SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C.

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

For the quarterly period ended September 27, 2008

Commission file number 001-13843

DUANE READE HOLDINGS, INC.(Exact name of registrant as specified in its charter)

DELAWARE(State or other jurisdiction of
incorporation or organization)

05-0599589(IRS Employer
ID Number)440 Ninth Avenue
New York, New York(Address of principal executive offices)

10001(Zip Code)


(212) 273-5700(Registrant's telephone number, including area code)

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

Yes ý                    No o*

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer o

Non-accelerated filer ý (Do not check if a smaller reporting company)

Smaller reporting company o


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

Yes o                    No ý

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

As
of November 4, 2008, there were 2,615,077 shares of common stock issued and outstanding. All except 20,100 shares of the registrant's outstanding common stock are held by its
parent.

---



---



INDEX

PART IFINANCIAL INFORMATION

6ITEM 1.FINANCIAL STATEMENTS

6Consolidated Statements of Operations (Unaudited)For the 13 and 39 Weeks Ended September 27, 2008 and September 29, 2007

6Consolidated Balance Sheets (Unaudited)As of September 27, 2008 and December 29, 2007

7Consolidated Statements of Cash Flows (Unaudited)For the 39 Weeks Ended September 27, 2008 and September 29, 2007

8Consolidated Statements of Comprehensive Loss (Unaudited)For the 13 and 39 Weeks Ended September 27, 2008 and September 29,
2007

9Notes to Consolidated Financial Statements (Unaudited)

10ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

38ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

53ITEM 4.CONTROLS AND PROCEDURES

53PART IIOTHER INFORMATION

54SIGNATURES

55


2

---





SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This and other of our public filings or public statements contain forward-looking statements within the meaning of Section 27A
of the Securities Act, Section 21E of the Securities Exchange Act and the Private Securities Litigation Reform Act of 1995, that involve a number of risks and uncertainties. These statements
relate to future events or our future financial performance with respect to our financial condition, results of operations, business plans and strategies, operating efficiencies or synergies,
competitive positions, growth opportunities for existing products such as private label merchandise, plans and objectives of management, capital expenditures, growth and maturation of our stores and
other matters. These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry's actual results, levels of activity, performance or achievements to
be materially different from those expressed or implied by any forward-looking statements. In some 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 the negative of those terms or other comparable
terminology. These statements are only predictions and such expectations may prove to be incorrect. Some of the things that could cause our actual results to differ substantially from our expectations
are:



3

---





4

---





We
undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this report. We do
not, nor does any other person, assume responsibility for the accuracy and completeness of those statements.

We
caution you that the areas of risk described above may not be exhaustive. We operate in a continually changing business environment, and new risks emerge from time to time. Management
cannot predict such new risks, nor can it assess the impact, if any, of such risks on our businesses or the extent to which any risk or combination of risks may cause actual results to differ
materially from those projected in any forward-looking statements. In light of these risks, uncertainties and assumptions, you should keep in mind that any forward-looking statement made in this
report might not occur.

5

---





PART IFINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

Duane Reade Holdings, Inc.    Consolidated Statements of Operations (Unaudited)    (In thousands)

13 Weeks Ended

39 Weeks EndedSeptember 27,
2008

September 29,
2007

September 27,
2008

September 29,
2007Net sales

$
431,005

$
408,828

$
1,309,538

$
1,255,146Cost of sales (exclusive of depreciation and amortization shown separately below)


296,261


283,740


902,667


877,195Gross profit


134,744


125,088


406,871


377,951Selling, general & administrative expenses


117,763


110,316


354,213


336,911Depreciation and amortization


16,667


18,007


52,260


54,460Store pre-opening expenses


300


200


548


350Gain on sale of pharmacy files





(1,337
)




(1,337
)Other expenses


7,883


4,111


12,032


13,352Operating loss


(7,869
)

(6,209
)

(12,182
)

(25,785
)Interest expense, net


13,633


15,731


40,913


44,810Loss before income taxes


(21,502
)

(21,940
)

(53,095
)

(70,595
)Income taxes


827


112


2,305


2,128Net loss

$
(22,329
)
$
(22,052
)
$
(55,400
)
$
(72,723
)


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

6

---





Duane Reade Holdings, Inc.        Consolidated Balance Sheets (Unaudited)        (In thousands, except share and per share data)

September 27,
2008

December 29,
2007ASSETSCurrent AssetsCash

$
1,382

$
1,380Receivables, net


52,085


55,707Inventories


212,952


211,678Prepaid expenses and other current assets


13,771


13,205Total Current Assets


280,190


281,970Property and equipment, net


187,453


195,740Goodwill


70,099


70,099Other assets, net


179,153


194,680Total Assets

$
716,895

$
742,489LIABILITIES AND STOCKHOLDERS' DEFICITCurrent LiabilitiesAccounts payable

$
78,200

$
75,769Accrued interest


3,839


9,158Accrued expenses


41,857


43,086Current portion of debt


155,145


141,352Current portion of capital lease obligations


4,250


3,994Total Current Liabilities


283,291


273,359Long-term debt


405,033


405,032Capital lease obligations, less current portion


2,269


5,475Deferred income taxes


28,462


27,423Redeemable preferred stock and accrued dividends


35,486


31,786Deferred rent liabilities


49,738


40,462Other non-current liabilities


38,117


32,275Total Liabilities


842,396


815,812Commitments and contingenciesStockholders' deficitPreferred stock, $0.01 par; authorized 50,000 shares; issued and outstanding: zero shares at September 27, 2008 and December 29, 2007





Common stock, $0.01 par; authorized 4,205,600 shares at September 27, 2008 and December 29, 2007; issued and outstanding: 2,615,077 shares at
September 27, 2008 and 2,595,077 shares at December 29, 2007


26


26Paid-in capital


255,212


251,716Accumulated other comprehensive (loss) income


(270
)

4Accumulated deficit


(380,469
)

(325,069
)Total Stockholders' Deficit


(125,501
)

(73,323
)Total Liabilities and Stockholders' Deficit

$
716,895

$
742,489


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

7

---





Duane Reade Holdings, Inc.        Consolidated Statements of Cash Flows (Unaudited)        (In thousands)

39 Weeks EndedSeptember 27,
2008

September 29,
2007Cash flows provided by (used in) operating activities:Net loss

$
(55,400
)
$
(72,723
)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization


54,999


57,200Deferred income taxes


2,192


1,950Non-cash rent expense


9,339


8,993Non-cash interest expense on redeemable preferred stock


4,666


923Asset impairment charges


3,405


Other non-cash expense (benefit)


332


(1,244
)Change in operating assets and liabilities:Receivables


3,622


3,647Inventories


(1,274
)

(1,189
)Prepaid expenses and other current assets


(566
)

11,486Accounts payable


2,431


(4,001
)Accrued expenses


(7,929
)

(12,452
)Other assets and liabilities, net


4,909


3,543NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES


20,726


(3,867
)Cash flows used in investing activities:Capital expenditures


(23,111
)

(20,058
)Lease acquisition, customer file and other costs


(11,958
)

(14,547
)Proceeds from sale of assets


525


3,335NET CASH USED IN INVESTING ACTIVITIES


(34,544
)

(31,270
)Cash flows provided by financing activities:Borrowings from revolving credit facility


1,544,744


1,490,788Repayments of revolving credit facility


(1,530,951
)

(1,494,800
)Capital contributions


978


2,342Issuance of common stock


2,000


Issuance of preferred stock





39,150Deferred financing costs


(1
)

(5
)Repayments of capital lease obligations


(2,950
)

(2,374
)NET CASH PROVIDED BY FINANCING ACTIVITIES


13,820


35,101Net change in cash


2


(36
)Cash at beginning of period


1,380


1,395Cash at end of period

$
1,382

$
1,359


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

8

---





Duane Reade Holdings, Inc.        Consolidated Statements of Comprehensive Loss (Unaudited)        (in thousands)

13 Weeks Ended

39 Weeks EndedSeptember 27,
2008

September 29,
2007

September 27,
2008

September 29,
2007Net loss

$
(22,329
)
$
(22,052
)
$
(55,400
)
$
(72,723
)Change in fair value of interest rate collar


(555
)

29


(275
)

(54
)Total other comprehensive income (loss)


(555
)

29


(275
)

(54
)Total comprehensive loss

$
(22,884
)
$
(22,023
)
$
(55,675
)
$
(72,777
)


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

9

---





Notes to Unaudited Consolidated Interim Financial Statements        (dollars in thousands)

1. Basis of Presentation

Duane Reade Holdings, Inc. ("Duane Reade Holdings" or the "Company") was formed in December 2003 by Oak Hill Capital Partners, LP, a private equity firm ("Oak Hill"), in
order to acquire Duane Reade Inc. and its subsidiaries (the "Acquisition"). Duane Reade Holdings, Inc. is a wholly-owned subsidiary of Duane Reade Shareholders, LLC ("Duane Reade
Shareholders"), a parent entity also established to effectuate the Acquisition. The Acquisition was completed on July 30, 2004 through the merger of Duane Reade Acquisition Corp. (a wholly
owned subsidiary of the Company) into Duane Reade Inc. with Duane Reade Inc. being the surviving entity and a wholly owned subsidiary of the Company after the merger transaction.

The
Company, along with certain of its subsidiaries, is a guarantor of the debt obligations of Duane Reade Inc. and Duane Reade, the New York general partnership that holds the
operating assets and liabilities ("Duane Reade GP"). The Company has no assets or operations other than its investment in its subsidiaries. The guarantees provided by the Company and its other
subsidiaries under the debt obligations of Duane Reade Inc. and Duane Reade GP (described in more detail in Note 6) are full and unconditional, joint and several.

The
Unaudited Consolidated Interim Financial Statements included herein reflect all adjustments which, in the opinion of management, are necessary to present a fair statement of the
results of operations, financial position, cash flows and comprehensive loss of the Company, and have been prepared, in all material respects, in accordance with the same accounting principles
followed in the preparation of the Company's Annual Consolidated Financial Statements for the year ended December 29, 2007. These Unaudited Consolidated Interim Financial Statements should be
read in conjunction with the Company's Consolidated Financial Statements included in its Annual Report on Form 10-K for the year ended December 29, 2007. The Unaudited
Consolidated Interim Financial Statements include the assets and operations of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated. The
results for the interim periods presented are not necessarily indicative of the results expected for the full year.

Accounting change:On September 30, 2007, the first day of the fourth quarter of 2007, the Company changed its method of accounting for the store occupancy
costs reflected on its statements of operations. The change resulted in a reclassification of the store occupancy costs previously included within cost of sales to selling, general and administrative
expenses. The Company believes this change in accounting more closely aligns these store occupancy cost components to the nature of expenses included in its financial statement captions, and will
improve the comparability of its financial statement presentation with industry peers. For the thirteen weeks ended September 27, 2008 and September 29, 2007, the change in accounting
resulted in a decrease to cost of sales of $42.5 million and $39.2 million, respectively, with a corresponding increase to gross profit and selling, general and administrative expenses
for each of the affected periods. For the thirty-nine weeks ended September 27, 2008 and September 29, 2007, the change in accounting resulted in a decrease to cost of sales
of $125.0 million and $119.7 million, respectively, with a corresponding increase to gross profit and selling, general and administrative expenses for each of the affected periods. This
accounting change had no effect on the operating loss for any of the periods presented.

2. Recently Issued Accounting Pronouncements

In May 2008, the Financial Accounting Standards Board ("FASB") approved FASB Staff Position ("FSP") APB 14-1, "Accounting for Convertible Debt Instruments That May Be
Settled in Cash upon

10

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

2. Recently Issued Accounting Pronouncements (Continued)

Conversion
(Including Partial Cash Settlement)." FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion (including partial cash
settlement) are not addressed by paragraph 12 of APB Opinion No. 14, "Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants." Additionally, FSP
APB 14-1 specifies that issuers of such instruments should separately account for the liability and the equity components in a manner that will reflect the entity's nonconvertible
debt borrowing rate when interest cost is recognized in subsequent periods, with equity component being valued based on the difference between such non-convertible debt borrowing rate and
the actual cash interest rate on such convertible debt. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years and must be applied retrospectively to all periods presented. The Company is evaluating the effect which the implementation of FSP APB 14-1
may have on the consolidated financial statements.

In
April 2008, the FASB issued FASB FSP No. FAS 142-3, "Determination of the Useful Life of Intangible Assets," which amends the factors that should be considered in
developing renewal or extension assumptions used in determining the useful lives of recognized intangible assets. FSP No. FAS 142-3 is effective for fiscal years beginning after
December 15, 2008, and interim periods within those years. The Company does not expect the adoption of FSP No. FAS 142-3 to have a material effect on the Company's
consolidated financial statements.

In
May 2008, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 162, "The Hierarchy of Generally Accepted Accounting Principles." This standard is intended
to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity
with generally accepted accounting principles in the United States for non-governmental entities. SFAS No. 162 is effective 60 days following approval by the U.S. Securities
and Exchange Commission ("SEC") of the Public Company Accounting Oversight Board's amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting
Principles." The Company does not expect SFAS No. 162 to have a material impact on the preparation of the Company's consolidated financial statements.

In
March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activitiesan Amendment of FASB Statement No. 133." The new
standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand the effects on an
entity's financial position, financial performance, and cash flows. SFAS No. 161 is effective prospectively for periods beginning on or after November 15, 2008. The adoption of SFAS
No. 161 is not currently expected to have a material effect on the Company's consolidated financial statements.

In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial StatementsAn Amendment of ARB No. 51." SFAS No. 160
establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, the amount of net income attributable to the parent and to the
noncontrolling interest, changes in a parent's ownership interest, and the valuation of any retained noncontrolling equity investment when a subsidiary is deconsolidated. This statement also
establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 is effective for
fiscal years beginning on or after December 15, 2008. The

11

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

2. Recently Issued Accounting Pronouncements (Continued)

adoption
of SFAS No. 160 is not currently expected to have a material effect on the Company's consolidated financial statements.

In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement
No. 115." This statement permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is applicable for the Company as of
December 30, 2007, the first day of fiscal 2008. The adoption of SFAS No. 159 did not have a material impact on the Company's consolidated financial statements.

In
September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," which defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is applicable for the Company as of December 30, 2007, the first day of fiscal 2008. In February
2008, the FASB issued FASB Staff Position FAS 157-2 which deferred the effective date of SFAS No. 157 for certain nonfinancial assets and liabilities until fiscal 2009. The
Company has adopted SFAS No. 157 to account for its financial assets and liabilities and such adoption did not have a material effect on its consolidated financial statements. The FASB Staff
Position SFAS No. 157-2 defers the effective date of SFAS No. 157 for certain nonfinancial assets and liabilities until fiscal 2009 but the Company does not currently expect
its adoption to have a material effect on the Company's consolidated financial statements.

In
December 2007, the FASB issued SFAS No. 141(R), "Business Combinations." SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the full
fair value of assets acquired and liabilities assumed in the transaction (whether a full or partial acquisition), establishes the acquisition-date fair value as the measurement objective
for all assets acquired and liabilities assumed, and requires the acquirer to disclose the information needed to evaluate and understand the nature and effect of the business combination. This
statement applies to all transactions or other events in which the acquirer obtains control of one or more businesses, including those sometimes referred to as "true mergers" or "mergers of equals"
and combinations achieved without the transfer of consideration, for example, by contract alone or through the lapse of minority veto rights. For new acquisitions made following the adoption of
SFAS 141(R), significant costs directly related to the acquisition including legal, audit and other fees, as well as most acquisition-related restructuring, will have to be expensed as incurred
rather than recorded to goodwill as is generally permitted under SFAS No. 141, "Business Combinations." Additionally, contingent purchase price arrangements (also known as
earn-outs) will be re-measured to estimated fair value with the impact reported in earnings, whereas under present rules the contingent purchase consideration is recorded to
goodwill when determined. Adoption of SFAS No. 141(R) is required for business combinations after December 15, 2008. Early adoption and retroactive application of SFAS No. 141(R)
to fiscal years preceding the effective date are not permitted.

3. Stock-Based Payments

In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment." This statement established standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), using the "modified" prospective
transition method. Under that transition method, compensation expense recognized for the thirteen and thirty-nine weeks ended

12

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

3. Stock-Based Payments (Continued)

September 27,
2008 and September 29, 2007 reflects the vested portion of share-based payments granted on or after January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123(R). The Company has elected to recognize compensation expense on a straight-line basis over the vesting period of the
respective options. During both thirteen week periods ended September 27, 2008 and September 29, 2007, the Company recorded pre-tax compensation expense of approximately
$0.2 million attributable to the vested portion of stock options granted after the adoption date. For the thirty-nine weeks ended September 27, 2008 and September 29,
2007, the corresponding expense recognized was $0.5 million and $0.8 million, respectively.

Management Stock Option Plan

The Company's Board of Directors adopted the Duane Reade Holdings, Inc. Management Stock Option Plan, referred to in this report
as the "2004 Option Plan," which became effective on the date the Acquisition was completed. The 2004 Option Plan is administered by the compensation committee of the Board of Directors. Any officer,
employee, director or consultant of Duane Reade Holdings or any of its subsidiaries or affiliates is eligible to be designated a participant under the 2004 Option Plan. On March 27, 2007, the
Company amended the
2004 Option Plan so that a maximum of 575,893 shares of its common stock (on a fully diluted basis) may be granted under the 2004 Option Plan.

Under
the 2004 Option Plan, the compensation committee of Duane Reade Holdings may grant awards of nonqualified stock options, incentive stock options, or any combination of the
foregoing. A stock option granted under the 2004 Option Plan will provide a participant with the right to purchase, within a specified period of time, a stated number of shares of the Company's common
stock at the price specified in the award agreement. Stock options granted under the 2004 Option Plan will be subject to such terms, including the exercise price and the conditions and timing of
exercise, not inconsistent with the 2004 Option Plan, as may be determined by the compensation committee and specified in the applicable stock option agreement.

There
were no stock option grants during the thirteen weeks ended September 27, 2008 and September 29, 2007.

The
Company granted options to purchase 165,000 shares of the Company's common stock to its current CEO at his appointment on April 2, 2008. The exercise price of these options is
$100 per share, which is consistent with all other options previously granted under the 2004 Option Plan. Sixty percent of the options will vest ratably in annual installments over four years, subject
to the CEO's continued employment, and 40% of the options will vest based on the Company's achievement of performance targets. Fifty percent of the performance portion of the CEO's options will vest
if and when the Company's principal shareholder, Oak Hill, receives at least a 1.5x cash-on-cash return on its July 2004 investment in the Company, and the remaining fifty
percent will vest if and when Oak Hill receives at least a 2x cash-on-cash return on its July 2004 investment in the Company, subject to the CEO's continued employment through
the date of any such return. The weighted-average grant-date fair value of the options granted during the thirty-nine weeks ended September 27, 2008 was $17.89.

During
the thirty-nine weeks ended September 29, 2007, a total of 171,000 options to acquire shares of the Company's common stock were granted, including 168,600
options granted to executive officers of the Company on December 31, 2006. The weighted-average grant-date fair value of the options granted during the thirteen and
thirty-nine weeks ended September 29, 2007 was $5.59.

13

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

3. Stock-Based Payments (Continued)

There
were no stock options exercised during the thirteen or thirty-nine weeks ended September 27, 2008 or September 29, 2007.

The
fair value of each option grant during the thirteen and thirty-nine weeks ended September 27, 2008 and September 29, 2007 was estimated on the date of grant
using the lattice-pricing model with the following weighted-average assumptions:

September 27,
2008

September 29,
2007Dividend yield


0.0
%

0.0
%Volatility


42.0
%

35.0
%Risk-free interest rate


3.1
%

4.7
%Post-vesting employment termination(1)


0.0
%

5.0
%






As
of September 27, 2008, there was $2.8 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted
under the stock-based compensation plan. That cost is expected to be recognized on a straight-line basis over a weighted-average period of approximately 3.3 years.

As
of September 27, 2008, a total of 171,887 shares of common stock of the Company were reserved for the issuance of additional stock options. The Company expects to satisfy the
exercise of stock options utilizing newly-issued shares.

4. Inventories and Cost of Sales

At September 27, 2008 and December 29, 2007, the value of inventories, consisting solely of finished goods, would have increased by $0.8 million and decreased by
$1.6 million, respectively, if they had been valued on a lower of first-in, first-out ("FIFO") cost or market basis instead of a last-in,
first-out ("LIFO") basis. Included within cost of sales are all warehouse expenses and distribution costs, except for depreciation and amortization expense, which is shown separately on
the consolidated statement of operations. The Company reflects promotional allowances from vendors as a reduction of inventory or advertising expense, depending on the nature of the allowance, when
such inventory is sold or advertising or promotions have been completed and the related allowances have been earned.

5. Exit and Disposal Activities

In the normal course of its business, the Company closes underperforming locations. In accordance with the provisions of SFAS No. 146, "Accounting for Costs Associated with Exit
or Disposal Activities," the Company establishes reserves for costs anticipated to be incurred in connection with such store closings. At September 27, 2008, the balance of this reserve was
$4.0 million. This balance will be used primarily for occupancy-related costs in these stores.

In
connection with the July 30, 2004 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

14

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

5. Exit and Disposal Activities (Continued)

Purchase
Business Combinations," the Company established a reserve of $17.0 million for costs anticipated to be incurred as a result of the planned closing of 11 of its stores. These costs
primarily relate to rent, utilities and other on-going occupancy-related expenses. At September 27, 2008, all of the planned closings had occurred, and the Company has recorded a
cumulative net total of $13.4 million of primarily occupancy-related costs against this reserve resulting in the reserve balance of $3.6 million at September 27, 2008. The balance
of this reserve is expected to be utilized primarily for occupancy-related costs in these closed stores.

6. Debt

Debt is summarized as follows (in thousands):

Description of Instrument

September 27,
2008

December 29,
2007Current debt:Asset-based revolving loan facility(1)

$
155,145

$
141,352Non-current debt:Senior secured floating rate notes due 2010

$
210,000

$
210,0009.75% Senior subordinated notes due 2011


195,000


195,0002.1478% Senior convertible notes due 2022(2)


33


32Total Non-current debt

$
405,033

$
405,032Total Debt

$
560,178

$
546,384






Asset-Based Revolving Loan Facility

On July 22, 2004, in connection with the Acquisition, the asset-based revolving loan facility was amended to increase the
borrowing capacity to an aggregate principal amount of $250.0 million, subject to an adjusted borrowing base calculation based upon specified advance rates against the value of inventory,
pharmacy prescription files and certain accounts receivable. The original maturity date of the amended asset-based revolving loan facility was July 21, 2008. In August 2005, in conjunction with
the issuance of $50.0 million aggregate principal amount of senior secured floating rate notes due 2010, the Company permanently reduced the maximum availability under the amended asset-based
revolving loan facility by $25.0 million to $225.0 million. On July 7, 2006, the Company entered into a further amendment to the amended asset-based revolving loan facility to
extend its maturity from July 21, 2008 to July 21, 2011, subject to the requirement that the Company refinance or restructure the

15

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

6. Debt (Continued)

$210.0 million
aggregate principal amount of the senior secured floating rate notes due 2010 and the $195.0 million aggregate principal amount of the 9.75% senior subordinated notes due
2011, in each case, on terms reasonably acceptable to the administrative agent and at least 120 days prior to each's respective scheduled maturity date. The Company fully intends to refinance
or restructure the outstanding principal amounts of its senior secured floating rate notes and senior subordinated notes within the required timeframe, in accordance with the requirements of the third
amendment.

On
September 28, 2007, the asset-based revolving loan facility was amended to exclude from the definition of capital expenditures any expenditure made with the proceeds of any
equity securities issued or capital contributions received by the Company, such as the proceeds of the redeemable preferred stock issued in 2007.

The
amended asset-based revolving loan facility includes a $50.0 million sub-limit for the issuance of letters of credit. Obligations under the revolving loan facility
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 is the sole obligor. However, the amended asset-based revolving loan facility is guaranteed 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
amended asset-based revolving loan facility contains a single fixed charge coverage requirement, which only becomes applicable when borrowings exceed 90 percent of the
borrowing base, as defined in the agreement governing the amended asset-based revolving loan facility. The July 2006 amendment reduced the ratios that the Company would be required to maintain in this
event. Borrowings under the amended asset-based revolving loan facility have not exceeded 90 percent of the borrowing base
and, as a result, the fixed charge covenant has not become applicable. There are no credit ratings related triggers in the amended asset-based revolving loan facility that would impact the cost of
borrowing, annual amortization of principal or related indebtedness maturity.

Revolving
loans under the amended asset-based revolving loan facility, at the Company's option, bear interest at either:



At
September 27, 2008, borrowings under the amended asset-based revolving loan facility were primarily LIBOR-based. At September 27, 2008, the amended asset-based revolving
loan facility bore interest at a weighted average annual rate of 4.3%.

The
Company's hedging activity at September 27, 2008 consists of a "no cost" interest rate collar designed to hedge interest rate variability on portions of its LIBOR-based
borrowings. The Company formally documents the relationship between the hedging instruments and the hedged items, as well as its risk management objectives and strategy for undertaking hedge
transactions. The interest rate collar qualifies for hedge accounting as a cash flow hedge. See Note 7 for a discussion of the terms of the hedging arrangement.

16

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

6. Debt (Continued)

At
September 27, 2008, there was $155.1 million outstanding under the asset- based revolving loan facility, and approximately $58.5 million of remaining
availability, net of $6.4 million reserved for outstanding standby letters of credit. At September 29, 2007, there was $153.1 million outstanding under the asset- based revolving
loan facility, and approximately $61.2 million of remaining availability, net of $5.7 million reserved for outstanding standby letters of credit. Obligations under this facility have
been classified as current liabilities because cash receipts controlled by the lenders are used to reduce
outstanding debt, and the Company does not meet the criteria of SFAS No. 6, "Classification of Short-Term Obligations Expected to be
RefinancedAn Amendment of ARB No. 43, Chapter 3A"to classify the debt as long-term.

Senior Secured Floating Rate Notes due 2010.On December 20, 2004, the Company closed an offering of $160.0 million aggregate principal amount of
senior secured floating rate notes due 2010. Using the net proceeds from that offering, together with approximately $2.2 million of borrowings under the amended asset-based revolving loan
facility, the Company repaid all outstanding principal under its previously existing $155.0 million senior term loan facility, along with approximately $3.6 million of early repayment
premium and accrued but unpaid interest through December 20, 2004. On August 9, 2005, the Company issued a further $50.0 million of senior secured floating rate notes. These new
notes were issued under the same indenture as the senior secured floating rate notes issued in December 2004, although they do not trade fungibly with those notes.

The
senior secured floating rate notes bear interest at a floating rate of LIBOR plus 4.50%, reset quarterly. Interest on the senior secured floating rate notes is payable quarterly on
each March 15, June 15, September 15, and December 15. The senior secured floating rate notes mature on December 15, 2010. At September 27, 2008, the senior
secured floating rate notes bore interest at a rate of 7.3%.

On
April 30, 2008, the Company entered into a hedging transaction through the acquisition of a "no cost collar." Under this arrangement, the Company capped its exposure on
$210.0 million of LIBOR-based borrowings at a maximum LIBOR rate of 5.2%. In addition, the Company established a minimum "floor" LIBOR rate of 2.6%, in line with then current LIBOR rates. At
September 27, 2008, the LIBOR rate in effect was approximately 2.8%, which was within the range of minimum and maximum allowable interest rates under the "no cost collar." As a result, at
September 27, 2008, this "no cost collar" did not have an impact on the overall effective interest rate on the Company's LIBOR-based borrowings. See Note 7 for further discussion of the
terms of this hedging arrangement.

The
Company guarantees the senior secured floating rate notes on a full and unconditional, senior secured basis. Duane Reade Inc. and Duane Reade GP are
co-obligors under the senior secured floating rate notes. The senior secured floating rate notes rank equally in right of payment with any of the Company's, Duane Reade Inc.'s or
Duane Reade GP's unsubordinated indebtedness and senior in right of payment to any of the Company's, Duane Reade Inc.'s or Duane Reade GP's subordinated or senior subordinated
indebtedness. All obligations under the senior secured floating rate notes are guaranteed on a senior basis by each of the Company's existing subsidiaries, other than Duane Reade Inc. and Duane
Reade GP, and will be guaranteed by future subsidiaries of Duane Reade Inc. and Duane Reade GP except certain foreign and certain domestic subsidiaries. The senior secured
floating rate notes and the guarantees are collateralized by a first priority interest in substantially all of Duane Reade Inc. and Duane Reade GP's assets other than certain excluded
assets defined in the indentures and those assets in which the lenders under the amended asset-based revolving loan facility

17

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

6. Debt (Continued)

have
a first priority interest. The senior secured floating rate notes and the guarantees are also collateralized by a second priority interest in all collateral pledged on a first priority basis to
lenders under the amended asset-based revolving loan facility.

Upon
the occurrence of specified change of control events, Duane Reade Inc. and Duane Reade GP will be required to make an offer to repurchase all of the senior secured
floating rate notes at 101% of the outstanding principal amount of the senior secured floating rate notes plus accrued and unpaid interest to the date of repurchase. The indenture governing the senior
secured floating rate notes contains certain affirmative and negative covenants that limit the ability of Duane Reade Inc., Duane Reade GP and their restricted subsidiaries, as defined,
to incur additional indebtedness, pay dividends, make repayments on indebtedness that is subordinated to the senior secured floating rate notes and to make certain other restricted payments, incur
certain liens, use proceeds from sales of assets, enter into business combination transactions (including mergers, consolidations and asset sales), enter into sale-leaseback transactions,
enter into transactions with affiliates and permit restrictions on the payment of dividends by restricted subsidiaries. The indenture governing the senior secured floating rate notes contains
customary events of default, which, if triggered, may result in the acceleration of the indebtedness outstanding under the indenture. There are no credit ratings related triggers in the indenture
governing the senior secured floating rate notes that would impact the cost of borrowing, annual amortization of principal or related indebtedness maturity. The indenture governing the senior secured
floating rate notes does not contain financial maintenance covenants.

At
September 27, 2008, the weighted average combined interest rate in effect on all variable rate debt outstanding was 6.0%.

Senior Subordinated Notes due 2011.On July 30, 2004, upon completion of the Acquisition, Duane Reade Inc. and Duane Reade GP
co-issued $195.0 million of 9.75% senior subordinated notes due 2011. The senior subordinated notes mature on August 1, 2011 and bear interest at 9.75% per annum payable in
semi-annual installments on February 1 and August 1. The senior subordinated notes are uncollateralized obligations and subordinated in right of payment to all of the
Company's, Duane Reade Inc.'s and Duane Reade GP's existing and future unsubordinated indebtedness, including borrowings under the amended asset-based revolving loan facility and the
senior secured floating rate notes. The senior subordinated notes will rank equally with any future senior subordinated indebtedness and senior to any future subordinated indebtedness. The senior
subordinated notes are guaranteed on an uncollateralized, senior subordinated basis by the Company and all of Duane Reade Inc.'s existing direct and indirect domestic subsidiaries other than
Duane Reade GP, which is a co-obligor under the senior subordinated notes. Upon the occurrence of specified change of control events, the Company will be required to make an offer
to repurchase all of the senior subordinated notes at 101% of the outstanding principal amount of the senior subordinated notes plus accrued and unpaid interest to the date of repurchase. The
indenture governing the senior subordinated notes contains certain affirmative and negative covenants that limit the ability of Duane Reade Inc., Duane Reade GP and their restricted
subsidiaries to incur additional indebtedness, pay dividends, make repayments on indebtedness that is subordinated to the senior subordinated notes and to make certain other restricted payments, incur
certain liens, use proceeds from sales of assets, enter into business combination transactions (including mergers, consolidations and asset sales), enter into transactions with affiliates and permit
restrictions on the payment of dividends by restricted subsidiaries. The indenture governing the senior subordinated notes contains customary events of default, which, if triggered, may result in

18

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

6. Debt (Continued)

the
acceleration of the indebtedness outstanding under the indenture. There are no credit ratings related triggers in the indenture governing the senior subordinated notes that would impact the cost
of borrowing, annual amortization of principal or related indebtedness maturity. The indenture governing the senior subordinated notes does not contain financial maintenance covenants.

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

In
connection with the Acquisition, Duane Reade Inc. made a tender offer to repurchase all of the $351.0 million outstanding principal value of the senior convertible
notes. Upon the closing of the
tender offer, a total of $350.9 million principal amount at maturity ($201.0 million issuance value) was tendered for repurchase, leaving only $55.0 thousand of principal amount
at maturity ($32.0 thousand of issuance value) outstanding. Duane Reade Inc. may redeem for cash all or a portion of the principal value of the outstanding senior convertible notes at
any time after April 16, 2007, at a price equal to the sum of the issue price plus accrued original issue discount and accrued cash interest, if any, to the redemption date.

7. Hedging Activities

Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Under SFAS No. 133, all derivatives, whether designated in hedging
relationships or not, are required to be recorded on the balance sheet at fair value. SFAS No. 133 defines requirements for designation and documentation of hedging relationships, as well as
ongoing effectiveness assessments, which must be met in order to qualify for hedge accounting. For a derivative that does not qualify as a hedge, changes in fair value would be recorded in earnings
immediately.

At
September 27, 2008, the Company's hedging activity consists of a "no cost" interest rate collar designed to hedge interest rate variability on portions of its LIBOR-based
borrowings. The Company formally documents the relationship between the hedging instruments and the hedged items, as well as its risk management objectives and strategy for undertaking hedge
transactions. This interest rate collar qualifies for hedge accounting as a cash flow hedge. Accordingly, the Company recognizes this derivative at fair value as either an asset or liability on the
consolidated balance sheets. All changes in fair value are recorded in accumulated other comprehensive income and subsequently reclassified into earnings when the related interest expense on the
underlying borrowing is recognized. The Company has not, and does not plan to, enter into any derivative financial instruments for trading or speculative purposes.

19

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

7. Hedging Activities (Continued)

On April 30, 2008, the Company entered into a hedging transaction through the acquisition of a "no cost collar." Under this arrangement, the Company capped its exposure on
$210.0 million of LIBOR-based borrowings at a maximum LIBOR rate of 5.2%. In addition, the Company established a minimum "floor" LIBOR rate of 2.6%, in line with then current LIBOR rates. At
September 27, 2008, the LIBOR rate in effect was approximately 2.8%, which was within the range of minimum and maximum allowable interest rates under the "no cost collar." As a result, at
September 27, 2008, this "no cost collar" did not have an impact on the overall effective interest rate on the Company's LIBOR-based borrowings.

On
May 25, 2005, the Company entered into a hedging transaction through the acquisition of a "no cost collar." Under this arrangement, the Company capped its exposure on
$130.0 million of LIBOR-based borrowings under the senior secured floating rate notes at a maximum LIBOR rate of 5.30%. In addition, the Company established a minimum "floor" LIBOR rate of
3.45%, in line with then current LIBOR rates. This hedging arrangement expired on June 16, 2008.

The
fair value of the interest rate collars resulted in a liability of $0.3 million and an asset of $4.0 thousand, at September 27, 2008 and December 29,
2007, respectively.

8. Issuance of Common Stock

On July 23, 2008, the Company's CEO purchased 20,000 shares of Duane Reade Holdings, Inc. common stock at a price of $100 per share. The proceeds from the stock issuance
were used for general corporate purposes.

9. Issuance of Preferred Stock and Common Stock Warrants in Connection with the Acquisition of Gristedes Store Leases

On February 20, 2007, the Company entered into an agreement to acquire up to eight leases from the Gristedes supermarket chain for certain locations in the borough of Manhattan,
New York City. As of September 27, 2008, the Company had completed the lease acquisitions for six of the former Gristedes locations. The Company has opened stores at five of the six former
Gristedes locations and expects to open the sixth store during the fourth quarter of 2008. The acquisition of these leases has been funded through a portion of the proceeds from the issuance of
$39.4 million of preferred stock and common stock warrants. The Company's agreement with Gristedes has expired and the Company is not obligated to acquire the remaining two leases.

On
March 27, 2007, certain affiliates of Oak Hill Capital Partners L.P. made an equity commitment of $39.4 million in the form of Series A preferred stock and
warrants to acquire approximately 11% (on a fully diluted basis) of the Company's common stock at an exercise price of $75.00 per share. The proceeds from this capital infusion were used, in part, to
acquire the Gristedes leases and to fund certain other capital expenditures. The funds raised through this commitment in excess of funds needed for the acquisition were used to fund the Company's
normal capital spending, fund new store openings or to reduce the Company's outstanding debt. The first portion of this equity commitment, which amounted to $13.0 million, was funded on
March 27, 2007 and the balance of the $39.4 million commitment, in which certain members of senior management also elected to participate, was funded on September 27, 2007. The
preferred stock has a 12-year mandatory redemption date from the issuance date and provides for an annual cash dividend of 10% payable quarterly subject to being declared by the Board of
Directors. To the extent the dividends are not paid in cash, the dividends will

20

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

9. Issuance of Preferred Stock and Common Stock Warrants in Connection with the Acquisition of Gristedes Store Leases (Continued)

cumulate
on a quarterly basis. The dividends are recorded within interest expense on the Statement of Operations. Under the agreements governing its indebtedness, the Company is not currently
permitted to pay such dividends in cash. As of September 27, 2008 and December 29, 2007, the Company had accrued unpaid dividends of $5.6 million and $2.4 million,
respectively.

Each
of the 525,334 shares of Series A preferred stock is immediately redeemable without penalty, at the Company's option prior to the mandatory redemption date, at a liquidation
preference of $75.00 per share plus any accrued but unpaid dividends as of the redemption date. The Company has the right, at its option, immediately prior to an initial public offering (IPO), to
require holders of the preferred stock to convert all (but not less than all) of such shares into a number of shares of the Company's common stock equal to the liquidation preference for such shares
of preferred stock, divided by the price per share of the Company's common stock set forth in the final prospectus to be used in connection with the IPO. Upon the occurrence of a change in control,
the Company will be required to redeem all outstanding shares of the Series A preferred stock at a redemption price per share of $75.00 per share plus accrued and unpaid dividends.

The
warrants are exercisable initially to purchase an aggregate of up to 384,174 shares of the Company's common stock. The purchase price for each share of the Series A preferred
stock is $75.00 per share, and warrants are exercisable for the Company's common stock at a price per share of $75.00, subject to certain adjustments.

In
accordance with SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," the Company has recorded the portion of the
proceeds that are attributable to the Series A preferred stock ($30.7 million) as a liability because of the mandatory redemption feature. The remaining amount of $8.4 million
(net of $0.3 million of expenses) was ascribed to the warrants, based on a relative fair value basis, and is recorded within additional paid-in capital. The Company has also
recorded a liability for the Series A preferred stock's mandatory redemption feature, which is considered a derivative financial instrument. The recorded liability for the Series A
preferred stock's mandatory redemption feature was $4.1 million and $3.2 million at September 27, 2008 and December 29, 2007, respectively. Such liability is included in
"Other non-current liabilities" on the Consolidated Balance Sheet.

10. Fair Value

On December 30, 2007, the first day of fiscal 2008, the Company adopted SFAS No. 157 to account for its financial assets and liabilities. This standard defines fair value,
provides guidance for measuring fair
value and requires certain disclosures. This standard does not require any new fair value measurements, however, it applies to all other accounting pronouncements that require or permit fair value
measurements. This standard does not apply to fair value measurements related to share-based payments, nor does it apply to fair value measurements related to inventory.

SFAS
No. 157 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted
quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to

21

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

10. Fair Value (Continued)

unobservable
inputs (Level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:



A
financial instrument's level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. The fair value estimates
presented in the tables below are based on the information available to the Company as of September 27, 2008 and December 29, 2007.

Valuation Techniques

At September 27, 2008, all of the Company's financial instruments had significant Level 3 inputs. The valuation approach
used to calculate the fair value of the Series A preferred stock's mandatory redemption feature is a combination of future liquidity event probabilities, risk-adjusted returns, and
a net present value analysis. The valuation methodology applied to the profits interest is based on a Monte Carlo simulation, which estimates the fair value of the profits interest based on several
inputs, including the fair value of the Company's equity, future liquidity event probabilities and the expected volatility of the underlying equity value. The interest rate collar is valued using
models that contain observable market data as well as models that have non-observable inputs, such as assumptions regarding the future performance of the underlying assets. The guarantees
for assigned store leases are valued using a probability weighted net present value analysis which considers the probability of future events which may cause the Company to fulfill the guarantees.

Fair Value on a Recurring Basis

The assets and liabilities measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level
of significant input to the valuations. As required by SFAS No. 157, the assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the
fair value measurement (dollars in thousands). The amounts representing liabilities are denoted in parentheses in the tables below.

Level 1

Level 2

Level 3

TotalSeries A Preferred stockmandatory redemption feature

$


$


$
(4,140
)
$
(4,140
)Profits interest








(1,671
)
$
(1,671
)Interest rate collar








(271
)
$
(271
)Guarantees








(678
)
$
(678
)Total

$


$


$
(6,760
)
$
(6,760
)


22

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

10. Fair Value (Continued)

The
table presented below summarizes the change in balance sheet carrying values associated with the Company's Level 3 assets and liabilities recorded at fair value on a recurring
basis during the thirteen weeks ended September 27, 2008 (dollars in thousands).

Preferred Stock
Mandatory
Redemption Feature(1)

Profits
Interest

Interest Rate
Collars, net

Guarantees(2)

TotalBalance at June 28, 2008

$
(3,290
)
$
(1,671
)
$
284

$
(583
)
$
(5,260
)Gains/(Losses)Included in net loss


(850
)







(95
)
$
(945
)Included in other comprehensive loss








(555
)



$
(555
)Transfers













$
Balance at September 27, 2008

$
(4,140
)
$
(1,671
)
$
(271
)
$
(678
)
$
(6,760
)The amount of gains/(losses) for the period included in net loss and attributable to the change in unrealized gains/(losses) for assets and liabilities
still held at September 27, 2008

$
(850
)
$


$


$
(95
)
$
(945
)


The
table presented below summarizes the change in balance sheet carrying values associated with the Company's Level 3 assets and liabilities recorded at fair value on a recurring
basis during the thirty-nine weeks ended September 27, 2008 (dollars in thousands).

Preferred Stock
Mandatory
Redemption Feature(1)

Profits
Interest

Interest Rate
Collars, net

Guarantees(2)

TotalBalance at December 29, 2007

$
(3,173
)
$
(1,671
)
$
4

$


$
(4,840
)Gains/(Losses)Included in net loss


(967
)







(678
)
$
(1,645
)Included in other comprehensive loss








(275
)



$
(275
)Transfers













$
Balance at September 27, 2008

$
(4,140
)
$
(1,671
)
$
(271
)
$
(678
)
$
(6,760
)The amount of gains/(losses) for the period included in net loss and attributable to the change in unrealized gains/(losses) for assets and liabilities
still held at September 27, 2008

$
(967
)
$


$


$
(678
)
$
(1,645
)


---

23

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

11. Other Expenses

The table below provides detail of other expenses for the thirteen and thirty-nine weeks ended September 27, 2008 and September 29, 2007 (dollars in thousands).

13 Weeks Ended

39 Weeks EndedSeptember 27,
2008

September 29,
2007

September 27,
2008

September 29,
2007Closed Store Costs

$
190

$
2,729

$
2,307

$
5,078Asset Impairment Charges(1)


3,405





3,405


Oak Hill Management Fees


313


313


938


938Accounting Investigation Costs











2,183Former CEO (Mr. Cuti) Matters


2,602


1,033


3,903


4,840Other(2)


1,373


36


1,479


313Total Other Expenses

$
7,883

$
4,111

$
12,032

$
13,352


---

In the normal course of its business, the Company closes underperforming locations. In accordance with the provisions of SFAS No. 146, "Accounting for the Costs
Associated with Exit or Disposal Activities," the Company establishes reserves for closed store costs anticipated to be incurred in connection with such closings. Note 5 includes a discussion
of these reserves. Note 13 includes a discussion of the costs relating to accounting investigations and the proceedings relating to Mr. Cuti. The Oak Hill management fee is payable
quarterly.

12. Income Taxes

Income taxes are recorded based on the estimated combined statutory tax rates expected to be applicable for the full fiscal year less applicable employment related tax credits. The
effective tax rate prior to the application of deferred tax asset valuation reserves is lower than the combined statutory rates, primarily reflecting the impact of these income tax credits. The
wage-based employment tax credits represent the economic benefits earned by the Company for its participation in various federal and state hiring incentive programs. These benefits are
based on the number of qualifying employees hired and retained by the Company for a specified time period. Employees qualify for these hiring programs primarily as a result of their enrollment in
various economic assistance programs.

As
a result of the Company's significant losses incurred in 2007 and 2006 and its anticipated future performance based on projections, the Company evaluated the need to record a
valuation allowance against its net deferred tax assets as part of the 2007 tax provision accounting procedures. The evaluation undertaken included a review of the individual deferred tax components
and a corresponding analysis of the anticipated time period during which the temporary differences giving rise to deferred tax assets and liabilities would reverse. Based on the results of this
analysis, the Company determined that, except for two specific items, all deferred tax assets and liabilities were expected to reverse within the same period. The non-reversing items
totaled $29.2 million and included post-2004 goodwill of $8.3 million and the deferred tax liability of $20.9 million associated with the trade name. Because these
items are not amortized for financial statement purposes, a reversal of the corresponding deferred tax liability is not expected to occur within the expiration period.

At
December 29, 2007, the Company had approximately $162.4 million of gross deferred tax assets and approximately $79.7 million of gross deferred tax liabilities,
resulting in a net deferred tax asset of $82.7 million. After adjusting for the value of the deferred tax liabilities that do not reverse, the

24

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

12. Income Taxes (Continued)

resulting
cumulative valuation allowance amounted to $112.0 million, of which $43.5 million was recorded in 2007.

During
the thirteen and thirty-nine weeks ended September 27, 2008, the Company incurred additional pre-tax losses of $21.5 million and
$53.1 million, respectively, and recorded incremental valuation allowances of $10.2 million and $23.6 million, respectively. At September 27, 2008, the Company had
approximately $176.4 million of gross deferred tax assets, approximately $72.3 million of gross deferred tax liabilities and had recorded a cumulative valuation allowance of
$135.6 million. The tax expense reported during the thirteen and thirty-nine weeks ended September 27, 2008 and September 29, 2007 primarily resulted from the deferred
tax liabilities generated by non-amortizable goodwill.

During
the thirteen and thirty-nine weeks ended September 27, 2008, there were no material changes to the Company's uncertain tax positions.

In
June 2008, the examination of Duane Reade Inc.'s New York State Franchise Tax filings for the 2001 through 2003 tax years was completed. The amounts paid to New York state in
connection with this settlement were previously accrued and were not material to the Company's consolidated financial statements. In October 2008, a similar examination of Duane Reade Inc.'s
New York State Franchise Tax filings for the period January 2004 through July 2004 was settled with no payments required.

The
Company reflects interest charges incurred in connection with audit settlements as interest expense; however, if any tax-related penalties were to be incurred, such
amounts would be recorded as a component of the income tax provision.

13. Commitments and Contingencies

The Company is party to legal actions arising in the ordinary course of business. Based on information presently available to the Company, it believes that the ultimate outcome of these
actions will not have a material, adverse effect on its financial position, results of operations or cash flows. In addition, the Company is a party to the following legal actions and matters:

During
2002, the Company initiated a legal action against its former property insurance carrier, in an attempt to recover what the Company believed to be a fair and reasonable settlement
for the business interruption portion of its claim originating from the September 11, 2001 World Trade Center terrorist attack, during which its single highest volume and most profitable store
was completely destroyed. After a lengthy litigation and appraisal process, an appraisal panel awarded the Company approximately $5.6 million (in addition to the $9.9 million that was
paid by the insurer to the Company in 2002). As a result of the insurer's refusal to pay this amount and also as a result of the Second Circuit Court of Appeals' interpretation of the Company's
insurance policy, in January 2007, the Company commenced another action in the U.S. District Court for the Southern District of New York to recover both the appraisal panel's award and additional
amounts under the policy. In August 2007, the District Court entered judgment in the amount of $0.8 million plus interest, and both parties appealed. The appeals have been briefed and are
awaiting argument in the Second Circuit Court of Appeals. However, due to the inherent uncertainty of litigation, there can be no assurance that this appeal will be successful.

Accordingly,
given the risks and uncertainties inherent in litigation, there can be no definitive assurance that the Company will actually receive any or all of the panel's appraised
value of this claim, and the Company has not recognized any income related to this matter, other than $9.4 million of the original $9.9 million paid by the insurer in 2002. It should be
noted that any payment to the Company that might be forthcoming as a result of this claim may also result in the incurrence of additional

25

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

13. Commitments and Contingencies (Continued)

expenses
that are contingent upon the amount of such insurance claim settlement. These expenses, if incurred, are not expected to exceed $4.0 million.

In
November 2004, Duane Reade Inc. was served with a purported class action complaint, Damassia v. Duane Reade Inc. The lawsuit was filed in the U.S. District Court for the
Southern District of New York. The complaint alleges that, from the period beginning November 1998, the Company incorrectly gave some employees the title "Assistant Manager," in an attempt to avoid
paying these employees overtime, in contravention of the Fair Labor Standards Act and New York law. The complaint seeks twice an unspecified amount of unpaid wages. In May 2008, the court certified
this case as a class action. The Company believes this claim to be without merit, and the Company intends to defend itself against this claim. However, due to the uncertainty of litigation, there can
be no assurance as to the ultimate outcome of this matter.

In
April 2006, the Company was served with a purported class action complaint, Chowdhury v. Duane Reade Inc. and Duane Reade Holdings, Inc. The complaint alleges that, from
a period beginning March 2000, the Company incorrectly classified certain employees in an attempt to avoid paying overtime to such employees, thereby violating the Fair Labor Standards Act and New
York law. In May 2008, the court certified this case as a class action. The complaint seeks an unspecified amount of damages. The Company believes this claim to be without merit and intends to
vigorously defend itself against this claim. However, due to the inherent uncertainty of litigation, there can be no assurance as to the ultimate outcome of this matter.

In
November 2007, the Company was served with a subpoena from the Office of the Attorney General of the State of New York. The subpoena requested information regarding services to
customers with limited English proficiency. The Company has cooperated with the Office of the Attorney General and believes this matter will be settled on terms acceptable to it. Should this matter
not be settled, the Company believes it has valid defenses to any claims that may be made against it and will vigorously defend itself.

In
January 2008, the Company was served with a subpoena from the Department of Health and Human Services, Office of the Inspector General. The subpoena seeks information relating to the
operation of the Company's pharmacy kiosks and information relating to a business relationship that the Company had with Mobility Plus, a provider of durable medical equipment. In February 2008, the
Company received an identical subpoena from the Office of the Attorney General of the State of New York, Medicaid Fraud Control Unit. The Company is in the process of responding to the information
requests from both entities. While the Company believes that it has been in compliance with all applicable rules and regulations, at this stage, there can be no assurance as to the ultimate outcome of
this matter.

Proceedings Relating to Anthony J. Cuti

On September 1, 2006, Anthony J. Cuti, a former Chairman, President and Chief Executive Officer of the Company, initiated an
arbitration before the American Arbitration Association against Duane Reade Inc., Duane Reade Holdings, Inc. and Duane Reade Shareholders, LLC, which are referred to as the
"respondents." The arbitration relates to his termination in November 2005. Mr. Cuti asserts various claims including, with respect to his employment agreement, breach of contract relating to
the notice of termination provision, failure to make certain payments toward his 1998 corporate-owned life insurance policy, relief from the non-competition and
non-solicitation covenants, failure to provide adequate information relating to the valuation of his profits interest and breach of the covenant of good faith and fair dealing. Other
claims relate to the patent rights for the Company's virtual pharmacy

26

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

13. Commitments and Contingencies (Continued)

kiosk
system and payment of an alleged deferred 2001 bonus based on any insurance recovery the Company may obtain on its business interruption claim in connection with the 2001 World Trade Center
tragedy. On March 16, 2007, Mr. Cuti sought leave to file an amended demand asserting additional allegations in support of his claim for breach of contract for failure to comply with the
notice of termination provision in his employment agreement, and a claim for defamation. On May 17, 2007, the arbitrator issued an order granting leave to file Mr. Cuti's amended demand.
Mr. Cuti seeks monetary damages, declaratory relief, rescission of his employment agreement and the payment of his legal costs and fees associated with his termination and the arbitration.

On
November 22, 2006, the respondents filed counterclaims and affirmative defenses against Mr. Cuti in the arbitration, alleging that between 2000 and 2005, Mr. Cuti
was responsible for improper practices involving invoice credits and rebillings for the construction of the Company's stores, that led to overstating the Company's publicly reported earnings, and that
caused the Company to create and maintain inaccurate records and publish financial statements containing misstatements. These counterclaims were based on information uncovered as of that date by an
investigation conducted by independent legal counsel and forensic accountants at the direction of the Audit Committee.

In
a press release dated April 2, 2007, the Company disclosed that, based on new information provided to the Company, the Audit Committee, with the assistance of independent
counsel and forensic accountants, was conducting a review and investigation concerning the propriety of certain real estate transactions and related matters and whether the accounting for such
transactions was proper. On April 9, 2007, the respondents sought leave to file proposed amended counterclaims based on that new information. On May 17, 2007, the arbitrator issued an
order granting leave to file the amended counterclaims. The amended counterclaims seek rescission of employment agreements entered into between the Company and Mr. Cuti, return of all
compensation paid under the employment agreements, other compensatory and punitive damages, and legal costs and fees associated with the Audit Committee's investigation and the arbitration.

On
May 18, 2007, the independent counsel and the forensic accountants completed their review and investigation. The independent counsel concluded that Mr. Cuti orchestrated
certain real estate and other transactions that led to overstating the Company's publicly reported earnings, and that caused the Company to create and maintain inaccurate records and publish financial
statements containing misstatements. On May 22, 2007, the Audit Committee determined, after considering the results of the review and investigation, that certain of the Company's
previously-issued financial statements would have to be restated. The Company filed the necessary restated financial statements for the periods affected.

On
May 22, 2007, the Company received a grand jury subpoena from the United States Attorney's Office for the Southern District of New York seeking documents relating to the
allegations in the amended counterclaims discussed above. The Company has cooperated fully with the investigation. The SEC also requested that the Company provide it with information related to this
matter.

On
May 25, 2007, the United States Attorney's Office for the Southern District of New York filed an application requesting that the arbitrator stay further proceedings in the
arbitration, including discovery, pending further developments in its criminal investigation of Mr. Cuti. Following briefing by the parties on the application, the arbitrator entered an order
staying the arbitration proceedings. The stay has been extended from time to time.

On
October 9, 2008, the United States Attorney's Office for the Southern District of New York and the SEC announced the filing of criminal and civil securities fraud charges
against Mr. Cuti and

27

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

13. Commitments and Contingencies (Continued)

another
former executive of the Company, William Tennant. In the criminal indictment, the government charges that Mr. Cuti and Mr. Tennant engaged in a scheme, involving the credits and
rebillings and real estate-related transactions discussed above, falsely to inflate the income and reduce the expenses that the Company reported to the investing public and others. The SEC's complaint
similarly alleges that Mr. Cuti and Mr. Tennant entered into a series of fraudulent transactions designed to boost reported income and enable the Company to meet quarterly and annual
earnings guidance.

Other

In connection with the assignment of certain store leases to third parties, the Company continues to guarantee lease obligations for
eight former stores. The respective purchasers have assumed the Company's obligations under these leases and are primarily liable for these obligations. Although the Company believes it to be
unlikely, assuming that each respective purchaser became insolvent, management estimates that the Company could settle these remaining
lease obligations for amounts substantially less than the aggregate remaining obligation of $32.7 million as of September 27, 2008. The obligations are for varying terms dependent upon
the respective lease, the longest of which lasts through January 15, 2028.

14. Subsequent Events

As discussed in Note 13, on October 9, 2008, the United States Attorney's Office for the Southern District of New York announced the filing of criminal securities fraud
charges against Mr. Cuti, the Company's former CEO, and Mr. William Tennant, another former executive of the Company. On the same date, the SEC announced the filing of civil securities
fraud charges against the same individuals. The Company has cooperated fully with the various government agencies in their investigations. In the criminal indictment, the government charged that the
two former executives engaged in fraudulent and illegal activities discussed above in Note 13.

On
November 3, 2008, Ms. Michelle D. Bergman informed the Company that she would be resigning from her position as Senior Vice President and General Counsel of the Company,
effective November 14, 2008. Under the terms of Ms. Bergman's letter of resignation, the Company will pay severance to Ms. Bergman equal to $375,000 (Ms. Bergman's base
salary during the 2008 fiscal year) and a pro rata bonus for the 2008 fiscal year. In addition, already-vested options to purchase 3,225 shares of the Company's common stock that were granted to
Ms. Bergman in 2006 will remain exercisable until December 31, 2009, and unvested options to purchase a further 3,225 shares of the registrant's common stock that were granted in 2006
will vest and be exercisable until December 31, 2009; all other options granted to Ms. Bergman will be treated in the manner specified in her employment letter. Ms. Bergman agreed
to a general release of claims against the Company, and she will continue to be bound by certain obligations in her existing agreements, including, without limitation, non-competition,
non-solicitation, non-hiring and non-disclosure provisions.

15. Condensed Consolidating Interim Financial Information of Subsidiary Guarantors and Co-Obligors

The 9.75% senior subordinated notes due 2011 and the senior secured floating rate notes due 2010 were co-issued by Duane Reade Inc. and Duane Reade GP, each of
whom is considered a "co-obligor." The Company and each of its other subsidiaries, composed of DRI I Inc., Duane Reade International, Inc. and Duane Reade
Realty, Inc., are guarantors of such notes. The guarantee of the Company and of each subsidiary guarantor is full and unconditional and joint and several.

28

---





Notes to Unaudited Consolidated Interim Financial Statements (Continued)    (dollars in thousands)

15. Condensed Consolidating Interim Financial Information of Subsidiary Guarantors and Co-Obligors (Continued)

The
following condensed consolidating interim financial information for the Company presents the financial information of Duane Reade Holdings, Inc., the co-obligors
and the subsidiary guarantors, prepared on the equity basis of accounting. Such presentation is based on the Company's understanding and interpretation of Rule 3-10 under the
Securities and Exchange Commission's Regulation S-X. Income tax expense (benefit) and deferred income taxes have been allocated to individual entities according to the Company's
income tax allocation methodology. Certain of the prior year information have been adjusted to conform its presentation to the current year. The financial information may not necessarily be indicative
of results of operations or financial position had the subsidiary guarantors operated as independent entities. Figures presented for Duane Reade GP's statements of operations reflect the impact
of the change in accounting for store occupancy costs discussed in Note 1.

29

---



DUANE READE HOLDINGS, INC.    Condensed Consolidating Statement of Operations (Unaudited)    For the 13 weeks ended September 27, 2008    (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedNet sales

$


$


$
431,005

$
10,351

$
(10,351
)
$
431,005Cost of sales (exclusive of depreciation and amortization shown separately below)








296,261








296,261Gross profit








134,744


10,351


(10,351
)

134,744Selling, general & administrative expenses








133,113


114


(15,464
)

117,763Depreciation and amortization








16,667








16,667Store pre-opening expense








300








300Gain on sale of pharmacy files

















Other expenses








7,883








7,883Operating (loss) income








(23,219
)

10,237


5,113


(7,869
)Equity earnings in affiliates


22,329


22,329





383


(45,041
)

Interest expense (income), net








13,633


(5,113
)

5,113


13,633Income (loss) before income taxes


(22,329
)

(22,239
)

(36,852
)

14,967


45,041


(21,502
)Income taxes (benefit)








1,417


(590
)




827Net income (loss)

$
(22,329
)
$
(22,329
)
$
(38,269
)
$
15,557

$
45,041

$
(22,329
)


30

---



DUANE READE HOLDINGS, INC.    Condensed Consolidating Statement of Operations (Unaudited)    For the 13 weeks ended September 29, 2007    (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedNet sales

$


$


$
408,828

$
9,810

$
(9,810
)
$
408,828Cost of sales (exclusive of depreciation and amortization shown separately below)








283,740








283,740Gross profit








125,088


9,810


(9,810
)

125,088Selling, general & administrative expenses








127,109


110


(16,903
)

110,316Depreciation and amortization








18,007








18,007Store pre-opening expense








200








200Gain on sale of pharmacy files








(1,337
)







(1,337
)Other expenses








4,111








4,111Operating (loss) income








(23,002
)

9,700


7,093


(6,209
)Equity earnings in affiliates


22,052


22,052





389


(44,493
)

Interest expense (income), net








15,731


(7,093
)

7,093


15,731Income (loss) before income taxes


(22,052
)

(22,052
)

(38,733
)

16,404


44,493


(21,940
)Income taxes (benefit)








198


(86
)




112Net income (loss)

$
(22,052
)
$
(22,052
)
$
(38,931
)
$
16,490

$
44,493

$
(22,052
)


31

---





DUANE READE HOLDINGS, INC.    Condensed Consolidating Statement of Operations (Unaudited)    For the 39 weeks ended September 27, 2008    (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedNet sales

$


$


$
1,309,538

$
31,526

$
(31,526
)
$
1,309,538Cost of sales (exclusive of depreciation and amortization shown separately below)








902,667








902,667Gross profit








406,871


31,526


(31,526
)

406,871Selling, general & administrative expenses








401,707


352


(47,846
)

354,213Depreciation and amortization








52,260








52,260Store pre-opening expense








548








548Gain on sale of pharmacy files

















Other expenses








12,032








12,032Operating (loss) income








(59,676
)

31,174


16,320


(12,182
)Equity earnings in affiliates


55,400


55,400





1,050


(111,850
)

Interest expense (income), net








40,913


(16,320
)

16,320


40,913Income (loss) before income taxes


(55,400
)

(55,400
)

(100,589
)

46,444


111,850


(53,095
)Income taxes (benefit)








4,367


(2,062
)




2,305Net income (loss)

$
(55,400
)
$
(55,400
)
$
(104,956
)
$
48,506

$
111,850

$
(55,400
)


32

---



DUANE READE HOLDINGS, INC.    Condensed Consolidating Statement of Operations (Unaudited)    For the 39 weeks ended September 29, 2007    (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedNet sales

$


$


$
1,255,146

$
30,216

$
(30,216
)
$
1,255,146Cost of sales (exclusive of depreciation and amortization shown separately below)








877,195








877,195Gross profit








377,951


30,216


(30,216
)

377,951Selling, general & administrative expenses








387,017


337


(50,443
)

336,911Depreciation and amortization








54,460








54,460Store pre-opening expense








350








350Gain on sale of pharmacy files








(1,337
)







(1,337
)Other expenses








13,352








13,352Operating (loss) income








(75,891
)

29,879


20,227


(25,785
)Equity earnings in affiliates


72,723


72,723





1,243


(146,689
)

Interest expense (income), net








44,810


(20,227
)

20,227


44,810Income (loss) before income taxes


(72,723
)

(72,723
)

(120,701
)

48,863


146,689


(70,595
)Income taxes (benefit)








3,638


(1,510
)




2,128Net income (loss)

$
(72,723
)
$
(72,723
)
$
(124,339
)
$
50,373

$
146,689

$
(72,723
)


33

---





DUANE READE HOLDINGS, INC.    Condensed Consolidating Balance Sheet (Unaudited)    As of September 27, 2008    (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedAssetsCurrent assetsCash

$


$


$
1,360

$
22

$


$
1,382Receivables, net








52,085








52,085Due from affiliates





77,615


107,903


(180
)

(185,338
)

Inventories








212,952








212,952Deferred income taxes





1,140


5,049


(6,189
)




Prepaid expenses and other assets








13,771








13,771Total current assets





78,755


393,120


(6,347
)

(185,338
)

280,190Investment in affiliates


(101,813
)

(101,823
)




(3,705
)

207,341


Property and equipment, net








187,453








187,453Goodwill








70,099








70,099Deferred income taxes





1,645


9,032


(10,677
)




Other assets, net








132,921


460,127


(413,895
)

179,153Total assets

$
(101,813
)
$
(21,423
)
$
792,625

$
439,398

$
(391,892
)
$
716,895Liabilities and Stockholders' Equity (Deficit)Current liabilitiesAccounts payable

$


$


$
78,200

$


$


$
78,200Due to affiliates











185,336


(185,336
)

Accrued interest








3,839








3,839Accrued expenses





2,843


39,014








41,857Current portion of debt








155,145








155,145Current portion of capital lease obligation








4,250








4,250Total current liabilities





2,843


280,448


185,336


(185,336
)

283,291Long term debt








818,928





(413,895
)

405,033Capital lease obligation, less current portion








2,269








2,269Deferred income taxes





75,992


(74,482
)

26,952





28,462Redeemable preferred stock and accrued dividends


31,112


32,679


33,920





(62,225
)

35,486Deferred rent liabilities








49,738








49,738Other non-current liabilities








38,117








38,117Total liabilities


31,112


111,514


1,148,938


212,288


(661,456
)

842,396Stockholders' equity (deficit)Common stock


26














26Paid-in-capital


247,520


247,535


255,238


2,395


(497,476
)

255,212Accumulated other comprehensive income








(270
)







(270
)Retained earnings (deficit)


(380,471
)

(380,472
)

(611,281
)

224,715


767,040


(380,469
)Total stockholders' equity (deficit)


(132,925
)

(132,937
)

(356,313
)

227,110


269,564


(125,501
)Total liabilities and stockholders' equity (deficit)

$
(101,813
)
$
(21,423
)
$
792,625

$
439,398

$
(391,892
)
$
716,895


34

---



DUANE READE HOLDINGS, INC.    Condensed Consolidating Balance Sheet (Unaudited)    As of December 29, 2007    (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedAssetsCurrent assetsCash

$


$


$
1,343

$
37

$


$
1,380Receivables, net








55,707








55,707Due from affiliates





78,621


106,656


61


(185,338
)

Inventories








211,678








211,678Deferred income taxes





1,140


5,049


(6,189
)




Prepaid expenses and other assets








13,205








13,205Total current assets





79,761


393,638


(6,091
)

(185,338
)

281,970Investment in affiliates


(46,423
)

(46,423
)




(2,655
)

95,501


Property and equipment, net








195,740








195,740Goodwill








70,099








70,099Deferred income taxes





1,645


9,032


(10,677
)




Other assets, net








148,448


412,377


(366,145
)

194,680Total assets

$
(46,423
)
$
34,983

$
816,957

$
392,954

$
(455,982
)
$
742,489Liabilities and Stockholders' Equity (Deficit)Current liabilitiesAccounts payable

$


$


$
75,769

$


$


$
75,769Due to affiliates











185,336


(185,336
)

Accrued interest








9,158








9,158Accrued expenses





1,712


41,374








43,086Current portion of debt








141,352








141,352Current portion of capital lease obligation








3,994








3,994Total current liabilities





1,712


271,647


185,336


(185,336
)

273,359Long term debt








771,177





(366,145
)

405,032Capital lease obligation, less current portion








5,475








5,475Deferred income taxes





77,258


(78,849
)

29,014





27,423Redeemable preferred stock and accrued dividends


31,113


31,113


31,786





(62,226
)

31,786Deferred rent liabilities








40,462








40,462Other non-current liabilities





2,436


29,839








32,275Total liabilities


31,113


112,519


1,071,537


214,350


(613,707
)

815,812Stockholder's equity (deficit)Common stock


26














26Paid-in-capital


247,509


247,535


251,743


2,395


(497,466
)

251,716Accumulated other comprehensive income








4








4Retained earnings (deficit)


(325,071
)

(325,071
)

(506,327
)

176,209


655,191


(325,069
)Total stockholders' equity (deficit)


(77,536
)

(77,536
)

(254,580
)

178,604


157,725


(73,323
)Total liabilities and stockholders' equity (deficit)

$
(46,423
)
$
34,983

$
816,957

$
392,954

$
(455,982
)
$
742,489


35

---





DUANE READE HOLDINGS, INC.    Condensed Consolidating Statement of Cash Flows (Unaudited)    For the 39 weeks ended September 27, 2008    (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedCash flows provided by (used in) operating activities:Net (loss) income

$
(55,400
)
$
(55,400
)
$
(104,956
)
$
48,506

$
111,850

$
(55,400
)Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:Depreciation and amortization








54,999








54,999Deferred income taxes





(113
)

4,367


(2,062
)




2,192Non-cash rent expense








9,339








9,339Non-cash interest expense on redeemable preferred stock








4,666








4,666Asset impairment charges








3,405








3,405Other non-cash expense








332








332Equity in income of subsidiaries


55,400


55,400





1,050


(111,850
)

Changes in operating assets and liabilities:Receivables





1,005


2,376


241





3,622Inventories








(1,274
)







(1,274
)Prepaid expenses and other current assets








(566
)







(566
)Accounts payable








2,431








2,431Accrued expenses





(22
)

(7,907
)







(7,929
)Other assets and liabilities, net





(870
)

53,529


(47,750
)




4,909NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES








20,741


(15
)




20,726Cash flows used in investing activities:Capital expenditures








(23,111
)







(23,111
)Lease acquisition and other costs








(11,958
)







(11,958
)Proceeds from sale of assets








525








525NET CASH USED IN INVESTING ACTIVITIES








(34,544
)







(34,544
)Cash flows from financing activities:Borrowings from revolving credit facility








1,544,744








1,544,744Repayments of revolving credit facility








(1,530,951
)







(1,530,951
)Capital contributions








978








978Issuance of common stock








2,000








2,000Issuance of preferred stock

















Deferred financing costs








(1
)







(1
)Repayments of capital lease obligations








(2,950
)







(2,950
)NET CASH USED IN FINANCING ACTIVITIES








13,820








13,820Net change in cash








17


(15
)




2Cash at beginning of period








1,343


37





1,380Cash at end of period

$


$


$
1,360

$
22

$


$
1,382


36

---



DUANE READE HOLDINGS, INC.    Condensed Consolidating Statement of Cash Flows (Unaudited)    For the 39 weeks ended September 29, 2007    (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedCash flows used in operating activities:Net (loss) income

$
(72,723
)
$
(72,723
)
$
(124,339
)
$
50,373

$
146,689

$
(72,723
)Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:Depreciation and amortization








57,200








57,200Deferred income taxes





(178
)

3,638


(1,510
)




1,950Non-cash rent expense








8,993








8,993Non-cash interest expense on redeemable preferred stock








923








923Asset impairment charges

















Other non-cash benefit








(1,244
)







(1,244
)Equity in income of subsidiaries


72,723


72,723





1,243


(146,689
)

Changes in operating assets and liabilities:Receivables





209


3,055


383





3,647Inventories








(1,189
)







(1,189
)Prepaid expenses and other current assets








11,486








11,486Accounts payable








(4,001
)







(4,001
)Accrued expenses





(31
)

(12,421
)







(12,452
)Other assets and liabilities, net








54,018


(50,475
)




3,543NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES








(3,881
)

14





(3,867
)Cash flows used in investing activities:Capital expenditures








(20,058
)







(20,058
)Lease acquisition and other costs








(14,547
)







(14,547
)Proceeds from sale of assets








3,335








3,335NET CASH USED IN INVESTING ACTIVITIES








(31,270
)







(31,270
)Cash flows from financing activities:Borrowings from revolving credit facility








1,490,788








1,490,788Repayments of revolving credit facility








(1,494,800
)







(1,494,800
)Capital contributions








2,342








2,342Issuance of common stock

















Issuance of preferred stock








39,150








39,150Deferred financing costs








(5
)







(5
)Repayments of capital lease obligations








(2,374
)







(2,374
)NET CASH PROVIDED BY FINANCING ACTIVITIES








35,101








35,101Net change in cash








(50
)

14





(36
)Cash at beginning of period








1,370


25





1,395Cash at end of period

$


$


$
1,320


39

$


$
1,359


37

---





ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion regarding our financial condition and results of operations for the thirteen and thirty-nine weeks
ended September 27, 2008 and the thirteen and thirty-nine weeks ended September 29, 2007 should be read in conjunction with the more detailed financial information contained
in our consolidated financial statements and their notes as well as the Special Note Regarding Forward-Looking Statements that are contained elsewhere in this report.

On
September 30, 2007, the first day of our fourth quarter of 2007, we changed our method of accounting for store occupancy costs reflected on our statements of operations. The
change resulted in a reclassification of the store occupancy costs previously included within cost of sales to selling, general and administrative expenses. We believe this change in accounting more
closely aligns these store occupancy cost components to the nature of expenses included in our financial statement captions and improves the comparability of our financial statement presentation with
industry peers. For the 13 weeks ended September 27, 2008 and September 29, 2007, the change in accounting resulted in a decrease to cost of sales of $42.5 million and
$39.2 million, respectively, with a corresponding increase to gross profit and selling, general and administrative expenses. For the 39 weeks ended September 27, 2008 and
September 29, 2007, the change in accounting resulted in a decrease to cost of sales of $125.0 million and $119.7 million, respectively, with a corresponding increase to gross
profit and selling, general and administrative expenses. The change in accounting had no effect on the operating loss for any of the periods presented. This Management's Discussion and Analysis of
Financial Condition and Results of Operations has been updated to reflect the change in accounting for all periods presented.

General

Our business consists of the sale of a wide variety of health and beauty care products, convenience-oriented food and general
merchandise items and a pharmacy operation managed to supply customers with their prescription needs. We refer to the non-prescription portion of our business as front-end
sales because most of these sales are processed through the front check-out sections of our stores. This portion of our business consists of brand name and private label items including
health and beauty care items, food and beverages, tobacco products, housewares, greeting cards, photofinishing services, photo supplies, seasonal and general merchandise and other products. Health and
beauty care products and convenience food represent our highest volume categories within front-end sales. The front-end portion of our business represented 54.7% and 54.5% of
our net sales in the thirteen weeks and thirty-nine weeks ended September 27, 2008, respectively, and 54.0% and 53.7% of our net sales in the thirteen weeks and
thirty-nine weeks ended September 29, 2007, respectively. The gross margins generated by our front-end business are generally higher as compared to the gross margins of
our pharmacy or back-end business.

Because
of our numerous convenient locations in high-traffic commercial and residential areas and the lack of other convenience-oriented retailers in our core market areas,
our front-end business is generally a larger proportion of our total sales than for other major conventional drugstore chains, whose front-end sales average between 30% and 40%
of total sales. Over the last few years, pharmacy sales have experienced a slower rate of growth primarily due to increased generic dispensing rates and reduced third party plan reimbursement rates,
including State Medicaid plans. The lower Maximum Allowable Costs ("MAC") reimbursement rates by The Centers for Medicare and Medicaid Services ("CMS"), State Medicaid and third party plans have
resulted in lower sales and margins on generic drugs. In addition, mandatory mail order plans have penetrated some prescription benefit management ("PBM") plans, and mail order intrusion into Medicare
Part D plans has also had the effect of lowering sales. Our pharmacy sales include all items we sell by prescriptions filled at our retail locations and by our Mail Order/Specialty Pharmacy
facility. In addition, we include in our pharmacy sales certain resales of retail pharmaceutical inventory. Sales processed through third party prescription plans

38

---



represented
approximately 93.4% and 93.3% of our prescription sales in the thirteen and thirty-nine weeks ended September 27, 2008, respectively, and approximately 92.9% and 93.0%
of our prescription sales in the thirteen and thirty-nine weeks ended September 29, 2007, respectively.

The
Medicare Modernization Act created a Medicare Part D benefit that expanded Medicare coverage of prescription drugs for senior citizens as well as for certain "dual eligible"
individuals that were previously covered under state administered Medicaid plans. This Medicare coverage has resulted in decreased pharmacy margins resulting from lower reimbursement rates than our
current margins on
state Medicaid prescriptions. The Medicare Part D program grew rapidly during 2007 and 2006 and has continued to grow in 2008 as more seniors become eligible and enroll for this coverage. For
the thirteen and thirty-nine weeks ended September 27, 2008, the Medicare Part D program represented approximately 13.2% and 12.8%, respectively, of our retail pharmacy
sales, as compared to 12.9% and 12.2%, of retail pharmacy sales for the thirteen and thirty-nine weeks ended September 29, 2007, respectively.

State
Medicaid programs which provide prescription benefits to low income households and individuals represented approximately 13.3% and 14.0% of our retail pharmacy sales for the
thirteen weeks ended September 27, 2008 and September 29, 2007, respectively. During the thirty-nine weeks ended September 27, 2008 and September 29, 2007,
state Medicaid programs represented approximately 13.8% and 14.2%, respectively, of our retail pharmacy sales. Over the past several years, New York State reduced Medicaid and EPIC prescription
reimbursement rates, adversely impacting our pharmacy gross margins. Under the Medicaid guidelines, providers cannot refuse to dispense prescriptions to Medicaid recipients who claim they do not have
the means to pay the required co-payments. Most Medicaid recipients decline to make the co-payments, resulting in the requirement for the provider to absorb this cost.

In
April 2008, the New York State legislature enacted additional reimbursement reductions which became effective on July 1, 2008. The recently enacted legislation has resulted in
changes to the Medicaid pharmacy reimbursement rates. These changes apply to payments that were issued for services provided on and after July 1, 2008. Additionally, in July 2008, New York
State increased the number of generic drugs subject to their MAC limitations. The MAC limitations effectively reduce the reimbursement received from New York State for the generic drugs and, while
they presently have not materially impacted our pharmacy gross margins and sales, the future adverse impact on our pharmacy gross margins and sales may be material.

In
July 2007, the Centers for Medicare & Medicaid Services issued a final rule that may negatively affect our level of reimbursements for certain generic drugs by setting an upper
limit on the amount of reimbursement for such drugs based on the "Average Manufacturer Price." As a result of a lawsuit brought by the National Association of Chain Drug Stores and the National
Community Pharmacists Association to challenge the implementation of the new rule, a federal court temporarily enjoined the implementation of the new rule pending the outcome of the lawsuit and the
lawsuit remains pending. In July 2008, Congress enacted H.R. 6331, the Medicare Improvements for Patients and Providers Act of 2008 ("MIPPA"). President Bush subsequently vetoed MIPPA and, on
July 15, 2008, Congress overrode President Bush's veto. MIPPA delayed the implementation of the use of Average Manufacturer Price with respect to payments made by State Medicaid Plans for
multiple source generic drugs until September 30, 2009. MIPPA also prohibited the Secretary of Health and Human Services from making public any Average Manufacturer Price information that was
previously disclosed to the Secretary of Health and Human Services. The outcomes of the lawsuit and the impact of MIPPA are uncertain at this time, so we currently are unable to determine what effect
the new rule will ultimately have on our business.

In
an effort to offset some of the adverse pharmacy gross margin impacts from the trends discussed above, there has been an intensified effort on the part of retailers to support
increased

39

---



utilization
of lower priced but higher margin generic prescriptions in place of branded medications. New generic drug introductions have also enabled retailers to increase the proportion of generic
prescriptions to total prescriptions dispensed. Improved generic utilization rates as well as a combination of direct purchases and contractual wholesaler purchases enabled us to offset the adverse
margin impact of Medicare Part D and reduced state Medicaid reimbursement rates during 2008.

We
are impacted by legislation to increase the minimum hourly wages. New York State increased the minimum hourly wage from $5.15 to $6.00 on January 1, 2005, to $6.75 on
January 1, 2006, and again to $7.15 on January 1, 2007. New Jersey increased the minimum hourly wage from $5.15 to $6.15 on October 1, 2005 and again to $7.15 on October 1,
2006. In addition, the federal minimum hourly wage increased to $6.55 in July 2008 and the U.S. Congress passed legislation that will result in a federal minimum hourly wage increase to $7.25 in July
2009. While these increases have impacted our cost of labor, we have, and believe we can continue to, offset a significant portion of these cost increases through initiatives designed to further
improve our labor efficiency.

Our
primary assets are our ownership of 100% of the outstanding capital stock of Duane Reade Inc., which in turn owns 99% of the outstanding partnership interest of Duane
Reade GP and all of the outstanding common stock of DRI I Inc. DRI I 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, Duane Reade 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 all other intellectual property rights. In turn, Duane
Reade Inc. and DRI I Inc. made a capital contribution of these intellectual property rights to Duane Reade International. This change created a controlled system to manage and exploit
these intellectual property rights separate and apart from the retail operations. In addition, Duane Reade GP distributed some of its store leases to Duane Reade Inc. and DRI
I Inc., which in turn made a capital contribution of these leases to Duane Reade Realty. Duane Reade Realty is the lessee under certain store leases entered into after its creation. Duane Reade
Realty subleases to Duane Reade GP the properties subject to those leases. The consolidated financial statements included in this report reflect the accounts of Duane Reade
Holdings, Inc. and its subsidiaries for all periods shown. All significant intercompany transactions and balances have been eliminated.

Considerations Related to Operating in the New York City Marketplace

We operate all of our stores in the New York City metropolitan area. As a result, our performance will be substantially affected by
economic conditions and other factors
affecting the region such as the regulatory environment, cost of energy, real estate, insurance, taxes and rent, weather, demographics, availability of labor and geopolitical factors such as
terrorism.

The
level of national economic activity as measured by a number of recent key economic indicators has shown a rapidly deteriorating economy. In addition, turmoil in the credit markets
has led to decreased credit availability, as well as consolidations and failures of financial institutions, many of which have substantial operations in New York City. The September 2008 unemployment
data for New York City indicated an unemployment rate of 5.8%, compared to a national rate of 6.1%. In comparison, the June 2008 unemployment data for New York City indicated an unemployment rate of
5.4%, compared to a national rate of 5.5%. Our sales and profitability have in the past been impacted by events and other factors that affect New York City. Furthermore, to the extent that personal
disposable income declines as a result of falling housing prices, increased energy costs or other macroeconomic factors, we could experience lower profit margins, lower sales and increased levels of
shrink.

40

---



Certain Line Items Presented

Net sales:Net sales include all front-end and pharmacy sales as well as certain resales of retail pharmaceutical inventory that are required to be
reported on a gross basis in accordance with Emerging Issues Task Force Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an
Agent." We refer to net sales excluding such resale activity as "net retail sales" and pharmacy sales excluding such resale activity as "pharmacy net retail sales."
"Same-store sales" represent sales for stores that have been open for at least 13 months and exclude any resale activity.

Cost of goods sold:Cost of goods sold includes all costs of products sold, net of any promotional income or rebates received from manufacturers or wholesalers.
Shrink losses are also recorded in cost of goods sold. Prior to the fourth quarter of fiscal 2007, we recorded store occupancy costs (including real estate-related income) in cost of goods sold. In
the fourth quarter of fiscal 2007, we changed our accounting for store occupancy costs to reclassify those costs to selling, general and administrative expenses. We believe this change in accounting
more closely aligns these store occupancy cost
components to the nature of expenses included in our financial statement captions, and will improve the comparability of our financial statement presentation with industry peers.

Selling general & administrative expenses:SG&A includes employee wages and related costs, professional fees, store occupancy costs, advertising expenses,
credit card fees and all other store and office-related operating expenses. Any real estate-related income is included in store occupancy costs.

Depreciation and amortization:Depreciation and amortization consists primarily of depreciation of fixtures and equipment and amortization of leasehold
improvements as well as intangible assets, including pharmacy files and lease acquisition costs.

Store pre-opening expenses:These expenses represent the labor costs we incur related to our employees performing various tasks associated with the
opening of a new location.

Results of Operations

The Thirteen Weeks Ended September 27, 2008 as Compared to the Thirteen Weeks Ended September 29, 2007

For the third quarter of 2008, we achieved net sales of $431.0 million and incurred a net loss of $22.3 million, as
compared to net sales of $408.8 million and a net loss of $22.1 million in the third quarter of the previous year. Pharmacy resale activity included in net sales was $16.9 million
in the third quarter of 2008, compared to $16.4 million in the previous year. The change in the current period net loss, compared to the prior year period, is primarily attributable to the
following factors:



41

---





The
positive impact of these items was partially offset by:



In
addition, the prior year net loss included a $1.3 million gain from the sale of several pharmacy prescription files, which did not recur in the current year.

The
following sets forth the results of operations for the periods indicated:

For the 13 Weeks EndedSeptember 27, 2008

September 29, 2007Dollars

% of Sales

Dollars

% of SalesIn thousands, except percentagesNet sales

$
431,005


100.0
%
$
408,828


100.0
%Cost of sales (exclusive of depreciation and amortization shown separately below)


296,261


68.7


283,740


69.4Gross profit


134,744


31.3


125,088


30.6Selling, general & administrative expenses


117,763


27.3


110,316


27.0Depreciation and amortization


16,667


3.9


18,007


4.4Store pre-opening expenses


300


0.1


200


0.0Gain on sale of pharmacy files





0.0


(1,337
)

(0.3
)Other expenses


7,883


1.8


4,111


1.0Operating loss


(7,869
)

(1.8
)

(6,209
)

(1.5
)Interest expense, net


13,633


3.2


15,731


3.8Loss before income taxes


(21,502
)

(5.0
)

(21,940
)

(5.4
)Income taxes


827


0.2


112


0.0Net loss

$
(22,329
)

(5.2
)
$
(22,052
)

(5.4
)


Net
sales were $431.0 million in the thirteen weeks ended September 27, 2008, representing an increase of 5.4% as compared to net sales of $408.8 million in the
thirteen weeks ended September 29, 2007. Resale activity accounted for 0.1% of the increase, while an increase in retail store sales represented the remaining 5.3%. Total same-store
sales increased by 5.0% over the third quarter of last year.

Pharmacy
sales increased from $188.0 million in the third quarter of 2007 to $195.4 million in the third quarter of 2008, an increase of 3.9%, and represented 45.3% of
total sales, as compared with 46.0% of total sales in the third quarter of 2007. Resale activity accounted for 0.3% of the sales increase, while retail sales accounted for the remaining 3.6% of the
increase. Pharmacy same-store sales increased by 3.7% from last year, and third-party reimbursed pharmacy sales represented 93.4% of total prescription sales, compared to 92.9% in the
third quarter of 2007. The switch of Zyrtec, a prescription allergy medication, to over-the-counter status negatively impacted
pharmacy same-store sales by 0.6%. The percentage of generic drugs dispensed increased by 3.8% over the prior year, negatively impacting the pharmacy same-store sales increase
by approximately 3.8%. Generic drugs generally have lower retail sales prices but are more profitable than branded drugs.

42

---



Front-end
sales increased from $220.8 million in the third quarter of 2007 to $235.6 million in the third quarter of 2008, an increase of 6.7%, and represented
54.7% of total sales, as compared to 54.0% of total sales in the third quarter of 2007. Front-end same-store sales increased by 6.0%, primarily due to the continued strong
performance in the food and beverage categories, over-the-counter products and health and beauty items. The aforementioned switch of Zyrtec to
over-the-counter status positively impacted front-end same-store sales by approximately 0.3%. Additionally, in June 2008 we raised the sales price on
our cigarettes commensurate with an increase in cigarette excise taxes in New York State. Although such additional sales do not result in any additional profit to us, the increase in the sales price
on our cigarettes positively impacted front-end same-store sales by 1.1% during the third quarter of 2008.

During
the thirteen weeks ended September 27, 2008, we opened four new stores and did not close any stores as compared to four stores opened and seven stores closed during the
thirteen weeks ended September 29, 2007. At September 27, 2008, we operated 245 stores, as compared to 241 stores at September 29, 2007 and 242 stores at December 29, 2007.

Cost
of sales as a percentage of net sales was 68.7% and 69.4% in the third quarters of 2008 and 2007, respectively, resulting in gross profit margins of 31.3% and 30.6% in each
respective period. Cost of sales also includes a LIFO provision of $0.8 million and $0.6 million during the thirteen weeks ended September 27, 2008 and September 29, 2007,
respectively. The improvement in gross profit margin reflects the impact of improved front-end selling margins resulting from a more favorable sales mix of higher profit margin products,
increased pharmacy margins due to higher rates of generic utilization and reductions in the level of front-end inventory shrink losses.

Selling,
general and administrative expenses were $117.8 million, or 27.3% of net sales, and $110.3 million, or 27.0% of net sales, in the third quarter of 2008 and 2007,
respectively. The increase in the 2008 expense percentage as compared to 2007 was due to increased employee benefit costs and utility costs in the current year and reduced real estate related income.

Depreciation
and amortization of property and equipment and intangible assets was $16.7 million in the third quarter of 2008, as compared to $18.0 million in the third
quarter of 2007. The decrease in the current period reflects the benefit realized from the termination of a lease for a store that was relocated.

We
incurred $0.3 million of store pre-opening expenses in the third quarter of 2008 attributable to the opening of four stores and $0.2 million of store
pre-opening expenses in the third quarter of 2007 attributable to the opening of four stores.

The
prior year period included a $1.3 million gain from the sale of several pharmacy prescription files, which did not recur in the current year.

In
the third quarter of 2008, other expenses included asset impairment charges to reduce the carrying value of certain store assets to fair value ($3.4 million), costs associated
with matters related to a former CEO (Mr. Cuti) ($2.6 million), additional accrued pension costs related to a contract settlement made in March 2006 ($1.4 million), costs
associated with closed stores ($0.2 million) and Oak Hill management fees ($0.3 million). During the third quarter of 2007, other expenses included costs associated with closed stores
($2.7 million), costs associated with various matters related to Mr. Cuti ($1.0 million), and Oak Hill management fees ($0.3 million).

Net
interest expense for the third quarter of 2008 was $13.7 million, as compared to $15.7 million in the third quarter of 2007. This decrease was primarily attributable to
lower interest rates applicable to our variable rate debt. At September 27, 2008, the weighted average interest rate on our variable rate outstanding debt was 6.04%, as compared to a weighted
average rate of 8.84% at September 29, 2007.

43

---



In
the third quarter of 2008, we recorded an income tax provision of $0.8 million, reflecting an estimated effective tax rate of 3.8%. This expense is inclusive of an incremental
valuation allowance of $10.2 million that largely offset the tax benefit generated by our operating loss in the quarter. In the comparable third quarter of 2007, we recorded an income tax
provision of $0.1 million, reflecting an estimated effective tax rate of 3.0%. This expense is inclusive of an incremental valuation allowance of $9.3 million that largely offset the tax
benefit generated by our operating loss in the quarter. The valuation allowances reflect the significant losses incurred in each period, as well as the anticipated financial performance over the next
several years and the unlikelihood of recognizing the future tax benefits of our accumulated losses.

The Thirty-nine Weeks Ended September 27, 2008 as Compared to the Thirty-nine Weeks Ended September 29, 2007

For the first nine months of 2008, we achieved net sales of $1.310 billion and incurred a net loss of $55.4 million, as
compared to net sales of $1.255 billion and a net loss of $72.7 million in the first nine months of the previous year. Pharmacy resale activity included in net sales was
$48.5 million in the first nine months of 2008, compared to $46.5 million in the previous year. The improvement in our net loss is primarily attributable to the following
factors:



The
positive impact of these items was partially offset by an increase in selling, general and administrative expenses of $17.3 million, primarily due to increased labor costs at
our stores to support the increased sales and new stores, additional administrative payroll and employee benefit costs due to increased staffing, recruitment and relocation fees paid in connection
with the hiring of senior management executives and a reduction in real estate related income. In addition, the prior year net
loss included a $1.3 million gain from the sale of several pharmacy prescription files, which did not recur in the current year.

44

---



The
following sets forth the results of operations for the periods indicated:

For the 39 Weeks EndedSeptember 27, 2008

September 29, 2007Dollars

% of Sales

Dollars

% of SalesIn thousands, except percentagesNet sales

$
1,309,538


100.0
%
$
1,255,146


100.0
%Cost of sales (exclusive of depreciation and amortization shown separately below)


902,667


68.9


877,195


69.9Gross profit


406,871


31.1


377,951


30.1Selling, general & administrative expenses


354,213


27.0


336,911


26.8Depreciation and amortization


52,260


4.0


54,460


4.3Store pre-opening expenses


548


0.0


350


0.0Gain on sale of pharmacy files





0.0


(1,337
)

(0.1
)Other expenses


12,032


0.9


13,352


1.1Operating loss


(12,182
)

(0.9
)

(25,785
)

(2.1
)Interest expense, net


40,913


3.1


44,810


3.6Loss before income taxes


(53,095
)

(4.0
)

(70,595
)

(5.6
)Income taxes


2,305


0.2


2,128


0.2Net loss

$
(55,400
)

(4.2
)
$
(72,723
)

(5.8
)


Net
sales were $1.310 billion in the thirty-nine weeks ended September 27, 2008, representing an increase of 4.3% as compared to net sales of
$1.255 billion in the thirty-nine weeks ended September 29, 2007. Resale activity accounted for 0.2% of the increase, while an increase in retail store sales represented the
remaining 4.1%. Total same-store sales increased by 4.7% over the first nine months of last year.

Pharmacy
sales increased from $580.7 million in the first nine months of 2007 to $596.2 million in the first nine months of 2008, an increase of 2.7%, and represented 45.5%
of total sales, as compared with 46.3% of total sales in the first nine months of 2007. Resale activity accounted for 0.3% of the sales increase, while retail sales accounted for the remaining 2.4% of
the increase. Pharmacy same-store sales increased by 2.9% from last year, and third-party reimbursed pharmacy sales represented 93.3% of total prescription sales, compared to 93.0% in the
first nine months of 2007. The percentage of generic drugs dispensed increased by 4.2% over the prior year, negatively impacting the pharmacy same-store sales increase by approximately
3.9%. Generic drugs generally have lower retail sales prices but are more profitable for us than branded drugs.

Front-end
sales increased from $674.4 million in the first nine months of 2007 to $713.4 million in the first nine months of 2008, an increase of 5.8%, and
represented 54.5% of total sales, as compared to 53.7% of total sales in the first nine months of 2007. Front-end same-store sales increased by 6.2%, primarily due to the
continued strong performance in the food and beverage categories, over-the-counter products and health and beauty items. In June 2008 we raised the sales price on our
cigarettes commensurate with an increase in cigarette excise taxes in New York State. Although such additional sales do not result in any additional profit to us, the increase in the sales price on
our cigarettes positively impacted front-end same-store sales by approximately 0.5% during the thirty-nine weeks ended September 27, 2008.

45

---



During
the thirty-nine weeks ended September 27, 2008, we opened nine stores and closed six stores, as compared to six stores opened and thirteen stores closed during
the thirty-nine weeks ended September 29, 2007.

Cost
of sales as a percentage of net sales was 68.9% and 69.9% in the first nine months of 2008 and 2007, respectively, resulting in gross profit margins of 31.1% and 30.1% in each
respective period. Cost of sales includes a LIFO provision of $2.4 million in the first nine months of 2008 as compared to a LIFO provision of $1.8 million in the first nine months of
2007. The improvement in gross profit margin is primarily due to improved front-end selling margins and increased pharmacy margins due to higher rates of generic utilization.

Selling,
general and administrative expenses were $354.2 million, or 27.0% of net sales, and $336.9 million, or 26.8% of net sales, in the first nine months of 2008 and
2007, respectively. The increase in the 2008 expense percentage as compared to 2007 was primarily due to increased medical benefit costs for our employees, increased recruitment and relocation fees
paid in connection with the hiring of senior management executives and reduced real estate related income.

Depreciation
and amortization of property and equipment and intangible assets was $52.3 million in the first nine months of 2008, as compared to $54.5 million in the first
nine months of 2007. The decrease is primarily due to the termination of a lease for a store that was relocated.

We
incurred store pre-opening expenses of $0.5 million in the first nine months of 2008, attributable to the opening of nine stores, as compared to $0.4 million
in the first nine months of 2007, attributable to the opening of six stores.

The
prior year period included a $1.3 million gain from the sale of several pharmacy prescription files, which did not recur in the current year.

For
the nine months ended September 27, 2008, other expenses totaled $12.0 million and included costs associated with matters related to Mr. Cuti
($3.9 million), asset impairment charges to reduce the carrying value of certain store assets to fair value ($3.4 million), costs associated with closed stores ($2.3 million),
additional accrued pension costs related to a contract settlement made in March 2006 ($1.4 million), and Oak Hill management fees ($0.9 million). During the nine months ended
September 29, 2007, other expenses totaled $13.4 million and included costs associated with the completion of the audit committee investigations and various other matters related to
Mr. Cuti ($7.0 million), costs associated with closed stores ($5.1 million), Oak Hill management fees ($0.9 million) and other expenses ($0.3 million).

Net
interest expense for the first nine months of 2008 was $40.9 million, as compared to $44.8 million in the first nine months of 2007. This decrease was primarily
attributable to lower interest rates and decreased debt levels incurred on our revolving credit borrowings as compared to the prior year.

In
the first nine months of 2008, we recorded an income tax provision of $2.3 million, reflecting an estimated effective tax rate of 4.3%. This expense is inclusive of an
incremental valuation allowance of $23.6 million that largely offset the tax benefit generated by our operating loss in the six month period. In the comparable first nine months of 2007, we
recorded an income tax provision of $2.1 million, reflecting an estimated effective tax rate of 3.0%. This expense is inclusive of an incremental valuation allowance of $36.5 million
that largely offset the tax benefit generated by our operating loss in the nine month period. The valuation allowances reflect the significant losses incurred in each period, as well as the
anticipated financial performance over the next several years and the unlikelihood of recognizing the future tax benefits of our accumulated losses.

46

---





Liquidity and Capital Resources

Working Capital and Cash Flow

The working capital deficit was $3.1 million at September 27, 2008, compared to a working capital balance of
$8.6 million at December 29, 2007. Working capital reflects the classification of outstanding borrowings under our amended asset-based revolving loan facility of $155.1 million at
September 27, 2008 and $141.4 million at December 29, 2007 as current liabilities. This current classification is required because cash receipts controlled by the lenders are used
to reduce outstanding debt and we do not meet the criteria of SFAS No. 6 to classify the debt as long-term, but is not an indication that this credit facility is expected to be
retired within the next year. This facility expires in July 2011 and we intend to continue to access it for our working capital needs throughout its remaining term. The decrease in our working capital
balance is primarily due to the increased revolving loan borrowings at September 27, 2008 compared to December 29, 2007.

Our
primary sources of liquidity are operating cash flows and availability under our revolving loan facility. We believe that, based on current levels of operations and anticipated
growth, cash flow from operations, together with other available sources of funds, including revolving loan borrowings under the amended asset-based revolving loan facility, will be adequate for the
next twelve months, to make required payments on our indebtedness, to fund anticipated capital expenditures and to satisfy our working capital requirements. See our Liquidity Assessment below for
further discussion.

Net
cash provided by operating activities was $20.7 million in the thirty-nine weeks ended September 27, 2008 compared to net cash used in operating activities
of $3.9 million in the thirty-nine weeks ended September 29, 2007. The change is primarily attributable to our improved operating results during the first nine months of 2008
compared to the first nine months of 2007.

Net
cash used in investing activities was $34.5 million in the thirty-nine weeks ended September 27, 2008, compared to $31.3 million in the
thirty-nine weeks ended September 29, 2007. In the first nine months of 2008, we spent $23.1 million on capital expenditures, primarily related to new stores and the
remodeling of existing locations, and $12.0 million on lease acquisition and other costs. These costs were partially offset by $0.5 million of proceeds received from the disposition of
certain properties. In the first nine months of 2007, we spent $20.1 million on capital expenditures, primarily related to new stores and the remodeling of existing locations, and
$14.5 million on lease acquisition and other costs. This was partially offset in 2007 by $3.3 million received in connection with the assignment of leases for certain closed stores and
the sale of several pharmacy prescription files.

Net
cash provided by financing activities was $13.8 million in the thirty-nine weeks ended September 27, 2008, and includes $2.0 million resulting from
the purchase of 20,000 shares of Duane Reade Holdings, Inc. common stock by our current CEO. Net cash provided by financing activities was $35.1 million in the thirty-nine
weeks ended September 29, 2007. Cash provided by financing activities for the thirty-nine weeks ended September 29, 2007 included $39.1 million (net of expenses of
$0.3 million) resulting from the issuance of preferred stock and warrants. See Note 9 to our Unaudited Consolidated Interim Financial Statements contained elsewhere in this report for
additional information regarding this transaction.

Operating Capital Requirements

Our operating capital requirements primarily result from opening and stocking new stores, remodeling and renovating existing retail
locations, purchasing pharmacy files and the continuing development of management information systems. We opened nine new stores in the first nine months of 2008, six new stores in the first nine
months of 2007, ten new stores in fiscal 2007 and five new stores during fiscal 2006. We currently plan to open a total of six additional new stores in the remainder of 2008. As of
September 27, 2008, we have completed the lease acquisitions for six of the

47

---



former
Gristedes locations. We have opened stores at five of the six former Gristedes locations and expect to open the sixth store during the fourth quarter of 2008. Our agreement with Gristedes has
expired and we are not obligated to acquire the remaining two leases.

Capital
spending in 2008 is expected to be approximately $50 million, with approximately $20 million related to maintenance capital spending. Historically, we have been
able to lease most of our store locations, so acquisitions of real estate are not expected to impact our capital requirements. We also require working capital to support inventory for our existing and
new stores. As current economic conditions continue or further deteriorate, we will continue to monitor the effects of the economic conditions on our operating capital requirements.

Other Factors Influencing our Liquidity

In June 2005, the appraisal panel in the World Trade Center insurance claim litigation determined the amount of our business
interruption loss as a result of the events of September 11, 2001. This determination by the panel is subject to existing appeals and potentially additional appeals, and on June 22,
2005, the Second Circuit Court of Appeals affirmed the decision of the trial court, with modifications, including modifications to certain of the legal tests on which the appraisal panel's decision
was based. Based on this decision and related modifications, the appraisal panel revised its previously issued determination to require an additional $5.6 million payment from the insurance
carrier in addition to the $9.9 million previously paid by the insurance carrier in 2002. As a result of the insurer's refusal to pay this amount and also as a result of the Second Circuit
Court of Appeals' interpretation of our insurance policy, in January 2007, we commenced another action in the U.S. District Court for the Southern District of New York to recover both the appraisal
panel's award and additional amounts under the policy. In August 2007, the District Court entered judgment in the amount of $0.8 million plus interest, and both parties appealed. The appeals
have been briefed and are awaiting argument in the Second Circuit Court of Appeals. However, due to the inherent uncertainty of litigation, there can be no assurance that this appeal will be
successful. Note 13 to the Unaudited Consolidated Interim Financial Statements contained elsewhere in this report provides a more detailed explanation of this matter.

Thirteen
of our stores, which generated approximately 5.9% of our net sales for fiscal 2007, had leases scheduled to expire before the end of fiscal 2009. We have renewed the leases for
six of the thirteen stores and believe we will be able to renew the remaining expiring leases or, alternatively, find other economically attractive alternatives, including alternative locations to
lease.

As
of September 27, 2008, approximately 5,200 of our approximately 7,000 employees were represented by various labor unions and were covered by collective bargaining agreements.
Pursuant to the terms of the collective bargaining agreements covering these employees, we are required, in some instances, to pay specified annual increases in salary and benefits contributions
relating to the member employees. While these increases have impacted our cost of labor, we have, and believe we can continue to, offset a significant portion of these cost increases through
initiatives designed to further improve our labor efficiency. Our collective bargaining agreements with the RWDSU/Local 338 and Local 340A New York Joint Board, UNITE
AFL-CIO, who, on a combined basis represent approximately 4,700 of our employees in all of our stores, expire on March 31, 2009. Approximately 500 of our employees in our two
distribution centers in Maspeth, Queens, NY and North Bergen, NJ are represented by
Local 210, International Brotherhood of Teamsters, Chauffeurs and Warehousemen, under a collective bargaining agreement that expired on August 31, 2008. In September 2008, we negotiated
a new collective bargaining agreement with this union which extends through August 31, 2011.

48

---



The
following table presents details of our significant commitments and obligations as at September 27, 2008, except that the data provided with respect to operating leases is as
of December 29, 2007:

Payments due by PeriodContractual Cash Obligations

Total

Within
1 year

Within
2-3 years

Within
4-5 years

After
5 years(dollars in thousands)Long-Term Debt(1)

$
405,033

$


$
405,000

$


$
33Asset-Based Revolving Loan Facility(2)


155,145





155,145





Capital Lease Obligations(3)


6,519


4,250


2,158


111


Operating Leases(4)


1,286,674


128,277


249,790


235,018


673,589Fixed Interest Payments(5)


57,038


19,013


38,025





Severance Payments(6)


146


26


16


15


89Redeemable Preferred Stock(7)


39,400











39,400Redeemable Preferred Stock Dividends(7)


89,496











89,496Total Contractual Cash Obligations

$
2,039,451

$
151,566

$
850,134

$
235,144

$
802,607


---

49

---





The
following table presents details of our other significant commercial commitments as at September 27, 2008:

Amount of Commitment Expiration
per PeriodOther Commercial Commitments

Total Amounts
Committed

Within
1 year

2-3 years

4-5 years

After
5 years(dollars in thousands)Standby Letters of Credit(1)

$
6,374

$
6,374

$


$


$
Total Commercial Commitments

$
6,374

$
6,374

$


$


$



---

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

In
connection with the November 21, 2005 replacement of Mr. Cuti, Mr. Cuti's employment contract specifies payments to him in cash totaling up to
$6.6 million. We have paid the full $6.6 million amount as of December 29, 2007. In addition, the employment contract provides for continued health insurance coverage for
Mr. Cuti during the 25-month period following termination and, upon expiration of that period, if Mr. Cuti is not otherwise eligible under another employer's comparable
medical plan, lifetime retiree medical benefits at a cost not to exceed $50,000 annually. In an ongoing arbitration between Mr. Cuti and us (explained in more detail in Note 13 to our
Unaudited Consolidated Interim Financial Statements contained elsewhere in this report), we are seeking, among other forms of relief, rescission of employment agreements entered into between us and
Mr. Cuti, the return of all compensation paid under the employment agreements, including the benefits described in this paragraph, and other monetary damages.

In
connection with the Acquisition, Mr. Cuti was granted equity interests in Duane Reade Shareholders and Duane Reade Holdings, consisting of options to purchase shares of our
common stock and a profits interest in Duane Reade Shareholders. Mr. Cuti's employment contract provides that, as a result of his replacement on November 21, 2005, he had the right to
require us to purchase for cash to be paid over a two year period all or a portion of these equity interests as he may designate, at a value determined in accordance with a formula. In connection with
his replacement, we have treated all of his equity interests as having vested. The profits interest and options will have no value unless the value of Duane Reade Shareholders and Duane Reade
Holdings, respectively, appreciate following the Acquisition. Mr. Cuti's purchase right will be suspended at any time when the exercise of such purchase rights would result in a default under
the financing arrangements of Duane Reade Shareholders, Duane Reade Holdings or Duane Reade Inc. On December 21, 2005, Mr. Cuti

50

---



provided
notice to Duane Reade Inc. that he was exercising his repurchase right to cause us to repurchase 5% of his profits interest. Pursuant to the procedures outlined in the new employment
agreement, Duane Reade Inc. has advised him that his profits interest as of December 21, 2005 was determined to have no value. The benefits described in this paragraph were all granted
under an employment agreement between Mr. Cuti and us. In an ongoing arbitration between Mr. Cuti and us (explained in more detail in Note 13 to our Unaudited Consolidated Interim
Financial Statements contained elsewhere in this report), we are seeking, among other forms of relief, rescission of employment agreements entered into between us and Mr. Cuti and the return of
all compensation paid under the employment agreements, including the benefits described in this paragraph. The determination that Mr. Cuti's profits interest as of December 21, 2005 had
no value is also one of several subjects specifically at issue in the arbitration.

In
connection with the assignment of certain store leases to third parties, we continue to guarantee lease obligations for eight former stores. The respective purchasers have assumed our
obligations under these leases and are primarily liable for these obligations. Although we believe it to be unlikely, assuming that each respective purchaser became insolvent, management estimates
that we could settle these remaining lease obligations for amounts substantially less than the aggregate remaining obligation of $32.7 million as of September 27, 2008. The lease
obligations are for varying terms dependent upon the respective lease, the longest of which lasts through January 15, 2028.

Debt

Refer to Note 6 to the Unaudited Consolidated Interim Financial Statements contained elsewhere in this report for a detailed
description with respect to the various components of our debt structure.

Liquidity Assessment

Duane Reade Holdings is a holding company formed in connection with the Acquisition to hold 100% of the common stock of Duane
Reade Inc. Duane Reade Holdings operates all of its business through Duane Reade Inc. and its subsidiaries and has no other independent assets, liabilities or operations, so, to the
extent it has liquidity requirements, it will depend on distributions of cash from Duane Reade Inc., to the extent permitted by the various agreements to which Duane Reade Inc. is a
party. Currently, we do not expect Duane Reade Holdings to have any material liquidity requirements.

We
believe that, based on current levels of operations and anticipated growth, cash flow from operations, together with other available sources of funds, including revolving loan
borrowings under the amended asset-based revolving loan facility, will be adequate to make required payments on our indebtedness, to fund anticipated capital expenditures and to satisfy our working
capital requirements. We base this belief on our cash flows from operations for the nine months ended September 27, 2008 of $20.7 million, cash flows from operations of
$19.3 million in fiscal 2007, projected improvements in working capital management, anticipated levels of capital expenditures and the available borrowing capacity under the
$225.0 million amended asset-based revolving loan facility, which was approximately $58.5 million at September 27, 2008 and approximately $61.2 million at
September 29, 2007. We are required to refinance our $210 million of outstanding senior secured floating rate notes prior to August 15, 2010. Although our ability to refinance
these notes will depend upon credit markets at that time as well as our financial performance, we fully intend to refinance the notes within the required timeframe.

Our
stockholder's deficit is expected to increase in 2008 due to continued losses; however, this deficit does not impact our liquidity as noted above and has no impact on our debt
covenants. Our ability to meet our debt service obligations and reduce our total debt will depend upon our future performance which, in turn, will be subject to general economic, financial, business,
competitive, legislative, regulatory and other conditions, many of which are beyond our control. In addition, our

51

---



operating
results, cash flow and capital resources may not be sufficient for repayment of our indebtedness in the future. Some risks that could adversely affect our ability to meet our debt service
obligations include, but are not limited to, reductions in third party prescription reimbursement rates, declines in the New York City economy, increases in competitive activity, adverse changes in
vendor credit terms, changes in drug consumption patterns, aggressive regulatory and reimbursement audit and recoupment activity, additional adverse legislative changes or a major disruption of
business in our markets from a terrorist event, natural disaster or other unexpected events. Other factors that may adversely affect our ability to service our debt are described above under "Special
Note Regarding Forward-Looking Statements." Borrowings under the amended asset-based revolving loan facility and the aggregate $210.0 million senior secured notes bear interest at floating
rates. Therefore, our financial condition will be affected by changes in prevailing interest rates. On April 30, 2008, we entered into a hedging transaction through the acquisition of a "no
cost collar." Under this arrangement, we capped our exposure on $210.0 million of LIBOR-based borrowings at a maximum LIBOR rate of 5.2%. In addition, we established a minimum "floor" LIBOR
rate of 2.6%, in line with then current LIBOR rates. At September 27, 2008, the LIBOR rate in effect was approximately 2.8%, which was within the range of minimum and maximum allowable interest
rates under the "no cost collar." As a result, at September 27, 2008, this "no cost collar" did not have an impact on the overall effective interest rate on our LIBOR-based borrowings.

Critical Accounting Policies

Our discussion of results of operations and financial condition relies on our consolidated financial statements that are prepared based
on certain critical accounting policies that require management to make judgments and estimates that are subject to varying degrees of uncertainty. We believe that investors need to be aware of these
policies and how they impact our financial reporting to gain a more complete understanding of our consolidated financial statements as a whole, as well as our related discussion and analysis presented
herein. While we believe that these accounting policies are grounded on sound measurement criteria, actual future events can and often do result in outcomes that can be materially different from these
estimates or forecasts. The accounting policies and related risks described in our Annual Report on Form 10-K for the year ended December 29, 2007 are those that depend most
heavily on these judgments and estimates. At September 27, 2008, there have been no material changes to any of the Critical Accounting Policies contained therein.

Off-Balance Sheet Arrangements

We are not a party to any agreements with, or commitments to, any special purpose entities that would constitute material
off-balance sheet financing other than the operating lease commitments detailed in the Contractual Cash Obligations table and the standby letters of credit detailed in the Other Commercial
Commitments table, both of which are presented above.

Seasonality

In general, sales of drugstore items such as prescription drugs, over-the-counter drugs and health and beauty
care products exhibit limited seasonality in the aggregate, but do vary by product category. Quarterly results are primarily affected by the timing of certain holidays, the timing of new store
openings and the sale of seasonal products, with the Christmas holiday season normally generating a higher proportion of sales and earnings than other periods.

Inflation

We believe that inflation has not had a material impact on our results of operations during the three years ended December 29,
2007 or the nine months ended September 27, 2008.

52

---



Recently Issued Accounting Pronouncements

Refer to Note 2 of the Unaudited Consolidated Interim Financial Statements contained elsewhere in this report for a detailed
description of various recently issued accounting pronouncements.

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our financial results are subject to risk from interest rate fluctuations on the portion of our debt that carries variable interest
rates. Variable rate debt outstanding at September 27, 2008 included $155.1 million of borrowings under our amended asset-based revolving loan facility and $210.0 million of
senior secured floating rate notes. At September 27, 2008, the weighted average combined interest rate in effect on all variable rate debt outstanding was 6.04%. A 0.50% change in interest
rates applied to the $365.1 million balance of floating rate debt would affect pre-tax annual results of operations by approximately $1.8 million, excluding the impact, if
any, of the "no cost collar" as detailed below. In addition, we also have $195.0 million of senior subordinated notes and $33.0 thousand of senior convertible notes outstanding at
September 27, 2008. The senior subordinated notes bear interest payable semi-annually at a fixed rate of 9.75%, and are therefore not subject to risk from interest rate
fluctuations. The senior convertible notes accrete interest at a fixed rate of 3.75% and are therefore not subject to risk from interest rate fluctuations.

On
April 30, 2008, we entered into a hedging transaction through the acquisition of a "no cost collar." Under this arrangement, we capped our exposure on $210.0 million of
LIBOR-based borrowings at a maximum LIBOR rate of 5.2%. In addition, we established a minimum "floor" LIBOR rate of 2.6%, in line with then current LIBOR rates. At September 27, 2008, the LIBOR
rate in effect was approximately 2.8%, which was within the range of minimum and maximum allowable interest rates under the "no cost collar." As a result, at September 27, 2008, this "no cost
collar" did not have an impact on the overall effective interest rate on our LIBOR-based borrowings.

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

ITEM 4.    CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act") designed to provide reasonable assurance that the information required to be reported in our Exchange Act filings is recorded,
processed, summarized and reported within the timeframes specified and pursuant to the regulations of the SEC, including controls and procedures designed to ensure that this information is accumulated
and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. It should be noted that
because of inherent limitations, our disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the
disclosure controls and procedures are met.

(a) Evaluation of Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our "disclosure controls and procedures" (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities
Exchange Act of 1934) as at the end of the period covered by this quarterly report.

53

---



Based
on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of that date, our disclosure controls and procedures required by
paragraph (b) of the Exchange Act Rules 13a-15 or 15d-15, were effective.

(b) Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the third quarter ended September 27, 2008 that have
materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II  OTHER INFORMATION

ITEM 1.    Legal Proceedings

Refer to Note 13 to the Unaudited Consolidated Interim Financial Statements contained elsewhere in this report for a detailed
description of the various legal proceedings in which we are involved.

ITEM 1A.    Risk Factors

For information regarding factors that could affect our results of operations, financial position and liquidity, see the risk factors
discussion provided in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 29, 2007. See also "Special Note Regarding Forward-Looking
Statements" above.

ITEM 2.    Unregistered Sales of Equity Securities and Use of Proceeds

None.

ITEM 3.    Defaults Upon Senior Securities

None.

ITEM 4.    Submission of Matters to a Vote of Security Holders

Not applicable.

ITEM 5.    Other Information

Not applicable.

ITEM 6.    Exhibits

Exhibit No.

Description31.1*

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**

Sarbanes-Oxley Section 906 Certifications of the Company's CEO and CFO.


---

54

---





SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.

Dated: November 11, 2008

DUANE READE HOLDINGS, INC.(Registrant)/s/ JOHN A. LEDERER John A. Lederer Chief Executive Officer, Chairman of the Board and Director
(Principal Executive Officer)/s/ JOHN K. HENRY John K. Henry Senior Vice President and Chief Financial Officer
(Principal Accounting and Financial Officer)


55

---



QuickLinks