<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
MAY 30, 1998 OR
----------------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
TO
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Commission File Number 0-16998
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DRUG EMPORIUM, INC.
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(Exact name of registrant as specified in its charter)
Delaware 31-1064888
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
155 Hidden Ravines Drive, Powell, Ohio 43065
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (614) 548-7080
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Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the close of the period covered by this report.
Class Outstanding at 5/30/98
- ---------------------------- --------------
Common stock, $.10 par value 13,179,785 shares
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INDEX
DRUG EMPORIUM, INC.
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
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<S> <C>
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets........................................................................3
Consolidated Statements of Operations..............................................................4
Consolidated Statements of Cash Flows .............................................................5
Notes to Consolidated Financial Statements.......................................................6-7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...............................................8-10
PART II. OTHER INFORMATION
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Item 6. Exhibits and Reports on Form 8-K..............................................................10
SIGNATURES.................................................................................................11
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</TABLE>
2
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DRUG EMPORIUM, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
May 30, 1998 February 28, 1998
------------ -----------------
(Unaudited) (Audited)
(In thousands)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................... $ 793 $ 783
Accounts receivable................................................. 12,363 17,410
Inventories, net of LIFO reserve of $22.4
million and $21.8 million at May 30, 1998
and February 28, 1998, respectively............................... 174,620 167,292
Income taxes and other.............................................. 2,053 1,692
-------- --------
Total current assets.......................................... 189,829 187,177
Property and equipment, net............................................ 26,118 26,777
Goodwill............................................................... 4,077 4,215
Other assets........................................................... 1,926 1,615
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Total assets.................................................. $221,950 $219,784
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Revolving credit line............................................... $ 20,800 $ 22,200
Accounts payable.................................................... 69,055 64,025
Accrued liabilities................................................. 14,500 14,785
Deferred income..................................................... 2,627 3,679
Current maturities of long-term debt................................ 3,319 3,375
-------- --------
Total current liabilities..................................... 110,301 108,064
Deferred rent.......................................................... 4,161 4,164
Convertible subordinated debt.......................................... 49,421 49,421
Long-term debt, other.................................................. 5,949 6,745
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Total long-term debt.......................................... 55,370 56,166
Shareholders' equity:
Preferred stock, authorized 2,000,000
shares, none issued............................................... -- --
Common stock, stated value $.10 per share,
authorized 28,000,000, issued and
outstanding 13,179,785 at May 30, 1998
and 13,179,785 at February 28, 1998............................... 1,318 1,318
Additional paid-in capital.......................................... 32,123 32,123
Retained earnings................................................... 18,677 17,949
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Total shareholders' equity.................................... 52,118 51,390
-------- --------
Total liabilities and shareholders' equity.................... $221,950 $219,784
======== ========
</TABLE>
See accompanying notes.
3
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DRUG EMPORIUM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended
May 30, 1998 May 31, 1997
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(Unaudited)
(In thousands, except
per-share data)
<S> <C> <C>
Net sales.............................................................. $209,172 $209,214
Cost of sales.......................................................... 165,543 164,592
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Gross margin..................................................... 43,629 44,622
Selling, administrative and occupancy expenses......................... 40,762 41,564
-------- --------
Operating income ...................................................... 2,867 3,058
Interest expense, net.................................................. 1,566 2,179
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Income before provision for income taxes............................... 1,301 879
Provision for income taxes............................................. 573 351
-------- --------
Net income ............................................................ $ 728 $ 528
======== ========
Earnings per common share:
Basic............................................................... $.06 $.04
==== ====
Diluted............................................................. $.05 $.04
==== ====
Weighted average number of common shares outstanding:
Basic............................................................... 13,180 13,179
====== ======
Diluted............................................................. 13,334 13,207
====== ======
Supplementary information:
LIFO provision included in cost of sales.............................. $650 $871
==== ====
</TABLE>
See accompanying notes.
4
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DRUG EMPORIUM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
May 30, 1998 May 31, 1997
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(Unaudited)
(In thousands)
<S> <C> <C>
Operating activities:
Net income ............................................................ $ 728 $ 528
Adjustments to reconcile to cash provided by
operations:
Depreciation and amortization........................................ 1,838 1,607
LIFO provision....................................................... 650 871
Cash provided by (used in) current assets
and liabilities:
Accounts payable and accrued liabilities 3,693 (7,505)
Accounts receivable.................................................. 5,047 (527)
Inventories at current cost.......................................... (7,978) 1,636
Other................................................................ (782) 1,189
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Net cash provided by (used in) operating
activities........................................................... 3,196 (2,201)
Investing activities:
Purchase of property and equipment, net................................ (934) (562)
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Net cash used in investing activities.................................. (934) (562)
Financing activities:
Net borrowings (repayments) under revolving
credit line.......................................................... (1,400) 4,100
Net repayments on term debt and other.................................. (852) (1,368)
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Net cash used in financing activities.................................. (2,252) 2,732
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Increase (decrease) in cash and cash
equivalents.......................................................... 10 (31)
Cash and cash equivalents, beginning of period........................... 783 779
------- -------
Cash and cash equivalents, end of period................................. $ 793 $ 748
======= =======
</TABLE>
See accompanying notes.
5
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DRUG EMPORIUM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The accompanying unaudited consolidated financial statements include the
accounts of Drug Emporium, Inc. and subsidiaries.
The information furnished reflects all adjustments which are, in the
opinion of management, necessary to fairly present the consolidated
financial position, results of operations and cash flows on a consistent
basis. Certain amounts in prior period financial statements have been
reclassified to conform with the current presentation.
2. The Company's cost of sales is computed using the gross profit method. The
gross profit percentage used is validated by physical inventories
conducted twice a year primarily in the second and fourth quarters and the
actual results of the LIFO calculations in the fourth quarter.
3. The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
Three Months Ended
May 30, 1998 May 31, 1997
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(Unaudited)
(In thousands, except per share data)
<S> <C> <C>
Numerator:
Net income and numerator for basic earnings
per share -- income available to common
stockholders........................................................ $728 $528
Effect of dilutive securities:
7.75% convertible debentures (1).................................. -- --
---- ----
Numerator for diluted earnings per share --
income available to common stockholders
after assumed conversions............................................ $728 $528
==== ====
Denominator:
Denominator for basic earnings per share --
weighted-average shares.............................................. 13,180 13,179
Effect of dilutive securities:
Employee stock options (2)........................................ 154 28
7.75% convertible debentures (1).................................. -- --
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Denominator for diluted earnings per share --
adjusted weighted-average shares and assumed
conversions.......................................................... 13,334 13,207
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Basic earnings per share............................................... $.06 $.04
==== ====
Diluted earnings per share............................................. $.05 $.04
==== ====
</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.
6
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DRUG EMPORIUM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(Unaudited)
4. 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 in the Company's second quarter of
Fiscal 1999.
5. The accompanying unaudited consolidated financial statements are presented
in accordance with the requirements for Form 10-Q and consequently do not
include all the disclosures normally required by generally accepted
accounting principles. Reference should be made to the Company's Form 10-K
for the fiscal year ended February 28, 1998 (File No. 0-16998) for
additional disclosures including a summary of the Company's accounting
policies, which have not significantly changed.
7
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
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The following table sets forth selected items from the Company's consolidated
statements of operations expressed as a percentage of net sales for the periods
indicated.
<TABLE>
<CAPTION>
Three Months Ended
May 30, 1998 May 31, 1997
------------ ------------
(Unaudited)
<S> <C> <C>
Net sales (in thousands)....................... $209,172 $209,214
======== ========
Gross margin................................... 20.86 21.33
Selling, administrative and
occupancy expenses............................. 19.49 19.87
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Operating income 1.37 1.46
===== =====
</TABLE>
Despite having four fewer stores in the current year period, net sales
remained constant at $209.2 million in both the current and prior year periods
on a comparable store sales increase of 1.8% due to a more effective advertising
program and a pharmacy comp sales increase of 5.3%.
The following table lists corporately-owned store openings and store closings
through the first quarter ended May 30, 1998 and the similar prior year period.
<TABLE>
<CAPTION>
Three Months Ended
May 30, 1998 May 31, 1997
------------ ------------
(Unaudited)
<S> <C> <C>
Number of stores at
beginning of period.......................... 135 138
Stores opened or acquired...................... 0 0
Stores closed or sold.......................... (1) 0
--- ---
Total stores at end of
period....................................... 134 138
=== ===
</TABLE>
Gross margin as a percentage of sales decreased during the three-month period
ended May 30, 1998 over the comparable prior year period due primarily to lower
third-party pharmacy gross margins and an anticipated drop in vendor rebate
income, partially offset by higher non-pharmacy margins. The Company has a
strategy in place to improve both pharmacy and non-pharmacy margins while
protecting the low price image of the store. The success of this strategy will
be required in order to achieve the Company's target of restoring margins to
1997 levels.
8
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Selling, administrative and occupancy expenses were lower in total and as a
percentage of sales for the three-month period ended May 30, 1998 over the
comparable prior year period as a result of ongoing initiatives to reduce
controllable operating costs which resulted in lower payroll and other operating
costs. These reductions were partially offset by higher advertising expense of
.3% of sales. Advertising expenses are expected to be higher in the first three
quarters of Fiscal 1999 and lower in the fourth quarter relative to the prior
year comparable quarters, with a projected full year advertising expense lower
as a percentage of sales by .1% relative to Fiscal 1998. Interest expense during
the first quarter of Fiscal 1999 was lower than the prior year first quarter by
$613,000 as a result of Fiscal 1998 debt reductions.
Inventory Valuation
- -------------------
The Company uses the LIFO method of accounting for its inventories. Under this
method, the cost of merchandise sold and reported in the financial statements
approximates current cost.
The Company, in computing its LIFO charge throughout the fiscal year, uses an
estimated percentage rate of inflation. The estimated inflation rate used was
one and one-half percent in Fiscal 1999 and two percent in Fiscal 1998. This
LIFO charge is adjusted at each year end based upon the actual weighted average
percentage rate of inflation during the year.
Liquidity and Capital Resources
- -------------------------------
The Company has a bank credit agreement (the "Agreement") which governs its
borrowings under its bank credit facilities.
As of May 30, 1998, the total credit facility under the Agreement allowed for
borrowings of up to $63,250,000, depending upon available collateral. The credit
facility consists of a $55,000,000 revolver which expires on May 31, 2000, and
term debt of $8,250,000 which is due in quarterly installments of $750,000. The
term debt is payable at the end of each of the Company's fiscal quarters. As of
May 30, 1998, the Company had excess availability under its revolving credit
agreement of $34,200,000.
The Company believes that internally generated funds and borrowings available
under its Agreement are sufficient to finance its current operations.
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 on
Form 10-Q that look forward in time, which includes everything other than
historical information, are forward-looking statements made pursuant to the safe
9
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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.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) The following Exhibit is included herein:
--Exhibit 27. Financial data schedule.
(b) 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
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DRUG EMPORIUM, INC.
---------------------------
(Registrant)
Date June 23, 1998 By /s/ DAVID L. KRIEGEL
-------------------- ------------------------
David L. Kriegel
Chairman
Chief Executive Officer
Date June 23, 1998 By /s/ MICHAEL P. LEACH
-------------------- -------------------------
Michael P. Leach
Chief Financial Officer
11
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> FEB-27-1999
<PERIOD-START> MAR-01-1998
<PERIOD-END> MAY-30-1998
<EXCHANGE-RATE> 1
<CASH> 793
<SECURITIES> 0
<RECEIVABLES> 12,363
<ALLOWANCES> 0
<INVENTORY> 174,620
<CURRENT-ASSETS> 189,829
<PP&E> 69,583
<DEPRECIATION> 43,465
<TOTAL-ASSETS> 221,950
<CURRENT-LIABILITIES> 110,301
<BONDS> 55,370
0
0
<COMMON> 1,318
<OTHER-SE> 50,800
<TOTAL-LIABILITY-AND-EQUITY> 221,950
<SALES> 209,172
<TOTAL-REVENUES> 209,172
<CGS> 165,543
<TOTAL-COSTS> 206,305
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,566
<INCOME-PRETAX> 1,301
<INCOME-TAX> 573
<INCOME-CONTINUING> 728
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 728
<EPS-PRIMARY> .06
<EPS-DILUTED> .05
</TABLE>
