of Duane Reade for a period of five years. The covenants not
to compete were recorded at acquisition cost and were being amortized over
the period of benefit using an accelerated method. During the first quarter
of 1997, Holdings and Duane Reade entered into agreements
F-7
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
in which the Company received consideration from the Group to terminate the
non-compete agreements. In accordance with APB Opinion No. 17, Intangible
Assets, the remaining carrying value of the non-compete agreements of $4.86
million as of December 28, 1996 was written off and has been included in the
accompanying consolidated statement of operations as amortization expense.
Goodwill is amortized on the straight-line method over 40 years. The
carrying value of goodwill is periodically reviewed and evaluated by the
Company based principally on its expected future undiscounted operating cash
flows. Should such evaluation result in the Company concluding that the
carrying amount of goodwill has been impaired, an appropriate write-down
would be made.
PRE-OPENING EXPENSES: Store pre-opening costs, other than capital
expenditures, are expensed when incurred.
INCOME TAXES: Income taxes are accounted for under the liability method
prescribed by Statement of Financial Accounting Standards No. 109.
RECENTLY ISSUED ACCOUNTING STANDARDS: In February 1997, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 128, Earnings per Share ("FAS 128") which requires the presentation of
basic and diluted earnings per share in a company's financial statements for
reporting periods ending subsequent to December 15, 1997. Early adoption of
FAS 128 is not permitted. The adoption of FAS 128 is not expected to have
material impact on the Company's consolidated financial statements.
ACCOUNTING ESTIMATES: The preparation of financial statements in
conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosures of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues, costs
and expenses during the reporting period. Actual results could differ from
those estimates.
NET LOSS PER COMMON SHARE: Net loss per common share is based on the
weighted average shares outstanding during each period (10,632,936 for the 52
weeks ended December 31, 1994, 10,649,895 for the 52 weeks ended December 30,
1995 and 10,575,299 for the 52 weeks ended December 28, 1996). Pursuant to
Securities and Exchange Commission Staff Accounting Bulletin No. 83, options
granted with exercise prices below the estimated initial public offering
price during the 12 month period preceding the date of the initial filing of
the Registration Statement have been included in the calculation of net loss
per common share, using the treasury stock method based on the estimated
initial public offering price of $15.00 per share, as if the options were
outstanding for all periods presented.
2. PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 30, DECEMBER 28,
1995 1996
-------------- --------------
<S> <C> <C>
Land............................................ $ 489 $ 489
Buildings and building improvements ............ 4,514 4,523
Furniture, fixtures and equipment .............. 6,261 6,881
Leasehold improvements ......................... 12,684 13,134
Property under capital leases .................. 4,894 5,063
-------------- --------------
28,842 30,090
Less--Accumulated depreciation and amortization 4,010 7,025
-------------- --------------
$24,832 $23,065
============== ==============
</TABLE>
F-8
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. OTHER ASSETS
Other assets are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 30, DECEMBER 28,
1995 1996
-------------- --------------
<S> <C> <C>
Deferred financing costs (net of accumulated amortization of $7,737
and $10,417)....................................................... $ 9,539 $ 7,811
Systems and integration costs (net of accumulated amortization of
$0 and $1,461) .................................................... 8,693 9,798
Other .............................................................. 1,189 967
-------------- --------------
$19,421 $18,576
============== ==============
</TABLE>
4. DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 30, DECEMBER 28,
1995 1996
-------------- --------------
<S> <C> <C>
Senior debt
Term loan facility (A)...................... $ 75,100 $ 69,475
Notes payable bank--revolving credit (A) .. 4,000 2,500
12% Senior Notes due September 15, 2002 (B) 90,000 90,000
Subordinated debt
15% Senior Subordinated Zero Coupon Notes
due September 15, 2004 (C) ................ 68,232 79,481
-------------- --------------
237,332 241,456
Less--Current portion ...................... 5,625 12,000
-------------- --------------
$231,707 $229,456
============== ==============
</TABLE>
(A) Outstanding balances under a Credit Agreement dated as of September 24,
1992, as amended, with a syndicate of lending institutions bear interest at
floating rates, which at December 28, 1996 averaged 9.0%. In addition to the
term loans, the Credit Agreement provides for a revolving credit facility of
$10.0 million (less amounts of letters of credit issued under the Credit
Agreement) which may be used for general corporate purposes and which expires
on September 30, 1998. As of December 28, 1996, the borrowings outstanding
under the revolving credit facility were $2.5 million (classified as a
noncurrent liability) and $0.2 million in letters of credit had been issued,
leaving $7.3 million available for borrowing.
On March 23, 1995, the Credit Agreement, which provided an A Term loan and
a B Term loan, was amended providing the Company with a new Term loan (the "C
Term Loan") of $15.0 million and increasing the Company's existing capital
expenditure limits for its store expansion program.
The proceeds of such borrowing were used to prepay all amounts due under
the A Term Loan due during 1995 ($13.0 million) and a portion ($2.0 million)
of the payment due under the A Term Loan on March 31, 1996.
In 1996, the Credit Agreement was further amended providing for the
postponement of $2.5 million of principal payments due during 1997 until 1998
and $10.0 million of principal payments due during 1998 until 1999.
F-9
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
At December 28, 1996, the aggregate principal amount of the term loan
matures during the fiscal year as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
1997 ................. $12,000
1998 ................. 17,625
1999 ................. 25,150
2000 ................. 14,700
2001 ................. --
---------
$69,475
=========
</TABLE>
Subject to certain conditions, voluntary prepayments of the Term Loan are
permitted without premium or penalty. Mandatory prepayments are required with
respect to asset sales, permitted issuance of debt or equity and 75% of
excess cash flows, as defined in the Credit Agreement, as amended. For the 52
weeks ended December 31, 1994, December 30, 1995 and December 28, 1996, there
were no voluntary or mandatory prepayments.
Obligations under the Credit Agreement are secured by a pledge of all of
Duane Reade's tangible and intangible assets and are guaranteed by its
partners, Daboco and DR Inc., which have pledged 100% of their partnership
interests in support of such guarantees. The guarantees are joint and several
and full and unconditional. The Credit Agreement contains restrictions on
indebtedness, asset sales, dividends and other distributions, capital
expenditures, transactions with affiliates and other unrelated business
activities. Financial performance covenants include interest coverage,
leverage ratio, minimum earnings and working capital levels. In 1996, the
Company obtained an Amendment revising certain covenant requirements and
limiting capital expenditures. At December 28, 1996, the Company is in
compliance with all of the covenants in the Credit Agreement.
(B) On September 25, 1992, Duane Reade issued $90,000,000 aggregate
principal amount of 12% Senior Notes due September 15, 2002, at face value.
Interest is payable at 12% semiannually. The Senior Notes are guaranteed by
Daboco and DR Inc. All of Daboco's assets are pledged to secure indebtedness
under the Credit Agreement discussed in (A) above. As a result, such
indebtedness will have claim on those assets that is prior to the claim of
holders of the Senior Notes. To the extent that the amount of senior
indebtedness exceeds the value of the collateral securing such indebtedness,
the Senior Notes will rank pari passu with the Term Loans.
Duane Reade is required to make a sinking fund payment on September 15,
2001 sufficient to retire 50% of the aggregate principal amount of Senior
Notes originally issued. The Senior Notes are subject to redemption at the
option of the issuer at 104.5% of par, plus accrued interest, at the end of
1997, declining to par, plus accrued interest, at the end of 2000. In the
event of a change in control, Duane Reade shall be obligated to make an offer
to purchase all outstanding Senior Notes at a repurchase price of 101% of the
principal amount.
(C) On September 25, 1992, Holdings issued $123,380,000 aggregate
principal amount of 15% Senior Subordinated Zero Coupon Notes due September
15, 2004 (the "Zero Coupon Notes"), net of an $81,909,000 discount. The
discount accretes through the Final Accretion Date of September 15, 1999.
Thereafter, cash interest is payable at 15% semi-annually through maturity.
Interest expense is determined using the effective interest method, which
applies a constant yield to carrying value over the life of the Zero Coupon
Notes.
The Credit Agreement and the Senior Note Indenture referred to in (A) and
(B) above provide for subordination of Holdings' debt to partnership debt.
The notes are redeemable at the option of the issuer, in whole or in part,
at 107.5% of Accreted Value (as defined in the Zero Coupon Note Indenture),
plus accrued interest, at the end of 1997 declining to par, plus accrued
interest, at the end of 2002. In the event of a change in control, Holdings
shall be obligated
F-10
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
to make an offer to purchase all outstanding Zero Coupon Notes at a
repurchase price of 101% of Accreted Value (as defined in the Indenture) or
principal amount, as applicable. The Accreted Value of the Zero Coupon Notes
was $83,443,000 at December 28, 1996.
Purchasers of the Zero Coupon Notes received 15% of the fully diluted
common stock of Holdings, with registration rights, for aggregate
consideration of $3,529,000 (Note 10).
The Indentures governing the Zero Coupon Notes and the Senior Notes
include certain restrictive covenants. Subject to certain exceptions, the
Indentures restrict transactions with affiliates, the incurrence of
additional indebtedness, the payment of dividends, the creation of liens,
certain asset sales, mergers and consolidations and certain other payments.
The Company's debt is thinly traded in the market place. Accordingly,
management is unable to determine fair market values for such debt at
December 28, 1996.
The Zero Coupon Notes and the Senior Notes were issued pursuant to
Registration Rights Agreements under which Holdings and Duane Reade
consummated registered exchange offers pursuant to which Holdings and Duane
Reade exchanged the Zero Coupon Notes and the Senior Notes, respectively, for
identical notes which have been registered under the Securities Act of 1933,
as amended. Since 1994, the Company has not been required to follow the
periodic reporting requirements of the SEC.
5. CAPITAL LEASE OBLIGATIONS
During 1994, the Company commenced installation of new management
information systems. Capital requirements for hardware, software and
integration costs for the new systems were provided principally by capital
lease financing.
As of December 28, 1996, the present value of capital lease obligations
was $4.2 million (of which $2.5 million was payable during the next twelve
months). Such obligations are payable in monthly installments over three to
five year periods and bear interest at an average rate of 12.2%.
F-11
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. INCOME TAXES
Deferred tax assets and liabilities are determined based on the difference
between book and tax bases of the respective assets and liabilities at
December 30, 1995 and December 28, 1996 using a 44.7% combined federal, state
and local tax rate in each year and are comprised of (in thousands):
<TABLE>
<CAPTION>
DECEMBER 30, DECEMBER 28,
1995 1996
-------------- --------------
<S> <C> <C>
Inventories...................... $ (3,238) $ (3,501)
-------------- --------------
Gross deferred tax liabilities . (3,238) (3,501)
-------------- --------------
Property and equipment .......... 719 955
Covenants not to compete ........ 4,318 1,851
Targeted jobs credit ............ 268 268
Zero Coupon debt discount ...... 9,885 14,041
Other ........................... 1,492 2,335
Net operating loss carryforward 49,217 50,072
-------------- --------------
Gross deferred tax assets ...... 65,899 69,522
-------------- --------------
Net deferred tax assets ......... 62,661 66,021
Valuation allowance ............. (62,661) (66,021)
-------------- --------------
$ -- $ --
============== ==============
</TABLE>
The Company deducted for income tax purposes for the period September 25
to December 31, 1992 approximately $88 million of payments made to former
partners of Duane Reade (the "Retirement Payments"). Approximately $38.5
million of the valuation allowance relates to these Retirement Payments. The
Retirement Payments and other current tax deductions resulted in a net
operating loss of approximately $112.0 million which may be available to
offset future taxable income of the Company through 2011. Due to the nature
of the Retirement Payments, future reductions in that portion of the
valuation allowance related to the Retirement Payments will be credited to
goodwill. Further, certain income tax law provisions may limit the use of the
available net operating loss carryforwards in the event of a significant
change in ownership interest.
The provision for income taxes for the 52 weeks ended December 31, 1994,
December 30, 1995 and December 28, 1996 differs from the amounts of income
tax determined by applying the applicable U.S. statutory federal income tax
rate to pretax loss as a result of the following (dollars in thousands):
<TABLE>
<CAPTION>
52 WEEKS ENDED 52 WEEKS ENDED 52 WEEKS ENDED
DECEMBER 31, 1994 DECEMBER 30, 1995 DECEMBER 28, 1996
--------------------- --------------------- ---------------------
<S> <C> <C> <C> <C> <C> <C>
Pretax accounting loss ....... $(16,438) 100.0% $(18,058) 100.0% $(17,854) 100.0%
=========== ======== =========== ======== =========== ========
Statutory rate ............... (5,753) (35.0) (6,320) (35.0) (6,249) (35.0)
State and local taxes, net of
federal tax ................. (1,105) (6.7) (1,233) (6.8) (1,201) (6.7)
Goodwill amortization ........ 1,218 7.4 1,218 6.7 1,218 6.8
Net operating losses not
utilized .................... 5,213 31.7 5,828 32.3 5,534 31.0
Nondeductible interest
expense ..................... 504 3.1 585 3.2 684 3.8
Other ........................ (77) (0.5) (78) (0.4) 14 0.1
----------- -------- ----------- -------- ----------- --------
Effective tax rate ........... $ -- --% $ -- --% $ -- --%
=========== ======== =========== ======== =========== ========
</TABLE>
F-12
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. STORE PRE-OPENING EXPENSES
Duane Reade opened eleven new store locations during the 52 weeks ended
December 31, 1994, eight new store locations during the 52 weeks ended
December 30, 1995 and one new store location during the 52 weeks ended
December 28, 1996.
8. COMMITMENTS AND CONTINGENCIES
LEASES
Duane Reade leases most store facilities under operating lease agreements
expiring on various dates through the year 2014. In addition to minimum
rentals, certain leases provide for annual increases based upon real estate
tax increases, maintenance cost increases and inflation. Rent expense for the
52 weeks ended December 31, 1994, December 30, 1995 and December 28, 1996 was
$17,373,000, $22,703,000 and $24,420,000, respectively.
Minimum annual rentals at December 28, 1996 (including obligations under a
new store lease entered into but not opened as of December 28, 1996) are as
follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
1997 ...................... $ 23,213
1998 ..................... 22,879
1999 ..................... 22,940
2000 ..................... 22,070
2001 ..................... 21,739
Remaining lease terms .... 126,837
----------
Total .................... $239,678
==========
</TABLE>
LITIGATION
The Company from time to time is involved in routine legal matters
incidental to its business. In the opinion of management, the ultimate
resolution of such matters will not have a material adverse effect on the
Company's financial position, results of operations or liquidity.
MANAGEMENT AGREEMENTS
The Company has employment agreements with several of its executives
providing, among other things, for employment terms of up to three years.
Pursuant to the terms of such employment and related agreements, the Company
and various executives entered into agreements pursuant to which (i)
executives' salary and bonuses were established and (ii) executives purchased
shares of Holdings' Class P common stock at a price of $162.00 per share and
shares of Holdings' common stock at a price of $2.00 per share, each
representing original cost. In the event of employment termination, all of
the stock may be repurchased by Holdings. As a result of the recapitalization
and the reverse stock split (Note 12), all outstanding shares were converted
into common stock. As of December 28, 1996, an aggregate 488,283 shares of
common stock are held by employees and former employees.
In addition, the Company has established a Supplemental Executive
Retirement Plan ("SERP") which presently covers only its Chairman. Such SERP
provides for vesting over a twenty year period. However, if the Chairman's
employment is terminated without cause, as defined, or if the Chairman
resigns with cause, as defined, such vesting becomes immediate, in which
event the Company would be liable to the Chairman (in addition to amounts
accrued in the financial statements) in the amount of approximately $650,000.
F-13
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. EMPLOYEE BENEFIT PLANS
On October 12, 1992, the Board of Directors of Holdings adopted the 1992
Stock Option Plan of Duane Reade Holding Corp. (the "Plan"). Under the Plan,
a committee designated by the Board of Directors of Holdings to administer
the Plan (the "Committee") may grant, to executive and other key employees of
the Company, nonqualified stock options to purchase up to an aggregate of
510,757 (adjusted for the recapitalization and the reverse stock split--see
Note 12) shares of common stock of Holdings at an exercise price fixed by the
Committee. The options are exercisable at such time or times as the Committee
determines at or subsequent to grant. The term of the options set by the
Committee shall not exceed 10 years.
As permitted, the Company applies Accounting Principles Board Opinion No.
25 and related Interpretations in accounting for its stock-based compensation
plan. Had compensation cost for the Company's stock-based compensation plan
been determined based on the fair value at the grant dates for awards under
the Plan, consistent with the alternative method of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation, the
effect on the Company's net loss for the 52 weeks ended December 30, 1995 and
December 28, 1996 would have been less than $100,000.
At December 28, 1996, there were outstanding nonqualified stock options to
purchase up to an aggregate of 820,403 (adjusted for the recapitalization and
the reverse stock split--see Note 12) shares of common stock (including
options granted outside the Plan). Options outstanding at each price level
vest over five years at 20% each year that the executive is employed. At
December 28, 1996, there were 102,207 vested share options.
Changes in options outstanding during 1995 and 1996 are summarized as
follows (adjusted for recapitalization--see Note 12):
<TABLE>
<CAPTION>
OPTION PRICE PER SHARE
------------------------------------------------- TOTAL
$.58 $7.34 $29.37 $40.86 OPTIONS
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Options outstanding, December 31,
1994.................................. 91,968 91,968 91,968 91,968 367,872
Options granted........................ 8,539 8,538 8,538 8,538 34,153
Options canceled....................... (60,397) (60,397) (60,397) (60,397) (241,588)
----------- ----------- ----------- ----------- -----------
Options outstanding, December 30,
1995.................................. 40,110 40,109 40,109 40,109 160,437
Options granted........................ 723,662 2,745 2,745 2,745 731,897
Options canceled....................... (13,728) (13,726) (13,726) (13,726) (54,906)
----------- ----------- ----------- ----------- -----------
Options outstanding, December 28,
1996.................................. 750,044 29,128 29,128 29,128 837,428
=========== =========== =========== =========== ===========
Weighted average remaining life on
outstanding options .................. 9.2 years 7.1 years 7.1 years 7.1 years 9.0 years
</TABLE>
The Company maintains an employee savings plan pursuant to Section 401(k)
(the "401(k) Plan") of the Internal Revenue Code ("IRC") which covers
substantially all non union employees, excluding in 1996 all key employees as
defined by IRC. Eligible participating employees may contribute up to 10% of
their pretax salaries, subject to certain IRC limitations. The 401(k) Plan,
as amended, provides for employer matching provisions at the discretion of
the Company (to a maximum of 1% of pretax salaries) and has a feature under
which the Company may contribute additional amounts for all eligible
employees. The Company's policy is to fund such costs under the 401(k) Plan
as accrued. For the 52 weeks ended December 31, 1994 and December 30, 1995,
employer contributions to the 401(k) Plan were $158,000 and $166,000,
respectively. There were no employer contributions for the 52 weeks ended
December 28, 1996.
Duane Reade is under contract with local unions to contribute to
multi-employer pension and welfare benefit plans for certain of its
employees. For the 52 weeks ended December 31, 1994, December 30, 1995 and
December 28, 1996, contributions to such plans were $3,899,000, $5,200,000
and $5,783,000, respectively.
F-14
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. STOCKHOLDERS' DEFICIENCY
In September 1992, pursuant to the terms of the Purchase Agreement
governing the Zero Coupon Notes (Note 4), purchasers of such notes received
15% of the fully diluted common stock of the Company for aggregate cash
consideration of $3,529,000.
Distributions made by the Company to the holders of its common stock,
which are restricted by the terms of the Indentures described in Note 4,
shall be made in the following order:
Class P voting and Class P-1 non-voting common stockholders are entitled
to the aggregate unpaid amount of approximately $19,210,000 accruing on
the outstanding shares at an annual rate of 15%, compounded quarterly.
Such holders are then entitled to the aggregate unreturned original cost
($162 per share) of the outstanding shares.
Common stockholders (together as a group, voting and Class A non-voting)
shall then receive an amount equal to the aggregate unreturned original
cost ($2 per share) of outstanding shares.
Final distribution of any remaining portion shall be made to all classes
of outstanding common stock.
In the event of a public offering of stock or a change of control, and
with a written request to the Company, each holder of Class A non-voting
common stock or Class P-1 non-voting common stock is entitled to convert its
stock, on a one-for-one basis, into voting common stock or Class P common
stock, respectively.
As a result of the recapitalization discussed in Note 12, all outstanding
classes of the Company's common stock were converted into a newly designated
class of common stock.
11. RELATED PARTY TRANSACTIONS
In 1992, the Company and its then principal stockholder entered into a
Professional Services Agreement whereby consulting, advisory, financial and
other services were provided at the Company's request, for a five year term.
During each of the 52 weeks ended December 31, 1994, December 30, 1995 and
December 28, 1996, such fees aggregated approximately $1,000,000.
12. SUBSEQUENT EVENTS
During June 1997, the Company entered into a recapitalization agreement
(the "Agreement") with its stockholders ("Stockholders") and certain
investors ("Investors"). The Agreement provided for (i) the purchase by the
Investors from the Stockholders of substantially all their stock holdings in
the Company, (ii) a conversion of all of the outstanding shares of the
Company into a newly authorized class of Class B common stock and (iii) the
creation of a new authorized class of preferred stock which will carry the
rights and preferences granted by the Company's Board of Directors when
issued.
Shares were converted as follows:
<TABLE>
<CAPTION>
APPROXIMATE
PRIOR CLASS CONVERSION RATE
- --------------------------------------- ---------------
<S> <C>
Common and Common Class A .............. 28/1
Common Class P and Common Class P-1 ... 355/1
</TABLE>
Additionally, on January 14, 1998, the Company effected an 8.326 reverse
stock split of the Company's common stock.
All references to common stock amounts, shares and per share data included
in the consolidated financial statements and notes have been adjusted to give
retroactive effect to the above transactions.
F-15
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 27,
1997
---------------
<S> <C>
ASSETS
Current assets ..............................................................
Cash ....................................................................... $ 218
Receivables ................................................................ 9,084
Inventories ................................................................ 65,872
Prepaid expenses ........................................................... 1,371
---------------
TOTAL CURRENT ASSETS ..................................................... 76,545
Property and equipment, net ................................................. 24,918
Goodwill, net of accumulated amortization of $17,397 ........................ 121,757
Other assets, net ........................................................... 16,300
---------------
TOTAL ASSETS ............................................................. $239,520
===============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities
Accounts payable ........................................................... $ 30,710
Accrued interest ........................................................... 623
Other accrued expenses ..................................................... 13,193
Current portion of senior debt ............................................. 660
Current portion of capital lease obligations ............................... 1,510
---------------
TOTAL CURRENT LIABILITIES ................................................ 46,696
Senior debt, less current portion ........................................... 170,708
Subordinated zero coupon debt, net of unamortized discount of $34,277 ...... 89,094
Capital lease obligations, less current portion ............................. 677
Other non-current liabilities ............................................... 5,906
---------------
TOTAL LIABILITIES ........................................................ 313,081
---------------
COMMITMENTS AND CONTINGENCIES (NOTE 8)
Stockholders' Deficiency
Preferred stock, $0.01 par; authorized 5,000,000 shares; none issued or
outstanding................................................................ --
Common stock, $0.01 par; authorized 30,000,000 shares; issued and
outstanding 10,257,832 shares ............................................. 103
Paid-in-capital ............................................................ 24,562
Accumulated deficit ........................................................ (98,226)
---------------
TOTAL STOCKHOLDERS' DEFICIENCY ........................................... (73,561)
---------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY ........................... $239,520
===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-16
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE 39 WEEKS ENDED
--------------------------------
SEPTEMBER 28, SEPTEMBER 27,
1996 1997
--------------- ---------------
<S> <C> <C>
Net Sales..................................... $281,093 $313,796
Cost of sales ................................ 215,797 236,413
--------------- ---------------
Gross profit ................................. 65,296 77,383
--------------- ---------------
Selling, general and administrative expenses 42,499 48,218
Amortization ................................. 8,514 3,826
Depreciation ................................. 2,295 2,584
Store pre-opening expenses ................... 139 600
Nonrecurring charges ......................... -- 10,887
--------------- ---------------
53,447 66,115
--------------- ---------------
Operating income ............................. 11,849 11,268
Interest expense, net ........................ 24,334 25,433
--------------- ---------------
Loss before income taxes ..................... (12,485) (14,165)
Income taxes ................................. -- --
--------------- ---------------
NET LOSS .................................. $(12,485) $(14,165)
=============== ===============
NET LOSS PER COMMON SHARE ................. $ (1.18) $ (1.34)
=============== ===============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING............................... 10,589 10,600
=============== ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-17
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY) (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
------------------ ---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
-------- -------- ------------ -------- --------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 28, 1996 . -- -- 10,062,497 $101 $24,564 $(84,061) $(59,396)
Issuance of common stock ... -- -- 195,335 2 (2) -- --
Net loss .................... -- -- -- -- -- (14,165) (14,165)
-------- -------- ------------ -------- --------- ------------- -----------
Balance, September 27, 1997 -- -- 10,257,832 $103 $24,562 $(98,226) $(73,561)
======== ======== ============ ======== ========= ============= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-18
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE 39 WEEKS ENDED
--------------------------------
SEPTEMBER 28, SEPTEMBER 27,
1996 1997
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net loss .......................................................... $(12,485) $(14,165)
Adjustments to reconcile net loss to net cash provided by/(used
in) operating activities .........................................
Depreciation and amortization of property and equipment ........ 2,295 2,584
Amortization of goodwill and other intangibles .................. 10,505 5,803
Accretion of principal of zero coupon debt ...................... 8,437 9,622
Other............................................................ 1,156 1,182
Changes in operating assets and liabilities:
Receivables .................................................... (385) (1,913)
Inventories .................................................... (1,844) (17,958)
Accounts payable ............................................... 1,546 10,695
Interest payable ............................................... (2,620) (3,250)
Prepaid and accrued expenses and other ......................... 51 4,197
--------------- ---------------
NET CASH PROVIDED BY/(USED IN) OPERATING ACTIVITIES ............ 6,656 (3,203)
--------------- ---------------
Cash flows from investing activities:
Proceeds from sale of capital assets ............................. -- 1,075
Capital expenditures ............................................. (913) (4,931)
Systems development costs ........................................ (2,068) --
Sale of government securities .................................... 44 --
--------------- ---------------
NET CASH USED IN INVESTING ACTIVITIES ........................... (2,937) (3,856)
--------------- ---------------
Cash flows from financing activities:
Deferred financing costs ......................................... (542) (309)
Repayments of senior debt ........................................ (4,625) (6,107)
Repayments of subordinated debt .................................. -- (9)
Proceeds from bank debt, revolving credit--net ................... 1,500 15,500
Capital lease financing .......................................... 274 --
Repayment of capital lease obligations ........................... (2,120) (2,014)
Repurchase of stock .............................................. (96) --
--------------- ---------------
NET CASH (USED IN)/PROVIDED BY FINANCING ACTIVITIES ............. (5,609) 7,061
--------------- ---------------
Net (decrease)/increase in cash .................................... (1,890) 2
Cash at beginning of period ........................................ 2,133 216
--------------- ---------------
Cash at end of period............................................... $ 243 $ 218
=============== ===============
Supplementary disclosure of cash flow information:
Cash paid for interest ........................................... $ 16,526 $ 16,541
=============== ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-19
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of Holdings,
Daboco, DR Inc. and Duane Reade (collectively, the "Company"). All
intercompany transactions and balances have been eliminated.
The interim financial data is unaudited; however, in the opinion of the
Company, the interim data includes all adjustments, consisting only of normal
recurring adjustments, necessary for a fair statement of the results for the
interim periods. The results of operations for any interim period should not
necessarily be considered indicative of the results of operations for a full
year.
The accompanying unaudited consolidated financial statements should be
read in conjunction with the consolidated financial statements and notes
thereto for the 52 weeks ended December 28, 1996 included elsewhere in this
prospectus.
RECEIVABLES: Receivables consist primarily of amounts due from vendors, a
majority of which relate to promotional programs. Receivables also arise as a
result of third party payment plans from the sale of prescription drugs;
commencing in May 1997, substantially all such receivables are sold without
recourse to a funding entity. The discount on the sale of such third party
receivables amounted to approximately $381,000 during the 39 weeks ended
September 27, 1997 and is included in interest expense.
INTANGIBLE ASSETS: In September 1992, Holdings and Duane Reade entered
into agreements with certain former members of management of Duane Reade,
former shareholders of Daboco and shareholders of former partners of Duane
Reade (collectively, the "Group") precluding such persons from competing with
the operations of Duane Reade for a period of five years. The covenants not
to compete were recorded at acquisition cost and were being amortized over
the period of benefit using an accelerated method. During the first quarter
of 1997, Holdings and Duane Reade entered into agreements with the Group in
which the Company received consideration from the Group to terminate the
non-compete agreements. In accordance with APB Opinion No. 17, Intangible
Assets, the remaining carrying value of the non-compete agreements of $4.86
million as of December 28, 1996 was written off during the fourth quarter of
1996 and charged to amortization expense.
Goodwill is amortized on the straight-line method over 40 years. The
carrying value of goodwill is periodically reviewed and evaluated by the
Company based on its expected future undiscounted operating cash flows.
Should such evaluation result in the Company concluding that the carrying
amount of goodwill has been impaired, an appropriate write-down would be
made.
NET LOSS PER COMMON SHARE: Net loss per common share is based on the
weighted average shares outstanding during each period: 10,588,862 and
10,599,722 for the 39 weeks ended September 28, 1996 and September 27, 1997,
respectively. Pursuant to Securities and Exchange Commission Staff Accounting
Bulletin No. 83, options granted with exercise prices below the estimated
initial public offering price during the 12 month period preceding the date
of the initial filing of the Registration Statement have been included in the
calculation of net loss per common share, using the treasury stock method
based on the estimated initial public offering price of $15.00 per share, as
if the options were outstanding for all periods presented. Outstanding share
amounts have been restated to give effect to the recapitalization described
in Note 10 and the reverse stock split described in Note 13.
F-20
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
2. PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 27, 1997
------------------
<S> <C>
Land............................................ $ 312
Buildings and building improvements ............ 4,286
Furniture, fixtures and equipment .............. 9,468
Leasehold improvements ......................... 15,303
Property under capital leases .................. 5,102
------------------
34,471
Less--Accumulated depreciation and amortization (9,553)
------------------
$24,918
==================
</TABLE>
3. OTHER ASSETS
Other assets are summarized as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 27, 1997
------------------
<S> <C>
Deferred financing costs (net of accumulated amortization of
$11,585)..................................................... $ 6,144
Systems and integration costs (net of accumulated
amortization of $2,653) ..................................... 8,364
Other ........................................................ 1,792
------------------
$16,300
==================
</TABLE>
4. DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 27, 1997
------------------
<S> <C>
Senior debt
Term loan facility (A)....................... $ 65,475
Notes payable bank--revolving credit (A) ... 16,000
12% Senior Notes due September 15, 2002 (B) 89,893
Subordinated debt
15% Senior Subordinated Zero Coupon Notes
due September 15, 2004 (C) ................. 89,094
------------------
260,462
Less--Current portion ........................ 660
------------------
$259,802
==================
</TABLE>
(A) Outstanding balances under a Credit Agreement dated as of September
24, 1992, as amended, with a syndicate of lending institutions bear interest
at floating rates, which at September 27, 1997 averaged 10.5%. In addition to
the term loan, the Credit Agreement provides for a revolving credit facility
of $20.0 million (less amounts of letters of credit issued under the Credit
Agreement) which may be used for general corporate purposes and which expires
on September 30, 1998. As of September 27, 1997, the borrowings outstanding
under the revolving credit facility were $16.0 million (classified as a
noncurrent liability) and $0.3 million in letters of credit had been issued.
F-21
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
Subject to certain conditions, voluntary prepayments of the Term Loan are
permitted without premium or penalty. Mandatory prepayments are required with
respect to asset sales, permitted issuance of debt or equity and 75% of
excess cash flows, as defined in the Credit Agreement, as amended. For the 39
weeks ended September 27, 1997, there were no voluntary or mandatory
prepayments.
Obligations under the Credit Agreement are secured by a pledge of all of
Duane Reade's tangible and intangible assets and are guaranteed by its
partners, Daboco and DR Inc., which have pledged 100% of their partnership
interests in support of such guarantees. The guarantees are joint and several
and full and unconditional. The Credit Agreement contains restrictions on
indebtedness, asset sales, dividends and other distributions, capital
expenditures, transactions with affiliates and other unrelated business
activities. Financial performance covenants include interest coverage,
leverage ratio, minimum earnings and working capital levels. At September 27,
1997, the Company is in compliance with all of the covenants in the Credit
Agreement. See Note 13.
(B) On September 25, 1992, Duane Reade issued $90,000,000 aggregate
principal amount of 12% Senior Notes due September 15, 2002 (the "Senior
Notes"), at face value. Interest is payable at 12% semiannually. The Senior
Notes are guaranteed by Daboco and DR Inc. All of Daboco's assets are pledged
to secure indebtedness under the Credit Agreement discussed in (A) above. As
a result, such indebtedness will have claim on those assets that is prior to
the claim of holders of the Senior Notes. To the extent that the amount of
senior indebtedness exceeds the value of the collateral securing such
indebtedness, the Senior Notes will rank pari passu with the Term Loans.
Duane Reade is required to make a sinking fund payment on September 15,
2001 sufficient to retire 50% of the aggregate principal amount of Senior
Notes originally issued. The Senior Notes are subject to redemption at the
option of the issuer at 104.5% of par, plus accrued interest, at the end of
1997, declining to par, plus accrued interest, at the end of 2000. In the
event of a change in control, Duane Reade shall be obligated to make an offer
to purchase all outstanding Senior Notes at a repurchase price of 101% of the
principal amount. A change of control did occur in June 1997 (see Note 10).
(C) On September 25, 1992, Holdings issued $123,380,000 aggregate
principal amount of 15% Senior Subordinated Zero Coupon Notes due September
15, 2004 (the "Zero Coupon Notes"), net of an $81,909,000 discount. The
discount accretes through the Final Accretion Date of September 15, 1999.
Thereafter, cash interest is payable at 15% semi-annually through maturity.
Interest expense is determined using the effective interest method, which
applies a constant yield to carrying value over the life of the Zero Coupon
Notes.
The Credit Agreement and the Senior Note Indenture referred to in (A) and
(B) above provide for subordination of Holdings' debt to partnership debt.
The notes are redeemable at the option of the issuer, in whole or in part,
at 107.5% of Accreted Value (as defined in the Zero Coupon Note Indenture),
plus accrued interest, at the end of 1997 declining to par, plus accrued
interest, at the end of 2002. In the event of a change in control, Holdings
shall be obligated to make an offer to purchase all outstanding Zero Coupon
Notes at a repurchase price of 101% of Accreted Value (as defined in the
Indenture) or principal amount, as applicable. A change of control did occur
in June 1997 (see Note 10). The Accreted Value of the Zero Coupon Notes was
$92,840,000 at September 27, 1997.
Purchasers of the Zero Coupon Notes received 15% of the fully diluted
common stock of Holdings, with registration rights, for aggregate
consideration of $3,529,000.
The Indentures governing the Zero Coupon Notes and the Senior Notes
include certain restrictive covenants. Subject to certain exceptions, the
Indentures restrict transactions with affiliates, the incurrence of
additional indebtedness, the payment of dividends, the creation of liens,
certain asset sales, mergers and consolidations and certain other payments.
F-22
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
The Company's debt is thinly traded in the market place. Accordingly,
management is unable to determine fair market values for such debt at
September 27, 1997.
The Zero Coupon Notes and the Senior Notes were issued pursuant to
Registration Rights Agreements under which Holdings and Duane Reade
consummated registered exchange offers pursuant to which Holdings and Duane
Reade exchanged the Zero Coupon Notes and the Senior Notes, respectively, for
identical notes which have been registered under the Securities Act of 1933,
as amended.
5. CAPITAL LEASE OBLIGATIONS
As of September 27, 1997, the present value of capital lease obligations
was $2.2 million (of which $1.5 million is payable during the next twelve
months). Such obligations are payable in monthly installments over three to
five year periods and bear interest at an average rate of 12.2%.
6. INCOME TAXES
Deferred tax assets and liabilities are determined based on the difference
between book and tax bases of the respective assets and liabilities at
September 27, 1997 using a 44.7% combined federal, state and local tax rate
and are comprised of (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 27, 1997
------------------
<S> <C>
Inventories .................... $ (3,382)
------------------
Gross deferred tax liabilities (3,382)
------------------
Property and equipment ......... 734
Deferred rent .................. 2,398
Targeted jobs credit ........... 284
Zero Coupon debt discount ..... 17,580
Net operating loss
carryforward................... 31,791
Other .......................... 352
------------------
Gross deferred tax assets ..... 53,139
------------------
Net deferred tax assets ........ 49,757
Valuation allowance............. (49,757)
------------------
$ --
==================
</TABLE>
The Company deducted for income tax purposes for the period September 25
to December 31, 1992 approximately $88 million of payments made to former
partners of Duane Reade (the "Retirement Payments"). Approximately $21
million of the valuation allowance relates to these Retirement Payments. The
Retirement Payments and other current tax deductions resulted in a net
operating loss of approximately $71 million which may be available to offset
future taxable income of the Company through 2012. Due to the nature of the
Retirement Payments, future reductions in that portion of the valuation
allowance related to the Retirement Payments will be credited to goodwill.
Further, due to the change in ownership arising as a result of the
recapitalization (see Note 10), certain income tax law provisions apply that
limit the ability of the Company to utilize the available net operating loss
carryforwards. It is estimated that the annual limitation will be $5.0
million.
F-23
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
The provision for income taxes for the 39 weeks ended September 28, 1996
and September 27, 1997 differs from the amounts of income tax determined by
applying the applicable U.S. statutory federal income tax rate to pretax loss
as a result of the following (dollars in thousands):
<TABLE>
<CAPTION>
39 WEEKS ENDED 39 WEEKS ENDED
SEPTEMBER 28, 1996 SEPTEMBER 27, 1997
---------------------- ----------------------
<S> <C> <C> <C> <C>
Pretax accounting loss .................... $(12,485) 100% $(14,165) 100%
=========== ========= =========== =========
Statutory rate............................. $ (4,370) (35.0)% $ (4,958) (35.0)%
State and local taxes, net of federal tax (837) (6.7) (262) (1.8)
Goodwill amortization ..................... 914 7.3 914 6.5
Net operating losses not utilized ........ 3,870 31.0 1,207 8.5
Nondeductible recapitalization costs ..... -- -- 2,485 17.5
Nondeductible interest expense ............ 513 4.1 596 4.2
Other ..................................... (90) (0.7) 18 0.1
----------- --------- ----------- ---------
Effective tax rate......................... $ -- --% $ -- --%
=========== ========= =========== =========
</TABLE>
7. STORE PRE-OPENING EXPENSES
Duane Reade opened one new store location during the 39 weeks ended
September 28, 1996 and five new stores during the 39 weeks ended September
27, 1997.
8. COMMITMENTS AND CONTINGENCIES
LEASES
Duane Reade leases all of its store facilities under operating lease
agreements expiring on various dates through the year 2014. In addition to
minimum rentals, certain leases provide for annual increases based upon real
estate tax increases, maintenance cost increases and inflation. Rent expense
for the 39 weeks ended September 28, 1996 and September 27, 1997 was
$18,248,000 and $19,572,000, respectively.
Minimum annual rentals at September 27, 1997 are as follows (in
thousands):
<TABLE>
<CAPTION>
<S> <C>
13 weeks ending December 27, 1997 $ 6,074
1998............................... 27,518
1999 .............................. 27,069
2000 .............................. 26,274
2001 .............................. 25,959
2002 .............................. 25,404
Remaining lease terms ............. 135,497
---------
Total.............................. $273,795
=========
</TABLE>
LITIGATION
The Company from time to time is involved in routine legal matters
incidental to its business. In the opinion of management, the ultimate
resolution of such matters will not have a material adverse effect on the
Company's financial position, results of operations or liquidity.
MANAGEMENT AGREEMENTS
Pursuant to the terms of various employment and related agreements, the
Company and various executives entered into agreements pursuant to which (i)
executives' salary and bonuses were established
F-24
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
and (ii) executives purchased shares of Holdings' previously issued Class P
common stock at a price of $162.00 per share and shares of Holdings' common
stock at a price of $2.00 per share, each representing original cost. In the
event of employment termination, all of the stock may be repurchased by
Holdings. As a result of the recapitalization (see Note 10) and the reverse
stock split (see Note 13), all shares were converted into common stock. As of
September 27, 1997, an aggregate of 488,283 shares of common stock are held
by employees and former employees.
COMMITMENTS
At September 27, 1997, the Company had a commitment of approximately $4.0
million in connection with the acquisition and installation of a point of
sale scanning system. The Company intends to finance substantially all of
such acquisition and installation costs through capital lease financing.
The Company has employment agreements with several of its executives
providing, among other things, for employment terms of up to three years. In
addition, the Company has established a Supplemental Executive Retirement
Plan ("SERP") which presently covers only its Chairman. Such SERP provides
for vesting over a twenty year period. However, if the Chairman's employment
is terminated without cause, as defined, or if the Chairman resigns with
cause, as defined, such vesting becomes immediate, in which event the Company
would be liable to the Chairman (in addition to amounts accrued in the
financial statements) in the amount of approximately $680,000.
9. EMPLOYEE BENEFIT PLANS
On October 12, 1992, the Company adopted the 1992 Stock Option Plan of
Duane Reade Holding Corp. (the "Plan"). Under the Plan, a committee
designated by the Board of Directors to administer the Plan (the "Committee")
may grant, to executive and other key employees of the Company, nonqualified
stock options to purchase up to an aggregate of 510,757 (adjusted for the
recapitalization--See Note 10--and the reverse stock split--see Note 13)
shares of common stock of the Company at an exercise price fixed by the
Committee. The options are exercisable at such time or times as the Committee
determines at or subsequent to grant. The term of the options set by the
Committee shall not exceed 10 years.
At September 27, 1997, there were outstanding nonqualified stock options
to purchase up to an aggregate of 646,187 shares of common stock (including
options granted outside the Plan), all of which are vested.
Changes in options outstanding (including options granted outside the
Plan) during the 39 weeks ended September 27, 1997 are summarized as follows:
<TABLE>
<CAPTION>
OPTION PRICE PER SHARE
----------------------------------------------------
TOTAL
$.58 $7.34-$12.77 $29.37 $40.86 OPTIONS
----------- -------------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Options outstanding, December 28, 1996 . 750,044 29,128 29,128 29,128 837,428
Options granted......................... 851 68,953 851 851 71,506
Options canceled........................ (262,747) -- -- -- (262,747)
----------- -------------- ----------- ----------- -----------
Options outstanding, September 27,
1997................................... 488,148 98,081 29,979 29,979 646,187
=========== ============== =========== =========== ===========
Weighted average remaining life on
outstanding options.................... 8.4 years 8.5 years 6.4 years 6.4 years 8.3 years
</TABLE>
During the second quarter of 1997, the Company adopted an Equity
Participation Plan under which options for a total of 1,321,181 shares of
common stock of the Company may be granted to employees, consultants and
non-employee directors of the Company if the Company meets specific
performance targets. At September 27, 1997, options for 1,005,772 shares have
been granted to employees.
F-25
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
Changes in options outstanding under the Equity Participation Plan during
the 39 weeks ended September 27, 1997 are summarized as follows:
<TABLE>
<CAPTION>
NUMBER
OF OPTIONS OPTION PRICE
------------ --------------
<S> <C> <C>
Options outstanding, December 28, 1996 -- --
Options granted ........................ 1,005,772 8.33
------------ --------------
Options outstanding, September 27,
1997................................... 1,005,772 $8.33
============ ==============
</TABLE>
As permitted, the Company applies Accounting Principles Board Opinion No.
25 and related Interpretations in accounting for its stock-based compensation
plan. Had compensation cost for the Company's stock-based compensation plan
been determined based on the fair value at the grant dates for awards under
the Plan, consistent with the alternative method of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation, the
effect on the Company's net loss for the 39 weeks ended September 28, 1996
and September 27, 1997 would have been less than $100,000 and $200,000,
respectively.
The Company maintains an employee savings plan pursuant to Section 401(k)
(the "401(k) Plan") of the Internal Revenue Code ("IRC") which covers
substantially all non-union employees other than key employees as defined by
IRC. Eligible participating employees may contribute up to 10% of their
pretax salaries, subject to certain IRC limitations. The 401(k) Plan, as
amended, provides for employer matching provisions at the discretion of the
Company (to a maximum of 1% of pretax salaries) and has a feature under which
the Company may contribute additional amounts for all eligible employees. The
Company's policy is to fund such costs under the 401(k) Plan as accrued.
There were no employer contributions for the 39 weeks ended September 28,
1996 and September 27, 1997.
Duane Reade is under contract with local unions to contribute to
multi-employer pension and welfare benefit plans for certain of its
employees. For the 39 weeks ended September 28, 1996 and September 27, 1997,
contributions to such plans were $4,121,000 and $4,844,000, respectively.
10. RECAPITALIZATION
During June 1997, the Company entered into a recapitalization agreement
(the "Agreement") with its stockholders ("Stockholders") and certain
investors ("Investors"). The Agreement provided for (i) the purchase by
Investors from the Stockholders of substantially all their stock holdings in
the Company, (ii) a conversion of all of the outstanding shares of the
Company into a newly authorized class of Class B Common stock and (iii) the
creation of a new authorized class of preferred stock which will carry the
rights and preferences granted by the Company's Board of Directors when
issued.
Shares were converted as follows:
<TABLE>
<CAPTION>
APPROXIMATE
PRIOR CLASS CONVERSION RATE
- ------------------------------------ ---------------
<S> <C>
Common and Common Class A ........... 28/1
Common Class P and Common Class P-1 355/1
</TABLE>
In addition, because of the change in control, the Company was obligated
to and made offers to repurchase all outstanding Senior Notes and Zero Coupon
Notes at 101% of the principal amount or accreted value thereof,
respectively. Such offers expired on September 12, 1997. The Company
repurchased an aggregate of $107,000 principal amount of Senior Notes and
$9,000 of Zero Coupon Notes pursuant to the offers.
These financial statements do not reflect any adjustments as a result of
the June 1997 change in control.
F-26
<PAGE>
DUANE READE HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
11. NONRECURRING CHARGES
During the first quarter of 1997, the Company considered a public offering
of its common stock and took certain steps in connection with these plans.
Such plans were abandoned upon consummation of the transaction discussed in
Note 10.
Costs and expenses incurred in connection with the abandoned public
offering and the recapitalization and the exchange offers referred to in Note
10 aggregated approximately $10.9 million, including investment banking fees
of $7.7 million (including $3.5 million to an affiliate of the Investors and
$0.6 million to the Stockholders), legal and accounting fees of $1.6 million,
stand-by commitment fees relating to the exchange offers of $1.2 million to
an affiliate of the Investors, and other costs of $0.4 million. The Company
has treated these expenses as non-recurring because such expenses related to
financing activities in connection with the Recapitalization and related
events, which the Company does not expect to repeat.
12. RELATED PARTY TRANSACTIONS
In 1992, the Company and the then principal stockholder of the Company
(who has subsequently sold most of its shares--see Note 10) entered into a
professional services agreement whereby consulting, advisory, financial and
other services were provided at the Company's request, for a five year term.
During the 39 weeks ended September 28, 1996, such fees aggregated
approximately $742,000. See Note 11.
In addition, the Investors paid an executive approximately $0.8 million
for advisory services rendered and a former executive approximately $1.6
million for the repurchase and cancellation of exercisable stock options. The
accompanying financial statements do not reflect such payments.
13. SUBSEQUENT EVENTS
On September 30, 1997, the Company entered into a credit agreement with an
affiliate of the Investors and various financial institutions providing for a
term loan of $65,475,000 and a revolving credit facility of $30,000,000.
Proceeds of the term loan were used to repay outstanding term loans
($63,475,000) and revolving loans ($2,000,000) pursuant to the Credit
Agreement discussed in Note 4.
The term loan is payable in quarterly installments of $165,000 from
December 1997 through March 2001, $31,000,000 in June 2001, quarterly
installments of $165,000 from September 2001 through March 2002 and
$31,000,000 in June 2002. Outstanding term and revolving loans at September
27, 1997 have been classified in accordance with such repayment terms.
Costs incurred in connection with the refinancing aggregated approximately
$2.7 million (including a funding fee of $2.4 million to an affiliate of the
Investors) and will be amortized over the term of the new credit agreement.
Unamortized deferred financing costs of approximately $1.8 million at
September 27, 1997 relating to the prior credit agreement will be charged to
earnings in the fourth quarter of 1997.
On January 14, 1998, the Company effected an 8.326 reverse stock split of
its common stock. All references to common stock amounts, shares and per
share data included herein have been adjusted to give retroactive effect to
such reverse stock split.
F-27
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
[DUANE READE INC. LOGO]
[PHOTO]
[PHOTO]
<PAGE>
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING MADE HEREBY, AND IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY, DLJ OR ANY OTHER PERSON. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY NEW SENIOR
SUBORDINATED NOTES BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING THE OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE
HEREOF.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Prospectus Summary ............................ 3
Risk Factors .................................. 11
Use of Proceeds ............................... 18
Capitalization ................................ 19
Unaudited Pro Forma Condensed Consolidated
Financial Statements.......................... 20
Selected Consolidated Historical Financial and
Operating Data ............................... 25
Management's Discussion and Analysis of
Financial Condition and Results of Operations 27
Business ...................................... 34
Management .................................... 43
Certain Relationship and Related Transactions 49
Principal Stockholders ........................ 51
Description of New Senior Subordinated Notes .. 52
Description of Certain Indebtedness ........... 74
Plan of Distribution .......................... 75
Legal Matters ................................. 75
Experts ....................................... 75
Additional Information ........................ 75
Index to Financial Statements.................. F-1
</TABLE>
$80,000,000
[DUANE READE INC. LOGO]
9 1/4% SENIOR SUBORDINATED
NOTES DUE 2008
PROSPECTUS
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
FEBRUARY 9, 1998
