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 June 28, 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 or a non-accelerated filer, as defined 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 August 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.



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INDEX

PART IFINANCIAL INFORMATION


6ITEM 1.FINANCIAL STATEMENTS


6Consolidated Statements of Operations (Unaudited)For the 13 and 26 Weeks Ended June 28, 2008 and June 30, 2007


6Consolidated Balance Sheets (Unaudited)As of June 28, 2008 and December 29, 2007


7Consolidated Statements of Cash Flows (Unaudited)For the 26 Weeks Ended June 28, 2008 and June 30, 2007


8Consolidated Statements of Comprehensive Loss (Unaudited)For the 13 and 26 Weeks Ended June 28, 2008 and June 30, 2007


9Notes to Consolidated Financial Statements (Unaudited)


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


36ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


50ITEM 4.CONTROLS AND PROCEDURES


50PART IIOTHER INFORMATION


52SIGNATURES


53


2

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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

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4

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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

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PART IFINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

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

13 Weeks Ended

26 Weeks EndedJune 28,
2008

June 30, 2007

June 28, 2008

June 30, 2007Net sales

$
451,395

$
431,930

$
878,532

$
846,318Cost of sales (exclusive of depreciation and amortization shown separately below)


311,960


300,868


606,405


593,454Gross profit


139,435


131,062


272,127


252,864Selling, general & administrative expenses


118,496


113,059


236,450


226,595Depreciation and amortization


17,674


18,416


35,593


36,453Store pre-opening expenses


200





247


150Other expenses


3,250


4,223


4,149


9,241Operating loss


(185
)

(4,636
)

(4,312
)

(19,575
)Interest expense, net


11,375


14,645


27,281


29,080Loss before income taxes


(11,560
)

(19,281
)

(31,593
)

(48,655
)Income taxes


518


856


1,478


2,016Net loss

$
(12,078
)
$
(20,137
)
$
(33,071
)
$
(50,671
)


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

6

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

June 28,
2008

December 29,
2007ASSETSCurrent AssetsCash

$
1,372

$
1,380Receivables, net


48,564


55,707Inventories


208,742


211,678Prepaid expenses and other current assets


11,806


13,205Total Current Assets


270,484


281,970Property and equipment, net


192,116


195,740Goodwill


70,099


70,099Other assets, net


187,212


194,680Total Assets

$
719,911

$
742,489LIABILITIES AND STOCKHOLDERS' DEFICITCurrent LiabilitiesAccounts payable

$
73,553

$
75,769Accrued interest


8,656


9,158Accrued expenses


45,837


43,086Current portion of debt


142,199


141,352Current portion of capital lease obligations


4,239


3,994Total Current Liabilities


274,484


273,359Long-term debt


405,033


405,032Capital lease obligations, less current portion


3,295


5,475Deferred income taxes


27,904


27,423Redeemable preferred stock and accrued dividends


34,225


31,786Other non-current liabilities


80,467


72,737Total Liabilities


825,408


815,812Commitments and contingenciesStockholders' deficitPreferred stock, $0.01 par; authorized 50,000 shares; issued and outstanding: zero shares at June 28, 2008 and December 29, 2007





Common stock, $0.01 par; authorized 4,205,600 shares at June 28, 2008 and December 29, 2007; issued and outstanding: 2,595,077 shares at June 28, 2008 and
December 29, 2007


26


26Paid-in capital


252,334


251,716Accumulated other comprehensive income


284


4Accumulated deficit


(358,141
)

(325,069
)Total Stockholders' Deficit


(105,497
)

(73,323
)Total Liabilities and Stockholders' Deficit

$
719,911

$
742,489


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

7

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

26 Weeks EndedJune 28, 2008

June 30, 2007Cash flows provided by (used in) operating activities:Net loss

$
(33,071
)
$
(50,671
)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization


37,418


38,281Deferred income taxes


1,399


1,908Non-cash rent expense


5,816


6,320Non-cash interest expense on redeemable preferred stock


2,556


412Other non-cash expense


153


2,264Change in operating assets and liabilities:Receivables


7,143


1,975Inventories


2,936


(1,633
)Prepaid expenses and other current assets


1,400


442Accounts payable


(2,216
)

(2,552
)Accrued expenses


1,373


(4,514
)Other assets and liabilities, net


1,860


193NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES


26,767


(7,575
)Cash flows used in investing activities:Capital expenditures


(16,321
)

(13,406
)Lease acquisition, customer file and other costs


(10,169
)

(8,811
)Proceeds from sale of assets


525


NET CASH USED IN INVESTING ACTIVITIES


(25,965
)

(22,217
)Cash flows provided by (used in) financing activities:Borrowings from revolving credit facility


1,026,877


1,006,854Repayments of revolving credit facility


(1,026,030
)

(1,017,073
)Capital contributions


278


2,457Issuance of preferred stock





39,150Deferred financing costs





(5
)Repayments of capital lease obligations


(1,935
)

(1,604
)NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES


(810
)

29,779Net change in cash


(8
)

(13
)Cash at beginning of period


1,380


1,395Cash at end of period

$
1,372

$
1,382


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

8

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

13 Weeks Ended

26 Weeks EndedJune 28,
2008

June 30,
2007

June 28,
2008

June 30,
2007Net loss

$
(12,078
)
$
(20,137
)
$
(33,071
)
$
(50,671
)Change in fair value of interest rate collar


496


45


280


(82
)Total other comprehensive income (loss)


496


45


280


(82
)Total comprehensive loss

$
(11,582
)
$
(20,092
)
$
(32,791
)
$
(50,753
)


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

9

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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 Duane Reade Holdings, Inc.) into Duane Reade Inc. with Duane Reade Inc. being the surviving entity and a wholly owned subsidiary of Duane Reade
Holdings, Inc. 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:During 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 June 28, 2008 and June 30, 2007, the change in accounting resulted in a decrease to cost of sales of
$41.1 million and $39.7 million, respectively, with a corresponding increase to gross profit and selling, general and administrative expenses for each of the affected periods. For the
twenty-six weeks ended June 28, 2008 and June 30, 2007, the change in accounting resulted in a decrease to cost of sales of $82.5 million and $80.5 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 April 2008, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position ("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

10

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Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

2.    Recently Issued Accounting Pronouncements (Continued)

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
March 2008, the FASB issued Statement of Financial Accounting Standards ("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 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

11

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Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

2.    Recently Issued Accounting Pronouncements (Continued)

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 Payment

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 twenty-six weeks ended June 28, 2008 and June 30, 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 the thirteen weeks ended June 28, 2008 and
June 30, 2007, the Company recorded pre-tax
compensation expense of approximately $0.3 million and $0.2 million, respectively, attributable to the vested portion of stock options granted after the adoption date. For the
twenty-six weeks ended June 28, 2008 and June 30, 2007, the corresponding expense was $0.3 million and $0.7 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.

12

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Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

3.    Stock-Based Payment (Continued)

On
April 2, 2008, the Company granted options to purchase 165,000 shares of the Company's common stock to its newly appointed CEO. 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 thirteen and twenty-six weeks ended June 28, 2008 was $17.89.

During
the twenty-six weeks ended June 30, 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 twenty-six
weeks ended June 30, 2007 was $5.59.

There
were no stock options exercised during the thirteen or twenty-six weeks ended June 28, 2008 or June 30, 2007.

The
fair value of each option grant during the thirteen and twenty-six weeks ended June 28, 2008 and June 30, 2007 was estimated on the date of grant using the
lattice-pricing model with the following weighted-average assumptions:

June 28,
2008

June 30,
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 June 28, 2008, there was $3.0 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 3.6 years.

As
of June 28, 2008, a total of 157,851 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 June 28, 2008 and December 29, 2007, inventories, consisting solely of finished goods, would have been higher by $4.8 thousand and lower 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.

13

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Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

4.    Inventories and Cost of Sales (Continued)

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 June 28, 2008, the balance of this reserve was $4.1 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 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 June 28, 2008, all of the planned closings had
occurred, and the Company has recorded a cumulative net total of $13.1 million of primarily occupancy-related costs against this reserve resulting in the reserve balance of $3.9 million
at June 28, 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

June 28,
2008

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

$
142,199

$
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

$
547,232

$
546,384


---

14

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Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

6.    Debt (Continued)

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 $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:



15

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

6.    Debt (Continued)



Borrowings
under the amended asset-based revolving loan facility continue to be primarily LIBOR-based. At June 28, 2008, the amended asset-based revolving loan facility bore
interest at a weighted average annual rate of 4.4%.

The
Company's hedging activities consist of "no cost" interest rate collars 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. These interest rate collars
qualify for hedge accounting as cash flow hedges. See Note 7 for a discussion of the terms of the hedging arrangements.

At
June 28, 2008, there was $142.2 million outstanding under the asset- based revolving loan facility, and approximately $71.4 million of remaining availability, net
of $6.4 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 June 28, 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
June 28, 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
June 28, 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 the hedging arrangements.

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

16

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

6.    Debt (Continued)

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 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
June 28, 2008, the weighted average combined interest rate in effect on all variable rate debt outstanding, including the effect of the "no cost" collar, was 6.1%.

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

17

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

6.    Debt (Continued)

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 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.

The
Company's hedging activities consist of "no cost" interest rate collars 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. These interest rate collars
qualify for hedge accounting as cash flow hedges. Accordingly, the Company recognizes these derivatives at fair value as either assets or liabilities 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.

18

---



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 June 28, 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 June 28, 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 an asset of $0.3 million and $4.0 thousand, at June 28, 2008 and December 29, 2007, respectively.

8.    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 June 28, 2008, the Company had completed the lease acquisitions for six of the former Gristedes stores. The Company has opened stores at five of the six former Gristedes
stores and expects to open the sixth store during the second half of 2008. The acquisition of these leases has been funded through 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 balance of the 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 of
$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 June 28, 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 cumulate on a quarterly basis to the extent not paid quarterly. 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
June 28, 2008 and December 27, 2007, the Company had accrued unpaid dividends of $4.5 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

19

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

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

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 $3.3 million and $3.2 million at June 28, 2008 and December 29, 2007, respectively. Such liability is included in "Other
non-current liabilities" on the Consolidated Balance Sheet.

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



20

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

9.    Fair Value (Continued)



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 June 28, 2008 and December 29, 2007.

Valuation Techniques

At June 28, 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

$


$


$
(3,290
)
$
(3,290
)Profits interest








(1,671
)

(1,671
)Interest rate collar








284


284Guarantees








(583
)

(583
)Total

$


$


$
(5,260
)
$
(5,260
)


21

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

9.    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 June 28, 2008 (dollars in thousands).

Preferred Stock
Mandatory
Redemption Feature(1)

Profits
Interest

Interest Rate
Collars, net

Guarantees(2)

TotalBalance at March 29, 2008

$
(4,865
)
$
(1,671
)
$
(212
)
$
(100
)
$
(6,848
)Gains/(Losses)Included in net loss


1,575








(483
)

1,092Included in other comprehensive loss








496





496Transfers














Balance at June 28, 2008

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

$
(583
)
$
(5,260
)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
June 28, 2008.

$
1,575

$


$


$
(483
)
$
1,092


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 twenty-six weeks ended June 28, 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


(117
)







(583
)

(700
)Included in other comprehensive loss








280





280Transfers














Balance at June 28, 2008

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

$
(583
)
$
(5,260
)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
June 28, 2008.

$
(117
)
$


$


$
(583
)
$
(700
)


---

22

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

10.    Other Expenses

The table below provides detail of other expenses for the thirteen and twenty-six weeks ended June 28, 2008 and June 30, 2007 (dollars in thousands).

13 Weeks Ended

26 Weeks EndedJune 28, 2008

June 30, 2007

June 28, 2008

June 30, 2007Closed Store Costs

$
1,919

$
660

$
2,117

$
2,349Former CEO (Mr. Cuti) Matters


1,018


1,403


1,300


3,807Oak Hill Management Fees


313


313


625


625Accounting Investigation





1,798





2,183Other





49


107


277Total Other Expenses

$
3,250

$
4,223

$
4,149

$
9,241


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. See Note 5 for a discussion of these reserves.
See Note 12 for a discussion of the costs relating to accounting investigations and the proceedings relating to Mr. Cuti. The Oak Hill management fee is payable quarterly.

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

23

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

11.    Income Taxes (Continued)

During
the thirteen and twenty-six weeks ended June 28, 2008, the Company incurred additional pre-tax losses of $11.6 million and
$31.6 million, respectively, and recorded incremental valuation allowances of $4.7 million and $13.4 million, respectively. At June 28, 2008, the Company had approximately
$166.1 million of gross deferred tax assets, approximately $71.3 million of gross deferred tax liabilities and had recorded a cumulative valuation allowance of $125.4 million. The
tax expense reported during the thirteen and twenty-six weeks ended June 28, 2008 and June 30, 2007 primarily resulted from the deferred tax liabilities generated by
non-amortizable goodwill.

During
the thirteen and twenty-six weeks ended June 28, 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 were
previously accrued and were not material to the Company's consolidated financial statements.

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.

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

24

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

12.    Commitments and Contingencies (Continued)

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 kiosk system and payment of an alleged deferred 2001 bonus based on any insurance recovery the

25

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

12.    Commitments and Contingencies (Continued)

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 has 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 is cooperating fully with the investigation. The SEC has 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 and is currently in effect until September 19, 2008.

26

---



Notes to Unaudited Consolidated Interim Financial Statements (Continued)

(dollars in thousands)

12.    Commitments and Contingencies (Continued)

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 $34.1 million as of June 28, 2008. The obligations are for varying terms dependent upon the respective lease, the longest of which lasts through
January 15, 2028.

13.    Subsequent Event

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
are expected to be used for general corporate purposes, including to fund normal capital spending, fund new store openings and/or reduce the Company's outstanding debt.

14.    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.

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 has 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.

27

---





DUANE READE HOLDINGS, INC.        Condensed Consolidating Statement of Operations (Unaudited)        For the 13 weeks ended June 28, 2008        (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedNet sales

$


$


$
451,395

$
10,802

$
(10,802
)
$
451,395Cost of sales (exclusive of depreciation and amortization shown separately below)








311,960








311,960Gross profit








139,435


10,802


(10,802
)

139,435Selling, general & administrative expenses








134,179


117


(15,800
)

118,496Depreciation and amortization








17,674








17,674Store pre-opening expense








200








200Other expenses








3,250








3,250Operating (loss) income








(15,868
)

10,685


4,998


(185
)Equity earnings in affiliates


12,078


12,078





285


(24,441
)

Interest expense (income), net








11,375


(4,998
)

4,998


11,375Income (loss) before income taxes


(12,078
)

(12,078
)

(27,243
)

15,398


24,441


(11,560
)Income taxes (benefit)








1,221


(703
)




518Net income (loss)

$
(12,078
)
$
(12,078
)
$
(28,464
)
$
16,101

$
24,441

$
(12,078
)


28

---





DUANE READE HOLDINGS, INC.        Condensed Consolidating Statement of Operations (Unaudited)        For the 13 weeks ended June 30, 2007        (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedNet sales

$


$


$
431,930

$
10,407

$
(10,407
)
$
431,930Cost of sales (exclusive of depreciation and amortization shown separately below)








300,868








300,868Gross profit








131,062


10,407


(10,407
)

131,062Selling, general & administrative expenses








130,064


142


(17,147
)

113,059Depreciation and amortization








18,416








18,416Store pre-opening expense

















Other expenses








4,223








4,223Operating (loss) income








(21,641
)

10,265


6,740


(4,636
)Equity earnings in affiliates


20,137


20,137





379


(40,653
)

Interest expense (income), net








14,645


(6,740
)

6,740


14,645Income (loss) before income taxes


(20,137
)

(20,137
)

(36,286
)

16,626


40,653


(19,281
)Income taxes (benefit)








1,611


(755
)




856Net income (loss)

$
(20,137
)
$
(20,137
)
$
(37,897
)
$
17,381

$
40,653

$
(20,137
)


29

---





DUANE READE HOLDINGS, INC.        Condensed Consolidating Statement of Operations (Unaudited)        For the 26 weeks ended June 28, 2008        (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedNet sales

$


$


$
878,532

$
21,175

$
(21,175
)
$
878,532Cost of sales (exclusive of depreciation and amortization shown separately below)








606,405








606,405Gross profit








272,127


21,175


(21,175
)

272,127Selling, general & administrative expenses








268,595


237


(32,382
)

236,450Depreciation and amortization








35,593








35,593Store pre-opening expense








247








247Other expenses








4,149








4,149Operating (loss) income








(36,457
)

20,938


11,207


(4,312
)Equity earnings in affiliates


33,071


33,071





667


(66,809
)

Interest expense (income), net








27,281


(11,207
)

11,207


27,281Income (loss) before income taxes


(33,071
)

(33,071
)

(63,738
)

31,478


66,809


(31,593
)Income taxes (benefit)








2,982


(1,504
)




1,478Net income (loss)

$
(33,071
)
$
(33,071
)
$
(66,720
)
$
32,982

$
66,809

$
(33,071
)


30

---





DUANE READE HOLDINGS, INC.        Condensed Consolidating Statement of Operations (Unaudited)        For the 26 weeks ended June 30, 2007        (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedNet sales

$


$


$
846,318

$
20,406

$
(20,406
)
$
846,318Cost of sales (exclusive of depreciation and amortization shown separately below)








593,454








593,454Gross profit








252,864


20,406


(20,406
)

252,864Selling, general & administrative expenses








259,908


227


(33,540
)

226,595Depreciation and amortization








36,453








36,453Store pre-opening expense








150








150Other expenses








9,241








9,241Operating (loss) income








(52,888
)

20,179


13,134


(19,575
)Equity earnings in affiliates


50,671


50,671





854


(102,196
)

Interest expense (income), net








29,080


(13,134
)

13,134


29,080Income (loss) before income taxes


(50,671
)

(50,671
)

(81,968
)

32,459


102,196


(48,655
)Income taxes (benefit)








3,396


(1,380
)




2,016Net income (loss)

$
(50,671
)
$
(50,671
)
$
(85,364
)
$
33,839

$
102,196

$
(50,671
)


31

---





DUANE READE HOLDINGS, INC.        Condensed Consolidating Balance Sheet (Unaudited)        As of June 28, 2008        (in thousands)

Duane Reade
Holdings, Inc.

Duane
Reade Inc.

Duane
Reade GP

Subsidiary
Guarantors

Consolidating
Adjustments

Duane Reade
Holdings, Inc.
ConsolidatedAssetsCurrent assetsCash

$


$


$
1,363

$
9

$


$
1,372Receivables








48,564








48,564Due from affiliates





77,670


107,684


(16
)

(185,338
)

Inventories








208,742








208,742Deferred income taxes





1,140


5,049


(6,189
)




Prepaid expenses and other assets








11,806








11,806Total current assets





78,810


383,208


(6,196
)

(185,338
)

270,484Investment in affiliates


(79,484
)

(79,494
)




(3,322
)

162,300


Property and equipment








192,116








192,116Goodwill








70,099








70,099Deferred income taxes





1,645


9,032


(10,677
)




Other assets








140,980


444,627


(398,395
)

187,212Total assets

$
(79,484
)
$
961

$
795,435

$
424,432

$
(421,433
)
$
719,911Liabilities and Stockholders' Equity (Deficit)Current liabilitiesAccounts payable

$


$


$
73,553

$


$


$
73,553Due to affiliates











185,336


(185,336
)

Accrued interest








8,656








8,656Accrued expenses





2,629


43,208








45,837Current portion of debt








142,199








142,199Current portion of capital lease obligation








4,239








4,239Total current liabilities





2,629


271,855


185,336


(185,336
)

274,484Long term debt








803,428





(398,395
)

405,033Capital lease obligation, less current portion








3,295








3,295Deferred income taxes





76,261


(75,867
)

27,510





27,904Redeemable preferred stock


31,112


32,679


32,659





(62,225
)

34,225Other non-current liabilities








80,467








80,467Total liabilities


31,112


111,569


1,115,837


212,846


(645,956
)

825,408Stockholders' equity (deficit)Common stock


26














26Paid-in-capital


247,520


247,535


252,360


2,395


(497,476
)

252,334Accumulated other comprehensive income








284








284Retained earnings (deficit)


(358,142
)

(358,143
)

(573,046
)

209,191


721,999


(358,141
)Total stockholders' equity (deficit)


(110,596
)

(110,608
)

(320,402
)

211,586


224,523


(105,497
)Total liabilities and stockholders' equity (deficit)

$
(79,484
)
$
961

$
795,435

$
424,432

$
(421,433
)
$
719,911


32

---





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








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








195,740








195,740Goodwill








70,099








70,099Deferred income taxes





1,645


9,032


(10,677
)




Other assets








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


31,113


31,113


31,786





(62,226
)

31,786Other non-current liabilities





2,436


70,301








72,737Total 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


33

---





DUANE READE HOLDINGS, INC.        Condensed Consolidating Statement of Cash Flows (Unaudited)        For the 26 weeks ended June 28, 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

$
(33,071
)
$
(33,071
)
$
(66,720
)
$
32,982

$
66,809

$
(33,071
)Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:Depreciation and amortization








37,418








37,418Deferred income taxes





(79
)

2,982


(1,504
)




1,399Non-cash rent expense








5,816








5,816Non-cash interest expense on redeemable preferred stock








2,556








2,556Other non-cash expense








153








153Equity in income of subsidiaries


33,071


33,071





667


(66,809
)

Changes in operating assets and liabilities:Receivables





951


6,115


77





7,143Inventories








2,936








2,936Prepaid and other current assets








1,400








1,400Accounts payable








(2,216
)







(2,216
)Accrued expenses





(2
)

1,375








1,373Other assets and liabilities, net





(870
)

34,980


(32,250
)




1,860NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES








26,795


(28
)




26,767Cash flows used in investing activities:Capital expenditures








(16,321
)







(16,321
)Lease acquisition and other costs








(10,169
)







(10,169
)Proceeds from sale of property








525








525NET CASH USED IN INVESTING ACTIVITIES








(25,965
)







(25,965
)Cash flows from financing activities:Borrowings from revolving credit facility








1,026,877








1,026,877Repayments of revolving credit facility








(1,026,030
)







(1,026,030
)Capital contributions








278








278Issuance of preferred stock

















Deferred financing costs

















Repayments of capital lease obligations








(1,935
)







(1,935
)NET CASH USED IN FINANCING ACTIVITIES








(810
)







(810
)Net change in cash








20


(28
)




(8
)Cash at beginning of period








1,343


37





1,380Cash at end of period

$


$


$
1,363

$
9

$


$
1,372


34

---





DUANE READE HOLDINGS, INC.        Condensed Consolidating Statement of Cash Flows (Unaudited)        For the 26 weeks ended June 30, 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

$
(50,671
)
$
(50,671
)
$
(85,364
)
$
33,839

$
102,196

$
(50,671
)Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:Depreciation and amortization








38,281








38,281Deferred income taxes





(108
)

3,396


(1,380
)




1,908Non-cash rent expense








6,320








6,320Non-cash interest expense on redeemable preferred stock








412








412Other non-cash expense








2,264








2,264Equity in income of subsidiaries


50,671


50,671





854


(102,196
)

Changes in operating assets and liabilities:Receivables





154


1,642


179





1,975Inventories








(1,633
)







(1,633
)Prepaid expenses and other current assets








442








442Accounts payable








(2,552
)







(2,552
)Accrued expenses





(46
)

(4,468
)







(4,514
)Other assets and liabilities, net








33,668


(33,475
)




193NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES








(7,592
)

17





(7,575
)Cash flows used in investing activities:Capital expenditures








(13,406
)







(13,406
)Lease acquisition and other costs








(8,811
)







(8,811
)NET CASH USED IN INVESTING ACTIVITIES








(22,217
)







(22,217
)Cash flows from financing activities:Borrowings from revolving credit facility








1,006,854








1,006,854Repayments of revolving credit facility








(1,017,073
)







(1,017,073
)Capital contributions








2,457








2,457Issuance of preferred stock








39,150








39,150Deferred financing costs








(5
)







(5
)Repayments of capital lease obligations








(1,604
)







(1,604
)NET CASH PROVIDED BY FINANCING ACTIVITIES








29,779








29,779Net change in cash








(30
)

17





(13
)Cash at beginning of period








1,370


25





1,395Cash at end of period

$


$


$
1,340

$
42

$


$
1,382


35

---





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 twenty-six weeks
ended June 28, 2008 and the thirteen and twenty-six weeks ended June 30, 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.

During
the 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 June 28, 2008 and June 30, 2007, the change in accounting resulted in a decrease to cost of sales of $41.1 million and $39.7 million, respectively, with a
corresponding increase to gross profit and selling, general and administrative expenses. For the 26 weeks ended June 28, 2008 and June 30, 2007, the change in accounting resulted
in a decrease to cost of sales of $82.5 million and $80.5 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 54.3% and 54.4% of
our net sales in the thirteen weeks and twenty-six weeks ended June 28, 2008, respectively, and 54.2% and 53.6% of our net sales in the thirteen weeks and twenty-six
weeks ended June 30, 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 reduced third party plan reimbursement rates, including State Medicaid and Medicare
Part D plans. The lower Maximum Allowable Costs ("MAC") reimbursement rates by 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 many 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 represented approximately 93.3% and 93.2% of our

36

---



prescription
sales in the thirteen and twenty-six weeks ended June 28, 2008, respectively, and approximately 93.0% of our prescription sales in the thirteen and
twenty-six weeks ended June 30, 2007.

The
Medicare Modernization Act created a new 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 as well as prescriptions that are not subject to third party reimbursement. 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 twenty-six weeks ended June 28, 2008, the Medicare Part D program represented approximately
12.6% of our retail pharmacy sales, as compared to 11.8% of retail pharmacy sales for the thirteen and twenty-six weeks ended June 30, 2007.

State
Medicaid programs which provide prescription benefits to low income households and individuals represented approximately 14.0% and 14.2% of our retail pharmacy sales for the
thirteen weeks ended June 28, 2008 and June 30, 2007, respectively. During the twenty-six weeks ended June 28, 2008 and June 30, 2007, state Medicaid programs
represented approximately 14.0% and 14.3%, 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 will apply to payments that are 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 will
adversely impact our pharmacy gross margins. We are currently assessing the extent of the adverse impact on our business from the new Medicaid reimbursement formula and the increased number of generic
drugs subject to MAC limitations.

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

37

---



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 partially offset the
adverse margin impact of Medicare Part D and reduced state Medicaid reimbursement rates during 2006 and 2007.

We
are also 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 slowing economy that may potentially lead to a recession in 2008 or 2009.
The New York City economy may be particularly susceptible to a downturn because of difficulties encountered in the financial services industry. The June 2008 unemployment data for New York City
indicated an unemployment rate of 5.4%, compared to a national rate of 5.5%. In comparison, the March 2008 unemployment data for New York City indicated an unemployment rate of 4.5%, compared to a
national rate of 5.1%. 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 (particularly in front-end
merchandise) and increased levels of shrink.

38

---



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 June 28, 2008 as Compared to the Thirteen Weeks Ended June 30, 2007

For the second quarter of 2008, we achieved net sales of $451.4 million and incurred a net loss of $12.1 million, as
compared to net sales of $431.9 million and a net loss of $20.1 million in the second quarter of the previous year. Pharmacy resale activity included in net sales was
$19.3 million in the second quarter of 2008, compared to $15.7 million in the previous year. The improvement in our net loss is primarily attributable to the following
factors:



39

---





The
positive impact of these items was partially offset by an increase in selling, general and administrative expenses of $5.4 million, primarily due to higher executive
recruitment related costs, increased labor costs at our stores to support the increased sales, additional administrative payroll and benefit costs due to increased staffing and an increase in store
occupancy costs due to the timing of the opening of new stores.

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

For the 13 Weeks EndedJune 28, 2008

June 30, 2007Dollars

% of Sales

Dollars

% of SalesIn thousands, except percentagesNet sales

$
451,395


100.0
%
$
431,930


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


311,960


69.1


300,868


69.7Gross profit


139,435


30.9


131,062


30.3Selling, general & administrative expenses


118,496


26.3


113,059


26.2Depreciation and amortization


17,674


3.9


18,416


4.3Store pre-opening expenses


200


0.0





0.0Other expenses


3,250


0.7


4,223


1.0Operating loss


(185
)

(0.1
)

(4,636
)

(1.1
)Interest expense, net


11,375


2.5


14,645


3.4Loss before income taxes


(11,560
)

(2.6
)

(19,281
)

(4.5
)Income taxes


518


0.1


856


0.2Net loss

$
(12,078
)

(2.7
)%
$
(20,137
)

(4.7
)%


Net
sales were $451.4 million in the thirteen weeks ended June 28, 2008, representing an increase of 4.5% as compared to net sales of $431.9 million in the thirteen
weeks ended June 30, 2007. Resale activity accounted for 0.8% of the increase, while an increase in retail store sales represented the remaining 3.7%. Total same-store sales
increased by 4.7% over the second quarter of last year.

Pharmacy
sales increased from $197.8 million in the second quarter of 2007 to $206.5 million in the second quarter of 2008, an increase of 4.4%, and represented 45.7% of
total sales, as compared with 45.8% of total sales in the second quarter of 2007. Resale activity accounted for 1.9% of the sales
increase, while retail sales accounted for the remaining 2.5% of the increase. Pharmacy same-store sales increased by 3.6% from last year, and third-party reimbursed pharmacy sales
represented 93.3% of total prescription sales, compared to 93.0% in the second quarter of 2007. The switch of Zyrtec, a prescription allergy medication, to over-the-counter
status negatively impacted pharmacy same-store sales by 0.7%. The percentage of generic drugs dispensed increased by 4.0% over the prior year, negatively impacting the pharmacy
same-store sales increase by approximately 3.6%. Generic drugs generally have lower retail sales prices but are more profitable than branded drugs.

Front-end
sales increased from $234.1 million in the second quarter of 2007 to $244.9 million in the second quarter of 2008, an increase of 4.6%, and
represented 54.3% of total sales, as compared to 54.2% of total sales in the second quarter of 2007. Front-end same-store sales increased by 5.6%, 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 0.6%. The front-end sales figure was adversely
impacted by approximately 0.5% due to the shift of Easter holiday

40

---



sales
into the first quarter this year from last year's second quarter. In addition, in June 2008 we raised the sales price on our cigarettes commensurate with an increase in cigarette excise taxes in
New York State and New York City. 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 0.3% during the second quarter of 2008.

During
the thirteen weeks ended June 28, 2008, we opened four new stores and closed five stores as compared to one store closed and no stores opened during the thirteen weeks
ended June 30, 2007. At June 28, 2008, we operated 241 stores, as compared to 244 stores at June 30, 2007 and 242 stores at December 29, 2007.

Cost
of sales as a percentage of net sales was 69.1% and 69.7% in the second quarters of 2008 and 2007, respectively, resulting in gross profit margins of 30.9% and 30.3% 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 June 28, 2008 and June 30, 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 $118.5 million, or 26.3% of net sales, and $113.1 million, or 26.2% of net sales, in the second quarter of 2008 and 2007,
respectively. The increase
in the 2008 expense percentage as compared to 2007 was primarily due to higher executive recruitment related costs.

Depreciation
and amortization of property and equipment and intangible assets was $17.7 million in the second quarter of 2008, as compared to $18.4 million in the second
quarter of 2007. The net decrease reflects a reduction in the number of stores and the timing of the opening of new stores.

We
incurred $0.2 million of store pre-opening expenses in the second quarter of 2008 attributable to the opening of four stores and no store pre-opening
expenses in the second quarter of 2007.

In
the second quarter of 2008, other expenses included costs associated with closed stores ($1.9 million), costs associated with matters related to a former CEO (Mr. Cuti)
($1.0 million) and Oak Hill management fees ($0.3 million). During the second quarter of 2007, other expenses included costs associated with the audit committee investigations and
various other matters related to Mr. Cuti ($3.2 million), costs associated with closed stores ($0.7 million) and Oak Hill management fees ($0.3 million).

Net
interest expense for the second quarter of 2008 was $11.4 million, as compared to $14.6 million in the second quarter of 2007. This decrease was primarily attributable
to lower interest rates applicable to our variable rate debt, lower borrowing levels on our amended asset-based revolving loan facility and a favorable $1.6 million non-cash fair
value adjustment for the preferred stock's mandatory redemption feature, which is considered a derivative financial instrument. At June 30, 2008, the weighted average interest rate on our
variable rate outstanding debt was 6.12%, as compared to a weighted average rate of 8.67% at June 30, 2007.

In
the second quarter of 2008, we recorded an income tax provision of $0.5 million, reflecting an estimated effective tax rate of 4.5%. This expense is inclusive of an incremental
valuation allowance of $4.7 million that largely offset the tax benefit generated by our operating loss in the quarter. In the comparable second quarter of 2007, we recorded an income tax
provision of $0.9 million, reflecting an estimated effective tax rate of 4.4%. This expense is inclusive of an incremental valuation allowance of $12.9 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.

41

---



The Twenty-Six Weeks Ended June 28, 2008 as Compared to the Twenty-Six Weeks Ended June 30, 2007

For the first six months of 2008, we achieved net sales of $878.5 million and incurred a net loss of $33.1 million, as
compared to net sales of $846.3 million and a net loss of $50.7 million in the first six months of the previous year. Pharmacy resale activity included in net sales was
$31.5 million in the first six months of 2008, compared to $30.1 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 $9.9 million, primarily due to increased labor costs at
our stores to support the increased sales, additional administrative payroll and benefit costs due to increased staffing, recruitment and relocation fees paid in connection with the hiring of senior
management executives and an increase in store occupancy costs due to the timing of the opening of new stores.

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

For the 26 Weeks EndedJune 28, 2008

June 30, 2007Dollars

% of Sales

Dollars

% of SalesIn thousands, except percentagesNet sales

$
878,532


100.0
%
$
846,318


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


606,405


69.0


593,454


70.1Gross profit


272,127


31.0


252,864


29.9Selling, general & administrative expenses


236,450


26.9


226,595


26.8Depreciation and amortization


35,593


4.1


36,453


4.3Store pre-opening expenses


247


0.0


150


0.0Other expenses


4,149


0.5


9,241


1.1Operating loss


(4,312
)

(0.5
)

(19,575
)

(2.3
)Interest expense, net


27,281


3.1


29,080


3.4Loss before income taxes


(31,593
)

(3.6
)

(48,655
)

(5.7
)Income taxes


1,478


0.2


2,016


0.2Net loss

$
(33,071
)

(3.8
)%
$
(50,671
)

(5.9
)%


42

---





Net sales were $878.5 million in the twenty-six weeks ended June 28, 2008, representing an increase of 3.8% as compared to net sales of $846.3 million in
the twenty-six weeks ended June 30, 2007. Resale activity accounted for 0.2% of the increase, while an increase in retail store sales represented the remaining 3.6%. Total
same-store sales increased by 4.6% over the first half of last year.

Pharmacy
sales increased from $392.7 million in the first half of 2007 to $400.7 million in the first half of 2008, an increase of 2.0%, and represented 45.6% of total
sales, as compared with 46.4% of total sales in the first half of 2007. Resale activity accounted for 0.4% of the sales increase, while retail sales accounted for the remaining 1.6% of the increase.
Pharmacy same-store sales increased by 2.5% from last year, and third-party reimbursed pharmacy sales represented 93.2% of total prescription sales, compared to 93.0% in the first half of
2007. The percentage of generic drugs dispensed increased by 4.4% 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 $453.6 million in the first half of 2007 to $477.8 million in the first half of 2008, an increase of 5.3%, and represented 54.4%
of total sales, as compared to 53.6% of total sales in the first half of 2007. Front-end same-store sales increased by 6.3%, primarily due to the continued strong performance
in the food and beverage categories, over-the-counter products and health and beauty items. In addition, in June 2008 we raised the sales price on our cigarettes commensurate
with an increase in cigarette excise taxes in New York State and New York City. 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 0.2% during the first half of 2008.

During
the twenty-six weeks ended June 28, 2008, we opened five stores and closed six stores, as compared to two stores opened and six stores closed during the
twenty-six weeks ended June 30, 2007.

Cost
of sales as a percentage of net sales was 69.0% and 70.1% in the first six months of 2008 and 2007, respectively, resulting in gross profit margins of 31.0% and 29.9% in each
respective period. Cost of sales includes a LIFO provision of $1.6 million in the first half of 2008 as compared to a LIFO provision of $1.2 million in the first half 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 $236.5 million, or 26.9% of net sales, and $226.6 million, or 26.8% of net sales, in the first six months of 2008 and
2007, respectively. The increase in the 2008 expense percentage as compared to 2007 was primarily due to recruitment and relocation fees paid in connection with the hiring of senior management
executives.

Depreciation
and amortization of property and equipment and intangible assets was $35.6 million in the first six months of 2008, as compared to $36.5 million in the first
six months of 2007. The net decrease reflects a reduction in the number of stores and the timing of the opening of new stores. At June 28, 2008, we operated 241 stores, as compared to 244
stores at June 30, 2007.

We
incurred store pre-opening expenses of $0.2 million in the first half of 2008, attributable to the opening of five stores, as compared to $0.2 million in the
first half of 2007, reflecting two new stores opened during that period.

For
the six months ended June 28, 2008, other expenses totaled $4.1 million and included costs associated with closed stores ($2.1 million), costs associated with
matters related to Mr. Cuti ($1.3 million), Oak Hill management fees ($0.6 million), and other expenses ($0.1 million). During the six months ended June 30, 2007,
other expenses totaled $9.2 million and included costs associated with the audit committee investigations and various other matters related to Mr. Cuti ($6.0 million), costs

43

---



associated
with closed stores ($2.3 million), Oak Hill management fees ($0.6 million) and other expenses ($0.3 million).

Net
interest expense for the first six months of 2008 was $27.3 million, as compared to $29.1 million in the first six 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 half of 2008, we recorded an income tax provision of $1.5 million, reflecting an estimated effective tax rate of 4.7%. This expense is inclusive of an incremental
valuation allowance of $13.4 million that largely offset the tax benefit generated by our operating loss in the six month period.
In the comparable first half of 2007, we recorded an income tax provision of $2.0 million, reflecting an estimated effective tax rate of 4.1%. This expense is inclusive of an incremental
valuation allowance of $27.2 million that largely offset the tax benefit generated by our operating loss in the six 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.

Liquidity and Capital Resources

Working Capital and Cash Flow

The working capital deficit was $4.0 million at June 28, 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 $142.2 million at
June 28, 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 due to an increase in capital expenditure accruals for new store openings and renovations and the early receipt from third party pharmacy receivables. The early receipt of payment on the third
party pharmacy receivables will not likely recur in the third quarter.

Other
factors affecting the decrease in working capital from December 29, 2007 include:



Our
primary sources of liquidity are operating cash flows and availability on 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 two
years, 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 $26.8 million in the twenty-six weeks ended June 28, 2008 compared to net cash used in operating activities of
$7.6 million in the twenty-six weeks ended June 30, 2007. The change is primarily attributable to our improved operating results during the first half of 2008 compared to the
first half of 2007, decreased receivables due to the timing of receipts from pharmacy third-party providers and decreased inventory.

Net
cash used in investing activities was $26.0 million in the twenty-six weeks ended June 28, 2008, compared to $22.2 million in the
twenty-six weeks ended June 30, 2007. In the first six months of 2008, we spent $16.3 million on capital expenditures, primarily related to new stores and the remodeling of

44

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existing
locations, and $10.2 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 six months of 2007, we spent $13.4 million on capital expenditures, primarily related to new stores and the remodeling of existing locations, and $8.8 million on
lease acquisition and other costs.

Net
cash used in financing activities was $0.8 million in the twenty-six weeks ended June 28, 2008, compared to net cash provided by financing activities of
$29.8 million in the twenty-six weeks ended June 30, 2007. Cash provided by financing activities for the twenty-six weeks ended June 30, 2007 included
$39.1 million (net of expenses of $0.3 million) resulting from the issuance of preferred stock and warrants. See Note 8 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 five new stores in the first
six months of 2008, two new stores in the first six months of 2007, ten new stores in fiscal 2007 and five new stores during fiscal 2006. We currently plan to open a total of ten additional new stores
in the remainder of 2008. As of June 28, 2008, we have completed the lease acquisitions for six of the former Gristedes stores. We have opened stores at five of the six former Gristedes stores
and expect to open the sixth store during the second half of 2008. Our agreement with Gristedes has expired and we are not obligated to acquire the balance of the leases.

Capital
spending in 2008 is expected to be between $50 to $55 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.

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. See Note 12 to the Unaudited Consolidated Interim Financial Statements contained elsewhere in this report for a more detailed explanation of this matter.

Thirteen
of our stores, which generated approximately 5.9% of our net sales for fiscal 2007, have leases scheduled to expire before the end of fiscal 2009. We believe that we will be
able to renew the expiring leases on economically favorable terms or, alternatively, find other economically attractive locations to lease.

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As
of June 28, 2008, approximately 5,300 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 4,900 of our employees in all of our stores, expire on March 31, 2009. Approximately 400 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 expires on
August 31, 2008. We are currently in the process of negotiating a new collective bargaining agreement with this union.

The
following table presents details of our significant commitments and obligations as at June 28, 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

$


$
210,000

$
195,000

$
33Asset-Based Revolving Loan Facility(2)


142,199








142,199


Capital Lease Obligations(3)


7,533


4,239


3,019


275


Operating Leases(4)


1,286,674


128,277


249,790


235,018


673,589Fixed Interest Payments(5)


66,544


19,013


38,025


9,506


Severance Payments(6)


161


39


16


15


91Real Estate Litigation Settlement(7)


46


46








Redeemable Preferred Stock(8)


39,400











39,400Redeemable Preferred Stock Dividends(8)


89,496











89,496Total Contractual Cash Obligations

$
2,037,086

$
151,614

$
500,850

$
582,013

$
802,609


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The
following table presents details of our other significant commercial commitments as at June 28, 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

$


$


$



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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

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an
ongoing arbitration between Mr. Cuti and us (explained in more detail in Note 12 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 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 12 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 $34.1 million as of June 28, 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

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the
amended asset-based revolving loan facility, will be adequate for the next two years 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 six months ended June 28, 2008 of $26.8 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 $71.4 million at June 28, 2008.

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 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 June 28, 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 June 28, 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 June 28, 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 Commerical
Commitments table, both of which are presented above.

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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 six months ended June 28, 2008.

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 June 28, 2008 included $142.2 million of borrowings under our amended asset-based revolving loan facility and $210.0 million of senior
secured floating rate notes. At June 28, 2008, the weighted average combined interest rate in effect on all variable rate debt outstanding was 6.12%. A 0.50% change in interest rates applied to
the $352.2 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 June 28, 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 June 28, 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 June 28, 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

50

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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.

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

On May 2, 2008, our Chief Compliance Officer resigned from the Company to assume a senior management position at a former
employer. We are in the process of recruiting a new executive to fill the position. We are utilizing the services of an out-sourced interim Chief Compliance Officer until a permanent Chief
Compliance Officer is appointed. The responsibilities of the permanent Chief Compliance Officer include monitoring our adherence to various regulatory requirements, codes of conduct and ethics
standards, including those designed to ensure accurate and timely financial reporting.

There
have been no other changes in our internal control over financial reporting that occurred during the second quarter ended June 28, 2008 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.

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PART II  OTHER INFORMATION

ITEM 1. Legal Proceedings

Refer to Note 12 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

On July 23, 2008, our 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 are expected to be used for general corporate purposes, including to fund normal capital spending, fund new store openings and/or reduce our outstanding
debt.

The
sale of these shares to our CEO was deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) of the Securities Act or Regulation D
promulgated under the Securities Act, as a transaction by an issuer not involving a public offering.

Our
CEO represented his intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends
were affixed to the securities issued in this transaction. Our CEO had adequate access, through employment or other relationships, to information about us. All certificates representing the securities
issued in this transaction included appropriate legends setting forth that the securities had not been offered or sold pursuant to a registration statement and describing the applicable restrictions
on transfer of the securities. There were no underwriters employed in connection with the transaction set forth above.

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.


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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: August 8, 2008

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


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