10-Q 1 a2051585z10-q.txt 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED APRIL 28, 2001 OR _ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-21379 COMMUNITY DISTRIBUTORS, INC. CDI GROUP, INC. (Exact name of registrants as specified in their charters) DELAWARE 22-1833660 22-3349976 (States or other jurisdictions of (I.R.S. Employer incorporation or organization) Identification Nos.) 800 COTTONTAIL LANE FRANKLIN TOWNSHIP SOMERSET, NEW JERSEY 08873-1227 (Address of principal executive offices) (732) 748-8900 (Registrants' telephone number, including area code) Indicate by check mark whether the registrants (1) have 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 registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes X No --- --- Number of shares of Common Stock, $.01 par value per share, of Community Distributors, Inc. outstanding at June 12, 2001: 1,000 shares. Number of shares of Class A Voting Common Stock, $.00001 par value per share, of CDI Group, Inc. outstanding at June 12, 2001: 196,632 shares. Number of shares of Class B Non-Voting Common Stock, $.00001 par value per share, of CDI Group, Inc. outstanding at June 12, 2001: 187,922 shares. COMMUNITY DISTRIBUTORS, INC. CDI GROUP, INC. INDEX

2 PART I - FINANCIAL INFORMATION Item 1. Condensed Financial Statements COMMUNITY DISTRIBUTORS, INC. CONDENSED STATEMENTS OF OPERATIONS (Unaudited) (Amounts in thousands)

See accompanying notes to condensed financial statements. 3 COMMUNITY DISTRIBUTORS, INC. CONDENSED BALANCE SHEETS (UNAUDITED) (Amounts in thousands)

See accompanying notes to condensed financial statements. 4 COMMUNITY DISTRIBUTORS, INC. CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) (Amounts in thousands)

See accompanying notes to condensed financial statements. 5 COMMUNITY DISTRIBUTORS, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (Dollars in Thousands) (Unaudited) (1) BASIS OF PRESENTATION: The accompanying financial statements should be read in conjunction with the audited financial statements of Community Distributors, Inc. (the "Company"), and the notes thereto contained in the Company's annual report on Form 10-K, as amended, for its fiscal year ended July 29, 2000. The Company, a wholly owned subsidiary of CDI Group, Inc. (the "Parent"), is engaged in the operation of retail stores throughout New Jersey. These interim financial statements are unaudited but, in the opinion of management, include all adjustments, consisting only of normal recurring items, necessary to fairly present the financial position and operating results and cash flows for the interim periods. Results for interim periods are not necessarily indicative of results for the full year. The year-end balance sheet data was derived from the audited financial statements but does not include all disclosures required by generally accepted accounting principles. (2) ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (3) CONTINGENCIES: The Company is a defendant in various lawsuits arising in the ordinary course of business. In the opinion of management, the disposition of these lawsuits should not have a material impact on the Company's results of operations, financial position, and cash flows. (4) DEBT: Long-term debt includes $74,000 of 10 1/4% senior notes due in 2004 (the "Senior Notes"), which are guaranteed by the Parent. The terms of the Senior Notes include certain restrictive covenants regarding the payment of dividends, the incurrence of debt, the use of proceeds resulting from disposition of assets and certain other defined activities. Under the relevant debt agreements, in the event of a change in control, as defined, the Company is required to repurchase all such outstanding notes. The Company maintains a $20,000 revolving credit facility (the "Facility") with a bank expiring in October 2002. This Facility bears interest at either prime rate or the London Interbank Offered Rate ("LIBOR") plus 1.75% and is collateralized by the Company's eligible accounts receivable and inventory balances, as defined. Included in the Facility is a $5,000 letter of credit facility. Outstanding letters of credit, guaranteeing certain contingent purchases which are not reflected in the accompanying financial statements, totaled approximately $129 and $3,144 at April 28, 2001 and July 29, 2000, respectively. At April 28, 2001, $8,871 of the Facility was available to the Company. The Facility contains certain financial and operating covenants, including a minimum fixed charge ratio. Additionally, the Company cannot make any dividend or other distributions with respect to any share of stock other than in certain limited circumstances. 6 COMMUNITY DISTRIBUTORS, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (Dollars in Thousands) (Unaudited) (5) INVENTORY COSTING METHOD: Inventory at interim periods is valued on a last-in, first-out (LIFO) basis that is determined based on current estimates of gross profit rate, inflation rates and inventory levels, and is adjusted for the results of physical inventories. The results of the last physical inventory that was taken on January 27, 2001 did not have a material impact on the results of operations, financial position and cash flows. 7 CDI GROUP, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (Amounts in thousands)

See accompanying notes to condensed consolidated financial statements. 8 CDI GROUP, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (Amounts in thousands)

See accompanying notes to condensed consolidated financial statements. 9 CDI GROUP, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Amounts in thousands)

See accompanying notes to condensed consolidated financial statements. 10 CDI GROUP, INC. AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Thousands) (Unaudited) (1) BASIS OF PRESENTATION: The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements of CDI Group, Inc. (the "Parent") and Subsidiary (collectively referred to as the "Company"), and the notes thereto contained in the Company's annual report on Form 10-K, as amended, for its fiscal year ended July 29, 2000. The accompanying condensed consolidated financial statements include the accounts of the Parent and its wholly-owned subsidiary, Community Distributors, Inc. (the "Subsidiary"), which is engaged in the operation of retail stores throughout New Jersey. These interim consolidated financial statements are unaudited but, in the opinion of the Company, include all adjustments, consisting only of normal recurring items, necessary to fairly present the financial position, operating results, and cash flows for the interim periods. Results for interim periods are not necessarily indicative of results for the full year. The year-end balance sheet data was derived from the audited financial statements but does not include all disclosures required by generally accepted accounting principles. (2) ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (3) CONTINGENCIES: The Company is a defendant in various lawsuits arising in the ordinary course of business. In the opinion of management, the disposition of these lawsuits should not have a material impact on the Company's consolidated results of operations, financial position, and cash flows. (4) DEBT: Long-term debt includes $74,000 of 10 1/4% senior notes due in 2004 (the "Senior Notes"), which are guaranteed by the Parent. The terms of the Senior Notes include certain restrictive covenants regarding the payment of dividends, the incurrence of debt, the use of proceeds resulting from disposition of assets and certain other defined activities. Under the relevant debt agreements, in the event of a change in control, as defined, the Company is required to repurchase all such outstanding notes. The Company maintains a $20,000 revolving credit facility (the "Facility") with a bank expiring in October 2002. This Facility bears interest at either prime rate or the London Interbank Offered Rate ("LIBOR") plus 1.75% and is collateralized by the Company's eligible accounts receivable and inventory balances, as defined. Included in the Facility is a $5,000 letter of credit facility. Outstanding letters of credit, guaranteeing certain contingent purchases which are not reflected in the accompanying financial statements, totaled approximately $129 and $3,144 at April 28, 2001 and July 29, 2000, respectively. At April 28, 2001, $8,871 of the Facility was available to the Company. The Facility contains certain financial and operating covenants, including a minimum fixed charge ratio. Additionally, the Company cannot make any dividend or other distributions with respect to any share of stock other than in certain limited circumstances. 11 CDI GROUP, INC. AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Thousands) (Unaudited) In addition to the outstanding Senior Notes issued by the Subsidiary, the Parent had outstanding long-term debt, consisting of senior subordinated notes due January 31, 2005, in the amount of $24,078 and $22,424 at April 28, 2001 and July 29, 2000, respectively, which includes accrued interest. (5) INVENTORY COSTING METHOD: Inventory at interim periods is valued on a last-in, first-out (LIFO) basis that is determined based on current estimates of gross profit rate, inflation rates and inventory levels, and is adjusted for the results of physical inventories. The results of the last physical inventory that was taken on January 27, 2001 did not have a material impact on the results of operations, financial position and cash flows. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY NOTE This Quarterly Report on Form 10-Q may contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, including, but not limited to, (i) statements about possible changes in the rate of increase of pharmacy sales to participants in managed health care plans and other third-party payer plans ("Third Party Plans") as a percentage of total pharmacy sales, and its impact on profitability; (ii) the ability of the Community Distributors, Inc. (the "Company") to meet its debt service obligations and to fund anticipated capital expenditures and working capital requirements in the future; and (iii) certain other statements identified or qualified by words such as "likely", "will", "suggests", "may", "would", "could", "should", "expects", "anticipates", "estimates", "plans", "projects", "believes", or similar expressions (and variants of such words or expressions). Investors are cautioned that forward-looking statements are inherently uncertain. These forward-looking statements represent the best judgment of the Company and of CDI Group, Inc. (the "Holding Company") as of the date of this Quarterly Report on Form 10-Q, and the Company and the Holding Company caution readers not to place undue reliance on such statements. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, including, but not limited to, the risks and uncertainties described or discussed in the section "Certain Risks" in the Annual Report on Form 10-K, as amended, for its fiscal year ended July 29, 2000 for the Company and for the Holding Company. RESULTS OF OPERATIONS Except where indicated below, the following discussion related to the operations of the Company only. The Holding Company conducts no operations separate from the Company. COMPARISON OF THE THREE MONTHS ENDED APRIL 28, 2001 (THE "2001 THREE-MONTH PERIOD") WITH THE THREE MONTHS ENDED APRIL 29, 2000 (THE "2000 THREE-MONTH PERIOD"). Net sales for the 2001 Three-Month Period were $72.8 million as compared to $68.7 million for the 2000 Three-Month Period, an increase of $4.1 million, or 6.0%. This increase, which includes a 4.8% increase in same-store sales, was primarily due to (i) a 2.9% decrease in sales of non-pharmacy products from $44.6 million for the 2000 Three-Month Period to $43.3 million for the 2001 Three-Month Period and (ii) a 22.4% increase in pharmacy sales from $24.1 million for the 2000 Three-Month Period to $29.5 million for the 2001 Three-Month Period, including a 25.7% increase in pharmacy sales to Third Party Plan customers from $20.6 million for the 2000 Three-Month Period to $25.9 million for the 2001 Three-Month Period. The Company attributes the decrease in net sales of non-pharmacy products to the continuing levels of increased competition in the Company's markets and a decline in personal consumer spending during the 2001 Three-Month Period. The number of prescriptions filled (including prescriptions filled for Third Party Plan customers) was approximately 585,000 for the 2001 Three-Month Period as compared to approximately 515,000 for the 2000 Three-Month Period, an increase of approximately 70,000, or 13.6%. The number of prescriptions filled for Third Party Plan customers increased to approximately 509,000 for the 2001 Three-Month Period, as compared to 437,000 for the 2000 Three-Month Period, an increase of approximately 72,000, or 16.5%. Pharmacy sales to non-Third Party Plan customers were $3.6 million in the 2001 Three-Month Period as compared to $3.5 million in the 2000 Three-Month Period, an increase of $0.1 million, or 2.9%, a smaller increase than pharmacy sales to Third Party Plan customers due to the increased participation of the Company's customers in Third Party Plans and a decrease in the number of prescriptions filled for non-Third Party Plan customers from approximately 78,000 in the 2000 Three-Month Period to approximately 76,000 in the 2001 Three-Month Period. Gross profit was $19.0 million for the 2001 Three-Month Period, as compared to $17.7 million for the 2000 Three-Month Period, an increase of $1.3 million, or 7.3%. Gross profit as a percentage of net sales was 26.1% for the 2001 Three-Month Period as compared to 25.8% for the 2000 Three-Month Period. This 0.3% increase in gross profit as a percentage of net sales was due primarily to an improved retail pricing strategy on non-pharmacy sales and to fewer clearance markdowns incurred on seasonal merchandise sales. Gross profit on total pharmacy sales (including sales to Third Party Plan customers) was $5.5 million for the 2001 Three-Month Period as compared to $5.1 million for the 2000 Three-Month Period, an increase of $0.4 million, or 13 7.8%, which was primarily the result of the increase in sales and prescriptions filled on a same store basis, the maturing of new stores opened in the last three fiscal years, and due to the acquisition of the inventory and customer lists of seven independent pharmacies during the last three fiscal years. Gross profit on sales to Third Party Plan customers was $4.3 million for the 2001 Three-Month Period as compared to $3.8 million for the 2000 Three-Month Period, an increase of $0.5 million, or 13.2%, which was primarily the result of the increase in the number of prescriptions sold to Third Party Plan customers. Gross profit on sales of pharmacy products to non-Third Party Plan customers was $1.2 million in the 2001 Three-Month Period as compared to $1.3 million in the 2000 Three-Month Period, a decrease of $0.1 million, or 7.7%, which was primarily the result of a decrease in the number of prescriptions sold to non-Third Party Plan customers. Although management expects that sales to Third Party Plan customers as a percentage of total pharmacy sales will continue to increase, management believes that as this rate of increase slows, margins will stabilize, resulting in pharmacy gross profit growth that more closely approximates pharmacy sales growth rates. Management believes that the rate of increase in sales to Third Party Plan customers as a percentage of total pharmacy sales should slow because the current growth rate, if continued, would reach the point at which almost all members of the population who may be eligible for enrollment in Third Party Plans will be so covered. However, management believes there will always be some pharmacy customers who do not enroll in Third Party Plans. The Company is unable to estimate when this increase will slow, or stop, if at all. Because of the lower margins on prescription sales to Third Party Plan participants, management believes that the increase in Third Party Plan prescription sales as a percentage of total pharmacy sales may further negatively impact profit margin, although this may be partly or wholly offset by the increases in non-pharmacy sales that may result from increased floor traffic associated with increased pharmacy sales. There can be no assurance, however, that the increase in Third Party Plan prescription sales as a percentage of total prescription sales will continue, or that any resulting decrease in overall margins will be offset by higher margins on non-pharmacy merchandise. Gross profit on non-pharmacy sales was $13.5 million for the 2001 Three-Month Period, as compared to $12.6 million for the 2000 Three-Month Period, an increase of $0.9 million, or 7.1%. Gross profit as a percentage of non-pharmacy sales was 31.2% for the 2001 Three-Month Period as compared to 28.3% for the 2000 Three-Month Period, an increase of 2.9%. Gross profit as a percentage of non-pharmacy sales increased primarily due to an improved retail pricing strategy and to fewer clearance markdowns incurred on seasonal merchandise sales. Selling, general and administrative expense as a percentage of net sales was 23.6% for the 2001 Three-Month Period, as compared to 23.4% for the 2000 Three-Month Period, an increase of 0.2%. This increase in selling, general and administrative expenses as a percentage of net sales is primarily due to higher costs for pharmacy personnel and related employee benefits, higher occupancy costs resulting from colder and wetter weather, and higher professional services costs related to computer software evaluation and implementation. Depreciation and amortization expense was $1.5 million for the 2001 Three-Month Period as compared to $1.4 million for the 2000 Three-Month Period, an increase of $0.1 million, or 7.1%. Other income, net was $0.3 million for the 2001 Three-Month Period as compared to $0.1 million for the 2000 Three-Month Period, an increase of $0.2 million, resulting from the receipt of $0.2 million as a member of the class in the Brand Name Drug class action litigation. The Company's net interest expense was $2.2 million in the 2001 Three-Month Period as compared to $2.1 million in the 2000 Three-Month Period, an increase of $0.1 million resulting from the higher level of outstanding balances on the Company's revolving line of credit. Non-cash interest expense on the Holding Company's outstanding subordinated debt was $0.5 in the 2001 and 2000 Three-Month Periods. The Company's income taxes benefit was $0.4 million for the 2001 Three-Month Period as compared to $1.3 million for the 2000 Three-Month Period, a decrease of $0.9 million. The Holding Company experienced a benefit from income taxes of $0.2 million in the 2001 and 2000 Three-Month Periods, related to the interest expense incurred on the outstanding subordinated debt. The Company's effective tax rate is consistently higher than the statutory tax rates, and varies from period to period, due to the amortization of goodwill and of beneficial leaseholds, both of which are not deductible when calculating taxable income. 14 The Company's net loss for the 2001 Three-Month Period was $1.2 million as compared to a net loss of $0.5 million in the 2000 Three-Month Period, an increase in the net loss of $0.7 million, which is primarily due to higher selling, general and administrative expenses during the 2001 Three-Month Period, a lower income tax benefit, and higher net interest expense, as previously discussed. The Holding Company incurred a net loss of $0.4 million for both the 2001 and 2000 Three-Month Periods, principally as a result of the accrued interest on the subordinated debt. COMPARISON OF THE NINE MONTHS ENDED APRIL 28, 2001 (THE "2001 NINE-MONTH PERIOD") WITH THE NINE MONTHS ENDED APRIL 29, 2000 (THE "2000 NINE-MONTH PERIOD"). Net sales for the 2001 Nine-Month Period were $229.0 million as compared to $216.5 million for the 2000 Nine-Month Period, an increase of $12.5 million, or 5.8%. This increase, which includes a 2.3% increase in same-store sales, was primarily due to (i) a 2.5% decrease in sales of non-pharmacy products from $147.5 million for the 2000 Nine-Month Period to $143.8 million for the 2001 Nine-Month Period, and (ii) a 23.5% increase in pharmacy sales from $69.0 million for the 2000 Nine-Month Period to $85.2 million for the 2001 Nine-Month Period, including a 28.4% increase in pharmacy sales to Third Party Plan customers from $57.8 million for the 2000 Nine-Month Period to $74.2 million for the 2001 Nine-Month Period. The Company attributes the decrease in net sales of non-pharmacy products to the continuing levels of increased competition in the Company's markets and a decline in personal consumer spending during the 2001 Nine-Month Period. The number of prescriptions filled (including prescriptions filled for Third Party Plan customers) was approximately 1,694,000 for the 2001 Nine-Month Period as compared to approximately 1,506,000 for the 2000 Nine-Month Period, an increase of approximately 188,000, or 12.5%. The number of prescriptions filled for Third Party Plan customers increased to approximately 1,459,000 for the 2001 Nine-Month Period, as compared to 1,256,000 for the 2000 Nine-Month Period, an increase of approximately 203,000, or 16.2%. Pharmacy sales to non-Third Party Plan customers were $11.0 million in the 2001 Nine-Month Period as compared to $11.2 million in the 2000 Nine-Month Period, a decrease of $0.2 million, or 1.8%, primarily as the result of increased participation of the Company's customers in Third Party Plans and a decrease in the number of prescriptions filled for non-Third Party Plan customers from approximately 250,000 in the 2000 Nine-Month Period to approximately 235,000 in the 2001 Nine-Month Period. Gross profit was $58.8 million for the 2001 Nine-Month Period, as compared to $59.6 million for the 2000 Nine-Month Period, a decrease of $0.8 million, or 1.3%. Gross profit as a percentage of net sales was 25.7% for the 2001 Nine-Month Period as compared to 27.5% for the 2000 Nine-Month Period. This 1.8% decrease in gross profit as a percentage of net sales was due primarily to pharmacy sales, which generate lower margins than sales of non-pharmacy merchandise, representing a higher percentage of total sales in the 2001 Nine-Month Period as compared to the 2000 Nine-Month Period, a decrease in the margin on pharmacy merchandise due to the new purchasing agreement with Cardinal Health, Inc. that was entered into during the second half of the 2000 fiscal year and continues after the end of fiscal 2001, and a decline in the margin on non-pharmacy merchandise due to continuing levels of increased competition in the Company's market and increased markdowns on seasonal merchandise during the first six months of this fiscal year. Gross profit on total pharmacy sales (including sales to Third Party Plan customers) was $16.2 million for the 2001 Nine-Month Period as compared to $14.3 million for the 2000 Nine-Month Period, an increase of $1.9 million, or 13.3%, which was primarily the result of the increase in sales and prescriptions filled on a same store basis, the maturing of new stores opened in the last three fiscal years, and due to the acquisition of the inventory and customer lists of seven independent pharmacies during the last three fiscal years. Gross profit on sales to Third Party Plan customers was $12.2 million for the 2001 Nine-Month Period as compared to $10.7 million for the 2000 Nine-Month Period, an increase of $1.5 million, or 14.0%, which was primarily the result of the increase in the number of prescriptions sold to Third Party Plan customers. Gross profit on sales of pharmacy products to non-Third Party Plan customers was $4.0 million in the 2001 Nine-Month Period as compared to $3.6 million in the 2000 Nine-Month Period, an increase of $0.4 million, or 11.1%, which was primarily the result of improved pricing on sales of prescriptions to non-Third Party Plan customers. Although management expects that sales to Third Party Plan customers as a percentage of total pharmacy sales will continue to increase, management believes that as this rate of increase slows, margins will stabilize, resulting in pharmacy gross profit growth that more closely approximates pharmacy sales growth rates. Management believes that the rate of increase in sales to Third Party Plan customers as a percentage of total pharmacy sales should slow because the current growth rate, if continued, would reach the point at which almost all members of the population who may be eligible for enrollment in Third Party Plans will be so covered. However, management believes there will 15 always be some pharmacy customers who do not enroll in Third Party Plans. The Company is unable to estimate when this increase will slow, or stop, if at all. Because of the lower margins on prescription sales to Third Party Plan participants, management believes that the increase in Third Party Plan prescription sales as a percentage of total pharmacy sales may further negatively impact profit margin, although this may be partly or wholly offset by the increases in non-pharmacy sales that may result from increased floor traffic associated with increased pharmacy sales. There can be no assurance, however, that the increase in Third Party Plan prescription sales as a percentage of total prescription sales will continue, or that any resulting decrease in overall margins will be offset by higher margins on non-pharmacy merchandise. Gross profit on non-pharmacy sales was $42.6 million for the 2001 Nine-Month Period, as compared to $45.3 million for the 2000 Nine-Month Period, a decrease of $2.7 million, or 6.0%. Gross profit as a percentage of non-pharmacy sales was 29.6% for the 2001 Nine-Month Period as compared to 30.7% for the 2000 Nine-Month Period, a decrease of 1.1%. Gross profit as a percentage of non-pharmacy sales decreased due to greater competition in the Company's market, a slowdown in consumer spending that resulted in a decrease in sales of non-pharmacy merchandise and an increase in the amount of markdowns incurred on seasonal merchandise during the first six months of this fiscal year. Selling, general and administrative expense as a percentage of net sales was 23.2% for the 2001 Nine-Month Period, as compared to 22.6% for the 2000 Nine-Month Period, an increase of 0.6%. This increase in selling, general and administrative expenses as a percentage of net sales is primarily due to higher costs for pharmacy personnel and related employee benefits, higher occupancy costs resulting from colder and wetter weather, and higher professional services costs related to computer software evaluation and implementation. Depreciation and amortization expense was $4.6 million for the 2001 Nine-Month Periods and was $4.4 million for the 2000 Nine-Month Period, an increase of $0.2 million, or 4.5%, primarily resulting from increased depreciation expense related to the higher rate of new stores opened during the current and prior two fiscal years. Other income, net was $0.8 million for the 2001 Nine-Month Period as compared to $0.3 million for the 2000 Nine-Month Period, an increase of $0.5 million, resulting from the receipt of $0.6 million as a member of the class in the Brand Name Drug class action litigation. The Company's net interest expense was $6.5 million in the 2001 Nine-Month Period as compared to $6.1 million in the 2000 Nine-Month Period, an increase of $0.4 million resulting from the higher level of outstanding balances on the Company's revolving line of credit. Non-cash interest expense on the Holding Company's outstanding subordinated debt was $1.7 million in the 2001 Nine-Month Period as compared to $1.5 million for 2000 Nine-Month Period, an increase of $0.2 million resulting from the compounding of interest on the subordinated debt. The Company's benefit for income taxes was $1.2 million for the 2001 Nine-Month Period as compared to a tax provision of $0.1 million for the 2000 Nine-Month Period. The Holding Company experienced a benefit from income taxes of $0.6 million in the 2001 Nine-Month Period as compared to $0.5 million in the 2000 Nine-Month Period, related to the interest expense incurred on the outstanding subordinated debt. The Company's effective tax rate is consistently higher than the statutory tax rates, and varies from period to period, due to the amortization of goodwill and of beneficial leaseholds, both of which are not deductible when calculating taxable income. The Company's net loss for the 2001 Nine-Month Period was $3.4 million as compared to a break-even result in the 2000 Nine-Month Period, an increase in the net loss of $3.4 million, which is primarily due to lower gross profit and higher selling, general and administrative expenses during the 2001 Nine-Month Period as previously discussed. The Holding Company incurred a net loss of $1.1 million for the 2001 Nine-Month Period as compared to $0.9 million in the 2000 Nine-Month Period, principally as a result of the accrued interest on the subordinated debt. LIQUIDITY AND CAPITAL RESOURCES COMPARISON OF THE THREE MONTHS ENDED APRIL 28, 2001 (THE "2001 THREE-MONTH PERIOD") WITH THE THREE MONTHS ENDED APRIL 29, 2000 (THE "2000 THREE-MONTH PERIOD"). 16 During the 2001 Three-Month Period, cash used in operations was $4.3 million as compared to $12.7 million for the 2000 Three-Month Period, a decrease of $8.4 million. This decrease in cash used in operations is primarily the result of a reduction of inventory during the 2001 Three-Month Period as compared to the 2000 Three-Month Period. Cash used in investing activities was $0.1 million during the 2001 Three-Month Period as compared to $1.0 million during the 2000 Three-Month Period, an increase of $0.9 million, which was primarily the result of one store opened during the 2000 Three-Month Period while no stores were opened during the 2001 Three-Month Period. Cash provided by financing activities was $4.3 million during the 2001 Three-Month Period as compared to $13.8 million during the 2000 Three-Month Period. Cash provided by financing activities during the 2001 Three-Month Period was from net borrowings on the Facility of $2.7 million and from a cash overdraft of $1.6 million while the cash provided by financing activities during the 2000 Three-Month Period was from net borrowings on the Facility of $10.4 million and from a cash overdraft of $3.4 million. COMPARISON OF THE NINE MONTHS ENDED APRIL 28, 2001 (THE "2001 NINE-MONTH PERIOD") WITH THE NINE MONTHS ENDED APRIL 29, 2000 (THE "2000 NINE-MONTH PERIOD"). During the 2001 Nine-Month Period, cash used in operations was $9.3 million as compared to $9.5 million for the 2000 Nine-Month Period, a decrease in cash used in operations of $0.2 million. The decrease in cash used in operations is primarily the result of the company's net loss of $3.4 million, increase in accounts receivable of $1.7 million and reduction in supplier advances received of $2.0 million, offset by a decrease in inventory of $6.9 million. Cash used in investing activities was $2.1 million during the 2001 Nine-Month Period as compared to $2.9 million during the 2000 Nine-Month Period, a decrease of $0.8 million resulting from opening of one less store during the 2001 Nine-Month Period as compared to the 2000 Nine-Month Period. Cash provided by financing activities was $11.3 million during the 2001 Nine-Month Period as compared to $12.6 million during the 2000 Nine-Month Period. Cash provided by financing activities during the 2001 Nine-Month Period was from net borrowings on the Facility of $9.7 million and by a cash overdraft of $1.6 million while the cash provided by financing activities during the 2000 Nine-Month Period was from net borrowings on the Facility of $9.2 million and by a cash overdraft of $3.4 million. The Company believes that, based on anticipated levels of operations, it will be able to meet its debt service obligations, including interest payments on the Senior Notes when due, and to fund anticipated capital expenditures and working capital requirements, and to comply with the terms of its debt agreements during the remainder of its fiscal years ended July 28, 2001 and July 27, 2002. The Company's ability to make scheduled payments of principal or interest thereon, or to refinance its indebtedness will depend on future operating performance and cash flow, which are subject to prevailing economic conditions, prevailing interest rates and financial, competitive, business and other factors beyond its control. The Company is considering from time to time repurchases of its Senior Notes. Any repurchases of Senior Notes may be made on the open market or in privately negotiated transactions. The Company plans to fund such purchases from its working capital. The Company expects that substantially all of its borrowings under the Facility will bear interest at floating rates; therefore, the Company's financial condition will be affected by any changes in prevailing rates. CERTAIN RISKS The Company is subject to certain risks, including: "FREEDOM OF CHOICE" AND "ANY WILLING PROVIDER" LEGISLATION. In July 1994, New Jersey adopted "Freedom of Choice, legislation that required Third-Party Plans to allow their customers to purchase prescription drugs from the provider of their choice as long as the provider meets uniformly established requirements, and "Any Willing Provider" legislation that requires each Third-Party Plan that has entered into an agreement with a prescription provider to permit other prescription providers to enter into similar agreements. If this legislation were repealed, larger national drugstore chains could enter into exclusive contracts with Third-Party Plans, which could reduce the Company's sales of prescriptions and potentially non-prescription items as well. In addition, since none of the states surrounding New Jersey (other than Delaware) has enacted similar legislation, the Company may be at a disadvantage if it chooses to expand outside of New Jersey. GOVERNMENT REGULATION AND REIMBURSEMENT PROGRAMS. The Company is subject to numerous federal, state, and local licensing and registration regulations with respect to, among other things, its pharmacy operations. Violations of any such regulations could result in various penalties, including suspension or revocation of the Company's licenses or 17 registrations or monetary fines, which could have a material adverse effect on the Company's financial condition and results of operations. Federal and New Jersey law requires the Company's pharmacists to offer free counseling to customers about their medication. In addition, the Company's pharmacists are required to conduct a prospective drug review before any new prescriptions are dispensed, and may conduct a similar review prior to refilling any prescriptions. New Jersey also regulates the dispensing of over-the-counter controlled dangerous substances. These requirements could result in increased costs to the Company. MEDICAID AND MEDICARE. A portion of the Company's services is reimbursed by government-sponsored programs such as Medicaid and Medicare, with the remainder being reimbursed by individual patients or Third-Party Plans. If the Company were to fail to comply with reimbursement regulations, or if such reimbursement programs were modified, the Company's business could be adversely affected. The Company is also subject to laws prohibiting the submission of false or fraudulent claims and certain financial relationships between health care providers that are intended to induce the referral of patients, or the recommendations of particular items or services. Violation of these laws could result in loss of licensure, civil and criminal penalties, and exclusion from federal health care programs. EMPLOYMENT REGULATION. The Company is subject to employment law governing minimum wage requirements, overtime and working conditions. An increase in the minimum wage rate, employee benefit costs, or other costs associated with employees could adversely affect the Company. POTENTIAL GROWTH AND EXPANSION. The Company has grown in recent years by opening new stores, remodeling and relocating existing stores and refining the product mix in existing stores. The ability of the Company to continue to grow in the future will depend on factors including existing and emerging competition, the availability of working capital to support growth, the Company's ability to manage costs and maintain margins in the face of pricing pressures, and the ability to recruit and train qualified personnel. New stores that the Company opens may not be profitable. RESTRICTIONS ON THE COMPANY. Both the Indenture governing the Senior Notes and the Facility impose on the Company certain requirements and restrictions, such as a requirement that the Company maintain certain financial ratios and satisfy certain financial tests, limitation on capital expenditures, and restrictions on the ability of the Company to incur debt, pay dividends, or take certain other corporate actions. These limitations may restrict the Company's ability to pursue its business strategies. DEBT SERVICE. The Company's ability to make scheduled payments of principal or interest thereon, or to refinance its indebtedness will depend on future operating performance and cash flow, which are subject to prevailing economic conditions, prevailing interest rates and financial, competitive, business and other factors beyond its control. The Company expects that substantially all of its borrowings under its credit facility will bear interest at floating rates; therefore, the Company's financial condition will be affected by any changes in prevailing rates. COMPETITION. The industries in which the Company operates are highly competitive. TRADE NAMES, SERVICE MARKS AND TRADEMARKS. The Company uses various trade names, service marks and trademarks including "Drug Fair" and "Cost Cutters" in the conduct of its business. A third party registered the service mark "Cost Cutters", but does not currently operate in the Company's market areas. If such third party commences operations in the Company's geographic market areas or licenses the use of the name to a third party, the Company could be required to stop using the name "Cost Cutters". In addition, any of the Company's other trade names, service marks or trademarks could be challenged or invalidated in the future. ECONOMIC CONDITIONS AND REGIONAL CONCENTRATION. All of the Company's stores are located in northern and central New Jersey. As a result, the Company is sensitive to economic, competitive, and regulatory condition in that region. LEASE RENEWALS ON THE COMPANY'S STORES. All of the Company's stores are leased. Although the Company has historically been successful in renewing its most important store leases when they have expired, there can be no assurance that the Company will continue to be able to do so. 18 LEVERAGE. In connection with the Company's issuance of the Senior Notes, the Company incurred a significant amount of indebtedness and, as a result, the Company is highly leveraged. The Company is permitted to incur substantial additional indebtedness in the future, subject to certain limitations contained in the Indenture governing the Senior Notes. CONTROLLING STOCKHOLDERS. The Holding Company owns all of the outstanding capital stock of the Company. The existing stockholders of the Holding Company, which include the Company's President and Chief Executive Officer, certain entities affiliated with the other directors of the Company, and other officers and employees of the Company, own all of the outstanding common stock of the Holding Company. These stockholders have the power to appoint new management and approve any action requiring the approval of the Company's stockholders, including adopting amendments to the Company's charter and approving mergers or sales of substantially all of the Company's assets. DEPENDENCE ON KEY PERSONNEL. The success of the Company depends upon the efforts, abilities and expertise of its Chief Executive Officer and other key employees. The loss of the services of any key employees could have a material adverse effect on the Company's financial condition and results of operations. 19 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Neither the Company nor the Holding Company engages in trading market risk sensitive instruments or purchases hedging instruments or "other than trading" instruments that are likely to expose the Company or the Holding Company to market risk, whether interest rate, foreign currency exchange, commodity price or equity price risk. Neither the Company nor the Holding Company has purchased options or entered into swaps or forward or futures contracts. The ability of the Company and the Holding Company (as guarantor) to make periodic interest payments on the Senior Notes, at a fixed rate of 10 1/4%, is not directly affected by fluctuations in the market. The Company's primary market risk exposure is that of interest rate risk on borrowings under the Facility, which are subject to interest rates based either on the lender's prime rate or London Interbank Offered Rate ("LIBOR"), and a change in the applicable interest rate would affect the rate at which the Company could borrow funds. 20 PART II - - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None. (b) Reports on Form 8-K Neither the Company nor the Holding Company filed any reports on Form 8-K during the three months ended April 28, 2001. 21 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrants duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized. COMMUNITY DISTRIBUTORS, INC. June 12, 2001 By: /s/ Todd H. Pluymers ------------------------------------- Todd H. Pluymers, Chief Financial Officer (AUTHORIZED OFFICER AND PRINCIPAL FINANCE AND ACCOUNTING OFFICER) CDI GROUP, INC. June 12, 2001 By: /s/ Todd H. Pluymers ------------------------------------- Todd H. Pluymers, Chief Financial Officer (AUTHORIZED OFFICER AND PRINCIPAL FINANCE AND ACCOUNTING OFFICER) 22

COMMUNITY DISTRIBUTORS INC 10-Q