-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, B7Mimg5tU9Aa8fLoHWGaubUeDpLtgANN7ww3KYSpuu0q9sflUPdLUC3aFVWGcjw0 zeFD1dO40wexiRxQhuL2/Q== 0000950152-97-004575.txt : 19970619 0000950152-97-004575.hdr.sgml : 19970619 ACCESSION NUMBER: 0000950152-97-004575 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970301 FILED AS OF DATE: 19970618 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: DRUG EMPORIUM INC CENTRAL INDEX KEY: 0000832922 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-DRUG STORES AND PROPRIETARY STORES [5912] IRS NUMBER: 311064888 STATE OF INCORPORATION: DE FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-16998 FILM NUMBER: 97625864 BUSINESS ADDRESS: STREET 1: 155 HIDDEN RAVINES DR CITY: POWELL STATE: OH ZIP: 43065 BUSINESS PHONE: 6145487080 MAIL ADDRESS: STREET 1: 155 HIDDEN RAVINES DR CITY: POWELL STATE: OH ZIP: 43065 FORMER COMPANY: FORMER CONFORMED NAME: NEW DE INC DATE OF NAME CHANGE: 19940518 10-K/A 1 DRUG EMPORIUM FORM 10-K/AMENDMENT NO. 1 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A Amendment #1 (MARK ONE) [ x ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended March 1, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from ____________ to ____________ Commission File Number 0-16998 DRUG EMPORIUM, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 31-1064888 (STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NO.) ---------- 155 HIDDEN RAVINES DRIVE POWELL, OHIO 43065 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) ---------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $0.10 PAR VALUE (TITLE OF CLASS) 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 so such filing requirements for the past 90 days. Yes __X__ No ___ 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. [ ] At May 16, 1997, there were 13,179,785 shares of Drug Emporium common stock outstanding. The aggregate market value of shares of common stock held by non-affiliates of the Registrant as of May 16, 1997 was approximately $57,661,559 based on a closing price of $4.375 per share on Nasdaq National Market on such date. DOCUMENTS INCORPORATED BY REFERENCE Part II, Items 6., 7. and 8., and Part IV, Item 14. incorporate by reference portions of the Drug Emporium, Inc. Annual Report to Stockholders for the year ended March 1, 1997. Part III, Items 10., 11., 12., and 13. incorporate by reference portions of the Drug Emporium, Inc. Proxy Statement for the 1997 Annual Meeting of Stockholders. With the exception of the information specifically incorporated by reference, the Drug Emporium, Inc. Annual Report to Stockholders for the year ended March 1, 1997 is not deemed filed as part of this report. 2 Consolidated Statements of Cash Flows for each of the Three Fiscal Years in the Period Ended March 1, 1997 17 Notes to Consolidated Financial Statements 18-22 Report of Independent Auditors 23
(2) Financial Statement Schedules Schedules for which provision is made in Regulation S-X are not required under the instructions contained therein, are inapplicable, or the information is included in the footnotes to the Consolidated Financial Statements. (3) Exhibits List (3) Articles of Incorporation and By-Laws 3.3 Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.3 to the Company's S-1 Registration Statement No. 33-21755) (10) Material Contracts 10.1 Drug Emporium, Inc. 1983 Incentive Stock Option Plan (incorporated by reference to Exhibit 10.2 to the Company's S-1 Registration Statement Registration No. 33-21755) ** 10.2 Drug Emporium, Inc. 1984 Incentive Stock Option Plan (incorporated by reference to Exhibit 10.3 to the Company's S-1 Registration Statement Registration No. 33-21755) ** 10.3 Drug Emporium, Inc. 1987 Incentive Stock Option Plan (incorporated by reference to Exhibit 10.4 to the Company's S-1 Registration Statement Registration No. 33-21755) ** 10.4 Drug Emporium, Inc. 1990 Incentive Stock Option Plan (incorporated by reference to Exhibit 10.41 to the Company's Annual Report on Form 10-K for the fiscal year ended February 28, 1990) ** 10.5 Drug Emporium, Inc. Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.5 to the Company's S-1 Registration Statement Registration No. 33-21755) ** 10.7 Form of License and Franchise Agreement (incorporated by reference to Exhibit 10.7 to the Company's S-1 Registration Statement Registration No. 33-21755) 10.8 Form of Option Agreement (incorporated by reference to Exhibit 10.8 to the Company's S-1 Registration Statement Registration No. 33-21755) 10.10 Third Amended and Restated Revolving Credit and Term Loan Agreement dated as of November 13, 1995, between Drug Emporium, Inc. and Bank One, Columbus, NA (incorporated by reference to Exhibit 10.1 of the Company's Form 10-Q for the period ended November 25, 1995) 10.11 Employment contract dated March 11, 1993 between David L. Kriegel and Drug Emporium, Inc. (incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended February 27, 1993) ** 3 10.12 Drug Emporium, Inc. 1993 Incentive Stock Option Plan (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended February 27, 1993) ** 10.13 Drug Emporium, Inc. 1993 Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the fiscal year ended February 27, 1993) ** 10.14 Amendments No. 1, 2 and 3 to Third Amended and Restated Revolving Credit and Term Loan Agreement dated as of November 13, 1995, (between Drug Emporium, Inc. and Bank One, Columbus, NA) and $5,000,000 Term Note dated April 18, 1997 ** 10.15 Amendment to Employment Agreement made the 11th day of March 1993 by and between Drug Emporium, Inc. and David L. Kriegel dated September 25, 1996, and Employment Security Agreements between Drug Emporium, Inc. and each of A. Joel Arnold, Jane H. Lagusch and Timothy S. McCord, dated September 25, 1996 ** (11) Statement re Computation of Per Share Earnings 11.1 Computation of Per Share Earnings is readily computable from information disclosed in the financial statements and therefore is not included as a separate exhibit. *(13) Annual Report to Security Holders, Form 10Q or Quarterly Report to Security Holders 13.1 Annual Report to Stockholders for Fiscal Year Ended March 1, 1997. (limited to those portions incorporated herein) *(21) Subsidiaries of Registrant 21.1 The Company has the following wholly-owned subsidiaries:
State of Name Incorporation ------------------------------------------------------------------------ Drug Emporium of Michigan, Inc. Delaware Drug Emporium of Maryland, Inc. Delaware Winter Fern Drug Distributors, Inc. Ohio RJR Drug Distributors Inc. Delaware Houston Venture, Inc. Ohio Emporium Venture, Inc. Ohio
(23) Consent of Experts 23.1 Consent of Ernst & Young LLP (27) Financial Data Schedule 27.1 Financial Data Schedule of the Company *Included with this Annual Report on Form 10-K **Compensatory plans, contracts or agreements (b) Reports on Form 8-K No reports on Form 8-K were filed during the fourth quarter of fiscal 1997. 4 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DRUG EMPORIUM, INC. (Registrant) Date: June 17, 1997 /s/ Timothy S. McCord /s/ David L. Kriegel - ------------------------------------- ------------------------------------ Timothy S. McCord David L. Kriegel Chief Financial Officer and Treasurer Chairman and Chief Executive Officer EX-13.1 2 EXHIBIT 13.1 1
FINANCIAL HIGHLIGHTS March 1, 1997 March 2, 1996 (Dollars in thousands, except per share data) (52 weeks) (53 weeks) ============================================================================================================== FOR THE YEAR ENDED: - -------------------------------------------------------------------------------------------------------------- Net sales $ 855,016 $ 738,772 - -------------------------------------------------------------------------------------------------------------- Operating income before special charges* $ 12,915 $ 13,372 - -------------------------------------------------------------------------------------------------------------- Net income $ 1,152 $ 2,342 - -------------------------------------------------------------------------------------------------------------- Average sales per store (52-week weighted average) $ 6,151 $ 5,941 - -------------------------------------------------------------------------------------------------------------- AT YEAR END: - -------------------------------------------------------------------------------------------------------------- Inventories at current cost $ 208,991 $ 209,652 - -------------------------------------------------------------------------------------------------------------- LIFO reserve (21,042) (21,154) - -------------------------------------------------------------------------------------------------------------- Inventories $ 187,949 $ 188,498 - -------------------------------------------------------------------------------------------------------------- Working capital $ 76,302 $ 80,195 - -------------------------------------------------------------------------------------------------------------- Shareholders' equity $ 49,567 $ 48,545 - -------------------------------------------------------------------------------------------------------------- Current ratio 1.59 1.63 - -------------------------------------------------------------------------------------------------------------- Long-term debt to equity 1.20 1.30 - -------------------------------------------------------------------------------------------------------------- Shares outstanding (in thousands) 13,153 13,184 - -------------------------------------------------------------------------------------------------------------- STORES OPEN: - -------------------------------------------------------------------------------------------------------------- Company-owned 138 136 - -------------------------------------------------------------------------------------------------------------- Franchised and licensed 91 90 - -------------------------------------------------------------------------------------------------------------- Total 229 226 - -------------------------------------------------------------------------------------------------------------- PER SHARE: - -------------------------------------------------------------------------------------------------------------- Net income $ 0.09 $ 0.18 - -------------------------------------------------------------------------------------------------------------- Shareholders' equity $ 3.77 $ 3.68 ============================================================================================================== * Special charges of $2,800,000 and $3,000,000 were recorded in Fiscal 1997 and Fiscal 1996, respectively.
2 SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth selected financial data and other operating information of the Company. The selected financial data is derived from the consolidated financial statements of the Company. The financial data should be read in conjunction with the consolidated financial statements and related notes contained elsewhere in this report and Management's Discussion and Analysis of Financial Condition and Results of Operations.
STATEMENT OF OPERATIONS DATA Year Ended - ------------------------------------------------------------------------------------------------------------------------ MARCH 1, March 2, February 25, February 26, February 27, (in thousands, except per share data) 1997 1996 1995 1994 1993 (52 WEEKS) (53 weeks) (52 weeks) (52 weeks) (52 weeks) ======================================================================================================================== Net sales $855,016 $738,772 $729,503 $749,040 $756,710 - ------------------------------------------------------------------------------------------------------------------------- Gross margin 185,475 160,146 153,696 155,473 154,002 - ------------------------------------------------------------------------------------------------------------------------- Selling, administrative and occupancy expenses 172,560 146,774 143,337 146,920 146,726 - ------------------------------------------------------------------------------------------------------------------------- Operating income before special charges 12,915 13,372 10,359 8,553 7,276 - ------------------------------------------------------------------------------------------------------------------------- Special charges 2,800 3,000 11,850 -- 4,357 - ------------------------------------------------------------------------------------------------------------------------- Interest, net 7,882 6,468 6,697 6,183 6,148 - ------------------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes 2,233 3,904 (8,188) 2,370 (3,229) - ------------------------------------------------------------------------------------------------------------------------- Provision (benefit) for income taxes 1,081 1,562 (2,797) 1,089 (562) - ------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 1,152 $ 2,342 $ (5,391) $ 1,281 $ (2,667) ========================================================================================================================= PER SHARE DATA: - ------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 0.09 $ 0.18 $ (0.41) $ 0.10 $ (0.20) - ------------------------------------------------------------------------------------------------------------------------- Cash dividends -- -- -- -- $ 0.04 - ------------------------------------------------------------------------------------------------------------------------- Shareholders' equity $ 3.77 $ 3.68 $ 3.50 $ 3.91 $ 3.82 - ------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET DATA: - ------------------------------------------------------------------------------------------------------------------------- Working capital $ 76,302 $ 80,195 $ 83,664 $ 82,176 $ 72,525 - ------------------------------------------------------------------------------------------------------------------------- Total assets $243,319 $243,898 $176,444 $198,085 $194,935 - ------------------------------------------------------------------------------------------------------------------------- Non-current liabilities $ 63,523 $ 67,391 $ 67,738 $ 68,761 $ 59,861 - ------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity $ 49,567 $ 48,545 $ 46,149 $ 51,484 $ 50,095 =========================================================================================================================
12 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 3 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following table sets forth selected items from the Company's Consolidated Statements of Operations expressed as a percentage of net sales for the years indicated.
Year Ended - -------------------------------------------------------------- March 1, March 2, February 25, 1997 1996 1995 (52 weeks) (53 weeks) (52 weeks) - -------------------------------------------------------------- Net sales (in thousands) $855,016 $738,772 $729,503 - -------------------------------------------------------------- Gross margin 21.7% 21.7% 21.1% - -------------------------------------------------------------- Selling, administrative and occupancy expense 20.2 19.9 19.7 - -------------------------------------------------------------- Operating income before special charges 1.5% 1.8% 1.4% - --------------------------------------------------------------
SALES Sales for Fiscal 1997 increased 16 percent over Fiscal 1996 and comparable-store sales increased two percent. The overall sales increase was achieved due to the impact of sales at acquired stores and comparable-store sales increases, partially offset by the impact of having 52 weeks in Fiscal 1997 versus 53 weeks in Fiscal 1996. Average sales per store for Fiscal 1997 (based on a weighted average number of stores) were up three percent over Fiscal 1996 as a result of the closing of underperforming stores, the acquisition of higher-volume stores and comparable-store sales increases. In Fiscal 1996, the additional one week of sales contributed $14.9 million to net sales. Pharmacy sales as a percentage of total sales were 26 percent in Fiscal 1997 and 25 percent in Fiscal 1996 and 1995. Management expects that pharmacy sales will continue to account for approximately one-fourth of sales in the coming year. The following table lists stores opened or acquired and stores closed for the years indicated:
Year Ended - -------------------------------------------------------------- March 1, March 2, February 25, 1997 1996 1995 (52 weeks) (53 weeks) (52 weeks) - -------------------------------------------------------------- Number of stores at beginning of year 136 113 133 - -------------------------------------------------------------- Stores opened or acquired 9 34 5 - -------------------------------------------------------------- Stores closed (7) (11) (25) - -------------------------------------------------------------- Total stores at end of year 138 136 113 ===============================================================
GROSS MARGIN Gross margin as a percentage of sales remained constant in Fiscal 1997 as compared to Fiscal 1996. Management achieved stability in the gross margin in Fiscal 1997 despite significant competitive pressures through improved category management, better buying and improved shrink control. Similar factors led to an increase in Fiscal 1996 gross margins over Fiscal 1995. For Fiscal 1998, management expects continued pressure on the pharmacy margins as sales through managed care networks increase as a percentage of pharmacy sales. General merchandise gross margins are expected to remain stable. Management's goal is to offset any downward pressure on margins by utilizing scanning data to improve overall category gross margins where opportunities allow, while at the same time protecting the low price image of the stores. SELLING, ADMINISTRATIVE AND OCCUPANCY Selling, administrative and occupancy expenses increased in Fiscal 1997 compared to Fiscal 1996 and Fiscal 1995 in total dollars and as a percentage of net sales. The increase over Fiscal 1996 is a result of transitional costs associated with the acquired stores and increased litigation costs. The increase in Fiscal 1996 over Fiscal 1995 was a result of increased ongoing costs related to the POS system and increased security system costs. SPECIAL CHARGES The impact of special charges on net income (loss) and descriptions of the components of the charges are shown below:
Year Ended - ------------------------------------------------------------------------------- March 1, March 2, February 25, 1997 1996 1995 (in thousands, except per share data) (52 weeks) (53 weeks) (52 weeks) - -------------------------------------------------------------------------------- RECONCILIATION OF NET INCOME (LOSS) TO NET INCOME (LOSS) BEFORE SPECIAL CHARGES: Net income (loss) $ 1,152 $ 2,342 $(5,391) - ------------------------------------------------------------------------------- Special charges, net of income taxes 1,680 1,800 7,110 - ------------------------------------------------------------------------------- Net income (loss) before special charges $ 2,832 $ 4,142 $ 1,719 - ------------------------------------------------------------------------------- Net income per share before special charges $ 0.22 $ 0.31 $ 0.13 ================================================================================
Store Closure Expense In Fiscal 1995, the Company sold seven stores in the Washington, D.C. market and closed fourteen additional stores. The cost associated with the 21 stores resulted in a pretax charge of $11,850,000. During Fiscal 1996, an additional pretax charge of $3,000,000 was taken to cover rent and related charges at several properties which have taken longer than expected to sublease. In Fiscal 1997, the Company incurred costs associated with stores closed during Fiscal 1997 and earlier of $1,300,000, which was recorded as a part of special charges. Management's goal is to sublease or through other means remove all significant closed-store obligations. Since March 1994, the Company has closed 43 stores, of which obligations continue at March 1, 1997 on five stores. Management continues to seek ways to relieve obligations on these stores. Impairment of Long-Lived Assets In Fiscal 1997, the Company adopted SFAS No. 121, Accounting for the Impairment of Long Lived Assets and for Long-Lived Assets to Be Disposed Of. Accordingly, the Company evaluated the ongoing [LOGO] DRUG EMPORIUM INC AND SUBSIDIARIES 13 4 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) value of its long-lived assets. Based on this evaluation, the Company determined that leasehold improvements and lease assets for certain stores were impaired and recorded, as a part of special charges, an amortization charge of $1,500,000. INTEREST, NET Interest, net increased during Fiscal 1997 and decreased during Fiscal 1996. The increase in Fiscal 1997 is due to increased borrowing related to store acquisitions. The decrease in Fiscal 1996 is due to lower borrowings during the first three quarters, partially offset by increased fourth quarter borrowings due to the stores acquired. Management's goal is to reduce borrowing costs in Fiscal 1998 by reducing debt through decreased inventory levels and improved operational cash flow. ACQUISITIONS On May 29, 1996, the Company completed a purchase of certain assets of six stores in the Philadelphia market. The acquisition was accounted for as a purchase. Late in the third quarter of Fiscal 1996, the Company acquired 26 stores from F&M Distributors, Inc. ("F&M") in two separate transactions. The acquired stores were located in Milwaukee, Baltimore and Detroit, with Detroit representing a new market for the Company. Three of the stores were subsequently closed or merged with existing Drug Emporium operations. None of the closed stores carried any future lease obligations to the Company. Six additional stores were also purchased in three separate transactions. The consolidated statements of operations reflect the results of operations of the acquired stores from the date acquired. INVENTORY VALUATION The Company uses the LIFO method of accounting for its inventories. Under this method, the cost of merchandise sold reported in the financial statements approximates current costs. The Company, in computing its LIFO charges throughout the fiscal year, uses an estimated percentage rate of inflation determined at the beginning of the fiscal year. This LIFO charge is adjusted at each year end based upon the actual weighted average percentage rate of inflation during the fiscal year.
Year Ended - ------------------------------------------------------------------ March 1, March 2, February 25, 1997 1996 1995 - ------------------------------------------------------------------ LIFO provision (benefit) (in thousands) $(112) $1,573 $200 - ------------------------------------------------------------------ Inflation rate -.1% 1.1% .1% ==================================================================
Inventory turnover approximated four turns for each of the years presented. Management's goal is to increase turns in the future by adjusting buying based on movement information provided through scanning and by seeking alternative distribution methods that will allow for reduced inventory of slower moving items. LIQUIDITY AND CAPITAL RESOURCES The Company signed a new bank agreement (the Agreement) on May 24, 1996. As of March 1, 1997, the Company's credit facility consisted of a term loan of $12,000,000 and a revolving credit loan availability of up to $55,000,000. The revolver expires on May 31, 2000, while the term debt is paid in quarterly installments of $750,000. During Fiscal 1997, the Company increased borrowings under the revolving credit facility by $20.1 million, as set forth in the consolidated statements of cash flows. This was a result of spending on acquisitions of approximately $10.1 million and timing of vendor payments, partially offset by other operational cash flows. The Company's borrowing rate can fluctuate between the bank's prime rate and a LIBO-based rate, depending on the ability of the Company to meet certain financial covenants. The Agreement requires a commitment fee on the revolver of .25% on the unused available credit and has no compensating balance requirements. Borrowings made pursuant to the Agreement are secured by inventory and accounts receivable. The Agreement prohibits the payment of dividends, stock repurchases and acquisition of the Company's convertible subordinated debentures. Cash paid for interest on the revolving credit line and long-term debt exceeded interest expense by approximately $1 million in Fiscal 1997 and was lower than interest expense by approximately $1 million in Fiscal 1996. The Company believes that internally generated funds and borrowings available under its Agreement are sufficient to finance the Company's current operations. DEFERRED TAX ASSET The Company's deferred tax asset at March 1, 1997 is primarily comprised of net operating loss and AMT credit carryforwards of $3,500,000. Management expects to generate taxable income through operations of at least this amount during the next few years. However, the Company has the ability to generate taxable income through tax planning strategies, if necessary, to utilize the net operating loss carryforward. 14 DRUG EMPORIUM INC AND SUBSIDIARIES [LOGO] 5
CONSOLIDATED BALANCE SHEETS (in thousands) - -------------------------------------------------------------------------------------------- ASSETS MARCH 1, 1997 March 2, 1996 - -------------------------------------------------------------------------------------------- CURRENT ASSETS: Cash and cash equivalents $ 779 $ 767 - ------------------------------------------------------------------------------------------- Accounts receivable 14,525 13,018 - ------------------------------------------------------------------------------------------- Inventories 187,949 188,498 - ------------------------------------------------------------------------------------------- Income taxes and other current assets 3,278 5,874 - ------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 206,531 208,157 - ------------------------------------------------------------------------------------------- Property and equipment, net 30,412 28,793 - ------------------------------------------------------------------------------------------- Goodwill 4,763 5,311 - ------------------------------------------------------------------------------------------- Other assets 1,613 1,637 - ------------------------------------------------------------------------------------------- TOTAL ASSETS $243,319 $243,898 =========================================================================================== (dollars in thousands) - ------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY MARCH 1, 1997 March 2, 1996 ============================================================================================ CURRENT LIABILITIES: Revolving credit line $ 41,600 $ 21,500 - ------------------------------------------------------------------------------------------- Accounts payable 64,571 69,143 - ------------------------------------------------------------------------------------------- Accrued liabilities 15,142 23,527 - ------------------------------------------------------------------------------------------- Deferred income 4,966 9,183 - ------------------------------------------------------------------------------------------- Current maturities of long-term debt 3,950 4,609 - ------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 130,229 127,962 - ------------------------------------------------------------------------------------------- Deferred rent 4,192 4,107 - ------------------------------------------------------------------------------------------- Convertible subordinated debt 49,421 49,421 - ------------------------------------------------------------------------------------------- Long-term debt, other 9,910 13,863 - ------------------------------------------------------------------------------------------- TOTAL LONG-TERM DEBT 59,331 63,284 - ------------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY: Preferred stock, authorized 2,000,000 shares, none issued -- -- - ------------------------------------------------------------------------------------------- Common stock, stated value $.10 per share, authorized 28,000,000; issued and outstanding 13,153,000 in 1997, 13,184,000 in 1996 1,315 1,318 - ------------------------------------------------------------------------------------------- Additional paid-in capital 31,994 32,121 - ------------------------------------------------------------------------------------------- Retained earnings 16,258 15,106 - ------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 49,567 48,545 - ------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $243,319 $243,898 =========================================================================================== See accompanying notes. 15
[LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 15 6
CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended - ---------------------------------------------------------------------------------------------------------- MARCH 1, 1997 March 2, 1996 February 25, 1995 (in thousands, except per share amounts) (52 weeks) (53 weeks) (52 weeks) - ---------------------------------------------------------------------------------------------------------- Net sales $ 855,016 $ 738,772 $ 729,503 - ---------------------------------------------------------------------------------------------------------- Cost of sales 669,541 578,626 575,807 - ---------------------------------------------------------------------------------------------------------- Gross margin 185,475 160,146 153,696 - ---------------------------------------------------------------------------------------------------------- Selling, administrative and occupancy expenses 172,560 146,774 143,337 - ---------------------------------------------------------------------------------------------------------- Special charges 2,800 3,000 11,850 - ---------------------------------------------------------------------------------------------------------- Interest expense, net 7,882 6,468 6,697 - ---------------------------------------------------------------------------------------------------------- Income (loss) before provision (benefit) for income taxes 2,233 3,904 (8,188) - ---------------------------------------------------------------------------------------------------------- Provision (benefit) for income taxes 1,081 1,562 (2,797) - ---------------------------------------------------------------------------------------------------------- Net income (loss) $ 1,152 $ 2,342 $ (5,391) - ---------------------------------------------------------------------------------------------------------- Net income (loss) per share $ .09 $ .18 $ (.41) - ---------------------------------------------------------------------------------------------------------- Weighted average number of common shares used in computing net income (loss) per share 13,169 13,182 13,166 ==========================================================================================================
See accompanying notes.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - ------------------------------------------------------------------------------------------------------------------------ Common Common Additional Total Stock Stock Paid-In Retained Shareholders' (in thousands) Shares Amount Capital Earnings Equity - ------------------------------------------------------------------------------------------------------------------------ Balance at February 26, 1994 13,154 $1,315 $32,014 $18,155 $51,484 - ------------------------------------------------------------------------------------------------------------------------ Exercise of stock options 17 2 54 -- 56 - ----------------------------------------------------------------------------------------------------------------------- Net loss -- -- -- (5,391) (5,391) - ----------------------------------------------------------------------------------------------------------------------- Balance at February 25, 1995 13,171 1,317 32,068 12,764 46,149 - ----------------------------------------------------------------------------------------------------------------------- Exercise of stock options 13 1 53 -- 54 - ----------------------------------------------------------------------------------------------------------------------- Net income -- -- -- 2,342 2,342 - ----------------------------------------------------------------------------------------------------------------------- Balance at March 2, 1996 13,184 1,318 32,121 15,106 48,545 - ----------------------------------------------------------------------------------------------------------------------- Retirement of treasury shares (31) (3) (127) -- (130) - ----------------------------------------------------------------------------------------------------------------------- Net income -- -- -- 1,152 1,152 - ----------------------------------------------------------------------------------------------------------------------- BALANCE AT MARCH 1, 1997 13,153 $1,315 $31,994 $16,258 $49,567 ======================================================================================================================= See accompanying notes.
16 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 7
CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended - -------------------------------------------------------------------------------------------------------------------- MARCH 1, 1997 March 2, 1996 February 25, 1995 (in thousands) (52 weeks) (53 weeks) (52 weeks) - -------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income (loss) $ 1,152 $ 2,342 $ (5,391) - ------------------------------------------------------------------------------------------------------------ ADJUSTMENTS TO RECONCILE TO CASH PROVIDED BY (USED FOR) OPERATIONS: Depreciation and amortization 8,788 6,934 7,411 - ------------------------------------------------------------------------------------------------------------ Deferred income taxes 500 1,000 (1,000) - ------------------------------------------------------------------------------------------------------------ LIFO provision (benefit) (112) 1,573 200 - ------------------------------------------------------------------------------------------------------------ CASH PROVIDED BY (USED FOR) CURRENT ASSETS AND LIABILITIES: Accounts payable and accrued liabilities (18,626) 34,128 (7,191) - ------------------------------------------------------------------------------------------------------------ Accounts receivable (1,507) (2,494) (913) - ------------------------------------------------------------------------------------------------------------ Inventories at current cost 7,921 (23,064) 14,444 - ------------------------------------------------------------------------------------------------------------ Other 2,439 3,446 (1,261) - ------------------------------------------------------------------------------------------------------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 555 23,865 20,681 - ------------------------------------------------------------------------------------------------------------ INVESTING ACTIVITIES Purchase of property and equipment, net (5,809) (2,773) (3,513) - ------------------------------------------------------------------------------------------------------------ Proceeds from sale of property and equipment -- -- 1,202 - ------------------------------------------------------------------------------------------------------------ Payment for purchase of retail stores, net of cash acquired (10,093) (40,644) -- - ------------------------------------------------------------------------------------------------------------ NET CASH (USED FOR) INVESTING ACTIVITIES (15,902) (43,417) (2,311) - ------------------------------------------------------------------------------------------------------------ FINANCING ACTIVITIES Net borrowings (repayments) under revolving credit line 20,100 21,500 (13,480) - ------------------------------------------------------------------------------------------------------------ Proceeds from term debt -- 15,000 -- - ------------------------------------------------------------------------------------------------------------ Net repayments and other (4,741) (17,903) (3,753) - ------------------------------------------------------------------------------------------------------------ NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 15,359 18,597 (17,233) - ------------------------------------------------------------------------------------------------------------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 12 (955) 1,137 - ------------------------------------------------------------------------------------------------------------ CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 767 1,722 585 - ------------------------------------------------------------------------------------------------------------ CASH AND CASH EQUIVALENTS, END OF YEAR $ 779 $ 767 $ 1,722 =============================================================================================================
See accompanying notes [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 17 8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Consolidation The consolidated financial statements include the accounts of Drug Emporium, Inc. and subsidiaries (the Company). All significant intercompany accounts and transactions have been eliminated in consolidation. Nature of Operations The Company is primarily in the business of operating and franchising retail stores specializing in the sale of health and beauty care products, over-the-counter medication, prescription drugs, greeting cards, cosmetics and highly-consumable products primarily in an everyday-low-price format. During Fiscal 1997, the stores operated under the names of Drug Emporium, F&M Super Drug Stores, I got it at Gary's and "big D." As of year end, approximately eighty percent of the Company-owned stores were located in the states of California, Georgia, Michigan, Ohio and Pennsylvania. Fiscal Year The fiscal year of the Company is the 52-53 week period ending on the Saturday closest to February 28 (29). The quarter and fiscal year ends for 1997 and 1996 were as follows:
Fiscal year 1997 Fiscal year 1996 - ---------------------------------------------------------------- First quarter June 1, 1996 May 27, 1995 Second quarter August 31, 1996 August 26, 1995 Third quarter November 30, 1996 November 25, 1995 Year end March 1, 1997 March 2, 1996 - -----------------------------------------------------------------
Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents includes cash on hand and deposits at financial institutions with maturities of less than three months. Accounts Receivable The Company uses the allowance method of accounting for uncollectible accounts. Accounts receivable are stated net of allowances for uncollectible accounts of $1,921,000 and $924,000 as of March 1, 1997 and March 2, 1996, respectively. Inventories Inventories are stated at the lower of cost or market. Cost is determined by use of the last-in, first-out (LIFO) method. If current cost had been used, inventories would have been approximately $21,042,000 and $21,154,000 higher than reported at March 1, 1997 and March 2, 1996, respectively. Cost of sales is primarily computed on an estimated basis and adjusted based on physical inventory counts which are generally taken at all locations twice annually. Property and Equipment Property and equipment are stated at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of owned assets. Leasehold improvements are amortized over the estimated useful life of the asset or the term of the lease, whichever is shorter. Pre-Opening Expenses Expenditures related to the opening of new stores, other than expenditures for capital assets, are charged against earnings when incurred. Goodwill Goodwill is amortized over 15 years using the straight-line method. The Company amortized $548,000, $597,000 and $611,000 of goodwill during Fiscal 1997, 1996 and 1995, respectively. Accumulated amortization was $3,773,000 at March 1, 1997 and $3,225,000 at March 2, 1996. Debt Issuance Costs Debt issuance costs incurred in connection with the convertible subordinated debt are amortized using a straight-line method over the term of the debt. Amortization expense related to the issuance costs is reported as interest expense and approximated $55,000 in 1997, $57,000 in 1996, and $58,000 in 1995. The amount of accumulated amortization, at March 1, 1997 and March 2, 1996, was $409,000 and $354,000, respectively. 18 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Advertising Costs The Company expenses production costs of radio and television advertising in the year incurred. Gross advertising costs, before vendor reimbursements, as a percentage of net sales, were: 1997 - 2.1%; 1996 - 2.3%; and 1995 - 2.3%. Net Income (Loss) Per Share Net income (loss) per common share is determined by dividing the weighted average number of common shares outstanding during the year into net income (loss). Common share equivalents in the form of stock options are excluded from the calculation since they have no dilutive effect on per-share figures. The assumed conversion of subordinated convertible debt into common stock had no dilutive effect on net earnings per common share. Franchise Arrangements Arrangements with franchisees and licensees who operate throughout the United States generally provide for initial fees, new store opening fees and continuing payments to the Company based upon a percentage of sales. The fees, when earned, and related costs are recorded net and included in the Company's selling, administrative and occupancy expenses. Reclassifications Certain amounts in prior years' financial statements have been reclassified to conform with the Fiscal 1997 presentation. NOTE 2 - SPECIAL CHARGES Store Closure Expense In Fiscal 1995, the Company sold seven stores in the Washington, D.C. market and closed fourteen additional stores. The cost associated with the 21 stores resulted in a pretax charge of $11,850,000. In Fiscal 1996, an additional pretax charge of $3,000,000 was taken to cover rent and related charges at several properties which have taken longer than expected to sublease. In Fiscal 1997, the Company incurred costs associated with stores closed during Fiscal 1997 and earlier of $1,300,000, which was recorded as a part of special charges. Sales generated from these closed stores during fiscal years 1997, 1996 and 1995 were as follows: $0, $0, and $71,797,000, respectively. Impairment of Long-Lived Assets In Fiscal 1997, the Company adopted SFAS No. 121, Accounting for the Impairment of Long Lived Assets and for Long-Lived Assets to Be Disposed Of. Accordingly, the Company evaluated the ongoing value of its long-lived assets. Based on this evaluation, the Company determined that leasehold improvements and lease assets for certain stores were impaired and recorded an amortization charge of $1,500,000 to recognize the impairment. NOTE 3 - REVOLVING CREDIT LINE The Company signed a new bank agreement (the Agreement) on May 24, 1996. The Agreement increased the available borrowings to help fund store acquisitions and replaced the previous bank credit agreement. As of March 1, 1997, the Company's credit facility consisted of the term loan of $12,000,000 (see Note 4) and a revolving credit loan availability of up to $55,000,000 of which $41,600,000 was utilized. The revolver expires on May 31, 2000, while the term debt is paid in quarterly installments of $750,000. The Company's borrowing rate can fluctuate between the bank's prime rate and a LIBO-based rate, depending on the ability of the Company to meet certain financial covenants. The Agreement requires a commitment fee on the revolver of .25% on the unused available credit and has no compensating balance requirements. Borrowings made pursuant to the Agreement are secured by substantially all of the assets of the Company. The Agreement prohibits the payment of dividends, stock repurchases, and acquisition of the Company's convertible subordinated debentures. NOTE 4 - LONG-TERM DEBT
(in thousands) March 1, 1997 March 2, 1996 - ------------------------------------------------------------------ Convertible subordinated debentures $49,421 $49,421 Term debt 12,000 15,000 Other 1,860 3,472 - ------------------------------------------------------------------ 63,281 67,893 Less current maturities (3,950) (4,609) - ------------------------------------------------------------------ $59,331 $63,284 - ------------------------------------------------------------------
The Company has $49,421,000 of 7.75% convertible subordinated debentures outstanding. These debentures are unsecured obligations of the Company and may be converted into common stock of the Company at any time prior to maturity, unless previously redeemed. The conversion rate is 65.1466 shares per $1,000 principal amount of debentures (or approximately $15.35 per [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 19 10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) share), subject to certain adjustments under the terms of these debentures. These debentures are redeemable at the option of the Company at 102.1% of par plus accrued interest. This redemption rate declines by .7% annually to par on October 1, 1999. The debentures are subject to a sinking fund, commencing October 1, 2000, calculated to retire at least 70% of the debentures prior to the final maturity date of October 1, 2014. The Company has reserved 3,387,624 shares of common stock for issuance upon conversion of the debentures. During Fiscal 1997, the convertible debentures traded in a range of 71.5% to 86.5% of par, with a year-end price of 83.5% of par. The term debt is part of the Agreement discussed in Note 3 and is payable in quarterly installments, with annual amounts of $3,000,000 due in Fiscal 1998, 1999, 2000 and 2001. The Company has other notes bearing interest at rates ranging from 8.18% to 9.00%. Principal amounts related to the notes due for fiscal years 1998 through 2002 are $950,000, $222,000, $234,000, $254,000 and $200,000, respectively. NOTE 5 - OPERATING LEASES The Company leases retail stores and certain equipment under non-cancelable operating leases which expire at various dates. Certain of the store leases require contingent rentals based upon sales in excess of specified amounts and generally require the Company to pay utilities, insurance and taxes, and certain leases are renewable with escalation clauses. Rent expense (excluding rent expense for closed stores from the date closed) was $32,854,000, $28,354,000 and $27,704,000 during Fiscal 1997, 1996 and 1995, respectively. At March 1, 1997, future minimum operating lease payments during the next five years and thereafter are: 1998 - $29,468,000; 1999 - $28,213,000; 2000 - $24,395,000; 2001 - $20,752,000; 2002 - $16,262,000 and $48,360,000 thereafter. At March 1, 1997, the future minimum lease payments for closed stores total approximately $11,337,000 for which the Company estimates it will receive approximately $9,928,000 of sublease income (for which there are subleases in force aggregating $4,994,000 at March 1, 1997). This estimate is contingent on the ability of the Company to sublease remaining closed-store leases within approximately one year. NOTE 6 - PROPERTY AND EQUIPMENT Property and equipment is summarized as follows:
- ------------------------------------------------------------------- (in thousands) March 1, 1997 March 2, 1996 - ------------------------------------------------------------------- Land and building $ 3,475 $ 3,475 - ------------------------------------------------------------------- Furniture and fixtures 38,941 34,544 - ------------------------------------------------------------------- Acquired leases and leasehold improvements 26,502 23,371 - ------------------------------------------------------------------- 68,918 61,390 - ------------------------------------------------------------------- Less allowances for depreciation and amortization (38,506) (32,597) - ------------------------------------------------------------------- $ 30,412 $ 28,793 ===================================================================
NOTE 7 - INCOME TAXES Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax amounts recorded in the consolidated balance sheets consisted of the following:
- ----------------------------------------------------------------- TAX AFFECTED AMOUNTS - ----------------------------------------------------------------- (in thousands) March 1, 1997 March 2, 1996 - ----------------------------------------------------------------- DEFERRED TAX ASSETS (LIABILITIES): Loss and AMT credit carryforwards $ 3,500 $ 4,000 - ----------------------------------------------------------------- Store closing reserve 1,000 2,000 - ----------------------------------------------------------------- Inventory valuation (3,000) (2,000) - ----------------------------------------------------------------- Other, net (500) (2,000) - ----------------------------------------------------------------- 1,000 2,000 - ----------------------------------------------------------------- Current tax balance 2,000 1,000 - ----------------------------------------------------------------- $ 3,000 $ 3,000 =================================================================
There were no significant deferred tax valuation allowances as of March 1, 1997 and March 2, 1996. Significant components of the provision (benefit) for income taxes are as follows:
- ----------------------------------------------------------------- (in thousands) 1997 1996 1995 - ----------------------------------------------------------------- CURRENT: Federal $ 339 $ 298 $ (2,060) - ----------------------------------------------------------------- State and local 242 264 263 - ----------------------------------------------------------------- Total current 581 562 (1,797) - ----------------------------------------------------------------- Deferred 500 1,000 (1,000) - ----------------------------------------------------------------- $ 1,081 $ 1,562 $ (2,797) - -----------------------------------------------------------------
20 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The reconciliation of income tax computed at the U.S. federal statutory tax rates to income tax expense (benefit) is:
- ----------------------------------------------------------------- (in thousands) 1997 1996 1995 - ----------------------------------------------------------------- Tax at statutory rate $ 759 $1,327 $(2,784) - ----------------------------------------------------------------- State income tax, net 160 174 174 - ----------------------------------------------------------------- Goodwill 186 203 208 - ----------------------------------------------------------------- Other, net (24) (142) (395) - ----------------------------------------------------------------- $1,081 $1,562 $(2,797) - -----------------------------------------------------------------
The Company received refunds, net of income taxes paid, of $1,889,000 and $49,000 during Fiscal 1996 and Fiscal 1995, respectively, and made income tax payments of $1,050,000 in Fiscal 1997. At March 1, 1997, the Company has net operating loss carryforwards of $3,138,000 for income tax purposes that expire in years 2009 and 2010 and $2,400,000 of alternative minimum tax credit carryforward which has no expiration date. NOTE 8 - SHAREHOLDERS' EQUITY The Company has authorized 2,000,000 shares of $1.00 par value preferred stock. The terms of the preferred stock are subject to determination by the Company's Board of Directors. The Company has a shareholder rights plan which provides for the distribution of a right to purchase one-hundredth of a share of preferred stock to each holder of common stock. The rights become exercisable upon the occurrence of certain triggering events, as defined in the plan. The Company has reserved 33,900 shares of Series A Preferred Stock in connection with the rights to be distributed under the plan with respect to the reserved shares of common stock. NOTE 9 - STOCK OPTION PLANS The Company has adopted stock option plans for key employees. Under such plans, the Board of Directors may grant options for shares of common stock at a price not less than 100% of the fair market value of the shares on the date of grant. If an employee owns stock possessing more than 10% of the total combined voting power of the Company, the option price must be 110% of the fair market value on the date of grant. The options vest based on the term of the optionee's continuous employment at 10% to 30% per year. Service prior to date of grant is considered under certain plans. In Fiscal 1997, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." In accordance with the provisions of SFAS No. 123, the Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for its employee stock options and, accordingly does not recognize compensation costs when the exercise price of its employee stock options is equal to or greater than the fair market value of the stock at the grant date. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by SFAS No. 123, net income and earnings per share would not have materially changed from what has been reported in Fiscal 1997 and 1996. The financial effects of applying SFAS No. 123 for providing proforma disclosures are not likely to be representative of the effects on reported net income and earnings per share for future years. The estimated fair value of the options is amortized into expense over the options' vesting periods. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1997 and 1996: Risk-free interest rate of 6.5%; no dividend yield; volatility factor of the expected market price of the Company's common stock of 0.46; and a weighted-average expected life of each option of five years. A summary of the Company's stock option activity during 1997, 1996 and 1995 and related information follows:
- ----------------------------------------------------------------------------- SHARES UNDER OPTION - ----------------------------------------------------------------------------- (in thousands, except per share amounts) 1997 1996 1995 - ----------------------------------------------------------------------------- Outstanding, beginning of year 881 931 664 - ----------------------------------------------------------------------------- Granted (at $4.16 to $4.97 per share) 118 5 323 - ----------------------------------------------------------------------------- Cancelled (83) (42) (39) - ----------------------------------------------------------------------------- Exercised (at $3.33 to $4.00 per share) -- (13) (17) - ----------------------------------------------------------------------------- Outstanding, end of year (at prices ranging from $4.13 to $8.81 per share) 916 881 931 - ----------------------------------------------------------------------------- Exercisable, end of year (at prices ranging from $4.57 to $8.81 per share) 761 302 283 =============================================================================
The weighted average per share price for options outstanding at the end of Fiscal 1997 was $4.98. At the end of fiscal years 1997, 1996 and 1995, there were 149,000, 217,000 and 221,000 shares, respectively, reserved for future grants. 22 DRUG EMPORIUM, INC AND SUBSIDIARIES [LOGO] 12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 10 - ACQUISITIONS On May 29, 1996, the Company completed a purchase of certain assets of six stores in the Philadelphia market at a total purchase price of $10.1 million. The acquisition was accounted for as a purchase. The consolidated statements of operations reflect the results of operations of the stores since the date acquired. The acquired stores contributed approximately $38,150,000 in sales during Fiscal 1997. During Fiscal 1996, the Company acquired 32 stores in five separate transactions for a total purchase price of $42 million. These acquisitions were accounted for as purchases. The consolidated statements of operations reflect the results of operations of the acquired enterprises since the dates acquired. The acquired stores contributed approximately $80 million in sales during Fiscal 1996. NOTE 11 - DEFINED CONTRIBUTION PLAN The Company provides a defined contribution 401(k) plan to substantially all employees. Participants may make voluntary contributions to the plan up to 15% of their compensation. Approximately $65,000, $50,000 and $50,000 was charged to expense for this plan in fiscal years 1997, 1996 and 1995, respectively. NOTE 12 - CONTINGENCY The Company is a defendant in a suit filed by one of the current franchisees of the Company alleging failure to perform as required by the franchise agreements and violation of state and federal antitrust laws. The plaintiff claims a loss of investment capital, out-of-pocket expenses, lost profits and goodwill, fraud, interference with contracts and deceptive trade practices and seeks damages. The Company intends to vigorously defend this suit and believes the ultimate outcome will not materially affect the financial position or results of operations of the Company. NOTE 13 - QUARTERLY FINANCIAL DATA (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------------- (in thousands, except per share amounts) - ----------------------------------------------------------------------------------------------------------------------------------- Net Gross Net Net Income Stock Prices Dividends Paid Sales Profit Income Per Common Share High Low Per Common Share - ----------------------------------------------------------------------------------------------------------------------------------- 1997: First quarter $206,743 $ 43,528 $ 501 $ .04 $4.31 $3.25 -- - ----------------------------------------------------------------------------------------------------------------------------------- Second quarter 212,573 45,922 250 .02 4.56 3.69 -- - ----------------------------------------------------------------------------------------------------------------------------------- Third quarter 206,219 45,187 271 .02 4.63 3.88 -- - ----------------------------------------------------------------------------------------------------------------------------------- Fourth quarter 229,481 50,838 130 .01 5.75 4.13 -- - ------------------------------------------------------------------------------------------------------------------------------------ $855,016 $185,475 $ 1,152 $ .09 -- =================================================================================================================================== 1996: First quarter $165,091 $ 35,057 $ 489 $ .04 $4.75 $4.00 -- - ----------------------------------------------------------------------------------------------------------------------------------- Second quarter 167,794 36,269 466 .03 5.06 4.00 -- - ----------------------------------------------------------------------------------------------------------------------------------- Third quarter 170,954 36,895 347 .03 5.06 3.88 -- - ----------------------------------------------------------------------------------------------------------------------------------- Fourth quarter 234,933 51,925 1,040 .08 4.25 3.25 -- - ----------------------------------------------------------------------------------------------------------------------------------- $738,772 $160,146 $ 2,342 $ .18 -- ===================================================================================================================================
22 DRUG EMPORIUM INC. AND SUBSIDIARIES [LOGO] 13 REPORT OF INDEPENDENT AUDITORS BOARD OF DIRECTORS DRUG EMPORIUM, INC. We have audited the accompanying consolidated balance sheets of Drug Emporium, Inc. and subsidiaries as of March 1, 1997 and March 2, 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended March 1, 1997. 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 in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Drug Emporium, Inc. and subsidiaries at March 1, 1997 and March 2, 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 1, 1997, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Columbus, Ohio April 4, 1997 -----END PRIVACY-ENHANCED MESSAGE-----