**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.**

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FORM 10-Q

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

**Forthe quarterly period ended June 25, 2005**

**Commissionfile number 001-13843**

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DUANE READE HOLDINGS, INC.

(Exact name of registrantas specified in its charter)

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

 

**(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 ý  No o

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

Yes o  No ý

 

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**INDEX**
| PART I—FINANCIAL INFORMATION |   | 5                                                                                                                                                                                                            |
|----------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                   |   | ITEM 1.—FINANCIAL  STATEMENTS                                                                                                                                                                           |   | 5 |
|                                   |   | Consolidated  Statements of Operations (Unaudited)—  For the 13 and 26 Weeks Ended June 25, 2005 for the Successor and the 13  and 26 Weeks Ended June 26, 2004 for the Predecessor           |   | 5 |
|                                   |   | Consolidated  Balance Sheets (Unaudited)—  As of June 25, 2005 and December 25, 2004                                                                                                          |   | 6 |
|                                   |   | Consolidated  Statements of Cash Flows (Unaudited)—  For the 26 Weeks Ended June 25, 2005 for the Successor and the 26 Weeks  Ended June 26, 2004 for the Predecessor                         |   | 7 |
|                                   |   | Consolidated  Statements of Comprehensive Income (Unaudited)—  For the 13 and 26 Weeks Ended June 25, 2005 for the Successor and the 13  and 26 Weeks Ended June 26, 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                                                                                                    |   | 27 |
|                                   |   | ITEM  3.—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET                                                                                                                                          |   |   |
|                                   |   | RISK                                                                                                                                                                                                         |   | 39 |
|                                   |   | ITEM 4.—CONTROLS AND  PROCEDURES                                                                                                                                                                        |   | 40 |
| PART II—OTHER  INFORMATION   |   | 41                                                                                                                                                                                                           |
| SIGNATURES                             |   | 47                                                                                                                                                                                                           |

 

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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;

·       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 Cox-2 inhibitors and theincreasing market share of internet-based and mail-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;

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·       liability and other claimsasserted against us including the items discussed under Part II, Item 1-LegalProceedings;

·       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;

·       our ability to continue tosecure suitable new store locations under 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—FINANCIALINFORMATION**

**ITEM 1.   FINANCIAL STATEMENTS**

**DuaneReade Holdings, Inc.—SuccessorDuane Reade Inc.—PredecessorConsolidated Statements of Operations (Unaudited)(In thousands)**
| ** **                                           | ** ** | **For the 13 Weeks Ended** | ** ** | **For the 26 Weeks Ended** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                           | ** ** | **Successor**                                  | ** ** | **Predecessor**                                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                                           | ** ** | **June 25,**                              | ** ** | **June 26,**                              | ** ** | **June 25,** | ** ** | **June 26,** | ** ** |
| ** **                                           | ** ** | **2005**                                       | ** ** | **2004**                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net sales                                            |       | $                                              | 399,500    |                                           |       | $ | 402,111 |   |   | $ | 794,267 |   |   | $ | 785,421 |   |   |
| Cost of sales                                        |       | 320,905                                        |       |                                           | 322,726    |   |   | 642,863 |   |   | 629,533 |   |   |
| Gross profit                                         |       | 78,595                                         |       |                                           | 79,385     |   |   | 151,404 |   |   | 155,888 |   |   |
| Selling,  general & administrative expenses |       | 64,541                                         |       |                                           | 59,924     |   |   | 129,040 |   |   | 118,567 |   |   |
| Labor contingency  expense                           |       | 1,100                                          |       |                                           | 1,100      |   |   | 2,200 |   |   | 2,200 |   |   |
| Transaction  expense                                 |       | 154                                            |       |                                           | 1,516      |   |   | 581 |   |   | 2,619 |   |   |
| Depreciation and  amortization                       |       | 17,851                                         |       |                                           | 9,239      |   |   | 35,497 |   |   | 18,305 |   |   |
| Store pre-opening  expenses                          |       | 50                                             |       |                                           | 209        |   |   | 150 |   |   | 365 |   |   |
| Other                                                |       | 2,033                                          |       |                                           | —     |   |   | 3,182 |   |   | — |   |   |
|                                                 |       | 85,729                                         |       |                                           | 71,988     |   |   | 170,650 |   |   | 142,056 |   |   |
| Operating (loss)  income                             |       | (7,134                                         | )          |                                           | 7,397      |   |   | (19,246 | ) |   | 13,832 |   |   |
| Interest expense,  net                               |       | 11,499                                         |       |                                           | 3,257      |   |   | 22,664 |   |   | 6,694 |   |   |
| (Loss) income  before income taxes                   |       | (18,633                                        | )          |                                           | 4,140      |   |   | (41,910 | ) |   | 7,138 |   |   |
| Income tax  (benefit) provision                      |       | (8,345                                         | )          |                                           | 1,605      |   |   | (18,819 | ) |   | 2,850 |   |   |
| Net (loss) income                                    |       | $                                              | (10,288    | )                                              |       | $ | 2,535 |   |   | $ | (23,091 | ) |   | $ | 4,288 |   |   |

 

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)**
| ** **                                                                                       | ** ** | **June 25,  2005** | ** ** | **December 25,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                       | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                       |       |                    |       |                        |       |   |   |   |   |
| Current Assets                                                                                   |       |                    |       |                        |       |   |   |   |   |
| Cash                                                                                             |       |                    | $          | 1,321                       |       |   |   | $ | 1,329 |   |   |
| Receivables, net                                                                                 |       |                    | 52,456     |                        |       |   | 58,056 |   |   |
| Inventories                                                                                      |       |                    | 278,069    |                        |       |   | 262,323 |   |   |
| Deferred income  taxes                                                                           |       |                    | 13,445     |                        |       |   | 9,027 |   |   |
| Prepaid expenses  and other current assets                                                       |       |                    | 35,561     |                        |       |   | 35,716 |   |   |
| TOTAL CURRENT  ASSETS                                                                            |       |                    | 380,852    |                        |       |   | 366,451 |   |   |
| Property and equipment, net                                                                      |       |                    | 236,022    |                        |       |   | 224,460 |   |   |
| Goodwill                                                                                         |       |                    | 52,216     |                        |       |   | 52,216 |   |   |
| Other assets                                                                                     |       |                    | 282,402    |                        |       |   | 297,032 |   |   |
| TOTAL ASSETS                                                                                     |       |                    | $          | 951,492                     |       |   |   | $ | 940,159 |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                    |       |                    |       |                        |       |   |   |   |   |
| Current Liabilities                                                                              |       |                    |       |                        |       |   |   |   |   |
| Accounts payable                                                                                 |       |                    | $          | 88,017                      |       |   |   | $ | 80,154 |   |   |
| Accrued interest                                                                                 |       |                    | 8,398      |                        |       |   | 8,209 |   |   |
| Accrued expenses                                                                                 |       |                    | 43,479     |                        |       |   | 56,735 |   |   |
| Current portion  of debt                                                                         |       |                    | 182,372    |                        |       |   | 153,870 |   |   |
| Current portion  of capital lease obligations                                                    |       |                    | 2,997      |                        |       |   | 780 |   |   |
| TOTAL CURRENT  LIABILITIES                                                                       |       |                    | 325,263    |                        |       |   | 299,748 |   |   |
| Long-term debt                                                                                   |       |                    | 355,032    |                        |       |   | 355,032 |   |   |
| Capital lease  obligations, less current portion                                                 |       |                    | 11,953     |                        |       |   | 2,008 |   |   |
| Deferred income  taxes                                                                           |       |                    | 33,524     |                        |       |   | 47,971 |   |   |
| Other non-current  liabilities                                                                   |       |                    | 64,769     |                        |       |   | 51,351 |   |   |
| TOTAL LIABILITIES                                                                                |       |                    | 790,541    |                        |       |   | 756,110 |   |   |
| Commitments and  contingencies (Note 8)                                                          |       |                    |       |                        |       |   |   |   |   |
| Stockholders’  equity                                                                       |       |                    |       |                        |       |   |   |   |   |
| Preferred stock,  $0.01 par; authorized 50,000 shares; issued and outstanding: none              |       |                    | —     |                        |       |   | — |   |   |
| Common stock,  $0.01 par; authorized 2,950,000 shares; issued and outstanding: 2,594,977  shares |       |                    | 26         |                        |       |   | 26 |   |   |
| Paid-in capital                                                                                  |       |                    | 239,472    |                        |       |   | 239,472 |   |   |
| Accumulated other  comprehensive income                                                          |       |                    | (7         | )                           |       |   | — |   |   |
| Accumulated  deficit                                                                             |       |                    | (78,540    | )                           |       |   | (55,449) |   |   |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                 |       |                    | 160,951    |                        |       |   | 184,049 |   |   |
| TOTAL LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                 |       |                    | $          | 951,492                     |       |   |   | $ | 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)**
| ** **                                                                                          | ** ** | **For the 26 Weeks Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **Successor**                                  | ** ** | **Predecessor** | ** ** |
| ** **                                                                                          | ** ** | **June 25,  2005**                        | ** ** | **June 26,  2004** | ** ** |
| Cash flows provided by  operating activities:                                                       |       |                                           |       |   |   |   |   |
| Net (loss) income                                                                                   |       | $                                              | (23,091    | ) |   | $ | 4,288 |   |   |
| Adjustments to reconcile  net (loss) income to net cash (used in) provided by operating activities: |       |                                           |       |   |   |   |   |
| Depreciation and amortization                                                                       |       | 37,238                                         |       |   | 19,260 |   |   |
| Deferred tax provision                                                                              |       | (18,858                                        | )          |   | 2,774 |   |   |
| Non-cash rent                                                                                       |       | 6,901                                          |       |   | 3,827 |   |   |
| Changes in operating  assets and liabilities (net of the effect of acquisitions):              |       |                                           |       |   |   |   |   |
| Receivables                                                                                         |       | 5,600                                          |       |   | (563 | ) |   |
| Inventories                                                                                         |       | (15,187                                        | )          |   | (333 | ) |   |
| Accounts payable                                                                                    |       | 8,288                                          |       |   | (8,486 | ) |   |
| Prepaid and accrued expenses                                                                        |       | (15,891                                        | )          |   | 3,058 |   |   |
| Other assets and liabilities, net                                                                   |       | 6,331                                          |       |   | (3,786 | ) |   |
| NET CASH (USED  IN) PROVIDED BY OPERATING ACTIVITIES                                                |       | (8,669                                         | )          |   | 20,039 |   |   |
| Cash flows used  in investing activities:                                                           |       |                                           |       |   |   |   |   |
| Capital expenditures                                                                                |       | (14,310                                        | )          |   | (16,182 | ) |   |
| Lease acquisition, customer file and other costs                                                    |       | (5,764                                         | )          |   | (11,517 | ) |   |
| Proceeds from sale of property                                                                      |       | 2,223                                          |       |   | — |   |   |
| NET CASH USED IN  INVESTING ACTIVITIES                                                              |       | (17,851                                        | )          |   | (27,699 | ) |   |
| Cash flows from  financing activities:                                                              |       |                                           |       |   |   |   |   |
| Borrowings from revolving credit facility                                                           |       | 901,942                                        |       |   | 798,122 |   |   |
| Repayments of revolving credit facility                                                             |       | (873,440                                       | )          |   | (791,168 | ) |   |
| Deferred financing costs                                                                            |       | (622                                           | )          |   | (138 | ) |   |
| Exercise of stock options                                                                           |       | —                                         |       |   | 1,126 |   |   |
| Repayments of capital lease obligations                                                             |       | (1,368                                         | )          |   | (206 | ) |   |
| NET CASH PROVIDED  BY FINANCING ACTIVITIES                                                          |       | 26,512                                         |       |   | 7,736 |   |   |
| Net change in cash                                                                                  |       | (8                                             | )          |   | 76 |   |   |
| Cash at beginning  of period                                                                        |       | 1,329                                          |       |   | 1,252 |   |   |
| Cash at end of period                                                                               |       | $                                              | 1,321      |   |   | $ | 1,328 |   |   |

 

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 (Unaudited)(in thousands)**
| ** **                                 | ** ** | **For the 13 Weeks Ended** | ** ** | **For the 26 Weeks Ended** | ** ** |
|--------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                 | ** ** | **Successor**                                  | ** ** | **Predecessor**                                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                                 | ** ** | **June 25,**                              | ** ** | **June 26,**                              | ** ** | **June 25,** | ** ** | **June 26,** | ** ** |
| ** **                                 | ** ** | **2005**                                       | ** ** | **2004**                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net (loss) income                          |       | $                                              | (10,288    | )                                              |       | $ | 2,535 |   |   | $ | (23,091 | ) |   | $ | 4,288 |   |   |
| Loss on interest rate collar, net of taxes |       | (7                                             | )          |                                           | —     |   |   | (7 | ) |   | — |   |   |
| Total Other  Comprehensive Income          |       | (7                                             | )          |                                           | —     |   |   | (7 | ) |   | — |   |   |
| Total  Comprehensive Income                |       | $                                              | (10,295    | )                                              |       | $ | 2,535 |   |   | $ | (23,098 | ) |   | $ | 4,288 |   |   |

 

The accompanying notes are an integral part of these financial statements

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**Notes to Unaudited Consolidated Interim FinancialStatements**

**(dollars inthousands)**

**1.**   Basisof 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 InterimFinancial Statements and these footnotes mean the predecessor for periodsending on or before July 30, 2004 and the successor for periods beginning afterJuly 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 accounting principlesfollowed in the preparation of the Company’s Annual Consolidated FinancialStatements for the year ended December 25, 2004. These UnauditedConsolidated Interim Financial Statements should be read in conjunction withthe Company’s Consolidated Financial Statements included in its Annual Reporton Form 10-K/A for the year ended December 25, 2004. The UnauditedConsolidated Interim Financial Statements include the accounts of the Companyand its subsidiaries. All significant intercompany transactions and balanceshave been eliminated. The results for the interim periods presented are notnecessarily indicative of the results expected for the full year.

The Company, along with certain of its subsidiaries,is a guarantor of the debt obligations of Duane Reade Inc. and DuaneReade, the New York general partnership (“Duane Reade GP”). Duane ReadeHoldings, Inc. has no assets or operations other than its investment in itssubsidiaries. The Unaudited Consolidated Interim Financial Statements presentedin Note 9 include the consolidated assets and operations of thesubsidiaries. The guarantees provided by the Company and its other subsidiariesunder the debt obligations of Duane Reade Inc. and Duane Reade GP arefull and unconditional, joint and several.

**2.**   Recently IssuedAccounting Pronouncements

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

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The Company previously adopted FAS No. 123, “Accountingfor Stock-Based Compensation” and, as permitted under FAS No. 123,has elected the disclosure-only provisions. The Company accounts for itsstock-based compensation plans under the recognition and measurement principlesof APB Opinion No. 25, “Accounting for Stock Issued to Employees,” andrelated interpretations. There is no stock-based employee compensation costreflected in net income, as all options granted under those plans had anexercise price equal to or greater than the market value of the underlyingcommon stock on the date of grant. The following table illustrates the effecton net (loss) income if the Company had applied the fair value recognitionprovisions of FAS No. 123 to stock-based employee compensation(dollars in thousands):
| ** **                                                                                                                                    | ** ** | **For the 13 Weeks Ended** | ** ** | **For the 26 Weeks Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **Successor**                                  | ** ** | **Predecessor**                                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                                                                                                                                    | ** ** | **June 25,  2005**                        | ** ** | **June 26,  2004**                        | ** ** | **June 25,  2005** | ** ** | **June 26,  2004** | ** ** |
| Net (loss) income, as  reported                                                                                                               |       | $                                              | (10,288    | )                                              |       | $ | 2,535 |   |   | $ | (23,091 | ) |   | $ | 4,288 |   |   |
| Adjust: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | 143                                            |       |                                           | 1,136      |   |   | 286 |   |   | 2,272 |   |   |
| Pro forma net (loss) income                                                                                                                   |       | $                                              | (10,431    | )                                              |       | $ | 1,399 |   |   | $ | (23,377 | ) |   | $ | 2,016 |   |   |

 

The pro forma compensation expense for stock optionshas been estimated using the Black-Scholes option pricing model with thefollowing assumptions: for the 13 and 26 weeks ended June 25, 2005, themodel assumes a dividend yield of 0%, expected volatility of 0%, a risk freeinterest rate of 4.1% and an expected term of 7 years. For the 13 and 26 weeksended June 26, 2004, the model assumes a dividend yield of 0%, expectedvolatility of 50%, a risk free interest rate of 6.6% and an expected term of 8years. 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, as a result of the Acquisition,all stock options, whether or not then vested, with an exercise price of $16.50or more per share were cancelled without any payment therefore, and theremaining “in the money” options (excluding certain management options thatwere forfeited in connection with the Acquisition), whether or not then vested,with exercise prices of less than $16.50 per share were converted into theright to receive the excess of $16.50 per share over the exercise price of eachof the options. As a consequence, subsequent to the July 30, 2004transaction date, all options issued by the Predecessor to purchase previouslyexisting Duane Reade Inc. common stock ceased to exist. In addition,pursuant to the completion of the Acquisition, the Successor issued options toacquire shares of Duane Reade Holdings, Inc. common stock to certain members ofthe Company’s senior management.

**3.**   Inventoryand Cost of Sales

At June 25, 2005, inventories, consisting solelyof finished goods, would have been lower by $6.4 million if they had beenvalued on a lower of first-in, first-out (“FIFO”) cost or market basis insteadof a last-in, first-out (“LIFO”) basis. Cost of sales includes all storeoccupancy-related costs and expenses, consisting of lease and sublease-relatedincome and expenses, other recurring real estate-related income and expensesprimarily from sales and terminations of leases related to store closings andrelocations, sales of market-related data, store utility costs, warehouseexpenses and distribution costs. The Company reflects promotional allowancesfrom vendors as a reduction of cost of sales or advertising expense, dependingon the nature of the allowance, when such advertising or promotions have beencompleted and the related allowances have been earned. For the quarter and sixmonths ended June 25, 2005, other real estate-related income was$0.1 million and $0.2 million, respectively, as compared to$1.3 million and $2.1 million in the quarter and six months ended June 26,2004, respectively.

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**4.**   Exitand Disposal Activities

In connection with the acquisition of Duane Reade Inc.and in accordance with the provisions of Emerging Issues Task Force Issue No. 95-3,“Recognition of Liabilities in Connection with Purchase Business Combinations”(EITF 95-3), the Company established a reserve of $17.0 million for costsanticipated to be incurred as a result of the planned closing of approximately11 of its stores. These costs primarily relate to rent, utilities and otheron-going occupancy-related expenses, as well as costs related to inventoryliquidation. During the 26 weeks ended June 25, 2005, eight of the 11planned closings occurred, and the Company recorded a net total of $1.5 millionof primarily occupancy-related costs against this reserve resulting in thebalance of $15.4 million at June 25, 2005.

**5.**   Pharmacyand Customer File Acquisitions

Duringthe 13 and 26 weeks ended June 25, 2005 and June 26, 2004, theCompany acquired certain pharmacy customer prescription files, which weremerged into existing stores, and the operations, including certain lease-relatedassets, of one existing pharmacy establishment, which is operated as a newstore. The table below provides details of this acquisition activity for eachof the periods presented (dollars in millions).
| ** **                                  | ** ** | **For the 13 Weeks Ended** | ** ** | **For the 26 Weeks Ended** | ** ** |
|---------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                  | ** ** | **Successor**                                  | ** ** | **Predecessor**                                | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| ** **                                  | ** ** | **June 25,  2005**                        | ** ** | **June 26,  2004**                        | ** ** | **June 25,  2005** | ** ** | **June 26,  2004** | ** ** |
| Customer  prescription files                |       |                                           | 3          |                                           |       |   | 1 |   |   |   | 4 |   |   |   | 5 |   |   |
| Pharmacy  establishments                    |       |                                           | —     |                                           |       |   | 1 |   |   |   | — |   |   |   | 1 |   |   |
| Total  acquisitions                         |       |                                           | 3          |                                           |       |   | 2 |   |   |   | 4 |   |   |   | 6 |   |   |
| Total acquisition cost (cash consideration) |       |                                           | $          | 1.6                                            |       |   |   | $ | 0.9 |   |   |   | $ | 2.4 |   |   |   | $ | 7.4 |   |   |
| Purchase price allocation:                  |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Identifiable  intangibles                   |       |                                           | $          | 1.4                                            |       |   |   | $ | 0.8 |   |   |   | $ | 2.2 |   |   |   | $ | 6.4 |   |   |
| Goodwill                                    |       |                                           | —     |                                           |       |   | — |   |   |   | — |   |   |   | 0.3 |   |   |
| Inventory                                   |       |                                           | 0.3        |                                           |       |   | 0.2 |   |   |   | 0.5 |   |   |   | 1.0 |   |   |
| Property and  equipment                     |       |                                           | —     |                                           |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Other assets and  liabilities, net          |       |                                           | (0.1       | )                                              |       |   | (0.1 | ) |   |   | (0.3 | ) |   |   | (0.3 | ) |   |
| Total                                       |       |                                           | $          | 1.6                                            |       |   |   | $ | 0.9 |   |   |   | $ | 2.4 |   |   |   | $ | 7.4 |   |   |

 

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.

**6.**   Debt

Totaldebt is composed of the following (in thousands):
| **Description of Instrument ** | ** ** | ** ** | ** **  | **June 25,  2005** | ** ** | **Dec. 25,  2004** | ** ** |
|-----------------------------------------------|------------|------------|-------------|-------------------------|------------|-------------------------|------------|
| Asset-Based Revolving  Loan Facility(1)       |       | $          | 182,372     |                    | $          | 153,870                 |       |
| Total Current Debt                            |       | $          | 182,372     |                    | $          | 153,870                 |       |
| Senior Floating Rate  Notes due 2010          |       | $          | 160,000     |                    | $          | 160,000                 |       |
| 9.75% Senior  Subordinated Notes due 2011     |       | 195,000    |        | 195,000                 |       |
| 2.1478% Senior  Convertible Notes due 2022    |       | 32         |        | 32                      |       |
| Total Non-current Debt                        |       | $          | 355,032     |                    | $          | 355,032                 |       |
| **Total Debt**                                | ** ** | **$**      | **537,404** | ** **              | **$**      | **508,902**             | ** ** |

 

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(1)          Obligationsunder this revolving loan facility are classified as current liabilitiesbecause cash receipts controlled by the lenders are used to reduce outstandingdebt and the Company does not meet the criteria of Statement of FinancialAccounting Standards No. 6 “Classification of Short Term ObligationsExpected to be Refinanced” (FAS 6), to reclassify the debt as long-term.This is not an indication that this credit facility is expected to be retiredwithin the next year. The Company intends to continue to utilize this facilityfor its working capital needs through the date of its maturity in July 2008.

***Amended Asset-Based Revolving Loan Facility:  ***OnJuly 21, 2003, Duane Reade GP entered into an asset-based revolvingloan facility which used a pre-determined percentage of the current value ofinventory and selected accounts receivable to calculate the availability offunds eligible to be borrowed up to an aggregate principal amount of$200 million. Prior to the amendment described below, the Company’sobligations under the credit agreement and related guarantees werecollateralized by substantially all of its 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 other current assets.Under the amended asset-based revolving loan facility, Duane Reade GP isthe sole obligor. However, the asset-based revolving loan facility isguaranteed on a full and unconditional basis by the Company, Duane Reade Inc.,and each of the Company’s other domestic subsidiaries other than the 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 June 25, 2005, the asset-based revolving loan facilitybore interest at an annual rate of 4.73%.

At June 25, 2005,there was $182.4 million outstanding under the asset-based revolving loanfacility, and approximately $61.8 million of remaining availability, netof $5.3 million reserved for 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 millionof early repayment premium and accrued but unpaid interest through December 20,2004. As 

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noted below, on February 3,2005, the registration statement filed on Form S-4 in connectionwith these notes was declared effective by the SEC. However, subsequent to suchdeclaration, certain post-effective amendments were filed and, on June 29,2005, the final amended registration statement was filed with, and declaredeffective by, the SEC, allowing the Company to re-initiate an offer to exchangethe unregistered notes for registered 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 June 25, 2005,the senior secured notes bore interest at an annual rate of 7.91%.

On May 25, 2005, the Company entered into a hedgingtransaction through the acquisition of a “no cost collar.” Under thisarrangement, the Company capped its exposure on $130.0 million ofLIBOR-based borrowings under the senior secured notes at a maximum LIBOR rateof 5.30%. In addition, the Company established a minimum “floor” LIBOR rate of3.45% in the line with current LIBOR rates. This hedging arrangement expires onJune 16, 2008. The fair value of the hedge agreement, net of taxes, isreflected on the Consolidated Statements of Comprehensive Income included withinthe 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 amendedasset-based revolving loan facility have a first priority interest. The seniorsecured notes and the guarantees are also collateralized by a second priorityinterest in all collateral pledged on a first priority basis to lenders underthe amended 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 assetsales), enter into sale-leaseback transactions, enter into transactions withaffiliates and permit restrictions on the payment of dividends by restrictedsubsidiaries. There are no credit ratings related triggers in the indenturegoverning the senior secured notes that would impact the cost of borrowing,annual amortization 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 as part of the offering ofthe senior secured notes, the Company was required to (i) file aregistration statement with the SEC within 120 days after the completionof the offering of the senior secured notes, (ii) use its reasonable bestefforts to cause the registration statement to become effective within180 days after the completion of the offering of the senior secured notes,and (iii) use its reasonable best efforts to complete an exchange offer ofthe initial senior secured notes for registered senior secured notes within210 days after the offering of the senior secured notes is completed. On January 21,2005, the Company filed a registration statement on Form S-4, 

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registeringan exchange offer relating to the senior secured notes. On February 3,2005, the registration statement was declared effective by the SEC. However, onMarch 7, 2005, prior to the completion of the exchange offer, the Companysuspended the exchange offer as a result of the restatement of its financialresults. On June 10, 2005 and June 29, 2005, the Company filedpost-effective amendments to the registration statement, reflecting the impactof these restatements on the financial statements included therein, as well ascertain developments in the Company’s ongoing World Trade Center litigation, inconnection with the events of September 11, 2001. The amended registrationstatement was declared effective on June 29, 2005, and the Company resumedthe exchange offer on June 30, 2005. The exchange offer was completed on July 29,2005, and all of the $160.0 million principal value of the initial seniorsecured notes were tendered for exchange. As stipulated in the registrationrights agreement, as a result of the delay in completing the exchange offer,the Company is required to pay the holders of the initial senior secured notes “liquidateddamages” in the aggregate amount of $1,096 per day for each elapsed day betweenthe 210 day deadline for completing the exchange offer and the actual exchangeoffer expiration date. The July 29, 2005 expiration date was 11 daysbeyond the deadline and therefore, on its next scheduled interest payment dateof September 15, 2005, the Company will remit, in addition to the regularquarterly interest payment amount, a total of $12,055 in liquidated damages. 

At June 25, 2005, theweighted average combined interest rate in effect on all variable rate debtoutstanding was 6.22%.

***Senior Subordinated Notes Due 2011:  ***OnJuly 30, 2004, upon completion of the Acquisition, Duane Reade Inc.and Duane Reade GP co-issued $195.0 million of 9.75% seniorsubordinated notes due 2011, which were registered on a Form S-4filing. 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 that limitthe ability of Duane Reade Inc., Duane Reade GP and their restrictedsubsidiaries to incur additional indebtedness, pay dividends, make repaymentson indebtedness that is subordinated to the senior subordinated notes and tomake certain other restricted payments, incur certain liens, use proceeds fromsales of assets, enter into business combination transactions (includingmergers, consolidations and asset sales), enter into transactions withaffiliates and permit restrictions on the payment of dividends by restrictedsubsidiaries. There are no credit ratings related triggers in the indenturegoverning 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 

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a semi-annual bondequivalent basis. In December 2002, Duane Reade Inc. repurchased atotal of $30.5 million principal value of the Convertible Notes at anaverage purchase price of $486.99 per $1,000 note, resulting in a remaining netoutstanding 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 total of $350.9 million principal value($201.0 million issuance value) was tendered for repurchase, leaving only$55.0 thousand principal value ($32.0 thousand of issuance value)outstanding. Duane Reade Inc. may redeem for cash all or a portion of theprincipal value of the outstanding Convertible Notes at any time after April 16,2007, at a price equal to the sum of the issue price plus accrued originalissue discount and accrued cash interest, if any, to the redemption date.

**7.**   IncomeTaxes

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.**   Commitmentsand Contingencies

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

During 2002, the Companyinitiated a legal action against its former property insurance carrier, in anattempt to recover what it believes to be a fair and reasonable settlement forthe business interruption portion of its claim originating from the September 11,2001 World Trade Center terrorist attack, during which its single highestvolume and most profitable store was completely destroyed. The claim is pendingbefore the United States District Court for the Southern District of New York.In September 2003, a trial on certain issues was held regarding some ofthe matters at issue in the litigation, including whether the Company wouldhave obtained a renewal of its lease at the World Trade Center. The Company receiveda favorable ruling from the trial court on this and other legal issues in thecase. The trial court’s decision was appealed by the insurance carrier to theSecond Circuit Court of Appeals with respect to several aspects of thedecision. In the meantime, the matter has moved into an appraisal process basedon the trial court’s interpretation of certain legal tests, whichinterpretation was among the aspects of the decision challenged by theinsurance carrier in its appeal. The appraisal process involved a panel of twoappraisers and an arbitrator (to resolve differences between the twoappraisers), who determine the amount of insured loss the Company hassustained. The Company was advised in early June 2005 that the panelreached a unanimous decision that the total amount of the business interruptionloss that the Company suffered as a result of the events of September 11,2001 is $50.6 million, including all interest adjustments. The Company has alsobeen advised that a written award will be provided by the panel in the nearfuture. It was also advised that the actual amount to be paid by the insurer tothe Company should be reduced by approximately $9.9 million, which representsthe amount that was previously paid to the Company in cash in fiscal 2002, forwhich the Company recognized approximately $9.4 million of income. In the eventof an unfavorable outcome for the Company, it will not be required to returnany of the $9.9 million initial 

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payment.The Company has been further advised that the written opinion of the panel willinclude calculations of the amount of the loss based on alternativeinterpretations of the legal test proposed by the insurance carrier that mayapply if the trial court’s decision is overturned or modified. On June 22,2005, the Court of Appeals affirmed the decision of the trial court, withmodifications, including modifications to certain of the legal tests on whichthe appraisal’s decision was based.  Theappraisal panel has asked the parties for submissions regarding theimplications of the court of appeals’ decision on the award. The effect of thedecision on the award is not certain and the Company is currently in theprocess of evaluating the opinion and its effect on the recovery and isconsidering its options. Accordingly, given the risks and uncertaintiesinherent in litigation, there can be no definitive assurance that the Companywill actually receive any or all of the panel’s appraised value of this claim,and the Company has not recognized any additional income related to thismatter. It should be noted that any payment to the Company that might beforthcoming as a result of this claim may also result in the incurrence ofadditional expenses that are contingent upon the amount of such insurance claimsettlement. These expenses, if incurred, are not expected to exceed $6.0 million.

Duane Reade Inc., Mr. Cuti,Mr. Henry and Mr. Charboneau were named as defendants in connectionwith the consolidation of several class action complaints alleging violationsof the federal 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.

The Company is a defendantin a class action suit in the Federal Court for the Southern District of NewYork filed in January 2000 regarding alleged violations of the Fair LaborStandards Act as to a group of individuals who provided delivery services on acontract basis to the Company. In December 2002, the judge in the actionissued a partial summary judgment in favor of a subclass of the plaintiffs andagainst the Company. In December 2003, the Company settled the issue ofthe amount of its liability to the plaintiffs without any admission ofwrongdoing and in an amount consistent with its previously establishedreserves. By a decision dated August 4, 2004, the district court awardedthe plaintiffs certain attorneys’ fees in this matter in the amount of $0.6 million.The Company has fully reserved the amounts of the fees in question and hasappealed this award. The Second Circuit recently affirmed the trial court’sdetermination on fees.

The Company is a party toa National Labor Relations Board (“NLRB”) administrative proceeding regarding adispute with the Allied Trades Council (“ATC”) over whether a negotiatingimpasse was reached between the Company and the union in August of 2001.The Allied Trades Council represents employees in 139 of the Company’s storesin a collective bargaining agreement that expired on August 31, 2001. TheCompany’s employees have been working pursuant to the terms of the Company’s December 6,2001 implemented contract with the ATC, which expired on August 31, 2004.The Company believes an impasse did in fact occur and as a result, it had theright to implement its latest contract proposal at that time which includedwage increases, health and welfare benefits, vacation and sick benefits and a401(k) retirement program. The Company discontinued making additionalpayments into the various funds associated with the union as it was providingmany of these benefits on a direct basis and because it believes it’s pastcontributions to these funds caused these funds to be in a position ofexcessive overfunding. In addition, the Company had concerns that its pastpayments into these funds were not being managed in a way to ensure they werebeing properly utilized for the benefit of its employees. On February 18,2004, an Administrative Law Judge (“ALJ”) who had reviewed various mattersrelated to this proceeding issued a decision and related recommendation, whichconcluded that the parties were not at 

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impasse.The remedies recommended by the ALJ included, among other things, a requirementfor the Company to make its employees whole by reimbursing them for expensesensuing from the failure to make contributions to the union funds and to makesuch 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 complicated administrative process to be followed by a fulljudicial review of all of the facts and circumstances, the final outcome cannotbe reliably determined at this time. The NLRB’s decision is subject to judicialreview by the D.C. Circuit Court of Appeals and a compliance hearing before anyfinancial remedy can be determined. The Company is in the process of filingappeal papers with the D.C. Circuit Court of Appeals. Subsequent to thecompletion of filing these papers, which will be late-summer 2005, the Courtwill schedule a hearing and sometime thereafter will render a decision. Whilethere can be no definitive assurance, the Company has been advised by itsoutside labor counsel that its petition for review contains a number of validdefenses and arguments against enforcement of the NLRB decision.

In light of the foregoing,while it is the Company’s belief that the final financial outcome of thislitigation cannot be determined, under the provisions of Statement of FinancialAccounting Standard No 5 which addresses contingencies, the Company hasrecorded cumulative pre-tax charges of $19.2 million, including $2.2 millionin the twenty-six weeks ended June 25, 2005. These charges represent theCompany’s current best estimate of the loss that would result upon applicationof the NLRB’s decision. The Company notes that such charges were based upon thefacts available to it at the time. In the Company’s opinion, such charges couldbe subject to significant modification in the future, upon review by the D.C.Circuit Court of Appeals, completion of a compliance hearing and any appealsrelating to the outcome of that hearing. These charges reflect the amount ofcontributions that the Company did not make into the union benefit funds forthe period from the August 31, 2001 expiration of the contract through June 25,2005, reduced by a portion of the benefits it paid directly to or for thebenefit of these employees over the same period. It also includes an interestcost for these net contributions from the date they would have been paid until June 25,2005. While this represents the Company’s current best estimate of the NLRB’sdecision, the Company believes that, as of June 25, 2005, the actual rangeof loss in this matter could be from $0 if the Circuit Court of Appeals doesnot enforce the NLRB decision at all, to approximately $43.0 million, ifthe NLRB’s decision is upheld and there is no offset for any benefits paid overthis period.

Until such time as furtherlegal developments warrant a change in the application of this accountingstandard, or until this matter is resolved, the Company will record additionalnon-cash pre-tax charges, including interest, which are calculated on the samebasis as the charges recorded in the 2003 and 2004 financial statements. TheCompany currently estimates that the pre-tax charge recorded during the full12 months of 2005 will approximate $4.4 million, subject to changesin the relevant interest rate.

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

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The Company is involved inan ongoing dispute with Cardinal Health, one of its former suppliers ofpharmaceutical products. Both parties have claims against the other involving,among other things, breach of contract, promissory estoppel and unjustenrichment. Duane Reade is seeking from Cardinal an unspecified amount ofdamages and punitive damages of at least $20 million. Cardinal is seekingapproximately $18 million in damages plus attorney’s fees and interest.While there can be no definitive assurance, the Company believes it hascounterclaims that offset the claims against it by Cardinal, as well asmeritorious defenses to these claims, and plans to vigorously pursue itsaffirmative claims and to vigorously defend itself in this action. Non-partydiscovery in the case has concluded and it is expected to go to trial in thesecond half of 2005.

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 to interpretationin light of the Company’s own specific facts and circumstances. The outcome ofthis matter, and the resulting amount of additional income tax expense, 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 UnitedStates District Court, Southern District of New York. The complaint allegesthat, from the period beginning November 1998, the Company incorrectlygave some employees the title, “Assistant Manager,” in an attempt to avoidpaying these employees overtime, in contravention of the Fair Labor StandardsAct and the New York Law. The complaint seeks an award equal to twice anunspecified amount of unpaid wages. The Company believes this claim to bewithout merit, and it intends to defend itself vigorously against this claim.However, due to the uncertainty of litigation, there can be no assurance as tothe ultimate outcome of this matter.

In January 2005, 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 Merger Transaction:***    TheCompany is aware of six purported class action complaints challenging theAcquisition consummated by Duane Reade Inc. and DuaneReade Acquisition that have been filed in the Court of Chancery of theState of Delaware, referred to as the “Delaware Complaints,” and threepurported class action complaints that have been filed in the Supreme Court ofthe State of New York. Two of the New York complaints have been dismissedwithout prejudice. The other New York complaint (the “New York Complaint”) ispending but has not been served on Duane Reade. The Delaware Complaints name Mr. Cutiand certain other members of the Company’s former board of directors andexecutive officers as well as Duane Reade as defendants. Four of theDelaware Complaints name Oak Hill as a defendant. The New York Complaint names Mr. Cutiand certain other members of the Company’s former board of directors and executiveofficers as well as Duane Reade as defendants. One of the dismissed NewYork complaints named Oak Hill as a defendant.

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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.

**DUANE READE HOLDINGS, INC.Condensed Consolidating Statement of Operations (Unaudited)**

**Forthe 13 weeks ended June 25, 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                                                  |       |                    | $          | —              |       |              |       | $              | —     |              |       |                    | $          | 399,500 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 399,500 |   |   |   |
| Cost of sales                                              |       |                    | —     |                |       |              | —     |           |       |              | 320,905    |                    |       |   | — |   |   |   | — |   |   |   | 320,905 |   |   |   |
| Gross profit                                               |       |                    | —     |                |       |              | —     |           |       |              | 78,595     |                    |       |   | — |   |   |   | — |   |   |   | 78,595 |   |   |   |
| Selling,  general & administrative expenses  |       |                    | —     |                |       |              | —     |           |       |              | 76,648     |                    |       |   | (12,107 | ) |   |   | — |   |   |   | 64,541 |   |   |   |
| Labor contingency                                          |       |                    | —     |                |       |              | —     |           |       |              | 1,100      |                    |       |   | — |   |   |   | — |   |   |   | 1,100 |   |   |   |
| Transaction expense                                        |       |                    | —     |                |       |              | —     |           |       |              | 154        |                    |       |   | — |   |   |   | — |   |   |   | 154 |   |   |   |
| Depreciation and  amortization                             |       |                    | —     |                |       |              | —     |           |       |              | 17,851     |                    |       |   | — |   |   |   | — |   |   |   | 17,851 |   |   |   |
| Store pre-opening expense                                  |       |                    | —     |                |       |              | —     |           |       |              | 50         |                    |       |   | — |   |   |   | — |   |   |   | 50 |   |   |   |
| Other                                                      |       |                    | —     |                |       |              | —     |           |       |              | 2,033      |                    |       |   | — |   |   |   | — |   |   |   | 2,033 |   |   |   |
| Operating (loss) income                                    |       |                    | —     |                |       |              | —     |           |       |              | (19,241    | )                       |       |   | 12,107 |   |   |   | — |   |   |   | (7,134 | ) |   |   |
| Equity earnings in  affiliates                             |       |                    | 10,288     |                |       |              | 10,288     |           |       |              | —     |                    |       |   | 170 |   |   |   | (20,746 | ) |   |   | — |   |   |   |
| Interest expense, net                                      |       |                    | —     |                |       |              | —     |           |       |              | 11,499     |                    |       |   | — |   |   |   | — |   |   |   | 11,499 |   |   |   |
| Income (loss) before  income taxes                         |       |                    | (10,288    | )                   |       |              | (10,288    | )              |       |              | (30,740    | )                       |       |   | 11,937 |   |   |   | 20,746 |   |   |   | (18,633 | ) |   |   |
| Income tax (benefit)  expense                              |       |                    | —     |                |       |              | —     |           |       |              | (13,767    | )                       |       |   | 5,422 |   |   |   | — |   |   |   | (8,345 | ) |   |   |
| Net income (loss)                                          |       |                    | $          | (10,288             | )          |              |       | $              | (10,288    | )                 |       |                    | $          | (16,973 | ) |   |   | $ | 6,515 |   |   |   | $ | 20,746 |   |   |   | $ | (10,288 | ) |   |   |

** **

19

----

**DUANE READE INC.**

**CondensedConsolidating Statement of Operations (Unaudited)**

**Forthe 13 weeks ended June 26, 2004**

**(Predecessor)**

**(in thousands)**
| ** **                                           | ** ** | ** **          | ** ** | ** **        | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane**           | ** ** |
|------------------------------------------------------|------------|---------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|---------------------|------------|
| ** **                                           | ** ** | **Duane**           | ** ** | **Duane**         | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Reade Inc.** | ** ** |
| ** **                                           | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**    | ** ** |
| Net sales                                            |       |                | $          | —            |       |           | $          | 402,111           |       |                | $          | — |   |   |   | $ | — |   |   |   | $ | 402,111 |   |   |
| Cost of sales                                        |       |                | —     |              |       | 322,726        |       |              | —     |                |       |   | — |   |   |   | 322,726 |   |   |
| Gross profit                                         |       |                | —     |              |       | 79,385         |       |              | —     |                |       |   | — |   |   |   | 79,385 |   |   |
| Selling,  general & administrative expenses |       |                | 4          |              |       | 70,650         |       |              | (10,730    | )                   |       |   | — |   |   |   | 59,924 |   |   |
| Labor contingency                                    |       |                | —     |              |       | 1,100          |       |              | —     |                |       |   | — |   |   |   | 1,100 |   |   |
| Transaction expense                                  |       |                | —     |              |       | 1,516          |       |              | —     |                |       |   | — |   |   |   | 1,516 |   |   |
| Depreciation and  amortization                       |       |                | —     |              |       | 9,239          |       |              | —     |                |       |   | — |   |   |   | 9,239 |   |   |
| Store pre-opening  expense                           |       |                | —     |              |       | 209            |       |              | —     |                |       |   | — |   |   |   | 209 |   |   |
| Operating (loss) income                              |       |                | (4         | )                 |       | (3,329         | )          |              | 10,730     |                |       |   | — |   |   |   | 7,397 |   |   |
| Equity earnings in  affiliates                       |       |                | (2,537     | )                 |       | —         |       |              | 40         |                |       |   | 2,497 |   |   |   | — |   |   |
| Interest expense, net                                |       |                | —     |              |       | 3,257          |       |              | —     |                |       |   | — |   |   |   | 3,257 |   |   |
| Income (loss) before  income taxes                   |       |                | 2,533      |              |       | (6,586         | )          |              | 10,690     |                |       |   | (2,497 | ) |   |   | 4,140 |   |   |
| Income tax (benefit)  expense                        |       |                | (2         | )                 |       | (2,553         | )          |              | 4,160      |                |       |   | — |   |   |   | 1,605 |   |   |
| Net income (loss)                                    |       |                | $          | 2,535             |       |           | $          | (4,033            | )          |                | $          | 6,530 |   |   |   | $ | (2,497 | ) |   |   | $ | 2,535 |   |   |

 

20

----

**DUANE READE HOLDINGS, INC.**

**CondensedConsolidating Statement of Operations****(Unaudited)**

**For the 26 weeks ended June 25,2005**

**(Successor)**

**(inthousands)**
| ** **                                           | ** ** | ** **              | ** ** | ** **          | ** ** | ** **        | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane Reade**    | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|-------------------------|------------|
| ** **                                           | ** ** | **Duane Reade**    | ** ** | **Duane**           | ** ** | **Duane**         | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Holdings, Inc.** | ** ** |
| ** **                                           | ** ** | **Holdings, Inc.** | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**        | ** ** |
| Net sales                                            |       |                    | $          | —              |       |              |       | $              | —     |              |       |                    | $          | 794,267 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 794,267 |   |   |
| Cost of sales                                        |       |                    | —     |                |       |              | —     |           |       |              | 642,863    |                    |       |   | — |   |   |   | — |   |   |   | 642,863 |   |   |
| Gross profit                                         |       |                    | —     |                |       |              | —     |           |       |              | 151,404    |                    |       |   | — |   |   |   | — |   |   |   | 151,404 |   |   |
| Selling,  general & administrative expenses |       |                    | —     |                |       |              | —     |           |       |              | 152,906    |                    |       |   | (23,866 | ) |   |   | — |   |   |   | 129,040 |   |   |
| Labor contingency                                    |       |                    | —     |                |       |              | —     |           |       |              | 2,200      |                    |       |   | — |   |   |   | — |   |   |   | 2,200 |   |   |
| Transaction expense                                  |       |                    | —     |                |       |              | —     |           |       |              | 581        |                    |       |   | — |   |   |   | — |   |   |   | 581 |   |   |
| Depreciation and  amortization                       |       |                    | —     |                |       |              | —     |           |       |              | 35,497     |                    |       |   | — |   |   |   | — |   |   |   | 35,497 |   |   |
| Store pre-opening  expense                           |       |                    | —     |                |       |              | —     |           |       |              | 150        |                    |       |   | — |   |   |   | — |   |   |   | 150 |   |   |
| Other                                                |       |                    | —     |                |       |              | —     |           |       |              | 3,182      |                    |       |   | — |   |   |   | — |   |   |   | 3,182 |   |   |
| Operating (loss) income                              |       |                    | —     |                |       |              | —     |           |       |              | (43,112    | )                       |       |   | 23,866 |   |   |   | — |   |   |   | (19,246 | ) |   |
| Equity earnings in  affiliates                  |       |                    | 23,091     |                |       |              | 23,091     |           |       |              | —     |                    |       |   | 362 |   |   |   | (46,544 | ) |   |   | — |   |   |
| Interest expense, net                                |       |                    | —     |                |       |              | —     |           |       |              | 22,664     |                    |       |   | — |   |   |   | — |   |   |   | 22,664 |   |   |
| Income (loss) before  income taxes                   |       |                    | (23,091    | )                   |       |              | (23,091    | )              |       |              | (65,776    | )                       |       |   | 23,504 |   |   |   | 46,544 |   |   |   | (41,910 | ) |   |
| Income tax (benefit)  expense                        |       |                    | —     |                |       |              | —     |           |       |              | (29,536    | )                       |       |   | 10,717 |   |   |   | — |   |   |   | (18,819 | ) |   |
| Net income (loss)                                    |       |                    | $          | (23,091             | )          |              |       | $              | (23,091    | )                 |       |                    | $          | (36,240 | ) |   |   | $ | 12,787 |   |   |   | $ | 46,544 |   |   |   | $ | (23,091 | ) |   |

 

21

----

 

**DUANE READE INC.**

**CondensedConsolidating Statement of Operations****(Unaudited)**

**For the 26 weeks ended June 26,2004**

**(Predecessor)**

**(inthousands)**
| ** **                                      | ** ** | ** **          | ** ** | ** **        | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane**           | ** ** |
|-------------------------------------------------|------------|---------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|---------------------|------------|
| ** **                                      | ** ** | **Duane**           | ** ** | **Duane**         | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Reade Inc.** | ** ** |
| ** **                                      | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**    | ** ** |
| Net sales                                       |       |                | $          | —            |       |           |       | $                 | 785,421    |                |       |   | $ | — |   |   |   | $ | — |   |   |   | $ | 785,421 |   |   |
| Cost of sales                                   |       |                | —     |              |       |           | 629,533    |              |       |                | —     |   |   |   | — |   |   |   | 629,533 |   |   |
| Gross profit                                    |       |                | —     |              |       |           | 155,888    |              |       |                | —     |   |   |   | — |   |   |   | 155,888 |   |   |
| Selling, general &  administrative expenses |       |                | 15         |              |       |           | 139,514    |              |       |                | (20,962    | ) |   |   | — |   |   |   | 118,567 |   |   |
| Labor contingency                               |       |                | —     |              |       |           | 2,200      |              |       |                | —     |   |   |   | — |   |   |   | 2,200 |   |   |
| Transaction expense                             |       |                | —     |              |       |           | 2,619      |              |       |                | —     |   |   |   | — |   |   |   | 2,619 |   |   |
| Depreciation and  amortization                  |       |                | —     |              |       |           | 18,305     |              |       |                | —     |   |   |   | — |   |   |   | 18,305 |   |   |
| Store pre-opening expense                       |       |                | —     |              |       |           | 365        |              |       |                | —     |   |   |   | — |   |   |   | 365 |   |   |
| Operating (loss) income                         |       |                | (15        | )                 |       |           | (7,115     | )                 |       |                | 20,962     |   |   |   | — |   |   |   | 13,832 |   |   |
| Equity earnings in  affiliates                  |       |                | (4,297     | )                 |       |           | —     |              |       |                | 83         |   |   |   | 4,214 |   |   |   | — |   |   |
| Interest expense, net                           |       |                | —     |              |       |           | 6,694      |              |       |                | —     |   |   |   | — |   |   |   | 6,694 |   |   |
| Income (loss) before  income taxes              |       |                | 4,282      |              |       |           | (13,809    | )                 |       |                | 20,879     |   |   |   | (4,214 | ) |   |   | 7,138 |   |   |
| Income tax (benefit)  expense                   |       |                | (6         | )                 |       |           | (5,514     | )                 |       |                | 8,370      |   |   |   | — |   |   |   | 2,850 |   |   |
| Net income (loss)                               |       |                | $          | 4,288             |       |           |       | $                 | (8,295     | )                   |       |   | $ | 12,509 |   |   |   | $ | (4,214 | ) |   |   | $ | 4,288 |   |   |

 

22

----

**DUANE READEHOLDINGS, INC.**

**CondensedConsolidating Balance Sheet (Unaudited)**

**As ofJune 25, 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                                            |       |                    | $         — |                |       | $           — |       | $       1,304 |       |              | $         17     |                    |       |   | $           — |   |   |   | $   1,321 |   |   |
| Receivables                                     |       |                    | —                                                        |                |       | (126,981                                                                  | )          | 291,984                                          |       |              | (44,155                                                       | )                       |       |   | (68,392 | ) |   |   | 52,456 |   |   |
| Inventories                                     |       |                    | —                                                        |                |       | —                                                                    |       | 278,069                                          |       |              | —                                                        |                    |       |   | — |   |   |   | 278,069 |   |   |
| Deferred income taxes                           |       |                    | —                                                        |                |       | 14,585                                                                    |       | 5,049                                            |       |              | (6,189                                                        | )                       |       |   | — |   |   |   | 13,445 |   |   |
| Prepaid expenses and  other assets         |       |                    | —                                                        |                |       | —                                                                    |       | 35,561                                           |       |              | —                                                        |                    |       |   | — |   |   |   | 35,561 |   |   |
| Total current assets                            |       |                    | —                                                        |                |       | (112,396                                                                  | )          | 611,967                                          |       |              | (50,327                                                       | )                       |       |   | (68,392 | ) |   |   | 380,852 |   |   |
| Investment in affiliates                        |       |                    | 160,951                                                       |                |       | (31,505                                                                   | )          | —                                           |       |              | (1,458                                                        | )                       |       |   | (127,988 | ) |   |   | — |   |   |
| Property and equipment                          |       |                    | —                                                        |                |       | —                                                                    |       | 236,022                                          |       |              | —                                                        |                    |       |   | — |   |   |   | 236,022 |   |   |
| Goodwill, net                                   |       |                    | —                                                        |                |       | —                                                                    |       | 52,216                                           |       |              | —                                                        |                    |       |   | — |   |   |   | 52,216 |   |   |
| Deferred income taxes                           |       |                    | —                                                        |                |       | 1,645                                                                     |       | 9,032                                            |       |              | (10,677                                                       | )                       |       |   | — |   |   |   | — |   |   |
| Other assets                                    |       |                    | —                                                        |                |       | 17,015                                                                    |       | 284,972                                          |       |              | 259,857                                                       |                    |       |   | (279,442 | ) |   |   | 282,402 |   |   |
| Total assets                                    |       |                    | $ 160,951                                                |                |       | $ (125,241                                                           | )          | $ 1,194,209                                 |       |              | $ 197,395                                                |                    |       |   | $ (475,822 | ) |   |   | $ 951,492 |   |   |
| Liabilities and Stockholders Equity             |       |                    |                                                          |                |       |                                                                      |       |                                             |       |              |                                                          |                    |       |   |   |   |   |   |   |   |   |
| Current liabilities                             |       |                    |                                                          |                |       |                                                                      |       |                                             |       |              |                                                          |                    |       |   |   |   |   |   |   |   |   |
| Accounts payable                                |       |                    | $         — |                |       | $           — |       | $    88,017                  |       |              | $         — |                    |       |   | $           — |   |   |   | $ 88,017 |   |   |
| Accrued interest                                |       |                    | —                                                        |                |       | —                                                                    |       | 8,398                                            |       |              | —                                                        |                    |       |   | — |   |   |   | 8,398 |   |   |
| Accrued expenses                                |       |                    | —                                                        |                |       | (124                                                                      | )          | 43,603                                           |       |              | —                                                        |                    |       |   | — |   |   |   | 43,479 |   |   |
| Current portion of debt                         |       |                    | —                                                        |                |       | —                                                                    |       | 182,372                                          |       |              | —                                                        |                    |       |   | — |   |   |   | 182,372 |   |   |
| Current portion of  capital lease obligation    |       |                    | —                                                        |                |       | —                                                                    |       | 2,997                                            |       |              | —                                                        |                    |       |   | — |   |   |   | 2,997 |   |   |
| Total current  liabilities                      |       |                    | —                                                        |                |       | (124                                                                      | )          | 325,387                                          |       |              | —                                                        |                    |       |   | — |   |   |   | 325,263 |   |   |
| Long term debt                                  |       |                    | —                                                        |                |       | —                                                                    |       | 620,449                                          |       |              | —                                                        |                    |       |   | (265,417 | ) |   |   | 355,032 |   |   |
| Capital lease  obligation, less current portion |       |                    | —                                                        |                |       | —                                                                    |       | 11,953                                           |       |              | —                                                        |                    |       |   | — |   |   |   | 11,953 |   |   |
| Deferred income taxes                           |       |                    | —                                                        |                |       | 70,222                                                                    |       | (68,945                                          | )          |              | 32,247                                                        |                    |       |   | — |   |   |   | 33,524 |   |   |
| Other non-current  liabilities                  |       |                    | —                                                        |                |       | 2,565                                                                     |       | 62,204                                           |       |              | —                                                        |                    |       |   | — |   |   |   | 64,769 |   |   |
| Total liabilities                               |       |                    | —                                                        |                |       | 72,663                                                                    |       | 951,048                                          |       |              | 32,247                                                        |                    |       |   | (265,417 | ) |   |   | 790,541 |   |   |
| Stockholders equity                             |       |                    |                                                          |                |       |                                                                      |       |                                             |       |              |                                                          |                    |       |   |   |   |   |   |   |   |   |
| Common stock                                    |       |                    | 26                                                            |                |       | —                                                                    |       | 26                                               |       |              | —                                                        |                    |       |   | (26 | ) |   |   | 26 |   |   |
| Paid-in-capital                                 |       |                    | 239,472                                                       |                |       | 17,015                                                                    |       | 321,889                                          |       |              | —                                                        |                    |       |   | (338,904 | ) |   |   | 239,472 |   |   |
| Accumulated other comprehensive  income         |       |                    | (7                                                            | )                   |       | (7                                                                        | )          | (7                                               | )          |              | —                                                        |                    |       |   | 14 |   |   |   | (7 | ) |   |
| Retained earnings                               |       |                    | (78,540                                                       | )                   |       | (214,912                                                                  | )          | (78,747                                          | )          |              | 165,148                                                       |                    |       |   | 128,511 |   |   |   | (78,540 | ) |   |
| Total stockholders  equity                      |       |                    | 160,951                                                       |                |       | (197,904                                                                  | )          | 243,161                                          |       |              | 165,148                                                       |                    |       |   | (210,405 | ) |   |   | 160,951 |   |   |
| Total liabilities and stockholders equity       |       |                    | $ 160,951                                                |                |       | $ (125,241                                                           | )          | $ 1,194,209                                 |       |              | $ 197,395                                                |                    |       |   | $ (475,822 | ) |   |   | $ 951,492 |   |   |

 

23

----

**DUANE READE HOLDINGS, INC.**

**CondensedConsolidating Balance Sheet (Unaudited)**

**As ofDecember 25, 2004**

**(Successor)**

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

 

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**DUANE READE HOLDINGS, INC.**

**CondensedConsolidating Statement of Cash Flows (Unaudited)**

**Forthe 26 weeks ended June 25, 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)                                                                           |       |                    | $          | (23,091             | )          |              |       | $              | (23,091    | )                 |       | $                       | (36,240    | ) |   | $ | 12,787 |   |   |   | $ | 46,544 |   |   |   | $ | (23,091 | ) |   |
| Adjustments to reconcile  net income (loss) to net cash used in  operating activities: |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Depreciation and amortization of property and  equipment                                    |       |                    | —     |                |       |              | —     |           |       | 37,238            |       |                    | —     |   |   |   | — |   |   |   | 37,238 |   |   |
| Deferred tax provision                                                                      |       |                    | —     |                |       |              | (39        | )              |       | (29,536           | )          |                    | 10,717     |   |   |   | — |   |   |   | (18,858 | ) |   |
| Other                                                                                       |       |                    | 23,091     |                |       |              | 23,091     |           |       | 6,901             |       |                    | 362        |   |   |   | (46,544 | ) |   |   | 6,901 |   |   |
| Changes in operating  assets and liabilities:                                               |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Receivables                                                                                 |       |                    | —     |                |       |              | 163        |           |       | 21,293            |       |                    | (15,856    | ) |   |   | — |   |   |   | 5,600 |   |   |
| Inventories                                                                                 |       |                    | —     |                |       |              | —     |           |       | (15,187           | )          |                    | —     |   |   |   | — |   |   |   | (15,187 | ) |   |
| Accounts payable                                                                            |       |                    | —     |                |       |              | —     |           |       | 8,288             |       |                    | —     |   |   |   | — |   |   |   | 8,288 |   |   |
| Prepaid and accrued expenses                                                                |       |                    | —     |                |       |              | (124       | )              |       | (15,767           | )          |                    | —     |   |   |   | — |   |   |   | (15,891 | ) |   |
| Increase in other assets (liabilities), net                                                 |       |                    | —     |                |       |              | —     |           |       | 14,356            |       |                    | (8,025     | ) |   |   | — |   |   |   | 6,331 |   |   |
| NET CASH USED IN  OPERATING ACTIVITIES                                                 |       |                    | —     |                |       |              | —     |           |       | (8,654            | )          |                    | (15        | ) |   |   | — |   |   |   | (8,669 | ) |   |
| Capital expenditures                                                                        |       |                    | —     |                |       |              | —     |           |       | (14,310           | )          |                    | —     |   |   |   | — |   |   |   | (14,310 | ) |   |
| Lease acquisition and other costs                                                           |       |                    | —     |                |       |              | —     |           |       | (5,764            | )          |                    | —     |   |   |   | — |   |   |   | (5,764 | ) |   |
| Proceeds from sale of property                                                              |       |                    | —     |                |       |              | —     |           |       | 2,223             |       |                    | —     |   |   |   | — |   |   |   | 2,223 |   |   |
| NET CASH USED IN INVESTING ACTIVITIES                                                       |       |                    | —     |                |       |              | —     |           |       | (17,851           | )          |                    | —     |   |   |   | — |   |   |   | (17,851 | ) |   |
| Cash flows from  financing activities:                                                      |       |                    |       |                |       |              |       |           |       |              |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Borrowings from revolving credit facility                                                   |       |                    | —     |                |       |              | —     |           |       | 901,942           |       |                    | —     |   |   |   | — |   |   |   | 901,942 |   |   |
| Repayments of revolving credit facility                                                     |       |                    | —     |                |       |              | —     |           |       | (873,440          | )          |                    | —     |   |   |   | — |   |   |   | (873,440 | ) |   |
| Deferred financing costs                                                                    |       |                    | —     |                |       |              | —     |           |       | (622              | )          |                    | —     |   |   |   | — |   |   |   | (622 | ) |   |
| Repayments of capital lease obligations                                                     |       |                    | —     |                |       |              | —     |           |       | (1,368            | )          |                    | —     |   |   |   | — |   |   |   | (1,368 | ) |   |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                                   |       |                    | —     |                |       |              | —     |           |       | 26,512            |       |                    | —     |   |   |   | — |   |   |   | 26,512 |   |   |
| Net change in cash                                                                          |       |                    | —     |                |       |              | —     |           |       | 7                 |       |                    | (15        | ) |   |   | — |   |   |   | (8 | ) |   |
| Cash at beginning of period                                                                 |       |                    | —     |                |       |              | —     |           |       | 1,297             |       |                    | 32         |   |   |   | — |   |   |   | 1,329 |   |   |
| Cash at end of  period                                                                      |       |                    | $          | —              |       |              |       | $              | —     |              |       | $                       | 1,304      |   |   | $ | 17 |   |   |   | $ | — |   |   |   | $ | 1,321 |   |   |

 

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**DUANE READE INC.**

**CondensedConsolidating Statement of Cash Flows (Unaudited)**

**Forthe 26 weeks ended June 26, 2004**

**(Predecessor)**

**(in thousands)**
| ** **                                                                                          | ** ** | ** **          | ** ** | ** **        | ** ** | ** **     | ** ** | ** **        | ** ** | **Duane**           | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------|------------|-------------------|------------|----------------|------------|-------------------|------------|---------------------|------------|
| ** **                                                                                          | ** ** | **Duane**           | ** ** | **Duane**         | ** ** | **Subsidiary** | ** ** | **Consolidating** | ** ** | **Reade Inc.** | ** ** |
| ** **                                                                                          | ** ** | **Reade Inc.** | ** ** | **Reade GP** | ** ** | **Guarantors** | ** ** | **Adjustments**   | ** ** | **Consolidated**    | ** ** |
| Cash flows from  operating activities:                                                              |       |                |       |              |       |           |       |              |       |                |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                                   |       |                | $          | 4,288             |       |           | $          | (8,295            | )          |                | $          | 12,509 |   |   |   | $ | (4,214 | ) |   |   | $ | 4,288 |   |   |
| Adjustments to reconcile  net income (loss) to net cash provided by/(used in) operating activities: |       |                |       |              |       |           |       |              |       |                |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization of property and  equipment                                            |       |                | —     |              |       | 19,260         |       |              | —     |                |       |   | — |   |   |   | 19,260 |   |   |
| Deferred tax provision                                                                              |       |                | (82        | )                 |       | (5,514         | )          |              | 8,370      |                |       |   | — |   |   |   | 2,774 |   |   |
| Other                                                                                               |       |                | (4,297     | )                 |       | 3,827          |       |              | 83         |                |       |   | 4,214 |   |   |   | 3,827 |   |   |
| Changes in operating assets  and liabilities:                                                       |       |                |       |              |       |           |       |              |       |                |       |   |   |   |   |   |   |   |   |
| Receivables                                                                                         |       |                | (1,732     | )                 |       | 1,218          |       |              | (49        | )                   |       |   | — |   |   |   | (563 | ) |   |
| Inventories                                                                                         |       |                | —     |              |       | (333           | )          |              | —     |                |       |   | — |   |   |   | (333 | ) |   |
| Accounts payable                                                                                    |       |                | —     |              |       | (8,486         | )          |              | —     |                |       |   | — |   |   |   | (8,486 | ) |   |
| Prepaid and accrued expenses                                                                        |       |                | 697        |              |       | 2,361          |       |              | —     |                |       |   | — |   |   |   | 3,058 |   |   |
| Increase in other assets (liabilities), net                                                         |       |                | —     |              |       | 17,114         |       |              | (20,900    | )                   |       |   | — |   |   |   | (3,786 | ) |   |
| NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES                                                 |       |                | (1,126     | )                 |       | 21,152         |       |              | 13         |                |       |   | — |   |   |   | 20,039 |   |   |
| Capital expenditures                                                                                |       |                | —     |              |       | (16,182        | )          |              | —     |                |       |   | — |   |   |   | (16,182 | ) |   |
| Lease acquisition and other costs                                                                   |       |                | —     |              |       | (11,517        | )          |              | —     |                |       |   | — |   |   |   | (11,517 | ) |   |
| NET CASH USED IN INVESTING ACTIVITIES                                                               |       |                | —     |              |       | (27,699        | )          |              | —     |                |       |   | — |   |   |   | (27,699 | ) |   |
| Cash flows from  financing activities:                                                              |       |                |       |              |       |           |       |              |       |                |       |   |   |   |   |   |   |   |   |
| Borrowings from revolving credit  facility                                                          |       |                | —     |              |       | 798,122        |       |              | —     |                |       |   | — |   |   |   | 798,122 |   |   |
| Repayments of revolving credit facility                                                             |       |                | —     |              |       | (791,168       | )          |              | —     |                |       |   | — |   |   |   | (791,168 | ) |   |
| Deferred financing costs                                                                            |       |                | —     |              |       | (138           | )          |              | —     |                |       |   | — |   |   |   | (138 | ) |   |
| Proceeds from exercise of stock options                                                             |       |                | 1,126      |              |       | —         |       |              | —     |                |       |   | — |   |   |   | 1,126 |   |   |
| Repayments of capital lease obligations                                                             |       |                | —     |              |       | (206           | )          |              | —     |                |       |   | — |   |   |   | (206 | ) |   |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                                           |       |                | 1,126      |              |       | 6,610          |       |              | —     |                |       |   | — |   |   |   | 7,736 |   |   |
| Net change in cash                                                                                  |       |                | —     |              |       | 63             |       |              | 13         |                |       |   | — |   |   |   | 76 |   |   |
| Cash at beginning of period                                                                         |       |                | —     |              |       | 1,204          |       |              | 48         |                |       |   | — |   |   |   | 1,252 |   |   |
| Cash at end of  period                                                                              |       |                | $          | —            |       |           | $          | 1,267             |       |                | $          | 61 |   |   |   | $ | — |   |   |   | $ | 1,328 |   |   |

 

26

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**10.**   Subsequent Event

On August 4, 2005 the Company priced a privateplacement of $50.0 million of Senior Secured Floating Rate Notes due 2010 (the“New Senior Secured Notes”) issued by Duane Reade Inc. and Duane Reade, whichare its wholly owned subsidiaries. The Company expects to close the privateplacement on August 9, 2005.

The Company will use the proceeds from the sale of theNew Senior Secured Notes to repay a portion of its outstanding borrowings underits amended asset-based revolving loan facility.  Concurrent with the closing of this privateplacement, the maximum commitment of the Company’s amended asset-basedrevolving loan facility will be reduced from $250 million to $225 million.In addition, the fixed charge coverage ratio was reduced until June 30,2007.

The New SeniorSecured Notes will be issued under the indenture governing the Company’sexisting Senior Secured Floating Rate Notes due 2010 and will be treated as asingle class with the existing Senior Secured Floating Rate Notes under thatindenture. However the New Senior Secured Notes will not be fungible with theexisting Senior Secured Floating Rate Notes. The New Senior Secured Notes willbear interest at a floating rate of LIBOR plus 4.50% and will havesubstantially the same terms as those of the existing Senior Secured FloatingRate Notes except that:

·       TheNew Senior Secured Notes will be issued at an offering price of 95.5% plusaccrued interest;

·       Theissuance of the New Senior Secured Notes will not be registered under theSecurities Act of 1933 but will be subject to a registration rights agreement;and

·       Thefirst payment of cash interest following the issue date of the New SeniorSecured Notes will be September 15, 2005.

**ITEM2.**                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 51.2% and 50.8% of our sales in the quarter and sixmonths ended June 25, 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%, but as is the case withmost other drug store chains, represents a decreasing share of business yearafter year due to the faster rate of pharmacy sales growth. Our pharmacy salesinclude all items we sell by prescription filled at our retail locations or byour central fill facility and delivered to our stores or direct to customers.In addition, we include in our pharmacy sales certain resales of retailpharmaceutical inventory. The pharmacy portion of our business is dominated byand dependent upon a number of third party private and government-sponsoredplans that contract with us as an authorized provider of prescriptions.

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Sales to third party prescription plans represented92.8% of our prescription sales in both the quarter and six months ended June 25,2005. Pharmacy sales have 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. As a result, pharmacy sales have grown at a rapid pace in bothnumbers of prescriptions dispensed as well as inflation driven increases incosts. While these factors all contributed to the increasing proportion ofpharmacy sales to our total sales, the rate of our pharmacy sales growth hasbeen slowing in the last few years due to an increased focus on the part ofboth government and private plans to control the high costs of providing thesebenefits. The rate of growth for pharmacy retailers has also slowed as a resultof an increased penetration by mail order and internet-based providers. In thesecond half of 2004 and continuing into the first half of 2005, we experienceda further slowing of pharmacy sales growth due to the negative publicitysurrounding the temporary recall of high volume Vioxx and other Cox-2inhibitors.

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

In fiscal 2003 and again in fiscal 2004, New YorkState reduced Medicaid and EPIC prescription reimbursement rates, adverselyimpacting our pharmacy gross margins. The most recent reductions becameeffective on October 1, 2004, and are expected to reduce reimbursements byapproximately $1.4 million on an annual basis. New Jersey also implementedreduced Medicaid reimbursement rates in 2003. The New York State legislaturehas also recently approved increases in co-payments by $1.00 per prescriptionfor branded drugs and $0.50 per prescription for generics effective August 1,2005. Under the Medicaid guidelines, providers cannot refuse to dispenseprescriptions to Medicaid recipients who claim that they do not have the meansto pay the required co-payments. Most Medicaid recipients decline to make theco-payments, resulting in the requirement for the provider to absorb this cost.These increased co-payments for New York Medicaid are expected to result infurther reduced reimbursements of approximately $1.4 million per year.

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 brandedmedications. Improved generic utilization rates as well as increased purchasesdirect from manufacturers rather than through wholesalers enabled us to achieveimproved gross margins on pharmacy retail sales during 2004 and in the first halfof 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.The New Jersey legislature has approved increases in the minimum hourly wagefrom $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 canoffset a 

28

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significant portion ofthese cost increases through initiatives designed to further improve our laborefficiency.

We operate approximately 87% of our 250 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 the first half of 2005, the New York City economy generallyreflected an improving trend for most of these external economic indicators.

Our primary assets are ourownership of 100% of the outstanding capital stock of Duane Reade Inc.,which in turn owns 99% of the outstanding partnership interest of 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. and DRI I Inc.made a capital contribution of these intellectual property rights to DuaneReade International. This change created a controlled system to manage andexploit these intellectual property rights separate and apart from the retailoperations. In addition, Duane Reade GP distributed some of its storeleases to Duane Reade Inc. and DRI I Inc., which in turn made acapital contribution of these leases to Duane Reade Realty. DuaneReade Realty is the lessee under certain store leases entered into afterits creation. Duane Reade Realty subleases to Duane Reade GP theproperties subject to those leases. The consolidated financial statementsincluded in this filing reflect the accounts of Duane Reade Holdings, Inc.and its subsidiaries. All significant intercompany transactions and balanceshave 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 June 2005unemployment data for New York City indicated an unemployment rate of 5.3%,compared to a national rate of 5.2%. In addition, the New York City unemploymentrate reflected a significant improvement as compared to the monthly averagerate of 8.5% reported for the first quarter of 2004.

**Results of Operations**

**TheThirteen Weeks Ended June 25, 2005 for the Successor as Compared to theThirteen Weeks Ended June 26, 2004 for the Predecessor**

For the secondquarter of 2005, we achieved net sales of $399.5 million and sustained anet loss of $10.3 million, as compared to net sales of $402.1 millionand net income of $2.5 million in the second quarter of the previous year.The decline in earnings is due to the following factors:

·       An increase in depreciationand amortization expense of $8.6 million from the Acquisition relatedpurchase accounting adjustments to the valuation of store leases, prescriptionpharmacy files and 

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property, plant andequipment under FAS 141 as well as the depreciation of capitalexpenditures and amortization of intangibles acquired in 2004 and 2005.

·       An increase in interestexpense of $8.2 million primarily resulting from the new debt incurred inconnection with the Acquisition.

·       Increased consulting andlitigation related expenses of $1.9 million that resulted from consultingcosts incurred in connection with various management initiatives to improve operatingperformance, litigation related legal costs for certain labor and real estaterelated disputes, the World Trade Center business interruption insurance claimand litigation defending new class actions.

·       An increase in non-cashrent expense of $1.4 million that was attributable to the application ofpurchase accounting under FAS 141, “Business Combinations,” in connection withthe July 30, 2004 Acquisition by Oak Hill.

·       Reduced real estate relatedincome of $1.1 million.

·       Increased store payrollcosts from higher minimum wages in New York and increased pharmacy labor ratesdriven by the pharmacist shortage.

·  Higher acquisition transaction and related costsof $0.7 million.

Thefollowing sets forth the results of operations for the periods indicated:
| ** **                                           | ** ** | **13 Weeks Ended**                        | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **Successor**                                       | ** ** | **Predecessor** | ** ** |
| ** **                                           | ** ** | **June 25, 2005**                         | ** ** | **June 26, 2004** | ** ** |
| ** **                                           | ** ** | **Dollars**                                         | ** ** | **% of Sales** | ** ** | **Dollars** | ** ** | **% of Sales** | ** ** |
| ** **                                           | ** ** | **In thousands, except percentages** | ** ** |
| Net sales                                            |       | $                                                   | 399,500    |   |   | 100.0 | % |   | $ | 402,111 |   |   | 100.0 | % |   |
| Cost of sales                                        |       | 320,905                                             |       |   | 80.3 |   |   | 322,726 |   |   | 80.3 |   |   |
| Gross profit                                         |       | 78,595                                              |       |   | 19.7 |   |   | 79,385 |   |   | 19.7 |   |   |
| Selling,  general & administrative expenses |       | 64,541                                              |       |   | 16.2 |   |   | 59,924 |   |   | 14.9 |   |   |
| Labor contingency                                    |       | 1,100                                               |       |   | 0.3 |   |   | 1,100 |   |   | 0.3 |   |   |
| Transaction  expense                                 |       | 154                                                 |       |   | 0.0 |   |   | 1,516 |   |   | 0.4 |   |   |
| Depreciation and  amortization                       |       | 17,851                                              |       |   | 4.5 |   |   | 9,239 |   |   | 2.3 |   |   |
| Store pre-opening  expenses                          |       | 50                                                  |       |   | 0.0 |   |   | 209 |   |   | 0.1 |   |   |
| Other                                                |       | 2,033                                               |       |   | 0.5 |   |   | — |   |   | 0.0 |   |   |
| Operating (loss)  income                             |       | (7,134                                              | )          |   | -1.8 |   |   | 7,397 |   |   | 1.8 |   |   |
| Interest expense,  net                               |       | 11,499                                              |       |   | 2.9 |   |   | 3,257 |   |   | 0.8 |   |   |
| (Loss) income  before income taxes                   |       | (18,633                                             | )          |   | -4.7 |   |   | 4,140 |   |   | 1.0 |   |   |
| Income tax  (benefit) expense                        |       | (8,345                                              | )          |   | -2.1 |   |   | 1,605 |   |   | 0.4 |   |   |
| Net (loss) income                                    |       | $                                                   | (10,288    | ) |   | -2.6 | % |   | $ | 2,535 |   |   | 0.6 | % |   |

 

Net sales were $399.5 million in the thirteenweeks ended June 25, 2005, representing a decrease of 0.6% as compared tonet sales of $402.1 million in the thirteen weeks ended June 26,2004. While retail sales to customers grew by 2.4% over this period, theincrease was more than offset by the impact of reduced resale activity.Same-store sales increased by 0.5% over the second quarter last year with thebalance of the increase coming from the full quarterly results of four net newstores opened in the second quarter last year and three net new stores openedsince the end of last year’s second quarter.

Pharmacy sales decreased from $202.3 million inthe second quarter of 2004 to $195.1 million in the second quarter of2005, a decrease of 3.6%, and represented 48.8% of total sales, as comparedwith 50.3% of total sales in the comparable period of 2004. The overallpharmacy sales decrease includes a decrease of 

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5.9% resulting from thereduced resale activity, partially offset by an increase of 2.3% in normalretail pharmacy sales. Pharmacy same-store sales increased by 0.2% over lastyear, and third-party reimbursed pharmacy sales represented 92.8% of totalprescription sales, as compared to 92.2% in the second quarter of 2004.Pharmacy same-store sales were adversely impacted by approximately 1.9% due tonegative publicity and significantly reduced consumer demand for arthritismedications and certain other high volume drugs and approximately 1.4% due toincreased mail order penetration resulting from conversion of certain thirdparty plans to mandatory mail order requirements. The percentage of genericprescriptions dispensed increased by 4.7% this year, resulting in a reductionof the pharmacy same-store sales increase by approximately 2.8%, but anincrease in gross margin per prescription dispensed. Generic prescriptionsgenerally have lower selling prices but are more profitable than brandedprescriptions.

Front-end sales increased from $199.8 million inthe second quarter of 2004 to $204.4 million in the second quarter of2005, an increase of 2.3%, and represented 51.2% of total sales, as compared to49.7% of total sales in the comparable period of 2004. Front-end same-storesales increased by 0.7%, primarily due to the favorable impact of the improvedDollar Rewards customer loyalty card and a generally improved level of consumerdemand.

During the thirteen weeks ended June 25, 2005, weopened one store, as compared to four stores opened during the thirteen weeksended June 26, 2004. At June 25, 2005, we operated 250 stores, ascompared to 247 stores at June 26, 2004.

Cost of sales as a percentage of net sales was 80.3%in the second quarter of 2005 and 2004, resulting in gross profit margins of19.7% in each period. The lack of change in gross profit margins was primarilyattributable to higher pharmacy gross margins associated with increased genericdispensing rates and direct purchases that were largely offset by increasednon-cash rent expense of $1.4 million, or 0.3% of sales, that was attributableto the application of purchase accounting under FAS 141, “BusinessCombinations,” in connection with the July 30, 2004 acquisition by OakHill. Cost of sales also includes (i) a $0.3 million LIFO provisionin the second quarter of both the current and prior years, and (ii) real-estaterelated income of $0.1 million in the second quarter of 2005 as comparedto $1.3 million in the second quarter of 2004.

Selling, general and administrative expenses were$64.5 million, or 16.2% of net sales and $59.9 million, or 14.9% ofnet sales, in the second quarters of 2005 and 2004, respectively. The increasein these expense ratios to sales as compared to the prior year primarilyreflects the reduced pharmacy resale activity in the current year (which reducesnet sales and adversely impacts the SG&A expense ratio), increased consultingand litigation related expenses, as well as increased labor costs for pharmacistsand increases in the New York minimum wage rates.

Depreciation and amortization of capital expendituresand intangible assets amounted to $17.9 million in the second quarter of2005, as compared to $9.2 million in the second quarter of 2004. Thisincrease was attributable to the aforementioned step-up in asset valuesresulting from the application of purchase accounting under FAS 141 thatwas required in connection with the Acquisition, as well as increases resultingfrom the depreciation of capital expenditures made in 2004 and 2005 andamortization of identifiable intangibles acquired over the same period.

We incurred store pre-opening expenses of$0.1 million in the second quarter of 2005, related to the opening of onestore. In the second quarter of last year, we incurred pre-opening costs of$0.2 million, attributable to the opening of four stores.

During the 13 weeks ended June 25, 2005, we recordedother expenses of $2.0 million resulting from the completion of theAcquisition.  These expenses include (i)$0.2 million attributable to the CEO’s annual $0.9 million long-term cash award,(ii) $0.3 million related to the annual $1.25 million management fee payable toOak Hill, (iii) $0.6 million representing a portion of the anticipated cost oftransferring the 

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ownership of a splitdollar life insurance policy to the CEO in July 2006 and (iv) $0.9 millionreflecting an allocation of the expenses associated with the implementation ofa tax indemnity insurance policy related to the deductibility of certainpayments made to the CEO in connection with the Acquisition.

Net interest expense for the second quarter of 2005was $11.5 million, as compared to $3.3 million in the second quarterof 2004. This increase was primarily attributable to the higher interest costsand increased debt in the current year resulting from the Acquisition. At June 25,2005, the weighted average interest rate on our variable rate outstanding debtwas 6.22%, as compared to 3.12% at June 26, 2004.

In the second quarter of2005, we recorded an income tax benefit of $8.3 million, reflecting anestimated effective tax rate of 44.8%, inclusive of the anticipated benefits ofwage-based income tax credits. In the comparable period last year, the incometax provision of $1.6 million reflected an estimated effective tax rate of38.8%, inclusive of the anticipated benefits of wage-based income tax credits.The income tax credits represent the economic benefits earned by us for ourparticipation in various federal and state employment incentive programs. Theincrease in the current year’s effective rate reflects the combined impact ofthe income tax credits and the pre-tax loss generated by us.

**TheTwenty-Six Weeks Ended June 25, 2005 for the Successor as Compared to theTwenty-Six Weeks Ended June 26, 2004 for the Predecessor**

For the first halfof 2005, we achieved net sales of $794.3 million and sustained a net lossof $23.1 million, as compared to net sales of $785.4 million and netincome of $4.3 million in the first half of the previous year. The declinein earnings is due to the following factors:

·       An increase in depreciationand amortization expense of $17.2 million from the Acquisition relatedpurchase accounting adjustments to the valuation of store leases, prescriptionpharmacy files and property, plant and equipment under FAS 141 as well asthe depreciation of capital expenditures and amortization of intangiblesacquired in 2004 and 2005.

·       An increase in interestexpenses of $16.0 million from the new debt incurred in connection withthe Acquisition.

·       A decline in gross marginfrom 19.8% in the first half of 2004 to 19.1% in the first half of 2005. Thedecrease was primarily attributable to lower vendor allowances, increasedinventory shrink losses, lower levels of real estate related income andincreased non-cash rent expense of $3.1 million, that was attributable to theapplication of purchase accounting under FAS 141, “Business Combinations,” inconnection with the July 30, 2004 Acquisition by Oak Hill.

·       Increased store payrollcosts resulting from higher minimum wages in New York and increased labor ratesfor pharmacists.

 

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·       Increased consulting andlitigation related expenses of $3.9 million that resulted from certainlabor and real estate related disputes, the World Trade Center businessinterruption insurance claim and litigation defending new class actions.

The following sets forth the results of operations forthe periods indicated:
| ** **                                           | ** ** | **26 Weeks Ended**                        | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **Successor**                                       | ** ** | **Predecessor** | ** ** |
| ** **                                           | ** ** | **June 25, 2005**                         | ** ** | **June 26, 2004** | ** ** |
| ** **                                           | ** ** | **Dollars**                                         | ** ** | **% of Sales** | ** ** | **Dollars** | ** ** | **% of Sales** | ** ** |
| ** **                                           | ** ** | **In thousands, except percentages** | ** ** |
| Net sales                                            |       | $                                                   | 794,267    |   |   | 100.0 | % |   | $ | 785,421 |   |   | 100.0 | % |   |
| Cost of sales                                        |       | 642,863                                             |       |   | 80.9 |   |   | 629,533 |   |   | 80.2 |   |   |
| Gross profit                                         |       | 151,404                                             |       |   | 19.1 |   |   | 155,888 |   |   | 19.8 |   |   |
| Selling,  general & administrative expenses |       | 129,040                                             |       |   | 16.2 |   |   | 118,567 |   |   | 15.1 |   |   |
| Labor contingency                                    |       | 2,200                                               |       |   | 0.3 |   |   | 2,200 |   |   | 0.3 |   |   |
| Transaction  expense                                 |       | 581                                                 |       |   | 0.1 |   |   | 2,619 |   |   | 0.3 |   |   |
| Depreciation and  amortization                       |       | 35,497                                              |       |   | 4.5 |   |   | 18,305 |   |   | 2.3 |   |   |
| Store pre-opening  expenses                          |       | 150                                                 |       |   | 0.0 |   |   | 365 |   |   | 0.0 |   |   |
| Other                                                |       | 3,182                                               |       |   | 0.4 |   |   | — |   |   | 0.0 |   |   |
| Operating (loss)  income                             |       | (19,246                                             | )          |   | -2.4 |   |   | 13,832 |   |   | 1.8 |   |   |
| Interest expense,  net                               |       | 22,664                                              |       |   | 2.9 |   |   | 6,694 |   |   | 0.9 |   |   |
| (Loss) income  before income taxes                   |       | (41,910                                             | )          |   | -5.3 |   |   | 7,138 |   |   | 0.9 |   |   |
| Income tax  (benefit) expense                        |       | (18,819                                             | )          |   | -2.4 |   |   | 2,850 |   |   | 0.4 |   |   |
| Net (loss) income                                    |       | $                                                   | (23,091    | ) |   | -2.9 | % |   | $ | 4,288 |   |   | 0.5 | % |   |

 

Net sales were $794.3 million in the twenty-sixweeks ended June 25, 2005, representing an increase of 1.1% as compared tonet sales of $785.4 million in the twenty-six weeks ended June 26,2004. Reduced resale activity accounted for a decrease of 2.2%, while retailsales to customers increased by 3.3% over this period. Same-store salesincreased by 1.2% over the first half of last year with the balance of theincrease coming from the full six-month results of six net new stores opened duringthe first half of 2004 and three net new stores opened since the end of lastyear’s second quarter.

Pharmacy sales decreased from $394.5 million inthe first half of 2004 to $390.5 million in the first half of 2005, adecrease of 1.0%, and represented 49.2% of total sales, as compared with 50.2%of total sales in the comparable period of 2004. The overall pharmacy salesdecrease includes a decrease of 4.5% resulting from the reduced resaleactivity, offset by an increase of 3.5% in normal retail pharmacy sales.Pharmacy same-store sales increased by 1.1% over last year, and third-partyreimbursed pharmacy sales represented 92.8% of total prescription sales, ascompared to 92.1% in the first half of 2004.

Front-end sales increased from $390.9 million inthe first half of 2004 to $403.8 million in the first half of 2005, anincrease of 3.3%, and represented 50.8% of total sales, as compared to 49.8% oftotal sales in the comparable period of 2004. Front-end same-store salesincreased by 1.3%, primarily due to a stronger cough and cold season, theimpact of the improved Dollar Rewards loyalty card and a generally improvedlevel of consumer demand.

During the twenty-six weeks ended June 25, 2005,we opened three stores and closed eight stores, as compared to seven storesopened and one store closed during the twenty-six weeks ended June 26,2004.

Cost of sales as a percentage of net sales was 80.9%in the first half of 2005 and 80.2% in the first half of 2004, resulting ingross profit margins of 19.1% and 19.8%, respectively. This decrease in grossprofit margins was primarily attributable to lower levels of vendor allowancesand real estate related income combined with higher inventory shrink losses andincreased non-cash rent expense of $3.1 million, or 1.4% of sales, that wasattributable to the application of purchase accounting under FAS 141, “Business

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Combinations,” inconnection with the Acquisition. Cost of sales also includes (i) a$0.1 million LIFO provision in the current year’s first six months ascompared to a LIFO provision of $0.7 million in the corresponding periodlast year, and (ii) real-estate related income of $0.2 million in thefirst half of 2005 as compared to $2.1 million in the first half of 2004.

Selling, general and administrative expenses were$129.0 million, or 16.2% of net sales, and $118.6 million, or 15.1%of net sales, in the first six months of 2005 and 2004, respectively. 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 capital expendituresand intangible assets amounted to $35.5 million in the first half of 2005,as compared to $18.3 million in the first half of 2004. 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$0.2 million in the first six months of 2005, related to the opening ofthree stores. In the comparable period last year, we incurred pre-opening costsof $0.4 million, attributable to the opening of seven stores.

During the 26 weeks ended June 25, 2005, werecorded other expenses of $3.2 million resulting from the completion of theAcquisition. These expenses include (i) $0.5 million attributable to theCEO’s annual $0.9 million long-term cash award, (ii) $0.6 million relatedto the annual $1.25 million management fee payable to Oak Hill, (iii) $1.2million representing a portion of the anticipated cost of transferring theownership of a split dollar life insurance policy to the CEO in July 2006 and(iv) $0.9 million reflecting an allocation of the expenses associated with theimplementation of a tax indemnity insurance policy related to the deductibilityof certain payments made to the CEO in connection with the Acquisition.

Net interest expense for the first half of 2005 was$22.7 million, as compared to $6.7 million in the first half of 2004.This increase was primarily attributable to the higher interest costs andincreased debt in the current year that was associated with the Acquisition.

In the first six months of2005, we recorded an income tax benefit of $18.8 million, reflecting anestimated effective tax rate of 44.9%, inclusive of the anticipated benefits ofwage-based income tax credits. In the comparable period last year, the incometax provision of $2.9 million reflected an estimated effective tax rate of39.9%, inclusive of the anticipated benefits of wage-based income tax credits.The income tax credits represent the economic benefits earned by us for ourparticipation in various federal and state employment incentive programs. Theincrease in the current year’s effective rate reflects the combined impact ofthe income tax credits and the reduced levels of pre-tax income generated byus.

**Liquidity and Capital Resources**

**Working Capital and Cash Flow**

Working capital was $55.6 million as of June 25,2005 and $66.7 million as of December 25, 2004. Working capitalreflects the classification of outstanding borrowings under our asset-basedrevolving loan facility of $182.4 million at June 25, 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 

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asset-based revolving loanexpires in July of 2008 and we intend to continue to access it for ourworking capital needs throughout its remaining term.

Net cash used in operating activities was$8.7 million in the twenty-six weeks ended June 25, 2005 compared tocash provided by operations of $20.0 million in the twenty-six weeks endedJune 26, 2004. The use of cash in the current year reflects the scheduled$19.0 million CEO SERP early termination payment.

Net cash used in investing activities was$17.9 million in the twenty-six weeks ended June 25, 2005, comparedto $27.7 million in the twenty-six weeks ended June 26, 2004. In thefirst half of 2005, capital expenditures, primarily related to new storeopenings and the remodeling of existing locations, were $14.3 million,while lease acquisition, pharmacy customer file and other costs were$5.8 million of cash used in investing activities. These amounts werepartially offset by $2.2 million of cash received in connection with the saleof property. In the first half of 2004, we spent $16.2 million on capitalexpenditures and $11.5 million on lease acquisition, pharmacy customerfile and other costs.

Net cash provided byfinancing activities was $26.5 million in the twenty-six weeks ended June 25,2005, compared to $7.7 million in the twenty-six weeks ended June 26,2004. The increase in cash provided by financing activities in the current yearwas primarily attributable to the increased utilization of cash for operatingand investing activities.

**The Acquisition**

The July 30, 2004Acquisition was financed as an all cash transaction whereby our common stockoutstanding immediately prior to the Acquisition was converted into the rightto receive $16.50 per share, without interest. The total transaction value,including transaction expenses and the repayment of indebtedness wasapproximately $748 million, which was funded through external andmanagement-related equity contributions of approximately $244 million anddebt of approximately $504 million.

**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 three newstores in the first half of 2005 and currently plan to open up to 7 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 through fiscal2008. We also require working capital to support inventory for our existing andnew stores. Historically, we have been able to lease almost all of our storelocations, 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 andpotentially additional appeals and, on June 22, 2005, The Court of Appealsaffirmed the decision of the trial court, with modifications, includingmodifications to certain of the legal tests on which the appraisal panel’sdecision was based. We are currently in the process of evaluating the opinionand its effect on the recovery and are considering our options. As a result ofthe appeal process and other uncertainties, we may not actually receive any orall of the panel’s appraised value of this claim, and we cannot be certain ofthe timing of future payments, if any, with respect to our claim. It shouldalso be noted that any payment to us that might be forthcoming as a result ofthis claim may also result in the incurrence of additional expenses that arecontingent upon the amount of such insurance claim settlement. These expenses,if incurred, are 

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not expected to exceed$6.0 million. Please refer to Note 8 of the Unaudited Consolidated InterimFinancial Statements included elsewhere in this document for a more detailedexplanation of this matter.

Eleven of our stores which generated approximately3.8% of our net sales for fiscal 2004 have leases scheduled to expire beforethe end of fiscal 2006. Four of these leases have renewal options. We believethat we will be able to renew the other expiring leases on economicallyfavorable terms or, alternatively, find other economically attractive locationsto lease.

As of June 25, 2005, approximately 4,100 of ourapproximately 6,000 employees were represented by various labor unions and werecovered by collective bargaining agreements. Pursuant to the terms of thecollective bargaining agreements covering these employees, we are required, insome instances, to pay specified annual increases in salary and benefitscontributions relating to the member employees. We do not believe that theseincreases will have a material impact on our liquidity or results ofoperations. Our collective bargaining agreement with Local 340A New York JointBoard, UNITE AFL-CIO (“UNITE”), who represents approximately 700 of ouremployees in 113 stores, expired on March 31, 2005. The parties haveagreed to an extension of this contract through September 30, 2005.

Under an employment agreement with our Chairman andCEO originally entered into in 1997 and subsequently amended in 2000 and 2001,and then amended and restated in 2002, and again amended and restated in connectionwith the completed Acquisition, we were required to fund $5.0 million premiumsannually through 2010 for a split dollar life insurance policy that wouldprovide certain post-retirement benefits. The enactment of the Sarbanes-OxleyAct has resulted in the need for additional guidance concerning thepermissibility of split dollar life insurance policies for executives. While webelieve this split dollar policy is permitted under current interpretations ofthe legislation, there can be no assurance that further interpretations orguidance to be provided by the SEC concerning this legislation will concur. Uponcompletion of the Acquisition, under Mr. Cuti’s amended and restatedemployment agreement, we elected to terminate the split dollar life insurance contractin exchange for, among other things, the payment to Mr. Cuti of$20.5 million on or prior to January 3, 2005 and $4.0 million onor prior to June 30, 2005. We have made all such required payments.Approximately $14.3 million of these payment obligations were offset bythe proceeds of the cash surrender value of the split dollar life insurancecontract, which was terminated on June 30, 2005 in connection with thefinal $4.0 million payment to the CEO.

The Acquisitionresulted in a restructuring of our debt, as well as the elimination of ourobligations under the CEO Split Dollar Life Insurance Policy, in exchange forcertain direct payments to our Chief Executive Officer. The following tablepresents details of our significant Commitments and Obligations as at June 25,2005, except that the data provided with respect to operating leases is as of December 25,2004:
| ** **                                 | ** ** | **Payments due by Period** | ** ** |
|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                 | ** ** | ** **                                | ** ** | **Within** | ** ** | ** ** | ** ** | ** ** | ** ** | **After** | ** ** |
| **Contractual Cash Obligations** | ** ** | ** **                                | ** ** | **Total** | ** ** | **1 year** | ** ** | **2-3 years** | ** ** | **4-5 years** | ** ** | **5 years** | ** ** |
| ** **                                 | ** ** | **(dollars in thousands)**      | ** ** |
| Debt Obligations(1)                        |       | $                                         | 537,404    |   | $ | 182,372 |   | $ | — |   | $ | — |   | $ | 355,032 |   |
| Capital Lease  Obligations                 |       | 14,947                                    |       | 2,997 |   | 6,484 |   | 5,466 |   | — |   |
| Operating Leases                           |       | 1,344,893                                 |       | 119,602 |   | 237,090 |   | 219,849 |   | 768,352 |   |
| Fixed Interest  Payments(2)                |       | 123,581                                   |       | 19,012 |   | 38,025 |   | 38,025 |   | 28,519 |   |
| Total Contractual Cash  Obligations        |       | $                                         | 2,020,825  |   | $ | 323,983 |   | $ | 281,599 |   | $ | 263,340 |   | $ | 1,151,903 |   |
|                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          At June 25, 2005,approximately $182.4 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.

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(2)   Excludedfrom the table are cash interest obligations on our variable-rate debt,consisting of the amended asset-based revolving loan agreement and the $160.0 millionof senior secured floating rate notes due 2010. The amended asset-basedrevolving loan agreement accrues interest at LIBOR plus a margin of 1.50% andthe senior secured notes accrue interest at LIBOR plus a margin of 4.50%. AtJune 25, 2005, the effective interest rates on each of these debtinstruments was 4.73% and 7.91%, respectively.

The above table does not include an additional$50.0 million of senior secured notes that we anticipate issuing onAugust 9, 2005 in an offering that was priced on August 4, 2005. Thenew senior secured notes will have substantially similar terms to those of theexisting senior secured notes, although the new senior secured notes will beissued at a discount to their redemption price at maturity and will thereforenot trade fungibly with the existing senior secured notes. The net proceeds ofthat offering, expected to be approximately $46.6 million, will be used torepay a portion of the outstanding amounts under the amended asset-basedrevolving loan facility and to pay expenses and commissions associated with theoffering and repayment. In connection with the offering, the amendedasset-based revolving loan facility was further amended to reduce the maximumcommitment amount from $250.0 million to $225.0 million and reducethe fixed charge coverage ratio until June 30, 2007. Giving effect to theoffering, the use of proceeds from the offering and the amendment to theamended asset-based revolving loan facility, as of June 25, 2005,$135.7 million of borrowings under the amended asset-based revolving loanfacility would have been outstanding, $83.4 million would have beenavailable to be borrowed under the facility, and the weighted-average combinedinterest rate on our floating rate indebtedness would have been 6.6%.

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. The profits interest and optionswill have no value unless the value of Duane Reade Shareholders, LLCand Duane Reade Holdings, Inc., respectively, appreciate followingthe Acquisition. Mr. Cuti’s purchase right will be suspended at any timewhen the exercise of such purchase rights would result in a default under thefinancing arrangements of us, Duane Reade Shareholders, LLC or DuaneReade Inc. Mr. Cuti’s purchase right will also terminate upon certainpublic offerings by us, Duane Reade Shareholders, LLC or DuaneReade Inc.

At June 25, 2005, wehave recorded a litigation-related non-current liability of $19.2 millionin connection with a National Labor Relations Board decision in alitigation-related matter with the Allied Trades Council, a union representingemployees in 139 of our stores. Because this decision is the initial phase of acomplex administrative and judicial process, the ultimate outcome, financialimpact and related timing of any future cash disbursement relating to thismatter cannot be determined at this time. This matter is more fully describedin Note 8 to the Unaudited Consolidated Interim Financial Statements.

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**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 DuaneReade 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 at least the next two years, to make required payments on ourindebtedness, to fund anticipated capital expenditures and to satisfy ourworking capital requirements. We base this belief on our recent levels of cashflow from operations of approximately $47.4 million in fiscal 2003 andcash flow from operations of $11.3 million in 2004 (which includes theabsorption of $40.6 million in Acquisition-related costs) and thesignificant additional borrowing capacity under the amended asset-basedrevolving loan facility, which amounted to approximately $62.3 million at June 25,2005. In January 2005, we borrowed an additional $19.0 million underthe amended asset-based revolving loan facility to fund a settlement obligationin connection with the termination of the Chairman’s SERP benefit. A net amountof approximately $10.3 million of this additional revolver borrowing wasrecovered upon the June 30, 2005 retirement of the Chairman’s split dollarlife insurance policy, in connection with the remittance to the Chairman of thefinal installment of $4.0 million under the Company’s $24.5 million SERP terminationobligation. In addition, as noted above, giving effect to the anticipatedrefinancing of a portion of the outstanding amounts under the amendedasset-based revolving loan facility and associated transactions, as ofJune 25, 2005, $135.7 million of borrowings under the amendedasset-based revolving loan facility would have been outstanding, and$83.4 million would have been available to be borrowed under the facility.Our ability to meet our debt service obligations and reduce our total debt willdepend upon our future performance which, in turn, will be subject to generaleconomic, financial, business, competitive, legislative, regulatory and otherconditions, many of which are beyond our control. In addition, our operatingresults, cash flow and capital resources may not be sufficient for an adverselitigation settlement or for repayment of our indebtedness in the future. Somerisks that could adversely affect our ability to meet our debt serviceobligations include, but are not limited to, reductions in third partyprescription reimbursement rates, declines in the New York City economy,increases in competitive activity, changes in drug consumption patterns,additional adverse legislative changes or a major disruption of business in ourmarkets from a terrorist event, natural disaster or other unexpected events.Other factors that may adversely affect our ability to service our debt aredescribed above under ‘‘Special Note Regarding Forward-Looking Statements.’’Borrowings under the amended asset-based revolving loan facility and the$160.0 million floating rate notes bear interest at floating rates.Therefore, our financial condition will be affected by changes in prevailinginterest rates. On May 25, 2005, we entered into a hedging transaction throughthe acquisition of a “no cost collar.” Under 

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thisarrangement, we capped our exposure on $130.0 million of LIBOR-based borrowingsunder the senior secured notes at a maximum LIBOR rate of 5.30%. In addition,we established a minimum “floor” LIBOR rate of 3.45%, in line with currentLIBOR rates. This hedging arrangement expires on June 16, 2008.

**CriticalAccounting 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 June 25, 2005, there have been no materialchanges 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 six months ended June 25, 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. The Company is currently evaluating the effect of adopting thisstatement.

**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 June 25, 2005 includes$182.4 million of borrowings under our amended asset-based revolving loanfacility and $160.0 million of senior secured floating rate notes. At June 25,2005, the weighted average combined interest rate in effect on all variablerate debt outstanding was 6.22%. A 0.50% change in interest rates applied tothe $342.4 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 June 25, 2005. TheSenior Subordinated Notes and Senior Convertible Notes bear interest payablesemi-annually at fixed rates of 9.75% and 3.75%, respectively, and aretherefore not subject to risk from interest rate fluctuations.

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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 current LIBORrates. 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 not an“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)   *Evaluationof Disclosure Controls and Procedures*.   An evaluation wascarried out under the supervision and with the participation of the Company’smanagement, including the Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rules 13a-15(e) or 15d-15(e) underthe Securities Exchange Act of 1934) as of the end of the period covered bythis quarterly report. Based upon that evaluation, the Company’s management,including the Chief Executive Officer and Chief Financial Officer, have eachconcluded that the design and operation of these disclosure controls andprocedures were effective as of the end of the period covered by this report.

(b)   *Changesin Internal Controls over Financial Reporting*.   During the mostrecent fiscal quarter, there have not been any significant changes in ourinternal controls over financial reporting or in other factors that that havematerially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting other than the remedial actionstaken by the Company to strengthen its controls and procedures in the areasdescribed in Item 9A of the Company’s Annual Report on Form 10-K/A for thefiscal year ended December 25, 2004, which was filed on May 16, 2005.

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**PART II—OTHERINFORMATION**

**ITEM 1.**                LegalProceedings

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.

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

Not applicable.

**ITEM 3.**                DefaultsUpon Senior Securities

Not applicable.

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

Not applicable.

**ITEM 5.**                OtherInformation

Not applicable.

**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).                                                                                                                                                          |

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| 3.4(i)  |   | Certificate of Incorporation of Duane Reade International, Inc.  (incorporated by reference to Exhibit 3.4(i) to the Company’s  Annual Report on Form 10- K for the year ended December 25, 1999  (the ‘‘1999 10-K’’)).                                                                                                                                                                                    |
|---------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.4(ii) |   | By-laws of Duane  Reade International, Inc. (incorporated by reference to Exhibit 3.4(ii) to  the 1999 10-K).                                                                                                                                                                                                                                                                                                                                 |
| 3.5(i)  |   | Certificate of  Incorporation of Duane Reade Realty, Inc. (incorporated by  reference to Exhibit 3.5(i) to the 1999 10-K).                                                                                                                                                                                                                                                                                                                    |
| 3.5(ii) |   | By-laws of Duane  Reade Realty, Inc. (incorporated by reference to  Exhibit 3.5(ii) to the 1999 10-K).                                                                                                                                                                                                                                                                                                                                        |
| 3.6(i)  |   | Amended and Restated  Certificate of Incorporation of Duane Reade Holdings, Inc.  (incorporated by reference to Exhibit 3.1(i) to the Company’s and  Duane Reade’s S-4 Registration Statement No 333-122206 with respect to  the Company’s and Duane Reade’s Senior Secured Floating Rate Notes due 2010  (the ‘‘Floating Rate Notes S-4’’)).                                                    |
| 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).                                                      |

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| 4.8  |   | Guarantor Supplemental Indenture governing the  initial notes and exchange notes, dated as of July 30, 2004, among the  Company, Duane Reade and DRI I Inc., Duane  Reade Realty, Inc. and Duane Reade International, Inc.,  as guarantors and U.S. Bank National Association, as trustee (incorporated by  reference to Exhibit 4.4 to the 3rd quarter 2004 10-Q).                                                                                                                  |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.9  |   | Second Guarantor  Supplemental Indenture governing the initial notes and the exchange notes,  dated as of March 25, 2005, among Duane Reade Holdings, Inc.  (‘‘Holdings’’), the Company, Duane Reade and DRI I Inc., Duane  Reade Realty, Inc. and Duane Reade International, Inc. as  guarantors and U.S. Bank National Association, as trustee (incorporated by  reference to Holdings’ Current Report on Form 8-K filed March 31,  2005). |
| 4.10 |   | Form of Exchange  Note (incorporated by reference to Exhibit 4.5 to the 3rd quarter 2004  10-Q).                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 4.11 |   | Registration Rights  Agreement, dated as of July 30, 2004, by and among Duane  Reade Acquisition Corp. and Banc of America Securities LLC,  Citigroup Global Markets Inc., Credit Suisse First Boston LLC and  UBS Securities LLC, as Initial Purchasers (incorporated by reference to  Exhibit 4.6 to the 3rd quarter 2004 10-Q).                                                                                                                                                        |
| 4.12 |   | Indenture, dated as of  April 16, 2002, between Duane Reade Inc., as issuer, the guarantors  named therein and State Street Bank and Trust Company, as trustee  (incorporated by reference to Exhibit 4.2 to the Company’s Registration  Statement on Form S-3 dated June 21, 2002 (the ‘‘Convertible Notes  S-3’’)).                                                                                                                                                      |
| 4.13 |   | Form of Senior  Convertible Notes due 2022 (incorporated by reference to Exhibit 4.2 to  the Convertible Notes S-3).                                                                                                                                                                                                                                                                                                                                                                                               |
| 4.14 |   | First Supplemental  Indenture, dated as of July 30, 2004, among the Company, as issuer,  DRI I Inc., Duane Reade Realty, Inc. and Duane  Reade International, Inc. as guarantors and U.S. Bank National  Association, as trustee (incorporated by reference to Exhibit 4.9 to the  3rd quarter 2004 10-Q).                                                                                                                                                                           |
| 10.1 |   | Duane Reade Inc.  Phantom Stock Plan (incorporated by reference to Exhibit 10.1 to the 3rd  quarter 2004 10-Q).                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.2 |   | Duane Reade Holdings, Inc.  Management Stock Option Plan (incorporated by reference to Exhibit 10.2  to the 3rd quarter 2004 10-Q).                                                                                                                                                                                                                                                                                                                                                                           |
| 10.3 |   | Stockholders and  Registration Rights Agreement, dated as of July 30, 2004, among Duane  Reade Holdings, Inc., Duane Reade Shareholders, LLC and  certain members of the management of Duane Reade Inc. (incorporated by  reference to Exhibit 10.3 to the 3rd quarter 2004 10-Q).                                                                                                                                                                                                        |
| 10.4 |   | Tax Sharing Agreement,  dated as of July 30, 2004, among Duane Reade Holdings, Inc.,  and the Subsidiaries as defined therein, Duane Reade and any parties  which become parties thereto (incorporated by reference to Exhibit 10.4  to the 3rd quarter 2004 10-Q).                                                                                                                                                                                                                                 |
| 10.5 |   | Services Agreement,  dated as of July 30, 2004, between Oak Hill Capital  Management, Inc. and Duane Reade Acquisition Corp (incorporated by  reference to Exhibit 10.5 to the 3rd quarter 2004 10-Q).                                                                                                                                                                                                                                                                                                   |

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| 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).                                                                                                                                                   |
| 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).                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

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| 10.16 |   | Amendment No 2 to the Merger Agreement, dated  as of June 13, 2004, by and among Duane  Reade Shareholders, LLC, Duane Reade Acquisition Corp. and  Duane Reade Inc. (incorporated by reference to Exhibit 2.2 of Duane  Reade Inc.’s Form 8-K dated June 14, 2004).                                                                                                                                                                                                                                                                                                                                      |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.17 |   | Amendment No 3 to  the Merger Agreement, dated as of June 18, 2004, by and among Duane  Reade Shareholders, LLC, Duane Reade Acquisition Corp. and  Duane Reade Inc. (incorporated by reference to Exhibit 2.1 of Duane  Reade Inc.’s Form 8-K dated June 21, 2004).                                                                                                                                                                                                                                                                                                                                      |
| 10.18 |   | Credit Agreement, dated as of July 21, 2003,  among Duane Reade, as the Borrower, Duane Reade Inc. and corporate  subsidiaries as the Facility Guarantors, Various Financial Institutions set  forth therein, as the Lenders, Fleet National Bank as the Administrative  Agent and Issuing Bank, Fleet Retail Finance Inc. as the Collateral  Agent, General Electric Capital Corporation as the Syndication Agent for the  Lenders and Congress Financial Corporation as the Documentation Agent for the  Lenders (incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 28, 2003). |
| 10.19 |   | Facility Guarantee,  dated as of July 21, 2003, among the Facility Guarantors, Fleet Retail  Finance Inc., Fleet National Bank and the Lenders (incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                         |
| 10.20 |   | Intellectual Property  Security Agreement, dated as of July 21, 2003, between Duane Reade, the  Facility Guarantors and Fleet Retail Finance Inc., as Collateral Agent  (incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                 |
| 10.21 |   | Security Agreement,  dated as of July 21, 2003, among Duane Reade, the Facility Guarantors,  and Fleet Retail Finance Inc., as Collateral Agent (incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                                        |
| 10.22 |   | Ownership Interest  Pledge Agreement, dated as of July 21, 2003, among Duane Reade Inc.  and DRI I Inc., and Fleet Retail Finance Inc., as Collateral Agent  (incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 28, 2003).                                                                                                                                                                                                                                                                                                                                                  |
| 10.23 |   | Preferability Letter, dated as of May 13, 2002,  issued by PricewaterhouseCoopers LLP, with respect to the Company’s change in  accounting method of inventory valuation (incorporated by reference to the  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).                                                                                                                                                                                                                        |

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| 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**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

Dated:   August 9, 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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