UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
SCHEDULE 14A
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DUANE READE INC.
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(Name of Registrant as Specified In Its Charter)
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(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
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(1) Title of each class of securities to which transaction applies:
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(2) Aggregate number of securities to which transaction applies:
___________
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (set forth the amount on which
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(1) Amount Previously Paid: ____________
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(3) Filing Party: Duane Reade Inc.
(4) Date Filed: December 29, 2003
EXPLANATORY NOTE: On December 24, 2003, Duane Reade held a conference call to
discuss the proposed acquisition of Duane Reade by an affiliate of Oak Hill
Capital Partners L.P.
IMPORTANT INFORMATION ABOUT THE TRANSACTION
In connection with the transaction, Duane Reade intends to file
relevant materials with the Securities and Exchange Commission ("SEC"),
including a proxy statement and the acquiring entities will file other relevant
documents with the SEC. BECAUSE THOSE DOCUMENTS WILL CONTAIN IMPORTANT
INFORMATION, HOLDERS OF DUANE READE COMMON STOCK ARE URGED TO READ THEM, IF AND
WHEN THEY BECOME AVAILABLE. When filed with the SEC, they will be available for
free (along with any other documents and reports filed by Duane Reade with the
SEC) at the SEC's website, www.sec.gov, and Duane Reade stockholders will
receive information at an appropriate time on how to obtain transaction-related
documents for free from Duane Reade. Such documents are not currently available.
PARTICIPANT INFORMATION REGARDING THE TRANSACTION
Rex Corner Holdings, LLC, Rex Corner Holdings, Inc. and Rex Corner
Acquisition Corp. were formed as the acquiring entities at the direction of the
equity sponsors, which currently include Oak Hill Capital Partners, L.P., Oak
Hill Capital Management Partners, L.P. and certain members of Duane Reade's
management. Andrew J. Nathanson and Tyler J. Wolfram are the initial directors
of each newly formed Delaware corporation. These entities and their directors
and officers may be deemed to be participants in the solicitation of proxies in
connection with the proposed transaction. As of the date of this communication,
Mr. Nathanson has an indirect interest (through his participation in an
investment partnership) of less than 1% in the outstanding shares of the common
stock of Duane Reade and none of the other foregoing participants has any direct
or indirect interest, by security holdings or otherwise, in Duane Reade.
Duane Reade and its directors and executive officers may be deemed to
be participants in the solicitation of proxies from its stockholders in
connection with the proposed transaction. Certain information regarding the
participants and their interest in the solicitation is set forth in the proxy
statement for Duane Reade's 2003 annual meeting of stockholders filed with the
SEC on April 10, 2003 and the Form 4s filed by Duane Reade's directors and
executive officers since April 10, 2003. Stockholders may obtain additional
information regarding the interests of such participants by reading the proxy
statement relating to the proposed transaction when it becomes available.
TRANSCRIPT OF DECEMBER 24, 2003 CONFERENCE CALL
P R E S E N T A T I O N
OPERATOR
Good morning, ladies and gentlemen, and welcome to the Duane Reade Merger
Agreement Conference Call. During the presentation, all participants will be in
a listen-only mode. [Operator Instructions] Any reproduction of this call, in
whole or in part, is not permitted without prior express written authorization
from Duane Reade. And as a reminder, ladies and gentlemen, this conference is
being recorded. I would now like to introduce your host for today's conference,
Ms. Cara O'Brien of Financial Dynamics. Please go ahead, ma'am.
CARA O'BRIEN - Financial Dynamics - Investor Relations Counsel
Thank you, operator. Good morning, everyone, and thank you for joining us this
morning. By now, you should have received a copy of the press release that was
released yesterday. If you have not, please call our offices at 212-850-5600 and
we will send one out to you immediately. Before introducing Duane Reade's
management team, I'd like to read the safe harbor language. Any statement in
yesterday's press release or this conference call that may be considered
forward-looking is subject to risks and uncertainties that could cause actual
results to differ materially. Actual results may differ from such
forward-looking statements due to the factors discussed in Duane Reade's forms
filed with the SEC, which the company urges investors to consider. Please note
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that any forward-looking statements used in this call should not be relied upon
as current after today's date. I'd now like to introduce Anthony Cuti, Chairman
of the Board and CEO, and John Henry, Senior Vice President and CFO. Tony and
John will make some opening comments about the quarter, and then they will
take-- pardon me, Tony and John will make some opening comments, and then they
will take your questions. Pardon me. Tony, please go ahead.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Thank you, Cara, and good morning, everyone. Thank you, everyone, for joining us
on this holiday. As you are all aware, yesterday we announced that Duane Reade
will be acquired by Oak Hill Capital Partners, and we are very pleased with this
transaction. Both the board and I believe that this transaction brings excellent
value to our shareholders. Under the terms of the agreement, Duane Reade's
stockholders would receive $17 per share in cash. This purchase price represents
a 22.8% premium over the average closing price of Duane Reade stock for the last
30 trading days, through December 22nd. Let me add that the financing is fully
committed, though of course subject to the customary conditions of a transaction
of this type. Let me give you a bit of background, given the industry conditions
and market conditions that have persisted for some time, and I think it's
important to understand that this transaction has evolved not quickly, but over
a substantial period of time. I guess I'd like to commence with last April, when
Duane Reade's board of directors decided to retain Bear Stearns to conduct a
review of strategic alternatives for this company. After a very thorough and
extensive and very intensive process, we came to the conclusion that the
agreement that we announced yesterday provides the best value for our
shareholders. We are encouraged by what this deal means for our business. We
believe that it will provide an opportunity to investigate, explore, experiment,
with new avenues to improve the business, while at the same time maintaining and
supporting our leadership position in the metro New York market. As it pertains
to our day-to-day operations, specifically in relation to our customers, our
employees, our business partners, our landlords, we want to assure everyone that
we will continue to operate as usual. Moreover, we're committed to doing as much
as we can to make this as seamless a transaction as possible for all involved.
Finally, we're pleased to partner with Oak Hill. It's a very well-established
and respected private equity firm that's been doing business since the mid 80s.
We believe this is the right partner for us at the right time. Personally, I'm
proud to stay on with Duane Reade in my current position as part of management
and look forward to continuing to remain dedicated to this business. Now, I
think there's quite a few questions, I would imagine, so I'm going to cut this
short and take your questions. Operator, could you take questions as they queue
up, please?
Q U E S T I O N S A N D A N S W E R S
OPERATOR
[Operator Instructions] We'll take our first question from John Heinbockel. Go
ahead, please.
JOHN HEINBOCKEL - Goldman Sachs - Analyst
Hey, Tony, a couple of things. Can you talk about timing? You guys have been,
you know, buffeted with some things over the past couple of years, and with the
New York at least bottoming and maybe showing some life as we head into next
year, it does seem a little surprising at the timing that, you know, you would
do this transaction now. Can you talk about the thought process and timing a
little bit?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Well, clearly, the thought process on timing was sponsored more by a lot of the
industry fundamentals that have been shifting than by an economy which, frankly,
you know, we say it's bottomed. If I had to guess, I would agree with you, John,
that it's bottomed, but you know, I think you and I have seen quite a few
quarters where we made the same comment and turned out to be wrong. I'm not
projecting myself; I think we've bottomed as well. I would agree with you. But I
think there's never ever any certainty on that one issue, and I don't think the
economic issue is the driving issue. I think, you know, looking out, it's not an
economic issue, it's an industry issue. We have an industry that's undergoing
significant change and having significant forces applied against it. For the
first time in our history, we've seen an industry whose script count growth has
been cut in half in one year. That's not just Duane Reade; it's everyone in the
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industry has felt that impact. We've seen legislation on a state and federal
level totally change the game for reimbursement and programs. We've seen mail
order come in a very aggressive way. You know, recently, we find-- hello?
JOHN HEINBOCKEL - Goldman Sachs - Analyst
I'm here.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Operator? Operator?
OPERATOR
I'm trying to find the line the hold music is coming from. Hold on.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Operator? Hello?
OPERATOR
Yes, I'm sorry. I had someone's line-- I'm not sure why the hold music is
coming, but we are back on line now, and--
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
John Heinbockel, are you still there? Hello?
JOHN HEINBOCKEL - Goldman Sachs - Analyst
Hello?
OPERATOR
Hold on one second.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Hello?
OPERATOR
Mr. Heinbockel, go ahead.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
All right, so let me just go on with your answer, John. I apologize for the
interruption. The-- as I was saying, it's an industry fundamentals issue. We,
almost a year ago, started addressing strategic alternatives, because we had
quite a few issues that we needed to address, and the clear answer was not to
continue to going forth with business as usual. Whether the economy was going to
stay flat or bubble up or down a little bit really wasn't the fundamental issue.
The fundamental issue was, how are we going to address the changing
pharmaceutical environment, and it was rapidly changing. We've had drug
reimportation, mail order, we have RX to OTC shifts cutting back revenues
strongly in a number of primary products, we have state Medicaid programs
cutting reimbursement, we have an oncoming Medicare program in 2006. All of
these issues needed to be addressed. There are a lot of different directions
that can be taken in response to those issues, but they are directions that
require risk, and classically, risk costs money in the near-term, with longer
term potential, but nevertheless, near-term costs. And we have not seen that our
shareholders are desirous of paying the short-term price of the cost of those
risks. And we said we need to protect shareholder value, and we also need to
have a viable direction for this company, going forward. And that's what led to
the strategic alternative review we had. So the timing of the issue, again, is
not prompted by an economic thing, because the economy cycles, we all know that.
But the important thing was the industry fundamentals and the things we had to
do as a business to address those fundamental changes.
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JOHN HEINBOCKEL - Goldman Sachs - Analyst
And if you take a longer-term view, kind of a strategic view, you had a 10%
EBITDA margin. It's come down to 5. I think there was always the thought that
that would rebound to somewhere in between-- you know, maybe closer to five than
ten. When you think of the things-- where this industry is headed over the next
three, four years, how do you look at, you know, Duane Reade's, you know, sort
of profit potential? Do you still think, you know, that you can get a recovery
in profit margin or the things you're talking about, that will prevent that?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
No, I think-- look, my hope and my vision has always been that in the longer
term, the company can get to a higher profit-- profitability. But the question
was, the road there -- it's not months, it's years, and the road there
necessitates investment, necessitates risk, and you know, we have seen a
shareholder group that doesn't really care to rationalize short-term losses for
long-term gains. Just one good example of it, John, was we took a flyer on a
merchandising program a year ago, and as you recall, we tried a new pricing and
merchandising program in outer boroughs, and we got crushed by the marketplace
for trying it. So-- and that, really, was small potatoes, versus the kind of
programs we need to investigate to respond to the ever-increasing pressure that
are driving prescription counts up and reimbursements down.
JOHN HEINBOCKEL - Goldman Sachs - Analyst
All right, one final thing -- you talked about operating flexibility, that
you'll have a private company. You'll have more debt and obviously more interest
expense as part of this. What does that do to financial flexibility and then how
does your- the balance sheet you will have, you've always expressed an interest
in some of the Eckerd assets, particularly Genovese. Does that come off the
table because of the debt you'll have, or is that still doable?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Well, you know, I don't know what's going on with Eckerd, frankly. I know no
more than you do, through the public press, but clearly we've always said that
there are certain Eckerd assets that are attractive to us and they remain
attractive at a reasonable price. I think what this does, of course, is that, as
you recall on our last conference call, I had a number of questions about on
what basis would you consider some of the Eckerd assets, and the resounding
comments I received from people calling in, significant shareholders, were that
we would not expect you to do an investment in that business unless it was
non-dilutive in the first year, and that seemed to be the interest level of the
preponderance of our large shareholders, and we adopted that, and we've echoed
that in the conference call. We said that it seems that we feel that, you know,
we should not embark on a program which is dilutive in the first year. I think
with a private equity investor, you know, they may have a longer horizon. They
may say, you know, it doesn't have to be non-dilutive in the first year. Maybe
it can be a three-year payback, and that's OK for them. And again, I'm
speculating here now; I want to make that clear. I have had no discussions
whatsoever regarding a deal for Eckerd assets with anyone in the recent days, so
there is-- this is just hypothesis. But I will tell you, hypothesizing, I would
think, I only then have to face the interests of one party, rather than look to
all my shareholders and say, "will they take and hold their breath for two
years, while I take this risk?"
JOHN HEINBOCKEL - Goldman Sachs - Analyst
OK, thanks.
OPERATOR
We'll take our next question from Steve Chick. Go ahead, please.
STEVE CHICK - JP Morgan - Analyst
Hi, thanks. I have a few questions. Tony, can-- I guess first off, can you
describe, I guess, the process, the bidding process, as you entertained your
different options and how much interest there was, and if there were other
options, or offers, on the table? And then secondly, have you-- over the course
yesterday, did you get a sense from your largest shareholders on what their
feelings were, and if this is something that, you know, at this price, that they
would likely approve?
5
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
All right, with regard to the process, it was extensive and exhausting. The
board-- you know, I've always touted the fact that we have an exceptional board.
For a company of any size, I would say the members of our board represent
leaders in industry, have impeccable reputations, and it's unusual to have a
regional chain to have that level- type of board representing the shareholders.
So I think the shareholders are fortunate. I will tell you, the board was
undaunting with regard to their commitment to making sure that the process was
getting the maximum value for the shareholders. They were extremely committed to
this issue, and drove very, very hard, which is why the process took as long as
it did. The board repeatedly went back to Bear Stearns and pushed Bear Stearns
to expand its search, make further contact, bring further people in. Management,
every time that search got expanded and a party showed interest, management had
to make time to present to that discussion group, answer its questions, and
satisfy the queries so that they could come with a level of interest which would
indicate whether they were a player who would enter the final round. And I would
tell you that the process went from May all the way up through November, and it
was exhaustive. It involved quite a few people, and Oak Hill came out on top.
But I can tell you that Bear Stearns contacted every party that I could imagine
that would be a reasonable party to contact and might have some reasonable
interest. So it was a very exhaustive search. With regard to shareholders-- I
think shareholders obviously are going to range from those who are disappointed
because their basis is higher than the price to those who would hopefully are
happy because their basis is lower. But I think from the perspective of value, I
think most of our shareholders are sophisticated. I think the fact that we have
received a value offer here which is at the very north end of industry
multiples, both on an EBITDA and P/E basis, should, in the analytical sense, be
satisfactory. You know, clearly when you invest at a higher level and you wind
up losing, no one can be happy with that position, and hopefully those who
invest at a lower level and come out on top will applaud the gain. But from a
perspective of value, I think when the analysis is done, they will see we are at
the high end of industry multiples.
STEVE CHICK - JP Morgan - Analyst
And could you comment on-- I mean, right now, could you comment on what current
sales and margin trends look like, I guess, for the existing quarter, because I
think right now we're trying to value this on expected EBITDA of $80m or so for
the year 2003, is where trends have been through the end of the year. Is that
too high?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Let me turn to John Henry for that.
JOHN HENRY - Duane Reade - SVP and CFO
Just some quick update here. Of course, we would not normally be expected to
update guidance until after the close of the quarter, but just to give you some
feel -- we had originally given guidance on sales for the quarter to be between
$362m and $367m. The outlook now looks like it's going to be in the range of
about $355m. Our front-end sales are comping down about 1%. Our guidance had
said they would be down about .5% to as high as .5% positive. And our pharmacy
comps are in the 7% range, where our guidance was about 8.5% to 9.5%. So, one
key factor that's affected that has been the weather. We've had two snowstorms,
one being a blizzard, so certainly we've suffered from that. While we've had
some benefit from a stronger flu season, it's only come towards the very end of
the quarter, so from the standpoint of evaluating this holiday season, I think
primarily because of the fact that we did have bad weather and it was a moderate
holiday season, not a great holiday season, you know, we're going to fall below
the low end of the estimates on sales.
STEVE CHICK - JP Morgan - Analyst
OK. And-- so I guess it's safe to say the valuation you guys are thinking about,
on an EBITDA basis, is below the $80m?
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JOHN HENRY - Duane Reade - SVP and CFO
I think the way to put this in perspective, I mean, Tony referenced the fact
that this is on the high end of the multiples. You know, the 23% premium to the
30-day trading average, the most recent 30-day trading average, 8.9 times
current year EBITDA, if you look at the consensus estimate and you do the P/E
multiple you're over 30 times. If you go to the forward P/E multiple, you're in
the 24 time range, and even with that multiple, it's 25% higher than the current
multiple used in looking at, say, for example, CVS. There's a lot of premium in
this deal and there was a lot of thought process that went into the fair value
considerations and the advice that we got from Bear Stearns. They went through a
very extensive process on it, and the fact that, you know, we want to pursue
opportunities to address some of these industry challenges is an important
factor on one hand. But on the other hand, there was an enormous amount of
attention paid by the board to ensuring that shareholders got a fully valued,
fair value, for this company, and I think as you go through the statistics to
this thing, and I know you guys in the analyst community are going to pore over
this in great detail, you're going to see that this a very fully priced deal.
STEVE CHICK - JP Morgan - Analyst
Right, OK. And I guess getting back to that original question, I mean, so Bear
Stearns-- certainly a process that occurred, and Bear Stearns looked at all the
alternatives. I mean, did you in fact, get offers that were simply at lower
prices in terms of selling the company?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
We got levels of interest that were at lower prices, yes, we did, and we
obviously, when the levels of interest were substantially lower, they fell out
of bed, and the levels of interest were proximal to the high level, we formed a
final group and tried to raise those levels of interest to a maximum value,
through Bear Stearns' negotiation, and again, through that process, Oak Hill
Capital came on top.
STEVE CHICK - JP Morgan - Analyst
OK. One last thing, if I could -- you know, as your margin structure has kind of
collapsed over the last couple of years, and results have worsened, you haven't
really had somewhat of a-- you haven't restructured or tried to restructure
things operationally without a transaction. You know, your capex, it appears, in
my view, at least, has been, you know, too high, and you haven't really got--
seen-- you haven't gone through any massive store closings, or maybe closed some
of those outer borough stores that might be underperforming. And I was wondering
if you entertained, you know, maybe, you know, as an alternative, operating the
company and doing some things while a public company first, and you know, maybe
giving it a shot for shareholders, as opposed to kind of going right for the
deal now? You know, it kind of seems like it could have been a first shot at
that, and then seeing how that goes before just kind of running right towards
kind of an LBO, if you will. I mean, can you just comment on that?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Yeah, sure. I think it's clear, Steve, that, you know, we didn't run toward
this. You know, strategically, we had a strategic planning meeting for the first
time, perhaps, in our history at a place called the Hudson Gill Farm in
literally, the fall of '02, and that was quite a while ago, but that gave birth
to the lengthy discussion, which lasted between ourselves, management, and the
board for five or six months before we said, "You know what, one of the
alternatives that seemed to be out there that we just haven't pursued for our
shareholders is the interest level being expressed by a number of private equity
buyers, and maybe there's an avenue there that brings more value than all of the
strategic avenues we're chasing internally," one of which-- and many forms of
which are exactly what you described. But you know, the go-forward projections,
based on those kind of cutbacks and one-time charges and expenses that are
incurred, are for a while, for quite a few quarters, depressing earnings even
further. And the question was, if we take more earnings hits, for restructuring
and closures, quarter after quarter, would our shareholders say, "You know, we
see the need for this, and down the road, this is going to be better," or are
they going to not enjoy the stock being pounded down into the single digits? And
we felt, based on conversations with a lot of our large shareholders, that with
the stock trading at $12, $13, they've about had it with downside issues. We
were criticized numerous times for adjusting guidance downward because, you
know, we had to face the realities of the economy and the industry changes, and
every time we did that, there wasn't a realization of the issues, there was just
7
an impatience with the net result of that action. So we listened to that message
and said shareholders are tired of downside guidance, disappointing quarters,
and taking on a plan that's going to bring that forward for quite a few quarters
going ahead, is not what our shareholders want. Our shareholders want us to seek
a maximum value equation, and that's what led the board to seek this
alternative. And that commenced in April, and as I say, it was an exhaustive
process. We went through quite a few presentations, quite a few solicitations,
before we came to this conclusion.
STEVE CHICK - JP Morgan - Analyst
OK, and one last thing, actually -- I think you said the closing date you expect
to be in the second quarter of 2004, right?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Well, I think, you know, an abundance of caution, you say the second quarter. We
like to think it's going to be 75 to 90 days. We're trying to project the
processes of submitting proxies and Securities and Exchange Commission response
to questions and all that. You know, you have to be cautious and say-- you know,
transactions should close as fast as possible. You don't want the burden of a
transaction misdirecting management's focus, so we like to get this thing
through in as reasonably quick a process, but the Securities and Exchange
Commission isn't going to allow the process to occur any quicker than a couple
of months, and more likely, 90 days.
STEVE CHICK - JP Morgan - Analyst
OK, thanks.
OPERATOR
We'll take our next question from Bob Summers. Go ahead, please.
BOB SUMMERS - - Analyst
Good morning. Could you just talk about the equity interest that management is
going to retain, and who falls underneath that umbrella?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Well, clearly, I'll be retaining a management equity interest myself, and each
of the senior vice presidents have invested in this deal. Subordinate to them,
many of the officers will be getting new options in the new company, so they'll
have an equity interest in the new deal as well. The specifics of all that will
be in the proxy.
BOB SUMMERS - - Analyst
OK. And then secondly, I was curious to know how, through the whole valuation
process, you know, the lawsuit, how much that factored into it, meaning, you
know, that there's been some judgment already. Obviously it's under appeal, the
dollar amount is substantial, and you know, a cynic could say that basically,
you know, that dollar amount could represent the premium to the 30-day average
stock price. Any thoughts there?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Well, clearly, you're referring to the World Trade Center suit?
BOB SUMMERS - - Analyst
Yes.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
All right. With regard to the World Trade Center suit, we have, and I repeated
this in all our conference calls, we are still very confident we're going to
prevail in that suit. Nevertheless, St. Paul, the insurer, who's on the other
side of the litigation, continues to successfully, you know, stonewall the
litigation through whatever legal tactics they've been taking. And again, their
counsel says that, you know, it would not be unusual for this to go on another
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year or more, and you know, you could be tied up with proceeds here for a year,
two years. There's no way of telling, and we've had lots of experiences, I'm
sure many of you had, what the outcome of litigation of this kind is. We
continue to say we think we're going to prevail, we think we're going to be
successful. I would tell you that, from 9-11 to the year '05 or '06, which is
when the proceeds would likely be received from the damages, is a long period of
time to be deprived of that capital, and it has also had impact on the company.
So, it's unfortunate but I want you to know that that was considered in all of
our discussions with all of the alternative buyers. That was listed on the side
of positives, to a list of potential negatives, that, you know, contingent
liabilities and what-not, that a potential buyer looks at. And we had counsel
give ranges of settlements that we thought were reasonable, OK, to all strategic
alternative buyers, so that they also considered that in their offer. So that's
part of the economics of the offer.
BOB SUMMERS - - Analyst
OK. I mean, and I guess just sort of expanding on that, it seems sort of
asymmetric that, you know, there's this potential windfall out there to the, you
know, new private owner, where the current shareholders have really been
absorbing that risk.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Well, I can tell you that one of the issues where is, of course, the
uncertainty, because this goes on for a while and you just don't know where this
is going. The other issue is, it's a receivable and it's a contingent
receivable, but there are contingent liabilities in our business. And keep in
mind that all those contingent liabilities are risks that, whoever that buyer
is, in this case, Oak Hill, is taking on. So the list of issues that went out
there contain not only the World Trade Center receivable, but other litigation.
We have supplier litigation going on, which is potentially positive or negative,
depending on what the outcome is going to be, and it involves significant legal
costs. We have other litigation matters that pose contingent liabilities,
potentially, going forward. So you know, all those issues had to be considered.
But I will tell you that the net of all contingencies, which were all listed,
were part of the valuation model. They were not excluded; they were included.
BOB SUMMERS - - Analyst
OK, thanks.
OPERATOR
We'll take our next question from [Scott Sopprell]. Go ahead, please.
SCOTT SOPPRELL - - Analyst
Good morning. I must say that as a shareholder, I'm extremely disappointed to
hear management describe this deal as creating value for shareholders. The
premiums that are paid are actually at a discount to where the stock traded a
mere three months ago. I think that anybody who's followed this company
recognizes that it's significantly under-earning its potential, not only because
of the loss of its most profitable store, the proceeds of which current
shareholders are not expected to get any in the settlement, but also because of
the significant litigation expense that the company is currently deducting from
its current earnings to litigate that receivable. Secondly, I think the folks
who follow this company know that the maturation of the many stores that have
opened over the last three years naturally go from losses in the first year to
profits in future years, and I think a conservative calculation of the potential
earnings power of this company says it could be earning well over $2 a share
within two or three years, so on the $17 price, I think this represents a very
poor recognition of value. And I, as one shareholder, would have no intention of
tending my shares at $17. So that-- that's my comment. Secondly, could you talk
just more specifically about the range of values for the World Trade Center
receivables that you provided to the buyers, so that public shareholders who
have invested in this company could be-- have the benefit of the same
information? Thank you.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
All right, you know, with regard to the opening comment, I want to repeat that
we have spent eight months soliciting interest in every single reasonably
interested buyer and received no indication from any of those parties that what
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you just stated, with regard to your sentiments, was indicative of the
sentiments of those people who were learned in the industry and otherwise, we
certainly would have received a higher range of offer. So I want to assure you
that the process was extensive, it reached down, it was a full disclosure
process. I think your estimates going forward are not in agreement with
consensus estimates by those people who follow the industry, so consensus
estimates are far lower than your $2 a share, not that I wouldn't be hopeful
that that could happen, but I do not believe that that is a reasonable
projection.
SCOTT SOPPRELL - - Analyst
Well, based on the projections that you- your company has provided, about the
recovery in margin, you could get to those numbers. I mean, I think it's in your
contention that you could get back to 8% operating margin, isn't that correct?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
I'm giving you the outlook. I said-- I'm telling you right now that that is not
consensus in the industry, that is not consensus among analysts, and that is not
our consensus in the near term, near term being under three years. Now, you
start looking out past a three-year horizon, as I indicated earlier in this
conversation, I, too, am hopeful that an improvement in profitability and
fundamentals can occur. But it's the path, over the next three years, that I was
concerned with. I do not have a shareholder group that, by and large, seemed to
have the very hopeful attitude and patience that you're exhibiting, because I
think if you're a patient shareholder and you're willing to take the bumpy road
for the next 36 months, then there might be a light at the end of the tunnel.
But the risks are substantial, and the hits to equity are substantial on the
way. So, the question becomes, you know, how to move, and we need to move where
the preponderance of our shareholder sentiments lie, and along the lines of the
most probable and successful outcome, and I really do believe that we spent
quite a bit of time on this and considering the multiples on a go-forward or
go-back basis, these are the very, very top end multiples anyone was realizing.
I believe the Eckerd transaction, which had been valued-- which is a far larger
company than we are, literally moved north yesterday as a result of this
transaction.
SCOTT SOPPRELL - - Analyst
But many of your public shareholders have made the case that the opening
program, specifically in the outer boroughs, is essentially beggaring the
profitability of company because those stores are not only less profitable, but
they take a while to build up to the operating margins that your mature store
base achieves. So, if you do this transaction and Oak Hill and the management
comes up with a new strategy, which is, one, to slow the new store openings and
let the store base mature and the take the margins back to 10% on an EBITDA
basis, that will create value very quickly, and in retrospect, I think we will
all have seen this transaction as very cynically timed.
JOHN HENRY - Duane Reade - SVP and CFO
I'd like to just make a comment in response to that. We have already cut back
the growth rate in the stores, in our stores, and we've been very, very public
about the fact that we expect to see some improvement in margins as a result of
the slowdown in the growth rate. That's certainly not been missed by any of the
investors, and I think that if you look at the consensus estimate for '04, which
is the year that benefits from that, the EPS consensus estimate is around 73
cents. That's a 30% improvement over the current-year consensus estimate. With
that 73-cent estimate consensus for next year, we're still looking at an implied
multiple here of about 24 times, which is a very significant multiple, on the
very strong end, and that's with all that benefit baked in. I did hear you
reference an 8% operating margin, and I just want to make sure that no one on
the call is confused about operating margins and EBITDA margins. We said that
the potential over the long-term could be that we could approach potentially an
8% EBITDA margin years down the road. We have never had, really, an 8% operating
margin historically and we're not expecting that we will in the future.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
All right, with regard to the World Trade Center estimates, you'll see that in
the proxy, there's a specific estimate for the World Trade Center claim, and we
put in that claim-- I'm going from memory, now, I believe it's a $30m proceeds
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estimate for the World Trade Center, right? So that was what we put in the
proxy.
SCOTT SOPPRELL - - Analyst
And is my estimate of $10m annual litigation expense, is that accurate?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
That-- well-- that's--you mean, just for the World Trade Center?
SCOTT SOPPRELL - - Analyst
Yes.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
No, I think that's high.
JOHN HENRY - Duane Reade - SVP and CFO
Litigation expenses have been running, you know, in the neighborhood of $2.5m to
$3m higher than normal. So we have incurred higher litigation-related expenses.
We're not talking $10m.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
And also, I wanted to point out that you'll notice in the proxy that adjoining
that $30m World Trade Center receivable estimate, OK, that we-- which is
contingent on a successful outcome, which is just our best estimate of what that
might be, are $10m-plus of other, negative contingent liabilities that we face
going forward, potentially. Now, again, these are estimates on legal cases that
are years from maturity, so they have the-- very much the risk, up and down,
that that kind of case has.
CARA O'BRIEN - Financial Dynamics - Investor Relations Counsel
Operator, can we take the next question now?
OPERATOR
We'll take our next question from Monica Aggarwal.
MONICA AGGARWAL - Merrill Lynch - Analyst
Good morning. First of all, what type of strategic interest did you see from,
you know, other chains? And then secondly, in terms of the timing, given that
the Eckerd business is up for sale, would that have impacted, you know, the way
people were thinking about Duane Reade and sort of bidding for that, either from
the private equity firms or from other strategic players?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Monica, you know, Duane Reade's acquisition profile, let's call it, is an
interesting phenomena. I joined the company in '96 and I can tell you not a year
went by where the Street didn't claim that we were one of the most acquirable
businesses, and yet acquisition didn't occur. And the interesting thing here is
that when we went public, once again, there was a frenzy over the fact that
here's a public equity over a regional chain that's prime for acquisition, and
acquisition multiples got built into an already aggressive industry multiple in
1998. The fact of the matter is that the industry itself is consolidated
tremendously and that consolidation has caused a number of issues. But with
regard to acquisition, it's created a huge Hart Scott Rodino overlap issues for
the potential acquirers. You look at Eckerd -- all the interest levels at Eckerd
by the larger chains have had to be accompanied by financial partners because of
the overlap issues, and I think what we have here is a strong regional chain
that has significant overlap with many of the larger players, and consequently,
the trust questions are substantial anytime one of the larger chains looks at
us. Smaller regional chains have been challenged, and as a result, you know,
investing-- investments from a smaller, regional chain are much more difficult.
Although there's no overlap, there isn't much synergy for them, because there is
no overlap, so that has been a challenge there. You know, I think as a result of
the Eckerd deal, if anything happens, it'll be that Eckerd breaks up and it
could likely create more New York holdings in existing chains, which would
11
create even more overlap issues for more companies. So, I really don't see right
now that the acquisition profile for Duane Reade has improved as a result of
events, OK?
MONICA AGGARWAL - Merrill Lynch - Analyst
Thank you.
OPERATOR
We'll take our next question from [Larry Avner]. Go ahead, please.
LARRY AVNER - - Analyst
Yeah, just a quick question on the financing -- is the financing at all subject
to syndication?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
You know, I'll ask John.
JOHN HENRY - Duane Reade - SVP and CFO
This is a fully committed deal. Banc of America has committed the full debt
financing for this financing.
LARRY AVNER - - Analyst
OK, so there's no-- it's not subject at all to syndication?
JOHN HENRY - Duane Reade - SVP and CFO
The debt has been syndicated, but the initial financing is committed to by--
it's the usual regulatory, you know-- but I don't think it's syndication
[inaudible]
LARRY AVNER - - Analyst
OK, so they-- in other words, they may syndicate it, but it's not a condition to
the deal, is what I'm trying to ask.
JOHN HENRY - Duane Reade - SVP and CFO
Right. It's fully committed funds. The conditions to this thing would be those
that are typical for a transaction of this nature, like MAC clauses, those kinds
of things -- material adverse changes -- those types of things, but it's fully
committed funding.
LARRY AVNER - - Analyst
Thank you.
OPERATOR
Next question comes from [Karen Mayler]. Go ahead, please.
KAREN MAYLER - - Analyst
Hi. Good morning. I'm wondering if you could expand on your comment that you
would experiment with new avenues of business? Might this include expanding
beyond the metro New York area?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Well, again, it could include. I'm not saying it does. You know, one of the
things that would not be appropriate for us to discuss is the very competitive
issues that we're facing and how we're going to respond to them. But yeah, all
of those possibilities are on the list of potential decisions, and we're not
excluding any of them, but the issue always was that all of those require
near-term negatives to earnings.
KAREN MAYLER - - Analyst
OK, thanks.
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OPERATOR
We'll take our next question from Brian Long. Go ahead, please.
LOU KAPALITA - Chesapeake Partners - Analyst
Actually, this is [Lou Kapalita] at Chesapeake Partners. You've answered most of
my questions, but a couple more. First of all, have you paid commitment fees on
the financing?
JOHN HENRY - Duane Reade - SVP and CFO
We have not, at the current point, paid any commitment fees on the financing.
Those arrangements are going to be dependent on the deal going through.
LOU KAPALITA - Chesapeake Partners - Analyst
And then secondly, earlier, you-- someone mentioned, and you commented on, a
purely hypothetical interest in certain Eckerd assets, the old Genovese chain.
Was that also explored as a possible alternative, since clearly those assets are
for sale, and there should be some meaningful synergies available, in a
combination between Duane Reade and the old Genovese assets?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Well, you know, first of all, we have, over the years, frankly, taken a number
of steps to reach out to JC Penney to see whether there was an interest in
parting with, you know, New York-area assets, and you know, I won't take you
through the lengthy and numerous discussions that we had, but the short of it
was, we really received little receptivity to our thinking, and when this asset
became formalized as being on the market, we were told that synergistic, large,
principled buyers were going to be the only first-round considerations, so you
know, we really didn't get very far with that proviso put on the transaction.
But that did not--
LOU KAPALITA - Chesapeake Partners - Analyst
Well, you're strategic, and you have synergies. I'm not sure in terms of large
-- you're not small. In New York, you're large.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Oh, no, but the issue was-- the deal was being touted as first, a deal that
would be offered in its entirety, and then however it's split up as a result of
buyer interests and buyer needs is a post-deal, so to speak, transaction. The
word was that if that first type of transaction could not be consummated, then,
you know, we would be called as part of a group that might take a piece, but
initially, the level of interest, as I understand it from the contacts we made,
was that they wanted a single transaction. Now clearly, Duane Reade, at a $1.5b
volume a year, was not in a position to be the aggressive bidder to acquire a
$15b company, particularly when, you know, the likes of CVS were involved. So we
sat back and said, "let's make sure they know our level of interest, make sure
people who are entertaining this transaction know our level of interest, and
hopefully we'll have a role to play, you know, when and if that opportunity
gives rise." To date, we have not been asked to play any role and have had no
conversations with anyone, other than the hypothetical I just shared with you.
CARA O'BRIEN - Financial Dynamics - Investor Relations Counsel
Operator, we have time for two more questions. Can we please move to the next
one.
OPERATOR
We'll take our next question from Gary Giblen. Go ahead, please.
GARY GIBLEN - C.L. King & Associates - Analyst
Hi. Good morning. I wonder if you could give us some flavor of what new
strategies or tactics you would follow under your new ownership, because you
mentioned you were hampered by the public ownership?
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ANTHONY CUTI - Duane Reade - Chairman, President & CEO
You know, I think it's not a matter of being hampered, because "hampered" is the
wrong characterization. I think you have-- I feel the management team has an
obligation to its owners. Right now, we're owned by our shareholders, and we
need to keep our fingers on the pulse of shareholder wants while we direct this
ship. I think to just point it in a direction that we personally have a vision
for and then not care what that does to near-term shareholder interests wouldn't
be following our duty. And we were-- you know, we were trying to do our best to
probe opportunities and the shareholder, the equity, got hit, the shareholder
reaction was pretty sharp, and you know, we felt that we didn't have a
shareholder group that wanted us to take these directions, and at the same time,
we saw-- maintained the status quo, a dangerous profile going forward, because
we would just have successfully poorer performance as we move forward into a
morphing industry condition. So you know, I think "hampered" is the wrong term.
I think it's a fact that we have a shareholder group that really had indicated
to us that they have no patience for a two- or three-year, "hold your breath
while we change" approach, and we do have a private equity world out there that
has a three to five-year time horizon and is better suited for the kind of risk
profile we're about to embark in than the public markets.
GARY GIBLEN - C.L. King & Associates - Analyst
I mean, are there things that you're contemplating that are-- that might be
short-term, you know, hits on EBITDA, you know, things-- tougher pricing or more
advertising or anything like that?
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Well, those are the kinds of things, Gary, that yes, we're contemplating things
like that. I'm not saying yes to any one of those specifically, but yes, those
kinds of things are exactly what we're contemplating, and you know, that means
short-term hits to earnings, and we know what that means to equity.
GARY GIBLEN - C.L. King & Associates - Analyst
OK, and yeah, "hamper" was too strong a word, but you get what I'm trying to get
at. So there will be-- you know, whatever it is, there are significant changes
ahead in your operating strategy, let's say, under the new--
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Yeah, I would tell you that-- I think we're not alone. I think you're going to
see significant changes in everyone's operating strategy in this industry. I
think you've seen much stronger companies, as far as their capital structure and
positioning, than Duane Reade, like Walgreen's and CVS, perform as well as
anyone can be expected in this environment, and we don't see their equity doing
anything but barely holding position, despite the fact that they're growing. And
I think that's another indication of the uncertainty in the environment we're
in.
GARY GIBLEN - C.L. King & Associates - Analyst
OK. Interesting. Thank you.
CARA O'BRIEN - Financial Dynamics - Investor Relations Counsel
Operator, we have time for one last question.
OPERATOR
And our last question will come from [U.Z. Zimmerman]. Go ahead, please.
U.Z. ZIMMERMAN - - Analyst
Just want to confirm what will happen to the convertible bond -- is there a
change of control there?
JOHN HENRY - Duane Reade - SVP and CFO
There is a change of control provision in the convertible bonds.
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U.Z. ZIMMERMAN - - Analyst
They'll be taken out. OK.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
All right, thank you very much. Operator, could I have a closing comment,
please? Operator? Closing comment--
OPERATOR
Yes, go ahead, sir.
ANTHONY CUTI - Duane Reade - Chairman, President & CEO
Yes -- I'd just like to say to everyone that it is not easy to have gone through
the years we did with the challenges that the economy brought, but more
importantly, the challenges that the industry has posted to this regional chain.
I want to repeat that we have gone through a very exhaustive process. My
management team-- it was not unusual for the management team over the last four
or five months to give up Saturdays, Sundays, vacations, working with potential
interested buyers to make sure their queries were satisfied so the board could
be satisfied in its quest to know that we were seeking every possible
alternative in getting the best possible deal on the table. Oak Hill has brought
us, I assure you, the best deal out there, and it is absolutely the north end of
multiples, as we've investigated them thoroughly, both on a go forward and
go-back basis in this industry. With regard to our customers who possibly are on
this call, and our associates, who also may be on the Internet, listening, I
want to assure you all, this is going to be as seamless a transaction as we
possibly can convey, and you know, you should be assured that we'll continue to
meet our obligations to our business associates and our employees alike. Thank
you all again.
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