**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 June 26, 2004.** | **Commission  file number 1-13843** |
|--------------------------------------------------------|-------------------------------------|

 

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

 

*                    Guarantorswith respect to the Company’s 2.1478% Senior Convertible Notes due 2022
| **440 Ninth Avenue  New York, New York**                  | **10001**  |
|-----------------------------------------------------------|------------|
| (Address of  principal executive offices)                 | (Zip Code) |
| **(212) 273-5700**                                        |
| (Registrant’s telephone number, including area code) |

 

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Indicate by check mark whetherthe registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x No o

Indicate by check markwhether the registrant is an accelerated filer (as defined in the Exchange Act Rule 12b-2):  Yes xNo o

The number of shares ofthe Common Stock outstanding as of August 4, 2004:  **24,538,799**

 

 

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This Form 10-Q/Aamends the Company’s quarterly report on Form 10-Q for the quarterlyperiod ended June 26, 2004, as filed on August 5, 2004, to includeadjustments to its previously filed consolidated financial statements relatedto (i) lease accounting under the provisions of FASB Technical Bulletin No. 85-3(FTB 85-3), (ii) certain inventory resale activity under theprovisions of Emerging Issues Task Force release 99-19 (EITF 99-19)and (iii) the classification of outstanding borrowings under the revolvingloan facility as current liabilities, rather than as long-term debt as previouslyreported, because cash receipts controlled by the lenders are used to reduceoutstanding debt, and the Company does not meet the criteria of Statement ofFinancial Accounting Standards No. 6 “Classification of Short TermObligations Expected to be Refinanced” (FAS 6), to reclassify the debt aslong-term, as well as to reflect certain previously unrecorded and immaterialaudit adjustments related to the periods affected. This Form 10-Q/Afurther amends the Company’s quarterly report on Form 10-Q for thefiscal quarter ended June 26, 2004 to include adjustments to itspreviously filed consolidated statement of cash flows for the first six monthsof 2004 and 2003 to reflect the reporting of revolving loan borrowings andrepayments separately on a gross basis as required under Statement of FinancialAccounting Standard No. 95 “Statement of Cash Flows” (FAS 95). It alsoamends the previously filed Form 10-Q to include in Part 1,Item 4, “Controls and Procedures,” the revised conclusion of the principalexecutive officer and principal financial officer regarding the effectivenessof the Company’s disclosure controls and procedures as of June 26, 2004.No attempt has been made in this Form 10-Q/A to modify or updateother disclosures as presented in the Form 10-Q except to conform tochanges as required by applicable law. For further information about therestatements, see “Item 2.—Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Restatements.”

**INDEX**
| PART I—FINANCIAL  INFORMATION | 5                                                                                                                                            |
|-----------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------|
|                                    | ITEM  1.—FINANCIAL STATEMENTS                                                                                                           | 5 |
|                                    | Consolidated Statements of Operations  (Unaudited)—  For the 13 and 26 Weeks Ended June 26, 2004 and June 28, 2003 (restated) | 5 |
|                                    | Consolidated  Balance Sheets  As of June 26, 2004 (Unaudited) and December 27, 2003 (restated)                                     | 6 |
|                                    | Consolidated  Statements of Cash Flows (Unaudited)—  For the 26 Weeks Ended June 26, 2004 and June 28, 2003 (restated)        | 7 |
|                                    | Notes  to Consolidated Financial Statements (Unaudited)                                                                                      | 8 |
|                                    | ITEM 2.—MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                | 22 |
|                                    | ITEM 3.—MARKET  RISK                                                                                                                    | 35 |
|                                    | ITEM  4.—CONTROLS AND PROCEDURES                                                                                                        | 35 |
| PART II—OTHER  INFORMATION    | 37                                                                                                                                           |
| SIGNATURES                              | 45                                                                                                                                           |

 

This and other of ourpublic filings or public statements contain forward-looking statements withinthe meaning of Section 27A of the Securities Act, Section 21E of theSecurities Exchange Act of 1934 and the Private Securities Litigation ReformAct of 1995, that involve a number of risks and uncertainties. These statementsrelate to future events or our future financial performance with respect to ourfinancial condition, results of operations, business plans and strategies,operating efficiencies or synergies, competitive positions, growthopportunities for existing products such as private label merchandise, plans 

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andobjectives of management, capital expenditures, growth and maturation of ourstores 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;

·       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;

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·       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 anyother person, 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.

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**PART I—FINANCIALINFORMATION**

**ITEM 1.     FINANCIALSTATEMENTS**

**Duane Reade Inc.Consolidated Statements of Operations (Unaudited)(In thousands, except per share amounts)**
| ** **                                      | ** ** | **Restated**                                   | ** ** |
|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                      | ** ** | **For the 13 Weeks Ended** | ** ** | **For the 26 Weeks Ended** | ** ** |
| ** **                                      | ** ** | **June 26,**                              | ** ** | **June 28,** | ** ** | **June 26,** | ** ** | **June 28,** | ** ** |
| ** **                                      | ** ** | **2004**                                       | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales                                       |       | $                                              | 402,111    |   | $ | 368,894 |   | $ | 785,421 |   | $ | 724,888 |   |
| Cost of sales                                   |       | 322,726                                        |       | 291,602 |   | 629,533 |   | 577,016 |   |
| Gross profit                                    |       | 79,385                                         |       | 77,292 |   | 155,888 |   | 147,872 |   |
| Selling, general  & administrative expenses |       | 59,924                                         |       | 57,598 |   | 118,567 |   | 111,472 |   |
| Labor contingency  expense                      |       | 1,100                                          |       | — |   | 2,200 |   | — |   |
| Transaction  expense                            |       | 1,516                                          |       | — |   | 2,619 |   | — |   |
| Depreciation and  amortization                  |       | 9,239                                          |       | 8,154 |   | 18,305 |   | 15,712 |   |
| Store pre-opening  expenses                     |       | 209                                            |       | 229 |   | 365 |   | 644 |   |
|                                            |       | 71,988                                         |       | 65,981 |   | 142,056 |   | 127,828 |   |
| Operating income                                |       | 7,397                                          |       | 11,311 |   | 13,832 |   | 20,044 |   |
| Interest expense,  net                          |       | 3,257                                          |       | 3,549 |   | 6,694 |   | 7,066 |   |
| Debt  extinguishment                            |       | —                                         |       | — |   | — |   | 105 |   |
| Income before income taxes                      |       | 4,140                                          |       | 7,762 |   | 7,138 |   | 12,873 |   |
| Income tax  provision                           |       | 1,605                                          |       | 3,716 |   | 2,850 |   | 5,666 |   |
| Net income                                      |       | $                                              | 2,535      |   | $ | 4,046 |   | $ | 4,288 |   | $ | 7,207 |   |
| Per common share—basic                     |       |                                           |       |   |   |   |   |   |   |
| Net income                                      |       | $                                              | 0.10       |   | $ | 0.17 |   | $ | 0.18 |   | $ | 0.30 |   |
| Weighted average common shares outstanding      |       | 24,482                                         |       | 24,038 |   | 24,446 |   | 24,038 |   |
| Per common share—diluted                   |       |                                           |       |   |   |   |   |   |   |
| Net income                                      |       | $                                              | 0.10       |   | $ | 0.17 |   | $ | 0.17 |   | $ | 0.30 |   |
| Weighted average common shares outstanding      |       | 24,687                                         |       | 24,351 |   | 24,646 |   | 24,345 |   |

 

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

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**Duane Reade Inc.Consolidated Balance Sheets(In thousands, except share and per share data)**
| ** **                                                                                                                      | ** ** | **Restated**      | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                      | ** ** | **June 26,** | ** ** | **December 27,** | ** ** |
| ** **                                                                                                                      | ** ** | **2004**          | ** ** | **2003** | ** ** |
| ** **                                                                                                                      | ** ** | **(Unaudited)**   | ** ** | ** ** | ** ** |
| ASSETS                                                                                                                          |       |              |       |   |   |   |   |   |   |
| Current Assets                                                                                                                  |       |              |       |   |   |   |   |   |   |
| Cash                                                                                                                            |       |              | $          | 1,328 |   |   |   | $ | 1,252 |   |   |
| Receivables, net                                                                                                                |       |              | 53,993     |   |   |   | 53,430 |   |   |
| Inventories, net                                                                                                                |       |              | 259,451    |   |   |   | 258,139 |   |   |
| Deferred income taxes                                                                                                           |       |              | 9,606      |   |   |   | 10,811 |   |   |
| Prepaid expenses and other current assets                                                                                       |       |              | 16,233     |   |   |   | 20,263 |   |   |
| TOTAL CURRENT ASSETS                                                                                                            |       |              | 340,611    |   |   |   | 343,895 |   |   |
| Property and equipment, net                                                                                                     |       |              | 193,174    |   |   |   | 189,469 |   |   |
| Goodwill, net                                                                                                                   |       |              | 161,625    |   |   |   | 161,318 |   |   |
| Deferred income  taxes                                                                                                          |       |              | 12,285     |   |   |   | 13,854 |   |   |
| Other assets                                                                                                                    |       |              | 98,384     |   |   |   | 88,836 |   |   |
| TOTAL ASSETS                                                                                                                    |       |              | $          | 806,079 |   |   |   | $ | 797,372 |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                       |       |              |       |   |   |   |   |   |   |
| Current liabilities                                                                                                             |       |              |       |   |   |   |   |   |   |
| Accounts payable                                                                                                                |       |              | $          | 77,041 |   |   |   | $ | 85,528 |   |   |
| Accrued interest                                                                                                                |       |              | 1,544      |   |   |   | 1,633 |   |   |
| Other accrued expenses                                                                                                          |       |              | 29,839     |   |   |   | 30,086 |   |   |
| Current portion of debt                                                                                                         |       |              | 77,307     |   |   |   | 70,353 |   |   |
| Current portion of capital lease obligations                                                                                    |       |              | 441        |   |   |   | 422 |   |   |
| TOTAL CURRENT LIABILITIES                                                                                                       |       |              | 186,172    |   |   |   | 188,022 |   |   |
| Long-term debt                                                                                                                  |       |              | 201,032    |   |   |   | 201,032 |   |   |
| Capital lease  obligations, less current portion                                                                                |       |              | 878        |   |   |   | 1,103 |   |   |
| Other non-current  liabilities                                                                                                  |       |              | 85,321     |   |   |   | 79,954 |   |   |
| TOTAL LIABILITIES                                                                                                               |       |              | 473,403    |   |   |   | 470,111 |   |   |
| Commitments and  Contingencies (Note 11)                                                                                        |       |              |       |   |   |   |   |   |   |
| Stockholders’  equity                                                                                                      |       |              |       |   |   |   |   |   |   |
| Preferred stock, $0.01 par; authorized 5,000,000  shares; issued and outstanding: none                                          |       |              | —     |   |   |   | — |   |   |
| Series A preferred stock, $0.01 par; authorized  75,000 shares; issued and outstanding: none                               |       |              | —     |   |   |   | — |   |   |
| Common stock, $0.01 par; authorized 75,000,000  shares; issued and outstanding; 24,538,799 and 24,403,550 shares,  respectively |       |              | 245        |   |   |   | 244 |   |   |
| Additional paid-in capital                                                                                                      |       |              | 333,043    |   |   |   | 331,917 |   |   |
| Retained deficit                                                                                                                |       |              | (612       | ) |   |   | (4,900 | ) |   |
| TOTAL STOCKHOLDERS’ EQUITY                                                                                                 |       |              | 332,676    |   |   |   | 327,261 |   |   |
| TOTAL LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                |       |              | $          | 806,079 |   |   |   | $ | 797,372 |   |   |

 

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

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**Duane Reade Inc.Consolidated Statements ofCash Flows (Unaudited)(In thousands)**
| ** **                                                                         | ** ** | **Restated**                                   | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                         | ** ** | **For the 26 Weeks Ended** | ** ** |
| ** **                                                                         | ** ** | **June 26,**                              | ** ** | **June 28,** | ** ** |
| ** **                                                                         | ** ** | **2004**                                       | ** ** | **2003** | ** ** |
| Cash flows provided by  operating activities:                                      |       |                                           |       |   |   |
| Net income                                                                         |       | $                                              | 4,288      |   | $ | 7,207 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                           |       |   |   |
| Depreciation and amortization                                                      |       | 19,260                                         |       | 16,728 |   |
| Deferred income taxes                                                              |       | 2,774                                          |       | 2,848 |   |
| Debt  extinguishment                                                               |       |                                           |       |   |   |
| Non-cash rent expense                                                              |       | 3,827                                          |       | 4,759 |   |
| Changes in  operating assets and liabilities (net of the effect of acquisitions):  |       |                                           |       |   |   |
| Receivables                                                                        |       | (563                                           | )          | (227 | ) |
| Inventories                                                                        |       | (333                                           | )          | (11,438 | ) |
| Accounts payable                                                                   |       | (8,486                                         | )          | 2,325 |   |
| Prepaid and accrued expenses                                                       |       | 3,058                                          |       | (3,110 | ) |
| Other assets and liabilities, net                                                  |       | (3,786                                         | )          | (5,112 | ) |
| NET CASH PROVIDED BY OPERATING ACTIVITIES                                          |       | 20,039                                         |       | 13,980 |   |
| Cash flows used  in investing activities:                                          |       |                                           |       |   |   |
| Capital expenditures                                                               |       | (16,182                                        | )          | (25,795 | ) |
| Lease acquisition, customer file and other costs                                   |       | (11,517                                        | )          | (9,903 | ) |
| NET CASH USED IN INVESTING ACTIVITIES                                              |       | (27,699                                        | )          | (35,698 | ) |
| Cash flows from  financing activities:                                             |       |                                           |       |   |   |
| Repayment of term notes                                                            |       | —                                         |       | (1,981 | ) |
| Retirement of senior subordinated notes                                            |       | —                                         |       | (1,621 | ) |
| Borrowings from revolving credit facility                                          |       | 798,122                                        |       | 171,500 |   |
| Repayments of revolving credit facility                                            |       | (791,168                                       | )          | (148,500 | ) |
| Proceeds from exercise of stock options                                            |       | 1,126                                          |       | — |   |
| Deferred financing costs                                                           |       | (138                                           | )          | (350 | ) |
| Repayments of capital lease obligations                                            |       | (206                                           | )          | (271 | ) |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                     |       | 7,736                                          |       | 18,777 |   |
| Net increase (decrease) in cash                                                    |       | 76                                             |       | (2,941 | ) |
| Cash at beginning  of period                                                       |       | 1,252                                          |       | 4,183 |   |
| Cash at end of period                                                              |       | $                                              | 1,328      |   | $ | 1,242 |   |

 

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

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

**1. Basis ofPresentation**

The Unaudited Consolidated Interim FinancialStatements included herein reflect all adjustments which, in the opinion of management,are necessary to present fairly the results of operations, financial positionand cash flows of Duane Reade Inc. (the “Company”), and have been prepared, inall material respects, in accordance with the same accounting principlesfollowed in the preparation of the Company’s Annual Consolidated FinancialStatements for the year ended December 27, 2003. These UnauditedConsolidated Interim Financial Statements should be read in conjunction withthe Company’s Consolidated Financial Statements included in its Annual Reporton Form 10-K/A for the year ended December 27, 2003. The UnauditedConsolidated Interim Financial Statements include the accounts of the Companyand its subsidiaries. All significant intercompany transactions and balanceshave been eliminated. Earnings per share amounts are calculated based on theweighted average number of shares outstanding during the period and may not adddue to rounding. The results for the interim periods presented are notnecessarily indicative of the results expected for the full year.

The Company has no assetsor operations other than its investment in its subsidiaries, each of which is aguarantor. Accordingly, the Unaudited Consolidated Interim Financial Statementspresent the consolidated assets and operations of the subsidiary guarantors. Theguarantees of the subsidiary guarantors, which relate to the Company’sobligations under its registered debt and credit agreement, are full andunconditional, joint and several.

**2. Restatements**

The Company hasrestated its 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.     Grossversus net sales and cost of sales accounting under Emerging Issues Task Force Release99-19 (EITF 99-19)

3.     Balancesheet classification of outstanding loan 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

4.     Reportingof revolving loan facility borrowings and repayments under FASB No. 95 “Statementof Cash Flows” (FAS 95)

5.     Restatements to include certain previously unrecorded andimmaterial audit adjustments related to the periods affected.

In connection with theserestatements, the Company obtained from the administrative agent under theamended asset-based revolving loan facility, an acknowledgement confirming thatthese restatements do not constitute an event of technical default, as definedin the document governing the amended asset-based revolving loan facility.

Based upon a review of theCompany’s lease accounting methods the Company determined that its previouspolicy of commencing rent expense when a store opens (and not at thecommencement of the lease) was inconsistent with FTB 85-3. Forconstruction purposes, the Company often takes possession of leased propertiesprior to opening. In accordance with FTB 85-3, the Company will recordrent expense 

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commencingon the date of possession. The Company is restating its previously issuedfinancial statements to reflect certain resales of retail inventory on a grossrevenue and cost of sales basis in accordance with EITF 99-19, ratherthan on a net basis as previously reported. The Company is restating itspreviously reported balance sheets for June 26, 2004 and December 27,2003 to reflect the classification of outstanding borrowings under therevolving loan facility as current liabilities rather than as long-term debt,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 intendsto continue to access it for its working capital needs throughout the remainingterm. The Company has also restated its consolidated statement of cash flowsfor the first six months of 2004 and 2003 to reflect the reporting of revolvingloan facility borrowings and repayments separately on a gross basis as requiredunder FAS 95. The effect of these restatements on the consolidated financialstatements for the thirteen weeks and twenty-six weeks ended June 26, 2004and June 28, 2003 is shown below. The Company has identified the source ofthe restatements from lease accounting (FTB 85-3), gross sales and costof sales (EITF 99-19) and other previously unrecorded and immaterialadjustments (Other).

**DuaneReade Inc.Consolidated Profit & Loss Restatement(in thousands)**
| ** **                                    | ** ** | ** **                 | ** ** | **For the 13 Weeks  Ended** | ** ** | **For the 26 Weeks  Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | ** **                 | ** ** | **June 26,  2004**                         | ** ** | **June 28,  2003**                         | ** ** | **June 26,  2004** | ** ** | **June 28,  2003** | ** ** |
| Sales                                         |       | as reported                |       | $                                          | 365,206    |                                       | $          | 355,146 |   | $ | 714,756 |   | $ | 688,768 |   |
|                                          |       | adjustment—EITF 99-19 |       | 36,905                                     |       | 13,748                                     |       | 70,665 |   | 36,120 |   |
|                                          |       | as restated                |       | $                                          | 402,111    |                                       | $          | 368,894 |   | $ | 785,421 |   | $ | 724,888 |   |
| Cost of Sales                                 |       | as reported                |       | $                                          | 285,018    |                                       | $          | 278,171 |   | $ | 558,803 |   | $ | 541,604 |   |
|                                          |       | adjustment—EITF 99-19 |       | 36,905                                     |       | 13,748                                     |       | 70,665 |   | 36,120 |   |
|                                          |       | adjustment—FTB 85-3   |       | 452                                        |       | 167                                        |       | 760 |   | 806 |   |
|                                          |       | adjustment—Other      |       | 351                                        |       | (484                                       | )          | (695 | ) | (1,514 | ) |
|                                          |       | as restated                |       | $                                          | 322,726    |                                       | $          | 291,602 |   | $ | 629,533 |   | $ | 577,016 |   |
| Gross Profit                                  |       | as reported                |       | $                                          | 80,188     |                                       | $          | 76,975 |   | $ | 155,953 |   | $ | 147,164 |   |
|                                          |       | adjustment—FTB 85-3   |       | (452                                       | )          | (167                                       | )          | (760 | ) | (806 | ) |
|                                          |       | adjustment—Other      |       | (351                                       | )          | 484                                        |       | 695 |   | 1,514 |   |
|                                          |       | as restated                |       | $                                          | 79,385     |                                       | $          | 77,292 |   | $ | 155,888 |   | $ | 147,872 |   |
| Selling, general and  administrative expenses |       | as reported                |       | $                                          | 59,924     |                                       | $          | 57,260 |   | $ | 118,567 |   | $ | 110,834 |   |
|                                          |       | adjustment—Other      |       | —                                     |       | 338                                        |       | — |   | 638 |   |
|                                          |       | as restated                |       | $                                          | 59,924     |                                       | $          | 57,598 |   | $ | 118,567 |   | $ | 111,472 |   |
| Earnings before tax                           |       | as reported                |       | $                                          | 4,943      |                                       | $          | 7,783 |   | $ | 7,203 |   | $ | 12,803 |   |
|                                          |       | adjustment                 |       | (803                                       | )          | (21                                        | )          | (65 | ) | 70 |   |
|                                          |       | as restated                |       | $                                          | 4,140      |                                       | $          | 7,762 |   | $ | 7,138 |   | $ | 12,873 |   |
| Income tax provision                          |       | as reported                |       | $                                          | 1,976      |                                       | $          | 3,725 |   | $ | 2,880 |   | $ | 5,633 |   |
|                                          |       | adjustment                 |       | (371                                       | )          | (9                                         | )          | (30 | ) | 33 |   |
|                                          |       | as restated                |       | $                                          | 1,605      |                                       | $          | 3,716 |   | $ | 2,850 |   | $ | 5,666 |   |
| Net income                                    |       | as reported                |       | $                                          | 2,967      |                                       | $          | 4,058 |   | $ | 4,323 |   | $ | 7,170 |   |
|                                          |       | adjustment                 |       | (432                                       | )          | (12                                        | )          | (35 | ) | 37 |   |
|                                          |       | as restated                |       | $                                          | 2,535      |                                       | $          | 4,046 |   | $ | 4,288 |   | $ | 7,207 |   |
| Net income per common  share—basic       |       | as reported                |       | $                                          | 0.12       |                                       | $          | 0.17 |   | $ | 0.18 |   | $ | 0.30 |   |
|                                          |       | adjustment                 |       | (0.02                                      | )          | —                                     |       | — |   | — |   |
|                                          |       | as restated                |       | $                                          | 0.10       |                                       | $          | 0.17 |   | $ | 0.18 |   | $ | 0.30 |   |
| Net income per common  share—diluted     |       | as reported                |       | $                                          | 0.12       |                                       | $          | 0.17 |   | $ | 0.18 |   | $ | 0.29 |   |
|                                          |       | adjustment                 |       | (0.02                                      | )          | —                                     |       | (0.01 | ) | 0.01 |   |
|                                          |       | as restated                |       | $                                          | 0.10       |                                       | $          | 0.17 |   | $ | 0.17 |   | $ | 0.30 |   |

 

9

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**DuaneReade Inc.Consolidated Balance Sheet Restatement(in thousands)**
| ** **                                         | ** ** | **As at June 26, 2004** | ** **               | **As at December 27, 2003** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------|--------------------------|-------------------------------------------------|------------|
| **Caption affected by restatement** | ** ** | ** **                                  | ** **               | **As Reported**                            | ** ** | ** Adjustment ** | ** ** | ** As Restated ** | ** ** | **As Reported** | ** ** | ** Adjustment ** | ** ** | ** As Restated ** | ** ** |
| Receivables                                        |       |                                        | $ 55,063            |                                            |       |   | $ (1,070 | ) |   |   | $ 53,993 |   |   |   | $ 53,689 |   |   |   | $    (259 | ) |   |   | $ 53,430 |   |   |
| Inventory                                          |       |                                        | 260,307                  |                                            |       |   | (856 | ) |   |   | 259,451 |   |   |   | 259,765 |   |   |   | (1,626 | ) |   |   | 258,139 |   |   |
| Current portion of  deferred income taxes          |       |                                        | 7,265                    |                                            |       |   | 2,341 |   |   |   | 9,606 |   |   |   | 8,150 |   |   |   | 2,661 |   |   |   | 10,811 |   |   |
| Prepaid & other  current assets      |       |                                        | 16,233                   |                                            |       |   | — |   |   |   | 16,233 |   |   |   | 19,504 |   |   |   | 759 |   |   |   | 20,263 |   |   |
| Total current assets                               |       |                                        | 340,196                  |                                            |       |   | 415 |   |   |   | 340,611 |   |   |   | 342,360 |   |   |   | 1,535 |   |   |   | 343,895 |   |   |
| Deferred income taxes                              |       |                                        | 3,623                    |                                            |       |   | 8,662 |   |   |   | 12,285 |   |   |   | 5,543 |   |   |   | 8,311 |   |   |   | 13,854 |   |   |
| Total assets                                       |       |                                        | $ 797,002           |                                            |       |   | $   9,077 |   |   |   | $ 806,079 |   |   |   | $ 787,526 |   |   |   | $   9,846 |   |   |   | $ 797,372 |   |   |
| Accounts payable                                   |       |                                        | $ 77,041            |                                            |       |   | $         — |   |   |   | $ 77,041 |   |   |   | $ 85,258 |   |   |   | $      270 |   |   |   | $ 85,528 |   |   |
| Accrued expenses                                   |       |                                        | 28,343                   |                                            |       |   | 1,496 |   |   |   | 29,839 |   |   |   | 27,489 |   |   |   | 2,597 |   |   |   | 30,086 |   |   |
| Current portion of debt                            |       |                                        | —                   |                                            |       |   | 77,307 |   |   |   | 77,307 |   |   |   | — |   |   |   | 70,353 |   |   |   | 70,353 |   |   |
| Total current  liabilities                         |       |                                        | 107,369                  |                                            |       |   | 78,803 |   |   |   | 186,172 |   |   |   | 114,802 |   |   |   | 73,220 |   |   |   | 188,022 |   |   |
| Long-term debt                                     |       |                                        | 278,339                  |                                            |       |   | (77,307 | ) |   |   | 201,032 |   |   |   | 271,385 |   |   |   | (70,353 | ) |   |   | 201,032 |   |   |
| Other noncurrent  liabilities                      |       |                                        | 67,645                   |                                            |       |   | 17,676 |   |   |   | 85,321 |   |   |   | 62,915 |   |   |   | 17,039 |   |   |   | 79,954 |   |   |
| Total liabilities                                  |       |                                        | $ 454,231           |                                            |       |   | $ 19,172 |   |   |   | $ 473,403 |   |   |   | $ 450,205 |   |   |   | $ 19,906 |   |   |   | $ 470,111 |   |   |
| Retained earnings                                  |       |                                        | $   9,483 |                                            |       |   | $ (10,095 | ) |   |   | $     (612 | ) |   |   | $   5,160 |   |   |   | $ (10,060 | ) |   |   | $ (4,900 | ) |   |
| Total  stockholders’ equity                   |       |                                        | $ 342,771           |                                            |       |   | $ (10,095 | ) |   |   | $ 332,676 |   |   |   | $ 337,321 |   |   |   | $ (10,060 | ) |   |   | $ 327,261 |   |   |
| Total liabilities and  stockholders’ equity   |       |                                        | $ 797,002           |                                            |       |   | $   9,077 |   |   |   | $ 806,079 |   |   |   | $ 787,526 |   |   |   | $   9,846 |   |   |   | $ 797,372 |   |   |
|                                                    |            |                                             |                          |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The adjustments toother noncurrent liabilities and noncurrent deferred income taxes relate tolease accounting under FTB 85-3. The adjustments to debt relate to the classificationof the revolving loan balance as a current liability as discussed above. Allother balance sheet adjustments relate to other previously unrecorded andimmaterial adjustments.

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**DuaneReade Inc.Consolidated Cash Flow Restatement(in thousands)**

 
| ** **                                                     | ** ** | ** **  | ** ** | **For the 26 Weeks Ended** | ** ** |
|----------------------------------------------------------------|------------|-------------|------------|------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **  | ** ** | ** 6/26/04**                              | ** ** | ** 6/28/03** | ** ** |
| Net income                                                     |       | as reported |       | $                                              | 4,323      |   | $ | 7,170 |   |
|                                                           |       | adjustment  |       | (35                                            | )          | 37 |   |
|                                                           |       | as restated |       | $                                              | 4,288      |   | $ | 7,207 |   |
| Deferred income taxes                                          |       | as reported |       | $                                              | 2,805      |   | $ | 2,817 |   |
|                                                           |       | adjustment  |       | (31                                            | )          | 31 |   |
|                                                           |       | as restated |       | $                                              | 2,774      |   | $ | 2,848 |   |
| Non-cash rent expense and other                                |       | as reported |       | $                                              | 3,067      |   | $ | 4,455 |   |
|                                                           |       | adjustment  |       | 760                                            |       | 304 |   |
|                                                           |       | as restated |       | $                                              | 3,827      |   | $ | 4,759 |   |
| Receivables                                                    |       | as reported |       | $                                              | (1,374     | ) | $ | (227 | ) |
|                                                           |       | adjustment  |       | 811                                            |       | — |   |
|                                                           |       | as restated |       | $                                              | (563       | ) | $ | (227 | ) |
| Inventories                                                    |       | as reported |       | $                                              | 437        |   | $ | (10,954 | ) |
|                                                           |       | adjustment  |       | (770                                           | )          | (484 | ) |
|                                                           |       | as restated |       | $                                              | (333       | ) | $ | (11,438 | ) |
| Accounts payable                                               |       | as reported |       | $                                              | (8,217     | ) | $ | 2,189 |   |
|                                                           |       | adjustment  |       | (269                                           | )          | 136 |   |
|                                                           |       | as restated |       | $                                              | (8,486     | ) | $ | 2,325 |   |
| Prepaid and accrued expenses                                   |       | as reported |       | $                                              | 3,400      |   | $ | (3,229 | ) |
|                                                           |       | adjustment  |       | (342                                           | )          | 119 |   |
|                                                           |       | as restated |       | $                                              | 3,058      |   | $ | (3,110 | ) |
| Other assets and liabilities, net                              |       | as reported |       | $                                              | (3,663     | ) | $ | (4,968 | ) |
|                                                           |       | adjustment  |       | (123                                           | )          | (144 | ) |
|                                                           |       | as restated |       | $                                              | (3,786     | ) | $ | (5,112 | ) |
| Net borrowings (repayments) on revolving  credit facility |       | as reported |       | $                                              | 6,954      |   | $ | 23,000 |   |
|                                                           |       | adjustment  |       | (6,954                                         | )          | (23,000 | ) |
|                                                           |       | as restated |       | $                                              | —     |   | $ | — |   |
| Borrowings from revolving credit facility                      |       | as reported |       | $                                              | —     |   | $ | — |   |
|                                                           |       | adjustment  |       | 798,122                                        |       | 171,500 |   |
|                                                           |       | as restated |       | $                                              | 798,122    |   | $ | 171,500 |   |
| Repayments of revolving credit facility                        |       | as reported |       | $                                              | —     |   | $ | — |   |
|                                                           |       | adjustment  |       | (791,168                                       | )          | (148,500 | ) |
|                                                           |       | as restated |       | $                                              | (791,168   | ) | $ | (148,500 | ) |

 

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**3. Subsequent Event—Acquisitionby Oak Hill Capital Partners, L.P.**

On July 30, 2004, theCompany was acquired through a merger transaction with Duane Reade AcquisitionCorp. (“Duane Reade Acquisition”), a wholly owned subsidiary of Duane ReadeHoldings, Inc. and an affiliate of Oak Hill Capital Partners, L.P. (“OakHill”), a private equity firm (the “Acquisition”). The Acquisition wasaccomplished through the merger of Duane Reade Acquisition into Duane ReadeInc., with Duane Reade Inc. being the surviving entity. The transaction wasunanimously approved by the independent members of Duane Reade’s board ofdirectors, who resigned from the board on July 30, 2004 in anticipation ofthe completion of the Acquisition. Under the terms of the merger agreement, whichwas approved by the Company’s stockholders at a special meeting on July 26,2004, the Company’s stockholders (other than those who exercise and perfecttheir appraisal rights) will receive $16.50 per share in cash, without interest.The aggregate value of the merger transaction is approximately$744 million, including transaction expenses and the repayment ofindebtedness. The equity financing necessary for the merger was provided by OakHill 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. At the special meeting of the Company’sstockholders on July 26, 2004, a total of 15,436,702 shares, representing62.9 % of the total outstanding shares of common stock as of the June 3,2004 record date, were voted in favor of the adoption of the merger agreement.As a result of the stockholders’ approval of the merger agreement and thesatisfaction of all other conditions to the merger, the merger and relatedfinancings were consummated on July 30, 2004.

**4. National LaborRelations Board Recommendation**

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 expires 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 andwelfare benefits, vacation and sick benefits and a 401(k) retirementprogram. The Company discontinued making additional payments into the variousfunds associated 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 atimpasse. The remedies recommended by the ALJ included, among other things, arequirement for the Company to make its employees whole by reimbursing them forexpenses ensuing from the failure to make contributions to the union funds andto make such funds whole, plus interest. If this recommendation is adopted bythe full NLRB and enforced by the circuit court of appeals, it could result inthe Company being required to contribute amounts that have yet to be determinedinto the union’s pension benefit, health and welfare and vacation funds. Anypotential required contributions resulting from a final judicial determinationof this matter would potentially be subject to offset by the amounts that theCompany had funded since it implemented its final contract proposal for thesesame benefits that were paid for its ATC employees. 

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Because this is just thefirst phase of a long and complicated administrative process likely to befollowed by a full judicial review of all of the facts and circumstances, thefinal outcome cannot be reliably determined at this time. The ALJ’srecommendation is not a binding order and has no force and effect of law.Rather, it is a recommendation to the full NLRB in Washington D.C., which willconduct a complete review at some point in the future and decide to uphold,reject or modify the recommendation. The full NLRB decision is also subject tojudicial review by the circuit court of appeals and a compliance hearing beforeany financial remedy can be determined. While there can be no definitiveassurance, the Company has been advised by its outside labor counsel that ithas numerous meritorious defenses and arguments in response to the ALJ’srecommendation.

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. These charges represent thecurrent best estimate of the loss that would result upon application of the ALJ’srecommendation. The Company notes that such charges were based upon the factsavailable to it at the time. In the Company’s opinion, such charges could besubject to significant modification in the future, upon review by the fullNLRB, the Federal Circuit Court of Appeals, completion of a compliance hearingand any appeals relating to the outcome of that hearing. These charges reflectthe amount of contributions that the Company did not make into the unionbenefit funds for the period from the August 31, 2001 expiration of thecontract through June 26, 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 June 26, 2004. While this representsthe Company’s current best estimate of the ALJ’s recommendation, the Companybelieves that the actual range of loss in this matter could be from $0, if theALJ’s recommendation is not followed, to approximately $29 million, if theALJ’s recommendation is upheld and there is no offset for any benefits paidover this 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. The Companycurrently estimates that the pre-tax charge in 2004 will approximate $4.4million.

**5. Inventory and Cost of Sales**

At June 26, 2004,inventories, consisting solely of finished goods, would have been greater by$0.9 million if they had been valued on a lower of first-in, first-out (“FIFO”)cost or market basis instead of a last-in, first-out (“LIFO”) basis. Cost ofsales includes all store occupancy-related costs and expenses, consisting oflease and sublease-related income and expenses, other recurring realestate-related income and expenses primarily from sales and terminations ofleases related to store closings and relocations, sales of market-related data,store utility costs, warehouse expenses and distribution costs. The Companyreflects promotional allowances from vendors as a reduction of cost of sales oradvertising expense, depending on the nature of the allowance, when suchadvertising or promotions have been completed and the related allowances havebeen earned. Other real estate-related income amounted to $1.3 million and $2.1million in the quarter and six months ended June 26, 2004, respectively,as compared to $0.2 million and $1.4 million in the quarter and six monthsended June 28, 2003, respectively. There was no income realized from thesale of market-related data in the second quarter or first six months of either2004 or 2003.

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**6.Recently Issued 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 disclosurerequirements of FAS No. 123 to require prominent disclosures about themethod of accounting for stock-based compensation and the effect of the methodused on reported results. As required, the Company adopted the disclosure-onlyprovisions of FAS No. 148 effective in 2002.

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-based compensationplans under the recognition and measurement principles of APB Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations. Thereis no stock-based employee compensation cost reflected in net income, as alloptions granted under those plans had an exercise price equal to or greaterthan the market value of the underlying common stock on the date of grant. Thefollowing table illustrates the effect on net income and earnings per share ifthe Company had applied the fair value recognition provisions of FAS No. 123to stock-based employee compensation (dollars in thousands):
| ** **                                                                                                                                             | ** ** | **For the 13 Weeks Ended**              | ** ** | **For the 26 Weeks Ended**              | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                                                                                                             | ** ** | **   June 26,     2004** | ** ** | **   June 28,     2003** | ** ** | **   June 26,     2004** | ** ** | **   June 28,     2003** | ** ** |
| Net income, as  reported (restated)                                                                                                                    |       |                                                        | $          | 2,535                                                       |       |   |   | $ | 4,046 |   |   |   | $ | 4,288 |   |   |   | $ | 7,207 |   |   |
| Adjust: Total stock-based employee compensation  (expense)/income determined under fair value based method for all awards, net  of related tax effects |       |                                                        | (1,136     | )                                                           |       |   | (378 | ) |   |   | (2,272 | ) |   |   | 9,018 |   |   |
| Pro forma net income (restated)                                                                                                                        |       |                                                        | $          | 1,399                                                       |       |   |   | $ | 3,668 |   |   |   | $ | 2,016 |   |   |   | $ | 16,225 |   |   |
| Income per common share:                                                                                                                               |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic—as  reported (restated)                                                                                                                     |       |                                                        | $          | 0.10                                                        |       |   |   | $ | 0.17 |   |   |   | $ | 0.18 |   |   |   | $ | 0.30 |   |   |
| Basic—pro  forma (restated)                                                                                                                       |       |                                                        | $          | 0.06                                                        |       |   |   | $ | 0.15 |   |   |   | $ | 0.08 |   |   |   | $ | 0.67 |   |   |
| Diluted—as  reported (restated)                                                                                                                   |       |                                                        | $          | 0.10                                                        |       |   |   | $ | 0.17 |   |   |   | $ | 0.17 |   |   |   | $ | 0.30 |   |   |
| Diluted—pro  forma (restated)                                                                                                                     |       |                                                        | $          | 0.06                                                        |       |   |   | $ | 0.15 |   |   |   | $ | 0.08 |   |   |   | $ | 0.67 |   |   |
| Basic shares                                                                                                                                           |       |                                                        | 24,482     |                                                        |       |   | 24,038 |   |   |   | 24,446 |   |   |   | 24,038 |   |   |
| Diluted shares                                                                                                                                         |       |                                                        | 24,687     |                                                        |       |   | 24,351 |   |   |   | 24,686 |   |   |   | 24,345 |   |   |

 

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 six months ending June 28,2003 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 income (expense) for stockoptions has been estimated using the Black-Scholes option pricing modelwith the following assumptions for each of the periods shown: dividend yield of0%, expected volatility of 50%, risk free interest rate of 6.6% and an expectedterm of 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.

14

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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.

**7. Acquisitions**

Duringthe second quarter and first six months of fiscal 2004 and fiscal 2003, theCompany acquired pharmacy customer files, which were merged into existingstores, and the operations, including certain lease-related assets, of a numberof pharmacy establishments, which were operated as new stores. The table belowprovides details of this acquisition activity for each of the periods presented(dollars in millions).
| ** **                         | ** ** | **For the 13 Weeks Ended**  | ** ** | **For the 26 Weeks Ended**  | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                         | ** ** | **  June 26,    2004** | ** ** | **  June 28,    2003** | ** ** | **  June 26,    2004** | ** ** | **  June 28,    2003** | ** ** |
| Customer prescription  files       |       |                                            | 1          |                                            |       |   | 2 |   |   |   | 5 |   |   |   | 6 |   |   |
| Pharmacy establishments            |       |                                            | 1          |                                            |       |   | — |   |   |   | 1 |   |   |   | 2 |   |   |
| Total acquisitions                 |       |                                            | 2          |                                            |       |   | 2 |   |   |   | 6 |   |   |   | 8 |   |   |
| Cash consideration                 |       |                                            | $          | 0.9                                             |       |   |   | $ | 0.4 |   |   |   | $ | 7.4 |   |   |   | $ | 6.0 |   |   |
| Total acquisition cost             |       |                                            | $          | 0.9                                             |       |   |   | $ | 0.4 |   |   |   | $ | 7.4 |   |   |   | $ | 6.0 |   |   |
| Purchase price allocation:         |       |                                            |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Identifiable intangibles           |       |                                            | $          | 0.8                                             |       |   |   | $ | 0.4 |   |   |   | $ | 6.4 |   |   |   | $ | 3.9 |   |   |
| Goodwill                           |       |                                            | —     |                                            |       |   | — |   |   |   | 0.3 |   |   |   | 0.9 |   |   |
| Inventory                          |       |                                            | 0.2        |                                            |       |   | 0.1 |   |   |   | 1.0 |   |   |   | 1.0 |   |   |
| Property and equipment             |       |                                            | —     |                                            |       |   | — |   |   |   | — |   |   |   | 0.5 |   |   |
| Other assets and  liabilities, net |       |                                            | (0.1       | )                                               |       |   | (0.1 | ) |   |   | (0.3 | ) |   |   | (0.3 | ) |   |
| Total                              |       |                                            | $          | 0.9                                             |       |   |   | $ | 0.4 |   |   |   | $ | 7.4 |   |   |   | $ | 6.0 |   |   |

 

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

**8.Debt**

Debtis composed of the following (in thousands):
| ** **                                 | ** ** | **Restated** | ** ** | **Restated**                | ** ** |
|--------------------------------------------|------------|--------------|------------|-----------------------------|------------|
| **Description of Instrument**    | ** ** | ** **   | ** ** | **June 26, 2004** | ** ** | **Dec. 27, 2003** | ** ** |
| Asset-Based Revolving  Loan Facility       |       |         | $          | 77,307                      |       |   |   | $ | 70,353 |   |   |
| Total Current Debt                         |       |         | $          | 77,307                      |       |   |   | $ | 70,353 |   |   |
| 2.1478% Senior  Convertible Notes due 2022 |       |         | $          | 201,032                     |       |   |   | $ | 201,032 |   |   |
| Total Non-current Debt                     |       |         | $          | 201,032                     |       |   |   | $ | 201,032 |   |   |
| **Total Debt**                             | ** ** | ** **   | **$**      | **278,339**                 |       | ** ** | ** ** | **$** | **271,385** |   |   |
|                                            |            |              |            |                             |            |  |  |  |  |  |  |  |  |

 

**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 

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interest at the rate of2.1478% per year on the principal amount at maturity, payable semi-annually inarrears on April 16 and October 16 of each year beginning on October 16,2002, until April 16, 2007. After that date, interest will accrue on thenotes as amortization of the original issue discount representing a yield tomaturity of 3.75% per year, computed on a semi-annual bond equivalent basis. InDecember 2002, the Company repurchased a total of $30.5 million principalvalue of the Convertible Notes at an average purchase price of $486.99 per$1,000 note, resulting in the remaining net outstanding balance of $201.0million.

As more fully detailed in the Registration Statementon Form S-3 filed with the SEC on June 21, 2002, holders of theConvertible Notes may convert each $1,000 in principal amount of theirConvertible Notes into 14.1265 shares of the Company’s common stock, subject toadjustment, only if (1) the sale price of the Company’s common stockreaches the “conversion trigger price,” as defined in the indenture governingthe Convertible Notes, of $44.60 per share, (2) the trading price of thenotes falls below 103% of the “average conversion value,” as defined in theindenture governing the Convertible Notes, (3) the notes are called forredemption, or (4) specified corporate transactions, including aconsolidation, merger, or a transfer of all or substantially all of the Company’sassets have occurred. Upon conversion, the Company has the right to deliver, inlieu of its common stock, cash or a combination of cash and common stock in anamount as described in the indenture. These notes are not considered to bepotential common shares, and are not included in the calculation of dilutedearnings per share, as the Company intends to settle any conversions in cash.

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 originalissue discount and accrued cash interest, if any, to the date of purchase ifthe Company experiences a change of control.

The Acquisition is deemed to be a “change of control”under the indenture governing the Convertible Notes. Within 15 days after thecompletion of the Acquisition, the Company is required to notify the holders ofthe Convertible Notes of their option to require the Company to purchase thenotes. The Company expects substantially all holders will exercise theserepurchase rights, and the Company intends to finance the repurchase of thesenotes from the funds raised to finance the Acquisition.

In connection with theconsummation 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, asa 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.

**Revolving Credit Facility**

On July 21, 2003, the Company completed therefinancing of the Fourth Amended and Restated Credit Agreement entered into bythe Company on July 10, 2001 (the “Senior Credit Agreement”). The newcredit facility (the “Credit Agreement”) is an asset-based revolving loan whichuses a pre-determined percentage of the current value of the Company’sinventory, customer prescription files and selected accounts receivable tocalculate the availability of funds eligible to be borrowed up to an aggregateprincipal amount of $200 million. The obligations of the Company under theCredit Agreement are 

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collateralized bysubstantially all of the assets of the Company. In addition, the CreditAgreement has been guaranteed by each of the Company’s corporate subsidiaries,and such guarantees are collateralized by substantially all assets of suchguarantors. The Credit Agreement matures 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 or in the indenture related to the Convertible Notes.

At June 26, 2004, there was $77.3 million outstandingunder the revolving credit facility, and approximately $119.8 million ofremaining availability, net of $2.9 million reserved for standby letters ofcredit. Obligations under this facility have been classified as currentliabilities because cash receipts controlled by the lenders are used to reduceoutstanding debt, and the Company does not meet the criteria of FAS 6 toreclassify the debt as long-term. The Company intends to continue to utilizethis facility for its working capital needs though the date of its maturity inJuly 2008. Borrowings under the Credit Agreement are principally LIBOR-based.The margin on these borrowings is fixed at 1.75% for the first year, and issubject to a sliding scale adjustment thereafter, based on remaining levels ofavailability.

On July 22, 2004, inconnection with the anticipated consummation of the Acquisition, the CreditAgreement was amended (the “Amended Credit Agreement”) to increase the Company’sborrowing capacity to an aggregate principal amount of $250 million, subject toan adjusted borrowing base calculation based upon specified advance ratesagainst the value of the Company’s inventory, customer prescription files andselected accounts receivable. The Amended Credit Agreement includes a $50million sub-limit for the issuance of letters of credit. Obligations under thisrevolving loan facility are secured by a first priority security interest ininventory, receivables, pharmacy prescription files and certain other currentassets. The Company and Duane Reade, a New York general partnership which isthe Company’s principal operating company and of which the Company is a generalpartner (“Duane Reade GP”), are co-obligors under the amended facility. Theamended facility is guaranteed by Duane Reade Holdings and each of Duane ReadeInc.’s domestic subsidiaries other than Duane Reade GP. Revolving loans underthe Amended Credit Agreement will, at the Company’s option, bear interest ateither (i) a rate equal to LIBOR (the London Interbank Offered Rate) plus amargin of from 1.50% to 2.00%, to be determined based on levels of borrowingavailability reset each fiscal quarter or (ii) a rate equal to the primerate of Fleet Retail Group Inc. plus a margin of from 0.00% to 0.50%, to bedetermined based on levels of borrowing availability reset each fiscal quarter.Borrowings under the amended facility continue to be primarily LIBOR-based.

**Senior Term Loan Facility**

On July 30, 2004, inconnection with the Acquisition, the Company entered into a Senior Term LoanFacility (the “Senior Term Loan”) in the principal amount of $155 million. Thisloan will mature on July 30, 2010. While there are no scheduled principalpayments over its term, the Company will be required to prepay the senior termloan together with accrued interest thereon, with (a) all net cashproceeds (i) from sales of property and assets by Duane Reade Holdings andits subsidiaries (excluding sales of inventory in the normal course of businessand certain other exceptions described in the Senior Term Loan), (ii) ofextraordinary receipts 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 or its affiliates) and (c) 50.0% of excess cashflow of Duane Reade Holdings and its subsidiaries. Loans under the Senior TermLoan facility will, at the Company’s option, bear interest at a rate per annumof (i) the reserve-adjusted LIBOR plus an applicable margin of 3.25%; or (ii) 2.25%,plus 

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thehigher 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 will be guaranteed by Duane Reade Holdings and each of the Company’sexisting and future direct and indirect subsidiaries, other than Duane Reade GPand certain foreign subsidiaries. The Senior Term Loan is secured 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 secured by a secondpriority security interest in all collateral pledged on a first priority basisto 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 related triggers in the Senior Term LoanFacility or in the senior subordinated notes described below.

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

On July 30, 2004,upon completion of the Acquisition, the Company entered into an IndentureAgreement for $195 million of 93¤4% SeniorSubordinated Notes due 2011 (the “Senior Notes”). These notes mature on August 1,2011 and bear interest at 9.75% per annum payable in semi-annual installmentson February 1 and August 1, commencing February 1, 2005. Thesenotes are unsecured obligations and subordinated in right of payment to all ofthe Company’s existing and future unsubordinated indebtedness, includingborrowings under the Amended Credit Agreement and the Senior Term Loan. Thenotes rank equally with the Company’s senior subordinated indebtedness andsenior to the Company’s subordinated indebtedness. These notes are guaranteedon an unsecured senior subordinated basis by all of the Company’s existingdirect and indirect domestic subsidiaries other than Duane Reade GP, which is aco-obligor under the Senior Notes. The Company may redeem the 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 the Company can redeem up to 35% of the SeniorNotes before August 1, 2007 with the net cash proceeds from certain equityofferings. Upon the occurrence of specified change of control events, theCompany will be required to make an offer to repurchase all of the Senior Notesat 101% of the outstanding principal amount of the notes plus accrued andunpaid interest to the date of repurchase. The indenture governing the SeniorNotes contains certain affirmative and negative covenants that limit theCompany’s ability to incur additional indebtedness, pay dividends, makerepayments on indebtedness that is subordinated to the Senior Notes and to makecertain other restricted payments, incur certain liens, use proceeds from salesof assets, enter into business combination transactions (including mergers,consolidations and asset sales), enter into transactions with affiliates andpermit restrictions on the payment of dividends by the Company’s subsidiaries.Under a registration rights agreement entered into as part of the offering ofthe Senior Notes, the Company is required to (i) file a registrationstatement within 120 days after the completion of the Acquisition, (ii) useits reasonable best efforts to cause the registration statement to becomeeffective within 180 days after the completion of the Acquisition, and (iii) useits reasonable and best efforts to complete the exchange offer within 210 daysafter the Acquisition is completed.

**9. Net Income per Common Share**

Net income per commonshare is based on the weighted average shares outstanding during each period inaccordance with the provisions of FAS No. 128 “Earnings per Share.” Basicearnings per share are computed based on the weighted average number of commonshares outstanding during the period. Diluted earnings per share gives effectto all dilutive potential common shares outstanding during the 

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period.Dilutive potential common shares include shares issuable upon exercise of theCompany’s “in-the-money” stock options. Of the options to purchase2,078,590 and 1,221,197 shares of common stock outstanding at June 26,2004 and June 28, 2003, respectively, options to purchase 1,475,932 sharesat June 26, 2004 and 195,970 shares at June 28, 2003 were notincluded in the computation of diluted earnings per share because the exerciseprices of such options were greater than the average market price of the commonshares and therefore the impact of these shares would be anti-dilutive.Dilutive potential common shares do not include any potential shares that couldbe issued relative to the Company’s 2.1478% Convertible Notes (see Note 7 tothese Unaudited Consolidated Interim Financial Statements for a description ofthe relevant conversion terms of the Convertible Notes).

Thefollowing table sets forth the computation of net income per common share forthe periods presented (in thousands, except per share amounts):
| ** **                                               | ** ** | **For the 13 Weeks Ended**              | ** ** | **For the 26 Weeks Ended**              | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                               | ** ** | **   June 26,     2004** | ** ** | **   June 28,     2003** | ** ** | **   June 26,     2004** | ** ** | **   June 28,     2003** | ** ** |
| Net income (restated)                                    |       |                                                        | $          | 2,535                                                       |       |   |   | $ | 4,046 |   |   |   | $ | 4,288 |   |   |   | $ | 7,207 |   |   |
| Weighted average common  shares outstanding—basic   |       |                                                        | 24,482     |                                                        |       |   | 24,038 |   |   |   | 24,446 |   |   |   | 24,038 |   |   |
| Potential dilutive  shares                               |       |                                                        | 205        |                                                        |       |   | 313 |   |   |   | 240 |   |   |   | 307 |   |   |
| Weighted average common  shares outstanding—diluted |       |                                                        | 24,687     |                                                        |       |   | 24,351 |   |   |   | 24,686 |   |   |   | 24,345 |   |   |
| Per common share—basic                              |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (restated)                                    |       |                                                        | $          | 0.10                                                        |       |   |   | $ | 0.17 |   |   |   | $ | 0.18 |   |   |   | $ | 0.30 |   |   |
| Per common share—diluted                            |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (restated)                                    |       |                                                        | $          | 0.10                                                        |       |   |   | $ | 0.17 |   |   |   | $ | 0.17 |   |   |   | $ | 0.30 |   |   |

 

**10. Income Taxes**

Income taxes are recordedbased on the estimated combined statutory tax rates expected to be applicablefor the full fiscal year less applicable employment related tax credits. Theeffective tax rate is lower than the combined statutory rates, primarilyreflecting the impact of these income tax credits. The effective tax rate of 39.9%recorded in the first six months of 2004 gives effect to the New York State taxlegislation passed in May 2003 with retroactive application to January 1,2003. This legislation effectively eliminated certain royalty fee and relatedinterest expense deductions. The employment tax credits represent the economicbenefits earned by the Company for its participation in various federal andstate hiring incentive programs. These benefits are based on the number ofqualifying employees hired and retained by the Company for a specified timeperiod. Employees qualify for these hiring programs primarily as a result oftheir enrollment in various economic assistance programs.

**11.Commitments and Contingencies**

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

During 2002, the Companyinitiated a legal action against its former property insurance carrier inFederal Court in the Southern District of New York, in an attempt to recoverwhat the Company believes to be a fair and reasonable settlement for thebusiness interruption portion of its claim originating from the September 11,2001 World Trade Center terrorist attack, during which the Company’s singlehighest 

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volumeand most profitable store was completely destroyed. The claim is pending beforethe United States District Court for the Southern District of New York. In September 2003,a trial on certain issues was held regarding some of the matters at issue inthe litigation, including whether the Company would have obtained a renewal ofits lease at the World Trade Center. The Company has received a favorableruling on this and other legal issues in the case and now the matter has movedinto an appraisal process. The appraisal process involves two appraisers and anumpire (to resolve differences between the two appraisers) who will determinethe amount of insured loss the Company has sustained. The insurance carrier hasappealed a number of the rulings by the trial court. In light of both the earlystate of the appraisal process and the inherent uncertainty in litigationrelating to the appeal, the amount of additional insurance proceeds, if any,the Company may collect under the terms of its insurance contract with thedefendant 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 unfavorable outcome to the Company,this amount would not be required to be returned to the insurance company.

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

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

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

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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 2004.

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 interpretation in light of theCompany’s own specific facts and circumstances. The outcome of this matter, andthe 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 “DelawareComplaints,” and three purported class action complaints that have been filedin the Supreme Court of the State of New York. Two of the New York complaintshave been dismissed without prejudice. The other New York complaint (the “NewYork Complaint”) is pending, but has not been served on Duane Reade. TheDelaware Complaints name Mr. Cuti and certain other members of the Company’sboard of directors and executive officers as well as Duane Reade as defendants.Four of the Delaware Complaints name Oak Hill as a defendant. The New YorkComplaint names Mr. Cuti and certain other members of the Company’s boardof directors and executive officers as well as Duane Reade as defendants. Oneof the 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 “Consolidated Complaint”).

The Consolidated Complaintalleges that defendants failed to disclose material information in thepreliminary proxy statement, which was filed with the SEC on March 19,2004. Specifically, the Consolidated Complaint alleges that the defendantsfailed to disclose: (1) the precise nature of the “Current EmploymentAgreement Estimated Payments,” as that term is used in the preliminary proxy,and the reasons for these payments; (2) the materials and data purportedlyused by Bear Stearns in calculating the “Current Employment Agreement EstimatedPayments,” instead of the disclosure in the preliminary proxy statement thatthese calculations were “approximations based on various assumptions since theprecise amounts payable would require actuarial or other expert valuation,”even though Bear Stearns allegedly relied on these calculations; (3) themethodology, projections and other information used by Bear Stearns tocalculate the estimated present value of the company; and (4) that themerger consideration represented an approximately 11.7% premium based upon thetrading price of Duane Reade shares on December 22, 2003, instead of thedisclosure in the preliminary proxy that shareholders would be receiving a muchhigher premium of 22.0%. The Consolidated Complaint and the New York Complaintallege, among other things, that the defendants purportedly breached dutiesowed to Duane Reade’s stockholders in connection with the transaction byfailing to: (a) appropriately value Duane Reade as a merger 

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candidate;(b) expose Duane Reade to the marketplace in an effort to obtain the besttransaction reasonably available, including to market Duane Reade to industryparticipants; and (c) adequately ensure that no conflicts of interestexist between defendants’ own interests and their fiduciary obligation tomaximize stockholder value. Plaintiffs seek, among other things: an order thatthe complaints are properly maintainable as a class action; a declaration thatdefendants have breached their fiduciary duties and other duties; injunctiverelief; an unspecified amount of monetary damages; attorneys’ fees, costs andexpenses; and such other and further relief as the court may deem just andproper. Duane Reade believes these lawsuits are without merit and plans todefend these lawsuits vigorously.

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

**General**

Our business consists of awide variety of health and beauty care products, convenience oriented food andgeneral merchandise items and a pharmacy operation managed to supply customerswith their prescription needs. We refer to the non-prescription portion of ourbusiness as front-end sales because most of these sales are processed throughthe front main check-out sections of our stores. This portion of our businessconsists of over-the-counter medications, health and beauty care items, foodand beverages, tobacco products, cosmetics, housewares, greeting cards,photofinishing, photo supplies, 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% of our sales in the quarter ended June 26, 2004, and 49.8% ofour sales in the six months ended June 26, 2004, and is characterized bygenerally higher gross margins that are approximately twice that of ourpharmacy or back-end business.

Because of our numerousconvenient locations in high-traffic commercial and residential areas and thelack of other convenience oriented retailers in our core market areas, ourfront-end business is generally a larger proportion of our total sales thanother major conventional drug store chains, which average between 30% to 40%,but as is the case with most other drug store chains, represents a decreasingshare of business year after year due to the faster rate of pharmacy salesgrowth. Our pharmacy sales include all items we sell by prescription filled atour retail locations or by our central fill facility and delivered to ourstores or direct to customers. The pharmacy portion of our business isdominated by and dependent upon a number of third party private andgovernment-sponsored plans that contract with us as an authorized provider ofprescriptions.

Sales to third partyprescription plans represented 92.2% and 92.1% of our prescription sales in thequarter and six months ended June 26, 2004, respectively. The pharmacyportion of our business is subject to a number of federal, state and localregulations that govern the conduct of this business. The high rate of growthin pharmacy sales has been due to a number of favorable demographic andindustry trends such as the aging of the population, expanding penetration ofthird party private and government-sponsored coverage and the increasing usageof prescription drugs to improve quality of life and in place of medicalprocedures. Along with the fast pace of growth in this area have come generallyhigher rates of product cost inflation, resulting in an increased focus on thepart of both government and private plans to control their costs of providingthese benefits. As a result, pharmacy gross margins have been under pressure.

During 2003, PresidentBush signed legislation that will expand Medicare coverage of prescriptiondrugs for senior citizens not participating in third party plans, whichrepresent less than 2% of our total revenue. This new Medicare coverage isplanned to take effect in 2006 and is expected to result in decreased pharmacymargins resulting from lower reimbursement rates than our current margins onprescriptions that are not subject to third party reimbursement. In June 2004,a temporary senior citizen prescription drug discount program furnished underthis Medicare legislation was implemented and is expected to remain in effectuntil the full Medicare program takes effect in 2006. This temporary program 

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is alsoexpected to result in lower pharmacy margins than those currently realized onprescriptions that are not subject to third party plan reimbursement. Based onour experience over time, we expect that increased utilization of prescriptiondrugs by senior citizens participating in the new programs will offset theeffect of lower margins on our revenues.

In fiscal 2003, New YorkState reduced Medicaid prescription reimbursement rates, adversely impactingour pharmacy gross margins. Recent New York State budget proposals also includethe possibility of additional reductions in Medicaid reimbursement rates.

While retaining its highrate of growth in 2003, the retail pharmacy industry experienced substantiallyreduced rates of pharmacy same-store sales growth resulting from a decline inthe demand for hormonal replacement drugs, conversion of some high volumeprescription drugs to over-the-counter status, increased levels of requiredco-payments by insurers, increased utilization of lower priced genericmedications and reductions in coverage resulting from high unemployment rates.These trends continued to be operative throughout the first half of 2004.

We operate approximately85% of our 247 stores in New York City and therefore our financial performanceis heavily influenced by the local economy. We analyze a number of economicindicators specific to New York City to gauge the health of this economyincluding unemployment rates, job creation, gross city product and bridge andtunnel commuter traffic patterns. We also analyze market share data, same-storesales trends, average store sales and sales per square foot data among otherkey performance indicators to monitor our overall performance.

The New York City economycontinues to experience higher rates of unemployment than the national economyoverall. June unemployment data for New York City indicated anunemployment rate of 7.4% compared to a national average of 5.6%. While thelocal economy still lags the national trend, the city did not experiencecontinued job losses during the quarter and has begun to report a rising rateof tax revenues. In addition, the New York City unemployment rate reflects asignificant improvement as compared to the monthly average rate of 8.5%reported for the first quarter of this year. We believe that these trendsreflect an improved fiscal situation for the city overall that is consistentwith the early stages of an improving local economy.

On July 30, 2004 wewere acquired through a merger transaction with Duane Reade Acquisition Corp. (“DuaneReade Acquisition”), a wholly owned subsidiary of Duane Reade Holdings, Inc.and an affiliate of Oak Hill Capital Partners, L.P. (“Oak Hill”), a privateequity firm (the “Acquisition”). The aggregate value of the Acquisition wasapproximately $744 million, including transaction expenses and the repayment ofa portion of our indebtedness. As a result of the Acquisition, our shares willno longer be listed on the New York Stock Exchange and Duane Reade willcontinue its operations as a privately held company. Each share of Duane Reade’scommon stock outstanding immediately prior to the Acquisition was convertedinto the right to receive $16.50 per share, without interest, in cash.

Oak Hill financed theacquisition out of their current $1.6 billion private equity fund, along withseveral co-investors. The funding also included third-party debt financings,including the issuance of 9.75% Senior Subordinated Notes due 2011 in a principalamount of $195 million, a new senior secured term loan facility in an aggregateamount of $155 million and an increase of our existing revolving creditfacility with Fleet Retail Group to $250 million, that resulted inapproximately $93.3 million of borrowing capacity after completion of themerger. The high-yield note offering and new debt facility were arranged by agroup of financial institutions led by Banc of America Securities LLC. As aresult of the Acquisition, Duane Reade expects to make a change of controloffer to purchase its outstanding Convertible Notes, in the principal amount of$201 million plus accrued and unpaid interest.

The Acquisition wasaccounted for as a purchase, in accordance with the provisions of Statement ofFinancial Accounting Standards No. 141, “Business Combinations,” whichwill result in new valuations for our and our subsidiaries’ assets andliabilities based on fair values as of the date of the acquisition. These 

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newvaluations will be finalized within one year after the closing of theAcquisition and will be the basis for our future impairment evaluations underStatement of Financial Accounting Standards No. 142, “Goodwill and OtherIntangible Assets.”

**Restatements**

The consolidated financial statements included hereinreflect the following restatements:

(1)   We restatedreported net sales and cost of sales to reflect revenues from resales ofcertain 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)   We restatedcost of sales to reflect changes in our lease accounting to conform to therequirements of FASB Technical Bulletin No. 85-3. As has been the case for manycompanies within the retail and other industries, we determined, based on areview 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)   We haverestated our previously reported balance sheets for June 26, 2004 and December 27,2003 to reflect the classification of outstanding borrowings under therevolving loan facility as current liabilities rather than as long-term debt,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.

(4)   We haverestated our consolidated statement of cash flows for the first six months of2004 and 2003 to reflect the reporting of revolving loan facility borrowingsand repayments separately on a gross basis as required under FAS 95. Inaddition, we restated our financial results to include certain previouslyunrecorded and immaterial audit adjustments relating to the periods affected.These restatements are included in the discussion of our results of operationsbelow and within the Consolidated Financial Statements presented elsewhere inthis filing. See Note 2 to the Consolidated Financial Statements for a furtherdiscussion of these restatements. 

In connection with theserestatements, we obtained from the administrative agent under the amendedasset-based revolving loan facility, an acknowledgement confirming that theserestatements do not constitute an event of technical default, as defined in thedocument governing the revolving loan facility.

**Results of Operations**

For the secondquarter ended June 26, 2004, we achieved net sales of $402.1 million and netincome of $2.5 million, or $0.10 per diluted share, compared to net sales of $368.9million and net income of $4.0 million, or $0.17 per diluted share, in thesecond quarter of the previous year. Resales of pharmaceutical retail inventorywere $36.9 million in the quarter ended June 26, 2004, as compared to $13.7million in the quarter ended June 28, 2003. Gross profit margins decreased from21.0% last year to 19.7% this year. The 

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decrease wasprimarily attributable to the impact of increased resale activity, whichgenerally has gross margins of less than one percent. In addition to the decreasein gross profit margins, net income declined principally due to the followingfactors:

·       Pre-taxtransaction expenses of $1.5 million related to the acquisition of the Company;

·       A$1.1 million increase in depreciation and amortization expense resulting fromthe depreciation of capital expenditures made in 2003 and 2004 as well asincreases in the amortization of identifiable intangibles;

·       Pre-taxlabor contingency expenses of $1.1 million related to a National LaborRelations Board Administrative Law Judge’s recommendation in a collectivebargaining agreement litigation related to the funding of certain employeebenefit funds (see Note 3 to the Unaudited Consolidated Interim FinancialStatements); and

·       Increased legal andprofessional expenses of $0.6 million associated with certain labor issues, ourattempt to recover the balance of our World Trade Center business interruptioninsurance claim and various other matters.

**ThirteenWeeks Ended June 26, 2004 versus Thirteen Weeks Ended June 28, 2003**

Thefollowing sets forth the results of operations for the periods indicated:
| ** **                                           | ** ** | **Restated**                                        | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **For the 13 Weeks Ended**                | ** ** |
| ** **                                           | ** ** | **June 26, 2004**                         | ** ** | **June 28, 2003** | ** ** |
| ** **                                           | ** ** | **Dollars**                                         | ** ** | **% of Sales** | ** ** | **Dollars** | ** ** | **% of Sales** | ** ** |
| ** **                                           | ** ** | **In thousands, except percentages** | ** ** |
| Net sales                                            |       | $                                                   | 402,111    |   |   | 100.0 | % |   | $ | 368,894 |   |   | 100.0 | % |   |
| Cost of sales                                        |       | 322,726                                             |       |   | 80.3 |   |   | 291,602 |   |   | 79.0 |   |   |
| Gross profit                                         |       | 79,385                                              |       |   | 19.7 |   |   | 77,292 |   |   | 21.0 |   |   |
| Selling,  general & administrative expenses |       | 59,924                                              |       |   | 14.9 |   |   | 57,598 |   |   | 15.6 |   |   |
| Labor contingency  expense                           |       | 1,100                                               |       |   | 0.3 |   |   | — |   |   | 0.0 |   |   |
| Transaction  expenses                                |       | 1,516                                               |       |   | 0.4 |   |   | — |   |   | 0.0 |   |   |
| Depreciation and  amortization                       |       | 9,239                                               |       |   | 2.3 |   |   | 8,154 |   |   | 2.2 |   |   |
| Store pre-opening  expenses                          |       | 209                                                 |       |   | 0.1 |   |   | 229 |   |   | 0.1 |   |   |
|                                                 |       | 71,988                                              |       |   | 17.9 |   |   | 65,981 |   |   | 17.9 |   |   |
| Operating income                                     |       | 7,397                                               |       |   | 1.8 |   |   | 11,311 |   |   | 3.1 |   |   |
| Interest expense,  net                               |       | 3,257                                               |       |   | 0.8 |   |   | 3,549 |   |   | 1.0 |   |   |
| Debt  extinguishment                                 |       | —                                              |       |   | 0.0 |   |   | — |   |   | 0.0 |   |   |
| Income before  income taxes                          |       | 4,140                                               |       |   | 1.0 |   |   | 7,762 |   |   | 2.1 |   |   |
| Income taxes                                         |       | 1,605                                               |       |   | 0.4 |   |   | 3,716 |   |   | 1.0 |   |   |
| Net income                                           |       | $                                                   | 2,535      |   |   | 0.6 | % |   | $ | 4,046 |   |   | 1.1 | % |   |

 

Net sales were $402.1 million in the second quarter of2004, an increase of 9.0% over net sales of $368.9 million for the secondquarter of 2003. Resale activity accounted for 6.3% of this increase, whilenormal retail sales to customers increased by 2.7% over this period. Same-storesales increased by 0.4% over the second quarter last year with the balance ofthe increase coming from the full quarterly results of four net new storesopened in the second quarter last year and 11 net new stores opened since theend of last year’s second quarter.

Pharmacy sales increased from $169.0 million in thesecond quarter of 2003 to $202.3 million in the second quarter of 2004, anincrease of 19.7%, and represented 50.3% of total sales, as compared with 45.8%of total sales in the second quarter of 2003. Resale activity in 2004 accountedfor 13.7% of the 

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pharmacy sales increase. Pharmacysame-store sales increased by 4.6% over last year, and third-party reimbursedpharmacy sales represented 92.2% of total prescription sales compared to 91.3%in the second quarter of 2003. Pharmacy same-store sales continued toexperience the general industry trend of reduced growth rates experiencedduring fiscal 2003. The major factors driving the slower sales growth rates inpharmacy were the trends toward increases in third party plan customerco-payments, reduced sales of hormonal replacement drugs, limitations onmaximum reimbursements for certain generic medications by third party plans,increased penetration by mail order and internet-based pharmacies and continuedhigh rates of unemployment that have reduced the number of customers covered byinsured plans.

Front-end sales decreased from $199.9 million in thesecond quarter of 2003 to $199.8 million in the second quarter of 2004, adecrease of 0.1%, and represented 49.7% of total sales, as compared to 54.2% oftotal sales in the second quarter of 2003. Front-end same-store sales declinedby 2.8%, partly due to declining tobacco sales in metro New York City, whichhas experienced increased restrictions on smoking in public places along withhigher taxes on tobacco products. Excluding tobacco sales, front-end same-storesales decreased by approximately 1.6%. We believe that the remaining decline insame-store front-end sales is largely attributable to the continued highunemployment rates in New York City that have restrained consumer demand.

We opened four new stores during the second quarter ofboth 2004 and 2003. At June 26, 2004, we operated 247 stores, as comparedto 236 stores at June 28, 2003.

Cost of sales as a percentage of net sales increasedto 80.3% for the second quarter of 2004 from 79.0% for the second quarter of2003, resulting in a decrease in gross profit margin to 19.7% for the secondquarter of 2004 from 21.0% for the second quarter of 2003.  This decrease was primarily attributable to theimpact of the increased resale activity, which was partially offset by higherfront-end selling margins and reduced shrink losses. These improvements werealso partially offset by higher store occupancy costs primarily resulting fromhigher rent expense attributable to new stores and store relocations. Cost ofsales also includes (i) a $0.3 million LIFO provision in the current year, ascompared to a LIFO provision of $0.2 million in the prior year, and (ii)real-estate related income amounting to $1.2 million and $0.1 million in thesecond quarter of 2004 and 2003, respectively.

Selling, general and administrative expenses were$59.9 million, or 14.9% of net sales, and $57.6 million, or 15.6% of net sales,in the second quarters of 2004 and 2003, respectively. The decrease in thepercentage of sales reflects the impact of increased resale activity, which hadthe effect of reducing our operating expense ratios to sales. Because resaleactivity does not incur any significant selling, general and administrativecosts, we believe it is more informative to discuss such costs as a percentageof sales, excluding such resale activity. Excluding the impact of the resaleactivity, SG&A expenses for the second quarter of 2004 and 2003 were 16.4%and 16.2% of net sales, respectively. The increase in these expenses as apercentage of sales is primarily attributable to the higher legal andprofessional expenses discussed above and higher insurance costs.

Depreciation and amortization of intangibles in thesecond quarters of 2004 and 2003 were $9.2 million and $8.2 million,respectively.  This increase resultedfrom the 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 second quarter of2003.

We incurred store pre-opening expenses of $0.2million, related to the opening of four new stores, during the second quarterof both 2003 and 2004.

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Net interest expense decreased 8.2% to $3.3 million inthe second quarter of 2004 from $3.5 million in the second quarter of2003.  This decline was primarilyattributable to the lower average interest rates on our outstanding revolvingcredit borrowings in the current year, as compared to the interest ratesincurred on our revolving credit and term loan borrowings in the prior year.

In the second quarter of2004, we recorded an income tax provision of $1.6 million, reflecting anestimated annual effective tax rate of 38.8%, inclusive of the anticipatedbenefits of employment tax credits. In the comparable period last year, theincome tax provision of $3.7 million reflected an estimated effective tax rateof 47.9%, inclusive of the anticipated benefits of employment tax credits, aswell as a retroactive adjustment to the first quarter’s tax expense, which hadbeen previously recorded at an effective rate of 38.2%. The increase in lastyear’s second quarter effective tax rate reflected New York State legislationpassed in May 2003 which retroactively eliminated certain tax deductionsattributable to royalty companies. The employment tax credits represent theeconomic benefits earned by us for our participation in various federal andstate hiring incentive programs. The decrease in the current year’s effectiverate reflects the combined impact of the employment tax credits and the reducedlevels of pre-tax income generated by the Company.

**Twenty-SixWeeks Ended June 26, 2004 versus Twenty-Six Weeks Ended June 28, 2003**

Thefollowing sets forth the results of operations for the periods indicated:
| ** **                                      | ** ** | **Restated**                          | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                      | ** ** | **For the 26 Weeks Ended**  | ** ** |
| ** **                                      | ** ** | **June 26, 2004**           | ** ** | **June 28, 2003** | ** ** |
| ** **                                      | ** ** | **Dollars**                           | ** ** | **% of Sales** | ** ** | **Dollars** | ** ** | **% of Sales** | ** ** |
| ** **                                      | ** ** | **In  thousands, except percentages** | ** ** |
| Net sales                                       |       | $                                     | 785,421    |   |   | 100.0 | % |   | $ | 724,888 |   |   | 100.0 | % |   |
| Cost of sales                                   |       | 629,533                               |       |   | 80.2 |   |   | 577,016 |   |   | 79.6 |   |   |
| Gross profit                                    |       | 155,888                               |       |   | 19.8 |   |   | 147,872 |   |   | 20.4 |   |   |
| Selling, general  & administrative expenses |       | 118,567                               |       |   | 15.1 |   |   | 111,472 |   |   | 15.4 |   |   |
| Labor contingency  expense                      |       | 2,200                                 |       |   | 0.3 |   |   | — |   |   | 0.0 |   |   |
| Transaction  expenses                           |       | 2,619                                 |       |   | 0.3 |   |   | — |   |   | 0.0 |   |   |
| Depreciation and  amortization                  |       | 18,305                                |       |   | 2.3 |   |   | 15,712 |   |   | 2.2 |   |   |
| Store pre-opening  expenses                     |       | 365                                   |       |   | 0.0 |   |   | 644 |   |   | 0.1 |   |   |
|                                            |       | 142,056                               |       |   | 18.1 |   |   | 127,828 |   |   | 17.6 |   |   |
| Operating income                                |       | 13,832                                |       |   | 1.8 |   |   | 20,044 |   |   | 2.8 |   |   |
| Interest expense,  net                          |       | 6,694                                 |       |   | 0.9 |   |   | 7,066 |   |   | 1.0 |   |   |
| Debt  extinguishment                            |       | —                                |       |   | 0.0 |   |   | 105 |   |   | 0.0 |   |   |
| Income before  income taxes                     |       | 7,138                                 |       |   | 0.9 |   |   | 12,873 |   |   | 1.8 |   |   |
| Income taxes                                    |       | 2,850                                 |       |   | 0.4 |   |   | 5,666 |   |   | 0.8 |   |   |
| Net income                                      |       | $                                     | 4,288      |   |   | 0.5 | % |   | $ | 7,207 |   |   | 1.0 | % |   |

 

Net sales were $785.4 million in the first six monthsof 2004, an increase of 8.4% over net sales of $724.9 million for the first sixmonths of 2003. Resale activity accounted for 4.8% of this increase, whilenormal retail sales to customers increased by 3.6% over this period. Same-storesales increased by 1.0% over the first six months last year with the balance ofthe increase coming from the full six month results of eight net new storesopened in the first six months last year and 11 net new stores opened since theend of last year’s second quarter.

Pharmacy sales increased from $335.2 million in thefirst six months of 2003 to $394.5 million in the first six months of 2004, anincrease of 17.7%, and represented 50.2% of total sales, as compared with 46.2%of total sales in the first six months of 2003. Resale activity in 2004accounted for 10.3% of the 

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pharmacy sales increase. Pharmacysame-store sales increased by 5.5% over last year, and third-party reimbursedpharmacy sales represented 92.1% of total prescription sales compared to 91.2%in the first six months of 2003. Pharmacy same-store sales continued toexperience the general industry trend of reduced growth rates experienced duringfiscal 2003.  The major factors drivingthe slower sales growth rates in pharmacy were the trends toward increases inthird party plan customer co-payments, reduced sales of hormonal replacementdrugs, limitations on maximum reimbursements for certain generic medications bythird party plans, increased penetration of 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 $389.7 million in thefirst six months of 2003 to $390.9 million in the first six months of 2004, anincrease of 0.3%, and represented 49.8% of total sales, as compared to 53.8% oftotal sales in the first six months of 2003. Front-end same-store sales declinedby 2.5%, largely due to declining tobacco sales in metro New York City, whichhas experienced increased restrictions on smoking in public places along withhigher taxes on tobacco products. Excluding tobacco sales, front-end same-store sales decreased byapproximately 1.1%. 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 first six months of 2004, we opened sevennew stores and closed one store, as compared to 11 stores opened and threestores closed in the comparable period last year.

Cost of sales as a percentage of net sales increasedto 80.2% for the first six months of 2004 from 79.6% for the first six monthsof 2003, resulting in a decrease in gross profit margin to 19.8% for the firstsix months of 2004 from 20.4% for the first six months of 2003. This decreasewas primarily attributable to the impact of increased resale activity, whichgenerally has gross margins of less than one percent, partially offset by higherfront-end selling margins and reduced shrink losses. These improvements werepartially offset by higher store occupancy costs primarily resulting fromhigher rent expense attributable to new stores and store relocations. Cost ofsales also includes (i) a $0.7 million LIFO provision in the current year, ascompared to a LIFO provision of $0.3 million in the prior year, and (ii)real-estate related income of $2.0 million and $1.3 million in the first sixmonths of 2004 and 2003, respectively.

Selling, general and administrative expenses were$118.6 million, or 15.1% of net sales, and $111.5 million, or 15.4% of netsales, in the first six months of 2004 and 2003, respectively. The decrease inthe percentage of sales reflects the impact of increased resale activity, whichhad the effect of reducing our operating expense ratios to sales. Becauseresale activity does not incur any significant selling, general andadministrative costs, we believe it is more informative to discuss such costsas a percentage of sales, excluding such resale activity. Excluding the impactof the resale activity, SG&A expenses for the first six months of 2004 and2003 were 16.6% and 16.2% of net sales, respectively. The increase in theseexpenses as a percentage of sales is primarily attributable to the higher legaland professional expenses discussed above, severance costs associated withcertain administrative staff reductions incurred during the first quarter andhigher insurance costs.

Depreciation and amortization of intangibles in thefirst six months of 2004 and 2003 were $18.3 million and $15.7 million,respectively.  This increase resultedfrom the depreciation of capital expenditures made in 2003 and 2004 as well asincreases in the amortization of identifiable intangibles, a major portionwhich resulted from pharmacy acquisitions completed since the beginning of2003.

We incurred store pre-opening expenses of $0.4 millionduring the first six months of 2004 related to the opening of seven newstores.  During the comparable periodlast year, we incurred pre-opening expenses of $0.6 million related to theopening of 11 new stores.

Net interest expense decreased 5.3% to $6.7 million inthe first six months of 2004 from $7.1 million in the first six months of2003.  This decline was primarilyattributable to the lower average interest rates on 

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our outstanding revolvingcredit borrowings in the current year, as compared to the interest ratesincurred on our revolving credit and term loan borrowings in the prior year.

In the first six months of 2003, we recorded a debtextinguishment charge of $0.1 million, reflecting 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.

In the first six months of2004, we recorded an income tax provision of $2.9 million, reflecting anestimated annual effective tax rate of 39.9%, inclusive of the anticipatedbenefits of employment tax credits. In the comparable period last year, theincome tax provision of $5.7 million reflected an estimated effective tax rateof 44.0%, inclusive of the anticipated benefits of employment tax credits.  The employment tax credits represent theeconomic benefits earned by us for our participation in various federal andstate hiring incentive programs. The decrease in the effective rate reflectsthe combined impact of the employment tax credits and the reduced levels ofpre-tax income generated by the Company.

**Liquidity and Capital Resources**

**Working Capital and Cash Flow**

Working capital was $154.4 million as of June 26, 2004and $155.9 million as of December 27, 2003. Working capital reflects theclassification of outstanding borrowings under our revolving loan facility of$77.3 million at June 26, 2004 and $70.4 million at December 27, 2003 ascurrent liabilities. This current classification is required because cashreceipts controlled by the lenders are used to reduce outstanding debt, and wedid not meet the criteria of FAS 6 to reclassify the debt as long-term but isnot an indication that this credit facility is expected to be retired withinthe next year. This facility expires in July of 2008 and we intend to continueto access it for our working capital needs throughout its remaining term.

For the first six months of 2004, net cash provided byoperating activities was $20.0 million, as compared to $14.0 million in thefirst six months of 2003. The increase was principally due to reducedmerchandise purchases during the first six months of 2004 and the collection ofcertain property insurance claims amounting to $1.3 million.

Net cash used in investing activities was $27.7million during the first six months of 2004, compared to $35.7 million duringthe first six months of 2003.  In thefirst six months of 2004, capital expenditures, primarily related to new storeopenings and the remodeling of existing locations, were $16.2 million, whilelease acquisition, pharmacy customer file and other costs accounted for $11.5million of cash used in investing activities. In the first six months of 2003, we spent $25.8 million on capitalexpenditures and $9.9 million on lease acquisition, pharmacy customer file andother costs.

Net cash provided byfinancing activities was $7.7 million for the first six months of 2004,compared to $18.8 million for the first six months of 2003. The decrease of$11.1 million reflects the improved level of cash flow generated by reducedinvesting activities and increased cash flow from operations discussed above.

**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 $93.3****millionof borrowing availability under our amended asset-based revolving loanfacility.

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**Operating Capital Requirements**

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 believe that there are significant opportunities to open additionalstores, and currently plan to open approximately 8-10 additional newstores during the remainder of this year (a total of 15-17 for all of2004), and 10-12 new stores in each of fiscal 2005 through fiscal 2008.We expect to spend approximately $40.0 million in 2004 on capital expenditures,primarily for new, renovated and replacement stores, and an additional $14million - $17 million for lease acquisition, pharmacy customer files and othercosts. We also require working capital to support inventory for our existingand new stores. Historically, we have been able to lease almost all of ourstore locations, so acquisitions of real estate are not expected to have asignificant impact on our capital requirements

**OtherFactors Influencing our Liquidity**

Ten of our stores that generated 4.1% of our net salesin fiscal 2003 have leases that are scheduled to expire before the end of 2005.One of these leases has a renewal option. We believe that we will be able torenew the expiring leases on economically favorable terms or, alternatively,find other economically attractive locations to lease.

As of June 26, 2004, approximately 4,500 of ourapproximately 6,300 employees were represented by various labor unions and werecovered by collective bargaining agreements. Pursuant to the terms of the collectivebargaining agreements covering these employees, we are required, in someinstances, to pay specified annual increases in salary and benefitscontributions relating to the member employees. We do not believe that theseincreases will have a material impact on our liquidity or results ofoperations. Our collective bargaining agreement with Local 340A New York JointBoard, UNITE AFL-CIO (“UNITE”), who represents approximately 700 of ouremployees in 113 stores, expired on March 31, 2004. The terms of theexpired contract have been extended by the mutual consent of UNITE and DuaneReade through August 31, 2004 while we continue to negotiate the terms ofa new agreement.

Under an employment agreement with our Chairman andCEO originally entered into in 1997 and subsequently amended in 2000 and 2001,and then amended and restated in 2002, and again amended and restated inconnection with the completed Acquisition, we were required to fund premiumsfor a split dollar life insurance policy that will provide certainpost-retirement benefits. During fiscal 2003 and fiscal 2004, the annualpremiums amounted to $5.0 million, and are scheduled to remain at$5.0 million per year through 2010. The enactment of the Sarbanes-OxleyAct has resulted in the need for additional guidance concerning thepermissibility of split dollar life insurance policies for executives. While webelieve this split dollar policy is permitted under current interpretations ofthe legislation, there can be no assurance that further interpretations orguidance to be provided by the SEC concerning this legislation will concur. Uponcompletion of the Acquisition, under Mr. Cuti’s employment agreement, wehave the opportunity to elect to terminate the split dollar life insurancecontract in exchange for, among other things, the payment to Mr. Cuti of$6.5 million on or prior to December 1, 2004, $14.0 million on or prior toJanuary 1, 2005 and $4.0 million on or prior to June 30, 2005, and weexpect to make that termination election. The parties to Mr. Cuti’semployment agreement are considering accelerating a portion of the firstpayment of $6.5 million in an amount up to $1.5 million to be paid prior to December 1,2004. A portion of these payment obligations will be satisfied either using thecash surrender value of the split dollar life insurance contract at the time weelect to terminate it (approximately $14.0 million as of August 2, 2004)or by transferring ownership of the split dollar life insurance contract to Mr. Cuti.

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As of June 26, 2004, there were no materialchanges in the Contractual Obligations and Commitments disclosed in our AnnualReport on Form 10-K/A for the year ended December 27, 2003,except that we paid the annual $5.0 million premium due in connection with theCEO Split Dollar Life Insurance Policy on January 26, 2004. The remainingfixed premium obligation under the terms of this policy amounts to $30.0million subject to the early termination provision described above.

We are party to multi-year, merchandise supplyagreements in the normal course of business. The largest of these agreements iswith AmerisourceBergen, our primary pharmaceutical supplier. Generally, theseagreements provide for certain volume commitments and may be terminated by us,subject in some cases to specified termination payments, none of which wouldconstitute a material adverse effect on our financial position, results ofoperations or cash flows. It is the opinion of management that if any of theseagreements were terminated or if any contracting party was to experience eventsprecluding fulfillment of its obligations, we would be able to find a suitablealternative supplier.

In connection with the Acquisition, Mr. Cuti wasgranted equity interests in Duane Reade Shareholders and Duane Reade Holdingsconsisting of options to purchase shares of Duane Reade Holdings common stockand a profits interest in Duane Reade Shareholders. Upon the occurrence ofcertain events, including the fifth anniversary of the effective date of theAcquisition, Mr. Cuti will have the right to require us to purchase forcash over a two year period all or a portion of these equity interests as hemay designate, at fair market value determined in accordance with a formula. Theprofits interest and options will have no value unless the value of Duane ReadeShareholders and Duane Reade Holdings, respectively, appreciate following theAcquisition. Mr. Cuti’s purchase right will be suspended at any time whenthe exercise of such purchase rights would result in a default under thefinancing arrangements of us, Duane Reade Shareholders or Duane Reade Holdings.Mr. Cuti’s purchase right will also terminate upon certain publicofferings by us, Duane Reade Shareholders or Duane Reade Holdings.

At June 26, 2004 we recorded a litigation-relatednon-current liability of $14.8 million in connection with a National LaborRelations Board Administrative Law Judge recommendation in a litigation-relatedmatter with the Allied Trades Council, a union representing employees in 139 ofour stores. Because this recommendation is only the initial phase of a complexadministrative and judicial process, the ultimate outcome, financial impact andrelated timing of any future cash disbursement relating to this matter can notbe determined at this time. This matter is more fully described in Note 3to the Unaudited Consolidated Interim Financial Statements.

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

**Debt**

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

**Convertible Notes**

The Convertible Notes were issued on April 16,2002 at a discounted value equivalent to 57.276% of face value. The ConvertibleNotes pay cash interest semiannually at a rate of 2.1478% of face value for thefirst five years and thereafter accrue original issue discount at a semi-annualbond equivalent rate of 3.75% yield to maturity on April 16, 2022. TheConvertible Notes are convertible into shares of our common stock upon theoccurrence of certain specified events. Holders of the Convertible Notes mayrequire us to purchase all or a portion of the Convertible Notes on each of the5, 10 and 15-year anniversaries of the issuance date at pre-specifiedprices. We may redeem for cash all or a portion of the Convertible Notes at 

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any time after April 16,2007 at a price equal to the sum of the issue price plus accrued original issuediscount and accrued cash interest, if any, to the redemption date. The Acquisitionwas deemed a “change of control” under the indenture governing the seniorconvertible notes. Within 15 days after the completion of the Acquisition, wewill be required to notify the holders of our Convertible Notes of their optionto require us to purchase the notes within 30 business days after thecompletion of the Acquisition, at a cash price equal to the sum of the issueprice plus accrued original issue discount and cash interest, if any, on suchnotes to the date of purchase. We expect that the holders of all orsubstantially all of our Convertible Notes will exercise their repurchaserights and we expect to fund the repurchase price from the funds raised tofinance the Acquisition. Until such Convertible Notes are fully redeemed, ourborrowing availability under our revolving credit facility will be reduced bythe issue price of any unredeemed senior convertible notes less any specificfinancing funds placed into a separate escrow account for the express purposeof redeeming such notes.

In connection with theconsummation of the Acquisition, we, Duane Reade Shareholders, LLC, theindirect parent of Duane Reade Acquisition Corp. and each of our subsidiariesthat are guarantors of the Convertible Notes entered into a supplementalindenture. Pursuant to the supplemental indenture, as a result of the merger ofDuane Reade Acquisition Corp. with and into Duane Reade Inc., the ConvertibleNotes may only be converted into the right to receive from us $16.50 (in cashand without interest) per share of our common stock issuable to a holder ofConvertible Notes in connection with such conversion.

**Credit Agreement**

On July 21, 2003, we completed the refinancing ofthe Fourth Amended and Restated Credit Agreement entered into by us on July 10,2001 (the “Senior Credit Agreement”). This credit facility (the “CreditAgreement”) is an asset-based revolving loan which uses a pre-determinedpercentage of the current value of our inventory, customer prescription filesand selected accounts receivable to calculate the availability of fundseligible to be borrowed up to an aggregate principal amount of $200 million.Our obligations under the Credit Agreement are collateralized by substantiallyall of our assets. In addition, the Credit Agreement has been guaranteed byeach of our corporate subsidiaries, and such guarantees are collateralized bysubstantially all assets of such guarantors. The Credit Agreement matures 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 or in the indenture related to the Convertible Notes.

At June 26, 2004 there was $77.3 millionoutstanding under the revolving credit facility, and approximately $119.8million of remaining availability, net of $2.9 million reserved for standbyletters of credit. Obligations under this facility have been classified ascurrent liabilities because cash receipts controlled by the lenders are used toreduce outstanding debt, and we do not meet the criteria of FAS 6 to reclassifythe debt as long-term. We intend to continue to utilize this facility for ourworking capital needs through the date of its maturity in July 2008.

On July 22, 2004, inconnection with the anticipated consummation of the Acquisition, the CreditAgreement was amended (the “Amended Credit Agreement”) to increase ourborrowing capacity to an aggregate principal amount of $250 million, subject toan adjusted borrowing base calculation based upon specified advance ratesagainst the value of our inventory, customer prescription files and selectedaccounts receivable. The Amended Credit Agreement includes a $50 millionsub-limit for the issuance of letters of credit. Obligations under this amendedasset-based revolving loan facility are secured by a first priority securityinterest in inventory, receivables, pharmacy prescription files and certainother current 

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assets.We and Duane Reade, a New York general partnership which is our principal operatingcompany and of which we are a general partner (“Duane Reade GP”), areco-obligors under the amended facility. The amended facility is guaranteed byDuane Reade Holdings and each of our domestic subsidiaries other than DuaneReade GP. Revolving loans under the Amended Credit Agreement will, at ouroption, bear interest at either (i) a rate equal to LIBOR (the LondonInterbank Offered Rate) plus a margin of from 1.50% to 2.00%, to be determinedbased on levels of borrowing availability reset each fiscal quarter or (ii) arate equal to the prime rate of Fleet Retail Group Inc. plus a margin of from0.00% to 0.50%, to be determined based on levels of borrowing availabilityreset each fiscal quarter. Borrowings under the amended facility continue to beprimarily LIBOR-based.

**Acquisition-RelatedDebt Financings**

**Senior Term Loan Facility**

On July 30, 2004, inconnection with the Acquisition, we entered into a Senior Term Loan Facility(the “Senior Term Loan”) in the principal amount of $155 million. This loan willmature on July 30, 2010. While there are no scheduled principal paymentsover its term, we will be required to prepay the senior term loans togetherwith accrued interest thereon, with (a) all net cash proceeds (i) fromsales of property and assets by Duane Reade Holdings and its subsidiaries(excluding sales of inventory in the normal course of business and certainother exceptions described in the Senior Term Loan), (ii) of extraordinaryreceipts as 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 or its affiliates) and (c) 50.0% of excess cashflow of Duane Reade Holdings and its subsidiaries. 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 the SeniorTerm Loan upon the closing of the Acquisition. All obligations under the SeniorTerm Loan will be guaranteed by Duane Reade Holdings and each of our existingand future direct and indirect subsidiaries, other than Duane Reade GP andcertain foreign subsidiaries. The Senior Term Loan is secured by a firstpriority security interest in substantially all of our assets other than thoseassets in which the lenders under the Amended Credit Agreement have a firstpriority interest. The Senior Term Loan is also secured by a second prioritysecurity interest in all collateral pledged on a first priority basis tolenders under the Amended Credit Agreement. The Senior Term Loan also containsaffirmative and negative covenants customary for a senior term loan facility,including, among other things, restrictions on indebtedness, liens, mergers andconsolidations, sales of assets, loans, acquisitions, joint ventures,restricted payments, transactions with affiliates, dividends and other paymentrestrictions affecting subsidiaries and sale leaseback transactions. The SeniorTerm Loan also requires Duane Reade Holdings and its subsidiaries to maintain amaximum leverage ratio and a minimum interest coverage ratio. There are nocredit related triggers in the Senior Term Loan Facility or in the seniorsubordinated notes described below.

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

On July 30, 2004,upon completion of the Acquisition, we entered into an Indenture Agreement for$195 million of 93¤4%Senior Subordinated Notes due 2011 (the “Senior Notes”). These notes mature on August 1,2011 and bear interest at 9.75% per annum payable in semi-annual installmentson February 1 and August 1, commencing February 1, 2005. Thesenotes are unsecured obligations and subordinated in right of payment to all ofour existing and future unsubordinated indebtedness, including borrowings underthe Amended Credit Agreement and the Senior Term Loan. The notes rank equallywith our senior subordinated indebtedness and senior to our subordinatedindebtedness. These notes are guaranteed on 

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anunsecured senior subordinated basis by all of our existing direct and indirectdomestic subsidiaries other than Duane Reade GP, which is a co-obligor underthe Senior Notes. We may redeem the notes, in whole or in part, at any time onor after August 1, 2008, at a redemption price of 104.875% declining topar on August 1, 2010, plus accrued and unpaid interest. In addition wecan redeem up to 35% of the Senior Notes before August 1, 2007 with the netcash proceeds from certain equity offerings. Upon the occurrence of specifiedchange of control events, we will be required to make an offer to repurchaseall of the Senior Notes at 101% of the outstanding principal amount of thenotes plus accrued and unpaid interest to the date of repurchase. The indenturegoverning the Senior Notes contains certain affirmative and negative covenantsthat limit our ability to incur additional indebtedness, pay dividends, makerepayments on indebtedness that is subordinated to the Senior Notes and to makecertain other restricted payments, incur certain liens, to use proceeds fromsales of assets, enter into business combination transactions (includingmergers, consolidations and asset sales), enter into transactions withaffiliates and permit restrictions on the payment of dividends by oursubsidiaries. Under a registration rights agreement entered into as part of theoffering of the Senior Notes, we are required to (i) file a registrationstatement within 120 days after the completion of the Acquisition, (ii) useour reasonable best efforts to cause the registration statement to becomeeffective within 180 days after the completion of the Acquisition and (iii) useour reasonable and best efforts to complete the exchange offer within 210 daysafter the Acquisition is completed.

**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 Oak Hill equitycontribution of approximately $240 million discussed above, revolving loanborrowings under our Amended Credit Agreement, our $155 million Senior TermLoan and the $195 million Senior Notes will be adequate for the payment of allof our obligations in connection with the Acquisition and for at least the nexttwo years to make required payments on our indebtedness, to fund anticipatedcapital expenditures and to satisfy our working capital requirements. We basethis belief on our recent levels of cash flow from operations of approximately$47.4 million and $42.5 million in fiscal 2003 and fiscal 2002, respectively,as well as our cash flow from operations of $20.0 million in the 26 weeks endedJune 26, 2004, and the significant additional borrowing capacity under ourAmended Credit Agreement which amounted to approximately $93.3 million upon thecompletion of the Acquisition. Our ability to meet our debt service obligationsand reduce our total debt will depend upon our future performance which, in turn,will be subject to general economic, financial, business, competitive,legislative, regulatory and other conditions, many of which are beyond ourcontrol. In addition, our operating results, cash flow and capital resourcesmay not be sufficient for repayment of our indebtedness in the future. Somerisks that could adversely affect our ability to meet our debt serviceobligations 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 Agreementbear interest at floating rates. Therefore, our financial condition will beaffected 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 materiallydifferent from these estimates or forecasts. The accounting policies andrelated risks described in our 

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AnnualReport on Form 10-K/A for the year ended December 27, 2003 arethose that depend most heavily on these judgments and estimates. At June 26,2004, there have been no material changes to any of the Critical AccountingPolicies contained therein.

**Seasonality**

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

**Inflation**

We believe that inflationhas not had a material impact on our results of operations during the threeyears ended December 27, 2003 or the 26 weeks ended June 26, 2004.

**RecentlyIssued 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.**                MARKET RISK

Our financial results are subject to risk frominterest rate fluctuations on debt, which carries variable interest rates.Variable rate debt outstanding under our Credit Agreement was approximately$77.3 million at June 26, 2004. At June 26, 2004, the weightedaverage combined interest rate in effect on all borrowings under the CreditAgreement was 3.12%. A 0.50% change in interest rates applied to the $77.3million balance of floating rate debt would affect pre-tax annual results ofoperations by approximately $0.4 million. In addition, we also have $201.0million of Convertible Notes outstanding at June 26, 2004. The ConvertibleNotes bear interest payable semi-annually at a fixed rate of 3.75%, 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.

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**ITEM 4.**                CONTROLS ANDPROCEDURES

The Company is notan “accelerated filer” within the SEC reporting rules and, as a result, iscurrently not required to include in its annual reports on Form 10-Kmanagement’s assessment of the effectiveness of its internal controls overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under theSecurities Exchange Act of 1934, as amended) pursuant to Section 404 of theSarbanes-Oxley Act of 2002.

(a)   *Evaluation of DisclosureControls and Procedures*.   An evaluation was carried out underthe supervision and with the participation of the Company’s management,including the Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls and procedures(as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Actof 1934) as of the end of the period covered by this quarterly report. Basedupon that evaluation, the Company’s management, including the Chief ExecutiveOfficer and Chief Financial Officer, have each concluded that the design andoperation of these disclosure controls and procedures were not effective as ofthe end of the period covered by this report based on the identification ofmaterial weaknesses in the Company’s internal control over financial reportingdescribed in the Company’s Annual Report on Form 10-K/A filed on May 16, 2005.This conclusion has been changed from the disclosure in the Company’s original Form 10-Qfiling. For a discussion of the reasons and matters on which these conclusionswere based, as well as the subsequent actions taken by the Company tostrengthen its controls and procedures in these areas, see Item 9A of theCompany’s Annual Report on Form 10-K/A for the fiscal year ended December 25,2004, filed on May 16, 2005.

(b)   *Changes in Internal Controls over Financial Reporting.*   Nochanges in our internal control over financial reporting (as defined in Rule13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934) occurredduring our last fiscal quarter covered by this quarterly report that havematerially affected, or are reasonably assured to materially affect, ourinternal control over financial reporting.

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**PART II**

**OTHER INFORMATION**

**ITEM 1.**                Legal Proceedings

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 umpire (toresolve differences between the two appraisers) who will determine the amountof insured loss we have sustained. The insurance carrier has appealed a numberof rulings by the trial court. In light of both the early stage of theappraisal process and the inherent uncertainty in litigation relating to ourappeal, the amount of additional insurance proceeds, if any, that we maycollect under the terms of our insurance contract with the defendant cannot bereasonable predicted or determined at this time, 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 have been named as defendants in connection with theconsolidation of several class action complaints alleging violations of thefederal securities laws that were filed from August 2002 through October 2002.The action, which is in the United States District Court for the SouthernDistrict of New York, is on behalf of shareholders who purchased our commonstock between April 1, 2002 and July 24, 2002, inclusive. Thecomplaint, which seeks an unspecified amount of damages, alleges 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 have filed an appeal. We continue to believe that theplaintiffs’ actions are completely baseless and wholly without merit, andintend to continue to vigorously defend ourselves.

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. The amount of attorney’s fees owed to the plaintiffs’attorneys remains an open issue in the case and we plan to vigorously defendclaims by these attorneys for fees. It is not anticipated that the amount ofattorneys’ fees that would be required to be paid in this matter would bematerial to our business and operations.

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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 August 2001. The plaintiffs have recently filed a motion seekingsummary judgment of $2.29 million of claims for alleged underfunding, includingrelated penalties and interest. In addition, at various times, the plaintiffshave stated that they believe we may owe additional amounts. However, anyadditional amounts that the plaintiffs may claim are not known at this time. Wehave filed a motion opposing these claims. We believe that we have madesufficient contributions to these funds and that we have meritorious defensesto the claims being made by these funds. Accordingly, we intend to vigorouslydefend ourselves in these matters. At this time, it is not possible todetermine the ultimate outcome of this case or the actual amount of liabilitywe 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 expires on August 31, 2004. We believe animpasse did in fact occur and as a result, we had the right to implement ourlatest contract 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.If this recommendation is adopted by the full NLRB and enforced by the circuitcourt of appeals, it could result in our 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 we had funded since we implemented our finalcontract proposal for these same benefits that were paid for our ATC employees.Because this is just the first phase of a long and complicated administrativeprocess likely to be followed by a full judicial review of all of the facts andcircumstances, the final outcome cannot be reliably determined at this time.The ALJ’s recommendation is not a binding order and has no force and effect oflaw. Rather, it is a recommendation to the full NLRB in Washington D.C., whichwill conduct a complete review at some point in the future and decide touphold, reject or modify the recommendation. The full NLRB decision is alsosubject to judicial review by the circuit court of appeals and a compliancehearing before any financial remedy can be determined. While there can be nodefinitive assurance, we have been advised by our outside labor counsel that wehave numerous meritorious defenses and arguments in response to the ALJ’srecommendation.

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. These charges represent our current best estimateof the loss that would result upon application of the ALJ’s recommendation. Wenote that such charges were based upon the facts available to us at the time.In our opinion, such charges could be subject to significant modification inthe future, upon review by the full NLRB, the Federal Circuit Court of Appeals,completion of a compliance hearing 

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and any appeals relatingto the outcome of that hearing. These charges reflect the amount ofcontributions that we did not make into the union benefit funds for the periodfrom the August 31, 2001 expiration of the contract through June 26,2004, reduced by a portion of the benefits we paid directly to or for thebenefit of these employees over the same period. It also includes an interestcost for these net contributions from the date they would have been paid until June 26,2004. While this represents our current best estimate of the ALJ’srecommendation, we believe that the actual range of loss in this matter couldbe from $0, if the ALJ’s recommendation is not followed, to approximately$29 million, if the ALJ’s recommendation is upheld and there is no offsetfor 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 charge in2004 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 2004.

A New York State TaxAppeals Tribunal ruling in a matter involving another company may have anadverse impact upon our New York State Franchise Tax filings from years 1999through 2002. This matter relates to the required combination of affiliatedsubsidiaries in recognizing royalty fee and related income for intangibleproperty. The ruling of the Tribunal is subject to further legal appeal andinterpretation in light of our own specific facts and circumstances. Theoutcome of this matter, and the resulting amount of additional income taxexpense, if any, cannot be determined by us at this time.

***Litigation Relating to the Merger Transaction***

We are aware of six purported class action complaintschallenging the merger transaction consummated by us and Duane ReadeAcquisition that have been filed in the Court of Chancery of the State ofDelaware, referred to as the “Delaware Complaints,” and three purported classaction complaints that have been filed in the Supreme Court of the State of NewYork. Two of the New York complaints have been dismissed without prejudice. Theother New York complaint (the “New York Complaint”) is pending, but has notbeen served on Duane Reade. The Delaware Complaints name Mr. Cuti andcertain other members of our board of directors and executive officers as wellas Duane Reade Inc. as defendants. Four of the Delaware Complaints name OakHill as a defendant. The New York Complaint names Mr. Cuti and certainother members of our board of directors and executive officers as well as DuaneReade Inc. as defendants. One of the dismissed New York complaints named OakHill 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 “Consolidated Complaint”).

The Consolidated Complaintalleges that defendants failed to disclose material information in thepreliminary proxy statement, which was filed with the SEC on March 19,2004. Specifically, the Consolidated Complaint alleges that the defendantsfailed to disclose: (1) the precise nature of the “Current EmploymentAgreement Estimated Payments,” as that term is used in the preliminary proxy,and the reasons for these payments; (2) the materials and data purportedlyused by Bear Stearns in calculating the “Current Employment Agreement EstimatedPayments,” instead of the disclosure in the preliminary 

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proxystatement that these calculations were “approximations based on variousassumptions since the precise amounts payable would require actuarial or otherexpert valuation,” even though Bear Stearns allegedly relied on thesecalculations; (3) the methodology, projections and other information usedby Bear Stearns to calculate the estimated present value of the company; and (4) thatthe merger consideration represented an approximately 11.7% premium based uponthe trading price of Duane Reade shares on December 22, 2003, instead ofthe disclosure in the preliminary proxy that shareholders would be receiving amuch higher premium of 22.0%. The Consolidated Complaint and the New YorkComplaint allege, among other things, that the defendants purportedly breachedduties owed to Duane Reade’s stockholders in connection with the transaction byfailing to: (a) appropriately value Duane Reade as a merger candidate; (b) exposeDuane Reade to the marketplace in an effort to obtain the best transactionreasonably available, including to market Duane Reade to industry participants;and (c) adequately ensure that no conflicts of interest exist betweendefendants’ own interests and their fiduciary obligation to maximizestockholder value. Plaintiffs seek, among other things: an order that thecomplaints are properly maintainable as a class action; a declaration thatdefendants have breached their fiduciary duties and other duties; injunctiverelief; an unspecified amount of monetary damages; attorneys’ fees, costs andexpenses; and such other and further relief as the court may deem just andproper. We believe these lawsuits are without merit and plan to defend theselawsuits vigorously.

**ITEM 2.**                Changes inSecurities and Use of Proceeds

Not applicable

**ITEM 3.**                Defaults UponSenior Securities

Not applicable

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

On July 26, 2004, theCompany held a special meeting of stockholders to consider the mergeragreement. At that meeting, a total of 17,706,765 shares were voted in personand by proxy, representing 72.2% of the total number of eligible voting shares.Of this amount, 15,436,702 shares were voted in favor of adopting the mergeragreement, 2,267,843 shares were voted in opposition to the adoption of themerger agreement and 2,220 shares abstained from voting. As a result of thestockholders’ approval of the merger agreement and the satisfaction of allother conditions to the merger, the merger and related financings wereconsummated on July 30, 2004.

**ITEM 5.**                Other Information

Not applicable

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**ITEM 6.**                Exhibits,Financial Statement Schedules and Reports on Form 8-K

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

(i)            FinancialStatements

(ii)        Exhibits:
| Exhibit No. | ** ** | ** **                                                                                                                                                                                                                                                                                                                                            | ** ** | **Description** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 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  the Company (incorporated by reference to Exhibit 3.1(i) to the  Company’s Registration Statement No. 333-41239 (the “Common Stock  S-1”)).                                                                                                                       |
| 3.1(ii)          |       | Certificate of Amendment of Amended and Restated  Certificate of Incorporation (incorporated by reference to Exhibit 3.1  to Amendment No. 1 to the Company’s Registration Statement on  Form S-3 dated July 22, 2001).                                                                                                      |
| 3.1(iii)         |       | Amended and Restated Bylaws of the Company  (incorporated by reference to Exhibit 3.1(ii) to the Common Stock  S-1).                                                                                                                                                                                                                        |
| 3.2(i)           |       | Certificate of Incorporation of DRI I Inc.  (incorporated by reference to Exhibit 3.2(i) to the S-1  Registration Statement No. 333-43313 with respect to the Company’s 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              |       | Second Amended and Restated Partnership Agreement of  Duane Reade (incorporated by reference to Exhibit 3.3 of the Notes S-1).                                                                                                                                                                                                                   |
| 3.4(i)           |       | Certificate of Incorporation of Duane Reade  International, Inc. (incorporated by reference to  Exhibit 3.4(i) to the Company’s Annual Report on Form 10-K for  the year ended December 25, 1999 (the “1999 10-K”)).                                                                                          |
| 3.4(ii)          |       | By-laws of Duane Reade International, Inc.  (incorporated by reference to Exhibit 3.4(ii) to the 1999 10-K).                                                                                                                                                                                                                           |
| 3.5(i)           |       | Certificate of Incorporation of Duane Reade  Realty, Inc. (incorporated by reference to Exhibit 3.5(i) to  the 1999 10-K).                                                                                                                                                                                                             |
| 3.5(ii)          |       | By-laws of Duane Reade Realty, Inc.  (incorporated by reference to Exhibit 3.5(ii) to the 1999 10-K).                                                                                                                                                                                                                                  |
| 4.1              |       | Form of Indenture (incorporated by reference to  Exhibit 4.1 of the Notes S-1).                                                                                                                                                                                                                                                             |
| 4.2              |       | Second Supplemental Indenture, dated as of  May 20, 2002, between Duane Reade Inc., the Subsidiary Guarantors, and  State Street Bank, as trustee (incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended September 28,  2002).                                                           |
| 4.3              |       | Indenture, dated as of April 16, 2002, between  Duane Reade Inc., as issuer, the guarantors named therein and State Street  Bank and Trust Company, as trustee (incorporated by reference to  Exhibit 4.2 to the Company’s Registration Statement on Form S-3  dated June 21, 2002 (the “Convertible Notes S-3”)). |
| 4.4              |       | Form of Senior Convertible Notes due 2022  (incorporated by reference to Exhibit 4.2 to the Convertible Notes S-3).                                                                                                                                                                                                                         |

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| 10.1  |   | Duane Reade Inc. 1997 Equity Participation Plan  (incorporated by reference to Exhibit 10.1 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2  |   | Duane Reade Inc. Holding Corp. 1992 Stock Incentive  Plan (incorporated by reference to Exhibit 10.2 to the Common Stock  S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.3  |   | Employment Agreement, dated as of February 22,  1993, as amended, between the Company and Gary Charboneau (incorporated by  reference to Exhibit 10.4 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.4  |   | Employment Agreement, dated as of April 10,  1995, as amended, between Duane Reade and Jerry M. Ray (incorporated by  reference to Exhibit 10.5 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.5  |   | Employment Letter Agreement, dated as of  October 9, 1996, between Duane Reade and Joseph Lacko (incorporated by  reference to Exhibit 10.6 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.6  |   | Agreement, dated as of November 22, 1996, as  amended, between Duane Reade and Drug, Chemical, Cosmetic, Plastics and  Affiliated Industries Warehouse Employees Local 815 (incorporated by  reference to Exhibit 10.8 to the Common Stock S-1).                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.7  |   | Agreement, dated December 6, 2001, between  Duane Reade and Allied Trades Council (incorporated by reference to  Exhibit 10.8 to the Company’s Annual Report on Form 10-K for the  year ended December 29, 2001 (the “2001 10-K”)).                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.8  |   | Employment Letter, dated June 10, 1999, between  the Company and John K. Henry (incorporated by reference to  Exhibit 10.18 to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.9  |   | Agreement, dated April 1, 2001, between Duane  Reade and Local 340A New York Joint Board, UNITE AFL-CIO (incorporated by  reference to Exhibit 10.19 to the 2001 10-K).                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.10 |   | First Amendment to Stockholders and Registration  Rights Agreement, dated as of January 16, 2002, by and among Duane Reade  Inc. and the stockholders party thereto (incorporated by reference to Exhibit 4.9 to the Convertible  Notes S-3).                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.11 |   | Preferability Letter, dated as of May 13, 2002,  issued by PricewaterhouseCoopers LLP, with respect to the Company’s change in  accounting method of inventory valuation (incorporated by reference to the  Company’s Quarterly Report on Form 10-Q for the period ended  March 30, 2002).                                                                                                                                                                                                                                                                                                                                    |
| 10.12 |   | Amended and Restated Employment Agreement, dated  August 12, 2002, between the Company and Anthony J. Cuti (incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the  period ended June 29, 2002).                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.13 |   | Shareholder Rights Agreement, dated as of  September 12, 2002, between the Company and EquiServe Trust Company,  N.A., as Rights Agent (incorporated by reference to Exhibit 4.1 to the  Company’s Current Report on Form 8-K, dated September 12, 2002).                                                                                                                                                                                                                                                                                                                                                                     |
| 10.14 |   | Third Amendment to the 1997 Equity Participation  Plan, dated May 8, 2003 (incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.15 |   | Employment Letter, dated June 24, 2003, between  the Company and Timothy R. LaBeau (incorporated by reference to the  Company’s Quarterly Report on Form 10-Q for the period ended  June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.16 |   | Credit Agreement, dated as of July 21, 2003,  among Duane Reade, as the Borrower, Duane Reade Inc. and corporate  subsidiaries as the Facility Guarantors, Various Financial Institutions set  forth therein, as the Lenders, Fleet National Bank as the Administrative  Agent and Issuing Bank, Fleet Retail Finance Inc. as the Collateral Agent,  General Electric Capital Corporation as the Syndication Agent for the Lenders  and Congress Financial Corporation as the Documentation Agent for the Lenders  (incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 28, 2003). |
| 10.17 |   | Facility Guarantee, dated as of July 21, 2003,  among the Facility Guarantors, Fleet Retail Finance Inc., Fleet National Bank  and the Lenders (incorporated by reference to the Company’s Quarterly Report  on Form 10-Q for the period ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                     |

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| 10.18 |   | Intellectual Property Security Agreement, dated as  of July 21, 2003, between Duane Reade, the Facility Guarantors and Fleet  Retail Finance Inc., as Collateral Agent (incorporated by reference to the  Company’s Quarterly Report on Form 10-Q for the period ended  June 28, 2003).                                                 |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.19 |   | Security Agreement, dated as of July 21, 2003,  among Duane Reade, the Facility Guarantors, and Fleet Retail Finance Inc., as  Collateral Agent (incorporated by reference to the Company’s Quarterly Report  on Form 10-Q for the period ended June 28, 2003).                                                                         |
| 10.20 |   | Ownership Interest Pledge Agreement, dated as of  July 21, 2003, among Duane Reade Inc. and DRI I Inc., and Fleet Retail  Finance Inc., as Collateral Agent (incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 28, 2003).                                                             |
| 10.21 |   | Amendment No. 1 to Shareholder Rights  Agreement, dated as of December 19, 2003, between the Company and  EquiServe Trust Company, N.A., as Rights Agent Council (incorporated by  reference to Exhibit 10.21 to the Company’s Annual Report on  Form 10-K for the year ended December 27, 2003 (the “2003 10-K”)). |
| 14.1  |   | Code of Business Conduct and Ethics (incorporated by  reference to Exhibit 14.1 to the 2003 10-K).                                                                                                                                                                                                                                                     |
| 21.1  |   | Subsidiaries of the Company (incorporated by  reference to Exhibit 21.1 to the 1999 10-K).                                                                                                                                                                                                                                                             |
| 23.1  |   | Consent of Independent Accountants (incorporated by  reference to Exhibit 23.1 to the 2003 10-K).                                                                                                                                                                                                                                                      |
| 23.2  |   | Consent of Independent Accountants (incorporated by  reference to Exhibit 23.2 to the 2003 10-K).                                                                                                                                                                                                                                                      |
| 31.1* |   | Sarbanes-Oxley Section 302 Certification of the  Company’s Chief Executive Officer (“CEO”).                                                                                                                                                                                                                                             |
| 31.2* |   | Sarbanes-Oxley Section 302 Certification of the  Company’s Chief Financial Officer (“CFO”).                                                                                                                                                                                                                                             |
| 32.0* |   | Sarbanes-Oxley Section 906 Certifications of  the Company’s CEO and CFO.                                                                                                                                                                                                                                                                          |

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*       filed herewith

(b)   Reports on Form 8-K:

On June 14, 2004, the Company filed a Current Reporton Form 8-K which contained, as an exhibit, a press releaseproviding information with respect to the First and Second Amendments to theAgreement and Plan of Merger (the “Merger Agreement”), in connection with theproposed acquisition of the Company by affiliates of Oak Hill Capital PartnersL.P. (“Oak Hill”).

On June 21, 2004, the Company filed a CurrentReport on Form 8-K which contained, as an exhibit, a press releaseproviding information with respect to the Third Amendment to the MergerAgreement, in connection with the proposed acquisition of the Company byaffiliates of Oak Hill.

On June 30, 2004, the Company filed a CurrentReport on Form 8-K which contained, as an exhibit, a press releaseproviding information with respect to the filing of the Company’s definitiveproxy statement in connection with the proposed acquisition of the Company byaffiliates of Oak Hill.

On July 9, 2004, the Company filed a CurrentReport on Form 8-K which contained relevant financial informationnot previously publicly released, such information having been provided tovarious lenders that same day in connection with the proposed acquisition ofthe Company by affiliates of Oak Hill.

On July 19, 2004, the Company filed a CurrentReport on Form 8-K which contained, as an exhibit, a press releaseproviding information with respect to the Company’s actual (unaudited)financial results for the 13 and 26 weeks ended June 26, 2004 and theCompany’s projected financial results for the remainder of the 2004 fiscalyear.

43

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On July 26, 2004, the Company filed a CurrentReport on Form 8-K which contained, as an exhibit, a press releaseproviding information with respect to the completion of an amendment to theCompany’s Credit Agreement and the pricing of the Company’s Senior SubordinatedNotes.

On July 27, 2004, the Company filed a CurrentReport on Form 8-K which contained, as an exhibit, a press releaseproviding information with respect to the successful stockholder vote inconnection with the proposed acquisition of the Company by affiliates of OakHill.

On August 2, 2004, the Company filed a CurrentReport on Form 8-K which contained, as an exhibit, a press releaseproviding information with respect to the consummation of the Company’sacquisition by affiliates of Oak Hill.

44

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
| Dated: June 16, 2005 |                        |
|----------------------|-----------------------------|
| ** **           | **DUANE  READE, INC.** |
|                 | (Registrant)                |
|                 | By:                         | /s/ JOHN K. HENRY |   |
|                 |                        | Name: | John K. Henry |
|                 |                        | Title: | *Senior Vice President and Chief Financial Officer* |
|                      |                             |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant in thecapacities indicated on June 16, 2005.
|                      | **SIGNATURES** | ** **                                          | ** ** | ** ** | **TITLES** | ** ** |
|----------------------|----------------|-----------------------------------------------------|------------|------------|------------|------------|
| /s/  ANTHONY J. CUTI |           | President and Chief  Executive Officer and Director |
| Anthony J. Cuti      |           | (Principal Executive Officer)                       |
| /s/  JOHN K. HENRY   |           | Senior Vice President  and Chief Financial Officer  |
| John K. Henry        |           | (Principal Accounting and Financial Officer)        |

 

45

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
| Dated: June 16, 2005 |            |
|---------------------------|-----------------|
| ** **                | **DRI I  INC.** |
|                      | By:             | /s/ JOHN K. HENRY |   |
|                      |            | Name: | John K. Henry |
|                      |            | Title: | *Senior Vice President and Chief Financial Officer* |
|                           |                 |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed on June 16, 2005 by:
|                      | **SIGNATURES** | ** **                                          | ** ** | ** ** | **TITLES** | ** ** |
|----------------------|----------------|-----------------------------------------------------|------------|------------|------------|------------|
| /s/  ANTHONY J. CUTI |           | President and Chief  Executive Officer and Director |
| Anthony J. Cuti      |           | (Principal Executive Officer)                       |
| /s/  JOHN K. HENRY   |           | Senior Vice President  and Chief Financial Officer  |
| John K. Henry        |           | (Principal Accounting and Financial Officer)        |

 

46

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
| Dated:     | June 16, 2005                                  |             |                                                |
|------------|-----------------------------------------------------|------------------|-----------------------------------------------------|
| ** ** |                                                | **DUANE  READE** |
| By:        | DRI I Inc., a general  partner                      | By:              | Duane Reade Inc., a  general partner                |
| By:        | /s/ JOHN K. HENRY                                   |             | By:                                                 | /s/ JOHN K. HENRY |   |
| Name:      | John K. Henry                                       | Name:            | John K. Henry                                       |
| Title:     | *Senior Vice President and Chief Financial Officer* | Title:           | *Senior Vice President and Chief Financial Officer* |
|            |                                                     |                  |                                                     |  |  |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below on June 16, 2005 by the following persons in thecapacities indicated with respect to Duane Reade Inc. and DRI I Inc., thegeneral partners of Duane Reade, on behalf of Duane Reade (except as otherwiseindicated):
|                      | **SIGNATURES** | ** **                                          | ** ** | ** ** | **TITLES** | ** ** |
|----------------------|----------------|-----------------------------------------------------|------------|------------|------------|------------|
| /s/  ANTHONY J. CUTI |           | President and Chief  Executive Officer and Director |
| Anthony J. Cuti      |           | (Principal Executive Officer)                       |
| /s/  JOHN K. HENRY   |           | Senior Vice President  and Chief Financial Officer  |
| John K. Henry        |           | (Principal Accounting and Financial Officer)        |

 

47

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
| Dated: June 16, 2005 |                               |
|---------------------------|------------------------------------|
| ** **                | **DUANE  READE REALTY, INC.** |
|                      | By:                                | /s/ JOHN K. HENRY |   |
|                      |                               | Name: | John K. Henry |
|                      |                               | Title: | *Senior Vice President and Chief Financial Officer* |
|                           |                                    |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed on June 16, 2005 by:
|                      | **SIGNATURES** | ** **                                          | ** ** | ** ** | **TITLES** | ** ** |
|----------------------|----------------|-----------------------------------------------------|------------|------------|------------|------------|
| /s/  ANTHONY J. CUTI |           | President and Chief  Executive Officer and Director |
| Anthony J. Cuti      |           | (Principal Executive Officer)                       |
| /s/  JOHN K. HENRY   |           | Senior Vice President  and Chief Financial Officer  |
| John K. Henry        |           | (Principal Accounting and Financial Officer)        |

 

48

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
| Dated: June 16, 2005 |                                      |
|---------------------------|-------------------------------------------|
| ** **                | **DUANE  READE INTERNATIONAL, INC.** |
|                      | By:                                       | /s/ JOHN K. HENRY |   |
|                      |                                      | Name: | John K. Henry |
|                      |                                      | Title: | *Senior Vice President and Chief Financial Officer* |
|                           |                                           |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed on June 16, 2005 by:
|                      | **SIGNATURES** | ** **                                          | ** ** | ** ** | **TITLES** | ** ** |
|----------------------|----------------|-----------------------------------------------------|------------|------------|------------|------------|
| /s/  GARY CHARBONEAU |           | President and Chief  Executive Officer and Director |
| Gary Charboneau      |           | (Principal Executive Officer)                       |
| /s/  JOHN K. HENRY   |           | Senior Vice President  and Chief Financial Officer  |
| John K. Henry        |           | (Principal Accounting and Financial Officer)        |

 

49

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