PART I

ITEM 1. BUSINESS

The Acquisition

On July 30, 2004, the Acquisition of Duane Reade Inc. (the “Acquisition”) was completed by a group of investors, including Oak Hill Capital Partners, L.P. (“Oak Hill”), and both former and certain current members of our management team. As part of the Acquisition, Duane Reade Acquisition Corp., our wholly-owned subsidiary, merged with and into Duane Reade Inc., with Duane Reade Inc. remaining as the surviving corporation.

As a result of the Acquisition, Duane Reade Inc.’s shares ceased to be listed on the New York Stock Exchange, and we operate as a privately held company. Each share of Duane Reade Inc.’s common stock outstanding immediately prior to the Acquisition was converted into the right to receive $16.50 per share, without interest, in cash.

General

We are the largest drugstore chain in New York City, which is the largest drugstore market in the United States in terms of sales volume. In 2006, we believe that we led the drugstore market in the New York metropolitan area in sales of both back-end (pharmacy) and front-end (non-pharmacy) categories. As of December 30, 2006, we operated 134 of our 248 stores in Manhattan’s high-traffic business and residential districts, representing over twice as many stores as our next largest competitor in Manhattan. In addition, at December 30, 2006, we operated 84 stores in New York’s densely populated outer boroughs and 30 stores in the surrounding New York and New Jersey suburbs, including the Hudson River communities of northeastern New Jersey, as well as Westchester, Nassau and Suffolk counties in New York. Since opening our first store in 1960, we have executed a marketing and operating strategy tailored to the unique characteristics of New York City, the most densely populated major market in the United States. Sales of higher margin front-end items accounted for approximately 53.5% of our total sales in fiscal 2006, one of the highest ratios in the chain drug industry.

We enjoy strong brand name recognition in the New York greater metropolitan area, which we believe results from our many locations in high-traffic areas of New York City, attractive window graphics, promotional advertising, and customer loyalty programs and the approximately 74 million shopping bags with the distinctive Duane Reade logo that were distributed to our customers in 2006.

We have developed an operating strategy designed to capitalize on the unique characteristics of the New York greater metropolitan area, which include high-traffic volume, complex distribution logistics and high costs of occupancy, advertising and personnel. The key elements of our operating strategy are:

· a convenient and value-oriented shopping experience;

· a low cost operating structure supported by high per store sales volume and relatively low warehouse, distribution and advertising costs; and

· a differentiated real estate strategy using flexible store formats.

We believe that our customer service orientation, competitive price format and broad product offerings provide a convenient and value-oriented shopping experience for our customers and help to build customer loyalty.

Despite the high costs of operating in the New York greater metropolitan area, our high volume stores generally allow us to effectively leverage occupancy costs, payroll and other store expenses. Our approximately 506,000 square foot primary distribution facility is centrally located in Maspeth, Queens, New York City. The facility is located within ten miles of approximately 88% of our stores, and none of our retail locations are farther than 50 miles from this facility. We also operate a second, smaller warehouse facility in North Bergen, New Jersey for the distribution of certain seasonal and slower-moving

merchandise. This approximately 114,000 square foot support facility enjoys similar proximity to most of our New York City locations while providing additional capacity and closer proximity to our stores located in New Jersey. We believe that these two central locations result in our relatively low warehouse and distribution costs as a percentage of sales.

We have demonstrated our ability to successfully operate stores using a wide variety of store configurations and sizes. Rather than confine our stores to a single, standardized format, we successfully adapt our store design to a variety of sizes and configurations. We believe this strategy provides us with a competitive advantage, as many of our competitors target more standardized spaces, which are difficult to find in the greater New York metropolitan area. For example, our store sizes range from under 500 to 17,200 square feet, and we operate 52 bi-level stores. Our guiding principle in store selection has not been the shape of the space, but rather its strategic location in high-traffic areas in order to provide greater convenience to our customers.

As of December 30, 2006, we operated 248 stores, five of which were opened during fiscal 2006. During fiscal 2005 and 2004, we opened 7 stores and 16 stores, respectively. We closed 8 stores in 2006, 11 stores in 2005 and 2 stores in 2004. Among the five new stores we opened during 2006, three were in Manhattan and two were in the densely populated, nearby suburbs. As of December 30, 2006, approximately 54% of our stores were in Manhattan, 34% were in the outer boroughs of New York City and 12% were located outside New York City. At December 30, 2006, we occupied 1.7 million square feet of retail space, approximately 3% less than at the end of fiscal 2005. Approximately 48% of the stores we operated at December 30, 2006 had been opened since the beginning of fiscal 2000.

Duane Reade, a New York general partnership (“Duane Reade GP”), was founded in 1960, and its parent, Duane Reade, Inc. operated as a public company from February 1998 through the completion of the July 30, 2004 Acquisition by Oak Hill.

In March 2006, as part of an expansion and realignment of the senior management team that started in November 2005 with the replacement of the former Chairman and Chief Executive Officer, our current Chairman, President and Chief Executive Officer Richard Dreiling announced a six-point strategic plan to transform the business and improve performance, known as “Duane Reade Full Potential.” The plan addresses:

· driving growth in front-end and pharmacy sales through improved customer service, transformation of store appearance, changing product selection and strengthening the Dollar Rewards program;

· creating front-end margin improvements through reduced shrink rates, improved promotional effectiveness and increasing the level of private label offerings;

· improving operating efficiencies and optimizing cost structure through managing expenses;

· reducing litigation cost and management burden;

· addressing underperforming stores as early as possible to reduce the risk and costs associated with closing additional stores; and

· optimizing working capital primarily through inventory reductions.

During 2006, the implementation of “Duane Reade Full Potential” resulted in improved sales and margin performance compared to 2005, as well as reduced litigation expenses and improved working capital management. A continued focus on this program is a central element of our business strategy going forward.

Where you can find additional information

We maintain a company website at www.duanereade.com. We make copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed with or furnished to the SEC available to investors on or through our website free of

charge as soon as reasonably practicable after we have electronically filed them with or furnished them to the SEC. The contents of our website do not constitute a portion of this report.

The public may read and copy any materials filed by us with the SEC at the SEC’s Public Reference Room, located at 100 F Street, N.E. Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains a website at which reports, proxy and information statements and other information regarding issuers that file electronically with the SEC are available. This website may be accessed at http://www.sec.gov.

Recent Developments

Acquisition of Gristedes Leases—On February 20, 2007, we announced that we had entered into an agreement to acquire up to eight Gristedes leased supermarket locations in Manhattan, New York City. The acquisition of the leases is subject to the satisfaction of certain conditions, including landlord consents. As of June 29, 2007, we had received the required consents for two of these locations which are expected to be placed in operation during the third quarter. We shortly expect to receive the balance of the consents required to complete this transaction.

Issuance of Preferred Stock and Common Stock Warrants—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 preferred stock and warrants to acquire (on a fully diluted basis) approximately 11% of our common stock at an exercise price of $75.00 per share. The proceeds from this capital infusion are to be used, in part, to acquire up to eight store leases from Gristedes and to fund new store openings and other capital expenditures. Any funds received in respect of this commitment in excess of funds needed for the acquisition will be used to fund our normal capital spending, fund new store openings or reduce our outstanding debt. The first portion of this equity commitment of $13.0 million was funded on March 27, 2007. The balance of the $39.4 million commitment, in which certain members of senior management have also elected to participate, was funded on June 28, 2007. The preferred stock has a 12 year maturity date from the issuance date and provides for an annual cash dividend of 10% payable quarterly (currently prohibited by the restrictions in our indentures and revolving credit agreement), subject to being declared by the Board of Directors. Each of the 525,334 shares of Series A preferred stock is immediately redeemable without penalty, at our option prior to the maturity dates, at a liquidation preference of $75.00 per share plus any accrued but unpaid dividends as of the redemption date. We have the right, at our option, as of immediately prior to an initial public offering, to require holders of the preferred stock to convert all (but not less than all) of such shares into a number of shares of our common stock equal to the liquidation preference for such shares of preferred stock, divided by the price per share of our common stock set forth in the final prospectus to be used in connection with the IPO.

COMPANY OPERATIONS

Front-End Merchandising

Our overall front-end merchandising strategy is to provide a broad selection of competitively priced, branded and private label drugstore products in convenient, customer friendly presentations. To further enhance customer service and loyalty, we attempt to maintain a consistent in-stock position in all merchandise categories. We offer brand name and private label health and beauty care products (including over-the-counter items), food and beverage items (including beer in all stores which have obtained the appropriate licenses), tobacco products, cosmetics, housewares, greeting cards, photofinishing services, photo supplies, seasonal and general merchandise and other products. Health and beauty care products represent our highest volume product categories within front-end sales. We allocate ample shelf space to popular brands of health and beauty care products. We place convenience items, such as candy, snacks and seasonal goods, near the check-out registers to provide all customers with optimum convenience and to

stimulate impulse purchases, while allowing the store employees to monitor those product categories that are particularly susceptible to theft.

In addition to a wide array of branded products, we also offer our own private label products under various names including “Apt.5”, “5th Avenue” and “Duane Reade.” Private label products provide customers with high-quality, lower priced alternatives to brand name products, while generating higher gross profit margins than brand name products. These offerings also enhance our reputation as a value-oriented retailer. We currently offer approximately 1,000 private label products, which, in fiscal 2006, accounted for approximately 7.8% of non-pharmacy sales. We believe that our strong brand image, reputation for quality and reliability in the New York City market, and our economies of scale in purchasing allow us to effectively manage an improved assortment of private label goods that offer an alternative for increased value to the consumer with higher profitability than comparable branded products.

We offer next-day photofinishing services in most of our stores, and one-hour photofinishing services in 99 stores. We believe that photofinishing services contribute significantly to sales of other merchandise categories because of the customer traffic increases that result from the customer visiting a store twice, in order to drop off film or digital media and to pick up the processed photos. Our photofinishing business has recently experienced negative growth as the industry as a whole experiences declines in use of traditional technologies and as we have made the transition to digital photofinishing.

We complement our product offerings with additional customer services such as ATMs, “Coinstar” coin-exchange machines, sales of lottery tickets and postage stamps, money transfer services and acceptance of food stamps and other government-sponsored benefits. We believe these services enhance our convenience image and promote stronger customer loyalty.

Pharmacy

Our pharmacy business is central to our customer identity and provides a critical link to our health and wellness business and sales in over-the-counter front-end products. Sales of prescription medications are expected to experience strong long-term growth trends attributable to the aging population, new drug discoveries, and increased use of quality of life prescription products. Increased prescription coverage through various private and government sponsored plans such as the recently implemented Medicare Part D program as well as the other favorable demographic trends mentioned above are expected to result in strong growth for all segments of this business. Our same-store prescription drug sales, which do not include resales of retail inventory, grew by 6.0% in 2006 as compared to 2005 and by 0.8% in 2005 as compared to 2004. Sales of prescription drugs, including resales of certain retail inventory, represented 46.5% of total sales in 2006, compared to 48.1% of total sales in 2005 and 51.0% of total sales in 2004. The number of generic prescriptions filled represented 51.4% of total prescriptions filled in 2006, as compared to 47.8% of total prescriptions filled in 2005 and 42.3% of total prescriptions filled in 2004. While the increase in the percentage of generic prescriptions filled reduces the rate of pharmacy same-store sales growth overall, it also increases our gross margin per prescription filled. This increased gross margin is due to lower cost generic prescriptions being more profitable than their branded equivalents. The trend of increases in generic prescriptions filled is the result of several high volume branded drug patent expirations that have enabled the introduction of lower cost generic alternatives. We have also continued to emphasize the value of using lower cost generic products to our customers.

We believe that our extensive network of conveniently located stores, strong local market position, pricing policies and reputation for high quality healthcare products and services provide a competitive advantage in attracting pharmacy business from individual customers as well as managed care organizations, insurance companies, employers and other third party payers. The percentage of our total prescription drug sales covered by third party plans increased to approximately 92.8% in 2006, as compared to approximately 92.7% in 2005 and approximately 92.3% in 2004.

Gross margins on sales covered by third party plans are generally lower than cash prescription drug sales because of the highly competitive nature of pricing for this business and the purchasing power of third party plans. During 2003, President Bush signed the Medicare Modernization Act, which 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 new Medicare coverage took effect in January 2006 and 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. This new Medicaid Part D program grew rapidly during 2006 and is projected to continue to grow in 2007 as more senior citizens enroll for this coverage. While the program has had an adverse impact on our pharmacy margins, based on our experience, we expect, over time, that increased utilization of prescription drugs by senior citizens participating in the new programs who previously were cash paying customers will partially offset the effect of lower margins on our revenues, although we are not certain this will be the case. State Medicaid programs that provide prescription benefits to low income households and individuals have historically represented approximately 24.5% of our retail pharmacy sales. As a result of dual eligible individuals being automatically enrolled into the Medicare Part D program, for the year ended December 30, 2006, state Medicaid plans declined to approximately 14% of our retail pharmacy sales, while the new Medicare Part D program represented approximately 12% of our retail pharmacy sales.

We believe that the higher volume of pharmacy sales to third party plan customers offsets the related lower gross profit margins and allows us to leverage other fixed store operating expenses. In addition, we believe that increased third party plan sales generate additional general merchandise sales by increasing customer traffic in our stores. As of December 30, 2006, we had contracts with over 200 third party plans, including virtually all major third party plans in our market areas. During fiscal 2006, New York Medicaid, the largest third party payer, represented approximately 15.7% and 7.0% of our retail pharmacy and chain sales, respectively.

Over the past several years, New York State reduced Medicaid and Elderly Pharmaceutical Insurance Coverage (EPIC) prescription reimbursement rates, adversely impacting our pharmacy gross margins. New York State also increased co-payments by $1.00 per prescription for branded drugs and $0.50 per prescription for generics effective in 2006. 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 do in fact decline to make the co-payments resulting in the requirement for the provider to absorb this cost. This resulted in lost reimbursements to us of approximately $1.6 million in fiscal 2006. For 2007, the New York State legislature enacted additional reimbursement reductions with an annual impact estimated at approximately $1.8 million.

In an effort to offset some of the adverse pharmacy gross margin impacts resulting from the trends discussed above, there has been an intensified effort on the part of retailers to support increased utilization of lower priced but higher margin generic prescriptions in place of branded medications. In addition, 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 partially offset the adverse margin impact of Medicare Part D and reduced state Medicaid reimbursement rates.

The rate of growth in pharmacy sales declined during 2004 and 2005, due to a number of factors, including a decline in demand for hormonal replacement medications, increasing third party plan co-payments, negative publicity surrounding certain arthritis medications, conversion of certain prescription drugs to over-the-counter status and increased mail order and internet based penetration. Although the conversion of prescription drugs to over-the-counter and mail order and internet penetration had a reduced negative effect on pharmacy sales in 2006, the rate of growth in pharmacy sales continued to slow in 2006 due to the other factors that influenced pharmacy sales growth in 2004 and 2005. These

trends, along with the continued pressure on the part of third party plans to reduce reimbursement rates to participating providers, combined to reduce our overall profitability during 2004 and 2005. In 2006, we experienced an improving rate of pharmacy sales growth attributable to a reduced impact of mail order, increased utilization of Medicare Part D, and a general increase in consumer demand attributable primarily to a strong economy and our Duane Reade Full Potential program.

Our central fill facility, which receives orders via internet, phone or fax from customers and physicians, determines which prescriptions can be most efficiently filled centrally and forwards the balance to the local stores. The selected prescriptions are filled and then delivered to the appropriate store in advance of the scheduled pickup, thereby reducing waiting times during peak periods.

We believe the central fill facility has several distinct advantages. One such advantage is improved inventory management, as stores supported by the facility are able to reduce their on-hand quantities of higher cost, slower turning drugs. We believe this is a substantial advantage because a majority of the available drugs are prescribed infrequently. The 1,000 most popular drugs sold by us account for more than 90% of all prescription purchases by our customers, with the remaining 1,500 accounting for less than 10%. We believe it is more efficient to keep less frequently requested inventory in a central location.

We believe dispensing accuracy can also be improved through the central fill facility because it permits the utilization of large, automated dispensing machines, which would typically not be cost effective to use in individual stores. We believe the cost of filling prescriptions is reduced and customer service is enhanced because in-store pharmacy staff members have more time to handle prescriptions required on a more immediate basis, as well as time to provide customer counseling. In December 2006, this facility serviced 138 of our stores and handled approximately 4,300 prescriptions per day, representing an increase of approximately 16% over the daily volume reported at the end of 2005.

All of our pharmacies are linked by computer systems that enable them to provide customers with a broad range of services. Our pharmacy computer network profiles customer medical and other relevant information, supplies customers with information concerning their drug purchases for income tax and insurance purposes and prepares prescription labels and receipts. The computer network also expedites transactions with third party plans by electronically transmitting prescription information directly to the third party plan and providing on-line adjudication. At the time of sale, on-line adjudication confirms customer eligibility, prescription coverage, pricing and co-payment requirements and automatically bills the respective plan. On-line adjudication also reduces losses from rejected claims and eliminates a portion of our administrative burden related to the billing and collection of receivables and related costs.

We operate a pharmacy kiosk system that enables customers to interact with a pharmacist located at our central fill facility. These kiosks also contain a digital scanning device designed to transmit customer’s prescriptions to our central fill facility for processing and delivery to the customer’s store of choice or directly to the customer through our home delivery service. The kiosks are designed to reduce wait times while providing a more cost-effective means of servicing customers during peak activity periods. At December 30, 2006 there were approximately 83 kiosks in service, including 44 in our stores and 39 operating in remote locations outside our stores.

Our Performance Script Network, launched in 2005, has begun to build a business providing pharmacy benefit administration and mail-order pharmacy services to New York-based employers and unions. While it is in the early stages of development, we believe this business represents an opportunity to further increase our pharmacy sales growth.

In 2006, Duane Reade opened its first Diabetes Resource Center in Manhattan. This facility provides free education, training and consultation to New York City residents with diabetes.

In addition, we recently installed an automated telephonic customer contact system to remind customers of refills and prescriptions awaiting pick-up at our stores.

Internet

Our interactive website, www.duanereade.com, is a convenient and efficient means that customers may use to access company information, refill prescriptions and purchase over-the-counter medications as well as health and beauty care products and other non-pharmacy items. Internet-based purchases are available for both front-end and pharmacy products and can be delivered directly to the customer or made available at the customer’s store of choice for pickup. Our strategy has been to develop the website as an additional vehicle to deliver superior customer service supplementing our convenient store locations. While sales generated on the website to date have been immaterial to our business overall, we believe www.duanereade.com has better positioned us to mitigate some of the adverse impact of mail-order and internet-based pharmacy distributors.

Store Operations

Our stores range in size from under 500 to 17,200 square feet, with an average of 6,987 square feet per store as of December 30, 2006. Our stores are designed to facilitate customer movement and convenience. We believe that our shelf configurations allow customers to find merchandise easily and allow store managers, security guards, cashiers and stock clerks to effectively monitor customer behavior. We attempt to group merchandise logically in order to enable customers to locate items quickly and to stimulate impulse purchases.

We establish each store’s hours of operation in an attempt to best serve customer traffic patterns and purchasing habits. Most stores in Manhattan’s business districts are generally open six days per week. In residential and certain business/shopping districts, most stores are open seven days per week, with a heavy emphasis on convenient, early morning openings and late evening closings. At December 30, 2006, 54 of our stores were open 24 hours a day. We intend to continue to identify stores where we believe extended operating hours would improve customer service and convenience and contribute to our profitability. Many of our stores offer delivery services as an added customer convenience. Customers can arrange for delivery by phone, fax, and internet or at the store. Each store is supervised by a store manager and one or more assistant store managers. Stores are supplied by deliveries from our primary warehouse located in Maspeth, Queens, New York and, for certain seasonal items, from our secondary distribution facility located in North Bergen, New Jersey, from one to as many as five times per week based on their volume and size constraints. This delivery frequency allows the stores to maintain a high in-stock position, maximize utilization of store selling space and minimize the amount of inventory required to be kept in the stores.

Purchasing and Distribution

We purchase approximately 94% of our non-pharmacy merchandise directly from manufacturers. We distribute approximately 84% of our non-pharmacy merchandise through our warehouses and receive direct-to-store deliveries for approximately 16% of our non-pharmacy purchases. Direct-to-store deliveries are made primarily for greeting cards, photofinishing, convenience foods, beverages and various categories of general merchandise. In total, we purchase from over 1,000 vendors. We believe that there are ample sources of supply for the merchandise we currently sell, and that the loss of any one non-pharmacy supplier would not have a material effect on our business.

We generally purchase prescription medications under long-term supply agreements. Approximately 40% of our pharmacy inventory at December 30, 2006 was shipped directly to our stores on a consignment basis.

We currently operate two warehouses, one of which is centrally located in Maspeth, Queens, New York City, and the other of which is located in the northern New Jersey community of North Bergen. The primary Maspeth warehouse, which is approximately 506,000 square feet, is located within ten miles of approximately 88% of our stores, and within approximately 50 miles of our farthest outlying locations. The

North Bergen location, which is principally used for trans-shipments of seasonal and slower-moving merchandise to our primary Maspeth facility, is also located within a convenient distance of a majority of our stores. The close proximity of the warehouses to the stores and to each other allows us to supply the stores frequently, thereby minimizing inventory and maximizing distribution economies. We also operate a fleet of trucks and vans, which we use for deliveries from the warehouses to the stores, as well as for shuttle deliveries between warehouses.

Advertising and Promotion

We regularly promote key items at reduced retail prices in print media during promotional periods. We distributed over 74 million bags with the highly recognizable Duane Reade logo in 2006, helping to promote our name throughout the New York greater metropolitan area. We also employ radio advertising that focuses on our convenient locations and timely seasonal promotions. In addition, we’ve recently begun utilizing Out-of-Home media, including bus and subway advertising, phone kiosk advertising and electronic screen advertising in elevators.

In November 1999, we launched the Dollar Rewards Club, the first major chain-wide “loyalty card” in the drugstore industry, to provide frequent shoppers with discounts. Membership currently exceeds 5.9 million members, and approximately 48.0% of our front-end sales are from customers using this card. The loyalty card enables us to tailor many of our promotions to the needs of our more frequent shoppers.

Management Information Systems

We have modern pharmacy and inventory management information systems. We use scanning point-of-sale (POS) systems in each of our stores. These systems allow better control of pricing, inventory and shrink. POS also provides sales analysis that allows for improved labor scheduling and helps optimize product shelf space allocation and design by allowing detailed analysis of stock-keeping unit sales.

We utilize a fully automated computer-assisted merchandise replenishment system for store front-end and pharmacy orders sourced through our distribution centers and our primary pharmacy supply distributor. These systems use item-specific and store-specific sales history to produce “suggested” orders for each store, which can be accepted or modified by the stores before being released.

We use radio frequency hand held scanning devices to communicate directly with our central processor located at our headquarters facility and permit real-time updates of adjustments to on-hand quantities in our perpetual inventory system. These devices are also used to support inventory ordering, transfers, price changes and direct store deliveries. We utilize a chain-wide specific item cost-based inventory tracking and valuation system which provides improved controls over inventory management and shrink-related losses. Our in-store shelf labeling system is designed to improve pricing accuracy, upgrade our ability to communicate item prices to our customers and reduce the costs associated with processing weekly price changes.

Competition

Our stores compete on the basis of convenience of location and store layout, product mix, selection, customer service and price. The New York City drugstore market is highly fragmented due to the complexities and costs of doing business in the most densely populated area of the country. We believe the diverse labor pool, local customer needs and the complex real estate market in New York City all favor regional chains that are familiar with the market. We tailor our store format to meet all of these requirements, which has proven successful in the business and residential neighborhoods of Manhattan, as well as the outer boroughs and surrounding areas.

Our primary competition comes from over 1,100 independent pharmacies located in New York City, as well as stores operated by major drugstore chains including CVS, Rite Aid, Eckerd and Walgreens. We believe that we have significant competitive advantages over independent drugstores in New York City. These include purchasing economies of scale, two strategically located warehouses that minimize store inventory and maximize selling space, a broad line of in-stock, brand name merchandise, the ability to offer a broad range of value-oriented private label products and a convenient store format. Against major drug chain competition, we enjoy the advantages of strategically located warehouses, a larger number of convenient locations and greater experience operating stores in the New York greater metropolitan area.

We also compete to a lesser extent with other classes of retail trade, including supermarkets and mass merchants. We believe that our concentration in the densely populated New York City market limits the ability of big box retailers and supermarkets to expand meaningfully in many of our prime trading areas.

An adverse trend for drugstore retailing has been the rapid growth in mail-order and internet-based prescription processors. These prescription distribution methods have grown in market share relative to drugstores as a result of the rapid rise in drug costs experienced in recent years. Mail-order prescription distribution methods have been perceived by many employers and insurers as being less costly than traditional distribution methods and have been mandated by an increasing number of third party pharmacy benefit managers, many of which also own and manage mail-order distribution operations. In addition to these forms of mail-order distribution, there have also been an increasing number of internet-based prescription distributors that specialize in offering certain high demand lifestyle drugs at deeply discounted prices. A number of these internet-based distributors operate illicitly and outside the reach of regulations that govern legitimate drug retailers. We believe these alternate distribution channels have acted to restrain the rate of sales growth for traditional chain drug retailers in the last few years.

Drugstore chains have increased their national market share from 40.0% of prescription sales in 1996 to approximately 41% in 2006, while mail-order market share has increased from approximately 12.0% in 1996 to approximately 15% in 2006, predominantly at the expense of independent drug retailers. We expect the increase in market share for mail-order to continue, which will continue to restrain growth for market participants and cause negative pricing pressure. While mail-order market shares are expected to continue to increase, we believe that the use of mail-order is limited due to the time delay associated with mail-order sales, which limits the ability of customers to use this channel to obtain drugs to treat acute conditions. Approximately 46% of our new prescriptions are for acute cases. Further, we believe the cost savings associated with mail-order prescriptions are generally achieved through large volume orders, and typically orders of less than a 90-day supply will cost the same or more than a retail purchase due to shipping costs. In 2005 we launched our Performance Script Network which provides pharmacy benefit administration and mail-order pharmacy services to New York based employers and unions.

Government Regulation

Our business is subject to extensive federal, state and local regulations. These regulations cover required qualifications, day to day operations, reimbursement and documentation of activities. We continuously monitor the effects of regulatory activity on our pharmacy and non-pharmacy related operations.

Licensure and Registration Laws

New York and New Jersey require that companies operating a pharmacy within the state be licensed by the state board of pharmacy. We currently have pharmacy licenses for each pharmacy we operate in New York and New Jersey including our central fill facility. The central fill facility is separately licensed by the New York State Board of Pharmacy. In addition, our pharmacies are required to be registered with state and federal authorities under statutes governing the regulation of controlled substances. Pharmacists who provide services on our behalf are required to obtain and maintain professional licenses and are

subject to state regulations regarding professional standards of conduct. Each of our pharmacists located in New York is required to be licensed by the State of New York. The State of New Jersey requires the pharmacists employed at our stores in New Jersey to be licensed in New Jersey.

Medicare and Medicaid

The pharmacy business operates under regulatory and cost containment pressures from federal and state legislation primarily affecting Medicaid and, to a lesser extent, Medicare.

We receive reimbursement from government sponsored third party plans, including Medicaid and Medicare, non-government third party plans such as managed care organizations and also directly from individuals (i.e. private-pay). For the 2006 fiscal year, our pharmacy payer mix, as a percentage of total prescription sales, was approximately 67% managed care organizations, 26% Medicaid/Medicare and 7% private-pay. Pricing for private-pay patients is based on prevailing regional market rates. However, federal laws and regulations contain a variety of requirements relating to the reimbursement and furnishing of prescription drugs under Medicaid. First, states are given authority, subject to applicable standards, to limit or specify conditions for the coverage of some drugs. Second, as discussed below, federal Medicaid law establishes standards for pharmacy practice, including patient counseling and drug utilization review. Third, federal regulations impose reimbursement requirements for prescription drugs furnished to Medicaid beneficiaries. Prescription drug benefits under Medicare are paid pursuant to the Medicare Prescription Drug Improvement and Modernization Act of 2003 (P.L. 108-173), or the Medicare Modernization Act which created the Medicare Part D benefit that became effective on January 1, 2006. In addition to requirements mandated by federal law, individual states have substantial discretion in determining administrative, coverage, eligibility and reimbursement policies under their respective state Medicaid programs that may affect our pharmacy operations.

The Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings, executive orders and freezes and funding restrictions, all of which may significantly impact our pharmacy operations. We cannot assure you that payments for pharmaceuticals under the Medicare and Medicaid programs will continue to be based on current methodologies or even remain similar to present levels. We may be subject to rate reductions as a result of federal or state budgetary constraints or other legislative changes related to the Medicare and Medicaid programs including, but not limited to, the Medicare Part D drug benefit. Over the past several years, New York State has reduced Medicaid and EPIC prescription reimbursement rates, adversely impacting our pharmacy gross margins.

Fraud and Abuse Laws

We are subject to federal and state laws and regulations governing financial and other arrangements between healthcare providers. Commonly referred to as the Fraud and Abuse laws, these laws prohibit certain financial relationships between pharmacies and physicians, vendors and other referral sources. Violations of Fraud and Abuse laws and regulations could subject us to, among other things, significant fines, penalties, injunctive relief, pharmacy shutdowns and possible exclusion from participation in federal and state healthcare programs, including Medicare and Medicaid. Changes in healthcare laws or new interpretations of existing laws may significantly affect our pharmacy business. Some of the Fraud and Abuse Laws that have been applied in the pharmaceutical industry include:

Federal Anti-Kickback Statute: The federal anti-kickback statute, Section 1128B(b) of the Social Security Act (42 U.S.C. 1320a-7b(b)), prohibits, among other things, the knowing and willful offer, payment, solicitation or acceptance of remuneration, directly or indirectly, in return for referring an individual to a provider of services for which payment may be made in whole or in part under a federal healthcare program, including the Medicare or Medicaid programs. In addition, the federal anti-kickback statute prohibits the knowing and willful solicitation or receipt of whoever knowingly and lawfully solicits

or receives any remuneration directly or indirectly in return for purchasing, leasing, ordering or arranging for or recommending the purchasing, leasing or ordering of any good, facility, service or item for which payment may be made in whole or in part under a federal health care program, including Medicare or Medicaid. Remuneration has been interpreted to include any type of cash or in-kind benefit, including long-term credit arrangements, gifts, supplies, equipment, prescription switching fees, or the furnishing of business machines. Several courts have found that the anti-kickback statute is violated if any purpose of the remuneration, not just the primary purpose, is to induce referrals.

Potential sanctions for violations of the anti-kickback statute include felony convictions, imprisonment, substantial criminal fines and exclusion from participation in any federal healthcare program, including the Medicare and Medicaid programs. Violations may also give rise to civil monetary penalties in the amount of $50,000, plus treble damages. In addition to the federal anti-kickback statute, many states, including New Jersey, have enacted State Medicaid anti-kickback statutes that are similar to the prohibitions of the federal anti-kickback statute. Potential sanctions and violations of state anti-kickback statutes are similar to those of federal anti-kickback statutes. Although we believe that our relationships with vendors, physicians, and other potential referral sources have been structured in compliance with Fraud and Abuse laws, including the federal and state anti-kickback statutes, the Department of Health and Human Services has acknowledged in its pharmaceutical industry compliance guidance that many common business activities potentially implicate the anti-kickback statute. We cannot offer any assurance that a government enforcement agency, private litigant, or court will not interpret our business relations to violate the Fraud and Abuse laws.

The False Claims Act: Under the False Claims Act, or the FCA, civil penalties may be imposed upon any person who, among other things, knowingly or recklessly submits, or causes the submission of false or fraudulent claims for payment to the federal government, for example in connection with Medicare and Medicaid. Any person who knowingly or recklessly makes or uses a false record or statement in support of a false claim, or to avoid paying amounts owed to the federal government, may also be subject to damages and penalties under the False Claims Act.

Moreover, private individuals may bring qui tam, or “whistle blower,” suits under the False Claims Act, and may receive a portion of amounts recovered on behalf of the federal government. Such actions must be filed under seal pending their review by the Department of Justice. Penalties of between $5,500 and $11,000 and treble damages may be imposed for each violation of the FCA. Several federal district courts have held that the False Claims Act may apply to claims for reimbursement when an underlying service was delivered in violation of other laws or regulations, including the anti-kickback statute.

In addition to the False Claims Act, the federal government has other civil and criminal statutes, which may be utilized if the government suspects that we have submitted false claims. Criminal provisions that are similar to the False Claims Act provide that if a corporation is convicted of presenting a claim or making a statement that it knows to be false, fictitious or fraudulent to any federal agency, it may be fined not more than twice any pecuniary gain to the corporation, or, in the alternative, no more than $500,000 per offense. Many states also have similar false claims statutes that impose liability for the types of acts prohibited by the FCA, and bills for state false claims laws similar to the federal FCA have been introduced in the New York State Assembly. The New Jersey Health Care Claims Fraud Act (N.J.S.A. 2C:21-4.2, et seq.) prohibits the filing of false or misleading claims for payment for health care services and imposes penalties including imprisonment and fines of five times the amount of the claim or more. Section 6031 of the Deficit Reduction Act of 2005 and Section 1901 of the Social Security Act provide a financial incentive for states to enact false claims acts that establish liability to the state for the submission of false or fraudulent claims to the state’s Medicaid program. If a state false claims act is determined to meet certain enumerated requirements, the state is entitled to an increase of 10 percentage points in its share of any amounts recovered under a state action brought under such law. Under Section 1909(b) of the Social Security Act, the United States Department of Health and Human Services, Office of Inspector

General is required to determine, in consultation with the Attorney General of the United States, whether a state has in effect a law relating to false or fraudulent claims submitted to a state Medicaid Program that meets the enumerated requirements. The effective date of Section 1909 of the Social Security Act is January 1, 2007. According to the Office of the Inspector General, neither New York nor New Jersey has had its false claims act reviewed by the Office of the Inspector General for this purpose. On May 19, 2005, Mayor Michael Bloomberg of New York City signed into law the New York City False Claims Act (Local Law 53 of 2005) which authorizes citizens to bring lawsuits to recover treble damages for fraudulent claims submitted to the city. Finally, the submission of false claims may result in termination of our participation in federal or state healthcare programs. Members of management and persons who actively participate in the submission of false claims can also be excluded from participation in federal healthcare programs.

We believe that we have sufficient procedures in place to provide for the accurate completion of claim forms and requests for payment. Nonetheless, given the complexities of the Medicare, Medicaid and other third party payer programs, we may code or bill in error, and such claims for payment may be treated as false claims by the enforcing agency or a private litigant.

Physician Self-Referral Laws

The federal physician self-referral law, Section 1877 of the Social Security Act (42 U.S.C. § 1395nn, commonly known as the “Stark Law”) prohibits physicians from referring Medicare patients for certain designated health services to entities with which the physician or an immediate family member of the physician has a financial relationship, unless an exception applies. The Stark Law is implicated if the physician has an ownership or financial relationship with the entity that is providing the designated health service. The Stark Law also prohibits the entity from billing for services provided pursuant to a prohibited referral. Among the designated services covered by the Stark Law include outpatient prescription drugs. Sanctions for violating the Stark Law include denial of payment and civil monetary penalties of not more than $15,000 for each bill or claim for a service. Any physician or other entity that enters into an arrangement or scheme (such as a cross-referral arrangement) which the physician or entity knows or should know has a principal purpose of issuing referrals by the physician to a particular entity which, if the physician directly made referrals to such entity, would be in violation of the Stark Law and is subject to a civil monetary penalty of not more than $100,000 for each such arrangement or scheme. The Stark Law is implicated if the physician, or an immediate family member of such physician, has an ownership or compensation arrangement with the entity. Both New York and New Jersey have enacted state physician self-referral statutes and regulations that are similar to the Stark Law in scope and purpose. The federal and state physician self-referral laws are also commonly referred to as Fraud and Abuse laws. Although we believe that our relationships with physicians and other individuals are in compliance with the Stark Law and its state equivalents, a government enforcement agent, private litigant or court may determine that our business relationships violate the Fraud and Abuse laws.

Drug Utilization Review

The Omnibus Budget Reconciliation Act of 1990, or OBRA 90, establishes a number of regulations regarding state Medicaid prescription drug benefits. Although OBRA 90 primarily focuses on drug manufacturers’ obligations to provide drug rebates under state Medicaid programs, it also requires states to create drug utilization review, or DUR, requirements in order to combat fraud, abuse, gross overuse, inappropriate or medically unnecessary care as well as to educate patients about potential adverse reactions. DUR requires pharmacists to discuss with patients relevant information in connection with dispensing drugs to patients. This information may include the name and description of the medication, route and dosage form of the drug therapy, special directions and precautions for patients, side effects, storage, refill and actions to be taken upon a missed dosage. Under DUR requirements, pharmacists are also required to make a reasonable effort to obtain the patient’s identification information, medical and

drug reaction history and to keep notes relevant to an individual’s drug therapy. We believe our pharmacists provide the required drug use consultation with our customers.

Healthcare Information Practices

The Health Insurance Portability and Accountability Act of 1996, or HIPAA, sets forth standards for electronic transactions; unique provider, employer, health plan and patient identifiers; security and electronic signatures as well as privacy protections relating to the exchange of individually identifiable health information. The Department of Health and Human Services, or DHHS, has released several rules mandating compliance with the standards set forth under HIPAA. We believe our pharmacies achieved compliance with DHHS’s standards governing the privacy of individually identifiable health information that became effective on April 14, 2003 and DHHS’s standards governing the security of electronically stored health information that became effective on April 20, 2005. In addition, we have implemented the uniform standards governing common healthcare transactions by the required compliance date of October 16, 2003. Finally, management has taken or will take all necessary steps to achieve compliance with other HIPAA rules as applicable, including the standard unique employer identifier rule, the standard health care provider identifier rule and the enforcement rule.

We continue to evaluate the effect of the HIPAA standards on our business. At this time, management believes that our pharmacies have taken all appropriate steps to achieve compliance with the HIPAA requirements. Moreover, HIPAA compliance is an ongoing process that will require continued attention and adaptation even after the official compliance dates. Management does not currently believe that the cost of compliance with the existing HIPAA requirements will be material to us; however, management cannot predict the cost of future compliance with HIPAA requirements. Noncompliance with HIPAA may result in criminal penalties and civil sanctions. The HIPAA standards have increased our regulatory and compliance burden and have significantly affected the manner in which our pharmacies use and disclose health information, both internally and with other entities.

In addition to the HIPAA restrictions relating to the exchange of healthcare information, individual states have adopted laws protecting the confidentiality of patient information which impact the manner in which pharmacy records are maintained. Violation of patient confidentiality rights under common law, state law or federal law could give rise to damages, penalties, civil or criminal fines and/or injunctive relief. We believe that our pharmacy operations and prescription file-buying program are in compliance with federal and state privacy protections. However, an enforcement agency or court may find a violation of state or federal privacy protections arising from our pharmacy operations or our prescription file-buying program.

Healthcare Reform and Federal Budget Legislation

In recent years, Congress has passed a number of federal laws that have created major changes in the healthcare system. In December 2000, the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000, or BIPA, was signed into law. Generally, BIPA addressed attempts to modify the calculation of average wholesale prices of drugs, or AWPs, upon which Medicare and Medicaid pharmacy reimbursement has been based. The federal government has been actively investigating whether pharmaceutical manufacturers have been improperly manipulating average wholesale prices, and several pharmaceutical manufacturers have paid significant civil and criminal penalties to resolve litigation relating to allegedly improper practices affecting AWP.

In response to BIPA and other criticisms of AWP pricing methodologies, the Medicare Modernization Act described above contains a number of drug pricing reforms, some of which were effective January 1, 2004. Section 1927 of the Social Security Act established the Medicaid drug rebate program. For a manufacturer’s covered outpatient drugs to be eligible for federal Medicaid funding under the Medicaid drug rebate program, the manufacturer must enter into a rebate agreement with the Centers

for Medicare & Medicaid Services, or “CMS,” and pay quarterly rebates to the states. Section 1927(b)(3) of the Act requires a participating manufacturer to report quarterly to CMS the average manufacturer price for each covered outpatient drug. Section 1927(k)(1) of the Social Security Act defines the “average manufacturer price” as the average price paid to the manufacturer by wholesalers for drugs distributed to the retail pharmacy class of trade, after deducting customary prompt pay discounts.

The Deficit Reduction Act of 2005 requires the Secretary of the United States Department of Health and Human Services to provide average manufacturer price data to the states on a monthly basis beginning July 1, 2006. This data provides states with pricing information that was generally not available previously and states may choose to use average manufacturer price in setting reimbursement amounts in their Medicaid programs.

The new Medicare Part D drug benefit went into effect on January 1, 2006. Prior to January 1, 2006, Medicare beneficiaries were able to receive some assistance with their prescription drug costs through a prescription drug discount card program which began in June, 2004. This discount card program gave enrollees access to negotiated discount prices for prescription drugs.

On January 28, 2005, the CMS published a final rule to implement the Medicare Part D drug benefit. Under the Medicare Part D drug benefit, Medicare beneficiaries are able to enroll in prescription drug plans offered by private entities or, to the extent private entities fail to offer a plan in a given area, through a government contractor. Medicare Part D prescription drug plans include both plans providing the drug benefit on a stand alone basis and Medicare Advantage plans that provide drug coverage as a supplement to an existing medical benefit under the applicable Medicare Advantage plan. Pursuant to the CMS final rule, we will be reimbursed for drugs that we provide to enrollees of a given Medicare Part D prescription drug plan in accordance with the terms of the agreements negotiated between the Medicare Part D plan and us. We accept most Medicare Part D plans in our market areas. The amount of reimbursement to us under Medicare Part D plans is less than the amount under New York and New Jersey state Medicaid, and generally less than traditional nongovernmental third-party plans.

CMS is continuing to issue sub-regulatory guidance on many additional aspects of the CMS final rule. We are monitoring these government pronouncements and statements of guidance and we cannot predict at this time the ultimate effect of the CMS final rule or other potential developments relating to its implementation on our business or results of operations.

Beginning January 1, 2005 and continuing through the present, many drugs have been reimbursed under new pricing methodologies. Although reporting obligations that currently arise under the AWP system and Medicaid Best Price statutes are imposed on pharmaceutical manufacturers, current and future changes in pricing methodologies may affect reimbursement rates, pharmaceutical marketing practices and the offering of discounts and incentives to purchasers, including retail pharmacies, in ways that are uncertain at this time.

Under Section 1902(a)(54) of the Social Security Act, each state is required to submit a Medicaid state plan to CMS describing its payment methodology for covered outpatient drugs. Federal regulations require, with certain exceptions, that each state’s Medicaid reimbursement for a drug not exceed (in the aggregate) the lower of (a) its estimated acquisition costs plus a reasonable dispensing fee or (b) the provider’s usual and customary charge to the public. The impact of the Deficit Reduction Act and the use of average manufacturer price data on state Medicaid reimbursement methodology and amounts for pharmacy services is uncertain at this time. The use of average manufacturer price data is not expected to impact our reimbursement rates until early 2008. If the state Medicaid plans in which we operate retail pharmacies implement the use of average manufacturer price data, such implementation may have a material, adverse impact on our pharmacy business.

It is uncertain at this time what additional healthcare reform initiatives, if any, will be implemented, or whether there will be other changes in the administration of governmental healthcare programs or

interpretations of governmental policies or other changes affecting the healthcare system. We cannot assure you that future healthcare or budget legislation or other changes, including those referenced above, will not materially adversely impact our pharmacy business.

Non-Healthcare Licenses

We have been granted cigarette tax stamping licenses from the State of New York and the City of New York, which permit us to buy cigarettes directly from the manufacturers and stamp the cigarettes ourselves. Our stores possess cigarette tax retail dealer licenses issued by the State of New York, the City of New York and the State of New Jersey. Most of our stores have been granted licenses by the United States Department of Agriculture, enabling them to serve as certified Food Stamp retailers. In addition, most of our stores possess beer licenses and food licenses issued by the State of New York. We seek to comply with all of these licensing and registration requirements and continue to actively monitor our compliance. By virtue of these license and registration requirements, we are obligated to observe certain rules and regulations, and a violation of these rules and regulations could result in suspension or revocation of one or more licenses or registrations and/or the imposition of monetary penalties or fines.

Minimum Wage Requirements

We are impacted by recent legislation in states 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 U.S. Congress recently passed legislation that would result in a federal minimum hourly wage increase to $7.25 two years after the effective date of the legislation, which date has yet to be determined. 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.

Employees

As of December 30, 2006, we had approximately 6,100 employees, 84% of whom were full time. Unions represent approximately 4,200 of our employees. Non-union employees include employees at corporate headquarters, store and warehouse management and all of our store pharmacists. The distribution facility employees are represented by the International Brotherhood of Teamsters, Chauffeurs and Warehousemen and Helpers of America, Local 210. Our three year contract with this union expires on August 31, 2008. Employees in 138 stores are represented by RWDSU/Local 338 and employees in the remaining 110 stores are represented by Local 340A New York Joint Board, UNITE AFL CIO. Our three year contracts with the RWDSU/Local 338 and Local 340A expire on March 31, 2009.

Intellectual Property

We hold a number of registered and unregistered trademarks. Trademarks we have registered in the United States Trademark Office include the name “Duane Reade;” the distinctive “DR” logo; “DR Express,” and its associated logo; “Christmas in New York;” “Mayfair Chemists;” “Fifth Avenue Preferred;” “Color for the City;” and “Apt. 5,” and its associated logo. We have applications currently pending before the United States Trademark Office to register our trademarks “Performance Script Network,” “New York’s Most Rewarding Drugstore,” and “DR Home Healthcare,” along with its associated logo. We believe that we have developed strong brand awareness within the New York City area for the Duane Reade trademark and other trademarks owned by the Company. We regard the Duane Reade name and logo, as well as our other trademarks, as valuable assets. In September of 1998, we acquired twenty-nine Rock Bottom stores, which we converted to the Duane Reade format in the 1999

fiscal year. In addition, in connection with the Rock Bottom acquisition, we acquired the “RockBottom” name and the “RockBottom” logo, each of which are registered trademarks.

In 2003, we filed a patent application for our pharmacy kiosk. We currently have a “patent pending” status on our pharmacy kiosk invention.

ITEM 1A. Risk Factors

The following risk factors should be read carefully in connection with evaluating us and this annual report on Form 10-K. Certain statements in this “Risk Factors” section are forward-looking statements. See “Forward-Looking Statements” above.

Risks Related to Our Business

We face a high level of competition in our markets.

We operate in highly competitive markets. In the New York greater metropolitan area, we compete against national, regional and local drugstore chains, discount drugstores, supermarkets, combination food and drugstores, discount general merchandise stores, mass merchandisers, independent drugstores and local merchants. Major chain competitors in the New York greater metropolitan area include CVS, Rite Aid, Eckerd and Walgreens. In addition, other chain stores may enter the New York greater metropolitan area and become significant competitors in the future. Many of our competitors have greater financial and other resources than we do. Currently, we have the largest market share in the New York metropolitan area compared to our competitors in the drugstore business. If any of our current competitors, or new competitors, were to devote significant resources to enhancing or establishing an increased presence in the New York greater metropolitan area, they could make it difficult for us to maintain or grow our market share or maintain our margins, and our advertising and promotional costs could increase. Over the past several years, our overall photofinishing business and sales of film have experienced significant declining sales as the industry as a whole experiences declines in use of traditional technologies and as we have made the transition to digital photofinishing. Our digital photofinishing business may not grow as expected. As a result, our business and prospects could suffer. This competition could materially adversely affect our results of operations and financial condition in the future. In addition to competition from the drugstore chains named above, our pharmacy business also competes with hospitals, health maintenance organizations and Canadian imports.

Another adverse trend for drugstore retailing has been the rapid growth in mail-order and internet-based prescription processors. These prescription distribution methods have grown in market share relative to drugstores as a result of the rapid rise in drug costs experienced in recent years. Mail-order prescription distribution methods have been perceived by employers and insurers as being less costly than traditional distribution methods and are being mandated by an increasing number of third party pharmacy benefit managers, many of which also own and manage mail-order distribution operations, as well as a growing number of employers and unions. In addition to these forms of mail-order distribution, there have also been an increasing number of internet-based prescription distributors that specialize in offering certain high demand lifestyle drugs at deeply discounted prices. A number of these internet-based distributors operate illicitly and outside the reach of regulations that govern legitimate drug retailers. Competition from Canadian imports has also created volume and pricing pressure. Imports from foreign countries may increase further if recently introduced legislation seeking to legalize the importation of drugs from Canada and other countries is eventually enacted. These alternate distribution channels have acted to restrain the rate of sales growth for traditional chain drug retailers in the last few years.

We operate in a concentrated region and, as a result, our business is significantly influenced by the economic conditions and other characteristics of the New York greater metropolitan area.

Substantially all of our stores are located in the greater New York metropolitan area. As a result, we are sensitive to, and our success will be substantially affected by, economic conditions and other factors affecting this region, such as the regulatory environment, the cost of energy, real estate, insurance, taxes and rent, weather, demographics, the availability of labor, and geopolitical factors such as terrorism. We cannot predict economic conditions in this region. During the 1990s, the New York City economy grew substantially, and our business benefited from this high rate of economic growth. As a result of the economic recession and the terrorist attack on the World Trade Center in September 2001, however, the New York City economy was materially adversely affected. Recent improvements in the New York City economy may not continue or impact our business favorably. During a downturn in New York’s economic conditions, our revenues and profitability could be materially adversely affected because of, among other things, a reduction in the size of the workforce in the New York greater metropolitan area, reduced income levels, a resulting increase in shrink or a decline in population growth. Because most of our stores are located in the highly urbanized areas throughout New York City and the surrounding metropolitan area, our stores experience a higher rate of shrink than our national competitors. In addition, our front-end sales have been negatively affected by declining tobacco sales in metro New York City, which has experienced increased restrictions on smoking in public places along with higher taxes on tobacco products. Our revenues and profitability were adversely affected by the August 2003 power blackout that affected the New York greater metropolitan area and by significant non-recurring increases in real estate taxes and insurance costs. In addition, our results were negatively impacted during the summer of 2004 by the Republican National Convention and related disruptions and the heightened security and terrorist alerts during the weeks leading up to the Convention. In 2005, our results were negatively affected by increased labor costs associated with the ongoing shortage of pharmacists in the New York City metropolitan area and increases in New York state and to a lesser extent New Jersey state minimum wage rates. In 2006, we continued to experience cost pressures from increased pharmacist salary costs as well as further increases in minimum wage rates. Any other unforeseen events or circumstances that affect the New York City metropolitan area could also materially adversely affect our revenues and profitability.

We require a significant amount of cash flow from operations and third party financing to pay our indebtedness, to execute our business plan and to fund our other liquidity needs.

We may not be able to generate sufficient cash flow from operations, our suppliers may not continue to extend us normal trade payments terms, and future borrowings may not be available to us under our amended asset-based revolving loan facility or otherwise in an amount we will need to pay our indebtedness, to execute our business plan or to fund our other liquidity needs. We expect to spend approximately $35.0 million in 2007 on capital expenditures, lease acquisitions, pharmacy customer file acquisitions and other costs. We also require working capital to support inventory for our existing stores. In addition, we may need to refinance some or all of our indebtedness, including indebtedness under our amended asset-based revolving loan facility, our senior subordinated notes and our senior secured floating rate notes, at or before maturity. We may not be able to refinance any of our indebtedness on commercially reasonable terms or at all. Failure to generate or raise sufficient funds may require us to modify, delay or abandon some of our future business initiatives or expenditure plans.

Our operations are subject to trends in the healthcare industry.

Pharmacy sales, which are lower-margin than front-end sales, represent a significant percentage of our total sales. Pharmacy sales, including resales of certain retail inventory, accounted for approximately 46.5% of total sales in the fiscal year ended December 30, 2006, approximately 48.1% of total sales in the fiscal year ended December 31, 2005 and approximately 51.0% of total sales in the fiscal year ended

December 25, 2004. Pharmacy sales not only have lower margins than non-pharmacy sales but are also subject to increasing margin pressure, as managed care organizations, insurance companies, government funded programs, employers and other third party payers, which collectively we call third party plans, have become prevalent in the New York greater metropolitan area and as these plans continue to seek cost containment. Also, any substantial delays in reimbursement, significant reduction in coverage or payment rates from third party plans may have a material, adverse effect on our business. In addition, an increasing number of employers are now requiring participants in their plans to obtain some of their prescription drugs, especially those for non-acute conditions, through mail-order providers. Medicare Part D benefits for senior citizens that became available in January of 2006 resulted in lower reimbursement rates and resultant gross margins than the non-third party plan margins and state Medicaid reimbursement rates they replaced. These factors and other factors related to pharmacy sales described below had a negative impact on our pharmacy sales in fiscal 2006 and could continue to have a negative impact in the future. See “—We face a high level of competition in our markets.” Sales to third party prescription plans represented 92.8% of our prescription sales for the fiscal year ended December 30, 2006, 92.7% of our prescription sales for the fiscal year ended December 31, 2005 and 92.3% of our prescription sales for the fiscal year ended December 25, 2004.

The continued conversion of various prescription drugs to over-the-counter medications may materially reduce our pharmacy sales and customers may seek to purchase such medications at non-pharmacy stores. Also, if the rate at which new prescription drugs become available slows or if new prescription drugs that are introduced into the market fail to achieve popularity, our pharmacy sales may be adversely affected. The withdrawal of certain drugs from the market or concerns about the safety or effectiveness of certain drugs or negative publicity surrounding certain categories of drugs may also have a negative effect on our pharmacy sales or may cause shifts in our pharmacy or front-end product mix. For example, the rate of growth in pharmacy sales declined during 2004 and 2005, due to a number of factors, including a decline in demand for hormonal replacement medications, increasing third party plan co-payments, negative publicity surrounding certain arthritis medications, conversion of certain prescription drugs to over-the-counter status and increased mail order and internet based penetration. Although the conversion of prescription drugs to over-the-counter and mail order and internet penetration had a reduced negative effect on pharmacy sales in 2006, the rate of growth in pharmacy sales continued to slow in 2006 due to the other factors that influenced pharmacy sales growth in 2004 and 2005.

Healthcare reform and enforcement initiatives of federal and state governments may also affect our revenues from prescription drug sales. These initiatives include:

· proposals designed to significantly reduce spending on Medicare, Medicaid and other government programs;

· changes in programs providing for reimbursement for the cost of prescription drugs by third party plans;

· the Medicare Modernization Act;

· increased scrutiny of, and litigation relating to, prescription drug manufacturers’ pricing and marketing practices; and

· regulatory changes relating to the approval process for prescription drugs.

These initiatives could lead to the enactment of, or changes to, federal regulations and state regulations in New York and New Jersey that could adversely impact our prescription drug sales and, accordingly, our results of operations. It is uncertain at this time what additional healthcare reform initiatives, if any, will be implemented, or whether there will be other changes in the administration of governmental healthcare programs or interpretations of governmental policies or other changes affecting the healthcare system.

Future healthcare or budget legislation or other changes, including those referenced above, may materially adversely impact our pharmacy business.

Changes in reimbursement levels for certain prescription drugs continue to reduce our margins on pharmacy sales and could have a material, adverse effect on our overall performance.

During the fiscal year ended December 30, 2006, the fiscal year ended December 31, 2005 and the fiscal year ended December 25, 2004, we were wholly or partially reimbursed by third party plans for approximately 92.8%, 92.7% and 92.3% of the prescription drugs that we sold, respectively. The percentage of prescription sales reimbursed by third party plans has been increasing, and we expect that percentage to continue to increase. Prescription sales reimbursed by third party plans, including Medicare and Medicaid plans, have lower gross margins than other pharmacy sales. Third party plans may not increase reimbursement rates sufficiently to offset expected increases in prescription acquisition costs, thereby reducing our margins and adversely affecting our profitability. In addition, continued increases in co-payments by third party plans may result in decreases in drug usage.

In particular, Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective reimbursement rate adjustments, administrative rulings, executive orders and freezes and funding restrictions, all of which may significantly impact our pharmacy operations. For the 2006 fiscal year, approximately 26.3% of our total prescription sales were paid for by Medicaid or Medicare. Over the last several years, a number of states experiencing budget deficits have moved to reduce Medicaid prescription reimbursement rates. Over the past several years, New York State reduced Medicaid and EPIC prescription reimbursement rates, adversely impacting our pharmacy gross margins. For example, effective September 5, 2006, the New York State Department of Health, Office of Medicaid Management, has applied a state based maximum acquisition cost to Medicaid reimbursement of multi-source generic drugs prior to the availability of federal upper limit price. In addition, effective July 15, 2006, New York State has limited Medicaid reimbursement for prescription drugs to the federal upper limit for specific multiple source drugs or the lower of a pharmacy’s usual and customary price charged to the general public or the estimated acquisition cost for a drug as established by the New York State Department of Health.

During 2003, President Bush signed the Medicare Modernization Act, which 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 new Medicare coverage took effect in January 2006 and has resulted in decreased pharmacy margins resulting from lower reimbursement rates than our current margins on prescriptions that are not subject to third party reimbursement.

If we fail to comply with all of the government regulations that apply to our business, we could incur substantial reimbursement obligations, damages, penalties, injunctive relief and/or exclusion from participation in federal or state healthcare programs.

Our pharmacy operations are subject to a variety of complex federal, state and local government laws and regulations, including federal and state civil fraud, anti-kickback, false claims and other laws. We endeavor to structure all of our relationships to comply with these laws. However, if any of our operations are found to violate these or other government regulations, we could suffer severe penalties, including suspension of payments from government programs; loss of required government certifications; loss of authorizations to participate in or exclusion from government reimbursement programs, such as the Medicare and Medicaid programs; loss of licenses; significant fines or monetary penalties for anti-kickback law violations, submission of false claims or other failures to meet reimbursement program requirements.

In addition to the regulations relating to our conduct of our pharmacy business, our pharmacists are subject to licensing requirements and are required to comply with various federal and state laws regarding compliance with dispensing procedures, anti-fraud statutes, false claims and other rules and regulations. We have a compliance program in place to determine whether our pharmacists’ licenses are appropriately valid to ensure that these pharmacists are eligible to process prescription reimbursements for certain state and federally funded programs. In the event that a pharmacist is determined to not have a valid license for purposes of processing certain state and federal claims, we could be subject to significant fines and penalties.

Federal and state laws that require our pharmacists to offer counseling, without additional charge, to their customers about medication, dosage, delivery systems, common side effects and other information the pharmacists deem significant can impact our business. Our pharmacists may also have a duty to warn customers regarding any potential negative effects of a prescription drug if the warning could reduce or negate these effects. Violations of federal, state, and common law privacy protections could give rise to significant damages, penalties, and/or injunctive relief. Additionally, we are subject to federal and state regulations relating to our pharmacy operations, including purchasing, storing and dispensing of controlled substances. Laws governing our employee relations, including minimum wage requirements, overtime and working conditions also impact our business. Increases in the federal minimum wage rate, employee benefit costs or other costs associated with employees could significantly increase our cost of operations, which could materially adversely affect our level of profitability.

We could be materially and adversely affected if either of our distribution centers is shut down.

We operate two centralized distribution centers, one in Queens, New York and the other in North Bergen, New Jersey. We ship most of our non-pharmacy products to our stores through our distribution centers. If either of our distribution centers is destroyed or shut down for any other reason, including because of weather or labor issues, we could incur significantly higher costs and longer lead times associated with distributing our products to our stores during the time it takes for us to reopen or replace the centers. We maintain business interruption insurance to protect us from the costs relating to matters such as a shutdown, but our insurance may not be sufficient, or the insurance proceeds may not be timely paid to us, in the event of a shutdown.

We rely on a primary supplier of pharmaceutical products to sell products to us on satisfactory terms. A disruption in our relationship with this supplier could have a material, adverse effect on our business.

We are party to multi-year, merchandise supply agreements in the normal course of business. The largest of these is with AmerisourceBergen, our primary pharmaceutical supplier, which supplied most of our pharmaceutical products in fiscal 2005 and 2006. Although it is the opinion of management that if any of these agreements were terminated or if any contracting party were to experience events precluding fulfillment of its obligations, we would be able to find a suitable alternative supplier, we may not be able to do so without significant disruption to our business. This could take a significant amount of time and result in a loss of customers.

We may be unable to attract, hire and retain qualified pharmacists, which could harm our business.

As our business expands, we believe that our future success will depend greatly on our continued ability to attract and retain highly skilled and qualified pharmacists. Our industry is experiencing an ongoing shortage of licensed pharmacists. Competition for qualified pharmacists and other pharmacy professionals has been especially strong, resulting in higher salaries, which we have recently matched by raising the salaries of our pharmacists. Although we generally have been able to meet our pharmacist staffing requirements in the past, our inability to do so in the future at costs that are favorable to us, or at

all, could negatively impact our revenue, and our customers could experience lower levels of customer care.

Most of our employees are covered by collective bargaining agreements. A failure to negotiate new agreements when the existing agreements terminate could disrupt our business.

As of December 30, 2006, we had approximately 6,100 employees, 84% of whom were full-time. Unions represent approximately 4,200 of our employees. Non-union employees include employees at corporate headquarters, store and warehouse management and all of our store pharmacists. The distribution facility employees are represented by the International Brotherhood of Teamsters, Chauffeurs and Warehousemen and Helpers of America, Local 210. Our three-year contract with this union expires on August 31, 2008. Local 210 represents approximately 400 employees in our Maspeth, New York and North Bergen, New Jersey warehouse facilities. At December 30, 2006, employees in 138 stores were represented by the RWDSU/Local 338 and employees in the remaining 110 stores were represented by Local 340A New York Joint Board, UNITE AFL-CIO. Our three year collective bargaining agreements with RWDSU/Local 338 and Local 340A expire on March 31, 2009.

Upon the expiration of any of our collective bargaining agreements, we may be unable to negotiate new collective bargaining agreements on terms favorable to us, and our business operations may be interrupted as a result of labor disputes, strikes, work stoppages or difficulties and delays in the process of renegotiating our collective bargaining agreements.

We may be subject to significant liability should the consumption of any of our products cause injury, illness or death.

Products that we sell could become subject to contamination, product tampering, mislabeling or other damage requiring us to recall our private label products. In addition, errors in the dispensing and packaging of pharmaceuticals could lead to serious injury or death. Product liability claims may be asserted against us with respect to any of the products or pharmaceuticals we sell and we may be obligated to recall our private label products. A product liability judgment against us or a product recall could have a material, adverse effect on our business, financial condition or results of operations.

We depend on our management team, and the loss of their services could have a material, adverse effect on our business.

Our success depends to a large extent on the continued service of our executive management team, including our Chairman and CEO, Richard Dreiling. Departures by our executive officers could have a negative impact on our business, as we may not be able to find suitable management personnel to replace departing executives on a timely basis. We do not maintain key-man life insurance on any of our executive officers.

Continued volatility in insurance related expenses and the markets for insurance coverage could have a material, adverse effect on us.

The costs of employee health, workers’ compensation, property and casualty, general liability, director and officer and other types of insurance could rise, while the amount and availability of coverage can decrease. Claims costs for workers’ compensation and other self-insured exposures have also increased. These conditions have been exacerbated by rising healthcare costs, legislative changes, economic conditions and the threat of terrorist attacks such as that which occurred on September 11, 2001. If our insurance-related costs increase significantly, or if we are unable to obtain adequate levels of insurance, our financial position and results of operations could be materially adversely affected.

Certain risks are inherent in providing pharmacy services, and our insurance may not be adequate to cover any claims against us.

Pharmacies are exposed to risks inherent in the packaging, dispensing and distribution of pharmaceuticals and other healthcare products. Although we maintain professional liability and errors and omissions liability insurance, the coverage limits under our insurance programs may not be adequate to protect us against future claims, and we may not maintain this insurance on acceptable terms in the future, which could materially adversely affect our business.

The outcome of current and future litigations and other proceedings in which we are involved may have a material, adverse effect on our results of operations and cash flow.

We are subject to various litigations and other proceedings in our business, which if determined unfavorably to us, could have a material, adverse effect on our results of operations and cash flow. In addition, any of the current or possible future civil or criminal actions in which we may be involved could require significant management and financial resources, which could otherwise be devoted to the operation of our business. For a more detailed discussion of these litigations and other proceedings, see “Item 3. Legal Proceedings.”

Risks Related to the Acquisition

We are named parties to a number of purported class action complaints in connection with the Acquisition that may have a negative impact on us.

A number of purported class action complaints challenging the Acquisition have been filed in various jurisdictions. All of these complaints purport to be brought on behalf of our former common stockholders and allege that the named defendants purportedly breached duties owed to the common stockholders in connection with the Acquisition. See “Item 3. Legal Proceedings—Litigation Relating to the Acquisition.”

An adverse outcome in this litigation could have a material, adverse effect on our results of operations and cash flows.

We are a company whose equity is not publicly traded and which is effectively controlled by a single stockholder. That stockholder may effect changes to our board of directors, management and business plan, and interests of that stockholder may conflict with the interests of our noteholders.

Duane Reade Shareholders owns all of the outstanding shares of our common stock. Oak Hill owns a majority of the voting membership interests in Duane Reade Shareholders. See “Item 6. Selected Financial Data.”

Accordingly, Oak Hill indirectly beneficially owns a majority of our outstanding shares of common stock and can determine the outcomes of the elections of members of our board of directors and the outcome of corporate actions requiring stockholder approval, including mergers, consolidations and the sale of all or substantially all of our assets. Oak Hill also controls our management, policies and financing decisions and is in a position to prevent or cause a change of control of us. The interests of Oak Hill could conflict with those of our public debt holders. For example, if we encounter financial difficulties or are unable to pay our debts as they come due, the interests of Oak Hill as an equity holder might conflict with the interests of our noteholders. Oak Hill may have an interest in pursuing acquisitions, divestitures or financings or other transactions that, in its judgment could enhance its equity investment, even though such transactions may involve significant risks to our noteholders. In addition, Oak Hill and its affiliates may in the future own interests in businesses that compete with ours.

Risks Related to Our Capital Structure

Our substantial indebtedness could prevent us from fulfilling our obligations under our indebtedness and may otherwise restrict our activities.

We have a significant amount of indebtedness. As of December 30, 2006, we had a total of approximately $572.5 million of indebtedness outstanding, consisting of approximately $157.1 million outstanding under the amended asset-based revolving loan facility, $210.0 million of outstanding senior secured floating rate notes, $195.0 million of outstanding senior subordinated notes and approximately $10.3 million of capital lease obligations.

Our outstanding indebtedness could:

· make it more difficult for us to satisfy our obligations with respect to either of the notes;

· limit our ability to obtain additional financing for funding our growth strategy, capital expenditures, acquisitions, working capital or other purposes;

· require us to dedicate a substantial portion of our operating cash flow to service our debt, thereby reducing funds available for our growth strategy, capital expenditures, acquisitions, working capital and other purposes;

· increase our vulnerability to adverse economic, regulatory and industry conditions;

· limit our flexibility in planning for, or responding to, changing business and economic conditions, including reacting to any economic slowdown in the New York greater metropolitan area;

· place us at a competitive disadvantage relative to our competitors with less indebtedness; and

· subject us to financial and other restrictive covenants, and our failure to comply with these covenants could result in an event of default, which, if not cured or waived, could result in the acceleration of all of our indebtedness.

During 2006, we extended the maturity of the amended asset-based revolving loan facility from 2008 to 2011. As a condition of this extension, we are required to refinance any outstanding amounts under the amended asset-based revolving loan facility prior to the maturity of any of the notes. We may not be able to obtain such refinancing on commercially reasonable terms or at all. Failure to refinance our indebtedness could have a material, adverse effect on us and could require us to dispose of assets if we cannot refinance our indebtedness.

Despite current indebtedness levels, we and our subsidiaries may still be able to incur substantial additional indebtedness. This could further exacerbate the risks associated with our existing substantial indebtedness.

We and our subsidiaries may be able to incur substantial additional indebtedness in the future. We are able to incur up to $225.0 million in total indebtedness under the amended asset-based revolving loan facility, of which approximately $157.1 million was outstanding as of December 30, 2006. Our ability to borrow under the amended asset-based revolving loan facility is subject to a borrowing base formula. The agreement governing the amended asset-based revolving loan facility also allows us to incur additional other indebtedness. The indentures governing the senior secured floating rate notes and the senior subordinated notes contain some limitations on the ability of Duane Reade Inc., Duane Reade GP and their restricted subsidiaries to incur indebtedness; however, those indentures may not prohibit those entities from incurring additional indebtedness. There is no restriction on the ability of Duane Reade Holdings to incur indebtedness. If new indebtedness is added to our and our subsidiaries’ current indebtedness levels, the related risks that we and they now face would intensify.

The agreements governing our indebtedness include restrictive and financial covenants that may limit our operating and financial flexibility.

The indenture governing the senior secured floating rate notes, the agreement governing the amended asset-based revolving loan facility and the indenture governing the senior subordinated notes contain covenants that, among other things, restrict our ability to take specific actions, even if we believe them to be in our best interest. These include restrictions on the ability of Duane Reade Inc., Duane Reade GP and their restricted subsidiaries to:

· incur additional indebtedness;

· pay dividends or distributions on, or redeem or repurchase, capital stock;

· incur certain liens;

· prepay, redeem or repurchase specified indebtedness;

· merge, consolidate or sell assets or enter into other business combination transactions;

· make acquisitions, capital expenditure investments or other investments;

· enter into transactions with affiliates;

· enter into sale-leaseback transactions;

· use proceeds from sale of assets;

· permit restrictions on the payment of dividends by their subsidiaries;

· impair the collateral; and

· change their business.

In addition, the agreement governing the amended asset-based revolving loan facility contains a financial covenant that will become effective in the event our borrowings under the loan facility result in less than 10% of the lesser of the borrowing base and total commitments remaining available. This financial covenant would require us to comply with a minimum fixed charge coverage ratio. Our failure to meet this financial covenant may result in the accelerated repayment of indebtedness under our amended asset-based revolving loan facility.

As a result of the investigation carried out by our Audit Committee, we failed to timely file this annual report on Form 10-K for the year ended December 30, 2006, and as of the date of the filing of this Form 10-K, we had not filed our quarterly report on Form 10-Q for the quarter ended March 31, 2007 (which was required to be filed with the SEC on or before May 15, 2007). Such failures are defaults under the indentures governing our senior secured floating rate notes and the indenture governing our senior subordinated notes but will not become events of default or result in the acceleration of those notes until after the expiration of the relevant grace periods. The lenders under our amended asset-based revolving loan facility have waived the default relating to the failure to file our Form 10-K until June 29, 2007, and they have also waived the default relating to the failure to file our Form 10-Q until July 15, 2007. The filing of this 10-K has cured the default relating to its late filing, and we anticipate we will be able to file the Form 10-Q prior to July 15, 2007.

ITEM 2. PROPERTIES

As of December 30, 2006, we were operating stores in the following locations:

	No. of Stores
Manhattan, NY		134
Brooklyn, NY		32
Queens, NY		30
New Jersey		13
Bronx, NY		12
Staten Island, NY		10
Nassau County, NY		8
Westchester County, NY		7
Suffolk County, NY		2
Total		248

All of our stores operated at December 30, 2006 are leased. Store leases generally average initial terms of 12 to 15 years. The average year of expiration for stores operating as of December 30, 2006 is 2015. Lease rates are generally subject to scheduled increases that average approximately 12% every five years. The following table sets forth the lease expiration dates of our leased stores on an annual basis through 2011 and thereafter. Of the 57 stores with leases expiring by December 31, 2011, 20 have renewal options.

	No. of Leases		Number With
Year	Expiring		Renewal Options
2007		9		0
2008		13		6
2009		13		4
2010		14		7
2011		8		3
Thereafter		191		98

We occupy approximately 70,000 square feet for our corporate headquarters, located in Manhattan, New York City, under a lease that expires in 2012.

We occupy approximately 506,000 square feet of warehouse space in Maspeth, Queens, New York City under a lease that expires in 2017.

We occupy approximately 114,000 square feet of warehouse space in North Bergen, New Jersey under a lease that expires in 2008.

ITEM 3. LEGAL PROCEEDINGS

We are party to legal actions arising in the ordinary course of business. Based on information presently available to us, we believe that the ultimate outcome of these actions will not have a material, adverse effect on the financial position, results of operations or cash flows of our company. In addition, we are a party to the following legal actions and matters:

During 2002, we initiated a legal action against our former property insurance carrier, in an attempt to recover what we believe to be a fair and reasonable settlement for the business interruption portion of our claim originating from the September 11, 2001 World Trade Center terrorist attack, during which our single highest volume and most profitable store was completely destroyed. After a lengthy litigation and

appraisal process, an appraisal panel awarded us approximately $5.6 million (in addition to the $9.9 million that was paid by the insurer to us 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 which is presently pending in the U.S. District Court for the Southern District to recover both the appraisal panel’s award and additional amounts under the policy.

Accordingly, given the risks and uncertainties inherent in litigation, there can be no definitive assurance that we will actually receive any or all of the panel’s appraised value of this claim, and we have 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 us 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 $6.0 million.

In December 2005, we and Cardinal Health, a former pharmacy inventory supplier, settled all matters relating to litigation arising out of a dispute regarding certain former supply arrangements and agreements. Under the terms of this settlement, we paid Cardinal Health $4.5 million over a period of time to settle an outstanding trade payable, and entered into an agreement whereby Cardinal will provide a secondary supply of pharmaceutical products to us until certain minimum purchase levels are achieved.

In November 2004, Duane Reade Inc. was served with a class action complaint, Damassia v. Duane Reade Inc. The lawsuit was filed in the United States District Court, Southern District of New York. The complaint alleges that, from the period beginning November 1998, we 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. We believe this claim to be without merit, and we intend to defend ourselves 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, we were served with a purported class action complaint, Enamul Chowdhury v. Duane Reade Inc. and Duane Reade Holdings, Inc. The complaint alleges that, from a period beginning March 2000, we 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. The complaint seeks an unspecified amount of damages. We believe this claim to be without merit, and intend to vigorously defend ourselves 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 January 2005, the Equal Employment Opportunity Commission filed an action against us in the U.S. District Court for the Southern District of New York alleging, among other things, that we created a hostile work environment for three female store employees, and potentially a class of such female employees. We believe that we have reached a settlement of this litigation, which settlement will not have a material impact on us or on our operating results.

In November 2006, the Attorney General of the State of New Jersey filed an action against us alleging that we violated certain state regulations including regulations relating to the presence of expired products on our shelves and certain pricing regulations. We have been in discussions with the Attorney General’s office regarding settling this action; however, there can be no assurance that this action will be settled on terms acceptable to us or at all. We believe that we have valid defenses to this action and we intend to vigorously defend ourselves.

Proceedings Relating to the Former Chairman and Chief Executive Officer

On September 1, 2006, Anthony J. Cuti, the former Chairman, President and Chief Executive Officer, initiated an arbitration before the American Arbitration Association against Duane Reade Inc., Duane

Reade Holdings, Inc. and Duane Reade Shareholders, LLC, which we refer 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 our virtual pharmacy kiosk system and payment of an alleged deferred 2001 bonus based on any insurance recovery we may obtain on our 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 our stores, that led to overstating our publicly reported earnings, and that caused us 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 our April 2, 2007 press release, we disclosed that, based on new information provided to us, 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 us 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 our publicly reported earnings, and that caused us 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 our previously-issued financial statements would have to be restated. The restatements and the results of the investigation are discussed more fully in Note 2 to the audited financial statements contained in this report.

On May 22, 2007, we 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. We are cooperating fully with the investigation. The SEC has also requested that we 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. The arbitrator has ordered briefing by the parties on the application.

Litigation Relating to the Acquisition

We are aware of six purported class action complaints challenging the Acquisition consummated by us and Duane Reade Acquisition that have been filed in the Court of Chancery of the State of Delaware, referred to as the “Delaware Complaints,” and three purported class action complaints that have been filed in the Supreme Court of the State of New York. Two of the New York complaints have been dismissed without prejudice. The other New York complaint (the “New York Complaint”) is pending, but has not been served on us. The Delaware Complaints name the former Chairman and CEO and certain other members of our board of directors and executive officers as well as Duane Reade GP as defendants. Four of the Delaware Complaints name Oak Hill as a defendant. The New York Complaint names the former Chairman and CEO and certain other members of our board of directors and executive officers as well as Duane Reade GP as defendants. One of the dismissed New York complaints named Oak Hill as a defendant.

The Delaware Complaints were consolidated on January 28, 2004, and on April 8, 2004 the plaintiffs in the Delaware actions filed a consolidated class action complaint. We believe these lawsuits are without merit and plan to defend these lawsuits vigorously. The plaintiffs in this litigation have been inactive for over three years.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the fourth quarter of fiscal 2006, we did not submit any matters to a vote of our security holders.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

As a result of the Acquisition, we have no publicly traded common stock and we have paid no dividends on our common stock since the Acquisition. Our predecessor paid no dividends in 2004 or 2003.

ITEM 6. SELECTED FINANCIAL DATA

The Selected Financial Data presented below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Audited Financial Statements and the notes related to those statements contained herein.

Duane Reade Holdings, Inc. was formed in December 2003 to acquire Duane Reade Inc. and its subsidiaries. Duane Reade Holdings, Inc. is a wholly-owned subsidiary of Duane Reade Shareholders, LLC, a parent entity also established to effectuate the Acquisition. The Acquisition was completed on July 30, 2004 through the merger of Duane Reade Acquisition (a wholly-owned subsidiary of Duane Reade Holdings, Inc.) into Duane Reade Inc. with Duane Reade Inc. being the surviving entity and a wholly-owned subsidiary of Duane Reade Holdings, Inc. after the merger transaction. As a result of the Acquisition and resulting change in control and change in historical cost basis of accounting, the operating results are presented separately for predecessor periods up to and including the closing date of the Acquisition (December 28, 2003 through July 30, 2004 and the fiscal years 2002 and 2003) and the successor periods following the closing date of the Acquisition (July 31, 2004 through December 25, 2004 and the fiscal years ending December 31, 2005 and December 30, 2006). The predecessor period financial statements include Duane Reade Inc. and all its subsidiaries and the successor period financial statements include Duane Reade Holdings, Inc. and all its subsidiaries. Duane Reade Holdings, Inc. had nominal activity and no operations prior to the completion of the Acquisition. Except where the context otherwise requires, all references to “we,” “us,” and “our” (and similar terms) in the data below and the related

footnotes mean the successor for periods ending after July 30, 2004 and the predecessor for periods ending on or prior to July 30, 2004.

The summary historical consolidated financial and other data set forth below as of and for the fiscal years ended December 28, 2002 and December 27, 2003, for the periods from December 28, 2003 to July 30, 2004 and from July 31, 2004 to December 25, 2004 and for the fiscal years ended December 31, 2005 and December 30, 2006 have been derived from our audited consolidated financial statements.

The financial data contained in this annual report reflect the restatements of our previously-issued financial statements as of and for the five months ended December 25, 2004, the seven months ended July 30, 2004 and the 2000 through 2003 fiscal years (collectively, the “Affected Periods”). The restatements resulted from an investigation that was conducted by our Audit Committee, with the assistance of independent counsel and forensic accountants, relating to real estate transactions and related matters that occurred during the 2000 through 2004 fiscal years for which the Company’s accounting was found to be improper. The independent counsel concluded that such transactions and matters had been orchestrated by the former Chairman and CEO. The restatements of the Affected Period financial statements also include corrections of misstatements in such financial statements that related to arrangements originated by the former Chairman and CEO for the issuance of improper credits and the subsequent rebilling of such credits related to amounts paid to construction and other contractors at our stores, which were the subject of a prior Audit Committee investigation. The restatements of the Affected Period financial statements have had no material impact on the financial statements for any periods in the 2005 or 2006 fiscal years and are not expected to have a material impact on the financial statements for any periods in the 2007 fiscal year. Please refer to Note 2 to the audited financial statements contained in this report for more information regarding the restatements and related impacts.

	Successor										Predecessor—Restated
							Restated
							Period from				Period from
							July 31, 2004				Dec. 28, 2003
	Fiscal Year(1)						through				through				Fiscal Year(1)
	2006			2005			Dec. 25, 2004(2)(3)				July 30, 2004(2)(3)				2003(3)			2002(3)
Statement of Operations Data
Net sales	$	1,584,778		$	1,589,451			$	670,568			$	927,801		$	1,465,275		$	1,325,523
Cost of sales	1,260,215			1,287,855				546,351				745,973			1,169,564			1,044,419
Gross profit	324,563			301,596				124,217				181,828			295,711			281,104
Selling, general & administrative expenses	275,044			273,672				101,677				142,268			229,900			201,814
Transaction expenses(4)	—			681				37,575				3,005			644			—
Labor contingency expense(5)	(18,004		)	4,400				1,789				2,611			12,600			—
Insurance recovery(6)	—			—				—				—			—			(9,378		)
Depreciation and amortization	71,932			70,594				27,009				21,396			31,419			26,374
Store pre-opening expenses	305			364				365				470			1,063			2,086
Other(7)	14,747			31,761				26,433				—			—			—
Operating (loss) income	(19,461		)	(79,876		)		(70,631		)		12,078			20,085			60,208
Interest expense, net	56,947			50,004				15,880				7,977			14,117			17,925
Debt extinguishment(8)	—			—				7,525				—			812			11,371
(Loss) income before income taxes and cumulative effect of accounting change	(76,408		)	(129,880		)		(94,036		)		4,101			5,156			30,912
Income tax (expense) benefit	(2,956		)	29,492				36,499				(1,046		)	(1,399		)	(11,001		)
(Loss) income before cumulative effect of accounting change	(79,364		)	(100,388		)		(57,537		)		3,055			3,757			19,911
Cumulative effect of accounting change, net(9)								—				—			—			(9,262		)
Net (loss) income	$	(79,364	)	$	(100,388	)		$	(57,537	)		$	3,055		$	3,757		$	10,649
Balance Sheet Data (at end of period)
Working capital(10)	$	6,204		$	50,384			$	67,073			N/A			$	155,873		$	230,031
Total assets	$	798,581		$	869,602			$	953,918			N/A			$	789,766		$	735,903
Total debt and capital lease obligations	$	572,464		$	554,222			$	511,690			N/A			$	272,910		$	269,741
Stockholders’ equity	$	2,737		$	81,834			$	181,961			N/A			$	318,630		$	312,494
Operating and Other Data
Net cash (used in) provided by operating activities	$	11,616		$	3,004			$	(11,561	)		$	20,694		$	45,536		$	36,377
Net cash used in investing activities	$	(29,070	)	$	(26,629	)		$	(437,249	)		$	(31,619	)	$	(53,207	)	$	(54,360	)
Net cash provided by financing activities	$	17,487		$	23,658			$	448,801			$	11,011		$	4,740		$	17,194
Number of stores at end of period	248			251				255				N/A			241			228
Same store sales growth(11)	4.6		%	1.9		%		0.6		%		N/A			2.7		%	4.8		%
Pharmacy same store sales growth(11)	2.6		%	0.8		%		5.0		%		N/A			7.5		%	12.1		%
Front-end same store sales growth(11)	6.2		%	2.8		%		-2.8		%		N/A			-0.8		%	0.0		%
Average store size (square feet) at end of period	6,987			6,955				7,035				N/A			7,115			6,921
Sales per square foot	$	881		$	862			$	813			N/A			$	816		$	836
Pharmacy sales as a % of net sales(12)	46.4		%	48.1		%		51.0		%		N/A			46.7		%	44.0		%
Third party plan sales as a % of prescription sales	92.8		%	92.7		%		92.3		%		N/A			91.4		%	90.2		%
Investing Activities:
Purchase of Duane Reade	$	—		$	—			$	413,684			$	—		$	—		$	—
New, remodeled and relocated stores	14,104			14,056				11,803				17,214			29,074			39,497
Office and warehouse expansions	—			—				—				—			2,070			528
Acquisitions	—			2,437				7,361				8,741			7,579			5,954
Asset proceeds	(2,500		)	(7,069		)		—				—			—			—
Other	17,466			17,205				4,401				5,664			14,484			8,381
Total	$	29,070		$	26,629			$	437,249			$	31,619		$	53,207		$	54,360

(1) The 2005 fiscal year contains 53 weeks. All other years shown contain 52 weeks.

(2) Statistics shown in the successor period reflect data for the 12 months ended December 25, 2004, as we do not provide these statistics on a partial year basis. Items identified as N/A are not reported by us for the 2004 predecessor period.

(3) The financial data for the periods indicated have been restated as a result of the investigation described in the introduction to these Selected Financial Data. Please refer to Note 2 to the audited financial statements contained in this report for more information regarding the restatements and related impacts.

Duane Reade Inc.
Profit & Loss Restatement

		Predecessor
		Year			Year
		Ended			Ended
		12/27/03			12/28/02
Cost of sales	as previously reported	$	1,168,408		$	1,041,303
	adjustment—Credits & Rebillings	—			—
	adjustment—Real Estate	1,156			3,116
	as restated	$	1,169,564		$	1,044,419
Gross profit	as previously reported	$	296,867		$	284,220
	adjustment—Credits & Rebillings	—			—
	adjustment—Real Estate	(1,156		)	(3,116		)
	as restated	$	295,711		$	281,104
Selling, general and administrative expenses	as previously reported	$	229,148		$	198,770
	adjustment—Credits & Rebillings	752			3,060
	adjustment—Real Estate	—			(16		)
	as restated	$	229,900		$	201,814
Depreciation and amortization expenses	as previously reported	$	32,335		$	26,935
	adjustment—Credits & Rebillings	(514		)	(323		)
	adjustment—Real Estate	(402		)	(238		)
	as restated	$	31,419		$	26,374
Operating income	as previously reported	$	21,077		$	65,807
	adjustment	(992		)	(5,599		)
	as restated	$	20,085		$	60,208
Earnings before tax	as previously reported	$	6,148		$	36,511
	adjustment	(992		)	(5,599		)
	as restated	$	5,156		$	30,912
Income tax provison	as previously reported	$	1,669		$	12,994
	adjustment	(270		)	(1,993		)
	as restated	$	1,399		$	11,001
Net income	as previously reported	$	4,479		$	14,255
	adjustment	(722		)	(3,606		)
	as restated	$	3,757		$	10,649

Duane Reade Inc.
Balance Sheet Restatement

		Predecessor
		Year			Year
		Ended			Ended
		12/27/03			12/28/02
Total assets	as previously reported	$	797,372		$	742,711
	adjustment	(7,606		)	(6,808		)
	as restated	$	789,766		$	735,903
Stockholder’s equity	as previously reported	$	327,261		$	320,403
	adjustment	(8,631		)	(7,909		)
	as restated	$	318,630		$	312,494

As at December 29, 2001, the cumulative impact on accumulated deficit was an increase of $4,303 and the cumulative impact on Stockholder’s equity was a decrease of $4,303.

Duane Reade Inc.
Operating and Other Data Restatement

		Predecessor
		Year				Year
		Ended				Ended
		12/27/03				12/28/02
Net cash (used in) provided by operating activities	as previously reported		$	47,444			$	42,537
	adjustment		(1,908		)		(6,160		)
	as restated		$	45,536			$	36,377
Net cash used in investing activities	as previously reported		$	55,115			$	60,520
	adjustment		(1,908		)		(6,160		)
	as restated		$	53,207			$	54,360
Detail of cash used in investing activities:
Other	as previously reported		$	16,392			$	14,541
	adjustment		(1,908		)		(6,160		)
	as restated		$	14,484			$	8,381

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 filing reflect the accounts of Duane Reade Holdings, Inc. and its subsidiaries for periods ending after July 30, 2004 and Duane Reade Inc. and its subsidiaries for periods ending on or earlier than July 30, 2004. All significant intercompany transactions and balances have been eliminated.

Considerations Related to Operating in the New York City Marketplace

All of our operations are conducted within the New York greater 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.

Between 2001 and 2003, the New York City economy experienced a regional cyclical downturn and a series of unusual events, such as the World Trade Center attacks and non-recurring increases in real estate taxes and insurance costs. The New York greater metropolitan area experienced above average unemployment levels, especially in the key midtown and downtown Manhattan financial districts and lagged behind the improving national economy throughout 2003 and the early part of 2004. However, since the second half of 2004, it has shown steady improvements in employment, tourism and overall commerce. The December 2006 unemployment data for New York City indicated an unemployment rate of 4.3%, compared to a national rate of 4.5%.

Impact of the Acquisition

The July 30, 2004 acquisition of Duane Reade Inc. was completed through a merger transaction with Duane Reade Acquisition, which was an acquisition vehicle formed by Oak Hill, a private equity firm. The aggregate value of the Acquisition was $747.5 million, including transaction expenses and the repayment of a portion of our indebtedness. As a result of the Acquisition, Duane Reade Inc.’s shares ceased to be listed on the New York Stock Exchange, and we now operate as a privately held company. Each share of Duane Reade Inc.’s common stock outstanding immediately prior to the Acquisition was converted into the right to receive $16.50 per share, without interest, in cash.

In connection with the Acquisition, we incurred significant additional indebtedness, including $195.0 million of senior subordinated notes, $155.0 million of borrowings under a senior term loan facility (which was refinanced in December 2004 in connection with the issuance of $160.0 million of senior secured floating rate notes), and $72.0 million of new borrowings under the amended asset-based revolving facility. On August 12, 2004, Duane Reade Inc. commenced a cash tender offer to repurchase the outstanding 2.1478% senior convertible notes in accordance with the indenture governing those notes. Pursuant to that offer, on September 13, 2004, Duane Reade Inc. completed the repurchase of a total of approximately $350.9 million aggregate principal amount at maturity of the senior convertible notes for a

cash purchase price of approximately $204.1 million, which represented 100% of the originally issued amount of the notes purchased, plus accrued but unpaid interest through the payment date. Following completion of the tender offer, $55,000 principal amount at maturity of those notes remained outstanding. As a result of the debt related financing of the Acquisition, our interest expense has been substantially higher following the Acquisition than our predecessor incurred in prior periods. We also pay a management fee of $1.3 million per year, payable quarterly, under our management agreement with an affiliate of Oak Hill Capital Partners, L.P.

The Acquisition was accounted for as a purchase, in accordance with the provisions of Statement of Financial Accounting Standards No. 141, “Business Combinations”, which resulted in new valuations for our and our subsidiaries’ assets and liabilities based on fair values as of the date of the Acquisition. These valuations were largely based on appraisals provided by an independent valuation consultant employed for this purpose.

RESULTS OF OPERATIONS

As mentioned above, due to the Acquisition and the resulting change in ownership, we are required to present separately our operating results for the predecessor period in the 2004 fiscal year (December 28, 2003 through July 30, 2004) and the successor period in the 2004 fiscal year (July 31, 2004 through December 25, 2004). In the following discussions, these periods (which we refer to as “fiscal 2004”) are compared to the 53-week successor period ended December 31, 2005. Management believes this is the most practical way to comment on our results of operations.

2006 and 2005 Overview

For the 2006 fiscal year, we achieved net sales of $1.585 billion and incurred a net loss of $79.4 million, as compared to net sales of $1.589 billion and a net loss of $100.4 million in the 2005 fiscal year. The 2005 fiscal year included an extra week of sales compared to 2006. Resales of pharmaceutical retail inventory were $54.4 million in 2006 as compared to $84.3 million in 2005. The loss sustained in the 2006 fiscal year was primarily attributable to the following factors:

· Pre-tax expenses of $14.7 million, reflecting a $10.2 million non-cash asset valuation write-down resulting from our SFAS No. 144 impairment analysis of certain stores, $2.9 million of costs associated with the former Chairman and CEO, $1.9 million of expenses attributable to the formation of our new management team, $1.3 million of Oak Hill management fees and $0.8 million of expenses associated with an accounting investigation conducted by our Audit Committee. These amounts were partially offset by the reversal of the $2.4 million excess liability for our Phantom Stock. These costs are contained within the caption “Other” on our Consolidated Statement of Operations.

· Pre-tax interest expenses of $56.9 million primarily related to the increased debt incurred in connection with the July 30, 2004 Acquisition, the additional $50.0 million senior secured notes issued during 2005 and increasing interest rates.

· Non-cash depreciation and amortization expenses of $71.9 million in 2006, including the impact of the Acquisition related purchase accounting adjustments to the valuation of store leases, prescription pharmacy files and property, plant and equipment.

These items were partially offset by non-recurring pre-tax income of $18.0 million recorded in 2006 to reflect the settlement of a labor dispute with a union which, at December 30, 2006, represented associates in 138 of our stores.

For the 2006 fiscal year, gross profit margin was 20.5%, as compared to 19.0% in the 2005 fiscal year. Gross profit margin in 2006 was positively affected by higher front-end selling margins, increased vendor allowances, reduced inventory shrink losses and improved sales leverage on store occupancy costs.

Selling, general and administrative expenses for 2006 were 17.4% of sales, as compared to 17.2% of sales in 2005. The increase in 2006 as compared to the prior year is primarily due to the decline in resale activity in 2006 which had the effect of increasing our 2006 operating expense ratios to gross sales. Because resale activity does not incur any significant selling, general and administrative costs, we believe it is more informative to discuss such costs as a percentage of sales, excluding such resale activity. Excluding the impact of the resale activity, SG&A expenses for 2006 were 18.0%, as compared to 18.2% in 2005. The decreased SG&A expenses in the current year compared to 2005 are primarily due to reduced legal, consulting and litigation-related expenses and various process related efficiencies, partially offset by increases in minimum wage rates and higher store pharmacist labor costs. The reduced legal and consulting costs reflect our efforts to resolve certain long-standing legal matters, the most significant of which are related to our efforts to recover the balance of our September 11 business interruption insurance claim and our litigation over the NLRB ruling in a dispute with one of our former unions. In addition, in 2006 we incurred $1.5 million of consulting expenses associated with a number of operational initiatives designed to improve sales and margins, reduce inventory shrink losses and improve working capital management. The increased pharmacist labor rates were due to the continued industry-wide workforce shortage of these professionals and the resultant increase in costs to fill these important positions.

2005 and 2004 Overview

For the 2005 fiscal year, we achieved net sales of $1.589 billion and incurred a net loss of $100.4 million, as compared to net sales of $670.6 million and a net loss of $57.5 million in the period from July 31, 2004 through December 25, 2004 and net sales of $927.8 million and net income of $3.1 million for the period from December 28, 2003 through July 30, 2004. Resales of pharmaceutical retail inventory were $84.3 million in 2005, $81.9 million in the period from July 31, 2004 through December 25, 2004 and $81.0 million for the period from December 28, 2003 through July 30, 2004. The loss sustained in the 2005 fiscal year was primarily attributable to the following factors:

· Pre-tax expenses of $31.8 million reflecting a $16.6 million non-cash write-down of our tradename valuation resulting from our annual impairment analysis, $11.8 million of expenses associated primarily with severance and other accelerated compensation-related costs resulting from the November 21, 2005 departure of the former Chairman and CEO, $2.1 million of costs related to our decision to close certain underperforming retail locations and $1.3 million of Oak Hill management fees. These costs are contained within the caption entitled “Other” on our Consolidated Statements of Operations.

· Pre-tax interest expenses of $50.0 million primarily related to the increased debt incurred in connection with the July 30, 2004 Acquisition, the additional $50.0 million senior secured notes issued during 2005 and increasing interest rates.

· Non-cash depreciation and amortization expenses of $70.6 million in 2005, including the full year impact of the Acquisition related purchase accounting adjustments to the valuation of store leases, prescription pharmacy files and property, plant and equipment.

For the 2005 fiscal year, gross profit margin was 19.0%, as compared to 18.5% and 19.6% for the 2004 periods subsequent to and prior to the Acquisition, respectively. Gross profit margin in 2005 was negatively affected by reduced levels of vendor rebates and allowances, increased inventory shrink losses and higher store occupancy costs.

Selling, general and administrative expenses for 2005 were 17.2% of sales, as compared to 15.2% and 15.3% in the 2004 periods subsequent to and prior to the Acquisition, respectively. The increase in 2005 as compared to the prior year is partially due to the decline in resale activity which had the effect of increasing our operating expense ratios to gross sales. Because resale activity does not incur any significant selling, general and administrative costs, we believe it is more informative to discuss such costs as a percentage of sales, excluding such resale activity. Excluding the impact of the resale activity, SG&A expenses for 2005 were 18.2%, as compared to 17.3% and 16.8% in the 2004 periods subsequent and prior to the acquisition, respectively. The increased SG&A expenses in the current year compared to the successor and predecessor periods in 2004 is primarily due to greater legal, consulting and litigation-related expenses, increases in minimum wage rates, and higher store pharmacist labor costs. The increased legal and consulting costs were attributable to our efforts to resolve certain legal matters, the most significant of which are related to our efforts to recover the balance of our September 11 business interruption insurance claim and our litigation over the NLRB ruling in a dispute with one of our former unions. In addition, in 2005 we incurred $3.6 million of consulting expenses associated with a number of operational initiatives designed to improve sales and margins, reduce inventory shrink losses and improve working capital management. The increased pharmacist labor rates were due to the continued industry-wide workforce shortage of these professionals and the resultant increase in costs to fill these critical positions.

The following sets forth our results of operations in dollars (in thousands) and as a percentage of sales for the periods indicated.

	Successor																		Predecessor
													Restated						Restated
													Period from						Period from
	Fiscal Year						Fiscal Year						July 31, 2004						Dec. 28, 2003
	Ended						Ended						through						through
	December 30, 2006						December 31, 2005						Dec. 25, 2004						July 30, 2004
	Dollars			% of Sales			Dollars			% of Sales			Dollars			% of Sales			Dollars			% of Sales
Net sales	$	1,584,778			100.0	%	$	1,589,451			100.0	%	$	670,568			100.0	%	$	927,801			100.0	%
Cost of sales	1,260,215				79.5	%	1,287,855				81.0	%	546,351				81.5	%	745,973				80.4	%
Gross profit	324,563				20.5	%	301,596				19.0	%	124,217				18.5	%	181,828				19.6	%
Selling, general and administrative expenses	275,044				17.4	%	273,672				17.2	%	101,677				15.2	%	142,268				15.3	%
Transaction expenses	—				0.0	%	681				0.0	%	37,575				5.6	%	3,005				0.3	%
Labor contingency expense	(18,004		)		-1.1	%	4,400				0.3	%	1,789				0.3	%	2,611				0.4	%
Depreciation and amortization	71,932				4.5	%	70,594				4.4	%	27,009				4.0	%	21,396				2.3	%
Store pre-opening expenses	305				0.0	%	364				0.0	%	365				0.1	%	470				0.1	%
Other	14,747				0.9	%	31,761				2.0	%	26,433				3.9	%	—				0.0	%
Operating (loss) income	(19,461		)		-1.2	%	(79,876		)		-5.0	%	(70,631		)		-10.5	%	12,078				1.3	%
Net interest expense	56,947				3.6	%	50,004				3.1	%	15,880				2.4	%	7,977				0.9	%
Debt extinguishment	—				0.0	%	—				0.0	%	7,525				1.1	%	—				0.0	%
(Loss) income before income taxes	(76,408		)		-4.8	%	(129,880		)		-8.2	%	(94,036		)		-14.0	%	4,101				0.4	%
Income tax (expense) benefit	(2,956		)		-0.2	%	29,492				1.9	%	36,499				5.4	%	(1,046		)		-0.1	%
Net (loss) income	$	(79,364	)		-5.0	%	$	(100,388	)		-6.3	%	$	(57,537	)		-8.6	%	$	3,055			0.3	%

The Twelve Months Ended December 30, 2006 Compared to the Twelve Months Ended December 31, 2005

Net sales were $1.58 billion in 2006 and $1.59 billion in 2005. 2006 net sales decreased by 0.3% as compared to the prior year net sales. Resale activity decreased by $29.8 million in 2006 compared to 2005, which represented a 1.9% decrease in overall net sales, while retail sales to customers increased by 1.7% over this same period. The extra 53rd week in 2005 accounted for $25.1 million of retail sales, without which the change in retail sales from 2005 to 2006 would have been an increase of 3.4%. The significant decline in resale activity was due to a general decrease in demand for branded pharmaceutical resales in favor of lower priced generic drugs. The decline in resale activity did not have a material impact on profitability or cash flows. Although overall 2006 same-store sales increased by 4.6% over 2005, the net sales impact of the improvement in same-store sales was offset by one less week of sales than in 2005, the full twelve month impact in 2006 of four net store closures in 2005 as well as the three net store closures in 2006.

Pharmacy sales were $736.1 million in 2006, a decrease of 3.6% as compared to 2005 pharmacy sales of $764.0 million. Reduced resale activity in 2006 accounted for 3.9% of the pharmacy sales decrease, while retail pharmacy sales to customers increased by 0.3% over the prior year. The extra week in 2005 accounted for $11.2 million of retail pharmacy sales, without which the change in retail pharmacy sales from 2005 to 2006 would have been an increase of 2.0%. Pharmacy same-store sales increased by 2.6% over 2005, and third-party reimbursed pharmacy sales represented 92.8% of total prescription sales, compared to 92.7% in fiscal 2005. During 2006, pharmacy same-store sales growth rates showed gradual improvement, increasing to 6.0% in the fourth quarter. The major factors driving the improved trend was the decision of a major union prescription plan to eliminate mandatory mail order requirements, easier access to coverage for proton pump inhibitors under New York State Medicaid and improvements in pharmacy services.

Front-end sales were $848.6 million in 2006 and $825.4 million in 2005, reflecting a year-over-year increase of 2.8%. The extra week in 2005 accounted for $13.9 million of front-end sales, without which the change in front-end sales from 2005 to 2006 would have been an increase of 4.6%. 2006 front-end same-store sales increased by 6.2% from 2005 primarily due to a steadily improving New York City economy, improvements in merchandising and customer service resulting from Duane Reade Full Potential and our enhanced Dollar Rewards customer loyalty card program.

During 2006, we opened five stores and closed eight stores, as compared to seven stores opened and eleven stores closed in 2005. At December 30, 2006, we operated 248 stores.

Cost of sales as a percentage of net sales in 2006 and 2005 was 79.5% and 81.0%, respectively, resulting in gross profit margins of 20.5% and 19.0%, respectively. As discussed above, gross profit margin in 2006 was positively affected by increased selling margins, higher levels of vendor rebates and allowances, reduced inventory shrink losses and improvements resulting from the enhanced Dollar Rewards loyalty card program. In addition we experienced an improved level of sales leverage relative to store occupancy costs.

litigation over the NLRB ruling in a dispute with one of our former unions. In addition, we incurred $1.5 million of consulting expenses associated with a number of operational initiatives designed to improve sales and margins, reduce inventory shrink losses and improve working capital management. The increased pharmacist labor rates were due to the continued industry-wide workforce shortage of these professionals and the resultant increase in costs to fill these critical positions. For a more detailed discussion of litigation related matters see “Item 3. Legal Proceedings.”

Depreciation of capital expenditures and amortization of intangibles was $71.9 million in 2006 and $70.6 million in 2005. The overall 2006 increase versus 2005 resulted from the depreciation of capital expenditures made in 2005 and 2006.

We incurred store pre-opening expenses of $0.3 million in 2006 related to the opening of five stores, while in 2005 we opened seven stores and incurred pre-opening expenses of $0.4 million.

Net interest expense in the 2006 fiscal year was $56.9 million, as compared to interest expenses of $50.0 million in fiscal 2005. The increase in 2006 as compared to 2005 was primarily attributable to the full-year impact of interest charges for the $50.0 million additional senior secured floating rate notes issued in August 2005, increased borrowings under our amended asset-based revolving loan facility since the end of 2005 as well as higher interest rates associated with the floating rate notes and our amended asset-based revolving credit facility.

In 2006, we recorded an income tax provision of $3.0 million, net of a valuation allowance of $38.1 million, while in 2005, we recorded an income tax benefit of $29.5 million, net of a valuation allowance of $30.4 million. The valuation allowances reflect the significant losses incurred in these years, as well as the anticipated financial performance over the next several years and the unlikelihood of recognizing the future benefits of the accumulated losses.

The Twelve Months Ended December 31, 2005 for the Successor Compared to the Period from July 31, 2004 through December 25, 2004 for the Successor and the Period from December 28, 2003 through July 30, 2004 for the Predecessor

Net sales were $1.59 billion in 2005, $670.6 million in the July 31, 2004 through December 25, 2004 period and $927.8 million in the December 28, 2003 through July 30, 2004 period. 2005 net sales decreased by 0.6% as compared to the aggregate prior year net sales. Resale activity decreased by 48.3% over the comparable period, while retail sales to customers increased by 4.9% over this same period. The extra 53rd week in 2005 contributed $25.5 million or 1.6% of this increase. The significant decline in resale activity was partially due to the loss of a large customer. Because gross margins on resale activity are less than one percent, the decline in resale activity did not have a material impact on profitability or cash flows. Overall 2005 same-store sales on a 52-week basis increased by 1.9% over 2004 with the balance of the sales increase coming from the full twelve month results of 14 net new stores opened last year, partially offset by the four net store closures in 2005.

Pharmacy sales were $764.0 million in 2005, a decrease of 6.3% as compared to aggregate 2004 pharmacy sales of $815.7 million. Reduced resale activity in 2005 accounted for 9.6% of the pharmacy sales decrease, while retail pharmacy sales to customers increased by 4.1% over the prior year. Pharmacy same-store sales on a 52-week basis increased by 0.8% over 2004, and third-party reimbursed pharmacy sales represented 92.7% of total prescription sales, compared to 92.3% in fiscal 2004. During 2005, pharmacy same-store sales continued to experience the general industry trend of reduced growth rates experienced during the last several years. The major factors driving the slower sales growth rates in pharmacy were the trends toward increases in third party plan customer co-payments, reduced sales of hormonal replacement drugs and certain arthritis medications, an increased proportion of lower priced generic prescriptions, and increased penetration by mail order and internet-based pharmacies.

Front-end sales were $825.4 million in 2005, $320.1 million in the July 31, 2004 through December 25, 2004 period and $462.5 million in the December 28, 2003 through July 30, 2004 period. Front-end sales in 2005 increased by 5.5% as compared to 2004 total predecessor and successor front-end sales. 2005 front-end same-store sales on a 52-week basis increased by 2.8% from 2004 primarily due to a steadily improving New York City economy and our enhanced Dollar Rewards customer loyalty card program.

During 2005, we opened seven stores and closed 11 stores, as compared to seven stores opened and one store closed in the period from July 31, 2004 through December 25, 2004 and nine stores opened and one store closed in the period from December 28, 2003 through July 30, 2004.

Cost of sales as a percentage of net sales in 2005 was 81.0%, resulting in a gross profit margin of 19.0%. Cost of sales as a percentage of net sales was 81.5% for the period from July 31, 2004 through December 25, 2004 and 80.4% for the period from December 28, 2003 through July 30, 2004, resulting in gross profit margins of 18.5% and 19.6%, respectively. As discussed above, gross profit margin in 2005 was negatively affected by lower levels of vendor rebates and allowances, increased inventory shrink losses and higher store occupancy costs.

Selling, general and administrative expenses for 2005 were 17.2% of sales, as compared to 15.2% and 15.3% in the 2004 periods subsequent to and prior to the Acquisition, respectively. The increase in 2005 as compared to the prior year is partially due to the decline in resale activity which had the effect of increasing our operating expense ratios to gross sales. Because resale activity does not incur any significant selling, general and administrative costs, we believe it is more informative to discuss such costs as a percentage of sales, excluding such resale activity. Excluding the impact of the resale activity, SG&A expenses for 2005 were 18.2%, as compared to 17.3% and 16.8% in the 2004 periods subsequent and prior to the acquisition, respectively. The increased SG&A expense percentage in the current year compared to the successor and predecessor periods in 2004 is primarily due to greater legal, consulting and litigation-related expenses, increases in minimum wage rates and higher store pharmacist labor costs. The increased legal and consulting costs were attributable to our efforts to resolve certain legal matters, the most significant of which are related to our efforts to recover the balance of our September 11 business interruption insurance claim and our litigation over the NLRB ruling in a dispute with one of our former unions. In addition, we incurred $3.6 million of consulting expenses associated with a number of operational initiatives designed to improve sales and margins, reduce inventory shrink losses and improve working capital management. The increased pharmacist labor rates were due to the continued industry-wide workforce shortage of these professionals and the resultant increase in costs to fill these critical positions. For a more detailed discussion of litigation related matters see “Item 3. Legal Proceedings.”

Depreciation of capital expenditures and amortization of intangibles was $70.6 million in 2005, $27.0 million in the July 31, 2004 through December 25, 2004 period and $21.4 million in the December 28, 2003 through July 30, 2004 period. The overall 2005 increase versus 2004 resulted from the depreciation of capital expenditures made in 2004 and 2005, as well as the full year impact of the Acquisition related purchase accounting adjustments to the valuation of store leases, prescription pharmacy files and property, plant and equipment.

We incurred store pre-opening expenses of $0.4 million in 2005 related to the opening of seven stores. In the period from July 31, 2004 through December 25, 2004, we incurred pre-opening expenses of $0.4 million and in the period from December 28, 2003 through July 30, 2004 we incurred pre-opening expenses of $0.5 million, related to the opening of seven stores and nine stores, respectively.

Net interest expense in the 2005 fiscal year was $50.0 million, as compared to $15.9 million for the July 31, 2004 through December 25, 2004 period and $8.0 million for the December 28, 2003 through July 30, 2004 period. The increase in 2005 as compared to the aggregate 2004 total was primarily attributable to the full-year impact of interest charges for the increased debt and higher interest rates associated with our new debt structure resulting from the Acquisition financing.

In the period from July 31, 2004 through December 25, 2004 we recorded a debt extinguishment charge of $7.5 million related to the December 2004 refinancing of a $155.0 million term loan with $160.0 million in floating rate notes.

In 2005, we recorded an income tax benefit of $29.5 million, net of a valuation allowance of $30.4 million. The valuation allowance reflects the significant loss incurred in 2005, as well as the anticipated financial performance over the next several years. In the period from July 31, 2004 through December 25, 2004, we recorded an income tax benefit of $36.5 million, reflecting a post-acquisition effective tax rate of 38.8%, inclusive of the anticipated benefits of employment tax credits. In the period from December 28, 2003 through July 30, 2004, the income tax provision of $1.0 million reflects an effective tax rate of 25.5%, inclusive of the anticipated benefits of employment tax credits. The changes in effective tax rates between these periods are primarily due to the impact of employment tax credits in relation to pre-tax income and certain non-deductible transaction expenses incurred during the period from July 31, 2004 to December 25, 2004. Employment tax credits do not vary with reported pre-tax income as they are based upon specific numbers of qualified new hires and represent the economic benefits earned by us for our participation in various federal and state hiring incentive programs.

Liquidity and Capital Resources

Working Capital

Working capital was $6.2 million as of December 30, 2006 and $50.4 million as of December 31, 2005. Working capital reflects the classification of outstanding borrowings under our amended asset-based revolving loan facility of $157.1 million at December 30, 2006 and $135.7 million at December 31, 2005 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 Statement of Financial Accounting Standards No. 6, “Classification of Short Term Obligations Expected to be Refinanced” to reclassify the debt as long-term, but is not an indication that this credit facility is expected to be retired within the next year. The amended asset-based revolving loan expires in July of 2011, and we intend to continue to access it for our working capital needs throughout its remaining term.

Cash Flow for the Twelve Months Ended December 30, 2006 as Compared to the Twelve Months Ended December 31, 2005

Net cash provided by operating activities was $11.6 million in fiscal 2006 as compared to $3.0 million in the 2005 fiscal year. The increase against the prior year primarily reflects the reduction in our operating loss. The adverse cash flow impact of our operating losses in 2006 and 2005 was largely offset by the benefit of reductions in inventory levels over the same periods.

Net cash used in investing activities in 2006 was $29.1 million, as compared to $26.6 million in 2005. Capital expenditures in 2006 of $25.1 million were $0.1 million lower than the corresponding 2005 figure, while lease acquisition, pharmacy customer file and other costs in 2006 of $6.5 million were lower than the 2005 figures by $2.0 million. Fiscal 2006 cash flow used in investing activities included $2.5 million of proceeds related to the disposition of certain properties, while fiscal 2005 cash flow used in investing activities included $7.1 million of proceeds resulting from similar property dispositions.

Net cash provided by financing activities in 2006 was $17.5 million, as compared to $23.7 million in 2005. The decrease in cash provided by financing activities in the current year reflects the improvement in cash flow from operations.

Cash Flow for the Twelve Months Ended December 31, 2005 for the Successor as Compared to the Period from July 31, 2004 through December 25, 2004 for the Successor and the Period from December 28, 2003 through July 30, 2004 for the Predecessor

Net cash provided by operating activities was $3.0 million in the 2005 fiscal year, as compared to $11.6 million of net cash used in operating activities in the period from July 30, 2004 through December 25, 2004 and net cash provided by operations of $20.7 million in the period from December 28, 2003 through July 30, 2004. The reduction against the prior year primarily reflects the aggregate cash payments of $11.5 million made in 2005 primarily in connection with the former Chairman and CEO’s SERP termination. The adverse cash flow impact of our increased operating loss in 2005 was largely offset by the benefit of reductions in inventory levels over the same period.

Net cash used in investing activities in 2005 was $26.6 million, as compared to $437.2 million (including $413.7 million to acquire the predecessor entity) and $31.6 million in the periods from July 30, 2004 through December 25, 2004 and December 28, 2003 through July 30, 2004, respectively. In addition, capital expenditures in 2005 of $25.2 million were $2.7 million lower than the combined 2004 successor and predecessor period figures, while lease acquisition, pharmacy customer file and other costs in 2005 of $8.5 million were lower than the combined 2004 successor and predecessor period figures by $16.6 million. Fiscal 2005 cash flow used in investing activities included $7.1 million of proceeds related to the disposition of certain properties, while aggregate fiscal 2004 cash flow used in investing activities included $2.2 million of expenditures related to a sale-leaseback transaction.

Net cash provided by financing activities in 2005 was $23.7 million, as compared to $448.8 million and $11.0 million in the periods from July 30, 2004 through December 25, 2004 and December 28, 2003 through July 30, 2004, respectively. The decrease in cash provided by financing activities in the current year reflects the non-recurrence of the equity contribution and the new debt incurred in connection with the Acquisition in 2004.

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 2006, seven new stores in 2005 and sixteen new stores in 2004. We currently plan to open 14 new stores and close 8 stores in 2007. The new store openings in 2007 include the acquisition of up to 8 leases in Manhattan from the Gristedes supermarket chain. This acquisition is subject to various conditions including, in some cases, the receipt of landlord consents. The acquisition of the Gristedes leases and the related build-out costs and working capital commitments will be funded through a commitment by certain affiliates of Oak Hill Capital Partners, L.P. to purchase up to $39.4 million in preferred equity and warrants to purchase common stock. Any funds raised through this commitment in excess of funds needed for the acquisition will be used to fund our normal capital spending, fund new store openings or reduce our outstanding debt. On March 27, 2007, Oak Hill and its affiliates funded $13.0 million under that commitment. 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. Capital spending in 2007 that is not related to the Gristedes acquisition is expected to be approximately $35 million. We presently plan to open a total of 12 additional stores in each of 2008 and 2009. In 2006, we spent approximately $25.1 million on capital expenditures, primarily for new, renovated and replacement stores, and we spent an additional $6.5 million for lease acquisition, pharmacy customer files and other costs. These amounts were partially offset by $2.5 million of proceeds we received resulting from the sale of two formerly operated properties. We also require working capital to support inventory for our existing and new stores. Historically, we have been able to lease almost all of our store locations, so acquisitions of real estate are not expected to have a significant impact on our capital requirements.

Liquidity Assessment

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

We believe that, based on current levels of operations and anticipated growth, cash flow from operations, together with other available sources of funds, including revolving loan borrowings under the amended asset-based revolving loan facility and up to $26.4 million of additional funds available from the sale of preferred equity and warrants to purchase our common stock will be adequate for the next two years, to make required payments on our indebtedness, to fund anticipated capital expenditures and the acquisition of up to eight Gristedes leases and to satisfy our working capital requirements. We base this belief on our recent levels of cash flow from operations of approximately $11.6 million in fiscal 2006 (which included the absorption of $12.2 million in non-recurring net cash payments made in connection with litigation settlements and executive severance) and $3.0 million in 2005 (which includes the absorption of $9.6 million in non-recurring net cash payments made in connection with the termination of the former Chairman and CEO’s SERP), 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 $53.1 million at March 31, 2007. Our stockholder’s equity is expected to become a deficit in 2007 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, 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 floating rate notes bear interest at floating rates. Therefore, our financial condition will be affected by changes in prevailing interest rates. On May 25, 2005, we entered into a hedging transaction through the acquisition of a “no cost collar.” Under this arrangement, we capped our exposure on $130 million of LIBOR-based borrowings under the floating rate notes at a maximum LIBOR rate of 5.30%. In addition, we established a minimum “floor” LIBOR rate of 3.45%, in line with then current LIBOR rates. This hedging arrangement expires on June 16, 2008.

Debt

Amended Asset-Based Revolving Loan Facility Our amended asset-based revolving loan facility has a maximum borrowing capacity of $225.0 million, subject to a borrowing base calculation based on specified advance rates against the value of our inventory, pharmacy prescription files and accounts receivable. On July 7, 2006, we amended the asset-based revolving loan facility to extend the maturity date from July 21, 2008 to July 21, 2011. This extension is subject to our refinancing or restructuring the aggregate principal amounts of our $210.0 million senior secured floating rate notes due 2010 and $195.0 million 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 amended asset-based revolving loan facility includes a $50 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 us, Duane Reade Inc. and each of our 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 we would be required to maintain in such an 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 our option, bear interest at either:

· a rate equal to LIBOR (the London Interbank Offered Rate) plus a margin of from 1.00% to 2.00%, determined based on levels of borrowing availability reset each fiscal quarter; or

· a rate equal to the prime rate of Banc of America Retail Group Inc. plus a margin of from 0.00% to 0.50%, determined based on levels of borrowing availability reset each fiscal quarter. Borrowings under the amended facility continue to be primarily LIBOR-based. At December 30, 2006, the amended asset-based revolving loan facility bore interest at a weighted average annual rate of 6.94%.

At December 30, 2006, there was $157.1 million outstanding under the amended asset-based revolving loan facility, and approximately $57.4 million of remaining availability, net of $5.5 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 we do not meet the criteria of SFAS No. 6 to reclassify the debt as long-term. We intend to continue to utilize this facility for our working capital needs though the date of its maturity in July 2011.

As a result of the investigation carried out by our Audit Committee, we failed to timely file this annual report on Form 10-K for the year ended December 30, 2006 and as of the date of the filing of this Form 10-K, we had not filed our quarterly report on Form 10-Q for the quarter ended March 31, 2007 (which was required to be filed with the SEC on or before May 15, 2007). Such failures are defaults under the indentures governing our senior secured floating rate notes and the indenture governing our senior subordinated notes but will not become events of default or result in the acceleration of those notes until after the expiration of the relevant grace periods. The lenders under our amended asset-based revolving loan facility have waived the default relating to the failure to file our Form 10-K until June 29, 2007, and they have also waived the default relating to the failure to file our Form 10-Q until July 15, 2007. The filing of this 10-K has cured the default relating to its late filing, and we anticipate we will be able to file the Form 10-Q prior to July 15, 2007.

Senior Secured Floating Rate Notes due 2010 On December 20, 2004, we 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, we repaid all outstanding principal under the 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, we issued a further $50.0 million of senior secured notes. These new notes were issued under the same indenture as the December 2004 notes, although they do not trade fungibly with those December 2004 notes.

The senior secured notes bear interest at a floating rate of LIBOR plus 4.50%, reset quarterly. Interest on the senior secured notes is payable quarterly on each March 15, June 15, September 15, and December 15. The senior secured notes mature on December 15, 2010. At December 30, 2006, the senior secured notes bore interest at an annual rate of 9.86%.

On May 25, 2005, we entered into a hedging transaction through the acquisition of a “no cost collar.” Under this arrangement, we capped our exposure on $130.0 million of LIBOR-based borrowings under the senior secured notes at a maximum LIBOR rate of 5.30%. In addition, we established a minimum “floor” LIBOR rate of 3.45% in line with then current LIBOR rates. This hedging arrangement expires on June 16, 2008. The changes in the fair value of the hedge agreement are reflected on the Consolidated Statements of Stockholder’s Equity and Comprehensive Income (Loss) included within the financial statements. At December 30, 2006, the LIBOR rate in effect for the senior secured notes was 5.36%, which exceeded the maximum rate under the “no cost collar.” As a result, the protection afforded by the “no cost collar” reduced the overall effective interest rate on the senior secured notes to 9.82%.

We guarantee the senior secured notes on a full and unconditional, senior secured basis. Duane Reade Inc. and Duane Reade GP are co-obligors under the senior secured notes. The senior secured notes rank equally in right of payment with any of our, Duane Reade Inc’s or Duane Reade GP’s unsubordinated indebtedness and senior in right of payment to any of our, Duane Reade Inc’s or Duane Reade GP’s subordinated or senior subordinated indebtedness. All obligations under the senior secured notes are guaranteed on a senior basis by each of our existing subsidiaries, other than Duane Reade Inc. and Duane Reade GP, and will be guaranteed by future subsidiaries of Duane Reade Inc. and Duane Reade GP except certain foreign and certain domestic subsidiaries. The senior secured notes and the guarantees are collateralized by a first priority interest in substantially all of our assets other than those assets in which the lenders under the amended asset-based revolving loan facility have a first priority interest. The senior secured 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, we will be required to make an offer to repurchase all of the senior secured notes at 101% of the outstanding principal amount of the senior secured notes plus accrued and unpaid interest to the date of repurchase. The indenture governing the senior secured 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 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 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 notes that would impact the cost of borrowing, annual amortization of principal or related indebtedness maturity. The indenture governing the senior secured notes does not contain financial maintenance covenants.

At December 30, 2006, the weighted average combined interest rate in effect on all variable rate debt outstanding, including the benefit afforded by the “no cost collar,” was 8.59%.

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 our, 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 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 us 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, we will be required to make an offer to repurchase all of the senior subordinated notes at 101% of the outstanding principal amount of the senior subordinated notes plus accrued and unpaid interest to the date of repurchase. The indenture governing the senior subordinated notes contains certain affirmative and negative covenants that limit the ability of Duane Reade Inc., Duane Reade GP and their restricted subsidiaries to incur additional indebtedness, pay dividends, make repayments on indebtedness that is subordinated to the senior subordinated notes and to make certain other restricted payments, incur certain liens, use proceeds from sales of assets, enter into business combination transactions (including mergers, consolidations and asset sales), enter into transactions with affiliates and permit restrictions on the payment of dividends by restricted subsidiaries. The indenture governing the senior subordinated notes contains customary events of default, which, if triggered, may result in 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.

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 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 carrier in addition to the $9.9 million previously paid by the insurance carrier in 2002. This decision of the appraisal panel is also subject to further litigation. As a result of the continued litigation and other uncertainties, we may not actually receive any or all of the panel’s appraised value of this claim, and we cannot be certain of the timing of future payments, if any, with respect to our claim. It should also be noted that any payment to us 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. Please see “Item 3. Legal Proceedings” for a more detailed explanation of this matter.

Twenty-two of our stores, which generated approximately 7.3% of our net sales for fiscal 2006, have leases scheduled to expire before the end of fiscal 2008. Six of these leases have renewal options. We believe that we will be able to renew the other expiring leases on economically favorable terms or, alternatively, find other economically attractive locations to lease.

As of December 30, 2006, approximately 4,200 of our approximately 6,100 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. We do not believe that these increases will have a material impact on our liquidity or results of operations. 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 3,800 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, under a collective bargaining agreement that expires on August 31, 2008.

The following tables provide information with respect to our commitments and obligations as at December 30, 2006:

	Payments due by Period
			Within		Within		Within		After
Contractual Cash Obligations	Total		1 year		2-3 years		4-5 years		5 years
	(dollars in thousands)
Long-Term Debt(1)	$	405,032	$	—	$	—	$	405,000	$	32
Asset-Based Revolving Loan Facility(2)	157,122		—		—		157,122		—
Capital Lease Obligations(3)	12,432		4,310		8,122		—		—
Operating Leases(4)	1,344,282		126,414		251,803		230,823		735,242
Fixed Interest Payments(5)	95,063		19,013		38,025		38,025		—
Former Chairman and Other Severance Payments(6)	2,941		2,806		17		16		102
Former Pharmacy Supplier Settlement(7)	500		500		—		—		—
Landlord Real Estate Litigation Settlement(8)	1,250		958		292		—		—
Executive Guaranteed Bonus(9)	825		825		—		—		—
Total Contractual Cash Obligations	$	2,019,447	$	154,826	$	298,259	$	830,986	$	735,376

(1) These amounts include $195.0 million of outstanding senior subordinated notes, $210.0 million of outstanding senior secured floating rate notes and $32,000 outstanding under the senior convertible notes due in 2022. For more information about the terms of the indebtedness described above, please see “—Debt,” above.

(2) At December 30, 2006, approximately $157.1 million was outstanding under our amended asset-based revolving loan facility. Obligations under this facility have been classified as current liabilities 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 reclassify the debt as long-term, however this is not an indication that this credit facility is expected to be retired within the next year. We intend to continue to use this facility for our working capital needs through the date of its maturity in July 2011.

(3) In January 2005, we entered into a 60-month lease for equipment to be used in the photofinishing departments of our stores. This lease replaced certain operating leases for similar equipment which were satisfied in December 2004. Note 11 to the consolidated financial statements provides further detail on Capital Lease obligations.

(4) Note 15 to the consolidated financial statements provides further detail on Operating Lease obligations.

(5) Reflects interest payable on $195.0 million of the senior subordinated notes.

(6) Reflects payments specified under the employment contract with the former Chairman and CEO to be made by us in connection with his replacement on November 21, 2005, as well as payments due to other executives whose employment was terminated during 2006. In an ongoing arbitration between Mr. Cuti and us (explained in more detail in “Item 3. Legal Proceedings”), 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 footnote, and other monetary damages.

(7) Reflects cash payments due to Cardinal Health, a former pharmacy inventory supplier, in connection with the settlement of an outstanding claim. In 2006, we paid $4.0 million toward the settlement amount.

(8) Reflects cash payments due to the landlord of one of the Company’s stores in connection with the settlement of a real estate litigation.

(9) Reflects a bonus paid on April 5, 2007 to our current Chairman and CEO, as specified in his employment contract.

				Amount of Commitment Expiration per Period
Other Commercial Commitments	Total Amounts Committed			Within 1 year			After 2-3 years			4-5 years			5 years
	(dollars in thousands)
Standby Letters of Credit(1)		$	5,500		$	5,352		$	148		$	—		$	—
Total Commercial Commitments		$	5,500		$	5,352		$	148		$	—		$	—

(1) Standby letters of Credit, primarily representing self-insured general liability claims and property lease security deposits, are renewed on an annual basis, unless otherwise requested by the beneficiary.

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 by Mr. Dreiling, Mr. Cuti’s employment contract specifies payments to Mr. Cuti in cash totaling up to $6.6 million. We have paid $4.2 million of this amount through December 30, 2006, and the remaining amount is scheduled, pursuant to the employment contract, to be paid in equal installments through December 2007. In addition, the employment contract provides for continued health insurance coverage for Mr. Cuti during the 25-month period following termination and, upon expiration of that period, if Mr. Cuti is not otherwise eligible under another employer’s comparable medical plan, lifetime retiree medical benefits at a cost not to exceed $50,000 annually. In an ongoing arbitration between Mr. Cuti and us (explained in more detail in “Item 3. Legal Proceedings”), 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 appointment of Mr. Dreiling, we were required under his employment contract to make a guaranteed payment to him of $330,000 on or before February 19, 2006, which was paid on February 17, 2006. In addition, Mr. Dreiling’s employment contract stipulates that a guaranteed 2006 bonus of not less than 100% of his current $825,000 annual salary be paid on the same date as any other senior executive bonuses related to the 2006 fiscal year are paid. This bonus was paid on April 5, 2007.

In connection with the Acquisition, the former Chairman and CEO 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. The former Chairman and CEO’s employment contract provides that, as a result of his replacement on November 21, 2005 by Mr. Dreiling, 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 by Mr. Dreiling, 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. The former Chairman and CEO’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, the former Chairman and CEO 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 “Item 3. Legal Proceedings”), 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 December 9, 2005 settlement of litigation between us and Cardinal Health, we were required to make payments to Cardinal Health totaling $4.5 million, including an initial payment of $2.0 million on January 15, 2006 and subsequent payments of $1.0 million each on June 15, 2006 and December 15, 2006 and $250,000 each on March 15, 2007 and June 15, 2007. All payments have been made in accordance with the schedule, and all such amounts had been previously accrued in the financial statements.

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 and standby letters of credit listed above.

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 the paragraphs below are those that depend most heavily on these judgments and estimates.

Receivables—Reserves for Uncollectible Accounts

At December 30, 2006 and December 31, 2005, accounts receivable included $39.4 million and $37.1 million, respectively, representing amounts due from various insurance companies, pharmacy benefit management companies and governmental agencies under third party payment plans for prescription sales made prior to those dates. Our accounting policy, which is based on our past collection experience, is to fully reserve for all pharmacy receivables over 120 days old that are unpaid at the evaluation date, as well as any other pharmacy receivables deemed potentially uncollectible. Pharmacy receivables other than NY Medicaid are adjudicated at the point of sale and do not generally have issues of collectibility. There was approximately $0.1 million and $0.4 million reserved for uncollectible pharmacy receivables at December 30, 2006 and December 31, 2005, respectively. Other receivables, which primarily consist of amounts due from vendors, are reserved for based upon a specific application of our historical collection experience to the total aged receivable balance. At December 30, 2006 and December 31, 2005, these

reserves were approximately $1.9 million and $3.6 million, respectively. The reduction in the reserves for other receivables between 2005 and 2006 was attributable to fully reserved receivables at the end of 2005 that were written off during 2006.

Inventory Shrink Estimates

We perform front-end and pharmacy physical inventories in all of our stores and the distribution centers at least once per year on a staggered cycle basis. Inventories are valued using the average specific item cost, last-in, first-out (LIFO) method reduced by estimated inventory shrink losses for the period between the last physical inventory in each store and the balance sheet date. These shrink estimates are based on the latest chain-wide trends. At December 30, 2006 and December 31, 2005, a change in this shrink estimate of 1.0% of front-end sales would impact year-to-date pre-tax earnings and related reserves by approximately $2.9 million and $4.0 million, respectively.

Insurance Liabilities and Reserves

At December 30, 2006 and December 31, 2005, there were $4.5 million and $4.0 million of accrued general liability claim costs, respectively, that primarily related to the gross amount payable for customer accident claims. Our policy is to recognize a liability for the estimated projected ultimate settlement value of these claims as well as a provision for incurred but unreported claims as of each balance sheet date. These estimates are made based on a review of the facts and circumstances of each individual claim using experienced third party claims adjustors. These estimates are also reviewed and monitored on an ongoing basis by management. For a majority of the claims, the maximum self-insured portion of any individual claim amounts to $250,000, although our historical claim settlement experience is significantly lower. At December 30, 2006, there were 251 outstanding claims with an average projected settlement value of approximately $17,850, as compared to 196 outstanding claims with an average projected settlement value of approximately $20,300 at December 31, 2005.

Impairment of Goodwill and Intangible Assets

At December 30, 2006, goodwill was approximately $70.4 million. Other net intangible assets consisted of favorable leases of $77.1 million, customer lists of $57.7 million, our trade name of $46.0 million and non-competition agreements of $0.2 million. Our policy is to evaluate our intangible and long-lived assets, exclusive of goodwill, for impairment, when circumstances indicate that impairment may have occurred. This evaluation is generally based on the future undiscounted operating cash flows of the related assets. These circumstances include, but are not limited to, a significant adverse change in legal factors or in the business climate, adverse action or assessment by a regulator, unanticipated competition or the loss of key personnel. Such write-downs would result in a non-cash charge to earnings. Goodwill and indefinite lived intangibles are not amortized but are evaluated annually as of the year end balance sheet date and between annual tests in certain circumstances as required under Statement of Financial Accounting Standards No. 142. We employ a market multiple valuation technique utilizing other public chain drug retailers to develop a reasonable multiple. Our most recent evaluation of goodwill and indefinite lived intangibles as of December 30, 2006 resulted in no impairment charge. Our most recent evaluation of long-lived assets under Statement of Financial Accounting Standards No. 144 as of December 30, 2006 resulted in an impairment charge of approximately $10.2 million for stores whose asset carrying values were greater than their undiscounted expected cash flows. We may be required to perform an additional interim impairment review if circumstances similar to those listed above indicate that impairment may have occurred. We may be required to recognize an impairment charge at the time an interim or future annual impairment review is performed, depending in part on the estimated value of our market capitalization.

Other Loss Contingencies

Liabilities for loss contingencies are recorded when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Loss contingencies often take years to resolve and can involve complicated litigation matters and potential regulatory actions, the outcomes of which are difficult to predict. At December 30, 2006, we have recorded one loss contingency representing legal settlement costs of $1.3 million. At December 31, 2005, we had recorded two loss contingencies representing (i) the estimated liability associated with the NLRB matter and (ii) other legal settlement costs of $2.9 million.

Income Taxes

Our effective tax rate was 3.9% in fiscal 2006, 22.7% in fiscal 2005, 38.8% in the successor period from July 31, 2004 through December 25, 2004 and 25.5% in the predecessor period from December 28, 2003 through July 30, 2004. The effective tax rate has been and is expected to continue to be a major factor in the determination of our profitability and cash flow. As such, a significant shift in the relative sources of our earnings, or changes in tax rules or interpretations, could have a material, adverse effect on our results of operations and cash flow. The decrease in our effective rate in 2006 and 2005 as compared to the 2004 successor period is attributable to the recording of valuation allowances of $38.1 million and $30.4 million, respectively, against a significant portion of our deferred tax assets and liabilities as a result of evaluating our current and anticipated future financial performance. We expect to continue to record additional valuation allowances during the 2007 fiscal year. The increase in our effective tax rate in the 2004 successor period as compared to the prior period reflects the impact of employment tax credits on significantly reduced pre-tax income, partially offset by incremental tax expense recorded in connection with the New York State legislation enacted during the second quarter of 2003, that eliminated deductions for royalty fee expenses paid to out of state affiliated companies. Employment tax credits represent the benefits earned by us for our participation in various Federal and state hiring incentive programs. These benefits are based on the number of qualifying employees hired and retained by us for a specified time period. Employees qualify for these hiring programs primarily as a result of their enrollment in various economic assistance programs.

Seasonality

The non-pharmacy business is seasonal in nature, with the Christmas holiday season 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 30, 2006.

Recently Issued Accounting Pronouncements

In December 2004, SFAS No. 123R, “Share-Based Payment” was issued. This statement established standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. The statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based transactions. We have adopted the provisions of this statement effective January 1, 2006. Due to the relatively small quantity of stock options granted during fiscal 2006, the adoption of this pronouncement has not had a material effect on our financial statements.

previously required that most voluntary changes in accounting principle be recognized by including in the current period’s net earnings the cumulative effect of changing to the new accounting principle. SFAS No. 154 also makes a distinction between “retrospective application” of an accounting principle and the “restatement” of financial statements to reflect the correction of an error. Another significant change in practice under SFAS No. 154 is that if an entity changes its method of depreciation, amortization, or depletion for long-lived, non-financial assets, the change must be accounted for as a change in accounting estimate. Under APB No. 20, such a change would have been reported as a change in accounting principle. SFAS No. 154 applies to accounting changes and error corrections that are made in fiscal years beginning after December 15, 2005. We have adopted SFAS No. 154, and such adoption has not had an effect on our consolidated financial statements.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Instruments,” which amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. This statement is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. We have adopted SFAS No. 155, and such adoption has not had an effect on our consolidated financial statements.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” an interpretation of SFAS No. 109, “Accounting for Income Taxes.” FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold for tax positions taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. We have adopted FIN 48 effective with the quarter ended March 31, 2007, and such adoption did not have a material effect on our consolidated financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 requires misstatements to be quantified based on their impact on each of the financial statements and related disclosures. SAB No. 108 is effective for fiscal years ending after November 15, 2006. We have adopted SAB No. 108 effective December 30, 2006, and such adoption has not had an effect on our consolidated financial statements.

DUANE READE HOLDINGS, INC. — SUCCESSOR
DUANE READE INC. — PREDECESSOR
Consolidated Statements of Cash Flows
(In thousands)

	Successor												Predecessor
									Restated				Restated
	Fiscal Year				Fiscal Year				Period from				Period from
	Ended				Ended				July 31, 2004				Dec. 28, 2003
	December 30,				December 31,				through				through
	2006				2005				Dec. 25, 2004				July 30, 2004
Cash flows from operating activities:
Net (loss) income		$	(79,364	)		$	(100,388	)		$	(57,537	)		$	3,055
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
Depreciation and amortization		75,882				74,510				28,568				22,497
Deferred income taxes		2,520				(30,150		)		(37,208		)		5,810
Debt extinguishment		—				—				4,425				—
Non-cash rent expense		10,956				13,243				6,221				4,383
Asset impairment charges		10,202				16,600				—				—
Reversal of labor contingency liability		(18,004		)		—				—				—
Other non-cash charges		382				—				—				—
Changes in operating assets and liabilities (net of effect of acquisitions):
Receivables		(800		)		1,675				(1,569		)		(3,057		)
Inventories		12,654				31,134				(1,682		)		4,385
Accounts payable		10,699				(7,018		)		14,673				(20,047		)
Prepaid and accrued expenses		(4,572		)		2,343				32,087				747
Other assets and liabilities, net		(8,939		)		1,055				461				2,921
Net cash provided by (used in) operating activities		11,616				3,004				(11,561		)		20,694
Cash flows from investing activities:
Capital expenditures		(25,112		)		(25,214		)		(10,360		)		(17,552		)
Lease acquisition, customer file and other costs		(6,458		)		(8,484		)		(11,013		)		(14,067		)
Proceeds on sales of assets		2,500				7,069				(2,192		)		—
Purchase of Duane Reade		—				—				(413,684		)		—
Net cash used in investing activities		(29,070		)		(26,629		)		(437,249		)		(31,619		)
Cash flows from financing activities:
Proceeds from subordinated note offering		—				—				195,000				—
Proceeds from floating rate note offering		—				47,750				160,000				—
Proceeds from term loan		—				—				155,000				—
Proceeds from additional capital		—				—				239,498				—
Repurchase of convertible notes		—				—				(201,000		)		—
Repayment of term loans		—				—				(155,000		)		—
Borrowings from revolving credit facility		1,850,549				1,833,698				743,186				941,503
Repayments of revolving credit facility		(1,829,120		)		(1,851,875		)		(670,661		)		(930,511		)
Deferred financing costs		(755		)		(3,094		)		(16,919		)		(841		)
Proceeds from exercise of stock options		—				—				—				1,126
Repayment of capital lease obligations		(3,187		)		(2,821		)		(303		)		(266		)
Net cash provided by financing activities		17,487				23,658				448,801				11,011
Net increase (decrease) in cash		33				33				(9		)		86
Cash at beginning of year		1,362				1,329				1,338				1,252
Cash at end of year		$	1,395			$	1,362			$	1,329			$	1,338
Supplementary disclosures of cash flow information:
Cash paid for interest		$	52,518			$	45,108			$	8,507			$	5,974
Cash paid for taxes on income, net of refunds received		$	198			$	1,001			$	(857	)		$	(697	)
Property acquired under capital lease financing		$	—			$	13,529			$	—			$	1,831

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

DUANE READE HOLDINGS, INC.—SUCCESSOR
DUANE READE INC.—PREDECESSOR
Consolidated Statements of Stockholder’s Equity and Comprehensive Income (Loss)

													Accumulated
													Other
	Preferred Stock				Common Stock			Paid-in		Accumulated			Comprehensive					Comprehensive
	Shares		Amount $		Shares	Amount $		Capital		(Deficit)			Income (Loss)			Total		Income (Loss)
Predecessor
Balance, December 27, 2003 as reported		—		$ —	24,403,550		$ 244		$ 331,917		$ (4,900	)		$ —		$ 327,261			$ —
Impact of restatements		—		—	—		—		—		(8,631	)		—		(8,631	)		—
Balance, December 27, 2003 as restated		—		$ —	24,403,550		$ 244		$ 331,917		$ (13,531	)		$ —		$ 318,630			$ —
Common stock issued for exercise of stock options		—		—	135,249		1		1,125		—			—		1,126			—
Net income—predecessor company		—		—	—		—		—		3,055			—		3,055			3,055
Balance, July 30, 2004		—		$ —	24,538,799		$ 245		$ 333,042		$ (10,476	)		$ —		$ 322,811			$ 3,055

Successor
Cash proceeds from sale of common stock		—		$ —	2,594,977		$ 26		$ 239,472		$ —			$ —		$ 239,498			$ —
Net loss		—		—	—		—		—		(57,537	)		—		(57,537	)		(57,537	)
Balance, December 25, 2004		—		$ —	2,594,977		$ 26		$ 239,472		$ (57,537	)		$ —		$ 181,961			$ (57,537	)

Interest rate hedge		—		—	—		—		—		—			260		260			$ 260
Net loss		—		—	—		—		—		(100,388	)		—		(100,388	)		(100,388	)
Balance, December 31, 2005		—		$ —	2,594,977		$ 26		$ 239,472		$ (157,925	)		$ 260		$ 81,834			$ (100,128	)

Grant and recognition of stock options		—		—	—		—		335		—			—		335			$ —
Interest rate hedge		—		—	—		—		—		—			(67	)	(67	)		(67	)
Net loss		—		—	—		—		—		(79,364	)		—		(79,364	)		(79,364	)
Balance, December 30, 2006		—		$ —	2,594,977		$ 26		$ 239,807		$ (237,289	)		$ 193		$ 2,737			$ (79,431	)

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

DUANE READE HOLDINGS, INC.—SUCCESSOR
DUANE READE INC.—PREDECESSOR
Notes to Consolidated Financial Statements

1. Organization and Summary of Significant Accounting Policies

Duane Reade Holdings, Inc. 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, a parent entity also established to effectuate the Acquisition. The Acquisition was completed on July 30, 2004 through the merger of Duane Reade Acquisition (a wholly-owned subsidiary of Duane Reade Holdings, Inc.) into Duane Reade Inc. with Duane Reade Inc. being the surviving entity and a wholly-owned subsidiary of Duane Reade Holdings, Inc. after the merger transaction. As a result of the Acquisition and resulting change in control and change in historical cost basis of accounting, the operating results are presented separately for the predecessor period up to and including the closing date of the Acquisition (December 28, 2003 through July 30, 2004) and the successor periods following the closing date of the Acquisition (July 31, 2004 through December 25, 2004 and the fiscal years ended December 31, 2005 and December 30, 2006). The predecessor period financial statements include Duane Reade Inc. and all its subsidiaries and the successor period financial statements include Duane Reade Holdings, Inc. and all its subsidiaries. Duane Reade Holdings, Inc. had nominal activity and no operations prior to the completion of the Acquisition. Except where the context otherwise requires, all references to the “Company” in the Consolidated Financial Statements and these footnotes mean the predecessor for periods ending on or before July 30, 2004 and the successor for periods ending after July 30, 2004.

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. Accordingly, the Consolidated Financial Statements present the consolidated net assets and operations of the 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 10) are full and unconditional, joint and several.

The primary assets of Duane Reade Holdings, Inc. are its ownership of 100% of the outstanding common stock of Duane Reade Inc. Duane Reade Inc. owns 99% of the outstanding partnership interest of Duane Reade GP, and 100% of 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 the Company’s operations of 248 drugstores located in the metropolitan New York market are conducted through Duane Reade GP. In August 1999, two new subsidiaries, Duane Reade International, Inc. and Duane Reade Realty, Inc., were established. 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.

Significant accounting policies followed in the preparation of the Consolidated Financial Statements are as follows:

Principles of consolidation: The Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated.

Reclassification: Certain prior year balances have been reclassified to conform to the current year’s presentation.

Reporting year: The fiscal year for the Company is the 52 or 53 week reporting period ending on the last Saturday in December. The 2006 fiscal year contains 52 weeks, while the 2005 fiscal year contains 53 weeks.

Receivables: Receivables consist primarily of amounts due from various insurance companies, pharmacy benefit management companies and governmental agencies under third party payment plans for prescription sales and amounts due from vendors, a majority of which relate to promotional programs. The Company’s accounting policy, which is based on its past collection experience, is to fully reserve for all pharmacy receivables over 120 days old that are unpaid at the evaluation date, as well as any other pharmacy receivables deemed potentially uncollectible. Pharmacy receivables other than NY Medicaid are adjudicated at the point of sale and do not generally have issues of collectibility. Other receivables, which primarily consist of amounts due from vendors, are reserved for based upon a specific application of the Company’s historical collection experience to the total aged receivable balance. The Company has provided an aggregate allowance for doubtful accounts of $2.0 million at December 30, 2006 and $4.0 million at December 31, 2005. The carrying value of the Company’s receivables approximates fair value given the short-term maturity of these financial instruments.

Inventories and cost of sales: Inventories are stated at the lower of cost or market with cost determined using the specific item average cost last-in, first-out (“LIFO”) method. When appropriate, provision is made for obsolete, slow-moving or damaged inventory. At December 30, 2006, inventories would have been $3.2 million lower if they were valued at the lower of specific item average cost first-in, first-out cost or market. The lower specific item average cost first-in, first-out valuation is due to an inventory purchase accounting step-up at July 30, 2004. The Company’s primary pharmaceutical supplier provides $30.0 million of inventory on a consignment basis. Prescription drug inventory over the consignment limit is owned. As of December 30, 2006 and December 31, 2005, there was approximately $45.3 million and $37.6 million, respectively, of prescription drug inventory over the $30.0 million consignment limit included in the Company’s consolidated balance sheets. Cost of sales includes all store occupancy related costs and expenses, consisting of lease and sublease related income and expenses, other real estate related income and expenses primarily resulting from the disposition of store leases, store utility costs and warehouse expenses and distribution costs. 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.

Property and equipment: Property and equipment are stated at cost. Depreciation and amortization are calculated using the half-year convention and straight-line method over the estimated useful lives of assets as follows:

Buildings and improvements		30 years
Furniture, fixtures and equipment		5-10 years
Computer equipment		5-7 years
Leasehold improvements		Life of lease or, if shorter, remaining useful life

Other assets: Deferred financing costs are amortized on a straight-line basis over the term of the underlying debt. Individual pharmacy customer files are amortized on a straight-line basis over their useful lives, generally the lesser of seven years or the remaining life of the store lease. Favorable leases are amortized on a straight-line basis over the remaining life of the lease. Non-competition contracts are amortized over three years.

In accordance with Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” the Company capitalizes certain costs incurred in the development of internal-use software. The Company capitalized $4.1 million, $4.7 million, $2.4 million and $1.9 million of computer software during fiscal 2006, fiscal 2005 and the successor and predecessor periods of 2004, respectively. These capitalized costs are amortized over the useful life of the software, generally seven years.

Impairment: The carrying values of intangible assets subject to amortization and long-lived assets are reviewed and evaluated for impairment by the Company annually at the balance sheet date and when events and circumstances indicate that the carrying amount of these assets may not be recoverable. For these intangible and long-lived assets, this evaluation is generally based on the future undiscounted operating cash flows of the related assets. Should such evaluation result in the Company concluding that the carrying amount of intangibles or long-lived assets has been impaired, an appropriate write-down to fair value based on discounted cash flows would be recorded. The Company’s most recent evaluation of long-lived assets under Statement of Financial Accounting Standards No. 144 as of December 30, 2006 resulted in an impairment charge of approximately $10.2 million for stores whose asset carrying values were greater than their undiscounted expected cash flows. There were no impairment charges recorded under SFAS No. 144 in fiscal 2005. Goodwill and indefinite lived intangibles that are not amortized are evaluated for impairment annually as of the year end balance sheet date and between annual tests in certain circumstances as required under Statement of Financial Accounting Standards No. 142. The Company employs a market multiple valuation technique utilizing other public chain drug retailers to develop a reasonable multiple. The Company’s most recent evaluation of goodwill and indefinite lived intangibles as of December 30, 2006 resulted in no impairment charge, as compared to an impairment charge of $16.6 million recorded against the value of the Company’s tradename at December 31, 2005.

Revenue recognition: The Company recognizes revenues from the sale of merchandise at the time that the merchandise is sold. The Company does not accrue for product returns because the amounts are de minimis.

Advertising expenses: Costs incurred to produce media advertising are charged to expense when the advertising takes place. For the 2006 fiscal year, the 2005 fiscal year and the successor and predecessor periods of 2004, advertising expense was $14.9 million, $16.3 million, $6.5 million and $7.2 million, respectively.

Pre-opening expenses: Store pre-opening costs, other than capital expenditures, are expensed when incurred.

Operating lease accounting: Rent expense for operating leases is expensed over the current lease term on a straight line basis commencing from the date of possession or delivery of the underlying asset. For the successor periods, rent for all leases in place at such acquisition date is expensed on a straight line basis commencing from acquisition date over the remaining lease term. Landlord allowances are amortized on a straight-line basis over the lease term.

Sales taxes: The Company reflects sales tax collected at the point-of-sale as a current liability, rather than as a component of revenue. Sales taxes collected in such a manner are remitted to the appropriate state authorities in accordance with their payment schedule.

Income taxes: Income taxes are accounted for under the asset and liability method prescribed by Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” Deferred tax assets and liabilities are determined based on the difference between the book and tax bases of the respective assets and liabilities as well as for the deferred tax effects of tax credit carryforwards. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. Valuation allowances are established when management determines that it is more likely than not that a deferred tax asset will not be realized. For the fiscal years ended December 30, 2006 and December 31, 2005, the Company’s balance sheet reflects valuation allowances of $68.5 million and $30.4 million, respectively. Please refer to Note 14 “Income Taxes’’ for additional information on this topic. The Company also establishes a reserve for costs of exposure on previously filed tax returns.

Recently issued accounting standards: In December 2004, Statement of Financial Accounting Standard No. 123(R), “Share-Based Payment” was issued. This statement established standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. The statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based transactions. The Company adopted the provisions of this statement effective January 1, 2006 and, as a result, recorded pre-tax compensation expense of approximately $0.3 million attributable to the vested portion of stock options granted after the adoption date.

In June 2005, the Financial Accounting Standards Board issued SFAS No. 154, “Accounting Changes and Error Corrections,” which requires entities that voluntarily make a change in accounting principle to apply that change retrospectively to prior periods’ financial statements, unless this would be impracticable. SFAS No. 154 supersedes Accounting Principles Board Opinion No. 20, “Accounting Changes,” which previously required that most voluntary changes in accounting principle be recognized by including in the current period’s net earnings the cumulative effect of changing to the new accounting principle. SFAS No. 154 also makes a distinction between “retrospective application” of an accounting principle and the “restatement” of financial statements to reflect the correction of an error. Another significant change in practice under SFAS No. 154 is that if an entity changes its method of depreciation, amortization, or depletion for long-lived, non-financial assets, the change must be accounted for as a change in accounting estimate. Under APB No. 20, such a change would have been reported as a change in accounting principle. SFAS No. 154 applies to accounting changes and error corrections that are made in fiscal years beginning after December 15, 2005. The Company has adopted SFAS No. 154, and such adoption has not had an effect on its consolidated financial statements.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Instruments,” which amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. This statement is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The Company has adopted SFAS No. 155, and such adoption has not had an effect on its consolidated financial statements.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” an interpretation of SFAS No. 109, “Accounting for Income Taxes.” FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold for tax positions taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has adopted FIN 48 effective with the quarter ended March 31, 2007, and such adoption did not have a material effect on its consolidated financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 requires misstatements to be quantified based on their impact on each of the financial statements and related disclosures. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The Company adopted SAB No. 108 as of December 30, 2006, and such adoption has not had an effect on its consolidated financial statements.

Employee stock option plans: The board of directors of Duane Reade Holdings, Inc. adopted the Duane Reade Holdings, Inc. Management Stock Option Plan (the “New Option Plan”), which became effective on the date the Acquisition was completed. The New 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 New Option Plan. As of December 30, 2006, a maximum of 370,293 shares of our common stock (on a fully diluted basis) may be granted under the New Option Plan.

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

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), using the prospective transition method. Under that transition method, compensation expense recognized for the fiscal year ended December 30, 2006 includes 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 No. 123(R). The Company has elected to recognize compensation expense on a straight-line basis over the vesting period of the respective options. Refer to Note 16 for additional information regarding stock option-based compensation expense.

Prior to the completion of the Acquisition on July 30, 2004, the Company maintained two stock-based employee compensation plans, which are also described more completely in Note 16.

The Company previously accounted for its stock-based compensation plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. There was no stock-based employee compensation cost reflected in net income, as all options granted under those plans had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of SFAS No. 123, as amended, to stock-based employee compensation (dollars in thousands):

	Successor						Predecessor
				Restated			Restated
	Fiscal Year			Period from			Period from
	Ended			July 31, 2004			Dec. 28, 2003
	December 31,			through			through
	2005			Dec. 25, 2004			July 30, 2004
Net (loss) income, as reported		($100,388	)		($57,537	)		$	3,055
Adjust: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects.(1)(2)		(3,155	)		(280	)		(2,607		)
Pro forma net (loss) income		($103,543	)		($57,817	)		$	448

(1) Stock-based compensation expense in fiscal 2005 did not reflect any tax effect, as the Company recorded a valuation allowance during the period.

(2) Includes expense of $2.0 million recorded in fiscal 2005 as a result of the replacement of the Company’s former Chairman and CEO, Mr. Anthony J. Cuti, on November 21, 2005.

The pro forma compensation expense for stock options has been estimated using the Black-Scholes option pricing model with the following assumptions as follows: For the 2005 fiscal year, the model assumes a dividend yield of 0%, expected volatility of 0%, a risk-free interest rate of 4.3% and an expected term of 7 years. For the period from July 30, 2004 through December 25, 2004, the model assumes a dividend yield of 0%, expected volatility of 0%, a risk-free interest rate of 4.1% and an expected term of 7 years. For the period from December 28, 2003 through July 30, 2004, the model assumes a dividend yield of 0%, expected volatility of 50%, a risk-free interest rate of 6.6% and an expected term of 8 years. These pro forma disclosures may not be representative of the effects on reported net income for future years since options vest over several years and options granted prior to 1995 are not considered.

For the 2005 fiscal year and the successor period of 2004, the weighted average fair value per share of the stock options granted in these periods calculated under the Black-Scholes option pricing methodology was $25.28 and $24.57, respectively.

In connection with the completion of the Acquisition, the two previously existing stock option plans were terminated. As more fully described in Note 16, the majority of options outstanding under these plans were cancelled or forfeited and the holders of the relatively small number of options whose exercise price was lower than the $16.50 per share cash consideration paid in the Acquisition received a cash payment equal to the difference between $16.50 per share and the option’s exercise price, multiplied by the number of options held by each individual option holder.

Use of estimates: The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of

revenues, costs and expenses during the reporting period. Significant estimates used in the preparation of the consolidated financial statements included herein follow:

Uncollectible accounts receivable: The Company’s accounts receivable primarily consists of amounts due from third party prescription plans, vendors and credit card processors. The Company fully reserves for all prescription plan receivables over 120 days old that are unpaid at the evaluation date, as well as any other pharmacy receivables deemed potentially uncollectible at the balance sheet date. Although the majority of vendor receivables are collected through authorized deductions against purchases, the Company reserves for the portion of such vendor receivables that it considers to be potentially uncollectible by applying its historical collection experience to the total aged receivable balance. The Company believes that this method provides adequate assurance that such balances are reflected at net realizable value at the balance sheet dates. Credit card receivables are normally collected within five days.

Inventory shrinkage: Inventory balances are presented net of the Company’s estimated provision for shrink, which is based on the most recent chain-wide trends. The Company takes physical inventories of front-end merchandise in its distribution centers as well as both front-end and pharmacy merchandise in its stores at least once per year. All store inventories are taken on a staggered cycle basis throughout the year.

General liability insurance claims: Liabilities for the gross amount payable of general liability insurance claims are primarily related to customer accidents. The Company’s policy is to recognize such liabilities based on estimates of the ultimate settlement value of these claims, as well as for estimated incurred but unreported claims as of each balance sheet date. For a majority of the claims, the Company’s maximum self-insured portion of an individual claim does not exceed $250,000, although the Company’s historical claim settlement experience is significantly lower. The Company carries primary general liability insurance coverage above the self-insured limit of $15 million and also has a general liability umbrella policy attachment which provides up to $100 million of additional insurance coverage. At December 30, 2006 and December 31, 2005, the Company has recorded a liability of $4.5 million and $4.0 million, respectively, reflecting the estimated gross settlement value of its general liability claims.

Other loss contingencies: Liabilities for loss contingencies are recorded when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable.

Significant vendor relationships: The Company is party to multi-year, merchandise supply agreements in the normal course of business. The largest of these agreements is with AmerisourceBergen, the Company’s primary pharmaceutical supplier. Generally, these agreements provide for certain volume commitments and may be terminated by the Company, subject in some cases to specified termination payments, none of which, in management’s opinion, would constitute a material adverse effect on the Company’s results of operations, financial position 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, the Company would be able to find a suitable alternative supplier.

2. Restatement Resulting from Audit Committee Investigation—

Investigation of Real Estate Transactions and Related Matters:

As previously disclosed, the Audit Committee of the Company, with the assistance of independent counsel (which engaged forensic accountants), conducted a review and investigation concerning certain real estate transactions and related matters and whether the accounting for such transactions was proper. That review and investigation has been completed.

As a result of the completion of the review and investigation, the Audit Committee determined that it will not be necessary to restate any previously-issued financial statements for any periods during the 2005 and 2006 fiscal years. However, the independent counsel identified approximately $14.4 million of pre-tax income from real estate transactions and related matters that occurred during the 2000 through 2004 fiscal

years (the “Real Estate Related Transactions”) for which the Company’s accounting was concluded by the Company to be improper. Based on the conclusions of the independent counsel relating to the Real Estate Related Transactions, as described in more detail below, the Audit Committee determined, on May 22, 2007, that a restatement of the Company’s previously-issued financial statements as of and for the five months ended December 25, 2004, the seven months ended July 30, 2004 and the 2000 through 2003 fiscal years (collectively, the “Affected Periods”) was required. The restatements have had no material impact on the Company’s financial statements for any periods during the 2005 or 2006 fiscal years and are not expected to have a material impact on the Company’s financial statements for any periods in the 2007 fiscal year.

The independent counsel concluded that the Real Estate Related Transactions were orchestrated by the former Chairman and CEO, who was replaced in November 2005, and were expressly designed to overstate the Company’s income. The primary method used in the scheme was to make payments to certain entities that were ostensibly in respect of services provided by the entities and record the payments in connection with the Company’s acquisition of various leases. The payments were therefore capitalized as part of the Company’s lease acquisition costs and amortized over the lives of the related leases. These amounts were in turn paid back to the Company by the entities ostensibly for terminating operations in certain stores, not exercising certain real estate options and for taking other actions in respect of various leases (the “Company Actions”). The payments made to the Company were generally recorded as income at or about the time the agreements relating to the Company Actions were signed. According to the independent counsel’s report, in order to accomplish the scheme, the former Chairman and CEO made certain false representations to the Company’s Chief Financial Officer, other members of the management of the Company and the Company’s independent accountants concerning the structure and economic substance of the Real Estate Related Transactions. The independent counsel concluded that the agreements for the Real Estate Related Transactions between the entities and the Company had not been negotiated at arm’s length and that the purported consideration in those Real Estate Related Transactions was illusory and lacking in economic substance. The independent counsel therefore concluded that the circular payments to the entities by the Company and payments by the entities back to the Company should not have been made and should not have been reflected in the financial statements as originally reported. The restatement of the financial statements as of and for the Affected Periods includes the adjustments required to properly reflect those circular payments and resulting adjustments to the related amortization originally recorded.

The review and investigation of the independent counsel and the forensic accountants was completed on May 18, 2007. 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 related to the above matters. The Company is cooperating fully with that investigation. In the Company’s arbitration proceeding against the former Chairman and CEO, on May 25, 2007, the U.S. Attorney’s office submitted a letter requesting a stay of the arbitration proceeding. The SEC has also requested that the Company provide it with information related to this matter. For more information regarding the arbitration proceeding, please see Note 15 to the audited financial statements contained within this report.

The Audit Committee’s conclusion that the financial statements for the Affected Periods should be restated was based on the conclusions of the independent counsel in the investigation and the accounting impact of the misstatements relating to real estate-related income, combined with the previously-disclosed misstatements described below under “Investigation of Credits and Rebillings.” The restatements of the financial statements as of and for the Affected Periods also include adjustments to correct those misstatements.

Investigation of Credits and Rebillings: As previously disclosed, the Audit Committee of the Company, with the assistance of independent counsel, conducted and completed a review and investigation of the fiscal periods from 2000 through September 30, 2006, relating to arrangements originated by the former

CEO for the issuance of improper credits and the subsequent rebilling of such credits related to amounts paid to construction and other contractors at its stores and the related improper accounting. The Audit Committee completed its investigation prior to the filing of the Company’s quarterly report on Form 10-Q for the quarter ended September 30, 2006 on January 10, 2007.

The investigation focused principally on the accounting impact of approximately $5.8 million of credits from construction contractors that were improperly taken into the Company’s income and offsetting rebillings which were improperly recorded as capital expenditures in subsequent quarters by the Company. The Audit Committee believes that all of such credits were subsequently rebilled by the contractors and that the Company paid the contractors such rebilled amounts.

The credits had the effect of improperly offsetting SG&A expense (and improperly increasing net income) during the periods in which they were received. Amounts subsequently rebilled by the Company were generally capitalized as store improvements, improperly increasing the reported level of property and equipment as well as subsequent depreciation expense. The overstated net property and equipment that resulted from the credit/rebilling practice was also carried through the Acquisition-related purchase accounting process on a dollar-for-dollar basis.

In the periods from fiscal 2000 through the seven months ended July 30, 2004, increased depreciation resulted in a partial offset and understatement of operating income and income before income taxes. In the periods subsequent to July 30, 2004, increased depreciation resulted in an overstatement of operating loss and loss before income taxes. Income tax expense may also have been reduced as a result, based on the tax impact of such depreciation expense. Due to tax valuation reserves being recorded during 2006, there would not be any impact upon income tax expense for the 2006 periods.

Net income (loss) for all of the above-described periods would reflect the combined impact of the overstatement or understatement of income (loss) before income taxes and any related changes in income tax expense (benefit).

The credit/rebilling practice resulted in the overstatement of net property and equipment in all periods since the re-billings occurred. As a result of the overstatement of net property and equipment and related purchase accounting adjustments made in connection with the Acquisition, goodwill was also understated.

In addition, as a part of its investigation, the Audit Committee also examined certain invoices from store maintenance and other contractors to determine whether the amounts paid to those contractors were accounted for properly. The Audit Committee concluded that any misstatements with respect to such invoices were inconsequential.

Summary Tables: The following tables summarize the restatements of the financial statements for the Affected Periods:

Duane Reade Holdings, Inc. (Successor)
Duane Reade Inc. (Predecessor)
Profit & Loss Restatement
(in thousands)

		Successor				Predecessor
		Period from				Period from
		7/31/04 to				12/28/03 to
		12/25/04				7/30/04
Cost of sales	as previously reported		$	542,897			$	745,090
	adjustment—Credits & Rebillings		—				—
	adjustment—Real Estate		3,454				883
	as restated		$	546,351			$	745,973
Gross profit	as previously reported		$	127,671			$	182,711
	adjustment—Credits & Rebillings		—				—
	adjustment—Real Estate		(3,454		)		(883		)
	as restated		$	124,217			$	181,828
Selling, general and administrative	as previously reported		$	101,677			$	142,293
expenses	adjustment—Credits & Rebillings		—				—
	adjustment—Real Estate		—				(25		)
	as restated		$	101,677			$	142,268
Depreciation and amortization	as previously reported		$	27,051			$	21,902
expenses	adjustment—Credits & Rebillings		—				(323		)
	adjustment—Real Estate		(42		)		(183		)
	as restated		$	27,009			$	21,396
Operating (loss) income	as previously reported		$	(67,219	)		$	12,430
	adjustment		(3,412		)		(352		)
	as restated		$	(70,631	)		$	12,078
Earnings (loss) before tax	as previously reported		$	(90,624	)		$	4,453
	adjustment		(3,412		)		(352		)
	as restated		$	(94,036	)		$	4,101
Income tax (benefit) provision	as previously reported		$	(35,175	)		$	1,136
	adjustment		(1,324		)		(90		)
	as restated		$	(36,499	)		$	1,046
Net (loss) income	as previously reported		$	(55,449	)		$	3,317
	adjustment		(2,088		)		(262		)
	as restated		$	(57,537	)		$	3,055

Duane Reade Holdings, Inc. (Successor)
Duane Reade Inc. (Predecessor)
Cash Flow Restatement
(in thousands)

		Successor				Predecessor
		Period from				Period from
		7/31/04 to				12/28/03 to
		12/25/04				7/30/04
Net income (loss)	as previously reported		$	(55,449	)		$	3,317
	adjustment		(2,088		)		(262		)
	as restated		$	(57,537	)		$	3,055
Depreciation and amortization expenses	as previously reported		$	28,610			$	23,003
	adjustment		(42		)		(506		)
	as restated		$	28,568			$	22,497
Deferred income taxes	as previously reported		$	(35,884	)		$	5,900
	adjustment		(1,324		)		(90		)
	as restated		$	(37,208	)		$	5,810
Net cash provided by (used in) operating activities	as previously reported		$	(8,107	)		$	21,552
	adjustment		(3,454		)		(858		)
	as restated		$	(11,561	)		$	20,694
Lease acquisition, customer file and other costs	as previously reported		$	14,467			$	14,925
	adjustment		(3,454		)		(858		)
	as restated		$	11,013			$	14,067
Net cash used in investing activities	as previously reported		$	440,703			$	32,477
	adjustment		(3,454		)		(858		)
	as restated		$	437,249			$	31,619

Duane Reade Holdings, Inc. (Successor)
Duane Reade Inc. (Predecessor)
Stockholder’s Equity Restatement
(in thousands)

		Successor				Predecessor
		Period from				Period from
		7/31/04 to				12/28/03 to
		12/25/04				7/30/04
Accumulated deficit	as previously reported		$	(55,449	)		$	(1,583	)
	adjustment		(2,088		)		(8,893		)
	as restated		$	(57,537	)		$	(10,476	)
Comprehensive income (loss)	as previously reported		$	(55,449	)		$	3,317
	adjustment		(2,088		)		(262		)
	as restated		$	(57,537	)		$	3,055
Stockholders’ equity	as previously reported		$	184,049			$	331,704
	adjustment		(2,088		)		(8,893		)
	as restated		$	181,961			$	322,811

As at December 27, 2003, the cumulative impact on accumulated deficit was an increase of $8,631 and the cumulative impact on Stockholders’ equity was a decrease of $8,631.

Certain of the figures presented in the Company’s balance sheet as of December 31, 2005 reflect the impact of the above adjustments and are different from previously published amounts. These revisions, which the Company deems immaterial, affect the balances of property and equipment, goodwill and accumulated deficit, among other line items. In summary the revisions are as follows: an increase to goodwill of $2.4 million, a decrease to property and equipment of $4.2 million and an increase to accumulated deficit of $2.1 million.

3. Acquisition of Duane Reade Inc.

On July 30, 2004, Duane Reade Holdings, Inc. indirectly acquired all of the outstanding shares of Duane Reade Inc., a publicly held corporation. The financial statements designated as “Predecessor” reflect the operations of Duane Reade prior to the Acquisition and the financial statements designated as “Successor” reflect the operations and accounts of Duane Reade Holdings, Inc. and its subsidiaries subsequent to the Acquisition.

The Acquisition was accounted for as a purchase, in accordance with the provisions of Statement of Financial Accounting Standards No. 141, “Business Combinations”, which created a new basis of accounting and resulted in new valuations for the Company’s and its subsidiaries’ assets and liabilities based on fair values as of the date of the Acquisition. These valuations were largely based on appraisals provided by an independent valuation consultant employed for this purpose.

The following transactions were completed in connection with the Acquisition:

· an investor group led by Oak Hill made a cash equity contribution to Duane Reade Acquisition of approximately $239.5 million;

· Duane Reade GP borrowed a further $72.0 million under its amended asset-based revolving loan facility, resulting in total borrowings of approximately $153.8 million; on July 30, 2004, Duane Reade Inc. became a co-obligor under that facility; the additional borrowings were used to complete the tender offer for the senior convertible notes and pay related interest due on such notes through July 30, 2004;

· Duane Reade Inc. and Duane Reade GP, as co-obligors, borrowed approximately $155.0 million under the senior term loan facility, which was later refinanced with the proceeds of an offering of $160.0 million of Senior Secured Floating Rate Notes due 2010;

· Duane Reade Inc. and Duane Reade GP issued $195.0 million of 93¤4% senior subordinated notes due 2011;

· The former Chairman and CEO forfeited the right to receive various payments under his existing employment contract and received, among other things, a profits interest in Duane Reade Shareholders, LLC and options in Duane Reade Holdings, Inc.; and

· the other members of senior management forfeited the right to receive approximately $4.2 million of payments under existing contracts, and the Company issued them phantom stock representing, in the aggregate, up to an approximately 1.5% fully diluted economic interest in the Company.

The total consideration paid in the Acquisition was approximately $747.5 million, consisting of:

· approximately $404.9 million to purchase the equity of Duane Reade Inc.;

· an aggregate amount of approximately $81.8 million to assume the amended asset-based revolving loan facility;

· an aggregate amount of approximately $203.2 million to repurchase our outstanding senior convertible notes (representing 100% of the originally issued amount of the notes purchased, plus $2.2 million of accrued but unpaid interest on those notes through July 30, 2004); and

· an aggregate of approximately $57.6 million to pay fees, costs and expenses, including legal and professional fees, and certain payments to members of management, incurred in connection with the Acquisition and related transactions.

· The sources and uses of funds for the acquisition are summarized as follows:

	(millions)
Sources of Funds
Equity contribution		$	239.5
Revolver borrowings		153.8
Senior term loan		155.0
Senior subordinated notes		195.0
Senior management phantom shares		4.2
Total sources of funds		$	747.5
Uses of Funds
Purchase of outstanding stock		$	404.9
Repayment of existing revolver		81.8
Repayment of senior convertible notes		203.2
Transaction fees and expenses		57.6
Total uses of funds		$	747.5

The acquisition cost for the Company of $413.7 million includes the $404.9 million cost of acquiring the Duane Reade Inc. stock and certain additional transaction fees and expenses. The remaining transaction fees and expenses included in the sources and uses above were expensed or included in deferred financing costs.

The following summarizes the opening balance sheet of Duane Reade Holdings, Inc. which includes the application of purchase adjustments to record the acquisition of assets and liabilities at fair value at the Acquisition date:

	July 30, 2004 (restated)
	(in thousands)
Cash		$	83,785
Receivables		49,578
Inventories		258,870
Deferred taxes		11,787
Other assets		20,734
Total current assets		424,754
Property and equipment		221,362
Goodwill		70,171
Customer lists		96,500
Favorable leases		108,929
Tradename		62,600
Other assets		54,083
Total assets		$	1,038,399
Accounts payable		$	65,482
Accrued expenses		32,669
Current debt		751
Total current liabilities		98,902
Debt		553,372
Deferred taxes		103,664
Other non-current liabilities		42,963
Total liabilities		798,901
Equity		239,498
Total liabilities and equity		$	1,038,399

The amounts assigned to customer lists and favorable leases are being amortized to income over a weighted average life of 5.3 and 6.0 years respectively. The amount assigned to the tradename is not subject to amortization. The Company will generally carry over the historic tax basis of the net assets acquired, therefore the goodwill from this transaction is not tax deductible.

4. Pharmacy and Customer File Acquisitions

During the 2005 fiscal year and the predecessor and successor periods of 2004, the Company acquired individual pharmacy customer files (which were merged into existing stores) and the operations, including certain lease-related assets, of a number of pharmacy establishments (which were operated as new stores). During the 2006 fiscal year, the Company did not acquire any pharmacy customer files or pharmacy establishments. The table below provides detail of this acquisition activity for each of the periods presented (dollars in millions).

	Successor											Predecessor
	Fiscal Year			Fiscal Year				Period from				Period from
	Ended			Ended				July 31, 2004				Dec. 28, 2003
	December 30,			December 31,				through				through
	2006			2005				Dec. 25, 2004				July 30, 2004
Customer prescription files		—			4				2				6
Pharmacy establishments		—			—				4				1
Total acquisitions		—			4				6				7
Purchase price allocation:
Identifiable intangibles		$	—		$	2.4			$	5.9			$	7.2
Goodwill		—			—				—				0.9
Inventory		—			0.4				1.5				1.3
Property and equipment		—			—				0.3				—
Other assets		—			—				0.2				—
Accruals and liabilities		—			(0.3		)		(0.5		)		(0.3		)
Total		$	—		$	2.5			$	7.4			$	9.1

The acquired operations have been included in the consolidated statements of operations from the date of acquisition and did not have a material effect on the reported results of operations of the Company for the periods presented.

5. Receivables

Receivables are summarized as follows (in thousands):

	December 30, 2006				December 31, 2005
Third party pharmacy plans		$	39,392			$	37,045
Due from vendors		15,196				19,539
Credit cards and other receivables		4,632				3,826
Subtotal		59,220				60,410
Less: allowance for doubtful accounts		(2,039		)		(4,029		)
Receivables, net of allowances		$	57,181			$	56,381

6. Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets are summarized as follows (in thousands):

	December 30, 2006			December 31, 2005
Prepaid rent / real estate receivables		$	14,094		$	12,993
Insurance claims receivable		1,739			1,882
Prepaid insurance		1,041			1,059
Prepaid cigarette taxes		910			965
Prepaid equipment leases & maintenance contracts		1,270			1,605
Miscellaneous prepaids & receivables		6,605			7,610
		$	25,659		$	26,114

7. Property and Equipment

Property and equipment are summarized as follows (in thousands):

	December 30, 2006			December 31, 2005
Furniture, fixtures and equipment		$	128,705		$	121,039
Building and leasehold improvements including construction in progress		155,477			145,445
		284,182			266,484
Less accumulated depreciation and amortization		76,034			41,588
		$	208,148		$	224,896

Depreciation and amortization of property and equipment was $33.7 million, $32.2 million, $11.8 million and $14.6 million in fiscal 2006, fiscal 2005 and the successor and predecessor periods of 2004, respectively.

8. Other Assets

Other assets are summarized as follows (in thousands):

	December 30, 2006			December 31, 2005
Favorable leases (net of accumulated amortization of $42,507 and $23,785)		$	77,097		$	87,681
Pharmacy customer lists (net of accumulated amortization of $45,049 and $25,553)		57,745			77,312
Tradename		46,000			46,000
Deferred financing costs (net of accumulated amortization of $9,424 and $5,474)		15,750			18,945
Software & systems development costs (net of accumulated amortization of $5,540 and $3,208)		14,780			13,652
Security deposits		2,153			2,349
Other		936			5,444
		$	214,461		$	251,383

For the fiscal years ended December 30, 2006 and December 31, 2005 and the successor and predecessor periods of fiscal 2004, amortization of intangible assets was $38.3 million, $38.4 million, $15.2 million and $6.8 million, respectively. Amortization expense includes amortization of software and system development costs amounting to $2.9 million, $2.6 million, $0.6 million and $1.1 million,

respectively. For the 2007 through 2011 fiscal years, the Company expects to incur annual expenses related to the amortization of existing intangible assets of $35.1 million, $32.0 million, $29.3 million, $22.4 million and $10.0 million, respectively.

In fiscal 2005, as the result of an impairment analysis performed under the guidelines set forth in SFAS No. 142, the Company recorded an impairment charge of $16.6 million which reduced the carrying value of the Company’s tradename from $62.6 million to $46.0 million.

9. Accrued Expenses

Other accrued expenses are summarized as follows (in thousands):

	December 30, 2006			December 31, 2005
Accrued salaries and benefits		$	14,128		$	8,685
Insurance related claims costs		4,480			4,531
Sales tax payable		1,622			2,115
Expense payables		5,988			5,711
Accrued professional fees		3,074			4,895
Closed store reserves		3,563			10,051
Accrued rent		1,176			2,603
Accrued legal liabilities		1,270			2,902
Other		11,079			10,466
		$	46,380		$	51,959

10. Debt

Debt is summarized as follows (in thousands):

	December 30,			December 31,
Description of Instrument	2006			2005
Current Debt:
Asset-Based Revolving Loan Facility(1)		$	157,122		$	135,693
Non-Current Debt:
Senior Floating Rate Notes due 2010		210,000			210,000
9.75% Senior Subordinated Notes due 2011		195,000			195,000
2.1478% Senior Convertible Notes due 2022		32			32
Total		405,032			405,032
Total Debt		$	562,154		$	540,725

(1) 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 to reclassify the debt as long-term. However, this is not an indication that this credit facility is expected to be retired within the next year. The Company intends to continue to use this facility for its working capital needs through the date of its recently extended maturity in 2011.

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 million, subject to an adjusted borrowing base calculation based upon specified advance rates against the value of inventory, pharmacy prescription files and 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.

The amended asset-based revolving loan facility includes a $50 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:

· a rate equal to LIBOR (the London Interbank Offered Rate) plus a margin of from 1.00% to 2.00%, determined based on levels of borrowing availability reset each fiscal quarter; or

At December 30, 2006, there was $157.1 million outstanding under the amended asset-based revolving loan facility, and approximately $57.4 million of remaining availability, net of $5.5 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 Statement of Financial Accounting Standards No. 6, “Classification of Short Term Obligations Expected to be Refinanced,” to reclassify the debt as long-term.

As a result of the investigation carried out by the Company’s Audit Committee, the Company failed to timely file this annual report on Form 10-K for the year ended December 30, 2006, and as of the date of the filing of this Form 10-K, the Company had not filed its quarterly report on Form 10-Q for the quarter ended March 31, 2007 (which was required to be filed with the SEC on or before May 15, 2007). Such failures are defaults under the indentures governing the Company’s senior secured floating rate notes and the indenture governing the Company’s senior subordinated notes but will not become events of default or result in the acceleration of those notes until after the expiration of the relevant grace periods. The lenders

under the Company’s amended asset-based revolving loan facility have waived the default relating to the Company’s failure to file its Form 10-K until June 29, 2007, and they have also waived the default relating to the Company’s failure to file its Form 10-Q until July 15, 2007. The filing of this 10-K has cured the default relating to its late filing, and the Company anticipates it will be able to file the Form 10-Q prior to July 15, 2007.

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 notes. These new notes were issued under the same indenture as the senior secured notes issued in December 2004, although they do not trade fungibly with those notes.

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 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 expires on June 16, 2008. The changes in the fair value of the hedge agreement are reflected on the Consolidated Statements of Stockholder’s Equity and Comprehensive Income (Loss) included within the financial statements. At December 30, 2006, the LIBOR rate in effect for the senior secured notes was 5.36%, which exceeded the maximum rate under the “no cost collar.” As a result, the protection afforded by the “no cost collar” reduced the overall effective interest rate on the senior secured notes to 9.82%.

The Company guarantees the senior secured notes on a full and unconditional, senior secured basis. Duane Reade Inc. and Duane Reade GP are co-obligors under the senior secured notes. The senior secured notes rank equally in right of payment with any of the Company’s, Duane Reade Inc.’s or Duane Reade GP’s unsubordinated indebtedness 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 notes are guaranteed on a senior basis by each of the Company’s existing subsidiaries, other than Duane Reade Inc. and Duane Reade GP, and will be guaranteed by future subsidiaries of Duane Reade Inc. and Duane Reade GP except certain foreign and certain domestic subsidiaries. The senior secured 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 those assets in which the lenders under the amended asset-based revolving loan facility have a first priority interest. The senior secured 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 notes at 101% of the outstanding principal amount of the senior secured notes plus accrued and unpaid interest to the date of repurchase. The indenture governing the senior secured 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 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 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 notes that would impact the cost of borrowing, annual amortization of principal or related indebtedness maturity. The indenture governing the senior secured notes does not contain financial maintenance covenants.

At December 30, 2006, the weighted average combined interest rate in effect on all variable rate debt outstanding, including the benefit afforded by the “no cost collar,” was 8.59%.

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 notes. The senior subordinated notes will rank equally with any future senior subordinated indebtedness and senior to any future subordinated indebtedness. The senior subordinated notes are guaranteed on an uncollateralized, senior subordinated basis by the Company and all of Duane Reade Inc.’s existing direct and indirect domestic subsidiaries other than Duane Reade GP, which is a co-obligor under the senior subordinated notes. Upon the occurrence of specified change of control events, the Company will be required to make an offer to repurchase all of the senior subordinated notes at 101% of the outstanding principal amount of the senior subordinated notes plus accrued and unpaid interest to the date of repurchase. The indenture governing the senior subordinated notes contains certain affirmative and negative covenants that limit the ability of Duane Reade Inc., Duane Reade GP and their restricted subsidiaries to incur additional indebtedness, pay dividends, make repayments on indebtedness that is subordinated to the senior subordinated notes and to make certain other restricted payments, incur certain liens, use proceeds from sales of assets, enter into business combination transactions (including mergers, consolidations and asset sales), enter into transactions with affiliates and permit restrictions on the payment of dividends by restricted subsidiaries. The indenture governing the senior subordinated notes contains customary events of default, which, if triggered, may result in 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.

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 “Convertible Notes”). The Convertible Notes were issued at a price of $572.76 per note (57.276% of the principal amount at maturity) and pay 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 will accrue 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 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 Convertible Notes. Upon the closing of the tender offer, a total of $350.9 million principal value ($201.0 million issuance value) was tendered for repurchase, leaving

only $55.0 thousand of principal value ($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 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.

At December 30, 2006, the aggregate maturities of debt are as follows: (dollars in thousands):

2010	$210,000
2011	352,122
Thereafter	32
	$	562,154

11. Capital Lease Obligations

The Company has entered into several capital lease agreements for the purpose of acquiring photo processing and point-of-sale equipment for use in its stores. The capital lease obligations are payable in monthly installments and bear interest at a weighted average rate of 12.8%. At December 30, 2006, the aggregate maturity of the capitalized lease obligations and the present value of the net minimum lease payments are as follows (in thousands):

2007	$	4,310
2008	4,175
2009	3,947
	12,432
Less amounts representing interest	2,122
	10,310
Less current maturities	3,173
	$	7,137

At December 30, 2006, assets acquired under capital leases and the corresponding accumulated amortization amounts were $15.1 million and $6.2 million, respectively.

12. Other Non-current Liabilities

At December 30, 2006, non-current liabilities consisted of the following:

	December 30,			December 31,
	2006			2005
Deferred rent		$	30,058		$	19,464
Labor contingency		—			20,694
Deferred credits		14,532			11,010
Phantom stock liability		1,454			4,199
Closed store reserve		3,707			2,987
Other		4,919			8,911
		$	54,670		$	67,265

Deferred credits primarily reflects landlord allowances that will be recognized over the lives of the respective lease agreements. The phantom stock liability represents the value of shares of common stock pledged to certain of the Company’s Senior Vice Presidents in exchange for certain forfeited payments to which they were entitled in connection with the completion of the Acquisition.

13. Stockholder’s Equity

Common Stock of Duane Reade Holdings, Inc. As of December 30, 2006, Duane Reade Holdings, Inc.’s common stock consisted of 3,050,000 authorized shares, par value $0.01 per share, of which 2,594,977 shares were issued and outstanding. All of the outstanding shares of Duane Reade Holdings, Inc. are beneficially owned by Duane Reade Shareholders, LLC. Oak Hill, together with the equity co-investors, owns on a fully diluted basis 100% of the outstanding membership interests in Duane Reade Shareholders, LLC.

Preferred Stock of Duane Reade Holdings, Inc. As of December 30, 2006, Duane Reade Holdings, Inc.’s preferred stock consisted of 50,000 authorized shares, par value $0.01 per share, of which there were no shares issued or outstanding.

Stockholders and Registration Rights Agreement

A stockholders and registration rights agreement was entered into among certain members of management and Duane Reade Shareholders. The stockholders and registration rights agreement contains, among other things, certain restrictions on the ability of the parties thereto to freely transfer the securities of Duane Reade Holdings held by such parties. In addition, the stockholders and registration rights agreement provides that the holders of a majority of the membership interests in Duane Reade Shareholders may, under certain circumstances, compel a sale of all or a portion of the equity in Duane Reade Holdings to a third party (commonly known as drag-along rights) and, alternatively, that stockholders of Duane Reade Holdings may participate in certain sales of stock by holders of a majority of the common stock of Duane Reade Holdings to third parties (commonly known as tag-along rights). The stockholders and registration rights agreement also contains certain corporate governance provisions regarding the nomination of directors and officers of Duane Reade Holdings by the parties thereto. The stockholders and registration rights agreement also provides that Duane Reade Shareholders will have the ability to cause Duane Reade Holdings to register common equity securities of Duane Reade Holdings under the Securities Act, and provide for procedures by which certain of the equity holders of Duane Reade Holdings and Duane Reade Shareholders may participate in such registrations.

Preemptive Rights Agreement

A preemptive rights agreement was entered into among certain Oak Hill entities, Duane Reade Shareholders, Duane Reade Holdings, Duane Reade Inc. and Messrs. Cuti, Charboneau, LaBeau, Henry and Ray. The preemptive rights agreement contains, among other things, certain preemptive rights for management, providing that certain equity securities issued by Duane Reade Shareholders or any of its subsidiaries to the members of Duane Reade Shareholders (other than Mr. Cuti) must dilute the interests of all of the parties to the preemptive rights agreement on a proportionate basis. In connection with any such issuance of equity securities, each of Messrs. Cuti, Charboneau, LaBeau, Henry and Ray have the right to purchase from the issuing entity a percentage of equity securities being issued equal to their percentage interest (including phantom stock interest) in Duane Reade Holdings as of such time (and, in the case of Mr. Cuti, taking into account his interest in Duane Reade Shareholders as of such time). To the extent any such members of management no longer maintain equity interests in Duane Reade Shareholders or any of its subsidiaries, they will cease to be beneficiaries of the preemptive rights agreement. Messrs. Charboneau and LaBeau no longer maintain equity interests in Duane Reade Inc. or any of its subsidiaries.

Prior to the completion of the Acquisition, Stockholder’s Equity included Preferred Stock and Common Stock as described below:

Preferred Stock—Duane Reade Inc’s preferred stock was composed of two separate issues: (a) Preferred stock, par value $0.01 per share, consisting of 5,000,000 authorized shares, of which there

were no shares issued or outstanding at July 30, 2004, and (b) Series A preferred stock, par value $0.01 per share, consisting of 75,000 authorized shares, of which there were no shares issued or outstanding at July 30, 2004. The Series A preferred shares were reserved for issuance in the event that the Shareholder Rights Plan was enacted in response to a potential attempted change of control.

The Company’s Board of Directors had the authority, without further action of the shareholders of the Company, to issue shares of preferred stock in one or more series and to fix or determine the designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series thereof, including the dividend rights, dividend rates, conversion rights, voting rights, terms of redemption (including sinking fund provisions), redemption price or prices, liquidation preferences, and the number of shares constituting any series.

The Company’s Board of Directors, without shareholder approval, could issue preferred stock with voting and conversion rights that could have adversely affected the voting power of holders of common stock. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, may have had the effect of discouraging, delaying, or preventing a change in control of the Company. In conjunction with the completion of the Acquisition, each of the authorized shares of preferred stock and Series A preferred stock were cancelled, and are no longer in existence.

Common Stock—Duane Reade Inc’s authorized common stock, par value $.01 per share, consisted of 75,000,000 authorized shares of which 24,538,799 shares were issued and outstanding at July 30, 2004.

Holders of the common stock were entitled to one vote for each share held of record on all matters submitted to a vote of stockholders. The issued and outstanding shares of common stock were validly issued, fully paid and non-assessable. Subject to the rights of the holders of any shares of preferred stock, the holders of outstanding shares of common stock were entitled to receive dividends out of assets legally available for dividend distribution at such times and in such amounts as the Board of Directors may from time to time have determined. The shares of common stock were not redeemable or convertible, and the holders of the common shares had no pre-emptive or subscription rights to purchase any securities of the Company.

Upon liquidation, dissolution or winding up of the Company, the holders of shares of common stock were entitled to receive on a pro-rata basis the assets of the Company that were legally available for distribution, after payment of all debts and other liabilities and subject to the preferential rights of any holders of preferred stock.

In connection with the completion of the Acquisition, each of the outstanding common shares of Duane Reade Inc. was converted into the right to receive cash consideration of $16.50 per share, without interest. On July 30, 2004, a total of $404.9 million was paid to shareholders in connection with the purchase by Duane Reade Acquisition Inc. of all outstanding shares of Duane Reade Inc. common stock. Following the completion of the Acquisition, Duane Reade Inc. common stock was de-listed from the New York Stock Exchange and is no longer publicly traded.

14. Income Taxes

The income tax provision for the 2006 and 2005 fiscal years and the successor and predecessor periods of fiscal 2004 consists of the following (in thousands):

	Successor											Predecessor
								Restated				Restated
								Period from				Period from
	Fiscal Year			Fiscal Year				July 31, 2004				Dec. 28, 2003
	Ended			Ended				through				through
	Dec. 30, 2006			Dec. 31, 2005				Dec. 25, 2004				July 30, 2004
Current:
Federal		$	—		$	217			$	—			$	(4,439	)
State & Local		436			780				218				(246		)
Deferred:
Federal		1,881			(15,402		)		(29,027		)		5,850
State & Local		639			(15,087		)		(7,690		)		(120		)
Total expense (benefit)		$	2,956		$	(29,492	)		$	(36,499	)		$	1,046

Deferred tax assets and liabilities are determined based on the difference between the book and tax bases of the respective assets and liabilities at December 30, 2006 and December 31, 2005 and are summarized as follows (in thousands):

	December 30, 2006				December 31, 2005
Deferred tax assets (liabilities)—current:
Deferred income		$	1,110			$	1,213
Inventories		(2,416		)		(2,385		)
Reserves		12,182				13,557
Other, net		265				177
		11,141				12,562
Less: Valuation allowance		(8,712		)		(4,845		)
Deferred income taxes—current asset (liability)		$	2,429			$	7,717
Deferred tax assets (liabilities)—non-current:
Deferred rent		$	13,720			$	8,860
Deferred income		5,177				3,385
Long lived assets		(87,500		)		(103,468		)
Labor contingency and other reserves		4,425				15,281
Alternative minimum tax credits		1,668				1,668
Wage-based and other tax credits		10,554				10,212
Net operating losses		78,262				52,280
Other, net		3,821				4,915
		30,127				(6,867		)
Less: Valuation allowance		(59,748		)		(25,522		)
Deferred income taxes—non-current (liability) asset		($29,621		)		($32,389		)
Total net deferred tax (liabilities) assets		($27,192		)		($24,672		)

As a result of the Company’s significant loss incurred in 2006 and its anticipated future performance based on recently completed projections, the Company evaluated the need to record a valuation allowance against its net deferred tax assets as part of the 2006 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 “book vs. tax” differences giving rise to the specific assets and liabilities would reverse. Based on the results of this analysis, the Company

determined that except for two specific deferred tax liability items, all other deferred tax assets and liabilities were expected to reverse within the same period. The non-reversing items total $27.2 million and include post-2004 goodwill of $6.2 million and the deferred tax liability of $21.0 million associated with the tradename. 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.

In fiscal 2006, fiscal 2005 and the successor period of 2004, the Company generated net operating losses of approximately $53.5 million, $62.7 million and $48.9 million, respectively. The federal net operating losses can be carried forward 20 years and will begin to expire in fiscal year 2018. The New York state and New York city net operating losses can be carried forward for a period ranging between 15 and 20 years and will begin to expire in fiscal year 2007. The New Jersey net operating losses can be carried forward seven years and will begin to expire in fiscal year 2011. The federal and state tax effects of these net operating losses are reflected as a tax benefit in the deferred income tax provision.

Additional deferred tax assets include federal and state tax credits totaling $12.2 million, including New York state Zone Equivalent Area credits of $5.1 million and combined federal Work Opportunity and Alternative Minimum Tax credits of $4.5 million, each of which can be carried forward indefinitely.

Realization of these assets is dependent on generating sufficient taxable income in future periods. Based on historical taxable income and projections of future taxable income over the periods that the deferred tax assets are deductible, management believes that it is more likely than not that the deferred tax assets will not be realized and has therefore established a valuation allowance against the deferred tax assets.

At December 30, 2006, the Company has approximately $141.3 million of gross deferred tax assets and approximately $100.0 million of gross deferred tax liabilities, resulting in a net deferred tax asset of $41.3 million. After adjusting for the value of the deferred tax liabilities that do not reverse, the resulting cumulative valuation allowance amounts to $68.5 million, of which $30.4 million was recorded in 2005 and $38.1 million was recorded in 2006.

The provision for income taxes for the 2006 fiscal year, the 2005 fiscal year and the successor and predecessor periods of fiscal 2004 differs from the amounts of income tax determined by applying the applicable U.S. statutory federal income tax rate to pre-tax (loss) income as a result of the following (dollars in thousands):

	Successor															Predecessor
											Restated					Restated
	Fiscal Year					Fiscal Year					Period from					Period from
	Ended					Ended					July 31, 2004					Dec. 28, 2003
	December 30,					December 31,					through					through
	2006					2005					Dec. 25, 2004					July 30, 2004
Pre-tax (loss) income	$	(76,408	)	100.0	%	$	(129,880	)	100.0	%	$	(94,036	)	100.0	%	$	4,101		100.0	%
Statutory rate	(26,743		)	35.0		(45,458		)	35.0		(32,913		)	35.0		1,435			35.0
State and local taxes, net of federal tax benefit	(8,112		)	10.6		(13,463		)	10.4		(7,379		)	7.8		172			4.2
Transaction costs	—			—		—			—		4,160			(4.4	)	—			—
Tax credits	(328		)	0.4		48			(0.0	)	(423		)	0.4		(592		)	(14.4	)
Other	46			(0.1	)	(986		)	0.8		56			(0.1	)	31			0.8
	(35,137		)	46.0		(59,859		)	46.1		(36,499		)	38.8		1,046			25.5
Change in valuation allowance	38,093			(49.9	)	30,367			(23.4	)	—			—		—			—
Income tax provision (benefit)	$	2,956		(3.9	)%	$	(29,492	)	22.7	%	$	(36,499	)	38.8	%	$	1,046		25.5	%

Employment tax credits represent the 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 or based upon the duration of their employment at certain qualifying locations.

15. Commitments and Contingencies

Leases: Duane Reade leases its store facilities under operating lease agreements expiring on various dates through the year 2033. In addition to minimum rentals, certain leases provide for annual increases based upon real estate tax increases, maintenance cost increases and inflation. Generally, the Company obtains a free rent period during the construction of leasehold improvements for stores. Additionally, the Company’s leases provide for escalations over the term of the lease. Rent expense, including deferred rent, real estate taxes and other rent-related costs and income for the fiscal years ended December 30, 2006 and December 31, 2005 and the successor and predecessor periods of fiscal 2004 was $145.1 million, $146.3 million, $59.7 million and $77.7 million, respectively.

Minimum annual cash rent obligations under non-cancelable operating leases at December 30, 2006 (including obligations under new store leases entered into but not opened as of December 30, 2006) are as follows (in thousands):

2007	$	126,414
2008	127,755
2009	124,048
2010	117,427
2011	113,396
2012 to 2016	464,362
2017 to 2021	227,423
2022 to 2026	41,533
2027 to 2031	1,683
2032 to 2033	241
Total	$	1,344,282

Income anticipated to be received during the periods shown above in connection with sub-lease arrangements existing at December 30, 2006 amounts to $46.4 million.

Purchase Commitments: The Company is party to multi-year, merchandise supply agreements in the normal course of business. The largest of these agreements is with AmerisourceBergen, the Company’s primary pharmaceutical supplier. Generally, these agreements provide for certain volume commitments and may be terminated by the Company, subject in some cases to specified termination payments, none of which, in management’s opinion, would constitute a material adverse effect on the Company’s results of operations, financial position 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, the Company would be able to find a suitable alternative supplier.

Litigation: 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 it believes 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 which is presently pending in the U.S. District Court for the Southern District to recover both the appraisal panel’s award and additional amounts under the policy.

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 $6.0 million.

In December 2005, the Company and Cardinal Health, a former pharmacy inventory supplier, settled all matters relating to litigation arising out of a dispute regarding certain former supply arrangements and agreements. Under the terms of this settlement, the Company paid Cardinal Health $4.5 million over a period of time to settle an outstanding trade payable, and entered into an agreement whereby Cardinal will provide a secondary supply of pharmaceutical products to the Company until certain minimum purchase levels are achieved.

In November 2004, Duane Reade Inc. was served with a class action complaint, Damassia v. Duane Reade Inc. The lawsuit was filed in the United States District Court, Southern District 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. The Company believes this claim to be without merit, and it 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, Enamul 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. The complaint seeks an unspecified amount of damages. The Company believes this claim to be without merit, and it 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 January 2005, the Equal Employment Opportunity Commission filed an action against the Company in the U.S. District Court for the Southern District of New York alleging, among other things, that the Company created a hostile work environment for three female store employees, and potentially a class of such female employees. The Company believes that it has reached a settlement of this litigation, which settlement will not have a material impact on the Company or its operating results.

In November 2006, the Attorney General of the State of New Jersey filed an action against the Company alleging that the Company violated certain state regulations including regulations relating to the presence of expired products on its shelves and certain pricing regulations. The Company has been in discussions with the Attorney General’s office regarding settling this action; however there can be no assurance that this action will be settled on terms acceptable to the Company or at all. The Company believes that it has valid defenses to this action and it intends to vigorously defend itself.

Proceedings Relating to the Former Chairman and Chief Executive Officer

On September 1, 2006, Anthony J. Cuti, the Company’s former Chairman, President and Chief Executive Officer, 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 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 restatements and the results of the investigation are discussed more fully in Note 2.

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.

Litigation Relating to the Acquisition

The Company is aware of six purported class action complaints challenging the Acquisition consummated by Duane Reade Inc. and Duane Reade Acquisition that have been filed in the Court of Chancery of the State of Delaware, referred to as the “Delaware Complaints,” and three purported class action complaints that have been filed in the Supreme Court of the State of New York. Two of the New York complaints have been dismissed without prejudice. The other New York complaint (the “New York Complaint”) is pending, but has not been served on the Company. The Delaware Complaints name the former Chairman and CEO and certain other members of the Company’s board of directors and executive officers as well as Duane Reade GP as defendants. Four of the Delaware Complaints name Oak Hill as a defendant. The New York Complaint names the former Chairman and CEO and certain other members of the Company’s board of directors and executive officers as well as Duane Reade GP as defendants. One of the dismissed New York complaints named Oak Hill as a defendant.

The Delaware Complaints were consolidated on January 28, 2004, and on April 8, 2004 the plaintiffs in the Delaware actions filed a consolidated class action complaint. The Company believes these lawsuits are without merit and plans to defend these lawsuits vigorously. The plaintiffs in this litigation have been inactive for over three years.

Management Agreements: The Company has employment agreements with several of its executives providing, among other things, for employment terms of up to four years. Pursuant to the terms of such employment and related agreements, the Company may be obligated for certain compensation and benefits in the event of termination.

16. Benefit Plans

Management Stock Option Plan

The board of directors of Duane Reade Holdings, Inc. adopted the Duane Reade Holdings, Inc. Management Stock Option Plan (the “New Option Plan”), which became effective on the date the Acquisition was completed. The New 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 New Option Plan. As at December 30, 2006, a maximum of 370,293 shares of our common stock (on a fully diluted basis) may be granted under the New Option Plan.

Under the New Option Plan, the compensation committee of Duane Reade Holdings, Inc. may grant awards of nonqualified stock options, incentive stock options, or any combination of the foregoing. A stock option granted under the New 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 New Option Plan will be subject to such terms, including the exercise price and the conditions and timing of exercise, not inconsistent with the New Option Plan, as may be determined by the compensation committee and specified in the applicable stock option agreement or thereafter. Options granted under this plan will (i) be issued at an exercise price reflective of the fair market value at the time of grant, (ii) generally vest ratably over five years and (iii) terminate after ten years.

A summary of activity under the Stock Option Plan as of December 30, 2006, and changes during the successor periods including the year ended December 30, 2006, are presented below:

	2004 Management Stock Option Plan
			Wtd. Avg			Wtd. Avg
	Total		Exercise			Fair
	Options		Price			Value
Options outstanding, July 30, 2004	—
Options granted	176,477			$	100.00		$	24.57
Options outstanding, December 25, 2004	176,477			$	100.00		$	24.57
Options granted	191,320			$	100.00		$	25.28
Options outstanding, December 31, 2005	367,797			$	100.00		$	24.94
Options granted	63,211			$	100.00		$	41.43
Options cancelled	(135,289	)		$	100.00		$	24.59
Options outstanding, December 30, 2006	295,719			$	100.00		$	28.63
Weighted average remaining life	8.6 years
options exerciseable	57,665

As a result of the November 21, 2005 replacement of Mr. Cuti by Mr. Dreiling, all of Mr. Cuti’s options had vested and were exercisable until March 21, 2006, on which date the options expired unexercised.

The weighted-average grant-date fair value of options granted during the 2006 fiscal year was $41.43. There were no stock options exercised during the 2006 fiscal year.

The Company has adopted a Black-Scholes option pricing formula method of valuation and has engaged an external valuation consultant to provide this analysis, the results of which were applied to the stock options issued during the 2006 fiscal year.

· The valuation formula reflects the following key assumptions:

· Expected dividend yield: 0%—The Company has historically not paid any dividends, nor does it currently expect to pay dividends in the foreseeable future.

· Expected volatility: 32.0%—The volatility figure reflects the weighted-average 1, 5 and 10-year observed volatility of comparable industry participants.

· Expected term (years): 6.5—The expected life represents the period of time for which options granted are expected to be outstanding. This estimate was derived from historical share option exercise experience, which management believes provides the best estimate of the expected term.

· Risk-free interest rate: 4.38%—This reflects the rate portrayed on the Treasury Yield Curve for a period of time equivalent to the expected term.

As of December 30, 2006, there was $2.0 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 5 years. During the 2006 fiscal year, the Company recognized approximately $0.3 million of compensation cost related to share-based payments.

As of December 30, 2006, a total of 74,574 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.

Prior to the completion of the Acquisition on July 30, 2004, the following two stock option plans were in effect:

1992 Stock Option Plan—On October 12, 1992, the Company adopted the 1992 Stock Option Plan of Duane Reade Holding Corp. (the “Plan”). Under the Plan, a committee designated by the Board of Directors to administer the Plan (the “Committee”) could grant, to executives and other key employees of the Company, nonqualified stock options to purchase up to an aggregate of 510,757 shares of common stock of the Company at an exercise price fixed by the Committee. The options were exercisable at such time or times as the Committee determined at or subsequent to grant. The term of the options set by the Committee did not exceed 10 years.

At July 30, 2004, there were outstanding nonqualified stock options to purchase up to an aggregate of 26,565 shares of common stock, all of which were vested. In connection with the completion of the Acquisition, all outstanding stock options with an exercise price equal to or greater than $16.50 per share were cancelled. Options with an exercise price less than $16.50 per share were considered “in-the-money,” and holders of such options received a payment equal to the difference between $16.50 and the exercise price of the option, multiplied by the number of options held by the option holder. The total amount expended in this regard amounted to $0.4 million

Changes in options outstanding (including options granted outside the Plan) during the predecessor period in 2004 are summarized as follows:

	1992 Stock Option Plan
	Option price per share										Wtd. Avg
	$0.58		$ 7.34- $12.77		$29.37		$40.86		Total Options		Exercise Price
Options outstanding, December 27, 2003	23,820		2,745			—		—	26,565			$	1.84
Options outstanding, July 30, 2004 pre-transaction	23,820		2,745			—		—	26,565			$	1.84
Options paid to holders	(23,820	)	(2,745	)					(26,565	)		$	1.84
Options outstanding, July 30, 2004 post-transaction	—		—			—		—	—			$	—

1997 Equity Participation Plan—During 1997, the Company adopted an Equity Participation Plan (the “1997 Equity Participation Plan”), as amended, which provided 3,971,181 options for shares of common stock of the Company to be granted to employees, consultants and non-employee directors of the Company. At July 30, 2004, options for 2,819,857 shares had been granted (net of options for 1,559,112 shares that had been cancelled) to employees and certain non-employee directors, and 2,052,025 options were issued and outstanding as of that date. Under the plan, options granted to employees generally vested 20% on each of the first through fifth anniversaries of the issue date, with some options subject to accelerated vesting if certain performance targets were achieved.

In connection with the completion of the Acquisition, all outstanding stock options with an exercise price equal to or greater than $16.50 per share were cancelled. Options with an exercise price less than $16.50 per share were considered “in-the-money,” and holders of such options, excluding a portion of which that were held by senior management and forfeited in connection with the right to receive certain change-of control payments, received a payment equal to the difference between $16.50 and the exercise price of the option, multiplied by the number of options held by the option holder. The total amount expended in this regard amounted to $1.4 million.

DUANE READE HOLDINGS, INC.
Condensed Consolidating Statement of Operations
For the fiscal year ended December 30, 2006
(Successor)
(in thousands)

																				Duane Reade
	Duane Reade				Duane				Duane			Subsidiary				Consolidating				Holdings, Inc.
	Holdings, Inc.				Reade Inc.				Reade GP			Guarantors				Adjustments				Consolidated
Net sales		$	—			$	—		$	1,584,778			$	38,317			$	(38,317	)		$	1,584,778
Cost of sales		—				—			1,260,215				—				—				1,260,215
Gross profit		—				—			324,563				38,317				(38,317		)		324,563
Selling, general & administrative expenses		—				—			334,445				396				(59,797		)		275,044
Labor contingency		—				—			(18,004		)		—				—				(18,004		)
Depreciation and amortization		—				—			71,932				—				—				71,932
Store pre-opening expense		—				—			305				—				—				305
Other		—				—			14,747				—				—				14,747
Operating (loss) income		—				—			(78,862		)		37,921				21,480				(19,461		)
Equity earnings in affiliates		79,364				79,364			—				1,410				(160,138		)		—
Interest expense, net		—				—			56,947				(21,480		)		21,480				56,947
Income (loss) before income taxes		(79,364		)		(79,364		)	(135,809		)		57,991				160,138				(76,408		)
Income tax (benefit) expense		—				—			5,232				(2,276		)		—				2,956
Net (loss) income		$	(79,364	)		$	(79,364	)	$	(141,041	)		$	60,267			$	160,138			$	(79,364	)

102

DUANE READE HOLDINGS, INC.
Condensed Consolidating Statement of Operations
For the fiscal year ended December 31, 2005
(Successor)
(in thousands)

																				Duane Reade
	Duane Reade				Duane				Duane			Subsidiary				Consolidating				Holdings, Inc.
	Holdings, Inc.				Reade Inc.				Reade GP			Guarantors				Adjustments				Consolidated
Net sales		$	—			$	—		$	1,589,451			$	37,628			$	(37,628	)		$	1,589,451
Cost of sales		—				—			1,287,855				—				—				1,287,855
Gross profit		—				—			301,596				37,628				(37,628		)		301,596
Selling, general & administrative expenses		—				—			324,239				271				(50,838		)		273,672
Labor contingency		—				—			4,400				—				—				4,400
Transaction expense		—				—			681				—				—				681
Depreciation and amortization		—				—			70,594				—				—				70,594
Store pre-opening expense		—				—			364				—				—				364
Other		—				—			31,761				—				—				31,761
Operating (loss) income		—				—			(130,443		)		37,357				13,210				(79,876		)
Equity earnings in affiliates		100,388				100,388			—				1,395				(202,171		)		—
Interest expense, net		—				—			50,004				(13,210		)		13,210				50,004
Income (loss) before income taxes		(100,388		)		(100,388		)	(180,447		)		49,172				202,171				(129,880		)
Income tax (benefit) expense		—				—			(40,974		)		11,482				—				(29,492		)
Net (loss) income		$	(100,388	)		$	(100,388	)	$	(139,473	)		$	37,690			$	202,171			$	(100,388	)

103

DUANE READE HOLDINGS, INC.
Condensed Consolidating Income Statement
For the period from July 31, 2004 through December 25, 2004
(Successor—Restated)
(in thousands)

	Duane Reade Holdings, Inc.				Duane Reade Inc.				Duane Reade GP			Subsidiary Guarantors				Consolidating Adjustments				Duane Reade Holdings, Inc. Consolidated
Net sales		$	—			$	—		$	670,568			$	—			$	—			$	670,568
Cost of sales		—				—			546,351				—				—				546,351
Gross profit		—				—			124,217				—				—				124,217
Selling, general & administrative expenses		—				—			120,555				(18,878		)		—				101,677
Labor contingency		—				—			1,789				—				—				1,789
Transaction expense		—				—			37,575				—				—				37,575
Depreciation and amortization		—				—			27,009				—				—				27,009
Store pre-opening expense		—				—			365				—				—				365
Other		—				—			26,433				—				—				26,433
Operating (loss) income		—				—			(89,509		)		18,878				—				(70,631		)
Equity earnings in affiliates		57,537				57,537			—				691				(115,765		)		—
Interest expense, net		—				—			15,880				—				—				15,880
Debt extinguishment		—				—			7,525				—				—				7,525
Income (loss) before income taxes		(57,537		)		(57,537		)	(112,914		)		18,187				115,765				(94,036		)
Income tax (benefit) expense		—				—			(43,826		)		7,327				—				(36,499		)
Net (loss) income		$	(57,537	)		$	(57,537	)	$	(69,088	)		$	10,860			$	115,765			$	(57,537	)

104

DUANE READE INC.
Condensed Consolidating Income Statement
For the period from December 28, 2003 through July 30, 2004
(Predecessor—Restated)
(in thousands)

	Duane Reade Inc.				Duane Reade GP			Subsidiary Guarantors				Consolidating Adjustments				Duane Reade Inc. Consolidated
Net sales		$	—		$	927,801			$	—			$	—			$	927,801
Cost of sales		—			745,973				—				—				745,973
Gross profit		—			181,828				—				—				181,828
Selling, general & administrative expenses		18			166,512				(24,262		)		—				142,268
Labor contingency		—			2,611				—				—				2,611
Transaction expense		—			3,005				—				—				3,005
Depreciation and amortization		—			21,396				—				—				21,396
Store pre-opening expense		—			470				—				—				470
Operating (loss) income		(18		)	(12,166		)		24,262				—				12,078
Equity earnings in affiliates		(3,069		)	—				150				2,919				—
Interest expense, net		—			7,977				—				—				7,977
Debt extinguishment		—			—				—				—				—
Income (loss) before income taxes		3,051			(20,143		)		24,112				(2,919		)		4,101
Income tax (benefit) expense		(4		)	(5,139		)		6,189				—				1,046
Net income (loss)		$	3,055		$	(15,004	)		$	17,923			$	(2,919	)		$	3,055

105

DUANE READE HOLDINGS, INC.
Condensed Consolidating Balance Sheet
As of December 30, 2006
(Successor)
(in thousands)

																					Duane Reade
	Duane Reade												Subsidiary				Consolidating				Holdings, Inc.
	Holdings, Inc.				Duane Reade Inc.				Duane Reade GP				Guarantors				Adjustments				Consolidated
Assets
Current assets
Cash		$	—			$	—			$	1,370			$	25			$	—			$	1,395
Receivables		—				—				57,181				—				—				57,181
Due from affiliates		—				72,259				112,934				145				(185,338		)		—
Inventories		—				—				218,924				—				—				218,924
Deferred income taxes		—				3,552				5,066				(6,189		)		—				2,429
Prepaid expenses and other assets		—				—				25,659				—				—				25,659
Total current assets		—				75,811				421,134				(6,019		)		(185,338		)		305,588
Investment in affiliates		2,209				2,209				—				(1,101		)		(3,317		)		—
Property and equipment		—				—				208,148				—				—				208,148
Goodwill		—				—				70,384				—				—				70,384
Deferred income taxes		—				1,645				9,032				(10,677		)		—				—
Other assets		—				—				168,229				345,082				(298,850		)		214,461
Total assets		$	2,209			$	79,665			$	876,927			$	327,285			$	(487,505	)		$	798,581
Liabilities and Stockholder’s Equity
Current liabilities
Accounts payable		$	—			$	—			$	83,410			$	—			$	—			$	83,410
Due to affiliates		—				—				—				185,336				(185,336		)		—
Accrued interest		—				—				9,299				—				—				9,299
Accrued expenses		—				132				46,248				—				—				46,380
Current portion of long term debt		—				—				157,122				—				—				157,122
Current portion of capital lease obligations		—				—				3,173				—				—				3,173
Total current liabilities		—				132				299,252				185,336				(185,336		)		299,384
Long term debt		—				—				703,882				—				(298,850		)		405,032
Capital lease obligations, less current portion		—				—				7,137				—				—				7,137
Deferred income taxes		—				74,871				(75,986		)		30,736				—				29,621
Other non-current liabilities		—				2,453				52,217				—				—				54,670
Total liabilities		—				77,456				986,502				216,072				(484,186		)		795,844
Stockholder’s equity
Common stock		26				—				—				—				—				26
Paid-in-capital		239,472				239,498				239,833				2,395				(481,391		)		239,807
Accumulated other comprehensive income		—				—				193				—				—				193
Retained earnings (deficit)		(237,289		)		(237,289		)		(349,601		)		108,818				478,072				(237,289		)
Total stockholder’s equity		2,209				2,209				(109,575		)		111,213				(3,319		)		2,737
Total liabilities and stockholder’s equity		$	2,209			$	79,665			$	876,927			$	327,285			$	(487,505	)		$	798,581

106

DUANE READE HOLDINGS, INC.
Condensed Consolidating Balance Sheet
As of December 31, 2005
(Successor)
(in thousands)

																					Duane Reade
	Duane Reade												Subsidiary				Consolidating				Holdings, Inc.
	Holdings, Inc.				Duane Reade Inc.				Duane Reade GP				Guarantors				Adjustments				Consolidated
Assets
Current assets
Cash		$	—			$	—			$	1,338			$	24			$	—			$	1,362
Receivables		—				—				56,381				—				—				56,381
Due from affiliates		—				71,983				112,660				—				(184,643		)		—
Inventories		—				—				231,578				—				—				231,578
Deferred income taxes		—				8,857				5,049				(6,189		)		—				7,717
Prepaid expenses and other assets		—				—				26,114				—				—				26,114
Total current assets		—				80,840				433,120				(6,165		)		(184,643		)		323,152
Investment in affiliates		81,574				81,574				—				309				(163,457		)		—
Property and equipment		—				—				224,896				—				—				224,896
Goodwill		—				—				70,171				—				—				70,171
Deferred income taxes		—				1,645				9,032				(10,677		)		—				—
Other assets		—				—				205,151				285,132				(238,900		)		251,383
Total assets		$	81,574			$	164,059			$	942,370			$	268,599			$	(587,000	)		$	869,602
Liabilities and Stockholder’s Equity
Current liabilities
Accounts payable		$	—			$	—			$	72,711			$	—			$	—			$	72,711
Due to affiliates		—				—				—				184,641				(184,641		)		—
Accrued interest		—				—				9,222				—				—				9,222
Accrued expenses		—				(107		)		52,066				—				—				51,959
Current portion of long term debt		—				—				135,693				—				—				135,693
Current portion of capital lease obligations		—				—				3,183				—				—				3,183
Total current liabilities		—				(107		)		272,875				184,641				(184,641		)		272,768
Long term debt		—				—				643,932				—				(238,900		)		405,032
Capital lease obligations, less current portion		—				—				10,314				—				—				10,314
Deferred income taxes		—				80,612				(81,235		)		33,012				—				32,389
Other non-current liabilities		—				1,980				65,285				—				—				67,265
Total liabilities		—				82,485				911,171				217,653				(423,541		)		787,768
Stockholder’s equity
Common stock		26				—				—				—				—				26
Paid-in-capital		239,472				239,498				239,498				2,395				(481,391		)		239,472
Accumulated other comprehensive income		—				—				260				—				—				260
Retained earnings (deficit)		(157,924		)		(157,924		)		(208,559		)		48,551				317,932				(157,924		)
Total stockholder’s equity		81,574				81,574				31,199				50,946				(163,459		)		81,834
Total liabilities and stockholder’s equity		$	81,574			$	164,059			$	942,370			$	268,599			$	(587,000	)		$	869,602

107

DUANE READE HOLDINGS, INC.
Condensed Consolidating Statement of Cash Flows
For the fiscal year ended December 30, 2006
(Successor)
(in thousands)

																					Duane Reade
	Duane Reade												Subsidiary				Consolidating				Holdings, Inc.
	Holdings, Inc.				Duane Reade Inc.				Duane Reade GP				Guarantors				Adjustments				Consolidated
Cash flows from operating activities:
Net income (loss)		$	(79,364	)		$	(79,364	)		$	(141,041	)		$	60,267			$	160,138			$	(79,364	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		—				—				75,882				—				—				75,882
Deferred tax provision		—				(436		)		5,232				(2,276		)		—				2,520
Deferred rent expense		—				—				10,956				—				—				10,956
Impairment charge		—				—				10,202				—				—				10,202
Reversal of labor contingency liability		—				—				(18,004		)		—				—				(18,004		)
Other non-cash expenses		—				—				382				—				—				382
Equity in income of subsidiaries		79,364				79,364				—				1,410				(160,138		)		—
Changes in operating assets and liabilities:
Receivables		—				(276		)		(1,074		)		550				—				(800		)
Inventories		—				—				12,654				—				—				12,654
Accounts payable		—				—				10,699				—				—				10,699
Prepaid and accrued expenses		—				239				(4,811		)		—				—				(4,572		)
Increase in other assets (liabilities), net		—				473				50,538				(59,950		)		—				(8,939		)
NET CASH PROVIDED BY OPERATING ACTIVITIES		—				—				11,615				1				—				11,616
Capital expenditures		—				—				(25,112		)		—				—				(25,112		)
Lease acquisition and other costs		—				—				(6,458		)		—				—				(6,458		)
Asset sale proceeds		—				—				2,500				—				—				2,500
NET CASH USED IN INVESTING ACTIVITIES		—				—				(29,070		)		—				—				(29,070		)
Cash flows from financing activities:
Deferred financing costs		—				—				(755		)		—				—				(755		)
Borrowings from revolving credit facility		—				—				1,850,549				—				—				1,850,549
Repayments of revolving credit facility		—				—				(1,829,120		)		—				—				(1,829,120		)
Repayments of capital lease obligations		—				—				(3,187		)		—				—				(3,187		)
NET CASH PROVIDED BY FINANCING ACTIVITIES		—				—				17,487				—				—				17,487
Net increase in cash		—				—				32				1				—				33
Cash at beginning of period		—				—				1,338				24				—				1,362
Cash at end of period		$	—			$	—			$	1,370			$	25			$	—			$	1,395

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DUANE READE HOLDINGS, INC.
Condensed Consolidating Statement of Cash Flows
For the fiscal year ended December 31, 2005
(Successor)
(in thousands)

																					Duane Reade
	Duane Reade												Subsidiary				Consolidating				Holdings, Inc.
	Holdings, Inc.				Duane Reade Inc.				Duane Reade GP				Guarantors				Adjustments				Consolidated
Cash flows from operating activities:
Net income (loss)		$	(100,388	)		$	(100,388	)		$	(139,473	)		$	37,690			$	202,171			$	(100,388	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		—				—				74,510				—				—				74,510
Deferred tax provision		—				(997		)		(40,635		)		11,482				—				(30,150		)
Deferred rent expense		—				—				13,243				—				—				13,243
Impairment charge		—				—				16,600				—				—				16,600
Equity in income of subsidiaries		100,388				100,388				—				1,395				(202,171		)		—
Changes in operating assets and liabilities:
Receivables		—				1,318				17,632				(17,275		)		—				1,675
Inventories		—				—				31,134				—				—				31,134
Accounts payable		—				—				(7,018		)		—				—				(7,018		)
Prepaid and accrued expenses		—				(321		)		2,664				—				—				2,343
Increase in other assets (liabilities), net		—				—				34,355				(33,300		)		—				1,055
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES		—				—				3,012				(8		)		—				3,004
Capital expenditures		—				—				(25,214		)		—				—				(25,214		)
Lease acquisition and other costs		—				—				(8,484		)		—				—				(8,484		)
Asset sale proceeds		—				—				7,069				—				—				7,069
NET CASH USED IN INVESTING ACTIVITIES		—				—				(26,629		)		—				—				(26,629		)
Cash flows from financing activities:
Proceeds from senior secured notes		—				—				47,750				—				—				47,750
Deferred financing costs		—				—				(3,094		)		—				—				(3,094		)
Borrowings from revolving credit facility		—				—				1,833,698				—				—				1,833,698
Repayments of revolving credit facility		—				—				(1,851,875		)		—				—				(1,851,875		)
Repayments of capital lease obligations		—				—				(2,821		)		—				—				(2,821		)
NET CASH PROVIDED BY FINANCING ACTIVITIES		—				—				23,658				—				—				23,658
Net (decrease) increase in cash		—				—				41				(8		)		—				33
Cash at beginning of period		—				—				1,297				32				—				1,329
Cash at end of period		$	—			$	—			$	1,338			$	24			$	—			$	1,362

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DUANE READE HOLDINGS, INC.
Condensed Consolidating Statement of Cash Flows
For the period from July 31, 2004 through December 25, 2004
(Successor - Restated)
(in thousands)

	Duane Reade Holdings, Inc.				Duane Reade Inc.				Duane Reade GP				Subsidiary Guarantors				Consolidating Adjustments				Duane Reade Holdings, Inc. Consolidated
Cash flows from operating activities:
Net income (loss)		$	(57,537	)		$	(57,537	)		$	(69,088	)		$	10,860			$	115,765			$	(57,537	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		—				—				28,568				—				—				28,568
Deferred tax provision		—				(709		)		(43,826		)		7,327				—				(37,208		)
Debt extinguishment		—				—				4,425				—				—				4,425
Non-cash rent expense		—				—				6,221				—				—				6,221
Equity in income of subsidiaries		57,537				57,537				—				691				(115,765		)		—
Changes in operating assets and liabilities:
Receivables		—				709				(2,278		)		—				—				(1,569		)
Inventories		—				—				(1,682		)		—				—				(1,682		)
Accounts payable		—				—				14,673				—				—				14,673
Prepaid and accrued expenses		—				—				32,087				—				—				32,087
Increase in other assets (liabilities), net		—				—				19,366				(18,905		)		—				461
NET CASH USED IN OPERATING ACTIVITIES		—				—				(11,534		)		(27		)		—				(11,561		)
Capital expenditures		—				—				(10,360		)		—				—				(10,360		)
Lease acquisition and other costs		—				—				(13,205		)		—				—				(13,205		)
Acquisition of Duane Reade		—				—				(413,684		)		—				—				(413,684		)
NET CASH USED IN INVESTING ACTIVITIES		—				—				(437,249		)		—				—				(437,249		)
Cash flows from financing activities:
Deferred financing costs		—				—				(16,919		)		—				—				(16,919		)
Proceeds from floating rate notes		—				—				160,000				—				—				160,000
Proceeds from senior subordinated notes		—				—				195,000				—				—				195,000
Repurchase of convertible notes		—				—				(201,000		)		—				—				(201,000		)
Borrowings from revolving credit facility		—				—				743,186				—				—				743,186
Repayments of revolving credit facility		—				—				(670,661		)		—				—				(670,661		)
Additional capital contribution		—				—				239,498				—				—				239,498
Repayments of capital lease obligations		—				—				(303		)		—				—				(303		)
NET CASH PROVIDED BY FINANCING ACTIVITIES		—				—				448,801				—				—				448,801
Net (decrease) increase in cash		—				—				18				(27		)		—				(9		)
Cash at beginning of period		—				—				1,279				59				—				1,338
Cash at end of period		$	—			$	—			$	1,297			$	32			$	—			$	1,329

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

	Duane Reade Inc.				Duane Reade GP				Subsidiary Guarantors				Consolidating Adjustments				Duane Reade Inc. Consolidated
Cash flows from operating activities:
Net income (loss)		$	3,055			$	(15,004	)		$	17,923			$	(2,919	)		$	3,055
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		—				22,497				—				—				22,497
Deferred tax provision		4,760				(5,139		)		6,189				—				5,810
Non-cash rent expense		—				4,383				—				—				4,383
Equity in income of subsidiaries		(3,069		)		—				150				2,919				—
Changes in operating assets and liabilities:
Receivables		(6,426		)		3,369				—				—				(3,057		)
Inventories		—				4,385				—				—				4,385
Accounts payable		—				(20,047		)		—				—				(20,047		)
Prepaid and accrued expenses		554				193				—				—				747
Increase in other assets (liabilities), net		—				27,172				(24,251		)		—				2,921
NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES		(1,126		)		21,809				11				—				20,694
Capital expenditures		—				(17,552		)		—				—				(17,552		)
Lease acquisition and other costs		—				(14,067		)		—				—				(14,067		)
NET CASH USED IN INVESTING ACTIVITIES		—				(31,619		)		—				—				(31,619		)
Cash flows from financing activities:
Deferred financing costs		—				(841		)		—				—				(841		)
Borrowings from revolving credit facility		—				941,503				—				—				941,503
Repayments of revolving credit facility		—				(930,511		)		—				—				(930,511		)
Proceeds from exercise of stock options		1,126				—				—				—				1,126
Repayments of capital lease obligations		—				(266		)		—				—				(266		)
NET CASH PROVIDED BY FINANCING ACTIVITIES		1,126				9,885				—				—				11,011
Net increase in cash		—				75				11				—				86
Cash at beginning of period		—				1,204				48				—				1,252
Cash at end of period		$	—			$	1,279			$	59			$	—			$	1,338

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Directors and Executive Officers

The following table sets forth information regarding our directors and executive officers as of June 1, 2007:

Name	Age	Position
Richard W. Dreiling	53	Chief Executive Officer, President and Chairman of the Board of Directors
Michelle D. Bergman	40	Senior Vice President—General Counsel and Secretary
David D’ Arezzo	48	Senior Vice President and Chief Marketing Officer
John K. Henry	57	Senior Vice President and Chief Financial Officer
Charles Newsom	56	Senior Vice President—Store Operations
Jerry M. Ray	58	Senior Vice President—Pharmacy Operations
Vincent A. Scarfone	49	Senior Vice President—Human Resources and Administration
Michael S. Green	34	Director
John P. Malfettone	51	Director
Andrew J. Nathanson	48	Director
Denis J. Nayden	53	Director
Tyler J. Wolfram	40	Director

Richard W. Dreiling was appointed our Chief Executive Officer, President and a director of Duane Reade Holdings, Inc. and Duane Reade Inc. on November 21, 2005. On March 26, 2007, Mr. Dreiling was named to the position of Chairman of the Board of Directors. Mr. Dreiling previously served as Executive Vice President—Chief Operating Officer of Longs Drug Store Corporation, an operator of a chain of retail drug stores on the West Coast and Hawaii, since March 2005, after having joined Longs in July 2003 as Executive Vice President and Chief Operations Officer. From 2000 to 2003, Mr. Dreiling served as Executive Vice President—Marketing, Manufacturing and Distribution at Safeway, Inc., a food and drug retailer. Prior to that, Mr. Dreiling served from 1998 to 2000 as President of Vons, a Southern California food and drug division of Safeway.

Michelle D. Bergman was promoted to the position of Senior Vice President—General Counsel in December 2005. Prior to that, Ms. Bergman had served as our Vice President—General Counsel since July 2002. From 2001 to 2002, Ms. Bergman served as Assistant General Counsel of AEA Investors, a private-equity investment firm and prior to that, from 2000 to 2001 she served as Vice President and Counsel at Credit Suisse First Boston, a global investment banking firm. Prior to that, Ms. Bergman was with the law firm of Latham & Watkins LLP.

David D’Arezzo was appointed as Senior Vice President and Chief Marketing Officer, a newly created position, in March 2006. Prior to joining us, he spent two years as Chief Operating Officer for Raley’s Family of Fine Foods, a privately held supermarket chain headquartered in West Sacramento, CA. From 2002 to 2003, he served as Executive Vice President of Merchandising and Replenishment at Office Depot, a nationwide office supply retailer, and from 1994 to 2002, he served in various roles with Wegman’s Food Markets, a regional specialty supermarket chain operating primarily in the northeastern United States, culminating with the position of Senior Vice President of Merchandising. Prior to joining Wegman’s, he held various brand management, marketing and sales positions at Pepsi-Cola Company.

John K. Henry has been our Chief Financial Officer since July 30, 2004. In addition, he is the Senior Vice President and Chief Financial Officer of Duane Reade Inc., having served in that capacity since August 1999. Prior to joining us, Mr. Henry was Senior Vice President and Chief Financial Officer of Global Household Brands, a consumer products manufacturer and distributor, from 1998 to 1999,

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Executive Vice President and Chief Financial Officer of Rickel Home Centers, a regional home improvement retailer, from 1994 to 1998 and Vice President of Finance of Supermarkets General Holdings Corporation, a regional supermarket retailer operating in the New York metropolitan market, from 1992 to 1994.

Charles Newsom was appointed as Senior Vice President in charge of Store Operations in January 2006. Prior to joining us, he served as Regional Vice President for Winn-Dixie, a regional supermarket retailer operating primarily in the southern United States, from November 2004 to December 2005. From July 2002 until July 2004, he was the Senior Group Vice President for the New York division of the Eckerd Corporation, a national retail drugstore chain, responsible for 459 stores in the New York metropolitan area. Before joining the Eckerd Corporation, he was the President of Pueblo Supermarkets, a regional supermarket chain in San Juan, Puerto Rico, and also served as Senior Vice President of Pueblo International LLC.

Jerry M. Ray has been Senior Vice President in charge of Pharmacy Operations since March 2006. He served as Senior Vice President of Store and Pharmacy Operations of Duane Reade Inc. from 1996 to 2006 and served as Vice President of Pharmacy Operations of Duane Reade Inc. from 1995 to 1996. From 1991 to 1994, Mr. Ray served as President and CEO of Begley Drugstores, Inc., a regional drugstore retailer operating in Virginia and Tennessee.

Vincent A. Scarfone was appointed our Senior Vice President of Human Resources and Administration in September 2006. Prior to joining us, Mr. Scarfone served as Vice President—Global Human Resources for Bureau Veritas Consumer Products Services from February 2005 to June 2006. From 1984 to 2004, Mr. Scarfone worked for Toys “R” Us Inc., holding several senior human resource positions including, from 2002 to 2004, Vice President of Human Resources, International Division.

Michael S. Green became one of our directors in July 2004. Mr. Green is currently a Partner of Oak Hill Capital Management, LLC where he has been since 2000. He serves on the Board of Directors of NSA International, LLC.

John P. Malfettone became one of our directors and a director of Duane Reade Inc. in January 2005. He is the Chief Operating Officer of Oak Hill Capital Management, LLC and is responsible for finance, operations, human resources, administration, information technology and business planning. In addition, Mr. Malfettone provides assistance to the Oak Hill investment team in managing portfolio company financial and business matters. Prior to joining Oak Hill in 2004, Mr. Malfettone was the Executive Vice President and Chief Financial Officer of MacDermid Inc., a New York Stock Exchange listed specialty chemical company. Prior to that, from 1990 to 2001, he worked at General Electric Co. serving in numerous roles including GE Capital Assistant Corporate Controller, GE Capital Corporate Controller, GE Capital EVP CFO and Managing Director in GE’s private equity business. He joined GE from the accounting and audit firm, KPMG Peat Marwick, where he was promoted to partner in 1988. Mr. Malfettone is on the Board of Directors of NY Credit Advisors.

Andrew J. Nathanson became one of our directors in July 2004. Mr. Nathanson is currently a private investor. From 2000 to 2006, Mr. Nathanson served as a Managing Partner at Oak Hill and Vice President of Oak Hill Capital Management, Inc., the principal business of which is acting as the investment adviser of Oak Hill. From 1989 to 2000, Mr. Nathanson served as Managing Director at Donaldson Lufkin & Jenrette Securities Corporation, an investment bank.

Denis J. Nayden became a director of Duane Reade Inc. in November 2004 and one of our directors in January 2005. Mr. Nayden is a Managing Partner of Oak Hill Capital Management, LLC and has been with the firm in that position since 2003. Mr. Nayden co-heads the Oak Hill industry groups focused on investments in basic industries and business and financial services. Prior to joining Oak Hill Capital Management, LLC in 2003, Mr. Nayden was Chairman and Chief Executive Officer of GE Capital from 2000 to 2002 and had a 25-year tenure at General Electric Co., during which time he also served as

116

President and Chief Operating Officer, Executive Vice President, Senior Vice President and General Manager in the Structured Finance Group, Vice President and General Manager in the Corporate Finance Group and Marketing Administrator for Air/Rail Financing as well as in various other positions of increasing responsibility. Mr. Nayden serves on the Boards of Directors of Genpact, GMH Communities Trust, Healthcare Services, Inc. Primus International, Inc. and RSC Holdings, Inc., as well as the University of Connecticut.

Tyler J. Wolfram became one of our directors at the time of our formation. He is currently a Partner of Oak Hill Capital Management, LLC, where he has been since 2001. During 2000, Mr. Wolfram served as Managing Director of Whitney & Co., a private equity investment firm. From 1998 to 2000, he served as Managing Director of Cornerstone Equity Investors, LLC, a private equity investment firm. Mr. Wolfram serves on the Board of Directors of NSA International, LLC.

Board Committees

On February 14, 2005, an Audit Committee of the board of directors of Duane Reade Holdings, Inc. was established following the Acquisition in accordance with Section 3(a)(58)(A) of the Exchange Act. Messrs. Michael S. Green, John P. Malfettone and Tyler J. Wolfram were designated and appointed to serve as the members of the Audit Committee. Mr. Malfettone was designated and appointed to serve as its Chairman. The board of directors has determined that Mr. Malfettone is qualified and designated as an Audit Committee Financial Expert.

On February 14, 2005, a Compensation Committee of the board of directors of Duane Reade Inc. was established. Messrs. Andrew J. Nathanson, Denis J. Nayden and Tyler J. Wolfram were designated and appointed to serve as the members of the Compensation Committee. Mr. Nathanson was designated and appointed to serve as its Chairman.

Compensation Committee Interlocks and Insider Participation

During fiscal 2005, Messrs. Nathanson and Wolfram were Vice Presidents of Duane Reade Holdings, Inc. Effective January 2006, Messrs. Nathanson and Wolfram are no longer Vice Presidents of Duane Reade Holdings, Inc. Mr. Nayden is not an employee of the Company or any of its subsidiaries.

Code of Ethics

The Company has implemented a Code of Business Conduct and Ethics for its corporate officers, management and other professional personnel. The Code is required to be signed by each such individual, and is kept on file at the Company’s corporate office. The full text of the Code of Ethics was filed as an exhibit to the Annual Report on Form 10-K of Duane Reade Inc. for the fiscal year ended December 27, 2003 and is available on the Company’s website at www.duanereade.com.

ITEM 11. EXECUTIVE COMPENSATION AND RELATED MATTERS—

COMPENSATION DISCUSSION AND ANALYSIS

1. Introduction We are the leading drugstore retailer in the New York metropolitan area, operating 248 stores and employing approximately 6,100 associates at December 30, 2006. Due to the highly competitive nature of the business environment in which we operate, we seek to attract, motivate and retain talented and energetic management and executive-level employees. In order to achieve this objective, we provide compensation packages that offer competitive base salaries as well as short and long-term incentive opportunities based on both corporate and individual performance.

In July 2004, we were acquired by Oak Hill, and we have no publicly-traded equity securities. Compensation decisions and policies affecting our senior-level executives are reviewed and approved by

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the Compensation Committee of the Board of Directors. The Committee, which consists entirely of non-management board members, is composed of the following individuals:

Andrew Nathanson—Chairman

Denis Nayden

Tyler Wolfram

No member of the Committee participates in any of our employee compensation programs.

The purpose of the Compensation Committee is to assist the Board of Directors in matters relating to executive compensation, establish goals for the award of incentive and performance-based compensation, administer our Management Stock Option Plan and monitor the performance of the executive officers.

During 2006, the Committee met 2 times to address various executive compensation issues including determination of executive incentive bonus target levels of performance and executive stock option awards. It also met in March, 2007 to review executives’ and the CEO’s performance and to review and approve executive salary increases that became effective in April 2007. At this meeting the Committee also approved the executive incentive bonus awards for 2006 performance that were paid in April of 2007.

2. Philosophy and Objectives The Compensation Committee oversees an executive compensation program designed to reflect our focus on achieving sales, EBITDA and growth targets. The objectives of the compensation program are:

· to attract, motivate and retain top quality executives with the qualifications necessary to drive our short- and long-term financial success;

· to encourage the achievement of key strategic, operational and financial goals, as detailed in the Duane Reade Full Potential sales growth and profit enhancement plan; and

· to appropriately reward the positive performance of key executives and other critical employees.

The Duane Reade Full Potential program consists of six key objectives to turn around the operations of the Company that had produced disappointing financial results in 2004 and 2005. The program was developed during the fourth quarter of 2005 under the direction of Mr. Dreiling. The six objectives are:

· Drive growth in front-end and pharmacy sales;

· Create margin improvements in the front-end;

· Improve operating efficiencies and optimize cost structure;

· Reduce litigation cost burden and related management distraction;

· Address underperforming stores to improve results or redeploy capital; and

· Optimize working capital and strengthen liquidity.

In making its decisions on an executive’s compensation, the Compensation Committee considers the nature and scope of all elements of an executive’s total compensation package, the executive’s responsibilities and his or her effectiveness in supporting our key strategic, operational and financial goals, including Duane Reade Full Potential.

3. The Process of Setting Executive Compensation

Executive compensation recommendations were submitted to the Compensation Committee from our CEO, that were based on a number of factors including a review of existing executive compensation levels against comparative companies in the chain drug retailing sector to understand the competitive market rates needed to attract and retain top talent. The review looked at individual executives with similar responsibilities and covered all elements of financial compensation, including base salaries, annual incentive bonuses and long-term financial incentives in the form of stock options, restricted stock grants, deferred compensation and retirement programs. This review of chain drug retailers included Walgreens,

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CVS, Rite Aid, Long’s Drug Stores and the Jean Coutu Group. The benchmark companies included both large-cap and smaller regional chains with some consideration being made for the differences in size. Other factors that were considered in the CEO’s recommendation were (i) the fact that the successful implementation of our turn-around strategy would require a very strong long-term commitment, (ii) an assessment of each executive’s responsibilities, (iii) their contributions to the Duane Reade Full Potential program, (iv) general performance reviews and (v) potential for promotion.

The Committee reviewed the CEO’s compensation recommendations and also considered the incumbent managers in place, their overall performance in relation to the requirements of their responsibilities, and the need to balance base annual salaries and benefits with both annual and long term incentives tied to improvements in our performance and achievement of individual objectives.

Our Chairman and CEO also provides a great deal of advice and input to the Committee regarding compensation of the named executive officers as well as all other vice presidents. This input includes assessments of their responsibilities, their contributions to the Duane Reade Full Potential program, general performance reviews and potential for promotion.

4. Components of Executive Compensation The key components of compensation for executive officers are annual base salary, annual cash awards under our Management Incentive Plan (MIP) which reflect the achievement of both corporate and personal objectives and long-term incentive stock options awards under the Management Stock Option Plan, which we refer to as the “New Option Plan”.

Annual Base Salary—Executive officers receive base salaries that reflect their responsibilities, length of service and job performance. The salary levels established by the Compensation Committee are considered sufficient to attract and retain qualified individuals who possess the qualities needed to ensure our long-term financial success. Executive officers’ salaries are now being reviewed annually after the completion of our fiscal year. During 2006, no changes were made to any of the annual salaries of the named executive officers (other than Ms. Bergman, whose salary was adjusted in light of her December 2005 promotion to Senior Vice President and General Counsel) due to the fact that the management team was being reorganized with new additions and changed responsibilities as well as the fact that it was the first year of implementation of the new Duane Reade Full Potential program. Of the named executive officers, only two other than Ms. Bergman (Mr. Henry and Mr. Ray) were our long-term executives, and both received retention bonuses in April of 2006 to reward them for their assistance during the initial transition period under our new CEO, Mr. Dreiling.

In April, 2007, all of the named executive officers received annual salary increases based on a review of their performance in 2006 by the Compensation Committee and individual assessments and recommendations for the senior vice presidents made by Mr. Dreiling. The specific increases in salary are highlighted below and the evaluations of their performance included assessments of their effectiveness in managing their individual responsibilities, contributions to the overall team performance and various leadership qualities.

Annual Incentive Awards—One of the primary objectives of the compensation program is to encourage our executives to achieve the goals of the Duane Reade Full Potential Plan. To that end, awards under the MIP are based upon the attainment of both corporate and individual objectives. Under the MIP, awards are set at a target level specific to each executive employee, generally between 50% and 100% of base salary. 80% of the target award is based upon the attainment of our annual EBITDA goal and 20% of the target award is based upon the individuals’ successful completion of one or more personal objectives. Determination of the executive’s level of achievement of his or her personal objectives is made by the Chief Executive Officer. The target award may be increased or decreased by up to 50%, to reflect variances in corporate financial performance from the target performance level. In fiscal 2006, we achieved our target internal Adjusted FIFO EBITDA performance level of $65.0 million, and all named executive officers were paid the full 80% component of their MIP target, except that executive officers joining us in 2006 received a pro-rated payment reflecting the amount of time they had been employed by us during the

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year. Payments in respect of the personal objective portion of the MIP award were based upon the CEO’s recommendations relative to each executive’s contributions to the Duane Reade Full Potential program and considered a range of operational initiatives to improve customer service, upgrade store standards, improve merchandising assortments, improve store presentations and promotional programs, reduce out of stocks and improve underperforming stores. Achievement in reducing litigation costs, management of inventory and process-based productivity improvements were also considered. The Committee concluded that these initiatives played a major part in the improved financial performance during 2006 that manifested itself in increased sales, higher gross margins and reduced expense ratios. In addition, during 2006, working capital was generally well controlled with further reductions in inventory investment over the year. With only one exception, all of the named executive officers received the full 20% individual objectives portion of their annual incentive awards for 2006.

Messrs. Henry and Ray and Ms. Bergman are entitled to an additional incentive payout depending on the amount of insurance proceeds, if any, that are collected by us as a result of our ongoing litigation with the insurance provider over the scope of our insurance coverage for our former location at the World Trade Center site (if they are still employed by us on the date of receipt of future insurance proceeds). Messrs. Henry and Ray are entitled to a maximum bonus payout equal to what they would have received if the insurance proceeds, taken together with our Adjusted FIFO EBITDA performance in 2001, would have entitled them to such a bonus for that year. Ms. Bergman is entitled to receive a target bonus if the insurance proceeds are equal to a preset level which has been determined by the Compensation Committee and a maximum bonus if the insurance proceeds reach a predetermined and higher amount. We believe it is necessary to keep the amounts of the potential thresholds confidential due to considerations relating to the lawsuit. The Compensation Committee determined to award such amounts to Messrs. Henry and Ray and any other management that were participating in the annual incentive compensation program in 2001 (if they are still employed by us on the date of receipt of future insurance proceeds) as a result of their service to us during 2001 and to Ms. Bergman as a result of her position as General Counsel in charge of managing the litigation throughout the case. It should be noted that unless we are successful in our litigation efforts, there will be no additional incentive payments under this program. For more information regarding this litigation, please see “Item 3. Legal Proceedings.”

The Compensation Committee also has the ability to award discretionary bonuses for superior performance or to recognize outstanding achievements.

Long-term Incentive Awards—Under the Option Plan, the Compensation Committee may grant stock options to any eligible employee. In 2006, non-qualified stock options were granted to each of our newly hired executive officers, including David D’Arezzo. Unless otherwise specified, options granted under the Option Plan vest in 20% increments on each of the first through fifth anniversaries of the grant date, such that the option grant is fully vested upon the fifth anniversary of the grant date. The options have a life of ten years and have been granted with an exercise price of $100.00 per share. This exercise price reflects the market value of our shares on July 30, 2004, when we were acquired by Oak Hill. Due to the declines in financial performance during 2004 and 2005 and the resultant decline of our market value since the Acquisition, the options granted during 2006 were premium options, requiring us to achieve improved financial performance before any realizable option value could be created. This structure is designed to link the management team’s long-term incentive rewards with the economic value of the original equity investors and create a requirement for significant value creation before the benefits of this aspect of their incentives are achieved. The five-year vesting period also encourages executive retention and preservation of shareholder value by aligning the interests of executives with those of shareholders and focusing the management team on our long-term performance. We have never made a practice of timing the grant of stock options to coincide with the release of material non-public information, nor have we ever backdated any stock option grants.

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OUTSTANDING EQUITY AWARDS AT END OF FISCAL YEAR 2006

Management Stock Option Plan

Our board of directors adopted the Duane Reade Holdings, Inc. Management Stock Option Plan, which is referred to in this report as the “New Option Plan,” which became effective on the date the Acquisition was completed. The New Option Plan is administered by the compensation committee of our 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 New Option Plan. On November 21, 2005, we amended the New Option Plan so that a maximum of 370,293 shares of our common stock (on a fully diluted basis) may be granted under the New Option Plan.

Under the New 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 New Option Plan will provide a participant with the right to purchase, within a specified period of time, a stated number of shares of our common stock at the price specified in the award agreement. Stock options granted under the New Option Plan will be subject to such terms, including the exercise price and the conditions and timing of exercise, not inconsistent with the New Option Plan, as may be determined by the compensation committee and specified in the applicable stock option agreement or thereafter.

The following table provides information about all equity compensation awards held by the named executive officers at December 30, 2006:

	Option Awards
Name	Number of Securities Underlying Unexercised Options (#) Exercisable		Number of Securities Underlying Unexercised Options (#) Unexercisable		Option Exercise Price ($)			Option Expiration Date
Richard W. Dreiling(1)		22,555		127,808		$	100		11/21/16
Michelle D. Bergman(2)		960		1,440		$	100		07/30/14
		2,440		3,660		$	100		07/30/14
John K. Henry(3)		12,240		18,360		$	100		07/30/14
Jerry M. Ray(4)		5,440		8,160		$	100		07/30/14
David D’Arezzo(5)		—		13,000		$	100		03/20/16

(1) Mr. Dreiling received a grant of 150,363 options on November 21, 2005 in connection with his joining the Company. 60% of the options granted are service-based and vest on a straight-line basis over a 4-year period, with 15% of the total grant becoming fully vested on each of the first through fourth anniversaries of the grant date. The remaining 40% of the options granted are performance-based and only vest upon the occurrence of specific financial milestones as more clearly specified in Mr. Dreiling’s option agreement. As of the date of this report, those milestones that would provide for vesting of the performance-based portion of the stock option grant have not been achieved.

(2) Ms. Bergman received an initial grant of 2,400 stock options on July 30, 2004 in connection with the completion of the Acquisition by Oak Hill. These options are service-based and vest in equal 20% increments on each of the first through fifth anniversaries of the grant date. On December 16, 2005, in recognition of Ms. Bergman’s promotion to the position of senior vice-president, she received an additional grant of 6,100 stock options, whose vesting schedule is identical to her original grant. At December 30, 2006, the vested portion of Ms. Bergman’s stock options totaled 40% of the total options granted to her.

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(3) Mr. Henry received an initial grant of 30,600 options on July 30, 2004 in connection with the completion of the Acquisition by Oak Hill. These options are service-based and vest in equal 20% increments on each of the first through fifth anniversaries of the grant date.

(4) Mr. Ray received an initial grant of 13,600 options on July 30, 2004 in connection with the completion of the Acquisition by Oak Hill. These options are service-based and vest in equal 20% increments on each of the first through fifth anniversaries of the grant date.

(5) Mr. D’Arezzo received an initial grant of 13,000 options on March 20, 2006 in connection with his joining the Company. These options are service-based and vest in equal 20% increments on each of the first through fifth anniversaries of the grant date.

OPTION EXERCISES AND STOCK VESTED

	Option Awards				Phantom Stock Awards
Name	Number of Shares Acquired on Exercise (#)		Value Realized on Exercise ($)		Number of Shares Acquired on Vesting (#)		Value Realized on Vesting ($)
John K. Henry(1)		—		—		7,422		$	285,079
Jerry M. Ray(2)		—		—		16,316		$	626,698

(1) At July 30, 2004, in connection with the completion of the Acquisition, Mr. Henry relinquished cash payments totaling $742,217 to which he would have otherwise been entitled, and received in exchange 7,422 shares of Phantom Stock with an equivalent value. The amount shown in this table reflects the valuation of the Phantom Stock as of July 30, 2006, the date on which such shares became fully vested. The valuation reflects the per share value of $38.41, based on the most current SFAS No. 142 equity valuation, which had been prepared as of July 1, 2006.

(2) At July 30, 2004, in connection with the completion of the Acquisition, Mr. Ray relinquished cash payments totaling $1,631,628 to which he would have otherwise been entitled, and received in exchange 16,316 shares of Phantom Stock with an equivalent value. The amount shown in this table reflects the valuation of the Phantom Stock as of July 30, 2006, the date on which such shares became fully vested. The valuation reflects the $38.41 SFAS No. 142 per share value as of July 1, 2006.

Senior Vice President Phantom Stock

Certain senior vice presidents of Duane Reade Inc. were awarded SVP phantom stock under a phantom stock plan that was adopted effective as of the date of the Acquisition, representing, in the aggregate, approximately 0.8% of the shares of our common stock (on a fully diluted basis). The SVP phantom stock was granted to the senior vice presidents for future services and in exchange for relinquishing certain payments in connection with the Acquisition and in entering into new employment letters.

At the closing of the Acquisition, Messrs. Henry and Ray relinquished an aggregate amount of approximately $1.6 million with respect to their rights under Duane Reade Inc.’s supplemental executive retirement plan/split dollar life insurance arrangement which would have required us to transfer ownership of the underlying life insurance policies to each of them. In addition, Mr. Ray relinquished retention payments totaling approximately $0.3 million, stock option proceeds of approximately $0.1 million and a payment of approximately $0.4 million under an existing price guarantee on stock options awarded to him in May 1999.

Each of Messrs. Henry and Ray entered into an award agreement under the Phantom Stock Plan under which he was awarded a specific number of shares of SVP phantom stock. References to awards are references to the total number of shares of SVP phantom stock granted to a particular senior vice

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president. This was a one time award of phantom stock to the senior vice presidents, and no other awards of phantom stock have been or are expected to be made. Each share of SVP phantom stock corresponds to a share of our common stock. The SVP phantom stock awards vested ratably over a two year period, subject to partial acceleration upon a change of control. Acceleration occurring in connection with a change of control will be to the extent necessary to participate in a transfer giving rise to a tag-along or drag-along right (as if the phantom shares representing the SVP phantom stock were actual shares, to the extent applicable). Awards are generally to be settled (or paid) in shares of our common stock or, in connection with a drag-along event, using the same form of consideration received by our common stockholders in connection with such a transaction, by treating one share of SVP phantom stock as a share of our common stock. Awards of SVP phantom stock will settle in whole or in part, depending upon the extent to which the senior vice president has vested in his award, on a drag-along event, tag-along event, initial public offering of our common stock or five years following the Acquisition. Awards of SVP phantom stock will also settle, to the extent vested, following the senior vice president’s death or termination of employment without “Cause” or for “Good Reason” as each term is defined in the new SVP employment letter. Upon termination of employment under certain limited circumstances, the SVP phantom stock awards may be settled in cash at fair market value, treating each share of SVP phantom stock as one share of our common stock. Shares of our common stock received by the senior vice presidents through the settlement of a SVP phantom stock award are subject to the stockholders and registration rights agreement which is more fully described in “Certain Relationships and Related Transactions—Agreements Relating to Duane Reade Holdings—Stockholders and Registration Rights Agreement.” In addition, SVP phantom stock awards participate in dividends to the same extent as the holders of our common stock. SVP phantom stock awards also contain a sunset provision that provides that these awards, to the extent not yet settled, may be settled in shares of our common stock no earlier than July 30, 2009.

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POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL

The following table describes the potential payments upon termination of employment or a change in control of Duane Reade for each of the named executive officers effective on December 30, 2006:

Benefits and Payments Upon Termination	Voluntary Termination			Termination for Cause or without Good Reason			Termination without Cause or for Good Reason prior to Change in Control			Termination without Cause or for Good Reason after Change in Control			Death
Richard W. Dreiling
Severance Payment(1)		$	—		$	—		$	3,300,000		$	3,300,000	$	—
Value of Stock Options(2)		—			—			—			—		—
Management Incentive Plan		—			—			825,000			825,000		825,000
Benefits(3)		31,889			31,889			38,921			38,921		31,889
Total		$	31,889		$	31,889		$	4,163,921		$	4,163,921	$	856,889
Michelle D. Bergman
Severance Payment(8)		$	—		$	—		$	350,000		$	350,000	$	—
Value of Stock Options(2)		—			—			—			—		—
Management Incentive Plan		—			—			—			—		—
Benefits(4)		13,584			13,584			13,584			13,584		13,584
Total		$	13,584		$	13,584		$	363,584		$	363,584	$	13,584
John K. Henry
Severance Payment(8)		$	—		$	—		$	430,000		$	430,000	$	—
Value of Stock Options(2)		—			—			—			—		—
Value of Phantom Shares(9)		331,623			331,623			331,623			331,623		331,623
Management Incentive Plan		—			—			—			—		—
Benefits(5)		17,133			17,133			17,133			17,133		17,133
Total		$	348,756		$	348,756		$	778,756		$	778,756	$	348,756
Jerry M. Ray
Severance Payment(8)		$	—		$	—		$	430,000		$	430,000	$	—
Value of Stock Options(2)		—			—			—			—		—
Value of Phantom Shares(9)		729,011			729,011			729,011			729,011		729,011
Management Incentive Plan		—			—			—			—		—
Benefits(6)		17,343			17,343			17,343			17,343		17,343
Total		$	746,354		$	746,354		$	1,176,354		$	1,176,354	$	746,354
David W. D’Arezzo
Severance Payment(8)		$	—		$	—		$	460,000		$	460,000	$	—
Value of Stock Options(2)		—			—			—			—		—
Management Incentive Plan		—			—			—			—		—
Benefits(7)		23,866			23,866			23,866			23,866		23,866
Total		$	23,866		$	23,866		$	483,866		$	483,866	$	23,866

(1) As defined in Mr. Dreiling’s employment contract, this represents twice the sum of (i) the current annual salary and (ii) the 2006 guaranteed bonus amount.

(2) Based upon the exercise price of $100.00 per share and the December 30, 2006 equity fair valuation of $44.68 per share, the stock options are considered to have no value.

(3) As defined in Mr. Dreiling’s employment contract, upon termination, he would be entitled to receive payment for: (i) accrued but unpaid salary through the date of termination ($31,731) and

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(ii) reimbursement for all properly documented business expenses incurred through the date of termination ($158). In addition, in the event that Mr. Dreiling’s termination occurs without cause or for good reason, he would be entitled to continued participation in the Company’s executive health insurance benefits program for a period not to exceed twenty-four months, subject to the condition that this coverage shall cease upon Mr. Dreiling’s eligibility to participate in another employer’s comparable health insurance benefits program ($7,032). In accordance with our policy, any accrued but unused vacation time would be forfeited.

(4) As defined in Ms. Bergman’s employment letter, upon termination, she would be entitled to receive payment for: (i) accrued but unpaid salary through the date of termination ($13,462) and (ii) reimbursement for all properly documented business expenses incurred through the date of termination ($122). In accordance with our policy, any accrued but unused vacation time would be forfeited.

(5) As defined in Mr. Henry’s employment letter, upon termination, he would be entitled to receive payment for: (i) accrued but unpaid salary through the date of termination ($16,538) and (ii) reimbursement for all properly documented business expenses incurred through the date of termination ($595). In accordance with our policy, any accrued but unused vacation time would be forfeited.

(6) As defined in Mr. Ray’s employment letter, upon termination, he would be entitled to receive payment for: (i) accrued but unpaid salary through the date of termination ($16,538) and (ii) reimbursement for all properly documented business expenses incurred through the date of termination ($805). In accordance with our policy, any accrued but unused vacation time would be forfeited.

(7) As defined in Mr. D’Arezzo’s employment letter, upon termination, he would be entitled to receive payment for: (i) accrued but unpaid salary through the date of termination ($17,692) and (ii) reimbursement for all properly documented business expenses incurred through the date of termination ($6,174). In accordance with our policy, any accrued but unused vacation time would be forfeited.

(8) Represents one year’s annual salary

(9) Represents the value of the 100% vested portion of the named individuals’ Phantom Share ownership, based upon the December 30, 2006 equity valuation of $44.68 per share.

Richard W. Dreiling

Mr. Dreiling’s employment agreement provides for an initial term of four years. Thereafter, the agreement shall continue for consecutive one-year periods unless either we or Mr. Dreiling gives the other written notice that the agreement will terminate at the end of such term at least 90 days prior to the end of the initial term or any extension term. If such notice of non-renewal is given by us, Mr. Dreiling is entitled to a severance payment of two times his then-current base salary and continued health benefits to be paid over a period of 24 months from the end of his employment term.

If Mr. Dreiling voluntarily leaves our employ without “good reason” (as defined in the employment agreement) or is discharged for “cause” (as defined in the employment agreement), he shall not be entitled to receive any further salary, bonuses, benefits or severance after his date of termination. If his employment terminates for death or disability, Mr. Dreiling (or his estate) will be entitled to any earned but unpaid bonuses, his one-time and 2006 guaranteed annual bonus (if unpaid), and an annual bonus for the year of termination based on actual achievement of Duane Reade Inc.’s EBITDA goals and pro rated based on his days of service prior to such termination.

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If Mr. Dreiling voluntarily leaves our employ for “good reason” or is terminated by Duane Reade without “cause,” Mr. Dreiling will be entitled to all the benefits due upon a termination for death or disability, plus a severance payment payable in equal installments over a period of 24 months of an amount equal to two times the sum of his then-current base salary plus the “severance bonus” (as defined in the employment agreement). Mr. Dreiling is also entitled to receive health benefits during the period he is receiving severance payments. If such a termination of Mr. Dreiling’s employment occurs within 24 months after a “change in control” (as such term is defined in the stock option agreement), he will be entitled to all of the foregoing benefits, except that the severance benefits shall be paid in a single lump sum rather than in installments.

Mr. Dreiling’s post-termination benefits are conditioned on his compliance with confidentiality provisions and covenants not to solicit employees of Duane Reade Inc. and not to compete with Duane Reade Inc. in the chain drug business in the greater New York area for a period of two years following his termination, and on his execution and non-revocation of a general release and waiver of claims in favor of Duane Reade Inc. Duane Reade Inc. reserves the right to cease payment of, and to “claw back,” certain of Mr. Dreiling’s post-termination benefits in the event that he breaches any of the non-competition and non-solicitation covenants.

If Mr. Dreiling’s employment is terminated by us without “cause” (as defined in the employment agreement) or if he voluntarily resigns for “good reason” (as defined in the employment agreement), then the next installment of his unvested service based options immediately vest in full, and all of his options that are vested remain exercisable for one year following his termination; any options that are unvested as of such termination are forfeited. If Mr. Dreiling is discharged by us for “cause,” then all of his options, whether vested or unvested, shall immediately be forfeited. If Mr. Dreiling voluntarily resigns without “good reason,” then all of his unvested options shall be forfeited, but his vested options shall remain exercisable for 90 days following his termination. If Mr. Dreiling’s employment with us terminates due to his death or disability, then a pro-rated portion (based on months of service before his termination) of the next installment of his unvested service-options immediately vest in full, and together with all of his other then vested options shall remain exercisable for a period of one year from the date of such termination. Any options that are unvested as of such termination shall be forfeited.

If a “change in control” (as defined in the stock option agreement) occurs, then Mr. Dreiling’s service-based options will vest to the extent necessary for him to exercise his rights pursuant to a “tag along” sale, and to satisfy our rights with respect to a “drag along” sale, and if such “change in control” results in the attainment of the applicable performance vesting conditions, all or a portion of his performance-based options will vest as of the date of the “change in control.” The terms and conditions of such “drag along” and “tag along” rights are set forth in the Stockholders and Registration Rights Agreement, dated as of July 30, 2004, among the Company, the Subsidiaries as defined therein, Duane Reade, and any other parties which become parties thereto, to which Mr. Dreiling became a party as a condition to the stock option grant, and a copy of which was filed as Exhibit 10.3 to our Form 10-K for the fiscal year ending December 25, 2004. See “Certain Relationships and Related Transactions—Agreements Relating to Duane Reade Holdings—Stockholders and Registration Rights Agreement.”

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Senior Vice Presidents

Under the SVP employment letters, if Mr. Henry’s or Mr. Ray’s employment is terminated by us without cause or by him for good reason at any time after the first anniversary of the effective date of the Acquisition, he will be entitled to a severance payment to be paid over 12 months equal to their prior 12 months’ base salary. Mr. Henry and Mr. Ray will be subject to restrictive covenants prohibiting them from competing with us in the New York greater metropolitan area and from soliciting our employees, generally during the period in which they are entitled to severance payments. For purposes of their SVP employment letters, “cause” means: (1) the commission of any act of fraud or embezzlement against us or any of our subsidiaries; (2) being convicted of, or pleading guilty to, a felony; (3) intentional misconduct which is materially injurious (or if made public, could be materially injurious) to our reputation or financial interests, including, without limitation, sexual or racial harassment of our employees, employees of our subsidiaries or other persons engaged in business with us or our subsidiaries; (4) material breach of any of our covenants or policies regarding the protection of our business interests including, without limitation, policies addressing confidentiality and non-competition; or (5) failure to follow the lawful instructions of the Board of Directors or CEO after having received prior written notice of such failure and such failure remaining uncorrected after ten days of having received such written notice. For purposes of their employment letters, “good reason” shall mean: (1) the assignment to Mr. Henry or Mr. Ray of any duties materially and adversely inconsistent with his position as Senior Vice President which results in a material and adverse change in his status, office or title with us; (2) a reduction in Mr. Henry’s or Mr. Ray’s salary from that in effect on July 30, 2004; or (3) a requirement that Mr. Henry or Mr. Ray relocate more than 20 miles outside the greater New York metropolitan area.

If Duane Reade Inc. terminates Ms. Bergman’s employment under certain circumstances, she would be entitled to receive severance equal to her prior 12 months’ base salary.

The employment of Ms. Bergman and Messrs. Newsom, D’Arezzo and Scarfone is “at will,” meaning that either the officer or we will be entitled to terminate his or her employment at any time and for any reason, with or without cause. In the event we terminate his or her employment other than for “cause,” the officer will be paid severance equal to one-year’s salary at his or her then current salary payable in bi-weekly installments. For purposes of each of their employment letters, “cause” means (1) a repeated refusal to comply with a lawful directive of the CEO, (2) serious misconduct, dishonesty or disloyalty directly related to the performance of duties for us, which results from a willful act or omission and which is materially injurious to our operations, financial condition or business reputation or any of our significant subsidiaries; (3) being convicted (or entering into a plea bargain admitting criminal guilt) in any criminal proceeding that may have an adverse impact on our reputation and standing in the community; (4) willful and continued failure to substantially perform his or her duties under his or her employment letter; or (5) any other material breach of his or her employment letter. In the event of termination for cause, the officer will be entitled to any unpaid salary through the date of termination, plus any earned and accrued unused vacation pay or deferred compensation payments. Each of Ms. Bergman and Messrs. Newsom, D’Arezzo and Scarfone will not be entitled to any other termination-related compensation from us.

COMPENSATION OF DIRECTORS

We do not compensate directors who are our employees or affiliates of Oak Hill for their service as directors. We expect that any independent directors that might be named in the future will receive customary fees for their service as directors. No directors received any such compensation in 2006.

CONTRACTS WITH THE FORMER CHAIRMAN AND CEO

In an ongoing arbitration between Mr. Cuti and us (explained in more detail in “Item 3. Legal Proceedings”), we are seeking, among other forms of relief, rescission of the employment agreement,

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which was entered into in December 2003 and modified in March 2004 and June 2004, described below and his July 2002 employment agreement and the return of all compensation paid under the employment agreements, including the benefits to which Mr. Cuti is described as being entitled to below.

Mr. Cuti’s Profits Interest

Mr. Cuti’s 2003 employment agreement provides for the award to Mr. Cuti of a profits interest in Duane Reade Shareholders that, based on the amount of the initial equity investments by the investor group led by Oak Hill and by management and given a sufficient appreciation in the value of Duane Reade Shareholders following the Acquisition, could have resulted in his possession of an approximately 7.9% equity interest in Duane Reade Shareholders (on a fully diluted basis), which, as of the effective date of the Acquisition, would have been equivalent to approximately 7.1% of the aggregate ownership interest in us on a consolidated basis. The profits interest will have no value unless the value of Duane Reade Shareholders appreciates. In connection with a realization event (such as a sale), if the fair market value of Duane Reade Shareholders appreciates, the 2003 employment agreement provides that Mr. Cuti is entitled to be allocated the first $20 million of such appreciation and will share in distributions of additional amounts in accordance with his pro rata interest. The profits interest was scheduled to vest over a five year period, subject, generally, to Mr. Cuti’s continued employment with us. The 2003 employment agreement provides that vesting of the profits interest will accelerate upon the occurrence of a change of control or an underwritten offering of common stock by Duane Reade Inc., Duane Reade Holdings or Duane Reade Shareholders that results in a public offering of at least 20% of such entity’s common stock or generates gross proceeds of at least $100 million. The profits interest is subject to customary drag-along, tag-along and registration rights as well as preemptive rights in specific circumstances. The profits interest is intended to meet certain IRS guidelines, but in the event that Mr. Cuti incurs any income taxes as a result of the grant of the profits interest, the 2003 employment agreement provides that we will indemnify him against such taxes.

The 2003 employment agreement between us and Mr. Cuti, which is described in further detail below, provides that, as a result of the November 21, 2005 replacement of Mr. Cuti by Mr. Dreiling, Mr. Cuti had the right to require us to purchase for cash to be paid over a two year period all or a portion of the equity interests he holds in Duane Reade Shareholders and Duane Reade Holdings as he may designate, at a value determined in accordance with a formula specified in the 2003 employment agreement. In connection with the replacement of Mr. Cuti by Mr. Dreiling, we have treated all of Mr. Cuti’s equity interests as having vested. The 2003 employment agreement provides that Mr. Cuti’s purchase right would 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. In accordance with the procedures outlined in the 2003 employment agreement, Duane Reade Inc. has advised Mr. Cuti that his profits interest as of December 21, 2005 was determined to have no value. 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 between Mr. Cuti and us.

Mr. Cuti’s 2003 Employment Agreement

On December 22, 2003, Mr. Cuti entered into an employment agreement revising the terms and conditions of his prior employment agreement. Following the execution of that employment agreement, we negotiated certain modifications to the terms and conditions of Mr. Cuti’s employment, and on March 16, 2004, we entered into the 2003 employment agreement, which was subsequently amended on June 18, 2004. The term of Mr. Cuti’s employment under the 2003 employment agreement was five years, during which time he would serve as our and Duane Reade Inc.’s Chairman of the board (except if prohibited by

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legal requirements), president and chief executive officer. The 2003 employment agreement contemplated an initial base salary of $1 million per annum and an annual bonus opportunity ranging from 0% to 175% of base salary based upon our success in achieving annual financial performance targets.

Under the terms of his 2002 employment agreement, Mr. Cuti participated in a supplemental executive retirement plan, or SERP, and Duane Reade Inc. agreed to satisfy its obligation to him under the SERP through the purchase of an insurance contract. The insurance contract provided benefits to Mr. Cuti’s beneficiaries upon his death, as well as retirement benefits upon the earlier of him reaching age 65 or three years after his termination date. As of June 3, 2004, under the terms of his 2002 employment agreement, Duane Reade Inc. was obligated to make annual premium payments under the insurance contract of approximately $5 million for each of the next six years (totaling a minimum of approximately $30.0 million as of June 3, 2004), subject to an accelerated payment equal to the present value of such amount upon the termination of Mr. Cuti’s employment with Duane Reade Inc. for any reason, the non-renewal of his prior employment agreement, the renewal of his prior employment agreement in accordance with its terms, the sale of Duane Reade Inc., Mr. Cuti’s attainment of age 65, or Duane Reade Inc.’s failure to timely pay the annual insurance premiums owed under the insurance contract. The 2003 employment agreement provided Duane Reade Inc. with an election to terminate the SERP obligations and the insurance contract arrangements. Upon the consummation of the Acquisition, Duane Reade Inc. exercised this election. The 2003 employment agreement provides that Mr. Cuti would waive his entitlement to the SERP and release Duane Reade Inc. from all of the obligations to make premium payments (totaling a minimum of approximately $30.0 million as of June 3, 2004 as described above) under the insurance contract in exchange for, among other things, the payment to Mr. Cuti of $20.5 million on or prior to January 3, 2005 and $4.0 million on or prior to June 30, 2005. All such required payments have been made. Approximately $14.3 million of these payment obligations were offset by the proceeds of the cash surrender value of the split dollar life insurance contract, which was terminated on June 30, 2005 in connection with the final $4.0 million payment Mr. Cuti.

The 2003 employment agreement provided for the relinquishment by Mr. Cuti of certain long-term incentives to which he was entitled under his 2002 employment agreement and lower severance payments (as described below) than those provided for in his 2002 employment agreement. The 2003 employment agreement provided for new long-term incentives to Mr. Cuti, including the profits interest in Duane Reade Shareholders described above under “—Mr. Cuti’s Profits Interest,” options to purchase 4% of the common stock of Duane Reade Holdings (on a fully diluted basis), and payments of $0.9 million on each of the first through fifth anniversaries of the effective date of the Acquisition, subject, generally, to his continued employment with us. In connection with the completion of the Acquisition, Mr. Cuti received a payment of $4,962,286 and forfeited all of his outstanding options, valued at approximately $2.7 million based on the Acquisition consideration of $16.50 per share, and the right to receive a payment of $1.0 million under an existing price guarantee of stock options granted in May 1999.

The 2003 employment agreement provides that the stock options and profits interest awards vest over five years subject, generally, to Mr. Cuti’s continued employment with us, and with respect to the profits interest subject to acceleration upon the occurrence of specific events, including a “change of control” (as described below). The 2003 employment agreement defines a “change of control” to include in specific circumstances, among other things:

· the acquisition by a third party of securities representing more than 50% of Duane Reade Inc.’s voting stock or the right to appoint a majority of the members of Duane Reade Inc.’s board of directors;

· the adoption of a plan of liquidation or the consummation of an agreement for the sale of all or substantially all of Duane Reade Inc.’s assets; or

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· prior to an underwritten offering of common stock by Duane Reade Inc., Duane Reade Holdings or Duane Reade Shareholders that results in a public offering of at least 20% of such common stock or generates gross proceeds of at least $100 million, the failure by Oak Hill to retain and exercise the power to designate a majority of the members of our board of directors appointable by the investor group led by Oak Hill.

In addition, upon a change of control, the vesting of stock options would occur to the extent necessary for Mr. Cuti to participate in a transfer giving rise to tag-along or drag-along rights.

As a result of the November 21, 2005 replacement of Mr. Cuti by Mr. Dreiling, the 2003 employment agreement provides that all of Mr. Cuti’s stock options and the profits interest were accelerated and became fully vested. On March 21, 2006, Mr. Cuti’s stock options expired unexercised.

All equity interests held by Mr. Cuti in Duane Reade Shareholders and Duane Reade Holdings are subject to customary drag-along, tag-along and registration rights as well as preemptive rights in specific circumstances. The tag-along and drag-along rights will, under certain circumstances, either afford Mr. Cuti the opportunity to or require him to participate, respectively, in a sale of all or a portion of the equity in Duane Reade Shareholders or Duane Reade Holdings.

The 2003 employment agreement also provides for the participation by Mr. Cuti in all benefit plans generally available to our senior executives, the continuation of the fringe benefits provided to Mr. Cuti under his 2002 employment agreement, retiree medical benefits for Mr. Cuti and his spouse, severance benefits and, following our election to terminate the SERP obligations and the insurance contract arrangements, and payment of the Prepayment Amount, the payment of premiums of up to $88,000 per year for term life insurance coverage. As a result of the November 21, 2005 replacement of Mr. Cuti by Mr. Dreiling, effective December 21, 2005, Mr. Cuti was no longer entitled to the payment of such premiums in respect of term life insurance coverage. The 2003 employment agreement provides indemnification for income taxes incurred by Mr. Cuti for certain payments to him that are not paid in cash or marketable property. In accordance with the 2003 employment agreement, we have paid the premiums owed on a life insurance policy owned by us pursuant to Mr. Cuti’s SERP/split dollar life insurance retention arrangement, which was originally established for Mr. Cuti in 1998 as part of his long-term compensation program. On August 11, 2006, subsequent to the second anniversary of the effective date of the Acquisition, we liquidated the cash surrender value of the life insurance policy and paid the proceeds of approximately $3.9 million, less applicable statutory income and payroll tax withholdings, to Mr. Cuti.

The 2003 employment agreement provides that we may terminate Mr. Cuti’s employment with Duane Reade Inc. and Duane Reade Holdings with or without “cause,” as defined in the 2003 employment agreement. The definition of termination for “cause” includes:

· a finding by the board of directors of the company that Mr. Cuti has committed an act of fraud or embezzlement against Duane Reade Holdings or Duane Reade Inc. or any of our subsidiaries;

· Mr. Cuti’s conviction of a felony; or

· any material willful breach of the 2003 employment agreement by Mr. Cuti.

The 2003 employment agreement also provides that Mr. Cuti may terminate his employment with Duane Reade Inc. and Duane Reade Holdings for “good reason,” as defined in the 2003 employment agreement, which includes:

· a reduction in the Mr. Cuti’s base salary without his consent;

· except as a result of any legal requirement, removal of Mr. Cuti from the positions of president, chief executive officer or Chairman of the board of directors of Duane Reade Inc. or Duane Reade Holdings without his consent or the assignment to Mr. Cuti of duties that are materially and adversely inconsistent with such positions without his consent;

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· except as a result of any legal requirement, the creation within Duane Reade Inc. or Duane Reade Holdings of any position equal to or superior to that of Mr. Cuti’s position or which does not report to Mr. Cuti;

· except as a result of any legal requirement, the failure of Mr. Cuti to be elected Chairman of the board of directors of Duane Reade Inc. or Duane Reade Holdings;

· the relocation of the offices in which Mr. Cuti is principally employed to a location outside of the borough of Manhattan without his consent;

· any material breach of the 2003 employment agreement by Duane Reade Inc., Duane Reade Holdings or Duane Reade Shareholders which includes our failure to have Andrew J. Nathanson, or an independent director appointed to the board of directors of Duane Reade Inc. in accordance with the terms of the 2003 employment agreement; or

· if Duane Reade Inc. becomes a direct or indirect subsidiary of an acquiring company, the failure to appoint Mr. Cuti to the position of chief executive officer of the acquiring company.

Upon the termination of Mr. Cuti’s employment by Duane Reade Inc. without cause or upon his resignation for good reason, the 2003 employment agreement provides that he would be entitled to receive the following severance payments: (1) a payment equal to three times the sum of his most recent base salary and the highest bonus actually paid to him during the term of the 2003 employment agreement (or 125% of base salary, if terminated during the first year of the term), plus (2) acceleration of the remaining unpaid $0.9 million cash payments. One quarter of this severance amount must be paid within 10 days of the termination of his employment and the remainder must be paid in substantially equal installments over the 25-month period following termination. In addition, the 2003 employment agreement provides that the unvested portion of his profits interest and stock options will immediately vest upon his termination without cause or upon his resignation for good reason, and he will generally be entitled to continued health, dental, disability, life insurance and similar benefits at our expense during the 25-month period following his termination. Neither non-renewal of the 2003 employment agreement nor a change of control of Duane Reade Inc. will independently trigger an obligation by Duane Reade Inc. to pay severance benefits to Mr. Cuti.

The 2003 employment agreement provides for a tax gross-up for any amounts due or paid to Mr. Cuti under the 2003 employment agreement, his 2002 employment agreement or any plan, program or arrangement of Duane Reade Inc., Duane Reade Holdings or Duane Reade Shareholders or their respective subsidiaries that is considered an “excess parachute payment” under the Internal Revenue Code. In connection with the November 21, 2005 replacement of Mr. Cuti by Mr. Dreiling, Mr. Cuti’s severance amount was calculated to equal $6.6 million, which amount is being paid in accordance with the 2003 employment agreement except that the installment period is equal to 25 months because we have agreed that Mr. Cuti’s last day of employment was December 21, 2005.

Mr. Cuti has agreed not to disclose or otherwise inappropriately use for his personal benefit, any of our confidential or proprietary information. Mr. Cuti has further agreed not to compete with Duane Reade Inc. during the term of the 2003 employment agreement and for three years thereafter, regardless of the grounds for the termination of his employment. If Mr. Cuti violates the non-competition provisions of the 2003 employment agreement, he will be required to repay to Duane Reade Inc. a portion of the payments he is entitled to receive under the 2003 employment agreement, in addition to any actual damages he may owe to us in excess of the amounts he repaid to Duane Reade Inc. If, however, an arbitrator determines that severance payments are owed to Mr. Cuti and such payments are not made to him within 15 days of the arbitrator’s ruling, the non-competition provision of the 2003 employment agreement will lapse.

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The 2003 employment agreement provides that Duane Reade Inc. will also indemnify Mr. Cuti for all costs, charges and expenses incurred by him by reason of him being or having served as a director, officer, employee or agent of Duane Reade Inc., Duane Reade Holdings or any of its subsidiaries. The 2003 employment agreement also requires Duane Reade Inc. to maintain a directors and officers liability insurance policy for so long as Mr. Cuti is employed by Duane Reade Inc. and for three years thereafter. The policy must be consistent with the level of coverage and premiums of similarly situated companies.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

All of Duane Reade Inc.’s issued and outstanding common stock is held by Duane Reade Holdings, Inc. whose principal address is 201 Main Street, Fort Worth, Texas 76102, and is beneficially owned by Oak Hill Capital Partners, L.P., whose principal address is 201 Main Street, Fort Worth, Texas 76102.

The table below sets forth, as at June 28, 2007, certain information regarding the beneficial ownership of the common stock of Duane Reade Holdings, by:

· each of our current directors and executive officers individually;

· each person who is known to be the beneficial owner of more than 5% of any class or series of capital stock; and

· all directors and executive officers as a group

For purposes of this table, a person is deemed to have “beneficial ownership” of any shares that the person has the right to acquire within 60 days after the date of this report. For purposes of calculating the percentage of outstanding shares held by each person named below, any shares that a person has the right to acquire within 60 days after the date of this report are deemed to be outstanding, but not for the purposes of calculating the percentage ownership of any other person.

Shares of Common Stock Beneficially Owned

Name of Beneficial Owner	Number of Shares Beneficially Owned		Percent of Outstanding Shares
Duane Reade Shareholders, LLC(1)		2,594,977		84.5	%
OHCP DR Co-Investors 2007 LLC(2)		384,174		12.9
Richard W. Dreiling(3)		23,435		—
Michelle D. Bergman(4)		6,820		—
David D’Arezzo(5)		4,440		—
John K. Henry(6)		19,272		—
Charles W. Newsom(7)		4,440		—
Jerry M. Ray(8)		9,472		—
Vincent A. Scarfone(9)		1,200		—
Michael S. Green		—		—
John P. Malfettone		—		—
Andrew J. Nathanson		—		—
Denis J. Nayden		—		—
Tyler J. Wolfram		—		—
All Officers & Directors (12 persons)		69,079		2.6	%

(1) Oak Hill, together with the equity co-investors, owns on a fully diluted basis 100% of the outstanding membership interests in Duane Reade Shareholders.

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(2) Oak Hill is the managing member of OHCP DR Co-Investors 2007 LLC. OHCP DR Co-Investors 2007 LLC holds warrants to purchase 384,174 shares of our common stock at an exercise price of $75.00 per share. OHCP DR Co-Investors 2007 LLC also owns 525,334 shares of our Series A preferred stock, par value $0.01 per share, which currently have a liquidation value of $75.00 per share. Each share of preferred stock is convertible, at our option, immediately prior to an initial public offering into a number of shares of our common stock equal to the liquidation preference for such share of preferred stock, divided by the price per share of our common stock set forth in the final prospectus to be used in connection with the IPO. OHCP DR Co-Investors is not deemed to beneficially own any shares of our common stock underlying the shares of preferred stock.

(3) Mr. Dreiling owns exercisable options to acquire 23,435 shares and unexercisable options to acquire 137,929 shares of common stock of Duane Reade Holdings, representing, in the aggregate, 4.7% of the common stock of Duane Reade Holdings (on a fully diluted basis).

(4) Ms. Bergman owns exercisable options to acquire 6,820 shares and unexercisable options to acquire 23,180 shares of the common stock of Duane Reade Holdings, representing, in the aggregate, less than 1% of Duane Reade Holdings common stock.

(5) Mr. D’Arezzo owns exercisable options to acquire 4,440 shares and unexercisable options to acquire 31,560 shares of the common stock of Duane Reade Holdings, representing, in the aggregate, 1% of Duane Reade Holdings common stock.

(6) Mr. Henry owns exercisable options to acquire 19,272 shares and unexercisable options to acquire 22,728 shares of common stock of Duane Reade Holdings, representing, in the aggregate, approximately 1.2% of Duane Reade Holdings common stock.

(7) Mr. Newsom owns exercisable options to acquire 4,440 shares and unexercisable options to acquire 31,560 shares of the common stock of Duane Reade Holdings, representing, in the aggregate, 1% of Duane Reade Holdings common stock.

(8) Mr. Ray owns exercisable options to acquire 9,472 shares and unexercisable options to acquire 20,528 shares of the common stock of Duane Reade Holdings, representing, in the aggregate, less than 1% of Duane Reade Holdings common stock.

(9) Mr. Scarfone owns exercisable options to acquire 1,200 shares and unexercisable options to acquire 26,800 shares of the common stock of Duane Reade Holdings, representing, in the aggregate, less than 1% of Duane Reade Holdings common stock.

Limited Liability Company Operating Agreement of Duane Reade Shareholders

The former Chairman and CEO and members of the investor group entered into an amended and restated limited liability company operating agreement for Duane Reade Shareholders. The amended and restated limited liability company operating agreement sets forth, among other things, the distribution and allocation of the profits and losses of the members of Duane Reade Shareholders, certain membership interest transfer restrictions, including drag-along rights and tag-along rights, and corporate governance provisions regarding the nomination of the managers and officers of Duane Reade Shareholders. The corporate governance provisions generally reflect the percentage ownership of Duane Reade Shareholders by the investor group and the former Chairman and CEO. The limited liability company operating agreement also provides that certain members of the investor group led by Oak Hill have the ability to cause Duane Reade Shareholders to take certain actions in order for it to register common equity securities of Duane Reade Shareholders under the Securities Act, and that the other equity holders of Duane Reade Shareholders may participate in such registration.

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The following table presents information as at December 30, 2006:

	(a)		(b)			(c)
Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights			Number of securities remaining available for future issuance under equity compensation plans, excluding securities reflected in column (a)
Equity compensation plans approved by security holders		—		$	0.00		—
Equity compensation plans not approved by security holders		295,719		$	100.00		74,574
Total		295,719		$	100.00		74,574

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Relationship with Oak Hill

Oak Hill Capital Partners, L.P. and certain related entities beneficially own 97.4% of our common equity. One Managing Director of Oak Hill (Mr. Nayden), two Partners of Oak Hill (Mr. Wolfram and Mr. Green) and the Chief Operating Officer of Oak Hill (Mr. Malfettone) serve as our directors. Those individuals all serve as directors of Duane Reade Inc. as well. We entered into the following agreements with affiliates of Oak Hill:

Management Services Agreement

Under a management services agreement between Oak Hill Capital Management, Inc. (an affiliate of Oak Hill Capital Partners, L.P.) and Duane Reade Acquisition, Oak Hill Capital Management, Inc. received a fee of $8.0 million at the closing of the Acquisition, and Oak Hill Capital Management, Inc. agreed to provide financial advisory and management services to us as Duane Reade Inc.’s Board of Directors may reasonably request following the Acquisition. In consideration of these services, Oak Hill Capital Management, Inc. will receive an annual fee of $1.3 million, payable quarterly.

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Tax Sharing Agreement

Duane Reade Holdings is the common parent of an affiliated group of corporations that includes Duane Reade Inc. and its subsidiaries. Duane Reade Holdings elected to file consolidated federal income tax returns on behalf of the group. Accordingly, Duane Reade Holdings, Duane Reade Inc. and its subsidiaries entered into a tax sharing agreement, under which Duane Reade Inc. and its subsidiaries will make payments to Duane Reade Holdings. These payments will not be in excess of Duane Reade Inc.’s and its subsidiaries’ tax liabilities, if these tax liabilities had been computed on a stand-alone basis.

Senior Vice President Retention Agreements

We currently have retention agreements with the senior vice presidents, as more fully described under “Senior Vice President Arrangements.”

Indemnification and Insurance

The merger agreement provided that Duane Reade Inc., as the surviving corporation in the Acquisition, must maintain all rights to indemnification and exculpation provided in its certificate of incorporation and bylaws as of the date of the merger agreement. Duane Reade Shareholders has agreed to indemnify and hold harmless, and provide advancement of expenses to Duane Reade Inc.’s current and former directors, officers and employees to the same extent such persons were indemnified on the date of the merger agreement.

The merger agreement also provides that, until July 30, 2010, Duane Reade Inc., as the surviving corporation in the Acquisition, must either maintain its policies of director and officer liability insurance or obtain comparable policies, as long as the annual premium payments do not exceed approximately $2.6 million. These insurance policies were purchased effective with the completion of the Acquisition.

Management Members’ Equity Participation

Members of our management own options to acquire shares representing in the aggregate approximately 10.2% of the outstanding common stock of Duane Reade Holdings on a fully diluted basis. The senior vice presidents own phantom stock representing in the aggregate approximately 0.8% of the outstanding common equity of our Company on a fully diluted basis.

Agreements Relating to Duane Reade Holdings

The following agreements, each containing customary terms, were entered into with respect to the equity and governance arrangements for Duane Reade Holdings:

Stockholders and Registration Rights Agreement

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ability to cause Duane Reade Holdings to register common equity securities of Duane Reade Holdings under the Securities Act, and provide for procedures by which certain of the equity holders of Duane Reade Holdings and Duane Reade Shareholders may participate in such registrations.

Preemptive Rights Agreement

A preemptive rights agreement was entered into among certain Oak Hill entities, Duane Reade Shareholders, Duane Reade Holdings, Duane Reade Inc. and Messrs. Cuti, Henry and Ray and certain former officers. The preemptive rights agreement contains, among other things, certain preemptive rights for management, providing that certain equity securities issued by Duane Reade Shareholders or any of its subsidiaries to the members of Duane Reade Shareholders (other than Mr. Cuti) must dilute the interests of all of the parties to the preemptive rights agreement on a proportionate basis. In connection with any such issuance of equity securities, each of Messrs. Cuti, Henry and Ray and the former officers have the right to purchase from the issuing entity a percentage of equity securities being issued equal to their percentage interest (including phantom stock interest) in Duane Reade Holdings as of such time (and, in the case of Mr. Cuti, taking into account his interest in Duane Reade Shareholders as of such time). To the extent any such members of management no longer maintain equity interests in Duane Reade Shareholders or any of its subsidiaries, they will cease to be beneficiaries of the preemptive rights agreement.

ITEM 14. PRINCIPAL ACCOUNTANT FEES and SERVICES

On September 27, 2005, the Company dismissed PricewaterhouseCoopers LLP as its Independent Registered Public Accounting Firm and engaged KPMG LLP in its place. In the discussions that follow, figures related to the 2005 fiscal year reflect the combined billings of both firms.

Audit Fees

Our current and former Independent Registered Public Accounting Firms, KPMG LLP and PricewaterhouseCoopers LLP, respectively, billed us an aggregate of $1,290,000 and $1,197,000 in fees for professional services rendered in connection with the audits of our financial statements for the fiscal years ended December 30, 2006 and December 31, 2005, respectively, and reviews of the financial statements included in our quarterly reports on Form 10-Q during such fiscal years, as well as professional services provided in both years in connection with the Company’s debt offerings and related SEC filings. A portion of the audit fees billed in 2006 are attributable to the two recently completed Audit Committee investigations, as detailed in Note 2 to the consolidated financial statements included in this report.

Audit Related Fees

Our current and former Independent Registered Public Accounting Firms, KPMG LLP and PricewaterhouseCoopers LLP, respectively, billed us an aggregate of $41,000 and $42,000 in fees for the fiscal years ended December 30, 2006 and December 31, 2005. In both years, these fees were primarily incurred for the annual audit of our 401k benefit plan.

Tax Fees

Our current Independent Registered Public Accounting Firm, KPMG LLP, did not bill us for any fees related to tax compliance, tax advice and tax planning during the fiscal year ended December 30, 2006. Our former Independent Registered Public Accounting Firm, PricewaterhouseCoopers LLP, billed us an aggregate of $24,000 in fees for tax compliance, tax advice and tax planning during the fiscal year ended December 31, 2005.

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All Other Fees

Our current and former Independent Registered Public Accounting Firms, KPMG LLP and PricewaterhouseCoopers LLP, respectively, did not bill us any additional fees that are not disclosed under “Audit Fees,” “Audit Related Fees” or “Tax Fees” for the last two fiscal years.

Audit Committee Pre-Approval Process, Policies and Procedures

Our Independent Registered Public Accounting Firm, KPMG LLP, has performed its audit procedures in accordance with pre-approval granted by our Audit Committee. Our Independent Registered Public Accounting Firm has informed the Audit Committee of the scope and nature of each service provided. With respect to the provision of services other than audit and review services, our Independent Registered Public Accounting Firm brought such services to the attention of our Audit Committee, or one or more members of our Audit Committee for the members of the Board of Directors to whom authority to grant such approval had been delegated by the Audit Committee, prior to commencing such services.

All of the services performed in connection with the fees detailed above were approved by the Audit Committee.

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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE

(a) The following documents are filed as a part of this report:

(i) Financial Statements (see Part II—Item 8. Financial Statements and Supplementary Data)

(ii) Exhibits:

For purposes of this list, “Company” refers to Duane Reade Inc.

Exhibit No.		Description
2.1		Agreement and Plan of Merger (the “Merger Agreement”), dated as of December 22, 2003, by and among Duane Reade Inc., Rex Corner Holdings, LLC and Rex Corner Acquisition Corp. (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on December 23, 2003).
2.41(i)		Amendment No. 1 to the Merger Agreement, dated as of June 10, 2004 (incorporated by reference to the Company’s Current Report on Form 8-K filed on June 14, 2004).
2.1(ii)		Amendment No. 2 to the Merger Agreement, dated as of June 13, 2004 (incorporated by reference to the Company’s Current Report on Form 8-K filed on June 14, 2004).
2.1(iii)		Amendment No. 3 to the Merger Agreement, dated as of June 18, 2004 (incorporated by reference to the Company’s Current Report on Form 8-K filed on June 21, 2004).
3.1(i)		Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1(i) to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 25, 2004 (the “3rd quarter 2004 10-Q”)).
3.1(ii)		Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.1(ii) to the S-4 Registration Statement No. 333-120803 with respect to the Company’s 93¤4% Senior Subordinated Notes due 2011 (the “Senior Subordinated Notes”) (the “Senior Subordinated Notes S-4”.))
3.2(i)		Certificate of Incorporation of DRI I Inc. (incorporated by reference to Exhibit 3.2(i) to the S-1 Registration Statement No. 333-43313 with respect to the Company’s 91¤4% Senior Subordinated Notes due 2008 (the “Notes S-1”)).
3.2(ii)		By-laws of DRI I Inc. (incorporated by reference to Exhibit 3.2(ii) of the Notes S-1).
3.3		Third Amended and Restated Partnership Agreement of Duane Reade (incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended June 28, 2003).
3.4(i)		Certificate of Incorporation of Duane Reade International, Inc. (incorporated by reference to Exhibit 3.4(i) to the Company’s Annual Report on Form 10- K for the year ended December 25, 1999 (the “1999 10-K”)).
3.4(ii)		By-laws of Duane Reade International, Inc. (incorporated by reference to Exhibit 3.4(ii) to the 1999 10-K).
3.5(i)		Certificate of Incorporation of Duane Reade Realty, Inc. (incorporated by reference to Exhibit 3.5(i) to the 1999 10-K).
3.5(ii)		By-laws of Duane Reade Realty, Inc. (incorporated by reference to Exhibit 3.5(ii) to the 1999 10-K).

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3.6(i)		Amended and Restated Certificate of Incorporation of Duane Reade Holdings, Inc. (incorporated by reference to Exhibit 3.1(i) to the Company’s and Duane Reade’s S-4 Registration Statement No. 333-122206 with respect to the Company’s and Duane Reade’s Senior Secured Floating Rate Notes due 2010 (the “Floating Rate Notes”) (the “Floating Rate Notes S-4”)).
3.6(ii)		Certificate of Amendment of the Certificate of Incorporation of Duane Reade Holdings, Inc. (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K dated November 23, 2005).
3.6(iii)		By-laws of Duane Reade Holdings, Inc. (incorporated by reference to Exhibit 3.1(ii) to the Floating Rate Notes S-4).
3.6(iv)		Certificate of Amendment of the Certificate of Incorporation of Duane Reade Holdings, Inc., dated March 27, 2007 (incorporated by reference to Exhibit 5.03 of the Company’s Form 8-K dated April 4, 2007).
3.7(i)		Certificate of Designations, Powers, Preferences and Rights of Series A Redeemable Preferred Stock of Duane Reade Holdings, Inc., dated as of March 27, 2007 (incorporated by reference to Exhibit 1.01(c) of the Company’s Form 8-K dated April 4, 2007).
3.7(ii)*		Certificate of Corrections of the Certificate of Designations, Powers, Preferences and Rights of Series A Redeemable Preferred Stock of Duane Reade Holdings, Inc., dated as of April 16, 2007.
4.1		Indenture governing the Senior Subordinated Notes, dated as of December 20, 2004, among the Company, Duane Reade, Duane Reade Holdings, Inc., DRI I Inc., Duane Reade International, Inc., Duane Reade Realty, Inc. and U.S. Bank National Association, as trustee, including the form of Senior Secured Floating Rate Note due 2010 (incorporated by reference to Exhibit 10.23 of the Senior Subordinated Notes S-4).
4.2		Registration Rights Agreement (relating to the Senior Subordinated Notes), dated as of December 20, 2004, among the Company, Duane Reade, Duane Reade Holdings, Inc., DRI I Inc., Duane Reade International, Inc., Duane Reade Realty, Inc. and the initial purchasers party thereto (incorporated by reference to Exhibit 10.24 of the Senior Subordinated Notes S-4).
4.3		Registration Rights Agreement (relating to the initial follow-on Senior Secured Floating Rate Notes due 2010), dated as of August 9, 2005, among the Company, Duane Reade, Duane Reade Holdings, Inc., DRI I Inc., Duane Reade International, Inc., Duane Reade Realty, Inc. and the initial purchaser party thereto (incorporated by reference to Exhibit 4.2 of the Company’s and Duane Reade’s S-4 Registration Statement No. 333-130476).
4.4		Amended and Restated Security Agreement (relating to the Senior Subordinated Notes), dated as of December 20, 2004, among the Company, Duane Reade, Duane Reade Holdings, Inc., DRI I Inc., Duane Reade International, Inc., Duane Reade Realty, Inc. and U.S. Bank National Association, as collateral agent (incorporated by reference to Exhibit 10.25 of the Senior Subordinated Notes S-4).
4.5		Intercreditor and Collateral Agency Agreement (relating to the Senior Subordinated Notes), dated as of December 20, 2004, among the Company, Duane Reade, Duane Reade Holdings, Inc., DRI I Inc., Duane Reade International, Inc., Duane Reade Realty, Inc. and U.S. Bank National Association, as collateral agent and indenture trustee (incorporated by reference to Exhibit 10.26 of the Senior Subordinated Notes S-4).

144

4.6		Amended and Restated Pledge Agreement (relating to the Senior Subordinated Notes), dated as of December 20, 2004, among the Company, Duane Reade, Duane Reade Holdings, Inc., DRI I Inc., Duane Reade International, Inc., Duane Reade Realty, Inc. and U.S. Bank National Association, as collateral agent (incorporated by reference to Exhibit 10.27 of the Senior Subordinated Notes S-4).
4.7		Indenture, dated as of July 30, 2004, between Duane Reade Acquisition Corp. and U.S. Bank National Association, as trustee (incorporated by reference to Exhibit 4.1 to the 3rd quarter 2004 10-Q).
4.8		Successor Supplemental Indenture governing the initial Senior Secured Floating Rate Notes due 2010 and the Floating Rate Notes into which they were exchanged, dated as of July 30, 2004, between the Company and U.S. Bank National Association, as trustee (incorporated by reference to Exhibit 4.2 to the 3rd quarter 2004 10-Q).
4.9		Co-obligor Supplemental Indenture governing the initial Senior Secured Floating Rate Notes due 2010 and the Floating Rate Notes into which they were exchanged, dated as of July 30, 2004, among the Company, Duane Reade and DRI I Inc., Duane Reade Realty, Inc. and Duane Reade International, Inc. as guarantors and U.S. Bank National Association, as trustee (incorporated by reference to Exhibit 4.3 to the 3rd quarter 2004 10-Q).
4.10		Guarantor Supplemental Indenture governing the initial Senior Secured Floating Rate Notes due 2010 and the Floating Rate Notes into which they were exchanged, dated as of July 30, 2004, among the Company, Duane Reade and DRI I Inc., Duane Reade Realty, Inc. and Duane Reade International, Inc., as guarantors and U.S. Bank National Association, as trustee (incorporated by reference to Exhibit 4.4 to the 3rd quarter 2004 10-Q).
4.11		Second Guarantor Supplemental Indenture governing the initial follow-on Senior Secured Floating Rate Notes due 2010 and the follow-on Floating Rate Notes into which they were exchanged, dated as of March 25, 2005, among Duane Reade Holdings, Inc. (“Holdings”), the Company, Duane Reade and DRI I Inc., Duane Reade Realty, Inc. and Duane Reade International, Inc. as guarantors and U.S. Bank National Association, as trustee (incorporated by reference to Holdings’ Current Report on Form 8-K filed March 31, 2005).
4.12		Form of Exchange Note (incorporated by reference to Exhibit 4.5 to the 3rd quarter 2004 10-Q).
4.13		Registration Rights Agreement, dated as of July 30, 2004, by and among Duane Reade Acquisition Corp. and Banc of America Securities LLC, Citigroup Global Markets Inc., Credit Suisse First Boston LLC and UBS Securities LLC, as Initial Purchasers (incorporated by reference to Exhibit 4.6 to the 3rd quarter 2004 10-Q).
4.14		Indenture, dated as of April 16, 2002, between Duane Reade Inc., as issuer, the guarantors named therein and State Street Bank and Trust Company, as trustee (incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-3 dated June 21, 2002 (the “Convertible Notes S-3”)).
4.15		Form of Senior Convertible Notes due 2022 (incorporated by reference to Exhibit 4.2 to the Convertible Notes S-3).
4.16		First Supplemental Indenture, dated as of July 30, 2004, among the Company, as issuer, DRI I Inc., Duane Reade Realty, Inc. and Duane Reade International, Inc. as guarantors and U.S. Bank National Association, as trustee (incorporated by reference to Exhibit 4.9 to the 3rd quarter 2004 10-Q).

145

10.1		Duane Reade Inc. Phantom Stock Plan (incorporated by reference to Exhibit 10.1 to the 3rd quarter 2004 10-Q).
10.2		Duane Reade Holdings, Inc. Management Stock Option Plan (incorporated by reference to Exhibit 10.2 to the 3rd quarter 2004 10-Q).
10.3		Stockholders and Registration Rights Agreement, dated as of July 30, 2004, among Duane Reade Holdings, Inc., Duane Reade Shareholders, LLC and certain members of the management of Duane Reade Inc. (incorporated by reference to Exhibit 10.3 to the 3rd quarter 2004 10-Q).
10.4		Tax Sharing Agreement, dated as of July 30, 2004, among Duane Reade Holdings, Inc., and the Subsidiaries as defined therein, Duane Reade and any parties which become parties thereto (incorporated by reference to Exhibit 10.4 to the 3rd quarter 2004 10-Q).
10.5		Services Agreement, dated as of July 30, 2004, between Oak Hill Capital Management, Inc. and Duane Reade Acquisition Corp (incorporated by reference to Exhibit 10.5 to the 3rd quarter 2004 10-Q).
10.6		Letter Agreement, dated as of March 19, 2004, by and among Duane Reade Shareholders, LLC, Duane Reade Acquisition Corp. and Duane Reade Inc. (incorporated by reference to Amendment No. 3 to the Company’s Schedule 13-E3, filed July 30, 2004).
10.7		Amended and Restated Employment Agreement, dated as of March 16, 2004, by and among Anthony J. Cuti, Duane Reade Acquisition Corp., Duane Reade Holdings, Inc. and Duane Reade Shareholders, LLC. (incorporated by reference to Amendment No. 3 to the Company’s Schedule 13-E3, filed July 30, 2004).
10.8		Letter Agreement, dated as of March 16, 2004, by and between John K. Henry and Duane Reade Acquisition Corp. (incorporated by reference to Amendment No. 3 to the Company’s Schedule 13-E3, filed July 30, 2004).
10.9		Letter Agreement, dated as of March 16, 2004, by and between Gary Charboneau and Duane Reade Acquisition Corp. (incorporated by reference to Amendment No. 3 to the Company’s Schedule 13-E3, filed July 30, 2004).
10.10		Letter Agreement, dated as of March 16, 2004, by and between Timothy R. LaBeau and Duane Reade Acquisition Corp. (incorporated by reference to Amendment No. 3 to the Company’s Schedule 13-E3, filed July 30, 2004).
10.11		Letter Agreement, dated as of March 16, 2004, by and between Jerry M. Ray and Duane Reade Acquisition Corp. (incorporated by reference to Amendment No. 3 to the Company’s Schedule 13-E3, filed July 30, 2004).
10.12		Agreement and Plan of Merger, dated as of December 22, 2003, as amended among Rex Corner Holdings, LLC (now known as Duane Reade Shareholders, LLC), Rex Corner Acquisition Corp. (now known as Duane Reade Acquisition Corp.) and Duane Reade Inc. (incorporated by reference to Amendment No. 3 to the Company’s Schedule 13-E3, filed July 30, 2004).
10.13		Amendment No. 1 to the Merger Agreement, dated as of June 10, 2004, by and among Duane Reade Shareholders, LLC, Duane Reade Acquisition Corp. and Duane Reade Inc. (incorporated by reference to Exhibit 2.1 of Duane Reade Inc.’s Form 8-K dated June 14, 2004).

146

10.14		Amendment No. 2 to the Merger Agreement, dated as of June 13, 2004, by and among Duane Reade Shareholders, LLC, Duane Reade Acquisition Corp. and Duane Reade Inc. (incorporated by reference to Exhibit 2.2 of Duane Reade Inc.’s Form 8-K dated June 14, 2004).
10.15		Amendment No. 3 to the Merger Agreement, dated as of June 18, 2004, by and among Duane Reade Shareholders, LLC, Duane Reade Acquisition Corp. and Duane Reade Inc. (incorporated by reference to Exhibit 2.1 of Duane Reade Inc.’s Form 8-K dated June 21, 2004).
10.16		Credit Agreement, dated as of July 21, 2003, among Duane Reade, as the Borrower, Duane Reade Inc. and corporate subsidiaries as the Facility Guarantors, Various Financial Institutions set forth therein, as the Lenders, Fleet National Bank as the Administrative Agent and Issuing Bank, Fleet Retail Finance Inc. as the Collateral Agent, General Electric Capital Corporation as the Syndication Agent for the Lenders and Congress Financial Corporation as the Documentation Agent for the Lenders (incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended June 28, 2003).
10.17		First Amendment to Credit Agreement, dated as of July 22, 2004, among Duane Reade, Duane Reade Inc., DRI I Inc., Duane Reade International, Inc. Duane Reade Realty, Inc. Fleet National Bank, as Issuing Bank and Administrative Agent, Fleet Retail Group, Inc. as Collateral Agent, Congress Financial Corporation, as Documentation Agent, General Electric Capital Corporation as Syndication Agent and Wells Fargo Retail Finance, LLC, as Syndication Agent and Co-Lead Arranger (incorporated by reference to the 3rd quarter 2004 10-Q).
10.18		Facility Guarantee, dated as of July 21, 2003, among the Facility Guarantors, Fleet Retail Finance Inc., Fleet National Bank and the Lenders (incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended June 28, 2003).
10.19		Intellectual Property Security Agreement, dated as of July 21, 2003, between Duane Reade, the Facility Guarantors and Fleet Retail Finance Inc., as Collateral Agent (incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended June 28, 2003).
10.20		Security Agreement, dated as of July 21, 2003, among Duane Reade, the Facility Guarantors, and Fleet Retail Finance Inc., as Collateral Agent (incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended June 28, 2003).
10.21		Ownership Interest Pledge Agreement, dated as of July 21, 2003, among Duane Reade Inc. and DRI I Inc., and Fleet Retail Finance Inc., as Collateral Agent (incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended June 28, 2003).
10.22		Preferability Letter, dated as of May 13, 2002, issued by PricewaterhouseCoopers LLP, with respect to the Company’s change in accounting method of inventory valuation (incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended March 30, 2002).
10.23		Agreement, dated April 1, 2006, between Duane Reade Inc. and Local 338 (incorporated by reference to Exhibit 10.23 to the Quarterly Report on Form 10-Q of Duane Reade Holdings, Inc. for the period ended April 1, 2006).
10.24		Agreement, dated April 1, 2006, between Duane Reade Inc. and Local 340A New York Joint Board, UNITE HERE (incorporated by reference to Exhibit 10.24 to the Quarterly Report on Form 10-Q of Duane Reade Holdings, Inc. for the period ended April 1, 2006).

147

10.25		Preemptive Rights Agreement, dated as of July 30, 2004, by and among the Company, Duane Reade Holdings, Inc., Duane Reade Shareholders, LLC, Anthony J. Cuti, Oak Hill Capital Partners, L.P., Oak Hill Capital Management Partners, L.P., OHCP DR Co-Investors, LLC and the management stockholders listed therein (incorporated by reference to Exhibit 10.27 to the Floating Rate Notes S-4).
10.26		Form of Nonqualified Stock Option Agreement pursuant to the Duane Reade Holdings 2004 Management Stock Option Plan (incorporated by reference to Exhibit 10.28 to the Senior Secured Notes S-4).
10.27		Nonqualified Stock Option Agreement, dated as of July 30, 2004, by and between Duane Reade Holdings, Inc. and Anthony J. Cuti (incorporated by reference to Exhibit 10.29 to the Senior Secured Notes S-4).
10.28		Employment Agreement, dated as of November 21, 2005, between Duane Reade Inc. and Richard W. Dreiling (incorporated by reference to Exhibit 10.21 to the registrant’s current report on Form 8-K, filed on November 23, 2005).
10.29		Nonqualified Stock Option Agreement, dated as of November 21, 2005, between Duane Reade Holdings, Inc. and Richard W. Dreiling (incorporated by reference to Exhibit 10.2 to the registrant’s current report on Form 8-K, filed on November 23, 2005).
10.30		Purchase Agreement dated as of August 4, 2005 among Duane Reade Holdings, Inc., Duane Reade, the Guarantors named therein and Banc of America Securities LLC (incorporated by reference to Exhibit 10.29 of the Quarterly Report on Form 10-Q of Duane Reade Holdings, Inc. for the period ended September 24, 2005.)
10.31		Letter Agreement, dated January 31, 2006 between Charles Newsom and the Company (incorporated by reference to Exhibit 10.32 of the Annual Report on Form 10-K of Duane Reade Holdings, Inc. for the fiscal year ended December 31, 2005 (the “2005 10-K”)).
10.32		Letter Agreement, dated March 1, 2006 between David D’Arezzo and the Company (incorporated by reference to Exhibit 10.33 of the 2005 10-K).
10.33		Third Amendment to Credit Agreement, dated as of July 7, 2006, among Duane Reade, Duane Reade Inc., DRI I Inc., Duane Reade International, Inc., Duane Reade Realty, Inc., Duane Reade Holdings, Inc. Bank of America, as Issuing Agent and Administrative Agent, Fleet Retail Group, LLC, as Collateral Agent, Wachovia Bank National Association, as Documentation Agent, General Electric Capital Corporation, as Syndication Agent and Wells Fargo Finance, LLC, as Syndication Agent and Co-Lead Arranger (incorporated by reference to Exhibit 10.34 of the Quarterly Report on Form 10-Q of Duane Reade Holdings, Inc. for the period ended July 1, 2006.)
10.34		Employment Letter, dated August 29, 2006 between Vincent A. Scarfone and the Company (incorporated by reference to Exhibit 10.35 of the Quarterly Report on Form 10-Q of Duane Reade Holdings, Inc. for the period ended September 30, 2006).
10.35		Purchase Agreement, dated March 27, 2007, between Duane Reade Holdings, Inc. and OHCP DR Co-Investors 2007, LLC (incorporated by reference to Exhibit 1.01(a) of the Company’s Form 8-K dated April 4, 2007).
10.36		Warrant to Purchase Shares of Common Stock of Duane Reade Holdings, Inc., dated March 27, 2007 (incorporated by reference to Exhibit 1.01(b) of the Company’s Form 8-K dated April 4, 2007).
10.37*		Employment Letter, dated August 29, 2006 and effective December 13, 2005 between Michelle D. Bergman and the Company.

148

14.1		Code of Business Conduct and Ethics (incorporated by reference to Exhibit 14.1 to the 2003 10-K).
21.1		Subsidiaries of the Company (incorporated by reference to Exhibit 21.1 to the 1999 10-K).
31.1*		Sarbanes-Oxley Section 302 Certification of the Company’s Chief Executive Officer (“CEO”).
31.2*		Sarbanes-Oxley Section 302 Certification of the Company’s Chief Financial Officer (“CFO”).
32*		Sarbanes-Oxley Section 906 Certifications of the Company’s CEO and CFO.

* Filed herewith

149

Delaware		05-0599589
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
440 Ninth Avenue, New York, NY		10001
(Address of principal executive offices)		(Zip Code)

Title of each class		Name of each exchange on which registered
None		Not applicable

Reports of Independent Registered Public Accounting Firms		61
Consolidated Statements of Operations—
For the fiscal years ended December 30, 2006 and December 31, 2005 and the period from July 31, 2004 through December 25, 2004 for the Successor and the period from December 28, 2003 through July 30, 2004 for the Predecessor		64
Consolidated Balance Sheets—
As of December 30, 2006 and December 31, 2005		65
Consolidated Statements of Cash Flows—
For the fiscal years ended December 30, 2006 and December 31, 2005 and the period from July 31, 2004 through December 25, 2004 for the Successor and the period from December 28, 2003 through July 30, 2004 for the Predecessor		66
Consolidated Statements of Stockholder’s Equity and Comprehensive Income Loss—
For the fiscal years ended December 30, 2006 and December 31, 2005 and the period from July 31, 2004 through December 25, 2004 for the Successor and the period from December 28, 2003 through July 30, 2004 for the Predecessor		67
Notes to Consolidated Financial Statements		68
Schedule II—Valuation and Qualifying Accounts		150

	1997 Equity Participation Plan
	Option price per share										Wtd. Avg
	$8.33- $15.77		$16.50- $19.93		$21.24- $29.38		$31.10- $38.75		Total Options		Exercise Price
Options outstanding, December 27, 2003	711,342		1,362,547		111,485		15,000		2,200,374			$	14.85
Options exercised	(135,249	)	—		—		—		(135,249	)		$	8.33
Options cancelled	—		(13,100	)	—		—		(13,100	)		$	16.55
Options outstanding, July 30, 2004 pre-transaction	576,093		1,349,447		111,485		15,000		2,052,025			$	15.27
Options paid to holders	(175,193	)	—		—		—		(175,193	)		$	8.78
Options forfeited	(400,900	)	—		—		—		(400,900	)		$	9.72
Options cancelled	—		(1,349,447	)	(111,485	)	(15,000	)	(1,475,932	)		$	17.54
Options outstanding, July 30, 2004 post-transaction	—		—		—		—		—			$	—

		Page
PART I
ITEM 1.	Business	5
ITEM 1A.	Risk Factors	20
ITEM 2.	Properties	29
ITEM 3.	Legal Proceedings	29
ITEM 4.	Submission of Matters to a Vote of Security Holders	32
PART II
ITEM 5.	Market for Registrant’s Common Equity and Related Stockholder Matters	32
ITEM 6.	Selected Financial Data	32
ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
ITEM 7A.	Quantitative and Qualitative Discussions About Market Risk	59
ITEM 8.	Financial Statements and Supplementary Data	60
ITEM 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	112
ITEM 9A.	Controls and Procedures	112
ITEM 9B.	Other Information	114
PART III
ITEM 10.	Directors and Executive Officers of the Registrant	115
ITEM 11.	Executive Compensation	117
ITEM 12.	Security Ownership of Certain Beneficial Owners and Management	137
ITEM 13.	Certain Relationships and Related Transactions	139
ITEM 14.	Principal Accountant Fees and Services	141
PART IV
ITEM 15.	Exhibits and Financial Statement Schedule	143
SIGNATURES		152

								Option		Non-Equity Incentive Plan		All Other
Name	Principal Position	Year		Salary		Bonus (2)		Awards ($) (3)		Compensation (4)		Compensation (5)		Total
Richard W. Dreiling	Chief Executive Officer		2006	825,000			330,000		—		825,000		129,660	2,109,660
Michelle D. Bergman	SVP - General Counsel		2006	350,000			—		—		350,000		9,025	709,025
John K. Henry	SVP - Chief Financial Officer		2006	430,000			75,000		—		430,000		28,433	963,433
Jerry M. Ray	SVP - Pharmacy Operations		2006	430,000			75,000		—		344,000		22,106	871,106
David D’Arezzo	SVP - Merchandising		2006	336,154	(1)		—		92,278		177,100		578,448	1,183,980

			Estimated Future Payouts Under Non-Equity Incentive Plan Awards (1)						All Other Option Awards: Number of Securities		Exercise or Base Price of Option			Grant Date Fair Value of Stock and Option
Name	Grant Date		Threshold ($)		Target ($)		Maximum ($)		Underlying Options (#)(2)		Awards ($/Sh)			Awards (3)
Richard W. Dreiling				825,000		825,000		1,237,500		—		—			—
Michelle D. Bergman				175,000		350,000		525,000		—		—			—
John K. Henry				215,000		430,000		645,000		—		—			—
Jerry M. Ray				215,000		430,000		645,000		—		—			—
David D’Arezzo		03/20/06		115,000		230,000		345,000		13,000		$	100		553,670

Year	Description	Balance at Beginning of Period			Charged to Cost and Expenses			Charged to Other Accounts		Deductions(1)			Balance at End of Period
2004 (Predecessor)	Accounts Receivable		$	1.3		$	1.8		—		$	1.0		$	2.1
2004 (Successor)	Accounts Receivable		$	2.1		$	1.9		—		—			$	4.0
2005 (Successor)	Accounts Receivable		$	4.0		$	4.2		—		$	4.2		$	4.0
2006 (Successor)	Accounts Receivable		$	4.0		$	2.0		—		$	4.0		$	2.0

Dated: June 29, 2007
	DUANE READE HOLDINGS, INC.
		(Registrant)
	By	/s/ JOHN K. HENRY
		John K. Henry
		Senior Vice President and Chief Financial Officer

	Name		Title
/s/ RICHARD W. DREILING		President and Chief Executive Officer and Director
Richard W. Dreiling		(Principal Executive Officer)
/s/ JOHN K. HENRY		Senior Vice President and Chief Financial Officer
John K. Henry		(Principal Accounting and Financial Officer)
/s/ MICHAEL S. GREEN		Director
Michael S. Green
/s/ JOHN P. MALFETTONE		Director
John P. Malfettone
/s/ ANDREW J. NATHANSON		Director
Andrew J. Nathanson
/s/ DENIS J. NAYDEN		Director
Denis J. Nayden
/s/ TYLER J. WOLFRAM		Director
Tyler J. Wolfram