<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended February 28, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number 0-16998
DRUG EMPORIUM, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 31-1064888
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NO.)
----------
155 HIDDEN RAVINES DRIVE
POWELL, OHIO 43065
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
----------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.10 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject so such
filing requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
At May 19, 1998 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 19, 1998 was approximately
$52,719,140 based on a closing price of $4.00 per share on Nasdaq National
Market on such date.
DOCUMENTS INCORPORATED BY REFERENCE
Part II, Items 6., 7. and 8., and Part IV, Item 14. incorporate by
reference portions of the Drug Emporium, Inc. Annual Report to Stockholders for
the year ended February 28, 1998. Part III, Items 10., 11., 12., and 13.
incorporate by reference portions of the Drug Emporium, Inc. Proxy Statement for
the 1998 Annual Meeting of Stockholders. With the exception of the information
specifically incorporated by reference, the Drug Emporium, Inc. Annual Report to
Stockholders for the year ended February 28, 1998 is not deemed filed as part of
this report.
1
<PAGE> 2
ITEM 1. BUSINESS
INTRODUCTION
In 1977, the first Drug Emporium store was opened in Columbus, Ohio. As
of February 28, 1998, the Company operates 135 company-owned stores, known as
Drug Emporium, F&M Super Drug Stores and "big D". In addition to the
Company-owned stores, as of February 28, 1998, there are 84 franchise stores.
The accompanying financial statements include only amounts related to
company-owned stores.
All the stores specialize in discount-priced merchandise, including
health and beauty aids, cosmetics and greeting cards. All stores with the
exception of the remaining "big D" store operate full service pharmacies. The
last "big D" discount store closed in April of 1998.
The Company's common stock trades on the Nasdaq National Market under
the symbol DEMP. As of February 28, 1998, there were 13,179,785 shares
outstanding. Drug Emporium's 7-3/4% convertible subordinated debentures, due
October 1, 2014, are traded on the Nasdaq National Market under the symbol
DEMPG.
STORE OPERATIONS
Company stores range in size from 19,000 to 38,000 square feet, with a
typical store having approximately 27,000 square feet, including retail selling
space and storage space in the rear of each store. Retail selling space on
average accounts for 80% of each store's total square footage.
Each store has a manager, one or two assistant managers, a head
pharmacist, and approximately 8 to 12 additional full-time employees and
approximately 24 part-time employees. The stores are grouped into six
operational regions, each overseen by a regional director or regional vice
president. The regional director or vice president's responsibilities include
visiting stores and assuring that Company standards for buying, merchandising,
customer service, store appearance and store procedures are maintained.
The Company's stores are located primarily in shopping centers on major
commercial thoroughfares. The capital expenditure required to fixture and equip
a store averages $350,000. Pre-opening expenses, including salaries and
promotional expenses, average $75,000 per store, and each store requires
approximately $1,200,000 in initial inventory.
The typical trade area for a Drug Emporium store exceeds 200,000 people
within a defined area, usually five miles. The customer profile is 80 percent
middle-to-upper income women between the ages of 21 and 65 who shop on a
two-and-a-half week cycle.
Drug Emporium stores accommodate an average of 6,000 shoppers per week
and provide an environment for shoppers seeking a pleasant and social shopping
experience. Drug Emporium fills a unique tenant category in a shopping center's
merchandising mix and Drug Emporium stores are well received by both hard and
soft goods national retailers.
Most stores are open seven days a week for a total of 84 hours per
week. In addition, the Company operates a total of twenty-one 24-hour stores.
Each store has a similar layout, generally with the pharmacy located in the rear
of the store. Company stores accept payment in cash, check or credit card and
from third-party providers.
The table set forth below lists the 219 Company-owned and franchise
Drug Emporium stores by market as of February 28, 1998:
<TABLE>
<CAPTION>
WHOLLY-OWNED:
-------------
<S> <C>
Philadelphia, PA.......................................................28
Columbus, Cincinnati and Dayton, OH....................................23
Los Angeles, San Francisco and San Diego CA............................21
Atlanta and Augusta, GA,...............................................19
Detroit, MI............................................................16
Baltimore, MD and Washington, DC....................................... 9
Milwaukee, WI.......................................................... 6
Louisville, KY......................................................... 4
Minneapolis, MN........................................................ 4
St. Louis, MO.......................................................... 4
Oklahoma City, OK...................................................... 1
---
135
===
</TABLE>
2
<PAGE> 3
INDEPENDENT FRANCHISES:
-----------------------
Seattle, Tacoma, WA....................................................20
Dallas, Ft. Worth, TX..................................................15
Lafayette, Shreveport, LA, and Amarillo, Abilene,
Denton, Longview, Lubbock, Tyler and Waco TX,
Little Rock, AR, and Wichita KS......................................11
Phoenix, Tucson, AZ.................................................... 9
San Antonio, Austin, Houston, TX....................................... 6
Charlotte, Raleigh, Durham, Concord, NC................................ 6
Barboursville, Charleston, WV.......................................... 4
Independence and Kansas City, MO and Overland Park KS.................. 3
Virginia Beach, Norfolk, VA............................................ 3
Greensboro, Winston-Salem, NC.......................................... 2
Victoria, Brownsville, TX.............................................. 2
Morris Plains, NJ...................................................... 1
Omaha, NE.............................................................. 1
Union City, NJ......................................................... 1
----
84
==
When selecting store location, the Company considers various geographic
and demographic factors, including population around the site, income level
within that area, proximity to major shopping centers, traffic count,
accessibility of site, proximity of competitors and available parking spaces.
Market research may be utilized through an outside market research firm which
identifies, among other things, trade area, trade area potential, demographic
factors, competitors and competitors' sales/strengths/weaknesses, and projects
three-year anticipated sales volumes.
Company and, to a limited extent, franchisee pharmacy matters are
supervised by the Director of Pharmacy who directs compliance with state and
federal pharmacy regulations and training. The Company has implemented a
computerized pharmacy system across its network of Company stores. Most
franchisees have installed similar systems. The system simplifies the
maintenance of patient profiles, label preparation, and inventory management.
FRANCHISE OPERATIONS
Drug Emporium continues to have a strong franchise-store network
consisting of 84 franchise stores. Drug Emporium maintains a Franchise Advisory
Board designed to provide a forum to investigate and discuss issues and concerns
of the Company and its franchisees.
Under its franchise system, the Company permits franchisees to operate
Drug Emporium stores in a specific geographic area based on ADIs (areas of
dominant influence of television signals). Prospective franchisees generally
must make a minimum equity investment of $1,000,000 per store and establish an
acceptable line of credit in the amount of $500,000 per store. The Company
advises franchisees in site selection, store layout, and establishing purchasing
and advertising policies.
The Company selects its franchisees carefully and works closely with
them to increase the likelihood of success for each franchisee. Prospective
franchisees sign confidentiality agreements in addition to a non-compete clause
contained within the executed franchise agreement. Upon execution of a franchise
agreement, the franchisee must pay a nonrefundable $25,000 fee for the first
store and a $10,000 commitment fee for each additional store designated for that
market. The balance of the $25,000 store fee ($15,000) is payable upon the
opening of each subsequent designated store in the market.
The current franchise agreement provides for franchise royalties at a
minimum rate of $6,000 per store for the second year and $25,000 per year per
store for stores open three years or more against the following percentage
royalties: 1% on gross sales from $3.5 million to $6 million, 2% from $6 million
to $8 million, 3% from $8 million to $10 million, and 1.25% on gross sales over
$10 million.
In addition, each franchisee must pay .1% of gross sales to the Company
to offset the cost of developing advertising. Each franchisee must also spend at
least 1% of gross sales for advertising. The current franchise agreement permits
the Company to require that .6% of the 1% advertising expenditure be contributed
to a national advertising program if such program is established by the Company.
The Company may either open its own stores or allow other franchisees
to open stores in a franchisee's territory outside a defined area for each
existing store if the franchisee fails to comply with the development schedule
agreed upon by the Company and the franchisee.
3
<PAGE> 4
Four franchise stores closed during Fiscal 1998.
ACQUISITION OF FRANCHISEES
The Company, from time to time, has acquired or sought to acquire
certain of its franchise operations. The Company's decision to pursue the
acquisition of a franchisee is based on the Company's evaluation of the growth
opportunities in a particular market, the impact the acquisition would have on
earnings per share and the quality of the franchisee's existing management.
Since 1983, the Company has acquired franchisees located in Los Angeles,
Washington, D.C., Atlanta, Cincinnati, Milwaukee, Minneapolis, St. Louis,
Charleston, S.C., Indianapolis, Orlando, Louisville, Oklahoma City and Baton
Rouge. The Company plans to evaluate future opportunities to acquire appropriate
franchisees from time to time and may use cash or securities to pay for such
acquisitions.
MERCHANDISING AND MARKETING
The Company's merchandising goal is to provide customers with the
widest available selection of health and beauty aids, cosmetics, prescription
drugs and general merchandise at everyday low prices. The Company estimates that
approximately 64% of a typical store's sales mix is health and beauty aids and
general merchandise, 29% pharmacy items and 7% cosmetics.
The Company is continuing to aggressively oversee strategies designed
to lower the total cost of acquiring merchandise in order to continue to be
competitive with other national and regional chain discounters. The Company is
continuing to invest in and upgrade its electronic in-store scanning and
backdoor receiving systems.
During Fiscal 1998, the Company's primary pharmacy supplier and general
merchandise distributor, McKesson Drug, accounted for over 35% of the Company's
purchases. No other single vendor accounted for more than 10% of the Company's
purchases. While the Company purchases from over 7,000 vendors, a majority of
its business is conducted with approximately 500 vendors. The Company believes
it is a significant customer for most of these 500 vendors.
The Company advertises through the use of television, radio, newspaper
and direct mail. Most advertising in Fiscal 1998 was print-based, utilizing
newspaper tabloids running approximately twice per month. Point of sale
advertising is also used. The Company's strategy of clustering stores within ADI
markets is an important factor in maximizing the effectiveness of its
advertising expenditures. The Company works with an advertising agency that
coordinates advertising for the entire chain.
CUSTOMER SERVICE
The Company believes that its commitment to customer service is an
important ingredient of its success. The Company encourages its managers and
other employees to be responsible to customers. The stores are designed to make
products easily accessible. Store employees are trained to be friendly and
helpful to customers.
COMPETITION
The sale of deep discount health and beauty aids, cosmetics and
prescription drugs is highly competitive. The Company believes that the
principal bases of competition in this market are price, product variety,
service, site location and customer recognition. The Company also believes that
there exist only a few similar companies, most of which are regional chains. The
Company's stores compete not only with those similar companies but with numerous
conventional drug stores with national or regional images, and also with
supermarkets, mass merchants and category-specific discount stores. Many of the
Company's supermarket, mass merchant and conventional drug store competitors
have more outlets and substantially greater financial resources than the Company
or have more convenient locations than Company stores. The Company believes that
its prices are competitive and that it offers greater product variety and better
service than its competitors. The Company also believes that the smaller size of
its stores compared to the major discount competitors provides a better shopping
experience and allows a better selection of sites in tight real estate markets
that exist in some major cities. The Company's ability to expand successfully
into new markets is especially sensitive to the competitive factors in those
markets.
4
<PAGE> 5
EMPLOYEES AND TRAINING
At February 28, 1998, the Company had a total of approximately 4,900
employees, both full-time and part-time, of which 179 were corporate staff
personnel. None of the employees are covered by a collective bargaining
agreement. The Company considers its relations with its employees to be good.
Drug Emporium believes that the training of store employees is one of
the most important elements of its business. The Company conducts training
classes at its headquarters, and senior management works closely with regional
and district managers in this regard.
REGULATION
The Company is also subject to the Fair Labor Standards Act, which
governs such matters as minimum wages, overtime and other working conditions. A
portion of the Company's personnel are paid at rates related to the federal
minimum wage, and accordingly, further increases in the minimum wage increase
the Company's labor costs.
The prescription drug business is subject to the federal Food, Drug and
Cosmetic Act, Drug Abuse Prevention and Control Act and Fair Packaging and
Labeling Act relating to the content and labeling of drug products, comparable
state statutes and state regulation regarding recordkeeping and licensing
matters. These regulatory functions contain civil and criminal penalties for
violations.
The sale of franchises by the Company is subject to regulation by the
Federal Trade Commission and various states in which it currently does business
or in which the Company may do business in the future. Such regulations
generally require the prior registration or an exemption from registration for
the sale of franchises and delivery to prospective franchisees of a franchise
disclosure document. No assurances can be given that any future changes in the
existing laws or the promulgation of new laws will not adversely affect the
Company.
SERVICE MARKS
The Company has obtained federal registrations of the servicemark "Drug
Emporium" and "Savings So Big You Need A Shopping Cart" for retail drug store
services, "Drug Emporium" for technical aid and assistance in the establishment
and operation of retail drug stores and "Drug Emporium", plus design, for retail
drug store services. The marks EMPORIUM GOLD, EMPORIUM SELECT, DRUG EMPORIUM
PRESCRIPTION PLUS and DRUG EMPORIUM EXPRESS are pending marks. DRUG EMPORIUM and
Design have also been registered in Australia and the United Kingdom.
The mark "Drug Emporium" has been registered in the states of Alabama,
Arizona, California, Colorado, Florida, Indiana, Kansas, Kentucky, Maryland,
Minnesota, Missouri, Nebraska, Nevada, New Jersey, New York, North Carolina,
Ohio, South Carolina, Tennessee, Texas, Washington, West Virginia and Wisconsin,
as well as in Mexico. The mark "Savings So Big You Need A Shopping Cart" has
been filed and is pending in Canada and Mexico. The mark "Drug Emporium," plus
design, and the shopping cart design have been filed in Mexico, Japan and
France, and the shopping cart design is registered in Canada. The Company
believes that these marks are of material importance to its business.
Federal registration of a mark does not create new substantive rights
to use the mark or to assert rights based on ownership, but it does provide
additional remedies for the protection of the mark.
EXECUTIVE OFFICERS OF THE COMPANY
<TABLE>
<CAPTION>
Served as
Name: Age: Position: Officer Since:
----- ---- --------- --------------
<S> <C> <C> <C>
David L. Kriegel 52 Chairman of the Board, Chief Executive 1992
Officer, President and Director
A. Joel Arnold 62 Senior Vice President 1995
Thomas H. Ziemke 55 Senior Vice president 1998
Jane H. Lagusch 52 Vice President, Secretary 1990
Michael P. Leach 28 Chief Financial Officer 1998
<FN>
(1) Officers serve until their successors are chosen and are qualified
subject to earlier
</TABLE>
5
<PAGE> 6
removal by the board of directors, and subject to rights, if any, under
employment contracts.
DAVID L. KRIEGEL
Since December 1992, Mr. Kriegel has been the Chairman and Chief
Executive Officer of the Company and since June of 1994 has been Chairman, Chief
Executive Officer and President of the Company. Mr. Kriegel is Chairman and
Chief Executive Officer of Kriegel Holding Company, Inc., a privately-owned
corporation dealing with real estate and distribution. Until January 1993, Mr.
Kriegel was Vice President of Cardinal Health, a division of Cardinal
Distribution, Inc., a publicly-owned company.
A. JOEL ARNOLD
Mr. Arnold was appointed to the office of Senior Vice President on June
15, 1995. He formerly held the position of Director of Merchandising and
Operations in which he served for two years. A registered pharmacist, Mr. Arnold
has 38 years' experience in the retail drug industry.
THOMAS H. ZIEMKE
In March of 1998, Mr. Ziemke was appointed to the position of Senior
Vice President with responsibility for marketing and purchasing. Mr. Ziemke has
been associated with Drug Emporium since 1984 when he became the operator of the
Los Angeles based Drug Emporium franchise. He became Vice President of Western
Operations when the Company purchased the franchise in 1987 and served in that
capacity until his promotion to Senior Vice President.
JANE H. LAGUSCH
Mrs. Lagusch has been associated with the Company in various capacities
since 1980 and has been an officer of the Company since 1986. She was appointed
to her current position, Vice President and Secretary of the Company, in 1993.
Mrs. Lagusch has responsibility for corporate administrative functions.
MICHAEL P. LEACH
Since March 1998, Mr. Leach has served as Chief Financial Officer. Mr.
Leach was previously Controller of the Company for approximately two years and
is a Certified Public Accountant. Previous to joining Drug Emporium, Mr. Leach
was employed by Ernst & Young LLP, the external auditors of the Company.
ITEM 2. PROPERTIES
Most of the Company's stores are occupied pursuant to long-term leases
that vary as to rental provisions, expiration dates, renewal options, rental
amounts and payment provisions. The Company does not deem any individual store's
lease to be significant in relation to its overall operations. For information
as to the amount of the Company's rental obligations for retail store leases,
see Note 4 of Notes to Consolidated Financial Statements.
The Company owns a 33,000 square foot executive office building and the
surrounding land for use as its principal office in Powell, Ohio. The Company
also owns a portion of the building and land at one of its Detroit area store
locations.
ITEM 3. LEGAL PROCEEDINGS
Nortex Drug Distributors, Inc. v. Drug Emporium, Inc., Case No.
C2-93-767, filed August 6, 1993 in the United States District Court, Southern
District of Ohio, Eastern Division, was dismissed subsequent to February 28,
1998, as a result of the parties reaching a confidential settlement agreement.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
6
<PAGE> 7
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the Nasdaq National Market
under the symbol DEMP. The following table sets forth, for the quarterly periods
shown, the high and low sale price per share as reported on the Nasdaq National
Market:
<TABLE>
<CAPTION>
Fiscal Quarter Ended High Low
- ------------------------------------------------------------------------
<S> <C> <C>
June 1, 1996 $4.313 $3.250
August 31, 1996 $4.563 $3.688
November 30, 1996 $4.625 $3.875
March 1, 1997 $5.750 $4.125
May 31, 1997 $5.500 $4.125
August 30, 1997 $5.313 $4.000
November 29, 1997 $4.750 $3.750
February 28, 1998 $5.375 $3.875
</TABLE>
The Company paid no dividends in Fiscal 1998 or 1997.
The Company's bank credit agreement prohibits payment of dividends,
stock repurchases and acquisition of the Company's convertible subordinated
debt.
At April 28, 1998, the Company had approximately 4,300 beneficial
owners of its common stock.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item 6 is incorporated by reference
from page 4 of the Drug Emporium, Inc. Annual Report to Stockholders for the
year ended February 28, 1998.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this Item 7 is incorporated by reference
from pages 5 through 7 of the Drug Emporium, Inc. Annual Report to Stockholders
for the year ended February 28, 1998.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item 8 is incorporated by reference
from pages 8 through 15 of the Drug Emporium, Inc. Annual Report to Stockholders
for the year ended February 28, 1998.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain of the information required by this Item 10 is set forth under
Item 1. "Executive Officers of the Company."
*
7
<PAGE> 8
ITEM 11. EXECUTIVE COMPENSATION
*
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
*
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
*
* Reference is made to information under the captions "Election of
Directors," "Executive Compensation," "Security Ownership of Certain
Beneficial Owners and Management," and "Compensation Committee
Interlocks and Insider Participation," in the Company's Proxy
Statement for the Annual Meeting of Stockholders to be held June 24,
1998. The Company mailed its definitive proxy statement to
stockholders on or about May 20, 1998.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
The following Consolidated Financial Statements of Drug Emporium, Inc.
are incorporated by reference in Item 8 from the pages set forth below
of the Drug Emporium, Inc. Annual Report to Stockholders for the year
ended February 28, 1998.
Page Nos. of
Annual Report
-------------
Consolidated Balance Sheets as of February 28, 1998 and
March 1, 1997 8
Consolidated Statements of Operations for each of the
Three Fiscal Years in the Period Ended February 28, 1998 9
Consolidated Statements of Shareholders' Equity for each
of the Three Fiscal Years in the Period Ended February
28, 1998 9
Consolidated Statements of Cash Flows for each of the
Three Fiscal Years in the Period Ended February 28, 1998 10
Notes to Consolidated Financial Statements 11-15
Report of Independent Auditors 16
(2) Financial Statement Schedules
Schedules for which provision is made in Regulation S-X are not
required under the instructions contained therein, are inapplicable, or
the information is included in the Notes to the Consolidated Financial
Statements.
(3) Exhibits List
(3) Articles of Incorporation and By-Laws
3.3 Restated Certificate of Incorporation
(Incorporated by reference to Exhibit 3.3 to the Company's
S-1 Registration Statement No. 33-21755)
8
<PAGE> 9
(10) Material Contracts
10.1 Drug Emporium, Inc. 1983 Incentive Stock Option Plan
(incorporated by reference to Exhibit 10.2 to the
Company's S-1 Registration Statement Registration No.
33- 21755) **
10.2 Drug Emporium, Inc. 1984 Incentive Stock Option Plan
(incorporated by reference to Exhibit 10.3 to the
Company's S-1 Registration Statement Registration No.
33- 21755) **
10.3 Drug Emporium, Inc. 1987 Incentive Stock Option Plan
(incorporated by reference to Exhibit 10.4 to the
Company's S-1 Registration Statement Registration No.
33- 21755) **
10.4 Drug Emporium, Inc. 1990 Incentive Stock Option Plan
(incorporated by reference to Exhibit 10.41 to the
Company's Annual Report on Form 10-K for the fiscal year
ended February 28, 1990) **
10.5 Drug Emporium, Inc. 1987 Non-Qualified Stock Option Plan
(incorporated by reference to Exhibit 10.5 to the
Company's S-1 Registration Statement Registration No.
33- 21755) **
10.7 Form of License and Franchise Agreement (incorporated by
reference to Exhibit 10.7 to the Company's S-1
Registration Statement Registration No. 33-21755)
10.8 Form of Option Agreement (incorporated by reference to
Exhibit 10.8 to the Company's S-1 Registration Statement
Registration No. 33-21755)
10.10 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) **
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 (incorporated by reference to the Company's
Annual Report on Form 10-K for the fiscal year ended
March 1, 1997)
*10.15 Amendment dated December 2, 1997 to Employment Agreement
made March 11, 1993, by and between Drug Emporium, Inc.
and David L. Kriegel **
*10.16 Form of Employment Security Agreements between Drug
9
<PAGE> 10
Emporium, Inc. and each of A. Joel Arnold, Jane H.
Lagusch and Timothy S. McCord, dated December 2, 1997 **
*10.17 Form of Severance Compensation Agreement between Drug
Emporium, Inc. and each of Michael P. Leach and Lee
Pfrogner, dated November 17, 1997 **
*10.18 Consulting Agreement dated December 2, 1997, between
David L. Kriegel and Drug Emporium, Inc. **
(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 10-Q OR QUARTERLY REPORT
TO SECURITY HOLDERS
13.1 Annual Report to Stockholders for Fiscal Year Ended
February 28, 1998 (limited to those portions
incorporated herein).
*(21) SUBSIDIARIES OF REGISTRANT
21.1 The Company has the following wholly-owned subsidiaries:
State of
Name Incorporation
---------------------------------------------------
Big D Atlantic, Inc. Delaware
D.E. Michigan Management Co. Delaware
Drug Emporium of Michigan, Inc. Delaware
Drug Emporium of Maryland, Inc. Delaware
Emporium Venture, Inc. Ohio
Houston Venture, Inc. Ohio
RJR Drug Distributors Inc. Delaware
*(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
A report on Form 8-K was filed on March 5, 1998, reporting five
management changes, including the appointment of Michael P. Leach to
the position of Chief Financial Officer, and Thomas H. Ziemke to the
position of Senior Vice President, as set forth in a press release
dated March 4, 1998.
10
<PAGE> 11
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DRUG EMPORIUM, INC.
(Registrant)
Date: May 19, 1998 By: /s/ David L. Kriegel
---------------------
David L. Kriegel
President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Date: May 19, 1998
/s/ Michael P. Leach /s/ David L. Kriegel
- ---------------------------------- -------------------------------------
Michael P. Leach David L. Kriegel
Chief Financial Officer Chief Executive Officer and Director
/s/ Robert S. Meeder, Sr.
-------------------------------------
Robert S. Meeder, Sr.
Director
/s/ William L. Sweet, Jr.
-------------------------------------
William L. Sweet, Jr.
Director
/s/ V. J. Wiechart, Sr.
-------------------------------------
V. J. Wiechart, Sr.
Director
12
<PAGE> 1
Exhibit 10.15
AMENDMENT TO EMPLOYMENT AGREEMENT
THIS AMENDMENT amends the Employment Agreement made the 11th day of
March, 1993 by and between DRUG EMPORIUM, INC., a Delaware Corporation having
its principal executive offices at 155 Hidden Ravines Drive, Powell, Ohio 43065
(the "Company"), and DAVID L. KRIEGEL, an individual residing at 3410 London
Drive, Lima, Ohio ("Kriegel"), and is entered into this 2nd day of December,
1997. This Amendment replaces the amendment signed on September 25, 1996.
WHEREAS Kriegel is employed as Chairman and Chief Executive Officer of
Company, and has served in that capacity since December 1, 1992; and
WHEREAS the Company is approached from time to time by outside
individuals and others who have an interest in acquiring all or a portion of the
Company's stock, some of whom have a background indicating the capability of
operating the Company, and some of whom do not; and
WHEREAS the Company desires to evaluate such individuals, companies and
potential offers in the best interests of its shareholders, without the
distraction of the effect of a change in control on its Chief Executive Officer;
and
WHEREAS the Company also wants to assure managerial continuity and
stability during any takeover attempt.
NOW, THEREFORE, in consideration of the foregoing and of the agreements
and covenants herein contained, Company and Kriegel agree that the Employment
Agreement between them dated March 11, 1993, be amended as follows:
1. The Company agrees that if:
a. There is a change in control of the Company as
defined herein; and
b. Kriegel leaves the employment of the Company for any
reason, other than discharge for cause as defined in
the Employment Agreement between Kriegel and Company,
within one year after such change in control; then
(1) Kriegel shall receive, in a lump sum, a cash
payment in the amount of the total of the
salary and bonus received by Kriegel from
the Company in the last three full fiscal
years prior to the date of the change in
control;
(2) Kriegel shall continue to receive all
employment benefits, including medical
benefits, health insurance and other, to
which he may be entitled as a member of
senior management of the Company for a
period of 36 months after the date of
termination;
1
<PAGE> 2
(3) Kriegel shall receive an additional
retirement benefit, over and above that to
which he would normally be entitled under
the Company's retirement plans, equal to the
actuarial equivalent of the additional
amount Kriegel would have earned under such
retirement plans or programs had he
accumulated three additional continuous
years of service. Such amount shall be paid
to Kriegel in a cash lump sum payment at his
normal retirement age, or, at Kriegel's
option, at his early retirement age as
provided for in such retirement plan.
Notwithstanding the provisions of subparagraphs (1),
(2) and (3) above, the aggregate present value of the
payments in the nature of compensation Kriegel shall
receive hereunder shall not exceed an amount
determined by multiplying three (3) times the
aggregate present value of Kriegel's base amount
calculated in accordance with Internal Revenue Code
Section 280G by ninety-nine percent (99%).
2. The amounts paid to Kriegel hereunder shall be considered
severance pay in consideration of the past services he has rendered to the
Company and in consideration of his continued service from the date hereof to
his entitlement to those payments. Kriegel shall have no duty to mitigate his
damages by seeking other employment. Should Kriegel actually receive payments
from any other employment, the payments called for hereunder shall not be
reduced or offset by any such payments.
3. The Company will reimburse Kriegel for all legal fees and
expenses incurred in good faith by Kriegel as a result of any dispute with any
party (including, but not limited to, the Company and/or an affiliate of the
Company) regarding the payment of any benefit provided for in Kriegel's
Employment Agreement as amended (including, but not limited to, all fees and
expenses incurred in disputing any termination or in seeking in good faith to
obtain or enforce any benefit or right provided by Kriegel's Employment
Agreement as amended or in connection with any tax audit or proceeding to the
extent attributable to the application of Section 4999 of the Code plus in each
case interest on any delayed payment at the applicable federal rate provided for
in Section 7872(f)(2)(A) of the Code. Such payments will be made within five
business days after delivery of Kriegel's written requests for payment
accompanied by any evidence of fees and expenses incurred as the Company may
reasonably require.
4. As used herein, the term "change in control" shall mean
either:
a. The ownership (whether direct or indirect) of shares
in excess of 50% of the outstanding shares of common
stock of the Company by a person or group of persons
not directors of the Company as of the date of this
agreement; or
2
<PAGE> 3
b. The occurrence of both of the following:
(1) The ownership (whether direct or indirect)
of shares in excess of 20% of the
outstanding shares of common stock of the
Company by a person or group of persons not
directors of the Company as of the date of
this Amendment; and
(2) Any change in the composition of the Board
of Directors of the Company resulting in a
majority of the directors of the Company, as
of the date of this Amendment, no longer
constituting a majority; provided, however,
that in making such determination, directors
who were elected by, and on the
recommendation of, such present majority
shall be treated as present directors.
5. The arrangements called for by this Amendment are not intended
to have any effect on Kriegel's participation in any other benefits available to
executive personnel or to preclude other compensation or additional benefits as
may be authorized by the Company or its board from time to time.
6. This Amendment shall be binding and shall inure to the benefit
of the respective successors, assigns, legal representatives and heirs to the
parties hereto.
7. This Amendment shall terminate if, prior to any change in
control as defined herein, Kriegel shall voluntarily resign, retire, become
permanently and totally disabled, or voluntarily take another position requiring
a substantial portion of his time. This Amendment shall also terminate if
Kriegel's employment as Chairman and Chief Executive Officer of the Company
shall have been terminated for any reason by the board of directors of the
Company for any reason prior to a change in control as defined herein.
DRUG EMPORIUM, INC.
By order of the Board of Directors
By:
-------------------------------- --------------------------------
David L. Kriegel
Its: Compensation Committee Chairman
3
<PAGE> 1
Exhibit 10.16
EMPLOYMENT SECURITY AGREEMENT
This Employment Security Agreement is made as of the _____ day of
________________________, 1998, by and between DRUG EMPORIUM, INC., a Delaware
Corporation having its principal executive offices at 155 Hidden Ravines Drive,
Powell, Ohio 43065 (the "Company"), and _______________________________________,
an individual employed by the Company (the "Executive"). This Agreement replaces
the Employment Security Agreement with the above named Executive dated September
25, 1997.
WHEREAS, Executive is employed by the Company in a key executive
capacity and possesses intimate knowledge of the business and affairs of the
Company and is a valuable asset to the operations of the Company; and
WHEREAS, the Company is approached from time to time by outside
individuals and others who have an interest in acquiring all or a portion of the
Company's stock, some of whom have a background indicating the capability of
operating the Company, and some of whom do not; and
WHEREAS, the Company desires to evaluate such individuals, companies
and potential offers in the best interests of its shareholders, without the
distraction of the effect of change in control on Executives; and
WHEREAS, the Company also wants to assure managerial continuity and
stability during any takeover attempt.
NOW, THEREFORE, in consideration of the foregoing, and of the
agreements and covenants herein contained, Company and Executive agree as
follows:
1. This Agreement shall be effective and binding immediately upon its
execution, but it shall not become operative unless and until a "change in
control" of the Company, as defined hereinbelow, shall occur. The date of such
change in control is referred to herein as the "operative date" of this
Agreement.
2. As used herein, the term "change in control" shall mean either:
a. The ownership (whether direct or indirect) of shares in
excess of 50% of the outstanding shares of common stock of
the Company by a person or group of persons not directors of
the Company as of the date of this agreement; or
b. The occurrence of both of the following:
(1) The ownership (whether direct or indirect) of shares
in excess of 20% of the outstanding shares of common
stock of the Company by
<PAGE> 2
a person or group of persons not directors of the
Company as of the date of this Agreement; and
(2) Any change in the composition of the Board of
Directors of the Company resulting in a majority of
the directors of the Company as of the date of this
Agreement no longer constituting a majority;
provided, however, that in making such
determination, directors who were elected by, and on
the recommendation of, such present majority shall
be treated as present directors.
3. The term of this Agreement shall commence with the operative date
and shall continue for a term of two calendar years thereafter. During the term
of this Agreement, the Company agrees to continue the Executive in the employ
of the Company, and the Executive agrees to remain in the employ of the
Company, in the Executive's then-present capacity with no diminution of
responsibility, and to exercise such authority and perform such duties as are
commensurate with the authority exercised and duties performed by the Executive
during the six months immediately prior to the operative date of this
Agreement. Such services shall be performed in the same metropolitan area where
the Executive was employed immediately prior to the operative date, or at such
other location as the Company may reasonably require or to which Company and
Executive may agree.
4. During the term of this Agreement, Executive shall be compensated
at a base salary, bonus, stock option and employee benefit level commensurate
with the salary, bonus, stock option and benefits to which the Executive was
entitled in the twelve months prior to the operative date, or such greater
amount provided by the Company for Executives of comparable duties.
5. The employment of Executive under this Agreement may be terminated,
and the Executive not be entitled to the benefits set forth herein, only upon
the occurrence of one or more of the following events:
a. Termination by the Company for cause, as defined
below; or
b. Voluntary resignation by the Executive, as defined
below.
6. "Cause" shall mean:
(i) the willful and continued failure by the Executive to
substantially perform the Executive's duties with the Company, or a subsidiary
of the Company, as such duties may reasonably be defined from time to time by
the Board (or a duly authorized committee thereof), or to abide by the
reasonable written policies of the Company or of the Executive's primary
employer (Other than any such failure resulting from the Executive's
incapacity due to physical or mental illness) after a written demand for
substantial performance is delivered to the Executive
2
<PAGE> 3
by the Board, which demand specifically identifies the manner in which the
Board believes that the Executive has not substantially performed the
Executive's duties or has not abided by any reasonable written policies,
(ii) the continued and willful engaging by the Executive in conduct
which is demonstrably and materially injurious to the Company or its
subsidiaries, or
(iii) the Executive's conviction of, or pleading of no contest to, a
felony.
For the purposes of clauses (i) and (ii) of this definition, no act, or failure
to act, on the Executive's part shall be deemed "willful" unless done, or
omitted to be done, by the Executive in bad faith and without reasonable belief
that the Executive's act, or failure to act, was in the best interest of the
Company or its subsidiaries. Any act, or failure to act, based upon authority
given pursuant to a resolution duly adopted by the Board or upon the
instructions of the Board (or committee thereof), the Company's chief
executive officer or other duly authorized senior officer of the Company (as
appropriate) or based upon the advice of counsel for the Company shall be
conclusively presumed to be done, or omitted to be done, by the Executive in
good faith and in the best interests of the Company and its subsidiaries. The
cessation of employment of the Executive shall not be deemed to be for Cause
unless and until there shall have been delivered to the Executive a copy of a
resolution duly adopted by the affirmative vote of not less than three quarters
(3/4) of the entire membership of the Board at a meeting of the Board called
and held for such purpose (after reasonable notice of any such meeting is
provided to the Executive and the Executive is given an opportunity, together
with counsel, to be heard before the Board) finding that, in the good faith
opinion of the Board, the Executive has acted in a manner described in clause
(i) or (ii) above and specifying the particulars thereof in detail.
No termination for cause under the preceding paragraph shall be deemed to have
occurred without prior service of a written notice of termination to the
Executive specifying the factual basis for the allegation of cause, and the
failure of the Executive to cure such basis within 30 days after the notice.
7. The Executive's resignation shall not be "voluntary" and shall not
be a reason for termination of the Agreement in the event that:
a. Without the express written consent of the Executive, the
Executive reasonably determines that he is assigned any
duties inconsistent with his position, duties, responsibility
and status with the Company at the operative date, or his
authority, position or title in effect immediately prior to
the operative date is materially changed;
b. The base salary and bonus opportunity benefits or perquisites
of the Executive in effect at the operative date of this
Agreement are materially reduced;
3
<PAGE> 4
c. The Company fails to continue in effect any benefit or
compensation plan providing the Executive with substantially
similar benefits to those which the Executive enjoyed as of
the operative date;
d. In the event that relocation of more than 25 miles or
excessive travel demands in comparison to those in effect as
of the operative date are made upon the Executive; or
e. The Executive terminates his employment for any reason during
the 30 day period immediately following the one year
anniversary of the change of control.
8. In the event of a breach of this Agreement by the Company or the
termination of the Executive's employment during the term of this Agreement
(including without limitation due to the death or permanent disability of the
Executive) other than for cause as defined above, then:
a. Executive shall receive, in a lump sum, a cash payment in the
amount of the total of the salary and bonus received by
Executive from the Company in the last two full fiscal years
prior to the operative date;
b. Executive shall continue to receive all employment benefits,
including medical benefits, health insurance and other, to
which he may be entitled as a member of senior management of
the Company for a period of 24 months after the termination
date; and
c. Executive shall receive an additional benefit, over and above
that to which he would normally be entitled under the
Company's retirement plans, equal to the actuarial equivalent
of the additional amount Executive would have earned under
such retirement plans or programs had he accumulated two
additional continuous years of service. Such amount shall be
paid to Executive in a cash lump sum payment at his normal
retirement age, or, at Executive's option, at his early
retirement age as provided for in such retirement net plan.
The Company will reimburse the Executive for all legal fees and
expenses incurred in good faith by the Executive as a result of any dispute
with any party (including, but not limited to, the Company and/or any
affiliate of the Company) regarding the payment of any benefit provided for in
this Agreement (including, but not limited to, all fees and expenses incurred
in disputing any termination or in seeking in good faith to obtain or enforce
any benefit or right provided by this Agreement), or in each case interest on
any delayed payment at the applicable federal rate provided for in Section
7872(f)(2)(A) of the Code. Such payments will be made within five business days
after delivery of the Executive's written requests for payment accompanied by
any evidence of fees and expenses incurred as the Company may reasonably
require.
4
<PAGE> 5
9. The amounts paid to Executive hereunder shall be considered
severance pay in consideration of the past services Executive has rendered to
the Company, and in consideration of continued service from the date hereof to
Executive's entitlement to those payments. Executive shall have no duty to
mitigate damages by seeking other employment. Should Executive actually receive
payments from any other employment, the payments called for hereunder shall not
be reduced or offset by any such payments.
10. In the event Executive's employment is terminated after the
operative date:
a. For twenty-four (24) months after the termination of
Executive's employment hereunder, Executive shall
not, unless acting with the prior written consent of
Company:
(1) Directly or indirectly, for himself, or on
behalf of or in conjunction with any
entity, solicit or endeavor to recruit or
hire, as an employee, consultant, agent or
representative, any person who was an
employee of the Company within six months
of the date that the Executive first
solicited or endeavored to recruit or hire
such person.
(2) Discourage or otherwise attempt to prevent
any person from doing business with the
Company.
b. In the event that the provisions of this Section
should ever be deemed to exceed the time limitations
permitted by applicable law, then such provisions
shall be deemed reformed to the maximum time
limitations permitted by applicable law.
c. Executive specifically acknowledges and agrees that
the remedy at law for any breach of the provision of
this section will be inadequate and that the
Company, in addition to any other relief available
to it, shall be entitled to temporary and permanent
injunctive relief without the necessity of providing
actual damage. The provision of this Section 10
shall remain applicable to Executive until a final
decision of a court of competent jurisdiction is
entered finding that Executive was discharged by the
Company in violation of Section 5 hereof.
11. The Company shall require any successor (whether direct or
indirect, by purchase, merger, consolidation, reorganization or otherwise) to
all or substantially all of the business and/or assets of the Company, by
agreement in form and substance satisfactory to the Executive, expressly to
assume and agree to perform this Agreement in the same manner and to the same
extent the Company would be required to perform if no such succession had taken
place. This Agreement shall be binding upon and inure to the benefit of the
Company and any successor to
5
<PAGE> 6
the Company, including without limitation any persons acquiring directly or
indirectly all or substantially all of the business and/or assets of the
Company whether by purchase, merger, consolidation, reorganization or otherwise
(and such successor shall thereafter be deemed the "Company" for the purposes
of this Agreement), but shall not otherwise be assignable, transferable or
delegable by the Company. The failure of the Company to obtain such an
assignment shall be a breach of this Agreement, in which event the date of
succession or transfer shall be deemed to be the date of the breach.
12. This Agreement and all rights of the Executive shall inure to the
benefit of and be enforceable by the Executive's personal or legal
representatives, estates, executors, administrators, heirs and beneficiaries.
All amounts payable to the Executive shall be paid, in the event of the
Executive's death, to the Executive's estate, heirs and representatives. This
Agreement shall inure to the benefit of, be binding upon and be enforceable by,
any successor, surviving or resulting corporation or other entity to which all
or substantially all of the Company's business and assets shall be transferred.
This Agreement shall not be terminated by the voluntary or involuntary
dissolution of the Company.
13. Executive's right to receive payments hereunder shall not be
assignable, transferable or delegable, whether by pledge, creation of a
security interest or otherwise, other than by a transfer by his will or by the
laws of descent and distribution and, in the event of any attempted assignment
or transfer contrary to this Section, the Company shall have no liability to
pay any amount so attempted to be assigned, transferred or delegated.
14. This Agreement and the rights and obligations hereunder shall be
governed by and construed in accordance with the laws of the State of Ohio,
without giving effect to the principles of conflict of laws of such State. Any
dispute arising out of this Agreement shall be determined by arbitration in
Columbus, Ohio under the rules of the American Arbitration Association then in
effect and judgment upon any award pursuant to such arbitration may be enforced
in any court having jurisdiction thereof.
15. MISCELLANEOUS
a. ENFORCEMENT: The provisions of this Agreement shall be
regarded as divisible, and if any of said provisions or any
part hereof are declared invalid or unenforceable by a
court of competent jurisdiction, the validity and
enforceability of the remainder of such provisions or parts
hereof and the applicability thereof shall not be affected
thereby.
b. WITHHOLDING: The Company shall be entitled to withhold from
amounts to be paid to the Executive hereunder any federal,
state or local withholding or other taxes or charges which
it is from time to time required to withhold.
6
<PAGE> 7
c. EXPENSES AND INTEREST: If, after a change in control of the
Company any claim or legal or arbitration proceeding shall
be made or brought to recover damages for breach hereof,
the Executive shall recover from the Company prejudgment
interest on any money judgment or arbitration award
obtained by the Executive, calculated at the rate of
interest announced by Bank One Columbus, Ohio from time to
time at its prime rate, calculated from the date that
payments to him should have been made under this Agreement.
d. PAYMENT OBLIGATIONS ABSOLUTE: The Company's obligation
during and after the term of this Agreement to pay the
Executive the compensation and to make the arrangements
provided herein shall be absolute and unconditional and
shall not be affected by any circumstances, including,
without limitation, any set off, counterclaim, recoupment,
defense or other right which the Company may have against
him or anyone else. All amounts payable by the Company
hereunder shall be paid without notice or demand. Each and
every payment made hereunder by the Company will not seek
to recover all or any part of such payment from the
Executive or from whosoever may be entitled thereto, for
any reason whatsoever.
e. WAIVER AND ENTIRE AGREEMENT: No provisions of this
Agreement may be modified, waived or discharged unless such
waiver, modification or discharge is agreed to in writing
signed by the Executive and the Company. No waiver by
either party hereto at any time of any breach by the other
party hereto or compliance with any condition or provision
of this Agreement to be performed by such other party shall
be deemed a waiver of similar or dissimilar provisions or
conditions at the same or at any prior or subsequent time.
NO agreements or representations, oral or otherwise,
expressed or implied with respect to the subject matter
hereof have been made by either party which are not set
forth expressly in this Agreement.
f. NOTICES: For all purposes of this Agreement, all
communications including without limitation notices,
consents, requests or approvals, provided for herein shall
be in writing and shall be deemed to have been duly given
when delivered or five business days after having been
mailed by United States registered or certified mail,
return receipt requested, postage prepaid, addressed to the
Company (to the attention of the Secretary of the Company)
at its principal executive office and to the Executive at
his principal residence, or to such other address as any
party may have furnished to the other in writing and in
accordance herewith, except that notices of change of
address shall be effective only upon receipt.
g. SEVERABILITY: The invalidity or unenforceability of any
particular provision of this Agreement shall not affect the
other provisions hereof, and this
7
<PAGE> 8
Agreement shall be construed in all respects as if such
invalid or unenforceable provisions were omitted.
IN WITNESS WHEREOF, the parties have caused this Agreement to be duly
executed and delivered as of the date first written above.
DRUG EMPORIUM, INC.
By order of the Board of Directors
By:___________________________________
Its: _________________________________
EXECUTIVE:
__________________________
8
<PAGE> 1
Exhibit 10.17
(Date)
***
***
***
RE: Severance Compensation
Dear :
The Board of Directors (the "Board") of Drug Emporium, Inc. (the
"Company") believes that the Company's employees are valuable asset and
acknowledges that the security of the Company's employees is important to the
Board and the Company. Therefore, if you are involuntarily terminated (other
than a termination of employment due to your death or disability), after the
date of this letter and prior to the second anniversary thereof, by the Company
without Cause (as defined below) following the occurrence of a Change in
Control (as defined below), you will be entitled to receive the following
payments and benefits:
1. A lump sum payment equal to two times your regular per annum
base salary compensation;
2. Continuation of your medical coverage (at no increased cost to
you) for twelve months; and
3. Outplacement services (at no cost to you) at a firm selected by
the Company for the period beginning on your termination date
and ending on the earlier of (a) the 3 month anniversary of your
termination date, and (b) the date on which you accept a new
employment position.
For purposes of this letter, "Cause" means (1) your failure in a
material and substantial way to perform your assigned duties, (2) you
materially breach any of your obligations to the Company, as set forth herein
or otherwise, or (3) you commit a material act of malfeasance, disloyalty,
dishonesty or breach of trust against the Company. For purposes of this letter,
"Change in Control" means:
* The acquisition (whether direct or indirect) of shares
representing in excess of 50% of the outstanding shares of
common stock of the Company by a person or group of persons not
directors of the Company as of the date of this letter; or
1
<PAGE> 2
* The occurrence of both of the following:
The acquisition (whether direct or indirect) of shares
representing in excess of 20% of the outstanding shares of
common stock of the Company by a person or group of persons
not directors of the Company as of the date of this letter;
and
Any change in the composition of the Board resulting in a
majority of the directors of the Company as of the date of
this letter no longer constituting a majority; provided,
however, that in making such determination, directors who
were elected by, and on the recommendation of, such present
majority will be treated as present directors.
The Company will reimburse you for all legal fees and expenses
incurred in good faith by you as a result of any dispute with any party
(including, but not limited to, the Company and/or any affiliate of the
Company) regarding the payment of any benefit provided for in this letter.
These payments will be made within five business days after delivery of your
written requests for payment accompanied by any evidence of fees and expenses
incurred as the Company reasonably may require.
The amounts paid to you hereunder will be considered severance pay in
consideration of the past services you have rendered to the Company, and in
consideration of your continued service from the date hereof until your
entitlement to those payments. You will have no duty to mitigate damages by
seeking other employment. Should you actually receive payments from other
employment, the payments called for under this letter will not be reduced or
offset by any such payments.
You agree to hold in a fiduciary capacity for the benefit of the
Company all secret or confidential information, knowledge or data relating to
the Company or any of its affiliated companies, and their respective
businesses, which has been or may be obtained by you during your employment by
the Company or any of its affiliated companies and which is not public
knowledge (other than by direct or indirect acts by you in violation of this
letter). After termination of your employment with the Company, you agree to
not, without the prior written consent of the Company or as may otherwise be
required by law or legal process, communicate or divulge any such information,
knowledge or data to anyone other than the Company and those designated by it.
The Company will require any successor to all or substantially all of
the business and/or assets of the Company to assume and agree to perform the
obligations set forth in this letter in the same manner and to the same extent
the Company would be required to perform if no such succession had occurred.
This letter and all your rights hereunder will inure to the benefit of and be
enforceable by your personal or legal representatives, estate, executor(s),
administrator(s),
2
<PAGE> 3
heirs or beneficiaries. All amounts payable to you will be paid, in the event
of your death, to your estate, heirs and representatives. This letter will
inure to the benefit of, by binding upon and be enforceable by, any successor,
surviving or resulting corporation or other entity to which all or
substantially all of the Company's business and assets are transferred.
Your right to receive payments hereunder will not be assignable,
transferable or delegable to you, whether by pledge, creation of a security
interest or otherwise other than by a testamentary transfer or by the laws of
descent and distribution and, in the event of any attempted assignment or
transfer to the contrary, the Company will have no liability to pay any amount
so attempted to be assigned, transferred or delegated.
This letter and the rights and obligations hereunder will be governed
by and construed in accordance with the laws of the State of Ohio, without
giving effect to the principles of conflict of the laws of Ohio. Any dispute
arising out of the this letter will be determined by arbitration in Columbus,
Ohio under the rules of the American Arbitration Association then in effect and
judgement upon any award pursuant to such arbitration may be entered and
enforced in any court having jurisdiction thereof.
The Company is entitled to withhold from amounts to be paid to you
thereunder any federal, state and local withholding or other taxes or charges
which it is form time to time required to withhold.
**************
If the Above meets with your approval, kindly sign both copies of this
letter in the space provided below. Please return the one original to the
Company and keep the other for your records.
Sincerely,
DRUG EMPORIUM, INC.
By:_______________________________
David L. Kriegel
Chairman & Chief Executive Officer
Agreed to and acknowledged:
___________________________________
(Name)
3
<PAGE> 1
Exhibit 10.18
CONSULTING AGREEMENT
THIS CONSULTING AGREEMENT ("Agreement"), dated December 2, 1997 is
made by and between David L. Kriegel ("Consultant") and Drug Emporium, Inc.
("Company").
Recitals
--------
1. The Company desires to continue to benefit from the Consultant's
business acumen and expertise by retaining the Consultant as a consultant after
his termination of employment as chief executive officer and Chairman of the
Board of the Company due to a change in control as defined in the amendment to
Consultant's Employment Agreement dated December 2, 1997.
2 . The Consultant, in accordance with the terms and provisions set
forth below, desires to be retained as a business consultant to the Company and
to consult with the Company's chief executive officer and certain other senior
officers of the Company regarding the retail deep-discount drugstore industry
and other relevant business matters.
Agreement
---------
NOW THEREFORE, in consideration of the mutual covenants and the
premises set forth herein, the Company and the Consultant hereby agree as
follows:
1. Term
----
The consulting term, ("Term"), shall commence upon the termination of
the Consultant's employment due to a change in control as defined in the first
amendment to the Consultant's Employment Agreement with the Company,
("Commencement Date"), and shall end on the first year anniversary of the
Commencement Date. The consulting Term may be extended or renewed only pursuant
to the mutual written agreement of the Consultant and the Company.
2. Consulting Commitment
---------------------
2.1 During each month of the consulting Term, the Consultant (subject
to allowances for illness and reasonable vacation) shall hold himself
available, upon reasonable notice and during normal business hours, for 20
hours of business discussions or consultations with the chief executive officer
of the Company or with other senior officers or directors of the Company as
designated by the chief executive officer with the advice and consent of the
Consultant. In connection with any consulting services rendered, the Consultant
shall report solely and directly to the chief executive officer.
2.2. During the Term all business discussions and consultations shall
occur either (a) by
1
<PAGE> 2
telephonic conference call, or (b) in person at the Company's corporate offices
(or at such other locations, as may be mutually agreed upon from time to time
by the Consultant and the chief executive officer). Except as provided in the
immediately preceding sentence, the Consultant shall not be required, without
his consent, to travel to any specified geographic location or to provide any
consulting service from any location other than the Consultant's primary
personal residence.
2.3 During the consulting Term, the Consultant's arrangement with the
Company under this Agreement shall be an exclusive consulting arrangement and
during such period the Consultant shall not, directly or indirectly, provide
consulting services, or offer to provide consulting services, for a fee or any
other remuneration or benefit to any individual or entity engaged in any
business which competes, directly or indirectly, with the business of the
Company or any of its subsidiaries.
3. Consulting Fees
---------------
During the Term, the Consultant shall receive a consulting fee equal
to $150,000 per annum to be evaluated annually commencing in December 1998,
payable by the Company on bi-weekly basis.
4. Expense Reimbursement
---------------------
During and in respect of the Term, the Consultant shall, upon
presentation to the Company of reasonable documentation, be entitled to prompt
and frill reimbursement for all reasonable business expenses, including,
without limitation, travel and commutations, hotel, restaurant and
communication costs incurred by or charged to the Consultant in or with respect
to the performance of consulting services under this Agreement and directed by
the chief executive officer.
5. Termination
-----------
5.1 The consulting Term may be terminated, effective upon thirty (30)
days prior written notice given by the Consultant or the Company, at any time
for any reason including, without limitation, prior to the Commencement Date.
If the Consultant should die during the consulting Term, the consulting Term
shall automatically be terminated. Any termination under this Section 5 shall
not be deemed to constitute a breach of this Agreement.
5.2 If the Agreement is terminated voluntarily by the Consultant
during the Term (other than for Good Reason as defined below or due to his
death or disability as defined below), the Consultant must provide thirty (30)
days notice after which the Company will not be obligated to pay the aggregate
amount of the remaining consulting fees that would have been paid to the
Consultant under this Agreement had the Term continued for the term specified
in Section 1 of this Agreement. For purposes of this Agreement, "Good Reason"
shall mean the repeated failure by the Company, after notice from the
Consultant, to pay the Consultant's consulting
2
<PAGE> 3
fees. For purposes of this Agreement, "disability" shall have the meaning
provided in the Company's disability insurance plan.
5.3 If the Agreement is terminated by the Company for any reason, by
the Consultant for Good Reason or due to the Consultant's death or his becoming
disabled, the Consultant shall be entitled to receive, within thirty (30) days
after the effective date of such termination, a lump sum payment equal to (a)
any remaining consulting fees earned by the consultant through the effective
date of such termination, but not yet paid by the Company, and (b) the
aggregate amount of the remaining consulting fees that would have been paid to
the Consultant under this Agreement had the Term continued for the term
specified in Section 1 of this Agreement.
5.4 If the consultant dies during the Term, the Consultant's estate
shall be entitled to receive, within thirty (30) days after the Consultant's
death, a lump sum payment in cash equal to the sum of (a) any consulting fees
earned by the Consultant through the date of death, but not yet paid by the
Company, and (b) the aggregate amount of the remaining consulting fees that
would, but for his death, have been paid to the Consultant under this Agreement
through the end of the Term. If the Consultant dies prior to the Commencement
Date, the Consultant's estate shall not be entitled to receive any amounts
hereunder.
5.5 Except as set forth in this Section 6, the Consultant shall not be
entitled to Any other compensation or benefits under this Agreement upon or as
a result of the termination of the Agreement.
6. Legal Fees
----------
In the event that a claim by the Consultant (or his estate) for
consulting fees under this Agreement is disputed by the Company, the Consultant
(or his estate) shall be promptly reimbursed by the Company for all legal fees
incurred by or charged to the Consultant (or his estate) in prosecuting such
claim, provided that the Consultant (or his estate) is successful as to the
disputed claim by reason of litigation, arbitration or settlement.
7. Miscellaneous
-------------
7.1 The parties hereto agree that the Consultant shall be an
independent contractor of the Company and shall not, among other things, be
subject to the supervision of any employee or director of the Company. The
Company and the Consultant agree that the Company shall not withhold any
amounts from the Consultant's bi-weekly consulting fee., without the prior
express written consent of the Consultant.
7.2 The Company shall, to the fullest extent permitted by law,
indemnify the Consultant from, and hold him harmless against, any and all
liabilities, costs and expenses (including, without limitation, fees and
expenses of legal counsel and/or other experts) incurred by reason of any
claim, suit or action brought against the Consultant as a direct or indirect
result of any act, omission, or failure to act, by or on behalf of the
Consultant while providing
3
<PAGE> 4
the services contemplated by this Agreement for the Company or for any
affiliate thereof, except for any act or omission which constitutes willful
gross misconduct by the Consultant. The obligation of the Company under this
Section 7.2 shall be in addition to and not in derogation of any other
indemnification by the Company which the Consultant may be entitled to under
other arrangements with the Company.
7.3 The Company shall require any successor to all or substantially
all of the business and/or assets of the Company, whether direct or indirect,
to assume and perform this Agreement.
7.4 No amendment, modification or waiver of any provision of this
Agreement shall be valid, binding or enforceable, unless it is in writing and
signed by the party against whom it is to be charged.
7.5 This Agreement constitutes a Consulting Agreement between the
Consultant and the Company regarding the subject matter here of and supersedes
any/all previous consulting agreements, promises, proposals, representations,
understanding and negotiations, whether written or oral, between the Consultant
and the Company regarding such subject matters.
7.6 All notices and other communications under this Agreement shall be
in writing and shall be delivered by hand or by certified mail (return receipt
requested), postage prepaid, properly addressed to the respective addresses set
forth below, or to such other address which the sending party has previously
received written notice of. Notice shall be deemed given upon delivery to the
addressee.
7.7 In the event that any disputes of any kind arise under or with
respect to this Agreement, the parties hereto agree to submit any such dispute
to binding arbitration in the State of Ohio in accordance with the rules of the
American Arbitration Association then in effect.
7.8 The validity, interpretation and performance of this Agreement
shall be governed by the laws of the State of Ohio.
IN WITNESS WHEREOF, the Consultant and the Company have executed this Agreement
as of the day and year first above written.
For: DRUG EMPORIUM, INC. Consultant:
By order of the Board of Directors
__________________________________ ______________________________
Its David L. Kriegel
Address: Address:
155 Hidden Ravines Drive 3410 London Drive
Powell, Ohio 43065 Lima, Ohio 45805
4
<PAGE> 1
Exhibit 13
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
February 28, 1998 March 1, 1997
(Dollars in thousands, except per share data) (52 weeks) (52 weeks)
=====================================================================================
<S> <C> <C>
FOR THE YEAR ENDED:
- -------------------------------------------------------------------------------------
Net sales $ 836,405 $ 855,016
- -------------------------------------------------------------------------------------
Operating income before special charges* $ 8,705 $ 12,915
- -------------------------------------------------------------------------------------
Net income $ 1,691 $ 1,152
- -------------------------------------------------------------------------------------
Average sales per store (52-week weighted average) $ 6,105 $ 6,151
- -------------------------------------------------------------------------------------
AT YEAR END:
- -------------------------------------------------------------------------------------
Inventories at current cost $ 189,043 $ 208,991
- -------------------------------------------------------------------------------------
LIFO reserve (21,751) (21,042)
- -------------------------------------------------------------------------------------
Inventories $ 167,292 $ 187,949
- -------------------------------------------------------------------------------------
Working capital $ 79,113 $ 76,302
- -------------------------------------------------------------------------------------
Shareholders' equity $ 51,390 $ 49,567
- -------------------------------------------------------------------------------------
Current ratio 1.73 1.59
- -------------------------------------------------------------------------------------
Long-term debt to equity 1.09 1.20
- -------------------------------------------------------------------------------------
Shares outstanding (in thousands) 13,180 13,153
- -------------------------------------------------------------------------------------
STORES OPEN:
- -------------------------------------------------------------------------------------
Company-owned 135 138
- -------------------------------------------------------------------------------------
Franchised 84 91
- -------------------------------------------------------------------------------------
Total 219 229
- -------------------------------------------------------------------------------------
PER SHARE (BASIC AND DILUTED):
- -------------------------------------------------------------------------------------
Earnings $ 0.13 $ 0.09
- -------------------------------------------------------------------------------------
Shareholders' equity $ 3.90 $ 3.77
=====================================================================================
</TABLE>
* Special charges (credits) of $(2,092,000) and $2,800,000 were recorded in
fiscal years 1998 and 1997, respectively.
<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.
STATEMENT OF OPERATIONS DATA
<TABLE>
<CAPTION>
Year Ended
- ----------------------------------------------------------------------------------------------------------------------------------
February 28, March 1, March 2, February 25, February 26,
1998 1997 1996 1995 1994
(in thousands, except per share data) (52 weeks) (52 weeks) (53 weeks) (52 weeks) (52 weeks)
==================================================================================================================================
<S> <C> <C> <C> <C> <C>
Net sales $ 836,405 $ 855,016 $ 738,772 $ 729,503 $ 749,040
- ----------------------------------------------------------------------------------------------------------------------------------
Gross margin 178,289 185,475 160,146 153,696 155,473
- ----------------------------------------------------------------------------------------------------------------------------------
Selling, administrative and occupancy expenses 169,584 172,560 146,774 143,337 146,920
- ----------------------------------------------------------------------------------------------------------------------------------
Operating income before special charges 8,705 12,915 13,372 10,359 8,553
- ----------------------------------------------------------------------------------------------------------------------------------
Special charges (credits) (2,092) 2,800 3,000 11,850 --
- ----------------------------------------------------------------------------------------------------------------------------------
Interest, net 7,653 7,882 6,468 6,697 6,183
- ----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 3,144 2,233 3,904 (8,188) 2,370
- ----------------------------------------------------------------------------------------------------------------------------------
Provision (benefit) for income taxes 1,453 1,081 1,562 (2,797) 1,089
- ----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 1,691 $ 1,152 $ 2,342 $ (5,391) $ 1,281
==================================================================================================================================
PER SHARE DATA:
Earnings (loss) (1) $ 0.13 $ 0.09 $ 0.18 $ (0.41) $ 0.10
- ----------------------------------------------------------------------------------------------------------------------------------
Cash dividends -- -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Shareholders' equity $ 3.90 $ 3.77 $ 3.68 $ 3.50 $ 3.91
- ----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET DATA:
Working capital $ 79,113 $ 76,302 $ 80,195 $ 83,664 $ 82,176
- ----------------------------------------------------------------------------------------------------------------------------------
Total assets $ 219,784 $ 243,319 $ 243,898 $ 176,444 $ 198,085
- ----------------------------------------------------------------------------------------------------------------------------------
Non-current liabilities $ 60,330 $ 63,523 $ 67,391 $ 67,738 $ 68,761
- ----------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity $ 51,390 $ 49,567 $ 48,545 $ 46,149 $ 51,484
==================================================================================================================================
</TABLE>
(1) Represents basic and diluted per share amounts as defined by Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (FAS No. 128).
Earnings (loss) per share amounts prior to 1998 have been restated as required
to comply with FAS No. 128. For further discussion, see the notes to the
consolidated financial statements.
4
<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
- ----------------------------------------------------------------------
February 28, March 1, March 2,
1998 1997 1996
(52 weeks) (52 weeks) (53 weeks)
- ----------------------------------------------------------------------
<S> <C> <C> <C>
Net sales (in thousands) $836,405 $855,016 $738,772
- ----------------------------------------------------------------------
Gross margin 21.3% 21.7% 21.7%
- ----------------------------------------------------------------------
Selling, administrative and
occupancy expense 20.3% 20.2% 19.9%
- ----------------------------------------------------------------------
Operating income 1.0% 1.5% 1.8%
- ----------------------------------------------------------------------
</TABLE>
SALES
Total sales for Fiscal 1998 decreased two percent from Fiscal 1997 and
comparable-store sales decreased by approximately one-half of one percent.
Overall sales decreased due to a lower store count and the comparable-store
sales decrease. Average sales per store for Fiscal 1998 (based on a weighted
average number of stores) were down approximately one percent over Fiscal 1997
due primarily to the comparable-store sales decreases.
Sales for Fiscal 1997 increased 16 percent over Fiscal 1996 and
comparable-store sales increased two percent in Fiscal 1997. The Fiscal 1997
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 29 percent, 27 percent,
and 25 percent of sales in Fiscal 1998, 1997, and 1996, respectively. Management
expects that pharmacy sales will continue to increase slightly as a percentage
of total sales in the coming year.
The following table lists stores opened or acquired and stores closed for
the years indicated:
<TABLE>
<CAPTION>
Year Ended
- -----------------------------------------------------------------
February 28, March 1, March 2,
1998 1997 1996
(52 weeks) (52 weeks) (53 weeks)
- -----------------------------------------------------------------
<S> <C> <C> <C>
Number of stores at
beginning of year 138 136 113
- -----------------------------------------------------------------
Stores opened or acquired 1 9 34
- -----------------------------------------------------------------
Stores closed (4) (7) (11)
- -----------------------------------------------------------------
Total stores at end of year 135 138 136
- -----------------------------------------------------------------
</TABLE>
GROSS MARGIN
Fiscal 1998 gross margins were lower than the previous fiscal year due to
increased inventory shrinkage and lower pharmacy margins, partially offset by
the benefits of improved category management on non-pharmacy margins. Fiscal
1998 revenue recognized from vendor contract payments has impacted margins at
levels similar to those seen in the previously reported two fiscal years.
For Fiscal 1999, management expects continued pressure on the pharmacy
margins due to the impact of pricing changes initiated by managed care networks.
It is also anticipated that income recognized from vendor contract payments will
decrease during Fiscal 1999 relative to the previous fiscal periods although the
Company believes that its category management efforts and lower inventory
shrinkage will eclipse the impact of this decrease. If the Company is successful
in its category management efforts, overall gross margins are anticipated to
recover and show a slight improvement over the levels seen in Fiscal 1997.
SELLING, ADMINISTRATIVE AND OCCUPANCY
Net advertising costs were slightly lower in dollars and as a percentage of
sales, compared to the prior fiscal year; however, gross advertising costs were
approximately .5% of sales higher than the prior year. Despite a planned
increase in the print advertising for Fiscal 1999, the Company anticipates lower
net advertising costs in Fiscal 1999 of .1% of sales through a more focused
approach to the costs associated with distributing and producing its
advertising.
Payroll costs were lower in dollars and as a percentage of sales by .2%
over the prior year as a result of an ongoing initiative to reduce
administrative costs. This trend is expected to continue in Fiscal 1999,
although at a slightly slower pace. In Fiscal 1998, occupancy costs were
constant in dollars and higher as a percentage of sales by .1% relative to
Fiscal 1997. Fiscal 1999 occupancy costs are expected to remain fixed as a
percentage of sales. Other operating expenses were higher in Fiscal 1998 over
Fiscal 1997 in dollars and as a percentage of sales due to decreased sales
leverage and higher pharmacy costs. In Fiscal 1999, the Company anticipates
reductions in operating costs of .1% over Fiscal 1998 due to lower POS equipment
rental expense.
Franchise fees, which are included as a reduction to operating costs, were
$4,794,000, $4,840,000 and $4,669,000 in Fiscal 1998, 1997 and 1996,
respectively. The Company has entered into an agreement with Western Drug
Distributors, Inc., its franchise store operator in the Seattle and Portland
area, to terminate Western's franchise agreement. The termination agreement is
contingent upon the successful completion of due diligence and subsequent
purchase of Western by Longs Drug Stores of Walnut Creek, California. The
Company's agreement with Western provides for a one-time lump sum payment to
Drug Emporium, Inc. based on the discounted present value of the future cash
flows of franchise fees anticipated over the life of the franchise agreement.
This transaction, if completed, is expected to result in significant reductions
to franchise fee revenue and interest costs on an ongoing basis as well as a
large one-time income impact at the date of the closing, which is estimated to
be early in the Company's second quarter of Fiscal 1999.
Selling, administrative and occupancy expenses increased in Fiscal 1997
compared to Fiscal 1996 in total dollars and as a percentage of net sales. The
increase in Fiscal 1997 over Fiscal 1996 is a result of transitional costs
associated with the acquired stores and increased litigation costs.
5
<PAGE> 4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
SPECIAL CHARGES (CREDITS)
The impact of special charges (credits) on net income and descriptions of the
components of the charges are shown below:
<TABLE>
<CAPTION>
Year Ended
- ------------------------------------------------------------------------------
February 28, March 1, March 2,
1998 1997 1996
(in thousands, except per share data) (52 weeks) (52 weeks) (53 weeks)
==============================================================================
<S> <C> <C> <C>
RECONCILIATION OF NET INCOME
TO NET INCOME BEFORE
SPECIAL CHARGES (CREDITS):
Net income $1,691 $1,152 $2,342
- ------------------------------------------------------------------------------
Special charges (credits),
net of income taxes (1,255) 1,680 1,800
- ------------------------------------------------------------------------------
Net income before
special charges (credits) $ 436 $2,832 $4,142
- ------------------------------------------------------------------------------
Earnings per share before
special charges (credits)
(basic and diluted) $ 0.03 $ 0.22 $ 0.31
- ------------------------------------------------------------------------------
</TABLE>
Store Closure Expense
Store closing reserves are established based on management's expectation of the
costs which will be incurred over the remaining lease terms of the closed
locations, net of expected sublease income. During Fiscal 1996, a pretax charge
of $3,000,000 was taken to cover rent and related charges for several closed
store locations. In Fiscal 1997, the Company recorded costs associated with
stores closed during Fiscal 1997 and earlier of $1,300,000, which was recorded
as a part of special charges. In Fiscal 1998, additional store closing charges
were offset by the receipt of $1,600,000 related to a favorable lease buyout.
Management's goal is to sublease or through other means remove all
significant closed-store obligations. Since March 1994, the Company has closed
46 stores, of which non-subleased obligations continue at February 28, 1998 on
four stores. Management continues to seek ways to relieve obligations on these
stores.
Impairment of Long-Lived Assets
In Fiscal 1997, the Company adopted SFAS No. 121, "Accounting for the Impairment
of Long Lived Assets and for Long-Lived Assets to Be Disposed Of". Accordingly,
the Company evaluated the ongoing value of its long-lived assets. Based on this
evaluation, the Company determined that leasehold improvements and lease assets
for certain stores were impaired and recorded as a part of special charges the
transitional amortization charge of $1,500,000 in Fiscal 1997. A $300,000 charge
was recorded in Fiscal 1998 and is shown as occupancy expense in the
consolidated statement of operations.
Settlement of Litigation and Recovery of Legal Costs
Subsequent to the end of Fiscal 1998, the Company reached a confidential
settlement agreement with one of its franchisees to resolve a longstanding
lawsuit. The impact of the settlement and associated legal costs is reflected in
the Fiscal 1998 results, net of a third-party recovery. The Company also
recorded a recovery of related prior period legal costs as a special credit in
Fiscal 1998.
Interest, Net
Interest, net decreased slightly in Fiscal 1998 over the previous period due
primarily to lower borrowings related to the $19,948,000 in inventory reductions
which took place during Fiscal 1998. Because these reductions followed unusually
high first quarter Fiscal 1998 borrowings and took place over the course of
Fiscal 1998, the full impact of the inventory reductions on interest expense
will not be seen until Fiscal 1999. Interest, net increased during Fiscal 1997
compared to Fiscal 1996 due to increased borrowing related to store
acquisitions.
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, and none of the closed
stores carried any future lease obligations to the Company. Six additional
stores were also purchased in three separate transactions in Fiscal 1996. The
consolidated statements of operations reflect the results of operations of the
acquired stores from the dates 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 uses an estimated percentage rate of
inflation determined at the beginning of the fiscal year in computing its LIFO
charges throughout the fiscal year. This LIFO charge is adjusted at each year
end based upon the actual weighted average percentage rate of inflation during
the fiscal year.
<TABLE>
<CAPTION>
Year Ended
- ----------------------------------------------------------------
February 28, March 1, March 2,
1998 1997 1996
================================================================
<S> <C> <C> <C>
LIFO provision (benefit)
(in thousands) $709 $(112) $1,573
- ----------------------------------------------------------------
Inflation (deflation) rate .4% (-.1)% 1.1%
- ----------------------------------------------------------------
</TABLE>
Inventory turnover approximated 3 turns for each of the years presented.
During Fiscal 1998, the Company began to realize the benefits of its new
inventory management system in the form of lower inventory levels, with FIFO
inventory dropping in total by $19,948,000, or $114,000 per store. Management
anticipates continued reductions in per-store inventory levels in the coming
fiscal year due to its ongoing inventory management efforts related to its
improved procurement and distribution processes.
LIQUIDITY AND CAPITAL RESOURCES
As of February 28, 1998, the Company's credit facility consisted of a term loan
of $9,000,000 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.
6
<PAGE> 5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
During Fiscal 1998, the Company decreased borrowings under the revolving
credit facility by $19,400,000, as set forth in the
consolidated statements of cash flows, which was due primarily to the Company's
successful inventory reduction program. As noted above, the Company anticipates
further reductions in its per store inventory levels, and thus its borrowing
needs, due to its ongoing efforts to better manage its procurement and
distribution processes.
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 assets of the company. 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
approximated interest expense in Fiscal 1998. Cash paid for interest on the
revolving credit line and long-term debt exceeded interest expense by
approximately $1,000,000 in Fiscal 1997 and was lower than interest expense by
approximately $1,000,000 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 February 28, 1998 is primarily comprised of
net operating loss and AMT credit carryforwards of $5,772,000. 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.
CLOSURE OF "BIG D" STORES
The Company is in the process of closing the remaining "Big D" store. Costs to
close the "Big D" stores and Fiscal 1998 "Big D" pretax losses from operations,
together totaling approximately $1,200,000, are recorded in the Fiscal 1998
results.
IMPACT OF YEAR 2000
Some of the Company's older computer programs were written using two digits
rather than four to define the applicable year. As a result, those computer
programs have time-sensitive software that does not correctly recognize the year
2000. This could cause a system failure or miscalculations causing disruptions
of operations, including, among other things, a temporary inability to process
transactions, send purchase orders, or engage in similar normal business
activities.
The Company has completed an assessment of this issue and is in the process
of modifying and replacing portions of its software so that its computer systems
will function properly with respect to dates in the year 2000 and thereafter.
The total Year 2000 project cost is not expected to exceed $500,000, which
includes $350,000 for the purchase of new hardware and software that will be
capitalized and $150,000 that will be expensed as incurred. The Company expects
to incur most of its Year 2000 costs during Fiscal 1999.
Most portions of the project are estimated to be completed not later than
February 27, 1999, which is prior to any anticipated impact on its operating
systems. The Company believes that with modifications to existing software and
conversions to new software, the Year 2000 issue will not pose significant
operational problems for its computer systems. However, if such modifications
and conversions are not made, or are not completed timely, the Year 2000 issue
could have a material impact on the operations of the Company.
The Company has initiated formal communications with all of its significant
suppliers to determine the extent to which the Company's interface systems are
vulnerable to those third parties' failure to remediate their own Year 2000
Issues. There is no guarantee that the systems of other companies on which the
Company's systems rely will be timely converted and would not have an adverse
effect on the Company's systems.
The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources and other factors. However,
there can be no guarantee that these estimates will be achieved and actual
results could differ materially from those anticipated. Specific factors that
might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes, and similar uncertainties.
FORWARD-LOOKING STATEMENTS
Statements in this Management's Discussion and Analysis of Financial Condition
and Results of Operations, as well as in certain other parts of this report that
look forward in time, which includes everything other than historical
information, are forward-looking statements made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements include statements concerning plans, objectives,
goals, strategies, future events or performance, and underlying assumptions and
other statements which are other than statements of historical facts. From time
to time, the Company may publish or otherwise make available forward-looking
statements of this nature. All such forward-looking statements are based on the
current expectations of management and are subject to, and are qualified by,
risks and uncertainties that could cause actual results to differ materially
from those expressed or implied by those statements. These risks and
uncertainties include, but are not limited to the high level of competition as
to price and selection from a variety of sources, the recent pressure on
pharmacy margins from managed care networks, the Company's ability to
economically eliminate underperforming stores and general economic conditions.
7
<PAGE> 6
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(in thousands)
- ------------------------------------------------------------------------------------------------
ASSETS FEBRUARY 28, 1998 March 1, 1997
=================================================================================================
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 783 $ 779
- ------------------------------------------------------------------------------------------------
Accounts receivable 17,410 14,525
- ------------------------------------------------------------------------------------------------
Inventories 167,292 187,949
- ------------------------------------------------------------------------------------------------
Income taxes and other current assets 1,692 3,278
- ------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 187,177 206,531
- ------------------------------------------------------------------------------------------------
Property and equipment, net 26,777 30,412
- ------------------------------------------------------------------------------------------------
Goodwill 4,215 4,763
- ------------------------------------------------------------------------------------------------
Other assets 1,615 1,613
- ------------------------------------------------------------------------------------------------
TOTAL ASSETS $219,784 $243,319
=================================================================================================
</TABLE>
<TABLE>
<CAPTION>
(dollars in thousands)
- ------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY FEBRUARY 28, 1998 March 1, 1997
=================================================================================================
<S> <C> <C>
CURRENT LIABILITIES:
Revolving credit line $ 22,200 $ 41,600
- ------------------------------------------------------------------------------------------------
Accounts payable 64,025 64,571
- ------------------------------------------------------------------------------------------------
Accrued liabilities 14,785 15,142
- ------------------------------------------------------------------------------------------------
Deferred income 3,679 4,966
- ------------------------------------------------------------------------------------------------
Current maturities of long-term debt 3,375 3,950
- ------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 108,064 130,229
- ------------------------------------------------------------------------------------------------
Deferred rent 4,164 4,192
- ------------------------------------------------------------------------------------------------
Convertible subordinated debt 49,421 49,421
- ------------------------------------------------------------------------------------------------
Long-term debt, other 6,745 9,910
- ------------------------------------------------------------------------------------------------
TOTAL LONG-TERM DEBT 56,166 59,331
- ------------------------------------------------------------------------------------------------
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 13,180,000 in 1998; 13,153,000 in 1997 1,318 1,315
- ------------------------------------------------------------------------------------------------
Additional paid-in capital 32,123 31,994
- ------------------------------------------------------------------------------------------------
Retained earnings 17,949 16,258
- ------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 51,390 49,567
- ------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $219,784 $243,319
=================================================================================================
</TABLE>
See accompanying notes.
8
<PAGE> 7
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended
- --------------------------------------------------------------------------------------------------
FEBRUARY 28, 1998 March 1, 1997 March 2, 1996
(in thousands, except per share amounts) (52 WEEKS) (52 weeks) (53 weeks)
==================================================================================================
<S> <C> <C> <C>
Net sales $ 836,405 $ 855,016 $ 738,772
- --------------------------------------------------------------------------------------------------
Cost of sales 658,116 669,541 578,626
- --------------------------------------------------------------------------------------------------
Gross margin 178,289 185,475 160,146
- --------------------------------------------------------------------------------------------------
Selling, administrative and occupancy expenses 169,584 172,560 146,774
- --------------------------------------------------------------------------------------------------
Special charges (credits) (2,092) 2,800 3,000
- --------------------------------------------------------------------------------------------------
Interest expense, net 7,653 7,882 6,468
- --------------------------------------------------------------------------------------------------
Income before provision for income taxes 3,144 2,233 3,904
- --------------------------------------------------------------------------------------------------
Provision for income taxes 1,453 1,081 1,562
- --------------------------------------------------------------------------------------------------
Net income $ 1,691 $ 1,152 $ 2,342
- --------------------------------------------------------------------------------------------------
Earnings per share (basic and diluted) $ 0.13 $ 0.09 $ 0.18
- --------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES USED IN
COMPUTING EARNINGS PER SHARE:
Basic 13,180 13,169 13,182
- --------------------------------------------------------------------------------------------------
Diluted 13,197 13,182 13,190
==================================================================================================
</TABLE>
See accompanying notes.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
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 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
- ------------------------------------------------------------------------------------------------------------------------------
Exercise of stock options 27 3 129 -- 132
- ------------------------------------------------------------------------------------------------------------------------------
Net income -- -- -- 1,691 1,691
- ------------------------------------------------------------------------------------------------------------------------------
BALANCE AT FEBRUARY 28, 1998 13,180 $1,318 $31,123 $17,949 $51,390
==============================================================================================================================
</TABLE>
See accompanying notes.
9
<PAGE> 8
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended
- --------------------------------------------------------------------------------------------------------------
FEBRUARY 28, 1998 March 1, 1997 March 2, 1996
(in thousands) (52 WEEKS) (52 weeks) (53 weeks)
==============================================================================================================
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 1,691 $ 1,152 $ 2,342
- --------------------------------------------------------------------------------------------------------------
ADJUSTMENTS TO RECONCILE TO CASH PROVIDED BY OPERATIONS:
Depreciation and amortization 7,345 8,788(1) 6,934
- --------------------------------------------------------------------------------------------------------------
Deferred income taxes 610 500 1,000
- --------------------------------------------------------------------------------------------------------------
LIFO provision (benefit) 709 (112) 1,573
- --------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY (USED FOR) CURRENT ASSETS AND LIABILITIES:
Accounts payable and accrued liabilities (2,725) (18,626) 34,128
- --------------------------------------------------------------------------------------------------------------
Accounts receivable (2,885) (1,507) (2,494)
- --------------------------------------------------------------------------------------------------------------
Inventories at current cost 19,948 7,921 (23,064)
- --------------------------------------------------------------------------------------------------------------
Other 1,268 2,439 3,446
- --------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 25,961 555 23,865
- --------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of property and equipment, net (2,949) (5,809) (2,773)
- --------------------------------------------------------------------------------------------------------------
Payment for purchase of retail stores, net of cash acquired -- (10,093) (40,644)
- --------------------------------------------------------------------------------------------------------------
NET CASH USED FOR INVESTING ACTIVITIES (2,949) (15,902) (43,417)
- --------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net borrowings (repayments) under revolving credit line (19,400) 20,100 21,500
- --------------------------------------------------------------------------------------------------------------
Proceeds from term debt -- -- 15,000
- --------------------------------------------------------------------------------------------------------------
Net repayments on term debt and other (3,608) (4,741) (17,903)
- --------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES (23,008) 15,359 18,597
- --------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4 12 (955)
- --------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 779 767 1,722
- --------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 783 $ 779 $ 767
==============================================================================================================
</TABLE>
See accompanying notes.
(1) Includes $1,500,000 related to the Company's adoption of FAS 121.
10
<PAGE> 9
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 1998, 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
seventy percent of the Company-owned stores were located in the states of
California, Georgia, Michigan, New Jersey, 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 1998 and 1997
were as follows:
<TABLE>
<CAPTION>
Fiscal year 1998 Fiscal year 1997
- -----------------------------------------------------------------------
<S> <C> <C>
First quarter May 31, 1997 June 1, 1996
- -----------------------------------------------------------------------
Second quarter August 30, 1997 August 31, 1996
- -----------------------------------------------------------------------
Third quarter November 29, 1997 November 30, 1996
- -----------------------------------------------------------------------
Year end February 28, 1998 March 1, 1997
- -----------------------------------------------------------------------
</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
$1,155,000 and $1,921,000 as of February 28, 1998 and March 1, 1997,
respectively. The decrease from Fiscal 1997 to Fiscal 1998 relates to the
write-off of approximately $700,000 of a specifically reserved franchise
receivable.
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 $21,751,000 and $21,042,000 higher
than reported at February 28, 1998 and March 1, 1997, 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, $548,000, and $597,000 of goodwill during Fiscal 1998, 1997
and 1996, respectively. Accumulated amortization was $4,321,000 at February 28,
1998 and $3,773,000 at March 1, 1997. The Company reviews its goodwill for
impairment annually, based upon expectations of nondiscounted cash flows and
operating income. As of February 28, 1998, management believes that none of its
goodwill is materially impaired.
Debt Issuance Costs
Debt issuance costs incurred in connection with the convertible subordinated
debt are amortized using a straight-line method over the term of the debt.
Amortization expense related to the issuance costs is reported as interest
expense and approximated $55,000 in 1998, $55,000 in 1997, and $57,000 in 1996.
The amount of accumulated amortization, at February 28, 1998 and March 1, 1997,
was $464,000 and $409,000, respectively.
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: 1998 - 2.6%; 1997 - 2.1%; and 1996 - 2.3%.
Earnings Per Share
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings per Share." Statement 128 replaced the calculation of primary and
fully diluted earnings per share with
11
<PAGE> 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
basic and diluted earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented, and where appropriate, restated to
conform to the Statement 128 requirements.
Franchise Arrangements
Arrangements with franchisees 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. Franchise fees were $4,794,000, $4,840,000 and $4,669,000 in
Fiscal 1998, 1997 and 1996, respectively.
Vendor Contract Income Recognition
From time to time the Company enters into contracts with various suppliers for
the purchase of merchandise for sale. These contracts may provide for
contractual payments from vendors in exchange for product conversion, product
placement, coverage of operational costs, purchase commitments, or similar
inducements. The Company records vendor contract payments as a reduction to cost
of sales over the life of the contract in the case of payments made with
recourse, or upon receipt in the case of non-recourse payments.
Store Closure Expense
The store closing reserve has been established based on management's expectation
of the costs which will be incurred over the remaining lease terms of the closed
locations, net of expected sublease income. In Fiscal 1996, a 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. In Fiscal 1998,
additional store closing charges were offset by the receipt of $1,600,000
related to a favorable lease buyout.
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 a transitional amortization charge
of $1,500,000 to recognize the impairment. The Fiscal 1997 transitional
impairment charge was recorded as a part of special charges. A charge of
$300,000 related to SFAS No. 121 was recorded as occupancy expense in the
consolidated statement of operations in Fiscal 1998.
Reclassifications
Certain amounts in prior years' financial statements have been reclassified to
conform to the Fiscal 1998 presentation.
NOTE 2 - REVOLVING CREDIT LINE
As of February 28, 1998, the Company's credit facility consisted of the term
loan of $9,000,000 (see Note 3) and a revolving credit loan availability of up
to $55,000,000 of which $22,200,000 was utilized at February 28, 1998. 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 3 - LONG-TERM DEBT
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
(in thousands) February 28, 1998 March 1, 1997
======================================================================
<S> <C> <C>
Convertible subordinated debentures $49,421 $49,421
- ----------------------------------------------------------------------
Term debt 9,000 12,000
- ----------------------------------------------------------------------
Other 1,120 1,860
- ----------------------------------------------------------------------
59,541 63,281
- ----------------------------------------------------------------------
Less current maturities (3,375) (3,950)
- ----------------------------------------------------------------------
$56,166 $59,331
- ----------------------------------------------------------------------
</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 share), subject to
certain adjustments under the terms of these debentures. These debentures are
redeemable at the option of the Company at 101.4% 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 1998, the convertible
debentures traded in a range of 78.5% to 91.75% of par, with a year-end price of
89% of par.
The term debt is part of the Agreement discussed in Note 2 and is payable
in quarterly installments, with annual amounts of
12
<PAGE> 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
$3,000,000 due in Fiscal 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 1999 through 2003 are $375,000, $238,000,
$258,000, $234,000 and $9,000, respectively.
NOTE 4 - OPERATING LEASES
The Company leases retail stores and certain equipment under non-cancelable
operating leases which expire at various dates. Certain of the store leases
require contingent rentals based upon sales in excess of specified amounts and
generally require the Company to pay utilities, common area maintenance,
insurance and taxes, and certain leases are renewable with escalation clauses.
Rent expense (excluding rent expense for closed stores from the date closed) was
$33,732,000, $32,854,000, and $28,354,000 during Fiscal 1998, 1997 and 1996,
respectively.
At February 28, 1998, future minimum operating lease payments during the
next five years and thereafter are: 1999 - $29,315,000; 2000 - $26,538,000; 2001
- - $22,820,000; 2002 - $18,418,000; 2003 - $15,123,000; and $38,334,000
thereafter. At February 28, 1998, the future minimum lease payments for closed
stores total approximately $8,275,000 for which the Company estimates it will
receive approximately $6,970,000 of sublease income (for which there are
subleases in force aggregating $4,516,000 at February 28, 1998). This estimate
is contingent on the ability of the Company to sublease remaining closed-store
leases within approximately one year.
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
(in thousands) February 28, 1998 March 1, 1997
==================================================================
<S> <C> <C>
Land and building $ 3,331 $ 3,475
- ------------------------------------------------------------------
Furniture and fixtures 40,188 38,941
- ------------------------------------------------------------------
Acquired leases and leasehold
improvements 26,449 26,502
- ------------------------------------------------------------------
69,968 68,918
- ------------------------------------------------------------------
Less allowances for depreciation
and amortization (43,191) (38,506)
- ------------------------------------------------------------------
$26,777 $30,412
==================================================================
</TABLE>
NOTE 6 - INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
The tax amounts recorded in the consolidated balance sheets consisted of
the following:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
TAX AFFECTED AMOUNTS
- --------------------------------------------------------------------
(in thousands) February 28, 1998 March 1, 1997
====================================================================
<S> <C> <C>
DEFERRED TAX ASSETS (LIABILITIES):
Loss and AMT credit carryforwards $ 5,772 $ 4,911
- --------------------------------------------------------------------
Store closing reserve 554 1,114
- --------------------------------------------------------------------
Allowance for receivables 439 730
- --------------------------------------------------------------------
Property and equipment 1,133 1,053
- --------------------------------------------------------------------
Other, net 1,748 2,062
- --------------------------------------------------------------------
9,646 9,870
- --------------------------------------------------------------------
Inventory valuation (4,739) (3,923)
- --------------------------------------------------------------------
Deferred income (3,974) (4,121)
- --------------------------------------------------------------------
Other (663) (946)
- --------------------------------------------------------------------
(9,376) (8,990)
- --------------------------------------------------------------------
Net deferred tax asset 270 880
- --------------------------------------------------------------------
Current tax balance 181 2,160
- --------------------------------------------------------------------
$ 451 $ 3,040
====================================================================
</TABLE>
There were no significant deferred tax valuation allowances as of February
28, 1998 and March 1, 1997. Significant components of the provision for income
taxes are as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------
(in thousands) 1998 1997 1996
=============================================================
<S> <C> <C> <C>
CURRENT:
Federal $ 579 $ 339 $ 298
- -------------------------------------------------------------
State and local 264 242 264
- -------------------------------------------------------------
Total current 843 581 562
- -------------------------------------------------------------
Deferred 610 500 1,000
- -------------------------------------------------------------
$1,453 $1,081 $1,562
=============================================================
</TABLE>
The reconciliation of income tax computed at the U.S. federal
statutory tax rates to income tax expense is:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------
(in thousands) 1998 1997 1996
=======================================================================
<S> <C> <C> <C>
Tax at statutory rate $ 1,069 $ 759 $ 1,327
- -----------------------------------------------------------------------
State income tax, net 174 160 174
- -----------------------------------------------------------------------
Goodwill 186 186 203
- -----------------------------------------------------------------------
Other, net 24 (24) (142)
- -----------------------------------------------------------------------
$ 1,453 $ 1,081 $ 1,562
=======================================================================
</TABLE>
The Company received refunds, net of income taxes paid, of $1,889,000 during
Fiscal 1996 and $550,000 during Fiscal 1998, and made an income tax payment of
$1,050,000 in Fiscal 1997.
At February 28, 1998, the Company has net operating loss carryforwards of
$9,316,882 for income tax purposes that expire in years 2010, 2012 and 2013, and
$2,604,431 of alternative minimum tax credit carryforward which has no
expiration date.
13
<PAGE> 12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7 - SHAREHOLDERS' EQUITY
The Company has authorized 2,000,000 shares of $1.00 par value preferred stock.
The terms of the preferred stock are subject to determination by the Company's
Board of Directors. The Company has a shareholder rights plan which provides for
the distribution of a right to purchase one-hundredth of a share of preferred
stock to each holder of common stock. The rights become exercisable upon the
occurrence of certain triggering events, as defined in the plan. The Company has
reserved 33,900 shares of Series A Preferred Stock in connection with the rights
to be distributed under the plan with respect to the reserved shares of common
stock. The plan expires on July 1, 1998, unless extended by the Company.
NOTE 8 - STOCK OPTION PLANS
The Company has adopted stock option plans for key employees. Under such plans,
the Board of Directors may grant options for shares of common stock at a price
not less than 100% 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 would have been impacted by $55,000 and $59,000 in
Fiscal 1998 and 1997, respectively. The financial effects of applying SFAS No.
123 for providing proforma disclosures are not likely to be representative of
the effects on reported net income and earnings per share for future years.
The estimated fair value of the options is amortized into expense over the
options' vesting periods. The fair value for these options was estimated at the
date of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions for Fiscal 1998, 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 0.44; and a weighted-average expected life of
each option of four or five years.
A summary of the Company's stock option activity during 1998, 1997, and
1996 and related information follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
SHARES UNDER OPTION
- ---------------------------------------------------------------------------------------------
(in thousands, except per share amounts) 1998 1997 1996
=============================================================================================
<S> <C> <C> <C>
Outstanding, beginning of year 916 881 931
- ---------------------------------------------------------------------------------------------
Granted (at $4.16 to $4.97 per share) -- 118 5
- ---------------------------------------------------------------------------------------------
Cancelled (93) (83) (42)
- ---------------------------------------------------------------------------------------------
Exercised (at $4.00 to $5.00 per share) (27) -- (13)
- ---------------------------------------------------------------------------------------------
Outstanding, end of year
(at prices ranging from $4.13 to $8.81 per share) 796 916 881
- ---------------------------------------------------------------------------------------------
Exercisable, end of year
(at prices ranging from $4.13 to $8.81 per share) 655 761 302
=============================================================================================
</TABLE>
The weighted average per share price for options outstanding was $5.02 and $4.98
at the end of Fiscal 1998 and 1997, respectively.
At the end of fiscal years 1998, 1997 and 1996, there were 187,000, 143,000
and 217,000 shares, respectively, reserved for future grants.
NOTE 9 - 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 10 - DEFINED CONTRIBUTION PLAN
The Company provides a defined contribution 401(k) plan to substantially all
employees. Participants may make voluntary contributions to the plan of up to
15% of their compensation. Approximately $154,000, $65,000, and $50,000 was
charged to expense for this plan in fiscal years 1998, 1997 and 1996,
respectively.
NOTE 11 - SETTLEMENT OF LITIGATION
Subsequent to the end of Fiscal 1998, the Company reached a confidential
settlement agreement with one of its franchisees to resolve a longstanding
lawsuit. The impact of the settlement and associated legal costs is reflected in
the Fiscal 1998 results, net of a third-party recovery. The Company recorded a
recovery of related prior period legal costs as a special credit in Fiscal 1998.
14
<PAGE> 13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
(in thousands, except per share amounts) 1998 1997 1996
==========================================================================================
<S> <C> <C> <C>
NUMERATOR:
Net income and numerator for basic
earnings per share - income available
to common stockholders $ 1,691 $ 1,152 $ 2,342
- ------------------------------------------------------------------------------------------
Effect of dilutive securities:
7.75% convertible debentures (1) -- -- --
- ------------------------------------------------------------------------------------------
Numerator for diluted earnings
per share - income available to common
stockholders after assumed conversions $ 1,691 $ 1,152 $ 2,342
- ------------------------------------------------------------------------------------------
DENOMINATOR:
Denominator for basic earnings
per share - weighted-average shares 13,180 13,169 13,182
- ------------------------------------------------------------------------------------------
Effect of dilutive securities:
Employee stock options (2) 17 13 8
- ------------------------------------------------------------------------------------------
7.75% convertible debentures (1) -- -- --
- ------------------------------------------------------------------------------------------
Dilutive potential common shares -- -- --
- ------------------------------------------------------------------------------------------
Denominator for diluted earnings
per share - adjusted weighted-average
shares and assumed conversions 13,197 13,182 13,190
- ------------------------------------------------------------------------------------------
Basic earnings per share $ 0.13 $ 0.09 $ 0.18
- ------------------------------------------------------------------------------------------
Diluted earnings per share $ 0.13 $ 0.09 $ 0.18
==========================================================================================
</TABLE>
(1) The effect of the 7.75% convertible debentures is antidilutive and thus
excluded in the calculation of diluted earnings per share.
(2) Additional options to purchase shares of common stock were outstanding
during each period but were not included in the computation of diluted earnings
per share because the exercise price of the options was greater than the average
market price of the common shares and, therefore, the effect would be
antidilutive.
NOTE 13 - SUBSEQUENT EVENT
The Company has entered into an agreement with Western Drug Distributors, Inc.,
its franchise store operator in the Seattle and Portland area, to terminate
Western's franchise agreement. The termination agreement is contingent upon the
successful completion of due diligence and subsequent purchase of Western by
Longs Drug Stores of Walnut Creek, California. The Company's agreement with
Western provides for a one-time lump sum payment to Drug Emporium, Inc. based on
the discounted present value of the future cash flows of franchise fees
anticipated over the life of the franchise agreement. This transaction, if
completed, is expected to result in significant reductions to franchise fee
revenue and interest costs on an ongoing basis as well as a large one-time
income impact at the date of the closing, which is estimated to be early in the
Company's second quarter of Fiscal 1999.
NOTE 14 - QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
- ------------------------------------------------------------------------------------------------------------------------------
Stock Prices
Net Gross Net Earnings Per Common ------------ Dividends Paid
Sales Profit Income Share (Basic and Diluted) High Low Per Common Share
==============================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C>
1998:
First quarter $209,214 $ 44,622 $ 528 $ .04 $ 5.50 $ 4.13 --
- ------------------------------------------------------------------------------------------------------------------------------
Second quarter 204,235 43,549 274 .02 5.31 4.00 --
- ------------------------------------------------------------------------------------------------------------------------------
Third quarter 199,571 42,344 283 .02 4.75 3.75 --
- ------------------------------------------------------------------------------------------------------------------------------
Fourth quarter 223,385 47,774 606 .05 5.38 3.88 --
- ------------------------------------------------------------------------------------------------------------------------------
$836,405 $178,289 $ 1,691 $ .13 --
==============================================================================================================================
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 --
==============================================================================================================================
</TABLE>
15
<PAGE> 14
REPORT OF INDEPENDENT AUDITORS
BOARD OF DIRECTORS
DRUG EMPORIUM, INC.
We have audited the accompanying consolidated balance sheets of Drug Emporium,
Inc. and subsidiaries as of February 28, 1998 and March 1, 1997, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended February 28, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Drug Emporium, Inc. and subsidiaries at February 28, 1998 and March 1, 1997, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended February 28, 1998, in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
Columbus, Ohio
April 15, 1998
16
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Forms S-8, Numbers 33-25768 and 33-69638) of Drug Emporium, Inc. and
subsidiaries of our report dated April 15, 1998, with respect to the
consolidated financial statements of Drug Emporium, Inc. and subsidiaries,
incorporated by reference in this Annual Report (Form 10-K) for the year ended
February 28, 1998.
ERNST & YOUNG LLP
Columbus, Ohio
May 19, 1998
11
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> FEB-28-1998
<PERIOD-START> MAR-02-1997
<PERIOD-END> FEB-28-1998
<CASH> 783
<SECURITIES> 0
<RECEIVABLES> 17,410
<ALLOWANCES> 0
<INVENTORY> 167,292
<CURRENT-ASSETS> 187,177
<PP&E> 69,968
<DEPRECIATION> 43,191
<TOTAL-ASSETS> 219,784
<CURRENT-LIABILITIES> 108,064
<BONDS> 56,166
0
0
<COMMON> 1,318
<OTHER-SE> 50,072
<TOTAL-LIABILITY-AND-EQUITY> 219,784
<SALES> 836,405
<TOTAL-REVENUES> 836,405
<CGS> 658,116
<TOTAL-COSTS> 169,584
<OTHER-EXPENSES> (2,092)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,653
<INCOME-PRETAX> 3,144
<INCOME-TAX> 1,453
<INCOME-CONTINUING> 1,691
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,691
<EPS-PRIMARY> .13
<EPS-DILUTED> .13
</TABLE>
