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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-10858
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
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the close of business on July 31, 2002.
Common stock, $0.01 par value -- 98,329,063 shares
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page
Item 1. Financial Statements (Unaudited) Number
------
Consolidated Balance Sheets -
June 30, 2002 and December 31, 2001........................... 3
Consolidated Statements of Income -
Three months and six months ended June 30, 2002 and 2001...... 4
Consolidated Statements of Cash Flows -
Six months ended June 30, 2002 and 2001....................... 5
Notes to Consolidated Financial Statements.................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 19
Item 2. Changes in Securities......................................... 22
Item 3. Defaults Upon Senior Securities............................... 22
Item 4. Submission of Matters to a Vote of Security Holders........... 22
Item 5. Other Information............................................. 22
Item 6. Exhibits and Reports on Form 8-K.............................. 22
SIGNATURES ........................................................... 23
Exhibit Index .......................................................... 24
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
---------------------
MANOR CARE, INC.
Consolidated Balance Sheets
June 30, December 31,
2002 2001
---- ----
(Unaudited) (Note 1)
(In thousands, except per share data)
ASSETS
Current assets:
Cash and cash equivalents $ 13,982 $ 26,691
Receivables, less allowances for doubtful
accounts of $63,821and $68,827, respectively 389,433 391,109
Prepaid expenses and other assets 25,477 31,630
Assets held for sale 50,661 57,735
Deferred income taxes 82,465 82,465
------------- -------------
Total current assets 562,018 589,630
Property and equipment, net of accumulated
depreciation of $708,859 and $680,811, respectively 1,504,134 1,556,910
Goodwill 82,382 80,408
Intangible assets, net of amortization of $9,860 and $9,127, respectively 11,431 17,242
Other assets 191,569 179,881
------------- -------------
Total assets $ 2,351,534 $ 2,424,071
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 93,781 $ 88,615
Employee compensation and benefits 124,146 115,533
Accrued insurance liabilities 99,068 76,450
Income tax payable 34,342
Other accrued liabilities 46,225 71,031
Long-term debt due within one year 8,176 5,388
------------- -------------
Total current liabilities 371,396 391,359
Long-term debt 654,610 715,830
Deferred income taxes 103,095 103,095
Other liabilities 188,312 167,249
Shareholders' equity:
Preferred stock, $.01 par value, 5 million shares authorized
Common stock, $.01 par value, 300 million shares authorized,
111.0 million shares issued 1,110 1,110
Capital in excess of par value 348,599 348,199
Retained earnings 948,598 878,250
Accumulated other comprehensive income 110 328
------------- -------------
1,298,417 1,227,887
Less treasury stock, at cost (12.3 and 8.7 million shares, respectively) (264,296) (181,349)
------------- -------------
Total shareholders' equity 1,034,121 1,046,538
------------- -------------
Total liabilities and shareholders' equity $ 2,351,534 $ 2,424,071
============= =============
See notes to consolidated financial statements.
3
MANOR CARE, INC.
Consolidated Statements Of Income
(Unaudited)
Three Months Ended June 30 Six Months Ended June 30
-------------------------- ------------------------
2002 2001 2002 2001
---- ---- ---- ----
(In thousands, except earnings per share)
Revenues $ 728,435 $ 663,336 $ 1,444,422 $ 1,301,529
Expenses:
Operating 603,467 541,058 1,193,797 1,068,255
General and administrative 30,421 29,737 60,348 56,312
Depreciation and amortization 31,587 32,145 63,356 62,984
Asset impairment 24,876 24,876
------------ ------------ ------------ ------------
690,351 602,940 1,342,377 1,187,551
------------ ------------ ------------ ------------
Income before other income (expenses)
and income taxes 38,084 60,396 102,045 113,978
Other income (expenses):
Interest expense (9,388) (12,212) (19,332) (26,433)
Gain (loss) on sale of assets 31,197 (155) 30,253 643
Equity in earnings of affiliated companies 1,137 606 1,873 309
Interest income and other 273 188 882 491
------------ ------------ ------------ ------------
Total other income (expenses), net 23,219 (11,573) 13,676 (24,990)
------------ ------------ ------------ ------------
Income before income taxes 61,303 48,823 115,721 88,988
Income taxes 23,295 18,611 43,974 33,793
------------ ------------ ------------ ------------
Income before cumulative effect 38,008 30,212 71,747 55,195
Cumulative effect of change in
accounting for goodwill (1,314)
------------ ------------ ------------ ------------
Net income $ 38,008 $ 30,212 $ 70,433 $ 55,195
============ ============ ============ ============
Earnings per share - basic:
Income before cumulative effect $ .38 $ .30 $ .72 $ .54
Cumulative effect (.01)
------------ ------------ ------------ ------------
Net income $ .38 $ .30 $ .70 (a) $ .54
============ ============ ============ ============
Earnings per share - diluted:
Income before cumulative effect $ .38 $ .29 $ .71 $ .53
Cumulative effect (.01)
------------ ------------ ------------ ------------
Net income $ .38 $ .29 $ .69 (a) $ .53
============ ============ ============ ============
Weighted average shares:
Basic 99,109 102,265 100,096 102,209
Diluted 100,561 103,992 101,348 103,876
(a) Doesn't add due to rounding
See notes to consolidated financial statements.
4
MANOR CARE, INC.
Consolidated Statements Of Income
(Unaudited)
Six Months Ended June 30
------------------------
2002 2001
---- ----
(In thousands)
OPERATING ACTIVITIES
Net income $ 70,433 $ 55,195
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 63,356 62,984
Asset impairment and other non-cash charges 26,190
Provision for bad debts 21,618 19,739
Net gain on sale of assets (30,253) (643)
Equity in earnings of affiliated companies (1,873) (309)
Changes in assets and liabilities, excluding sold facilities and acquisitions:
Receivables (39,170) (15,713)
Prepaid expenses and other assets 21,939 (6,570)
Liabilities (7,240) 24,842
------------- -------------
Total adjustments 54,567 84,330
------------- -------------
Net cash provided by operating activities 125,000 139,525
------------- -------------
INVESTING ACTIVITIES
Investment in property and equipment (44,321) (40,114)
Investment in systems development (1,851) (3,375)
Acquisitions (35,430) (12,534)
Proceeds from sale of assets 84,174 3,790
Adjustment of acquisition of assets from development joint venture 1,183
------------- -------------
Net cash provided by (used in) investing activities 3,755 (52,233)
------------- -------------
FINANCING ACTIVITIES
Net repayments under bank credit agreements (54,000) (281,000)
Principal payments of long-term debt (4,432) (6,816)
Proceeds from issuance of senior notes 200,000
Payment of deferred financing costs (3,316)
Proceeds from exercise of stock options 56 1,997
Purchase of common stock for treasury (83,088) (3,788)
------------- -------------
Net cash used in financing activities (141,464) (92,923)
------------- -------------
Net decrease in cash and cash equivalents (12,709) (5,631)
Cash and cash equivalents at beginning of period 26,691 24,943
------------- -------------
Cash and cash equivalents at end of period $ 13,982 $ 19,312
============= =============
See notes to consolidated financial statements.
5
MANOR CARE, INC.
Notes To Consolidated Financial Statements
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management of Manor Care, Inc. (the Company), the interim data includes all
adjustments necessary for a fair statement of the results of the interim periods
and all such adjustments are of a normal recurring nature except for the asset
impairment that is discussed in Note 2. Operating results for the six months
ended June 30, 2002 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2002.
The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. For further information, refer to the consolidated
financial statements and footnotes thereto included in Manor Care, Inc.'s annual
report on Form 10-K for the year ended December 31, 2001.
At June 30, 2002, the Company operated 297 skilled nursing facilities, 72
assisted living facilities with 13 facilities held for sale, 94 outpatient
therapy clinics and 88 home health offices. The Company sold its only hospital
on April 30, 2002.
NOTE 2 - ASSET IMPAIRMENT
During the second quarter of 2002, the Company recorded a charge of $24.9
million that consisted of $19.9 million for the impairment of certain long-lived
assets and $5.0 million for the impairment of the vision businesses' intangible
assets. During the Company's quarterly review of long-lived assets, management
determined that the following long-lived assets were impaired: nine assisted
living facilities that are classified as held for sale, seven long-term care
facilities and five land parcels.
The long-term care facilities, consisting of four skilled nursing and three
assisted living facilities, were impaired based on the carrying value exceeding
the projected future undiscounted cash flows. Based on market conditions and
their history of negative cash flows, management determined that the necessary
profitability levels would not occur in the near future. The Company closed or
has plans to close four of the facilities. Management is currently looking at
alternatives for the other three facilities. The Company may continue to operate
the facilities, sell the facilities for their current operations or sell the
facilities for alternative uses. The carrying values of the seven facilities
were reduced by $12.5 million to their estimated fair values of $8.7 million.
The
6
estimated fair values were determined based on comparable sales values. The
carrying values of five land parcels exceeded their estimated fair values by
$1.5 million. The fair values were based on estimated sales values under current
market conditions.
During the second quarter of 2002, the Company received offers on ten of the
assisted living facilities that are held for sale. The offers, less the cost to
sell, were less than the carrying value on nine of these facilities and required
a write down of the asset values by $5.9 million to their estimated fair values
of $36.5 million. The facilities are located in Michigan, Ohio, Pennsylvania and
Texas.
In the second quarter of 2002, the Company decided that the vision business was
no longer a long-term strategy. Because of this decision, the non-compete and
management contracts were impaired and written down by $5.0 million. The fair
value of the management contracts was determined based on a discounted cash flow
or a multiple of projected earnings.
NOTE 3 - ACQUISITIONS/DIVESTITURE
On April 30, 2002, the Company completed the sale of its hospital to Health
Management Associates, Inc. (HMA) for $79.7 million in cash. Separately, the
Company invested $16.0 million to acquire 20 percent of the HMA entity owning
the hospital. The total gain on the sale of the hospital was $38.8 million. The
Company recorded a pretax gain of $31.1 million and deferred $7.7 million, or 20
percent, of the gain. Simultaneously, the Company acquired for $16.0 million a
20 percent interest in another HMA entity that recently acquired a hospital.
NOTE 4 - GOODWILL AND INTANGIBLE ASSETS
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
No. 142, "Goodwill and Other Intangible Assets," that the Company adopted
January 1, 2002. Under this Statement, goodwill and indefinite-lived intangible
assets are no longer amortized but are reviewed annually for impairment, or more
frequently if impairment indicators arise. Manor Care has no indefinite-lived
intangible assets. The Company completed its initial impairment test in the
second quarter of 2002, which resulted in an impairment loss of $1.3 million
related to the Company's vision business. The impairment loss, with zero tax
effect, was recorded retroactive to January 1, 2002 as a cumulative effect of a
change in accounting principle. The Company's first-quarter 2002 restated
results are as follows:
Dollars Basic and Diluted
in Thousands Earnings Per Share
------------ ------------------
Income before cumulative effect $33,739 $ .33
Cumulative effect (1,314) (.01)
------- -----
Net income $32,425 $ .32
======= =====
7
The effects of adding back the goodwill amortization for the three and six
months ended June 30, 2001 and the year ended December 31, 2001 are as follows:
Three months ended Six months ended
June 30 June 30 Year
------- ------- ----
2002 2001 2002 2001 2001
---- ---- ---- ---- ----
(In thousands, except earnings per share)
Reported income before
cumulative effect $ 38,008 $ 30,212 $ 71,747 $ 55,195 $ 68,490
Add back: goodwill amortization,
net of tax of $205, $410 and $812,
respectively 656 1,309 2,591
---------- ---------- ---------- ---------- ----------
Adjusted income before
cumulative effect $ 38,008 $ 30,868 $ 71,747 $ 56,504 $ 71,081
========== ========== ========== ========== ==========
Diluted earnings per share:
Reported income before
cumulative effect $ .38 $ .29 $ .71 $ .53 $ .66
Goodwill amortization, net of tax .01 .01 .03
---------- ---------- ---------- ---------- ----------
Adjusted income before
cumulative effect $ .38 $ .30 $ .71 $ .54 $ .69
========== ========== ========== ========== ==========
The changes in the carrying amount of goodwill for the six months ended June 30,
2002 are as follows:
Long-Term Care
Segment Other Total
-------- -------- --------
(In thousands)
Balance as of January 1, 2002 $ 8,491 $ 71,917 $ 80,408
Goodwill from acquisitions 3,288 3,288
Impairment loss:
Cumulative effect of change in
accounting principle (1,314) (1,314)
-------- -------- --------
Balance as of June 30, 2002 $ 8,491 $ 73,891 $ 82,382
======== ======== ========
8
NOTE 5 - REVENUES
Revenues for certain health care services are as follows:
Three Months Ended Six Months Ended
June 30 June 30
------- -------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(In thousands)
Skilled nursing and assisted living services $ 621,911 $ 563,041 $1,226,101 $1,103,246
Home health and hospice services 72,898 57,653 139,624 113,641
Rehabilitation services
(excludes intercompany revenues) 22,477 23,746 43,361 47,859
Hospital care 5,383 14,929 21,344 29,457
Other services (includes assets held for sale) 5,766 3,967 13,992 7,326
---------- ---------- ---------- ----------
$ 728,435 $ 663,336 $1,444,422 $1,301,529
========== ========== ========== ==========
NOTE 6 - EARNINGS PER SHARE
The calculation of earnings per share (EPS) is as follows:
Three Months Ended Six Months Ended
June 30 June 30
------- -------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(In thousands, except earnings per share)
Numerator:
Income before cumulative effect
[Income available to common shareholders] $ 38,008 $ 30,212 $ 71,747 $ 55,195
Denominator:
Denominator for basic EPS -
weighted-average shares 99,109 102,265 100,096 102,209
Effect of dilutive securities:
Stock options 1,147 1,459 964 1,413
Non-vested restricted stock 305 268 288 254
---------- ---------- ---------- ----------
Denominator for diluted EPS -
adjusted for weighted-average
shares and asuumed conversions 100,561 103,992 101,348 103,876
========== ========== ========== ==========
EPS - Income before cumulative effect:
Basic $ .38 $ .30 $ .72 $ .54
Diluted $ .38 $ .29 $ .71 $ .53
Options to purchase shares of the Company's common stock that were not included
in the computation of diluted EPS because the options' exercise prices were
greater than the average market price of the common shares were: 2.1 million
shares with an average exercise price of $32 for the first half of 2002 and 2.4
million shares with an average exercise price of $33 for the first half of 2001.
9
NOTE 7 - SEGMENT INFORMATION
The Company provides a range of health care services. The Company has one
reportable operating segment, long-term care, which includes the operation of
skilled nursing and assisted living facilities. The "Other" category includes
the non-reportable segments and corporate items. The revenues in the "Other"
category include services for assisted living facilities held for sale,
rehabilitation, home health and hospice, and hospital care. The Company's
hospital was sold on April 30, 2002. Asset information, including capital
expenditures, is not reported by segment by the Company. Operating performance
represents revenues less operating expenses and does not include general and
administrative expense, depreciation and amortization, asset impairment, other
income and expense items, income taxes and cumulative effect.
Long-Term
Care Other Total
------ ------- ------
(In thousands)
Three months ended June 30, 2002
Revenues from external customers $ 621,911 $ 106,524 $ 728,435
Intercompany revenues 14,197 14,197
Depreciation and amortization 29,703 1,884 31,587
Operating margin 116,265 8,703 124,968
Three months ended June 30, 2001
Revenues from external customers 563,041 100,295 663,336
Intercompany revenues 9,357 9,357
Depreciation and amortization 29,100 3,045 32,145
Operating margin 109,080 13,198 122,278
Six months ended June 30, 2002
Revenues from external customers 1,226,101 218,321 1,444,422
Intercompany revenues 27,734 27,734
Depreciation and amortization 58,383 4,973 63,356
Operating margin 231,475 19,150 250,625
Six months ended June 30, 2001
Revenues from external customers 1,103,246 198,283 1,301,529
Intercompany revenues 18,392 18,392
Depreciation and amortization 57,025 5,959 62,984
Operating margin 205,428 27,846 233,274
NOTE 8 - CONTINGENCIES
One or more subsidiaries or affiliates of Manor Care of America, Inc. (MCA) 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
10
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 MCA. The Actions allege
that Cenco transported and/or generated hazardous substances that came to be
located at the sites in question. 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 MCA 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 its future environmental liabilities will be approximately $24.0 to $28.5
million. The Company has received or expects to receive between $20.3 million
and $24.5 million of insurance proceeds, depending upon the ultimate
liabilities, which will offset most amounts due as a result of these exposures.
The Company is party to various other legal matters arising in the ordinary
course of business including patient care-related claims and litigation. At June
30, 2002 and December 31, 2001, the general and professional liability consisted
of short-term reserves of $48.0 million, which were included in accrued
insurance liabilities, and long-term reserves of $107.5 million and $88.5
million, respectively, which were included in other long-term liabilities. The
expense for general and professional liability claims and premiums was $23.7
million and $41.3 million for the three and six months ended June 30, 2002,
respectively, and $15.7 million and $28.8 million for the three and six months
ended June 30, 2001, respectively, which was included in operating expenses.
There can be no assurance that such provision and liability will not require
material adjustment in future periods.
NOTE 9 - COMPREHENSIVE INCOME
Comprehensive income represents the sum of net income plus other comprehensive
income (loss). Comprehensive income totaled $37.6 million and $70.2 million for
the three and six months ended June 30, 2002, respectively, and $30.2 million
and $54.9 million for the three and six months ended June 30, 2001,
respectively. The other comprehensive loss of $0.4 million and $0.2 million in
the three and six months ended June 30, 2002, respectively, primarily relates to
unrealized loss on investments. The other comprehensive loss of $0.3 million in
the first quarter of 2001 represents the after tax loss of the terminated
treasury lock agreement that the Company entered into as a hedge of interest
rates on the future issuance of the Senior Notes in March 2001.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
RESULTS OF OPERATIONS - OVERVIEW
Federal Medicare Payment Legislation. Certain of the increases in
Medicare reimbursement for skilled nursing facilities provided for under the
Medicare, Medicaid and SCHIP Balanced Budget Refinement Act of 1999, or BBRA 99,
and the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of
2000, or BIPA 2000, will sunset in October 2002. Unless Congress enacts
additional legislation, the loss of revenues associated with this occurrence
could have a material adverse effect on us. If Congress fails to act, we
estimate that our revenues in the fourth quarter of 2002 could be reduced by
approximately $15 million related to this issue. If this were to occur, we would
take certain actions to reduce costs to mitigate the reduction in revenues.
While Congress could promptly act on this issue, no assurances can be given as
to whether Congress will take action, the timing of any action or the form of
any relief enacted.
CRITICAL ACCOUNTING POLICIES
General and Professional Liability. Our general and professional
reserves include amounts for patient care-related claims and incurred but not
reported claims. We evaluated the adequacy of our general and professional
liability reserves with our independent actuary during the second quarter of
2002 for all policy periods through May 31, 2002. The amount of our reserves is
determined based on an estimation process that uses information obtained from
both company-specific and industry data. The estimation process requires us to
continuously monitor and evaluate the life cycle of the claims. Using data
obtained from this monitoring and our assumptions about emerging trends, we
along with our independent actuary develop information about the size of
ultimate claims. The most significant assumptions used in the estimation process
include determining the trend in costs, the expected cost of claims incurred but
not reported and the expected costs to settle unpaid claims. Our assumptions
take into consideration our internal efforts to contain our costs by reviewing
our risk management programs, our operational and clinical initiatives, and
other industry changes affecting the long-term care market. Our current accrual
per month is approximately $6.0 million. We do see an improving underlying trend
in terms of patient liability costs. New patient claims have not increased over
2001 levels and costs per claim have decreased in each quarter of this year.
Although we believe our reserves are adequate, we can give you no assurance that
this liability will not require material adjustment in future periods.
12
RESULTS OF OPERATIONS -
QUARTER AND YEAR-TO-DATE JUNE 30, 2002 COMPARED WITH JUNE 30, 2001
On April 30, 2002, we sold our only hospital. The hospital recorded revenues of
$21.3 million and operating expenses of $19.9 million for the four months ended
April 30, 2002. In the table below, we excluded our hospital's revenues and
operating expenses from all periods so that you may compare our results in a
more meaningful way.
Second Quarter First Half
2002 2001 2002 2001
---- ---- ---- ----
(In thousands)
Revenues $ 723,052 $ 648,408 $1,423,078 $1,272,072
Operating expenses 597,636 528,007 1,173,867 1,042,593
Revenues. Our revenues increased $74.6 million, or 12 percent, from the
second quarter of 2001 to 2002. Revenues from our long-term care segment
(skilled nursing and assisted living facilities excluding assets held for sale)
increased $58.9 million, or 10 percent, due to increases in rates/patient
mix--$53.5 million, capacity--$5.0 million and occupancy--$0.4 million. Our
revenues from the home health business increased $15.2 million, or 26 percent,
primarily because of an increase in home health visits and hospice services.
Our revenues in the first half of 2002 increased $151.0 million, or 12 percent,
compared with the first half of 2001. Revenues from our long-term care segment
increased $122.9 million, or 11 percent, due to increases in rates/patient
mix--$111.9 million, capacity--$8.7 million and occupancy--$2.3 million. Our
revenues from the home health business increased $26.0 million, or 23 percent,
primarily because of an increase in home health visits and hospice services.
Our average rates per day for the long-term care segment were as follows:
Second Quarter First Half
-------------- ----------
2002 2001 Increase 2002 2001 Increase
---- ---- -------- ---- ---- --------
Medicare $334 $319 5% $334 $308 8%
Medicaid $123 $113 9% $122 $113 8%
Private and other (skilled) $181 $172 5% $180 $172 5%
The Medicare rate increase related to the positive effect of BIPA 2000 with many
of the provisions beginning April 1, 2001, as well as our higher acuity
patients. The increase in rates was also a result of the shift in the mix of our
patients to a higher percentage of Medicare patients.
Our bed capacity increased between the first half of 2001 and 2002 based on the
timing of opening four facilities with 308 beds and purchasing/leasing two
facilities with 355 beds, which was partially offset by the closing/sale of
three facilities with 450 beds. Our occupancy levels remained constant for the
second quarter and first half of 2001 and 2002: long-term care facilities--87
percent, long-term care excluding start-up facilities--88 percent and skilled
nursing facilities--88
13
percent. The quality mix of revenues from Medicare, private pay and insured
patients related to skilled nursing and assisted living facilities and
rehabilitation operations remained constant at 68 percent for the second quarter
and first half of 2001 and 2002.
Operating Expenses. Our operating expenses increased $69.6 million, or
13 percent, from the second quarter of 2001 to 2002. Operating expenses
increased $51.7 million, or 11 percent, from our long-term care segment and $9.8
million, or 20 percent, from our home health business because of an increase in
services.
The most significant portion of our long-term care increase in operating
expenses between the second quarters of 2001 to 2002 related to labor costs,
including temporary staffing, of $31.2 million. Our other operating expense
increases for this segment included ancillary costs, excluding internal labor,
of $9.7 million and general and professional liability expense of $6.9 million.
Ancillary costs, which include various types of therapies, medical supplies and
prescription drugs, increased as a result of our more medically complex
patients. Our general and professional liability expense increased because we
recorded expense of $4.9 million in the second quarter of 2002 due to a
court-ordered liquidation of one of our insurers. The reserve represents our
estimated costs for claims in 1993 to 1997 that may not be covered by government
emergency recovery funds. Refer to our critical accounting policies for
additional discussion of our general and professional liability costs.
Also, during the second quarter of 2002, we reversed $2.1 million of the $23.6
million charge that was recorded in 2001 related to the damage award from the
arbitration decision with NeighborCare Pharmacy Services, or NeighborCare. We
paid $21.5 million in April and the reversal was based on an amendment to the
decision and award on June 21, 2002. See discussion of the interest expense
portion of the award below.
Operating expenses for the first half of 2002 increased $131.3 million, or 13
percent, from the first half of 2001. Operating expenses increased $96.8
million, or 11 percent, from our long-term care segment and $21.3 million, or 22
percent, from our home health business because of an increase in services.
We attribute the largest portion ($59.4 million) of the long-term care operating
expense increase between the first half of 2001 and 2002 to labor costs and
temporary staffing. Our other operating expense increases for this segment
included ancillary costs, excluding internal labor, of $16.0 million and general
and professional liability expense of $10.8 million. See our discussion above
for the $4.9 million unusual charge for general and professional liability
expense in 2002 and the reversal of $2.1 million in charges for the NeighborCare
arbitration.
General and Administrative Expenses. Our general and administrative
expenses, which approximated 4 percent of revenues, increased $0.7 million and
$4.0 million from the second quarter and first half of 2001 to 2002,
respectively. The increases related to stock appreciation
14
rights, professional services and general inflation. The increases were
partially offset by decreases in deferred compensation plans.
Depreciation and Amortization. Depreciation increased $0.2 million and
$1.8 million from the second quarter and first half of 2001 to 2002,
respectively, as a result of additional depreciation for our new construction
projects and renovations of existing facilities completed in the past year.
Amortization decreased $0.8 million and $1.4 million from the second quarter and
first half of 2001 to 2002, respectively. We no longer amortize goodwill that
amounted to $0.9 million and $1.7 million in the second quarter and first half
of 2001. See Note 4 to the consolidated financial statements for additional
discussion of the change in accounting principle for goodwill.
Asset Impairment. During the second quarter of 2002, we recorded a
charge of $24.9 million that consisted of $19.9 million for the impairment of
certain long-lived assets and $5.0 million for the impairment of our vision
businesses' intangible assets. During our quarterly review of long-lived assets,
we determined that the following long-lived assets were impaired: nine assisted
living facilities that are classified as held for sale, seven long-term care
facilities and five land parcels.
We determined that our long-term care facilities, consisting of four skilled
nursing and three assisted living facilities, were impaired based on the
carrying value exceeding the projected future undiscounted cash flows. Based on
market conditions and their history of negative cash flows, we determined that
the necessary profitability levels would not occur in the near future. We closed
or have plans to close four of the facilities. We are currently looking at
alternatives for the other three facilities. We may continue to operate the
facilities, sell the facilities for their current operations or sell the
facilities for alternative uses. We reduced the carrying values of the seven
facilities by $12.5 million to their estimated fair values of $8.7 million. The
estimated fair values were determined based on comparable sales values. We also
determined that the carrying values of five land parcels exceeded our estimated
fair values by $1.5 million. The fair values were based on estimated sales
values under current market conditions.
During the second quarter of 2002, we received offers on ten of our assisted
living facilities that are held for sale. The offers, less the cost to sell,
were less than our carrying values on nine of these facilities and required us
to write down the asset values by $5.9 million to their estimated fair values of
$36.5 million. The facilities are located in Michigan, Ohio, Pennsylvania and
Texas. We expect to sell these facilities by the end of the year.
In the second quarter of 2002, we decided that our vision business was no longer
a long-term strategy. Because of this decision, our non-compete and management
contracts were impaired and written down by $5.0 million. The fair value of the
management contracts was determined based on a discounted cash flow or a
multiple of projected earnings.
15
As a result of the write-down of assets, change in the intangible assets'
estimated useful life and sale of our hospital, depreciation and amortization is
expected to decrease by approximately $4.5 million on an annual basis.
Interest Expense. When excluding capitalized interest and interest from
the arbitration decision with NeighborCare, our interest expense in the second
quarter and first half of 2002 decreased $3.1 million and $7.8 million compared
with the same periods in 2001 because of lower interest rates and debt levels.
We accrued $1.0 million of interest expense in the fourth quarter of 2001
related to the NeighborCare arbitration and reversed $0.5 million in the second
quarter of 2002 due to an amended arbitration decision.
Gain (Loss) on Sale of Assets. Our gain on sale of assets in the first
half of 2002 primarily related to the gain of $31.1 million recognized on the
sale of our hospital to Health Management Associates, Inc. Our gain on sale of
assets in the first half of 2001 primarily related to the sale of a skilled
nursing facility.
Equity in Earnings of Affiliated Companies. We recorded equity losses
related to our development joint venture with Alterra Healthcare Corporation on
this line item during the first half of 2001 and then began to consolidate the
results of the 13 assisted living facilities in the second half of 2001. During
the second quarter and first half of 2001, we recorded equity losses of $1.9
million and $3.1 million, respectively, related to this joint venture.
We were a 50 percent owner in a partnership that sold its only nursing home in
June 2001. During the second quarter of 2001, we reversed $1.5 million of
previously recorded losses for this partnership. These losses were booked in
excess of our investment because we had guaranteed the partnership's debt, which
was paid off with the sale of the nursing home.
Cumulative Effect of Change in Accounting Principle. In July 2001, the
Financial Accounting Standards Board issued Statement No. 142, "Goodwill and
Other Intangible Assets," that we adopted January 1, 2002. Under this Statement,
goodwill and indefinite-lived intangible assets are no longer amortized but are
reviewed annually for impairment, or more frequently if impairment indicators
arise. We completed our initial impairment test in the second quarter of 2002
and determined that $1.3 million of our goodwill was impaired related to our
vision business. The impairment loss, with zero tax effect, was recorded
retroactive to January 1, 2002 as a cumulative effect of a change in accounting
principle.
FINANCIAL CONDITION - JUNE 30, 2002 AND DECEMBER 31, 2001
Our receivables decrease of $1.7 million included the reduction of $19.8 million
from the sale of our hospital.
16
Assets held for sale decreased $7.1 million because of the write-down of the
assets by $5.9 million to their estimated fair values and the receipt of cash in
2002 of $1.2 million from a settlement with Alterra Healthcare Corporation and
the third-party equity investors in 2001.
Property and equipment decreased $52.8 million primarily because of depreciation
of $58.1 million, disposal of our hospital's assets of $20.4 million and
impairment of our long-term care assets of $12.5 million. These decreases were
partially offset by $44.3 million in new construction and renovations and
maintenance to existing facilities.
Accrued insurance liabilities increased $22.6 million primarily due to the
reclassification of an $18.8 million environmental liability from other
long-term liabilities. The payment is due in January 2003. Most of this payment
will be offset by insurance proceeds that are due in January 2003. As a result,
we also reclassified $9.5 million from other long-term assets to receivables.
Income taxes payable decreased $34.3 million primarily because of our $35.3
million payment to the Internal Revenue Service (IRS) related to the settlement
agreement for corporate-owned life insurance, or COLI, for the years 1993
through 1997.
Other accrued liabilities decreased $24.8 million primarily because of our $22.0
million payment to NeighborCare in the second quarter of 2002 related to the
arbitration decision.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows. During the first half of 2002, we satisfied our cash
requirements from cash generated from operating activities and proceeds from
sale of assets. We used the cash principally for capital expenditures,
acquisitions, to repay debt and to purchase our common stock. Cash flows from
operating activities were $125.0 million for the first half of 2002. Our
operating cash flows decreased $14.5 million from the first half of 2001 because
we had two significant unusual operating cash outflows in the second quarter of
2002. The payments included $22.0 million to NeighborCare related to the
arbitration decision and $35.3 million to the IRS related to the settlement
agreement for COLI.
Investing Activities. Our expenditures for property and equipment of
$44.3 million in the first half of 2002 included $10.4 million to construct new
facilities and expand existing facilities. On April 30, 2002, we completed the
sale of our hospital for $79.7 million. Separately, we acquired 20 percent
interests in two separate entities, one that owns our former hospital, for a
total of $32.0 million.
Debt Agreement. At June 30, 2002, outstanding borrowings totaled $280.0
million under a five-year, revolving credit agreement. After consideration of
usage for letters of credit, the remaining credit availability under the
five-year agreement totaled $185.0 million at June 30, 2002.
17
Stock Purchase. On December 4, 2001, our board of directors authorized
us to spend up to $100 million to purchase our common stock from January 1, 2002
through December 31, 2003. On July 16, 2002, our board authorized an additional
$100 million through December 31, 2003. We purchased 3,580,700 shares for $83.1
million in the first half of 2002 and an additional 375,000 shares for $7.7
million in July 2002. We may use the shares for internal stock option and 401(k)
match programs and for other uses, such as possible future acquisitions.
We believe that our cash flow from operations will be sufficient to cover debt
payments, future capital expenditures and operating needs. It is likely that we
will pursue growth from acquisitions, partnerships and other ventures that 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.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This report may include forward-looking statements. We have based these
forward-looking statements on our current expectations and projections about
future events. We identify forward-looking statements in this report by using
words or phrases such as "anticipate," "believe," "estimate," "expect,"
"intend," "may be," "objective," "plan," "predict," "project," and "will be" and
similar words or phrases, or the negative thereof.
These forward-looking statements are subject to numerous assumptions, risks and
uncertainties. Factors which may cause our actual results, performance or
achievements to be materially different from any future results, performance or
achievements expressed or implied by us in those statements include, among
others: changes in Medicare, Medicaid and certain private payors' reimbursement
levels; existing government regulations, including applicable health care, tax
and health and safety regulations, and changes in, or the failure to comply
with, governmental regulations or the interpretations thereof; legislative
proposals for health care reform; competition and general economic and business
conditions; the ability to attract and retain qualified personnel; changes in
current trends in the cost and volume of general and professional liability
claims and other litigation.
Although we believe the expectations reflected in our forward-looking statements
are based upon reasonable assumptions, we can give no assurance that we will
attain these expectations or that any deviations will not be material. Except as
otherwise required by the federal securities laws, we disclaim any obligations
or undertaking to publicly release any updates or revisions to any
forward-looking statement contained in this report to reflect any change in our
expectations with regard thereto or any change in events, conditions or
circumstances on which any such statement is based.
18
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
See the discussion of our market risk in our Form 10-K for the year ended
December 31, 2001. At June 30, 2002, the fair value of our 7 1/2% and 8% Senior
Notes exceeded the carrying value by approximately $8.5 million, which
represented a decline in fair value since year end.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
------------------
Since May of 1999, we and other related persons and entities have been parties
to several actions by or against Genesis Health Ventures, Inc. and its
subsidiary, NeighborCare Pharmacy Services, Inc. In June 2000, Genesis and
NeighborCare filed voluntary petitions for bankruptcy under Chapter 11 of the
Bankruptcy Code, which effectively stayed the actions to the extent they had not
been stayed already. In September 2001, Genesis' bankruptcy court confirmed its
plan of reorganization, or the Genesis Bankruptcy Plan, and the Genesis
Bankruptcy Plan became effective in October 2001. The status of the various
Genesis/NeighborCare lawsuits is as follows:
First Action. In May 1999, NeighborCare instituted an arbitration
proceeding and filed a lawsuit in the Circuit Court for Baltimore City, Maryland
against us; our wholly owned subsidiary, Manor Care of America, Inc. formerly
known as Manor Care, Inc., or MCA; and MCA's wholly owned subsidiary, ManorCare
Health Services, Inc., or MCHS, seeking damages, preliminary and permanent
injunctive relief, and a declaratory judgment related to allegations that the
defendants had improperly sought to terminate certain long-term Master Service
Agreements between Vitalink, now known as NeighborCare, and MCHS. MCHS had
sought to terminate the Master Service Agreements effective June 1, 1999,
although they did not expire by their terms until September 30, 2004. On May 13,
1999, NeighborCare and the defendants agreed:
- To consolidate the Maryland action into the arbitration;
- To dismiss the Maryland action with prejudice as to
jurisdiction and without prejudice as to the merits; and
- To stay termination of the agreements at issue until a
decision could be reached in the arbitration.
NeighborCare subsequently dismissed the Maryland action and consolidated certain
of those claims into the arbitration by filing an amended demand for
arbitration.
On February 14, 2002, the arbitrator rendered a decision and award and, on June
21, 2002,
19
the arbitrator issued an amendment to the decision and award. The decision and
the amendment denied defendants' right to terminate the Master Service
Agreements, thus requiring MCHS to continue performing under the agreements
until they expire September 30, 2004. The decision and the amendment also
ordered defendants to pay damages and certain related amounts to NeighborCare as
a result of NeighborCare being precluded from supplying certain facilities owned
by affiliates of MCHS. We estimated a total charge of $24.6 million arising from
the decision and award and booked this amount in the fourth-quarter of 2001.
Based on the June 21, 2002 amendment, we reversed $2.6 million of the charge in
the second-quarter of 2002.
Second Action. In May 1999, Genesis filed suit in federal district
court in Delaware against us; MCA; our Chief Executive Officer, Paul A. Ormond;
and our Chairman at that time, Stewart Bainum, Jr. The complaint alleges that
the defendants fraudulently induced Genesis to acquire, in August 1998, all of
the outstanding stock of Vitalink Pharmacy Services, Inc., an approximately 50
percent-owned subsidiary of MCA, without advising Genesis of the defendants'
alleged intent to terminate the Master Service Agreements that are the subject
of the arbitration described above or their alleged intent not to renew them
beyond their current term of September 30, 2004. The complaint further alleges
that the defendants' alleged conduct constituted violations of Section 10(b) of
the Securities Exchange Act of 1934, and constituted common law fraudulent
misrepresentation and negligent misrepresentation. The suit also alleges that
our ownership in a partnership known as Heartland Healthcare Services violates a
non-compete provision signed by MCA. The suit seeks compensatory and punitive
damages in excess of $100 million and preliminary and permanent injunctive
relief enforcing the covenant not to compete.
In March 2000, the court granted the defendants' motion to stay the action in
its entirety pending the arbitration discussed above, but denied the motion with
respect to the alternative request to dismiss the action. Following receipt of
the February 14, 2002 arbitration decision and award described above, the court
returned the lawsuit to its active calendar. On April 30, 2002, the defendants:
(i) moved to strike the allegations in the First Amended Complaint that were
disposed of by the arbitration decision and award, and (ii) filed their answer
and affirmative defenses to the remaining allegations. The defendants' motion to
strike is presently pending.
The court has scheduled the matter for trial beginning March 10, 2003. We intend
to vigorously defend the lawsuit. Although the ultimate outcome of the case is
uncertain, management believes that it is not likely to have a material adverse
effect on our financial condition.
Third Action. In August 1999, MCA filed a separate action in federal
district court in Delaware against Genesis concerning Genesis' 1998 acquisition
of Vitalink. MCA's lawsuit charges that Genesis violated Section 11 and Section
12 of the Securities Act of 1933, when
20
Genesis issued approximately $293 million of Genesis Preferred Stock to MCA for
MCA's interest in Vitalink. The suit alleges that Genesis misrepresented and/or
omitted material facts. The lawsuit sought, among other things, compensatory
damages and rescission, which would void MCA's purchase of the Genesis Preferred
Stock and require Genesis to return to MCA the consideration that it paid at the
time of the Vitalink sale.
On September 29, 2000, while Genesis' bankruptcy petition was pending, the court
granted in part and denied in part Genesis' motion to dismiss the lawsuit.
Pursuant to the Genesis Bankruptcy Plan, virtually all affirmative claims
against Genesis and/or its affiliated debtors that arose prior to September 20,
2001 were discharged. MCA's set-off and recoupment rights, however, were
specifically preserved by the Genesis Bankruptcy Plan. Accordingly, on October
22, 2001, MCA filed a motion for reconsideration or clarification of the Court's
September 29, 2000 order for the limited purpose of obtaining reconsideration or
clarification of the September 29, 2000 order insofar as it might affect MCA's
set-off and recoupment rights against Genesis. On or about December 5, 2001,
Genesis filed its cross-motion to dismiss the lawsuit in its entirety, including
the claims sustained by the September 29, 2000 Order, based upon the discharge
provision of its Bankruptcy Plan. MCA's motion and Genesis' cross-motion are
pending before the Court. On April 30, 2002, the defendants in the lawsuit filed
by Genesis in May 1999 (including MCA) filed their affirmative defenses to that
action. Among their affirmative defenses, the defendants included defenses based
upon the set-off and recoupment rights arising from Genesis' misrepresentations
and/or omissions of material fact that formed the basis of this lawsuit.
Additional NeighborCare Complaint. In July 1999, NeighborCare filed an
additional complaint in the Circuit Court for Baltimore County, Maryland against
Omnicare, Inc. and Heartland Healthcare Services, Inc. seeking injunctive relief
and compensatory and punitive damages. Heartland Healthcare Services, Inc. is a
partnership between us and subsidiaries of Omnicare. The complaint includes
counts for tortious interference with Vitalink's purported contractual rights
under the Master Service Agreements. In November 1999, the court stayed the
matter pending the arbitration. Although we cannot predict the ultimate outcome
of the case, management believes that it is not likely to have a material
adverse effect on our financial condition.
Fourth Action. In December 1999, MCA filed suit in federal court in
Toledo, Ohio against Genesis; Cypress Group, L.L.C.; TPG Partners II, L.P.; and
Nazem, Inc. The complaint alleges that the issuance by Genesis of its Series H
and Series I Preferred Stock violated the terms of the Series G Preferred Stock
and the terms of a rights agreement entered into between Genesis and MCA in
connection with the Vitalink transaction. In February 2000, the defendants moved
to dismiss the case. That motion was pending before the court as of the time the
matter was automatically stayed by Genesis' June 2000 bankruptcy filing.
Following the bankruptcy filing, the case was closed subject to being reopened
on motion by any party after entry of an injunction imposed by Section 524 of
the Bankruptcy Code. Such
21
an injunction was issued by the bankruptcy court on September 20, 2001, as part
of the order confirming the Genesis Bankruptcy Plan. Pursuant to the Genesis
Bankruptcy Plan, virtually all affirmative claims against Genesis and its
affiliated debtors that arose prior to September 20, 2001 were discharged. MCA's
set-off and recoupment rights, however, were specifically preserved by the
Genesis Bankruptcy Plan. MCA is currently evaluating whether any further action
is appropriate or necessary with respect to this matter.
See Note 8 - Contingencies in the notes to the consolidated financial statements
for a discussion of litigation related to environmental matters and patient-care
related claims.
Item 2. Changes in Securities.
----------------------
None
Item 3. Defaults Upon Senior Securities.
--------------------------------
None
Item 4. Submission of Matters to a Vote of Security Holders.
----------------------------------------------------
None
Item 5. Other Information.
------------------
None
Item 6. Exhibits and Reports on Form 8-K.
---------------------------------
(a) Exhibits
S-K Item
601 No.
- -------
99.1 Chief Executive Officer Certification Pursuant To 18 U.S.C. Section
1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act
Of 2002
99.2 Chief Financial Officer Certification Pursuant To 18 U.S.C. Section
1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act
Of 2002
(b) Reports on Form 8-K
None
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Manor Care, Inc.
(Registrant)
Date August 12, 2002 By /s/ Geoffrey G. Meyers
---------------- --------------------------------------------
Geoffrey G. Meyers, Executive Vice President
and Chief Financial Officer
23
EXHIBIT INDEX
Exhibit
- -------
99.1 Chief Executive Officer Certification Pursuant To 18 U.S.C. Section
1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act
Of 2002
99.2 Chief Financial Officer Certification Pursuant To 18 U.S.C. Section
1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act
Of 2002
24