ASSISTED LIVING CONCEPTS INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20459

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FORM 10-K
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(MARK ONE)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .

COMMISSION FILE NUMBER 1-13498

ASSISTED LIVING CONCEPTS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

NEVADA 93-1148702
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

11835 NE GLENN WIDING DRIVE, BUILDING E
PORTLAND, OR 97220-9057
(503) 252-6233
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01

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 at least the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K: [ ]

The Registrant had 6,431,759 shares of common stock, $.01 par value,
outstanding at March 22, 2002. The aggregate market value of the voting stock
held by non-affiliates of the registrant on such date was approximately $13.5
million.

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PART I

Except as otherwise noted, references in this report to "ALC," the
"Company," "us" or "we" refer to Assisted Living Concepts, Inc. and its
subsidiaries.

ITEM 1. BUSINESS

OVERVIEW

We operate, own and lease free-standing assisted living residences. These
residences are primarily located in small, middle-market, rural and suburban
communities with a population typically ranging from 10,000 to 40,000. As of
December 31, 2001 we had operations in 16 states.

We provide personal care and support services and make available routine
nursing services (as permitted by applicable law) designed to meet the personal
and health care needs of our residents. We believe that this combination of
residential, personal care, support and health care services provides a
cost-efficient alternative to, and affords an independent lifestyle for,
individuals who do not require the broader array of medical services that
nursing facilities are required by law to provide.

We experienced significant and rapid growth between 1994 and 1998,
primarily through the development of assisted living residences and, to a much
lesser extent, through acquisition of assisted living residences, opening our
last twenty residences in 1999. At the completion of our initial public offering
in November 1994 we had an operating base of five leased residences located in
Oregon. As of December 31, 2001, we operated 184 assisted living residences
(7,115 units) of which we owned 129 residences (5,010 units) and leased 55
residences (2,105 units). For the year ended December 31, 2001, we had an
average occupancy rate of 84.0% and an average monthly rental rate of $2,073 per
unit.

The principal elements of our business strategy are to:

- increase occupancy and improve operating efficiencies at our residences;

- reduce overhead costs where possible;

- establish necessary financing to meet maturing obligations; and

- increase rental and service revenue.

We anticipate that the majority of our revenues will continue to come from
private pay sources. However, we believe that by having located some of our
residences in states with favorable regulatory and reimbursement climates, we
should have a stable source of residents eligible for Medicaid reimbursement to
the extent that private pay residents are not available and, in addition,
provide our private pay residents with alternative sources of income if their
private funds are depleted and they become Medicaid eligible.

Although we manage the mix of private paying tenants and Medicaid paying
tenants residing in our facilities, any significant increase in our Medicaid
population could have an adverse effect on our financial position, results of
operations or cash flows, particularly if the states operating these programs
continue to limit, or more aggressively seek limits on, reimbursement rates. See
"Risk Factors -- We depend on reimbursement by government payors and other third
parties for a significant portion of our revenues" included in Item 7.

Assisted Living Concepts, Inc., is a Nevada corporation. Our principal
executive offices are located at 11835 NE Glenn Widing Drive, Building E,
Portland, Oregon 97220-9057, and our telephone number is (503) 252-6233.

REORGANIZATION

On October 1, 2001, Assisted Living Concepts, Inc. (the "Company"), and its
wholly owned subsidiary, Carriage House Assisted Living, Inc. voluntarily filed
for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code,
as amended (the "Bankruptcy Code"). The bankruptcy court gave final

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approval to the first amended joint plan of reorganization (the "Plan") on
December 28, 2001, and the plan became effective on January 1, 2002 (the
"Effective Date").

Under the Plan, on the Effective Date, the Company issued general unsecured
creditors their pro rata shares, subject to the reserve described below (the
"Reserve"), of the following securities:

- $40.25 million principal amount of 10% senior secured notes, due January
1, 2009 (the "Senior Secured Notes");

- $15.25 million principal amount of junior secured notes, due January 1,
2012 (the "Junior Secured Notes"); and

- 6.24 million shares of new common stock (representing 96% of the new
common stock).

The Senior Secured Notes and the Junior Secured Notes (collectively the
"New Notes") are secured by 57 of our properties.

The remaining 4% of the new common stock, subject to the Reserve, was
issued on the Effective Date to the Company's shareholders immediately prior to
the Effective Date.

Under the Plan, 1.1% of the senior notes, junior notes and new common stock
that would otherwise have been issued on the Effective Date were held back as a
reserve (the "Reserve") to cover general unsecured claims that had not been
either made or settled by the December 19, 2001 cutoff date established under
the Plan. The reserved securities will be issued once all these outstanding
general unsecured claims have been settled. If the Reserve is insufficient to
cover these outstanding general unsecured claims, we will have no further
liability with respect to these claims. If the Reserve exceeds the amount of
these outstanding general unsecured claims, the excess securities in the Reserve
will be distributed pro rata among the holders of all general unsecured claims,
including those settled prior to the cutoff date.

We adopted fresh-start reporting, as of December 31, 2001, in accordance
with the American Institute of Certified Public Accountants Statement of
Position 90-7, Financial Reporting By Entities in Reorganization Under the
Bankruptcy Code (SOP 90-7). Under fresh-starting reporting, a new entity has
been deemed created for financial reporting purposes. See Note 1 to the
consolidated financial statements included in Item 14 of this report for
additional information.

MANAGEMENT CHANGES

On the Effective Date, a new Board of Directors of the reorganized Company
consisting of seven members was established as follows: W. Andrew Adams
(Chairman), Andre Dimitriadis, Mark Holliday, Richard Ladd, Matthew Patrick,
Leonard Tannenbaum, and Wm. James Nicol, then the President and Chief Executive
Officer of the Company.

Subsequent to the Effective Date, Steven L. Vick replaced Wm. James Nicol
as President, Chief Executive Officer and Director. Mr. Vick joins the Company
from Alterra Healthcare Corporation where he previously served as President and
Chief Operating Officer. Prior to Alterra, Mr. Vick co-founded Sterling House
Corporation in 1991 and served as its President until its merger with Alterra in
October, 1997. Previously, he practiced as a certified public accountant
specializing in health care consulting.

SERVICES

Our residences offer residents a supportive, "home-like" setting and
assistance with activities of daily living. Residents are individuals who, for a
variety of reasons, cannot live alone, or elect not to do so, and do not need
the 24-hour skilled medical care provided in nursing facilities. We design
services provided to these residents to respond to their individual needs and to
improve their quality of life. This individualized assistance is available 24
hours a day, to meet both anticipated and unanticipated needs, including routine
health-related

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services, which are made available and are provided according to the resident's
individual needs and state regulatory requirements. Available services include:

- General services, such as meals, laundry and housekeeping;

- Support services, such as assistance with medication, monitoring health
status, coordination of transportation; and

- Personal care, such as dressing, grooming and bathing.

We also provide or arrange access to additional services beyond basic
housing and related services, including physical therapy and pharmacy services.

Although a typical package of basic services provided to a resident
includes meals, housekeeping, laundry and personal care, we do not have a
standard service package for all residents. Instead, we are able to accommodate
the changing needs of our residents through the use of individual service plans
and flexible staffing patterns. Our multi-tiered rate structure for services is
based upon the acuity of, or level of services needed by, each resident.
Supplemental and specialized health-related services for those residents
requiring 24-hour supervision or more extensive assistance with activities of
daily living are provided by third-party providers who are reimbursed directly
by the resident or a third-party payor (such as Medicaid or long-term care
insurance). Our policy is to assess the level of need of each resident
regularly.

OPERATIONS

Each residence has an on-site administrator who is responsible for the
overall day-to-day operation of the residence, including quality of care,
marketing, social services and financial performance. The administrator is
assisted by professional and non-professional personnel, some of whom may be
independent providers or part-time personnel, including nurses, personal service
assistants, maintenance and kitchen personnel. The nursing hours vary depending
on the residents' needs. We consult with outside providers, such as registered
nurses, pharmacists, and dietitians, for purposes of medication review, menu
planning and responding to any special dietary needs of residents. Personal
service assistants who primarily are full-time employees are responsible for
personal care, dietary services, housekeeping and laundry services. Maintenance
services are performed by full and part-time employees.

We have established an infrastructure that includes 4 regional vice
presidents of operations who oversee the overall performance and finances of
each region, 18 regional directors of operations and 2 associate regional
directors of operations who oversee the day-to-day operations of up to 6 to 11
residences, and team leaders who provide peer support for either three or four
residences. We also have regional property managers who oversee the maintenance
of the residences and several regional marketing coordinators who assist with
marketing the residences. Corporate and regional personnel work with the
administrators to establish residence goals and strategies, quality assurance
oversight, development of our internal policies and procedures, government
relations, marketing and sales, community relations, development and
implementation of new programs, cash management, legal support, treasury
functions, and human resource management.

COMPETITION

The long-term care industry generally is highly competitive. We expect that
the assisted living business, in particular, will become even more competitive
in the future given the relatively low barriers to entry and continuing health
care cost containment pressures.

We compete with numerous other companies providing similar long-term care
alternatives. We operate in 16 states and each community in which we operate
provides a unique market. Overall, most of our markets include an assisted
living competitor offering assisted living facilities that are similar in size,
price and range of service. Our competitors include other companies that provide
adult day care in the home, higher priced assisted living centers (typically
larger facilities with more amenities), congregate care facilities where tenants
elect the services to be provided, and continuing care retirement centers on
campus-like settings.

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We expect to face increased competition from new market entrants as
assisted living receives increased attention and the number of states which
include assisted living in their Medicaid programs increases. Competition will
also grow from new market entrants, including publicly and privately held
companies focusing primarily on assisted living. Nursing facilities that provide
long-term care services are also a potential source of competition for us.
Providers of assisted living residences compete for residents primarily on the
basis of quality of care, price, reputation, physical appearance of the
facilities, services offered, family preferences, physician referrals and
location. Some of our competitors operate on a not-for-profit basis or as
charitable organizations. Some of our competitors are significantly larger than
us and have, or may obtain, greater resources than ours. While we generally
believe that there is moderate competition for less expensive segments of the
private market and for Medicaid residents in small communities, we have seen an
increase in competition in certain of our markets.

We believe that many assisted living markets have been overbuilt.
Regulation and other barriers to entry into the assisted living industry are not
substantial. In addition, because the segment of the population that can afford
to pay our daily resident fee is finite, the number of new assisted living
facilities may outpace demand in some markets. The effects of such overbuilding
include (a) significantly longer fill-up periods, (b) newly opened facilities
attract residents from existing facilities, (c) pressure to lower or refrain
from increasing rates, (d) competition for workers in already tight labor
markets and (e) lower margins until excess units are absorbed.

We believe that each local market is different, and we are and will
continue to react in a variety of ways, including selective price discounting,
to the specific competitive environment that exists in each market. There can be
no assurance that we will be able to compete effectively in those markets where
overbuilding exists, or that future overbuilding in other markets where we
operate our residences will not adversely affect our operations.

FUNDING

Assisted living residents or their families generally pay the cost of care
from their own financial resources. Depending on the nature of an individual's
health insurance program or long-term care insurance policy, the individual may
receive reimbursement for costs of care under an "assisted living," "custodial"
or "alternative care benefit." Government payments for assisted living have been
limited. Some state and local governments offer subsidies for rent or services
for low-income elders. Others may provide subsidies in the form of additional
payments for those who receive Supplemental Security Income (SSI). Medicaid
provides coverage for certain financially or medically needy persons, regardless
of age, and is funded jointly by federal, state and local governments. Medicaid
contracts for assisted living vary from state to state.

In 1981, the federal government approved a Medicaid waiver program called
Home and Community Based Care which was designed to permit states to develop
programs specific to the healthcare and housing needs of the low-income elderly
eligible for nursing home placement (a "Medicaid Waiver Program"). In 1986,
Oregon became the first state to use federal funding for licensed assisted
living services through a Medicaid Waiver Program authorized by Medicaid
Services ("CMS"), formerly the Health Care Financing Administration. Under a
Medicaid Waiver Program, states apply to CMS for a waiver to use Medicaid funds
to support community-based options for the low-income elderly who need long-term
care. These waivers permit states to reallocate a portion of Medicaid funding
for nursing facility care to other forms of care such as assisted living. In
1994, the federal government implemented new regulations which empowered states
to further expand their Medicaid Waiver Programs and eliminated restrictions on
the amount of Medicaid funding states could allocate to community-based care,
such as assisted living. A limited number of states including Oregon, New
Jersey, Texas, Arizona, Nebraska, Florida, Idaho and Washington currently have
operating Medicaid Waiver Programs that allow them to pay for assisted living
care. We participate in Medicaid programs in all of these states except Florida.
Without a Medicaid Waiver Program, states can only use federal Medicaid funds
for long-term care in nursing facilities.

During the years ended December 31, 1999, 2000 and 2001, direct payments
received from state Medicaid agencies accounted for approximately 10.4%, 11.1%
and 12.5%, respectively, of our revenue while

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the tenant-paid portion received from Medicaid residents accounted for
approximately 5.9%, 6.2% and 6.8%, respectively, of our revenue during these
periods. We expect in the future that state Medicaid reimbursement programs will
continue to constitute a significant source of our revenue.

GOVERNMENT REGULATION

Our assisted living residences are subject to certain state statutes, rules
and regulations, including those which provide for licensing requirements. In
order to qualify as a state licensed facility, our residences must comply with
regulations which address, among other things, staffing, physical design,
required services and resident characteristics. As of December 31, 2001, we had
obtained licenses in Oregon, Washington, Idaho, Nebraska, Texas, Arizona, Iowa,
Louisiana, Ohio, New Jersey, Pennsylvania, Florida, Michigan, Georgia and South
Carolina. We are not currently subject to state licensure requirements in
Indiana. Our residences are also subject to various local building codes and
other ordinances, including fire safety codes. These requirements vary from
state to state and are monitored to varying degrees by state agencies.

As a provider of services under the Medicaid program in the United States,
we are subject to Medicaid fraud and abuse laws, which prohibit any bribe,
kickback, rebate or remuneration of any kind in return for the referral of
Medicaid patients, or to induce the purchasing, leasing, ordering or arranging
of any goods or services to be paid for by Medicaid. Violations of these laws
may result in civil and criminal penalties and exclusions from participation in
the Medicaid program. The Inspector General of the Department of Health and
Human Services issued "safe harbor" regulations specifying certain business
practices, which are exempt from sanctions under the fraud and abuse law.
Several states in which we operate have laws that prohibit certain direct or
indirect payments or fee-splitting arrangements between health care providers if
such arrangements are designed to induce or encourage the referral of patients
to a particular provider. We, at all times, attempt to comply with all
applicable fraud and abuse laws. There can be no assurance that administrative
or judicial interpretation of existing laws or regulations or enactments of new
laws or regulations will not have a material adverse effect on our results of
operations or financial condition.

Currently, the federal government does not regulate assisted living
residences as such. State standards required of assisted living providers are
less in comparison with those required of other licensed health care operators.
Current Medicaid regulations provide for comparatively flexible state control
over the licensure and regulation of assisted living residences. There can be no
assurance that federal regulations governing the operation of assisted living
residences will not be implemented in the future or that existing state
regulations will not be expanded.

Under the Americans with Disabilities Act of 1990, all places of public
accommodation are required to meet certain federal requirements related to
access and use by disabled persons. Although we believe that our facilities are
substantially in compliance with, or are exempt from, present requirements, we
will incur additional costs if required changes involve a greater expenditure
than anticipated or must be made on a more accelerated basis than anticipated.
Further legislation may impose additional burdens or restrictions with respect
to access by disabled persons, the costs of compliance with which could be
substantial.

See Risk Factors, "We are subject to significant government regulation."

LIABILITY AND INSURANCE

Providing services in the senior living industry involves an inherent risk
of liability. Participants in the senior living and long-term care industry are
subject to lawsuits alleging negligence or related legal theories, many of which
may involve large claims and result in the incurrence of significant legal
defense costs. We currently maintain insurance policies to cover such risks in
amounts which we believe are in keeping with industry practice. There can be no
assurance that a claim in excess of our insurance will not be asserted. A claim
against us not covered by, or in excess of, our insurance, could have a material
adverse affect on us.

Based on poor loss experience, insurers for the long term care industry
have become increasingly wary of liability exposures. A number of insurance
carriers have stopped writing coverage to this market, and those remaining have
increased premiums and deductibles substantially. While nursing homes have been
primarily

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affected, assisted living companies, including us, have experienced premium and
deductible increases. During the claim year ended December 31, 2001, our
professional liability insurance coverage included retention levels of $250,000
per incident for all states except Florida and Texas in which our retention
level is $500,000. Our professional liability insurance is on a claims-made
basis. In certain states, particularly Florida and Texas, many long-term care
providers are facing very difficult renewals. There can be no assurance that we
will be able to obtain liability insurance in the future or that, if such
insurance is available, it will be available on terms acceptable to us.

EMPLOYEES

As of December 31, 2001 we had 3,727 employees, of whom 1,725 were
full-time employees and 2,002 were part-time employees. None of our employees
are represented by any labor union. We believe that our labor relations are
generally good.

ITEM 2. PROPERTIES

The following chart sets forth, as of December 31, 2001, the location,
number of units, opening date, ownership status and occupancy of our residences.

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(1) Reflects the date we commenced operations.

(2) As of December 31, 2001, we owned 129 residences and we leased 55 residences
pursuant to long-term operating leases. Of the 129 owned residences, 38 are
subject to permanent mortgage financing, 3 are subject to HUD mortgage
financing, 31 are subject to financing with Heller Healthcare Finance, Inc.
and the remaining 57 owned properties are collateral for the New Notes. See
Notes 4, 6 and 7 to the consolidated financial statements included elsewhere
herein.

(3) Occupancy is calculated based upon occupied units at December 31, 2001.

(4) As of December 31, 2001, Sumner, Washington had received a notice of license
revocation. The notice of license revocation is still pending as of the date
of this filing.

(5) Due to market conditions, we closed this facility on March 15, 2002. This
property is one of fifty-seven properties which serve as collateral for the
New Notes. We are currently exploring disposal options of this facility
which may include selling the facility or leasing it to a third party. If we
elect to sell the property, we must first obtain permission from BNY Midwest
Trust Company, the New Notes trustee and all proceeds must be submitted to
the trustee.

In 2001, we also leased office space for the corporate office in Portland,
Oregon and the regional offices in Dallas, Texas and Dublin, Ohio.

ITEM 3. LEGAL PROCEEDINGS

On October 1, 2001, we voluntarily filed for bankruptcy protection under
Chapter 11 of the Bankruptcy Code. The bankruptcy court gave final approval to
our Plan of reorganization on December 28, 2001, and the plan became effective
on the Effective Date, January 1, 2002.

Under the Plan, on the Effective Date, the Company issued general unsecured
creditors their pro rata shares, subject to the Reserve, of the following
securities:

- $40.25 million principal amount of Senior Secured Notes;

- $15.25 million principal amount of Junior Secured Notes; and

- 6.24 million shares of new common stock (representing 96% of the new
common stock).

The New Notes are secured by 57 of our properties.

The remaining 4% of the new common stock, subject to the Reserve, was
issued on the Effective Date to the Company's shareholders immediately prior to
the Effective Date.

Under the Plan, 1.1% of the senior notes, junior notes and new common stock
that would otherwise have been issued on the Effective Date were held back in
the Reserve to cover general unsecured claims that had not been either made or
settled by the December 19, 2001 cutoff date established under the Plan. The
reserved securities will be issued once all these outstanding general unsecured
claims have been settled. If the Reserve is insufficient to cover these
outstanding general unsecured claims, we will have no further liability with
respect to these claims. If the Reserve exceeds the amount of these outstanding
general unsecured claims, the excess securities will be distributed pro rata
among the holders of all general unsecured claims, including those settled prior
to the cutoff date.

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Insurance Coverage Dispute

In September 2000, we reached an agreement to settle the class action
litigation relating to the restatement of our consolidated financial statements
for the years ended December 31, 1996 and 1997 and the first three fiscal
quarters of 1998. This agreement received final court approval on November 30,
2000 and we were dismissed from the litigation with prejudice. On September 28,
2001, we made our final installment of $1.0 million on our promissory note for
the class action litigation settlement. Although we were dismissed from the
litigation with prejudice, a dispute which arose with our corporate liability
insurance carriers remains unresolved. At the time we settled the class action
litigation, the Company and the insurance carriers agreed to resolve this
dispute through binding arbitration, and we filed a complaint for a declaratory
judgment that we are not liable to the carriers as claimed. The carriers
counter-claimed to recover an amount capped at $4.0 million.

After filing our bankruptcy petition on October 1, 2001, we made a motion
for dismissal of our complaint for declaratory relief in the arbitration based
upon having filed for bankruptcy protection. An objection was filed to our
motion, and one of our insurance carriers filed a proof of claim in the amount
of $4.0 million in the bankruptcy proceeding. We dispute that claim. We offered
(and the offer currently remains outstanding) to settle the dispute for $75,000
to be paid out as part of the bankruptcy process. See Notes 1 and 13 to the
consolidated financial statements included elsewhere herein.

Other Litigation

In addition to the matters referred to in the immediately preceding
paragraphs, we are involved in various lawsuits and claims arising in the normal
course of business. In the aggregate, such other suits and claims should not
have a material adverse effect on our financial condition, results of
operations, cash flow and liquidity.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

PREDECESSOR COMPANY

Our Common Stock, par value $0.01 (the "Common Stock"), was listed on the
American Stock Exchange ("AMEX") under the symbol "ALF" until October 26, 2001.
On October 26, 2001, our Common Stock was delisted and ceased trading on the
AMEX. On November 29, 2001, our Common Stock was listed and began trading on the
OTC Bulletin Board(R) ("OTC.BB") under the symbol "ALFC". The following table
sets forth the high and low closing sales prices of our Common Stock, as
reported by the AMEX, for the periods indicated.

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(1) On April 15, 1999, the AMEX halted trading in the Common Stock. Trading was
resumed on October 4, 1999 after a restatement related to the years ended
December 31, 1996 and 1997 and the first three fiscal quarters of 1998 was
completed.

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(2) From the period from November 29, 2001 through December 31, 2001, the high
and low closing sales prices of our Common Stock, as reported by OTC.BB,
were $0.04 and $0.01, respectively. The OTC.BB market quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may
not necessarily represent actual transactions.

As of December 31, 2001, we had approximately 102 holders of record of the
Predecessor Company's Common Stock. We are unable to estimate the number of
additional shareholders whose shares are held for them in street name or nominee
accounts.

SUCCESSOR COMPANY

Our Common Stock, par value $0.01 (the "Common Stock"), is listed on the
OTC.BB under the symbol "ASLC".

Our current policy is to retain any earnings to finance the operations of
our business. In addition, certain outstanding indebtedness and certain lease
agreements restrict the payment of cash dividends. It is anticipated that the
terms of future debt financing may do so as well. Therefore, the payment of any
cash dividends on the Common Stock is unlikely in the foreseeable future.

As of March 1, 2002, we had approximately 33 holders of record of the
Successor Company's Common Stock. We are unable to estimate the number of
additional shareholders whose shares are held for them in street name or nominee
accounts.

ITEM 6. SELECTED FINANCIAL DATA

The following table presents selected historical consolidated financial
data. The consolidated statement of operations data for the years ended December
31, 1999, 2000 and 2001, as well as the consolidated balance sheet data as of
December 31, 2000 and 2001, are derived from our consolidated financial
statements included elsewhere in this report which have been audited by KPMG
LLP, independent auditors. Upon emergence from Chapter 11 proceedings, we
adopted fresh-start reporting in accordance with the American Institute of
Certified Public Accountants Statement of Position 90-7, Financial Reporting By
Entities in Reorganization Under the Bankruptcy Code. In connection with the
adoption of fresh-start reporting, a new entity has been deemed created for
financial reporting purposes effective December 31, 2001. Consequently, the
consolidated balance sheet data at December 31, 2001 is labeled "Successor
Company," and reflects the Plan and the principles of fresh-start reporting.
Periods presented prior to December 31, 2001 have been designated "Predecessor
Company." Note 1 to our consolidated financial statements, included elsewhere in
this Report, provides a reconciliation of the Predecessor Company's consolidated
balance sheet as of December 31, 2001 to that of the Successor Company which
presents the adjustments that give effect to the reorganization and fresh-start
reporting. You should read the selected financial data below in conjunction with
our consolidated financial statements, including the related notes, and the
information in Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

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(1) 6,431,759 shares of common stock of the Successor Company were issued upon
the cancellation of all shares of the Predecessor Company as of the
Effective Date, excluding 68,241 shares subject to the Reserve that will be
issued upon settlement of certain unsecured bankruptcy claims. See Note 1 to
the consolidated financial statements included elsewhere herein.

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QUARTERLY FINANCIAL DATA
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE, OCCUPANCY AND AVERAGE RENTAL DATA)
PREDECESSOR COMPANY

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(1) Quarter net loss per share amounts may not add to the full year total due to
rounding.

(2) 6,431,759 shares of common stock of the Successor Company were issued upon
the cancellation of all shares of the Predecessor Company as of the
Effective Date, excluding 68,241 shares subject to the Reserve that will be
issued upon settlement of certain unsecured bankruptcy claims. See Note 1 to
the consolidated financial statements included elsewhere herein.

(3) Based upon available units.

ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

We operate, own and lease free-standing assisted living residences. These
residences are primarily located in small middle-market rural and suburban
communities with a population typically ranging from 10,000 to 40,000. We
provide personal care and support services, and make available routine nursing
services (as permitted by applicable law) designed to meet the personal and
health care needs of our residents. As of December 31, 2001, we had operations
in 16 states.

We experienced significant and rapid growth between 1994 and 1998,
primarily through the development of assisted living residences and, to a lesser
extent, through the acquisition of assisted living residences. At the closing of
our initial public offering in November 1994, we had an operating base of five
leased residences (137 units) located in Oregon. We opened twenty residences
(798 units) in 1999 and no residences in 2000. As of December 31, 2001, we
operated 184 residences (7,115 units), of which we owned 129 residences (5,010
units) and leased 55 residences (2,105 units).

We derive our revenues primarily from resident fees for the delivery of
assisted living services. Resident fees typically are paid monthly by residents,
their families, state Medicaid agencies or other third parties. Resident fees
include revenue derived from a multi-tiered rate structure, which varies based
upon type of room

15

and on the level of care provided. Resident fees are recognized as revenues when
services are provided. Our operating expenses include:

- residence operating expenses, such as staff payroll, food, property
taxes, utilities, insurance and other direct residence operating
expenses;

- general and administrative expenses consisting of regional management and
corporate support functions such as legal, accounting and other
administrative expenses;

- building rentals; and

- depreciation and amortization.

We anticipate that the majority of our revenues will continue to come from
private pay sources. However, we believe that by having located some of our
residences in states with favorable regulatory and reimbursement climates, we
should have a stable source of residents eligible for Medicaid reimbursement to
the extent that private pay residents are not available and, in addition,
provide our private pay residents with alternative sources of income when their
private funds are depleted and they become Medicaid eligible.

Although we manage the mix of private paying tenants and Medicaid paying
tenants residing in our facilities, any significant increase in our Medicaid
population could have an adverse effect on our financial position, results of
operations or cash flows, particularly if states operating these programs
continue to, or more aggressively seek, limits on reimbursement rates. See "Risk
Factors -- We depend on reimbursement by third-party payors."

REORGANIZATION

On October 1, 2001, we voluntarily filed for bankruptcy protection under
Chapter 11 of the Bankruptcy Code. The bankruptcy court gave final approval to
our Plan of reorganization on December 28, 2001, and the plan became effective
on the Effective Date, January 1, 2002.

Under the Plan, on the Effective Date, the Company issued general unsecured
creditors their pro rata shares, subject to the Reserve, of the following
securities:

- $40.25 million principal amount of Senior Secured Notes;

- $15.25 million principal amount of Junior Secured Notes; and

- 6.24 million shares of new common stock (representing 96% of the new
common stock).

The New Notes are secured by 57 of the Company's properties.

The remaining 4% of the new common stock, subject to the Reserve, was
issued on the Effective Date to the Company's shareholders immediately prior to
the Effective Date.

Under the Plan, 1.1% of the senior notes, junior notes and new common stock
that would otherwise have been issued on the Effective Date were held back in
the Reserve to cover general unsecured claims that had not been either made or
settled by the December 19, 2001 cutoff date established under the Plan. The
reserved securities will be issued once all these outstanding general unsecured
claims have been settled. If the Reserve is insufficient to cover these
outstanding general unsecured claims, we will have no further liability with
respect to these claims. If the Reserve exceeds the amount of these outstanding
general unsecured claims, the excess securities will be distributed pro rata
among the holders of all general unsecured claims, including those settled prior
to the cutoff date.

On the Effective Date, a new Board of Directors of the reorganized Company
consisting of seven members was established as follows: W. Andrew Adams
(Chairman), Andre Dimitriadis, Mark Holliday, Richard Ladd, Matthew Patrick,
Leonard Tannenbaum, and Wm. James Nicol, then the President and Chief Executive
Officer of the Company. Subsequent to the Effective Date, Steven L. Vick
replaced Mr. Nicol as President, Chief Executive Officer and Director.

16

We adopted fresh-start reporting, as of December 31, 2001, in accordance
with the American Institute of Certified Public Accountants Statement of
Position 90-7, Financial Reporting By Entities in Reorganization Under the
Bankruptcy Code (SOP 90-7). Under fresh-starting reporting, a new entity has
been deemed created for financial reporting purposes. See Note 1 to the
consolidated financial statements included in Item 14 of this report for
additional information.

FRESH-START REPORTING

Upon emergence from Chapter 11 proceedings, we adopted fresh-start
reporting in accordance with the American Institute of Certified Public
Accountants Statement of Position 90-7, Financial Reporting By Entities in
Reorganization Under the Bankruptcy Code (SOP 90-7). In connection with the
adoption of fresh-start reporting, a new entity has been deemed created for
financial reporting purposes. For financial reporting purposes, we adopted the
provisions of fresh-start reporting effective December 31, 2001. Consequently,
the consolidated balance sheet and related information included in Item 6 and
Item 14 at December 31, 2001 is labeled "Successor Company," and reflects the
Plan and the principles of fresh-start reporting. Periods presented prior to
December 31, 2001 have been designated "Predecessor Company." For purposes of
this Item 7, references to operating results and cash flows for periods ended
prior to December 31, 2001 refer to the operating results and cash flows of the
Predecessor Company, and references to working capital and other balance sheet
data, liquidity and prospective information regarding future periods refer to
the Successor Company.

In adopting the requirements of fresh-start reporting as of December 31,
2001, we were required to value our assets and liabilities at their estimated
fair value and eliminate our accumulated deficit at December 31, 2001. With the
assistance of financial advisors who relied upon various valuation methods
including discounted projected cash flows and other applicable ratios and
economic industry information relevant to our operations, and through
negotiations with the various creditor parties in interest, we determined our
reorganization value to be $32.8 million.

The adjustments to reflect the adoption of fresh-start reporting, including
the adjustments to record property, plant and equipment, at their fair values,
have been reflected in the consolidated balance sheet as of December 31, 2001.
In addition, the Successor Company's balance sheet was further adjusted to
eliminate existing liabilities subject to compromise, associated deferred
financing costs and deferred gains, goodwill, and the historical consolidated
shareholders' equity. See Note 1 to the consolidated financial statements
included elsewhere herein for a reconciliation of the Predecessor Company and
the Successor Company consolidated balance sheets as of December 31, 2001.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate these estimates, including
those related to bad debts, income taxes, financing operations, contingencies
and litigation. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.

We believe the following critical accounting policies are more significant
to the judgments and estimates used in the preparation of our consolidated
financial statements:

Fresh-Start Reporting. Upon emerging from Chapter 11 proceedings we
adopted fresh-start reporting in accordance with SOP 90-7. For financial
reporting purposes, we were required to value our assets and liabilities at
their current fair value. With assistance of financial advisors in reliance
upon various valuation methods, including discounted projected cash flow
analysis and other applicable ratios
17

and economic industry information relevant to our operations and through
negotiations with various creditor parties in interest, we determined a
reorganization value of $32.8 million. The reorganization value was
allocated to our assets and liabilities based upon their fair value.

The determination of fair value of assets and liabilities required
significant estimates and judgments made by management, particularly as it
related to the fair market value of our debt, operating leases and
property, plant and equipment. The fair value of our debt at December 31,
2001 was determined based upon current effective interest rates for similar
debt instruments. The fair value of our leases and property, plant and
equipment were based on current market rentals and building values. Results
may differ under different assumptions or conditions.

Income Taxes. Historically, we have not recorded a provision for
income taxes as we had generated a loss for both financial reporting and
tax purposes. We have recorded a 100% valuation allowance for our net
deferred tax assets as we believe it is more likely than not that the
benefit will not be realized. Pursuant to SOP 90-7, the income tax benefit,
if any, of any future realization of the remaining NOL carryforwards and
other deductible temporary differences existing as of the effective date
will be applied as a reduction to additional paid-in capital.

18

RESULTS OF OPERATIONS

Year ended December 31, 2001 compared to year ended December 31, 2000

The following table sets forth, for the periods presented, the number of
total residences and units operated, average occupancy rates, the sources of our
revenue and operating expenses as a percentage of revenue. The portion of
revenues received from state Medicaid agencies are labeled as "Medicaid state
portion" while the portion of our revenues that a Medicaid-eligible resident
must pay out of his or her own resources is labeled "Medicaid resident portion."

19

Other Data:

We incurred a net loss of $63.9 million, or $3.73 per basic and diluted
share, on revenue of $150.7 million for the year ended December 31, 2001 (the
"2001 Period") as compared to a net loss of $25.8 million, or $1.51 per basic
and diluted share, on revenue of $139.4 million for the year ended December 31,
2000 (the "2000 Period"). Net loss before extraordinary gain on reorganization
was $143.4 million, or $8.38 per basic and diluted share, for the 2001 Period as
compared to a net loss of $25.8 million, or $1.51 per basic and diluted share,
for the 2000 Period.

We had certificates of occupancy for 184 residences (7,115 units) at the
end of 2001 compared to 185 residences (7,149 units) in 2000. In accordance with
the Plan, we discontinued one lease (34 units), effective December 1, 2001.

Revenue. Revenue was $150.7 million for the 2001 Period as compared to
$139.4 million for the 2000 Period, an increase of $11.3 million or 8.1%. The
increase in revenue was primarily attributable to a combination of an increase
in average occupancy to 84.0% and average monthly rental rate of $2,073 for the
2001 period compared to average occupancy of 80.7% and average monthly rental
rate of $1,991 for the 2000 period.

Residence Operating Expenses. Residence operating expenses were $103.9
million for the 2001 Period as compared to $95.0 million for the 2000 Period, an
increase of $8.9 million or 9.4%.

The principal elements of the increase include:

- $7.6 million related to increases in payroll costs due to increases in
occupancy, wages, benefits, and medical and workers compensation
insurance premiums;

- $1.0 million related to increased utility costs;

- $2.0 million related to increases in professional and property liability
insurance premiums and deductibles or retentions; and

- $700,000 related to an increase in kitchen expense, including food, as a
result of increased occupancy.

These increases were offset by the following decreases:

- $1.9 million decrease in bad debt expense due to more timely collection
of aged account receivable balances;

- $600,000 decrease in property tax expense as a result of changes in
assessments and related estimates; and

- $100,000 decrease in property related repairs and maintenance.

Corporate General and Administrative. Corporate general and administrative
expenses as reported were $17.2 million for the 2001 Period as compared to $18.4
million for the 2000 Period, a decrease of $1.2 million

20

or 6.5%. The 2000 Period include a reduction of $900,000 related to an insurance
reimbursement for legal and professional fees incurred in prior periods in
connection with the class action litigation. Excluding the $900,000
reimbursement, corporate general and administrative expenses for the 2000 Period
were $19.3 million, compared to $17.2 million for the 2001 Period, a decrease of
$2.1 million. The principal elements of the decrease include:

- $440,000 decrease related to reduced premiums for directors, officers and
corporate liability insurance;

- $600,000 decrease related to lower professional fees, including financial
advisory and legal;

- $200,000 decrease in communication expense due to implementation of more
efficient communications infrastructure; and

- $180,000 decrease in payroll and related expenses due to 2000 corporate
general and administrators expenses including $1.2 million of severance
related pay for prior officers, offset by a $1.0 million increase due to
increases in wages and benefits resulting primarily from increased
employee retention and increases in benefit rates.

Building Rentals. Building rentals were $16.0 million for both the 2001
and 2000 Periods. Building rentals for the 2001 Period include $145,000 of a
retroactive rent increase paid to one lessor during the first quarter of 2001
and exclude $200,000 of building rental expense related to 16 operating leases
on facilities repurchased in October 2001. Excluding these two items, the
increase in building rentals was due to scheduled annual rent escalators.

Depreciation and Amortization. Depreciation and amortization was $10.3
million for the 2001 Period as compared to $9.9 million for the 2000 Period, an
increase of $400,000 or 4.0%. Depreciation expense was $10.0 million and
amortization expense related to goodwill was $292,000 for the 2001 Period as
compared to $9.6 million and $292,000, respectively, for the 2000 Period. The
increase in depreciation is the result of improvements to our communications
infrastructure and the purchase of 16 previously leased residences on October
24, 2001.

Interest Expense. Interest expense was $19.5 million for the 2001 Period
as compared to $16.4 million for the 2000 Period, an increase of $3.1 million or
18.9%. The increase was related to interest incurred on our $4.0 million bridge
loan, interest incurred on HUD loans with principal of $7.9 million, interest
incurred on Heller Healthcare, Inc. ("Heller") credit facility draws of $17.0
million and $23.5 million of Heller financing in connection with the purchase of
16 previously leased facilities. Additionally, $1.9 million of deferred
financing costs were written off to interest expense when the maturity of the
Heller credit facility changed during the fourth quarter of 2001.

Interest Income. Interest income was $655,000 for the 2001 Period as
compared to $786,000 for the 2000 Period, a decrease of $131,000. The decrease
is related to interest income earned on lower average cash balances during the
2001 Period.

Gain (Loss) on Sale of Assets. Loss on disposal of assets was $88,000 for
the 2001 Period, whereas gain on sale of assets was $13,000 for the 2000 Period,
a difference of $101,000. The loss during the 2001 Period was primarily related
to the sale of undeveloped land. The gain during the 2000 Period was related to
the sale of retired computer equipment.

Other Income (Expense). Other income was $30,000 for the 2001 Period as
compared to other income of $67,000 for the 2000 Period. Other income during the
2000 Period was primarily related to a contract to provide development services
to a third party.

Debt Restructure and Reorganization Costs. During the 2001 Period we
incurred $8.6 million of costs associated with establishing and implementing the
Plan. These costs include $7.4 million of professional fees, primarily legal,
accounting and investment advisory fees and $1.2 million of payments related to
the Plan made in accordance with employment agreements.

Fresh-Start Adjustments. Fresh-start valuation adjustments of $119.3
million were recorded pursuant to the provisions of AICPA SOP 90-7, which
require entities to record their assets and liabilities at estimated fair
21

values. The fresh-start valuation adjustment is principally the result of the
elimination of predecessor company goodwill and the revaluation of debt and
property, plant and equipment to estimated fair values.

Extraordinary Item -- Gain on Reorganization. During the 2001 Period, an
extraordinary gain on reorganization of $79.5 million was recorded in accordance
with the implementation of the Plan (See Note 1 to the consolidated financial
statements included elsewhere herein).

Net Loss. As a result of the above, net loss was $63.9 million or $3.73
per basic and diluted share for the 2001 Period, compared to a net loss of $25.8
million or $1.51 per basic and diluted share for the 2000 Period. Loss before
extraordinary gain on reorganization was $143.4 million, or $8.38 per basic and
diluted share, for the 2001 period.

Year ended December 31, 2000 compared to year ended December 31, 1999

Prior to 2001 we were a development company with an increasing number of
assisted living residences. Where appropriate in the following comparison of
results for fiscal 1999 and 2000, we have included separate data with respect to
Same Store Residences. Same Store Residences are defined as those residences
which were operating throughout comparable periods. There were 165 Same Store
Residences included in operating results for all of fiscal years 1999 and 2000.

Other Data:

We incurred a net loss of $25.8 million, or $1.51 per basic and diluted
share, on revenue of $139.4 million for the 2000 Period as compared to a net
loss of $28.9 million, or $1.69 per basic and diluted share, on revenue of
$117.5 million for the year ended December 31, 1999 (the "1999 Period").

We had certificates of occupancy for 185 residences, all of which were
included in the operating results as of the end of both the 2000 Period and 1999
Period. Of the residences included in operating results as of the end of the
2000 Period and 1999 Period, we owned 115 residences and leased 70 residences
(all of which were operating leases).
22

Revenue. Revenue was $139.4 million for the 2000 Period as compared to
$117.5 million for the 1999 Period, an increase of $21.9 million or 18.6%.

The increase includes:

- $7.5 million related to the full year impact of the 20 residences (798
units) which opened during the 1999 Period;

- $14.4 million was attributable to the 165 Same Store Residences (6,351
units).

Revenue from the Same Store Residences was $127.9 million for the 2000
Period as compared to $113.5 million for the 1999 Period, an increase of $14.4
million or 12.7%. The increase in revenue from Same Store Residences was
attributable to a combination of an increase in average occupancy to 83.7% and
average monthly rental rate to $1,985 for the 2000 Period as compared to average
occupancy of 77.8% and average monthly rental rate of $1,891 for these same
residences in the 1999 Period.

Residence Operating Expenses. Residence operating expenses were $95.0
million for the 2000 Period as compared to $81.8 million for the 1999 Period, an
increase of $13.2 million or 16.2%.

The increase includes:

- $4.9 million related to the full year impact of the 20 residences (798
units) which opened during the 1999 Period;

- $8.3 million was attributable to the 165 Same Store Residences (6,351
units).

Residence operating expenses for the Same Store Residences were $85.7
million for the 2000 period as compared to $77.4 million for the 1999 Period, an
increase of $8.3 million or 10.7%.

The principal elements of the increase in Same Store Residence operating
expenses are:

- $4.2 million related to additional payroll expenses incurred in
connection with the increase in occupancy at the Same Store Residences
during the period;

- $1.4 million related to increase in real estate taxes as a result of
changes in assessments;

- $1.3 million related to provision for uncollectible rent due to the
completion of an assessment of our accounts receivable collections
process begun during the three months ended December 31, 2000. As a
result, we increased our provision for bad debts, primarily related to
private pay accounts, and wrote off or reserved balances where the
probability of collection was low;

- $378,000 related to increase in utility costs as a result of increase in
rates and increase in usage as result of an increase in occupancy; and

- $277,000 related to increase in maintenance expense associated with the
upkeep of our buildings.

Corporate General and Administrative. Corporate general and administrative
expenses as reported were $18.4 million for the 2000 Period as compared to $21.2
million for the 1999 Period. Our corporate general and administrative expenses
before capitalized payroll costs were $21.8 million for the 1999 Period compared
to $18.4 million for the 2000 Period, a decrease of $3.4 million. The principal
elements of the decrease include:

- $2.8 million related to decreased professional fees primarily associated
with legal, financial advisory and accounting costs due to regulatory
issues, securityholder litigation and the restatement of our financial
statements for the years ended December 31, 1996, 1997 and the first
three fiscal quarters of 1998;

- $1.2 million as a result of reimbursement of legal and professional fees
from our insurance carrier as a result of the settlement of our
litigation related to the restatement of the financial statements for the
years ended December 31, 1996 and 1997 and the first three fiscal
quarters of 1998. Of the $1.2 million in reimbursements, we incurred
approximately $600,000 of the underlying expenses during the 2000 Period
and the remaining $600,000 during the year ended December 31, 1999; and

23

- $1.8 million in the 1999 Period related to the final operations of our
home health business.

The decrease was offset by increases in corporate, general and
administrative expense of:

- $1.3 million related to increased network costs associated with the
development of our communications infrastructure, including dial-up and
intranet access for our remote locations;

- $500,000 related to increased payroll costs, including severance costs of
$1.2 million relating to former officers; and

- $700,000 related to increased premiums for our directors and officers and
liability insurance policies.

We capitalized $617,000 of payroll costs associated with the development of
new residences during the 1999 Period. Since we discontinued our development
activities during the 1999 Period, we did not capitalize any payroll costs in
the 2000 Period.

Building Rentals. Building rentals were $16.0 million for the 2000 Period
as compared to $15.4 million for the 1999 Period, an increase of $600,000 or
3.9%. This increase was primarily attributable to the additional rental expense
associated with the March 1999 amendment of 16 of our leases which were
previously accounted for as financings. The amendment eliminated our continuing
involvement in the residences in the form of a fair value purchase option. As a
result of the amendment, the leases have been reclassified as operating leases
for the last nine months of the 1999 Period and the full 2000 Period.

Depreciation and Amortization. Depreciation and amortization was $9.9
million for the 2000 Period as compared to $9.0 million for the 1999 Period, an
increase of $900,000 or 10.0%. Depreciation expense was $9.6 million and
amortization expense related to goodwill was $292,000 for the 2000 Period as
compared to $8.7 million and $294,000, respectively, for the 1999 Period. The
increase in depreciation is the result of a full year of depreciation associated
with the 20 owned residences that commenced operations during the 1999 Period.

Class Action Litigation Settlement. During the third quarter of the 2000
Period we settled the class action litigation against us related to the
restatement of our financial statements for the years ended December 31, 1996
and 1997 and the first three fiscal quarters of 1998. The total cost of this
settlement to us was $10.0 million. Accordingly, we recognized a charge of $10.0
million during the 2000 Period. We received reimbursements of approximately $1.2
million from our corporate liability insurance carriers and other parties in
relation to the settlement. The $1.2 million of reimbursements has been recorded
as a reduction of corporate, general and administrative expenses as discussed
above.

Site Abandonment Costs. In the 1999 Period, the Company wrote-off $4.9
million of capitalized cost relating to the abandonment of all remaining
development sites, with the exception of certain sites where the Company owned
the land.

Interest Expense. Interest expense was $16.4 million for the 2000 Period as
compared to $15.2 million for the 1999 Period. Interest expense before
capitalization for the 2000 Period was $16.4 million as compared to $17.2
million for the 1999 Period, a net decrease of $800,000.

Interest expense decreased by:

- $840,000 due to the March 1999 amendment of 16 of our operating leases
which were previously accounted for as financings. As a result, the
leases were accounted for as operating leases, effective March 31, 1999.
Accordingly, rent expense related to such leases after the date of the
amendment, has been classified as building rentals, rather than interest
expense;

- $80,000 due to financing fees related to variable rate debt and letter of
credit renewals; and

- $95,000 due to interest expense associated with the repayment of joint
venture advances in February 1999.

This decrease was offset by an increase in interest expense of $215,000 as
a result of increases in interest rates on variable rate debt.

24

We capitalized $2.0 million of interest expense for the 1999 Period. There
was no capitalized interest in the 2000 Period as a result of the
discontinuation of our development activities.

Interest Income. Interest income was $786,000 for the 2000 Period as
compared to $1.6 million for the 1999 Period, a decrease of $814,000. The
decrease is related to interest income earned on lower average cash balances
during the 2000 Period.

Loss on Sale of Marketable Securities. Loss on sale of marketable
securities was $368,000 for the 2000 Period as a result of the sale of
securities with a historical cost basis of $2.0 million for proceeds of $1.6
million.

Gain (Loss) on Sale of Assets. Gain on sale of assets was $13,000 for the
2000 Period as compared to a loss of $127,000 for the 1999 Period. The gain
during the 2000 Period was related to the sale of miscellaneous equipment. The
loss during the 1999 Period was related to the disposal of leasehold
improvements associated with relocating our corporate offices in January 1999.

Other Income (Expense). Other income was $67,000 for the 2000 Period as
compared to other expense of $260,000 for the 1999 Period. Other income during
the 2000 Period was primarily related to a contract to provide development
services to a third party. Other expenses during the 1999 Period included
$170,000 of administrative fees incurred in connection with our February 1999
repurchase of the remaining joint venture partner's interest in the operations
of 17 residences.

Net Loss. As a result of the above, net loss was $25.8 million or $1.51 per
basic and diluted share for the 2000 Period, compared to a net loss of $28.9
million or $1.69 loss per basic and diluted share for the 1999 Period.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2001, we had a working capital deficit of $6.3 million and
unrestricted cash and equivalents of $6.1 million.

Net cash used in operating activities was $7.7 million during the year
ended December 31, 2001. The primary uses were a decrease in other current
liabilities of $8.2 million primarily due to payment of $7.8 million on our
class action litigation payable. This is offset by a $5.8 million increase in
accrued expenses due to a $1.4 million increase in accrued workers compensation
payable, an increase of $700,000 in accrued payroll due to timing, and the
nonpayment of $3.9 million of interest on the subordinated convertible
debentures which was eliminated in accordance with the Plan.

Net cash used in investing activities totaled $29.7 million during the year
ended December 31, 2001. The primary uses of cash were $23.5 million related to
the purchase of 16 previously leased facilities and purchases of property and
equipment of $2.1 million. Restricted cash increased by $4.1 million due to
workers compensation deposits required by our insurance carrier (funds will be
withdrawn from this account as 2001 workers compensation claims are incurred and
paid) and due to the segregation of cash restricted for tenant security
deposits.

Net cash provided by financing activities was $36.1 million during the year
ended December 31, 2001. We received gross proceeds of $7.9 million in
connection with long-term HUD insured financing secured by three Texas
properties, $23.5 million from Heller to purchase 16 previously leased
facilities in Texas, $18.5 million in draws on our Heller line of credit and
$1.0 million on the Heller debtor-in-possession facility during the year ended
December 31, 2001. Costs associated with the closing of the HUD insured
financings and the establishment of the Heller line of credit were $300,000 and
$5.9 million, respectively. Of the $7.9 million in gross proceeds we received
from the HUD insured financing, $4.0 million was used to pay off our $4.0
million bridge loan payable, $300,000 was used for HUD insured loan closing
costs, $3.0 million was used to pay down the Heller line of credit and the
remaining proceeds were used to fund HUD escrow accounts. Principal payments on
long term debt and capital lease obligations were $4.7 million (including the
$3.0 million payment on the Heller line of credit) for the year ended December
31, 2001.

25

On October 1, 2001, we voluntarily filed for bankruptcy protection under
Chapter 11 of the Bankruptcy Code. The bankruptcy court gave final approval to
our Plan of reorganization on December 28, 2001, and the plan became effective
on the Effective Date, January 1, 2002.

Under the Plan, on the Effective Date, the Company issued general unsecured
creditors their pro rata shares, subject to the Reserve, of the following
securities:

- $40.25 million principal amount of Senior Secured notes;

- $15.25 million principal amount of Junior Secured Notes; and

- 6.24 million shares of new common stock (representing 96% of the new
common stock).

The New Notes are secured by 57 of the Company's properties.

The remaining 4% of the new common stock, subject to the Reserve, was
issued on the Effective Date to the Company's shareholders immediately prior to
the Effective Date.

Under the Plan, 1.1% of the senior notes, junior notes and new common stock
that would otherwise have been issued on the Effective Date were held back in
the Reserve to cover general unsecured claims that had not been either made or
settled by the December 19, 2001 cutoff date established under the Plan. The
reserved securities will be issued once all these outstanding general unsecured
claims have been settled. If the Reserve is insufficient to cover these
outstanding general unsecured claims, we will have no further liability with
respect to these claims. If the Reserve exceeds the amount of these outstanding
general unsecured claims, the excess securities will be distributed pro rata
among the holders of all general unsecured claims, including those settled prior
to the cutoff date.

On March 2, 2001, we entered into an agreement with Heller for a line of
credit facility up to $45.0 million (the "Existing Facility"). This line was
scheduled to mature on August 31, 2002 and would have been secured by up to 32
properties. This line carried an interest rate of 3.85% over the three-month
LIBOR rate floating monthly and required monthly interest-only payments until
maturity.

As of June 27, 2001, we amended the Existing Facility, reducing the
aggregate line of credit available from $45.0 million to $20.0 million. The
Existing Facility was scheduled to mature on September 28, 2001, which maturity
was extended to October 12, 2001 by Heller, and was secured by 26 properties.

On October 4, 2001, in connection with our bankruptcy petition, we entered
into a debtor-in-possession facility with Heller in an amount of up to $4.4
million (the "DIP Facility"). The DIP Facility carried an interest rate
calculated at 5.0% over three month LIBOR, floating monthly, and was payable
monthly in arrears. We had $1.0 million outstanding under this DIP Facility on
the Effective Date which was refinanced in the "Exit Facility" as defined below.

Concurrent with the closing of the DIP Facility, we entered into a further
amendment of the Existing Facility, which amendment, among other things,
extended the maturity of the Existing Facility to be coterminous with the DIP
Facility, amended the interest to be calculated at 5.0% over three month LIBOR,
floating monthly, payable monthly in arrears, increased the aggregate line of
credit available from $20.0 million to $39.6 million and permitted the financing
of the acquisition by Texas ALC Partners, L.P. ("Texas ALC") of sixteen
properties previously leased by Texas ALC from the current lessor thereunder, T
and F Properties, L.P. (the "Meditrust Properties" and the acquisition by Texas
ALC, the "Meditrust Acquisition"). The purchase of the Meditrust Properties was
completed on October 24, 2001. The DIP Collateral and the collateral for the
Existing Facility (including the Meditrust Properties when acquired)
cross-collateralized both the DIP Facility and the Existing Facility, as
amended. We had $39.5 million outstanding under the Existing Facility which was
refinanced under the "Exit Facility," as defined below.

The DIP Facility was refinanced through the Existing Facility, as amended
by the second amendment in connection with the exit from bankruptcy (the "Exit
Facility"). The principal amount of the Exit Facility will not exceed $44.0
million and will mature on January 1, 2005. Principal will be payable monthly in
a monthly amount of $50,000 for the first year, $65,000 for the second year and
$80,000 for the last year of the Exit Facility term. Interest will be calculated
at 4.5% over three month LIBOR, floating monthly (not to be less
26

than 8%), and payable monthly in arrears. The Exit Facility is secured by 31
properties. At December 31, 2001, we had $40.5 million outstanding under the
Exit Facility.

Our credit agreements with U.S. Bank contain restrictive covenants which
include compliance with certain ratios. The agreements also requires us to
deposit $500,000 in cash collateral with U.S. Bank in the event certain
regulatory actions are commenced with respect to the properties securing our
obligations to U.S. Bank. U.S. Bank is required to release such deposits upon
satisfactory resolution of the regulatory action. As of the date of this filing,
no such additional deposits have been required.

In August, 2001, we received a waiver of U.S. Bank's right to declare an
event of default for our failure to meet the September 30, 2001 and December 31,
2001 cash balance requirements and other financial ratios set forth in the
amended U.S. Bank loan agreement. There can be no assurance that we will be able
to meet these requirements as of the end of future quarters or that U.S. Bank
will grant waivers of any such future failure to meet these requirements.

The Company will not meet the existing financial requirements established
for the Predecessor Company on March 31, 2002, as set forth in the amended U.S.
Bank loan agreement. The Company is in the process of renegotiating these
covenants to consider the reorganization of the Company (Successor Company) with
U.S. Bank. Management believes, based on discussions with U.S. Bank that new
covenants will be established for the Successor entity to allow the Company to
maintain future compliance.

Failure to comply with any covenant constitutes an event of default, which
will allow U.S. Bank (at its discretion) to declare any amounts outstanding
under the loan documents to be due and payable. Certain of our leases and loan
agreements contain covenants and cross-default provisions such that a default on
one of those agreements could cause us to be in default on one or more other
agreements.

Approximately $27.2 million of our indebtedness was secured by letters of
credit held by U.S. Bank as of December 31, 2001 which in some cases have
termination dates prior to the maturity of the underlying debt. As such letters
of credit expire, beginning in 2003, we will need to obtain replacement letters
of credit, post cash collateral or refinance the underlying debt. There can be
no assurance that we will be able to procure replacement letters of credit from
the same or other lending institutions on terms that are acceptable to us. In
the event that we are unable to obtain a replacement letter of credit or provide
alternate collateral prior to the expiration of any of these letters of credit,
we would be in default on the underlying debt.

We have future minimum annual lease payments over the next five years of
$13.1 million, $13.1 million, $13.3 million, $12.8 million and $12.9 million,
respectively. At December 31, 2001, we have $164.1 million of long-term
indebtedness, of which annual principal payments due over the next five years
are $2.6 million, $2.7 million, $41.1 million, $2.1 million and $2.3 million,
respectively.

Our ability to make payments on and to refinance any of our indebtedness,
to satisfy our lease obligations and to fund planned capital expenditures will
depend on our ability to generate cash in the future. This, to a certain extent,
is subject to general economic, financial, competitive, legislative, regulatory
and other factors that are beyond our control. In addition, our ability to draw
additional amounts under our Heller facility may depend on us satisfying certain
conditions to draw additional amounts under the facility.

Based upon our current level of operations, we believe that our current
cash on hand, $2.4 million of available credit under our Heller facility and
cash flow from operations are sufficient to meet our liquidity needs for the
next several years.

There can be no assurance, however, that our business will generate
sufficient cash flow from operations, that currently anticipated cost savings
and operating improvements will be realized on schedule or that we will satisfy
the conditions to draw additional amounts under the Heller facility, all of
which may be necessary to enable us to pay our indebtedness, to satisfy our
lease obligations and to fund our other liquidity needs. As a result, we may
need to refinance all or a portion of our indebtedness, on or before maturity.
There can be no assurance that we will be able to refinance any of our
indebtedness, on commercially reasonable terms or at all.

27

SEASONALITY

We are subject to modest effects of seasonality. During the calendar fourth
quarter holiday periods assisted living residents sometimes move out to join
family celebrations and move-ins are often deferred. The first quarter of each
calendar year usually coincides with increased illness among assisted living
residents which can result in increased costs or increases in move-outs due to
death or move-outs to skilled nursing facilities. As a result of these factors,
assisted living operations sometimes produce greater earnings in the second and
third quarters of a calendar year and lesser earnings in the first and fourth
quarters. We do not believe that this seasonality will cause fluctuations in our
revenues or operating cash flows to such an extent that we will have difficulty
paying our expenses, including rent, which does not fluctuate seasonality.

INFLATION

We do not believe that inflation has materially adversely affected our
operations. We expect, however, that salary and wage increases for our skilled
staff will continue to be higher than average salary and wage increases, as is
common in the health care industry. We expect that we will be able to offset the
effects of inflation on salaries and other operating expenses by increases in
rental and service rates, subject to applicable restrictions, with respect to
services that are provided to residents eligible for Medicaid reimbursement.

RECENT ACCOUNTING PRONOUNCEMENTS

As of the Effective Date, and in accordance with the early adoption
provisions of SOP 90-7, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 141 Business Combinations ("SFAS No. 141"),
Statement of Financial Accounting Standards No. 142 Goodwill and Other
Intangible Assets ("SFAS No. 142"), Statement of Financial Accounting Standards
No. 143 Accounting for Asset Retirement Obligations ("SFAS No. 143") and
Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets ("SFAS No. 144"). The adoption of
these statements had no impact on the consolidated financial statements of the
Company.

The principal provisions of SFAS No. 141 require that all business
combinations be accounted for by the purchase method of accounting and
identifiable intangible assets are to be recognized apart from goodwill.

The principal provisions of SFAS No. 142 require that goodwill and other
intangible assets deemed to have an indefinite useful life are not amortized but
rather tested annually for impairment. Under SFAS No. 142, intangible assets
that have finite useful lives will continue to be amortized over their useful
lives. SFAS No. 142 requires companies to test intangible assets that will not
be amortized for impairment at least annually by comparing the fair value of
those assets to their recorded amounts.

The principal provisions of SFAS No. 143 address financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and for the associated asset retirement costs. SFAS No. 143 requires an
enterprise to record the fair value of an asset retirement obligation as a
liability in the period in which it incurs a legal obligation associated with
the retirement of tangible long-lived assets that result from the acquisition,
construction, development and or normal use of the assets. The enterprise also
is to record a corresponding increase to the carrying amount of the related
long-lived asset (i.e., the associated asset retirement costs) and to depreciate
that cost over the life of the asset. The liability is changed at the end of
each period to reflect the passage of time (i.e., accretion expense) and changes
in the estimated future cash flows underlying the initial fair value
measurement. Because of the extensive use of estimates, most enterprises will
record a gain or loss when they settle the obligation.

The principal provisions of SFAS No. 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. While SFAS No.
144 supersedes Statement of Accounting Standards No. 121 Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of("SFAS No. 121"), it retains many of the fundamental provisions of that
statement.

28

RISK FACTORS

Set forth below are the risks that we believe are material. This report on
Form 10-K, including the risks discussed below, contains forward-looking
statements made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements may be affected
by risks and uncertainties, including without limitation (i) our ability to
control costs and improve operating margins, (ii) the possibility that we will
experience a decrease in occupancy in our residences, which would adversely
affect residence revenues and operating margins, (iii) our ability to operate
our residences in compliance with evolving regulatory requirements, and (iv) the
degree to which our future operating results and financial condition may be
affected by a reduction in Medicaid reimbursement rates. In light of such risks
and uncertainties, our actual results could differ materially from such
forward-looking statements. Except as may be required by law, we do not
undertake any obligation to publicly release any revisions to any
forward-looking statements contained herein to reflect events and circumstances
occurring after the date hereof or to reflect the occurrence of unanticipated
events.

WE ARE HIGHLY LEVERAGED; OUR LOAN AND LEASE AGREEMENTS CONTAIN FINANCIAL
COVENANTS.

We are highly leveraged. After giving effect to the Plan and the
application of fresh start reporting, we had total indebtedness, including
short-term portion, of $164.1 million and shareholders' equity of $32.8 million
as of December 31, 2001. We obtained some relief through the implementation of
our Plan but will continue to be highly leveraged (see Note 1 of the
consolidated financial statements included elsewhere herein). The degree to
which we are leveraged could have important consequences, including:

- making it difficult to satisfy our debt or lease obligations;

- increasing our vulnerability to general adverse economic and industry
conditions;

- limiting our ability to obtain additional financing;

- requiring dedication of a substantial portion of our cash flow from
operations to the payment of principal and interest on our debt and
leases, thereby reducing the availability of such cash flow to fund
working capital, capital expenditures or other general corporate
purposes;

- limiting our flexibility in planning for, or reacting to, changes in our
business or industry; and

- placing us at a competitive disadvantage to less leveraged competitors.

Several of our debt instruments and leases contain financial covenants,
including debt-to-cash flow and net worth tests. In August, 2001, we received a
waiver of U.S. Bank's right to declare an event of default for our failure to
meet the September 30, 2001 and December 31, 2001 quarterly cash balance
requirements and other financial ratios set forth in the amended U.S. Bank loan
agreement. There can be no assurance that we will be able to meet these
requirements as of the end of future quarters or that U.S. Bank will grant
waivers of any such future failure to meet these requirements.

The Company will not meet the existing financial requirements established
for the Predecessor Company on March 31, 2002, as set forth in the amended U.S.
Bank loan agreement. The Company is in the process of renegotiating these
covenants to consider the reorganization of the Company (Successor Company) with
U.S. Bank. Management believes, based on discussions with U.S. Bank that new
covenants will be established for the Successor entity to allow the Company to
maintain future compliance.

Failure to comply with any covenant constitutes an event of default, which
will allow U.S. Bank (at its discretion) to declare any amounts outstanding
under the loan documents to be due and payable. We cannot provide assurance that
we will comply in the future with the modified financial covenants included in
the agreement, or with the financial covenants set forth in our other debt
agreements and leases. If we fail to comply with one or more of the U.S. Bank
covenants or any other debt or lease covenants (after giving effect

29

to any applicable cure period), the lender or lessor may declare us in default
of the underlying obligation and exercise any available remedies, which may
include:

- in the case of debt, declaring the entire amount of the debt immediately
due and payable;

- foreclosing on any residences or other collateral securing the
obligation; and

- in the case of a lease, terminating the lease and suing for damages

Many of our debt instruments and leases contain "cross-default" provisions
pursuant to which a default under one obligation can cause a default under one
or more other obligations. Accordingly, if enforced, we could experience a
material adverse effect on our financial condition.

IF AN ACTIVE TRADING MARKET DOES NOT DEVELOP FOR OUR SECURITIES, HOLDERS MAY NOT
BE ABLE TO RESELL THOSE SECURITIES.

On October 26, 2001, our common stock and our two series of convertible
subordinated debentures were delisted from the American Stock Exchange ("AMEX").
Our common stock currently trades on the over-the-counter bulletin board
("OTC.BB"). At this time there can be no assurances that our securities will
ever be listed on any exchange, or that there will be an active trading market
for our common stock.

INCREASES IN UTILITY COSTS COULD REDUCE OUR PROFITABILITY.

Utility costs represent a significant percentage of our operating costs.
The cost of utilities may continue to rise. While we have not historically
included utility surcharges in the rental rates we charge to our residents, we
may do so in the future. There can be no assurance that we will be able to do
so. Increases in the costs of utilities that we are unable to pass on to our
residents could significantly reduce our profits.

WE ARE INVOLVED IN A DISPUTE WITH OUR CORPORATE LIABILITY INSURANCE CARRIER.

In September 2000, we reached an agreement to settle the class action
litigation relating to the restatement of our consolidated financial statements
for the years ended December 31, 1996 and 1997 and the first three fiscal
quarters of 1998. This agreement received final court approval on November 30,
2000 and we were dismissed from the litigation with prejudice. On September 28,
2001, we made our final installment of $1.0 million on our promissory note for
the class action litigation settlement. Although we were dismissed from the
litigation with prejudice, a dispute which arose with our corporate liability
insurance carriers remains unresolved. At the time we settled the class action
litigation, the Company and the insurance carriers agreed to resolve this
dispute through binding arbitration, and we filed a complaint for a declaratory
judgment that we are not liable to the carriers as claimed. The carriers
counter-claimed to recover an amount capped at $4.0 million.

After filing for bankruptcy on October 1, 2001, we made a motion for
dismissal of our complaint for declaratory relief in the arbitration based upon
having filed for bankruptcy protection. An objection was filed to our motion,
and one of our insurance carriers filed a proof of claim in the amount of $4.0
million in the bankruptcy proceeding. We dispute that claim. We offered (and the
offer currently remains outstanding) to settle the dispute for $75,000 to be
paid out as an Allowed Class 4 Claim in the bankruptcy process. See Notes 1 and
13 to the consolidated financial statements included elsewhere herein.

WE ARE PARTY TO OTHER LEGAL PROCEEDINGS.

Participants in the senior living and long-term care industry, including
us, are routinely subject to lawsuits and claims. Many of the persons who bring
these lawsuits and claims seek significant monetary damages, and these lawsuits
and claims often result in significant defense costs. As a result, the defense
and ultimate outcome of lawsuits and claims against us may result in higher
operating expenses. Those higher operating expenses could have a material
adverse effect on our business, financial condition, results of operations, cash
flow or liquidity.

30

CERTAIN OF OUR LEASES MAY BE TERMINATED AS RESULT OF INCREASE IN CONCENTRATED
OWNERSHIP IN OUR COMMON STOCK AND UPON OCCURRENCE OF OTHER EVENTS.

Certain of our leases with LTC provide LTC with the option to exercise
certain remedies, including the termination of many of our leases with LTC, upon
a change of control under which at least 30% ownership of our common stock is
held by a party or combination of parties directly or indirectly. LTC has the
same option if the stockholders approve a plan of liquidation or the
stockholders approve of a merger or consolidation that meets certain conditions.

WE MAY BE LIABLE FOR LOSSES NOT COVERED BY OR IN EXCESS OF OUR INSURANCE.

In order to protect ourselves against the lawsuits and claims made against
us, we currently maintain insurance policies in amounts and covering risks that
are consistent with industry practice. However, as a result of poor loss
experience, a number of insurance carriers have stopped providing insurance
coverage to the long-term care industry, and those remaining have increased
premiums and deductibles substantially. While nursing homes have been primarily
affected, assisted living companies, including us, have experienced premium and
deductible increases. During our claim year ended December 31, 2000, our
professional liability insurance coverage included deductible levels of $100,000
per incident. For the claim years ending December 31, 2001 and 2002, this
deductible has been replaced with a retention level of $250,000 per incident,
except in Florida and Texas in which the retention level is $500,000 per
incident. Our professional liability insurance is on a claims-made basis. In
certain states, particularly Florida and Texas, many long-term care providers
are facing very difficult renewals. There can be no assurance that we will be
able to obtain liability insurance in the future on commercially reasonable
terms or at all. A claim against us, covered by, or in excess of, our insurance,
could have a material adverse affect on our operations, cash flows.

WE ARE SUBJECT TO SIGNIFICANT GOVERNMENT REGULATION.

The operation of assisted living facilities and the provision of health
care services are subject to state and federal laws, and state and local
licensure, certification and inspection laws that regulate, among other matters:

- the number of licensed residences and units per residence;

- the provision of services;

- equipment;

- staffing, including professional licensing and criminal background
checks;

- operating policies and procedures;

- fire prevention measures;

- environmental matters;

- resident characteristics;

- physical design and compliance with building and safety codes;

- confidentiality of medical information;

- safe working conditions;

- family leave; and

- disposal of medical waste.

The cost of compliance with these regulations is significant. In addition,
it could adversely affect our financial condition or results of operations if a
court or regulatory tribunal were to determine we have failed to comply with any
of these laws or regulations. Because these laws and regulations are amended
from time to time, we cannot predict when and to what extent liability may
arise. See "-- We must comply with laws and regulations regarding the
confidentiality of medical information," "-- We must comply with restrictions

31

imposed by laws benefiting disabled persons", "-- We may incur significant costs
and liability as a result of medical waste" and "-- We may incur significant
costs related to environmental remediation or compliance."

In the ordinary course of business, we receive and have received notices of
deficiencies for failure to comply with various regulatory requirements. We
review such notices and, in most cases, will agree with the regulator upon the
steps to be taken to bring the facility into compliance with regulatory
requirements. From time to time, we may dispute the matter and sometimes will
seek a hearing if we do not agree with the regulator. In some cases or upon
repeat violations, the regulator may take one or more adverse actions against a
facility, such as:

- the imposition of fines -- the Company paid $16,000 and $15,000,
respectively, in the aggregate for the years ended December 31, 2000 and
2001;

- temporary stop placement of admission of new residents, or imposition of
other conditions to admission of new residents to a facility -- these
applied to two residences in 2001;

- termination of a facility's Medicaid contract;

- conversion of a facility's license to provisional status; and

- suspension or revocation of a facility's license, which in 2001 included
one residence in Washington against which the state has commenced license
revocation procedures. This matter is still pending as of the date of
this filing.

The operation of our residences is subject to state and federal laws
prohibiting fraud by health care providers, including criminal provisions, which
prohibit filing false claims or making false statements to receive payment or
certification under Medicaid, or failing to refund overpayments or improper
payments. Violation of these criminal provisions is a felony punishable by
imprisonment and/or fines. We may be subject to fines and treble damage claims
if we violate the civil provisions which prohibit the knowing filing of a false
claim or the knowing use of false statements to obtain payment.

State and federal governments are devoting increasing attention and
resources to anti-fraud initiatives against health care providers. The Health
Insurance Portability and Accountability Act of 1996 ("HIPAA") and the Balanced
Budget Act of 1997 expanded the penalties for health care fraud, including
broader provisions for the exclusion of providers from the Medicaid program. We
have established policies and procedures that we believe are sufficient to
ensure that our facilities will operate in substantial compliance with these
anti-fraud and abuse requirements. While we believe that our business practices
are consistent with Medicaid criteria, those criteria are often vague and
subject to change and interpretation. Aggressive anti-fraud actions, however,
could have an adverse effect on our financial position, results of operations or
cash flows.

We are subject to regulation by the Securities and Exchange Commission
("SEC"). In April, 1999, we received a preliminary inquiry from the SEC
regarding the restatement of our financial statements for the years ended
December 31, 1996 and 1997 and the first three quarters of 1998 and related
matters. We provided the SEC with information and documents in response to the
inquiry, and have received no correspondence from the SEC regarding the inquiry
since March 2000. The SEC has never alleged any violation of law in connection
with the inquiry. There can be no assurance that the SEC will not resume its
inquiry.

WE MUST COMPLY WITH LAWS AND REGULATIONS REGARDING THE CONFIDENTIALITY OF
MEDICAL INFORMATION.

In 1996, the HIPAA law created comprehensive new requirements regarding the
confidentiality of medical information that is or has been electronically
transmitted or maintained. The Department of Health and Human Services has
enacted regulations implementing the law, and we may have to significantly
change the way we maintain and transmit healthcare information for our residents
to comply with these regulations.

Although HIPAA was intended ultimately to reduce administrative expenses
and burdens faced within the health care industry, we believe the law could
initially bring about significant and, in some cases, costly

32

changes. HHS has released two rules to date mandating the use of new standards
with respect to certain health care transactions and health information. The
first rule requires the use of uniform standards for common health care
transactions, including health care claims information, plan eligibility,
referral certification and authorization, claims status, plan enrollment and
disenrollment, payment and remittance advice, plan premium payments and
coordination of benefits.

Second, HHS has released new standards relating to the privacy of
individually identifiable health information. These standards not only require
our operators' compliance with rules governing the use and disclosure of
protected health information, but they also require entities to impose those
rules, by contract, on any business associate to whom such information is
disclosed. Rules governing the security of health information have been proposed
but have not yet been issued in final form.

HHS finalized the new transaction standards on August 17, 2000, and covered
entities will be required to comply with them by October 16, 2002. Congress
passed legislation in December 2001 that delays for one year (October 16, 2003)
the compliance date, but only for entities that submit a compliance plan to HHS
by the original implementation deadline. The privacy standards were issued on
December 28, 2000, and, after certain delays, became effective April 14, 2001,
with a compliance date of April 14, 2003. The Bush Administration and Congress
are taking a careful look at the existing regulations, but it is uncertain
whether there will be additional changes to the privacy standards or their
compliance date. With respect to the security regulation, once they are issued
in final form, affected parties will have approximately two years to be fully
compliant. Sanctions for failing to comply with HIPAA include criminal penalties
and civil sanctions.

WE MUST COMPLY WITH RESTRICTIONS IMPOSED BY LAWS BENEFITING DISABLED PERSONS.

Under the Americans with Disabilities Act of 1990, all places of public
accommodation are required to meet certain federal requirements related to
access and use by disabled persons. A number of additional federal, state and
local laws exist that also may require us to modify existing residences to allow
disabled persons to access the residences. We believe that their residences are
either substantially in compliance with present requirements or are exempt from
them. However, if required changes cost more than anticipated, or must be made
sooner than anticipated, we would incur additional costs. Further legislation
may impose additional burdens or restrictions related to access by disabled
persons, and the costs of compliance could be substantial.

WE MAY INCUR SIGNIFICANT COSTS AND LIABILITY AS A RESULT OF MEDICAL WASTE.

Our facilities generate potentially infectious waste due to the illness or
physical condition of the residents, including blood-soaked bandages, swabs and
other medical waste products and incontinence products of those residents
diagnosed with infectious diseases. The management of potentially infectious
medical waste, including handling, storage, transportation, treatment and
disposal, is subject to regulation under federal and state laws. These laws and
regulations set forth requirements for managing medical waste, as well as
permit, record keeping, notice and reporting obligations. Any finding that we
are not in compliance with these laws and regulations could adversely affect our
business operations and financial condition. Because these laws and regulations
are amended from time to time, we cannot predict when and to what extent
liability may arise. In addition, because these environmental laws vary from
state to state, expansion of our operations to states where they do not
currently operate may subject us to additional restrictions on the manner in
which they operate their facilities.

We may be liable under some laws and regulations as an owner, operator or
an entity that arranges for the disposal of hazardous or toxic substances at a
disposal site. In that event, we may be liable for the costs of any required
remediation or removal of the hazardous or toxic substances at the disposal
site. In connection with the ownership or operation of our properties, we could
be liable for these costs, as well as some other costs, including governmental
fines and injuries to persons or properties. As a result, any hazardous or toxic
substances which are present, with or without our knowledge, at any property
held or operated by us could have an adverse effect on our business, financial
condition or results of operations.

33

WE COULD INCUR SIGNIFICANT COSTS RELATED TO ENVIRONMENTAL REMEDIATION OR
COMPLIANCE.

We are subject to various federal, state and local environmental laws,
ordinances and regulations. Some of these laws, ordinances and regulations hold
a current or previous owner, lessee or operator of real property liable for the
cost of removal or remediation of some hazardous or toxic substances that could
be located on, in or under such property. These laws and regulations often
impose liability whether or not we knew of, or were responsible for, the
presence of the hazardous or toxic substances. The costs of any required
remediation or removal of these substances could be substantial. Furthermore,
there is no limit to our liability under such laws and regulations. As a result,
our liability could exceed their property's value and aggregate assets. The
presence of these substances or failure to remediate these substances properly
may also adversely affect our ability to sell or our property, or to borrow
using their property as collateral.

MANY ASSISTED LIVING MARKETS HAVE BEEN OVERBUILT.

Many assisted living markets have been overbuilt, including certain markets
in which we currently operate. In addition, the barriers to entry into the
assisted living industry are not substantial. The effects of overbuilding
include:

- it takes significantly longer for our residences and our subsidiaries'
residences to fill up,

- newly opened facilities may attract residents from some or all of the our
current facilities,

- there is pressure to lower or not increase rates paid by residents in the
our residences,

- there is increased competition for workers in already tight labor
markets, and

- our profit margins and the profit margins of our subsidiaries are lower
until vacant units in our residences are filled.

If we are unable to compete effectively in markets as a result of
overbuilding, we will suffer lower revenue and may suffer a loss of market
share.

Due to market conditions facing one location in Indiana, we closed the
facility, effective March 15, 2002.

WE MAY NOT BE ABLE TO ATTRACT AND RETAIN QUALIFIED EMPLOYEES AND CONTROL LABOR
COSTS.

We compete with other providers of long-term care with respect to
attracting and retaining qualified personnel. A shortage of qualified personnel
may require us to enhance our wage and benefits packages in order to compete.
Some of the states in which we operate impose licensing requirements on
individuals serving as administrators at assisted living residences, and others
may adopt similar requirements. We also depend upon the available labor pool of
lower-wage employees. We cannot guarantee that our labor costs will not
increase, or that, if they do increase, they can be matched by corresponding
increases in revenues.

OUR BUSINESS RELIES HEAVILY ON CERTAIN MARKETS AND AN ECONOMIC DOWNTURN OR
CHANGES IN THE LAWS AFFECTING OUR BUSINESS IN THOSE MARKETS COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR RESULTS.

Our business depends significantly on our properties located in Texas,
Indiana, Oregon, Ohio and Washington. As of December 31, 2001, 21.6% of our
properties were located in Texas, 11.4% in Indiana, 10.3% in Oregon, 9.7% in
Ohio and 8.6% in Washington. An economic downturn, or changes in the laws
affecting our business, in these markets could have a material adverse effect on
our operating results. In addition, there can be no assurance that the economy
in any of these markets will continue to grow.

WE DEPEND ON REIMBURSEMENT BY GOVERNMENTAL PAYORS AND OTHER THIRD PARTIES FOR A
SIGNIFICANT PORTION OF OUR REVENUES.

Although revenues at a majority of our residences come primarily from
private payors, we derive a substantial portion of our revenues from
reimbursements by third-party governmental payors, including state Medicaid
waiver programs. We expect that state Medicaid waiver programs will continue to
constitute a significant source of our revenues in the future, and it is
possible that the proportionate percentage of revenue
34

received by us from Medicaid waiver programs will increase. There are continuing
efforts by governmental payors and by non-governmental payors, such as
commercial insurance companies and health maintenance organizations, to contain
or reduce the costs of health care by lowering reimbursement rates, increasing
case management review of services and negotiating reduced contract pricing.
Also, there have been, and we expect that there will continue to be, additional
proposals to reduce the federal and some state budget deficits by limiting
Medicaid reimbursement in general. If any of these proposals are adopted at
either the federal or the state level, it could have a material adverse effect
on our business, financial condition, results of operations and prospects. The
state of Washington recently approved legislation which would limit future
increase in rental reimbursements. The approval is preliminary and we have not
yet quantified the financial impact of such legislation. Additionally, the state
of New Jersey currently has a hold on additional beds for Medicaid residences.
This hold may impact our ability to move new Medicaid tenants into our
facilities.

The following table sets forth the sources of our revenue for states where
we participate in Medicaid programs. The portion of revenues received from state
Medicaid agencies are labeled as "Medicaid State Paid Portion" while the portion
of our revenues that a Medicaid-eligible resident must pay out of his or her own
resources is labeled "Medicaid Tenant Paid Portion."

In addition, although we manage the mix of private paying tenants and
Medicaid paying tenants residing in our facilities, any significant increase in
our Medicaid population could have an adverse effect on our financial position,
results of operations or cash flows, particularly if the states operating these
programs continue to limit, or more aggressively seek limits on, reimbursement
rates.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE REGARDING MARKET RISK AND RISK
SENSITIVE INSTRUMENTS

Market risk represents the risk of changes in value of a financial
instrument, derivative or non-derivative, caused by fluctuations in interest
rates, foreign exchange rates and equity prices. Changes in these factors could
cause fluctuations in our earnings and cash flows.

For fixed rate debt, changes in interest rates generally affect the fair
market value of the debt instrument, but not our earnings or cash flows. We do
not have an obligation to prepay any of our fixed rate debt prior to maturity,
and therefore, interest rate risk and changes in the fair market value of our
fixed rate debt will not have an impact on our earnings or cash flows until we
decide, or are required, to refinance such debt.

For variable rate debt, changes in interest rates generally do not impact
the fair market value of the debt instrument, but do affect our future earnings
and cash flows. We had variable rate debt of $66.7 million outstanding at
December 31, 2001 with a weighted average interest rate of 6.1%, of which $40.2
million has an interest rate floor of 8.0%. Assuming that our balance of
variable rate debt, excluding $40.2 million which has an interest rate floor of
8.0%, remains constant at $26.5 million, each one-percent increase in interest
rates would result in an annual increase in interest expense, and a
corresponding decrease in cash flows, of $265,000. Conversely, each one-percent
decrease in interest rates would result in an annual decrease in interest
expense, and a corresponding increase in cash flows, of $265,000. For our $40.2
million of variable rate debt which has a interest rate floor of 8.0%, each
one-percent increase in interest rates in excess of 8.0% would result in an

35

annual increase in interest expense, and a corresponding decrease in cash flows,
of $402,000. Conversely, each one-percent decrease at interest rates of 9.0% or
greater would result in an annual decrease in interest expense, and a
corresponding increase in cash flows, of $405,000.

The table below presents principal cash flows and related weighted average
interest rates by expected maturity dates of our long-term debt (in thousands).

- ---------------
(1) The Junior Notes were issued at a discount. The face amount of these notes
is $15.25 million and they notes bear interest at 8.0% for the first three
years, payable in kind, and thereafter bear interest at 12.0% for the
remaining term of the loan, payable semi-annually.

We are also exposed to market risks from fluctuations in interest rates and
the effects of those fluctuations on market values of our cash equivalents and
short-term investments. These investments generally consist of overnight
investments that are not significantly exposed to interest rate risk, except to
the extent that changes in interest rates will ultimately affect the amount of
interest income earned and cash flow from these investments.

We do not have any derivative financial instruments in place to manage
interest costs, but that does not mean we will not use them as a means to manage
interest rate risk in the future.

We do not use foreign currency exchange forward contracts or commodity
contracts and do not have foreign currency exposure.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Financial statements and supplementary data required by this Item 8 are set
forth as indicated in Item 14.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

36

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

GENERAL

We have provided below certain information regarding our directors and
executive officers:

- ---------------
(1) Member of the Audit Committee.

(2) Member of the Compensation Committee.

(3) Member of the Quality Assurance and Compliance Committee.

Steven Vick became our President, Chief Executive Officer and a member of
our Board of Directors on February 18, 2002. Mr. Vick previously served as
President of Alterra Healthcare Corporation ("Alterra") from January 5, 2001 to
February 15, 2002 and as the Chief Operating Officer from October 1997 to
January 2001 and a director from October 1997 to February 15, 2002. He served as
the President and a director of Sterling House Corporation ("Sterling") since he
co-founded Sterling in 1991 until subsequent to Sterling's merger with the
Alterra in October 1997. Mr. Vick previously practiced as a certified public
accountant specializing in health care consulting.

W. Andrew Adams became a member of the Board of Directors in January 2002.
He has served as President and a director of the National Health Investors, Inc.
("NHI") since its inception in 1991 and currently serves as its President, Chief
Executive Officer and Chairman of the Board. Mr. Adams has also been President
and a director of National HealthCare Corporation ("NHC"), NHI's Investment
Advisor, since 1974. He also serves in these positions for National Health
Realty, Inc. since its spin-off in late 1997. Mr. Adams serves on the Board of
Directors of Lipscomb University in Nashville, Tennessee, SunTrust Bank in
Nashville, Tennessee, and Boy Scouts of America. He received his M.B.A. from
Middle Tennessee State University. NHI owns 8.6% of our common stock and $5.0
million of our New Notes.

Andre Dimitriadis became a member of the Board of Directors in January
2002. Mr. Dimitriadis founded LTC Properties, Inc. ("LTC") in 1992 and has been
its Chairman and Chief Executive Officer since its inception. In 2000, Mr.
Dimitriadis also assumed the position of President of LTC. Mr. Dimitriadis is
also the Chief Executive Officer and Chairman of the Board of CLC Healthcare,
Inc. (previously LTC Healthcare, Inc.) and serves on the board of Magellan
Health Services. CLC Healthcare, Inc. owns 22.4% of our common stock and $1.9
million of our New Notes and LTC owns $11.0 million of our New Notes. We
currently lease 37 properties (1,426 units) from LTC.

Mark Holliday became a member of the Board of Directors in January 2002.
Mr. Holliday is currently with Heartland Capital Corporation, a private hedge
fund focusing on financially distressed companies. Previously, Mr. Holliday held
the position of Financial Analyst with Continental Partners where he specialized
in restructuring advisory services. Mr. Holliday has over 10 years of
restructuring and bankruptcy related experience.

37

Richard C. Ladd served as Chairman of our Board of Directors from March
1999 to March 2000 and has been a director since September 1994. Since September
1994, Mr. Ladd has been the President of Ladd and Associates, a health and
social services consulting firm. He is also co-director of the National
Long-Term Care Balancing Project and was an adjunct assistant professor at the
School of Internal Medicine, University of Texas Medical Branch at Galveston,
Texas. From June 1992 to September 1994, Mr. Ladd served as the Texas
Commissioner of Health and Human Services where he oversaw the development and
implementation of a 22,000-bed Medicaid Waiver Program to be used for assisted
living and other community-based service programs. From November 1981 to June
1992, Mr. Ladd served as Administrator of the Oregon Senior and Disabled
Services Division. He is also a member of numerous professional and honorary
organizations.

Matthew Patrick became a member of the Board of Directors in January 2002.
Mr. Patrick is currently a consultant to long-term care companies on financial
strategy and organizational issues. Previously Mr. Patrick was Vice President
and Treasurer of Sun Healthcare Group, Inc., from 1998 through July, 2001. From
1993 to 1998, Mr. Patrick was Vice President of the Dallas Agency of The Sanwa
Bank, Ltd. From 1992 to 1993, Mr. Patrick served as financial consultant for
Merrill, Lynch, Pierce, Fenner and Smith, Inc.'s Private Client Group in Dallas
and from 1985 to 1990 he held various financial positions in the International
Division of National Westminster Bank, PLC.

Leonard Tannenbaum, CFA, was elected to the Board of Directors in January
2001. Mr. Tannenbaum is currently the Managing Partner at MYFM Capital LLC, an
investment banking firm. Mr. Tannenbaum currently serves on the board of
directors of the following public companies: Cortech, Inc.; New World
Coffee-Manhattan Bagel, Inc.; and General Devices, Inc. He also currently serves
on the board of Timesys, an embedded Linux company, and Transcentives.com, an
internet holding company. He formerly served on the board of Westower
Corporation. Previously, Mr. Tannenbaum was the president of the on-line auction
company CollectingNation.com, a partner in a $50 million hedge fund, an
assistant portfolio manager at Pilgrim Baxter, and an Assistant Vice President
in Merrill Lynch's small company group. Mr. Tannenbaum received both his M.B.A.
and Bachelors of Science from the Wharton School at the University of
Pennsylvania. Mr. Tannenbaum currently owns $323,875 of our New Notes.

Sandra Campbell joined us as Senior Vice President, General Counsel and
Secretary in January of 1998. Ms. Campbell has over 20 years of experience in
practicing law in real property, secured transactions and general business law.
Prior to joining us, she was a partner in the law firm of Bullivant Houser
Bailey where she was employed from April 1995 to January 1998. From January 1992
to April 1995, Ms. Campbell served as Chief Legal Counsel for First Fidelity
Thrift & Loan Association.

Nancy Gorshe joined us as Vice President of Community Relations in January
of 1998 and currently serves as Chief Operating Officer. Ms. Gorshe has over
twenty years of experience in the field of geriatric health, community and
long-term care and housing. Prior to joining us, she was President of Franciscan
ElderCare Corporation which is comprised of nursing homes, assisted living
facilities, and subacute units in nursing homes and hospitals from 1993 to 1997.
In addition, Ms. Gorshe has served as Executive Director of Providence
Elderplace, a long-term care HMO.

Drew Q. Miller joined us in March, 2000 as Senior Vice President, Chief
Financial Officer and Treasurer. Mr. Miller has over 16 years of senior finance
and accounting experience in health care services. From 1996 to 2000, Mr. Miller
served as Chief Executive Officer and President of Advantage Behavior Health,
Inc., a southern California-based comprehensive behavioral management company.
Prior to Advantage, he served as Chief Operating Officer and Chief Financial
Officer of Comprehensive Care Corporation, a publicly traded company engaged in
the development, delivery and management of behavioral services.

M. Catherine Maloney joined us as Controller in June 1998, and currently
serves as Vice President, Controller, and Chief Accounting Officer. Prior to
joining us, Ms. Maloney was an Audit Manager with KPMG LLP.

38

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Exchange Act requires our officers, directors and
greater than ten-percent stockholders to file with the Commission and the
American Stock Exchange initial reports of ownership and reports of changes in
ownership of our Common Stock and other equity securities. Such persons or
entities are required by Commission regulations to furnish us with copies of all
Section 16(a) forms they file.

To our knowledge, based solely on review of the copies of such reports
furnished to us and written representations that no other reports were required,
during the fiscal year ended December 31, 2001, each of our officers, directors
and 10% stockholders complied with all Section 16(a) filing requirements
applicable to them.

ITEM 11. EXECUTIVE COMPENSATION

We have set forth in the following table information concerning the
compensation paid during the fiscal year ended December 31, 2001 to our Chief
Executive Officer and each of our four other most highly compensated executive
officers (collectively, the "Named Executive Officers").

SUMMARY COMPENSATION TABLE

- ---------------
(1) Excludes certain perquisites and other personal benefit amounts, such as car
allowance, which, for any executive officer did not exceed, in the
aggregate, the lesser of $50,000 or 10% of the total annual salary and bonus
for such executive.

(2) Mr. Nicol and Mr. Miller began their employment with us in November 2000 and
March 2000, respectively. Mr. Nicol was appointed President and Chief
Executive Officer in November 2000.

(3) All options were cancelled, effective December 31, 2001, in accordance with
the Plan. See Note 1 to the consolidated financial statements contained
elsewhere herein.

STOCK OPTION GRANTS IN LAST FISCAL YEAR

There were no stock option grants to any of the Named Executive Officers
during the 2001 fiscal year.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES

There were no options exercised in the last fiscal year and all outstanding
options were cancelled effective December 31, 2001 in accordance with the Plan.

39

COMPENSATION OF DIRECTORS

Non-employee directors are compensated for services as a director and are
reimbursed for travel expenses incurred in connection with their duties as
directors. Under the terms of the 1994 Stock Option Plan, each new non-employee
director receives non-qualified options to purchase 20,000 shares of common
stock at the time he or she joins the Board of Directors. Such director options
vest with respect to one third of the amount of each grant on each of the first,
second and third anniversaries of the grant date, and expire on the earlier of
the seventh anniversary of the date of vesting or one year following the
director's ceasing to be a director for any reason. All options granted under
the 1994 Stock Option Plan were cancelled in accordance with the Plan. See Note
1 to the consolidated financial statements contained elsewhere herein.

During 2001, each non-employee director received a fee of $5,000 per
quarter for services as a director (except for the Vice Chair who received
$5,000 per month), plus, effective March 25, 2001, $2,500 for attendance
in-person, or $1,000 for attendance by telephone, at each meeting of the Board
of Directors or of any committee meeting held on a day on which the Board of
Directors did not meet. In addition, Chairs of Committees received $500 and $250
per month, respectively for attendance in-person and for attendance by telephone
at each meeting of the Board of Directors.

During 2002, non-employee directors will receive $12,000 per year, payable
quarterly, in arrears, $1,000 for attendance in-person and $500 for attendance
by telephone (unless it is purely an administrative meeting in which event there
is no compensation), at each meeting of the Board of Directors or of any
committee meeting held on a day on which the Board of Directors did not meet.

EMPLOYMENT AGREEMENTS

Set forth below are summaries of employment and consulting agreements with
certain individuals who were Named Executive Officers during 2001 and with
Steven Vick, who was appointed as President and Chief Executive Officer as of
February 18, 2002.

Steven Vick

Effective February 18, 2002, we entered into an employment agreement with
Steven Vick, providing for Mr. Vick's services as President and Chief Executive
Officer. The agreement provides for a three year term, unless terminated earlier
due to Mr. Vick's death, disability, mutual agreement or by us for "Cause" (as
defined). If employment is terminated by us during the first year of the term,
without "Cause," we must continue to pay Mr. Vick his then current salary,
bonuses and stock options pro rata, and other benefits (to the extent eligible),
as of the date of terminations, for six months following the date of
termination. Upon the termination of Mr. Vick's employment due to death or
disability, Mr. Vick's salary, bonuses and stock options pro rata, and other
benefits (to the extent eligible) continue for a period of six months following
such termination. The agreement provides for an annual salary of $275,000,
subject to annual review, scheduled bonus of $50,000 for each million dollars of
audited earnings for fiscal 2002, excluding depreciation, amortization, taxes,
any one-time gains from the sale of assets and any one-time charges. Mr. Vick's
bonus is to be paid in advance at $25,000 per quarter, commencing April 1, 2002.
If the bonus is insufficient to cover the advances, such advances shall be
applied to the following year's bonus to the extent they exceed the 2002 bonus.
Mr. Vick's bonus for fiscal years 2003 and 2004 shall be determined by the Board
of Directors and Compensation Committee of the Board, but the basis for
determining the bonus, as set forth above, may not be changed in such a way as
to reduce the amount of the bonus unless Mr. Vick received base salary and bonus
for the year in question of at least $600,000. The agreement also provides for
moving expenses for Mr. Vick to relocate to Portland, Oregon, in the amount of
up to $150,000. If, during the first year of the agreement, Mr. Vick voluntarily
resigns (excluding death or disability) or is terminated by us with cause, Mr.
Vick must reimburse us for all moving expenses paid directly to him, or on his
behalf, within 30 days. The agreement also provides that pursuant to a separate
stock option agreement, Mr. Vick will receive a non-qualified stock option to
purchase 65,000 shares of common stock. The option will vest over three years at
a rate of 59.30657 shares per calendar day. The exercise price for each share of
common stock will be $3.125.

40

Sandra Campbell

On December 31, 1997, we entered into an employment agreement with Sandra
Campbell providing for Ms. Campbell's services as Senior Vice President, General
Counsel and Secretary. We and Ms. Campbell agreed to amend and restate the
employment agreement in its entirety as of the Effective Date. The agreement, as
amended and restated, is automatically extended on a continuous basis. We may
terminate the amended and restated agreement at any time or Ms. Campbell may
terminate her employment without cause by providing us with not less than 45
days' advance written notice. If we terminate Ms. Campbell's employment other
than for "Death, Disability or Cause," or Ms. Campbell resigns as a result of
"Change in Control; Diminution in Duties," giving the Company 30 days' advance
written notice of such intent, she will be entitled to receive payment of her
base salary for a period of one year immediately following the date of
termination of her employment. The amended and restated agreement automatically
terminates upon Ms. Campbell's death and may terminate upon us giving Ms.
Campbell 60 days' advance written notice in event of "Disability." The amended
and restated agreement provides that Ms. Campbell's annual base salary of at
least $220,000. Ms. Campbell received $100,000 upon the effective date of the
amended and restated agreement. In addition, we and Ms. Campbell have entered
into an Officers and Directors Indemnification Agreement that provides Ms.
Campbell with the maximum amount of protection allowed under Nevada law against
liability and expenses incurred by her in any proceeding in which she is
involved due to her role as an officer to the extent that such protection is not
inconsistent with our Certificate of Incorporation or Bylaws.

Nancy Gorshe

On February 3, 1998, we entered into an employment agreement with Nancy
Gorshe providing for Ms. Gorshe's services as Vice President/Community
Relations. We and Ms. Gorshe agreed to amend and restate the employment
agreement in its entirety as of the Effective Date for Ms. Gorshe's services as
Senior Vice President of Community Relations and Chief Operating Officer. The
agreement, as amended and restated, is automatically extended on a continuous
basis. We may terminate the amended and restated agreement at any time or Ms.
Gorshe may terminate her employment without cause by providing us with not less
than 45 days' advance written notice. If we terminate Ms. Gorshe's employment
other than for "Death, Disability or Cause," or Ms. Gorshe resigns as a result
of "Change in Control; Diminution in Duties," giving the Company 30 days'
advance written notice of such intent, she will be entitled to receive payment
of her base salary for a period of one year immediately following the date of
termination of her employment. The amended and restated agreement automatically
terminates upon Ms. Gorshe's death and may terminate upon us giving Ms. Gorshe
60 days' advance written notice in event of "Disability." The amended and
restated agreement provides that Ms. Gorshe's annual base salary is at least
$200,000. Ms. Gorshe received $50,000 upon the effective date of the amended and
restated agreement. In addition, we and Ms. Gorshe have entered into an Officers
and Directors Indemnification Agreement that provides Ms. Gorshe with the
maximum amount of protection allowed under Nevada law against liability and
expenses incurred by her in any proceeding in which she is involved due to her
role as an officer to the extent that such protection is not inconsistent with
our Certificate of Incorporation or Bylaws.

Drew Q. Miller

On March 16, 2000, we entered into an employment agreement with Drew Q.
Miller providing for Mr. Miller's services as Senior Vice President, Chief
Financial Officer and Treasurer. We and Mr. Miller agreed to amend and restate
the employment agreement in its entirety as of the Effective Date for Mr.
Miller's services as Senior Vice President, Chief Financial Officer and
Treasurer. The agreement, as amended and restated, is automatically extended on
a continuous basis. We may terminate the amended and restated agreement at any
time or Mr. Miller may terminate his employment without cause by providing us
with not less than 45 days' advance written notice. If we terminate Mr. Miller's
employment other than for "Death, Disability or Cause," or Mr. Miller resigns as
a result of "Change in Control; Diminution in Duties," giving the Company 30
days' advance written notice of such intent, he will be entitled to receive
payment of his base salary for a period of one year immediately following the
date of termination of his employment. The amended and restated agreement
automatically terminates upon Mr. Miller's death and may terminate upon us
giving

41

Mr. Miller 60 days' advance written notice in event of "Disability." The amended
and restated agreement provides that Mr. Miller's annual base salary is at least
$215,000. In addition, we and Mr. Miller have entered into an Officers and
Directors Indemnification Agreement that provides Mr. Miller with the maximum
amount of protection allowed under Nevada law against liability and expenses
incurred by him in any proceeding in which he is involved due to his role as an
officer to the extent that such protection is not inconsistent with our
Certificate of Incorporation or Bylaws.

Ron W. Kerr

Effective January 1, 2001, we entered into an employment agreement with Mr.
Ron W. Kerr, providing for Mr. Kerr's services as Vice President of the Eastern
Region or in such other capacity as the Board of Directors may request, so long
as Mr. Kerr shall have the same or similar responsibilities. The agreement
provides for such services for the initial term of one year, with an automatic
rollover at the end of each year from and after the effective date for an
additional year unless terminated by us in writing within 90 days prior to the
anniversary date of the effective date of the agreement (in which event Mr. Kerr
will have one year of employment remaining until the termination of the
agreement. The agreement provides for a base salary of $130,000 per year and for
bonus eligibility under the Executive Incentive Compensation Plan. Mr. Kerr or
us may terminate the agreement without cause at any time giving 30 days' advance
written notice. In the event that we terminate Mr. Kerr's employment without
cause, Mr. Kerr will be entitled to receive $130,000. The agreement may also be
terminated without further payment due to death or disability or for cause.

Wm. James Nicol

Effective November 1, 2000, we entered into an employment agreement with
Wm. James Nicol, providing for Mr. Nicol's services as President and Chief
Executive Officer. We and Mr. Nicol agreed to amend and restate the employment
agreement in its entirety as of January 1, 2001. The amended and restated
agreement provided for such employment for a period beginning on November 1,
2001 and ending on the day after the date on which our Plan was consummated. The
amended and restated agreement provided for Mr. Nicol's annual salary of
$360,000. The amended and restated agreement provided for a "Restructuring
Approval Bonus" to be paid to Mr. Nicol in the amount of $125,000, and for a
"Restructuring Consummation Bonus" in the amount of $125,000, calculated based
upon EBITDA at September 30, 2001, to be paid upon the Effective Date of the
Plan. Mr. Nicol was paid the Restructuring Approval Bonus in 2001 and the
Restructuring Consummation Bonus in 2002. In addition, we entered into a first
amendment to the amended and restated employment agreement as of January 2, 2002
which provided that either party could terminate Mr. Nicol's employment by
providing at least 30 days prior notice. This amendment also provided that if
Mr. Nicol's employment was terminated, for any reason, he was to receive
$186,000. Mr. Nicol's agreement was terminated in 2002 and he was paid such
amount. In addition, we and Mr. Nicol entered into an Officers and Directors
Indemnification Agreement that provided Mr. Nicol with the maximum amount of
protection allowed under Nevada law against liability and expenses incurred by
him in any proceeding in which he was involved due to his role as an officer or
director to the extent that such protection is not inconsistent with our
Certificate of Incorporation or Bylaws.

Other Employment Agreements

We have entered into six other employment agreements with other Vice
Presidents of the Company. Each of these agreements provides comparable terms to
those of Mr. Kerr's agreement, as described above. The base salary of the
individuals covered under these agreements ranges from $110,000 to $130,000 per
year.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

At December 31, 2001, the Compensation Committee was comprised of John
Gibbons (Chair), Jill Krueger and Leonard Tannenbaum. Currently, the
Compensation Committee is comprised of Leonard Tannenbaum (Chair), W. Andrew
Adams and Andre Dimitriadis.

42

In December 2000, we entered into an agreement with MYFM Capital, LLC
("MYFM") under which the we could establish a line of credit with BET Associates
LP ("BET") as lender, providing for loans of up to $10.0 million. In early 2001,
we terminated the agreement and paid MYFM $50,000 in connection with such
termination. Bruce E. Toll, who is the beneficial owner of 832,960 of our common
shares, and was a member of our Board of Directors from January 2001 to January
1, 2002, is the sole member of BRU Holdings Company, Inc., LLC, which is the
sole general partner of BET. Leonard Tannenbaum is the Managing Partner of MYFM
Capital, LLC, the son-in-law of Mr. Toll, a 10% limited partner of BET, and
served on our Board of Directors during 2001.

W. Andrew Adams became a member of the Board of Directors in January 2002.
Mr. Adams currently serves as President, Chief Executive Officer and Chairman of
the Board of Directors of NHI. NHI owns 557,214 shares of our common stock and
$5.0 million of our New Notes.

Andre Dimitriadis, who has served on our Board of Directors since January
2002, is the President, Chief Executive Officer and Chairman of the Board of LTC
and is Chief Executive Office and Chairman of the Board of CLC Healthcare, Inc.
(previously LTC Healthcare, Inc.). LTC owns $11.0 million of our New Notes and
CLC Healthcare, Inc. owns 22.4% of our common stock and $1.9 million of our New
Notes. We currently lease 37 properties (1,426 units) from LTC. During 2001, we
paid LTC approximately $12.5 million for building rent. In accordance with our
Plan, effective January 1, 2002, we entered into a Master Lease Agreement with
LTC under which 16 leases were consolidated. This Master Lease Agreement
provides for aggregate rent reductions of $875,000 per year and restructures the
provision related to minimum rent increases for the 16 properties for the
initial remaining term. As a result of the change in future annual rent
increases as to the 16 properties under the Master Lease Agreement, we are
required to account for rent expense on a straight-line basis. In exchange for
the rent reduction, LTC filed a claim in the bankruptcy proceeding (to which we
did not object) in the amount of $2,500,000. The claim was approved by the Court
and entitled LTC to $590,694 of Senior Secured Notes, $223,803 of Junior Secured
Notes and 91,576 shares of common stock. Prior to the issuance of any common
stock to LTC, LTC entered into an agreement with Healthcare Holdings, Inc., a
wholly owned subsidiary of CLC Healthcare, Inc. to allow it to purchase LTC's
right to receive the common stock. The Master Lease Agreement also provides LTC
with the option to exercise certain remedies, including the termination of the
Master Lease Agreement and certain other LTC leases due to cross-default rights,
upon a change of control under which at least 30% ownership of our common stock
is held by a party or combination of parties directly or indirectly. LTC has the
same option if the stockholders approve a plan of liquidation or the
stockholders approve a merger or consolidation meeting certain conditions. At
the same time that we entered into the Master Lease Agreement, we also amended
16 other leases with LTC under which the renewal rights of certain of those
leases are tied together differently than previously with certain other leases.

We entered into a month-to-month contract for long distance services with
TMC Communications in 2001. John Gibbons, who served on our Board of Directors
during 2001, owns 50% of TMC. During 2001, we paid TMC Communications $32,700.

We have contracted with Learning.Net for training resources. John Gibbons,
who served on our Board of Directors during 2001, owns 12% of Learning.Net.
During 2001, we paid Learning.Net $25,700 for software licensing fees and
training courses.

On January 1, 2002 we entered into a Registration Rights Agreement with
LTC, CLC Healthcare, Inc. (formerly LTC Healthcare, Inc.), NHI and Cerberus
Capital Management, L.P., which requires us to register the resale of securities
acquired by these entities in connection with our Plan. Andre Dimitriadis is
President, Chief Executive Officer and Chairman of the Board of LTC and Chief
Executive Officer and Chairman of the Board of CLC Healthcare, Inc. and W.
Andrew Adams is President, Chief Executive Officer and Chairman of the Board of
NHI.

43

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

We have set forth in the following table information as of February 16,
2002 with respect to the beneficial ownership of our Common Stock (based upon
information provided by such persons) by:

(1) each of our directors;

(2) each person who is known by us to own beneficially more than 5% of
our common stock;

(3) Steven Vick, our current President and Chief Executive Officer,
and each of the Named Executive Officers for the fiscal year ended December
31, 2001; and

(4) our directors and executive officers as a group.

- ---------------
* Less than 1%.

(1) Except as otherwise noted above, the address of the directors and officers
is c/o Assisted Living Concepts, Inc., 11835 NE Glenn Widing Drive, Building
E, Portland, Oregon, 97220-9057.

(2) Mr. W. Andrew Adams is the President, Chief Executive Officer and Chairman
of the Board of NHI. NHI is the holder of 557,214 shares of our common
stock.

(3) As reported on Schedule 13D filed with the SEC on January 15, 2002. Mr.
Andre Dimitriadis is the President, Chief Executive Officer and Chairman of
the Board of LTC and Chief Executive Officer and Chairman of the Board of
CLC Healthcare, Inc. (previously LTC Healthcare, Inc.). CLC Healthcare, Inc.
is the holder of 1,452,793 shares and Mr. Dimitriadis is the holder of
20,628 shares of our common stock.

(4) As reported on Schedule 13D filed with the SEC on January 9, 2002. Mr.
Stephen Feinberg in his capacity as the managing member of Cerberus
Associates, LLC, the general partner of Cerberus Partners, LP, and as the
investment manager for each of Cerberus International, Ltd., Cerberus
Institutional, Ltd. and the Funds, possesses the power to vote the following
shares of common stock: 229,028 held by Cerberus Partners, LP; 582,451
shares held by Cerberus International, Ltd.; 219,882 shares held by Cerberus
Institutional, LTD; and 182,626 shares held in the aggregate by certain
private investments funds.

44

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In 2001, we entered into a consulting agreement with Richard C. Ladd, who
is currently a member of our Board of Directors. The agreement provides for Mr.
Ladd to provide consultation services to us on the advisability of establishing
a committee on quality improvement, its membership and charter. The initial
contract was for a period of 4 months, which was amended to a month-to-month
basis. Assisted Living Concepts, Inc. or Mr. Ladd may terminate the contract at
any time by the terminating party providing at least 30-days prior written
notice to the other party of their intention to terminate the contract. Mr. Ladd
is reimbursed at the rate of $150 per hour, not to exceed $2,500 for any one
month. We paid Mr. Ladd $8,090 for such services during the year ended December
31, 2001. Additionally, we have allowed Mr. Ladd and his spouse to participate
in our health insurance programs. We paid premiums on their behalf of $7,900
during the year ended December 31, 2001.

For information regarding certain other relationships and related
transactions, see Item 11 "Compensation Committee Interlocks and Insider
Participation."

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) 1 and 2. Consolidated Financial Statements and Financial Statement
Schedules

The financial statements and financial statement schedules listed in the
accompanying index to financial statements and financial statement schedules are
filed as part of this Annual Report.

3. Exhibits

Those Exhibits required to be filed by Item 601 of Regulation S-K are
listed on the accompanying index immediately following the signature page and
are filed as part of this Report.

(b) Reports on Form 8-K

On October 1, 2001 we filed a report on Form 8-K announcing the Company had
reached an agreement for financial reorganization with the holders of its two
series of convertible subordinated debentures that will be implemented through a
pre-negotiated plan of reorganization.

On October 9, 2001, we filed a report on Form 8-K announcing the Company
received notice from the American Stock Exchange ("AMEX") indicating that AMEX
intends to file an application with the Securities and Exchange Commission to
strike the Company's common stock and its two series of convertible subordinated
debentures from listing and registration on the AMEX.

On October 29, 2001, we filed a report on Form 8-K announcing the court
issuance of an Interim Order approving debtor-in-possession financing, the
acquisition of sixteen previously leased assisted living facilities and notice
from AMEX that the Company's common stock and two series of convertible
debentures would be delisted.

On November 6, 2001, we filed a report on Form 8-K announcing the court
approval of the Company's Disclosure Statement on October 30, 2001.

On December 19, 2001 we filed a report on Form 8-K announcing the
confirmation of our First Amended Joint Plan of Reorganization by the United
States Bankruptcy Court for the District of Delaware in Wilmington.

On January 4, 2002 we filed a report on Form 8-K announcing the emergence
from Chapter 11 Bankruptcy.

On January 31, 2002 we filed a report on Form 8-K announcing the election
of Steven Vick as President and CEO, effective February 18, 2002.

45

ASSISTED LIVING CONCEPTS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
(ITEM 14(a))

46

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholders
of Assisted Living Concepts, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheet of Assisted
Living Concepts, Inc. and subsidiaries as of December 31, 2001 (Successor
Company) and the accompanying consolidated balance sheet of Assisted Living
Concepts, Inc. and subsidiaries as of December 31, 2000 and the related
consolidated statements of operations, comprehensive loss, shareholders' equity,
and cash flows for each of the years in the three-year period ended December 31,
2001 (Predecessor Company). These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Assisted
Living Concepts Inc. and subsidiaries as of December 31, 2001 and the financial
position of the Predecessor Company as of December 31, 2000 and the results of
the Predecessor Company's operations and cash flows for each of the years in the
three-year period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.

As described in Note 1 to the consolidated financial statements, on January
1, 2002 the Company consummated a Joint Plan of Reorganization (the Plan) which
had been confirmed by the United States Bankruptcy Court. The Plan resulted in a
change of ownership of the Predecessor Company and, accordingly, effective
December 31, 2001 the Company accounted for the change in ownership through
fresh-start reporting. As a result, the consolidated information prior to
December 31, 2001 is presented on a different cost basis than that as of
December 31, 2001 and, therefore, is not comparable.

/s/ KPMG LLP

Portland, Oregon
March 25, 2002

47

ASSISTED LIVING CONCEPTS, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

ASSETS

The accompanying notes are an integral part of these consolidated financial
statements.
48

ASSISTED LIVING CONCEPTS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(IN THOUSANDS)

The accompanying notes are an integral part of these consolidated financial
statements.
49

ASSISTED LIVING CONCEPTS, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)

The accompanying notes are an integral part of these consolidated financial
statements.
50

ASSISTED LIVING CONCEPTS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

The accompanying notes are an integral part of these consolidated financial
statements.
51

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

THE COMPANY

Assisted Living Concepts, Inc. ("the Company") owns, leases and operates
assisted living residences which provide housing to older persons who need help
with the activities of daily living such as bathing and dressing. The Company
provides personal care and support services and makes available routine health
care services, as permitted by applicable law, designed to meet the needs of its
residents.

REORGANIZATION

On October 1, 2001, Assisted Living Concepts, Inc. (the "Company"), and its
wholly owned subsidiary, Carriage House Assisted Living, Inc. ("Carriage House",
and together with the Company, the "Debtors") each filed a voluntary petition
under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code")
in the United States Bankruptcy Court for the District of Delaware in Wilmington
(the "Court"), case nos. 01-10674 and 01-10670, respectively, which are being
jointly administered. The Court gave final approval to the first amended joint
plan of reorganization (the "Plan") on December 28, 2001.

On January 1, 2002 (the "Effective Date") the Debtors emerged from the
proceedings under Chapter 11 of the Bankruptcy Code. The Plan authorized the
issuance as of the Effective Date (subject to the Reserve described below) of
$40.25 million aggregate principal amount of seven-year secured notes (the "New
Senior Secured Notes"), bearing interest at 10% per annum, payable semi-annually
in arrears, and $15.25 million aggregate principal amount of ten-year secured
notes (the "New Junior Secured Notes" and collectively with the New Senior
Secured Notes, the "New Notes"), bearing interest payable in additional New
Junior Secured Notes for three years at 8% per annum and thereafter payable in
cash at 12% per annum, payable semi-annually in arrears, and (c) 6,500,000
shares of new common stock, par value $0.01 (the "New Common Stock") of the
reorganized Company, of which 4% was issued to shareholders of the Predecessor
Company.

At the Effective Date, the new Board of Directors of the reorganized
Company consists of seven members as follows: Leonard Tannenbaum, Andre
Dimitriadis, W. Andrew Adams (Chairman), Matthew Patrick, Mark Holliday, Richard
Ladd and Wm. James Nicol, then the President and Chief Executive Officer of the
Company. At the Effective Date, Steven L. Vick replaced Mr. Nicol as President,
Chief Executive Officer and Director.

The Company held back from the initial issuance of New Common Stock and New
Notes on the Effective Date, $440,178 of New Senior Secured Notes, $166,775 of
New Junior Secured Notes and 68,241 shares of New Common Stock (collectively,
the "Reserve") to be issued to holders of general unsecured claims at a later
date. The total amount of, and the identities of all of the holders of, the
general unsecured claims were not known as of the Effective Date, either because
they were disputed or they were not made by their holders prior to December 19,
2001, the cutoff date for calculating the Reserve (the "Cutoff Date"). Once the
total amount and the identities of the holders of those claims are determined,
the shares of New Common Stock and the New Notes held in the Reserve will be
distributed pro rata among the holders of those claims (the date of this
distribution, the "Subsequent Distribution Date").

If the Reserve is insufficient to cover the general unsecured claims
allowed after the Cutoff Date, the Company and its subsidiaries will have no
further liability with respect to those general unsecured claims and the holders
of those claims will receive proportionately lower distributions of shares of
New Common Stock and New Notes than the holders of general unsecured claims
allowed prior to the Cutoff Date. If the Reserve exceeds the distributions
necessary to cover the general unsecured claims allowed after the Cutoff Date,
the additional securities remaining in the Reserve will be distributed among all
holders of the general unsecured claims so as to ensure that each holder of a
general unsecured claim receives, in the aggregate, its pro rata share of the
New Common Stock and the New Notes. In this case, the holders of the general
unsecured

52

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

claims allowed prior to the Cutoff Date will receive distributions of securities
both on the Effective Date and on the Subsequent Distribution Date.

As a result of the consummation of the Plan, the Company recognized an
extraordinary gain on reorganization as follows (in thousands):

FRESH START REPORTING

Upon emergence from Chapter 11 proceedings, the Company adopted fresh-start
reporting in accordance with the American Institute of Certified Public
Accountants Statement of Position 90-7, Financial Reporting By Entities in
Reorganization Under the Bankruptcy Code (SOP 90-7). In connection with the
adoption of fresh-start reporting, a new entity has been deemed created for
financial reporting purposes. For financial reporting purposes, the Company
adopted the provisions of fresh-start reporting effective December 31, 2001.
Consequently, the consolidated balance sheet and related information at December
31, 2001 is labeled Successor Company, and reflects the Plan and the principles
of fresh-start reporting. Periods presented prior to December 31, 2001 have been
designated Predecessor Company.

In adopting the requirements of fresh-start reporting as of December 31,
2001, the Company was required to value its assets and liabilities at fair value
and eliminate its accumulated deficit as of December 31, 2001. A $32.8 million
reorganization value was determined by the Company with the assistance of
financial advisors in reliance upon various valuation methods, including
discounted projected cash flow analysis and other applicable ratios and economic
industry information relevant to the operation of the Company and through
negotiations with various creditor parties in interest.

The following reconciliation of the Predecessor Company's consolidated
balance sheet as of December 31, 2001 to that of the Successor Company was
prepared to present the adjustments that give effect to the reorganization and
fresh-start reporting.

The adjustments entitled Reorganization reflect the consummation of the
Plan, including the elimination of existing liabilities subject to compromise,
assets conveyed to a lender and reflect the reorganization value of the
Successor Company.

53

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The adjustments entitled Fresh-Start Adjustments reflect the adoption of
fresh start reporting, including the elimination of goodwill and adjustments to
record property, plant and equipment and other long-term assets and liabilities,
at their fair values. Management estimated the fair value of its assets and
liabilities by utilizing commonly used discounted cash flow valuation methods.

54

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of
the Predecessor Company as of December 31, 2000 and for the three years ended
December 31, 2001, and the Successor Company at December 31, 2001. All
significant intercompany balances and transactions have been eliminated in
consolidation.

FACTORS AFFECTING COMPARABILITY OF FINANCIAL INFORMATION

The amounts recorded in the consolidated balance sheet of the Predecessor
Company were materially changed with the implementation of fresh-start
reporting. Consequently, the consolidated balance sheet of the Successor Company
is generally not comparable to that of the Predecessor Company, principally due
to the adjustment of property, plant and equipment, deferred financing costs,
deferred gains, goodwill, long-term debt and leases to estimated fair value, the
discharge of liabilities subject to compromise and the recapitalization of the
Company. The Company recorded an extraordinary gain of $79.5 million from the
restructuring of its debt in accordance with the provisions of the Plan.
Fresh-start valuation adjustments of $119.3 million were made to reduce the net
assets and liabilities of the Successor Company to fair value as of December 31,
2001.

CASH EQUIVALENTS AND MARKETABLE SECURITIES

Cash equivalents of $4.6 million and $1.0 million at December 31, 2000 and
2001, respectively, consist of highly liquid investments with maturities of
three months or less at the date of purchase. The Company's investments in
marketable securities are classified as available for sale. These investments
are stated at fair value with any unrealized gains or losses included as
accumulated other comprehensive loss in shareholders' equity. Interest income is
recognized when earned.

LEASES

The Company determines the classification of its leases as either operating
or capital at their inception. The Company re-evaluates such classification
whenever circumstances or events occur that require the reevaluation of the
leases.

The Company accounts for arrangements entered into under sale and leaseback
agreements pursuant to Statement of Financial Accounting Standards (SFAS) No.
98, "Accounting for Leases." For transactions that qualify as sales and
operating leases, a sale is recognized and the asset is removed from the books.
For

55

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

transactions that qualify as sales and capital leases, the sale is recognized,
but the asset remains on the books and a capital lease obligation is recorded.
Transactions that do not qualify for sales treatment are treated as financing
transactions. In the case of financing transactions, the asset remains on the
books and a finance obligation is recorded as part of long-term debt. Losses on
sale and leaseback agreements are recognized at the time of the transaction
absent indication that the sales price is not representative of fair value.
Gains are deferred and recognized on a straight-line basis over the initial term
of the lease. In accordance with fresh-start reporting, such gains were
eliminated from the Predecessor Company's books as of the Effective date.

All of the Company's leases contain various provisions for annual increases
in rent, or rent escalators. Certain of these leases contain rent escalators
with future minimum annual rent increases that are not considered contingent
rents. The total amount of the rent payments under such leases with
non-contingent rent escalators is being charged to expense on the straight-line
method over the term of the leases. The Company records a deferred credit,
included in other liabilities, to reflect the excess of rent expense over cash
payments. This deferred credit is reduced in the later years of the lease term
as the cash payments exceed the rent expense. Other liabilities of the
Predecessor Company included $1.9 million and $1.8 million of such amounts at
December 31, 2000 and 2001, respectively. In accordance with fresh-start
reporting, the Predecessor Company's deferred credit was eliminated as of the
Effective Date. However, lease expense for those leases with non-contingent rent
escalators from the Effective Date forward will continue to be charged to
expense on the straight-line method over the remaining term of the leases. (See
Note 5).

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost and depreciation is computed
over the assets' estimated useful lives on the straight-line basis as follows:

Equipment under capital lease is recorded at the net present value of the
future minimum lease payments at the inception of the lease. Amortization of
equipment under capital lease is provided using the straight-line method over
the shorter of the life of the lease or the estimated useful life.

As of the Effective Date, the Successor Company adjusted its property,
plant and equipment to estimated fair value in conjunction with the
implementation of fresh-start reporting. The Successor Company maintains the
same policies concerning transactions affecting property and equipment.

Asset impairment is analyzed on assets to be held and used by the rental
demand by market to determine if future cash flows (undiscounted and without
interest charges) are less than the carrying amount of the asset. If an
impairment is determined to have occurred, an impairment loss is recognized to
the extent the assets carrying amount exceeds its fair value. Assets the Company
intends to dispose of are reported at the lower of (i) fair carrying amount or
(ii) fair value less the cost to sell. The Company has not recognized any
impairment losses on property through the year ended December 31, 2001.

Maintenance and repairs are charged to expense as incurred, and significant
betterments and improvements are capitalized.

GOODWILL

Goodwill of the Predecessor Company consisted of costs in excess of the
fair value of the net assets acquired in purchase transactions as of the date of
acquisition have been recorded as goodwill and was being

56

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

amortized over periods ranging between 15 and 20 years on a straight-line basis.
In accordance with fresh-start reporting, the Predecessor Company's goodwill was
eliminated as of the Effective Date.

ADVERTISING COSTS

Advertising costs are expensed as incurred and were $1,429,000, $840,000
and $828,000 for the years ended December 31, 1999, 2000 and 2001, respectively.

DEFERRED FINANCING COSTS

Financing costs related to the issuance of debt are capitalized as other
assets and amortized to interest expense over the term of the related debt using
the straight-line method, which approximates the effective interest method. As
of the Effective Date, approximately $3.8 million of net deferred financing fees
associated with the debts that were discharged as a result of the Plan were
eliminated as reorganization and fresh-start adjustments.

INCOME TAXES

The Company uses the asset and liability method of accounting for income
taxes under which deferred tax assets and liabilities are recognized for the
estimated future tax consequences attributable to the differences between the
financial statement carrying amounts of the existing assets and liabilities and
their respective tax bases (temporary differences). Deferred tax assets are
reduced by a valuation allowance when, in the opinion of management, it is more
likely than not that some portion or all of the deferred tax assets will not be
realized.

UNFAVORABLE LEASES

As of the Effective Date, the Successor Company revalued its leases in
conjunction with the implementation of fresh-start reporting. At December 31,
2001, an unfavorable lease credit of $3,796,000 was established and is included
in the consolidated balance sheet of the Successor Company. Amortization of
unfavorable leases is computed using the straight-line method over the life of
the respective leases.

REVENUE RECOGNITION

Revenue is recognized when services are rendered and consists of residents'
fees for basic housing and support services and fees associated with additional
services such as routine health care and personalized assistance on a fee for
service basis. The collectibility of the accounts receivable is assessed
periodically and a provision for doubtful accounts is recorded as considered
necessary.

CLASSIFICATION OF EXPENSES

Residence operating expenses exclude all expenses associated with corporate
or support functions which have been classified as corporate general and
administrative expense.

NET LOSS PER COMMON SHARE

Basic earnings per share (EPS) is calculated using net loss attributable to
common shares divided by the weighted average number of common shares
outstanding for the period. Diluted EPS is calculated in periods with net income
using income attributable to common shares considering the effects of dilutive
potential common shares divided by the weighted average number of common shares
and dilutive potential common shares outstanding for the period.

57

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Pursuant to fresh-start accounting, common stock was adjusted to reflect
the capitalization of the Successor Company in accordance with the Plan.

Vested options to purchase 983,000, 477,000 and 880,000 shares of common
stock were outstanding during the years ended December 31, 1999, 2000 and 2001,
respectively. These options were excluded from the respective computations of
diluted loss per share, as their inclusion would be antidilutive. All
outstanding options were cancelled upon the Effective Date of the Plan.

Also excluded from the computations of diluted loss per share, for the
years ended December 31, 1999, 2000 and 2001 were, 6,685,789 shares of common
stock issuable upon conversion of the Company's convertible subordinated
debentures (see Note 1) as their inclusion would be antidilutive. These
convertible subordinated debentures were eliminated upon the Effective Date of
the Plan.

SEGMENT REPORTING

Financial Accounting Standards Board Statement (FASB) of Financial
Accounting Standards (SFAS) No. 131, Disclosure about Segments of an Enterprise
and Related Information requires public enterprises to report certain
information about their operating segments in a complete set of financial
statements to shareholders. It also requires reporting of certain
enterprise-wide information about the Company's products and services, its
activities in different geographic areas, and its reliance on major customers.
The basis for determining the Company's operating segments is the manner in
which management operates the business. The Company has no foreign operations
and no customers which provide over 10 percent of gross revenue. The Company
reviews operating results at the residence level; it also meets the aggregation
criteria in order to report the results as one business segment.

USE OF ESTIMATES

The Company has made certain estimates and assumptions relating to the
reporting of assets and liabilities, and the disclosure of contingent assets and
liabilities, and the reported amounts of revenue and expenses during the
reporting period to prepare these financial statements in conformity with
accounting principles generally accepted in the United States of America. Actual
results could differ from those estimates.

WORKERS COMPENSATION

The Company utilizes third-party insurance for losses and liabilities
associated with workers compensation claims subject to deductible levels of
$250,000 per occurrence. Losses up to this deductible level are accrued based
upon the Company's estimates of the aggregate liability for claims incurred
based on Company experience.

PROFESSIONAL LIABILITY

The Company utilizes third-party insurance for losses and liabilities
associated with professional liability claims subject to deductible levels of
$100,000 per occurrence for the year ended December 31, 2000 and retention
levels of $250,000 for all states except Florida and Texas, where the retention
levels are $500,000 per occurrence, for the year ended December 31, 2001. Losses
up to these deductible and retention levels are accrued based upon the Company's
estimates of the aggregate liability for claims incurred based on Company
experience.

RECLASSIFICATIONS

Certain reclassifications have been made in the prior years' financial
statements to conform to the current year's presentation. Such reclassifications
had no effect on previously reported net loss or shareholders' equity.
58

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FAIR VALUE OF FINANCIAL INSTRUMENTS

At December 31, 2001 the carrying amount of the Successor Company's assets
and liabilities are presented at fair value because of the implementation of SOP
90-7. At December 31, 2000 the carrying amount of the Predecessor Company's cash
and cash equivalents, accounts receivable, accounts payable and accrued
liabilities approximates fair value because of the short-term nature of the
accounts and/or because they are invested in accounts earning market rates of
interest. At December 31, 2000 the carrying amount of the Predecessor Company's
long-term debt approximates fair value as the interest rates approximate the
current rates available to the Predecessor Company. The following table sets
forth the carrying amount and approximate fair value (based on quoted market
values) of the Predecessor Company's subordinated debentures as of December 31,
2000 (in thousands):

STOCK-BASED COMPENSATION

The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations including FASB
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation an interpretation of APB Opinion No. 25 issued in March 2000, to
account for its fixed plan stock options. Under this method, compensation
expense is recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. SFAS No. 123, Accounting for
Stock-Based Compensation, established accounting and disclosure requirements
using a fair value-based method of accounting for stock-based employees
compensation plans. As allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic value-based method of accounting described
above, and has adopted the disclosure requirements of SFAS No. 123.

The Company accounts for stock and stock options issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
(EITF) consensus on Issue No. 96-18, Accounting for Equity Instruments that are
Issued to Other than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services.

PREDECESSOR COMPANY

The Amended and Restated 1994 Employee Stock Option Plan (the "1994 Plan")
combined an incentive and nonqualified stock option plan, a stock appreciation
rights ("SAR") plan and a stock award plan (including restricted stock). The
1994 Plan was a long-term incentive compensation plan and is designed to provide
a competitive and balanced incentive and reward program for participants.

The Company's Non-Executive Employee Equity Participation Plan (the
"Non-Officer Plan") was a non-qualified stock option plan intended as a
long-term incentive compensation plan designed to provide a competitive and
balanced incentive and reward program for participants.

Upon implementation of the Plan, all options under the 1994 Plan and
Non-Officer Plan were cancelled.

CONCENTRATION OF CREDIT RISK

The Company depends on the economies of Texas, Indiana, Oregon, Ohio and
Washington and to some extent, on the continued funding of State Medicaid waiver
programs in some of those states. As of

59

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 2001, 21.6% of the Company's properties were in Texas, 11.4% in
Indiana, 10.3% in Oregon, 9.7% in Ohio and 8.6% in Washington. Adverse changes
in general economic factors affecting the respective health care industries or
laws and regulator environment in each of these states, including Medicaid
reimbursement rates, could have a material adverse effect on the Company's
financial condition and results of operations.

State Medicaid reimbursement programs constitute a significant source of
revenue for the Company. During the years ended December 31, 1999, 2000 and
2001, direct payments received from state Medicaid agencies accounted for
approximately 10.4%, 11.1%, and 12.5% respectively, of the Company's revenue
while the tenant paid portion received from Medicaid residents accounted for
approximately 5.9%, 6.2% and 6.8%, respectively, of the Company's revenue during
these periods. The Company expects in the future that State Medicaid
reimbursement programs will constitute a significant source of revenue for the
Company.

2. CASH

The Company's cash and cash equivalents consist of the following (in
thousands):

3. LONG-TERM RESTRICTED CASH

Long-term restricted cash consists of the following:

4. CASH HELD FOR TENANT SECURITY DEPOSITS AND CASH RESTRICTED FOR TENANT
SECURITY DEPOSITS

At December 31, 2000, cash held for tenant security deposits was a general
unrestricted asset of the Company. During 2001, the Company borrowed $2.5
million on its credit facility with Heller Healthcare Finance, Inc., and, in
accordance with the agreement, established a restricted cash account for funds
held for tenant security deposits with such proceeds. (See note 7).

60

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

5. LEASES

A summary of leases that the Company has entered into is as follows:

The Company has five Oregon leases (the "Oregon Leases") where the lessor
in each case obtained funding through the sale of bonds issued by the state of
Oregon, Housing and Community Services Department ("OHCS"). In connection with
the Oregon Leases, the Company entered into "Lease Approval Agreements" with
OHCS and the lessor, pursuant to which the Company is obligated to comply with
the terms and conditions of certain regulatory agreements to which the lessor is
a party (See Note 7). The leases, which have fixed terms of 10 years, have been
accounted for as operating leases. Aggregate deposits on these residences as of
December 31, 2000 and 2001 were $126,000 and $90,000, respectively, which are
reflected in other assets. The Company previously had six Oregon Leases and
terminated one of these leases effective December 1, 2001 in accordance with the
Plan. The lessor of this property filed a claim against the Company in the
bankruptcy proceedings regarding the early termination of this lease. The claim
was approved by the Court and resulted in the issuance of $90,502 of Senior
Notes, $34,290 of Junior Notes and 14,031 shares of common stock to this lessor.

In March 1999, the Company amended 16 leases, resulting in the
reclassification of such leases from financings to operating leases.

In June 1999, the Company amended all of its 37 leases with LTC. These
amendments included provisions to restructure future minimum annual rent
increases, or "rent escalators," that were not deemed to be contingent rents.
Because of the rent escalators, prior to the amendments, the Company accounted
for rent expense related to such leases on a straight-line basis. From the date
of the amendment forward, the Company has accounted for the amended leases on a
contractual cash payment basis and amortizes the deferred rent balance, at the
date of the amendment, over the remaining initial term of the lease. Those
amendments also redefined the lease renewal option with respect to certain
leases and provided the lessor with the option to declare an event of default in
the event of a change of control of under certain circumstances. In addition,
the amendments also provide the Company with the ability, subject to certain
conditions, to sublease or assign its leases with respect to two Washington
residences. (See Note 9).

61

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

In accordance with the Company's Plan, effective January 1, 2002, the
Company entered into a Master Lease Agreement with LTC under which 16 leases
were consolidated. This Master Lease Agreement provides for aggregate rent
reductions of $875,000 per year and restructures the provision related to
minimum rent increases for the 16 properties for the initial remaining term. As
a result of the change in future annual rent increases as to the 16 properties
under the Master Lease Agreement, the Company is required to account for rent
expense on a straight-line basis. In exchange for the rent reduction, LTC filed
a claim in the bankruptcy proceeding (to which the Company did not object) in
the amount of $2,500,000. The claim was approved by the Court and entitled LTC
to $590,694 of Senior Secured Notes, $223,803 of Junior Secured Notes and 91,576
shares of common stock. Prior to the issuance of any common stock to LTC, LTC
entered into an agreement with Healthcare Holdings, Inc., a wholly owned
subsidiary of CLC Healthcare, Inc. to allow it to purchase LTC's right to
receive the common stock. The Master Lease Agreement also provides LTC with the
option to exercise certain remedies, including the termination of the Master
Lease Agreement and certain other LTC leases due to cross-default rights, upon a
change of control under which at least 30% ownership of the Company's common
stock is held by a party or combination of parties directly or indirectly. LTC
has the same option if the stockholders approve a plan of liquidation or the
stockholders approve a merger or consolidation meeting certain conditions. At
the same time that the Company entered into the Master Lease Agreement, they
also amended 16 other leases with LTC under which the renewal rights of certain
of those leases are tied together differently than previously with certain other
leases.

Certain of the Company's leases and loan agreements contain covenants and
cross-default provisions such that a default on one of those instruments could
cause the Company to be in default on one or more other instruments. Pursuant to
certain lease agreements, the Company restricted $1.0 million of cash balances
as additional collateral (see Note 3). The Company did not meet certain
financial covenants at December 31, 2001 but has subsequently received a waiver
of the right to declare an event of default (see Note 7).

In October 2001, the Company repurchased 16 previously leased properties
from one lessor. These properties were purchased with funds borrowed from Heller
Healthcare Finance, Inc. ("Heller") (see Notes 1 and 7).

On January 1, 2002 the Company emerged from the proceedings under Chapter
11 of the Bankruptcy Code. The Company's Plan of reorganization included the
Company conveying two facilities to one lender in satisfaction of $5.9 million
of debt. The Company then leased these two properties, one in South Carolina and
one in Pennsylvania, from this lender under a new Master Lease, incorporating
two existing leases as well. Terms under the Master Lease on the South Carolina
facility conveyed to the lender effective January 1, 2002, include monthly
payments in the amount of $19,000, $20,000, $21,000 and $21,667 for the years
ended December 31, 2002, 2003, 2004 and all years thereafter until the end of
the lease term, respectively. Terms under the Master Lease for the Pennsylvania
facility conveyed effective January 1, 2002, include monthly payments of $22,330
increasing to $23,780 over the next four years, expiring in 2006. The Company's
Plan of reorganization also included the amendment of two existing leases with
the same lender. Such leases were amended under the Master Lease to provide base
rental rates of $2,000 per month with rent escalation clauses based upon revenue
levels with rental rates not to exceed $22,000 per month, expiring in 2006.

62

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of December 31, 2001, future minimum annual lease payments under
operating leases are as follows (in thousands):

2002...................................................... $ 13,070
2003...................................................... 13,053
2004...................................................... 13,290
2005...................................................... 12,842
2006...................................................... 12,894
Thereafter................................................ 48,813
--------
$113,962
========

6. PROPERTY AND EQUIPMENT

As of December 31, 2000 and 2001, property and equipment, stated at cost
for the Predecessor Company and fair value for the Successor Company, consist of
the following (in thousands):

As of the Effective Date, the Successor Company adjusted its property,
plant and equipment to estimated fair value in conjunction with the
implementation of fresh-start reporting. The Successor Company maintains the
same policies concerning transactions affecting property and equipment.

Land, buildings and certain furniture and equipment relating to 41
residences serve as collateral for long-term debt, 57 residences serve as
collateral for the Senior and Junior Secured Notes (See Note 7) and 31
residences serve as collateral for Heller financings. (See Note 7).

Depreciation and amortization expense was $8.7 million, $9.6 million and
$10.1 million, for the years ended December 31, 1999, 2000 and 2001,
respectively.

63

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

7. LONG-TERM DEBT

As of December 31, 2000 and 2001, long-term debt consists of the following
(in thousands):

The Trust Deed Notes payable to OHCS are secured by buildings, land,
furniture and fixtures of six Oregon residences. The notes are payable in
monthly installments including interest at effective rates ranging from 7.375%
to 9.0%.

The Variable Rate Multifamily Revenue Bonds are payable to the Washington
State Housing Finance Commission Department and at December 31, 2001 were
secured by an $8.7 million letter of credit and by buildings, land, furniture
and fixtures of the five Washington residences. The letter of credit expires in
2003. The bonds had a weighted average interest rate of 3.16% during 2001.

The Variable Rate Demand Housing Revenue Bonds, Series 1997 are payable to
the State of Idaho Housing and Finance Association and at December 31, 2001 were
secured by a $7.5 million letter of credit and by buildings, land, furniture and
fixtures of four Idaho residences. The letter of credit expires in 2004. The
bonds had a weighted average interest rate of 3.15% during 2001.

The Variable Rate Demand Housing Revenue Bonds with the State of Ohio
Housing Finance Agency ("OHFA") are due July 2018 and are secured by a $13.5
million letter of credit and by buildings, land, furniture and fixtures of seven
Ohio residences. The letter of credit expires in 2005. The bonds had a weighted
average interest rate of 3.02% during 2001.

At December 31, 2001, mortgage loans includes three fixed rate loans
secured by seven Texas residences, three Oregon residences and three New Jersey
residences. These loans collectively require monthly principal

64

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

and interest payments of $230,000, with balloon payments of $11.8 million, $5.3
million and $7.2 million due at maturity in May 2008, August 2008 and September
2008, respectively. These loans bear fixed annual interest rates between 7.58%
to 8.79%.

At December 31, 2000, mortgage loans also included a $5.9 million mortgage
loan at a fixed annual interest rate of 8.79%, secured by one Pennsylvania
residence and one South Carolina residence. In accordance with the Company's
Plan of reorganization, the Company conveyed two facilities to this lender in
satisfaction of the $5.9 million of debt. The Company continues to operate these
residences under operating leases with the same lender. (See Notes 1 and 5).

Housing and Urban Development ("HUD") Insured mortgages include three
separate loan agreements entered into in 2001. These are fixed rate mortgages,
each of which is secured by one facility in Texas. These loans mature between
July 1, 2036 and August 1, 2036 and collectively require monthly principal and
interest payments of $50,000. The loans bear fixed annual interest rates between
7.40% and 7.55%.

Heller Healthcare Finance, Inc. ("Heller") credit facility is a secured
line of credit up to $44.0 million. This is a variable rate credit facility,
secured by 31 facilities. This credit facility matures in January 2005 and
required monthly principal payments of $50,000 for 2002, $65,000 for 2003 and
$80,000 for 2004. The interest on the credit facility is calculated at 4.5% over
three month LIBOR, floating monthly (not to be less than 8%), and is payable
monthly in arrears. The Company made an additional draw of $1.1 million on its
Heller credit facility in January 2002.

On January 1, 2002 the Debtors emerged from the proceedings under Chapter
11 of the Bankruptcy Code. The Company's Plan of reorganization included the
issuance of $40.25 million aggregate principal amount of seven-year secured
notes (the "New Senior Secured Notes"), bearing interest at 10% per annum,
payable semi-annually in arrears, and $15.25 million aggregate principal amount
of ten-year secured notes (the "New Junior Secured Notes" and collectively with
the New Senior Secured Notes, the "New Notes"), bearing interest payable in
additional New Junior Secured Notes for three years at 8% per annum and
thereafter payable in cash at 12% per annum, payable semi-annually in arrears.
The New Junior Secured Notes were issued at a discount of $2.6 million. The
discount will be amortized over the life of the New Junior Secured Notes using
the effective interest method. The New Notes are secured by 57 properties. (See
Note 1).

Of the $55.5 million outstanding in New Notes, $18.2 million is payable to
related parties. (See Note 9).

As of the Effective Date, the Successor Company revalued its long-term debt
in conjunction with the implementation of fresh-start reporting. At December 31,
2001, an adjustment of $3.1 million was recorded to reduce long-term debt to its
fair market value. Amortization of this adjustment is computed using the
straight-line method over the individual loan life.

As of December 31, 2001, the following annual principal payments are
required (in thousands):

2002...................................................... $ 2,622
2003...................................................... 2,662
2004...................................................... 41,059
2005...................................................... 2,119
2006...................................................... 2,258
Thereafter................................................ 114,818
--------
Total........................................... $165,538
Fresh Start adjustment.................................... (1,455)
--------
$164,083
========

65

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The Company's credit agreements with U.S. Bank contain restrictive
covenants which include compliance with certain financial ratios. Pursuant to
amendments to these credit agreements, the Company has provided additional cash
collateral in exchange for the waivers of certain possible defaults related to
the delivery of financial statements and compliance with financial covenants,
including an amendment to certain financial covenants. The amendments also
provides for the release of the additional collateral upon the achievement of
specified performance targets, provided that the Company is in compliance with
the other terms of the loan agreements. The Predecessor Company has achieved
certain of these specified targets during previous years and currently has $4.3
million in additional cash collateral deposits outstanding with U.S. Bank.

In August, 2001, the Company received a waiver of U.S. Bank's right to
declare an event of default for the Company's failure to meet the June 30, 2001,
September 30, 2001 and probable failure to meet the December 31, 2001 cash
balance requirements and other financial ratios set forth in the amended U.S.
Bank loan agreement. There can be no assurance that the Company will be able to
meet these requirements as of the end of future quarters or that U.S. Bank will
grant waivers of any such future failure to meet these requirements.

The Company will not meet the existing financial requirements established
for the Predecessor Company on March 31, 2002, as set forth in the amended U.S.
Bank loan agreement. The Company is in the process of renegotiating these
covenants to consider the reorganization of the Company (Successor Company) with
U.S. Bank. Management believes, based on discussions with U.S. Bank that new
covenants will be established for the Successor entity to allow the Company to
maintain future compliance.

In addition to the debt agreements with OHCS related to the six owned
residences in Oregon, the Company has entered into Lease Approval Agreements
with OHCS and the lessor of the Oregon Leases, which obligates the Company to
comply with the terms and conditions of the underlying trust deed relating to
the leased buildings. Under the terms of the OHCS debt agreements, the Company
is required to maintain a capital replacement escrow account to cover expected
capital expenditure requirements for the Oregon Leases and the six OHCS loans,
which as of December 31, 2000 and 2001 was $422,000 and $363,000, respectively,
and is reflected in other assets in the accompanying financial statements. In
addition, for the six OHCS loans in the Company's name, a contingency escrow
account is required. This account had a balance of $172,000 and $136,000,
respectively, as of December 31, 2000 and 2001, and is reflected in other
current assets. Distribution of any assets or income of any kind by the Company
is limited to once per year after all reserve and loan payments have been made,
and only after receipt of written authorization from OHCS.

As of December 31, 2000 and 2001, the Company was restricted from
distributing $278,000 and $322,000 respectively, of income, in accordance with
the terms of the loan agreements and Lease Approval Agreements with OHCS.

As a further condition of the debt agreements, the Company is required to
comply with the terms of certain regulatory agreements which provide, among
other things, that in order to preserve the federal income tax exempt status of
the bonds, the Company is required to lease at least 20% of the units of the
projects to low or moderate income persons as defined in Section 142(d) of the
Internal Revenue Code. There are additional requirements as to the age and
physical condition of the residents with which the Company must also comply.
Non-compliance with these restrictions may result in an event of default and
cause acceleration of the scheduled repayment.

8. INCOME TAXES

The Company incurred a loss for both financial reporting and tax return
purposes for the years ended December 31, 1999, 2000, and 2001 and, as such,
there was no current or deferred tax provision allocated to the loss before
extraordinary gain on reorganization or to the extraordinary gain on
reorganization.

66

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The provision for income taxes differs from the amount of loss determined
by applying the applicable U.S. statutory federal rate to loss before
extraordinary gain on reorganization as a result of the following items at
December 31:

An analysis of the significant components of deferred tax assets and
liabilities, consists of the following as of December 31 (in thousands):

The valuation allowance for deferred tax assets as of December 31, 2000 and
2001 was $25.5 million and $45.4 million, respectively. The increase in the
total valuation allowance for the years ended December 31, 1999, 2000 and 2001
was $10.5 million, $6.1 million, and $19.9 million, respectively.

As a result of acquisitions, the Company acquired net operating loss
carryforwards for federal and state tax purposes approximating $311,000 which
are available to offset future taxable income, if any, through 2011. The future
use of these net operating loss carryforwards is subject to certain limitations
under the Internal Revenue Code and therefore, the Company has established a
valuation allowance of $117,500 to offset the deferred tax asset related to the
loss carryforwards. Additionally, any tax benefit realized from the use of
approximately $100,000 of the acquired operating loss carryforwards will be
applied to reduce goodwill. Following the consummation of the Plan, the Company
has approximately $93.5 million of Net Operating Loss (NOL) carryforwards which
will expire between 2009 and 2022. These NOLs have been reduced to

67

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

$10.7 million as a result of the discharge and cancellation of various
prepetition liabilities under the Plan. The reduction of the NOLs will be
effective on January 1, 2003.

The NOLs remaining after the application of the cancellation of
indebtedness provisions are subject to certain provisions of the Internal
Revenue Code which restricts the utilization of the losses. In addition, any net
unrealized built-in losses resulting from the excess of tax basis over the
carrying value of the Company's assets (primarily property and equipment) as of
the Effective Date, which are recognized within five years are also subject to
these provisions. Section 382 of the Internal Revenue Code imposes limitations
on the utilization of the loss carryforwards and built-in losses after certain
changes of ownership of a loss company. The Company is deemed to be a loss
company for these purposes. Under these provisions, the Company's ability to
utilize these loss carryforwards and built-in losses in the future will
generally be subject to an annual limitation of approximately $1.6 million.

There can be no assurances that the Company will be able to utilize these
NOLs or built-in losses and therefore management has established a 100 percent
valuation allowance to offset the associated net deferred tax asset.

Pursuant to SOP 90-7, the income tax benefit, if any, of any future
realization of the remaining NOL carryforwards and other deductible temporary
differences existing as of the Effective Date will be applied as a reduction to
additional paid-in capital.

9. RELATED PARTY TRANSACTIONS

Assisted Living Facilities, Inc.

The Company leases six residences from Assisted Living Facilities, Inc. The
spouse of the Company's former president and chief executive officer owns a 25%
interest in Assisted Living Facilities, Inc. For the years ended December 31,
1999 and 2000, the Company incurred lease rental expense of $1.3 million.
Assisted Living Facilities, Inc., is no longer considered a related party since
the resignation of the former president and chief executive officer on October
19, 2000.

National Health Investors, Inc.

W. Andrew Adams, who has been a member of the Company's Board of Directors
and its Chair since January 2002, is the President, Chief Executive Officer and
Chairman of the Board of Directors of National Health Investors, Inc. ("NHI").
NHI currently owns 557,214 shares of the Company's common stock and $5.0 million
of the Company's New Notes.

LTC Properties, Inc. and CLC Healthcare, Inc.

Andre Dimitriadis, who has been a member of the Company's Board of
Directors and the Chair of its Audit Committee since January 2002, is the
President, Chief Executive Officer and Chairman of the Board of LTC Properties,
Inc. ("LTC") and is the Chief Executive Officer and Chairman of the Board of CLC
Healthcare, Inc. (previously LTC Healthcare, Inc.). LTC owns $11.0 million of
the Company's New Notes and CLC Healthcare, Inc. owns 22.4% of the Company's
common stock and $1.9 million of the Company's New Notes (see Note 7). The
Company currently leases 37 properties (1,426 units) from LTC. (See Note 5).

The Company incurred annual lease expense of $8.9 million, $8.8 million and
$9.0 million for the years ended December 31, 1999, 2000 and 2001, respectively,
pursuant to these leases.

In June 1999, the Company amended all of its 37 LTC leases. These
amendments restructured provisions related to future minimum annual rent
increases, or "rent escalators," which prior to the amendments required the
Company to account for rent expense related to such leases on a straight-line
basis. From the date of the

68

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

amendment forward, the Company is accounting for the amended leases on a
contractual cash payment basis and amortizing the deferred rent balance as of
the date of the amendment over the remaining initial term of the leases. Those
amendments also redefined the lease renewal option with respect to certain
leases and provided the lessor with the option to declare an event of default in
the event of a change of control under certain circumstances. In addition, the
amendments provide the Company with the ability, subject to certain conditions,
to sublease or assign its leases with respect to two Washington residences.

In accordance with our Plan, effective January 1, 2002, we entered into a
Master Lease Agreement with LTC under which 16 leases were consolidated. This
Master Lease Agreement provides for aggregate rent reductions of $875,000 per
year and restructures the provision related to minimum rent increases for the 16
properties for the initial remaining term. As a result of the change in future
annual rent increases as to the 16 properties under the Master Lease Agreement,
we are required to account for rent expense on a straight-line basis. In
exchange for the rent reduction, LTC filed a claim in the bankruptcy proceeding
(to which we did not object) in the amount of $2,500,000. The claim was approved
by the Court and entitled LTC to $590,694 of Senior Secured Notes, $223,803 of
Junior Secured Notes and 91,576 shares of common stock. Prior to the issuance of
any common stock to LTC, LTC entered into an agreement with Healthcare Holdings,
Inc., a wholly owned subsidiary of CLC Healthcare, Inc. to allow it to purchase
LTC's right to receive the common stock. The Master Lease Agreement also
provides LTC with the option to exercise certain remedies, including the
termination of the Master Lease Agreement and certain other LTC leases due to
cross-default rights, upon a change of control under which at least 30%
ownership of our common stock is held by a party or combination of parties
directly or indirectly. LTC has the same option if the stockholders approve a
plan of liquidation or the stockholders approve a merger or consolidation
meeting certain conditions. At the same time that we entered into the Master
Lease Agreement, we also amended 16 other leases with LTC under which the
renewal rights of certain of those leases are tied together differently than
previously with certain other leases.

MYFM Capital, LLC and BET Associates

In December 2000, the Company entered into an agreement with MYFM Capital,
LLC ("MYFM") under which the Company could establish a line of credit with BET
Associates LP ("BET") as lender, providing for loans of up to $10.0 million.
Subsequent to December 31, 2001, the Company terminated the agreement and paid
MYFM $50,000 in connection with such termination. Bruce E. Toll, who is the
beneficial owner of 3.1 million of the Company's common shares, and a member of
the Company's Board of Directors from January 16, 2001 to January 1, 2002, is
the sole member of BRU Holdings Company, Inc., LLC, which is the sole general
partner of BET. Leonard Tannenbaum is the Managing Partner of MYFM Capital, LLC,
the son-in-law of Mr. Toll, a 10% limited partner of BET, and is a current
member of the Company's Board of Directors. In addition, Mr. Tannenbaum
currently owns $323,875 of the Company's New Notes.

TMC Communications and Learning.Net

The Company entered into a month to month contract for long distance
services with TMC Communications in 2001. John Gibbons, who served as a director
of the Company during 2001 owns 50% of TMC. During 2001, the Company paid TMC
Communications $32,700.

The Company contracted with Learning.Net for training resources. John
Gibbons, who served as a director of the Company during 2001 owns 12% of
Learning.Net. During 2001, the Company paid Learning.Net $25,700 for software
licensing fees and training courses.

Agreement with Richard C. Ladd

In 2001, the Company entered into an agreement with Richard C. Ladd, who is
currently a member of the Company's Board of Directors. The agreement provides
for Mr. Ladd to provide consultation services to
69

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

the Company on the advisability of establishing a committee on quality
improvement, its membership and charter. The initial contract was for a period
of 4 months, which was amended to provide services on a month-to-month basis.
The Company or Mr. Ladd may terminate the contract at any time by the
terminating party providing at least 30-days prior written notice to the other
party of their intention to terminate the contract. Mr. Ladd is reimbursed at
the rate of $150 per hour, not to exceed $2,500 for any one month. The Company
paid Mr. Ladd $8,090 for such services for the year ended December 31, 2001.
Additionally, the Company has allowed Mr. Ladd and his spouse to participate in
its health insurance programs. The Company paid premiums on their behalf of
$7,900 during the year ended December 31, 2001.

10. STOCK OPTION PLANS AND RESTRICTED STOCK

Predecessor Company

Prior to January 1, 2002, the effective date of the Company's Plan of
reorganization, the Company had two Stock Option Plans (the "Option Plans")
which provided for the issuance of incentive and non-qualified stock options and
restricted stock. Except for the Board of Directors administering the options of
the non-employee Directors, the Option Plans were administered by the
Compensation Committee of the Board of Directors which established the terms and
provisions of options granted under the Option Plans, not otherwise provided
under the Option Plans. Incentive options could be granted only to officers or
other full-time employees of the Company, while non-qualified options could be
granted to directors, officers or other employees of the Company, or consultants
who provide services to the Company.

The Amended and Restated 1994 Stock Option Plan combined an incentive and
nonqualified stock option plan, a stock appreciation rights ("SAR") plan and a
stock award plan (including restricted stock). The 1994 Plan was a long-term
incentive compensation plan and was designed to provide a competitive and
balanced incentive and reward program for participants.

Under the Amended and Restated 1994 Stock Option Plan (the "1994 Plan"),
the Company could grant options or award restricted stock to its employees,
consultants and other key persons for up to 2,208,000 shares of common stock.
The exercise price of each option equaled the market price of the Company's
stock on the date of grant. Each option expired on the date specified in the
option agreement, but not later than the tenth anniversary of the date on which
the option was granted. Options typically vested three years from the date of
issuance and typically were exercisable within seven years from the date of
vesting. Each option was exercisable in equal installments as designated by the
Compensation Committee or the Board at the option price designated by the
Compensation Committee or the Board, as applicable; however, incentive options
could not be less than the fair market value of the common stock on the date of
grant. All options were nontransferable and subject to adjustment upon changes
in the Company's capitalization. The Board of Directors, at its option, could
discontinue or amend the 1994 Plan at any time, provided that certain conditions
were satisfied.

Under the Non-Executive Employee Equity Participation Plan of Assisted
Living Concepts, Inc. (the "Non-Officer Plan") the Company could grant
consultants and non-executives up to 1,000,000 shares of Common Stock pursuant
to non-qualified options granted under the Non-Officer Plan. Officers, directors
and significant employees of the Company were not eligible to participate in the
Non-Officer Plan.

Following is the per share weighted-average fair value of each option grant
as estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions. There were no options granted
during 2001 and all options were cancelled effective December 31, 2001 in
accordance with the Company's Plan of reorganization, therefore the following
table excludes any data related to 2001.

70

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The Company applies APB Opinion No. 25 in accounting for its Option Plans,
and accordingly, no compensation cost has been recognized for its stock options
issued to employees in the financial statements as all options were issued at
fair value on the date of the grant. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under SFAS
No. 123, the Company's net loss would have been reduced to the pro forma amounts
indicated below: (in thousands except per share data)

Pro forma net loss reflects only options granted after 1995. Therefore, the
full impact of calculating compensation costs for stock options under SFAS No.
123 is not reflected in the pro forma net loss amounts presented above because
compensation cost is reflected over the option's vesting period of three years
and compensation cost for options granted prior to January 1, 1996 is not
considered. The resulting pro forma compensation costs may not be representative
of that expected in the future years.

There were no options granted during 2001 and all options were cancelled
effective December 31, 2001 in accordance with the Company's Plan of
reorganization, therefore the following table excludes any data related to 2001.

A summary of the status of the Company's stock options as of December 31,
1999 and 2000 and changes during the years ended on those dates is presented
below:

At December 31, 2001 the Predecessor Company cancelled 1,473,898 options
with a weighted-average exercise price of $3.38 each. The Successor Company had
no options outstanding at December 31, 2001.

71

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

In October 1997, the Company awarded 250,000 shares of non-voting
restricted stock to two key executive officers. At the time of the grant the
Company's common stock had a fair market value of $17.00 per share. No cash
consideration was paid for such shares by the recipients. Such shares vested in
three equal annual installments, commencing on the fourth anniversary of grant.
The Company recorded unearned compensation expense of $4.3 million in connection
with the issuance of the restricted stock as of the date of the grant. This
unearned compensation expense was reflected as a separate component of
shareholders' equity to be amortized as compensation expense over the seven year
vesting period. The Company recorded $608,000 and $180,000 of compensation
expense with respect to such award for the years ended December 31, 1998 and
1999, respectively. The Company recorded the issuance of the restricted stock in
1998 upon issuance. During the first quarter of 1999, the Company retired the
250,000 shares of restricted stock upon payment to the two key executives of
$750,000 and $187,500 (the latter of which was reduced to $87,500 to reflect
repayment of a $100,000 bonus paid in 1998 to one of the key executives) in
consideration for the forfeiture of their interest in the 250,000 shares of
restricted stock.

In November 2000, the Board of Directors, at the recommendation of the
Compensation Committee, approved an offer (the "Offer") to holders of options
under both the 1994 Stock Option Plan and the Non-Officer Plan. The Company
agreed to make lump sum payments of $250 to each option holder that agreed to
the cancellation of all of his options having an exercise price of $5.00 or
greater ("Eligible Options"), except that certain executive officers, directors,
and consultants were asked to agree to the cancellation of their Eligible
Options without any payment. The Company completed the Offer in December 2000,
paying approximately $17,000 for the cancellation of options covering the
issuance of 596,103 shares of common stock.

11. WORKERS COMPENSATION

The Company utilizes third-party insurance for losses and liabilities
associated with workers compensation claims subject to deductible levels of
$250,000 per occurrence for all claims incurred beginning January 1, 2000.
Claims incurred prior to January 1, 2000 were fully insured. Losses up to this
deductible level are accrued based upon the Company's estimates of the aggregate
liability for claims incurred based on Company experience. At December 31, 2000
and 2001, other current liabilities includes reserves for workers compensation
claims payable of approximately $1.0 million and $2.5 million, respectively.

In addition, the Company maintains cash deposits as required by the
insurance carrier. At December 31, 2001, such deposits were $1.1 million and
$2.8 million, respectively. These deposits are utilized to pay claims as costs
are incurred.

12. PROFESSIONAL LIABILITY

The Company utilizes third-party insurance for losses and liabilities
associated with professional liability claims subject to deductible levels of
$100,000 per occurrence for the year ended December 31, 2000 and retention
levels of $250,000 for all states except Florida and Texas, where the retention
levels are $500,000 per occurrence, for the year ended December 31, 2001. Losses
up to these deductible and retention levels are accrued based upon the Company's
estimates of the aggregate liability for claims incurred based on Company
experience. At December 31, 2000 and 2001, other current liabilities includes
reserves for professional liability claims payable of approximately $485,000 and
$1.0 million, respectively.

13. LEGAL PROCEEDINGS

Insurance Coverage Dispute

In September, 2000, the Company reached an agreement to settle the class
action litigation relating to the restatement of its consolidated financial
statements for the years ended December 31, 1996 and 1997 and

72

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

the first three fiscal quarters of 1998. This agreement received final court
approval on November 30, 2000 and the Company was dismissed from the litigation
with prejudice. On September 28, 2001, the Company made its final installment of
$1.0 million on its promissory note for the class action litigation settlement.
Although the Company was dismissed from the litigation with prejudice, a dispute
which arose with its corporate liability insurance carriers remains unresolved.
At the time the Company settled the class action litigation, the Company and the
insurance carriers agreed to resolve this dispute through binding arbitration,
and the Company filed a complaint for a declaratory judgment that it was not
liable to the carriers as claimed. The carriers counter-claimed to recover an
amount capped at $4.0 million.

After filing for bankruptcy on October 1, 2001, the Company made a motion
for dismissal of its complaint for declaratory relief in the arbitration based
upon having filed for bankruptcy protection. An objection was filed to its
motion, and one of its insurance carriers filed a proof of claim in the amount
of $4.0 million in the bankruptcy proceeding. The Company disputes that claim.
The Company offered (and the offer currently remains outstanding) to settle the
dispute for $75,000 to be paid out as a general unsecured claim in the
bankruptcy process. (See Note 1).

In addition to the matter referred to in the immediately preceding
paragraphs, the Company is involved in various lawsuits and claims arising in
the normal course of business. In the aggregate, such other suits and claims
should not have a material adverse effect on the Company's financial condition,
results of operations, cash flow and liquidity.

14. EMPLOYEE BENEFIT PLANS

The Company has a 401(k) Savings Plan ("the Savings Plan") which is a
defined contribution plan covering employees of Assisted Living Concepts, Inc.
who have one year of service and are age 21 or older. Each year participants may
contribute up to 15% of pre-tax annual compensation and 100% of any Employer
paid cash bonus (not to exceed $10,500), as defined in the Savings Plan. ALC may
provide matching contributions as determined annually by ALC's Board of
Directors. Contributions are subject to certain limitations. The Company has not
made any contributions to this Savings Plan.

The Company has a Severance Pay Plan for Administrators, Associate
Administrators, and Corporate and Regional Office Operations Employees ("the
Severance Plan"). The Severance Plan was amended, effective January 1, 2001.
This Severance Plan covers certain eligible employees and provides that under
specific conditions employees may receive up to 6 months annual base salary as
severance pay, depending upon their length of service with the Company and other
factors that are defined in the Severance Plan. During the years ended December
31, 1999 and 2001, the Company paid out benefits of $19,000 and $3,000,
respectively, under this plan. No such benefits were paid during the year ended
December 31, 2000.

15. SUBSEQUENT EVENT

2002 Incentive Award Plan

On March 6, 2002, the Company adopted the 2002 Incentive Award Plan of
Assisted Living Concepts, Inc., ("the 2002 Plan"). The 2002 Plan consists of two
plans, one pertaining solely to the grant of incentive stock options and one
pertaining to the grant of other incentive awards. The 2002 Plan is intended to
obtain, retain services of, and provide incentive for, directors, key employees
and consultants to further the growth, development and financial success of the
Company by personally benefiting through the ownership of the Company stock
and/or rights which recognize such growth, development and financial success.

The 2002 Plan provides for the Company to grant options to its eligible
employees, consultants and independent directors. The aggregate number of shares
which may be issued upon exercise of options or other awards under the 2002 Plan
shall not exceed 325,000, which, on March 6, 2002, subject to shareholder

73

ASSISTED LIVING CONCEPTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

approval, the Company's Board of Directors increased by an additional 325,000.
The exercise price and vesting period of each option shall be set by the
Company's Compensation Committee of its Board of Directors, but the exercise
price may not be less than the deemed fair value of the Company's stock on the
date of grant. Each option shall expire on the date specified in the option
agreement, but not later than the tenth anniversary of the date on which the
option was granted. The Board of Directors, at its option, may discontinue or
amend the 2002 Plan at any time, provided that certain conditions are satisfied.

74

SIGNATURES

Pursuant to the requirements of Sections 13 or 15(d) the Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

ASSISTED LIVING CONCEPTS INC.
Registrant

March 29, 2002 By: /s/ DREW Q. MILLER
------------------------------------
Name: Drew Q. Miller
Title: Senior Vice President, Chief
Financial
Officer and Treasurer

March 29, 2002 By: /s/ M. CATHERINE MALONEY
------------------------------------
Name: M. Catherine Maloney
Title: Vice President, Controller
and
Chief Accounting Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS:

That the undersigned officers and directors of Assisted Living Concepts,
Inc. do hereby constitute and appoint Steven L. Vick or Drew Q. Miller, and each
of them, the lawful attorney and agent or attorneys and agents with power and
authority to do any and all acts and things and to execute any and all
instruments which said attorneys and agents, or either of them, determine may be
necessary or advisable or required to enable to comply with the Securities and
Exchange Act of 1934, as amended, and any rules or regulations or requirements
of the Securities and Exchange Commission in connection with this Annual Report
on Form 10-K. Without limiting the generality of the foregoing power and
authority, the powers granted include the power and authority to sign the names
of the undersigned officers and directors in the capacities indicated below to
this Annual Report on Form 10-K or amendment or supplements thereto, and each of
the undersigned hereby ratifies and confirms all that said attorneys and agent,
or either of them, shall do or cause to be done by virtue hereof. This Power of
Attorney may be signed in several counterparts.

IN WITNESS WHEREOF, each of the undersigned has executed this Power of
Attorney as of the dated indicated opposite his or her name.

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934,
THE REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.

76

SCHEDULE II

ASSISTED LIVING CONCEPTS, INC.

VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001
(IN THOUSANDS)

- ---------------
(1) Represents amounts written off. For the year ended December l31, 2001, the
deductions also includes $193,000 of fresh start adjustments.

(2) $561,000 of additions were charged to operating expenses, $510,000 of
additions related to home health operations which were discontinued and are
reported in general and administrative expenses in 1999.

(3) Balance at December 31, 2001 is that of the Successor Company.

77

ASSISTED LIVING CONCEPTS, INC. AND SUBSIDIARIES
INDEX TO EXHIBITS