##### Table of Contents



UNITED STATES 
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended September 30, 2007
 or
 o
    
    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 Commission file number: 1-10858
 Manor Care, Inc.
  Delaware
    
    34-1687107(State or other jurisdiction of
    
    (IRS Employerincorporation 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
 þ o
  þ o o
 o þ




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##### 



Manor Care, Inc.
Form 10-Q
Table of Contents
 PageNumberPart I.
    
    Financial InformationItem 1.
    
    Financial Statements (Unaudited)Consolidated Balance Sheets  September 30, 2007 and December 31, 2006
    
    
    3Consolidated Statements of Income  Three and nine months ended September 30, 2007 and 2006
    
    
    4Consolidated Statements of Cash Flows  Nine months ended September 30, 2007 and 2006
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    22Item 4.
    
    Controls and Procedures
    
    
    22Part II.
    
    Other InformationItem 1.
    
    Legal Proceedings
    
    
    22Item 1A.
    
    Risk Factors
    
    
    23Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    24Item 3.
    
    Defaults Upon Senior Securities
    
    
    24Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    24Item 5.
    
    Other Information
    
    
    24Item 6.
    
    Exhibits
    
    
    24Signatures
    
    
    25Exhibit Index
    
    
    26EX-31.1EX-31.2EX-32.1EX-32.2EX-99.1
  2




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##### Table of Contents



Part I. Financial Information
 
 Financial Statements.
 Manor Care, Inc.
 
  September 30,
    
    
    December 31,2007
    
    
    2006(Unaudited)
    
    

(Note 1)(In thousands, except share and per share data)AssetsCurrent assets:Cash and cash equivalents
    
    $
    120,928
    
    
    $
    17,658Receivables, less allowances for doubtful
accounts of $91,942 and $74,644, respectively
    
    
    583,946
    
    
    
    565,831Convertible note hedge receivable
    
    
    200,033Prepaid expenses and other assets
    
    
    42,624
    
    
    
    34,924Deferred income taxes
    
    
    8,219
    
    
    
    781Total current assets
    
    
    955,750
    
    
    
    619,194Property and equipment, net of accumulated
depreciation of $953,070 and $844,471, respectively
    
    
    1,473,419
    
    
    
    1,493,576Goodwill
    
    
    134,758
    
    
    
    132,997Intangible assets, net of amortization of $2,376 and $1,862, respectively
    
    
    5,218
    
    
    
    5,782Other assets
    
    
    124,442
    
    
    
    146,928Total assets
    
    $
    2,693,587
    
    
    $
    2,398,477Liabilities And Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    118,336
    
    
    $
    120,621Employee compensation and benefits
    
    
    175,269
    
    
    
    165,001Warrant payable
    
    
    113,863Accrued insurance liabilities
    
    
    110,927
    
    
    
    109,538Income tax payable
    
    
    53,099
    
    
    
    10,118Other accrued liabilities
    
    
    57,466
    
    
    
    79,904Long-term debt due within one year
    
    
    418,313
    
    
    
    38,447Total current liabilities
    
    
    1,047,273
    
    
    
    523,629Long-term debt
    
    
    532,304
    
    
    
    955,211Deferred income taxes
    
    
    63,604
    
    
    
    78,741Other liabilities
    
    
    282,768
    
    
    
    267,703Shareholders equity:Preferred stock, $.01 par value, 5 million shares authorizedCommon stock, $.01 par value, 300 million shares authorized,
111.0 million shares issued
    
    
    1,110
    
    
    
    1,110Capital in excess of par value
    
    
    510,494
    
    
    
    407,506Retained earnings
    
    
    1,512,221
    
    
    
    1,437,145Accumulated other comprehensive loss
    
    
    (12,442
    )
    
    
    (29,217
    )2,011,383
    
    
    
    1,816,544Less treasury stock, at cost (37.8 and 38.3 million shares, respectively)
    
    
    (1,243,745
    )
    
    
    (1,243,351
    )Total shareholders equity
    
    
    767,638
    
    
    
    573,193Total liabilities and shareholders equity
    
    $
    2,693,587
    
    
    $
    2,398,477
  3




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##### Table of Contents



Manor Care, Inc.
 
   Three Months Ended
    
    
    Nine Months EndedSeptember 30
    
    
    September 302007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands, except per share amounts)Revenues
    
    $
    967,814
    
    
    $
    915,515
    
    
    $
    2,884,660
    
    
    $
    2,679,024Expenses:Operating
    
    
    797,631
    
    
    
    752,495
    
    
    
    2,378,065
    
    
    
    2,211,511General and administrative
    
    
    56,461
    
    
    
    45,437
    
    
    
    183,336
    
    
    
    141,334Depreciation and amortization
    
    
    37,729
    
    
    
    36,732
    
    
    
    112,568
    
    
    
    108,820Asset impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,082891,821
    
    
    
    834,664
    
    
    
    2,673,969
    
    
    
    2,472,747Income before other income (expenses) and
income taxes
    
    
    75,993
    
    
    
    80,851
    
    
    
    210,691
    
    
    
    206,277Other income (expenses):Interest expense
    
    
    (8,155
    )
    
    
    (8,749
    )
    
    
    (25,375
    )
    
    
    (23,668
    )Loss on sale of assets
    
    
    (145
    )
    
    
    (125
    )
    
    
    (5,277
    )
    
    
    (284
    )Equity in earnings of affiliated companies
    
    
    630
    
    
    
    971
    
    
    
    1,614
    
    
    
    4,558Interest income and other
    
    
    1,665
    
    
    
    203
    
    
    
    2,803
    
    
    
    1,431Total other expenses, net
    
    
    (6,005
    )
    
    
    (7,700
    )
    
    
    (26,235
    )
    
    
    (17,963
    )Income before income taxes
    
    
    69,988
    
    
    
    73,151
    
    
    
    184,456
    
    
    
    188,314Income taxes
    
    
    30,592
    
    
    
    26,649
    
    
    
    71,557
    
    
    
    69,256Income before cumulative effect
    
    
    39,396
    
    
    
    46,502
    
    
    
    112,899
    
    
    
    119,058Cumulative effect of change in accounting
principle, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,476
    )Net income
    
    $
    39,396
    
    
    $
    46,502
    
    
    $
    112,899
    
    
    $
    116,582Earnings per share  basic:Income before cumulative effect
    
    $
    .54
    
    
    $
    .63
    
    
    $
    1.54
    
    
    $
    1.56Cumulative effect
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (.03
    )Net income
    
    $
    .54
    
    
    $
    .63
    
    
    $
    1.54
    
    
    $
    1.53Earnings per share  diluted:Income before cumulative effect
    
    $
    .49
    
    
    $
    .60
    
    
    $
    1.43
    
    
    $
    1.51Cumulative effect
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (.03
    )Net income
    
    $
    .49
    
    
    $
    .60
    
    
    $
    1.43
    
    
    $
    1.48Weighted-average shares:Basic
    
    
    73,282
    
    
    
    73,833
    
    
    
    73,186
    
    
    
    76,326Diluted
    
    
    79,856
    
    
    
    77,386
    
    
    
    79,118
    
    
    
    78,887Cash dividends declared per common share
    
    $
    .17
    
    
    $
    .16
    
    
    $
    .51
    
    
    $
    .48
  4




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Manor Care, Inc.
 
   Nine Months Ended September 302007
    
    
    2006(In thousands)Operating ActivitiesNet income
    
    $
    112,899
    
    
    $
    116,582Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    112,568
    
    
    
    108,820Asset impairment and other non-cash charges
    
    
    25,210
    
    
    
    15,050Stock option and restricted stock compensation
    
    
    13,994
    
    
    
    14,980Provision for bad debts
    
    
    44,980
    
    
    
    42,920Deferred income taxes
    
    
    (22,575
    )
    
    
    (20,559
    )Net loss on sale of assets
    
    
    5,277
    
    
    
    284Equity in earnings of affiliated companies
    
    
    (1,614
    )
    
    
    (4,558
    )Changes in assets and liabilities, excluding sold facilities and acquisitions:Receivables
    
    
    (90,665
    )
    
    
    (145,800
    )Prepaid expenses and other assets
    
    
    20,039
    
    
    
    9,771Liabilities
    
    
    29,807
    
    
    
    17,238Total adjustments
    
    
    137,021
    
    
    
    38,146Net cash provided by operating activities
    
    
    249,920
    
    
    
    154,728Investing ActivitiesInvestment in property and equipment
    
    
    (83,956
    )
    
    
    (105,759
    )Investment in systems development
    
    
    (4,743
    )
    
    
    (2,822
    )Investment in partnership
    
    
    
    
    
    
    (9,275
    )Acquisitions
    
    
    (2,907
    )
    
    
    (19,298
    )Net change in restricted cash and cash equivalents
    
    
    (18,086
    )Proceeds from sale of assets
    
    
    33,982
    
    
    
    40Net cash used in investing activities
    
    
    (75,710
    )
    
    
    (137,114
    )Financing ActivitiesNet borrowings (repayments) under revolving credit facility
    
    
    (36,000
    )
    
    
    18,800Proceeds from issuance of senior notes
    
    
    
    
    
    
    250,000Principal payments of long-term debt
    
    
    (9,492
    )
    
    
    (1,472
    )Payment of financing costs
    
    
    
    
    
    
    (5,915
    )Purchase of common stock for treasury
    
    
    
    
    
    
    (270,634
    )Dividends paid
    
    
    (37,328
    )
    
    
    (37,080
    )Proceeds from exercise of stock options
    
    
    5,119
    
    
    
    14,374Excess tax benefits from share-based payment arrangements
    
    
    6,761
    
    
    
    17,319Net cash used in financing activities
    
    
    (70,940
    )
    
    
    (14,608
    )Net increase in cash and cash equivalents
    
    
    103,270
    
    
    
    3,006Cash and cash equivalents at beginning of period
    
    
    17,658
    
    
    
    12,293Cash and cash equivalents at end of period
    
    $
    120,928
    
    
    $
    15,299
  5




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Manor Care, Inc.
 
   Note 1  Accounting Policies
 Basis of Presentation
    Comprehensive Income
  Goodwill
  6




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Long-TermCare and
    
    
    Hospice andRehabilitation
    
    
    Home Health
    
    
    Other
    
    
    Total(In thousands)Balance at January 1, 2006
    
    $
    66,522
    
    
    $
    36,384
    
    
    $
    451
    
    
    $
    103,357Goodwill from acquisitions
    
    
    10,290
    
    
    
    19,350
    
    
    
    
    
    
    
    29,640Balance at December 31, 2006
    
    
    76,812
    
    
    
    55,734
    
    
    
    451
    
    
    
    132,997Goodwill from acquisitions
    
    
    1,836
    
    
    
    
    
    
    
    
    
    
    
    1,836Goodwill written off related to sale
    
    
    
    
    
    
    (75
    )
    
    
    
    
    
    
    (75
    )Balance at September 30, 2007
    
    $
    78,648
    
    
    $
    55,659
    
    
    $
    451
    
    
    $
    134,758
 Insurance Liabilities
  New Accounting Standards
   7




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Note 2  Divestitures
  Note 3  Debt
     8




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Note 4  Income Taxes
     9




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Note 5  Contingencies
   10




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Note 6  Stock-Based Compensation
    11




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Note 7  Earnings Per Share
  Three Months Ended
    
    
    Nine Months EndedSeptember 30
    
    
    September 302007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands, except earnings per share)Numerator:Numerator for basic EPS  income before
cumulative effect
    
    $
    39,396
    
    
    $
    46,502
    
    
    $
    112,899
    
    
    $
    119,058After-tax amount of interest expense on
Convertible Senior Notes (Old Notes)
    
    
    24
    
    
    
    27
    
    
    
    80
    
    
    
    82Numerator for diluted EPS
    
    $
    39,420
    
    
    $
    46,529
    
    
    $
    112,979
    
    
    $
    119,140Denominator:Denominator for basic EPS  weighted-
average shares
    
    
    73,282
    
    
    
    73,833
    
    
    
    73,186
    
    
    
    76,326Effect of dilutive securities:Stock options
    
    
    902
    
    
    
    961
    
    
    
    865
    
    
    
    960Restricted stock or units
    
    
    245
    
    
    
    81
    
    
    
    163
    
    
    
    51Convertible Senior Notes
    
    
    5,427
    
    
    
    2,511
    
    
    
    4,904
    
    
    
    1,550Denominator for diluted EPS 
adjusted for weighted-average
shares and assumed conversions
    
    
    79,856
    
    
    
    77,386
    
    
    
    79,118
    
    
    
    78,887EPS  Income before cumulative effect:Basic
    
    $
    .54
    
    
    $
    .63
    
    
    $
    1.54
    
    
    $
    1.56Diluted
    
    $
    .49
    
    
    $
    .60
    
    
    $
    1.43
    
    
    $
    1.51
   12




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Note 8  Employee Benefit Plans
   Three Months Ended
    
    
    Nine Months EndedSeptember 30
    
    
    September 302007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)Service cost
    
    $
    678
    
    
    $
    806
    
    
    $
    2,035
    
    
    $
    2,398Interest cost
    
    
    452
    
    
    
    1,165
    
    
    
    1,626
    
    
    
    3,370Expected return on plan assets
    
    
    (46
    )
    
    
    (1,112
    )
    
    
    (487
    )
    
    
    (3,337
    )Amortization of unrecognized transition asset
    
    
    (12
    )
    
    
    (12
    )
    
    
    (36
    )
    
    
    (36
    )Amortization of prior service cost
    
    
    482
    
    
    
    646
    
    
    
    1,452
    
    
    
    1,815Amortization of net loss
    
    
    21
    
    
    
    299
    
    
    
    263
    
    
    
    904Settlement loss
    
    
    302
    
    
    
    
    
    
    
    25,003Net pension cost
    
    $
    1,877
    
    
    $
    1,792
    
    
    $
    29,856
    
    
    $
    5,114
 Note 9  Segment Information
  13




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Long-TermCare and
    
    Hospice andRehabilitation
    
    Home Health
    
    Other
    
    Total(In thousands)Three months ended September 30, 2007Revenues from external customers
    
    $
    830,450
    
    
    $
    131,315
    
    
    $
    6,049
    
    
    $
    967,814Depreciation and amortization
    
    
    36,080
    
    
    
    1,399
    
    
    
    250
    
    
    
    37,729Operating margin
    
    
    152,795
    
    
    
    18,463
    
    
    
    (1,075
    )
    
    
    170,183Three months ended September 30, 2006Revenues from external customers
    
    $
    779,027
    
    
    $
    127,918
    
    
    $
    8,570
    
    
    $
    915,515Intersegment revenues
    
    
    
    
    
    
    
    
    
    
    968
    
    
    
    968Depreciation and amortization
    
    
    35,334
    
    
    
    812
    
    
    
    586
    
    
    
    36,732Operating margin
    
    
    139,311
    
    
    
    21,465
    
    
    
    2,244
    
    
    
    163,020Nine months ended September 30, 2007Revenues from external customers
    
    $
    2,469,285
    
    
    $
    399,353
    
    
    $
    16,022
    
    
    $
    2,884,660Depreciation and amortization
    
    
    108,276
    
    
    
    3,476
    
    
    
    816
    
    
    
    112,568Operating margin
    
    
    458,367
    
    
    
    51,387
    
    
    
    (3,159
    )
    
    
    506,595Nine months ended September 30, 2006Revenues from external customers
    
    $
    2,306,890
    
    
    $
    348,063
    
    
    $
    24,071
    
    
    $
    2,679,024Intersegment revenues
    
    
    
    
    
    
    
    
    
    
    3,000
    
    
    
    3,000Depreciation and amortization
    
    
    104,699
    
    
    
    2,312
    
    
    
    1,809
    
    
    
    108,820Operating margin
    
    
    408,659
    
    
    
    56,346
    
    
    
    2,508
    
    
    
    467,513
 Note 10  Proposed Merger
    14




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Critical Accounting Policies
 General and Professional Liability.
 Workers Compensation Liability.
 15




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##### Table of Contents



Results of Operations 
Quarter and Year-To-Date September 30, 2007 Compared with September 30, 2006
 Overview.
  ̈
    
    We recorded expenses of $13.7 million, or $.11 per share, for transaction costs. See
Note 10 to our consolidated financial statements for a discussion of the proposed merger. ̈
    
    We recorded additional income taxes of $4.5 million, or $.05 per share, primarily
related to the nondeductible transaction costs for tax purposes, as discussed in Note 10 to
our consolidated financial statements.
   ̈
    
    We recorded a non-cash charge of $25.1 million, or $.20 per share, as a result of the
termination and full settlement of an overfunded defined benefit pension plan, as discussed
in Note 8 to our consolidated financial statements. ̈
    
    Our stock-based compensation expense of $25.5 million and deferred compensation expense
of $9.2 million were higher than expected. The expense for the first nine months was
higher than expected by $18.0 million, or $.14 per share, primarily because of our stock
price increase of over 37 percent for the first nine months of 2007. Of the stock-based
compensation and deferred compensation expense, we recorded approximately 17 percent in
operating expenses and the remaining amount in general and administrative expenses. ̈
    
    We recorded expenses of $16.5 million, or $.13 per share, for transaction costs, as
discussed in Note 10 to our consolidated financial statements. ̈
    
    We recorded additional income taxes of $4.5 million, or $.05 per share, primarily
related to the nondeductible transaction costs for tax purposes, as discussed above. ̈
    
    We recorded a loss of $4.7 million, $.04 per share, related to the sale of our
investment in two hospitals, as discussed in Note 2 to our consolidated financial
statements. ̈
    
    We recorded expenses of $1.1 million, or about $.01 per share, related to separation and
other expenses for former officers. ̈
    
    The items above were partially offset by a tax benefit of $1.4 million, or $.02 per
share, related primarily to tax credits from prior periods.
   ̈
    
    Our stock-based compensation expense of $27.4 million and deferred compensation expense
of $6.6 million were higher than expected. The expense for the first nine months was
higher than expected by $11.3 million, or $.09 per share, primarily because of our stock
price increase of over 31 percent for the first nine months, stock option grants that
vested immediately as a result of an option reload feature, and executive retirements that
accelerated the amortization of restricted stock expense. Of the stock-based compensation
and deferred compensation expense, we recorded approximately 22 percent in operating
expenses and the remaining amount in general and administrative expenses.
 16




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##### Table of Contents



 ̈
    
    The cumulative effect of the change in accounting for SARs of $4.0 million ($2.5 million
after tax, or $.03 per share) was a result of the adoption of Statement 123R, as reported
on a separate line item in our income statement. We were required to change the
measurement method for our SARs liability from intrinsic value to fair value on January 1,
2006. ̈
    
    We recorded a charge of $11.1 million, or $.09 per share, related to the write-down of
our transcription business, which we sold in the fourth quarter of 2006. We reported the
charge on a separate line item in our income statement.
 Revenues  Quarter.
 Revenues  First Nine Months.
 Revenue Factors  Quarter and First Nine Months.
 Third Quarter
    
    
    
    
    
    First Nine Months2007
    
    2006
    
    Increase
    
    2007
    
    2006
    
    IncreaseMedicare
    
    $
    417.71
    
    
    $
    383.16
    
    
    
    9
    %
    
    $
    412.17
    
    
    $
    380.34
    
    
    
    8
    %Medicaid
    
    $
    161.19
    
    
    $
    153.13
    
    
    
    5
    %
    
    $
    159.60
    
    
    $
    151.81
    
    
    
    5
    %Private and other (skilled only)
    
    $
    243.81
    
    
    $
    227.02
    
    
    
    7
    %
    
    $
    240.85
    
    
    $
    226.28
    
    
    
    6
    %
  17




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##### Table of Contents



Third Quarter
    
    First Nine Months2007
    
    2006
    
    2007
    
    2006Total
    
    
    89
    %
    
    
    89
    %
    
    
    89
    %
    
    
    89
    %Skilled nursing facilities
    
    
    89
    %
    
    
    89
    %
    
    
    89
    %
    
    
    90
    %
   Operating Expenses  Quarter.
   Operating Expenses  First Nine Months.
   18




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##### Table of Contents



General and Administrative Expenses.
 Interest Expense.
 Equity in Earnings of Affiliated Companies.
 Interest Income and Other.
 Income Taxes.
 Financial Condition  September 30, 2007 and December 31, 2006
  19




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##### Table of Contents



Liquidity and Capital Resources
 Cash Flows.
 Investing Activities.
 Debt Agreements.
     20




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##### Table of Contents



Stock Purchase.
  Cautionary Statement Concerning Forward-Looking Statements
   21




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##### Table of Contents



Quantitative and Qualitative Disclosures About Market Risk
  
 Controls and Procedures
  
 Part II. Other Information
 
 Legal Proceedings.
 Crescente v. Manor Care, Inc. et al.
 22




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##### Table of Contents



Risk Factors.
  23




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##### Table of Contents



Unregistered Sales of Equity Securities and Use of Proceeds.
  
 Defaults Upon Senior Securities.
  
 Submission of Matters to a Vote of Security Holders.
  
 Other Information.
  
 Exhibits.
 S-K Item601 No.31.1*
    
    Chief Executive Officer Certification31.2*
    
    Chief Financial Officer Certification32.1*
    
    Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2*
    
    Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 200299.1*
    
    Letter Agreement, dated July 2, 2007, between Manor Care, Inc. and JPMorgan Chase Bank,
National Association
 
 *
    
    Filed herewith. 24




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##### Table of Contents



Signatures
  Manor Care, Inc.
(Registrant)Date  November 9, 2007
    By
    /s/ Steven M. CavanaughSteven M. Cavanaugh, Vice President andChief Financial Officer 25




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##### Table of Contents



Exhibit Index
 Exhibit31.1
    
    Chief Executive Officer Certification31.2
    
    Chief Financial Officer Certification32.1
    
    Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200299.1
    
    Letter Agreement, dated July 2,
2007, between Manor Care, Inc. and JPMorgan Chase Bank, National Association
 26