1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended October 31, 1997 Commission File Number 0-14491 ARBOR DRUGS, INC. ----------------- (Exact name of registrant as specified in its charter) State of Michigan 38-2054345 ---------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3331 West Big Beaver, Troy, Michigan 48084 -------------------------------------- ----- (Address of principal executive offices) Zip Code 248-643-9420 ------------ (Registrant's telephone number, including area code) 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 November 25, 1997 - ------------------------------------- -------------------------------- Common Stock, $.01 par value 39,507,553 1 2 ARBOR DRUGS, INC. AND SUBSIDIARIES INDEX Page No. -------- PART I FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets - October 31, 1997 and July 31, 1997 3 Condensed Consolidated Statements of Income- Three Months Ended October 31, 1997 and 1996 4 Condensed Consolidated Statements of Cash Flows - Three Months Ended October 31, 1997 and 1996 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 7-8 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 9 2 3 ARBOR DRUGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in Thousands) October 31, July 31, 1997 1997 ----------- -------- ASSETS Current assets: Cash and cash equivalents $26,577 $43,537 Securities available for sale 6,415 335 Accounts receivable 29,197 25,565 Inventory 154,895 131,700 Deferred taxes 2,015 1,965 Prepaid expenses 2,883 1,388 --------- --------- Total current assets 221,982 204,490 --------- --------- Property and equipment: Land and land improvements 28,686 23,124 Buildings 28,010 27,795 Furniture, fixtures and equipment 72,201 71,700 Leasehold improvements 46,475 45,075 Less accumulated depreciation (64,011) (63,745) --------- --------- 111,361 103,949 --------- --------- Other assets: Intangible assets 20,869 21,238 --------- --------- $354,212 $329,677 ========= ========= LIABILITIES Current liabilities: Notes payable, current portion $935 $611 Accounts payable 76,266 60,422 Accrued rent 8,184 7,753 Accrued expenses 3,569 2,886 Accrued compensation and benefits 7,389 8,466 Income tax payable 4,837 3,436 --------- --------- Total current liabilities 101,180 83,574 --------- --------- Notes payable, net of current portion 16,168 16,301 Deferred income tax 6,053 6,023 Minority interest in subsidiaries 792 768 --------- --------- 23,013 23,092 --------- --------- SHAREHOLDERS' EQUITY Preferred stock: $.01 par value; 2,000,000 shares authorized; none issued -- -- Common stock: $.01 par value; 40,000,000 shares authorized; 39,505,453 and 39,416,331 issued and outstanding, respectively 395 394 Additional paid-in capital 76,464 74,870 Retained earnings 153,160 147,747 --------- --------- 230,019 223,011 --------- --------- $354,212 $329,677 ========= ========= The accompanying notes are an integral part of the condensed consolidated financial statements. 3 4 ARBOR DRUGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (Amounts in Thousands, Except Three Months Ended Per Share Data) October 31, ----------------------------- 1997 1996 ------- ----------- Net sales $254,223 $224,973 Costs and expenses: Cost of sales 189,320 167,315 Selling, general and administrative 53,293 47,856 --------- --------- Income from operations 11,610 9,802 Interest expense (360) (372) Interest income 457 330 --------- --------- Income before income tax 11,707 9,760 Provision for income tax 3,928 3,367 --------- --------- Net income $7,779 $6,393 ========= ========= Earnings per common share $0.19 $0.16 ========= ========= Weighted average number of shares 40,978 38,807 ========= ========= Earnings per common share - assuming full dilution $0.19 $0.16 ========= ========= Weighted average number of shares - assuming full dilution 41,111 38,924 ========= ========= Cash dividend per common share $0.060 $0.047 ========= ========= The accompanying notes are an integral part of the condensed consolidated financial statements. 4 5 ARBOR DRUGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited) Three Months Ended October 31, ------------------- (Dollars in Thousands) 1997 1996 ---- ---- Operating activities: Net income $7,779 $6,393 Adjustments to reconcile to net cash provided by operations: Depreciation and amortization 4,117 4,096 Changes in operating assets and liabilities: Accounts receivable (3,632) (6,071) Inventory (23,195) (13,897) Prepaid expenses (1,495) (447) Accounts payable 15,844 12,582 Accrued expenses 41 1,543 Income tax payable 1,401 1,755 --------- --------- Net cash provided by operations 860 5,954 --------- --------- Investing activities: Purchase of property and equipment, net (10,600) (11,208) Purchase of intangible assets (560) (951) Purchase of short-term investments (6,080) (2,645) --------- --------- Net cash used in investing activities (17,240) (14,804) --------- --------- Financing activities: Borrowings, net of principal payments on debt 191 (610) Dividends paid (2,366) (1,756) Proceeds from exercise of stock options and stock purchase plan 1,595 5,126 --------- --------- Net cash (used in) provided by financing activities (580) 2,760 --------- --------- Net decrease in cash and cash equivalents (16,960) (6,090) --------- --------- Cash and cash equivalents at beginning of period 43,537 34,955 --------- --------- Cash and cash equivalents at end of period $26,577 $28,865 ========= ========= Cash paid for income tax $2,280 $165 ========= ========= Cash paid for interest $503 $612 ========= ========= The accompanying notes are an integral part of the condensed consolidated financial statements. 5 6 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 necessary for a fair presentation of financial position, results of operations and cash flows at October 31, 1997, 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, 1997. 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. EARNINGS PER SHARE Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share," was issued in February 1997 and is effective for interim and annual periods beginning after December 15, 1997. Earlier adoption is not permitted. Using SFAS No. 128, "earnings per share" would have been $.20 and $.17, for the quarters ending October 31, 1997 and 1996, respectively, and "earnings per share-assuming dilution" would have been $.19 and $.16 for the quarters ending October 31, 1997 and 1996, respectively. 6 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS References to years are to the Company's fiscal years, which end July 31. NET SALES Net sales reached $254.2 million for the three months ended October 31, 1997, an increase of 13.0 percent over the three months ended October 31, 1996. The increase reflects an increase in comparable store sales (stores open for one year or more) of 7.1 percent and sales made by stores opened in the last 12 months. As of October 31, 1997, the Company operated 202 stores, compared to 188 stores as of October 31, 1996, and 199 stores as of July 31, 1997. Prescription drug sales were $140.8 million for the three months ended October 31, 1997, an increase of 17.5 percent over the three months ended October 31, 1996, accounting for 55.4 percent of total sales for the three months ended October 31, 1997, compared to 53.3 percent for the three months ended October 31, 1996. The increases, in both absolute amount and relative contribution, were primarily attributable to the larger store base, a greater number of prescriptions filled on a comparable-store basis and an increase in the average prescription price. The latter reflected price increases for certain existing brand name drugs and the introduction of new brand name drugs, offset in part by the lower prices of generic drugs, which are marketed as the corresponding brand name drugs lose patent protection. COST OF SALES Cost of sales represented 74.5 percent of net sales for the three months ended October 31, 1997, compared to 74.4 percent for the three months ended October 31, 1996. Generally, the increases reflect rising pharmaceutical product costs and gross margin percentage pressure due to the reimbursement practices of the Company's third-party providers. Third-party providers generally pay the Company an amount determined by formula to reimburse it for the cost of the prescription drugs dispensed plus a fixed dispensing fee to compensate it for the services rendered. As pharmaceutical costs increase, the gross margin percentage on such sales decreases because the dispensing fee remains the same pursuant to the applicable third-party program. Changes in the reimbursement formulas of the various third-party providers with which the Company has contracts may also affect the Company's gross margin and operating income. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative ("SG&A") expenses, as a percentage of net sales, amounted to 21.0 percent for the three months ended October 31, 1997, compared to 21.3 percent for the three months ended October 31, 1996. The decrease was primarily attributable to the Company's efforts to control expenses and by the higher level of net sales. 7 8 PROVISION FOR INCOME TAX The provision for income tax as a percentage of income before income tax was 33.6 percent for the three months ended October 31, 1997, compared to 34.5 percent for the three months ended October 31, 1996. LIQUIDITY AND CAPITAL RESOURCES For the three months ended October 31, 1997, net cash was provided by operations ($.9 million) and through the exercise of stock options and employee stock purchase plan purchases ($1.6 million). Cash was principally used for capital expenditures and acquisitions ($11.2 million), purchase of short-term investments ($6.1 million) and cash dividends ($2.4 million). In the aggregate, the Company's net cash decreased by $17.0 million. The Company anticipates fiscal 1998 capital expenditures to total approximately $30 million. The funds will be used to open new stores, remodel existing stores and invest in retailing systems. The Company's current expansion plan contemplates adding approximately 20 new Arbor drugstores in fiscal 1998 through the leasing and development of new sites and, if suitable opportunities arise, acquisitions. As of October 31, 1997, 4 new stores have been opened and one store was consolidated during the current fiscal year. The Company believes that existing cash, cash equivalents and short-term investments, cash provided from future operations and funds available under a $50 million line of credit will support anticipated expansion and working capital needs arising in the ordinary course of business during fiscal 1998. As of October 31, 1997, the Company had no outstanding borrowings against its line of credit. 8 9 PART II OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit 11: Computation of Earnings Per Share Page 11 Exhibit 27: Financial Data Schedule (b) Reports on Form 8-K: None 9 10 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: November 26, 1997 /s/ Gilbert C. Gerhard ------------------------------ Gilbert C. Gerhard (Duly Authorized Officer and Principal Financial Officer) 10 11 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION Exhibit 11 Computation of Earnings Per Share Exhibit 27 Financial Data Schedule