** **

**SECURITIESAND EXCHANGE COMMISSIONWASHINGTON, D.C.**

** **

**FORM 10-Q**

** **
| **Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities  and Exchange Act of 1934** |
|---------------------------------------------------------------------------------------------------|
| **For  the quarterly period ended September 29, 2001.**                                           | **Commission file number 333-41239** |

** **

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

 

| **DELAWARE**                                                    | **04-3164702**           |
|-----------------------------------------------------------------|--------------------------|
| (State or other jurisdiction of  incorporation or organization) | (IRS Employer ID Number) |

 

| **DRI  I Inc.***                     | **Delaware**  | **04-3166107** |
|--------------------------------------|---------------|----------------|
| **Duane  Reade***                    | **New  York** | **11-2731721** |
| **Duane  Reade International, Inc*** | **Delaware**  | **22-3672347** |
| **Duane  Reade Realty, Inc ***       | **Delaware**  | **13-4074383** |

 

*  Guarantors with respect to the Company's 91⁄4% Senior SubordinatedNotes due 2008

 

| **440 Ninth Avenue****New  York, New York** | **10001**  |
|---------------------------------------------|------------|
| (Address of principal executive offices)    | (Zip Code) |

 

**(212) 273-5700**

(Registrant'stelephone number, including area code)

 

----

 

**Securities registered pursuant toSection 12(b) of the Act:**

 
| **Title  of each class**                    | **Name  of each exchange on which registered** |
|---------------------------------------------|------------------------------------------------|
| Common Stock, $.01 par value per share      | New York Stock Exchange. Inc.                  |
| 91⁄4% Senior Subordinated Notes due 2008 | None                                           |

 

----

 

**Securitiesregistered pursuant to Section 12 (g) of the Act:**None.

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ýNo o

 

The number of shares of the Common Stock outstandingas of November 9, 2001:  23,328,317

 

 

INDEX

 
| PART I  | - FINANCIAL INFORMATION                                                                                                       |   |
|---------|-------------------------------------------------------------------------------------------------------------------------------|--------|
|    |                                                                                                                          |   |
|    | ITEM 1. - FINANCIAL STATEMENTS                                                                                                |   |
|    |                                                                                                                          |   |
|    | Consolidated  Statements of Operations (Unaudited) - For the 13 and 39 Weeks Ended  September 29, 2001 and September 23, 2000 |   |
|    |                                                                                                                          |   |
|    | Consolidated Balance Sheets  - As of September 29, 2001 (Unaudited) and December 30, 2000                                     |   |
|    |                                                                                                                          |   |
|    | Consolidated  Statements of Cash Flows (Unaudited) - For the 39 Weeks Ended September 29,  2001 and September 23, 2000        |   |
|    |                                                                                                                          |   |
|    | Notes  to Consolidated Financial Statements (Unaudited)                                                                       |   |
|    |                                                                                                                          |   |
|    | ITEM  2. - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS  OF OPERATIONS                        |   |
|    |                                                                                                                          |   |
| PART II | -  OTHER INFORMATION                                                                                                          |   |

 

 

PART I – FINANCIALINFORMATIONITEM 1. FINANCIAL STATEMENTS

 

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

 
|                                            |   | **For  the 13 Weeks Ended** |    | **For  the 39 Weeks Ended** |   |
|-------------------------------------------------|--------|-----------------------------|---------|-----------------------------|--------|
|                                            |   | **Sept 29,****2001**        |    | **Sept 23,****2000**        |   | **Sept 29,****2001** |   | **Sept 23, 2000** |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Net sales                                       |   | $                           | 279,433 |                        | $      | 242,978 |   | $ | 843,460 |   | $ | 712,803 |   |
| Cost of sales                                   |   | 213,614                     |    | 178,291                     |   | 641,768 |   | 533,039 |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Gross profit                                    |   | 65,819                      |    | 64,687                      |   | 201,692 |   | 179,764 |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Selling, general & administrative  expenses |   | 42,974                      |    | 38,227                      |   | 130,870 |   | 111,772 |   |
| Depreciation and amortization                   |   | 6,685                       |    | 6,167                       |   | 19,745 |   | 18,161 |   |
| Store pre-opening expenses                      |   | 482                         |    | 327                         |   | 1,381 |   | 1,078 |   |
|                                            |   | 50,141                      |    | 44,721                      |   | 151,996 |   | 131,011 |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Operating income                                |   | 15,678                      |    | 19,966                      |   | 49,696 |   | 48,753 |   |
| Interest expense, net                           |   | 5,099                       |    | 9,011                       |   | 21,834 |   | 26,045 |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Income before income taxes                      |   | 10,579                      |    | 10,955                      |   | 27,862 |   | 22,708 |   |
| Income taxes                                    |   | 4,224                       |    | 4,729                       |   | 11,649 |   | 9,583 |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Income before extraordinary charge              |   | 6,355                       |    | 6,226                       |   | 16,213 |   | 13,125 |   |
| Extraordinary charge, net of income taxes       |   | -                           |    | -                           |   | 1,491 |   | - |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Net income                                      |   | $                           | 6,355   |                        | $      | 6,226 |   | $ | 14,722 |   | $ | 13,125 |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Per Common Share – Basic                   |   |                        |    |                        |   |   |   |   |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Income before extraordinary charge              |   | $                           | 0.28    |                        | $      | 0.35 |   | $ | 0.80 |   | $ | 0.75 |   |
| Extraordinary charge, net of income taxes       |   | -                           |    | -                           |   | 0.07 |   | - |   |
| Net income                                      |   | $                           | 0.28    |                        | $      | 0.35 |   | $ | 0.73 |   | $ | 0.75 |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Weighted Average Common Shares Outstanding      |   | 22,933                      |    | 17,824                      |   | 20,254 |   | 17,578 |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Per Common Share – Diluted                 |   |                        |    |                        |   |   |   |   |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Income before extraordinary charge              |   | $                           | 0.27    |                        | $      | 0.34 |   | $ | 0.77 |   | $ | 0.72 |   |
| Extraordinary charge, net of income taxes       |   | -                           |    | -                           |   | 0.07 |   | - |   |
| Net income                                      |   | $                           | 0.27    |                        | $      | 0.34 |   | $ | 0.70 |   | $ | 0.72 |   |
|                                            |   |                        |    |                        |   |   |   |   |   |
| Weighted Average Common Shares Outstanding      |   | 23,781                      |    | 18,555                      |   | 21,168 |   | 18,344 |   |

 

The accompanying notes are an integral partof these financial statements.

 

**Duane Reade Inc.**Consolidated Balance Sheets(In thousands, except share and per share data.)

 
|                                                                                                            |   | **Sept 29,****2001** |    | **December 30,****2000** |   |
|-----------------------------------------------------------------------------------------------------------------|--------|----------------------|---------|--------------------------|--------|
|                                                                                                            |   | **(Unaudited)**      |    |                     |   |
| ASSETS                                                                                                          |   |                 |    |                     |   |
| Current Assets                                                                                                  |   |                 |    |                     |   |
| Cash                                                                                                            |   | $                    | 1,095   |                     | $      | 979 |   |
| Receivables                                                                                                     |   | 69,782               |    | 48,953                   |   |
| Inventories                                                                                                     |   | 209,753              |    | 172,568                  |   |
| Deferred income taxes                                                                                           |   | 8,831                |    | 13,023                   |   |
| Prepaid expenses and other current assets                                                                       |   | 7,425                |    | 8,770                    |   |
| TOTAL CURRENT ASSETS                                                                                            |   | 296,886              |    | 244,293                  |   |
|                                                                                                            |   |                 |    |                     |   |
| Property and equipment, net                                                                                     |   | 128,700              |    | 107,883                  |   |
| Goodwill, net of accumulated amortization  of $34,327 and $31,020                                               |   | 156,819              |    | 152,951                  |   |
| Deferred income taxes                                                                                           |   | 4,352                |    | 8,852                    |   |
| Other assets                                                                                                    |   | 69,797               |    | 56,951                   |   |
| TOTAL ASSETS                                                                                                    |   | $                    | 656,554 |                     | $      | 570,930 |   |
|                                                                                                            |   |                 |    |                     |   |
| LIABILITIES AND  STOCKHOLDERS' EQUITY                                                                           |   |                 |    |                     |   |
| Current Liabilities                                                                                             |   |                 |    |                     |   |
| Accounts payable                                                                                                |   | $                    | 51,235  |                     | $      | 47,575 |   |
| Accrued interest                                                                                                |   | 3,756                |    | 8,394                    |   |
| Other accrued expenses                                                                                          |   | 24,101               |    | 19,830                   |   |
| Current portion of long-term debt                                                                               |   | 7,758                |    | 12,325                   |   |
| Current portion of capital lease  obligations                                                                   |   | 458                  |    | 1,703                    |   |
| TOTAL CURRENT LIABILITIES                                                                                       |   | 87,308               |    | 89,827                   |   |
|                                                                                                            |   |                 |    |                     |   |
| Long-term debt, less current portion                                                                            |   | 253,840              |    | 337,913                  |   |
| Capital lease obligations, less current  portion                                                                |   | 843                  |    | 1,060                    |   |
| Other non-current liabilities                                                                                   |   | 38,655               |    | 27,633                   |   |
| TOTAL LIABILITIES                                                                                               |   | 380,646              |    | 456,433                  |   |
|                                                                                                            |   |                 |    |                     |   |
| Stockholders' equity                                                                                            |   |                 |    |                     |   |
| Preferred stock, $0.01 par; authorized  5,000,000 shares; issued and outstanding: none                          |   | -                    |    | -                        |   |
| Common stock, $0.01 par; authorized  75,000,000 shares; issued and outstanding 23,102,641 and 18,232,339 shares |   | 231                  |    | 182                      |   |
| Paid-in capital                                                                                                 |   | 304,801              |    | 154,536                  |   |
| Accumulated other comprehensive loss                                                                            |   | (3,623               | )       | -                        |   |
| Accumulated deficit                                                                                             |   | (25,501              | )       | (40,221                  | )      |
| TOTAL STOCKHOLDERS' EQUITY                                                                                      |   | 275,908              |    | 114,497                  |   |
|                                                                                                            |   |                 |    |                     |   |
| TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                                                      |   | $                    | 656,554 |                     | $      | 570,930 |   |

 

The accompanying notes are an integral partof these financial statements.

 

**Duane Reade Inc.**ConsolidatedStatements of Cash Flows (Unaudited)(In thousands)

 
|                                                                                         |   | **For the 39 Weeks Ended** |   |
|----------------------------------------------------------------------------------------------|--------|----------------------------|--------|
|                                                                                         |   | **Sept 29, 2001**          |   | **Sept 23, 2000** |   |
| Cash flows (used in) provided by operating  activities:                                      |   |                       |   |   |   |
| Net income                                                                                   |   | $                          | 14,722 |   | $ | 13,125 |   |
| Adjustments to reconcile net income to net  cash (used in) provided by operating activities: |   |                       |   |   |   |
| Depreciation and amortization of property  and equipment                                     |   | 11,155                     |   | 10,118 |   |
| Amortization of goodwill and other intangibles                                               |   | 9,784                      |   | 9,298 |   |
| Deferred tax provision                                                                       |   | 11,974                     |   | 9,493 |   |
| Extraordinary charge                                                                         |   | 1,491                      |   | - |   |
| Non-cash rent expense                                                                        |   | 4,142                      |   | 3,623 |   |
| Changes in operating assets and  liabilities (net of effect of acquisitions):                |   |                       |   |   |   |
| Receivables                                                                                  |   | (11,997                    | )      | (7,194 | ) |
| Inventories                                                                                  |   | (37,192                    | )      | (19,095 | ) |
| Accounts payable                                                                             |   | 3,660                      |   | 932 |   |
| Prepaid and accrued expenses                                                                 |   | (6,750                     | )      | (5,796 | ) |
| Increase in other (assets) liabilities,  net                                                 |   | (5,235                     | )      | (7,552 | ) |
| NET CASH (USED IN) PROVIDED BY OPERATING  ACTIVITIES                                         |   | (4,246                     | )      | 6,952 |   |
|                                                                                         |   |                       |   |   |   |
| Cash flows used in investing activities:                                                     |   |                       |   |   |   |
| Lease acquisition and other costs                                                            |   | (4,391                     | )      | (1,640 | ) |
| Capital expenditures                                                                         |   | (31,883                    | )      | (19,210 | ) |
| NET CASH USED IN INVESTING ACTIVITIES                                                        |   | (36,274                    | )      | (20,850 | ) |
|                                                                                         |   |                       |   |   |   |
| Cash flows from financing activities:                                                        |   |                       |   |   |   |
| Proceeds from equity offering                                                                |   | 130,446                    |   | - |   |
| Net borrowings (repayments) – term loans                                                |   | (99,640                    | )      | 2,562 |   |
| Net borrowings (repayments) – revolving  credit facility                                |   | 11,000                     |   | 13,500 |   |
| Exercise of stock options                                                                    |   | 2,181                      |   | 582 |   |
| Financing costs                                                                              |   | (1,889                     | )      | (1,177 | ) |
| Repayments of capital lease obligations                                                      |   | (1,462                     | )      | (1,412 | ) |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                                    |   | 40,636                     |   | 14,055 |   |
|                                                                                         |   |                       |   |   |   |
| Net increase in cash                                                                         |   | 116                        |   | 157 |   |
| Cash at beginning of period                                                                  |   | 979                        |   | 1,013 |   |
| Cash at end of period                                                                        |   | $                          | 1,095  |   | $ | 1,170 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

 

**Notesto Consolidated Financial Statements (Unaudited)**

 

**1. Basis of Presentation**

 

The Unaudited Consolidated Financial Statements included herein reflectall adjustments (consisting of normal recurring items) which, in the opinion ofmanagement, are necessary to present fairly the results of operations,financial position and cash flows of Duane Reade Inc. (the “Company”), and havebeen prepared, in all material respects, in accordance with the same accountingprinciples followed in the preparation of the Company’s annual financialstatements for the year ended December 30, 2000.  These financial statements should be read in conjunction with theCompany’s financial statements included in its Annual Report on Form 10-K forthe year ended December 30, 2000.  TheUnaudited Consolidated Financial Statements include the accounts of the Companyand its subsidiaries.  All significantintercompany transactions and balances have been eliminated.  Certain prior year amounts have beenreclassified to conform to the current year presentation.  Cost of sales includes all store occupancyrelated costs and expenses, lease and sublease related income, income fromsales of market related data and warehouse expenses.  Earnings per share amounts are calculated based on the weightedaverage shares outstanding and may not add due to rounding. The results for theinterim periods presented are not necessarily indicative of the results expectedfor the full year.

 

The Company has noassets or operations other than its investment in its subsidiary guarantors.Accordingly, the Unaudited Consolidated Financial Statements present thecombined assets and operations of the subsidiary guarantors.

 

**2. World Trade Center Disaster and Related BusinessInterruption and Property Losses**

 

On September 11, 2001,as a result of the terrorist attack on the World Trade Center in lowerManhattan, the Company lost all of its inventory and other property and equipmentin its World Trade Center location and lost a portion of its inventory andother property in several other locations. The Company also experiencedsubstantial business disruption resulting from the permanent loss of two storesand temporary closings of 20 additional stores during the period immediatelyfollowing the attacks. The Company believes that it is fully insured for itsproperty and business interruption losses in connection with this event, aswell as the extra costs to return temporarily closed stores to normaloperations. As of September 29, 2001 all of the temporarily closed stores hadreopened. At September 29, 2001, the Company had recognized an insurance claimreceivable of $4.2 million representing the portion of its identified property lossesdeemed fully recoverable. Expected insurance recoveries for the businessinterruption portion of the Company’s insurance claim will be recognized whencollection of such recoveries is assured.

 

**3.Completed Follow-on Equity Offering**

 

On May 14, 2001, theCompany filed a Form S-3 registration statement for a public equity offering(the “Offering”) of 4,000,000 primary shares of its common stock (the “PrimaryShares”) and 3,000,000 secondary shares of its common stock. The underwritingagreement for this offering also provided the underwriters with a 30-day optionto purchase up to an additional 1,050,000 secondary shares (“AdditionalSecondary Shares” and collectively with the 3,000,000 secondary shares, the“Secondary Shares”) to cover over-allotments of shares.  The Offering was declared effective by theSecurities and Exchange Commission on June 7, 2001 and was priced at $34.50 pershare to the public with underwriting discounts and commissions of $1.66 pershare that resulted in proceeds of $32.84 per share to the Company and theselling stockholders.  The Offering wasclosed on June 13, 2001 and resulted in $130.4 million net proceeds to theCompany after deducting various expenses related to the Offering.  In addition, the Company received proceeds of$0.5 million related to the exercise of stock options related to a portion ofthe shares of selling stockholders sold as Secondary Shares in theOffering.  The net proceeds to theCompany from the sale of the Primary Shares, together with the proceeds itreceived from the related exercise of stock options, were used to repay aportion of amounts outstanding under the Company’s credit agreement (the“Senior Credit Agreement”), as amended, by and among Duane Reade (and itsaffiliates), Credit Suisse First Boston (“CSFB”), as syndication agent for thelenders thereunder, and Fleet National Bank (“Fleet”), as administrative agentfor the lenders thereunder. The Secondary Shares were sold by certain sellingstockholders primarily affiliated with private equity funds managed by CSFB, aswell as by certain management investors.

 

**4. Extraordinary Charge**

 

In the second quarter, inconnection with the Offering and the related refinancing of a portion of theCompany’s outstanding term loans under its Senior Credit Agreement, the Companyrecorded a $1.5 million extraordinary charge, net of an income tax benefit of$1.1 million, representing the accelerated amortization of deferred financingcosts associated with the portion of outstanding term loans retired or refinancedas a result of the completed Offering and related debt refinancing.

 

**5. Net Income per Common Share**

 

Net income per common share is based on the weighted average sharesoutstanding during each period in accordance with the provisions of FinancialAccounting Standards Board (“FASB”) Statement No. 128 “Earnings PerShare.”  Basic earnings per share iscomputed based on the weighted average number of common shares outstandingduring the period.  Diluted earnings pershare gives effect to all dilutive potential common shares outstanding duringthe period.  Dilutive potential commonshares include shares issuable upon exercise of the Company’s"in-the-money" stock options. Of the options to purchase 2,286,143 and 2,367,101 shares ofcommon stock outstanding at September 29, 2001 and September 23, 2000,respectively, options to purchase 45,156 shares at September 29, 2001 and659,168 shares at September 23, 2000 were not included in the computation ofdiluted earnings per share because the exercise prices of such options weregreater than the average market price of the common shares.

 

The following table setsforth the computation of income per common share for the periods presented (inthousands, except per share amounts):

 
|                                                                                 |   | **For  the 13 Weeks Ended** |   | **For  the 39 Weeks Ended** |   |
|--------------------------------------------------------------------------------------|--------|-----------------------------|--------|-----------------------------|--------|
|                                                                                 |   | **Sept 29, 2001**           |   | **Sept 23, 2000**           |   | **Sept 29, 2001** |   | **Sept 23, 2000** |   |
|                                                                                 |   |                        |   |                        |   |   |   |   |   |
| Income before extraordinary charge                                                   |   | $                           | 6,355  |                        | $      | 6,226 |   | $ | 16,213 |   | $ | 13,125 |   |
| Extraordinary charge, net of income taxes                                            |   | -                           |   | -                           |   | 1,491 |   | - |   |
| Net Income                                                                           |   | $                           | 6,355  |                        | $      | 6,226 |   | $ | 14,722 |   | $ | 13,125 |   |
|                                                                                 |   |                        |   |                        |   |   |   |   |   |
| Weighted average  number of common shares outstanding during the period – basic |   | 22,933                      |   | 17,824                      |   | 20,254 |   | 17,578 |   |
| Potential  dilutive shares                                                           |   | 848                         |   | 731                         |   | 914 |   | 766 |   |
| Weighted average  number of shares outstanding – diluted                        |   | 23,781                      |   | 18,555                      |   | 21,168 |   | 18,344 |   |
|                                                                                 |   |                        |   |                        |   |   |   |   |   |
| Per common share  – basic                                                       |   |                        |   |                        |   |   |   |   |   |
|                                                                                 |   |                        |   |                        |   |   |   |   |   |
| Income before extraordinary charge                                                   |   | $                           | 0.28   |                        | $      | 0.35 |   | $ | 0.80 |   | $ | 0.75 |   |
| Extraordinary charge, net of income taxes                                            |   | -                           |   | -                           |   | 0.07 |   | - |   |
| Net income                                                                           |   | $                           | 0.28   |                        | $      | 0.35 |   | $ | 0.73 |   | $ | 0.75 |   |
|                                                                                 |   |                        |   |                        |   |   |   |   |   |
|                                                                                 |   |                        |   |                        |   |   |   |   |   |
| Per common share  – diluted                                                     |   |                        |   |                        |   |   |   |   |   |
|                                                                                 |   |                        |   |                        |   |   |   |   |   |
| Income before extraordinary charge                                                   |   | $                           | 0.27   |                        | $      | 0.34 |   | $ | 0.77 |   | $ | 0.72 |   |
| Extraordinary charge, net of income taxes                                            |   | -                           |   | -                           |   | 0.07 |   | - |   |
| Net income                                                                           |   | $                           | 0.27   |                        | $      | 0.34 |   | $ | 0.70 |   | $ | 0.72 |   |

 

**6. Income Taxes**

 

Income taxes arerecorded based on the estimated effective tax rate expected to be applicablefor the full fiscal year less applicable employment related tax credits. Theeffective tax rate is greater than the statutory rate, primarily reflecting theimpact of non-deductible goodwill and state taxes.

 

**7. Acquisitions**

 

During the first nine months of fiscal 2001, the Company acquiredcertain assets of sixteen separate independently owned pharmacyestablishments.  The total cost of theseacquisitions, which was principally paid for by the issuance of common stock,was $18.6 million and was allocated as follows: identified intangibles ($13.6million), goodwill ($8.7 million), inventory ($2.3 million), property andequipment ($1.5 million) and other assets ($0.3 million), net of the currentliability for the balance of a purchase price payable ($4.5 million) andaccruals for expenses and liabilities assumed ($3.3 million).  For the 13 weeks ended September 29, 2001,the Company acquired certain assets of six pharmacy establishments at a totalcost of $10.7 million. Goodwill of $8.2 million related to acquisitionscompleted after June 30, 2001 has been recognized in accordance with FinancialAccounting Standards Board Pronouncements Nos. 141 (FAS 141) and 142 (FAS 142),“Business Combinations” and “Goodwill and Other Intangible Assets”respectively. Under FAS 142, goodwill acquired in business combinations forwhich the acquisition date is after June 30, 2001 is not amortized. Theoperations of the acquired stores have been included in the consolidatedfinancial statements from the dates of the acquisitions. The pro forma impactof these acquisitions was not material to sales or results of operations of theCompany for the thirteen or thirty-nine week periods ended September 29, 2001.

 

**8. NewlyAdopted Accounting Standards**

 

Financial Accounting Standards Board Pronouncement No. 133 (FAS 133),“Accounting for Derivative Instruments and Hedging Activities,” requirescompanies to disclose the nature and substance of derivative instrumenttransactions in which they may engage and to record in their financialstatements the fair value of derivative assets and liabilities.  At September 29, 2001, the Company hasreflected a tax-affected loss on an interest rate swap transaction of $3.6million in the “Accumulated other comprehensive loss” component ofShareholders’ Equity, in accordance with FAS 133’s provisions related to cashflow hedges.

 

The Company maintains an interest rate risk management strategy thatallows for the use of derivative instruments to minimize significant,unanticipated earnings fluctuations caused by interest rate volatility. TheCompany’s specific goals are (1) to manage interest rate sensitivity bymodifying the maturity characteristics of certain of its debt instruments and(2) to lower (where possible) the cost of borrowed funds. The Company usesinterest rate swaps to convert a portion of its variable rate debt to fixedrates. The resulting cost of funds is lower than it would have been had fixedrate borrowings been issued directly. As a result of applying the net proceedsof $130.4 million from the completed Offering to retirement of outstandingvariable rate debt, after the effects of the interest rate swaps have beenconsidered, all but $8.1 million of the remaining $158.1 million of SeniorCredit Agreement outstanding term loans at September 29, 2001 were effectivelyhedged to fixed rates.

 

Due to the volatilenature of short-term interest rates, the Senior Credit Agreement allows forsome latitude with respect to the Company’s ability to engage in transactionsaimed at minimizing a portion of the risk associated with the fluctuation inshort-term interest rates. In November 2000, the Company purchased a two-yearinterest rate swap agreement with a notional amount of $150.0 million offloating rate term loan borrowings. This swap agreement, which became effective on January 12, 2001,effectively served to convert this floating rate component of the Company’sdebt structure to a fixed rate of 5.8075% plus the applicable margins asdefined in the Senior Credit Agreement. It is likely that the Company will continue to engage in transactionsinvolving swaps, hedges and other types of derivative instruments in acontinuing effort to moderate and minimize the effects of changes in short-terminterest rates.

 

During the thirdquarter, the Company adopted Financial Accounting Standards BoardPronouncements Nos. 141 (FAS 141) and 142 (FAS 142) “Business Combinations” and“Goodwill and Other Intangible Assets”, respectively, for acquisitionscompleted after June 30, 2001 (See Note No. 7 “Acquisitions”). This adoptiondid not have a material impact on the Company’s results of operations,financial position or cash flows. Beginning in fiscal 2002, the Company expects that the annual goodwillamortization will be reduced by approximately $4.4 million upon the adoption ofFAS 142 for acquisitions completed prior to July 1, 2001.

 

**9.Credit Facility**

 

On July 10, 2001, TheCompany entered into the Fourth Amended and Restated Credit Agreement.  The Fourth Amended and Restated CreditAgreement resulted in a refinancing of our outstanding Term B and Term C loansinto a new Term B loan with reduced LIBOR margins and an extended maturitydate. The Fourth Amended and Restated Credit Agreement was made possible as aresult of the completed Offering and related improvement in the Company’sleverage ratios.  As of September 29,2001, the outstanding balances of the Term A and Term B loans were $18.9million and $139.2 million, respectively. The LIBOR margin on the new Term Bloan was reduced to 2.50% from 3.00% on the Term B and Term C loans in effectprior to the refinancing. Additionally, the Fourth Amended and Restated CreditAgreement provides for an increase in permitted revolver borrowings from $60.0to $100.0 million of which $80.0 million was made available as of the date ofthe refinancing. Annual permitted capital expenditures were increased from$30.0 to $50.0 million and certain restrictive covenants were modified toprovide the Company with additional flexibility.

 

**10.Other Events**

 

During the third quarter, the Company concluded the settlement of anarbitration proceeding related to the 1998 acquisition of Rock Bottom Stores,Inc. The Company recorded a current receivable of $6.0 million representingproceeds to be received under this settlement. The settlement proceeds werereceived in full on October 4, 2001. The settlement was allocated to litigationrelated costs ($3.5 million), goodwill ($1.5 million), and interest income($1.0 million).

 

During the third quarter,the Company ceased operations in one former Rock Bottom store located inBellmore, Long Island. As a result of this transaction, we incurred a loss of$0.2 million on the transfer of inventory and other assets which was reflectedin selling, general and administrative expenses.

 

**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND**                ** RESULTS OF OPERATIONS**

 

***The information contained herein includescertain forward-looking statements that involve a number of risks anduncertainties. A number of facts could cause actual results, performance,achievements of the Company, or industry results to be materially differentfrom any future results, performance or achievements expressed or implied bysuch forward-looking statements. These factors include, but are not limited to,the competitive environment in the drugstore industry in general and in theCompany's specific market area; inflation; changes in costs of goods andservices; economic conditions in general and in the Company's specific marketareas; demographic changes; changes in prevailing interest rates and theavailability of and terms of financing to fund the anticipated growth of theCompany's business; liability and other claims asserted against the Company;changes in operating strategy or development plans; the ability to attract andretain qualified personnel; the significant indebtedness of the Company; labordisturbance; changes in the Company’s acquisition and capital expenditureplans; and other factors referenced herein. In addition, such forward lookingstatements are necessarily dependent upon assumptions, estimates and dates thatmay be incorrect or imprecise and involve known and unknown risks,uncertainties and other factors. Accordingly, any forward-looking statementsincluded herein do not purport to be predictions of future events orcircumstances and may not be realized. Forward-looking statements can beidentified by, among other things, the use of forward-looking terminology suchas "believes," "expects," "may," "will,”"should," "seeks,” "pro forma,” "anticipates,""intends" or the negative of any thereof or other variations thereonor comparable terminology, or by discussion of strategy or intentions.  Given these uncertainties, investors arecautioned not to place undue reliance on such forward-looking statements. TheCompany disclaims any obligations to update any such factors or to publiclyannounce the results of any revisions to any of the forward-looking statementscontained herein to reflect future events or developments.***

 

**Results of Operations**

 

The following sets forththe results of operations as a percentage of sales for the periods indicated.

 
|                                       |   | **13 Weeks Ended** |   | **39 Weeks Ended** |   |
|--------------------------------------------|--------|--------------------|--------|--------------------|--------|
|                                       |   | **Sept 29, 2001**  |   | **Sept 23, 2000**  |   | **Sept 29, 2001** |   | **Sept 23, 2000** |   |
| Net  sales                            |   | 100.0              | %      | 100.0              | %      | 100.0 | % | 100.0 | % |
| Cost of sales                              |   | 76.4               |   | 73.4               |   | 76.1 |   | 74.8 |   |
| Gross profit                               |   | 23.6               |   | 26.6               |   | 23.9 |   | 25.2 |   |
| Selling,  general and admin expenses       |   | 15.4               |   | 15.7               |   | 15.5 |   | 15.7 |   |
| Depreciation  & amortization           |   | 2.4                |   | 2.5                |   | 2.3 |   | 2.5 |   |
| Store  pre-opening expense                 |   | 0.2                |   | 0.1                |   | 0.2 |   | 0.2 |   |
| Operating  income                          |   | 5.6                |   | 8.3                |   | 5.9 |   | 6.8 |   |
| Interest  expense, net                     |   | 1.8                |   | 3.7                |   | 2.6 |   | 3.7 |   |
| Income before  income taxes                |   | 3.8                |   | 4.6                |   | 3.3 |   | 3.1 |   |
| Income taxes                               |   | 1.5                |   | 1.9                |   | 1.4 |   | 1.3 |   |
| Income before  extraordinary charge        |   | 2.3                |   | 2.7                |   | 1.9 |   | 1.8 |   |
| Extraordinary  charge, net of income taxes |   | -                  |   | -                  |   | 0.2 |   | - |   |
| Net income                                 |   | 2.3                | %      | 2.7                | %      | 1.7 | % | 1.8 | % |

 

 

**ThirteenWeeks Ended September 29, 2001 versus Thirteen Weeks September 23, 2000**

 

On September 11, 2001, as a result of the terrorist attack on the WorldTrade Center in lower Manhattan, the Company lost all of its inventory andother property and equipment in its World Trade Center location and lost aportion of its inventory and other property in several other locations. TheCompany also experienced substantial business disruption resulting from thepermanent loss of two stores and temporary closings of 20 additional storesduring the period immediately following the attacks. The Company believes thatit is fully insured for its property and business interruption losses inconnection with this event as well as the extra costs to return temporarily closedstores to normal operations. As of September 29, 2001 all of the temporarilyclosed stores had reopened. At September 29, 2001, the Company had recognizedan insurance claim receivable of $4.2 million representing the portion of itsidentified property losses deemed fully recoverable. Business interruptionlosses related to lost sales, resultant lower gross profit, and increasedexpenses that primarily resulted from the lost stores and temporary storeclosings during this period have been reflected in results of operations.  Expected insurance recoveries for thebusiness interruption portion of the Company’s insurance claim will berecognized when collection of such recoveries is assured.

 

Net sales were $279.4million in the third quarter of 2001, an increase of 15.0% over net sales of$243.0 million for the third quarter of 2000. Pharmacy sales increased from$86.5 million in the third quarter of 2000 to $109.9 million in the thirdquarter of 2001, an increase of 27.1%, and represented 39.3% of total sales,while front-end sales increased from $156.5 million in the third quarter of2000 to $169.5 million in the third quarter of 2001, an increase of 8.3%, andrepresented 60.7% of total sales.  Forthe third quarter of 2001, third-party reimbursed pharmacy sales represented86.9% of total pharmacy sales, as compared to 84.0% in the third quarter of2000. The increase in total sales over last year was attributable to the fullquarterly impact of seven stores opened during the third quarter of 2000 andsales from 27 net new stores opened since the third quarter of 2000, combinedwith increased comparable store sales, for the ten week period preceding theWorld Trade Center disaster, of 7.5%, including increases in pharmacy andfront-end same store sales of 17.5% and 3.0%, respectively. For the three weekperiod subsequent to the World Trade Center disaster, the two storespermanently lost and the large number of temporarily closed stores coupled withrestricted access to other locations resulted in substantial declines in ournormal sales trends. During the third quarter of 2001 we opened nine stores,compared to seven store openings in last year’s third quarter.  In addition to the two stores lost as aresult of the World Trade Center disaster, we closed one additional store,compared to one store closure during the third quarter of 2000.  At September 29, 2001, we operated 193stores, versus 166 at September 23, 2000.

 

Cost of sales as a percentage of net sales increased to 76.4% for thethird quarter of 2001 from 73.4% for the third quarter of 2000, resulting in adecrease in gross profit margin to 23.6% for the third quarter of 2001 from26.6% for the third quarter of 2000. This decrease was attributable to a variety of factors primarilyresulting from the World Trade Center disaster, including reduced customerdemand for higher margin discretionary purchases and lower levels of vendorincome from sales related rebates and allowances, partially offset by increasedincome associated with proceeds received from sales of market related data.Cost of sales also reflects higher estimates of inventory shrink losses. Inaddition, gross margins declined due to the impact of an increased proportionof lower margin pharmacy and third-party reimbursed pharmacy sales in relationto front-end sales.

 

Selling, general and administrative expenses were $43.0 million, or15.4% of net sales, and $38.2 million, or 15.7% of net sales, in the thirdquarters of 2001 and 2000, respectively. The decrease in these expenses as a percentage of sales is primarily dueto reductions in earnings-based incentive compensation and related benefitcosts.

 

Depreciation and amortization of intangibles in the third quarters of2001 and 2000 were $6.7 million and $6.2 million, respectively.  This increase resulted primarily fromincreases in the amortization of pharmacy customer lists and lease acquisitioncosts for pharmacy acquisitions completed since the third quarter of 2000,combined with incremental depreciation expenses related to capital expendituresin 2000 and 2001.

 

We incurred store pre-opening expenses of $0.5 million during the thirdquarter of 2001 related to the opening of nine stores.  During the comparable period last year, weincurred pre-opening expenses of $0.3 million related to the opening of sevenstores.

 

Net interest expense decreased 43.4% to $5.1 million in the thirdquarter of 2001 from $9.0 million in the third quarter of 2000.  This decrease was primarily attributable tothe second quarter repayment of $130.4 million of senior debt from the proceedsfrom sales of Primary Shares in the Offering, which is more fully described inthe section entitled “Liquidity and Capital Resources” beginning on page12.  In addition, interest expense wasreduced by $1.0 million in interest income associated with the settlement of anarbitration proceeding related to the 1998 acquisition of Rock Bottom Stores.

 

Our income before income taxes in the third quarter of 2001 decreased3.4% to $10.6 million from $11.0 million in the third quarter of 2000,reflecting the factors discussed above.

 

In the third quarter of 2001, we recorded an income tax provision of$4.2 million, reflecting an estimated annual effective tax rate of 43.0%,reduced by $0.3 million of employment tax credits. In the comparable periodlast year, the income tax provision of $4.7 million reflected an estimatedeffective tax rate of 44.0%, reduced by employment tax credits of $0.1 million.

 

Our net income was $6.4million in the third quarter of 2001, compared to $6.2 million in the thirdquarter of 2000, reflecting the decline in pre-tax income, offset by the taxprovision reduction of $0.5 million.

 

**Thirty-NineWeeks Ended September 29, 2001 versus Thirty-Nine Weeks Ended September 23,2000**

 

Net sales were $843.5million in the first nine months of 2001, an increase of 18.3% over net salesof $712.8 million for the first nine months of 2000. Pharmacy sales increasedfrom $250.1 million in the first nine months of 2000 to $324.7 million in thefirst nine months of 2001, an increase of 29.8%, and represented 38.5% of totalsales, while front-end sales increased from $462.7 million in the first ninemonths of 2000 to $518.8 million in the first nine months of 2001, an increaseof 12.1%, and represented 61.5% of total sales.  For the first nine months of 2001, third-party reimbursedpharmacy sales represented 86.5% of total pharmacy sales, as compared to 84.0%in the first nine months of 2000. The increase in total sales over last yearwas attributable to increased comparable store sales, for the thirty-six weekspreceding the World Trade Center disaster, of 7.9%, including increases inpharmacy and front-end same store sales of 17.2% and 2.8%, respectively,combined with the impact of sales from 27 net new stores opened since the thirdquarter of 2000, offset by lower sales volume after the September 11, 2001terrorist attack. We opened twenty-four stores and closed three stores duringthe first nine months of 2001, compared to eighteen store openings and onestore closure during the first nine months of 2000.

 

Cost of sales as a percentage of net sales increased to 76.1% for thefirst nine months of 2001 from 74.8% for the first nine months of 2000,resulting in a decrease in gross profit margin to 23.9% for the first ninemonths of 2001 from 25.2% for the first nine months of 2000.  This decrease was primarily attributable toan increased proportion of lower margin pharmacy and third-party reimbursedpharmacy sales in relation to front-end sales, and was further affected by theimpact of the factors described above relative to the third quarter.

 

Selling, general and administrative expenses were $130.9 million, or15.5% of net sales, and $111.8 million, or 15.7% of net sales in the first ninemonths of 2001 and 2000, respectively. The decrease in these expenses as a percentage of sales reflected theleveraging of expenses against maturing and new store sales growth as well asreductions in earnings-based incentive compensation and related benefits costs.

 

Depreciation and amortization of intangibles in the first nine monthsof 2001 and 2000 were $19.7 million and $18.2 million, respectively.  This increase resulted primarily fromincreases in the amortization of pharmacy customer lists and lease acquisitioncosts for pharmacy acquisitions completed since the third quarter of 2000,combined with incremental depreciation expenses related to capital expendituresin 2000 and 2001.

 

We incurred store pre-opening expenses of $1.4 million during the firstnine months of 2001 related to the opening of 24 stores. Pre-opening costs of$1.1 million were incurred during the first nine months of 2000 for the openingof eighteen stores

 

Net interest expense decreased 16.2% to $21.8 million in the first ninemonths of 2001 from $26.0 million in the first nine months of 2000.  This decrease was primarily attributable tothe second quarter repayment of $130.4 million of senior debt from the proceedsfrom sales of the Primary Shares in the Offering, which is more fully describedin the section entitled “Liquidity and Capital Resources.”  In addition, interest expense benefited from$1.0 million of interest income associated with the settlement of anarbitration proceeding related to the 1998 acquisition of Rock Bottom Stores,Inc. and a continuing decrease in short-term interest rates that reduced theinterest rates on $8.1 million of our floating rate term borrowings and all ofour revolving loans under the Senior Credit Agreement.

 

Our income before income taxes in the first nine months of 2001increased 22.7% to $27.9 million from $22.7 million in the first nine months of2000, reflecting increased sales and related gross profit dollars and reducedinterest costs, partially offset by increases in selling, general andadministrative expenses and the third quarter impact of business interruptionassociated with the World Trade Center disaster (as more fully described underour Discussion and Analysis of Results of Operations for the 13 weeks endedSeptember 29, 2001).

 

In the first nine months of 2001, we recorded an income tax provisionof $11.6 million, reflecting an estimated annual effective tax rate of 43.0%,partially offset by $0.3 million of employment-related tax credits. In thecomparable period last year, the income tax provision of $9.6 million reflectedan estimated effective tax rate of 44.0%, offset by $0.4 million ofemployment-related tax credits.

 

During the first ninemonths of 2001, we recorded an extraordinary charge of $1.5 million, net of anincome tax benefit of $1.1 million, reflecting the accelerated amortization ofdeferred financing costs related to (a) the portion of our Senior CreditAgreement which was repaid with the proceeds of the Primary Shares under theOffering, and (b) the remaining portion of our Term B and Term C loans thatwere refinanced as a result of the completed Offering and related debtrefinancing.

 

Our net income was $14.7million in the first nine months of 2001, compared to $13.1 million in thefirst nine months of 2000, reflecting the improvement in pre-tax income,partially offset by the incremental tax provision of $2.0 million and theextraordinary charge of $1.5 million described above.

 

**Liquidity and Capital Resources**

 

On June 13, 2001, we completed a public offering (the “Offering”) ofour common stock.  A total of 8,050,000shares, including 4,000,000 primary shares (the “Primary Shares”) and 4,050,000secondary shares (the “Secondary Shares”), were sold at a net price, afterunderwriting discounts and commissions, of $32.84 per share. Sales of thePrimary Shares resulted in net proceeds of $130.4 million to the Company, afterunderwriting discounts, commissions and expenses connected with theOffering.  The Secondary Shares werecomposed of 3,740,000 shares owned by private equity funds managed by CreditSuisse First Boston Corporation, 228,000 shares representing options exercisedby members of our management team and 82,000 shares owned by the same membersof management. The exercise of options by selling stockholders generatedadditional proceeds to the Company of $0.5 million. The combined proceeds ofthis transaction of $130.9 million were used to reduce the outstanding balancesof the term and revolving loans under the Senior Credit Agreement by $91.5million and $39.4 million respectively.

 

Working capital was $209.6 million as of September 29, 2001 and $154.5million as of December 30, 2000. The increase was primarily due to increases ininventory related to the opening of twenty-four additional stores during thefirst nine months of 2001 and higher inventory levels attributable to thebusiness interruption associated with the World Trade Center disaster, combinedwith an increase in accounts receivable reflecting the settlement of anarbitration proceeding related to the 1998 purchase of Rock Bottom Stores,Inc., as well as the anticipated insurance recovery of property-related damagesincurred in the World Trade Center disaster. Working capital was also higherthan at December 30, 2000 due to a reduction in the current portion ofoutstanding term loans payable under the Senior Credit Agreement resulting fromthe Offering. This was partially offset by a reduction in the current portionof the deferred tax asset related to the current year’s tax provision and anincrease in accounts payable related to the additional inventory purchasedduring the period.

 

For the first ninemonths of 2001, net cash used by operating activities was $4.2 million, ascompared to net cash provided by operating activities of $7.0 million in thefirst nine months of 2000. The decrease was primarily due to the higherinvestment in working capital described above.

 

For the 39 weeks endedSeptember 29, 2001, our EBITDA (earnings before interest, taxes, depreciation,amortization and deferred rent charges) increased by 4.1% to $73.4 million, or8.7% of sales, compared to $70.5 million, or 9.9% of sales, in the first ninemonths of 2000.

 

Net cash used ininvesting activities was $36.3 million during the first nine months of 2001,compared to $20.8 million during the first nine months of 2000.  In the first nine months of 2001, capitalexpenditures, primarily related to new store openings and the remodeling ofexisting locations, amounted to $31.9 million, while lease and pharmacycustomer file acquisition costs accounted for $4.4 million of cash used ininvesting activities.  In the first ninemonths of 2000, $19.2 million was spent on capital expenditures and $1.6million on lease and pharmacy customer file acquisition costs.

 

Net cash provided byfinancing activities was $40.6 million for the first nine months of 2001,compared to $14.1 million for the first nine months of 2000. The increasereflects the higher level of capital expenditures, higher cash acquisitionrelated costs and the increase in working capital investment over the prioryear.

 

Our capital requirementsprimarily result from opening and stocking new stores, remodeling andrenovating existing retail locations and from the continuing development ofmanagement information systems. We believe that there are significant opportunitiesto open additional stores.  We currentlyplan to open approximately 30 new stores this year, including the 24 storesopened during the first nine months, and 35 to 40 new stores in fiscal 2002. Weexpect to spend approximately $37.0 million in 2001 on capital expenditures,primarily for new, renovated and replacement stores, and an additional $6.0million for lease and pharmacy customer file acquisition costs. We also requireworking capital to support inventory for our existing stores. Historically, wehave been able to lease all of our store locations.

 

We believe that, basedon current levels of operations and anticipated growth, cash flow fromoperations, together with other available sources of funds, including revolvingand term loan borrowings under our Senior Credit Agreement, will be adequatefor at least the next two years to make required payments of principal andinterest on our indebtedness, to fund anticipated capital expenditures andworking capital requirements, and to comply with the terms of our debtagreements. As of September 29, 2001, we had $23.5 million of borrowings underthe revolving portion of our Senior Credit Agreement and had $55.7 million ofremaining availability, net of $0.8 million of outstanding Letters of Credit.  Our ability to meet our debt serviceobligations and reduce our total debt will be dependent upon our futureperformance, which, in turn, will be subject to general economic, financial,business, competitive, legislative, regulatory, and other conditions, many ofwhich are beyond our control. In addition, we cannot assure you that ouroperating results, cash flow and capital resources will be sufficient to repayour indebtedness in the future. Substantially all of our future revolving andoutstanding term loan borrowings under our Senior Credit Agreement bearinterest at floating rates. There was approximately $181.6 million of floatingrate debt outstanding on September 29, 2001; therefore, our financial conditionwill be affected by changes in prevailing interest rates. On December 20, 2000,we entered into a two-year interest rate swap in the notional amount of $150.0million. This swap, which had an effective date of January 12, 2001,represented a hedging transaction whereby we would receive interest at afloating rate and pay interest at a fixed LIBOR rate.  The effect of this swap was to fix our interest obligations on$150.0 million of floating rate debt for two years at a LIBOR rate of 5.8075%plus the applicable margins as defined in the Senior Credit Agreement. See“Market Risk.”

 

The Senior CreditAgreement and the indenture relating to our senior subordinated notes containvarious covenants that limit or restrict, among other things, subject tospecified exceptions, our ability to make capital expenditures, incurindebtedness, permit liens on our property, enter into transactions withaffiliates, make restricted payments, investments or acquisitions, enter intomergers, consolidations or dissolutions, conduct assets sales, pay dividends ordistributions and enter into other specified transactions and businessactivities.  Financial performancecovenants included in our Senior Credit Agreement include interest coverage,leverage ratios, minimum net worth requirements and fixed charge coveragerequirements.  At September 29, 2001, wewere in compliance with all financial performance covenants.

 

**Tax Benefits from Net OperatingLosses**

 

At December 30, 2000, wehad net operating loss carryforwards, or NOLs, of approximately $23.0 million,which are due to expire in the years 2007 through 2018. These NOLs may be usedto offset future taxable income through 2018 and thereby reduce or eliminateour federal income taxes otherwise payable. The Internal Revenue Code of 1986,as amended, imposes significant limitations on the utilization of NOLs in theevent of an "ownership change," as defined in Section 382 of theCode. This Section 382 limitation is an annual limitation on the amount ofpre-ownership change NOLs that a corporation may use to offset its post-ownershipchange income. The Section 382 limitation is calculated by multiplying thevalue of a corporation's stock immediately before an ownership change by thelong-term tax-exempt rate (as published by the Internal Revenue Service).Generally, an ownership change occurs with respect to a corporation if theaggregate increase in the percentage of stock ownership by value of thatcorporation by one or more 5% shareholders, including specified groups ofshareholders who in the aggregate own at least 5% of that corporation's stock,exceeds 50 percentage points over a three-year testing period. Ourrecapitalization in 1997 caused us to experience an ownership change. As aresult, we are currently subject to an annual Section 382 limitation ofapproximately $8.5 million in 2001 and approximately $5.1 million from 2002 to2007 on the amount of NOLs generated prior to the recapitalization that we mayuse to offset future taxable income. All of the NOL's existing as of December30, 2000 were generated prior to the 1997 recapitalization and accordingly,were subject to this limitation.  It ispossible that as a result of the sale of common stock in our June 2001offering, combined with future issuance of new shares or sales, we may incur afurther ownership change.  Anyadditional limitation due to a further ownership change could be morerestrictive than the current limitations. We cannot assure you that we will beable to use any NOLs to offset future taxable income.  Based on our recent and projected performance, however,management believes that it is more likely than not that the full value of theNOLs will be realized.

 

**Seasonality**

 

In general, sales ofdrugstore items such as prescription drugs, over-the-counter drugs and healthand beauty care products exhibit limited seasonality in the aggregate, but dovary by product category. Quarterly results are primarily affected by thetiming of new store openings and the sale of seasonal products, with theChristmas holiday season generating a higher proportion of sales and earningsthan other periods.

 

**Recently Issued AccountingPronouncements**

 

FASB Statement No. 133"Accounting for Derivative Instruments and Hedging Activities"requires that derivative instruments such as interest rate swaps be recorded asassets and liabilities at fair value and provides guidance for recognition ofchanges in fair value depending on the reason for holding the derivative. Asdiscussed in Note No. 8, “Newly Adopted Accounting Standards,” we adoptedStatement No. 133 during the first quarter of 2001, but this action did nothave a material impact on our consolidated financial statements.

 

During the thirdquarter, the Company adopted Financial Accounting Standards BoardPronouncements Nos. 141 (FAS 141) and 142 (FAS 142) “Business Combinations” and“Goodwill and Other Intangible Assets”, respectively, for acquisitionscompleted after June 30, 2001 (See Note No. 7 “Acquisitions”). This adoptiondid not have a material impact on the Company’s results of operations,financial position or cash flows. Beginning in fiscal 2002, the Company expects that the annual goodwillamortization will be reduced by approximately $4.4 million upon the adoption ofFAS 142 for acquisitions completed prior to July 1, 2001.

 

**Market Risk**

 

Our financial resultsare subject to risk from interest rate fluctuations on debt, which carriesvariable interest rates. Variable rate debt outstanding under our Senior CreditAgreement was approximately $181.6 million at September 29, 2001. On December20, 2000, we purchased a two-year interest rate swap in the notional amount of$150.0 million.  This swap, which had aneffective date of January 12, 2001, represented a hedging transaction toeffectively convert $150.0 million of floating rate debt to a fixed rate.  This fixed rate is equivalent to a LIBORrate of 5.8075% plus the applicable margins described in our Senior CreditAgreement.  At September 29, 2001, theweighted average prime, 30-day and 90-day LIBOR rates in effect on the $31.6million balance of the floating rate term and revolving debt was 3.51%. A 0.50%change in interest rates applied to the $31.6 million balance of floating ratedebt would affect pre-tax annual results of operations by $0.2 million. We alsohave $80.0 million of senior subordinated notes outstanding at September 29,2001, which bear interest payable semi-annually at a fixed rate of 9.25%, andare therefore not subject to risk from interest rate fluctuations.

 

The principal objectiveof our investment management activities is to maintain acceptable levels ofinterest rate and liquidity risk to facilitate our funding needs. As part ofour risk management, we may use additional derivative financial products suchas interest rate hedges and interest rate swaps in the future.

### ** **

 

**PART II**

**OTHER INFORMATION**

 

**ITEM 1.  Legal Proceedings**

                                Weare a party to legal actions arising in the ordinary course of business.  Based on information presently available tous, we believe that we have adequate legal defenses or insurance coverage forthese actions and that the ultimate outcome of these actions will not have amaterial adverse effect on us.

 

                                Duringthe third quarter, we entered into a settlement agreement related to anarbitration proceeding associated with a dispute arising from our 1998acquisition of Rock Bottom Stores. Under this agreement, both parties havereleased each other from any and all outstanding claims in connection with thisacquisition.

 

 
|   | **ITEM  2.  Changes in Securities and Use of  Proceeds**  Not applicable                                                                                                                                                                                                                                                                                                         |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                  |   |
|   | **ITEM  3.  Defaults Upon Senior Securities**  Not applicable                                                                                                                                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                  |   |
|   | **ITEM  4.  Submission of Matters to a Vote of  Security Holders**  Not applicable                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                  |   |
|   | **ITEM 5.  Other Information**  On August 31, 2001, Duane Reade’s collective bargaining agreement with the  Allied Trades Council, covering employees at approximately 140 stores,  expired pursuant to its terms.   Leading up to that date and continuing thereafter, the parties have  continued negotiating terms for a successor collective bargaining agreement. |
|   |                                                                                                                                                                                                                                                                                                                                                                                  |   |
|   | **ITEM  6.  Exhibits, Financial Statement  Schedules and Reports on Form 8-K**                                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                  |   |
|   | (a)                                                                                                                                                                                                                                                                                                                                                                                   | The following documents are filed as a part of this report: |
|   |                                                                                                                                                                                                                                                                                                                                                                                  |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                  | (i)            Financial  Statements |
|   |                                                                                                                                                                                                                                                                                                                                                                                  |   |
|   |                                                                                                                                                                                                                                                                                                                                                                                  | (ii)           Exhibits |

 
| 3.1(i)   |   | Amended and Restated Certificate of Incorporation of  the Company (incorporated by reference to Exhibit 3.1(i) to the Company’s  Registration Statement No. 333-41239 (the “Common Stock S-1”)).                                          |
|----------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(ii)  |   | Certificate of Amendment of Amended and Restated  Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to  Amendment No. 1 to the Company’s Registration Statement on Form S-3 dated  July 22, 2001).                             |
| 3.1(iii) |   | Amended and Restated By-laws of the Company  (incorporated by reference to Exhibit 3.1(ii) to the Common Stock S-1).                                                                                                                                     |
| 3.2(i)   |   | Certificate of Incorporation of DRI I Inc.  (incorporated by reference to Exhibit 3.2(i) to the S-1 Registration  Statement No. 333-43313 with respect to the Company’s 9 1⁄4% Senior  Subordinated Notes due 2008 (the “Notes S-1”)). |
| 3.2(ii)  |   | By-laws of DRI I Inc. (incorporated by reference to  Exhibit 3.2(ii) to the Notes S-1).                                                                                                                                                                  |
| 3.3      |   | Second Amended and Restated Partnership Agreement of  Duane Reade (incorporated by reference to Exhibit 3.3 to the Notes S-1).                                                                                                                           |
| 3.4(i)   |   | Certificate of Incorporation of Duane Reade  International, Inc. (incorporated by reference to Exhibit 3.4(i) to the  Company’s Annual Report on Form 10-K for the year ended December 26, 1999  (the “1999 10-K”)).                      |

 
| 3.4(ii) |   | By-laws of Duane Reade International, Inc.  (incorporated by reference to exhibit 3.4(ii) to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.5(i)  |   | Certificate of Incorporation of Duane Reade Realty,  Inc. (incorporated by reference to Exhibit 3.5(i) to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 3.5(ii) |   | By-laws of Duane Reade Realty, Inc. (incorporated by  reference to Exhibit 3.5(ii) to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 4.1     |   | Form of Indenture (incorporated by reference to  Exhibit 4.1 to the Notes S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.1    |   | Duane Reade Inc. 1997 Equity Participation Plan  (incorporated by reference to Exhibit 10.1 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.2    |   | Duane Reade Inc. Holding Corp. 1992 Stock Incentive  Plan (incorporated by reference to Exhibit 10.2 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.3    |   | Employment Agreement, dated as of October 27, 1997,  between the Company and Anthony J. Cuti (incorporated by reference to Exhibit  10.3 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.4    |   | Employment Agreement, dated as of February 22, 1993,  as amended, between the Company and Gary Charboneau (incorporated by  reference to Exhibit 10.4 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.5    |   | Employment Agreement, dated as of April 10, 1995, as  amended, between Duane Reade and Jerry M. Ray (incorporated by reference to  Exhibit 10.5 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.6    |   | Employment Letter Agreement, dated as of October 9,  1996, between Duane Reade and Joseph Lacko (incorporated by reference to  Exhibit 10.6 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.7    |   | Employment Letter Agreement, dated as of February  12, 1997, between the Company and William Tennant (incorporated by reference  to Exhibit 10.7 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.8    |   | Agreement, dated as of November 22, 1996, as  amended, between Duane Reade and Drug, Chemical, Cosmetic, Plastics and  Affiliated Industries Warehouse Employees Local 815 (incorporated by  reference to Exhibit 10.8 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.9    |   | Agreement, dated July 16, 1992, as amended, between  Duane Reade and Allied Trades Council (incorporated by reference to Exhibit  10.9 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.10   |   | Stockholders and Registration Rights Agreement,  dated as of June 18, 1997, among the Company, DLJMB Funding II, Inc., DLJ  Merchant Banking Partners II, L.P., DLJ Diversified Partners, L.P., DLJ First  ESC L.L.C., DLJ Offshore Partners, II, C.V., DLJ EAB Partners, L.P., UK  Investment Plan 1997 Partners, Bankers Trust New York Corporation, Conac  & Co., Muico & Co., Roton & Co., Putnam High Yield Trust,  PaineWebber Managed Investment Trust on behalf of PaineWebber High Income  Fund, USL Capital Corporation, Pearlman Family Partners, The Marion Trust,  Bruce L. Weitz, BCIP Associates, BCIP Trust Associates, L.P., Tyler Capital  Fund L.P., Tyler International, L.P.-II, and Tyler Massachusetts, L.P.  (incorporated by reference to Exhibit 10.13 to the Common Stock S-1). |
| 10.11   |   | Amended and Restated Partnership Security Agreement,  dated as of September 11, 1998, among Duane Reade Inc. and DRI I Inc. and  Fleet National Bank, as Administrative Agent (incorporated by reference to  Exhibit 10.15 to the Company’s Current Report on Form 8-K dated September 24,  1998).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.12   |   | Amended and Restated Borrower Security Agreement,  dated as of September 11, 1998, between Duane Reade and Fleet National Bank  as Administrative Agent (incorporated by reference to Exhibit 10.16 to the  Company’s Current Report on Form 8-K dated September 24, 1998).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.13   |   | Amended and Restated Holdings Pledge Agreement,  dated as of September 11, 1998, among Duane Reade Inc. and Fleet National  Bank, as Administrative Agent (incorporated by reference to Exhibit 10.17 to  the Company’s Current Report on Form 8-K dated September 24, 1998).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.14   |   | Promissory Note, dated as of November 9, 1998,  between the Company and Anthony J. Cuti (incorporated by reference to Exhibit  10.16 to the Company’s 1998 Annual Report on Form 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.15   |   | Employment Letter, dated June 10, 1999, between the  Company and John K. Henry (incorporated by reference to Exhibit 10.18 to the  1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.16   |   | Promissory Note, dated as of June 7, 1999, between  the Company and Anthony J. Cuti (incorporated by reference to Exhibit 10.19  to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.17   |   | Promissory Note, dated as of December 30, 1999,  between the Company and Anthony J. Cuti (incorporated by reference to Exhibit  10.20 to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.18   |   | Fourth Amended and Restated Credit Agreement, dated  as of July 10, 2001, among Duane Reade, as the Borrower, Duane Reade Inc. and  DRI I Inc., as the Parent Guarantors, Various Financial Institutions set  forth therein, as the Lenders, Credit Suisse First Boston, as the Syndication  Agent for the Lenders, and Credit Lyonnais New York Branch, as the  Documentation Agent for the Lenders (incorporated by reference to Exhibit  10.29 to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2001).                                                                                                                                                                                                                                                                            |
| 10.19   |   | First Amendment to Employment Agreement, dated March  13, 2000, between the Company and Anthony J. Cuti (incorporated by reference  to Exhibit 10.23 to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.20   |   | Agreement, dated April 1, 1999, between Duane Reade  and Local 340A/340B, New York (incorporated by reference to Exhibit 10.21 to  the Company’s Quarterly Report on Form 10-Q for the period ended September  23, 2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.21   |   | Promissory Note, dated as of January 10, 2001,  between the Company and Anthony J. Cuti (incorporated by reference to Exhibit  10.24 to the 2000 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.22   |   | Second Amendment to Employment Agreement, dated May  1, 2001, between the Company and Anthony J. Cuti (incorporated by reference  to Exhibit 10.25 to the Company’s Quarterly Report on Form 10-Q for the  period ended March 31, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.23   |   | Second Amendment to Employment Agreement, as  amended, dated May 21, 2001, between the Company, Credit Suisse First Boston  Ltd. and Anthony J. Cuti (incorporated by reference to Exhibit 10.1 to  Amendment No. 1 to the Company’s Registration Statement on Form S-3 dated  July 22, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.24   |   | Employment Letter, dated June 14, 2001, between the  Company and Bruce E. Schwallie (incorporated by reference to Exhibit 10.28 to  the Company's Quarterly Report on Form 10-Q for the period ended June 30,  2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 21.1    |   | Subsidiaries of the Company (incorporated by  reference to Exhibit 21.1 to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

 

 
|   | (b)    | Reports on Form 8-K:           | None   |
|--------|--------|--------------------------------|--------|
|   |   |                           |   |
|   | (c)    | Financial Statement Schedules: | None   |

 

 

Schedules for which provision is made in theapplicable accounting regulations of the Commission are either not requiredunder the related instructions, are inapplicable or not material, or theinformation called for thereby is otherwise included in the financialstatements and therefore has been omitted.

 

**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated:    November 13, 2001
|   |   | **DUANE  READE, Inc.** |
|--------|--------|------------------------|
|   |   | (Registrant)           |
|   |   |                   |   |
|   |   | By:                    | /s/ John K. Henry |
|   |   |                   | Name: | John K. Henry |
|   |   |                   | Title: | Senior Vice President and Chief Financial |
|   |   |                   |   | Officer |

 

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant in the capacities indicated on November 13,2001.
| SIGNATURES          |   | TITLES                                             |
|---------------------|--------|----------------------------------------------------|
|                |   |                                               |
| /s/ Anthony J. Cuti |   | President and Chief Executive Officer and Director |
| Anthony J. Cuti     |   | (Principal Executive Officer)                      |
|                |   |                                               |
|                |   |                                               |
| /s/ John K. Henry   |   | Senior Vice President and Chief Financial Officer  |
| John K. Henry       |   | (Principal Accounting and Financial Officer)       |

 

** **

**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated:    November 13, 2001
|   | **DRI I  Inc.** |
|--------|-----------------|
|   |            |   |   |
|   | By:             | /s/ John K. Henry |
|   |            | Name: | John K. Henry |
|   |            | Title: | Senior Vice President and Chief Financial Officer |
|        |                 |  |  |  |

 

 

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed on November 13, 2001 by:
| SIGNATURES          |   | TITLES                                             |
|---------------------|--------|----------------------------------------------------|
|                |   |                                               |
| /s/ Anthony J. Cuti |   | President and Chief Executive Officer and Director |
| Anthony J. Cuti     |   | (Principal Executive Officer)                      |
|                |   |                                               |
|                |   |                                               |
| /s/ John K. Henry   |   | Senior Vice President and Chief Financial Officer  |
| John K. Henry       |   | (Principal Accounting and Financial Officer)       |

 

**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

Dated:    November 13, 2001

 
|   |                                              |   | **DUANE  READE** |
|--------|---------------------------------------------------|--------|------------------|
|   |                                              |   |             |   |
| By:    | DRI I Inc., a general partner                     |   | By:              | Duane Reade Inc**.**, a general partner |
|   |                                              |   |             |   |
|   |                                              |   |             |   |
| By:    | /s/ John K. Henry                                 |   | By:              | /s/ John K. Henry |
| Name:  | John K. Henry                                     |   | Name:            | John K. Henry |
| Title: | Senior Vice President and Chief Financial Officer |   | Title:           | Senior Vice President and Chief Financial Officer |
|        |                                                   |        |                  |  |  |  |

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below on November 13, 2001 by the following persons in the capacitiesindicated with respect to Duane Reade Inc. and DRI I Inc., the general partnersof Duane Reade, on behalf of Duane Reade (except as otherwise indicated):
| SIGNATURES          |   | TITLES                                             |
|---------------------|--------|----------------------------------------------------|
|                |   |                                               |
| /s/ Anthony J. Cuti |   | President and Chief Executive Officer and Director |
| Anthony J. Cuti     |   | (Principal Executive Officer)                      |
|                |   |                                               |
|                |   |                                               |
| /s/ John K. Henry   |   | Senior Vice President and Chief Financial Officer  |
| John K. Henry       |   | (Principal Accounting and Financial Officer)       |

 

 

** **

**         SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated:    November 13, 2001
|   | **DUANE  READE REALTY, Inc.** |
|--------|-------------------------------|
|   |                          |   |   |
|   | By:                           | /s/ John K. Henry |
|   |                          | Name: | John K. Henry |
|   |                          | Title: | Senior Vice President and Chief Financial Officer |
|        |                               |  |  |  |

 

 

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed on November 13, 2001 by:
| SIGNATURES          |   | TITLES                                             |
|---------------------|--------|----------------------------------------------------|
|                |   |                                               |
| /s/ Anthony J. Cuti |   | President and Chief Executive Officer and Director |
| Anthony J. Cuti     |   | (Principal Executive Officer)                      |
|                |   |                                               |
|                |   |                                               |
| /s/ John K. Henry   |   | Senior Vice President and Chief Financial Officer  |
| John K. Henry       |   | (Principal Accounting and Financial Officer)       |

 

**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated:    November 13, 2001
|   | **DUANE  READE INTERNATIONAL, Inc.** |
|--------|--------------------------------------|
|   |                                 |   |   |
|   | By:                                  | /s/ John K. Henry |
|   |                                 | Name: | John K. Henry |
|   |                                 | Title: | Senior Vice President and Chief Financial Officer |
|        |                                      |  |  |  |

 

 

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed on November 13, 2001 by:
| SIGNATURES          |   | TITLES                                             |
|---------------------|--------|----------------------------------------------------|
|                |   |                                               |
| /s/ Anthony J. Cuti |   | President and Chief Executive Officer and Director |
| Anthony J. Cuti     |   | (Principal Executive Officer)                      |
|                |   |                                               |
|                |   |                                               |
| /s/ John K. Henry   |   | Senior Vice President and Chief Financial Officer  |
| John K. Henry       |   | (Principal Accounting and Financial Officer)       |