**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C.**

 

**FORM 10-Q**

 

**QuarterlyReport Pursuant to Section 13 or 15 (d) of the Securities and Exchange Act of1934**

 

| **For  the quarterly period ended June 28, 2003.** |   | **Commission  file number 333-41239** |
|---------------------------------------------------------|--------|---------------------------------------|

 

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**DUANE READEINC.**

(Exact name of registrant as specified in its charter)

 

| **DELAWARE**                                                    |                                |                |   | **04-3164702**           |
|-----------------------------------------------------------------|-------------------------------------|---------------------|--------|--------------------------|
| (State or other  jurisdiction of incorporation or organization) |                                |                |   | (IRS Employer ID Number) |
|                                                            |                                |                |
|                                                            |                                |                |
|                                                            | **DRI  I Inc.***               | **Delaware**        |   | **04-3166107**           |
|                                                            | **Duane Reade***                    | ** New  York** |   | **11-2731721**           |
|                                                            | **Duane Reade International, Inc*** | **Delaware**        |   | **22-3672347**           |
|                                                            | **Duane Reade Realty, Inc ***       | **Delaware**        |   | **13-4074383**           |
|                                                                 |                                     |                     |        |                          |  |  |

 

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

 

| **Title of each class**                |   | **Name of each exchange on which registered** |
|----------------------------------------|--------|-----------------------------------------------|
| Common Stock, $.01 par value per share |   | New York Stock Exchange. Inc.                 |

 

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

None.

 

Indicate by checkmark whether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes ý  No o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in the ExchangeAct Rule 12b-2):  Yes ý  No o

 

The number of shares of the Common Stock outstandingas of August 8, 2003:  **24,037,742**

 

 

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INDEX

 
| PART I – FINANCIAL  INFORMATION |
|--------------------------------------|
|                                 |   |   |
|                                 | ITEM 1. – FINANCIAL  STATEMENTS |   |
|                                 |   |   |
|                                 | Consolidated  Statements of Operations (Unaudited) -  For the 13 and 26 Weeks Ended June 28, 2003 and June 29, 2002 |   |
|                                 |   |   |
|                                 | Consolidated Balance Sheets  As of June 28, 2003 (Unaudited) and December 28, 2002 |   |
|                                 |   |   |
|                                 | Consolidated  Statements of Cash Flows (Unaudited) -  For the 13 and 26 Weeks Ended June 28, 2003 and June 29, 2002 |   |
|                                 |   |   |
|                                 | 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                           |
|                                      |  |  |  |  |

 

Forward-looking statements in our public filings orother public statements are subject to known and unknown risks, uncertaintiesand other factors which may cause our actual results, performance orachievements to be materially different from any future results, performance orachievements expressed or implied by such forward-looking statements. Theseforward-looking statements were based on various factors and were derivedutilizing numerous assumptions and other important factors that could causeactual results to differ materially from those in the forward-lookingstatements. Forward-looking statements include the information concerning ourfuture financial performance, business strategy, projected plans andobjectives. Statements preceded by, followed by or that otherwise include thewords “believes”, “expects”, “anticipates”, “intends”, “projects”, “estimates”,“plans”, “may increase”, “may fluctuate” and similar expressions or future orconditional verbs such as “will”, “should”, “would”, “may”, “might” and “could”are generally forward-looking in nature and not historical facts. You shouldunderstand that the following important factors and assumptions could affectour future results and could cause actual results to differ materially fromthose expressed in such forward-looking statements:

 

•                  the competitive environment in thedrugstore industry in general and in the metropolitan New York area;

 

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

 

**•     **the continued efforts of Federal,State and municipal governament agencies to reduce Medicade reimbursment rates,modify Medicare benefits and/or reduce prescription drug costs;

2

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•                  the strength of the economy ingeneral and the economic conditions in the metropolitan New York area, inparticular, including changes in consumer purchasing power and/or spendingpatterns;

 

•                  changes in cost of goods andservices;

 

•                  trends in the healthcare industry,including continued conversion of various prescription drugs toover-the-counter medications;

 

•                  changes in federal and state laws andregulations, including the potential impact of changes in regulationssurrounding the importation of pharmaceuticals from foreign countries;

 

•                  liability and other claims assertedagainst us;

 

•                  changes in our operating strategy ordevelopment plans;

 

•                  our ability to attract, hire andretain qualified personnel, including our ability to attract qualifiedpharmacists;

 

•                  our significant indebtedness;

 

•                  interest rate fluctuations andchanges in capital market conditions or other events affecting our ability toobtain necessary financing on favorable terms to fund the anticipated growth ofour business;

 

•                  labor disturbances, including anyresulting from the suspension or termination of our collective bargainingagreements;

 

•                  the continued impact of, or newoccurrences of, terrorist attacks in the New York City metropolitan area;

 

•                  changes in our acquisition andcapital expenditure plans;

 

•                  our ability to continue to securesuitable new store locations under acceptable lease terms;

 

•                  our ability to successfully implementand manage new computer systems and technologies;

 

•                  demographic changes; and

 

•                  other risks and uncertaintiesdetailed from time to time in our filings with the Securities and ExchangeCommission.

 

Other factors and assumptions not identified abovewere also involved in the derivation of these forward-looking statements, andthe failure of such other assumptions to be realized as well as other factorsmay also cause actual results to differ materially from those projected. Mostof these factors are difficult to predict accurately and are generally beyondour control.

 

You should consider theareas of risk described above in connection with any forward-looking statementsthat may be made by us generally. Except for our ongoing obligations todisclose material information under the federal securities laws, we undertakeno obligation to release publicly any revisions to any forward-lookingstatements, to report events or to report the occurrence of unanticipatedevents unless required by law. For any forward-looking statements contained inany document, we claim the protection of the safe harbor for forward-lookingstatements contained in the Private Securities Litigation Reform Act of 1995.

 

3

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**PART I -FINANCIAL INFORMATION**

**ITEM 1.  FINANCIALSTATEMENTS**

 

**Duane Reade Inc.**

Consolidated Statements ofOperations (Unaudited)

(In thousands, except per share amounts)

 
|                                                                         |   | **For the 13 Weeks Ended** |    | **For the 26 Weeks Ended** |   |
|------------------------------------------------------------------------------|--------|----------------------------|---------|----------------------------|--------|
|                                                                         |   | **June 28,  2003**    |    | **June 29,  2002**    |   | **June 28,  2003** |   | **June 29,  2002** |   |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Net sales                                                                    |   | $                          | 355,146 |                       | $      | 324,754 |   | $ | 688,768 |   | $ | 630,558 |   |
| Cost of sales                                                                |   | 278,171                    |    | 256,268                    |   | 541,604 |   | 492,622 |   |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Gross profit                                                                 |   | 76,975                     |    | 68,486                     |   | 147,164 |   | 137,936 |   |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Selling, general & administrative expenses                               |   | 57,260                     |    | 48,480                     |   | 110,834 |   | 96,158 |   |
| Insurance recovery                                                           |   | —                     |    | (9,378                     | )      | — |   | (9,378 | ) |
| Depreciation and amortization                                                |   | 8,154                      |    | 6,759                      |   | 15,712 |   | 13,503 |   |
| Store pre-opening expenses                                                   |   | 229                        |    | 827                        |   | 644 |   | 1,343 |   |
|                                                                         |   | 65,643                     |    | 46,688                     |   | 127,190 |   | 101,626 |   |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Operating income                                                             |   | 11,332                     |    | 21,798                     |   | 19,974 |   | 36,310 |   |
| Interest expense, net                                                        |   | 3,549                      |    | 4,990                      |   | 7,066 |   | 10,671 |   |
| Debt extinguishment                                                          |   | —                     |    | 13,107                     |   | 105 |   | 13,107 |   |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Income before income taxes and cumulative effect of  accounting  change |   | 7,783                      |    | 3,701                      |   | 12,803 |   | 12,532 |   |
| Income taxes                                                                 |   | 3,725                      |    | 1,371                      |   | 5,633 |   | 4,940 |   |
| Income before cumulative effect of accounting change                         |   | 4,058                      |    | 2,330                      |   | 7,170 |   | 7,592 |   |
| Cumulative effect of accounting change,  net of  income taxes           |   | —                     |    | —                     |   | — |   | (9,262 | ) |
| Net income (loss)                                                            |   | $                          | 4,058   |                       | $      | 2,330 |   | $ | 7,170 |   | $ | (1,670 | ) |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Per Common Share – Basic                                                |   |                       |    |                       |   |   |   |   |   |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Income before cumulative effect of accounting  change                   |   | $                          | 0.17    |                       | $      | 0.10 |   | $ | 0.30 |   | $ | 0.32 |   |
| Cumulative effect of accounting change,  net of  income taxes           |   | —                     |    | —                     |   | — |   | (0.39 | ) |
| Net income (loss)                                                            |   | $                          | 0.17    |                       | $      | 0.10 |   | $ | 0.30 |   | $ | (0.07 | ) |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Weighted Average Common Shares Outstanding                                   |   | 24,038                     |    | 23,875                     |   | 24,038 |   | 23,751 |   |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Per Common Share – Diluted                                              |   |                       |    |                       |   |   |   |   |   |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Income before cumulative effect of accounting  change                   |   | $                          | 0.17    |                       | $      | 0.09 |   | $ | 0.29 |   | $ | 0.31 |   |
| Cumulative effect of accounting change,  net of  income taxes           |   | —                     |    | —                     |   | — |   | (0.38 | ) |
| Net income (loss)                                                            |   | $                          | 0.17    |                       | $      | 0.09 |   | $ | 0.29 |   | $ | (0.07 | ) |
|                                                                         |   |                       |    |                       |   |   |   |   |   |
| Weighted Average Common Shares Outstanding                                   |   | 24,351                     |    | 24,634                     |   | 24,345 |   | 24,454 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

4

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**Duane Reade Inc.**

Consolidated Balance Sheets

(Inthousands, except share and per share data)

 
|                                                                                              |   | **June 28,  2003** |       | **December 28,  2002** |       |
|---------------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
|                                                                                              |   | **(Unaudited)**    |       |                   |       |
| ASSETS                                                                                            |   |               | ** ** |                   | ** ** |
| Current Assets                                                                                    |   |               |       |                   |       |
| Cash                                                                                              |   | $                  | 1,242      |                   | $          | 4,183 |   |
| Receivables                                                                                       |   | 62,235             |       | 62,008                 |       |
| Inventories                                                                                       |   | 232,329            |       | 220,338                |       |
| Deferred income taxes                                                                             |   | 4,477              |       | 5,416                  |       |
| Prepaid expenses and other current assets                                                         |   | 19,933             |       | 16,006                 |       |
| TOTAL CURRENT ASSETS                                                                              |   | 320,216            |       | 307,951                |       |
|                                                                                              |   |               |       |                   |       |
| Property and equipment, net                                                                       |   | 185,325            |       | 169,507                |       |
| Goodwill, net of accumulated amortization of $35,323                                              |   | 161,318            |       | 160,403                |       |
| Deferred income taxes                                                                             |   | 4,611              |       | 6,489                  |       |
| Other assets                                                                                      |   | 90,249             |       | 85,173                 |       |
| TOTAL ASSETS                                                                                      |   | $                  | 761,719    |                   | $          | 729,523 |   |
|                                                                                              |   |               |       |                   |       |
| LIABILITIES AND STOCKHOLDERS’  EQUITY                                                        |   |               |       |                   |       |
| Current liabilities                                                                               |   |               |       |                   |       |
| Accounts payable                                                                                  |   | $                  | 59,965     |                   | $          | 57,776 |   |
| Accrued interest                                                                                  |   | 1,791              |       | 2,192                  |       |
| Other accrued expenses                                                                            |   | 26,145             |       | 27,453                 |       |
| Current portion of long-term debt                                                                 |   | 3,751              |       | 3,962                  |       |
| Current portion of capital lease obligations                                                      |   | 407                |       | 472                    |       |
| TOTAL CURRENT LIABILITIES                                                                         |   | 92,059             |       | 91,855                 |       |
|                                                                                              |   |               |       |                   |       |
| Long-term debt, less current portion                                                              |   | 283,391            |       | 263,782                |       |
| Capital lease obligations, less current portion                                                   |   | 1,319              |       | 1,525                  |       |
| Other non-current liabilities                                                                     |   | 47,913             |       | 42,493                 |       |
| TOTAL LIABILITIES                                                                                 |   | 424,682            |       | 399,655                |       |
|                                                                                              |   |               |       |                   |       |
| Commitments and Contingencies (Note 11)                                                           |   |               |       |                   |       |
|                                                                                              |   |               |       |                   |       |
| 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: 24,037,742 shares |   | 240                |       | 240                    |       |
| Paid-in capital                                                                                   |   | 329,542            |       | 329,542                |       |
| Retained earnings                                                                                 |   | 7,255              |       | 86                     |       |
| TOTAL STOCKHOLDERS’ EQUITY                                                                   |   | 337,037            |       | 329,868                |       |
|                                                                                              |   |               |       |                   |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                   |   | $                  | 761,719    |                   | $          | 729,523 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

5

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**Duane ReadeInc.**

ConsolidatedStatements of Cash Flows (Unaudited)

(In thousands)

 
|                                                                                      |   | **For the 26 Weeks Ended** |   |
|-------------------------------------------------------------------------------------------|--------|----------------------------|--------|
|                                                                                      |   | **June 28,  2003**    |   | **June 29,  2002** |   |
| Cash flows provided by operating activities:                                              |   |                       |   |   |   |
| Net income (loss)                                                                         |   | $                          | 7,170  |   | $ | (1,670 | ) |
| Adjustments to reconcile net income (loss) to net cash  provided by operating activities: |   |                       |   |   |   |
| Depreciation and amortization                                                             |   | 16,727                     |   | 14,323 |   |
| Deferred income taxes                                                                     |   | 2,817                      |   | 5,227 |   |
| Cumulative effect of accounting change, net of tax                                        |   | —                     |   | 9,262 |   |
| Other                                                                                     |   | 4,455                      |   | 7,996 |   |
| Changes in operating assets and liabilities (net of  the effect of acquisitions):         |   |                       |   |   |   |
| Receivables                                                                               |   | (227                       | )      | (1,628 | ) |
| Inventories                                                                               |   | (10,954                    | )      | (1,432 | ) |
| Accounts payable                                                                          |   | 2,189                      |   | (16,926 | ) |
| Prepaid and accrued expenses                                                              |   | (3,229                     | )      | 2,378 |   |
| Other assets and liabilities, net                                                         |   | (4,968                     | )      | (3,851 | ) |
| NET CASH PROVIDED BY OPERATING ACTIVITIES                                                 |   | 13,980                     |   | 13,679 |   |
|                                                                                      |   |                       |   |   |   |
| Cash flows used in investing activities:                                                  |   |                       |   |   |   |
| Capital expenditures                                                                      |   | (25,795                    | )      | (25,259 | ) |
| Lease, customer file and other acquisition costs                                          |   | (9,903                     | )      | (5,357 | ) |
| NET CASH USED IN INVESTING ACTIVITIES                                                     |   | (35,698                    | )      | (30,616 | ) |
|                                                                                      |   |                       |   |   |   |
| Cash flows from financing activities:                                                     |   |                       |   |   |   |
| Proceeds from convertible note offering                                                   |   | —                     |   | 218,501 |   |
| Repayment of term loans                                                                   |   | (1,981                     | )      | (53,366 | ) |
| Net borrowing (repayment) of revolving credit facility                                    |   | 23,000                     |   | (10,000 | ) |
| Retirement of senior subordinated notes                                                   |   | (1,621                     | )      | (78,379 | ) |
| Proceeds from exercise of stock options                                                   |   | —                     |   | 1,157 |   |
| Deferred financing costs                                                                  |   | (350                       | )      | (8,000 | ) |
| Repayments of capital lease obligations                                                   |   | (271                       | )      | (851 | ) |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                                 |   | 18,777                     |   | 69,062 |   |
|                                                                                      |   |                       |   |   |   |
| Net (decrease) increase in cash                                                           |   | (2,941                     | )      | 52,125 |   |
| Cash at beginning of period                                                               |   | 4,183                      |   | 4,972 |   |
| Cash at end of period                                                                     |   | $                          | 1,242  |   | $ | 57,097 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

6

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**Notesto Consolidated Financial Statements**

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

 

**1. Basis of Presentation**

 

The UnauditedConsolidated Financial Statements included herein reflect all adjustments(consisting of normal recurring items) which, in the opinion of management, arenecessary to present fairly the results of operations, financial position andcash flows of Duane Reade Inc. (the “Company”), and have been prepared, in allmaterial respects, in accordance with the same accounting principles followedin the preparation of the Company’s annual financial statements for the yearended December 28, 2002. These financial statements should be read inconjunction with the Company’s financial statements included in its AnnualReport on Form 10-K for the year ended December 28, 2002. The UnauditedConsolidated Financial Statements include the accounts of the Company and itssubsidiaries.  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 and 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 and income from salesof market related data amounted to $0.1 million and $1.3 million, for thequarter and six months ended June 28, 2003, respectively, as compared to$0.4 million and $1.1 million, for the quarter and six months endedJune 29, 2002, respectively. Earnings per share amounts are calculatedbased on the weighted average number of shares outstanding during the periodand may not add due to rounding. The results for the interim periods presentedare not necessarily indicative of the results expected for the full year.

 

TheCompany has no assets or operations other than its investment in its subsidiaryguarantors. Accordingly, the Unaudited Consolidated Financial Statementspresent the combined assets and operations of the subsidiary guarantors. Theguarantees of the subsidiary guarantors are full and unconditional, joint andseveral.

 

**2. World Trade Center Disasterand Related Business Interruption and Property Losses**

 

On September 11,2001, a terrorist attack on the World Trade Center complex in downtownManhattan resulted in the total destruction of that landmark and significantdisruption of commerce throughout the entire city, within which most of theCompany’s stores are located. The attack resulted in the complete loss of twostores. During the fourth quarter of 2001, the Company received insurancereimbursement for a portion of the property losses associated with thisdisaster. In fiscal 2002, the remaining September 11 related propertylosses were reimbursed and the Company received approximately $9.4 milliontoward its business interruption claim that was recognized as a separate itemof income in the second quarter of fiscal 2002. This business interruptionrecovery represented a partial payment of the Company’s losses and the Companyis currently in litigation with the insurance carrier to recover the balance ofits business interruption claim. Additional insurance recoveries for thebusiness interruption portion of the Company’s insurance claim, which, if any,could be material, will be recognized when collection of such recoveries isassured.  Litigation expenses associatedwith this insurance recovery are being expensed as incurred.

 

**3. Accounting Change**

 

As of December 30, 2001, the Company adopted achange in accounting method to convert from the retail dollar first-in,first-out (“FIFO”) method to a specific cost based last-in, first-out (“LIFO”)method. Adoption of the specific cost LIFO method more accurately valuesinventory by eliminating the averaging inherent in the retail method. Inaddition, the specific cost LIFO method reflects the impact of inflation in theCompany’s gross margin. The effect of changing from the retail FIFO method tothe specific cost LIFO method was a reduction in inventory of $16.0 million,resulting in a cumulative effect of an accounting change as ofDecember 30, 2001 of approximately $9.3 million, net of an income taxbenefit of $6.7 million ($0.39 per basic common share and $0.38 per dilutedcommon share, respectively).

 

7

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**4. Inventory**

 

At June 28,2003, inventories would have been greater by $0.3 million if they had beenvalued on a lower of FIFO cost or market basis.

 

**5. Debt Extinguishment**

 

During the firstquarter of 2003, the Company retired the remaining $1.6 million principalamount of the outstanding 9.25% Senior Subordinated Notes due 2008 (the “SeniorNotes”). In connection with this retirement, the Company recorded a $0.1million debt extinguishment charge, representing the premium paid to theholders of the Senior Notes and the accelerated amortization of deferredfinancing costs associated with the Senior Notes retired. The total cash outlayrequired for this transaction, including principal ($1.6 million), early terminationpremiums ($0.1 million) and accrued interest earned from August 15, 2002to the payment date ($0.1 million), amounted to approximately $1.8 million.

 

In the second quarter of2002, the Company recorded debt extinguishment charges of $13.1 million,reflecting (a) $2.1 million of accelerated amortization of deferred financingcosts related to senior credit agreement loans repaid and 9.25% senior notesretired with proceeds from the 2002 convertible note offering, (b) $7.1 millionfor payment of consent premiums and expenses related to the 9.25% senior notetender offer and (c) $3.9 million related to the termination of an interestrate swap agreement. In accordance with the provisions of FAS 145, which becameeffective January 1, 2003, these debt extinguishment costs, which wereshown in previous SEC filings as extraordinary items totaling $7.7 million, netof a 41.0% income tax provision, were reclassified and are now included as acomponent of income before income taxes and cumulative effect of accountingchange.  Reported net income wasunaffected, and the Company's results of operations, financial position andcash flows were not materially impacted by this reclassification.

 

**6. Stock Option Exchange Offer**

 

On February 27,2003, the Company offered each eligible employee the opportunity to exchangeall of his or her currently outstanding options to purchase shares of theCompany’s common stock granted under the 1992 Stock Option Plan or the 1997Equity Participation Plan with an exercise price equal to or in excess of $16per share (other than certain options granted on May 7, 1999 pursuant tothe Company’s Deferred Compensation Stock Grant Program). At the close of theoffer on March 27, 2003, the Company accepted for exchange and cancellationoptions to purchase an aggregate of 1,337,449 shares of common stock.  The grant of new options will occur on orafter September 28, 2003, but not later than October 28, 2003. Eachnew option issued in exchange for a cancelled option will have an exerciseprice equal to the average closing price of the Company’s common stock asreported on the New York Stock Exchange for the five-day trading period endingimmediately prior to the date of the grant (but in no event less than theclosing price on the date of the grant). If an employee resigns or isterminated for any reason prior to the grant date of the new options, he or shewill not be eligible to receive the new options. Each new option will vest inthree equal installments beginning on the first anniversary of the date ofgrant and will have a ten-year term.

 

8

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**7. Acquisitions**

 

During the second quarterand first half of fiscal 2003 and fiscal 2002, the Company acquired pharmacycustomer files (which were merged into existing stores) and the operations,including certain lease-related assets, of a number of pharmacy establishments(which were operated as new stores). The table below provides details of this acquisition activity for eachof the periods presented (dollars in millions).

 
|                              |   | **For the 13 Weeks  Ended** |   | **For the 26 Weeks Ended** |   |
|-----------------------------------|--------|-----------------------------|--------|----------------------------|--------|
|                              |   | **June 28, 2003**           |   | **June 29, 2002**          |   | **June 28, 2003** |   | **June 29, 2002** |   |
|                              |   |                        |   |                       |   |   |   |   |   |
| Customer prescription files       |   | 2                           |   | —                     |   | 6 |   | 6 |   |
| Pharmacy establishments           |   | —                      |   | 4                          |   | 2 |   | 7 |   |
| Total acquisitions                |   | 2                           |   | 4                          |   | 8 |   | 13 |   |
|                              |   |                        |   |                       |   |   |   |   |   |
| Cash consideration                |   | $                           | 0.4    |                       | $      | 1.6 |   | $ | 6.1 |   | $ | 3.0 |   |
| Common stock consideration        |   | —                      |   | 3.1                        |   | — |   | 14.3 |   |
| Total acquisition cost            |   | $                           | 0.4    |                       | $      | 4.7 |   | $ | 6.1 |   | $ | 17.3 |   |
|                              |   |                        |   |                       |   |   |   |   |   |
| Purchase price allocation:        |   |                        |   |                       |   |   |   |   |   |
| Identifiable intangibles          |   | $                           | 0.4    |                       | $      | 3.0 |   | $ | 3.9 |   | $ | 12.5 |   |
| Goodwill                          |   | —                      |   | 0.7                        |   | 0.9 |   | 1.7 |   |
| Inventory                         |   | 0.1                         |   | 1.0                        |   | 1.0 |   | 1.7 |   |
| Property and equipment            |   | —                      |   | 0.1                        |   | 0.5 |   | 1.7 |   |
| Other assets and liabilities, net |   | (0.1                        | )      | (0.1                       | )      | (0.2 | ) | (0.3 | ) |
| Total                             |   | $                           | 0.4    |                       | $      | 4.7 |   | $ | 6.1 |   | $ | 17.3 |   |

 

The operations of theacquired pharmacies have been included in the consolidated statement ofoperations from the date of acquisition and did not have a material effect onthe sales, results of operations or earnings per share of the Company for theperiods presented.

 

**8. 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 Financial Accounting Standards Board (“FASB”)Statement No. 128 “Earnings Per Share.” Basic earnings per share iscomputed based on the weighted average number of common shares outstandingduring the period. Diluted earnings per share gives effect to all dilutivepotential common shares outstanding during the period. Dilutive potentialcommon shares include shares issuable upon exercise of the Company’s“in-the-money” stock options. Of the options to purchase 1,221,197 and2,665,419 shares of common stock outstanding at June 28, 2003 andJune 29, 2002, respectively, options to purchase 195,970 shares atJune 28, 2003 and 55,156 shares at June 29, 2002 were not included inthe 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.

 

9

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The followingtable sets forth the computation of income per common share for the periodspresented (in thousands, except per share amounts):

 
|                                                            |   | **For the 13  Weeks Ended** |   | **For the 26  Weeks Ended** |   |
|-----------------------------------------------------------------|--------|-----------------------------|--------|-----------------------------|--------|
|                                                            |   | **June 28,  2003**     |   | **June 29,  2002**     |   | **June 28,  2003** |   | **June 29,  2002** |   |
|                                                            |   |                        |   |                        |   |   |   |   |   |
| Income before cumulative effect of accounting change            |   | $                           | 4,058  |                        | $      | 2,330 |   | $ | 7,170 |   | $ | 7,592 |   |
| Cumulative effect of accounting change,  net of income taxes    |   | —                      |   | —                      |   | — |   | (9,262 | ) |
| Net  income (loss)                                              |   | $                           | 4,058  |                        | $      | 2,330 |   | $ | 7,170 |   | $ | (1,670 | ) |
|                                                            |   |                        |   |                        |   |   |   |   |   |
| Weighted  average common shares outstanding  –  basic |   | 24,038                      |   | 23,875                      |   | 24,038 |   | 23,751 |   |
| Potential  dilutive shares                                      |   | 313                         |   | 759                         |   | 307 |   | 703 |   |
| Weighted  average common shares outstanding – diluted      |   | 24,351                      |   | 24,634                      |   | 24,345 |   | 24,454 |   |
|                                                            |   |                        |   |                        |   |   |   |   |   |
| Per  common share – basic                                  |   |                        |   |                        |   |   |   |   |   |
|                                                            |   |                        |   |                        |   |   |   |   |   |
| Income before cumulative effect of accounting change            |   | $                           | 0.17   |                        | $      | 0.10 |   | $ | 0.30 |   | $ | 0.32 |   |
| Cumulative effect of accounting change,  net of income taxes    |   | —                      |   | —                      |   | — |   | (0.39 | ) |
| Net income (loss)                                               |   | $                           | 0.17   |                        | $      | 0.10 |   | $ | 0.30 |   | $ | (0.07 | ) |
|                                                            |   |                        |   |                        |   |   |   |   |   |
| Per  common share – diluted                                |   |                        |   |                        |   |   |   |   |   |
|                                                            |   |                        |   |                        |   |   |   |   |   |
| Income before cumulative effect of accounting change            |   | $                           | 0.17   |                        | $      | 0.09 |   | $ | 0.29 |   | $ | 0.31 |   |
| Cumulative effect of accounting change,  net of income taxes    |   | —                      |   | —                      |   | — |   | (0.38 | ) |
| Net income (loss)                                               |   | $                           | 0.17   |                        | $      | 0.09 |   | $ | 0.29 |   | $ | (0.07 | ) |

 

**9. Income Taxes**

 

Incometaxes are recorded based on the estimated combined statutory tax rates expectedto be applicable for the full fiscal year less applicable employment relatedtax credits. The effective tax rate is lower than the combined statutory rates,primarily reflecting the impact of these wage-related income tax credits. Theeffective income tax rate of 44% recorded in 2003 gives effect to the New YorkState tax legislation passed in May 2003, with retroactive application toJanuary 1, 2003.

 

**10. Recently Issued Accounting Pronouncements**

 

Duringthe first quarter of 2003, the Company adopted Statement of FinancialAccounting Standards ("FAS") No. 145, “Rescission of FASB StatementsNo. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections.” Under FAS No. 145, gains and losses related to the extinguishmentof debt should no longer be segregated on the income statement as extraordinaryitems. Instead, such gains and losses should be included as a component ofincome from continuing operations. The provisions of FAS No. 145 are effectivefor fiscal years beginning after May 15, 2002. Upon adoption, the Companyreclassified from extraordinary charges to other income (loss), for the fiscalyears ended December 28, 2002 and December 29, 2001, pre-tax debtextinguishment costs of $11.4 million and $2.6 million, respectively. Theincome tax provisions for the 2002 and 2001 fiscal years applicable to incomebefore income taxes and cumulative effect of accounting change were adjustedcommensurately. Reported net income remained unaffected by thereclassification, and thus, this adoption did not have a material impact on theCompany’s results of operations, financial position or cash flows.

 

10

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During the first quarterof 2003, the Company adopted FAS No. 146, “Accounting for Costs Associated withExit or Disposal Activities.” This statement nullifies Emerging Issues TaskForce (EITF) Issue No. 94-3, “Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring).” FAS No. 146 requires that a liability forcosts associated with an exit or disposal activity be recognized when theliability is incurred. The provisions of FAS No. 146 are effective for exit ordisposal activities initiated after December 31, 2002. The adoption of FASNo. 146 did not have a material impact on the Company’s results of operations,financial position or cash flows.

 

In September 2002,the Emerging Issues Task Force released Issue No. 02-16, “Accounting by aReseller for Cash Consideration Received from a Vendor”. The pronouncementaddresses two issues. The first issue requires that vendor allowances becategorized as a reduction in cost of sales unless they are a reimbursement ofcosts incurred to sell the vendor’s products, in which case, the cashconsideration should be characterized as a reduction of that cost. Cashconsideration received in excess of the fair value of the benefit receivedshould be characterized as a reduction of cost of sales. Transition provisionsfor this portion of the pronouncement apply to all agreements entered into ormodified after December 31, 2002. As a result of the application of thisportion of the pronouncement, the Company changed its accounting policy tolimit vendor allowances treated as a reduction of advertising costs to onlythose allowances paid by vendors to fund specific radio advertising promotions.All other promotional advertising allowances will be treated as a reduction incost of sales. The application of this new accounting policy did not have amaterial impact on the Company’s consolidated results of operations, financialposition or cash flows for the periods reported, and is not expected to have amaterial impact on the Company’s consolidated results of operations, financialposition or cash flows in the future. The second issue requires that rebates orrefunds payable only if the customer completes a specified cumulative level ofpurchases should be recognized as a reduction of cost of sales based on asystematic and rational allocation over the purchasing period. This provisionis required to be applied to all new arrangements initiated afterNovember 21, 2002 and is consistent with the Company’s past practice.

 

In November 2002,the Financial Accounting Standards Board issued FASB Interpretation (FIN) No.45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 clarifiesthe requirements of FAS No. 5, “Accounting for Contingencies,” relating to aguarantor’s accounting for and disclosure of, the issuance of certain types ofguarantees. FIN No. 45 elaborates on the existing disclosure requirements formost guarantees, including loan guarantees such as standby letters of credit.It also clarifies that at the time a company issues a guarantee, the companymust recognize an initial liability for the fair value, or market value, of theobligations it assumes under the guarantee and must disclose that informationin its interim and annual financial statements. The provisions related torecognizing a liability at inception of the guarantee for the fair value of theguarantor’s obligations does not apply to product warranties or to guarantees accountedfor as derivatives. The recognition provisions of FIN No. 45 are effective forcertain guarantees issued after January 1, 2003. The adoption of thisinterpretation did not have a material impact on the Company’s results ofoperations, financial position or cash flows.

 

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 adoptiondid not have a material impact on the Company’s consolidated results ofoperations, financial position or cash flows.

 

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 the market value of the underlying commonstock on the date of grant. The following table illustrates the effect on netincome and earnings per share if the Company had applied the fair valuerecognition provisions of FAS No. 123 to stock-based employee compensation(dollars in thousands):

 

11

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|                                                                                                                                                    |   | **For the 13 Weeks Ended** |   | **For the 26 Weeks Ended** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|--------|----------------------------|--------|
|                                                                                                                                                    |   | **June 28, 2003**          |   | **June 29, 2002**          |   | **June 28, 2003** |   | **June 29, 2002** |   |
|                                                                                                                                                    |   |                       |   |                       |   |   |   |   |   |
| Net income (loss), as reported                                                                                                                          |   | $                          | 4,058  |                       | $      | 2,330 |   | $ | 7,170 |   | $ | (1,670 | ) |
|                                                                                                                                                    |   |                       |   |                       |   |   |   |   |   |
| Adjust: Total stock-based employee  compensation income (expense) determined under fair value based method for  all awards, net of related tax effects. |   | 2,066                      |   | (967                       | )      | 4,131 |   | (1,934 | ) |
|                                                                                                                                                    |   |                       |   |                       |   |   |   |   |   |
| Pro forma net income (loss)                                                                                                                             |   | $                          | 6,124  |                       | $      | 1,363 |   | $ | 11,301 |   | $ | (3,604 | ) |
|                                                                                                                                                    |   |                       |   |                       |   |   |   |   |   |
| Income (loss) per common share:                                                                                                                         |   |                       |   |                       |   |   |   |   |   |
| Basic - as reported                                                                                                                                     |   | $                          | 0.17   |                       | $      | 0.10 |   | $ | 0.30 |   | $ | (0.07 | ) |
| Basic - pro forma                                                                                                                                       |   | $                          | 0.25   |                       | $      | 0.06 |   | $ | 0.47 |   | $ | (0.15 | ) |
|                                                                                                                                                    |   |                       |   |                       |   |   |   |   |   |
| Diluted - as reported                                                                                                                                   |   | $                          | 0.17   |                       | $      | 0.09 |   | $ | 0.29 |   | $ | (0.07 | ) |
| Diluted - pro forma                                                                                                                                     |   | $                          | 0.25   |                       | $      | 0.06 |   | $ | 0.46 |   | $ | (0.15 | ) |

 

As described in moredetail in Note 6, the Company cancelled 1,337,449 outstanding stock optionsduring the first quarter of 2003 in connection with the Stock Option ExchangeOffer. The pro forma income shown in the table above for 2003 includes thereversal of pro forma expenses previously disclosed totaling $2.4 million perquarter, related to the granting of these original options.  When replacement stock options are issuedlater in 2003, the Company expects to incur pro forma compensation expensewhich will reflect 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.

 

In January 2003, theFinancial Accounting Standards Board issued FIN No. 46, “Consolidation ofVariable Interest Entities.” FIN No. 46 requires a variable interest entity tobe consolidated by a company if that company is subject to a majority of therisk of loss from the variable interest entity’s activities or entitled toreceive a majority of the entity’s residual returns or both. The consolidationrequirements of FIN No. 46 apply immediately to variable interest entitiescreated after January 31, 2003. The consolidation requirements apply toolder entities in the first fiscal year or interim period beginning afterJune 15, 2003. Certain of the disclosure requirements apply in allfinancial statements issued after January 31, 2003, regardless of when thevariable interest entity was established. The adoption of the provisionsthrough June 28, 2003 did not have a material impact on the Company's resultsof operations, financial position or cash flows, and the Company does notbelieve that the adoption of the remaining provisions will have a materialimpact on its results of operations, financial position or cash flows.

 

**11. Commitments and Contingencies**

 

During 2002, the Companyinitiated a legal action against its former property insurance carrier, in anattempt to recover what the Company believes to be a fair and reasonablesettlement for the business interruption portion of its claim stemming from theSeptember 11, 2001 World Trade Center terrorist attack, during which theCompany’s single highest volume and most profitable store was completelydestroyed. Discovery has been concluded in this litigation and a trial oncertain issues is currently scheduled for autumn 2003.

 

12

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The Company, Anthony J.Cuti, its Chairman, President and Chief Executive Officer, John K. Henry, itsChief Financial Officer, and Gary Charboneau, its Senior Vice President ofSales and Marketing, have been named as defendants in connection with theconsolidation of several class action complaints alleging violations of thefederal securities laws that were filed from August 2002 throughOctober 2002. The action, which is in the United States District Court forthe Southern District of New York, is on behalf of shareholders who purchasedDuane Reade Inc.’s common stock between April 1, 2002 and July 24,2002, inclusive. The complaint alleges that the defendants violated the federalsecurities laws by issuing materially false and misleading statements duringthe class period.  The Company believesthat these actions are completely baseless and wholly without merit. TheCompany will continue to vigorously defend these actions.

 

The Company is a defendant in a class action suit in the Federal Courtfor the Southern District of New York regarding alleged violations of the FairLabor Standards Act as to a group of individuals who provided delivery serviceson a contract basis to the Company. In December 2002, the judge in theaction issued a partial summary judgment in favor of a subclass of theplaintiffs and against the Company. The Company has established reserves thatit believes are appropriate in its judgment and in accordance with applicableaccounting rules. The Company continues to vigorously defend itself in thisaction.

 

The Company is party to other legal actions arising in the ordinarycourse of business.  Based oninformation presently available, 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 theCompany’s results of operations, financial position or cash flows.

 

A recent New York StateTax Appeals 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.

 

**12. Subsequent Event**

 

On July 21, 2003,the Company completed the refinancing of its previously existing senior creditagreement, a portion of which was scheduled to mature in February 2004.The new credit facility (the “Credit Agreement”) is an asset-based revolvingloan which uses a pre-determined percentage of the current value of theCompany’s inventory 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 DRI I Inc., Duane ReadeInc., Duane Reade International, Inc. and Duane Reade Realty, Inc., and suchguarantees are secured by substantially all assets of such guarantors.  The Credit Agreement matures onJuly 20, 2008.

 

Under the new facility,approximately $184 million was initially available, of which approximately$103.5 million was borrowed and used to repay in full the outstanding term Aloans ($3.1 million), term B loans ($60.0 million) and revolver borrowings($38.5 million) under the Company’s previous senior credit agreement, as wellas accumulated interest to the repayment date and certain expenses associatedwith the new financing ($1.9 million). Upon closing and repayment of all outstanding borrowings and relatedcosts, the Company had approximately $80 million of additional availabilityunder this new Credit Agreement, and the previous credit agreement has beenterminated.

 

In connection with therefinancing and termination of the existing senior credit agreement, theCompany incurred pre-tax debt extinguishment expenses of $0.7 million,representing the accelerated amortization of the remaining deferred financingcosts associated with the previous senior credit agreement. These expenses willbe recognized in the third quarter of 2003.

 

13

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**ITEM 2. MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND**** RESULTS OF OPERATIONS**

 

**Results of Operations**

 

The following setsforth the results of operations as a percentage of sales for the periodsindicated.

 
|                                                                   |   | **For the 13 Weeks Ended** |   | **For the 26 Weeks Ended** |   |
|------------------------------------------------------------------------|--------|----------------------------|--------|----------------------------|--------|
|                                                                   |   | **June 28, 2003**          |   | **June 29, 2002**          |   | **June 28, 2003** |   | **June 29, 2002** |   |
| Net sales                                                              |   | 100.0                      | %      | 100.0                      | %      | 100.0 | % | 100.0 | % |
| Cost of sales                                                          |   | 78.3                       |   | 78.9                       |   | 78.6 |   | 78.1 |   |
| Gross profit                                                           |   | 21.7                       |   | 21.1                       |   | 21.4 |   | 21.9 |   |
| Selling,  general and administrative expenses                          |   | 16.1                       |   | 14.9                       |   | 16.1 |   | 15.3 |   |
| Insurance  recovery                                                    |   | —                     |   | (2.9                       | )      | — |   | (1.5 | ) |
| Depreciation  & amortization                                       |   | 2.3                        |   | 2.1                        |   | 2.3 |   | 2.1 |   |
| Store  pre-opening expense                                             |   | 0.1                        |   | 0.3                        |   | 0.1 |   | 0.2 |   |
| Operating  income                                                      |   | 3.2                        |   | 6.7                        |   | 2.9 |   | 5.8 |   |
| Interest  expense, net                                                 |   | 1.0                        |   | 1.5                        |   | 1.0 |   | 1.7 |   |
| Debt  extinguishment                                                   |   | —                     |   | 4.1                        |   | — |   | 2.1 |   |
| Income before  income taxes and cumulative effect of accounting change |   | 2.2                        |   | 1.1                        |   | 1.9 |   | 2.0 |   |
| Income taxes                                                           |   | 1.0                        |   | 0.4                        |   | 0.8 |   | 0.8 |   |
| Income before  cumulative effect of accounting change                  |   | 1.2                        |   | 0.7                        |   | 1.1 |   | 1.2 |   |
| Cumulative  effect of accounting change, net of income taxes           |   | —                     |   | —                     |   | — |   | (1.5 | ) |
| Net income  (loss)                                                     |   | 1.2                        | %      | 0.7                        | %      | 1.1 | % | (0.3 | )% |

 

**Thirteen Weeks Ended June 28, 2003 versus Thirteen WeeksEnded June 29, 2002**

 

Netsales were $355.1 million in the second quarter of 2003, an increase of 9.4%over net sales of $324.8 million for the second quarter of 2002. Pharmacy salesincreased from $135.4 million in the second quarter of 2002 to $155.2 millionin the second quarter of 2003, an increase of 14.7%, and represented 43.7% oftotal sales, as compared with 41.7% of total sales in the second quarter of2002. Front-end sales increased from $189.4 million in the second quarter of2002 to $199.9 million in the second quarter of 2003, an increase of 5.6%, andrepresented 56.3% of total sales, as compared to 58.3% of total sales in thesecond quarter of 2002.  For the secondquarter of 2003, third-party reimbursed pharmacy sales represented 91.3% oftotal pharmacy sales, as compared to 89.8% in the second quarter of 2002. Theincrease in total sales over last year was attributable to the full quarterlyimpact of ten stores opened during the second quarter of 2002 and sales from 18net new stores opened since June 2002, combined with increased comparablestore sales of 3.1%, including an 8.0% increase in pharmacy same-store salespartially offset by a 0.4% decline in front-end same-store sales. During thesecond quarter of 2003, we opened four new stores, as compared to 10 new storesopened during the second quarter of 2002. At June 28, 2003, we operated236 stores, as compared to 218 stores at June 29, 2002.

 

Cost of sales as apercentage of net sales decreased to 78.3% for the second quarter of 2003 from78.9% for the second quarter of 2002, resulting in an increase in gross profitmargin to 21.7% for the second quarter of 2003 from 21.1% for the secondquarter of 2002.  This increase wasattributable to a comparison against an unusually high promotional period inthe prior year, partially offset by higher store occupancy costs resulting inpart from a January 1, 2003 New York City real estate tax increase, lowervolume related vendor discounts and allowances, and a greater proportion oflower margin pharmacy and third-party reimbursed pharmacy sales in relation tofront-end sales. Cost of sales also includes a $0.2 million LIFO provision inthe current year, compared to $0.4 million in the comparable period last year.

 

14

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Selling, general andadministrative expenses were $57.3 million, or 16.1% of net sales, and $48.5million, or 14.9% of net sales, in the second quarters of 2003 and 2002,respectively.  The increase in theseexpenses as a percentage of sales is attributable to increased costs associatedwith the significant number of one-hour photo departments added since thecomparable period last year, higher property insurance costs, increases incredit and debit card processing fees and greater litigation-related expensesprimarily associated with the World Trade Center business interruption insuranceclaim.

 

During the second quarterof 2002, we received a partial payment of $9.9 million toward our businessinterruption insurance claim originating from the September 11thWorld Trade Center disaster. After deducting certain claims-related expenses,we recorded a net benefit of $9.4 million in pre-tax income. We are currentlyengaged in litigation to recover the balance of the outstanding claim.Additional insurance recoveries related to the business interruption claim,which, if any, could be material, will be recognized when such collection isassured.

 

Depreciation andamortization of intangibles in the second quarters of 2003 and 2002 were $8.2million and $6.7 million, respectively. This increase resulted primarily from increases in the amortization ofidentifiable intangibles resulting from pharmacy acquisitions completed sincethe second quarter of 2002, combined with incremental depreciation expensesrelated to capital expenditures in 2002 and 2003.

 

We incurred storepre-opening expenses of $0.2 million during the second quarter of 2003 relatedto the opening of four new stores. During the comparable period last year, we incurred pre-opening expensesof $0.8 million related to the opening of 10 new stores.

 

Net interest expensedecreased 28.9% to $3.5 million in the second quarter of 2003 from $5.0 millionin the second quarter of 2002.  Thisdecline was primarily attributable to the second quarter 2002 completion of theconvertible note offering, the proceeds of which were used to retire highercost senior subordinated notes and term loan debt.

 

In the second quarter of2002, we recorded debt extinguishment charges of $13.1 million, reflecting (a)$2.1 million of accelerated amortization of deferred financing costs related tosenior credit agreement loans repaid and 9.25% senior notes retired withproceeds from the 2002 convertible note offering, (b) $7.1 million for paymentof consent premiums and expenses related to the 9.25% senior note tender offerand (c) $3.9 million related to the termination of an interest rate swapagreement. In accordance with the provisions of FAS 145, which became effectiveJanuary 1, 2003, these debt extinguishment costs, which were shown inprevious SEC filings as extraordinary items totaling $7.7 million, net of a41.0% income tax provision, were reclassified and are now included as acomponent of income before income taxes and cumulative effect of accountingchange.  Reported net income wasunaffected, and our results of operations, financial position and cash flowswere not materially impacted by this reclassification.

 

Our income before incometaxes and cumulative effect of accounting change in the second quarter of 2003increased to $7.8 million from $3.7 million in the second quarter of 2002,reflecting the factors discussed above.

 

In the second quarter of2003, we recorded an income tax provision of $3.7 million, reflecting anestimated annual effective tax rate of 44.0%, inclusive of the anticipatedbenefits of employment tax credits. Additionally, the second quarter of 2003includes a retroactive adjustment to the first quarter’s income tax expense,which was previously recorded at an effective rate of 38.0%. The increase inthe effective tax rate was to give effect to New York State tax legislationpassed in May 2003 with retroactive application to January 1, 2003.In the comparable period last year, the income tax provision of $1.4 millionreflected an estimated effective tax rate of 37.0%, inclusive of theanticipated benefits of employment tax credits.

 

15

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**Twenty-Six Weeks Ended June 28, 2003 versus Twenty-SixWeeks Ended June 29, 2002**

 

Netsales were $688.8 million in the first six months of 2003, an increase of 9.2%over net sales of $630.6 million for the first six months of 2002. Pharmacysales increased from $262.6 million in the first six months of 2002 to $299.1million in the first six months of 2003, an increase of 13.9%, and represented43.4% of total sales, as compared with 41.6% of total sales in the first sixmonths of 2002. Front-end sales increased from $368.0 million in the first sixmonths of 2002 to $389.7 million in the first six months of 2003, an increaseof 5.9%, and represented 56.6% of total sales, as compared to 58.4% of totalsales in the first six months of 2002. For the first six months of 2003, third-party reimbursed pharmacy salesrepresented 91.2% of total pharmacy sales, as compared to 89.5% in the firstsix months of 2002. The increase in total sales over last year was attributableto the full six month impact of 20 stores opened during the first six months of2002 and sales from 18 net new stores opened since June 2002, combinedwith increased comparable store sales of 2.4%, including a 7.2% increase inpharmacy same-store sales partially offset by a 1.2% decline in front-endsame-store sales. During the first six months of 2003, we opened 11 new storesand closed three stores, as compared to 20 new stores opened and two storesclosed during the first six months of 2002.

 

Cost of sales as apercentage of net sales increased to 78.6% for the first six months of 2003from 78.1% for the first six months of 2002, resulting in a decrease in grossprofit margin to 21.4% for the first six months of 2003 from 21.9% for thefirst six months of 2002.  This decreasewas attributable to the reduced levels of same-store front-end sales reflectingthe continued impact of the recessionary economy in the New York metropolitanarea, increased Christmas holiday inventory clearance markdowns incurred in thefirst quarter of this year and higher store occupancy costs resulting in partfrom a January 1, 2003 New York City real estate tax increase. Inaddition, gross margins declined due to the impact of an increased proportionof lower margin pharmacy and third-party reimbursed pharmacy sales in relationto front-end sales. Cost of sales also includes a $0.3 million LIFO provisionin the first half of the current year, compared to $0.8 million in thecomparable period last year.

 

Selling, general andadministrative expenses were $110.8 million, or 16.1% of net sales, and $96.2million, or 15.3% of net sales, in the first six months of 2003 and 2002,respectively.  The increase in theseexpenses as a percentage of sales is attributable to the lower than usualsame-store sales growth, higher promotional and advertising expenses, increasedcosts associated with the significant number of one-hour photo departmentsadded since the comparable period last year, increased credit and debit cardprocessing fees and higher property insurance costs than the prior period.

 

During the first half of2002, we received a partial payment of $9.9 million toward our businessinterruption insurance claim originating from the September 11thWorld Trade Center disaster. After deducting certain claims-related expenses,we recorded a net benefit of $9.4 million in pre-tax income. We are currentlyengaged in litigation to recover the balance of the outstanding claim.Additional insurance recoveries related to the business interruption claim,which, if any, could be material, will be recognized when such collection isassured.

 

Depreciation andamortization of intangibles in the first six months of 2003 and 2002 were $15.7million and $13.5 million, respectively. This increase resulted primarily from increases in the amortization ofidentifiable intangibles resulting from pharmacy acquisitions completed sincethe second quarter of 2002, combined with incremental depreciation expensesrelated to capital expenditures in 2002 and 2003.

 

We incurred storepre-opening expenses of $0.6 million during the first six months of 2003related to the opening of 11 new stores. During the comparable period last year, we incurred pre-opening expensesof $1.3 million related to the opening of 20 new stores.

 

Net interest expensedecreased 33.8% to $7.1 million in the first six months of 2003 from $10.7million in the first six months of 2002. This decline was primarily attributable to the second quarter 2002completion of the convertible note offering, the proceeds of which were used toretire higher cost senior subordinated notes and term loan debt.

 

16

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In the first six monthsof 2003, we recorded a debt extinguishment charge of $0.1 million, reflectingthe payment of early termination premiums related to the retirement of the $1.6million remaining balance of the 9.25% senior notes and the write-off of theremaining deferred financing costs associated with the 9.25% senior notes. Inthe first six months of 2002, we recorded debt extinguishment charges of $13.1million, reflecting (a) $2.1 million of accelerated amortization of deferredfinancing costs related to senior credit agreement loans repaid and 9.25%senior notes retired with proceeds from the 2002 convertible note offering, (b)$7.1 million for payment of consent premiums and expenses related to the 9.25%senior note tender offer and (c) $3.9 million related to the termination of aninterest rate swap agreement. In accordance with the provisions of FAS 145,which became effective January 1, 2003, these debt extinguishment costs,which were shown in previous SEC filings as extraordinary items totaling $7.7million, net of a 41.0% income tax provision, were reclassified and are nowincluded as a component of income before income taxes and cumulative effect ofaccounting change.  Reported net incomewas unaffected, and our results of operations, financial position and cashflows were not materially impacted by this reclassification.

 

Our income before incometaxes and cumulative effect of accounting change in the first six months of2003 increased to $12.8 million from $12.5 million in the first six months of2002, reflecting the factors discussed above.

 

In the first six monthsof 2003, we recorded an income tax provision of $5.6 million, reflecting anestimated annual effective tax rate of 44.0%, inclusive of the anticipatedbenefits of employment tax credits. In the comparable period last year, theincome tax provision of $4.9 million reflected an estimated effective tax rateof 39.4%, inclusive of the anticipated benefits of employment tax credits. Theincrease in the effective tax rate was primarily the result of increased taxesattributable to New York State tax legislation passed in May 2003 withretroactive application to January 1, 2003.

 

Duringthe first six months of 2002, as a result of the change in accounting method ofinventory valuation from retail dollar FIFO to specific cost LIFO, we recordeda one-time, non-cash charge of $9.3 million, net of an income tax benefit of$6.7 million.

 

**Liquidity and Capital Resources**

 

Working capital was$228.2 million as of June 28, 2003 and $216.1 million as ofDecember 28, 2002. The increase was primarily due to an increase ininventory related to the opening of eight net additional stores and a build-upof summertime and “back-to-school” seasonal merchandise which we anticipatewill be sold during the third quarter of 2003.

 

Forthe first six months of 2003, net cash provided by operating activities was$14.0 million, as compared to $13.7 million in the first six months of 2002.

 

Net cash used ininvesting activities was $35.7 million during the first six months of 2003,compared to $30.6 million during the first six months of 2002.  In the first half of 2003, capitalexpenditures, primarily related to new store openings and the remodeling ofexisting locations, amounted to $25.8 million, while lease, pharmacy customerfile and other acquisition costs accounted for $9.9 million of cash used ininvesting activities.  In the first halfof 2002, we spent $25.2 million on capital expenditures and $5.4 million onlease, pharmacy customer file and other acquisition costs.

 

Netcash provided by financing activities was $18.8 million for the first sixmonths of 2003, compared to $69.1 million for the first six months of 2002. Thedecrease is primarily attributable to the portion of the cash proceeds realizedfrom the April 2002 convertible note offering that were not used to retirethe 9.25% Senior Notes until July 2002.

 

Ourcapital requirements primarily result from opening and stocking new stores,remodeling and renovating existing retail locations and from the continuingdevelopment of management information systems. We believe that there aresignificant opportunities to open additional stores, and currently plan to openapproximately 6 to 8 additional new stores during the remainder of this year (atotal of 17 to 19 for all of 2003), and 18 to 22 new stores in fiscal 2004. Weexpect to spend approximately $40.0 million in 2003 on capital expenditures,primarily for new, renovated and replacement stores, and an additional $13.0million for lease, pharmacy customer file and other acquisition costs. We alsorequire working capital to support inventory for our existing stores.Historically, we have been able to lease most of our store locations.

 

17

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OnJuly 21, 2003, we completed the refinancing of our existing senior creditagreement. Refer to Note 12 to the consolidated financial statements foradditional information regarding this transaction.

 

Webelieve that, based on current levels of operations and anticipated growth,cash flow from operations, together with other available sources of funds,including revolving loan borrowings under our new Credit Agreement, will beadequate for at least the next two years to make required payments of principaland interest on our indebtedness, to fund anticipated capital expenditures andto satisfy our working capital requirements. Our ability to meet our debtservice obligations and reduce our total debt will depend upon our futureperformance which, in turn, will be subject to general economic, financial,business, competitive, legislative, regulatory and other conditions, many ofwhich are beyond our control. In addition, we cannot assure you that ouroperating results, cash flow and capital resources will be sufficient forrepayment of our indebtedness in the future. As borrowings under the new CreditAgreement bear interest at floating rates, our financial condition will beaffected by changes in prevailing interest rates.

 

Thenew Credit Agreement and the indenture relating to our senior convertible notescontain various covenants that limit or restrict, among other things, subjectto certain exceptions, capital expenditures, the incurrence of indebtedness,the creation of liens, transactions with affiliates, restricted payments,investments and acquisitions, mergers, consolidations, dissolutions, assetsales, dividends, distributions and certain other transactions and businessactivities.  Financial performancecovenants included in the new Credit Agreement are limited to a single fixedcharge coverage requirement that only becomes operable when borrowings exceed90 percent of the borrowing base, as defined in the new Credit Agreement.  On July 21, 2003, upon completion ofthe refinancing of the senior credit agreement, we had approximately $80million of borrowing capacity (see Note 12 to the consolidated financialstatements). Borrowings under the new Credit Agreement have not exceeded 90percent of the borrowing base. There are no credit ratings related triggers inour new Credit Agreement or in the indenture related to our convertible notes.

 

### **Critical Accounting Policies**

### ** **

Ourdiscussion of results of operations and financial condition relies on ourconsolidated financial statements that are prepared based on certain criticalaccounting policies that require management to make judgments and estimatesthat are subject to varying degrees of uncertainty. We believe that investorsneed to be aware of these policies and how they impact our financial reportingto gain a more complete understanding of our consolidated financial statementsas a whole, as well as our related discussion and analysis presented herein.While we believe that these accounting policies are grounded on soundmeasurement criteria, actual future events can and often do result in outcomesthat can be materially different from these estimates or forecasts. The accountingpolicies and related risks described in our Annual Report on Form 10-K for theyear ended December 28, 2002 are those that depend most heavily on thesejudgments and estimates.  As ofJune 28, 2003, there have been no material changes to any of the CriticalAccounting Policies contained therein.

 

**Seasonality**

 

Ingeneral, sales of drugstore items such as prescription drugs, over-the-counterdrugs and health and beauty care products exhibit limited seasonality in theaggregate, but do vary by product category. Quarterly results are primarilyaffected by the timing of new store openings and the sale of seasonal products,with the Christmas holiday season generating a higher proportion of sales andearnings than other periods.

 

**Recently Issued AccountingPronouncements**

 

Duringthe first quarter of 2003, we adopted Statement of Financial AccountingStandards ("FAS") No. 145, “Rescission of FASB Statements No. 4, 44,and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” UnderFAS No. 145, gains and losses related to the extinguishment of debt should nolonger be segregated on the income statement as extraordinary items. Instead,such gains and losses should be included as a component of income fromcontinuing operations. The provisions of FAS No. 145 are effective for fiscalyears beginning after May 15, 2002. Upon adoption, we reclassified fromextraordinary charges to other income (loss), for the fiscal years endedDecember 28, 2002 and December 29, 2001, pre-tax amounts of $11.4million and $2.6 million, respectively. The income tax provisions for the 2002and 2001 fiscal years applicable to income before income taxes and cumulativeeffect of accounting change were adjusted commensurately. Reported net incomeremained unaffected by the reclassification, and thus, this adoption did nothave a material impact on our results of operations, financial position or cashflows.

 

18

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During the first quarterof 2003, we adopted FAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities.” This statement nullifies Emerging Issues Task Force(EITF) Issue No. 94-3, “Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit an Activity (including Certain Costs Incurredin a Restructuring).” FAS No. 146 requires that a liability for costsassociated with an exit or disposal activity be recognized when the liabilityis incurred. The provisions of FAS No. 146 are effective for exit or disposalactivities initiated after December 31, 2002. The adoption of FAS No. 146did not have a material impact on our results of operations, financial positionor cash flows.

 

In September 2002,the Emerging Issues Task Force released Issue No. 02-16, “Accounting by aReseller for Cash Consideration Received from a Vendor”. The pronouncementaddresses two issues. The first issue requires that vendor allowances becategorized as a reduction in cost of sales unless they are a reimbursement ofcosts incurred to sell the vendor’s products, in which case, the cashconsideration should be characterized as a reduction of that cost. Cashconsideration received in excess of the fair value of the benefit receivedshould be characterized as a reduction of cost of sales. Transition provisions forthis portion of the pronouncement apply to all agreements entered into ormodified after December 31, 2002. As a result of the application of thisportion of the pronouncement, we changed our accounting policy to limit vendorallowances treated as a reduction of advertising costs to only those allowancespaid by vendors to fund specific radio advertising promotions. All otherpromotional advertising allowances will be treated as a reduction in cost ofsales. The application of this new accounting policy did not have a materialimpact on our consolidated results of operations, financial position or cashflows for the periods reported, and is not expected to have a material impacton our consolidated results of operations, financial position or cash flows inthe future. The second issue requires that rebates or refunds payable only ifthe customer completes a specified cumulative level of purchases should berecognized as a reduction of cost of sales based on a systematic and rationalallocation over the purchasing period. This provision is required to be appliedto all new arrangements initiated after November 21, 2002 and isconsistent with our past practice.

 

In November 2002,the Financial Accounting Standards Board issued FASB Interpretation (FIN) No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others.” FIN No. 45 clarifies therequirements of FAS No. 5, “Accounting for Contingencies,” relating to aguarantor’s accounting for and disclosure of, the issuance of certain types ofguarantees. FIN No. 45 elaborates on the existing disclosure requirements formost guarantees, including loan guarantees such as standby letters of credit.It also clarifies that at the time a company issues a guarantee, the companymust recognize an initial liability for the fair value, or market value, of theobligations it assumes under the guarantee and must disclose that informationin its interim and annual financial statements. The provisions related torecognizing a liability at inception of the guarantee for the fair value of theguarantor’s obligations does not apply to product warranties or to guaranteesaccounted for as derivatives. The recognition provisions of FIN No. 45 areeffective for certain guarantees issued after January 1, 2003. Theadoption of this interpretation did not have a material impact on our resultsof operations, financial position or cash flows.

 

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. We have not adopted such voluntarychange to the fair value based method. In addition, this statement amends thedisclosure requirements of FAS 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. The adoption did not have amaterial impact on our consolidated results of operations, financial positionor cash flows.

 

In January 2003, theFinancial Accounting Standards Board issued FIN No. 46, “Consolidation ofVariable Interest Entities.” FIN No. 46 requires a variable interestentity to be consolidated by a company if that company is subject to a majorityof the risk of loss from the variable interest entity’s activities or entitledto receive a majority of the entity’s residual returns or both. Theconsolidation requirements of FIN No. 46 apply immediately to variable interestentities created after January 31, 2003. The consolidation requirementsapply to older entities in the first fiscal year or interim period beginningafter June 15, 2003. Certain of the disclosure requirements apply in allfinancial statements issued after January 31, 2003, regardless of when thevariable interest entity was established. The adoption of the provisionsthrough June 28, 2003 did not have a material impact on our results ofoperations, financial position or cash flows, and we do not believe that theadoption of the remaining provisions will have a material impact on our resultsof operations, financial position or cash flows.

 

19

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**ITEM 3. MARKET RISK**

 

Ourfinancial results are subject to risk from interest rate fluctuations on thatportion of our debt which carries variable interest rates. Variable rate debtoutstanding under our senior credit agreement was approximately $86.1 millionat June 28, 2003. At June 28, 2003, the weighted average combinedinterest rate in effect on all borrowings under the senior credit agreement was3.67%. A 0.50% change in interest rates applied to the $86.1 million balance offloating rate debt would affect pre-tax annual results of operations byapproximately $0.4 million. We also have $201.0 million of senior convertiblenotes outstanding at June 28, 2003, which bear interest payablesemi-annually at a fixed rate of 3.75%, and are therefore not subject to riskfrom interest rate fluctuations.

 

Theprincipal objective of our investment management activities is to maintainacceptable levels of interest rate and liquidity risk to facilitate our fundingneeds. As part of our risk management, we may use derivative financial productssuch as interest rate hedges and interest rate swaps in the future.

 

**ITEM4. CONTROLS AND 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-15 and 15d-15 under the Securities Exchange Act of 1934,as amended (the “Exchange Act”)) as of the end of the period covered by thisquarterly 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)         Changes in InternalControls over Financial Reporting.  During the most recent fiscal quarter, there have not been anysignificant changes in our internal controls over financial reporting or inother factors that have materially affected, or are reasonably likely to materiallyaffect, our internal controls over financial reporting.

 

**PART II**

 

**OTHER INFORMATION**

 

**ITEM 1.  LegalProceedings**

 

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 stemming from the September 11, 2001World Trade Center terrorist attack, during which our single highest volume andmost profitable store was completely destroyed. Discovery has been concluded inthis litigation and a trial on certain issues is currently scheduled for autumn2003.

 

Duane Reade Inc., AnthonyJ. Cuti, our Chairman, President and Chief Executive Officer, John K. Henry,our Chief Financial Officer, and Gary Charboneau, our Senior Vice President ofSales and Marketing, have been named as defendants in connection with theconsolidation of several class action complaints alleging violations of thefederal securities laws that were filed from August 2002 throughOctober 2002. The action, which is in the United States District Court forthe Southern District of New York, is on behalf of shareholders who purchasedour common stock between April 1, 2002 and July 24, 2002, inclusive.The complaint alleges that the defendants violated the federal securities lawsby issuing materially false and misleading statements during the classperiod.  We believe that these actionsare completely baseless and wholly without merit. We will continue tovigorously defend these actions.

 

20

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Weare a defendant in a class action suit in the Federal Court for the SouthernDistrict of New York regarding alleged violations of the Fair Labor StandardsAct as to a group of individuals who provided delivery services on a contractbasis to us. In December 2002, the judge in the action issued a partialsummary judgment in favor of a subclass of the plaintiffs and against us. Wehave established reserves that we believe are appropriate in our judgement andin accordance with applicable accounting rules. We continue to vigorouslydefend ourselves in this action.

 

Weare party to other legal actions arising in the ordinary course ofbusiness.  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 material adverse effect on our results of operations,financial position or cash flows.

 

**ITEM 2.  Changes in Securities and Use of Proceeds**

 

Not applicable

 

**ITEM 3.  Defaults UponSenior Securities**

 

Not applicable

 

**ITEM 4.  Submission of Matters to a Vote of Security Holders**

 

The Company’s annual meeting of stockholders was heldon May 8, 2003.  At the meeting,the shareholders re-elected the Board of Directors slate of nominees (AnthonyJ. Cuti, David L. Jaffe, Carl M. Pradelli, Kevin Roberg, William Simon andKenneth B. Woodrow) to serve as members of the Board of Directors through the2004 meeting. All of the members had served on the Board since the prior shareholders'meeting. David W. Johnson had previously advised the Company of his intent toresign from the Board of Directors and did not stand for re-election. Inaddition, the shareholders approved the Third Amendment to the 1997 EquityParticipation Plan (the “Plan”), increasing by 1,000,000 the number of sharesavailable for issuance as stock options under the Plan.

 

**ITEM 5.  OtherInformation**

 

Not applicable

 

**ITEM6.  Exhibits****, FinancialStatement Schedules and Reports on Form 8-K**

 

(a)                                  Thefollowing documents are filed as a part of this report:

 

(i)                                     FinancialStatements

 

(ii)                                  Exhibits:

 
| **Exhibit No.** |   | **Description**                                                                                                                                                                                                                                             |
|-----------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                                                                        |
| 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 *           |   | Third Amended and Restated  Partnership Agreement of Duane Reade dated July 16, 2003.                                                                                                                                                                       |
| 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).                                                                                                                                               |

 

21

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| 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                  |   | 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”)).                                                                                                                                                                             |
| 4.2                  |   | 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, as amended (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

 

  |   | Promissory Note, dated  as of November 9, 1998, between the Company and Anthony J. Cuti  (incorporated by reference to Exhibit 10.16 to the Company’s 1998 Annual  Report on Form 10-K (the “1998 10-K”)).                                                                                                                                                                                                                                                                                           |
| 10.9                 |   | Employment Letter,  dated June 10, 1999, between the Company and John K. Henry (incorporated  by reference to Exhibit 10.18 to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                      |
| 10.10                |   | 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).                                                                                                                                                                                                                                                                                                                                             |
| 10.11                |   | 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).                                                                                                                                                                                                                                                                       |
| 10.12                |   | 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).                                                                                                                                                                                                           |
| 10.13                |   | 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).                                                                                                                                                                                                                                                                               |
| 10.14                |   | 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).                                                                                                                                                                                                                                                |
| 10.15 *              |   | Third Amendment to the  1997 Equity Participation Plan, dated May 8, 2003                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.16 *              |   | Employment Letter,  dated June 24, 2003, between the Company and Timothy R. LaBeau                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.17 *              |   | 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. |
| 10.18 *              |   | Facility Guarantee,  dated as of July 21, 2003, among the Facility Guarantors, Fleet Retail  Finance Inc., Fleet National Bank and the Lenders.                                                                                                                                                                                                                                                                                                                                                                     |
| 10.19 *              |   | Intellectual Property  Security Agreement, dated as of July 21, 2003, between Duane Reade, the  Facility Guarantors and Fleet Retail Finance Inc., as Collateral Agent.                                                                                                                                                                                                                                                                                                                                             |
| 10.20 *              |   | Security Agreement,  dated as of July 21, 2003, among Duane Reade, the Facility Guarantors,  and Fleet Retail Finance Inc., as Collateral Agent.                                                                                                                                                                                                                                                                                                                                                                    |
| 10.21 *              |   | 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.                                                                                                                                                                                                                                                                                                                                                        |
| 21.1                 |   | Subsidiaries of the  Company (incorporated by reference to Exhibit 21.1 to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                          |

 

22

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| 23.0   |   | Consent of Independent  Accountants (incorporated by reference to Exhibit 23.0 to the Company’s  Annual Report on Form 10-K for the year ended December 28, 2002 (the  “2002 10-K”)). |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.0 * |   | Sarbanes-Oxley Section  302 Certifications of the Company’s CEO and CFO.                                                                                                                             |
| 32.0 * |   | Sarbanes-Oxley Section  906 Certifications of the Company’s CEO and CFO.                                                                                                                             |

 

----

*  filed herewith

 

(b)                                 Reportson Form 8-K:

 

On May 14, 2003, the Company filed a CurrentReport on Form 8-K which contained, as an exhibit, a press release providinginformation with respect to certain proposed New York State legislative changesand their potential impact, if enacted, on the Company’s financial results forthe 2003 fiscal year.

 

On July 3, 2003, the Company filed a CurrentReport on Form 8-K which contained, as an exhibit, a press release providinginformation with respect to the Company’s anticipated financial results for the13 weeks ended June 28, 2003.

 

On July 24, 2003, the Company filed a CurrentReport on Form 8-K which contained, as an exhibit, a press release providinginformation with respect to the Company’s financial results for the 13 and 26weeks ended June 28, 2003 and its outlook for the third quarter andremainder of the 2003 fiscal year.

 

(c)                                  FinancialStatement Schedules:                           None

 

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

 

23

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**SIGNATURES**

** **

Pursuantto the requirements 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: | August 11, 2003 |                 |
|--------|----------------------|----------------------|
|   |                 |                 |
|   |                 | **DUANE READE INC.** |
|   |                 | (Registrant)         |
|   |                 |                 |   |
|   |                 | By:                  | /s/ John K. Henry |   |
|   |                 |                 | Name: | John K. Henry |
|   |                 |                 | Title: | Senior Vice President  and Chief Financial Officer |
|        |                      |                      |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant in thecapacities indicated on August 11, 2003.

 
| **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) |

 

24

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**SIGNATURES**

** **

Pursuantto the requirements 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: | August 11, 2003 |           |
|--------|----------------------|----------------|
|   |                 |           |
|   |                 | **DRI I Inc.** |
|   |                 |           |   |
|   |                 | By:            | /s/ John K. Henry |   |
|   |                 |           | Name: | John K. Henry |
|   |                 |           | Title: | Senior Vice President  and Chief Financial Officer |
|        |                      |                |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed on August 11, 2003 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) |

 

25

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**SIGNATURES**

** **

Pursuantto the requirements 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: | August 11, 2003                                    |            |
|--------|---------------------------------------------------------|-----------------|
|   |                                                    |            |
|   |                                                    | **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 the requirements of the SecuritiesExchange Act of 1934, this report has been signed below on August 11, 2003by the following persons in the capacities indicated with respect to DuaneReade Inc. and DRI I Inc., the general partners of Duane Reade, on behalf ofDuane 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) |

 

26

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**SIGNATURES**

** **

Pursuantto the requirements 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: | August 11, 2003 |                         |
|--------|----------------------|------------------------------|
|   |                 |                         |
|   |                 | **DUANE READE REALTY, Inc.** |
|   |                 |                         |   |
|   |                 | By:                          | /s/ John K. Henry |   |
|   |                 |                         | Name: | John K. Henry |
|   |                 |                         | Title: | Senior Vice President  and Chief Financial Officer |
|        |                      |                              |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed on August 11, 2003 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) |

 

27

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**SIGNATURES**

** **

Pursuantto the requirements 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: | August 11, 2003 |                                |
|--------|----------------------|-------------------------------------|
|   |                 |                                |
|   |                 | **DUANE READE INTERNATIONAL, Inc.** |
|   |                 |                                |   |
|   |                 | By:                                 | /s/ John K. Henry |   |
|   |                 |                                | Name: | John K. Henry |
|   |                 |                                | Title: | Senior Vice President  and Chief Financial Officer |
|        |                      |                                     |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed on August 11, 2003 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) |

 

28

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