<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 27, 2000 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.
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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 (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 27, 2000
----------------------------- ------------------------------
Common Stock, $ .10 par value 13,193,285 shares
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<PAGE> 2
INDEX
DRUG EMPORIUM, INC.
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
------------------------------ --------
<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 . . . . . . . . 8-11
PART II. OTHER INFORMATION
--------------------------
Item 6. Exhibits and Reports . . . . . . . . . . . . . . . . . . . . 12
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
</TABLE>
2
<PAGE> 3
DRUG EMPORIUM, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
<TABLE>
<CAPTION>
May 27, 2000 February 26, 2000
----------------------- --------------------
(Unaudited) (Audited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . $ 727 $ 708
Accounts receivable . . . . . . . . . . . . . . . . 24,151 25,840
Inventories, net of LIFO reserve of $26.0
million and $25.3 million at May 27, 2000
and February 26, 2000, respectively. . . . . . 169,617 182,148
Other . . . . . . . . . . . . . . . . . . . . . . . 3,282 3,274
----------------------- --------------------
Total current assets . . . . . . . . . . . 197,777 211,970
Property and equipment, net. . . . . . . . . . . . . 41,312 40,079
Goodwill. . . . . . . . . . . . . . . . . . . . . . . 9,005 9,252
Other assets . . . . . . . . . . . . . . . . . . . . 3,996 3,924
----------------------- --------------------
Total assets . . . . . . . . . . . . . . . $252,090 $265,225
======================= ====================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Revolving credit line . . . . . . . . . . . . . $ 76,620 $ 85,968
Accounts payable . . . . . . . . . . . . . . . . 66,027 69,580
Accrued liabilities . . . . . . . . . . . . . . 17,731 21,912
Deferred income . . . . . . . . . . . . . . . . 3,261 3,645
Current maturities of long-term debt . . . . . . 5,031 5,033
----------------------- --------------------
Total current liabilities . . . . . . . . 168,670 186,138
Deferred rent . . . . . . . . . . . . . . . . . . . . 3,600 3,643
Convertible subordinated debt . . . . . . . . . . . . 46,921 46,921
Long-term debt, other . . . . . . . . . . . . . . . . 14,240 1,266
----------------------- --------------------
Total long-term debt . . . . . . . . . 61,161 48,187
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 13,193,285 at May 27, 2000
and at February 26, 2000 . . . . . . . . . . . . 1,320 1,320
Additional paid-in capital . . . . . . . . . . . . 32,199 32,199
Retained earnings (deficit). . . . . . . . . . . . (14,860) (6,262)
----------------------- --------------------
Total shareholders' equity . . . . . . . . 18,659 27,257
----------------------- --------------------
Total liabilities and shareholders' equity $252,090 $265,225
======================= ====================
</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 27, 2000 May 29, 1999
------------ ------------
<S> <C> <C>
Net sales . . . . . . . . . . . . . $216,868 $226,212
Cost of sales . . . . . . . . . . . 170,470 177,421
--------------- ---------------
Gross margin . . . . . . . . . 46,398 48,791
Selling, administrative and
occupancy expenses . . . . . . 51,964 46,694
Interest expense, net . . . . . . . 3,032 1,724
--------------- ---------------
Income (loss) before
provision for income
taxes . . . . . . . . . . . . (8,598) 373
Provision for income taxes. . . . . -- 149
--------------- ---------------
Net income (loss) . . . . . . . . . $(8,598) $ 224
Earnings (loss) per common share:
Basic and diluted . . . . . . . . $ (.65) $ .02
=============== ===============
Weighted average number of
common shares outstanding:
Basic . . . . . . . . . . . . . . 13,193 13,189
=============== ===============
Diluted . . . . . . . . . . . . . 13,193 13,387
=============== ===============
Supplementary information:
LIFO provision included
in cost of sales . . . . . . . $ 715 $ 720
=============== ===============
</TABLE>
See accompanying notes.
4
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DRUG EMPORIUM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended
------------------
May 27, 2000 May 29, 1999
------------ ------------
<S> <C> <C>
Operating activities:
Net income (loss) . . . . . . . . . . . . . . . . . . . $ (8,598) $ 224
Adjustments to reconcile to cash provided by (used in)
Operations:
Depreciation and amortization . . . . . . . . . . . 3,104 2,373
LIFO provision . . . . . . . . . . . . . . . . . . 715 720
Cash provided by (used for) operating assets and
liabilities:
Accounts payable and accrued liabilities . . . . . (8,118) (24,752)
Accounts receivable . . . . . . . . . . . . . . . . 1,689 (3,525)
Inventories at current cost . . . . . . . . . . . . 11,816 (4,066)
Other . . . . . . . . . . . . . . . . . . . . . . . (529) (2,291)
------------------------ -------------------------
Net cash provided by (used in) operating activities . . 79 (31,317)
Investing activities:
Purchase of property and equipment, net . . . . . . . . (3,684) (1,301)
------------------------ -------------------------
Net cash used in investing activities . . . . . . . . . (3,684) (1,301)
Financing activities:
Net borrowings (payments) under revolving
credit line . . . . . . . . . . . . . . . . . . . . (9,348) 32,426
Proceeds from long term debt and capital lease
obligations . . . . . . . . . . . . . . . . . . . . . . 14,048 ----
Principle payments on long term debt and capital lease (1,076) ----
------------------------ -------------------------
Net cash provided by financing activities 3,624 32,426
------------------------ -------------------------
Increase (decrease) in cash and cash
equivalents. . . . . . . . . . . . . . . . . . . . . . 19 (192)
Cash and cash equivalents, beginning of period . . . . . . 708 893
------------------------ -------------------------
Cash and cash equivalents, end of period . . . . . . . . . $ 727 $ 701
======================== =========================
</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.
The unaudited consolidated financial statements are presented in
accordance with the requirements for Form 10Q and consequently do not
include all of 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 26, 2000 (File No. 0-16998) for
additional disclosures including a summary of the Company's accounting
policies, which have not significantly changed.
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.
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
------------------
May 27, 2000 May 29, 1999
--------------- ----------------
<S> <C> <C>
Numerator:
Net income (loss) and numerator
for basic and diluted earnings
(loss) per share . . . . . . . $ (8,598) $ 224
Denominator:
Denominator for basic earnings
(loss) per share - weighted-
average shares . . . . . . . . . 13,193 13,189
Effect of dilutive securities:
Employee stock options . . . ---- 198
--------------- -----------------
Denominator for diluted earnings
(loss) per share - adjusted
weighted-average shares . . . 13,193 13,387
=============== =================
Basic earnings (loss) per share . . $ (.65) $ .02
=============== =================
Diluted earnings (loss) per share . $ (.65) $ .02
=============== =================
</TABLE>
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. The effect of the 7.75% convertible debentures is antidilutive and
thus excluded in the calculation of diluted earnings per share.
6
<PAGE> 7
DRUG EMPORIUM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)
4. The Company operates in two business segments: retail store based
operations (brick-and-mortar) and the operations of the Company's
online retail internet store, DrugEmporium.com (online). The Company
evaluates segment performance based on operating income (loss). The
operations of Drug Emporium.com did not effectively begin until Fiscal
2000 and therefore in prior years the Company operated as one business
segment.
The following is a reconciliation of the significant components of each
segment's net sales for Fiscal 2001.
<TABLE>
<CAPTION>
Brick-and-Mortar Online
Segment Segment Total
------- ------- -----
<S> <C> <C> <C>
(in thousands)
Pharmacy $ 74,186 $ 130 $ 74,316
General Merchandise 141,522 1,030 142,552
-------- ------ --------
Net Sales $215,708 $1,160 $216,868
======== ====== ========
</TABLE>
The following is a reconciliation of the company's business segments to
the Fiscal 2001 consolidated financial statements.
<TABLE>
<CAPTION>
Brick-and-Mortar Online
Segment Segment Total
------- ------- -----
<S> <C> <C> <C>
(in thousands)
Net Sales $215,708 $ 1,160 $216,868
Operating income (loss) 2,407 (7,973) (5,566)
Depreciation and
amortization (2,254) (850) (3,104)
Total assets 236,099 15,991 252,090
Capital expenditures 1,793 1,891 3,684
</TABLE>
5. The Company anticipates that the cash resources available to
DrugEmporium.com will support operations at least through the second
quarter of Fiscal 2001 at which time the Company will be at the funding
limit under its current bank agreement. The Company has engaged an
investment banking company to raise new capital for DrugEmporium.com or
assist in a merger or sale of DrugEmporium.com to a strategic partner
and anticipates that such a transaction will occur prior to the third
quarter of Fiscal 2001. If the Company is not successful with such a
transaction additional debt financing would be required to support the
operations of DrugEmporium.com, however, there can be no assurance that
additional financing will be available. In the event new capital is not
raised, a sale or merger does not occur, or additional debt financing
is not available, the Company will have to consider other alternatives
including ceasing operations of DrugEmporium.com. Certain of these
alternatives could cause evaluation of the assets of DrugEmporium.com
for impairment and the assumption of lease and other financial
obligations which could have a material adverse impact on the Company's
financial position and results of operations.
6. SA&O expenses were somewhat offset by recognition in the quarter of a
partial settlement in the amount of $2.5 million resulting from a class
action antitrust brand name prescription drug lawsuit that has been
pending for several years.
7. Subsequent to the statements presented in this Form 10Q, on June 23,
2000 the Company repurchased 2,500 of its convertible subordinate
debentures at 20.75% of their face value plus accrued interest. This
satisfies the Fiscal 2001 $2.5 million sinking fund requirement as
outlined in the bond indenture agreement, and results in a $1.9 million
gain to be recognized in the second quarter of this year.
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 27, 2000 May 29, 1999
------------ ------------
<S> <C> <C>
Net sales (in thousands) . . . . $216,868 $226,212
Gross margin . . . . . . . . . 21.39% 21.57%
Selling, administrative and
occupancy expenses . . . . 23.96% 20.64%
Operating income (loss) . . . . (2.57%) .93%
</TABLE>
First quarter sales decreased 4.1% to $216.9 million in the current
year from $226.2 million in the prior year quarter. This decrease is due to the
net closing of four under-performing stores as well as a 2.5% decrease in same
store sales.
For the quarter, the Company's gross margin decreased as a percent of
sales from the prior year. This decrease is entirely the result of the lower
relative gross margins that were realized by DrugEmporium.com for the quarter.
Excluding the effect of DrugEmporium.com, gross margin percents for the brick
and mortar segment of the business were the same as last year.
Higher Selling, Administrative and Occupancy expenses versus last year
were entirely the result of DrugEmporium.com. SA&O expenses were somewhat offset
by recognition in the quarter of a partial settlement in the amount of $2.5
million resulting from a class action antitrust brand name prescription drug
lawsuit that has been pending for several years.
Interest for the quarter is higher, when compared to the comparable
prior year quarter, due to carrying a higher average balance on the Company's
revolving credit facility. In addition, at the beginning of the quarter, the
Company obtained term financing from Back Bay Capital to fund DrugEmporium.com's
operations which resulted in higher interest expense for the quarter.
EBITDA for the first quarter of Fiscal 2001 was $(2.0) million compared
to $5.2 million for last year's comparable quarter. Excluding e-commerce costs,
EBITDA was $5.4 million for the quarter. Net income (loss) was $(8.6) million
for the quarter. Excluding e-commerce, the net income (loss) was $(.5) million
for the quarter versus net income of $.3 million in the prior year. Earnings
(loss) per share were $(0.65) for the quarter. Excluding e-commerce, earnings
(loss) per share were $(0.04) for the quarter versus earnings (loss) per share
of $.02 in the prior year.
DrugEmporium.com
----------------
In March 1997, the Company established an electronic commerce site on
the internet with the URL DrugEmporium.com. This experimental site served as the
foundation for the Company's development of a superior online drug store, also
known as DrugEmporium.com. The new site, which was relaunched in September 1999,
emphasizes customer service, selection, price and convenience.
8
<PAGE> 9
The Company has established a separate subsidiary for its e-commerce drug store
and has invested substantial resources in order to enhance the business
processes around its website. In addition the Company has made material
financial commitments related to its online drugstore. As of May 27, 2000, the
Company is precluded by its banking agreement with Fleet Retail Finance, Inc.
from providing additional funding for the operations of DrugEmporium.com from
its revolving credit facility, although the Company has sufficient capacity
under this facility to do so. As a result, the Company put in place $12.5
million of term financing from Back Bay Capital during the quarter. Management
believes that the Company has sufficient borrowing capacity under this term loan
to fund the operations of DrugEmporium.com through the second quarter of Fiscal
2001. Beyond that timeframe, the Company will need to either secure additional
financing for DrugEmporium.com, enter into a strategic partnership, or
investigate other options in order to ensure that DrugEmporium.com has
sufficient working capital to continue operations.
Although the Company expects to be successful in executing one of these options,
there is no guarantee that this will happen. The Company has engaged an
investment banking firm to raise new capital for DrugEmorium.com or assist in a
merger or sale of Drug Emporium.com to a strategic partner and anticipates that
such a transaction will occur prior to the third quarter of Fiscal 2001.
Finally, the Company expects the operating results for its Internet subsidiary
to negatively impact its consolidated operating results for at least the next
quarter.
Store Growth and Remodels
-------------------------
The following table lists openings for corporately owned stores and
store closings through the first quarter ended May 27, 2000 and the similar
prior year period.
<TABLE>
<CAPTION>
Three Months Ended
May 27, 2000 May 29, 1999
------------ ------------
<S> <C> <C>
Number of stores at
Beginning of period . . . . . 137 141
Stores opened or acquired . . . . . 1
Stores closed or sold . . . . . . (1) (2)
----------------- ---------------
Total stores at end of period . . 136 140
</TABLE>
The Company has plans to open approximately four new stores in the next
twelve months and to continue its store growth after that time at a similar
pace. A significant number of the Company's stores have experienced a major or
minor remodeling since the Company began its ongoing program to update and
remodel its existing store base. These remodels are typically done in the first
and second quarters of the year so as not to interrupt business during the
holiday selling season.
9
<PAGE> 10
Balance Sheet Items
-------------------
The Company's inventory balance is lower at the end of the first
quarter compared to the prior year-end balance primarily due to seasonal buying
cycles as well as to the Company's efforts to lower its average store inventory
level. An increase in property and equipment is the result of capital
expenditures related to the company's store remodeling program, which
intensified during the first quarter, as well as Drug Emporium.com capital
expenditures. The balance on the Company's revolving credit facility is lower at
the end of the first quarter as compared to the prior year end balance primarily
due to the decrease in inventory levels and the addition of $12.5 million of
term financing provided by Back Bay Capital for the purpose of financing the
operations of DrugEmporium.com. This term loan, along with a capital lease,
account for the increase in long-term debt. The decrease in accounts payable is
largely the result of the reduction of inventory levels.
Liquidity and Capital Resources
-------------------------------
The Company has a bank credit agreement (the "Agreement"), which
governs its borrowings under its bank credit facility. As of May 27, 2000, the
Company's credit facility had available capacity of $110 million with
outstanding borrowings of $76.6 million. Lower inventory levels helped reduce
the outstanding borrowings from the year-end level of $86.0 million. The Company
believes that internally generated funds and borrowings available under its
Agreement are sufficient to finance its current operations. As of quarter end,
the Company is in compliance with all financial performance covenants as
required by its bank credit agreement. Management anticipates that the Company
will remain in compliance with such financial covenants at least through the end
of Fiscal 2001.
With the $12.5 million in term financing obtained in the first quarter, the
Company anticipates that the cash resources available to DrugEmporium.com will
support operations at least through the second quarter of Fiscal 2001, at which
time the Company will be at the funding limit under the current Agreement. The
Company has engaged an investment banking firm to raise new capital for
DrugEmporium.com or assist in a merger or sale of DrugEmporium.com to a
strategic partner and anticipates that such a transaction will occur prior to
the third quarter of Fiscal 2001. If the Company is not able to effect such a
transaction, additional debt financing would be required to support the
operations of DrugEmporium.com, however, there can be no assurance that
additional financing will be available. In the event new capital is not raised,
a sale or merger does not occur, or additional debt financing is not available,
the Company will have to consider other alternatives including ceasing
operations of DrugEmporium.com. Certain of these alternatives could cause
evaluation of the assets of DrugEmporium.com for impairment and the assumption
of lease and other financial obligations which could have a material adverse
impact on the Company's financial position and results of operations.
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 2000 and Fiscal 2001. This estimated LIFO charge
is adjusted at each year-end based upon the actual weighted average inflation
rate during the year.
10
<PAGE> 11
Cautionary Statement Concerning 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
Form 10Q report that look forward in time, 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 following factors among others
that could affect the outcome of the Company's forward looking statements:
competition as to price and selection from other drugstore chains, from
supermarkets, mail order companies, membership clubs, and other internet
companies and from other third party plans; the actions of health maintenance
organizations, managed care organizations, pharmacy benefit management companies
and other third party payers attempting to reduce prescription drug costs which
results in downward pressure on pharmacy margins; economic conditions generally
or in the Drug Emporium markets; federal and/or state regulatory and legislative
actions, including internet regulation taxes and pharmacy regulations; customer
preferences and spending patterns; the ability to secure a financial or
strategic partner for its online store; the ability to economically eliminate
under-performing stores; the ability to implement or adjust to new technologies
for both the brick and mortar stores and the online store; the ability to
continue to purchase on favorable terms; the ability to attract, hire and retain
key personnel; the ability to improve operating margins; and the ability to
secure and maintain key contracts and relationships relating to both internet
and brick and mortar operations.
11
<PAGE> 12
PART II - OTHER INFORMATION
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: July 11, 2000 By /s/ David L. Kriegel
------------------------- ----------------------------------------
David L. Kriegel
Chairman
Chief Executive Officer
Date: July 11, 2000 By /s/ Terry L. Moore
------------------------- ----------------------------------------
Terry L. Moore
Chief Financial Officer and Treasurer
13
