COMMUNITY DISTRIBUTORS INC, 10-K/A, 2000-11-14

COMMUNITY DISTRIBUTORS INC
10-K/A, 2000-11-14
DRUG STORES AND PROPRIETARY STORES

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The following items were the subject of a Form 12b-25 and are included herein:
Items 6, 7 and 8.

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

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FORM 10-K/A
AMENDMENT NO. 2

FOR ANNUAL REPORT AND TRANSITION REPORTS PURSUANT
TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED JULY 29, 2000
OR

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<C> <S>
/ / TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FOR THE TRANSITION PERIOD FROM ______________ TO ______________

COMMISSION FILE NUMBER: 0-21379

COMMUNITY DISTRIBUTORS, INC.
CDI GROUP, INC.

(Exact Names of Registrants as Specified in Their Charter)

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22-1833660
DELAWARE 22-3349976
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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800 COTTONTAIL LANE, FRANKLIN TOWNSHIP, SOMERSET, NEW JERSEY 08873-1227
(Address of Principal Executive Offices)
Registrant's telephone number, including area code
(732) 748-8900
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Securities registered pursuant to Section 12(b) of the Act: NONE

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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
-------------------------------------------------- --------------------------------------------------
None None
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-X 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. / /

The number of shares of the Common Stock, par value $.01 per share, of
Community Distributors, Inc., outstanding as of October 27, 2000 was 1,000, and
the number of shares of the Common Stock, par value $.00001 per share of CDI
Group, Inc., outstanding as of October 27, 2000 was 442,517.

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CONTENTS

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PAGE
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PART I

Item 1. Business.................................................... 3

Item 2. Properties.................................................. 12

Item 3. Legal Proceedings........................................... 13

Item 4. Submission of Matters to a Vote of Securityholders.......... 13

PART II

Item 5. Market for Registrants' Common Equity and Related
Stockholder Matters......................................... 14

Item 6. Selected Historical Financial Data.......................... 14

Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 17

Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 28

Item 8. Financial Statements and Supplementary Data................. 29

Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 56

PART III

Item 10. Directors and Executive Officers of the Registrants......... 57

Item 11. Executive Compensation...................................... 59

Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 61

Item 13. Certain Relationships and Related Transactions.............. 64

PART IV

Item 14. Exhibits and Financial Statement Schedules.................. 67
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PART I

ITEM 1. BUSINESS

COMPANY OVERVIEW

Community Distributors, Inc. (the "Company") is among the largest regional
drugstore chains in the United States and the only regional chain focused
primarily on the densely populated northern and central New Jersey markets,
although several national and other regional drugstore chains have operations in
these areas. CDI Group, Inc. (the "Holding Company") is the owner of all of the
outstanding capital stock of the Company. The Company operates a chain of 51
drug and general merchandise stores under two separate formats, Drug Fair and
Cost Cutters. Of the Company's 51 stores, 30 have been opened since 1989 and all
of the remaining 21 have been refurbished since 1991. The Company was acquired
by the Holding Company on January 30, 1995 (the "Acquisition"). As used in this
Annual Report on Form 10-K (the "Report"), the terms "fiscal 1996," "fiscal
1997," "fiscal 1998," "fiscal 1999," and "fiscal 2000" refer to the fiscal years
ended or ending July 28, 1996, July 26, 1997, July 25, 1998, July 31, 1999, and
July 29, 2000, respectively, of the Company or the Holding Company, as
applicable.

DRUG FAIR. Drug Fair is a chain of 36 large-format drugstores with an
average store size of approximately 17,000 square feet. All of the stores
contain a pharmacy in the rear of the store, which is the focal point of the
store layout. In fiscal 2000, the Company's pharmacies (including four at Cost
Cutters locations) filled over 2.0 million prescriptions, an average weekly
volume of approximately 1,000 prescriptions per pharmacy, and pharmacy sales
increased 18.7% over fiscal 1999. Currently, approximately 84.4% of the
Company's prescription sales are made to participants in managed health care
plans and other third-party payer plans ("Third-Party Plans"). Drug Fair's
strategy is to utilize large-format stores to capitalize on the increased
customer traffic associated with its growing pharmacy business to increase sales
of higher margin non-pharmacy merchandise, including health and beauty care
items, housewares, greeting cards, stationery, candy and seasonal items. General
merchandise accounted for approximately 53.2% of Drug Fair revenues in fiscal
2000. Drug Fair stores are primarily located in neighborhood shopping centers
that are easily accessible and generate significant customer traffic.

COST CUTTERS. Cost Cutters is a 15-store general merchandise chain with an
average store size of approximately 30,000 square feet. Cost Cutters stimulates
customer traffic by offering a non-pharmacy merchandise mix similar to Drug
Fair, a high-impact merchandise presentation and an everyday low price strategy,
with prices generally 10%-15% lower than Drug Fair. Cost Cutters offers a
broader selection of products than Drug Fair while still focusing on health and
beauty care items, housewares, greeting cards, stationery, candy and seasonal
items. Currently, five locations have pharmacies, one within the store and four
as separate Drug Fair storefronts adjacent to the store. The Company believes
there is an opportunity to open Drug Fair pharmacies at certain additional Cost
Cutters locations. Cost Cutters stores are primarily located near major
highways, drawing customers from a wider area than a typical drugstore and
emphasizing their destination-store orientation.

BUSINESS INFORMATION

The Company's products may be divided generally into two categories:
pharmacy and general merchandise, which includes over-the-counter
pharmaceuticals, health and beauty care items, housewares, stationery and
greeting cards, candy, food and beverage (primarily convenience foods),
cosmetics and seasonal and promotional items. The principal products offered by
the Company in these two industry categories and the approximate percentage of
revenues attributable to such categories are described below.

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STORE OPERATIONS

The Company's stores are operated under two separate formats, Drug Fair and
Cost Cutters. The Company employs different pricing strategies for Drug Fair and
Cost Cutters, each targeted towards the customers it seeks to attract. Drug Fair
uses a more traditional promotional pricing strategy, with a limited number of
discounted items. In contrast, Cost Cutters relies on an everyday low price
strategy by offering lower prices on most items on a regular basis, which
management believes is consistent with its destination-store orientation.

The following table sets forth the approximate percentage of revenues
attributable to each major product category at Drug Fair and Cost Cutters stores
during fiscal 2000:

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PERCENTAGE OF FISCAL 2000
SALES BY CATEGORY
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CATEGORY: DRUG FAIR COST CUTTERS
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Pharmacy.................................................... 43.6% 9.9%
Health and Beauty Care and OTC Pharmaceuticals.............. 15.0 21.8
Other Merchandise........................................... 9.9 11.0
Housewares.................................................. 7.2 15.9
Stationery and Greeting Cards............................... 7.0 12.4
Candy, Food and Beverage.................................... 6.4 9.7
Seasonal and Promotional.................................... 7.4 13.7
Cosmetics................................................... 3.5 5.6
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100.0% 100.0%
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Excluding revenue generated by stores that were open less than twelve months
before the beginning of the applicable fiscal year, the Company's stores
generated net sales of $250.3 million in fiscal 1999 (from 41 stores), and
$261.3 million in fiscal 2000 (from 43 stores), an increase of 4.4%. The Company
attributes this growth to increased pharmacy sales as well as increased sales of
non-pharmacy merchandise generated by increased customer traffic, as well as the
successful implementation of the Company's merchandising strategies.

DRUG FAIR

Drug Fair is a 36-store chain of larger sized traditional drugstores
primarily located in easily accessible neighborhood shopping centers. Drug Fair
has built a base of loyal customers by offering a broader range of non-pharmacy
general merchandise within this larger format, including an expanded selection
of health and beauty care items, housewares, greeting cards, stationery and
seasonal items, in a convenient setting with attractive prices. Drug Fair's
strategy is to emphasize its broad selection of merchandise and offer
competitive prices relative to its competition. In particular, the Company
believes that its broader selection of non-pharmacy general merchandise is a
significant competitive strength. The Company's long-standing philosophy of
customer service has made Drug Fair a leader in local pharmacy services in its
markets.

The first Drug Fair store was opened in 1954 in Scotch Plains, New Jersey
and the Company's current Drug Fair locations average approximately 17,000
square feet, ranging between 11,200 and 23,400 square feet. The Company believes
that its store size and locations are important factors to store profitability.
Most Drug Fair stores are contained in neighborhood shopping centers that are
easily accessible and generate significant customer traffic. All stores are open
seven days a week, from 9:00 a.m. to 9:30 p.m., Monday through Friday, with
slightly reduced hours on weekends, totaling approximately 83 hours per week.

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PHARMACY. In fiscal 2000, the Company's pharmacies filled over 2.0 million
prescriptions, representing an average weekly volume of approximately 1,000
prescriptions per pharmacy, and pharmacy sales increased 18.7% over fiscal 1999.
Currently, approximately 84.4% of prescription volume results from sales to
Third-Party Plan participants. The Company offers discounts on prescriptions to
senior citizens, who accounted for approximately 7.4% of prescription sales
volume in fiscal 2000.

All Drug Fair stores contain a pharmacy in the rear of the store, each
staffed by two full-time registered pharmacists. The pharmacy is the focal point
of the store layout, which is also designed to promote optimal customer flow and
shopping convenience. New and remodeled stores typically have enhancements such
as pharmacy waiting and consultation areas. In addition, for the past six years
Drug Fair stores have featured free home delivery of prescriptions. The Company
believes that this delivery service represents an attractive alternative to the
drive-through pharmacy service offered by some of its competitors while avoiding
the significant capital expenditures required to remodel stores to accommodate
drive-through services.

GENERAL MERCHANDISE. As a customer-oriented, lower-cost retail drugstore,
Drug Fair strives to compete on the bases of cost and maintaining a high-quality
image with the consumer. General merchandise is an important component of Drug
Fair's revenues, comprising approximately 53.2% of Drug Fair revenues in fiscal
2000. General merchandise products are well stocked and displayed on shelves
within easy reach of consumers. With its convenient merchandise layout and large
selection, Drug Fair retains its small-store atmosphere while offering a variety
of merchandise selections typically seen in larger retail stores. Drug Fair
offers a selection of general merchandise similar to that of its drugstore
competitors but, due to its above average size, is able to expand its selection
of items and offer a wider assortment of higher margin non-pharmacy merchandise.
For example, seasonal items have been a key contributor to Drug Fair's success,
comprising 7.4% of Drug Fair's revenues in fiscal 2000. Seasonal items are
prominently displayed along the entrance, providing a varied product mix and
generating impulse buying. With nearly 58,000 non-pharmacy stock keeping units
("SKUs") including seasonal items, Drug Fair also offers expanded greeting card
and household item selections to the consumer.

In addition to its general merchandise offerings, the Company seeks to
attract customers by offering ancillary conveniences and services, such as
lottery tickets, convenience food sections and film processing in many of its
stores, including its own on-site one-hour photo finishing labs in 25 Drug Fair
locations. Management believes that it offers the lowest prices for one-hour
film developing in its markets. The Company intends to continue to experiment
with new products and services designed to increase customer traffic and enhance
convenience.

COST CUTTERS

Cost Cutters is a 15-store general merchandise chain focused on the product
areas of health and beauty care, housewares, greeting cards, stationery, candy
and seasonal items. The stores are self-service oriented, and feature a
non-pharmacy merchandise mix similar to that of Drug Fair, with more than a 90%
overlap in general merchandise, at prices generally 10%-15% lower than at Drug
Fair. Currently, one Cost Cutters location houses its own pharmacy, and the
Company has added Drug Fair pharmacies adjacent to four of its Cost Cutters
locations. The Company believes there is an opportunity to open Drug Fair
pharmacies in certain additional Cost Cutters locations. Cost Cutters is unique
in its merchandising strategy in its markets and provides a much broader product
variety and deeper discounts than other local stores, while successfully
competing with mass merchandise stores.

The Company opened its first Cost Cutters store in 1983 in Norwood, New
Jersey and the Company's Cost Cutters stores average approximately 30,000 square
feet in size, ranging from 21,000 to 37,000 square feet. In expanding to new
sites, the Company has opportunistically negotiated favorable

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lease terms, typically from grocery stores that are relocating, rather than
paying higher prices for new real estate. Most of the stores are located in
shopping centers, near highways in easily accessible locations for surrounding
communities. By comparison, larger discount department chains, such as WalMart,
Target and K-Mart, typically build new stores in excess of 100,000 square feet
and focus more on higher-priced products such as apparel, sporting goods,
electronics and appliances. The Company believes that the accessibility and
manageable size of a Cost Cutters store is attractive to consumers at a time
when larger discount merchandisers continue to open larger and more complex
stores that many customers may find less convenient. All stores are open seven
days a week, from 9:00 a.m. to 9:30 p.m., Monday through Friday, with slightly
reduced hours on weekends, totaling approximately 83 hours per week.

PHARMACY. While pharmacy is not the main focus of the Cost Cutters chain,
one Cost Cutters location houses its own pharmacy and the Company has Drug Fair
pharmacies as separate storefronts adjacent to four of its Cost Cutters
locations with a pass-through between the store and the pharmacy. The Company
believes there is an opportunity to add Drug Fair pharmacies to certain
additional Cost Cutters stores depending on factors such as lease restrictions,
location, store size, layout and competition. The Company estimates that it
costs $75,000 to $100,000 to install a Drug Fair pharmacy next to an existing
Cost Cutters location (assuming construction of a new storefront is required),
excluding costs of staffing and inventory.

GENERAL MERCHANDISE. With over 59,000 non-pharmacy SKUs, including seasonal
items, and substantial overlap in merchandise with Drug Fair, Cost Cutters
distinguishes itself through its merchandise presentation, pricing strategy,
assortment of items targeted to impulse purchases and a strong merchandising
position in greeting cards, stationery, seasonal items and household products.
In addition to traditional retail drugstore general merchandise such as health
and beauty care items, over-the-counter ("OTC") pharmaceuticals, candy and
seasonal items, Cost Cutters also sells luggage, kitchenware and an extended
selection of houseware products and automotive-related goods. One of the
Company's merchandising strategies is a high-impact merchandise presentation
based on well-stocked shelves that are highly visible to the customer, promoting
a value superstore image. Seven Cost Cutters locations contain on-site one-hour
photofinishing labs.

Cost Cutters is less promotional than most other discount stores because it
utilizes an everyday low price strategy. Competitors such as K-Mart and Bradlees
generally employ what is known as a "high-low" pricing strategy, in which
everyday prices are generally higher than at Cost Cutters but are reduced below
Cost Cutters' prices during periodic store-wide sales. The Company believes that
Cost Cutters' pricing strategy is more attractive to consumers than alternative
pricing strategies for the majority of its product offerings, including health
and beauty care products that are typically purchased when needed as opposed to
when offered on sale.

ADVERTISING AND PROMOTION

The Company aggressively advertises its Drug Fair and Cost Cutters chains
through extensive use of colorful, high-quality direct mail circulars
distributed to its neighborhood markets. Approximately 26 Drug Fair circular
programs are distributed annually, with each circular typically containing a
selection of approximately 200 specially priced items chosen to build customer
traffic. Cost Cutters distributes approximately 17 circular programs annually,
each containing approximately 200 items, of which 10% to 15% have been reduced
in price. The circulars often contain coupons good for item discounts and
advertise "Special" and "Bonus" buys. "Special" buys are items that are carried
at reduced prices while supplies last. "Bonus" buys are items carried every day
that include an additional amount of the same product or another product for no
extra cost. The Company estimates the average circular program costs $155,000 to
produce and distribute to approximately 800,000 recipients, although in some
cases the cost is partially offset by co-op advertising rebates received from
featured suppliers.

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PURCHASING AND DISTRIBUTION

By operating both Drug Fair and Cost Cutters chains, the Company believes
that it is able to take advantage of economies of scale available to larger
chains in purchasing merchandise and maintaining up-to-date systems and
technology. Although the Company utilizes two separate retail formats, the 51
stores are operated as one company through centralized purchasing and
distribution and use complementary marketing strategies. The Company believes
that its focus on consistent execution of its purchasing, pricing and
merchandising strategies has been instrumental in its success to date.

The Company maintains centralized budgeting, pricing, purchasing,
warehousing and inventory control functions at its corporate offices. Products
are purchased for both store chains by merchandise managers, each of whom is
responsible for a distinct product category (for example, cosmetics or
housewares) and reports to the Company's Vice President of Merchandising.

Approximately 56.0% of all non-prescription purchases are received at the
Company's current central warehouse and distribution center in Somerset, New
Jersey. These products are delivered to the stores by the Company's eleven owned
trucks. The balance of general merchandise is shipped directly to the stores by
manufacturers and distributors. All prescription drugs are shipped directly to
the individual stores by wholesale drug distributors on a daily basis. The
Company has an agreement with Cardinal Health, Inc. ("Cardinal") to supply
pharmaceuticals, health and beauty care, home health care and related products.
The term of the Company's supply agreement with Cardinal (the "Cardinal
Agreement") expires in February 2003. Pursuant to the terms of the Cardinal
Agreement, the Company purchases pharmacy and health and beauty care products at
a specified discount to Cardinal's Costs. The Company believes that Cardinal's
Cost (as defined in the Cardinal Agreement) is higher than Cardinal's actual
cost for the pharmaceutical products it supplies because it does not reflect all
discounts that may be available to Cardinal from its suppliers. Bellco Drug
Corporation ("Bellco") serves as a secondary supplier for products that are not
routinely carried by or are out of stock at Cardinal, and the Company believes
that its pharmacy products are readily available from numerous other wholesale
suppliers of pharmacy products that would be able to supply the Company's
requirements on substantially similar terms in the event that Cardinal and/or
Bellco were unable to do so. Management believes that by operating both chains
it is able to purchase most of its products at competitive prices by purchasing
products in truck-load or container quantities.

The Company buys products from more than 1,600 suppliers and manufacturers
and seeks to purchase its merchandise directly from manufacturers in order to
take advantage of promotional programs offered only to retailers, including
co-op advertising allowances, promotional displays and materials and price
promotions. The Company believes that its relationships with its vendors are
good. The Company often utilizes prompt cash payments to obtain additional
merchandise discounts. None of the Company's suppliers or manufacturers
represented more than 10% of the Company's total non-pharmacy purchases during
fiscal 2000.

MANAGEMENT INFORMATION SYSTEMS

The Company operates an in-house data processing system in connection with
the operation and management control functions of its business. This system
incorporates both proprietary and commercially available software, including the
JDA Software, Inc. ("JDA") Merchandise Management System, the Company's E-3
warehouse replenishment system and Lawson Associates payroll and general ledger
systems, and is designed to integrate the key retailing functions of merchandise
planning, purchase order management, sales capture, merchandise distribution,
receiving, order entry, inventory control and replenishment. Management believes
its systems enable the Company to maintain a virtually constant "in-stock"
position in all key lines of merchandise. In anticipation of continued growth,
the Company purchased a new comprehensive processing system developed by JDA.
Effective June 1, 1998, the Company implemented the Accounts Payable, Sales
Audit, and Point-of-Sale Interface

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modules of the JDA processing system. In late September 1998, the Company
implemented the Sales Analysis, Inventory Management, Electronic Data
Interchange and Purchasing modules of the JDA processing system.

The Company monitors sales at its 51 stores through a point-of-sale network,
utilizing IBM Chain Sales software and hardware, which links store terminals to
a central computer located at the Company's headquarters. The Company uses this
system to provide management with detailed information on individual store
operations on a daily basis.

All sales data is recorded by cashiers, utilizing scanners, in each store at
the time of sale. Sales data is transmitted to the central computer where it is
compiled to produce daily, weekly and monthly management reports. Reports are
organized by line of merchandise, class, item and store, and enable management
to monitor sales and profitability by location. Based upon this information,
management makes merchandising decisions as required, including reorders,
special promotions and changes in buying programs. As a means of further
inventory verification, physical inventories are taken twice a year at all
stores and the warehouse. The Company also employs Telxon and Symbol
Technologies radio frequency equipment in order to constantly monitor and update
inventory, shelf labels and prices.

All of the Company's stores contain Sensormatic Electronic Article
Surveillance Systems designed to minimize theft. Since its installation five
years ago, this system has contributed to reducing overall shrinkage to
approximately 1.5% of sales, which management believes is below the industry
average.

COMPETITION

The Company competes in its markets with several national, regional and
local drugstore chains, large grocery stores and supermarkets, membership clubs,
deep discount drugstores, combination food and drugstores, discount general
merchandise stores, mass merchandisers, independent drugstores and local
merchants. Historically, consumers were faced with few alternatives for filling
their prescriptions. Today's customer has a number of options including
independent or chain drugstores, food retailers, mass merchants (including
discounters and deep discounters) and "mail-order" pharmacies, as well as
supermarkets, combination food and drugstores, hospitals and HMOs. The Company's
on-site one-hour photofinishing labs also compete with a variety of mini-lab
photo-processors and photo-specialty shops.

The Company believes that the primary elements of competition in its
industries include pricing, store location and design, product selection,
customer service and convenience. The Company believes that it competes
successfully because of its pricing policies, reputation for reliability,
convenient store locations, superior pharmacy services, broad selection of
merchandise and effective sales techniques. However, the competitive environment
is often affected by factors beyond a particular retailer's control, such as
shifts in consumer preferences, economic conditions and population and traffic
patterns. The Company believes that in the future the ability to compete
effectively will be increasingly dependent on quality merchandising and customer
service, the effectiveness of cost containment measures, especially with respect
to pharmacy services, and advanced information systems.

GOVERNMENT REGULATION

Pharmacies are subject to extensive federal, state and local regulation.
These regulations cover required qualifications, day-to-day operations,
reimbursement and documentation of activities.

LICENSES AND REGULATION. The Company's pharmacists are required to be
licensed by the New Jersey Board of Pharmacy. All stores with pharmacies and the
Company's distribution center are also registered with the Federal Drug
Enforcement Administration, although no pharmaceuticals are stored in the
distribution center. Various other federal and state licenses (including state
licenses required to sell cigarettes) are required for the conduct of the
Company's business as presently conducted. The Company seeks to comply with all
such licensing and registration requirements and continues to

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actively monitor its compliance with such requirements. By virtue of these
licenses and registration requirements, the Company is obligated to observe
certain rules and regulations, and a violation of these rules and regulations
could result in a suspension or revocation of one or more licenses or
registrations and/or monetary penalties or fines. The sale of pharmaceutical
products at new stores requires the issuance of additional licenses, with
respect to which the licensing authorities may conduct investigations.

In 1990, the United States Congress enacted the Omnibus Budget
Reconciliation Act of 1990 (OBRA), which required states to implement
pharmaceutical drug use review programs for Medicaid beneficiaries by
January 1, 1993. Under OBRA, pharmacists are required to offer counseling,
without additional charge, to customers covered by Medicaid about medication,
dosage, delivery systems, common side effects and other information deemed
significant by the pharmacists. The State of New Jersey enacted broader
regulations that require pharmacists to provide such counseling to all
customers, regardless of whether they are covered by Medicaid. As a result, the
Company's pharmacists must provide counseling to customers and have a duty to
warn customers regarding any potential adverse effects of a prescription drug if
the warning could reduce or negate such effects. In addition, the Company's
pharmacists are required to conduct a prospective drug review before any new
prescriptions are dispensed, and may conduct a similar review prior to refilling
any prescriptions if considered appropriate. Such reviews include screening for
potential drug therapy problems due to (i) potential or actual reactions to
drugs, (ii) therapeutic appropriateness, (iii) over utilization, or
underutilization, (iv) appropriate use of generic drugs, (v) therapeutic
duplication, (vi) drug-disease contraindications, (vii) drug-drug interactions,
(viii) incorrect drug dosage or duration of drug treatment, (ix) drug-allergy
interactions, and (x) clinical abuse or misuse. Further, New Jersey closely
regulates the dispensing by pharmacists of over-the-counter controlled dangerous
substances, imposing requirements as to: (i) filling and refilling of
prescriptions, (ii) labeling of prescriptions, and (iii) monitoring the use of
Schedule V over-the-counter controlled dangerous substances to determine, in a
pharmacist's professional judgment, whether the substance has or will be used
for unauthorized or illicit consumption or distribution. The Company believes
its series of training programs for pharmacy personnel and its pharmacy computer
network are designed to ensure that these requirements are satisfied, but
violations of these regulations could have an adverse impact on the Company.

STATE LAWS AFFECTING ACCESS TO SERVICES. In July 1994, the State of New
Jersey adopted "Freedom of Choice" and "Any Willing Provider" legislation, which
the Company believes results in a "level playing field" in New Jersey for
regional drugstore chains such as the Company. The "Freedom of Choice"
legislation permits Third-Party Plan participants to purchase prescription drugs
from the provider of their choice if the provider meets uniformly established
requirements. In states which have not adopted similar legislation, many
Third-Party Plans align themselves by agreement with particular drugstore chains
under arrangements whereby members of a Third-Party Plan are required to
purchase their drugs at a particular drugstore chain in order for most or all of
the cost to be paid by the Third-Party Plan. As a result, other drugstore chains
and independent drugstores are in effect precluded from selling prescription
drugs to the applicable members. The "Any Willing Provider" legislation requires
that any Third-Party Plan that has entered into an agreement with a prescription
provider must permit any other licensed provider to participate in such
Third-Party Plan as a preferred or contracting provider if it is willing to
accept the terms of such agreement. Such legislation may increase competition
for the Company's pharmacies.

MEDICARE AND MEDICAID. The pharmacy business has long operated under
regulatory and cost containment pressures from state and federal legislation
primarily affecting Medicaid and, to a lesser extent, Medicare.

The Medicaid program is a cooperative federal-state program designed to
enable states to provide medical assistance to aged, blind, or disabled
individuals, or members of families with dependent children whose income and
resources are insufficient to meet the costs of necessary medical services.

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Federal laws and regulations contain a variety of requirements relating to
the furnishing of prescription drugs under Medicaid. First, states are given
authority, subject to certain standards, to limit or specify conditions to the
coverage of particular drugs. Second, federal Medicaid law establishes standards
affecting pharmacy practice, such as the OBRA counseling and drug utilization
review requirements described above. Third, federal regulations impose certain
requirements relating to the reimbursement for prescription drugs furnished to
Medicaid recipients. Among other things, federal regulations establish "upper
limits" on payment levels. In addition to requirements imposed by federal law,
states have substantial discretion to determine administrative, coverage,
eligibility and payment policies under their state Medicaid programs which may
affect the Company's operations.

The Medicare program is a federally funded and administered health insurance
program for individuals age 65 and older or who are disabled. Medicare covers a
limited number of specifically designated prescription drugs. As a result of the
Balanced Budget Act of 1997, reimbursement for these products is generally
limited to 95% of the published average wholesale price for such products. Over
the last several years, an increasing number of Medicare beneficiaries have been
served through health maintenance organizations. In addition to the limited
Medicare coverage for specified products described above, some of these health
maintenance organizations providing health care benefits to Medicare
beneficiaries may offer expanded drug coverage.

The Medicare and Medicaid programs are subject to statutory and regulatory
changes, retroactive and prospective rate adjustments, administrative rulings
and freezes and funding restrictions, all of which may adversely affect the
Company's business. There can be no assurance that payments for pharmaceutical
supplies and services under governmental reimbursement programs will continue to
be based on the current methodology or remain comparable to present levels. In
this regard, the Company may be subject to rate reductions as a result of
federal budgetary legislation related to the Medicare and Medicaid programs. In
addition, various Medicaid programs periodically experience budgetary shortfalls
which may result in Medicaid payment delays.

FRAUD AND ABUSE. The Company is subject to federal and state laws
prohibiting the submission of false or fraudulent claims and governing its
billing relationships and financial and other arrangements among health care
providers and vendors. These laws include the federal anti-kickback statute,
which prohibits, among other things, (i) knowingly and willfully soliciting,
receiving, offering or paying any remuneration directly or indirectly to induce
or in return for the referral of an individual to a person for the furnishing of
any item or service for which payment may be made in whole or in part under
federal health care programs, or (ii) purchasing, ordering or recommending, or
arranging for purchasing or ordering such covered items or services. Many states
have enacted similar statutes which are not necessarily limited to items and
services for which payment is made by federal health care programs. New Jersey,
for example, enacted the "Healthcare Cost Reduction Act" in 1991. Federal and
state courts have interpreted these laws broadly. Violations of these laws may
result in fines, imprisonment, civil money penalties and exclusion from the
federal and state funded health care programs.

The Department of Health and Human Services Office of Inspector General has
issued a "Special Fraud Alert" concerning prescription drug marketing practices
that could potentially violate the federal anti-kickback statute. According to
the Special Fraud Alert, examples of practices that may violate the statute
include certain arrangements under which remuneration is made to pharmacists to
recommend the use of a particular pharmaceutical product.

In addition, a number of states have undertaken enforcement actions against
pharmaceutical manufacturers involving pharmaceutical marketing programs,
including programs containing incentives to pharmacists to dispense one
particular product rather than another. These enforcement actions arose under
state consumer protection laws which generally prohibit false advertising,
deceptive trade practices, and the like. Other proposed action by state pharmacy
boards or federal regulators could

10
<PAGE>
reduce or eliminate the reimbursement pharmacies receive to conduct therapeutic
interchange or compliance programs on behalf of health plans or other pharmacy
benefit managers.

The Company seeks to maintain its contract arrangements with other health
care providers, its pharmaceutical suppliers and its pharmacy practices in
compliance with these laws. There can be no assurance that such laws will not,
however, be interpreted in the future in a manner inconsistent with the
Company's interpretation and application.

HEALTH CARE LEGISLATION. Prescription drug sales have represented a
significant portion of the Company's revenues. These revenues may be affected by
changes within the health care industry, including changes in programs providing
for reimbursement of the cost of prescription drugs by Third-Party Plans,
regulatory changes relating to the approval process for prescription drugs and
proposals to reduce significantly projected increases in federal spending on
Medicare, Medicaid and other governmental programs.

In recent years, a number of legislative proposals have been introduced in
Congress to reform the health care system, including proposals in the context of
federal budget legislation. In addition, a number of states have enacted and are
considering various health care reforms. For example, several state Medicaid
programs have established mandatory statewide managed care programs for Medicaid
beneficiaries to control costs through negotiated or capitated rates, as opposed
to traditional cost based reimbursement for Medicaid services, and proposed to
use savings achieved through these programs to expand coverage to those not
previously eligible for Medicaid. Also, a provision of the FDA Modernization
Act, which became effective November 21, 1998, expressly permits pharmacy drug
compounding under certain conditions for individual patients. This maintains and
could increase the range of services provided by the Company. The Company cannot
predict whether or in what form health care legislation may be adopted in the
future, at the federal or state level, or the impact of any such legislation on
the Company's financial position or results of operations. However, to the
extent health care legislation expands the number of persons receiving health
care benefits covering the purchase of prescription drugs (such as through
government-sponsored managed care initiatives), it could result in increased
purchases of such drugs and could thereby have a favorable impact on both the
Company and the retail drug industry in general. Nevertheless, there can be no
assurance that any such legislation will be enacted or, if enacted, that such
legislation will not have an adverse effect on the Company.

LABOR LAWS. The Company is subject to laws governing its relationship with
employees, including minimum wage requirements, overtime and working conditions.
An increase in the minimum wage rate, employee benefit costs or other costs
associated with employees could adversely affect the Company.

TRADE NAMES, SERVICE MARKS AND TRADEMARKS

The Company uses various trade names, service marks and trademarks,
including "Drug Fair" and "Cost Cutters," in the conduct of its business.
Historically, the Company has relied on common law protection of its trade
names, service marks and trademarks. Common law provides the Company with
limited protection for its trade names, service marks and trademarks within its
product lines and in its geographic market areas. Although the Company has filed
a federal service mark registration application for the service mark "Drug
Fair," a third party which does not currently operate in the Company's
geographic markets owns an issued federal service mark registration for the name
"Cost Cutters."

11
<PAGE>
EMPLOYEES

As of October 15, 2000, the Company had approximately 1,800 employees of
which approximately 45% were full-time and 55% were part-time. None of such
employees are covered by collective bargaining agreements or represented by
unions. The Company has not experienced any material business interruption as a
result of labor disputes and the Company considers its employee relations to be
good.

ITEM 2. PROPERTIES

The Company's stores by location, fiscal year opened, fiscal year
refurbished and size were as follows on October 27, 2000:

<TABLE>
<CAPTION>
FISCAL YEAR SQUARE
LOCATION OPENED/REFURBISHED FOOTAGE
-------- ------------------ --------
<S> <C> <C>
DRUG FAIR
South Plainfield................................... 1959/1994 21,250
Manville........................................... 1965/1991 20,000
Old Bridge......................................... 1969/1992 16,527
Edison............................................. 1970/1992 15,000
Freehold........................................... 1970/1974 16,000
Westfield.......................................... 1972/1991 23,424
Aberdeen........................................... 1974/1993 11,620
Fairfield.......................................... 1976/1991 19,600
Hazlet............................................. 1976/1991 12,000
Berkeley Heights................................... 1977/1993 16,800
Milburn............................................ 1977/1992 21,112
Warren............................................. 1978/1991 15,000
Wyckoff............................................ 1981/1995 15,960
Rahway............................................. 1983/1993 13,900
Isellin............................................ 1985/1993 16,265
Englewood.......................................... 1988/1992 13,440
Cranford........................................... 1989/- 13,661
Oakland............................................ 1989/- 20,205
Middlesex.......................................... 1991/- 23,000
Stirling........................................... 1993/- 15,777
Verona............................................. 1995/- 17,200
Chatham............................................ 1995/- 20,800
Clifton............................................ 1996/- 11,200
Ramsey............................................. 1996/- 17,000
Somerset........................................... 1996/- 18,050
Plainfield......................................... 1997/- 18,000
Hillside........................................... 1998/- 17,600
Florham Park....................................... 1998/- 12,750
North Arlington.................................... 1999/- 15,500
Fairview........................................... 1999/- 14,225
Port Monmouth...................................... 1999/- 16,450
Belleville......................................... 1999/- 19,000
Clifton............................................ 1999/- 16,000
Wayne.............................................. 2000/- 17,993
Sayreville......................................... 2000/- 17,500
</TABLE>

12
<PAGE>

<TABLE>
<CAPTION>
FISCAL YEAR SQUARE
LOCATION OPENED/REFURBISHED FOOTAGE
-------- ------------------ --------
<S> <C> <C>
Morris Plains...................................... 2000/- 17,300
Little Falls....................................... 2001/- 12,500
COST CUTTERS
Norwood............................................ 1983/1992 24,630
Bricktown.......................................... 1984/1993 26,878
Middletown......................................... 1984/1993 27,988
Hamilton........................................... 1985/1993 33,300
Union.............................................. 1985/1994 35,217
West Long Branch................................... 1986/1996 27,113
Wall............................................... 1987/1993 30,000
Hillsborough....................................... 1990/1994 20,600
Parsippany......................................... 1991/- 29,575
Lacey.............................................. 1992/- 34,000
Wayne.............................................. 1992/- 29,000
Ocean.............................................. 1993/- 36,890
Toms River......................................... 1994/- 34,000
Elizabeth.......................................... 1995/- 25,000
Lincoln Park....................................... 1995/- 30,100
</TABLE>

All of the Company's stores are leased pursuant to long-term leases
containing generally favorable terms. The current leases expire between
March 31, 2002 and April 30, 2039 (assuming renewal options are exercised), with
an average of 18 years remaining on lease terms. Twenty-one leases will expire
between 2001-2015 and 30 leases will expire after 2015. One lease is currently
on a month-to-month basis.

ITEM 3. LEGAL PROCEEDINGS

The Company is from time to time involved in routine litigation incidental
to the conduct of its business. The Company believes that no current pending
litigation to which it is a party will, individually or in the aggregate, have a
material adverse effect on its financial position or results of operations or
cash flows. The Company has not been required to expend in the past, and does
not expect to be required to expend in the future, any significant amounts for
investigation of environmental conditions, remediation of environmental
conditions or other similar matters.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

None.

13
<PAGE>
PART II

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

The Common Stock of the Registrants is not publicly traded.

On October 16, 1997, the Holding Company issued an aggregate of 24,237
shares of its Common Stock to twelve of its shareholders, all of whom were
officers, directors or other members of the Company's management, pursuant to
the exercise of stock options previously granted to such persons. These sales of
Common Stock were made by the Holding Company in reliance of the exemption from
registration provided by Rule 701 under the Securities Act of 1933, as amended
(the "Securities Act").

On October 16, 1997, the Company issued $80,000,000 aggregate principal
amount of its 10 1/4% Senior Notes due 2004 (the "Original Notes") to Donaldson,
Lufkin & Jenrette Securities Corporation and Bear, Stearns & Co., Inc. (the
"Initial Purchasers") in a transaction exempt under Regulation D under the
Securities Act. The Initial Purchasers resold the Original Notes to certain
qualified institutional buyers in reliance upon, and subject to the restrictions
imposed pursuant to, Rule 144A under the Securities Act.

On October 16, 1997, the Holding Company issued amended and restated
subordinated notes due 2005 (the "Subordinated Notes") in the same principal
amounts to the original holders thereof in connection with the issuance of the
Original Notes and the Holding Company's Guarantee of such Notes. These amended
and restated Subordinated Notes were issued in reference on the exemption from
registration under the Securities Act provided by Section 4(a) thereof.

On February 13, 1998, the Company commenced an offer to exchange $80,000,000
in aggregate principal amount of its 10 1/4% Senior Notes due 2004, Series B
(the "Exchange Notes") that had been registered under the Securities Act for a
like principal amount of the Original Notes. This exchange was commenced
pursuant to the terms of the Registration Rights Agreement, dated as of
October 16, 1997, between the Company and the Initial Purchasers. Each of the
Exchange Notes and the Original Notes has been guaranteed by the Holding
Company. An aggregate principal amount of $80,000,000 of Exchange Notes were
issued in exchange for the Original Notes on March 20, 1998, and the Original
Notes were retired. The Exchange Notes are referred to hereinafter
interchangeably with the Original Notes as the "Senior Notes."

On September 16, 1998, the Board of Directors of the Company authorized the
repurchase by the Company of up to $6.0 million principal amount of Senior Notes
on the open market. On October 6, 1998, the Company repurchased an aggregate of
$5.0 million principal amount of Senior Notes at a purchase price of $930 per
$1,000 principal amount of Senior Notes, plus accrued and unpaid interest. On
October 13, 1998, the Company repurchased an additional $1.0 million principal
amount of Senior Notes at a purchase price of $925 per $1,000 principal amount
of Senior Notes, plus accrued and unpaid interest. As of October 15, 1998,
$74.0 million aggregate principal amount of Senior Notes remained outstanding.

ITEM 6. SELECTED HISTORICAL FINANCIAL DATA

SELECTED FINANCIAL DATA OF THE COMPANY

The selected financial data presented below under the captions "Statement of
Operations Data" and "Balance Sheet Data" as of and for each of the periods in
the five-year period ended July 29, 2000, are derived from the audited financial
statements of the Company. The financial statements for fiscal 1996, fiscal
1997, fiscal 1998, fiscal 1999 and fiscal 2000 have been audited by
PricewaterhouseCoopers, LLP. The selected financial and other data presented
below under the caption "Other Data" as of and for all of the periods presented,
are unaudited.

14
<PAGE>
The selected financial data presented below should be read in conjunction
with the audited financial statements and the related notes thereto of the
Company for fiscal 1998, fiscal 1999, and fiscal 2000 appearing elsewhere in
this Report. For additional information, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

<TABLE>
<CAPTION>
TWELVE TWELVE TWELVE TWELVE TWELVE
MONTHS MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED ENDED
JULY 28, 1996 JULY 26, 1997 JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Net sales......................... $215,731 $231,033 $248,242 $275,270 $292,513
Cost of sales..................... 152,645 163,157 173,648 197,812 212,067
-------- -------- -------- -------- --------
Gross profit...................... 63,086 67,876 74,594 77,458 80,446
Selling, general and
administrative expense.......... 47,487 50,831 56,074 62,317 65,021
Other income, net................. 353 401 579 805 440
Administrative fees............... 250 250 250 250 250
Depreciation and
amortization(1)................. 4,341 4,399 5,386 5,910 5,915
-------- -------- -------- -------- --------
Operating income.................. 11,361 12,797 13,463 9,786 9,700
Interest expense, net............. 3,998 3,018 6,748 8,033 8,142
-------- -------- -------- -------- --------
Income before income taxes........ 7,363 9,779 6,715 1,753 1,558
Provision for income taxes........ 3,659 5,216 3,679 1,574 1,510
-------- -------- -------- -------- --------
Net income (loss)................. $ 3,704 $ 4,563 $ 3,036 $ 179 $ 48
======== ======== ======== ======== ========

Balance Sheet Data (End of
Period):
Working capital (unaudited)....... $ 11,196 $ 9,875 $ 20,461 $ 16,884 $ 18,934
Total assets...................... 84,931 81,256 91,282 90,495 94,859
Total debt........................ 39,360 29,467 80,418 74,311 75,494
Stockholder's equity (deficit).... 22,772 27,335 (14,386) (15,327) (15,279)
Other Data (unaudited):
Ratio of earnings to fixed
charges(2)...................... 2.1x 2.7x 1.3x 1.2x 1.0x
Adjusted EBITDA(3)................ $ 16,913 $ 18,695 $ 18,566 $ 17,639 $ 18,214
Gross margin...................... 29.2% 29.4% 30.1% 28.1% 27.5%
Adjusted EBITDA margin(4)......... 7.8% 8.1% 7.5% 6.4% 6.2%
Capital expenditures.............. $ 2,887 $ 1,287 $ 3,525 $ 5,435 $ 4,340
Pharmacy sales growth............. 10.8% 16.3% 15.4% 24.2% 18.7%
Pharmacy sales as a % of total.... 22.1 24.1 25.8% 28.9% 32.3%
Third-Party Plan sales as a % of
pharmacy sales.................. 61.5% 70.1% 74.8% 79.9% 83.8%
Store data (unaudited):
Number of stores at end of period:
Drug Fair....................... 25 26 28 32 36
Cost Cutters.................... 17 17 17 17 15
-------- -------- -------- -------- --------
Total........................... 42 43 45 49 51
======== ======== ======== ======== ========
Same-store sales growth
(unaudited)(5):
Drug Fair....................... 3.5% 6.7% 6.9% 7.7% 5.3%
Cost Cutters.................... 0.9 2.7 3.9% 0.0% (1.3%)
-------- -------- -------- -------- --------
Total........................... 2.4% 4.8% 5.5% 4.3% 2.8%
======== ======== ======== ======== ========
</TABLE>

------------------------

(1) Depreciation and amortization amounts for the periods set forth include
amortization of goodwill, beneficial leasehold intangibles, deferred
financing costs incurred and pharmacy customer lists.

15
<PAGE>
(2) The ratio of earnings to fixed charges is computed by adding fixed charges
(interest and one-third of rental expenses, which the Company believes is
representative of that portion of rental expenses attributable to interest)
to income before income taxes and dividing that sum by the sum of the fixed
charges.

(3) Adjusted EBITDA represents net income plus depreciation and amortization,
income taxes, net interest expense, non-cash LIFO reserves against inventory
and non-cash rental expense. Changes in LIFO inventory reserves and non-cash
rental expense are excluded in Adjusted EBITDA because they reflect non-cash
expense that do not directly impact the ability of the Company to service
its debt obligations. While Adjusted EBITDA should not be construed as a
substitute for income from operations, net income or cash flows from
operating activities (as defined by generally accepted accounting
principles), or other measurements determined by generally accepted
accounting principles, in analyzing the Company's operating performance,
financial position or cash flows, the Company has included Adjusted EBITDA
because management understands that it is commonly used by certain investors
and analysts to analyze and compare companies on the basis of operating
performance, leverage and liquidity and to determine a company's ability to
service debt. Unlike net income or EBITDA, Adjusted EBITDA may not be a
measure of the ultimate profitability of a company, and may not be as
meaningful to other investors or analysts. In addition, the method of
calculating Adjusted EBITDA set forth above may be different from
calculations of Adjusted EBITDA employed by other companies and,
accordingly, may not be directly comparable to such other calculations.

The Adjusted EBITDA calculations for the periods presented are as follows:

(4) Adjusted EBITDA margin is calculated as the amount of Adjusted EBITDA for a
period divided by net sales for such period. While Adjusted EBITDA margin
should not be construed as a substitute for gross margin, or other
measurements determined by generally accepted accounting principles, in
analyzing the Company's operating performance, financial position or cash
flows, the Company has included presentation of Adjusted EBITDA margin
because management believes it is commonly used by certain investors and
analysts to analyze and compare companies on the basis of operating
performance, leverage and liquidity and to determine a company's ability to
service debt. Management believes that Adjusted EBITDA margin is a
meaningful supplement to gross margin because it measures the Company's
profitability on a cash flow basis, which is material to a determination of
the Company's ability to service its debt.

(5) Same-store sales growth is calculated based on net sales for stores open for
the whole of the indicated and the previous period.

16
<PAGE>
SELECTED FINANCIAL DATA OF THE HOLDING COMPANY
CDI GROUP, INC.
SUMMARY FINANCIAL AND OPERATING DATA

<TABLE>
<CAPTION>
TWELVE TWELVE TWELVE TWELVE TWELVE
MONTHS MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED ENDED
JULY 28, 1996 JULY 26, 1997 JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales......................... $215,731 $231,033 $248,242 $275,270 $292,513
Cost of sales..................... 152,645 163,157 173,648 197,812 212,067
-------- -------- -------- -------- --------
Gross profit...................... 63,086 67,876 74,594 77,458 80,446
Selling, general and
administrative expense.......... 47,487 50,831 56,074 62,317 65,021
Other income, net................. 353 401 579 805 440
Administrative fees............... 250 250 250 250 250
Depreciation and Amortization..... 4,341 4,399 5,386 5,910 5,915
-------- -------- -------- -------- --------
Operating income.................. 11,361 12,797 13,463 9,786 9,700
Interest expense, net............. 5,326 4,586 8,423 9,878 10,172
-------- -------- -------- -------- --------
Income (loss) before income
taxes........................... 6,035 8,211 5,040 (92) (472)
Provision (benefit) for income
taxes........................... 3,442 4,433 3,109 947 833
-------- -------- -------- -------- --------
Net Income (loss)................. $ 2,593 $ 3,778 $ 1,931 $ (1,039) $ (1,305)
======== ======== ======== ======== ========

Balance Sheet Data (End of Period)
Working capital (unaudited)....... $ 11,656 $ 10,363 $ 22,356 $ 17,537 $ 19,644
Total assets...................... 84,950 81,332 90,668 90,633 95,347
Total debt........................ 54,782 46,301 98,935 95,569 97,674
Stockholders' equity (deficit).... 7,077 10,855 (32,214) (34,373) (35,678)
</TABLE>

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

CAUTIONARY NOTE

This Annual Report on Form 10-K may contain "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities and Exchange Act of 1934, as amended, including,
but not limited to, (i) statements about possible changes in the rate of
increase of pharmacy sales to Third Party Plans as a percentage of total
pharmacy sales, and its impact on profitability; (ii) the ability of the Company
to meet its debt service obligations and to fund anticipated capital
expenditures and working capital requirements in the future; and (iii) certain
other statements identified or qualified by words such as "likely", "will",
"suggests", "may", "would", "could", "should", "expects", "anticipates",
"estimates", "plans", "projects", "believes", or similar expressions (and
variants of such words or expressions). Investors are cautioned that forward-
looking statements are inherently uncertain. These forward-looking statements
represent the judgment of the Company and of the Holding Company as of the date
of this Annual Report on Form 10-K, and the Company and the Holding Company
caution readers not to place undue reliance on such statements. Actual
performance and results of operations may differ materially from those projected
or suggested in the forward-looking statements due to certain risks and
uncertainties, including, but not limited to, the risks and uncertainties
described or discussed under the heading "Certain Risks" below and throughout
this document and previous filings with the SEC.

17
<PAGE>
RESULTS OF OPERATIONS

As discussed in Note 10 to the Financial Statements, the Company has
restated its financial statements for fiscal year ended July 31, 1999 to adjust
for an understatement of accounts payable. The impact is to reduce gross profit
and net income by $1 million and $600,000, respectively. The information set
forth in "Selected Historical Financial Data" and the discussion set forth below
regarding results of operations for 1999 gives effect to this restatement.

COMPARISON OF FISCAL 2000 WITH FISCAL 1999

Net sales for fiscal 2000 were $292.5 million as compared to $275.3 million
for fiscal 1999, an increase of $17.2 million, or 6.2%. The results for fiscal
2000 include fifty-two weeks while the results for fiscal 1999 include
fifty-three weeks. Net sales for fiscal 1999 exclusive of the fifty-third week
("Comparable fiscal 1999") were $270.5 million as compared to $292.5 million for
fiscal 2000, an increase of $22.0 million, or 8.1%. This increase, which
includes a 2.8% increase in same store sales on a comparable fifty-two week
basis, was primarily due to (i) a 2.6% increase in sales of non-pharmacy
products from $193.0 million for Comparable fiscal 1999 to $198.0 million for
fiscal 2000, and (ii) a 21.2% increase in pharmacy sales from $78.0 million for
Comparable fiscal 1999 to $94.5 million for fiscal 2000, including a 27.8%
increase in pharmacy sales to Third-Party Plan customers from $62.3 million for
Comparable fiscal 1999 to $79.6 million for fiscal 2000. The Company attributes
the increase in net sales of non-pharmacy products to the opening of three new
store locations, the acquisition of the inventory and the customer lists of two
independent pharmacies offset by the closing of one Cost Cutters store during
fiscal 2000 in addition to the opening of five new store locations and the
acquisition of the inventory and the customer lists of two independent
pharmacies during Comparable fiscal 1999, as well as to increased customer
traffic in the Company's stores associated with the increase in total pharmacy
sales. The number of prescriptions filled (including prescriptions filled for
Third-Party Plan customers) was approximately 2,037,000 for fiscal 2000 as
compared to approximately 1,843,000 for Comparable fiscal 1999, an increase of
approximately 194,000, or 10.5%. The number of prescriptions filled for
Third-Party Plan customers increased to approximately 1,706,000 for fiscal 2000,
as compared to 1,482,000 for Comparable fiscal 1999, an increase of
approximately 224,000, or 15.1%. Pharmacy sales to non-Third-Party Plan
customers were $14.9 million for fiscal 2000 as compared to $15.7 million for
Comparable fiscal 1999, a decrease of $0.8 million, or 5.1%. This decrease was
the result of improved retail prices on pharmacy products, offset by a greater
amount of participation of the Company's customers in Third-Party Plans which
resulted in a decrease in the volume of pharmacy products sold to
non-Third-Party Plan customers from approximately 361,000 in Comparable fiscal
1999 to approximately 331,000 in fiscal 2000.

Gross profit was $80.4 million for fiscal 2000, as compared to
$77.5 million for fiscal 1999, an increase of $2.9 million, or 3.7%. Gross
profit as a percentage of net sales was 27.5% for fiscal 2000 as compared to
28.2% for fiscal 1999. This 0.7% decrease in gross profit as a percentage of
sales was due primarily to (i) pharmacy sales, which generate lower margins than
sales of non-pharmacy merchandise, representing a higher percentage of total
sales in fiscal 2000 as compared to fiscal 1999, (ii) the incurrence of an
increase in LIFO reserve in fiscal 2000 of $2.0 million as compared to an
increase in LIFO reserve in fiscal 1999 of $1.4 million, and (iii) a decline in
the margin on non-pharmacy merchandise due to greater competition in the
Company's market and increased markdowns on seasonal merchandise.

Gross profit on total pharmacy sales (including sales to Third-Party Plan
customers) was $19.0 million for fiscal 2000 as compared to $16.6 million for
fiscal 1999, an increase of $2.4 million, or 14.5%, which was primarily the
result of an increase in sales on a same store basis combined with the maturing
of new stores opened in the Company's last three fiscal years. Gross profit on
sales to Third-Party Plan customers was $13.3 million for fiscal 2000 as
compared to $10.7 million for fiscal 1999, an increase of $2.6 million, or
24.3%, which was primarily the result of an increase in sales of prescriptions

18
<PAGE>
to Third-Party Plan customers as a percentage of total sales of prescriptions.
Gross profit on sales of pharmacy products to non-Third-Party Plan customers was
$5.7 million for fiscal 2000 as compared to $5.9 million for fiscal 1999, a
decrease of $0.2 million, or 3.4%, which was primarily the result of a decrease
in sales of prescriptions to Third-Party Plan customers as a percentage of total
sales of prescriptions.

Although management expects that sales to Third-Party Plan customers as a
percentage of total pharmacy sales will continue to increase, management
believes that as this rate of increase slows, margins will stabilize, resulting
in pharmacy gross profit growth that more closely approximates pharmacy sales
growth rates. Management believes that the rate of increase in sales to
Third-Party Plan customers as a percentage of total pharmacy sales will slow
because the current growth rate, if continued, would reach the point at which
almost all members of the population who may be eligible for enrollment in
Third-Party Plans will be so covered. However, management believes there will
always be some pharmacy customers who do not enroll in Third-Party Plans. The
Company is unable to estimate when this increase will slow, or stop, if at all.
Because of the lower margins on prescription sales to Third-Party Plan
participants, management believes that the increase in Third-Party Plan
prescription sales as a percentage of total pharmacy sales will negatively
impact profit margin, although this may be partly or wholly offset by the
increases in non-pharmacy sales that may result from increased floor traffic
associated with increased pharmacy sales. There can be no assurance, however,
that the increase in Third-Party Plan prescription sales as a percentage of
total prescription sales will continue, or that any resulting decrease in
pharmacy margins will be offset by higher margins on non-pharmacy merchandise.

Gross profit on non-pharmacy sales was $61.4 million for fiscal 2000 as
compared to $60.9 million for fiscal 1999, an increase of $0.5 million or 0.8%.
Gross profit as a percentage of non-pharmacy sales was 31.0% for fiscal 2000 as
compared to 31.1% for fiscal 1999, a decrease of 0.1%. This 0.1% decrease in
gross profit as a percentage of sales is due primarily to the fact that the
Company incurred an increase in LIFO reserve in fiscal 2000 of $2.0 million as
compared to an increase in LIFO reserve in fiscal 1999 of $1.4 million, to a
decline in the margin on non-pharmacy merchandise due to greater competition in
the Company's market and to an increase in the amount of markdowns taken on
seasonal merchandise.

Selling, general and administrative expense as a percentage of net sales was
22.2% for fiscal 2000 as compared to 22.6% during fiscal 1999. Excluding the
one-time consulting engagement fees paid in the amount of $0.4 million during
fiscal 1999, selling, general and administrative expense as a percentage of
sales was 22.2% for fiscal 2000 as compared to 22.5% for fiscal 1999, a decrease
of 0.3%. This decrease in selling, general and administrative expense as a
percentage of net sales is primarily due to a greater rate of growth of total
net sales from fiscal 1999 to fiscal 2000 of 6.2% as compared to the increase in
total selling, general and administrative expense from $62.3 million for fiscal
1999 to $65.0 million for fiscal 2000, or an increase of 4.3%.

Depreciation and amortization expense for fiscal 2000 and fiscal 1999 was
$5.9 million. This increase resulted from the higher level of depreciation
expense associated with the number of stores opened during the current and two
prior fiscal years as well as due to the increased level of expenditures to
implement new technologies.

Other income, net was $0.4 million for fiscal 2000 as compared to
$0.8 million for fiscal 1999, a decrease of $0.4 million, which is the result of
the one-time gain on the repurchase of an aggregate of $6.0 million in aggregate
principal amount of Senior Notes in fiscal 1999.

The Company's net interest expense was $8.1 million for fiscal 2000 as
compared to $8.0 million for fiscal 1999, an increase of $0.1 million, or 1.3%,
resulting from higher average balances borrowed against the Company's revolving
line of credit. Non-cash interest expense on the Holding Company's outstanding
subordinated debt was $2.0 million during fiscal 2000 as compared to
$1.8 million during

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fiscal 1999, an increase of $0.2 million, resulting from the compounding of
interest on the outstanding subordinated debt.

The Company's provision for income taxes was $1.5 million for fiscal 2000 as
compared to $1.6 million for fiscal 1999, a decrease of $0.1 million, or 6.3%,
which was primarily the result of the lower income before income taxes in fiscal
2000. The Holding Company experienced a benefit from income taxes of
$0.7 million in fiscal 2000 as compared to a benefit of $0.8 million in fiscal
1999 related to the interest expense incurred on the outstanding subordinated
debt. The Company's effective tax rate is consistently higher than the statutory
tax rates, and varies from period to period, due to amortization of goodwill and
of beneficial leaseholds that are not deductible when calculating taxable
income.

The Company had no net income or loss during fiscal 2000 as compared to net
income of $0.2 million for fiscal 1999, a decrease of $0.2 million, which is
primarily due to lower operating income and to increased levels of interest,
depreciation and amortization incurred. The Holding Company incurred a net loss
of $1.3 million for fiscal 2000 as compared to a net loss of $1.2 million during
fiscal 1999, an increase in the net loss of $0.1 million due to the higher
amount of accrued interest on the subordinated notes.

COMPARISON OF FISCAL 1999 WITH FISCAL 1998

Net sales for fiscal 1999 were $275.3 million as compared to $248.2 million
for fiscal 1998, an increase of $27.1 million, or 10.9%. The results for fiscal
1999 include fifty-three weeks while the results for fiscal 1998 include
fifty-two weeks. Net sales for fiscal 1999 exclusive of the fifty-third week
("Comparable fiscal 1999") were $270.5 million as compared to $248.2 million for
fiscal 1998, an increase of $22.3 million, or 9.0%. This increase, which
includes a 4.3% increase in same store sales on a comparable fifty-two week
basis, was primarily due to (i) a 4.8% increase in sales of non-pharmacy
products from $184.1 million for fiscal 1998 to $193.0 million for Comparable
fiscal 1999, and (ii) a 21.7% increase in pharmacy sales from $64.1 million for
fiscal 1998 to $78.0 million for Comparable fiscal 1999, including a 28.2%
increase in pharmacy sales to Third-Party Plan customers from $48.6 million for
fiscal 1998 to $62.3 million for Comparable fiscal 1999. The Company attributes
the increase in net sales of non-pharmacy products to the opening of five new
store locations and the acquisition of the inventory and the customer lists of
two independent pharmacies during Comparable fiscal 1999 as compared to the
opening of two new store locations and the acquisition of the inventory and the
customer lists of two independent pharmacies during fiscal 1998, as well as to
increased customer traffic in the Company's stores associated with the increase
in total pharmacy sales. The number of prescriptions filled (including
prescriptions filled for Third-Party Plan customers) was approximately 1,843,000
for Comparable fiscal 1999 as compared to approximately 1,633,000 for fiscal
1998, an increase of approximately 210,000, or 12.9%. The number of
prescriptions filled for Third-Party Plan customers increased to approximately
1,482,000 for Comparable fiscal 1999, as compared to 1,240,000 for fiscal 1998,
an increase of approximately 242,000, or 19.5%. Pharmacy sales to non-Third-
Party Plan customers were $15.7 million for Comparable fiscal 1999 as compared
to $15.5 million for fiscal 1998, an increase of $0.2 million, or 1.3%. This
increase was the result of improved retail prices on pharmacy products, offset
by participation of the Company's customers in Third-Party Plans which resulted
in a decrease in the volume of pharmacy products sold to non-Third-Party Plan
customers from approximately 393,000 in fiscal 1998 to approximately 361,000 in
Comparable fiscal 1999.

Gross profit was $77.5 million for fiscal 1999, as compared to
$74.6 million for fiscal 1998, an increase of $2.9 million, or 3.9%. Gross
profit as a percentage of net sales was 28.2% for fiscal 1999 as compared to
30.1% for fiscal 1998. This 1.9% decrease in gross profit as a percentage of
sales was due primarily to (i) pharmacy sales, which generate lower margins than
sales of non-pharmacy merchandise, representing a higher percentage of total
sales in fiscal 1999 as compared to fiscal 1998, (ii) the incurrence of an
increase in LIFO reserve in fiscal 1999 of $1.4 million as compared to a
decrease in

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LIFO reserve in fiscal 1998 of $0.8 million, and (iii) a decline in the margin
on non-pharmacy merchandise due to greater competition in the Company's market.

Gross profit on total pharmacy sales (including sales to Third-Party Plan
customers) was $16.6 million for fiscal 1999 as compared to $13.2 million for
fiscal 1998, an increase of $3.4 million, or 25.8%, which was primarily the
result of an increase in sales on a same store basis combined with the maturing
of new stores opened in the Company's last three fiscal years, the additional
week of sales in fiscal 1999 and improved purchase prices from the Company's
primary prescription drug wholesaler. Gross profit on sales to Third-Party Plan
customers was $10.7 million for fiscal 1999 as compared to $7.4 million for
fiscal 1998, an increase of $3.3 million, or 44.6%, which was primarily the
result of an increase in sales of prescriptions to Third-Party Plan customers as
a percentage of total sales of prescriptions. Gross profit on sales of pharmacy
products to non-Third-Party Plan customers was $5.9 million for fiscal 1999 as
compared to $5.8 million for fiscal 1998, an increase of $0.1 million, or 1.7%,
increasing slightly due to improved purchase prices from the Company's
wholesaler and improved retail prices.

Gross profit on non-pharmacy sales was $60.9 million for fiscal 1999 as
compared to $61.4 million for fiscal 1998, a decrease of $0.5 million, or 0.8%.
Gross profit as a percentage of non-pharmacy sales was 31.1% for fiscal 1999 as
compared to 33.4% for fiscal 1998, a decrease of 2.2%. This 2.2% decrease in
gross profit as a percentage of sales is due primarily to the fact that the
Company incurred an increase in LIFO reserve in fiscal 1999 of $1.4 million as
compared to a decrease in LIFO reserve in fiscal 1998 of $0.8 million, and to a
decline in the margin on non-pharmacy merchandise due to greater competition in
the Company's market.

Selling, general and administrative expense as a percentage of net sales was
22.6% for fiscal 1999 and fiscal 1998. Excluding the one-time performance
related bonuses paid to the President and the Chief Financial Officer of the
Company in the amount of $1.4 million during fiscal 1998, and one-time
consulting engagement fees paid in the amount of $0.4 million during fiscal 1999
and in the amount of $0.2 million during fiscal 1998, selling, general and
administrative expense as a percentage of sales was 22.5% for fiscal 1999 as
compared to 22.0% for fiscal 1998, an increase of 0.5%. This increase in
selling, general and administrative expenses is primarily due to the higher
level of warehousing payroll incurred to consolidate the Company's warehouses
and corporate office into one larger facility, the higher cost of occupancy of
the one larger warehouse and corporate office facility, costs incurred to make
the Company's computer systems year 2000 compliant, as well as higher levels of
selling, general and administrative expenses incurred at the Company's five new
store openings during fiscal 1999 as new stores typically incur higher levels of
selling, general and administrative expenses during the first three years after
they are opened.

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<PAGE>
Depreciation and amortization expense for fiscal 1999 was $5.9 million as
compared to $5.4 million for fiscal 1998, an increase of $0.5 million, or 9.3%.
This increase resulted from the higher level of depreciation expense associated
with the increased number of stores.

Other income, net was $0.8 million for fiscal 1999 as compared to
$0.6 million for fiscal 1998, an increase of $0.2 million, which is the result
of the one-time gain on the repurchase of an aggregate of $6.0 million in
aggregate principal amount of Senior Notes in October 1998.

The Company's net interest expense was $8.0 million for fiscal 1999 as
compared to $6.7 million for fiscal 1998, an increase of $1.3 million, or 19.4%,
resulting from a higher total average long-term debt outstanding during fiscal
1999 as compared to fiscal 1998 and from higher average balances borrowed
against the Company's revolving line of credit. Non-cash interest expense on the
Holding Company's outstanding subordinated debt was $1.8 million during fiscal
1999 as compared to $1.7 million during fiscal 1998, an increase of
$0.1 million, resulting from the compounding of interest on the outstanding
subordinated debt.

The Company's provision for income taxes was $1.6 million for fiscal 1999 as
compared to $3.7 million for fiscal 1998, a decrease of $2.1 million, or 56.8%,
which was primarily the result of the lower income before income taxes in fiscal
1999. The Holding Company experienced a benefit from income taxes of
$0.8 million in fiscal 1999 and $0.6 million in fiscal 1998 related to the
interest expense incurred on the outstanding subordinated debt. The Company's
effective tax rate is consistently higher than the statutory tax rates, and
varies from period to period, due to amortization of goodwill and of beneficial
leaseholds which are not deductible when calculating taxable income.

The Company's net income for fiscal 1999 was $0.2 million as compared to net
income of $3.0 million for fiscal 1998, a decrease of $2.8 million, which is
primarily due to lower operating income and to increased levels of interest,
depreciation and amortization incurred. The Holding Company incurred a net loss
of $1.2 million for fiscal 1999 as compared to a net loss of $1.1 million during
fiscal 1998, an increase of $0.1 million, principally as a result of the factors
described above.

LIQUIDITY AND CAPITAL RESOURCES

THE COMPANY

During fiscal 2000, cash from operations was $3.1 million as compared to
cash used by operations of $2.6 million during fiscal 1999, an increase in cash
from operations of $5.7 million. The increase in cash from operations is
primarily the result of a lower net income, a lower investment in inventory
related to the lower rate of new store openings during fiscal 2000 as compared
to fiscal 1999, a lower growth in Third-Party Plan prescription receivables, an
increase in the deferred tax liability, an increase in prepaid expenses, and an
increase in the deferred tax liability, offset by a greater amount of supplier
advances received and an increase in accounts payable and accrued expenses. Cash
used in investing activities was $5.3 million during fiscal 2000 as compared to
$6.1 million during fiscal 1999, an increased use of cash of $0.8 million, which
was the result of a lower level of expenditures related to fewer new store
openings in fiscal 2000 as compared to fiscal 1999, offset by a greater amount
of expenditures to purchase independent pharmacies in fiscal 2000 as compared to
fiscal 1998. Cash provided by financing activities was $2.4 million during
fiscal 2000 as compared to cash used in financing activities of $1.8 million
during fiscal 1999. During fiscal 2000, the cash provided by financing
activities resulted from the net proceeds of borrowings on the Company's
revolving line of credit in the amount of $0.1 million and a cash overdraft of
$2.3 million while the cash used in financing activities during fiscal 1999
consisted primarily of net revolver borrowings of $1.2 million and a cash
overdraft of $3.6 million offset by $5.6 million used for the repurchase of
$6.0 million aggregate principal amount of Senior Notes and $1.1 million used
for the payment of a dividend to the common shareholders of the Holding Company.

22
<PAGE>
During fiscal 1999, cash used in operations was $2.6 million as compared to
cash provided by operations of $10.5 million during fiscal 1998, an increased
use of cash of $13.4 million. The increase in cash used in operations is the
result of lower net income, as well as the higher level of investment in
inventory related to the significant increase in pharmacy sales, the improvement
of the replenishment rate to the Company's stores from its warehouse, and for
the opening of five new stores, in addition to the slower collection of
Third-Party Plan prescription receivables due to the bankruptcy filing of The
Pharmacy Fund, Inc. with whom the Company had an arrangement to factor its
Third-Party Plan prescription receivables until September 9, 1998. Cash used in
investing activities was $6.1 million during fiscal 1999 as compared to
$3.8 million during fiscal 1998, an increased use of cash of $2.3 million, which
was the result of the opening of five new store locations during fiscal 1999 as
compared to the opening of two new store locations during fiscal 1998. Cash used
in financing activities was $1.8 million during fiscal 1999 as compared to cash
provided by financing activities of $2.2 million during fiscal 1998. During
fiscal 1998, the cash provided by financing activities resulted from the net
proceeds, after payment of a dividend of approximately $45.0 million to the
common shareholders of the Holding Company, of the issuance of the
$80.0 million aggregate principal amount of Senior Notes. The cash used in
financing activities during fiscal 1999 consisted primarily of net revolver
borrowings of $1.2 million and a cash overdraft of $3.6 million offset by
$5.6 million used for the repurchase of $6.0 million aggregate principal amount
of Senior Notes and $1.1 million used for the payment of a dividend to the
common shareholders of the Holding Company.

Historically, cash flows from operations, augmented when necessary by
borrowing under the Company's commercial loan facilities, have been sufficient
to fund working capital needs, investing activities (consisting primarily of
capital expenditures) and financing activities (normal debt service consisting
of interest payments and repayments of term and revolving loans outstanding).
Working capital was $18.9 million, $16.9 million, $20.5 million and
$9.9 million on July 29, 2000, July 31, 1999, July 25, 1998, and July 26, 1997,
respectively.

To date, the Company has repurchased $6.0 million of its outstanding Senior
Notes. The Company may in the future repurchase additional Senior Notes if it is
able to obtain appropriate waivers under its revolving credit facility and such
Senior Notes are available at a discount. Any such repurchases could affect the
Company's ability to cover its debt service obligations and working capital
requirements in the future.

In the last few years, the Company's capital requirements primarily resulted
from opening and stocking new stores, remodeling and refurbishing existing
stores and continuing development of new management information systems. The
Company has opened 26 new stores since 1990. The Company estimates that the
average initial new store investment is between $0.3 million and $0.6 million,
not including inventory costs which may range from $0.4 million to
$0.5 million. Such costs may be slightly higher in the event that the Company
elects to purchase prescription customer files from existing drugstores in the
area in which such stores are opened. Depending on the availability of suitable
locations, the Company intends to open an average of three to five new Drug Fair
stores annually over the next several years, and may open additional Drug Fair
storefronts at Cost Cutters locations. In the event that the Company is
successful in opening four new stores in each of the next several years, the
Company could incur opening expenses of between approximately $2.8 million and
approximately $4.4 million (including inventory costs). Since fiscal 1995, new
Drug Fair stores have not been profitable on an operating basis (that is, prior
to the allocation of corporate overhead) until 36 months after opening, on
average.

Of the Company's 51 stores, 30 have been opened since 1989 and all of the
remaining 21 stores have been refurbished since 1991. The total cost of this
refurbishment program was approximately $3.0 million or approximately $125,000
per store. The Company also spends approximately $0.5 million annually to update
its point of sale network and other management information systems and, as part
of

23
<PAGE>
this effort, the Company completed the installation of the remaining modules of
a comprehensive processing system from JDA in late September 1998.

The Company paid one-time performance-related bonuses to Mr. Frank Marfino,
its President and Chief Executive Officer, and Mr. Todd Pluymers, its Chief
Financial Officer in the aggregate amount of approximately $1.4 million, in
February and July 1998.

On May 21, 1998, the Company entered into a lease for new warehouse and
office facilities in Somerset, New Jersey. This lease, which expires on
March 21, 2004, provides for the lease of approximately 204,000 square feet of
warehouse and office space. The Company occupied this new facility in
September 1998 and has vacated its prior corporate offices and two warehouse
facilities.

The Company has no current long-term debt outstanding other than the Senior
Notes. On October 6, 1998, the Company repurchased an aggregate of $5.0 million
principal amount of Senior Notes at a purchase price of $930 per $1,000
principal amount of Senior Notes, plus accrued and unpaid interest. On
October 13, 1998, the Company repurchased an additional $1.0 million principal
amount of Senior Notes at a purchase price of $925 per $1,000 principal amount
of Senior Notes, plus accrued and unpaid interest. As of October 15, 1998,
$74.0 million aggregate principal amount of Senior Notes remained outstanding.
The Company's interest obligations, payable semi-annually, under the Senior
Notes will aggregate $7.6 million in fiscal 2000 and each fiscal year thereafter
until maturity of the Senior Notes. The repurchases described above were made
pursuant to a resolution adopted by the Board of Directors of the Company on
September 16, 1998 that authorized the repurchase of up to $6.0 million
aggregate principal amount of Senior Notes. The Company may repurchase
additional Senior Notes from time to time as authorized by its Board of
Directors and subject to the conditions of the Company's revolving credit
facility.

After the issuance of the Senior Notes on October 25, 1997, the Company's
total debt increased from approximately $29.5 million to approximately
$80.2 million, resulting in a corresponding increase in the Company's interest
expense obligations. $45.0 million of the proceeds of the sale of the Senior
Notes was paid to the Holding Company on October 16, 1997 in the form of a
dividend (the "Holding Company Dividend"), and most of the rest of the proceeds
from such sale were used to repay the amount outstanding under the Company's
previous revolving credit facility ($29.3 million), and pay transaction fees and
expenses ($3.8 million), leaving $1.9 million of the proceeds available.

The Company believes that, based on anticipated levels of operations, it
will be able to meet its debt service obligations, including interest payments
on the Senior Notes, when due and to fund anticipated capital expenditures and
working capital requirements, and to comply with the terms of its debt
agreements during the remainder of fiscal 2001. The Company's ability to make
scheduled payments of principal or interest on, or to refinance, its
indebtedness will depend on future operating performance and cash flow, which
are subject to prevailing economic conditions, prevailing interest rates and
financial, competitive, business and other factors beyond its control. Although
the Company's cash flow and borrowings under its credit facility are intended to
cover the Company's debt service obligations and working capital requirements
over the near term, the Company's current credit facility does not mature until
October 2002, and the Senior Notes do not mature until October 2004.
Accordingly, the Company's principal financing expenses over the near term are
expected to relate to the payment of interest on such indebtedness. The Company
expects that substantially all of its borrowings under its current credit
facility will bear interest at floating rates, therefore, the Company's
financial condition will be affected by any changes in prevailing interest
rates. Because (i) the Company has not guaranteed the obligations of the Holding
Company under its outstanding Subordinated Notes (as defined below), (ii) no
interest is payable on the Subordinated Notes until their maturity, and
(iii) the maturity date of the Subordinated Notes is subsequent to the maturity
date of the Senior Notes, the Company does not believe that its liquidity will
be materially affected by the Holding Company's obligations under the
Subordinated Notes, during the term of the Senior Notes.

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<PAGE>
The Company entered into its current $20.0 million credit facility
simultaneously with the consummation of the sale of the Senior Notes. As of
July 29, 2000, the Company had outstanding borrowings under the credit facility
of $1.3 million. In addition, the Company believes that as of July 29, 2000, the
Company's borrowing base (as defined under the credit facility) was sufficient
to support borrowings of up to $20.0 million under such facility. The Company's
credit facility is being used primarily for working capital purposes.

THE HOLDING COMPANY

Although the Holding Company does not conduct operations separate from the
Company, the Holding Company has issued $13.25 million (not including accrued
interest) in Senior Subordinated Notes due 2005 (the "Subordinated Notes").
Interest on these Subordinated Notes is not currently payable, but accrues at a
rate of 10% per annum. In addition, the Holding Company has issued a Guarantee
of the Senior Notes. Because the Holding Company does not conduct operations
separate from the Company, it is dependent entirely on cash flow generated, and
borrowings made, by the Company. Furthermore, the Holding Company has nominal,
if any, liquid assets. The Company's ability to make distributions of funds to
the Holding Company is limited by the terms of the Indenture governing the
Senior Notes (the "Indenture") and the Company's credit facility. Under the
terms of the Indenture, any payments by the Company to the Holding Company
(other than payments specifically made to satisfy tax obligations of the Holding
Company, payments made to satisfy the Holding Company's obligations under the
management fee agreements currently in place with BancBoston and Harvest,
payments of up to $250,000 per year to provide for the operating expenses of the
Holding Company and certain payments not to exceed $500,000 in any fiscal year
for the repurchase of equity from departing or deceased directors, officers or
employees), must satisfy the conditions set forth in the covenant in the
Indenture titled "Limitation on Restricted Payments", including conditions that
the Company be able to incur at least $1.00 of additional indebtedness under the
debt incurrence ratio described in the Indenture and that the aggregate amount
of all such restricted payments not exceed an amount equal to 50% of the
aggregate Consolidated Net Income (as defined) of the Company after the issue
date of the Senior Notes (or in the event Consolidated Net Income for such
period is a deficit then minus 100% of such deficit). Under the terms of the
Company's credit facility, the Company is prohibited from paying dividends to
the Holding Company in excess of (i) payments to the Holding Company in an
amount, not to exceed $250,000 in the aggregate per fiscal year, sufficient to
pay reasonable and necessary operating expenses and other general corporate
expenses, and (ii) cash dividends to the Holding Company to the extent necessary
to permit the Holding Company to repurchase equity securities of the Holding
Company held by departing or deceased directors, officers or employees of the
Holding Company or the Company, subject to a maximum on such repurchases of
$500,000 in the aggregate in any fiscal year and a maximum of $2,000,000 in the
aggregate during the period from the date of the Company's credit facility
through October 16, 2002.

The Holding Company believes that, based on anticipated levels of operations
of the Company, distributions from the Company will be sufficient to permit the
Holding Company to meet its obligations under the Subordinated Notes and its
Guarantee of the Senior Notes when they become due. Because the Company will be
restricted in making distributions to the Holding Company in the event that it
is unable to fulfill its obligations under the Senior Notes, in the event of
such a default it is unlikely that the Holding Company will be able to fulfill
its obligations under its Guarantee of the Senior Notes. The Holding Company's
ability to make scheduled payments of principal and interest on, or to refinance
the Subordinated Notes, will depend on the future operating performance and cash
flow of the Company, which are subject to prevailing economic conditions,
prevailing interest rates and financial, competitive, business and other factors
beyond the control of the Company and the Holding Company.

25
<PAGE>
SEASONALITY

The business of the Company is seasonal in nature. Historically, the
Company's revenues and income are highest during its second and fourth fiscal
quarters, with the second quarter being the highest due to the holiday season.

INFLATION

The Company believes that inflation has not had a material impact on results
of operations for the Company during the three year period ended July 29, 2000.

YEAR 2000

The Company has not incurred any significant costs in excess of those
previously disclosed in conjunction with its Year 2000 Compliance efforts. The
Company's evaluation of Year 2000 Compliance, both of its internal systems and
of its suppliers, is an ongoing process. Due to the uncertainty of ongoing Year
2000 Compliance by the Company's third party suppliers, which is beyond the
Company's control, the potential effect on financial results and the condition
of the Company cannot be measured.

CERTAIN RISKS

The Company is subject to certain risks, including:

"FREEDOM OF CHOICE" AND "ANY WILLING PROVIDER" LEGISLATION. In July 1994,
New Jersey adopted "Freedom of Choice" legislation that requires Third-Party
Plans to allow their customers to purchase prescription drugs from the provider
of their choice as long as the provider meets uniformly established
requirements, and "Any Willing Provider" legislation that requires each
Third-Party Plan that has entered into an agreement with a prescription provider
to permit other prescription providers to enter into similar agreements. If this
legislation were repealed, larger national drugstore chains could enter into
exclusive contracts with Third-Party Plans, which could reduce the Company's
sales of prescriptions and potentially non-prescription items as well. In
addition, since none of the states surrounding New Jersey (other than Delaware)
has enacted similar legislation, the Company may be at a disadvantage if it
chooses to expand outside of New Jersey.

GOVERNMENT REGULATION AND REIMBURSEMENT PROGRAMS. The Company is subject to
numerous federal, state, and local licensing and registration regulations with
respect to, among other things, its pharmacy operations. Violations of any such
regulations could result in various penalties, including suspension or
revocation of the Company's licenses or registrations or monetary fines, which
could have a material adverse effect on the Company's financial condition and
results of operations.

Federal and New Jersey law requires the Company's pharmacists to offer free
counseling to customers about their medication. In addition, the Company's
pharmacists are required to conduct a prospective drug review before any new
prescriptions are dispensed, and may conduct a similar review prior to refilling
any prescriptions. New Jersey also regulates the dispensing of over-the-counter
controlled dangerous substances. These requirements could result in increased
costs to the Company.

MEDICAID AND MEDICARE. A portion of the Company's services are reimbursed
by government sponsored programs such as Medicaid and Medicare, with the
remainder being reimbursed by individual patients or Third-Party Plans. If the
Company were to fail to comply with reimbursement regulations, or if such
reimbursement programs were modified, the Company's business could be adversely
affected. The Company is also subject to laws prohibiting the submission of
false or fraudulent claims and certain financial relationships between health
care providers that are intended to induce the referral of patients, or the
recommendations of particular items or services. Violation of

26
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these laws could result in loss of licensure, civil and criminal penalties, and
exclusion from federal health care programs.

EMPLOYMENT REGULATION. The Company is subject to employment laws governing
minimum wage requirements, overtime and working conditions. An increase in the
minimum wage rate, employee benefit costs, or other costs associated with
employees could adversely affect the Company.

POTENTIAL GROWTH AND EXPANSION. The Company has grown in recent years by
opening new stores, remodeling and relocating existing stores and refining the
product mix in existing stores. The ability of the Company to continue to grow
in the future will depend on factors including existing and emerging
competition, the availability of working capital to support growth, the
Company's ability to manage costs and maintain margins in the face of pricing
pressures, and the ability to recruit and train additional qualified personnel.
New stores that the Company opens may not be profitable.

RESTRICTIONS ON THE COMPANY. Both the Indenture governing the Senior Notes
and the Company's revolving credit facility impose on the Company certain
requirements and restriction, such as a requirement that the Company maintain
certain financial ratios and satisfy certain financial tests, limitations on
capital expenditures, and restrictions on the ability of the Company to incur
debt, pay dividends, or take certain other corporate actions. These limitations
may restrict the Company's ability to pursue its business strategies.

COMPETITION. The industries in which the Company operates are highly
competitive.

TRADE NAMES, SERVICE MARKS AND TRADEMARKS. The Company uses various trade
names, service marks and trademarks, including "Drug Fair" and "Cost Cutters,"
in the conduct of its business. A third party registered the service mark "Cost
Cutters," but does not currently operate in the Company's market areas. If such
third party commences operations in the Company's geographic market areas or
licenses the use of the name to a third party, the Company could be required to
stop using the name "Cost Cutters." In addition, any of the Company's other
trade names, service marks or trademarks could be challenged or invalidated in
the future.

ECONOMIC CONDITIONS AND REGIONAL CONCENTRATION. All of the Company's stores
are located in northern and central New Jersey. As a result, the Company is
sensitive to economic, competitive, and regulatory conditions in that region.

LEASE RENEWALS ON THE COMPANY'S STORES. All of the Company's stores are
leased. Although the Company has historically been successful in renewing its
most important store leases when they have expired, there can be no assurance
that the Company will continue to be able to do so.

LEVERAGE. In connection with the Company's issuance of the Senior Notes,
the Company incurred a significant amount of indebtedness and, as a result, the
Company is highly leveraged. The Company is permitted to incur substantial
additional indebtedness in the future, subject to certain limitations contained
in the Indenture governing the Senior Notes.

CONTROLLING STOCKHOLDERS. The Holding Company owns all of the outstanding
capital stock of the Company. The existing stockholders of the Holding Company,
which include the Company's President and Chief Executive Officer, certain
entities affiliated with the other directors of the Company, and other officers
and employees of the Company, own all of the outstanding common stock of the
Holding Company. These stockholders have the power to appoint new management and
approve any action requiring the approval of the Company's stockholders,
including adopting amendments to the Company's charter and approving mergers or
sales of substantially all of the Company's assets.

DEPENDENCE ON KEY PERSONNEL. The success of the Company depends upon the
efforts, abilities and expertise of its executive officers and other key
employees, including its Chief Executive Officer and

27
<PAGE>
President. The loss of the services of any key employees could have a material
adverse effect on the Company's financial condition and results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Neither the Company nor the Holding Company engages in trading market risk
sensitive instruments or purchases hedging instruments or "other than trading"
instruments that are likely to expose the Company or the Holding Company to
market risk, whether interest rate, foreign currency exchange, commodity price
or equity price risk. Neither the Company nor the Holding Company has purchased
options or entered into swaps or forward or futures contracts. The ability of
the Company and the Holding Company (as guarantor) to make periodic interest
payments on the Senior Notes, at a fixed rate of 10 1/4%, is not directly
affected by fluctuations in the market. The Company's primary market risk
exposure is that of interest rate risk on borrowings under the Company's
revolving credit facility, which are subject to interest rates based either on
the lender's prime rate or London Interbank Offered Rate ("LIBOR"), and a change
in the applicable interest rate would affect the rate at which the Company could
borrow funds.

28
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

COMMUNITY DISTRIBUTORS, INC.
FINANCIAL STATEMENTS
TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of independent accountants........................... 30

Balance sheets at July 31, 1999, and July 29, 2000.......... 31

Statements of income for the years ended July 25, 1998,
July 31, 1999, and July 29, 2000.......................... 32

Statements of cash flows for the years ended July 25, 1998,
July 31, 1999, and July 29, 2000.......................... 33

Statements of stockholder's deficit for the years ended
July 25, 1998, July 31, 1999, and July 29, 2000........... 34

Notes to financial statements............................... 35
</TABLE>

29
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS

To the Stockholder of
Community Distributors, Inc.:

In our opinion, after the restatement as described in Note 10 the
accompanying balance sheets and the related statements of income, cash flows and
stockholder's deficit present fairly, in all material respects, the financial
position of Community Distributors, Inc. at July 29, 2000 and July 31, 1999, and
the results of its operations and its cash flows for each of the three years in
the period ended July 29, 2000, in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

PRICEWATERHOUSECOOPERS LLP

New York, New York
November 13, 2000

30
<PAGE>
COMMUNITY DISTRIBUTORS, INC.

BALANCE SHEETS

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
AT AT
JULY 31, 1999 JULY 29, 2000
------------- -------------
<S> <C> <C>
ASSETS:
Current Assets:
Cash and cash equivalents................................... $ 285 $ 464
Accounts receivable......................................... 5,240 7,356
Inventories................................................. 35,787 37,076
Prepaid expenses and other current assets................... 1,013 1,625
-------- --------
Total current assets...................................... 42,325 46,521
-------- --------
Property and Equipment:
Leasehold improvements...................................... 7,943 8,940
Furniture, fixtures and equipment........................... 13,275 16,130
Automobiles and trucks...................................... 761 882
-------- --------
21,979 25,952
Less: Accumulated depreciation and amortization............. (9,118) (12,114)
-------- --------
Property and equipment, net................................. 12,861 13,838
-------- --------
Beneficial leaseholds, net.................................. 1,063 751
Other assets................................................ 920 1,708
Deferred financing costs, net............................... 2,659 2,139
Deferred tax assets......................................... 980 2,130
Goodwill, net............................................... 29,687 27,772
-------- --------
Total assets.............................................. $ 90,495 $ 94,859
======== ========

LIABILITIES AND STOCKHOLDER'S DEFICIT:
Current Liabilities:
Revolver Borrowings......................................... $ 1,200 $ 1,250
Accounts payable............................................ 15,357 17,220
Accrued liabilities......................................... 5,796 5,450
Deferred tax liabilities.................................... 1,950 2,452
Current portion of supplier advances........................ 653 993
Income taxes payable........................................ 485 222
-------- --------
Total current liabilities................................. 25,441 27,587
Long-term debt.............................................. 74,000 74,000
Supplier advances, net of current portion................... 1,803 2,762
Other liabilities........................................... 2,629 3,195
Due to parent............................................... 1,949 2,594
-------- --------
Total liabilities......................................... 105,822 110,138
======== ========
Commitments and contingencies

STOCKHOLDER'S DEFICIT:
Common stock, $.01 par value, 1,000 shares authorized,
issued and outstanding.................................... -- --
Additional paid-in capital.................................. -- --
Retained earnings........................................... 2,215 2,263
Distribution in excess of capital........................... (17,542) (17,542)
-------- --------
Total stockholder's deficit............................... (15,327) (15,279)
-------- --------
Total liabilities and stockholder's deficit............... $ 90,495 $ 94,859
======== ========
</TABLE>

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

31
<PAGE>
COMMUNITY DISTRIBUTORS, INC.

STATEMENTS OF INCOME

(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
------------------ ------------------ ------------------
<S> <C> <C> <C>
Net sales.................................. $248,242 $275,270 $292,513
Cost of sales.............................. 173,648 197,812 212,067
-------- -------- --------
Gross profit............................. 74,594 77,458 80,446
Selling, general and administrative
expenses................................. 56,074 62,317 65,021
Administrative fees........................ 250 250 250
Depreciation and amortization.............. 5,386 5,910 5,915
Other income, net.......................... 579 805 440
-------- -------- --------
Operating income......................... 13,463 9,786 9,700
Interest expense, net...................... 6,748 8,033 8,142
-------- -------- --------
Income before income taxes............... 6,715 1,753 1,558
Provision for income taxes................. 3,678 1,574 1,510
-------- -------- --------
Net income............................... $ 3,037 $ 179 $ 48
======== ======== ========
</TABLE>

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

32
<PAGE>
COMMUNITY DISTRIBUTORS, INC.

STATEMENTS OF CASH FLOWS

(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
------------------ ------------------ ------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 3,037 $ 179 $ 48
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization........................... 4,586 5,058 5,705
Amortization of deferred financing costs................ 800 767 520
Deferred rent liabilities............................... 523 585 641
LIFO provision.......................................... (806) 1,358 1,958
Gain on repurchase of senior notes...................... -- (395) --
Gain on sale of property and equipment.................. -- -- 63
Changes in operating assets and liabilities:
Accounts receivable................................... 1,535 (4,161) (2,116)
Inventories........................................... 1,793 (7,899) (3,247)
Prepaid expenses and other current assets............. 72 -- (612)
Other assets.......................................... (166) 292 2
Deferred tax assets................................... (34) (234) (1,150)
Due to parent......................................... 549 569 645
Deferred tax liabilities.............................. 1,726 (167) 502
Accounts payable and accrued liabilities.............. (1,228) 308 (812)
Income taxes payable.................................. (503) 485 (263)
Supplier advances..................................... (1,556) 759 1,299
Other liabilities..................................... 193 (74) (75)
-------- -------- --------
Net cash provided by (used in) operating activities..... 10,521 (2,570) 3,108
Cash flows used in investing activities:
Capital expenditures...................................... (3,525) (5,438) (4,359)
Acquisitions of pharmacy customer lists................... (310) (645) (968)
Proceeds from sale of fixed assets........................ -- 3 19
-------- -------- --------
Net cash used in investing activities................... (3,835) (6,080) (5,308)
Cash flows (used in) provided by financing activities:
Proceeds from issuance of Senior Notes.................... 80,000 -- --
Distribution to parent.................................... (45,000) (1,120) --
Debt issuance costs paid.................................. (3,870) -- --
Proceeds from revolver borrowings......................... 900 41,960 64,650
Payments made on revolver borrowings...................... (900) (40,760) (64,600)
Repurchase of senior notes................................ -- (5,605) --
Cash overdraft............................................ -- 3,690 2,329
Payments made on long-term debt........................... (29,269) -- --
Capital received from parent.............................. 353 -- --
-------- -------- --------
Net cash (used in) provided by financing activities..... 2,214 (1,835) 2,379
-------- -------- --------
Net increase (decrease) in cash and cash equivalents.... 8,900 (10,485) 179
Cash and cash equivalents beginning of period............... 1,870 10,770 285
-------- -------- --------
Cash and cash equivalents end of period..................... $ 10,770 $ 285 $ 464
======== ======== ========

Supplemental disclosures of cash information:
Cash paid during the period:
Income taxes............................................ $ 2,047 $ 815 $ 1,782
======== ======== ========
Interest................................................ $ 4,875 $ 8,198 $ 8,174
======== ======== ========
</TABLE>

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

33
<PAGE>
COMMUNITY DISTRIBUTORS, INC.

STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)

(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
DISTRIBUTION TOTAL
PAID-IN RETAINED IN EXCESS STOCKHOLDER'S
SHARES AMOUNT CAPITAL EARNINGS OF CAPITAL EQUITY (DEFICIT)
-------- -------- -------- -------- ------------ ----------------
<S> <C> <C> <C> <C> <C> <C>
Balance, July 26, 1997................... 1,000 -- $ 18,000 $ 9,335 $ -- $ 27,335
Net loss for three months ended October
25, 1997............................... -- -- -- (119) -- (119)
Capital contribution from parent......... -- -- 242 -- -- 242
Distribution to parent................... -- -- (18,242) (9,216) (17,542) (45,000)
Net income for the nine month period from
October 26, 1997 to July 25, 1998...... -- -- -- 3,156 -- 3,156
----- ----- -------- ------- -------- --------
Balance, July 25, 1998................... 1,000 -- -- 3,156 (17,542) (14,386)
Net income............................... -- -- -- 179 -- 179
Distribution to parent................... -- -- -- (1,120) -- (1,120)
----- ----- -------- ------- -------- --------
Balance, July 31, 1999................... 1,000 -- -- 2,215 (17,542) (15,327)
Net income............................... -- -- -- 48 -- 48
----- ----- -------- ------- -------- --------
Balance, July 29, 2000................... 1,000 $ -- $ -- $ 2,263 $(17,542) $(15,279)
===== ===== ======== ======= ======== ========
</TABLE>

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

34
<PAGE>
COMMUNITY DISTRIBUTORS, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)

1. ORGANIZATION:

ORGANIZATION AND PRINCIPLES OF CONSOLIDATION

Community Distributors Inc. (the "Company") owns and operates in the State
of New Jersey a chain of drug stores under the name "Drug Fair" and a chain of
general merchandise stores under the name "Cost Cutters". The Company manages
and operates as one business segment. The Company is a wholly-owned subsidiary
of CDI Group, Inc. (the "Parent") and under the principles of consolidation
would be considered part of the consolidated results of the Parent. These
separate Company financial statements and notes to financial statements solely
represent the financial position and results of operations of the Company.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

ACCOUNTING YEAR

The Company maintains its accounts on a 52-53 week fiscal year ending with
the last Saturday in July. The years ended July 25, 1998 and July 29, 2000 each
contained 52 weeks, respectively. The year ended July 31, 1999 contained 53
weeks.

REVENUE RECOGNITION

Sales are net of returns and exclude sales tax. Revenues include sales from
all stores operating during the period.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents are considered by the Company to be financial
instruments with maturities, when purchased, of three months or less, and are
presented at cost which approximates fair value.

INVENTORIES

Inventories are stated at the lower of cost, using the dollar-value, double
extension last-in, first-out method (LIFO), or market. If the first-in,
first-out (FIFO) method of inventory accounting had been used, inventories would
have been approximately $2,935 and $4,893 higher than reported at July 31, 1999
and July 29, 2000, respectively. Management believes that inventories accounted
for on a FIFO basis approximates current replacement costs. Inventories are
reflected net of reserves for excess/ obsolete/damaged inventories in the
amounts of $155 and $61 at July 31, 1999 and July 29, 2000, respectively.

PROPERTY AND EQUIPMENT

Property and equipment, including computer software costs, are recorded at
cost and are depreciated on a straight-line basis over the estimated useful
lives of the assets which range from three to seven years. Leasehold
improvements are amortized over the expected useful life of the improvement or
the life of the lease, whichever is shorter. Depreciation expense recorded for
the fiscal years ended July 25, 1998, July 31, 1999 and July 29, 2000 was
$2,094, $2,648 and $2,988, respectively. The cost and related accumulated
depreciation or amortization of assets retired or sold are removed from the
respective accounts and any gain or loss is recognized in operations.

35
<PAGE>
BENEFICIAL LEASEHOLDS

Beneficial lease rights have been recorded on purchased leases based on
differences between contractual rents under the respective lease agreements and
prevailing market rents at the date of the acquisition of the Company.
Beneficial lease rights are amortized over the lease terms using the
straight-line method. Accumulated amortization at July 31, 1999 and July 29,
2000 was $2,505 and $2,817, respectively.

GOODWILL

Goodwill, which represents the excess of the Parent's purchase price of
acquired assets over the fair market value of net assets of the Company acquired
on January 30, 1995, is being amortized using the straight-line method over
twenty years. The Company evaluates the recoverability of goodwill on an annual
basis, or earlier, if circumstances indicate that such an evaluation is
necessary. The Company's assessment of recoverability considers current and
future profitability, estimated undiscounted future cash flows from operations,
and any other events or changes in circumstances which indicate that the
carrying amount of goodwill may not be recoverable. In the event an impairment
of goodwill, or related asset, is indicated to have occurred, the Company's
policy is to allocate goodwill to long lived assets on a pro rata basis using
the relative fair value of those assets at the date the goodwill arose for
purposes of determining the recoverability of long-lived assets. The Company has
incurred no impairment of goodwill, or related assets, since its inception.
Accumulated amortization as of July 31, 1999 and July 29, 2000 was $8,625 and
$10,540, respectively.

DEFERRED FINANCING COSTS

Deferred financing costs are amortized over the term of the respective
borrowings, which is approximately 7 years.

SUPPLIER ADVANCES

Included in the accompanying balance sheets are $2,456 and $3,756 of
advances received related to various inventory supply agreements at July 31,
1999 and July 29, 2000, respectively. Such amounts are being recorded as a
reduction of cost of sales as the Company's supply agreement obligations are
fulfilled, generally ranging from three to five years from the point that the
supplier advance is received. The Company's obligations under the supply
agreements are fulfilled through the passage of time for those supply agreements
that are for a specific period of time and by the purchasing of inventory for
those supply agreements that stipulate the purchasing of a specific amount of
inventory. The Company is currently committed to approximately $58,248 of
additional purchases under the inventory supply agreements at July 29, 2000. In
the event the Company does not fulfill its obligations under the inventory
supply agreements, a pro rata portion of the advance will be required to be
repaid, approximating the amounts presented in the financial statements as
Supplier Advances at July 29, 2000. The amount presented as the current portion
of the supplier advances is estimated by the Company as the amount related to
the passage of time and the estimated inventory purchases to be made during the
twelve months following July 29, 2000, as applicable to the specific inventory
supply agreements.

PREOPENING AND ADVERTISING COSTS

Costs associated with new stores prior to opening and advertising costs are
expensed as incurred. Advertising expense of $1,703, $2,662 and $2,189 for the
years ended July 25, 1998, July 31, 1999 and July 29, 2000, respectively is net
of co-op advertising rebates received from vendors in the amount of $4,430,
$4,303 and $4,196 for the years ended July 25, 1998, July 31, 1999 and July 29,
2000, respectively.

36
<PAGE>
INTEREST EXPENSE (NET)

Interest expense for the fiscal years ended July 25, 1998, July 31, 1999 and
July 29, 2000 which has been recorded net of interest income was:

<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
------------------ ------------------ ------------------
<S> <C> <C> <C>
Interest expense........... $7,007 $8,191 $8,164
Interest income............ (259) (158) (22)
------ ------ ------
Interest expense (net)..... $6,748 $8,033 $8,142
====== ====== ======
</TABLE>

INCOME TAXES

Deferred tax liabilities and assets are recorded for the expected future tax
consequences of events that have been included in the financial statements or
tax returns. Under this method, deferred tax liabilities and assets are
determined on the basis of the differences between the financial statement and
tax bases of assets and liabilities ("temporary differences") at enacted tax
rates in effect for the years in which the temporary differences are expected to
reverse.

CONCENTRATIONS OF RISK

Financial instruments which potentially subject the Company to
concentrations of credit risk are cash and cash equivalents. Such amounts are
primarily held in a single major commercial bank. The Company holds no
collateral for these financial instruments, and such amounts may, at times,
exceed insurable limits.

All of the Company's stores are located in northern and central New Jersey.
As a result, the Company is sensitive to economic, competitive, and regulatory
conditions in that region. The success of the Company's future operations will
be substantially affected by its ability to compete effectively in New Jersey,
and no prediction can be made as to economic conditions in that region.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amount of cash and cash equivalents, accounts receivable and
accounts payable, as reflected in the accompanying balance sheets approximate
their fair value because their maturities are generally less than one year in
duration. The Company estimates that the carrying amount of its long-term fixed
rate debt and amounts reflected as long-term liabilities approximate their fair
value. Management is not aware of any factors that would significantly affect
the value of these amounts. The Company does not utilize derivative financial
instruments nor does it engage in hedging activities.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make significant estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS

The Company has adopted Statement of Financial Accounting Standards No. 121
"ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO
BE DISPOSED OF" ("SFAS No. 121"). SFAS No. 121 prescribes the accounting for the
impairment of long-lived assets, such as property, plant and equipment and
intangible assets, as well as the accounting for long-lived assets that are held
for

37
<PAGE>
disposal. The statement requires that such assets be reviewed when events or
circumstances indicate that an impairment might exist. The Company has concluded
that no impairment of long-lived assets existed at July 25, 1998 and July 31,
1999.

STOCK OPTIONS

The Company has adopted Statement of Financial Accounting Standards
No. 123, "ACCOUNTING FOR STOCK BASED COMPENSATION" ("SFAS No. 123"). SFAS
No. 123 prescribes the accounting for stock options and requires that options be
valued at their fair market value, as defined in the statement, on the date of
grant. SFAS No. 123 allows companies to either fully adopt its requirements or
to elect to only disclose the impact that the requirements would have. The
Company has adopted SFAS No. 123 for disclosure purposes only and will account
for stock options, in the event issued, under APB Opinion No. 25, "ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES."

RECLASSIFICATION

Certain prior year amounts were reclassified to conform to 2000
presentations.

3. DEBT:

Long-term debt consists of the following:

<TABLE>
<CAPTION>
AT AT
JULY 31, 1999 JULY 29, 2000
------------- -------------
<S> <C> <C>
Senior Notes-due October 15, 2004 interest at 10 1/4%
payable semi- annually on April 15 and October
15................................................. $74,000 $74,000
Less, current portion due within one year............ -- --
------- -------
Long-term portion.................................... $74,000 $74,000
======= =======
</TABLE>

On October 16, 1997, the Company issued $80,000 of 10 1/4% senior notes due
in 2004 which are guaranteed by the Parent. The net proceeds of such issuance
was $76,130. The Company used $29,269 of such net proceeds to refinance
substantially all of its then existing indebtedness and $45,000 of the net
proceeds was used to pay a dividend to the Parent which then paid a dividend of
the same amount to the stockholders of the Parent. The terms of the senior notes
include certain restrictive covenants regarding the payment of dividends, the
incurrence of debt, the use of proceeds resulting from disposition of assets and
certain other defined activities. Under the relevant debt agreements, in the
event of a change in control, as defined, the Company is required to repurchase
all such outstanding notes.

On October 16, 1997, the Company also replaced its then existing credit
facility ("Old Credit Facility") with a $20,000 five year revolving credit
facility concurrent with the issuance of the $80,000 of senior notes. This
facility bears interest at either prime rate or London Interbank Offered Rate
("LIBOR") plus 1.75% and is collateralized by the Company's eligible accounts
receivable and inventory balances, as defined. Included in the $20,000 five year
revolving credit facility is a $5,000 letter of credit facility. The new
facility contains certain financial and operating covenants, including a minimum
fixed charge ratio. Additionally, the Company cannot make any dividend or other
distributions with respect to any share of stock other than in certain limited
circumstances. The Company must pay a commitment fee of 1/4 of 1.00% per annum
on the daily average unutilized revolving credit facility commitment. For the
year ended July 29, 2000, the Company incurred approximately $81 of commitment
fees and letter of credit fees under this facility.

On October 6, 1998, the Company repurchased $5,000 principal amount of
Senior Notes at a purchase price of $4,675, plus accrued and unpaid interest. On
October 13, 1998, the Company

38
<PAGE>
repurchased $1,000 principal amount of Senior Notes at a purchase price of $930,
plus accrued and unpaid interest. These repurchases of Senior Notes resulted in
a gain of $395 during the year ended July 31, 1999.

4. COMMITMENTS:

LEASES

The Company conducts all of its warehousing and retailing operations from
leased facilities. Annual store rent is composed of a fixed minimum amount, and
for certain stores, contingent rent which is based upon a percentage of sales
exceeding a stipulated amount. These leases, which may be renewed for periods
ranging from five to thirty years, generally provide that the Company pay
insurance, maintenance costs and property taxes. These additional charges are
subject to escalation for increases in the related costs. Minimum rental
commitments under long-term noncancelable operating leases are as follows at
July 29, 2000:

<TABLE>
<CAPTION>
FISCAL YEAR
ENDING JULY
-----------
<S> <C>
2001........................................................ $ 11,384
2002........................................................ 11,267
2003........................................................ 10,676
2004........................................................ 10,377
2005........................................................ 8,850
Thereafter.................................................. 56,409
--------
$108,963
========
</TABLE>

Annual rent expense is comprised of a fixed minimum amount, plus contingent
rent based on a percentage of sales exceeding a stipulated amount. For the year
ended July 25, 1998, July 31, 1999, and July 29, 2000, respectively, total rent
expense included:

<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
------------------ ------------------ ------------------
<S> <C> <C> <C>
Fixed minimum rent......... $9,045 $10,181 $10,993
Contingent rent............ 219 250 231
------ ------- -------
Rent expense............... $9,264 $10,431 $11,224
====== ======= =======
</TABLE>

The Company recognizes rental expense from leases with scheduled rent
increases on the straight-line basis. During the years ended July 25, 1998,
July 31, 1999, July 29, 2000, the Company recognized rent expense in excess of
amounts paid of approximately $523, $585, and $641, respectively, which expense
is included in the amounts above.

LETTERS OF CREDIT

Outstanding letters of credit, guaranteeing certain contingent purchases
which are not reflected in the accompanying financial statements, aggregate
approximately $2,016 and $3,144 at July 31, 1999 and July 29, 2000.

39
<PAGE>
5. INCOME TAXES:

The provision for income taxes for the years ended July 25, 1998, July 31,
1999 and July 29, 2000, respectively, consist of the following:

<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
------------------ ------------------ ------------------
<S> <C> <C> <C>
Current.................... $1,987 $1,760 $2,158
Deferred................... 1,691 (186) (648)
------ ------ ------
$3,678 $1,574 $1,510
====== ====== ======
</TABLE>

The component of deferred taxes at July 31, 1999 and July 29, 2000 are
summarized as follows:

<TABLE>
<CAPTION>
AT JULY 31, AT JULY 29,
1999 2000
----------- -----------
<S> <C> <C>
Supplier advances, current.............................. $ 126 $ 33
Inventory............................................... 235 298
Accruals and reserves................................... 687 692
Inventory (LIFO reserve)................................ (3,251) (3,475)
Depreciation............................................ 253 --
------- -------
Net deferred tax liability-current...................... (1,950) (2,452)
======= =======
Depreciation............................................ -- 570
Accruals and reserves................................... 962 1,560
Supplier advances, non-current.......................... 18 --
------- -------
Net deferred tax asset-long-term........................ $ 980 $ 2,130
======= =======
</TABLE>

The following table accounts for the differences between the actual
provision and the amounts obtained by applying the statutory U.S. Federal income
tax rate of 34% to the income before provision for income taxes:

<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
------------------ ------------------ ------------------
<S> <C> <C> <C>
Federal statutory tax
rate..................... 34% 34% 34%
State and local income
taxes, net of federal tax
benefit.................. 6% 14% 13%
Goodwill amortization...... 13% 47% 50%
Other...................... 2% (5)% --
-- -- --
55% 90% 97%
== == ==
</TABLE>

6. RELATED PARTY TRANSACTIONS:

Included in the Company's statements of income for the years ended July 25,
1998, July 31, 1999 and July 29, 2000 are administrative fees of $250, for each
of the years, respectively. The Company has entered into administrative fee
agreements with certain shareholders of the Parent, whereby these shareholders
will provide advisory and consulting services to the Board of Directors. These
administrative fee agreements require the Company to pay $250 of administrative
fees annually.

40
<PAGE>
7. LITIGATION:

The Company is a defendant in various lawsuits arising in the ordinary
course of business. In the opinion of management, the disposition of these
lawsuits should not have a material impact on the Company's consolidated results
of operations, financial position, and cash flows.

8. EMPLOYEE BENEFIT PLAN:

On July 1, 1995, the Company implemented a 401(k) salary deferral plan (the
"Plan") which is available to eligible employees, as defined. The Plan provides
for the Company to make discretionary contributions, however, the Company
elected not to make contributions for all periods through July 29, 2000.

9. STOCKHOLDER'S EQUITY:

On October 16, 1997 the Company paid a dividend to the Parent in the amount
of $45,000. The Parent then declared and paid a dividend of $45,000 to its
stockholders. The Company's dividend of $45,000 was funded by the proceeds of
its offering of $80,000 of senior notes completed in October 1997.

The $45,000 dividend has been reflected in these financial statements as a
return of earnings and capital existing as of the dividend date. The remaining
excess of the dividend, $17,542, has been recorded as a distribution in excess
of capital.

On January 4, 1999 the Company paid a dividend to the Parent in the amount
of $1,120. The Parent then declared and paid a dividend of $1,120 to its
stockholders. The Company's dividend of $1,120 was funded from the Company's
operating cash flow.

10. REVISION OF JULY 31, 1999 FINANCIAL STATEMENTS:

The Company has revised its financial statements for the fiscal year ended
July 31, 1999 to adjust for an understatement of Accounts Payable. The impact of
this revision is to reduce gross profit and net income by $1,000 and $600,
respectively.

41
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY

CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of independent accountants........................... 43

Consolidated balance sheets at July 31, 1999 and July 29,
2000...................................................... 44

Consolidated statements of income for the years ended July
25, 1998, July 31, 1999, and July 29, 2000................ 45

Consolidated statements of cash flows for the years ended
July 25, 1998, and July 31, 1999, and July 29, 2000....... 46

Consolidated statements of stockholders' deficit for the
years ended July 31, 1999 and July 29, 2000............... 47

Notes to consolidated financial statements.................. 48
</TABLE>

42
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
CDI Group, Inc. and Subsidiary:

In our opinion, after the restatement as described in Note 11 the
accompanying consolidated balance sheets and the related consolidated statements
of operations, cash flows and stockholders' deficit present fairly, in all
material respects, the financial position of CDI Group, Inc. and Subsidiary at
July 29, 2000 and July 31, 1999, and the results of their operations and their
cash flows for each of the three years in the period ended July 29, 2000, in
conformity with accounting principles generally accepted in the United States of
America. These consolidated financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
consolidated financial statements based on our audits. We conducted our audits
of these statements in accordance with auditing standards generally accepted in
the United States of America, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

PRICEWATERHOUSECOOPERS LLP

New York, New York
November 13, 2000

43
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
AT AT
JULY 31, 1999 JULY 29, 2000
------------- -------------
<S> <C> <C>
ASSETS:

Current Assets:
Cash and cash equivalents................................. $ 285 $ 464
Accounts receivable....................................... 5,266 7,389
Inventories............................................... 35,787 37,076
Prepaid expenses and other current assets................. 1,155 2,080
-------- --------
Total current assets.................................. 42,493 47,009
-------- --------

Property and Equipment:
Leasehold improvements.................................... 7,943 8,940
Furniture, fixtures and equipment......................... 13,275 16,130
Automobiles and trucks.................................... 761 882
-------- --------
21,979 25,952
Less: Accumulated depreciation and amortization............. (9,118) (12,114)
-------- --------
Property and equipment, net................................. 12,861 13,838
-------- --------
Beneficial leaseholds, net.................................. 1,063 751
Other assets................................................ 920 1,708
Deferred financing costs, net............................... 2,659 2,139
Deferred tax assets......................................... 980 2,130
Goodwill, net............................................... 29,687 27,772
-------- --------
Total assets.......................................... $ 90,663 $ 95,347
======== ========

LIABILITIES AND STOCKHOLDERS' DEFICIT:

Current Liabilities:
Revolver Borrowings....................................... $ 1,200 $ 1,250
Accounts payable.......................................... 15,357 17,220
Accrued liabilities....................................... 5,796 5,450
Deferred tax liabilities.................................. 1,950 2,452
Current portion of supplier advances...................... 653 993
Income taxes payable...................................... -- --
-------- --------
Total current liabilities............................. 24,956 27,365
Long-term debt.............................................. 74,000 74,000
Subordinated debt........................................... 20,369 22,424
Supplier advances, net of current portion................... 1,803 2,762
Other liabilities........................................... 2,629 3,195
-------- --------
Total liabilities..................................... 123,757 129,746
-------- --------
Commitments and contingencies
Redeemable preferred stock, $1.00 par value, 7,862
authorized, issued and outstanding at July 31, 1999, and
July 29, 2000 at net redemption value of $100 per share... 786 786
Redeemable share of Class A voting common stock, 57,963 and
57,963 shares issued and outstanding at July 31, 1999 and
July 29, 2000, respectively, at net redemption value...... 493 493

STOCKHOLDERS' DEFICIT:

Class A voting common stock, $.00001 par value, authorized
600,000 shares, 196,632 issued and outstanding at July 31,
1999 and July 29, 2000.................................... -- --
Class B non-voting common stock, $.00001 par value,
authorized 600,000 shares, 187,922 issued and outstanding
at July 31, 1999 and July 29, 2000........................ -- --
Additional paid-in capital.................................. -- --
Retained earnings........................................... 231 (1,074)
Distribution in excess of capital........................... (34,604) (34,604)
-------- --------
Total stockholders' deficit........................... (34,373) (35,678)
-------- --------
Total liabilities and stockholders' deficit........... $ 90,663 $ 95,347
======== ========
</TABLE>

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

44
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
------------------ ------------------ ------------------
<S> <C> <C> <C>
Net sales.................................. $248,242 $275,270 $292,513
Cost of sales.............................. 173,648 197,812 212,067
-------- -------- --------
Gross profit............................. 74,594 77,458 80,446
Selling, general and administrative
expenses................................. 56,074 62,317 65,021
Administrative fees........................ 250 250 250
Depreciation and amortization.............. 5,386 5,910 5,915
Other income, net.......................... 579 805 440
-------- -------- --------
Operating income......................... 13,463 9,786 9,700
Interest expense, net...................... 8,423 9,878 10,172
-------- -------- --------
Income (loss) before income taxes........ 5,040 (92) (472)
Provision (benefit) for income taxes....... 3,109 947 833
-------- -------- --------
Net income (loss)........................ $ 1,931 $ (1,039) $ (1,305)
======== ======== ========
</TABLE>

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

45
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
------------------ ------------------ ------------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income (loss)................................... $ 1,931 $ (1,039) $ (1,305)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization..................... 4,586 5,058 5,705
Amortization of deferred financing costs.......... 800 767 520
Deferred rent liabilities......................... 523 585 641
Non-cash interest expense......................... 1,683 1,845 2,055
LIFO provision.................................... (806) 1,358 1,958
Gain on repurchase of Senior Notes................ -- (395) --
Gain on sale of property and equipment............ -- -- 63
Changes in operating assets and liabilities
Accounts receivable............................. 1,546 (4,161) (2,123)
Inventories..................................... 1,793 (7,899) (3,247)
Prepaid expenses and other current assets....... (451) 427 (925)
Other assets.................................... (166) 292 2
Deferred tax assets............................. (34) (234) (1,150)
Deferred tax liabilities........................ 1,726 (167) 502
Accounts payable and accrued liabilities........ (1,233) 308 (812)
Income taxes payable............................ -- -- --
Supplier advances............................... (1,556) 759 1,299
Other liabilities............................... 194 (74) (75)
-------- -------- --------
Net cash provided by (used in) operating
activities.................................. 10,536 (2,570) 3,108
-------- -------- --------
Cash flows used in investing activities:
Capital expenditures................................ (3,525) (5,438) (4,359)
Acquisition of pharmacy customer lists.............. (310) (645) (968)
Proceeds from sale of fixed assets.................. -- 3 19
-------- -------- --------
Net cash used in investing activities......... (3,835) (6,080) (5,308)
-------- -------- --------
Cash flows (used in) provided by financing activities:
Proceeds from issuance of senior notes.............. 80,000 -- --
Distribution paid................................... (45,000) (1,120) --
Senior notes issuance fees paid..................... (3,870) -- --
Proceeds from repayment of loans to Directors and
officers.......................................... 182 -- --
Proceeds from exercise of common stock options...... 243 -- --
Proceeds from revolver borrowings................... 900 41,960 64,650
Payments made on revolver borrowings................ (900) (40,760) (64,600)
Cash overdraft...................................... -- 3,690 2,329
Repurchase of Senior Notes.......................... -- (5,605) --
Payments made on long-term debt..................... (29,269) -- --
Payments on subordinated debt....................... (87) -- --
-------- -------- --------
Net cash (used in) provided by financing
activities.......................................... 2,199 (1,835) 2,379
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents......................................... 8,900 (10,485) 179
Cash and cash equivalents beginning of period......... 1,870 10,770 285
-------- -------- --------
Cash and cash equivalents end of period............... $ 10,770 $ 285 $ 464
======== ======== ========

Supplemental disclosures of cash information:
Cash paid during the period:
Income taxes...................................... $ 2,047 $ 815 $ 1,782
======== ======== ========
Interest.......................................... $ 4,875 $ 8,198 $ 8,174
======== ======== ========
</TABLE>

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

46
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
COMMON STOCK
------------------------------ ADDITIONAL DISTRIBUTION TOTAL
CLASS A CLASS B PAID-IN RETAINED IN EXCESS OF STOCKHOLDERS'
SHARES SHARES AMOUNT CAPITAL EARNINGS CAPITAL EQUITY (DEFICIT)
-------- -------- -------- ---------- -------- ------------ ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, July 26, 1997................. 196,632 187,922 $ -- $ 3,846 $ 7,009 -- $ 10,855
Net loss for the three month period
ended October 25, 1997............... -- -- -- -- (459) -- (459)
Distribution paid...................... (3,846) (6,550) (34,604) (45,000)
Net income for the period from October
26, 1997 to July 25, 1998............ 2,390 2,390
------- ------- ---- -------- ------- -------- --------
Balance, July 25, 1998................. 196,632 187,922 -- -- 2,390 (34,604) (32,214)
Net income (loss)...................... -- -- -- -- (1,039) -- (1,039)
Distribution paid...................... -- -- -- -- (1,120) -- (1,120)
------- ------- ---- -------- ------- -------- --------
Balance, July 31, 1999................. 196,632 187,922 $ -- $ -- $ 231 $(34,604) $(34,373)
Net income (loss)...................... -- -- -- -- (1,305) -- (1,305)
------- ------- ---- -------- ------- -------- --------
Balance, July 29, 2000................. 196,632 187,922 $ -- $ -- $(1,074) $(34,604) $(35,678)
======= ======= ==== ======== ======= ======== ========
</TABLE>

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

47
<PAGE>
CDI GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

1. ORGANIZATION:

CDI Group, Inc. (the "Parent") and Subsidiary (collectively referred to as
the "Company"), owns and operates in the State of New Jersey a chain of drug
stores under the name "Drug Fair" and general merchandise stores under the name
"Cost Cutters". The Company manages and operates as one business segment.

The accompanying consolidated financial statements include the accounts of
the Parent and its wholly-owned subsidiary, Community Distributors, Inc. (the
"Subsidiary"). All significant intercompany accounts and transactions have been
eliminated in consolidation.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

ACCOUNTING YEAR

The Company maintains its accounts on a 52-53 week year ending with the last
Saturday in July. The fiscal years ended July 25, 1998, and July 29, 2000 each
contained 52 weeks, respectively. The year ended July 31, 1999 contained 53
weeks.

REVENUE RECOGNITION

Sales are net of returns and exclude sales tax. Revenues include sales from
all stores operating during the period.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents are considered by the Company to be financial
instruments with maturities, when purchased, of three months or less, and are
presented at cost which approximates fair value.

INVENTORIES

Inventories are stated at the lower of cost or market, using the
dollar-value, double extension last-in, first-out (LIFO) method. If the
first-in, first-out (FIFO) method of inventory accounting had been used,
inventories would have been approximately $2,953 and $4,893 higher than reported
at July 31, 1999 and July 29, 2000, respectively. Management believes that
inventories accounted for on a FIFO basis approximates current replacement
costs. Inventories are reflected net of reserves for excess/ obsolete/damaged
inventories in the amounts of $155 and $61 at July 31, 1999 and July 29, 2000,
respectively.

PROPERTY AND EQUIPMENT

Property and equipment, including computer software costs, are recorded at
cost and are depreciated on a straight-line basis over the estimated useful
lives of the assets, which range from three to seven years. Leasehold
improvements are amortized over the expected useful life of the improvement or
the life of the lease, whichever is shorter. Depreciation expense recorded for
the fiscal years ended July 25, 1998, July 31, 1999, and July 29, 2000 was
$2,094, $2,648 and $2,988, respectively. The cost and related accumulated
depreciation of assets retired or sold are removed from the respective accounts
and any gain or loss is recognized in operations.

48
<PAGE>
BENEFICIAL LEASEHOLDS

Beneficial leasehold rights existing at the acquisition date have been
recorded for acquired leases based on differences between contractual rents
under the respective lease agreements and prevailing market rents on the
acquisition date. Beneficial leaseholds are amortized over the lease terms using
the straight-line method. Accumulated amortization at July 31, 1999 and
July 29, 2000 was $2,505 and $2,817, respectively.

GOODWILL

Goodwill, which represents the excess of the Parent's purchase price of
acquired assets over the fair market value of net assets of the Subsidiary
acquired on January 30, 1995, is being amortized using the straight-line method
over twenty years. The Company evaluates the recoverability of goodwill on an
annual basis or earlier, if circumstances indicate that such an evaluation is
necessary. The Company's assessment of recoverability considers current and
future profitability, estimated undiscounted future cash flows from operations,
and any other events or changes in circumstances which indicate that the
carrying amount of goodwill may not be recoverable. In the event an impairment
of goodwill, or related asset, is indicated to have occurred, the Company's
policy is to allocate goodwill to long lived assets on a pro rata basis using
the relative fair value of those assets, at the date the goodwill arose for
purposes of assessing the recoverability of long-lived assets. The Company has
incurred no impairment of goodwill, or related assets, since its inception.
Accumulated amortization as of July 31, 1999 and July 29, 2000 was $8,625 and
$10,540, respectively.

DEFERRED FINANCING COSTS

Deferred financing costs are amortized over the term of the respective
borrowings, which is approximately 7 years.

SUPPLIER ADVANCES

Included in the accompanying consolidated balance sheets are $2,456 and
$3,756 of advances received related to various inventory supply agreements at
July 31, 1999 and July 29, 2000, respectively. Such amounts are being recorded
as a reduction of cost of sales as the Subsidiary's supply agreement obligations
are fulfilled, generally ranging from three to five years from the point that
the supplier advance is received. The Subsidiary's obligations under the supply
agreements are fulfilled through the passage of time for those supply agreements
that are for a specific period of time and by the purchasing of inventory for
those supply agreements that stipulate the purchasing of a specific amount of
inventory. The Subsidiary is currently committed to approximately $58,248 of
additional purchases under the inventory supply agreements at July 29, 2000. In
the event the Subsidiary does not fulfill its obligations under the inventory
supply agreements, a pro rata portion of the advance will be required to be
repaid, approximating the amounts presented in the financial statements as
Supplier Advances at July 29, 2000. The amount presented as the current portion
of the supplier advances is estimated by the Subsidiary as the amount related to
the passage of time and the estimated inventory purchases to be made during the
twelve months following July 29, 2000, as applicable to the specific inventory
supply agreements.

PRE-OPENING AND ADVERTISING COSTS

Costs associated with new stores prior to opening and advertising costs are
expensed as incurred. Net Advertising expense of $1,703, $2,662 and $2,189 for
the years ended July 25, 1998, July 31, 1999 and July 29, 2000, respectively is
net of co-op advertising rebates received from vendors in the amount of $4,430,
$4,303 and $4,196 for the years ended July 25, 1998, July 31, 1999 and July 29,
2000, respectively.

49
<PAGE>
INTEREST EXPENSE (NET)

Interest expense recorded for the fiscal years ended July 25, 1998,
July 31, 1999 and July 29, 2000, respectively, net of interest income was:

<TABLE>
<CAPTION>
FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
-------------- -------------- --------------
<S> <C> <C> <C>
Interest expense............................. $8,692 $10,043 $10,201
Interest income.............................. (269) (165) (29)
------ ------- -------
Interest expense (net)....................... $8,423 $ 9,878 $10,172
====== ======= =======
</TABLE>

INCOME TAXES

CONCENTRATIONS OF RISK

All of the Subsidiary's stores are located in northern and central New
Jersey. As a result, the Company is sensitive to economic, competitive, and
regulatory conditions in that region. The success of the Company's future
operations will be substantially affected by its ability to compete effectively
in New Jersey, and no prediction can be made as to economic conditions in that
region.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amount of cash and cash equivalents, accounts receivable and
accounts payable, as reflected in the accompanying consolidated balance sheets
approximate their fair value because their maturities are generally less than
one year in duration. The Company estimates that the carrying amount of its
long-term fixed rate debt and amounts reflected as long-term liabilities
approximate their fair value. Management is not aware of any factors that would
significantly affect the value of these amounts. The Company does not utilize
derivative financial instruments nor does it engage in hedging activities.

USE OF ESTIMATES

ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS

The Company has adopted Statement of Financial Accounting Standards No. 121
"ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO
BE DISPOSED OF" ("SFAS No. 121").

50
<PAGE>
SFAS No. 121 prescribes the accounting for the impairment of long-lived assets,
such as property, plant and equipment and intangible assets, as well as the
accounting for long-lived assets that are held for disposal. The statement
requires that the carrying value of such assets be reviewed when events or
circumstances indicate that an impairment might exist. The Company has concluded
that no impairment of long-lived assets existed at July 31, 1999 and July 29,
2000.

STOCK OPTIONS

The Company has adopted Statement of Financial Accounting Standards No. 123
"ACCOUNTING FOR STOCK BASED COMPENSATION" ("SFAS No. 123"). SFAS No. 123
prescribes the accounting for stock options and requires that options be valued
at their fair market value, as defined in the statement, on the date of grant.
SFAS No. 123 allows companies to either fully adopt its requirements or to elect
to only disclose the impact that the requirements would have. The Company has
adopted SFAS No. 123 for disclosure purposes only, to the extent material, and
will continue to account for its stock options under APB Opinion No. 25,
"ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES."

RECLASSIFICATION

Certain prior year amounts were reclassified to conform to 2000
presentations.

3. DEBT:

Long-term debt consists of the following:

<TABLE>
<CAPTION>
AT AT
JULY 31, 1999 JULY 29, 2000
------------- -------------
<S> <C> <C>
Senior notes-due October 15, 2004 interest at 10 1/4%
payable semi-annually on April 15 and October 15.......... $74,000 $74,000
Senior subordinated notes and accrued interest-due January
31, 2005, principal plus interest at a rate of 10% per
annum, are payable upon maturity.......................... 20,369 22,424
------- -------
Total................................................... 94,369 96,424
Less, current portion due within one year................. -- --
------- -------
Long-term portion........................................... $94,369 $96,424
======= =======
</TABLE>

On January 30, 1995, the Parent issued $13,250 in senior subordinated notes
which are due January 31, 2005. Principal on the notes is payable upon maturity
plus interest at a rate of 10% per annum. Payment of principal and interest on
the notes is subordinated to the prior payment in full of all of the Company's
obligations under the senior notes and revolving credit facility.

On October 16, 1997, the Subsidiary issued $80,000 of 10 1/4% senior notes
due 2004 which are guaranteed by the Parent. The net proceeds of such issuance
was $76,130. The Subsidiary used $29,269 of such net proceeds to refinance
substantially all of its then existing indebtedness and $45,000 of the net
proceeds was used to pay a dividend to the Parent which then paid a dividend of
the same amount to the stockholders of the Parent. The terms of the senior notes
include certain restrictive covenants regarding the payment of dividends, the
incurrence of debt, the use of proceeds resulting from disposition of assets and
certain other defined activities. Under the relevant debt agreements in the
event of a change in control, as defined, the Company is required to repurchase
all such outstanding notes.

On October 16, 1997, the Subsidiary also replaced its then existing credit
facility ("Old Credit Facility") with a $20,000 five year revolving credit
facility concurrent with the issuance of the $80,000 of senior notes. This
facility bears interest at either prime rate or London Interbank Offered Rate

51
<PAGE>
("LIBOR") plus 1.75% and is collateralized by the Subsidiary's eligible accounts
receivable and inventory balances, as defined. Included in the $20,000 five year
revolving credit facility is a $5,000 letter of credit facility. The new
facility contains certain financial and operating covenants, including a minimum
fixed charge ratio. Additionally, the Company cannot make any dividend or other
distributions with respect to any share of stock other than in certain limited
circumstances. The Subsidiary is required to pay a commitment fee of 1/4 of
1.00% per annum on the daily average unutilized revolving credit facility
commitment. For the year ended July 29, 2000, the Subsidiary incurred
approximately $81 of commitment fees and letter of credit fees under this
facility.

On October 6, 1998, the Subsidiary repurchased $5,000 principal amount of
Senior Notes at a purchase price of $4,675, plus accrued and unpaid interest. On
October 13, 1998, the Subsidiary repurchased $1,000 principal amount of Senior
Notes at a purchase price of $930, plus accrued and unpaid interest. These
repurchases of Senior Notes resulted in a gain of $395 during the year ended
July 31, 1999.

4. COMMITMENTS:

LEASES

The Company conducts all of its warehousing and retailing operations from
leased facilities. Annual store rent is composed of a fixed minimum amount, and
for certain stores, contingent rent which is based upon a percentage of sales,
exceeding a stipulated amount. The leases, which may be renewed for periods
ranging from five to thirty years, generally provide that the Company pay
insurance, maintenance costs and property taxes. These additional charges are
subject to escalation for increases in the related costs. Minimum rental
commitments under long-term noncancelable operating leases are as follows at
July 29, 2000:

Annual rent expense is comprised of a fixed minimum amount, plus contingent
rent based on a percentage of sales exceeding a stipulated amount. For the years
ended July 25, 1998, July 31, 1999, and July 29, 2000, respectively, total rent
expense included:

<TABLE>
<CAPTION>
FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
-------------- -------------- --------------
<S> <C> <C> <C>
Fixed minimum rent........... $9,045 $10,181 $10,993
Contingent rent.............. 219 250 231
------ ------- -------
Rent expense................. $9,264 $10,431 $11,224
====== ======= =======
</TABLE>

The Company recognizes rental expense for leases with scheduled rent
increases on the straight-line basis. During the years ended July 25, 1998,
July 31, 1999 and July 29, 2000, the Company recognized rent expense in excess
of amounts paid of $523, $585 and $641, respectively, which expense is included
in the amounts above.

52
<PAGE>
LETTERS OF CREDIT

Outstanding letters of credit, guaranteeing certain contingent purchases
commitments, which are not reflected in the accompanying financial statements,
aggregate approximately $2,016 and $3,144 at July 31, 1999 and July 29, 2000.

5. INCOME TAXES:

The provision for income taxes for the years ended July 25, 1998, July 31,
1999, and July 29, 2000, respectively, consist of the following:

<TABLE>
<CAPTION>
FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
-------------- -------------- --------------
<S> <C> <C> <C>
Current...................... $1,417 $1,133 $1,480
Deferred..................... 1,692 (186) (647)
------ ------ ------
$3,109 $ 947 $ 833
====== ====== ======
</TABLE>

The components of deferred taxes at July 31, 1999 and July 29, 2000 are
summarized as follows:

<TABLE>
<CAPTION>
AT AT
JULY 31, 1999 JULY 29, 2000
------------- -------------
<S> <C> <C>
Supplier advances, current........................... $ 126 $ 33
Inventory............................................ 235 298
Accruals and reserves................................ 687 692
Inventory (LIFO reserve)............................. (3,251) (3,475)
Depreciation......................................... 253 --
------- -------
Net deferred tax liability-current............... (1,950) (2,452)
======= =======
Depreciation......................................... -- 570
Accruals and reserves................................ 962 1,560
Supplier advances, non-current....................... 18 --
------- -------
Net deferred tax asset-long-term................. $ 980 $ 2,130
======= =======
</TABLE>

The following table accounts for the differences between the actual
provision and the amounts obtained by applying the statutory U.S. Federal income
tax rate of 34% to the income before income taxes:

<TABLE>
<CAPTION>
FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
-------------- -------------- --------------
<S> <C> <C> <C>
Federal statutory tax rate... 34% 34% 34%
State and local income taxes,
net of federal tax
benefit.................... 6% (271)% (46)%
Goodwill amortization........ 20% (888)% (163)%
Other........................ 2% 96% (1)%
-- ------ ----
62% (1,029)% (176)%
== ====== ====
</TABLE>

6. RELATED PARTY TRANSACTIONS:

Included in the Company's consolidated statements of income for the years
ended July 25, 1998, July 31, 1999, and July 29, 2000 are administrative fees of
$250, for each of the years, respectively. The

53
<PAGE>
Company has entered into administrative fee agreements with certain shareholders
of the Parent, whereby these shareholders will provide advisory and consulting
services to the Board of Directors. These administrative fee agreements require
the Company to pay $250 of administrative fees annually.

7. REDEEMABLE STOCK:

REDEEMABLE PREFERRED

On January 30, 1995, 7,500 shares of $1.00 par value Preferred Stock were
issued for $100 per share, for an aggregate consideration of $750. On
October 31, 1995, 7,143 shares of $1.00 par value Preferred Stock were redeemed
by the Company from stockholders and were sold to certain members of management
of the Company at the redemption price of $100 per share. At the same time, the
management of the Company purchased an additional 362 of the $1.00 par value
Preferred Stock shares at the same price as the initial consideration paid on
January 30, 1995. The Company's Preferred Stock is redeemable at the option of
the Company at any time, unless prohibited by the terms of any credit or other
financing agreement with any lender to the Company, at a price equal to $100 per
share, subject to appropriate adjustment in the event of any stock dividend,
stock split, combination or other similar recapitalization affecting the
Preferred Stock ("Liquidation Value"). On January 31, 2005, unless prohibited by
the terms of any credit or other financing agreement with any lender to the
Company, the Company will redeem all of the Preferred Stock outstanding at a
price per share equal to the Liquidation Value. Upon any voluntary or
involuntary liquidation, dissolution or winding up of the Company, the holders
of Preferred Stock shall be entitled to be paid the Liquidation Value of the
Preferred Stock before any payments could be made to holders of Common Stock.

REDEEMABLE COMMON

Under certain circumstances defined in the respective stock purchase
agreements, up to 57,963 shares of Class A Common Stock can be put back to the
Company with a redemption price to be determined under the stock purchase
agreement. Such redemption price cannot exceed the original issue price which
was ten dollars per share.

During fiscal 1998 certain executives of the management group of the Company
exercised options to purchase 24,237 shares of Class A Common Stock at an
aggregate purchase price of approximately $242.

LOANS TO OFFICERS AND DIRECTORS

On October 31, 1995, the Company issued 33,726 shares of Class A Common
Stock and 3,643 of Preferred Stock to certain directors and officers of the
Company in consideration for a note signed by each director and officer. These
notes bear interest at 8.0% and are due on various dates through January 31,
2005. All such shares are pledged as collateral toward these notes.

The outstanding balance of the notes due from certain directors and officers
at July 31, 1999 and July 29, 2000 of $87, has been reflected as a reduction of
the redemption value of the related redeemable Preferred and Common Stock.

8. STOCKHOLDERS' EQUITY:

COMMON STOCK

On January 30, 1995, 212,078 shares of Class A Common Stock and 187,922
shares of Class B Common Stock were issued for consideration of $4,000 (average
of $10.00 per share). Class A Common Stock ("Class A") and Class B Common Stock
("Class B") stockholders have the same rights and privileges with the exception
that each holder of record of Class A stock is entitled to one vote per share so
held, while Class B stockholders have no voting rights. Class A and Class B
stockholders are

54
<PAGE>
entitled to convert any or all such shares into an equivalent number of Class B
and Class A shares, respectively, except in the event that the holder of
Class B is a bank holding company or subsidiary thereof and such holder is
restricted by applicable banking laws from holding any (or any additional)
shares with voting rights. The conversion feature of the Class A and Class B
shares only affects the voting status of such shareholders, and the exercise of
such feature by all of the holders of the Class B shares would not trigger a
change in control event as defined in the Company's debt agreements.

On October 31, 1995, 30,016 shares of Class A Common Stock were redeemed by
the Company from the stockholders and 14,570 shares of Class A Common Stock were
sold to management at the repurchase price of $10 per share, which approximated
fair market value at the original issue date of January 30, 1995 and at the
repurchase date of October 31, 1995.

STOCK OPTIONS AND WARRANTS

On January 30, 1995, the Board of Directors approved the 1995 Stock Option
Plan (the "Plan"), which provides for the issuance of up to 65,882 shares of
Class A Voting Common Stock to employees and consultants of the Company and its
affiliates. The Plan is intended to be an incentive stock option plan within the
meaning of Section 422 of the Internal Revenue Service Code of 1986. The option
exercise price under each incentive option shall be not less than 100% of the
fair market value of the stock on the grant date, as determined by the Board of
Directors. On January 30, 1995, the Company issued options to purchase 37,649
shares of Class A Common Stock, at a price of $10 per share, to a senior
executive of the Company pursuant to the Plan. The options expire on
January 31, 2005 and expiration may be accelerated due to termination of
employment of the senior executive as well as various other reasons as
stipulated in the Option Agreement. These options vest as follows:

<TABLE>
<CAPTION>
NUMBER OF
OPTIONS VESTING DATE VESTED
--------------- ----------------
<S> <C>
10,667..................................................... January 30, 1996
10,667..................................................... January 30, 1997
10,667..................................................... January 30, 1998
2,824..................................................... January 30, 1999
2,824..................................................... January 30, 2000
</TABLE>

On January 30, 1995, non-Plan options to acquire 4,706 shares of Class A
Common Stock at $10 per share were issued to a senior executive of the Company.
These options are exercisable immediately after any disposition event as defined
by the Option Agreement.

Except for the options granted to a senior executive described above,
options granted to date under the plan expire approximately ten years after the
date of grant, one-half of the options granted vest in equal amounts over five
years provided the grantee remains an employee of the Company and one-half of
the options granted vest in equal amounts over five years based on meeting
certain performance goals.

On January 30, 1995, the Company issued a warrant to purchase 16,667 shares
of Class A Common stock, at a price of $.001 per share, to its' principal bank.
The holder of the warrant may exercise the rights represented by the warrant in
whole or in part at any time through January 30, 2005.

On March 18, 1998, the Company issued 1,500 options to an executive of the
Company at an exercise price equaling the current fair market value of $31 per
share.

55
<PAGE>
A summary of stock option transactions follows:

<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JULY 25, 1998 JULY 31, 1999 JULY 29, 2000
----------------------- ----------------------- -----------------------
<S> <C> <C> <C>
Options outstanding at
beginning of period... 67,079 38,924 38,778
Options granted......... 1,500 -- --
Options exercised....... 29,655 -- --
Options canceled........ -- (146) (1,203)
Options outstanding at
end of period......... 38,924 38,778 37,575
Options available for
grant at end of
period................ 1,615 1,615 1,615
Options vested and
outstanding at end of
period................ 12,001 19,702 26,846
Option price per share
for outstanding
options............... 37,424 shares at $10.00 37,278 shares at $10.00 36,325 shares at $10.00
1,500 shares at $31.00 1,500 shares at $31.00 1,250 shares at $31.00
</TABLE>

On October 16, 1997 the Subsidiary paid a dividend to the Parent in the
amount of $45,000. The Parent then declared and paid a dividend of $45,000 to
its stockholders. The Subsidiary's dividend of $45,000 was funded by the
proceeds of its offering of $80,000 of senior notes completed in October 1997.

The $45,000 dividend has been reflected in these consolidated financial
statements as a return of earnings and capital existing as of the dividend date.
The remaining excess of the dividend, $34,604, has been recorded as a
distribution in excess of capital.

On January 4, 1999, the Subsidiary paid a dividend to the Parent in the
amount of $1,120. The Parent then declared and paid a dividend of $1,120 to its
stockholders. The dividend of $1,120 was funded from the Subsidiary's operating
cash flow.

9. LITIGATION:

10. EMPLOYEE BENEFIT PLAN:

11. REVISION OF JULY 31, 1999 FINANCIAL STATEMENTS:

The Company has revised its financial statements for the fiscal year ended
July 31, 1999 to adjust for an understatement of Accounts Payable. The impact of
the revision is to reduce gross profit and net income by $1,000 and $600,
respectively.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

56
<PAGE>
PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS

The following table sets forth certain information with respect to the
directors, executive officers and key employees of the Holding Company and the
Company:

<TABLE>
<CAPTION>
NAME AGE TITLE
---- --- -----
<S> <C> <C>
Frank Marfino............................. 57 President, Chief Executive Officer and
Director of the Holding Company

Lynn L. Shallcross........................ 59 President-Cost Cutters Division of the
Company

Todd H. Pluymers.......................... 36 Chief Financial Officer of the Holding
Company and the Company

Barrie Levine............................. 55 Vice President-Pharmacy Operations of the
Company

William F. Gilligan....................... 58 Vice President-Distribution of the Company

Michael P. Quinn.......................... 47 Vice President-Merchandising of the
Company

Kevin Marron.............................. 43 Director-MIS of the Company

Alan J. Kirschner......................... 46 Director-Loss Prevention of the Company

Mark H. DeBlois........................... 44 Director of the Holding Company and the
Company

Harvey P. Mallement....................... 60 Director of the Holding Company and the
Company
</TABLE>

MR. MARFINO has been a Director and the President and Chief Executive
Officer of the Holding Company and the Company since February 1995. Prior to
February 1995, Mr. Marfino had served as the Chief Operating Officer of the
Company beginning in 1990 after having served as Vice President in charge of
Operations and Merchandising. Prior to joining the Company in 1982, Mr. Marfino
held senior positions, including Regional Manager and Director of Administrative
Operations with Two Guys Discount Stores/Vorando, Inc. over a 19 year period.

MR. SHALLCROSS has been President of the Cost Cutters division since 1984.
Mr. Shallcross joined the Company in 1971 and has held numerous positions in
management including pharmacist, pharmacist-manager, and district manager.
Mr. Shallcross is a graduate of Rutgers College of Pharmacy and has been a
licensed pharmacist since 1964.

MR. PLUYMERS joined the Company in April 1991 as Chief Financial Officer
and was appointed Chief Financial Officer of the Holding Company in
January 1995. Prior to joining the Company, Mr. Pluymers was employed by Arthur
Andersen & Co. from 1986 through 1991, most recently as an Audit Manager.
Mr. Pluymers is a graduate of Westminster College with a degree in Business
Administration/Accounting and is a Certified Public Accountant.

MR. LEVINE joined the Company as Vice President-Pharmacy Operations in
1993. Prior to joining the Company, Mr. Levine was employed by Supermarkets
General (Pathmark) since 1971. At Pathmark, Mr. Levine held various positions,
including Regional Pharmacy and Regional Front-End Supervisor, Regional Non-Food
Product Manager, and Manager of Pharmacy Services. Mr. Levine is a graduate of
Brooklyn College of Pharmacy and a licensed pharmacist in several states.

57
<PAGE>
MR. GILLIGAN has been Vice President-Distribution since 1985 after serving
as General Manager for 11 years with Atlantic Distribution Center in Jersey
City, New Jersey and 11 years with Wakefern Food Corporation, parent company of
Shop-Rite supermarkets. Trained in distribution management at Ohio State
University and Rutgers University, Mr. Gilligan is responsible for the daily
management of the distribution center, transportation logistics, property
management and the administrative staff. Mr. Gilligan has over 35 years of
experience in Distribution-Warehouse Management.

MR. QUINN joined the Company as Vice President-Merchandising on March 16,
1998. Prior to joining the Company, Mr. Quinn held the position of Vice
President-General Manager of Alpine Distributors, Inc., the non-food division of
Twin County Grocers, from 1994 to 1998. From 1992 to 1994, Mr. Quinn was
employed as a Divisional Merchandise Manager at the Rx Place, a Division of
Woolworth Corp. Mr. Quinn is a graduate of Manhattan College.

MR. MARRON has been Director-Management Information Systems for the Company
since 1986. Mr. Marron's work experience includes six years with Arthur's
Catalog Showroom and six years with MIS Software Corporation prior to joining
the Company. Mr. Marron has been instrumental in the creation of or installation
of a majority of the software applications for the Company, including inventory
management, sales, marketing, distribution, warehouse management, shelf labeling
and point-of-sale in store applications.

MR. KIRSCHNER joined the Company as Director-Loss Prevention in 1991. As
Director-Loss Prevention, Mr. Kirschner is also responsible for point-of-sale
and human resources for the Company. Prior to 1991, Mr. Kirschner held a similar
position with NBO Menswear and Rickel Home Centers, Inc. and has over twenty
years of experience in retail and loss prevention management. Mr. Kirschner is a
graduate of Jersey City State College.

MR. DEBLOIS has been a Director of the Holding Company and the Company
since 1995. Since 1990, Mr. DeBlois has been employed as an officer, most
recently as a Managing Director, of BancBoston Ventures Inc., a private equity
investment firm with committed capital in excess of $750 million that provides
private equity and mezzanine financing to middle market companies for
management-led buyouts, acquisitions and growth capital. Mr. DeBlois is a
graduate of Boston College.

MR. MALLEMENT has been a Director of the Holding Company and the Company
since 1995. Since 1981, Mr. Mallement has been Managing General Partner of
Harvest Partners, Inc., a private equity investment and growth financing firm
with committed capital in excess of $600 million that provides equity investment
financing that focuses on the acquisition of medium sized companies and
financing of growth businesses. Mr. Mallement is also a director of Symbol
Technologies, Inc. and is a graduate of the City College of New York with a
masters degree in Business Administration.

Pursuant to a Stockholder Agreement entered into as of January 30, 1995, as
amended, the holders of a substantial majority of the outstanding common stock
of the Holding Company (the "Common Stock"), including BancBoston and Harvest,
and their affiliates, as well as the Holding Company, Banque Paribas, Paribas
Principal, Inc., TA Holding, Inc., Jon Tietbohl and Frank Marfino, have agreed
that each of the Holding Company and the Company will have a Board of Directors
comprised of up to five members. The stockholders party to the Stockholder
Agreement have agreed to vote for the following persons as directors: (i) up to
two individuals designated by the holders of a majority of the outstanding
shares of Common Stock purchased by BancBoston in 1995 (the "BBV Stock");
(ii) up to two individuals designated by the holders of a majority of the
outstanding shares of Common Stock purchased by Harvest and its affiliates in
1995 (the "Harvest Stock"); and (iii) Frank Marfino, so long as he continues to
be employed by the Holding Company as President and Chief Executive Officer, and
thereafter, his successor as President and Chief Executive Officer. Mr. DeBlois
has been designated for election to the Board of Directors of the Holding
Company and the Company by the holders of a majority of the BBV Stock, and
Mr. Mallement has been designated for election to

58
<PAGE>
the Board of Directors of the Holding Company and the Company by the holders of
a majority of the Harvest Stock.

Executive officers of the Holding Company and the Company are appointed by
their respective Boards of Directors on an annual basis and serve until their
successors have been duly elected and qualified. There are no family
relationships among any of the executive officers and directors of the Holding
Company and the Company.

COMPENSATION OF DIRECTORS

Directors of the Holding Company and the Company do not receive compensation
from the Holding Company or the Company for their service in such capacities.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE. Not applicable.

ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

The following table sets forth the aggregate compensation paid by the
Company for services rendered during fiscal 1998, fiscal 1999 and fiscal 2000 to
the Company's Chief Executive Officer and five other most highly-compensated
executive officers for fiscal 2000.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
ANNUAL COMPENSATION
FISCAL --------------------- ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS(1) COMPENSATION
--------------------------- -------- -------- ---------- ------------
<S> <C> <C> <C> <C>
Frank Marfino................................. 1998 $460,384 $1,447,702 $3,534(2)
President and Chief Executive Officer 1999 $493,399 $ 256,230 $5,320(2)
2000 $496,125 $ 124,031 $3,621(2)

Lynn L. Shallcross............................ 1998 $171,231 $ 50,000 $3,126(3)
President--Cost Cutters Division 1999 $181,923 $ 60,000 $3,232(3)
2000 $172,615 $ 33,440 $2,038(3)

Todd H. Pluymers.............................. 1998 $140,674 $ 227,500 $ 747(4)
Chief Financial Officer 1999 $150,761 $28,875 $ 797(4)
2000 $153,780 $27,287 $ 793(4)

Barrie Levine................................. 1998 $129,038 $ 22,500 $1,697(5)
Vice President--Pharmacy Operations 1999 $136,538 $ 22,000 $2,278(5)
2000 $138,846 $ 27,192 $1,141(5)

Michael Quinn................................. 1998 $43,269 -- --
Vice President--Merchandising 1999 $129,908 $ 7,500 $1,645(6)
2000 $125,288 $ 12,634 $1,890(6)

William F. Gilligan........................... 1998 $111,231 $ 20,520 $2,046(7)
Vice President--Distribution 1999 $118,192 $ 22,400 $2,111(7)
2000 $119,691 $ 17,684 $1,487(7)
</TABLE>

------------------------

(1) Reflects bonuses paid during the fiscal year with respect to achievement of
certain performance goals relating to the prior fiscal year. The amounts of
annual bonuses that may be paid to the named executive officers for fiscal
2000 have not yet been determined. See "Certain Relationships and Related
Transactions."

59
<PAGE>
(2) Amounts include the values of the personal use of a company car equal to
$1,275, $1,325 and $1,300 for fiscal 1998, 1999 and 2000, respectively, as
well as the incremental cost of additional life insurance premiums in the
amounts of $2,259, $3,995 and $2,321 for fiscal 1998, 1999 and 2000,
respectively.

(3) Amounts include the values of the personal use of a company car equal to
$520, $540 and $510 for fiscal 1998, 1999 and 2000, respectively, as well as
the incremental cost of additional life insurance premiums in the amounts of
$2,606, $2,692 and $1,528 for fiscal 1998, 1999, and 2000, respectively.

(4) Amounts include the values of the personal use of a company car equal to
$520, $520 and $520 for fiscal 1998, 1999 and 2000, respectively, as well as
the incremental cost of additional life insurance premiums in the amounts of
$227, $267 and $273 for fiscal 1998, 1999, and 2000, respectively.

(5) Amounts include the values of the personal use of a company car equal to
$520, $530 and $520 for fiscal 1998, 1999 and 2000, respectively, as well as
the incremental cost of additional life insurance premiums in the amounts of
$1,177, $1,748 and $621 for fiscal 1998, 1999, and 2000, respectively.

(6) Amount includes the value of the personal use of a company car equal to
$1,350 and $1,530 for fiscal 1999 and 2000, respectively, as well as the
incremental cost of additional life insurance premiums in the amount of $295
and $360 for fiscal 1999 and 2000, respectively.

(7) Amounts include the values of the personal use of a company car equal to
$520, $530 and $520 for fiscal 1998, 1999 and 2000, respectively, as well as
the incremental cost of additional life insurance premiums in the amounts of
$1,526, $1,581 and $967 for fiscal 1998, 1999, and 2000, respectively.

STOCK OPTIONS TABLE

The following table sets forth the number of options to purchase Common
Stock held by the Company's Chief Executive Officer and one other executive
officer as of the end of fiscal 2000. None of the Company's four other most
highly-compensated executive officers held any options to purchase Common Stock
as of the end of fiscal 2000, and there were no options to purchase Common Stock
granted during fiscal 2000.

<TABLE>
<CAPTION>
FISCAL YEAR END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FISCAL YEAR END (#) AT FISCAL YEAR-END ($)
EXERCISABLE/UNEXERCISABLE(1) EXERCISABLE/UNEXERCISABLE(1)
------------------------------ ----------------------------
<S> <C> <C>
Frank Marfino................ 14,825/7,530 $0

Michael Quinn................ 0/1,500 $0
</TABLE>

------------------------

(1) The value of unexercised in-the-money options is calculated by determining
the difference between the book value of the Common Stock underlying the
options at the end of fiscal 2000, which was negative, and the option
exercise price. The Common Stock was not publicly traded at the end of
fiscal 2000.

EMPLOYMENT AGREEMENTS

In connection with the acquisition of the Company by the Holding Company in
1995, the Company entered into Employment Agreements with each of
Messrs. Marfino, Shallcross, Pluymers, Levine and Gilligan. Each of these
Employment Agreements contains customary confidential information and inventions
assignment provisions and provides for a one-year non-competition period upon
termination.

Mr. Marfino's Employment Agreement, which expires in January 2001, provides
for Mr. Marfino to receive an annual base salary of $450,000 (subject to annual
increases based on a consumer price index), and an incentive bonus based on the
financial performance of the Company. Mr. Marfino is not

60
<PAGE>
entitled to receive a bonus for any fiscal year in which the Company's Actual
EBITDA (as defined in the Employment Agreement) is less than 90% of a forecasted
EBITDA. In the event that Actual EBITDA is more than 90% of forecasted EBITDA,
Mr. Marfino will receive a bonus calculated with respect to the amount by which
Actual EBITDA exceeds forecasted EBITDA, of which $50,000 is guaranteed. In the
event that Mr. Marfino's employment is terminated by the Company prior to the
end of the term of the Employment Agreement or any extension thereof, or he
resigns under circumstances in which he is deemed to have terminated his
employment for Good Reason (as defined therein), Mr. Marfino is entitled to
receive his base salary through the end of the initial term of his Employment
Agreement or any extension term and a pro rated minimum bonus and incentive
bonus. In the event that Mr. Marfino's employment is terminated as a result of
death or disability, Mr. Marfino or his estate is entitled to severance pay of
one year of base salary and a pro rated minimum bonus and incentive bonus. In
the event that Mr. Marfino's employment is terminated upon the expiration of the
term of the Employment Agreement or any extension term, Mr. Marfino shall be
entitled only to receive a pro rated minimum bonus and incentive bonus.

The Employment Agreements for Messrs. Shallcross, Pluymers, Levine and
Gilligan, each of which expires in January 2001, currently provide for base
salaries of $176,000, $156,142, $140,000 and $120,500, respectively. The
Employment Agreement for Mr. Quinn, which expires in March 2001, currently
provides for a base salary of $128,500. In the event that the employment of any
of these officers is terminated during the respective terms of their Employment
Agreements for death, disability, resignation or termination by the Company
other than for "cause," the relevant officer will receive severance pay of his
base salary for one year after termination. No severance pay is payable under
any of the Employment Agreements in the event of termination for "cause."

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

Neither the Board of Directors of the Company, nor the Board of Directors of
the Holding Company, has ever maintained a compensation committee. Executive
compensation decisions are considered and decided by all of the directors of the
Company. All executive compensation decisions relating to fiscal 2000, including
decisions relating to the compensation of Frank Marfino, the President and Chief
Executive Officer of the Company, were decided by Mark DeBlois, Harvey Mallement
and Frank Marfino, each of whom was a director of the Company during all of
fiscal 2000. No officers or employees of the Company or the Holding Company
other than Mr. Marfino participated in any discussions of the Board of Directors
of either company regarding executive compensation.

INDEBTEDNESS OF MANAGEMENT

Mr. Frank Marfino, the President and Chief Executive Officer of the Holding
Company and the Company, and a director of the Holding Company and the Company,
had an outstanding loan from the Company which was incurred by Mr. Marfino in
connection with his purchase of shares of capital stock of the Company
concurrently with the acquisition of the Company by the Holding Company in
January 1995. In connection with this loan, Mr. Marfino executed a full-recourse
promissory note to the Company which required Mr. Marfino to pay cash interest
at a rate of 8% per annum. This loan was repaid in October 1998. See "Certain
Relationships and Related Transactions."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

BENEFICIAL OWNERSHIP

The Holding Company is the beneficial owner, with sole voting power and
investment power, of 100% of the outstanding capital stock of the Company.

The following table sets forth certain information regarding beneficial
ownership of the Common Stock(1) and Preferred Stock(2) of the Holding Company
(i) by each person known to the Company to

61
<PAGE>
own beneficially more than 5% of each class of outstanding voting capital stock
of the Holding Company, (ii) by each director of the Company and the Holding
Company, (iii) by each of the executive officers of the Company and the Holding
Company named in the "Summary Compensation Table," and (iv) by all directors and
executive officers of the Company and the Holding Company as a group, as of
October 25, 2000.

<TABLE>
<CAPTION>
CLASS A COMMON STOCK PREFERRED STOCK
---------------------------------- ----------------------------------
AMOUNT AND NATURE AMOUNT AND NATURE
OF BENEFICIAL PERCENT OF OF BENEFICIAL PERCENT OF
NAME AND ADDRESS OWNERSHIP(3) CLASS OWNERSHIP(3) CLASS
---------------- ----------------- ---------- ----------------- ----------
<S> <C> <C> <C> <C>
BancBoston Ventures Inc............ 159,389(4) 43.2% -- --
175 Federal St.
Boston, MA 02110

Mark H. DeBlois.................... 159,389(5) 43.2% -- --
c/o BancBoston Ventures Inc.
175 Federal St.
Boston, MA 02110

Harvest Partners International, 51,851(6) 20.4% -- --
L.P..............................
c/o Harvest Partners, Inc.
767 Third Avenue
New York, NY 10017

Harvey P. Mallement................ 83,816(7) 32.9% -- --
c/o Harvest Partners, L.P.
767 Third Avenue
New York, NY 10017

Paribas Principal, Inc............. 40,000(8) 15.7% -- --
787 Seventh Avenue
New York, NY 10017

DBG Auslands-Holding GmbH.......... 73,525(9) 22.4% -- --
Emil-von-Behring-Strasse 2
D-60439 Frankfurt-am-Main GERMANY

Harvest Technology Partners, 17,901(6) 7.0% -- --
L.P..............................
c/o Harvest Partners, Inc.
767 Third Avenue
New York, NY 10017

Banque Paribas..................... 16,667(8) 6.1% -- --
787 Seventh Avenue
New York, NY 10019

European Development Capital....... 14,064(6) 5.5% -- --
Corporation N.V.
c/o Harvest Partners, Inc.
767 Third Avenue
New York, NY 10017

Frank Marfino...................... 50,824(10) 18.9% 4,000 50.9%

Lynn L. Shallcross................. 8,211(11) 3.2% 1,073 13.6%

Todd H. Pluymers................... 6,781(11) 2.7% 715 9.1%
</TABLE>

62
<PAGE>

<TABLE>
<CAPTION>
CLASS A COMMON STOCK PREFERRED STOCK
---------------------------------- ----------------------------------
AMOUNT AND NATURE AMOUNT AND NATURE
OF BENEFICIAL PERCENT OF OF BENEFICIAL PERCENT OF
NAME AND ADDRESS OWNERSHIP(3) CLASS OWNERSHIP(3) CLASS
---------------- ----------------- ---------- ----------------- ----------
<S> <C> <C> <C> <C>
William F. Gilligan................ 6,781(11) 2.7% 715 9.1%

Barrie Levine...................... 2,927(11) 1.1% 143 1.8%

All Directors and Executive
Officers as a
Group (7 persons)................ 318,729(12) 83% 6,646 84.5%
</TABLE>

------------------------

(1) The Common Stock is comprised of Class A Voting Common Stock, $.00001 par
value per share ("Class A Common Stock"), and Class B Non-Voting Common
Stock, $.00001 par value per share ("Class B Common Stock"), each having
the same rights and privileges, other than with respect to voting rights
and powers. Holders of shares of Class A Common Stock have full voting
rights and powers as to all matters submitted to the stockholders of the
Holding Company for vote, consent or approval. Shares of Class A Common
Stock are convertible into shares of Class B Common Stock. Shares of
Class B Common Stock are convertible into shares of Class A Common Stock,
except in the event that the holder is a bank holding company or subsidiary
thereof and such holder is restricted by applicable banking laws from
holding any (or any additional) shares with voting rights.

(2) The Preferred Stock of the Holding Company, $1.00 par value per share (the
"Preferred Stock"), has a liquidation value of $100 per share and is
mandatorily redeemable by the Holding Company on January 31, 2005, or
optionally redeemable by the Holding Company at any time, in either case at
the liquidation value thereof. Holders of Preferred Stock have no voting
rights with respect to such shares.

(3) As used in this table, "beneficial ownership" means the sole or shared
power to vote or direct the voting of a security, or the sole or shared
investment power with respect to a security. A person is deemed as of any
date to have "beneficial ownership" of any security that such person has
the right to acquire within 60 days after such date. For purposes of
computing the percentage of outstanding shares held by each person named
above, any security that such person has the right to acquire within
60 days of the date of calculation is deemed to be outstanding, but is not
deemed to be outstanding for purposes of computing the percentage ownership
of any other person.

(4) Includes 114,397 shares of Class B Common Stock.

(5) The shares shown as beneficially owned by Mr. DeBlois represent 159,389
shares owned of record by BancBoston. Mr. DeBlois is a Managing Director of
BancBoston and may be deemed to control BancBoston, and accordingly may be
deemed to control the voting and disposition of the shares of Class A
Common Stock owned by BancBoston. As such, Mr. DeBlois may be deemed to
have shared voting and investment power with respect to all shares held by
BancBoston. However, Mr. DeBlois disclaims beneficial ownership of the
securities held by BancBoston.

(6) Harvest Partners International, L.P. ("Harvest Partners") is affiliated
with Harvest Technology Partners, L.P. ("Harvest") and European Development
Capital Corporation N.V. ("European Development"). In the aggregate,
Harvest Partners, Harvest and European Development hold 83,816 shares of
Class A Common Stock, representing 32.9% of the shares outstanding. Harvest
Partners, Harvest and European each disclaim beneficial ownership of all
shares held by the others.

(7) The shares shown as beneficially owned by Mr. Mallement represent 51,851
shares owned of record by Harvest Partners, 17,901 shares owned of record
by Harvest and 14,064 shares owned

63
<PAGE>
of record by European Development. Mr. Mallement either directly (whether
through ownership interest or position) or through one or more
intermediaries, may be deemed to control the voting and disposition of the
Class A Common Stock owned by each of Harvest Partners, Harvest and
European Development, and accordingly may be deemed to have shared voting
and investment power with respect to all shares held by each of Harvest
Partners, Harvest and European Development. However, Mr. Mallement
disclaims beneficial ownership of the securities held by each of Harvest
Partners, Harvest and European Development except to the extent of his
pecuniary interests therein.

(8) Paribas Principal, Inc. is affiliated with Banque Paribas, which holds a
presently exercisable warrant to purchase 16,667 shares of Class A Common
Stock, representing 6.1% of the shares of Class A Common Stock outstanding
on a fully diluted basis. In the aggregate, on a fully diluted basis,
Paribas Principal and Banque Paribas would hold, upon exercise of all such
warrants, 56,667 shares of Class A Common Stock, representing 20.9% of the
shares outstanding. Paribas Principal and Banque Paribas each disclaim
beneficial ownership of all shares held by the other.

(9) Includes 73,525 shares of Class B Common Stock.

(10) Includes 14,825 shares subject to exercisable options. In addition, all of
such shares are subject to repurchase by the Holding Company upon
termination of employment under certain circumstances.

(11) All of such shares are subject to repurchase by the Holding Company upon
termination of employment under certain circumstances.

(12) Includes 14,825 shares subject to exercisable options. In addition, 60,699
shares are subject to repurchase by the Holding Company upon termination
of employment under certain circumstances. Except as noted above, the
Company believes that the beneficial holders listed in the table above
have sole voting power and investment power over the shares described as
being beneficially owned by them.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In connection with the acquisition of the Company by the Holding Company,
the Company entered into Employment Agreements with each of Mr. Frank Marfino,
the President and Chief Executive Officer of the Company, Mr. Todd Pluymers, the
Chief Financial Officer of the Company, Mr. Lynn Shallcross, the President of
the Cost Cutters division of the Company, Mr. William Gilligan, the Vice
President--Distribution of the Company and Mr. Barrie Levine, the Vice
President--Pharmacy Operations of the Company. In March 1998, the Company
entered into an Employment Agreement with Mr. Michael Quinn, Vice
President--Merchandising of the Company. See "Executive Compensation--Employment
Agreements."

The holders of a substantial majority of the outstanding Common Stock have
also entered into a Stockholder Agreement pursuant to which such stockholders
agreed (i) to vote their shares of Common Stock in favor of a specified size and
composition of the respective Boards of Directors of the Holding Company and the
Company, (ii) not to transfer shares of Common Stock in violation of such
Stockholder Agreement, (iii) to consent to and participate in certain sales of
the Holding Company approved by the Board of Directors of the Holding Company
and holders of a majority of the Common Stock held by each of BancBoston and
Harvest and certain transferees and (iv) not to vote in favor of, or permit the
Board of Directors of the Holding Company to vote in favor of, certain actions
relating to corporate governance, including the borrowing of money, the payment
of dividends and the making of any guarantees of obligations of other persons,
not approved by BancBoston and Harvest. See "Directors and Executive Officers."

64
<PAGE>
The Company is also bound by Management Fee Agreements each dated as of
January 30, 1995 (as amended, the "Management Fee Agreements"), pursuant to
which the Company is required to pay an annual fee of $125,000 to each of
BancBoston and Harvest Partners, Inc., an affiliate of Harvest, in consideration
for certain management services provided by such entities in connection with the
administration of the Company's business. These services include providing
advice and administrative oversight with respect to the Company's business
direction and policy in the promotion, development and operation of the
Company's business. The Company's obligations under the respective Management
Fee Agreements shall continue so long as BancBoston or Harvest, as the case may
be, owns any shares of capital stock of the Holding Company. Payments under the
Management Agreements will constitute "Permitted Payments" under the Indenture.

Banque Paribas, the agent for the Company's previous credit facility, holds
a presently exercisable warrant (the "Paribas Warrant") to purchase 16,667
shares of Common Stock and Paribas Principal, Inc. ("Paribas Principal"), an
affiliate of Banque Paribas, holds 40,000 shares of Common Stock. The Company
repaid all amounts outstanding under its previous credit facility with a portion
of the proceeds of the Offering and terminated this credit facility
simultaneously with the closing of the sale of the Senior Notes. After the
consummation of the sale of the Senior Notes, Paribas Principal continued to
hold 40,000 shares of Common Stock, and the Paribas Warrant remains outstanding.
In connection with the payment of the Dividend, Banque Paribas and Paribas
Principal received approximately $1.66 million and $4.0 million, respectively.

The Holding Company, BancBoston, Harvest, Banque Paribas, Paribas Principal,
Harvest Technology Partners, L.P., European Development Capital Corporation
N.V., Deutsche Beteiligungsgesellschaft mbH, Frank Marfino and certain other
stockholders of the Holding Company are party to a Registration Rights
Agreement, dated as of January 30, 1995, pursuant to which the Holding Company
granted the other parties thereto piggy-back registration rights with respect to
their shares of Common Stock subject to certain limitations in the event of an
underwritten offering, and certain demand registration rights which are
exercisable during certain periods after the initial public offering of the
Common Stock. In addition, if the Holding Company has not completed an initial
public offering of its Common Stock prior to January 30, 2003, the holders of a
majority of the securities initially issued to Banque Paribas and Paribas
Principal are permitted to cause the Holding Company to effect such an initial
public offering pursuant to the terms of the Registration Rights Agreement.

The Company paid a dividend of approximately $45.0 million to the Holding
Company out of the proceeds of the sale of the Senior Notes. The Holding Company
paid the Dividend to its shareholders, including management and certain
employees of the Company, BancBoston and Harvest. Messrs. Marfino, Shallcross,
Pluymers, Gilligan and Levine received approximately $3.6 million, $578,000,
$442,000, $436,000 and $142,000, respectively, and BancBoston, Harvest, Harvest
Technology Partners, L.P. and European Development Capital Corporation N.V.
received approximately $15.9 million, $5.2 million, $1.8 million and
$1.4 million, respectively, from the Dividend.

The Company paid one-time performance-related bonuses of approximately
$1.2 million and $200,000 to Mr. Marfino and Mr. Pluymers, respectively, in
fiscal 1998. These bonuses were paid pursuant to a commitment made by the Board
of Directors of the Company in October 1997 to grant bonuses to these officers
in such amounts in consideration of the contributions made by such officers to
the growth and success of the Company over the period since its acquisition in
January 1995.

On October 16, 1997, the Holding Company issued amended and restated
Subordinated Notes in the same principal amounts to the original holders thereof
in connection with the issuance of the Original Notes and the Holding Company's
Guarantee of such Notes. These Subordinated Notes were reissued in order to
expressly provide for the subordination of the Holding Company's obligations
thereunder to the obligations of the Holding Company under the Indenture,
including its guarantee of the Senior Notes. No officers or directors of the
Company or the Holding Company hold any

65
<PAGE>
Subordinated Notes, although the following 5% or greater shareholders of the
Holding Company hold Subordinated Notes in the following original principal
amounts:

<TABLE>
<CAPTION>
NOTEHOLDER PRINCIPAL AMOUNT
---------- ----------------
<S> <C>
BancBoston.................................................. $5,753,890

Harvest..................................................... 1,889,970

Harvest Technology Partners, L.P............................ 643,210

European Development Capital Corporation, N.V............... 505,286

DBG Auslands Holding GmbH................................... 2,641,821
</TABLE>

On January 4, 1999 the Company paid the Holding Company a dividend in the
amount of approximately $1.1 million, and the Holding Company paid a dividend of
approximately $1.1 million to its stockholders, which includes management,
certain employees of the Company, BancBoston and Harvest.

66
<PAGE>
PART IV

ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
--------------------- -----------
<C> <S>
3.1 Certificate of Incorporation, as amended, of CDI Group, Inc.
(the "Holding Company").*

3.2 By-laws of the Holding Company.*

3.3 Certificate of Incorporation, as amended, of Community
Distributors, Inc. (the "Company").*

3.4 Amended and Restated By-laws of the Company.*

4.1 Indenture, dated as of October 16, 1997, by and among the
Company, the Holding Company and the Bank of New York, as
Trustee.*

4.2 Form of the Company's 10 1/4% Senior Notes due 2004.*

10.1 Investor Securities Purchase Agreement, dated as of January
30, 1995, by and among the Holding Company, BancBoston
Ventures Inc. ("BBV"), Harvest Partners International, LP
("HPI"), Harvest Technology Partners, LP ("HPT"), European
Development Capital Corporation N.V. ("EDCC") and Deutsche
Beteiligungsgesellschaft mbH ("DBMBH", and together with
BBV, HPI, HTP, EDCC and DBMBH, the "Investors"), as amended
by that certain First Amendment to Securities Purchase
Agreement, dated as of October 16, 1997, by and among the
Holding Company and the Investors.*

10.2 Purchase Agreement, dated as of October 10, 1997, by and
among the Company, the Holding Company, DLJ and BSC.*

10.3 Form of Holding Company's Amended and Restated Senior
Subordinated Note due 2005.*

10.4 Exchange Agency Agreement, dated as of February 13, 1998,
among the Exchange Agent, the Holding Company and the
Company.*

10.5 Stockholder Agreement, dated as of January 30, 1995, by and
among the Holding Company, the Investors, PPI, TAH,
Tietbohl, Frank Marfino and certain other persons
(collectively, the "Stockholders"), as amended by that
certain First Amendment to Stockholder Agreement, dated as
of October 16, 1997, by and among the Holding Company and
the Stockholders.*

10.7 Company Stock Purchase Warrant, dated as of January 30,
1995, issued by the Holding Company to Banque Paribas, as
amended by that certain Amendment of Common Stock Purchase
Warrant, Acknowledgment and Waiver, dated as of September
30, 1997, by and between the Company and the Bank.*

10.8 Loan and Security Agreement, dated as of October 16, 1997,
by and between PNC Bank, National Association and the
Company.*

10.9 The Company's $20,000,000 Revolving Loan Note, dated as of
October 16, 1997.*

10.10 Lease Agreement, dated as of May 15, 1995, by and between
105 Sylvania Place, L.L.C. and the Company (South
Plainfield, New Jersey).*

10.11 Lease Agreement, dated as of May 5, 1998, by and between JAM
Realty Company and the Company (Branchburg Township
(Somerville), New Jersey).*

10.12 Sublease Agreement, dated as of May 20, 1998, between
Mitsubishi Electronics America, Inc. and Community
Distributors, Inc. (Somerset, New Jersey).**

10.13 Letter Agreement, dated as of October 16, 1997, by and
between the Company and Frank Marfino regarding bonus
payment.*
</TABLE>

67
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
--------------------- -----------
<C> <S>
10.14 Employment and Non-Competition Agreement, dated as of
January 30, 1995 by and between the Company and Todd H.
Pluymers.*+

10.15 Letter Agreement, dated as of October 16, 1997, by and
between the Company and Todd H. Pluymers regarding bonus
payment.*

10.16 Employment and Non-Competition Agreement, dated as of
January 30, 1995 by and between the Company and Lynn L.
Shallcross.*+

10.17 Employment and Non-Competition Agreement, dated as of
January 30, 1995 by and between the Company and William F.
Gilligan.*+

10.18 Employment and Non-Competition Agreement, dated as of
February 17, 1995 by and between the Company and Barrie
Levine.*+

10.19 Employment and Non-Competition Agreement, dated as of March
16, 1998 by and between the Company and Michael Quinn.***+

10.20 Employment and Non-Competition Agreement, dated as of
January 30, 1995 by and between the Company and Frank
Marfino.*+

10.21 CDI Group, Inc. 1995 Stock Option Plan.+

12.1 Statement re: Computation of Ratio of Earnings to Fixed
Charges for the Company.

12.2 Statement re: Computation of Ratio of Earnings to Fixed
Charges for CDI Group, Inc.

21.1 List of Subsidiaries of CDI Group, Inc.*

24.1 Power of Attorney (included in signature page to the Form
10-K filed by the Registrants on October 27, 2000).

27.1 Financial Data Schedule of Community Distributors, Inc.

27.2 Financial Data Schedule of CDI Group, Inc.

99.1 Community Distributors, Inc. Summary of Valuation and
Qualifying Accounts.

99.2 CDI Group, Inc. Summary of Valuation and Qualifying
Accounts.

99.3 Reports of Independent Accountants on Financial Statement
Schedule.
</TABLE>

------------------------

* Incorporated by reference to the exhibits to the Registrants' Registration
Statement No. 333-41281, on Form S-4, filed by the Registrants with respect
to $80,000,000 aggregate principal amount of the Company's 10 1/4% Senior
Notes due 2004, Series B.

** Incorporated by reference to the same numbered exhibit to the Registrants'
Annual Report on Form 10-K, filed by the Registrants on October 23, 1998,
with respect to the Registrants' fiscal year ended July 25, 1998.

*** Incorporated by reference to the same numbered exhibit to the Registrants'
Annual Report filed by the Registrant on October 29, 1999, with respect to
the Registrants' fiscal year ended July 31, 1999.

+ This item is a management contract or compensatory plan.

All schedules other than those set forth in Exhibits 27.1, 27.2, 99.1 and
99.2 have been omitted because either they are not required, are not
applicable, or the information is otherwise set forth in the Consolidated
Financial Statements and notes thereto.

68
<PAGE>
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, each of the Registrants has duly caused this report to be
signed on its behalf by the undersigned thereunto duly authorized as of
November 13, 2000.

<TABLE>
<S> <C> <C>
COMMUNITY DISTRIBUTORS, INC.

By: /s/ TODD H. PLUYMERS
-----------------------------------------
Todd H. Pluymers,
CHIEF FINANCIAL OFFICER (PRINCIPAL
FINANCIAL
AND ACCOUNTING OFFICER)
</TABLE>

<TABLE>
<S> <C> <C>
CDI GROUP, INC.

By: /s/ TODD H. PLUYMERS
-----------------------------------------
Todd H. Pluymers,
CHIEF FINANCIAL OFFICER (PRINCIPAL
FINANCIAL
AND ACCOUNTING OFFICER)
</TABLE>