**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.**

**FORM 10-Q/A**

**Quarterly Report Pursuant to Section 13or 15 (d) of the Securities andExchange Act of 1934**
| **For the quarterly period ended September 25, 2004.** | **Commission  file number 001-13843** |
|-------------------------------------------------------------|---------------------------------------|

 

----

DUANE READE INC.

(Exact name of registrantas specified in its charter)

| DELAWARE                                                        | **04-3164702**            |
|-----------------------------------------------------------------|---------------------------|
| (State or other jurisdiction of  incorporation or organization) | (IRS Employer  ID Number) |
| **440  Ninth Avenue  New York, New York**                       | **10001**                 |
| (Address of principal executive offices)                        | (Zip Code)                |

 

**(212) 273-5700**

(Registrant’s telephonenumber, including area code)

----

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

Yes o  No x

Indicateby check mark whether the registrant is an accelerated filer (as defined in theExchange Act Rule 12b-2):

Yes o  No x

 

 

----

This Form 10-Q/A amends the Company’s quarterlyreport on Form 10-Q for the quarterly period ended September 25, 2004, as filedon November 15, 2004, to include adjustments to its previously filedconsolidated financial statements related to (i) lease accounting under theprovisions of FASB Technical Bulletin No. 85-3 (FTB 85-3), (ii) certaininventory resale activity under the provisions of Emerging Issues Task Forcerelease 99-19 (EITF 99-19) and (iii) the classification of outstandingborrowings under the revolving loan facility as current liabilities, ratherthan as long-term debt as previously reported, because cash receipts controlledby the lenders are used to reduce outstanding debt, and the Company does notmeet the criteria of Statement of Financial Accounting Standards No. 6“Classification of Short Term Obligations Expected to be Refinanced” (FAS 6),to reclassify the debt as long-term, as well as to reflect certain previouslyunrecorded and immaterial audit adjustments related to the periods affected.This Form 10-Q/A further amends the Company’s quarterlyreport on Form 10-Q for the fiscal quarter ended September 25, 2004 to includeadjustments to its previously filed consolidated statement of cash flows forthe first nine months of 2004 and 2003 to reflect the reporting of revolvingloan borrowings and repayments separately on a gross basis as required underStatement of Financial Accounting Standard No. 95 “Statement of Cash Flows” (FAS 95). In addition,this Form 10-Q/A amends the Company’s quarterly report on Form 10-Q for theperiod from July 31, 2004 through and as of September 25, 2004 to correct thelease accounting to reflect straight-line rent expense (for leases in effect onthe July 30, 2004 acquisition date) calculated from the date of the Company’sacquisition by Oak Hill rather than from the original lease commencement datesas previously recorded. This accounting treatment is required under theprovisions of Statement of Financial Accounting Standard No. 141 “BusinessCombinations (FAS 141). This adjusted lease accounting has no impact upon leasematurities, the timing of any lease payments or cash flows from past or futureoperating activities. It also amends the previously filed Form 10-Q to includein Part 1, Item 4, “Controls and Procedures,” the revised conclusion of theprincipal executive officer and principal financial officer regarding theeffectiveness of the Company’s disclosure controls and procedures as ofSeptember 25, 2004. No attempt has been made in this Form 10-Q/A to modify orupdate other disclosures as presented in the Form 10-Q except to conform tochanges as required by applicable law. For further information about the restatements,see “Item 2.—Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Restatements.”

**INDEX**
| PART I—FINANCIAL INFORMATION | 4                                                                                                                                                                                                                                                                                                                                                                             |
|----------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                   | ITEM 1.—FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                             | 4 |
|                                   | Consolidated Statements of Operations (Unaudited)—  For the period from July 31, 2004 through September 25, 2004 for  the Successor and the periods from June 27, 2004 through July 30,  2004 and December 28, 2003 through July 30, 2004 and the 13  Weeks and 39 Weeks Ended September 27, 2003 for the Predecessor (restated) | 4 |
|                                   | Consolidated Balance Sheets—  As of September 25, 2004 (Unaudited) for the Successor and  December 27, 2003 for the Predecessor (restated)                                                                                                                                                                                                                     | 5 |
|                                   | Consolidated Statements of Cash  Flows (Unaudited)—  For the period from July 30, 2004 through September 25, 2004 for  the Successor and the period from December 28, 2003 through  July 30, 2004 and the 39 Weeks Ended September 27, 2003 for the  Predecessor  (restated)                                                                    | 6 |
|                                   | Notes to Consolidated Financial Statements (Unaudited)                                                                                                                                                                                                                                                                                                                        | 7 |
|                                   | ITEM 2.—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND  RESULTS OF OPERATIONS                                                                                                                                                                                                                                                                      | 22 |
|                                   | ITEM 3.—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                                                                                                                                                                                                                                                  | 38 |
|                                   | ITEM 4.—CONTROLS AND PROCEDURES                                                                                                                                                                                                                                                                                                                                          | 39 |
| PART II—OTHER INFORMATION    | 40                                                                                                                                                                                                                                                                                                                                                                            |
| SIGNATURES                             | 47                                                                                                                                                                                                                                                                                                                                                                            |

 

----

**SPECIAL**NOTE REGARDING FORWARD-LOOKING STATEMENTS

This and other ofour public filings or public statements contain forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933, Section 21Eof the Securities Exchange Act of 1934 and the Private Securities LitigationReform Act of 1995, that involve a number of risks and uncertainties. Thesestatements relate to future events or our future financial performance withrespect to our financial condition, results of operations, business plans andstrategies, operating efficiencies or synergies, competitive positions, growthopportunities for existing products such as private label merchandise, plansand objectives of management, capital expenditures, growth and maturation ofour stores and other matters. These statements involve known and unknown risks,uncertainties and other factors that may cause our or our industry’s actualresults, levels of activity, performance or achievements to be materiallydifferent from those expressed or implied by any forward-looking statements. Insome cases, you can identify forward-looking statements by terminology such as “may,”“will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,”“estimate,” “predict,” “potential,” “pro forma,” “seek,” or “continue” or thenegative of those terms or other comparable terminology. These statements areonly predictions and such expectations may prove to be incorrect. Some of thethings that could cause our actual results to differ substantially from ourexpectations are:

·       thecompetitive environment in the drugstore industry in general and in the NewYork greater metropolitan area;

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

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

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

·       oursignificant indebtedness;

·       thestrength of the economy in general and the economic conditions in the New Yorkgreater metropolitan area, in particular, including changes in consumerpurchasing power and/or spending patterns;

·       changesin the cost of goods and services;

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

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

·       changesin federal and state laws and regulations, including the potential impact ofchanges in regulations surrounding the importation of pharmaceuticals fromforeign countries and changes in minimum wage rates;

·       liabilityand other claims asserted against us including the items discussed under Part II,Item 1-Legal Proceedings;

·       changesin our operating strategy or development plans;

2

----

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

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

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

·       thecontinued impact of, or new occurrences of, terrorist attacks in the New Yorkgreater metropolitan area and any actions that may be taken by federal, stateor municipal authorities in response to or in anticipation of such occurrences;

·       changesin our acquisition and capital expenditure plans;

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

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

·       ourability to limit fraud and shrink;

·       demographicchanges; and

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

We undertake no obligation to update or revise anyforward-looking statements, whether as a result of new information, futureevents or otherwise, after the date of this filing. We do not, nor does any otherperson, assume responsibility for the accuracy and completeness of thosestatements.

We caution you that the areas of risk described abovemay not be exhaustive. We operate in a continually changing businessenvironment, and new risks emerge from time to time. Management cannot predictsuch new risks, nor can it assess the impact, if any, of such risks on ourbusinesses or the extent to which any risk or combination of risks may causeactual results to differ materially from those projected in any forward-lookingstatements. In light of these risks, uncertainties and assumptions, you shouldkeep in mind that any forward-looking statement made in this filing might notoccur.

3

----

**PART I**—FINANCIALINFORMATIONITEM 1. FINANCIAL STATEMENTS

**Duane Reade Inc.Consolidated Statements of Operations (Unaudited)(In thousands)**
| ** **                                           | ** ** | **Successor  Restated**      | ** ** | **Predecessor—Restated** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **                                           | ** ** | **Period from**         | ** ** | **Period from**          | ** ** | **Three Months** | ** ** | **Period from** | ** ** | **Nine Months** | ** ** |
| ** **                                           | ** ** | **July 31, 2004**  | ** ** | **June 27, 2004**   | ** ** | **Ended** | ** ** | **Dec. 28, 2003** | ** ** | **Ended** | ** ** |
| ** **                                           | ** ** | **through**                  | ** ** | **through**                   | ** ** | **September 27,** | ** ** | **through** | ** ** | ** September 27, ** | ** ** |
| ** **                                           | ** ** | **Sept. 25, 2004** | ** ** | **July 30, 2004**   | ** ** | **2003** | ** ** | **July 30, 2004** | ** ** | **2003** | ** ** |
| Net sales                                            |       |                         | $          | 238,050                       |       |   |   | $ | 142,379 |   |   |   | $ | 356,944 |   |   |   | $ | 927,801 |   |   |   | $ | 1,081,832 |   |   |
| Cost of sales                                        |       |                         | 194,116    |                          |       |   | 115,557 |   |   |   | 284,389 |   |   |   | 745,090 |   |   |   | 861,405 |   |   |
| Gross profit                                         |       |                         | 43,934     |                          |       |   | 26,822 |   |   |   | 72,555 |   |   |   | 182,711 |   |   |   | 220,427 |   |   |
| Selling,  general & administrative expenses |       |                         | 37,418     |                          |       |   | 23,726 |   |   |   | 56,611 |   |   |   | 142,293 |   |   |   | 168,083 |   |   |
| Labor contingency  expense                           |       |                         | 689        |                          |       |   | 411 |   |   |   | — |   |   |   | 2,611 |   |   |   | — |   |   |
| Transaction  expense                                 |       |                         | 37,118     |                          |       |   | 386 |   |   |   | — |   |   |   | 3,005 |   |   |   | — |   |   |
| Depreciation and  amortization                       |       |                         | 7,280      |                          |       |   | 3,596 |   |   |   | 8,162 |   |   |   | 21,902 |   |   |   | 23,874 |   |   |
| Store pre-opening  expenses                          |       |                         | 366        |                          |       |   | 105 |   |   |   | 154 |   |   |   | 470 |   |   |   | 798 |   |   |
| Other                                                |       |                         | 25,291     |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                                                 |       |                         | 108,162    |                          |       |   | 28,224 |   |   |   | 64,927 |   |   |   | 170,281 |   |   |   | 192,755 |   |   |
| Operating (loss)  income                             |       |                         | (64,228    | )                             |       |   | (1,402 | ) |   |   | 7,628 |   |   |   | 12,430 |   |   |   | 27,672 |   |   |
| Interest expense,  net                               |       |                         | 6,283      |                          |       |   | 1,283 |   |   |   | 3,386 |   |   |   | 7,977 |   |   |   | 10,452 |   |   |
| Debt  extinguishment                                 |       |                         | —     |                          |       |   | — |   |   |   | 707 |   |   |   | — |   |   |   | 812 |   |   |
| (Loss) income before income taxes                    |       |                         | (70,511    | )                             |       |   | (2,685 | ) |   |   | 3,535 |   |   |   | 4,453 |   |   |   | 16,408 |   |   |
| Income tax  (benefit) provision                      |       |                         | (32,473    | )                             |       |   | (1,714 | ) |   |   | 1,558 |   |   |   | 1,136 |   |   |   | 7,225 |   |   |
| Net (loss) income                                    |       |                         | $          | (38,038                       | )          |   |   | $ | (971 | ) |   |   | $ | 1,977 |   |   |   | $ | 3,317 |   |   |   | $ | 9,183 |   |   |

 

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

4

----

**Duane Reade Inc.Consolidated Balance Sheets(In thousands, except share and per share data)**
| ** **                                                                                                       | ** ** | **Successor**          | ** ** | **Predecessor**       | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                       | ** ** | **Restated**           | ** ** | **Restated**          | ** ** |
| ** **                                                                                                       | ** ** | **September 25,** | ** ** | **December 27,** | ** ** |
| ** **                                                                                                       | ** ** | **2004**               | ** ** | **2003**              | ** ** |
| ** **                                                                                                       | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| ASSETS                                                                                                           |       |                   |       |                  |       |   |   |   |   |
| Current Assets                                                                                                   |       |                   |       |                  |       |   |   |   |   |
| Cash                                                                                                             |       |                   | $          | 1,377                 |       |   |   | $ | 1,252 |   |   |
| Receivables, net                                                                                                 |       |                   | 55,461     |                  |       |   | 53,430 |   |   |
| Inventories, net                                                                                                 |       |                   | 271,101    |                  |       |   | 258,139 |   |   |
| Deferred income  taxes                                                                                           |       |                   | 22,454     |                  |       |   | 10,811 |   |   |
| Prepaid expenses  and other current assets                                                                       |       |                   | 19,224     |                  |       |   | 20,263 |   |   |
| TOTAL CURRENT  ASSETS                                                                                            |       |                   | 369,617    |                  |       |   | 343,895 |   |   |
| Property and  equipment, net                                                                                     |       |                   | 227,025    |                  |       |   | 189,469 |   |   |
| Goodwill, net                                                                                                    |       |                   | 116,875    |                  |       |   | 161,318 |   |   |
| Deferred income  taxes                                                                                           |       |                   | —     |                  |       |   | 13,854 |   |   |
| Other assets                                                                                                     |       |                   | 254,224    |                  |       |   | 88,836 |   |   |
| TOTAL ASSETS                                                                                                     |       |                   | $          | 967,741               |       |   |   | $ | 797,372 |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                       |       |                   |       |                  |       |   |   |   |   |
| Current liabilities                                                                                              |       |                   |       |                  |       |   |   |   |   |
| Accounts payable                                                                                                 |       |                   | $          | 80,323                |       |   |   | $ | 85,528 |   |   |
| Accrued interest                                                                                                 |       |                   | 3,839      |                  |       |   | 1,633 |   |   |
| Other accrued  expenses                                                                                          |       |                   | 56,639     |                  |       |   | 30,086 |   |   |
| Current portion of debt                                                                                          |       |                   | 152,939    |                  |       |   | 70,353 |   |   |
| Current portion of  capital lease obligations                                                                    |       |                   | 762        |                  |       |   | 422 |   |   |
| TOTAL CURRENT  LIABILITIES                                                                                       |       |                   | 294,502    |                  |       |   | 188,022 |   |   |
| Long-term debt                                                                                                   |       |                   | 350,032    |                  |       |   | 201,032 |   |   |
| Capital lease  obligations, less current portion                                                                 |       |                   | 2,209      |                  |       |   | 1,103 |   |   |
| Deferred income taxes                                                                                            |       |                   | 70,299     |                  |       |   | — |   |   |
| Other non-current  liabilities                                                                                   |       |                   | 49,239     |                  |       |   | 79,954 |   |   |
| TOTAL LIABILITIES                                                                                                |       |                   | 766,281    |                  |       |   | 470,111 |   |   |
| Commitments and Contingencies (Note 10)                                                                          |       |                   |       |                  |       |   |   |   |   |
| Stockholders’ equity                                                                                        |       |                   |       |                  |       |   |   |   |   |
| Preferred stock,  $0.01 par; authorized 5,000,000 shares; issued and outstanding: none  (Predecessor)            |       |                   |       |                  |       |   | — |   |   |
| Series A  preferred stock, $0.01 par; authorized 75,000 shares; issued and outstanding:  none (Predecessor) |       |                   |       |                  |       |   | — |   |   |
| Common stock,  $0.01 par; authorized 75,000,000 shares; issued and outstanding: 24,403,550  shares (Predecessor) |       |                   |       |                  |       |   | 244 |   |   |
| Preferred  stock, $0.01 par; authorized 50,000 shares; issued and outstanding: none  (Successor)                 |       |                   | —     |                  |       |   |   |   |   |
| Common stock,  $0.01 par; authorized 2,950,000 shares; issued and outstanding: 2,594,977  shares (Successor)     |       |                   | 26         |                  |       |   |   |   |   |
| Additional paid-in  capital                                                                                      |       |                   | 239,472    |                  |       |   | 331,917 |   |   |
| Retained deficit                                                                                                 |       |                   | (38,038    | )                     |       |   | (4,900 | ) |   |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                 |       |                   | 201,460    |                  |       |   | 327,261 |   |   |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                 |       |                   | $          | 967,741               |       |   |   | $ | 797,372 |   |   |

 

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

5

----

**Duane Reade Inc.Consolidated Statements of Cash Flows (Unaudited)(In thousands)**
| ** **                                                                                          | ** ** | **Successor**                | ** ** | ** **                    | ** ** | ** **             | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-------------------------------|------------|------------------------|------------|
| ** **                                                                                          | ** ** | **Restated**                 | ** ** | **Predecessor—Restated** | ** ** |
| ** **                                                                                          | ** ** | **Period from**         | ** ** | **Period from**          | ** ** | **Nine Months**   | ** ** |
| ** **                                                                                          | ** ** | **July 31, 2004**  | ** ** | **Dec. 28, 2003**   | ** ** | **Ended**              | ** ** |
| ** **                                                                                          | ** ** | **through**                  | ** ** | **through**                   | ** ** | **September 27,** | ** ** |
| ** **                                                                                          | ** ** | **Sept. 25, 2004** | ** ** | **July 30, 2004**   | ** ** | **2003**               | ** ** |
| Cash flows (used in) provided by operating  activities:                                             |       |                         |       |                          |       |                   |       |   |   |   |   |   |   |
| Net (loss) income                                                                                   |       |                         | $          | (38,038                       | )          |                   |       | $ | 3,317 |   |   |   | $ | 9,183 |   |   |
| Adjustments to reconcile  net (loss) income to net cash (used in) provided by operating activities: |       |                         |       |                          |       |                   |       |   |   |   |   |   |   |
| Depreciation and  amortization                                                                      |       |                         | 8,011      |                          |       |                   | 23,003     |   |   |   | 25,333 |   |   |
| Deferred income  taxes                                                                              |       |                         | (32,473    | )                             |       |                   | 5,900      |   |   |   | 5,798 |   |   |
| Debt  extinguishment                                                                                |       |                         |       |                          |       |                   | —     |   |   |   | 730 |   |   |
| Non-cash rent  expense                                                                              |       |                         | 2,488      |                          |       |                   | 4,383      |   |   |   | 6,813 |   |   |
| Changes in operating  assets and liabilities (net of the effect of acquisitions):                   |       |                         |       |                          |       |                   |       |   |   |   |   |   |   |
| Receivables                                                                                         |       |                         | 1,026      |                          |       |                   | (3,057     | ) |   |   | (1,117 | ) |   |
| Inventories                                                                                         |       |                         | (7,521     | )                             |       |                   | 4,385      |   |   |   | (23,851 | ) |   |
| Accounts payable                                                                                    |       |                         | 14,842     |                          |       |                   | (20,047    | ) |   |   | 12,261 |   |   |
| Prepaid and  accrued expenses                                                                       |       |                         | 27,540     |                          |       |                   | 747        |   |   |   | 174 |   |   |
| Other assets and  liabilities, net                                                                  |       |                         | 2,129      |                          |       |                   | 2,921      |   |   |   | (5,560 | ) |   |
| NET CASH (USED IN)  PROVIDED BY OPERATING ACTIVITIES                                                |       |                         | (21,996    | )                             |       |                   | 21,552     |   |   |   | 29,764 |   |   |
| Cash flows used in investing activities:                                                            |       |                         |       |                          |       |                   |       |   |   |   |   |   |   |
| Capital expenditures                                                                                |       |                         | (4,571     | )                             |       |                   | (17,552    | ) |   |   | (34,523 | ) |   |
| Lease acquisition,  customer file and other costs                                                   |       |                         | (7,633     | )                             |       |                   | (14,925    | ) |   |   | (11,261 | ) |   |
| Purchase of Duane  Reade                                                                            |       |                         | (413,684   | )                             |       |                   | —     |   |   |   | — |   |   |
| NET CASH USED IN  INVESTING ACTIVITIES                                                              |       |                         | (425,888   | )                             |       |                   | (32,477    | ) |   |   | (45,784 | ) |   |
| Cash flows from financing activities:                                                               |       |                         |       |                          |       |                   |       |   |   |   |   |   |   |
| Proceeds from Term  Loan                                                                            |       |                         | 155,000    |                          |       |                   | —     |   |   |   | — |   |   |
| Proceeds from  Senior Notes                                                                         |       |                         | 195,000    |                          |       |                   | —     |   |   |   | — |   |   |
| Repurchase of  Convertible Notes                                                                    |       |                         | (201,000   | )                             |       |                   | —     |   |   |   | — |   |   |
| Proceeds from sale  of common stock                                                                 |       |                         | 239,498    |                          |       |                   | —     |   |   |   | — |   |   |
| Repayment of term  notes                                                                            |       |                         | —     |                          |       |                   | —     |   |   |   | (65,091 | ) |   |
| Retirement of  senior subordinated notes                                                            |       |                         | —     |                          |       |                   | —     |   |   |   | (1,621 | ) |   |
| Borrowings from revolving credit facility                                                           |       |                         | 415,047    |                          |       |                   | 941,503    |   |   |   | 554,463 |   |   |
| Repayments of revolving credit facility                                                             |       |                         | (343,453   | )                             |       |                   | (930,511   | ) |   |   | (472,047 | ) |   |
| Proceeds from  exercise of stock options                                                            |       |                         | —     |                          |       |                   | 1,126      |   |   |   | — |   |   |
| Deferred financing  costs                                                                           |       |                         | (12,049    | )                             |       |                   | (841       | ) |   |   | (2,191 | ) |   |
| Repayments of  capital lease obligations                                                            |       |                         | (120       | )                             |       |                   | (266       | ) |   |   | (373 | ) |   |
| NET CASH PROVIDED  BY FINANCING ACTIVITIES                                                     |       |                         | 447,923    |                          |       |                   | 11,011     |   |   |   | 13,140 |   |   |
| Net increase  (decrease) in cash                                                                    |       |                         | 39         |                          |       |                   | 86         |   |   |   | (2,880 | ) |   |
| Cash at beginning  of period                                                                        |       |                         | 1,338      |                          |       |                   | 1,252      |   |   |   | 4,183 |   |   |
| Cash at end of  period                                                                              |       |                         | $          | 1,377                         |       |                   |       | $ | 1,338 |   |   |   | $ | 1,303 |   |   |

 

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

6

----

**Notesto Unaudited Consolidated Interim Financial Statements**(dollars in thousands, except per share data)

**1.   Basis of Presentation**

On July 30, 2004, Duane Reade Inc. was acquiredthrough a merger transaction with Duane Reade Acquisition Corp. (“Duane ReadeAcquisition”), a wholly owned subsidiary of Duane Reade Holdings, Inc. andan affiliate of Oak Hill Capital Partners, L.P. (“Oak Hill”), a private equityfirm (the “Acquisition”). The Acquisition was accomplished through the mergerof Duane Reade Acquisition into Duane Reade Inc., with Duane Reade Inc. beingthe surviving entity.

The accompanying financial statements designated asthe “Successor” are the financial statements of Duane Reade Inc. andsubsidiaries for periods subsequent to July 30, 2004. Although Duane ReadeInc. was the legal entity that remained after the Acquisition, all financialstatements for periods prior to and including July 30, 2004, the date ofthe Acquisition, are referred to as the financial statements of the “Predecessor.”The “Company” refers to the operations of Duane Reade Inc. and subsidiaries forboth the Predecessor and Successor periods.

The Acquisition was accounted for in accordance withthe purchase method of accounting. Accordingly, the purchase price of theAcquisition has been allocated to identifiable assets acquired and liabilitiesassumed based upon their estimated fair values at the acquisition date. Thisallocation is preliminary and includes a number of estimates which, uponfurther evaluation, may require modification.

The Unaudited Consolidated Interim FinancialStatements included herein reflect all adjustments which, in the opinion ofmanagement, are necessary to present fairly the results of operations,financial position and cash flows of Duane Reade Inc. (the “Company”), and havebeen prepared, in all material respects, in accordance with the same accountingprinciples followed in the preparation of the Predecessor’s Annual ConsolidatedFinancial Statements for the year ended December 27, 2003. These UnauditedConsolidated Interim Financial Statements should be read in conjunction withthe Predecessor’s Consolidated Financial Statements included in its AnnualReport on Form 10-K, as amended to date, for the year ended December 27,2003. The Unaudited Consolidated Interim Financial Statements include theaccounts of the Company and its subsidiaries. All significant intercompanytransactions and balances have been eliminated. The results for the interimperiods presented are not necessarily indicative of the results expected forthe full year.

The Company has no assetsor operations other than its investment in its subsidiaries, each of which,other than Duane Reade, a New York general partnership which is the Companys’principal operating company and of which the Company is a general partner (“DuaneReade GP”), is a guarantor of the Company’s various debt instruments. DuaneReade GP is a co-obligor under each of the Company’s debt facilities.Accordingly, the Unaudited Consolidated Interim Financial Statements presentthe consolidated assets and operations of the subsidiary guarantors. Theguarantees of the subsidiary guarantors, which relate to the Company’sobligations under its debt and credit agreements, are full and unconditional,joint and several.

****

**2.   Restatements**

The Company has restatedits consolidated financial statements to conform certain accounting practicesto the following accounting requirements:

1.     Leaseaccounting under FASB Technical Bulletin No. 85-3 (FTB 85-3)

2.     Acquisitionlease accounting under FASB No. 141 “Business Combinations”

7

----

3.     Grossversus net sales and cost of sales accounting under Emerging Issues Task ForceRelease 99-19 (EITF 99-19)

4.     Balancesheet classification of outstanding borrowings under the revolving loanfacility because cash receipts controlled by the lenders are used to reduceoutstanding debt, and the Company does not meet the criteria under FASB No. 6“Classification of Short-Term Obligations Expected to be Refinanced” (FAS 6) toreclassify the debt as long-term

5.     Reportingof revolving loan facility borrowings and repayments under FASB No. 95“Statement of Cash Flows” (FAS 95)

6.     Restatementsto include certain previously unrecorded and immaterial audit adjustmentsrelated to the periods affected.

In connection with these restatements, the Companyobtained from the administrative agent under the amended asset-based revolvingloan facility, an acknowledgement confirming that these restatements do notconstitute an event of technical default, as defined in the document governingthe amended asset-based revolving loan facility.

Based upon a review of the Company’s leaseaccounting methods the Company determined that its previous policy ofcommencing rent expense when a store opens (and not at the commencement of thelease) was inconsistent with FTB 85-3. For construction purposes, the Companyoften takes possession of leased properties prior to opening. In accordancewith FTB 85-3, the Company will record rent expense commencing on the date ofpossession. In accordance with the provisions of FAS 141, the Company hasrestated reported balance sheet liabilities, goodwill and results ofoperations, cost of sales and selling, general and administrative expenses tocorrect the lease accounting to reflect straight-line rent expense (for leasesin effect on the July 30, 2004 acquisition date) calculated from the date ofthe Company’s acquisition by Oak Hill rather than from the original leasecommencement dates as previously recorded. This adjusted lease accounting hasno impact upon lease maturities, the timing of any lease payments or cash flowsfrom past or future operating activities. The Company is restating itspreviously issued financial statements to reflect certain resales of retailinventory on a gross revenue and cost of sales basis in accordance with EITF99-19, rather than on a net basis as previously reported. The Company isrestating its previously reported balance sheets for September 25, 2004 andDecember 27, 2003 to reflect the classification of outstanding borrowings underthe revolving loan facility as current liabilities rather than as long-termdebt, as previously reported. The change is being made because cash receiptscontrolled by the lenders are used to reduce outstanding debt, and the Companydoes not meet the criteria of FAS 6 to reclassify the debt as long-term. Thisis not an indication that this credit facility is expected to be retired withinthe next year. This facility expires in July 2008 and the Company intends tocontinue to access it for its working capital needs throughout the remainingterm. The Company has also restated its consolidated statements of cash flowsfor the successor period from July 31, 2004 through September 25, 2004 and thepredecessor periods from December 28, 2003 through July 30, 2004 and the firstnine months of fiscal 2003 to reflect the reporting of revolving loan facilityborrowings and repayments separately on a gross basis as required under FAS 95.The effect of these restatements on the consolidated financial statements for thesuccessor period from July 31, 2004 through September 25, 2004 and thepredecessor periods from June 27, 2004 through July 30, 2004, from December 28,2003 through July 30, 2004 and the thirteen and thirty-nine weeks endedSeptember 27, 2003 is shown below. The Company has identified the source of therestatements from lease accounting (FTB 85-3), acquisition lease accounting(FAS 141), gross sales and cost of sales (EITF 99-19), classification ofoutstanding borrowings under the revolving loan facility (FAS 6), reporting of revolving borrowings and payments(FAS 95) and other previously unrecorded and immaterial adjustments (Other).

8

----

**Duane Reade Inc.Consolidated Profit & Loss Restatement(in thousands)**
| ** **                                    | ** ** | ** **                 | ** ** | **Successor**                    | ** ** | ** ** | **Predecessor**                  | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|----------------------------------|------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | ** **                 | ** ** | ** Period from ** | ** ** | ** ** | ** Period from ** | ** ** | ** Period from ** | ** ** | **For the  13** | ** ** | **For the  39** | ** ** |
| ** **                                    | ** ** | ** **                 | ** ** | **7/31/04**                      | ** ** | ** ** | **6/27/04**                      | ** ** | **12/28/03** | ** ** | **Weeks** | ** ** | **Weeks** | ** ** |
| ** **                                    | ** ** | ** **                 | ** ** | **through**                      | ** ** | ** ** | **through**                      | ** ** | **through** | ** ** | **Ended** | ** ** | **Ended** | ** ** |
| ** **                                    | ** ** | ** **                 | ** ** | **9/25/04**                      | ** ** | ** ** | **7/30/04**                      | ** ** | **7/30/04** | ** ** | **9/27/03** | ** ** | **9/27/03** | ** ** |
| Sales                                         |       | as reported                |       |                             | $          | 217,556    |                             |       |   |   | $ | 132,085 |   |   |   | $ | 846,841 |   |   | $ | 338,630 |   | $ | 1,027,398 |   |
|                                          |       | adjustment—EITF 99-19 |       |                             | 20,494     |       |                             |       |   | 10,294 |   |   |   | 80,960 |   |   | 18,314 |   | 54,434 |   |
|                                          |       | as restated                |       |                             | $          | 238,050    |                             |       |   |   | $ | 142,379 |   |   |   | $ | 927,801 |   |   | $ | 356,944 |   | $ | 1,081,832 |   |
| Cost of Sales                                 |       | as reported                |       |                             | $          | 172,765    |                             |       |   |   | $ | 104,421 |   |   |   | $ | 663,224 |   |   | $ | 266,520 |   | $ | 808,124 |   |
|                                          |       | adjustment—EITF 99-19 |       |                             | 20,494     |       |                             |       |   | 10,294 |   |   |   | 80,960 |   |   | 18,314 |   | 54,434 |   |
|                                          |       | adjustment—FTB 85-3   |       |                             | 308        |       |                             |       |   | 217 |   |   |   | 977 |   |   | 129 |   | 935 |   |
|                                          |       | adjustment—FAS 141    |       |                             | 865        |       |                             |       |   | — |   |   |   | — |   |   | — |   | — |   |
|                                          |       | adjustment—Other      |       |                             | (316       | )          |                             |       |   | 625 |   |   |   | (71 | ) |   | (574 | ) | (2,088 | ) |
|                                          |       | as restated                |       |                             | $          | 194,116    |                             |       |   |   | $ | 115,557 |   |   |   | $ | 745,090 |   |   | $ | 284,389 |   | $ | 861,405 |   |
| Gross Profit                                  |       | as reported                |       |                             | $          | 44,791     |                             |       |   |   | $ | 27,664 |   |   |   | $ | 183,617 |   |   | $ | 72,110 |   | $ | 219,274 |   |
|                                          |       | adjustment—FTB 85-3   |       |                             | (308       | )          |                             |       |   | (217 | ) |   |   | (977 | ) |   | (129 | ) | (935 | ) |
|                                          |       | adjustment—FAS 141    |       |                             | (865       | )          |                             |       |   | — |   |   |   | — |   |   | — |   | — |   |
|                                          |       | adjustment—Other      |       |                             | 316        |       |                             |       |   | (625 | ) |   |   | 71 |   |   | 574 |   | 2,088 |   |
|                                          |       | as restated                |       |                             | $          | 43,934     |                             |       |   |   | $ | 26,822 |   |   |   | $ | 182,711 |   |   | $ | 72,555 |   | $ | 220,427 |   |
| Selling, general and administrative  expenses |       | as reported                |       |                             | $          | 37,355     |                             |       |   |   | $ | 23,726 |   |   |   | $ | 142,293 |   |   | $ | 56,296 |   | $ | 167,130 |   |
|                                          |       | adjustment—FAS 141    |       |                             | 63         |       |                             |       |   | — |   |   |   | — |   |   | — |   | — |   |
|                                          |       | adjustment—Other      |       |                             | —     |       |                             |       |   | — |   |   |   | — |   |   | 315 |   | 953 |   |
|                                          |       | as restated                |       |                             | $          | 37,418     |                             |       |   |   | $ | 23,726 |   |   |   | $ | 142,293 |   |   | $ | 56,611 |   | $ | 168,083 |   |
| Earnings before tax                           |       | as reported                |       |                             | $          | (69,591    | )                                |       |   |   | $ | (1,843 | ) |   |   | $ | 5,360 |   |   | $ | 3,405 |   | $ | 16,208 |   |
|                                          |       | adjustment                 |       |                             | (920       | )          |                             |       |   | (842 | ) |   |   | (907 | ) |   | 130 |   | 200 |   |
|                                          |       | as restated                |       |                             | $          | (70,511    | )                                |       |   |   | $ | (2,685 | ) |   |   | $ | 4,453 |   |   | $ | 3,535 |   | $ | 16,408 |   |
| Income tax provision                          |       | as reported                |       |                             | $          | (32,048    | )                                |       |   |   | $ | (1,325 | ) |   |   | $ | 1,555 |   |   | $ | 1,499 |   | $ | 7,132 |   |
|                                          |       | adjustment                 |       |                             | (425       | )          |                             |       |   | (389 | ) |   |   | (419 | ) |   | 59 |   | 93 |   |
|                                          |       | as restated                |       |                             | $          | (32,473    | )                                |       |   |   | $ | (1,714 | ) |   |   | $ | 1,136 |   |   | $ | 1,558 |   | $ | 7,225 |   |
| Net income                                    |       | as reported                |       |                             | $          | (37,543    | )                                |       |   |   | $ | (518 | ) |   |   | $ | 3,805 |   |   | $ | 1,906 |   | $ | 9,076 |   |
|                                          |       | adjustment                 |       |                             | (495       | )          |                             |       |   | (453 | ) |   |   | (488 | ) |   | 71 |   | 107 |   |
|                                          |       | as restated                |       |                             | $          | (38,038    | )                                |       |   |   | $ | (971 | ) |   |   | $ | 3,317 |   |   | $ | 1,977 |   | $ | 9,183 |   |

 

9

----

**Duane Reade Inc.Consolidated Balance SheetRestatement(in thousands)**
| ** **                                         | ** ** | **Successor**                                    | ** ** | **Predecessor**                                 | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                         | ** ** | **As at September 25, 2004** | ** ** | **As at December 27, 2003** | ** ** |
| **Caption affected by restatement** | ** ** | ** **                                       | ** ** | **As Reported**                            | ** ** | ** Adjustment ** | ** ** | **As Restated** | ** ** | **As Reported** | ** ** | ** Adjustment ** | ** ** | ** As Restated ** | ** ** |
| Receivables                                        |       |                                             | $          | 56,686                                          |       |   | $ | (1,225 | ) | $ | 55,461 |   |   | $ | 53,689 |   |   |   | $ | (259 | ) |   |   | $ | 53,430 |   |   |
| Inventory                                          |       |                                             | 264,064    |                                            |       | 7,037 |   | 271,101 |   |   | 259,765 |   |   |   | (1,626 | ) |   |   | 258,139 |   |   |
| Current portion  of deferred income taxes          |       |                                             | 20,590     |                                            |       | 1,864 |   | 22,454 |   |   | 8,150 |   |   |   | 2,661 |   |   |   | 10,811 |   |   |
| Prepaid &  other current   assets         |       |                                             | 19,224     |                                            |       | — |   | 19,224 |   |   | 19,504 |   |   |   | 759 |   |   |   | 20,263 |   |   |
| Total current  assets                              |       |                                             | 361,941    |                                            |       | 7,676 |   | 369,617 |   |   | 342,360 |   |   |   | 1,535 |   |   |   | 343,895 |   |   |
| Property &  equipment, net                |       |                                             | 194,809    |                                            |       | 32,216 |   | 227,025 |   |   | 189,469 |   |   |   | — |   |   |   | 189,469 |   |   |
| Goodwill, net                                      |       |                                             | 188,892    |                                            |       | (72,017 | ) | 116,875 |   |   | 161,318 |   |   |   | — |   |   |   | 161,318 |   |   |
| Deferred income  taxes                             |       |                                             | —     |                                            |       | — |   | — |   |   | 5,543 |   |   |   | 8,311 |   |   |   | 13,854 |   |   |
| Other assets                                       |       |                                             | 217,508    |                                            |       | 36,716 |   | 254,224 |   |   | 88,836 |   |   |   | — |   |   |   | 88,836 |   |   |
| Total assets                                       |       |                                             | $          | 963,150                                         |       |   | $ | 4,591 |   | $ | 967,741 |   |   | $ | 787,526 |   |   |   | $ | 9,846 |   |   |   | $ | 797,372 |   |   |
| Accounts payable                                   |       |                                             | $          | 80,323                                          |       |   | $ | — |   | $ | 80,323 |   |   | $ | 85,258 |   |   |   | $ | 270 |   |   |   | $ | 85,528 |   |   |
| Accrued expenses                                   |       |                                             | 63,747     |                                            |       | (7,108 | ) | 56,639 |   |   | 27,489 |   |   |   | 2,597 |   |   |   | 30,086 |   |   |
| Current portion of debt                            |       |                                             | —     |                                            |       | 152,939 |   | 152,939 |   |   | — |   |   |   | 70,353 |   |   |   | 70,353 |   |   |
| Total current  liabilities                         |       |                                             | 148,671    |                                            |       | 145,831 |   | 294,502 |   |   | 114,802 |   |   |   | 73,220 |   |   |   | 188,022 |   |   |
| Long-term debt                                     |       |                                             | 502,971    |                                            |       | (152,939 | ) | 350,032 |   |   | 271,385 |   |   |   | (70,353 | ) |   |   | 201,032 |   |   |
| Deferred income  taxes                             |       |                                             | 17,196     |                                            |       | 53,103 |   | 70,299 |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Other noncurrent  liabilities                      |       |                                             | 90,149     |                                            |       | (40,910 | ) | 49,239 |   |   | 62,915 |   |   |   | 17,039 |   |   |   | 79,954 |   |   |
| Total liabilities                                  |       |                                             | $          | 761,196                                         |       |   | $ | 5,085 |   | $ | 766,281 |   |   | $ | 450,205 |   |   |   | $ | 19,906 |   |   |   | $ | 470,111 |   |   |
| Retained earnings                                  |       |                                             | $          | (37,543                                         | )          |   | $ | (494 | ) | $ | (38,038 | ) |   | $ | 5,160 |   |   |   | $ | (10,060 | ) |   |   | $ | (4,900 | ) |   |
| Total  stockholders’ equity                   |       |                                             | $          | 201,954                                         |       |   | $ | (494 | ) | $ | 201,460 |   |   | $ | 337,321 |   |   |   | $ | (10,060 | ) |   |   | $ | 327,261 |   |   |
| Total liabilities and  stockholders’ equity   |       |                                             | $          | 963,150                                         |       |   | $ | 4,591 |   | $ | 967,741 |   |   | $ | 787,526 |   |   |   | $ | 9,846 |   |   |   | $ | 797,372 |   |   |
|                                                    |            |                                                  |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The adjustments to other noncurrent liabilities andnoncurrent deferred income taxes relate to lease accounting under FAS 141 and FTB 85-3. The adjustments to debt relate to theclassification of the revolving loan balance as a current liability asdiscussed above. All other balance sheet adjustments relate topurchase price accounting and otherpreviously unrecorded andimmaterial adjustments.

10

----

**Duane Reade Inc.Consolidated Cash Flow Restatement(in thousands)**
| ** **                                                | ** ** | ** **  | ** ** | **Successor**        | ** ** | ** ** | **Predecessor**      | ** ** |
|-----------------------------------------------------------|------------|-------------|------------|----------------------|------------|------------|----------------------|------------|
| ** **                                                | ** ** | ** **  | ** ** | **Period from** | ** ** | ** ** | **Period from** | ** ** | **For the 39** | ** ** |
| ** **                                                | ** ** | ** **  | ** ** | **7/31/04**          | ** ** | ** ** | **12/28/03**         | ** ** | ** Weeks ** | ** ** |
| ** **                                                | ** ** | ** **  | ** ** | **through**          | ** ** | ** ** | **through**          | ** ** | **Ended** | ** ** |
| ** **                                                | ** ** | ** **  | ** ** | **9/25/04**          | ** ** | ** ** | **7/30/04**          | ** ** | **9/27/03** | ** ** |
| Net income                                                |       | as reported |       | $                    | (37,543    | )          |                 | $          | 3,805 |   | $ | 9,076 |   |
|                                                      |       | adjustment  |       | (495                 | )          |       | (488                 | )          | 107 |   |
|                                                      |       | as restated |       | $                    | (38,038    | )          |                 | $          | 3,317 |   | $ | 9,183 |   |
| Deferred income taxes                                     |       | as reported |       | $                    | (32,045    | )          |                 | $          | 1,480 |   | $ | 5,706 |   |
|                                                      |       | adjustment  |       | (428                 | )          |       | 4,420                |       | 92 |   |
|                                                      |       | as restated |       | $                    | (32,473    | )          |                 | $          | 5,900 |   | $ | 5,798 |   |
| Non-cash rent expense and other                           |       | as reported |       | $                    | 1,252      |       |                 | $          | 3,406 |   | $ | 7,110 |   |
|                                                      |       | adjustment  |       | 1,236                |       |       | 977                  |       | 433 |   |
|                                                      |       | as restated |       | $                    | 2,488      |       |                 | $          | 4,383 |   | $ | 7,543 |   |
| Receivables                                               |       | as reported |       | $                    | (2,523     | )          |                 | $          | (474 | ) | $ | (1,117 | ) |
|                                                      |       | adjustment  |       | 3,549                |       |       | (2,583               | )          | — |   |
|                                                      |       | as restated |       | $                    | 1,026      |       |                 | $          | (3,057 | ) | $ | (1,117 | ) |
| Inventories                                               |       | as reported |       | $                    | (6,567     | )          |                 | $          | 4,015 |   | $ | (22,767 | ) |
|                                                      |       | adjustment  |       | (954                 | )          |       | 370                  |       | (1,084 | ) |
|                                                      |       | as restated |       | $                    | (7,521     | )          |                 | $          | 4,385 |   | $ | (23,851 | ) |
| Accounts payable                                          |       | as reported |       | $                    | 14,842     |       |                 | $          | (19,777 | ) | $ | 12,057 |   |
|                                                      |       | adjustment  |       | —               |       |       | (270                 | )          | 204 |   |
|                                                      |       | as restated |       | $                    | 14,842     |       |                 | $          | (20,047 | ) | $ | 12,261 |   |
| Prepaid and accrued expenses                              |       | as reported |       | $                    | 27,207     |       |                 | $          | 6,492 |   | $ | (259 | ) |
|                                                      |       | adjustment  |       | 333                  |       |       | (5,745               | )          | 433 |   |
|                                                      |       | as restated |       | $                    | 27,540     |       |                 | $          | 747 |   | $ | 174 |   |
| Other assets and liabilities, net                         |       | as reported |       | $                    | 5,372      |       |                 | $          | (400 | ) | $ | (5,375 | ) |
|                                                      |       | adjustment  |       | (3,243               | )          |       | 3,321                |       | (185 | ) |
|                                                      |       | as restated |       | $                    | 2,129      |       |                 | $          | 2,921 |   | $ | (5,560 | ) |
| Net borrowings  (repayments) on revolving credit facility |       | as reported |       | $                    | 71,594     |       |                 | $          | 10,992 |   | $ | 82,416 |   |
|                                                      |       | adjustment  |       | (71,594              | )          |       | (10,992              | )          | (82,416 | ) |
|                                                      |       | as restated |       | $                    | —     |       |                 | $          | — |   | $ | — |   |
| Borrowings from revolving  credit facility                |       | as reported |       | $                    | —     |       |                 | $          | — |   | $ | — |   |
|                                                      |       | adjustment  |       | 415,047              |       |       | 941,503              |       | 554,463 |   |
|                                                      |       | as restated |       | $                    | 415,047    |       |                 | $          | 941,503 |   | $ | 554,463 |   |
| Repayments of revolving  credit facility                  |       | as reported |       | $                    | —     |       |                 | $          | — |   | $ | — |   |
|                                                      |       | adjustment  |       | (343,453             | )          |       | (930,511             | )          | (472,047 | ) |
|                                                      |       | as restated |       | $                    | (343,453   | )          |                 | $          | (930,511 | ) | $ | (472,047 | ) |

 

11

----

**3.   Acquisitionby Oak Hill Capital Partners, L.P.**

At the special meeting of the Company’s stockholdersheld on July 26, 2004, a total of 15,436,702 shares, representing 62.9% ofthe total outstanding shares of common stock as of the June 3, 2004 recorddate, were voted in favor of the adoption of the merger agreement. TheAcquisition was unanimously approved by the independent members of Duane ReadeInc.’s board of directors, who resigned from the board on July 30, 2004 inanticipation of the completion of the Acquisition. Under the terms of themerger agreement, the Company’s stockholders received $16.50 per share in cash,without interest. The aggregate value of the merger transaction wasapproximately $744 million, including transaction expenses and the repaymentof indebtedness. The equity financing necessary for the merger was provided byOak Hill and an affiliate equity fund, Oak Hill Capital Management Partners,L.P. as well as several co-investors selected by Oak Hill to participate in thetransaction. The debt financing necessary for the merger was provided by asyndicate of banking institutions led by Banc of America Securities LLC. Mr. AnthonyJ. Cuti, the Company’s Chairman, President and CEO, the Company’s Senior VicePresidents and certain other members of management have equity interests in theacquiring entity and have continued in the same management positions after theAcquisition. The new board of directors is comprised of certain executives ofOak Hill and Mr. Cuti. As a result of the stockholders’ approval of themerger agreement and the satisfaction of all other conditions to the merger,the merger and related financings were consummated on July 30, 2004.

Thefollowing pro-forma financial information presents the results of operations  for the quarters and nine monthperiods ended September 25, 2004 and September 27, 2003 as if theAcquisition has occurred at the beginning of each fiscal year. Certainone-time expenses associated with the transaction are included in each of theperiods shown, since each assumes the transaction occurred at the beginning  of thatyear.  This information does not purportto be indicative of the actual results that would have been achieved if theacquistion had occurred as assumed, or of future results.
| ** ** | ** ** | **Restated**                 | ** ** | **Restated**                 | ** ** |
|------------|------------|------------------------------|------------|------------------------------|------------|
| ** ** | ** ** | **13 Weeks Ended** | ** ** | **39 Weeks Ended** | ** ** |
| ** ** | ** ** | **Sept 25, 2004**  | ** ** | **Sept 27, 2003**  | ** ** | **Sept 25, 2004** | ** ** | **Sept 27, 2003** | ** ** |
| Sales      |       |                         | $          | 380,429                      |       |   |   | $ | 356,944 |   |   | $ | 1,165,851 |   | $ | 1,081,832 |   |
| Net Loss   |       |                         | $          | (9,319                       | )          |   |   | $ | (4,962 | ) |   | $ | (58,750 | ) | $ | (54,642 | ) |

 

**4.   NationalLabor Relations Board Decision**

The Company is a party to a National Labor RelationsBoard (“NLRB”) administrative proceeding regarding a dispute with the AlliedTrade Council (“ATC”) over whether a negotiating impasse was reached betweenthe Company and the union in August of 2001. The ATC represents employeesin 139 of the Company’s stores pursuant to a collective bargaining agreementthat expired on August 31, 2001. The employees have been working pursuantto the terms of the Company’s December 6, 2001 implemented contract withthe ATC, which expired on August 31, 2004. The Company believes an impassedid occur and as a result, the Company had the right to implement its latestcontract proposal at that time which included wage increases, health and welfarebenefits, vacation and sick benefits and a 401(k) retirement program. TheCompany discontinued making additional payments into the various fundsassociated with the union as it was providing many of these benefits on adirect basis and because its past contributions to these funds had caused thesefunds to be in a position of excessive overfunding. In addition, the Companyhad concerns that its past payments into these funds were not being managed ina way to ensure they were being properly utilized for the benefit of theCompany’s employees. On February 18, 2004, an Administrative Law Judge (“ALJ”)who had reviewed various matters related to this proceeding issued a decisionand related recommendation, which concluded that the parties were not at impasse.The remedies recommended by the ALJ included, among other things, a requirementfor the Company to make its employees whole by reimbursing them for expensesensuing from the failure to make contributions to the 

12

----

union funds and to makesuch funds whole, plus interest. This recommendation was adopted by the fullNLRB on September 15, 2004. If it is enforced by the circuit court ofappeals, it could result in the Company being required to contribute amountsthat have yet to be determined into the union’s pension benefit, health andwelfare and vacation funds. Any potential required contributions resulting froma final judicial determination of this matter would potentially be subject tooffset by the amounts that the Company had funded since it implemented itsfinal contract proposal for these same benefits that were paid for its ATCemployees. Because the NLRB decision represents the first phase of a long andcomplicated administrative process to be followed by a full judicial review ofall of the facts and circumstances, the final outcome cannot be reliablydetermined at this time. The full NLRB decision is subject to judicial reviewby the circuit court of appeals and a compliance hearing before any financialremedy can be determined. While there can be no definitive assurance, theCompany has been advised by its outside labor counsel that it has numerousmeritorious defenses and arguments in response to the NLRB’s decision.

In light of the foregoing, while it is the Company’sbelief that the final financial outcome of this litigation cannot be determinedat this time, under the provisions of Statement of Financial AccountingStandard (“FAS”) No. 5 which addresses contingencies, the Company recordeda pre-tax charge of $12.6 million for the year ended December 27,2003 and additional pre-tax charges of $1.1 million in each of the quartersended March 27, 2004 and June 26, 2004, $0.4 million in the periodfrom June 27, 2004 through July 30, 2004 and $0.7 million during theperiod from July 31, 2004 through September 25, 2004. These chargesrepresent the current best estimate of the loss that would result uponapplication of the NLRB’s decision. The Company notes that such charges werebased upon the facts available to it at the time. In the Company’s opinion, suchcharges could be subject to significant modification in the future, upon reviewby the Federal Circuit Court of Appeals, completion of a compliance hearing andany appeals relating to the outcome of that hearing. These charges reflect theamount of contributions that the Company did not make into the union benefitfunds for the period from the August 31, 2001 expiration of the contractthrough September 25, 2004, reduced by a portion of the benefits theCompany paid directly to or for the benefit of these employees over the sameperiod. It also includes an interest cost for these net contributions from thedate they would have been paid until September 25, 2004. While thisrepresents the Company’s current best estimate of the NLRB’s decision, theCompany believes that the actual range of loss in this matter could be from $0,if the NLRB’s decision is not followed, to approximately $30 million, ifthe NLRB’s decision is upheld and there is no offset for any benefits paid overthis period.

Until such time as furtherlegal developments warrant a change in the application of this accountingstandard, or until this matter is resolved, the Company will record additionalnon-cash pre-tax charges, including interest, which are calculated on the samebasis as the charge recorded in the 2003 financial statements.

**5.   RecentlyIssued Accounting Pronouncements**

In December 2002, FAS No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure” was issued. Thisstatement provides alternative methods of transition for a voluntary change tothe fair value based method of accounting for stock-based employeecompensation. The Company has not adopted such voluntary change to the fairvalue based method. In addition, this statement amends the disclosure requirementsof FAS No. 123 to require prominent disclosures about the method ofaccounting for stock-based compensation and the effect of the method used onreported results. As required, the Company adopted the disclosure-onlyprovisions of FAS No. 148 effective in 2002.

13

----

TheCompany previously adopted FAS No. 123, “Accounting for Stock-BasedCompensation” and, as permitted under FAS No. 123, has elected thedisclosure-only provisions. The Company accounts for its stock-basedcompensation plans under the recognition and measurement principles of APBOpinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations. There is no stock-based employee compensation cost reflectedin net income, as all options granted under those plans had an exercise price equalto or greater than the market value of the underlying common stock on the dateof grant. The following table illustrates the effect on net (loss) income ifthe Company had applied the fair value recognition provisions of FAS No. 123to stock-based employee compensation (dollars in thousands):
| ** **                                                                                                                                             | ** ** | **Successor**                                                                    | ** ** | ** ** | **Predecessor**                                                                 | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                             | ** ** | **Period from  July 31, 2004  through  Sept. 25, 2004** | ** ** | ** ** | **Period from  June 27, 2004  through  July 30, 2004** | ** ** | **3 Months  Ended  Sept. 27,  2003** | ** ** | **Period from  Dec. 28, 2003  through  July 30, 2004** | ** ** | **9 Months  Ended  Sept. 27,  2003** | ** ** |
| Net (loss)  income, as reported (restated)                                                                                                             |       |                                                                             | $          | (38,038    | )                                                                               |       |   |   | $ | (971 | ) |   |   | $ | 1,977 |   |   |   | $ | 3,317 |   |   | $ | 9,183 |   |
| Adjust: Total stock-based employee compensation  (expense)/income determined under fair value based method for all awards, net  of related tax effects |       |                                                                             | —     |       |                                                                            |       |   | (335 | ) |   |   | (378 | ) |   |   | (2,607 | ) |   | 8,640 |   |
| Pro forma net  (loss) income (restated)                                                                                                                |       |                                                                             | $          | (38,038    | )                                                                               |       |   |   | $ | (1,306 | ) |   |   | $ | 1,599 |   |   |   | $ | 710 |   |   | $ | 17,823 |   |

 

As described in previous SEC filings issued during2003, the Company cancelled 1,337,449 outstanding stock options during thefirst quarter of 2003 in connection with the Stock Option Exchange Offer. Thepro forma income shown in the table above for the nine months ending September 27,2003 includes the reversal of pro forma expenses previously disclosed totaling$9.7 million, related to the granting of these original options. On October 1,2003, the Company issued 1,320,947 options at an exercise price of $16.55 pershare to replace those options exchanged in connection with the Stock OptionExchange Offer. As a result, beginning in the fourth quarter of 2003, theCompany has been incurring pro forma compensation expense which reflects thefair value of the replacement stock options granted.

The pro forma compensation (expense) income for stockoptions has been estimated using the Black-Scholes option pricing model withthe following assumptions for each of the periods shown: dividend yield of 0%,expected volatility of 50%, risk free interest rate of 6.6% and an expected termof 8 years. These pro forma disclosures may not be representative of theeffects on reported net income for future periods since options vest overseveral years and options granted prior to 1995 are not considered.

On July 30, 2004, asa result of the Acquisition, all stock options, whether or not then vested,with an exercise price of $16.50 or more per share were cancelled without anypayment therefore, and the remaining “in the money” options (excluding certainmanagement options that were forfeited in connection with the Acquisition),whether or not then vested, with exercise prices of less than $16.50 per sharewere converted into the right to receive the excess of $16.50 per share overthe exercise price of each of the options. As a consequence, subsequent to the July 30,2004 transaction date, all options issued by the Predecessor to purchasepreviously existing Duane Reade Inc. common stock ceased to exist.

**6.   Inventoryand Cost of Sales**

At September 25,2004, inventories, consisting solely of finished goods, would have been greaterby $1.2 million if they had been valued on a lower of first-in, first-out (“FIFO”)cost or market basis instead of 

14

----

alast-in, first-out (“LIFO”) basis. Cost of sales includes all storeoccupancy-related costs and expenses, consisting of lease and sublease-relatedincome and expenses, other recurring real estate-related income and expensesprimarily from sales and terminations of leases related to store closings andrelocations, sales of market-related data, store utility costs, warehouseexpenses and distribution costs. The Company reflects promotional allowancesfrom vendors as a reduction of cost of sales or advertising expense, dependingon the nature of the allowance, when such advertising or promotions have beencompleted and the related allowances have been earned. For the periods from July 31,2004 through September 25, 2004 and June 27, 2004 through July 30,2004, other real estate-related income amounted to $0.1 million and $0.0million, respectively, as compared to $0.2 million in the three monthsended September 27, 2003, and for the periods from July 31, 2004through September 25, 2004 and December 28, 2003 through July 30,2004, other real estate-related income amounted to $0.1 million and $2.1 million, respectively, ascompared to $1.6 million in the nine monthsended September 27, 2003. There was no income realized from the sale ofmarket-related data in any of the periods presented.

**7.   Acquisitions**

Duringeach of the periods attributable to the “Successor” and “Predecessor” financialstatements, the Company acquired pharmacy customer files, which were mergedinto existing stores, and the operations, including certain lease-related assets,of a number of pharmacy establishments, which were operated as new stores. Thetable below provides details of this acquisition activity for each of theperiods presented (dollars in millions).
| ** **                   | ** ** | **Successor**                                                                    | ** ** | ** ** | **Predecessor**                                                                 | ** ** |
|------------------------------|------------|----------------------------------------------------------------------------------|------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                   | ** ** | **Period from  July 31, 2004  through  Sept. 25, 2004** | ** ** | ** ** | **Period from  June 27, 2004  through  July 30, 2004** | ** ** | **3 Months  Ended  Sept. 27,  2003** | ** ** | **Period from  Dec. 28, 2003  through  July 30, 2004** | ** ** | **9 Months  Ended  Sept. 27,  2003** | ** ** |
| Customer  prescription files |       |                                                                             | —     |       |                                                                            |       |   | 1 |   |   |   | 1 |   |   |   | 6 |   |   |   | 7 |   |   |
| Pharmacy establishments      |       |                                                                             | 4          |       |                                                                            |       |   | — |   |   |   | — |   |   |   | 1 |   |   |   | 2 |   |   |
| Total  acquisitions          |       |                                                                             | 4          |       |                                                                            |       |   | 1 |   |   |   | 1 |   |   |   | 7 |   |   |   | 9 |   |   |
| Cash acquisition cost        |       |                                                                             | $          | 6.4        |                                                                            |       |   |   | $ | 1.7 |   |   |   | $ | 0.1 |   |   |   | $ | 9.1 |   |   |   | $ | 6.2 |   |   |
| Total acquisition  cost      |       |                                                                             | $          | 6.4        |                                                                            |       |   |   | $ | 1.7 |   |   |   | $ | 0.1 |   |   |   | $ | 9.1 |   |   |   | $ | 6.2 |   |   |
| Purchase price  allocation:  |       |                                                                             |       |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Identifiable  intangibles    |       |                                                                             | $          | 5.1        |                                                                            |       |   |   | $ | 0.8 |   |   |   | $ | — |   |   |   | $ | 7.2 |   |   |   | $ | 3.9 |   |   |
| Goodwill                     |       |                                                                             | —     |       |                                                                            |       |   | 0.6 |   |   |   | — |   |   |   | 0.9 |   |   |   | 0.9 |   |   |
| Inventory                    |       |                                                                             | 1.3        |       |                                                                            |       |   | 0.3 |   |   |   | 0.1 |   |   |   | 1.3 |   |   |   | 1.1 |   |   |
| Property and  equipment      |       |                                                                             | 0.3        |       |                                                                            |       |   |   |   |   |   | — |   |   |   | — |   |   |   | 0.5 |   |   |
| Accruals and liabilities     |       |                                                                             | (0.3       | )          |                                                                            |       |   |   |   |   |   | — |   |   |   | (0.3 | ) |   |   | (0.2 | ) |   |
| Total                        |       |                                                                             | $          | 6.4        |                                                                            |       |   |   | $ | 1.7 |   |   |   | $ | 0.1 |   |   |   | $ | 9.1 |   |   |   | $ | 6.2 |   |   |

 

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

15

----

**8.   Debt**

Debt is composed of the following(in thousands):
| ** **                                | ** ** | **Restated** | ** ** | **Restated**                 | ** ** |
|-------------------------------------------|------------|--------------|------------|------------------------------|------------|
| **Description of Instrument**   | ** ** | ** **   | ** ** | **Sept. 25, 2004** | ** ** | **Dec. 27, 2003** | ** ** |
| Asset-Based Revolving Loan Facility       |       |         | $          | 152,939                      |       |   |   | $ | 70,353 |   |   |
| Total Current Debt                        |       |         | $          | 152,939                      |       |   |   | $ | 70,353 |   |   |
| Term Loan Facility                        |       |         | $          | 155,000                      |       |   |   | $ | — |   |   |
| 9.75% Senior Subordinated Notes due 2011  |       |         | 195,000    |                         |       |   | — |   |   |
| 2.1478% Senior Convertible Notes due 2022 |       |         | 32         |                         |       |   | 201,032 |   |   |
| Total Non-current Debt                    |       |         | $          | 350,032                      |       |   |   | $ | 201,032 |   |   |
| **Total Debt**                            | ** ** | ** **   | **$**      | **502,971**                  |       | ** ** | ** ** | **$** | **271,385** |   |   |
|                                           |            |              |            |                              |            |  |  |  |  |  |  |  |  |

 

**Revolving CreditFacility**

On July 21, 2003, Duane Reade GP entered into anew credit facility (the “Credit Agreement”). This Credit Agreement is anasset-based revolving loan which used a pre-determined percentage of thecurrent value of the Company’s inventory and selected accounts receivable tocalculate the availability of funds eligible to be borrowed up to an aggregateprincipal amount of $200 million. Prior to the amendment described below, theobligations of the Company under the Credit Agreement were collateralized bysubstantially all of the assets of the Company. In addition, the CreditAgreement was guaranteed by each of the Company’s corporate subsidiaries, andsuch guarantees were collateralized by substantially all assets of such guarantors.The Credit Agreement is scheduled to mature on July 20, 2008.

The Credit Agreement contains a single fixed chargecoverage requirement which only becomes applicable when borrowings exceed 90percent of the borrowing base, as defined in the Credit Agreement. Borrowingsunder the Credit Agreement have not exceeded 90 percent of the borrowing baseand, as a result, the fixed charge covenant did not become applicable duringthe period. There are no credit ratings related triggers in the CreditAgreement that would impact the cost of borrowing, annual amortization ofprincipal or related indebtedness maturity.

On July 22, 2004, in connection with theAcquisition, the Credit Agreement was amended (the “Amended Credit Agreement”)to increase the Company’s borrowing capacity to an aggregate principal amountof $250 million, subject to an adjusted borrowing base calculation based uponspecified advance rates against the value of the Company’s selected inventory,pharmacy prescription files and selected accounts receivable. The AmendedCredit Agreement includes a $50 million sub-limit for the issuance of lettersof credit. Obligations under the revolving loan facility are collateralized bya first priority security interest in inventory, receivables, pharmacyprescription files, deposit accounts and certain other current assets. Underthe amended facility, Duane Reade GP is the borrower. The amended facility isguaranteed by Duane Reade Holdings, the Company and each of its domesticsubsidiaries other than Duane Reade GP. Revolving loans under the AmendedCredit Agreement, at the Company’s option, bear interest at either (i) arate equal to LIBOR (the London Interbank Offered Rate) plus a margin of from1.50% to 2.00%, determined based on levels of borrowing availability reset eachfiscal quarter or (ii) a rate equal to the prime rate of Banc of AmericaRetail Group Inc. plus a margin of from 0.00% to 0.50%, determined based onlevels of borrowing availability reset each fiscal quarter. Borrowings underthe amended facility continue to be primarily LIBOR-based.

16

----

AtSeptember 25, 2004, there was $152.9 million outstanding under therevolving credit facility, and approximately $93.7 million of remainingavailability, net of $2.9 million reserved for standby letters of credit.  Obligations under thisfacility have been classified as current liabilities because cash receiptscontrolled by the lenders are used to reduce outstanding debt, and the Companydoes not meet the criteria of FAS 6 to reclassify the debt as long-term. TheCompany intends to continue to utilize this facility for its working capitalneeds though the date of its maturity in July 2008. Borrowings under the CreditAgreement are principally LIBOR-based. The margin on these borrowings is fixedat 1.75% for the first year, and is subject to a sliding scale adjustmentthereafter, based on remaining levels of availability.

**Senior Term Loan Facility**

On July 30, 2004, inconnection with the Acquisition, the Company entered into a Senior Term Loan inthe principal amount of $155 million. This loan will mature on July 30,2010. While there are no scheduled principal payments over its term, theCompany will be required to prepay the senior term loan together with accruedinterest thereon, with (a) all net cash proceeds (i) from sales ofproperty and assets by Duane Reade Holdings and its subsidiaries (excludingsales of inventory in the normal course of business and certain otherexceptions described in the Senior Term Loan), (ii) of extraordinaryreceipts, casualties and condemnations as defined in the Senior Term Loan and (iii) fromthe issuance or incurrence of additional debt of Duane Reade Holdings or any ofits subsidiaries other than certain identified indebtedness permitted under theSenior Term Loan, (b) 50.0% of all net cash proceeds from the issuance ofadditional equity of Duane Reade Holdings or any of its subsidiaries (excludingequity issued to Oak Hill and other exceptions specified in the Senior TermLoan) and (c) 50.0% of excess cash flow of Duane Reade Holdings and itssubsidiaries (beginning with the fiscal year ending December 2005). Loansunder the Senior Term Loan facility, at the Company’s option, bear interest ata rate per annum of (i) the reserve-adjusted LIBOR plus an applicablemargin of 3.25%; or (ii) 2.25%, plus the higher of (a) the prime rateof Bank of America, N.A. and (b) the Federal Funds rate plus 0.50%. DuaneReade GP became a co-obligor under the Senior Term Loan upon the closing of theAcquisition. All obligations under the Senior Term Loan are guaranteed by DuaneReade Holdings and each of the Company’s existing subsidiaries, other thanDuane Reade GP, and will be guaranteed by future subsidiaries except certainforeign subsidiaries. The Senior Term Loan is collateralized by a firstpriority security interest in substantially all of the Company’s assets otherthan those assets in which the lenders under the Amended Credit Agreement havea first priority interest. The Senior Term loan is also collateralized by asecond priority security interest in all collateral pledged on a first prioritybasis to lenders under the Amended Credit Agreement. The Senior Term Loan alsocontains affirmative and negative covenants customary for a senior term loanfacility, including, among other things, restrictions on indebtedness, liens,mergers and consolidations, sales of assets, loans, acquisitions, jointventures, restricted payments, transactions with affiliates, dividends andother payment restrictions affecting subsidiaries and sale leasebacktransactions. The Senior Term Loan also requires Duane Reade Holdings and itssubsidiaries to maintain a maximum leverage ratio and a minimum interestcoverage ratio. There are no credit ratings related triggers in the Senior TermLoan Facility that would impact the cost of borrowing, annual amortization ofprincipal or related indebtedness maturity.

**$195 Million 9**3¤4%Senior Subordinated Notes Due 2011

On July 30, 2004,upon completion of the Acquisition, the Company entered into an Indenture for$195 million of 93¤4%Senior Subordinated Notes due 2011 (the “Senior Subordinated Notes”). TheSenior Subordinated Notes mature on August 1, 2011 and bear interest at9.75% per annum payable in semi-annual installments on February 1 and August 1,commencing February 1, 2005, to the holders of record on the immediatelypreceding January 15 and July 15. The Senior Subordinated Notes areuncollateralized obligations and subordinated in right of payment to all of theCompany’s existing and future unsubordinated indebtedness, including borrowingsunder the Amended Credit Agreement (as defined 

17

----

above)and the Senior Term Loan (as defined above). The Senior Subordinated Notes willrank equally with any future senior subordinated indebtedness and senior to anyfuture subordinated indebtedness. The Senior Subordinated Notes are guaranteedon an uncollateralized, senior subordinated basis by all of the Company’sexisting direct and indirect domestic subsidiaries other than Duane Reade GP,which is a co-obligor under the Senior Subordinated Notes. The Company mayredeem the Senior Subordinated Notes, in whole or in part, at any time on orafter August 1, 2008, at a redemption price of 104.875% declining to paron August 1, 2010, plus accrued and unpaid interest. In addition, theCompany, Duane Reade Shareholders or Duane Reade Holdings, at the Company’soption, can redeem up to 35% of the Senior Subordinated Notes before August 1,2007 with the net cash proceeds from certain equity offerings. Upon theoccurrence of specified change of control events, the Company and Duane ReadeGP will be required to make an offer to repurchase all of the SeniorSubordinated Notes at 101% of the outstanding principal amount of the SeniorSubordinated Notes plus accrued and unpaid interest to the date of repurchase.The indenture governing the Senior Subordinated Notes contains certainaffirmative and negative covenants that limit the Company’s ability to incuradditional indebtedness, pay dividends, make repayments on indebtedness that issubordinated to the Senior Subordinated Notes and to make certain otherrestricted payments, incur certain liens, use proceeds from sales of assets,enter into business combination transactions (including mergers, consolidationsand asset sales), enter into transactions with affiliates and permitrestrictions on the payment of dividends by the Company’s subsidiaries. Under aregistration rights agreement entered into as part of the offering of theSenior Subordinated Notes, the Company is required to (i) file aregistration statement with the SEC within 120 days after the completion of theAcquisition, (ii) use its reasonable best efforts to cause theregistration statement to become effective within 180 days after the completionof the Acquisition, and (iii) use its reasonable best efforts to completethe exchange offer within 210 days after the Acquisition is completed. Thereare no credit ratings related triggers in the Senior Subordinated Notes thatwould impact the cost of borrowing, annual amortization of principal or relatedindebtedness maturity.

**2.1478%Senior Convertible Notes due April 16, 2022**

On April 16, 2002, the Company completed anoffering of $381.5 million aggregate principal amount of Senior ConvertibleNotes maturing on April 16, 2022 (the “Convertible Notes”). TheConvertible Notes were issued at a price of $572.76 per note (57.276% of theprincipal amount at maturity) and pay cash interest at the rate of 2.1478% peryear on the principal amount at maturity, payable semi-annually in arrears on April 16and October 16 of each year beginning on October 16, 2002, until April 16,2007. After that date, interest will accrue on the notes as amortization of theoriginal issue discount representing a yield to maturity of 3.75% per year,computed on a semi-annual bond equivalent basis. In December 2002, the Companyrepurchased a total of $30.5 million principal value of the Convertible Notesat an average purchase price of $486.99 per $1,000 note, resulting in the thenremaining net outstanding balance of $201.0 million. Because the Acquisitionconstituted a “change of control” under the indenture governing the ConvertibleNotes, the Company offered to repurchase all of the outstanding ConvertibleNotes. As a result, on September 13, 2004, the Company repurchased all but$55,000 aggregate principal amount at maturity of Convertible Notes for $201.0million plus $3.1 million of accrued and unpaid interest.

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

18

----

In connection with theplanned consummation of the Acquisition, the Company, Duane Reade Shareholders,LLC, the indirect parent of Duane Reade Acquisition Corp. and each of thesubsidiaries of the Company that are guarantors of the Convertible Notesentered into a supplemental indenture. Pursuant to the supplemental indenture,as a result of the merger of Duane Reade Acquisition Corp. with and into theCompany, the Convertible Notes may only be converted into the right to receivefrom the Company $16.50 (in cash and without interest) per share of the Company’scommon stock issuable to a holder of Convertible Notes in connection with suchconversion. These notes are not considered to be potential common shares, andare not included in the calculation of diluted earnings per share, as theCompany intends to settle any conversions in cash.

**9.**   IncomeTaxes

Income taxes are recordedbased on the estimated combined statutory tax rates expected to be applicablefor the full fiscal year less applicable employment related tax credits. Theeffective tax rate is lower than the combined statutory rates, primarilyreflecting the impact of these income tax credits. During the predecessorperiod of December 28, 2003 through July 30, 2004, the effective taxrate of 25.5% reflects the impact of an allocated portion of these tax creditsapplied against the pre-tax income recorded by the predecessor entity. Theeffective tax rate of 46.1% recorded by the Company during the period followingthe Acquisition is reflective of the substantial pre-tax loss incurred as aresult of the transaction-related expenses, plus the impact of the remainder ofthe tax credits allocated to the post-Acquisition period. The employment taxcredits represent the economic benefits earned by the Company for itsparticipation in various federal and state hiring incentive programs. These benefitsare based on the number of qualifying employees hired and retained by theCompany for a specified time period. Employees qualify for these hiringprograms primarily as a result of their enrollment in various economicassistance programs.

**10.**   Commitmentsand Contingencies

The Company is a party to legal actions arising in theordinary course of business. Based on information presently available tomanagement, the Company believes that it has adequate legal defenses orinsurance coverage for these actions and that the ultimate outcome of theseactions will not have a material adverse effect on the financial position,results of operation or cash flows of the Company. In addition, the Company isa party to the following legal actions and matters:

During 2002, the Company initiated a legal actionagainst its former property insurance carrier in Federal Court in the SouthernDistrict of New York, in an attempt to recover what the Company believes to bea fair and reasonable settlement for the business interruption portion of itsclaim originating from the September 11, 2001 World Trade Center terroristattack, during which the Company’s single highest volume and most profitablestore was completely destroyed. The claim is pending before the United StatesDistrict Court for the Southern District of New York. In September 2003, atrial on certain issues was held regarding some of the matters at issue in thelitigation, including whether the Company would have obtained a renewal of itslease at the World Trade Center. The Company has received a favorable ruling onthis and other legal issues in the case and now the matter has moved into anappraisal process. The appraisal process involves two appraisers and anarbitrator (to resolve differences between the two appraisers) who willdetermine the amount of insured loss the Company has sustained. The insurancecarrier has appealed a number of the rulings by the trial court. In light ofboth the early state of the appraisal process and the inherent uncertainty inlitigation relating to the appeal, the amount of additional insurance proceeds,if any, the Company may collect under the terms of its insurance contract withthe defendant cannot be reasonably predicted or determined at this time, andtherefore, the Company has not accrued any additional income related to thispotential settlement. In fiscal 2002, the Company received an advance ofapproximately $9.4 million toward its business interruption claim that wasrecognized as a separate component of income in the Company’s consolidatedstatement of income. In the event of an 

19

----

unfavorable outcome to theCompany, this amount would not be required to be returned to the insurancecompany.

The Company, Anthony J. Cuti, its Chairman, Presidentand Chief Executive Officer, John K. Henry, its Senior Vice President and ChiefFinancial Officer, and Gary Charboneau, its Senior Vice President of Sales andMarketing, were named as defendants in connection with the consolidation ofseveral class action complaints alleging violations of the federal securitieslaws that were filed from August 2002 through October 2002. Theaction, which was in the United States District Court for the Southern Districtof New York, was on behalf of shareholders who purchased Duane Reade Inc.’scommon stock between April 1, 2002 and July 24, 2002, inclusive. Thecomplaint, which sought an unspecified amount of damages, alleged that thedefendants violated the federal securities laws by issuing materially false andmisleading statements during the class period. On December 1, 2003, thedistrict judge granted the Company’s motion to dismiss the plaintiff’s action,with prejudice. The plaintiffs subsequently filed an appeal. On August 17, 2004,the US Court of Appeals affirmed the district court’s ruling in favor of theCompany.

The Company is a defendant in a class action suit inthe Federal Court for the Southern District of New York regarding allegedviolations of the Fair Labor Standards Act as to a group of individuals whoprovided delivery services on a contract basis to the Company. In December 2002,the judge in the action issued a partial summary judgment in favor of asubclass of the plaintiffs and against the Company. In December 2003, theCompany settled the issue of the amount of its liability to the plaintiffswithout any admission of wrongdoing and in an amount consistent with theCompany’s previously established reserves. By a decision dated August 4,2004, the district court awarded the plaintiffs certain attorneys’ fees in thismatter. The Company has fully reserved the amount of the fees in question andhas appealed this award to the US Circuit Court of Appeals.

The Company is a party to related lawsuits, IrvingKroop, et al. v. Duane Reade, NY, NY et al., 00 Civ. 9841, et al.,instituted by the trustees of several union benefit funds wherein the fundsclaim that the Company did not make certain required contributions to thesefunds from January 2000 through July 31, 2001. By decisionsdated August 5, 2004 and September 27, 2004, the District Courtawarded judgment to the funds on certain aspects of their complaints. Thesepartial judgments, for which the Company has provided adequate reserves, aresubject to further appeal by the Company. The remaining unresolved portions ofthe plaintiffs’ claims are still being litigated and accordingly, the Companyintends to continue to vigorously defend itself in these matters. At this time,it is not possible to determine the ultimate outcome of this case or the actualamount of additional liability the Company may face, if any.

The Company is involved in an ongoing dispute withCardinal Health, one of its former suppliers of pharmaceutical products. Bothparties have claims against the other involving, among other things, breach ofcontract, promissory estoppel and unjust enrichment. Duane Reade is seekingfrom Cardinal an unspecified amount of damages and punitive damages of at least$20 million. Cardinal is seeking approximately $18 million in damages plusattorney’s fees and interest. While there can be no definitive assurance, theCompany believes it has counterclaims that offset the claims against it byCardinal, as well as meritorious defenses to these claims, and plans tovigorously pursue its affirmative claims and to vigorously defend itself inthis action. Non-party discovery in this case has been concluded and it isexpected to go to trial sometime in 2005.

The Company is involved in litigation related to adispute with the Allied Trades Council, a union representing employees in 139of its stores. This litigation is more fully described in Note 3 to theseUnaudited Consolidated Interim Financial Statements.

A New York State Tax Appeals Tribunal ruling in amatter involving another company may have an adverse impact upon the Company’sNew York State Franchise Tax filings from years 1999 through 2002. This matterrelates to the required combination of affiliated subsidiaries in recognizingroyalty fee and related income for intangible property. The ruling of theTribunal is subject to further legal appeal and 

20

----

interpretation in light ofthe Company’s own specific facts and circumstances. The outcome of this matter,and the resulting amount of additional income tax expense, if any, cannot bedetermined by the Company at this time.

***Litigation Relatingto the Merger Transaction:  ***Duane Reade is aware ofsix purported class action complaints challenging the merger transactionconsummated by the Company and Duane Reade Acquisition that have been filed inthe Court of Chancery of the State of Delaware, referred to as the “Delaware Complaints,”and three purported class action complaints that have been filed in the SupremeCourt of the State of New York. Two of the New York complaints have beendismissed without prejudice. The other New York complaint (the “New YorkComplaint”) is pending, but has not been served on Duane Reade. The DelawareComplaints name Mr. Cuti and certain other members of the Company’s boardof directors and executive officers as well as Duane Reade as defendants. Fourof the Delaware Complaints name Oak Hill as a defendant. The New York Complaintnames Mr. Cuti and certain other members of the Company’s board ofdirectors and executive officers as well as Duane Reade as defendants. One ofthe dismissed New York complaints named Oak Hill as a defendant.

The Delaware Complaints were consolidated on January 28,2004, and on April 8, 2004 the plaintiffs in the Delaware actions filed aconsolidated class action complaint. The Company believes these lawsuits arewithout merit and plans to defend these lawsuits vigorously.

21

----

**ITEM 2.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**General**

Our business consists of a wide variety of health andbeauty care products, convenience oriented food and general merchandise itemsand a pharmacy operation managed to supply customers with their prescriptionneeds. We refer to the non-prescription portion of our business as front-endsales because most of these sales are processed through the front maincheck-out sections of our stores. This portion of our business consists ofbrand name and private label health and beauty care items, food and beverages,tobacco products, cosmetics, housewares, greeting cards, photofinishingservices, photo supplies and seasonal and general merchandise. Health andbeauty care products, including over-the-counter items, represent our highestvolume categories within front-end sales. The front-end portion of our businessrepresented 49.7% and 49.8% of our sales in the quarter and nine months ended September 25,2004, respectively, and is characterized by generally higher gross margins thatare approximately twice that of our pharmacy or back-end business.

Because of our numerous convenient locations inhigh-traffic commercial and residential areas and the lack of other convenienceoriented retailers in our core market areas, our front-end business isgenerally a larger proportion of our total sales than other major conventionaldrug store chains, which average between 30% to 40%, but as is the case withmost other drug store chains, represents a decreasing share of business yearafter year due to the faster rate of pharmacy sales growth. Our pharmacy salesinclude all items we sell by prescription filled at our retail locations or byour central fill facility and delivered to our stores or direct to customers.The pharmacy portion of our business is dominated by and dependent upon anumber of third party private and government-sponsored plans that contract withus as an authorized provider of prescriptions.

Sales to third party prescription plans represented92.3% and 92.2% of our prescription sales in the quarter and nine months ended September 25,2004, respectively. The pharmacy portion of our business is subject to a numberof federal, state and local regulations that govern the conduct of thisbusiness. The high rate of growth in pharmacy sales has been due to a number offavorable demographic and industry trends such as the aging of the population,expanding penetration of third party private and government-sponsoredcoverage and the increasing usage of prescription drugs to improve quality oflife and in place of medical procedures. Along with the fast pace of growth inthis area have come generally higher rates of product cost inflation, resultingin an increased focus on the part of both government and private plans tocontrol their costs of providing these benefits. As a result, pharmacy grossmargins have been under pressure.

During 2003, President Bush signed legislation thatwill expand Medicare coverage of prescription drugs for senior citizens notparticipating in third party plans, which represent less than 2% of our totalrevenue. This new Medicare coverage is planned to take effect in 2006 and isexpected to result in decreased pharmacy margins resulting from lower reimbursementrates than our current margins on prescriptions that are not subject to thirdparty reimbursement. In June 2004, a temporary senior citizen prescriptiondrug discount program furnished under this Medicare legislation was implementedand is expected to remain in effect until the full Medicare program takeseffect in 2006. This temporary program has also resulted in lower pharmacymargins than those previously realized on prescriptions that were not subjectto third party plan reimbursement. Based on our experience over time, we expectthat increased utilization of prescription drugs by senior citizensparticipating in the new programs will offset the effect of lower margins onour revenues.

In fiscal 2003 and again in fiscal 2004, New YorkState reduced Medicaid and EPIC prescription reimbursement rates, adverselyimpacting our pharmacy gross margins. The most recent reductions 

22

----

became effective on October 1,2004, and are expected to reduce reimbursements by approximately $1.4 millionon an annual basis.

While retaining its high rate of growth in 2003, theretail pharmacy industry experienced substantially reduced rates of pharmacysame-store sales growth resulting from a decline in the demand for hormonalreplacement drugs, conversion of some high volume prescription drugs toover-the-counter status, increased levels of required co-payments by insurers,increased utilization of lower priced generic medications, increasedpenetration by mail order and internet-based pharmacies and reductions in coverageresulting from high unemployment rates. While there has been some improvementin employment trends during 2004, these same factors have generally continuedto restrain pharmacy sales growth.

We operate approximately 85% of our 255 stores in NewYork City and therefore our financial performance is heavily influenced by thelocal economy. We analyze a number of economic indicators specific to New YorkCity to gauge the health of this economy including unemployment rates, jobcreation, gross city product and bridge and tunnel commuter traffic patterns.We also analyze market share data, same-store sales trends, average store salesand sales per square foot data among other key performance indicators tomonitor our overall performance.

The New York City economy continues to experiencehigher rates of unemployment than the national economy overall. The September seasonallyadjusted unemployment data for New York City indicated an unemployment rate of6.9% compared to a national average of 5.4%. While still trailing the nationalaverages, the New York City unemployment rate does reflect an improvement ascompared to the monthly average rate of 8.5% reported for the first quarter ofthis year. We believe that these trends reflect an improved fiscal situation forthe city overall that is consistent with the early stages of an improving localeconomy.

On July 30, 2004 we were acquired through amerger transaction with Duane Reade Acquisition Corp. (“Duane Reade Acquisition”),a wholly owned subsidiary of Duane Reade Holdings, Inc. and an affiliateof Oak Hill Capital Partners, L.P. (“Oak Hill”), a private equity firm (the “Acquisition”).The aggregate value of the Acquisition was approximately $744 million,including transaction expenses and the repayment of a portion of ourindebtedness. As a result of the Acquisition, our shares are no longer listedon the New York Stock Exchange and Duane Reade has continued itsoperations as a privately held company. Each share of Duane Reade’s commonstock outstanding immediately prior to the Acquisition was converted into theright to receive $16.50 per share, without interest, in cash.

Oak Hill, certain related entities and severalco-investors funded the equity for the Acquisition. The funding also includedthird-party debt financings, including the issuance of 9.75% SeniorSubordinated Notes due 2011 in a principal amount of $195 million, a new seniorsecured term loan facility in an aggregate amount of $155 million and anincrease of our existing revolving credit facility with Banc of America RetailGroup to $250 million, that resulted in approximately $90.4 million ofborrowing capacity after completion of the merger. As a result of theAcquisition, on September 13, 2004, we completed a Change of Control offerto repurchase our outstanding Convertible Notes, and, as a result, all but$55,000 principal amount at maturity of the $351.0 million total outstandingprincipal amount at maturity were repurchased.

The Acquisition wasaccounted for as a purchase, in accordance with the provisions of Statement ofFinancial Accounting Standards No. 141, “Business Combinations”, whichresulted in new valuations for our and our subsidiaries’ assets and liabilitiesbased on fair values as of the date of the acquisition. These valuations are preliminaryand are based upon information that was available to management at the time thefinancial statements were prepared. Accordingly, these purchase priceallocations may change based upon our final valuations, some of which will bebased on third party appraisals currently being conducted. 

23

----

TheCompany fully expects to complete these valuations and the final allocation ofthe purchase price within the allowable one year timeframe after the closing ofthe transaction.

Restatements

The consolidated financial statements includedherein reflect the following restatements:

(1)   Werestated reported net sales and cost of sales to reflect revenues from resalesof certain retail inventory on a gross basis rather than on a net basis aspreviously reported. These transactions have experienced significant growthover the last few years and this change reflects the need to conform ouraccounting practice to the provisions of EITF 99-19. The restatements relatingto the resales had no net effect on net income or cash flows from operations,as the amount of increase in net sales is equal to the amount of increase incost of sales as the profit margin on these sales had previously been recordedto cost of goods sold. Pharmacy same-store sales do not include such resales.

(2)   Werestated cost of sales to reflect changes in our lease accounting to conform tothe requirements of FASB Technical Bulletin No. 85-3. As has been the case formany companies within the retail and other industries, we determined, based ona review of our lease-related accounting methods, that our previous policy ofcommencing rent expense when a store opens (and not at the commencement of alease) was inconsistent with FTB 85-3. For construction purposes, we often takepossession of leased properties prior to opening. The revised accounting policyrecords rent expense commencing on the date of possession. The restatementsrelating to lease accounting had no impact upon lease maturities, the timing ofany lease payments or cash flows from past or future operating activities.

(3) In accordance with the provisions of FAS 141,we have restated reported balance sheet liabilities, goodwill and results ofoperations, cost of sales and selling, general and administrative expenses tocorrect the lease accounting to reflect straight-line rent expense (for leasesin effect on the July 30, 2004 acquisition date) calculated from the date ofour acquisition by Oak Hill rather than from the original lease commencementdates as previously recorded. This adjusted lease accounting has no impact uponlease maturities, the timing of any lease payments or cash flows from past orfuture operating activities.

(4)   We haverestated our previously reported balance sheets for September 25, 2004 andDecember 27, 2003 to reflect the classification of outstanding borrowings underthe revolving loan facility as current liabilities rather than as long-termdebt, as previously reported. The change is being made because cash receiptscontrolled by the lenders are used to reduce outstanding debt, and we do notmeet the criteria of FAS 6 to reclassify the debt as long-term. This is not anindication that this credit facility is expected to be retired within the nextyear. This facility expires in July 2008, and we intend to continue to accessit for our working capital needs throughout its remaining term.

(5)   We haverestated our consolidated statements of cash flows for the first nine months of2004 and 2003 to reflect the reporting of revolving loan facility borrowingsand repayments separately on a gross basis as required under FAS 95. In addition, we restated our financial results toinclude certain previously unrecorded and immaterial audit adjustments relatingto the periods affected. These restatements are included in the discussion ofour results of operations below and within the Consolidated FinancialStatements presented elsewhere in this filing. See Note 2 to the ConsolidatedFinancial Statements for a further discussion of these restatements. 

In connection with these restatements, weobtained from the administrative agent under the amended asset-based revolvingloan facility, an acknowledgement confirming that these restatements do notconstitute an event of technical default, as defined in the document governingthe revolving loan facility.

24

----

**Results of Operations**

As a result of theAcquisition and resulting change in control, under U.S. GAAP the Company isrequired to present separately its operating results for the predecessorperiods in the 2004 fiscal year (June 27, 2004 through July 30, 2004and December 28, 2003 through July 30, 2004) and the successor periodin the 2004 fiscal year (July 31, 2004 through September 25, 2004).In the following discussion, these are compared to the full fiscal thirdquarter and year-to-date predecessor periods ended September 27, 2003.Management believes this is the most practical way to comment on the results ofoperations.

**ThePeriod from July 31, 2004 through September 25, 2004 for theSuccessor and the period from June 27, 2004 through July 30, 2004 forthe Predecessor Compared to the Three Months Ended September 27, 2003 forthe Predecessor**

For the period from July 31, 2004 through September 25,2004, we achieved net sales of $238.1 million and sustained a net loss of $38.0 million, and for the periodfrom June 27, 2004 through July 30, 2004, we achieved net sales of$142.4 million and incurred a net loss of $1.0 million, as compared toaggregate net sales of $356.9 million and net income of $2.0 million in thethird quarter of the previous year. Resales of pharmaceutical retail inventorywere $20.5 million and $10.3 million in the successor and predecessor periodsof 2004, respectively, as compared to $18.3 million in the third quarter of2003. For the 2004 periods subsequent to and prior to the Acquisition, grossprofit margins were 18.5% and 18.8%, respectively, ascompared to 20.3% in the third quarter of last year. The decrease was primarilyattributable to the impact of increased resale activity, which generally hasgross margins of less than one percent, combined with front-end same-storesales declines in both the predecessor and successor period of the current year’sthird quarter that resulted in our inability to leverage increased new storeoccupancy expenses. Overall product gross margins which exclude occupancy costswere slightly higher than the previous year in both the predecessor andsuccessor periods. In addition to the decrease in gross profit margins, netincome declined principally due to the following factors:

·       Pre-taxtransaction expenses of $37.1 million in the successor period ended September 25,2004 and $0.4 million in the predecessor period ended July 30, 2004 thatwere related to the Acquisition, including certain change-of-control paymentsto management and contractual fees payable to Oak Hill upon consummation of thetransaction;

·       Expensesassociated with the CEO Supplemental Executive Retirement Plan termination andother compensation related costs incurred in connection with the Acquisition;

·       Anincrease in amortization expense of $2.1 million in the current year’ssuccessor period attributable to the preliminary acquisition related purchaseaccounting adjustments to the valuation of store leases and prescriptionpharmacy files under FAS 141. The balance of the increase is attributable tothe depreciation of capital expenditures and amortization of intangiblesacquired in 2003 and 2004 that impact both the successor and predecessorperiods of the current year;

·       Increasedstore pharmacy labor costs incurred in both the successor and predecessorperiods that were required to maintain hiring rates in line with the localmarket;

·       Pre-taxlabor contingency expenses of $1.1 million related to a National LaborRelations Board ruling in a collective bargaining agreement litigation relatedto the funding of certain employee benefit funds (see Note 3 to the UnauditedConsolidated Interim Financial Statements);

·       Increasedadvertising and promotional expenses in both the successor and predecessorperiods of the current year to stimulate sales; and

25

----

·       Increasedlegal and litigation related expenses associated with certain labor issues, ourattempt to recover the balance of our World Trade Center business interruptioninsurance claim and various other matters, as well as $0.6 million related to alitigation settlement.

Thefollowing sets forth the results of operations for the periods indicated:
| ** **                                          | ** ** | **Successor—Restated**                                                          | ** ** | **Predecessor—Restated**                                                   | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **Period from  July 31, 2004  through  September 25, 2004** | ** ** | **Period from  June 27, 2004  through  July 30, 2004** | ** ** | **For the 13 Weeks  Ended  September 27, 2003** | ** ** |
| **In thousands, except percentages** | ** ** | ** **                                                                           | ** ** | **Dollars**                                                                     | ** ** | **% of Sales** | ** ** | **Dollars** | ** ** | **% of Sales** | ** ** | **Dollars** | ** ** | **% of Sales** | ** ** |
| Net sales                                           |       | $                                                                                    | 238,050    |                                                                            |       | 100.0 | % |   | $ | 142,379 |   |   | 100.0 | % |   | $ | 356,944 |   |   | 100.0 | % |   |
| Cost of sales                                       |       | 194,116                                                                              |       |                                                                            | 81.5       |   |   | 115,557 |   |   | 81.2 |   |   | 284,389 |   |   | 79.7 |   |   |
| Gross profit                                        |       | 43,934                                                                               |       |                                                                            | 18.5       |   |   | 26,822 |   |   | 18.8 |   |   | 72,555 |   |   | 20.3 |   |   |
| Selling, general &  administrative expenses     |       | 37,418                                                                               |       |                                                                            | 15.7       |   |   | 23,726 |   |   | 16.7 |   |   | 56,611 |   |   | 15.9 |   |   |
| Labor contingency  expense                          |       | 689                                                                                  |       |                                                                            | 0.3        |   |   | 411 |   |   | 0.3 |   |   | — |   |   | — |   |   |
| Transaction expense                                 |       | 37,118                                                                               |       |                                                                            | 15.6       |   |   | 386 |   |   | 0.3 |   |   | — |   |   | — |   |   |
| Depreciation and  amortization                      |       | 7,280                                                                                |       |                                                                            | 3.1        |   |   | 3,596 |   |   | 2.5 |   |   | 8,162 |   |   | 2.3 |   |   |
| Store pre-opening  expenses                         |       | 366                                                                                  |       |                                                                            | 0.2        |   |   | 105 |   |   | 0.1 |   |   | 154 |   |   | 0.0 |   |   |
| Other                                               |       | 25,291                                                                               |       |                                                                            | 10.6       |   |   | — |   |   | — |   |   | — |   |   | — |   |   |
|                                                |       | 108,162                                                                              |       |                                                                            | 45.4       |   |   | 28,224 |   |   | 19.8 |   |   | 64,927 |   |   | 18.2 |   |   |
| Operating (loss) income                             |       | (64,228                                                                              | )          |                                                                            | (27.0      | ) |   | (1,402 | ) |   | (1.0 | ) |   | 7,628 |   |   | 2.1 |   |   |
| Interest expense, net                               |       | 6,283                                                                                |       |                                                                            | 2.6        |   |   | 1,283 |   |   | 0.9 |   |   | 3,386 |   |   | 0.9 |   |   |
| Debt extinguishment                                 |       | —                                                                               |       |                                                                            | —     |   |   | — |   |   | — |   |   | 707 |   |   | 0.2 |   |   |
| (Loss) income before  income taxes                  |       | (70,511                                                                              | )          |                                                                            | (29.6      | ) |   | (2,685 | ) |   | (1.9 | ) |   | 3,535 |   |   | 1.0 |   |   |
| Income tax (benefit)  provision                     |       | (32,473                                                                              | )          |                                                                            | (13.6      | ) |   | (1,714 | ) |   | (1.2 | ) |   | 1,558 |   |   | 0.4 |   |   |
| Net (loss) income                                   |       | $                                                                                    | (38,038    | )                                                                               |       | (16.0 | )% |   | $ | (971 | ) |   | (0.7 | )% |   | $ | 1,977 |   |   | 0.6 | % |   |
|                                                     |            |                                                                                      |            |                                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Net sales were $238.1 million in the July 31,2004 through September 25, 2004 period and $142.4 million in the June 27,2004 through July 30, 2004 period. Overall, aggregate net sales increasedby 6.6% as compared to net sales of $356.9 million for the third quarter of2003. Resale activity accounted for 3.5% of this increase, while normal retailsales to customers increased by 3.1% over this period. Same-store salesincreased by 0.5% over the third quarter last year with the balance of theincrease coming from the full quarterly results of three net new stores openedin the third quarter last year and 16 net new stores opened since the end oflast year’s third quarter.

Pharmacy sales increased from $167.0 million in thethird quarter of 2003 to an aggregate total of $191.2 million in the thirdquarter of 2004, an increase of 14.5%, and represented 50.3% of total sales, ascompared with 46.8% of total sales in the third quarter of 2003. Resaleactivity in 2004 accounted for 7.5% of the pharmacy sales increase. Pharmacysame-store sales increased by 5.1% over last year, and third-party reimbursedpharmacy sales represented 92.3% of total prescription sales compared to 91.4%in the third quarter of 2003. Pharmacy same-store sales continued to experiencethe general industry trend of reduced growth rates experienced during fiscal2003. The major factors driving the slower sales growth rates in pharmacy werethe trends toward increases in third party plan customer co-payments, reducedsales of hormonal replacement drugs, limitations on maximum reimbursements forcertain generic medications by third party plans, increased penetration by mailorder and internet-based pharmacies and continued high rates of unemployment thathave reduced the number of customers covered by insured plans.

Front-end sales decreased from $189.9 million in thethird quarter of 2003 to an aggregate total of $189.2 million in the thirdquarter of 2004, a decrease of 0.4%, and represented 49.7% of total sales, ascompared to 53.2% of total sales in the third quarter of 2003. Front-endsame-store sales declined by 3.2%, 

26

----

partly due to decliningtobacco sales in metro New York City, which has experienced increasedrestrictions on smoking in public places along with higher taxes on tobaccoproducts. Excluding tobacco sales, front-end same-store sales decreasedby approximately 2.2%. We believe that the remaining decline in same-storefront-end sales is largely attributable to the continued high unemploymentrates in New York City that have restrained consumer demand.

During the period from July 31, 2004 through September 25,2004, we opened seven stores and closed one store, and from June 27, 2004through July 30, 2004 we opened two stores, as compared to three storesopened during the three months ended September 27, 2003. At September 25,2004, we operated 255 stores, as compared to 239 stores at September 27,2003.

Cost of sales as a percentage of net sales was 81.5% for the period from July 31,2004 through September 25, 2004 and 81.2% for the period from June 27,2004 through July 30, 2004, resulting in gross profit margins of 18.5% and 18.8%, respectively. Inthe third quarter of 2003, cost of sales as a percentage of net sales was79.7%, resulting in a gross profit margin of 20.3%. This decrease in grossprofit margins was primarily attributable to the effect of the increased resaleactivity, combined with the adverse impact of the limited access and salesdisruptions associated with the Republican National Convention as well as thecontinuing effects of a less than robust local economy. These factors resultedin our inability to leverage increased new store occupancy expenses. Cost ofsales also includes (i) a $0.3 million LIFO provision in the current yearas compared to a LIFO provision of $0.2 million in the prior year and (ii) real-estaterelated income of $0.1 million in the third quarters of both 2004 and 2003.

Selling, general and administrative expenses were$37.4 million, or 15.7% of net sales, and $23.7 million, or 16.7% of netsales, in the July 31, 2004 through September 25, 2004 period and theJune 27, 2004 through July 30, 2004 period, respectively, as comparedto $56.6 million, or 15.9% of net sales, in the third quarter of 2003. Thedecrease in the percentage of sales reflects the impact of increased resaleactivity, which had the effect of reducing our operating expense ratios tosales. Because resale activity does not incur any significant selling, generaland administrative costs, we believe it is more informative to discuss suchcosts as a percentage of sales, excluding such resale activity. Excluding theimpact of the resale activity, SG&A expenses for the successor andpredecessor periods of 2004 were 17.2% and 18.0%  of net sales,respectively, as compared to 16.7% of net sales duringthe third quarter of 2003. The increase in these expenses as a percentage ofsales is primarily attributable to the increased labor costs associated withadjustments to pharmacists’ labor rates in response to increases in marketsalary rates for these professionals, increased advertising and promotionalexpenses to stimulate sales and higher legal and litigation related expenses.

Depreciation and amortization of intangibles amountedto $7.3 million and $3.6 million for the July 31, 2004 through September 25,2004 and June 27, 2004 through July 30, 2004 periods, respectively,versus $8.2 million in the third quarter of 2003. This increase resulted fromthe depreciation of capital expenditures made in 2003 and 2004 as well asincreases in the amortization of identifiable intangibles, a major portion ofwhich resulted from pharmacy acquisitions completed since the third quarter of2003. In addition, as at July 30, 2004, in accordance with the purchase accountingrequirements of FAS 141, certain intangible assets (primarily store leases andpharmacy customer files) were written-up to their estimated fair value,resulting in incremental amortization expense of $2.1 million being recordedsubsequent to that date.

We incurred store pre-opening expenses of $0.4 millionin the July 31, 2004 through September 25, 2004 period, and $0.1million in the June 27, 2004 through July 30, 2004 period, related tothe opening of seven stores and two stores, respectively. In the third quarterof last year, we incurred pre-opening costs of $0.2 million, attributable tothe opening of three stores.

Net interest expense for the July 31, 2004through September 25, 2004 period was $6.3 million, and for the June 27,2004 through July 30, 2004 period was $1.3 million. In the third quarterof 2003, net interest 

27

----

expense amounted to $3.4million. This increase was primarily attributable to the higher interest costsand increased debt in the current year’s successor period that was associatedwith the new debt structure resulting from the Acquisition, as compared to thelower debt levels and interest rates incurred on our revolving creditborrowings and convertible notes in the prior year.

In the third quarter of 2003, we recorded a debtextinguishment charge of $0.7 million, reflecting the accelerated amortizationof the remaining deferred financing fees related to our term loans and existingrevolver facility which were fully repaid in connection with the July 2003refinancing of our Senior Credit Agreement with an asset-based revolving creditfacility.

In the period from July 31,2004 through September 25, 2004, we recorded an income tax benefit of $32.5million, reflecting an effective tax rate of 46.1%, inclusive of theanticipated benefits of employment tax credits. In the period from June 27,2004 through July 30, 2004, the income tax benefit of $1.7 millionreflects (i) an effective tax rate of 25.5% applied to the pre-taxperformance for that period and (ii) a retroactive adjustment applied tothe pre-tax results for the first six months of 2004, to reduce the effectivetax rate from the 39.9% rate previously applied to the adjusted predecessorperiod 25.5% effective rate. In the comparable period last year, the income taxprovision of $1.6 million reflected an estimated effective tax rate of 44.1%,inclusive of the anticipated benefits of employment tax credits. The employmenttax credits represent the economic benefits earned by us for our participationin various federal and state hiring incentive programs. The decrease in thecurrent year’s effective rate reflects the combined impact of the employmenttax credits and the reduced levels of pre-tax income generated by us.

**ThePeriod from July 31, 2004 through September 25, 2004 for theSuccessor and the period from December 28, 2003 through July 30, 2004for the Predecessor Compared to the Nine Months Ended September 27, 2003for the Predecessor**

For the period fromJuly 31, 2004 through September 25, 2004, we achieved sales of $238.1 million and sustained anet loss of $38.0million, and for the period from December 28, 2003 through July 30,2004, we achieved net sales of $927.8 million and generated net income of $3.3million, as compared to aggregate net sales of $1.1 billion and net income of$9.2 million in the first nine months of the previous year. Resales ofpharmaceutical retail inventory were $20.5 million and $81.0 million in thesuccessor and predecessor periods of 2004, respectively, as compared to $54.4million in the first nine months of 2003. For the 2004 periods subsequent toand prior to the Acquisition, gross profit margins were 18.5% and 19.7%, respectively, ascompared to 20.4% in the first nine months of last year. The lower gross profitmargin in the successor period compared to the predecessor periods wasprimarily attributable to the increased resale activity as well as increasedoccupancy costs for new stores. Selling gross profit margins excluding storeoccupancy expenses increased over the previous year in both the predecessor andsuccessor periods. Although gross profit margins for the predecessor periodwere higher against the prior year, net income declined principally due to thefollowing factors:

·       Pre-taxtransaction expenses of $37.1 million in the successor period ended September 25,2004 and $3.0 million in the predecessor period ended July 30, 2004 thatwere related to the Acquisition, including certain change-of-control paymentsto management and contractual fees payable to Oak Hill upon consummation of thetransaction;

·       Expensesassociated with the CEO Supplemental Executive Retirement Plan termination andother compensation related costs incurred in connection with the Acquisition;

·       Anincrease in amortization expense of $2.1 million in the current year’ssuccessor period attributable to the preliminary acquisition related purchaseaccounting adjustments to the valuation of store leases and prescriptionpharmacy files under FAS 141. The balance of the increase is attributable tothe depreciation of capital expenditures and amortization of intangiblesacquired in 2003 and 2004 that impact both the successor and predecessorperiods of the current year;

28

----

·       Pre-taxlabor contingency expenses of $3.3 million related to a National LaborRelations Board ruling in a collective bargaining agreement litigation relatedto the funding of certain employee benefit funds (see Note 3 to the UnauditedConsolidated Interim Financial Statements);

·       Increasedadvertising and promotional expenses in both the successor and predecessorperiods of the current year to stimulate sales; and

·       Increasedlegal and litigation related expenses associated with certain labor issues, ourattempt to recover the balance of our World Trade Center business interruptioninsurance claim and various other matters, as well as $0.6 million related to alitigation settlement.

Thefollowing sets forth the results of operations for the periods indicated:
| ** **                                            | ** ** | **Successor—Restated**                                                          | ** ** | **Predecessor—Restated**                                                       | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **Period from  July 31, 2004  through  September 25, 2004** | ** ** | **Period from  December 28, 2003  through  July 30, 2004** | ** ** | **For the 39 Weeks  Ended  September 27, 2003** | ** ** |
| **In thousands, except percentages**   | ** ** | ** **                                                                           | ** ** | **Dollars**                                                                         | ** ** | **% of Sales** | ** ** | **Dollars** | ** ** | **% of Sales** | ** ** | **Dollars** | ** ** | **% of Sales** | ** ** |
| Net sales                                             |       | $                                                                                    | 238,050    |                                                                                |       | 100.0 | % |   | $ | 927,801 |   |   | 100.0 | % |   | $ | 1,081,832 |   |   | 100.0 | % |   |
| Cost of sales                                         |       | 194,116                                                                              |       |                                                                                | 81.5       |   |   | 745,090 |   |   | 80.3 |   |   | 861,405 |   |   | 79.6 |   |   |
| Gross profit                                          |       | 43,934                                                                               |       |                                                                                | 18.5       |   |   | 182,711 |   |   | 19.7 |   |   | 220,427 |   |   | 20.4 |   |   |
| Selling, general  & administrative expenses  |       | 37,418                                                                               |       |                                                                                | 15.7       |   |   | 142,293 |   |   | 15.3 |   |   | 168,083 |   |   | 15.5 |   |   |
| Labor contingency  expense                            |       | 689                                                                                  |       |                                                                                | 0.3        |   |   | 2,611 |   |   | 0.3 |   |   | — |   |   | — |   |   |
| Transaction  expense                                  |       | 37,118                                                                               |       |                                                                                | 15.6       |   |   | 3,005 |   |   | 0.3 |   |   | — |   |   | — |   |   |
| Depreciation and  amortization                        |       | 7,280                                                                                |       |                                                                                | 3.1        |   |   | 21,902 |   |   | 2.4 |   |   | 23,874 |   |   | 2.2 |   |   |
| Store pre-opening  expenses                           |       | 366                                                                                  |       |                                                                                | 0.2        |   |   | 470 |   |   | 0.1 |   |   | 798 |   |   | 0.1 |   |   |
| Other                                                 |       | 25,291                                                                               |       |                                                                                | 10.6       |   |   | — |   |   | — |   |   | — |   |   | — |   |   |
|                                                  |       | 108,162                                                                              |       |                                                                                | 45.4       |   |   | 170,281 |   |   | 18.4 |   |   | 192,755 |   |   | 17.8 |   |   |
| Operating (loss)  income                              |       | (64,228                                                                              | )          |                                                                                | (27.0      | ) |   | 12,430 |   |   | 1.3 |   |   | 27,672 |   |   | 2.6 |   |   |
| Interest expense,  net                                |       | 6,283                                                                                |       |                                                                                | 2.6        |   |   | 7,977 |   |   | 0.9 |   |   | 10,452 |   |   | 1.0 |   |   |
| Debt  extinguishment                                  |       | —                                                                               |       |                                                                                | —     |   |   | — |   |   | — |   |   | 812 |   |   | 0.1 |   |   |
| (Loss) income  before income taxes                    |       | (70,511                                                                              | )          |                                                                                | (29.6      | ) |   | 4,453 |   |   | 0.5 |   |   | 16,408 |   |   | 1.5 |   |   |
| Income tax  (benefit) provision                       |       | (32,473                                                                              | )          |                                                                                | (13.6      | ) |   | 1,136 |   |   | 0.1 |   |   | 7,225 |   |   | 0.7 |   |   |
| Net (loss) income                                     |       | $                                                                                    | (38,038    | )                                                                                   |       | (16.0 | )% |   | $ | 3,317 |   |   | 0.4 | % |   | $ | 9,183 |   |   | 0.8 | % |   |
|                                                       |            |                                                                                      |            |                                                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Net sales were $238.1 million in the July 31,2004 through September 25, 2004 period and $927.8 million in the December 28,2003 through July 30, 2004 period. Overall, sales increased by 7.8% ascompared to net sales of $1.1 billion for the first nine months of 2003. Resaleactivity accounted for 4.3% of this increase, while normal retail sales tocustomers increased by 3.5% over this period. Same-store sales increased by0.8% over the comparable period last year with the balance of the increasecoming from the full nine month results of 11 net new stores opened in thefirst nine months last year and 16 net new stores opened since the end of lastyear’s third quarter.

Pharmacy sales increased from $502.2 million in thefirst nine months of 2003 to $585.7 million in the first nine months of 2004,an increase of 16.6%, and represented 50.2% of total sales, as compared with46.4% of total sales in the first nine months of 2003. Resale activity in 2004accounted for 9.4% of the pharmacy sales increase. Pharmacy same-store salesincreased by 5.4% over last year, and third-party reimbursed pharmacy salesrepresented 92.2% of total prescription sales compared to 91.3% in the sameperiod last year. Pharmacy same-store sales continued to experience the generalindustry trend of reduced growth rates experienced during fiscal 2003. Themajor factors driving the slower sales growth rates in pharmacy were the trendstoward increases in third party plan customer co-payments, reduced sales of 

29

----

hormonal replacementdrugs, limitations on maximum reimbursements for certain generic medications bythird party plans, increased penetration by mail order and internet-basedpharmacies and continued high rates of unemployment that have reduced thenumber of customers covered by insured plans.

Front-end sales increased from $579.6 million in thefirst nine months of 2003 to $580.1 million in the first nine months of 2004,an increase of 0.1%, and represented 49.8% of total sales, as compared to 53.6%of total sales in the first nine months of 2003. Front-end same-store salesdeclined by 2.8%, partly due to declining tobacco sales in metro New York City,which has experienced increased restrictions on smoking in public places alongwith higher taxes on tobacco products. Excluding tobacco sales, front-endsame-store sales decreased by approximately 1.5%. We believe that the remainingdecline in same-store front-end sales is largely attributable to the continuedhigh unemployment rates in New York City that have restrained consumer demand.

During the period from July 31, 2004 through September 25,2004, we opened seven stores and closed one store, and from December 28,2003 through July 30, 2004 we opened nine stores and closed one store, ascompared to fourteen stores opened and three stores closed during the ninemonths ended September 27, 2003.

Cost of sales as a percentage of net sales was 81.5% for the period from July 31,2004 through September 25, 2004 and 80.3% for the period from December 28,2003 through July 30, 2004, resulting in gross profit margins of 18.5%and 19.7%, respectively. In the first nine months of 2003, cost of sales as apercentage of net sales was 79.6%, resulting in a gross profit margin of 20.4%.As discussed above, the lower gross profit margin results are primarilyattributable to increased resale activity combined with additional new storeoccupancy costs that could not be leveraged against the modest sales growthexperienced during the current year. Cost of sales also includes (i) a$1.0 million LIFO provision in the current year, as compared to a LIFOprovision of $0.5 million in the prior year, and (ii) real-estate relatedincome of $2.1 million and $1.4 million in the first nine months of 2004 and2003, respectively.

Selling, general and administrative expenses were$37.4 million, or 15.7% of net sales, and $142.3 million or 15.3% of netsales, in the July 31, 2004 through September 25, 2004 period and theDecember 28, 2003 through July 30, 2004 periods, respectively, ascompared to $168.1 million, or 15.5% of net sales, in the first nine months of2003. The decrease in the percentage of sales reflects the impact of increasedresale activity, which had the effect of reducing our operating expense ratiosto sales. Because resale activity does not incur any significant selling,general and administrative costs, we believe it is more informative to discusssuch costs as a percentage of sales, excluding such resale activity. Excludingthe impact of the resale activity, SG&A expenses for the successor andpredecessor periods of 2004 were 17.2% and 16.8%  of net sales, respectively, ascompared to 16.4% of net sales duringthe first nine months of 2003. The increase in these expenses as a percentageof sales is primarily attributable to (i) increased store labor andrelated expenses associated with higher salary rates for pharmacists in lightof increased competition for these professionals that has been caused by anoverall shortage in the available workforce, (ii) increased legal andlitigation related expenses primarily associated with our efforts to recoverour September 11 business interruption insurance claim and various unionlabor litigations, (iii) higher promotional and advertising costs tostimulate sales, (iv) increased litigation settlement costs and (v) severancecosts associated with certain administrative staff reductions incurred duringthe first quarter.

Depreciation and amortization of intangibles amountedto $7.3 million and $21.9 million for the July 31, 2004 through September 25,2004 and December 28, 2003 through July 30, 2004 periods,respectively, versus $23.9 million in the first nine months of 2003. Thisincrease resulted from the depreciation of capital expenditures made in 2003and 2004 as well as increases in the amortization of identifiable intangibles,a major portion of which resulted from pharmacy acquisitions completed sincethe beginning of 2003. In addition, as at July 30, 2004, in accordancewith the purchase accounting requirements of FAS 141, certain intangible assets(primarily store leases and pharmacy customer files) 

30

----

were written-up to theirestimated fair value, resulting in incremental amortization expense of $2.1million being recorded subsequent to that date.

We incurred store pre-opening expenses of $0.4 millionin the July 31, 2004 through September 25, 2004 period, and $0.5million in the December 28, 2003 through July 30, 2004 period,related to the opening of seven stores and nine stores, respectively. In thecomparable nine month period last year, we incurred pre-opening costs of $0.8million, attributable to the opening of 14 stores.

Net interest expense for the July 31, 2004through September 25, 2004 period was $6.3 million, and for the December 28,2003 through July 30, 2004 period was $8.0 million. In the comparableperiod of 2003, net interest expense amounted to $10.5 million. This increasein the current year was primarily attributable to the interest costs associatedwith increased debt and higher interest rates associated with our new debtstructure resulting from the Acquisition.

In the first nine months of 2003, we recorded a debtextinguishment charge of $0.8 million, reflecting (i) the payment of earlytermination premiums related to the retirement of the $1.6 million outstandingbalance of the 9.25% senior notes and the write-off of the remaining deferredfinancing costs associated with those notes and (ii) the acceleratedamortization of the remaining deferred financing costs related to our termloans and existing revolver facility which were fully repaid in connection withthe July 2003 refinancing of our Senior Credit Agreement with anasset-based revolving credit facility.

In the period from July 31,2004 through September 25, 2004, we recorded an income tax benefit of $32.5million, reflecting an effective tax rate of 46.1%, inclusive of theanticipated benefits of employment tax credits. In the period from December 28,2003 through July 30, 2004, the income tax provision of $1.1 millionreflects an effective tax rate of 25.5%, inclusive of the anticipated benefitsof employment tax credits. In the comparable period last year, the income taxprovision of $7.2 million reflected an estimated effective tax rate of 44.0%,inclusive of the anticipated benefits of employment tax credits. The employmenttax credits represent the economic benefits earned by us for our participationin various federal and state hiring incentive programs.

**Liquidity and Capital Resources**

**Working Capital and Cash Flow**

Working capital was $75.1million as of September 25, 2004 and $155.9 million as of December 27, 2003.Working capital reflects the classification of outstanding borrowings under ourrevolving loan facility of $152.9 million at September 25, 2004 and $70.4million at December 27, 2003 as current liabilities. This current classificationis required because cash receipts controlled by the lenders are used to reduceoutstanding debt, and we did not meet the criteria of FAS 6 to reclassify thedebt as long-term but is not an indication that this credit facility isexpected to be retired within the next year. This facility expires in July of2008 and we intend to continue to access it for our working capital needsthroughout its remaining term.

Net cash used in operating activities was $22.0million in the period from July 30, 2004 through September 25, 2004and net cash provided by operations was $21.6 million in the period from December 28,2003 through July 30, 2004 compared to cash provided by operations of$29.8 million in the first nine month of 2003. Cash Acquisition transaction relatedexpenses of $38.2 million accounted for the use of cash in the successorperiod.

Net cash used in investing activities was $425.9million and $32.5 million, in the periods from July 30, 2004 through September 25,2004 and December 28, 2004 through July 30, 2004, respectively,compared to $45.8 million in the first nine months of 2003. The increase in thesuccessor period primarily represents the $413.7 million cash cost of acquiringthe Company. In addition, capital expenditures in the current year of $22.1million declined by $12.4 million while lease acquisition, pharmacy customerfile and other costs of $22.6 million increased by $11.3 million versus theprevious year.

31

----

Net cash provided byfinancing activities was $447.9 million and $11.0 million in the periods from July 30,2004 through September 25, 2004 and December 28, 2003 through July 30,2004, respectively, compared to net cash provided by financing activities of$13.1 million in the first nine months of 2003. The increase in cash provided byfinancing activities in the current year was primarily attributable to theequity contribution received and the new debt incurred in connection with theAcquisition.

**The Acquisition**

The July 30, 2004Acquisition was financed as an all cash transaction whereby our common stockoutstanding immediately prior to the Acquisition was converted into the rightto receive $16.50 per share, without interest. The total transaction value,including transaction expenses and the repayment of indebtedness was approximately$744 million, which was funded through new equity investments of approximately$244 million and debt of approximately $500 million. Upon closing ofthe Acquisition, we had approximately $90.4****millionof borrowing availability under our Amended Credit Agreement, net of $2.9million reserved for standby letters of credit.

**Operating CapitalRequirements**

Our operating capitalrequirements primarily result from opening and stocking new stores, remodelingand renovating existing retail locations, purchasing pharmacy files and thecontinuing development of management information systems. We opened a total of17 stores in 2003, a decline from 32 stores opened in 2002 and 31 stores openedin 2001. We opened 16 new stores in the nine month year-to-date period in 2004and currently plan to open approximately 0-2 additional new stores duringthe remainder of this year (a total of 16-18 for all of 2004), and 10-12new stores in each of fiscal 2005 through fiscal 2008. We expect to spendapproximately $40.0 million in 2004 on capital expenditures, primarily for new,renovated and replacement stores, and an additional $14 million - $17 millionfor lease acquisition, pharmacy customer files and other costs. We also requireworking capital to support inventory for our existing and new stores.Historically, we have been able to lease almost all of our store locations, soacquisitions of real estate are not expected to have a significant impact onour capital requirements.

**OtherFactors Influencing our Liquidity**

Ten of our stores whichgenerated approximately 4.1% of our net sales for fiscal 2003 have leasesscheduled to expire before the end of fiscal 2005. One of these leases has arenewal option. We believe that we will be able to renew the other expiringleases on economically favorable terms or, alternatively, find othereconomically attractive locations to lease.

As of September 25,2004, approximately 4,600 of our approximately 6,500 employees were representedby various labor unions and were covered by collective bargaining agreements.Pursuant to the terms of the collective bargaining agreements covering theseemployees, we are required, in some instances, to pay specified annualincreases in salary and benefits contributions relating to the memberemployees. We do not believe that these increases will have a material impacton our liquidity or results of operations. Our collective bargaining agreementwith Local 340A New York Joint Board, UNITE AFL-CIO (“UNITE”), whorepresents approximately 700 of our employees in 113 stores, expired on March 31,2004. The terms of the expired contract have been extended by the mutualconsent of UNITE and Duane Reade through November 30, 2004 while wecontinue to negotiate the terms of a new agreement.

Under an employmentagreement with our Chairman and CEO originally entered into in 1997 andsubsequently amended in 2000 and 2001, and then amended and restated in 2002,and again amended and restated in connection with the completed Acquisition, wewere required to fund premiums for a split dollar life insurance policy thatwould provide certain post-retirement benefits. During fiscal 2003 and fiscal2004, the annual premiums amounted to $5.0 million, and were scheduled toremain at $5.0 million 

32

----

per yearthrough 2010. The enactment of the Sarbanes-Oxley Act has resulted in the needfor additional guidance concerning the permissibility of split dollar lifeinsurance policies for executives. While we believe this split dollar policy ispermitted under current interpretations of the legislation, there can be noassurance that further interpretations or guidance to be provided by the SECconcerning this legislation will concur. Upon completion of the Acquisition,under Mr. Cuti’s amended and restated employment agreement, we elected toterminate the split dollar life insurance contract in exchange for, among otherthings, the payment to Mr. Cuti of $6.5 million on or prior to December 1,2004, $14.0 million on or prior to January 1, 2005 and $4.0 million on orprior to June 30, 2005. The parties to Mr. Cuti’s employmentagreement agreed to accelerate a portion of the first payment of $6.5 million,in the amount of $1.5 million, which was paid on August 12, 2004. Aportion of these payment obligations will be satisfied either using the cashsurrender value of the split dollar life insurance contract at the time weelect to terminate it (approximately $14.0 million as of September 30,2004) or by transferring ownership of the split dollar life insurance contractto Mr. Cuti.

The Acquisition resulted ina restructuring of our debt, as well as the elimination of our obligationsunder the CEO Split Dollar Life Insurance Policy, in exchange for certaindirect payments to our Chief Executive Officer. The following table presentsdetails of our significant Commitments and Obligations as at September 25,2004, except that the data provided with respect to operating leases is as of December 27, 2003:

**Payments due by Period(dollars in thousands)**
| **Contractual Cash Obligations—Restated** | ** ** | ** ** | ** ** | **Total** | ** ** | **Within  1 year** | ** **     | **2-3 years** | ** ** | **4-5 years** | ** ** | **After  5 years** | ** ** |
|----------------------------------------------------------|------------|------------|------------|-----------|------------|-------------------------|----------------|--------------------|------------|--------------------|------------|-------------------------|------------|
| Debt(1)                                                  |       | $          | 502,971    |      | $          | 152,939                 |           | $                  | —     |               | $          | —                  |       | $ | 350,032 |   |
| Capital Lease  Obligations                               |       | 2,970      |       | 762       |       | 1,472                   |           | 736                |       | —             |       |
| Operating Leases                                         |       | 1,195,902  |       | 111,028   |       | 219,048                 |           | 202,006            |       | 663,820            |       |
| CEO SERP Termination                                     |       | 23,000     |       | 23,000    |       | —                  |           | —             |       | —             |       |
| Fixed Interest Payments(2)                               |       | 133,088    |       | 19,013    |       | 38,025                  |           | 38,025             |       | 38,025             |       |
| Total Contractual Cash Obligations                       |       | $1,857,931 |       | $         | 306,742    |                    | $258,545  |               | $240,767   |               | $1,051,877 |                    |
|                                                          |            |            |            |           |            |                         |                |                    |            |                    |            |                         |            |  |  |  |  |  |

----

(1)   AtSeptember 25, 2004, approximately $152.9 million was outstanding under ouramended asset-based revolving loan agreement. Obligations under this facilityhave been classified as current liabilities because cash receipts controlled bythe lenders are used to reduce outstanding debt, and we do not meet thecriteria of FAS 6 to reclassify the debt as long-term. We intend to continue toutilize this facility for our working capital needs through the date of itsmaturity in July 2008.

(2)   Reflectsinterest payable on $195.0 million outstanding under the senior subordinatednotes.

We currently have $307.9million of variable rate debt outstanding. Assuming a constant weighted averageinterest rate of 4.09%, we estimate that our future interest payable on suchdebt would be $12.6 million within one year, $25.2 million within two to threeyears, $17.7 million within four to five years and $5.3 million thereafter.

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

33

----

In connection with theAcquisition, Mr. Cuti was granted equity interests in Duane ReadeShareholders and Duane Reade Holdings consisting of options to purchase sharesof Duane Reade Holdings common stock and a profits interest in Duane ReadeShareholders. Upon the occurrence of certain events, including the fifthanniversary of the effective date of the Acquisition, Mr. Cuti will havethe right to require us to purchase for cash over a two year period all or aportion of these equity interests as he may designate, at fair market valuedetermined in accordance with a formula. The profits interest and options willhave no value unless the value of Duane Reade Shareholders and Duane ReadeHoldings, respectively, appreciate following the Acquisition. Mr. Cuti’spurchase right will be suspended at any time when the exercise of such purchaserights would result in a default under the financing arrangements of us, DuaneReade Shareholders or Duane Reade Holdings. Mr. Cuti’s purchase right willalso terminate upon certain public offerings by us, Duane Reade Shareholders orDuane Reade Holdings.

At September 25,2004, we recorded a litigation-related non-current liability of$15.9 million in connection with a National Labor Relations Board decisionin a litigation-related matter with the Allied Trades Council, a unionrepresenting employees in 139 of our stores. Because this decision is theinitial phase of a complex administrative and judicial process, the ultimateoutcome, financial impact and related timing of any future cash disbursementrelating to this matter cannot be determined at this time. This matter is morefully described in Note 3 to the Unaudited Consolidated Interim FinancialStatements.

**Off-Balance SheetArrangements**

We are not a party to anyagreements with, or commitments to, any special purpose entities that wouldconstitute material off-balance sheet financing other than the operating leasecommitments detailed in the Contractual Obligations and Commitments tablepresented above.

**Debt**

Prior to the Acquisition,our debt structure had two primary components, consisting of Convertible Notesand the Credit Agreement.

**Convertible Notes**

The Convertible Notes wereissued on April 16, 2002 at a discounted value equivalent to 57.276% offace value. The Convertible Notes paid cash interest semiannually at a rate of2.1478% of face value for the first five years and thereafter accrued originalissue discount at a semi-annual bond equivalent rate of 3.75% yield to maturityon April 16, 2022. The Convertible Notes were convertible into shares ofour common stock upon the occurrence of certain specified events. Holders ofthe Convertible Notes could require us to purchase all or a portion of theConvertible Notes on each of the 5, 10 and 15-year anniversaries of theissuance date at pre-specified prices. We could redeem for cash all or aportion of the Convertible Notes at any time after April 16, 2007 at a priceequal to the sum of the issue price plus accrued original issue discount andaccrued cash interest, if any, to the redemption date.

The Acquisition was deemedto be a “change of control” under the indenture governing the ConvertibleNotes. As a result, within 15 days after the completion of the Acquisition, wewere required to notify the holders of the Convertible Notes of their option torequire us to purchase the notes. On August 12, we initiated a cash tenderoffer in order to satisfy our repurchase obligation under the indenture. Thetender offer provided that we would pay each holder the purchase price of$572.76 per $1,000 of principal value, plus accrued interest calculated fromthe previous payment date of April 16, 2004, through the expiration dateof the tender offer. The tender offer expired on September 10, 2004, atwhich point all but $55,000 of principal value of the total $351.0 millionoutstanding principal value of the notes were tendered for repurchase. On September 13,2004, we paid the paying agent, US Bank National Association, a total of $204.1million, representing $201.0 million of purchase price redemption and $3.1million of accrued interest. We used a portion of the funds raised to financethe Acquisition combined with additional borrowings on our revolving creditagreement to finance the repurchase of these notes.

34

----

In connection with theconsummation of the Acquisition, we, Duane Reade Shareholders, LLC, theindirect parent of Duane Reade Inc., and each of our subsidiaries that areguarantors of the Convertible Notes entered into a supplemental indenture. Pursuantto the supplemental indenture, as a result of the merger of Duane ReadeAcquisition Corp. with and into Duane Reade Inc., the Convertible Notes mayonly be converted into the right to receive from us $16.50 (in cash and withoutinterest) per share of our common stock issuable to a holder of ConvertibleNotes in connection with such conversion.

**Credit Agreement**

On July 21, 2003, weentered into a new credit facility (the “Credit Agreement”). This CreditAgreement is an asset-based revolving loan which used a pre-determinedpercentage of the current value of our inventory and selected accountsreceivable to calculate the availability of funds eligible to be borrowed up toan aggregate principal amount of $200 million. Prior to the amendment describedbelow, our obligations under the Credit Agreement were collateralized bysubstantially all of our assets. In addition, the Credit Agreement wasguaranteed by each of our corporate subsidiaries, and such guarantees werecollateralized by substantially all assets of such guarantors. The CreditAgreement is set to mature on July 20, 2008.

The Credit Agreementcontains a single fixed charge coverage requirement which only becomesapplicable when borrowings exceed 90 percent of the borrowing base, as definedin the Credit Agreement. Borrowings under the Credit Agreement have notexceeded 90 percent of the borrowing base and, as a result, the fixed chargecovenant did not become applicable during the period. There are no creditratings related triggers in the Credit Agreement that would impact the cost ofborrowing, annual amortization of principal or related indebtedness maturity.

On July 22, 2004, inconnection with the Acquisition, the Credit Agreement was amended (the “AmendedCredit Agreement”) to increase our borrowing capacity to an aggregate principalamount of $250 million, subject to an adjusted borrowing base calculation basedupon specified advance rates against the value of our inventory, customerprescription files and selected accounts receivable. The Amended CreditAgreement includes a $50 million sub-limit for the issuance of letters ofcredit. Obligations under the amended asset-based revolving loan facility arecollateralized by a first priority security interest in inventory, receivables,pharmacy prescription files, deposit accounts and certain other current assets.Under the amended facility, Duane Reade GP is the borrower. The amendedfacility is guaranteed by Duane Reade Holdings, us and each of our domesticsubsidiaries other than Duane Reade GP. Revolving loans under the AmendedCredit Agreement, at our option, bear interest at either (i) a rate equalto LIBOR (the London Interbank Offered Rate) plus a margin of from 1.50% to2.00%, determined based on levels of borrowing availability reset each fiscal quarteror (ii) a rate equal to the prime rate of Banc of America Retail GroupInc. plus a margin of from 0.00% to 0.50%, determined based on levels ofborrowing availability reset each fiscal quarter. Borrowings under the amendedfacility continue to be primarily LIBOR-based.

At September 25, 2004there was $152.9 million outstanding under the revolving credit facility, andapproximately $93.7 million of remaining availability, net of $2.9 millionreserved for standby letters of credit. Obligationsunder this facility have been classified as current liabilities because cashreceipts controlled by the lenders are used to reduce outstanding debt, and wedo not meet the criteria of FAS 6 to reclassify the debt as long-term. Weintend to continue to utilize this facility for our working capital needsthrough the date of its maturity in July 2008.

35

----

**Acquisition-RelatedDebt Financings**

**Senior Term LoanFacility**

On July 30, 2004, inconnection with the Acquisition, we entered into a Senior Term Loan in theprincipal amount of $155 million. This loan will mature on July 30, 2010.While there are no scheduled principal payments over its term, we will berequired to prepay the senior term loan together with accrued interest thereon,with (a) all net cash proceeds (i) from sales of property and assetsfrom Duane Reade Holdings and its subsidiaries (excluding sales of inventory inthe normal course of business and certain other exceptions described in theSenior Term Loan), (ii) of extraordinary receipts, casualties and condemnationsas defined in the Senior Term Loan and (iii) from the issuance orincurrence of additional debt of Duane Reade Holdings or any of itssubsidiaries other than certain identified indebtedness permitted under theSenior Term Loan, (b) 50.0% of all net cash proceeds from the issuance ofadditional equity of Duane Reade Holdings or any of its subsidiaries (excludingequity issued to Oak Hill and other exceptions specified in the Term Loan) and (c) 50.0%of excess cash flow of Duane Reade Holdings and its subsidiaries (beginningwith the fiscal year ending December 2005). Loans under the Senior TermLoan facility will, at our option, bear interest at a rate per annum of (i) thereserve-adjusted LIBOR plus an applicable margin of 3.25%; or (ii) 2.25%,plus the higher of (a) the prime rate of Bank of America, N.A. and (b) theFederal Funds rate plus 0.50%. Duane Reade GP became a co-obligor under theSenior Term Loan upon the closing of the Acquisition. All obligations under theSenior Term Loan are guaranteed by Duane Reade Holdings and each of ourexisting subsidiaries, other than Duane Reade GP, and will be guaranteed byfuture subsidiaries except certain foreign subsidiaries. The Senior Term Loanis collateralized by a first priority security interest in substantially all ofour assets other than those assets in which the lenders under the AmendedCredit Agreement have a first priority interest. The Senior Term Loan is alsocollateralized by a second priority security interest in all collateral pledgedon a first priority basis to lenders under the Amended Credit Agreement. TheSenior Term Loan also contains affirmative and negative covenants customary fora senior term loan facility, including, among other things, restrictions onindebtedness, liens, mergers and consolidations, sales of assets, loans,acquisitions, joint ventures, restricted payments, transactions withaffiliates, dividends and other payment restrictions affecting subsidiaries andsale leaseback transactions. The Senior Term Loan also requires Duane ReadeHoldings and its subsidiaries to maintain a maximum leverage ratio and aminimum interest coverage ratio. We are in compliance with all of these debtrelated financial covenants. There are no credit ratings related triggers inthe Senior Term Loan Facility that would impact the cost of borrowing, annualamortization of principal or related indebtedness maturity.

**$195Million 9**3¤4% SeniorSubordinated Notes Due 2011

On July 30, 2004,upon completion of the Acquisition, we entered into an Indenture for $195million of 93¤4%Senior Subordinated Notes due 2011 (the “Senior Subordinated Notes”). TheSenior Subordinated Notes mature on August 1, 2011 and bear interest at9.75% per annum payable in semi-annual installments on February 1 and August 1,commencing February 1, 2005, to the holders of record on the immediatelypreceding January 15 and July 15. The Senior Subordinated Notes areuncollateralized obligations and subordinated in right of payment to all of ourexisting and future unsubordinated indebtedness, including borrowings under theAmended Credit Agreement (as defined above) and the Senior Term Loan (asdefined above). The Senior Subordinated Notes will rank equally with any futuresenior subordinated indebtedness and senior to any future subordinatedindebtedness. The Senior Subordinated Notes are guaranteed on anuncollateralized, senior subordinated basis by all of our existing direct andindirect subsidiaries other than Duane Reade GP, which is a co-obligor underthe Senior Subordinated Notes. We may redeem the Senior Subordinated Notes, inwhole or in part, at any time on or after August 1, 2008, at a redemptionprice of 104.875% declining to par on August 1, 2010 plus accrued andunpaid interest. In addition, we, Duane Reade Shareholders or Duane ReadeHoldings, at our option, can redeem up to 35% of the Senior Subordinated Notesbefore August 1, 2007 with the net cash proceeds 

36

----

fromcertain equity offerings. Upon the occurrence of specified change of controlevents, we and Duane Reade GP will be required to make an offer to repurchaseall of the Senior Subordinated Notes at 101% of the outstanding principalamount of the Senior Subordinated Notes plus accrued and unpaid interest to thedate of repurchase. The indenture governing the Senior Subordinated Notescontains certain affirmative and negative covenants that limit our ability toincur additional indebtedness, pay dividends, make repayments on indebtednessthat is subordinated to the Senior Subordinated Notes and to make certain otherrestricted payments, incur certain liens, use proceeds from sales of assets,enter into business combination transactions (including mergers, consolidationsand asset sales), enter into transactions with affiliates and permitrestrictions on the payment of dividends by our subsidiaries. Under aregistration rights agreement entered into as part of the offering of theSenior Subordinated Notes, we are required to (i) file a registrationstatement with the SEC within 120 days after the completion of the Acquisition,(ii) use our reasonable best efforts to cause the registration statementto become effective within 180 days after the completion of the Acquisition,and (iii) use our reasonable best efforts to complete the exchange offerwithin 210 days after the Acquisition is completed. There are no credit ratingsrelated triggers in the Senior Subordinated Notes that would impact the cost ofborrowing, annual amortization of principal or related indebtedness maturity.

**Liquidity Assessment**

We believe that, based oncurrent levels of operations and anticipated growth, cash flow from operations,together with other available sources of funds, including the initial equitycontribution of approximately $240 million discussed above, revolving loanborrowings under our Amended Credit Agreement, our $155 million Senior TermLoan and the $195 million Senior Subordinated Notes will be adequate for thepayment of all of our obligations in connection with the Acquisition and, forat least the next two years, to make required payments on our indebtedness, tofund anticipated capital expenditures and to satisfy our working capitalrequirements. We base this belief on our recent levels of cash flow fromoperations of approximately $47.4 million and $42.5 million in fiscal 2003 andfiscal 2002, respectively, as well as our cash flow from operations, excludingcash costs attributable to the Acquisition, of $38.2 million in the 39 weeksended September 25, 2004, and the significant additional borrowingcapacity under our Amended Credit Agreement which amounted to approximately$90.4 million upon the completion of the Acquisition and approximately $93.7million at September 25, 2004. Our ability to meet our debt serviceobligations and reduce our total debt will depend upon our future performancewhich, in turn, will be subject to general economic, financial, business,competitive, legislative, regulatory and other conditions, many of which arebeyond our control. In addition, our operating results, cash flow and capitalresources may not be sufficient for repayment of our indebtedness in thefuture. Some risks that could adversely affect our ability to meet our debtservice obligations include, but are not limited to, reductions in third partyprescription reimbursement rates, further declines in the New York Cityeconomy, increases in competitive activity, additional adverse legislativechanges or a major disruption of our business in our markets from a terroristevent or natural disaster. Our borrowings under our Amended Credit Agreementand Senior Term Loan bear interest at floating rates. Therefore, our financialcondition will be affected by changes in prevailing interest rates.

**Critical Accounting Policies**

Our discussion of resultsof operations and financial condition relies on our consolidated financialstatements that are prepared based on certain critical accounting policies thatrequire management to make judgments and estimates that are subject to varyingdegrees of uncertainty. We believe that investors need to be aware of thesepolicies and how they impact our financial reporting to gain a more completeunderstanding of our consolidated financial statements as a whole, as well asour related discussion and analysis presented herein. While we believe thatthese accounting policies are grounded on sound measurement criteria, actualfuture events can and often do result in outcomes that can be materially 

37

----

differentfrom these estimates or forecasts. The accounting policies and related risksdescribed in our Annual Report on Form 10-K, as amended, for theyear ended December 27, 2003 are those that depend most heavily on thesejudgments and estimates. At September 25, 2004, there have been nomaterial changes to any of the Critical Accounting Policies contained therein.

**Seasonality**

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

**Inflation**

We believe that inflationhas not had a material impact on our results of operations during the threeyears ended December 27, 2003 or the nine months ended September 25,2004.

**Recently Issued Accounting Pronouncements**

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

**ITEM 3.**                QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our financial results aresubject to risk from interest rate fluctuations on debt, which carries variableinterest rates. Variable rate debt outstanding at September 25, 2004included $152.9 million of borrowings under our Amended Credit Agreement and$155.0 million of term loans. At September 25, 2004, the weighted averagecombined interest rate in effect on all variable rate debt outstanding was 4.09%.A 0.50% change in interest rates applied to the $307.9 million balance offloating rate debt would affect pre-tax annual results of operations byapproximately $1.5 million. In addition, we also have $195.0 million of SeniorSubordinated Notes and $32,000 of Senior Convertible Notes outstanding at September 25,2004. The Senior Subordinated Notes and Senior Convertible Notes bear interestpayable semi-annually at fixed rates of 9.75% and 3.75%, respectively, and aretherefore not subject to risk from interest rate fluctuations.

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

38

----

**ITEM 4.**                CONTROLSAND PROCEDURES

The Company is not an “accelerated filer” within theSEC reporting rules and, as a result, is currently not required to include inits annual reports on Form 10-K management’s assessment of the effectiveness ofits internal controls over financial reporting (as defined in Rules 13a-15(f)and 15d-15(f) under the Securities Exchange Act of 1934, as amended) pursuantto Section 404 of the Sarbanes-Oxley Act of 2002.

**

(a)   *Evaluation of Disclosure Controls and Procedures.*   An evaluation was carried out under the supervisionand with the participation of the Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures (as defined inRules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) as ofthe end of the period covered by this quarterly report. Based upon that evaluation,the Company’s management, including the Chief Executive Officer and ChiefFinancial Officer, have each concluded that the design and operation of thesedisclosure controls and procedures were not effective as of the end of theperiod covered by this report based on the identification of materialweaknesses in the Company’s internal control over financial reporting describedin the Company’s Annual Report on Form 10-K/A filed on May 16, 2005. Thisconclusion has been changed from the disclosure in the Company’s original Form10-Q filing. For a discussion of the reasons andmatters on which these conclusions were based, as well as the subsequentactions taken by the Company to strengthen its controls and procedures  in theseareas, see Item 9A of the Company’s Annual Report on Form 10-K/A for the fiscalyear ended December 25, 2004, filed on May 16, 2005.

(b)   *Changes in InternalControls over Financial Reporting*.   No changes in our internalcontrol over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f)under the Securities Exchange Act of 1934) occurred during our last fiscalquarter covered by this quarterly report that have materially affected, or arereasonably assured to materially affect, our internal control over financialreporting.

39

----

**PART II**

**OTHER INFORMATION**

**ITEM 1.**                LegalProceedings

We are party to legal actions arising in the ordinarycourse of business. Based on information presently available to us, we believethat we have adequate legal defenses or insurance coverage for these actionsand that the ultimate outcome of these actions will not have a materiallyadverse effect on the financial position, results of operations or cash flowsof our company. In addition, we are a party to the following legal actions andmatters:

During 2002, we initiated a legal action against ourformer property insurance carrier, in an attempt to recover what we believe tobe a fair and reasonable settlement for the business interruption portion ofour claim originating from the September 11, 2001 World Trade Centerterrorist attack, during which our single highest volume and most profitablestore was completely destroyed. The claim is pending before the United StatesDistrict Court for the Southern District of New York. In September 2003, atrial on certain issues was held regarding some of the matters at issue in thelitigation, including whether we would have obtained a renewal of our lease atthe World Trade Center. We have received a favorable ruling on this and otherlegal issues in the case and now the matter has moved into an appraisalprocess. The appraisal process involves two appraisers and an arbitrator (toresolve differences between the two appraisers) who will determine the amountof insured loss we have sustained. The insurance carrier has appealed a numberof rulings by the trial court. In light of both the early stage of theappraisal process and the inherent uncertainty in litigation relating to ourappeal, the amount of additional insurance proceeds, if any, that we maycollect under the terms of our insurance contract with the defendant cannot bereasonable predicted or determined at this time, and therefore, the Company hasnot accrued any additional income related to this potential settlement. Infiscal 2002, we received an advance of approximately $9.4 million towardthe business interruption claim that was recognized as a separate component ofincome in the consolidated statement of income. In the event of an unfavorableoutcome to us, this amount would not be required to be returned to theinsurance company.

Duane Reade Inc., Anthony J. Cuti, our Chairman,President and Chief Executive Officer, John K. Henry, our Senior Vice Presidentand Chief Financial Officer and Gary Charboneau, our Senior Vice President ofSales and Marketing were named as defendants in connection with theconsolidation of several class action complaints alleging violations of thefederal securities laws that were filed from August 2002 through October 2002.The action, which was in the United States District Court for the SouthernDistrict of New York, was on behalf of shareholders who purchased our commonstock between April 1, 2002 and July 24, 2002, inclusive. Thecomplaint, which sought an unspecified amount of damages, alleged that thedefendants violated the federal securities laws by issuing materially false andmisleading statements during the class period. On December 1, 2003, thedistrict judge granted our motion to dismiss the plaintiff’s action, withprejudice. The plaintiffs subsequently filed an appeal. On August 17,2004, the US Court of Appeals affirmed the district court’s ruling in ourfavor.

We are a defendant in a class action suit in theFederal Court for the Southern District of New York regarding allegedviolations of the Fair Labor Standards Act as to a group of individuals whoprovided delivery services on a contract basis to us. In December 2002,the judge in the action issued a partial summary judgment in favor of asubclass of the plaintiffs and against us. In December 2003, we settledthe issue of the amount of our liability to the plaintiffs without anyadmission of wrongdoing and in an amount consistent with our previouslyestablished reserves. By a decision dated August 4, 2004, the districtcourt awarded the plaintiffs certain attorneys’ fees in this matter. We havefully reserved the amount of the fees in question and have appealed this awardto the US Circuit Court of Appeals

40

----

We are a party to related lawsuits, Irving Kroop, etal. v. Duane Reade, NY, NY et al., 00 Civ. 9841, et al., instituted by thetrustees of several union benefit funds wherein the funds claim that we did notmake certain required contributions to these funds from January 2000through July 31, 2001. By decisions dated August 5, 2004 and September 27,2004, the District Court awarded judgment to the funds on certain aspects oftheir complaints. These partial judgments, for which we have provided adequatereserves, are subject to further appeal by us. The remaining unresolvedportions of the plaintiffs’ claims are still being litigated and accordingly,we intend to continue to vigorously defend ourself in these matters. At thistime, it is not possible to determine the ultimate outcome of this case or theactual amount of additional liability we may face, if any.

We are a party to a National Labor Relations Board (“NLRB”)administrative proceeding regarding a dispute with the Allied Trade Council (“ATC”)over whether a negotiating impasse was reached between us and the union in August of2001. The ATC represents employees in 139 of our stores in a collectivebargaining agreement that expired on August 31, 2001. Our employees havebeen working pursuant to the terms of our December 6, 2001 implementedcontract with the ATC, which expired on August 31, 2004. We believe an impassedid in fact occur and as a result, we had the right to implement our latestcontract proposal at that time which included wage increases, health andwelfare benefits, vacation and sick benefits and a 401k retirement program. Wediscontinued making additional payments into the various funds associated withthe union as we were providing many of these benefits on a direct basis andbecause our past contributions to these funds had caused these funds to be in aposition of excessive overfunding. In addition, we had concerns that our pastpayments into these funds were not being managed in a way to ensure they werebeing properly utilized for the benefit of our employees. On February 18,2004, an Administrative Law Judge (“ALJ”) who had reviewed various mattersrelated to this proceeding issued a decision and related recommendation, whichconcluded that the parties were not at impasse. The remedies recommended by theALJ included, among other things, a requirement for us to make our employeeswhole by reimbursing them for expenses ensuing from the failure to makecontributions to the union funds and to make such funds whole, plus interest.This recommendation was adopted by the full NLRB on September 15, 2004. Ifit is enforced by the circuit court of appeals, it could result in our beingrequired to contribute amounts that have yet to be determined into the union’spension benefit, health and welfare and vacation funds. Any potential requiredcontributions resulting from a final judicial determination of this matterwould potentially be subject to offset by the amounts that we had funded sincewe implemented our final contract proposal for these same benefits that werepaid for our ATC employees. Because the NLRB decision represents the firstphase of a long and complicated administrative process to be followed by a fulljudicial review of all of the facts and circumstances, the final outcome cannotbe reliably determined at this time. The full NLRB decision is subject tojudicial review by the circuit court of appeals and a compliance hearing beforeany financial remedy can be determined. While there can be no definitiveassurance, we have been advised by our outside labor counsel that we havenumerous meritorious defenses and arguments in response to the NLRB’s decision.

In light of the foregoing, while it is our belief thatthe final financial outcome of this litigation cannot be determined, under theprovisions of Statement of Financial Accounting Standard (“FAS”) No. 5which addresses contingencies, we recorded a pre-tax charge of$12.6 million for the year ended December 27, 2003 and additionalpre-tax charges of $1.1 million in each of the quarters ended March 27,2004 and June 26, 2004, $0.4 million in the period from June 27, 2004through July 30, 2004 and $0.7 million in the period from July 31,2004 through September 25, 2004. These charges represent our current bestestimate of the loss that would result upon application of the NLRB’s decision.We note that such charges were based upon the facts available to us at thetime. In our opinion, such charges could be subject to significant modificationin the future, upon review by the Federal Circuit Court of Appeals, completionof a compliance hearing and any appeals relating to the outcome of that hearing.These charges reflect the amount of contributions that we did not make into theunion benefit funds for the period from the August 31, 2001 expiration ofthe contract through September 25, 2004, reduced by a portion of the 

41

----

benefits we paid directlyto or for the benefit of these employees over the same period. It also includesan interest cost for these net contributions from the date they would have beenpaid until September 25, 2004. While this represents our current bestestimate of the NLRB’s decision, we believe that the actual range of loss inthis matter could be from $0, if the NLRB’s decision is not followed, toapproximately $30 million, if the NLRB’s decision is upheld and there isno offset for any benefits paid over this period.

Until such time as further legal developments warranta change in the application of this accounting standard, or until this matteris resolved, we will record additional non-cash pre-tax charges, includinginterest, which are calculated on the same basis as the charge recorded in the2003 financial statements. We currently estimate that the pre-tax chargerecorded during the full 12 months of 2004 will approximate $4.4 million.

We are involved in an ongoing dispute with CardinalHealth, one of our former suppliers of pharmaceutical products. Both partieshave claims against the other involving, among other things, breach ofcontract, promissory estoppel and unjust enrichment. Duane Reade is seekingfrom Cardinal an unspecified amount of damages and punitive damages of at least$20 million. Cardinal is seeking approximately $18 million in damages plusattorney’s fees and interest. While there can be no definitive assurance, webelieve we have counterclaims that offset the claims against us by Cardinal, aswell as meritorious defenses to these claims, and plan to vigorously pursue ouraffirmative claims and to vigorously defend ourself in this action. Non-partydiscovery in the case has concluded and it is expected to go to trial sometimein 2005.

A New York State Tax Appeals Tribunal ruling in amatter involving another company may have an adverse impact upon our New YorkState Franchise Tax filings from years 1999 through 2002. This matter relatesto the required combination of affiliated subsidiaries in recognizing royalty feeand related income for intangible property. The ruling of the Tribunal issubject to further legal appeal and interpretation in light of our own specificfacts and circumstances. The outcome of this matter, and the resulting amountof additional income tax expense, if any, cannot be determined by us at thistime.

***Litigation Relatingto the Merger Transaction:  ***We are aware of sixpurported class action complaints challenging the merger transactionconsummated by us and Duane Reade Acquisition that have been filed in the Courtof Chancery of the State of Delaware, referred to as the “Delaware Complaints,”and three purported class action complaints that have been filed in the SupremeCourt of the State of New York. Two of the New York complaints have beendismissed without prejudice. The other New York complaint (the “New YorkComplaint”) is pending, but has not been served on Duane Reade. The DelawareComplaints name Mr. Cuti and certain other members of our board ofdirectors and executive officers as well as Duane Reade Inc. as defendants.Four of the Delaware Complaints name Oak Hill as a defendant. The New YorkComplaint names Mr. Cuti and certain other members of our board ofdirectors and executive officers as well as Duane Reade Inc. as defendants. Oneof the dismissed New York complaints named Oak Hill as a defendant.

The Delaware Complaintswere consolidated on January 28, 2004, and on April 8, 2004 theplaintiffs in the Delaware actions filed a consolidated class actioncomplaint.We believe these lawsuits are without merit and plan to defend theselawsuits vigorously.

**ITEM 2.**                UnregisteredSales of Equity Securities and Use of Proceeds

Not applicable.

**ITEM 3.**                DefaultsUpon Senior Securities

Not applicable.

42

----

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

Not applicable.

**ITEM 5.**                OtherInformation

We are a voluntary filerand file annual reports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, amendments to those reports and otherinformation with the Securities and Exchange Commission (“SEC”). The public canobtain copies of these materials by contacting the SEC at 1-800-SEC-0330,or by accessing the SEC’s website at *www.sec.gov.*Inaddition, a link to our SEC filings is provided on our website at *www.duanereade.com*.

**ITEM6.**                Exhibits
| Exhibit No. | ** ** | ** **                                                                                                                                                                                                                                                                                                                               | ** ** | **Description** |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 2.1         |       | Agreement  and Plan of Merger (the “Merger Agreement”), dated as of December 22,  2003, by and among Duane Reade Inc., Rex Corner Holdings, LLC and Rex Corner  Acquisition Corp. (incorporated by reference to Exhibit 2.1 to the  Company’s Current Report on Form 8-K filed on December 23, 2003). |
| 2.1(i)      |       | Amendment  No. 1 to the Merger Agreement, dated as of June 10, 2004 (incorporated  by reference to the Company’s Current Report on Form 8-K filed on  June 14, 2004).                                                                                                                                                     |
| 2.1(ii)     |       | Amendment  No. 2 to the Merger Agreement, dated as of June 13, 2004 (incorporated  by reference to the Company’s Current Report on Form 8-K filed on  June 14, 2004).                                                                                                                                                     |
| 2.1(iii)    |       | Amendment  No. 3 to the Merger Agreement, dated as of June 18, 2004 (incorporated  by reference to the Company’s Current Report on Form 8-K filed on  June 21, 2004).                                                                                                                                                     |
| 3.1(i)      |       | Amended  and Restated Certificate of Incorporation of Duane Reade Inc.                                                                                                                                                                                                                                                                   |
| 3.1(ii)     |       | 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  91¤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 (incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 28, 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).                                                                                                                                                                                                                       |
| 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 July 30, 2004, between Duane Reade Acquisition Corp. and U.S.  Bank National Association, as trustee.                                                                                                                                                                                                            |
| 4.2         |       | Successor  Supplemental Indenture governing the initial notes and exchange notes, dated  as of July 30, 2004, between the Company and U.S. Bank National Association,  as trustee.                                                                                                                                                       |
| 4.3         |       | Co-obligor  Supplemental Indenture governing the initial notes and exchange notes, dated  as of July 30, 2004, among the Company, Duane Reade and DRI I Inc., Duane  Reade Realty, Inc. and Duane Reade International, Inc. as guarantors and U.S.  Bank National Association, as trustee.                                               |

43

----

 
| 4.4  |   | Guarantor  Supplemental Indenture governing the initial notes and exchange notes, dated  as of July 30, 2004, among the Company, Duane Reade and DRI I Inc., Duane  Reade Realty, Inc. and Duane Reade International, Inc., as guarantors and U.S.  Bank National Association, as trustee.                                                                                                                                                                                                                                                                                                                                                          |
|------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.5  |   | Form  of Exchange Note (included as Exhibit A1 to Exhibit 4.3 of this 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.6  |   | Registration  Rights Agreement, dated as of July 30, 2004, by and among Duane Reade  Acquisition Corp. and Banc of America Securities LLC, Citigroup Global  Markets Inc., Credit Suisse First Boston LLC and UBS Securities LLC, as  Initial Purchasers.                                                                                                                                                                                                                                                                                                                                                                                           |
| 4.7  |   | 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”)).                                                                                                                                                                                                                                                                                                         |
| 4.8  |   | Form of Senior Convertible Notes due 2022  (incorporated by reference to Exhibit 4.2 to the Convertible Notes S-3).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 4.9  |   | First Supplemental Indenture, dated as of July 30,  2004, among the Company, as issuer, DRI I Inc., Duane Reade Realty, Inc. and  Duane Reade International, Inc. as guarantors and U.S. Bank National  Association, as trustee.                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.1 |   | Duane Reade Inc. Phantom Stock Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.2 |   | Duane Reade Holdings, Inc. Management Stock Option  Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.3 |   | Stockholders and Registration Rights Agreement,  dated as of July 30, 2004, among Duane Reade Holdings, Inc., Duane Reade  Shareholders, LLC and certain members of the management of Duane Reade Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.4 |   | Tax Sharing Agreement, dated as of July 30, 2004,  among Duane Reade Holdings, Inc., and the Subsidiaries as defined therein,  Duane Reade and any parties which become parties thereto.                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.5 |   | Services Agreement, dated as of July 30, 2004,  between Oak Hill Capital Management, Inc. and Duane Reade Acquisition Corp.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.6 |   | $155,000,000 Senior Secured Term Credit Agreement,  dated as of July 30, 2004 among Duane Reade Holdings, Inc., Duane Reade Inc.,  Duane Reade and Bank of America, N.A., as Administrative Agent, Credit Suisse  First Boston, Cayman Islands Branch, as Syndication Agent, Citicorp North  America Inc., Wells Fargo Bank, and National Association, as Co-Documentation  Agents, Banc of America Securities LLC and Credit Suisse First Boston, Cayman  Islands Branch, as Joint Lead Arrangers and Banc of America Securities LLC,  Credit Suisse First Boston, Cayman Islands Branch and Citroen Global Markets  Inc., as Joint Book Managers. |
| 10.7 |   | First Amendment to Credit Agreement, dated as of  July 22, 2004, among Duane Reade, Duane Reade Inc., DRI I Inc., Duane Reade  International, Inc., Duane Reade Realty, Inc., Fleet National Bank, as  Issuing Bank and Administrative Agent, Fleet Retail Group, Inc., as  Collateral Agent, Congress Financial Corporation, as Documentation Agent,  General Electric Capital Corporation as Syndication Agent and Wells Fargo  Retail Finance, LLC, as Syndication Agent and Co-Lead Arranger.                                                                                                                                                   |
| 10.8 |   | Letter Agreement, dated as of March 19, 2004, by and  among Duane Reade Shareholders, LLC, Duane Reade Acquisition Corp. and Duane  Reade Inc. (incorporated by reference to Amendment No. 3 to the Company’s  Schedule 13-E3, filed July 30, 2004).                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.9 |   | Amended and Restated Employment Agreement, dated as  of March 16, 2004, by and among Anthony J. Cuti, Duane Reade Acquisition  Corp., Duane Reade Holdings, Inc. and Duane Reade Shareholders, LLC.  (incorporated by reference to Amendment No. 3 to the Company’s Schedule  13-E3, filed July 30, 2004).                                                                                                                                                                                                                                                                                                                                     |

44

----

 
| 10.10 |   | Letter Agreement, dated  as of March 16, 2004, by and between John K. Henry and Duane Reade  Acquisition Corp. (incorporated by reference to Amendment No. 3 to the  Company’s Schedule 13-E3, filed July 30, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                              |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11 |   | Letter Agreement, dated as of March 16, 2004, by and  between Gary Charboneau and Duane Reade Acquisition Corp. (incorporated by  reference to Amendment No. 3 to the Company’s Schedule 13-E3, filed July 30,  2004).                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.12 |   | Letter Agreement, dated as of March 16, 2004, by and  between Timothy R. LaBeau and Duane Reade Acquisition Corp. (incorporated by  reference to Amendment No. 3 to the Company’s Schedule 13-E3, filed July 30,  2004).                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.13 |   | Letter Agreement, dated as of March 16, 2004, by and  between Jerry M. Ray and Duane Reade Acquisition Corp. (incorporated by  reference to Amendment No. 3 to the Company’s Schedule 13-E3, filed July 30,  2004).                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.14 |   | Agreement and Plan of  Merger, dated as of December 22, 2003, as amended among Rex Corner Holdings,  LLC (now known as Duane Reade Shareholders, LLC), Rex Corner Acquisition  Corp. (now known as Duane Reade Acquisition Corp.) and Duane Reade Inc.  (incorporated by reference to Amendment No. 3 to the Company’s Schedule  13-E3, filed July 30, 2004).                                                                                                                                                                                                                                                                                     |
| 10.15 |   | Credit Agreement, dated as of July 21, 2003,  among Duane Reade, as the Borrower, Duane Reade Inc. and corporate  subsidiaries as the Facility Guarantors, Various Financial Institutions set  forth therein, as the Lenders, Fleet National Bank as the Administrative  Agent and Issuing Bank, Fleet Retail Finance Inc. as the Collateral Agent,  General Electric Capital Corporation as the Syndication Agent for the Lenders  and Congress Financial Corporation as the Documentation Agent for the Lenders  (incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 28, 2003). |
| 10.16 |   | Facility Guarantee, dated as of July 21, 2003,  among the Facility Guarantors, Fleet Retail Finance Inc., Fleet National Bank  and the Lenders (incorporated by reference to the Company’s Quarterly Report  on Form 10-Q for the period ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                     |
| 10.17 |   | Intellectual Property Security Agreement, dated as  of July 21, 2003, between Duane Reade, the Facility Guarantors and Fleet  Retail Finance Inc., as Collateral Agent (incorporated by reference to the  Company’s Quarterly Report on Form 10-Q for the period ended  June 28, 2003).                                                                                                                                                                                                                                                                                                                                            |
| 10.18 |   | Security Agreement, dated as of July 21, 2003,  among Duane Reade, the Facility Guarantors, and Fleet Retail Finance Inc., as  Collateral Agent (incorporated by reference to the Company’s Quarterly Report  on Form 10-Q for the period ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                    |
| 10.19 |   | Ownership Interest Pledge Agreement, dated as of  July 21, 2003, among Duane Reade Inc. and DRI I Inc., and Fleet Retail  Finance Inc., as Collateral Agent (incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                        |
| 10.20 |   | 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).                                                                                                                                                                                                                                                                                                                                         |
| 10.21 |   | 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”)).                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.22 |   | 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).                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

45

----

 
| 10.23 |   | 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). |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 14.1  |   | Code of Business Conduct and Ethics (incorporated by  reference to Exhibit 14.1 to the 2003 10-K).                                                                                                                                                    |
| 31.1* |   | Sarbanes-Oxley Section 302 Certification of the  Company’s Chief Executive Officer (“CEO”).                                                                                                                                       |
| 31.2* |   | Sarbanes-Oxley Section 302 Certification of the  Company’s Chief Financial Officer (“CFO”).                                                                                                                                       |

----

*                    filed herewith

46

----

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
| Dated:   June 17, 2005 |
|---------------------------------------|
| ** **                            | **DUANE  READE INC.** |
|                                  | /s/ ANTHONY J. CUTI |
|                                  | Anthony J. Cuti |
|                                  | *President and Chief Executive Officer* |
|                                  | *(Principal Executive Officer)* |
|                                  | /s/ JOHN K. HENRY |
|                                  | John K. Henry |
|                                  | *Senior Vice President and Chief Financial Officer* |
|                                  | *(Principal Accounting and Financial Officer)* |

 

47

----