<PAGE> 1
FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-10858
HCR MANOR CARE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 34-1687107
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
333 N. SUMMIT STREET, TOLEDO, OHIO 43604-2617
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (419) 252-5500
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange
Title of each class on which registered
---------------------------- -----------------------
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Title of each class
----------------------------
7 1/2% SENIOR NOTES DUE JUNE 15, 2006
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [X]
(Cover page 1 of 2 pages)
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Based on the closing price of $24.8125 per share on March 11, 1999, the
aggregate market value of the registrant's voting stock held by non-affiliates
was $2,227,849,217. Solely for purposes of this computation, the registrant's
directors and executive officers have been deemed to be affiliates. Such
treatment is not intended to be, and should not be construed to be, an admission
by the registrant or such directors and officers that all of such persons are
"affiliates", as that term is defined under the Securities Act of 1934.
The number of shares of Common Stock, $.01 par value, of HCR
Manor Care, Inc. outstanding as of March 11, 1999 was 111,024,222.
DOCUMENTS INCORPORATED BY REFERENCE
The following document is incorporated herein by reference in the Part
indicated:
Specific portions of the registrant's Proxy Statement for the Annual
Stockholders' Meeting to be held May 4, 1999 are incorporated by reference
in Part III.
(Cover page 2 of 2 pages)
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TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS ................................................2
ITEM 2. PROPERTIES .............................................10
ITEM 3. LEGAL PROCEEDINGS ......................................12
ITEM 4. SUBMISSION OF MATTERS
TO A VOTE OF SECURITY HOLDERS ..........................12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK
AND RELATED STOCKHOLDER MATTERS ........................12
ITEM 6. SELECTED FINANCIAL DATA ................................13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS ..........................................14
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK.......................................25
ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA .....................................26
ITEM 9. CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ...............................55
PART III
ITEM 10. DIRECTORS AND EXECUTIVE
OFFICERS OF THE REGISTRANT .............................55
ITEM 11. EXECUTIVE COMPENSATION .................................57
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT...................................57
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS ...........................................57
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K ................................58
SIGNATURES ........................................................64
EXHIBITS .......................................................E-1
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PART I
ITEM 1. BUSINESS
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GENERAL DEVELOPMENT OF BUSINESS
On September 24, 1998, the stockholders of Health Care and Retirement
Corporation (HCR) and the stockholders of Manor Care, Inc. (Manor Care)
separately approved the merger of the companies, effective September 25, 1998.
In accordance with the Amended and Restated Agreement and Plan of Merger (the
Merger Agreement) dated June 10, 1998, each share of Manor Care common stock was
converted into one share of HCR common stock for a total of approximately 63.9
million shares and Manor Care stock options outstanding were converted into
approximately 2.1 million shares of HCR common stock based on the option pricing
formula defined in the Merger Agreement. As a result of the transaction, Manor
Care became a wholly owned subsidiary of HCR and HCR changed its name to HCR
Manor Care, Inc. (HCR Manor Care or the Company). The merger has been accounted
for by the pooling-of-interests method. Accordingly, the consolidated financial
statements give retroactive effect to the merger and include the combined
operations for all periods presented.
HCR Manor Care is a provider of a range of health care services, including
skilled nursing care, assisted living, subacute medical care, rehabilitation
therapy, home health care and management services for subacute care,
rehabilitation therapy, vision care and eye surgery. The Company operates in one
business segment. See Note 7 to the consolidated financial statements for
disclosure of revenues by similar health care services.
The most significant portion of HCR Manor Care's business relates to skilled
nursing care and assisted living. At December 31, 1998 the Company operated 297
skilled nursing facilities and 63 assisted living facilities in 32 states with
more than half located in Ohio, Michigan, Illinois, Pennsylvania and Florida.
Within some of the Company's centers, there are medical specialty units which
provide subacute medical care, rehabilitation programs or Alzheimer's care
programs. Some of the Company's assisted living facilities operate under the
brand names "Arden Courts" and "Springhouse." The Arden Courts facilities are
specifically focused on providing care to persons suffering from early to
middle-stage Alzheimer's disease and related memory impairment, while the
Springhouse facilities serve the general assisted living population of frail
elderly. At December 31, 1998 the Company operated 82 outpatient rehabilitation
clinics, an acute care hospital and 71 home health care offices. The home health
care business includes the Company's 41% ownership interest in the common stock
and all of the preferred stock of In Home Health, Inc.
Subsidiaries of Manor Care owned approximately 50% of Vitalink Pharmacy
Services, Inc. (Vitalink) common stock. On April 26, 1998 Vitalink entered into
an Agreement and Plan of Merger (Vitalink Merger Agreement) with Genesis Health
Ventures, Inc. (Genesis). Pursuant to the Vitalink Merger Agreement, on August
28, 1998, Manor Care received 586,240 shares of Genesis Series G Cumulative
Convertible Preferred Stock valued at $293.1 million as consideration for all of
its common stock of Vitalink. The preferred stock bears cash dividends at the
initial rate of 5.9375%. The financial results of Vitalink were recorded as
income from discontinued pharmacy
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operations for all periods presented.
During the fourth quarter of 1998, the Company formed a strategic alliance with
Alternative Living Services, Inc. to develop a broad based network primarily
dedicated to the care of patients suffering from Alzheimer's disease.
Alternative Living Services, Inc. has announced plans to change its name to
Alterra Healthcare Corporation (Alterra). Key provisions of the alliance include
the sale of 29 centers to Alterra for approximately $200 million in cash;
creation of a joint venture to develop and construct up to $500 million of
Alzheimer's dementia care assisted living facilities in the Company's core
markets over the next three to five years; and the formation of a new company to
provide a variety of ancillary services, including rehabilitation therapy and
home and hospice care, to residents in Alterra centers. The asset sale and
creation of the development joint venture are expected to be completed in the
first half of 1999.
The executive offices of the Company are located at 333 N. Summit Street,
Toledo, Ohio 43604-2617. Its telephone number is (419) 252-5500.
NARRATIVE DESCRIPTION OF BUSINESS
Long Term Care Services
The Company is one of the largest providers of long term care in the country
with the majority of its skilled nursing facilities operating under the name
ManorCare Health Services or Heartland Health Care Center.
Skilled Nursing Centers. The Company's facilities have interdisciplinary
teams of experienced professionals providing services prescribed by physicians.
These include registered nurses, licensed practical nurses and certified nursing
assistants who provide individualized comprehensive nursing care around the
clock. Quality of Life programs are designed to give the highest possible level
of functional independence to residents. Licensed therapists provide physical,
speech, respiratory and occupational therapy for patients recovering from
strokes, heart attacks, orthopedic conditions or other illnesses, injuries or
disabilities. In addition, the centers provide first-class dietary services,
social services, therapeutic recreational activities, housekeeping and laundry
services. Many of the Company's centers are accredited by the Joint Commission
on Accreditation of Healthcare Organizations (JCAHO).
Assisted Living Services. The Company has a number of assisted living
centers as well as units in its skilled nursing centers dedicated to providing
personal care services and assistance with general activities of daily living
such as dressing, bathing, meal preparation and medication management. A
comprehensive resident assessment helps determine the appropriate package of
services desired or required by each resident. The assisted living staff
encourages residents to socialize and participate in a broad spectrum of
activities.
Residential or Retirement Care. The Company has two retirement centers
which offer a protected environment, including upscale apartment settings, fine
dining and planned social activities for residents with a greater degree of
independence.
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Specialty Services
Subacute Medical and Rehabilitation Care. The Company's commitment to
reducing the cost of quality health care is exemplified by its leadership in
subacute programs designed to shorten or eliminate hospital stays. Working
closely with patients, families and insurers, interdisciplinary teams develop
comprehensive, individualized patient care plans that target the essential
medical, functional and discharge planning objectives. Programs for medically
complex patients cover post-coronary surgery care, oncology, intravenous pain
management, peritoneal and hemo dialysis and complex wound care needs.
Rehabilitation programs promote recovery from major surgery, stroke, amputation,
joint replacement, head injury or general neurologic or orthopedic conditions.
Alzheimer's Care. As the industry's recognized leader in Alzheimer's
care, the Company provides innovative services and facilities for the care of
Alzheimer's patients in early, middle and advanced stages of the disease.
Specialized care and programming are provided by trained staff in dedicated
units for persons with Alzheimer's or related disorders in a rapidly growing
number of assisted living and skilled nursing centers. The Company has 44
centers totally dedicated to the care of Alzheimer's residents.
Health Care Services
The Company provides rehabilitation therapy in skilled centers of its own and
others, hospitals and 82 outpatient clinics in midwestern and mid-Atlantic
states and in Texas and Florida. The Company's home health care business
specializes in all levels of home health, hospice care and rehabilitation
therapy from 33 offices in 5 states. In Home Health, Inc. has 38 offices in 14
states. The Company owns and operates a 172 bed acute care hospital in Texas.
The Company entered into long-term agreements that provide capital and
management services to physician practices, specializing in vision care and
refractive eye surgery. Management services are also provided to 39 subacute
care and acute rehabilitation programs in hospitals and skilled nursing centers.
Labor
Labor costs account for approximately 60% of the Company's operating expenses
and the Company competes with other health care providers with respect to
attracting and retaining qualified or skilled personnel. HCR Manor Care also
depends on the available labor pool of low-wage employees. A shortage of nurses
or other trained personnel or general inflationary pressures may require the
Company to enhance its wage and benefits package in order to compete. Although
the Company does not currently have a staffing shortage nor does it foresee one
given structural changes in the supply and demand for nurses, a shortage of
nurses or other health care workers in the geographic areas in which the Company
operates could adversely affect the ability of the Company to attract and retain
qualified personnel and could increase its operating costs.
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Customers
There are no individual customers or related group of customers which account
for a significant portion of the Company's revenue. The Company does not expect
that the possible loss of a single customer or group of related customers would
have a material adverse effect.
Certain classes of patients rely on a common source of funds for payment of the
cost of their care. The following table reflects the allocation of such revenue
sources among Medicare, Medicaid and private pay and other sources for the last
three years for services related to skilled nursing, assisted living and
rehabilitation operations.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Medicaid 29% 27% 28%
Medicare 22% 23% 20%
Private pay & other 49% 50% 52%
---- ---- ----
100% 100% 100%
==== ==== ====
</TABLE>
Private pay and other sources include commercial insurance, individual patients'
own funds, managed care plans and the Veterans Administration. Although payment
rates vary among these sources, such rates are largely determined by market
forces and costs.
The government reimbursement programs such as Medicare and Medicaid prescribe,
by regulation, the billing methods and amounts which may be charged and
reimbursed for the care of patients covered by such programs. On August 5, 1997,
Congress enacted the Balanced Budget Act of 1997 (Budget Act), which seeks to
achieve a balanced federal budget by, among other things, reducing federal
spending on the Medicare and Medicaid programs. The law contains numerous
changes affecting Medicare payments to skilled nursing facilities, home health
agencies, hospices, and therapy providers, among others. For cost reporting
periods beginning prior to July 1, 1998, Medicare reimbursement for skilled
nursing facilities operates on a retrospective payment system in which each
facility receives an interim payment during the year, which is later adjusted to
reflect actual allowable direct and indirect costs of services based on the
submission of a cost report at the end of each year. The Budget Act resulted in
a shift to a prospective Medicare payment system in which skilled nursing
facilities will be reimbursed at a per diem rate for specific covered services
regardless of their actual cost. Specifically, the Budget Act provides that,
over three cost reporting periods beginning on or after July 1, 1998, the
Medicare program will phase in this prospective payment system. A similar
prospective payment system is required to be established for home health
services beginning October 1, 2000. The Budget Act also reduces payments to many
providers and suppliers, including therapy providers and hospices and gives
states greater flexibility in the administration of their Medicaid programs by
repealing the requirement that payment be reasonable and adequate to cover the
costs of "efficiently and economically operated" nursing facilities. There can
be no assurance that additional federal, state and local laws or regulations
will not be imposed or expanded in a manner that would have a material adverse
effect on the Company.
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Regulation and Licenses
General. Health care is an area of extensive and frequent regulatory
change. Various aspects of HCR Manor Care's business are subject to regulation
by the federal government and the states in which the Company operates. Skilled
nursing facilities and assisted living facilities and other health care
businesses, including home health agencies, are subject to annual licensure and
other regulatory requirements. In particular, the operation of nursing
facilities and the provision of health care services are subject to federal,
state and local laws relating to the delivery and adequacy of medical care,
distribution of pharmaceuticals, equipment, personnel, operating policies, fire
prevention, rate-setting and compliance with building codes and environmental
laws. Skilled nursing facilities are subject to periodic inspection by
governmental and other authorities to assure continued compliance with various
standards, their continued licensing under state law, certification under the
Medicare and Medicaid programs and continued participation in the Veterans
Administration program and the ability to participate in other third party
programs. The Company is also subject to inspection regarding record keeping and
inventory control. From time to time, HCR Manor Care, like others in the health
care industry, may receive notices from federal and state regulatory agencies
relating to alleged deficiencies for failure to comply with applicable
standards. Such notices may require the Company to take corrective action, and
may impose civil money penalties and/or other operating restrictions on the
Company. Failure of the skilled nursing facilities to comply with such
directives or otherwise to be in substantial compliance with licensure and
certification laws, rules and regulations could result in loss of certification
as a Medicare and Medicaid provider and/or a loss of licensure. The Company's
assisted living facilities are subject to varying degrees of regulation and
licensing by local and state health and social service agencies and other
regulatory authorities specific to their location. While regulations and
licensing requirements often vary significantly from state to state, they
typically address, among other things: personnel education, training and
records; facility services, including administration of medication, assistance
with supervision of medication management and limited nursing services; physical
plant specifications; furnishing of resident units; food and housekeeping
services; emergency evacuation plans; and resident rights and responsibilities.
Failure of the assisted living facilities to be in compliance with licensing
requirements could result in loss of licensure. In most states, assisted living
facilities also are subject to state or local building codes, fire codes and
food service licensure or certification requirements. In addition, since the
assisted living industry is relatively new, the manner and extent to which it is
regulated at the federal and state levels are evolving. Changes in the laws or
new interpretations of existing laws as applied to the skilled nursing
facilities, the assisted living facilities or other components of the Company's
health care businesses may have a significant impact on the Company's methods
and costs of doing business.
Licensing and Certification. The Company's success depends in part upon
its ability to satisfy applicable regulations and requirements and to procure
and maintain required licenses and Medicare and Medicaid certifications in
rapidly changing regulatory environments. Any failure to satisfy applicable
regulations or to procure or maintain a required license or certification could
have a material adverse effect on the Company. In addition, certain regulatory
developments, such as revisions in the building code requirements for assisted
living and skilled nursing facilities,
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mandatory increases in scope and quality of care to be offered to residents and
revisions in licensing and certification standards, could have a material
adverse effect on HCR Manor Care.
Health Care Reforms. In recent years, there have been numerous
initiatives on the federal and state levels for comprehensive reforms affecting
the payment for and availability of health care services. Aspects of certain of
these health care initiatives, such as reductions in funding of the Medicare and
Medicaid programs, potential changes in reimbursement regulations by the Health
Care Financing Administration, enhanced pressure to contain health care costs by
Medicare, Medicaid and other payors and greater state flexibility in the
administration of Medicaid, could adversely affect HCR Manor Care.
Certificate of Need Laws. Many states have adopted Certificate of Need
(CON) or similar laws which generally require that the appropriate state agency
approve certain acquisitions and determine that a need exists for certain bed
additions, new services and capital expenditures or other changes prior to beds
and/or new services being added or capital expenditures being undertaken. To the
extent that CON or other similar approvals are required for the expansion of the
Company's operations, either through facility acquisitions or expansion or
provision of new services or other changes, such expansion could be adversely
affected by the failure or inability to obtain the necessary approvals, changes
in the standards applicable to such approvals and possible delays and expenses
associated with obtaining such approvals. There can be no assurance that the
Company will be able to obtain CON approval for all future projects requiring
such approval.
Anti-Remuneration Laws. The Company is also subject to federal and
state laws which govern financial and other arrangements involving health care
providers. These laws prohibit certain direct and indirect payments or
fee-splitting arrangements between health care providers that are designed to
induce or encourage the referral of patients to, or the recommendation of, a
particular provider for medical products and services. These laws include the
federal "Stark Legislation" which prohibits, with limited exceptions, the
referral of patients for certain designated health services, including home
health services, physical therapy and occupational therapy, by a physician to an
entity in which the physician has a financial interest. The January 1998 notice
of proposed rule making to issue regulations implementing the Stark Legislation
makes clear that the restrictions apply to referrals for designated health
services provided in skilled nursing facilities. Certain exceptions are
available for employment agreements, leases, in-office ancillary services, and
other physician arrangements. Although the Company has sought to comply in all
respects with all applicable provisions of the Stark Legislation, final
implementing regulations have not been issued, and there can be no assurance
that its physician arrangements will be found to be in compliance with the Stark
Legislation, as such law ultimately may be interpreted. In addition, the Company
is subject to the federal "anti-kickback law" which prohibits, among other
things, the offer, payment, solicitation or receipt of any form of remuneration
in return for the referral of patients, or the purchasing, leasing, ordering, or
arranging for any goods, services or items for which payment can be made under
Medicare, Medicaid or other federal health care programs. Possible sanctions for
violation of the anti-kickback law include criminal penalties, civil money
penalties and/or exclusion from participation in Medicare, Medicaid or other
federal health care programs.
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The federal government, private insurers and various state enforcement agencies
have increased their scrutiny of providers' business practices and claims in an
effort to identify and prosecute fraudulent and abusive practices. The federal
government has issued fraud alerts concerning home health services and the
provision of medical services and supplies to skilled nursing facilities;
accordingly, these areas may come under closer scrutiny by the government. In
addition, in July 1995, federal officials announced a major anti-fraud
initiative called Operation Restore Trust. This program, currently operating in
17 states, targets fraud involving skilled nursing facilities, home health
agencies, suppliers of medical equipment and hospices. In addition, the
Department of Health and Human Services Office of Inspector General and the
Department of Justice have from time to time established enforcement initiatives
focusing on specific billing practices or other suspected areas of abuse.
Current initiatives include the appropriateness of therapy services provided to
Medicare beneficiaries residing in skilled nursing facilities. The Health
Insurance Portability and Accountability Act of 1996 (HIPPA), which became
effective January 1, 1997, expands the scope of certain fraud and abuse laws to
include all health care services, whether or not they are reimbursed under a
federal health care program, and creates new enforcement mechanisms to combat
fraud and abuse, including an incentive program, under which individuals can
receive up to $1,000 for providing information on Medicare fraud and abuse that
leads to the recovery of at least $100 of Medicare funds. The Budget Act also
expands numerous health care fraud provisions. Furthermore, many states restrict
certain business relationships between physicians and other providers of health
care services, and some have enacted laws similar to the federal Stark
Legislation and the anti-kickback law. In addition, some states prohibit
business corporations from providing, or holding themselves out as a provider
of, medical care. Possible sanctions for violation of any of these restrictions
or prohibitions include loss of licensure or eligibility to participate in
reimbursement programs and civil and criminal penalties. These laws vary from
state to state and have seldom been interpreted by the courts or regulatory
agencies. Although the Company has sought to structure its business
relationships and transactions in compliance with these federal and state
anti-remuneration laws, there can be no assurance that such laws will ultimately
be interpreted in a manner consistent with the practices of, and business
transactions by, the Company. Failure to comply with such laws can result in
civil money penalties, exclusion from the Medicare, Medicaid and other federal
health care programs, and criminal convictions.
Related Party Rule. Prior to the implementation of the prospective
payment system for skilled nursing facilities (i.e., for cost reporting periods
beginning prior to July 1, 1998), the Medicare program limits certain allowable
costs for items and services provided by companies that are associated or
affiliated with, have control of, or are controlled by, a Medicare provider.
Many state Medicaid programs have adopted the same rule in determining costs
that will be included in the payment rates. The Medicare program may consider
Vitalink and In Home Health, Inc. to be related parties with subsidiaries of the
Company which are Medicare providers, and may consider certain subsidiaries of
the Company to be related parties with other HCR Manor Care subsidiaries which
are Medicare providers. Consequently, unless a provider qualifies for the
exception to the related party rule, the Medicare program will only reimburse
the provider for the cost incurred by the related party in providing products or
services, rather than the related party's charge. An organization can qualify
for an exception from the related party rule by meeting the following
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criteria: 1) the entities are bona-fide separate organizations; 2) a substantial
part of the supplying organization's business activity is conducted with
non-related organizations and there is an open, competitive market for such
services or products; 3) the services or products are commonly obtained by a
provider from other organizations and are not a basic element of patient care
ordinarily furnished directly to patients by the providers; and 4) the charge to
the provider is in line with the charge for such services and products in the
open market and no more than the charge made under comparable circumstances to
others. The Company believes that, to the extent the related party rule applies
to it and its subsidiaries, the operations of its subsidiaries would qualify for
the exception to the related party rule. There can be no assurance that the
interpretation and application of the related party rule and the exception
thereto by governmental authorities will result in the Company qualifying for
the exception. The application of the Medicare related party rule could
materially affect allowable payments to the Company's skilled nursing facilities
for pre-July 1, 1998 cost reports.
False Claim Regulation. False claims are prohibited pursuant to
criminal and civil statutes. Criminal provisions at 42 U.S.C. Section 1320a-7b
prohibit filing false claims or making false statements to receive payment or
certification under Medicare and Medicaid, or failing to refund overpayments or
improper payments; offenses for violation are felonies punishable by up to five
years imprisonment, and/or $25,000 fines. Criminal penalties may also be imposed
pursuant to the Federal False Claim Act, 18 U.S.C. Section 287. In addition,
under HIPPA, Congress enacted a criminal health care fraud statute for fraud
involving a health care benefit program, which is defined to include both public
and private payors. Civil provisions at 31 U.S.C. Section 3729 prohibit the
knowing filing of a false claim or the knowing use of false statements to obtain
payment; penalties for violations are fines of not less than $5,000 nor more
than $10,000, plus treble damages, for each claim filed. Also, the statute
allows any individual to bring a suit, known as a qui tam action, alleging false
or fraudulent Medicare or Medicaid claims or other violations of the statute and
to potentially share in any amounts paid by the entity to the government in
fines or settlement. Although the Company has sought to comply with such
statutes, there can be no assurance that such laws will ultimately be
interpreted in a manner consistent with the practices of, and business
transactions by, the Company.
Competitive Conditions
The Company's nursing facilities compete primarily on a local and regional basis
with many long term care providers, some of whom may own as few as a single
nursing center. The ability of the Company to compete successfully varies from
location to location depending on a number of factors, including the number of
competing centers in the local market, the types of services available, quality
of care, reputation, age and appearance of each center and the cost of care in
each locality. In general, the Company seeks to compete in each market by
establishing a reputation within the local community for quality and caring
health services, attractive and comfortable facilities and the provision of
specialized health care.
The Company also competes with a variety of other companies in providing
assisted living services, rehabilitation therapy services and home health care
services. Given the relatively low barriers to
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entry and continuing health care cost containment pressures in the assisted
living industry, the Company expects that the assisted living industry will
become increasingly competitive in the future. Increased competition in the
future could limit the Company's ability to attract and retain residents, to
maintain or increase resident service fees or to expand its business.
Employees
As of December 31, 1998, the Company has approximately 55,000 full and part-time
employees. Approximately 6,300 of the employees are salaried and the remainder
are paid on an hourly basis. Approximately 2,400 of the employees are members of
labor unions.
ITEM 2. PROPERTIES
- ------------------
The principal properties of the Registrant and its subsidiaries, which are of
material importance to the conduct of its business, consist of 360 long term
care centers located in 32 states. The centers are predominately single story
structures with brick or stucco facades, dry wall partitions and attractive
interior finishes. Common areas of the skilled nursing facilities include
dining, therapy, personal care and activity rooms, resident and visitor lounges,
as well as administrative offices and employee lounges. The Company believes
that all of its centers have been well maintained and are suitable for the
conduct of its business. For the year ended December 31, 1998, approximately 89%
of the beds were utilized.
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The following table shows the number and location of centers and beds operated
by the Company as of December 31, 1998.
<TABLE>
<CAPTION>
Number of Centers
-----------------
Assisted
Skilled Living Number of Beds
------- ------ --------------
<S> <C> <C> <C>
Pennsylvania 45 8 7,760
Florida 35 15 6,328
Ohio 43 5 6,063
Illinois 28 4 3,911
Michigan 26 1 3,490
Texas 19 3,004
Maryland 13 7 2,549
California 9 4 1,793
Wisconsin 11 1,395
Indiana 5 1 1,062
Virginia 6 1 970
West Virginia 7 940
Oklahoma 7 938
New Jersey 4 5 899
South Carolina 7 877
Kansas 3 1 522
Washington 4 483
Georgia 2 3 479
New Mexico 3 455
Missouri 3 430
Iowa 4 411
Arizona 1 4 395
Delaware 2 1 347
Colorado 2 300
Nevada 1 1 236
North Dakota 2 215
Tennessee 1 211
Kentucky 1 200
Utah 1 140
North Carolina 1 120
Connecticut 2 116
South Dakota 1 99
--- --- ------
297 63 47,138
=== === ======
</TABLE>
The Company owns 336 of these centers, leases 21 and has partnerships in 3
centers. Of the assisted living facilities, there are 35 Arden Courts and 28
Springhouse centers with a total of 5,752 beds. There are 20 properties subject
to liens which encumber the properties in an aggregate amount of $65,796,000.
The Company leases space for its corporate headquarters in Toledo, Ohio and
Manor Care's corporate office in Gaithersburg, Maryland which the Company plans
to exercise a purchase option and sell in 1999. The Company also leases space
for its outpatient therapy clinics and home health care offices. In addition,
the Company owns one hospital in Texas.
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ITEM 3. LEGAL PROCEEDINGS
- -------------------------
See the second and third paragraphs of the section "Commitments and Contingency"
on page 23-24 under Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
- ----------------------------------------------------------------------------
The Company's common stock is listed under the symbol "HCR" on the New York
Stock Exchange which is the principal market on which the stock is traded.
The range of market prices by quarter in trading on the New York Stock Exchange
for 1997 and 1998 is shown below.
<TABLE>
<CAPTION>
Low High
--- ----
<S> <C> <C>
1997
First Quarter $25.0000 $30.7500
Second Quarter $27.7500 $34.8750
Third Quarter $32.9375 $38.3750
Fourth Quarter $35.5000 $42.5000
1998
First Quarter $36.4375 $47.8750
Second Quarter $35.9375 $45.0625
Third Quarter $23.5000 $43.1250
Fourth Quarter $23.5000 $35.0000
</TABLE>
No cash dividends have been declared or paid on the common stock.
The number of stockholders of record on January 31, 1999 was 5,100. More than
78% of the outstanding shares were registered in the name of Depository Trust
Company, or CEDE, which held such shares on behalf of 272 brokerage firms, banks
and other financial institutions. The shares attributed to these financial
institutions, in turn, represented the interests of more than 32,000
unidentified beneficial owners.
12
<PAGE> 15
ITEM 6. SELECTED FINANCIAL DATA
- ------- -----------------------
<TABLE>
<CAPTION>
FIVE-YEAR FINANCIAL HISTORY 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands, except per share and other data)
<S> <C> <C> <C> <C> <C>
Results of Operations
- ---------------------
Revenues $2,209,087 $2,228,534 $2,022,710 $1,660,230 $1,474,497
Expenses:
Operating 1,715,575 1,760,923 1,598,826 1,295,242 1,143,627
General and administrative 96,017 99,881 100,971 93,637 75,563
Depreciation and amortization 119,223 112,723 99,165 76,594 66,945
Provision for restructuring charge, merger expenses,
asset impairment and other related charges 278,261 26,300
--------- --------- --------- --------- ---------
2,209,076 1,973,527 1,825,262 1,465,473 1,286,135
--------- --------- --------- --------- ---------
Income from continuing operations before other income
(expenses) and income taxes 11 255,007 197,448 194,757 188,362
Other income (expenses):
Interest expense (46,587) (56,805) (47,799) (34,193) (36,662)
Equity in earnings of affiliated companies 5,376 2,806 1,500 531
Interest income and other 16,635 23,289 11,353 8,019 1,985
Interest income from advances to discontinued
lodging segment 16,058 20,314 15,492 10,665
--------- --------- --------- --------- ---------
Total other income (expenses) (24,576) (14,652) (14,632) (10,151) (24,012)
--------- --------- --------- --------- ---------
Income (loss) from continuing operations before
income taxes (24,565) 240,355 182,816 184,606 164,350
Income taxes 21,597 85,064 64,177 66,025 64,452
--------- --------- --------- --------- ---------
Income (loss) from continuing operations $(46,162) $155,291 $118,639 $118,581 $99,898
========= ========= ========= ========= =========
Earnings per share -
Income (loss) from continuing operations:
Basic $(.42) $1.44 $1.10 $1.08 $.92
Diluted $(.42) $1.40 $1.06 $1.06 $.90
Manor Care dividends per share $.04 $.09 $.09 $.09 $.09
Financial Position
- ------------------
Total assets $2,715,140 $2,568,368 $2,382,038 $2,005,366 $1,744,917
Long-term debt 693,180 751,281 731,346 474,353 372,920
Stockholders' equity 1,199,168 1,163,029 994,690 999,303 878,316
Other Data (Unaudited)
- ----------------------
Number of skilled and assisted living facilities 360 335 323 306 293
</TABLE>
The financial results represent the combined results of HCR and Manor Care for
all periods presented. See Note 1 to the consolidated financial statements for
discussion of the periods combined for 1996 through 1998. For 1995 and 1994,
HCR's financial information for the years ended December 31, 1995 and 1994 were
combined with Manor Care's financial information for the years ended May 31,
1995 and 1994.
The Company changed its method of accounting for its investment in In Home
Health, Inc. (IHHI), effective January 1, 1998. See Note 2 to the consolidated
financial statements for further discussion. Due to the deconsolidation of IHHI
in 1998, the individual income statement line items are not comparative to prior
years, however, there is no effect on income (loss) from continuing operations.
IHHI's revenues of $109.7 million and $124.3 million for 1997 and 1996,
respectively, and operating expenses of $125.6 million and $122.1 million for
1997 and 1996, respectively, continue to be included in the Company's financial
results above. The Company invested in IHHI in October 1995, therefore, IHHI's
results are not included in 1995 and 1994.
The decrease in stockholders' equity in 1996 is the result of the $167.3 million
dividend of the discontinued lodging segment.
13
<PAGE> 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- -------------------------------------------------------------------------------
OF OPERATIONS
- -------------
RESULTS OF OPERATIONS - OVERVIEW
On September 24, 1998 the stockholders of Health Care and Retirement Corporation
(HCR) and the stockholders of Manor Care, Inc. (Manor Care) separately approved
the merger of the companies, effective September 25, 1998. In accordance with
the Amended and Restated Agreement and Plan of Merger (the Merger Agreement)
dated June 10, 1998, each share of Manor Care common stock was converted into
one share of HCR common stock for a total of approximately 63.9 million shares
and Manor Care stock options outstanding were converted into approximately 2.1
million shares of HCR common stock based on the option pricing formula defined
in the Merger Agreement. As a result of the transaction, Manor Care became a
wholly owned subsidiary of HCR and HCR changed its name to HCR Manor Care, Inc.
(HCR Manor Care or the Company). The merger has been accounted for by the
pooling-of-interests method. Accordingly, the consolidated financial statements
give retroactive effect to the merger and include the combined operations for
all periods presented. See Note 1 to the consolidated financial statements for
further discussion.
HCR Manor Care is a provider of a range of health care services, including
skilled nursing care, assisted living, subacute medical care, rehabilitation
therapy, home health care and management services for subacute care,
rehabilitation therapy, vision care and eye surgery. The most significant
portion of HCR Manor Care's business relates to skilled nursing care and
assisted living. At December 31, 1998 the Company operated 297 skilled nursing
facilities and 63 assisted living facilities in 32 states with more than half
located in Ohio, Michigan, Illinois, Pennsylvania and Florida. Within some of
the Company's centers, there are medical specialty units which provide subacute
medical care, rehabilitation programs or Alzheimer's care programs. Some of the
Company's assisted living facilities operate under the brand names "Arden
Courts" and "Springhouse." The Arden Courts facilities are specifically focused
on providing care to persons suffering from early to middle-stage Alzheimer's
disease and related memory impairment, while the Springhouse facilities serve
the general assisted living population of frail elderly. These assisted living
facilities provide housing, personalized support and health care services in a
non-institutional setting designed to address the needs of the elderly or
Alzheimer's afflicted.
Growth in the core business continues with the construction of new facilities.
During 1998 the Company opened two skilled nursing facilities and 26 assisted
living facilities with a total of 1,920 beds. Also, the Company sold two
Springhouse facilities for $4.7 million and terminated a management contract.
During 1997 the Company opened four skilled nursing facilities and seven
assisted living facilities with a total of 1,019 beds. In addition, the Company
purchased one skilled nursing facility for $13.4 million. During 1996 the
Company opened four skilled nursing facilities and three assisted living
facilities with a total of 693 beds. Additionally, the Company acquired three
skilled nursing facilities for $22.2 million cash and assumed liabilities of
$12.5 million. The Company sold four skilled nursing centers for $17.3 million
and transferred an assisted living facility with a net book value of $4.9
million to the discontinued lodging segment.
14
<PAGE> 17
The Company has developed an integrated health care network from acquisitions,
investments and management agreements.
During the fourth quarter of 1998, the Company formed a strategic alliance with
Alternative Living Services, Inc. to develop a broad based network primarily
dedicated to the care of patients suffering from Alzheimer's disease.
Alternative Living Services, Inc. has announced plans to change their name to
Alterra Healthcare Corporation (Alterra). Key provisions of the alliance include
the sale of 29 centers to Alterra for approximately $200 million in cash;
creation of a joint venture to develop and construct up to $500 million of
Alzheimer's dementia care assisted living facilities in the Company's core
markets over the next three to five years; and the formation of a new company to
provide a variety of ancillary services, including rehabilitation therapy and
home and hospice care, to residents in Alterra centers. The asset sale and
creation of the development joint venture are expected to be completed in the
first half of 1999.
MileStone Healthcare, Inc. (MileStone), acquired in January 1997 and a wholly
owned subsidiary, is a provider of program management services for subacute care
and acute rehabilitation programs in hospitals and skilled nursing centers.
These services were provided in 39 subacute and rehabilitation units at December
31, 1998.
Heartland Rehabilitation Services, Inc., a wholly owned subsidiary, provides
rehabilitation therapy in long term care centers of the Company, other skilled
centers, hospitals and outpatient therapy clinics serving the midwestern and
mid-Atlantic states, Texas and Florida. This subsidiary expanded its operations
by a net increase in clinics of 9 in 1998, 22 in 1997 and 32 in 1996, totaling
82 outpatient clinics at December 31, 1998.
HCR Home Health Care and Hospice, Inc., a wholly owned subsidiary, specializes
in all levels of home health, hospice care and rehabilitation therapy with
offices located in Ohio, Michigan, Indiana, Illinois and Florida. This
subsidiary had 33 offices at December 31, 1998.
The Company owns 41% of the common stock and all of the preferred stock of In
Home Health, Inc. (IHHI). IHHI 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. During 1998 the Company changed the
accounting for its investment in IHHI. The investment was consolidated until the
fourth quarter of 1998 when the Company changed to the equity method of
accounting, retroactive to January 1, 1998. This change to the equity method
resulted from a Second Preferred Stock Modification Agreement (the Agreement)
between the Company and IHHI executed on December 22, 1998. Under the terms of
the Agreement, the Company irrevocably waived the right of the preferred stock
to vote on an as-if-converted basis along with the common stock, except with
respect to certain protective rights. In consideration for the Company entering
into the Agreement, IHHI waived the right to pay the 12% annual dividend on the
preferred stock in the form of shares of common stock. IHHI has historically
paid this dividend in cash, and as a result of the Agreement will continue to do
so. The Agreement does not affect the voting rights of the common stock. As a
result of the Agreement, the Company no longer has a majority voting power with
respect to the election of IHHI's board of directors.
The Company is the general partner and a limited partner of Mesquite Community
Hospital, L.P., which owns and operates Mesquite Community Hospital in Mesquite,
Texas, a Dallas suburb. It is
15
<PAGE> 18
a general medical/surgical acute care hospital with 172 licensed beds.
Vision Management Services, Inc., a majority owned subsidiary, and RVA
Management Services, Inc., a wholly owned subsidiary, entered into long-term
management contracts in 1996 and 1995 with physician practices in the midwestern
states, specializing in vision care and refractive eye surgery. The Company
receives a management fee equal to a percentage of operating income as defined
by the agreements.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
As explained above, the Company changed the accounting for its investment in
IHHI retroactive to January 1, 1998. In the table below, IHHI's financial
results have been removed from 1997 to be comparative with 1998.
<TABLE>
<CAPTION>
Percent
1998 1997 Change
---- ---- ------
<S> <C> <C> <C>
Revenues $2,209,087 $2,118,866 4 %
Expenses:
Operating 1,715,575 1,635,321 5 %
General and administrative 96,017 99,038 (3)%
Depreciation and amortization 119,223 109,771 9 %
</TABLE>
Changes in Medicare reimbursement affected the Company's results during 1998.
Under the Balanced Budget Act of 1997 (Budget Act), a new Medicare prospective
payment system (PPS) commenced on July 1, 1998. The new payment system becomes
effective for different segments of the health care continuum (hospitals,
skilled nursing, home health, etc.) at different times and even commences at
different dates for different nursing facilities. Although management believes
that PPS will ultimately be a net positive for its skilled nursing business, the
same may not be true for other businesses and customers of the Company.
MileStone Healthcare, Inc. (MileStone) provides management services to skilled
nursing, subacute care and acute rehabilitation programs, primarily in
hospitals. MileStone lost certain contracts during the second and third quarters
that have not been replaced and expects contract cancellations to continue in
1999 due to the impact of PPS on its customers. Under PPS, MileStone's customers
will look for ways to provide services at a lower cost, which includes
performing services internally or demanding significant price concessions, or it
may exit this segment of their business. In addition, the Budget Act also had an
unfavorable impact on the reimbursement for home health care companies due to an
interim payment system (IPS), which was effective October 1997 for IHHI and
January 1998 for HCR's home health business. PPS is scheduled to replace IPS for
home health reimbursement in October 2000. Under IPS, reimbursement rates were
reduced as a result of revised rate ceilings combined with establishing an
annual payment limitation per individual. As a result of IPS, the Company has
been focusing on reducing its costs to offset the revenue reductions. The
Company's rehabilitation business also was impacted due to reduced reimbursement
from the April 1998 implementation of Medicare reimbursement ceilings for speech
and occupational therapy salaries (salary equivalency). See discussion of
impairment charges on these businesses below.
Revenues increased $90.2 million or 4% from the prior year. Revenues from
skilled nursing and assisted living facilities increased $99.2 million or 5% due
to increases in rates ($44.6 million), capacity ($51.7 million) and occupancy
($2.9 million). This increase was offset by a decrease in
16
<PAGE> 19
revenues primarily due to changes in reimbursement, as discussed above, from the
Company's ancillary businesses, such as MileStone, home health and
rehabilitation.
There was a net increase of 1,500 beds during 1998. The occupancy level was 88%
in 1997 compared to 89% in 1998. The quality mix of revenue from Medicare,
private pay and insured patients related to skilled nursing and assisted living
facilities and rehabilitation operations declined from 73% in 1997 to 71% in
1998.
Operating expenses increased $80.3 million or 5% compared to 1997. Operating
expenses from skilled nursing and assisted living facilities increased $93.3
million or 6% which was attributable to expensing start-up costs in 1998 ($22.7
million), labor costs ($46.7 million) which included wages from increased bed
capacity, and higher ancillary costs, bad debt expense and other general costs.
During the fourth quarter of 1998, the Company elected to adopt Statement of
Position 98-5 "Reporting on the Costs of Start-up Activities" (SOP 98-5), which
requires start-up costs to be expensed as incurred. The cumulative effect of
expensing the start-up costs capitalized as of January 1, 1998 was $9.4 million
($5.6 million after tax). During 1998 the Company expensed $22.7 million of
start-up costs and reversed $4.9 million of amortized start-up costs included in
depreciation and amortization. The operating expenses for the ancillary
businesses decreased $13.0 million due to the changes in reimbursement, as
discussed above, and correspond to the decline in revenues.
General and administrative expenses decreased $3.0 million from the prior year.
By excluding the net gains from sale of assets, general and administrative
expenses were constant as a result of reclassifying $5.7 million to the
provision for restructuring charge, merger expenses, asset impairment and other
related charges, as explained below. In 1998 a gain of $7.4 million from the
sale of three former Manor Care corporate office buildings and a loss of $2.0
million from the sale of two Springhouse facilities were included in general and
administrative expenses. In 1997 a gain of $2.0 million from the sale of a
former Manor Care corporate office building was included in general and
administrative expenses.
Depreciation and amortization increased $9.5 million from the prior year. By
excluding $2.9 million of start-up costs that were amortized in 1997 before the
adoption of SOP 98-5, depreciation and amortization increased $12.4 million. The
increase was primarily due to increases in property and equipment resulting from
additions and renovations to existing facilities as well as the completion of
new construction projects during the past year.
In 1998 the Company recorded a $278.3 million charge related to restructuring,
merger expenses, asset impairment and other related charges. A component
pertains to Manor Care's $13.5 million charge recorded in the second quarter in
connection with its plan to separate its skilled nursing, assisted living and
home health businesses from its skilled nursing facility management, real estate
and healthcare facility development business. As a result of the merger with
HCR, the separation of Manor Care's businesses did not occur. Another component
of the charge related to the merger of HCR and Manor Care which totaled $134.7
million. In connection with the merger, HCR Manor Care developed a plan to
integrate the businesses of both companies that includes closing Manor Care's
corporate office in Gaithersburg, Maryland and realigning the operating
divisions from eight to six. The remaining $130.0 million of the charge related
to other unusual costs as a result of the merger and asset impairment unrelated
to the restructuring. The liability outstanding at December 31, 1998 relating to
these charges is recorded in other accrued liabilities.
17
<PAGE> 20
The components consist of the following (in thousands):
<TABLE>
<CAPTION>
Cash/ Liability
Non-cash Charge Activity at 12/31/98
-------- ------ -------- -----------
<S> <C> <C> <C> <C>
Manor Care spin-off:
Employee benefits cash $5,917 $(5,300) $617
Transaction costs cash 6,805 (6,805)
Write-down of assets non-cash 778 (778)
-------- --------- -------
13,500 (12,883) 617
-------- --------- -------
HCR and Manor Care merger:
Employee benefits cash 41,028 (12,734) 28,294
Deferred compensation non-cash 11,867 (11,867)
Other exit costs cash 4,234 4,234
Merger transaction costs cash 21,122 (21,122)
Write-down of assets non-cash 56,468 (56,468)
-------- --------- -------
134,719 (102,191) 32,528
-------- --------- -------
Other costs:
Amortization non-cash 7,863 (7,863)
Duplicate costs cash 5,725 (5,725)
Other cash 1,685 (685) 1,000
Asset impairment unrelated to merger non-cash 114,769 (114,769)
-------- --------- -------
130,042 (129,042) 1,000
-------- --------- -------
Total $278,261 $(244,116) $34,145
======== ========= =======
</TABLE>
In Manor Care's planned spin-off of its non-healthcare businesses a total of 208
employees were terminated. The employees did not receive a lump-sum severance
payment upon termination but receive their severance as biweekly payments
through 1999. The transaction costs primarily included financial advisory,
legal, and accounting fees and expenses, and printing and mailing costs.
In the HCR and Manor Care merger, the employee benefit costs related to
severance payments and retention bonuses for 505 corporate employees and 26
field employees of Manor Care who received termination notices. A total of 364
employees have left the Company as of December 31, 1998 but 269 employees
continue to be paid their severance payments on a biweekly basis. The majority
of the Manor Care employees remaining with the Company at yearend have
termination dates in the first quarter of 1999. The cash severance payments will
continue through 1999. The deferred compensation expense of $11.9 million was
attributable to the lapsing of restrictions on HCR's restricted stock due to the
merger. The other exit costs pertain to various lease agreements and hardware
and software contracts that will be terminated. The merger transaction costs
primarily included financial advisory, legal, and accounting fees and expenses,
and printing and mailing costs.
HCR Manor Care identified two groups of assets that were impaired as a result of
the merger. The Company has integrated the information systems of the companies
which resulted in the write-off of the net book value ($45.2 million) of Manor
Care's computer hardware and software that was no longer being utilized by the
Company as of December 31, 1998. Certain construction development project costs
($11.3 million), excluding the land value, have been abandoned due to a change
in
18
<PAGE> 21
strategy.
The Company recorded other unusual costs as a result of the merger. The non-cash
charge primarily related to the amortization of certain Manor Care software
applications which are being used until the transition to HCR applications. The
carrying value of the software is being amortized over its estimated useful life
ranging from six to nine months. Certain general and administrative costs of
$5.7 million represented salaries and benefits for employees performing
duplicate services in Toledo or Gaithersburg.
The Company anticipates an annual savings of $30 million going forward with $20
million realized in 1999 from the termination of employees, reduced deferred
compensation expense and reduced contract costs, offset by compensation expense
for approximately 200 employees hired or to be hired in the Company's corporate
office in Toledo, Ohio. The Company has identified additional Manor Care
software with a remaining net book value of approximately $11.0 million in use
at December 31, 1998 to be abandoned as a result of the integration of the
information systems. This will result in additional amortization expense over
the next two quarters based on the timing of completing the restructuring plan.
The Company also recorded a charge for impairment of certain assets based on its
quarterly review of long-lived and intangible assets. Management determined that
MileStone's intangible assets with a net book value of $52.5 million were
impaired based on the effects of changes in the Medicare reimbursement system
discussed above and reduced the book value by $44.6 million to the assets
estimated fair value. The fair value was determined based on a multiple of
projected annual earnings. The remaining useful life has been adjusted from 38
years to 18 years.
The asset impairment of the Company's home health businesses was also related
largely to the Medicare reimbursement changes discussed above. Based on the
impact of IPS in 1998 and the anticipated effects of PPS after October 2000,
management determined that the expected future earnings does not support the
carrying value of these assets. Therefore, the book value of the related
goodwill was reduced by $22.0 million to zero. Its estimated fair value was
determined based on a multiple of projected annual earnings.
Management determined that the fixed assets for five skilled nursing facilities
and two assisted living facilities were impaired based on the carrying value
exceeding the undiscounted cash flows. The skilled nursing facilities were
generating negative cash flows and the fixed assets were written off except for
the land. The estimated fair value of the assisted living facilities was
determined based on a multiple of projected annual earnings. The fixed assets of
the skilled nursing and assisted living facilities had a carrying value of $23.8
million and were written down by $19.9 million.
The Company has three vision management businesses. The first business was a
start-up business in 1995 which had $4.6 million in advances and $1.0 million in
fixed assets. Since the business has not been able to generate cash flows to
cover its expenses, the assets were written off. With the second business, the
Company had advances of $1.5 million which were written down by $1.1 million.
The third business had a forty-year management contract with a carrying value of
$11.8 million. Based on a multiple of projected annual earnings, the estimated
fair value was $3.4 million and the remaining estimated useful life was reduced
from 36 years to 16 years. The primary reason for the decrease in projected
annual earnings was declining reimbursement.
19
<PAGE> 22
Management determined that the intangible assets for six rehabilitation
businesses were impaired based on the carrying value exceeding the undiscounted
cash flows. The businesses were generating negative cash flows and the Company
had exhausted all measures to return the operations to a level of profitability.
The book value of the related intangible assets was reduced by $8.4 million to
zero carrying value.
As a result of the write-down of assets and change in the estimated useful life,
depreciation and amortization is expected to decline by $2.4 million on an
annual basis, excluding the accelerated amortization of Manor Care's computer
software.
Interest expense decreased $10.2 million compared to the prior year due to the
retirement of $140.1 million of Manor Care's 9.5% Senior Subordinated Notes in
November 1997. The Senior Subordinated Notes were redeemed at a price of 103.56%
and the premium paid on redemption was recorded as an extraordinary item of $3.2
million after taxes. The decline in the minority interest related to the removal
of IHHI's minority interest due to the deconsolidation. Interest income from
advances to discontinued lodging segment declined from the prior year due to the
prepayment of $110.0 million and $115.7 million of indebtedness in the second
quarter and fourth quarter of 1997, respectively.
The income taxes recorded for 1998 included the tax effects of the provision for
restructuring charge, merger expenses, asset impairment and other related
charges, some of which are not deductible for income tax purposes. The effective
tax rate, excluding these items, was 36.1% compared to 35.4% for 1997.
The Company had a loss from continuing operations of $46.2 million primarily due
to the provision for restructuring charge, merger expenses, asset impairment and
other related charges of $278.3 million ($213.5 million net of taxes).
During 1998 the Company recorded a gain of $99.8 million ($59.9 million after
tax) from the conversion of Vitalink Pharmacy Services, Inc. (Vitalink) common
stock to Genesis Health Ventures, Inc. (Genesis) preferred stock. On April 26,
1998 Vitalink entered into an Agreement and Plan of Merger (Vitalink Merger
Agreement) with Genesis. Pursuant to the Vitalink Merger Agreement that was
consummated on August 28, 1998, Manor Care received 586,240 shares of Genesis
Series G Cumulative Convertible Preferred Stock valued at $293.1 million as
consideration for all of its common stock of Vitalink. The preferred stock bears
cash dividends at the initial rate of 5.9375% which amounted to $5.8 million in
1998 and was classified as other income. The financial results of Vitalink were
recorded as income from discontinued pharmacy operations for all periods
presented. The net income from discontinued pharmacy operations was
significantly higher in 1997 due to the after-tax gain of $30.4 million 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.
During 1998 the Company recorded an extraordinary loss from the early
extinguishment of debt totaling $31.7 million ($19.0 million after tax). On
September 25,1998 the Company repaid the outstanding debt under HCR's and Manor
Care's prior credit arrangements. In conjunction with the extinguishment of
debt, the Company terminated three interest rate swaps with a total notional
amount of $350 million that were designated as a hedge of Manor Care's debt. The
20
<PAGE> 23
extraordinary loss primarily related to the termination of the swaps but also
included the unamortized debt issue costs.
On November 20, 1997 a consensus was reached by the Emerging Issues Task Force
regarding the reengineering costs (Issue 97-13) providing that all reengineering
costs be expensed as incurred. As a result, in November 1997 Manor Care expensed
$3.2 million of reengineering costs after taxes as the cumulative effect of a
change in accounting principle.
The Company believes that inflation has had no material impact on the results of
operations.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Revenues increased $205.8 million or 10% from the prior year. Revenues from
skilled nursing and assisted living facilities increased $149.9 million due to
increases in rates ($117.6 million) and capacity ($39.3 million). Revenues from
the Company's ancillary businesses, excluding IHHI, increased $70.6 million and
90% of the increase was due to the acquisition of various rehabilitation
companies and MileStone during the latter part of 1996 and in 1997. IHHI's
revenues decreased $14.7 million primarily due to adjustments to Medicare
receivables in connection with recent Medicare reimbursement decisions related
to the allowability of community liaison costs and required documentation to
support allowable costs. These adjustments are reported as a deduction from
revenue.
The growth in bed capacity during 1997 was 1,191 beds, due to the purchase of
one nursing facility and the opening of four skilled nursing centers, six Arden
Courts and one Springhouse facility. The occupancy levels were 88% in 1996 and
1997. The quality mix of revenue from Medicare, private pay and insured patients
related to skilled nursing and assisted living facilities and rehabilitation
operations was 72% in 1996 compared to 73% in 1997.
Operating expenses increased $162.1 million or 10% from the prior year.
Operating expenses from skilled nursing and assisted living facilities increased
$101.6 million primarily due to labor costs, additional capacity and general
increases in expenses. Operating expenses from the Company's ancillary
businesses increased $60.5 million and 79% of the increase was due to the
acquisition of various businesses during the year.
General and administrative expenses were relatively constant compared to the
prior year. A gain of $2.0 million from the sale of a corporate office building
was included in general and administrative expenses for 1997. In 1996 a gain of
$7.3 million from the sale of four nursing centers offset by charitable
contributions expense of $5.0 million was included in general and administrative
expenses. The increase in depreciation and amortization of $13.6 million was
primarily due to increases in property and equipment resulting from additions
and renovations to existing facilities as well as the completion of new
construction projects during the past year.
Manor Care recorded a provision of $26.3 million in 1996 related to impairment
of certain long-lived assets ($21.2 million) and costs associated with Manor
Care's restructuring of its healthcare business ($5.1 million). The non-cash
asset impairment charges were attributable to write-downs of property, equipment
and capitalized system development costs.
Interest expense increased $9.0 million which was attributable to higher debt
levels in connection
21
<PAGE> 24
with newly developed facilities and acquisitions. The minority interest of $13.2
million increased from the prior year due to the minority owners' share of
IHHI's net loss of $20.0 million for 1997. Interest income from advances to
discontinued lodging segment declined $4.3 million from the prior year due to
the prepayment of $110.0 million of indebtedness in the second quarter of 1997.
On November 1, 1996 Manor Care completed the spin-off of its lodging segment by
contributing its net investment in discontinued lodging operations to Choice
Hotels International, Inc.(Choice). Manor Care shareholders of record on October
10, 1996, received one share of Choice common stock for each outstanding share
of Manor Care common stock. Accordingly, lodging results are reported as a
discontinued operation for 1996.
The Company believes that inflation has had no material impact on the results of
operations.
FINANCIAL CONDITION - DECEMBER 31, 1998 AND 1997
Property and equipment increased $135.4 million as a result of $295.6 million in
new construction and renovations and maintenance to existing facilities offset
by the sale of two Springhouse facilities and three corporate office buildings,
the write-down of assets and depreciation for the year. The expenditures for
property and equipment resulted in an increase in debt for the Company.
There was no valuation allowance related to the deferred tax assets at December
31, 1998 and 1997, as the assets could be realized through the reversal of
existing taxable temporary differences.
NEW ACCOUNTING STANDARD
In June 1998 the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (FAS 133), which
is effective January 1, 2000. This Statement permits early adoption as of the
beginning of any fiscal quarter after its issuance. This Statement will require
the Company to recognize all derivatives on the balance sheet at fair value.
Management has not determined when it will adopt this Statement nor has it
determined the impact of adoption.
CAPITAL RESOURCES AND LIQUIDITY
During 1998 the Company satisfied its cash requirements from a combination of
cash generated from operating activities and borrowings under bank credit
agreements. The Company used the cash principally for capital expenditures,
systems development and merger expenses. At December 31, 1998 the Company
maintained $33.7 million in cash and cash equivalents. Expenditures for property
and equipment during 1998 consisted of $177.3 million for construction of new
facilities and $118.3 million for renovation and maintenance of existing
facilities.
Concurrent with the merger, a five-year, $500 million credit agreement (5 Year
Agreement) and a 364-day, $300 million credit agreement (364 Day Agreement) were
established with a group of banks, under which both HCR Manor Care and Manor
Care are borrowers. The credit agreements were established to repay borrowings
of the two companies under prior credit arrangements, to provide additional
credit capacity for future developments and to provide credit back-up for the
issuance of commercial paper. At December 31, 1998 outstanding borrowings of
both companies aggregated $476 million under the 5 Year
22
<PAGE> 25
Agreement and $230 million under the 364 Day Agreement - a total of $706
million. The Company plans to annually refinance the 364 Day Agreement. After
consideration of usage for letters of credit, the remaining credit availability
under the combined agreements totaled $85.7 million.
During the fourth quarter of 1998, the Company formed a strategic alliance with
Alternative Living Services, Inc. (Alterra). The key provisions of the alliance
include the sale of 29 centers to Alterra for approximately $200 million in cash
and creation of a joint venture to develop and construct up to $500 million of
Alzheimer's dementia care assisted living facilities in the Company's core
markets over the next three to five years. The asset sale and creation of the
development joint venture are expected to be completed in the first half of
1999.
HCR Manor Care believes that its cash flow from operations will be sufficient to
cover debt payments, future capital expenditures and operating needs. It is
likely that the Company will pursue growth from acquisitions, partnerships and
other ventures which would be funded from excess cash from operations, credit
available under the bank credit agreement and other financing arrangements that
are normally available in the marketplace.
COMMITMENTS AND CONTINGENCY
The Company has cash flow commitments related to the restructuring plan that
will require approximately $34 million in 1999, primarily for employee benefits.
As of December 31, 1998 the Company had contractual commitments of $72.9 million
relating to its internal construction program. The Company has total letters of
credit of $58.2 million at December 31, 1998 that benefit certain third party
insurers and bondholders of certain industrial revenue bonds, and 63% relate to
recorded liabilities. The Company had obligations under noncancelable operating
leases totaling $126.3 million at December 31, 1998. This amount includes the
lease for the Company's new headquarters in Toledo that was finalized in January
1999, as well as Manor Care's previous headquarters in Gaithersburg, Maryland
that the Company plans to exercise a purchase option and sell in 1999.
One or more subsidiaries or affiliates of Manor Care 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. Sections 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 Manor Care. The Actions
allege that Cenco transported and/or generated hazardous substances that came to
be located at the sites in question. The Company believes 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 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
23
<PAGE> 26
for some of the waste disposal sites where Manor Care is alleged to be a
potentially responsible party has not yet been quantified. Based upon its
current assessment of the likely outcome of the Actions, the Company believes
that the potential environmental liability exposure, after consideration of
insurance coverage, is approximately $5 million.
The Company is party to various other legal proceedings arising in the ordinary
course of business. The Company does not believe the results of such
proceedings, even if unfavorable to the Company, would have a material adverse
effect on its financial position.
YEAR 2000
The Year 2000 issue is the result of computer programs being written using two
digits rather than four digits to define the year. Any of the HCR Manor Care
computer software and hardware that are date sensitive and all of our embedded
chip devices could recognize a two digit date of `00' as `1900' rather than
`2000'. This could result in system failures and miscalculations causing
disruptions to our operations.
In 1995, HCR began an evaluation and upgrade to all of its technical
infrastructure including hardware, operating systems and business applications.
With the completion of that upgrade process, the Company will have in place, a
complete package of technical solutions that properly utilize dates beyond
December 31, 1999. The estimated costs of this package are expected to be $35
million. Most of these costs will be capitalized and amortized over a five to
twelve year period. As of December 31, 1998 the Company has incurred
approximately $19 million ($2 million expensed and $17 million capitalized). The
Company has completed the technical solution definition and is 70% complete with
the implementation. All computer hardware, software and operating system
upgrades are expected to be in place by the end of the third quarter of 1999. It
has not been necessary to accelerate our original implementation plan due to the
Year 2000 issue.
To insure that our embedded chip devices, vendor and supplier interfaces are
also Year 2000 compliant, the Company has put into place an assessment,
remediation, testing, implementation and contingency plan for all products,
services and relationships that do not meet our Year 2000 compliance standards.
The Company expects all phases along with the contingency plan to be completed
by the end of the third quarter of 1999 with internal resources. The Company has
queried our significant suppliers and at this point, based on their
representations, the Company does not believe that Year 2000 presents a material
exposure as it relates to our embedded chip devices, system interfaces,
significant suppliers or vendors. The Company believes today that the most
likely worst case scenario, if it occurred, would involve temporary disruptions
in delivery of medical and other supplies and temporary disruptions in payments,
especially payments from Medicare and other government programs. If the federal
and state healthcare reimbursement agencies or their intermediaries were to fail
to implement Year 2000 compliant technologies before December 31, 1999, a
temporary cash flow disruption could result. Those agencies and intermediaries
have Year 2000 plans in place and the Company continues to monitor the status of
those projects. However, all of the governmental agencies have stated that
interim payment procedures would be implemented if their Year 2000 solutions are
not in place by January 1, 2000.
The foregoing assessment is based on information currently available to the
Company. The
24
<PAGE> 27
Company will revise its assessment as it implements its Year 2000 strategy. The
Company's Year 2000 compliance program is an ongoing process and the risk
assessments and estimates of costs and completion dates for various phases of
the program are subject to change. The cost of the Year 2000 program and the
dates on which the Company believes the phases of the program will be completed
are based on management's best estimates, which were derived using numerous
assumptions of future events. Factors that could cause such changes include
availability of qualified personnel and consultants, the actions of third
parties and material changes in governmental regulations. There can be no
guarantee that these estimates will be achieved and actual results could differ
materially from those anticipated.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
Statements contained in this report which are not historical facts may be
forward-looking statements within the meaning of federal law. Such
forward-looking statements reflect management's beliefs and assumptions and are
based on information currently available to management. Forward-looking
statements involve known and unknown risks, uncertainties and other factors that
may cause the actual results, performance or achievements of the Company or
industry results to be materially different from any future results, performance
or achievements expressed or implied by such forward-looking statements. Such
factors include, among others, the following: general economic and business
conditions, both nationally and in the regions in which the Company operates;
industry capacity; demographic changes; existing government regulations and
changes in, or the failure to comply with, governmental regulations; legislative
proposals for health care reform; the ability to enter into managed care
provider arrangements on acceptable terms; changes in Medicare and Medicaid
reimbursement levels; liability and other claims asserted against the Company;
competition; changes in business strategy or development plans; and the ability
to attract and retain qualified personnel. All subsequent written and oral
forward-looking statements attributable to the Company or persons acting on its
behalf are expressly qualified in their entirety by the cautionary statements
set forth or referred to above in this paragraph. The Company disclaims any
obligation to update such factors or to publicly announce the result of any
revisions to any of the forward-looking statements contained herein to reflect
future events or developments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
The Company's market risks inherent in derivatives and other financial
instruments result primarily from changes in U.S. interest rates. The Company is
not a party to any material derivative financial instruments. The Company's
interest expense is most sensitive to changes in the general level of U.S.
interest rates applicable to its U.S. dollar indebtedness. To mitigate the
impact of fluctuations in variable interest rates, the Company could, at its
option, convert to fixed interest rates by either refinancing variable rate debt
with fixed rate debt or entering into interest rate swaps.
The Company has three interest rate swaps with a notional amount of $30.3
million at December 31, 1998 that effectively convert the Company's interest
rate exposure on a floating rate operating lease to a fixed interest rate of
5.6%. The final payment on the operating lease of $30.3 million relating to
Manor Care's corporate headquarters is due in August 2002 but the Company plans
to exercise a purchase option on the building and sell it in 1999.
25
<PAGE> 28
The following table provides information about the Company's significant
interest rate risk at December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
Outstanding Fair Value
----------- ----------
<S> <C> <C>
Variable rate debt:
364 Day Credit Agreement, matures September 1999,
interest at a Eurodollar based rate plus .40% $230,000 $230,000
5 Year Credit Agreement, matures September 2003,
interest at a Eurodollar based rate plus .40% $476,000 $476,000
Fixed rate debt:
Senior Notes, due June 2006, interest rate at 7.5% $150,000 $154,773
Interest rate swaps - liability:
Pay variable rate (average 6.1%) and receive fixed rate
(5.6%), due August 2002 $494
</TABLE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------
Page
----
Report of Ernst & Young LLP Independent Auditors 27
Consolidated Balance Sheets 28
Consolidated Statements of Operations 29
Consolidated Statements of Cash Flows 30
Consolidated Statements of Stockholders' Equity 31
Notes to Consolidated Financial Statements 32
Supplementary Data (Unaudited) - Summary of Quarterly Results 54
26
<PAGE> 29
REPORT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS
The Board of Directors and Stockholders
HCR Manor Care, Inc.
We have audited the accompanying consolidated balance sheets of HCR Manor Care,
Inc. and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1998. Our audits also
include the financial statement schedule listed in the Index at Item 14. These
financial statements and schedule 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 consolidated financial position of HCR Manor Care,
Inc. and subsidiaries at December 31, 1998 and 1997, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
As discussed in Note 2 to the financial statements, in 1998 the Company changed
its method of accounting for start-up costs and in 1997 the Company changed its
method of accounting for business reengineering costs.
ERNST & YOUNG LLP
Toledo, Ohio
January 28, 1999
27
<PAGE> 30
HCR MANOR CARE, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
------------ ------------
(In thousands)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 33,718 $ 47,933
Receivables, less allowances for
doubtful accounts of $58,125 and $52,590 314,883 308,797
Prepaid expenses and other assets 33,920 45,627
Deferred income taxes 35,235 43,375
----------- -----------
Total current assets 417,756 445,732
Net property and equipment 1,740,326 1,604,913
Intangible assets, net of amortization of $10,023 and $15,101:
Goodwill 57,349 130,915
Other 23,453 32,124
Net investment in Genesis preferred stock 293,120
Investment in discontinued pharmacy segment 184,819
Other assets 183,136 169,865
----------- -----------
Total assets $ 2,715,140 $ 2,568,368
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 107,341 $ 101,746
Employee compensation and benefits 60,976 80,137
Accrued insurance liabilities 26,313 30,010
Income tax payable 29,692
Other accrued liabilities 72,534 54,943
Revolving loans 230,000
Long-term debt due within one year 6,547 7,106
----------- -----------
Total current liabilities 503,711 303,634
Long-term debt 693,180 751,281
Deferred income taxes 245,564 246,469
Other liabilities 72,422 100,661
Minority interest 1,095 3,294
Stockholders' equity:
Preferred stock, $.01 par value, 5 million shares authorized
Common stock, $.01 par value, 300 million shares authorized,
110.9 and 115.9 million shares issued 1,109 7,199
Capital in excess of par value 356,333 471,930
Retained earnings 841,726 850,539
----------- -----------
1,199,168 1,329,668
Less treasury stock, at cost (7.8 million shares) (166,639)
----------- -----------
Total stockholders' equity 1,199,168 1,163,029
----------- -----------
Total liabilities and stockholders' equity $ 2,715,140 $ 2,568,368
=========== ===========
</TABLE>
See accompanying notes.
28
<PAGE> 31
HCR MANOR CARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year ended December 31
----------------------
1998 1997 1996
---- ---- ----
(In thousands, except per share amounts)
<S> <C> <C> <C>
Revenues $2,209,087 $2,228,534 $2,022,710
Expenses:
Operating 1,715,575 1,760,923 1,598,826
General and administrative 96,017 99,881 100,971
Depreciation and amortization 119,223 112,723 99,165
Provision for restructuring charge, merger expenses,
asset impairment and other related charges 278,261 26,300
--------- --------- ---------
2,209,076 1,973,527 1,825,262
--------- --------- ---------
Income from continuing operations before
other income (expenses) and income taxes 11 255,007 197,448
Other income (expenses):
Interest expense (46,587) (56,805) (47,799)
Minority interest (443) 13,245 2,169
Equity in earnings of affiliated companies 5,376 2,806 1,500
Interest income and other 17,078 10,044 9,184
Interest income from advances to discontinued lodging segment 16,058 20,314
--------- --------- ---------
Total other income (expenses) (24,576) (14,652) (14,632)
--------- --------- ---------
Income (loss) from continuing operations before income taxes (24,565) 240,355 182,816
Income taxes 21,597 85,064 64,177
--------- --------- ---------
Income (loss) from continuing operations (46,162) 155,291 118,639
Discontinued operations:
Income from discontinued pharmacy operations
(net of taxes of $7,256, $36,992 and $9,977, respectively) 8,044 41,209 12,406
Gain on conversion of Vitalink stock (net of taxes of $39,908) 59,861
Income from discontinued lodging operations (net of taxes of $10,221) 13,220
--------- --------- ---------
Income before extraordinary item and cumulative effect 21,743 196,500 144,265
Extraordinary item (net of taxes of $12,690 and $2,150, respectively) (19,036) (3,216)
Cumulative effect of change in accounting principle
(net of taxes of $3,759 and $2,115, respectively) (5,640) (3,173)
--------- --------- ---------
Net income (loss) $(2,933) $190,111 $144,265
========= ========= =========
Earnings per share - basic
Income (loss) from continuing operations $(.42) $1.44 $1.10
Income from discontinued operations (net of taxes) .62 .38 .24
Extraordinary item (net of taxes) (.17) (.03)
Cumulative effect (net of taxes) (.05) (.03)
----- ----- -----
Net income (loss) $(.03)* $1.76 $1.33*
===== ===== =====
Earnings per share - diluted
Income (loss) from continuing operations $(.42) $1.40 $1.06
Income from discontinued operations (net of taxes) .62 .37 .23
Extraordinary item (net of taxes) (.17) (.03)
Cumulative effect (net of taxes) (.05) (.03)
----- ----- -----
Net income (loss) $(.03)* $1.71 $1.29
===== ===== =====
Weighted average shares:
Basic 108,958 108,159 108,337
Diluted 108,958 110,881 111,964
*Doesn't add due to rounding.
</TABLE>
See accompanying notes.
29
<PAGE> 32
HCR MANOR CARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31
----------------------
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $(2,933) $190,111 $144,265
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Income from discontinued operations (67,905) (41,209) (25,626)
Depreciation and amortization 119,329 113,268 101,130
Asset impairment and other non-cash charges 191,745 26,300
Provision for bad debts 39,485 50,196 21,834
Deferred income taxes (32,673) 41,586 3,115
Gain on sale of assets (6,545) (2,058) (7,321)
Minority interest 443 (13,245) (2,169)
Equity in earnings of affiliated companies (5,376) (2,806) (1,500)
Changes in assets and liabilities, excluding sold facilities and acquisitions:
Receivables (83,798) (107,732) (77,905)
Prepaid expenses and other assets 17,679 (23,188) (4,758)
Liabilities (34,048) (32,696) 37,002
-------- -------- --------
Total adjustments 138,336 (17,884) 70,102
-------- -------- --------
Net cash provided by continuing operations 135,403 172,227 214,367
Net cash provided by (used in) discontinued operations 17,836 (8,440) 81,034
-------- -------- --------
Net cash provided by operating activities 153,239 163,787 295,401
-------- -------- --------
INVESTING ACTIVITIES
Investment in property and equipment (295,578) (223,876) (194,918)
Investment in systems development (22,158) (29,110) (17,227)
Acquisitions (9,841) (98,381) (58,750)
Proceeds from sale of assets 24,137 6,680 17,283
(Advances to) payments from non-consolidated affiliates (2,799) 213,133 2,921
Decrease due to deconsolidation of subsidiary (13,948)
Other, net (6,847) 3,469 (22,520)
-------- -------- --------
Net cash used in investing activities of continuing operations (327,034) (128,085) (273,211)
Net cash used in investing activities of discontinued operations (6,810) (83,524) (134,385)
-------- -------- --------
Net cash used in investing activities (333,844) (211,609) (407,596)
-------- -------- --------
FINANCING ACTIVITIES
Net borrowings under bank credit agreements 191,940 186,093 7,451
Issuance of debentures 150,000
Principal payments of long-term debt (6,788) (47,064) (1,896)
Payment of debentures (146,100) (9,900)
Proceeds from exercise of stock options 3,120 11,894 13,120
Purchase of common stock for treasury (4,838) (47,707) (46,331)
Dividends paid by Manor Care (2,805) (6,141) (5,519)
-------- -------- --------
Net cash provided by (used in) financing activities of continuing operations 180,629 (49,025) 106,925
Net cash provided by (used in ) financing activities of discontinued operations (11,026) 91,964 17,128
-------- -------- --------
Net cash provided by financing activities 169,603 42,939 124,053
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (11,002) (4,883) 11,858
Net Manor Care cash flows for December 1997 (3,213)
Cash and cash equivalents at beginning of period 47,933 52,816 40,958
-------- -------- --------
Cash and cash equivalents at end of period $33,718 $47,933 $52,816
======== ======== ========
</TABLE>
See accompanying notes.
30
<PAGE> 33
HCR MANOR CARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Capital Total
Common Stock in Excess Treasury Stock Stock-
------------ of Par Retained -------------- holders'
Shares Amount Value Earnings Shares Amount Equity
------ ------ ----- -------- ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996 114,461 $6,888 $435,063 $695,840 (5,429) $(87,483) $1,050,308
Vesting of restricted stock 1,012 1,012
Purchase of treasury stock (1,805) (46,331) (46,331)
Exercise of stock options 370 35 10,597 (3,670) 370 6,299 13,261
Tax benefit from restricted stock
and exercise of stock options 3,646 3,646
Effect of HCR's 50% stock
distribution 163 (163)
Net income 144,265 144,265
Dividend of discontinued lodging
segment (167,289) (167,289)
Manor Care cash dividends
($.088 per share) (5,519) (5,519)
Other 745 592 1,337
------- ------ -------- -------- -------- -------- ----------
Balance at December 31, 1996 114,831 7,086 450,900 664,219 (6,864) (127,515) 994,690
Purchase of treasury stock (1,493) (48,104) (48,104)
Exercise of stock options 1,037 113 9,018 (4,908) 512 8,980 13,203
Tax benefit from restricted stock
and exercise of stock options 7,504 7,504
Net income 190,111 190,111
Dividend of discontinued lodging
segment 7,151 7,151
Manor Care cash dividends
($.088 per share) (6,141) (6,141)
Other 4,508 107 4,615
------- ------ -------- -------- -------- -------- ----------
Balance at December 31, 1997 115,868 7,199 471,930 850,539 (7,845) (166,639) 1,163,029
Adjustment to conform Manor
Care's fiscal year 9 121 4,627 4,748
Issue and vesting of restricted stock 339 3 13,110 13,113
Purchase of treasury stock (369) (16,056) (16,056)
Exercise of stock options 218 6 2,138 (6,993) 577 10,742 5,893
Tax benefit from restricted stock
and exercise of stock options 34,997 34,997
Net loss (2,933) (2,933)
Manor Care cash dividends
($.044 per share) (2,805) (2,805)
Exchange of Manor Care common
stock and stock options for
HCR Manor Care common stock (5,488) (6,099) (165,854) 7,637 171,953
Other (109) (709) (818)
------- ------ -------- -------- -------- -------- ----------
Balance at December 31, 1998 110,946 $1,109 $356,333 $841,726 $1,199,168
======= ====== ======== ======== ======== ======== ==========
</TABLE>
See accompanying notes.
31
<PAGE> 34
HCR MANOR CARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS COMBINATION AND BASIS OF PRESENTATION
On September 24, 1998, the stockholders of Health Care and Retirement
Corporation (HCR) and the stockholders of Manor Care, Inc. (Manor Care)
separately approved the merger of the companies, effective September 25, 1998.
In accordance with the Amended and Restated Agreement and Plan of Merger (the
Merger Agreement) dated June 10, 1998, each share of Manor Care common stock was
converted into one share of HCR common stock for a total of approximately 63.9
million shares, and Manor Care stock options outstanding were converted into
approximately 2.1 million shares of HCR common stock based on the option pricing
formula defined in the Merger Agreement. As a result of the transaction, Manor
Care became a wholly owned subsidiary of HCR and HCR changed its name to HCR
Manor Care, Inc. (HCR Manor Care or the Company).
The merger has been accounted for by the pooling-of-interests method.
Accordingly, the accompanying consolidated financial statements give retroactive
effect to the merger and include the combined operations for all periods
presented. The historical financial information of Manor Care (previously
reported on fiscal years ending May 31) has been restated. As of January 1,
1998, Manor Care's historical financial information has been restated to conform
with HCR's quarterly and annual reporting period for 1998. For 1997 and 1996
Manor Care's historical financial information for the twelve months ended
November 30, 1997 and 1996 were combined with HCR's annual reporting period of
December 31, 1997 and 1996, respectively. HCR Manor Care's financial position as
of December 31, 1997 consists of HCR's financial position as of December 31,
1997 combined with Manor Care's financial position as of November 30, 1997. Due
to the different fiscal yearends, Manor Care's results for the month of December
1997 are not included in the restated financial statements for 1998 or 1997. For
December 1997, Manor Care had revenues of $113.7 million, operating expenses of
$90.8 million, income from continuing operations of $6.1 million, net income of
$6.0 million and cash dividends of $1.4 million.
Summarized results of the separate companies through September 30, 1998 follow
(dollars in thousands):
<TABLE>
<CAPTION>
Manor Charge
HCR Care (see Note 3) Consolidated
--- ---- ------------ ------------
<S> <C> <C> <C> <C>
Nine months ended September 30, 1998
Revenues $683,072 $970,856 $1,653,928
Income (loss) from continuing operations 59,979 63,798 $(197,621) (73,844)
Net income (loss) 59,979 126,063 (216,657) (30,615)
Other changes in stockholders' equity 1,567 (244) 1,323
Year ended December 31, 1997
Revenues 891,963 1,336,571 2,228,534
Income from continuing operations 70,121 85,170 155,291
Net income 70,121 119,990 190,111
Other changes in stockholders' equity (29,149) 7,377 (21,772)
Year ended December 31, 1996
Revenues 782,023 1,240,687 2,022,710
Income from continuing operations 59,443 59,196 118,639
Net income 59,443 84,822 144,265
Other changes in stockholders' equity (40,839) (159,044) (199,883)
</TABLE>
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<PAGE> 35
2. ACCOUNTING POLICIES
NATURE OF OPERATIONS
HCR Manor Care is a provider of a range of health care services, including
skilled nursing care, assisted living, subacute medical care, rehabilitation
therapy, home health care and management services for subacute care,
rehabilitation therapy, vision care and eye surgery. The most significant
portion of HCR Manor Care's business relates to skilled nursing care and
assisted living, operating 360 centers in 32 states with more than half located
in Ohio, Michigan, Illinois, Pennsylvania and Florida. The Company provides
rehabilitation therapy in nursing centers of its own and others, and 82
outpatient therapy clinics serving the midwestern and mid-Atlantic states, Texas
and Florida. The home health care business specializes in all levels of home
health, hospice care and rehabilitation therapy from 71 offices located in 16
states.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of HCR Manor Care and
its majority owned subsidiaries. As a result of Manor Care's spin-off of its
lodging operations in 1996 and the merger of Vitalink Pharmacy Services, Inc.
(Vitalink) with and into Genesis Health Ventures, Inc. (Genesis) in 1998, the
accompanying consolidated financial statements reflect the lodging and pharmacy
segments as discontinued operations. Significant intercompany accounts and
transactions have been eliminated in consolidation, except for advances to the
discontinued lodging segment and the related interest income.
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 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 affiliate as they occur. Losses are limited to the
extent of the Company's investments in, advances to and guarantees for the
investee. The Company's 41% ownership interest in In Home Health, Inc. (IHHI)
and its ownership interest in certain partnerships are recorded under the equity
method.
During 1998 the Company changed the accounting for its investment in IHHI. The
Company owns 41% of the common stock and all of the preferred stock of IHHI. The
investment was consolidated until the fourth quarter of 1998 when the Company
changed to the equity method of accounting, retroactive to January 1, 1998. The
change to the equity method resulted from a Second Preferred Stock Modification
Agreement (the Agreement) between the Company and IHHI executed on December 22,
1998. Under the terms of the Agreement, the Company irrevocably waived the right
of the preferred stock to vote on an as-if-converted basis along with the common
stock, except with respect to certain protective rights. In consideration for
the Company entering into the Agreement, IHHI waived the right to pay the 12%
annual dividend on the preferred stock in the form of shares of common stock.
IHHI has historically paid this dividend in cash, and as a result of the
Agreement will continue to do so. The Agreement does not affect the voting
rights of the common stock. As a result of the Agreement, the Company no longer
has a majority voting power with respect to the election of IHHI's board of
directors.
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<PAGE> 36
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 of these entities.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
CASH EQUIVALENTS
Investments with a maturity of three months or less when purchased are
considered cash equivalents for purposes of the statements of cash flows.
RECEIVABLES AND REVENUES
Revenues are recognized when the related patient services are provided.
Receivables and revenues are stated at amounts estimated by management to be the
net realizable value.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Depreciation is provided on the
straight-line method over the estimated useful lives of the assets, generally 3
to 20 years for equipment and furnishings and 10 to 40 years for buildings and
improvements.
Direct incremental costs 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.
INTANGIBLE ASSETS
Goodwill and other intangible assets of businesses acquired are amortized by the
straight-line method over periods ranging from 5 to 15 years for noncompete
agreements, 20 to 40 years for management contracts and 20 to 40 years for
goodwill. Deferred financing costs are amortized to interest expense over the
life of the related borrowings, using the interest method.
IMPAIRMENT OF LONG-LIVED ASSETS
The carrying value of long-lived and intangible assets is reviewed quarterly to
determine if facts and circumstances suggest that the assets may be impaired or
that the amortization period may need to be changed. The Company considers
external factors relating to each asset, including contract changes, local
market developments, national health care trends and other publicly available
information. If these external factors and the projected undiscounted cash flows
of the company over the remaining amortization period indicate that the asset
will not be recoverable, the carrying value will be adjusted to the estimated
fair value. See Note 3 for further discussion of impairment charges in 1998.
34
<PAGE> 37
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 ten years.
Prior to November 1997, the Company capitalized and amortized its business
process reengineering costs related to its system projects. On November 20, 1997
a consensus was reached by the Emerging Issues Task Force regarding business
process reengineering costs (Issue 97-13) providing that all reengineering costs
be expensed as incurred. As a result, in November 1997, the Company changed its
accounting policy and expensed $3.2 million of reengineering costs (net of
taxes) as the cumulative effect of a change in accounting principle.
START-UP COSTS
Prior to 1998, the Company capitalized start-up costs and amortized the costs
over two years. In April 1998, the American Institute of Certified Public
Accountants issued Statement of Position 98-5 "Reporting on the Costs of
Start-up Activities" (SOP 98-5), which requires start-up costs to be expensed as
incurred. In the fourth quarter of 1998, the Company elected to adopt SOP 98-5
as of January 1, 1998. The cumulative effect of expensing all capitalized
start-up costs as of January 1 was $9.4 million or $5.6 million after tax.
INVESTMENT IN LIFE INSURANCE
Investment in corporate owned life insurance policies is recorded net of policy
loans in other assets. The net life insurance expense, which includes premiums
and interest on cash surrender borrowings, net of all increases in cash
surrender values, is included in operating expenses.
INTEREST RATE SWAPS
The Company enters into interest rate swap agreements to modify the interest
characteristics of its outstanding debt. Each interest rate swap agreement is
designated with all or a portion of the principal balance and term of a specific
obligation. These agreements involve the exchange of amounts based on a fixed
interest rate for amounts based on variable interest rates over the life of the
agreement without an exchange of the notional amount upon which the payments are
based. The differential to be paid or received as interest rates change is
accrued and recognized as an adjustment of interest expense related to the debt.
The fair value of the swap agreements and changes in the fair value as a result
of changes in market interest rates are not recognized in the financial
statements.
Gains and losses on terminations of interest rate swap agreements are deferred
as an adjustment to the carrying amount of the outstanding debt and amortized as
an adjustment to interest expense related to the debt over the remaining term of
the original contract life of the terminated swap agreement. In the event of the
early extinguishment of a designated debt obligation and its associated interest
rate swap, any realized or unrealized gain or loss from the swap would be
recognized in income coincident with the extinguishment gain or loss.
ADVERTISING EXPENSE
The cost of advertising is expensed as incurred. The Company incurred $20.3
million, $12.7 million and $13.1 million in advertising costs for the years
ended December 31, 1998, 1997 and 1996, respectively.
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<PAGE> 38
TREASURY STOCK
The Company records the purchase of its common stock for treasury at cost. The
treasury stock is reissued on a first-in, first-out method. If the proceeds from
reissuance of treasury stock exceeds the cost of the treasury stock, the gain is
recorded in capital in excess of par value. If the cost of the treasury stock
exceeds the proceeds from reissuance of the treasury stock, the loss is first
charged against any gains previously recorded in capital in excess of par value
and any remainder is charged to retained earnings.
STOCK BASED COMPENSATION
Stock options are granted for a fixed number of shares to employees with an
exercise price equal to the fair value of the shares at the date of grant. The
Company accounts for the stock option grants in accordance with APB Opinion No.
25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes no
compensation expense for the stock options.
EARNINGS PER SHARE
Basic earnings per share (EPS) is computed by dividing net income (income
available to common stockholders) by the weighted-average number of common
shares outstanding during the period. The computation of diluted EPS is similar
to basic EPS except that the number of shares is increased to include the number
of additional common shares that would have been outstanding if the dilutive
potential common shares had been issued. Dilutive potential common shares for
the Company include shares issuable upon exercise of the Company's nonqualified
stock options and restricted stock that has not vested.
NEW ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (FAS 133), which
is effective January 1, 2000. This Statement permits early adoption as of the
beginning of any fiscal quarter after its issuance. This Statement will require
the Company to recognize all derivatives on the balance sheet at fair value.
Management has not determined when it will adopt this Statement nor has it
determined the impact of adoption.
3. RESTRUCTURING CHARGE, MERGER EXPENSES, ASSET IMPAIRMENT AND OTHER
CHARGES
In 1998 the Company recorded a $278.3 million charge related to restructuring,
merger expenses, asset impairment and other related charges. In the second
quarter Manor Care recorded a charge of $13.5 million in connection with its
plan to separate its skilled nursing, assisted living and home health businesses
from its skilled nursing facility management, real estate and healthcare
facility development business. As a result of the merger with HCR, the
separation of Manor Care's businesses did not occur. Charges related to the
merger of HCR and Manor Care totaled $134.7 million. In connection with the
merger, HCR Manor Care developed a plan to integrate the businesses of both
companies that includes closing Manor Care's corporate office in Gaithersburg,
Maryland and realigning the operating divisions from eight to six. The remaining
$130.0 million of the charge related to other unusual costs as a result of the
merger and asset impairment unrelated to the restructuring. The liability
outstanding at December 31, 1998 relating to these charges is recorded in other
accrued liabilities.
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<PAGE> 39
The components consist of the following (in thousands):
<TABLE>
<CAPTION>
Cash/ Liability
Non-cash Charge Activity at 12/31/98
-------- ------ -------- -----------
<S> <C> <C> <C>
Manor Care planned spin-off:
Employee benefits cash $5,917 $(5,300) $617
Transaction costs cash 6,805 (6,805)
Write-down of assets non-cash 778 (778)
-------- --------- -------
13,500 (12,883) 617
-------- --------- -------
HCR and Manor Care merger:
Employee benefits cash 41,028 (12,734) 28,294
Deferred compensation non-cash 11,867 (11,867)
Other exit costs cash 4,234 4,234
Merger transaction costs cash 21,122 (21,122)
Write-down of assets non-cash 56,468 (56,468)
-------- --------- -------
134,719 (102,191) 32,528
-------- --------- -------
Other costs:
Amortization non-cash 7,863 (7,863)
Duplicate costs cash 5,725 (5,725)
Other cash 1,685 (685) 1,000
Asset impairment unrelated to merger non-cash 114,769 (114,769)
-------- --------- -------
130,042 (129,042) 1,000
-------- --------- -------
Total $278,261 $(244,116) $34,145
======== ========= =======
</TABLE>
In Manor Care's planned spin-off of its non-healthcare businesses a total of 208
employees were terminated. The employees did not receive a lump-sum severance
payment upon termination but receive their severance as biweekly payments
through 1999. The transaction costs primarily included financial advisory, legal
and accounting fees and expenses, and printing and mailing costs.
In the HCR and Manor Care merger, the employee benefit costs related to
severance payments and retention bonuses for 505 corporate employees and 26
field employees of Manor Care who received termination notices. A total of 364
employees have left the Company as of December 31, 1998 but 269 employees
continue to be paid their severance payments on a biweekly basis. The majority
of the Manor Care employees remaining with the Company at yearend have
termination dates in the first quarter of 1999. The cash severance payments will
continue through 1999. The deferred compensation expense of $11.9 million was
attributable to the lapsing of restrictions on HCR's restricted stock due to the
merger. The other exit costs pertain to various lease agreements and hardware
and software contracts that will be terminated. The merger transaction costs
primarily included financial advisory, legal and accounting fees and expenses,
and printing and mailing costs.
HCR Manor Care identified two groups of assets that were impaired as a result of
the merger. The Company has integrated the information systems of the companies
which resulted in the write-off of the net book value ($45.2 million) of Manor
Care's computer hardware and software that was no longer being utilized by the
Company as of December 31, 1998. Certain construction development project costs
($11.3 million), excluding the land value, have been abandoned due to a change
in strategy.
The Company recorded other unusual costs as a result of the merger. The non-cash
charge primarily related to the amortization of certain Manor Care software
applications which are being used until the transition to HCR applications. The
carrying value of the software is being amortized over its estimated useful life
ranging from six to nine months. Certain general and administrative costs of
$5.7 million represented salaries and benefits for employees performing
duplicative
37
<PAGE> 40
services in Toledo or Gaithersburg.
The Company also recorded a charge for impairment of certain assets based on its
quarterly review of long-lived and intangible assets. The charge of $114.8
million consisted of a majority of the goodwill related to the Company's program
management service business, all of the goodwill related to the Company's home
health businesses, the intangible assets related to six of the Company's
rehabilitation businesses, a majority of the fixed assets related to seven
facilities and certain assets relating to the Company's vision management
businesses. A significant feature of the Company's evaluation is the evolving
impact of the Balanced Budget Act of 1997 (Budget Act) under which a new
Medicare prospective payment system (PPS) commenced on July 1, 1998 and an
interim payment system (IPS) for home health businesses commenced on October 1,
1997 for the Company. PPS is scheduled to replace IPS for home health
reimbursement in October 2000. These new reimbursement systems have had an
unfavorable impact on the program management service, home health and vision
management businesses resulting in an impairment loss. The write-off of the
facility fixed assets and the rehabilitation company intangible assets resulted
from specific entities which were not generating cash flow despite efforts by
the Company to return the operations to a level of profitability. The estimated
fair value of the impaired assets was based on a multiple of projected annual
earnings.
Manor Care recorded a provision of $26.3 million in 1996 related to impairment
of certain long-lived assets ($21.2 million) and costs associated with Manor
Care's restructuring of its healthcare business ($5.1 million). The non-cash
asset impairment charges were attributable to write-downs of property, equipment
and capitalized system development costs.
4. ACQUISITIONS/DIVESTITURES
In December 1998 the Company entered into an agreement to sell 29 facilities to
Alternative Living Services, Inc. (Alterra) for approximately $200 million in
cash which is expected to be completed in the first half of 1999.
The Company paid $9.8 million, $68.4 million and $58.8 million in 1998, 1997 and
1996, respectively, for the acquisition of rehabilitation therapy businesses,
skilled nursing centers and management services agreements. The acquisitions
were accounted for under the purchase method of accounting. Certain of these
agreements contain a provision for additional consideration contingent upon the
future financial results of the business. The maximum contingent consideration
aggregates $37.1 million and will, if earned, be paid over the next four years
and treated as additions to the purchase price of the businesses. The results of
operations of the acquired businesses are included in the consolidated
statements of income from the date of acquisition. The pro forma consolidated
results of operations would not be materially different from the amounts
reported in 1998 and 1997. The Company also acquired 1.5 million shares of
Vitalink Pharmacy Services, Inc. common stock for $30.0 million in 1997.
During 1998 the Company sold two assisted living facilities for $4.7 million and
three corporate office buildings for $16.5 million. During 1997 the Company sold
one corporate office building for $6.7 million. During 1996 the Company sold
four skilled nursing centers for $17.3 million.
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<PAGE> 41
5. DISCONTINUED LODGING OPERATIONS
On November 1, 1996, Manor Care completed the spin-off of its lodging segment.
Manor Care'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 1996.
For the year ended December 31, 1996, the financial results from the
discontinued lodging operations are as follows: revenue of $374.0 million,
income before income taxes of $23.4 million and net income of $13.2 million.
Included in the discontinued lodging operations is interest expense charged by
Manor Care 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 December 31, 1997 and 1996, interest
allocated amounted to $16.1 million and $20.3 million, respectively. Total
advances amounted to $225.7 million which were prepaid in full in 1997.
6. DISCONTINUED PHARMACY OPERATIONS
A subsidiary of Manor Care owned approximately 50% of Vitalink Pharmacy
Services, Inc. (Vitalink) common stock. On April 26, 1998 Vitalink entered into
an Agreement and Plan of Merger (Vitalink Merger Agreement) with Genesis Health
Ventures, Inc. (Genesis). Pursuant to the Vitalink Merger Agreement, on August
29, 1998, Manor Care received .045 shares of Series G Cumulative Convertible
Preferred Stock of Genesis (Genesis Preferred Stock) for each share of Vitalink
common stock. Manor Care received 586,240 preferred shares valued at $293.1
million as consideration for all of its common stock of Vitalink. As a result of
the conversion of stock, the Company recorded a gain of $99.8 million ($59.9
million after tax). Accordingly, the Vitalink results are reported as
discontinued operations for all periods presented.
The Genesis Preferred Stock bears cash dividends at an initial annual rate of
5.9375% which amounted to $5.8 million in 1998. Genesis Preferred Stockholders
are initially entitled to 13.441 votes per share of Genesis Preferred Stock, and
will vote together with the 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 is
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.
39
<PAGE> 42
The revenues, income from discontinued pharmacy operations before income taxes
and net income from discontinued pharmacy operations for the years ended
December 31, 1998, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Revenues (a) $381,075 $432,834 $158,014
Income from discontinued pharmacy
operations before income taxes (b) 15,300 78,201 22,383
Net income from discontinued pharmacy
operations 8,044 41,209 12,406
Gain on conversion of Vitalink stock
(net of taxes) 59,861
</TABLE>
(a) Includes sales to Manor Care's skilled nursing and assisted living
facilities of $31,828, $44,599 and $36,154 for the years ended December 31,
1998, 1997 and 1996, respectively
(b) Income from discontinued pharmacy operations before income taxes for 1997
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.
7. REVENUES
The Company receives reimbursement under the federal Medicare program and
various state Medicaid programs. Revenues under these programs totalled $1.1
billion, $1.2 billion and $1.1 billion for the years ended December 31, 1998,
1997 and 1996, respectively. In 1996, 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 the modification, the Company recognized revenues of $20.0 million in 1997,
which had been reserved in prior years. Medicare and certain Medicaid program
revenues are subject to audit and retroactive adjustment by government
representatives. In the opinion of management, any differences between the net
revenue recorded and final determination will not materially affect the
consolidated financial statements. Net third party settlements receivable
amounted to $6.4 million and $8.1 million at December 31, 1998 and 1997,
respectively. There were no non-governmental receivables which represented
amounts in excess of 10% of total receivables at December 31, 1998 and 1997.
Revenues for certain health care services are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Skilled and assisted living services $1,987,815 $1,888,578 $1,738,667
Rehabilitation services 70,522 72,645 51,992
Home health services 48,416 168,209 173,081
Other services 102,334 99,102 58,970
---------- ---------- ----------
$2,209,087 $2,228,534 $2,022,710
========== ========== ==========
</TABLE>
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<PAGE> 43
8. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
---- ----
(In thousands)
<S> <C> <C>
Land and improvements $179,481 $ 165,979
Buildings and improvements 1,615,366 1,460,863
Equipment and furnishings 369,752 357,844
Capitalized leases 32,293 32,293
Construction in progress 125,724 103,748
---------- ----------
2,322,616 2,120,727
Less accumulated depreciation 582,290 515,814
---------- ----------
Net property and equipment $1,740,326 $1,604,913
========== ==========
</TABLE>
Depreciation expense amounted to $110.8 million, $96.2 million and $88.9 million
for the years ended December 31, 1998, 1997 and 1996, respectively. Accumulated
depreciation includes $9.2 million and $8.1 million at December 31, 1998 and
1997, respectively, relating to capitalized leases.
9. DEBT
Debt consists of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
---- ----
(In thousands)
<S> <C> <C>
Five Year Agreement $476,000
364 Day Agreement 230,000
Prior credit facilities $521,941
Senior Notes, net of discount 149,555 149,490
Mortgages and other notes 68,014 78,877
Capital lease obligations (see Note 11) 6,158 8,079
-------- --------
929,727 758,387
Less:
364 Day Agreement 230,000
Amounts due within one year 6,547 7,106
-------- --------
Long-term debt $693,180 $751,281
======== ========
</TABLE>
Concurrent with the merger, a five-year, $500 million credit agreement (5 Year
Agreement) and a 364-day, $300 million credit agreement (364 Day Agreement) were
established with a group of banks, under which both HCR Manor Care and Manor
Care are borrowers. The credit agreements were established to repay borrowings
of the two companies under prior credit arrangements, as discussed below, to
provide additional credit capacity for future developments and to provide credit
back-up for the issuance of commercial paper. The credit agreements contain
various covenants, restrictions and events of default. Among other things, these
provisions require HCR Manor Care to maintain certain financial ratios and
impose certain limits on its ability to incur indebtedness, create liens, pay
dividends, repurchase stock, dispose of assets and make acquisitions.
41
<PAGE> 44
Loans under the 364 Day Agreement which mature September 24, 1999, bear interest
at variable rates that reflect, at the election of the Company, either the agent
bank's base lending rate or an increment over Eurodollar indices of .175% to
.525%, depending on the quarterly performance of a key ratio. In addition, the
364 Day Agreement provides for a fee on the total amount of the facility,
ranging from .10% to .225%, depending on the performance of the same ratio.
Loans under the 5 Year Agreement which mature September 24, 2003, bear interest
at variable rates that reflect, at the election of the Company, the agent bank's
base lending rate, rates offered by any of the participating banks under bid
procedures, or an increment over Eurodollar indices of .15% to .50%, depending
on the quarterly performance of a key ratio. In addition to direct borrowings,
the 5 Year Agreement may be used to support the issuance of up to $100 million
of letters of credit. The 5 Year Agreement also provides for a fee on the total
amount of the facility, ranging from .125% to .25%, depending on the performance
of the same key ratio.
Whenever the aggregate utilization of both credit facilities exceeds $400
million, an additional fee of .05% is due on loans. The average interest rate on
loans under the 5 Year and 364 Day Credit Agreements was 5.75% at December 31,
1998, excluding the fee on the total facility. After consideration of usage for
letters of credit, the remaining credit availability under the combined
agreements totaled $85.7 million.
On September 25, 1998, the Company repaid $264 million outstanding under HCR's
prior credit agreement and $325 million on Manor Care's prior credit
arrangements. The repayment of the prior credit facilities was accounted for as
an early extinguishment of debt. In conjunction with the extinguishment of debt,
the Company terminated three interest rate swaps with a total notional amount of
$350 million that were designated as a hedge of Manor Care's debt. The loss on
terminating the swaps along with the unamortized debt issue costs was recorded
as an extraordinary item that totaled $19.0 million after taxes of $12.7
million.
In June 1996, Manor Care issued $150 million of 7.5% Senior Notes due 2006.
These notes are redeemable at the option of Manor Care 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 the redemption. The proceeds of the offering were used to repay
borrowings under Manor Care's prior credit facility.
In November 1992, Manor Care issued $150 million of 9.5% Senior Subordinated
Notes due November 2002. In July 1996, Manor Care repurchased $9.9 million of
the Senior Subordinated Notes for $10.5 million. In November 1997, Manor Care
redeemed all outstanding Senior Subordinated Notes due 2002 at a redemption
price of 103.56% with the proceeds of borrowings under Manor Care's prior credit
facility. Manor Care recorded an extraordinary item of $3.2 million after taxes
representing the premium paid on redemption.
Interest rates on mortgages and other long-term debt ranged from 4.65% to
11.58%. Maturities range from 2000 to 2019. Owned property with a net book value
of $169.7 million was pledged or mortgaged. Interest paid on all debt amounted
to $47.1 million, $56.2 million and $40.7 million for the years ended December
31, 1998, 1997 and 1996, respectively.
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<PAGE> 45
Capitalized interest costs amounted to $8.6 million, $4.9 million and $5.7
million for the years ended December 31, 1998, 1997 and 1996, respectively.
Debt maturities for the five years subsequent to December 31, 1998 are as
follows: 1999 - $236.5 million; 2000 - $6.0 million; 2001 - $5.9 million; 2002 -
$6.1 million and 2003 - $484.1 million.
10. INTEREST RATE HEDGE
The Company entered into multiple interest rate swap agreements to hedge its
exposure to fluctuations in interest rates on certain long-term debt and
operating leases. At December 31, 1998, 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 5.6% and mature
simultaneously with the relevant operating lease in 2002. 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 repayment of Manor Care's prior credit arrangements in
September 1998, Manor Care terminated three interest rate swaps with a notional
principal amount of $350.0 million resulting in a $31.3 million cash loss. The
loss on terminating the swaps was recorded as an extraordinary item along with
the unamortized debt issue costs. These agreements effectively converted Manor
Care's interest rate exposure on certain floating rate debt to a weighted
average fixed rate of 6.53%.
In conjunction with the June 1996 issuance of $150.0 million of 7.5% Senior
Notes, Manor Care 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
7.5% 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 6.9%.
11. LEASES
The Company leases certain property and equipment under both operating and
capital leases, which expire at various dates to 2036. Certain of the facility
leases contain purchase options. Payments under noncancelable operating leases,
minimum lease payments and the present value of net minimum lease payments under
capital leases as of December 31, 1998 are as follows:
43
<PAGE> 46
<TABLE>
<CAPTION>
Operating Capital
Leases Leases
------ ------
(In thousands)
<S> <C> <C>
1999 $ 13,777 $ 1,154
2000 12,890 900
2001 11,405 753
2002 40,235 757
2003 7,374 761
Later years 40,589 12,476
------- ------
Total minimum lease payments $126,270 16,801
========
Less amount representing interest 10,643
-------
Present value of net minimum
lease payments (included in
long-term debt - see Note 9) $ 6,158
=======
</TABLE>
The operating lease amounts above include the monthly lease payments and
residual guarantees related to the new Company headquarters that was finalized
in January 1999, as well as the Manor Care headquarters in Gaithersburg,
Maryland. Rental expense was $18.0 million, $22.2 million and $16.9 million for
the years ended December 31, 1998, 1997 and 1996, respectively.
12. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Current:
Federal $46,903 $37,436 $52,443
State and local 7,367 6,042 8,619
------- ------- -------
54,270 43,478 61,062
Deferred:
Federal (27,800) 35,188 2,636
State and local (4,873) 6,398 479
-------- -------- --------
(32,673) 41,586 3,115
-------- -------- -------
Provision for income taxes from
continuing operations 21,597 85,064 64,177
Provision for income taxes from
discontinued operations 47,164 36,992 20,198
Benefit for income taxes from
extraordinary items (12,690) (2,150)
Benefit for income taxes from cumulative
effect of change in accounting principle (3,759) (2,115)
-------- -------- -------
Total provision for income taxes $52,312 $117,791 $84,375
======== ======== =======
</TABLE>
44
<PAGE> 47
The reconciliation of the amount computed by applying the statutory federal
income tax rate to income (loss) from continuing operations before income taxes
to the provision (benefit) for income taxes from continuing operations is as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Income taxes (benefit) computed at statutory rate $(8,598) $84,124 $63,986
Differences resulting from:
Write-off of nondeductible goodwill 22,028
Nondeductible transaction costs 7,217
State and local income taxes 1,621 8,086 5,914
Nondeductible compensation 2,028
Exclusion of dividends received (2,093) (672) (672)
Jobs tax credits (1,484) (765) (450)
Corporate owned life insurance (1,079) (6,455) (5,620)
Other 1,957 746 1,019
------- -------- --------
Provision for income taxes from
continuing operations $21,597 $85,064 $64,177
======= ======= =======
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. Significant components of
the Company's federal and state deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(In thousands)
<S> <C> <C>
Deferred tax assets:
Employee compensation and benefits $32,346 $22,605
Allowances for receivables and settlements 21,577 28,206
Accrued insurance reserves 11,153 12,329
Other 3,938 6,391
--------- ---------
$69,014 $69,531
========= =========
Deferred tax liabilities:
Fixed asset and intangible asset
bases differences $155,134 $181,593
Gain on Vitalink transactions 71,236 31,778
Purchased tax benefits 38,938 43,291
Pension receivable 6,867 5,983
Other 7,168 9,980
--------- ---------
$279,343 $272,625
========= =========
Net deferred tax liabilities $(210,329) $(203,094)
========= =========
</TABLE>
The income tax receivable was $6.3 million at December 31, 1998. Income taxes
paid amounted to $9.0 million, $28.5 million and $50.7 million for the years
ended December 31, 1998, 1997 and 1996, respectively.
45
<PAGE> 48
13. COMMITMENTS/CONTINGENCY
One or more subsidiaries or affiliates of Manor Care 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. Sections 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 Manor Care. The Actions
allege that Cenco transported and/or generated hazardous substances that came to
be located at the sites in question. The Company believes 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 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 Manor Care is alleged to be a potentially responsible party has not
yet been quantified. Based upon its current assessment of the likely outcome of
the Actions, the Company believes that the potential environmental liability
exposure, after consideration of insurance coverage, is approximately $5
million.
The Company is party to various other legal proceedings arising in the ordinary
course of business. The Company does not believe the results of such
proceedings, even if unfavorable to the Company, would have a material adverse
effect on its financial position.
As of December 31, 1998, the Company had contractual commitments of $72.9
million relating to its internal construction program.
46
<PAGE> 49
14. EARNINGS PER SHARE
The calculation of earnings per share (EPS) is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In thousands, except EPS)
<S> <C> <C> <C>
Numerator:
Income (loss) from continuing operations
(income available to common stockholders) $(46,162) $155,291 $118,639
Denominator:
Denominator for basic EPS - weighted-
average shares 108,958 108,159 108,337
Effect of dilutive securities:
Stock options 2,722 3,627
------- ------- -------
Denominator for diluted EPS - adjusted
weighted-average shares and assumed
conversions 108,958 110,881 111,964
======= ======= =======
Income (loss) from continuing operations:
Basic EPS $(.42) $1.44 $1.10
Diluted EPS $(.42) $1.40 $1.06
</TABLE>
In 1998 the dilutive effect of stock options would have been 2,349,000 shares.
These shares were not included in the calculation because the effect would be
antidilutive with a loss from continuing operations. Restricted stock awards of
339,500 shares in 1997 were not included in the computation of diluted EPS
because the effect would be antidilutive. Options to purchase shares of the
Company's common stock that were not included in the computation of diluted EPS
because the options' exercise price was greater than the average market price of
the common shares were: 1,091,725 shares for the 1997 calculation and 920,550
shares for the 1996 calculation
15. STOCK PLANS
The Company has stock option plans for key employees and for outside directors
which authorize the grant of options for up to 11,199,000 and 800,000 shares,
respectively. There were 3,772,792 shares available for future grant at December
31, 1998. Generally, the exercise price of each option equals the market price
of the Company's stock on the date of grant and an option's maximum term is ten
years. The options for key employees vest between three and five years and the
options for outside directors vest immediately.
47
<PAGE> 50
In accordance with Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (FAS 123), the Company has elected to
apply Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations in accounting for its plans, and
accordingly, did not recognize compensation expense for options granted in 1995
through 1998. If the Company had accounted for its 1995 through 1998 options
under the fair value method of FAS 123, net income and earnings per share would
have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In thousands, except earnings per share)
<S> <C> <C> <C>
Net income (loss) - as reported $(2,933) $190,111 $144,265
Net income (loss) - pro forma $(17,581) $186,933 $142,642
Earnings per share - as reported:
Basic $(.03) $1.76 $1.33
Diluted $(.03) $1.71 $1.29
Earnings per share - pro forma:
Basic $(.16) $1.73 $1.32
Diluted $(.16) $1.68 $1.27
</TABLE>
The pro forma effect on net income for 1998, 1997 and 1996 is not representative
of the pro forma effect on net income in future years, because it does not take
into consideration pro forma compensation expense related to grants prior to
1995 and there was additional pro forma compensation expense in 1998 as a result
of the merger. In 1998 all outstanding Manor Care options were converted, under
their original terms, into the right to receive shares of HCR Manor Care common
stock, therefore, the remaining fair value of 1995 through 1998 grants was
expensed in 1998. Also, the vesting was accelerated for stock options granted in
1996 and 1997 for certain HCR executive officers which required the remaining
fair value to be expensed in 1998.
The fair value of each option grant is estimated on the date of grant using a
Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1998, 1997 and 1996, respectively: dividend yield
of 0% for HCR for all years; dividend yield based on historical dividends of
$.088 per share annually for Manor Care, expected volatility of 28.0%, 23.3% and
15.7%; risk-free interest rates of 4.72%, 5.70% and 6.19%; and expected lives of
4.5, 7.1 and 7.1 years. The weighted average fair value of options granted is
$10.53, $13.56 and $9.56 per share in 1998, 1997 and 1996, respectively. The
option valuation model was developed for use in estimating the fair value of
traded options which have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective
assumptions including the expected stock price volatility. Since the Company's
stock options have characteristics significantly different from those of traded
options, and since variations in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options.
48
<PAGE> 51
Information regarding these option plans for 1996, 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Shares Price
------ -----
<S> <C> <C>
Options outstanding at
January 1, 1996 9,011,229 $12.42
Options granted 1,349,950 $35.67
Options forfeited (2,190,970) $18.47
Options exercised (740,260) $9.45
Adjustment as a result of the spin-off 1,454,915
----------
Options outstanding at
December 31, 1996 8,884,864 $11.79
Options granted 1,181,522 $34.65
Options forfeited (143,473) $21.67
Options exercised (1,548,968) $8.09
----------
Options outstanding at
December 31, 1997 8,373,945 $15.53
Options granted 1,808,370 $34.22
Options forfeited (256,838) $29.01
Options exercised (804,489) $7.47
Converted to stock (see Note 1) (3,313,467)
----------
Options outstanding at
December 31, 1998 5,807,521 $20.04
==========
Options exercisable at
December 31, 1996 5,326,068 $7.32
December 31, 1997 4,816,141 $9.06
December 31, 1998 3,984,996 $14.24
</TABLE>
In connection with the spin-off of Manor Care's lodging segment, the outstanding
options held by current and former employees of Manor Care as of November 1,
1996 were redenominated in both Manor Care 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.
49
<PAGE> 52
The following tables summarize information about options outstanding and options
exercisable at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding
-------------------
Weighted
Weighted Average
Range of Average Remaining
Exercise Number Exercise Contractual
Prices Outstanding Price Life
------ ----------- ----------- -----------
<S> <C> <C> <C>
$ 5 - $10 2,275,239 $ 5.90 3.0
$10 - $20 670,440 $15.21 5.4
$20 - $30 719,448 $24.54 7.4
$30 - $45 2,142,394 $35.06 8.8
---------
5,807,521 $20.04 5.9
=========
<CAPTION>
Options Exercisable
-------------------
Weighted
Range of Average
Exercise Number Exercise
Prices Exercisable Price
------ ----------- --------
<C> <C> <C>
$ 5 - $10 2,275,239 $5.90
$10 - $20 670,440 $15.21
$20 - $30 531,523 $23.40
$30 - $45 507,794 $40.78
----------
3,984,996 $14.24
=========
</TABLE>
The Company has a restricted stock plan for corporate officers and certain key
senior management employees which authorizes up to 1,892,866 restricted shares
to be issued. During 1991 HCR corporate officers were issued 892,866 restricted
shares that vested 20% of the shares each year. During 1997 executive officers
and key senior management employees were awarded 339,500 restricted shares
contingent upon the achievement during 1997 of certain performance-based
criteria. Such criteria were met at December 31, 1997. The restricted stock was
issued in January 1998 with a fair value of $38.63 after certification by the
Board of Directors that the criteria were achieved. The restrictions associated
with the restricted stock lapsed as of September 25, 1998 as a result of the
merger and the total deferred compensation expense of $11.9 million was recorded
in the provision for restructuring charge.
Compensation expense related to stock options granted in October, 1991 and
restricted stock was $12.7 million, $0.4 million and $1.0 million for the years
ended December 31, 1998, 1997 and 1996, respectively.
50
<PAGE> 53
16. EMPLOYEE BENEFIT PLANS
The Company has two qualified, defined benefit pension plans (Pension Plans).
Manor Care's and HCR's defined benefit pension plans were amended to freeze all
future benefits under the plans in 1996 and 1994, respectively. Manor Care
recognized a curtailment gain of $2.4 million in 1996 which reduced pension
expense.
The funded status of the Pension Plans is as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
(In thousands)
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year $39,857 $41,775
Interest cost 2,528 2,757
Actuarial losses 1,486 488
Benefits paid (4,573) (5,163)
------- -------
Benefit obligation at end of year 39,298 39,857
------- -------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year 60,476 53,580
Actual return on plan assets 5,962 10,953
Company contributions 100 1,106
Benefits paid (4,573) (5,163)
------- -------
Fair value of plan assets at end of year 61,965 60,476
------- -------
Funded status of the plan 22,667 20,619
Unrecognized net actuarial gains (5,971) (6,184)
------- -------
Prepaid benefit cost $16,696 $14,435
======= =======
</TABLE>
HCR's prepaid benefit was $17.4 million and $15.5 million at December 31, 1998
and 1997, respectively. Manor Care's accrued pension cost was $0.7 million and
$1.1 million at December 31, 1998 and 1997, respectively.
The components of the net pension income for the Pension Plans are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Interest cost $ 2,528 $ 2,757 $ 2,593
Service cost 3,244
Expected return on plan assets (4,691) (4,527) (4,109)
Amortization of transition asset (219)
Amortization of prior service cost 32
Curtailment gain (2,367)
------- ------- -------
Net pension income $(2,163) $(1,770) $ (826)
======= ======= =======
</TABLE>
The actuarial present value of benefit obligations is based on an average
discount rate of 7.0% and 7.22% at December 31, 1998 and 1997, respectively. The
freezing of future pension benefits eliminated any future salary increases from
the computation effective December 31,
51
<PAGE> 54
1994 for HCR and December 31, 1996 for Manor Care. During 1996 Manor Care
assumed salary increases of 4.5%. The average expected long-term rate of return
on assets is 10% and 9.35% for 1998 and 1997, respectively.
HCR has a Senior Executive Retirement Plan (SERP) which is a non-qualified plan
designed to provide pension benefits and life insurance for certain officers (20
employees). Manor Care also has a Supplemental Executive Retirement Plan (SERP)
which is a non-qualified plan designed to provide pension benefits for certain
officers (3 employees). Pension benefits are based on compensation and length of
service. The benefits under the HCR SERP are provided from a combination of the
benefits to which the corporate officers are entitled under HCR's defined
benefit pension plan and from life insurance policies that are owned by certain
officers who have assigned the corporate interest (HCR's share of premiums paid)
in the policies to HCR. HCR's share of the cash surrender value of the policies
was $22.9 million and $14.2 million at December 31, 1998 and 1997, respectively,
and was included in other assets. Manor Care's SERP is unfunded. The accrued and
unfunded liability for the combined SERP was $8.2 million and $7.1 million at
December 31, 1998 and 1997, respectively, and was included in other long-term
liabilities.
HCR maintains a savings program qualified under Section 401(k) of the Internal
Revenue Code (401(k)) and a non-qualified, unfunded deferred compensation
program. HCR contributes an amount equal to one-half of the participant's
contributions up to a maximum matching contribution of 2% or 3% of the
participant's compensation, as defined. Manor Care maintains a savings program
qualified under Section 401(k) of the Internal Revenue Code (401(k)) and a
non-qualified, deferred compensation program. Manor Care's contribution under
both plans is limited to a maximum aggregate of 6% of the annual salary of a
participant. The Company's combined expense for these plans amounted to $8.8
million, $11.3 million and $11.2 million for the years ended December 31, 1998,
1997 and 1996, respectively. The decrease in expense for 1998 was primarily due
to a decline in earnings on HCR's unfunded deferred compensation plan.
17. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount and fair value of the financial instruments are as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------- -------- -------
(In thousands)
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 33,718 $ 33,718 $ 47,933 $ 47,933
Debt, excluding capitalized leases 923,569 931,930 750,308 764,347
Interest rate swaps - liability 494 3,768
</TABLE>
The carrying amount of cash and cash equivalents is equal to its fair value due
to the short maturity of the investments.
52
<PAGE> 55
The carrying amount of debt, excluding capitalized lease obligations,
approximates its fair value due to the significant amount of variable rate debt.
The fair value is estimated using discounted cash flow analyses, based on the
Company's current incremental borrowing rates and the quoted market rate of the
Senior Notes. The fair market value for the outstanding interest rate swap
agreements was determined based on quoted market rates.
18. STOCKHOLDER RIGHTS PLAN
Each outstanding share of the Company's common stock includes an exercisable
Right which, under certain circumstances, will entitle the holder to purchase
from the Company one one-hundredth of a share of Series A Junior Participating
Preferred Stock for an exercise price of $150, subject to adjustment. The Rights
expire on May 2, 2005. Such rights will not be exercisable nor transferable
apart from the common stock until ten days after a person or group acquires 15%,
except as noted below, of the Company's common stock or initiates a tender offer
or exchange offer that would result in ownership of 15% of the Company's common
stock. In the event that the Company is merged, and its common stock is
exchanged or converted, the Rights will entitle the holders to buy shares of the
acquirer's common stock at a 50% discount. Under certain other circumstances,
the Rights can become rights to purchase the Company's common stock at a 50%
discount. The Rights may be redeemed by the Company for one cent per Right at
any time prior to the first date that a person or group acquires a beneficial
ownership of 15% of the Company's common stock.
The description and terms of the Rights are set forth in a Rights Agreement,
dated as of May 2, 1995, and amended on June 10, 1998 (Rights Agreement),
between the Company and Harris Trust and Savings Bank, as Rights Agent. Pursuant
to the Rights Agreement, the trigger percentage is raised to 20% in the case of
a Bainum Family Member or Bainum Family Entity, as defined in the Rights
Agreement.
53
<PAGE> 56
HCR MANOR CARE, INC.
SUPPLEMENTARY DATA (UNAUDITED)
SUMMARY OF QUARTERLY RESULTS
<TABLE>
<CAPTION>
Year ended December 31, 1998
----------------------------
First Second Third Fourth Year
----- ------ ----- ------ ----
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Revenues $551,149 $545,393 $557,386 $555,159 $2,209,087
Income (loss) from continuing operations before
other income (expenses) 71,674 47,142 (164,651) 45,846 11
Income (loss) from continuing operations 42,481 26,481 (142,806) 27,682 (46,162)
Income from discontinued operations (net of taxes) 4,370 3,521 60,014 67,905
Income (loss) before extraordinary item and cumulative effect 46,851 30,002 (82,792) 27,682 21,743
Net income (loss) 41,211 30,002 (101,828) 27,682 (2,933)
Earnings per share - basic:
Income (loss) from continuing operations $.39 $.24 $(1.32) $.25 $(.42)
Income from discontinued operations $.04 $.03 .55 $.62
Income (loss) before extraordinary item and cumulative effect $.43 $.28 $(.76) $.25 $.20
Earnings per share - diluted:
Income (loss) from continuing operations $.38 $.24 $(1.32) $.25 $(.42)
Income from discontinued operations $.04 $.03 .55 $.62
Income (loss) before extraordinary item and cumulative effect $.42 $.27 $(.76) $.25 $.20
<CAPTION>
Year ended December 31, 1997
----------------------------
First Second Third Fourth Year
----- ------ ----- ------ ----
<S> <C> <C> <C> <C> <C>
Revenues $546,543 $558,774 $551,677 $571,540 $2,228,534
Income from continuing operations before
other income (expenses) 65,969 65,914 53,328 69,796 255,007
Income from continuing operations 37,204 41,204 35,994 40,889 155,291
Income (loss) from discontinued operations (net of taxes) 40,512 (4,564) 2,017 3,244 41,209
Income before extraordinary item and cumulative effect 77,716 36,640 38,011 44,133 196,500
Net income 77,716 36,640 38,011 37,744 190,111
Earnings per share - basic:
Income from continuing operations $.34 $.38 $.33 $.38 $1.44
Income (loss) from discontinued operations $.38 $(.04) $.02 $.03 $.38
Income before extraordinary item and cumulative effect $.72 $.34 $.35 $.41 $1.82
Earnings per share - diluted:
Income from continuing operations $.34 $.37 $.32 $.37 $1.40
Income (loss) from discontinued operations $.37 $(.04) $.02 $.03 $.37
Income before extraordinary item and cumulative effect $.70 $.33 $.34 $.40 $1.77
</TABLE>
The summary of quarterly results represents the combined results of HCR and
Manor Care for all periods presented. See Note 1 to the consolidated financial
statements for further discussion.
During the fourth quarter of 1998, the Company changed three items which
affected the previously reported quarterly results. First the Company changed
its method of accounting for start-up costs retroactive to January 1, 1998.
Prior to 1998, start-up costs were capitalized and amortized, and during 1998
the costs were expensed as incurred. This increased expenses by $0.7 million,
$8.4
54
<PAGE> 57
million and $5.7 million in the first, second and third quarters of 1998,
respectively. Second, the Company changed its method of accounting for its
investment in In Home Health, Inc. (IHHI), effective January 1, 1998. See Note 2
to the consolidated financial statements for further discussion. Due to the
deconsolidation of IHHI in 1998, the individual income statement line items
changed, however, there is no effect on income (loss) from continuing
operations. The previously reported results included IHHI's revenues of $26.1
million, $23.3 million and $19.8 million for the first, second and third
quarters of 1998, respectively. The previously reported results included IHHI's
operating expenses of $24.9 million, $22.0 million and $18.4 million, for the
first, second and third quarters of 1998, respectively. Third, the Company
reclassified the gain on conversion of Vitalink stock of $99.8 million ($59.9
million after tax) from other income to income from discontinued operations.
In the second, third and fourth quarters of 1998, the Company recorded a
provision for restructuring charge, merger expenses, asset impairment and other
related charges of $13.5 million ($9.1 million after tax), $240.7 million
($188.5 million after tax) and $24.1 million ($15.9 million after tax),
respectively.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- -----------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------------------
Information on directors of the Registrant is incorporated herein by reference
under the heading "Election of Directors" in the Registrant's Proxy Statement
which will be filed pursuant to Regulation 14A with the Commission prior to
April 30, 1999. The names, ages, offices and positions held during the last five
years of each of the Company's executive officers is set forth below.
EXECUTIVE OFFICERS
------------------
NAME AGE OFFICE AND EXPERIENCE
- ---- --- ---------------------
PAUL A. ORMOND 49 President and Chief Executive Officer of the
Company since August 1991, Chairman of the
Board of the Company from August 1991 to
September 1998, and President and Chief
Executive Officer of Health Care and
Retirement Corporation of America (HCRA), a
subsidiary of the Company, since October
1991. Member of Class I of the Board of
Directors of the Company, with a term
expiring in 2001.
55
<PAGE> 58
M. KEITH WEIKEL 61 Senior Executive Vice President and Chief
Operating Officer of the Company since August
1991 and Senior Executive Vice President and
Chief Operating Officer of HCRA since October
1991. Member of Class III of the Board of
Directors of the Company, with a term
expiring in 2000.
GEOFFREY G. MEYERS 54 Executive Vice President and Chief Financial
Officer of the Company since August 1991,
Treasurer of the Company from August 1991 to
August 1998, and Executive Vice President and
Chief Financial Officer of HCRA since October
1991.
R. JEFFREY BIXLER 53 Vice President and General Counsel of the
Company and HCRA since November 1991 and
Secretary of the Company and HCRA since
December 1991.
NANCY A. EDWARDS 48 Vice President and General Manager of Central
Division of the Company and HCRA since
December 1993.
JEFFREY W. FERGUSON 51 Vice President and General Manager of Midwest
Division of the Company and HCRA since
February 1995; Vice President and Director of
Marketing of the Company from August 1991 to
February 1995; and Vice President and
Director of Marketing of HCRA from October
1991 to February 1995.
LARRY R. GODLA 41 Vice President of Development and
Construction of the Company since January
1999; Vice President of Construction and
Development of Manor Care, Inc. and ManorCare
Health Services, Inc.(MCHS), a subsidiary of
Manor Care, Inc., since September 1996 and
Vice President of Construction of Manor Care,
Inc. and MCHS from 1994 to September 1996.
JEFFREY A. GRILLO 40 Vice President and General Manager of
Mid-Atlantic Division of the Company and MCHS
since February 1999, Regional Director of
Operations in Mid-Atlantic District of MCHS
from 1996 to January 1999 and Regional
Director of Operations in Southeast District
of MCHS from 1994 to 1996.
56
<PAGE> 59
SPENCER C. MOLER 51 Vice President and Controller of the Company
since August 1991, Controller of HCRA since
October 1991 and Treasurer of HCRA from
October 1991 to August 1998.
RICHARD W. PARADES 42 Vice President and General Manager of
Mid-States Division of the Company and MCHS
since January 1999, District Vice President
and General Manager, Mid-States, of MCHS from
February 1997 to December 1998 and Regional
Director of Operations of Mid-States District
of MCHS from 1994 to January 1997.
F. JOSEPH SCHMITT 51 Vice President and General Manager of
Southern Division of the Company and HCRA
since December 1993.
PAUL G. SIEBEN 52 Vice President and Director of Development
and Construction of the Company since August
1991 and Vice President and Director of
Development and Construction of HCRA since
October 1991.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
Information on executive compensation is incorporated herein by reference under
the heading "Executive Compensation" in the Registrant's Proxy Statement which
will be filed with the Commission prior to April 30, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -----------------------------------------------------------------------
Information on security ownership of certain beneficial owners is incorporated
herein by reference under the heading "Security Ownership of Certain Management
and Beneficial Owners" in the Registrant's Proxy Statement which will be filed
with the Commission prior to April 30, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------
Information on certain relationships and related transactions is incorporated
herein by reference under the heading "Election of Directors" in the
Registrant's Proxy Statement which will be filed with the Commission prior to
April 30, 1999.
57
<PAGE> 60
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- -------------------------------------------------------------------------
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statements of HCR Manor Care, Inc. and
subsidiaries are filed as part of this Form 10-K in Item 8 on the pages
indicated:
Page
----
Report of Ernst & Young LLP Independent Auditors 27
Consolidated Balance Sheets - December 31, 1998 and 1997 28
Consolidated Statements of Operations -
Years ended December 31, 1998, 1997 and 1996 29
Consolidated Statements of Cash Flows -
Years ended December 31, 1998, 1997 and 1996 30
Consolidated Statements of Stockholders' Equity -
Years ended December 31, 1998, 1997 and 1996 31
Notes to Consolidated Financial Statements - December 31, 1998 32
The following consolidated financial statement schedule of HCR Manor Care, Inc.
and subsidiaries is included in this Form 10-K on page 59:
Schedule II Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
58
<PAGE> 61
HCR MANOR CARE, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
<TABLE>
<CAPTION>
Charged Additions
Balance at to Costs Deduc- From Balance
Beginning Other and tions Acquisi- at End of
of Period (Note 1) Expenses (Note 2) tions Period
---------- -------- -------- -------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Year ended December 31, 1998:
Deducted from asset accounts:
Allowance for doubtful accounts $52,590 $(469) $39,485 $(33,481) $58,125
======= ====== ======= ========= =======
Year ended December 31, 1997:
Deducted from asset accounts:
Allowance for doubtful accounts $39,136 $34,745 $(22,431) $1,140 $52,590
======= ======= ========= ====== =======
Year ended December 31, 1996:
Deducted from asset accounts:
Allowance for doubtful accounts $32,097 $21,834 $(16,088) $1,293 $39,136
======= ======= ========= ====== =======
</TABLE>
(1) Amount includes $1,725,000 for Manor Care's December 1997 net activity
offset by the removal of In Home Health, Inc.'s (IHHI) allowance for doubtful
accounts of $2,194,000 as of January 1, 1998 due to the deconsolidation of IHHI.
(2) Uncollectible accounts written off, net of recoveries.
59
<PAGE> 62
EXHIBITS
S-K Item 601
No. Document
- --------------
2.1 -- Amended and Restated Agreement and Plan of Merger, dated as
of June 10, 1998, by and among Manor Care, Inc., Catera
Acquisition Corp. and the Registrant (filed as Annex A to the
Registrant's Registration Statement on Form S-4, File No.
333-61677 and incorporated herein by reference).
3.1 -- Certificate of Incorporation of Health Care and Retirement
Corporation (filed as Exhibit 4.1 to the Registrant's
Registration Statement on Form S-1, File No. 33-42535 and
incorporated herein by reference).
3.2 -- Form of Certificate of Amendment of Certificate of
Incorporation of the Registrant (filed as Annex D to the
Registrant's Registration Statement on Form S-4, File No.
333-61677 and incorporated herein by reference).
3.3 -- Form of Amended and Restated By-laws of the Registrant (filed
as Annex E to the Registrant's Registration Statement on Form
S-4, File No. 333-61677 and incorporated herein by
reference).
4.1 -- Rights Agreement, dated as of May 2, 1995, between Health
Care and Retirement Corporation and Harris Trust and Savings
Bank (filed as Exhibit 1 to the Registrant's Registration
Statement on Form 8-A and incorporated herein by reference).
4.2 -- Second Rights Agreement dated as of June 10, 1998 between
Health Care and Retirement Corporation and Harris Trust and
Savings Bank (filed as Exhibit 4.1 to the Registrant's Form
8-K filed on October 1, 1998 and incorporated herein by
reference).
4.3 -- Registration Rights Amendment dated as of September 25, 1998
between HCR Manor Care, Inc. and Stewart Bainum, Stewart
Bainum, Jr., Bainum Associates Limited Partnership, MC
Investment Limited Partnership, Realty Investment Company,
Inc., Mid Pines Associates Limited Partnership, The Stewart
Bainum Declaration of Trust and The Jane L. Bainum
Declaration of Trust (filed as Exhibit 4.2 to the
Registrant's Form 8-K filed on October 1, 1998 and
incorporated herein by reference).
4.4 -- Credit Agreement dated as of September 25, 1998 among HCR
Manor Care, Inc., Manor Care, Inc., Bank of America National
Trust and Savings Association, The Chase Manhattan Bank, TD
Securities (USA) Inc., and the Other Financial Institutions
Party Hereto (filed as Exhibit 4 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1998 and incorporated herein by reference).
4.5 -- 364 Credit Amendment dated as of September 25, 1998 among HCR
Manor Care, Inc., Manor Care, Inc., Bank of America National
Trust and Savings Association, The Chase Manhattan Bank, TD
Securities (USA) Inc., and the Other Financial Institutions
Party Hereto (filed as Exhibit 4.1 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1998 and incorporated herein by reference).
4.6 -- Indenture dated as of June 4, 1996 between Manor Care, Inc.
and Wilmington Trust Company, Trustee (filed as Exhibit 4.1
to Manor Care, Inc.'s Form 8-K dated June 4, 1996 and
incorporated herein by reference).
4.7 -- Supplemental Indentures dated as of June 4, 1996 between
Manor Care, Inc. and Wilmington Trust Company, Trustee (filed
as Exhibit 4.2 to Manor Care, Inc.'s Form 8-K dated June 4,
1996 and incorporated herein by reference).
10.1 -- Stock Purchase Agreement and amendment among HCR, HCRC Inc.,
O-I Health Care Holding Corp. and Owens-Illinois, Inc. dated
as of August 30, 1991 (filed as Exhibit 10.1
60
<PAGE> 63
and 10.1(a) to the Registrant's Registration Statement on
Form S-1, File No. 33-42535 and incorporated herein by
reference).
10.2 -- Form of Annual Incentive Award Plan (filed as Exhibit 10.2 to
the Registrant's Registration Statement on Form S-1, File No.
33-42535 and incorporated herein by reference).
10.3 -- Performance Award Plan (filed on pages A1 to A4 of the
Registrant's Proxy Statement dated March 22, 1994 in
connection with its Annual Meeting held on May 3, 1994 and
incorporated herein by reference).
10.4 -- Amended Stock Option Plan for Key Employees (filed as Exhibit
4 to the Registrant's Registration Statement on Form S-8,
File No. 33-83324 and incorporated herein by reference).
10.5 -- First Amendment, Second Amendment and Third Amendment to
the Amended Stock Option Plan for Key Employees (filed as
Exhibits 4.1, 4.2 and 4.3, respectively, to the Registrant's
Registration Statement on Form S-8, File No. 333-64181 and
incorporated herein by reference).
10.6 -- Revised form of Non-Qualified Stock Option Agreement between
HCR and various Key Employees participating in the Stock
Option Plan for Key Employees (filed as Exhibit 4.7 to the
Registrant's Registration Statement on Form S-8, File
No.33-48885 and incorporated herein by reference).
10.7 -- Amended Restricted Stock Plan (filed on pages A1 to A9 of the
Registrant's Proxy Statement dated March 25, 1997 in
connection with its Annual Meeting held on May 6, 1997 and
incorporated herein by reference).
10.8 -- First Amendment to Amended Restricted Stock Plan (filed as
Exhibit 4.2 to the Registrant's Registration Statement on
Form S-8, File No. 333-64235 and incorporated herein by
reference).
10.9 -- Revised form of Restricted Stock Plan Agreement between HCR
and officers participating in Restricted Stock Plan (filed as
Exhibit 10.7(a) to the Registrant's Registration Statement on
Form S-1, File No. 33-42535 and incorporated herein by
reference).
10.10 -- Executive Officer Deferred Compensation Plan dated December
18, 1991 (filed as Exhibit 10.12 to the Registrant's Annual
Report on Form 10-K for the period ended December 31, 1991
and incorporated herein by reference).
10.11 -- Form of Indemnification Agreement between HCR and various
officers and directors (filed as Exhibit 10.9 to the
Registrant's Registration Statement on Form S-1, File No.
33-42535 and incorporated herein by reference).
10.12 -- Senior Executive Retirement Plan dated October 1, 1992 (filed
as Exhibit 10.15 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1992 and incorporated
herein by reference).
10.13 -- Senior Management Savings Plan dated December 17, 1992 (filed
as Exhibit 10.16 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1992 and incorporated
herein by reference).
10.14 -- Manor Care, Inc.'s Severance Plan for Selected Employees
(filed as Exhibit 10.11 to Manor Care, Inc.'s Annual Report
on Form 10-K for the year ended May 31, 1998 and incorporated
herein by reference).
10.15 -- Manor Care, Inc.'s Form of Executive Cash Incentive Plan
(filed as Exhibit 10.2 to Manor Care, Inc.'s Annual Report on
Form 10-K for the year ended May 31, 1995 and incorporated
herein by reference).
10.16 -- Form of Second Amended Employment Agreement between the
Registrant, HCRA, and
61
<PAGE> 64
Paul A. Ormond (filed as Exhibit 10.9 to the Registrant's
Annual Report on Form 10-K for the year ended December 31,
1997 and incorporated herein by reference).
10.17 -- Form of Second Amended Employment Agreement between the
Registrant, HCRA and M. Keith Weikel (filed as Exhibit 10 to
the Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998 and incorporated herein by
reference).
10.18 -- Form of Second Amended Employment Agreement between the
Registrant, HCRA and Geoffrey G. Meyers (filed as Exhibit
10.11 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1997 and incorporated herein by
reference).
10.19 -- Form of Second Amended Employment Agreement between the
Registrant, HCRA and R. Jeffrey Bixler (filed as Exhibit
10.12 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1997 and incorporated herein by
reference).
10.20 -- Form of Executive Retention Agreement among the Registrant,
HCRA and Paul A. Ormond (filed as Exhibit 10.1 to the
Registrant's Registration Statement on Form S-4, File No.
333-61677 and incorporated herein by reference).
10.21 -- Form of Executive Retention Agreement among the Registrant,
HCRA and M. Keith Weikel (filed as Exhibit 10.2 to the
Registrant's Registration Statement on Form S-4, File No.
333-61677 and incorporated herein by reference).
10.22 -- Form of Executive Retention Agreement among the Registrant,
HCRA and Geoffrey G. Meyers (filed as Exhibit 10.3 to the
Registrant's Registration Statement on Form S-4, File No.
333-61677 and incorporated herein by reference).
10.23 -- Form of Executive Retention Agreement among the Registrant,
HCRA and R. Jeffrey Bixler (filed as Exhibit 10.4 to the
Registrant's Registration Statement on Form S-4, File No.
333-61677 and incorporated herein by reference).
10.24 -- Form of Retention Agreement among the Registrant, Manor Care,
Inc. and Stewart Bainum, Jr. (filed as Exhibit 10.13 to Manor
Care, Inc.'s Annual Report on Form 10-K for the year ended
May 31, 1998 and incorporated herein by reference).
10.25 -- Form of Noncompetition Agreement among the Registrant, Manor
Care, Inc. and Stewart Bainum, Jr.(filed as Exhibit 10.12 to
Manor Care, Inc.'s Annual Report on Form 10-K for the year
ended May 31, 1998 and incorporated herein by reference).
10.26 -- Form of Chairman's Service Agreement between the Registrant
and Stewart Bainum, Jr. (filed as Exhibit 10.7 to the
Registrant's Registration Statement on Form S-4, File No.
333-61677 and incorporated herein by reference).
10.27 -- Stock Option Plan for Outside Directors (filed as Exhibit 4.4
to the Registrant's Registration Statement on Form S-8, File
No. 33-48885 and incorporated herein by reference).
10.28 -- First Amendment, Second Amendment and Third Amendment to the
Stock Option Plan for Outside Directors (filed as Exhibits
4.4, 4.5 and 4.6, respectively, to the Registrant's
Registration Statement on Form S-8, File No. 333-64181 and
incorporated herein by reference).
10.29 -- Form of Non-Qualified Stock Option Agreement between HCR and
various outside directors participating in Stock Option Plan
for Outside Directors (filed as Exhibit 4.6 to the
Registrant's Registration Statement on Form S-8, File No.
33-48885 and incorporated herein by reference).
10.30 -- Manor Care, Inc.'s Non-Employee Director Stock Compensation
Plan (filed as Exhibit A to Manor Care, Inc.'s Proxy
Statement dated August 28, 1996 which is Exhibit 99 to the
Annual Report on Form 10-K for the year ended May 31, 1997
and incorporated herein by reference).
62
<PAGE> 65
*21 -- Subsidiaries of the Registrant
*23 -- Consent of Independent Auditors
*27.1 -- Financial Data Schedule for the year ended December 31, 1998
*27.2 -- Financial Data Schedules that are being restated for the
three months ended March 31, 1998, the six months ended June
30, 1998 and the nine months ended September 30, 1998.
*27.3 -- Financial Data Schedule that is being restated for the year
ended December 31, 1997.
REPORTS ON FORM 8-K
On October 1, 1998, HCR Manor Care, Inc. filed a Form 8-K announcing the
consummation of the merger between HCR and Manor Care.
- ------------
* Filed herewith.
63
<PAGE> 66
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.
HCR MANOR CARE, INC.
(Registrant)
by /s/ R. Jeffrey Bixler
--------------------------------
R. Jeffrey Bixler
Vice President, General Counsel and Secretary
DATE: March 29, 1999
64
<PAGE> 67
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of HCR Manor Care, Inc.
and in the capacities and on the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Stewart Bainum, Jr.
- -------------------------------
Stewart Bainum, Jr. Chairman of the Board, Director March 29, 1999
/s/ Joseph H. Lemieux
- -------------------------------
Joseph H. Lemieux Director March 29, 1999
/s/ William H. Longfield
- -------------------------------
William H. Longfield Director March 25, 1999
/s/ Frederic V. Malek
- -------------------------------
Frederic V. Malek Director March 29, 1999
/s/ Geoffrey G. Meyers
- -------------------------------
Geoffrey G. Meyers Executive Vice President and Chief Financial
Officer (Principal Financial Officer) March 29, 1999
/s/ Spencer C. Moler
- -------------------------------
Spencer C. Moler Vice President and Controller (Principal
Accounting Officer) March 29, 1999
/s/ Paul A. Ormond
- -------------------------------
Paul A. Ormond President and Chief Executive Officer
(Principal Executive Officer); Director March 29, 1999
/s/ Robert G. Siefers
- -------------------------------
Robert G. Siefers Director March 29, 1999
/s/ M. Keith Weikel
- -------------------------------
M. Keith Weikel Senior Executive Vice President and
Chief Operating Officer; Director March 29, 1999
/s/ Gail R. Wilensky
- -------------------------------
Gail R. Wilensky Director March 29, 1999
/s/ Thomas L. Young
- -------------------------------
Thomas L. Young Director March 29, 1999
</TABLE>
65
<PAGE> 68
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
21 Subsidiaries of the Registrant
23 Consent of Independent Auditors
27.1 Financial Data Schedule for the year ended December
31, 1998
27.2 Financial Data Schedules that are being restated for
the three months ended March 31, 1998, the six months
ended June 30, 1998 and the nine months ended
September 30, 1998.
27.3 Financial Data Schedule that is being restated for the year
ended December 31, 1997.
66
<PAGE> 1
EXHIBIT 21
HCR Manor Care, Inc.
Subsidiaries of the Company
HCR Manor Care, Inc. is a Delaware corporation. The following list sets forth
the principal subsidiaries of the Company and the place of their incorporation.
Except as otherwise noted, all of these subsidiaries are directly or indirectly
wholly owned by the Company.
1. ManorCare Health Services, Inc., a Delaware corporation - includes 68
active omitted subsidiaries operating in the United States and
providing health care services.
2. New ManorCare Health Services, Inc., a Delaware corporation - includes
19 active omitted subsidiaries operating in the United States and
providing health care services.
3. Four Seasons Nursing Centers, Inc., a Delaware corporation.
4. Health Care and Retirement Corporation of America, an Ohio corporation
- includes 19 active omitted subsidiaries operating in the United
States and providing health care services.
5. Heartland Rehabilitation Services, Inc., an Ohio corporation - includes
22 active omitted subsidiaries operating in the United States and
providing health care services.
6. HCR Home Health Care and Hospice, Inc., an Ohio corporation - includes
2 active omitted subsidiaries operating in the United States and
providing health care services.
7. In Home Health, Inc., a Minnesota corporation, of which the Company
owns 41% of its common stock and all of its preferred stock.
8. MileStone Healthcare, Inc., a Delaware corporation.
9. Community Hospital of Mesquite, Inc., a Texas corporation.
10. Genesis Health Ventures, Inc., a Pennsylvania corporation, of which the
Company effectively controls approximately 18% of the voting capital
stock.
11. MNR Finance Corp., a Delaware corporation.
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8, No. 33-44257) pertaining to the Health Care and Retirement Corporation of
America Stock Purchase and Savings Program of Health Care and Retirement
Corporation (HCR), the Registration Statement (Form S-8, No. 33-48885)
pertaining to the Health Care and Retirement Corporation Stock Option Plan for
Outside Directors and the Stock Option Plan for Key Employees of HCR, the
Registration Statement (Form S-8, No. 33-83324) pertaining to the Health Care
and Retirement Corporation Amended Stock Option Plan for Key Employees of HCR,
the Registration Statement (Form S-8, No. 33-87640) pertaining to the HCR Stock
Purchase and Retirement Savings Plan (formerly known as Health Care and
Retirement Corporation of America Stock Purchase and Savings Program) of HCR,
the Registration Statement (Form S-8, No.333-64181) pertaining to the Health
Care and Retirement Corporation Stock Option Plan for Outside Directors and the
Stock Option Plan for Key Employees of HCR and the Registration Statement (Form
S-8, No. 333-64235) pertaining to the Health Care and Retirement Corporation
Amended Restricted Stock Plan of HCR of our report dated January 28, 1999, with
respect to the consolidated financial statements and schedule of HCR Manor Care,
Inc. included in the Annual Report (Form 10-K) for the year ended December 31,
1998.
ERNST & YOUNG LLP
Toledo, Ohio
March 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 33,718
<SECURITIES> 0
<RECEIVABLES> 373,008
<ALLOWANCES> 58,125
<INVENTORY> 0
<CURRENT-ASSETS> 417,756
<PP&E> 2,322,616
<DEPRECIATION> 582,290
<TOTAL-ASSETS> 2,715,140
<CURRENT-LIABILITIES> 503,711
<BONDS> 693,180
0
0
<COMMON> 1,109
<OTHER-SE> 1,198,059
<TOTAL-LIABILITY-AND-EQUITY> 2,715,140
<SALES> 0
<TOTAL-REVENUES> 2,209,087
<CGS> 0
<TOTAL-COSTS> 1,715,575
<OTHER-EXPENSES> 119,223
<LOSS-PROVISION> 39,485
<INTEREST-EXPENSE> 46,587
<INCOME-PRETAX> (24,565)
<INCOME-TAX> 21,597
<INCOME-CONTINUING> (46,162)
<DISCONTINUED> 67,905
<EXTRAORDINARY> (19,036)
<CHANGES> (5,640)
<NET-INCOME> (2,933)
<EPS-PRIMARY> (0.03)
<EPS-DILUTED> (0.03)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998 DEC-31-1998
<PERIOD-START> JAN-01-1998 JAN-01-1998 JAN-01-1998
<PERIOD-END> MAR-31-1998 JUN-30-1998 SEP-30-1998
<CASH> 17,042 42,762 79,296
<SECURITIES> 0 0 0
<RECEIVABLES> 350,167 344,407 356,143
<ALLOWANCES> 52,367 48,771 54,517
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 400,468 419,639 466,293
<PP&E> 2,174,894 2,240,131 2,275,271
<DEPRECIATION> 518,005 539,133 557,532
<TOTAL-ASSETS> 2,609,301 2,690,858 2,732,759
<CURRENT-LIABILITIES> 312,127 287,491 509,834
<BONDS> 747,808 821,900 690,205
0 0 0
0 0 0
<COMMON> 7,182 7,206 1,108
<OTHER-SE> 1,194,404 1,220,400 1,137,377
<TOTAL-LIABILITY-AND-EQUITY> 2,609,301 2,690,858 2,732,759
<SALES> 0 0 0
<TOTAL-REVENUES> 551,149 1,096,542 1,653,928
<CGS> 0 0 0
<TOTAL-COSTS> 423,314 853,744 1,281,829
<OTHER-EXPENSES> 28,383 58,212 89,482
<LOSS-PROVISION> 9,655 16,795 23,407
<INTEREST-EXPENSE> 10,675 22,122 34,064
<INCOME-PRETAX> 64,216 103,763 (66,502)
<INCOME-TAX> 21,735 34,801 7,342
<INCOME-CONTINUING> 42,481 68,962 (73,844)
<DISCONTINUED> 4,370 7,891 67,905
<EXTRAORDINARY> 0 0 (19,036)
<CHANGES> (5,640) (5,640) (5,640)
<NET-INCOME> 41,211 71,213 (30,615)
<EPS-PRIMARY> 0.38 0.66 (0.28)
<EPS-DILUTED> 0.37 0.64 (0.28)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 47,933
<SECURITIES> 0
<RECEIVABLES> 361,387
<ALLOWANCES> 52,590
<INVENTORY> 0
<CURRENT-ASSETS> 445,732
<PP&E> 2,120,727
<DEPRECIATION> 515,814
<TOTAL-ASSETS> 2,568,368
<CURRENT-LIABILITIES> 303,634
<BONDS> 751,281
0
0
<COMMON> 7,199
<OTHER-SE> 1,155,830
<TOTAL-LIABILITY-AND-EQUITY> 2,568,368
<SALES> 0
<TOTAL-REVENUES> 2,228,534
<CGS> 0
<TOTAL-COSTS> 1,760,923
<OTHER-EXPENSES> 112,723
<LOSS-PROVISION> 34,745
<INTEREST-EXPENSE> 56,805
<INCOME-PRETAX> 240,355
<INCOME-TAX> 85,064
<INCOME-CONTINUING> 155,291
<DISCONTINUED> 41,209
<EXTRAORDINARY> (3,216)
<CHANGES> (3,173)
<NET-INCOME> 190,111
<EPS-PRIMARY> 1.76
<EPS-DILUTED> 1.71
</TABLE>
