-----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, GAy9eSaftVpC/+gewRatK8Qkz7yzKgprqMfsCksG3AS+4Bs7BNgU0K/pixihfY4I Q0F01nyuLQU0XrKZv/BjRA== 0000950152-99-004734.txt : 19990520 0000950152-99-004734.hdr.sgml : 19990520 ACCESSION NUMBER: 0000950152-99-004734 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19990227 FILED AS OF DATE: 19990519 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-K405 SEC ACT: SEC FILE NUMBER: 000-16998 FILM NUMBER: 99630620 BUSINESS ADDRESS: STREET 1: 155 HIDDEN RAVINES DR CITY: POWELL STATE: OH ZIP: 43065 BUSINESS PHONE: 7405487080 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-K405 1 DRUG EMPORIUM, INC. FORM 10-K405 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (MARK ONE) [ x ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended February 27, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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. [X] At May 17, 1999 there were 13,191,285 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 17, 1999 was approximately $114,605,884 based on a closing price of $8.688 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 February 27, 1999. Part III, Items 10., 11., 12., and 13. incorporate by reference portions of the Drug Emporium, Inc. Proxy Statement for the 1999 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 February 27, 1999 is not deemed filed as part of this report. 1 2 ITEM 1. BUSINESS INTRODUCTION In 1977, the first Drug Emporium store was opened in Columbus, Ohio. As of February 27, 1999, the Company operates 141 company-owned stores, known as Drug Emporium, F&M Super Drug Stores and Vix Drug Stores. In addition to the Company-owned stores, as of February 27, 1999, there are 52 franchise stores. The accompanying financial statements include only amounts related to company-owned stores. The stores specialize in discount-priced merchandise, including health and beauty aids, vitamins, cosmetics, greeting cards and pharmacy. Drug Emporium also operates DrugEmporium.com, an online drug store selling competitively priced health and beauty aids, cosmetics, vitamins and prescription drugs. DrugEmporium.com is an independent division of the Company that operates with key organizational and customer links to Drug Emporium, Inc. The Company's common stock trades on the Nasdaq National Market under the symbol DEMP. As of February 27, 1999, there were 13,185,785 shares outstanding. Drug Emporium's 7-3/4% convertible subordinated debentures, due October 1, 2014, are traded on the Nasdaq National Market under the symbol DEMPG. STORE OPERATIONS Company stores range in size from 18,000 to 49,000 square feet, with a typical store having approximately 27,000 square feet, including retail selling space and storage space in the rear of each store. Retail selling space on average accounts for 80% of each store's total square footage. Each store has a manager, one or two assistant managers, a head pharmacist, and approximately 8 to 12 additional full-time employees and approximately 24 part-time employees. The stores are grouped into six operational regions, each overseen by a regional director or regional vice president. The regional director or vice president's responsibilities include visiting stores and assuring that Company standards for buying, merchandising, customer service, store appearance and store procedures are maintained. The Company's stores are located primarily in shopping centers on major commercial thoroughfares. The capital expenditure required to fixture and equip a new store averages $350,000. Pre-opening expenses, including salaries and promotional expenses, average $75,000 per store, and each store requires approximately $1,200,000 in initial inventory. The typical trade area for a Drug Emporium store exceeds 200,000 people within a defined area, usually five miles. The customer profile is 80 percent middle-to-upper income women between the ages of 21 and 65 who shop on a two-and-a-half week cycle. Drug Emporium stores accommodate an average of 6,000 shoppers per week and provide an environment for shoppers seeking a pleasant and social shopping experience. Drug Emporium fills a unique tenant category in a shopping center's merchandising mix and Drug Emporium stores are well received by both hard and soft goods national retailers. Most stores are open seven days a week for a total of 84 hours per week. In addition, the Company operates a total of twenty-six 24-hour stores. Each store has a similar layout, generally with the pharmacy located in the rear of the store. Company stores accept payment in cash, check or credit card and from third-party providers. The table set forth below lists the 193 Company-owned and franchise Drug Emporium stores by market as of February 27, 1999:
COMPANY-OWNED: -------------- Philadelphia, PA . . . . . . . . . . . . . . . . . . 28 Columbus, Cincinnati and Dayton, OH . . . . . . . . 21 Los Angeles, San Francisco and San Diego CA . . . . 21 Atlanta and Augusta, GA . . . . . . . . . . . . . . 17
2 3 Detroit, MI . . . . . . . . . . . . . . . . . . . . 15 Buffalo and Rochester, NY . . . . . . . . . . . . . 12 Baltimore, MD and Washington, DC . . . . . . . . . . 8 Milwaukee, WI . . . . . . . . . . . . . . . . . . . 6 Louisville, KY . . . . . . . . . . . . . . . . . . . 4 Minneapolis, MN . . . . . . . . . . . . . . . . . . 4 St. Louis, MO . . . . . . . . . . . . . . . . . . . 4 Oklahoma City, OK . . . . . . . . . . . . . . . . . 1 --- 141 INDEPENDENT FRANCHISES: ----------------------- Dallas, Ft. Worth, TX . . . . . . . . . . . . . . . 15 Lafayette, Shreveport, LA, and Amarillo, Abilene, Denton, Longview, Lubbock, Tyler and Waco, TX, Little Rock, AR, and Wichita, KS . . . . . . . . . 11 San Antonio, Austin, TX . . . . . . . . . . . . . . 5 Charlotte, Raleigh, Durham, Concord, NC . . . . . . 6 Barboursville, Charleston, WV . . . . . . . . . . . 4 Independence and Kansas City, MO and Overland Park, KS . . . . . . . . . . . . . . . . 3 Virginia Beach, VA . . . . . . . . . . . . . . . . . 2 Greensboro, Winston-Salem, NC . . . . . . . . . . . 2 Victoria, Brownsville, TX . . . . . . . . . . . . . 2 Morris Plains, NJ . . . . . . . . . . . . . . . . . 1 Union City, NJ . . . . . . . . . . . . . . . . . . 1 -- 52
When selecting store location, the Company considers various geographic and demographic factors, including population around the site, income level within that area, proximity to major shopping centers, traffic count, accessibility of site, proximity of competitors and available parking spaces. Market research may be utilized through an outside market research firm which identifies, among other things, trade area, trade area potential, demographic factors, competitors and competitors' sales/strengths/weaknesses, and projects three-year anticipated sales volumes. Company and, to a limited extent, franchisee pharmacy matters are supervised by the Director of Pharmacy who directs compliance with state and federal pharmacy regulations and training. FRANCHISE OPERATIONS Drug Emporium's franchise-store network consists of 52 stores. Drug Emporium maintains a Franchise Advisory Board designed to provide a forum to evaluate and discuss issues and concerns of the Company and its franchisees. Under its franchise system, the Company permits franchisees to operate Drug Emporium stores in a specific geographic area based on ADIs (areas of dominant influence of television signals). Prospective franchisees generally must make a minimum equity investment of $1,000,000 per store and establish an acceptable line of credit in the amount of $500,000 per store. The Company advises franchisees in site selection, store layout, and establishing purchasing and advertising policies. The Company selects its franchisees carefully and works closely with them to increase the likelihood of success for each franchisee. Prospective franchisees sign confidentiality agreements in addition to a non-compete clause contained within the executed franchise agreement. Upon execution of a franchise agreement, the franchisee must pay a nonrefundable $25,000 fee for the first store and a $10,000 commitment fee for each additional store designated for that market. The balance of the $25,000 store fee ($15,000) is payable upon the opening of each subsequent designated store in the market. The current franchise agreement provides for franchise royalties at a minimum rate of $6,000 per store for the second year and $25,000 per year per store for stores open three years or more against the following percentage royalties: 1% on gross sales from $3.5 million to $6 million, 2% from $6 million to $8 million, 3% from $8 million to $10 million, and 1.25% on gross sales over $10 million. In addition, each franchisee must also spend at least 1% of gross sales for advertising. The current franchise agreement permits the Company to require that .6% of the 1% advertising expenditure be contributed to a national advertising program if such program is established by the Company. 3 4 The Company may either open its own stores or allow other franchisees to open stores in a franchisee's territory outside a defined area for each existing store if the franchisee fails to comply with the development schedule agreed upon by the Company and the franchisee. Thirty-two franchise stores were sold or closed during Fiscal 1999. ACQUISITION OF FRANCHISEES The Company, from time to time, has acquired or sought to acquire certain of its franchise operations. The Company's decision to pursue the acquisition of a franchisee is based on the Company's evaluation of the growth opportunities in a particular market, the impact the acquisition would have on earnings per share and the quality of the franchisee's existing management. Since 1983, the Company has acquired franchisees located in Los Angeles, Washington, D.C., Atlanta, Cincinnati, Milwaukee, Minneapolis, St. Louis, Charleston, S.C., Indianapolis, Orlando, Louisville, Oklahoma City, San Diego and Baton Rouge. The Company plans to evaluate future opportunities to acquire appropriate franchisees from time to time and may use cash or securities to pay for such acquisitions. MERCHANDISING AND MARKETING The Company's merchandising goal is to provide customers with the widest available selection of health and beauty aids, cosmetics, prescription drugs and general merchandise at everyday low prices. The Company estimates that approximately 62% of a typical store's sales mix is health and beauty aids and general merchandise, 31% pharmacy items and 7% cosmetics. The Company is continuing to aggressively oversee strategies designed to lower the total cost of acquiring merchandise in order to continue to be competitive with other national and regional chain discounters. The Company is continuing to invest in and upgrade its electronic in-store scanning and backdoor receiving systems. During Fiscal 1999, the Company's primary pharmacy supplier and general merchandise distributor, McKesson Drug, accounted for over 35% of the Company's purchases. No other single vendor accounted for more than 10% of the Company's purchases. While the Company purchases from over 7,000 vendors, a majority of its business is conducted with approximately 500 vendors. The Company believes it is a significant customer for most of these 500 vendors. The Company advertises through the use of television, radio, newspaper and direct mail. Most advertising in Fiscal 1999 was print-based, utilizing newspaper tabloids running approximately twice per month. Point of sale advertising is also used. The Company's strategy of clustering stores within ADI markets is an important factor in maximizing the effectiveness of its advertising expenditures. The Company works with an advertising agency that coordinates advertising for the entire chain. CUSTOMER SERVICE The Company believes that its commitment to customer service is an important ingredient of its success. The Company encourages its managers and other employees to be responsible to customers. The stores are designed to make products easily accessible. Store employees are trained to be friendly and helpful to customers. COMPETITION The sale of deep discount health and beauty aids, cosmetics, vitamins and prescription drugs is highly competitive. The Company believes that the principal bases of competition in this market are price, product variety, service, site location and customer recognition. The Company also believes that there exist only a few similar companies, most of which are regional chains. The Company's stores compete not only with those similar companies but with numerous conventional drug stores with national or regional images, and also with supermarkets, mass merchants and category-specific discount stores. Many of the Company's supermarket, mass merchant and conventional drug store competitors have more outlets and substantially greater financial resources than the Company or have more convenient locations than Company stores. The Company believes that its prices are 4 5 competitive and that it offers greater product variety and better service than its competitors. The Company also believes that the smaller size of its stores compared to the major discount competitors provides a better shopping experience and allows a better selection of sites in tight real estate markets that exist in some major cities. The Company's ability to expand successfully into new markets is especially sensitive to the competitive factors in those markets. DrugEmporium.Com In March 1997, the Company established an electronic commerce site on the internet with the URL DrugEmporium.com. This experimental site served as the foundation for the Company's current efforts to develop a superior online drug store, which will also be known as DrugEmporium.com. The new site, which is in development, will emphasize customer service, selection, price and convenience, and is expected to be fully operational during Fiscal 2000. The Company has established a separate subsidiary for its e-commerce drug store. In addition, the Company is in the process of establishing a separate capital structure for this online subsidiary in order to meet the significant capital requirements necessary to effectively compete in the online market. The Company has invested substantial resources to revamp the business processes around the site and those efforts are ongoing in nature. In addition, the Company has made material financial commitments related to its online drug store which will begin to take effect during the Company's second fiscal quarter. Although the Company expects to be able to fund the added costs through third party equity investments in its on-line subsidiary, there is no guarantee that this financing will be available. In the event financing is not available, the Company will be required to fund its e-commerce sight development and other related costs from its existing business. These start-up costs may negatively impact the overall operating results of the Company over at least the next several quarters. 5 6 EMPLOYEES AND TRAINING At February 27, 1999, the Company had a total of approximately 5,820 employees, both full-time and part-time, of which 164 were corporate staff personnel. None of the employees are covered by a collective bargaining agreement. The Company considers its relations with its employees to be good. Drug Emporium believes that the training of store employees is one of the most important elements of its business. The Company conducts training classes at its headquarters, and senior management works closely with regional and district managers in this regard. REGULATION The Company is also subject to the Fair Labor Standards Act, which governs such matters as minimum wages, overtime and other working conditions. A portion of the Company's personnel are paid at rates related to the federal minimum wage, and accordingly, further increases in the minimum wage increase the Company's labor costs. The prescription drug business is subject to the federal Food, Drug and Cosmetic Act, Drug Abuse Prevention and Control Act and Fair Packaging and Labeling Act relating to the content and labeling of drug products, comparable state statutes and state regulation regarding record keeping and licensing matters. These regulatory functions contain civil and criminal penalties for violations. The sale of franchises by the Company is subject to regulation by the Federal Trade Commission and various states in which it currently does business or in which the Company may do business in the future. Such regulations generally require the prior registration or an exemption from registration for the sale of franchises and delivery to prospective franchisees of a franchise disclosure document. No assurances can be given that any future changes in the existing laws or the promulgation of new laws will not adversely affect the Company. SERVICE MARKS The Company has obtained federal registrations for the service marks DRUG EMPORIUM, DRUG EMPORIUM and design, the Drug Emporium logo and DRUG EMPORIUM, INC. The marks DRUG EMPORIUM EXPRESS, SAVINGS SO BIG YOU NEED A SHOPPING CART (re-filed), EMPORIUM GOLD, DRUG EMPORIUM CONSUMER DIRECT, DE DIRECT (the words), DE DIRECT (STYLIZED) AND DE DIRECT (the design) are pending marks. The mark DRUG EMPORIUM and design has been registered in Arkansas, Minnesota, Nebraska, Wisconsin, Texas, West Virginia, New York, Nevada, Missouri, Kentucky, Indiana, California, Alabama, Kansas, New Jersey, South Carolina and North Carolina. DRUG EMPORIUM has been registered in Ohio, Florida, Wisconsin, Tennessee, New York and Maryland. The mark DRUG EMPORIUM and design has been registered in Mexico, Japan, France, Canada, Australia and the United Kingdom. SAVINGS SO BIG YOU NEED A SHOPPING CART is registered in Canada and Mexico and the Drug Emporium Logo is registered in Canada. Federal registration of a mark does not create new substantive rights to use the mark or to assert rights based on ownership, but it does provide additional remedies for the protection of the mark. EXECUTIVE OFFICERS OF THE COMPANY
Served as Name: Age: Position: Officer Since: - ----- ---- --------- -------------- David L. Kriegel 53 Chairman of the Board, Chief Executive 1992 Officer, President and Director A. Joel Arnold 63 Senior Vice President 1995 Thomas H. Ziemke 56 Senior Vice President 1998 Jane H. Lagusch 53 Vice President, Secretary 1990 Michael P. Leach 29 Chief Financial Officer, Treasurer 1998
6 7 (1) Officers serve until their successors are chosen and are qualified subject to earlier removal by the board of directors, and subject to rights, if any, under employment contracts. DAVID L. KRIEGEL - ---------------- Since December 1992, Mr. Kriegel has been the Chairman and Chief Executive Officer of the Company and since June of 1994 has been Chairman, Chief Executive Officer and President of the Company. Mr. Kriegel is Chairman and Chief Executive Officer of Kriegel Holding Company, Inc., a privately-owned corporation dealing with real estate and distribution. Prior to January 1993, Mr. Kriegel was Vice President of Cardinal Health, a division of Cardinal Distribution, Inc., a publicly-owned company. Mr. Kriegel is a Director of Tele Spectrum Worldwide, Inc., a publicly held company; an Advisory Board Member of Bank One, Ohio and a Trustee of Ohio Northern University. A. JOEL ARNOLD - -------------- Mr. Arnold was appointed to the office of Senior Vice President 1995. He is responsible for store operations, merchandising, pharmacy and loss control. He formerly held the position of Director of Merchandising and Operations in which he served for two years. A registered pharmacist, Mr. Arnold has 40 years' experience in the retail drug industry. THOMAS H. ZIEMKE - ---------------- In March of 1998, Mr. Ziemke was appointed to the office of Senior Vice President with responsibility for marketing and purchasing. Mr. Ziemke has been associated with Drug Emporium since 1984 when he became the operator of the Los Angeles based Drug Emporium franchise. He became Vice President of Western Operations when the Company purchased the franchise in 1987 and served in that capacity until his promotion to Senior Vice President. JANE H. LAGUSCH - --------------- Mrs. Lagusch has been associated with the Company in various capacities since 1980 and has been an officer of the Company since 1986. She was appointed to her current position, Vice President and Secretary of the Company, in 1993. Mrs. Lagusch has responsibility for corporate administrative functions. MICHAEL P. LEACH - ---------------- Since March 1998, Mr. Leach has served as Chief Financial Officer. Mr. Leach was previously Controller of the Company for approximately two years and is a Certified Public Accountant. Previous to joining Drug Emporium, Mr. Leach was employed by Ernst & Young LLP, the external auditors of the Company. ITEM 2. PROPERTIES - ------- ---------- Most of the Company's stores are occupied pursuant to long-term leases that vary as to rental provisions, expiration dates, renewal options, rental amounts and payment provisions. The Company does not deem any individual store's lease to be significant in relation to its overall operations. For information as to the amount of the Company's rental obligations for retail store leases, see Note 4 of Notes to Consolidated Financial Statements. The Company owns a 33,000 square foot executive office building and the surrounding land for use as its principal office in Powell, Ohio. The Company also owns a portion of the building and land at one of its Detroit area store locations. ITEM 3. LEGAL PROCEEDINGS - ------- ----------------- Nortex Drug Distributors, Inc. v. Drug Emporium, Inc., Case No. C2-93-767, filed August 6, 1993 in the United States District Court, Southern District of Ohio, Eastern Division, was dismissed during Fiscal 1999, as a result of the parties reaching a confidential settlement agreement. 7 8 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- --------------------------------------------------- Not applicable. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ------- --------------------------------------------------------------------- The Company's common stock is traded on the Nasdaq National Market under the symbol DEMP. The following table sets forth, for the quarterly periods shown, the high and low sale price per share as reported on the Nasdaq National Market:
Fiscal Quarter Ended High Low - -------------------------------------------------------------------------------- May 31, 1997 $5.500 $4.125 August 30, 1997 $5.313 $4.000 November 29, 1997 $4.750 $3.750 February 28, 1998 $5.375 $3.875 May 30, 1998 $4.563 $3.813 August 29, 1998 $4.813 $3.750 November 28, 1998 $4.688 $3.188 February 27, 1999 $8.688 $4.125
The Company paid no dividends in Fiscal 1999 or 1998. At April 26, 1999 the Company had approximately 4,200 beneficial owners of its common stock. ITEM 6. SELECTED FINANCIAL DATA - ------- ----------------------- The information required by this Item 6 is incorporated by reference from page 6 of the Drug Emporium, Inc. Annual Report to Stockholders for the year ended February 27, 1999. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - ------- ----------------------------------------------------------------------- OF OPERATIONS ------------- The information required by this Item 7 is incorporated by reference from pages 7 through 10 of the Drug Emporium, Inc. Annual Report to Stockholders for the year ended February 27, 1999. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- ------------------------------------------- The information required by this Item 8 is incorporated by reference from pages 11 through 18 of the Drug Emporium, Inc. Annual Report to Stockholders for the year ended February 27, 1999. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------- --------------------------------------------------------------- FINANCIAL DISCLOSURE -------------------- None. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------- -------------------------------------------------- Certain of the information required by this Item 10 is set forth under Item 1. "Executive Officers of the Company." * 8 9 ITEM 11. EXECUTIVE COMPENSATION - -------- ---------------------- * ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- -------------------------------------------------------------- * ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ---------------------------------------------- * * Reference is made to information under the captions "Election of Directors," "Executive Compensation," "Security Ownership of Certain Beneficial Owners and Management," and "Compensation Committee Interlocks and Insider Participation," in the Company's Proxy Statement for the Annual Meeting of Stockholders to be held June 23, 1999. The Company will mail its definitive proxy statement to stockholders on or about May 21, 1999. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - -------- --------------------------------------------------------------- (a)(1) Financial Statements -------------------- The following Consolidated Financial Statements of Drug Emporium, Inc. are incorporated by reference in Item 8 from the pages set forth below of the Drug Emporium, Inc. Annual Report to Stockholders for the year ended February 27, 1999.
Page Nos. of Annual Report ------------- Consolidated Balance Sheets as of February 27, 1999 and February 28, 1998 11 Consolidated Statements of Operations for each of the Three Fiscal Years in the Period Ended February 27, 1999 12 Consolidated Statements of Shareholders' Equity for each of the Three Fiscal Years in the Period Ended February 27, 1999 12 Consolidated Statements of Cash Flows for each of the Three Fiscal Years in the Period Ended February 27, 1999 13 Notes to Consolidated Financial Statements 14-18 Report of Independent Auditors 19
(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 Notes 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) 9 10 (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. 1987 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 Loan and Security Agreement dated as of October 28, 1998, between Drug Emporium, Inc. and BankBoston Retail Finance, (incorporated by reference to Exhibit 10.1 of the Company's Form 10-Q for the period ended November 28, 1998) 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) ** 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) ** 10.15 Amendment dated December 2, 1997 to Employment Agreement made March 11, 1993, by and between Drug Emporium, Inc. and David L. Kriegel (incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the fiscal year ended February 28, 1998) ** 10.16 Form of Employment Security Agreements between Drug Emporium, Inc. and each of A. Joel Arnold, Jane H. Lagusch and Timothy S. McCord, dated December 2, 1997 (incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the fiscal year ended February 28, 1998) ** 10.17 Form of Severance Compensation Agreement between Drug Emporium, Inc. and each of Michael P. Leach and Lee Pfrogner, dated November 17, 1997 (incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the fiscal year ended February 28, 1998) ** 10 11 10.18 Consulting Agreement dated December 2, 1997, between David L. Kriegel and Drug Emporium, Inc. (incorporated by reference to Exhibit 10.18 to the Company's Annual Report on Form 10-K for the fiscal year ended February 28, 1998) ** (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 February 27, 1999 (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 Express, Inc. Delaware D.E. Michigan Management Co. Delaware Drug Emporium of Michigan, Inc. Delaware Drug Emporium of Maryland, Inc. Delaware Emporium Venture, Inc. Ohio Houston Venture, Inc. Ohio RJR Drug Distributors Inc. Delaware DrugEmporium.com, Inc. Delaware
*(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 8-10 -------------------- None. 11 12 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: May 19, 1999 By: /s/ David L. Kriegel - ------------------- --------------------- David L. Kriegel President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: Date: May 19, 1999 - ------------------- /s/ Michael P. Leach /s/ David L. Kriegel - ------------------------------------ ------------------------------------ Michael P. Leach David L. Kriegel Chief Financial Officer Chief Executive Officer and Director /s/ Walter E. Sinterman ------------------------------------ Walter E. Sinterman Director /s/ William Sweet, Jr. ------------------------------------ William Sweet, Jr. Director /s/ Wesley Wright ------------------------------------ Wesley Wright Director 12 EX-13 2 EXHIBIT 13 1 [PHOTOGRAPH] CONNECTING WITH OUR CUSTOMERS THE 1999 DRUG EMPORIUM ANNUAL REPORT 2 ABOUT THE COMPANY Drug Emporium is a national chain of 141 Company-owned drug stores operating as Drug Emporium, F&M Super Drug Stores and Vix Drug Stores. In addition to the Company-owned stores, there are 52 franchised Drug Emporium store locations. The combined revenues of the Company-owned and franchised stores is approximately $1.2 billion. Net sales in the Company's financial statements reflect only revenues from the Company-owned stores. All stores operate full-service pharmacies and specialize in discount-priced merchandise, including health and beauty aids, vitamins, cosmetics and greeting cards. The typical store location is a large, 26,000 square foot site, offering a wide selection of brand name and quality private label products. Drug Emporium also operates DrugEmporium.com, an online drug store selling competitively priced health and beauty aids, cosmetics, vitamins and prescription drugs. DrugEmporium.com is an independent division of the Company that operates with key organizational and customer links to Drug Emporium, Inc. The Company was founded in 1977 and its stock was first publicly traded in 1988. As of February 27, 1999, there were 13,185,785 shares of Common Stock outstanding, which are traded on the Nasdaq National Market under the symbol DEMP. The Company's 7-3/4 percent Convertible Subordinated Debentures due October 1, 2014 are traded on Nasdaq under the symbol DEMPG.
FINANCIAL HIGHLIGHTS FEBRUARY 27, 1999 FEBRUARY 28, 1998 (Dollars in thousands, except per share data) (52 weeks) (52 weeks) ================================================================================================ FOR THE YEAR ENDED: Net sales $ 839,443 $ 836,405 - ----------------------------------------------------------------------------------------------- Operating income before special charges* $ 5,285 $ 8,705 - ----------------------------------------------------------------------------------------------- Net income $ 3,799 $ 1,691 - ----------------------------------------------------------------------------------------------- Average sales per store (52-week weighted average) $ 6,312 $ 6,105 - ----------------------------------------------------------------------------------------------- AT YEAR END: Inventories at current cost $ 187,575 $ 189,043 - ----------------------------------------------------------------------------------------------- LIFO reserve (22,786) (21,751) - ----------------------------------------------------------------------------------------------- Inventories $ 164,789 $ 167,292 - ----------------------------------------------------------------------------------------------- Working capital $ 64,632 $ 79,113 - ----------------------------------------------------------------------------------------------- Shareholders' equity $ 55,222 $ 51,390 - ----------------------------------------------------------------------------------------------- Current ratio 1.53 1.73 - ----------------------------------------------------------------------------------------------- Long-term debt to equity .90 1.09 - ----------------------------------------------------------------------------------------------- Shares outstanding (in thousands) 13,186 13,180 - ----------------------------------------------------------------------------------------------- STORES OPEN: Company-owned 141 135 - ----------------------------------------------------------------------------------------------- Franchised and licensed 52 84 - ----------------------------------------------------------------------------------------------- Total 193 219 - ----------------------------------------------------------------------------------------------- PER SHARE (BASIC AND DILUTED): Earnings $ 0.29 $ 0.13 - ----------------------------------------------------------------------------------------------- Shareholders' equity $ 4.19 $ 3.90 ===============================================================================================
* Net one-time gains of $(6,760,000) and $(2,092,000) were recorded in fiscal years 1999 and 1998, respectively. 3 WE DELIVER VALUE TO OUR CUSTOMERS, BY UNDERSTANDING WHO THEY ARE, ANTICIPATING THEIR NEEDS AND RESPONDING TO THEIR CHANGING LIFESTYLES. TO OUR SHAREHOLDERS "Connecting With Our Customers" is not only the theme of our annual report this year, but an integral part of our long-term growth strategy. In order to best serve our shareholders and grow our Company, we have committed ourselves to providing the best prices, product selection and service to our customers and strengthening and expanding our customer base in creative and long-lasting ways. Our connection with our customers takes place not only when we serve customers, but also when we order merchandise, stock our shelves, and plan store layouts. In short, connecting with our customers is a part of everything we do. Our dedication to our customers manifested itself in many ways in fiscal 1999. From remodeling older Drug Emporium sites and beginning the expansion of the "Do-It-Yourself Health" section of our stores to laying the groundwork for such in-store conveniences as paycheck cashing, ATM services and postage stamp sales, we took many steps to broaden the products and services we offer. We introduced the CyberZone in some of our stores, enabling customers to access health information from the Internet. In addition, our improved operating efficiencies have enabled our pharmacists to increase their focus on customer care. Accordingly, pharmacy sales accounted for the largest percentage of our revenue increase for fiscal 1999. The time that we have spent rebuilding the foundation of Drug Emporium and repositioning the Company to achieve and sustain a higher level of financial success has been a critical investment not only in our future, but also in our ability to build shareholder value. It is something that we never lose sight of, and we have been working diligently to realize the potential of this Company on behalf of our shareholders. In fiscal 1999, we strengthened our balance sheet, made substantial progress with our Internet initiative and expanded our regional presence with the strategic acquisition of Vix Drug Stores. We also made substantial investments in technology, with the implementation of new point-of-sale and pharmacy systems. FINANCIAL PERFORMANCE FOR FISCAL 1999 AND BEYOND We are only just beginning to realize the financial benefits of many of the improvements we have made in the last few years. For fiscal 1999, our financial results, which showed modest improvements, illustrate a company approaching the end of a successful turnaround. Net sales for fiscal 1999 were $839.4 million, compared with $836.4 million for the prior fiscal year. Vix Drug Stores, acquired during the fourth quarter of fiscal 1999, contributed $5.9 million to the Company's net sales. The increase also reflects a 1.3% rise in same store sales and the closing of 6 underperforming stores. Fiscal 1999 net income climbed 124% to $3.8 million, or $0.29 per basic and diluted share, from $1.7 million, or $0.13 per basic and diluted share, for fiscal 1998. Before a $14.4 million special credit for the sale of Western Drug Distributors, a former [PHOTOGRAPH] David L. Kriegel, Chairman, Chief Executive Officer and President [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 1 4 DELIVERING OUR CUSTOMERS A WIDE RANGE OF PRODUCTS AT A LOW PRICE [PHOTOGRAPH] CAPTION FOR PHOTOGRAPH-- (When we launched our Web site in March 1997, we were the first drug store on the Internet. As electronic commerce grows, we are positioning ourselves to be the leader in on-line drugstore sales. We are implementing the best available technology to redesign our Web site. When complete, www.DrugEmporium.com will offer cost-conscious consumers a more extensive array of products, more efficient fulfillment and greater ease of use. Today, the site still offers a number of unique advantages. DrugEmporium.com is backed by a solid brick-and-mortar operation, licensed to fill prescriptions in all 50 states.) Drug Emporium franchisee, fiscal 1999 net income was $763,000, or $0.06 per basic and diluted share. Our pharmacy, which accounted for about 31% of sales in fiscal 1999, benefited from both pricing and the continuing product mix shift towards higher cost prescriptions. As a result, we reported an increase of 8.2% in comparable pharmacy sales. Moreover, pharmacy margins, which were 21.4% for the year, seem to have stabilized following years of constant cost-containment pressures from managed care. Improved generic substitution rates should fuel further pharmacy margin improvement in fiscal 2000. The non-pharmacy segment of our business, which accounted for about 69% of sales in fiscal 1999, exhibited some softness last year and generated negative comparable sales of approximately (1%), due to market saturation in specific regions, especially Atlanta. However, our initiative to increase the front-end shelf space allocated to vitamins, nutrition and herbal remedies and the expansion of our food offerings have resulted in more significant sales contributions from those departments. We anticipate further growth for these areas in fiscal 2000, as well as higher cosmetics sales stemming from recently completed resets of the category and the introduction of new business lines by Johnson & Johnson and Procter & Gamble. In fiscal 2000, the Company will be introducing such products and services as postage stamps, money orders, utility bill paying, ATMs and paycheck cashing. By offering these conveniences at our successfully converted Vix locations and all of our Drug Emporium stores, we expect to improve customer traffic and boost front-end sales. These products and services are expected to be available in all of our markets by the end of this fiscal year. In addition to our efforts to increase front-end sales, we also have taken a number of steps to improve margins for our front-end operations. We are refining our product mix to increase the emphasis on higher-margin categories and product lines, implementing a new shrink-reduction program, and continuing to utilize our Mission Critical inventory management program. IMPROVING OUR POSITIONING FOR GROWTH In fiscal 1999, Drug Emporium took a major step toward securing its future growth by structuring a new revolving credit facility for $100 million, about $85 million of which was available at year end. This credit 2 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 5 INCREASING SHAREHOLDER VALUE FOR OUR INVESTORS [PHOTOGRAPH] CAPTION FOR PHOTOGRAPH-- (Pictured here is the Herb and Nutritional Center in one of our newly acquired Vix stores. Vitamins and herbs have become an excellent source of high-margin, front-end sales growth as the popularity of "Do-it-Yourself" healthcare has escalated. Relying heavily on the successful Vix model, we will be expanding the herb and vitamin sections in all Drug Emporium and F&M stores.) facility offers us a more favorable rate, increased flexibility and greater access to capital for both strategic acquisitions and day-to-day operations. The Company's balance sheet improved in other ways as well. We reduced our total debt by $16.5 million from year-end fiscal 1998 to the end of fiscal 1999, and, as a result, lowered our total interest expense significantly, by $2.2 million, or 28%, to $5.5 million. On the operating side, our inventory-reduction program, Mission Critical, has enabled us to improve inventory turns and cut approximately $40 million from comparable store inventory over the past two years. We expect further reductions in comparable store inventory and increases in cash flow as we continue to use this successful program to trim greater quantities of secondary product lines. Our employees were instrumental to our growth in fiscal 1999. Regardless of the size or complexity of the problems we encountered, they were always there willing to contribute both the support and hard work needed to push our Company forward. We feel that it would be mutually beneficial for them to have the opportunity to participate as owners, not only to better align their interests with those of our shareholders, but also to reward them personally for the growth of our Company. Therefore, the Board of Directors has requested shareholder approval of the 1999 Stock Option Plan. VIX DRUG STORES ACQUISITION During the first quarter of fiscal 2000, we completed the acquisition of Vix Drug Stores, a 12-store, deep- discount New York chain in Buffalo and Rochester-two new markets for Drug Emporium. This acquisition represents the continuation of our strategic plan to geographically concentrate our store base. Not only are the Vix stores extremely compatible with our existing store base, but they also incorporate some interesting ideas to drive customer count. We will be applying some of these strategies to our other stores throughout fiscal 2000, as well as adding value to the acquisition by broadening the product mix at the Vix chain. In addition, we believe we can learn from the strong store-within-a-store herbal business that Vix has developed. We expect the Vix stores to contribute about $92 million in sales for fiscal 2000. [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 3 6 DEVELOPING, CHALLENGING AND INVESTING IN OUR PEOPLE [PHOTOGRAPH] CAPTION FOR PHOTOGRAPH-- (Our employees are dedicated to providing friendly, high-quality service. They understand that the customers who rely on them to fill their prescriptions are real people with real concerns. They are committed to addressing those concerns, answering their questions and giving them the information they need to feel completely comfortable with the medications we supply.) MOVING FORWARD WITH AMERICA'S FIRST ON-LINE DRUG STORE On a cold winter day in March 1997, Millie Baker of Tequesta, FL., became the first customer of the Internet's first drug store, www.DrugEmporium.com. At that time, we were uncertain what to expect in terms of order volume and customer interest. The Internet has grown exponentially since then, more people have become comfortable making on-line purchases, and several other pharmacy sites have popped up. In response, we have been honing our strategy to maximize the success of our e-commerce initiatives. We have many advantages over our on-line competitors. We were the first drug store on the Internet, and unlike most other on-line drug stores, we are backed by a brick-and-mortar operation with long-standing supplier relationships, and licenses to fill prescriptions in all 50 states. We are committed to maintaining the integrity of our site by keeping our drug fulfillment independent of our pharmaceutical advertisers, thereby retaining the trust of our customers by protecting their utmost privacy. Both of these ethical obligations, we believe, will boost the popularity of our Web site as acceptance for this channel grows. Currently, we are preparing to introduce our next-generation Web site, www.DrugEmporium.com, which is being designed to exceed customers' expectations in terms of convenience, product selection, price and ease of use. To ensure that the site operates reliably, we have selected the best available technology. The project is running on schedule and should be completed by the end of the summer. To expand our on-line client base, we are evaluating a number of marketing options, which we will begin to implement as we move closer to completing the site improvements. CHANGES TO OUR BOARD OF DIRECTORS Our Board has undergone significant change in this past year. The accidental death of one director and retirement of two others was a sad loss for the Company. V.J. "Tom" Wiechart, Sr., R.Ph., a director since 1993, passed away in August 1998. A registered pharmacist and owner of several drug stores, Mr. Wiechart provided unique insights into dealing with managed 4 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 7 SUPPORTING OUR CUSTOMERS LIFESTYLE AND NEEDS [PHOTOGRAPH] CAPTION FOR PHOTOGRAPH-- (In line with our commitment to keep our customers informed, we have begun featuring a "CyberZone" in a number of our stores in fiscal 1999. The CyberZone provides customers with limited Internet access, directly linking them to health-related Web sites. Of course, they are also free to check out our very own www.DrugEmporium.com Web site where they can learn more about the Company and experience our on-line drug store first-hand. The information available on the sites ranges from fitness and nutritional guidelines to disease management.) care issues and valuable business advice. He also served as both a friend to and advocate of our pharmacists. His presence will be greatly missed. Macy T. Block retired from our Board at the end of January. Upon his retirement, Mr. Block commended us on turning around Drug Emporium toward profitability. We thank him for his years of service to the Company as well as his kind words. Robert S. Meeder served on our Board for 11 years. His contributions to the Company were numerous during such critical periods as our public stock offering and later, our reorganization. Mr. Meeder retired from the Board at the end of fiscal 1999 to devote more time to other business interests. We were pleased to add Donald B. Hayes, Sr., John J. Havlicek and Robert W. McCurdy, R.Ph. to our Board of Directors this year. They bring expertise in the areas of banking, franchising and pharmacy. We look forward to reporting our progress to shareholders and the financial community as we secure Drug Emporium's place in the new millennium. With solid management, dedicated employees and carefully planned strategies, we believe that our Company is well-positioned to grow stronger in fiscal 2000 and beyond. To all of our shareholders, employees and customers, thank you for making it possible for us to continue to reach higher. /s/ David L. Kriegel David L. Kriegel Chairman, Chief Executive Officer and President [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 5 8 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 - ---------------------------------------------------------------------------------------------------------------------- February 27, February 28, March 1, March 2, February 25, 1999 1998 1997 1996 1995 (in thousands, except per share data) (52 weeks) (52 weeks) (52 weeks) (53 weeks) (52 weeks) ====================================================================================================================== Net sales $ 839,443 $ 836,405 $ 855,016 $ 738,772 $ 729,503 - -------------------------------------------------------------------------------------------------------------------- Gross margin 176,729 178,289 185,475 160,146 153,696 - -------------------------------------------------------------------------------------------------------------------- Selling, administrative and occupancy expenses 171,444 169,584 172,560 146,774 143,337 - -------------------------------------------------------------------------------------------------------------------- Operating income before special charges (credits) 5,285 8,705 12,915 13,372 10,359 - -------------------------------------------------------------------------------------------------------------------- Special (credits) charges (6,760) (2,092) 2,800 3,000 11,850 - -------------------------------------------------------------------------------------------------------------------- Interest, net 5,487 7,653 7,882 6,468 6,697 - -------------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes 6,558 3,144 2,233 3,904 (8,188) - -------------------------------------------------------------------------------------------------------------------- Provision (benefit) for income taxes 2,759 1,453 1,081 1,562 (2,797) - -------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 3,799 $ 1,691 $ 1,152 $ 2,342 $ (5,391) ====================================================================================================================== PER SHARE DATA: Earnings (loss) (1) $ 0.29 $ 0.13 $ 0.09 $ 0.18 $ (0.41) - -------------------------------------------------------------------------------------------------------------------- Cash dividends -- -- -- -- -- - -------------------------------------------------------------------------------------------------------------------- Shareholders' equity $ 4.19 $ 3.90 $ 3.77 $ 3.68 $ 3.50 - -------------------------------------------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET DATA: Working capital $ 64,632 $ 79,113 $ 76,302 $ 80,195 $ 83,664 - -------------------------------------------------------------------------------------------------------------------- Total assets $ 230,689 $ 219,784 $ 243,319 $ 243,898 $ 176,444 - -------------------------------------------------------------------------------------------------------------------- Non-current liabilities $ 53,775 $ 60,330 $ 63,523 $ 67,391 $ 67,738 - -------------------------------------------------------------------------------------------------------------------- Total shareholders' equity $ 55,222 $ 51,390 $ 49,567 $ 48,545 $ 46,149 =====================================================================================================================
(1) Represents basic and diluted per share amounts as defined by Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (FAS No. 128). Earnings (loss) per share amounts prior to 1998 have been restated as required to comply with FAS No. 128. 6 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 9 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 - ----------------------------------------------------------------- February 27, February 28, March 1, 1999 1998 1997 (52 weeks) (52 weeks) (52 weeks) ================================================================== Net sales (in thousands) $839,443 $836,405 $855,016 - ----------------------------------------------------------------- Gross margin 21.0% 21.3% 21.7% - ----------------------------------------------------------------- Selling, administrative and occupancy expense 20.4% 20.3% 20.2% - ------------------------------------------------------------------ Operating income 0.6% 1.0% 1.5% ==================================================================
SALES Total sales for Fiscal 1999 increased by .4 percent over the prior year. This increase was the result of additional sales from the Vix acquisition, a comparable store sales increase of 1.3 percent, and a reduction in sales as a result of the lower average store count. Average sales per store for Fiscal 1999 based on a weighted average number of stores were up 3.4 percent over Fiscal 1998 due to the comparable store sales increase as well as the closure of six under-performing stores. Total sales for Fiscal 1998 decreased 2.2 percent from Fiscal 1997, while comparable store sales for the period decreased .6 percent. The total sales decrease was due to a lower store count in Fiscal 1998 versus Fiscal 1997, as well as the comparable store sales decrease. Average sales per store for Fiscal 1998 based on a weighted average number of stores were down .7 percent versus Fiscal 1997, primarily due to the comparable store sales decrease. Pharmacy sales as a percentage of total sales were 31 percent, 29 percent, and 27 percent of sales in Fiscal 1999, 1998, and 1997, respectively. Management expects that pharmacy sales will continue to increase as a percentage of total sales in the coming year. The following table lists stores opened or acquired and stores closed for the years indicated:
Year Ended - ----------------------------------------------------------------- February 27, February 28, March 1, 1999 1998 1997 (52 weeks) (52 weeks) (52 weeks) ================================================================= Number of stores at beginning of year 135 138 136 - ----------------------------------------------------------------- Stores opened or acquired 12 1 9 - ----------------------------------------------------------------- Stores closed (6) (4) (7) - ----------------------------------------------------------------- Total stores at end of year 141 135 138 =================================================================
GROSS MARGIN Fiscal 1999 gross margins were lower than the prior year due to lower pharmacy gross margins as well as an expected drop in vendor rebate income, partially offset by higher non-pharmacy margins that resulted from improved category management. The company does not anticipate further declines in gross margins in Fiscal 2000. In the 2nd Quarter of Fiscal 1999, the Company recorded a $1.7 million one time inventory write down due to store closure-related inventory liquidations and other inventory write-downs. The non-recurring inventory-related costs of this special charge were recorded as a component of gross margins in accordance with Emerging Issues Task Force (EITF) Issue No. 96-9. Excluding the impact of this write-down, total gross margins as a percentage of sales for Fiscal 1999 were 21.3 percent. Fiscal 1998 gross margins were lower than Fiscal 1997 due to increased inventory shrinkage and lower pharmacy margins, partially offset by the benefits of improved category management on non-pharmacy margins. SELLING, ADMINISTRATIVE AND OCCUPANCY Net advertising costs for Fiscal 1999 were slightly lower in both dollars and as a percentage of sales versus the prior year. In addition, gross advertising costs (expenditures before vendor cooperative funding) were .2 percent of sales lower than the prior year. The Company anticipates net advertising costs for the coming fiscal year to be consistent with Fiscal 1999. Payroll costs excluding taxes, benefits and other payroll related expenses for Fiscal 1999 were lower in both dollars and as a percentage of sales versus the prior year as a result of the Company's ongoing initiative to reduce administrative costs. Occupancy costs for Fiscal 1999 were lower in both dollars and as a percentage of sales versus the prior year due to fewer stores and higher per store sales. Other operating expenses were higher in Fiscal 1999 versus the prior year in both dollars and as a percentage of sales, primarily due to higher depreciation expense. In addition, franchise fees, which are netted against other operating expenses, were lower in Fiscal 1999 due to the termination of the Western Drug Distributors, Inc. franchise agreement. The Western Drug buyout lowered franchise fees for Fiscal 1999 by .2 percent of sales versus the prior year and is projected to lower franchise fees an additional .2 percent in Fiscal 2000. Franchise fees were $3,435,000, $4,794,000 and $4,840,000 in Fiscal 1999, 1998 and 1997 respectively. The reduction in franchise fees in Fiscal 1999 was the result of an agreement with Western Drug Distributors, Inc., the Drug Emporium franchise store operator in the Seattle and Portland area, to terminate Western's franchise agreement. Selling, administrative and occupancy expenses as a percentage of net sales increased in Fiscal 1998 compared to Fiscal 1997. [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 7 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The increase in Fiscal 1998 over Fiscal 1997 is a result of higher occupancy costs and other operating expenses offset by lower advertising and payroll costs. SPECIAL CHARGES (CREDITS) The impact of special charges (credits) on net income and descriptions of the components of the charges are shown below:
Year Ended - ------------------------------------------------------------------------------ February 27, February 28, March 1, 1999 1998 1997 (in thousands, except per share data) (52 weeks) (52 weeks) ( 52 weeks) ============================================================================== RECONCILIATION OF NET INCOME TO NET INCOME BEFORE SPECIAL CHARGES (CREDITS): Net income $3,799 $ 1,691 $1,152 - ------------------------------------------------------------------------------ Special charges (credits), net of income taxes (3,036) (1,255) 1,680 - ------------------------------------------------------------------------------ Net income before special charges (credits) $ 763 $ 436 $2,832 - ------------------------------------------------------------------------------ Earnings per share before special charges (credits) (basic and diluted) $ 0.06 $ 0.03 $ 0.22 - ------------------------------------------------------------------------------
One Time Gain Related to the Sale of Western Drug Distributors During Fiscal 1999 the Company entered into an agreement with Western Drug Distributors, Inc., its franchise store operator in the Seattle and Portland area, to terminate Western Drug's franchise agreement. The termination was related to the sale of Western Drug to Longs Drug Stores of Walnut Creek, California. The Company's agreement with Western Drug provided for a one-time lump sum payment to Drug Emporium, Inc. of $15.4 million. Approximately $14.4 million of the payment was related to the buyout and is recorded as a special credit in the Company's Statement of Operations. The remaining amounts of the payment relate primarily to franchise fee receivables accrued in the normal course of business, reimbursements for legal costs and interest. Store Closure Expense Store closing reserves are established based on management's expectation of the costs which will be incurred over the remaining lease terms of the closed locations, net of expected sublease income. In Fiscal 1997, the Company recorded costs associated with stores closed during Fiscal 1997 and earlier of $1.3 million, which was recorded as a part of special charges. In Fiscal 1998, additional store closing charges were offset by the receipt of $1.6 million related to a favorable lease buyout. During Fiscal 1999, as a result of an ongoing review of its business operations, the Company recorded special and nonrecurring charges of $9.4 million. The charges include a noncash component of $1.3 million to write down store equipment, fixtures and leasehold improvements at store locations to be closed, an accrual of $6.4 million to close seven underperforming store locations and record additional costs related to the Washington, D. C. area vacant store locations, and $1.7 million recorded as a component of gross margins in the Fiscal 1999 statement of operations due to store closure-related inventory liquidations and other inventory writedowns. The non-recurring inventory-related costs of the special charge have been recorded as a component of gross margins in accordance with Emerging Issues Task Force (EITF) Issue No. 96 - 9. Management's goal is to sublease or through other means remove all significant closed-store obligations. Since March 1994, the Company has closed 51 stores, of which non-subleased obligations continue at February 27, 1999 on eight 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 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, the transitional amortization charge of $1.5 million. A $300,000 charge was recorded in Fiscal 1998 and is shown as occupancy expense in the consolidated statement of operations. No charge was recorded during Fiscal 1999. Settlement of Litigation and Recovery of Legal Costs Subsequent to the end of Fiscal 1998, the Company reached a confidential settlement agreement with one of its franchisees to resolve a longstanding lawsuit. The impact of the settlement and associated legal costs is reflected in the Fiscal 1998 results, net of a third-party recovery. The Company also recorded a recovery of related prior period legal costs as a special credit in Fiscal 1998. INTEREST, NET Net interest expense decreased significantly in Fiscal 1999 due to a lower average balance on the Company's revolving credit facility versus the prior year. The lower average revolver balance was primarily a result of the pay down of the revolver with the $15.4 million in proceeds that resulted from the termination of the company's franchise agreement with Western Drug Distributors, Inc. and inventory reductions. Net interest for Fiscal 1998 showed a slight decrease versus Fiscal 1997 as the result of approximately $20 million in inventory reductions that took place during the year that were related to the Company's "Mission Critical" initiative. 8 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) ACQUISITIONS On February 5, 1999 the Company completed its purchase of substantially all of the assets of the Vix drug store chain, which operates twelve deep discount drug stores in the Buffalo and Rochester, New York areas. Both areas represent new markets for the Company. The acquired stores were operated under the Vix name by Tops, a division of Ahold International. The Company paid $31.2 million in cash for the assets of the business and assumed all store real estate leases. No other liabilities were assumed. The acquisition was financed through the use of the Company's bank facility and is expected to be accretive to earnings during Fiscal 2000. Fiscal 2000 sales are expected to increase by $92 million as a result of the acquisition. The acquisition was accounted for as a purchase. The Fiscal 1999 consolidated statement 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 cost. The Company uses an estimated percentage rate of inflation determined at the beginning of the fiscal year in computing its LIFO charges throughout the fiscal year. This LIFO charge is adjusted at each year-end based upon the actual weighted average percentage rate of inflation.
Year Ended - ---------------------------------------------------------------- February 27, February 28, March 1, 1999 1998 1997 ================================================================ LIFO provision (benefit) (in thousands) $1,035 $709 $(112) - ---------------------------------------------------------------- Inflation (deflation) rate .8% .4% (-.1)% ================================================================
Inventory turnover was approximately four turns for Fiscal 1999 versus three turns for the prior fiscal year. During Fiscal 1999, the company continued to realize the benefits of the "Mission Critical" inventory reduction initiative that was implemented on a company wide basis in Fiscal 1998. This initiative has resulted in a reduction in the average per store inventory level to $1.3 million in Fiscal 1999 from $1.4 million in Fiscal 1998. Due primarily to this drop, the Company was able to lower its inventory levels, adjusted for the Vix acquisition, by $19.6 million dollars. As a result of its ongoing inventory management efforts, the Company expects this trend of lower per-store inventory levels and the resulting positive effect on inventory turnover and liquidity to continue in Fiscal 2000, although at a slower rate. LIQUIDITY AND CAPITAL RESOURCES During Fiscal 1999, the Company terminated its existing banking relationship and entered into a new agreement with BankBoston (the "Agreement"). The Agreement allows for revolving borrowings of up to $100 million, depending upon available collateral, and expires on October 31, 2003. The Agreement provides for an advance rate against both inventory and accounts receivable collateral, and provides for a more favorable LIBOR-based borrowing interest rate. At the company's current level of working capital, the asset collateral borrowing base exceeds the $100 million credit facility limit. The Company's borrowing rate can fluctuate between the bank's prime rate and a LIBOR-based rate, depending on the ability of the Company to meet certain financial performance measures. The Agreement requires a commitment fee on the revolver of .25 percent on the unused available credit and has no compensating balance requirements. Borrowings made pursuant to the Agreement are secured by substantially all assets of the Company. The repurchase of the Company's convertible subordinated debentures and stock and the payment of dividends are permitted, although some restrictions apply. As of February 27, 1999, the Company's credit facility consisted of outstanding borrowings of $15.1 million, leaving $84.9 million available and unused as of that date. During Fiscal 1999, the Company generated $53.5 million in cash flow from operations versus $26.0 million in the prior year. The majority of this cash flow was the result of the $15.4 million one-time lump sum payment related to the termination of the Western Drug Distributors, Inc. franchise agreement, a temporary increase in accounts payable and accrued liabilities of $23.8 million and a permanent reduction in inventory of $19.6 million. The Company anticipates further reductions in its per store inventory levels during Fiscal 2000, and thus its borrowing needs, due to its ongoing efforts to better manage its procurement and distribution processes. The company invested $5.7 million of cash flow from operations in capital expenditures, while another $31.2 million was used to fund the Vix acquisition. In addition, the Company used $16.4 million of cash flow from operations to pay down debt. The Company's Fiscal 1999 balance sheet reflects net working capital of $64.6 million versus net working capital of $79.1 million at the end of the prior year. The decrease in net working capital is the result of a net increase in the Company's contingency reserve for store closings in the amount of $4.8 million, a net $6.6 million impact of the Vix transaction on working capital, and the pay off of approximately $7.5 million in long term debt carried by the Company's former bank at the time the Company changed its revolving credit facility. [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 9 12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Cash paid for interest on the revolving credit line and long-term debt was approximately $150,000 lower than the interest expense reported in the Company's Fiscal 1999 financial statements. In Fiscal 1998, cash paid for interest on the revolving credit line and long-term debt was approximately equal to that reported on the Company's financial statements, while in Fiscal 1997, cash interest paid was approximately $1 million more than reported. The Company believes that internally generated funds and borrowings available under its Agreement are sufficient to finance the Company's current operations. CLOSURE OF "BIG D" STORES The Company closed its single remaining "Big D" store in March, 1998. Pretax losses from the "Big D" operation in the amount of $.4 million and $1.2 million are included in the Fiscal 1999 and Fiscal 1998 results, respectively. IMPACT OF YEAR 2000 The Company has completed its assessment of the Information Technology-related (IT-related) systems for the Year 2000 issue. For IT-related systems, the Company's accounting software and AS400 applications are Year 2000 compliant. The Company is finalizing implementation of Year 2000 solutions in its pharmacy, payroll, host merchandising systems, store register systems, vendor EDI documents and other applications. These applications are expected to be compliant by May 1999. The Company has completed the majority of its assessment of non-IT-related systems for Year 2000 compliance. A limited number of non-IT-related systems are not Year 2000 compliant, and are expected to be upgraded by June 1999. The Company has surveyed and is working with its outside suppliers and software vendors related to Year 2000 compliance. The external software companies that the Company utilizes for pharmacy, merchandising, store register and accounting systems have provided the company with a Year 2000 compliant version of their respective products. The Company estimates that its Year 2000 effort is approximately 85 percent complete as of the end of February 1999 and will be substantially completed as of May 1999. The Company's total estimate of Year 2000 compliance costs is projected to be $1,400,000, with $1,250,000 estimated to be incurred related to the purchase of hardware and software to be capitalized and $150,000 related to costs which will be expensed as incurred. The Company incurred the majority of its Year 2000 costs during Fiscal 1999. Most of the costs were related to the hardware required to run the Year 2000 compliant version of the in-store pharmacy system which was required to be implemented approximately one year earlier than would otherwise have been necessary. The Company is currently developing a contingency plan in the event of any systems not being Year 2000 compliant. If the Company does not become Year 2000 compliant in a timely manner, the Year 2000 issue could have a material impact on the operations of the Company by impairing its ability to process customer transactions, order and pay for merchandise for sale, and perform certain other functions. In addition, although the Company has initiated formal communications with all of its significant suppliers to determine the extent to which the Company is vulnerable to those third parties' failure to remediate their own Year 2000 issues and the Company has received assurances regarding these issues from some (but not all) of its vendors, there is no guarantee that these third party systems will be compliant. Any such non-compliance could have a material adverse effect on the Company. For example, if some of the Company's merchandise vendors are not Year 2000 compliant it could impact the ability of the company to procure merchandise from those vendors. The costs of the project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. FORWARD-LOOKING STATEMENTS Statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as in certain other parts of this report that look forward in time, which includes everything other than historical information, are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance, and underlying assumptions and other statements which are other than statements of historical facts. From time to time, the Company may publish or otherwise make available forward-looking statements of this nature. All such forward-looking statements are based on the current expectations of management and are subject to, and are qualified by, risks and uncertainties that could cause actual results to differ materially from those expressed or implied by those statements. These risks and uncertainties include, but are not limited to the high level of competition as to price and selection from a variety of sources, the recent downward pressure on pharmacy margins from managed care networks, the Company's ability to economically eliminate under-performing stores, the Company's ability to identify and address all Year 2000 issues and general economic conditions. 10 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 13
CONSOLIDATED BALANCE SHEETS (in thousands) - ----------------------------------------------------------------------------------------------------- ASSETS February 27, 1999 February 28, 1998 ====================================================================================================== CURRENT ASSETS: Cash and cash equivalents $ 893 $ 783 - ----------------------------------------------------------------------------------------------------- Accounts receivable 18,323 17,410 - ----------------------------------------------------------------------------------------------------- Inventories 164,789 167,292 - ----------------------------------------------------------------------------------------------------- Income taxes and other current assets 2,319 1,692 - ----------------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 186,324 187,177 - ----------------------------------------------------------------------------------------------------- Property and equipment, net 30,708 26,777 - ----------------------------------------------------------------------------------------------------- Goodwill 10,237 4,215 - ----------------------------------------------------------------------------------------------------- Other assets 3,420 1,615 - ----------------------------------------------------------------------------------------------------- Total assets $230,689 $219,784 ======================================================================================================
(dollars in thousands) - ----------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY February 27, 1999 February 28, 1998 ===================================================================================================== CURRENT LIABILITIES: Revolving credit line $ 15,106 $ 22,200 - ----------------------------------------------------------------------------------------------------- Accounts payable 80,393 64,025 - ----------------------------------------------------------------------------------------------------- Accrued liabilities 22,047 14,785 - ----------------------------------------------------------------------------------------------------- Deferred income 3,904 3,679 - ----------------------------------------------------------------------------------------------------- Current maturities of long-term debt 242 3,375 - ----------------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 121,692 108,064 - ----------------------------------------------------------------------------------------------------- Deferred rent 3,850 4,164 - ----------------------------------------------------------------------------------------------------- Convertible subordinated debt 49,421 49,421 - ----------------------------------------------------------------------------------------------------- Long-term debt, other 504 6,745 - ----------------------------------------------------------------------------------------------------- TOTAL LONG-TERM DEBT 49,925 56,166 - ----------------------------------------------------------------------------------------------------- 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 13,186,000 in 1999; 13,180,000 in 1998 1,319 1,318 - ----------------------------------------------------------------------------------------------------- Additional paid-in capital 32,155 32,123 - ----------------------------------------------------------------------------------------------------- Retained earnings 21,748 17,949 - ----------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 55,222 51,390 - ----------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $230,689 $219,784 =====================================================================================================
See accompanying notes [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 11 14 CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended - ------------------------------------------------------------------------------------------------------- February 27, 1999 February 28, 1998 March 1, 1997 (in thousands, except per share amounts) (52 weeks) (52 weeks) (52 weeks) ======================================================================================================== Net sales $ 839,443 $ 836,405 $ 855,016 - ------------------------------------------------------------------------------------------------------- Cost of sales 662,714 658,116 669,541 - ------------------------------------------------------------------------------------------------------- Gross margin 176,729 178,289 185,475 - ------------------------------------------------------------------------------------------------------- Selling, administrative and occupancy expenses 171,444 169,584 172,560 - ------------------------------------------------------------------------------------------------------- Special charges (credits) (6,760) (2,092) 2,800 - ------------------------------------------------------------------------------------------------------- Interest expense, net 5,487 7,653 7,882 - ------------------------------------------------------------------------------------------------------- Income before provision for income taxes 6,558 3,144 2,233 - ------------------------------------------------------------------------------------------------------- Provision for income taxes 2,759 1,453 1,081 - ------------------------------------------------------------------------------------------------------- Net income $ 3,799 $ 1,691 $ 1,152 - ------------------------------------------------------------------------------------------------------- Earnings per share (basic and diluted) $ 0.29 $ 0.13 $ 0.09 - ------------------------------------------------------------------------------------------------------- WEIGHTED AVERAGE NUMBER OF COMMON SHARES USED IN COMPUTING EARNINGS PER SHARE: Basic 13,180 13,180 13,169 - ------------------------------------------------------------------------------------------------------- Diluted 13,214 13,197 13,182 =======================================================================================================
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 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 - ------------------------------------------------------------------------------------------------ Exercise of stock options 27 3 129 -- 132 - ------------------------------------------------------------------------------------------------ Net income -- -- -- 1,691 1,691 - ------------------------------------------------------------------------------------------------ Balance at February 28, 1998 13,180 $ 1,318 $ 32,123 $ 17,949 $ 51,390 - ------------------------------------------------------------------------------------------------ Exercise of stock options 6 1 32 -- 33 - ------------------------------------------------------------------------------------------------ Net income -- -- -- 3,799 3,799 - ------------------------------------------------------------------------------------------------ BALANCE AT FEBRUARY 27, 1999 13,186 $ 1,319 $ 32,155 $ 21,748 $ 55,222 =================================================================================================
See accompanying notes 12 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 15 CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended - --------------------------------------------------------------------------------------------------------------------------- February 27, 1999 February 28, 1998 March 1, 1997 (in thousands) (52 weeks) (52 weeks) (52 weeks) =========================================================================================================================== OPERATING ACTIVITIES Net income $ 3,799 $ 1,691 $ 1,152 - --------------------------------------------------------------------------------------------------------------------------- ADJUSTMENTS TO RECONCILE TO CASH PROVIDED BY OPERATIONS: Depreciation and amortization 8,798(2) 7,345 8,788(1) - --------------------------------------------------------------------------------------------------------------------------- Deferred income taxes 24 610 500 - --------------------------------------------------------------------------------------------------------------------------- LIFO provision (benefit) 1,035 709 (112) - --------------------------------------------------------------------------------------------------------------------------- CASH PROVIDED BY (USED FOR) CURRENT ASSETS AND LIABILITIES: Accounts payable and accrued liabilities 23,843 (2,725) (18,626) - --------------------------------------------------------------------------------------------------------------------------- Accounts receivable (913) (2,885) (1,507) - --------------------------------------------------------------------------------------------------------------------------- Inventories at current cost 19,637 19,948 7,921 - --------------------------------------------------------------------------------------------------------------------------- Other (2,766) 1,268 2,439 =========================================================================================================================== NET CASH PROVIDED BY OPERATING ACTIVITIES 53,457 25,961 555 =========================================================================================================================== INVESTING ACTIVITIES Purchase of property and equipment, net (5,737) (2,949) (5,809) - --------------------------------------------------------------------------------------------------------------------------- Payment for purchase of retail stores, net of cash acquired (31,175) - (10,093) =========================================================================================================================== NET CASH USED FOR INVESTING ACTIVITIES (36,912) (2,949) (15,902) - --------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Net borrowings (repayments) under revolving credit line (7,094) (19,400) 20,100 - --------------------------------------------------------------------------------------------------------------------------- Proceeds from term debt - - - - --------------------------------------------------------------------------------------------------------------------------- Net repayments on term debt and other (9,341) (3,608) (4,741) - --------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES (16,435) (23,008) 15,359 - --------------------------------------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 110 4 12 - --------------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 783 779 767 - --------------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 893 $ 783 $ 779 ===========================================================================================================================
See accompanying notes. (1) Includes $1,500,000 related to the Company's adoption of FAS 121. (2) Includes $1,300,000 related to noncash store closure charge to write down store equipment, fixtures and leasehold improvements. [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 13 16 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 1999, the stores operated under the names of Drug Emporium, F&M Super Drug Stores, and Vix Deep Discount. As of year-end, approximately eighty percent of the Company-owned stores were located in the states of California, Georgia, Michigan, New Jersey, New York, Ohio and Pennsylvania. Fiscal Year The fiscal year of the Company is the 52-53 week period ending on the Saturday closest to the end of February. The quarter and fiscal year ends for 1999 and 1998 were as follows:
Fiscal year 1999 Fiscal year 1998 ================================================================= First quarter May 30, 1998 May 31, 1997 - ----------------------------------------------------------------- Second quarter August 29, 1998 August 30, 1997 - ---------------------------------------------------------------- Third quarter November 28, 1998 November 29, 1997 - ---------------------------------------------------------------- Year end February 27, 1999 February 28, 1998 =================================================================
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 $1,051,000 and $1,155,000 as of February 27, 1999 and February 28, 1998, 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 $22,786,000 and $21,751,000 higher than reported at February 27, 1999 and February 28, 1998, 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 $580,000, $548,000, and $548,000 of goodwill during Fiscal 1999, 1998 and 1997, respectively. Accumulated amortization was $4,901,000 at February 27, 1999 and $4,321,000 at February 28, 1998. The Company reviews its goodwill for impairment annually, based upon expectations of nondiscounted cash flows and operating income. As of February 27, 1999, management believes that none of its goodwill is impaired. 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 1999, $55,000 in 1998, and $55,000 in 1997. The amount of accumulated amortization, at February 27, 1999 and February 28, 1998, was $519,000 and $464,000, respectively. Advertising Costs The Company records expense for the production costs of radio and television advertising in the year incurred. Gross advertising costs, before vendor reimbursements, as a percentage of net sales, were 2.4 percent, 2.6 percent, and 2.1 percent in Fiscal 1999, 1998 and 1997, respectively. 14 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 17 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 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 as a reduction to the Company's selling, administrative and occupancy expenses. Net franchise fees were $3,435,000, $4,794,000 and $4,840,000 in Fiscal 1999, 1998 and 1997, respectively. Vendor Contract Income Recognition From time to time the Company enters into contracts with various suppliers for the purchase of merchandise for sale. These contracts may provide for contractual payments from vendors in exchange for product conversion, product placement, coverage of operational costs, purchase commitments, or similar inducements. The Company records vendor contract payments as a reduction of cost of sales over the life of the contract in the case of payments made with recourse, or when receivable in the case of non-recourse payments. Store Closure Expense The store closing reserve has been established based on management's expectation of the costs which will be incurred over the remaining lease terms of the closed locations, net of expected sublease income. In Fiscal 1997, the Company incurred costs associated with stores closed during Fiscal 1997 and earlier of $1.3 million, which was recorded as a part of special charges. In Fiscal 1998, additional store closing charges were offset by the receipt of $1.6 million related to a favorable lease buyout. During Fiscal 1999, as a result of an ongoing review of its business operations, the Company recorded special and nonrecurring charges of $9.4 million. The charges include a noncash component of $1.3 million to write down store equipment, fixtures and leasehold improvements at store locations to be closed, an accrual of $6.4 million to close seven underperforming store locations and record additional costs related to the Washington, D. C. area vacant store locations, and $1.7 million recorded as a component of gross margins in the Fiscal 1999 statement of operations due to store closure-related inventory liquidations and other inventory writedowns. The non-recurring inventory-related costs of the special charge have been recorded as a component of gross margins in accordance with Emerging Issues Task Force (EITF) Issue No. 96 - 9. 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 leased assets for certain stores were impaired and recorded, as a part of special charges, the transitional amortization charge of $1,500,000. A $300,000 charge was recorded in Fiscal 1998 and is shown as occupancy expense in the consolidated statement of operations. No charge was recorded during Fiscal 1999. Reclassifications Certain amounts in prior years' financial statements have been reclassified to conform to the Fiscal 1999 presentation. NOTE 2 - REVOLVING CREDIT LINE During Fiscal 1999, the Company terminated its existing banking relationship and entered into a new agreement with BankBoston (the "Agreement"). The Agreement allows for revolving borrowings of up to $100 million, depending upon available collateral, and expires on October 31, 2003. The Agreement provides for an advance rate against both inventory and accounts receivable collateral. At the company's current level of working capital, the asset collateral borrowing base exceeds the $100 million credit facility limit. As of February 27, 1999, the Company's credit facility consisted of outstanding borrowings of $15.1 million, leaving $84.9 million available and unused as of that date. The Company's borrowing rate can fluctuate between the bank's prime rate and a LIBOR-based rate, depending on the ability of the Company to meet certain financial performance measures. At February 27, 1999, the weighted average borrowing rate was 6.97 percent. The Agreement requires a commitment fee on the revolver of .25 percent on the unused available credit and has no compensating balance requirements. Borrowings made pursuant to the Agreement are secured by substantially all assets of the Company. The repurchase of the Company's convertible subordinated debentures and stock and the payment of dividends are permitted, although some restrictions apply. NOTE 3 - LONG-TERM DEBT
- ---------------------------------------------------------------------- (in thousands) February 27, 1999 February 28, 1998 March 1, 1997 ====================================================================== Convertible subordinated debentures $49,421 $49,421 $49,421 - ---------------------------------------------------------------------- Term debt - 9,000 12,000 - ---------------------------------------------------------------------- Other 746 1,120 1,860 - ---------------------------------------------------------------------- 50,167 59,541 63,281 - ---------------------------------------------------------------------- Less current maturities (242) (3,375) (3,950) - ---------------------------------------------------------------------- $49,925 $56,166 $59,331 ======================================================================
The Company has $49,421,000 of 7.75 percent 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 share), [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 15 18 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) subject to certain adjustments under the terms of these debentures. These debentures are redeemable at the option of the Company at 100.7 percent of par plus accrued interest. This redemption rate will decline by .7 percent, to par on October 1, 1999. The debentures are subject to a sinking fund, commencing October 1, 2000, calculated to retire at least 70 percent 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 1999, the convertible debentures traded in a range of 76.75 percent to 89.5 percent of par, with a year-end price of 81.08 percent of par. The Company has a note bearing variable interest at 7.79 percent on February 27, 1999. Principal amounts related to the notes due for fiscal years 2000 through 2004 are $242,000, $260,000, $232,000, $7,000 and $5,000, respectively. NOTE 4 - 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, common area maintenance, insurance and taxes. Certain leases are renewable with escalation clauses. Rent expense (excluding rent expense for closed stores from the date closed) was $33,052,000, $33,732,000, and $32,854,000 during Fiscal 1999, 1998 and 1997, respectively. At February 27, 1999, future minimum operating lease payments during the next five years and thereafter are: 2000 - $31,116,000; 2001 - $28,769,000; 2002 - - $24,174,000; 2003 - $20,587,000; 2004 - $16,296,000; and $34,510,000 thereafter. At February 27, 1999, the future minimum lease payments for closed stores total approximately $10,954,000 for which there are subleases in force aggregating $4,118,000. NOTE 5 - PROPERTY AND EQUIPMENT Property and equipment is summarized as follows:
- ------------------------------------------------------------------------------------ (in thousands) February 27, 1999 February 28, 1998 March 1, 1997 ===================================================================================== Land and building $ 3,331 $ 3,331 $ 3,475 - ------------------------------------------------------------------------------------ Furniture and fixtures 44,817 40,188 38,941 - ------------------------------------------------------------------------------------ Acquired leases and leasehold improvements 31,311 26,449 26,502 - ------------------------------------------------------------------------------------ 79,459 69,968 68,918 - ------------------------------------------------------------------------------------ Less allowances for depreciation and amortization (48,751) (43,191) (38,506) - ------------------------------------------------------------------------------------ $ 30,708 $ 26,777 $ 30,412 ====================================================================================
NOTE 6 - 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) February 27, 1999 February 28, 1998 ================================================================================== Deferred tax assets (liabilities): Loss and AMT credit carryforwards $ 2,493 $ 3,629 - ---------------------------------------------------------------------------------- Store closing reserve 2,124 495 - --------------------------------------------------------------------------------- Allowance for receivables 357 393 - --------------------------------------------------------------------------------- Property and equipment 827 1,031 - --------------------------------------------------------------------------------- Other 400 817 - ---------------------------------------------------------------------------------- 6,201 6,365 Inventory valuation (2,397) (2,170) - ---------------------------------------------------------------------------------- Deferred income (3,189) (3,556) - --------------------------------------------------------------------------------- Other (649) (649) - ---------------------------------------------------------------------------------- (6,235) (6,375) Net deferred tax liability (34) (10) - --------------------------------------------------------------------------------- Current tax balance (2,051) 275 - --------------------------------------------------------------------------------- $(2,085) $ 265 ==================================================================================
There were no significant deferred tax valuation allowances as of February 27, 1999 and February 28, 1998. Significant components of the provision for income taxes are as follows:
- ------------------------------------------------------------------ (in thousands) 1999 1998 1997 - ------------------------------------------------------------------ Current: Federal $ 2,494 $ 579 $ 339 - ------------------------------------------------------------------ State and local 242 264 242 - ------------------------------------------------------------------ Total current 2,736 843 581 - ------------------------------------------------------------------ Deferred 24 610 500 - ------------------------------------------------------------------ $ 2,760 $ 1,453 $ 1,081 ==================================================================
The reconciliation of income tax computed at the U.S. federal statutory tax rates to income tax expense is:
- ----------------------------------------------------------------- (in thousands) 1999 1998 1997 - ----------------------------------------------------------------- Tax at statutory rate $2,230 $1,069 $ 759 - ----------------------------------------------------------------- State income tax, net 160 174 160 - ------------------------------------------------------------------ Goodwill 186 186 186 - ------------------------------------------------------------------ Other, net 184 24 (24) - ------------------------------------------------------------------ $2,760 $1,453 $1,081 =================================================================
16 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The Company received refunds, net of income taxes paid, of $2,060,000 during Fiscal 1998, and made income tax payments of $1,050,000 in Fiscal 1997 and $478,000 in Fiscal 1999. At February 27, 1999, the Company has $2,493,219 of alternative minimum tax credit carry forward which has no expiration date. NOTE 7 - 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. The rights plan was renewed during Fiscal 1999. NOTE 8 - 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 percent of the fair market value of the shares on the date of grant. If an employee owns stock possessing more than 10 percent of the total combined voting power of the Company, the option price must be 110 percent 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 percent to 30 percent 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 would have been impacted by $125,000, $55,000 and $59,000 in Fiscal 1999, 1998 and 1997, respectively. 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 Fiscal 1999, 1998 and 1997: Risk-free interest rate of 6.5 percent; no dividend yield; volatility factor of the expected market price of the Company's common stock of 0.44; and a weighted-average expected life of each option of five years. A summary of the Company's stock option activity during 1999, 1998, and 1997 and related information follows:
- ----------------------------------------------------------------------------------------- SHARES UNDER OPTION - ----------------------------------------------------------------------------------------- (in thousands, except per share amounts) 1999 1998 1997 ========================================================================================== Outstanding, beginning of year 796 916 881 - ----------------------------------------------------------------------------------------- Granted (at $4.16 to $6.50 per share) 152 - 118 - ----------------------------------------------------------------------------------------- Cancelled (74) (93) (83) - ----------------------------------------------------------------------------------------- Exercised (at $4.81 to $6.50 per share) (6) (27) - - ----------------------------------------------------------------------------------------- Outstanding, end of year (at prices ranging from $4.03 to $8.81 per share) 868 796 916 - ----------------------------------------------------------------------------------------- Exercisable, end of year (at prices ranging from $4.03 to $8.81 per share) 678 655 761 ==========================================================================================
The weighted average per share price for options outstanding was $5.23 and $5.02 at the end of fiscal years 1999 and 1998, respectively. At the end of fiscal years 1999, 1998, and 1997 there were 55,000, 187,000, and 149,000 shares, respectively, reserved for future grants. NOTE 9 - ACQUISITIONS On February 5, 1999 the Company completed its purchase of substantially all of the assets of the Vix drug store chain, which operates twelve deep discount drug stores in the Buffalo and Rochester, New York areas. Both areas represent new markets for the Company. The acquired stores were operated under the Vix name by Tops, a division of Ahold International. The Company paid $31.2 million in cash for the assets of the business and assumed all store real estate leases. No other liabilities were assumed. The acquisition was accounted for as a purchase. The Fiscal 1999 consolidated statement of operations reflects the results of operations of the acquired stores since the date acquired. [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 17 20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 10 - DEFINED CONTRIBUTION PLAN The Company provides a defined contribution 401(k) plan to substantially all employees. Participants may make voluntary contributions to the plan of up to 15 percent of their compensation. Approximately $151,000, $154,000, and $65,000 was charged to expense for this plan in fiscal years 1999, 1998 and 1997, respectively. NOTE 11 - SETTLEMENT OF LITIGATION During Fiscal 1999, the Company reached a confidential settlement agreement with one of its franchisees to resolve a longstanding lawsuit. The impact of the settlement and associated legal costs was accounted for and reflected in the Fiscal 1998 results, net of a third-party recovery. The Company recorded a recovery of related prior period legal costs as a special credit in Fiscal 1998. NOTE 12 - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
- ------------------------------------------------------------------------------------ (in thousands, except per share amounts) 1999 1998 1997 ==================================================================================== NUMERATOR: Net income and numerator for basic earnings per share - income available to common stockholders $ 3,799 $ 1,691 $ 1,152 - ------------------------------------------------------------------------------------ Effect of dilutive securities: 7.75% convertible debentures (1) -- -- -- - ------------------------------------------------------------------------------------ Numerator for diluted earnings per share - income available to common stockholders after assumed conversions $ 3,799 $ 1,691 $ 1,152 - ------------------------------------------------------------------------------------ DENOMINATOR: Denominator for basic earnings per share - weighted-average shares 13,180 13,180 13,169 - ------------------------------------------------------------------------------------ Effect of dilutive securities: Employee stock options (2) 34 17 13 - ------------------------------------------------------------------------------------ 7.75% convertible debentures (1) -- -- -- - ------------------------------------------------------------------------------------ Dilutive potential common shares -- -- -- - ------------------------------------------------------------------------------------ Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions 13,214 13,197 13,182 - ------------------------------------------------------------------------------------ Basic earnings per share $ 0.29 $ 0.13 $ 0.09 - ------------------------------------------------------------------------------------ Diluted earnings per share $ 0.29 $ 0.13 $ 0.09 ====================================================================================
(1) The effect of the 7.75% convertible debentures is antidilutive and thus excluded in the calculation of diluted earnings per share. (2) Additional options to purchase shares of common stock were outstanding during each period but were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price of the common shares and, therefore, the effect would be antidilutive. NOTE 13 - QUARTERLY FINANCIAL DATA (UNAUDITED)
- -------------------------------------------------------------------------------------------------------------------------------- (in thousands, except per share amounts) - -------------------------------------------------------------------------------------------------------------------------------- Earnings Earnings Per Common Per Common Stock Prices Net Gross Net Share Share ------------ Dividends Paid Sales Profit Income (Basic) (Diluted) High Low Per Common Share ================================================================================================================================ 1999: First quarter $209,172 $ 43,629 $ 728 $ .06 $ .06 $4.56 $3.81 -- - -------------------------------------------------------------------------------------------------------------------------------- Second quarter 204,845 42,570 3,286 .25 .24 4.81 3.75 -- - -------------------------------------------------------------------------------------------------------------------------------- Third quarter 199,132 42,881 (767) (.06) (.06) 4.69 3.19 -- - -------------------------------------------------------------------------------------------------------------------------------- Fourth quarter 226,294 47,649 552 .04 .04 8.69 4.13 -- - -------------------------------------------------------------------------------------------------------------------------------- $839,443 $176,729 $ 3,799 $ .29 $ .29 -- ================================================================================================================================ 1998: First quarter $209,214 $ 44,622 $ 528 $ .04 $ .04 $5.50 $4.13 -- - -------------------------------------------------------------------------------------------------------------------------------- Second quarter 204,235 43,549 274 .02 .02 5.31 4.00 -- - -------------------------------------------------------------------------------------------------------------------------------- Third quarter 199,571 42,344 283 .02 .02 4.75 3.75 -- - -------------------------------------------------------------------------------------------------------------------------------- Fourth quarter 223,385 47,774 606 .05 .05 5.38 3.88 -- - -------------------------------------------------------------------------------------------------------------------------------- $ 836,405 $178,289 $ 1,691 $ .13 $ .13 -- ================================================================================================================================
18 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 21 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 February 27, 1999 and February 28, 1998, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended February 27, 1999. 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 February 27, 1999 and February 28, 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended February 27, 1999, in conformity with generally accepted accounting principles. /s/ Ernst + Young LLP Columbus, Ohio April 15, 1999 REPORT OF MANAGEMENT The Management of Drug Emporium is responsible for the integrity and objectivity of the financial statements and related information. Accounting principles used in preparing the financial statements are those that are generally accepted in the United States, and include amounts that are based on our best judgments with due consideration given to materiality. Drug Emporium is dedicated to the highest standards of integrity, ethics and social responsibility. This dedication is reflected in written policy statements covering, among other subjects, compliance with all laws, proper business practices and adherence to the highest standards of conduct and practices in transactions with suppliers. Management's responsibilities are documented in the Company's Code of Conduct Policy which is reviewed and signed annually by members of management. Management believes that a sound, dynamic system of internal financial controls that balances benefits and costs provides the best safeguard for Company assets. Professional financial managers are responsible for implementing and overseeing the financial control system, reporting on management's stewardship of the assets entrusted to it by shareholders and maintaining accurate records. The Audit Committee of the Board of Directors is composed entirely of outside directors and meets at least annually with the independent auditors and management. The independent auditors have free access to the committee. The Audit Committee concerns itself with the scope of the audit, the adequacy of internal controls, the quality of financial reporting and other related matters. The Company has retained the services of Ernst & Young LLP as independent auditors. The independent auditors maintain an understanding of the internal control structure of the Company and conduct such tests and other auditing procedures considered necessary in the circumstances to express the opinion in the report. /s/ David L. Kriegel David L. Kriegel Chairman and Chief Executive Officer /s/ Michael P. Leach Michael P. Leach Chief Financial Officer [LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 19 22 BOARD OF DIRECTORS AND COMPANY MANAGEMENT BOARD OF DIRECTORS - ------------------------------------------------------------------------------- John Havlicek(3) Franchise Owner Wendy's International, Inc. Donald B. Hayes, Sr.(1) Chairman andCEO Mainbancorp, Inc. David L. Kriegel(3) Chairman, CEO and President Drug Emporium, Inc. Robert W. McCurdy, R.Ph.(1) Assistant to the Dean Ohio Northern University Walter E. Sinterman(2) President Sinco, Inc. William L. Sweet, Jr.(2) Partner Beckman Lawson, LLP Wesley C. Wright(1) President Diversified Retail Solutions (1) Audit Committee (2) Compensation Committee (3) Executive Committee - ------------------------------------------------------------------------------- [PHOTOGRAPH] V. J. Wiechart, Sr. R.Ph. Member of the Board Directors and Drug Emporium Foundation Trustee [PHOTOGRAPH] Roy Kerscher Member of the Franchise Advisory Board and Drug Emporium Foundation Trustee In 1998, the Company was saddened by the passing of two people who were very dear and important to us: V.J. "Tom" Wiechart and Roy J. Kerscher. Mr. Wiechart served on our Board of Directors from 1993 until his death in August 1998. In addition, he was a member of our Audit Committee. As a registered pharmacist and the owner of several pharmacies, he brought to the Company a unique and valuable perspective and keen business sense. As a member of our Franchise Advisory Board Mr. Kerscher was a valuable contributor to our Company. His in-depth knowledge of the grocery business, his ability to devise creative solutions to challenging issues, and the care and dedication he brought to his work made him a great asset to us. Mr. Wiechart and Mr. Kerscher will both be missed. We extend our condolences to both their families. - ------------------------------------------------------------------------------- CORPORATE OFFICERS - -------------------------------------------------------------------------------- David L. Kriegel Chairman, CEO and President A. Joel Arnold, R.Ph. Senior Vice President Thomas H. Ziemke Senior Vice President Jane H. Lagusch Vice President and Secretary Michael P. Leach Chief Financial Officer and Treasurer Lee Pfrogner, R.Ph. Vice President FRANCHISE ADVISORY BOARD - -------------------------------------------------------------------------------- William O. Conn Volunteer Drug Distributors, Inc. Charlotte, NC Franchise Timothy B. Dargusch Director - Franchise Operations Richard Gibson Emporium Drug Mart, Inc. Longview, TX Franchise Ron Mann Mann Drug, Inc. Brownsville/Victoria, TX Franchise James A. Stiffler Jim Stiffler, Inc. Westerville, OH Alan Stotsky, R.Ph. American Coastal Realty Detroit, MI REGIONAL OPERATORS - ------------------------------------------------------------------------------- Earl J. Connell Vice President - Eastern Region Victor J. Tenuto Vice President - Great Lakes Region Roger D. Wilson Vice President - Southeastern Region Ronald L. Schneider, R.Ph. Director - Western Region Richard D. Jump Director - Central Region David L. Seimetz Vice President - Midwest Region DEPARTMENT DIRECTORS - ------------------------------------------------------------------------------- Stephen M. Denovchek, RPh. Director - Pharmacy Operations Larry Hood Director - Purchasing Louis C. Matt, Jr. Director - Real Estate & Store Planning Terry L. Moore Controller Kimberly A. Oeberst Director - Human Resources James J. Schanzenbach Director of Information Services DRUG EMPORIUM FOUNDATION TRUSTEES - ------------------------------------------------------------------------------- Gene Graves Chairman and CEO Lakeview Farms, Inc. David L. Kriegel Chairman, CEO and President Drug Emporium, Inc. Thomas J. Moening Chairman and CEO Webb Insurance Agency, Inc. 20 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO] 23 [PHOTOGRAPH] Gene Wilborn, of Emporium Drug Mart, Inc., accepted the Franchise Operator of the Year Award at the Company's Annual Show in August. Emporium Drug Mart, Inc. operates eleven stores in Denton, Longview, Amarillo, Abilene, Lubbock, Waco and Tyler, Texas; Wichita, Kansas; Shreveport and Lafayette, Louisiana and Little Rock, Arkansas. CORPORATE INFORMATION CORPORATE OFFICES Drug Emporium, Inc. 155 Hidden Ravines Drive Powell, Ohio 43065 Phone: 740/548-7080 WEB SITE ADDRESS http://www.DrugEmporium.com AUDITORS Ernst & Young LLP Columbus, Ohio TRANSFER AGENT American Stock Transfer & Trust Company 40 Wall Street New York, New York 10005 STOCK TRADING AND BOND TRADING Common Shares are traded on the Nasdaq National Market under the symbol DEMP. The Company's 7-3/4% Convertible Subordinated Debentures, due October 1, 2014, are traded on the Nasdaq system under the symbol DEMPG. STOCK PRICES Information on stock prices and dividends is reflected in Note 13 of the consolidated financial statements. At April 26, 1999, the Company had approximately 4,200 beneficial holders of its common stock. FORM 10-K A copy of the annual report on Form 10-K for the fiscal year ended February 27, 1999 is available without charge to any stockholder upon written request directed to the Corporate Secretary. 24 THANK YOU FOR SHOPPING AT DRUG EMPORIUM, F&M AND VIX STORES. CORPORATE OFFICES: Drug Emporium, Inc. 155 Hidden Ravines Drive Powell, Ohio 43065 740.548.7080 ON-LINE STORE: http://www.DrugEmporium.com ARKANSAS *9112 Rodney Parham Road, Suite 110 Little Rock, AR 72205 CALIFORNIA 9922 Katella Avenue Anaheim, CA 92804 3555 Clares Street Capitola, CA 95010 12155 Central Avenue Chino, CA 91710 1067 N. Grand Avenue Covina, CA 91724 16119 Brookhurst Fountain Valley, CA 92708 3171 Walnut Avenue Fremont, CA 94538 2475 E. Chapman Avenue Fullerton, CA 92631 9062 Adams Avenue Huntington Beach, CA 92646 4951 La Palma Avenue La Palma , CA 90623 1941 West Imperial Highway La Habra, CA 90631 17875 Colima Road La Puente, CA 91748 6030 Lankershim Avenue N. Hollywood, CA 91606 5833 Jarvis Avenue Newark, CA 94560 1538 E. Chapman Avenue Orange, CA 92866 2701 Manhattan Beach Redondo Beach, CA 90278 1880 S. Pacific Coast Hwy Redondo Beach, CA 90277 5931 University Avenue San Diego, CA 92115 4950 C Almaden Expressway San Jose, CA 95118 9805 Campo Road Spring Valley, CA 91977 24663 Crenshaw Boulevard Torrance, CA 90505 13852 Red Hill Avenue Tustin, CA 92680 GEORGIA 191 Alps Road Athens, GA 30606 2953 N. Druid Hills Road Atlanta, GA 30329 2625 Piedmont Road Atlanta, GA 30324 2909 Washington Road Augusta, GA 30909 3999 Austell Road Austell, GA 30001 1543 Highway 138 Conyers, GA 30208 7424 Douglas Boulevard Douglasville, GA 30135 2320 Pleasant Hill Road Duluth, GA 30136 4400 Roswell Road, Suite 128 Marietta, GA 30062 3605 Sandy Plains Rd, Suite 300 Marietta, GA 30066 4975 Jimmy Carter Boulevard Norcross, GA 30093 4015 Holcomb Bridge Road Norcross, GA 30071 11060 Alpharetta Highway Roswell, GA 30076 1475 Holcomb Bridge Road Roswell, GA 30076 1900 Rockbridge Road Stone Mountain, GA 30087 4000 La Vista Road Tucker, GA 30084 4740 Jonesboro Road Union City, GA 30291 INDIANA 700 Eastern Boulevard Clarksville, IN 47130 KANSAS 9301 Santa Fe Overland Park, KS 66212 *8829 West Central Avenue Wichita , KS 67212 KENTUCKY 2310 Buttermilk Crossing Crescent Springs, KY 41017 7654 Mall Road Florence, KY 41042 90 Alexander Pike Ft. Thomas, KY 41075 6801 Dixie Highway Louisville, KY 40258 7100 Preston Highway Louisville, KY 40219 4944 Shelbyville Road Louisville, KY 40207 LOUISIANA *500 Bertrand Drive Lafayette, LA 70506 *5819 East Kings Highway Shreveport, LA 71105 MARYLAND 6501 Baltimore National Pike Baltimore, MD 21228 570 Baltimore Pike Bel Air, MD 21014 5416 Annapolis Road Bladensburg, MD 20710 1403 Merritt Boulevard Dundalk, MD 21222 6320 Ritchie Highway Glen Burnie, MD 21061 6197 Livingston Road Oxon Hill, MD 20745 801 Goucher Boulevard Towson, MD 21204 MICHIGAN 2105 South Telegraph Road Bloomfield Hills, MI 48302 22200 Michigan Avenue Dearborn, MI 48124 18859 East Nine Mile Road Eastpointe , MI 48021 30100 Grand River Avenue Farmington Hills, MI 48336 31005 Orchard Lake Road Farmington Hills, MI 48334 280 West Nine Mile Ferndale, MI 48220 1700 Dix Avenue Lincoln Park, MI 48146 13505 Middlebelt Road Livonia, MI 48150 1260 Rochester Road Rochester Hills, MI 48307 30777 Gratiot Ave. Roseville, MI 48066 31157 Woodward Ave. Royal Oak, MI 48073 29712 Southfield Road Southfield, MI 48076 14544 Racho Road Taylor, MI 48180 27690 Van Dyke Warren , MI 48093 35715 Warren Road Westland, MI 48185 MINNESOTA 503 87th Lane NE Blaine, MN 55434 5900 Shingle Creek Parkway Brooklyn Center, MN 55430 780 West 66th Street Richfield, MN 55423 MISSOURI *2341 S M-291 Highway Independence, MO 64057 *1020 West 103rd Street Kansas City, MO 64114 10320 Manchester Road Kirkwood, MO 63122 7435 Watson Road Shrewsbury, MO 63119 10550 Baptist Church Road St. Louis, MO 63128 1067 Regency Parkway I-70 and Zembehl Road St. Charles, MO 63301 NEW JERSEY Route 38 & Cuthbert Road Cherry Hill, NJ 08002 100 Barclay SC/Route #70 E. Cherry Hill, NJ 08034 1690 Nottingham Way Hamilton, NJ 08619 310 White Horse Pike Lawnside, NJ 08045 3371 Brunswick Pike Lawrenceville, NJ 08648 Route 38 & Lenola Road Moorestown, NJ 08057 *2888 Route 10 West Morris Plains, NJ 07950 1014 Rt. 9 & Ernston Road Parlin, NJ 08859 1 Shoppers Lane Turnersville, NJ 08012 *3196 Kennedy Blvd. Union City, NJ 07087 NEW YORK 3330 Sheridan Drive Amherst, NY 14226 1740 Kenmore Avenue Buffalo, NY 14216 101 French Road, Suite 20 Cheektowaga, NY 14227 3401 Genesee Street Cheektowaga, NY 14225 100 Village Landing Fairport, NY 14450 2255 E. Ridge Road Irondequoit, NY 14622 3640 Delaware Avenue Kenmore, NY 14217 2429 Military Road Niagara Falls, NY 14304 3333 W. Henrietta Road Rochester, NY 14623 1900 Ridge Road West Seneca, NY 14224 705 Maple Road Williamsville, NY 14221 4101 Transit Road Williamsville, NY 14221 NORTH CAROLINA *8330 Pineville Matthews Road Charlotte, NC 28226 *5401 South Boulevard, Suite 230-A Charlotte, NC 28217 *6321 Albemarle Road Charlotte, NC 28212 *3400 Westgate Drive Durham, NC 27707 *2803 Battleground Avenue Greensboro, NC 27408 *980 Cloverleaf Plaza Kannapolis, NC 28083 *8111 Creedmoor Road Raleigh, NC 27613 OHIO 6106 Wilmington Pike Centerville, OH 45459 3670 Werk Road Cincinnati, OH 45248 2692 Madison Avenue, Suite B Cincinnati, OH 45208 8445 Colerain Avenue Cincinnati, OH 45239 485 East Kemper Road Cincinnati, OH 45246 8590 Beechmont Avenue Cincinnati, OH 45255 7700 Montgomery Road Cincinnati, OH 45236 3790 East Broad Street Columbus, OH 43213 260 Graceland Boulevard Columbus, OH 43214 2650 Bethel Road Columbus, OH 43220 3574 Soldano Blvd Columbus, OH 43228 5737 Emporium Square Columbus, OH 43231 5439 Salem Avenue Dayton, OH 45426 5522 Springboro Pike Dayton, OH 45449 7040 Perimter Loop Drive Dublin, OH 43016 379 Stoneridge Lane Gahanna, OH 43230 965 Hebron Road Heath, OH 43056 6430 Tussing Road Reynoldsburg, OH 43068 OKLAHOMA 4202 N.W. Expressway Oklahoma City, OK 73116 PENNSYLVANIA 925 Easton Road Abington, PA 19001 239 Concord Road Aston, PA 19014 2637 Street Road Bensalem, PA 19020 2920 Springfield Road Broomall, PA 19008 125 West Lincoln Highway Exton, PA 19341 305 Lancaster Pike Frazer, PA 19355 610 Old York Road Jenkinstown, PA 19046 553 South Broad Street Lansdale, PA 19446 Route 1 Levittown, PA 19056 2830 Dekalb Pike Norristown, PA 19401 1200 Welsh Road North Wales, PA 19454 24th & Oregon Philadelphia, PA 19145 9212 Franford Avenue At Linden Philadelphia, PA 19114 3899 Aramingo Avenue Philadelphia, PA 19137 6515 Castor Avenue Philadelphia, PA 19149 314 Lewis Road Royersford, PA 19468 550 East Lancaster Avenue St. David, PA 19087 2637 Ridge Pike Trooper, PA 19403 501 South 69th Street Upper Darby, PA 19082 599 Old York Road Warminster, PA 18974 TEXAS *2550 Barrow Street Abilene, TX 79605 *4210 B S.W. 45th Avenue Amarillo, TX 79109 *800 E. Road To Six Flags Arlington, TX 76011 *3700 Bee Caves Road Austin, TX 78746 *7301 Burnet Road, #200 Austin, TX 78757 *230 Security Drive Brownsville, TX 78521 *3065 N. Josey Lane Carrollton, TX 75006 *12801 Midway Road Dallas, TX 75244 *9661 Audelia Road, Suite 300 Dallas, TX 75238 *5517 Arapaho Road Dallas, TX 75248 *354 Hillside Village Dallas, TX 75214 *824 West University Denton, TX 76201 *6242 Hulen Bend Boulevard Ft. Worth, TX 76132 *6900 Ridgmar Meadow Road Ft. Worth, TX 76116 *950 W. Centerville Road Garland, TX 75041 *770 Bedford-Eugless Road Hurst, TX 76053 *420 E. FM 3040, Suite 700 Lewisville, TX 75067 *2321 West Loop 281 Longview, TX 75604 *5109 82nd Street Lubbock, TX 79424 *2201 Preston Road - Suite B Plano, TX 75093 *1021 N. Central Expressway Plano, TX 75075 *1736 E. Beltline Road Richardson, TX 75081 *50 Dal Rich Shopping Center Richardson, TX 75080 *2211 NW Military Highway, #127 San Antonio, TX 78213 *1530 Austin Highway, #101 San Antonio, TX 78218 *5614 South Broadway Tyler, TX 75703 *4303 N. Navarro Street, North Victoria, TX 77901 *5900 Bosque Boulevard Waco, TX 76710 VIRGINIA 5935 Centreville Crest Lane Centreville, VA 22020 *2165 Cunningham Drive Hampton, VA 23666 *3750 Virginia Beach Boulevard #25 Virginia Beach, VA 23452 WISCONSIN 16800 Blue Mound Road Brookfield, WI 53005 6200 West Brown Deer Road Brown Deer, WI 53223 5050 S. 74th Street Greenfield, WI 53221 6251 S. 27th Street Greenfield, WI 53221 1537 E. Moreland Boulevard Waukesha, WI 53186 10909 West Oklahoma Avenue West Allis, WI 53227 WEST VIRGINIA *3 Mall Road Barboursville, WV 25504 *120 Beckley Crossing Beckley, WV 25801 *5101 McCorkle Avenue, SE Charleston, WV 25304 *1603 Kanawha Boulevard West Charleston, WV 25312 * FRANCHISE LOCATIONS [LOGO] Printed in the U.S.A. on recycled paper (C) 1999 Drug Emporium, Inc. EX-23 3 EXHIBIT 23 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Forms S-8, Numbers 33-25768 and 33-69638) of Drug Emporium, Inc. and subsidiaries of our report dated April 15, 1999, with respect to the consolidated financial statements of Drug Emporium, Inc. and subsidiaries, incorporated by reference in this Annual Report (Form 10-K) for the year ended February 27, 1999. ERNST & YOUNG LLP Columbus, Ohio May 19, 1999 EX-27.1 4 EXHIBIT 27.1
5 1,000 U.S. DOLLARS 12-MOS FEB-27-1999 MAR-01-1998 FEB-27-1999 1 893 0 18,323 0 164,789 186,324 79,459 48,751 230,689 121,692 49,925 0 0 1,319 53,903 230,689 839,443 839,443 662,714 171,444 (6,760) 0 5,487 6,558 2,759 3,799 0 0 0 3,799 .29 .29
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