<PAGE>   1


                     SECURITIES AND EXCHANGE COMMISSION
                              Washington, D.C.
                                    20549

                                  FORM 10-K
---
 X   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
---  EXCHANGE ACT OF 1934

     For the fiscal year ended July 31, 1996
---
---  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934

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 No.)
incorporation or organization)

3331 West Big Beaver, Troy, Michigan                      48084
------------------------------------------              -----------
(Address of principal executive offices)                 (Zip Code)

Registrant's telephone number, including area code:  (810) 643-9420

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:

                        Common Stock, $.01 par value
                        ----------------------------
                              (Title of Class)

     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. (X) Yes ( ) No

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. (X)

     The aggregate market value of the voting stock held by non-affiliates of
the registrant as of October 18, 1996, was $611,030,256.

     The number of outstanding shares of the registrant's common stock as of
October 18, 1996 was 25,327,679.

Documents Incorporated by Reference

     Certain portions of the registrant's definitive proxy statement pursuant
to Regulation 14A of the Securities Exchange Act of 1934 for the 1996 Annual
Meeting of Shareholders are incorporated by reference in Part III of this Form
10-K.

                                                                            1
<PAGE>   2

                                   PART I

Item 1.   Business

General

     Arbor Drugs, Inc. (the "Company") is the largest Michigan-based drugstore
chain and the second largest drugstore chain operating in Michigan in terms of
total revenues.  As of July 31, 1996, the Company had 182 stores located
primarily in southeastern Michigan.

     Unless the context otherwise requires, references to the "Company" include
the Company's consolidated subsidiaries.  References to a fiscal year are to
the twelve months ended July 31.

Products

     The Company's drugstores sell four principal categories of products:
prescription drugs, health and beauty aids (including proprietary drugs and
cosmetics), photofinishing and film and general merchandise.  General
merchandise includes seasonal and promotional goods, greeting cards,
convenience foods and alcoholic and nonalcoholic beverages.  In fiscal 1996,
prescription drugs accounted for approximately 51.3 percent, health and beauty
aids for approximately 20.5 percent, photofinishing and film for approximately
4.9 percent and general merchandise for approximately 23.3 percent of the
Company's net sales.  Contributions to net sales are not indicative of
contributions to income from operations because gross margins vary among
product categories and products within each category.

     The Company's business normally generates somewhat higher revenues during
its second and fourth fiscal quarters (the Christmas and summer seasons).  The
Company believes that these higher revenues,  in combination with the fixed
nature of certain administrative and store operating costs and seasonal changes
in product mix, result in higher operating income for these periods.

Merchandising and Marketing

     The Company's merchandising  strategy  is  to  offer a broad selection  of
traditional drugstore items, including both nationally advertised and private
label brand products.  Substantially all products are offered at competitive
prices.  The Company emphasizes value and customer service in attractive,
conveniently located drugstores.  It uses color, signs, packaging and other
merchandising aids to reinforce its name and low prices, and to showcase its
products.

     The pharmacy department in each drugstore carries a complete line of both
brand name and generic drugs.  The Company has been expanding its prescription
drug business by promoting the use of less costly generic drugs, whenever
possible, and by entering into arrangements with insurance companies, health
maintenance organizations ("HMOs") and other health care groups for the sale of
prescription drugs under third-party reimbursement programs.  See "Significant
Customers" below.

                                                                            2

<PAGE>   3

     As part of the Company's merchandising of pharmaceutical products, each
pharmacy department utilizes Arbortech Plus(SM), a computerized pharmacy system.
Arbortech Plus(SM) enables the Company's pharmacists to recall a customer's
pharmacy history, with a view to identifying possible allergies, drug
interactions or therapeutic duplication, and to provide customers with a
complete record of medication dispensed.  This system affords each of the
Company's drugstores access to this information, thus enabling customers to be
served by any store in the chain.  Arbortech Plus(SM) also enables the Company
to identify generic equivalents of brand name drugs, centrally control
prescription prices, increase the speed of processing prescriptions and reduce
the paperwork normally involved in, and thus expedite the collection of amounts
due the Company under, third-party reimbursement programs.

     The Company promotes its private label Arbor(TM) brand products and
presently offers approximately 1,000 such products, including a wide variety of
vitamins, products for skin, hair and personal care, health products and
proprietary drugs for colds, allergies and other ailments.  Offering private
label products enables the Company to sell products, comparable in quality to
name brand products, at substantially lower prices to its customers, but at
higher gross margins for the Company.

     The primary photo processing marketing program used by the Company is
Picture! Picture!(SM), which offers a "two for the price of one"  photo
processing service, with guaranteed overnight processing.  Additional programs
are Picture! Plus!(SM) and the Picture! Picture! Club(SM), which offer customers
one print plus a free roll of film and prizes for volume photofinishing.
Picture Pronto(SM), is a one-hour photo processing service offered in 172 stores
as of July 31, 1996.  The Company intends to offer this service in all new
locations.  All photo processing services are provided by an independent
contractor.

     The Company advertises extensively, principally through the use of
television, radio, direct mail and advertising circulars.

Expansion Program

     As of July 31, 1996, the Company operated 182 drugstores, a net increase
of 15 drugstores from the end of fiscal 1995.  During fiscal 1996, the Company
opened 15 drugstores and purchased the prescription files of a number of
independent drugstores. Assuming no significant construction delays, the
Company anticipates adding approximately 15 to 20 drugstore locations in
Michigan during  fiscal 1997.   The Company may also continue to purchase the
prescription files of various independent drugstores, as opportunities arise.

     In addition to adding drugstores in southeastern Michigan, the Company has
expanded, and plans to continue to expand, in other areas of Michigan.  The
Company may also expand into contiguous states.  The Company's 470,000
square foot distribution center, which was expanded in fiscal 1996, is expected
to serve the Company's distribution needs for the next several years. The
Company expects that this expanded facility will accommodate approximately 400
stores.

                                                                            3

<PAGE>   4







Purchasing and Distribution

     The Company centrally purchases most of its merchandise directly from
manufacturers,  enabling it  to  benefit from promotional  programs and volume
discounts that certain manufacturers offer to retailers.  Approximately 81
percent of the merchandise  purchased  by  the Company is received at its
distribution center for redistribution  to  its drugstores.  The balance of
store merchandise is shipped directly to the Company's drugstores  by
manufacturers  and  distributors  at prices negotiated at the corporate level.

Significant Customers

     In fiscal 1996, 42.5 percent of the Company's net sales (approximately 83%
of pharmacy net sales) were attributable to payments by third-party providers
under prescription drug plans.  Six of such third-party providers accounted for
approximately one-third of  fiscal 1996 net sales and one, Blue Cross Blue
Shield of Michigan, accounted for more than 10 percent of fiscal 1996 net sales
(11.2 percent).

     The Company participates in the majority of third-party plans offered to
employer groups in its primary marketplace, the greater metropolitan Detroit
area.  Accordingly, if any employer group were to change its third-party plan,
the Company believes it is likely that it would continue to fill prescriptions
for such group under a different third-party plan.  In the event the Company
were unable to service one or more of its principal third-party provider plans,
however, the Company's revenues would be adversely affected.

Competition

     The Company's primary competitors are other drugstore chains, independent
drugstore operators, mail order distributors, hospitals, HMOs, department
stores (including discount stores) and supermarkets.  Many of the businesses
with which the Company competes are larger and have been in business longer or
have substantially greater financial resources than the Company.

     Competition remained keen during fiscal 1996 with the Company competing on
the basis of price, convenience, store design, product selection, quality and
variety.  See "Merchandising and Marketing" above.

Significant Proprietary Rights

     The Arbor(TM) trade name is considered to be of material importance to the
business of the Company.  The Company also holds servicemarks for some of its
photo finishing products and pharmacy systems.


Regulatory Matters and Insurance

     All of the Company's pharmacy departments and all pharmacists  employed by
the Company are licensed by the Michigan Board of Pharmacy.  The Company's
drugstores and its warehouse facility are also registered with the United
States Drug Enforcement Administration and are subject to various licensing and
regulatory requirements.  Beer and wine are sold in all of the Company's
drugstores, and liquor is sold in approximately half of the drugstores.  The
sale of alcoholic beverages is regulated by the Michigan Liquor Control

                                                                            4

<PAGE>   5

Commission. By virtue of these various license and registration requirements,
the Company is obligated to observe certain rules and regulations.  A violation
of these rules and regulations could result in a suspension or revocation of
such licenses or registrations with respect to one or more of the Company's
drugstores or the distribution center.

     The Company carries general liability insurance, subject to self-insured
retentions, with respect to druggist, product, premises and "dram-shop" claims.

Employees

     As of July 31, 1996, the Company had approximately 6,900 employees,
approximately 400 of whom were employed in the Company's executive office and
distribution center and the remainder of whom were employed in the Company's
drugstores.  A majority of the drugstore employees work on a part-time basis
(fewer than 35 hours per week).

     The Company's employees are not represented by unions.  The Company
believes that its relations with its employees are good.

Item 2.   Properties

     As of July 31, 1996, over 90 percent of the Company's 182 drugstores were
leased.  Only eight of the leases are due to expire within the next five years.
In addition to base rentals, the majority of the Company's store leases
require additional rentals based on a percentage of sales.  In most instances,
the leases obligate the Company to pay its pro rata share of common area 
maintenance charges, taxes and insurance.

     The Company owns its 470,000 square foot distribution center, which is
located in Novi, Michigan.  The Company leases its 54,000 square foot executive
offices, which are located in Troy, Michigan.

Item 3.   Legal Proceedings

     In November 1993 the Securities and Exchange Commission (the "SEC") issued
a formal Order of Private Investigation relating to the Company's reporting of
certain third-party reimbursement practices and a contractual dispute over
these practices with Blue Cross of Michigan (which has been settled).  The
Company has complied with the SEC's requests for information made in November
1993 and October 1994.

     The Company is also involved in various routine litigation incidental to
its business, none of which, in the opinion of management, is deemed to be
material.

Item 4.   Submission of Matters to a Vote of Security Holders

     None.

Item 10.   Directors and Executive Officers of the Registrant

     Set forth below is certain information with respect to the executive
officers of the Company.

                                                                              5


<PAGE>   6


<TABLE>
<CAPTION>
     Name                    Age                  Position
     ----                    ---                  --------
     <S>                     <C>                  <C>
     Eugene Applebaum        59                   Chairman of the Board, 
                                                  President and Chief Executive
                                                  Officer

     Markus M. Ernst         59                   Executive Vice President, 
                                                  Chief Operating Officer and
                                                  Director

     Gilbert C. Gerhard      54                   Senior Vice 
                                                  President-Finance and 
                                                  Administration, Chief 
                                                  Financial Officer, Secretary,
                                                  Treasurer and Director

     Donald M. Stutrud       48                   Senior Vice President-Store 
                                                  Operations

     Eric B. Bolokofsky      44                   Senior Vice 
                                                  President-Merchandising

     Dennis J. Wozniak       40                   Senior Vice 
                                                  President-Purchasing and 
                                                  Marketing

     John M. Enokian         63                   Senior Vice President - 
                                                  Health Services

</TABLE>

     Mr. Applebaum is a founder of the Company and has been the President and a
Director of the Company and its predecessors since 1963.  In January 1985, Mr.
Applebaum was elected Chairman of the Board and Chief Executive Officer.  Mr.
Applebaum has been a licensed pharmacist in the State of Michigan since 1960.

     Mr. Ernst has been Executive Vice President and a Director of the Company
since 1974, having served as a director and executive officer of one of the
Company's predecessors since 1968.  Mr. Ernst has also served as Chief
Operating Officer since 1985.  Mr. Ernst joined the Company in 1968.

     Mr. Gerhard has been Senior Vice President - Finance and Administration
since February 1994.  Mr. Gerhard has also served as Chief Financial Officer,
Secretary and Treasurer since 1983 when he joined the Company.  Mr. Gerhard was
Vice President-Finance and Administration from 1983 until February 1994.

     Mr. Stutrud has been Senior Vice President - Store Operations since
February 1991.  Mr. Stutrud served as Vice President - Store Operations from
March 1986 until January 1991.  Mr. Stutrud joined the Company in 1971.

     Mr. Bolokofsky has been Senior Vice President - Merchandising since
February 1994.  Mr. Bolokofsky served as Vice President - Merchandising from
October 1987 until February 1994.  Mr. Bolokofsky joined the Company in 1976.

     Mr. Wozniak has been Senior Vice President - Purchasing and Marketing
since February 1994.  Mr. Wozniak served as Vice President - Purchasing from
October 1987 until February 1994.  Mr. Wozniak joined the Company in 1978.

     Mr. Enokian has been Senior Vice President - Health Services since April
1996.  Mr. Enokian served as Vice President - Health Services from 

                                                                             6

<PAGE>   7

February 1991 until April 1996.  Mr. Enokian joined the Company in 1965 as a 
licensed pharmacist.


                                   PART II


Item 5.   Market for the Registrant's Common
          Equity and Related Stockholder Matters

     The Company's Common Stock is regularly quoted on the National
Association of Securities Dealers Automated Quotation System (NASDAQ) National
Market System under the symbol ARBR. The following table sets forth, for the
periods indicated, the high and low closing sale prices for the Company's
Common Stock and cash dividends paid.


<TABLE>
<CAPTION>
                                 Common Stock Prices     
                                 -------------------              Dividends
        Quarter Ended              High          Low              Per Share
                                   ----          ---              ---------  
       <S>                        <C>            <C>                  <C>
        Fiscal 1995 *
        -----------

        October 31                $14.50         $12.50               $.04
        January 31                 16.00          13.13                .05
        April 30                   17.50          14.67                .05
        July 31                    17.50          15.75                .05

        Fiscal 1996
        -----------

        October 31                $19.88         $16.25               $.05
        January 31                 23.25          18.00                .07
        April 30                   22.50          19.38                .07
        July 31                    21.75          17.88                .07

        Fiscal 1997
        -----------

        October 31 (through
        October 18)               $26.00         $21.38               $.07
</TABLE>


*All data has been restated to give effect to the May 1995 3-for-2 stock
split.

     The Company intends to continue to declare quarterly cash dividends on its
Common Stock, subject to the Company's earnings, financial condition, capital
requirements and other such factors as are deemed relevant by the Board of
Directors.

     On October 18, 1996, there were approximately 8,400 shareholders of
record of the Company (including individual participants in security position
listings).



                                                                            7



<PAGE>   8
Item 6.   Six Year Summary of Selected Financial Data

The following tables set forth selected consolidated financial data for each of
the fiscal years shown.


<TABLE>
<CAPTION>
                                         1996        1995            1994            1993               1992          1991
                                         ----        ----            ----            ----               ----          ----
<S>                                    <C>        <C>                <C>              <C>             <C>             <C>
Results of Operations
  (In thousands, except per share
  data)

  Net sales                            $826,130    $707,150          $618,562         $534,966        $476,848        $405,899

  Operating costs and expenses:

    Cost of sales                       611,924     521,707           454,207          390,896         346,140         292,433
    Selling, general and
       administrative                   172,969     149,829           132,759          117,337         105,783          91,509
    Provision for third-party
       settlement and related
       expenses                           -           -                 7,000           16,000           -               -     
                                       --------    --------          --------         --------        --------        -------- 
    Income from operations               41,237      35,614            24,596           10,733          24,925          21,957
  Interest expense                       (1,654)     (2,035)           (1,667)          (1,738)         (2,763)         (2,878)
  Interest income                         1,453       1,359               995              961           1,399             805 
                                       --------    --------          --------         --------        --------        -------- 
    Income before income tax             41,036      34,938            23,924            9,956          23,561          19,884
  Provision for income tax               14,012      11,871             9,846            3,047           7,787           6,831 
                                       --------    --------          --------         --------        --------        -------- 
       Net income                       $27,024     $23,067           $14,078           $6,909         $15,774         $13,053 
                                       ========    ========          ========         ========        ========        ======== 
  Earnings per common                                                                                 
    share (a) (b)                         $1.08       $0.94             $0.58            $0.28           $0.65           $0.59

Financial Position
  (at fiscal year end, in thousands)

  Current assets                       $163,449    $148,445          $140,597         $133,827        $126,340        $107,604
  Current liabilities                    70,515      67,059            72,443           71,220          66,477          42,948
  Total assets                          273,705     246,594           233,660          215,579         200,423         175,673
  Notes payable, net of current
    portion                              20,802      22,260            23,679           18,151          12,986          27,500
  Shareholders' equity                  176,169     150,716           129,964          118,473         113,874          99,191
  Shareholders' equity
    per share (a)                         $7.02       $6.09             $5.30            $4.86           $4.69           $4.11
  Dividends per share (a)                $0.260      $0.190            $0.153           $0.123          $0.093          $0.085
</TABLE>

(a) Reflects 3-for-2 stock splits effected May 1995 and May 1991.

(b) 1994 and 1993 per share amounts include charges for the settlement of
    third-party providers' reimbursement claims and related expenses and the
    disposition of a lease dispute. Excluding these charges, 1994 and 1993
    earnings per common share would have been $ .83 and $ .74, respectively.



                                                                               8

<PAGE>   9


 Item 7.   Management's Discussion and Analysis of
           Results of Operations and Financial Condition

Results of Operations:  Fiscal 1996 vs. Fiscal 1995


<TABLE>
<CAPTION>
        Components of earnings:                              Percentage
                                                 Percentage  Increase
                                                 of Fiscal   (Decrease)
                                   Fiscal 1996   1996 Net    Compared to
                                  (In Millions)  Sales       Fiscal 1995
                                  -------------  ----------  -----------
        <S>                       <C>            <C>         <C>

        Net sales                     $826.1       100.0%      16.8%
        Cost of sales                  611.9        74.1       17.3
        Selling, general and
         administrative expense        173.0        20.9       15.4
                                  -------------  ----------  -----------

        Income from operations          41.2         5.0       15.8
        Interest expense, net of
         interest income                  .2          --      (70.3)
        Income tax                      14.0         1.7       18.0
                                  -------------  ----------  -----------

        Net income                     $27.0         3.3%      17.2%
                                  =============  ==========  ===========
</TABLE>



     Net sales reached $826.1 million in fiscal 1996, an increase of 16.8
percent over fiscal 1995 net sales of $707.2 million.  The increase reflected
an increase in comparable store sales (sales by stores in operation for at
least 12 months) of 10.0 percent and the sales made by the drugstores opened in
fiscal 1996.

     Prescription drug sales accounted for 51.3 percent of net sales in fiscal
1996, an increase from 49.8 percent in fiscal 1995.  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.

     The net sales attributable to each of the Company's three other principal
product categories increased in absolute terms as a result of the larger store
base and increased comparable store sales.   The percentage of net sales
attributable to the general merchandise and health and beauty aids categories
declined slightly (from 24.4% and 21.1%, respectively, in fiscal 1995 to 23.3%
and 20.5%, respectively, in fiscal 1996).  The photofinishing and film category
increased its contribution to net sales (from 4.7% in fiscal 1995 to 4.9% in
fiscal 1996)due to new product introductions.

     While net sales attributable to the general merchandise and health and
beauty aids categories continues to increase in absolute terms, these
categories declined slightly as a percentage of total sales owing to greater
growth in the prescription drug sales category.

     The Company's gross margin declined from 26.2 percent in fiscal 1995 to
25.9 percent in fiscal 1996 primarily due to the effect of rising
pharmaceutical product costs and gross margin percentage pressure due to 

                                                                            9

<PAGE>   10


the reimbursement practices of the Company's third-party providers. 
Third-party providers, which accounted for approximately 83 percent of the
Company's prescription drug sales in fiscal 1996, 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 ("SG&A") expenses decreased as a
percentage of net sales to 20.9 percent in fiscal 1996 from 21.2 percent in
fiscal 1995.  The decrease was primarily attributable to the Company's efforts
to control expenses and by the higher level of net sales.

     The Company's effective tax rate (the provision for income tax as a
percentage of income before income tax) increased to 34.1  percent in fiscal
1996 from 34.0 percent in fiscal 1995.

Results of Operations:  Fiscal 1995 vs. Fiscal 1994


<TABLE>
<CAPTION>
Components of earnings:                                      Percentage
                                                 Percentage  Increase
                                                 of Fiscal   (Decrease)
                                   Fiscal 1995   1995 Net    Compared to
                                  (In Millions)  Sales       Fiscal 1994
                                  -------------  ----------  -----------
        <S>                       <C>            <C>         <C>
        Net sales                     $707.2       100.0%     14.3%
        Cost of sales                  521.7        73.8      14.9
        Selling, general and
         administrative expense        149.9        21.2      12.9
                                  -------------  ----------  -----------

        Income from operations          35.6         5.0      44.8
        Interest expense, net of
         interest income                 0.6         0.1     (14.3)
        Income tax                      11.9         1.6      21.4
                                  -------------  ----------  -----------
        Net income                     $23.1         3.3%     63.8%
                                  =============  ==========  ===========
</TABLE>



     Net sales reached $707.2 million in fiscal 1995, an increase of 14.3
percent over fiscal 1994 net sales of $618.6 million.  The increase reflected
an increase in comparable store sales (sales by stores in operation for at
least 12 months) of 9.0 percent and the sales made by the drugstores opened in
fiscal 1995.

     Prescription drug sales accounted for 49.8 percent of net sales in fiscal
1995, an increase from 49.0 percent in fiscal 1994.  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.

                                                                         10

<PAGE>   11



     The net sales attributable to each of the Company's three other principal
product categories increased in absolute terms as a result of the larger store
base and increased comparable store sales.  Photofinishing and film increased
as a percent of net sales, from 4.6% in 1994 to 4.7% in 1995 due to new product
introductions.  The percentage of net sales attributable to the general
merchandise and health and beauty aids categories declined (from 24.8% and
21.6%, respectively in fiscal 1994 to 24.4% and 21.1%, respectively in fiscal
1995); however, net sales attributable to these categories continues to
increase in absolute terms.

     The Company's gross margin declined from 26.6 percent in fiscal 1994 to
26.2 percent in fiscal 1995 primarily due to the effect of rising
pharmaceutical product costs and gross margin percentage pressure due to the
reimbursement practices of the Company's third-party providers.  Third-party
providers, which accounted for approximately 80 percent of the Company's
prescription drug sales in fiscal 1995, 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.

     "SG&A" expenses decreased as a percentage of net sales to 21.2 percent in
fiscal 1995 from 21.5 percent in fiscal 1994.  The decrease was primarily
attributable to the Company's efforts to control expenses and by the higher
level of net sales.

     The 1994 provision for third-party settlement of $7,000,000 reflects the
Company's settlement dated June 7, 1994, with the United States and the State
of Michigan to resolve certain claims made by them.

     The Company's effective tax rate (the provision for income tax as a
percentage of income before income tax) decreased to 34.0 percent in fiscal
1995 from 41.2 percent in fiscal 1994.  The increase reflects the Company's
preliminary assessment for the 1994 provision that the after-tax effect of the
1994 settlement, referred to above, would be approximately $6.1 million.

Liquidity and Capital Resources

     During fiscal 1996, net cash was provided by operations ($27.4 million) and
through the exercise of stock options and employee stock purchase plan purchases
($4.9 million).  Cash was principally used for capital expenditures and
acquisitions ($28.5 million), cash dividends ($6.5 million) and principal
payments on debt ($1.4 million). These activities resulted in a net cash
decrease of $4.8 million.

     The Company's capital expenditures in fiscal 1996 were made primarily to
expand the Company's distribution center and store base and remodel existing
stores.  In addition, the Company continued to invest in various retailing
systems, such as its pharmacy (Arbortech PlusSM) and point-of-sale computer
systems.  The Company anticipates fiscal 1997 capital expenditures of
approximately $25 million for these purposes.

                                                                            11

<PAGE>   12



     During fiscal 1996, the Company added 15 drugstores through opening new
locations.  The Company also acquired the prescription files of various
independent drugstores.  The Company's current expansion plan contemplates
adding approximately 15 to 20 new Arbor drugstores in fiscal 1997 through
leasing new sites, developing new sites and if suitable opportunities arise,
acquisitions.  Four drugstores have been opened in fiscal 1997 to date.

     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 1997.
As of July 31, 1996, the Company had outstanding borrowings against its line of
credit aggregating $1.5 million.

Item 8.   Financial Statements and Supplementary Data

     The financial statements and supplementary data required by this Item are
included in the Consolidated  Financial  Statements set forth on pages F-1
through F-12, attached hereto and found immediately following the signature
page of this Report.

Item 9.   Disagreements on Accounting and Financial Disclosures

     None.
                                  PART III

Item 10.  Directors and Executive Officers of the Registrant


     Information required by this Item, which is not included in Part I hereof,
will be contained in the Proxy Statement for the Annual Meeting of Shareholders
(the "1996  Proxy Statement"), to be held on December 3, 1996, under the
captions, "Election of Directors" and is incorporated herein by reference.


Item 11.  Executive Compensation

     Information required by this Item will be contained in the 1996 Proxy
Statement  under  the captions, "Executive Compensation," "Compensation
Committee Interlocks and Insider Participation" and "Information Concerning
Meetings of the Board of Directors and Board Committees and Director
Compensation," and is incorporated herein by reference.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

     Information required by this Item will be contained in the 1996 Proxy
Statement, under the captions, "Election of Directors" and "Beneficial
Ownership of Common Stock," and is incorporated herein by reference.


                                                                             12

<PAGE>   13


Item 13.  Certain Relationships and Related Transactions

     Information required by this Item will be contained in the 1996 Proxy
Statement under the caption, "Certain Relationships and Related Transactions,"
and is incorporated herein by reference.

                                   PART IV

Item 14.  Exhibits, Financial Statements and Reports on Form 8-K

     (a)  The following financial statements and financial statement
          schedules are filed as part of this Report:

          (1) Financial Statements:

                    Report of Independent Accountants
                    
                    Consolidated Financial Statements:
                    
                    Consolidated Balance Sheets -- July 31, 1996
                    and 1995
                    
                    Consolidated Statements of Income -- Fiscal Years
                    ended July 31, 1996, 1995 and 1994
                    
                    Consolidated Statements of Shareholders' Equity --
                    Fiscal Years ended July 31, 1996, 1995 and 1994
                    
                    Consolidated Statements of Cash Flows -- Fiscal
                    Years ended July 31, 1996, 1995 and 1994
                    
                    Notes to Consolidated Financial Statements
                    
          (2) Financial Statement Schedules:

               Schedule II - Valuation and Qualifying Accounts


     All other schedules are omitted because they are not applicable, not
required or because the information is included in the consolidated financial
statements or notes thereto.

          (3)  Executive Compensation Plans and Arrangements

               -  1986 Stock Option Plan
               -  1996 Stock Option Plan

     (b)  Reports on Form  8-K.  No Reports on Form 8-K were filed by the
          Company during the last quarter of the fiscal year ended July 31,
          1996.

     (c)  Exhibits

          3.1  Restated Articles of Incorporation, as amended,
               filed as Exhibit 3.1 to the Registrant's Annual Report on Form
               10-K for the year ended July 31, 1988, are incorporated herein
               by reference.

                                                                           13


<PAGE>   14


          3.2  Bylaws, filed  as Exhibit 3.2 to the Registrant's
               Form S-1 Registration Statement (Registration No. 33-4378), are
               incorporated herein by reference.

          4.0  Credit Agreement (the "Credit Agreement") dated as of
               May 14, 1992 among Arbor Drugs, Inc., NBD Bank, N.A.,
               Manufacturers Bank, N.A., Continental Bank N.A., and NBD Bank,
               N.A., as Agent, filed as Exhibit 10.5 to the Registrant's Annual
               Report on Form 10-K for the year ended July 31, 1992, is
               incorporated herein by reference.

          4.0A Letter, dated June 2, 1994, from NBD Bank, N.A. (in
               its capacity as a Bank and as Agent), Continental Bank, N.A. and
               Comerica Bank to Arbor Drugs, Inc., filed as Exhibit 10.3 to
               the Registrant's Annual Report on Form 10-K for the year
               ended July 31, 1994, is incorporated herein by reference.

          4.0B First Amendment to Credit Agreement, dated as of
               August 29, 1994, among Arbor Drugs, Inc., NBD Bank, N.A. (in its
               capacity as a Bank and as Agent), Continental Bank, N.A. and
               Comerica Bank, filed as Exhibit 10.4 to the Registrant's
               Annual Report on Form 10-K for the year ended July 31, 1994,
               is incorporated herein by reference.

          4.1  The Registrant undertakes to furnish to the Securities and
               Exchange Commission, upon request, a copy of all long-term
               debt instruments not filed herewith.

          10.1 Amended and restated Arbor Drugs, Inc. Stock Option
               Plan, dated June 4, 1993, filed as Exhibit 10.1 to the
               Registrant's Annual Report on Form 10-K for the year ended July
               31, 1993, is incorporated herein by reference.

          10.2 Arbor Drugs, Inc. 1996 Stock Option Plan, filed as Annex 1
               to the Registrant's Proxy Statement for its 1995 Annual
               Meeting of Shareholders, is incorporated herein by reference.

          11.  Computation of Earnings Per Share.

          21.  Subsidiaries of The Registrant.

          23.1 Consent of Coopers & Lybrand L.L.P., independent
               accountants.

           27. Financial Data Schedule.                            
                                                                            
                                                                           14


<PAGE>   15



                                 SIGNATURES

     Pursuant to the requirements of Section 13 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, on October 18, 1996.

                                     ARBOR DRUGS, INC.
                                        
                                        
                                     By: /s/ Eugene Applebaum
                                        ------------------------------------
                                        Eugene Applebaum,
                                        Chairman of the Board, Chief Executive
                                        Officer and President
                                        

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on October 18, 1996.






Signature                           Capacity
---------                           --------


/s/ Eugene Applebaum
------------------------------       
Eugene Applebaum                    Chairman of the Board, Chief 
                                    Executive Officer and President
                                    (Principal Executive Officer)

/s/ Markus M. Ernst
------------------------------       
Markus M. Ernst                     Executive Vice President, Chief Operating 
                                    Officer and Director

/s/ Gilbert C. Gerhard
------------------------------
Gilbert C. Gerhard                  Senior Vice President-Finance and
                                    Administration, Chief Financial Officer, 
                                    Secretary, Treasurer and Director
                                    (Principal Financial and Accounting
                                    Officer)

/s/ David B. Hermelin
------------------------------
David B. Hermelin                   Director

                                                                          15

<PAGE>   16



/s/ Spencer M. Partrich
------------------------------
Spencer M. Partrich                 Director

/s/ Laurie M. Shahon
------------------------------
Laurie M. Shahon                    Director

/s/ Samuel Valenti III
------------------------------
Samuel Valenti III                  Director


                                                                            16


<PAGE>   17

                       ARBOR DRUGS, INC. AND SUBSIDIARIES

                                 _____________









             REPORT ON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF JULY 31, 1996 AND 1995 AND
                         FINANCIAL STATEMENT SCHEDULES
                FOR THE YEARS ENDED JULY 31, 1996, 1995 AND 1994








                                                                            17

<PAGE>   18




                     ARBOR DRUGS, INC. AND SUBSIDIARIES

                 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                      AND FINANCIAL STATEMENT SCHEDULES

                                _____________


                                                               Pages
                                                               -----
Report of Independent Accountants                               F-2


Financial Statements:

     Consolidated Balance Sheets -- July 31, 1996 and 1995      F-3

     Consolidated Statements of Income -- Fiscal Years ended
     July 31, 1996, 1995 and 1994                               F-4

     Consolidated Statements of Shareholders' Equity --
     Fiscal Years ended July 31, 1996, 1995 and 1994            F-4

     Consolidated Statements of Cash Flows -- Fiscal Years
     ended July 31, 1996, 1995 and 1994                         F-5
                                                           
     Notes to Consolidated Financial Statements              F-6 - F-9


Financial Statement Schedules:

     Schedule   II - Valuation and Qualifying Accounts          F-12



     All other schedules are omitted because they are not applicable,
     not required or because the information is included in the
     consolidated financial statements or notes thereto.


                                     F-1



<PAGE>   19




                       REPORT OF INDEPENDENT ACCOUNTANTS


To the Shareholders and Board of
Directors of Arbor Drugs, Inc.:


We have audited the consolidated financial statements and the financial
statement schedule of Arbor Drugs, Inc. and Subsidiaries listed in the index on
page F-1 of this Form 10-K.  These financial statements and financial statement
schedule are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements.  An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation.  We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Arbor Drugs, Inc.
and Subsidiaries as of July 31, 1996 and 1995, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended July 31, 1996, in conformity with generally accepted accounting
principles.  In addition, in our opinion, the financial statement schedule
referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information required to be included therein.



/s/ Coopers & Lybrand L.L.P.
-----------------------------
Detroit, Michigan
September 27, 1996


                                     F-2

<PAGE>   20

                         CONSOLIDATED BALANCE SHEETS

                     ARBOR DRUGS, INC. AND SUBSIDIARIES



July 31,                                        1996      1995
-----------------------------------------------------------------
(Dollars in thousands)
ASSETS
Current assets:
  Cash and cash equivalents                    $34,955   $39,798
  Short-term investments                           855       170
  Accounts receivable                           17,507    14,020
  Inventory                                    106,283    89,553
  Prepaid expenses                               3,849     4,904
-----------------------------------------------------------------
    Total current assets                       163,449   148,445
-----------------------------------------------------------------
Property and equipment:
  Land and land improvements                    16,928    14,591
  Buildings                                     23,879    17,433
  Furniture, fixtures and equipment             65,874    58,369
  Leasehold improvements                        40,036    35,695
    Less accumulated depreciation             (57,598)  (49,705)
-----------------------------------------------------------------
                                                89,119    76,383
-----------------------------------------------------------------
Intangible assets                               21,137    21,766
-----------------------------------------------------------------
    Total assets                              $273,705  $246,594
=================================================================
LIABILITIES
Current liabilities:
  Notes payable, current portion                $1,568    $1,529
  Accounts payable                              51,014    50,341
  Accrued rent and other                         9,285     7,712
  Accrued compensation and benefits              6,687     5,144
  Income tax payable                             1,961     2,333
-----------------------------------------------------------------
    Total current liabilities                   70,515    67,059
-----------------------------------------------------------------
Notes payable, net of current portion           20,802    22,260
Deferred income tax                              5,538     5,938
Minority interest in subsidiaries                  681       621
-----------------------------------------------------------------
                                                27,021    28,819
-----------------------------------------------------------------
SHAREHOLDERS' EQUITY
Preferred stock: $.01 par value;
  2,000,000 shares authorized;
  none issued                                      --        --
Common stock: $.01 par value;
  40,000,000 shares authorized;
  25,083,166 and 24,765,602 issued
  and outstanding, respectively                    251       248
Additional paid-in capital                      53,812    48,902
Retained earnings                              122,106   101,566
-----------------------------------------------------------------
                                               176,169   150,716
-----------------------------------------------------------------
    Total liabilities & shareholders' equity  $273,705  $246,594
=================================================================

The accompanying notes are an integral part of the consolidated financial
statements.


                                     F-3




<PAGE>   21




                       CONSOLIDATED STATEMENTS OF INCOME

                       ARBOR DRUGS, INC. AND SUBSIDIARIES




Fiscal Years Ended July 31,                      1996       1995       1994
--------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Net sales                                      $826,130    $707,150    $618,562
Costs and expenses:
  Cost of sales                                 611,924     521,707     454,207
  Selling, general and administrative           172,969     149,829     132,759
  Provision for third-party settlement
   and related expenses                             --         --         7,000
--------------------------------------------------------------------------------
    Income from operations                       41,237      35,614      24,596
Interest expense                                 (1,654)     (2,035)     (1,667)
Interest income                                   1,453       1,359         995
--------------------------------------------------------------------------------
    Income before income tax                     41,036      34,938      23,924
Provision for income tax                         14,012      11,871       9,846
--------------------------------------------------------------------------------
     Net income                                $ 27,024    $ 23,067    $ 14,078
================================================================================
Weighted average number of common
  shares outstanding (in thousands)              24,944      24,646      24,427
================================================================================
Earnings per common share                      $   1.08    $   0.94    $   0.58
================================================================================
Cash dividend per common share                 $  0.260    $  0.190    $  0.153
================================================================================



                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY


                                                        
                                 Common Stock    Additional   
                               ---------------    Paid-In    Retained 
(In thousands)                 Shares   Amount    Capital    Earnings   TOTAL
--------------------------------------------------------------------------------
Balance, July 31, 1993        16,242    $162     $45,463   $ 72,848    $118,473
Net income                        --      --         --      14,078      14,078
Cash dividends of $.153                            
  per share                       --      --         --      (3,746)     (3,746)
Exercise of stock options,        98       1       1,158        --        1,159
--------------------------------------------------------------------------------
Balance, July 31, 1994        16,340     163      46,621     83,180     129,964 
Net income                        --      --          --     23,067      23,067 
Cash dividends of $.190                                                        
  per share                       --      --          --     (4,681)     (4,681)
Exercise of options and                                                        
  stock purchase plan            179       2       2,364         --       2,366 
Three-for-two stock split      8,247      83         (83)        --          -- 
--------------------------------------------------------------------------------
Balance, July 31, 1995        24,766     248      48,902    101,566     150,716
Net income                        --      --          --     27,024      27,024
Cash dividends of $.260                                                         
  per share                       --      --          --     (6,484)     (6,484)
Exercise of options and                                                         
  stock purchase plan            317       3       4,910         --       4,913
--------------------------------------------------------------------------------
Balance, July 31, 1996        25,083    $251     $53,812   $122,106    $176,169
================================================================================


The accompanying notes are an integral part of the consolidated financial
statements.

                                     F-4


<PAGE>   22




                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                       ARBOR DRUGS, INC. AND SUBSIDIARIES



Fiscal Years Ended July 31,                  1996        1995        1994
--------------------------------------------------------------------------------
(Dollars in thousands)

Operating activities:
 Net income                                $27,024      $23,067      $14,078  
 Adjustments to reconcile net                                                 
   cash provided by operations:                                               
     Depreciation                           11,971       10,886        9,027  
     Amortization                            4,471        4,601        3,940  
     Deferred income tax                       304       (1,053)         (17) 
     Changes in operating assets                                              
       and liabilities:                                                       
         Accounts receivable                (3,487)      (1,238)      (4,469) 
         Inventory                         (16,730)      (6,155)     (13,057) 
         Prepaid expenses                      351        1,829        3,573  
         Accounts payable                      673       (2,577)      11,357  
         Third-party settlement                                               
           and related expenses                 --       (5,000)     (11,000) 
         Accrued expenses                    3,176        1,049        3,008  
         Income tax payable                   (372)       1,136       (2,430) 
--------------------------------------------------------------------------------
         Net cash provided
           by operations                    27,381       26,545       14,010
--------------------------------------------------------------------------------
Investing activities:
 Purchase of property and equipment, net   (24,707)     (16,700)     (14,371)
 Purchase of intangible assets              (3,842)      (3,873)      (9,907)
 (Purchase), sale or maturity of                                             
   short-term investments                     (685)       1,094        2,211 
--------------------------------------------------------------------------------
         Net cash used in
           investing activities            (29,234)     (19,479)     (22,067)
--------------------------------------------------------------------------------
Financing activities:
 Proceeds from borrowings                       --           --        6,900 
 Principal payments on debt                 (1,419)      (1,373)      (1,228)
 Dividends paid                             (6,484)      (4,681)      (3,746)
 Proceeds from exercise of stock options                                     
   and stock purchase plan                   4,913        2,366        1,159 
--------------------------------------------------------------------------------
         Net cash provided by
           (used in) financing activities   (2,990)      (3,688)       3,085
--------------------------------------------------------------------------------
Net increase (decrease) in cash
 and cash equivalents                       (4,843)       3,378       (4,972)
Cash and cash equivalents at
 beginning of year                          39,798       36,420       41,392
--------------------------------------------------------------------------------
Cash and cash equivalents at
 end of year                               $34,955      $39,798      $36,420
================================================================================

The accompanying notes are an integral part of the consolidated financial
statements.

                                     F-5





<PAGE>   23
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       ARBOR DRUGS, INC. AND SUBSIDIARIES


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

     The preparation of these consolidated financial statements, in order to be
   presented in conformity with generally accepted accounting principles,
   requires that management use estimates and assumptions regarding events
   anticipated and transpired, together with their potential effects upon the
   reported amounts of assets and liabilities, as well as the disclosures and
   assessments of contingent assets and liabilities, at the date of the
   financial statements, and in determining the reported amounts of revenues,
   costs and expenses of the reporting periods. Actual results could differ
   from those estimates.

   STOCK REPURCHASE PLAN

     On July 25, 1996, the Board of Directors authorized management to
   repurchase up to one million shares of the Company's common stock in
   the open market, at prices acceptable to management. Shares purchased under
   the program will be retired. No shares have been purchased to date.

   BASIS OF OPERATION

     The consolidated financial statements include Arbor Drugs, Inc.
   ("Company") and its subsidiaries, whose primary business activity is
   the operation of drugstores, principally in southeastern Michigan. All
   significant intercompany transactions have been eliminated in consolidation.

   CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

     The Company considers all highly liquid investments with a maturity of
   three months or less to be cash equivalents. Short-term investments
   include all liquid investments with a maturity greater than three months and
   are stated at cost, which approximates market.

   RECEIVABLES

     The Company has contractual arrangements with third-party providers of
   insurance, enabling the Company to obtain reimbursement from these
   carriers for prescription services performed by the Company for benefit of
   its customers. Consequently, significant revenue and accounts receivable
   result from these arrangements.

   INVENTORY VALUATION

     Inventories are stated at the lower of cost or market assuming a last-in,
   first-out cost flow. Had the first-in, first-out method for determining
   cost been used, inventories would have been increased by approximately
   $25,607,000 and $22,814,000 at July 31, 1996 and 1995, respectively.

   PROPERTY AND EQUIPMENT

     All property and equipment are recorded at cost. Maintenance and repair
   costs are charged to expense as incurred. Upon retirement or disposal,
   the asset cost and related accumulated depreciation are eliminated from the
   respective accounts and the resulting gain or loss is included in the
   results of operations for the period.

   DEPRECIATION

     Depreciation is computed using primarily the straight-line method based on
   the following range of estimated useful lives:

     Buildings  ....................................40 years
     Furniture, fixtures and equipment 
       and land improvements........................5 to 20 years
     Leasehold improvements  .......................Lesser of lease term or 
                                                    useful lives, ranging from
                                                    5 to 20 years  
   INCOME TAX

     Deferred tax assets and liabilities are recognized for temporary
   differences at the tax rate expected to be in effect when the related
   asset is recovered or the related liability is settled.

   PREOPENING EXPENSES

     Preopening expenses of retail drugstores are charged to income as
   incurred.

   ADVERTISING

     Advertising production costs are expensed the first time the related
   advertising takes place. Advertising expense for the years ended July
   31, 1996, 1995 and 1994 was approximately $15,146,000, $14,774,000 and
   $13,079,000, respectively.

   STOCK BASED COMPENSATION

     Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
   "Accounting for Stock Based Compensation," was issued in October 1995,
   with an effective date for fiscal years beginning in 1996, accordingly, the
   Company has yet to adopt the provisions promulgated therein. It is the
   Company's intent that, when adopted, such compensation will continue to be
   measured using the intrinsic value method, in accordance with APB Opinion No.
   25, "Accounting for Stock Issued to Employees."

                                     F-6
<PAGE>   24
2. INTANGIBLE ASSETS:

   Intangible assets consist of the following:
   July 31,                                          1996         1995
   ----------------------------------------------------------------------
                                                (Dollars in thousands)

   Prescription customer files                      $19,026      $19,767
   Leaseholds                                         3,091        3,631
   Developed software                                 5,067        4,883
   Other                                             12,274       10,895
   ----------------------------------------------------------------------
                                                     39,458       39,176
   Less accumulated amortization                     18,321       17,410
   ----------------------------------------------------------------------
                                                    $21,137      $21,766
   ======================================================================

     Prescription customer files and other intangible assets consist primarily
   of amounts, other than leaseholds, allocated upon the purchase of assets
   of existing retail operations and are generally amortized over a period
   not to exceed 15 years.

     Leaseholds represent the amounts paid for, or allocated to, beneficial
   lease agreements assumed by the Company upon purchase of assets of
   existing retail operations or leases. Amortization is recorded using the
   straight-line method over the term of the related lease agreement.

     All intangible assets are evaluated for potential impairment of value on
   an on-going basis. Such evaluations consider current, as well as
   anticipated, operating results, measured on the basis of undiscounted cash
   flows, of the operation relative to the asset. Usefulness of the underlying
   asset in the operation of the Company is also a basis of evaluation.
   Additionally, trends and other circumstances are used in such evaluations and
   estimates.

3. NOTES PAYABLE:

      Approximate fair market values are as follows:

<TABLE>
<CAPTION>

   July 31,                                                                       1996         1995
-------------------------------------------------------------------------------------------------------
                                                                        (Dollars in thousands)
<S>                                                                      <C>          <C>
   Mortgage note payable, interest at 8.75 percent, monthly interest
     and principal installments of $60,976 through July 1, 2014                $ 6,634      $ 6,778
   Senior note, interest at 9.93 percent, semiannual interest and
    $500,000 principal payments, final payment due October 31, 1997              3,500        4,500
   Mortgage note payable, interest at 9.68 percent, monthly interest            
    and principal installments of $62,298 through July 1, 2012                   6,071        6,223
   Line of credit term loan, interest at 7.16 percent, quarterly interest
    only payments, due December 15, 1997                                         1,500        1,500
   Mortgage note payable, interest at 8.49 percent, monthly interest
    and principal installments of $42,926 through December 1, 2012               4,554        4,677
   Other borrowings                                                                111          111
-------------------------------------------------------------------------------------------------------
                                                                                22,370       23,789
   Less current portion                                                          1,568        1,529
-------------------------------------------------------------------------------------------------------
                                                                               $20,802      $22,260
=======================================================================================================
</TABLE>

        As of July 31, 1996, the Company had a $50 million line of credit with
an outstanding balance of $1.5 million. This credit facility expires
November 30, 2001.
        Maturities of notes payable for the next five fiscal years
are approximately as follows:

<TABLE>
<S>            <C>              <C>                            <C>               

1997  ........$1,458,000        1998  ........$4,501,000        1999  ........$  548,000   
2000  ........$  600,000        2001  ........$  656,000                                       
</TABLE>

        The senior note, term loan and line of credit agreement contain certain
covenants, the most restrictive of which require the Company to maintain
minimum current, debt service and equity ratios and maintain a minimum amount
of net worth. Certain property has been pledged as collateral under terms of
the mortgage notes payable.
        
        Interest costs capitalized for the years ended July 31, 1996, 1995 and
1994 were approximately $552,000, $328,000 and $264,000, respectively.
        
        Cash paid for interest, net of capitalized interest, was approximately
$1,646,000, $2,232,000 and $1,700,000 for the years ended July 31, 1996, 1995
and 1994, respectively.
        
4. RENTAL EXPENSE AND LEASE COMMITMENTS:

        The Company leases certain facilities, transportation, data processing
and photo development equipment under operating lease agreements expiring on
various dates through the year 2020. In addition to minimum rentals, certain
lease agreements provide for contingent rental payments based upon attainment
of specified
                                     F-7
<PAGE>   25



                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                                                       CONTINUED

   sales volume or increases in the consumer price index. Most leases
   contain renewal options for periods ranging from 5 to 30 years. The following
   are summaries of rental expense and the future minimum annual rental payments
   required under all operating leases:

   Year Ended July 31,                             1996            1995
   -----------------------------------------------------------------------------
                                                        (Dollars in thousands)
   Rental expense: 
     Minimum rentals                              $16,974         $14,848
     Contingent rentals                             1,846           1,574
   -----------------------------------------------------------------------------
                                                  $18,820         $16,422 
   =============================================================================

    Minimum annual rentals: 
    Year ending July 31:
     1997                                                  $ 21,388
     1998                                                    22,361 
     1999                                                    21,447 
     2000                                                    19,178 
     2001                                                    17,452 
   Remaining lease term                                     191,719
   -----------------------------------------------------------------------------
                                                           $293,545
   =============================================================================

     Accrued rent of $6,835,000 and $5,781,000 is included in accrued expenses
   as of July 31, 1996 and 1995, respectively.

5. EMPLOYEE RETIREMENT PLANS:

     The Company maintains an employee savings plan, pursuant to section 401(k)
   of the Internal Revenue Code. Eligible participating employees may
   contribute up to 15 percent of their salaries, subject to certain
   limitations, for investment in either the common stock of the Company or
   various other investment options. Contributions by the Company are
   discretionary.

6. INCOME TAX:

     The provision for federal income tax consists of the following:
   Year Ended July 31,                 1996              1995            1994
   -----------------------------------------------------------------------------
                                               (Dollars in thousands)
   Currently payable                 $13,708          $10,745          $6,112 
   Deferred                              304            1,126           3,734 
   -----------------------------------------------------------------------------
                                     $14,012          $11,871          $9,846 
   =============================================================================

      The provision for deferred income tax is attributed to the tax effect of 
   differences caused by the timing of expense and revenue recognition, between
   financial statement and tax accounting, for certain transactions, at the tax
   rates expected to be in effect when the related asset is recovered or 
   liability is settled. These differences are primarily attributed to the 
   following:

   July 31,                                       1996                1995
   -----------------------------------------------------------------------------
                                                    (Dollars in thousands)

   Vendor agreement discounts                    $  832              $  130
   Depreciation and amortization                   (251)                291
   Provision for third-party settlements             --               1,750
   -----------------------------------------------------------------------------

      The provision for income tax, as a percentage of income before tax, was
   34.1 percent, 34.0 percent and 41.2 percent in 1996, 1995 and 1994, 
   respectively. These rates differ from the statutory rate due to:

      In 1996 and 1995, income earned on tax-exempt investments reduced the
    provision by approximately $300,000.

      In 1994, the provision reflects the Company's preliminary assessment that
   the after-tax effect of the Company's settlement with the United States and
   the State of Michigan will be approximately $6.1 million. Also, income 
   earned on tax-exempt investments reduced the provision by approximately 
   $255,000.

     Prepaid expenses include the current portion of deferred income taxes of
   $1,790,000 and $2,494,000 in 1996 and 1995, respectively.
   
     Cash paid for income taxes was approximately $12,738,000, $8,800,000 and
   $8,135,000 in 1996, 1995 and 1994, respectively.


                                     F-8
<PAGE>   26


7. STOCK OPTION AND STOCK PURCHASE PLANS:

     Under the Company's 1986 and 1996 Stock Option Plans, certain of the
   Company's key employees have been granted nonqualified stock options
   which allow the employee to purchase shares of common stock at prices equal
   to market value at the date of grant and become exercisable 12 months after
   grant, on a pro rata basis, over a five-year period. There were
   approximately 1,198,000 shares exercisable at July 31, 1996.

     The Company is currently authorized to grant options to purchase up to an 
   aggregate of 5,806,250 shares of its common stock, of which 4,366,001
   shares have been granted and 3,340,469 shares were outstanding as of July
   31, 1996.

Stock option transactions are summarized as follows.

<TABLE>
<CAPTION>



                                                         Number of Shares       Option Price Range
   -------------------------------------------------------------------------------------------------
<S>                                                     <C>                  <C>
   Balance, July 31, 1993                                   1,618,777                $2.67-15.83                   
     Granted                                                  640,426                10.83-12.50                   
     Terminated                                               (19,500)                8.33-15.83                   
     Exercised                                               (145,980)                2.67-11.67                   
   -------------------------------------------------------------------------------------------------
   Balance, July 31, 1994                                   2,093,723                $4.00-15.83                   
     Granted                                                  985,351                13.03-15.17                   
     Terminated                                               (17,445)                8.33-15.83                   
     Exercised                                               (196,284)                4.00-13.17                   
   -------------------------------------------------------------------------------------------------
   Balance, July 31, 1995                                   2,865,345                $6.05-15.83                   
     Granted                                                  738,000                16.25-17.50                   
     Terminated                                               (47,150)               11.67-17.50                   
     Exercised                                               (215,726)                7.45-15.83                   
   -------------------------------------------------------------------------------------------------
   Balance, July 31, 1996                                   3,340,469                $6.05-17.50                   
   =================================================================================================
</TABLE>
                                                                          

     The Company has an Employee Stock Purchase Plan where employees may
   subscribe, through payroll withholdings, to purchase shares of the Company's
   common stock at the lower of 85% of market value at the beginning or end of
   each calendar quarter. Employees may not purchase in excess of 15% of gross
   pay under the plan, or 25% of gross pay in combination with withholdings 
   under the 401(k) plan.

     Transactions under the Employee Stock Purchase Plan are summarized as 
   follows:
    

<TABLE>
<CAPTION>
                                                         Number of Shares        Issue Price Range
----------------------------------------------------------------------------------------------------
<S>                                                     <C>                        <C>
   Shares issued during the year ended July 31,
   1996                                                      101,828                $14.025-17.80
   1995                                                       45,715                $13.600-17.53
====================================================================================================
</TABLE>


8. QUARTERLY FINANCIAL SUMMARY (UNAUDITED):

<TABLE>
<CAPTION>
   (Dollars in thousands, except per share data)
   
                                                           For the Three Months Ended
   -----------------------------------------------------------------------------------------------
<S>                                            <C>        <C>            <C>            <C>

   Fiscal Year                                 OCT. 31,     JAN. 31,       APRIL 30,      JULY 31,
   1996                                         1995         1996           1996           1996
   -----------------------------------------------------------------------------------------------
   Net sales                                   $190,704      $214,501      $208,242    $212,683
   Gross profit                                  49,449        56,232        53,560      54,965
   Net income                                     5,125         8,711         6,057       7,131
   Earnings per share                          $  .21        $  .35*       $   .24     $   .28
   ===============================================================================================

<CAPTION>
                                                           For the Three Months Ended
   -----------------------------------------------------------------------------------------------
   Fiscal Year                                 OCT. 31,     JAN. 31,       APRIL 30,      JULY 31,
   1995                                         1994         1995            1995          1995
   -----------------------------------------------------------------------------------------------
   <S>                                       <C>       <C>        <C>        <C>
   Net sales                                   $167,340      $185,134      $174,806    $179,870
   Gross profit                                  43,842        48,630        45,793      47,178
   Net income                                     4,709         7,488         5,230       5,640
   Earnings per share                          $  .19        $  .30        $  .21      $  .23
   ===============================================================================================
</TABLE>

Amounts may not total due to rounding.

*Earnings per share, assuming full dilution, were $.34.

                                      F-9
<PAGE>   27
                       ARBOR DRUGS, INC. AND SUBSIDIARIES
                                        
                                  SCHEDULE II

                       VALUATION AND QUALIFYING ACCOUNTS
                       ----------------------------------
<TABLE>
<CAPTION>

COLUMN A                        COLUMN B                 COLUMN C                 COLUMN D          COLUMN E
--------                        --------                 --------                 --------          --------

                                BALANCE AT       CHARGES        CHARGES TO                           BALANCE
                                BEGINNING        TO COST/        OTHER                               AT END
DESCRIPTION                     OF PERIOD        EXPENSES       ACCOUNTS         DEDUCTIONS         OF PERIOD
-----------                     ---------       ---------      ----------        ----------         ---------
<S>                             <C>              <C>           <C>               <C>                 <C>
Year End July 31, 1996:
=======================

Allowance For Doubtful 
Accounts                      $  543,390         $ 366,537          -              $ 209,223          $  700,704


Year End July 31, 1995:
=======================

Allowance For Doubtful
Accounts                      $1,018,510         $ 212,817          -              $ 687,937          $  543,390

Year End July 31, 1994:
=======================

Allowance For Doubtful        $1,014,652         $ 236,526          -              $ 232,668          $1,018,510
Accounts

</TABLE>

                                      F-12
<PAGE>   28




     INDEX TO EXHIBITS                                         

3.1  Restated Articles of Incorporation, as
     amended, filed as Exhibit 3.1 to the Registrant's
     Annual Report on Form 10-K for the year ended
     July 31, 1988, are incorporated herein by reference.

3.2  Bylaws, filed  as Exhibit 3.2 to the Registrant's
     Form S-1 Registration Statement (Registration
     No. 33-4378), are incorporated herein by reference.

4.0  Credit Agreement (the "Credit Agreement") dated
     as of May 14,1992 among Arbor Drugs, Inc.,
     NBD Bank, N.A., Manufacturers Bank, N.A.,
     Continental Bank N.A., and NBD Bank, N.A.,
     as Agent, filed as Exhibit 10.5 to the Registrant's
     Annual Report on Form 10-K for the year ended
     July 31, 1992, is incorporated herein by reference.

4.0A Letter, dated June 2, 1994, from NBD Bank, N.A.
     (in its capacity as a Bank and as Agent),
     Continental Bank, N.A. and Comerica Bank
     to Arbor Drugs, Inc., filed as Exhibit 10.3 to the
     Registrant's Annual Report on Form 10-K for the year
     ended July 31, 1994, is incorporated herein by
     reference.

4.0B First Amendment to Credit Agreement, dated as of
     August 29, 1994, among Arbor Drugs, Inc.,
     NBD Bank, N.A. (in its capacity as a Bank
     and as Agent), Continental Bank, N.A. and Comerica Bank,
     filed as Exhibit 10.4 to the Registrant's Annual Report
     on Form 10-K for the year ended July 31, 1994, is
     incorporated herein by reference.

4.1  The Registrant undertakes to furnish to the
     Securities and Exchange Commission, upon request, a
     copy of all long-term debt instruments not filed herewith.

10.1 Amended and restated Arbor Drugs, Inc. Stock Option
     Plan, dated June 4, 1993, filed as Exhibit 10.1 to the
     Registrant's Annual Report on Form 10-K for the year
     ended July 31, 1993, is incorporated herein by reference.

10.2 Arbor Drugs, Inc. 1996 Stock Option Plan, filed as Annex
     1 to the Registrant's Proxy Statement for its 1995 Annual
     Meeting of Shareholders, is incorporated herein by reference.

11.  Computation of Earnings Per Share. 

21.  Subsidiaries of The Registrant. 

23.1 Consent of Coopers & Lybrand L.L.P., independent 
     accountants.

27.  Financial Data Schedule.