**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C.**

 

**FORM 10-Q**

 

**Quarterly Report Pursuant to Section 13 or 15 (d)of the Securities and Exchange Act of 1934**

 
| **For  the qu****arterly period ended March 27, 2004.** |   | **Commission file number 1-13843** |
|--------------------------------------------------------------|--------|------------------------------------|

 

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**DUANE READE INC.**

(Exact name of registrant as specified inits 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** |

 

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*                 Guarantors withrespect to the Company’s 2.1478% Senior Convertible Notes due 2022

 
| **440 Ninth Avenue  New York, New York**                  |   |   |   | **10001**  |
|-----------------------------------------------------------|--------|--------|--------|------------|
| (Address of principal executive offices)                  |   |   |   | (Zip Code) |
|                                                      |   |   |   |       |
| **(212) 273-5700**                                        |
| (Registrant’s telephone number, including area code) |

 

Securities registeredpursuant to Section 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                       |   |

 

Securities registered pursuant toSection 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

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in the Exchange ActRule 12b-2):  Yes ý  No o

 

The number ofshares of the Common Stock outstanding as of May 5, 2004:  **24,471,431**

 

 

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INDEX

 
| PART I – FINANCIAL INFORMATION |                                                                                                                     |
|-------------------------------------|--------------------------------------------------------------------------------------------------------------------------|
|                                |                                                                                                                     |   |
|                                | ITEM 1. – FINANCIAL STATEMENTS                                                                                      |   |
|                                |                                                                                                                     |   |
|                                | Consolidated  Statements of Income (Unaudited) -  For the 13 Weeks Ended March 27, 2004 and March 29, 2003     |   |
|                                |                                                                                                                     |   |
|                                | Consolidated Balance Sheets  As of March 27, 2004 (Unaudited) and December 27, 2003                            |   |
|                                |                                                                                                                     |   |
|                                | Consolidated  Statements of Cash Flows (Unaudited) -  For the 13 Weeks Ended March 27, 2004 and March 29, 2003 |   |
|                                |                                                                                                                     |   |
|                                | Notes to  Consolidated Financial Statements (Unaudited)                                                                  |   |
|                                |                                                                                                                     |   |
|                                | ITEM 2. –                                                                                                           | MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |   |
|                                |                                                                                                                     |   |   |
|                                | ITEM 3. –                                                                                                           | MARKET RISK |   |
|                                |                                                                                                                     |   |   |
|                                | ITEM 4. –                                                                                                           | CONTROLS AND PROCEDURES |   |
|                                |                                                                                                                     |   |
| PART II – OTHER INFORMATION    |                                                                                                                     |
|                                |                                                                                                                     |
| SIGNATURES                          |                                                                                                                     |

 

This and other of ourpublic filings or public statements contain forward-looking statements withinthe meaning of Section 27A of the Securities Act, Section 21E of theSecurities Exchange Act of 1934 and the Private Securities Litigation ReformAct of 1995, that involve a number of risks and uncertainties. These statementsrelate to future events or our future financial performance with respect to ourfinancial condition, results of operations, business plans and strategies,operating efficiencies or synergies, competitive positions, growthopportunities for existing products such as private label merchandise, plansand objectives of management, capital expenditures, growth and maturation ofour stores and other matters. These statements involve known and unknown risks,uncertainties and other factors that may cause our or our industry’s actualresults, levels of activity, performance or achievements to be materiallydifferent from those expressed or implied by any forward-looking statements. Insome cases, you can identify forward-looking statements by terminology such as“may,” “will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,”“intend,” “believe,” “estimate,” “predict,” “potential,” “pro forma,” “seek,”or “continue” or the negative of those terms or other comparable terminology.These statements are only predictions and such expectations may prove to beincorrect. Some of the things that could cause our actual results to differsubstantially from our expectations are:

 

•                                          theoutcome of the legal proceedings that have been instituted against us andothers following announcement of our merger agreement with Duane ReadeAcquisition Corp. and Duane Reade Shareholders, LLC;

 

•                                          theactual terms of certain financings that will be obtained for the merger;

 

•                                          costs,fees, expenses and charges related to the merger;

 

•                                          failureto consummate the merger;

 

•                                          thecompetitive environment in the drugstore industry in general and in themetropolitan New York area;

 

•                                          theability to open and operate new stores on a profitable basis and to increasesales in existing stores;

 

•                                          thecontinued efforts of health maintenance organizations, managed careorganizations, pharmacy benefit management companies and other third partypayers to reduce prescription reimbursement rates;

 

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•                                          thecontinued efforts of federal, state and municipal government agencies to reduceMedicaid reimbursement rates, modify Medicare benefits and/or reduceprescription drug costs;

 

•                                          thestrength of the economy in general and the economic conditions in themetropolitan New York area, in particular, including changes in consumerpurchasing power and/or spending patterns;

 

•                                          changesin cost of goods and services;

 

•                                          trendsin the healthcare industry, including continued conversion of variousprescription drugs to over-the-counter medications and the increasing marketshare on the part of internet-based and mail-order-based providers;

 

•                                          changesin federal and state laws and regulations, including the potential impact ofchanges in regulations surrounding the importation of pharmaceuticals fromforeign countries;

 

•                                          liabilityand other claims asserted against us including the items discussed under PartII, Item 1-Legal Proceedings;

 

•                                          changesin our operating strategy or development plans;

 

•                                          ourability to attract, hire and retain qualified personnel, including our abilityto attract qualified pharmacists;

 

•                                          oursignificant indebtedness;

 

•                                          interestrate fluctuations and changes in capital market conditions or other eventsaffecting our ability to obtain necessary financing on favorable terms to fundthe anticipated growth of our business;

 

•                                          labordisturbances, including any resulting from the suspension or termination of ourcollective bargaining agreements;

 

•                                          thecontinued impact of, or new occurrences of, terrorist attacks in the New Yorkmetropolitan area and any actions that may be taken by federal, state ormunicipal authorities in response to or in anticipation of such occurrences;

 

•                                          changesin our acquisition and capital expenditure plans;

 

•                                          ourability to continue to secure suitable new store locations under acceptablelease terms;

 

•                                          ourability to successfully implement and manage new computer systems andtechnologies;

 

•                                          ourability to limit fraud and shrink;

 

•                                          demographicchanges; and

 

•                                          otherrisks and uncertainties detailed from time to time in our filings with theSecurities and Exchange Commission (the “SEC”).

 

We undertake noobligation to update or revise any forward-looking statements, whether as aresult of new information, future events or otherwise, after the date of thisfiling. We do not, nor does any other person, assume responsibility for theaccuracy and completeness of those statements.

 

We caution you that theareas of risk described above may not be exhaustive. We operate in acontinually changing business environment, and new risks emerge from time totime. Management cannot predict such new risks, nor can it assess the impact,if any, of such risks on our businesses or the extent to which any risk orcombination of risks, may cause actual results to differ materially from thoseprojected in any forward-looking statements. In light of these risks,uncertainties and assumptions, you should keep in mind that any forward-lookingstatement made in this filing might not occur.

 

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PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

**Duane Reade Inc.**

Consolidated Statements ofIncome (Unaudited)

(Inthousands, except per share amounts)

 
|                                         |   | **For the 13  Weeks Ended** |    |
|----------------------------------------------|--------|-----------------------------|---------|
|                                         |   | **March 27,  2004**    |    | **March 29,  2003** |   |
|                                         |   |                        |    |   |   |
| Net sales                                    |   | $                           | 349,550 |   | $ | 333,622 |   |
| Cost of sales                                |   | 273,785                     |    | 263,433 |   |
|                                         |   |                        |    |   |   |
| Gross profit                                 |   | 75,765                      |    | 70,189 |   |
|                                         |   |                        |    |   |   |
| Selling, general and administrative expenses |   | 58,643                      |    | 53,574 |   |
| Labor contingency                            |   | 1,100                       |    | — |   |
| Transaction expenses                         |   | 1,102                       |    | — |   |
| Depreciation and amortization                |   | 9,066                       |    | 7,557 |   |
| Store pre-opening expenses                   |   | 157                         |    | 416 |   |
|                                         |   | 70,068                      |    | 61,547 |   |
|                                         |   |                        |    |   |   |
| Operating income                             |   | 5,697                       |    | 8,642 |   |
| Interest expense, net                        |   | 3,437                       |    | 3,517 |   |
| Debt extinguishment                          |   | —                      |    | 105 |   |
|                                         |   |                        |    |   |   |
| Income before income taxes                   |   | 2,260                       |    | 5,020 |   |
| Income taxes                                 |   | 904                         |    | 1,908 |   |
|                                         |   |                        |    |   |   |
| Net income                                   |   | $                           | 1,356   |   | $ | 3,112 |   |
|                                         |   |                        |    |   |   |
| Per common share – basic                |   |                        |    |   |   |
|                                         |   |                        |    |   |   |
| Net income                                   |   | $                           | 0.06    |   | $ | 0.13 |   |
|                                         |   |                        |    |   |   |
| Weighted average common shares outstanding   |   | 24,409                      |    | 24,038 |   |
|                                         |   |                        |    |   |   |
| Per common share – diluted              |   |                        |    |   |   |
|                                         |   |                        |    |   |   |
| Net income                                   |   | $                           | 0.06    |   | $ | 0.13 |   |
|                                         |   |                        |    |   |   |
| Weighted average common shares outstanding   |   | 24,651                      |    | 24,368 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

4

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**Duane ReadeInc.**

Consolidated Balance Sheets

(In thousands, except share and per share data)

 
|                                                                                                                           |   | **March 27,  2004** |    | **December 27,  2003** |   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                                                                           |   | **(Unaudited)**          |    |                        |   |
| ASSETS                                                                                                                         |   |                     |    |                        |   |
| Current Assets                                                                                                                 |   |                     |    |                        |   |
| Cash                                                                                                                           |   | $                        | 1,285   |                        | $      | 1,252 |   |
| Receivables, net                                                                                                               |   | 59,124                   |    | 53,689                      |   |
| Inventories, net                                                                                                               |   | 250,029                  |    | 259,765                     |   |
| Deferred income taxes                                                                                                          |   | 7,923                    |    | 8,150                       |   |
| Prepaid expenses and other current assets                                                                                      |   | 17,751                   |    | 19,504                      |   |
| TOTAL CURRENT ASSETS                                                                                                           |   | 336,112                  |    | 342,360                     |   |
|                                                                                                                           |   |                     |    |                        |   |
| Property and equipment, net                                                                                                    |   | 191,055                  |    | 189,469                     |   |
| Goodwill, net of accumulated amortization of $35,323                                                                           |   | 161,625                  |    | 161,318                     |   |
| Deferred income taxes                                                                                                          |   | 4,940                    |    | 5,543                       |   |
| Other assets                                                                                                                   |   | 99,651                   |    | 88,836                      |   |
| TOTAL ASSETS                                                                                                                   |   | $                        | 793,383 |                        | $      | 787,526 |   |
|                                                                                                                           |   |                     |    |                        |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                      |   |                     |    |                        |   |
| Current Liabilities                                                                                                            |   |                     |    |                        |   |
| Accounts payable                                                                                                               |   | $                        | 76,837  |                        | $      | 85,258 |   |
| Accrued interest                                                                                                               |   | 3,582                    |    | 1,633                       |   |
| Other accrued expenses                                                                                                         |   | 30,981                   |    | 27,489                      |   |
| Current portion of capital lease obligations                                                                                   |   | 431                      |    | 422                         |   |
| TOTAL CURRENT LIABILITIES                                                                                                      |   | 111,831                  |    | 114,802                     |   |
|                                                                                                                           |   |                     |    |                        |   |
| Long-term debt, less current portion                                                                                           |   | 276,470                  |    | 271,385                     |   |
| Capital lease obligations, less current portion                                                                                |   | 992                      |    | 1,103                       |   |
| Other noncurrent liabilities                                                                                                   |   | 65,357                   |    | 62,915                      |   |
| TOTAL LIABILITIES                                                                                                              |   | 454,650                  |    | 450,205                     |   |
|                                                                                                                           |   |                     |    |                        |   |
| Stockholders’ equity                                                                                                      |   |                     |    |                        |   |
| Preferred stock, $0.01 par; authorized 5,000,000  shares; issued and outstanding: none                                         |   | —                   |    | —                      |   |
| Series A preferred stock, $0.01 par; authorized 75,000  shares; issued and outstanding: none                                   |   | —                   |    | —                      |   |
| Common stock, $0.01 par; authorized 75,000,000 shares;  issued and outstanding: 24,410,306 and 24,403,550 shares, respectively |   | 244                      |    | 244                         |   |
| Paid-in capital                                                                                                                |   | 331,974                  |    | 331,917                     |   |
| Retained earnings                                                                                                              |   | 6,515                    |    | 5,160                       |   |
| TOTAL STOCKHOLDERS’ EQUITY                                                                                                |   | 338,733                  |    | 337,321                     |   |
|                                                                                                                           |   |                     |    |                        |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                |   | $                        | 793,383 |                        | $      | 787,526 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

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**Duane Reade Inc.**

Consolidated Statements of CashFlows (Unaudited)

(In thousands)

 
|                                                                               |   | **For the 13 Weeks Ended** |   |
|------------------------------------------------------------------------------------|--------|----------------------------|--------|
|                                                                               |   | **March 27,  2004**   |   | **March 29,  2003** |   |
| Cash flows provided by operating activities:                                       |   |                       |   |   |   |
| Net income                                                                         |   | $                          | 1,356  |   | $ | 3,112 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |                       |   |   |   |
| Depreciation and amortization of property and  equipment                           |   | 6,276                      |   | 5,117 |   |
| Amortization of other intangibles                                                  |   | 3,268                      |   | 2,948 |   |
| Deferred tax provision                                                             |   | 830                        |   | 1,909 |   |
| Other                                                                              |   | 1,594                      |   | 2,323 |   |
| Changes in operating assets and liabilities (net of  the effect of acquisitions):  |   |                       |   |   |   |
| Receivables                                                                        |   | (5,435                     | )      | (150 | ) |
| Inventories                                                                        |   | 10,509                     |   | (11,785 | ) |
| Accounts payable                                                                   |   | (8,421                     | )      | 3,056 |   |
| Prepaid and accrued expenses                                                       |   | 6,645                      |   | 693 |   |
| Other assets and liabilities, net                                                  |   | (4,428                     | )      | (3,476 | ) |
| NET CASH PROVIDED BY OPERATING ACTIVITIES                                          |   | 12,194                     |   | 3,747 |   |
|                                                                               |   |                       |   |   |   |
| Cash flows used in investing activities:                                           |   |                       |   |   |   |
| Capital expenditures                                                               |   | (7,862                     | )      | (14,250 | ) |
| Lease acquisition, customer file and other costs                                   |   | (9,258                     | )      | (6,659 | ) |
| NET CASH USED IN INVESTING ACTIVITIES                                              |   | (17,120                    | )      | (20,909 | ) |
|                                                                               |   |                       |   |   |   |
| Cash flows from financing activities:                                              |   |                       |   |   |   |
| Repayments of term loans                                                           |   | —                     |   | (991 | ) |
| Net borrowings – revolving credit facility                                    |   | 5,085                      |   | 17,000 |   |
| Repurchase of senior subordinated notes                                            |   | —                     |   | (1,621 | ) |
| Deferred financing costs                                                           |   | (80                        | )      | — |   |
| Exercise of stock options                                                          |   | 56                         |   | — |   |
| Repayments of capital lease obligations                                            |   | (102                       | )      | (158 | ) |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                          |   | 4,959                      |   | 14,230 |   |
|                                                                               |   |                       |   |   |   |
| Net increase (decrease) in cash                                                    |   | 33                         |   | (2,932 | ) |
| Cash at beginning of period                                                        |   | 1,252                      |   | 4,183 |   |
| Cash at end of period                                                              |   | $                          | 1,285  |   | $ | 1,251 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

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**Notesto Consolidated Financial Statements**

**(Unaudited, dollars in thousands, except per share data)**

 

**1. Basis of Presentation**

 

The UnauditedConsolidated Interim Financial Statements included herein reflect alladjustments (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 consolidatedfinancial statements for the year ended December 27, 2003. These UnauditedConsolidated Interim Financial Statements should be read in conjunction withthe Company’s financial statements included in its Annual Report on Form 10-Kfor the year ended December 27, 2003 and related amendments. The UnauditedConsolidated Interim Financial Statements include the accounts of the Companyand its subsidiaries.  All significantintercompany transactions and balances have been eliminated. Cost of salesincludes all store occupancy-related costs and expenses, consisting of leaseand sublease-related income and expenses, other recurring real estate-relatedincome and expenses primarily from sales and terminations of leases related tostore closings and relocations, sales of market-related data, store utilitycosts, warehouse expenses and distribution costs. The Company reflectspromotional allowances from vendors as a reduction of cost of sales oradvertising expense, depending on the nature of the allowance, when suchadvertising or promotions have been completed and the related allowances havebeen earned. Other recurring real estate-related income amounted to $0.7million in the quarter ended March 27, 2004 compared to $1.1 million inthe quarter ended March 29, 2003. There was no income realized from thesale of market related data in the first quarter of either 2004 or 2003.Earnings per share amounts are calculated based on the weighted average numberof shares outstanding during the period and may not add due to rounding. Theresults for the interim periods presented are not necessarily indicative of theresults expected for the full year.

 

The Company has no assetsor operations other than its investment in its subsidiary guarantors.Accordingly, the Unaudited Consolidated Interim Financial Statements presentthe combined assets and operations of the subsidiary guarantors.  The guarantees of the subsidiary guarantors,which relate to the Company’s obligations under its registered debt and creditagreement, are full and unconditional, joint and several.

 

**2.  Planned Merger with Oak Hill**

 

On December 23,2003, the Company announced that it had entered into a definitive mergeragreement to be acquired by Duane Reade Acquisition Corp. (“Duane ReadeAcquisition”), an affiliate of Oak Hill Capital Partners, L.P. (“Oak Hill”).Under the terms of the merger agreement, which remains subject to the approvalof the Company’s stockholders, such stockholders would receive $17.00 per sharein cash, without interest. The purchase price represents a 22.8% premium overthe $13.84 per share average closing price of the Company’s common stock forthe 30 trading days immediately preceding the announcement of the mergertransaction. The aggregate value of the merger transaction exceeds$740 million, including the repayment of indebtedness. The transaction wasunanimously approved by the independent members of Duane Reade’s board ofdirectors. The equity financing necessary for the merger will be provided byOak Hill and an affiliate equity fund, Oak Hill Capital Management Partners,L.P. and any other investor who Oak Hill selects to participate in thetransaction as an equity co-investor. The debt financing necessary for themerger will be provided by a syndicate of banking institutions led by Banc ofAmerica Securities LLC. Mr. Anthony J. Cuti, the Company’s Chairman,President and CEO, the Company’s Senior Vice Presidents and certain othermembers of management will, at the closing of the transaction, have equityinterests in the acquiring entity. The closing of this transaction is subjectto certain terms and conditions, including receipt of stockholder approval andthe proceeds from the financing to be provided by third parties. The mergeragreement is subject to a termination fee of $10.0 million plus reimbursent ofexpenses of up to $2.0 million, all of which is to be paid by the Company ifthe merger agreement is terminated under certain circumstances.

 

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**3. National Labor Relations Board Recommendation**

 

The Company is a party toa National Labor Relations Board (“NLRB”) administrative proceeding regarding adispute with the Allied Trades Council over whether a negotiating impasse wasreached between the Company and the union in August of 2001. The AlliedTrades Council represents employees in 139 of the Company’s stores pursuant toa collective bargaining agreement that expired on August 31, 2001. Theemployees have been working pursuant to the terms of the Company’sDecember 6, 2001 implemented contract with the ATC, which expires onAugust 31, 2004. The Company believes an impasse did occur and as aresult, the Company had the right to implement its latest contract proposal atthat time which included wage increases, health and welfare benefits, vacationand sick benefits and a 401(k) retirement program. The Company discontinuedmaking additional payments into the various funds associated with the union as itwas providing many of these benefits on a direct basis and because its pastcontributions to these funds had caused these funds to be in a position ofexcessive overfunding. In addition, the Company had concerns that its pastpayments into these funds were not being managed in a way to ensure they werebeing properly utilized for the benefit of the Company’s employees. OnFebruary 18, 2004, an Administrative Law Judge (“ALJ”) who had reviewedvarious matters related to this proceeding issued a decision and relatedrecommendation, which concluded that the parties were not at impasse. Theremedies recommended by the ALJ included, among other things, a requirement forthe Company to make its employees whole by reimbursing them for expensesensuing from the failure to make contributions to the union funds and to makesuch funds whole, plus interest. If this recommendation is adopted by the fullNLRB and enforced by the circuit court of appeals, it could result in theCompany being required to contribute amounts that have yet to be determinedinto the union’s pension benefit, health and welfare and vacation funds. Anypotential required contributions resulting from a final judicial determinationof this matter would potentially be subject to offset by the amounts that theCompany had funded since it implemented its final contract proposal for thesesame benefits that were paid for its Allied Trades Council employees. Becausethis is just the first phase of a long and complicated administrative processlikely to be followed by a full judicial review of all of the facts andcircumstances, the final outcome cannot be reliably determined at this time.The ALJ’s recommendation is not a binding order and has no force and effect oflaw. Rather, it is a recommendation to the full NLRB in Washington D.C., whichwill conduct a complete review at some point in the future and decide touphold, reject or modify the recommendation. The full NLRB decision is alsosubject to judicial review by the circuit court of appeals and a compliancehearing before any financial remedy can be determined. While there can be nodefinitive assurance, the Company has been advised by its outside labor counselthat it has numerous meritorious defenses and arguments in response to theALJ’s recommendation.

 

In light of theforegoing, while it is the Company’s belief that the final financial outcome ofthis litigation cannot be determined at this time, under the provisions ofStatement of Financial Accounting Standard (“FAS”) No. 5 which addresses thesecontingencies, the Company recorded a pre-tax charge of $12.6 million forthe year ended December 27, 2003 and an additional pre-tax charge of $1.1million in the quarter ended March 27, 2004. These charges represent thecurrent best estimate of the loss that would result upon application of theALJ’s recommendation. The Company notes that such charges were based upon thefacts available to it at the time. In the Company’s opinion, such charges couldbe subject to significant modification in the future, upon review by the fullNLRB, the Federal Circuit Court of Appeals, completion of a compliance hearingand any appeals relating to the outcome of that hearing. These charges reflectthe amount of contributions that the Company did not make into the union benefitfunds for the period from the August 31, 2001 expiration of the contractthrough March 27, 2004, reduced by a portion of the benefits the Company

 

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paid directly to or forthe benefit of these employees over the same period. It also includes aninterest cost for these net contributions from the date they would have beenpaid until March 27, 2004. While this represents the Company’s currentbest estimate of the ALJ’s recommendation, the Company believes that the actualrange of loss in this matter could be from $0, if the ALJ’s recommendation isnot followed to approximately $28 million, if the ALJ’s recommendation isupheld and there is no offset for any benefits paid over this period.

 

Until such time asfurther legal developments warrant a change in the application of thisaccounting standard, or until this matter is resolved, the Company will recordadditional non-cash pre-tax charges, which are calculated on the same basis asthe charge recorded in the 2003 financial statements. The Company currentlyestimates that the charge in 2004 will approximate $4.4 million.

 

**4. Acquisitions**

 

During the first quartersof fiscal 2004 and fiscal 2003, the Company acquired pharmacy customer files,which were merged into existing stores, and the operations, including certainlease-related assets, of a number of pharmacy establishments, which wereoperated as new stores.  The table belowprovides details of this acquisition activity for each of the periods presented(dollars in millions).

 

|                               |   | **13 weeks  ended** |   |
|------------------------------------|--------|---------------------|--------|
|                               |   | **March 27,  2004** |   | **March 29,  2003** |   |
|                               |   |                |   |   |   |
| Customer  prescription files       |   | 4                   |   | 4 |   |
| Pharmacy  establishments           |   | —              |   | 2 |   |
| Total  acquisitions                |   | 4                   |   | 6 |   |
|                               |   |                |   |   |   |
| Cash  consideration                |   | $                   | 6.6    |   | $ | 5.6 |   |
|                               |   |                |   |   |   |
| Purchase  price allocation:        |   |                |   |   |   |
| Identifiable  intangibles          |   | $                   | 5.7    |   | $ | 3.5 |   |
| Goodwill                           |   | 0.3                 |   | 0.9 |   |
| Inventory                          |   | 0.8                 |   | 0.9 |   |
| Property  and equipment            |   | —              |   | 0.5 |   |
| Other  assets and liabilities, net |   | (0.2                | )      | (0.2 | ) |
| Total                              |   | $                   | 6.6    |   | $ | 5.6 |   |

 

The acquired operationshave been included in the consolidated statement of operations from the date ofacquisition and did not have a material effect on sales, results of operationsor earnings per share of the Company for the periods presented.

 

**5. Inventory**

 

At March 27, 2004,inventories, consisting solely of finished goods, would have been greater by$0.5 million if they had been valued on a lower of first-in, first-out (“FIFO”)cost or market basis instead of a last-in, first-out (“LIFO”) basis.

 

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**6. Debt**

 

Long-term debt iscomposed of the following (in thousands):

 
| **Description of Instrument**              |   | **Balance at  Mar. 27, 2004** |        | **Balance at  Dec. 27, 2003** |   |
|--------------------------------------------|--------|-------------------------------|-------------|-------------------------------|--------|
|                                       |   |                          |        |                          |   |
| 2.1478%  Senior Convertible Notes due 2022 |   | $                             | 201,032     |                          | $      | 201,032 |   |
| Revolving  credit facility                 |   | 75,438                        |        | 70,353                        |   |
|                                       |   | 276,470                       |        | 271,385                       |   |
| Less  – Current portion               |   | —                        |        | —                        |   |
|                                       |   | **$**                         | **276,470** |                          | **$**  | **271,385** | ** ** |

 

**2.1478% Senior Convertible Notes dueApril 16, 2022:* ***OnApril 16, 2002, the Company completed an offering of $381.5 millionaggregate principal amount of Senior Convertible Notes maturing onApril 16, 2022 (the “Convertible Notes”). The Convertible Notes wereissued at a price of $572.76 per note (57.276% of the principal amount atmaturity) and pay cash interest at the rate of 2.1478% per year on theprincipal amount at maturity, payable semi-annually in arrears on April 16and October 16 of each year beginning on October 16, 2002, untilApril 16, 2007. After that date, interest will accrue on the notes asamortization of the original issue discount representing a yield to maturity of3.75% per year, computed on a semi-annual bond equivalent basis. InDecember 2002, the Company repurchased a total of $30.5 million principalvalue of the Convertible Notes at an average purchase price of $486.99 per$1,000 note, resulting in the remaining net outstanding balance of $201.0million.

 

As more fullydetailed in the Registration Statement on Form S-3 filed with the SEC onJune 21, 2002, holders of the Convertible Notes may convert each $1,000 inprincipal amount of their convertible notes into 14.1265 shares of theCompany’s common stock, subject to adjustment, only if (1) the sale priceof the Company’s common stock reaches the “conversion trigger price,” asdefined, of $44.60 per share, (2) the trading price of the notes falls below103% of the “average conversion value,” as defined, (3) the notes arecalled for redemption, or (4) specified corporate transactions, includinga consolidation, merger, or a transfer of all or substantially all of theCompany’s assets have occurred. Upon conversion, the Company has the right todeliver, in lieu of its common stock, cash or a combination of cash and commonstock in an amount as described in the indenture. These notes are notconsidered to be potential common shares, and are not included in thecalculation of diluted earnings per share, as the Company intends to settle anyconversions in cash.

 

Holders of theConvertible Notes may require the Company to purchase all or a portion of theirnotes on April 16, 2007 at a price of $572.76 per note plus accrued cashinterest, if any; on April 16, 2012 at a price of $689.68 per note plusaccrued cash interest, if any; and on April 16, 2017 at a price of $830.47per note plus accrued cash interest, if any. The Company may choose to pay thepurchase price of such notes in cash or common stock or a combination of cashand common stock. In addition, each holder may require the Company to purchasefor cash all or a portion of such holder’s notes at a price equal to the sum ofthe issue price plus accrued original issue discount and accrued cash interest,if any, to the date of purchase if the Company experiences a change of control.The Company’s planned acquisition by Duane Reade Acquisition would result in achange of control. The Company expects substantially all holders will exercisethis change of control right if this transaction is consummated.

 

The Company mayredeem for cash all or a portion of the convertible notes at any time afterApril 16, 2007, at a price equal to the sum of the issue price plusaccrued original issue discount and accrued cash interest, if any, to theredemption date.

 

**Revolving credit facility: **On July 21, 2003, the Company completed therefinancing of the Fourth Amended and Restated Credit Agreement entered into bythe Company on July 10, 2001 (the “Senior Credit Agreement”). The new creditfacility (the “Credit Agreement”) is an asset-based revolving loan which uses apre-determined percentage of the current value of the Company’s inventory, customerprescription files and selected accounts receivable to calculate theavailability of funds eligible to be borrowed up to an aggregate principalamount of $200 million. The obligations of the Company under the CreditAgreement are secured by substantially all of the assets of the Company. Inaddition, the Credit Agreement has been guaranteed by each of the Company’scorporate subsidiaries, and such guarantees are secured by substantially allassets of such guarantors.  The CreditAgreement matures on July 20, 2008.

 

10

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Under the CreditAgreement, approximately $103.5 million was borrowed and used to repay in fullthe outstanding balances of Term A, Term B and revolver borrowings under theSenior Credit Agreement, as well as accumulated interest to the repayment dateand certain expenses associated with the new financing.  At March 27, 2004, there was $75.4million outstanding under the revolving credit facility, and approximately$123.4 million of remaining availability, net of $1.2 million reserved forstandby letters of credit. Borrowings under the Credit Agreement areprincipally LIBOR-based. The margin on these borrowings is fixed at 1.75% forthe first year, and is subject to a sliding scale adjustment thereafter, basedon remaining levels of availability.

 

The Credit Agreementcontains a single fixed charge coverage requirement which only becomesapplicable when borrowings exceed 90 percent of the borrowing base, as definedin the Credit Agreement. Borrowings under the Credit Agreement have notexceeded 90 percent of the borrowing base and, as a result, the fixed chargecovenant did not become applicable during the period. There are no creditratings related triggers in the Credit Agreement or in the indenture related tothe Convertible Notes.

 

**7. Net Income per Common Share**

 

Net income per commonshare is based on the weighted average shares outstanding during each period inaccordance with the provisions of FAS No. 128 “Earnings Per Share.” Basicearnings per share is computed based on the weighted average number of commonshares outstanding during the period. Diluted earnings per share gives effectto all dilutive potential common shares outstanding during the period. Dilutivepotential common shares include shares issuable upon exercise of the Company’s“in-the-money” stock options. Of the options to purchase 2,215,183 and1,235,236 shares of common stock outstanding at March 27, 2004 andMarch 29, 2003, respectively, options to purchase 126,485 shares atMarch 27, 2004 and 210,009 shares at March 29, 2003 were not includedin the computation of diluted earnings per share because the exercise prices ofsuch options were greater than the average market price of the common sharesand therefore the impact of these shares would be anti-dilutive. Dilutivepotential common shares do not include any potential shares that could beissued relative to the Company’s 2.1478% Convertible Notes (see Note 6 to theseUnaudited Consolidated Interim Financial Statements for a description of therelevant conversion terms of the Convertible Notes).

 

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

 
|                                                       |   | **For the 13 Weeks Ended** |   |
|------------------------------------------------------------|--------|----------------------------|--------|
|                                                       |   | **March 27,  2004**   |   | **March 29,  2003** |   |
|                                                       |   |                       |   |   |   |
| Net  income                                                |   | $                          | 1,356  |   | $ | 3,112 |   |
|                                                       |   |                       |   |   |   |
| Weighted  average common shares outstanding – basic   |   | 24,409                     |   | 24,038 |   |
| Potential  dilutive shares                                 |   | 242                        |   | 330 |   |
| Weighted  average common shares outstanding – diluted |   | 24,651                     |   | 24,368 |   |
|                                                       |   |                       |   |   |   |
| Net income per common share - basic                        |   | $                          | 0.06   |   | $ | 0.13 |   |
|                                                       |   |                       |   |   |   |
| Net income per common share – diluted                 |   | $                          | 0.06   |   | $ | 0.13 |   |

 

**8. Income Taxes**

 

Income taxes are recordedbased on the estimated combined statutory tax rates expected to be applicablefor the full fiscal year less applicable employment related tax credits. Theeffective tax rate is lower than the combined statutory rates, primarilyreflecting the impact of these income tax credits. The effective tax rate of40% recorded in the first quarter of 2004 gives effect to the New York Statetax legislation passed in May 2003 with retroactive application toJanuary 1, 2003.  This legislationeffectively eliminated certain royalty fee and related interest expensedeductions. The employment tax credits represent the economic benefits earnedby us for our participation in various Federal and state hiring incentiveprograms. These benefits are based on the number of qualifying employees hiredand retained by us for a specified time period. Employees qualify for thesehiring programs primarily as a result of their enrollment in various economicassistance programs.

 

11

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**9. Recently Issued Accounting Pronouncements**

 

In December 2002,FAS No. 148, “Accounting for Stock-Based Compensation – Transition andDisclosure” was issued. This statement provides alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. The Company has not adopted suchvoluntary change to the fair value based method. In addition, this statementamends the disclosure requirements of FAS No. 123 to require prominentdisclosures about the method of accounting for stock-based compensation and theeffect of the method used on reported results. As required, the Company adoptedthe disclosure-only provisions of FAS No. 148 effective in 2002.

 

The Company previouslyadopted FAS No. 123, “Accounting for Stock-Based Compensation” and, aspermitted under FAS No. 123, has elected the disclosure-only provisions. TheCompany accounts for its stock-based compensation plans under the recognitionand measurement principles of APB Opinion No. 25, “Accounting for Stock Issuedto Employees,” and related interpretations. There is no stock-based employeecompensation cost reflected in net income, as all options granted under thoseplans had an exercise price equal to or greater than the market value of theunderlying common stock on the date of grant. The following table illustratesthe effect on net income and earnings per share if the Company had applied thefair value recognition provisions of FAS No. 123 to stock-based employeecompensation (dollars in thousands):

 

|                                                                                                                                                    |   | **13 weeks  ended** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|
|                                                                                                                                                    |   | **March 27,  2004** |   | **March 29,  2003** |   |
|                                                                                                                                                    |   |                |   |   |   |
| Net  income, as reported                                                                                                                                |   | $                   | 1,356  |   | $ | 3,112 |   |
|                                                                                                                                                    |   |                |   |   |   |
| Adjust:  Total stock-based employee compensation (expense)/income determined under  fair value based method for all awards, net of related tax effects. |   | (1,136              | )      | 9,395 |   |
|                                                                                                                                                    |   |                |   |   |   |
| Pro  forma net income                                                                                                                                   |   | $                   | 220    |   | $ | 12,507 |   |
|                                                                                                                                                    |   |                |   |   |   |
| Income  per common share:                                                                                                                               |   |                |   |   |   |
| Basic  - as reported                                                                                                                                    |   | $                   | 0.06   |   | $ | 0.13 |   |
| Basic  - pro forma                                                                                                                                      |   | $                   | 0.01   |   | $ | 0.52 |   |
|                                                                                                                                                    |   |                |   |   |   |
| Diluted  - as reported                                                                                                                                  |   | $                   | 0.06   |   | $ | 0.13 |   |
| Diluted  - pro forma                                                                                                                                    |   | $                   | 0.01   |   | $ | 0.52 |   |

 

As described in previousSEC filings issued during 2003, the Company cancelled 1,337,449 outstandingstock options during the first quarter of 2003 in connection with the StockOption Exchange Offer. The pro forma income shown in the table above for thethree months ending March 29, 2003 includes the reversal of pro formaexpenses previously disclosed totaling $9.7 million, related to the granting ofthese original options.  OnOctober 1, 2003, the Company issued 1,320,947 options at an exercise priceof $16.55 per share to replace those options exchanged in connection with theStock Option Exchange Offer. As a result, beginning in the fourth quarter of2003, the Company has been incurring pro forma compensation expense whichreflects the fair value of the replacement stock options granted.

 

The pro formacompensation income (expense) for stock options has been estimated using theBlack-Scholes option pricing model with the following assumptions for each ofthe periods shown: dividend yield of 0%, expected volatility of 50%, risk freeinterest rate of 6.6% and an expected term of 8 years. These pro formadisclosures may not be representative of the effects on reported net income forfuture periods since options vest over several years and options granted priorto 1995 are not considered.

 

12

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**10. Commitments and Contingencies**

 

The Company is party tolegal actions arising in the ordinary course of business. Based on informationpresently available to management, the Company believes that it has adequatelegal defenses or insurance coverage for these actions and that the ultimateoutcome of these actions will not have a material adverse effect on thefinancial position, results of operation or cash flows of the Company. Inaddition, the Company is a party to the following legal actions and matters:

 

During 2002, the Companyinitiated a legal action against its former property insurance carrier inFederal Court in the Southern District of New York, in an attempt to recoverwhat the Company believes to be a fair and reasonable settlement for thebusiness interruption portion of its claim originating from theSeptember 11, 2001 World Trade Center terrorist attack, during which theCompany’s single highest volume and most profitable store was completelydestroyed. In September 2003, a trial on certain issues was held regardingsome of the matters at issue in the litigation, including whether the Companywould have obtained a renewal of its lease at the World Trade Center. TheCompany has received a favorable ruling on this and other legal issues in thecase and now the matter has moved into an appraisal process. The appraisalprocess involves two appraisers and an umpire (to resolve differences betweenthe two appraisers) who will determine the amount of insured loss the Companyhas sustained. The insurance carrier has appealed a number of the rulings bythe trial court. In light of both the early state of the appraisal process andthe inherent uncertainty in litigation relating to the appeal, the amount ofadditional insurance proceeds, if any, the Company may collect under the termsof its insurance contract with the defendant cannot be reasonably predicted ordetermined at this time. In fiscal 2002, the Company received an advance of approximately$9.4 million toward its business interruption claim that was recognized asa separate component of income in the Company’s consolidated statement ofincome. In the event of an unfavorable outcome to the Company, this amountwould not be required to be returned to the insurance company.

 

The Company, Anthony J.Cuti, its Chairman, President and Chief Executive Officer, John K. Henry, itsSenior Vice President and Chief Financial Officer, and Gary Charboneau, itsSenior Vice President of Sales and Marketing, have been named as defendants inconnection with the consolidation of several class action complaints allegingviolations of the federal securities laws that were filed from August 2002through October 2002. The action, which is in the United States DistrictCourt for the Southern District of New York, is on behalf of shareholders whopurchased Duane Reade Inc.’s common stock between April 1, 2002 andJuly 24, 2002, inclusive. The complaint, which seeks an unspecified amountof damages, alleges that the defendants violated the federal securities laws byissuing materially false and misleading statements during the class period. OnDecember 1, 2003, the district judge granted the Company’s motion todismiss the plaintiff’s action, with prejudice. The plaintiffs have filed anappeal. The Company continues to believe that the plaintiffs’ actions arecompletely baseless and wholly without merit, and intends to continue tovigorously defend itself.

 

The Company is adefendant in a class action suit in the Federal Court for the Southern Districtof New York regarding alleged violations of the Fair Labor Standards Act as toa group of individuals who provided delivery services on a contract basis tothe Company. In December 2002, the judge in the action issued a partialsummary judgment in favor of a subclass of the plaintiffs and against theCompany. In December 2003, the Company settled the issue of the amount ofits liability to the plaintiffs without any admission of wrongdoing and in anamount consistent with the Company’s previously established reserves. Theamount of attorney’s fees owed to the plaintiffs’ attorneys remains an openissue in the case, and the Company plans to vigorously defend claims by theseattorneys for fees. It is not anticipated that the amount of attorneys feesthat would be required to be paid in this matter would be material to thebusiness and operations of the Company.

 

The Company is a party torelated lawsuits, Irving Kroop, et al v. Duane Reade, NY, NY et al, 00 Civ.9841, et al., instituted by the trustees of several union benefit funds whereinthe funds claim that the Company did not make certain required contributions tothese funds from January 2000 through August 2001. The plaintiffshave recently filed a motion seeking summary judgment of $2.29 million ofclaims for alleged underfunding and related penalties and interest. Inaddition, at various times, the plaintiffs have stated that they believe theCompany may owe additional amounts. However, any additional amounts that theplaintiffs may claim are not known at this time. The Company has filed a motionopposing these claims. The Company believes that it has made sufficientcontributions to these funds and that it has meritorious defenses to the claimsbeing made by these funds. Accordingly, the Company intends to vigorouslydefend itself in these matters. At this time, it is not possible to determinethe ultimate outcome of this case or the actual amount of liability the Companymay face, if any.

 

13

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The Company is involvedin an ongoing dispute with Cardinal Health, one of its former suppliers ofpharmaceutical products. Both parties have claims against the other involving,among other things, breach of contract, promissory estoppel and unjustenrichment. Duane Reade is seeking from Cardinal an unspecified amount ofdamages and punitive damages of at least $20 million. Cardinal is seekingapproximately $18 million in damages plus attorney’s fees and interest. Whilethere can be no definitive assurance, the Company believes it has counterclaimsthat offset the claims against it by Cardinal, as well as meritorious defensesto these claims, and plans to vigorously pursue its affirmative claims and tovigorously defend itself in this action. Non-party discovery in this case hasbeen concluded and it is expected to go to trial sometime in 2004.

 

The Company is involvedin litigation related to a dispute with the Allied Trades Council, a unionrepresenting employees in 139 of its stores. This litigation is more fullydescribed in Note 3 to these Unaudited Consolidated Interim FinancialStatements.

 

A New York State TaxAppeals Tribunal ruling in a matter involving another company may have anadverse impact upon the Company’s New York State Franchise Tax filings fromyears 1999 through 2002. This matter relates to the required combination ofaffiliated subsidiaries in recognizing royalty fee and related income forintangible property. The ruling of the Tribunal is subject to further legalappeal and interpretation in light of the Company’s own specific facts andcircumstances. The outcome of this matter, and the resulting amount ofadditional income tax expense, if any, cannot be determined by the Company atthis time.

 

***Litigation Relating to the Merger Transaction:***  Duane Reade is aware of six purported classaction complaints challenging the merger transaction that have been filed inthe Court of Chancery of the State of Delaware, referred to as the “DelawareComplaints,” and three purported class action complaints that have been filedin the Supreme Court of the State of New York. Two of the New York complaintshave been dismissed without prejudice. The other New York complaint (the “NewYork Complaint”) is pending, but has not been served on Duane Reade. TheDelaware Complaints name Mr. Cuti and certain other members of theCompany’s board of directors and executive officers as well as Duane Reade asdefendants. Four of the Delaware Complaints name Oak Hill as a defendant. The NewYork Complaint names Mr. Cuti and certain other members of the Company’sboard of directors and executive officers as well as Duane Reade as defendants.One of the dismissed New York complaints named Oak Hill as a defendant.

 

The Delaware Complaintswere consolidated on January 28, 2004, and on April 8, 2004 the plaintiffs inthe Delaware actions filed a consolidated class action complaint (the“Consolidated Complaint”).

 

The ConsolidatedComplaint alleges that defendants failed to disclose material information inthe preliminary proxy statement, which was filed with the SEC on March 19,2004.  Specifically, the ConsolidatedComplaint alleges that the defendants failed to disclose: (1) the precisenature of the “Current Employment Agreement Estimated Payments,” as that termis used in the preliminary proxy, and the reasons for these payments: (2) thematerials and data purportedly used by Bear Stearns in calculating the “CurrentEmployment Agreement Estimated Payments,” instead of the disclosure in thepreliminary proxy statement that these calculations were “approximations basedon various assumptions since the precise amounts payable would requireactuarial or other expert valuation,” even though Bear Stearns allegedly reliedon these calculations; (3) the methodology, projections and other informationused by Bear Stearns to calculate the estimated present value of the company;(4) that the merger consideration represented an approximately 11.7% premiumbased upon the trading price of Duane Reade shares on December 22, 2003,instead of the disclosure in the preliminary proxy that shareholders would bereceiving a much higher premium of 22.0%. The Consolidated Complaint and the New York Complaint allege, amongother things, that the defendants purportedly breached duties owed to DuaneReade’s stockholders in connection with the transaction by failing to: (a)appropriately value Duane Reade as a merger candidate; (b) expose Duane Readeto the marketplace in an effort to obtain the best transaction reasonably available,including to market Duane Reade to industry participants; and (c) adequatelyensure that no conflicts of interest exist between defendants’ own interestsand their fiduciary obligation to maximize stockholder value.  Plaintiffs seek, among other things: anorder that the complaints are properly maintainable as a class action; adeclaration that defendants have breached their fiduciary duties and otherduties; injunctive relief; an unspecified amount of monetary damages;attorneys’ fees, costs and expenses; and such other and further relief as thecourt may deem just and proper.  DuaneReade believes these lawsuits are without merit and plans to defend theselawsuits vigorously.

 

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

 

**General**

 

Our business consists ofa wide variety of health and beauty care products, convenience oriented foodand general merchandise items and a pharmacy operation managed to supplycustomers with their prescription needs. We refer to the non-prescriptionportion of our business as front-end sales because most of these sales areprocessed through the front main check-out sections of our stores. This portionof our business consists of over-the-counter medications, health and beautycare items, food and beverages, tobacco products, cosmetics, housewares,greeting cards, photofinishing, photo supplies, seasonal and generalmerchandise. Health and beauty care products, including over-the-counter items,represent our highest volume categories within front-end sales. The front-endportion of our business represented 54.7% of our sales in the quarter endedMarch 27, 2004 and is characterized by generally higher gross margins thatare approximately twice that of our pharmacy or back-end business. Ourfront-end business is generally a larger proportion of our total sales thanother major drug store chains, which average 35% to 45%, but similar to mostother drug store chains, represents a decreasing share of business year afteryear due to the faster rate of pharmacy sales growth. Our high percentage offront-end sales is driven by our convenient locations in high trafficresidential and commercial areas. Our pharmacy sales include all items we sellby prescription filled within our retail locations or in our central fillfacility and delivered to our stores or direct to customers. The pharmacyportion of our business is dominated by and dependent upon a number of thirdparty private and government-sponsored plans that contract with us as anauthorized provider of prescriptions.

 

Third party prescriptionplans represented 92.0% of our pharmacy sales in the quarter endedMarch 27, 2004. The pharmacy portion of our business is subject to anumber of federal, state and local regulations that govern the conduct of thisbusiness. Pharmacy sales have been among the fastest growing retail categoriesover the last several years due to a number of favorable demographic andindustry trends such as the aging of the population, expanding penetration ofthird party private and government-sponsored coverage and the increasing usageof prescription drugs to improve quality of life and in place of medicalprocedures. Along with the fast pace of growth in this area have come generallyhigher rates of product cost inflation, resulting in an increased focus on thepart of both government and private plans to control their costs of providingthese benefits. As a result, pharmacy gross margins have been under pressure.

 

During 2003, PresidentBush signed legislation that will expand Medicare coverage of senior citizens'prescriptions. This new Medicare coverage is planned to take effect in 2006 andis expected to result in decreased pharmacy margins resulting from lower reimbursementrates than our current margins on customer-paid cash prescriptions. In June2004, a temporary senior citizen discount program furnished under this Medicarelegislation is expected to be implemented and will remain in effect until thefull Medicare program takes effect in 2006. This temporary program is alsoexpected to result in lower pharmacy margins than those realized from ourcustomer-paid cash prescription business.

 

In fiscal 2003, New YorkState reduced Medicaid prescription reimbursement rates, adversely impactingour pharmacy gross margins.  Recent NewYork State budget proposals also include the possibility of additionalreductions in Medicaid reimbursement rates.

 

While remaining one ofthe fastest growing retail categories in 2003, the industry as a wholeexperienced substantially reduced rates of pharmacy same-store sales growthresulting from a decline in the demand for hormonal replacement drugs,conversion of some high volume prescription drugs to over-the-counter status,increased levels of required co-payments by insurers, increased utilization oflower priced generic medications and reductions in coverage resulting from highunemployment rates. These trends continued to be operative throughout the firstquarter of 2004.

 

We operate approximately85% of our 243 stores in New York City and therefore our financial performanceis heavily influenced by the local economy. We analyze a number of economicindicators specific to New York City to gauge the health of this economyincluding unemployment rates, job creation, gross city product and bridge andtunnel commuter traffic patterns. We also analyze market share data, same-storesales trends, average store sales and sales per square foot data among otherkey performance indicators to monitor our overall performance.

 

The New York City economycontinued to experience higher rates of unemployment than the national economyoverall. March unemployment data for New York City indicated anunemployment rate of 7.9% compared to a national average of 5.7%. While thelocal economy still lags the national trend, the city did not experiencecontinued job losses during the quarter and has begun to report a rising rateof tax revenues. These trends reflect an improved fiscal situation for the cityoverall that is consistent with the early stages of an improving local economy.

 

In connection with themerger, the Company filed a preliminary proxy statement on March 19, 2004and intends to file additional relevant materials with the SEC, including adefinitive proxy statement, and the acquiring entities will file other relevantdocuments with the SEC. BECAUSE THOSE DOCUMENTS WILL CONTAIN IMPORTANTINFORMATION, HOLDERS OF DUANE READE COMMON STOCK ARE URGED TO READ THEM, IF ANDWHEN THEY BECOME AVAILABLE. When filed with the SEC, they will be available forfree (along with any other documents and reports filed by Duane Reade with theSEC) at its website,*www.sec.gov*,and Duane Reade stockholders will receive information at an appropriate time onhow to obtain the definitive proxy statement for free from Duane Reade. Aspecial meeting of Duane Reade’s stockholders will be convened as soon aspracticable after the filing of definitive proxy materials with the SEC. Wecurrently anticipate consummating the merger by the end of June 2004.

 

Duane Reade Shareholders,LLC, Duane Reade Holdings, Inc. and Duane Reade Acquisition were formed as theacquiring entities at the direction of the equity sponsors, which currentlyinclude Oak Hill, Oak Hill Capital Management Partners, L.P. and certainmembers of Duane Reade’s management. Andrew J. Nathanson and Tyler J. Wolframare the initial directors of each newly formed Delaware corporation. Theseentities and their directors and officers may be deemed to be participants in thesolicitation of proxies in connection with the proposed transaction. As of thedate of this report, Mr. Nathanson has an indirect interest (through hisparticipation in an investment partnership) of less than 1% in the outstandingshares of the common stock of Duane Reade and none of the other forgoingparticipants has any direct or indirect interest, by security holdings orotherwise, in Duane Reade.

 

Duane Reade andits directors and executive officers may be deemed to be participants in thesolicitation of proxies from its stockholders in connection with the proposedtransaction. Certain information regarding the participants and their interestin the solicitation is set forth in Duane Reade’s Amendment No.1 to its AnnualReport on Form 10-K filed with the SEC on April 26, 2004. Stockholders mayobtain additional information regarding the interests of such participants byreading the preliminary proxy statement and the definitive proxy statement whenit becomes available.

 

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**Results of Operations**

 

For the first quarterended March 27, 2004, we achieved net sales of $349.6 million and netincome of $1.4 million or $0.06 per diluted share, compared to net sales of$333.6 million and net income of $3.1 million or $0.13 per diluted share in thefirst quarter of the previous year. Although gross margins increased from 21.0%last year to 21.7% this year, the decline in net income is principally due tothe following factors:

 

•                  A$1.5 million increase in depreciation and amortization expense resulting fromthe depreciation of capital expenditures made in 2003 and 2004 as well asincreases in the amortization of identifiable intangibles resulting frompharmacy acquisitions completed since the first quarter of 2003;

•                  Pre-taxlabor contingency expenses of $1.1 million related to a National LaborRelations Board Administrative Law Judge's recommendation in a collectivebargaining agreement litigation related to funding of certain employee benefitfunds (see Note 3 to the Unaudited Consolidated Interim Financial Statements);

•                  Pre-taxtransaction expenses of $1.1 million related to the proposed merger; and

•                  Increasedlegal and litigation related expenses by $0.6 million associated with certainlabor issues, our attempt to recover the balance of our World Trade Centerbusiness interruption insurance claim and various other matters.

 

The following sets forththe results of operations for the periods indicated.

 
|                                          |   | **13 weeks  ended  March 27, 2004** |    | **13 weeks  ended  March 29, 2003** |   |
|-----------------------------------------------|--------|------------------------------------------|---------|------------------------------------------|--------|
| ***In thousands,  except percentages***       |   | **Dollars**                              |    | **% of Sales**                           |   | **Dollars** |   | **% of Sales** |   |
| Net  sales                                    |   | $                                        | 349,550 |                                     | 100.0  | % | $ | 333,622 |   | 100.0 | % |
| Cost  of sales                                |   | 273,785                                  |    | 78.3                                     |   | 263,433 |   | 79.0 |   |
| Gross  profit                                 |   | 75,765                                   |    | 21.7                                     |   | 70,189 |   | 21.0 |   |
| Selling,  general and administrative expenses |   | 58,643                                   |    | 16.8                                     |   | 53,574 |   | 16.1 |   |
| Labor  contingency                            |   | 1,100                                    |    | 0.3                                      |   | — |   | — |   |
| Transaction  expenses                         |   | 1,102                                    |    | 0.3                                      |   | — |   | — |   |
| Depreciation  and amortization                |   | 9,066                                    |    | 2.6                                      |   | 7,557 |   | 2.2 |   |
| Store  pre-opening expense                    |   | 157                                      |    | —                                   |   | 416 |   | 0.1 |   |
| Operating  income                             |   | 5,697                                    |    | 1.7                                      |   | 8,642 |   | 2.6 |   |
| Interest  expense, net                        |   | 3,437                                    |    | 1.0                                      |   | 3,517 |   | 1.1 |   |
| Debt  extinguishment                          |   | —                                   |    | —                                   |   | 105 |   | — |   |
| Income  before income taxes                   |   | 2,260                                    |    | 0.7                                      |   | 5,020 |   | 1.5 |   |
| Income  taxes                                 |   | 904                                      |    | 0.3                                      |   | 1,908 |   | 0.6 |   |
| Net  income                                   |   | $                                        | 1,356   |                                     | 0.4    | % | $ | 3,112 |   | 0.9 | % |

 

**Thirteen Weeks Ended March 27, 2004 versus ThirteenWeeks Ended March 29, 2003**

 

Net sales were $349.6million in the first quarter of 2004, an increase of 4.8% over net sales of$333.6 million for the first quarter of 2003. Same-store sales increased by1.6% over the first quarter last year with the balance of the increase comingfrom the full quarterly results of four net new stores opened in the firstquarter last year and 11 net new stores opened since the end of last year’s firstquarter.

 

Pharmacy sales increasedfrom $143.8 million in the first quarter of 2003 to $158.5 million in the firstquarter of 2004, an increase of 10.2%, and represented 45.3% of total sales, ascompared with 43.1% of total sales in the first quarter of 2003. Pharmacysame-store sales increased by 6.6% over last year, and third-party reimbursedpharmacy sales represented 92.0% of total pharmacy sales compared to 91.1% inthe first quarter of 2003. Pharmacy same-store sales continued to experiencethe general industry trend of reduced growth rates experienced during fiscal2003.  The major factors driving theslower sales growth rates in pharmacy were the trends toward increases in thirdparty plan customer co-payments, reduced sales of hormonal replacement drugs,limitations on maximum reimbursements for certain generic medications by thirdparty plans and continued high rates of unemployment in our market areas thathave reduced the number of customers covered by insured plans.

 

16

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Front-end sales increasedfrom $189.8 million in the first quarter of 2003 to $191.1 million in the firstquarter of 2004, an increase of 0.7%, and represented 54.7% of total sales, ascompared to 56.9% of total sales in the first quarter of 2003. Front-end samestore sales declined by 2.3%, largely due to declining tobacco sales in metroNew York City, which has experienced increased restrictions on smoking inpublic places along with higher taxes on tobacco products.  Excluding tobacco sales, front-endsame-store sales decreased by approximately 0.6%. We believe that the remainingdecline in same-store front-end sales is largely attributable to the continuedhigh unemployment rates in New York City that have restrained consumer demand.

 

During the first quarterof 2004, we opened three new stores and closed one store. At March 27,2004, we operated 243 stores, as compared to 232 stores at March 29, 2003.

 

Cost of sales as apercentage of net sales decreased to 78.3% for the first quarter of 2004 from79.0% for the first quarter of 2003, resulting in an increase in gross profitmargin to 21.7% for the first quarter of 2004 from 21.0% for the first quarterof 2003.  This increase was primarilyattributable to higher front-end selling margins and reduced shrink losses.These improvements were partially offset by higher store occupancy costsprimarily resulting from higher rent expense attributable to new stores andstore relocations.   Cost of sales alsoincludes a $0.2 million LIFO provision in both the current and prior years.

 

Selling, general andadministrative expenses were $58.6 million, or 16.8% of net sales, and $53.6million, or 16.1% of net sales, in the first quarters of 2004 and 2003,respectively.  The increase in these expensesas a percentage of sales is primarily attributable to the higher legal andlitigation related expenses discussed above, increased promotional andadvertising expenses, severance costs associated with certain administrativestaff reductions and higher insurance costs.

 

Depreciation andamortization of intangibles in the first quarters of 2004 and 2003 were $9.1million and $7.6 million, respectively. This increase resulted from the depreciation of capital expendituresmade in 2003 and 2004 as well as increases in the amortization of identifiableintangibles resulting from pharmacy acquisitions completed since the firstquarter of 2003.

 

We incurred storepre-opening expenses of $0.2 million during the first quarter of 2004 relatedto the opening of three new stores. During the comparable period last year, we incurred pre-opening expensesof $0.4 million related to the opening of seven new stores.

 

Net interest expensedecreased 2.3% to $3.4 million in the first quarter of 2004 from $3.5 millionin the first quarter of 2003.  Thisdecline was primarily attributable to the lower average interest rates on ouroutstanding revolving credit borrowings in the current year, as compared to theinterest rates incurred on our revolving credit and term loan borrowings in theprior year.

 

In the first quarter of2003, we recorded a debt extinguishment charge of $0.1 million, reflecting thepayment of early termination premiums related to the retirement of the $1.6million outstanding balance of the 9.25% senior notes and the write-off of theremaining deferred financing costs associated with those notes.

 

In the first quarter of2004, we recorded an income tax provision of $0.9 million, reflecting anestimated annual effective tax rate of 40.0%, inclusive of the anticipatedbenefits of employment tax credits. In the comparable period last year, theincome tax provision of $1.9 million reflected an estimated effective tax rateof 38.0%, inclusive of the anticipated benefits of employment tax credits. Theincrease in the effective tax rate reflects New York State legislation passedin May 2003 which eliminated certain tax deductions attributable to royaltycompanies. The employment tax credits represent the economic benefits earned byus for our participation in various Federal and state hiring incentiveprograms.

 

**Liquidity and Capital Resources**

 

Working capital was$224.3 million as of March 27, 2004 and $227.6 million as ofDecember 27, 2003. The decrease was primarily due to reduced levels ofmerchandise purchases and the collection of certain property insurancerecoveries.

 

For the first quarter of2004, net cash provided by operating activities was $12.2 million, as comparedto $3.7 million in the first quarter of 2003. The increase was principally dueto reduced merchandise purchases during this year’s first quarter and thecollection of certain property insurance recoveries.

 

17

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Net cash used ininvesting activities was $17.1 million during the first quarter of 2004,compared to $20.9 million during the first quarter of 2003.  In the first quarter of 2004, capitalexpenditures, primarily related to new store openings and the remodeling ofexisting locations, amounted to $7.9 million, while lease acquisition, pharmacycustomer file and other costs accounted for $9.2 million of cash used ininvesting activities.  In the firstquarter of 2003, we spent $14.2 million on capital expenditures and $6.7million on lease acquisition, pharmacy customer file and other costs.

 

Net cash provided byfinancing activities was $5.0 million for the first quarter of 2004, comparedto $14.2 million for the first quarter of 2003. The decrease primarily reflectsthe improved level of cash flow generated by operations.

 

Our capital requirementsprimarily result from opening and stocking new stores, remodeling andrenovating existing retail locations, purchasing pharmacy files and thecontinuing development of management information systems. We believe that thereare significant opportunities to open additional stores, and currently plan toopen approximately 12 - 14 additional new stores during the remainder of thisyear (a total of 15 - 17 for all of 2004), and 10-12 new stores in fiscal 2005.We expect to spend approximately $40.0 million in 2004 on capital expenditures,primarily for new, renovated and replacement stores, and an additional $14 to$16 million for lease acquisition, pharmacy customer file and other costs. Wealso require working capital to support inventory for our existing and newstores. Historically, we have been able to lease most of our store locations.

 

Leases for 10 of ourstores that generated 4.1% of our net sales for fiscal 2003 are scheduled toexpire before the end of 2005. One of these leases has a renewal option.  We believe that we will be able to renew theexpiring leases on economically favorable terms or, alternatively, find othereconomically attractive locations to lease.

 

As of March 27,2004, approximately 5,600 of our approximately 6,100 employees were representedby various labor unions and were covered by collective bargaining agreements.Pursuant to the terms of the collective bargaining agreements covering theseemployees, we are required, in some instances, to pay specified annualincreases in salary and benefits contributions relating to the memberemployees. We do not believe that these increases will have a material impacton our liquidity or results of operations. Our collective bargaining agreement with Local 340A New York JointBoard, UNITE AFL-CIO (“UNITE”), who represents approximately 700 of ouremployees in 113 stores, expired on March 31, 2004.  The terms of the expired contract have been extended by themutual consent of UNITE and Duane Reade through May 31, 2004 while we continueto negotiate the terms of a new agreement.

 

Under an employmentagreement with our Chairman and CEO originally entered into in 1997 andsubsequently amended in 2000 and 2001, and then amended and restated in 2002,we are required to fund premiums for a split dollar life insurance policy thatwill provide certain post-retirement benefits. During fiscal 2002 and fiscal2003, the premiums amounted to $4.0 million and $5.0 million,respectively, and are scheduled to remain at $5.0 million per year through2010. The premiums have been established at a level anticipated to besufficient to cover the full amount of the projected retirement benefits, aswell as to return the full cost of the premiums plus a 3% rate of interest tous. Recent Sarbanes-Oxley legislation has resulted in the need for additionalguidance concerning the permissibility of split dollar life insurance policiesfor executives. While we believe this split dollar policy is permitted undercurrent interpretations of the legislation, there can be no assurance thatfurther interpretations or guidance to be provided by the SEC concerning thislegislation will concur.

 

Our planned acquisitionby Duane Reade Acquisition will be financed as an all cash transaction wherebyour stockholders will receive $17.00 per share outstanding, without interest,on the date of the closing, which is expected to occur during the secondcalendar quarter of 2004. The total transaction value, including the repaymentof indebtedness and transaction-related expenses is approximately $742 million,which will be funded through new equity investments of approximately$242 million and debt of approximately $500 million. Upon closing, weexpect to have approximately $90 million of borrowing availability underan amendment to our revolving credit facility (the “Credit Agreement”) and nodebt amortization requirements or significant maturities until July 2008.

 

18

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Our debt structure hastwo primary components, senior convertible notes (“Convertible Notes”) and theCredit Agreement.  The Convertible Noteswere issued on April 16, 2002 at a discounted value equivalent to 57.276% offace value.  The Convertible Notes pay cashinterest semiannually at a rate of 2.1478% of face value for the first fiveyears and thereafter accrue original issue discount at a semi-annual bondequivalent rate of 3.75% yield to maturity on April 16, 2022. The ConvertibleNotes are convertible into shares of our common stock upon the occurrence ofcertain specified events. Holders of the Convertible Notes may require us topurchase all or a portion of the Convertible Notes on each of the 5, 10 and15-year anniversaries of the issuance date at pre-specified prices. We mayredeem for cash all or a portion of the Convertible Notes at any time afterApril 16, 2007 at a price equal to the sum of the issue price plus accruedoriginal issue discount and accrued cash interest, if any, to the redemptiondate. The Credit Agreement, which we entered into on July 21, 2003, is anasset-based revolving loan which uses a pre-determined percentage of thecurrent value of our inventory, customer prescription files and selectedaccounts receivable to calculate the availability of funds eligible to beborrowed, up to an aggregate principal amount of $200 million.  Borrowings under this facility areprincipally LIBOR-based, with the margin fixed at 1.75% for the first year andsubject to a sliding scale adjustment thereafter, based on remaining levels ofavailability. This facility matures on July 20, 2008.

 

We believe that, based oncurrent levels of operations and anticipated growth, cash flow from operations,together with other available sources of funds, including revolving loanborrowings under our Credit Agreement, will be adequate for at least the nexttwo years to make required payments of principal and interest on ourindebtedness, to fund anticipated capital expenditures and to satisfy ourworking capital requirements. We base this belief on our existing levels ofcash flow from operations of approximately $40 million annually and significantadditional borrowing capacity under our Credit Agreement which amounted to over$120 million at March 27, 2004. Our ability to meet our debt serviceobligations and reduce our total debt will depend upon our future performancewhich, in turn, will be subject to general economic, financial, business,competitive, legislative, regulatory and other conditions, many of which arebeyond our control. In addition, we cannot assure you that our operating results,cash flow and capital resources will be sufficient for repayment of ourindebtedness in the future.  Such risksthat could adversely affect our ability to meet our debt service obligationsinclude but are not limited to reductions in third party prescriptionreimbursement rates, further declines in the New York City economy, increasesin competitive activity, additional business adverse legislative changes or amajor disruption of business in our markets from a terrorist event or naturaldisaster. Our borrowings under our Credit Agreement bear interest at floatingrates. Therefore, our financial condition will be affected by changes inprevailing interest rates. As of March 27, 2004, we had $75.4 million ofborrowings outstanding under our asset-based revolving credit agreement andthere was $123.4 million of remaining availability, net of $1.2 millionreserved for outstanding Standby Letters of Credit.

 

The Credit Agreementcontains a single fixed charge coverage requirement which only becomesapplicable when borrowings exceed 90 percent of the borrowing base, as definedin the Credit Agreement. Borrowings under the Credit Agreement have notexceeded 90 percent of the borrowing base and, as a result, the fixed chargecovenant did not become applicable during the period. There are no creditratings related triggers in the Credit Agreement or in the indenture related tothe Convertible Notes.

 

There have been nomaterial changes in the Contractual Obligations and Commitments disclosed inour Annual Report on Form 10-K, and related amendments, for the year endedDecember 27, 2003, except that we paid the annual $5.0 million premium duein connection with the CEO Split Dollar Life Insurance Policy. The remainingfixed premium obligation under the terms of this policy amounts to $30.0million.

 

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We are party tomulti-year, merchandise supply agreements in the normal course of business. Thelargest of these agreements is with AmerisourceBergen, our primary pharmaceuticalsupplier. Generally, these agreements provide for certain volume commitmentsand may be terminated by us, subject in some cases to specified terminationpayments, none of which would constitute a material adverse effect on ourfinancial position, results of operations or cash flows. It is the opinion ofmanagement that if any of these agreements were terminated or if anycontracting party was to experience events precluding fulfillment of itsobligations, we would be able to find a suitable alternative supplier.

 

In addition toMr. Cuti’s post-retirement benefits discussed above, in the event of achange of control or our failure to renew Mr. Cuti’s current employmentagreement that expires on December 31, 2004, we will be required to payseverance benefits equal to five times the “earnings amount” of approximately$4.1 million (based upon the sum of Mr. Cuti’s current annual salary,maximum incentive bonus and a supplemental non-compete payment).

 

At March 27, 2004 werecorded a litigation-related non-current liability of $13.7 million inconnection with a National Labor Relations Board Administrative Law Judgerecommendation in a litigation-related matter with the Allied Trades Council, aunion representing employees in 139 of our stores. Because this recommendationis only the initial phase of a complex administrative and judicial process, theultimate outcome, financial impact and related timing of any future cashdisbursement relating to this matter can not be determined at this time. Thismatter is more fully described in Note 3 to the Unaudited ConsolidatedInterim Financial Statements.

 

We are not a party to anyagreements with, or commitments to, any special purpose entities that wouldconstitute material off-balance sheet financing other than the operating leasecommitments detailed in the Contractual Obligations and Commitments tablepresented in our Annual Report on Form 10-K for the year ended December 27,2003 and related amendments.

 

**CriticalAccounting Policies**

 

Our discussion of resultsof operations and financial condition relies on our consolidated financialstatements that are prepared based on certain critical accounting policies thatrequire management to make judgements and estimates that are subject to varyingdegrees of uncertainty. We believe that investors need to be aware of thesepolicies and how they impact our financial reporting to gain a more completeunderstanding of our consolidated financial statements as a whole, as well asour related discussion and analysis presented herein. While we believe thatthese accounting policies are grounded on sound measurement criteria, actualfuture events can and often do result in outcomes that can be materiallydifferent from these estimates or forecasts. The accounting policies and relatedrisks described in our Annual Report on Form 10-K for the year endedDecember 27, 2003 and related amendments are those that depend mostheavily on these judgments and estimates. At March 27, 2004, there have been no material changes to any ofthe Critical Accounting Policies contained therein.

 

**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.

 

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**Recently Issued Accounting Pronouncements**

 

In December 2002,SFAS No. 148, “Accounting for Stock-Based Compensation — Transition andDisclosure” was issued. This statement provides alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. We have not adopted such voluntarychange to the fair value based method. In addition, this statement amends thedisclosure requirements of SFAS No. 123 to require prominent disclosures aboutthe method of accounting for stock-based compensation and the effect of themethod used on reported results. As required, we adopted the disclosure-onlyprovisions of FAS No. 148 effective in 2002.

 

**ITEM 3****. MARKETRISK**

 

Our financial results aresubject to risk from interest rate fluctuations on debt, which carries variableinterest rates. Variable rate debt outstanding under our Credit Agreement wasapproximately $75.4 million at March 27, 2004. At March 27, 2004, theweighted average combined interest rate in effect on all borrowings under theCredit Agreement was 2.85%. A 0.50% change in interest rates applied to the$75.4 million balance of floating rate debt would affect pre-tax annual resultsof operations by approximately $0.4 million. In addition, we also have $201.0million of Convertible Notes outstanding at March 27, 2004. TheConvertible Notes bear interest payable semi-annually at a fixed rate of 3.75%,and are 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 derivative financial products such as interestrate hedges and interest rate swaps in the future.

 

**ITEM 4****. CONTROLSAND PROCEDURES**

 

(a)          Evaluationof Disclosure Controls and Procedures. Our Chief Executive Officer and Chief Financial Officer have evaluatedthe effectiveness of our disclosure controls and procedures (as such term isdefined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of1934, as amended (the “Exchange Act”)) as of the end of the period covered bythis quarterly report (the “Evaluation Date”). Based on such evaluation, suchofficers have concluded that, as of the Evaluation Date, our disclosurecontrols and procedures are effective in alerting them on a timely basis tomaterial information relating to our Company (including our consolidatedsubsidiaries) required to be included in our reports filed or submitted underthe Exchange Act.

 

(b)         Changesin Internal Controls over Financial Reporting. Since the date of their mostrecent evaluation, there have not been any significant changes in our internalcontrols over financial reporting or in other factors that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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**PART II**

 

**OTHER INFORMATION**

 

**ITEM 1.  Legal Proceedings**

 

We are party to legalactions arising in the ordinary course of business. Based on informationpresently available to us, we believe that we have adequate legal defenses orinsurance coverage for these actions and that the ultimate outcome of theseactions will not have a materially adverse effect on the financial position,results of operations or cash flows of our company. In addition, we are a partyto the following legal actions and matters:

 

During 2002, we initiateda legal action against our former property insurance carrier, in an attempt torecover what we believe to be a fair and reasonable settlement for the businessinterruption portion of our claim originating from the September 11, 2001World Trade Center terrorist attack, during which our single highest volume andmost profitable store was completely destroyed. In September 2003, a trialon certain issues was held regarding some of the matters at issue in thelitigation, including whether we would have obtained a renewal of our lease atthe World Trade Center. We have received a favorable ruling on this and otherlegal issues in the case and now the matter has moved into an appraisalprocess. The appraisal process involves two appraisers and an umpire (toresolve differences between the two appraisers) who will determine the amountof insured loss we have sustained. The insurance carrier has appealed a numberof rulings by the trial court. In light of both the early stage of theappraisal process and the inherent uncertainty in litigation relating to ourappeal, the amount of additional insurance proceeds, if any, that we maycollect under the terms of our insurance contract with the defendant cannot bereasonable predicted or determined at this time. In fiscal 2002, we received anadvance of approximately $9.4 million toward the business interruptionclaim that was recognized as a separate component of income in the consolidatedstatement of income. In the event of an unfavorable outcome to us, this amountwould not be required to be returned to the insurance company.

 

Duane Reade Inc.,Anthony J. Cuti, our Chairman, President and Chief Executive Officer, John K.Henry, our Senior Vice President and Chief Financial Officer and GaryCharboneau, our Senior Vice President of Sales and Marketing have been named asdefendants in connection with the consolidation of several class actioncomplaints alleging violations of the federal securities laws that were filedfrom August 2002 through October 2002. The action, which is in theUnited States District Court for the Southern District of New York, is onbehalf of shareholders who purchased our common stock between April 1,2002 and July 24, 2002, inclusive. The complaint, which seeks anunspecified amount of damages, alleges that the defendants violated the federalsecurities laws by issuing materially false and misleading statements duringthe class period. On December 1, 2003, the district judge granted ourmotion to dismiss the plaintiffs’ action, with prejudice. The plaintiffs havefiled an appeal. We continue to believe that the plaintiff’s actions arecompletely baseless and wholly without merit, and intend to continue tovigorously defend ourselves.

 

We are a defendant in aclass action suit in the Federal Court for the Southern District of New Yorkregarding alleged violations of the Fair Labor Standards Act as to a group ofindividuals who provided delivery services on a contract basis to us. InDecember 2002, the judge in the action issued a partial summary judgmentin favor of a subclass of the plaintiffs and against us. In December 2003,we settled the issue of the amount of our liability to the plaintiffs withoutany admission of wrongdoing and in an amount consistent with our previouslyestablished reserves. The amount of attorney’s fees owed to the plaintiffs’attorneys remains an open issue in the case and we plan to vigorously defendclaims by these attorneys for fees. It is not anticipated that the amount ofattorneys fees that would be required to be paid in this matter would bematerial to our business and operations.

 

We are a party to aNational Labor Relations Board (NLRB) administrative proceeding regarding adispute with the Allied Trades Council over whether a negotiating impasse wasreached between us and the union in August of 2001. The Allied TradesCouncil represents employees in 139 of our stores in a collective bargainingagreement that expired on August 31, 2001. Our employees have been workingpursuant to the terms of our December 6, 2001 implemented contract withthe ATC, which expires on August 31, 2004. We believe an impasse did infact occur and as a result, we had the right to implement our latest contractproposal at that time which included wage increases, health and welfarebenefits, vacation and sick benefits and a 401k retirement program. Wediscontinued making additional payments into the various funds associated withthe union as we were providing many of these benefits on a direct basis andbecause our past contributions to these funds had caused these funds to be in aposition of excessive overfunding. In addition, we had concerns that our pastpayments into these funds were not being managed in a way to ensure they werebeing properly utilized for the benefit of our employees. On February 18,2004, an Administrative Law Judge (“ALJ”) who had reviewed various mattersrelated to this proceeding issued a decision and related recommendation,

 

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which concluded that theparties were not at impasse. The remedies recommended by the ALJ included,among other things, a requirement for us to make our employees whole byreimbursing them for expenses ensuing from the failure to make contributions tothe union funds and to make such funds whole, plus interest. If thisrecommendation is adopted by the full NLRB and enforced by the circuit court ofappeals, it could result in our being required to contribute amounts that haveyet to be determined into the union’s pension benefit, health and welfare andvacation funds. Any potential required contributions resulting from a finaljudicial determination of this matter would potentially be subject to offset bythe amounts that we had funded since we implemented our final contract proposalfor these same benefits that were paid for our Allied Trades Council employees.Because this is just the first phase of a long and complicated administrativeprocess likely to be followed by a full judicial review of all of the facts andcircumstances, the final outcome cannot be reliably determined at this time.The ALJ’s recommendation is not a binding order and has no force and effect oflaw. Rather, it is a recommendation to the full NLRB in Washington D.C., whichwill conduct a complete review at some point in the future and decide to uphold,reject or modify the recommendation. The full NLRB decision is also subject tojudicial review by the circuit court of appeals and a compliance hearing beforeany financial remedy can be determined. While there can be no definitiveassurance, we have been advised by our outside labor counsel that we havenumerous meritorious defenses and arguments in response to the ALJ’srecommendation.

 

In light of theforegoing, while it is our belief that the final financial outcome of thislitigation cannot be determined, under the provisions of Statement of FinancialAccounting Standard (“FAS”) No. 5 which addresses these contingencies, werecorded a pre-tax charge of $12.6 million for the year endedDecember 27, 2003 and an additional pre-tax charge of $1.1 million in thequarter ended March 27, 2004. These charges represent our current bestestimate of the loss that would result upon application of the ALJ’srecommendation. We note that such charges were based upon the facts availableto us at the time. In our opinion, such charges could be subject to significantmodification in the future, upon review by the full NLRB, the Federal CircuitCourt of Appeals, completion of a compliance hearing and any appeals relatingto the outcome of that hearing. These charges reflect the amount ofcontributions that we did not make into the union benefit funds for the periodfrom the August 31, 2001 expiration of the contract through March 27,2004, reduced by a portion of the benefits we paid directly to or for thebenefit of these employees over the same period. It also includes an interestcost for these net contributions from the date they would have been paid untilMarch 27, 2004. While this represents our best estimate of the ALJ’srecommendation, we believe that the actual range of loss in this matter couldbe from $0, if the ALJ’s recommendation is not followed, to approximately$28 million, if the ALJ’s recommendation is upheld and there is no offsetfor any benefits paid over this period.

 

Until such time asfurther legal developments warrant a change in the application of thisaccounting standard, or until this matter is resolved, we will recordadditional non-cash pre-tax charges, which are calculated on the same basis asthe charges recorded in the 2003 financial statements. We currently estimatethat the charge in 2004 will approximate $4.4 million.

 

We are a party to relatedlawsuits, Irving Kroop, et al v. Duane Reade, NY, NY et al, 00 Civ. 9841, etal., instituted by the trustees of several union benefit funds wherein thefunds claim that we did not make certain required contributions to these fundsfrom January 2000 through August 2001. The plaintiffs have recentlyfiled a motion seeking summary judgment of $2.29 million of claims for allegedunderfunding and related penalties and interest. In addition, at various times,the plaintiffs have stated that they believe we may owe additional amounts.However, any additional amounts that the plaintiffs may claim are not known atthis time. We have filed a motion opposing these claims. We believe that wehave made sufficient contributions to these funds and that we have meritoriousdefenses to the claims being made by these funds. Accordingly, we intend tovigorously defend ourselves in these matters. At this time, it is not possibleto determine the ultimate outcome of this case or the actual amount ofliability we may face, if any.

 

We are involved in anongoing dispute with Cardinal Health, one of our former suppliers ofpharmaceutical products. Both parties have claims against the other involving,among other things, breach of contract, promissory estoppel and unjustenrichment. Duane Reade is seeking from Cardinal an unspecified amount ofdamages and punitive damages of at least $20 million. Cardinal is seekingapproximately $18 million in damages plus attorney’s fees and interest. Whilethere can be no definitive assurance, we believe we have counterclaims thatoffset the claims against us by Cardinal, as well as meritorious defenses tothese claims, and plan to vigorously pursue our affirmative claims and tovigorously defend ourself in this action. Non-party discovery in the case hasconcluded and it is expected to go to trial sometime in 2004.

 

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A New York State Tax AppealsTribunal ruling in a matter involving another company may have an adverseimpact upon our New York State Franchise Tax filings from years 1999 through2002. This matter relates to the required combination of affiliatedsubsidiaries in recognizing royalty fee and related income for intangibleproperty. The ruling of the Tribunal is subject to further legal appeal andinterpretation in light of our own specific facts and circumstances. Theoutcome of this matter, and the resulting amount of additional income taxexpense, if any, cannot be determined by us at this time.

 

***Litigation Relating to the MergerTransaction***

 

We are aware of sixpurported class action complaints challenging the merger transaction that havebeen filed in the Court of Chancery of the State of Delaware, referred to asthe “Delaware Complaints,” and three purported class action complaints thathave been filed in the Supreme Court of the State of New York. Two of the NewYork complaints have been dismissed without prejudice. The other New Yorkcomplaint (the “New York Complaint”) is pending, but has not been served onDuane Reade. The Delaware Complaints name Mr. Cuti and certain othermembers of our board of directors and executive officers as well as us asdefendants. Four of the Delaware Complaint names Oak Hill as a defendant. TheNew York Complaint names Mr. Cuti and certain other members of our boardof directors and executive officers as well as us as defendants. One of thedismissed New York complaints named Oak Hill as a defendant.

 

The Delaware Complaintswere consolidated on January 28, 2004, and on April 8, 2004 the plaintiffs inthe Delaware actions filed a consolidated class action complaint (the“Consolidated Complaint”).

 

The ConsolidatedComplaint alleges that defendants failed to disclose material information inthe preliminary proxy statement, which was filed with the SEC on March 19,2004.  Specifically, the ConsolidatedComplaint alleges that the defendants failed to disclose: (1) the precisenature of the “Current Employment Agreement Estimated Payments,” as that termis used in the preliminary proxy, and the reasons for these payments: (2) thematerials and data purportedly used by Bear Stearns in calculating the “CurrentEmployment Agreement Estimated Payments,” instead of the disclosure in thepreliminary proxy statement that these calculations were “approximations basedon various assumptions since the precise amounts payable would requireactuarial or other expert valuation,” even though Bear Stearns allegedly reliedon these calculations; (3) the methodology, projections and other informationused by Bear Stearns to calculate the estimated present value of the company;(4) that the merger consideration represented an approximately 11.7% premiumbased upon the trading price of Duane Reade shares on December 22, 2003,instead of the disclosure in the preliminary proxy that shareholders would bereceiving a much higher premium of 22.0%. The Consolidated Complaint and the New York Complaint allege, amongother things, that the defendants purportedly breached duties owed to DuaneReade’s stockholders in connection with the transaction by failing to: (a)appropriately value Duane Reade as a merger candidate; (b) expose Duane Readeto the marketplace in an effort to obtain the best transaction reasonablyavailable, including to market Duane Reade to industry participants; and (c)adequately ensure that no conflicts of interest exist between defendants’ owninterests and their fiduciary obligation to maximize stockholder value.  Plaintiffs seek, among other things: anorder that the complaints are properly maintainable as a class action; adeclaration that defendants have breached their fiduciary duties and otherduties; injunctive relief; an unspecified amount of monetary damages;attorneys’ fees, costs and expenses; and such other and further relief as thecourt may deem just and proper.  Webelieve these lawsuits are without merit and plan to defend these lawsuitsvigorously.

 
|   | **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**                                   |
|   |                                                                   |
|   | Not applicable                                                         |

 

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|   | **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: |
|        |                                                                                    |  |  |  |

 
| **Exhibit No.** |   | **Description**                                                                                                                                                                                                                                                                                                                              |
|-----------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                                                                                                                                                         |
| 2.1             |   | Agreement and Plan of  Merger, dated as of December 22, 2003, by and among Duane Reade Inc.,  Rex Corner Holdings, LLC and Rex Corner Acquisition Corp. (incorporated by  reference to Exhibit 2.1 to the Company’s Current Report on  Form 8-K filed on December 23, 2003).                                        |
| 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  Bylaws 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) of the Notes S-1).                                                                                                                                                                                                                                                      |
| 3.3             |   | Second Amended and  Restated Partnership Agreement of Duane Reade (incorporated by reference to  Exhibit 3.3 of 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 25, 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 of the Notes S-1).                                                                                                                                                                                                                                                              |
| 4.2             |   | Second Supplemental  Indenture, dated as of May 20, 2002, between Duane Reade Inc., the Subsidiary  Guarantors, and State Street Bank, as trustee (incorporated by reference to  the Company’s Quarterly Report on Form 10-Q for the period ended  September 28, 2002).                                                            |
| 4.3             |   | Indenture, dated as of  April 16, 2002, between Duane Reade Inc., as issuer, the guarantors  named therein and State Street Bank and Trust Company, as trustee  (incorporated by reference to Exhibit 4.2 to the Company’s Registration  Statement on Form S-3 dated June 21, 2002 (the “Convertible Notes  S-3”)). |
| 4.4             |   | Form of Senior  Convertible Notes due 2022 (incorporated by reference to Exhibit 4.2 to the  Convertible Notes S-3).                                                                                                                                                                                                                         |
| 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 February 22, 1993, as amended, between the Company and Gary  Charboneau (incorporated by reference to Exhibit 10.4 to the Common Stock  S-1).                                                                                                                                                        |
| 10.4            |   | 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).                                                                                                                                                               |
| 10.5            |   | 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).                                                                                                                                                                   |
| 10.6            |   | 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).                                                                                        |
| 10.7            |   | Agreement, dated  December 6, 2001, between Duane Reade and Allied Trades Council  (incorporated by reference to Exhibit 10.8 to the Company’s Annual Report on  Form 10-K for the year ended December 29, 2001 (the “2001 10-K”)).                                                                                 |
| 10.8            |   | 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).                                                                                                                                                                                          |

 

25

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| 10.9   |   | Agreement, dated  April 1, 2001, between Duane Reade and Local 340A New York Joint Board,  UNITE AFL-CIO (incorporated by reference to Exhibit 10.19 to the 2001 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.10  |   | First Amendment to  Stockholders and Registration Rights Agreement, dated as of January 16,  2002, by and among Duane Reade Inc. and the stockholders party thereto (incorporated by reference to Exhibit 4.9  to the Convertible Notes S-3).                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.11  |   | Preferability Letter,  dated as of May 13, 2002, issued by PricewaterhouseCoopers LLP, with respect  to the Company’s change in accounting method of inventory valuation  (incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended March 30, 2002).                                                                                                                                                                                                                                                                                                                                              |
| 10.12  |   | Amended and Restated  Employment Agreement, dated August 12, 2002, between the Company and  Anthony J. Cuti (incorporated by reference to the Company’s Quarterly Report  on Form 10-Q for the period ended June 29, 2002).                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.13  |   | Shareholder Rights  Agreement, dated as of September 12, 2002, between the Company and  EquiServe Trust Company, N.A., as Rights Agent (incorporated by reference to  Exhibit 4.1 to the Company’s Current Report on Form 8-K, dated  September 12, 2002).                                                                                                                                                                                                                                                                                                                                                                              |
| 10.14  |   | Third Amendment to the  1997 Equity Participation Plan, dated May 8, 2003 (incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.15  |   | Employment Letter,  dated June 24, 2003, between the Company and Timothy R. LaBeau  (incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.16  |   | Credit Agreement, dated  as of July 21, 2003, among Duane Reade, as the Borrower, Duane Reade  Inc. and corporate subsidiaries as the Facility Guarantors, Various Financial  Institutions set forth therein, as the Lenders, Fleet National Bank as the  Administrative Agent and Issuing Bank, Fleet Retail Finance Inc. as the  Collateral Agent, General Electric Capital Corporation as the Syndication  Agent for the Lenders and Congress Financial Corporation as the Documentation  Agent for the Lenders (incorporated by reference to the Company’s Quarterly  Report on Form 10-Q for the period ended June 28, 2003). |
| 10.17  |   | Facility Guarantee,  dated as of July 21, 2003, among the Facility Guarantors, Fleet Retail Finance  Inc., Fleet National Bank and the Lenders (incorporated by reference to the  Company’s Quarterly Report on Form 10-Q for the period ended  June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                    |
| 10.18  |   | Intellectual Property  Security Agreement, dated as of July 21, 2003, between Duane Reade, the  Facility Guarantors and Fleet Retail Finance Inc., as Collateral Agent  (incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                            |
| 10.19  |   | Security Agreement,  dated as of July 21, 2003, among Duane Reade, the Facility Guarantors,  and Fleet Retail Finance Inc., as Collateral Agent (incorporated by reference  to the Company’s Quarterly Report on Form 10-Q for the period ended  June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                   |
| 10.20  |   | Ownership Interest  Pledge Agreement, dated as of July 21, 2003, among Duane Reade Inc. and  DRI I Inc., and Fleet Retail Finance Inc., as Collateral Agent (incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the  period ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                       |
| 10.21  |   | Amendment No. 1 to  Shareholder Rights Agreement, dated as of December 19, 2003, between the  Company and EquiServe Trust Company, N.A., as Rights Agent Council  (incorporated by reference to Exhibit 10.21 to the Company’s Annual Report on  Form 10-K for the year ended December 27, 2003 (the “2003 10-K”)).                                                                                                                                                                                                                                                                                                           |
| 14.1   |   | Code of Business  Conduct and Ethics (incorporated by reference to Exhibit 14.1 to the 2003  10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 21.1   |   | Subsidiaries of the  Company (incorporated by reference to Exhibit 21.1 to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 23.1   |   | Consent of Independent  Accountants (incorporated by reference to Exhibit 23.1 to the 2003 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 23.2   |   | Consent of Independent  Accountants (incorporated by reference to Exhibit 23.2 to the 2003 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.1 * |   | Sarbanes-Oxley  Section 302 Certification of the Company’s Chief Executive Officer (“CEO”).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 31.2 * |   | Sarbanes-Oxley  Section 302 Certification of the Company’s Chief Financial Officer  (“CFO”).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 32.0 * |   | Sarbanes-Oxley  Section 906 Certifications of the Company’s CEO and CFO.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |

 

----

*  filed herewith

 

26

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(b)                                 Reportson Form 8-K:

 

On March 12, 2004,the Company filed a Current Report on Form 8-K which contained, as an exhibit,a press release providing information with respect to a revision to theCompany’s previously announced financial results for the 13 weeks endedDecember 27, 2003.

 

On April 21, 2004,the Company filed a Current Report on Form 8-K which contained, as an exhibit,a press release providing information with respect to the Company’s financialresults for the 13 weeks ended March 27, 2004.

 

(c)                                  FinancialStatement Schedules:         None

 

Schedules for whichprovision is made in the applicable accounting regulations of the Commissionare either not required under the related instructions, are inapplicable or notmaterial, or the information called for thereby is otherwise included in thefinancial statements and therefore has been omitted.

 

27

----

 

**SIGNATURES**

 

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

 
| Dated: | May 6, 2004 |                  |              |
|--------|-------------|-----------------------|-------------------|
|   |        | **DUANE READE, Inc.** |
|   |        | (Registrant)          |
|   |        |                  |              |
|   |        | By:                   | /s/ John K. Henry |   |
|   |        |                  | Name:             | John K. Henry |
|   |        |                  | Title:            | Senior Vice President  and Chief Financial  Officer |
|        |             |                       |                   |  |  |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant in thecapacities indicated on May 6, 2004.

 
| **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) |                                                |

 

28

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| Dated: | May 6, 2004 |           |              |
|--------|-------------|----------------|-------------------|
|   |        | **DRI I Inc.** |
|   |        |           |              |
|   |        | By:            | /s/ John K. Henry |   |
|   |        |           | Name:             | John K. Henry |
|   |        |           | Title:            | Senior Vice President  and Chief Financial  Officer |
|        |             |                |                   |  |  |

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned on May 6, 2004 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) |                                                |

 

29

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| Dated: | May 6, 2004                                         |   |            |                                                |              |
|--------|-----------------------------------------------------|--------|-----------------|-----------------------------------------------------|-------------------|
|   |                                                |   | **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 May 6, 2004 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) |                                                |

 

30

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 
| Dated:   May  6, 2004 |                         |                                                |
|--------------------------------------|------------------------------|-----------------------------------------------------|
|                                 | **DUANE READE REALTY, Inc.** |
|                                 |                         |                                                |
|                                 | By:                          | /s/ John K. Henry                                   |   |
|                                 | Name:                        | John K. Henry                                       |
|                                 | Title:                       | Senior Vice President  and Chief Financial  Officer |
|                                      |                              |                                                     |  |  |  |

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned on May 6, 2004 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) |                                                |

 

31

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 
| Dated:   May  6, 2004 |                                |              |                                                |
|--------------------------------------|-------------------------------------|-------------------|-----------------------------------------------------|
|                                 | **DUANE READE INTERNATIONAL, Inc.** |
|                                 |                                |              |                                                |
|                                 | By:                                 | /s/ John K. Henry |                                                |
|                                 |                                | Name:             | John K. Henry                                       |
|                                 |                                | Title:            | Senior Vice President  and Chief Financial  Officer |
|                                      |                                     |                   |                                                     |  |  |

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned on May 6, 2004 by:

 
| **SIGNATURES**      |   | **TITLES**                                    |                                                |
|---------------------|--------|-----------------------------------------------|-----------------------------------------------------|
|                |   |                                          |                                                |
| /s/ Gary Charboneau |   |                                          | President and Chief  Executive Officer and Director |   |
| Gary Charboneau     |   | (Principal Executive  Officer)                |                                                |
|                |   |                                          |                                                |
|                |   |                                          |                                                |
| /s/ John K. Henry   |   |                                          | Senior Vice President  and Chief Financial Officer  |   |
| John K. Henry       |   | (Principal Accounting  and Financial Officer) |                                                |

 

32

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