Paragon Pharmacies Limited
TSX VENTURE : PGN

Paragon Pharmacies Limited

January 29, 2007 22:54 ET

Paragon Pharmacies Limited Announces Results For The Three Month Period Ended November 30, 2006

KELOWNA, BRITISH COLUMBIA--(CCNMatthews - Jan. 29, 2007) -

Not for dissemination in the United States of America

Paragon Pharmacies Limited ("Paragon") (TSX VENTURE:PGN) is pleased to announce that the interim unaudited consolidated financial statements of Paragon and its subsidiaries (collectively, the "Company") for the three month period ended November 30, 2006 have been filed on SEDAR and are available for viewing at www.sedar.com. These statements have been prepared by management of the Company and have not been reviewed by the Company's auditors.

Certain selected operational and financial information for the Company for the 3 months ended November 30, 2006 and for the 12 months ended August, 2006 are set out below and should be read in conjunction with the Company's audited financial statements filed on SEDAR.

Summary Discussion and Analysis for the Company

The following is a discussion of the consolidated financial condition and results of operations of the Company for the three month period ended November 30, 2006. This discussion and analysis should be read in conjunction with the Company's interim unaudited consolidated financial statements and accompanying notes for the three month period ended November 30, 2006. The unaudited consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles ("GAAP"). All references to dollars are in Canadian funds unless otherwise indicated.

OVERVIEW

As at November 30, 2006, the Company owned and operated 19.5 stores (17.5 retail pharmacies and 2 home health care stores) in British Columbia and Alberta. The retail pharmacies operated under either the IDA brand name and banner program or the Super Drug Mart brand name and the home health care stores as Canadian Medical Supplies. The Super Drug Mart stores were acquired on April 28, 2006. Paragon Pharmacies Ltd. amalgamated with Rinoa Enterprises Ltd. to form Paragon Pharmacies Limited on November 1, 2006 and accordingly the financial results from the acquired assets are included from that date forward. The Company also owns a 28.0% interest in Catalyst Healthcare Ltd. (servicing the pharmacy needs of long term care service providers) and a 50% interest in a distribution centre.

OVERALL PERFORMANCE

The following provides a summary of the Company's overall performance for the three month period ended November 30, 2006 compared to the three month period ended November 30, 2005.

- Completed amalgamation with Rinoa Enterprises Ltd., a capital pool company, on October 31, 2006 to form Paragon Pharmacies Limited publicly traded on the TSX Venture Exchange (TSX VENTURE:PGN)

- Hired Ben Holden as VP Corporate Development and commenced more corporate development activities

- Continued integration of the Super Drug Mart stores

- First quarter total sales revenue of $16.275 million (2005: $6.848), an increase of 137.7%

- Total comparable store sales growth of 5.2%(i)

(i) Note: Comparable sales growth excludes Super Drug Mart stores as not owned for comparable quarters

- Total gross margin of $5.273 million (2005: $2.059 million), an increase of 156.1%

- Total gross margin as a percentage of sales of 32.4% (2005: 30.1%)

- Total operating expenses, excluding amortization, bank charges and interest, interest on long-term debt and stock-based compensation, of $4.367 million or 26.8% of sales versus $1.986 million or 29.0% of sales in 2005

- First quarter EBITDA(1) of $0.906 million (2005: $0.073 million), an increase of 1,141.9%

- First quarter EBITDA margin(2) of 5.6% (2005: 1.1%), an increase of 422.6%

- First quarter net loss of $0.086 million (2005: $0.270 million loss), a decrease of 68.1%

- First quarter purchases of capital assets of $0.123 million, compared to $0.108 million in 2005

- Net debt of $7.516 million, compared to $2.077 million in 2005 (see table in the Financial Position section for calculation)

o Net debt to equity of 0.40:1, compared to 0.11:1 in 2005

(1) EBITDA defined as earnings before interest on long-term debt, bank charges and interest, income taxes, amortization, stock-based compensation, loss from discontinued operations, loss on equity investments and amalgamation costs greater than cash received. (See table in the Results of Operations for calculation of EBITDA).

(2) EBITDA margin defined as EBITDA divided by Revenue.

RESULTS OF OPERATIONS

The following table presents a summary of certain selected operating data and consolidated financial information for the Company.




3 Months Ended
-------------------------------------------------------------------------
November 30, November 30,
2006 2005
-------------------------------------------------------------------------
Revenue 16,274,593 6,847,999
-------------------------------------------------------------------------
Cost of Goods Sold & Other Operating
Expenses(1) 15,368,614 6,775,049
-------------------------------------------------------------------------
EBITDA(2) 905,979 72,950
-------------------------------------------------------------------------
Amortization 517,434 271,685
-------------------------------------------------------------------------
Bank charges and interest 39,567 12,289
-------------------------------------------------------------------------
Stock-based compensation 0 0
-------------------------------------------------------------------------
Operating income (loss)3 348,978 (211,024)
-------------------------------------------------------------------------
Interest on long-term debt 177,408 49,695
-------------------------------------------------------------------------
Income (loss) before other items 171,570 (260,719)
-------------------------------------------------------------------------
Loss on equity investments (98,678) (7,948)
-------------------------------------------------------------------------
Amalgamation costs greater than cash received (158,943) 0
-------------------------------------------------------------------------
Loss from discontinued operations 0 (1,435)
-------------------------------------------------------------------------
Net loss (86,051) (270,102)
-------------------------------------------------------------------------
Per common share
- Basic net earnings ($0.003) ($0.029)
- Diluted net earnings ($0.003) ($0.029)
-------------------------------------------------------------------------


(1) Other operating expenses include selling, general and administration expenses (excludes amortization, bank charges and interest, interest on long term debt and stock-based compensation).

(2) EBITDA defined as earnings before interest on long-term debt, bank charges and interest, income taxes, amortization, stock-based compensation, loss from discontinued operations, loss on equity investments and amalgamation costs greater than cash received.

(3) Operating loss defined as loss before interest on long-term debt, taxes, loss on disposal of capital assets, loss on equity investment, loss from discontinued operations and amalgamation costs greater than cash received.

Sales

Sales revenue is comprised of sales to customers of the Company's retail pharmacies, home health care stores and central fill pharmacies (only including September and October 2005 for Paragon Central Fill Ltd. that was disposed of October 31, 2005).

Sales in the first quarter were $16.275 million compared to $6.848 million for the same period last year, an increase of $9.427 million or 137.7% . Increases were a result of growth in same store sales and new sales from the recently acquired Super Drug Mart stores. Same store sales growth is attributed to growth in prescription sales and the addition/enhancement of giftware, cosmetics and home healthcare front stores categories.

Cost of Goods Sold and Other Operating Expenses

Cost of goods sold is comprised of the cost of goods sold through the Company's retail pharmacies, home health care stores and central fill pharmacies (September 2005 and October 2005 only for Paragon Central Fill Ltd. that was disposed of October 31, 2005). Other operating expenses include general and administrative, selling, and corporate expenses, excluding stock-based compensation, amortization, bank charges and interest on long-term debt.

Total cost of goods sold and other operating expenses for the first quarter were $15.369 million compared to $6.775 million in the same period last year, an increase of $8.594 million or 126.8% . This was primarily a result of the acquisition of the Super Drug Mart stores. Gross margin as a percentage of sales increased 230 basis points to 32.4% from 30.1% in the same period last year. Other operating expenses as a percentage of sales decreased 220 basis points to 26.8% compared to the same period last year. This decrease is primarily a result of tighter expense monitoring, and increased sales revenues.

Amortization

Amortization of capital and intangible assets in the first quarter was $0.517 million compared to $0.272 million in the same period last year, an increase of $0.246 million or 90.5% . This increase is primarily a result of the acquisition of the Super Drug Mart stores on April 28, 2006.

Operating Income

Operating income for the first quarter was $0.349 million compared to a loss of $0.211 million in the same period last year, an increase of $0.560 million or 265.4%. First quarter operating margin increased 520 basis points to 2.1% compared to the first quarter of last year. EBITDA margin, defined as EBITDA divided by Sales, increased to 5.6% from 1.1% in the first quarter last year.

Interest Expense

Interest expense, defined as interest on long-term debt and capital leases, for the first quarter was $0.177 million compared to $0.050 million in the same period last year, an increase of $0.128 million or 257.0% . This increase is a result of debt financing obtained for the Super Drug Mart acquisition.

Loss on Other Items

The loss on equity investments resulted from the Company's share of losses recognized on its equity investments in Catalyst Healthcare Ltd. and 1036985 Alberta Ltd. (Cochrane Super Drug Mart).

For the first quarter, loss on equity investments was $0.099 million compared to $0.008 million in 2005, loss from discontinued operations was $Nil compared to $0.001 million in 2005, and amalgamation costs greater than cash received was $0.159 million compared to $Nil in 2005.

Net Loss

The net loss for the first quarter was $0.086 million compared to a loss of $0.270 million in the same period last year, a decrease of $0.184 million or 68.1%. On a diluted basis, earnings per share were ($0.003) in the first quarter compared to ($0.029) in the same period last year.

FINANCIAL POSITION

The following table provides a summary of certain information with respect to the Company's financial position at the end of the periods indicated.



November 30, August 31,
2006 2006
---------------------------------------------------------------------------
Cash $ 2,741,812 $ 86,331
---------------------------------------------------------------------------
Current portion of long-term debt and capital
leases 3,096,276 3,098,914
---------------------------------------------------------------------------
Long-term debt and capital leases 7,161,904 7,977,746
---------------------------------------------------------------------------

---------------------------------------------------------------------------
Net debt 7,516,368 2,076,781
---------------------------------------------------------------------------

---------------------------------------------------------------------------
Shareholders' equity 18,813,391 18,974,350
---------------------------------------------------------------------------

---------------------------------------------------------------------------
Total capitalization 26,329,759 6,984,628
---------------------------------------------------------------------------

---------------------------------------------------------------------------
Net debt: Shareholders' equity 0.40:1 0.11:1
Net debt: Total capitalization 0.29:1 0.30:1
Net debt: EBITDA(1) 8.30:1 2.32:1(2)
EBITDA(1): Cash interest expense 5.11:1 4.77:1(2)
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(1) EBITDA defined as earnings before interest on long-term debt, bank charges and interest, income taxes, amortization, stock-based compensation, loss from discontinued operations, loss on equity investments and amalgamation costs greater than cash received.

(2) EBITDA computed, as defined above in Note 1, for the 3 months ended August 31, 2006 is 896,184.

LIQUIDITY AND CAPITAL RESOURCES

For the 3 month period ended November 30, 2006, the ratio of current assets to current liabilities was 1.69:1 compared to 1.97:1 at August 31, 2006. Working capital was $6.695 million compared to $6.902 million at August 31, 2006.

The Company also had access to a $2 million operating line with a Canadian chartered bank and at November 30, 2006 maintained an indebtedness of $Nil on the line.

The Company's principal capital requirements are to fund working capital needs, renovate existing stores and acquire new stores in connection with its expansion strategy. These capital requirements have generally been satisfied by a combination of cash flow from operations and borrowings under its term and operating loans and the issuance of common shares. Future expansion could result in additional debt and equity financings (see Subsequent Event).

Operating Activities

For the first quarter, net cash flow generated from operating activities from continued operations was $1.616 million compared to $0.419 million in the same period last year. This increase was primarily due to improved operations, better management of working capital, and the acquisition of the Super Drug Mart stores.

Investing Activities

For the first quarter, net cash flow from investing activities was $1.654 million compared to $0.435 million in the same period last year. This increase relates primarily to the release of $1,500,000 of cash held in trust.

Financing Activities

For the first quarter, net cash flow from financing activities was negative $0.615 million compared to negative $0.295 million in the same period last year. This decrease relates primarily due to the paying down of long term debt.

As of November 30, 2006, the Company's long term debt financing includes Toronto Dominion Bank ($8,333,333); Third Party Loan Agreement ($1,204,094); CIT Financial Ltd. ($14,719); Ford Credit ($61,703); and Microsoft Capital Corporation ($9,296). The term loans are secured by general security agreements against all existing and future acquired assets of the Company. As at November 30, 2006, the Company is in compliance with all covenants.

Future Liquidity

Based on current operating levels and available funds, there will be sufficient means to satisfy the Company's working capital needs and debt-service requirements for the coming fiscal year. Any future acquisitions or Greenfield developments may require additional debt and equity financing while maintaining the existing covenants (see Subsequent Event).

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no off-balance sheet arrangements.

TRANSACTIONS WITH RELATED PARTIES

The Company has the following amounts due from related parties: ACO Super Drug Mart Ltd. ($118,082); Catalyst Healthcare Ltd. ($44,905); 1036985 Alberta Ltd. (Super Drug Mart Cochrane) $347,249; and Super Drug Mart Partnership $135,142. The amounts due are non-interest bearing with no fixed terms of repayment. The parties are related via common shareholders.

Three of the Company's retail pharmacies have lease agreements for their premises with a related party, related via common shareholders. These transactions were recorded at fair market value and represent annual rent of $263,391 in 2007, $290,475 in 2008, $272,547 in 2009, $199,437 in 2010 and $199,437 in 2011.

SUBSEQUENT EVENT

On January 11, 2007 the Company agreed to a financing to raise up to $4,000,000 through a private placement of units of the Company ("Units") at a price of $0.80 per Unit, with each Unit being comprised of one common share and one-half of one common share purchase warrant ("Purchase Warrant"). Each whole Purchase Warrant shall entitle the holder to acquire one common share of the Company for a period of 24 months from the closing date at an exercise price of $1.00 per common share. Closing of the private placement is subject to necessary TSX Venture Exchange ("TSXV") approval and is expected to occur on or about February 16, 2007.

The Company has also agreed, subject to receipt of applicable TSXV and shareholder approval, among other things, to complete an additional financing with a private investment fund (the "Lender") for a combination of (i) $3,000,000 of Units at a price of $0.80 per Unit, with each Unit being comprised of one common share ("Common Share") and one-half of one Common Share purchase warrant ("Warrant"). Each whole Warrant shall entitle the holder to acquire one Common Share for a period of 24 months from the closing date at an exercise price of $1.00 per Common Share; and (ii) $20,000,000 of secured convertible debt with a 2 year term (the "Convertible Debt"), the proceeds of which are to be used by the company to complete future acquisitions. The Convertible Debt will pay interest at a rate of 15% and will convert into Common Shares under certain circumstances, or at the option of the Lender, at a price of $0.8028 per Common Share. Interest may be paid in additional Common Shares from treasury based on market price at the time, and additional interest, also potentially payable in Common Shares based on market price at the time, may apply if acquisitions do not meet certain financial criteria. The Convertible Debt financing will require shareholder approval, as the Lender, assuming conversion of the Convertible Debt, will acquire a substantial interest in the Company. The Company anticipates that a shareholder meeting will be held on or about March 30, 2007, with closing of the financing expected in April of 2007. This Convertible Debt financing will be subject to terms and conditions customary of transactions of this nature.

OUTSTANDING SHARE DATA

The Company had 32,189,484 common shares outstanding at November 30, 2006. As at this same date, the Company had outstanding options to acquire 710,615 of its common shares and warrants to acquire 5,676,200 of its common shares. All options were exercisable with 145,115 at $0.20, 197,000 at $1.00 and 368,500 at $1.50. There were 41,200 warrants at $1.50 expiring throughout December 2006 (and subsequently expired), 2,000,000 warrants at $1.25 expiring in August 2008 and 3,635,000 warrants at $0.80 expiring in April 2008.

CHANGES IN ACCOUNTING POLICIES

There were no changes in accounting policies during the first quarter.

FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS

Fair value

The carrying amount reported on the interim consolidated balance sheet for cash and cash equivalents, accounts receivable, due from (to) related parties and accounts payable and accrued liabilities approximated their fair value due to the short-term nature of these accounts. The carrying value of capital leases approximated their fair value given that the interest rates inherent in the leases reflect rates currently available for leases with similar terms and maturities. The long-term debt is subject to both fixed and floating interest rates. The floating rate debt appropriately reflects rates currently available for debt with similar terms and maturities. Accordingly, the fair value of this debt is not materially different from the carrying value. The fixed rate debt, which has a carrying value of $1,275,093 at November 30, 2006 (August 31, 2006 - $1,579,241), has a fair value of $1,228,644 (August 31, 2006 - $1,493,030).

Interest rate risk

A portion of long-term debt is at a floating interest rate and as a result, the Company is exposed to changes in interest rates. Increases or decreases in these rates could affect the Company's earnings.

Credit risk

The Company is exposed to credit risk to the extent that its customers may experience financial difficulty and would be unable to meet their obligations. However, the Company has a large number of diverse customers, thereby minimizing the concentration of credit risk.

BILL 102, THE TRANSPARENT DRUG SYSTEM FOR PATIENTS ACT, 2006

The roll-out of the Ontario Transparent Drug System for Patients Act, 2006 (the "Act") continues to create challenges for pharmacies in the province of Ontario. The Act received Royal Assent on June 20, 2006 and since then various professional organizations have been addressing the impact of the reforms to the provincial drug system.

The most significant changes are:

- the drug benefit price of generic products now cannot exceed 50% of the original brand price (whereas previously the first generic was set at 70% of brand price and subsequent generics at up to 90% of the first generic price)

- professional allowances paid to pharmacies are restricted to expenditures for direct patient care and capped at 20% of the total generic drug costs reimbursed by the Ontario Drug Benefit ("ODB") program

- the dispensing fee for ODB prescriptions increased from $6.54 to $7.00 while the permitted mark-up is to decline from 10% to 8% as of April 1, 2007

- also by April 1, 2007 the government has committed to begin paying pharmacists for certain professional services from a $50-million fund ear-marked for that purpose

Currently, the Company does not own or operate any pharmacies in the Province of Ontario.

Management is watching closely as other provinces consider similar measures to reduce drug program costs. British Columbia has initiated an activity-based cost survey as a first step to changing its approach to compensating drug stores for delivery of its PharmaCare services, which will likely be addressed once the year-long Conversation on Health is concluded. One of the four priorities of the new Minister of Health and Wellness in Alberta is implementing a new pharmaceutical strategy to assure the sustainability of that province's drug coverage for seniors and low-income citizens.

DISCLOSURE CONTROLS AND PROCEDURES

Multilateral Instrument 52-109 Certification of Disclosure in Issuers' Annual and Interim Filings, requires the President and Chief Executive Officer ("CEO"), and the Chief Financial Officer ("CFO") of the Company, to file annual and quarterly certificates certifying that they are responsible for establishing and maintaining controls and procedures for the Company, and that they have designed such disclosure controls and procedures, or have caused them to be designed under their supervision, to provide reasonable assurance that material information relating to the Company is made known to them by others within the Company during the period in which the interim filings are being prepared. The CEO and CFO believe controls and procedures have been designed to provide reasonable assurance that all information is made known to them and the reliability of the financial reporting and the preparation of financial statements for external purposes.



Interim Consolidated Statement of Loss and Deficit
Three Month Periods Ended November 30, 2006 and 2005
(Unaudited)
--------------------------------------------------------------------------
--------------------------------------------------------------------------
November 30, November 30,
2006 2005
(Unaudited) (Unaudited)
(3 months) (3 months)
$ $
---------------------------
---------------------------
REVENUE 16,274,593 6,847,999

COST OF SALES 11,001,243 4,788,585
---------------------------

GROSS PROFIT 5,273,350 2,059,414
---------------------------
EXPENSES
Selling, general and administration 4,367,371 1,986,464
Amortization 517,434 271,685
Bank charges and interest 39,567 12,289
Interest on long-term debt 177,408 49,695
---------------------------
5,101,780 2,320,133
---------------------------
INCOME (LOSS) BEFORE OTHER ITEM 171,570 (260,719)

OTHER ITEM
Loss on equity investments (Note 9) (98,678) (7,948)
Amalgamation costs greater than cash received (158,943) -
---------------------------

NET INCOME (LOSS) FROM CONTINUING OPERATIONS (86,051) (268,667)

LOSS FROM DISCONTINUED OPERATIONS - (1,435)
---------------------------

NET LOSS (86,051) (270,102)

DEFICIT, BEGINNING OF PERIOD (4,900,249) (3,651,356)

Disposition of Paragon Central Fill Ltd. - 373,586
---------------------------
DEFICIT, END OF PERIOD (4,986,300) (3,547,872)
---------------------------
---------------------------


Interim Consolidated Balance Sheets

November 30, 2006 and August 31, 2006
(Unaudited)
---------------------------------------------------------------------
---------------------------------------------------------------------
November 30, August 31,
2006 2006
(Unaudited) (Audited)
$ $
--------------------------

ASSETS
CURRENT
Cash and cash equivalents 2,741,812 86,331
Cash held in trust - 1,500,000
Accounts receivable 3,314,811 2,828,929
Income taxes recoverable 1,484 -
Inventory 9,866,364 8,826,745
Prepaid expenses and deposits 216,531 165,449
Due from related parties (Note 5) 319,404 597,684
--------------------------
16,460,406 14,005,138

Deferred costs 19,187 367,533
Capital assets (Note 3) 1,369,576 1,368,903
Intangible assets (Note 4) 5,063,902 5,457,545
Investment in private companies (Note 9) 406,556 435,445
Goodwill, at cost 12,420,709 12,420,709
--------------------------
35,740,336 34,055,273
--------------------------
--------------------------
LIABILITIES
CURRENT

Accounts payable and accrued liabilities 6,668,765 4,004,263
Current portion of long-term debt (Note 6) 3,036,209 3,037,853
Current portion of capital leases (Note 7) 60,067 61,061
--------------------------
9,765,041 7,103,177

Long-term debt (Note 6) 7,086,936 7,891,608
Capital leases (Note 7) 74,968 86,138
--------------------------
16,926,945 15,080,923
--------------------------
SHAREHOLDERS' EQUITY
Share capital (Note 8) 22,865,286 22,939,536
Contributed surplus (Note 8) 934,405 935,063
Deficit (4,986,300) (4,900,249)
--------------------------
18,813,391 18,974,350
--------------------------
35,740,336 34,055,273
--------------------------
--------------------------


APPROVED BY THE BOARD

"Craig Cameron", Director

"Reginald Hihn", Director


Interim Consolidated Statement of Cash Flows

Three Month Periods Ended November 30, 2006 and 2005
(Unaudited)
--------------------------------------------------------------------------
--------------------------------------------------------------------------
November 30, November 30,
2006 2005
(Unaudited) (Unaudited)
(3 months) (3 months)
$ $
---------------------------
---------------------------
CASH FLOWS RELATED TO
THE FOLLOWING ACTIVITIES:

OPERATING
Net income (loss) from continuing operations (86,051) (270,102)
Adjustments for:
Amortization 517,434 271,685
Loss on equity investment 98,678 7,948
---------------------------
530,061 9,531
Changes in non-cash working capital and other
non-cash items:
Accounts receivable (485,882) (190,760)
Inventory (1,039,619) 36,155
Prepaid expenses and deposits (51,082) 62,220
Accounts payable and accrued liabilities 2,664,502 501,874
Income taxes (1,484) -
---------------------------
Operating cash flow from continuing operations 1,616,496 419,020
---------------------------
Net loss from discontinued operations

Current assets - 184,834
Current liabilities - (120,619)
---------------------------
Operating cash flow from discontinued
operations - 64,215
---------------------------
- 483,235
---------------------------
FINANCING
Advances (repayment) from related parties 278,280 (286,081)
Deposits received in advance for issuance of
shares - 250,000
Issuance of share capital, net of share
issuance costs (74,907) -
(Repayment) advances of long-term debt, net (806,316) (41,991)
Repayment of capital leases (12,164) (217,013)
---------------------------
(615,107) (295,085)
---------------------------
INVESTING
Cash received from trust account 1,500,000 -
Proceeds on disposition of Paragon Central
Fill Ltd. - 250,000
Purchase of Prairie Supply Co-op shares (69,789) -
Purchase of interest in Catalyst Healthcare
Ltd. (Note 9) - (263)
Deferred costs 348,346 -
Intangible assets (1,392) -
Proceeds on disposal of capital assets - 294,145
Purchase of capital assets (123,073) (108,401)
---------------------------
1,654,092 435,481
---------------------------
NET (DECREASE) INCREASE IN CASH 2,655,481 623,631

CASH, BEGINNING OF PERIOD 86,331 417,276
---------------------------
CASH, END OF PERIOD 2,741,812 1,040,907
---------------------------
---------------------------

Represented by:
Cash - continuing operations 2,741,812 1,037,753
Cash - discontinued operations - 3,154
---------------------------
2,741,812 1,040,907
---------------------------
---------------------------

SUPPLEMENTARY INFORMATION:
Interest paid 216,975 49,695
---------------------------
---------------------------

Notes to the Interim Consolidated Financial Statements
Three Month Periods Ended November 30, 2006 and 2005
(Unaudited)
---------------------------------------------------------------------------
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1. BASIS OF PRESENTATION

These unaudited interim consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and follow the same accounting policies and methods of application with those used in the preparation of the audited annual consolidated financial statements for the year ended August 31, 2006 and 2005, and include all adjustments necessary to present fairly the results for the interim periods. Certain information and disclosure included in the year end consolidated financial statements have been condensed or omitted. In the opinion of Management, all adjustments considered necessary for fair presentation have been included in these interim consolidated financial statements. These financial statements should be read in conjunction with the consolidated financial statements and notes for the year ended August 31, 2006 and 2005.

Paragon Pharmacies Limited (the "Company") is comprised of one single operating segment which is drug store operations which focuses on the customer and communities in which they are located. In addition, the pharmacies offer supplemental services such as Canada Post outlets, lottery tickets and transit pass sales.

These interim consolidated financial statements also reflect the amalgamation of Rinoa Enterprises Ltd. ("Rinoa") and Paragon Pharmacies Ltd. ("Paragon") on October 31, 2006 to create Paragon Pharmacies Limited (Note 2).

2. AMALGAMATION WITH RINOA ENTERPRISES LTD.

On October 13, 2006 the respective shareholders of Paragon Pharmacies Ltd. ("Paragon") and Rinoa Enterprises Ltd. ("Rinoa") approved the amalgamation of both companies. On October 31, 2006, the Amalgamation was completed. The terms of the Amalgamation involved the reverse take over of Rinoa by Paragon to create a new company under the name Paragon Pharmacies Limited (the "Company").

Pursuant to the Amalgamation, all outstanding securities of both Paragon and Rinoa were exchanged for the Company's securities on a one for one basis. On November 2, 2006, the TSX Venture Exchange ("the Exchange") approved the amalgamation as Rinoa's Qualifying Transaction. As a result, on November 3, 2006, Rinoa ceased to be a Capital Pool Company and its common shares were delisted from trading on the Exchange. Also on November 3, 2006, in accordance with Exchange Policy 2.5, the common shares of Paragon Pharmacies Limited commenced trading on the Exchange.

As Paragon was deemed to be the acquirer for accounting purposes, the Company's assets and liabilities are included in the interim consolidated financial statements at their carrying value.

As the shareholders of Paragon obtained control of Rinoa reverse takeover accounting was applied.

The consolidated interim financial statements of the combined entities are considered a continuation of the financial statements of Paragon Pharmacies Limited.

The accounting for the reverse take-over reflects the fair value of Rinoa's assets acquired, after reflecting the business combination with Paragon as follows:



---------------------------
$
---------------------------
Current assets 3,896
Current liabilities (79,815)
---------------------------
(75,919)
Cash acquired 585,982
---------------------------
510,063
---------------------------
---------------------------


3. CAPITAL ASSETS

--------------------------------------------------------
November 30, 2006 August 31, 2006
(Unaudited) (Audited)
(3 months) (12 months)
--------------------------------------------------------
Accumulated Net Book Net Book
Cost Amortization Value Value
$ $ $ $
--------------------------------------------------------

Furniture and
fixtures 660,340 365,757 294,583 282,674
Automotive 155,622 74,211 81,411 83,644
Nursing home and
pharmacy equipment 54,938 7,780 47,158 10,598
Computer equipment 563,765 342,308 221,457 224,147
Computer software 131,031 90,121 40,910 60,827
Assets under
capital lease 185,806 33,533 152,273 163,907
Leasehold
improvements 1,115,991 584,207 531,784 543,106
--------------------------------------------------------
2,867,493 1,497,917 1,369,576 1,368,903
--------------------------------------------------------
--------------------------------------------------------


4. INTANGIBLE ASSETS

--------------------------------------------------------
November 30, 2006 August 31, 2006
(Unaudited) (Audited)
(3 months) (12 months)
--------------------------------------------------------
Accumulated Net Book Net Book
Cost Amortization Value Value
$ $ $ $
--------------------------------------------------------

Prescription files 7,245,105 2,631,745 4,613,360 4,975,005
Pre-operating costs 27,823 3,012 24,811 26,098
Operating leases 466,551 104,048 362,503 391,109
Loan financing fees 71,395 8,167 63,228 65,333
Non-competition
agreement 10,000 10,000 - -
--------------------------------------------------------
7,820,874 2,756,972 5,063,902 5,457,545
--------------------------------------------------------
--------------------------------------------------------

5. DUE FROM (TO) RELATED PARTIES

-------------------------------------------------
November 30, August 31,
2006 2006
(Unaudited) (Audited)
(3 months) (12 months)
$ $
-------------------------------------------------
ACO Super Drug Mart Ltd. (118,082) (67,392)
Catalyst Healthcare Ltd. (44,905) 96,904
1036985 Alberta Ltd.
(Cochrane Super Drug Mart) 347,249 184,058
Super Drug Mart Partnership 135,142 384,114
-------------------------------------------------
319,404 597,684
-------------------------------------------------
-------------------------------------------------


The amounts due from (to) related parties are non-interest bearing with no fixed terms of repayment. The parties are related as they have common shareholders.

During the period, the Company paid $67,627 (year ended August 31, 2006 - $95,168) in rent for premises leased under operating leases with related parties. These transactions have been recorded at fair market value.



6. LONG-TERM DEBT

--------------------------------
November 30, August 31,
2006 2006
(Unaudited) (Audited)
(3 months) (12 months)
$ $
--------------------------------

Toronto Dominion Bank
Loan payable bearing interest at tiered
rates from prime plus 0.50% to prime
plus 1.50% per annum, repayable in monthly
instalments of $166,667 plus interest, due
April 2011, secured by a general security
agreement, first charge on all the assets of
the Company including its subsidiaries, with
a specific first charge on the inventory of
the Company, and unlimited guarantees of
advances executed by the Company and its
subsidiaries 8,833,333 9,333,333

Third Party Loan Agreement
Non-interest bearing loan, repayable in
monthly instalments of $83,333, due February
2008, secured by a general security agreement 1,204,094 1,500,000

CIT Financial Ltd.
Loan bearing interest at prime plus 4.9%,
secured by a general security agreement, a
general assignment of book debts and personal
guarantees, repayable at $823 per month,
including interest 14,719 16,887

Microsoft Capital Corporation
Loan payable bearing interest at 2.567% per annum,
payable in blended monthly instalments of $941,
due September 2007, secured by certain capital
assets, a general security agreement covering all
assets and undertakings of Black Mountain Pharmacy
(1979) Ltd. 9,296 12,046

Ford Credit
Non-interest bearing loan, repayable in monthly
instalments of $450, due May 2009, secured by a
general security agreement covering all assets
and undertakings of the Company 13,049 14,400

Non-interest bearing loan, repayable in monthly
instalments of $463, due November 2010, secured
by a general security agreement covering all
assets and undertakings of the Company 21,750 23,601

Non-interest bearing loan, repayable in monthly
instalments of $572, due November 2010, secured
by a general security agreement covering all
assets and undertakings of the Company 26,904 29,194
--------------------------
10,123,145 10,929,461

Less current portion 3,036,209 3,037,853
--------------------------
7,086,936 7,891,608
--------------------------
--------------------------


Principal payments required in each of the next five twelve month periods
ended November 30 are as follows:

---------
$
---------
2007 3,036,209
2008 2,229,792
2009 2,012,422
2010 2,011,387
2011 and subsequent 833,330



7. CAPITAL LEASES
------------
November 30,
2006
(Unaudited)
$
------------
Period ending November 30, 2008 68,765
2009 35,037
2010 22,784
2011 12,986
2012 15,017
------------

Total minimum lease payments 154,988

Less amount representing interest at rates ranging from
3% - 18.2% 19,553
------------
Balance of obligation 135,035

Less current portion 60,067
------------
74,968
------------
------------


8. SHARE CAPITAL
--------------------------
Number of
Common Amount
Shares Issued $
--------------------------

Authorized
Unlimited number of common voting shares
Unlimited number of first and second
preferred shares, issuable in series, rights
to be determined by directors

Issued

Balance, August 31, 2006 26,884,599 24,525,924

Shares issued to the shareholders of Rinoa on
the acquisition of Rinoa by Paragon 5,299,825 510,063

Issuance of common shares on exercise of
agent options 5,060 1,670
--------------------------
Balance, November 30, 2006 32,189,484 25,037,657
--------------------------
--------------------------

November 30, August 31,
2006 2006
(Unaudited) (Audited)
$ $
--------------------------
Shares issued 25,037,657 24,525,924
Share issuance costs (2,172,371) (1,586,388)
--------------------------
Share capital 22,865,286 22,939,536
--------------------------
--------------------------


Granting of options

During the three month period ended November 30, 2006, the Company issued nil options (twelve month period ended August 31, 2006 - Nil) with a weighted average exercise price of $Nil (August 31, 2006 - $Nil), which vested immediately, to certain directors, officers, employees and consultants of the Company.

28,825 Rinoa agent options were exercised prior to October 31, 2006 with a weighted average exercise price of $0.20. 250,000 Rinoa directors' options were exercised on October 31, 2006 with a weighted average exercise price of $0.20.

5,060 options with a weighted average exercise price of $0.20 were exercised during November 2006 (twelve month period ended August 31, 2006 - Nil) and 20,000 options (twelve month period ended August 31, 2006 - Nil options) with a weighted average exercise price of $1.00 (August 31, 2006 - $Nil) were cancelled.



The options outstanding at November 30, 2006 were as follows:

Number of Exercise
Options Price
Date Issued Outstanding $ Expiry Date
---------------------------------------------------------------------------
February 27, 2004 197,000 1.00 February 27, 2009
December 10, 2004 118,500 1.50 December 10, 2009
June 30, 2005 250,000 1.50 June 30, 2010
-----------
565,500

November 3, 2005 145,115 0.20 November 3, 2007
(Outstanding options of
Rinoa at November 30, 2006)
-----------
710,615
-----------
-----------


The weighted average exercise price of the options outstanding and exercisable at November 30, 2006 is $1.10 (August 31, 2006 - $1.31).

Warrants



The following warrants were issued entitling the holder thereof to purchase
one common share of the Company as described below:

---------------------------------------------------------------------------
Number Number Number
Date of of of Total Exercise
Issued Warrants Warrants Warrants Warrants Price Expiry
Exercised Expired Outstanding $ Date
---------------------------------------------------------------------------

June 13, 2003 19,500 9,750 9,750 - 1.00 June 12,
2005
July 17, 2003 14,940 - 14,940 - 1.00 July 17,
2005
July 24, 2003 13,800 - 13,800 - 1.00 July 24,
2005
December 11, December
2003 113,600 - 113,600 - 1.00 11, 2005
March 23, March 23,
2004 10,536 - 10,536 - 1.00 2006
April 16, April 16,
2004 52,792 - 52,792 - 1.50 2006
May 31, 2004 60,270 - 60,270 - 1.50 May 31,
2006
August 6, August 6,
2004 18,720 - 18,720 - 1.50 2006
September
15, 2004 15,787 - 15,787 - 1.50 September
15, 2006
December 1, December
2004 9,200 - - 9,200 1.50 1, 2006
---------------------------------------------------------------------------


Number Number Number Total Exercise
Date of of of Warrants Price Expiry
Issued Warrants Warrants Warrants Outstanding $ Date
Exercised Expired
---------------------------------------------------------------------------
December December 15,
15, 2004 32,000 - - 32,000 1.50 2006
February August 25,
28, 2006 2,000,000 - - 2,000,000 1.25 2008
April April 28,
28, 2006 3,635,000 - - 3,635,000 0.80 2008
----------------------------------------
5,996,145 9,750 310,195 5,676,200
----------------------------------------
----------------------------------------


The weighted average exercise price of the warrants outstanding and exercisable at November 30, 2006 is $0.96 (August 31, 2006 - $0.97) . The weighted average exercise price of the warrants granted during the three month period ended November 30, 2006 was $Nil (twelve month period ended August 31, 2006 - $0.96). The weighted average exercise price of the warrants exercised and expired during the three month period was $Nil and $1.50, respectively (twelve month period ended August 31, 2006 - $Nil and $1.28, respectively).

Subsequent to November 30, 2006, on December 1, 2006 and December 15, 2006 warrants totalling 9,200 and 32,000, respectively, expired and were therefore cancelled.



Stock-based compensation

Contributed surplus results from the recording of stock-based compensation
as follows:

--------
$
--------
Contributed surplus, August 31, 2006 935,063
Exercise of Agents Options (658)
--------
Contributed surplus, November 30, 2006 934,405
--------
--------


The fair value of each option and warrant granted was estimated to be $0.26
to $0.33 and $0.10 to $0.19, respectively, on the date of grant, using the
Black-Scholes option-pricing model with weighted average assumptions as
follows:


Options
Discount rate - equivalent to 3 to 5 year bond 3.13 - 3.47%
Expected life (years) 5 years
Expected volatility 17 - 21%
Expected dividends 0

Warrants
Discount rate - equivalent to 1 to 3 year bond 2.34% - 4.12%
Expected life (years) 2 - 2.5 years
Expected volatility 14 - 22%
Expected dividends 0



9. INVESTMENT IN PRIVATE COMPANIES AND LOSS ON EQUITY INVESTMENTS

a) Catalyst Healthcare Ltd.

On October 24, 2005, the Company purchased 2,630,297 common shares in the initial share issuance of Catalyst Healthcare Ltd. ("Catalyst") for cash consideration of $263. This acquisition represented a 32.6% interest in Catalyst. On October 31, 2005, the Company was issued an additional 169,603 shares in Catalyst with an aggregate value of $169,603 (Note 3). This additional issuance increased the Company's investment in Catalyst to 33.9%. Due to further share issuances by Catalyst, the Company's investment at November 30, 2006 was 28.0% (August 31, 2006 - 28.5%).

The Company has recognized its share of Catalyst's net loss, which aggregated $72,645 for the three month period ended November 30, 2006 (for the twelve month period ended August 31, 2006 - $97,221), in the interim consolidated statement of loss and against its investment on the interim consolidated balance sheet. Since the Company's portion of this loss, totalling $72,645, exceeded its total investment, the investment was written down to $Nil at November 30, 2006.

b) 1036985 Alberta Ltd. (operating as Cochrane Super Drug Mart)

On April 28, 2006, the Company purchased 50% beneficial interest in the outstanding shares in 1036985 Alberta Ltd. ("Cochrane Super Drug Mart") for $350,025, an equity investment. For the three month period ended November 30, 2006 and the twelve month period ended August 31, 2006, Cochrane Super Drug Mart reported net income of $52,066 and $25,550, respectively. The Company has recognized its portion of this income, totalling $26,033 and $12,775, in the consolidated statements of loss and in its investment on the consolidated balance sheet at November 30, 2006 and August 31, 2006, respectively.

c) ACO Super Drug Mart Ltd.

On April 28, 2006, the Company purchased a 50% beneficial interest in the outstanding shares in ACO Super Drug Mart Ltd. ("ACO") for $12,325, an equity investment. For the period ended August 31, 2006, ACO reported a net loss of $59,203. Since the Company's portion of this loss, totalling $29,602, exceeded its total investment, the investment was written down to $Nil at August 31, 2006.

d) Prairie Supply Co-op

In November 2006, the Company purchased a share certificate for 69,789 common class A shares valued at $1.00 per common share in Prairie Supply Co-op ("Prairie") for dividends on inventory previously purchased. All new members with Prairie are required to have an investment of three months dividends converted into common class A shares, valued at $1.00 per share, which are redeemable upon account closure. The investment is being carried at cost.

10. COMMITMENTS

a) The Company and its subsidiaries lease premises under operating leases, which expire between July 2007 and January 2018. Rental payments, excluding operating costs and taxes, over the next five periods ended November 30 are as follows:



---------
$
---------
2007 1,551,242
2008 1,365,575
2009 1,046,431
2010 759,769
2011 614,249



Three of the above leases were entered into with related parties, related via common shareholders. These transactions were recorded at fair market value and represent annual rent of $263,391 in 2007, $290,475 in 2008, $272,547 in 2009, $199,437 in 2010 and $199,437 in 2011.

b) In fiscal 2003, Glenpark I.D.A. Pharmacy Ltd. entered into a lease for certain equipment requiring annual payments of $2,808 for a five year term.


11. FINANCIAL INSTRUMENTS

Fair value

The carrying amount reported on the interim consolidated balance sheet for cash and cash equivalents, accounts receivable, income taxes recoverable, due from (to) related parties and accounts payable and accrued liabilities approximated their fair value due to the short-term nature of these accounts. The carrying value of capital leases approximated their fair value given that the interest rates inherent in the leases reflect rates currently available for leases with similar terms and maturities. The long-term debt is subject to both fixed and floating interest rates. The floating rate debt appropriately reflects rates currently available for debt with similar terms and maturities. Accordingly, the fair value of this debt is not materially different from the carrying value. The fixed rate debt, which has a carrying value of $1,275,093 at November 30, 2006 (August 31, 2006 - $1,579,241), has a fair value of $1,228,644 (August 31, 2006 - $1,493,030).

Interest rate risk

A portion of long-term debt is at a floating interest rate and as a result, the Company is exposed to changes in interest rates. Increases or decreases in these rates could affect the Company's earnings.

Credit risk

The Company is exposed to credit risk to the extent that its customers may experience financial difficulty and would be unable to meet their obligations. However, the Company has a large number of diverse customers, thereby minimizing the concentration of credit risk.

12. SUBSEQUENT EVENT

On January 11, 2007 the Company agreed to a financing to raise up to $4,000,000 through a private placement of units of the Company ("Units") at a price of $0.80 per Unit, with each Unit being comprised of one common share and one-half of one common share purchase warrant ("Purchase Warrant"). Each whole Purchase Warrant shall entitle the holder to acquire one common share of the Company for a period of 24 months from the closing date at an exercise price of $1.00 per common share. Closing of the private placement is subject to necessary TSX Venture Exchange ("TSXV") approval and is expected to occur on or about February 16, 2007.

The Company has also agreed, subject to receipt of applicable TSXV and shareholder approval, among other things, to complete an additional financing with a private investment fund (the "Lender") for a combination of (i) $3,000,000 of Units at a price of $0.80 per Unit, with each Unit being comprised of one common share ("Common Share") and one-half of one Common Share purchase warrant ("Warrant"). Each whole Warrant shall entitle the holder to acquire one Common Share for a period of 24 months from the closing date at an exercise price of $1.00 per Common Share; and (ii) $20,000,000 of secured convertible debt with a 2 year term (the "Convertible Debt"), the proceeds of which are to be used by the company to complete future acquisitions. The Convertible Debt will pay interest at a rate of 15% and will convert into Common Shares under certain circumstances, or at the option of the Lender, at a price of $0.8028 per Common Share. Interest may be paid in additional Common Shares from treasury based on market price at the time, and additional interest, also potentially payable in Common Shares based on market price at the time, may apply if acquisitions do not meet certain financial criteria. The Convertible Debt financing will require shareholder approval, as the Lender, assuming conversion of the Convertible Debt, will acquire a substantial interest in the Company. The Company anticipates that a shareholder meeting will be held on or about March 30, 2007, with closing of the financing expected in April of 2007. This Convertible Debt financing will be subject to terms and conditions customary of transactions of this nature.


The TSX Venture Exchange does not accept responsibility for the adequacy or accuracy of this release and has neither approved nor disapproved the contents of this press release.

Contact Information

  • Paragon Pharmacies Limited
    Craig Cameron
    President and Chief Executive Officer
    (250) 491-3936