Paragon Pharmacies Limited
TSX VENTURE : PGN

Paragon Pharmacies Limited

December 15, 2006 00:35 ET

Paragon Pharmacies Limited Announces Year-End August 31, 2006 and Fourth Quarter 2006 Results for Predecessor Companies

KELOWNA, BRITISH COLUMBIA--(CCNMatthews - Dec. 15, 2006) -

Not for dissemination in the United States of America

Paragon Pharmacies Limited ("Paragon") (TSX VENTURE:PGN) is pleased to announce that the audited financial statements for the year ended August 31, 2006 for Paragon's predecessors, Rinoa Enterprises Ltd. ("Rinoa") and Paragon Pharmacies Ltd. and its subsidiaries (the "Company") have been filed on SEDAR and will be available for viewing at www.sedar.com. Effective October 31, 2006, Rinoa, a capital pool company, and the Company amalgamated to form Paragon Pharmacies Limited (the "Amalgamation").

Certain selected operational and financial information for the Company for the 12 months ended 2006 and 2005 and for the fourth quarters of 2006 and 2005 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 year ended August 31, 2006, prior to giving effect to the Amalgamation to form Paragon Pharmacies Limited. This discussion and analysis should be read in conjunction with the Company's annual audited consolidated financial statements and accompanying notes for the year ended August 31, 2006.

OVERVIEW

As at August 31, 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 and accordingly, the financial results from April 29 to August 31, 2006 of the acquired assets are included in the annual financial statements ending August 31, 2006. The Company also owns a 28.5% interest in Catalyst Healthcare Ltd. (servicing the pharmacy needs of long term care service providers), a 50% interest in another Super Drug Mart store and a 50% interest in a distribution centre.

OVERALL PERFORMANCE

The following provides a summary of the Company's overall performance for the year ended August 31, 2006 compared to the year ended August 31, 2005.

Increased store count to 19.5 from 10

-- Opened a Greenfield store in Castlegar, BC on February 20, 2006

-- Acquisition of 9.5 Super Drug Mart stores in Calgary and surrounding area on April 28, 2006

-- Sold 100% of it shares held in Paragon Central Fill Ltd. to Catalyst Healthcare Ltd. on October 31, 2005 and as at August 31, 2006 held 28.5% ownership interest in Catalyst

- Total sales revenue of $39.771 million (2005: $26.962 million), an increase of 47.5%

- Total comparable store sales growth of 7.0%

-- Comparable store pharmacy sales growth of 7.2%

-- Comparable store front store sales growth of 6.7%

-- Comparable store other sales growth of 6.8%

Note: Comparable sales growth excludes Super Drug Mart stores

- Total gross margin of $12.113 million (2005: $8.150 million), an increase of 48.6%

- Total gross margin as a percentage of sales of 30.5% (2005: 30.2%)

- Total operating expenses, excluding amortization, bank charges and interest, interest on long-term debt and stock-based compensation, of $10.801 million or 27.2% of sales versus $8.211 million or 30.5% of sales in 2005

- EBITDA(1) of $1.312 million (2005: ($0.061 million)), an increase of 2,235.9% or $1.373 million

- EBITDA margin(2) of 3.3% (2005: (0.2%)), an increase of 1,548.0%

- Net loss of $1.622 million, a decrease of 10.7% compared to 2005

-- Loss per share (diluted) of $0.06 versus $0.19 in prior year

- Purchases of capital assets of $0.299 million, compared to $0.494 in 2005

- Net debt of $10.990 million, compared to $2.077 million in 2005 (See table in Financial Position section for calculation)

-- Net debt to equity of 0.58:1, compared to 0.42:1 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 and loss on equity investments. (See table in the Results of Operations for calculation of EBITDA).

(2) EBITDA margin defined as EBITDA divided by Revenue

SELECTED ANNUAL INFORMATION

The following table provides a summary of certain selected consolidated annual financial information for the Company. The 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.



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2006 2005 2004(2)
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Revenue $39,771,211 $26,962,454 $20,171,879
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Loss before other items(1) 1,480,481 1,553,425 2,019,704
- Loss per share - Basic $0.06 $0.16 $0.24
- Loss per share - Diluted $0.06 $0.16 $0.24
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Net loss 1,622,479 1,816,392 1,690,576
- Net loss per share - Basic $0.06 $0.19 $0.20
- Net loss per share - Diluted $0.06 $0.19 $0.20
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Total assets 34,055,273 10,333,317 11,396,450
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Total long-term financial
liabilities(3) 7,977,746 2,052,458 2,517,042
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Cash dividends 0 0 0
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Other items include:
(1) Loss on disposal of capital assets of $Nil
(2005 - $8,868; 2004 - $Nil); loss on equity investment $96,771
(2005: $Nil: 2004: $35,000); loss from discontinued operations of
$43,659; (2005 - $284,500; 2004: $144,180); loss on non-controlling
interest of $Nil (2005: $Nil; 2004: $1,364).
(2) For comparison purposes, certain of the 2004 figures were reclassified
to conform to the 2005 consolidated financial statement presentation of
discontinued operations.
(3) Does not include current portion of long-term financial liabilities:
2006: $3,098,914; 2005: $438,885; 2004: $377,563.


2006

2006 saw the Company's store count increase materially in size to 19.5 stores. This growth combined with continued operational improvements resulted in improved financial performance for the Company. Overall sales revenue was up 47.5% reflecting the increased store count and same store sales growth of 7.0%. Gross margin rate increased 30 basis points and EBITDA margin 350 basis points. As of August 31, 2006, the Company owned 100% of seventeen retail pharmacies and two home health care stores; 50% of one retail pharmacy; 50% of a distribution center; and 28.5% of Catalyst Healthcare Ltd.

On October 31, 2005, the Company sold its 100% interest in Paragon Central Fill Ltd. to Catalyst Healthcare Ltd. for a combination of cash and shares with the Company owning 28.5% of Catalyst as at August 31, 2006. The Company opened a 1,312 square foot retail pharmacy in Castlegar, BC in February 2006. In April of 2006, the Company acquired, in an asset purchase, 9.5 Super Drug Mart stores and focused its attention over the remainder of the year integrating this operation with the Company. Also during the year, the Company prepared for its amalgamation with Rinoa Enterprises Ltd., a capital pool corporation, and subsequent listing on the TSX Venture Exchange under the symbol PGN. This transaction was completed on October 31, 2006.

2005

2005 saw improved operational and financial performance for the Company. Specifically, in the second half of 2005, the positive financial impact of the Company's emphasis towards improving store operations were recognized. Streamlined operations and a stronger emphasis on profitability yielded significant EBITDA growth over 2004. Corporate restructuring allowed a reduction in overhead while improving overall performance and support for future growth. As of August 31, 2005 the Company owned 100% of seven retail pharmacies, one central fill pharmacy and two home health care stores. During 2005, one retail pharmacy was closed due to site redevelopment, and two home health care stores were closed, with continuing operations consolidated into existing operations. On November 1, 2004, a third party purchased the assets and operating name and assumed the corresponding liabilities of the direct pharmacy business.

2004

2004 was a year of start-up cost and "road building" for the Company. The corporate infrastructure was assembled, including head office and key employees, to ensure the organization was scaleable to support planned growth. As well, additional expenses were incurred to clean-up operations, finance two Greenfield operations and to dissolve partnerships. As of August 31, 2004, the Company owned 100% of eight retail pharmacies, one central fill pharmacy and four home health care stores.

RESULTS OF OPERATIONS

The following table presents a summary of certain selected operating data and consolidated financial information for the Company for the 12 month period indicated.



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2006 2005 $ Change % Change
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Revenue $39,771,211 $26,962,454 $12,808,757 47.5%
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Cost of Goods Sold & Other
Operating Expenses(1) 38,459,327 27,023,874 11,435,453 42.3%
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EBITDA(2) 1,311,884 (61,420) 1,373,304 2,235.9%
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Amortization 1,423,724 1,078,119 345,605 32.1%
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Bank charges and interest 285,139 53,756 231,383 430.4%
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Stock-based compensation 698,114 139,090 559,024 401.9%
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Operating Loss(3) (1,095,093) (1,332,385) 237,292 17.8%
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Interest on long-term debt 385,388 221,040 164,348 74.4%
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Loss before other items (1,480,481) (1,553,425) 72,944 4.7%
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Loss on disposal of capital
assets and loss on equity
investment (96,771) (8,868) (87,903) (991.2%)
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Income taxes (recovery) 1,568 (30,401) 31,969 105.2%
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Loss from continuing
operations (1,578,820) (1,531,892) 46,928 3.1%
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Loss from discontinued
operations (43,659) (284,500) (240,841) (84.7%)
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Net loss (1,622,479) (1,816,392) 193,913 10.7%
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Per common share
- Basic net earnings ($0.06) ($0.19) $0.13
- Diluted net earnings ($0.06) ($0.19) $0.13
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(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 and loss on equity
investments.
(3) Operating loss defined as loss before interest on long-term debt,
taxes, loss on disposal of capital assets, loss on equity investment,
and loss from discontinued operations.


Sales

Sales revenue is comprised of sales to customers of the Company's retail pharmacies, central fill pharmacy (up until October 31, 2005) and home health care stores.

Sales in 2006 were $39.771 million compared to $26.962 million in 2005, an increase of 47.5% or $12.809 million. This increase was due to the acquisition of the Super Drug Mart stores and to same store improved operations with a 7.0% sales growth over 2005.

Pharmacy sales in 2006 were $23.997 million compared to $17.516 million in 2005, an increase of 37.0%. On a same store basis, pharmacy sales increased 7.2% over 2005 and accounted for 60.3% of the Company's total sales mix (2005: 65.0%).

Front store sales in 2006 were $11.251 million compared to $6.066 million in 2005, an increase of 85.5% . On a same store basis, front store sales increased 6.7% over 2005 and accounted for 28.3% of the Company's total sales mix (2005: 22.5%). The higher percentage of front store sales in the Super Drug Mart stores sales mix is driving this shift in the Company's overall sales mix.

Other store revenue in 2006 was $4.524 million compared to $3.381 million in 2005, an increase of 33.8%. On a same store basis, other store revenue increased 6.8% over 2005 and accounted for 11.4% of the Company's total sales mix (2005: 12.5%). Other revenue includes post office, lottery, bus passes and miscellaneous and interest revenue.

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, central fill pharmacy (up until October 31, 2005) and home health care stores. Other operating expenses include general and administrative, selling, and corporate expenses excluding amortization, bank charges and interest, interest on long-term debt and stock-based compensation.

Total cost of goods sold and other operating expenses were $38.459 million compared to $27.024 million in 2005, an increase of 42.3% . Gross margin as a percentage of sales increased in 2006 to 30.5% from 30.2% in 2005 reflecting the Company's continued commitment to higher gross margin product categories including cosmetics, giftware and home healthcare. Other operating expenses as a percentage of sales decreased to 27.2% from 30.5% in 2005.

Amortization

Depreciation and amortization of capital assets and intangible assets was $1.424 million in 2006 compared to $1.078 million in 2005, an increase of $0.346 million or 32.1%. This increase is a result of the Company's expansion plan and subsequent investment in capital assets during the year.

Bank Charges and Interest

Bank charges and interest was $0.285 million in 2006 compared to $0.054 million in 2005, an increase of $0.231 million or 430.4%. This increase was primarily a result of penalties paid for early repayment of various term loans with the proceeds from new debt facilities obtained in conjunction with the Super Drug Mart acquisition.

Stock-based Compensation

Stock-based compensation was $0.698 million in 2006 compared to $0.139 million in 2005, an increase of $0.559 million or 401.9%. This increase is a result of the warrants issued on the equity portion of the financing of the Super Drug Mart acquisition (issued to persons who became insiders after giving affect to the acquisition).

Operating Loss

Operating loss was $1.095 million in 2006 compared to $1.332 million in 2005, a decrease of $0.237 million or 17.8%.

Interest Expense

Interest expense, defined as interest on long-term debt and capital leases, was $0.385 million in 2006 compared to $0.221 million in 2005. This increase can be attributed to the increased levels of debt attained in April 2006 to finance the Super Drug Mart acquisition.

Loss on Other Items

Loss on disposal of capital assets was $Nil (2005: $0.009 million); and loss on equity investments was $0.097 million (2005: $Nil).

Income Taxes

Income taxes were $0.002 million compared to an income tax recovery of $0.030 million in 2005, which resulted from the carry back of losses.

Loss from Continuing Operations

Loss from continuing operations was $1.579 million (2005: $1.532 million) an increase of 3.1% or $0.047 million over 2005.

Loss from Discontinued Operations

Loss on discontinued operations was $0.044 million (2005: $0.285 million) a decrease of 84.7% or $0.241 million over 2005.

Net Loss

The net loss in 2006 was $1.622 million versus a net loss of $1.816 million in 2005, a decrease of $0.194 million or 10.7% . This represented a $0.13 per common share improvement on a basic and diluted basis compared to 2005.

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.



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2006 2005
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Cash $86,331 $414,562
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Bank indebtedness 0 0
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Current portion of long-term debt and capital leases 3,098,914 438,885
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Long-term debt and capital leases 7,977,746 2,052,458
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Net debt 10,990,329 2,076,781
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Shareholders' equity 18,974,350 4,907,847
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Total capitalization 29,964,679 6,984,628
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Net debt: Shareholders' equity 0.58:1 0.42:1
Net debt: Total capitalization 0.37:1 0.30:1
Net debt: EBITDA(1) 8.38:1 (33.81:1)
EBITDA(1): Cash interest expense 3.40:1 (0.28:1)
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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 and loss on equity
investments.


OUTSTANDING SHARE DATA

The Company had 26,884,599 common shares outstanding at August 31, 2006. As at this same date, the Company had issued options to acquire 585,500 of its common shares and warrants to acquire 5,691,987 of its common shares. All options were exercisable with 217,000 at $1.00 and 368,500 at $1.50. There were 56,987 warrants at $1.50 expiring throughout the 2006 calendar year, 2,000,000 warrants at $1.25 expiring in August 2008 and 3,635,000 warrants at $0.80 expiring in April 2008.

LIQUIDITY AND CAPITAL RESOURCES

At August 31, 2006 the ratio of current assets to current liabilities was 1.97:1 compared to 1.44:1 in 2005. Working capital was $6.902 million compared to $1.470 million in 2005.

The Company's principal capital requirements are to fund working capital needs, renovate existing stores and acquire and develop 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 loans and the issuance of common shares.

Operating Activities

Net cash flow generated from operating activities was $1.404 million compared to negative $0.806 million in 2005. This difference was primarily from positive cash flow from store operations and better management of working capital, most specifically inventory and accounts payable and accrued liabilities.

Investing Activities

Net cash outflow from investing activities was $20.201 million compared to $0.747 million in 2005. This increased outflow is primarily due to cash paid on the purchase of Super Drug Mart assets ($18.682 million) and $1.5 million of cash held in trust from a third party loan.

Financing Activities

Net cash flow from financing activities was $18.466 million compared to $1.256 million in 2005. This increase is primarily due to the issuance of share capital and advances of long-term debt related to the Super Drug Mart acquisition.

In 2006, the Company received net proceeds of $10.617 million in share capital from the issuance of common shares and the exercise of warrants into common shares. Also during the year, the Company entered into an agreement with TD bank for a $10 million term loan amortized over five years, a $2 million line of credit and a $500,000 letter of credit facility.

As of August 31, 2006, the Company's long term debt financing includes: TD Bank ($9,333,333), Third Party Loan Agreement ($1,500,000); CIT Financial Ltd. ($16,887); Ford Credit ($67,195), and Microsoft Capital Corporation ($12,046). The term loans are secured by general security agreements against all existing and future acquired assets of the Company. As at August 31, 2006, the Company is in compliance with all covenants.

The net effect of the Company's operating, investing and financing activities was a decrease in its cash balance of $330,945.

Contractual Obligations

The following table presents a summary of the contractual obligations of the Company for the next five years as at August 31, 2006.



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Payments Due By Period
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Contractual Fiscal Fiscal Fiscal Fiscal Fiscal
Obligations 2007 2008 2009 2010 2011 Total
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Long
-term
liabil-
ities $3,037,853 $2,526,725 $2,016,022 $2,012,422 $1,336,440 $10,929,462
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Capital
leases 75,711 52,805 21,627 15,558 8,479 174,180
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Operating
leases 1,630,047 1,447,448 1,150,721 806,051 644,665 5,678,932
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Other
commit-
ments 2,808 2,808 468 0 0 6,084
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Total $4,746,419 $4,029,786 $3,188,838 $2,834,031 $1,989,584 $16,788,658
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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 material acquisitions or material Greenfield developments will require additional debt and equity financing while maintaining the covenants.

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. ($67,392); Catalyst Healthcare Ltd. $96,904; 1036985 Alberta Ltd. (Cochrane Super Drug Mart) $184,058 and Super Drug Mart Partnership $384,114. The amounts due are non-interest bearing with no fixed terms of repayment. The parties are related as they have common shareholders.

During the year, the company paid $95,168 in rent for premises leased under operating leases with related parties. These transactions have been recorded at fair market value and represent annual rent of $266,087 in 2007, $285,043 in 2008, $286,690 in 2009, $212,981 in 2010 and $199,428 in 2011.

QUARTERLY INFORMATION

Summary of Quarterly Information

The fiscal year-end of the Company is August 31 with quarter end falling on the following dates: November 30 (Quarter 1); February 28 (Quarter 2); May 31 (Quarter 3); August 31 (Quarter 4). The following table provides a summary of certain selected consolidated financial information for the Company for each of the eight most recently completed fiscal quarters. The 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.



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First Quarter Second Quarter
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2006(2) 2005(2) 2006 2005
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Revenue 6,847,999 6,507,128 7,690,203 7,497,769

Loss before other items(1) 249,874 529,742 587,200 556,864
- Loss per share - Basic ($0.03) ($0.06) ($0.03) ($0.06)
- Loss per share - Diluted ($0.03) ($0.06) ($0.03) ($0.06)
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Net loss 259,257 563,892 647,724 609,596
- Net loss per share - Basic ($0.03) ($0.07) ($0.04) ($0.06)
- Net loss per share
- Diluted ($0.03) ($0.07) ($0.04) ($0.06)
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Third Quarter Fourth Quarter
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2006 2005 2006 2005

Revenue 8,108,828 5,257,424 17,124,181 7,700,133
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Loss before other items(1) 573,366 403,014 70,041 63,805
- Loss per share - Basic ($0.02) ($0.04) $0.00 ($0.01)
- Loss per share - Diluted ($0.02) ($0.04) $0.00 ($0.01)
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Net loss 649,396 465,503 66,102 177,401
- Net loss per share - Basic ($0.02) ($0.05) $0.00 ($0.02)
- Net loss per share
- Diluted ($0.02) ($0.05) $0.00 ($0.02)
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(1) Loss on disposal of capital assets in Q4-2005: $8,868
Loss on equity investment in Q1-2006; $7,948; Q2-2006: $61,157;
Q3-2006: $75,885; Q4-2006: ($48,219)
Loss from discontinued operations of Q1-2006: $1,435; Q2-2006:
($633); Q3-2006: $145; Q4-2006: $42,712; Q1-2005: $34,150; Q2-2005:
$52,732; Q3-2005: $62,489; Q4-2005: $135,129.
(2) First quarter 2005 and 2006 figures taken from Management prepared
financial statements.


Results of Operations - Fourth Quarter

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



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3 Months Ended
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August August $ Change % Change
2006 2005
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Revenue $17,124,181 $7,700,133 $9,424,048 122.4%
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Cost of Goods Sold
& Other Operating
Expenses(1) 16,227,997 7,341,919 8,886,078 121.0%
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EBITDA(2) 896,184 358,214 537,970 150.2%
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Amortization 529,628 271,037 258,591 95.4%
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Bank charges and interest 248,625 (5,021) 253,646 (5,051.7%)
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Stock-based compensation 0 83,687 (83,687) (100.0%)
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Operating Income(3) 117,931 8,511 109,420 1285.6%
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Interest on long-term debt 187,972 72,316 115,656 159.9%
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Loss before other items (70,041) (63,805) (6,236) 9.8%
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Gain (loss) on disposal
of capital assets and
loss on equity investment 48,219 (8,868) 57,087 (643.7%)
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Income taxes 1,568 (30,401) 31,969 105.2%
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Loss from continuing
operations 23,390 42,272 (18,882) (44.7%)
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Loss from discontinued
operations 42,712 135,129 (92,417) (68.4%)
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Net loss (66,102) (177,401) 111,299 62.7%
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Per common share
- Basic net earnings ($0.00) ($0.02) $0.02
- Diluted net earnings ($0.00) ($0.02) $0.02
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(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 and loss on equity
investments.
(3) Operating income defined as earnings before interest on long-term debt,
taxes, loss on disposal of capital assets, loss on equity investment,
and loss from discontinued operations.


Sales

Sales revenue is comprised of sales to customers of the Company's retail pharmacies, central fill pharmacy (fiscal 2005 only) and home health care stores.

Sales in the fourth quarter of 2006 were $17.124 million compared to $7.700 million in 2005, an increase of 122.4% or $9.424 million. This increase was due to the acquisition of the Super Drug Mart stores and to same store sales growth.

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, central fill pharmacy (fiscal 2005 only) and home health care stores. Other operating expenses include general and administrative, selling, and corporate expenses excluding amortization, bank charges and interest, interest on long-term debt and stock-based compensation.

Total cost of goods sold and other operating expenses were $16.228 million compared to $7.342 million in 2005, an increase of 121.0%. This increase is primarily due to the acquisition of the Super Drug Mart stores. Gross margin as a percentage of sales decreased in 2006 to 28.0% from 30.2% in 2005. Other operating expenses as a percentage of sales decreased to 22.8% from 25.6% in 2005.

Amortization

Depreciation and amortization of capital assets and intangible assets was $0.530 million in 2006 compared to $0.271 million in 2005, an increase of $0.259 million or 95.4%. This increase is due to the depreciation and amortization on the capital assets and intangible assets acquired in the Super Drug Mart acquisition.

Bank Charges and Interest

Bank charges and interest were $0.249 million in 2006 compared to ($0.005 million) in 2005, an increase of $0.254 million or 5,051.7% . This increase was primarily a result of penalties paid for early payment in full of some term loans upon structuring of debt financing related to the Super Drug Mart acquisition.

Stock-based Compensation

Stock-based compensation was $Nil in 2006 compared to $0.084 million in 2005, a decrease of $0.084 million or 100.0%. There were no options or warrants issued in the fourth quarter of 2006.

Operating Income

Operating income was $0.118 million in 2006 compared to $0.009 million in 2005, an increase of $0.109 million or 1285.6% .

Interest Expense

Interest expense, defined as interest on long-term debt and capital leases, was $0.188 million in 2006 compared to $0.072 million in 2005. This increase can be attributed to the increased levels of debt attained in April 2006 to finance the Super Drug Mart acquisition.

Loss on Other Items

Loss on equity investment was negative $0.048 million (2005: $Nil), and loss on disposal of capital assets was $Nil (2005: $0.009 million).

Income Taxes

Income taxes were $0.002 million compared to an income tax recovery of $0.030 million in 2005, due to losses carried back.

Loss from Continuing Operations

Loss from continuing operations was $0.023 million (2005: $0.042 million) a decrease of 44.7% or $0.019 million over 2005.

Loss from Discontinued Operations

Loss on discontinued operations was $0.043 million (2005: $0.135 million) a decrease of 68.4% or $0.092 million over 2005.

Net Loss

The net loss in 2006 was $0.066 million versus a net loss of $0.177 million in 2005, a decrease of $0.111 million or 62.7% . This represented a $0.02 per common share improvement on a basic and diluted basis compared to 2005.

SUBSEQUENT EVENTS

Amalgamation with Rinoa Enterprises Ltd.

On October 31, 2006, Rinoa completed its "Qualifying Transaction" under Policy 2.4 of the TSX Venture Exchange by amalgamating with the Company to form Paragon Pharmacies Limited. In this transaction, all of the issued and outstanding common shares of the Company, all of the issued and outstanding options of the Company and all of the issued and outstanding common share purchase warrants of the Company, as well as the issued and outstanding common shares of Rinoa and issued and outstanding share purchase options of Rinoa became equivalent securities of Paragon.

CHANGES IN ACCOUNTING POLICIES

There were no changes in accounting policies during fiscal 2006.

FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS

Fair value

The carrying amount reported on the consolidated balance sheet for cash and cash equivalents, accounts receivable, due from (to) related parties, accounts payable and accrued liabilities and due to shareholder 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 the debt is not materially different from the recorded value. The fixed rate debt, which has a carrying value of $1,579,241 at August 31, 2006, has a fair value of $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 Ontario government has radically changed the way it does business with drug manufacturers and pharmacies. The Transparent Drug System for Patients Act introduced restrictions on the professional allowances paid by generic companies to pharmacies. The maximum allowance is set at 20 per cent on claims paid by the government, with no limit to generic discounts for privately paid claims. However, confusion in the wording of what constitutes an acceptable benefit for patient care has delayed payments to pharmacies. The province also imposed a 50 per cent price rule on generics in place of a 70/90 approach, whereby reimbursement for the first generic was set at 70 per cent of the brand-name drug and subsequent generics were priced at up to 90 per cent of the first. Bill 102 increased the dispensing fee paid to $7.00 from $6.54, reduced the pharmacy mark-up from 10 to 8 per cent while committing the government to invest $50 million in professional services to be delivered by pharmacists. It established a Pharmacy Council which includes representation from chain and independent pharmacies and will develop the framework for reimbursement on front-line pharmacy care. At this point, both the Ontario Pharmacists' Association and the Canadian Association of Chain Drug Stores (of which Super Drug Mart is a member) are pressing for clarification on key points in the new regulations. Because of the size and influence of the Ontario drug plan, it is possible that other provincial governments may also move to regulate generic rebates or adopt similar pricing rules.

FORWARD LOOKING STATEMENTS

This discussion of the consolidated financial condition and results of operations of the Company contains forward-looking statements regarding, among other things, the Company's beliefs, plans, objectives, strategies, estimates, intentions and expectations, including as they relate to its operating and financial results, capital expenditures and the ability to execute on its operating, investing and financing strategies. Consequently, actual results and events may differ materially from those included in, contemplated or implied by such forward looking statements for a variety of reasons. Forward-looking statements are subject to inherent risks and uncertainties including, but not limited to, market and general economic conditions, certain property and casualty risks, the availability to attract and retain pharmacists, the availability and terms of financing, changes in the Company's relationship with its key suppliers, competitive factors, changes in regulatory environments affecting the Company's business, and the accuracy in management's assumptions. This list is not exhaustive of the factors that may affect any of the Company's forward-looking statements. Investors and others should carefully consider these and other factors and not place undue reliance on these forward-looking statements. In addition, these forward-looking statements relate to the date on which they were made and the Company disclaims and has no intention or obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

NON-GAAP FINANCIAL MEASURES

The Company reports its financial results in accordance with Canadian GAAP. However, the foregoing contains references to non-GAAP financial measures, such as operating margin, EBITDA (earning before stock-based compensation, interest, taxes, depreciation and amortization), EBITDA margin and cash interest expense. Non-GAAP financial measures do not have standardized meanings prescribed by GAAP and therefore may not be comparable to similar measures presented by other reporting issuers.

These non-GAAP financial measures have been included in this Management's Discussion and Analysis as they are measures which management uses to assist in evaluating the Company's operating performance against its expectations and against other companies in the retail drug store industry. Management believes that non-GAAP financial measures assist in identifying underlying operating trends.

These non-GAAP financial measures, particularly EBITDA and EBITDA margin, are also common measures used by investors, financial analysts and rating agencies. These groups may use EBITDA and other non-GAAP financial measures to value the Company and assess the Company's ability to service its debt.



Consolidated Statements of Loss and Deficit
Years Ended August 31, 2006 and 2005
-------------------------------------------------------------------------
-------------------------------------------------------------------------
2006 2005
$ $
------------------------
------------------------

REVENUE 39,771,211 26,962,454

COST OF SALES 27,658,204 18,812,868
------------------------

GROSS PROFIT 12,113,007 8,149,586
------------------------

EXPENSES
Selling, general and administration 10,801,123 8,211,006
Amortization 1,423,724 1,078,119
Bank charges and interest 285,139 53,756
Interest on long-term debt 385,388 221,040
Stock-based compensation (Notes 3 and 13) 698,114 139,090
------------------------
13,593,488 9,703,011
------------------------
LOSS BEFORE OTHER ITEMS (1,480,481) (1,553,425)
------------------------

OTHER ITEMS
Loss on disposal of capital assets - (8,868)
Loss on equity investment (Note 14) (96,771) -
------------------------
(96,771) (8,868)
------------------------
LOSS BEFORE INCOME TAXES (1,577,252) (1,562,293)

INCOME TAXES (RECOVERY) (Note 15)
Current 1,568 (30,401)
------------------------

LOSS FROM CONTINUING OPERATIONS (1,578,820) (1,531,892)

LOSS FROM DISCONTINUED OPERATIONS (Note 5) (43,659) (284,500)
------------------------

NET LOSS (1,622,479) (1,816,392)

DEFICIT, BEGINNING OF YEAR (3,651,356) (1,834,964)

DISPOSITION OF PARAGON CENTRAL FILL LTD. (Note 4) 373,586 -
------------------------

DEFICIT, END OF YEAR (4,900,249) (3,651,356)
------------------------
------------------------


Consolidated Balance Sheet
August 31, 2006 and 2005
--------------------------------------------------------------------------
--------------------------------------------------------------------------

2006 2005
$ $
------------------------
------------------------

ASSETS
CURRENT
Cash and cash equivalents 86,331 414,562
Cash held in trust (Note 7) 1,500,000 -
Accounts receivable 2,828,929 1,146,621
Income taxes receivable - 30,970
Inventory 8,826,745 2,851,382
Prepaid expenses and deposits 165,449 131,224
Due from related parties (Note 10) 597,684 -
Current assets from discontinued operations
(Note 5) - 267,991
------------------------
14,005,138 4,842,750

Deferred costs (Note 3) 367,533 211,022
Capital assets (Note 8) 1,368,903 1,282,764
Intangible assets (Note 9) 5,457,545 2,418,325
Investment in private companies (Note 14) 435,445 -
Goodwill, at cost 12,420,709 1,538,044
Long-term assets from discontinued operations
(Note 5) - 40,412
------------------------
34,055,273 10,333,317
------------------------
------------------------

LIABILITIES
CURRENT
Accounts payable and accrued liabilities 4,004,263 2,732,488
Due to related parties (Note 10) - 5,121
Current portion of long-term debt (Note 11) 3,037,853 361,621
Current portion of capital leases (Note 12) 61,061 77,264
Current liabilities from discontinued operations
(Note 5) - 196,518
------------------------
7,103,177 3,373,012

Long-term debt (Note 11) 7,891,608 1,824,274
Capital leases (Note 12) 86,138 228,184
------------------------
15,080,923 5,425,470
------------------------

SHAREHOLDERS' EQUITY
Share capital (Note 13) 22,939,536 8,322,254
Contributed surplus (Notes 3 and 13) 935,063 236,949
Deficit (4,900,249) (3,651,356)
------------------------
18,974,350 4,907,847
------------------------
34,055,273 10,333,317
------------------------
------------------------


Consolidated Statement of Cash Flows
Years Ended August 31, 2006 and 2005
---------------------------------------------------------------------------
---------------------------------------------------------------------------
2006 2005
$ $
------------------------
------------------------

CASH FLOWS RELATED TO THE FOLLOWING ACTIVITIES:

OPERATING
Net loss from continuing operations (1,578,820) (1,531,892)
Adjustments for:
Amortization 1,423,724 1,078,119
Stock-based compensation (Notes 3 and 13) 698,114 139,090
Loss on disposal of capital assets - 8,868
Loss on equity investment (Note 14) 96,771 -
------------------------
639,789 (305,815)

Changes in non-cash working capital and other
non-cash items:
Accounts receivable (1,523,547) 42,414
Inventory 945,660 96,671
Prepaid expenses and deposits (2,216) 26,791
Accounts payable and accrued liabilities 1,271,775 (506,211)
Income taxes 30,970 63,150
------------------------
Operating cash flow from continuing operations 1,362,431 (583,000)
------------------------

Net loss from discontinued operations (43,659) (284,500)
Non-cash items 16,360 195,292
Current assets 265,277 (91,582)
Current liabilities (196,518) (41,748)
------------------------
Operating cash flow from discontinued operations 41,460 (222,538)
------------------------
1,403,891 (805,538)
------------------------

FINANCING
(Repayment) advances from (to) related parties (648,822) 166,412
Repayment of advances to shareholder - (90,000)
Issuance of share capital, net of share issuance
costs 10,617,282 1,569,203
Advances (repayment) of long-term debt, net 8,743,566 (320,871)
Repayment of capital leases (246,154) (68,602)
------------------------
18,465,872 1,256,142
------------------------

INVESTING
Cash held in trust (Note 7) (1,500,000) -
Deferred costs (156,511) (211,022)
Proceeds on disposition of Paragon Central Fill
Ltd. (Note 4) 250,000 -
Purchase of interest in Catalyst Healthcare Ltd.
(Note 14(b)) (263) -
Cash paid on purchase of Super Drug Mart assets (18,682,277) -
Purchase of intangible assets (97,823) (93,212)
Proceeds on sale of intangible assets - 50,000
Proceeds on sale of capital assets 285,540 1,413
Purchase of capital assets (299,374) (493,860)
------------------------
(20,200,708) (746,681)
------------------------

NET DECREASE IN CASH AND CASH EQUIVALENTS (330,945) (296,077)

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 417,276 713,353
------------------------

CASH AND CASH EQUIVALENTS, END OF YEAR 86,331 417,276
------------------------
------------------------

Represented by:
Cash from continuing operations 86,331 414,562
Cash from discontinued operations - 2,714
------------------------
86,331 417,276
------------------------
------------------------


Notes to the Consolidated Financial Statements
Years Ended August 31, 2006 and 2005
---------------------------------------------------------------------------
---------------------------------------------------------------------------


1. NATURE OF OPERATIONS

Paragon Pharmacies Ltd. (the "Company") was incorporated on August 1, 2002 in the province of Alberta under the Alberta Business Corporations Act and commenced active operations in March 2003. The Company is comprised of one single operating segment which is drug store operations which focuses on the customer and the communities in which they are located. In addition, the pharmacies offer supplemental services such as Canada Post outlets, lottery tickets and transit sales.

2. ACQUISITIONS

a) Acquisition of Super Drug Mart

On April 28, 2006, Paragon purchased:

1. All of the businesses, assets, inventory, contracts, agreements and intellectual property utilized by nine Super Drug Mart ("SDM") retail pharmacy operations located in Western Canada;

2. A 50% interest in the shares of 1036985 Alberta Ltd. (Cochrane Super Drug Mart); and

3. A 50% interest in the shares of ACO Super Drug Mart Ltd.

The aggregate consideration for this acquisition was $22,724,468, including various post-closing adjustments and acquisition costs. Funds to complete the acquisition were raised by way of debt, private equity and the issuance of shares to the vendor.



The purchase price allocation of the assets acquired was as follows:

-------------
$
-------------

Cash floats 42,191
Accounts receivable 158,761
Inventory 6,921,023
Deposits 32,009
Capital assets 325,206
Intangible assets
Prescription files 3,533,712
Leases 466,551
Investments 362,350
Goodwill 10,882,665
-------------
Assets acquired 22,724,468
-------------
-------------


b) Purchase of prescription files

During fiscal 2005, a subsidiary of the Company purchased prescription files from a third party entity for $90,000.

3. SIGNIFICANT ACCOUNTING POLICIES

Basis of accounting

The Company's accounting policies and standards of financial disclosure are in accordance with Canadian generally accepted accounting principles ("GAAP") as prescribed by the Canadian Institute of Chartered Accountants.

Consolidation

The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries which include Mironuck Pharmacy Ltd., Glenpark I.D.A. Pharmacy Ltd., Paragon Medical Supplies Ltd., Paragon Payless Pharmacy Ltd., Paragon Crestview Pharmacy Ltd., Paragon South Calgary Ltd. (Note 5), Black Mountain Pharmacy (1979) Ltd., Paragon Lake Country Pharmacy Ltd., Paragon Central Fill Ltd. (until October 31, 2005 - Note 4), Paragon Mission Pharmacy (B.C.) Ltd. and Paragon Columbia Pharmacy Ltd. The Company's wholly-owned subsidiaries have been fully consolidated in the financial results.

Paragon Columbia Pharmacy Ltd. is a new entity incorporated in the province of British Columbia on December 19, 2005 and commenced active operations on February 20, 2006.

Accounting for long-term investments

The Company's equity investments in Canada Direct Pharmacy Ltd. (see below), Catalyst Healthcare Ltd., ACO Super Drug Mart Ltd. and 1036985 Alberta Ltd. (Cochrane Super Drug Mart) have been recorded using the equity method.

Canada Direct Pharmacy Ltd. was effectively dissolved on February 24, 2006. This dissolution had no effect on these consolidated financial statements in fiscal 2006 and 2005, as the investment in Canada Direct Pharmacy Ltd. had been previously written down to $Nil.

Use of estimates

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenue and expenses for the reported periods. Actual results could differ from those estimates.

The recoverable amount of the Company's accounts receivable and inventory are based on management estimates. Management reviews these estimates on a periodic basis and, if required, makes adjustments prospectively.

Revenue recognition

Revenue from the sale of pharmaceutical products is recognized at the time of the sale to the consumer. Revenue from the sale of medical supplies and equipment is recognized on delivery and when ultimate collection is reasonably assured. Revenue from repairs and maintenance services is recognized when the services are performed.

Cash and cash equivalents

Cash and cash equivalents are defined as cash and highly liquid investments, which have maturities of less than three months at the date of acquisition.

Accounting for certain consideration received from vendors

The Company receives allowances from certain of its merchandise vendors and records the cash consideration received from the respective vendors as a reduction in the price of the vendor's products. This reduction is recorded to the related inventory and cost of sales when recognized in the balance sheet and income statements, respectively.

Inventory

Inventory is valued at the lower of cost and net realizable value and is determined principally on an average cost basis.

Deferred costs

Deferred costs represents amounts expended directly and incrementally for the amalgamation as described in Note 18. Upon finalization of the amalgamation, these costs will be recognized as part of the total cost of amalgamation.

Capital assets

Capital assets are recorded at the lower of cost less accumulated amortization and fair value and are amortized using the declining-balance method at the following annual rates:




Furniture and fixtures 20%
Automotive 30%
Nursing home and pharmacy equipment 30%
Computer equipment 30%
Computer software 100%


Assets under capital lease are amortized over the term of their respective leases.

Leasehold improvements are recorded at cost and are amortized over the shorter of their useful life or a straight-line basis over the non-cancellable term of the lease.

Intangible assets

Intangible assets are recorded at cost and are amortized using the straight-line method over the following periods:



Prescription files 5 years
Pre-operating costs 5 years
Non-competition agreements 2 years


Operating leases are amortized using the straight-line method over the remaining terms of the corresponding leases, ranging from nine to forty-two months.

Loan financing fees are amortized using the straight-line method over a period of five years, effectively representing the term of the corresponding loan.

Goodwill

Goodwill represents the excess of the acquisition cost of companies over the fair value of the identifiable net assets acquired.

Long-lived assets

The carrying value of the Company's long-lived assets, including intangible assets and goodwill, is tested for recoverability whenever events or changes in circumstances indicate that the carrying value may not be recoverable. An impairment loss is recognized when the carrying value of the asset exceeds the undiscounted future cash flows expected from its use and eventual disposition. The amount of impairment loss is determined as the excess of the carrying value of the asset over its fair value.

Future income taxes

Income taxes are accounted for by the liability method of income tax allocation. Under this method, future income tax assets and liabilities are determined based on temporary differences between the carrying amount of balance sheet items and their tax basis. Future income tax assets and liabilities are measured under this method by using substantively enacted tax rates that are expected to apply when such tax assets or liabilities are either settled or realized.

Stock-based compensation

The Company issues stock options and warrants to certain directors, executives, employees and consultants. The Company accounts for its grants under those plans in accordance with the fair value based method of accounting for stock-based compensation. The compensation expense is recognized over the period in which the option vests, with a corresponding increase to contributed surplus in shareholders' equity.

4. DISPOSITION OF PARAGON CENTRAL FILL LTD.

On October 31, 2005, the Company sold 100% of its shares held in Paragon Central Fill Ltd. ("Central Fill") to Catalyst Healthcare Ltd. ("Catalyst"). Proceeds of $419,603 were comprised of cash of $250,000 and shares in Catalyst of $169,603. These proceeds were used by the Company to settle amounts receivable from Central Fill. This disposition represents a non-arm's length transaction that has been recorded at the carrying amount.

The following table depicts the net assets disposed of and the corresponding adjustment to retained earnings:



----------
$
----------

Cash 47,957
Accounts receivable 130,536
Inventory 196,400
Prepaid expenses 24,037
Capital assets 294,145
Accounts payable (415,498)
Due to related parties (433,511)
Long-term debt and capital leases (217,651)
Share capital (1)
----------
(373,586)
Retained earnings adjustment 373,586
----------
-
----------
----------


5. DISCONTINUED OPERATIONS AND WIND-UP OF ENTITY

In August 2005, Paragon South Calgary Ltd. (a single drugstore held in a separate legal entity) was closed and ceased operations due to the sale of the building in which the pharmacy was located and leased space. This cessation of operations represents a discontinued operation as the operations and cash flows of this entity have been completely eliminated from ongoing operations. As payment for early termination of the lease, the landlord agreed to pay the Company $109,566, which was used to pay-out the Company's long-term debt of $107,066, originally due December 2008. In fiscal 2005, the $109,566 owing from the landlord was recorded in current assets from discontinued operations and the aforementioned debt was reclassified to the current liabilities from discontinued operations.

On August 31, 2006, Paragon South Calgary Ltd. was wound-up into the Company and the legal entity was formally dissolved on November 14, 2006.

The following table sets forth the results of operations associated with the above noted discontinued operations:



-------------------
2006 2005
$ $
-------------------
REVENUE - 543,697
COST OF SALES - 389,804
-------------------

GROSS PROFIT - 153,893
-------------------

EXPENSES
Selling, general and administration 8,141 309,497
Amortization - 60,789
Bank charges and interest 524 4,384
Interest on long-term debt 206 7,933
-------------------
8,871 382,603
-------------------
LOSS BEFORE OTHER ITEMS (8,871) (228,710)
-------------------

OTHER ITEMS
Gain on lease termination - 109,566
Write-down of capital assets due to discontinued
operations - (80,126)
Loss on sale of capital assets (16,360) -
Gain on sale of prescription files - 829
Write-down of inventory due to discontinued operations (18,428) (30,853)
Write-off of goodwill - (55,206)
-------------------
(34,788) (55,790)
-------------------
LOSS FROM DISCONTINUED OPERATIONS (43,659) (284,500)
-------------------
-------------------


6. BANK INDEBTEDNESS

The Company has an operating line of credit available to a maximum of the lesser of: a) $2.5 million; or b) the total of 75% of the Receivable Value calculated as total accounts receivable less over 60 day accounts and 50% of the inventory value net of accounts payable to a maximum of $1 million. This line bears interest at prime plus 1%. As at August 31, 2006, $Nil has been drawn on this line of credit.

Included in the facility above, the Company has available a maximum of $500,000 for the issuance of letters of credit in favor of Canada Post Corporation. These issued letters are renewed annually on August 1, as required. As at August 31, 2006, letters aggregating $480,000 have been issued.

These facilities are secured by a general security agreement representing a first charge on all the assets and undertakings of the Company and its subsidiaries, unlimited guarantees of advances by the Company and its subsidiaries, subordination / priority agreements with a certain supplier and an assignment of fire insurance over assets of the Company and its subsidiaries.

7. CASH HELD IN TRUST

As at August 31, 2006, the Company had $1.5 million held in trust (2005 - $Nil) due to the receipt of funds from the third party loan agreement as detailed in Note 11. Subsequent to year-end, these funds were released from trust and invested in a short-term GIC.



8. CAPITAL ASSETS

-------------------------------------
2006
-------------------------------------
Accumulated Net Book
Cost Amortization Value
$ $ $
-------------------------------------
Furniture and fixtures 618,814 336,140 282,674
Automotive 131,689 48,045 83,644
Nursing home and pharmacy equipment 19,366 8,768 10,598
Computer equipment 525,263 301,116 224,147
Computer software 123,099 62,272 60,827
Assets under capital lease 257,830 93,923 163,907
Leasehold improvements 1,070,181 527,075 543,106
-------------------------------------
2,746,242 1,377,339 1,368,903
-------------------------------------
-------------------------------------


---------------------------------------
2005
---------------------------------------
Accumulated Net Book
Cost Amortization Value
$ $ $
---------------------------------------

Furniture and fixtures 424,291 273,872 150,419
Automotive 108,427 46,340 62,087
Nursing home and pharmacy equipment 50,462 12,308 38,154
Computer equipment 548,586 282,904 265,682
Computer software 73,366 65,637 7,729
Assets under capital lease 428,202 153,818 274,384
Leasehold improvements 851,579 367,270 484,309
---------------------------------------
2,484,913 1,202,149 1,282,764
---------------------------------------
---------------------------------------

9.INTANGIBLE ASSETS

---------------------------------------
2006
---------------------------------------
Accumulated Net Book
Cost Amortization Value
$ $ $
---------------------------------------

Prescription files 7,245,105 2,270,100 4,975,005
Pre-operating costs 27,826 1,728 26,098
Operating leases 466,551 75,442 391,109
Loan financing fees 70,000 4,667 65,333
Non-competition agreements 10,000 10,000 -
---------------------------------------
7,819,482 2,361,937 5,457,545
---------------------------------------
---------------------------------------

---------------------------------------
2005
---------------------------------------
Accumulated Net Book
Cost Amortization Value
$ $ $
---------------------------------------

Prescription files 3,711,393 1,293,068 2,418,325
Non-competition agreements 10,000 10,000 -
---------------------------------------
3,721,393 1,303,068 2,418,325
---------------------------------------
---------------------------------------


The pre-operating costs were incurred prior to the commencement of active operations of Paragon Columbia Pharmacy Ltd. on February 20, 2006, the intangible assets associated with operating leases were acquired as part of the acquisition of Super Drug Mart (Note 2(a)) and the loan financing fees pertain to the new debt obtained from the Toronto Dominion Bank (Note 11).

10. DUE (TO) FROM RELATED PARTIES



-------------------------
2006 2005
$ $
-------------------------

ACO Super Drug Mart Ltd. (67,392) -
Catalyst Healthcare Ltd. 96,904 -
1036985 Alberta Ltd. (Cochrane Super Drug Mart) 184,058 -
Super Drug Mart Limited Partnership 384,114 -
OK Valley Drugs Ltd. - (7,647)
R499 Enterprises Ltd. - 2,526
-------------------------
597,684 (5,121)
-------------------------
-------------------------


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

During the year, the Company paid $95,168 in rent for premises leased under operating leases with related parties. These transactions have been recorded at fair market value.



11. LONG-TERM DEBT
----------------
2006 2005
$ $
----------------
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
exxecuted by the Company and it subsidiaries 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 1,500,000 -

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 16,887 25,168

Desante Financial Services Ltd.
Promissory note of Paragon Crestview Pharmacy Ltd.
bearing interest at 8%, payable in blended monthly
instalments of $2,430, due October 2008, repaid
during the year - 81,344

Promissory note of Paragon Crestview Pharmacy Ltd.
bearing interest at 8%, payable in blended monthly
instalments of $506, due October 2008, repaid during
the year - 16,947

Promissory note bearing interest at 8%, payable in
blended monthly instalments of $1,622, due December
2008, repaid during the year - 56,789

Promissory note of Paragon Payless Pharmacy Ltd.
bearing interest at 8%, payable in blended monthly
instalments of $2,430, due October 2008, repaid
during the year - 81,344

Promissory note of Paragon Payless Pharmacy Ltd.
bearing interest at 8%, payable in blended monthly
instalments of $506, due October 2008, repaid during
the year - 16,947

Promissory note of the Company, bearing interest
at 8.25%, payable in blended monthly instalments
of $20,877, due April 2011, repaid during the
year - 1,133,438

Promissory note of the Company, bearing interest
at 8.87%, payable in blended monthly instalments
of $12,832, due July 2011, repaid during the
year - 706,882

The Desante debt was secured by a general security
agreement covering all assets and undertakings of
the Company.

Microsoft Capital Corporation
Loan payable bearing interest at 2.567% per annum,
payable in blended monthly instalments of $941,
due September 2007, secured by a certain capital
assets, a general security agreement covering all
assets and undertakings of Black Mountain Pharmacy
(1979) Ltd. 12,046 22,871

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 14,400 19,799

Non-interest bearing loan, repayable in monthly
instalments of $554, due May 2009, secured by a
general security agreement covering all assets and
undertakings of the Company, repaid during the year - 24,366

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 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 29,194 -
--------------------
10,929,461 2,185,895
Less current portion 3,037,853 361,621
--------------------
7,891,608 1,824,274
--------------------
--------------------

Principal payments required in each of the next five fiscal
years are as follows:

-------------
$
-------------

2007 3,037,853
2008 2,526,725
2009 2,016,022
2010 2,012,422
2011 1,336,440

12. CAPITAL LEASES
---------
$
---------

Year ending August 31, 2007 75,711
2008 52,805
2009 21,627
2010 15,558
2011 8,479
---------

Total minimum lease payments 174,180

Less amount representing interest at rates ranging from
3% - 18.2% 26,981
-------

Balance of obligation 147,199

Less current portion 61,061
---------
86,138
---------
---------


13. 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, 2004 8,317,682 7,382,473
Issuance of common shares for cash on
exercise of warrants - $1.00 per share 9,750 9,750
Issuance of common shares for cash - $1.50
per share 1,125,667 1,688,501
---------------------------

Balance, August 31, 2005 9,453,099 9,080,724
Issuance of common shares for cash - $1.00
per share 7,500,000 7,500,000
Issuance of common shares for cash - $0.80
per share 4,931,500 3,945,200
Issuance of common shares on acquisition of
SDM - $0.80 per share 5,000,000 4,000,000
---------------------------
Balance, August 31, 2006 26,884,599 24,525,924
---------------------------
---------------------------

---------------------------
2006 2005
$ $
---------------------------
Shares issued 24,525,924 9,080,724
Share issuance costs (1,586,388) (758,470)
---------------------------

Share capital 22,939,536 8,322,254
---------------------------
---------------------------


Granting of options

The Company is authorized to issue options to employees, directors, officers and consultants under its stock option plan. The terms of the options are determined on a grant by grant basis.

During the year ended August 31, 2006, the Company issued Nil options (2005 - 383,500) with a weighted average exercise price of $Nil (2005 - $1.50), which vested immediately, to certain directors, officers, employees and consultants of the Company.

No options were exercised during the year ended August 31, 2006 (2005 - Nil) and Nil options (2005 - 25,000 options) with a weighted average exercise price of $Nil (2005 - $1.30) were cancelled.



The options outstanding at August 31, 2006 were as follows:

---------------------------------------------------------------------------
Date Number of Options Exercise Price
Issued Outstanding $ Expiry Date
---------------------------------------------------------------------------

February 27, 2004 217,000 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
-------------------
585,500
-------------------
-------------------


The weighted average exercise price of the options outstanding and exercisable at August 31, 2006 is $1.31 (2005 - $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 of of Total Exercise
Date of Warrants Warrants Warants Price Expiry
Issued Warrants 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 11,
2003 113,600 - 113,600 - 1.00 2005
March 23,
March 23, 2004 10,536 - 10,536 - 1.00 2006
April 16, 2004 52,792 - 52,792 - 1.50 April 16,
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, September 15,
2004 15,787 - - 15,787 1.50 2006
December 1, December 1,
2004 9,200 - - 9,200 1.50 2006
December 15, December 15,
2004 32,000 - - 32,000 1.50 2006
February 28, August 25,
2006 2,000,000 - - 2,000,000 1.25 2008
April 28, April 28,
2006 3,635,000 - - 3,635,000 0.80 2008
-------------------------------------------
5,996,145 9,750 294,408 5,691,987
-------------------------------------------
-------------------------------------------


Warrants

The weighted average exercise price of the warrants outstanding and exercisable at August 31, 2006 is $0.97 (2005 - $1.32). The weighted average exercise price of the warrants granted during the year ended August 31, 2006 was $0.96 (2005 - $1.50). The weighted average exercise price of the warrants exercised and expired during the year was $Nil and $1.28, respectively (2005 - $1.00 and $1.00 respectively).

The 2,000,000 warrants issued on February 28, 2006 were issued to a company owned by a director of the Company. Accordingly, these warrants have been included in stock-based compensation expense on the consolidated statement of loss and deficit.

The 3,635,000 warrants issued on April 28, 2006 were issued in conjunction with the Super Drug Mart acquisition (Note 2(a)). As these warrants were issued to members of the management team who have continued their employment with the Company, these have been included in stock-based compensation expense on the consolidated statement of loss and deficit.

Subsequent to August 31, 2006, on September 15, 2006, 15,787 warrants expired and were therefore cancelled.

Stock-based compensation

The Company recorded compensation expense using a fair-value based method for stock options and warrants granted to directors, executives, employees and consultants in the consolidated financial statements. Contributed surplus results from the recording of stock-based compensation as follows:



-------
$
-------

Contributed surplus, opening 97,859
2005 stock-based compensation 139,090
-------
Contributed surplus, August 31, 2005 236,949
2006 stock-based compensation 698,114
-------
2011 and subsequent 935,063
-------
-------


The fair value of each option and warrant granted was estimated to be $0.26 to $0.38 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:



----------------------------
2006 2005
----------------------------
Options
Discount rate - equivalent to 3- to
5-year bond 3.13 - 3.47% 3.13 - 3.47%
Expected lives 5 years 5 years
Expected volatility 17 - 21% 17 - 21%
Expected dividends Nil Nil
Warrants
Discount rate - equivalent to 1- to
3-year bond 2.34% - 4.12% 2.34% - 3.22%
Expected lives 2 - 2.5 years 2 years
Expected volatility 14 - 22% 12 - 22%
Expected dividends Nil Nil


14. INVESTMENT IN PRIVATE COMPANIES AND LOSS ON EQUITY INVESTMENTS

a) Canada Direct Pharmacy Ltd.

As at September 1, 2004, the Company held a 34.7% interest in Canada Direct Pharmacy Ltd. For the year ended August 31, 2005, CDP reported net income of $18,757. Given that the Company has already written down its investment to $Nil in fiscal 2004 and the accumulated losses exceeded the Company's share of income for fiscal 2005, no further adjustment was required. This entity was formally dissolved on February 24, 2006.

b) Catalyst Healthcare Ltd.

On October 24, 2005, the Company purchased 2,630,297 common shares in the initial share issuance of 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 4). This additional issuance increased the Company's investment in Catalyst to 33.9%. Due to further share issuances by Catalyst throughout fiscal 2006, the Company's investment at August 31, 2006 was 28.5%.

The Company has recognized its share of Catalyst's net loss, which aggregated $97,221, in the consolidated statement of loss and against its investment on the consolidated balance sheet.

c) ACO Super Drug Mart Ltd.

On April 28, 2006, the Company purchased 50% of the outstanding shares in ACO Super Drug Mart Ltd. ("ACO") for $12,325 (Note 2(a)), 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) 1036985 Alberta Ltd. (operating as Cochrane Super Drug Mart)

On April 28, 2006, the Company purchased 50% of the outstanding shares in 1036985 Alberta Ltd. ("Cochrane Super Drug Mart") for $350,025 (Note 2(a)), an equity investment. For the period ended August 31, 2006, Cochrane Super Drug Mart reported a net income of $25,550. The Company has recognized its portion of this income, totalling $12,775, in the consolidated statement of loss and in its investment on the consolidated balance sheet at August 31, 2006.



15. INCOME TAXES

-----------------------
2006 2005
$ $
-----------------------
Loss from continuing operations (1,578,820) (1,531,892)
Income taxes (recovery) 1,568 (30,401)
-----------------------
Loss before income taxes (1,577,252) (1,562,293)
-----------------------
-----------------------

Computed income tax expense at statutory rate of
33.86%, (2005 - 35.07%) (534,058) (547,896)
Non-deductible differences 475,205 206,122
Income tax rate adjustments - 19,080
Benefit of tax assets not recognized 132,673 292,293
Benefit of tax losses utilized (72,252) -
-----------------------
1,568 (30,401)
-----------------------
-----------------------


The Company has accumulated the following tax balances, the future benefit of which $Nil (2005 - $Nil) has been reflected in these consolidated financial statements.

Non-capital losses as at August 31, 2006 of $2,080,624 available for carry forward expire as follows:



-----------
$
-----------

2010 101,898
2014 368,349
2015 518,949
2016 1,091,428


16. COMMITMENTS

a) The Company and its subsidiaries leased premises under operating leases, which expire between January 2007 and August 2014. Rental payments, excluding operating costs and taxes, over the next five periods ended August 31 are as follows:



-----------
$
-----------
2007 1,630,047
2008 1,447,448
2009 1,150,721
2010 806,051
2011 644,665


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 $266,087 in 2007, $285,043 in 2008, $286,690 in 2009, $212,981 in 2010 and $199,428 in 2011.

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

17. FINANCIAL INSTRUMENTS

Fair value

The carrying amount reported on the 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 the debt is not materially different from the recorded value. The fixed rate debt, which has a carrying value of $1,579,241 at August 31, 2006, has a fair value of $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.

18. SUBSEQUENT EVENTS

Amalgamation with Rinoa Enterprises Ltd.

On October 31, 2006, Rinoa Enterprises Ltd. ("Rinoa") completed its "Qualifying Transaction" under Policy 2.4 of the TSX Venture Exchange ("TSX Venture") by amalgamating with the Company to form Paragon Pharmacies Limited ("Amalco"). In this transaction, all of the issued and outstanding common shares of the Company ("Company Shares"), all of the issued and outstanding options of the Company ("Company Options") and all of the issued and outstanding common share purchase warrants of the Company ("Company Warrants") (collectively, the "Company's Securities"), as well as the issued and outstanding common shares of Rinoa ("Rinoa Shares") and issued and outstanding share purchase options of Rinoa ("Rinoa Options") (collectively, the "Rinoa Securities") became equivalent securities of Amalco.

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