SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------- FORM 10-Q ------------- [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended January 31, 1994 or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________ Commission file number: 0-14491 ------- ARBOR DRUGS, INC. - --------------------------------------------------------------------------- (Exact Name of Registrant as Specified in its Charter) Michigan 38-2054345 - -------------------------------- -------------------------------- (State or Other Jurisdiction of (I.R.S. Employer Identification Incorporation or Organization) No.) 3331 West Big Beaver Troy, Michigan 48084 (810) 643-9420 - --------------------------------------------------------------------------- (Address, Including Zip Code, and Telephone Number, Including Area Code of Registrant's Principal Executive Offices) - --------------------------------------------------------------------------- (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [_] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at February 22, 1994 - ---------------------------- -------------------------------- Common Stock, $.01 par value 16,303,623 ARBOR DRUGS, INC. AND SUBSIDIARIES INDEX ----- Page No. -------- PART I FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets - January 31, 1994 and July 31, 1993 3 Condensed Consolidated Statements of Income - Three and Six Months ended January 31, 1994 and 1993 4 Condensed Consolidated Statements of Cash Flows - Six Months Ended January 31, 1994 and 1993 5 Notes to Condensed Consolidated Financial Statements 6-7 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 8-10 PART II OTHER INFORMATION Item 1. Legal Proceedings 11 Item 4. Submission of Matters to a Vote of Security Holders 12 Item 6. Exhibits and Reports on Form 8-K 13 NYFS01...:\08\16508\0001\7120\FRM22394.M00 ARBOR DRUGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars In Thousands) January 31, July 31, ASSETS 1994 1993 ---------- -------- Current assets: Cash and cash equivalents $ 31,430 $ 41,392 Short-term investments 953 3,475 Accounts receivable 11,817 8,313 Inventory 83,707 70,341 Deferred taxes 6,293 8,424 Prepaid expenses 1,798 1,882 -------- -------- Total current assets 135,998 133,827 -------- -------- Property and equipment: Land and land improvements 8,761 8,937 Buildings 12,720 14,194 Furniture, fixtures and equipment 49,136 47,207 Leasehold improvements 29,273 27,982 Less accumulated depreciation (36,852) (33,095) --------- --------- 63,038 65,225 -------- -------- Other assets: Intangible assets 22,071 16,527 Property held for resale 3,243 - -------- -------- 25,314 16,527 -------- -------- $ 224,350 $215,579 --------- -------- LIABILITIES Current liabilities: Notes payable, current portion $ 1,350 $ 1,339 Accounts payable 46,758 41,561 Liability for third-party settlement and related expenses 10,575 16,000 Accrued rent 4,531 3,795 Accrued compensation and benefits 4,205 3,461 Income tax payable 2,473 3,627 Accrued expenses 1,833 1,437 -------- -------- Total current liabilities 71,725 71,220 -------- -------- Notes payable, net of current portion 17,529 18,151 Deferred income tax 6,939 7,008 Minority interest in subsidiaries 659 727 -------- -------- 25,127 25,886 -------- -------- SHAREHOLDERS' EQUITY Preferred stock: $.01 par value; 2,000,000 share authorized; none issued - - Common stock: $.01 par value; 40,000,000 shares authorized; 16,270,323 and 16,242,873 issued and outstanding, respectively 163 162 Additional paid-in capital 45,795 45,463 Retained earnings 81,540 72,848 -------- -------- 127,498 118,473 -------- -------- $224,350 $215,579 -------- -------- The accompanying notes are an integral part of the condensed consolidated financial statements. NYFS01...:\08\16508\0001\7120\FRM22394.M00 ARBOR DRUGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (Amounts In Thousands, Except Three Months Ended Six Months Ended Per Share Data) January 31, January 31, ------------------ ---------------- 1994 1993 1994 1993 -------- -------- -------- -------- Net sales $159,596 $140,412 $303,400 $264,661 Costs and expenses: Cost of sales 117,133 102,569 222,757 193,483 Selling, general and administrative 32,435 29,844 64,320 57,584 -------- -------- -------- -------- Income from operations 10,028 7,999 16,323 13,594 Interest expense (456) (411) (889) (919) Interest income 260 218 531 468 -------- -------- -------- -------- Income before income tax 9,832 7,806 15,965 13,143 Provision for income tax 3,358 2,605 5,486 4,100 -------- -------- -------- -------- Net income $ 6,474 $ 5,201 $ 10,479 $ 9,043 ======== ======== ======== ======== Earnings per common share $ .40 $ .32 $ .64 $ .56 ======== ======== ======== ======== Weighted average number of common shares outstanding 16,255 16,214 16,250 16,201 ======== ======== ======== ======== Cash dividend per common share $0.060 $0.050 $0.110 $0.085 ======== ======== ======== ======== The accompanying notes are an integral part of the condensed consolidated financial statements. NYFS01...:\08\16508\0001\7120\FRM22394.M00 ARBOR DRUGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended (Dollars In Thousands) January 31, ------------------ 1994 1993 ------- ------- Operating activities: Net income $10,479 $ 9,043 Adjustments to reconcile to net cash provided by operations: Depreciation 4,397 4,040 Amortization 1,755 1,377 Changes in operating assets and liabilities: Accounts receivable (3,504) (3,872) Inventory (13,366) (5,709) Prepaid expenses 84 (1,395) Accounts payable 5,197 2,217 Third-party settlement and related expenses (5,425) - Accrued expenses 1,876 1,087 Income tax payable (1,154) (186) Deferred income tax 2,062 21 ------- ------- Net cash provided by operations 2,401 6,623 ------- ------- Investing activities: Purchase of property and equipment, net (2,210) (7,062) Purchase of intangible assets (7,367) (1,829) Maturity of short-term investments 2,522 210 Purchase of property held for development or resale (3,243) - ------- ------- Net cash used in investing activities (10,298) (8,681) ------- ------- Financing activities: Principal payments on debt (611) (20,729) Dividends paid (1,787) (1,377) Proceeds from borrowing - 6,450 Proceeds from exercise of stock options 333 394 ------- ------- Net cash used in financing activities (2,065) (15,262) ------- ------- Net decrease in cash and cash equivalents (9,962) (17,320) Cash and cash equivalents at beginning of period 41,392 47,755 ------- ------- Cash and cash equivalents at end of period $31,430 $30,435 ======= ======= Cash paid for income tax $ 4,376 $ 4,099 ======= ======= Cash paid for interest $ 943 $ 888 ======= ======= The accompanying notes are an integral part of the condensed consolidated financial statements. NYFS01...:\08\16508\0001\7120\FRM22394.M00 ARBOR DRUGS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles and reflect, in the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position, results of operations and cash flows at January 31, 1994 and for all periods presented. The condensed consolidated financial statements should be read in conjunction with the annual consolidated financial statements and notes contained in Arbor's Annual Report on Form 10-K for the fiscal year ended July 31, 1993. The results of operations for any interim period should not necessarily be considered indicative of the results of operations for the full year. 2. INVENTORY VALUATION Inventory at interim periods is valued on a last-in, first-out (LIFO) basis which is determined based upon estimates of gross profit rates, inflation rates and inventory levels, and is adjusted for the results of physical inventories when taken. 3. LEGAL PROCEEDINGS As discussed in the Company's Annual Report on Form 10-K for its fiscal year ended July 31, 1993, the Company settled a contractual dispute with Blue Cross of Michigan relating to its reimbursement practices, and the United States Attorney for the Eastern District of Michigan (the "United States Attorney") has been investigating the Company's third-party reimbursement practices for possible criminal violations. The Company does not believe that it has engaged in any conduct that should result in criminal charges being brought. Although the criminal investigation has not been discontinued, in February 1994, at the request of the United States Attorney, the Company agreed that information that the Company and others had furnished in connection with the criminal investigation could be used as part of a review by the Civil Division of the United States Attorney's office, in NYFS01...:\08\16508\0001\7120\FRM22394.M00 conjunction with the Department of Health and Human Services ("HHS"), of possible excess Medicaid reimbursement claims by the Company under the federal False Claims Act. The Company understands that the review is at an early stage and, to date, neither the Civil Division nor HHS has asserted any claim against the Company. The Company believes it is premature to assess the effect on the Company of these investigations or any claims that may be asserted as a result thereof. NYFS01...:\08\16508\0001\7120\FRM22394.M00 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS Net Sales --------- Net sales increased by 13.7% and 14.6% for the three and six months ended January 31, 1994, respectively, over the comparable periods of the prior year. The increases were primarily attributable to increases of 7.1% and 8.1% in comparable store sales (sales by stores in operation for at least 12 months) for the three and six months ended January 31, 1994, respectively. In addition, sales increased due to the opening of new drugstores. The Company operated 152 stores at the end of the current fiscal quarter, as compared to 131 stores at the end of the second quarter of fiscal 1993. Nine of the 21 additional stores were added during the last two weeks of the quarter ended January 31, 1994. Cost of Sales ------------- Cost of sales as a percentage of net sales, for the three and six months ended January 31, 1994, was 73.4%. The percentages for the comparable periods of the prior year were 73.0% and 73.1%, respectively. The increases in the cost percentages principally reflect rising pharmaceutical product costs and the resulting gross margin pressure due to the reimbursement practices of the Company's third party provider programs and the increase in pharmacy sales as a percentage of total sales. Selling, General and Administrative Expense ------------------------------------------- Selling, general and administrative expense as a percentage of net sales, was 20.3% and 21.2% for the three and six months ended January 31, 1994, respectively, as compared to 21.3% and 21.8% for the comparable periods of the prior year. The decrease in the three and six month percentages was primarily due to the fact that selling, general and administrative expense in the quarter ended January 31, 1993, included a one-time charge of $1,025,000 owing to the disposition of a lease dispute. Additionally, the percentages declined due to the Company's disciplined expense control and leveraging provided by higher sales. NYFS01...:\08\16508\0001\7120\FRM22394.M00 Interest Expense ---------------- Interest expense net of interest income, for the three and six months ended January 31, 1994 was $196,000 and $358,000, respectively, as compared to $193,000 and $451,000 in the comparable periods of the prior year. The decrease in net interest expense for the six months ended January 31, 1994, is due to higher cash balances during that time period, due primarily, to the repayment of a $20,000,000 note in the second half of fiscal 1993. Provision for Income Tax ------------------------ The provision for income tax as a percentage of income before income tax, was 34.2% and 34.4%, respectively, for the three and six months ended January 31, 1994, as compared to 33.4% and 31.2% in the three and six months ended January 31, 1993, respectively. The increase in the percentages for the three and six month periods was due to an increase in the corporate federal statutory tax rate to 35 percent, effective January 1, 1993. Additionally, impacting the increase in the percentage for the six-month period ended January 31, 1994, was the adoption in the first quarter of fiscal 1993 of the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." The benefit of adopting this statement for the six months ended January 31, 1993, was a decrease in the provision for income tax in the amount of $285,000. FINANCIAL CONDITION Cash flow provided by operations for the six months ended January 31, 1994 was $2,401,000. These funds, in addition to cash, cash equivalents and short-term investments available at the beginning of the current fiscal year, were principally used for capital expenditures, payment of dividends and debt retirement, which totaled $15,218,000 for the six month period. For the first half of the current fiscal year, total net use of cash and cash equivalents was $9,962,000, including the first third of the Company's $15 million settlement of a contractual dispute with Blue Cross of Michigan. The remainder of the settlement will be paid within the next twelve months. For information with respect to certain related matters, see Note 3 of Notes to Condensed Consolidated Financial Statements and Item 1 of this Report. NYFS01...:\08\16508\0001\7120\FRM22394.M00 During the fiscal year ending July 31, 1994, the Company plans to open or acquire approximately 18 to 20 stores, including 10 drugstores that were acquired from a drugstore chain in January 1994. One of the ten stores acquired from the drugstore chain was consolidated with the operations of an existing Company drugstore. The Company is also evaluating the possibility of consolidating one or more of the remaining acquired stores into existing Arbor drugstores. As of February 24, 1994, 14 new stores have been opened or acquired during the current fiscal year. Construction delays due to unseasonably cold weather in southeastern Michigan will defer the opening of several stores from the second half of fiscal 1994 to the first half of fiscal 1995. The Company believes that existing cash, cash equivalents and short-term investments and cash provided from operations, together with funds available under a $50 million line of credit, will be adequate for anticipated expansion and working capital needs arising in the ordinary course of business during the current fiscal year. NYFS01...:\08\16508\0001\7120\FRM22394.M00 PART II OTHER INFORMATION Item 1. Legal Proceedings ----------------- As discussed in the Company's Annual Report on Form 10-K for its fiscal year ended July 31, 1993, the Company settled a contractual dispute with Blue Cross of Michigan relating to its reimbursement practices, and the United States Attorney for the Eastern District of Michigan (the "United States Attorney") has been investigating the Company's third-party reimbursement practices for possible criminal violations. The Company does not believe that it has engaged in any conduct that should result in criminal charges being brought. Although the criminal investigation has not been discontinued, in February 1994, at the request of the United States Attorney, the Company agreed that information that the Company and others had furnished in connection with the criminal investigation could be used as part of a review by the Civil Division of the United States Attorney's office, in conjunction with the Department of Health and Human Services ("HHS"), of possible excess Medicaid reimbursement claims by the Company under the federal False Claims Act. The Company understands that the review is at an early stage and, to date, neither the Civil Division nor HHS has asserted any claim against the Company. The Company has also been advised that the Securities and Exchange Commission is investigating the Company's reporting of related matters. The Company believes it is premature to assess the effect on the Company of these investigations or any claims that may be asserted as a result thereof. NYFS01...:\08\16508\0001\7120\FRM22394.M00 Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- The Annual Meeting of Shareholders of the Company was held on December 7, 1993. At the annual meeting, the following persons were elected as directors of the Company and the following votes were cast for or were withheld from voting with respect to the election of each such person: Votes ----------------------- Name For Withheld -------- --------- -------- Eugene Applebaum 13,438,635 21,742 Markus M. Ernst 13,439,537 20,840 Gilbert C. Gerhard 13,407,532 52,845 David B. Hermelin 13,440,162 20,215 Spencer M. Partrich 13,440,062 20,315 Laurie M. Shahon 13,440,537 19,840 Samuel Valenti III 13,440,587 19,790 There were 750 broker non-votes and no abstentions in connection with the election of the directors at the annual meeting. In addition, at the annual meeting, the adoption of the Company's Amended and Restated Stock Option Plan, pursuant to which the number of shares available for grant under the Plan was increased from 1,537,500 shares to 2,537,500 shares, was approved by the Company's shareholders by a vote of 10,486,381 shares for the adoption and 1,535,293 shares against adoption, with 40,926 shares abstaining and 1,397,777 broker non-votes. NYFS01...:\08\16508\0001\7120\FRM22394.M00 Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a) Exhibit 11: Computation of Earnings Per Share (b) Reports on Form 8-K: NONE SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ARBOR DRUGS, INC. ----------------- (Registrant) DATED: February 24, 1994 /s/ Gilbert C. Gerhard --------------------- ------------------------------ Gilbert C. Gerhard (Duly Authorized Officer and Principal Financial Officer) NYFS01...:\08\16508\0001\7120\FRM22394.M00 EXHIBIT INDEX Exhibit No. Description ----------- ----------- Exhibit 11 Computation of Earnings Per Share NYFS01...:\08\16508\0001\7120\FRM22394.M00