**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C.**

 

**FORM 10-Q**

 

**QuarterlyReport Pursuant to Section 13 or 15 (d) of the Securities and Exchange Actof 1934**

 

| **For the quarterly period ended March 26,  2005** | ** ** | **Commission file number  001-13843** |
|---------------------------------------------------------|------------|---------------------------------------|

 

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**DUANE READE HOLDINGS, INC.**

(Exact name of registrantas specified in its charter)

 

| **DELAWARE**                                                    | ** ** | **05-0599589**            |
|-----------------------------------------------------------------|------------|---------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (IRS Employer ID  Number) |
|                                                            |       |                      |
| **440  Ninth Avenue  New York, New York**                       | ** ** | **10001**                 |
| (Address of principal  executive offices)                       |       | (Zip Code)                |

 

**(212) 273-5700**

(Registrant’s telephonenumber, including area code)

 

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Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

Yes ý  No o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in the Exchange Act Rule 12b-2):

Yes o  No ý

 

 

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INDEX

 
| PART I — FINANCIAL  INFORMATION |                                                                                                                                                                               |
|--------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                 |                                                                                                                                                                               |   |
|                                 | ITEM 1. — FINANCIAL  STATEMENTS                                                                                                                                               |   |
|                                 |                                                                                                                                                                               |   |
|                                 | Consolidated  Statements of Operations (Unaudited) -  For the 13 Weeks Ended March 26, 2005 for the Successor and the 13 Weeks  Ended March 27, 2004 for the Predecessor |   |
|                                 |                                                                                                                                                                               |   |
|                                 | Consolidated  Balance Sheets (Unaudited) -  As of March 26, 2005 and December 25, 2004                                                                                   |   |
|                                 |                                                                                                                                                                               |   |
|                                 | Consolidated  Statements of Cash Flows (Unaudited) -  For the 13 Weeks Ended March 26, 2005 for the Successor and the 13 Weeks  Ended March 27, 2004 for the Predecessor |   |
|                                 |                                                                                                                                                                               |   |
|                                 | Notes  to Consolidated Financial Statements (Unaudited)                                                                                                                            |   |
|                                 |                                                                                                                                                                               |   |
|                                 | ITEM  2. — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS  OF OPERATIONS                                                                        |   |
|                                 |                                                                                                                                                                               |   |
|                                 | ITEM  3. — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                                                         |   |
|                                 |                                                                                                                                                                               |   |
|                                 | ITEM 4. — CONTROLS AND  PROCEDURES                                                                                                                                            |   |
|                                 |                                                                                                                                                                               |   |
| PART II — OTHER INFORMATION     |                                                                                                                                                                               |
|                                 |                                                                                                                                                                               |   |
| SIGNATURES                           |                                                                                                                                                                               |   |

 

**SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

This and other of our public filings or publicstatements contain forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, Section 21E of the Securities Exchange Actof 1934 and the Private Securities Litigation Reform Act of 1995, that involvea number of risks and uncertainties. These statements relate to future eventsor our future financial performance with respect to our financial condition,results of operations, business plans and strategies, operating efficiencies orsynergies, competitive positions, growth opportunities for existing productssuch as private label merchandise, plans and objectives of management, capitalexpenditures, growth and maturation of our stores and other matters. Thesestatements involve known and unknown risks, uncertainties and other factorsthat may cause our or our industry’s actual results, levels of activity,performance or achievements to be materially different from those expressed orimplied by any forward-looking statements. In some cases, you can identify forward-lookingstatements by terminology such as “may,” “will,” “could,” “would,” “should,” “expect,”“plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential,” “proforma,” “seek,” or “continue” or the negative of those terms or other comparableterminology. These statements are only predictions and such expectations mayprove to be incorrect. Some of the things that could cause our actual resultsto differ substantially from our expectations are:

 

•                                          the competitive environment in the drugstoreindustry in general and in the New York greater metropolitan area;

 

•                                          the ability to open and operate newstores on a profitable basis and to increase sales in existing stores;

 

•                                          the continued efforts of healthmaintenance organizations, managed care organizations, pharmacy benefitmanagement companies and other third party payers to reduce prescriptionreimbursement rates and pricing pressure from internet-based andmail-order-based providers;

 

•                                          our significant indebtedness;

 

•                                          the continued efforts of federal, stateand municipal government agencies to reduce Medicaid reimbursement rates,modify Medicare benefits and/or reduce prescription drug costs;

 

•                                          the impact of the newly enacted MedicarePrescription Drug, Improvement and Modernization Act of 2003 (P.L. 108-179),or, the Medicare Drug Act, and the contemplated Medicare Part D benefit createdthereunder;

 

•                                          the strength of the economy in generaland the economic conditions in the New York greater metropolitan area including,in particular, seasonal and weather-related factors, special events, changes in

 

2

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consumer purchasing power and/or spending patterns;

 

•                                          changes in the cost of goods andservices;

 

•                                          trends in the healthcare industry, includingcontinued conversion of various prescription drugs to over-the-countermedications, negative publicity and the related sales declines for certaincategories of drugs including Cox-2 inhibitors and the increasing market shareof internet-based and mail-order-based providers;

 

•                                          employee disputes and labor disturbances,including any resulting from the suspension or termination of our collectivebargaining agreements;

 

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

 

•                                          liability and other claims assertedagainst us including the items discussed under Part II, Item 1-LegalProceedings;

 

•                                          the outcome of the legal proceedings thathave been instituted against us and others following announcement of theacquisition of Duane Reade Inc.;

 

•                                          changes in our operating strategy ordevelopment plans;

 

•                                          our ability to attract, hire and retainqualified personnel, including our ability to attract qualified pharmacists;

 

•                                          interest rate fluctuations and changes incapital market conditions or other events affecting our ability to obtainnecessary financing on favorable terms to fund the anticipated growth of ourbusiness;

 

•                                          the continued impact of, or newoccurrences of, terrorist attacks in the New York greater metropolitan area andany actions that may be taken by federal, state or municipal authorities inresponse to or in anticipation of such occurrences;

 

•                                          changes in timing of our acquisition ofstores and prescription files and capital expenditure plans;

 

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

 

•                                          our ability to successfully implement andmanage new computer systems and technologies;

 

•                                          our ability to limit fraud and shrink;

 

•                                          demographic changes; and

 

•                                          other risks and uncertainties detailed elsewherein this filing and from time to time in our other filings with the Securitiesand 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.

 

3

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**PART I — FINANCIALINFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS**

 

**Duane Reade Holdings, Inc.— Successor**

**Duane Reade Inc.— Predecessor**

ConsolidatedStatements of Operations (Unaudited)

(Inthousands)

 
| ** **                                   | ** ** | **For the 13 Weeks Ended** | ** ** |
|----------------------------------------------|------------|----------------------------|------------|
| ** **                                   | ** ** | **Successor**              | ** ** | **Predecessor** | ** ** |
| ** **                                   | ** ** | **March 26,  2005**   | ** ** | **March 27,  2004** | ** ** |
| Net sales                                    |       | $                          | 394,767    |   | $ | 383,310 |   |
| Cost of sales                                |       | 321,958                    |       | 306,808 |   |
|                                         |       |                       |       |   |   |
| Gross profit                                 |       | 72,809                     |       | 76,502 |   |
|                                         |       |                       |       |   |   |
| Selling, general and administrative expenses |       | 64,499                     |       | 58,643 |   |
| Labor contingency                            |       | 1,100                      |       | 1,100 |   |
| Transaction expenses                         |       | 427                        |       | 1,102 |   |
| Depreciation and amortization                |       | 17,646                     |       | 9,066 |   |
| Store pre-opening expenses                   |       | 100                        |       | 157 |   |
| Other                                        |       | 1,148                      |       | — |   |
|                                         |       | 84,920                     |       | 70,068 |   |
|                                         |       |                       |       |   |   |
| Operating (loss) income                      |       | (12,111                    | )          | 6,434 |   |
| Interest expense, net                        |       | 11,165                     |       | 3,437 |   |
|                                         |       |                       |       |   |   |
| (Loss) income before income taxes            |       | (23,276                    | )          | 2,997 |   |
| Income tax (benefit) expense                 |       | (10,474                    | )          | 1,245 |   |
|                                         |       |                       |       |   |   |
| Net (loss) income                            |       | $                          | (12,802    | ) | $ | 1,752 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

4

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**Duane Reade Holdings, Inc.**

ConsolidatedBalance Sheets (Unaudited)

(Inthousands, except share and per share data)

 
| ** **                                                                                      | ** ** | **March 26,  2005** | ** ** | **December 25,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|--------------------------|------------|------------------------|------------|
| ** **                                                                                      | ** ** | **(Unaudited)**          | ** ** | ** **             | ** ** |
| ASSETS                                                                                          |       |                     |       |                   |       |
| Current Assets                                                                                  |       |                     |       |                   |       |
| Cash                                                                                            |       | $                        | 1,336      |                   | $          | 1,329 |   |
| Receivables, net                                                                                |       | 57,160                   |       | 58,056                 |       |
| Inventories, net                                                                                |       | 261,149                  |       | 262,323                |       |
| Deferred income taxes                                                                           |       | 9,027                    |       | 9,027                  |       |
| Prepaid expenses and other current assets                                                       |       | 34,096                   |       | 35,716                 |       |
| TOTAL CURRENT ASSETS                                                                            |       | 362,768                  |       | 366,451                |       |
|                                                                                            |       |                     |       |                   |       |
| Property and equipment, net                                                                     |       | 236,977                  |       | 224,460                |       |
| Goodwill                                                                                        |       | 52,216                   |       | 52,216                 |       |
| Other assets                                                                                    |       | 290,401                  |       | 297,032                |       |
| TOTAL ASSETS                                                                                    |       | $                        | 942,362    |                   | $          | 940,159 |   |
|                                                                                            |       |                     |       |                   |       |
| LIABILITIES AND STOCKHOLDERS’  EQUITY                                                      |       |                     |       |                   |       |
| Current Liabilities                                                                             |       |                     |       |                   |       |
| Accounts payable                                                                                |       | $                        | 79,144     |                   | $          | 80,154 |   |
| Accrued interest                                                                                |       | 3,649                    |       | 8,209                  |       |
| Other accrued expenses                                                                          |       | 39,188                   |       | 56,735                 |       |
| Current portion of debt                                                                         |       | 179,810                  |       | 153,870                |       |
| Current portion of capital lease obligations                                                    |       | 2,899                    |       | 780                    |       |
| TOTAL CURRENT LIABILITIES                                                                       |       | 304,690                  |       | 299,748                |       |
|                                                                                            |       |                     |       |                   |       |
| Long-term debt                                                                                  |       | 355,032                  |       | 355,032                |       |
| Capital lease obligations, less current portion                                                 |       | 12,717                   |       | 2,008                  |       |
| Deferred income taxes                                                                           |       | 37,496                   |       | 47,971                 |       |
| Other non current liabilities                                                                   |       | 61,180                   |       | 51,351                 |       |
| TOTAL LIABILITIES                                                                               |       | 771,115                  |       | 756,110                |       |
|                                                                                            |       |                     |       |                   |       |
| Commitments and contingencies (Note 8)                                                          |       |                     |       |                   |       |
|                                                                                            |       |                     |       |                   |       |
| Stockholders’ equity                                                                       |       |                     |       |                   |       |
| Preferred stock, $0.01 par; authorized 50,000 shares; issued and  outstanding: none             |       | —                   |       | —                 |       |
| Common stock, $0.01 par; authorized 2,950,000 shares; Issued and  outstanding: 2,594,977 shares |       | 26                       |       | 26                     |       |
| Paid-in capital                                                                                 |       | 239,472                  |       | 239,472                |       |
| Accumulated deficit                                                                             |       | (68,251                  | )          | (55,449                | )          |
| TOTAL STOCKHOLDERS’ EQUITY                                                                 |       | 171,247                  |       | 184,049                |       |
|                                                                                            |       |                     |       |                   |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                 |       | $                        | 942,362    |                   | $          | 940,159 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

5

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**Duane Reade Holdings, Inc.— Successor**

**Duane Reade Inc.— Predecessor**

ConsolidatedStatements of Cash Flows (Unaudited)

(Inthousands)

 
| ** **                                                                                          | ** ** | **For the 13 Weeks Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                          | ** ** | **Successor**              | ** ** | **Predecessor** | ** ** |
| ** **                                                                                          | ** ** | **March 26,  2005**   | ** ** | **March 27,  2004** | ** ** |
| Cash flows provided by operating activities:                                                        |       |                       |       |   |   |
| Net (loss) income                                                                                   |       | $                          | (12,802    | ) | $ | 1,752 |   |
| Adjustments to reconcile net (loss) income to net cash (used in)  provided by operating activities: |       |                       |       |   |   |
| Depreciation and amortization of property and equipment                                             |       | 8,114                      |       | 6,276 |   |
| Amortization of other intangibles                                                                   |       | 10,445                     |       | 3,268 |   |
| Deferred tax provision                                                                              |       | (10,474                    | )          | 1,169 |   |
| Non-cash rent                                                                                       |       | 3,594                      |       | 1,902 |   |
| Changes in operating assets and liabilities (net of the effect of acquisitions):               |       |                       |       |   |   |
| Receivables                                                                                         |       | 897                        |       | (4,779 | ) |
| Inventories                                                                                         |       | 1,409                      |       | 9,512 |   |
| Accounts payable                                                                                    |       | (1,010                     | )          | (8,690 | ) |
| Prepaid and accrued expenses                                                                        |       | (22,906                    | )          | 6,303 |   |
| Other assets and liabilities, net                                                                   |       | 6,083                      |       | (4,520 | ) |
| NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES                                                 |       | (16,650                    | )          | 12,193 |   |
|                                                                                                |       |                       |       |   |   |
| Cash flows used in investing activities:                                                            |       |                       |       |   |   |
| Capital expenditures                                                                                |       | (7,132                     | )          | (7,862 | ) |
| Lease acquisition, customer file and other costs                                                    |       | (3,096                     | )          | (9,257 | ) |
| Proceeds from sale of property                                                                      |       | 2,223                      |       | — |   |
| NET CASH USED IN INVESTING ACTIVITIES                                                               |       | (8,005                     | )          | (17,119 | ) |
|                                                                                                |       |                       |       |   |   |
| Cash flows from financing activities:                                                               |       |                       |       |   |   |
| Borrowings from revolving credit facility                                                           |       | 475,674                    |       | 391,344 |   |
| Repayments of revolving credit facility                                                             |       | (449,734                   | )          | (386,259 | ) |
| Deferred financing costs                                                                            |       | (607                       | )          | (80 | ) |
| Exercise of stock options                                                                           |       | —                     |       | 56 |   |
| Repayments of capital lease obligations                                                             |       | (671                       | )          | (102 | ) |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                                           |       | 24,662                     |       | 4,959 |   |
|                                                                                                |       |                       |       |   |   |
| Net increase in cash                                                                                |       | 7                          |       | 33 |   |
| Cash at beginning of period                                                                         |       | 1,329                      |       | 1,252 |   |
| Cash at end of period                                                                               |       | $                          | 1,336      |   | $ | 1,285 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

6

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**Notes to Unaudited Consolidated InterimFinancial Statements**

**(dollars in thousands)**

 

**1. Basis of Presentation**

 

Duane Reade Holdings, Inc. was formed inDecember 2003 by Oak Hill Capital Partners, LP, a private equity firm (‘‘OakHill’’) in order to acquire Duane Reade Inc. and its subsidiaries (the ‘‘Acquisition’’).Duane Reade Holdings, Inc. is a wholly-owned subsidiary of Duane Reade Shareholders, LLCa parent entity also established to effectuate the Acquisition. The Acquisitionwas completed on July 30, 2004 through the merger of Duane Reade Acquisition(a wholly owned subsidiary of Duane Reade Holdings, Inc.) into Duane Reade Inc.with Duane Reade Inc. being the surviving entity and a wholly ownedsubsidiary of Duane Reade Holdings, Inc. after the mergertransaction. As a result of the Acquisition and resulting change in control andchange in historical cost basis of accounting, the operating results arepresented separately for predecessor periods up to and including the closingdate of the Acquisition and the successor period following the closing date ofthe Acquisition. The predecessor period financial statements include Duane Reade Inc.and all its subsidiaries and the successor period financial statements includeDuane Reade Holdings, Inc. and all its subsidiaries. Duane Reade Holdings, Inc.had nominal activity and no operations prior to the completion of theAcquisition. Except where the context otherwise requires, all references to the‘‘Company’’ in the Unaudited Consolidated Interim Financial Statements andthese footnotes mean the predecessor for periods ending on or before July 30, 2004and the successor for periods ending after July 30, 2004.

 

The Unaudited Consolidated Interim FinancialStatements included herein reflect all adjustments which, in the opinion ofmanagement, are necessary to present a fair statement of the results ofoperations, financial position and cash flows of the Company, and have beenprepared, in all material respects, in accordance with the same accountingprinciples followed in the preparation of the Company’s Annual Consolidated FinancialStatements for the year ended December 25, 2004. 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 25, 2004. The UnauditedConsolidated Interim Financial Statements include the accounts of the Companyand its subsidiaries.  All significantintercompany transactions and balances have been eliminated. The results forthe interim periods presented are not necessarily indicative of the resultsexpected for the full year.

 

The Company, along with certain of its subsidiaries,is a guarantor of the debt obligations of Duane Reade Inc. and DuaneReade, the New York general partnership (“Duane Reade GP”). It has noassets or operations other than its investment in its subsidiaries. Accordingly,the Unaudited Consolidated Interim Financial Statements present the consolidatedassets and operations of the subsidiaries. The guarantees provided by the Company and its other subsidiaries underthe debt obligations of Duane Reade Inc. and Duane Reade GP are fulland unconditional, joint and several.

 

**2. Recently Issued Accounting Pronouncements**

 

In December 2004, SFAS No. 123R, “Share-BasedPayment” was issued. This statement established standards for the accountingfor transactions in which an entity exchanges its equity instruments for goodsor services. The statement focuses primarily on accounting for transactions inwhich an entity obtains employee services in share-based transactions. Theprovisions of this statement are required to be adopted for interim or annualperiods beginning after December 15, 2005. The Company is currently evaluatingthe effect of adopting this statement.

 

The Company previously adopted FAS No. 123, “Accountingfor Stock-Based Compensation” and, as permitted under FAS No. 123,has elected the disclosure-only provisions. The Company accounts for itsstock-based compensation plans under the recognition and measurement principlesof APB Opinion No. 25, “Accounting for Stock Issued to Employees,” andrelated interpretations. There is no stock-based employee compensation costreflected in net income, as all options granted under those plans had anexercise price equal to or greater than the market value of the underlyingcommon stock on the date of grant. The following table illustrates the effecton net (loss) income if the Company had applied the fair value recognitionprovisions of FAS No. 123 to stock-based employee compensation(dollars in thousands):

 

7

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| ** **                                                                                                                                     | ** ** | **13 weeks ended**       | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                     | ** ** | **March 26,  2005** | ** ** | **March 27,  2004** | ** ** |
| Net (loss)  income, as reported                                                                                                                |       | $                        | (12,802    | ) | $ | 1,752 |   |
|                                                                                                                                           |       |                     |       |   |   |
| Adjust: Total  stock-based employee compensation expense determined under fair value based method  for all awards, net of related tax effects. |       | 143                      |       | 1,136 |   |
|                                                                                                                                           |       |                     |       |   |   |
| Pro forma net  (loss) income                                                                                                                   |       | $                        | (12,945    | ) | $ | 616 |   |

 

The pro forma compensation expense for stock optionshas been estimated using the Black-Scholes option pricing model with the followingassumptions: for the first quarter of 2005, the model assumes a dividend yieldof 0%, expected volatility of 0%, a risk free interest rate of 4.1% and anexpected term of 7 years and for the first quarter of 2004, the model assumes adividend yield of 0%, expected volatility of 50%, a risk free interest rate of6.6% and an expected term of 8 years. These pro forma disclosures may not berepresentative of the effects on reported net income for future periods sinceoptions vest over several years and options granted prior to 1995 are notconsidered.

 

On July 30, 2004, as a result of the Acquisition, allstock options, whether or not then vested, with an exercise price of $16.50 ormore per share were cancelled without any payment therefore, and the remaining “inthe money” options (excluding certain management options that were forfeited inconnection with the Acquisition), whether or not then vested, with exerciseprices of less than $16.50 per share were converted into the right to receivethe excess of $16.50 per share over the exercise price of each of the options.As a consequence, subsequent to the July 30, 2004 transaction date, alloptions issued by the Predecessor to purchase previously existing Duane Reade Inc.common stock ceased to exist.

 

**3. Inventory and Cost of Sales**

 

At March 26, 2005, inventories, consisting solelyof finished goods, would have been lower by $6.7 million if they had beenvalued on a lower of first-in, first-out (“FIFO”) cost or market basis insteadof a last-in, first-out (“LIFO”) basis. Cost of sales includes all storeoccupancy-related costs and expenses, consisting of lease and sublease-relatedincome and expenses, other recurring real estate-related income and expensesprimarily from sales and terminations of leases related to store closings andrelocations, sales of market-related data, store utility costs, warehouseexpenses and distribution costs. The Company reflects promotional allowancesfrom vendors as a reduction of cost of sales or advertising expense, dependingon the nature of the allowance, when such advertising or promotions have beencompleted and the related allowances have been earned. For the thirteen weeksended March 26, 2005, other real estate-related income was $0.1 millionas compared to $0.8 million in the thirteen weeks ended March 27,2004. There was no income realized from the sale of market-related data in anyof the periods presented.

 

**4. Exit and Disposal Activities**

 

In connection with theacquisition of Duane Reade Inc. and in accordance with the provisions ofEmerging Issues Task Force Issue No. 95-3, “Recognition of Liabilities inConnection with Purchase Business Combinations” (EITF 95-3), the Companyestablished a reserve of $17.0 million for costs anticipated to be incurred asa result of the planned closing of approximately 11 of its stores.  These costs primarily relate to rent,utilities and other on-going occupancy-related expenses, as well as costsrelated to inventory liquidation.  Duringthe thirteen weeks ended March 26, 2005, eight of the 11 planned closingsoccurred (although each of the eight stores operated for some portion of thisperiod), and the Company recorded a net total of $0.6 million of primarilyoccupancy-related costs against this reserve resulting in the balance of $16.3million at March 26, 2005.

 

8

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**5. Pharmacy and Customer File Acquisitions**

 

During the first quarters of 2005 and 2004, theCompany acquired pharmacy customer files, which were merged into existingstores.  The table below provides detailsof this acquisition activity for each of the periods presented (dollars in millions).

 

| ** **                         | ** ** | **13 weeks ended**       | ** ** |
|------------------------------------|------------|--------------------------|------------|
| ** **                         | ** ** | **March 25,  2005** | ** ** | **March 27,  2004** | ** ** |
| Customer  prescription files       |       | 1                        |       | 4 |   |
| Total  acquisitions                |       | 1                        |       | 4 |   |
|                               |       |                     |       |   |   |
| Cash consideration                 |       | $                        | 0.8        |   | $ | 6.6 |   |
|                               |       |                     |       |   |   |
| Purchase price  allocation:        |       |                     |       |   |   |
| Identifiable  intangibles          |       | $                        | 0.8        |   | $ | 5.7 |   |
| Goodwill                           |       | —                   |       | 0.3 |   |
| Inventory                          |       | 0.2                      |       | 0.8 |   |
| Other assets and  liabilities, net |       | (0.2                     | )          | (0.2 | ) |
| Total                              |       | $                        | 0.8        |   | $ | 6.6 |   |

 

The acquired operations have been included in theconsolidated statement of operations from the date of acquisition and did nothave a material effect on sales or results of operations of the Company for theperiods presented.

 

**6. Debt**

 

Total debt is composed of the following (in thousands):

 

| **Description of Instrument**              | ** ** | **March 26,  2005** | ** **  | **Dec. 25,  2004** | ** ** |
|--------------------------------------------|------------|--------------------------|-------------|--------------------|------------|
| Asset-Based  Revolving Loan Facility (1)   |       | $                        | 179,810     |               | $          | 153,870 |   |
| Total Current  Debt                        |       | $                        | 179,810     |               | $          | 153,870 |   |
|                                       |       |                     |        |               |       |
| Senior Floating  Rate Notes due 2010       |       | $                        | 160,000     |               | $          | 160,000 |   |
| 9.75% Senior  Subordinated Notes due 2011  |       | 195,000                  |        | 195,000            |       |
| 2.1478% Senior  Convertible Notes due 2022 |       | 32                       |        | 32                 |       |
| Total  Non-current Debt                    |       | $                        | 355,032     |               | $          | 355,032 |   |
|                                       |       |                     |        |               |       |
| **Total  Debt**                            | ** ** | **$**                    | **534,842** | ** **         | **$**      | **508,902** | ** ** |

 

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(1) Obligations under this revolving loan facility are classified ascurrent liabilities because cash receipts controlled by the lenders are used toreduce outstanding debt and the Company does not meet the criteria of FAS 6 toreclassify the debt as long-term. This is not an indication that this creditfacility is expected to be retired within the next year. The Company intends tocontinue to utilize this facility for its working capital needs through thedate of its maturity in July 2008.

 

***AmendedAsset-Based Revolving Loan Facility:  ***On July 21, 2003, Duane Reade GPentered into a new credit agreement. This credit agreement was an asset-basedrevolving loan which used a pre-determined percentage of the current value ofinventory and selected accounts receivable to calculate the availability offunds eligible to be borrowed up to an aggregate principal amount of $200 million.Prior to the amendment described below, the Company’s obligations under the creditagreement and related guarantees were collateralized by substantially all of itsassets.

 

On July 22, 2004, in connection with theAcquisition, the asset-based revolving loan facility was amended to increasethe borrowing capacity to an aggregate principal amount of $250 million,subject to an adjusted borrowing base calculation based upon specified advancerates against the value of the Company’s selected inventory, pharmacyprescription files and selected accounts receivable. The amended asset-basedrevolving loan facility includes a $50 million sub-limit for the issuanceof letters of credit.  Obligations underthe revolving loan facility are collateralized by a first priority interest ininventory, receivables, pharmacy prescription files, deposit accounts andcertain other current assets. Under the amended asset-based revolving loanfacility, Duane Reade Inc. and Duane Reade GP are co-obligors. The

 

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asset-based revolving loan facility is guaranteed fully and on anunconditional basis by the Company and each of the Company’s other domestic subsidiariesother than the co-obligors.

 

The asset-based revolving loan facility contains asingle fixed charge coverage requirement which only becomes applicable whenborrowings exceed 90 percent of the borrowing base, as defined in the asset-basedrevolving loan facility. Borrowings under the asset-based revolving loanfacility have not exceeded 90 percent of the borrowing base and, as a result,the fixed charge covenant has not become applicable. There are no creditratings related triggers in the asset-based revolving loan facility that wouldimpact the cost of borrowing, annual amortization of principal or relatedindebtedness maturity. The asset-based revolving loan facility is scheduled tomature on July 20, 2008.

 

Revolving loans under the asset-based revolving loanfacility, at the Company’s option, bear interest at either (i) a rate equal toLIBOR (the London Interbank Offered Rate) plus a margin of from 1.50% to 2.00%,determined based on levels of borrowing availability reset each fiscal quarteror (ii) a rate equal to the prime rate of Banc of America Retail Group Inc.plus a margin of from 0.00% to 0.50%, determined based on levels of borrowingavailability reset each fiscal quarter. Borrowings under the amended facilitycontinue to be primarily LIBOR-based. At March 26, 2005, the asset basedrevolving loan facility bore interest at a rate of 4.32%.

 

At March 26, 2005, there was $179.8 millionoutstanding under the revolving credit facility, and approximately $62.6 millionof remaining availability, net of $4.2 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 the Company does not meet the criteria of Statementof Financial Accounting Standards No. 6 “Classification of Short TermObligations Expected to be Refinanced” (FAS 6), to reclassify the debt aslong-term. The Company intends to continue to utilize this facility for itsworking capital needs though the date of its maturity in July 2008.

 

*** Senior Secured Floating RateNotes due 2010****:* On December 20, 2004, theCompany closed an unregistered offering of $160.0 million aggregateprincipal amount of senior secured floating rate notes due 2010. As notedbelow, on February 3, 2005, the registrationstatement filed on Form S-4 in connection with these notes was declaredeffective by the SEC. Using the net proceeds (without deducting expenses) fromthat offering, together with approximately $2.2 million of borrowingsunder the amended asset-based revolving loan facility, the Company repaidall outstanding principal under the $155.0 million senior term loanfacility, along with approximately $3.6 million of early repayment premiumand accrued but unpaid interest through December 20, 2004.

 

The senior secured notes bearinterest at a floating rate of LIBOR plus 4.50%, reset quarterly. Interest onthe senior secured notes is payable quarterly on each March 15,June 15, September 15, and December 15, beginning on March 15,2005. The senior secured notes mature on December 15, 2010. At March 26, 2005,the Senior Secured Floating Rate Notes bore interest at a rate of 7.05%.

 

The Company guarantees the seniorsecured notes on a full and unconditional, senior secured basis. Duane Reade Inc.and Duane Reade GP are co-obligors under the senior secured notes. Thesenior secured notes rank equally in right of payment with any of the Company’s,Duane Reade Inc.’s or Duane Reade GP’s unsubordinated indebtedness andsenior in right of payment to any of the Company’s, Duane Reade Inc.’s orDuane Reade GP’s subordinated or senior subordinated indebtedness. Allobligations under the senior secured notes are guaranteed on a senior basis byeach of the Company’s existing subsidiaries, other than Duane Reade Inc.and Duane Reade GP, and will be guaranteed by future subsidiaries of DuaneReade Inc. and Duane Reade GP except certain foreign and certaindomestic subsidiaries. The senior secured notes and the guarantees are collateralizedby a first priority interest in substantially all of Duane Reade Inc. andDuane Reade GP’s assets other than those assets in which the lenders underthe amended asset-based revolving loan facility have a first priorityinterest. The senior secured notes and the guarantees are also collateralizedby a second priority security interest in all collateral pledged on a firstpriority basis to lenders under the amended asset-based revolving loanfacility.

 

Upon the occurrence of specifiedchange of control events, Duane Reade Inc. and Duane Reade GP will berequired to make an offer to repurchase all of the senior secured notes at 101%of the outstanding principal amount of the senior secured notes plus accruedand unpaid interest to the date of repurchase. The indenture governing thesenior secured notes contains certain affirmative and negative covenants thatlimit the ability of Duane Reade Inc., Duane Reade GP and theirrestricted subsidiaries, as defined, to incur additional indebtedness, pay dividends,make repayments on indebtedness that is subordinated to the senior securednotes and to make certain other restricted payments, incur certain liens, useproceeds from sales of assets, enter into business combination transactions(including mergers, consolidations and asset sales), enter into sale-leasebacktransactions, enter into transactions with affiliates and permit restrictionson the payment of dividends by restricted subsidiaries. The indenture governingthe senior secured notes does not contain financial maintenance covenants.Under a registration rights agreement entered into as part of the offering ofthe senior secured notes, the Company was required to (i) file aregistration statement with the SEC within 120 days after the completionof the offering of the senior secured notes, (ii) use its reasonable bestefforts to cause the registration statement to become effective within180 days after the completion of offering of the senior secured notes, and(iii) use its reasonable best efforts to complete an exchange

 

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offer of the initial senior secured notes forregistered senior secured notes within 210 days after the offering of thesenior secured notes is completed. On January 21, 2005, the Company filed aregistration statement on Form S-4, registering an exchange offer relating tothe senior secured notes.  On February 3,2005, the registration statement was declared effective by the SEC. However, onMarch 7, 2005, prior to the completion of the exchange offer, the Companysuspended the exchange offer as a result of the restatement of its financialresults. The Company expects to resume the exchange offer once the prospectusfor the exchange offer is updated to take account of the restatements. Thereare no credit ratings related triggers in the indenture governing the seniorsecured notes that would impact the cost of borrowing, annual amortization ofprincipal or related indebtedness maturity.

 

At March 26, 2005, the weighted average combinedinterest rate in effect on all variable rate debt outstanding was 5.60%.

 

***SeniorSubordinated Notes Due 2011:  ***On July 30, 2004, upon completion ofthe Acquisition, Duane Reade Inc. and Duane Reade GP co-issued $195 millionof 9.75% senior subordinated notes due 2011, which were registered on a FormS-4 filing deemed effective by the SEC on December 29, 2004. The senior subordinatednotes mature on August 1, 2011 and bear interest at 9.75% per annumpayable in semi-annual installments on February 1 and August 1,commencing February 1, 2005. The senior subordinated notes are uncollateralizedobligations and subordinated in right of payment to all of the Company’s, DuaneReade Inc.’s and Duane Reade GP’s existing and future unsubordinatedindebtedness, including borrowings under the amended asset-based revolving loanfacility and the senior secured notes. The senior subordinated notes will rankequally with any future senior subordinated indebtedness and senior to anyfuture subordinated indebtedness. The senior subordinated notes are guaranteedon an uncollateralized, senior subordinated basis by the Company and all of DuaneReade Inc.’s existing direct and indirect domestic subsidiaries other thanDuane Reade GP, which is a co-obligor under the senior subordinated notes.Upon the occurrence of specified change of control events, the Company will berequired to make an offer to repurchase all of the senior subordinated notes at101% of the outstanding principal amount of the senior subordinated notes plusaccrued and unpaid interest to the date of repurchase. The indenture governingthe senior subordinated notes contains certain affirmative and negativecovenants that limit the ability of Duane Reade Inc., Duane Reade GPand their restricted subsidiaries to incur additional indebtedness, paydividends, make repayments on indebtedness that is subordinated to the senior subordinatednotes and to make certain other restricted payments, incur certain liens, useproceeds from sales of assets, enter into business combination transactions(including mergers, consolidations and asset sales), enter into transactionswith affiliates and permit restrictions on the payment of dividends by restrictedsubsidiaries.  There are no creditratings related triggers in the indenture governing the senior subordinated notesthat would impact the cost of borrowing, annual amortization of principal orrelated indebtedness maturity.

 

***2.1478%Senior Convertible Notes due April 16, 2022:*****  **On April 16,2002, Duane Reade Inc. completed an offering of $381.5 millionaggregate principal amount of Senior Convertible Notes maturing on April 16,2022 (the “Convertible Notes”). The Convertible Notes were issued at a price of$572.76 per note (57.276% of the principal amount at maturity) and pay cashinterest at the rate of 2.1478% per year on the principal amount at maturity,payable semi-annually in arrears on April 16 and October 16 of eachyear beginning on October 16, 2002, until April 16, 2007. After thatdate, interest will accrue on the notes as amortization of the original issuediscount representing a yield to maturity of 3.75% per year, computed on asemi-annual bond equivalent basis. In December 2002, Duane Reade Inc.repurchased a total of $30.5 million principal value of the ConvertibleNotes at an average purchase price of $486.99 per $1,000 note, resulting in a remainingnet outstanding balance of $201.0 million.

 

In connection with the Acquisition, Duane Reade Inc.made a tender offer to repurchase all of the $351.0 million outstandingprincipal value of the Convertible Notes. Upon the closing of the tender offer,a total of $350.9 million principal value ($201.0 million issuancevalue) was tendered for repurchase, leaving only $55.0 thousand principal value($32.0 thousand of issuance value) outstanding. Duane Reade Inc. mayredeem for cash all or a portion of the principal value of the outstandingConvertible Notes at any time after April 16, 2007, at a price equal to the sumof the issue price plus accrued original issue discount and accrued cashinterest, if any, to the redemption date.

 

**7. Income Taxes**

 

Income taxes are recorded based on the estimatedcombined statutory tax rates expected to be applicable for the full fiscal yearless applicable employment related tax credits. The effective tax rate is lowerthan the combined statutory rates, primarily reflecting the impact of theseincome tax credits. The wage-based employment tax credits represent theeconomic benefits earned by the Company for its participation in various federaland state 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.

 

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**8. Commitments and Contingencies**

 

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

 

During 2002, the Companyinitiated a legal action against its former property insurance carrier, in anattempt to recover what it believes to be a fair and reasonable settlement forthe business interruption portion of its claim originating from theSeptember 11, 2001 World Trade Center terrorist attack, during which itssingle highest volume and most profitable store was completely destroyed. Theclaim is pending before the United States District Court for the SouthernDistrict of New York. In September 2003, a trial on certain issues washeld regarding some of the matters at issue in the litigation, includingwhether the Company would have obtained a renewal of its lease at the WorldTrade Center. The Company has received a favorable ruling on this and otherlegal issues in the case and now the matter has moved into an appraisalprocess. The appraisal process involves two appraisers and an arbitrator (toresolve differences between the two appraisers) who will determine the amountof insured loss the Company has sustained. The insurance carrier has appealed anumber of rulings by the trial court. The appraisal process is proceeding andthe Company may have a determination by late in the second quarter or early inthe third quarter of 2005. However, in light of the inherent uncertainty inlitigation relating to the insurance carrier’s appeal, the amount of additionalinsurance proceeds, if any, that the Company may collect under the terms of ourinsurance contract with the defendant cannot be reasonably predicted ordetermined at this time, and therefore, the Company has not accrued anyadditional income related to this potential settlement. In fiscal 2002, theCompany received an advance of approximately $9.4 million toward thebusiness interruption claim that was recognized as a separate component ofincome in the consolidated statement of income. In the event of an unfavorableoutcome to the Company, this amount would not be required to be returned to theinsurance company.

 

Duane Reade Inc., Mr. Cuti,Mr. Henry and Mr. Charboneau 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 was in the United States DistrictCourt for the Southern District of New York, was on behalf of shareholders whopurchased the Company’s common stock between April 1, 2002 andJuly 24, 2002,inclusive. The complaint, which sought an unspecified amount of damages,alleged that the defendants violated thefederal securities laws by issuing materially false and misleading statementsduring the class period. On December 1, 2003, the district judge grantedthe Company’s motion to dismiss the plaintiff’s action, with prejudice. Theplaintiffs subsequently filed an appeal. On August 17, 2004, the U.S.Court of Appeals affirmed the district court’s ruling in the Company’s favor.

 

The Company is a defendant in aclass action suit in the Federal Court for the Southern District of New Yorkfiled in January 2000 regarding alleged violations of the Fair Labor StandardsAct as to a group of individuals who provided delivery services on a contractbasis to the Company. In December 2002, the judge in the action issued apartial summary judgment in favor of a subclass of the plaintiffs and againstthe Company. In December 2003, the Company settled the issue of the amountof its liability to the plaintiffs without any admission of wrongdoing and inan amount consistent with its previously established reserves. By a decisiondated August 4, 2004, the district court awarded the plaintiffs certainattorneys’ fees in this matter. The Company has fully reserved the amounts ofthe fees in question and has appealed this award.

 

The Company is a party to aNational Labor Relations Board (“NLRB”) administrative proceeding regarding adispute with the Allied Trades Council (“ATC”) over whether a negotiatingimpasse was reached between the Company and the union in August of 2001. TheAllied Trades Council represents employees in 139 of the Company’s stores in acollective bargaining agreement that expired on August 31, 2001.The Company’s employees have been working pursuant to the terms of the Company’sDecember 6, 2001 implemented contract with the ATC, which expired onAugust 31, 2004. The Company believes an impasse did in fact occur and asa result, it had the right to implement its latest contract proposal at thattime which included wage increases, health and welfare benefits, vacation andsick benefits and a 401(k) retirement program. The Company discontinued makingadditional payments into the various funds associated with the union as it wasproviding many of these benefits on a direct basis and because it believes it’spast contributions to these funds caused these funds to be in a position ofexcessive overfunding. In addition, the Company had concerns that its pastpayments into these funds were not being managed in a way to ensure they werebeing properly utilized for the benefit of its 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 the Company to make itsemployees whole by reimbursing them for expenses ensuing from the failure tomake contributions to the union funds and to make such funds whole, plusinterest. This recommendation was adopted by a three-member panel of theNLRB on September 15, 2004. The NLRB’s determination has been appealed bythe Company. If it is enforced by the court of appeals, it could result in the

 

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Company being required to contribute amounts thathave yet to be determined into the union’s pension benefit, health and welfareand vacation funds. Any potential required contributions resulting from a finaljudicial determination of this matter would potentially be subject to offset bythe amounts that the Company had funded since it implemented its final contractproposal for these same benefits that were paid for its Allied Trades Councilemployees. Because the NLRB decision represents the first phase of a long andcomplicated administrative process to be followed by a full judicial review ofall of the facts and circumstances, the final outcome cannot be reliably determinedat this time. The NLRB’s decision is subject to judicial review by the D.C.Circuit Court of Appeals and a compliance hearing before any financial remedycan be determined. The Company is in the process of filing appeal papers withthe D.C. Circuit Court of Appeals. Subsequent to the completion of filing thesepapers, which will be mid-summer 2005, the Court will schedule a hearing andsometime thereafter will render a decision. While there can be no definitiveassurance, the Company has been advised by its outside labor counsel that itspetition for review contains a number of valid defenses and arguments againstenforcement of the NLRB decision.

 

In light of the foregoing, whileit is the Company’s belief that the final financial outcome of this litigationcannot be determined, under the provisions of Statement of Financial AccountingStandard No 5 which addresses contingencies, the Company has recorded cumulativepre-tax charges of $18.1 million, including $1.1 million in thethirteen weeks ended March 26, 2005. These charges represent the Company’scurrent best estimate of the loss that would result upon application of theNLRB’s decision. 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 D.C.Circuit Court of Appeals, completion of a compliance hearing and any appealsrelating to the outcome of that hearing. These charges reflect the amount ofcontributions that the Company did not make into the union benefit funds forthe period from the August 31, 2001 expiration of the contract through March 26,2005, reduced by a portion of the benefits it 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 March 26,2005. While this represents the Company’s current best estimate of the ALJ’srecommendation, the Company believes that, as of March 26, 2005, theactual range of loss in this matter could be from $0 if the Circuit Court ofAppeals does not enforce the NLRB decision at all, to approximately $40 million,if the NLRB’s decision is upheld and there is no offset for any benefits paidover this period.

 

Until such time as further legaldevelopments warrant a change in the application of this accounting standard,or until this matter is resolved, the Company will record additional non-cashpre-tax charges, including interest, which are calculated on the same basis asthe charges recorded in the 2003 and 2004 financial statements. The Companycurrently estimates that the pre-tax charge recorded during the full12 months of 2005 will approximate $4.4 million, subject to changesin the relevant interest rate.

 

The Company is a party to relatedlawsuits, Irving Kroop, et al v. Duane Reade, NY, NY et al, 00 Civ. 9841, etal., instituted by the trustees of several union benefit funds wherein thefunds claim that the Company did not make certain required contributions tothese funds from January 2000 through August 2001. By decisions datedAugust 5, 2004 and September 27, 2004, the District Court awardedjudgment to the funds on certain aspects of their complaints. These partial judgments, for which the Company has provided adequate reserves, are subject tofurther appeal by the Company. The remaining unresolved portions of theplaintiffs’ claims are still being litigated and accordingly, the Companyintends to continue to vigorously defend itself in these matters. At this time,it is not possible to determine the ultimate outcome of this case or the actualamount of liability the Company may face, if any.

 

The Company is involved in anongoing dispute with Cardinal Health, one of its former suppliers ofpharmaceutical products. Both parties have claims against the other involving,among other things, breach of contract, promissory estoppel and unjustenrichment. Duane Reade is seeking from Cardinal an unspecified amount ofdamages and punitive damages of at least $20 million.Cardinal is seeking approximately $18 million in damages plus attorney’sfees and interest. While there can be no definitive assurance, the Companybelieves it has counterclaims that offset the claims against it by Cardinal, aswell as meritorious defenses to these claims, and plans to vigorously pursueits affirmative claims and to vigorously defend itself in this action.Non-party discovery in the case has concluded and it is expected to go to trialin the second half of 2005.

 

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

 

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In November 2004, Duane Reade Inc.was served with a class action complaint, Damassia v. Duane Reade Inc.The lawsuit was filed in the United States District Court, Southern District ofNew York. The complaint alleges that, from the period beginning November 1998,the Company incorrectly gave some employees the title, “Assistant Manager,” inan attempt to avoid paying these employees overtime, in contravention of theFair Labor Standards Act and the New York Law. The complaint seeks twice anunspecified amount of unpaid wages. The Company believes this claim to bewithout merit, and it intends to defend itself vigorously against this claim.However, due to the uncertainty of litigation, there can be no assurance as tothe ultimate outcome of this matter.

 

In January 2005, the Equal Employment OpportunityCommission filed an action against the Company in the U.S. District Court forthe Southern District of New York alleging, among other things, that theCompany created a hostile work environment for three female store employees,and potentially a class of such female employees.  This action is in its early stages, andaccordingly it is not possible to determine the ultimate outcome, which, ifadverse, could be material.  However, theCompany believes that the allegations are wholly without merit and intends to vigorouslydefend itself in this matter.

 

***Litigation Relating to the Merger Transaction:***  TheCompany is aware of six purported class action complaints challenging the Acquisitionconsummated by Duane Reade Inc. and Duane Reade Acquisition that havebeen filed in the Court of Chancery of the State of Delaware, referred to asthe “Delaware Complaints,” and three purported class action complaints thathave been filed in the Supreme Court of the State of New York. Two of the NewYork complaints have been dismissed without prejudice. The other New Yorkcomplaint (the “New York Complaint”) is pending but has not been served on the DuaneReade.  The Delaware Complaints name Mr. Cutiand certain other members of the Company’s board of directors and executiveofficers as well as Duane Reade as defendants. Four of the DelawareComplaints name Oak Hill as a defendant. The New York Complaint names Mr. Cutiand certain other members of the Company’s board of directors and executiveofficers as well as Duane Reade as defendants. One of the dismissed NewYork complaints named Oak Hill as a defendant.

 

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

 

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**9. Condensed Consolidating Financial Informationof Subsidiary Guarantors and Co-Obligors**

 

The 9.75% Senior Subordinated Notes due 2011 and theSenior Secured Floating Rate Notes due 2010 were co-issued by Duane Reade Inc.and Duane Reade GP, each of whom is considered a “co-obligor.” The Companyand each of its’ other subsidiaries, composed of DRI I Inc., Duane Reade International, Inc.and Duane Reade Realty, Inc., are guarantors of such notes. Theguarantee of the Company and of each subsidiary guarantor is full andunconditional and joint and several.

 

The following condensed consolidating financialinformation for the Company presents the financial information of Duane Reade Holdings, Inc.,the co-obligors and the subsidiary guarantors, prepared on the equity basis ofaccounting. Such presentation is based on the Company’s understanding andinterpretation of Rule 3-10 under the Securities and Exchange Commission’sRegulation S-X. The financial information may not necessarily be indicative ofresults of operations or financial position had the subsidiary guarantorsoperated as independent entities.

 

**DUANE READE HOLDINGS, INC.**

**Condensed Consolidating Statementof Operations**

**For the 13 weeks ended March 26,2005**

**(Successor)**

**(in thousands)**

** **
| ** **                                      | ** ** | ** **         | ** ** | ** **     | ** ** | ** **   | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane Reade**    | ** ** |
|-------------------------------------------------|------------|--------------------|------------|----------------|------------|--------------|------------|----------------|------------|-------------------|------------|--------------------|------------|
| ** **                                      | ** ** | **Duane Reade**    | ** ** | **Duane**      | ** ** | **Duane**    | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Holdings, Inc.** | ** ** |
| ** **                                      | ** ** | **Holdings, Inc.** | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**   | ** ** |
| Net sales                                       |       | $                  | —     |           | $          | —       |       | $              | 394,767    |              | $          | —             |       | $ | — |   | $ | 394,767 |   |
| Cost of sales                                   |       | —             |       | —         |       | 321,958      |       | —         |       | —            |       | 321,958            |       |
| Gross profit                                    |       | —             |       | —         |       | 72,809       |       | —         |       | —            |       | 72,809             |       |
| Selling, general  & administrative expenses |       | —             |       | —         |       | 76,258       |       | (11,759        | )          | —            |       | 64,499             |       |
| Labor  contingency                              |       | —             |       | —         |       | 1,100        |       | —         |       | —            |       | 1,100              |       |
| Transaction  expense                            |       | —             |       | —         |       | 427          |       | —         |       | —            |       | 427                |       |
| Depreciation and  amortization                  |       | —             |       | —         |       | 17,646       |       | —         |       | —            |       | 17,646             |       |
| Store pre-opening  expense                      |       | —             |       | —         |       | 100          |       | —         |       | —            |       | 100                |       |
| Other                                           |       | —             |       | —         |       | 1,148        |       | —         |       | —            |       | 1,148              |       |
| Operating (loss)  income                        |       | —             |       | —         |       | (23,870      | )          | 11,759         |       | —            |       | (12,111            | )          |
| Equity earnings  in affiliates                  |       | 12,802             |       | 12,802         |       | —       |       | 193            |       | (25,797           | )          | —             |       |
| Interest  expense, net                          |       | —             |       | —         |       | 11,165       |       | —         |       | —            |       | 11,165             |       |
| Income (loss)  before income taxes              |       | (12,802            | )          | (12,802        | )          | (35,035      | )          | 11,566         |       | 25,797            |       | (23,276            | )          |
| Income tax  (benefit) expense                   |       | —             |       | —         |       | (15,765      | )          | 5,291          |       | —            |       | (10,474            | )          |
| Net income  (loss)                              |       | $                  | (12,802    | )              | $          | (12,802      | )          | $              | (19,270    | )                 | $          | 6,275              |       | $ | 25,797 |   | $ | (12,802 | ) |
|                                                 |            |                    |            |                |            |              |            |                |            |                   |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

**DUANE READE INC.**

**Condensed Consolidating Statementof Operations**

**For the 13 weeks ended March 27,2004**

**(Predecessor)**

**(in thousands)**

 
| ** **                                      | ** ** | ** **     | ** ** | ** **         | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane**        | ** ** |
|-------------------------------------------------|------------|----------------|------------|--------------------|------------|----------------|------------|-------------------|------------|------------------|------------|
| ** **                                      | ** ** | **Duane**      | ** ** | ** **         | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Reade Inc.**   | ** ** |
| ** **                                      | ** ** | **Reade Inc.** | ** ** | **Duane Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated** | ** ** |
| Net sales                                       |       | $              | —     |               | $          | 383,310        |       | $                 | —     |             | $          | — |   | $ | 383,310 |   |
| Cost of sales                                   |       | —         |       | 306,808            |       | —         |       | —            |       | 306,808          |       |
| Gross profit                                    |       | —         |       | 76,502             |       | —         |       | —            |       | 76,502           |       |
| Selling, general  & administrative expenses |       | 11             |       | 68,865             |       | (10,233        | )          | —            |       | 58,643           |       |
| Labor  contingency                              |       | —         |       | 1,100              |       | —         |       | —            |       | 1,100            |       |
| Transaction expense                             |       | —         |       | 1,102              |       | —         |       | —            |       | 1,102            |       |
| Depreciation and  amortization                  |       | —         |       | 9,066              |       | —         |       | —            |       | 9,066            |       |
| Store pre-opening  expense                      |       | —         |       | 157                |       | —         |       | —            |       | 157              |       |
| Operating (loss)  income                        |       | (11            | )          | (3,788             | )          | 10,233         |       | —            |       | 6,434            |       |
| Equity earnings  in affiliates                  |       | (1,758         | )          | —             |       | 42             |       | 1,716             |       | —           |       |
| Interest  expense, net                          |       | —         |       | 3,437              |       | —         |       | —            |       | 3,437            |       |
| Income (loss)  before income taxes              |       | 1,747          |       | (7,225             | )          | 10,191         |       | (1,716            | )          | 2,997            |       |
| Income tax  (benefit) expense                   |       | (5             | )          | (3,001             | )          | 4,251          |       | —            |       | 1,245            |       |
| Net income  (loss)                              |       | $              | 1,752      |               | $          | (4,224         | )          | $                 | 5,940      |             | $          | (1,716 | ) | $ | 1,752 |   |
|                                                 |            |                |            |                    |            |                |            |                   |            |                  |            |  |  |  |  |  |  |  |  |  |

 

15

----

 

**DUANE READE HOLDINGS, INC.**

**Condensed Consolidating BalanceSheet**

**For the period ended March 26,2005**

**(Successor)**

**(in thousands)**

 
| ** **                                      | ** ** | ** **         | ** ** | ** **     | ** ** | ** **   | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane Reade**    | ** ** |
|-------------------------------------------------|------------|--------------------|------------|----------------|------------|--------------|------------|----------------|------------|-------------------|------------|--------------------|------------|
| ** **                                      | ** ** | **Duane Reade**    | ** ** | **Duane**      | ** ** | **Duane**    | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Holdings, Inc.** | ** ** |
| ** **                                      | ** ** | **Holdings, Inc.** | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**   | ** ** |
| Assets                                          |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Current assets                                  |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Cash                                            |       | $                  | —     |           | $          | —       |       | $              | 1,294      |              | $          | 42                 |       | $ | — |   | $ | 1,336 |   |
| Receivables                                     |       | —             |       | (127,866       | )          | 313,504      |       | (60,086        | )          | (68,392           | )          | 57,160             |       |
| Inventories                                     |       | —             |       | —         |       | 261,149      |       | —         |       | —            |       | 261,149            |       |
| Deferred income  taxes                          |       | —             |       | 10,167         |       | 5,049        |       | (6,189         | )          | —            |       | 9,027              |       |
| Prepaid expenses  and other assets              |       | —             |       | —         |       | 34,096       |       | —         |       | —            |       | 34,096             |       |
| Total current  assets                           |       | —             |       | (117,699       | )          | 615,092      |       | (66,233        | )          | (68,392           | )          | 362,768            |       |
| Investment in  affiliates                       |       | 171,247            |       | (21,209        | )          | —       |       | (1,289         | )          | (148,749          | )          | —             |       |
| Property and  equipment                         |       | —             |       | —         |       | 236,977      |       | —         |       | —            |       | 236,977            |       |
| Goodwill, net                                   |       | —             |       | —         |       | 52,216       |       | —         |       | —            |       | 52,216             |       |
| Deferred income  taxes                          |       | —             |       | 1,645          |       | 9,032        |       | (10,677        | )          | —            |       | —             |       |
| Other assets                                    |       | —             |       | 17,015         |       | 292,971      |       | 263,657        |       | (283,242          | )          | 290,401            |       |
| Total assets                                    |       | $                  | 171,247    |           | $          | (120,248     | )          | $              | 1,206,288  |              | $          | 185,458            |       | $ | (500,383 | ) | $ | 942,362 |   |
|                                            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Liabilities and  Stockholders Equity            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Current  liabilities                            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Accounts payable                                |       | $                  | —     |           | $          | —       |       | $              | 79,144     |              | $          | —             |       | $ | — |   | $ | 79,144 |   |
| Accrued interest                                |       | —             |       | —         |       | 3,649        |       | —         |       | —            |       | 3,649              |       |
| Accrued expenses                                |       | —             |       | 70             |       | 39,118       |       | —         |       | —            |       | 39,188             |       |
| Current portion  of debt                        |       | —             |       | —         |       | 179,810      |       | —         |       | —            |       | 179,810            |       |
| Current portion  of capital lease obligation    |       | —             |       | —         |       | 2,899        |       | —         |       | —            |       | 2,899              |       |
| Total current  liabilities                      |       | —             |       | 70             |       | 304,620      |       | —         |       | —            |       | 304,690            |       |
|                                            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Long term debt                                  |       | —             |       | —         |       | 624,249      |       | —         |       | (269,217          | )          | 355,032            |       |
| Capital lease  obligation, less current portion |       | —             |       | —         |       | 12,717       |       | —         |       | —            |       | 12,717             |       |
| Deferred income  taxes                          |       | —             |       | 65,850         |       | (55,174      | )          | 26,821         |       | —            |       | 37,497             |       |
| Other non-current  liabilities                  |       | —             |       | 2,564          |       | 58,615       |       | —         |       | —            |       | 61,179             |       |
| Total liabilities                               |       | —             |       | 68,484         |       | 945,027      |       | 26,821         |       | (269,217          | )          | 771,115            |       |
|                                            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Stockholders  equity                            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Common stock                                    |       | 26                 |       | —         |       | 26           |       | —         |       | (26               | )          | 26                 |       |
| Paid-in-capital                                 |       | 239,472            |       | 17,015         |       | 321,889      |       | —         |       | (338,904          | )          | 239,472            |       |
| Retained earnings                               |       | (68,251            | )          | (205,747       | )          | (60,654      | )          | 158,637        |       | 107,764           |       | (68,251            | )          |
| Total  stockholders equity                      |       | 171,247            |       | (188,732       | )          | 261,261      |       | 158,637        |       | (231,166          | )          | 171,247            |       |
| Total  liabilities and stockholders equity      |       | $                  | 171,247    |           | $          | (120,248     | )          | $              | 1,206,288  |              | $          | 185,458            |       | $ | (500,383 | ) | $ | 942,362 |   |
|                                                 |            |                    |            |                |            |              |            |                |            |                   |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

16

----

 

**DUANE READE HOLDINGS, INC.**

**Condensed Consolidating BalanceSheet**

**For the fiscal year endedDecember 25, 2004**

**(Successor)**

**(in thousands)**

 
| ** **                                      | ** ** | ** **         | ** ** | ** **     | ** ** | ** **   | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane Reade**    | ** ** |
|-------------------------------------------------|------------|--------------------|------------|----------------|------------|--------------|------------|----------------|------------|-------------------|------------|--------------------|------------|
| ** **                                      | ** ** | **Duane Reade**    | ** ** | **Duane**      | ** ** | **Duane**    | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Holdings, Inc.** | ** ** |
| ** **                                      | ** ** | **Holdings, Inc.** | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**   | ** ** |
| Assets                                          |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Current assets                                  |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Cash                                            |       | $                  | —     |           | $          | —       |       | $              | 1,297      |              | $          | 32                 |       | $ | — |   | $ | 1,329 |   |
| Receivables                                     |       | —             |       | (127,936       | )          | 314,394      |       | (60,010        | )          | (68,392           | )          | 58,056             |       |
| Inventories                                     |       | —             |       | —         |       | 262,323      |       | —         |       | —            |       | 262,323            |       |
| Deferred income  taxes                          |       | —             |       | 10,167         |       | 5,049        |       | (6,189         | )          | —            |       | 9,027              |       |
| Prepaid expenses  and other assets              |       | —             |       | —         |       | 35,716       |       | —         |       | —            |       | 35,716             |       |
| Total current  assets                           |       | —             |       | (117,769       | )          | 618,779      |       | (66,167        | )          | (68,392           | )          | 366,451            |       |
| Investment in  affiliates                       |       | 184,049            |       | (8,407         | )          | —       |       | (1,096         | )          | (174,546          | )          | —             |       |
| Property and  equipment                         |       | —             |       | —         |       | 224,460      |       | —         |       | —            |       | 224,460            |       |
| Goodwill, net                                   |       | —             |       | —         |       | 52,216       |       | —         |       | —            |       | 52,216             |       |
| Deferred income  taxes                          |       | —             |       | 1,645          |       | 9,032        |       | (10,677        | )          | —            |       | —             |       |
| Other assets                                    |       | —             |       | 17,015         |       | 299,603      |       | 251,831        |       | (271,417          | )          | 297,032            |       |
| Total assets                                    |       | $                  | 184,049    |           | $          | (107,516     | )          | $              | 1,204,090  |              | $          | 173,891            |       | $ | (514,355 | ) | $ | 940,159 |   |
|                                            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Liabilities and Stockholders  Equity            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Current  liabilities                            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Accounts payable                                |       | $                  | —     |           | $          | —       |       | $              | 80,154     |              | $          | —             |       | $ | — |   | $ | 80,154 |   |
| Accrued interest                                |       | —             |       | —         |       | 8,209        |       | —         |       | —            |       | 8,209              |       |
| Accrued expenses                                |       | —             |       | —         |       | 56,735       |       | —         |       | —            |       | 56,735             |       |
| Current portion  of debt                        |       | —             |       | —         |       | 153,870      |       | —         |       | —            |       | 153,870            |       |
| Current portion  of capital lease obligation    |       | —             |       | —         |       | 780          |       | —         |       | —            |       | 780                |       |
| Total current  liabilities                      |       | —             |       | —         |       | 299,748      |       | —         |       | —            |       | 299,748            |       |
|                                            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Long term debt                                  |       | —             |       | —         |       | 612,424      |       |           |       | (257,392          | )          | 355,032            |       |
| Capital lease  obligation, less current portion |       | —             |       | —         |       | 2,008        |       | —         |       | —            |       | 2,008              |       |
| Deferred income  taxes                          |       | —             |       | 65,849         |       | (39,408      | )          | 21,530         |       | —            |       | 47,971             |       |
| Other  non-current liabilities                  |       | —             |       | 2,565          |       | 48,786       |       | —         |       | —            |       | 51,351             |       |
| Total  liabilities                              |       | —             |       | 68,414         |       | 923,558      |       | 21,530         |       | (257,392          | )          | 756,110            |       |
|                                            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Stockholders  equity                            |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Common stock                                    |       | 26                 |       | —         |       | —       |       | —         |       | —            |       | 26                 |       |
| Paid-in-capital                                 |       | 239,472            |       | 17,015         |       | 321,915      |       | —         |       | (338,930          | )          | 239,472            |       |
| Retained  earnings                              |       | (55,449            | )          | (192,945       | )          | (41,383      | )          | 152,361        |       | 81,967            |       | (55,449            | )          |
| Total  stockholders equity                      |       | 184,049            |       | (175,930       | )          | 280,532      |       | 152,361        |       | (256,963          | )          | 184,049            |       |
| Total  liabilities and stockholders equity      |       | $                  | 184,049    |           | $          | (107,516     | )          | $              | 1,204,090  |              | $          | 173,891            |       | $ | (514,355 | ) | $ | 940,159 |   |
|                                                 |            |                    |            |                |            |              |            |                |            |                   |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

17

----

 

**DUANE READE HOLDINGS, INC.**

**Condensed Consolidating Statementof Cash Flows**

**For the 13 weeks ended March 26,2005**

**(Successor)**

**(in thousands)**

 
| ** **                                                                                             | ** ** | ** **         | ** ** | ** **     | ** ** | ** **   | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane Reade**    | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------------|------------|--------------|------------|----------------|------------|-------------------|------------|--------------------|------------|
| ** **                                                                                             | ** ** | **Duane Reade**    | ** ** | **Duane**      | ** ** | **Duane**    | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Holdings, Inc.** | ** ** |
| ** **                                                                                             | ** ** | **Holdings, Inc.** | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**   | ** ** |
| Cash flows from  operating activities:                                                                 |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Net income  (loss)                                                                                     |       | $                  | (12,802    | )              | $          | (12,802      | )          | $              | (19,270    | )                 | $          | 6,275              |       | $ | 25,797 |   | $ | (12,802 | ) |
| Adjustments to  reconcile net income (loss) to net cash (used in) / provided by operating  activities: |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Depreciation and  amortization of property and equipment                                               |       | —             |       | —         |       | 18,559       |       | —         |       | —            |       | 18,559             |       |
| Deferred tax provision                                                                                 |       | —             |       | —         |       | (15,765      | )          | 5,291          |       | —            |       | (10,474            | )          |
| Other                                                                                                  |       | 12,802             |       | 12,802         |       | 3,594        |       | 193            |       | (25,797           | )          | 3,594              |       |
| Changes in  operating assets and liabilities:                                                          |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Receivables                                                                                            |       | —             |       | (70            | )          | 891          |       | 76             |       | —            |       | 897                |       |
| Inventories                                                                                            |       | —             |       | —         |       | 1,409        |       | —         |       | —            |       | 1,409              |       |
| Accounts payable                                                                                       |       | —             |       | —         |       | (1,010       | )          | —         |       | —            |       | (1,010             | )          |
| Prepaid and  accrued expenses                                                                          |       | —             |       | 70             |       | (22,976      | )          | —         |       | —            |       | (22,906            | )          |
| Increase in  other assets (liabilities), net                                                           |       | —             |       | —         |       | 17,908       |       | (11,825        | )          | —            |       | 6,083              |       |
| NET CASH  PROVIDED BY (USED IN) OPERATING ACTIVITIES                                                   |       | —             |       | —         |       | (14,437      | )          | 10             |       | —            |       | (16,650            | )          |
|                                                                                                   |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Capital  expenditures                                                                                  |       | —             |       | —         |       | (7,132       | )          | —         |       | —            |       | (7,132             | )          |
| Lease  acquisition and other costs                                                                     |       | —             |       | —         |       | (3,096       | )          | —         |       | —            |       | (3,096             | )          |
| Proceeds from sale of property                                                                         |       | —             |       | —         |       | 2,223        |       | —         |       | —            |       | 2,223              |       |
| NET CASH USED IN  INVESTING ACTIVITIES                                                                 |       | —             |       | —         |       | (8,005       | )          | —         |       | —            |       | (8,005             | )          |
|                                                                                                   |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Cash flows from  financing activities:                                                                 |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Deferred  financing costs                                                                              |       | —             |       | —         |       | (607         | )          | —         |       | —            |       | (607               | )          |
| Borrowings from  revolving credit facility                                                             |       | —             |       | —         |       | 475,674      |       | —         |       | —            |       | 475,674            |       |
| Repayments of  revolving credit facility                                                               |       | —             |       | —         |       | (449,734     | )          | —         |       | —            |       | (449,734           | )          |
| Repayments of  capital lease obligations                                                               |       | —             |       | —         |       | (671         | )          | —         |       | —            |       | (671               | )          |
| NET CASH  PROVIDED BY FINANCING ACTIVITIES                                                             |       | —             |       | —         |       | 24,662       |       | —         |       | —            |       | 24,662             |       |
|                                                                                                   |       |               |       |           |       |         |       |           |       |              |       |               |       |
| Net (decrease)  increase in cash                                                                       |       | —             |       | —         |       | (3           | )          | 10             |       | —            |       | 7                  |       |
| Cash at  beginning of period                                                                           |       | —             |       | —         |       | 1,297        |       | 32             |       | —            |       | 1,329              |       |
| Cash at end of  period                                                                                 |       | $                  | —     |           | $          | —       |       | $              | 1,294      |              | $          | 42                 |       | $ | — |   | $ | 1,336 |   |
|                                                                                                        |            |                    |            |                |            |              |            |                |            |                   |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

 

18

----

 

**DUANE READE INC.**

**Condensed Consolidating Statementof Cash Flows**

**For the 13 weeks ended March 27,2004**

**(Predecessor)**

**(in thousands)**

 
| ** **                                                                                            | ** ** | ** **     | ** ** | ** **   | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane**        | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------------|------------|--------------|------------|----------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                            | ** ** | **Duane**      | ** ** | **Duane**    | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Reade Inc.**   | ** ** |
| ** **                                                                                            | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated** | ** ** |
| Cash flows from  operating activities:                                                                |       |           |       |         |       |           |       |              |       |             |       |
| Net income  (loss)                                                                                    |       | $              | 1,752      |         | $          | (4,224         | )          | $                 | 5,940      |             | $          | (1,716 | ) | $ | 1,752 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by / (used in) operating activities: |       |           |       |         |       |           |       |              |       |             |       |
| Depreciation and  amortization of property and equipment                                              |       | —         |       | 9,544        |       | —         |       | —            |       | 9,544            |       |
| Deferred tax  provision                                                                               |       | (80            | )          | (3,002       | )          | 4,251          |       | —            |       | 1,169            |       |
| Other                                                                                                 |       | (1,758         | )          | 1,902        |       | 42             |       | 1,716             |       | 1,902            |       |
| Changes in  operating assets and liabilities:                                                         |       |           |       |         |       |           |       |              |       |             |       |
| Receivables                                                                                           |       | (906           | )          | (3,987       | )          | 114            |       | —            |       | (4,779           | )          |
| Inventories                                                                                           |       | —         |       | 9,512        |       | —         |       | —            |       | 9,512            |       |
| Accounts payable                                                                                      |       | —         |       | (8,690       | )          | —         |       | —            |       | (8,690           | )          |
| Prepaid and  accrued expenses                                                                         |       | 936            |       | 5,367        |       | —         |       | —            |       | 6,303            |       |
| Increase in other  assets (liabilities), net                                                          |       | —         |       | 5,730        |       | (10,250        | )          | —            |       | (4,520           | )          |
| NET CASH  PROVIDED BY (USED IN) OPERATING ACTIVITIES                                                  |       | (56            | )          | 12,152       |       | 97             |       | —            |       | 12,193           |       |
|                                                                                                  |       |           |       |         |       |           |       |              |       |             |       |
| Capital  expenditures                                                                                 |       | —         |       | (7,862       | )          | —         |       | —            |       | (7,862           | )          |
| Lease  acquisition and other costs                                                                    |       | —         |       | (9,257       | )          | —         |       | —            |       | (9,257           | )          |
| NET CASH USED IN  INVESTING ACTIVITIES                                                                |       | —         |       | (17,119      | )          | —         |       | —            |       | (17,119          | )          |
|                                                                                                  |       |           |       |         |       |           |       |              |       |             |       |
| Cash flows from  financing activities:                                                                |       |           |       |         |       |           |       |              |       |             |       |
| Deferred  financing costs                                                                             |       | —         |       | (80          | )          | —         |       | —            |       | (80              | )          |
| Borrowings from  revolving credit facility                                                            |       | —         |       | 391,344      |       | —         |       | —            |       | 391,344          |       |
| Repayments of  revolving credit facility                                                              |       | —         |       | (386,259     | )          | —         |       | —            |       | (386,259         | )          |
| Proceeds from  exercise of stock options                                                              |       | 56             |       | —       |       | —         |       | —            |       | 56               |       |
| Repayments of  capital lease obligations                                                              |       | —         |       | (102         | )          | —         |       | —            |       | (102             | )          |
| NET CASH  PROVIDED BY FINANCING ACTIVITIES                                                            |       | 56             |       | 4,903        |       | —         |       | —            |       | 4,959            |       |
|                                                                                                  |       |           |       |         |       |           |       |              |       |             |       |
| Net (decrease)  increase in cash                                                                      |       | —         |       | (64          | )          | 97             |       | —            |       | 33               |       |
| Cash at  beginning of period                                                                          |       | —         |       | 1,204        |       | 48             |       | —            |       | 1,252            |       |
| Cash at end of  period                                                                                |       | $              | —     |         | $          | 1,140          |       | $                 | 145        |             | $          | — |   | $ | 1,285 |   |
|                                                                                                       |            |                |            |              |            |                |            |                   |            |                  |            |  |  |  |  |  |  |  |  |

 

 

19

----

 

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

 

**General**

 

Our business consists of the sale of a wide variety ofhealth and beauty care products, convenience oriented food and generalmerchandise items and a pharmacy operation managed to supply customers withtheir 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 brand name and private label health and beauty care items, food andbeverages, tobacco products, cosmetics, housewares, greeting cards, photofinishingservices, photo supplies and seasonal and general merchandise. Health andbeauty care products, including over-the-counter items, represent our highestvolume categories within front-end sales. The front-end portion of our businessrepresented 50.5% of our sales in the quarter ended March 26, 2005, and ischaracterized by generally higher gross margins that are approximately twicethat of our pharmacy or back-end business.

 

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

 

Sales to third party prescription plans represented92.7% of our prescription sales in the quarter ended March 26, 2005.  Pharmacy sales have experienced a faster rateof sales growth than the front-end portion of our business due to a number offavorable demographic and industry trends such as the aging of the population,expanded penetration of third party private and government-sponsored coverageand the increasing utilization of prescriptions to improve quality of life andin place of medical procedures. As a result, pharmacy sales have grown at arapid pace in both numbers of prescriptions dispensed as well as inflationdriven increases in costs.  While thesefactors all contributed to the increasing proportion of pharmacy sales to ourtotal sales, the rate of our pharmacy sales growth has been slowing in the lastfew years due to an increased focus on the part of both government and privateplans to control the high costs of providing these benefits. The rate of growthfor pharmacy retailers has also slowed as a result of an increased penetrationby mail order and internet based providers. In the second half of 2004 weexperienced a further slow down of pharmacy sales growth due to the negativepublicity surrounding the temporary recall of high volume Vioxx and other Cox 2inhibitors.

 

During 2003, President Bush signed the Medicare DrugAct, which created a new Medicare Part D benefit that will expand Medicarecoverage of prescription drugs for senior citizens not participating in thirdparty plans. Sales to such customers represent less than 2% of our totalrevenue. This new Medicare coverage is scheduled to take effect in 2006 and isexpected to result in decreased pharmacy margins resulting from lowerreimbursement rates than our current margins on prescriptions that are notsubject to third party reimbursement. In June 2004, a temporary seniorcitizen prescription drug discount program furnished under this Medicarelegislation was implemented and is expected to remain in effect until the fullMedicare program takes effect in 2006. This temporary program has also resultedin lower pharmacy margins than those previously realized on prescriptions that werenot subject to third party plan reimbursement. Based on our experience overtime, we expect that increased utilization of prescription drugs by seniorcitizens participating in the new programs will offset the effect of lower marginson our revenues.

 

In fiscal 2003 and again infiscal 2004, New York State reduced Medicaid and EPIC prescriptionreimbursement rates, adversely impacting our pharmacy gross margins. The mostrecent reductions became effective on October 1, 2004, and are expected toreduce reimbursements by approximately $1.4 million on an annual basis.New Jersey also implemented reduced Medicaid reimbursement rates in 2003. TheNew York State legislature has also recently approved increases in co-payments by $1.00 per prescription for branded drugs and $0.50per prescription for generics in the new budget which will take effect on July1, 2005. Under the Medicaid guidelines, providers cannot refuse to dispenseprescriptions to Medicaid recipients who claim that they do not have the meansto pay the required co-payments. Most Medicaid recipients do in fact decline tomake the co-payments, resulting in the requirement for the provider to absorbthis cost. These increased co-payments for NY Medicaid are expected to result infurther reduced reimbursements of approximately $1.4 million per year.

 

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In an effort to offset some ofthe adverse pharmacy gross margin impacts from the trends discussed above,there has been an intensified effort on the part of retailers to supportincreased utilization of lower priced but higher margin generic prescriptionsin place of branded medications. Improved generic utilization ratesas well as increased purchases direct from manufacturers rather than throughwholesalers enabled us to achieve improved gross margins on pharmacy retailsales during 2004 and in the first quarter of 2005.

 

We are also impacted by recentlegislation in states to increase the minimum hourly wages above the federalminimum of $5.15. New York State increased the minimum hourly wage from $5.15to $6.00 on January 1, 2005 with further scheduled increases to $6.75 onJanuary 1, 2006 and $7.15 on January 1, 2007. The New Jersey legislature hasapproved increases in the minimum hourly wage from $5.15 to $6.15 on October 1,2005 and to $7.15 on October 1, 2006. While these increases will impact ourcost of labor, we believe we can offset a significant portion of these costincreases through initiatives designed to further improve our labor efficiency.

 

We operate approximately 85% ofour 249 stores in New York City and the remainder in the surrounding areas, andour financial performance is therefore heavily influenced by thelocal economy. We analyze a number of economic indicators specific to New YorkCity to gauge the health of this economy, including unemployment rates, jobcreation, gross city product and bridge and tunnel commuter traffic patterns.We also analyze market share data, same-store sales trends, average store sales and sales per square foot data amongother key performance indicators to monitor our overall performance. During2004 and the first quarter of 2005, the New York City economy generallyreflected an improving trend for most of these external economic indicators.

 

Our primary assets are ourownership of 100% of the outstanding capital stock of Duane Reade Inc.,which in turn owns 99% of the outstanding partnership interest of Duane Reade GPand all of the outstanding common stock of DRI I Inc. DRI I Inc. ownsthe remaining 1% partnership interest in Duane Reade GP. Substantially allof our operations are conducted through Duane Reade GP. InAugust 1999, we established two new subsidiaries, Duane Reade International, Inc.and Duane Reade Realty, Inc. Duane Reade GPdistributed to Duane Reade Inc. and DRI I Inc. all rights, title, andinterest in all its trademarks, trade names and all other intellectual propertyrights. In turn, Duane Reade Inc. and DRI I Inc. made a capitalcontribution of these intellectual property rights to Duane Reade International.This change created a controlled system to manage and exploit theseintellectual property rights separate and apart from the retail operations. Inaddition, Duane Reade GP distributed some of its store leases to Duane Reade Inc.and DRI I Inc., which in turn made a capital contribution of these leasesto Duane Reade Realty. Duane Reade Realty is the lessee under certainstore leases entered into after its creation. Duane Reade Realty subleasesto Duane Reade GP the properties subject to those leases. The consolidatedfinancial statements included in this filing reflect the accounts of Duane Reade Holdings, Inc.and its subsidiaries. All significant intercompany transactions and balanceshave been eliminated.

 

**New York CityEconomy**

 

Between 2001 and 2003, the NewYork City economy experienced a regional cyclical downturn and a series ofunusual events, such as the World Trade Center attacks and one-time significantincreases in real estate taxes and insurance costs. The New York greatermetropolitan area experienced above average unemployment levels, especially inthe key midtown and downtown Manhattan financial districts and lagged behindthe improving national economy throughout 2003 and the early part of 2004. However,more recently it has shown substantial improvements in employment, tourism andoverall commerce relative to the last few years. The March 2005 seasonallyadjusted unemployment data for New York City indicated an unemployment rate of 5.2%,compared to a national rate of 5.2%. In addition, the New York Cityunemployment rate reflected a significant improvement as compared to themonthly average rate of 8.5% reported for the first quarter of 2004.

 

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**Results of Operations**

 

**The Thirteen Weeks Ended March 26, 2005 forthe Successor as Compared to the Thirteen Weeks Ended March 27, 2004 forthe Predecessor**

 

For the first quarter of 2005, we achieved net sales of $394.8 millionand sustained a net loss of $12.8 million, as compared to net sales of$383.3 million and net income of $1.8 million in the first quarter ofthe previous year. The decline in earnings is due to the following factors:

 

•                                          An increase in depreciation andamortization expense by $8.6 million. This increase was attributable tothe acquisition related purchase accounting adjustments to the valuation ofstore leases, prescription pharmacy files and property, plant and equipmentunder FAS 141 as well as the depreciation of capital expenditures andamortization of intangibles acquired in 2004 and 2005.

 

•                                          Increased interest expenses by $7.7 millionresulting from the new debt incurred in connection with the Acquisition.

 

•                                          A decline in gross margin from 20.0% inthe first quarter of 2004 to 18.4% in the first quarter of 2005. The decreasewas primarily attributable to lower vendor allowances, increased inventoryshrink losses, lower levels of real estate related income and increasednon-cash rent expense of $1.9 million, or 0.5% of sales, that was attributableto the application of purchase accounting under FAS 141, “BusinessCombinations,” in connection with the July 30, 2004 acquisition by OakHill.

 

•                                          Increased store payroll costs resultingfrom higher minimum wages in New York and increased pharmacy labor rates drivenby the pharmacist shortage.

 

•                                          Increased legal and litigation relatedexpenses that resulted from certain labor related disputes, the World TradeCenter business interruption insurance claim and litigation with a formerpharmacy supplier.

 

The following sets forth the results of operations for the periodsindicated:

 
| ** **                                      | ** ** | **13 Weeks  Ended**      | ** ** |
|-------------------------------------------------|------------|--------------------------|------------|
| ** **                                      | ** ** | **Successor**            | ** ** | **Predecessor** | ** ** |
| ** **                                      | ** ** | **March 26,  2005** | ** ** | **March 27,  2004** | ** ** |
| **In thousands, except percentages**            | ** ** | **Dollars**              | ** ** | **% of  Sales** | ** ** | **Dollars** | ** ** | **% of  Sales** | ** ** |
| Net sales                                       |       | $                        | 394,767    |   | 100.0 | % | $ | 383,310 |   | 100.0 | % |
| Cost of sales                                   |       | 321,958                  |       | 81.6 |   | 306,808 |   | 80.0 |   |
| Gross profit                                    |       | 72,809                   |       | 18.4 |   | 76,502 |   | 20.0 |   |
| Selling, general  & administrative expenses |       | 64,499                   |       | 16.3 |   | 58,643 |   | 15.3 |   |
| Labor  contingency                              |       | 1,100                    |       | 0.3 |   | 1,100 |   | 0.3 |   |
| Transaction  expense                            |       | 427                      |       | 0.1 |   | 1,102 |   | 0.3 |   |
| Depreciation and  amortization                  |       | 17,646                   |       | 4.5 |   | 9,066 |   | 2.4 |   |
| Store  pre-opening expenses                     |       | 100                      |       | 0.0 |   | 157 |   | 0.0 |   |
| Other                                           |       | 1,148                    |       | 0.3 |   | — |   | 0.0 |   |
| Operating (loss)  income                        |       | (12,111                  | )          | -3.1 |   | 6,434 |   | 1.7 |   |
| Interest  expense, net                          |       | 11,165                   |       | 2.8 |   | 3,437 |   | 0.9 |   |
| (Loss) income  before income taxes              |       | (23,276                  | )          | -5.9 |   | 2,997 |   | 0.8 |   |
| Income tax  (benefit) expense                   |       | (10,474                  | )          | -2.7 |   | 1,245 |   | 0.3 |   |
| Net (loss)  income                              |       | $                        | (12,802    | ) | -3.2 | % | $ | 1,752 |   | 0.5 | % |

 

Net sales were $394.8 million in the thirteenweeks ended March 27, 2005, representing an increase of 3.0% as comparedto net sales of $383.3 million in the thirteen weeks ended March 27,2004. Resale activity accounted for a decrease of 1.5%, while retail sales tocustomers increased by 4.5% over this period. Same-store sales increased by 2.0%over the first quarter last year with the balance of the increase coming from thefull quarterly results of two net new stores opened in the first quarter lastyear and six net new stores opened since the end of last year’s first quarter.

 

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Pharmacy sales increased from $192.2 million inthe first quarter of 2004 to $195.5 million in the first quarter of 2005,an increase of 1.7%, and represented 49.5% of total sales, as compared with 50.1%of total sales in the first quarter of 2004. The overall pharmacy salesincrease includes a decrease of 2.9% resulting from the reduced resaleactivity, offset by an increase of 4.6% in normal retail pharmacy sales. Pharmacysame-store sales increased by 2.0% over last year, and third-party reimbursedpharmacy sales represented 92.7% of total prescription sales compared to 92.0%in the first quarter of 2004. Pharmacy same-store sales were adversely impactedby approximately 1.6% due to negative publicity and significantly reducedconsumer demand for arthritis medications and certain other high volume drugsand approximately 1.4% due to increased mail order penetration resulting fromconversion of certain third party plans to mandatory mail order requirements.The percentage of generic prescriptions dispensed increased by 4% this year,resulting in a reduction of the pharmacy same-store sales increase byapproximately 2.9%, but an increase in gross margin per prescription dispensed.Generic prescriptions generally have lower retails but are more profitable thanbranded prescriptions.

 

Front-end sales increased from $191.1 million inthe first quarter of 2004 to $199.3 million in the first quarter of 2005,an increase of 4.3%, and represented 50.5% of total sales, as compared to 49.9%of total sales in the first quarter of 2004. Front-end same-store sales increasedby 2.0%, primarily due to the earlier timing of the Easter holiday as comparedto the prior year, a stronger cough and cold season and a generally improvedlevel of consumer demand.

 

During the thirteen weeks ended March 26, 2005, weopened two stores and closed eight stores, as compared to three stores openedand one store closed during the thirteen weeks ended March 27, 2004. At March 26,2005, we operated 249 stores, as compared to 243 stores at March 27, 2004.

 

Cost of sales as a percentage of net sales was 81.6% inthe first quarter of 2005 and 80.0% in the first quarter of 2004, resulting ingross profit margins of 18.4% and 20.0%, respectively.  This decrease in gross profit margins wasprimarily attributable to lower levels of vendor allowances and real estaterelated income combined with higher inventory shrink losses and increased non-cashrent expense of $1.9 million, or 0.5% of sales, that was attributable to theapplication of purchase accounting under FAS 141, “Business Combinations,” inconnection with the July 30, 2004 acquisition by Oak Hill. Cost of sales alsoincludes (i) a $0.2 million LIFO benefit in the current year’s firstquarter as compared to a LIFO provision of $0.3 million in thecorresponding period last year, and (ii) real-estate related income of $0.1 millionin the first quarter of 2005 as compared to $0.8 million in the firstquarter of 2004.

 

Selling, general and administrative expenses were $64.5 million,or 16.3% of net sales and $58.6 million, or 15.3% of net sales, in the firstquarter of 2005 and 2004, respectively.  Theincrease in these expense ratios to sales as compared to the prior yearprimarily reflects the increased legal and litigation related expenses incurredin the current year, as well as increased labor costs associated with theongoing shortage of pharmacists in the marketplace and increases in the NewYork minimum wage rates.

 

Depreciation and amortization of capital expendituresand intangible assets amounted to $17.6 million in the first quarter of2005, as compared to $9.1 million in the first quarter of 2004.  This increase was attributable to theaforementioned step-up in asset values resulting from the application ofpurchase accounting under FAS 141 that was required in connection with theAcquisition as well as increases resulting from the depreciation of capitalexpenditures made in 2004 and 2005 and amortization of identifiable intangiblesacquired over the same period.

 

We incurred store pre-opening expenses of $0.1 millionin the first quarter of 2005, related to the opening of two stores. In the firstquarter of last year, we incurred pre-opening costs of $0.2 million,attributable to the opening of three stores.

 

Net interest expense for the first quarter of 2005 was$11.2 million, as compared to $3.4 million in the first quarter of2004. This increase was primarily attributable to the higher interest costs andincreased debt in the current year that was associated with the new debtstructure resulting from the Acquisition, as compared to the lower debt levelsand interest rates incurred on our revolving credit borrowings and convertiblenotes in the prior year. At March 26, 2005, the weighted average interestrate on our variable rate outstanding debt was 5.60%, as compared to 2.85% at March 27,2004.

 

In the first quarter of 2005, we recorded an incometax benefit of $10.5 million, reflecting an estimated effective tax rateof 45.0%, inclusive of the anticipated benefits of employment tax credits. Inthe comparable period last year, the income tax provision of $1.2 millionreflected an estimated effective tax rate of 41.5%, inclusive of theanticipated benefits of employment tax credits. The employment tax creditsrepresent the economic benefits earned by us for our participation in various federaland state hiring incentive programs. The increase in the current year’seffective rate reflects the combined impact of the employment tax credits andthe reduced levels of pre-tax income generated by us.

 

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**Liquidity and Capital Resources**

 

**Working Capital and Cash Flow**

 

Working capital was $58.1 million as of March 26,2005 and $66.7 million as of December 25, 2004. Working capital reflectsthe classification of outstanding borrowings under our revolving loan facilityof $179.8 million at March 26, 2005 and $153.9 million atDecember 25, 2004 as current liabilities. This current classification isrequired 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 Term ObligationsExpected to be Refinanced” (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.

 

Net cash used in operating activities was $16.7 millionin the thirteen weeks ended March 26, 2005 compared to cash provided byoperations of $12.2 million in the thirteen weeks ended March 27,2004. The use of cash in the current year reflects the scheduled $19.0 millionCEO SERP early termination payment.

 

Net cash used in investing activities was $8.0 millionin the thirteen weeks ended March 26, 2005, compared to $17.1 millionin the thirteen weeks ended March 27, 2004. In the first quarter of 2005,capital expenditures, primarily related to new store openings and theremodeling of existing locations, were $7.1 million, while leaseacquisition, pharmacy customer file and other costs were $3.1 million ofcash used in investing activities.  Theseamounts were partially offset by $2.2 million of cash received in connectionwith the sale of property.  In the firstquarter of 2004, we spent $7.9 million on capital expenditures and $9.2 millionon lease acquisition, pharmacy customer file and other costs.

 

Net cash provided by financing activities was $24.7 millionin the thirteen weeks ended March 26, 2005, compared to 5.0 millionin the thirteen weeks ended March 27, 2004. The increase in cash providedby financing activities in the current year was primarily attributable to fund theuse of cash for operating and investing activities.

 

**The Acquisition**

 

The July 30, 2004 Acquisition was financed as anall cash transaction whereby our common stock outstanding immediately prior tothe Acquisition was converted into the right to receive $16.50 per share,without interest. The total transaction value, including transaction expensesand the repayment of indebtedness was approximately $748 million, whichwas funded through external and management-related equity contributions ofapproximately $244 million and debt of approximately $504 million.

 

**Operating Capital Requirements**

 

Our operating capital requirements primarily resultfrom opening and stocking new stores, remodeling and renovating existing retaillocations, purchasing pharmacy files and the continuing development ofmanagement information systems. We opened 2 new stores in the first quarter of2005 and currently plan to open approximately 8-10 additional new stores duringthe remainder of this year (a total of 10-12 for all of 2005), and 10-12 newstores in each of fiscal 2006 through fiscal 2008. We also require workingcapital to support inventory for our existing and new stores. Historically, wehave been able to lease almost all of our store locations, so acquisitions ofreal estate are not expected to have a significant impact on our capitalrequirements.

 

**Other Factors Influencing our Liquidity**

 

Eleven of our stores which generated approximately 3.8%of our net sales for fiscal 2004 have leases scheduled to expire before the endof fiscal 2006. Four of these leases have renewal options.  We believe that we will be able to renew theother expiring leases on economically favorable terms or, alternatively, findother economically attractive locations to lease.

 

As of March 26, 2005, approximately 4,200 of ourapproximately 6,300 employees were represented by various labor unions and werecovered by collective bargaining agreements. Pursuant to the terms of thecollective bargaining agreements covering these employees, we are required, insome instances, 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, 2005. We are in discussionswith UNITE regarding an extension of this contract.

 

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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 would provide certainpost-retirement benefits. During fiscal 2003 and fiscal 2004, the annualpremiums were $5.0 million, and were scheduled to remain at $5.0 millionper year through 2010. The enactment of the Sarbanes-Oxley Act has resulted inthe need for additional guidance concerning the permissibility of split dollarlife insurance policies for executives. While we believe this split dollar policy is permitted under currentinterpretations of the legislation, there can be no assurance that further interpretationsor guidance to be provided by the SEC concerning this legislation willconcur.  Upon completion of theAcquisition, under Mr. Cuti’s amended and restated employment agreement,we elected to terminate the split dollar life insurance contract in exchangefor, among other things, the payment to Mr. Cuti of $20.5 million onor prior to January 3, 2005 and $4.0 million on or prior toJune 30, 2005. We have made all such required payments. A portion of thesepayment obligations (approximately $14.2 million) will be offset by theproceeds of the cash surrender value of the split dollar life insurancecontract at the time we elect to terminate it (approximately $14.2 millionas of March 31, 2005) which we expect to occur on June 30, 2005.

 

The Acquisition resulted in a restructuring of our debt,as well as the elimination of our obligations under the CEO Split Dollar LifeInsurance Policy, in exchange for certain direct payments to our ChiefExecutive Officer. The following table presents details of our significantCommitments and Obligations as at March 26, 2005, except that the dataprovided with respect to operating leases is as of December 25, 2004:

 
| ** **                          | ** ** | **Payments  due by Period** | ** ** |
|-------------------------------------|------------|-----------------------------|------------|
| ** **                          | ** ** | ** **                  | ** ** | **Within** | ** ** | ** ** | ** ** | ** ** | ** ** | **After** | ** ** |
| **Contractual  Cash Obligations**   | ** ** | **Total**                   | ** ** | **1 year** | ** ** | **2-3  years** | ** ** | **4-5  years** | ** ** | **5 years** | ** ** |
| ** **                          | ** ** | **(dollars  in thousands)** | ** ** |
| Debt Obligations (1)           |       | $                           | 534,842    |   | $ | 179,810 |   | $ | — |   | $ | — |   | $ | 355,032 |   |
| Capital Lease  Obligations          |       | 15,616                      |       | 2,899 |   | 6,405 |   | 6,312 |   | — |   |
| Operating Leases                    |       | 1,344,893                   |       | 119,602 |   | 237,090 |   | 219,849 |   | 768,352 |   |
| CEO SERP  Termination               |       | 4,043                       |       | 4,043 |   | — |   | — |   | — |   |
| Fixed Interest  Payments            |       | 123,581                     |       | 19,012 |   | 38,025 |   | 38,025 |   | 28,519 |   |
| Total  Contractual Cash Obligations |       | $                           | 2,022,975  |   | $ | 325,366 |   | $ | 281,520 |   | $ | 264,186 |   | $ | 1,151,903 |   |

 

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(1) At March 26, 2005, approximately $179.8 million wasoutstanding under our asset-based revolving loan facility.  Obligations under this facility have beenclassified as current liabilities because cash receipts controlled by thelenders are used to reduce outstanding debt and the Company does not meet thecriteria of FAS 6 to reclassify the debt as long-term, however this is not anindication that this credit facility is expected to be retired within the nextyear.  We intend to continue to use thisfacility for our working capital needs through the date of its maturity in July2008.

 

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, LLC and Duane Reade Holdings, Inc.consisting of options to purchase shares of Duane Reade Holdings, Inc.common stock and a profits interest in Duane Reade Shareholders, LLC.  Upon the occurrence of certain events,including the fifth anniversary of the effective date of the Acquisition, Mr. Cutiwill have the right to require us to purchase for cash over a two year periodall or a portion of these equity interests as he may designate, at fair marketvalue determined in accordance with a formula. The profits interest and options will have no value unless the value ofDuane Reade Shareholders, LLC and Duane Reade Holdings, Inc.,respectively, appreciate following the Acquisition.  Mr. Cuti’s purchase right will besuspended at any time when the exercise of such purchase rights would result ina default under the financing arrangements of us, Duane Reade Shareholders, LLCor Duane Reade Inc.  Mr. Cuti’spurchase right will also terminate upon certain public offerings by us, Duane Reade Shareholders, LLCor Duane Reade Inc.

 

At March 26, 2005, we have recorded alitigation-related non-current liability of $18.1 million in connectionwith a National Labor Relations Board decision in a litigation-related matterwith the Allied Trades Council, a union representing employees in 139 of ourstores. Because this decision is the initial phase of a complex administrativeand judicial process, the ultimate outcome, financial impact and related timingof any future cash disbursement relating to this matter cannot be determined atthis time. This matter is more fully described in Note 7 to the UnauditedConsolidated Interim Financial Statements.

 

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**Off-Balance Sheet Arrangements**

 

We are not a party to any agreements with, orcommitments to, any special purpose entities that would constitute materialoff-balance sheet financing other than the operating lease commitments detailedin the Contractual Obligations and Commitments table presented above.

 

**Debt**

 

Refer to Note 6 of the Unaudited Consolidated InterimFinancial Statements contained elsewhere in this document for a detailed descriptionwith respect to the various components of our debt structure.

 

**Liquidity Assessment**

 

Duane Reade Holdings, Inc. is a holdingcompany formed in connection with the Acquisition to hold 100% of the commonstock of Duane Reade Inc. Duane Reade Holdings, Inc. operatesall of its business through Duane Reade Inc. and its subsidiaries and hasno other independent assets, liabilities or operations, so, to the extent ithas liquidity requirements, it will depend on distributions of cash from Duane Reade Inc.,to the extent permitted by the various agreements to which Duane Reade Inc.is a party. Currently, we do not expect Duane Reade Holdings, Inc. tohave any material liquidity requirements.

 

We believe that, based on current levels of operationsand anticipated growth, cash flow from operations, together with otheravailable sources of funds, including revolving loan borrowings under theamended asset-based revolving loan facility will be adequate for at least thenext two years, to make required payments on our indebtedness, to fundanticipated capital expenditures and to satisfy our working capital requirements.We base this belief on our recent levels of cash flow from operations ofapproximately $47.4 million in fiscal 2003 and cash flow from operationsof $11.3 million in 2004 (which includes the absorption of $40.6 millionin Acquisition-related costs) and the significant additional borrowing capacityunder the amended asset-based revolving loan facility, which amounted toapproximately $62.6 million at March 26, 2005. In January 2005, weborrowed an additional $19.0 million under the amended asset-basedrevolving loan facility to fund a settlement obligation in connection with thetermination of the Chairman’s SERP benefit. We expect to recover a portion ofthis additional revolver borrowing (a net amount of approximately $10.0 million)upon the retirement of the Chairman’s split dollar life insurance policy onJune 30, 2005. Our ability to meet our debt service obligations and reduce ourtotal debt will depend upon our future performance which, in turn, will besubject to general economic, financial, business, competitive, legislative,regulatory and other conditions, many of which are beyond our control. Inaddition, our operating results, cash flow and capital resources may not besufficient for an adverse litigation settlement or for repayment of ourindebtedness in the future. Some risks that could adversely affect our abilityto meet our debt service obligations include, but are not limited to,reductions in third party prescription reimbursement rates, declines in the NewYork City economy, increases in competitive activity, changes in drugconsumption patterns, additional adverse legislative changes or a majordisruption of business in our markets from a terrorist event, natural disasteror other unexpected events. Other factors that may adversely affect our abilityto service our debt are described above under ‘‘Special Note RegardingForward-Looking Statements.’’ Borrowings under the amended asset-basedrevolving loan facility and the $160.0 million floating rate notes bearinterest at floating rates. Therefore, our financial condition will be affectedby changes in prevailing interest rates.

 

**Critical Accounting Policies**

 

Our discussion of results of operations and financialcondition relies on our consolidated financial statements that are preparedbased on certain critical accounting policies that require management to makejudgments and estimates that are subject to varying degrees of uncertainty. Webelieve that investors need to be aware of these policies and how they impactour financial reporting to gain a more complete understanding of ourconsolidated financial statements as a whole, as well as our related discussionand analysis presented herein. While we believe that these accounting policiesare grounded on sound measurement criteria, actual future events can and oftendo result in outcomes that can be materially different from these estimates orforecasts. The accounting policies and related risks described in our AnnualReport on Form 10-K/A for the year ended December 25, 2004 are those thatdepend most heavily on these judgments and estimates.  At March 26, 2005, there have been nomaterial changes to any of the Critical Accounting Policies contained therein.

 

**Seasonality**

 

In general, sales of drugstore items such asprescription drugs, over-the-counter drugs and health and beauty care productsexhibit limited seasonality in the aggregate, but do vary by product category.Quarterly results are primarily affected by the timing of new store openingsand the sale of seasonal products, with the Christmas holiday season generatinga higher proportion of sales and earnings than other periods.

 

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**Inflation**

 

We believe that inflation has not had a materialimpact on our results of operations during the three years endedDecember 25, 2004 or the three months ended March 26, 2005.

 

**Recently Issued Accounting Pronouncements**

 

In December 2004, SFAS No. 123R, “Share-BasedPayment” was issued. This statement established standards for the accounting fortransactions in which an entity exchanges its equity instruments for goods orservices. The statement focuses primarily on accounting for transactions inwhich an entity obtains employee services in share-based transactions. Theprovisions of this statement are required to be adopted for interim or annualperiods beginning after December 15, 2005. The Company is currently evaluatingthe effect of adopting this statement.

 

In December 2002, SFAS 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. We have not adopted such voluntary change to the fair value basedmethod. In addition, this statement amends the disclosure requirements of SFAS No. 123to require prominent disclosures about the method of accounting for stock-basedcompensation and the effect of the method used on reported results. Asrequired, we adopted the disclosure-only provisions of FAS No. 148effective in 2002.

 

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

 

Our financial results are subject to risk frominterest rate fluctuations on debt, which carries variable interest rates.Variable rate debt outstanding at March 26, 2005 included $179.8 millionof borrowings under our amended asset-based revolving loan facility and $160.0 millionof senior secured floating rate notes. At March 26, 2005, the weightedaverage combined interest rate in effect on all variable rate debt outstandingwas 5.60%. A 0.50% change in interest rates applied to the $339.8 millionbalance of floating rate debt would affect pre-tax annual results of operationsby approximately $1.7 million. In addition, we also have $195.0 millionof Senior Subordinated Notes and $32.0 thousand of Senior Convertible Notesoutstanding at March 26, 2005. The Senior Subordinated Notes and SeniorConvertible Notes bear interest payable semi-annually at fixed rates of 9.75%and 3.75%, respectively, and are therefore not subject to risk from interestrate fluctuations.

 

The principal objective of our investment managementactivities is to maintain acceptable levels of interest rate and liquidity riskto facilitate our funding needs. As part of our risk management, we may usederivative financial products such as interest rate hedges and interest rateswaps in the future.

 

**ITEM 4. CONTROLS AND PROCEDURES**

** **

(a) *Evaluation of DisclosureControls and Procedures*. An evaluation was carried out under thesupervision and with the participation of the Company’s management, includingthe Chief Executive Officer and Chief Financial Officer, of the effectivenessof the design and operation of our disclosure controls and procedures (as definedin Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) asof the end of the period covered by this quarterly report. Based upon thatevaluation, the Company’s management, including the Chief Executive Officer andChief Financial Officer, have each concluded that the design and operation ofthese disclosure controls and procedures were not effective as of the end ofthe period covered by this report based on the identification of materialweaknesses in the Company’s internal control over financial reporting describedin the Company’s Annual Report on Form 10-K/A filed on May 16, 2005.  For a discussion of the reasons and matterson which these conclusions were based, as well as the subsequent actions takenby the Company to strengthen its controls and procedures in these areas, seeItem 9A of the Company’s Annual Report on Form 10-K/A for the fiscal year endedDecember 25, 2004, filed on May 16, 2005.

 

(b) *Changes in Internal Controls over FinancialReporting*. During the most recent fiscal quarter, other thanremediation steps referred to in the preceding paragraph, there have not beenany significant changes in our internal controls over financial reporting or inother factors that that have materially affected, or are reasonably likely tomaterially affect, our internal controls over financial reporting.

 

27

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**PART II**

 

**OTHER INFORMATION**

 

**ITEM 1.  Legal Proceedings**

 

Refer to Note 8 of the Unaudited Consolidated InterimFinancial Statements included elsewhere in this document for a detaileddescription of the various legal proceedings in which we are involved.

 

**ITEM 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

 

Not applicable.

 

**ITEM 3.  Defaults Upon Senior Securities**

 

Not applicable.

 

**ITEM 4.  Submission of Matters to a Vote of SecurityHolders**

 

Not applicable.

 

**ITEM 5.  Other Information**

 

 

**ITEM 6.  Exhibits**

 

For purposes of this list, ‘‘Company’’ refers to DuaneReade Inc.

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                      |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1             |       | Agreement and  Plan of Merger (the ‘‘Merger Agreement’’), dated as of December 22, 2003, by  and amongDuane 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) the Company’s Quarterly Report on Form 10-Q for  the quarter ended September 25, 2004 (the ‘‘3rd quarter 2004 10-Q’’)).                                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.1(ii)         |       | Amended and  Restated Bylaws of the Company (incorporated by reference to Exhibit 3.1(ii)  to the S-4 Registration Statement No 333-120803 with respect to the  Company’s 9.75% Senior Subordinated Notes due 2011 (the ‘‘Senior Subordinated  Notes S-4’’.))                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.2(i)          |       | Certificate of  Incorporation of DRI I Inc. (incorporated by reference to Exhibit 3.2(i)  to the S-1 Registration Statement No 333-43313 with respect to the  Company’s 9.25% Senior Subordinated Notes due 2008 (the ‘‘Notes S-1’’)).                                                                                                                            |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.2(ii)         |       | By-laws of DRI I Inc.  (incorporated by reference to Exhibit 3.2(ii) of the Notes S-1).                                                                                                                                                                                                                                                                                                         |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.3             |       | Third Amended  and Restated Partnership Agreement of Duane Reade (incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 28, 2003).                                                                                                                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.4(i)          |       | Certificate of  Incorporation of Duane Reade International, Inc. (incorporated by  reference to Exhibit 3.4(i) to the Company’s Annual Report on Form 10- K for  the year ended December 25, 1999 (the ‘‘1999 10-K’’)).                                                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.4(ii)         |       | By-laws of Duane  Reade International, Inc. (incorporated by reference to Exhibit  3.4(ii) to the 1999 10-K).                                                                                                                                                                                                                                                                              |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.5(i)          |       | Certificate of  Incorporation of Duane Reade Realty, Inc. (incorporated by  reference to Exhibit 3.5(i) to the 1999 10-K).                                                                                                                                                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.5(ii)         |       | By-laws of Duane  Reade Realty, Inc. (incorporated by reference to Exhibit 3.5(ii) to  the 1999 10-K).                                                                                                                                                                                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.6(i)          |       | Amended and  Restated Certificate of Incorporation of Duane Reade Holdings, Inc.  (incorporated by reference to Exhibit 3.1(i) to the Company’s and Duane Reade’s  S-4 Registration Statement No 333-122206 with respect to the Company’s  and Duane Reade’s Senior Secured Floating Rate Notes due 2010 (the ‘‘Floating  Rate Notes S-4’’)). |

 

28

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| 3.6(ii) |   | By-laws of Duane  Reade Holdings, Inc. (incorporated by reference to the Floating  Rate Notes S-4).                                                                                                                                                                                                                                                                                                                                                                                                          |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.1     |   | Indenture  governing the notes, dated as of December 20, 2004, among the Company, Duane  Reade, Duane Reade Holdings, Inc., DRI I Inc., Duane Reade International, Inc.,  Duane Reade Realty, Inc. and U.S. Bank National Association, as  trustee, including the form of Senior Secured Floating Rate Note due 2010  (incorporated by reference to Exhibit 10.23 of the Senior Subordinated Notes  S-4).                                                                           |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.2     |   | Registration  Rights Agreement (relating to the notes), dated as of December 20, 2004,  among the Company, Duane Reade, Duane Reade Holdings, Inc., DRI I Inc.,  Duane Reade International, Inc., Duane Reade Realty, Inc.  and the initial purchasers party thereto (incorporated by reference to  Exhibit 10.24 of the Senior Subordinated Notes S-4).                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.3     |   | Amended and  Restated Security Agreement (relating to the notes), dated as of December 20,  2004, among the Company, Duane Reade, Duane Reade Holdings, Inc.,  DRI I Inc., Duane Reade International, Inc., Duane Reade Realty, Inc.  and U.S. Bank National Association, as collateral agent (incorporated by  reference to Exhibit 10.25 of the Senior Subordinated Notes S-4).                                                                                                   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.4     |   | Intercreditor  and Collateral Agency Agreement (relating to the notes), dated as of December  20, 2004, among the Company, Duane Reade, Duane Reade Holdings, Inc.,  DRI I Inc., Duane Reade International, Inc., Duane Reade Realty, Inc.  and U.S. Bank National Association, as collateral agent and indenture trustee  (incorporated by reference to Exhibit 10.26 of the Senior Subordinated Notes  S-4).                                                                      |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.5     |   | Indenture, dated  as of July 30, 2004, between Duane Reade Acquisition Corp. and U.S. Bank  National Association, as trustee (incorporated by reference to Exhibit 4.1 to  the 3rd quarter 2004 10-Q).                                                                                                                                                                                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.6     |   | Successor  Supplemental Indenture governing the initial notes and exchange notes, dated  as of July 30, 2004, between the Company and U.S. Bank National Association,  as trustee (incorporated by reference to Exhibit 4.2 to the 3rd quarter 2004  10-Q).                                                                                                                                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.7     |   | Co-obligor  Supplemental Indenture governing the initial notes and exchange notes, dated  as of July 30, 2004, among the Company, Duane Reade and DRI I Inc.,  Duane Reade Realty, Inc. and Duane Reade International, Inc.  as guarantors and U.S. Bank National Association, as trustee (incorporated by  reference to Exhibit 4.3 to the 3rd quarter 2004 10-Q).                                                                                                                      |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.8     |   | Guarantor  Supplemental Indenture governing the initial notes and exchange notes, dated  as of July 30, 2004, among the Company, Duane Reade and DRI I Inc.,  Duane Reade Realty, Inc. and Duane Reade International, Inc.,  as guarantors and U.S. Bank National Association, as trustee (incorporated by  reference to Exhibit 4.4 to the 3rd quarter 2004 10-Q).                                                                                                                      |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.9     |   | Second Guarantor  Supplemental Indenture governing the initial notes and the exchange notes,  dated as of March 25, 2005, among Duane Reade Holdings, Inc. (‘‘Holdings’’),  the Company, Duane Reade and DRI I Inc., Duane Reade Realty, Inc.  and Duane Reade International, Inc. as guarantors and U.S. Bank  National Association, as trustee (incorporated by reference to Holdings’  Current Report on Form 8-K filed March 31, 2005). |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.10    |   | Form of Exchange  Note (incorporated by reference to Exhibit 4.5 to the 3rd quarter 2004 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                        |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.11    |   | Registration  Rights Agreement, dated as of July 30, 2004, by and among Duane Reade Acquisition  Corp. and Banc of America Securities LLC, Citigroup Global Markets Inc.,  Credit Suisse First Boston LLC and UBS Securities LLC, as Initial  Purchasers (incorporated by reference to Exhibit 4.6 to the 3rd quarter 2004  10-Q).                                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.12    |   | 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’’)).                                                                                                                                                                     |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.13    |   | Form of Senior  Convertible Notes due 2022 (incorporated by reference to Exhibit 4.2 to the  Convertible Notes S-3).                                                                                                                                                                                                                                                                                                                                                                                                   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.14    |   | First  Supplemental Indenture, dated as of July 30, 2004, among the Company, as  issuer, DRI I Inc., Duane Reade Realty, Inc. and Duane Reade International, Inc.  as guarantors and U.S. Bank National Association, as trustee (incorporated by  reference to Exhibit 4.9 to the 3rd quarter 2004 10-Q).                                                                                                                                                                                     |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.1    |   | Duane Reade Inc.  Phantom Stock Plan (incorporated by reference to Exhibit 10.1 to the 3rd  quarter 2004 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.2    |   | Duane Reade Holdings, Inc.  Management Stock Option Plan (incorporated by reference to Exhibit 10.2 to  the 3rd quarter 2004 10-Q).                                                                                                                                                                                                                                                                                                                                                                          |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.3    |   | Stockholders and  Registration Rights Agreement, dated as of July 30, 2004, among Duane Reade Holdings, Inc.,  Duane Reade Shareholders, LLC and certain members of the management  of Duane Reade Inc. (incorporated by reference to Exhibit 10.3 to the 3rd  quarter 2004 10-Q).                                                                                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.4    |   | Tax Sharing  Agreement, dated as of July 30, 2004, among Duane Reade Holdings, Inc.,  and the Subsidiaries as defined therein, Duane Reade and any parties  which become parties thereto (incorporated by reference to Exhibit 10.4 to  the 3rd quarter 2004 10-Q).                                                                                                                                                                                                                                     |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.5    |   | Services  Agreement, dated as of July 30, 2004, between Oak Hill Capital Management, Inc.  and Duane Reade Acquisition Corp (incorporated by reference to Exhibit  10.5 to the 3rd quarter 2004 10-Q).                                                                                                                                                                                                                                                                                                       |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.6    |   | $155,000,000  Senior Secured Term Credit Agreement, dated as of July 30, 2004 among Duane Reade Holdings, Inc.,  Duane Reade Inc., Duane Reade and Bank of America, N.A., as  Administrative Agent,                                                                                                                                                                                                                                                                                                |

 

29

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|   |   | Credit Suisse  First Boston, Cayman Islands Branch, as Syndication Agent, Citicorp North  America Inc., Wells Fargo Bank, and National Association, as  Co-Documentation Agents, Banc of America Securities LLC and Credit  Suisse First Boston, Cayman Islands Branch, as Joint Lead Arrangers and Banc  of America Securities LLC, Credit Suisse First Boston, Cayman Islands  Branch and Citroen Global Markets Inc., as Joint Book Managers  (incorporated by reference to Exhibit 10.6 to the 3rd quarter 2004 10-Q).                                                                                                     |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.7   |   | First Amendment  to Credit Agreement, dated as of July 22, 2004, among Duane Reade, Duane Reade Inc.,  DRI I Inc., Duane Reade International, Inc., Duane Reade Realty, Inc.,  Fleet National Bank, as Issuing Bank and Administrative Agent, Fleet Retail  Group, Inc., as Collateral Agent, Congress Financial Corporation, as  Documentation Agent, General Electric Capital Corporation as Syndication  Agent and Wells Fargo Retail Finance, LLC, as Syndication Agent and  Co-Lead Arranger (incorporated by reference to Exhibit 10.7 to the 3rd  quarter 2004 10-Q).                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.8   |   | Letter  Agreement, dated as of March 19, 2004, by and among Duane Reade Shareholders, LLC,  Duane Reade Acquisition Corp. and Duane Reade Inc. (incorporated by  reference to Amendment No 3 to the Company’s Schedule 13-E3, filed July  30, 2004).                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.9   |   | Amended and  Restated Employment Agreement, dated as of March 16, 2004, by and among  Anthony J. Cuti, Duane Reade Acquisition Corp., Duane Reade Holdings, Inc.  and Duane Reade Shareholders, LLC. (incorporated by reference to  Amendment No 3 to the Company’s Schedule 13-E3, filed July 30, 2004).                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.10  |   | Letter  Agreement, dated as of March 16, 2004, by and between John K. Henry and  Duane Reade Acquisition Corp. (incorporated by reference to Amendment No 3  to the Company’s Schedule 13-E3, filed July 30, 2004).                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.11  |   | Letter  Agreement, dated as of March 16, 2004, by and between Gary Charboneau  and Duane Reade Acquisition Corp. (incorporated by reference to  Amendment No 3 to the Company’s Schedule 13-E3, filed July 30, 2004).                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.12  |   | Letter  Agreement, dated as of March 16, 2004, by and between Timothy R. LaBeau  and Duane Reade Acquisition Corp. (incorporated by reference to  Amendment No 3 to the Company’s Schedule 13-E3, filed July 30, 2004).                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.13  |   | Letter  Agreement, dated as of March 16, 2004, by and between Jerry M. Ray and  Duane Reade Acquisition Corp. (incorporated by reference to Amendment No 3  to the Company’s Schedule 13-E3, filed July 30, 2004).                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.14  |   | Agreement and  Plan of Merger, dated as of December 22, 2003, as amended among Rex Corner  Holdings, LLC (now known as Duane Reade Shareholders, LLC),  Rex Corner Acquisition Corp. (now known as Duane Reade Acquisition  Corp.) and Duane Reade Inc. (incorporated by reference to Amendment No 3  to the Company’s Schedule 13-E3, filed July 30, 2004).                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.15  |   | Amendment No 1  to the Merger Agreement, dated as of June 10, 2004, by and among Duane Reade Shareholders, LLC,  Duane Reade Acquisition Corp. and Duane Reade Inc. (incorporated by  reference to Exhibit 2.1 of Duane Reade Inc.’s Form 8-K dated June 14,  2004).                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.16  |   | Amendment No 2  to the Merger Agreement, dated as of June 13, 2004, by and among Duane Reade Shareholders, LLC,  Duane Reade Acquisition Corp. and Duane Reade Inc. (incorporated by  reference to Exhibit 2.2 of Duane Reade Inc.’s Form 8-K dated June 14,  2004).                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.17  |   | Amendment No 3  to the Merger Agreement, dated as of June 18, 2004, by and among Duane Reade Shareholders, LLC,  Duane Reade Acquisition Corp. and Duane Reade Inc. (incorporated by  reference to Exhibit 2.1 of Duane Reade Inc.’s Form 8-K dated June 21,  2004).                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.18  |   | 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). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.19  |   | Facility  Guarantee, dated as of July 21, 2003, among the Facility Guarantors, Fleet  Retail Finance Inc., Fleet National Bank and the Lenders (incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.20  |   | 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).                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.21  |   | 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).                                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.22  |   | 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).                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.23  |   | 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                                                                                                                                                                                                                                                                                                                                                                                                                                   |

 

30

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|   |   | Company’s  Quarterly Report on Form 10-Q for the period ended March 30, 2002).                                                                                                                                                                                                                                                                                                                                       |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.24  |   | 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’’)).                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.25  |   | 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).                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.26  |   | Agreement, dated  as of April 1, 2004, by and between the Company and Local 340A, New York,  Joint Board, UNITE-HERE (incorporated by reference to Exhibit 10.22 of the  Senior Subordinated Notes S-4).                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.27  |   | Preemptive  Rights Agreement, dated as of July 30, 2004, by and among the Company, Duane Reade Holdings, Inc.,  Duane Reade Shareholders, LLC, Anthony J. Cuti, Oak Hill Capital  Partners, L.P., Oak Hill Capital Management Partners, L.P., OHCP DR  Co-Investors, LLC and the management stockholders listed therein  (incorporated by reference to Exhibit 10.27 to the Floating Rate Notes S-4). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 14.1   |   | Code of Business  Conduct and Ethics (incorporated by reference to Exhibit 14.1 to the 2003  10-K).                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 31.1*  |   | Sarbanes-Oxley  Section 302 Certification of the Company’s Chief Executive Officer (‘‘CEO’’).                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 31.2*  |   | Sarbanes-Oxley  Section 302 Certification of the Company’s Chief Financial Officer (‘‘CFO’’).                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 32.0** |   | Sarbanes-Oxley  Section 906 Certifications of the Company’s CEO and CFO.                                                                                                                                                                                                                                                                                                                                                  |

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*                                         Filed herewith

 

**                                  Furnished herewith

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
| Dated:   May 16, 2005 |                                                                                            |
|--------------------------------------|-------------------------------------------------------------------------------------------------|
|                                 |                                                                                            |
| ** **                           | **DUANE READE HOLDINGS, INC.**                                                                  |
|                                 | (Registrant)                                                                                    |
|                                 |                                                                                            |
|                                 |                                                                                            |
|                                 | /s/ Anthony J. Cuti                                                                             |   |
|                                 | Anthony J. Cuti                                                                                 |
|                                 |                                                                                            |
|                                 | President and Chief Executive Officer  (Principal Executive Officer)                            |
|                                 |                                                                                            |
|                                 | /s/ John K. Henry                                                                               |   |
|                                 | John K. Henry                                                                                   |
|                                 |                                                                                            |
|                                 | Senior Vice President and Chief Financial Officer  (Principal Accounting and Financial Officer) |

 

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