================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities and
Exchange Act of 1934
For the quarterly period ended June 26, 1999. Commission file number 333-41239
------------------------------
DUANE READE INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3164702
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
DRI I Inc.* Delaware 04-3166107
Duane Reade* New York 11-2731721
* Guarantors with respect to the Company's 9 1/4% Senior Subordinated Notes due
2008
440 Ninth Avenue
New York, New York 10001
(Address of principal executive offices) (Zip Code)
(212) 273-5700
(Registrant's telephone number, including area code)
-----------------------------
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- -------------------
Common Stock, $.01 par value per share New York Stock Exchange. Inc.
9 1/4% Senior Subordinated Notes due 2008 None
----------------------------
Securities registered pursuant to Section 12 (g) of the Act:
None.
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
The number of shares of the Common Stock outstanding as of August 10, 1999:
17,116,008
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<PAGE>
INDEX
PAGE
PART I
ITEM 1. - FINANCIAL STATEMENTS
Consolidated Statements of Operations (Unaudited)
For the 13 and 26 Weeks Ended June 26, 1999
and June 27, 1998 3
Consolidated Balance Sheets
As of June 26, 1999 (Unaudited) and December 26, 1998 4
Consolidated Statements of Cash Flows (Unaudited)
For the 13 and 26 Weeks Ended June 26, 1999
and June 27, 1998 5
Notes to Consolidated Financial Statements 6
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 9
PART II - OTHER INFORMATION 15
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
Duane Reade Inc.
Consolidated Statements of Operations (Unaudited)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
For the 13 Weeks Ended For the 26 Weeks Ended
---------------------- ----------------------
June 26, June 27, June 26, June 27,
1999 1998 1999 1998
--------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Net sales $ 208,675 $ 134,796 $ 399,039 $ 254,179
Cost of sales 156,456 100,233 300,864 190,810
--------- --------- --------- ---------
Gross profit 52,219 34,563 98,175 63,369
--------- --------- --------- ---------
Selling, general & administrative expenses 33,144 21,803 64,865 40,919
Amortization 2,505 1,436 4,791 2,852
Depreciation 2,426 1,300 4,803 2,386
Store pre-opening expenses 717 962 996 1,867
--------- --------- --------- ---------
38,792 25,501 75,455 48,024
--------- --------- --------- ---------
Operating income 13,427 9,062 22,720 15,345
Interest expense, net 7,170 5,321 13,950 12,559
--------- --------- --------- ---------
Income before income taxes 6,257 3,741 8,770 2,786
Income taxes 1,190 -- 1,667 --
--------- --------- --------- ---------
Income before extraordinary charge 5,067 3,741 7,103 2,786
Extraordinary charge, net of income taxes of $-0- -- -- -- (23,600)
--------- --------- --------- ---------
Net income (loss) $ 5,067 $ 3,741 $ 7,103 $ (20,814)
========= ========= ========= =========
Per Common Share - Basic
Income before extraordinary charge $ 0.30 $ 0.22 $ 0.42 $ 0.18
Extraordinary charge -- -- -- (1.53)
--------- --------- --------- ---------
Net income (loss) $ 0.30 $ 0.22 $ 0.42 $ (1.35)
========= ========= ========= =========
Weighted average common shares outstanding 17,112 16,983 17,100 15,411
========= ========= ========= =========
Per Common Share - Diluted
Income before extraordinary charge $ 0.28 $ 0.21 $ 0.39 $ 0.17
Extraordinary charge -- -- -- (1.42)
--------- --------- --------- ---------
Net income (loss) $ 0.28 $ 0.21 $ 0.39 $ (1.25)
========= ========= ========= =========
Weighted average common shares outstanding 18,359 18,231 18,349 16,639
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
Duane Reade Inc.
Consolidated Balance Sheets
(In thousands, except share amounts)
<TABLE>
<CAPTION>
June 26, December 26,
1999 1998
--------- ---------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets
Cash $ 962 $ 869
Receivables 30,084 25,547
Inventories 147,214 134,313
Property held for sale 862 11,527
Prepaid expenses and other current assets 5,384 4,774
--------- ---------
TOTAL CURRENT ASSETS 184,506 177,030
Property and equipment, net 93,046 71,974
Goodwill, net of accumulated amortization of $25,732 and $21,954 153,622 144,946
Other assets 37,627 34,190
--------- ---------
TOTAL ASSETS $ 468,801 $ 428,140
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 58,562 $ 50,028
Accrued interest 6,771 3,636
Other accrued expenses 17,910 25,677
Current portion of long-term debt 7,850 5,600
Current portion of capital leases 2,003 2,089
--------- ---------
TOTAL CURRENT LIABILITIES 93,096 87,030
Senior debt, less current portion 321,738 299,350
Capital lease obligations, less current portion 3,943 3,930
Other noncurrent liabilities 19,292 15,041
--------- ---------
TOTAL LIABILITIES 438,069 405,351
--------- ---------
Stockholders' equity
Preferred stock, $0.01 par; authorized 5,000,000 shares;
issued and outstanding: none -- --
Common stock, $0.01 par; authorized 30,000,000 shares;
issued and outstanding 17,113,308 and 16,985,557 shares 171 170
Paid-in capital 127,046 126,207
Accumulated deficit (96,485) (103,588)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 30,732 22,789
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 468,801 $ 428,140
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
Duane Reade Inc.
Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
<TABLE>
<CAPTION>
For the 26 Weeks Ended
-----------------------
June 26, June 27,
1999 1998
--------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 7,103 $ (20,814)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Extraordinary charge -- 23,600
Depreciation and amortization of property and equipment 4,803 2,386
Amortization of goodwill and other intangibles 5,453 3,366
Accretion of principal of zero coupon debt -- 1,659
Gain on sale of assets (444) --
Other 2,452 1,201
Changes in operating assets and liabilities (net of effect
of acquisitions):
Receivables (4,537) (4,410)
Inventories (11,109) (29,942)
Accounts payable 8,534 19,109
Prepaid and accrued expenses (7,280) (2,190)
Increase in other (assets) liabilities, net (3,802) (2,996)
--------- ---------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 1,173 (9,031)
--------- ---------
Cash flows from investing activities:
Pharmacy acquisitions (10,332) --
Proceeds from sale of assets 10,732 --
Capital expenditures (24,905) (16,745)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (24,505) (16,745)
--------- ---------
Cash flows from financing activities:
Proceeds from initial public offering, net -- 101,606
Proceeds from new term loan 25,000 130,000
Proceeds from new senior subordinated notes -- 80,000
Repayment of old term loan -- (65,310)
Repayment of old senior subordinated notes -- (89,893)
Repayment of zero coupon debt -- (99,346)
Premiums paid on early extinguishment of debt -- (11,496)
Fees and expenses related to early extinguishment of debt -- (478)
Net borrowings (repayments) - old revolving credit facility -- (24,500)
Deferred financing costs (1,080) (5,042)
Exercise of stock options 840 106
Repayments of new term loan (2,862) (450)
Net borrowings - new revolving credit facility 2,500 12,000
Repayments of capital lease obligations (973) (1,070)
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 23,425 26,127
--------- ---------
Net increase in cash 93 351
Cash at beginning of period 869 261
--------- ---------
Cash at end of period $ 962 $ 612
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
DUANE READE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. Basis of Presentation
The consolidated financial statements included herein reflect all adjustments
which, in the opinion of management, are necessary to present fairly the results
of operations and financial position of Duane Reade Inc. (the "Company"), and
have been prepared in accordance with the same accounting principles followed in
the presentation of the Company's annual financial statements for the year ended
December 26, 1998. The financial statements should be read in conjunction with
the Company's financial statements included in its Annual Report on Form 10K for
the year ended December 26, 1998. The results for the interim periods presented
are not necessarily indicative of the results expected for the full year.
The Company has no assets or operations other than its investment in its
subsidiary guarantors. Accordingly, the consolidated financial statements
present the combined assets and operations of the subsidiary guarantors.
2. Net Income (Loss ) per Common Share
Net income (loss) per common share is based on the weighted average shares
outstanding during each period in accordance with the provisions of FASB
Statement No. 128 "Earnings Per Share." Basic earnings per share is computed
based on the weighted average number of common shares outstanding during the
period. Diluted earnings per share gives effect to all dilutive potential common
shares outstanding during the period. Dilutive potential common shares include
shares issuable upon exercise of the Company's stock options. Dilutive potential
common shares relating to options to purchase common stock were not included in
the weighted average number of shares for the 26 weeks ended June 27, 1998
because their effect would have been anti-dilutive.
3. Income Taxes
Income taxes are recorded based on the estimated effective tax rate expected to
be applicable for the full fiscal year. The effective tax rate is lower than the
statutory rate, reflecting the benefit of net operating loss carryforwards.
While such carryforwards are adequate to offset all federal taxes that are
expected to be payable for the year (and therefore no tax payments are
expected), for accounting purposes, the benefit of certain carryforwards serves
to reduce goodwill, and not income tax expense, resulting in an effective rate
greater than zero.
4. Acquisition
On September 11, 1998, the Company purchased substantially all of the operating
assets (including inventory and leases) of Rock Bottom Stores, Inc., a health
and beauty aid retailer operating 38 stores primarily in the outer boroughs of
New York City (the "Rock Bottom Acquisition"). The purchase price paid was $64.9
million, subject to certain post-closing adjustments. The acquisition, accounted
for under the purchase method, was financed with additional term loans under the
Existing Credit Agreement. The purchase price was allocated to inventory ($18.2
million), property held for sale ($8.2 million), property ($14.7 million),
identifiable intangibles ($5.2 million) and goodwill ($27.8 million) net of
reserves for expenses and store closings ($9.2 million).
Ten stores acquired as part of the acquisition were designated for sale or
closure. These stores were operated for a period of time after the Rock Bottom
Acquisition. Six of these stores were sold in March 1999 at no resultant gain or
loss. One of the remaining stores has been turned back to the landlord and the
Company has been released from the lease obligations. The results of operations
from these ten stores have not been included in the Company's statements of
operations for any period. Their results have been included in goodwill. Any
gain or loss resulting from the remaining stores' will be included in goodwill
in the period sold.
6
<PAGE>
DUANE READE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
The operating results of the Rock Bottom stores to be retained have been
included in the consolidated statement of operations from the date of
acquisition. The unaudited pro forma results for the 26 weeks ended June 27,
1998 presented below assume the acquisition occurred as of December 28, 1997 (in
thousands, except per share amounts):
For the 26 weeks ended
------------------------
June 26, June 27,
1999 1998
--------- -----------
(Historical) (Pro Forma)
Net sales $ 399,039 $ 342,315
========= ===========
Operating income $ 22,720 $ 18,115
========= ===========
Income before extraordinary charge $ 7,103 $ 3,360
Extraordinary charge, net of income taxes
of $-0- -- (23,600)
--------- -----------
Net income (loss) $ 7,103 $ (20,240)
========= ===========
Per Common Share-Basic:
Income (loss) before extraordinary charge $ 0.42 $ 0.22
Extraordinary charge -- (1.53)
--------- -----------
Net income (loss) $ 0.42 $ (1.31)
========= ===========
Per Common Share-Diluted:
Income (loss) before extraordinary charge $ 0.39 $ 0.20
Extraordinary charge -- (1.42)
--------- -----------
Net income (loss) $ 0.39 $ (1.22)
========= ===========
In management's opinion, the unaudited pro forma combined results are not
necessarily indicative of the actual results that would have occurred had the
acquisition been consummated at the beginning of fiscal 1998 or of future
results of the combined operations under the ownership and management of the
Company.
5. Refinancing Plan and Initial Public Offering
In February 1998, the Company successfully completed an initial public offering
of its stock which was part of a plan to refinance all of the Company's existing
indebtedness (the "Refinancing Plan") in order to enhance the Company's
financial flexibility to pursue growth opportunities and implement capital
improvements. The Refinancing Plan resulted in a reduction in the Company's
overall indebtedness, a simplification of the Company's capital structure and
access to additional borrowings. The principal components of the Refinancing
Plan were; (i) the sale by the Company of 6.7 million shares of common stock for
net proceeds of approximately $102 million; (ii) the execution of a new secured
credit agreement (the "Existing Credit Agreement") which provides for borrowings
up to approximately $160 million ($130 million of term loans and up to $30
million of revolving loans); (iii) the issuance of $80 million aggregate
principal amount of the Company's 9 1/4% Senior Subordinated Notes due 2008 (the
"Senior Notes") for net proceeds of approximately $77 million; (iv) the
repayment of all outstanding borrowings under the Company's former credit
agreement (the "Old Credit Agreement"); (v) the redemption of the Company's
outstanding Zero Coupon Notes; and (vi) the redemption of the Company's
outstanding 12% Senior Notes due 2002. The interest rates under the Existing
Credit Agreement are approximately the same as interest rates under the Old
Credit Agreement.
7
<PAGE>
DUANE READE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
6. Extraordinary Charge
During the 26 weeks ended June 27, 1998, as a result of the completion of the
Refinancing Plan, the Company incurred a $23.6 million extraordinary charge due
to the early extinguishment of debt. The extraordinary charge included
redemption premiums on the Senior Notes and Zero Coupon Notes of approximately
$11.5 million, accelerated amortization of deferred financing costs and other
transaction expenses of approximately $8.1 million, and accelerated accretion of
Zero Coupon Notes to the indenture stated value of approximately $4.0 million.
7. Income (Loss) Per Common Share
The following table sets forth the computation of income (loss) per common share
for the periods presented (in thousands, except per share amounts):
<TABLE>
<CAPTION>
For the 13 Weeks Ended For the 26 Weeks Ended
---------------------- ----------------------
June 26, June 27, June 26, June 27,
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Income before extraordinary charge $ 5,067 $ 3,741 $ 7,103 $ 2,786
Extraordinary charge -- -- -- (23,600)
---------- ---------- ---------- ----------
Net income (loss) $ 5,067 $ 3,741 $ 7,103 $ (20,814)
========== ========== ========== ==========
Weighted average number of common
shares outstanding
during the period - basic 17,112 16,983 17,100 15,411
Dilutive potential securities 1,247 1,248 1,249 1,228
---------- ---------- ---------- ----------
Weighted average number of shares
outstanding - diluted 18,359 18,231 18,349 16,639
---------- ---------- ---------- ----------
Per common share - basic
Income before extraordinary charge $ .30 $ 0.22 $ .42 $ 0.18
Extraordinary charge -- -- -- (1.53)
---------- ---------- ---------- ----------
Net income (loss) $ .30 $ 0.22 $ .42 $ (1.35)
========== ========== ========== ==========
Per common share - diluted
Income before extraordinary charge $ .28 $ 0.21 $ .39 $ 0.17
Extraordinary charge -- -- -- (1.42)
---------- ---------- ---------- ----------
Net income (loss) $ .28 $ 0.21 $ .39 $ (1.25)
========== ========== ========== ==========
</TABLE>
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The information contained herein includes certain forward-looking statements
that involve a number of risks and uncertainties. A number of facts 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 operation strategy or development plans; the ability to attract and
retain qualified personnel; the significant indebtedness of the Company; labor
disturbance; 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 discussion 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.
Results of Operations
The following sets forth the results of operations as a percentage of sales for
the periods indicated.
<TABLE>
<CAPTION>
For the 13 Weeks Ended For the 26 Weeks Ended
---------------------- ----------------------
June 26, 1999 June 27, 1998 June 26, 1999 June 27, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 75.0 74.4 75.4 75.1
----- ----- ----- -----
Gross profit 25.0 25.6 24.6 24.9
Selling, general and
administrative expenses 15.9 16.2 16.3 16.1
Amortization 1.2 1.1 1.2 1.1
Depreciation 1.2 0.9 1.2 1.0
Store pre-opening expenses 0.3 0.7 0.2 0.7
----- ----- ----- -----
Operating income 6.4 6.7 5.7 6.0
Interest expense, net 3.4 3.9 3.5 4.9
----- ----- ----- -----
Income before income taxes 3.0 2.8 2.2 1.1
Income taxes 0.6 -- 0.4 --
----- ----- ----- -----
Income before
extraordinary charge 2.4 2.8 1.8 1.1
Extraordinary charge -- -- -- (9.3)
----- ----- ----- -----
Net income (loss) 2.4% 2.8% 1.8% (8.2)%
===== ===== ===== =====
</TABLE>
9
<PAGE>
Second Quarter 1999 versus Second Quarter 1998.
Net sales in the second quarter 1999 were $208.7 million, an increase of 54.8%
over last year's second quarter net sales of $134.8 million. The increase was
primarily attributable to sales from the 28 former Rock Bottom stores that the
Company purchased in September 1998, increased comparable store sales of 7.1%
and the inclusion of 17 stores opened during the 26 weeks ended June 27, 1998
for the entire period and the sales from new stores. The Company opened eleven
stores (including six acquired Love's stores in Manhattan) during the second
quarter of 1999 compared to eight store openings during the second quarter of
1998.
Cost of sales as a percentage of net sales increased to 75.0% this year from
74.4% in the comparable quarter last year resulting in a decrease in gross
profit margin to 25.0% from 25.6%. The decrease in gross profit margin was
principally related to the impact of the Rock Bottom stores acquired in
September of 1998.
Selling, general and administrative expenses were $33.1 million or 15.9% of net
sales and $21.8 million or 16.2% of net sales in the second quarter of 1999 and
1998, respectively. The percentage decrease in 1999 compared to 1998 reflects
the leveraging of store operating costs as the operating costs for the stores
opened last year increase at a lesser rate than store sales.
Amortization of goodwill and other intangibles in the second quarter of 1999 and
1998 was $2.5 million and $1.4 million, respectively. The increase in
amortization resulted principally from the amortization of goodwill and
identifiable intangible assets related to the Rock Bottom stores as well as
increases in the amortization of lease acquisition and customer list costs for
pharmacy acquisitions during 1998.
The increase in depreciation from $1.3 million in the second quarter of 1998 to
$2.4 million in the second quarter of 1999 resulted principally from
depreciation on new stores opened in the second half of 1998 and the first six
months of 1999 as well as depreciation expense on the 28 former Rock Bottom
stores.
The Company incurred pre-opening costs of $0.7 million during the second quarter
of 1999 related to the opening of eleven stores. Pre-opening costs of $1.0
million were incurred during the second quarter of 1998 for the opening of eight
stores.
Net interest expense increased 34.7% to $7.2 million in the second quarter of
1999 from $5.3 million in the second quarter of 1998. The increase was
principally due to the impact of additional term loans of $80 million incurred
in the third quarter of 1998 and $25 million incurred in March 1999.
Income before income taxes increased by 67.3% or $2.6 million to $6.3 million in
the second quarter of 1999 from $3.7 million in the second quarter of 1998
primarily as a result of increased sales and gross profit dollars partially
offset by increased selling, general and administrative expenses; depreciation;
amortization and net interest expense.
Income tax expense for the second quarter of 1999 was $1.2 million or 0.6% of
net sales versus no provision for income taxes in the second quarter of 1998.
The Company anticipates that in 1999 it will begin to utilize the net tax loss
carryforward benefits it has accumulated in past years and, therefore, has
provided for income tax expense at its anticipated current year effective tax
rate of 19% (See Note 3 to consolidated financial statements).
The Company's net income increased by $1.4 million to $5.1 million in the second
quarter of 1999 from $3.7 million in the second quarter of 1998 due to factors
discussed above.
Twenty-six Weeks Ended June 26, 1999 versus Twenty-six Weeks Ended June 27, 1998
Net sales for the twenty-six weeks ended June 26, 1999 were $399.0 million, an
increase of 57.0% over the net sales for the first twenty-six weeks of 1998 of
$254.2 million. The increase was attributable to sales from the 28 former Rock
Bottom stores that the Company purchased in September 1998, increased comparable
store sales of 7.1% and the sales generated by new stores. The Company opened 14
stores during the period compared to 17 store openings during the same period
last year.
10
<PAGE>
Cost of sales for the twenty-six weeks ended June 26, 1999 as a percentage of
net sales increased to 75.4% from 75.1% in the comparable period last year,
resulting in a decrease in gross profit margin to 24.6% from 24.9%. The decrease
in gross profit margin was principally related to the impact of the Rock Bottom
stores acquired in September 1998.
Selling, general and administrative expenses were $64.9 million or 16.3% of net
sales and $40.9 million or 16.1% of net sales for the twenty-six weeks ended
June 26, 1999 and June 27, 1998, respectively. The percentage increase in 1999
compared to 1998 resulted principally from higher administrative costs as well
as transition costs of approximately $600,000 incurred during the first quarter
of 1999.
Amortization of goodwill and other intangibles for the twenty-six weeks ended
June 26, 1999 and June 27, 1998 was $4.8 million and $2.9 million, respectively.
The increase in amortization resulted principally from the amortization of
goodwill and identifiable intangible assets related to the Rock Bottom stores as
well as increases in the amortization of lease acquisition and customer list
costs for pharmacy acquisitions during 1998.
The increase in depreciation from $2.4 million for the twenty-six weeks ended
June 27, 1998 to $4.8 million for the twenty-six weeks ended June 26, 1999
resulted principally from new stores opened in 1998 and the first half of 1999
as well as depreciation expense on the 28 former Rock Bottom stores.
The Company incurred pre-opening costs of $1.0 million during the twenty-six
weeks ended June 26, 1999 related to the opening of 14 stores. Pre-opening costs
of $1.9 million were incurred during the twenty-six weeks ended June 27, 1998
for the opening of 17 stores.
Net interest expense increased 11.1% to $14.0 million during the twenty-six
weeks ended June 26, 1999 from $12.6 million in the comparable period last year.
The increase was principally due to the impact of additional term loans of $80
million secured during the third quarter of 1998 and $25 million secured in
March 1999.
Income before income taxes for the twenty-six weeks ended June 26, 1999
increased by $6.0 million to $8.8 million from $2.8 million in the comparable
prior year period, primarily as a result of increased sales and gross profit
dollars partially offset by increased selling, general and administrative
expenses, depreciation, amortization and net interest expense.
Income tax expense for the twenty-six weeks ended June 26, 1999 amounted to $1.7
million or .4% of net sales versus no provision for income taxes in the
comparable prior year period. The Company anticipates it will begin to utilize
in 1999 the net tax loss carryforward benefits it has accumulated in past years
and, therefore, has provided for income tax expense at its current year
anticipated effective tax rate of 19%. (See Note 3 to consolidated financial
statement)
The Company's income before extraordinary charge increased by $4.3 million to
$7.1 million for the twenty-six weeks ended June 26, 1999 from $2.8 million in
the twenty-six weeks ended June 27, 1998 due to the factors discussed above.
Results for the twenty-six weeks ended June 27, 1998 also included a $23.6
million extraordinary charge for costs associated with the early extinguishment
of debt as part of the Company's initial public offering and related financing.
Net income for the twenty-six weeks ended June 26, 1999 was $7.1 million
compared to a net loss for the twenty-six weeks ended June 27, 1998 of $20.8
million.
Liquidity and Capital Resources
Working capital was $91.4 million and $90.0 million as of June 26, 1999 and
December 26, 1998, respectively. The increase is principally due to increases in
net owned inventory and receivables partially offset by a reduction in property
held for sale. The increase in inventory reflects inventory related to the
opening of 14 additional stores. The property held for sale was reduced as a
result of the disposition, at no gain or loss, of six stores acquired from Rock
Bottom Stores, Inc. which the Company elected not to continue to operate and the
related inventories as well as the disposition of the Company's former
distribution center facility.
11
<PAGE>
The Company's EBITDA (earnings before interest, taxes, depreciation,
amortization, extraordinary charge and other non-cash items) for the second
quarter of 1999 increased by 52.6% to $19.3 million from $12.6 million for the
second quarter of 1998. EBITDA as a percentage of sales was 9.2% for the second
quarter of 1999 compared to 9.4% for the second quarter of 1998. The Company's
EBITDA for the twenty-six weeks ended June 26, 1999 increased by 57.5% to $34.3
million from $21.8 million for the twenty-six weeks ended June 27, 1998. EBITDA
as a percentage of sales was 8.6% for both twenty-six week periods.
For the twenty-six weeks ended June 26, 1999, net cash provided by operating
activities was $1.2 million, compared to net cash used in operating activities
of $9.0 million during the twenty-six weeks ended June 27, 1998. Cash provided
by operating activities was greater then the increase in the net owned inventory
and receivables which were required to support the Company's expanding store
base.
During the twenty-six weeks ended June 26, 1999, net cash used in investing
activities was $24.5 million compared to $16.7 million during the twenty-six
weeks ended June 27, 1998. This reflects capital expenditures in 1999 related to
the conversion of former Rock Bottom stores to the hybrid Duane Reade format,
new store openings and remodelings and the acquisition of seven pharmacies, net
of proceeds related to the disposition of six former Rock Bottom store locations
and the Company's former distribution center facility. The Company sold the
leases for the six stores for proceeds of approximately $3.5 million and
liquidated the stores' inventories for proceeds of approximately $3.0 million.
The Company sold its former distribution center facility for proceeds of
approximately $4.2 million.
For the twenty-six weeks ended June 26, 1999, net cash provided by financing
activities was $23.4 million compared to $26.1 million for the twenty-six weeks
ended June 27, 1998. The decrease from last year resulted from the
implementation of the Company's Refinancing Plan during the first half of 1998.
During the quarter ended March 27, 1999, the Company secured an additional term
loan of $25 million. In addition, the Company increased its revolving credit
facility from $30 million to $40 million. This will provide the Company with
additional flexibility under the existing credit agreement for the Company's
working capital requirements.
The Company's capital requirements primarily result from opening and stocking
new stores. The Company believes that there are significant opportunities to
open additional stores, and currently plans to open 30 to 40 stores during 1999
and 2000. The Company has expended approximately $25.0 million on capital
expenditures during the twenty-six weeks ended June 26, 1999 and expects to
spend approximately $5.0 million during the remainder of 1999. Capital
expenditures are made 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 records significant accounts receivable related to pharmacy sales in
connection with third party plans and these receivables are collectible within
30 to 45 days. Prior to September 8, 1998, the Company had a non-recourse
factoring arrangement with an independent third party, Pharmacy Fund, Inc. (the
"Pharmacy Fund") under which the Company sold it accounts receivable associated
with the third party plans. On September 8, 1998, Pharmacy Fund declared
bankruptcy and no longer purchases the Company's third party plan receivables.
The outstanding amount from Pharmacy Fund at June 26, 1999 is not considered
material to the Company's operating results or cash flow and, the Company
believes that it will not suffer any loss from the bankruptcy. The Company plans
to collect its own receivables for the foreseeable future.
The Company believes that, based on current levels of operations and anticipated
growth, cash flow from operations, together with other available sources of
funds, including borrowings under the Existing Credit Agreement, will be
adequate for at least the next two years to make required payments of principal
and interest on the Company's indebtedness, to fund anticipated capital
expenditures and working capital requirements and to comply with terms of its
debt agreements. As of June 26, 1999, the Company had borrowed approximately $19
million under the revolving portion of its bank credit facility and had
approximately $20.5 million of remaining availability. 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
12
<PAGE>
general economic, financial, business, competitive, legislative, regulatory and
other conditions, many of which are beyond the Company's control. In addition,
there can be no assurance that the Company's operating results, cash flow and
capital resources will be sufficient for repayment of its indebtedness in the
future. Substantially all of the Company's borrowings under the Existing Credit
Agreement bear interest at floating rates; therefore, the Company's financial
condition will be affected by the changes in prevailing interest rates. The
Company has entered into interest rate protection agreements to minimize the
impact from a rise in interest rates.
Tax Benefits from Net Operating Losses
At December 26, 1998, the Company had net operating loss carryforwards ("NOLs")
of approximately $107 million, which are due to expire in the years 2007 through
2018. These NOLs may be used to offset future taxable income through 2018 and
thereby reduce or eliminate the Company's federal income taxes otherwise
payable. The Internal Revenue Code of 1986, as amended (the "Code"), imposes
significant limitations on the utilization of NOLs in the event of an "ownership
change," as defined in Section 382 of the Code (the "Section 382 Limitation").
The Section 382 Limitation is an annual limitation on the amount of
pre-ownership change NOLs that a corporation may use to offset its
post-ownership change income. The Section 382 Limitation is calculated by
multiplying the value of a corporation's stock immediately before an ownership
change by the long-term tax-exempt rate (as published by the Internal Revenue
Service). Generally, an ownership change occurs with respect to a corporation if
the aggregate increase in the percentage of stock ownership (by value) of that
corporation by one or more 5% shareholders (including certain groups of
shareholders who in the aggregate own at least 5% of that corporation's stock)
exceeds 50 percentage points over a three-year testing period. The
Recapitalization caused the Company to experience an ownership change. As a
result, the Company currently is subject to an annual Section 382 Limitation of
approximately $5.1 million on the amount of NOLs generated prior to the
Recapitalization that the Company may utilize to offset future taxable income.
NOLs generated by the Company since the Recapitalization (approximately $37
million) are not subject to the Section 382 Limitation and may be used to offset
future taxable income. There can be no assurance that any NOLs will be able to
be used by the Company to offset future taxable income or that such NOLs will
not become subject to limitation due to future ownership changes.
Year 2000 Update
The Company has implemented a program to ensure that the Company computer
systems and applications (IT Systems) and non-IT Systems will function properly
beyond 1999. This program includes inventorying year 2000 items; assigning
priorities to the identified items; assessing year 2000 compliance of items
determined to be material to the Company; remediating or replacing material
items that are not year 2000 compliant; and determining contingency plans that
may be required.
The Company has completed implementing year 2000 compliance for its IT Systems
and is in the process of completing its non-IT Systems, which includes surveying
significant third party vendors. Year 2000 compliance of the Company's IT
Systems has been successfully tested.
The Company is using both internal and external resources to address year 2000
issues and believes that the cost of such modifications will approximate
$600,000. Approximately $250,000 of this includes system upgrades that had been
previously identified for operational enhancements. Management regularly
monitors the status of the year 2000 compliance process.
The failure to correct a material year 2000 problem could result in an
interruption in, or failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, financial condition and liquidity. No assurances,
however, can be given that the Company will be able to identify and address all
year 2000 issues due to their complexity as well as the Company's dependence on
the technical skills of employees and independent contractors and on the
representations and preparedness of third parties with which the Company does
business. Although the Company believes that its efforts are designed to
appropriately identify and address year 2000 issues that are subject to the
Company's reasonable control, there can be no assurance that year 2000 issues
will not have a material adverse effect on the Company's business, financial
condition or results of operations.
13
<PAGE>
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 seasonable products. In view of the
Company's recent expansion of seasonal merchandising, the Company expects
slightly greater revenue sensitivity relating to seasonality in the future.
Recently Issued Accounting Pronouncements
FASB Statement No. 133 "Accounting for Derivative Instruments and Hedging
Activities" requires that derivative instruments such as options, forward
contracts and swaps be recorded as assets and liabilities at fair value and
provides guidance for recognition of changes in fair value depending on the
reason for holding the derivative. The Company does not presently have
significant transactions involving derivative instruments, but may do so in the
future. The Company is required to adopt Statement No. 133 for the second
quarter of 2001 and may adopt it earlier.
Market Risk
The financial results of the Company are subject to risk from interest rate
fluctuations on debt which carries variable interest rates. Variable rate debt
outstanding (under the Existing Credit Agreement) was approximately $249.6
million at June 26, 1999, which is somewhat lower than the Company expects its
outstanding variable debt rate to be during the next twelve months. The
anticipated outstanding balances however, are not expected to be materially
greater than at June 26,1999. Based on June 26, 1999 outstanding balances, a
0.50% change in interest rates would affect annual results of operations by
approximately $1.2 million. The Company also has $80 million of Senior Notes
outstanding at June 26, 1999. These notes, which bear interest at a fixed rate
of 9 1/4%, are not subject to risk from interest rate fluctuations.
The principal objective of the Company's investment management activities is to
maintain acceptable levels of interest rate and liquidity risk to facilitate the
funding needs of the Company. As part of its investment management, the Company
may use derivative financial products such as interest rate hedges and interest
rate swaps. During the six months ended June 27, 1998, there were no derivative
positions. During the six months ended June 26, 1999, in connection with the
Existing Credit Agreement requirements, the Company has an interest rate
protection agreement in place. The interest rate protection agreement caps the
LIBOR interest rate at 6.5% on $65 million of variable rate debt.
14
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. 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.
In addition, the Company is currently party to legal actions arising
out of disputes over the purchase price with respect to the Rock Bottom
Acquisition. The disputed amounts are not material to the Company, and the
Company believes that the ultimate outcome of these actions will not have a
material adverse effect on the Company.
ITEM 2. Changes in Securities and Use of Proceeds.
Not applicable.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
ITEM 5. Other Information
Not applicable.
ITEM 6. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K
(a) The following documents are filed as a part of this report:
(i) Financial Statements
(ii) Exhibits:
3.1(i) Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.1(i) to the
Company's Registration Statement No. 333-41239 (the "Common
Stock S-1")).
3.1(ii) Form of Amended and Restated Bylaws of the Company
(incorporated by reference to Exhibit 3.1(i) to the Common
Stock S-1).
3.2(i) Certificate of Incorporation of DRI I Inc. (incorporated by
reference to Exhibit 3.2(i) to the S-1 Registration Statement
No. 333-43313 with respect to the Company's 9 1/4% Senior
Subordinated Notes due 2008 (the "Notes S-1")).
3.2(ii) By-laws of DRI I Inc. (incorporated by reference to Exhibit
3.2(ii) of the Notes S-1)
3.3 Second Amended and Restated Partnership Agreement of Duane
Reade (incorporated by reference to Exhibit 3.3 of the Notes
S-1)
4.1 Form of Indenture (incorporated by reference to Exhibit 4.1 of
the Notes S-1)
15
<PAGE>
10.1 Duane Reade Inc. 1997 Equity Participation Plan (incorporated
by reference to Exhibit 10.1 to the Company's Form S-1
registration Statement (File No. 333-41239), the "Common Stock
S-1").
10.2 Duane Reade Inc. Holding Corp. 1992 Stock Incentive Plan
(incorporated by reference to Exhibit 10.2 to the Common Stock
S-1).
10.3 Employment Agreement, dated as of October 27, 1997, between
the Company and Anthony J. Cuti (incorporated by reference to
Exhibit 10.3 to the Common Stock S-1).
10.4 Employment Agreement, dated as of February 22, 1993, as
amended, between the Company and Gary Charboneau (incorporated
by reference to Exhibit 10.4 to the Common Stock S-1).
10.5 Employment Agreement, dated as of April 10, 1995, as amended,
between Duane Reade and Jerry M. Ray (incorporated by
reference to Exhibit 10.5 to the Common Stock S-1).
10.6 Employment Letter Agreement, dated as of October 9, 1996,
between Duane Reade and Joseph Lacko (incorporated by
reference to Exhibit 10.6 to the Common Stock S-1).
10.7 Employment Letter Agreement, dated as of February 12, 1997,
between the Company and William Tennant (incorporated by
reference to Exhibit 10.7 to the Common Stock S-1).
10.8 Agreement, dated as of November 22, 1996 between Duane Reade
and Drug, Chemical, Cosmetic, Plastics and Affiliated
Industries Warehouse Employees Local 815 (incorporated by
reference to Exhibit 10.8 to the Common Stock S-1).
10.9 Agreement, dated July 16, 1992, as amended, between Duane
Reade and Allied Trades Council (incorporated by reference to
Exhibit 10.9 to the Common Stock S-1).
10.10 Agreement, dated February 4, 1997, as amended between Duane
Reade and The Pharmacy Fund, Inc. (incorporated by reference
to Exhibit 10.10 to the Common Stock S-1).
10.11 Stockholders and Registration Rights Agreement, dated as of
June 18, 1997, among the Company, DLJMB Funding II, Inc., DLJ
Merchant Banking Partners II, L.P., DLJ Diversified Partners,
L.P., DLJ Second ESC L.L.C., DLJ Offshore Partners, II, C.V.,
DLJ EAB Partners, L.P., UK Investment Plan 1997 Partners,
Bankers Trust New York Corporation, Conac & Co., Muico & Co.,
Roton & Co. , Putnam High Yield Trust, PaineWebber Managed
Investment Trust on behalf of PaineWebber High Income Fund,
USL Capital Corporation, Pearlman Family Partners, The Marion
Trust, Bruce L. Weitz, BCIP Associates, BCIP Trust Associates,
L.P., Tyler Capital Fund L.P., Tyler International, L.P.-II,
and Tyler Massachusetts, L.P. (incorporated by reference to
Exhibit 10.13 to the Common Stock S-1).
10.12 Second Amended and Restated Credit Agreement, dated as of
March 17, 1999, among Duane Reade, as the Borrower, Duane
Reade Inc. and DRI I Inc., as the Parent Guarantors, Various
Financial Institutions set forth therein, as the Lenders, DLJ
Capital Funding, Inc., as the Syndication Agent for the
Lenders, Fleet National Bank, as the Administrative Agent for
the Lenders and Credit Lyonnais New York Branch, as the
Documentation Agent for the Lenders (incorporated by reference
to Exhibit 10.12 of the Company's Quarterly Report on Form
10-Q for the quarter ended March 27, 1999).
10.13 Amended and Restated Partnership Security Agreement, dated as
of September 11, 1998, among Duane Reade Inc. and DRI I Inc.
and Fleet National Bank, as Administrative Agent (Incorporated
by reference to Exhibit 10.15 of the Company's Current Report
on Form 8-K dated September 24, 1998).
10.14 Amended and Restated Borrower Security Agreement, dated as of
September 11, 1998, between Duane Reade and Fleet National
Bank as Administrative Agent (Incorporated by reference to
Exhibit 10.16 of the Company's Current Report on Form 8-K
dated September 24, 1998).
10.15 Amended and Restated Holdings Pledge Agreement, dated as of
September 11, 1998, among Duane Reade Inc. and Fleet National
Bank, as Administrative Agent (incorporated by reference to
Exhibit 10.17 of the Company's Current Report on Form 8-K
dated September 24, 1998).
16
<PAGE>
10.16 Amendment Agreement to Credit Agreement, dated as of March 17,
1999, among Duane Reade, Duane Reade Inc., DRI I Inc., various
financial institutions as Lenders, DLJ Capital Funding, Inc.,
as Syndication Agent, Fleet National Bank, as Administrative
Agent, and Credit Lyonnais New York Branch, as Documentation
Agent (incorporated by reference to Exhibit 10.16 of the
Company's Quarterly Report on Form 10-Q for the quarter ended
March 27, 1999).
10.17 Promissory Note, dated as of November 9, 1998, between the
Company and Anthony J. Cuti and (incorporated by reference to
Exhibit 10.17 to the Company's 1998 Annual Report on Form
10-K).
27.1* Financial Data Schedule.
* Filed herewith.
(b) Reports on Form 8-K. None.
(c) Financial Statement Schedules: None.
Schedules for which provision is made in the applicable accounting regulations
of the Commission are either not required under the related instructions, are
inapplicable or not material, or the information called for thereby is otherwise
included in the financial statements and therefore has been omitted.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: August 10, 1999
DUANE READE INC.
(Registrant)
By:/s/ John Henry
-----------------------------------
Name: John Henry
Title: Senior Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on August 10, 1999:
SIGNATURES TITLES
---------- ------
/s/ Anthony J. Cuti President and Chief Executive Officer and Director
- ------------------------ (Principal Executive Officer)
Anthony J. Cuti
/s/ John Henry Senior Vice President, Chief Financial Officer
- ------------------------ (Principal Accounting and Financial Officer)
John Henry
18
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: August 10, 1999
DRI I Inc.
By: /s/ John Henry
-----------------------------------
Name: John Henry
Title: Senior Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed on August 10, 1999 by:
SIGNATURES TITLES
---------- ------
/s/ Anthony J. Cuti President and Chief Executive Officer and Director
- ------------------------ (Principal Executive Officer)
Anthony J. Cuti
/s/ John Henry Senior Vice President, Chief Financial Officer
- ------------------------ (Principal Accounting and Financial Officer)
John Henry
19
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: August 10, 1999
DUANE READE INC.,
By: DRI I Inc. a general partner By: Duane Reade Inc., a general partner
By: /s/ John Henry By: /s/ John Henry
----------------------------- ------------------------------------
Name: John Henry Name: John Henry
Title: Senior Vice President and Title: Senior Vice President and Chief
Chief Financial Officer Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below on August 10, 1999 by the following persons in
the capacities indicated with respect to Duane Reade Inc. and DRI I Inc., the
general partners of Duane Reade, on behalf of Duane Reade (except as otherwise
indicated):
SIGNATURES TITLES
---------- ------
/s/ Anthony J. Cuti President and Chief Executive Officer and Director
- ------------------------ (Principal Executive Officer)
Anthony J. Cuti
/s/ John Henry Senior Vice President, Chief Financial Officer
- ------------------------ (Principal Accounting and Financial Officer)
John Henry
20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED BALANCE SHEET AS OF JUNE 26, 1999 AND THE RELATED
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE 13 AND 26 WEEKS ENDED JUNE 26, 1999
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000895364
<NAME> Duane Reade Inc.
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-25-1999 DEC-25-1999
<PERIOD-END> JUN-26-1999 JUN-26-1999
<CASH> 962 962
<SECURITIES> 0 0
<RECEIVABLES> 30,084 30,084
<ALLOWANCES> 0 0
<INVENTORY> 147,214 147,214
<CURRENT-ASSETS> 184,506 184,506
<PP&E> 93,046 93,046
<DEPRECIATION> (21,476) (21,476)
<TOTAL-ASSETS> 468,801 468,801
<CURRENT-LIABILITIES> 93,096 93,096
<BONDS> 335,534 335,534
0 0
0 0
<COMMON> 171 171
<OTHER-SE> 30,561 30,561
<TOTAL-LIABILITY-AND-EQUITY> 468,801 468,801
<SALES> 208,675 399,039
<TOTAL-REVENUES> 208,675 399,039
<CGS> 156,456 300,864
<TOTAL-COSTS> 156,456 300,864
<OTHER-EXPENSES> 0 0
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<INTEREST-EXPENSE> 7,170 13,950
<INCOME-PRETAX> 6,257 8,770
<INCOME-TAX> 1,190 1,667
<INCOME-CONTINUING> 5,067 5,067
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
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<NET-INCOME> 5,067 5,067
<EPS-BASIC> .30 .42
<EPS-DILUTED> .28 .39
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