<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
August 26, 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
-------
DRUG EMPORIUM, INC.
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 31-1064888
--------------------------------------------------------------------------------
(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
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
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 August 26, 2000
----------------------------- ------------------------------
Common Stock, $ .10 par value 13,193,285 shares
<PAGE> 2
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 . . 8-10
PART II. OTHER INFORMATION
--------------------------
Item 6. Exhibits and Reports on Form 8 - K . . . . . . . 11-12
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
2
<PAGE> 3
DRUG EMPORIUM, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
<TABLE>
<CAPTION>
August 26, 2000 February 26, 2000
-------------------- -------------------
(Unaudited) (Audited)
(Restated)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ........................................... $ 752 $ 708
Accounts receivable ................................................. 23,927 25,815
Inventories .......................................................... 187,935 204,677
Other ................................................................ 2,300 2,112
--------- ---------
Total current assets ....................................... 214,914 233,312
Property and equipment, net .......................................... 30,078 29,860
Goodwill ............................................................... 8,759 9,252
Other assets ........................................................... 3,636 3,859
Net assets of discontinued operations ................................. 6,721 5,158
--------- ---------
Total assets ............................................... $ 264,108 $ 281,441
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Revolving credit line ........................................... $ 86,054 $ 85,968
Accounts payable ................................................. 62,884 65,562
Accrued liabilities .............................................. 20,817 20,253
Deferred income .................................................. 2,735 3,645
Current maturities of long-term debt ............................. 268 5,033
--------- ---------
Total current liabilities ................................. 172,758 180,461
Deferred rent ......................................................... 3,573 3,643
Convertible subordinated debt ......................................... 46,921 46,921
Long-term debt, other ................................................. 12,879 382
--------- ---------
Total long-term debt .................................... 59,800 47,303
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 August 26, 2000
and at February 26, 2000 ......................................... 1,320 1,320
Additional paid-in capital ......................................... 32,199 32,199
Retained (deficit) earnings ........................................ (5,542) 16,515
--------- ---------
Total shareholders' equity ................................. 27,977 50,034
--------- ---------
Total liabilities and shareholders' equity ................. $ 264,108 $ 281,441
========= =========
See accompanying notes.
</TABLE>
3
<PAGE> 4
DRUG EMPORIUM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per-share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
August 26, August 28, August 26, August 28,
2000 1999 2000 1999
--------- --------- --------- ---------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Net sales ......................................... $ 212,139 $ 223,110 $ 427,847 $ 449,286
Cost of sales ..................................... 167,990 173,047 336,468 349,720
--------- --------- --------- ---------
Gross margin .................................. 44,149 50,063 91,379 99,566
Selling, administrative and
occupancy expenses ........................... 47,806 47,492 91,915 94,139
Gain on purchase of
Convertible Bonds ................................. 1,934 -- 1,934 --
Interest expense, net ............................. 2,593 1,838 4,979 3,562
--------- --------- --------- ---------
Income (loss) before
provision for income
taxes ........................................ (4,316) 733 (3,581) 1,865
Provision (benefit) for income
taxes ............................................. -- 293 (2,504) 746
--------- --------- --------- ---------
Net income (loss) from
Continuing Operations ............................. ($ 4,316) $ 440 ($ 1,077) $ 1,119
Discontinued Operations, Net
of Income Tax ..................................... ($ 12,362) ($ 814) ($ 20,980) ($ 837)
--------- --------- --------- ---------
Net Income (loss) ................................. ($ 16,678) ($ 374) ($ 22,057) $ 282
========= ========= ========= =========
Earnings (loss) per common Share:
Continuing Operations ............................. ($ .33) $ .03 ($ .08) $ .09
========= ========= ========= =========
Discontinued Operations ........................... ($ .93) ($ .06) ($ 1.59) ($ .07)
========= ========= ========= =========
Net Income (loss) per share ....................... ($ 1.26) ($ .03) ($ 1.67) $ .02
========= ========= ========= =========
Weighted average number of
common shares outstanding:
Basic & Diluted ................................. 13,193 13,193 13,193 13,191
========= ========= ========= =========
See accompanying notes.
</TABLE>
4
<PAGE> 5
DRUG EMPORIUM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
----------------
August 26, 2000 August 28, 1999
--------------- ---------------
(Restated)
<S> <C> <C>
Operating activities:
Net income (loss) .............................................................. ($22,057) $ 282
Adjustments to reconcile to cash provided by (used in) Operations:
Depreciation and amortization .............................................. 6,267 4,802
Cash provided by (used for) operating assets and liabilities:
Accounts payable and accrued liabilities ................................... (5,495) (16,762)
Accounts receivable ........................................................ 1,834 (15,617)
Inventories at current cost ................................................ 16,774 (7,757)
Other ...................................................................... (955) (1,947)
-------- --------
Net cash provided by (used in) operating activities ............................... (3,632) (36,999)
Investing activities:
Purchase of property and equipment, net ......................................... (6,312) (3,497)
-------- --------
Net cash used in investing activities ........................................... (6,312) (3,497)
Financing activities:
Net borrowings (payments) under revolving
credit line ................................................................ 86 40,400
Proceeds from long term debt and capital leases ................................ 12,227 --
Principle payments on long term debt and capital lease ........................ (2,325) (75)
-------- --------
Net cash provided by financing activities ..................................... 9,988 40,325
-------- --------
Increase (decrease) in cash and cash
equivalents ................................................................... 44 (171)
Cash and cash equivalents, beginning of period .................................... 708 893
-------- --------
Cash and cash equivalents, end of period .......................................... $ 752 $ 722
======== ========
See accompanying notes.
</TABLE>
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.
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. This quarterly report on Form 10-Q contains
certain restated financial information regarding the Company's
financial position for certain prior year reporting periods. For more
details concerning such restated financial information, see note 2
below.
2. During the quarter ended August 26, 2000, the Company changed its
method of accounting for its inventories from the last-in, first-out
(LIFO) method to the first-in, first-out (FIFO) method. The Company
believes the change is preferable because of recent operating losses
and demands on liquidity, users of the Company's consolidated
financial statements principally are interested in understanding the
Company's current financial position, and the FIFO method better
illustrates that position. In additon, inventory costs have been
relatively stable and relatively unaffected by inflation and the FIFO
method is a widely recognized method used by the Company's competitors
and peer group. This change in method of inventory accounting has been
applied retroactively by restating the prior years' financial
statements. The effect of the change was a decrease in net loss of
$432,000 or $.03 per share, and $864,000 or $.07 per share, for the
three and six month periods ended August 28, 1999, respectively. This
change did not affect the quarter ended August 26, 2000 operating
results, however, the change did reduce the net loss during the six
months ended August 26, 2000 by $2,790,000 or $.21 per share. The net
effect on the balance sheet as of February 26, 2000, of this
accounting change, was to increase inventory by $25.3 million,
increase net deferred tax liabilities by $2.5 million and increase
retained earnings by $22.8 million.
3. On September 15, 2000, Drug Emporium, Inc. finalized the sale of its
online subsidiary, DrugEmporium.com to HealthCentral.com. The purchase
price included 480,000 shares of preferred HealthCentral.com stock
convertible into up to 2.4 million shares of HealthCentral.com common
stock, which was valued at approximately $3.15 per share at the time
of the transaction and the assumption by HealthCentral.com of
approximately $2 million in current liabilities and $6 million in
future lease obligations of DrugEmporium.com. As a result of the sale,
the financial results of DrugEmporium.com are reported as
"Discontinued operations, Net of Income Tax" in the Consolidated
Statements of Operations for all periods presented. In addition, the
net assets of DrugEmporium.com have been separately disclosed in the
Balance Sheets as net assets of discontinued operations. The loss from
discontinued operations in the second quarter of fiscal 2001 includes
a $6 million charge attributable to the sale of DrugEmporium.com.
4. In the second quarter of fiscal 2001, the Company repurchased $2.5
million worth 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 resulted in a $1.9 million gain recognized in
this quarter.
5. 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.
6
<PAGE> 7
DRUG EMPORIUM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Unaudited)
6. The following table sets forth the computation of basic and diluted
earnings (loss) per share for consolidated operations.
<TABLE>
<CAPTION>
(In thousands, except per share data)
Three Months Ended Six Months Ended
------------------ ----------------
August 26, 2000 August 28, 1999 August 26, 2000 August 28, 1999
(Restated) (Restated)
<S> <C> <C> <C> <C>
Numerator:
Net income (loss) and numerator
for basic and diluted earnings
(loss) per share . . . . . . .
($16,678) ($ 374) ($22,057) $ 282
Denominator:
Denominator for diluted earnings
(loss) per share - adjusted
weighted-average shares .................. 13,193 13,193 13,193 13,191
======== ======== ======== ==========
Basic and Diluted earnings (loss)
per share ....................................... ($ 1.26) ($ .03) ($ 1.67) $ .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.
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 Six Months Ended
------------------ ----------------
August 26, 2000 August 28, 1999 August 26, 2000 August 28, 1999
--------------- --------------- --------------- ---------------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Net sales (in thousands) .................... $ 212,139 $ 223,110 $ 427,849 $ 449,286
Gross margin ............................... 20.8% 22.4% 21.4% 22.2%
Selling, administrative and
occupancy expenses .................... 22.5% 21.3% 21.5% 21.0%
Operating income (loss) ................... (1.7%) 1.1% (0.1%) 1.2%
</TABLE>
Second quarter sales decreased 4.1% to $212.1 million in the current
year from $223.1 million in the prior year quarter. This decrease is due to a
lower average store count for the quarter as well as a 2.7% decrease in same
store sales.
Pharmacy margins for the quarter improved over the prior year as a
result of increased cash discounts and pharmacy rebate income. Improved
pharmacy margins helped offset a decline in non-pharmacy margins that was due
to a combination of competitive pricing pressures, lower non-pharmacy rebate
income, higher distribution costs, lower cash discounts and an increase in
shrink expense.
Interest for the quarter is higher, than the prior year quarter, due
to carrying a higher average balance on the Company's revolving credit
facility.
EBITDA from continuing operations for the second quarter of Fiscal
2001 was $.6 million compared to $4.9 million for last year's comparable
quarter. Net loss was $4.3 million for the quarter versus net income of $.4
million in the prior year. Earnings (loss) per share was $(0.33) for the
quarter versus $.03 in the prior year quarter.
Sales from discontinued operations were $1.2 million for the
quarter versus $36,000 in the prior year. This increase in sales is the result
of the re-launch of DrugEmporium.com in the third quarter of fiscal 2000. Gross
margin for the quarter was (6.6%) versus a margin of 17.3% in the prior year
quarter as a result of the intense competition with other internet retailers
and the significant discounts that must be offered to internet shoppers in
order to attract them to shop on one internet site versus another. Total SA& O
expenses for the quarter were $11.7 million versus $1.4 million last year while
interest expense was $.7 million versus $0 in the prior year quarter. As a
result of all of the above, the net loss from discontinued operations for the
quarter was $12.4 million versus $.8 for the prior year quarter.
8
<PAGE> 9
Store Growth and Remodels
-------------------------
The following table lists openings for corporately owned stores and
store closings through the second quarter ended August 26, 2000 and the
similar prior year period.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
August 26, 2000 August 28, 1999 August 26, 2000 August 28, 1999
--------------- --------------- --------------- ----------------
<S> <C> <C> <C> <C>
Number of stores at
Beginning of period ................... 136 140 137 141
Stores opened or acquired ................... 1 2
Stores closed or sold ..................... (2) (1) (3) (3)
---- ---- ---- ----
Total stores at end of period ............. 134 140 134 140
</TABLE>
The Company plans to open four new stores in the next six months and
to continue its store growth after that time by adding approximately five new
stores in the subsequent twelve-month period. 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.
Balance Sheet Items
-------------------
The Company's Accounts Receivable balance as of the end of the second
quarter is lower versus the prior year-end balance as a result of the Company
more effectively collecting third party accounts receivable amounts. Inventory
balances are lower compared to the prior year-end due to the Company's efforts
to better manage its inventory. The increase in property and equipment versus
the prior year is the result of capital expenditures related to the Company's
store remodeling program. The balance on the Company's revolving credit
facility is slightly higher at the end of the second quarter versus the prior
year-end balance due to a reduction in accounts payable, accrued expenses, and
current portion of long term debt; offset by a decrease in inventory levels.
The increase in other long-term debt is the result of the Company putting in
place a $12.5 million term note with Back Bay Capital for the purpose of
funding the operations of DrugEmporium.com. This note matures on May 1, 2002.
Liquidity and Capital Resources
-------------------------------
The Company has a bank credit agreement (the "Agreement"), which
governs its borrowings under its bank credit facility. As of August 26, 2000,
the Company's credit facility had available capacity of $110 million with
outstanding borrowings of $86.0 million. Even though the Company's liquidity
typically tightens up during the second and third quarters of its fiscal year
as a result of seasonal inventory build ups, the Company believes that through
various initiatives by management to maximize internally generated funds, and
through borrowings available under its Agreement, that the Company's liquidity
position is sufficient to finance its current operations, despite the
liabilities and closing costs that the Company was required to fund as a result
of the sale of DrugEmporium.com. As of quarter end, the Company is in
compliance with all financial performance covenants as required by its bank
credit agreement.
9
<PAGE> 10
Inventory Valuation
-------------------
During the quarter ended August 26, 2000, the Company changed its
method of accounting for its inventories from last-in, first-out (LIFO) method
to the first-in, first-out (FIFO) method. The Company believes the change is
preferable because of recent operating losses and demands on liquidity, users
of the Company's consolidated financial statements principally are interested
in understanding the Company's current financial position, and the FIFO method
better illustrates that position. In additon, inventory costs have been
relatively stable and relatively unaffected by inflation and the FIFO method is
a widely recognized method used by the Company's competitors and peer group.
This change in method of inventory accounting has been applied retroactively by
restating prior years' financial statements. The effect of the change was a
decrease in net loss of $432,000 or $.03 per share, and $864,000 or $.07 per
share, for the three and six month periods ended August 28, 1999, respectively.
This change did not affect the quarter ended August 26, 2000 operating results,
however, the change did reduce the net loss during the six months ended August
26, 2000 by $2,790,000 or $.21 per share. The net effect on the balance sheet
as of February 26, 2000, of this accounting change, was to increase inventory
by $25.3 million, increase net deferred tax liabilities by $2.5 million and
increase retained earnings by $22.8 million.
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; the ability to maintain
sufficient liquidity in order to support operations: the ability to maintain
satisfactory relationships with suppliers both in terms of procuring
merchandise and in terms of maintaining adequate trade credit, federal and/or
state regulatory and legislative actions, including taxes and pharmacy
regulations; customer preferences and spending patterns; the ability to
economically eliminate under-performing stores; the ability to implement or
adjust to new technologies 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.
10
<PAGE> 11
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On March 7, 2000, certain franchisees of Drug Emporium ("Franchisees")
filed a Demand for Arbitration ("Demand") with the American Arbitration
Association against Drug Emporium and Drug Emporium.com ("Drug Emporium
entities"). In the Demand, Franchisees assert claims in contract, tort and
under the Texas Deceptive Trade Practices Act, alleging that Drug Emporium and
Drug Emporium.com have encroached upon their franchisees through the
establishment of on-line stores on the internet which makes sales in the
territories in which Franchisees' stores are located. Franchisees seek
declaratory and injunctive relief and unspecified money damages encompassing
Franchisees' alleged losses to date, punitive damages, and treble damages under
the Texas Deceptive Trade Practices Act. The Drug Emporium entities filed a
response to the Demand on April 17, 2000.
On September 2, 2000, the arbitrators delivered the following Order
regarding this matter:
"Order, pending final hearing determination and entry of judgment in
this matter, that Respondents, their officers, directors, agents, employees and
all others in active concert or participation with them be and they are hereby
enjoined and restrained from selling drugs and related goods or products at
retail to any customer or purchaser physically within the Claimants'
territories (as those territories are defined in the Claimants' franchise
agreements), and, further, the Respondents are directed to place a clear notice
to prospective customers within Claimants' territories on the DrugEmporium.com
web site that states that DrugEmporium.com is unable to ship orders to the
above-identified territories, and to direct such customers to the nearest Drug
Emporium franchised outlet in the enjoined territory. Respondents shall be
permitted 12 weeks to put in place the terms of this Order."
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of the stockholders of Drug Emporium, Inc. was held
on July 12, 2000. The items voted on at the meeting were the election of
directors and the approval and ratification of Ernst & Young, LLP as the
independent auditors. The proxies for the meeting were solicited pursuant to
Regulation 14 under the securities Exchange Act of 1934. There was no
solicitation in opposition to management's nominees and all such nominees were
elected.
The following persons were elected as directors for a three-year term:
Name Votes For Withheld Authority
---- --------- ------------------
David L. Kriegel 11,954,386 350,343
Donald B. Hayes 12,025,080 279,649
The following summarized the vote with respect to the ratification of Ernst &
Young, LLP as the independent auditors:
APPOINTMENT OF AUDITORS
Votes for Votes Against Abstentions
--------- ------------- -----------
12,189,735 91,373 23,621
Item 6. Exhibits and Reports on form 8-K
(A) Exhibits
11
<PAGE> 12
Exhibit No. Description of Document
----------- -----------------------
10.1 Amendment VI to Loan and Security Agreement
Bank Boston Retail Finance, Inc. and Drug Emporium, Inc.
10.2 Amendment VII to Loan and Security Agreement
Bank Boston Retail Finance, Inc. and Drug Emporium, Inc
18. Letter from Ernst & Young, LLP regarding change in accounting method
27. Financial Data Schedules
(B) Reports on Form 8-K
The Company filed a Form 8-K dated July 24, 2000 regarding the sale of
DrugEmporium.com to HealthCentral.com.
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: October 11, 2000 By: /s/ David L. Kriegel
--------------------- ---------------------------------------
David L. Kriegel
Chairman
Chief Executive Officer
Date: October 11, 2000 By: /s/ Terry L. Moore
--------------------- ---------------------------------------
Terry L. Moore
Chief Financial Officer and Treasurer
13
