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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.

FORM 10-K

Commission file number 333-41239

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

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Guarantors with respect to the Company's 2.1478% Senior Convertible Notes due 2022

        Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in the Exchange Act Rule 12b-2): Yes ý    No o

        The only class of voting securities of Duane Reade Inc. is its Common Stock, par value $.01 per share (the "Common Stock"). On March 21, 2003, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $308 million.

        The number of shares of the Common Stock outstanding as of March 21, 2003: 24,037,742

DOCUMENTS INCORPORATED BY REFERENCE

        Certain exhibits as listed on the Exhibit Index and filed with registrant's registration statements on Form S-1 (Nos. 333-41239 and 333-43313) under the Securities Act of 1933, as amended, are incorporated by reference into Part IV of this Form 10-K.

INDEX

        Forward-looking statements in our public filings or other public statements are subject to known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous assumptions and other important factors that could cause actual results to differ materially from those in the forward-looking statements. Forward-looking statements include the information concerning our future financial performance, business strategy, projected plans and objectives. Statements preceded by, followed by or that otherwise include the words "believes", "expects", "anticipates", "intends", "projects", "estimates", "plans", "may increase", "may fluctuate" and similar expressions or future or conditional verbs such as "will", "should", "would", "may", "might" and "could" are generally forward-looking in nature and not historical facts. You should understand that the following important factors and assumptions could affect our future results and could cause actual results to differ materially from those expressed in such forward-looking statements:

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the competitive environment in the drugstore industry in general and in the metropolitan New York area;



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the continued efforts of health maintenance organizations, managed care organizations, pharmacy benefit management companies and other third party payers to reduce prescription drug costs and pharmacy reimbursement rates;

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interest rate fluctuations and changes in capital market conditions or other events affecting our ability to obtain necessary financing on favorable terms to fund the anticipated growth of our business;



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changes in cost of goods and services;



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the strength of the economy in general and the economic conditions in the metropolitan New York area, in particular, including changes in consumer purchasing power and/or spending patterns;



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demographic changes;



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changes in federal and state laws and regulations;



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liability and other claims asserted against us;



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changes in our operating strategy or development plans;



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our ability to attract, hire and retain qualified personnel, including our ability to attract qualified pharmacists;



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our significant indebtedness;



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labor disturbances, including any resulting from the suspension or termination of our collective bargaining agreements;



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the continued impact of, or new occurrences of, terrorist attacks in the New York City metropolitan area;



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trends in the healthcare industry;



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changes in our acquisition and capital expenditure plans;



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our ability to continue to secure suitable new store locations under acceptable lease terms;



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our ability to implement successfully and to manage new computer systems and technologies;



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the potential impact of the war with Iraq on the economy or the metropolitan New York market; and



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other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

        Other factors and assumptions not identified above were also involved in the derivation of these forward-looking statements, and the failure of such other assumptions to be realized as well as other factors may also cause actual results to differ materially from those projected. Most of these factors are difficult to predict accurately and are generally beyond our control.

        You should consider the areas of risk described above in connection with any forward-looking statements that may be made by us generally. Except for our ongoing obligations to disclose material information under the federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events unless required by law. For any forward-looking statements contained in any document, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

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PART I

ITEM 1. BUSINESS

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. As of December 28, 2002, we operated 124 of our 228 stores in Manhattan's high-traffic business and residential districts. In addition, at December 28, 2002, we had a total of 104 stores in New York's outer boroughs and in densely populated New York suburbs, including the Hudson River communities of northeastern New Jersey. Since opening our first store in 1960, we have successfully 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. According to data published in Drug Store News, we were the leading U.S. drugstore chain, as measured in terms of sales per square foot, in both 2000 and 2001. In 2002, we believe that we led the New York City drugstore market in sales of both pharmacy and front-end product categories. Sales of higher margin front-end items accounted for 58.2% of our total sales in fiscal 2002, the highest of any major conventional drugstore chain in the United States.

        For the fiscal year ended December 28, 2002, we had sales of $1.27 billion and income before extraordinary charges and the cumulative effect of an accounting change of $31.5 million, compared to sales of $1.14 billion and income before extraordinary charges of $26.2 million in the 2001 fiscal year. Compared to fiscal 2001, fiscal 2002 sales and income before extraordinary charges and the cumulative effect of an accounting change increased by 11.4% and 20.1%, respectively. Income before extraordinary charges and the cumulative effect of an accounting change included the benefit of a $9.4 million partial payment of our business interruption insurance claim related to the September 11, 2001 World Trade Center disaster, as well as the related business interruption losses associated with that claim. During the fiscal year ended December 28, 2002, we incurred after-tax extraordinary charges of $6.6 million principally related to the retirement of debt and a charge of $9.3 million representing the cumulative effect of an accounting change from the dollar based retail FIFO method of inventory valuation to a specific cost based LIFO method of valuation. During fiscal 2001, we incurred after-tax extraordinary charges of $1.5 million related to the retirement of debt. These items are more fully explained in the notes to the accompanying financial statements included herein. Including the extraordinary charges and cumulative effect of the accounting change, net income for the fiscal year ended December 28, 2002 was $15.6 million, compared to $24.7 million in fiscal 2001.

        We enjoy strong brand name recognition in metropolitan New York, which we believe results from our many locations in high-traffic areas of New York City, attractive window displays and signage, radio advertising and the 80 million shopping bags with the distinctive Duane Reade logo that our customers used in 2002. Surveys conducted in recent years have indicated that approximately 95% of the people who live in Manhattan have shopped at a Duane Reade store.

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

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a convenient and value-oriented shopping experience;



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



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a differentiated real estate strategy using flexible store formats.

        We believe that our everyday low price format and broad product offerings provide a convenient and value-oriented shopping experience for our customers and help to build customer loyalty. Our

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everyday low price format results in prices that we believe are lower, on average, than the everyday prices offered by our competitors.

        Despite the high costs of operating in metropolitan New York, we have successfully achieved low operating cost margins due, in part, to high per store sales volume and relatively low warehouse, distribution and advertising costs. Our high volume stores allow us to effectively leverage occupancy costs, payroll and other store expenses. Our 475,000 square foot primary distribution facility is centrally located in Maspeth, Queens, New York City. The facility is located within ten miles of approximately 85% of our stores, and none of our retail locations are more than 50 miles from this facility. During fiscal 2002 we opened an additional 165,000 square foot support facility in North Bergen, NJ that replaced 60,000 square feet of public warehouse space. The new support facility enjoys similar proximity to most of our New York City locations while providing additional capacity and closer proximity to our expanding group of stores located in New Jersey. We believe that these centrally efficient locations result in 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 metropolitan New York. For example, our store sizes range from 1,600 to 14,700 square feet, and we operate 48 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. In addition, our management team has extensive experience with, and knowledge of, the metropolitan New York real estate market, allowing us to quickly and successfully pursue attractive real estate opportunities.

        As of December 28, 2002, we operated 228 stores, 32 of which were opened during fiscal 2002. During fiscal 2001 and 2000, we opened 31 stores and 24 stores, respectively. We closed four stores in 2002, we closed one store in 2001 and lost two stores as a result of the September 11 terrorist attack on the World Trade Center, and we closed one store in fiscal 2000. Among the 28 net stores we opened during fiscal 2002, 11 were in Manhattan, 12 were in the outer boroughs of the city and five were in densely populated, nearby suburbs. As of December 28, 2002, approximately 54% of our stores were in Manhattan, 32% were in the outer boroughs and 14% were located outside New York City. At December 28, 2002, we occupied 1,577,980 square feet of retail space, approximately 10% more than in fiscal 2001 and 59% more than at the end of fiscal 1998. Approximately 40% of the stores we operated at December 28, 2002 were opened within the past three years.

        We were founded in 1960, and we have been a public company since February 1998.

        Our periodic and current reports are available free of charge on our website, www.duanereade.com.

COMPANY OPERATIONS

        Merchandising:    Our overall merchandising strategy is to provide the broadest selection of branded and private label drugstore products available in metropolitan New York and to sell them at everyday low prices. To further enhance customer service and loyalty, we attempt to maintain a consistent in-stock position in all merchandise categories. In addition to prescription and over-the-counter drugs, we offer brand name and private label health and beauty care products, food and beverage items, tobacco products, cosmetics, housewares, hosiery, greeting cards, photofinishing services, photo supplies, seasonal merchandise and other products. Health and beauty care products, including over-the-counter drugs, represent our highest volume product categories. We allocate ample shelf space to popular brands of health and beauty care products. We also offer large sizes, which we believe appeal to the value consciousness of many New York consumers. We place convenience items, such as candy, snacks and seasonal goods, near the check-out registers to provide all customers with optimum convenience

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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. 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 in excess of 800 private label products, which, in fiscal 2002, accounted for approximately 7.4% 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 increasing assortment of private label goods that offer an alternative for increased value to the consumer with higher profitability than comparable branded products. During fiscal 2002 we introduced a private label cosmetic line under the name of "apt.5". We believe that this line offers a varied assortment of department store quality beauty care cosmetic products at value prices.

        We also offer next-day photofinishing services in all of our stores, and during fiscal 2002 we increased the number of stores with one-hour photofinishing departments from 33 to 98 stores. While the costs of initiating this expansion increased our selling, general and administrative costs in 2002, 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.

        We complement our product offerings with additional customer services such as ATM machines, sales of lottery tickets and money transfer services. We believe these services enhance our convenience image and promote stronger customer loyalty.

        Pharmacy:    We believe that our pharmacy business will continue to contribute significantly to our growth. We also believe that a larger pharmacy business will enhance customer loyalty and generate incremental customer traffic, which should increase sales of our wide variety of over-the-counter drugs and other non-pharmacy merchandise. Our prescription drug sales, as reflected by same store pharmacy sales, grew by 12.1% in 2002 compared to 2001. Sales of prescription drugs represented 41.8% of total sales in 2002, compared to 39.2% of total sales in 2001. The average number of prescriptions our pharmacists filled per store per week increased slightly to 983 in 2002, as compared to 979 in 2001. The modest increase is primarily due to the large number of new immature stores added during the year, and remains below the industry chain store average of approximately 1,350. We believe that the average number of prescriptions filled per week lags behind the industry average because of our concentration of stores in business, rather than residential areas. The number of generic prescriptions filled represented 40.1% of total prescriptions filled in the 2002 fiscal year, as compared to 33.9% of total prescriptions filled in the 2001 fiscal year. This increase is significant as lower cost generic prescriptions generally carry higher profit margins and dollar profitability for each prescription dispensed. The increase 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 made several operational changes to improve overall awareness of generic alternatives.

        We believe that our extensive network of conveniently located stores, strong local market position, pricing policies and reputation for high quality health care 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 90.2% in 2002 from approximately 86.9% in 2001. Gross margins on sales covered by third party plans are generally lower than other prescription drug sales because of the highly competitive nature of pricing for this business and the purchasing power of third party plans. We believe that the higher volume of pharmacy sales to third party plan customers offsets these lower gross profit margins. We also believe this allows

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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 28, 2002, we had contracts with over 200 third party plans, including every major third party plan in our market areas. New York Medicaid, the largest third party payer, represented approximately 22.0% and 9.2% of our pharmacy and chain sales, respectively.

        Medicaid reimbursement rates to drug store providers are regulated under state administered programs. Over the last year, a number of states experiencing budget deficits have moved to reduce Medicaid reimbursement rates to participating drug store providers. To date, there have been no significant adverse changes to reimbursement rates in either of the New York or New Jersey Medicaid programs. However, both of these states are experiencing significant budget deficits and there are currently budget proposals in each state that would lower Medicaid reimbursement rates significantly. However, these proposals face significant opposition and their ultimate outcome cannot be determined at this time.

        During 1999, we launched our central fill facility, a new service initiative aimed at improving customer service at our higher volume pharmacies and the first of its kind in the chain drugstore industry. 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 is improved inventory management, since stores supported by the facility may reduce their on-hand quantities of higher cost, slower turning drugs. We believe this is a substantial advantage because a majority of available drugs are prescribed infrequently. The 1,000 most popular drugs sold by us account for more than 85% of all purchases, with the remaining 1,500 accounting for less than 15%. We believe it is more efficient to keep the bulk of this inventory in a central location rather than spread throughout the stores.

        Dispensing accuracy can also be improved through the central fill facility because it permits the purchase of large, automated dispensing machines, which would be too expensive for 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 to provide customer counseling. At December 28, 2002, this facility serviced more than 80 of our stores and handled approximately 1,700 prescriptions per day, nearly 2¹/2 times the volume reported a year ago.

        Another important component of our pharmacy growth strategy is the continued acquisition of customer prescription files from independent pharmacies in market areas currently served by existing Duane Reade stores. In 2002, we purchased the prescription files of 10 pharmacies. When appropriate, we will retain the services of the pharmacist, whose personal relationship with the customers generally maximizes the retention rate of customers associated with the purchased file. Given the large number of independent pharmacies in metropolitan New York, we believe that these stores present additional future acquisition opportunities.

        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 and pricing and co-payment requirements and automatically bills the respective plan. On-line adjudication also reduces losses from

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rejected claims and eliminates a portion of our paperwork for billing and collection of receivables and related costs.

        Internet:    In 1999, we launched an interactive website, "www.duanereade.com," which customers may use to access company information, fill 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, further supporting our strength as a "brick-and-mortar" retailer. While sales generated on the website to date have been immaterial to our business overall, we believe "www.duanereade.com" has positioned us to develop internet business in the future.

        Store Operations:    Our stores range in size from 1,600 to 14,700 square feet, with an average of 6,921 square feet per store. Our stores are designed to facilitate customer movement and to minimize inventory shrink. We believe that providing straight aisles and well-stocked shelves allows customers to find merchandise easily and allows 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 and to optimize store labor productivity. Most stores in Manhattan's business districts are generally open five days per week. In residential and certain business/shopping districts, stores are open six or seven days per week, with a heavy emphasis on convenient, early morning openings and late evening closings. At December 28, 2002, 27 of our stores were open 24 hours a day, 365 days a year. We intend to continue to identify stores at which 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, 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 in Maspeth, Queens, New York City an average of three times per week, allowing the stores to maintain a high in-stock position, maximize utilization of store selling space and minimize the amount of inventory required to be in the stores.

        During fiscal 2002, we experienced significant increases in shrink that we believe resulted from the recessionary economy and increased unemployment throughout our trading areas. In response, we established an increased operational focus that included (1) increased numbers of full-time security guards in high shrink stores, (2) introduction of improved on-line inventory stock ledger reporting for use by management in monitoring purchases and warehouse deliveries (3) improved vendor direct-delivery store level receiving procedures (4) enhanced exception reporting of cashier transactions (5) increased use of digital surveillance cameras and (6) the continued use of a state-of-the-art Electronic Article Surveillance, or EAS, system that detects unremoved EAS tags on valuable or easily concealed merchandise. We staff a full-time team of loss prevention professionals and use an anonymous call-in line to allow employees to report instances of theft. We also monitor employee behavior and conduct ongoing audits of warehouse picking and receiving. We believe that these measures will improve our control over inventory shrink.

        Purchasing and Distribution:    We purchase approximately 96% of our non-pharmacy merchandise directly from manufacturers. We distribute approximately 83% of our non-pharmacy merchandise through our warehouse and receive direct-to-store deliveries for approximately 17% of our non-pharmacy purchases. Direct-to-store deliveries are made primarily for greeting cards, photofinishing, convenience foods and beverages. In total, we purchase from over 1,000 vendors. We

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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 manage non-pharmacy purchasing through a combination of forward buying and vendor discount buying in ways that we believe maximize our buying power. For example, we use a computerized forecasting and inventory investment program that is designed to determine optimal forward buying quantities before an announced or anticipated price increase has been implemented. By forward buying, we stock up on regularly carried items when manufacturers temporarily reduce the cost of goods or when a price increase has been announced or is anticipated.

        We generally purchase prescription medications under long-term supply agreements. Approximately 55% of our pharmacy inventory at December 28, 2002 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 is a smaller facility located in North Bergen, New Jersey. The Maspeth warehouse, which contains approximately 475,000 square feet devoted to inventory, is located within ten miles of approximately 85% of our stores, and within 50 miles of our farthest outlying locations. The close proximity of the warehouses to the stores 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.

        Advertising and Promotion:    We regularly promote key items at reduced retail prices during promotional periods. We use store windows and in-store signs to communicate savings and value to shoppers. Additionally, in 2002, we distributed over 80 million bags with the highly recognizable Duane Reade logo, helping to promote our name throughout metropolitan New York. We also use full color circulars to announce new stores and heavily circulate them in local areas to attract customers. We usually do not rely heavily on distributed print media to promote our core market stores but, because of our strong brand recognition and high-traffic locations, we typically rely on store window displays as our primary method of advertising. We also employ radio advertising that focuses on our convenient locations and timely seasonal promotions.

        In November 1999, we launched the Dollar Rewards Club, the first chain-wide "loyalty card" in the drugstore industry, to provide frequent shoppers with additional discounts. Membership currently exceeds 2.9 million members. We believe that the average Dollar Rewards card member spends approximately 40% more per visit than does a non-member. The loyalty card also enables us to tailor many of our promotions to the needs of these more frequent shoppers. Members of the Dollar Rewards Club may use their loyalty cards when making purchases through our website, "www.duanereade.com."

        Management Information Systems:    We currently have modern pharmacy and inventory management information systems. The pharmacy system, PDX, has reduced the processing time for electronic reimbursement approval for prescriptions from third party plans. We use scanning point-of-sale, or 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 orders sourced through our distribution centers. This system uses 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 to the distribution centers.

        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

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quantities in our perpetual inventory system. These devices are also used to support inventory ordering, transfers, price changes and direct store deliveries. In 2002, we completed the implementation of a full chain-wide specific item cost based inventory tracking and valuation system. We believe this new system provides improved controls over inventory management and shrink related losses.

        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 complex real estate market in New York City all favor regional chains and independents that are familiar with the market. We tailor our store format to meet all of these requirements, and this has proven successful in both the business and residential neighborhoods of Manhattan, as well as the outer boroughs and surrounding areas.

        Our primary competition comes from over 700 independent pharmacies located in New York City as well as stores operated by major drug store 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 and a convenient store format. Against major drug chain competition, Duane Reade enjoys the advantages of strategically located warehouses, a larger number of convenient locations, and greater experience operating stores in the New York metropolitan area.

        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.    States generally 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. In addition, our pharmacies are 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 are licensed by the State of New York. The State of New Jersey licenses the pharmacists employed at our stores 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 fiscal year ended December 28, 2002, our pharmacy payer mix, as a percentage of total pharmacy sales, was approximately 68% managed care organizations, 22% Medicaid/Medicare and 10% private-pay. Pricing for private-pay patients is based on prevailing regional market rates. However, federal law 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, however, are significantly more limited than those available under Medicaid at this time. In addition to requirements mandated by federal law, states have substantial discretion in determining administrative,

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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.

        Referral Restrictions.    We are subject to federal and state laws governing financial and other arrangements between health care providers. Commonly referred to as the Fraud and Abuse laws, these laws prohibit certain financial relationships between pharmacies and physicians or other referral sources. Recently, there has been increased government scrutiny and enforcement activity relating to drug manufacturers' marketing practices under these Fraud and Abuse laws. Violations of these laws and regulations could subject us to fines, pharmacy shutdowns and possible exclusion from participation in federal healthcare programs such as Medicare and Medicaid. Changes in these healthcare laws or new interpretations of the existing laws may affect our pharmacy business.

        Drug Use 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 use 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 what a patient should do upon a missed dosage. Under DUR requirements, pharmacists are also required to take reasonable efforts to obtain the patient's identification information, medical and drug reaction history and to keep notes relevant to an individual's drug therapy. 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 protecting privacy in the exchange of individually identifiable health information. The Department of Health and Human Services, or DHHS, has released three rules mandating compliance with the standards set forth under HIPAA. First, our pharmacies are required to comply with DHHS's standards governing the privacy of the use and disclosure of individually identifiable health information by April 14, 2003. Second, we will have to implement the uniform standards governing common healthcare transactions by October 16, 2003. Finally, rules governing the security of health information were issued on February 20, 2003, with a compliance date of April 21, 2005.

        We are evaluating the effect of the HIPAA standards on our business and are taking steps to achieve compliance. At this time, management anticipates that our pharmacies will be able to comply with the HIPAA requirements that have been adopted. However, HIPAA compliance is an ongoing process, which will require continued attention and adaptation even after the official compliance dates. Management is not in the position to either estimate the cost of compliance with the existing HIPAA requirements or predict the cost of compliance with HIPAA requirements that are not yet effective. Noncompliance with HIPAA may result in criminal penalties and civil sanctions. The HIPAA privacy and security standards may increase our regulatory and compliance burden and may have a significant

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effect on the manner in which our pharmacies use and disclose health information, both internally and with other entities, therefore the cost of compliance may significantly impact our business, financial condition, results of operations or cash flow. However, no such exposure is apparent at this time. In addition to the HIPAA restrictions relating to the exchange of healthcare information, states have adopted laws protecting the confidentiality of patient information which impacts the manner in which pharmacy records are maintained.

        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, which became effective in April 2001, includes provisions designed to further mitigate the reimbursement cuts contained in the Balanced Budget Act of 1997. BIPA also clarifies the government's policy with regard to coverage of drugs and biologics, and addresses certain reimbursement issues. BIPA mandated a study by the General Accounting Office regarding payment for drugs and biologics under Medicare Part B, and requires the General Accounting Office to report to the secretary of the DHHS specific recommendations for revised payment methodologies. BIPA established a temporary moratorium on direct or indirect reductions, but not increases, in payment rates in effect on January 1, 2001, until the Secretary reviews the General Accounting Office report.

        BIPA also addresses attempts to modify the calculation of average wholesale prices of drugs, or AWPs, upon which Medicare and Medicaid pharmacy reimbursement is based. The federal government has been actively investigating whether pharmaceutical manufacturers have been manipulating average wholesale prices. In May 2000, the Health Care Financing Administration, or HCFA, proposed using new pricing data from the Department of Justice for updating Medicare reimbursement allowances for drugs and biologics. HCFA subsequently withdrew its proposal in November 2000, citing the likelihood of Congressional action in this area. The Bush administration and Congress are currently reviewing the validity of using AWPs as the benchmark for prescription drug reimbursement under Medicare Part B and may institute reforms in the manner in which prescription drugs are reimbursed under Medicare Part B by creating a new benchmark for prescription drug reimbursement.

        It is uncertain at this time what additional health care reform initiatives, including a Medicare prescription drug benefit, if any, will be implemented, or whether there will be other changes in the administration of governmental health care programs or interpretations of governmental policies or other changes affecting the healthcare system. We cannot assure you that future health care 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 from 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 dealers licenses issued by the State of New York, the City of New York and the State of New Jersey. In addition, a number of our stores possess beer 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.

        Employees:    As of December 28, 2002, we had approximately 6,000 employees, 83% of whom were full-time. Unions represent approximately 4,600 of our employees. Non-union employees include employees at corporate headquarters, employees at our personnel office, store and warehouse management and most part-time employees, as well as approximately 50% of our store pharmacists. The distribution facility employees are represented by the International Brotherhood of Teamsters, Chauffeurs and Warehousemen and Helpers of America, Local 815. Our recently renegotiated

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three-year contract with this union expires on August 31, 2005. Employees in some stores are represented by the Allied Trades Council ("ATC") and other stores are represented by Local 340A New York Joint Board, UNITE AFL-CIO ("UNITE"). On August 31, 2001, our collective bargaining agreement with the ATC expired after we were unable to reach agreement with the ATC on terms for a successor agreement. The ATC unsuccessfully attempted to strike some of our stores, but our employees remained at work at all times and have been working pursuant to the terms of our December 6, 2001 implemented contract with the ATC, which expires on August 31, 2004. Our current contract with UNITE expires on March 31, 2004. We believe that our relations with our employees are good. We have implemented a series of training programs for our employees, which are designed to reduce turnover, improve productivity and enhance their ability to assist customers.

        Trademarks:    The name "Duane Reade" and the "DR" logo are registered trademarks. We believe that we have developed strong brand awareness within the New York City area. As a result, we regard the Duane Reade logo as a valuable asset. In addition, in connection with the Rock Bottom acquisition, we acquired the "Rock Bottom" name and the "Rock Bottom" logo, each of which are registered trademarks. In 2002, we introduced a new private label cosmetic line that sells under the brand name "apt.5." The "apt.5" name and "apt.5" logo are registered trademarks as well.

ITEM 2. PROPERTIES

        As of December 28, 2002, we were operating stores in the following locations:

        With the exception of a recently purchased store located in Irvington, New Jersey, all of our stores are leased. Store leases are generally for 15-year terms. The average year of expiration for stores operating as of December 28, 2002 is 2012. 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 over each of the next five years and thereafter. Of the 42 stores with leases expiring in the next five years, 17 have renewal options.

        We occupy 95,000 square feet for our corporate headquarters, located in Manhattan, New York City, under a lease that expires in 2012.

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        We occupy a 475,000 square foot warehouse in Maspeth, Queens, New York City under a lease that expires in 2017.

        We occupy a 165,000 square foot warehouse in North Bergen, New Jersey under leases that expire 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 we have adequate legal defenses or insurance coverage for these actions and that the ultimate outcome of these actions will not have a materially adverse effect on the financial position, results of operations or cash flows of our company.

        During 2002 we initiated a legal action against our 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 stemming from the September 11, 2001 World Trade Center terrorist attack, during which our single highest volume and most profitable store was completely destroyed. This litigation is currently in the discovery phase.

        Duane Reade Inc., Anthony J. Cuti, our Chairman, President and Chief Executive Officer, John K. Henry, our Chief Financial Officer and Gary Charboneau, our Senior Vice President of Marketing have been named as defendants in connection with the consolidation of several class action complaints alleging violations of the federal securities laws that were filed from August 2002 through October 2002. The action, which is in the United States District Court for the Southern District of New York, is on behalf of shareholders who purchased our common stock between April 1, 2002 and July 24, 2002, inclusive. The complaint alleges that the defendants violated the federal securities laws by issuing materially false and misleading statements during the class period. We believe that these actions are completely baseless and wholly without merit. We will vigorously defend these actions in court.

        We are a defendant in a class action suit in the Federal Court for the Southern District of New York regarding alleged violations of the Fair Labor Standards Act as to a group of individuals who provided delivery services on a contract basis to us. In December, 2002, the judge in the action issued a partial summary judgment in favor of a subclass of the plaintiffs and against us. We have established reserves that we believe are appropriate in accordance with applicable accounting rules. We believe that we have a number of meritorious arguments on appeal and intend to continue to vigorously defend ourself in this action.

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

        During the fourth quarter of fiscal 2002, we did not submit any matters to a vote of our security holders.

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PART II

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

        Our common stock is listed on the New York Stock Exchange under the symbol: "DRD." On March 21, 2003, the last sale price of our common stock was $12.80 per share. At March 21, 2003, there were 52 registered stockholders of our common stock, compared with 75 registered stockholders at March 15, 2002. Since a significant portion of our common stock is held in "street" name or nominee name, we are unable to determine the exact number of beneficial holders. We paid no dividends in 2002 or 2001, and do not currently anticipate paying cash dividends in the foreseeable future.

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ITEM 6.    SELECTED FINANCIAL DATA

        The Selected Financial Data of Duane Reade Inc. should be read in conjunction with the Consolidated Audited Financial Statements and Notes contained herein.

In thousands, except per share amounts, percentages and store data

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(1)

The 2000 fiscal year contains 53 weeks. All other years shown contain 52 weeks.

(2)

We incurred after-tax expenses of approximately $6.6 million and $1.5 million in fiscal 2002 and fiscal 2001, respectively, related to the retirement of a portion of our debt. Refer to Note 19 of the Consolidated Financial Statements for a further explanation of these charges.

(3)

We incurred after-tax expenses of approximately $9.3 million in fiscal 2002 related to the conversion of our inventory valuation method from retail dollar FIFO to specific cost LIFO. Refer to Note 1 of the Consolidated Financial Statements for a further explanation of this charge.

(4)

On January 14, 1998, the Company effected an 8.326 reverse stock split of its common stock. All references to common stock shares and per share data have been adjusted to give retroactive effect to such reverse stock split.

(5)

Same store sales figures include stores that have been in operation for at least 13 months.

(6)

Sales per square foot prior to fiscal 1999 exclude 29 Rock Bottom stores acquired in September of 1998, which were converted to the Duane Reade format in fiscal 1999.

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ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        The following should be read in connection with all consolidated financial statements and their notes included elsewhere in this report.

General

        We generate revenues primarily through sales of over-the-counter and prescription pharmaceutical products, health and beauty care products, food and beverage items, tobacco products, cosmetics, housewares, hosiery, greeting cards, photofinishing, photo supplies and seasonal merchandise. Health and beauty care products, including over-the-counter drugs, represent our highest volume product categories. Our primary costs and expenses are inventory costs, labor expenses and occupancy costs.

        We achieved sales per square foot of $836 in fiscal 2002, $818 in fiscal 2001 and $847 in fiscal 2000. We believe that sales per square foot is a useful measure of comparing our performance to that of our competitors because it is a measure of a store's sales productivity. Our sales per square foot may be subject to declines in the future as we continue to open large numbers of new stores. The opening of these additional stores may result in a decline in sales per square foot principally because (1) the average square footage for new stores will often be greater than that of the existing store base and (2) new stores generally take some time to reach a mature level of sales. We believe that our competitors in the industry experience increases and decreases in sales per square foot for similar reasons. Over the next two years, we plan to open 35 to 45 stores, of which we anticipate that approximately two-thirds will be located outside of Manhattan. There are no plans for any significant number of store closings.

        Our primary assets are our ownership of 99% of the outstanding partnership interest of Duane Reade, a New York general partnership, and ownership of all of the outstanding common stock of DRI I Inc. DRI I Inc. owns the remaining 1% partnership interest in Duane Reade. Substantially all of our operations are conducted through Duane Reade. In August 1999, we established two new subsidiaries, Duane Reade International and Duane Reade Realty. Duane Reade 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 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 the properties subject to those leases. The Consolidated Financial Statements included herein reflect the accounts of Duane Reade Inc. and its subsidiaries. All significant intercompany transactions and balances have been eliminated.

Results of Operations

        On September 11, 2001, a terrorist attack on the World Trade Center complex in downtown Manhattan resulted in the total destruction of that landmark and significant disruption of commerce throughout the entire city, within which most of our stores are located. The attack resulted in the complete loss of two stores, one of which was our top performing store based on sales volume and profit contribution. Also, as a result of this disaster and the related disruptions within our market in the immediate quarter following the disaster, we reported significant declines in sales and earnings growth trends from the levels achieved prior to the disaster.

        In fiscal 2002, we continued to be affected by the lost sales and profits resulting from the destruction of the two stores and the relocation of certain employers and customers from downtown Manhattan. This, combined with declines in the financial markets and the general recessionary

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economy, continued to have an adverse impact on our sales and earnings performance. During fiscal 2002, we received insurance reimbursements for all of our remaining property losses associated with the September 11 disaster and approximately $9.4 million toward our business interruption claim that was recognized as a separate item of income in our attached financial statements. This business interruption recovery represented a partial payment of our losses and we are currently in litigation with the insurance carrier to recover the balance of our business interruption claim.

        The following sets forth the results of operations as a percentage of sales for the periods indicated.

Fiscal 2002 Compared to Fiscal 2001

        Net sales in the year ended December 28, 2002 were $1.27 billion, an increase of 11.4% over the year ended December 29, 2001 sales of $1.14 billion. The increase was due to an increase in comparable store sales of 4.8% and the inclusion of 31 stores opened during 2001 for the entire 2002 period and 28 net new stores opened in 2002. The increase in comparable store sales was primarily attributable to improved pharmacy sales, which increased to 41.8% of total sales in 2002 compared to 39.2% of total sales in 2001. Pharmacy sales have followed the general industry trend reflecting accelerated growth rates versus front-end sales. Pharmacy comparable store sales increased by 12.1%, while front-end comparable store sales were flat.

        Cost of sales as a percentage of net sales increased to 77.5% for 2002 from 76.2% for 2001, resulting in a decrease in gross profit margin to 22.5% for 2002 from 23.8% for 2001. The gross margin decline primarily resulted from the absence of comparable store growth in the higher margin front-end sales and the faster growth rate of lower margin pharmacy sales. The absence of growth in comparable front-end sales for the year was primarily attributable to the recessionary economy which pervaded the metro New York market throughout 2002. Gross profit was also adversely impacted by higher shrink related losses. In addition, for 2002 and 2001, cost of sales includes other related real estate income and income from the sale of market related data totaling $5.5 million and $10.6 million, respectively.

        Selling, general and administrative expenses were $198.5 million, or 15.6% of net sales, and $173.0 million, or 15.1% of net sales, in 2002 and 2001, respectively. The increase as a percentage of sales reflects a lower rate of same store sales growth in fiscal 2002 than in 2001, increased labor costs and operating leases associated with the startup of 65 incremental one hour photo processing

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departments, higher costs of property insurance in the aftermath of the September 11 disaster and increased legal and litigation-related expenses.

        Depreciation and amortization of intangibles in 2002 and 2001 was $26.9 million and $26.6 million, respectively. The increase was attributable to capital spending for property and equipment additions during 2001 and 2002, primarily in support of new store growth as well as amortization expenses for pharmacy customer lists and lease acquisition costs for acquisitions completed during 2001 and 2002. Fiscal 2002 also reflects a benefit of approximately $4.3 million due to the elimination of goodwill amortization, attributable to our adoption of Financial Accounting Standard No. 142.

        Store pre-opening expenses of $2.1 million related to the opening of 32 stores in 2002 as compared to $1.7 million reflecting 31 store openings in 2001.

        Net interest expense decreased to $17.9 million in 2002 from $27.6 million in 2001. The decrease in interest expense was principally due to the $210.5 million of proceeds from the April 2002 Convertible Note Offering that were used to reduce higher cost term loan, revolver and 9¹/4% Senior Subordinated Note borrowings. In addition, we realized lower interest rates on the floating rate portion of our revolving credit facility during 2002.

        Our pre-tax income increased 15.8% to $50.3 million in 2002 from $43.5 million in 2001.

        During 2002, we recorded an income tax provision of $18.9 million, reflecting an effective tax rate of 40.9%, reduced by certain wage-related income tax credits amounting to $1.7 million. During 2001, we recorded an income tax provision of $17.2 million, reflecting an effective tax rate of 43.0%, reduced by wage-related income tax credits totaling $1.4 million.

        During 2002, we recorded total net extraordinary charges of $6.6 million, net of an income tax benefit of $4.7 million, which were composed of the following: (1) $1.8 million, reflecting the accelerated amortization of deferred financing costs related to (a) loans under our Senior Credit Agreement that were repaid with the proceeds of our offering of senior convertible notes, (b) our 9¹/4% Senior Subordinated Notes that were purchased pursuant to a tender offer completed in June 2002, and (c) the December 2002 repurchase of a portion of our senior convertible notes, (2) $4.1 million associated with the payment of consent premiums and other expenses related to the tender offer, (3) $2.3 million related to the termination of the interest rate swap agreement tied to interest expenses on the loans under the Senior Credit Agreement that were retired with proceeds from the convertible notes offering, and (4) an extraordinary gain of $1.6 million related to the December 2002 repurchase of $17.5 million of our outstanding senior convertible notes.

        During 2002, as a result of the change in accounting method for inventory valuation from retail dollar FIFO to specific cost LIFO, we recorded a one-time, non-cash charge of $9.3 million, net of an income tax benefit of $6.7 million.

        Net income was $15.6 million in 2002 and $24.7 million in 2001. The decrease was due to the factors previously described.

Fiscal 2001 Compared to Fiscal 2000

        Net sales in the 52-week year ended December 29, 2001 were $1.14 billion, an increase of 14.3% over the 53-week year ended December 30, 2000 sales of $1.00 billion. On a comparable 52-week basis, net sales in 2001 increased 16.3% over the same period in 2000. The increases were due to increased comparable store sales of 6.3% and the inclusion of 24 stores opened during 2000 for the entire 2001 period and 28 net new stores opened in 2001. The increase in comparable store sales was primarily attributable to improved pharmacy sales, which increased to 39.2% of total sales in 2001 compared to 35.4% of total sales in 2000. Pharmacy sales have followed the general industry trend reflecting accelerated growth rates versus front-end sales. Pharmacy and front-end comparable sales increased by 16.6% and 0.6%, respectively.

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        Cost of sales as a percentage of net sales increased to 76.2% for 2001 from 74.6% for 2000, resulting in a decrease in gross profit margin to 23.8% for 2001 from 25.4% for 2000. Cost of goods sold in 2001 includes two unusual items, a loss of $2.6 million from the early termination of a supply agreement and a gain of $1.4 million from the sale of a few stores' customer lists. The combined net loss of $1.2 million for these unusual items represented 0.1% of sales in 2001. The balance of the gross margin decline primarily resulted from the low front-end comparable store growth rate of 0.6% and the faster growth rate of lower margin pharmacy sales. The low growth rate in comparable front-end sales for the year was primarily attributable to the impact of customer disruptions in the aftermath of the World Trade Center disaster, the recessionary economy in the second half of the year and a mild flu season in the fourth quarter that depressed sales of cough and cold categories. Lower margin pharmacy sales benefited in the fourth quarter from increased demand for ciprofloxacin as a result of anthrax scares, as well as higher rates of sales in certain sleep aids and anti-depressants. Gross profit was also adversely impacted by the loss of front-end sales related allowances in the period following the World Trade Center disaster.

        Selling, general and administrative expenses were $173.0 million, or 15.1% of net sales, and $155.6 million, or 15.6% of net sales, in 2001 and 2000, respectively. The decrease as a percentage of sales reflects improved efficiencies and additional expense leveraging against new store sales, as well as a reduction in earnings-based incentive compensation and benefit costs.

        Depreciation and amortization of intangibles in 2001 and 2000 was $26.6 million and $23.2 million, respectively. The increase was attributable to capital spending for property and equipment additions during 2000 and 2001, primarily in support of new store growth as well as amortization expenses for goodwill, pharmacy customer lists and lease acquisition costs for acquisitions completed during 2000 and 2001.

        Store pre-opening expenses of $1.7 million related to the opening of 31 stores in 2001 as compared to $1.4 million reflecting 24 store openings in 2000.

        Net interest expense decreased to $27.6 million in 2001 from $35.9 million in 2000. The decrease in interest expense was principally due to the $130.4 million of proceeds from the June, 2001 Equity Offering that were used to reduce term loan and revolver borrowings and lower interest rates on the floating rate portion of our revolving credit facility during 2001, as well as one less week in fiscal 2001 as compared to fiscal 2000. This was partially offset by increased revolver borrowings attributable to the lost sales and earnings in the aftermath of the World Trade Center disaster.

        Our pre-tax income increased 13.5% to $43.5 million in 2001 from $38.3 million in 2000.

        During 2001, we recorded an income tax provision of $17.2 million, reflecting an effective tax rate of 43.0%, reduced by certain wage-related income tax credits amounting to $1.4 million. During 2000, we recorded an income tax provision of $15.6 million, reflecting an effective tax rate of 42.9%, reduced by wage-related income tax credits totaling $0.8 million.

        Net income was $24.7 million in 2001 and $22.7 million in 2000. The increase of $2.0 million is a result of the increase in pre-tax income of $5.2 million in 2001 versus 2000, partially offset by the incremental income tax provision of $1.6 million and the after-tax extraordinary charge of $1.5 million in 2001, reflecting the write-off of deferred financing costs as a result of the June 2001 early retirement of debt.

Liquidity and Capital Resources

        On April 16, 2002, we completed an offering (the "2002 Offering") of $381.5 million aggregate principal amount of senior convertible notes maturing on April 16, 2022 (the "Convertible Notes"). After deducting commissions and expenses related to the offering, we realized net proceeds of $210.5 million. A portion of the proceeds was used to repay an aggregate of approximately $86.1 million in principal amount of Term A loans and Term B loans and $41.5 million in principal

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amount of revolving loans (which revolving loans may be reborrowed) under our Senior Credit Agreement. In addition, we terminated an interest rate swap agreement, which was set to expire in January 2003, at a cost of approximately $3.9 million.

        The Convertible Notes were issued at a discount and pay cash interest at the rate of 2.1478% per year on the principal amount at maturity, 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. Holders of the Convertible Notes may convert each $1,000 in principal amount of their Convertible Notes into 14.1265 shares of our common stock, subject to adjustment, only if (1) the sale price of our common stock reaches, or the trading price of the notes falls below, specified thresholds, (2) the notes are called for redemption, or (3) specified corporate transactions have occurred. Upon conversion, we have the right to deliver, in lieu of our common stock, cash or a combination of cash and common stock in an amount as described in the indenture. It is our intention to redeem these notes by delivering cash. Holders of the Convertible Notes may require us to purchase all or a portion of their notes on April 16, 2007 at a price of $572.76 per note plus accrued cash interest, if any; on April 16, 2012 at a price of $689.68 per note plus accrued cash interest, if any; and on April 16, 2017 at a price of $830.47 per note plus accrued cash interest, if any. We may choose to pay the purchase price of such notes in cash or common stock or a combination of cash and common stock. In addition, if we experience a change in control, each holder may require us to purchase for cash all or a portion of such holder's notes at a price equal to the sum of the issue price plus accrued original issue discount and accrued cash interest, if any, to the date of purchase. We may redeem for cash all or a portion of the 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.

        On June 3, 2002, we completed a tender offer and consent solicitation (the "Tender Offer") to purchase our outstanding 9¹/4% Senior Subordinated Notes due 2008 (the "Senior Notes"). On June 3, 2002, we expended a total of $87.1 million from the balance of the proceeds of the 2002 Offering to pay our obligations under the Tender Offer. This payment was composed of principal value ($78.4 million), premium payments ($6.5 million) and accrued interest earned from February 16, 2002 through the payment date ($2.2 million). During the fourth quarter of 2002, we repurchased and retired $17.5 million of the Convertible Notes at a cost of $14.9 million, resulting in an extraordinary gain, prior to the effect of income taxes, of $2.6 million.

        At December 28, 2002, we had $4.8 million in Term A and $60.3 million in Term B loans outstanding under our Senior Credit Agreement, $201.0 million of outstanding Convertible Notes and $1.6 million of outstanding Senior Notes. We had no outstanding borrowings under our $80.0 million revolving credit facility (other than $0.8 million of outstanding standby letters of credit) and $4.2 million in cash. On February 18, 2003 we retired the remaining $1.6 million of Senior Notes. Any amounts outstanding under our revolving loans and Term A loans mature on February 15, 2004 and the Term B loans mature on February 15, 2007. Our outstanding borrowings under the Senior Credit Agreement are principally LIBOR based borrowings with margins of 1.75% on revolver and Term A loans and a margin of 2.50% on Term B loans. We are currently evaluating proposals for refinancing our Senior Credit Agreement and expect to replace the Agreement with a longer term maturity financing during the current year. We expect that the interest rates we obtain upon the refinancing of these loans will be approximately equivalent to the rates currently in effect.

        The Senior Credit Agreement contains various covenants that limit or restrict, among other things, subject to certain exceptions, our ability to make capital expenditures, incur indebtedness, permit liens on our property, enter into transactions with affiliates, make restricted payments, investments or acquisitions, enter into mergers, consolidations or dissolutions, conduct asset sales, pay dividends or distributions and enter into other specified transactions and business activities. Financial performance covenants included in our Senior Credit Agreement include interest coverage, leverage ratios, minimum net worth requirements and fixed charge coverage requirements. At December 28, 2002, we were in

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compliance with all financial performance covenants in our Senior Credit Agreement. There are no credit ratings related triggers in our Senior Credit Agreement or in the indenture related to our Convertible Notes that would impact cost of borrowing, annual amortization of principal or related debt maturities.

        Working capital was $230.9 million as of December 28, 2002 and $214.1 million as of December 29, 2001. The increase of $16.8 million was primarily due to an increase in accounts receivable of $4.9 million combined with a decrease of $7.1 million in accrued interest and the current portion of long-term debt. The increase in accounts receivable primarily reflects the growth of the third-party pharmacy business. The change in accrued interest and the current portion of long-term debt is reflective of the restructuring of our debt, including the liquidation of our Senior Notes and the accelerated repayment of a portion of our outstanding term loans.

        For fiscal 2002, net cash provided by operating activities was $42.5 million, compared to $25.8 million for fiscal 2001. The primary reason for the increase was the lower rate of growth in working capital in 2002 over 2001 than experienced in 2001 over 2000.

        For fiscal 2002, net cash used in investing activities was $60.5 million, compared to $48.1 million in fiscal 2001. Net cash used in investing activities in 2002 was for capital expenditures of $47.6 million, primarily related to the opening and remodeling of new and renovated stores, combined with $12.9 million for lease, pharmacy file and other acquisition costs. Net cash used in investing activities in 2001 was due to capital expenditures of $41.0 million and $8.5 million for lease, pharmacy file and other acquisition costs, partially offset by $1.4 million of proceeds generated by the sale of certain stores' pharmacy customer files.

        For fiscal 2002, net cash provided by financing activities was $17.2 million, compared to $26.3 million in fiscal 2001. The lower levels of cash provided by financing activities in 2002 resulted from the improved level of cash flow from operating activities partially offset by increased capital expenditures to support increased levels of new store growth and higher levels of cash spending for lease, pharmacy file and other acquisition costs. Proceeds of $210.5 million from the 2002 Offering were used to repay a portion of our outstanding senior debt.

        Our capital requirements primarily result from opening and stocking new stores, remodeling and renovating existing retail locations and from the continuing development of management information systems. We believe that there are significant opportunities to open additional stores, and currently plan to open approximately 35 to 45 stores during the next two years. We expect to spend approximately $40.0 million in fiscal 2003 on capital expenditures, primarily for new and replacement stores and an additional $13.0 million for lease and pharmacy file acquisitions and other costs. We also require working capital to support inventory for our existing stores. Historically, we have been able to lease our store locations.

        Leases for 13 of our stores that generated approximately 4.2% of our net sales for fiscal 2002 are scheduled to expire before the end of fiscal 2004. Four 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 28, 2002, approximately 4,600 of our approximately 6,000 employees were represented by various labor unions and were covered by collective bargaining agreements. Pursuant to the terms of the collective bargaining agreements covering these employees, we are required, in some instances, to pay specified annual increases in salary and benefits contributions relating to the member employees. We do not believe that these increases will have a material impact on our liquidity or results of operations.

        Under an employment agreement with our Chairman and CEO negotiated during fiscal 2002, we are required to fund premiums for a split dollar life insurance policy that will provide certain post-retirement benefits. During fiscal 2002 these premiums amounted to $4.0 million and are

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scheduled to increase to $5.0 million per year in fiscal 2003 through 2010. The premiums have been established at a level anticipated to be sufficient to cover the full amount of the projected retirement benefits as well as to return the full cost of the premiums, plus a 3% rate of interest. Recent Sarbanes-Oxley legislation has resulted in the need for additional guidance concerning the permissibility of split dollar life insurance policies for executives. While we believe this split dollar policy is permitted under current interpretations of the legislation, there can be no assurance that future interpretations or guidance to be provided by the SEC concerning this legislation will concur.

        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 subject to an extension, refinancing or replacement of our Senior Credit Agreement, will be adequate for at least the next two years to make required payments of principal and interest on our indebtedness, to fund anticipated capital expenditures and to satisfy our working capital requirements. 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, we cannot assure you that our operating results, cash flow and capital resources will be sufficient for repayment of our indebtedness in the future. Substantially all of our borrowings under the Senior Credit Agreement bear interest at floating rates. Therefore, our financial condition will be affected by changes in prevailing interest rates.

        The following table provides additional information with respect to our Commitments and Obligations:

(1)

At December 28, 2002, this represented the outstanding balance of term loans ($65.1 million) under our Senior Credit Agreement, combined with the outstanding balance of our 2.1478% Senior Convertible Notes due 2022 ($201.0 million) and our 9.25% Senior Subordinated Notes due 2008 ($1.6 million), as further detailed in Note 11 to the Consolidated Financial Statements.

(2)

Refer to Note 12 of the Consolidated Financial Statements for further detail on Capital Lease Obligations.

(3)

Refer to Note 17 of the Consolidated Financial Statements for further detail on Operating Lease Obligations.

(4)

Recent Sarbanes-Oxley legislation has resulted in the need for additional guidance concerning the permissibility of split dollar life insurance policies for executives. While we believe this split dollar policy is permitted under current interpretations of the legislation, there can be no assurance that

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further interpretations or guidance to be provided by the SEC concerning this legislation will concur.

(1)

Standby Letters of Credit, primarily representing property lease security deposits, are renewed on an annual basis.

        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. Generally, these agreements provide for certain volume commitments and are terminable by us, subject in some cases to specified termination payments, none of which 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.

        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 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.

        Pharmacy Receivables—Reserves for Uncollectible Accounts—At December 28, 2002, accounts receivable included $33.5 million of amounts due from various insurance companies and governmental agencies under third party payment plans for prescription sales made prior to the year-end date. Our accounting policy is to fully reserve for all unpaid pharmacy receivables over 120 days old, as well as any others deemed potentially uncollectible. This policy is based on our past collection experience. Our uncollectible pharmacy receivable losses amounted to $1.2 million in fiscal 2002 and there was approximately $3.8 million reserved for uncollectible pharmacy receivables at December 28, 2002.

        Inventory Shrink Estimates—We take complete physical inventories in all of our stores at least once per year and front-end physical inventories in most stores twice per year on a staggered cycle basis. We take physical inventories at our distribution centers twice per year. Front-end inventories at balance sheet dates are valued using the specific-cost, item-based 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 28, 2002, a change in this shrink estimate of 1.0% of front-end sales would impact current year pre-tax earnings by approximately $2.8 million.

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        Insurance Liabilities and Reserves—At December 28, 2002, there were $2.5 million of accrued general liability claim costs that primarily related to our self-insured portion of customer accident claims. Our policy is to recognize a liability for the estimated self-insured portion of the 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 the vast majority of claims, the maximum self-insured portion of any individual claim amounts to $100,000, however, our historical claim settlement experience is significantly lower. At December 28, 2002, there were 259 outstanding claims with an average projected settlement value of approximately $9,600, as compared to 172 outstanding claims with an average projected settlement value of $13,000 at December 29, 2001.

        Impairment of Goodwill and Intangible Assets—At December 28, 2002, goodwill, net of accumulated amortization, amounted to approximately $160.4 million. Other net intangible assets consisted of lease acquisition costs of $35.5 million, customer lists of $21.1 million and non-compete agreements amounting to $1.5 million. Our policy is to evaluate our intangible assets, exclusive of goodwill, for impairment as of each balance sheet date by comparing the expected undiscounted cash flows from the underlying stores or assets over their remaining asset lives to the net intangible asset values. Any intangible asset for which the projected undiscounted cash flow is insufficient to recover the asset's carrying value is considered impaired and would be written down to its net recoverable value. Such write-downs would result in a non-cash charge to earnings. Based upon our anticipated future revenues and cash flows and the net intangible balances existing at December 28, 2002, all stores are projected to recover their intangible asset values within their useful lives. Goodwill is evaluated at least annually as required under Statement of Financial Accounting Standards No 142. We utilize the market capitalization of our common stock in performing the required impairment test. Our most recent evaluation did not indicate any impairment of goodwill. However, we may be required to perform an interim impairment review if circumstances indicate that an impairment may have occurred. 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. 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 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 28, 2002, we have recorded one loss contingency, representing our estimated portion of a potential settlement of an ongoing lawsuit between various retailers and a delivery drivers union.

        Income Taxes—Our effective tax rate, which was 37.5% for the fiscal year ended December 28, 2002, 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.

Change in Accounting Method

        During the first quarter of 2002, we adopted a change in accounting method to convert from the retail dollar based first-in, first-out ("FIFO") method of inventory valuation to an item specific cost based last-in, first-out ("LIFO") method of inventory valuation. This change resulted in a one-time non-cash after tax charge of approximately $9.3 million, which was recorded in the first quarter as the cumulative effect of an accounting change. Adoption of the specific cost LIFO method has resulted in

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the recognition of the latest item costs in our reported gross margins, and has made our results more comparable to other major retailers in our industry.

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. See Note 23 to the Consolidated Financial Statements for our quarterly results and an indication of our results of operations.

Inflation

        We believe that inflation has not had a material impact on our results of operations during the three years ended December 28, 2002.

Recently Issued Accounting Pronouncements

        During the third quarter of 2001, we adopted Financial Accounting Standards Board Pronouncements Nos. 141 (FAS 141) and 142 (FAS 142) "Business Combinations" and "Goodwill and Other Intangible Assets", respectively, for acquisitions completed after June 30, 2001 (See Note 5 "Acquisitions"). These adoptions did not have a material impact on our results of operations, financial position or cash flows. During the first quarter ended March 30, 2002, we adopted these same standards for goodwill related to acquisitions completed prior to July 1, 2001. For the 52 weeks ended December 28, 2002, our goodwill amortization expense was reduced by $4.3 million as a result of the adoption of these standards. Had these standards been adopted prior to the 2001 fiscal year, our net income for the 52 weeks ended December 29, 2001 would have been approximately $27.3 million. In addition, for the 52 weeks ended December 29, 2001, our net income per basic share outstanding and net income per diluted share outstanding would have been $1.30 and $1.25, respectively. At December 28, 2002, included within the "other assets" category on our balance sheet, were intangible assets totaling $71.5 million, net of accumulated amortization of $55.0 million. The $71.5 million is primarily composed of costs related to the acquisition of store leases ($35.5 million) and pharmacy customer files ($21.1 million), deferred financing costs ($7.3 million) and all other net intangible assets ($7.6 million). Lease acquisition costs are generally amortized over the remaining lease life, pharmacy file acquisition costs are amortized over seven years, and deferred financing costs are amortized over the life of the financing agreement.

        During the first quarter of 2002, we adopted Financial Accounting Standards Board Pronouncement No. 144 (FAS 144), "Accounting for the Impairment or Disposal of Long-Lived Assets." FAS 144 supersedes FAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." The provisions of FAS 144 are effective for financial statements issued after December 15, 2001. This adoption did not have a material impact on our results of operations, financial position or cash flows (See Critical Accounting Policies above).

        In April 2002, FAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued. Under FAS No. 145, gains and losses related to the extinguishment of debt should no longer be segregated on the income statement as extraordinary items. Instead, such gains and losses should be included as a component of income from continuing operations. The provisions of FAS No. 145 are effective for fiscal years beginning after May 15, 2002 with early adoption encouraged. Upon adoption, we will reclassify from extraordinary charges to other income / (loss), for the fiscal years ended December 28, 2002 and December 29, 2001, pre-tax amounts of $11.4 million and $2.6 million, respectively. The income tax provisions for the 2002 and 2001 fiscal years will be adjusted commensurately. Reported net income will remain unaffected by the reclassification.

        In July 2002, FAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," was issued. This statement nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability

27

Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." FAS No. 146 requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of FAS No. 146 are effective for exit or disposal activities initiated after December 31, 2002, with early adoption encouraged.

        In September 2002, the Emerging Issues Task Force released Issue No. 02-16, "Accounting by a Reseller for Cash Consideration Received from a Vendor". The pronouncement addresses two issues. The first issue requires that vendor allowances be categorized as a reduction of cost of sales unless they are a reimbursement of costs incurred to sell the vendor's products, in which case, the cash consideration should be characterized as a reduction of that cost. Cash consideration received from a vendor in excess of the fair value of the benefit received should be characterized as a reduction of cost of sales. As required, we will adopt this portion of the pronouncement in 2003. The second issue requires that rebates or refunds payable only if the customer completes a specified cumulative level of purchases should be recognized as a reduction of cost of sales based on a systematic and rational allocation over the purchase period. This portion of the pronouncement is to be applied to all new arrangements initiated after November 21, 2002. We do not expect that the adoption of this pronouncement will have a material impact on our consolidated results of operations, financial position, or cash flows.

        In November 2002, the Financial Accounting Standards Board issued FASB Interpretation (FIN) No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN No. 45 clarifies the requirements of FAS No. 5, "Accounting for Contingencies," relating to a guarantor's accounting for and disclosure of, the issuance of certain types of guarantees. FIN No. 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor's obligations does not apply to product warranties or to guarantees accounted for as derivatives. The recognition provisions of FIN No. 45 became effective for us beginning on January 1, 2003. We do not believe that this interpretation will have a material impact on our financial position, results of operations or cash flows.

        In December 2002, SFAS No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure" was issued. This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures about the method of accounting for stock-based compensation and the effect of the method used on reported results. As required, we adopted SFAS No. 148 effective in 2002. The adoption did not have a material impact on our consolidated results of operations, financial position, or cash flows.

        In January 2003, the Financial Accounting Standards Board issued FIN No. 46, "Consolidation of Variable Interest Entities." FIN No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The consolidation requirements of FIN No. 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. We do not believe that the adoption of these provisions will have a material impact on our financial position, results of operations or cash flows.

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ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCUSSIONS ABOUT MARKET RISK

        Our financial results are subject to risk from interest rate fluctuations on debt which carries variable interest rates. Variable rate debt outstanding under our Senior Credit Agreement was approximately $65.1 million at December 28, 2002. At December 28, 2002, the weighted average combined interest rate in effect on all borrowings under the Senior Credit Agreement was 4.32%. A 0.50% change in interest rates applied to the $65.1 million balance of floating rate debt existing at December 28, 2002 would affect pre-tax annual results of operations by approximately $0.3 million. In addition, we also have $201.0 million of Convertible Notes and $1.6 million of Senior Notes outstanding at December 28, 2002. These notes bear interest payable semi-annually at fixed rates of 3.75% and 9.25%, respectively, and are therefore not subject to risk from interest rate fluctuations. The $1.6 million of Senior Notes were retired on February 18, 2003.

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

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Accountants

To the Board of Directors and Stockholders of Duane Reade Inc.

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Duane Reade, Inc. and its subsidiaries (the "Company") at December 28, 2002 and December 29, 2001 and the results of their operations and their cash flows for each of the 52-week periods ended December 28, 2002 and December 29, 2001 and for the 53-week period ended December 30, 2000, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 1 to the consolidated financial statements, in fiscal 2002, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."

As also described in Note 1 to the consolidated financial statements, the Company has adopted the specific cost LIFO method of inventory accounting, effective December 30, 2001.

PricewaterhouseCoopers LLP
New York, NY
February 14, 2003

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DUANE READE INC.

Consolidated Statements of Operations

(In thousands, except per share amounts)

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

31

DUANE READE INC.

Consolidated Balance Sheets

(Dollars in thousands)

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

32

DUANE READE INC.

Consolidated Statements of Cash Flows

(In thousands)

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

33

DUANE READE INC.

Consolidated Statements of Stockholders' Equity

(Dollars in thousands)