<PAGE>
FORM 10-K/A
AMENDMENT NO. 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended May 31, 1997
----------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _______________
Commission File Number 1-8195
MANOR CARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-1200376
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
11555 Darnestown Road, Gaithersburg, Maryland 20878
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (301) 979-4000
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange On
Title of Each Class Which Registered
- --------------------------------- ------------------------
Common Stock, Par Value $.10 per share New York Stock Exchange
Registrant's Guaranty of 4-3/4% Con-
vertible Subordinated Debentures due
September 1, 1997 issued by Cenco
Incorporated
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Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class
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9-1/2% Senior Subordinated Notes due November 15, 2002
7-1/2% Senior Notes due June 15, 2006
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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
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (S)(S)229.405 of this chapter) 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. [ ]
The aggregate market value of the voting stock held by non-affiliates
was $1,511,705,020 as of August 5, 1997 based upon a closing price of $32.4375
per share.
The number of shares of Manor Care's Common Stock outstanding at May
31, 1997 was 63,621,828.
DOCUMENTS INCORPORATED BY REFERENCE:
PART I 1997 Annual Report to Stockholders
PART II 1997 Annual Report to Stockholders (Item 5 only)
PART III Proxy Statement dated August 15, 1997
INTRODUCTION
This Form 10-K/A (Amendment No. 1) amends Manor Care, Inc.'s report on Form
10-K for the fiscal year ended May 31, 1997. The financial statements set forth
under Item 8 hereof have been restated to reflect the results of Vitalink
Pharmacy Services, Inc. ("Vitalink") as a discontinued operation for all periods
presented. On April 26, 1998, Vitalink entered into an Agreement and Plan of
Merger with Genesis Health Ventures, Inc., pursuant to which Vitalink will merge
with and into a wholly owned subsidiary of Genesis. See Item 7 and the footnote
in Item 8 entitled "Subsequent Events" for more information.
PART I
Item 1. Business
The information in the paragraph captioned "Industry Segments" in Manor Care's
original Form 10-K for the fiscal year ended May 31, 1997 is hereby deleted and
restated in its entirety by the industry segment information in the footnotes to
the financial statements set forth under Item 8 hereof. The remainder of Item 1
is not amended by this Form 10-K/A.
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PART II
ITEM 6. Selected Financial Data.
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<TABLE>
<CAPTION>
Fiscal Years Ended May 31,
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1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Revenues $1,294,574 $1,141,911 $ 946,761 $ 859,394 $ 802,687
Expenses:
Operating expenses 1,012,799 883,459 719,780 650,637 631,835
Depreciation and amortization 70,851 63,723 50,621 45,662 44,719
General corporate and other 68,563 72,322 63,197 45,666 26,968
Provisions for asset impairment and
restructuring - 26,300 - - -
---------- ---------- ---------- ---------- ----------
Total expenses 1,152,213 1,045,804 833,598 741,965 703,522
---------- ---------- ---------- ---------- ----------
Income from continuing operations before
other income and (expenses) and income
taxes 142,361 96,107 113,163 117,429 99,165
---------- ---------- ---------- ---------- ----------
Other income and (expenses):
Interest income from advances to
discontinued lodging segment 21,221 19,673 15,492 10,665 7,083
Interest expense (40,599) (31,259) (23,534) (27,519) (35,798)
Other income, net 11,098 6,125 7,195 1,504 3,475
---------- ---------- ---------- ---------- ----------
Income from continuing operations before
income taxes 134,081 90,646 112,316 102,079 73,925
Income taxes 51,186 36,694 44,338 44,214 27,894
---------- ---------- ---------- ---------- ----------
Income from continuing operations $ 82,895 $ 53,952 $ 67,978 $ 57,865 $ 46,031
========== ========== ========== ========== ==========
<CAPTION>
As of May 31,
---------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets $1,640,978 $1,656,927 $1,276,175 $1,073,487 $1,017,673
Long-term debt 491,600 490,575 315,271 223,892 330,189
Shareholders' equity 690,431 707,769 624,873 533,815 361,642
<CAPTION>
Fiscal Years Ended May 31,
---------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA:
Cash provided by continuing operating
activities $ 77,614 $ 186,848 $ 106,416 $ 123,104 $ 97,716
Cash used in continuing investing activities 115,324 247,404 177,015 67,304 63,854
Cash provided by (used in) continuing
financing activities (6,541) 122,698 80,093 (123,241) (97,684)
Investment in property and equipment and
systems development 178,821 132,795 89,737 71,365 43,717
</TABLE>
3
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ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF MANOR CARE'S
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
INTRODUCTION
On June 10, 1998, Manor Care, Inc., ("Manor Care"), Health Care &
Retirement Corporation, a Delaware corporation ("HCR"), and Catera Acquisition
Corp., a Delaware corporation and wholly owned subsidiary of HCR ("Merger Sub"),
entered into an Agreement and Plan of Merger (the "Merger Agreement"), pursuant
to which Merger Sub will merge with and into Manor Care (the "Merger"). The
Merger Agreement provides that, with certain limited exceptions, each
outstanding share of Manor Care's common stock, par value $.10 per share, shall
be converted into the right to receive one share of common stock of HCR, par
value $.01 per share. Upon completion of the transaction, Manor Care will become
a wholly owned subsidiary of HCR and the stockholders of Manor Care will become
stockholders of HCR.
The consummation of the transactions contemplated by the Merger Agreement are
subject to the approval of the stockholders of Manor Care and HCR, the receipt
of certain regulatory approvals and the expiration of antitrust waiting periods.
The transaction is expected to be completed during the fourth quarter of
calendar year 1998. If completed, the transaction will be accounted for as a
pooling of interests. Due to the impending Merger, the Company no longer plans
to separate its skilled nursing, assisted living and home health businesses from
its skilled nursing facility management, real estate and healthcare facility
development businesses.
A number of significant factors, which are discussed below, affected the
consolidated results of operations, financial condition and liquidity of Manor
Care, Inc. (the "Company") during the three fiscal years ended May 31, 1997,
May 31, 1996 and May 31, 1995. This discussion should be read in conjunction
with the Consolidated Financial Statements and notes thereto for such fiscal
years included elsewhere in this Form 10-K/A.
The health care industry is highly regulated by Federal, state and local law.
Certain of these regulations apply to the relationship between the Company,
Vitalink and In Home Health, including the provisions of the Medicare related
party rule and the federal and state anti-remuneration laws. The Medicare
related party rule limits the amount the Medicare program will reimburse for
products and services provided by a related party. Manor Care has treated
Vitalink and In Home Health as related parties in compliance with this rule. The
Company intends to continue to treat Vitalink Pharmacy Services, Inc.
("Vitalink") and In Home Health, Inc. ("In Home Health") as related parties.
Accordingly, the Company does not expect that the Medicare related party rule
will have a material effect on the conduct of its business. The anti-
remuneration laws govern certain financial arrangements among health care
providers and others who may be in a position to refer or recommend patients to
such providers. The Company has treated, and will continue to treat, Vitalink
and In Home Health as separate entities, capable of referring or recommending
patients to, or receiving referrals or recommendations from, the Company
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for purposes of the anti-remuneration laws. The Company intends to continue to
treat Vitalink and In Home Health as separate entities. Accordingly, the Company
believes that its business arrangements with Vitalink and In Home Health are in
compliance with the anti-remuneration laws.
Certain matters discussed in this Form 10-K/A constitute forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. All of these forward-looking statements are based on estimates and
assumptions made by management of the Company which, although believed by
management of the Company to be reasonable, are inherently subject to risks and
uncertainties. Should one or more of these risks or uncertainties materialize,
or should underlying assumptions prove incorrect, actual results may vary
materially from those anticipated, estimated, projected or expected. Therefore,
investors should not place undue reliance upon such estimates and forward-
looking statements.
Risk factors that could cause the Company's actual results, performance or
achievements to be different from any future results, performance or
achievements expressed or implied by such forward-looking statements include,
without limitation: (i) the Company's success in implementing its business
strategy including its success in completing the Merger, (ii) the Company's
success in arranging financing where required, (iii) the nature and extent of
future competition, (iv) the extent of future health care reform and regulation,
including cost containment measures, (v) significant changes in the Company's
shareholder base, (vi) increases in the Company's cost of borrowing, (vii) costs
associated with the planned Merger, (viii) changes in the mix of payment sources
for patient services, including any decrease in the amount and percentage of
revenues derived from private payors, (ix) the ability of the Company to
continue to deliver high quality care and to attract private pay residents, and
(x) changes in general economic conditions (including the labor market) and/or
in the markets in which the Company may from time to time compete. Many of such
risk factors are beyond the control of the Company and its management.
Other risk factors that could cause the actual results, performance or
achievements of the Company to be different from any future results, performance
or achievements are also detailed from time to time in the Company's public
statements and/or filings with the Securities and Exchange Commission.
OVERVIEW AND OUTLOOK
The Company owns and operates skilled nursing and assisted living facilities
serving primarily the private pay elderly market. The Company's skilled nursing
facilities provide high acuity, long-term care and Alzheimer's services
principally to residents over the age of 65. The Company's assisted living
facilities operate under the brand names "Springhouse" and "Arden Courts".
Springhouse facilities serve the general assisted living population of frail
elderly, while Arden Courts facilities are specifically focused on providing
care to persons suffering from early to middle-stage Alzheimer's disease and
related memory impairment. These assisted living facilities provide housing,
personalized support and health care services in a non-institutional setting
designed to address the individual needs of the elderly or Alzheimer's
afflicted requiring assistance with activities of daily living, such as
eating, bathing, dressing and personal hygiene, but who do not require the
level of care provided by a skilled nursing facility.
The Company also owns approximately 51% of Vitalink, 64% of the voting stock
of In Home Health and an acute care hospital. Vitalink is a publicly traded
institutional pharmacy company which provides medications, consulting,
infusion and other ancillary services to approximately 173,000 institutional
beds as well as to home infusion patients through 57 pharmacies. As a result of
the anticipated merger of Vitalink with and into Genesis Health Ventures, Inc.
("Genesis"), the accompanying consolidated financial statements reflect the
pharmacy operations as a discontinued operation.
In Home Health is a publicly traded company which provides a broad range of
professional and support services to clients requiring medical and personal
assistance in their homes. Services provided include nursing care, infusion
therapy, rehabilitation, and personal care.
The Company has increased skilled nursing capacity by approximately 2.5%
annually over the last five fiscal years. Overall occupancy has remained
relatively stable during this period. Occupancy for mature facilities--those
facilities owned by the Company for a full two-year period--decreased from
90.3% to 89.8%, between fiscal year 1996 and fiscal year 1997. This decline in
occupancy has resulted in an annual decrease in revenues of approximately $5
million. During the five-year period from fiscal year 1993 to fiscal year
1997, the Company has increased assisted living capacity substantially, from 3
facilities with 321 beds to 31 facilities with 3,173 beds.
Despite increasing competition for private pay customers, the Company has
consistently maintained a high ratio of private pay revenues. The slight
decline in the Company's private pay mix over the past four years can be
attributed primarily to the inroads that assisted living providers have
achieved in this market segment.
RESULTS OF OPERATIONS
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Revenues recorded under Federal and state medical assistance programs are
subject to adjustment upon audit by appropriate government agencies. (See
"Revenue Recognition" footnote disclosure.) For fiscal years 1997, 1996 and
1995, these revenues amounted to $596.0 million, $502.0 million and $391.1
million, respectively. In the opinion of management, any difference between
revenues recorded and final determination will not be significant. The Company
does not anticipate a material effect on revenues as a result of the Balanced
Budget Act of 1997. However, because the regulations pertaining to this Act have
neither been proposed nor implemented, this preliminary conclusion is subject to
change as a result. The Company will disclose any such material effect as may be
required.
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Comparison of Fiscal Year Results
SKILLED NURSING FACILITIES. Skilled nursing revenues increased from $989.0
million to $1.1 billion ($77.1 million or 7.8%) in fiscal 1997 compared to the
prior year. The increase in revenues is attributable to an increase in average
daily rates of approximately 6.0% ($61 million) and an increase in bed capacity
of approximately 5.7%. The increase in average rates includes the incremental
impact of settlements with government agencies related to prior period cost
reports of approximately $4 million. The growth in bed capacity is attributable
to the purchase of two nursing facilities (279 beds), openings of newly
constructed facilities (398 beds) and additional bed development at existing
centers (467 beds), and is net of the sale of four facilities (498 beds) in the
second quarter of 1997.
Skilled nursing revenues increased from $893.5 million to $989.0 million in
fiscal year 1996 ($95.5 million or 10.7%). The increase in revenues is
attributable to an increase in average daily rates of approximately 6% ($59
million) and an increase in bed capacity of approximately 3.3%. The increase
in rates includes the incremental impact of settlements with government
agencies related to prior period cost reports of approximately $7 million. The
growth in bed capacity is attributable to the purchase of four nursing
facilities (569 beds), openings of newly constructed facilities (360 beds) and
additional bed development at existing centers (35 beds).
Skilled nursing operating expenses increased from $746.1 million in 1996 to
$802.4 million in 1997 ($56.2 million or 7.5%). Additional capacity accounts for
$20.5 million of this increase. The remainder of the increase is caused by
additional staffing necessitated by higher patient acuity and more complex
product and service offerings. Gross margin as a percentage of sales increased
from 24.6% in fiscal year 1996 to 24.7% in fiscal year 1997.
Operating expenses increased from $671.0 million in 1995 to $746.1 million in
1996 ($75.1 million or 11.2%). The increase in operating expenses was
attributable to additional capacity, as well as to additional staffing
necessitated by higher patient acuity and more complex product and service
offerings. Gross margin as a percentage of sales decreased slightly from 24.9%
to 24.6% from fiscal year 1995 to 1996.
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ASSISTED LIVING. Assisted living revenues increased for fiscal year 1997 by
45.5% or $17.7 million due to increases in rates at existing facilities ($5.3
million), capacity increases ($11.1 million) and occupancy increases ($1.3
million). Assisted living revenues increased $26.5 million or 214.2% in 1996 due
to capacity growth and rate increases. Manor Care acquired six assisted living
facilities and opened five Arden Courts in fiscal year 1996.
Operating expenses increased $12.4 million to $45.3 million or 80.1% of net
revenues in fiscal year 1997 compared to $32.8 million or 84.4% of net
revenues in fiscal year 1996 as a result of increases in capacity and
inflation.
Operating expenses increased $22.9 million to $32.8 million or 84.4% of net
revenues in fiscal year 1996 compared to $9.9 million or 71.4% of net revenues
in fiscal year 1995 as a result of increases in capacity and inflation. The
increase in operating expenses as a percentage of revenue was due to a
significant level of new assisted living development.
HOME HEALTH. Home health revenues increased 67.7% or $50.2 million for the
fiscal year 1997, reflecting a full year of home health operations. Manor Care
entered into the home health business with the acquisition of In Home Health
in October 1995. Home health revenues of $74.2 million for fiscal year 1996
represent revenues contributed by In Home Health from its acquisition in October
1995 through May 1996.
Operating expenses increased $50.6 million to $124.5 million or 100.1% of
net revenues in fiscal year 1997 compared to $73.9 million or 99.6% of net
revenues in fiscal year 1996. The increase from 1996 to 1997 represents the
impact of a full year of expenses in fiscal year 1997 versus eight months of
expenses for the fiscal year 1996.
There were no home health revenues or operating expenses in fiscal year
1995, as the Company did not enter the home health business until fiscal year
1996.
The majority of In Home Health's revenues is derived from services provided
to Medicare beneficiaries. Currently, Medicare reimburses participating
Medicare certified home health agencies for the reasonable costs incurred to
provide covered visits to eligible beneficiaries, subject to certain cost
limits. Due to certain limitations on the nature and the amount of the costs
that are reimbursable, In Home Health incurs a loss on the Medicare business.
During 1997, several cost reimbursement issues that were in dispute for
several years were resolved through decisions by the PRRB and the U.S. District
Court. As a result of these decisions and other communications from HCFA, it
became clear that some costs incurred by In Home Health would not be
reimbursed by Medicare. Although In Home Health has restructured its
operations and eliminated a portion of these nonreimbursable costs, In Home
Health will continue to incur some costs that are not reimbursed by Medicare,
as it believes they constitute a necessary function to the conduct of its
business.
The Balanced Budget Act of 1997 requires HCFA to implement a prospective
payment system for home health agencies by October 1, 1999, with up to a four-
year phase-in period. Prospective rates determined by HHS would reflect a 15%
reduction to the cost limits and per patient limits as of September 30, 1999.
In the event the implementation deadline is not met, the reduction will be
applied to the reimbursement system then in place. The impact of such a
change, if implemented, on In Home Health's results of operations cannot be
predicted with any certainty at this time and would depend, to a large extent,
on the reimbursement rates for home nursing established on an interim basis
and under the prospective payment system. There can be no assurances that such
reimbursement rates, if enacted, would cover the costs incurred by In Home
Health to provide home nursing
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services. Until the prospective payment system takes effect on October 1,
1999, the Budget Act establishes an interim payment system (the "IPS") that
provides for lowering of reimbursement limits for home health visits. Cost
limit increases for fiscal years 1995 and 1996 have been eliminated. In
addition, for cost reporting periods beginning on October 1, 1997, home health
agencies' cost limits will be determined at the lesser of (i) their actual costs
(ii) cost limits based on 105% of median costs of free-standing home health
agencies or (iii) an agency-specific per-patient cost cap, based on 98% of 1994
costs adjusted for inflation. In Home Health is unable to determine the effect
of the IPS until HCFA finalizes related regulatory guidance on the
implementation of the IPS. The new cost limits will apply to In Home Health for
the cost reporting period beginning October 1, 1997. A reduction in these cost
limits could have a significant effect on In Home Health's results of
operations; however, the effect of such reductions cannot be predicted with any
level of certainty.
OTHER RESULTS OF OPERATIONS. General corporate and other expenses
represented 5.3% of revenue in fiscal year 1997 and 6.3% of revenue in fiscal
year 1996. General corporate and other expenses includes all indirect
operating expenses as well as risk management, information systems, treasury,
accounting, legal and other administrative support for the Company and its
various subsidiaries. The reduction of general corporate and other expenses is
partially due to a reduction in employees related to the discontinued lodging
segment and reengineering efforts in both organizational and financial
systems. Additionally, general corporate and other expenses for fiscal year
1997 included a gain of $7.3 million from the sale of four nursing centers and
charitable contributions expense of $5.0 million.
Interest expense increased 29.9% and 32.8% in fiscal years 1997 and 1996,
respectively. The interest expense increases are primarily due to additional
borrowings in connection with newly developed facilities and acquisitions, as
discussed above.
The Company recorded provisions of $26.3 million in fiscal year 1996 related
to the impairment of certain long lived assets and costs associated with the
Manor Care's restructuring of its healthcare business. The most significant
components of the provisions were non-cash asset impairment charges of $21.2
million relating to writedowns of property, equipment and capitalized system
development costs.
On November 1, 1996, Manor Care completed the spin-off of its lodging
segment by contributing its net investment in discontinued lodging operations
totaling $164.2 million to Choice Hotels International, Inc. Manor Care
shareholders of record on October 10, 1996, received one share of Choice
Hotels International, Inc. common stock for each outstanding share of Manor
Care common stock. Accordingly, lodging results are reported as discontinued
operations for all periods presented.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains adequate capital resources, including strong operating
cash flows and committed lines of credit, to support ongoing operations and to
fulfill capital requirements in the foreseeable future.
In September 1996, the Company amended its $250.0 million competitive advance
and multi-currency revolving credit facility (the "Credit Facility") to provide
for the spin-off of the lodging division. The Credit Facility expires in
September 2001. At May 31, 1997, bank lines totaled $275.0 million, of which
$176.5 million remained unused.
On November 1, 1996, the Company separated its lodging business from its
healthcare business via a tax-free spin-off of the lodging division. In
conjunction with this spin-off, the Company received a three-year, $225.7
million, 9% note from its lodging segment. In April 1997, the Company received a
prepayment of $110.0 million on the advances to the discontinued lodging
segment. In October 1997, the Company received prepayment of the remaining
$115.7 million. All proceeds were used to repay borrowings under the Credit
Facility.
In June 1996, the Company completed a public offering of unsecured Senior
Notes in the amount of $150.0 million, the proceeds of which were used to repay
borrowings under the Credit Facility. The notes are due in June 2006 and carry a
7 1/2% interest rate.
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The Company's working capital ratio was 1.2 at May 31, 1997 and 0.9 at May
31, 1996.
ACQUISITIONS, OPENINGS, DIVESTITURES AND SALES OF PROPERTY
During fiscal year 1997, investment in property and equipment utilized in
continuing operations and systems development amounted to $178.8 million. In
addition, the Company purchased two nursing centers for $17.8 million and opened
four newly constructed skilled nursing facilities and six assisted living
facilities. The Company also transferred an assisted living facility to the
discontinued lodging segment with an approximate net book value of $4.9 million
and sold four nursing centers in Indiana, Iowa, Illinois and Texas for $17.3
million. During fiscal year 1996, investment in property and equipment utilized
in continuing operations and systems development amounted to $132.8 million.
Additionally, during fiscal year 1996, $51.4 million was spent to acquire four
additional nursing centers and six assisted living facilities with five attached
skilled nursing units.
In October 1995, the Company purchased approximately 41% of In Home Health,
Inc.'s common stock for $22.9 million and invested another $20.0 million for
100% of its outstanding voting convertible preferred stock and for warrants to
purchase an additional 6 million shares of common stock. The In Home Health
redeemable preferred stock may be redeemed in cash at the option of the Company
on and after October 24, 2000. The In Home Health redeemable preferred stock
ranks senior to the In Home Health common stock, has voting rights on an as-if
converted basis, and is initially convertible into 10 million shares of In Home
Health common stock at a conversion price of $2.00 per share. The In Home Health
redeemable preferred stock bears dividends at 12% per annum and has a
liquidation preference of $100.00 per share. The In Home Health redeemable
preferred stock will accrete over five years from its fair value of $18,500,000
on the date of issuance to its redemption price of $20 million as of the
redemption date. The In Home Health warrants purchased by the Company have an
exercise price of $3.75 per share and expire in October 1998.
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The Company believes that cash flows from operations, and available borrowings
under the Credit Facility, will provide it with sufficient resources to meet its
working capital needs, to finance projected capital expenditures and to meet its
liquidity requirements through fiscal year 2001.
SHAREHOLDERS' EQUITY
Shareholders' equity decreased to $690.4 million at May 31, 1997 from $707.8
million at May 31, 1996. This decrease was primarily due to the $164.2 million
dividend of the discontinued lodging segment and $6.1 million of cash
dividends paid, offset by net income of $136.9 million and stock options
exercised of $12.3 million.
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IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 "Earnings Per Share" ("SFAS 128"), which
is effective for fiscal years ending after December 15, 1997, including interim
periods. Earlier adoption is not permitted. However, an entity is permitted to
disclose pro forma earnings per share amounts computed under SFAS 128 in the
notes to the financial statements in periods prior to adoption. The statement
requires restatement of all prior-period earnings per share data presented after
the effective date. SFAS 128 specifies the computation, presentation, and
disclosure requirements for earnings per share and is substantially similar to
the standard recently issued by the International Accounting Standards Committee
entitled "International Accounting Standards, Earnings Per Share." ManorCare
Health Services plans to adopt SFAS 128 in fiscal year 1998 and has not
determined the impact of adoption to be significant.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 130 "Reporting Comprehensive Income"
("SFAS 130"), which is effective for fiscal years beginning after December 15,
1997. The statement establishes standards for reporting and display of
comprehensive income and its components. The Company plans to adopt SFAS 130 in
fiscal year 1999 and has not determined the impact of adoption to be
significant.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"), which is effective for fiscal years beginning after December 15, 1997.
The Company plans to adopt SFAS 131 in fiscal year 1999 and has not determined
the impact of adoption to be significant.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
MANOR CARE, INC.
<TABLE>
<S> <C>
Report of Independent Public Accountants.................................. F-2
Consolidated Balance Sheets as of May 31, 1997 and 1996 .................. F-3
Consolidated Statements of Income for the fiscal years ended May 31, 1997,
1996 and 1995............................................................ F-4
Consolidated Statements of Cash Flows for the fiscal years ended May 31,
1997, 1996 and 1995 ..................................................... F-5
Consolidated Statements of Shareholders' Equity for the years ended
May 31, 1997, 1996 and 1995 ............................................. F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
F-1
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE SHAREHOLDERS OF MANOR CARE, INC.:
We have audited the accompanying consolidated balance sheets of Manor Care,
Inc. (a Delaware Corporation) and subsidiaries as of May 31, 1997 and 1996,
and the related consolidated statements of income, shareholders' equity and cash
flows for each of the three years in the period ended May 31, 1997. These
financial statements and the schedule referred to below are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and 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 financial position of Manor Care, Inc. and
subsidiaries as of May 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended May 31,
1997 in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The schedule listed in the
index in Item 16, Exhibit 99.1 is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in the audits of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
consolidated financial statements taken as a whole.
/s/ Arthur Andersen LLP
Washington, D.C.
June 27, 1997 (except with respect to the matters discussed in the footnote
entitled "Subsequent Events" as to which the date is June 10,
1998)
F-2
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MAY 31, 1997 MAY 31, 1996
------------ ------------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents...................... $ 29,222 $ 61,644
Receivables (net of allowances for doubtful
accounts of $36,621 and $22,148).............. 135,446 87,174
Inventories.................................... 12,531 11,308
Income taxes................................... 32,266 39,282
Other.......................................... 7,988 5,777
---------- ----------
Total current assets......................... 217,453 205,185
---------- ----------
Property and equipment, at cost, net of
accumulated depreciation........................ 1,004,663 910,016
---------- ----------
Goodwill......................................... 29,576 23,452
---------- ----------
Advances to discontinued lodging segment......... 115,723 225,723
---------- ----------
Net investment in discontinued pharmacy segment.. 178,079 71,010
---------- ----------
Net investment in discontinued lodging segment... -- 159,537
---------- ----------
Other assets..................................... 95,484 62,004
---------- ----------
Total assets................................. $1,640,978 $1,656,927
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt.............. $ 12,680 $ 23,984
Accounts payable............................... 59,590 81,886
Accrued expenses............................... 109,540 111,023
Income taxes payable........................... -- 7,889
---------- ----------
Total current liabilities.................... 181,810 224,782
---------- ----------
Mortgages and other long-term debt............... 491,600 490,575
---------- ----------
Deferred income taxes ($187,585 and $149,494) and
other........................................... 261,624 215,678
---------- ----------
Minority interest................................ 15,513 18,123
---------- ----------
SHAREHOLDERS' EQUITY
Common stock $.10 par, 160.0 million shares
authorized; 66.8 million and 65.8 million
shares issued ................................ 6,682 6,581
Contributed capital............................ 194,640 174,364
Retained earnings.............................. 538,630 571,925
Cumulative translation adjustment.............. -- (1,362)
Treasury stock, 3.2 million and 3.0 million
shares, at cost............................... (49,521) (43,739)
---------- ----------
Total shareholders' equity................... 690,431 707,769
---------- ----------
$1,640,978 $1,656,927
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED MAY 31
------------------------------------
1997 1996 1995
---------- ---------- --------
(IN THOUSANDS OF DOLLARS
EXCEPT PER SHARE INFORMATION)
<S> <C> <C> <C>
Revenues................................ $1,294,574 $1,141,911 $946,761
---------- ---------- --------
Expenses:
Operating expenses.................... 1,012,799 883,459 719,780
Depreciation and amortization......... 70,851 63,723 50,621
General corporate and other........... 68,563 72,322 63,197
Provisions for asset impairment and
restructuring........................ -- 26,300 --
---------- ---------- --------
Total expenses........................ 1,152,213 1,045,804 833,598
---------- ---------- --------
Income from continuing operations before
other income and (expenses) and income
taxes.................................. 142,361 96,107 113,163
---------- ---------- --------
Other income and (expenses):
Interest income from advances to
discontinued lodging segment......... 21,221 19,673 15,492
Interest income and other............. 8,499 5,385 7,277
Minority interest expense............. 2,599 740 (82)
Interest expense...................... (40,599) (31,259) (23,534)
---------- ---------- --------
Total other income and (expenses),
net.................................. (8,280) (5,461) (847)
---------- ---------- --------
Income from continuing operations before
income taxes........................... 134,081 90,646 112,316
Income taxes............................ 51,186 36,694 44,338
---------- ---------- --------
Income from continuing operations....... 82,895 53,952 67,978
Discontinued operations
Income from discontinued pharmacy
operations (net of income taxes of
$33,514, $9,306 and $7,818,
respectively)........................ 42,218 11,519 9,697
Income from discontinued lodging
operations (net of income taxes of
$8,734, $14,966 and $13,144,
respectively)........................ 11,829 20,436 16,811
---------- ---------- --------
Net income.............................. $ 136,942 $ 85,907 $ 94,486
========== ========== ========
Weighted average shares of common stock
outstanding............................ 63,257 62,628 62,480
---------- ---------- --------
Net income per share of common stock:
Net income from continuing
operations........................... $ 1.31 $ 0.86 $ 1.09
Income from discontinued pharmacy
operations (net of taxes)............ 0.67 0.18 0.15
Income from discontinued lodging
operations (net of taxes)............ 0.19 0.33 0.27
---------- ---------- --------
Net income per share of common stock.... $ 2.16(a) $ 1.37 $ 1.51
========== ========== ========
</TABLE>
- --------
(a) Does not add due to rounding.
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED MAY 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................... $ 136,942 $ 85,907 $ 94,486
Reconciliation of net income to net
cash provided by operating activi-
ties:
Income from discontinued pharmacy op-
erations............................ (42,218) (11,519) (9,697)
Income from discontinued lodging op-
erations............................ (11,829) (20,436) (16,811)
Depreciation and amortization........ 70,851 63,723 50,621
Provisions for asset impairment and
restructuring....................... -- 26,300 --
Amortization of debt discount........ 513 455 499
Provisions for bad debts............. 15,930 13,778 10,815
Increase (decrease) in deferred tax-
es.................................. 26,354 (4,949) 1,757
Gain on sale of healthcare facili-
ties................................ (7,322) -- 50
Minority interest.................... (2,599) (740) 82
Changes in assets and liabilities
(excluding sold facilities and
acquisitions):
Change in receivables............... (64,864) (30,890) (18,397)
Change in inventories and other
current assets..................... (3,783) 44 (7,991)
Change in current liabilities....... (21,829) 46,807 15,597
Change in income taxes payable...... (5,444) 13,062 (12,597)
Change in other liabilities......... (13,088) 5,306 (1,998)
--------- --------- ---------
Net cash provided by continuing opera-
tions................................ 77,614 186,848 106,416
--------- --------- ---------
Net cash (utilized) provided by dis-
continued pharmacy operations........ (234) 11,768 14,754
--------- --------- ---------
Net cash provided by discontinued
lodging operations................... 40,599 52,682 48,604
--------- --------- ---------
Net cash provided by operating activi-
ties................................. 117,979 251,298 169,774
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in property and equip-
ment................................ (163,068) (118,359) (81,337)
Investment in systems development.... (15,753) (14,436) (8,400)
Acquisition of assisted living facil-
ities............................... -- (19,050) --
Purchase of home health business..... -- (22,950) --
Acquisition of healthcare facili-
ties................................ (17,793) (32,369) (56,745)
Acquisition of Vitalink stock........ (30,000) -- --
Sale of healthcare business.......... -- -- 13,334
Sale of healthcare facilities........ 17,283 -- --
Advances to discontinued pharmacy
segment............................. (15,857) 22 8,721
Advances to discontinued lodging seg-
ment................................ 113,267 (27,201) (51,461)
Other items, net..................... (3,403) (13,061) (1,127)
--------- --------- ---------
Net cash utilized by investing
activities of continuing operations.. (115,324) (247,404) (177,015)
--------- --------- ---------
Net cash utilized by investing
activities of discontinued pharmacy
operations........................... (93,911) (11,714) (14,698)
--------- --------- ---------
Net cash utilized by investing ac-
tivities of discontinued lodging op-
erations............................. (29,424) (169,641) (92,422)
--------- --------- ---------
Net cash utilized by investing ac-
tivities............................. (238,659) (428,759) (284,135)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings of long-term debt......... 179,981 149,000 207,254
Principal payments of long-term
debt................................ (176,986) (22,976) (122,440)
Proceeds from exercise of stock op-
tions............................... 12,254 3,307 841
Treasury stock acquired.............. (5,782) (1,131) (73)
Retirement of debentures............. (9,900) -- --
Dividends paid....................... (6,108) (5,502) (5,489)
--------- --------- ---------
Net cash (utilized) provided by fi-
nancing activities of continuing op-
erations............................. (6,541) 122,698 80,093
--------- --------- ---------
Net cash provided (utilized) by fi-
nancing activities of discontinued
pharmacy operations.................. 94,145 (54) (56)
--------- --------- ---------
Net cash provided by financing
activities of discontinued lodging
operations........................... 654 43,687 50,008
--------- --------- ---------
Net cash provided by financing
activities........................... 88,258 166,331 130,045
--------- --------- ---------
Net change in cash and cash equiva-
lents................................ (32,422) (11,130) 15,684
Cash and cash equivalents, at begin-
ning of year......................... 61,644 72,774 57,090
--------- --------- ---------
Cash and cash equivalents, at end of
year................................. $ 29,222 $ 61,644 $ 72,774
========= ========= =========
NON-CASH ACTIVITIES:
Liabilities assumed in connection
with acquisition of properties...... $ -- $ 68,250 $ --
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
----------------- CONTRIBUTED RETAINED TRANSLATION
SHARES AMOUNT CAPITAL EARNINGS ADJUSTMENT
---------- ------ ----------- --------- -----------
(IN THOUSANDS OF DOLLARS, EXCEPT COMMON SHARES)
<S> <C> <C> <C> <C> <C>
Balance, May 31, 1994..... 65,436,734 $6,545 $167,316 $ 402,520 $ (31)
Net income.............. -- -- -- 94,486 --
Exercise of stock op-
tions.................. 77,000 8 833 -- --
Cash dividends.......... -- -- -- (5,489) --
Other................... -- -- 550 3 740
---------- ------ -------- --------- -------
Balance, May 31, 1995..... 65,513,734 6,553 168,699 491,520 709
Net income.............. -- -- -- 85,907 --
Exercise of stock op-
tions.................. 269,156 28 3,279 -- --
Cash dividends.......... -- -- -- (5,502) --
Other................... -- -- 2,386 -- (2,071)
---------- ------ -------- --------- -------
Balance, May 31, 1996..... 65,782,890 6,581 174,364 571,925 (1,362)
Net income.............. -- -- -- 136,942 --
Exercise of stock op-
tions.................. 1,011,951 101 12,153 -- --
Cash dividends.......... -- -- -- (6,108) --
Dividend of discontinued
lodging segment........ -- -- -- (164,225) 1,362
Tax benefit of common
stock transactions
related to employee
benefit plans.......... -- -- 6,818 -- --
Other................... -- -- 1,305 96 --
---------- ------ -------- --------- -------
Balance, May 31, 1997..... 66,794,841 $6,682 $194,640 $ 538,630 $ --
========== ====== ======== ========= =======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUBSEQUENT EVENTS
MERGER
On June 10, 1998, Manor Care, Inc., ("Manor Care"), a Delaware corporation,
Health Care & Retirement Corporation, a Delaware corporation ("HCR"), and Catera
Acquisition Corp., a Delaware corporation and wholly owned subsidiary of HCR
("Merger Sub"), entered into an Agreement and Plan of Merger (the "Merger
Agreement"), pursuant to which Merger Sub will merge with and into Manor Care.
The Merger Agreement provides that, with certain limited exceptions, each
outstanding share of Manor Care's common stock, par value $.10 per share, shall
be converted into the right to receive one share of common stock of HCR, par
value $.01 per share. Upon completion of the transaction, Manor Care will become
a wholly owned subsidiary of HCR and the stockholders of Manor Care will become
stockholders of HCR. The consummation of the transactions contemplated by the
Merger Agreement are subject to the approval of the stockholders of Manor Care
and HCR, the receipt of certain regulatory approvals and the expiration of
antitrust waiting periods.
The transaction is expected to be completed during the fourth quarter of
calendar year 1998. If completed, the transaction will be accounted for as a
pooling of interests. Due to the impending Merger, the Company no longer plans
to separate its skilled nursing, assisted living and home health businesses from
its skilled nursing facility management, real estate and healthcare facility
development businesses.
DISCONTINUED PHARMACY OPERATIONS
On April 26, 1998, Vitalink Pharmacy Services, Inc. ("Vitalink") entered into
an Agreement and Plan of Merger (the "Vitalink Merger Agreement") with Genesis
Health Ventures, Inc. ("Genesis"), a Pennsylvania corporation. Pursuant to the
Vitalink Merger Agreement, Vitalink will merge with and into Genesis (the
"Vitalink Merger"). In accordance with the Vitalink Merger Agreement, holders of
the common stock of Vitalink will receive for each share of Vitalink common
stock held, at the election of the holder, either cash consideration in the
amount of $22.50, or 0.045 shares of Series G Cumulative Convertible Preferred
Stock of Genesis (the "Genesis Preferred Stock").
The Vitalink Merger Agreement may be terminated (i) by either party, if the
Board of Directors of the other has withdrawn, changed or modified its
recommendation that its stockholders vote in favor of the Vitalink Merger;
(ii) by Vitalink prior to the approval of its stockholders of the Vitalink
Merger, if it receives a Superior Proposal (as defined in the Vitalink Merger
Agreement) which was not solicited after the date of the Vitalink Merger
Agreement; (iii) by either party if any court of competent jurisdiction or
other governmental body has issued a final and nonappealable order, decree or
ruling or taken any other action restraining, enjoining or otherwise
prohibiting the Vitalink Merger; and (iv) upon the occurrence of certain other
events specified in the Vitalink Merger Agreement. Under certain
circumstances, Vitalink would be obligated to pay Genesis a $20 million fee if
the Vitalink Merger Agreement is terminated.
Manor Care, the beneficial owner of approximately 50% of the outstanding
shares of Vitalink common stock, and Genesis have entered into a Voting
Agreement, dated April 26, 1998 (the "Voting Agreement"), pursuant to which
Manor Care agreed to vote all of its shares of Vitalink common stock in favor
of the adoption and approval of the Vitalink Merger, the Vitalink Merger
Agreement and the transactions contemplated thereby. Manor Care has also
agreed to elect to receive Genesis Preferred Stock as Vitalink Merger
consideration with respect to all of its Vitalink common stock.
The Genesis Preferred Stock will bear cash dividends at an initial annual
rate of 5.9375%. Genesis Preferred Stockholders will be initially entitled to
13.441 votes per share of Genesis Preferred Stock, and will vote together with
the holders of Genesis common stock as a single class on all matters to be
voted on by holders of Genesis common stock, and as a separate class on
matters as to which the Pennsylvania Business Corporation Law requires a
separate class vote.
At the option of Manor Care, each share of Genesis Preferred Stock will be
convertible at any time into Genesis common stock at a conversion price of
$37.20 per share, subject to adjustment under certain circumstances. Beginning
April 26, 2001, Genesis may under certain circumstances, force conversion of
the Genesis Preferred Stock, at conversion prices ranging from $37.20 to
$38.87 per share of Genesis common stock. Dividends will cease to accrue in
respect of the Genesis Preferred Stock as of the date of the conversion
thereof. The revenues from discontinued pharmacy operations for fiscal years
1997, 1996 and 1995 (including sales to the Company's skilled nursing and
assisted living facilities of $41,365, $34,829 and $39,560) are $274,038,
$141,115 and $112,257, respectively. The income from discontinued pharmacy
operations before income taxes and net income from discontinued pharmacy
operations for the years ended May 31, 1997, 1996 and 1995 were as follows.
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(In thousands of dollars)
<S> <C> <C> <C>
Income from discontinued pharmacy operations
before income taxes $75,732(a) $20,825 $17,515
Net income from discontinued pharmacy operations $42,218 $11,519 $ 9,697
</TABLE>
(a) Income from discontinued pharmacy operations before income taxes includes a
$50.3 million pretax gain resulting from the issuance of 11.4 million shares
of Vitalink common stock in connection with Vitalink's merger with TeamCare,
the pharmacy subsidiary of GranCare, Inc. in February 1997.
F-7
<PAGE>
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statments include the accounts of Manor Care, Inc.
and its subsidiaries (the "Company"). As a result of the Company's spin-off of
its lodging operations and the Vitalink Merger, the accompanying consolidated
financial statements reflect the lodging and pharmacy segments as discontinued
operations. All significant intercompany transactions have been eliminated
except for advances to the discontinued lodging segment and the related interest
income.
CASH
The Company considers all highly liquid securities purchased with a maturity
of three months or less to be cash equivalents.
PROPERTY AND EQUIPMENT
The components of property and equipment at May 31, were:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C>
Land............................................ $ 97,569 $ 92,884
Building and improvements....................... 969,660 886,059
Capitalized leases.............................. 12,747 12,747
Furniture, fixtures and equipment............... 214,239 197,376
Facilities in progress.......................... 58,200 49,067
------------ ------------
1,352,415 1,238,133
Less: Accumulated depreciation.................. (347,752) (328,117)
------------ ------------
$ 1,004,663 $ 910,016
============ ============
</TABLE>
Depreciation has been computed for financial reporting purposes using the
straight-line method. A summary of the ranges of estimated useful lives upon
which depreciation rates have been based follows.
<TABLE>
<S> <C>
Building and improvements........................................ 10-40 years
Furniture, fixtures and equipment................................ 3-20 years
</TABLE>
Accumulated depreciation includes $9.4 million and $9.7 million at May 31,
1997 and 1996, respectively, relating to capitalized leases. Capitalized
leases are depreciated on a straight-line basis over the lesser of the lease
term or the remaining useful life of the leased property.
CAPITALIZATION POLICIES
Major renovations and replacements are capitalized to appropriate property
and equipment accounts. Upon sale or retirement of property, the cost and
related accumulated depreciation are eliminated from the accounts and the
related gain or loss is taken into income. Maintenance, repairs, and minor
replacements are charged to expense.
Construction overhead and costs incurred to ready a project for its intended
use are capitalized for major development projects and are amortized over the
lives of the related assets.
The Company capitalizes interest on borrowings applicable to facilities in
progress. Interest has been capitalized as follows: 1997, $4.6 million; 1996,
$3.1 million; 1995, $1.8 million.
ACCOUNTING FOR CAPITALIZED SYSTEMS DEVELOPMENT COSTS
Costs incurred for systems development include direct payroll and consulting
costs. These costs are capitalized and are amortized over the lesser of the
estimated useful lives of the related systems or five years.
F-8
<PAGE>
ACCOUNTING FOR INVESTMENTS IN JOINT VENTURES
The Company uses the equity method to account for investments in entities in
which it has less than a majority interest but can exercise significant
influence. These investments are classified on the accompanying consolidated
balance sheets as other long-term assets. Under the equity method, the
investment, originally recorded at cost, is adjusted to recognize the Company's
share of the net earnings or losses of the affiliates as they occur. Losses are
limited to the extent of the Company's investments in, advances to and
guarantees for the investee.
GOODWILL
Goodwill primarily represents an allocation of the excess purchase price of
certain acquisitions over the recorded fair value of the net assets. Goodwill
is amortized over 40 years. Amortization expense amounted to $.3 million, $.2
million and $.1 million in each of the years ended May 31, 1997, 1996 and
1995, respectively.
MINORITY INTEREST
The Company has controlling investments in certain entities which are not
wholly owned. Amounts reflected as minority interest represent the minority
owners' share of income in these entities. Minority interest liability
represents the cumulative minority owners' share of income in these entities.
SELF-INSURANCE PROGRAMS
The Company self-insures for certain levels of general and professional
liability, automobile liability, and workers' compensation coverage. The
estimated costs of these programs are accrued at present values at a discount
rate of 7% based on actuarial projections for known and incurred but not
reported claims.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company has elected the disclosure-only alternative permitted under
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). The Company has disclosed herein pro
forma net income and pro forma earnings per share in the footnotes using the
fair value based method beginning in fiscal year 1997 with comparable
disclosures for fiscal year 1996.
NET INCOME PER SHARE OF COMMON STOCK
Net income per share of common stock has been computed based on the weighted
average number of shares of common stock outstanding. Stock options are included
in the calculation when dilutive.
REVENUE RECOGNITION
Revenues are recognized at the time the service is provided to the patient.
The Company records revenue for services to Medicare beneficiaries at the time
the services are rendered and based on the Medicare cost reimbursement
principles. Under those principles, Medicare reimburses the Company for the
reasonable costs
F-9
<PAGE>
(as defined) incurred in providing care to Medicare beneficiaries. The Company
reports as reimbursable costs in the Medicare cost reports only those costs it
believes to be reimbursable under the applicable Medicare cost reimbursement
principles. In determining the amount of revenue to be recorded, those costs
are reduced for costs that are in excess of reimbursable cost limits, and for
costs for which reimbursement may be questionable based on the Company's
understanding of reimbursement principles in effect at that time. Accordingly,
this process results in recording revenue only for the costs that the Company
believes are reasonably assured of recovery. Refer to "Commitments and
Contingencies" footnote for additional information.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported or disclosed in its financial
statements and the notes related thereto. Actual results could differ from
those estimates.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 "Earnings Per Share" ("SFAS 128"), which
is effective for fiscal years ending after December 15, 1997, including interim
periods. Earlier adoption is not permitted. However, an entity is permitted to
disclose pro forma earnings per share amounts computed under SFAS 128 in the
notes to the financial statements in periods prior to adoption. The statement
requires restatement of all prior-period earnings per share data presented after
the effective date. SFAS 128 specifies the computation, presentation, and
disclosure requirements for earnings per share and is substantially similar to
the standard recently issued by the International Accounting Standards Committee
entitled "International Accounting Standards, Earnings Per Share," ManorCare
Health Services plans to adopt SFAS 128 in fiscal year 1998 and has not
determined the impact of adoption to be significant.
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130 "Reporting Comprehensive Income" ("SFAS 130"), which is effective for
fiscal years beginning after December 15, 1997. The statement establishes
standards for reporting and display of comprehensive income and its
components. The Company is in the process of determining the timing and has
not determined the impact of adoption to be significant.
In June 1997, the FASB issued SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"), which is effective for
fiscal years beginning after December 15, 1997. The Company plans to adopt
SFAS 131 in fiscal year 1999 and has not determined the impact of adoption to
be significant.
F-10
<PAGE>
LONG-TERM RECEIVABLES
Long-term receivables of $22.0 million and $19.1 million at May 31, 1997 and
1996, respectively, represent accounts receivable for Medicare at In Home
Health, Inc. ("IHHI"), relating primarily to the reimbursement of disputed
costs from prior years.
Approximately 55% of IHHI's revenue is derived from services provided to
Medicare beneficiaries through cost reimbursement programs. Virtually all of
the payments for these services are based on the Medicare program's
reimbursable costs incurred in rendering the services. Cost reports are filed
annually and are subject to audit and retroactive adjustment. IHHI reports
revenue for those costs that it believes are probable of recovery under
applicable Medicare statutes and regulations.
Over the years Medicare auditors have claimed that certain costs were not
reimbursable under the Medicare program. These positions are based on
interpretations promulgated after the period covered by the cost reports that
are contrary to IHHI's interpretation or on what IHHI believes is the
misapplication of specific reimbursement principles.
As of May 31, 1997, IHHI has received reports challenging $18.9 million of
these costs. An additional $18.8 million of costs similar to the costs which
have been challenged have been incurred through May 31, 1997 related to open
cost reporting years. Of this $37.7 million, approximately $22.5 million
related to the treatment of certain community liaison personnel costs, which
Medicare alleges are unreimbursable sales costs. Other significant disputed
costs related to physical therapists employed by IHHI and certain other branch
and corporate expenses.
As of May 31, 1997 total IHHI accounts receivable due from Medicare were
approximately $40.5 million including, the disputed costs of $37.7 million. On
a consolidated basis, the Company has established reserves against these
disputed costs of $9.8 million. The Company does not believe that the
resolutions of these disputed costs will be accomplished in the next year.
Therefore, they have been classified as a non-current asset. Additionally, as
of May 31, 1997, IHHI had received approximately $12.5 million in payment from
Medicare for disputed costs. Because Medicare may seek repayment of these
amounts, the potential liability is recorded as an offset to Receivables on the
Consolidated Balance Sheet. Subsequent to year end IHHI received three court
decisions relating to certain of these amounts. IHHI evaluated these decisions
on its recorded accounts receivable and, accordingly, recorded a reserve of
$15.5 million in fiscal year 1998. The net impact to the Company after taxes and
minority interest was approximately $3.8 million.
ACCRUED EXPENSES
Accrued expenses at May 31, 1997 and 1996 were as follows.
<TABLE>
<CAPTION>
1997 1996
------------ ------------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C>
Payroll........................................... $ 55,120 $ 51,922
Taxes, other than income.......................... 14,125 12,302
Insurance......................................... 17,346 22,310
Interest.......................................... 7,457 1,875
Other............................................. 15,492 22,614
------------ ------------
$ 109,540 $ 111,023
============ ============
</TABLE>
F-11
<PAGE>
LONG-TERM DEBT
Maturities of long-term debt at May 31, 1997 were as follows.
<TABLE>
<CAPTION>
FISCAL YEAR
-----------
(IN THOUSANDS OF DOLLARS)
<S> <C>
1998............................................... $ 12,680
1999............................................... 6,357
2000............................................... 6,618
2001............................................... 5,965
2002............................................... 6,024
2003 to 2024....................................... 466,636
--------
$504,280
========
</TABLE>
Long-term debt, consisting of mortgages, capital leases, Senior Notes, and
Senior Subordinated Notes, was net of discount of $1.2 million and $1.0
million at May 31, 1997 and 1996, respectively. Amortization of discount was
$0.5 million in 1997, 1996, and 1995, including the write-off associated with
debt redemptions. At May 31, 1997, the Company had mortgages and capital
leases of $80.2 million.
Interest paid was $34.1 million in 1997, $29.8 million in 1996 and $22.4
million in 1995. During fiscal year 1997, interest rates on subordinated debt
ranged from 4.8% to 9.5%. Interest rates on mortgages and other long-term debt
ranged from 2.6% to 12.0%. The weighted average interest rate in fiscal year
1997 was 7.6%.
In June 1996, the Company issued $150.0 million of 7 1/2% Senior Notes due
2006. These notes are redeemable at the option of the Company at any time at a
price equal to the greater of (a) the principal amount or (b) the sum of the
present values of the remaining scheduled payments of principal and interest,
discounted with an applicable treasury rate plus 15 basis points, plus accrued
interest to the date of redemption. The proceeds of this offering were used to
repay borrowings under the Company's $250.0 million competitive advance and
multi-currency revolving credit facility (the "Facility").
In November 1992, the Company issued $150.0 million of 9 1/2% Senior
Subordinated Notes due November 2002. In July 1996, the Company repurchased
$9.9 million of the 9 1/2% Senior Subordinated Notes for $10.5 million.
In September 1996, the Company amended the Facility provided by a group of
sixteen banks. The Facility provides that up to $75.0 million is available for
borrowings in foreign currencies. Borrowings under the Facility are, at the
option of the Company, at one of several rates including LIBOR plus 20 basis
points. In addition, the Company has the option to request participating banks
to bid on loan participation at lower rates than those contractually provided
by the Facility. The Facility presently requires the Company to pay fees of
1/10 of 1% on the entire loan commitment. The Facility requires payment of
interest only prior to its termination date of September 6, 2001. At May 31,
1997, outstanding revolver borrowings amounted to $85.0 million.
Various debt agreements impose, among other restrictions, restrictions
regarding financial ratios and payment of dividends. Pursuant to such
restrictions, owned property with a net book value of $145.8 million was
pledged or mortgaged and approximately $167.4 million of retained earnings was
not available for cash dividends.
F-12
<PAGE>
LEASES
The Company operates certain property and equipment under leases, some with
purchase options that expire at various dates through 2035. Future minimum
lease payments from continuing operations are as follows.
<TABLE>
<CAPTION>
OPERATING CAPITALIZED
LEASES LEASES
------------- -------------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C>
1998.......................................... $ 8,816 $ 1,825
1999.......................................... 7,967 1,045
2000.......................................... 6,969 719
2001.......................................... 6,093 292
2002.......................................... 5,172 292
Thereafter.................................... 44,710 1,904
------------- ------------
Total minimum lease payments.................. $ 79,727 $ 6,077
------------- ------------
Less: Amount representing interest............ 1,606
------------
Present value of lease payments............... 4,471
------------
Less: Current portion......................... 1,445
------------
Lease obligations included in long-term debt.. $ 3,026
============
</TABLE>
Rental expense from continuing operations under noncancelable operating
leases was $8.0 million in 1997, $6.3 million in 1996 and $3.5 million in 1995.
INTEREST RATE HEDGING
The Company has entered into multiple interest rate swap agreements to hedge
its exposure to fluctuations in interest rates on its long-term debt and
operating leases. At May 31, 1997, the Company had three interest rate swap
agreements outstanding, with a total notional principal amount of $30.3
million. These agreements effectively convert the Company's interest rate
exposure on a floating rate operating lease to a fixed interest rate of 5.60%
and mature simultaneously with the relevant operating lease in 2002. The
weighted average interest rate under the lease was 6.21% for the year ended
May 31, 1997. While the Company is exposed to credit loss in the event of
nonperformance by other parties to outstanding interest rate swap agreements,
the Company does not anticipate any such credit losses.
In conjunction with the June 1996 issuance of $150.0 million of 7 1/2%
Senior Notes, the Company also entered into a series of interest rate swap and
treasury lock agreements having a total notional principal amount of $150.0
million. Agreements with a total notional principal amount of $100.0 million
were terminated concurrent with the pricing of the notes offering on May 30,
1996 with a $2.7 million cash gain. The remaining agreement, with a total
notional principal amount of $50.0 million was terminated on October 23, 1996
with a $1.4 million cash gain. The gains on the termination of the agreements
have been deferred and are being amortized against interest expense over the
life of the 7 1/2% Senior Notes effectively reducing the interest rate on the
Notes to 7.1%. The effect of the agreements on interest expense during the
period that the agreements were outstanding was to reduce interest expense to
6.2%.
INCOME TAXES
Because of the relative ownership percentages, the Company files a separate
income tax return for IHHI. The consolidated tax provision, therefore, is based
upon the separate tax provisions of each of the companies.
F-13
<PAGE>
Income tax provisions were as follows for the year ended May 31.
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Current tax expense:
Federal........................................ $ 20,239 $ 33,968 $ 35,051
State.......................................... 4,237 7,165 7,669
Deferred tax expense:
Federal........................................ 21,513 (3,614) 1,276
State.......................................... 5,197 (825) 342
-------- -------- --------
$51,186 $ 36,694 $ 44,338
</TABLE>
Deferred tax assets (liabilities) are comprised of the following at May 31.
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Depreciation and amortization.............. $ (98,185) $ (81,906) $ (79,501)
Purchased tax benefits..................... (44,110) (45,527) (46,212)
Gain on stock issuance..................... (37,187) (11,896) (11,896)
Other...................................... (22,400) (18,916) (17,690)
--------- --------- ---------
Gross deferred tax liabilities............. (201,882) (158,245) (155,299)
--------- --------- ---------
Tax deposit................................ 5,754 5,754 12,000
Reimbursement reserve...................... 9,550 16,882 5,064
Reserve for doubtful accounts.............. 12,454 9,242 7,562
Deferred compensation...................... 13,982 9,526 9,476
Other...................................... 4,675 6,629 7,524
--------- --------- ---------
Gross deferred tax assets.................. 46,415 48,033 41,626
--------- --------- ---------
Net deferred tax........................... $(155,467) $(110,212) $(113,673)
========= ========= =========
</TABLE>
A reconciliation of income tax expense at the statutory rate to income tax
expense included in the consolidated statements of income follows.
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Federal income tax rate....................... 35% 35% 35%
======== ======== ========
Federal taxes at statutory rate............... $ 46,928 $ 31,726 $ 39,311
State income taxes, net of Federal tax
benefit...................................... 6,132 4,121 5,207
Minority interest............................. (910) (259) 29
Tax credits................................... (143) (19) (910)
Other......................................... (821) 1,125 701
-------- -------- --------
Income tax expense............................ $ 51,186 $ 36,694 $ 44,338
======== ======== ========
</TABLE>
Income taxes paid on a consolidated basis for the years ended May 31, 1997,
1996, and 1995 were $41.7 million, $48.2 million, and $62.1 million,
respectively.
CAPITAL STOCK
There are 5.0 million shares of authorized but unissued preferred stock with
a par value of $1.00 per share. The rights of the preferred shares will be
determined by the Board of Directors when issued.
During fiscal years 1997 and 1996, the Company acquired 134,118 and 30,208
shares of its common stock for a total cost of $5.8 million and $1.1 million,
respectively. A total of 8.9 million shares of common stock
F-14
<PAGE>
have been authorized, under various stock option plans, to be granted to key
executive officers and key employees. At May 31, 1997 and 1996, options for
the purchase of an aggregate of 3,041,807 and 3,667,527 shares were
outstanding at prices equal to the market value of the stock at date of grant.
Options totaling 822,717 are presently exercisable and 2,219,090 will become
exercisable from fiscal year 1998 to 2002 and will expire at various dates to
February 2007. In addition, 49,957 options have been granted to non-employee
directors. Options totaling 7,630 are presently exercisable and 42,327 options
will become exercisable from fiscal year 1998 to 2001 and will expire at
various dates to September 2001.
Option activity under the above plans was as shown in the table below.
<TABLE>
<CAPTION>
OPTIONS 1997 1996 1995
------- --------- --------- ---------
<S> <C> <C> <C>
Granted: No. of shares........................ 956,400 582,168 110,000
Avg. Option Price........................... $ 38.82 $ 30.89 $ 27.50
Adjustment as a result of the spin-off: No. of
shares....................................... 1,454,915 -- --
Exercised: No. of shares...................... 1,011,951 269,156 77,000
Avg. Option Price........................... $ 8.45 $ 12.34 $ 10.92
Canceled: No. of shares....................... 2,010,127 148,735 --
Avg. Option Price........................... $ 22.42 $ 20.57 --
Outstanding at May 31:
No. of shares............................... 3,091,764 3,702,527 3,538,250
Avg. Option Price........................... $ 14.87 $ 16.87 $ 14.36
Available for grant at May 31: No. of shares.. 1,680,826 1,089,899 1,603,500
</TABLE>
In connection with the spin-off of the Company's lodging segment, the
outstanding options held by current and former employees of the Company as of
November 1, 1996 were redenominated in both Company and lodging company stock
and the number and exercise prices of the options were adjusted based on the
relative trading prices of shares of the common stock of the two companies to
retain the intrinsic value of the options. The total number of options
outstanding increased by 1,454,915 as a result of this adjustment.
The Company applies Accounting Principles Board Opinion 25 and related
Interpretations in accounting for its various stock option plans and employee
stock purchase plan and, accordingly, no compensation expense has been
recognized for options granted and shares purchased under the provisions of
these plans. Had compensation expense for options granted and shares purchased
under the stock-based compensation plans been determined based on the fair
value at the grant dates, net income and earnings per share would have been as
follows for the years ended May 31.
<TABLE>
<CAPTION>
1997 1996
------------- ------------
(IN THOUSANDS OF DOLLARS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
Net income:
As reported..................................... $ 136,942 $ 85,907
Pro forma....................................... $ 128,141 $ 81,697
Earnings per share:
As reported..................................... $ 2.16 $ 1.37
Pro forma....................................... $ 2.03 $ 1.30
</TABLE>
The effects of applying SFAS 123 in this pro forma disclosure are not likely
to be representative of the effects on reported net income for future years.
SFAS 123 does not apply to awards granted prior to fiscal year 1996 and
additional awards are anticipated in future years.
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option-pricing model. In computing these pro forma
amounts, the Company has assumed a risk-free interest rate equal to
approximately 6.36% and 6.37% for fiscal years 1997 and 1996, respectively,
expected volatility of 12.8%, dividend yields based on historical dividends of
$.088 per share annually and expected option lives of eight years. The average
fair values of the options granted during 1997 and 1996, as measured on the
dates of the grants, are estimated to be $15.12 and $11.96, respectively.
F-15
<PAGE>
ACQUISITIONS AND DIVESTITURES
During fiscal year 1997, the Company acquired a nursing center in California
for $4.4 million and a nursing center in Michigan for $13.4 million. Through
new construction, the Company opened four skilled nursing centers and six
assisted living facilities. The Company sold four nursing centers in Indiana,
Iowa, Illinois, and Texas for $17.3 million and transferred an assisted living
facility with an approximate net book value of $4.9 million to the
discontinued lodging segment.
During fiscal year 1996, the Company acquired four nursing centers and an
operating lease for approximately $45.4 million, of which $32.4 million was
cash and the remainder was assumed liabilities. Additionally, six assisted
living facilities, with five attached skilled nursing units, were purchased
for $74.3 million, of which $19.0 million was cash and the remainder was
assumed liabilities. In October 1995, the Company purchased for $22.9 million
approximately 41% of the common stock of IHHI, a provider of home health
services. The Company paid an additional $20.0 million to IHHI for 100% of its
outstanding voting convertible preferred stock and for warrants to purchase an
additional 6.0 million shares of common stock. As a result of this
transaction, the Company currently has effective control of approximately 63%
of the voting stock of IHHI. IHHI is consolidated in the Company's financial
statements.
During fiscal year 1995, the Company purchased nine nursing centers and
assisted living facilities for approximately $56.7 million. In March 1995, the
Company sold its investment in a physicians' practice management business for
$13.3 million. The physicians' practice management investment was made in
fiscal year 1994 in the amount of $10.0 million.
Unless otherwise noted, acquisitions are accounted for as purchases.
Acquisition costs in excess of fair market value of the assets acquired are
allocated to goodwill.
PROVISIONS FOR ASSET IMPAIRMENT AND RESTRUCTURING
The Company periodically reviews the net realizable value of its long-term
assets based on certain circumstances which indicate the carrying amount of an
asset may not be recoverable. If the carrying amount exceeds the net
realizable value, an impairment loss is recorded in the period the impairment
is determined.
The Company recorded provisions of $26.3 million in fiscal year 1996 related
to the impairment of certain long-lived assets and costs associated with the
Company's restructuring. The most significant components of the provisions
were non-cash impairment charges of $21.2 million relating to writedowns of
property, equipment and capitalized systems development costs and $5.1 million
related to the spinoff of the lodging segment in fiscal year 1996.
In fiscal year 1996, the Company determined that it incurred costs in excess
of the original amount expected to complete a systems development project for
billing and receivables which began in fiscal year 1995. Intensive testing
during a six month pilot identified over 100 major system problems. At this
time, it was determined that the newly developed system was not functional and
that a major system re-write was needed. Therefore, the Company compared the
estimated net realizable value of the systems, based on the fair value of
similar assets, to the carrying amount of these costs. The carrying amount was
determined to be in excess of the fair value and accordingly, the related
assets were written down by $13 million to the net realizable value.
DISCONTINUED LODGING OPERATIONS
On November 1, 1996, the Company completed the spin-off of its lodging
segment. The Company's shareholders of record on October 10, 1996 received one
share of Choice Hotels International, Inc. common stock for each outstanding
share of Manor Care common stock. Accordingly, lodging results are reported as
discontinued operations for all periods presented.
The revenues, income from discontinued lodging operations before income taxes,
and net income from discontinued lodging operations for the years ended May 31,
1997, 1996, and 1995 were as follows.
<TABLE>
<CAPTION>
1997 1996 1995
------- -------- --------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Revenues.......................................... $89,849 $374,873 $302,535
Income from discontinued lodging operations
before income taxes.............................. $20,563 $ 35,402 $ 29,955
Net income from discontinued lodging operations... $11,829 $ 20,436 $ 16,811
</TABLE>
F-16
<PAGE>
Net income from discontinued lodging operations for the year ended May 31,
1996 includes the results of operations of the lodging segment through March 7,
1996, the measurement date. During the period from the measurement date through
May 31, 1996, the lodging segment incurred a net loss of $12.0 million. The net
loss was primarily the result of provisions for asset impairment and costs and
expenses directly associated with the spin-off totaling $33.3 million. The non-
cash provision for asset impairment in the discontinued lodging segment reflects
primarily the writedown of European hotel assets based on expected future cash
flows. This non-cash provision was recorded in accordance with SFAS 121. No loss
on the disposal of the discontinued lodging operations was recognized as the
discontinued lodging segment generated income between the measurement date and
the date of the spin-off.
Included in discontinued lodging operations is interest expense charged by
the continuing healthcare segment to the discontinued lodging segment relating
to cash advances provided to the discontinued lodging segment for the
acquisition and renovation of lodging assets. For the years ended May 31,
1997, 1996, and 1995, interest so allocated amounted to $3.4 million, $19.7
million, and $15.5 million, respectively. The indebtedness related to lodging
acquisitions and renovations is reflected as advances to discontinued lodging
segment in the consolidated balance sheets. Such advances amounted to $115.7
million and $225.7 million at May 31, 1997 and 1996, respectively. The
indebtedness is to be repaid over a three year period from the date of the
spin-off. Interest is charged at an annual rate of 9% on the indebtedness. The
Company received a prepayment of $110.0 million on the advances to the
discontinued lodging segment. This payment was subject to a prepayment penalty
of $1.9 million.
General corporate expenses of $5.5 million, $7.4 million, and $6.3 million,
respectively, were charged to discontinued lodging operations for the years
ended May 31, 1997, 1996, and 1995. Allocation of general corporate charges
was principally determined based on time allocations.
For purposes of providing an orderly transition after the spin-off, the
Company has entered into various agreements with the discontinued lodging
segment, including, among others, a Tax Sharing Agreement, Corporate Services
Agreement, Employee Benefits Allocation Agreement and Support Services
Agreement. These agreements provide, among other things, that the Company (i)
will provide certain corporate and support services, such as accounting, tax,
and computer systems support and (ii) will provide certain risk management
services and other miscellaneous administrative services. These agreements
will extend for a period of 30 months from the spin-off date or until such
time as the discontinued lodging segment has arranged to provide such services
in-house or through another unrelated provider of such services.
COMMITMENTS AND CONTINGENCIES
The Company is a defendant in a number of lawsuits arising in the ordinary
course of business. In the opinion of management and counsel to the Company,
the ultimate outcome of such litigation will not have a material adverse
effect on the Company's financial position or results of operations.
Revenues recorded under Federal and state medical assistance programs are
subject to adjustment upon audit by appropriate government agencies. For
fiscal years 1997, 1996, and 1995 these revenues amounted to $596.0 million,
$502.0 million, and $391.1 million, respectively. In the opinion of management,
any difference between revenues recorded and final determination will not be
significant. In fiscal year 1996, the increase in revenues subject to audit
adjustment is due, in large part, to the investment in IHHI. The Company does
not anticipate a material effect on revenues as a result of the Balanced Budget
Act of 1997. However, the regulations pertaining to this Act have neither been
proposed nor implemented, and therefore, this preliminary conclusion may change
as a result.
In fiscal year 1997, the Health Care Financing Administration issued a
modification to regulations governing the treatment of interest expense and
investment income offsets for Medicare reimbursement purposes. As a result of
this modification the Company recognized revenues of approximately $20 million
in fiscal year 1997, which had been reserved in prior years.
As of May 31, 1997, the Company had contractual commitments of $58.2 million
relating to its internal construction program.
F-17
<PAGE>
One or more subsidiaries or affiliates of the Company have been identified
as potentially responsible parties ("PRPs") in a variety of actions (the
"Actions") relating to waste disposal sites which allegedly are subject to
remedial action under the Comprehensive Environmental Response Compensation
Liability Act, as amended, 42 U.S.C. (S)(S)9601 et seq. ("CERCLA") and similar
state laws. CERCLA imposes retroactive, strict joint and several liability on
PRPs for the costs of hazardous waste clean-up. The Actions arise out of the
alleged activities of Cenco, Incorporated and its subsidiary and affiliated
companies ("Cenco"). Cenco was acquired in 1981 by a wholly owned subsidiary
of the Company. The Actions allege that Cenco transported and/or generated
hazardous substances that came to be located at the sites in question. The
Company believes that the waste disposal activities at issue occurred prior to
the Manor Care subsidiary's acquisition of Cenco. Environmental proceedings
such as the Actions may involve owners and/or operators of the hazardous waste
site, multiple waste generators and multiple waste transportation disposal
companies. Such proceedings typically involve efforts by governmental entities
and/or private parties to allocate or recover site investigation and clean-up
costs, which costs may be substantial. The potential liability exposure for
currently pending environmental claims and litigation, without regard to
insurance coverage, cannot be quantified with precision because of the
inherent uncertainties of litigation in the Actions and the fact that the
ultimate cost of the remedial actions for some of the waste disposal sites
where the Company is alleged to be a potentially responsible party has not yet
been quantified. The Company believes that the potential environmental
liability exposure, after consideration of insurance coverage, is
approximately $3 million. Future liabilities for the pending environmental
claims and litigation, without regard to insurance, currently are not expected
to exceed approximately $46 million. The Company estimated future liabilities
without regard to insurance based on counsel's evaluation of the range of
potential liability and cost of defense in each of the Actions. The Company
has accrued the liabilities based on its estimate of the likely outcome of the
Actions, taking into account insurance coverage available for the liabilities.
BUSINESS SEGMENT INFORMATION
The Company operates principally in three segments: skilled nursing
operations, assisted living operations and home health operations. Income
(loss) from operations consists of total revenues less operating, depreciation
and amortization, and general corporate expenses.
<TABLE>
<CAPTION>
SKILLED ASSISTED HOME
NURSING(b) LIVING HEALTH ELIMINATIONS TOTAL
---------- -------- -------- ------------ ----------
1997
- ---- (IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C>
Revenues................ $1,113,690 $56,530 $124,354 $ -- $1,294,574
Income (loss) from
operations............. 144,836 (2,710) (2,928) 3,163 142,361
Identifiable assets..... 1,223,317 180,228 60,407 -- 1,463,952(c)
Depreciation and
amortization........... 60,943 6,848 3,060 -- 70,851
Capital expenditures.... 122,812 55,967 42 -- 178,821
1996
- ----
Revenues................ $1,028,901 $38,857 $ 74,153 $ -- $1,141,911
Income (loss) from
operations............. 99,189(a) (6,997)(a) 67 3,848 96,107
Identifiable assets..... 1,381,516 148,713 72,598 -- 1,602,827(c)
Depreciation and
amortization........... 56,242 5,733 1,748 -- 63,723
Capital expenditures.... 109,063 23,170 562 -- 132,795
1995
- ----
Revenues................ $ 938,946 $12,368 -- $(4,553) $ 946,761
Income (loss) from
operations............. 110,691 (1,202) -- 3,674 113,163
Identifiable assets..... 1,153,648 72,344 -- -- 1,225,992(c)
Depreciation and
amortization........... 48,675 1,946 -- -- 50,621
Capital expenditures.... 62,509 27,228 -- -- 89,737
</TABLE>
- --------
(a) Includes total provisions for asset impairment and restructuring of $26.3
million, of which $25.1 million relates to skilled nursing operations and
$1.2 million relates to assisted living operations.
(b) Includes skilled nursing, hospital and corporate operations.
(c) Does not include net investment in discontinued pharmacy segment of
$178,079, $71,010 and $67,071 or advances from the discontinued pharmacy
segment of $1,053, $16,910 and $16,888 at May 31, 1997, 1996 and 1995.
F-18
<PAGE>
PENSION, PROFIT SHARING AND INCENTIVE PLANS
The Company has various pension and profit sharing plans, including a
supplemental executive retirement plan, and contributes to certain union
welfare plans. The provision for these plans amounted to $11.8 million in
1997, $11.6 million in 1996, and $11.0 million in 1995. All vested benefits
under retirement plans are funded or accrued.
The Company sponsors a defined contribution profit sharing plan covering
substantially all of its employees. Contributions of up to 6% of each covered
employee's salary are determined based on the employee's level of contribution
to the plan, years of service and Company profitability. The cost of the plan
totaled $7.2 million in 1997, $5.8 million in 1996, and $4.8 million in 1995.
Also included in the Company's retirement plans is a defined benefit pension
plan covering substantially all of its employees. The benefits are based on
service credits for years of participation after January 1, 1992. In addition,
there is a prior benefit equal to the accrued benefit at December 31, 1991 for
certain individuals who were participants in a predecessor plan. No new
participants were eligible to enter this plan after August 15, 1996 and
service credits for all participants were frozen as of December 31, 1996.
Service cost benefits earned during fiscal years 1997, 1996 and 1995
approximated the plan's annual costs of $4.0 million, $2.8 million, and $2.7
million, respectively. As of February 28, 1997, 1996, and 1995, plan assets of
approximately $20.3 million, $14.4 million, and $11.0 million compared to
vested benefit obligations of $17.0 million, $12.4 million, and $8.7 million,
respectively.
Projected benefit obligations were not significantly different from
accumulated benefit obligations of $21.0 million, $16.3 million, and $11.0
million as of the same dates. Liabilities recorded on the Company's balance
sheets as of May 31, 1997, 1996, and 1995 were $2.3 million, $2.0 million, and
$0.5 million, respectively. Projected benefit obligations were determined
using an assumed discount rate of 7.5% for 1997, 7.0% for 1996, and 8.5% for
1995, an assumed rate of return on plan assets of 8.25%, and an assumed
compensation increase of 4.5%.
Vitalink participates in the various pension and profit sharing plans of the
Company. The Company charged Vitalink $0.5 million, $0.4 million and $0.3
million, respectively, for the three years ended May 31, 1997 to participate in
these plans.
The Company also has various incentive compensation plans for certain
personnel. Incentive compensation expense was $3.8 million in 1997, $3.4
million in 1996, and $3.1 million in 1995.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values of long-term debt instruments were determined by discounting
future cash flows using the Company's current market rates and do not vary
substantially from the amounts recorded on the consolidated balance sheet.
The balance sheet carrying amounts of cash, cash equivalents, and
receivables approximate fair value due to the short-term nature of these
items. Management believes that the fair value of the advances to the
discontinued lodging segment approximates the carrying value.
Total fair market value for the outstanding interest rate swap agreements at
May 31, 1997 and 1996 was $1.4 million and $1.8 million, respectively. Fair
values were determined based on quoted rates.
F-19
<PAGE>
SUMMARY OF QUARTERLY RESULTS
(UNAUDITED)
<TABLE>
<CAPTION>
INCOME FROM
CONTINUING
OPERATIONS BEFORE
QUARTERS ENDED OTHER INCOME AND
(IN THOUSANDS OF DOLLARS, (EXPENSES) AND
EXCEPT PER SHARE DATA) REVENUE INCOME TAXES NET INCOME PER SHARE
- ------------------------- ---------- ----------------- ---------- ---------
<S> <C> <C> <C> <C>
FISCAL 1997
August....................... $ 306,445 $ 30,161 $ 23,685 $ .38
November..................... 317,080 35,449 32,444 .51
February..................... 322,631 39,046 61,392 .97
May.......................... 338,418 37,705 19,421 .30
---------- -------- -------- -----
$1,294,574 $142,361 $136,942 $2.16
========== ======== ======== =====
FISCAL 1996
August....................... $ 250,548 $ 25,442 $ 28,426 $ .45
November..................... 274,201 32,660 28,788 .46
February..................... 306,426 31,198 22,302 .36
May.......................... 310,736 6,807 6,391 .10
---------- -------- -------- -----
$1,141,911 $ 96,107 $ 85,907 $1.37
========== ======== ======== =====
</TABLE>
F-20
<PAGE>
QUARTERLY MARKET PRICE RANGE OF COMMON STOCK AND DIVIDENDS PAID
(UNAUDITED)
<TABLE>
<CAPTION>
MARKET PRICE PER SHARE CASH DIVIDENDS PAID
------------------------ ----------------------
PER SHARE
QUARTERS ENDED HIGH LOW AMOUNT DATE
- -------------- ----------- ----------- ----------------------
<S> <C> <C> <C> <C>
FISCAL 1997
August......................... $ 39.63* $ 31.50* $ .022 8/27/96
November....................... $ 42.25* $ 23.75 $ .022 11/27/96
February....................... $ 28.00 $ 24.13 $ .022 2/27/97
May............................ $ 28.38 $ 21.88 $ .022 5/27/97
FISCAL 1996
August......................... $ 34.25* $ 27.78* $ .022 8/25/95
November....................... $ 35.58* $ 30.50* $ .022 11/27/95
February....................... $ 40.25* $ 32.75* $ .022 2/27/96
May............................ $ 43.50* $ 36.50* $ .022 5/24/96
</TABLE>
- --------
* Market prices prior to November 1, 1996, are reflective of the stock value
prior to the spin-off of the discontinued lodging business.
F-21
<PAGE>
PART IV
-------
<TABLE>
<S> <C> <C>
ITEM 14. Exhibits, Financial Statement Schedules, and
- ------- --------------------------------------------
Reports on Form 8-K.
-------------------
(a) 1.
2. Financial Statement Schedules
The following Report and Schedule are filed herewith on the
pages indicated:
Report of Independent Public Accountants
Schedule II - Valuation and Qualifying Accounts
All other schedules are not applicable
<CAPTION>
3. Exhibits
<S> <C>
3.1 - Articles of Incorporation, as amended. Exhibit 3.1 to
Form 10-Q for the quarter ended August 31, 1994 is
incorporated herein by reference.
3.2 - By-Laws, as amended. Exhibit 3.2 to Form 10-K for the
year ended May 31, 1988 is incorporated herein by
reference.
4.1 - Indenture dated as of November 15, 1992 covering
9-1/2% Senior Subordinated Notes due 2002 between
Manor Care, Inc. and Chemical Bank. Exhibit 4.1 to
Registration Statement No. 33-52734 is incorporated
herein by reference.
4.2 - Indenture dated as of June 4, 1996 between Manor
Care, Inc. and Wilmington Trust Company, Trustee.
Exhibit 4.1 to Form 8-K dated June 4, 1996 is
incorporated herein by reference.
4.3 - Supplemental Indentures dated as of June 4, 1996
between Manor Care, Inc. and Wilmington Trust
Company, Trustee. Exhibit 4.2 to Form 8-K dated
June 4, 1996 is incorporated herein by reference.
4.4 - Indenture dated as of November 22, 1996 between Manor
Care, Inc. and Chase Manhattan Bank. Exhibit 4.1 to
Report on Form 8-K dated November 5, 1996 is
incorporated herein by reference.
10.1 - Supplemental Executive Retirement Plan. Exhibit 10.2
to Form 10-K for the year ended May 31, 1986 is
incorporated herein by reference.
</TABLE>
<PAGE>
<TABLE>
<S> <C>
10.2 - Form of Executive Cash Incentive Plan. Exhibit 10.2
to Form 10-K for the year ended May 31, 1995 is
incorporated herein by reference.
10.3 - Non-Employee Director Stock Option and Deferred
Compensation Stock Purchase Plan. Exhibit A to the
Proxy Statement dated August 10, 1994 is incorporated
herein by reference.
10.4 - Long-Term Incentive Plan. Exhibit A to Proxy
Statement dated August 28, 1995 which is Exhibit 99
to Form 10-K for the year ended May 31, 1995 is
incorporated herein by reference.
10.5 - Non-Employee Director Stock Compensation Plan.
Exhibit A to Proxy Statement dated August 28, 1996
which is Exhibit 99 to the Report on Form 10-K for
the year ended May 31, 1997 is incorporated herein by
reference.
10.6 - Master Aircraft Lease Agreement dated September 1,
1994 between Manor Care, Inc. and Wilderness
Investment Company, Inc. Exhibit 10.17 to Form 10-K
for the year ended May 31, 1995 is incorporated
herein by reference.
10.7 - Lease dated as of August 30, 1995 between The
Gaithersburg Realty Trust and Manor Care, Inc.
Exhibit 10.11 to Form 10-K for the year ended
May 31, 1996 is incorporated herein by reference.
10.8 - Guarantee dated as of August 30, 1995 made by Manor
Care, Inc., ManorCare Health Services, Inc., Choice
Hotels International, Inc., Quality Hotels Europe,
Inc., Four Seasons Nursing Center, Inc., MNR
Financial Corp., Boulevard Motel Corp. and Chemical
Bank. Exhibit 10.12 to Form 10-K for the year ended
May 31, 1996 is incorporated herein by reference.
10.9 - Loan Agreement dated as of November 1, 1996 between
MNR Finance Corp. and Choice Hotels International,
Inc. Exhibit 2.6 to Report on Form 8-K dated
November 5, 1996 is incorporated herein by reference.
10.10 - Amended and Restated Competitive Advance and Multi-
Currency Revolving Credit Facility Agreement dated as
of November 30, 1994, as amended and restated as of
September 6, 1996 between Manor Care, Inc. and Chase
Manhattan Bank. Exhibit 10.1 to the Report on Form
8-K dated November 5, 1996 is incorporated herein by
reference.
13 - 1997 Annual Report to Stockholders (information
incorporated by reference) (previously filed).
21 - Subsidiaries of the Registrant (previously filed).
</TABLE>
<PAGE>
<TABLE>
<S> <C>
23.1 - Consent of Independent Public Accountants.
23.2 - Consent of Independent Public Accountants.
27 - Financial Data Schedule.
99 - Proxy Statement dated August 15, 1997 (previously filed).
</TABLE>
(b) Reports on Form 8-K.
No Reports on Form 8-K were filed during the fourth quarter of the
fiscal year ended May 31, 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: August 3, 1998 MANOR CARE, INC.
By: /s/ James H. Rempe
--------------------------------
James H. Rempe
Senior Vice President,
General Counsel & Secretary
<PAGE>
SCHEDULE II
MANOR CARE, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in thousands of dollars)
<TABLE>
<CAPTION>
BALANCE AT CHARGE TO BALANCE AT
BEGINNING OF PROFIT WRITE- END
DESCRIPTION PERIOD AND LOSS OTHER OFFS OF PERIOD
- ----------- ------------ --------- ------- -------- ----------
<S> <C> <C> <C> <C> <C>
Year ended May 31, 1997
Allowance for doubtful
accounts.............. $22,148 $15,930 $ -- $ (1,457) $36,621
Year ended May 31, 1996
Allowance for doubtful
accounts.............. $17,419 $13,778 $ 1,030(a) $(10,079) $22,148
Year ended May 31, 1995
Allowance for doubtful
accounts.............. $13,368 $10,815 $ -- $(6,764) $17,419
</TABLE>
(a) Represents reserves of acquired companies.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the application
of our report dated June 27, 1997 (except with respect to the matters discussed
in the footnote entitled "Subsequent Events" as to which the date is June 10,
1998) included in Manor Care, Inc.'s Form 10-K/A (Amendment No. 1) for the
fiscal year ended May 31, 1997, to the supplemental note to the financial
statements included therein and labeled "Subsequent Events". It should be noted
that we have performed no audit procedures subsequent to June 27 1997, the date
of our report, except with respect to the supplemental note as to which the date
is June 10, 1998. Furthermore, we have not audited any financial statements of
Manor Care, Inc. as of any date or for any period subsequent to May 31, 1997
(the date of audited financial statements included in Manor Care, Inc.'s 1997
Annual Report to Shareholders).
/s/ ARTHUR ANDERSEN LLP
Washington, D.C.
August 3, 1998
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report dated June 27, 1997 (except with respect to the matters discussed in
the footnote entitled "Subsequent Events", as to which the date is June 10,
1998), included in Manor Care, Inc.'s Form 10-K/A (Amendment No. 1) for the year
ended May 31, 1997, into the Company's previously filed Registration Statement
File Nos. 2-80129, 2-73420, 33-9766, 33-20241, 33-27834, 33-36213, 2-78242, 33-
52734, 33-64680, 33-67850, 33-58903, 33-58907, 33-63965, 333-14165, 333-16669
and 333-18607.
/s/ ARTHUR ANDERSEN LLP
Washington, D.C.
August 3, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION FOR MANOR CARE, INC.
EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS, THE CONSOLIDATED STATEMENTS OF
INCOME AND THE CONSOLIDATED STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAY-31-1997
<PERIOD-END> MAY-31-1997
<CASH> 29,222
<SECURITIES> 0
<RECEIVABLES> 172,067
<ALLOWANCES> 36,621
<INVENTORY> 12,531
<CURRENT-ASSETS> 217,453
<PP&E> 1,352,415
<DEPRECIATION> 347,752
<TOTAL-ASSETS> 1,640,978
<CURRENT-LIABILITIES> 181,810
<BONDS> 491,600
0
0
<COMMON> 6,682
<OTHER-SE> 683,749
<TOTAL-LIABILITY-AND-EQUITY> 1,640,978
<SALES> 0
<TOTAL-REVENUES> 1,294,574
<CGS> 0
<TOTAL-COSTS> 996,869
<OTHER-EXPENSES> 70,851
<LOSS-PROVISION> 15,930
<INTEREST-EXPENSE> 40,599
<INCOME-PRETAX> 134,081
<INCOME-TAX> 51,186
<INCOME-CONTINUING> 82,895
<DISCONTINUED> 54,047
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 136,942
<EPS-PRIMARY> 2.16
<EPS-DILUTED> 2.16
</TABLE>
