UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

þ		Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2005

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Manor Care, Inc.

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		34-1687107 (IRS Employer Identification No.)
333 N. Summit Street, Toledo, Ohio (Address of principal executive offices)		43604-2617 (Zip Code)

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: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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 þ No o

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 o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer þ Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ

Based on the closing price of $39.73 per share on June 30, 2005, the aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates was $3,312,400,112. 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 Manor Care, Inc. outstanding as of February 28, 2006 was 79,071,372.

Documents Incorporated By Reference

The following document is incorporated by reference in the Part indicated:

     We incorporate by reference specific portions of the registrant’s Proxy Statement for the Annual Stockholders’ Meeting to be held May 9, 2006 in Part III.

 

 

Manor Care, Inc.
Form 10-K
Table of Contents

				Page
				Number
PART I
Item 1.		Business			2
Item 1A.		Risk Factors			8
Item 1B.		Unresolved Staff Comments			15
Item 2.		Properties			15
Item 3.		Legal Proceedings			17
Item 4.		Submission of Matters to a Vote of Security Holders			17
PART II
Item 5.		Market for Registrant's Common Equity, Related Stockholder
		Matters and Issuer Purchases of Equity Securities			17
Item 6.		Selected Financial Data			19
Item 7.		Management's Discussion and Analysis of Financial
		Condition and Results of Operations			20
Item 7A.		Quantitative and Qualitative Disclosures about Market Risk			38
Item 8.		Financial Statements and Supplementary Data			39
Item 9.		Changes in and Disagreements with Accountants on
		Accounting and Financial Disclosure			74
Item 9A.		Controls and Procedures			74
Item 9B.		Other Information			77
PART III
Item 10.		Directors and Executive Officers of the Registrant			77
Item 11.		Executive Compensation			78
Item 12.		Security Ownership of Certain Beneficial Owners and
		Management and Related Stockholder Matters			78
Item 13.		Certain Relationships and Related Transactions			79
Item 14.		Principal Accounting Fees and Services			79
PART IV
Item 15.		Exhibits, Financial Statement Schedules			79
Signatures					86
Exhibit Index					88
EX-10.11 Restricted Stock Unit Award Agreement
EX-10.32 Employment Agreement Stephen L. Guillard
EX-21 Subsidiaries
EX-23 Consent
EX-31.1 CEO Certification
EX-31.2 CFO Certification
EX-32.1 CEO Section 1350 Certification
EX-32.2 CFO Section 1350 Certification

PART I

Item 1. Business

General Development of Business

Manor Care, Inc., which we also refer to as Manor Care and HCR Manor Care, provides a range of health care services, including skilled nursing care, assisted living, subacute medical and rehabilitation care, hospice care, home health care and rehabilitation therapy. The most significant portion of our business relates to long-term care, including skilled nursing care and assisted living. Our other segment is hospice and home health care. We provide greater detail about the revenues of certain health care services and other segment information in Notes 4 and 16 to the consolidated financial statements.

Our executive offices are located at 333 N. Summit Street, Toledo, Ohio 43604-2617. Our telephone number is (419) 252-5500. Our Internet website is at www.hcr-manorcare.com. Our filings with the Securities and Exchange Commission, or SEC, are available free of charge through our website with a hyperlink to the SEC’s website as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.

Narrative Description of Business

Long-Term Care Services

We are a leading owner and operator of long-term care centers in the United States, with the majority of our facilities operating under the respected Heartland, ManorCare and Arden Courts names. On December 31, 2005, we operated 276 skilled nursing facilities and 65 assisted living facilities in 30 states with 62 percent of our facilities located in Florida, Illinois, Michigan, Ohio and Pennsylvania.

     Skilled Nursing Centers. Our facilities use interdisciplinary teams of experienced medical professionals to provide services prescribed by physicians. These teams include registered nurses, licensed practical nurses and certified nursing assistants, who provide individualized comprehensive nursing care around the clock. We design “Quality of Life” programs to give the highest practicable level of functional independence to patients. 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 nutrition services, social services, activities, and housekeeping and laundry services.

     Assisted Living Services. We have a number of stand-alone assisted living centers as well as units within our 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. We use a comprehensive resident assessment to help determine the appropriate package of services desired or required by each resident. Our assisted living staff encourages residents to socialize and participate in a broad spectrum of activities.

     Subacute Medical and Rehabilitation Care. Our leadership in subacute programs designed to shorten or eliminate hospital stays exemplifies our commitment to reducing the cost of quality health care. Working closely with patients, families and insurers, interdisciplinary teams of experienced medical professionals develop comprehensive, individualized patient care plans that target the essential medical, functional and discharge planning objectives. We provide medical and rehabilitation programs for patients recovering from major surgery; severe injury; or serious cardiovascular, respiratory, infectious, endocrine or neurological illnesses with a primary goal of a return to home or a similar environment.

     Alzheimer’s Care. As an industry leader in Alzheimer’s care, we provide innovative services and facilities to care for Alzheimer’s patients in early, middle and advanced stages of the disease. Trained staffs provide specialized care and programming for persons with Alzheimer’s or related disorders in freestanding Arden Courts facilities and in dedicated units within many of our skilled nursing centers.

Hospice and Home Health Care

Our hospice and home health business specializes in all levels of hospice care, home health and rehabilitation therapy with 103 offices in 24 states. Our hospice services focus on the physical, spiritual and psychosocial needs of individuals facing a life-limiting illness. Palliative and clinical care, education, counseling and other resources not only take into consideration their needs, but the needs of family members, as well. Our home health care is designed to assist those who wish to stay at home or in assisted living residences but still require some degree of medical care or assistance with daily activities. For skilled care, our registered and licensed practical nurses and therapy professionals can provide services such as wound care and dressing changes; infusion therapy; cardiac rehabilitation; and physical, occupational and speech therapies. In addition, our home health aides can assist with daily activities such as personal hygiene, assistance with walking and getting in and out of bed, medication management, light housekeeping and generally maintaining a safe environment.

Other Health Care Services

In addition to the rehabilitation provided in each of our skilled nursing centers, we provide rehabilitation therapy in our outpatient therapy clinics and at work sites, schools, hospitals and other health care settings. Our 91 outpatient therapy clinics are located in Midwestern and Mid-Atlantic states, Texas and Florida.

Other Services

We own a medical transcription company that converts medical dictation into electronically formatted patient records. Health care providers use the records in connection with patient care and other administrative purposes.

Customers

No individual customer or related group of customers accounts for a significant portion of our revenues. We do not expect that the 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 to pay the cost of their care. The following table reflects the allocation of 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.

		2005				2004				2003
Medicare			39	%			36	%			32	%
Private pay and other			32				33				35
Medicaid			29				31				33
			100	%			100	%			100	%

Medicare is a health insurance program for the aged and certain other chronically disabled individuals, operated by the federal government. Medicaid is a medical assistance program for the indigent, operated by individual states with the financial participation of the federal government.

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, market forces and costs largely determine these rates.

Government reimbursement programs such as Medicare and Medicaid prescribe, by law, the billing methods and amounts that may be charged and reimbursed to care for patients covered by these programs. Congress passed a number of laws that have effected major changes in the Medicare and Medicaid programs. See the “Results of Operations – Overview” section on 21-23 under Item 7, Management’s Discussion and Analysis, for additional discussion of Medicare and Medicaid legislation.

Regulation and Licenses

Health care is an area of extensive regulatory oversight and frequent regulatory change. The federal government and the states in which we operate regulate various aspects of our business.

These regulatory bodies, among other things, require us annually to license our skilled nursing facilities, assisted living facilities in some states and other health care businesses, including home health agencies and hospices. In particular, to operate nursing facilities and provide health care services we must comply with 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, building codes and environmental protection.

Governmental and other authorities periodically inspect our skilled nursing facilities to assure that we continue to comply with their various standards. We must pass these inspections to continue our licensing under state law, to obtain certification under the Medicare and Medicaid programs and to continue our participation in the Veterans Administration program. We can only participate in other third-party programs if our facilities pass these inspections. In addition, these authorities inspect our record keeping and inventory control.

From time to time, we, like others in the health care industry, may receive notices from federal and state regulatory agencies alleging that we failed to comply with applicable standards. These notices may require us to take corrective action, and may impose civil money penalties and/or other operating restrictions on us. If our skilled nursing facilities fail to comply with these directives or otherwise fail to comply substantially with licensure and certification laws, rules and regulations, we could lose our certification as a Medicare and Medicaid provider and/or lose our licenses.

Local and state health and social service agencies and other regulatory authorities specific to their location regulate, to varying degrees, our assisted living facilities. 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. If assisted living facilities fail to comply with licensing requirements, these facilities could lose their licenses. Most states also subject assisted living facilities 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 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 our health care businesses may have a significant impact on our methods and costs of doing business.

See Item 1A, Risk Factors, for additional discussion of laws and regulations applicable to our business.

Employees

As of December 31, 2005, we had approximately 58,000 full- and part-time employees. Approximately 6,400 of our employees are salaried, and we pay the remainder on an hourly basis. Approximately 1,400 of our employees are members of labor unions.

Other Areas

See Item 1A, Risk Factors, for a discussion of our labor costs and competition.

Executive Officers of the Registrant

The names, ages, offices and positions held during the last five years of each of our executive officers are as follows:

Executive Officers

Name		Age				Office and Experience
Paul A. Ormond			56			President and Chief Executive Officer since August 1991; Chairman of the Board since September
						2001 and from August 1991 to September 1998; and member of Class I of the Board of Directors, with
						a term expiring in 2007.
M. Keith Weikel			67			Senior Executive Vice President and Chief Operating Officer since August 1991; and member of Class
						III of the Board of Directors, with a term expiring in 2006.
Geoffrey G. Meyers			61			Executive Vice President and Chief Financial Officer since August 1991.
Stephen L. Guillard			56			Executive Vice President of Manor Care since June 2005; and Chairman and Chief Executive Officer
						of Harborside Healthcare Corporation from 1988 to May 2005.
R. Jeffrey Bixler			60			Vice President and General Counsel since November 1991 and Secretary since December 1991.
Nancy A. Edwards			55			Vice President and General Manager of Central Division since December 1993.

Name		Age				Office and Experience
John K. Graham			45			Group Vice President, Hospice and Home Health Care since March 2005; Vice President and General
						Manager of Eastern Division from July 2002 to February 2005; and Vice President and Director of
						Rehabilitation Services from September 1998 to June 2002.
Jeffrey A. Grillo			47			Vice President and General Manager of Mid-Atlantic Division since February 1999.
Lynn M. Hood			44			Vice President and General Manager of Southeast Division since February 2006; Assistant
						Vice President/General Manager of South-West Division(1) from September 2004 to January
						2006; Regional Director of Operations(1) for certain groups of facilities from 1995 to
						August 2004.
Larry C. Lester			63			Vice President and General Manager of Midwest Division, and Director of Marketing since July 2003;
						and Vice President and General Manager of Midwest Division from January 2000 to June 2003.
Spencer C. Moler			58			Vice President and Controller since August 1991.
Susan E. Morey			53			Vice President and General Manager of Eastern Division since May 2005; Assistant Vice
						President/General Manager of Eastern Division(1) from November 2001 to April 2005; and
						Regional Director of Operations(1) for certain groups of facilities from 1997 to
						October 2001.
Michael J. Reed			54			Vice President and General Manager of Assisted Living Division since December 2005; Vice President
						and General Manager of Assisted Living Division(1) from October 2005 to November 2005;
						Senior Vice President of Marketing of Harborside Healthcare Corporation from November 2003 to
						September 2005; Vice President of Fountains Inc. from July 2001 to September 2003.
F. Joseph Schmitt			57			Vice President and General Manager of West Division since February 2006; Vice President and
						General Manager of South-West Division from September 2004 to January 2006; and Vice President and
						General Manager of Southern Division from December 1993 to August 2004.

Item 1A. Risk Factors

The following are certain risk factors that could affect our business, operations and financial condition. These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report on Form 10-K because these factors could cause the actual results and conditions to differ materially from those projected in forward-looking statements. This section does not describe all risks applicable to us, our industry or our business, and we intend it only as a summary of certain material factors. If any of the following risks actually occur, our business, financial condition or results of operations could be negatively affected. In that case, the trading price of our stock could decline.

We depend upon reimbursement by third-party payors.

Our revenues are derived from private and governmental third-party payors. In 2005, 39 percent of our long-term care and rehabilitation revenues were derived from Medicare, 29 percent from Medicaid and 32 percent from commercial insurers, managed care plans, workers’ compensation payors and other private pay revenue sources. There are pressures from many payors to control health care costs and to reduce or limit increases in reimbursement rates for health care services. Governmental payment programs are subject to statutory and regulatory changes, retroactive rate adjustments, administrative or executive orders and government funding restrictions, all of which may materially increase or decrease the rate of program payments to us for our services. In the past, we have experienced a decrease in revenues primarily attributable to declines in government reimbursement as a result of the Balanced Budget Act of 1997, or the Budget Act. Although certain rate reductions resulting from the Budget Act were mitigated temporarily by the SCHIP Balanced Budget Refinement Act of 1999 and the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000, the Budget Act significantly changed the method of payment under the Medicare and Medicaid programs for our services. The Centers for Medicare & Medicaid Services, or CMS, has issued a final Medicare skilled nursing facility payment rule for the 12 months ended September 30, 2006 that implements refinements to the patient classification system and triggers the expiration of a payment add-on for certain high-acuity patients. Skilled nursing facilities continued to be paid under the prior classification system from October 1, 2005 through December 31, 2005, and the new classification system became effective January 1, 2006. The final rule also adopts a 3.1 percent market basket increase for the 12 months ended September 30, 2006. Therefore, while Medicare payments to skilled nursing facilities were reduced by an estimated $1.02 billion because of the expiration of temporary add-on payments, according to CMS this reduction will be more than offset by a $510 million increase from the refined classification system and a $530 million increase from the payment rate update. The changes that took effect January 1, 2006 will have a negative impact on our Medicare rate. Our average Medicare rate of $379 for the fourth quarter of 2005 increased over $17 per day compared with the third quarter of 2005. Of this increase, about $11 per day was related to the market basket increase, and our mix shift accounted for the additional $6 per day. We previously expected our average Medicare rate to decrease $17 to $20 per day in the first

quarter of 2006 as a result of the expiration of the add-on payments and the new patient classification refinements. Now we expect to substantially offset this decrease with the continuing shift to higher-acuity patients. In addition, in February 2006 Congress enacted the Deficit Reduction Act which will reduce net Medicare and Medicaid spending by approximately $11 billion over five years. See the “Results of Operations – Overview” section on pages 21-23 under Item 7, Management’s Discussion and Analysis, for additional discussion of Medicare and Medicaid legislation and the effects of the Deficit Reduction Act on us. It is possible that future budget cuts in Medicare may be enacted by Congress and implemented by CMS. Therefore, we cannot assure you that payments from governmental or private payors will remain at levels comparable to present levels or will, in the future, be sufficient to cover the costs allocable to patients eligible for reimbursement pursuant to such programs.

Due to budgetary shortfalls, many states are considering or have enacted cuts to their Medicaid programs, including funding for our services. In the future, changes to Medicaid may include reducing eligibility, eliminating optional services and transitioning Medicaid patients to less care-intensive settings. In addition, a number of states use various funding mechanisms, including provider assessment programs and intergovernmental transfers, to increase federal Medicaid matching funds. Federal regulations permit states to use these funding sources toward a state’s share of Medicaid expenditures if the state program meets federal requirements. The Department of Health and Human Services has established a Medicaid Commission to advise Congress and the Department’s Secretary on ways to modernize the Medicaid program so that it can provide high-quality health care to its beneficiaries in a financially sustainable manner. The Medicaid Commission is charged with recommending options to achieve $10 billion in Medicaid savings over five years along with longer-term Medicaid financing reforms. On September 1, 2005, the Commission released its “short-term” Medicaid savings recommendations, which include changes to nursing home eligibility rules. Some of the options that could be considered by the Medicaid Commission include curtailing intergovernmental transfers and limiting provider assessment programs in order to decrease federal Medicaid matching funds. Further, the Deficit Reduction Act includes several changes to the Medicaid program designed to rein in program spending.

The health care industry reimbursement process is complex and can involve lengthy delays between the time that revenue is recognized and the time that reimbursement amounts are settled. As a result, the reimbursement process may affect our financial condition and results of operations. In fact, we are subject to periodic audits by the Medicare and Medicaid programs, and the paying agencies for these programs have various rights and remedies against us if they assert that we have overcharged the programs or failed to comply with program requirements. These payment and government agencies can reopen previously filed and reviewed cost reports and require us to repay any overcharges, as well as make deductions from future amounts due to us. In the ordinary course of business, we appeal the Medicare and Medicaid program’s denial of costs claimed to seek recovery of those denied costs. For example, we are currently appealing the Medicare fiscal intermediary’s incorrect adjustment of certain expenses on the former Manor

Care’s home office cost reports from 1997 to 1999, which required us to make a repayment of $34.1 million in 2005, an amount that is recorded as a receivable on our balance sheet. Although we believe that we have strong arguments to support why these amounts should be returned to us, there is no guarantee that we will be successful in our appeal or that this process will be completed in an expeditious manner. While not expected or considered likely, a failure of our appeal could lead to the establishment of reserves and the eventual write-off of the receivables we have established. More generally, due to the complexity of the reimbursement process, we could be subject to civil false claims assessments, fines, criminal penalties or program exclusions as a result of review of program violations by the Department of Justice and the Office of Inspector General, Department of Health and Human Services. Private pay sources also reserve rights to conduct audits and make monetary adjustments.

See the “Results of Operations – Overview” section on pages 21-23 under Item 7, Management’s Discussion and Analysis, for additional discussion of Medicare and Medicaid legislation.

If we fail to comply with extensive laws and government regulations, we could suffer penalties or be required to make significant changes to our operations.

The health care industry, including our company, is required to comply with extensive and complex laws and regulations at the federal, state and local government levels relating to, among other things,

			¨ Licensure and certification;
			¨ Adequacy and quality of health care services;
			¨ Qualifications of health care and support personnel;
			¨ Quality of medical equipment;
			¨ Confidentiality, maintenance and security issues associated with medical records and claims processing;
			¨ Relationships with physicians and other referral sources;
			¨ Operating policies and procedures;
			¨ Addition of facilities and services; and
			¨ Billing for services.

Many of these laws and regulations are expansive, and we do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. In addition, certain regulatory developments, such as revisions in the building code requirements for assisted living and skilled nursing facilities, 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 us. In the future, different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our facilities, equipment, personnel, services, capital expenditure programs and operating expenses.

If we fail to comply with applicable laws and regulations, we could be subjected to liabilities, including criminal penalties, civil penalties (including the loss of our licenses to operate one or more of our facilities) and exclusion of one or more of our facilities from participation in the Medicare, Medicaid, and other federal and state health care programs. Both federal and state government agencies have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of health care companies and, in particular, skilled nursing facilities and hospice and home health care agencies. These investigations relate to a wide variety of topics, including:

			¨ Cost reporting and billing practices;
			¨ Quality of care;
			¨ Financial relationships with referral sources; and
			¨ Medical necessity of services provided.

In addition, the Office of the Inspector General of the Department of Health and Human Services and the Department of Justice have, from time to time, established national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. As other participants in the health care industry, we receive requests for information from governmental agencies in connection with their regulatory or investigational authority. Moreover, health care providers are also subject to ‘‘qui tam’’ whistleblower lawsuits and false claims provisions at both the state and federal level.

We are required to comply with laws governing the transmission and privacy of health information.

The Health Insurance Portability and Accountability Act of 1996, or HIPAA, requires us to comply with standards for the exchange of health information within our company and with third parties, such as payors, business associates and patients. These include standards for common health care transactions, such as:

			¨ Claims information, plan eligibility, payment information and the use of electronic signatures;
			¨ Unique identifiers for providers, employers, health plans and individuals; and
			¨ Security, privacy and enforcement.

The Department of Health and Human Services has released final rules to implement a number of these requirements, and several HIPAA initiatives have become effective, including privacy protections, transaction standards and security standards. If we fail to comply with these standards, we could be subject to criminal penalties and civil sanctions.

State efforts to regulate the construction or expansion of health care providers could impair our ability to expand our operations.

Some states require health care providers (including skilled nursing facilities, hospices, home health agencies and assisted living facilities) to obtain prior approval, known as a certificate of need, or CON, for:

			¨ The purchase, construction or expansion of health care facilities;
			¨ Capital expenditures exceeding a prescribed amount; or
			¨ Changes in services or bed capacity.

To the extent that we require a CON or other similar approvals to expand our operations, either by acquiring facilities or expanding or providing new services or other changes, our expansion could be adversely affected by the failure or inability to obtain the necessary approvals, changes in the standards applicable to those approvals, and possible delays and expenses associated with obtaining those approvals. We cannot assure you that we will be able to obtain CON approval for all future projects requiring that approval.

Health care reform legislation may affect our business.

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 could adversely affect us, such as:

			¨ Reductions in funding of the Medicare and Medicaid programs;
			¨ Potential changes in reimbursement regulations by CMS;
			¨ Enhanced pressure to contain health care costs by Medicare, Medicaid and other payors; and
			¨ Greater state flexibility and additional operational requirements in the administration of Medicaid.

There can be no assurance as to the ultimate content, timing or effect of any health care reform legislation, nor is it possible at this time to estimate the impact of potential legislation on us. That impact may be material to our financial condition or our results of operations.

We face national, regional and local competition.

Our 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. Our ability 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.

We also compete with a variety of other companies in providing assisted living services, hospice and home health care services, and rehabilitation therapy services. Given the relatively low barriers to entry and continuing health care cost-containment pressures in the assisted living industry, we expect that the assisted living industry will become increasingly competitive in the future. Increased competition in the future could limit our ability to attract and retain residents, to maintain or increase resident service fees, or to expand our business.

Labor costs may increase with a potential shortage of qualified personnel.

A shortage of nurses or other trained personnel and general inflationary pressures have required us to enhance our wage and benefits packages in order to compete for qualified personnel. We compete with other health care providers to attract and retain qualified or skilled personnel. We also compete with various industries for lower-wage employees. We have used and will continue to use, when needed, high-priced temporary help to supplement staffing levels in certain markets with shortages of health care workers. If a shortage of nurses or other health care workers occurred in all geographic areas in which we operate, it could adversely affect our ability to attract and retain qualified personnel and could further increase our operating costs.

See the “Results of Operations – Overview” section on page 23 under Item 7, Management’s Discussion and Analysis, for additional discussion of labor.

Our operations are subject to occupational health and safety regulations.

We are subject to a wide variety of federal, state and local occupational health and safety laws and regulations. The types of regulatory requirements faced by health care providers such as us include:

			¨ Air and water quality control requirements;
			¨ Occupational health and safety requirements (such as standards regarding blood-borne pathogens and ergonomics) and waste     management requirements;
			¨ Specific regulatory requirements applicable to asbestos, polychlorinated biphenyls and radioactive substances;
			¨ Requirements for providing notice to employees and members of the public about hazardous materials and wastes; and
			¨ Certain other requirements.

If we fail to comply with these standards, we may be subject to sanctions and penalties.

We may be unable to reduce costs to offset decreases in our occupancy rates or other expenses completely.

We depend on implementing adequate cost management initiatives in response to fluctuations in levels of occupancy in our skilled nursing and assisted living facilities and in other sources of income in order to maintain our current cash flow and earnings levels. Fluctuation in our occupancy levels may become more common as we increase our emphasis on patients with shorter stays but higher acuities. A decline in our occupancy rates could result in decreased revenues. If we are unable to put in place corresponding adjustments in costs in response to declines in census or other revenue shortfalls, we may be unable to prevent future decreases in earnings. As a result, our financial condition and operating results may be adversely affected.

The cost of general and professional liability claims may increase.

Patient care liability remains a serious industry-wide cost issue. The long-term care industry received some assistance with the passage of tort reform measures in Florida, Ohio, Pennsylvania, Texas and other states. Despite those reforms, if patient care claims significantly increase in number and size, our future financial condition and operating results may be adversely affected.

Item 1B. Unresolved Staff Comments

None

Item 2. Properties

Our principal properties and those of our subsidiaries, which are of material importance to the conduct of our and their business, consist of 341 long-term care centers located in 30 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, and patient and visitor lounges, as well as administrative offices and employee lounges. We believe that all of our centers have been well maintained and are suitable for the conduct of our business. For the year ended December 31, 2005, approximately 88 percent of the beds were utilized.

The following table shows the number and location of centers and beds we operated as of December 31, 2005 for our long-term care segment.

		Number of Centers
						Assisted
		Skilled				Living				Number of Beds
Pennsylvania			46				9				8,031
Ohio			43				9				6,231
Florida			28				11				4,610
Illinois			29				8				4,538
Michigan			27				3				3,667
Maryland			14				9				2,719
Texas			12				4				2,100
California			9								1,289
Virginia			6				2				1,038
West Virginia			7								927
Wisconsin			8								868
Indiana			4				1				859
South Carolina			7								853
New Jersey			4				4				747
Kansas			3								487
Washington			4								482
Oklahoma			4								478
Missouri			3								430
Iowa			4								406
Delaware			2				1				356
Colorado			2								310
Georgia			2								257
Kentucky			1				1				242
North Dakota			2								215
Nevada			1								189
Connecticut							3				180
Utah			1								140
North Carolina			1								120
Arizona			1								118
South Dakota			1								99
Total			276				65				42,986

We own 333 of these centers, lease seven, and have a partnership in one center. We operate 65 assisted living facilities with a total of 5,080 beds. Five of our properties are subject to liens that encumber the properties in an aggregate amount of $3.9 million.

We lease space for our corporate headquarters in Toledo, Ohio under a synthetic lease. We discuss our off-balance sheet obligation for this lease in the “Capital Resources and Liquidity” section on page 34 under Item 7, Management’s Discussion and Analysis. We also lease space for our hospice and home health offices and outpatient therapy clinics.

Item 3. Legal Proceedings

See the “Commitments and Contingencies” section on pages 35-36 under Item 7, Management’s Discussion and Analysis, for a discussion of litigation related to environmental matters and patient care-related claims.

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

Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our 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 high, low and closing prices of our stock on the New York Stock Exchange and dividends declared and paid during 2005 and 2004 were as follows:

														Cash
		High				Low				Close				Dividends
2005
First Quarter		$	36.59			$	32.26			$	36.36			$	.15
Second Quarter		$	41.16			$	30.87			$	39.73			$	.15
Third Quarter		$	40.46			$	34.70			$	38.41			$	.15
Fourth Quarter		$	41.10			$	36.46			$	39.77			$	.15
2004
First Quarter		$	37.25			$	32.44			$	35.29			$	.14
Second Quarter		$	36.57			$	30.28			$	32.68			$	.14
Third Quarter		$	32.75			$	29.20			$	29.96			$	.14
Fourth Quarter		$	35.84			$	29.42			$	35.43			$	.14

In January 2006, our Board of Directors increased our quarterly dividend to 16 cents per share of common stock. We intend to declare and pay regular quarterly cash dividends; however, there can be no assurance that any dividend will be declared, paid or increased in the future.

On January 31, 2006, we had 2,271 stockholders of record. Approximately 93 percent of our outstanding shares were registered in the name of The Depository Trust Company, or Cede & Co., which held these shares on behalf of several hundred brokerage firms, banks and other financial institutions. We believe that the shares attributed to these financial institutions represent the interests of approximately 30,000 beneficial owners, including employees’ interests in stock in our 401(k) plan.

Issuer Purchases of Equity Securities

The following table provides information with respect to stock repurchased by us during the fourth quarter of 2005:

														Approximate
										Total Number of				Dollar Value of
										Shares Purchased				Shares that May
		Total Number				Average Price				as Part of Publicly				Yet Be Purchased
		of Shares				Paid per				Announced Plans				Under the Plans
Period		Purchased				Share				or Programs (1)				or Programs (1)
10/1/05-10/31/05														$	53,701,788
11/1/05-11/30/05														$	53,701,788
December ASR settlement (2)														$	52,494,794
12/1/05-12/31/05			293,000			$	39.54				293,000			$	40,910,136
Total			293,000			$	39.54				293,000

Item 6. Selected Financial Data

Five-Year Financial History

		2005				2004				2003				2002				2001
		(In thousands, except per share amounts and Other Data)
Results of Operations
Revenues		$	3,417,290			$	3,208,867			$	3,029,441			$	2,905,448			$	2,694,056
Expenses:
Operating			2,820,431				2,647,849				2,523,534				2,401,636				2,271,808
General and administrative			164,189				140,587				157,566				131,628				115,094
Depreciation and amortization			139,203				127,821				128,810				124,895				128,159
Asset impairment			2,451												33,574
			3,126,274				2,916,257				2,809,910				2,691,733				2,515,061
Income before other income (expenses) and income taxes			291,016				292,610				219,531				213,715				178,995
Other income (expenses):
Interest expense			(41,240	)			(42,420	)			(41,927	)			(37,651	)			(50,800	)
Early extinguishment of debt			(18,634	)			(11,160	)
Gain (loss) on sale of assets			16,431				6,400				3,947				30,651				(445	)
Equity in earnings of affiliated companies			5,492				6,975				7,236				4,761				1,407
Interest income and other			4,607				2,474				1,625				1,208				835
Total other expenses, net			(33,344	)			(37,731	)			(29,119	)			(1,031	)			(49,003	)
Income before income taxes			257,672				254,879				190,412				212,684				129,992
Income taxes			96,717				86,657				71,405				80,820				61,502
Income before cumulative effect		$	160,955			$	168,222			$	119,007			$	131,864			$	68,490
Earnings per share:
Income before cumulative effect
Basic		$	1.93			$	1.94			$	1.33			$	1.34			$	.67
Diluted		$	1.89			$	1.90			$	1.30			$	1.33			$	.66
Cash dividends declared per common share		$	.60			$	.56			$	.25
Cash Flows
Cash flows from operations		$	353,948			$	329,766			$	300,464			$	283,293			$	283,427
Financial Position
Total assets		$	2,339,234			$	2,350,464			$	2,396,711			$	2,329,072			$	2,424,071
Long-term debt			730,466				555,275				659,181				373,112				715,830
Shareholders’ equity			773,723				984,159				975,105				1,016,047				1,046,538
Other Data (Unaudited)
Number of skilled nursing and assisted living facilities			341				344				363				366				368

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

Results of Operations — Overview

Manor Care, Inc., which we also refer to as Manor Care or HCR Manor Care, provides a range of health care services, including skilled nursing care, assisted living, subacute medical and rehabilitation care, hospice care, home health care and rehabilitation therapy.

     Long-Term Care. The most significant portion of our business relates to long-term care, including skilled nursing care and assisted living. On December 31, 2005, we operated 276 skilled nursing facilities and 65 assisted living facilities in 30 states with 62 percent of our facilities located in Florida, Illinois, Michigan, Ohio and Pennsylvania. Within some of our centers, we have medical specialty units which provide subacute medical and rehabilitation care and/or Alzheimer’s care programs.

The table below details the activity in the number of skilled nursing and assisted living facilities and beds during the past three years. The additions represent facilities that we built. The divestitures include facilities that were sold or converted into a long-term acute care hospital, as well as facilities with a lease that expired or was terminated. We sold certain facilities that no longer fit our strategic growth plan. Their results of operations are insignificant to us. We currently have four skilled nursing facilities under construction, three of which we expect to open in 2006. We have not included in the table any activity related to expansion of beds in existing facilities.

		2005								2004								2003
		Facilities				Beds				Facilities				Beds				Facilities				Beds
Skilled nursing facilities:
Additions			1				100				2				173				—				—
Divestitures			4				565				16				2,613				3				374
Assisted living facilities:
Divestitures			—				—				5				532				—				—

     Hospice and Home Health. Our hospice and home health business includes all levels of hospice care, home care and rehabilitation therapy, with 103 offices in 24 states. The growth in our hospice and home health business is primarily a result of opening additional offices and expansion of our hospice client base in existing markets where we benefit from our long-term care relationships. We also had growth from small acquisitions.

     Other Health Care Services. In addition to the rehabilitation provided in each of our skilled nursing centers, we provide rehabilitation therapy in our outpatient therapy clinics and at work sites, schools, hospitals and other health care settings. Our 91 outpatient therapy clinics are located in Midwestern and Mid-Atlantic states, Texas and Florida.

 

     Other Services. We own a medical transcription company that converts medical dictation into electronically formatted patient records. Health care providers use the records in connection with patient care and other administrative purposes.

     Medicare and Medicaid Payments. Government reimbursement programs such as Medicare and Medicaid prescribe, by law, the billing methods and amounts that may be charged and reimbursed to care for patients covered by these programs. Congress has passed a number of laws that have effected major changes in the Medicare and Medicaid programs. The Balanced Budget Act of 1997, or the Budget Act, sought to achieve a balanced federal budget by, among other things, reducing federal spending on Medicare and Medicaid to various providers.

In 1999 and 2000, Congress passed legislation to redress certain reductions in Medicare reimbursement resulting from the Budget Act. Further refinements also were made by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. In addition, in February 2006 Congress enacted the Deficit Reduction Act, or DEFRA, which will reduce net Medicare and Medicaid spending. Several key provisions of these bills include:

		¨		A temporary payment increase for certain high-cost nursing home patients, for services provided from April 1, 2000 and continuing until the Centers for Medicare & Medicaid Services, or CMS, implements a refined patient classification to better account for medically complex patients. While CMS did not implement such refinements for several years, CMS’ final payment rule for fiscal year 2006 adopted the new patient classification refinements effective January 1, 2006, thus triggering the expiration of the high-acuity payment add-ons. The combined effect of these changes will have a negative impact on our Medicare rate in 2006. Our average Medicare rate of $379 for the fourth quarter of 2005 increased over $17 per day compared with the third quarter of 2005. Of this increase, about $11 per day was related to the payment rate increase of 3.1 percent effective October 1, 2005, and our mix shift accounted for the additional $6 per day. We previously expected our average Medicare rate to decrease $17 to $20 per day in the first quarter of 2006 as a result of the expiration of the add-on payments and the new patient classification refinements. Now we expect to substantially offset this decrease with the continuing shift to higher-acuity patients.
		¨		A moratorium on the Budget Act’s annual $1,500 therapy cap (indexed for inflation) on each of physical/speech therapy and occupational therapy beginning with services provided on or after January 1, 2000 through December 31, 2002. The per-beneficiary limits, which were adjusted for inflation to $1,590, were imposed from September 1, 2003 to December 8, 2003, but were suspended again through calendar year 2005. With the expiration of the moratorium, they became effective January 1, 2006, subject to an exception process that will allow additional therapy to beneficiaries over the cap levels. The inflation-adjusted caps are $1,740 in 2006.

		¨		As a result of DEFRA, beginning in 2006 Medicare skilled nursing facility reimbursement of uncollected co-insurance amounts for those individuals who are not dually eligible for Medicare and Medicaid will be reduced by 30 percent. As a result of this provision, we expect our revenues to decrease by approximately $1.0 million in 2006.
		¨		As a result of DEFRA, for home health agencies, freezing Medicare payments in 2006 to the 2005 amounts, continuing a 5 percent add-on payment for home health agencies in rural areas in 2006 and linking payment updates to home health quality reporting in 2007. As a result of this provision, we expect our revenues to decrease by approximately $3.0 million in 2006.

Our Medicare rates for 2003 through 2005 were affected by the following annual increases. CMS increased skilled nursing facility payment rates by providing an inflation update (or market basket increase) of 3.0 percent, 2.8 percent and 3.1 percent effective October 1, 2003, 2004 and 2005, respectively. Further, effective October 1, 2003, CMS increased skilled nursing facility payment rates by an additional 3.26 percent to reflect “forecast error” underpayments since 1998. No assurances can be given as to whether Congress will increase or decrease reimbursement in the future, the timing of any action or the form of relief, if any, that may be enacted.

We face challenges with respect to states’ Medicaid payments since many currently do not cover the total costs incurred in providing care to those patients. States will continue to control Medicaid expenditures but also look for adequate funding sources, including provider assessments. Our average Medicaid rate increased 8 percent between 2004 and 2005. However, when taking into account the increase in accompanying state provider assessments, the net Medicaid rate increased approximately 1 percent between 2004 and 2005. We expect our Medicaid rate net of provider assessments to increase between 2-3 percent in 2006. Further, DEFRA includes several changes to the Medicaid program designed to rein in program spending. This includes, among others, strengthening the Medicaid asset transfer restrictions for persons seeking to qualify for Medicaid long-term care coverage, which could, due to the timing of the penalty period, increase facilities’ exposure to uncompensated care. Other provisions could increase state funding for home and community-based services, potentially having an impact on funding for nursing facilities. There is no assurance that the funding for our services will increase or decrease in the future.

On February 6, 2006, the Bush Administration released its fiscal year 2007 budget proposal, which, if passed, would reduce Medicare spending by $2.5 billion in fiscal year 2007 and $35.9 billion over five years. In particular, the budget proposal would freeze payments in fiscal 2007

for skilled nursing facilities and home health agencies, among other providers. In 2008 and 2009, the payment update for these providers would be market basket minus 0.4 percent. The budget also proposes to reduce the increase in payment updates for hospice services by 0.4 percent below the full market basket level for each of the years 2007 through 2009.

The budget also includes a series of proposals having an impact on Medicaid and the State Children’s Health Insurance Program, including administrative changes to the financing structure of Medicaid that would save more than $12 billion over five years. These changes include proposed reforms to Medicaid provider assessments.

     Labor. Labor costs consist of wages, temporary nursing staffing and payroll overhead, including workers’ compensation. Labor costs accounted for approximately 58 percent of the operating expenses of our long-term care segment in 2005. This percentage is lower than prior years because of the increase in provider assessments, some of which were retroactive to prior periods. Excluding prior-period assessments, the percentage was approximately 60 percent. Our long-term care wage rate increases in 2005 were approximately 3.5 percent. We continued to decrease our temporary staffing expense and workers’ compensation expense in 2005. See additional discussion of workers’ compensation under Critical Accounting Policies.

We compete with other health care providers to attract and retain qualified or skilled personnel. We also compete with various industries for lower-wage employees. Although we currently do not face a staffing shortage in all markets where we operate, we have used high-priced temporary help to supplement staffing levels in markets with shortages of health care workers. Since 2001, we have implemented additional training and education programs which have helped with retention of employees. Our temporary staffing costs have decreased year over year since 2001 and currently represent less than 1 percent of our labor costs. If a shortage of nurses or other health care workers occurred in all geographic areas in which we operate, it could adversely affect our ability to attract and retain qualified personnel and could further increase our operating costs.

     General and Professional Liability Costs. Patient care liability is still a serious industry-wide cost issue. The health care industry is making progress in state legislatures and at the national level to enact tort reform. With tort reform and our proactive management initiatives, our number of new claims has stabilized and our average settlement cost per claim has a downward trend. During 2003, strong tort reform legislation capping medical malpractice awards was passed in Texas and upheld by a state constitutional amendment. Other key states made a start at meaningful tort reform. The long-term care industry received some assistance with the passage of a measure of tort reform in Florida in May 2001 that became fully effective on October 5, 2001. The 2001 legislation included caps on punitive damages, limits to add-on legal fees, tougher rules of evidence and a reduced statute of limitations. While we cannot insure that any of these or other legislative changes will have a positive impact on the current trend, we believe that these changes were an important first step in achieving more balanced tort laws in our country.

 

Critical Accounting Policies

The accompanying consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles. When more than one accounting principle, or the method of its application, is generally accepted, we select the principle or method that is appropriate in our specific circumstances. Application of these accounting principles requires us to make estimates about the future resolution of existing uncertainties; as a result, actual results could differ from these estimates. In preparing these financial statements, we have made our best estimates and judgments of the amounts and disclosures included in the financial statements, giving due regard to materiality.

     Receivables and Revenue Recognition. Revenues are recognized when the related patient services are provided. The revenues are based on established rates adjusted to amounts estimated to be received under governmental programs and other third-party contractual arrangements. Receivables and revenues are stated at amounts estimated by us to be the net realizable value. No individual customer or group of customers accounts for a significant portion of our revenues or receivables. Certain classes of patients rely on a common source of funds to pay the cost of their care, such as the federal Medicare program and various state Medicaid programs. Medicare program revenues for the years prior to the implementation of the prospective payment system and certain Medicaid program revenues are subject to audit and retroactive adjustment by government representatives. We are currently appealing the Medicare fiscal intermediary’s incorrect adjustment of certain expenses on the former Manor Care’s home office cost reports from 1997 to 1999, which required us to make a repayment of $34.1 million in 2005, an amount that is recorded as a receivable on our balance sheet. Although we believe that we have strong arguments to support why these amounts should be returned to us, there is no guarantee that we will be successful in our appeal or that this process will be completed in an expeditious manner. While not expected or considered likely, a failure of our appeal could lead to the establishment of reserves and the eventual write-off of the receivables we have established.

     Allowance for Doubtful Accounts. We evaluate the collectibility of our accounts receivable based on certain factors, such as payor type, historical collection trends and aging categories. The percentage that we apply to the receivable balances is based on our historical experience and time limits, if any, for each particular pay source, such as private, other/insurance, Medicare and Medicaid.

     Impairment of Property and Equipment and Intangible Assets. We evaluate our property and equipment and intangible assets on a quarterly basis to determine if facts and circumstances suggest that the assets may be impaired or the life of the asset may need to be changed. We consider internal and external factors of the individual facility or asset, including changes in the

regulatory environment, changes in national health care trends, current period cash flow loss combined with a history of cash flow losses, and local market developments. If these factors and the projected undiscounted cash flow of the entity over its remaining life indicate that the asset will not be recoverable, the carrying value will be adjusted to its fair value if it is lower. If our projections or assumptions change in the future, we may be required to record additional impairment charges for our assets.

     General and Professional Liability. We purchase general and professional liability insurance and have maintained an unaggregated self-insured retention per occurrence ranging from $0.5 million to $12.5 million, depending on the policy year and state. In addition, for the policy period beginning June 1, 2004, we formed a captive insurance entity to provide a coverage layer of $12.5 million in excess of $12.5 million per claim.

Our general and professional reserves include amounts for patient care-related claims and incurred but not reported claims. 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 based on our historical experience and other available industry information. 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. We also monitor the reasonableness of the judgments made in the prior-year estimation process and adjust our current-year assumptions accordingly. Semi-annually, our independent actuary evaluates our ultimate cost.

We do see an improving trend in terms of patient liability costs. Over the past three years, our number of new claims has been similar and our average settlement cost per claim has a downward trend. Our independent actuary provides us with a range of indicated losses in the second quarter and fourth quarter every year. Based on our own review of trends and confirmed with our independent actuary’s 2005 fourth-quarter analysis, it was determined that our accrual rate would not change. In prior years, we lowered our accrual rate by approximately $1.2 million on a quarterly basis in the fourth quarter of 2004 and by approximately $4.0 million on a quarterly basis in the fourth quarter of 2003. We expect our accrual for current claims per month to be $5.1 million through our policy period ending May 31, 2006. At December 31, 2005 and 2004, our general and professional liability consisted of short-term reserves of $61.8 million and $65.9 million, respectively, and long-term reserves of $118.5 million and $122.5 million, respectively. The expense for general and professional liability claims, premiums and administrative fees was $72.5 million, $78.7 million and $87.9 million for the years ended December 31, 2005, 2004 and 2003, respectively. Although we believe our liability reserves are adequate and appropriate, we can give no assurance that these reserves will not require material adjustment in future periods.

 

     Workers’ Compensation Liability. Our workers’ compensation reserves are determined based on an estimation process that uses company-specific data. We continuously monitor the claims and develop information about the ultimate cost of the claims based on our historical experience. The most significant assumptions used in the estimation process include determining the trend in costs, the expected costs of claims incurred but not reported and the expected future costs related to existing claims. In addition, we review industry trends, changes in the regulatory environment and our internal efforts to contain our costs with safety and training programs. During 2003 and continuing into 2004, we expanded and increased attention to our safety, training and claims management programs. The number of new claims in 2005 decreased in comparison to the past two years. As a result of these factors, our workers’ compensation expense decreased over the last three years. Our expense was $24.5 million, $26.6 million and $38.9 million for the years ended December 31, 2005, 2004 and 2003, respectively. At December 31, 2005 and 2004, the workers’ compensation liability consisted of short-term reserves of $20.8 million and $23.7 million, respectively, and long-term reserves of $40.5 million and $41.5 million, respectively. Although we believe our liability reserves are adequate and appropriate, we can give no assurance that these reserves will not require material adjustment in future periods.

Year Ended December 31, 2005 Compared with Year Ended December 31, 2004

     Revenues. Our revenues increased $208.4 million, or 6 percent, from 2004 to 2005. The increase included revenues of $63.2 million in the first quarter of 2005 associated with provider assessments. Revenues from our long-term care segment (skilled nursing and assisted living facilities), excluding revenues in the first quarter associated with provider assessments, increased $122.5 million, or 5 percent, due to increases in rates/patient mix of $219.7 million and occupancy of $17.5 million that were partially offset by a decrease in capacity of $114.7 million. Our revenues from the hospice and home health segment increased $10.9 million, or 3 percent, primarily because of an increase in the number of patients utilizing our hospice services.

Our rate increases for the long-term care segment related to Medicare, Medicaid and private pay sources. Our average Medicare rate increased 6 percent from $340 per day in 2004 to $362 per day in 2005. Our Medicare rate increased as a result of inflationary increases, as described in the Overview, as well as a shift to higher-acuity Medicare patients. Our average Medicaid rate, excluding prior-period revenues, increased 8 percent from $136 per day in 2004 to $147 per day in 2005. However, when taking into account the increase in state provider assessments, the net Medicaid rate increased approximately 1 percent compared with the prior year. Our average private and other rates for our skilled nursing facilities increased 7 percent from $200 per day in 2004 to $214 per day in 2005. The increase in overall rates was also a result of a shift in the mix of our patients to a higher percentage of Medicare patients.

Our occupancy levels remained constant at 88 percent for 2004 and 2005. Excluding start-up facilities, our occupancy levels were 88 percent for 2004 and 89 percent for 2005. Our occupancy levels for skilled nursing facilities remained constant at 89 percent for 2004 and 2005.

Our bed capacity declined between 2004 and 2005, primarily because of the divestiture of facilities in 2004 and 2005 (see our table in the Overview). The quality mix of revenues from Medicare, private pay and insured patients that related to long-term care facilities and rehabilitation operations was 69 percent in 2004 compared with 71 percent in 2005.

     Operating Expenses. Our operating expenses increased $172.6 million, or 7 percent, from 2004 to 2005. The increase included provider assessments for several states of $57.5 million in the first quarter of 2005.

Excluding provider assessments in the first quarter of 2005, operating expenses from our long-term care segment increased $87.5 million, or 4 percent, between 2004 and 2005. The largest portion of the long-term care operating expense increase related to ancillary costs for higher-acuity patients, excluding internal labor, of $63.9 million and provider assessments of $27.2 million. Ancillary costs, which include various types of therapies, medical supplies and prescription drugs, increased as a result of our more medically complex patients. Partially offsetting these increases were decreases in labor costs of $20.0 million and general and professional liability expense of $5.9 million. Our labor costs declined due to the divestiture of facilities in 2004. Our average wage rates increased 3.5 percent compared with 2004. Refer to our Overview and Critical Accounting Policies for additional discussion of our general and professional liability costs.

Our operating expenses from our hospice and home health segment increased $21.1 million, or 7 percent, between 2004 and 2005. During the first quarter of 2005, our hospice and home health segment was reorganized in preparation for future growth. We appointed a new general manager and new divisional and regional management. Margins declined this year primarily due to an increase in labor costs of $11.8 million. In addition, other direct nursing care costs, including medical equipment and supplies, increased $4.3 million.

     General and Administrative Expenses. Our general and administrative expenses increased $23.6 million from 2004 to 2005. The costs associated with our stock appreciation rights, restricted stock, non-qualified defined benefit plans and deferred compensation plans increased $16.1 million. Our restricted stock expense was higher than 2004 because of awards of performance-vested restricted stock in 2005 and the acceleration of the expense for time-vested restricted stock as discussed in more detail in Note 1 to the consolidated financial statements. The remaining increases related to wages, training costs associated with new computer systems and other general inflationary costs.

     Depreciation and Amortization. Our depreciation expense increased $10.6 million from 2004 to 2005. We recorded a $1.5 million adjustment to correct the amortization of leasehold improvements in 2005. See Note 1 to our consolidated financial statements for further discussion. Excluding the leasehold improvement adjustment and the impact of divested facilities in 2004 and 2005, depreciation expense increased $11.5 million because of new construction projects and renovations to existing facilities.

     Asset Impairment. During our quarterly review of long-lived assets, management determined that one facility’s net assets of $2.5 million should be written off. The majority of the assets related to leasehold improvements were incurred in 2003. We changed facility management several times in the last three years and tried different marketing approaches. We concluded that we will not be able to improve the facility’s cash flow to a sufficient level to justify the asset value now or in the future. We will continue to operate this leased skilled nursing facility.

     Early Extinguishment of Debt. During 2005, we redeemed the remaining $100 million of our subsidiary’s 7.5% Senior Notes and $150 million of our 8% Senior Notes. In conjunction with the redemption of these notes, we recorded expenses of $18.6 million. These expenses included make-whole payments of $12.3 million for early redemption of the notes and unwind fees of $5.6 million related to the termination of the interest rate swap agreements.

During 2004, we purchased $50 million of our subsidiary’s 7.5% Senior Notes and $50 million of our 8% Senior Notes, pursuant to cash tender offers. We recorded costs of $11.2 million related to these tender offers, including a prepayment premium of $10.5 million; fees and expenses of $0.4 million; and the write-off of deferred financing costs of $0.3 million.

     Gain on Sale of Assets. Our gain on sale of assets in 2005 primarily related to a $17.6 million gain from the sale of three non-strategic skilled nursing facilities in New Mexico. Our gain on sale of assets in 2004 primarily resulted from the sale of 15 facilities and certain other assets.

     Equity in Earnings of Affiliated Companies. Our equity earnings decreased from 2004 to 2005 primarily because of the decline in earnings from our ownership interests in two hospitals.

     Interest Income and Other. Our interest income increased in 2005 as a result of the short-term investment of our cash and cash equivalents.

     Income Taxes. Our effective tax rate was 37.5 percent in 2005 compared with 34.0 percent in 2004. Our effective tax rate was lower in 2004 primarily because of the adjustment of prior years’ estimated federal and state tax liabilities. In 2004, the Internal Revenue Service completed the examination of our federal income tax returns through 2001. We expect our 2006 effective tax rate to be comparable to 2005.

     Inflation. We believe that inflation has had no material impact on our results of operations.

Year Ended December 31, 2004 Compared with Year Ended December 31, 2003

     Revenues. Our revenues increased $179.4 million, or 6 percent, from 2003 to 2004. Revenues from our long-term care segment increased $117.8 million, or 5 percent, due to increases in rates/patient mix of $211.6 million and occupancy of $15.5 million that were partially offset by a decrease in capacity of $109.3 million. Our revenues from the hospice and home health segment increased $54.4 million, or 17 percent, primarily because of an increase in the number of patients utilizing our hospice services.

Our rate increases for the long-term care segment related to Medicare, Medicaid and private pay sources. Our average Medicare rate increased 7 percent from $317 per day in 2003 to $340 per day in 2004. Our Medicare rate increased as a result of inflationary increases and CMS forecast error underpayments, as described in the Overview, as well as higher acuity Medicare patients. Our average Medicaid rate increased 4 percent from $131 per day in 2003 to $136 per day in 2004. Our average private and other rates for our skilled nursing facilities increased 5 percent from $190 per day in 2003 to $200 per day in 2004. The increase in overall rates was also a result of a shift in the mix of our patients to a higher percentage of Medicare patients.

Our occupancy levels remained constant at 88 percent for 2003 and 2004. Excluding start-up facilities, our occupancy levels were 89 percent for 2003 and 88 percent for 2004. Our occupancy levels for skilled nursing facilities remained constant at 89 percent for 2003 and 2004.

Our bed capacity declined between 2003 and 2004, primarily because of the divestiture of facilities in 2004 (see our table in the Overview). The quality mix of revenues from Medicare, private pay and insured patients that related to long-term care facilities and rehabilitation operations was 67 percent in 2003 compared with 69 percent in 2004. In the fourth quarter of 2004, our quality mix of revenues increased to 70 percent.

     Operating Expenses. Our operating expenses increased $124.3 million, or 5 percent, from 2003 to 2004. During the second quarter of 2003, we recorded an expense of $8.4 million for a proposed settlement of a review of certain Medicare cost reports filed by facilities of the former Manor Care, prior to the implementation of the prospective payment system. This review, which was conducted by the Department of Justice and the Office of Inspector General of the Department of Health and Human Services, focused primarily on nursing cost allocations made in reliance upon instructions from the facilities’ Medicare fiscal intermediary for the period 1992-1998. We believe the facilities were fully entitled to the reimbursement they received for these allocations. The definitive settlement agreement was finalized and $8.4 million paid in the second quarter of 2004.

Operating expenses from our long-term care segment increased $73.9 million, or 3 percent, between 2003 and 2004. The largest portion of the long-term care operating expense increase of $34.6 million related to labor costs. Our average wage rates increased 5 percent compared with

2003. Our other operating expense increase for this segment included ancillary costs, excluding internal labor, of $30.8 million. Ancillary costs, which include various types of therapies, medical supplies and prescription drugs, increased as a result of our more medically complex patients. Offsetting these increases was a decrease in our general and professional liability expense of $9.2 million because of the decrease in our claims accrual. Refer to our Overview and Critical Accounting Policies for additional discussion of our general and professional liability costs.

Our operating expenses from our hospice and home health segment increased $45.3 million, or 17 percent, between 2003 and 2004. The increase in our costs was directly related to the growth in our business. The increase related to labor costs of $28.7 million, ancillary costs including pharmaceuticals of $4.7 million and other direct nursing care costs, including medical equipment and supplies, of $2.9 million.

     General and Administrative Expenses. Our general and administrative expenses decreased $17.0 million from 2003 to 2004. The decrease in expense primarily related to costs associated with our stock appreciation rights and deferred compensation plans. During 2003, our stock price increased over 85 percent, which resulted in a significant increase in expense. During 2004, our stock price was stable and, as a result, no major fluctuations occurred in this expense. The decrease in these costs included in general and administrative expenses was $11.9 million.

In 2003, we terminated our split-dollar arrangements covering an executive life insurance program and transferred our share of the split-dollar life insurance policies to the officers and key employees. This action resulted in a charge of $5.3 million and was taken to comply with the Sarbanes-Oxley Act of 2002 and contractual requirements, as well as to address tax law changes.

     Depreciation and Amortization. Our depreciation expense increased $0.9 million from 2003 to 2004. Excluding our divested facilities, depreciation expense increased $4.3 million because of new construction projects and renovations to existing facilities. Our amortization decreased $1.9 million from 2003 to 2004, primarily due to a decline in software amortization.

     Gain on Sale of Assets. Our gain on sale of assets in 2004 primarily resulted from the sale of 15 facilities and certain other assets. Our gain on sale of assets in 2003 primarily related to the sale of non-strategic land parcels and securities.

     Income Taxes. Our effective tax rate was 34.0 percent in 2004 compared with 37.5 percent in 2003. Our effective tax rate was lower in 2004 primarily because of the adjustment of prior years’ estimated federal and state tax liabilities. In 2004, the Internal Revenue Service completed the examination of our federal income tax returns through 2001.

     Inflation. We believe that inflation has had no material impact on our results of operations.

Financial Condition — December 31, 2005 and 2004

Receivables increased $69.3 million primarily because of an increase in Medicare rates in the fourth quarter, delay in receipt of certain Medicaid payments, and recording a $34.1 million receivable related to Medicare settlement payments, as discussed previously under Receivables and Revenue Recognition in our Critical Accounting Policies.

Our current deferred income taxes resulted in a net liability instead of a net asset at December 31, 2005 primarily as a result of the deferral of prepaid employee leasing services.

Other accrued liabilities increased $12.9 million primarily due to the increase in provider assessments.

Long-term debt increased $175.2 million because we issued $400 million of convertible senior notes, borrowed $22.8 million on our revolving credit facility and redeemed $250 million of our senior notes. In conjunction with the issuance of the convertible senior notes, we entered into a convertible note hedge and recorded a tax benefit of $29.3 million that decreased our long-term deferred income tax liability. See Note 6 to our consolidated financial statements for further discussion.

New Accounting Standard

In December 2004, the Financial Accounting Standards Board issued Statement No. 123 (revised 2004), “Share-Based Payment” (Statement 123R), which is a revision of Statement No. 123, “Accounting for Stock-Based Compensation” (Statement 123). Statement 123R replaces APB Opinion No. 25 and amends Statement No. 95, “Statement of Cash Flows.” Statement 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair value. The pro forma footnote disclosure is no longer an alternative to financial statement recognition. Statement 123R is effective for us beginning January 1, 2006. There are two transition alternatives, modified-prospective and modified-retrospective. Under the modified-prospective method, we will be required to recognize compensation cost in the financial statements on the date of adoption. Under the modified-retrospective method, we will be required to restate prior periods by recognizing in the financial statements the same amount of compensation cost as previously reported in the pro forma footnote disclosures under Statement 123. We will be permitted to apply the modified-retrospective method either to all periods presented or to the start of the fiscal year in which Statement 123R is adopted.

In addition, Statement 123R requires awards classified as liabilities (such as cash-settled stock appreciation rights) to be measured at fair value at each reporting date versus measured at intrinsic value under Statement 123. The time value of the liability will be recognized as compensation cost but then be reversed as the settlement date approaches. At expiration, total

compensation cost will not differ from that which would result under the intrinsic-value method. Management adopted Statement 123R on January 1, 2006 under the modified-prospective-transition method. As of December 31, 2005, substantially all of our options were vested, and the pretax expense expected to be recorded in 2006 related to stock options outstanding at December 31, 2005 is $0.2 million. In anticipation of adopting Statement 123R, we have replaced most of the awards of cash-settled stock appreciation rights and stock options with restricted stock units and performance-vested restricted stock. Management estimates that the one-time cumulative effect of the change in accounting principle will be $4.5 million ($2.8 million after tax) related to the fair value calculation of its cash-settled stock appreciation rights on January 1, 2006.

Capital Resources and Liquidity

     Cash Flows. During 2005, we satisfied our cash requirements primarily with cash generated from operating activities and issuance of convertible senior notes. We used the cash principally for capital expenditures, the purchase of our common stock, the paydown of debt, the net payment of the convertible note hedge and warrant, and the payment of dividends. Cash flows from operating activities were $353.9 million for 2005, an increase of $24.2 million from 2004. Our operating cash flows increased in 2005 primarily because of the deferral of federal income tax payments. The increase was partially offset by the Medicare settlement payments of $34.1 million in 2005 related to the former Manor Care home office cost reports for 1997 through 1999, which are recorded as receivables and are under appeal. Because we deferred federal tax payments in 2005, we estimate that our federal tax payments will increase by approximately $70 million in 2006.

     Investing Activities. Our expenditures for property and equipment of $135.0 million in 2005 included $37.0 million to construct new facilities and expand existing facilities. The proceeds from the sale of assets primarily related to the sale of three skilled nursing facilities. In 2006, we expect our property and equipment expenditures to approximate the amount in 2005 because of our routine capital improvements, our bed and therapy expansions under way, and our four skilled nursing facilities under construction.

     Debt Agreements. On May 27, 2005, we terminated our three-year $200 million revolving credit facility and entered into a five-year $300 million unsecured revolving credit facility, with an uncommitted option available to increase the facility by up to an additional $100 million (accordion feature). The new unsecured revolving credit facility includes a $125 million sublimit for letters of credit. As of December 31, 2005, outstanding borrowings totaled $22.8 million under the new facility. After consideration of usage for letters of credit, there was $232.2 million available for future borrowing plus the accordion feature.

On August 1, 2005, we issued $400 million of 2.125% Convertible Senior Notes due 2035. The net proceeds of $390.8 million were used to purchase $237.0 million of our common stock (as discussed below), to pay the net cost of $53.8 million of the convertible note hedge and warrant option transactions, and to redeem the remaining $100 million principal amount of our subsidiary’s 7.5% Senior Notes. See Note 6 to the consolidated financial statements for further discussion of the debt issuance. In December 2005, we also redeemed the remaining $150 million of our 8% Senior Notes.

The holders of our $100 million Convertible Senior Notes due 2023 have the ability to convert the notes when the average of the last reported stock price for 20 trading days immediately prior to conversion is greater than or equal to $37.34, which it was as of December 31, 2005. The holders of $6.6 million principal amount of the Old Notes can convert their notes into shares of our common stock. The holders of $93.4 million principal amount of the New Notes can convert their notes into cash for the principal value and into shares of our common stock for the excess value, if any. See Note 6 to our consolidated financial statements for a discussion of Old Notes and New Notes.

In addition, the holders of the $93.4 million principal amount of New Notes and the $400 million principal amount of 2.125% Convertible Senior Notes may require us to convert or repurchase their notes upon the occurrence of certain events, which we currently view as remote. We are required to satisfy the principal value in cash upon conversion or repurchase.

Our five-year credit agreement requires us to meet certain measurable financial ratio tests, to refrain from certain prohibited transactions (such as certain liens, larger-than-permitted dividends, stock redemptions and asset sales), and to fulfill certain affirmative obligations (such as paying taxes when due and maintaining properties and licenses). We met all covenants at December 31, 2005. None of our debt agreements permit the lenders to determine in their sole discretion that a material adverse change has occurred and either refuse to lend additional funds or accelerate current loans. Our 6.25% Senior Note agreement contains a clause that is triggered if we were to have a change-of-control that is immediately followed by a downgrade in debt rating by either Standard & Poor’s Ratings Service or Moody’s Investors Service, Inc. If a change-of-control were followed by a rating agency downgrade, we are obligated to offer to redeem the 6.25% Senior Notes. As long as we offer to make such redemption, we will have satisfied the conditions of the 6.25% Senior Notes. Both Standard & Poor’s Ratings Service and Moody’s Investors Service, Inc. maintain an investment grade rating for our 6.25% Senior Notes, 2.125% Convertible Senior Notes due 2023 and 2.125% Convertible Senior Notes due 2035.

     Stock Purchase. At December 31, 2004, we had remaining authority to purchase $57.3 million of our common stock. On July 22, 2005, we announced that our Board of Directors authorized management to spend an additional $300 million to purchase common stock through December 31, 2006. We purchased 8.4 million shares during 2005 for $316.4 million, including 4.6 million shares as part of an accelerated share repurchase agreement, as described in Note 13 to the consolidated financial statements. At December 31, 2005, we had remaining unused repurchase authority of $40.9 million. On January 27, 2006, we announced that our Board of

Directors authorized an additional $100 million to purchase common stock through December 31, 2006. We expect to use all of our authority to repurchase shares in 2006. We may use the shares for internal stock option and 401(k) match programs and for other uses, such as possible acquisitions.

     Cash Dividends. On January 27, 2006, we announced that Manor Care will pay a quarterly cash dividend of 16 cents per share to shareholders of record on February 13, 2006. This dividend will approximate $12.6 million and is payable February 27, 2006. We intend to declare and pay regular quarterly cash dividends; however, there can be no assurance that any dividends will be declared, paid or increased in the future.

     Contractual Obligations. The following table provides information about our contractual obligations at December 31, 2005:

		Payments Due by Years
										2007-				2009-				After
		Total				2006				2008				2010				2010
		(In thousands)
Debt, including interest payments (1)		$	897,522			$	30,129			$	60,256			$	575,887			$	231,250
Capital lease obligations			14,088				1,985				2,249				955				8,899
Operating leases (2)			76,412				13,406				20,214				31,518				11,274
Internal construction projects			22,275				22,275
Deferred acquisition costs			2,000								2,000
Total		$	1,012,297			$	67,795			$	84,719			$	608,360			$	251,423

In addition to our contractual obligations in the table above, we also have unfunded non-qualified defined contribution plans with obligations of $51.8 million, as well as senior executive retirement plan obligations, or SERP, of $49.0 million. We will be required to make payments upon termination in a lump sum or retirement in a lump sum or installment basis. We have committed to release a portion of Manor Care’s share of the cash surrender value of split-dollar life insurance arrangements, which totaled $47.8 million at December 31, 2005, to fund the SERP obligations, if necessary.

We believe that our cash flow from operations will be sufficient to cover operating needs, future capital expenditure requirements, scheduled debt payments of miscellaneous small borrowing arrangements and capitalized leases, cash dividends and some share repurchase. Because of our significant annual cash flow, we believe that we will be able to refinance the major pieces of our debt as they mature. It is likely that we will pursue growth from acquisitions, partnerships and other ventures that we would fund from excess cash from operations, credit available under our revolving credit facility and other financing arrangements that are normally available in the marketplace.

Commitments and Contingencies

     Letters of Credit. We had total letters of credit of $45.0 million at December 31, 2005 which benefit certain third-party insurers, and 98 percent of these letters of credit were related to recorded liabilities.

     Environmental Liabilities. One or more subsidiaries or affiliates of Manor Care have been identified as potentially responsible parties in a variety of actions relating to waste disposal sites that allegedly are subject to remedial action under the federal Comprehensive Environmental Response Compensation Liability Act, or CERCLA, and similar state laws. CERCLA imposes retroactive, strict joint and several liability on potentially responsible parties 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 was acquired in 1981 by a wholly owned subsidiary of Manor Care. The actions allege that Cenco transported or generated hazardous substances that came to be located at the sites in question. Environmental proceedings may involve owners and/or operators of the hazardous waste site, multiple waste generators and multiple waste transportation disposal companies. These proceedings involve efforts by governmental entities or private parties to allocate or recover site investigation and clean-up costs, which costs may be substantial. We cannot quantify with precision the potential liability exposure for currently pending environmental claims and litigation, without regard to insurance coverage, because of the inherent uncertainties of litigation and because the ultimate cost of the remedial actions for some of the waste disposal sites where subsidiaries or affiliates of Manor Care are alleged to be a potentially responsible party has not yet been determined. At December 31, 2005, we had $4.8 million accrued in other long-term liabilities based on our current assessment of the likely outcome of the actions, which was reviewed with our outside advisors. At December 31, 2005, there were no receivables related to insurance recoveries.

 

     General and Professional Liability. We are party to various other legal matters arising in the ordinary course of business, including patient care-related claims and litigation. At December 31, 2005, the general and professional liability consisted of short-term reserves of $61.8 million and long-term reserves of $118.5 million. We can give no assurance that this liability will not require material adjustment in future periods.

Cautionary Statement Concerning Forward-Looking Statements

This report includes 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,” “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, the following:

		¨		Changes in the health care industry because of political and economic influences;
		¨		Changes in Medicare, Medicaid and certain private payors’ reimbursement levels or coverage requirements;
		¨		Existing government regulations and changes in, or the failure to comply with, governmental regulations or the interpretations thereof;
		¨		Changes in current trends in the cost and volume of patient care-related claims and workers’ compensation claims and in insurance costs related to such claims;
		¨		The ability to attract and retain qualified personnel;
		¨		Our existing and future debt which may affect our ability to obtain financing in the future or compliance with current debt covenants;
		¨		Our ability to maintain or increase our occupancy levels in our skilled nursing and assisted living facilities;
		¨		Our ability to maintain or increase our revenues in our hospice and home health care and rehabilitation businesses;

		¨		Our ability to control operating costs;
		¨		Integration of acquired businesses;
		¨		Changes in, or the failure to comply with, regulations governing the transmission and privacy of health information;
		¨		State regulation of the construction or expansion of health care providers;
		¨		Legislative proposals for health care reform;
		¨		Competition;
		¨		The failure to comply with occupational health and safety regulations;
		¨		The ability to enter into managed care provider arrangements on acceptable terms;
		¨		Litigation;
		¨		A reduction in cash reserves and shareholders’ equity upon our repurchase of our stock;
		¨		An increase in senior debt or reduction in cash flow upon our purchase or sale of assets; and
		¨		Conditions in the financial markets.

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.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Changes in U.S. interest rates expose us to market risks inherent with derivatives and other financial instruments. Our interest expense is most sensitive to changes in the general level of U.S. interest rates applicable to our U.S. dollar indebtedness. During 2005, we issued $400 million of 2.125% Convertible Senior Notes due 2035. We also redeemed the remaining $100 million of our subsidiary’s 7.5% Senior Notes and $150 million of our 8% Senior Notes. In conjunction with the redemption of our senior notes, we terminated our interest rate swap agreements associated with these notes. As of December 31, 2005, outstanding borrowings totaled $22.8 million under our revolving credit facility.

The tables below provide information about our derivative financial instruments that are sensitive to changes in interest rates, including interest rate swaps and debt obligations. For debt obligations, the tables present principal cash flows and weighted-average interest rates by expected maturity dates. We assume the holders of our $100 million and $400 million convertible senior notes will not require us to redeem or convert the notes through 2010, and we do not expect to redeem them in 2010. Therefore, we have included both of these notes in the Thereafter column. For interest rate swaps, the table presents notional amounts by expected (contractual) maturity date. Notional amounts are used to calculate the contractual payments to be exchanged under the contract.

     The following table provides information about our significant interest rate risk at December 31, 2005:

		Expected Maturity Dates
																														Fair Value Dec. 31,
		2006				2007				2008				2009				2010				Thereafter				Total				2005
		(Dollars in thousands)
Long-term debt:
Fixed-rate debt																						$	699,985			$	699,985			$	752,398
Average interest rate																							3.4	%			3.4	%
Variable-rate debt																		$	22,800							$	22,800			$	22,800
Average interest rate																				(1)								(1)

     The following table provides information about our significant interest rate risk at December 31, 2004:

																														Fair
																														Value
		Expected Maturity Dates																												Dec. 31,
		2005				2006				2007				2008				2009				Thereafter				Total				2004
		(Dollars in thousands)
Long-term debt:
Fixed-rate debt						$	100,000							$	150,000							$	300,000			$	550,000			$	610,942
Average interest rate							7.5	%							8.0	%							5.0	%			6.3	%
Interest rate swaps — fixed to variable:
Notional amount						$	100,000							$	100,000											$	200,000			$	5,021
Pay variable rate							L+ 5.1	%							L+ 5.0	%											L+ 5.1	%
Receive fixed rate							7.5	%							8.0	%											7.8	%

L= six-month LIBOR (approximately 2.8% at December 31, 2004)

Item 8. Financial Statements and Supplementary Data

		Page
Report of Independent Registered Public Accounting Firm		40
Consolidated Balance Sheets		41
Consolidated Statements of Income		42
Consolidated Statements of Cash Flows		43
Consolidated Statements of Shareholders’ Equity		44
Notes to Consolidated Financial Statements		45
Supplementary Data (Unaudited) — Summary of Quarterly Results		73

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
Manor Care, Inc.

We have audited the accompanying consolidated balance sheets of Manor Care, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. Our audits also include the financial statement schedule listed in the Index at Item 15. 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 the standards of the Public Company Accounting Oversight Board (United States). 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 Manor Care, Inc. and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. 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.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Manor Care, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated January 31, 2006 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP                    

Toledo, Ohio
January 31, 2006

Manor Care, Inc.

Consolidated Balance Sheets

		December 31,				December 31,
		2005				2004
		(In thousands, except per share data)
Assets
Current assets:
Cash and cash equivalents		$	12,293			$	32,915
Receivables, less allowances for doubtful accounts of $60,726 and $54,532, respectively			494,620				425,278
Prepaid expenses and other assets			24,416				24,762
Deferred income taxes							57,412
Total current assets			531,329				540,367
Net property and equipment			1,484,475				1,495,152
Goodwill			103,357				92,672
Intangible assets, net of amortization of $3,309 and $4,499, respectively			20,012				18,865
Other assets			200,061				203,408
Total assets		$	2,339,234			$	2,350,464
Liabilities And Shareholders’ Equity
Current liabilities:
Accounts payable		$	112,952			$	102,178
Employee compensation and benefits			157,002				139,900
Accrued insurance liabilities			108,275				102,973
Income tax payable			4,936				4,710
Other accrued liabilities			62,938				49,992
Deferred income taxes			3,633
Long-term debt due within one year			2,635				2,501
Total current liabilities			452,371				402,254
Long-term debt			730,466				555,275
Deferred income taxes			102,919				134,518
Other liabilities			279,755				274,258
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			364,845				366,649
Retained earnings			1,319,162				1,208,493
Accumulated other comprehensive loss			(978	)			(1,227	)
			1,684,139				1,575,025
Less treasury stock, at cost (32.3 and 25.0 million shares, respectively)			(910,416	)			(590,866	)
Total shareholders’ equity			773,723				984,159
Total liabilities and shareholders’ equity		$	2,339,234			$	2,350,464

See accompanying notes.

Manor Care, Inc.

Consolidated Statements of Income

		Year ended December 31,
		2005				2004				2003
		(In thousands, except per share data)
Revenues		$	3,417,290			$	3,208,867			$	3,029,441
Expenses:
Operating			2,820,431				2,647,849				2,523,534
General and administrative			164,189				140,587				157,566
Depreciation and amortization			139,203				127,821				128,810
Asset impairment			2,451
			3,126,274				2,916,257				2,809,910
Income before other income (expenses) and income taxes			291,016				292,610				219,531
Other income (expenses):
Interest expense			(41,240	)			(42,420	)			(41,927	)
Early extinguishment of debt			(18,634	)			(11,160	)
Gain on sale of assets			16,431				6,400				3,947
Equity in earnings of affiliated companies			5,492				6,975				7,236
Interest income and other			4,607				2,474				1,625
Total other expenses, net			(33,344	)			(37,731	)			(29,119	)
Income before income taxes			257,672				254,879				190,412
Income taxes			96,717				86,657				71,405
Net income		$	160,955			$	168,222			$	119,007
Earnings per share:
Basic		$	1.93			$	1.94			$	1.33
Diluted		$	1.89			$	1.90			$	1.30
Weighted-average shares:
Basic			83,269				86,762				89,729
Diluted			85,044				88,725				91,313
Cash dividends declared per common share		$	.60			$	.56			$	.25

See accompanying notes.

Manor Care, Inc.

Consolidated Statements of Cash Flows

		Year ended December 31,
		2005				2004				2003
		(in thousands)
Operating Activities
Net income		$	160,955			$	168,222			$	119,007
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			139,203				127,821				128,810
Asset impairment			2,451
Restricted stock compensation			11,243				1,908				1,177
Early extinguishment of debt			18,634				11,160
Provision for bad debts			34,665				30,124				29,241
Deferred income taxes			58,769				6,357				62,005
Net gain on sale of assets			(16,431	)			(6,400	)			(3,947	)
Equity in earnings of affiliated companies			(5,492	)			(6,975	)			(7,236	)
Changes in assets and liabilities, excluding sold facilities and acquisitions:
Receivables			(123,065	)			(50,778	)			(48,299	)
Prepaid expenses and other assets			11,074				4,356				(8,353	)
Liabilities			61,942				43,971				28,059
Total adjustments			192,993				161,544				181,457
Net cash provided by operating activities			353,948				329,766				300,464
Investing Activities
Investment in property and equipment			(135,007	)			(151,071	)			(101,230	)
Investment in systems development			(2,674	)			(2,516	)			(3,461	)
Acquisitions			(8,685	)			(4,025	)			(13,276	)
Proceeds from sale of assets			27,909				55,031				17,991
Proceeds from sale of minority interests in consolidated entity							2,778
Net cash used in investing activities			(118,457	)			(99,803	)			(99,976	)
Financing Activities
Net borrowings (repayments) under revolving credit facility			22,800								(259,300	)
Proceeds from issuance of senior notes			400,000								299,372
Principal payments of long-term debt			(252,496	)			(107,075	)			(14,578	)
Net payment of convertible note hedge and warrant option transactions			(53,800	)
Payment of financing costs and debt prepayment premium			(28,226	)			(11,181	)			(7,444	)
Purchase of common stock for treasury			(316,363	)			(135,564	)			(145,105	)
Dividends paid			(50,286	)			(49,306	)			(22,284	)
Proceeds from exercise of stock options			22,258				19,827				4,548
Net cash used in financing activities			(256,113	)			(283,299	)			(144,791	)
Net increase (decrease) in cash and cash equivalents			(20,622	)			(53,336	)			55,697
Cash and cash equivalents at beginning of period			32,915				86,251				30,554
Cash and cash equivalents at end of period		$	12,293			$	32,915			$	86,251

See accompanying notes.

Manor Care, Inc.

Consolidated Statements of Shareholders’ Equity

														Accumulated
														Other
						Capital								Comprehensive												Total
		Common				in Excess				Retained				Income				Treasury Stock								Shareholders’
		Stock				of Par Value				Earnings				(Loss)				Shares				Amount				Equity
										(In thousands, except per share data)
Balance at January 1, 2003		$	1,110			$	349,304			$	1,006,295			$	(11	)			(15,981	)		$	(340,651	)		$	1,016,047
Issue and vesting of restricted stock							(2,104	)			(320	)							175				3,601				1,177
Purchase of treasury stock																			(7,598	)			(164,592	)			(164,592	)
Exercise of stock options							463				(13,121	)							1,385				28,890				16,232
Tax benefit from stock transactions							10,169																				10,169
Cash dividends declared ($.25 per share)											(22,284	)															(22,284	)
Comprehensive income:
Net income											119,007
Other comprehensive income (loss), net of tax:
Unrealized gain on investments and reclassification adjustment															(212	)
Minimum pension liability															(476	)
Amortization of derivative loss															37
Total comprehensive income																											118,356
Balance at December 31, 2003			1,110				357,832				1,089,577				(662	)			(22,019	)			(472,752	)			975,105
Issue and vesting of restricted stock							(752	)											133				2,660				1,908
Purchase of treasury stock																			(4,446	)			(145,269	)			(145,269	)
Exercise of stock options							2,818												1,289				24,495				27,313
Tax benefit from stock transactions							6,751																				6,751
Cash dividends declared ($.56 per share)											(49,306	)															(49,306	)
Comprehensive income:
Net income											168,222
Other comprehensive income (loss), net of tax:
Unrealized gain on investments and reclassification adjustment															(535	)
Minimum pension liability															(67	)
Amortization of derivative loss															37
Total comprehensive income																											167,657
Balance at December 31, 2004			1,110				366,649				1,208,493				(1,227	)			(25,043	)			(590,866	)			984,159
Issue and vesting of restricted stock							2,476												286				4,665				7,141
Purchase of treasury stock																			(9,212	)			(349,536	)			(349,536	)
Exercise of stock options							10,105												1,665				25,321				35,426
Tax benefit from stock transactions							10,092																				10,092
Cash dividends declared ($.60 per share)											(50,286	)															(50,286	)
Convertible note hedge and warrant, net of $29.3 million tax benefit							(24,477	)																			(24,477	)
Comprehensive income:
Net income											160,955
Other comprehensive income, net of tax:
Minimum pension liability															132
Amortization of derivative loss															117
Total comprehensive income																											161,204
Balance at December 31, 2005		$	1,110			$	364,845			$	1,319,162			$	(978	)			(32,304	)		$	(910,416	)		$	773,723