**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.**

**FORM 10-Q**

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

**Forthe quarterly period ended September 24, 2005**

**Commissionfile number 001-13843**

**DUANE READE HOLDINGS, INC.**

(Exact name of registrantas specified in its charter)

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

 

**(212) 273-5700**

(Registrant’s telephonenumber, including area code)

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

Yes x  No o

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

Yes o  No x

Indicate by check markwhether the registrant is a shell company (as defined in the Exchange Act Rule 12b-2):

Yes o  No x

 

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**INDEX**

| PART I—FINANCIAL  INFORMATION                                                                                                                                                                                                                                                                                                                                             |   | 5  |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----|--------|
| ITEM  1.—FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                  |   | 5  |   |
| Consolidated  Statements of Operations (Unaudited)—  For the 13 and 39 Weeks Ended September 24, 2005 and the period from  July 31, 2004 through September 25, 2004 for the Successor and  the periods from June 27, 2004 through July 30, 2004 and from  December 28, 2003 through July 30, 2004 for the Predecessor                  |   | 5  |   |
| Consolidated  Balance Sheets (Unaudited)—  As of September 24, 2005 and December 25, 2004                                                                                                                                                                                                                                                                            |   | 6  |   |
| Consolidated  Statements of Cash Flows (Unaudited)—  For the 39 Weeks Ended September 24, 2005 and the period from  July 31, 2004 through September 25, 2004 for the Successor and the  period from December 28, 2003 through July 30, 2004 for the  Predecessor                                                                                 |   | 7  |   |
| Consolidated  Statements of Comprehensive Income (Loss) (Unaudited)—  For the 13 and 39 Weeks Ended September 24, 2005 and the period from  July 31, 2004 through September 25, 2004 for the Successor and  the periods from June 27, 2004 through July 30, 2004 and from  December 28, 2003 through July 30, 2004 for the Predecessor |   | 8  |   |
| Notes  to Consolidated Financial Statements (Unaudited)                                                                                                                                                                                                                                                                                                                             |   | 9  |   |
| ITEM  2.—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND  RESULTS OF OPERATIONS                                                                                                                                                                                                                                                                      |   | 29 |   |
| ITEM  3.—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                                                                                                                                                                                                                                                                                                           |   | 42 |   |
| ITEM  4.—CONTROLS AND PROCEDURES                                                                                                                                                                                                                                                                                                                                               |   | 42 |   |
| PART II—OTHER  INFORMATION                                                                                                                                                                                                                                                                                                                                                |   | 43 |   |
| SIGNATURES                                                                                                                                                                                                                                                                                                                                                                          |   | 48 |   |

 

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**SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS**

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

·       the competitive environmentin the drugstore industry in general and in the New York greater metropolitanarea;

·       the ability to open andoperate new stores on a profitable basis and the maturation of those stores andthe ability to increase sales in existing stores;

·       the continued efforts ofhealth maintenance 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 significantindebtedness;

·       the continued efforts offederal, state and municipal government agencies to reduce Medicaidreimbursement rates, modify Medicare benefits and/or reduce prescription drugcosts and/or coverages;

·       the impact of the MedicarePrescription Drug, Improvement and Modernization Act of 2003 (P.L. 108-179),or, the Medicare Drug Act, and the contemplated Medicare Part D benefitcreated thereunder;

·       the strength of the economyin general and the economic conditions in the New York greater metropolitanarea including, in particular, seasonal and weather-related factors, specialevents, changes in consumer purchasing power and/or spending patterns;

·       changes in the cost ofgoods and services;

·       trends in the healthcareindustry, including continued conversion of various prescription drugs toover-the-counter medications, negative publicity and the related sales declinesfor certain categories of drugs including, without limitation, Cox-2inhibitors and the increasing market share of internet-based andmail-order-based providers;

·       employment disputes andlabor disturbances, including any resulting from the suspension or terminationof our collective bargaining agreements;

·       changes in federal andstate laws and regulations, including the potential impact of changes inregulations surrounding the importation of pharmaceuticals from foreigncountries and changes in laws governing minimum wage requirements;

3

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·       liability and other claimsasserted against us including the items discussed under Part II,Item 1—Legal Proceedings;

·       the outcome of the legalproceedings that have been instituted against us and others followingannouncement of the acquisition of Duane Reade Inc.;

·       changes in our operatingstrategy or development plans;

·       our ability to attract,hire and retain qualified personnel, including our ability to attract qualifiedpharmacists at acceptable wage rates;

·       interest rate fluctuationsand changes in capital market conditions or other events affecting our abilityto obtain necessary financing on favorable terms to fund the anticipated growthof our business;

·       the continued impact of, ornew occurrences of, terrorist attacks in the New York greater metropolitan areaand any actions that may be taken by federal, state or municipal authorities inresponse to or in anticipation of such occurrences;

·       changes in timing of ouracquisition of stores and prescription files and capital expenditure plans;

·  changes in real estate marketconditions and our ability to continue to secure suitable new store locationsunder acceptable lease terms;

·       our ability to successfullyimplement and manage new computer systems and technologies;

·       our ability to limit fraudand shrink;

·       demographic changes; and

·       other risks anduncertainties detailed elsewhere in this filing and from time to time in ourother filings with the Securities and Exchange Commission (the “SEC”).

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

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

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**PART I—FINANCIAL INFORMATION**

**ITEM 1.   FINANCIAL STATEMENTS**

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

**Duane Reade Inc.—Predecessor**

**ConsolidatedStatements of Operations (Unaudited)**

**(In thousands)**

| ** **                                           | ** ** | **Successor**                | ** ** | ** **                   | ** ** | **Predecessor**              | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                           | ** ** | ** **                   | ** ** | **Period from**         | ** ** | ** **                   | ** ** | ** ** | ** ** | **Period from** | ** ** | **Period from** | ** ** |
| ** **                                           | ** ** | **Three Months**        | ** ** | **July 31, 2004**  | ** ** | **Nine Months**         | ** ** | ** ** | ** ** | **June 27, 2004** | ** ** | **Dec. 28, 2003** | ** ** |
| ** **                                           | ** ** | **Ended**                    | ** ** | **through**                  | ** ** | **Ended**                    | ** ** | ** ** | ** ** | **through** | ** ** | **through** | ** ** |
| ** **                                           | ** ** | **Sept. 24, 2005** | ** ** | **Sept. 25, 2004** | ** ** | **Sept. 24, 2005** | ** ** | ** ** | ** ** | **July 30, 2004** | ** ** | **July 30, 2004** | ** ** |
| Net sales                                            |       |                         | $          | 378,557                      |       |                         |       | $ | 238,050 |   |   |   | $ | 1,172,824 |   |   |   |   |   | $ | 142,379 |   |   |   | $ | 927,801 |   |   |
| Cost of sales                                        |       |                         | 305,866    |                         |       |                         | 194,116    |   |   |   | 948,729 |   |   |   |   |   | 115,557 |   |   |   | 745,090 |   |   |
| Gross profit                                         |       |                         | 72,691     |                         |       |                         | 43,934     |   |   |   | 224,095 |   |   |   |   |   | 26,822 |   |   |   | 182,711 |   |   |
| Selling,  general & administrative expenses |       |                         | 67,950     |                         |       |                         | 37,418     |   |   |   | 196,990 |   |   |   |   |   | 23,726 |   |   |   | 142,293 |   |   |
| Labor contingency  expense                           |       |                         | 1,100      |                         |       |                         | 689        |   |   |   | 3,300 |   |   |   |   |   | 411 |   |   |   | 2,611 |   |   |
| Transaction  expense                                 |       |                         | 236        |                         |       |                         | 37,118     |   |   |   | 817 |   |   |   |   |   | 386 |   |   |   | 3,005 |   |   |
| Depreciation and  amortization                       |       |                         | 17,816     |                         |       |                         | 7,280      |   |   |   | 53,313 |   |   |   |   |   | 3,596 |   |   |   | 21,902 |   |   |
| Store pre-opening  expenses                          |       |                         | 114        |                         |       |                         | 366        |   |   |   | 264 |   |   |   |   |   | 105 |   |   |   | 470 |   |   |
| Other                                                |       |                         | 1,454      |                         |       |                         | 25,291     |   |   |   | 4,636 |   |   |   |   |   | — |   |   |   | — |   |   |
|                                                 |       |                         | 88,670     |                         |       |                         | 108,162    |   |   |   | 259,320 |   |   |   |   |   | 28,224 |   |   |   | 170,281 |   |   |
| Operating (loss)  income                             |       |                         | (15,979    | )                            |       |                         | (64,228    | ) |   |   | (35,225 | ) |   |   |   |   | (1,402 | ) |   |   | 12,430 |   |   |
| Interest expense,  net                               |       |                         | 12,654     |                         |       |                         | 6,283      |   |   |   | 35,318 |   |   |   |   |   | 1,283 |   |   |   | 7,977 |   |   |
| (Loss) income  before income taxes                   |       |                         | (28,633    | )                            |       |                         | (70,511    | ) |   |   | (70,543 | ) |   |   |   |   | (2,685 | ) |   |   | 4,453 |   |   |
| Income tax  (benefit) provision                      |       |                         | (12,885    | )                            |       |                         | (32,473    | ) |   |   | (31,704 | ) |   |   |   |   | (1,714 | ) |   |   | 1,136 |   |   |
| Net (loss) income                                    |       |                         | $          | (15,748                      | )          |                         |       | $ | (38,038 | ) |   |   | $ | (38,839 | ) |   |   |   |   | $ | (971 | ) |   |   | $ | 3,317 |   |   |

 

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

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**DuaneReade Holdings, Inc.Consolidated Balance Sheets(In thousands, except share and per share data)**

| ** **                                                                                       | ** ** | **September 24,** | ** ** | **December 25,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                       | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                                                                       | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                       |       |                   |       |                  |       |   |   |   |   |
| Current Assets                                                                                   |       |                   |       |                  |       |   |   |   |   |
| Cash                                                                                             |       |                   | $          | 1,321                 |       |   |   | $ | 1,329 |   |   |
| Receivables, net                                                                                 |       |                   | 54,158     |                  |       |   | 58,056 |   |   |
| Inventories                                                                                      |       |                   | 258,316    |                  |       |   | 262,323 |   |   |
| Deferred income  taxes                                                                           |       |                   | 13,445     |                  |       |   | 9,027 |   |   |
| Prepaid expenses  and other current assets                                                       |       |                   | 22,819     |                  |       |   | 35,716 |   |   |
| TOTAL CURRENT  ASSETS                                                                            |       |                   | 350,059    |                  |       |   | 366,451 |   |   |
| Property and  Equipment, net                                                                     |       |                   | 230,102    |                  |       |   | 224,460 |   |   |
| Goodwill                                                                                         |       |                   | 52,216     |                  |       |   | 52,216 |   |   |
| Other Assets                                                                                     |       |                   | 274,728    |                  |       |   | 297,032 |   |   |
| TOTAL ASSETS                                                                                     |       |                   | $          | 907,105               |       |   |   | $ | 940,159 |   |   |
| **LIABILITIES AND STOCKHOLDER’S EQUITY**                                                    |       |                   |       |                  |       |   |   |   |   |
| Current Liabilities                                                                              |       |                   |       |                  |       |   |   |   |   |
| Accounts payable                                                                                 |       |                   | $          | 73,140                |       |   |   | $ | 80,154 |   |   |
| Accrued interest                                                                                 |       |                   | 3,636      |                  |       |   | 8,209 |   |   |
| Accrued expenses                                                                                 |       |                   | 39,302     |                  |       |   | 56,735 |   |   |
| Current portion  of debt                                                                         |       |                   | 139,760    |                  |       |   | 153,870 |   |   |
| Current portion  of capital lease obligations                                                    |       |                   | 3,089      |                  |       |   | 780 |   |   |
| TOTAL CURRENT  LIABILITIES                                                                       |       |                   | 258,927    |                  |       |   | 299,748 |   |   |
| Long-term debt                                                                                   |       |                   | 402,892    |                  |       |   | 355,032 |   |   |
| Capital lease  obligations, less current portion                                                 |       |                   | 11,146     |                  |       |   | 2,008 |   |   |
| Deferred income  taxes                                                                           |       |                   | 20,644     |                  |       |   | 47,971 |   |   |
| Other non-current  liabilities                                                                   |       |                   | 68,212     |                  |       |   | 51,351 |   |   |
| TOTAL LIABILITIES                                                                                |       |                   | 761,821    |                  |       |   | 756,110 |   |   |
| Commitments and  contingencies (Note 8)                                                          |       |                   |       |                  |       |   |   |   |   |
| Stockholder’s 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: 2,597,977 shares |       |                   | 26         |                  |       |   | 26 |   |   |
| Paid-in capital                                                                                  |       |                   | 239,472    |                  |       |   | 239,472 |   |   |
| Accumulated other  comprehensive income                                                          |       |                   | 74         |                  |       |   | — |   |   |
| Accumulated  deficit                                                                             |       |                   | (94,288    | )                     |       |   | (55,449 | ) |   |
| TOTAL STOCKHOLDER’S  EQUITY                                                                 |       |                   | 145,284    |                  |       |   | 184,049 |   |   |
| TOTAL LIABILITIES AND  STOCKHOLDER’S EQUITY                                                 |       |                   | $          | 907,105               |       |   |   | $ | 940,159 |   |   |

 

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

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**DuaneReade Holdings, Inc.—SuccessorDuane Reade Inc.—PredecessorConsolidated Statements of Cash Flows (Unaudited)(In thousands)**

| ** **                                                                                               | ** ** | **Successor**                | ** ** | ** **                   | ** ** | **Predecessor** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|-----------------|------------|
| ** **                                                                                               | ** ** | ** **                   | ** ** | **Period from**         | ** ** | ** **      | ** ** | **Period from** | ** ** |
| ** **                                                                                               | ** ** | **Nine Months**         | ** ** | **July 31, 2004**  | ** ** | ** **      | ** ** | **Dec. 28, 2003** | ** ** |
| ** **                                                                                               | ** ** | **Ended**                    | ** ** | **through**                  | ** ** | ** **      | ** ** | **through** | ** ** |
| ** **                                                                                               | ** ** | **Sept. 24, 2005** | ** ** | **Sept. 25, 2004** | ** ** | ** **      | ** ** | **July 30, 2004** | ** ** |
| Cash flows (used in) provided by operating  activities:                                                  |       |                         |       |                         |       |            |       |   |   |   |   |   |   |
| Net (loss) income                                                                                        |       | $                            | (38,839    | )                            |       | $               | (38,038    | ) |   |   |   |   | $ | 3,317 |   |   |
| Adjustments to reconcile net (loss) income to net  cash (used in) provided by operating activities: |       |                         |       |                         |       |            |       |   |   |   |   |   |   |
| Depreciation and  amortization                                                                           |       | 56,082                       |       |                         | 8,011      |            |       |   |   |   | 23,003 |   |   |
| Deferred income taxes                                                                                    |       | (31,744                      | )          |                         | (32,473    | )               |       |   |   |   | 5,900 |   |   |
| Non-cash rent expense                                                                                    |       | 10,132                       |       |                         | 2,488      |            |       |   |   |   | 4,383 |   |   |
| Other                                                                                                    |       | (2,104                       | )          |                         | —     |            |       |   |   |   | — |   |   |
| Change in operating assets and liabilities (net of the  effect of acquisitions):                    |       |                         |       |                         |       |            |       |   |   |   |   |   |   |
| Receivables                                                                                              |       | 3,898                        |       |                         | 1,026      |            |       |   |   |   | (3,057 | ) |   |
| Inventories                                                                                              |       | 4,466                        |       |                         | (7,521     | )               |       |   |   |   | 4,385 |   |   |
| Accounts payable                                                                                         |       | (6,589                       | )          |                         | 14,842     |            |       |   |   |   | (20,047 | ) |   |
| Prepaid and accrued  expenses                                                                            |       | (12,088                      | )          |                         | 27,540     |            |       |   |   |   | 747 |   |   |
| Other assets and  liabilities, net                                                                       |       | 6,274                        |       |                         | 2,129      |            |       |   |   |   | 2,921 |   |   |
| NET CASH (USED IN)  PROVIDED BY OPERATING ACTIVITIES                                                     |       | (10,512                      | )          |                         | (21,996    | )               |       |   |   |   | 21,552 |   |   |
| Cash flows used in investing activities:                                                                 |       |                         |       |                         |       |            |       |   |   |   |   |   |   |
| Capital expenditures                                                                                     |       | (18,386                      | )          |                         | (4,571     | )               |       |   |   |   | (17,552 | ) |   |
| Lease acquisition,  customer file and other costs                                                        |       | (6,904                       | )          |                         | (7,633     | )               |       |   |   |   | (14,925 | ) |   |
| Proceeds from sale of assets                                                                             |       | 7,069                        |       |                         | —     |            |       |   |   |   | — |   |   |
| Purchase of Duane Reade                                                                                  |       | —                       |       |                         | (413,684   | )               |       |   |   |   | — |   |   |
| NET CASH USED IN  INVESTING ACTIVITIES                                                                   |       | (18,221                      | )          |                         | (425,888   | )               |       |   |   |   | (32,477 | ) |   |
| Cash flows from financing activities:                                                                    |       |                         |       |                         |       |            |       |   |   |   |   |   |   |
| Proceeds from Term Loan                                                                                  |       | —                       |       |                         | 155,000    |            |       |   |   |   | — |   |   |
| Proceeds from Senior  Subordinated Notes                                                                 |       | —                       |       |                         | 195,000    |            |       |   |   |   | — |   |   |
| Proceeds from Senior  Secured Notes                                                                      |       | 47,860                       |       |                         | —     |            |       |   |   |   | — |   |   |
| Repurchase of  Convertible Notes                                                                         |       | —                       |       |                         | (201,000   | )               |       |   |   |   | — |   |   |
| Proceeds from sale of  common stock                                                                      |       | —                       |       |                         | 239,498    |            |       |   |   |   | — |   |   |
| Borrowings from  revolving credit facility                                                               |       | 1,339,509                    |       |                         | 415,047    |            |       |   |   |   | 941,503 |   |   |
| Repayments of revolving  credit facility                                                                 |       | (1,353,619                   | )          |                         | (343,453   | )               |       |   |   |   | (930,511 | ) |   |
| Proceeds from exercise  of stock options                                                                 |       | —                       |       |                         | —     |            |       |   |   |   | 1,126 |   |   |
| Deferred financing costs                                                                                 |       | (2,942                       | )          |                         | (12,049    | )               |       |   |   |   | (841 | ) |   |
| Repayments of capital  lease obligations                                                                 |       | (2,083                       | )          |                         | (120       | )               |       |   |   |   | (266 | ) |   |
| NET CASH PROVIDED BY  FINANCING ACTIVITIES                                                               |       | 28,725                       |       |                         | 447,923    |            |       |   |   |   | 11,011 |   |   |
| Net increase (decrease)  in cash                                                                         |       | (8                           | )          |                         | 39         |            |       |   |   |   | 86 |   |   |
| Cash at beginning of  period                                                                             |       | 1,329                        |       |                         | 1,338      |            |       |   |   |   | 1,252 |   |   |
| Cash at end of period                                                                                    |       | $                            | 1,321      |                         |       | $               | 1,377      |   |   |   |   |   | $ | 1,338 |   |   |

 

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

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**DuaneReade Holdings, Inc.—SuccessorDuane Reade Inc.—PredecessorConsolidated Statements of Comprehensive Income (Loss) (Unaudited)(in thousands)**

| ** **                         | ** ** | **Successor**                | ** ** | **Predecessor**              | ** ** |
|------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | ** **                   | ** ** | **Period from**         | ** ** | ** ** | ** ** | **Period from** | ** ** | **Period from** | ** ** |
| ** **                         | ** ** | **Three Months**        | ** ** | **July 31, 2004**  | ** ** | **Nine Months** | ** ** | **June 27, 2004** | ** ** | **December 28, 2003** | ** ** |
| ** **                         | ** ** | **Ended**                    | ** ** | **through**                  | ** ** | **Ended** | ** ** | **through** | ** ** | **through** | ** ** |
| ** **                         | ** ** | **Sept. 24, 2005** | ** ** | **Sept. 25, 2004** | ** ** | **Sept. 24, 2005** | ** ** | **July 30, 2004** | ** ** | **July 30, 2004** | ** ** |
| Net (loss) income                  |       |                         | $          | (15,748                      | )          |   |   | $ | (38,038 | ) |   |   | $ | (38,839 | ) |   |   | $ | (971 | ) |   |   | $ | 3,317 |   |   |   |
| FMV of interest rate collar        |       |                         | 81         |                         |       |   | — |   |   |   | 74 |   |   |   | — |   |   |   | — |   |   |   |
| Total Other Comprehensive Income   |       |                         | 81         |                         |       |   | — |   |   |   | 74 |   |   |   | — |   |   |   | — |   |   |   |
| Total  Comprehensive Income (Loss) |       |                         | $          | (15,667                      | )          |   |   | $ | (38,038 | ) |   |   | $ | (38,765 | ) |   |   | $ | (971 | ) |   |   | $ | 3,317 |   |   |   |

 

The accompanying notes are an integral part of these financial statements

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**Notesto Unaudited Consolidated Interim Financial Statements(dollars in thousands)**

**1.  **Basis of Presentation

Duane Reade Holdings, Inc. was formed in December 2003by Oak Hill Capital Partners, LP, a private equity firm (“Oak Hill”) in orderto acquire Duane Reade Inc. and its subsidiaries (the “Acquisition”).Duane Reade Holdings, Inc. is a wholly-owned subsidiary of DuaneReade Shareholders, LLC a parent entity also established to effectuate theAcquisition. The Acquisition was completed on July 30, 2004 through themerger of Duane Reade Acquisition (a wholly owned subsidiary of DuaneReade Holdings, Inc.) into Duane Reade Inc. with DuaneReade Inc. being the surviving entity and a wholly owned subsidiary ofDuane Reade Holdings, Inc. after the merger transaction. As a resultof the Acquisition and resulting change in control and change in historicalcost basis of accounting, the operating results are presented separately forpredecessor periods up to and including the closing date of the Acquisition andthe successor period following the closing date of the Acquisition. Thepredecessor period financial statements include Duane Reade Inc. and allits subsidiaries and the successor period financial statements include DuaneReade Holdings, Inc. and all its subsidiaries. DuaneReade Holdings, Inc. had nominal activity and no operations prior tothe completion of the Acquisition. Except where the context otherwise requires,all references to the “Company” in the Unaudited Consolidated Interim FinancialStatements and these footnotes mean the predecessor for periods ending on orbefore July 30, 2004 and the successor for periods beginning 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 ConsolidatedFinancial Statements 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. TheUnaudited Consolidated Interim Financial Statements include the accounts of theCompany and its subsidiaries. All significant intercompany transactions andbalances have been eliminated. The results for the interim periods presentedare not necessarily indicative of the results expected for the full year.

The Company, along withcertain of its subsidiaries, is a guarantor of the debt obligations of DuaneReade Inc. and Duane Reade, the New York general partnership (“DuaneReade GP”). Duane Reade Holdings, Inc. has no assets or operationsother than its investment in its subsidiaries. The Unaudited Condensed ConsolidatingInterim Financial Statements presented in Note 9 include the consolidatedassets and operations of the subsidiaries. The guarantees provided by theCompany and its other subsidiaries under the debt obligations of DuaneReade Inc. and Duane Reade GP are full and unconditional, joint andseveral.

**2.  **RecentlyIssued Accounting Pronouncements

In December 2004, Statement of FinancialAccounting Standard (SFAS) No. 123R, “Share-Based Payment” wasissued. 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 annual periodsbeginning after December 15, 2005. The Company is currently evaluating theeffect of adopting this statement.

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TheCompany previously adopted FAS No. 123, “Accounting for Stock-BasedCompensation” and, as permitted under FAS No. 123, has elected the disclosure-onlyprovisions. The Company accounts for its stock-based compensation plans underthe recognition and measurement principles of APB Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations. There is nostock-based employee compensation cost reflected in net income, as all optionsgranted had an exercise price equal to or greater than the market value of theunderlying common stock on the date of grant. The following table illustratesthe effect on net (loss) income if the Company had applied the fair valuerecognition provisions of FAS No. 123 to stock-based employeecompensation (dollars in thousands):

| ** **                                                                                                                                                 | ** ** | **Successor**         | ** ** | ** **                   | ** ** | **Predecessor**      | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                 | ** ** | **Three Months** | ** ** | **Period from**         | ** ** | **Nine Months** | ** ** | ** ** | ** ** | **Period from** | ** ** | **Period from** | ** ** |
| ** **                                                                                                                                                 | ** ** | **Ended**             | ** ** | **July 31, 2004**  | ** ** | **Ended**            | ** ** | ** ** | ** ** | **June 27, 2004** | ** ** | **Dec. 28, 2003** | ** ** |
| ** **                                                                                                                                                 | ** ** | **Sept. 24,**    | ** ** | **through**                  | ** ** | **Sept. 24,**   | ** ** | ** ** | ** ** | **through** | ** ** | **through** | ** ** |
| ** **                                                                                                                                                 | ** ** | **2005**              | ** ** | **Sept. 25, 2004** | ** ** | **2005**             | ** ** | ** ** | ** ** | **July 30, 2004** | ** ** | **July 30, 2004** | ** ** |
| Net (loss)  income, as reported                                                                                                                            |       |                  | $          | (15,748                      | )          |                 |       | $ | (38,038 | ) |   |   | $ | (38,839 | ) |   |   |   |   | $ | (971 | ) |   |   | $ | 3,317 |   |   |
| Less: Total stock-based employee compensation  expense determined under fair value based method for all awards,  net of related tax effects |       |                  | 143        |                         |       |                 | —     |   |   |   | 429 |   |   |   |   |   | 335 |   |   |   | 2,607 |   |   |
| Pro forma net  (loss) income                                                                                                                               |       |                  | $          | (15,891                      | )          |                 |       | $ | (38,038 | ) |   |   | $ | (39,268 | ) |   |   |   |   | $ | (1,306 | ) |   |   | $ | 710 |   |   |

 

The pro forma compensation expense for stock optionshas been estimated using the Black-Scholes option pricing model with thefollowing assumptions: for all periods during the 2005 fiscal year, the modelassumes a dividend yield of 0%, expected volatility of 0%, a risk free interestrate of 4.1% and an expected term of 7 years, and for all periods during the2004 fiscal year, the model assumes a dividend yield of 0%, expected volatilityof 50%, a risk free interest rate of 6.6% and an expected term of 8 years.These pro forma disclosures may not be representative of the effects onreported net (loss) income for future periods since options vest over severalyears and options granted prior to 1995 are not considered.

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

**3.  **Inventory and Cost of Sales

At September 24,2005, inventories, consisting solely of finished goods, would have been lowerby $6.3 million if they had been valued on a lower of first-in, first-out(“FIFO”) cost or market basis instead of a last-in, first-out (“LIFO”) basis.Cost of sales includes all store occupancy-related costs and expenses,consisting of lease and sublease-related income and expenses, other recurringreal estate-related income and expenses primarily from sales and terminationsof leases related to store closings and relocations, sales of market-relateddata, store utility costs, warehouse expenses and distribution costs. TheCompany reflects promotional allowances from vendors as a reduction of cost ofsales or advertising expense, depending on the nature of the allowance, whensuch advertising or promotions have been completed and the related allowanceshave been earned. For the quarter and nine months ended September 24,2005, other real estate-related income was $2.2 million and $2.5 million,respectively, as compared to 

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$0.0 million,$2.1 million and $0.1 million in the period from June 27, 2004through July 30, 2004, the period from December 28, 2003 through July 30,2004, and the period from July 31, 2004 through September 25, 2004, respectively.

**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 ofLiabilities in Connection with Purchase Business Combinations” (EITF 95-3),the Company established a reserve of $17.0 million for costs anticipatedto be incurred as a result of the planned closing of approximately 11 of itsstores. These costs primarily relate to rent, utilities and other on-goingoccupancy-related expenses, as well as costs related to inventory liquidation.During the 39 weeks ended September 24, 2005, ten of the 11 plannedclosings occurred, and the Company charged $2.6 million of primarilyoccupancy-related costs to this reserve. At September 24, 2005, thebalance was $14.3 million.

**5.  **Pharmacyand Customer File Acquisitions

Duringthe periods attributable to the “Successor” and “Predecessor” financialstatements, the Company acquired certain pharmacy customer prescription files,which were merged into existing stores, and the operations, including certainlease-related assets, of existing pharmacy establishments, which are operatedas new stores. The table below provides details of this acquisition activityfor each of the periods presented (dollars in millions).

| ** **                   | ** ** | **Successor**         | ** ** | ** **                   | ** ** | **Predecessor**      | ** ** |
|------------------------------|------------|-----------------------|------------|------------------------------|------------|----------------------|------------|
| ** **                   | ** ** | **Three Months** | ** ** | **Period from**         | ** ** | **Nine Months** | ** ** | ** ** | ** ** | **Period from** | ** ** | **Period from** | ** ** |
| ** **                   | ** ** | **Ended**             | ** ** | **July 31, 2004**  | ** ** | **Ended**            | ** ** | ** ** | ** ** | **June 27, 2004** | ** ** | **Dec. 28, 2003** | ** ** |
| ** **                   | ** ** | **Sept. 24,**    | ** ** | **through**                  | ** ** | **Sept. 24,**   | ** ** | ** ** | ** ** | **through** | ** ** | **through** | ** ** |
| ** **                   | ** ** | **2005**              | ** ** | **Sept. 25, 2004** | ** ** | **2005**             | ** ** | ** ** | ** ** | **July 30, 2004** | ** ** | **July 30, 2004** | ** ** |
| Customer  prescription files |       |                  | —     |                         |       |                 | —     |   |   |   | 4 |   |   |   |   |   | 1 |   |   |   | 6 |   |   |
| Pharmacy  establishments     |       |                  | —     |                         |       |                 | 4          |   |   |   | — |   |   |   |   |   | — |   |   |   | 1 |   |   |
| Total  acquisitions          |       |                  | —     |                         |       |                 | 4          |   |   |   | 4 |   |   |   |   |   | 1 |   |   |   | 7 |   |   |
| Total acquisition cost       |       |                  | $          | —                       |       |                 |       | $ | 6.4 |   |   |   | $ | 2.4 |   |   |   |   |   | $ | 1.7 |   |   |   | $ | 9.1 |   |   |
| Purchase price allocation:   |       |                  |       |                         |       |                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Identifiable  intangibles    |       |                  | $          | 0.1                          |       |                 |       | $ | 5.1 |   |   |   | $ | 2.3 |   |   |   |   |   | $ | 0.8 |   |   |   | $ | 7.2 |   |   |
| Goodwill                     |       |                  | —     |                         |       |                 | —     |   |   |   | — |   |   |   |   |   | 0.6 |   |   |   | 0.9 |   |   |
| Inventory                    |       |                  | (0.1       | )                            |       |                 | 1.3        |   |   |   | 0.4 |   |   |   |   |   | 0.3 |   |   |   | 1.3 |   |   |
| Property and  equipment      |       |                  | —     |                         |       |                 | 0.3        |   |   |   | — |   |   |   |   |   | — |   |   |   | — |   |   |
| Accruals and  liabilities    |       |                  | —     |                         |       |                 | (0.3       | ) |   |   | (0.3 | ) |   |   |   |   | — |   |   |   | (0.3 | ) |   |
| Total                        |       |                  | $          | —                       |       |                 |       | $ | 6.4 |   |   |   | $ | 2.4 |   |   |   |   |   | $ | 1.7 |   |   |   | $ | 9.1 |   |   |

 

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

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**6.  **Debt

Totaldebt is composed of the following (in thousands):

| ** **                                   | ** ** | **Balance at** | ** ** | **Balance at**          | ** ** |
|----------------------------------------------|------------|---------------------|------------|------------------------------|------------|
| **Description of Instrument**      | ** ** | ** **          | ** ** | **Sept. 24, 2005** | ** ** | **Dec. 25, 2004** | ** ** |
| Asset-Based Revolving  Loan Facility(1)      |       |                | $          | 139,760                      |       |   |   | $ | 153,870 |   |   |
| Total Current Debt                           |       |                | $          | 139,760                      |       |   |   | $ | 153,870 |   |   |
| Senior Secured Floating  Rate Notes due 2010 |       |                | $          | 207,860                      |       |   |   | $ | 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                       |       |                | $          | 402,892                      |       |   |   | $ | 355,032 |   |   |
| **Total Debt**                               |       | ** **          | **$**      | **542,652**                  |       | ** ** | ** ** | **$** | **508,902** |   |   |
|                                              |            |                     |            |                              |            |  |  |  |  |  |  |  |  |

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(1)    Obligations under this revolving loan facility areclassified as current liabilities because cash receipts controlled by thelenders are used to reduce outstanding debt and the Company does not meet thecriteria of Statement of Financial Accounting Standards No. 6 “Classificationof Short Term Obligations Expected to be Refinanced” (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.

***Asset-Based Revolving Loan Facility:******  ***On July 21,2003, Duane Reade GP entered into an asset-based revolving loan facilitywhich used a pre-determined percentage of the current value of inventory andselected accounts receivable to calculate the availability of funds eligible tobe borrowed up to an aggregate principal amount of $200 million. Prior tothe amendment described below, the Company’s obligations under the creditagreement and related guarantees were collateralized by substantially all ofits assets.

On July 22, 2004, inconnection with the Acquisition, the asset-based revolving loan facility wasamended to increase the borrowing capacity to an aggregate principal amount of$250 million, subject to an adjusted borrowing base calculation based uponspecified advance rates against the value of the Company’s selected inventory,pharmacy prescription files and selected accounts receivable. The amendedasset-based revolving loan facility includes a $50 million sub-limit forthe issuance of letters of credit. Obligations under the revolving loanfacility are collateralized by a first priority interest in inventory,receivables, pharmacy prescription files, deposit accounts and certain othercurrent assets. Under the asset-based revolving loan facility, DuaneReade GP is the sole obligor. However, the asset-based revolving loanfacility is guaranteed on a full and unconditional basis by the Company, DuaneReade Inc., and each of the Company’s other domestic subsidiaries other thanthe obligor.

The asset-based revolvingloan facility contains a single fixed charge coverage requirement which onlybecomes applicable when borrowings exceed 90 percent of the borrowing base, asdefined in the agreement governing the asset-based revolving loan facility.Borrowings under the asset-based revolving loan facility have not exceeded90 percent of the borrowing base and, as a result, the fixed chargecovenant has not become applicable. There are no credit ratings relatedtriggers in the asset-based revolving loan facility that would impact the costof borrowing, annual amortization of principal or related indebtednessmaturity. The asset-based revolving loan facility is scheduled to mature on July 20,2008.

Revolving loans under theasset-based revolving loan facility, at the Company’s option, bear interest ateither (i) a rate equal to LIBOR (the London Interbank Offered Rate) plusa margin of from 1.50% to 2.00%, determined based on levels of borrowingavailability reset each fiscal quarter or (ii) a rate equal to the primerate of Banc of America Retail Group Inc. plus a margin of from 0.00% to0.50%, determined based on levels of borrowing availability reset each fiscalquarter. Borrowings under the amended facility continue to be primarilyLIBOR-based. At September 24, 2005, the asset-based revolving loan facilitybore interest at an annual rate of 5.26%.

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In connection with theissuance of $50.0 million aggregate principal amount of senior secured floatingrate notes due 2010 in August 2005, the Company permanently reduced theamount of availability under the asset-based revolving loan facility by $25.0million. As a result, at September 24, 2005, the total amount that couldbe borrowed under the asset-based revolving loan facility was reduced to $225.0million. At September 24, 2005, there was $139.8 million outstandingunder the asset-based revolving loan facility, and approximately$79.9 million of remaining availability, net of $5.3 million reservedfor standby letters of credit.

***Senior Secured Floating Rate Notes 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. Using the netproceeds from that offering, together with approximately $2.2 million ofborrowings under the amended asset-based revolving loan facility, the Companyrepaid all outstanding principal under its previously existing$155.0 million senior term loan facility, along with approximately$3.6 million of early repayment premium and accrued but unpaid interestthrough December 20, 2004. On August 9, 2005, the Company issued afurther $50.0 million of senior secured notes. These new notes were issuedunder the same indenture as the senior secured notes issued in December 2004,although they do not trade fungibly with those notes.

The senior secured notesbear interest at a floating rate of LIBOR plus 4.50%, reset quarterly. Intereston the senior secured notes is payable quarterly on each March 15, June 15,September 15, and December 15, beginning on March 15, 2005. Thesenior secured notes mature on December 15, 2010. At September 24,2005, the senior secured notes bore interest at an annual rate of 8.37%.

On May 25, 2005, theCompany entered into a hedging transaction through the acquisition of a “nocost collar.” Under this arrangement, the Company capped its exposure on$130.0 million of LIBOR-based borrowings under the senior secured notes ata maximum LIBOR rate of 5.30%. In addition, the Company established a minimum “floor”LIBOR rate of 3.45% in the line with then current LIBOR rates. This hedgingarrangement expires on June 16, 2008. The changes in the fair value of thehedge agreement are reflected on the Consolidated Statements of ComprehensiveIncome (Loss) included within the financial statements.

The Company guarantees thesenior secured notes on a full and unconditional, senior secured basis. DuaneReade Inc. and Duane Reade GP are co-obligors under the seniorsecured notes. The senior secured notes rank equally in right of payment withany of the Company’s, Duane Reade Inc.’s or Duane Reade GP’sunsubordinated indebtedness and senior in right of payment to any of theCompany’s, Duane Reade Inc.’s or Duane Reade GP’s subordinated orsenior subordinated indebtedness. All obligations under the senior securednotes are guaranteed on a senior basis by each of the Company’s existingsubsidiaries, other than Duane Reade Inc. and Duane Reade GP, andwill be guaranteed by future subsidiaries of Duane Reade Inc. and DuaneReade GP except certain foreign and certain domestic subsidiaries. Thesenior secured notes and the guarantees are collateralized by a first priorityinterest in substantially all of Duane Reade Inc. and Duane Reade GP’sassets other than those assets in which the lenders under the amended asset-basedrevolving loan facility have a first priority interest. The senior securednotes and the guarantees are also collateralized by a second priority interestin all collateral pledged on a first priority basis to lenders under theamended asset-based revolving loan facility.

Upon the occurrence ofspecified change of control events, Duane Reade Inc. and DuaneReade GP will be required to make an offer to repurchase all of the seniorsecured notes at 101% of the outstanding principal amount of the senior securednotes plus accrued and unpaid interest to the date of repurchase. The indenturegoverning the senior secured notes contains certain affirmative and negativecovenants that limit the ability of Duane Reade Inc., Duane Reade GPand their restricted subsidiaries, as defined, to incur additionalindebtedness, pay dividends, make repayments on indebtedness that issubordinated to the senior secured notes and to make certain other restrictedpayments, incur certain liens, use proceeds from sales of assets, enter intobusiness combination transactions (including mergers, consolidations and asset 

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sales),enter into sale-leaseback transactions, enter into transactions with affiliatesand permit restrictions on the payment of dividends by restricted subsidiaries.There are no credit ratings related triggers in the indenture governing thesenior secured notes that would impact the cost of borrowing, annualamortization of principal or related indebtedness maturity.

The indenture governingthe senior secured notes does not contain financial maintenance covenants.Under a registration rights agreement entered into on August 9, 2005, theCompany is required to file a registration statement to register the issuanceof new senior secured notes (with substantially the same terms) in exchange forthe senior secured notes issued on August 9, 2005. The Company is requiredto (i) file a registration statement with the SEC within 120 days after August 9,2005, (ii) use its reasonable best efforts to cause the registration statementto become effective within 180 days after August 9, 2005, and (iii) useits reasonable best efforts to complete the exchange offer within 210 daysafter August 9, 2005.

At September 24,2005, the weighted average combined interest rate in effect on all variablerate debt outstanding was 7.13%.

***Senior Subordinated Notes Due 2011:******  ***On July 30,2004, upon completion of the Acquisition, Duane Reade Inc. and DuaneReade GP co-issued $195.0 million of 9.75% senior subordinated notesdue 2011. The senior subordinated notes mature on August 1, 2011 and bearinterest at 9.75% per annum payable in semi-annual installments on February 1and August 1, commencing February 1, 2005. The senior subordinatednotes are uncollateralized obligations and subordinated in right of payment toall of the Company’s, Duane Reade Inc.’s and Duane Reade GP’sexisting and future unsubordinated indebtedness, including borrowings under theamended asset-based revolving loan facility and the senior secured notes. Thesenior subordinated notes will rank equally with any future senior subordinatedindebtedness and senior to any future subordinated indebtedness. The seniorsubordinated notes are guaranteed on an uncollateralized, senior subordinatedbasis by the Company and all of Duane Reade Inc.’s existing direct andindirect domestic subsidiaries other than Duane Reade GP, which is aco-obligor under the senior subordinated notes. Upon the occurrence ofspecified change of control events, the Company will be required to make anoffer to repurchase all of the senior subordinated notes at 101% of theoutstanding principal amount of the senior subordinated notes plus accrued andunpaid interest to the date of repurchase. The indenture governing the seniorsubordinated notes contains certain affirmative and negative covenants thatlimit the ability of Duane Reade Inc., Duane Reade GP and theirrestricted subsidiaries to incur additional indebtedness, pay dividends, makerepayments 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 byrestricted subsidiaries. There are no credit ratings related triggers in theindenture governing the senior subordinated notes that would impact the cost ofborrowing, annual amortization of principal or related indebtedness maturity.

***2.1478% Senior Convertible Notes due April 16,2022:*****  **OnApril 16, 2002, Duane Reade Inc. completed an offering of$381.5 million aggregate principal amount of Senior Convertible Notesmaturing on April 16, 2022 (the “Convertible Notes”). The ConvertibleNotes were issued at a price of $572.76 per note (57.276% of the principalamount at maturity) and pay cash interest at the rate of 2.1478% per year onthe principal amount at maturity, payable semi-annually in arrears on April 16and October 16 of each year beginning on October 16, 2002, until April 16,2007. After that date, interest will accrue on the notes as amortization of theoriginal issue discount representing a yield to maturity of 3.75% per year,computed on a semi-annual bond equivalent basis. In December 2002, DuaneReade Inc. repurchased a total of $30.5 million principal value ofthe Convertible Notes at an average purchase price of $486.99 per $1,000 note,resulting in a remaining net outstanding balance of $201.0 million.

In connection with theAcquisition, Duane Reade Inc. made a tender offer to repurchase all of the$351.0 million outstanding principal value of the Convertible Notes. Uponthe closing of the tender offer, a 

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total of$350.9 million principal value ($201.0 million issuance value) wastendered 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 tothe sum of the issue price plus accrued original issue discount and accruedcash interest, if any, to the redemption date.

**7.  **Income Taxes

Income taxes are recordedbased on the estimated combined statutory tax rates expected to be applicablefor the full fiscal year less employment-related income tax credits estimatedto be earned during the year. The effective tax rate is lower than the combinedstatutory rates, primarily reflecting the impact of these income tax credits.The tax credits represent the economic benefits earned by the Company for itsparticipation in various federal and state employment incentive programs. Thesebenefits are based on the number of qualifying employees hired and retained bythe Company for a specified time period. Employees qualify for these hiringprograms primarily as a result of their enrollment in various federal andstate-sponsored economic assistance programs.

**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 or insurancecoverage for these actions and that the ultimate outcome of these actions willnot have a material adverse effect on the financial position, results ofoperation or cash flows of the Company. In addition, the Company is a party tothe following legal actions and matters:

During 2002, the Company initiated a legal actionagainst its former property insurance carrier, in an attempt to recover what itbelieves to be a fair and reasonable settlement for the business interruptionportion of its claim originating from the September 11, 2001 World TradeCenter terrorist attack, during which its single highest volume and mostprofitable store was completely destroyed. The claim is pending before theUnited States District Court for the Southern District of New York. In September 2003,a trial on certain issues was held regarding some of the matters at issue inthe litigation, including whether the Company would have obtained a renewal ofits lease at the World Trade Center. The Company received a favorable rulingfrom the trial court on this and other legal issues in the case. The trialcourt’s decision was appealed by the insurance carrier to the Second CircuitCourt of Appeals with respect to several aspects of the decision. In themeantime, the matter moved into an appraisal process based on the trial court’sinterpretation of certain legal tests, which interpretation was among theaspects of the decision challenged by the insurance carrier in its appeal. Theappraisal process involves a panel of two appraisers and an arbitrator (toresolve differences between the two appraisers), who determine the amount ofinsured loss the Company has sustained. In June 2005, the appraisal paneldetermined that the total amount of the business interruption loss that the Companysuffered as a result of the events of September 11, 2001 was $50.6million, including all interest adjustments. The panel further found that theactual amount to be paid by the insurer should be reduced by approximately $9.9million, plus interest, which represents the amount that was previously paid tothe Company in cash by the insurer in 2002. On June 22, 2005, the Court ofAppeals affirmed the decision of the trial court, with modifications, includingmodifications to certain of the legal tests on which the appraisal panel’sdecision was based. The appraisal panel has recently requested additionalsubmissions in order to assist it in making a final determination as to theimpact of the Second Circuit’s opinion on its original award. The Company believesthat the panel’s decision will result in a reduction of the original award, butthe amount of the reduction of this claim, if any, cannot be determined at thistime. Accordingly, given the risks and uncertainties inherent in litigation,there can be no definitive assurance that the Company will actually receive anyor all of the panel’s appraised value of this claim, and the Company has notrecognized any additional income related to this matter. It should be 

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noted that any payment tothe Company that might be forthcoming as a result of this claim may also resultin the incurrence of additional expenses that are contingent upon the amount ofsuch insurance claim settlement. These expenses, if incurred, are not expectedto exceed $6.0 million.

Duane Reade Inc., Mr. Cuti, Mr. Henryand Mr. Charboneau were named as defendants in connection with theconsolidation of several class action complaints alleging violations of thefederal securities laws that were filed from August 2002 through October 2002.The action, which was in the United States District Court for the SouthernDistrict of New York, was on behalf of shareholders who purchased the Company’scommon stock between April 1, 2002 and July 24, 2002, inclusive. Thecomplaint, which sought an unspecified amount of damages, alleged that thedefendants violated the federal securities laws by issuing materially false andmisleading statements during the class period. On December 1, 2003, thedistrict judge granted the Company’s motion to dismiss the plaintiff’s action,with prejudice. The plaintiffs subsequently filed an appeal. On August 17,2004, the U.S. Court of Appeals affirmed the district court’s ruling in theCompany’s favor, thus fully resolving this matter in favor of the Company.

The Company is a defendant in a class action suit inthe Federal Court for the Southern District of New York filed in January 2000regarding alleged violations of the Fair Labor Standards Act as to a group ofindividuals who provided delivery services on a contract basis to the Company.In December 2002, the judge in the action issued a partial summaryjudgment in favor of a subclass of the plaintiffs and against the Company. In December 2003,the Company settled the issue of the amount of its liability to the plaintiffswithout any admission of wrongdoing and in an amount consistent with itspreviously established reserves. By a decision dated August 4, 2004, thedistrict court awarded the plaintiffs certain attorneys’ fees in this matter inthe amount of $0.6 million. The Company has fully reserved the amounts ofthe fees in question and has appealed this award. The Second Circuit recentlyaffirmed the trial court’s determination on fees.

The Company is a party to a National Labor RelationsBoard (“NLRB”) administrative proceeding regarding a dispute with the AlliedTrades Council (“ATC”) over whether a negotiating impasse was reached betweenthe Company and the union in August of 2001. The Allied Trades Councilrepresents employees in 139 of the Company’s stores in a collective bargainingagreement that expired on August 31, 2001. The Company’s employees havebeen working pursuant to the terms of the Company’s December 6, 2001implemented contract with the ATC, which expired on August 31, 2004. TheCompany believes an impasse did in fact occur and as a result, it had the rightto implement its latest contract proposal at that time which included wageincreases, health and welfare benefits, vacation and sick benefits and a 401(k) retirementprogram. The Company discontinued making additional payments into the variousfunds associated with the union as it was providing many of these benefits on adirect basis and because it believes its past contributions to these fundscaused these funds to be in a position of excessive overfunding. In addition,the Company had concerns that its past payments into these funds were not beingmanaged in a way to ensure they were being properly utilized for the benefit ofits employees. On February 18, 2004, an Administrative Law Judge (“ALJ”)who had reviewed various matters related to this proceeding issued a decisionand related recommendation, which concluded that the parties were not atimpasse. The remedies recommended by the ALJ included, among other things, arequirement for the Company to make its employees whole by reimbursing them forexpenses ensuing from the failure to make contributions to the union funds andto make such funds whole, plus interest. This recommendation was adopted by athree-member panel of the NLRB on September 15, 2004. The NLRB’sdetermination has been appealed by the Company. If it is enforced by the courtof appeals, it could result in the Company being required to contribute amountsthat have yet to be determined into the union’s pension benefit, health andwelfare and vacation funds. Any potential required contributions resulting froma final judicial determination of this matter would potentially be subject tooffset by the amounts that the Company had funded since it implemented itsfinal contract proposal for these same benefits that were paid for its AlliedTrades Council employees. Because the NLRB decision represents the first phaseof a long and 

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complicated administrativeprocess to be followed by a full judicial review of all of the facts andcircumstances, the final outcome cannot be reliably determined at this time.The NLRB’s decision is subject to judicial review by the D.C. Circuit Court ofAppeals and a compliance hearing before any financial remedy can be determined.The Company has filed appeal papers with the D.C. Circuit Court of Appeals, andthe Court has scheduled a hearing to occur later this year with its decision tofollow sometime thereafter. While there can be no definitive assurance, theCompany has been advised by its outside labor counsel that its petition forreview contains a number of valid defenses and arguments against enforcement ofthe NLRB decision.

In light of the foregoing, while it is the Company’sbelief that the final financial outcome of this litigation cannot bedetermined, under the provisions of Statement of Financial Accounting StandardNo. 5 which addresses contingencies, the Company has recorded cumulativepre-tax charges of $20.3 million, including $3.3 million in the ninemonths ended September 24, 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 are based upon the facts currentlyavailable to it. In the Company’s opinion, such charges could be subject tosignificant modification in the future, upon review by the D.C. Circuit Courtof Appeals, completion of a compliance hearing and any appeals relating to theoutcome of that hearing. These charges reflect the amount of contributions thatthe Company did not make into the union benefit funds for the period from the August 31,2001 expiration of the contract through September 24, 2005, reduced by aportion of the benefits it paid directly to or for the benefit of theseemployees over the same period. It also includes an interest cost for these netcontributions from the date they would have been paid until September 24,2005. While this represents the Company’s current best estimate of the NLRB’sdecision, the Company believes that, as of September 24, 2005, the actualrange of loss in this matter could be from $0 if the Circuit Court of Appealsdoes not enforce the NLRB decision at all, to approximately $46.0 million,if the NLRB’s decision is upheld and there is no offset for any benefits paidover this period.

Until such time as further legal developments warranta change in the application of this accounting standard, or until this matteris resolved, the Company will record additional non-cash pre-tax charges,including interest, which are calculated on the same basis as the chargesrecorded in the 2003 and 2004 financial statements. The Company currentlyestimates that the pre-tax charge recorded during the full 12 months of2005 will approximate $4.4 million, subject to changes in the relevantinterest rate.

The Company is a party to related lawsuits, IrvingKroop, et al v. Duane Reade, NY, NY et al, 00 Civ. 9841, et al.,instituted by the trustees of several union benefit funds wherein the fundsclaim that the Company did not make certain required contributions to thesefunds from January 2000 through August 2001. By decisions dated August 5,2004 and September 27, 2004, the District Court awarded judgment to thefunds on certain aspects of their complaints. These partial judgments, forwhich the Company has provided adequate reserves, are subject to further appealby the Company. In October, the Company paid $705 thousand in fullsettlement of the partial summary judgment. The remaining unresolved portionsof the plaintiffs’ claims are still being litigated and accordingly, theCompany intends to continue to vigorously defend itself in these matters. Atthis time, it is not possible to determine the ultimate outcome of this case orthe actual amount of liability the Company may face, if any.

The Company is involved in an ongoing dispute withCardinal Health, one of its former suppliers of pharmaceutical products. Bothparties have claims against the other involving, among other things, breach ofcontract, promissory estoppel and unjust enrichment. Duane Reade isseeking from Cardinal an unspecified amount of damages and punitive damages ofat least $20 million. Cardinal is seeking approximately $18 millionin damages plus attorney’s fees and interest. While there can be no definitiveassurance, the Company believes it has counterclaims that offset the claimsagainst it by Cardinal, as well as meritorious defenses to these claims, andplans to vigorously pursue its affirmative claims and to vigorously defenditself in this action. This case has been scheduled for trial in early 2006.

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A New York State TaxAppeal decision in a matter involving another company may have an adverseimpact upon the Company’s New York State Franchise Tax filings from years 1999through 2002. This matter relates to the required combination of affiliatedsubsidiaries in recognizing royalty fee and related income for intangibleproperty. The application of the decision to the Company is subject tointerpretation 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.

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 DistrictCourt, Southern District of New York. The complaint alleges that, from theperiod beginning November 1998, the Company incorrectly gave someemployees the title, “Assistant Manager,” in an attempt to avoid paying theseemployees overtime, in contravention of the Fair Labor Standards Act and theNew York Law. The complaint seeks an award equal to twice an unspecified amountof unpaid wages. The Company believes this claim to be without merit, and itintends to defend itself vigorously against this claim. However, due to theuncertainty of litigation, there can be no assurance as to the ultimate outcomeof this matter.

In January 2005, theEqual Employment Opportunity Commission filed an action against the Company inthe U.S. District Court for the Southern District of New York alleging, amongother things, that the Company created a hostile work environment for threefemale store employees, and potentially a class of such female employees. Thisaction is in its early stages, and accordingly it is not possible to determinethe ultimate outcome, which, if adverse, could be material. However, theCompany believes that the allegations are wholly without merit and intends tovigorously defend itself in this matter.

***Litigation Relating to the Acquisition:***   TheCompany is aware of six purported class action complaints challenging theAcquisition consummated by Duane Reade Inc. and Duane Reade Acquisitionthat have been filed in the Court of Chancery of the State of Delaware,referred to as the “Delaware Complaints,” and three purported class actioncomplaints that have been filed in the Supreme Court of the State of New York.Two of the New York complaints have been dismissed without prejudice. The otherNew York complaint (the “New York Complaint”) is pending but has not beenserved on Duane Reade. The Delaware Complaints name Mr. Cuti and certainother members of the Company’s former board of directors and executive officersas well as Duane Reade as defendants. Four of the Delaware Complaints nameOak Hill as a defendant. The New York Complaint names Mr. Cuti and certainother members of the Company’s former board of directors and executive officersas well as Duane Reade as defendants. One of the dismissed New Yorkcomplaints named Oak Hill as a defendant.

The Delaware Complaintswere consolidated on January 28, 2004, and on April 8, 2004 theplaintiffs in the Delaware actions filed a consolidated class action complaint.The Company believes these lawsuits are without merit and plans to defend theselawsuits vigorously.

**9.   CondensedConsolidating Financial Information of Subsidiary Guarantors and Co-Obligors**

The 9.75% SeniorSubordinated Notes due 2011 and the Senior Secured Floating Rate Notes due 2010were co-issued by Duane Reade Inc. and Duane Reade GP, each of whomis considered a “co-obligor.” The Company and each of its’ other subsidiaries,composed of DRI I Inc., Duane Reade International, Inc. andDuane Reade Realty, Inc., are guarantors of such notes. The guaranteeof the Company and of each subsidiary guarantor is full and unconditional andjoint and several.

The following condensedconsolidating financial information for the Company presents the financialinformation of Duane Reade Holdings, Inc., the co-obligors and thesubsidiary guarantors, prepared on the equity basis of accounting. Suchpresentation is based on the Company’s understanding and interpretation of Rule 3-10under the Securities and Exchange Commission’s Regulation S-X. The financialinformation may not necessarily be indicative of results of operations orfinancial position had the subsidiary guarantors operated as independententities.

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**DUANE READEHOLDINGS, INC.Condensed Consolidating Statement of Operations (Unaudited)For the 13 weeks ended September 24, 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                                            |       |                    | $          | —              |       |              |       | $              | —     |              |       | $                       | 378,557    |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 378,557 |   |   |
| Cost of sales                                        |       |                    | —     |                |       |              | —     |           |       | 305,866           |       |                    | —     |   |   |   | — |   |   |   | 305,866 |   |   |
| Gross profit                                         |       |                    | —     |                |       |              | —     |           |       | 72,691            |       |                    | —     |   |   |   | — |   |   |   | 72,691 |   |   |
| Selling, general  & administrative expenses |       |                    | —     |                |       |              | —     |           |       | 79,964            |       |                    | (12,014    | ) |   |   | — |   |   |   | 67,950 |   |   |
| Labor contingency                                    |       |                    | —     |                |       |              | —     |           |       | 1,100             |       |                    | —     |   |   |   | — |   |   |   | 1,100 |   |   |
| Transaction  expense                                 |       |                    | —     |                |       |              | —     |           |       | 236               |       |                    | —     |   |   |   | — |   |   |   | 236 |   |   |
| Depreciation and  amortization                       |       |                    | —     |                |       |              | —     |           |       | 17,816            |       |                    | —     |   |   |   | — |   |   |   | 17,816 |   |   |
| Store pre-opening  expense                           |       |                    | —     |                |       |              | —     |           |       | 114               |       |                    | —     |   |   |   | — |   |   |   | 114 |   |   |
| Other                                                |       |                    | —     |                |       |              | —     |           |       | 1,454             |       |                    | —     |   |   |   | — |   |   |   | 1,454 |   |   |
| Operating (loss) income                              |       |                    | —     |                |       |              | —     |           |       | (27,993           | )          |                    | 12,014     |   |   |   | — |   |   |   | (15,979 | ) |   |
| Equity earnings in  affiliates                       |       |                    | 15,748     |                |       |              | 15,748     |           |       | —            |       |                    | 224        |   |   |   | (31,720 | ) |   |   | — |   |   |
| Interest expense,  net                               |       |                    | —     |                |       |              | —     |           |       | 12,654            |       |                    | —     |   |   |   | — |   |   |   | 12,654 |   |   |
| Income (loss) before income taxes                    |       |                    | (15,748    | )                   |       |              | (15,748    | )              |       | (40,647           | )          |                    | 11,790     |   |   |   | 31,720 |   |   |   | (28,633 | ) |   |
| Income tax  (benefit) expense                        |       |                    | —     |                |       |              | —     |           |       | (18,291           | )          |                    | 5,406      |   |   |   | — |   |   |   | (12,885 | ) |   |
| Net income (loss)                                    |       |                    | $          | (15,748             | )          |              |       | $              | (15,748    | )                 |       | $                       | (22,356    | ) |   | $ | 6,384 |   |   |   | $ | 31,720 |   |   |   | $ | (15,748 | ) |   |

 

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**DUANE READEHOLDINGS, INC.Condensed Consolidating Statement of Operations (Unaudited)For the period from July 31, 2004 through September 25, 2004(Successor)(in thousands)**

| ** **                                           | ** ** | ** **              | ** ** | ** **          | ** ** | ** **        | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane Reade**    | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|-------------------------|------------|
| ** **                                           | ** ** | **Duane Reade**    | ** ** | **Duane**           | ** ** | **Duane**         | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Holdings, Inc.** | ** ** |
| ** **                                           | ** ** | **Holdings, Inc.** | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**        | ** ** |
| Net sales                                            |       |                    | $          | —              |       |              |       | $              | —     |              |       | $                       | 238,050    |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 238,050 |   |   |
| Cost of sales                                        |       |                    | —     |                |       |              | —     |           |       | 194,116           |       |                    | —     |   |   |   | — |   |   |   | 194,116 |   |   |
| Gross profit                                         |       |                    | —     |                |       |              | —     |           |       | 43,934            |       |                    | —     |   |   |   | — |   |   |   | 43,934 |   |   |
| Selling, general  & administrative expenses |       |                    | —     |                |       |              | 2          |           |       | 44,746            |       |                    | (7,330     | ) |   |   | — |   |   |   | 37,418 |   |   |
| Labor contingency                                    |       |                    | —     |                |       |              | —     |           |       | 689               |       |                    | —     |   |   |   | — |   |   |   | 689 |   |   |
| Transaction  expense                                 |       |                    | —     |                |       |              | —     |           |       | 37,118            |       |                    | —     |   |   |   | — |   |   |   | 37,118 |   |   |
| Depreciation and  amortization                       |       |                    | —     |                |       |              | —     |           |       | 7,280             |       |                    | —     |   |   |   | — |   |   |   | 7,280 |   |   |
| Store pre-opening  expense                           |       |                    | —     |                |       |              | —     |           |       | 366               |       |                    | —     |   |   |   | — |   |   |   | 366 |   |   |
| Other                                                |       |                    | —     |                |       |              | —     |           |       | 25,291            |       |                    | —     |   |   |   | — |   |   |   | 25,291 |   |   |
| Operating (loss) income                              |       |                    | —     |                |       |              | (2         | )              |       | (71,556           | )          |                    | 7,330      |   |   |   | — |   |   |   | (64,228 | ) |   |
| Equity earnings  in affiliates                       |       |                    | 38,038     |                |       |              | 38,037     |           |       | —            |       |                    | 420        |   |   |   | (76,495 | ) |   |   | — |   |   |
| Interest expense,  net                               |       |                    | —     |                |       |              | —     |           |       | 6,283             |       |                    | —     |   |   |   | — |   |   |   | 6,283 |   |   |
| Income (loss) before income taxes                    |       |                    | (38,038    | )                   |       |              | (38,039    | )              |       | (77,839           | )          |                    | 6,910      |   |   |   | 76,495 |   |   |   | (70,511 | ) |   |
| Income tax  (benefit) expense                        |       |                    | —     |                |       |              | (1         | )              |       | (35,848           | )          |                    | 3,376      |   |   |   | — |   |   |   | (32,473 | ) |   |
| Net income (loss)                                    |       |                    | $          | (38,038             | )          |              |       | $              | (38,038    | )                 |       | $                       | (41,991    | ) |   | $ | 3,534 |   |   |   | $ | 76,495 |   |   |   | $ | (38,038 | ) |   |

 

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**DUANE READE INC.Condensed Consolidating Statement of Operations (Unaudited)For the period from June 27, 2004 through July 30, 2004(Predecessor)(in thousands)**

| ** **                                            | ** ** | **Duane**           | ** ** | **Duane**         | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Duane Reade Inc.** | ** ** |
|-------------------------------------------------------|------------|---------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|--------------------------------|------------|
| ** **                                            | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**               | ** ** |
| Net sales                                             |       |                | $          | —            |       |           | $          | 142,379           |       |                           | $          | — |   |   |   | $ | — |   |   |   | $ | 142,379 |   |   |
| Cost of sales                                         |       |                | —     |              |       | 115,557        |       |              | —     |                           |       |   | — |   |   |   | 115,557 |   |   |
| Gross profit                                          |       |                | —     |              |       | 26,822         |       |              | —     |                           |       |   | — |   |   |   | 26,822 |   |   |
| Selling, general  & administrative expenses  |       |                | 3          |              |       | 27,023         |       |              | (3,300     | )                              |       |   | — |   |   |   | 23,726 |   |   |
| Labor contingency                                     |       |                | —     |              |       | 411            |       |              | —     |                           |       |   | — |   |   |   | 411 |   |   |
| Transaction  expense                                  |       |                | —     |              |       | 386            |       |              | —     |                           |       |   | — |   |   |   | 386 |   |   |
| Depreciation and  amortization                        |       |                | —     |              |       | 3,596          |       |              | —     |                           |       |   | — |   |   |   | 3,596 |   |   |
| Store pre-opening  expense                            |       |                | —     |              |       | 105            |       |              | —     |                           |       |   | — |   |   |   | 105 |   |   |
| Operating (loss) income                               |       |                | (3         | )                 |       | (4,699         | )          |              | 3,300      |                           |       |   | — |   |   |   | (1,402 | ) |   |
| Equity earnings  in affiliates                        |       |                | 970        |              |       | —         |       |              | 22         |                           |       |   | (992 | ) |   |   | — |   |   |
| Interest expense,  net                                |       |                | —     |              |       | 1,283          |       |              | —     |                           |       |   | — |   |   |   | 1,283 |   |   |
| Income (loss) before income taxes                     |       |                | (973       | )                 |       | (5,982         | )          |              | 3,278      |                           |       |   | 992 |   |   |   | (2,685 | ) |   |
| Income tax  (benefit) expense                         |       |                | (2         | )                 |       | (3,819         | )          |              | 2,107      |                           |       |   | — |   |   |   | (1,714 | ) |   |
| Net income (loss)                                     |       |                | $          | (971              | )          |           | $          | (2,163            | )          |                           | $          | 1,171 |   |   |   | $ | 992 |   |   |   | $ | (971 | ) |   |

 

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**DUANE READEHOLDINGS, INC.Condensed Consolidating Statement of Operations (Unaudited)For the 39 weeks ended September 24, 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                                       |       |                    | $          | —              |       |              |       | $              | —     |              |       | $                       | 1,172,824  |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 1,172,824 |   |   |
| Cost of sales                                   |       |                    | —     |                |       |              | —     |           |       | 948,729           |       |                    | —     |   |   |   | — |   |   |   | 948,729 |   |   |
| Gross profit                                    |       |                    | —     |                |       |              | —     |           |       | 224,095           |       |                    | —     |   |   |   | — |   |   |   | 224,095 |   |   |
| Selling, general  & administrative expenses |       |                    | —     |                |       |              | —     |           |       | 232,870           |       |                    | (35,880    | ) |   |   | — |   |   |   | 196,990 |   |   |
| Labor contingency                               |       |                    | —     |                |       |              | —     |           |       | 3,300             |       |                    | —     |   |   |   | — |   |   |   | 3,300 |   |   |
| Transaction  expense                            |       |                    | —     |                |       |              | —     |           |       | 817               |       |                    | —     |   |   |   | — |   |   |   | 817 |   |   |
| Depreciation and  amortization             |       |                    | —     |                |       |              | —     |           |       | 53,313            |       |                    | —     |   |   |   | — |   |   |   | 53,313 |   |   |
| Store pre-opening  expense                      |       |                    | —     |                |       |              | —     |           |       | 264               |       |                    | —     |   |   |   | — |   |   |   | 264 |   |   |
| Other                                           |       |                    | —     |                |       |              | —     |           |       | 4,636             |       |                    | —     |   |   |   | — |   |   |   | 4,636 |   |   |
| Operating (loss) income                         |       |                    | —     |                |       |              | —     |           |       | (71,105           | )          |                    | 35,880     |   |   |   | — |   |   |   | (35,225 | ) |   |
| Equity earnings  in affiliates                  |       |                    | 38,839     |                |       |              | 38,839     |           |       | —            |       |                    | 586        |   |   |   | (78,264 | ) |   |   | — |   |   |
| Interest expense,  net                          |       |                    | —     |                |       |              | —     |           |       | 35,318            |       |                    | —     |   |   |   | — |   |   |   | 35,318 |   |   |
| Income (loss) before income taxes               |       |                    | (38,839    | )                   |       |              | (38,839    | )              |       | (106,423          | )          |                    | 35,294     |   |   |   | 78,264 |   |   |   | (70,543 | ) |   |
| Income tax  (benefit) expense                   |       |                    | —     |                |       |              | —     |           |       | (47,829           | )          |                    | 16,125     |   |   |   | — |   |   |   | (31,704 | ) |   |
| Net income (loss)                               |       |                    | $          | (38,839             | )          |              |       | $              | (38,839    | )                 |       | $                       | (58,594    | ) |   | $ | 19,169 |   |   |   | $ | 78,264 |   |   |   | $ | (38,839 | ) |   |

 

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**DUANE READE INC.Condensed Consolidating Statement of Operations (Unaudited)For the period from December 28, 2003 through July 30, 2004(Predecessor)(in thousands)**

| ** **                                      | ** ** | **Duane**           | ** ** | **Duane**         | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Duane Reade Inc.** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|--------------------------------|------------|
| ** **                                      | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**               | ** ** |
| Net sales                                       |       |                | $          | —            |       |           | $          | 927,801           |       |                           | $          | — |   |   |   | $ | — |   |   |   | $ | 927,801 |   |   |
| Cost of sales                                   |       |                | —     |              |       | 745,090        |       |              | —     |                           |       |   | — |   |   |   | 745,090 |   |   |
| Gross profit                                    |       |                | —     |              |       | 182,711        |       |              | —     |                           |       |   | — |   |   |   | 182,711 |   |   |
| Selling, general  & administrative expenses |       |                | 18         |              |       | 166,537        |       |              | (24,262    | )                              |       |   | — |   |   |   | 142,293 |   |   |
| Labor contingency                               |       |                | —     |              |       | 2,611          |       |              | —     |                           |       |   | — |   |   |   | 2,611 |   |   |
| Transaction  expense                            |       |                | —     |              |       | 3,005          |       |              | —     |                           |       |   | — |   |   |   | 3,005 |   |   |
| Depreciation and  amortization                  |       |                | —     |              |       | 21,902         |       |              | —     |                           |       |   | — |   |   |   | 21,902 |   |   |
| Store pre-opening  expense                      |       |                | —     |              |       | 470            |       |              | —     |                           |       |   | — |   |   |   | 470 |   |   |
| Operating (loss) income                         |       |                | (18        | )                 |       | (11,814        | )          |              | 24,262     |                           |       |   | — |   |   |   | 12,430 |   |   |
| Equity earnings  in affiliates                  |       |                | (3,331     | )                 |       | —         |       |              | 147        |                           |       |   | 3,184 |   |   |   | — |   |   |
| Interest expense,  net                          |       |                | —     |              |       | 7,977          |       |              | —     |                           |       |   | — |   |   |   | 7,977 |   |   |
| Income (loss) before income taxes               |       |                | 3,313      |              |       | (19,791        | )          |              | 24,115     |                           |       |   | (3,184 | ) |   |   | 4,453 |   |   |
| Income tax  (benefit) expense                   |       |                | (4         | )                 |       | (5,049         | )          |              | 6,189      |                           |       |   | — |   |   |   | 1,136 |   |   |
| Net income (loss)                               |       |                | $          | 3,317             |       |           | $          | (14,742           | )          |                           | $          | 17,926 |   |   |   | $ | (3,184 | ) |   |   | $ | 3,317 |   |   |

 

23

----

**DUANE READEHOLDINGS, INC.Condensed Consolidating Balance Sheet (Unaudited)As of September 24, 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                                                  |       |                    | $          | —              |       |              | $          | —         |       | $                 | 1,314      |                    |       | $ | 7 |   |   |   | $ | — |   |   |   | $ | 1,321 |   |   |
| Receivables                                           |       |                    | —     |                |       | (126,989          | )          | 281,669        |       |              | (32,130    | )                       |       |   | (68,392 | ) |   |   | 54,158 |   |   |
| Inventories                                           |       |                    | —     |                |       | —            |       | 258,316        |       |              | —     |                    |       |   | — |   |   |   | 258,316 |   |   |
| Deferred income  taxes                                |       |                    | —     |                |       | 14,585            |       | 5,049          |       |              | (6,189     | )                       |       |   | — |   |   |   | 13,445 |   |   |
| Prepaid expenses  and other assets                    |       |                    | —     |                |       | —            |       | 22,819         |       |              | —     |                    |       |   | — |   |   |   | 22,819 |   |   |
| Total current  assets                                 |       |                    | —     |                |       | (112,404          | )          | 569,167        |       |              | (38,312    | )                       |       |   | (68,392 | ) |   |   | 350,059 |   |   |
| Investment in  affiliates                             |       |                    | 145,210    |                |       | (47,246           | )          | —         |       |              | (1,682     | )                       |       |   | (96,282 | ) |   |   | — |   |   |
| Property and  equipment                               |       |                    | —     |                |       | —            |       | 230,102        |       |              | —     |                    |       |   | — |   |   |   | 230,102 |   |   |
| Goodwill, net                                         |       |                    | —     |                |       | —            |       | 52,216         |       |              | —     |                    |       |   | — |   |   |   | 52,216 |   |   |
| Deferred income  taxes                                |       |                    | —     |                |       | 1,645             |       | 9,032          |       |              | (10,677    | )                       |       |   | — |   |   |   | — |   |   |
| Other assets                                          |       |                    | —     |                |       | 17,015            |       | 277,299        |       |              | 259,857    |                    |       |   | (279,443 | ) |   |   | 274,728 |   |   |
| Total assets                                          |       |                    | $          | 145,210             |       |              | $          | (140,990       | )          | $                 | 1,137,816  |                    |       | $ | 209,186 |   |   |   | $ | (444,117 | ) |   |   | $ | 907,105 |   |   |
| Liabilities and Stockholder’s Equity             |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |
| Current liabilities                                   |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |
| Accounts payable                                      |       |                    | $          | —              |       |              | $          | —         |       | $                 | 73,140     |                    |       | $ | — |   |   |   | $ | — |   |   |   | $ | 73,140 |   |   |
| Accrued interest                                      |       |                    | —     |                |       | —            |       | 3,636          |       |              | —     |                    |       |   | — |   |   |   | 3,636 |   |   |
| Accrued expenses                                      |       |                    | —     |                |       | (137              | )          | 39,439         |       |              | —     |                    |       |   | — |   |   |   | 39,302 |   |   |
| Current portion of  debt                              |       |                    | —     |                |       | —            |       | 139,760        |       |              | —     |                    |       |   | — |   |   |   | 139,760 |   |   |
| Current portion of  capital lease obligation     |       |                    | —     |                |       | —            |       | 3,089          |       |              | —     |                    |       |   | — |   |   |   | 3,089 |   |   |
| Total current  liabilities                            |       |                    | —     |                |       | (137              | )          | 259,064        |       |              | —     |                    |       |   | — |   |   |   | 258,927 |   |   |
| Long term debt                                        |       |                    | —     |                |       | —            |       | 668,309        |       |              | —     |                    |       |   | (265,417 | ) |   |   | 402,892 |   |   |
| Capital lease  obligation, less current portion       |       |                    | —     |                |       | —            |       | 11,146         |       |              | —     |                    |       |   | — |   |   |   | 11,146 |   |   |
| Deferred income  taxes                                |       |                    | —     |                |       | 70,227            |       | (87,236        | )          |              | 37,653     |                    |       |   | — |   |   |   | 20,644 |   |   |
| Other non-current  liabilities                        |       |                    | —     |                |       | 2,565             |       | 65,647         |       |              | —     |                    |       |   | — |   |   |   | 68,212 |   |   |
| Total liabilities                                     |       |                    | —     |                |       | 72,655            |       | 916,930        |       |              | 37,653     |                    |       |   | (265,417 | ) |   |   | 761,821 |   |   |
| Stockholder’s equity                             |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |
| Common stock                                          |       |                    | 26         |                |       | —            |       | 26             |       |              | —     |                    |       |   | (26 | ) |   |   | 26 |   |   |
| Paid-in-capital                                       |       |                    | 239,472    |                |       | 17,015            |       | 321,890        |       |              | —     |                    |       |   | (338,905 | ) |   |   | 239,472 |   |   |
| Accumulated other  comprehensive income               |       |                    | —     |                |       | —            |       | 74             |       |              | —     |                    |       |   | — |   |   |   | 74 |   |   |
| Retained earnings                                     |       |                    | (94,288    | )                   |       | (230,660          | )          | (101,104       | )          |              | 171,533    |                    |       |   | 160,231 |   |   |   | (94,288 | ) |   |
| Total stockholder’s  equity                      |       |                    | 145,210    |                |       | (213,645          | )          | 220,886        |       |              | 171,533    |                    |       |   | (178,700 | ) |   |   | 145,284 |   |   |
| Total liabilities and  stockholder’s equity |       |                    | $          | 145,210             |       |              | $          | (140,990       | )          | $                 | 1,137,816  |                    |       | $ | 209,186 |   |   |   | $ | (444,117 | ) |   |   | $ | 907,105 |   |   |

 

24

----

**DUANE READEHOLDINGS, INC.Condensed Consolidating Balance Sheet (Unaudited)As of December 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  Stockholder’s 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 |   |   |
| Stockholder’s 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 stockholder’s  equity                 |       |                    | 184,049    |                |       | (175,930          | )          | 280,532        |       | 152,361           |       |                    | (256,963   | ) |   |   | 184,049 |   |   |
| Total liabilities and  stockholder’s equity |       |                    | $          | 184,049             |       |              | $          | (107,516       | )          | $                 | 1,204,090  |                    | $          | 173,891 |   |   | $ | (514,355 | ) |   |   | $ | 940,159 |   |   |

 

25

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**DUANEREADE HOLDINGS, INC.Condensed Consolidating Statement of Cash Flows (Unaudited)For the 39 weeks ended September 24, 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)                                                                                                     |       |                    | $          | (38,839             | )          |              |       | $              | (38,839    | )                 |       | $                       | (58,594    | ) |   | $ | 19,169 |   |   |   | $ | 78,264 |   |   |   | $ | (38,839 | ) |   |
| Adjustments  to reconcile net income (loss) to net cash (used in) / provided  by operating activities: |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Depreciation and amortization of property and  equipment                                                         |       |                    | —     |                |       |              | —     |           |       | 56,082            |       |                    | —     |   |   |   | — |   |   |   | 56,082 |   |   |
| Deferred tax provision                                                                                                |       |                    | —     |                |       |              | —     |           |       | (47,829           | )          |                    | 16,125     |   |   |   | (40 | ) |   |   | (31,744 | ) |   |
| Deferred rent expense                                                                                                 |       |                    | —     |                |       |              | —     |           |       | 10,132            |       |                    | —     |   |   |   | — |   |   |   | 10,132 |   |   |
| Other                                                                                                                 |       |                    | 38,839     |                |       |              | 38,839     |           |       | (2,104            | )          |                    | 586        |   |   |   | (78,264 | ) |   |   | (2,104 | ) |   |
| Changes  in operating assets and liabilities:                                                                         |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Receivables                                                                                                           |       |                    | —     |                |       |              | 137        |           |       | 31,601            |       |                    | (27,880    | ) |   |   | 40 |   |   |   | 3,898 |   |   |
| Inventories                                                                                                           |       |                    | —     |                |       |              | —     |           |       | 4,466             |       |                    | —     |   |   |   | — |   |   |   | 4,466 |   |   |
| Accounts payable                                                                                                      |       |                    | —     |                |       |              | —     |           |       | (6,589            | )          |                    | —     |   |   |   | — |   |   |   | (6,589 | ) |   |
| Prepaid and accrued expenses                                                                                          |       |                    | —     |                |       |              | (137       | )              |       | (11,951           | )          |                    | —     |   |   |   | — |   |   |   | (12,088 | ) |   |
| Increase in other assets (liabilities), net                                                                      |       |                    | —     |                |       |              | —     |           |       | 14,299            |       |                    | (8,025     | ) |   |   | — |   |   |   | 6,274 |   |   |
| NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES                                                                   |       |                    | —     |                |       |              | —     |           |       | (10,487           | )          |                    | (25        | ) |   |   | — |   |   |   | (10,512 | ) |   |
| Capital expenditures                                                                                                  |       |                    | —     |                |       |              | —     |           |       | (18,386           | )          |                    | —     |   |   |   | — |   |   |   | (18,386 | ) |   |
| Lease acquisition and other costs                                                                                     |       |                    | —     |                |       |              | —     |           |       | (6,904            | )          |                    | —     |   |   |   | — |   |   |   | (6,904 | ) |   |
| Proceeds from sale of property                                                                                        |       |                    | —     |                |       |              | —     |           |       | 7,069             |       |                    | —     |   |   |   | — |   |   |   | 7,069 |   |   |
| NET CASH USED IN INVESTING ACTIVITIES                                                                                 |       |                    | —     |                |       |              | —     |           |       | (18,221           | )          |                    | —     |   |   |   | — |   |   |   | (18,221 | ) |   |
| Cash  flows from financing activities:                                                                                |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Proceeds from senior secured notes                                                                                    |       |                    | —     |                |       |              | —     |           |       | 47,860            |       |                    | —     |   |   |   | — |   |   |   | 47,860 |   |   |
| Deferred financing costs                                                                                              |       |                    | —     |                |       |              | —     |           |       | (2,942            | )          |                    | —     |   |   |   | — |   |   |   | (2,942 | ) |   |
| Borrowings from revolving credit facility                                                                             |       |                    | —     |                |       |              | —     |           |       | 1,339,509         |       |                    | —     |   |   |   | — |   |   |   | 1,339,509 |   |   |
| Repayments of revolving credit  facility                                                                              |       |                    | —     |                |       |              | —     |           |       | (1,353,619        | )          |                    | —     |   |   |   | — |   |   |   | (1,353,619 | ) |   |
| Repayments of capital lease obligations                                                                          |       |                    | —     |                |       |              | —     |           |       | (2,083            | )          |                    | —     |   |   |   | — |   |   |   | (2,083 | ) |   |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                                                             |       |                    | —     |                |       |              | —     |           |       | 28,725            |       |                    | —     |   |   |   | — |   |   |   | 28,725 |   |   |
| Net (decrease) increase in cash                                                                                       |       |                    | —     |                |       |              | —     |           |       | 17                |       |                    | (25        | ) |   |   | — |   |   |   | (8 | ) |   |
| Cash at beginning of period                                                                                           |       |                    | —     |                |       |              | —     |           |       | 1,297             |       |                    | 32         |   |   |   | — |   |   |   | 1,329 |   |   |
| Cash at end of  period                                                                                                |       |                    | $          | —              |       |              |       | $              | —     |              |       | $                       | 1,314      |   |   | $ | 7 |   |   |   | $ | — |   |   |   | $ | 1,321 |   |   |

 

26

----

**DUANE READEHOLDINGS, INC.Condensed Consolidating Statement of Cash Flows (Unaudited)For the period from July 31, 2004 through September 25, 2004(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)                                                                                     |       |                    | $          | (38,038             | )          |              |       | $              | (38,038    | )                 |       |                    | $          | (41,991 | ) |   |   | $ | 3,534 |   |   |   | $ | 76,495 |   |   |   | $ | (38,038 | ) |   |
| Adjustments to reconcile net income (loss) to net  cash (used in) / provided by operating activities: |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Depreciation and  amortization of property and equipment                                         |       |                    | —     |                |       |              | —     |           |       |              | 8,011      |                    |       |   | — |   |   |   | — |   |   |   | 8,011 |   |   |
| Deferred tax provision                                                                                |       |                    | —     |                |       |              | (1         | )              |       |              | (35,848    | )                       |       |   | 3,376 |   |   |   | — |   |   |   | (32,473 | ) |   |
| Other                                                                                                 |       |                    | 38,038     |                |       |              | 38,037     |           |       |              | 2,488      |                    |       |   | 420 |   |   |   | (76,495 | ) |   |   | 2,488 |   |   |
| Changes in operating assets and liabilities:                                                          |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Receivables                                                                                           |       |                    | —     |                |       |              | 67         |           |       |              | 956        |                    |       |   | 3 |   |   |   | — |   |   |   | 1,026 |   |   |
| Inventories                                                                                           |       |                    | —     |                |       |              | —     |           |       |              | (7,521     | )                       |       |   | — |   |   |   | — |   |   |   | (7,521 | ) |   |
| Accounts payable                                                                                      |       |                    | —     |                |       |              | —     |           |       |              | 14,842     |                    |       |   | — |   |   |   | — |   |   |   | 14,842 |   |   |
| Prepaid and accrued  expenses                                                                         |       |                    | —     |                |       |              | (65        | )              |       |              | 27,605     |                    |       |   | — |   |   |   | — |   |   |   | 27,540 |   |   |
| Increase in other assets  (liabilities), net                                                          |       |                    | —     |                |       |              | —     |           |       |              | 8,779      |                    |       |   | (6,650 | ) |   |   | — |   |   |   | 2,129 |   |   |
| NET CASH PROVIDED BY  (USED IN) OPERATING ACTIVITIES                                                  |       |                    | —     |                |       |              | —     |           |       |              | (22,679    | )                       |       |   | 683 |   |   |   | — |   |   |   | (21,996 | ) |   |
| Capital expenditures                                                                                  |       |                    | —     |                |       |              | —     |           |       |              | (4,571     | )                       |       |   | — |   |   |   | — |   |   |   | (4,571 | ) |   |
| Lease acquisition and  other costs                                                                    |       |                    | —     |                |       |              | —     |           |       |              | (7,633     | )                       |       |   | — |   |   |   | — |   |   |   | (7,633 | ) |   |
| Acquisition of Duane  Reade                                                                           |       |                    | —     |                |       |              | —     |           |       |              | (413,684   | )                       |       |   | — |   |   |   | — |   |   |   | (413,684 | ) |   |
| NET CASH USED IN  INVESTING  ACTIVITIES                                                               |       |                    | —     |                |       |              | —     |           |       |              | (425,888   | )                       |       |   | — |   |   |   | — |   |   |   | (425,888 | ) |   |
| Cash flows from financing activities:                                                                 |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Proceeds from sale of  common  stock                                                                  |       |                    | —     |                |       |              | —     |           |       |              | 239,498    |                    |       |   | — |   |   |   | — |   |   |   | 239,498 |   |   |
| Proceeds from term notes                                                                              |       |                    | —     |                |       |              | —     |           |       |              | 155,000    |                    |       |   | — |   |   |   | — |   |   |   | 155,000 |   |   |
| Proceeds from senior  subordinated notes                                                              |       |                    | —     |                |       |              | —     |           |       |              | 195,000    |                    |       |   | — |   |   |   | — |   |   |   | 195,000 |   |   |
| Deferred financing costs                                                                              |       |                    | —     |                |       |              | —     |           |       |              | (12,049    | )                       |       |   | — |   |   |   | — |   |   |   | (12,049 | ) |   |
| Repurchase of convertible  notes                                                                      |       |                    | —     |                |       |              | —     |           |       |              | (201,000   | )                       |       |   | — |   |   |   | — |   |   |   | (201,000 | ) |   |
| Borrowings from revolving  credit facility                                                            |       |                    | —     |                |       |              | —     |           |       |              | 415,047    |                    |       |   | — |   |   |   | — |   |   |   | 415,047 |   |   |
| Repayments of revolving  credit facility                                                              |       |                    | —     |                |       |              | —     |           |       |              | (343,453   | )                       |       |   | — |   |   |   | — |   |   |   | (343,453 | ) |   |
| Repayments of capital  lease obligations                                                              |       |                    | —     |                |       |              | —     |           |       |              | (120       | )                       |       |   | — |   |   |   | — |   |   |   | (120 | ) |   |
| NET CASH PROVIDED BY  FINANCING  ACTIVITIES                                                           |       |                    | —     |                |       |              | —     |           |       |              | 447,923    |                    |       |   | — |   |   |   | — |   |   |   | 447,923 |   |   |
| Net (decrease)  increase in cash                                                                      |       |                    | —     |                |       |              | —     |           |       |              | (644       | )                       |       |   | 683 |   |   |   | — |   |   |   | 39 |   |   |
| Cash at beginning  of period                                                                          |       |                    | —     |                |       |              | —     |           |       |              | 1,279      |                    |       |   | 59 |   |   |   | — |   |   |   | 1,338 |   |   |
| Cash at end of  period                                                                                |       |                    | $          | —              |       |              |       | $              | —     |              |       |                    | $          | 635 |   |   |   | $ | 742 |   |   |   | $ | — |   |   |   | $ | 1,377 |   |  |

 

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**DUANE READE INC.Condensed Consolidating Statement of Cash Flows (Unaudited)For the period from December 28, 2003 through July 30, 2004(Predecessor)(in thousands)**

| ** **                                                                                            | ** ** | **Duane**           | ** ** | **Duane**         | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Duane Reade Inc.** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|--------------------------------|------------|
| ** **                                                                                            | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**               | ** ** |
| Cash flows from operating  activities:                                                                |       |                |       |              |       |           |       |              |       |                           |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                                     |       |                | $          | 3,317             |       |           | $          | (14,742           | )          |                           | $          | 17,926 |   |   |   | $ | (3,184 | ) |   |   | $ | 3,317 |   |   |
| Adjustments to reconcile  net income (loss) to net cash (used in) / provided by operating activities: |       |                |       |              |       |           |       |              |       |                           |       |   |   |   |   |   |   |   |   |
| Depreciation and  amortization of property and equipment                                              |       |                | —     |              |       | 23,003         |       |              | —     |                           |       |   | — |   |   |   | 23,003 |   |   |
| Deferred tax  provision                                                                               |       |                | 4,760      |              |       | (5,049         | )          |              | 6,189      |                           |       |   | — |   |   |   | 5,900 |   |   |
| Other                                                                                                 |       |                | (3,331     | )                 |       | 4,383          |       |              | 147        |                           |       |   | 3,184 |   |   |   | 4,383 |   |   |
| Changes in operating  assets and liabilities:                                                         |       |                |       |              |       |           |       |              |       |                           |       |   |   |   |   |   |   |   |   |
| Receivables                                                                                           |       |                | (6,426     | )                 |       | 3,369          |       |              | —     |                           |       |   | — |   |   |   | (3,057 | ) |   |
| Inventories                                                                                           |       |                | —     |              |       | 4,385          |       |              | —     |                           |       |   | — |   |   |   | 4,385 |   |   |
| Accounts payable                                                                                      |       |                | —     |              |       | (20,047        | )          |              | —     |                           |       |   | — |   |   |   | (20,047 | ) |   |
| Prepaid and  accrued expenses                                                                         |       |                | 554        |              |       | 193            |       |              | —     |                           |       |   | — |   |   |   | 747 |   |   |
| Increase in other  assets (liabilities), net                                                     |       |                | —     |              |       | 27,172         |       |              | (24,251    | )                              |       |   | — |   |   |   | 2,921 |   |   |
| NET CASH PROVIDED  BY (USED IN) OPERATING ACTIVITIES                                                  |       |                | (1,126     | )                 |       | 22,667         |       |              | 11         |                           |       |   | — |   |   |   | 21,552 |   |   |
| Capital  expenditures                                                                                 |       |                | —     |              |       | (17,552        | )          |              | —     |                           |       |   | — |   |   |   | (17,552 | ) |   |
| Lease acquisition  and other costs                                                                    |       |                | —     |              |       | (14,925        | )          |              | —     |                           |       |   | — |   |   |   | (14,925 | ) |   |
| NET CASH USED IN  INVESTING ACTIVITIES                                                                |       |                | —     |              |       | (32,477        | )          |              | —     |                           |       |   | — |   |   |   | (32,477 | ) |   |
| Cash flows from financing activities:                                                                 |       |                |       |              |       |           |       |              |       |                           |       |   |   |   |   |   |   |   |   |
| Deferred financing  costs                                                                             |       |                | —     |              |       | (841           | )          |              | —     |                           |       |   | — |   |   |   | (841 | ) |   |
| Borrowings from  revolving credit facility                                                            |       |                | —     |              |       | 941,503        |       |              | —     |                           |       |   | — |   |   |   | 941,503 |   |   |
| Repayments of  revolving credit facility                                                              |       |                | —     |              |       | (930,511       | )          |              | —     |                           |       |   | — |   |   |   | (930,511 | ) |   |
| Proceeds from  exercise of stock options                                                              |       |                | 1,126      |              |       | —         |       |              | —     |                           |       |   | — |   |   |   | 1,126 |   |   |
| Repayments of  capital lease obligations                                                              |       |                | —     |              |       | (266           | )          |              | —     |                           |       |   | — |   |   |   | (266 | ) |   |
| NET CASH PROVIDED  BY FINANCING ACTIVITIES                                                            |       |                | 1,126      |              |       | 9,885          |       |              | —     |                           |       |   | — |   |   |   | 11,011 |   |   |
| Net (decrease)  increase in cash                                                                      |       |                | —     |              |       | 75             |       |              | 11         |                           |       |   | — |   |   |   | 86 |   |   |
| Cash at beginning  of period                                                                          |       |                | —     |              |       | 1,204          |       |              | 48         |                           |       |   | — |   |   |   | 1,252 |   |   |
| Cash at end of period                                                                                 |       |                | $          | —            |       |           | $          | 1,279             |       |                           | $          | 59 |   |   |   | $ | — |   |   |   | $ | 1,338 |   |   |

 

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**ITEM 2.**                MANAGEMENT’SDISCUSSION AND 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,photofinishing services, photo supplies and seasonal and general merchandise.Health and beauty care products, including over-the-counter items, representour highest volume categories within front-end sales. The front-end portion ofour business represented 51.9% and 51.2% of our sales in the quarter and ninemonths ended September 24, 2005, respectively, and is characterized bygenerally higher gross margins that are approximately twice that of ourpharmacy 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%. Historically, front-endsales have represented a decreasing share of business year after year, however,over the last few years, pharmacy sales have experienced a declining rate ofgrowth. Our pharmacy sales include all items we sell by prescription filled atour retail locations or by our central fill facility and delivered to ourstores or direct to customers. In addition, we include in our pharmacy salescertain resales of retail pharmaceutical inventory. The pharmacy portion of ourbusiness is dominated by and dependent upon a number of third party private andgovernment-sponsored plans that contract with us as an authorized provider ofprescriptions.

Sales to third party prescription plans represented92.7% and 92.6% of our prescription sales in the quarter and nine months endedSeptember 24, 2005, respectively. Historically, excluding pharmacy resaleactivity, our pharmacy sales experienced a faster rate of sales growth than thefront-end portion of our business due to a number of favorable demographic andindustry trends such as the aging of the population, expanded penetration ofthird party private and government-sponsored coverage and the increasingutilization of prescriptions to improve quality of life and in place of medicalprocedures.  While these factors arestill operative, our rate of non-resale pharmacy sales growth has steadilydeclined over the last two and a half years to the point where our most recentpharmacy sales results reflect a lower rate of growth than the front-endportion of our business. This slower pharmacy sales growth is the result ofincreased mail order penetration (that results in losses of retail basedprescription sales to mail order providers), negative publicity surrounding theadverse side effects of certain arthritis medications and other high volumedrugs, conversion of certain high volume prescription drugs to over-the-counterfront-end products and increased use of lower priced but more profitablegeneric drugs in place of higher priced branded medications.

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 as a means of providing limited benefits to seniorcitizens until the full Medicare program takes effect in 2006. This temporaryprogram has also resulted in lower pharmacy margins than those previouslyrealized on prescriptions that were not subject to 

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third party planreimbursement. Based on our experience, we expect, over time, that increasedutilization of prescription drugs by senior citizens participating in the newprograms (that previously were cash paying customers) will offset the effect oflower margins on our revenues, however there can be no assurance that this willbe the case. State Medicaid programs that provide prescription benefits to lowincome households and individuals represent approximately 23% of our retailpharmacy sales.

In fiscal 2003 and again in fiscal 2004, New YorkState reduced Medicaid and Elderly Pharmaceutical Insurance Coverage (EPIC)prescription reimbursement rates, adversely impacting our pharmacy grossmargins. The most recent reductions became effective on October 1, 2004,and are expected to reduce reimbursements by approximately $1.4 million onan annual basis. New Jersey also implemented reduced Medicaid reimbursementrates in 2003. The New York State legislature has also recently approvedincreases in co-payments by $1.00 per prescription for branded drugs and $0.50per prescription for generics effective August 1, 2005. Under the Medicaidguidelines, providers cannot refuse to dispense prescriptions to Medicaidrecipients who claim that they do not have the means to pay the requiredco-payments. Most Medicaid recipients decline to make the co-payments, resultingin the requirement for the provider to absorb this cost. These increasedco-payments for New York Medicaid are expected to result in further reducedreimbursements of approximately $1.4 million per year. Recently, Congresshas been considering certain additional changes to reduce reimbursementformulas for state Medicaid programs. These changes, if enacted and passed onto providers through the state reimbursement formulas, would adversely impactour future pharmacy gross margins.

In an effort to offset some of the adverse pharmacygross margin impacts from the trends discussed above, there has been anintensified effort on the part of retailers to support increased utilization oflower priced but higher margin generic prescriptions in place of branded medications.Improved generic utilization rates as well as increased purchases direct frommanufacturers rather than through wholesalers enabled us to achieve improvedgross margins on pharmacy retail sales during 2004 and throughout 2005.

We are also impacted by recent state legislation aimedat increasing the minimum hourly wage. New York State increased the minimumhourly wage from $5.15 to $6.00 on January 1, 2005 with further scheduledincreases to $6.75 on January 1, 2006 and $7.15 on January 1, 2007. TheNew Jersey legislature has approved 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 our cost of labor, we believe we can offset asignificant portion of these cost increases through initiatives designed tofurther improve our labor efficiency.

We operate approximately 87% of our 249 stores in NewYork City and the remainder in the surrounding areas, and our financialperformance is therefore heavily influenced by the local economy. We analyze anumber of economic indicators specific to New York City to gauge the health ofthis economy, including unemployment rates, job creation, gross city productand bridge and tunnel commuter traffic patterns. We also analyze market sharedata, same-store sales trends, average store sales and sales per square footdata among other key performance indicators to monitor our overall performance.During 2004 and 2005, the New York City economy generally reflected animproving 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 DuaneReade GP and all of the outstanding common stock of DRI I Inc. DRII Inc. owns the remaining 1% partnership interest in Duane Reade GP.Substantially all of our operations are conducted through Duane Reade GP.In August 1999, we established two new subsidiaries, DuaneReade International, Inc. and Duane Reade Realty, Inc.Duane Reade GP distributed to Duane Reade Inc. and DRI I Inc.all rights, title, and interest in all its trademarks, trade names and allother intellectual property rights. In turn, Duane Reade Inc. andDRI I Inc. made a capital contribution of these intellectual propertyrights to Duane Reade International. 

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Thischange created a controlled system to manage and exploit these intellectualproperty rights separate and apart from the retail operations. In addition,Duane Reade GP distributed some of its store leases to DuaneReade Inc. and DRI I Inc., which in turn made a capital contributionof these leases to Duane Reade Realty. Duane Reade Realty is thelessee under certain store leases entered into after its creation. Duane Reade Realtysubleases to Duane Reade GP the properties subject to those leases. Theconsolidated financial statements included in this filing reflect the accountsof Duane Reade Holdings, Inc. and its subsidiaries. All significantintercompany transactions and balances have been eliminated.

**New York City Economy**

Between 2001 and 2003, theNew York 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 and overall commerce relative to the last few years. The September 2005unemployment data for New York City indicated an unemployment rate of 5.9%,compared to a national rate of 5.1%.

**Results of Operations**

As a result of theAcquisition and resulting change in control, under U.S. GAAP we are required topresent separately the operating results for the predecessor periods in the2004 fiscal year (June 27, 2004 through July 30, 2004 and December 28,2003 through July 30, 2004) and the successor period in the 2004 fiscalyear (July 31, 2004 through September 25, 2004). In the followingdiscussion, these are compared to the full fiscal third quarter andyear-to-date successor periods ended September 24, 2005. Management believesthis is the most practical way in which to comment on the results ofoperations.

**The Thirteen Weeks Ended September 24, 2005 forthe Successor as Compared to the Period from June 27, 2004 through July 30,2004 for the Predecessor and the Period from July 31, 2004 through September 25,2004 for the Successor**

For the third quarter of 2005, we achieved net salesof $378.6 million and sustained a net loss of $15.7 million, ascompared to net sales of $238.1 million and a net loss of$38.0 million in the period from July 31, 2004 through September 25,2004 and net sales of $142.4 and a net loss of $1.0 million in the period from June 27,2004 through July 30, 2004.

The prior year’saggregate net loss of $39.0 million included pre-tax charges of:

·       $37.5million, associated with expenses related to the Acquisition, and

·       $25.3million, primarily related to our exercise of our option to terminate ourobligations under the Chairman’s supplemental executive retirement plan.

The current year’snet loss of $15.7 million reflects:

·       increasednon-cash depreciation and amortization expenses of $6.9 million, resulting fromthe application of purchase accounting related to the Acquisition,

·       increasedinterest expense of $5.1 million associated with higher debt levels primarilyresulting from the debt incurred as part of the Acquisition, and

·       higherselling, general and administrative expenses of $6.8 million, primarilyattributable to increased consulting and litigation-related legal expenses andincreased pharmacy labor costs.

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Thefollowing sets forth the results of operations for the periods indicated:

| ** **                                           | ** ** | **Successor**                                       | ** ** | ** **                       | ** ** | **Predecessor** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------|------------|-----------------|------------|
| ** **                                           | ** ** | ** **                                          | ** ** | **Period from**             | ** ** | ** **      | ** ** | **Period from** | ** ** |
| ** **                                           | ** ** | ** **                                          | ** ** | **July 31, 2004**      | ** ** | ** **      | ** ** | **June 27, 2004** | ** ** |
| ** **                                           | ** ** | **3 Months Ended**                        | ** ** | **through**                      | ** ** | ** **      | ** ** | **through** | ** ** |
| ** **                                           | ** ** | **September 24, 2005**                    | ** ** | **September 25, 2004** | ** ** | ** **      | ** ** | **July 30, 2004** | ** ** |
| ** **                                           | ** ** | **Dollars**                                         | ** ** | **% of Sales**         | ** ** | **Dollars**     | ** ** | **% of Sales** | ** ** | ** ** | ** ** | **Dollars** | ** ** | **% of Sales** | ** ** |
| ** **                                           | ** ** | **In thousands, except percentages** | ** ** |
| Net sales                                            |       | $                                                   | 378,557    |                             |       | 100.0           | %          |   | $ | 238,050 |   |   | 100.0 | % |   |   |   | $ | 142,379 |   |   | 100.0 | % |   |
| Cost of sales                                        |       | 305,866                                             |       |                             | 80.8       |            |       | 194,116 |   |   | 81.5 |   |   |   |   | 115,557 |   |   | 81.2 |   |   |
| Gross profit                                         |       | 72,691                                              |       |                             | 19.2       |            |       | 43,934 |   |   | 18.5 |   |   |   |   | 26,822 |   |   | 18.8 |   |   |
| Selling,  general & administrative expenses |       | 67,950                                              |       |                             | 17.9       |            |       | 37,418 |   |   | 15.7 |   |   |   |   | 23,726 |   |   | 16.7 |   |   |
| Labor contingency  expense                           |       | 1,100                                               |       |                             | 0.3        |            |       | 689 |   |   | 0.3 |   |   |   |   | 411 |   |   | 0.3 |   |   |
| Transaction  expense                                 |       | 236                                                 |       |                             | 0.1        |            |       | 37,118 |   |   | 15.6 |   |   |   |   | 386 |   |   | 0.3 |   |   |
| Depreciation and  amortization                       |       | 17,816                                              |       |                             | 4.7        |            |       | 7,280 |   |   | 3.1 |   |   |   |   | 3,596 |   |   | 2.5 |   |   |
| Store pre-opening  expenses                          |       | 114                                                 |       |                             | 0.0        |            |       | 366 |   |   | 0.2 |   |   |   |   | 105 |   |   | 0.1 |   |   |
| Other                                                |       | 1,454                                               |       |                             | 0.4        |            |       | 25,291 |   |   | 10.6 |   |   |   |   | — |   |   | — |   |   |
|                                                 |       | 88,670                                              |       |                             | 23.4       |            |       | 108,162 |   |   | 45.4 |   |   |   |   | 28,224 |   |   | 19.8 |   |   |
| Operating (loss)  income                             |       | (15,979                                             | )          |                             | (4.2       | )               |       | (64,228 | ) |   | (27.0 | ) |   |   |   | (1,402 | ) |   | (1.0 | ) |   |
| Interest expense,  net                               |       | 12,654                                              |       |                             | 3.3        |            |       | 6,283 |   |   | 2.6 |   |   |   |   | 1,283 |   |   | 0.9 |   |   |
| (Loss) income  before income taxes                   |       | (28,633                                             | )          |                             | (7.6       | )               |       | (70,511 | ) |   | (29.6 | ) |   |   |   | (2,685 | ) |   | (1.9 | ) |   |
| Income tax  (benefit) provision                      |       | (12,885                                             | )          |                             | (3.4       | )               |       | (32,473 | ) |   | (13.6 | ) |   |   |   | (1,714 | ) |   | (1.2 | ) |   |
| Net (loss) income                                    |       | $                                                   | (15,748    | )                                |       | (4.2            | )%         |   | $ | (38,038 | ) |   | (16.0 | )% |   |   |   | $ | (971 | ) |   | (0.7 | )% |   |

 

Net sales were $378.6 million in the thirteenweeks ended September 24, 2005, representing a decrease of 0.5% ascompared to aggregate net sales of $380.4 million in the thirteen weeksended September 25, 2004. While retail sales to customers grew by 2.7%over this period, the increase was more than offset by the impact of reduced pharmacyresale activity. Same-store sales increased by 2.1% over the third quarter lastyear with the balance of the increase coming from the full quarterly results ofeight net new stores opened in the third quarter last year, partially offset byfive net stores closed since the end of last year’s third quarter.

Pharmacy sales decreased to $181.9 million in thethird quarter of 2005 from an aggregate total of $191.2 million in thethird quarter of 2004, a decrease of 4.8%, and represented 48.1% of totalsales, as compared with 50.3% of total sales in the comparable period of 2004.The overall pharmacy sales decrease includes a decrease of 6.0% resulting fromthe reduced resale activity, partially offset by an increase of 1.2% in normalretail pharmacy sales. Pharmacy same-store sales increased by 0.3% over lastyear, and third-party reimbursed pharmacy sales represented 92.7% of totalprescription sales, as compared to 92.3% in the third quarter of 2004. Pharmacysame-store sales were adversely impacted by approximately 1.8% due to negativepublicity and significantly reduced consumer demand for arthritis medicationsand certain other high volume drugs and approximately 1.9% due to increasedmail order penetration resulting from conversion of certain third party plansto mandatory mail order requirements. The percentage of generic prescriptionsdispensed increased by 4.2% this year, resulting in a reduction of the pharmacysame-store sales increase by approximately 2.5%, but an increase in grossmargin per prescription dispensed. Generic prescriptions generally have lowerselling prices but are more profitable than branded prescriptions.

Front-end sales increased from an aggregate total of$189.2 million in the third quarter of 2004 to $196.6 million in thethird quarter of 2005, an increase of 3.9%, and represented 51.9% of totalsales, as compared to 49.7% of total sales in the comparable period of 2004.Front-end same-store sales increased by 3.7%, primarily due to the favorableimpact of the improved Dollar Rewards customer loyalty card 

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promotional program, agenerally improved level of consumer demand and the sales disruptions in theprior year associated with the Republican National Convention.

During the thirteen weeks ended September 24,2005, we opened two stores and closed three stores, as compared to seven storesopened and one store closed during the period from July 31, 2004 through September 25,2004 and two stores opened during the period from June 27, 2004 through July 30,2004. At September 24, 2005, we operated 249 stores, as compared to 255stores at September 25, 2004.

Cost of sales as a percentage of net sales was 80.8%in the third quarter of 2005, resulting in a gross profit margin of 19.2%. Inthe period from July 31, 2004 through September 25, 2004, cost ofsales as a percentage of net sales was 81.5%, and in the period from June 27,2004 through July 30, 2004, cost of sales as a percentage of net sales was81.2%, resulting in gross profit margins of 18.5% and 18.8%, respectively. Theimprovement in gross profit margin as compared to last year’s aggregate figureof 18.6% was primarily attributable to a reduced level of pharmacy resaleactivity. Pharmacy resales generally experience gross margins of less than 1%.Excluding pharmacy resale activity, gross margins were flat against theprevious year. Lower front-end product margins associated with reduced vendorallowances and increased inventory shrink losses were offset by increasedpharmacy margins associated with increased generic dispensing rates and thebenefits of direct purchases. Store occupancy expenses in the current period includenon-cash rent expense of $3.2 million, or 0.9% of sales, as compared to $3.0million, or 0.8% of sales, in the comparable prior year period. Cost of salesalso includes (i) a $0.3 million LIFO provision in the third quarterof both the current and prior years, and (ii) real-estate related incomeof $2.2 million in the third quarter of 2005 as compared to an aggregatetotal of $0.1 million in the third quarter of 2004.

Selling, general and administrative expenses were$68.0 million, or 17.9% of net sales in the third quarter of 2005, ascompared to $37.4 million, or 15.7% of net sales, in the period from July 31,2004 through September 25, 2004 and $23.7 million, or 16.7% of net sales,in the period from June 27, 2004 through July 30, 2004. The increasein these expense ratios to sales as compared to the prior year primarilyreflects the reduced pharmacy resale activity in the current year (whichreduces net sales and adversely impacts the SG&A expense ratio), increasedconsulting and litigation related expenses, as well as increased labor costsfor pharmacists and increases in the New York minimum wage rates whichincreased our front-end labor costs.

Depreciation and amortization of property andequipment and intangible assets amounted to $17.8 million in the thirdquarter of 2005, as compared to $7.3 million and $3.6 million for the July 31,2004 through September 25, 2004 and June 27, 2004 through July 30,2004 periods, respectively. 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 million in the third quarter of 2005, related to the opening of twostores. In the period from July 31, 2004 through September 25, 2004,we incurred store pre-opening expenses of $0.4 million, and in the periodfrom June 27, 2004 through July 30, 2004, we incurred storepre-opening expenses of $0.1 million, related to the opening of seven storesand two stores, respectively,

During the 13 weeks ended September 24, 2005 andthe period from July 31, 2004 through September 25, 2004, we recordedother expenses of $1.5 million and $25.3 million, respectively, resulting fromthe completion of the Acquisition. In 2005, these expenses include (i) $0.2million attributable to the CEO’s annual $0.9 million long-term cash award, (ii) $0.3million related to the annual $1.25 million management fee payable to Oak Hill,(iii) $0.7 million representing a portion of the anticipated cost oftransferring the ownership of a split dollar life insurance policy to the CEOin July 2006 and (iv) $0.2 million reflecting an allocation ofthe expenses associated with the implementation of a tax 

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indemnity insurance policyrelated to the deductibility of certain payments made to the CEO in connectionwith the Acquisition. In 2004, these expenses consist of (i) $0.2 millionattributable to the CEO’s annual $0.9 million long-term cash award, (ii) $0.2million related to the annual $1.25 million management fee payable to Oak Hill,(iii) $0.4 million representing a portion of the anticipated cost oftransferring the ownership of a split dollar life insurance policy to the CEOin July 2006 and (iv) $24.5 million representing the amount payableto the CEO as a result of our election to terminate our obligations under theexecutive’s Supplemental Executive Retirement Plan (SERP).

Net interest expense for the third quarter of 2005 was$12.7 million, as compared to $6.3 million in the July 31, 2004through September 25, 2004 period and $1.3 million in the June 27,2004 through July 30, 2004 period. This increase reflects the higherinterest costs and increased debt in the current year primarily resulting fromthe Acquisition. At September 24, 2005, the weighted average interest rateon our variable rate outstanding debt was 7.13%, as compared to 4.09% at September 25,2004.

In the third quarter of2005, we recorded an income tax benefit of $12.9 million, reflecting anestimated effective tax rate of 45.0%, inclusive of the anticipated benefits ofwage-based income tax credits. In the period from July 31, 2004 through September 25,2004, we recorded an income tax benefit of $32.5 million, reflecting aneffective rate of 46.1%, inclusive of the anticipated benefits of income taxcredits. In the period from June 27, 2004 through July 30, 2004, theincome tax benefit of $1.7 million reflects (i) an effective tax rate of25.5% applied to the pre-tax performance for that period and (ii) a retroactiveadjustment applied to the pre-tax results for the first six months of 2004, toreduce the effective rate from the 39.9% rate previously applied to theadjusted predecessor period 25.5% effective rate. The income tax creditsrepresent the economic benefits earned by us for our participation in variousfederal and state employment incentive programs. The increase in the currentyear’s effective rate reflects the combined impact of the income tax creditsand the pre-tax loss generated by us.

**The Thirty-Nine Weeks Ended September 24, 2005for the Successor as Compared to the Period from December 28, 2003 throughJuly 30, 2004 for the Predecessor and the Period From July 31, 2004through September 25, 2004 for the Successor**

For the first ninemonths of 2005, we achieved net sales of $1.2 billion and sustained a net lossof $38.8 million, as compared to net sales of $238.1 million and anet loss of $38.0 million in the period from July 31, 2004 through September 25,2004 and net sales of $927.8 million and net income of $3.3 million in theperiod from December 28, 2003 through July 30, 2004. The decline inearnings as compared to the prior year’s aggregate figure is due to thefollowing factors:

·       Anincrease in depreciation and amortization expense of $24.1 million fromthe Acquisition related purchase accounting adjustments to the valuation ofstore leases, prescription pharmacy files and property and equipment underFAS 141 as well as the depreciation of capital expenditures andamortization of intangibles acquired in 2004 and 2005.

·       Anincrease in interest expenses of $21.1 million primarily from the new debtincurred in connection with the Acquisition.

·       Adecline in gross margin from 19.4% in the first nine months of 2004 to 19.1% inthe first nine months of 2005. The decrease was primarily attributable to lowervendor allowances, increased inventory shrink losses, lower levels of realestate related income and increased non-cash rent expense of $3.3 million, thatwas attributable to the application of purchase accounting under FAS 141, “BusinessCombinations,” in connection with the Acquisition.

·       Increasedstore payroll costs resulting from increased labor rates for pharmacists andhigher minimum wages in New York.

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·       Increasedconsulting and litigation related expenses of $6.8 million that resultedfrom certain labor and real estate related disputes, the World Trade Centerbusiness interruption insurance claim and litigation defending new classactions.

Thefollowing sets forth the results of operations for the periods indicated:

| ** **                                           | ** ** | **Successor**                                       | ** ** | ** **                       | ** ** | **Predecessor** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------|------------|-----------------|------------|
| ** **                                           | ** ** | ** **                                          | ** ** | **Period from**             | ** ** | ** **      | ** ** | **Period from** | ** ** |
| ** **                                           | ** ** | ** **                                          | ** ** | **July 31, 2004**      | ** ** | ** **      | ** ** | **December 28, 2003** | ** ** |
| ** **                                           | ** ** | **9 Months Ended**                        | ** ** | **through**                      | ** ** | ** **      | ** ** | **through** | ** ** |
| ** **                                           | ** ** | **September 24, 2005**                    | ** ** | **September 25, 2004** | ** ** | ** **      | ** ** | **July 30, 2004** | ** ** |
| ** **                                           | ** ** | **Dollars**                                         | ** ** | **% of Sales**         | ** ** | **Dollars**     | ** ** | **% of Sales** | ** ** | ** ** | ** ** | **Dollars** | ** ** | **% of Sales** | ** ** |
| ** **                                           | ** ** | **In thousands, except percentages** | ** ** |
| Net sales                                            |       | $                                                   | 1,172,824  |                             |       | 100.0           | %          |   | $ | 238,050 |   |   | 100.0 | % |   |   |   |   | $ | 927,801 |   |   |   | 100.0 | % |   |
| Cost of sales                                        |       | 948,729                                             |       |                             | 80.9       |            |       | 194,116 |   |   | 81.5 |   |   |   |   |   | 745,090 |   |   |   | 80.3 |   |   |
| Gross profit                                         |       | 224,095                                             |       |                             | 19.1       |            |       | 43,934 |   |   | 18.5 |   |   |   |   |   | 182,711 |   |   |   | 19.7 |   |   |
| Selling,  general & administrative expenses |       | 196,990                                             |       |                             | 16.8       |            |       | 37,418 |   |   | 15.7 |   |   |   |   |   | 142,293 |   |   |   | 15.3 |   |   |
| Labor contingency  expense                           |       | 3,300                                               |       |                             | 0.3        |            |       | 689 |   |   | 0.3 |   |   |   |   |   | 2,611 |   |   |   | 0.3 |   |   |
| Transaction  expense                                 |       | 817                                                 |       |                             | 0.1        |            |       | 37,118 |   |   | 15.6 |   |   |   |   |   | 3,005 |   |   |   | 0.3 |   |   |
| Depreciation and  amortization                       |       | 53,313                                              |       |                             | 4.5        |            |       | 7,280 |   |   | 3.1 |   |   |   |   |   | 21,902 |   |   |   | 2.4 |   |   |
| Store pre-opening  expenses                          |       | 264                                                 |       |                             | 0.0        |            |       | 366 |   |   | 0.2 |   |   |   |   |   | 470 |   |   |   | 0.1 |   |   |
| Other                                                |       | 4,636                                               |       |                             | 0.4        |            |       | 25,291 |   |   | 10.6 |   |   |   |   |   | — |   |   |   | — |   |   |
|                                                 |       | 259,320                                             |       |                             | 22.1       |            |       | 108,162 |   |   | 45.4 |   |   |   |   |   | 170,281 |   |   |   | 18.4 |   |   |
| Operating (loss)  income                             |       | (35,225                                             | )          |                             | (3.0       | )               |       | (64,228 | ) |   | (27.0 | ) |   |   |   |   | 12,430 |   |   |   | 1.3 |   |   |
| Interest expense,  net                               |       | 35,318                                              |       |                             | 3.0        |            |       | 6,283 |   |   | 2.6 |   |   |   |   |   | 7,977 |   |   |   | 0.9 |   |   |
| (Loss) income  before income taxes                   |       | (70,543                                             | )          |                             | (6.0       | )               |       | (70,511 | ) |   | (29.6 | ) |   |   |   |   | 4,453 |   |   |   | 0.5 |   |   |
| Income tax  (benefit) provision                      |       | (31,704                                             | )          |                             | (2.7       | )               |       | (32,473 | ) |   | (13.6 | ) |   |   |   |   | 1,136 |   |   |   | 0.1 |   |   |
| Net (loss) income                                    |       | $                                                   | (38,839    | )                                |       | (3.3            | )%         |   | $ | (38,038 | ) |   | (16.0 | )% |   |   |   |   | $ | 3,317 |   |   |   | 0.4 | % |   |

 

Net sales were $1.2 billion in the thirty-nineweeks ended September 24, 2005, representing an increase of 0.6% ascompared to aggregate net sales of $1.2 billion in the thirty-nine weeksended September 25, 2004. Reduced resale activity accounted for a decreaseof 2.5%, while retail sales to customers increased by 3.4% over this period.Same-store sales increased by 1.4% over the first nine months of last year withthe balance of the increase coming from the full nine-month results of 14 netnew stores opened during the first nine months of 2004, partially offset by sixnet stores closed since the end of last year’s third quarter.

Pharmacy sales decreased from $585.7 million inthe first nine months of 2004 to $572.4 million in the first nine monthsof 2005, a decrease of 2.3%, and represented 48.8% of total sales, as comparedwith 50.2% of total sales in the comparable period of 2004. The overallpharmacy sales decrease includes a decrease of 5.0% resulting from the reducedresale activity, offset by an increase of 2.7% in normal retail pharmacy sales.Pharmacy same-store sales increased by 0.7% over last year, and third-partyreimbursed pharmacy sales represented 92.6% of total prescription sales, ascompared to 92.2% in the first nine months of 2004.

Front-end sales increased from $580.1 million inthe first nine months of 2004 to $600.4 million in the first nine monthsof 2005, an increase of 3.5%, and represented 51.2% of total sales, as comparedto 49.8% of total sales in the comparable period of 2004. Front-end same-storesales increased by 2.0%, primarily due to a stronger cough and cold season, theimpact of the improved Dollar Rewards loyalty card promotional program and agenerally improved level of consumer demand as well as sales disruptions in theprevious year resulting from the Republican National Convention.

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During the thirty-nine weeks ended September 24,2005, we opened five stores and closed eleven stores, as compared to sevenstores opened and one store closed during the period from July 31, 2004through September 25, 2004 and nine stores opened and one store closed forthe period from December 28, 2003 through July 30, 2004.

Cost of sales as a percentage of net sales was 80.9%in the first nine months of 2005, 81.5% in the period from July 31, 2004through September 25, 2004 and 80.3% in the period from December 28,2003 through July 30, 2004, resulting in gross profit margins of 19.1%,18.5% and 19.7%, respectively. The decrease in gross profit margin as comparedto the aggregate nine month 2004 figure of 19.4% was primarily attributable tolower levels of vendor allowances combined with higher inventory shrink lossesand increased non-cash rent expense of $3.3 million, or 0.3% of sales, that wasattributable to the application of purchase accounting under FAS 141, “BusinessCombinations,” in connection with the Acquisition. Cost of sales also includes (i) a$0.4 million LIFO provision in the current year’s first nine months ascompared to a LIFO provision of $1.0 million in the corresponding periodlast year, and (ii) real-estate related income of $2.5 million in thefirst nine months of 2005 as compared to $2.1 million in the comparable2004 period.

Selling, general and administrative expenses were$197.0 million, or 16.8% of net sales in the first nine months of 2005, ascompared to $37.4 million, or 15.7% of net sales, in the period from July 31,2004 through September 25, 2004 and $142.3 million, or 15.3% of net sales,in the period from December 28, 2003 through July 30, 2004. Theincrease in these expense ratios to sales as compared to the prior yearprimarily reflects the increased consulting and litigation related expensesincurred in the current year, as well as increased labor costs associated withthe ongoing shortage of pharmacists in the marketplace and increases in the NewYork minimum wage rates.

Depreciation and amortization of property andequipment and intangible assets amounted to $53.3 million in the firstnine months of 2005, as compared to $7.3 million and $21.9 million for theJuly 31, 2004 through September 25, 2004 and December 28, 2003through July 30, 2004 periods, respectively. This increase wasattributable to the aforementioned step-up in asset values resulting from theapplication of purchase accounting under FAS 141 that was required inconnection with the Acquisition as well as increases resulting from thedepreciation of capital expenditures made in 2004 and 2005 and amortization ofidentifiable intangibles acquired over the same period.

We incurred store pre-opening expenses of$0.3 million in the first nine months of 2005, related to the opening offive stores. In the comparable period last year, we incurred pre-opening costsof $0.9 million, attributable to the opening of sixteen stores.

During the 39 weeks ended September 24, 2005 andthe period from July 31, 2004 through September 25, 2004, we recordedother expenses of $4.6 million and $25.3 million, respectively, resulting fromthe completion of the Acquisition. In 2005, these expenses include (i) $0.7million attributable to the CEO’s annual $0.9 million long-term cash award, (ii) $0.9million related to the annual $1.25 million management fee payable to Oak Hill,(iii) $2.0 million representing a portion of the anticipated cost oftransferring the ownership of a split dollar life insurance policy to the CEOin July 2006 and (iv) $1.0 million reflecting an allocation ofthe expenses associated with the implementation of a tax indemnity insurancepolicy related to the deductibility of certain payments made to the CEO inconnection with the Acquisition. In 2004, these expenses consisted of (i) $0.2million attributable to the CEO’s annual $0.9 million long-term cashaward, (ii) $0.2 million related to the annual $1.25 million managementfee payable to Oak Hill, (iii) $0.4 million representing a portion of theanticipated cost of transferring the ownership of a split dollar life insurancepolicy to the CEO in July 2006 and (iv) $24.5 million representingthe amount payable to the CEO as a result of our election to terminate ourobligations under the executive’s Supplemental Executive Retirement Plan(SERP).

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Net interest expense for the first nine months of 2005was $35.3 million, as compared to $6.3 million in the July 31,2004 through September 25, 2004 period and $8.0 million in the December 28,2003 through July 30, 2004 period. This increase was primarilyattributable to the higher interest costs and increased debt in the currentyear that was associated with the Acquisition.

In the first nine monthsof 2005, we recorded an income tax benefit of $31.7 million, reflecting anestimated effective tax rate of 45.0%, inclusive of the anticipated benefits ofwage-based income tax credits. In the period from July 31, 2004 through September 25,2004, we recorded an income tax benefit of $32.5 million, reflecting aneffective tax rate of 46.1%, and in the period from December 28, 2003through July 30, 2004, the income tax provision of $1.1 million reflectedan effective tax rate of 25.5%, both of which were inclusive of the anticipatedbenefits of wage-based income tax credits. The income tax credits represent theeconomic benefits earned by us for our participation in various federal andstate employment incentive programs. The increase in the current year’seffective rate as compared to the prior year’s 9-month composite rate reflectsthe combined impact of the income tax credits and the reduced levels of pre-taxincome generated by us.

**Liquidity and Capital Resources**

**Working Capital and Cash Flow**

Working capital was $91.1 million as of September 24,2005 and $66.7 million as of December 25, 2004. Working capitalreflects the classification of outstanding borrowings under our asset-basedrevolving loan facility of $139.8 million at September 24, 2005 and$153.9 million at December 25, 2004 as current liabilities. Thiscurrent classification is required because cash receipts controlled by thelenders are used to reduce outstanding debt and we do not meet the criteria ofStatement of Financial Accounting Standards No. 6 “Classification of ShortTerm Obligations Expected to be Refinanced” (FAS 6) to reclassify the debt aslong-term, but is not an indication that this credit facility is expected to beretired within the next year. The asset-based revolving loan expires in July of2008, and we intend to continue to access it for our working capital needsthroughout its remaining term.

Net cash used in operating activities was$10.5 million in the thirty-nine weeks ended September 24, 2005,compared to cash used in operating activities of $22.0 million in the periodfrom July 31, 2004 through September 25, 2004 and cash provided byoperations of $21.6 million in the period from December 28, 2003 through July 30,2004. The use of cash in the current year reflects the scheduled$23.0 million CEO SERP early termination payments, partially offset by thesplit dollar life insurance cash surrender proceeds of $14.3 million.

Net cash used in investing activities was$18.2 million in the thirty-nine weeks ended September 24, 2005,compared to $425.9 million (including $413.7 million to acquire Duane ReadeInc.) in the period from July 30, 2004 through September 25, 2004 and$32.5 million in the period from December 28, 2003 through July 30,2004. In the current year, capital expenditures of $18.4 million and lease acquisition,pharmacy customer file and other acquisition costs of $6.9 million decreasedfrom the prior year by $3.7 million and $15.6 million, respectively.

Net cash provided byfinancing activities was $28.7 million in the thirty-nine weeks ended September 24,2005, compared to $447.9 million (including $388.5 million attributable to thefinancing of the acquisition) in the period from July 31, 2004 through September 25,2004 and $11.0 million in the period from December 28, 2003 through July 30,2004. Cash provided by financing activities in the current year was primarilyattributable to the increased utilization of cash for operating activities.

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**Operating Capital Requirements**

Our operating capitalrequirements primarily result from opening and stocking new stores, remodelingand renovating existing retail locations, purchasing pharmacy files and thecontinuing development of management information systems. We opened five newstores in the first nine months of 2005 and currently plan to open up to five additionalnew stores during the remainder of this year (a total of up to 10 storesfor all of 2005), and 8-10 new stores in each of fiscal 2006 throughfiscal 2008. We also require working capital to support inventory for ourexisting and new stores. Historically, we have been able to lease almost all ofour store locations, so acquisitions of real estate are not expected to have asignificant impact on our capital requirements.

**OtherFactors Influencing our Liquidity**

We have recently been advised that the appraisal panelin the World Trade Center insurance claim litigation has determined the amountof the business interruption loss we incurred as a result of the events of September 11,2001. This determination by the panel is subject to existing appeals and potentiallyadditional appeals and, on June 22, 2005, The Court of Appeals affirmedthe decision of the trial court, with modifications, including modifications tocertain of the legal tests on which the appraisal panel’s decision was based.We are currently in the process of evaluating the opinion and its effect on therecovery and are considering our options. As a result of the appeal process andother uncertainties, we may not actually receive any or all of the panel’sappraised value of this claim, and we cannot be certain of the timing of futurepayments, if any, with respect to our claim. It should also be noted that anypayment to us that might be forthcoming as a result of this claim may alsoresult in the incurrence of additional expenses that are contingent upon theamount of such insurance claim settlement. These expenses, if incurred, are notexpected to exceed $6.0 million. Please refer to Note 8 of the UnauditedConsolidated Interim Financial Statements included elsewhere in this documentfor a more detailed explanation of this matter.

Ten 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 wewill be able to renew the other expiring leases on economically favorable termsor, alternatively, find other economically attractive locations to lease.

As of September 24, 2005, approximately 4,100 ofour approximately 6,100 employees were represented by various labor unions andwere covered 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 ofour employees in 113 stores, expired on March 31, 2005. The parties haveagreed to an extension of this contract through September 30, 2005 andcontinue to negotiate a successor contract. Duane Reade and UNITE have agreedto honor the terms and conditions of the expired collective bargainingagreement while discussions are ongoing. Effective September 1, 2005, DuaneReade and Local 210, International Brotherhood of Teamsters (“Local 210”)agreed on a successor collective bargaining agreement which will expire onAugust 31, 2008. Local 210 represents approximately 300 employees in ourMaspeth, New York and North Bergen, New Jersey warehouse facilities.

The Acquisition resulted in a restructuring of ourdebt, as well as the elimination of our obligations under the CEO Split DollarLife Insurance Policy, in exchange for certain direct payments to our ChiefExecutive Officer.

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Thefollowing table presents details of our significant Commitments and Obligationsas at September 24, 2005, except that the data provided with respect tooperating 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)                       |       | $                                         | 544,792    |   | $ | 139,760 |   | $ | — |   | $ | — |   | $ | 405,032 |   |
| Capital Lease  Obligations                 |       | 14,235                                    |       | 3,089 |   | 6,552 |   | 4,594 |   | — |   |
| Operating Leases                           |       | 1,344,893                                 |       | 119,602 |   | 237,090 |   | 219,849 |   | 768,352 |   |
| Fixed Interest  Payments(2)                |       | 114,075                                   |       | 19,012 |   | 38,025 |   | 38,025 |   | 19,013 |   |
| Total Contractual Cash  Obligations        |       | $2,017,995                                |       | $ | 281,463 |   | $ | 281,667 |   | $ | 262,468 |   | $ | 1,192,397 |   |
|                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          At September 24,2005, approximately $139.8 million was outstanding under our asset-basedrevolving loan facility. Obligations under this facility have been classifiedas current liabilities because cash receipts controlled by the lenders are usedto reduce outstanding debt and we do not meet the criteria of FAS 6 toreclassify the debt as long-term, however this is not an indication that thiscredit facility is expected to be retired within the next year. We intend tocontinue to use this facility for our working capital needs through the date ofits maturity in July 2008.

(2)          Excluded from the tableare cash interest obligations on our variable-rate debt, consisting of theamended asset-based revolving loan agreement and the senior secured floatingrate notes due 2010. The amended asset-based revolving loan agreement accruesinterest at LIBOR plus a margin of 1.50% and the senior secured notes accrueinterest at LIBOR plus a margin of 4.50%. At September 24, 2005, theeffective interest rates on each of these debt instruments were 5.26% and8.37%, respectively.

The above table includes an additional$50.0 million principal amount of senior secured notes that were issued onAugust 9, 2005. The new senior secured notes have substantially similarterms to those of the existing senior secured notes, although the new seniorsecured notes were issued at a discount to their redemption price at maturityand therefore do not trade fungibly with the senior secured notes issued in December 2004.The net proceeds of that offering, amounting to approximately$46.6 million, were used to repay a portion of the outstanding amountsunder the amended asset-based revolving loan facility and to pay expenses andcommissions associated with the offering and repayment. In connection with theoffering, the amended asset-based revolving loan facility was further amendedto reduce the maximum commitment amount from $250.0 million to$225.0 million and reduce the fixed charge coverage ratio until June 30,2007.

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 DuaneReade Holdings, Inc. consisting of options to purchase shares ofDuane Reade Holdings, Inc. common stock and a profits interest inDuane 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. 

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The profits interest andoptions will have no value unless the values of DuaneReade Shareholders, LLC and Duane Reade Holdings, Inc.,respectively, appreciate following the Acquisition. Mr. Cuti’s purchaseright will be suspended at any time when the exercise of such purchase rightswould result in a default under the financing arrangements of us, DuaneReade Shareholders, LLC or Duane Reade Inc. Mr. Cuti’spurchase right will also terminate upon certain public offerings by us, DuaneReade Shareholders, LLC or Duane Reade Inc.

At September 24,2005, we have recorded a litigation-related non-current liability of$20.3 million in connection with a National Labor Relations Board decisionin a litigation-related matter with the Allied Trades Council, a unionrepresenting employees in 139 of our stores. Because this decision is theinitial phase of a complex administrative and judicial process, the ultimateoutcome, financial impact and related timing of any future cash disbursementrelating to this matter cannot be determined at this time. This matter is morefully described in Note 8 to the Unaudited Consolidated Interim FinancialStatements.

**Off-Balance Sheet Arrangements**

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

**Debt**

Refer to Note 6 of theUnaudited Consolidated Interim Financial Statements contained elsewhere in thisdocument for a detailed description with respect to the various components ofour 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 DuaneReade Inc., to the extent permitted by the various agreements to whichDuane Reade Inc. is a party. Currently, we do not expect Duane Reade Holdings, Inc.to have any material liquidity requirements.

We believe that, based oncurrent levels of operations and anticipated growth, cash flow from operations,together with other available sources of funds, including revolving loanborrowings under the amended asset-based revolving loan facility will beadequate for the next two years, to make required payments on our indebtedness,to fund anticipated capital expenditures and to satisfy our working capitalrequirements. We base this belief on our recent levels of cash flow fromoperations of approximately $11.3 million in 2004 (which includes theabsorption of $40.6 million in Acquisition-related costs), projectedimprovements in working capital management, reduced levels of capitalexpenditures and the additional borrowing capacity under the $225.0 million amendedasset-based revolving loan facility, which was approximately $79.9 millionat September 24, 2005. In the first nine months of 2005, excluding $8.7 millionof non-recurring net disbursements attributable to the termination of ourobligations in connection with the Chairman’s SERP, our cash used in operatingand investing activities was approximately $1.8 million and $18.2 million,respectively. 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 

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to,reductions in third party prescription reimbursement rates, declines in the NewYork City economy, increases in competitive activity, adverse changes in vendorcredit terms, changes in drug consumption patterns, additional adverselegislative changes or a major disruption of business in our markets from aterrorist event, natural disaster or other unexpected events. Other factorsthat may adversely affect our ability to service our debt are described aboveunder “Special Note Regarding Forward-Looking Statements.” Borrowings under theamended asset-based revolving loan facility and the $207.9 million seniorsecured notes bear interest at floating rates. Therefore, our financialcondition will be affected by changes in prevailing interest rates. On May 25,2005, we entered into a hedging transaction through the acquisition of a “nocost collar.” Under this arrangement, we capped our exposure on $130.0 millionof LIBOR-based borrowings under the senior secured notes at a maximum LIBORrate of 5.30%. In addition, we established a minimum “floor” LIBOR rate of3.45%, in line with then current LIBOR rates. This hedging arrangement expireson June 16, 2008.

**Critical Accounting Policies**

Our discussion of resultsof operations and financial condition relies on our consolidated financialstatements that are prepared based on certain critical accounting policies thatrequire management to make judgments and estimates that are subject to varyingdegrees of uncertainty. We believe that investors need to be aware of thesepolicies and how they impact our financial reporting to gain a more completeunderstanding of our consolidated financial statements as a whole, as well asour related discussion and analysis presented herein. While we believe thatthese accounting policies are grounded on sound measurement criteria, actualfuture events can and often do result in outcomes that can be materiallydifferent from these estimates or forecasts. The accounting policies andrelated risks described in our Annual Report on Form 10-K/A for theyear ended December 25, 2004 are those that depend most heavily on thesejudgments and estimates. At September 24, 2005, there have been nomaterial changes to any of the Critical Accounting Policies contained therein.

**Seasonality**

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

**Inflation**

We believe that inflationhas not had a material impact on our results of operations during the threeyears ended December 25, 2004 or the nine months ended September 24,2005.

**RecentlyIssued Accounting Pronouncements**

In December 2004,SFAS No. 123R, “Share-Based Payment” was issued. This statementestablished standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services. The statement focusesprimarily on accounting for transactions in which an entity obtains employeeservices in share-based transactions. The provisions of this statement arerequired to be adopted for interim or annual periods beginning after December 15,2005. We are currently evaluating the effect of adopting this statement.

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**ITEM 3.**                QUANTITATIVEAND QUALITATIVE 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 September 24, 2005 includes$139.8 million of borrowings under our amended asset-based revolving loanfacility and $207.9 million of senior secured floating rate notes. At September 24,2005, the weighted average combined interest rate in effect on all variablerate debt outstanding was 7.13%. A 0.50% change in interest rates applied tothe $347.6 million balance of floating rate debt would affect pre-taxannual results of operations by approximately $1.7 million. In addition,we also have $195.0 million of Senior Subordinated Notes and $32.0thousand of Senior Convertible Notes outstanding at September 24, 2005.The Senior Subordinated Notes and Senior Convertible Notes bear interestpayable semi-annually at fixed rates of 9.75% and 3.75%, respectively, and aretherefore not subject to risk from interest rate fluctuations.

On May 25, 2005, we entered into a hedgingtransaction through the acquisition of a “no cost collar.” Under thisarrangement, we capped our exposure on $130.0 million of LIBOR-based borrowingsunder the floating rate notes at a maximum LIBOR rate of 5.30%. In addition, weestablished a minimum “floor” LIBOR rate of 3.45%, in line with then currentLIBOR rates. This hedging arrangement expires on June 16, 2008.

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

**ITEM 4.**                CONTROLSAND PROCEDURES

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

(a)   *Evaluation of Disclosure Controls and Procedures*.   Anevaluation was carried out under the supervision and with the participation ofthe Company’s management, including the Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) or15d-15(e) under the Securities Exchange Act of 1934) as of the endof the period covered by this quarterly report. Based upon that evaluation, theCompany’s management, including the Chief Executive Officer and Chief FinancialOfficer, have each concluded that the design and operation of these disclosurecontrols and procedures were effective as of the end of the period covered bythis report.

(b)   *Changes in Internal Controls over Financial Reporting*.   Duringthe most recent fiscal quarter, there have not been any significant changes inour internal controls over financial reporting or in other factors that thathave materially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting.

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**PART II—OTHERINFORMATION**

**ITEM 1.**                Legal Proceedings

Refer to Note 8 of theUnaudited Consolidated Interim Financial Statements included elsewhere in thisdocument for a detailed description of the various legal proceedings in whichwe are involved.

**ITEM2.**                UnregisteredSales of Equity Securities and Use of Proceeds

Not applicable.

**ITEM3.**                DefaultsUpon Senior Securities

Not applicable.

**ITEM4.**                Submissionof Matters to a Vote of Security Holders

Not applicable.

**ITEM 5.**                Other Information

On October 3, 2005, theCompany issued a Current Report on Form 8-K in connection with the dismissal ofPricewaterhousecoopers LLP and the subsequent engagement of KPMG LLP as itsIndependent Registered Public Accounting Firm. Such changes were effective asof September 27, 2005.

**ITEM 6.**                Exhibits

Forpurposes of this list, “Company” refers to Duane Reade Inc.
| Exhibit No. | ** ** | ** **                                                                                                                                                                                                                                                                                                                                          | ** ** | **Description** |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 2.1              |       | Agreement and Plan of  Merger (the “Merger Agreement”), dated as of December 22, 2003, by and  among Duane Reade Inc., Rex Corner Holdings, LLC and Rex Corner  Acquisition Corp. (incorporated by reference to Exhibit 2.1 to the  Company’s Current Report on Form 8-K filed on December 23,  2003). |
| 2.1(i)           |       | Amendment No 1 to  the Merger Agreement, dated as of June 10, 2004 (incorporated by  reference to the Company’s Current Report on Form 8-K filed on  June 14, 2004).                                                                                                                                                       |
| 2.1(ii)          |       | Amendment No 2 to  the Merger Agreement, dated as of June 13, 2004 (incorporated by  reference to the Company’s Current Report on Form 8-K filed on  June 14, 2004).                                                                                                                                                       |
| 2.1(iii)         |       | Amendment No 3 to  the Merger Agreement, dated as of June 18, 2004 (incorporated by  reference to the Company’s Current Report on Form 8-K filed on  June 21, 2004).                                                                                                                                                       |
| 3.1(i)           |       | Amended and Restated Certificate  of Incorporation of the Company (incorporated by reference to  Exhibit 3.1(i) 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”)).                                                                                   |

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| 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”)).                                                                |
| 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                                                                                                                                                         |

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|      |   | 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, 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).                                                                                                                                                   |

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| 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).                                                                                                                                                                                                                                                                                                                                                                          |

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| 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  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).                                                                                                                                                                                                                                                        |
| 10.28  |   | Second Amendment to Credit Agreement, dated as of  August 4, 2005, by and among Duane Reade, Duane Reade Inc., DRI I Inc., Duane  Reade International, Inc., Duane Reade Realty, Inc., Duane Reade Holdings,  Inc., the Lenders party thereto, Fleet National Bank, as Issuing Bank and  Administrative Agent, Fleet Retail Finance 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 10.1 to Duane Reade Holding’s Interim Report on Form 8-K dated August  4, 2005). |
| 10.29* |   | Purchase  Agreement dated as of August 4, 2005 among Duane Reade Holdings, Inc.,  Duane Reade, the Guarantors named therein and Banc of America Securities LLC.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 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 therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

Dated:  November 8,2005

|        | **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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