10-Q 1 l88981ae10-q.txt DAIRY MART CONVENIENCE STORES, INC. 10-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MAY 5, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-12497 DAIRY MART CONVENIENCE STORES, INC. (Exact name of registrant as specified in its charter) DELAWARE 04-2497894 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) ONE DAIRY MART WAY, 300 EXECUTIVE PARKWAY WEST, HUDSON, OHIO 44236 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (330) 342-6600 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 |_| APPLICABLE ONLY TO CORPORATE ISSUERS: SHARES OF COMMON STOCK OUTSTANDING JUNE 6, 2001 - 5,004,592 2 PART I. FINANCIAL INFORMATION DAIRY MART CONVENIENCE STORES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The accompanying notes are an integral part of these financial statements. 2 3 DAIRY MART CONVENIENCE STORES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS)

The accompanying notes are an integral part of these financial statements. 3 4 DAIRY MART CONVENIENCE STORES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)

The accompanying notes are an integral part of these financial statements. 4 5 DAIRY MART CONVENIENCE STORES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 5, 2001 (UNAUDITED) The unaudited consolidated financial statements for Dairy Mart Convenience Stores, Inc. and Subsidiaries ("Dairy Mart" or the "Company") have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information presented not misleading. The information furnished reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented, and which are of a normal, recurring nature. These financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company's Form 10-K, filed with the Securities and Exchange Commission for the fiscal year ended February 3, 2001. 1. ACCOUNTING POLICIES The financial statements included herein have been prepared in accordance with the accounting policies described in Note 1 to the February 3, 2001 audited consolidated financial statements included in the Company's Form 10-K. Certain prior year amounts have been reclassified to conform to the presentation used for the current year. 2. CHANGES IN CAPITAL ACCOUNTS An analysis of the capital stock accounts for the first fiscal quarter ended May 5, 2001 follows:

As of May 5, 2001, there were 2,057,178 shares of Common Stock held as treasury stock at an aggregate cost of $15,004,847, leaving 5,004,593 shares outstanding. 3. EARNINGS PER SHARE Earnings per share is based on the weighted average number of shares outstanding, including the dilutive effect of stock options, if appropriate, during each period. The weighted average number of shares used in the calculation of basic earnings per share was 5,002,882 and 4,895,594 for the first fiscal quarter ended May 5, 2001 and April 29, 2000, respectively. The weighted average number of shares used in the calculation of diluted earnings per share was 5,002,882 and 4,895,594 for the first fiscal quarter ended May 5, 2001 and April 29, 2000, respectively. 5 6 4. SEASONALITY The results of operations for the first fiscal quarter ended May 5, 2001 are not necessarily indicative of results to be expected for the full fiscal year. The convenience store industry in Dairy Mart's marketing areas experiences a higher percentage of revenues and gross profits during the summer months than during the winter months. Historically, Dairy Mart has achieved more favorable financial results in its second and third fiscal quarters, as compared to its first and fourth fiscal quarters. 5. IMPLEMENTATION OF NEW ACCOUNTING STANDARDS On December 31, 200, the Company adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment to FASB Statement No. 133." These statements, which establish the accounting and financial reporting requirements for derivative instruments, require companies to recognize derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. The adoption of this standard did not have a material impact on the Company's consolidated financial statements. 6. SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION (UNAUDITED) Dairy Mart's payment obligations under the Series A and Series B Senior Subordinated Notes are guaranteed by certain of Dairy Mart's subsidiaries ("Guarantor Subsidiaries"). The Notes are fully and unconditionally guaranteed on an unsecured, senior subordinated, joint and several basis by each of the Guarantor Subsidiaries. The following supplemental financial information sets forth, on a consolidating basis, statements of operations, balance sheets and cash flow information for Dairy Mart Convenience Stores, Inc. ("Parent Company"), for the Guarantor Subsidiaries and for Financial Opportunities, Inc. ("FINOP"), Dairy Mart's non-guarantor subsidiary. Separate complete financial statements of the respective Guarantor Subsidiaries would not provide additional information which would be useful in assessing the financial condition of the Guarantor Subsidiaries, and are omitted accordingly. Investments in subsidiaries are accounted for by the Parent Company on the equity method for purposes of the supplemental consolidating presentation. Earnings of the subsidiaries are, therefore, reflected in the Parent Company's investment accounts and earnings. The principal elimination entries eliminate the Parent Company's investments in subsidiaries and inter-company balances and transactions. 6 7 SUPPLEMENTAL CONSOLIDATING STATEMENT OF OPERATIONS FOR THE FIRST FISCAL QUARTER ENDED MAY 5, 2001 (UNAUDITED) (IN THOUSANDS)

7 8 SUPPLEMENTAL CONSOLIDATING BALANCE SHEETS AS OF MAY 5, 2001 (UNAUDITED) (IN THOUSANDS)

8 9 SUPPLEMENTAL CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE FIRST FISCAL QUARTER ENDED MAY 5, 2001 (UNAUDITED) (IN THOUSANDS)

9 10 SUPPLEMENTAL CONSOLIDATING STATEMENT OF OPERATIONS FOR THE FIRST FISCAL QUARTER ENDED APRIL 29, 2000 (UNAUDITED) (IN THOUSANDS)

10 11 SUPPLEMENTAL CONSOLIDATING BALANCE SHEETS AS OF FEBRUARY 3, 2001 (UNAUDITED) (IN THOUSANDS)

11 12 SUPPLEMENTAL CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE FIRST FISCAL QUARTER ENDED APRIL 29, 2000 (UNAUDITED) (IN THOUSANDS)

12 13 DAIRY MART CONVENIENCE STORES, INC. AND SUBSIDIARIES ================================================================================ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS: FIRST QUARTER FISCAL YEAR 2002 RESULTS COMPARED TO FIRST QUARTER FISCAL YEAR 2001 RESULTS

13 14 REVENUES Revenues for the first fiscal quarter decreased $11.2 million compared to the same period for the prior fiscal year. A summary of revenues by functional area is shown below:

Convenience store revenues decreased $5.1 million, or 5.7%, for the first fiscal quarter compared to the same period for the prior fiscal year. This decrease was primarily due to the sale or closing of 29 underperforming stores, a 0.2% decrease in comparable convenience store merchandise sales, and the closing of 11 branded quick serve restaurant operations. Although the reduction in stores had a negative impact on revenues, it did not have a material adverse impact on results of operations, since the majority of stores closed or sold had been operating at a loss. Gasoline revenues decreased $6.1 million for the first fiscal quarter compared to the same period for the prior fiscal year. Gasoline revenues decreased as a result of a 7.4 million gallon decrease in the number of gallons sold in the first quarter as compared to last year, partially offset by an increase in the average selling price of gasoline of 7.9 cents per gallon compared to the same period for the prior fiscal year. Gasoline gallons decreased as a result of unfavorable weather conditions during the quarter as compared to last year, the general downturn in the U.S. economy and the higher retail price of gasoline. GROSS PROFITS Gross profits decreased $1.7 million for the first fiscal quarter compared to the same period for the prior fiscal year. A summary of gross profits by functional area is shown below:

Convenience store gross profits decreased $2.0 million, or 6.6%, for the first fiscal quarter compared to the same period for the prior fiscal year. This decrease was primarily due to the decrease in convenience store revenues as described above. Convenience store gross profit margins were relatively unchanged. Gasoline gross profits increased $0.3 million for the first fiscal quarter compared to the same period for the prior fiscal year. This increase was primarily attributable to an increase in the average gasoline gross profit of 1.8 cents per gallon compared to the same period for the prior fiscal year. The increase in average gasoline gross profit was partially offset by the decrease in gasoline gallons sold, as discussed above. 14 15 OPERATING AND ADMINISTRATIVE EXPENSES Operating and administrative expenses decreased $0.3 million for the first fiscal quarter compared to the same period for the prior fiscal year. A summary of operating and administrative expenses is shown below:

Operating expenses decreased $1.0 million for the first fiscal quarter compared to the same period for the prior fiscal year. This decrease was primarily due to the sale or closing of 29 underperforming stores, partially offset by an increase in depreciation and occupancy expenses. General and administrative expenses increased $0.7 million for the first fiscal quarter compared to the same period for the prior fiscal year. This increase was primarily due to severance and related costs associated with a reduction in corporate headquarter positions, expenses related to the acquisition of the Company by DM Acquisition Corp., and an increase in insurance costs, partially offset by reductions in wages and store closing costs. INTEREST EXPENSE, INFLATION AND TAXES Interest expense increased $0.8 million for the first fiscal quarter compared to the same period for the prior fiscal year. The increase for the first fiscal quarter as compared to the same period for the prior fiscal year was primarily attributable to an increase in the average outstanding balance of the revolving credit facility and an increase in bank fees, partially offset by a decrease in interest rates. Inflation did not have a material effect on the Company's revenues, gross profit, and operating and administrative expenses in the first quarters of fiscal 2002 and 2001, other than the increase in the selling price and cost of gasoline, as identified above. The Company did not record a tax benefit in the current year first quarter because of the uncertainty as to its ability to utilize current operating losses to offset potential future income tax liabilities. The Company recorded a tax benefit at the effective rate of 46.0% for the first quarter of fiscal year 2001. The effective rate was higher than the statutory rate because of the non-deductible amortization of acquired assets. 15 16 LIQUIDITY AND CAPITAL RESOURCES The Company has a $30.0 million senior revolving credit facility (the "Credit Facility"). The Company can issue up to $15.0 million of letters of credit under the facility. The facility is due and payable on September 15, 2002. As of May 5, 2001, the Company had $24.4 million in outstanding revolving credit loans and had $4.4 million in outstanding letters of credit under the facility. As of May 5, 2001, the Company was in compliance with the terms of the Credit Facility, including required financial ratio covenants. As discussed in Item 1. Business--General of the Company's Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended February 3, 2001, the Company has implemented the previously disclosed Business Restructuring Plan and Business Segmentation Plan. The Company is also seeking alternative sources of financing to repay its outstanding obligations under the Credit Facility. These sources include, for example, the execution of long-term vendor supply agreements that would involve the receipt by the Company of monies due upon the execution of such agreements. During the first quarter of fiscal year 2002, the Company executed a long-term vendor supply agreement and received $8.7 million in cash in connection therewith. These proceeds were used to reduce outstanding borrowings under the Credit Facility. The Company is also seeking to consummate the previously disclosed merger that would result in the sale of the Company in its entirety and a refinancing of the Credit Facility and its senior subordinated notes. However, because the merger agreement is subject to certain conditions, including completion of necessary financing arrangements and stockholder approval, no assurances can be given that the merger will be consummated. Currently, the Company has not yet mailed its definitive Proxy Statement to its stockholders nor has it mailed its Exchange Offer to its noteholders. Furthermore, DM Acquisition Corp. has not completed definitive financing documents with respect to those entities that are providing financing for the transaction. If the merger is not completed and the Company is unable to successfully implement the Business Restructuring Plan, the Business Segmentation Plan and otherwise realize an improvement in operating results during fiscal year 2002, the Company may not be in compliance with certain amended financial ratio covenants as required by the Credit Facility. If the Company is not in compliance with these certain financial ratio covenant requirements in the future and the Credit Facility lenders do not waive these requirements or otherwise amend the Credit Facility, the Company would be in default and the Credit Facility lenders could cause repayment of the Credit Facility to be accelerated in which case amounts outstanding under the Credit Facility would become immediately due and payable. In addition, certain other indebtedness and obligations of the Company, including the senior subordinated notes, certain mortgage notes payable and certain operating leases, material to the Company's operations, would become immediately due and payable upon an acceleration of the Company's Credit Facility. The Company is not currently in default under any of these arrangements. Management anticipates that the cash flow from operations, the proceeds from the sale of certain assets and the execution of long-term vendor supply agreements will provide the Company with adequate liquidity to fund operations and meet its ongoing debt service requirements. At May 5, 2001, the Company had $87.7 million, net of original issue discount of $0.7 million, outstanding in 10.25% senior subordinated notes due March 15, 2004. CASH FLOW FROM OPERATING ACTIVITIES During the current year's first quarter, net cash provided by operating activities increased $4.1 million compared to the same period of the prior year. This increase was primarily a result of the increase in other assets and liabilities, net, due to the receipt of $8.7 million upon the execution of a long-term vendor supply agreement, partially offset by decreased earnings of the Company and unfavorable changes in working capital accounts in relation to the first quarter of the prior fiscal year. CASH USED BY INVESTING ACTIVITIES Net cash used in investing activities decreased $6.2 million in the current year first quarter compared to the prior year primarily as a result of decreased purchases of property and equipment and short-term investments partially offset by lower proceeds from the sale of property and equipment in the current year first quarter compared to the prior year first quarter. 16 17 CASH PROVIDED BY FINANCING ACTIVITIES Net cash used by financing activities was $.9 million for the current year first quarter compared to $6.0 million net cash provided by financing activities for the same period of the prior year. During the current year first quarter the Company repaid $.9 million of long-term obligations compared with borrowings of $6.1 million on its revolving credit facility during the first quarter of the prior year. CAPITAL EXPENDITURES The Company's capital expenditures were $7.0 million lower in the first quarter of fiscal year 2002 than in the first quarter of the previous year. In the first quarter of fiscal year 2001, the Company purchased $8.5 million of property and equipment, primarily for the construction of nine new stores that opened in fiscal year 2001. The Company has suspended its new store expansion program and the related capital expenditures pending its ability to consummate the merger. Management estimates that capital expenditures will be required in the range of $2.0 million to $.30 million annually to replace existing property, plant and equipment that becomes obsolete and worn out in the ordinary course of business. ENVIRONMENTAL RESPONSIBILITY The Company's financial statements are prepared in conformity with the American Institute of Certified Public Accountants' Statement of Position ("SOP") No. 96-1, "Environmental Remediation Liabilities," which provides guidance on specific accounting issues that are present in the recognition, measurement and disclosure of environmental remediation liabilities. The Company accrues its estimate of all costs to be incurred for assessment and remediation with respect to release of regulated substances from existing and previously operated retail gasoline facilities. SIGNIFICANT EVENTS As previously disclosed, on March 15, 2001, in connection with the Company's review of its strategic alternatives, including a possible sale, the Company executed a merger agreement (the "Merger Agreement") pursuant to which DM Acquisition Corp. agreed to acquire the Company in a cash merger for $4.50 per share. DM Acquisition Corp. is controlled by Robert B. Stein, Jr., the Chairman, President and Chief Executive Officer of the Company. The Merger Agreement provides that DM Acquisition Corp. will be merged with and into the Company and that each share of the Company's Common Stock outstanding immediately prior to the merger, other than those owned by Mr. Stein and his affiliates, will be converted into the right to receive $4.50 per share in cash. The Company's board of directors, based on the unanimous recommendation of a special committee of independent directors, has approved the transaction and recommended that the Company's stockholders approve the transaction. In connection with the merger, the Company will solicit its senior subordinated noteholders to exchange their subordinated notes of the Company and receive, for each $10,000 in principal amount of the old notes, $3,870 in principal amount of new notes of the Company, $6,191.30 in cash and a warrant to purchase Common Stock of the Company that will not become exercisable until after the merger is completed. The Company has entered into an exchange and voting agreement pursuant to which holders of approximately 70% of the senior subordinated notes have agreed to participate in the exchange. The Merger Agreement is subject to customary conditions, including completion of necessary financing arrangements and approval of holders of a majority (excluding those shares held by persons who will have an interest in the buyout entity) of the shares of the Company's Common Stock voting at a special meeting. If the merger is completed, the Company will no longer be a public company. There can be no assurance, however, that the Company or DM Acquisition Corp. will be able to complete the merger. In addition, the Company has reinitiated and modified a previously announced comprehensive program to improve the Company's profitability and reduce debt (the "Business Segmentation Plan"). Under the Business Segmentation Plan, the Company will attempt to sell or otherwise close approximately 200 stores that do not meet internal profitability criteria, reduce corporate and field overhead and apply proceeds from the sale of stores to reduce outstanding borrowings. However, as a result of experiencing further losses from operations, the Company has modified and accelerated the portion of the 17 18 Business Segmentation Plan that relates to a reduction in corporate overhead. Under this modification, the Company has commenced a business restructuring plan (the "Business Restructuring Plan") pursuant to which certain general and administrative overhead costs have been reduced in advance of those cost reductions which can only be achieved after the underperforming stores are sold or closed. Accordingly, in the first quarter of fiscal year 2002, approximately 30 executive, managerial and administrative positions were eliminated. These staff reductions and associated costs are expected to result in savings of approximately $3.0 million per year. The Company has commenced implementing each of these plans and intends to complete them whether or not the merger is completed. There can be no assurance, however, that either of these plans will be successfully completed as contemplated. FORWARD LOOKING STATEMENTS This Form 10-Q contains forward-looking statements within the meaning of the "safe-harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements relating to the Company's plans and objectives to complete a merger, implement business segmentation and restructuring plans, upgrade and remodel store locations, build new stores and increase gasoline sales, reduce the impact of under-performing stores, sell or lease certain assets, the Company's availability of supplies of gasoline, the estimated costs for environmental remediation, successful implementation of tax planning strategies, and the sufficiency of the Company's liquidity and the availability of capital. Such statements are based on management's current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Such factors and uncertainties include, but are not limited to, the availability of financing and additional capital to complete the merger or otherwise pursue the Company's alternative business strategy, each on acceptable terms, if at all, the future profitability of the Company, the availability of desirable store locations, the Company's ability to negotiate and enter into lease, acquisition and supply agreements on acceptable terms, competition and pricing in the Company's market areas, volatility in the wholesale gasoline market due to supply interruptions, modifications of environmental regulatory requirements, detection of unanticipated environmental conditions, the timing of reimbursements from state environmental trust funds, the Company's ability to manage its long-term indebtedness, weather conditions, the favorable resolution of certain pending and future litigation, and general economic conditions. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. QUANTITATIVE AND QUALITATIVE MARKET RISK The Company does not have any instruments that it believes would be materially affected by any future interest rate changes. 18 19 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is a defendant in an action brought by a former supplier of certain dairy products to convenience stores formerly owned by the Company in Massachusetts, Rhode Island, Connecticut, and New York ("New England Stores") entitled New England Dairies, Inc. v. Dairy Mart Convenience Stores, Inc. and Dairy Mart, Inc., Civil Action No. 397CU00894 (US District Court, CT). The defendants are contesting the claims and, at this time, the Company is not able to determine what the results of this litigation will be. The trial was completed on December 7, 2000 and it is not known when the judge will issue his ruling. The Company has recognized no provision for any possible loss in the accompanying financial statements. The action is more fully described in the Company's Form 10-K for the fiscal year ended February 3, 2001, as filed with the Securities and Exchange Commission. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. a) Exhibits: 1. Exhibit (11) - Statement re Computation of Per-Share Earnings. 2. Exhibit (27) - Financial Data Schedule. Submitted in electronic format only. b) Reports on Form 8-K On March 16, 2001, the Company filed a Current Report on Form 8-K, under Item 5, disclosing the Fourth Amendment to the Company's Amended and Restated Credit Agreement. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DAIRY MART CONVENIENCE STORES, INC. DATE: June 19, 2001 /s/ GREGORY G. LANDRY ----------------------- Gregory G. Landry Vice Chairman and Chief Financial Officer 19

DAIRY MART CONVENIENCE STORES INC 10-Q