Back to GetFilings.com

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

DUANE READE INC.
(Exact name of registrant as specified in its charter)

*

Guarantors with respect to the Company's 2.1478% Senior Convertible Notes due 2022 and the Company's 91/4% Senior Subordinated Notes due 2008

(212) 273-5700
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

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 ý        No o

        The number of shares of the Common Stock outstanding as of August 12, 2002: 23,947,742

INDEX

2

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Duane Reade Inc.
Consolidated Statements of Operations (Unaudited)
(In thousands, except per share amounts)

The accompanying notes are an integral part of these financial statements.

3

Duane Reade Inc.
Consolidated Balance Sheets
(In thousands, except share amounts)

The accompanying notes are an integral part of these financial statements.

4

Duane Reade Inc.
Consolidated Statements of Cash Flows (Unaudited)
(In thousands)

The accompanying notes are an integral part of these financial statements.

5

Notes to Consolidated Financial Statements

1.    Basis of Presentation

        The Unaudited Consolidated Financial Statements included herein reflect all adjustments (consisting of normal recurring items) which, in the opinion of management, are necessary to present fairly the results of operations, financial position and cash flows of Duane Reade Inc. (the "Company"), and have been prepared, in all material respects, in accordance with the same accounting principles followed in the preparation of the Company's annual financial statements for the year ended December 29, 2001, except as disclosed herein. These financial statements should be read in conjunction with the Company's financial statements included in its Annual Report on Form 10-K for the year ended December 29, 2001. The Unaudited Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated. Earnings per share amounts are calculated based on the weighted average number of shares outstanding during the period and may not add due to rounding. 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 Unaudited Consolidated Financial Statements present the combined assets and operations of the subsidiary guarantors.

2.    World Trade Center Disaster and Related Business Interruption and Property Losses

        On September 11, 2001, as a result of the terrorist attack on the World Trade Center in lower Manhattan, the Company lost all of its inventory and other property and equipment in its World Trade Center location and lost a portion of its inventory and other property in several other locations. The Company also experienced substantial business disruption resulting from the permanent loss of two stores and temporary closings of 20 additional stores during the period immediately following the attack. The Company believes that it is fully insured for its property and business interruption losses in connection with this event, as well as the extra costs to return temporarily closed stores to normal operations. The Company has collected its property loss claim and a partial payment of $9.9 million toward its business interruption and extra expenses claim and remains actively engaged in discussions with its insurance carrier's adjusters and auditors regarding additional payments to be received toward final settlement of its business interruption claim. Additional insurance recoveries for the business interruption portion of the Company's insurance claim, which could be material, will be recognized when collection of such recoveries is assured.

3.    Accounting Change

        As of December 30, 2001, the Company adopted a change in accounting method to convert from the retail dollar first-in, first-out ("FIFO") method to a specific cost based last-in, first-out ("LIFO") method. Adoption of the specific cost LIFO method will more accurately value inventory by eliminating the averaging inherent in the retail method. In addition, the specific cost LIFO method will reflect the effect of inflation in the company's gross margin. The effect of changing from the retail method to the specific cost method was a reduction in inventory of $16.0 million and a cumulative effect of an accounting change as of December 30, 2001 of approximately $9.3 million, net of an income tax benefit of $6.7 million ($0.39 per basic common share and $0.38 per diluted common share, respectively). The cumulative effect of changing from FIFO to LIFO on periods prior to December 30, 2001 can not be determined. Pro forma effects of the change for prior periods have not been presented as cost information is not determinable.

6

4.    Inventory

        At June 29, 2002, inventories would have been greater by $0.8 million if they had been valued on a lower of first-in, first-out cost or market basis.

5.    Completed Convertible Notes Offering and Tender Offer

        On April 16, 2002, the Company completed an offering (the "Offering") of $381.5 million aggregate principal amount of Senior Convertible Notes maturing on April 16, 2022 (the "Convertible Notes"). The Convertible Notes were issued at a price of $572.76 per note (57.276% of the principal amount at maturity) and pay cash interest at the rate of 2.1478% per year on the principal amount at maturity, payable semi-annually in arrears on April 16 and October 16 of each year beginning on October 16, 2002, until April 16, 2007. After that date, interest will accrue on the notes as amortization of the original issue discount representing a yield to maturity of 3.75% per year, computed on a semi-annual bond equivalent basis. After deducting commissions and expenses related to the offering, net proceeds of $210.5 million were realized by the Company. A portion of the proceeds was used to repay an aggregate of approximately $50.1 million in principal amount of Term A loans and Term B loans and $41.5 million in principal amount of revolving loans (which revolving loans may be reborrowed) under our Senior Credit Agreement. In addition, the Company terminated an interest rate swap agreement, which was set to expire in January 2003, at a cost of approximately $3.9 million. The Company anticipates that the balance of the proceeds will primarily be used for future debt reductions.

        Holders of the Convertible Notes may convert each $1,000 in principal amount of their convertible notes into 14.1265 shares of our common stock, subject to adjustment, only if (1) the sale price of our common stock reaches, or the trading price of the notes falls below, specified thresholds, (2) the notes are called for redemption, or (3) specified corporate transactions have occurred. Upon conversion, we have the right to deliver, in lieu of our common stock, cash or a combination of cash and common stock in an amount as described in the indenture.

        Holders of the Convertible Notes may require us to purchase all or a portion of their notes on April 16, 2007 at a price of $572.76 per note plus accrued cash interest, if any; on April 16, 2012 at a price of $689.68 per note plus accrued cash interest, if any; and on April 16, 2017 at a price of $830.47 per note plus accrued cash interest, if any. The Company may choose to pay the purchase price of such notes in cash or common stock or a combination of cash and common stock. In addition, if the Company experiences a change in control, each holder may require it to purchase for cash all or a portion of such holder's notes at a price equal to the sum of the issue price plus accrued original issue discount and accrued cash interest, if any, to the date of purchase.

        The Company may redeem for cash all or a portion of the convertible notes at any time after April 16, 2007, at a price equal to the sum of the issue price plus accrued original issue discount and accrued cash interest, if any, to the redemption date.

        On June 3, 2002, the Company completed a tender offer and consent solicitation (the "Tender Offer") to purchase all of its $80 million of outstanding principal amount of 9¹/4% Senior Notes due 2008 (the "Senior Notes"). The Tender Offer was priced at $1,083.50 per each $1,000 principal amount of Senior Notes tendered to the Company on or before the consent deadline of May 20, 2002 (the "consent deadline"), and $1,063.50 per each $1,000 principal amount of Senior Notes tendered to the Company after the consent deadline but before the May 31, 2002 expiration date, plus accrued and unpaid interest on the principal amount thereof through the payment date. Of the total $80 million Senior Notes outstanding, $78.2 million were tendered on or before the consent deadline and an additional $0.2 million were tendered thereafter. On June 3, 2002, the Company paid a total of $87.1 million from the balance of the proceeds of the Offering in satisfying the Tender Offer. This payment was composed of principal value ($78.4 million), premium payments ($6.5 million) and accrued interest earned from February 16, 2002 through the payment date ($2.2 million).

7

6.    Extraordinary Charge

        Upon successful completion of the Offering and Tender Offer, the Company repaid an aggregate of approximately $50.1 million in principal amount of Term A loans and Term B loans outstanding under the Senior Credit Agreement and $78.4 million of the $80 million aggregate principal amount of outstanding Senior Notes. In connection with these repayments, the Company recorded a $1.2 million extraordinary charge, net of an income tax benefit of $0.9 million, representing the accelerated amortization of deferred financing costs associated with the portion of outstanding term loans and 9¹/4% Senior Subordinated Notes retired. In addition, the Company recorded a $4.2 million extraordinary charge, net of an income tax benefit of $2.9 million, representing the consent premium paid to the holders of the Senior Notes tendered for retirement and certain related expenses. Finally, the Company recorded a $2.3 million extraordinary charge, net of an income tax benefit of $1.6 million, representing the cost to terminate the interest rate swap agreement that was tied to interest expenses on Term A loans, Term B loans and revolving loans that were repaid with the proceeds of the Offering.

7.    Net Income per Common Share

        Net income 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 "in-the-money" stock options. Of the options to purchase 2,665,419 and 2,004,160 shares of common stock outstanding at June 29, 2002 and June 30, 2001, respectively, options to purchase 55,156 shares at June 29, 2002 and 45,156 shares at June 30, 2001 were not included in the computation of diluted earnings per share because the exercise prices of such options were greater than the average market price of the common shares and the impact of these shares would have been anti-dilutive.

8

        The following table sets forth the computation of income per common share for the periods presented (in thousands, except per share amounts):

8.    Income Taxes

        Income taxes are recorded based on the estimated combined statutory tax rates expected to be applicable for the full fiscal year less applicable employment related tax credits. The effective tax rate is lower than the combined statutory rates, primarily reflecting the impact of these wage-related income tax credits.

9

9.    Acquisitions

        During the first six months of fiscal 2002, the Company acquired the customer files of six pharmacies and the operations, including certain lease-related assets, of seven pharmacy establishments. The total cost of these acquisitions, which was principally paid for by the issuance of common stock, was $17.3 million and was allocated as follows: identified intangibles ($12.5 million), inventory ($1.7 million), property and equipment ($1.7 million), goodwill ($1.7 million) and other assets ($0.1 million), net of accruals for expenses and liabilities assumed ($0.4 million). For the 13 weeks ended June 29, 2002, the Company acquired the operations, including certain lease-related assets, of four pharmacy establishments at a total cost of $4.7 million. The operations of the acquired stores have been included in the consolidated financial statements from the dates of the acquisitions. The pro forma impact of these acquisitions was not material to sales, results of operations or earnings per share of the Company for the thirteen or twenty-six week periods ended June 29, 2002.

10.  Newly Adopted Accounting Standards

        During the third quarter of 2001, the Company adopted Financial Accounting Standards Board Pronouncements Nos. 141 (FAS 141) and 142 (FAS 142) "Business Combinations" and "Goodwill and Other Intangible Assets", respectively, for acquisitions completed after June 30, 2001 (See Note No. 7 "Acquisitions"). This adoption did not have a material impact on the Company's results of operations, financial position or cash flows. During the first quarter ended March 30, 2002, the Company adopted these same standards for goodwill related to acquisitions completed prior to July 1, 2001. For the thirteen and twenty-six weeks ended June 29, 2002, the Company's goodwill amortization expense was reduced by $1.1 million and $2.2 million, respectively, as a result of the adoption of these standards. Had these standards been adopted prior to the 2001 fiscal year, the Company's net income for the thirteen and twenty-six weeks ended June 30, 2001 would have been approximately $6.4 million and $9.7 million, respectively. In addition, for the thirteen and twenty-six weeks ending June 30, 2001, the Company's earnings per basic share outstanding would have been $0.33 and $0.52, respectively, and the Company's earnings per diluted share outstanding would have been $0.32 and $0.49, respectively. At June 29, 2002, included within the "other assets" category on the Company's balance sheet, were intangible assets totaling $72.3 million, net of accumulated amortization of $48.0 million. The $72.3 million is primarily composed of costs related to the acquisition of store leases ($34.6 million) and pharmacy customer files ($21.8 million), deferred financing costs ($9.3 million) and all other net intangible assets totaling $6.6 million. Lease acquisition costs are generally amortized over the remaining lease life, pharmacy file acquisition costs are amortized over seven years, and deferred financing costs are amortized over the life of the financing agreement. Based on the net intangible asset values at June 29, 2002, the Company anticipates that it will incur expenses related to the amortization of intangible assets of $6.1 million for the balance of the 2002 fiscal year. For the 2003 through 2006 fiscal years, the Company expects to incur annual expenses related to the amortization of intangible assets of $11.0 million, $10.4 million, $9.2 million and $8.7 million, respectively.

11.  Commitments and Contingencies

        We are a party to legal actions arising in the ordinary course of business. Based on information presently available to us, we believe that we have 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 our financial position, cash flows or results of operations.

12.  Subsequent Events

        On July 10, 2002, the Company, using a portion of the remaining proceeds from the Offering, repaid an aggregate of $36.0 million in principal amount of Term A loans and Term B loans under the Senior Credit Agreement. After giving effect to this repayment, the Company had a remaining outstanding balance of $66.8 million of Term A loans and Term B loans in the aggregate. In addition, as a result of this transaction, the Company recorded an extraordinary charge of $0.2 million, net of an income tax benefit of $0.1 million, representing the accelerated amortization of that portion of deferred financing costs attributable to the Term A loans and Term B loans that were repaid.

10

        On August 12, 2002, Anthony J. Cuti, the Company's Chairman, President and CEO and the Compensation Committee of the Board of Directors executed an amended and restated employment agreement (the "Employment Agreement") extending the term of Mr. Cuti's employment to December 31, 2004. The Employment Agreement provides for a continuation of his current salary of $750,000 per annum through December 31, 2002 and an increase to $850,000 per annum for calendar year 2003. Thereafter the Board of Directors may increase, but not decrease, Mr. Cuti's base salary. In addition, on each January 1 beginning with January 1, 2004, the rate of Mr. Cuti's base salary will be increased by the percentage increase in the Consumer Price Index For All Urban Consumers respecting New York, New York, as published by the Bureau of Labor Statistics for the 12-month period preceding such date. The Employment Agreement also provides for a continuation of annual incentive bonuses of up to 200% of Mr. Cuti's base salary if certain maximum performance targets are achieved. The Employment Agreement provides for an additional long-term cash target award of $975,000 if the maximum performance targets for both 2003 and 2004 are achieved. Mr. Cuti will also receive an increase in his annual supplemental employment retirement benefit to 50% of his maximum salary and annual incentive bonus increased by 2% for each full or partial year after age 60 that Mr. Cuti provides services to the Company as an employee or in any other capacity in which he is actively engaged by the Company as a director or consultant. As a result, the Company has increased the previously existing split dollar life insurance policy in an amount sufficient to yield the annual retirement benefits to Mr. Cuti. Under terms more fully described in the Employment Agreement, upon Mr. Cuti's termination of employment for reasons other than cause, Mr. Cuti would be entitled to severance benefits equal to five years of his maximum base salary and incentive bonus (the "Severance Amount"), plus an additional 60% of the Severance Amount.

        At June 29, 2002, Mr. Cuti had approximately $1.2 million in notes payable to the Company on December 19, 2002 and $2.6 million in notes payable to the Company on November 9, 2003 (the "Cuti Notes"). Upon the occurrence of certain change of control and employment termination events (none of which has occurred as of the filing date) under Mr. Cuti's previous employment agreement and the new Employment Agreement, all principal and interest on the Cuti Notes would be forgiven. Mr. Cuti has notified the Board of Directors that he has waived his right to receive the benefit of any forgiveness event related to the Cuti Notes.

11

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

        The information contained herein includes certain forward-looking statements that involve a number of risks and uncertainties. A number of facts could cause our actual results, performance, achievements, 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 our specific market area; inflation; changes in costs of goods and services; economic conditions in general and in our specific market areas; demographic changes; changes in prevailing interest rates and the availability of and terms of financing to fund the anticipated growth of our business; liability and other claims asserted against us; changes in operating strategy or development plans; the ability to attract and retain qualified personnel; our significant indebtedness; labor disturbances; the continued impact of, or new occurrences of, terrorist attacks in the New York City metropolitan area; changes in our 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, investors are cautioned not to place undue reliance on such forward-looking statements. We disclaim 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.