Item 1. Business
Pharmhouse Corp. (the "Registrant" or the "Company") operates a chain of 32 discount drug stores, 13 of which are operated under the name Pharmhouse (the "Pharmhouse Stores") and 19 of which are operated under the name The Rx Place (the "Rx Stores"). The Registrant's stores are located primarily in the mid-Atlantic and New England states and emphasize a pricing policy of everyday discount prices on all merchandise. The Pharmhouse Stores average approximately 35,000 square feet in size and the Rx Stores average approximately 25,000 square feet. The Registrant maintains one distribution center in Pennsylvania to support its store operations. In prior years, the Registrant characterized its stores as "deep discount stores", but management has recently determined that the term "discount stores" more accurately describes its current operations.
(a) General Development of the Registrant's Business Since Commencement of the Fiscal Year Ended January 31, 1998 ("fiscal 1998")
Since the commencement of fiscal 1998, the following significant events have occurred with respect to the Registrant and its business:
(i) Final Disposition of the Woolworth Dispute
On January 31, 1997, the Registrant and Woolworth entered into a Mutual Release and Settlement Agreement resolving all outstanding disputes and settling all legal proceedings arising out of the acquisition by the Registrant of 24 Rx Stores from Woolworth. (For information concerning the acquisition of the 24 Rx Stores see Item 1 of the Registrant's Annual Report on Form 10- K for the fiscal year ended February 3, 1996 (the "1996 Form 10- K")). On June 24, 1997, the Registrant and Woolworth amended the Mutual Release and Settlement Agreement (such agreement and amendment are collectively referred to herein as the "Woolworth Settlement") to provide for the final disposition of seven of the Rx Stores (the "Affected Stores") that were part of the dispute.
A summary of the principal terms of the Woolworth Settlement is as follows:
(A) Woolworth surrendered for cancellation two of the three outstanding Purchase Money Notes in principal amounts totaling $5.5 million and modified the third such Note (in the original principal amount of $2.9 million, and originally due April 1998) so that such Note constitutes a non-interest bearing contingent note obligation of $1 million which will be surrendered by Woolworth for cancellation on July 30, 1998, subject to certain conditions. Woolworth also released the Registrant from its $1.1 million accrued interest obligation under the Purchase Money Notes.
(B) The Registrant received an option to terminate its occupancy and obligations under the leases governing the Affected Stores, subject to certain conditions. Woolworth further agreed to pay the rental and other fixed monthly charges and occupancy costs for the Affected Stores through stipulated dates. Pursuant to the Woolworth Settlement, the Registrant has closed five of the Affected Stores and reassigned to Woolworth the leases for these stores. (Prior to returning these five stores to Woolworth, the Registrant liquidated and/or transferred to its other stores the inventory and other assets located therein). Of the two remaining Affected Stores, the Registrant operated one such store with the assistance of the Woolworth rent and occupancy subsidy until September 1997, at which time the Registrant negotiated a new lease with the landlord of the property and has continued to operate this store without any further subsidy or other obligation from Woolworth. With respect to the remaining Affected Store, the Registrant continues to operate this store for which Woolworth is providing a subsidy for the rent and other occupancy costs. Pursuant to the Woolworth Settlement, either party has the option to terminate this arrangement under certain notice provisions until the lease governing such store expires in fiscal 2001. (In addition, during fiscal 1998, the Registrant closed one under-performing Pharmhouse store that was not part of the Woolworth Settlement).
For further information concerning the Woolworth Settlement, reference is made to (i) Item 1 of the Registrant's Annual Report on Form 10-K for the fiscal year ended February 1, 1997 ("fiscal 1997") (the "1997 Form 10-K"); (ii) the Registrant's Current Report on Form 8-K dated February 6, 1997; and (iii) the Registrant's Quarterly Report on Form on 10-Q for the quarterly period ended November 1, 1997, all incorporated herein by reference. See also Item 2
Item 2. Properties
(a) Stores
The following table sets forth the number of Pharmhouse stores and Rx stores in operation in each of the following states as of April 15, 1998:
Of the Registrant's thirty-two stores currently in operation, thirty-one are located in leased premises and one is located in premises owned by the Registrant in Winchester, Virginia.
With respect to the leases governing the Registrant's store properties, twenty-seven expire during the five year period from fiscal 1999 through fiscal 2003, three expire during the period from fiscal 2004 through fiscal 2008 and one is operated on a month-to-month basis. In addition, one lease, originally due to expire during fiscal 1999, will be converted to a month-to-month lease effective in May 1998 in connection with the settlement of certain litigation related to this store, as more fully described in Item 3
Item 3. Legal Proceedings
On January 31, 1997, the Registrant and Woolworth entered into the Woolworth Settlement (subsequently amended on June 24, 1997) pursuant to which the Registrant and Woolworth resolved their outstanding disputes arising out of the April 1995 acquisition of 24 Rx Stores from Woolworth. For further information, reference is made to Item 1(a), MD&A Item 7 and Notes to the Consolidated Financial Statements contained in Part IV of the Registrant's 1997 Form 10-K, incorporated herein by reference.
On January 31, 1998, the Registrant and a landlord of one of the Registrant's Pharmhouse stores reached an out-of-court settlement of certain litigation related to the lease for such store. Under the terms of the settlement agreement with the landlord, as amended on May 1, 1998, the Registrant will receive the sum of $1,675,000 ($200,000 of which was paid by the landlord on May 1, 1998 and $1,475,000 of which is payable on May 31, 1998), plus accrued interest on the outstanding balance since January 31, 1998, in exchange for waiving its exclusive right to use its space to operate a discount drugstore or discount pharmacy, thereby permitting the landlord to lease out space in the shopping center to any other tenant who operates a drugstore or pharmacy, discount or otherwise. The terms of the agreement also provide for the following: effective on May 1, 1998, the Registrant's present fixed monthly rent obligation for this store will convert to a percentage rent calculation; and effective on September 30, 1998, the Registrant has the right to terminate the lease for this store upon 90 days prior notice to the landlord and the landlord has the right to recapture the premises for this store upon 120 days prior notice to the Registrant. In connection with this transaction, the Registrant has recorded in its fiscal 1998 fourth quarter other income, net of related legal expenses, amounting to $1,346,000.
The Registrant is also subject to various legal proceedings and claims which arise in the ordinary course of its business. In the opinion of management, the amount of the Registrant's ultimate liability, if any, arising out of such actions will not materially affect the financial condition or operations of the Registrant.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of the Registrant's security holders during the fourth quarter of fiscal 1998.
PART II.
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters
(a) Identification of Principal Market
The Registrant's Common Shares, $.01 par value, are currently traded on The Nasdaq SmallCap Market, a segment of The Nasdaq Stock Market, under the symbol "PHSE". The following table sets forth the high and low bid and asked quotations of the Registrant's Common Shares for each quarterly period during the last two fiscal years as reported on the Nasdaq SmallCap Market.
Bid and Asked Quotations
On April 15, 1998, the last reported sale price for the Company's Common Stock on the Nasdaq SmallCap Market was $4.50 per share.
(b) Holders of Common Shares
The approximate number of holders of record of Common Shares of the Registrant as of January 31, 1998 was 2,312.
(c) Dividend History
During the past three fiscal years and through the date of this Report, the Registrant has not declared any cash or stock dividends and was, and continues to be, subject to restrictions against the payment of cash dividends under its agreements with its senior and subordinated lenders.
Item 6.
Item 6. Selected Financial Data
The selected financial data presented below should be read in conjunction with the Consolidated Financial Statements and Related Notes, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial information included elsewhere in this Report. The data as of January 31, 1998 and February 1, 1997 and for each of fiscal 1998, fiscal 1997 and fiscal 1996 are derived from the Registrant's audited consolidated financial statements included elsewhere in this Report. The data as of February 3, 1996, January 28, 1995 and January 29, 1994 and for each of fiscal 1995 and fiscal 1994 are derived from the Registrant's audited consolidated financial statements not included in this Report.
(1)Includes operations of 38 stores effective April 28, 1995. (2)Fifty-three week fiscal year. (3)Excludes provision for store closure of $(185) in fiscal 1998, $573 in fiscal 1997 and $(244) in fiscal 1994. (4)Other income represents income from a settlement of litigation related to a lease of one of the Registrant's Pharmhouse stores (for further information, reference is made to Item 3 and to Note 12 in the notes to the consolidated financial statements included in this Report). (5)Extraordinary gain resulted from the following: in fiscal 1997, debt and interest cancellation, net of related costs and provisions in connection with the Woolworth Settlement; in fiscal 1997, from early retirement of debt. (6)Amount includes a $1 million contingent obligation which is scheduled to be canceled by Woolworth in July 1998 in connection with the Woolworth Settlement.
For further information concerning the provisions of the Woolworth Settlement, reference is made to paragraph (a)(i) in Item 1 of this Report.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the selected financial data presented in Item 6 of this Report and the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements appearing in Item 8
Item 8. Financial Statements and Supplementary Data
The following documents are filed on the pages listed below as a part of this report.
1. Financial Statements
Report of Independent Accountants
Consolidated Statements of Operations for each of the three years in the period ended January 31, 1998
Consolidated Balance Sheets at January 31, 1998 and February 1, 1997
Consolidated Statements of Cash Flows for each of the three years in the period ended January 31, 1998
Consolidated Statements of Shareholders' Equity for each of the three years in the period ended January 31, 1998
Notes to Consolidated Financial Statements
2. Financial Statement Schedule
Report of Independent Accountants on Financial Statement Schedule F- 20
I. Valuation and Qualifying Accounts F- 21
All other schedules have been omitted because either they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto.
Item 9.
Item 9. Disagreements on Accounting and Financial Disclosure
Within the 24 months prior to the date of the Registrant's most recent financial statements, there were no reports on Form 8-K filed or required to be filed by the Registrant involving a reporting disagreement on any matter of accounting principles or practices or financial statement disclosure.
PART III.
Item 10.
Item 10. Directors and Executive Officers of the Registrant
(a) Identification of Directors
The following table contains information regarding all current directors of the Registrant.
Arrangements or Understandings With Regard to Selection of Directors or Nominees
None.
(b) Identification of Executive Officers The executive officers of the Registrant and their ages and offices with the Registrant are as follows:
Name and Age Positions with Registrant ------------------- --------------------------------- Manfred Brecker (71) Chairman of the Board
Kenneth A. Davis (49) President, Chief Executive Officer, Chief Operating Officer and a director
Marcie B. Davis (45) Executive Vice President, Secretary, Treasurer and a director
Joseph Keller (52) Senior Vice President-Administration and Operations and a director
Richard A. Davis (45) Senior Vice President-Finance and Chief Financial Officer
Eileen Abbate (50) Vice President-Advertising
Amparo Castro (41) Vice President-Controller and Assistant Treasurer
Daniel Thigpen (47) Vice President-Store Operations
Richard Davis has been an employee of the Registrant since November 1995. From February 1990 to October 1995, he was a Senior Associate at BDO Seidman, LLP, an international accounting and consulting firm. Mr. Davis is a Certified Public Accountant.
Eileen Abbate has been an employee of the Registrant since April 1990, other than during a brief period while she was employed elsewhere. She was elected Vice President-Advertising in April 1992. Prior to joining the Registrant, she was the Advertising Director of Drug Fair/Cost Cutters from 1988 to March 1990.
Amparo Castro has been an employee of the Registrant since June 1989, other than during a brief period while she was employed elsewhere. She was elected Vice President and Assistant Treasurer of the Registrant in 1996 and Controller of the Registrant in August 1991. Prior to joining the Registrant, she was manager of financial reporting of Henri Bendel Inc., a division of The Limited Inc., from 1987 to June 1989.
Daniel Thigpen has been an employee of the Registrant since 1972. He was elected Vice President of Store Operations of the Registrant in April 1995. Prior thereto, he held various management positions of the Registrant including Director of Store Special Projects from 1992 to 1995 and District Manager from 1985 to 1992. Mr. Thigpen held various store level positions of the Registrant from 1972 to 1985.
For information regarding officers of the Registrant who are also directors, reference is hereby made to Item 10(a) of this Report.
(c) Identification of Certain Significant Employees
None.
(d) Family Relationships
Kenneth A. Davis is the son-in-law of Manfred Brecker; Marcie B. Davis is the daughter of Manfred Brecker and the wife of Kenneth A. Davis; Richard A. Davis is the brother of Kenneth A. Davis.
(e) Business Experience
See Items 10(a) and 10(b) above.
(f) Involvement in Certain Legal Proceedings
None.
Item 11.
Item 11. Executive Compensation
(a) General
The following sets forth certain information with respect to executive compensation.
(b) Summary Compensation Table
The following table sets forth certain information concerning the annual and long-term compensation paid or accrued on behalf of the Chairman of the Board, the Chief Executive Officer and the three other most highly compensated Executive Officers (the "Named Executive Officers") for each of the Registrant's last three completed fiscal years:
ANNUAL COMPENSATION LONG TERM COMPENSATION AWARDS ------------------------ -------------------------
(*) Employment of Richard A. Davis commenced on November 5, 1995.
The foregoing table does not include severance compensation of $110,000 paid to a former executive officer of the Registrant whose employment with the Registrant terminated in 1996, all of which was accrued in the Registrant's 1997 fiscal year. For further information concerning the compensation and prior employment arrangements of this former officer, reference is made to Item 11 of the Registrant's 1997 Form 10-K.
YEAR - Refers to fiscal years ended January 31, 1998, February 1, 1997 and February 3, 1996, respectively.
SALARY - The Registrant leases a number of automobiles that are made available to certain of its executive officers as well as to other members of management and supervisory employees for use in the performance of their duties. The Summary Compensation Table does not include the value the executive officers derived from their personal use of these automobiles, which in any event would not exceed the lesser of $25,000 per year or 10% of the salary reported in the Summary Compensation Table as to any Named Executive Officer.
RESTRICTED STOCK AWARDS - The amounts set forth under this column represent the excess of the fair market value of the restricted shares vested during the fiscal year over the purchase price of such restricted shares. The restricted shares were sold to certain of the Named Executive Officers in December 1991. A portion of the shares purchased by each such officer vested over the subsequent four year period.
LTIP PAYOUTS - None paid. No plan in place.
ALL OTHER COMPENSATION - Includes contributions made by the Registrant to its 401(k) plan on behalf of the Named Executive Officers.
(c) Fiscal 1998 Option and Stock Appreciation Right ("SAR") Grants No options or Stock Appreciation Rights were granted by the Registrant to the Named Executive Officers during fiscal 1998.
(d) Options Exercised and Fiscal Year-End Option Values The following table sets forth certain information concerning options exercised and the options outstanding at January 31, 1998 held by the Named Executive Officers:
(*) Market value of securities underlying in-the-money options at the end of fiscal 1998 (based on $5.50 per share, the closing price of Common Shares on the Nasdaq SmallCap Market on 1/30/98) minus the exercise price.
(e) Long-term incentive plan None.
(f) Defined benefit or actuarial plan
None.
(g) Compensation of directors
Each member of the Board who is not an officer or employee of the Registrant or any of its subsidiaries (an "Independent Director") is entitled to receive certain remuneration for services rendered.
Pursuant to the Independent Directors Plan, as amended, a total of 50,000 Common Shares were reserved for issuance to Independent Directors. The Independent Directors Plan provides that each Independent Director elected by shareholders to serve as a member of the Board, through the 1998 Annual Meeting of Shareholders, is entitled to an award of 2,500 common shares upon his or her election or re-election. Each annual award of Common Shares under the Independent Directors Plan is effected automatically on the business day next succeeding each of the annual meetings of shareholders (or special meetings in lieu thereof) at which an Independent Director is elected.
The Board of Directors of the Registrant further amended the Directors Plan to increase the number of shares reserved under such plan to 80,000 and to provide that each Independent Director, at his or her election, may receive, in lieu of cash fees of $500 per Board Meeting, and in lieu of cash fees of $250 per Committee Meeting, Common Shares of the Registrant for each Board Meeting and Committee Meeting attended by such Independent Director during each year of his incumbency as a Director. The number of such Common Shares per Board Meeting and per Committee Meeting attended shall be determined by dividing the sum of $500 ($250 for Committee Meetings) by the closing price of the Common Shares on the NASDAQ SmallCap Market on the trading day immediately preceding each such Meeting. The total number of such Common Shares so issuable to each Independent Director shall be determined within ten days after the date of each Annual Meeting of the Board of Directors. This amendment, which is subject to shareholder ratification, became effective as of the date of the Board of Directors Meeting held on January 22, 1998. All of the Independent Directors of the Registrant elected to accept Common Shares in lieu of cash fees for attendance at that Board Meeting and for all subsequent Board Meetings and Committee Meetings to be held during their current terms as Directors. Pursuant to such amendment, the termination date of the Directors Plan was extended to the date immediately preceding the date of the Shareholder's Meeting of the Registrant in the year 2001 in which directors are elected.
(h) Employment contracts and termination of employment and change in control arrangements
In July 1995, the Registrant entered into Executive Employment Agreements with each of Manfred Brecker, Chairman of the Board, and Kenneth A. Davis, President and Chief Executive Officer of the Registrant. Each such agreement provides for an employment term continuing through the end of the Registrant's 1999 fiscal year (i.e., January 30, 1999). Under his employment agreement, Mr. Brecker is paid an annual base salary of $175,000, subject to annual cost of living increases, and a special bonus, in consideration of services rendered and to be rendered, in the amount of $100,000, payable in four equal annual installments commencing in 1995. Pursuant to his employment agreement, Mr. Davis is to be paid annual base salary of $225,000 increased to $250,000 effective January 31, 1996, subject to annual cost of living increases, and an annual bonus equal to $10,000 for every $.05 per share of pre-tax income for the appropriate fiscal year. Mr. Davis' base salary will further increase to $300,000 retroactively to the first day of the fiscal year in which the Company achieves profitability. The employment agreements with Messrs. Brecker and Davis also provide that, if such executive's employment with the Company is terminated (i) by the Registrant in breach of the agreement or (ii) by the executive for "Good Reason", as defined in the agreement to include, among other events, the occurrence of a change in control of the Registrant, such executive shall be entitled to continue to be paid his base salary then in effect for a period of three years from the date of termination of employment or, in lieu thereof, a lump sum amount equal to the discounted present value of such three years of base salary.
In November 1995, the Registrant entered into an Executive Employment Agreement with Richard A. Davis with respect to his employment as the Registrant's Senior Vice President-Finance and Chief Financial Officer continuing through January 30, 1999. Pursuant to this employment agreement, Mr. Davis: (a) currently receives an annual base salary of $132,300, which reflects increases from his initial base salary of $110,000 plus annual increases based on cost of living adjustments; and (b) was granted options to purchase 50,000 Common Shares of the Registrant at an exercise price equal to the fair market value of such shares as of the date of their grant. The options granted to Mr. Davis vest ratably over a three year period commencing with the first anniversary date of Mr. Davis' employment with the Registrant. The employment agreement with Mr. Davis also provides for one year's additional compensation based on similar termination provisions as are described in the preceding paragraph with respect to Mr. Brecker's and Mr. Kenneth Davis' employment agreements.
(i) Re-pricing of options
None.
(j) Additional information with respect to Compensation Committee Interlocks and Insider Participation in compensation decisions. See Item 13(b) of this Report.
The Registrant has a Compensation Committee none of whose members is an officer or employee of the Registrant. The members of the Compensation Committee are Melvin Katz, Michael Feder and Raymond Steele. The Compensation Committee is involved in the development of criteria to determine future compensation of the Chief Executive Officer and other executive officers of the Registrant.
(k) Board compensation report on executive compensation
Pursuant to the instructions for this Item, no response is required.
(l) Performance graph
Pursuant to the instructions for this Item, no response is required.
Item 12.
Item 12. Security Ownership of Certain
Beneficial Owners and Management
(a) Security Ownership of Certain Beneficial Owners
The following table provides information as of April 15, 1998 with respect to holdings of the Registrant's Common Shares by all persons known by the Registrant to be the beneficial owners of more than 5% of the total number of Common Shares outstanding as of that date. Each beneficial owner has sole voting and investment power with respect to the shares set forth opposite his or her name in the following table, except as otherwise disclosed in the footnotes to the table:
Name and Address Amount and Nature Percentage of Beneficial Owner of Beneficial Ownership of Class * - - ---------------------- ---------------------- --------- Anne Brecker 487,336 (1) 16.3% 860 Broadway New York, New York 10003
Kenneth A. Davis 392,519 (2) 13.1% 860 Broadway New York, New York 10003
Hemisphere Trading Co., Inc. 260,000 (3) 8.7% 5796 Shelby Oaks Drive Memphis, TN 38134-7333
*Calculation based upon 2,997,263 Common Shares and Common Share Equivalents outstanding as of April 15, 1998 (including total non-qualified options of 215,273 and total incentive options of 187,149, all of which are exercisable within 60 days).
(1) Includes 481,542 shares owned by Mrs. Brecker and 5,794 shares held by trusts, of which she is the trustee, for the benefit of her children. Mrs. Brecker disclaims beneficial ownership of the shares held by such trusts. Does not include 1,281 shares beneficially owned by Mrs. Brecker's husband, Manfred Brecker, the Chairman of the Board of the Registrant, with respect to which Mrs. Brecker disclaims beneficial ownership.
(2) Includes 153,663 shares subject to options granted to Mr. Davis pursuant to Registrant's 1991 Non-Qualified Stock Option Plan (the "Non-Qualified Plan") and 59,552 shares subject to options granted pursuant to the Registrant's 1991 Incentive Stock Option Plan (the "Incentive Option Plan"), all of which are exercisable within 60 days. Does not include 122,472 shares beneficially owned by Mr. Davis' wife. Mr. Davis disclaims beneficial ownership of the shares held by his wife.
(3) As reported on Amendment #1 to Schedule 13D filed by Hemisphere Trading Co. Inc. ("Hemisphere") on April 7, 1997. According to such Schedule 13D, Hemisphere has shared voting power and shared dispositive power with respect to all 260,000 of these shares.
(b) Security Ownership of Management
The following table sets forth certain information as of April 15, 1998 with respect to holdings of the Registrant's Common Shares beneficially owned by each of the Registrant's directors and Named Executive Officers and by all officers and directors of the Registrant as a group.
Name of Amount and Nature Percentage Beneficial Owner of Beneficial Ownership of Class - - ----------------- ------------------------- ---------- Manfred Brecker 1,281 (1) *
Kenneth A. Davis 392,519 (2) 13.1%
Joseph Keller 108,153 (3) 3.6%
Marcie B. Davis 122,472 (4) 4.1%
Richard A. Davis 33,333 (5) 1.1%
Melvin Katz 7,960 *
Michael A. Feder 7,500 *
Peter Gerard 7,500 *
Raymond L. Steele 8,879 *
Officers and directors as a group (consisting of 12 persons) 726,745 (6) 24.2%
* Less than 1%
(1) Does not include 481,542 shares owned by Mr. Brecker's wife, Anne Brecker, or 5,794 shares held by trusts for the benefit of Mr. Brecker's adult children, of which his wife is the trustee. Mr. Brecker disclaims beneficial ownership of the shares held by his wife and shares held by the trusts.
(2) Includes 153,663 shares subject to options granted to Mr. Davis pursuant to the Registrant's Non-Qualified Plan and 59,552 shares subject to options granted pursuant to the Registrant's Incentive Option Plan, all of which are exercisable within 60 days. Does not include 122,472 shares beneficially owned by Mr. Davis' wife. Mr. Davis disclaims beneficial ownership of the shares held by his wife.
(3) Includes 12,874 shares subject to options granted to Mr. Keller under the Non-Qualified Plan and 26,000 shares subject to options granted under the Incentive Option Plan, all of which are exercisable within 60 days.
(4) Includes 42,299 shares subject to options granted to Ms. Davis pursuant to the Registrant's Non-Qualified Plan and 17,379 shares subject to options granted under the Incentive Option Plan, all of which are exercisable within 60 days. Does not include 392,519 shares beneficially owned by Ms. Davis' husband. Ms. Davis disclaims beneficial ownership of the shares held by her husband.
(5) Includes 33,333 shares subject to options granted to Mr. Richard A. Davis pursuant to the Registrant's Incentive Option Plan, all of which are exercisable within 60 days.
(6) Includes an aggregate of 215,273 shares subject to options granted under the Registrant's Non-Qualified Plan and 152,724 options granted under the Incentive Option Plan, all of which are exercisable within 60 days.
(c) Changes in Control
None
Item 13.
Item 13. Certain Relationships and Related Transactions
(a) Transactions with Management and Others
None.
(b) Certain Business Relationships
Maloney, Mehlman & Katz, a law firm of which Melvin Katz, a director of the Registrant, is currently a member, currently provides legal services to the Registrant, and received fees for services rendered to the Registrant during fiscal 1998 totaling approximately $79,000.
(c) Indebtedness of Management
None.
(d) Transactions with Promoters
Pursuant to the instructions for this Item, no response is required.
PART IV.
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as part of this Report:
1. Financial Statements
Report of Independent Accountants
Consolidated Statements of Operations for each of the three years in the period ended January 31, 1998
Consolidated Balance Sheets at January 31, 1998 and February 1, 1997
Consolidated Statements of Cash Flows for each of the three years in the period ended January 31, 1998
Consolidated Statements of Shareholders' Equity for each of the three years in the period ended January 31, 1998
Notes to Consolidated Financial Statements
2.Financial Statement Schedule
Report of independent accountants on financial statement schedule
I. Valuation and Qualifying Accounts
All other schedules have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
3. Exhibits
3.1 Restated Certificate of Incorporation, as amended, of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K dated December 24, 1991, Commission File No. 1-7090). 3.2 Certificate of Amendment of Certificate of Incorporation of the Registrant dated April 1, 1993 (incorporated by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K dated April 9, 1993, Commission File No. 1090). 3.3 By-Laws, as amended, of the Registrant (incorporated by reference from Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended February 3, 1990, Commission File No. 1-7090).
Exhibits 10.1 through 10.5 were filed as Exhibits 10.4 and 10.9 through 10.12, respectively, to the Registrant's Current Report on Form 8-K dated December 24, 1991, Commission File Number 1- 7090, Exhibits 10.6 through 10.12 were filed as Exhibits 10.6 through 10.12, respectively, to the Registrant's 1996 Form 10-K Report dated May 3, 1996, Commission File Number 1-7090 and Exhibit 10.13 was filed as Exhibit 10.13 to the Registrant's 1997 Form 10-K Report dated May 2, 1997, Commission File Number 1- 7090, all of which are incorporated herein by reference thereto:
10.1 Warrant Agreement dated as of December 24, 1991 by and between the Registrant and Rosenthal & Rosenthal, Inc.
10.2 S.E. Nichols Inc. 1991 Incentive Stock Option Plan.
10.3 S.E. Nichols 1991 Non-Qualified Stock Option Plan.
10.4 Form of Agreement under S.E. Nichols Inc. 1991 Non- Qualified Stock Option Plan.
10.5 Form of Restricted Stock Purchase Agreement and Memorandum.
10.6 Pharmhouse Corp. 1995 Stock Option Plan previously filed with the Registrant's Definitive Proxy Statement filed with the Commission on October 11, 1995.
10.7 Amendment to 1992 Equity Compensation Plan for Non- Employee Directors previously filed with the Registrant's Definitive Proxy Statement filed with the Commission on October 11, 1995.
10.8 Warrant Agreement dated January 23, 1996 between the Registrant and Brenner Securities Corporation.
10.9 Employment Agreement dated July 14, 1995 between the Registrant and Kenneth A.Davis.
10.10 Employment Agreement dated July 14, 1995 between the Registrant and Manfred Brecker.
10.11 Employment Agreement dated December 15, 1995 between the Registrant and Gerald Katz.
10.12 Employment Agreement dated November 6, 1995 between the Registrant and Richard A. Davis.
10.13 Mutual Release and Woolworth Settlement dated January 31, 1997 between the Registrant and Woolworth.
10.14 Amendment to Mutual Release and Settlement Agreement dated June 24, 1997 between the Registrant and Woolworth.
10.15 $40,000,000 Loan and Security Agreement dated May 14, 1998 between the Registrant and Foothill Capital Corporation.
Unless otherwise noted, all references to the "Commission" in this index shall mean the Securities and Exchange Commission.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Pharmhouse Corp. (Registrant)
By: /s/ Kenneth A. Davis -------------------------- Kenneth A. Davis President, Chief Executive Officer and Chief Operating Officer
By: /s/ Richard A. Davis -------------------------- Richard A. Davis Senior Vice President-Finance and Chief Financial Officer
Dated: May 18, 1998
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ Manfred Brecker Chairman of the Board of Directors May 13, 1998 - - ------------------- Manfred Brecker
/s/ Kenneth A. Davis President, Chief Executive May 13, 1998 - - ------------------- Officer, Chief Operating Kenneth A. Davis Officer and a Director
/s/ Marcie B. Davis Executive Vice President, May 13, 1998 - - ------------------- Secretary, Treasurer and Marcie B. Davis a Director
/s/ Joseph Keller Senior Vice President- May 13, 1998 - - ------------------- Administration & Operations Joseph Keller and a Director
/s/ Melvin Katz Director May 13, 1998 - - ------------------ Melvin Katz
/s/Michael A. Feder Director May 13, 1998 - - -------------------- Michael A. Feder
/s/Peter Gerard Director May 13, 1998 - - -------------------- Peter Gerard
/s/ Raymond L. Steele Director May 13, 1998 - - -------------------- Raymond L. Steele
EXHIBIT 22.1
Subsidiaries of the Registrant
Name State of Incorporation - - --------------------- ----------------------
Nichols Realty, Inc. Pennsylvania
Rx Realty Corp. Delaware
Report of Independent Accountants
To the Board of Directors andShareholders of Pharmhouse Corp.In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Pharmhouse Corp. and its subsidiaries at January 31, 1998 and February 1, 1997 and the results of their operations and their cash flows for each of the fiscal years ended January 31, 1998, February 1, 1997 and February 3, 1996 in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
New York, New York April 24, 1998, except as to Note 4 and Note 13, which is as of May 14, 1998
PHARMHOUSE CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
Fiscal Year Ended January 31, February 1, February 3, 1998 1997 1996 --------------------------------------- Revenues: Net sales $ 194,658 $ 224,292 $ 203,130 Video rental, service and other income 6,093 7,437 6,399 --------------------------------------- 200,751 231,729 209,529 --------------------------------------- Costs and Expenses: Cost of merchandise sold 155,393 176,390 159,528 Selling, general and administrative expense 47,548 56,344 49,582 Provision for store closure (185) 573 - --------------------------------------- 202,756 233,307 209,110 ---------------------------------------
Operating income (loss) (2,005) (1,578) 419
Interest expense (3,032) (4,230) (3,544) Other income, net 1,346 - - --------------------------------------- Loss before extraordinary gain (3,691) (5,808) (3,125) Extraordinary gain, net - 7,142 618 --------------------------------------- Net earnings (loss) $(3,691) $ 1,334 $(2,507) =======================================
Basic earnings (loss) per share: Loss before extraordinary gain$ (1.48) $ (2.56) $ (1.41) Extraordinary gain, net - 3.15 0.28 --------------------------------------- Net earnings (loss) $ (1.48) $ 0.59 $ (1.13) ======================================= Average number of shares 2,491 2,267 2,217 =======================================
See accompanying Notes to Consolidated Financial Statements.
PHARMHOUSE CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts)
January 31, February 1, 1998 1997 ------- ------- ASSETS Current assets Cash $ 3,296 $ 2,915 Receivables, net of allowances of $1,075 and $987, respectively 4,518 7,307 Merchandise inventory 37,332 49,796 Prepaid expenses and other 1,292 1,861 ------- ------- Total current assets 46,438 61,879 Property, fixtures and equipment, net 4,795 5,580 Video rental inventory, net 1,972 2,531 Other assets 487 256 ------- ------- Total assets $53,692 $70,246 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Current portion of long-term debt $ 4,647 $ 7,640 Accounts payable 20,713 24,155 Provision for store closure 284 1,615 Accrued expenses and other liabilities 2,628 3,586 ------- ------- Total current liabilities 28,272 36,966 Long-term debt, net of current portion 19,154 24,400 Other liabilities 1,372 498 ------- ------- Total liabilities 48,798 61,894 ------- ------- COMMITMENTS AND CONTIGENCIES SHAREHOLDERS' EQUITY Preferred stock, $.10 par; authorized and unissued 2,500,000 shares Common stock, $.01 par; authorized 25,000,000 shares; issued 2,594,841 and 2,359,064 shares, respectively 26 23 Additional paid-in capital 21,728 21,498 Accumulated deficit (16,859) (13,168) ------- ------- 4,895 8,353 Treasury stock, at cost 1 1 ------- ------- Total shareholders' equity 4,894 8,352 ------- ------- Total liabilities and shareholders' equity $53,692 $70,246 ======= =======
See accompanying Notes to Consolidated Financial Statements
PHARMHOUSE CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands except share amounts)
PHARMHOUSE CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business and Background Pharmhouse Corp. (the "Company" or "Pharmhouse") operates a chain of 32 discount drug stores located in eight states in the mid-Atlantic and New England regions of the United States, 13 of which operate under the name Pharmhouse (the "Pharmhouse Stores") and 19 of which operate under the name Rx Place (the "Rx Stores"), the latter stores having been acquired from F. W. Woolworth Co., a subsidiary of Woolworth Corporation (collectively "Woolworth"), in late April 1995. Pursuant to the settlement terms of certain litigation between Pharmhouse and Woolworth, the Company has ceased operating and has returned to Woolworth five of the 24 Rx Stores purchased from Woolworth. The Company presently has an option to reassign to Woolworth the lease for one Rx Store which remains subject to the settlement agreement. In prior years, the Company has characterized its stores as "deep discount stores", but management has recently determined that the term "discount stores" more accurately describes its current store operations.
During the last three fiscal years, except for 24 stores acquired from Woolworth during fiscal 1996, the Company has not opened new stores. The Company closed six stores during fiscal 1998. Five of such six closed stores were returned to Woolworth in connection with the settlement agreement with Woolworth. One of the closed stores was a Pharmhouse store (such closing was unrelated to the settlement agreement). For further information concerning the settlement agreement with Woolworth, see "Final Disposition of the Woolworth Dispute" in Note 2.
Fiscal Year The fiscal year is the 52 or 53 week reporting period ending on the Saturday closest to January 31 of each year. References to fiscal 1998, 1997 and 1996 refer to the fiscal years ended January 31, 1998, February 1, 1997 and February 3, 1996, respectively. Fiscal 1996 comprised a 53 week reporting period whereas fiscal 1998 and 1997 each comprised 52 weeks.
Principles of Consolidation These consolidated financial statements include the accounts of Pharmhouse Corp. and its two wholly-owned real estate subsidiaries, Nichols Realty, Inc. and Rx Realty Corp. (collectively the "Company"). All inter-company transactions and balances have been eliminated.
Reclassification Certain fiscal 1997 and fiscal 1996 amounts have been reclassified to conform with the presentation used in fiscal 1998.
Use of Estimates The consolidated financial statements have been prepared in conformity with generally accepted accounting principles which require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements. Actual results could differ from these estimates. During the fourth quarter of fiscal 1998, the Company recorded an adjustment to inventory of $1.7 million, primarily related to the Rx Stores, to reflect inventory shrinkage in excess of amounts previously accrued. The shrinkage accrual rate used in fiscal 1998 was consistent with the Company's historical accrual experience. The Company has increased its shrinkage accrual rate beginning in fiscal 1999.
Receivables Receivables are primarily generated by third party pharmacy revenues (i.e., Medicare, Medicaid and health insurance plans). Reference is made to Item 1 (a) (iii) of this Report for information concerning the sale by the Company of such third party receivable. Receivables also include vendor coupons and advertising and promotional allowances receivable and, at January 31, 1998, a receivable arising from the settlement of litigation (see Note 12).
Merchandise Inventory Merchandise inventory is carried at the lower of cost or market, with cost determined on the first-in first-out retail inventory method.
Pre-opening Costs Store pre-opening costs are expensed in the fiscal year in which the store is opened.
Property, Fixtures and Equipment and Video Rental Inventory, Net Property, fixtures and equipment, including significant improvements thereto, are recorded at cost. Expenditures for repairs and maintenance are charged to expense as incurred. The cost of property, fixtures and equipment is depreciated over estimated useful lives of 5 to 25 years using the straight- line method. Leasehold improvements are amortized over the shorter of the estimated useful life of the asset or the remaining term of the lease. Video rental inventory is amortized over two years.
Provision for Store Closure Provision is made for net costs and expenses associated with store closures when a decision is made to close the store.
Stock-Based Compensation The Company accounts for stock-based compensation under the requirements of Accounting Principles Board Opinion No. 25 and, in accordance with Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Awards of Stock-Based Compensation to Employees", which was adopted by the Company during fiscal 1997, has provided the additional required disclosures in the Notes to the Consolidated Financial Statements (Note 6).
Income Taxes Income taxes are provided based on the liability method of accounting pursuant to SFAS No.109, "Accounting for Income Taxes". Deferred income taxes are recorded to reflect the tax consequences on future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end. Where appropriate, valuation reserves are recorded.
Basic and Diluted Earnings (Loss) per Share In 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings per Share". SFAS No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. It is calculated as net income available to common shareholders divided by the weighted average number of common shares outstanding. All earnings (loss) per share amounts for all periods have been presented to conform to SFAS 128 requirements. Diluted earnings (loss) per share has not been presented because such amounts are anti-dilutive.
Leased Department Revenues Leased department revenues of $27,000, $229,000, and $103,000 in fiscal 1998, 1997 and 1996, respectively, is included in other income.
Significant Supplier Approximately 40%, 30% and 28% of the Company's total purchases in fiscal years 1998, 1997 and 1996, respectively, represented purchases from one unaffiliated supplier.
Recently Issued Accounting Standards In February 1997, the FASB issued SFAS No. 129, "Disclosure about Capital Structure". This Statement, which established standards for disclosing information about an entity's capital structure, had no effect on the disclosures in the Company's fiscal 1998 financial statements as the Company's capital structure is not complex.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", which is effective for the Company's fiscal 1998 consolidated financial statements. This Statement established standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 130 had no effect on the Company's fiscal 1998 financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information", which is effective for the Company's fiscal 1998 consolidated financial statements. The Statement requires enterprises to report certain financial information on segments that would be determined based on the Company's internal reporting. As the Company has only one business segment, retail, SFAS No. 131 did not have an effect on disclosures in the notes to the fiscal 1998 financial statements.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Post-retirement Benefits". This Statement, which revises disclosures about pensions and other post-retirement benefit plans, is effective for financial statements with periods beginning after December 15, 1997. Restatement of disclosures for earlier periods is required upon adoption. The Company anticipates that the adoption of SFAS No. 132 will not have a significant effect on its 1999 financial statements.
NOTE 2 - ACQUISITION, LITIGATION AND FINAL DISPOSITION OF THE WOOLWORTH DISPUTE Acquisition On April 28, 1995, the Company acquired, and accounted for as a purchase, the assets and business of the 24 Rx Place discount drug stores (the "Acquisition") from Woolworth. The total cost of the Acquisition was $39.5 million, including $23.5 million in cash, $12.5 million in notes issued to Woolworth (the "Purchase Money Notes") and $2.9 million for the related costs of acquisition (includes cost of issuance of warrants to the Company's financial advisor, see Note 7). The Company also assumed Woolworth's obligations under the leases of the acquired stores. The Acquisition, consisting primarily of merchandise inventory and store property and equipment, was financed through a senior secured revolving credit facility (the "Senior Credit Facility") provided by a financial institution, a $3 million secured subordinated term loan (the "Subordinated Loan") provided by an unaffiliated trade supplier and the Purchase Money Notes.
Litigation In January 1996, the Company instituted legal action against Woolworth in the Supreme Court of the State of New York seeking, among other relief, damages and indemnification arising out of Woolworth's alleged fraud and breach of certain covenants, representations and warranties made by Woolworth in connection with the Acquisition. Pending resolution of the Company's claims, the Company withheld payment of all further installments of principal and interest arising out of the Purchase Money Notes held by Woolworth.
Final Disposition of the Woolworth Dispute On January 31, 1997, the Company and Woolworth entered into a Mutual Release and Settlement Agreement resolving all outstanding disputes and settling all legal proceedings arising out of the Acquisition. On June 24, 1997, the Company and Woolworth amended the Mutual Release and Settlement Agreement (such agreement and amendment are collectively referred to herein as the "Woolworth Settlement") to provide for a final disposition of the seven Rx Stores (the "Affected Stores") that were part of the dispute. The major aspects of the Woolworth Settlement include:
Debt and Interest Forgiveness - Woolworth surrendered for cancellation two of the three outstanding Purchase Money Notes in principal amounts totaling $5.5 million and modified the third such Note (in the original principal amount of $2.9 million, and originally due April 1998) so that such Note constitutes a non-interest bearing contingent note obligation of $1 million which will be surrendered by Woolworth for cancellation on July 30, 1998, subject to certain conditions. Woolworth also released the Company from its $1.1 million accrued interest obligation on the Purchase Money Notes. In fiscal 1997, by reason of the foregoing, the Company recorded an extraordinary gain of $7.1 million consisting of $8.5 million in debt and interest forgiveness less certain costs and provisions (including a $1 million store closure provision related to two Affected Stores).
Return of Stores and Reimbursement of Rental and Occupancy Costs - The Company received an option to terminate its occupancy and obligations under the leases governing the Affected Stores, subject to certain conditions. Woolworth further agreed to pay the rent and other fixed monthly charges and occupancy costs for the Affected Stores through stipulated dates. Pursuant to the Woolworth Settlement, the Company has closed five of the Affected Stores and reassigned to Woolworth the leases for these stores. (Prior to returning such five stores to Woolworth, the Company liquidated and/or transferred to its other stores the inventory and other assets located therein). Of the two remaining Affected Stores, the Company operated one such store with the assistance of the Woolworth subsidy until September 1997, at which time the Company negotiated a new lease with the landlord of the property and has continued to operate this store without any further subsidy or other obligation from Woolworth. With respect to the last remaining Affected Store, the Company has continued to operate such store for which Woolworth is providing a subsidy for the rent and occupancy costs. Pursuant to the Woolworth Settlement, either party has the option to terminate this arrangement under certain notice provisions until the lease governing such store expires in January 2001.
Use of "The Rx Place" Name - Woolworth agreed to extend the Company's license to use the service mark "The Rx Place" for an additional three year period through April 28, 2001, subject to the Company's right to extend such license for one additional year upon proper notification, as defined in the agreement.
NOTE 3-PROPERTY, FIXTURES AND EQUIPMENT AND VIDEO RENTAL INVENTORY, NET A summary of property, fixtures and equipment and video rental inventory, net at January 31, 1998 and February 1, 1997 follows (000's omitted):
January 31, February 1, 1998 1997 ---------- ---------- Property, fixtures and equipment $ 11,874 $ 11,690 Less accumulated depreciation and amortization 7,079 6,110 ---------- ---------- $ 4,795 $ 5,580 ========== ==========
January 31, February 1, 1998 1997 ---------- ---------- Video rental inventory $ 6,435 $ 5,441 Less accumulated amortization 4,463 2,910 ---------- ---------- $ 1,972 $ 2,531 ========== ==========
Total depreciation and amortization expense of property, fixtures and equipment and video rental inventory was $2,985,000, $2,775,000 and $1,940,000 in fiscal 1998, 1997 and 1996, respectively. Included in these amounts is amortization expense of video rental inventory of $1,827,000, $1,629,000 and $997,000 in fiscal 1998, 1997 and 1996, respectively.
For information concerning the return of stores to Woolworth and other provisions of the Woolworth Settlement, see Note 2.
NOTE 4 - BORROWINGS A summary of the Company's borrowings at January 31, 1998 and February 1, 1997 is set forth below (000's omitted):
January 31, 1998 February 1, 1997 ---------------------------- --------------------------- Current Non-current Current Non-current Total portion portion Total portion portion ---------------------------- --------------------------- Senior Credit Facility (*) $21,401 $2,247 $19,154 $29,040 $7,040 $22,000 Subordinated Loan 1,400 1,400 - 2,000 600 1,400 Contingent Note 1,000 1,000 - 1,000 - 1,000 ------------------------ ----------------------- Total $23,801 $4,647 $19,154 $32,040 $7,640 $24,400 ======================== =======================
(*) Effective May 14, 1998, this Senior Credit Facility was replaced and refinanced by the New Senior Credit Facility whose provisions are described below.
New Senior Credit Facility On May 14, 1998, the Company and Foothill Capital Corporation ("Foothill") entered into a Loan and Security Agreement (the "New Senior Credit Facility" or "New Facility") providing for aggregate credit to the Company of up to $35 million. The New Facility consists of: (i) a Term Loan up to $3 million and (ii) revolving advances equal to the lesser of (a) 65% of eligible inventory (at cost) or (b) $35 million less the outstanding principal amount of the Term Loan. Under the New Facility, subject to the foregoing formula, the maximum revolving advances could increase up to an aggregate of $35 million as the outstanding principal amount of the term loan is reduced. The duration of both the revolving and term loans under the New Senior Credit Facility is five years. The total loans which may be advanced by Foothill to the Company is subject to an increase to an aggregate of $40 million upon the satisfaction of certain conditions. The initial funds advanced under the New Facility were used to pay outstanding borrowings, charges, fees and temporary cash collateral account aggregating $22.6 million owing by the Company to its prior senior secured lender ("Prior Lender"). The cash collateral of $1 million, less any potential draw-downs, will be returned by the Prior Lender to the Company within thirty days. In addition, the Company incurred other transaction fees of approximately $1 million.
Indebtedness under the New Senior Credit Facility is secured by a first priority lien on substantially all of the Company's assets and, among other conditions, restricts the payment of dividends and requires that the Company maintain specified minimum tangible net worth and EBITDA (earnings before interest, taxes, depreciation and amortization) levels. The New Facility is at a borrowing rate of prime plus 1.125%, subject to decrease if the Company reaches certain EBITDA levels during the term of the facility.
Senior Credit Facility The borrowing availability with the Company's Prior Lender was based on the lesser of 60% of eligible inventory at cost or $45 million. The weighted average interest rate under the Senior Credit Facility during fiscal 1998, including the effect of facility fees, was 11.2%. During fiscal 1998, the highest borrowing level under the Senior Credit Facility was $30 million, which borrowing occurred in February 1997, and the lowest borrowing level was $18.8 million, which borrowing occurred in January 1998. During the fourth quarter of fiscal 1998, the Company's net worth fell below the minimum level established under the Senior Credit Facility. The Company was advised by its Prior Lender that it would amend such minimum net worth requirement as of January 31, 1998 and subsequent periods. By that time, however, the Company had elected to enter into the New Senior Credit Facility with Foothill on May 14, 1998 and thereby repaid all outstanding indebtedness to the Prior Lender because, among other considerations, the New Facility provides the Company with greater borrowing availability.
During the first quarter of fiscal 1999, the Company's Prior Lender extended an over-advance to the Company in the amount of $1.4 million, the outstanding balance of which was fully repaid out of the proceeds of the New Senior Credit Facility on May 15, 1998.
Subordinated Loan The Subordinated Loan payable to an unaffiliated trade supplier is being repaid in monthly installments of $50,000 with a $1.25 million balloon payment due on April 28, 1998. Pursuant to an agreement dated April 24, 1998 between the Company and the subordinated lender, the terms for the balloon payment have been amended as follows: the Company will make three consecutive monthly installments of $50,000 commencing on May 1, 1998 and a final installment of $1.1 million on August 1, 1998. The parties are currently negotiating to have the amended August 1, 1998 due date for the balloon payment extended further; however, there can be no assurance that the Company will be successful in that regard. The subordinated lender has been granted a second priority lien on substantially all of the Company's assets. The loan has a borrowing rate of prime plus 3%.
Contingent Note In connection with the Woolworth Settlement, Woolworth surrendered for cancellation two of the three then outstanding Purchase Money Notes in the aggregate amount of $5.5 million and modified the third Note (in the original principal amount of $2.9 million and originally due in April 1998) so that such Note constitutes a contingent non-interest bearing obligation of $1 million which will be surrendered by Woolworth for cancellation on July 30, 1998, subject to certain conditions. For further information concerning the Woolworth Settlement, see discussion under "Acquisition, Litigation and Final Disposition of the Woolworth Dispute" in Note 2.
NOTE 5 - INCOME TAXES The Company is not subject to federal income taxes in fiscal 1998 as the Company did not generate taxable earnings. The Company has significant net operating loss carryforwards which are available to offset future taxable income. State and local income taxes, which are computed on a basis other than income (e.g., capital stock, etc.), are not material and such amounts are included in SG&A expense.
The Company has available two classes of net operating loss ("NOL") which may be used to offset future taxable income. NOL Class #1 is the NOL generated pre-petition (e.g., prior to the 1990 Chapter 11 filing of the Company). The Company's use of NOL Class #1 is limited by formula, pursuant to the federal income tax code, to $255,000 per annum, plus the unused carry- forward balance (which, at January 31, 1998, was $442,000). The total available NOL Class #1 at January 31, 1998 amounts to approximately $2.7 million which expires in 2006.
NOL Class #2 is the NOL generated subsequent to the filing and is not subject to annual limitation. The NOL Class #2 available at January 31, 1998 amounts to approximately $12.7 million.
Deferred income tax temporary differences are determined in accordance with SFAS No. 109. The temporary differences giving rise to deferred taxes primarily relate to property and equipment, employee stock options and allowances for doubtful accounts. At January 31, 1998 and February 1, 1997, the Company has established a valuation allowance of 100% since it does not appear more likely than not that a tax asset will be realized.
NOTE 6 - STOCK OPTION AND COMPENSATION PLANS The Company has three stock option plans (a 1991 Non-Qualified Stock Option Plan; a 1991 Incentive Stock Option Plan; and a 1995 Stock Option Plan (collectively the "Stock Option Plans")) and one equity compensation plan in effect, all of which have been approved by the Company's shareholders.
1991 Non-Qualified Stock Option Plan Under the 1991 Non-Qualified Stock Option Plan (the "Non- Qualified Plan"), a total of 274,604 Common Shares were reserved for issuance to employees of the Company. The exercise price of such options is not less than 25% of the fair market value of the Common Shares subject to such options on the date of grant.
Participation in the Non-Qualified Plan was voluntary but an election to participate was irrevocable. Seven employees of the Company elected to participate (two such employees are no longer employed by the Company), each of whom specified the dollar amount by which his or her respective annual salary was reduced during each of the Company's three fiscal years commencing February 2, 1992. In return for such salary reductions, each employee participating in the Non-Qualified Plan received discounted stock options entitling each to purchase Common Shares at 25% of the fair market value of such common shares on the date of grant of the options. On June 30, 1992, 253,525 of the options available for grant under the Non- Qualified Plan were granted at an exercise price of $.544 per Common Share (equal to 25% of the fair market value on the date of grant), of which 34,942 were subsequently forfeited.
During fiscal 1997, 45,000 restricted Common Shares were granted to an executive at a nominal purchase price. As a result of the termination of this executive's employment, 15,000 of such shares were issued to him and 30,000 were forfeited pursuant to vesting provisions governing their issuance. As of January 31, 1998, 64,942 of the options granted under the Non-Qualified Plan were forfeited, 15,000 were exercised and 218,583 remain exercisable.
1991 Incentive Stock Option Plan Under the 1991 Incentive Stock Option Plan (the "Incentive Plan"), a total of 298,850 Common Shares were reserved for issuance to employees of the Company. Each of the options granted under the Incentive Plan is an incentive stock option, as that term is defined in Section 422 of the Internal Revenue Code of 1986, as amended, the exercise price of which is the fair market value of the Common Shares on the date the options were granted. Of the options available for grant under the Incentive Plan, 286,902 were granted in December 1991 at an exercise price of $1.914 per Common Share, of which 92,149 of such options were subsequently canceled. During fiscal 1997, 70,415 options under the Incentive Plan were granted at exercise prices per Common Share ranging from $3.19 to $3.75, such amounts being equal to or above the fair market values on the dates of the respective grants. As of January 31, 1998, 113,804 of the options granted under the Incentive Plan lapsed owing to the termination of optionees' employment, 19,879 were exercised and 223,634 remain exercisable.
1995 Stock Option Plan Under the 1995 Stock Option Plan (the "1995 Plan"), a total of 500,000 Common Shares have been reserved for issuance upon the exercise of stock options and related stock appreciation rights ("SARs").
Pursuant to the 1995 Plan, the Company may grant incentive stock options ("ISOs"), non-qualified stock options ("NSOs") and SAR's to officers, directors and key employees of the Company. The 1995 Plan is administered by the Compensation Committee of the Company's Board of Directors which selects the optionees, authorizes the grant of options and determines the exercise price and other terms of the options, including the vesting schedule thereof, if any. The per share exercise price of each ISO granted under the 1995 Plan must be at least 100% of the fair market value of a Common Share (and not less than 110% of the fair market value in the case of any optionee of an ISO who beneficially owns more than 10% of the total combined voting power of the Company) on the date such option is granted. The per share exercise price of an NSO must be at least 25% of the fair market value of a Common Share on the date such option is granted.
The 1995 Plan also provides for the grant of SAR's, which may be granted on a stand-alone basis or in tandem with stock options, which may be surrendered to the Company in exchange for cash, Common Shares or a combination thereof, as determined by the committee administering the 1995 Plan, having a value equal to the dollar amount obtained by multiplying (x) the number of shares subject to the surrendered SAR or option by (y) the amount by which the fair market value per Common Share exceeds the exercise price per share specified in the agreement governing the surrendered SAR's or options.
As of January 31, 1998, 472,585 options had been issued under the 1995 Option Plan, at exercise prices of $3.1875 to $3.5063 (such amounts being equal to the fair market values on the date of grant), 21,000 lapsed owing to the termination of optionees' employment resulting in 451,585 options outstanding.
The combined activity in the Stock Option Plans for the three fiscal years ended January 31, 1998 was as follows:
Number of shares Exercise price per share -------- ------------------------ Outstanding at January 28, 1995 422,549 $0.544 - $1.914 Fiscal 1996 Activity: Granted - Exercised - Canceled (5,776) $0.544 - $1.914 --------- Outstanding at February 3, 1996 416,773 Fiscal 1997 Activity: Granted 588,000 $3.188 - $5.875 Exercised - Canceled (16,724) $0.544 - $1.914 -------- Outstanding at February 1, 1997 988,049 Fiscal 1998 Activity: Granted - Exercised 31,592) $1.914 - $3.750 Canceled (62,655) $1.914 - $3.750 -------- Available for grant at January 31, 1998 893,802 ========
1992 Equity Compensation Plan for Non-Employee Directors Under the 1992 Equity Compensation Plan for Non-Employee Directors, as amended in fiscal 1996, (the "Independent Directors Plan"), a total of 50,000 Common Shares were reserved for issuance to members of the Board of Directors of the Company who do not serve as officers or employees of the Company or any of its subsidiaries (the "Independent Directors"). The Independent Directors Plan provides that each Independent Director elected by shareholders, commencing with the shareholders meeting held June 30, 1992 through the 1998 shareholders' meeting, shall be entitled to an award of 2,000 Common Shares (2,500 effective in fiscal 1996) upon his or her election or re-election. The fair market value of such shares is expensed upon issuance and added to Additional Paid-in Capital.
The Board of Directors further amended the Directors Plan to increase the number of shares reserved under such plan to 80,000 and to provide that each Independent Director, at his or her election, may receive, in lieu of cash fees of $500 per Board Meeting, and in lieu of cash fees of $250 per Committee Meeting, Common Shares of the Company for each Board Meeting and Committee Meeting attended by such Independent Director during each year of his or her incumbency as a Director. The number of such Common Shares per Board Meeting and per Committee Meeting attended shall be determined by dividing the sum of $500 ($250 for Committee Meetings) by the closing price of the Common Shares on the NASDAQ SmallCap Market on the trading day immediately preceding each such Meeting. This amendment, which is subject to shareholder ratification, became effective as of the date of the Board of Directors Meeting held on January 22, 1998. All of the Independent Directors of the Company elected to accept Common Shares in lieu of cash fees for attendance at that Board Meeting and for all subsequent Board Meetings and Committee Meetings to be held during their current terms as Directors. Pursuant to such amendment, the termination date of the Directors Plan was extended to the date immediately preceding the date of the Shareholders' meeting of the Company in the year 2001 in which directors are elected.
During fiscal 1997, the Company issued 2,500 Common Shares to a former director for past services rendered to the Company.
Application of SFAS No. 123 - Pro Forma Net Income and Net Income Per Common Share SFAS No. 123 requires the Company to disclose pro forma net income and net income per share determined as if the Company had accounted for stock-based compensation awards granted after December 31, 1994 under the fair value method of that Statement. The fair values of options under SFAS No. 123 were estimated at each grant date using a Black-Scholes option pricing model with the following assumptions: a risk-free interest rate of 6.1%, a dividend yield of zero, a volatility factor of the expected market price of the Company's common stock of 1.05 and an expected option life of seven and one-half years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For these pro forma disclosures, the estimated fair value of options and other stock-based awards is amortized to expense over the award's vesting period. The Company's fiscal 1998 and fiscal 1997 reported and pro forma information is as follows:
Fiscal 1998 Fiscal 1997 ----------- ----------- Net income (loss), as reported $(3,691,000) $1,334,000 Pro forma net income (loss) $(4,027,000) $1,007,000 Net income (loss) per share, as reported $ (1.48) $ 0.59 Pro forma net income(loss) per share $ (1.61) $ 0.44
In fiscal 1996, there were no stock-based compensation awards granted under the Stock Option Plans. Accordingly, no adjustment to the Company's fiscal 1996 pro forma results is required under SFAS No. 123.
NOTE 7 - WARRANTS In April 1995, in connection with the Acquisition, the Company issued 85,867 warrants to purchase the Company's Common Shares to its financial advisor (such amount being equal to 3% of the Company's issued and outstanding shares, including Common Share equivalents), subject to certain anti-dilution protection, for a per share exercise price of approximately $0.94. The difference between the fair market value of the warrants on the date of grant and the exercise price was included in the acquisition cost of the Rx Stores (see Note 2). All of such warrants were exercised during fiscal 1997.
In December 1991, the Company issued warrants to its previous secured lender to purchase 209,195 of its Common Shares at varying exercise prices ranging from $.19 to $1.91. In June 1997, the Company filed a Registration Statement under the Securities Act of 1933 relating to the offer and sale of such securities by that lender. As of August 2, 1997, all of such warrants had been exercised. The exercise of the warrants resulted in an increase to paid-in capital of $111,127, net of related expenses.
NOTE 8 - EMPLOYEE BENEFIT PLAN The Company has a defined contribution 401(k) savings plan which allows employees to contribute a percentage of compensation not to exceed amounts permitted under the Internal Revenue Code. The Company matches 100% of the first $1 of employee contribution each week plus 25% of any additional compensation contributed, up to a maximum of 3% of annual compensation. The Company's contribution into the 401(k) savings plan amounted to $111,000, $105,000 and $81,000 in fiscal 1998, 1997 and 1996, respectively.
NOTE 9 - RELATED PARTY TRANSACTIONS One of the Company's directors is a member of a law firm which provided legal services to the Company for fees and disbursements aggregating $79,000, $71,000 and $328,000 in fiscal 1998, 1997 and 1996, respectively.
NOTE 10 - PROVISION FOR STORE CLOSURE During fiscal 1997, the Company recorded a $1.6 million provision for estimated costs related to the closing of three stores, including two Rx stores which were returned to Woolworth in connection with the Woolworth Settlement. During fiscal 1998, the Company closed three additional Rx stores in connection with the Woolworth Settlement. No additional provision for store closure was provided for these stores as the unused provision remaining from fiscal 1997 is estimated to be sufficient to cover the anticipated closure costs for these three Rx stores. The provision for store closure primarily includes costs for inventory mark-downs, employee severance and miscellaneous wind-down expenses.
The following table summarizes activity during the last three fiscal years with respect to the provision for store closure (000's):
1998 1997 1996 ------ ------- ------ Balance, beginning of year $1,615 $ - $ - Activity: Provision - 1,615 - Amounts charged against accrual (1,146) - - Reversal of prior year over-accrual (185) - - ------ ------- ------ Balance, end of year $ 284 $ 1,615 $ - ====== ======= ======
For further information concerning the return of stores to Woolworth and other provisions of the Woolworth Settlement, see Note 2.
NOTE 11 - COMMITMENTS AND CONTINGENCIES Operating Leases The Company's operating leases are principally for retail store locations, a distribution facility and the executive offices. At January 31, 1998, future minimum rental payments required under operating leases that have initial or remaining non- cancelable lease terms in excess of one year, without regard to potential sublease revenue, is set forth below (000's):
Fiscal Year Amount ----------- --------- 1999 $ 6,657 2000 6,433 2001 6,304 2002 6,598 2003 6,251 Thereafter 51,553
Rent expense, excluding certain real estate tax and maintenance costs, for all operating leases is comprised of the following (000's):
Fiscal Fiscal Fiscal 1998 1997 1996 ------ ------ ------ Minimum rentals $7,198 $8,466 $6,781 Contingent rentals 34 93 117 Sublease revenue (788) (904) (927) ------- ------- ------- $6,444 $7,655 $ 5,971 ======= ======= =======
Legal Matters For information concerning the terms of a recent settlement of litigation between the Company and one of its landlords for a leased store, see Note 12.
In the normal course of business, the Company is subject to various legal proceedings and claims. In the opinion of management, any ultimate liability arising from or related to these claims should not have a material adverse effect on future results of operations or the consolidated financial position of the Company.
Supply Agreement The Company is a party to a three year supply agreement with McKesson Drug Company pursuant to which the Company is required to purchase a minimum of 90% of its pharmaceutical and certain other merchandise from McKesson.
Letters of Credit The Company had letters of credit outstanding of approximately $1 million at January 31, 1998.
NOTE 12 - OTHER INCOME, NET On January 31, 1998, the Company and a landlord for one of the Company's Pharmhouse stores reached an out-of-court settlement of certain litigation related to a lease for such store. Under the terms of the settlement agreement with the landlord, as amended on May 1, 1998, the Company will receive the sum of $1,675,000 ($200,000 of which was paid by the landlord on May 1, 1998 and $1,475,000 of which is payable on May 31, 1998) plus accrued interest on the outstanding balance since January 31, 1998, in exchange for waiving its exclusive right to use its space to operate a discount drugstore or discount pharmacy, thereby permitting the landlord to lease out space in the shopping center to any other tenant who operates a drugstore or pharmacy, discount or otherwise. The terms of the agreement also provide for the following: effective on May 1, 1998, the Company's present fixed monthly rent obligation for this store will convert to a percentage rent calculation; and effective on September 30, 1998, the Company has the right to terminate the lease upon 90 days prior notice to the landlord and the landlord has the right to recapture the premises for this store upon 120 days prior notice to the Company.
In connection with this transaction, the Company has recorded in its fiscal 1998 fourth quarter other income, net of related legal expenses, of $1,346,000.
NOTE 13 - SUBSEQUENT EVENT On May 14, 1998, the Company and Foothill entered into the New Senior Credit Facility providing for aggregate credit to the Company of up to $35 million. The New Facility consists of (i) a Term Loan up to $3 million and (ii) revolving advances equal to the lesser of (a) 65% of eligible inventory (at cost) or (b) $35 million less the outstanding principal amount of the term loan. Under the New Facility, subject to the foregoing formula, the maximum revolving advances could increase up to an aggregate of $35 million as the outstanding principal amount of the term loan is reduced. The duration of both the revolving and term loans under the New Senior Credit Facility is five years. The total loans which may be advanced by Foothill to the Company is subject to an increase to an aggregate of $40 million upon the satisfaction of certain conditions. The initial funds advanced under the New Facility were used to repay outstanding borrowings, charges, transaction fees and temporary cash collateral account aggregating $22.6 million owing by the Company to its Prior Lender. The cash collateral of $1 million, less any potential draw-downs, will be returned to the Company within thirty days. In addition, the Company incurred other transaction fees of approximately $1 million.
Indebtedness under the New Senior Credit Facility is secured by a first priority lien on substantially all of the Registrant's assets and, among other conditions, restricts the payment of dividends and requires that the Registrant maintain specified minimum tangible net worth and EBITDA levels. The New Facility is at a borrowing rate of prime plus 1.125%, subject to decrease if the Company reaches certain EBITDA levels during the term of the facility.
Report of Independent Accountants on Financial Statement Schedule
To the Board of Directors and Shareholders of Pharmhouse Corp.
Our audits of the consolidated financial statements referred to in our report dated April 24, 1998 and May 14, 1998 appearing on page of the 1998 Annual Report on Form 10-K of Pharmhouse Corp. for the year ended January 31, 1998 also included an audit of the Financial Statement Schedule listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
PRICE WATERHOUSE LLP
New York, New York May 14, 1998
PHARMHOUSE CORP. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (In thousands)
Additions Deductions
Balance at Charged to Balance beginning costs and Bad debt Bad debt at end of of period expenses write offs recoveries period
Reserves deducted in balance sheet
January 31, 1998: Allowance for doubtful accounts $ 987 $ 281 $ (193) $ - $1,075
February 1, 1997: Allowance for doubtful accounts $ 918 $ 219 $ (150) $ - $ 987
February 3, 1996: Allowance for doubtful accounts $ 618 $ 383 $ (37) $ (46) $ 918