<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 29, 1999 OR
------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
___________________ TO ___________________
Commission File Number 0-16998
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DRUG EMPORIUM, INC.
- --------------------------------------------------------------------------------
(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 (740) 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 May 29, 1999
- ----------------------------- -------------
Common Stock, $ .10 par value 13,192,285 shares
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INDEX
DRUG EMPORIUM, INC.
PART I. FINANCIAL INFORMATION Page No.
- ------------------------------ --------
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 ..... 8-11
PART II. OTHER INFORMATION
- --------------------------
Item 5. Other Information ................................ 12
Item 6. Exhibits and Reports .............................. 12
SIGNATURES .......................................................... 13
2
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DRUG EMPORIUM, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands Except Share Data)
<TABLE>
<CAPTION>
May 29, 1999 February 27, 1999
------------ -----------------
(Unaudited) (Audited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................. $ 701 $ 893
Accounts receivable ................................... 21,848 18,323
Inventories, net of LIFO reserve of $23.5 ............. 168,135 164,789
million and $22.8 million at May 29, 1999
and February 27, 1999, respectively ...............
Other ................................................. 4,019 2,319
-------- --------
Total current assets .......................... 194,703 186,324
Property and equipment, net ............................. 30,121 30,708
Goodwill ................................................ 9,991 10,237
Other assets ............................................ 3,745 3,420
-------- --------
Total assets ................................. $238,560 $230,689
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Revolving credit line .............................. $ 47,532 $ 15,106
Accounts payable ................................... 58,563 80,393
Accrued liabilities ................................ 19,120 22,047
Deferred income .................................... 4,024 3,904
Current maturities of long-term debt ............... 242 242
-------- --------
Total current liabilities ................... 129,481 121,692
Deferred rent .......................................... 3,708 3,850
Convertible subordinated debt ........................... 49,421 49,421
Long-term debt, other ................................... 464 504
-------- --------
Total long-term debt ....................... 49,885 49,925
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 13,192,285 at May 29, 1999
and 13,179,785 at February 27, 1999 ............... 1,319 1,319
Additional paid-in capital ............................ 32,195 32,155
Retained earnings ..................................... 21,972 21,748
-------- --------
Total shareholders' equity ................... 55,486 55,222
-------- --------
Total liabilities and shareholders' equity ... $238,560 $230,689
======== ========
</TABLE>
See accompanying notes.
3
<PAGE> 4
DRUG EMPORIUM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) (In thousands, except per-share data)
<TABLE>
<CAPTION>
Three Months Ended
------------------
May 29, 1999 May 30, 1998
------------ ------------
<S> <C> <C>
Net sales ......................................... $226,212 $209,172
Cost of sales ..................................... 177,421 165,543
-------- --------
Gross Margin .................................. 48,791 43,629
Selling, administrative and occupancy expenses .... 46,694 40,762
Interest expense, net ............................. 1,724 1,566
-------- --------
Income before provision for income taxes .......... 373 1,301
Provision for income taxes ....................... 149 573
-------- --------
Net income ........................................ $ 224 $ 728
======== ========
Earnings per common share:
Basic ........................................... $ .02 $ .06
======== ========
Diluted ......................................... $ .02 $ .06
======== ========
Weighted average number of
Common shares outstanding:
Basic ........................................... 13,189 13,180
======== ========
Diluted ......................................... 13,387 13,189
======== ========
Supplementary information:
LIFO provision included in cost of sales ....... $ 720 $ 650
======== ========
</TABLE>
See accompanying notes.
4
<PAGE> 5
DRUG EMPORIUM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (In thousands)
<TABLE>
<CAPTION>
Three Months Ended
------------------
May 29, 1999 May 30, 1998
------------ ------------
<S> <C> <C>
Operating activities:
Net income ............................................... $ 224 $ 728
Adjustments to reconcile to cash provided by (used in)
Operations:
Depreciation and amortization ........................ 2,373 1,838
LIFO provision ....................................... 720 650
Cash provided by (used for) current assets and liabilities:
Accounts payable and accrued liabilities ............. (24,752) 3,693
Accounts receivable .................................. (3,525) 5,047
Inventories at current cost .......................... (4,066) (7,978)
Other ................................................ (2,291) (782)
-------- --------
Net cash provided by (used in) operating activities ....... (31,317) 3,196
Investing activities:
Purchase of property and equipment, net ................... (1,301) (934)
-------- --------
Net cash used in investing activities ..................... (1,301) (934)
Financing activities:
Net borrowings (repayments) under revolving
Credit line .......................................... 32,426 (1,400)
Net repayments on term debt and other .................... 0 (852)
-------- --------
Net cash provided by (used in) financing activities ...... 32,426 (2,252)
-------- --------
Increase (decrease) in cash and cash
Equivalents .............................................. (192) 10
Cash and cash equivalents, beginning of period .............. 893 783
-------- --------
Cash and cash equivalents, end of period .................... $ 701 $ 793
======== ========
</TABLE>
See accompanying notes.
5
<PAGE> 6
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.
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.
<TABLE>
<CAPTION>
(Unaudited) (In thousands, except per share data)
Three Months Ended
------------------
May 29, 1999 May 30, 1998
------------ --- --------
<S> <C> <C>
Numerator:
Net income and numerator for basic earnings per
Share - income available to common
Stockholders .................................. $ 224 $ 728
Effect of dilutive securities:
7.75% convertible
debentures ................................ -- --
Numerator for diluted earnings
Per share - income available to
Common stockholders after
Assumed conversions ........................... $ 224 $ 728
Denominator:
Denominator for basic earnings per share -
Weighted-average shares ....................... 13,189 13,180
Effect of dilutive securities:
Employee stock options(1) ................. 198 9
7.75% convertible debentures(2) ........... -- --
Denominator for diluted earnings per share -
Adjusted weighted-average shares and assumed
Conversions .................................. 13,387 13,189
Basic earnings per share ......................... $ .02 $ .06
Diluted earnings per share ....................... $ .02 $ .06
</TABLE>
(1) 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.
(2) The effect of the 7.75% convertible debentures is antidilutive and thus
excluded in the calculation of diluted earnings per share.
6
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DRUG EMPORIUM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)
4. In March 1997, the Company established an electronic commerce site
on the internet with the URL DrugEmporium.com. This site served as the
foundation for the Company's current efforts to develop a new superior online
drug store, which will also be known as DrugEmporium.com. The new site, which is
in development, is expected to be fully operational during the second quarter of
Fiscal 2000. The Company has invested substantial resources to revamp the
business processes around the site and those efforts are ongoing in nature. In
addition, during the first quarter of Fiscal 2000, the Company made material
financial commitments related to its online drug store which will begin to take
effect during the Company's second fiscal quarter. Future commitments relating
to advertising, site hosting and maintenance, and development costs total
approximately $9.0 million, with terms ranging from 12 to 24 months commencing
during the second quarter.
5. The accompanying unaudited consolidated financial statements are
presented in accordance with the requirements for Form 10Q 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 27, 1999 (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
- ---------------------
The following table sets forth selected items derived 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 29, 1999 May 30, 1998
-------------------------------
<S> <C> <C>
Net sales (in thousands) ..... $ 226,212 $ 209,172
=========== ===========
Gross margin .................. 21.57% 20.86%
Selling, administrative and
Occupancy expenses ........ 20.64% 19.49%
----------- -----------
Operating income .............. .93% 1.37%
</TABLE>
First quarter sales increased 8.1% to $226.2 million in the current
year from $209.2 million in the prior year period. The increase is the result of
the addition of the twelve Vix Stores purchased in February 1999 and a .3%
increase in same store sales, partially offset by the closure of six
under-performing stores.
During the quarter, the Company's gross margin improved .7% over the
prior year period as a result of higher non-pharmacy margins and stable pharmacy
margins. The increase in non-pharmacy margins is related to higher selling gross
margins and higher vendor rebate income. Gross margins for the remainder of
fiscal 2000 are expected to continue to show improvement over the prior year
periods. These improvements are not likely to be as large as the first quarter,
however, as the Company intensifies its advertising program.
Higher payroll and depreciation costs combined with lower franchise fee
income caused net income to decline in the quarter relative to the prior year.
Payroll costs in the quarter were higher than the prior year period due to
increased costs relating to e-commerce, the integration of the Vix stores and
employee benefits. Other than e-commerce costs, the increased payroll costs were
primarily related to one-time events and should not impact future quarters.
Depreciation and amortization was higher due to the addition of goodwill
amortization related to the Vix purchase and the impact of the Company's store
remodeling and technology development initiatives. Franchise fees were lower by
.4% of sales as a result of a reduction in the number of franchise stores, due
to the sale of the Seattle franchise in the second quarter of Fiscal 1999 and
the closure of three franchise stores in the Kansas City area. The Company has
several technology-related initiatives underway to cut operating costs,
including the implementation of a Wide Area Network to lower communications and
mail costs and a program to cut bad check losses.
8
<PAGE> 9
The following table lists corporately-owned stores openings and store
closing through the first quarter ended May 29, 1999 and the similar prior year
period.
<TABLE>
<CAPTION>
Three Months Ended
May 29, 1999 May 30, 1998
------------ ------------
<S> <C> <C>
Number of stores at
Beginning of period ....... 141 135
Stores opened or acquired ..... 1 0
Stores closed or sold ......... (2) (1)
---- ----
Total stores at end of period . 140 134
==== ====
</TABLE>
Store Growth and Remodels
- -------------------------
The Company has plans to open approximately five new stores in the next
twelve months and continue its store growth after that time at a similar pace.
Leases have been signed for one of the projected five locations. In addition,
the Company has also been aggressively updating and remodeling its existing
store base. This renovation program is expected to result in a majority of its
stores having undergone some type of remodeling by the end of the current fiscal
year. To date, approximately one-third of the Company's stores have experienced
a major or minor remodeling since this program started.
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. In computing its LIFO charge throughout
the fiscal year, the Company uses an estimated inflation rate, which was one and
one-half percent in both Fiscal 1999 and Fiscal 2000. This estimated LIFO charge
is adjusted at each year end based upon the actual weighted average inflation
rate 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 29, 1999, the
Company's credit facility consisted of outstanding borrowings of $47.5 million,
leaving $52.5 million available and unused as of that date. Significant items
impacting availability from year end level of $84.9 million include a $24
million routine vendor payment made shortly after year end and the ending of a
pharmacy receivables prefunding relationship with McKesson.
The Company's EBITDA remained stable during the first quarter of Fiscal
2000 at $5.2 million versus $5.3 million in the prior year. The Company believes
that internally generated funds and borrowings available under its Agreement are
sufficient to finance its current operations.
DrugEmporium.Com
- ----------------
In March 1997, the Company established an electronic commerce site on
the internet with the URL DrugEmporium.com. This site served as the foundation
for the Company's current efforts to develop a superior online drug store, which
will also be known as DrugEmporium.com. The new site, which is in development,
will emphasize customer service, selection, price and convenience, and is
expected to be fully operational during the second quarter of Fiscal 2000. The
Company has established a separate subsidiary for its e-commerce drug store. In
addition, the Company is in the process of establishing a separate capital
structure for this online subsidiary in order to meet the significant capital
requirements necessary to effectively compete in the online market.
9
<PAGE> 10
The Company has invested substantial resources to revamp the business
processes around the site and those efforts are ongoing in nature. In addition,
the Company has made material financial commitments related to its online drug
store which will begin to take effect during the Company's second fiscal
quarter. Although the Company expects to be able to fund the added costs through
third party equity investments in its on-line subsidiary, there is no guarantee
that this financing will be available. In the event financing is not available,
the Company will be required to fund its e-commerce site development and other
related costs from its existing business.
E-commerce start-up costs may negatively impact the overall operating
results of the Company over at least the next several quarters. To date, the
Company has contributed approximately $1.2 million in cash for site development
costs, of which $1.1 million was capitalized and $.1 million was expensed, in
the first quarter of Fiscal 2000. In addition, the Company has made future
commitments relating to advertising, site hosting and maintenance, and
development costs totaling approximately $9.0 million, with terms ranging from
12 to 24 months, commencing during the second quarter.
Year 2000
- ---------
The Company has completed its assessment of the Information
Technology-related (IT-related) systems for the Year 2000 issue. For IT-related
systems, the Company's accounting software and AS400 applications are Year 2000
compliant. The Company is finalizing implementation of Year 2000 solutions in
its host merchandising systems, store register systems, vendor EDI documents and
other applications. These applications are expected to be compliant by the end
of June 1999. The Company has completed the majority of its assessment of
non-IT-related systems for Year 2000 compliance. A limited number of
non-IT-related systems are not Year 2000 compliant, and are expected to be
upgraded by the end of June 1999.
The Company has surveyed and is working with its outside suppliers and
software vendors related to Year 2000 compliance. The external software
companies that the Company utilizes for pharmacy, merchandising, store register
and accounting systems have provided the company with a Year 2000 compliant
version of their respective products. The Company estimates that its Year 2000
effort is approximately 85 percent complete as of the end of May 1999 and will
be substantially completed as of the end of June 1999. The Company's total
estimate of Year 2000 compliance costs is projected to be $1,400,000, with
$1,250,000 estimated to be incurred related to the purchase of hardware and
software to be capitalized and $150,000 related to costs which will be expensed
as incurred. The Company incurred the majority of its Year 2000 costs during
Fiscal 1999. Most of the costs were related to the hardware required to run the
Year 2000 compliant version of the in-store pharmacy system which was required
to be implemented approximately one year earlier than would otherwise have been
necessary.
The Company is currently developing a contingency plan in the event of
any systems not being Year 2000 compliant. If the Company does not become Year
2000 compliant in a timely manner, the Year 2000 issue could have a material
impact on the operations of the Company by impairing its ability to process
customer transactions, order and pay for merchandise for sale, and perform
certain other functions. In addition, although the Company has initiated formal
communications with all of its significant suppliers to determine the extent to
which the Company is vulnerable to those third parties' failure to remediate
their own Year 2000 issues and the Company has received assurances regarding
these issues from some (but not all) of its vendors, there is no guarantee that
these third party systems will be compliant. Any such non-compliance could have
a material adverse effect on the Company. For example, if some of the Company's
merchandise vendors are not Year 2000 compliant it could impact the ability of
the Company to procure merchandise from those vendors.
The costs of the project and the date on which the Company believes it
will complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources and other factors.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ materially from those anticipated. Specific factors
that might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes, and similar uncertainties.
10
<PAGE> 11
Forward-Looking Statements
- --------------------------
Statements in this Management's Discussion and Analysis of Financial
Condition and Results of Operations, except for historical information contained
herein, 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, possible further downward
pressure on pharmacy margins from managed care networks, the Company's ability
to economically eliminate under-performing stores, the Company's ability to
identify and address all Year 2000 issues, the competitive environment of the
on-line drugstore industry, the ability of the company to secure and maintain
key contracts, relationships and financing related to its on-line store,
technical issues related to the development of the web site and general economic
conditions.
11
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PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8K
None
12
<PAGE> 13
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 22, 1999 By /s/ David L. Kriegel
------------------ -------------------------
David L. Kriegel
Chairman
Chief Executive Officer
Date: June 22, 1999 By /s/ Michael P. Leach
------------------ -------------------------
Michael P. Leach
Chief Financial Officer
13
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> FEB-26-2000
<PERIOD-START> FEB-28-1999
<PERIOD-END> MAY-29-1999
<EXCHANGE-RATE> 1
<CASH> 701
<SECURITIES> 0
<RECEIVABLES> 21,848
<ALLOWANCES> 0
<INVENTORY> 168,135
<CURRENT-ASSETS> 194,703
<PP&E> 79,169
<DEPRECIATION> 49,048
<TOTAL-ASSETS> 238,560
<CURRENT-LIABILITIES> 129,481
<BONDS> 49,885
0
0
<COMMON> 1,319
<OTHER-SE> 54,167
<TOTAL-LIABILITY-AND-EQUITY> 238,560
<SALES> 226,212
<TOTAL-REVENUES> 226,212
<CGS> 177,421
<TOTAL-COSTS> 46,694
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,724
<INCOME-PRETAX> 373
<INCOME-TAX> 149
<INCOME-CONTINUING> 224
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 224
<EPS-BASIC> .02
<EPS-DILUTED> .02
</TABLE>
