<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
Amendment #1
(MARK ONE)
[ x ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended March 1, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ____________ to ____________
Commission File Number 0-16998
DRUG EMPORIUM, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 31-1064888
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NO.)
----------
155 HIDDEN RAVINES DRIVE
POWELL, OHIO 43065
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
----------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.10 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject so such
filing requirements for the past 90 days.
Yes __X__ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
At May 16, 1997, there were 13,179,785 shares of Drug Emporium common
stock outstanding. The aggregate market value of shares of common stock held by
non-affiliates of the Registrant as of May 16, 1997 was approximately
$57,661,559 based on a closing price of $4.375 per share on Nasdaq National
Market on such date.
DOCUMENTS INCORPORATED BY REFERENCE
Part II, Items 6., 7. and 8., and Part IV, Item 14. incorporate by
reference portions of the Drug Emporium, Inc. Annual Report to Stockholders for
the year ended March 1, 1997. Part III, Items 10., 11., 12., and 13.
incorporate by reference portions of the Drug Emporium, Inc. Proxy Statement
for the 1997 Annual Meeting of Stockholders. With the exception of the
information specifically incorporated by reference, the Drug Emporium, Inc.
Annual Report to Stockholders for the year ended March 1, 1997 is not deemed
filed as part of this report.
<PAGE> 2
<TABLE>
<S> <C>
Consolidated Statements of Cash Flows for each of the
Three Fiscal Years in the Period Ended March 1, 1997 17
Notes to Consolidated Financial Statements 18-22
Report of Independent Auditors 23
</TABLE>
(2) Financial Statement Schedules
Schedules for which provision is made in Regulation S-X are not
required under the instructions contained therein, are
inapplicable, or the information is included in the footnotes to
the Consolidated Financial Statements.
(3) Exhibits List
(3) Articles of Incorporation and By-Laws
3.3 Restated Certificate of Incorporation
(Incorporated by reference to Exhibit
3.3 to the Company's S-1 Registration
Statement No. 33-21755)
(10) Material Contracts
10.1 Drug Emporium, Inc. 1983 Incentive
Stock Option Plan (incorporated by
reference to Exhibit 10.2 to the
Company's S-1 Registration Statement
Registration No. 33-21755) **
10.2 Drug Emporium, Inc. 1984 Incentive
Stock Option Plan (incorporated by
reference to Exhibit 10.3 to the
Company's S-1 Registration Statement
Registration No. 33-21755) **
10.3 Drug Emporium, Inc. 1987 Incentive
Stock Option Plan (incorporated by
reference to Exhibit 10.4 to the
Company's S-1 Registration Statement
Registration No. 33-21755) **
10.4 Drug Emporium, Inc. 1990 Incentive
Stock Option Plan (incorporated by
reference to Exhibit 10.41 to the
Company's Annual Report on Form 10-K
for the fiscal year ended February 28,
1990) **
10.5 Drug Emporium, Inc. Non-Qualified
Stock Option Plan (incorporated by
reference to Exhibit 10.5 to the
Company's S-1 Registration Statement
Registration No. 33-21755) **
10.7 Form of License and Franchise
Agreement (incorporated by reference
to Exhibit 10.7 to the Company's S-1
Registration Statement Registration
No. 33-21755)
10.8 Form of Option Agreement (incorporated
by reference to Exhibit 10.8 to the
Company's S-1 Registration Statement
Registration No. 33-21755)
10.10 Third Amended and Restated Revolving
Credit and Term Loan Agreement dated
as of November 13, 1995, between Drug
Emporium, Inc. and Bank One, Columbus,
NA (incorporated by reference to
Exhibit 10.1 of the Company's Form
10-Q for the period ended November 25,
1995)
10.11 Employment contract dated March 11,
1993 between David L. Kriegel and Drug
Emporium, Inc. (incorporated by
reference to the Company's Annual
Report on Form 10-K for the fiscal
year ended February 27, 1993) **
<PAGE> 3
10.12 Drug Emporium, Inc. 1993 Incentive
Stock Option Plan (incorporated by
reference to Exhibit 10.12 to the
Company's Annual Report on Form 10-K
for the fiscal year ended February 27,
1993) **
10.13 Drug Emporium, Inc. 1993 Non-Qualified
Stock Option Plan (incorporated by
reference to Exhibit 10.13 to the
Company's Annual Report on Form 10-K
for the fiscal year ended February 27,
1993) **
10.14 Amendments No. 1, 2 and 3 to Third
Amended and Restated Revolving Credit
and Term Loan Agreement dated as of
November 13, 1995, (between Drug
Emporium, Inc. and Bank One, Columbus,
NA) and $5,000,000 Term Note dated
April 18, 1997 **
10.15 Amendment to Employment Agreement made
the 11th day of March 1993 by and
between Drug Emporium, Inc. and David
L. Kriegel dated September 25, 1996,
and Employment Security Agreements
between Drug Emporium, Inc. and each
of A. Joel Arnold, Jane H. Lagusch and
Timothy S. McCord, dated September
25, 1996 **
(11) Statement re Computation of Per Share Earnings
11.1 Computation of Per Share Earnings is
readily computable from information
disclosed in the financial statements
and therefore is not included as a
separate exhibit.
*(13) Annual Report to Security Holders, Form 10Q or
Quarterly Report to Security Holders
13.1 Annual Report to Stockholders for
Fiscal Year Ended March 1, 1997.
(limited to those portions
incorporated herein)
*(21) Subsidiaries of Registrant
21.1 The Company has the following
wholly-owned subsidiaries:
<TABLE>
<CAPTION>
State of
Name Incorporation
------------------------------------------------------------------------
<S> <C>
Drug Emporium of Michigan, Inc. Delaware
Drug Emporium of Maryland, Inc. Delaware
Winter Fern Drug Distributors, Inc. Ohio
RJR Drug Distributors Inc. Delaware
Houston Venture, Inc. Ohio
Emporium Venture, Inc. Ohio
</TABLE>
(23) Consent of Experts
23.1 Consent of Ernst & Young LLP
(27) Financial Data Schedule
27.1 Financial Data Schedule of the Company
*Included with this Annual Report on Form 10-K
**Compensatory plans, contracts or agreements
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of
fiscal 1997.
<PAGE> 4
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
DRUG EMPORIUM, INC.
(Registrant)
Date: June 17, 1997
/s/ Timothy S. McCord /s/ David L. Kriegel
- ------------------------------------- ------------------------------------
Timothy S. McCord David L. Kriegel
Chief Financial Officer and Treasurer Chairman and Chief Executive Officer
<PAGE> 1
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
March 1, 1997 March 2, 1996
(Dollars in thousands, except per share data) (52 weeks) (53 weeks)
==============================================================================================================
FOR THE YEAR ENDED:
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Net sales $ 855,016 $ 738,772
- --------------------------------------------------------------------------------------------------------------
Operating income before special charges* $ 12,915 $ 13,372
- --------------------------------------------------------------------------------------------------------------
Net income $ 1,152 $ 2,342
- --------------------------------------------------------------------------------------------------------------
Average sales per store (52-week weighted average) $ 6,151 $ 5,941
- --------------------------------------------------------------------------------------------------------------
AT YEAR END:
- --------------------------------------------------------------------------------------------------------------
Inventories at current cost $ 208,991 $ 209,652
- --------------------------------------------------------------------------------------------------------------
LIFO reserve (21,042) (21,154)
- --------------------------------------------------------------------------------------------------------------
Inventories $ 187,949 $ 188,498
- --------------------------------------------------------------------------------------------------------------
Working capital $ 76,302 $ 80,195
- --------------------------------------------------------------------------------------------------------------
Shareholders' equity $ 49,567 $ 48,545
- --------------------------------------------------------------------------------------------------------------
Current ratio 1.59 1.63
- --------------------------------------------------------------------------------------------------------------
Long-term debt to equity 1.20 1.30
- --------------------------------------------------------------------------------------------------------------
Shares outstanding (in thousands) 13,153 13,184
- --------------------------------------------------------------------------------------------------------------
STORES OPEN:
- --------------------------------------------------------------------------------------------------------------
Company-owned 138 136
- --------------------------------------------------------------------------------------------------------------
Franchised and licensed 91 90
- --------------------------------------------------------------------------------------------------------------
Total 229 226
- --------------------------------------------------------------------------------------------------------------
PER SHARE:
- --------------------------------------------------------------------------------------------------------------
Net income $ 0.09 $ 0.18
- --------------------------------------------------------------------------------------------------------------
Shareholders' equity $ 3.77 $ 3.68
==============================================================================================================
* Special charges of $2,800,000 and $3,000,000 were recorded in Fiscal 1997 and Fiscal 1996, respectively.
</TABLE>
<PAGE> 2
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected financial data and other operating
information of the Company. The selected financial data is derived from the
consolidated financial statements of the Company. The financial data should be
read in conjunction with the consolidated financial statements and related notes
contained elsewhere in this report and Management's Discussion and Analysis of
Financial Condition and Results of Operations.
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS DATA
Year Ended
- ------------------------------------------------------------------------------------------------------------------------
MARCH 1, March 2, February 25, February 26, February 27,
(in thousands, except per share data) 1997 1996 1995 1994 1993
(52 WEEKS) (53 weeks) (52 weeks) (52 weeks) (52 weeks)
========================================================================================================================
<S> <C> <C> <C> <C> <C>
Net sales $855,016 $738,772 $729,503 $749,040 $756,710
- -------------------------------------------------------------------------------------------------------------------------
Gross margin 185,475 160,146 153,696 155,473 154,002
- -------------------------------------------------------------------------------------------------------------------------
Selling, administrative and occupancy expenses 172,560 146,774 143,337 146,920 146,726
- -------------------------------------------------------------------------------------------------------------------------
Operating income before special charges 12,915 13,372 10,359 8,553 7,276
- -------------------------------------------------------------------------------------------------------------------------
Special charges 2,800 3,000 11,850 -- 4,357
- -------------------------------------------------------------------------------------------------------------------------
Interest, net 7,882 6,468 6,697 6,183 6,148
- -------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 2,233 3,904 (8,188) 2,370 (3,229)
- -------------------------------------------------------------------------------------------------------------------------
Provision (benefit) for income taxes 1,081 1,562 (2,797) 1,089 (562)
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 1,152 $ 2,342 $ (5,391) $ 1,281 $ (2,667)
=========================================================================================================================
PER SHARE DATA:
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 0.09 $ 0.18 $ (0.41) $ 0.10 $ (0.20)
- -------------------------------------------------------------------------------------------------------------------------
Cash dividends -- -- -- -- $ 0.04
- -------------------------------------------------------------------------------------------------------------------------
Shareholders' equity $ 3.77 $ 3.68 $ 3.50 $ 3.91 $ 3.82
- -------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET DATA:
- -------------------------------------------------------------------------------------------------------------------------
Working capital $ 76,302 $ 80,195 $ 83,664 $ 82,176 $ 72,525
- -------------------------------------------------------------------------------------------------------------------------
Total assets $243,319 $243,898 $176,444 $198,085 $194,935
- -------------------------------------------------------------------------------------------------------------------------
Non-current liabilities $ 63,523 $ 67,391 $ 67,738 $ 68,761 $ 59,861
- -------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity $ 49,567 $ 48,545 $ 46,149 $ 51,484 $ 50,095
=========================================================================================================================
</TABLE>
12 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO]
<PAGE> 3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth selected items from the Company's Consolidated
Statements of Operations expressed as a percentage of net sales for the years
indicated.
<TABLE>
<CAPTION>
Year Ended
- --------------------------------------------------------------
March 1, March 2, February 25,
1997 1996 1995
(52 weeks) (53 weeks) (52 weeks)
- --------------------------------------------------------------
<S> <C> <C> <C>
Net sales (in thousands) $855,016 $738,772 $729,503
- --------------------------------------------------------------
Gross margin 21.7% 21.7% 21.1%
- --------------------------------------------------------------
Selling, administrative and
occupancy expense 20.2 19.9 19.7
- --------------------------------------------------------------
Operating income before
special charges 1.5% 1.8% 1.4%
- --------------------------------------------------------------
</TABLE>
SALES
Sales for Fiscal 1997 increased 16 percent over Fiscal 1996 and comparable-store
sales increased two percent. The overall sales increase was achieved due to the
impact of sales at acquired stores and comparable-store sales increases,
partially offset by the impact of having 52 weeks in Fiscal 1997 versus 53 weeks
in Fiscal 1996. Average sales per store for Fiscal 1997 (based on a weighted
average number of stores) were up three percent over Fiscal 1996 as a result of
the closing of underperforming stores, the acquisition of higher-volume stores
and comparable-store sales increases. In Fiscal 1996, the additional one week of
sales contributed $14.9 million to net sales.
Pharmacy sales as a percentage of total sales were 26 percent in Fiscal 1997
and 25 percent in Fiscal 1996 and 1995. Management expects that pharmacy sales
will continue to account for approximately one-fourth of sales in the coming
year.
The following table lists stores opened or acquired and stores closed for the
years indicated:
<TABLE>
<CAPTION>
Year Ended
- --------------------------------------------------------------
March 1, March 2, February 25,
1997 1996 1995
(52 weeks) (53 weeks) (52 weeks)
- --------------------------------------------------------------
<S> <C> <C> <C>
Number of stores at
beginning of year 136 113 133
- --------------------------------------------------------------
Stores opened or acquired 9 34 5
- --------------------------------------------------------------
Stores closed (7) (11) (25)
- --------------------------------------------------------------
Total stores at end of year 138 136 113
===============================================================
</TABLE>
GROSS MARGIN
Gross margin as a percentage of sales remained constant in Fiscal 1997 as
compared to Fiscal 1996. Management achieved stability in the gross margin in
Fiscal 1997 despite significant competitive pressures through improved
category management, better buying and improved shrink control. Similar factors
led to an increase in Fiscal 1996 gross margins over Fiscal 1995.
For Fiscal 1998, management expects continued pressure on the pharmacy
margins as sales through managed care networks increase as a percentage of
pharmacy sales. General merchandise gross margins are expected to remain stable.
Management's goal is to offset any downward pressure on margins by utilizing
scanning data to improve overall category gross margins where opportunities
allow, while at the same time protecting the low price image of the stores.
SELLING, ADMINISTRATIVE AND OCCUPANCY
Selling, administrative and occupancy expenses increased in Fiscal 1997 compared
to Fiscal 1996 and Fiscal 1995 in total dollars and as a percentage of net
sales. The increase over Fiscal 1996 is a result of transitional costs
associated with the acquired stores and increased litigation costs. The increase
in Fiscal 1996 over Fiscal 1995 was a result of increased ongoing costs related
to the POS system and increased security system costs.
SPECIAL CHARGES
The impact of special charges on net income (loss) and descriptions of the
components of the charges are shown below:
<TABLE>
<CAPTION>
Year Ended
- -------------------------------------------------------------------------------
March 1, March 2, February 25,
1997 1996 1995
(in thousands, except per share data) (52 weeks) (53 weeks) (52 weeks)
- --------------------------------------------------------------------------------
RECONCILIATION OF NET INCOME
(LOSS) TO NET INCOME (LOSS)
BEFORE SPECIAL CHARGES:
<S> <C> <C> <C>
Net income (loss) $ 1,152 $ 2,342 $(5,391)
- -------------------------------------------------------------------------------
Special charges, net of
income taxes 1,680 1,800 7,110
- -------------------------------------------------------------------------------
Net income (loss)
before special charges $ 2,832 $ 4,142 $ 1,719
- -------------------------------------------------------------------------------
Net income per share
before special charges $ 0.22 $ 0.31 $ 0.13
================================================================================
</TABLE>
Store Closure Expense
In Fiscal 1995, the Company sold seven stores in the Washington, D.C. market and
closed fourteen additional stores. The cost associated with the 21 stores
resulted in a pretax charge of $11,850,000. During Fiscal 1996, an additional
pretax charge of $3,000,000 was taken to cover rent and related charges at
several properties which have taken longer than expected to sublease. In Fiscal
1997, the Company incurred costs associated with stores closed during Fiscal
1997 and earlier of $1,300,000, which was recorded as a part of special charges.
Management's goal is to sublease or through other means remove all
significant closed-store obligations. Since March 1994, the Company has closed
43 stores, of which obligations continue at March 1, 1997 on five stores.
Management continues to seek ways to relieve obligations on these stores.
Impairment of Long-Lived Assets
In Fiscal 1997, the Company adopted SFAS No. 121, Accounting
for the Impairment of Long Lived Assets and for Long-Lived Assets to
Be Disposed Of. Accordingly, the Company evaluated the ongoing
[LOGO] DRUG EMPORIUM INC AND SUBSIDIARIES 13
<PAGE> 4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
value of its long-lived assets. Based on this evaluation, the Company determined
that leasehold improvements and lease assets for certain stores were impaired
and recorded, as a part of special charges, an amortization charge of
$1,500,000.
INTEREST, NET
Interest, net increased during Fiscal 1997 and decreased during Fiscal 1996. The
increase in Fiscal 1997 is due to increased borrowing related to store
acquisitions. The decrease in Fiscal 1996 is due to lower borrowings during the
first three quarters, partially offset by increased fourth quarter borrowings
due to the stores acquired. Management's goal is to reduce borrowing costs in
Fiscal 1998 by reducing debt through decreased inventory levels and improved
operational cash flow.
ACQUISITIONS
On May 29, 1996, the Company completed a purchase of certain assets of six
stores in the Philadelphia market. The acquisition was accounted for as a
purchase.
Late in the third quarter of Fiscal 1996, the Company acquired 26 stores from
F&M Distributors, Inc. ("F&M") in two separate transactions. The acquired stores
were located in Milwaukee, Baltimore and Detroit, with Detroit representing a
new market for the Company. Three of the stores were subsequently closed or
merged with existing Drug Emporium operations. None of the closed stores carried
any future lease obligations to the Company.
Six additional stores were also purchased in three separate transactions.
The consolidated statements of operations reflect the results of operations
of the acquired stores from the date acquired.
INVENTORY VALUATION
The Company uses the LIFO method of accounting for its inventories. Under this
method, the cost of merchandise sold reported in the financial statements
approximates current costs.
The Company, in computing its LIFO charges throughout the fiscal year, uses
an estimated percentage rate of inflation determined at the beginning of the
fiscal year. This LIFO charge is adjusted at each year end based upon the actual
weighted average percentage rate of inflation during the fiscal year.
<TABLE>
<CAPTION>
Year Ended
- ------------------------------------------------------------------
March 1, March 2, February 25,
1997 1996 1995
- ------------------------------------------------------------------
<S> <C> <C> <C>
LIFO provision (benefit)
(in thousands) $(112) $1,573 $200
- ------------------------------------------------------------------
Inflation rate -.1% 1.1% .1%
==================================================================
</TABLE>
Inventory turnover approximated four turns for each of the years presented.
Management's goal is to increase turns in the future by adjusting buying based
on movement information provided through scanning and by seeking alternative
distribution methods that will allow for reduced inventory of slower moving
items.
LIQUIDITY AND CAPITAL RESOURCES
The Company signed a new bank agreement (the Agreement) on May 24, 1996. As of
March 1, 1997, the Company's credit facility consisted of a term loan of
$12,000,000 and a revolving credit loan availability of up to $55,000,000. The
revolver expires on May 31, 2000, while the term debt is paid in quarterly
installments of $750,000.
During Fiscal 1997, the Company increased borrowings under the revolving
credit facility by $20.1 million, as set forth in the consolidated statements of
cash flows. This was a result of spending on acquisitions of approximately $10.1
million and timing of vendor payments, partially offset by other operational
cash flows.
The Company's borrowing rate can fluctuate between the bank's prime rate and
a LIBO-based rate, depending on the ability of the Company to meet certain
financial covenants. The Agreement requires a commitment fee on the revolver of
.25% on the unused available credit and has no compensating balance
requirements. Borrowings made pursuant to the Agreement are secured by inventory
and accounts receivable. The Agreement prohibits the payment of dividends, stock
repurchases and acquisition of the Company's convertible subordinated
debentures.
Cash paid for interest on the revolving credit line and long-term debt
exceeded interest expense by approximately $1 million in Fiscal 1997 and was
lower than interest expense by approximately $1 million in Fiscal 1996. The
Company believes that internally generated funds and borrowings available under
its Agreement are sufficient to finance the Company's current operations.
DEFERRED TAX ASSET
The Company's deferred tax asset at March 1, 1997 is primarily comprised of net
operating loss and AMT credit carryforwards of $3,500,000. Management expects to
generate taxable income through operations of at least this amount during the
next few years. However, the Company has the ability to generate taxable income
through tax planning strategies, if necessary, to utilize the net operating loss
carryforward.
14 DRUG EMPORIUM INC AND SUBSIDIARIES [LOGO]
<PAGE> 5
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
(in thousands)
- --------------------------------------------------------------------------------------------
ASSETS MARCH 1, 1997 March 2, 1996
- --------------------------------------------------------------------------------------------
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 779 $ 767
- -------------------------------------------------------------------------------------------
Accounts receivable 14,525 13,018
- -------------------------------------------------------------------------------------------
Inventories 187,949 188,498
- -------------------------------------------------------------------------------------------
Income taxes and other current assets 3,278 5,874
- -------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 206,531 208,157
- -------------------------------------------------------------------------------------------
Property and equipment, net 30,412 28,793
- -------------------------------------------------------------------------------------------
Goodwill 4,763 5,311
- -------------------------------------------------------------------------------------------
Other assets 1,613 1,637
- -------------------------------------------------------------------------------------------
TOTAL ASSETS $243,319 $243,898
===========================================================================================
(dollars in thousands)
- -------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY MARCH 1, 1997 March 2, 1996
============================================================================================
CURRENT LIABILITIES:
Revolving credit line $ 41,600 $ 21,500
- -------------------------------------------------------------------------------------------
Accounts payable 64,571 69,143
- -------------------------------------------------------------------------------------------
Accrued liabilities 15,142 23,527
- -------------------------------------------------------------------------------------------
Deferred income 4,966 9,183
- -------------------------------------------------------------------------------------------
Current maturities of long-term debt 3,950 4,609
- -------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 130,229 127,962
- -------------------------------------------------------------------------------------------
Deferred rent 4,192 4,107
- -------------------------------------------------------------------------------------------
Convertible subordinated debt 49,421 49,421
- -------------------------------------------------------------------------------------------
Long-term debt, other 9,910 13,863
- -------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT 59,331 63,284
- -------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY:
Preferred stock, authorized 2,000,000 shares, none issued -- --
- -------------------------------------------------------------------------------------------
Common stock, stated value $.10 per share, authorized 28,000,000;
issued and outstanding 13,153,000 in 1997, 13,184,000 in 1996 1,315 1,318
- -------------------------------------------------------------------------------------------
Additional paid-in capital 31,994 32,121
- -------------------------------------------------------------------------------------------
Retained earnings 16,258 15,106
- -------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 49,567 48,545
- -------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $243,319 $243,898
===========================================================================================
See accompanying notes.
15
</TABLE>
[LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 15
<PAGE> 6
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended
- ----------------------------------------------------------------------------------------------------------
MARCH 1, 1997 March 2, 1996 February 25, 1995
(in thousands, except per share amounts) (52 weeks) (53 weeks) (52 weeks)
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $ 855,016 $ 738,772 $ 729,503
- ----------------------------------------------------------------------------------------------------------
Cost of sales 669,541 578,626 575,807
- ----------------------------------------------------------------------------------------------------------
Gross margin 185,475 160,146 153,696
- ----------------------------------------------------------------------------------------------------------
Selling, administrative and occupancy expenses 172,560 146,774 143,337
- ----------------------------------------------------------------------------------------------------------
Special charges 2,800 3,000 11,850
- ----------------------------------------------------------------------------------------------------------
Interest expense, net 7,882 6,468 6,697
- ----------------------------------------------------------------------------------------------------------
Income (loss) before provision (benefit) for income taxes 2,233 3,904 (8,188)
- ----------------------------------------------------------------------------------------------------------
Provision (benefit) for income taxes 1,081 1,562 (2,797)
- ----------------------------------------------------------------------------------------------------------
Net income (loss) $ 1,152 $ 2,342 $ (5,391)
- ----------------------------------------------------------------------------------------------------------
Net income (loss) per share $ .09 $ .18 $ (.41)
- ----------------------------------------------------------------------------------------------------------
Weighted average number of common shares used in
computing net income (loss) per share 13,169 13,182 13,166
==========================================================================================================
</TABLE>
See accompanying notes.
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------
Common Common Additional Total
Stock Stock Paid-In Retained Shareholders'
(in thousands) Shares Amount Capital Earnings Equity
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at February 26, 1994 13,154 $1,315 $32,014 $18,155 $51,484
- ------------------------------------------------------------------------------------------------------------------------
Exercise of stock options 17 2 54 -- 56
- -----------------------------------------------------------------------------------------------------------------------
Net loss -- -- -- (5,391) (5,391)
- -----------------------------------------------------------------------------------------------------------------------
Balance at February 25, 1995 13,171 1,317 32,068 12,764 46,149
- -----------------------------------------------------------------------------------------------------------------------
Exercise of stock options 13 1 53 -- 54
- -----------------------------------------------------------------------------------------------------------------------
Net income -- -- -- 2,342 2,342
- -----------------------------------------------------------------------------------------------------------------------
Balance at March 2, 1996 13,184 1,318 32,121 15,106 48,545
- -----------------------------------------------------------------------------------------------------------------------
Retirement of treasury shares (31) (3) (127) -- (130)
- -----------------------------------------------------------------------------------------------------------------------
Net income -- -- -- 1,152 1,152
- -----------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 1, 1997 13,153 $1,315 $31,994 $16,258 $49,567
=======================================================================================================================
See accompanying notes.
</TABLE>
16 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO]
<PAGE> 7
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended
- --------------------------------------------------------------------------------------------------------------------
MARCH 1, 1997 March 2, 1996 February 25, 1995
(in thousands) (52 weeks) (53 weeks) (52 weeks)
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 1,152 $ 2,342 $ (5,391)
- ------------------------------------------------------------------------------------------------------------
ADJUSTMENTS TO RECONCILE TO CASH PROVIDED BY (USED FOR) OPERATIONS:
Depreciation and amortization 8,788 6,934 7,411
- ------------------------------------------------------------------------------------------------------------
Deferred income taxes 500 1,000 (1,000)
- ------------------------------------------------------------------------------------------------------------
LIFO provision (benefit) (112) 1,573 200
- ------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY (USED FOR) CURRENT ASSETS AND LIABILITIES:
Accounts payable and accrued liabilities (18,626) 34,128 (7,191)
- ------------------------------------------------------------------------------------------------------------
Accounts receivable (1,507) (2,494) (913)
- ------------------------------------------------------------------------------------------------------------
Inventories at current cost 7,921 (23,064) 14,444
- ------------------------------------------------------------------------------------------------------------
Other 2,439 3,446 (1,261)
- ------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 555 23,865 20,681
- ------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of property and equipment, net (5,809) (2,773) (3,513)
- ------------------------------------------------------------------------------------------------------------
Proceeds from sale of property and equipment -- -- 1,202
- ------------------------------------------------------------------------------------------------------------
Payment for purchase of retail stores, net of cash acquired (10,093) (40,644) --
- ------------------------------------------------------------------------------------------------------------
NET CASH (USED FOR) INVESTING ACTIVITIES (15,902) (43,417) (2,311)
- ------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net borrowings (repayments) under revolving credit line 20,100 21,500 (13,480)
- ------------------------------------------------------------------------------------------------------------
Proceeds from term debt -- 15,000 --
- ------------------------------------------------------------------------------------------------------------
Net repayments and other (4,741) (17,903) (3,753)
- ------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 15,359 18,597 (17,233)
- ------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 12 (955) 1,137
- ------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 767 1,722 585
- ------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 779 $ 767 $ 1,722
=============================================================================================================
</TABLE>
See accompanying notes
[LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 17
<PAGE> 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation
The consolidated financial statements include the accounts of Drug Emporium,
Inc. and subsidiaries (the Company). All significant intercompany accounts and
transactions have been eliminated in consolidation.
Nature of Operations
The Company is primarily in the business of operating and franchising retail
stores specializing in the sale of health and beauty care products,
over-the-counter medication, prescription drugs, greeting cards, cosmetics and
highly-consumable products primarily in an everyday-low-price format. During
Fiscal 1997, the stores operated under the names of Drug Emporium, F&M Super
Drug Stores, I got it at Gary's and "big D." As of year end, approximately
eighty percent of the Company-owned stores were located in the states of
California, Georgia, Michigan, Ohio and Pennsylvania.
Fiscal Year
The fiscal year of the Company is the 52-53 week period ending on the Saturday
closest to February 28 (29). The quarter and fiscal year ends for 1997 and 1996
were as follows:
<TABLE>
<CAPTION>
Fiscal year 1997 Fiscal year 1996
- ----------------------------------------------------------------
<S> <C> <C>
First quarter June 1, 1996 May 27, 1995
Second quarter August 31, 1996 August 26, 1995
Third quarter November 30, 1996 November 25, 1995
Year end March 1, 1997 March 2, 1996
- -----------------------------------------------------------------
</TABLE>
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents includes cash on
hand and deposits at financial institutions with maturities of less than three
months.
Accounts Receivable
The Company uses the allowance method of accounting for uncollectible accounts.
Accounts receivable are stated net of allowances for uncollectible accounts of
$1,921,000 and $924,000 as of March 1, 1997 and March 2, 1996, respectively.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined by use
of the last-in, first-out (LIFO) method. If current cost had been used,
inventories would have been approximately $21,042,000 and $21,154,000 higher
than reported at March 1, 1997 and March 2, 1996, respectively. Cost of sales is
primarily computed on an estimated basis and adjusted based on physical
inventory counts which are generally taken at all locations twice annually.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided on a
straight-line basis over the estimated useful lives of owned assets. Leasehold
improvements are amortized over the estimated useful life of the asset or the
term of the lease, whichever is shorter.
Pre-Opening Expenses
Expenditures related to the opening of new stores, other than expenditures for
capital assets, are charged against earnings when incurred.
Goodwill
Goodwill is amortized over 15 years using the straight-line method. The Company
amortized $548,000, $597,000 and $611,000 of goodwill during Fiscal 1997, 1996
and 1995, respectively. Accumulated amortization was $3,773,000 at March 1, 1997
and $3,225,000 at March 2, 1996.
Debt Issuance Costs
Debt issuance costs incurred in connection with the convertible subordinated
debt are amortized using a straight-line method over the term of the debt.
Amortization expense related to the issuance costs is reported as interest
expense and approximated $55,000 in 1997, $57,000 in 1996, and $58,000 in 1995.
The amount of accumulated amortization, at March 1, 1997 and March 2, 1996, was
$409,000 and $354,000, respectively.
18 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO]
<PAGE> 9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
Advertising Costs
The Company expenses production costs of radio and television advertising in the
year incurred. Gross advertising costs, before vendor reimbursements, as a
percentage of net sales, were:
1997 - 2.1%; 1996 - 2.3%; and 1995 - 2.3%.
Net Income (Loss) Per Share
Net income (loss) per common share is determined by dividing the weighted
average number of common shares outstanding during the year into net income
(loss). Common share equivalents in the form of stock options are excluded from
the calculation since they have no dilutive effect on per-share figures. The
assumed conversion of subordinated convertible debt into common stock had no
dilutive effect on net earnings per common share.
Franchise Arrangements
Arrangements with franchisees and licensees who operate throughout the United
States generally provide for initial fees, new store opening fees and continuing
payments to the Company based upon a percentage of sales. The fees, when earned,
and related costs are recorded net and included in the Company's selling,
administrative and occupancy expenses.
Reclassifications
Certain amounts in prior years' financial statements have been reclassified to
conform with the Fiscal 1997 presentation.
NOTE 2 - SPECIAL CHARGES
Store Closure Expense
In Fiscal 1995, the Company sold seven stores in the Washington, D.C. market and
closed fourteen additional stores. The cost associated with the 21 stores
resulted in a pretax charge of $11,850,000. In Fiscal 1996, an additional pretax
charge of $3,000,000 was taken to cover rent and related charges at several
properties which have taken longer than expected to sublease. In Fiscal 1997,
the Company incurred costs associated with stores closed during Fiscal 1997 and
earlier of $1,300,000, which was recorded as a part of special charges. Sales
generated from these closed stores during fiscal years 1997, 1996 and 1995 were
as follows: $0, $0, and $71,797,000, respectively.
Impairment of Long-Lived Assets
In Fiscal 1997, the Company adopted SFAS No. 121, Accounting for the
Impairment of Long Lived Assets and for Long-Lived Assets to Be Disposed Of.
Accordingly, the Company evaluated the ongoing value of its long-lived assets.
Based on this evaluation, the Company determined that leasehold improvements and
lease assets for certain stores were impaired and recorded an amortization
charge of $1,500,000 to recognize the impairment.
NOTE 3 - REVOLVING CREDIT LINE
The Company signed a new bank agreement (the Agreement) on May 24, 1996. The
Agreement increased the available borrowings to help fund store acquisitions and
replaced the previous bank credit agreement.
As of March 1, 1997, the Company's credit facility consisted of the term loan
of $12,000,000 (see Note 4) and a revolving credit loan availability of up to
$55,000,000 of which $41,600,000 was utilized. The revolver expires on May 31,
2000, while the term debt is paid in quarterly installments of $750,000.
The Company's borrowing rate can fluctuate between the bank's prime rate and
a LIBO-based rate, depending on the ability of the Company to meet certain
financial covenants. The Agreement requires a commitment fee on the revolver of
.25% on the unused available credit and has no compensating balance
requirements.
Borrowings made pursuant to the Agreement are secured by substantially all of
the assets of the Company. The Agreement prohibits the payment of dividends,
stock repurchases, and acquisition of the Company's convertible subordinated
debentures.
NOTE 4 - LONG-TERM DEBT
<TABLE>
<CAPTION>
(in thousands) March 1, 1997 March 2, 1996
- ------------------------------------------------------------------
<S> <C> <C>
Convertible subordinated debentures $49,421 $49,421
Term debt 12,000 15,000
Other 1,860 3,472
- ------------------------------------------------------------------
63,281 67,893
Less current maturities (3,950) (4,609)
- ------------------------------------------------------------------
$59,331 $63,284
- ------------------------------------------------------------------
</TABLE>
The Company has $49,421,000 of 7.75% convertible subordinated debentures
outstanding. These debentures are unsecured obligations of the Company and may
be converted into common stock of the Company at any time prior to maturity,
unless previously redeemed. The conversion rate is 65.1466 shares per $1,000
principal amount of debentures (or approximately $15.35 per
[LOGO] DRUG EMPORIUM, INC. AND SUBSIDIARIES 19
<PAGE> 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
share), subject to certain adjustments under the terms of these debentures.
These debentures are redeemable at the option of the Company at 102.1% of par
plus accrued interest. This redemption rate declines by .7% annually to par on
October 1, 1999. The debentures are subject to a sinking fund, commencing
October 1, 2000, calculated to retire at least 70% of the debentures prior to
the final maturity date of October 1, 2014. The Company has reserved 3,387,624
shares of common stock for issuance upon conversion of the debentures.
During Fiscal 1997, the convertible debentures traded in a range of 71.5% to
86.5% of par, with a year-end price of 83.5% of par.
The term debt is part of the Agreement discussed in Note 3 and is payable in
quarterly installments, with annual amounts of $3,000,000 due in Fiscal 1998,
1999, 2000 and 2001.
The Company has other notes bearing interest at rates ranging from 8.18% to
9.00%. Principal amounts related to the notes due for fiscal years 1998 through
2002 are $950,000, $222,000, $234,000, $254,000 and $200,000, respectively.
NOTE 5 - OPERATING LEASES
The Company leases retail stores and certain equipment under non-cancelable
operating leases which expire at various dates. Certain of the store leases
require contingent rentals based upon sales in excess of specified amounts and
generally require the Company to pay utilities, insurance and taxes, and certain
leases are renewable with escalation clauses. Rent expense (excluding rent
expense for closed stores from the date closed) was $32,854,000, $28,354,000 and
$27,704,000 during Fiscal 1997, 1996 and 1995, respectively.
At March 1, 1997, future minimum operating lease payments during the next
five years and thereafter are: 1998 - $29,468,000; 1999 - $28,213,000; 2000 -
$24,395,000; 2001 - $20,752,000; 2002 - $16,262,000 and $48,360,000 thereafter.
At March 1, 1997, the future minimum lease payments for closed stores total
approximately $11,337,000 for which the Company estimates it will receive
approximately $9,928,000 of sublease income (for which there are subleases in
force aggregating $4,994,000 at March 1, 1997). This estimate is contingent on
the ability of the Company to sublease remaining closed-store leases within
approximately one year.
NOTE 6 - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
(in thousands) March 1, 1997 March 2, 1996
- -------------------------------------------------------------------
<S> <C> <C>
Land and building $ 3,475 $ 3,475
- -------------------------------------------------------------------
Furniture and fixtures 38,941 34,544
- -------------------------------------------------------------------
Acquired leases and leasehold
improvements 26,502 23,371
- -------------------------------------------------------------------
68,918 61,390
- -------------------------------------------------------------------
Less allowances for depreciation
and amortization (38,506) (32,597)
- -------------------------------------------------------------------
$ 30,412 $ 28,793
===================================================================
</TABLE>
NOTE 7 - INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
The tax amounts recorded in the consolidated balance sheets consisted of the
following:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
TAX AFFECTED AMOUNTS
- -----------------------------------------------------------------
(in thousands) March 1, 1997 March 2, 1996
- -----------------------------------------------------------------
DEFERRED TAX ASSETS (LIABILITIES):
<S> <C> <C>
Loss and AMT credit carryforwards $ 3,500 $ 4,000
- -----------------------------------------------------------------
Store closing reserve 1,000 2,000
- -----------------------------------------------------------------
Inventory valuation (3,000) (2,000)
- -----------------------------------------------------------------
Other, net (500) (2,000)
- -----------------------------------------------------------------
1,000 2,000
- -----------------------------------------------------------------
Current tax balance 2,000 1,000
- -----------------------------------------------------------------
$ 3,000 $ 3,000
=================================================================
</TABLE>
There were no significant deferred tax valuation allowances as of March 1,
1997 and March 2, 1996. Significant components of the provision (benefit) for
income taxes are as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
(in thousands) 1997 1996 1995
- -----------------------------------------------------------------
<S> <C> <C> <C>
CURRENT:
Federal $ 339 $ 298 $ (2,060)
- -----------------------------------------------------------------
State and local 242 264 263
- -----------------------------------------------------------------
Total current 581 562 (1,797)
- -----------------------------------------------------------------
Deferred 500 1,000 (1,000)
- -----------------------------------------------------------------
$ 1,081 $ 1,562 $ (2,797)
- -----------------------------------------------------------------
</TABLE>
20 DRUG EMPORIUM, INC. AND SUBSIDIARIES [LOGO]
<PAGE> 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
The reconciliation of income tax computed at the U.S. federal statutory tax
rates to income tax expense (benefit) is:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
(in thousands) 1997 1996 1995
- -----------------------------------------------------------------
<S> <C> <C> <C>
Tax at statutory rate $ 759 $1,327 $(2,784)
- -----------------------------------------------------------------
State income tax, net 160 174 174
- -----------------------------------------------------------------
Goodwill 186 203 208
- -----------------------------------------------------------------
Other, net (24) (142) (395)
- -----------------------------------------------------------------
$1,081 $1,562 $(2,797)
- -----------------------------------------------------------------
</TABLE>
The Company received refunds, net of income taxes paid, of $1,889,000 and
$49,000 during Fiscal 1996 and Fiscal 1995, respectively, and made income tax
payments of $1,050,000 in Fiscal 1997.
At March 1, 1997, the Company has net operating loss carryforwards of
$3,138,000 for income tax purposes that expire in years 2009 and 2010 and
$2,400,000 of alternative minimum tax credit carryforward which has no
expiration date.
NOTE 8 - SHAREHOLDERS' EQUITY
The Company has authorized 2,000,000 shares of $1.00 par value preferred stock.
The terms of the preferred stock are subject to determination by the Company's
Board of Directors. The Company has a shareholder rights plan which provides for
the distribution of a right to purchase one-hundredth of a share of preferred
stock to each holder of common stock. The rights become exercisable upon the
occurrence of certain triggering events, as defined in the plan. The Company has
reserved 33,900 shares of Series A Preferred Stock in connection with the rights
to be distributed under the plan with respect to the reserved shares of common
stock.
NOTE 9 - STOCK OPTION PLANS
The Company has adopted stock option plans for key employees. Under such plans,
the Board of Directors may grant options for shares of common stock at a price
not less than 100% of the fair market value of the shares on the date of grant.
If an employee owns stock possessing more than 10% of the total combined voting
power of the Company, the option price must be 110% of the fair market value on
the date of grant. The options vest based on the term of the optionee's
continuous employment at 10% to 30% per year. Service prior to date of grant is
considered under certain plans.
In Fiscal 1997, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." In
accordance with the provisions of SFAS No. 123, the Company applies Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
related interpretations in accounting for its employee stock options and,
accordingly does not recognize compensation costs when the exercise price of its
employee stock options is equal to or greater than the fair market value of the
stock at the grant date. If the Company had elected to recognize compensation
cost based on the fair value of the options granted at grant date as prescribed
by SFAS No. 123, net income and earnings per share would not have materially
changed from what has been reported in Fiscal 1997 and 1996. The financial
effects of applying SFAS No. 123 for providing proforma disclosures are not
likely to be representative of the effects on reported net income and earnings
per share for future years.
The estimated fair value of the options is amortized into expense over the
options' vesting periods. The fair value for these options was estimated at the
date of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions for 1997 and 1996: Risk-free interest rate of 6.5%;
no dividend yield; volatility factor of the expected market price of the
Company's common stock of 0.46; and a weighted-average expected life of each
option of five years.
A summary of the Company's stock option activity during 1997, 1996 and 1995
and related information follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
SHARES UNDER OPTION
- -----------------------------------------------------------------------------
(in thousands, except per share amounts) 1997 1996 1995
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Outstanding, beginning of year 881 931 664
- -----------------------------------------------------------------------------
Granted (at $4.16 to $4.97 per share) 118 5 323
- -----------------------------------------------------------------------------
Cancelled (83) (42) (39)
- -----------------------------------------------------------------------------
Exercised (at $3.33 to $4.00 per share) -- (13) (17)
- -----------------------------------------------------------------------------
Outstanding, end of year
(at prices ranging from $4.13 to $8.81 per share) 916 881 931
- -----------------------------------------------------------------------------
Exercisable, end of year
(at prices ranging from $4.57 to $8.81 per share) 761 302 283
=============================================================================
</TABLE>
The weighted average per share price for options outstanding at the end of
Fiscal 1997 was $4.98.
At the end of fiscal years 1997, 1996 and 1995, there were 149,000, 217,000
and 221,000 shares, respectively, reserved for future grants.
22 DRUG EMPORIUM, INC AND SUBSIDIARIES [LOGO]
<PAGE> 12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
NOTE 10 - ACQUISITIONS
On May 29, 1996, the Company completed a purchase of certain assets of six
stores in the Philadelphia market at a total purchase price of $10.1 million.
The acquisition was accounted for as a purchase. The consolidated statements of
operations reflect the results of operations of the stores since the date
acquired. The acquired stores contributed approximately $38,150,000 in sales
during Fiscal 1997.
During Fiscal 1996, the Company acquired 32 stores in five separate
transactions for a total purchase price of $42 million. These acquisitions were
accounted for as purchases. The consolidated statements of operations reflect
the results of operations of the acquired enterprises since the dates acquired.
The acquired stores contributed approximately $80 million in sales during Fiscal
1996.
NOTE 11 - DEFINED CONTRIBUTION PLAN
The Company provides a defined contribution 401(k) plan to substantially all
employees. Participants may make voluntary contributions to the plan up to 15%
of their compensation. Approximately $65,000, $50,000 and $50,000 was charged to
expense for this plan in fiscal years 1997, 1996 and 1995, respectively.
NOTE 12 - CONTINGENCY
The Company is a defendant in a suit filed by one of the current franchisees of
the Company alleging failure to perform as required by the franchise agreements
and violation of state and federal antitrust laws. The plaintiff claims a loss
of investment capital, out-of-pocket expenses, lost profits and goodwill, fraud,
interference with contracts and deceptive trade practices and seeks damages. The
Company intends to vigorously defend this suit and believes the ultimate outcome
will not materially affect the financial position or results of operations of
the Company.
NOTE 13 - QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
- -----------------------------------------------------------------------------------------------------------------------------------
Net Gross Net Net Income Stock Prices Dividends Paid
Sales Profit Income Per Common Share High Low Per Common Share
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1997:
First quarter $206,743 $ 43,528 $ 501 $ .04 $4.31 $3.25 --
- -----------------------------------------------------------------------------------------------------------------------------------
Second quarter 212,573 45,922 250 .02 4.56 3.69 --
- -----------------------------------------------------------------------------------------------------------------------------------
Third quarter 206,219 45,187 271 .02 4.63 3.88 --
- -----------------------------------------------------------------------------------------------------------------------------------
Fourth quarter 229,481 50,838 130 .01 5.75 4.13 --
- ------------------------------------------------------------------------------------------------------------------------------------
$855,016 $185,475 $ 1,152 $ .09 --
===================================================================================================================================
1996:
First quarter $165,091 $ 35,057 $ 489 $ .04 $4.75 $4.00 --
- -----------------------------------------------------------------------------------------------------------------------------------
Second quarter 167,794 36,269 466 .03 5.06 4.00 --
- -----------------------------------------------------------------------------------------------------------------------------------
Third quarter 170,954 36,895 347 .03 5.06 3.88 --
- -----------------------------------------------------------------------------------------------------------------------------------
Fourth quarter 234,933 51,925 1,040 .08 4.25 3.25 --
- -----------------------------------------------------------------------------------------------------------------------------------
$738,772 $160,146 $ 2,342 $ .18 --
===================================================================================================================================
</TABLE>
22 DRUG EMPORIUM INC. AND SUBSIDIARIES [LOGO]
<PAGE> 13
REPORT OF INDEPENDENT AUDITORS
BOARD OF DIRECTORS
DRUG EMPORIUM, INC.
We have audited the accompanying consolidated balance sheets of Drug Emporium,
Inc. and subsidiaries as of March 1, 1997 and March 2, 1996, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended March 1, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Drug Emporium, Inc. and subsidiaries at March 1, 1997 and March 2, 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended March 1, 1997, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
Columbus, Ohio
April 4, 1997
