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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20459
FORM 10-K
(Mark One)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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 (IRS EmployerIdentification No.)
ofincorporation or organization)
11835 N.E. 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:
Name of each exchange
Title of each class on which registered
- ------------------- -----------------------
Common Stock, par value $.01 American Stock Exchange
6% Convertible Subordinated Debentures Due November
2002 American Stock Exchange
5.625% Convertible Subordinated Debentures Due May
2003 American Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act:
None.
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 17,171,077 shares of common stock, $.01 par value,
outstanding at May 31, 1999. The aggregate market value of the voting stock
held by non-affiliates of the registrant on such date was approximately $49.4
million.
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PART I
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, lease and develop 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 June 30, 1999 we had operations or development activities in
five regions in 16 states.
We also provide personal care and support services and make available
routine nursing services (as permitted by applicable regulations) designed to
meet the 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 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 have experienced significant and rapid growth, primarily through the
development of assisted living residences and, to a much lesser extent,
through acquisitions of residences. When we completed our initial public
offering in November 1994 we had a base of five residences (137 units). As of
June 30, 1999, we had 175 assisted living residences in operation representing
an aggregate of 6,741 units. Of these residences, we owned 105 residences
(4,123 units) and leased 70 residences (2,620 units). For the three months
ended June 30, 1999, our 127 Stabilized Residences (those residences that had
been operating for twelve months prior to the beginning of the period or had
achieved 95.0% occupancy within the first twelve months of operations) had an
average occupancy rate of approximately 83.9% and an average monthly rental
rate of approximately $1,860 per unit. Our 175 residences in operation during
the three months ended June 30, 1999 had an average occupancy rate of
approximately 74.3% and an average monthly rental rate of approximately $1,881
per unit.
We are currently developing and, to a lesser extent, seeking to acquire
additional assisted living residences in Indiana, Michigan, New Jersey, Iowa,
Arizona, Georgia, and South Carolina. As of June 30, 1999, we had six
residences with 245 units that had received certificates of occupancy but were
not yet operating. In addition, we had four residences with 156 units that
were under construction as of the same date. We also owned land for
development of 10 sites, including three for expansion projects, where
construction had not yet commenced. We have significantly reduced our
development activity in 1999 in order to focus on stabilizing our current base
of operating residences. We wrote-off approximately $2.4 million in fiscal
year 1998 and $4.8 million through June 30, 1999 primarily associated with
sites which we will no longer seek to develop. For the twelve months ended
December 31, 1998, we commenced operations with respect to 57 residences
(2,297 units). We intend to commence operation on an additional 20 residences
(800 units) for the comparable period in 1999, 10 of which commenced operation
through June 30, 1999. In addition to the development and construction costs
incurred during 1998 with respect to these residences, we expect to incur up
to an additional $30.0 million in capital expenditures and related start-up
costs for the twelve months ended December 31, 1999, approximately $25.0
million of which had been incurred as of June 30, 1999.
We have significantly reduced development activity in order to focus on our
core business of operating our existing residences. The principal elements of
our business strategy are to:
. increase occupancy and improve operating efficiencies at our existing
base of residences;
. expand market penetration in existing markets;
. serve higher-acuity residents; and
. pursue strategic business alliances.
2
We anticipate that revenues at a majority of our residences will continue to
come from private pay sources. However, we believe that locating residences in
states with favorable regulatory and reimbursement climates should provide 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.
Assisted Living Concepts, Inc. is a Nevada corporation. Our principal
executive offices are located at 11835 N.E. Glenn Widing Drive, Building E,
Portland, Oregon 97220-9057, and our telephone number is (503) 252-6233.
Recent Developments
Restatement of Historical Financial Statements
On February 1, 1999, we announced that after consultation with our
independent auditors we would restate our financial statements for the fiscal
quarter ended June 30, 1997, the fiscal quarter ended September 30, 1997, the
fiscal year ended December 31, 1997, the fiscal quarter ended March 31, 1998,
the fiscal quarter ended June 30, 1998 and the fiscal quarter ended September
30, 1998. On March 31, 1999, we announced that the restatement would be more
extensive than we had previously believed, and might include periods prior to
the second quarter of 1997, including the fiscal year ended December 31, 1996.
After further consultation with our independent auditors, we determined to
restate our financial statements for the fiscal year ended December 31, 1996,
the fiscal year ended December 31, 1997 and each of the first three fiscal
quarters of the fiscal year ended December 31, 1998.
The restatement resulted primarily from:
. the earlier recognition of certain expenses that we previously
capitalized in connection with our development and financing activities;
. a modification in how we accounted for certain of our lease
arrangements;
. a modification in how we accounted for certain of our acquisitions and
joint venture agreements;
. the capitalization of fees we received during 1997 and 1998 that we
previously recorded as a reduction of expenses or other income;
. the elimination of an impairment write-down that we had previously
recorded on three of our residences;
. the elimination of certain accrued expenses previously recorded pursuant
to a change in accounting principle; and
. an increase in the amount of goodwill that we wrote-off in the second
quarter of 1998 relating to exiting our home health operations.
The overall effect of the restatement on net income and net income per share
in each of the periods subject to the restatement is illustrated in the
following table:
As previously reported As restated
--------------------------------- -----------------------
Net Income
(Loss) Per
Share Net Loss
--------------- Per Basic and
Period Net Income (Loss) Basic Diluted Net Loss Diluted Share
------ ----------------- ------ ------- -------- -------------
(in thousands, except per share data)
Year ended 12/31/96..... $ 149 $ 0.02 $ 0.01 $ (1,915) $(0.23)
Year ended 12/31/97..... $ 4,209 $ 0.35 $ 0.34 $ (2,479) $(0.21)
Quarter ended
3/31/98(1)............. $ 1,906 $ 0.12 $ 0.12 $ (784) $(0.05)
Quarter ended 6/30/98... $(4,378) $(0.28) $(0.28) $(11,831) $(0.75)
Quarter ended 9/30/98... $ 2,722 $ 0.16 $ 0.16 $ (720) $(0.04)
(1) Net income and net income per share, as previously reported for the
quarter ended March 31, 1998, do not reflect the cumulative effect of
the change in accounting principle which was adopted during the quarter
ended June 30, 1998, effective January 1, 1998.
3
Termination of Merger Agreement
On February 1, 1999, we agreed with American Retirement Corporation ("ARC")
to terminate our previously announced merger agreement, which had been entered
into during November 1998. We recorded a charge of approximately $1.1 million
in the fourth quarter of 1998, and $200,000 the first quarter of 1999 for
expenses incurred related to the terminated merger.
Securityholder Litigation
Since February 1, 1999 12 separate complaints, which have been consolidated
into one action, have been filed against us and certain of our officers and
directors on behalf of purchasers of our common stock, 6.0% Convertible
Subordinated Debentures (the "6.0% Debentures") and 5.625% Convertible
Subordinated Debentures (the "5.625% Debentures" and, together with the 6.0%
Debentures, the "Debentures") in the United States District Court for the
District of Oregon. On July 23, 1999, a consolidated complaint was filed in
connection with this litigation naming as additional defendants certain of our
directors that were not named previously, as well as our independent auditors
(solely in connection with our 1998 offering of 5.625% Debentures) and the
underwriters in connection with our October 1997 offering of 6.0% Debentures.
See Item 3 (Legal Proceedings) for information regarding this litigation.
Termination of Joint Venture Agreements
During fiscal years 1997 and 1998, we entered into joint venture agreements
with respect to the operation of certain start-up residences pursuant to which
90% of the operating risks and rewards related to such residences were
allocated to the joint venture partner, in which we had an interest. We
consolidated the operations of the joint venture agreements in our financial
statements. The joint venture partner reimbursed us for 90% of the start-up
losses of the joint venture residences incurred in the second quarter of 1997
and through the third quarter of 1998, and we recognized such reimbursements
as other income in our financial statements during such quarters. We have
determined to restate such loss reimbursements as loans, rather than other
income. We also have reflected amounts paid to repurchase the joint venture
partner's interest in the operations of the joint venture residences in excess
of reimbursed losses as interest and other expense.
During the first quarter of 1999, we negotiated with the joint venture
partner to acquire, for $3.8 million, all of such partner's remaining
interests in the operations of the remaining 17 residences subject to joint
venture agreements through the third quarter of 1998. The joint venture
partner did not reimburse us for any start-up losses, nor have we entered into
any new joint venture agreements with respect to the operation of start-up
residences, subsequent to the third quarter of 1998.
Management Changes
On March 16, 1999, our board of directors announced the appointment of Dr.
Keren Brown Wilson, our co-founder, as our President and Chief Executive
Officer. The board also announced the appointment of Leslie J. Mahon as Vice
President and Chief Operating Officer and James W. Cruckshank as Vice
President and Chief Financial Officer. As of March 16, 1999, we also entered
into a consulting agreement with William McBride, pursuant to which Mr.
McBride agreed to provide us with consulting services and to resign from his
position as our Chief Executive Officer, and amended Dr. Wilson's existing
employment agreement. The terms of these agreements are summarized in Item 11.
On March 31, 1999, we announced the resignation of Mr. McBride as Chairman
of the Board of Directors and the election by the board of Richard C. Ladd as
Interim Chairman. We also announced that Mr. McBride had decided not to seek
reelection to the board of directors at the next annual meeting.
In April 1999, we announced the increase in the number of board members from
five to six and the election by the board of Jill Krueger to serve as a
director and as chairman of our Audit Committee.
4
Amendments to Certain Leases
In March 1999, we amended 16 leases with a single lessor. Prior to the
amendment the leases were accounted for as financings due to our continuing
involvement in the residences in the form of a fair market value purchase
option. The amendments resulted in the reclassification of such leases from
financings to operating leases.
In June 1999, we amended all of our 37 leases with another lessor. These
amendments restructured provisions related to future minimum annual rent
increases, or "rent escalators," which prior to the amendments required us to
account for rent expense related to such leases on a straight-line basis. From
the date of the amendment forward, we will account for the amended leases on a
contractual cash payment basis and amortize the deferred rent balance as of
the date of the amendment over the remaining initial terms 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 under certain circumstances. In addition,
the amendments also provide us with the ability, subject to certain
conditions, to sublease or assign our leases with respect to two Washington
residences.
Write-off Related to Reduced Development Activity
As a result of a continued reduction in our new residence development
activities, we will incur write-offs of $1.3 million relating to previously
capitalized development costs during the first quarter of 1999 and an
additional $3.5 million in the second quarter of 1999. In the event that in
the future we do not complete and open residences planned for development, we
may incur similar write-offs. However, we have no present intention of
commencing further development activity beyond the 10 residences currently
included in construction in process as of June 30, 1999.
Amendment of Loan Agreements
During the third quarter of 1999, we amended certain loan agreements with
one of our creditors. Pursuant to the amendment, we agreed to provide $8.3
million of additional cash collateral in exchange for the forbearance or
waiver of certain possible defaults, including an amendment to certain
financial covenants. The amendment provides for the release of the additional
collateral upon the achievement of specified performance targets, provided
that we are in compliance with the other terms of the loan agreements.
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 but do not typically 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 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 and 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
5
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). We
assess the level of need of each resident regularly.
Operations
Each residence has an on-site program director who is responsible for the
overall day-to-day operation of the residence, including quality of care,
marketing, social services and financial performance. The program director 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 five regional
operational managers who oversee the overall performance and finances of each
region, operations managers who oversee the day-to-day operations of up to 10
to 12 residences, and team leaders who provide peer support for up to three to
four residences. Presently, residence personnel also are supported by
corporate staff based at our headquarters. Corporate and regional personnel
work with the program directors to establish residence goals and strategies,
quality assurance oversight, development of Company policies and procedures,
government relations, marketing and sales, community relations, development
and implementation of new programs, cash management and treasury functions,
and human resource management.
Competition
The long-term care industry generally is highly competitive. We compete with
other assisted living providers, including an increasing number of hospitals
offering assisted living, and with numerous other companies providing similar
long-term care alternatives, such as home health agencies, life care at home,
community-based service programs, retirement communities and convalescent
centers. We expect that, as assisted living receives increased attention and
the number of states which include assisted living in their Medicaid programs
increases, competition will 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. Our major competitors are other long-term care facilities, including
assisted living facilities within the same geographic area as our residences
because our experience indicates that senior citizens who move into long-term
care communities frequently choose communities near their homes.
We believe that the rapid growth of the assisted living industry has
resulted in an oversupply of assisted living residences in certain of our
markets. Recently, we have experienced slower fill-up of Start-Up Residences
in these markets than expected, as well as declining occupancy in our
Stabilized Residences due to the increase in options available to potential
new residents when units are vacated. 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 have opened or plan to open
residences will not adversely affect our operations.
6
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.
Although a majority of our revenues come from private payors, the cost
structure of the residences has historically been, and is expected to continue
to be, sufficiently low so that the residences are able to operate profitably
if all of their revenues are derived through Medicaid contracts.
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 the
Health Care Financing Administration ("HCFA"). Under a Medicaid Waiver
Program, states apply to HCFA 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 and Washington currently have
operating Medicaid Waiver Programs that allow them to pay for assisted living
care. 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, 1996, 1997 and 1998, direct payments
received from state Medicaid agencies accounted for approximately 12.4%, 11.1%
and 10.7%, respectively, of our revenue while the tenant-paid portion received
from Medicaid residents accounted for approximately 6.9%, 5.9% and 5.8%,
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 May 31, 1999, we had
obtained licenses in Oregon, Washington, Idaho, Nebraska, Texas, Arizona,
Iowa, Louisiana, Ohio, New Jersey, Pennsylvania, Florida, Michigan and South
Carolina. We are not subject to state licensure requirements in Indiana and we
expect that we will obtain licenses in other states as required. 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
7
the fraud and abuse law. Several states in which we operate or intend to
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. For instance, the states we initially targeted for
development/expansion typically do not set staffing ratios. 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. A number of additional federal, state and
local laws exist that also may require modifications to planned facilities to
create access to the properties by disabled persons. Although we believe that
our facilities currently under development 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.
Employees
As of May 31, 1999 we had 3,576 employees, of whom 1,506 were full-time
employees and 2,070 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 June 30, 1999 the location, number of
units, date of licensure, and ownership status of our residences. In addition,
the chart sets forth occupancy rates as of May 31, 1999.
Opening Occupancy (%)
Residence Units Date(1) Ownership(2) at 5/31/99
--------- ----- ------- ------------ -------------
Western Region
Idaho
Burley.............................. 35 08/97 Leased 68.6
Caldwell............................ 35 08/97 Leased 37.1
Garden City......................... 48 04/97 Owned 72.9
Hayden.............................. 39 11/96 Leased 94.9
Idaho Falls......................... 39 01/97 Owned 100.0
Moscow.............................. 35 04/97 Owned 65.7
Nampa............................... 39 02/97 Leased 66.7
Rexburg............................. 35 08/97 Owned 45.7
Twin Falls.......................... 39 09/97 Owned 51.3
---
Sub Total......................... 344
Oregon
Astoria............................. 28 08/96 Owned 89.3
Bend................................ 46 11/95 Owned 97.8
Brookings........................... 36 07/96 Owned 88.9
Canby............................... 25 12/90 Leased 100.0
8
Opening Occupancy (%)
Residence Units Date(1) Ownership(2) at 5/31/99
--------- ----- ------- ------------ -------------
Estacada............................ 30 01/97 Owned 96.7
Eugene.............................. 47 08/97 Leased 93.6
Hood River.......................... 30 10/95 Owned 96.7
Klamath Falls....................... 36 10/96 Leased 75.0
Lincoln City........................ 33 10/94 Owned 63.6
Madras.............................. 27 03/91 Owned 100.0
Myrtle Creek........................ 34 03/96 Leased 97.1
Newberg............................. 26 10/92 Leased 100.0
Newport............................. 36 06/96 Leased 88.9
Pendleton........................... 39 04/91 Leased 56.4
Prineville.......................... 30 10/95 Owned 100.0
Redmond............................. 37 03/95 Leased 89.2
Silverton........................... 30 07/95 Owned 100.0
Sutherlin........................... 30 01/97 Leased 100.0
Talent.............................. 36 10/97 Owned 100.0
---
Sub Total......................... 636
Washington
Battle Ground....................... 40 11/96 Leased 90.0
Bremerton........................... 39 05/97 Owned 64.1
Camas............................... 36 03/96 Leased 94.4
Enumclaw............................ 40 04/97 Owned 80.0
Ferndale............................ 39 10/98 Owned 46.2
Grandview........................... 36 02/96 Leased 80.6
Hoquiam............................. 40 07/97 Leased 97.5
Kelso............................... 40 08/96 Leased 95.0
Kennewick........................... 36 12/95 Leased 38.9
Port Orchard........................ 39 06/97 Owned 97.4
Port Townsend....................... 39 01/98 Owned 100.0
Spokane............................. 39 09/97 Owned 56.4
Sumner.............................. 48 03/98 Owned 87.5
Vancouver........................... 44 06/96 Leased 45.5
Walla Walla......................... 36 02/96 Leased 100.0
Yakima.............................. 48 07/98 Owned 79.2
---
Sub Total......................... 639
Midwest Region
Indiana
Bedford............................. 39 03/98 Owned 48.7
Bloomington......................... 39 01/98 Owned 71.8
Camby............................... 39 12/98 Owned 23.1
Elkheart............................ 39 09/97 Leased 89.7
Fort Wayne.......................... 39 06/98 Owned 25.6
Franklin............................ 39 05/98 Owned 59.0
Huntington.......................... 39 02/98 Owned 56.4
Jeffersonville...................... 39 03/99 Owned 20.5
Kendalville......................... 39 05/98 Owned 38.5
LaPorte............................. 39 10/98 Owned 46.2
Logansport.......................... 39 02/98 Owned 87.2
Madison............................. 39 10/97 Leased 89.7
Marion.............................. 39 03/98 Owned 25.6
Muncie.............................. 39 02/98 Owned 100.0
New Albany.......................... 39 05/98 Owned 56.4
New Castle.......................... 39 02/98 Owned 53.9
Seymour............................. 39 05/98 Owned 59.0
9
Opening Occupancy (%)
Residence Units Date(1) Ownership(2) at 5/31/99
--------- ----- ------- ------------ -------------
Shelbyville......................... 39 05/98 Owned 84.6
Warsaw.............................. 39 10/97 Owned 43.6
---
Sub Total......................... 741
Iowa
Atlantic............................ 30 09/98 Owned 60.0
Carroll............................. 35 01/99 Owned 34.3
Clarinda............................ 35 09/98 Owned 48.6
Council Bluff....................... 50 03/99 Owned 32.0
Denison............................. 35 05/98 Leased 48.6
---
Sub Total......................... 185
Michigan
Three Rivers........................ 39 04/99 Owned 12.8
Nebraska
Beatrice............................ 39 07/97 Leased 69.2
Blair............................... 30 07/98 Owned 60.0
Columbus............................ 39 06/98 Owned 100.0
Fremont............................. 39 05/98 Owned 97.4
Nebraska City....................... 30 06/98 Owned 96.7
Norfolk............................. 39 04/97 Leased 71.8
Seward.............................. 30 10/98 Owned 43.3
Wahoo............................... 39 06/97 Leased 64.1
York................................ 39 05/97 Leased 94.9
---
Sub Total......................... 324
Southeast Region
Florida
Quincy.............................. 39 04/99 Owned 20.5
Milton.............................. 39 06/99 Owned --
---
Sub Total......................... 78
Louisiana
Alexandria.......................... 47 07/98 Owned 57.5
Bunkie.............................. 39 01/99 Owned 25.6
Houma............................... 48 08/98 Owned 70.8
Ruston.............................. 39 01/99 Owned 25.6
---
Sub Total......................... 173
South Carolina
Aiken............................... 39 02/98 Owned 76.9
Clinton............................. 39 11/97 Leased 43.6
Goose Creek......................... 39 08/98 Owned 48.7
Greenwood........................... 39 05/98 Leased 18.0
James Island........................ 39 08/98 Owned 56.4
North Augusta....................... 39 10/98 Owned 23.1
Port Royal.......................... 39 09/98 Owned 51.3
Summerville......................... 39 02/98 Owned 82.1
---
Sub Total......................... 312
Texas
Athens.............................. 38 11/95 Leased 97.4
Carthage............................ 30 10/95 Leased 93.3
Gun Barrel City..................... 40 10/95 Leased 92.5
Henderson........................... 30 09/96 Leased 96.7
Jacksonville........................ 39 12/95 Leased 100.0
10
Opening Occupancy (%)
Residence Units Date(1) Ownership(2) at 5/31/99
--------- ----- ------- ------------ -------------
Longview............................ 30 09/95 Leased 96.7
Lufkin.............................. 39 05/96 Leased 97.4
Marshall............................ 40 07/95 Leased 100.0
Nacogdoches......................... 30 06/96 Leased 100.0
Paris Oaks.......................... 50 12/98 Owned 100.0
-----
Sub Total......................... 366
Southwest Region
Texas
Abilene............................. 38 10/96 Leased 86.8
Amarillo............................ 50 03/96 Leased 96.0
Beaumont............................ 50 04/96 Leased 92.0
Big Springs......................... 38 05/96 Leased 100.0
Bryan............................... 30 06/96 Leased 100.0
Canyon.............................. 30 06/96 Leased 93.3
Cleburne............................ 44 01/96 Owned 97.7
College Station..................... 39 10/96 Leased 100.0
Conroe.............................. 38 07/96 Leased 100.0
Denison............................. 30 01/96 Owned 86.7
Gainesville......................... 40 01/96 Leased 97.5
Greenville.......................... 40 11/95 Leased 75.0
Levelland........................... 30 01/96 Leased 100.0
Lubbock............................. 50 07/96 Leased 96.0
McKinney............................ 39 01/97 Owned 94.9
McKinney............................ 50 05/98 Owned 100.0
Mesquite............................ 50 07/96 Leased 90.0
Midland............................. 50 12/96 Owned 98.0
Mineral Wells....................... 30 07/96 Leased 96.7
Orange.............................. 36 03/96 Leased 100.0
Pampa............................... 36 08/96 Leased 100.0
Plainview........................... 36 07/96 Leased 100.0
Plano............................... 60 05/98 Owned 95.0
Port Arthur......................... 50 05/96 Owned 96.0
Rowlett............................. 36 10/96 Owned 100.0
Sherman............................. 39 10/95 Leased 97.4
Sulphur Springs..................... 30 01/96 Owned 100.0
Sweetwater.......................... 30 03/96 Leased 100.0
Temple.............................. 40 01/97 Leased 67.5
Wichita Falls....................... 50 10/96 Leased 64.0
-----
Sub Total......................... 1,209
Arizona
Apache Junction..................... 48 03/98 Owned 81.3
Bullhead City....................... 40 08/97 Leased 80.0
Lake Havasu......................... 36 04/97 Leased 58.3
Mesa................................ 50 01/98 Owned 72.00
Payson.............................. 39 10/98 Owned 84.6
Prescott Valley..................... 39 10/98 Owned 30.8
Surprise............................ 50 10/98 Owned 12.0
Yuma................................ 48 03/98 Owned 62.5
-----
Sub Total......................... 350
11
Opening Occupancy (%)
Residence Units Date(1) Ownership(2) at 5/31/99
--------- ----- ------- ------------ -------------
Northeast Region
New Jersey
Bridgeton........................... 39 03/98 Owned 87.2
Burlington.......................... 39 11/97 Owned 100.0
Egg Harbor.......................... 39 04/99 Owned 48.7
Glassboro........................... 39 03/97 Leased 100.0
Millville........................... 39 05/97 Leased 100.0
Pennsville.......................... 39 11/97 Owned 97.4
Rio Grande.......................... 39 11/97 Owned 94.9
Vineland............................ 39 01/97 Leased 97.4
-----
Sub Total......................... 312
Ohio
Bellefountaine...................... 35 03/97 Owned 80.0
Bucyrus............................. 35 01/97 Owned 94.3
Cambridge........................... 39 10/97 Owned 43.6
Celina.............................. 39 04/97 Owned 79.5
Defiance............................ 35 02/96 Owned 91.4
Findlay............................. 39 03/97 Owned 20.5
Fremont............................. 39 07/97 Leased 51.3
Greenville.......................... 39 02/97 Owned 79.5
Hillsboro........................... 39 03/98 Owned 53.9
Kenton.............................. 35 03/97 Owned 100.0
Lima................................ 39 06/97 Owned 56.4
Marion.............................. 39 04/97 Owned 48.7
Newark.............................. 39 10/97 Leased 92.3
Sandusky............................ 39 09/98 Owned 23.1
Tiffin.............................. 35 06/97 Leased 62.9
Troy................................ 39 03/97 Leased 94.9
Wheelersburg........................ 39 09/97 Leased 30.8
Zanesville.......................... 39 12/97 Owned 66.7
-----
Sub Total......................... 682
Pennsylvania
Butler.............................. 39 12/97 Owned 61.5
Hermitage........................... 39 03/98 Owned 100.0
Indiana............................. 39 03/98 Owned 43.6
Johnstown........................... 39 06/98 Owned 46.2
Latrobe............................. 39 12/97 Owned 89.7
Lower Burrell....................... 39 01/97 Owned 100.0
New Castle.......................... 39 04/98 Owned 71.8
Penn Hills.......................... 39 05/98 Owned 53.9
Uniontown........................... 39 06/98 Owned 56.4
-----
Sub Total......................... 351
-----
Grand Total....................... 6,741
=====
- --------
(1) Reflects the date operations commenced, typically the licensure date for
developed residences and the date of purchase for acquired residences.
(2) As of June 30, 1999, we owned 105 residences, 37 of which were subject to
permanent mortgage financing and 68 of which were unencumbered, and we
leased 70 residences pursuant to long-term operating leases. See Notes 5
and 8 to the consolidated financial statements included elsewhere herein.
12
We also lease in total approximately 28,000 square feet of office space for
the Corporate and Regional offices in Portland, Oregon; Glendale, Arizona;
Dallas, Texas; Omaha, Nebraska; and Dublin, Ohio.
Construction and Development Activities
We are developing additional residences or expanding existing residences in
Indiana, Florida, Michigan, Iowa, New Jersey and South Carolina. As of June
30, 1999, we had six residences with 245 units that had received certificates
of occupancy but were not yet operating. In addition, we had four residences
with 156 units that were under construction as of the same date. We also owned
land for development of nine sites, including three for expansion projects,
where construction had not yet commenced. We have significantly reduced our
development activity in 1999 in order to focus on stabilizing our current base
of operating residences.
We generally locate our residences in well-established residential
neighborhoods in smaller rural and suburban communities, where the population
typically ranges from 10,000 to 40,000 with a higher than average percentage
of middle aged or elderly individuals. To provide the appropriate level of
personal care efficiently and economically, and to ensure that residents are
not intimidated by residence size, we develop residences ranging in size from
30 to 50 residential units and containing approximately 16,000 to 32,000 total
square feet, with studio and one-bedroom units comprising an average of 320
square feet and 450 square feet, respectively, of private living space.
Historically, we have either retained outside developers to construct
residences or acquired newly constructed residences from developers under
"turn-key" agreements. Since the end of 1997 we have expanded almost entirely
through outside development. Because of the planned reduction of development
activities in 1999, we intend to conduct an increasing portion of such
development activities internally. Where we use outside developers, we approve
all aspects of development including, among other things, market feasibility,
site selection, plans and specifications, the proposed construction budget and
selection of the architect and general contractor. We estimate the average
construction time for a typical residence to be approximately five to nine
months, depending upon the number of units.
ITEM 3. Legal Proceedings
Securityholder Litigation
Since February 1, 1999, 12 separate complaints, which have since been
consolidated into one action, have been filed against us and certain of our
officers and directors in the United States District Court for the District of
Oregon. On July 23, 1999, a consolidated complaint was filed in connection
with this litigation. The consolidated complaint purports to be brought on
behalf of a class of purchasers of our common stock from July 28, 1997 through
March 31, 1999 and on behalf of a class of purchasers of our Debentures from
the date of issuance through March 31, 1999. The consolidated complaint
alleges violations of the federal securities laws and seeks unspecified
damages. It also names as additional defendants certain of our directors that
were not named previously, as well as our independent auditors (solely in
connection with our 1998 offering of 5.625% Debentures) and the underwriters
in connection with our 1997 offering of 6.0% Debentures. We cannot predict the
outcome of the foregoing litigation and currently are unable to evaluate the
likelihood of success or the range of possible loss. However, if the foregoing
consolidated action were determined adversely to us, such a determination
could have a material adverse effect on our financial condition, results of
operations, cash flow or liquidity.
Other Litigation
In addition to the matter referred to in the immediately preceding
paragraph, we are involved in various lawsuits and claims arising in the
normal course of business. In the opinion of our management, although the
outcomes of these other suits and claims are uncertain, in the aggregate such
other suits and claims should not have a material adverse effect on our
financial condition, results of operations, cash flow or liquidity.
ITEM 4. Submission of Matters to a Vote of Security Holders
Not applicable.
13
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Our Common Stock, par value $0.01 (the "Common Stock"), is listed on the
American Stock Exchange ("AMEX") under the symbol "ALF." The following table
sets forth the high and low closing sales prices of the Common Stock, as
reported by the AMEX, for the periods indicated.
1997 1998
------------- -------------
High Low High Low
------ ------ ------ ------
Years ended December 31:
1st Quarter.................................. $10.68 $ 7.13 $21.63 $17.50
2nd Quarter.................................. 14.50 9.88 21.38 14.13
3rd Quarter.................................. 19.75 13.25 18.00 12.44
4th Quarter.................................. 22.38 15.75 14.50 9.88
For the period from January 1, 1999 to April 15, 1999, the high and low
closing sales prices of the Common Stock, as reported by the AMEX was $14.50
and $2.88, respectively. On April 15, 1999, the AMEX halted trading in the
Common Stock.
As of May 31, 1999, we had approximately 80 holders of record of Common
Stock. We are unable to estimate the number of additional stockholders whose
shares are held for them in street name or nominee accounts.
Our current policy is to retain any earnings to finance the operations and
expansion 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.
ITEM 6. Selected Financial Data
The following table presents selected historical condensed consolidated
financial data for us and our Predecessor. Our "Predecessor" consisted of:
Assisted Living Facilities, Inc., an S-Corporation; Madras Elder Care, a
partnership; and Lincoln City Partners, a partnership, which, prior to
December 31, 1994, owned the five residences operated by us in December 1994.
The consolidated statement of operations data of the Predecessor for the
eleven months ended November 30, 1994 and the consolidated statement of
operations data of the Company for the one month ended December 31, 1994 and
the year ended December 31, 1995, as well as the consolidated balance sheet
data at December 31, 1994, 1995 and 1996, are derived from our audited
consolidated financial statements and those of the Predecessor. The
consolidated statement of operations data for the years ended December 31,
1996, 1997 and 1998, as well as the consolidated balance sheet data at
December 31, 1997 and 1998, are derived from our consolidated financial
statements included elsewhere in this report which have been audited by KPMG
LLP, independent auditors. 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."
14
Predecessor The Company
------------ ------------------------------------------------
Eleven One Month
Months Ended Ended Years Ended December 31,
November 30, December 31, -----------------------------------
1994 1994 1995 1996 1997 1998
------------ ------------ ------- ------- ------- --------
(in thousands, except per share data)
Consolidated Statements
of Operations Data:
Revenue................. $1,841 $ 212 $ 4,067 $21,022 $49,605 $ 89,384
Operating expenses:
Residence operating
expenses............. 1,127 125 2,779 14,055 31,591 57,443
Management Fees....... 93 -- -- -- -- --
Corporate general and
administrative....... -- 152 1,252 1,864 4,050 11,099
Building rentals...... -- 42 798 3,949 7,969 12,764
Depreciation and
amortization......... 105 13 296 1,094 3,683 6,339
Terminated merger
expense.............. -- -- -- -- -- 1,068
Site abandonment
costs................ -- -- -- -- -- 2,377
Write-off of impaired
assets............... -- -- -- -- -- 8,521
------ ------ ------- ------- ------- --------
Total operating
expenses........... 1,325 332 5,125 20,962 47,293 99,611
------ ------ ------- ------- ------- --------
Operating income
(loss)................. 516 (120) (1,058) 60 2,312 (10,227)
------ ------ ------- ------- ------- --------
Other income (expense):
Interest expense...... 297 8 96 1,146 4,946 11,039
Interest income....... (12) (64) (579) (455) (1,526) (3,869)
Loss on sale of
assets............... -- -- -- 854 1,250 651
Debenture conversion
costs................ -- -- -- 426 -- --
Other expenses........ -- -- -- 4 121 1,174
------ ------ ------- ------- ------- --------
Total other (income)
expenses........... 285 (56) (483) 1,975 4,791 8,995
------ ------ ------- ------- ------- --------
Income (loss) before
taxes and
cumulative effect of
change in
accounting principle... 231 (64) (575) (1,915) (2,479) (19,222)
Provision for income
taxes.................. 85 -- -- -- -- --
Cumulative effect of
change in
accounting principle... -- -- -- -- -- (1,523)
------ ------ ------- ------- ------- --------
Net income (loss)....... $ 146 $ (64) $ (575) $(1,915) $(2,479) $(20,745)
====== ====== ======= ======= ======= ========
Basic and diluted net
loss per common share:
Loss before cumulative
effect of change in
accounting
principle............ -- $(0.01) $ (0.10) $ (0.23) $ (0.21) $ (1.18)
Cumulative effect of
change in accounting
principle............ -- -- -- -- -- $ (0.09)
------ ------ ------- ------- ------- --------
Basic and diluted net
loss per common share.. -- $(0.01) $ (0.10) $ (0.23) $ (0.21) $ (1.27)
====== ====== ======= ======= ======= ========
Basic and diluted
weighted average common
shares outstanding..... -- 6,000 6,000 8,404 11,871 16,273
At December 31,
--------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
(in thousands)
Consolidated Balance Sheet Data:
Working capital.................. $13,122 $(5,320) $(27,141) $ 40,062 $ 43,856
Total assets..................... 17,903 53,546 147,223 324,367 414,669
Long-term debt, excluding current
portion......................... 1,101 24,553 49,663 157,700 266,286
Shareholders' equity............. 16,219 15,644 56,995 132,244 119,197
15
Quarterly Financial Data (Unaudited)
(in thousands except per share data)
1997 Quarterly Financial Data 1998 Quarterly Financial Data
----------------------------------------- ---------------------------------------------
1st 2nd 3rd 4th Year to 1st 2nd 3rd 4th Year to
Qtr Qtr Qtr Qtr Date Qtr Qtr Qtr Qtr Date
------ ------- ------- ------- ------- ------- -------- ------- ------- --------
Results of Operations
Revenue................. $9,479 $11,108 $12,765 $16,253 $49,605 $18,773 $ 21,353 $24,012 $25,246 $ 89,384
Operating income
(loss)................. 805 1,010 303 194 2,312 1,408 (8,609) 1,657 (4,684) (10,227)
Net income (loss) before
cumulative effect of
change in accounting
principle.............. 31 (74) (1,475) (961) (2,479) 739 (11,831) (720) (7,410) (19,222)
Change in accounting
principle.............. -- -- -- -- -- (1,523) -- -- -- (1,523)
Net income (loss)....... 31 (74) (1,475) (961) (2,479) (784) (11,831) (720) (7,410) (20,745)
Basic and diluted income
(loss) per share(1)
Income (loss) per common
share before cumulative
effect of change in
accounting principle... 0.00 (0.01) (0.13) (0.07) (0.21) 0.05 (0.75) (0.04) (0.43) (1.18)
Cumulative effect of
change in accounting
principle.............. -- -- -- -- -- (0.10) -- -- -- (0.09)
Loss per share.......... $ 0.00 $ (0.01) $ (0.13) $ (0.07) $ (0.21) $ (0.05) $ (0.75) $ (0.04) $ (0.43) $ (1.27)
Basic and diluted
weighted average common
shares outstanding..... 11,004 11,044 11,084 14,429 11,871 15,688 15,679 16,604 17,094 16,273
- --------
(1) Quarter net income (loss) per share amounts may not add to the full year
total due to rounding.
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Restatement
On February 1, 1999, we announced that after consultation with our
independent auditors, we would restate our financial statements for the fiscal
quarter ended June 30, 1997, the fiscal quarter ended September 30, 1997, the
fiscal year ended December 31, 1997, the fiscal quarter ended March 31, 1998,
the fiscal quarter ended June 30, 1998 and the fiscal quarter ended September
30, 1998. On March 31, 1999, we announced that the restatement would be more
extensive than we had previously believed, and might include periods prior to
the second quarter of 1997, including the fiscal year ended December 31, 1996.
After further consultation with our independent auditors, we determined to
restate our financial statements for the fiscal year ended December 31, 1996,
the fiscal year ended December 31, 1997 and each of the first three fiscal
quarters of the fiscal year ended December 31, 1998.
The restatement reduced the net income for the fiscal years ended December
31, 1996 and 1997 and for the nine months ended September 30, 1998 by $2.1
million, $6.7 million and $11.0 million, respectively. The cumulative effect
of the restatement reduced shareholders' equity by $19.7 million through
September 30, 1998. As a result of the restatement, we reported net losses of
$1.9 million, $2.5 million and $13.3 million for the fiscal years 1996 and
1997 and the nine months ended September 30, 1998, respectively, compared to
previously reported net income of $149,000, $4.2 million and a net loss of
$2.4 million, respectively. As a result of the restatement, the Company
reported net loss per diluted share of $0.23, $0.21 and $0.84 for the fiscal
years ended December 31, 1996 and 1997 and the nine months ended September 30,
1998, respectively, compared to previously reported net income of $0.03 and
$0.34, and net loss of $0.14, per diluted share, respectively. After the
restatement, the Company's cash position as of December 31, 1996 and 1997 and
as of September 30, 1998 was $2.1 million, $63.3 million and $79.6 million,
respectively, as compared to $2.1 million, $63.4 million and $79.8 million,
respectively, as previously reported. In addition, our working capital
position as of December 31, 1996 and 1997 and as of September 30, 1998 was
negative $27.1 million, positive $40.1 million and positive
16
$63.0 million, respectively, as compared to previously reported working
capital of negative $26.4 million, positive $41.0 million and positive $64.1
million, respectively.
The restatement resulted primarily from: (i) the earlier recognition of
certain expenses that we previously capitalized in association with our
development and financing activities; (ii) a modification in how we accounted
for certain of our lease arrangements; (iii) a modification in how we
accounted for certain of our acquisitions and our joint venture arrangements;
(iv) the capitalization of fees we received during 1997 and 1998 that we
previously recorded as a reduction of expenses or other income; (v) the
elimination of an impairment write-down that we had previously recorded on
three of our residences; (vi) the elimination of certain accrued expenses
previously recorded pursuant to a change in accounting principle and (vii) an
increase in the amount of goodwill that we wrote off in the second quarter of
1998 related to exiting our home health operations.
Overview
We operate free-standing assisted living residences, primarily 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
regulations) designed to meet the personal and health care needs of our
residents. As of June 30, 1999, we had operations or development activities in
five regions (as defined by ALC) in 16 states.
We have experienced significant and rapid growth, 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 began operating five residences (137
units) located in Oregon. As of June 30, 1999, we had received certificates of
occupancy on 181 residences (6,986 units), of which 175 residences (6,741
units) were included in operating results. Residences typically receive a
certificate of occupancy upon completion of construction. Residences are
included in operating results when they receive a license or its equivalent
from the state in which they are located. It may take several months to
receive a license after receiving a certificate of occupancy. Of the
residences included in our operating results, we owned 105 residences (4,121
units) and leased 70 residences (2,620 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 responsible
parties. Resident fees include revenue derived from a multi-tiered rate
structure, which varies based 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 corporate and regional
support functions such as legal, accounting and other administrative
expenses;
. building rentals; and
. depreciation and amortization.
Our operating results for the year ended December 31, 1998 were adversely
affected by several factors, including:
. write-offs in the second quarter and fourth quarter relating to our
decisions not to proceed with the development of certain sites which we
had acquired for development;
. a write-off in the second quarter relating to our decision to
discontinue the home health care business which we acquired in October
1997; and
. merger related expenses incurred during the fourth quarter related to
our proposed merger with ARC.
17
In addition, our results of operations were negatively impacted, commencing
in the fourth quarter of 1998, as a result of the diversion of management's
time and attention resulting from the proposed merger with ARC and its
subsequent termination, as well as from certain regulatory issues in
Washington and Oregon. These distractions continued into 1999 and, as such,
our operating results for the year ended December 31, 1998 are not necessarily
indicative of our future operating performance. With respect to our Stabilized
Residences (as defined below), we expect our operating margins to be
substantially lower in 1999 because our occupancy rates have declined and our
operating expenses have increased in those residences. This is partly due to
increased competition in certain markets for labor and residents and partly
due to the diversion of management's time and attention relating to the
matters described above, and also to a restatement of our financial statements
for certain prior periods and the securityholder litigation, both of which
commenced in February 1999. These factors have also resulted in slower fill-up
and increased operating expenses in our Start-Up Residences (as defined
below).
For the year ended December 31, 1998, we commenced operations in 57
additional residences, 53 of which were developed and four of which were
acquired. We intend to commence operation on an additional 20 residences
during the year ended December 31, 1999 (the "1999 Period"), 10 of which had
commenced operation through June 30, 1999. In addition to the development and
construction costs incurred during 1998 with respect to these residences, we
expect to incur up to an additional $30.0 million in capital expenditures and
related start-up costs for the twelve months ended December 31, 1999,
approximately $25.0 million of which had been incurred as of June 30, 1999. We
expect that Start-Up Residences will incur significant operating losses during
the fill-up period. As a result, our operating results will be adversely
affected by operating losses at certain residences, primarily Start-Up
Residences, which we expect will range from $3.5 million to $5.0 million
during 1999.
We believe that our current cash on hand and our working capital resources
will be sufficient to meet our capital needs for the next 12 to 18 months.
However, to provide us with additional capital, we may explore various
financing alternatives and/or commitments to engage in sale and leaseback
transactions. We currently do not have in place any of such loan or lease
commitments. As a result of the securityholder litigation, the restatement and
other factors, there can be no assurances that financing from any source will
be available in the future, or, if available, that such financing will be on
terms acceptable to us. See "Liquidity and Capital Resources" and "Risk
Factors--We may require additional financing."
Results of Operations
The following table sets forth, for periods presented, the number of total
residences and units operated, average occupancy rates and the sources of our
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."
Years Ended
December 31,
-------------------
Total Residences 1996 1997 1998
---------------- ----- ----- -----
Residences operated (end of period)..................... 60 109 165
Units operated (end of period).......................... 2,139 4,024 6,329
Average occupancy rate.................................. 76.7% 71.7% 72.3%
Sources of revenue:
Medicaid state portion................................ 12.4% 11.1% 10.7%
Medicaid resident portion............................. 6.9% 5.9% 5.8%
Private............................................... 80.7% 83.0% 83.5%
----- ----- -----
Total............................................... 100.0% 100.0% 100.0%
===== ===== =====
18
The following table sets forth, for the periods presented for Stabilized
Residences, the total number of residences and units operated, average
occupancy rates and the sources of our revenue. Stabilized Residences are
defined as those residences, which were operating for more than twelve months
prior to the beginning of the period or had achieved a 95% occupancy rate as
of the beginning of the reporting period.
Years Ended
December 31,
-------------------
Stabilized Residences 1996 1997 1998
--------------------- ----- ----- -----
Residences operated (end of period)..................... 7 32 65
Units operated (end of period).......................... 204 1,063 2,434
Average occupancy rate.................................. 96.5% 95.1% 93.9%
Sources of revenue:
Medicaid state portion................................ 19.9% 11.4% 14.5%
Medicaid resident portion............................. 11.5% 6.5% 8.2%
Private............................................... 68.6% 82.1% 77.3%
----- ----- -----
Total............................................... 100.0% 100.0% 100.0%
===== ===== =====
The following table sets forth, for the periods presented for Start-up
Residences, the total number of residences and units operated, average
occupancy rates and the sources of our revenue. Start-up Residences are
defined as those residences, which were operating for less than twelve months
prior to the beginning of the period or had not achieved a 95% occupancy rate
as of the beginning of the reporting period.
Years ended
December 31,
-------------------
Start-up Residences 1996 1997 1998
------------------- ----- ----- -----
Residences operated (end of period)..................... 53 77 100
Units operated (end of period).......................... 1,935 2,961 3,895
Average occupancy rate.................................. 73.0% 59.8% 55.7%
Sources of revenue:
Medicaid state portion................................ 9.8% 11.3% 7.1%
Medicaid resident portion............................. 5.3% 5.7% 3.4%
Private............................................... 84.9% 83.0% 89.5%
----- ----- -----
Total............................................... 100.0% 100.0% 100.0%
===== ===== =====
The following table sets forth, for the periods presented for Same Store
Residences, the total number of residences and units operated, average
occupancy rates and the sources of our revenue. Same Store Residences are
defined as those residences, which were operating throughout comparable
periods.
Years ended Years ended
December 31, December 31,
------------ ------------
Same Store Residences 1996 1997 1997 1998
--------------------- ----- ----- ----- -----
Residences operated (end of period).............. 19 19 59 59
Units operated (end of period)................... 595 605 2,104 2,157
Average occupancy rate........................... 90.0% 95.6% 86.9% 93.5%
Sources of revenue:
Medicaid state portion......................... 16.1% 13.8% 11.9% 15.1%
Medicaid resident portion...................... 9.1% 7.6% 6.5% 8.7%
Private........................................ 74.8% 78.6% 81.6% 76.2%
----- ----- ----- -----
Total........................................ 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
19
The following tables relating to Stabilized Residences, Start-up Residences
and Same Store Residences exclude the effects of corporate level expenses,
including general and administrative expenses and corporate level interest
expense. In addition, the following tables exclude the effect of the
capitalization of corporate and property level interest expense.
The following table sets forth, for the periods presented, the results of
operations for Stabilized Residences (in thousands).
Years ended December 31,
------------------------
Stabilized Residences 1996 1997 1998
--------------------- ------- ------- --------
Revenue..,,,,,,..................................... $4,084 $21,245 $46,260
Residence operating expenses........................ 2,422 12,255 27,456
------- ------ -------
Residence operating income.......................... 1,662 8,990 18,804
Building rentals.................................... 935 3,323 7,193
Depreciation and amortization....................... 138 945 1,777
------ ------- -------
Total other operating expenses...................... 1,073 4,268 8,970
------ ------- -------
Operating income.................................... $ 589 $ 4,722 $ 9,834
====== ======= =======
The following tables sets forth, for the periods presented, the results of
operations for Start-up Residences (in thousands).
Years ended December 31,
------------------------
Start-up Residences 1996 1997 1998
------------------- -------- ------- -------
Revenue............................................. $16,938 $27,164 $40,013
Residence operating expenses........................ 11,633 18,519 27,591
------- ------- -------
Residence operating income........................ 5,305 8,645 12,422
Building rentals.................................... 3,014 4,612 5,535
Depreciation and amortization....................... 956 2,010 4,063
------- ------- -------
Total other operating expenses.................... 3,970 6,622 9,598
------- ------- -------
Operating income................................ $ 1,335 $ 2,023 $ 2,824
======= ======= =======
The following table sets forth, for the periods presented, the results of
operations for the 19 Same Store Residences included in operating results for
all of fiscal years 1996 and 1997, and the 59 Same Store Residences included
in operating results for all of fiscal years 1997 and 1998 (in thousands).
Years ended Years ended
December 31, December 31,
--------------- ---------------
Same Store Residences 1996 1997 1997 1998
--------------------- ------- ------- ------- -------
Revenue..................................... $10,877 $12,397 $38,274 $42,002
Residence operating expenses................ 6,682 7,070 22,908 24,801
------- ------- ------- -------
Residence operating income................ 4,195 5,327 15,366 17,201
Building rentals............................ 2,374 2,440 5,635 6,375
Depreciation and amortization............... 543 461 2,280 1,647
------- ------- ------- -------
Total other operating expenses............ 2,917 2,901 7,915 8,022
------- ------- ------- -------
Operating income........................ $ 1,278 $ 2,426 $ 7,451 $ 9,179
======= ======= ======= =======
20
Year ended December 31, 1998 compared to year ended December 31, 1997
We incurred a net loss (after the cumulative effect of change in accounting
principle and other charges as described below) of $20.7 million, or $1.27 per
basic and diluted share, on revenue of $89.4 million for the year ended
December 31, 1998 (the "1998 Period") as compared to a net loss of $2.5
million, or $0.21 per basic and diluted share, on revenue of $49.6 million for
the year ended December 31, 1997 (the "1997 Period").
We had certificates of occupancy for 173 residences, 165 of which were
included in the operating results as of the end of the 1998 Period as compared
to 130 residences with certificates of occupancy, 109 of which were included
in the operating results as of the end of the 1997 Period. Of the residences
included in operating results as of the end of the 1998 Period, we owned 95
residences and leased 70 residences (54 of which were operating leases and 16
of which were accounted for as financings) as compared to 42 owned residences
and 67 leased residences (51 of which were operating leases and 16 of which
were accounted for as financings) as of the end of the 1997 Period.
Revenue. Revenue was $89.4 million for the 1998 Period as compared to $49.6
million for the 1997 Period, an increase of $39.8 million. Of this increase:
. $18.5 million or 46.5% related to the full year impact of the 49
residences (1,875 units) which opened during the 1997 Period;
. $15.7 million or 39.4% related to the opening of an additional 57
residences (2,297 units) during the 1998 Period;
. $3.7 million or 9.3% was attributable to the 59 Same Store Residences
(2,157 units); and
. the remaining $1.9 million or 4.8% related to our ancillary service
operation.
Revenue from the Same Store Residences was $42.0 million for the 1998 Period
as compared to $38.3 million for the 1997 Period, an increase of $3.7 million
or 9.7%. The increase in revenue for Same Store Residences was attributable to
a combination of an increase in average occupancy to 93.5% and average monthly
rental rate to $1,753 for the 1998 Period as compared to 86.9% and $1,720,
respectively, for the 1997 Period.
Of the $89.4 million in revenues reported for the 1998 Period:
. $46.3 million or 51.8% was attributable to Stabilized Residences;
. $40.0 million or 44.7% was attributable to Start-Up Residences; and
. $3.1 million or 3.5% was attributable to our ancillary service
operation.
As of the end of the 1998 Period, we had 65 Stabilized Residences (2,434
units) with an average occupancy of 93.9% and an average monthly rental rate
of $1,762 and we had 100 Start-Up Residences (3,895 units) with an average
occupancy of 55.7% and an average monthly rental rate of $1,934.
Residence Operating Expenses. Residence operating expenses were $57.4
million for the 1998 Period as compared to $31.6 million for the 1997 Period,
an increase of $25.8 million. Of this increase:
. $10.5 million or 40.7% related to the full year impact of the 49
residences (1,885 units) which opened during the 1997 Period;
. $11.8 million or 45.7% related to the opening of an additional 57
residences (2,297 units) during the 1998 Period;
. $1.9 million or 7.4% was attributable to the 59 Same Store Residences
(2,157 units); and
. the remaining $1.6 million or 6.2% related to expenses associated with
our ancillary service operation.
Residence operating expenses for the Same Store Residences were $24.8
million for the 1998 Period as compared to $22.9 million for the 1997 Period,
an increase of $1.9 million or 8.3%. This increase results from
21
the additional expenses incurred in connection with the increase in occupancy
at the Same Store Residences during the period.
Of the $57.4 million in residence operating expenses reported for the 1998
Period, $27.5 million or 47.9% was attributable to Stabilized Residences,
$27.6 million or 48.1% was attributable to Start-Up Residences and $2.3
million or 4.0% was attributable to our ancillary service operation.
Corporate General and Administrative. Corporate general and administrative
expenses as reported were $11.1 million for the 1998 Period as compared to
$4.1 million for the 1997 Period. Our corporate general and administrative
expenses before capitalized payroll costs were $12.9 million for the 1998
Period as compared to $5.9 million for the 1997 Period, an increase of $7.0
million. This increase results from additional investments in our corporate
and regional infrastructure to support the opening of new residences and the
on-going operation of our existing base of residences. Of the increase:
. $3.9 million or 56.0% related to increased payroll costs;
. $525,000 or 7.5% related to increased marketing expenses;
. $450,000 or 6.5% related to the increased corporate office rental
expense; and
. the remaining $2.1 million or 30.0% related to increased general
corporate expenses such as legal and travel related expenses.
We capitalized $1.8 million of payroll costs associated with the development
of new residences for each of the 1998 Period and the 1997 Period.
We expect to incur increased corporate general and administrative expenses
for the 1999 Period primarily as a result of:
. the increase in the number of regional offices from three to five;
. increased marketing and advertising expenses associated with residence
fill-up activities;
. an increase in professional fees associated with the restatement and
security-holder litigation;
. an increase in severance expense associated with management changes; and
. an increase in expenses associated with final operations of our home
health operations.
In addition, corporate general and administrative expenses as reported in
the 1999 Period are expected to increase as a result of the reduction in the
amount of capitalized payroll costs associated with development activities.
Building Rentals. Building rentals were $12.8 million for the 1998 Period as
compared to $8.0 million for the 1997 Period, an increase of $4.8 million. Of
the increase:
. $4.2 million was the result of the full year impact of the 26 operating
leases entered into during the 1997 Period;
. $400,000 related to the four leases entered into during the 1998 Period;
and
. the remainder of the increase was primarily driven by an increase in
expense on leases entered into prior to the 1997 Period offset by one
operating lease which was terminated during the 1998 Period.
As of the end of the 1998 Period we had 54 operating leases as compared to
51 operating leases as of the end of the 1997 Period.
Depreciation and Amortization. Depreciation and amortization was $6.3
million for the 1998 Period as compared to $3.7 million for the 1997 Period,
an increase of $2.6 million. Depreciation expense was $5.9 million
22
and amortization expense was $398,000 for the 1998 Period as compared to $2.9
million and $800,000, respectively, for the 1997 Period. The increase in
depreciation is the result of:
. the full year effect of depreciation on the 16 owned residences which
commenced operations during the 1997 Period;
. depreciation associated with the 53 owned residences that commenced
operations during the 1998 Period; and
. depreciation associated with the full year impact of seven residences
which were sold and leased back during the 1997 Period which were
accounted for as financings.
Amortization expense decreased as a result of the change in accounting for
certain costs incurred prior to opening new residences. Effective January 1,
1998, we adopted Statement of Position 98-5, Reporting on the Costs of Start-
Up Activities ("SOP 98-5"). See the discussion of cumulative effect of change
in accounting principle below.
Terminated Merger Expense. During the fourth quarter of the 1998 Period, we
recorded a $1.1 million charge relating to our terminated merger with ARC. On
February 1, 1999 we agreed with ARC to terminate our previously announced
merger agreement, which had been entered into during November 1998. We
incurred approximately $200,000 of additional merger related expenses during
the first quarter of 1999.
Site Abandonment Costs. As a result of our decision to reduce the number of
new residence openings during the 1999 Period and beyond, we wrote-off $2.4
million of capitalized costs during the 1998 Period relating to the
abandonment of 36 development sites. Of such costs, $1.0 million were written-
off during the second quarter and the remaining $1.4 million were written-off
during the fourth quarter 1998. We had not written-off any such costs prior to
1998.
As a result of a continued reduction in our new residence development
activities, we will incur write-offs of $1.3 million relating to previously
capitalized development costs during the first quarter of 1999 and an
additional $3.5 million in the second quarter of 1999. In the event that in
the future we do not complete and open residences planned for development, we
may incur similar write-offs. However, we have no present intention of
commencing further development activity beyond the 10 residences currently
included in construction in process as of June 30, 1999.
Write-Off of Impaired Assets and Related Expenses. In the 1998 Period, we
recorded an $8.5 million charge consisting of:
. $7.5 million write-off of unamortized goodwill resulting from the exit
from our home health operations;
. a $1.0 million provision for exit costs associated with closing such
home health care operation. During the fourth quarter of 1998, we
reduced the provision by $400,000 from $1.4 million as a result of a
change in the estimate for such exit costs.
Interest Expense. Interest expense was $11.0 million for the 1998 Period as
compared to $4.9 million for the 1997 Period. Gross interest expense for the
1998 Period was $17.0 million compared to $11.5 million for the 1997 Period, a
net increase of $5.5 million.
Interest expense increased by:
. $4.8 million due to the full year impact of interest expense related to
the October 1997 issuance of 6.0% Debentures;
. $3.6 million due to interest expense related to the April 1998 issuance
of 5.625% Debentures;
. $1.8 million related to the new mortgage financing entered into during
the 1998 Period;
23
. $750,000 related to the full year impact of seven residences which were
sold and leased back during the 1997 Period which were accounted for as
financings; and
. $475,000 related to interest expense associated with losses which were
reimbursed by the partner to our joint venture agreement (accounted for
as loans) incurred in connection with the operation of joint venture
residences (interest was calculated based on the average loan balance
using an imputed 20% interest rate, and other expense was calculated
based on a $10,000 administrative fee per residence).
This increase was offset by:
. a $5.5 million reduction associated with construction financing used to
fund development activity during the 1997 Period which was either repaid
or converted to leases prior to the 1998 Period; and
. a $400,000 reduction as a result of the redemption in August 1998 of the
7.0% Convertible Subordinated Debentures due 2005 (the "7.0%
Debentures").
We capitalized $6.0 million of interest expense for the 1998 Period compared
to $6.6 million for the 1997 Period. We expect a further reduction in the
amount of capitalized interest in the 1999 Period as a result of the reduction
in our development activities. As such, we expect reported interest expense in
the 1999 Period to increase.
Interest Income. Interest income was $3.9 million for the 1998 Period as
compared to $1.5 million for the 1997 Period, an increase of $2.4 million. The
increase is related to interest income earned on higher average cash balances
during the 1998 Period primarily resulting from the April 1998 offering of the
5.625% Debentures from which we received net proceeds of approximately $72.2
million.
Loss on Sale of Assets. Loss on sale of assets was $651,000 for the 1998
Period as compared to $1.3 million for the 1997 Period. Of the loss on sale of
assets recorded during the 1998 Period, $547,000 resulted from losses
pertaining primarily to additional capital costs incurred during the 1998
Period on sale and leaseback transactions completed in the 1997 Period and
$75,000 related to losses incurred in connection with terminating one
operating lease during the 1998 Period. The remainder of the loss on sale of
assets was attributable to losses incurred in connection with one sale and
leaseback transaction completed during the 1998 Period. We entered into four
sale and leaseback transactions during the 1998 Period as compared to 24 sale
and leaseback transactions during the 1997 Period.
Other Expenses. Other expense was $1.2 million for the 1998 Period as
compared to $121,000 for the 1997 Period. Other expenses during the 1998
Period included $907,000 of financing costs which were expensed during the
period. Of such amount, $614,000 related to financing costs which had been
previously capitalized and deferred in association with a future financing
commitment terminated during the fourth quarter 1998 and the remaining
$293,000 was associated with the termination of a swap agreement at the end of
the third quarter of the 1998 Period. In addition, other expenses during the
1998 Period included $210,000 of administrative fees incurred in connection
with our repurchase of the joint venture partner's interest in the operations
of 21 residences during the period.
Cumulative Effect of Change in Accounting Principle. We adopted AICPA
Statement of Position 98-5, Reporting on the Costs of Start-up Activities
("SOP 98-5") effective January 1, 1998. Under SOP 98-5, start-up costs
associated with the opening of new residences are expensed as incurred. We
recognized a charge of $1.5 million during the 1998 Period associated with
adopting such provision. Prior to the adoption of SOP 98-5, we capitalized
pre-opening costs on our balance sheet and amortized such costs over a 12-
month period.
Net Loss. As a result of the above, net loss (after the cumulative effect of
change in accounting principle and other charges as described above) was $20.7
million or $1.27 per basic and diluted share for the 1998 Period, compared to
$2.5 million, or $0.21 per basic and diluted share for the 1997 Period.
24
Year ended December 31, 1997 compared to year ended December 31, 1996
We incurred a net loss of $2.5 million, or $0.21 per basic and diluted
share, on revenue of $49.6 million for the year ended December 31, 1997 (the
"1997 Period") as compared to a net loss of $1.9 million, or $0.23 per basic
and diluted share, on revenues of $21.0 million for the year ended December
31, 1996 (the "1996 Period").
We had certificates of occupancy for 130 residences, 109 of which were
included in the operating results as of the end of the 1997 Period as compared
to 67 residences with certificates of occupancy, 60 of which were included in
the operating results as of the end of the 1996 Period. Of the residences
included in the operating results as of the end of the 1997 Period, we owned
42 residences and leased 67 residences (51 of which were operating leases and
16 of which were accounted for as financings) as compared to 26 owned
residences and 34 leased residences (25 of which were operating leases and
nine of which were accounted for as financings) as of the end of the 1996
Period.
Revenue. Revenue was $49.6 million for the 1997 Period as compared to $21.0
million for the 1996 Period, an increase of $28.6 million. Of this increase:
. $13.2 million or 46.2% related to the full year impact of the 41
residences (1,544 units) which opened during the 1996 Period;
. $12.7 million or 44.4% related to the opening of an additional 49
residences (1,875 units) during the 1997 Period;
. $1.5 million or 5.2% was attributable to the 19 Same Store Residences
(605 units); and
. the remaining $1.2 million or 4.2% related to ancillary revenues earned
in connection with the acquisition of Home and Community Care, Inc.
("HCI").
Revenue from the Same Store Residences was $12.4 million for the 1997 Period
as compared to $10.9 million for the 1996 Period, an increase of $1.5 million
or 13.8%. All of the increase in revenue for Same Store Residences was
attributable to an increase in average occupancy to 95.6% for the 1997 period
as compared to 90.0% for the 1996 period. The average monthly rental rate for
the Same Store Residences increased to $1,772 for the 1997 Period as compared
to $1,670 per month for the 1996 Period.
Of the $49.6 million in revenues reported for the 1997 Period:
. $21.2 million or 42.8% was attributable to Stabilized Residences;
. $27.2 million or 54.8% was attributable to Start-Up Residences; and
. $1.2 million or 2.4% was attributable to ancillary service operations.
As of the end of the 1997 Period, we had 32 Stabilized Residences (1,063
units) with an average occupancy of 95.1% and an average monthly rental rate
of $1,735 and we had 77 Start-Up Residences (2,961 units) with an average
occupancy of 59.8% and an average monthly rental rate of $1,782.
Residence Operating Expenses. Residence operating expenses were $31.6
million for the 1997 Period as compared to $14.1 million for the 1996 Period,
an increase of $17.5 million. Of this increase:
. $6.1 million or 34.9% related to the full year impact of the 41
residences (1,544 units) which opened during the 1996 Period;
. $10.2 million or 58.3% related to the opening of an additional 49
residences (1,885 units) during the 1997 Period;
. $388,000 or 2.2% was attributable to the 19 Same Store Residences (605
units); and
. the remaining $800,000 or 4.6% related to expenses associated with our
ancillary service operation.
Residence operating expenses for the Same Store Residences were $7.1 million
for the 1997 Period as compared to $6.7 million for the 1996 Period, an
increase of $388,000 or 5.8%. This increase results from the
25
additional expenses incurred in connection with the increase in occupancy at
the Same Store Residences during the period.
Of the $31.6 million in residence operating expenses reported for the 1997
Period, $12.3 million or 38.9% was attributable to Stabilized Residences,
$18.5 million or 58.6% was attributable to Start-Up Residences and $800,000 or
2.5% was attributable to our ancillary service operation.
Corporate General and Administrative. Corporate general and administrative
expenses were $4.1 million for the 1997 Period as compared to $1.9 million for
the 1996 Period. Our corporate general and administrative expenses before
capitalized payroll costs were $5.9 million for the 1997 Period as compared to
$3.0 million for the 1996 Period, an increase of $2.9 million. This increase
results from an additional investment in our corporate and regional
infrastructure to support the development and operation of new residences
including the expansion into new states.
We capitalized $1.8 million of payroll costs for the 1997 Period as compared
to $1.1 million for the 1996 Period resulting from an increase in development
activities.
Building Rentals. Building rentals were $8.0 million for the 1997 Period as
compared to $4.0 million for the 1996 Period, an increase of $4.0 million. Of
this increase, $1.3 million or 32.5% related to the full year impact of the 20
leases (four of which were repurchased) entered into during the 1996 Period
and the remaining $2.7 million or 67.5% related to the 26 leases entered into
during the 1997 Period. The nine leases entered into prior to the 1996 Period
remained relatively unchanged. As of the end of the 1997 Period we had 51
operating leases as compared to 25 operating leases as of the end of the 1996
Period.
Depreciation and Amortization. Depreciation and amortization was $3.7
million for the 1997 Period as compared to $1.1 million for the 1996 Period,
an increase of $2.6 million. Depreciation expense was $2.9 million and
amortization expense was $800,000 for the 1997 Period as compared to $805,000
and $289,000, respectively, for the 1996 Period. The increase in depreciation
is the result of:
. the full year effect of depreciation on the 26 owned residences which
commenced operations during the 1996 Period;
. depreciation associated with the 16 owned residences that commenced
operations during the 1997 Period; and
. depreciation associated with the sale and leaseback of seven residences
during the 1997 Period and nine residences during the 1996 Period which
were accounted for as financings.
Amortization expense increased as a result of the amortization of additional
pre-opening costs and goodwill.
Interest Expense. Interest expense was $4.9 million for the 1997 Period as
compared to $1.2 million for the 1996 Period. Gross interest expense for the
1997 Period was $11.5 million compared to $3.5 million for the 1996 Period, an
increase of $8.0 million. Of the increase:
. $5.3 million or 66.2% was due to construction financing used to fund
development activity during the 1997 Period;
. $1.5 million or 18.7% was related to the sale and leaseback of an
additional seven residences during the 1997 Period which were accounted
for as financings;
. $1.1 million or 13.8% was due to interest expense related to the October
1997 issuance of the 6.0% Debentures; and
. the remaining $100,000 or 1.3% was related to new mortgage financing
incurred during the 1997 Period.
26
We capitalized $6.6 million of interest expense for the 1997 Period compared
to $2.3 million for the 1996 Period. We completed the sale and leaseback of
seven residences during the 1997 Period and nine residences during the 1996
Period, which were accounted for as financings, and recorded building rental
payments as interest expense.
Interest Income. Interest income was $1.5 million for the 1997 Period as
compared to $455,000 for the 1996 Period, an increase of $1.1 million. The
increase is related to interest income earned on higher average cash balances
during the 1997 Period primarily resulting from the October 1997 offerings of
common stock and the 6.0% Debentures from which we received net proceeds of
approximately $155.0 million.
Loss on Sale of Assets. Loss on sale of assets was $1.3 million for the 1997
Period as compared to $854,000 (net of an $82,000 gain on the sale of land)
for the 1996 Period. Of the loss on sale of assets recorded during the 1997
Period, $650,000 or 52.0% resulted from losses incurred in connection with 10
sale and leaseback transactions entered into during the 1997 Period and the
remaining $600,000 or 48.0% resulted from losses resulting primarily from
additional capital costs incurred during the 1997 Period on sale and leaseback
transactions completed in the 1996 Period. We entered into 24 sale and
leaseback transactions during the 1997 Period as compared to 19 sale and
leaseback transactions (four of which were repurchased) during the 1996
Period.
Debenture Conversion Cost. In the third quarter of 1996, $6.1 million of the
$20.0 million of 7% Debentures were converted into 811,333 shares of our
common stock. We incurred a charge of $426,000 during the third quarter of the
1996 Period in connection with the conversion.
Net Loss. As a result of the above, net loss was $2.5 million or $0.21 per
basic and diluted share for the 1997 Period, compared to a net loss of $1.9
million, or $0.23 per basic and diluted share for the 1996 Period.
Liquidity and Capital Resources
We have historically financed our activities with the net proceeds from the
offerings of debt and equity securities, sale and leaseback financing, long-
term mortgage financing and cash flows from operations. At December 31, 1998,
we had $267.7 million of indebtedness outstanding, including $161.3 million of
convertible subordinated debentures. As of December 31, 1998, approximately
89% of our indebtedness bore interest at fixed rates, with a weighted average
interest rate of 6.9%. Our variable rate indebtedness carried an average rate
of 3.6% as of December 31, 1998. As of December 31, 1998, we had working
capital of $43.9 million as compared to $40.1 million as of December 31, 1997.
As of December 31, 1998, our unrestricted cash balance was $55.0 million as
compared to $63.4 million as of December 31, 1997.
Net cash provided by operating activities was $3.0 million for the year
ended December 31, 1998, as compared with $4.5 million provided by operating
activities for the year ended December 31, 1997 and $3.1 million used in
operating activities for the year ended December 31, 1996, respectively.
Net cash used in investing activities was $123.3 million for the year ended
December 31, 1998, as compared with $94.0 million and $82.3 million,
respectively, for the years ended December 31, 1997 and 1996. During the year
ended December 31, 1998, the primary uses of cash were:
. $118.0 million related to the development of new assisted living
residences in Arizona, Iowa, Indiana, Nebraska, New Jersey, Ohio,
Pennsylvania, South Carolina, Florida, Michigan and Washington;
. $11.4 million related to the acquisition of three residences in Texas
and one residence in Louisiana; and
. $4.0 million invested in marketable securities.
27
During the year ended December 31, 1998, we received proceeds of $8.1
million relating to the sale and leaseback of three residences and
restrictions on $2.0 million of funds held in trust were released. In
addition, we converted construction financing on one residence of
approximately $2.2 million into an operating lease through the completion of a
sale and leaseback transaction.
Net cash provided by financing activities was $112.0 million for the year
ended December 31, 1998, as compared with $150.6 million and $87.2 million,
respectively, for the years ended December 31, 1997 and 1996. In April 1998,
we completed the offering of $75.0 million of 5.625% Debentures due May 2003
realizing net proceeds of $72.2 million after discounts, commissions and other
expenses. The 5.625% Debentures are convertible at any time at or prior to
maturity, unless previously redeemed, at a conversion price of $26.184 per
common share, which equates to an aggregate of 2,864,345 shares of common
stock. In addition, for the year ended December 31, 1998, we received $49.0
million of proceeds from long-term mortgage financing, including,
. $35.8 million of fixed rate first mortgages secured by 15 assisted
living residences, with an average rate of 8.0% and
. $13.2 million of variable rate financing with Ohio Housing Finance
Agency secured seven residences.
Several of our leases and loan agreements contain restrictive covenants that
generally relate to the use, operation and disposition of the residences that
are leased or, in the case of loan agreements, serve as collateral for the
subject indebtedness. In addition, certain of our leases and loan agreements
contain cross-default provisions such that a default on one of those
instruments could cause us to be in default on one or more other instruments.
During the third quarter of 1999, we amended certain loan agreements with
one of our creditors. Pursuant to the amendment, we agreed to provide $8.3
million of additional cash collateral in exchange for the waiver of certain
possible defaults, including an amendment to certain financial covenants. In
August 1999, we restricted $8.3 million of cash balances as a result of such
amendment. The amendment also provides for the release of the additional
collateral upon the achievement of specified performance targets, provided
that we are in compliance with the other terms of the loan agreements.
For the twelve months ended December 31, 1998, we commenced operations with
respect to 57 residences (2,297 units), 53 of which were developed and four of
which were acquired. We intend to commence operation on an additional 20
residences (approximately 800 units) during the 1999 Period, 10 of which
commenced operation through June 30, 1999. In addition to the development and
construction costs incurred during 1998 with respect to these residences, we
expect to incur up to an additional $30.0 million in capital expenditures and
related start-up costs for the twelve months ended December 31, 1999,
approximately $25.0 million of which had been incurred as of June 30, 1999. We
expect that Start-Up Residences will incur significant operating losses during
the fill-up period. As a result, our operating income will be adversely
affected by operating losses at certain residences, primarily Start-Up
Residences, which we expect will range from $3.5 million to $5.0 million
during 1999.
During the first quarter of 1999, we made cash payments of approximately
$1.2 million related to severance arrangements and repurchases of restricted
stock.
We believe that our current cash on hand and working capital resources are
sufficient to meet our capital needs for the next 12 to 18 months. However, to
provide us with additional capital, we may explore various financing
alternatives and/or commitments to engage in sale and leaseback transactions.
We currently do not have in place any of such loan or lease commitments. As a
result of the securityholder litigation, the restatement and other factors,
there can be no assurances that financing from any source will be available in
the future, or, if available, that such financing will be available on terms
acceptable to us.
As of December 31, 1998, we had invested excess cash balances in short-term
certificates of deposit and highly liquid marketable debt securities.
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Inflation
We do not believe that inflation has materially adversely affected our
operations. We expect 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
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. SFAS No. 137, issued in June 1999, deferred the effective
date of SFAS No. 133 to all fiscal quarters of fiscal years beginning after
June 15, 2000. We do not expect the adoption of this statement to have a
material impact on our results of operations.
Year 2000
See discussion regarding year 2000 issues in Risk Factors.
29
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 Reform Act of 1995. Forward-looking statements involve known and
unknown risks, uncertainties and other factors that may cause our actual
results and future events to differ materially from those set forth or
contemplated in the forward-looking statements. Forward-looking statements
depend on assumptions, data or methods which may be incorrect or imprecise.
We face difficulties in stabilizing our operations following our rapid growth.
We have experienced rapid growth since 1994, which has placed significant
demands on our management resources. Our ability to stabilize operations and
manage our business following this growth requires us to continue to expand
our operational, financial and management information systems and to continue
to attract, train, motivate, manage and retain key employees. If we are unable
to manage this growth effectively, our business, financial condition and
results of operations could be adversely affected. Our ability to stabilize
operations and manage our business efficiently has been, and for the
foreseeable future will continue to be, adversely affected by the diversion of
management's time and attention to the pending securityholder litigation and
matters relating to the restatement of our financial statements for prior
reporting periods. See, "--We may incur significant costs and liability as a
result of our securityholder litigation," and "--We may be in technical
default under our loan and lease obligations."
We are highly leveraged; our loan and lease agreements contain financial
covenants
We are highly leveraged. We had total indebtedness, including short term
portion, of $267.7 million as of December 31, 1998 ($235.9 million as of June
30, 1999). In addition, we had shareholders' equity of $119.2 million as of
December 31, 1998 ($101.8 million as of June 30, 1999). The degree to which we
are leveraged could have important consequences, including:
. making it more 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 of, and interest on, our debt or
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. There can be no assurance
that we will be in compliance with these financial covenants in the future,
particularly if we are unable to stabilize our operations and efficiently
manage our business. If we fail to comply with one or more of these covenants
(after giving effect 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;
. in the case of a lease, terminating the lease and suing for damages.
In addition, 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, it could
30
have a material adverse effect on our financial condition if any lender or
lessor notifies us that we are in default under any debt instrument or lease.
We may require additional financing.
Our ability to satisfy our obligations, including payments with respect to
our outstanding indebtedness and lease obligations, will depend on future
performance, which is subject to our ability to stabilize our operations and
to a certain extent, to general economic, financial, competitive, legislative,
regulatory and other factors that are beyond our control. Although we believe
that our current cash on hand and cash available from operations are
sufficient to meet our capital needs through the end of 1999, there can be no
assurance that cash available from operations will be sufficient to fund our
operations beyond such time. We are reviewing our future capital requirements
to identify financing options. As a result of the securityholder litigation,
the restatement and other factors, there can be no assurance that financing
from any source will be available in the future, or, if available, that such
financing will be available on terms acceptable to us.
Certain of our indebtedness is secured by letters of credit which in some
cases have termination dates prior to the maturity of the underlying debt. As
such letters of credit expire, 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 may incur significant costs and liability as a result of our securityholder
litigation.
Since February 1, 1999, twelve separate complaints, which have since been
consolidated into one action, have been filed against us and certain of our
officers and directors in the United States District Court for the District of
Oregon. On July 23, 1999, a consolidated complaint was filed in connection
with this litigation. The consolidated complaint purports to be brought on
behalf of a class of purchasers of our common stock from July 28, 1997 through
March 31, 1999 and on behalf of a class of purchasers of our Debentures from
the date of issuance through March 31, 1999. The consolidated complaint
alleges violations of the federal securities laws and seeks unspecified
damages. It also names as additional defendants certain of our directors that
were not named previously, as well as our independent auditors (solely in
connection with our 1998 offering of 5.625% Debentures) and the underwriters
in connection with our 1997 offering of 6.0% Debentures.
Pursuant to our by-laws, we are obligated to indemnify our officers and
directors to the maximum extent allowed by law for any liability incurred by
them as a result of the litigation. In addition, we previously entered into
indemnity agreements with certain of these defendants. We cannot predict the
outcome of the foregoing litigation and currently are unable to evaluate the
likelihood of success or the range of possible loss. However, if the foregoing
litigation were determined adversely to us, such a determination could have a
material adverse effect on our financial condition, results of operations,
cash flow or liquidity. See Item 3 (Legal Proceedings).
We face significant competition.
We believe that the rapid growth of the assisted living industry has
resulted in an oversupply of assisted living residences in certain of our
markets. Recently, we have experienced slower fill-up of Start-Up Residences
in these markets than expected, as well as declining occupancy in our
Stabilized Residences due to the increase in options available to potential
new residents when units are vacated. 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 have opened or plan to open
residences will not adversely affect our operations.
The long-term care industry is a highly competitive industry. We expect that
the assisted living business, in particular, will become even more competitive
in the future. We compete with numerous other companies providing similar
long-term care alternatives.
31
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 waiver programs increases. These new market
entrants will include publicly and privately held companies, including not for
profit corporations, focusing primarily on assisted living, as well as
hospitals and nursing homes that offer assisted living as a segment of their
overall businesses. We also compete with nursing facilities that provide long-
term care services. We also face competition for development and acquisitions
of assisted living residences. Some of our present and potential competitors
are significantly larger and have, or may obtain, greater financial resources
than we do. Consequently, we cannot guarantee that we will not encounter
increased competition in the future which could limit our ability to attract
residents or expand our business and could have a material adverse effect on
our financial condition and results of operations and prospects.
We may be in technical default under our debt and lease agreements.
Almost all of our loan agreements and leases contain customary covenants
requiring that we deliver periodic financial statements and certify that they
are materially accurate. As a result of the restatement initially announced in
February 1999, it is possible that a lender or lessor may assert a default
under the terms of these instruments with regard to the financial statements
for reporting periods in 1996, 1997, 1998 and 1999. We have received waivers
from certain of our creditors and lessors with respect to possible defaults
under certain of these covenants. There can be no assurance that one or more
other creditors or lessors will not attempt to declare a default and exercise
any remedies they may deem available, which could include attempting to
terminate the applicable lease or foreclose on one or more residences securing
the applicable indebtedness. As of September 23, 1999, we had not received
notice of a declaration of default from any such other creditor or lessor. We
continue to make all required payments under each of these instruments.
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. We also depend upon the available labor
pool of low-wage employees. A shortage of qualified personnel may require us
to enhance our wage and benefits packages in order to compete. Most of the
states in which we operate impose licensing requirements on individuals
serving as program directors at assisted living residences. In many states in
which we operate, particularly South Carolina, the growth in demand for
licensed assisted living program directors has exceeded the rate at which
candidates can be licensed. Until a program director at a particular residence
can be licensed, we are required to retain the services of outside licensed
managers at a significant additional cost. 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.
We will suffer operating losses for each of our new residences.
We currently plan to open 20 residences in 1999. We expect that Start-Up
Residences will incur significant operating losses during the fill-up period.
As a result, our operating income will be adversely affected by operating
losses at certain residences, primarily Start-Up Residences, which we expect
will range from $3.5 million to $5.0 million. We cannot guarantee that we will
not experience unforeseen expenses, difficulties, complications and delays in
connection with the expansion of our operational base which could have a
material adverse effect on our financial condition and results of operations.
Our properties are geographically concentrated and we depend on the economies
and Medicaid waiver programs of the specific areas in which we operate our
properties.
We depend on the economies of Texas, Oregon, Ohio, Indiana and Washington
and, to some extent, on the continued funding of state Medicaid waiver program
in those states. As of December 31, 1998, 23.1% of our properties were in
Texas, 11.0% in Oregon, 10.4% in Ohio, 11.0% in Indiana and 9.2% in
Washington. Adverse changes in general economic factors affecting the
respective health care industries or laws and regulatory environment in each
of these states, including Medicaid reimbursement rates, could have a material
adverse effect on our financial condition and results of operations.
32
We depend on reimbursements by third-party payors.
A portion of our revenues depends upon reimbursement from third-party
payors, including state Medicaid waiver programs and private insurers. For the
years ended December 31, 1996, 1997 and 1998, direct payments received from
Medicaid funded programs accounted for approximately 12.4%, 11.1%, and 10.7%,
respectively, of our revenue. Also, our tenant-paid portion of Medicaid
residents accounted for approximately 6.9%, 5.9%, and 5.8%, respectively, of
our revenue during the years ended December 31, 1996, 1997 and 1998. We expect
that state Medicaid waiver programs will constitute a significant source of
our revenue in the future. Furthermore, we cannot guarantee that our
proportionate percentage of revenue received from Medicaid waiver programs
will not increase. There are continuing efforts by governmental and private
third-party payors to contain or reduce the costs of health care by lowering
reimbursement rates, increasing case management review of services and
negotiating reduced contract pricing. Our revenues and profitability will be
affected if these efforts are successful. Also, there has been, and our
management expects that there will continue to be, a number of proposals
attempting to reduce the federal and some state budget deficits by limiting
Medicaid reimbursement in general. Adoption of any of these proposals at
either the federal or the state level could have a material adverse effect on
our business, financial condition, results of operations and prospects.
We are subject to significant government regulation.
We are subject to federal and state regulations which govern various aspects
of our business. The development and operation of assisted living facilities
and the provision of health care services are subject to federal laws, and
state and local licensure, certification and inspection laws that regulate,
among other matters:
. the number of licensed residences;
. the provision of services;
. equipment;
. staffing, including professional licensing and criminal background
checks;
. operating policies and procedures;
. fire prevention measures;
. environmental matters;
. resident characteristics; and
. physical design and compliance with building and safety codes.
In the ordinary course of our 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, we 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. These adverse actions can include:
. the imposition of fines;
. temporary stop placement of admission of new residents, or imposition of
other conditions to admission of new residents to the facility;
. termination of a facility's Medicaid contract; and
. suspension or revocation of a facility's license.
During 1998, these adverse actions resulted in our paying aggregate fines of
$9,800 on eight residences and temporary suspension of admissions at certain
residences. During 1998, a license revocation action was
33
commenced with respect to one of our residences in the State of Washington. In
July 1999 following discussions with the licensing agency we settled this
action without the revocation becoming effective. Because regulations vary
from one jurisdiction to another and because determinations regarding whether
to seek a suspension or revocation, or to impose a fine, are subject to
administrative discretion, it is difficult for us to predict whether a
particular remedy will be sought or obtained in any given case. These types of
regulatory enforcement actions may adversely affect facility occupancy levels,
revenues and costs of operation. We cannot guarantee that federal, state, or
local governments will not impose additional restrictions on our activities
that could materially adversely affect us.
State and local laws regulating our operations vary significantly from one
jurisdiction to another. In some states in which we are currently developing
assisted living facilities, a certificate of need or other similar approval
may be required for the acquisition or construction of new facilities or the
expansion of the number of licensed units or beds or services. We could be
adversely affected by our failure or inability to obtain these approvals,
changes in the standards applicable for these approvals and possible delays
and expenses associated with obtaining these approvals.
We are also subject to various laws and regulations, both federal and state,
due to the size and nature of our business, including laws and regulations
relating to:
. safe working conditions;
. family leave; and
. disposal of medical waste.
Our cost to comply 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 that we had 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. In addition, because these laws vary from state to state, expansion
of our operations to states where we do not currently operate may subject us
to additional restrictions on the manner in which we operate our facilities.
See "Restrictions imposed by laws benefiting disabled persons" and "Medical
waste."
Federal and state fraud and abuse laws, such as "anti-kickback" laws and
"self-referral" laws, govern some financial arrangements among health care
providers and others who may be in a position to refer or recommend patients
to these providers. We have established policies and procedures that we
believe are sufficient to ensure that our facilities will operate in
substantial compliance with applicable regulatory requirements. However, we
cannot guarantee that these fraud and abuse laws will be interpreted in a
manner consistent with our practices.
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 and planned
residences to allow disabled persons to access the residences. We believe that
our residences are either substantially in compliance with present
requirements or are exempt from them, and we attempt to check for compliance
in all facilities we consider acquiring. 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.
Medical waste
Some of our facilities generate potentially infectious waste due to the
illness or physical condition of the residents, including, for example, blood-
soaked bandages, swabs and other medical waste products and incontinence
products of those residents diagnosed with infectious diseases. The management
of potentially
34
infectious medical waste, including handling, storage, transportation,
treatment and disposal, is subject to regulation under various laws, both
federal and state. These laws and regulations set forth the management
requirements, 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 we do not currently operate may subject us to
additional restrictions on the manner in which we operate our facilities.
We may be adversely affected by health care reform efforts.
Health care and related services is an area of extensive and dynamic
regulatory change. Changes in the law, new interpretations of existing laws,
or changes in payment methodology, which may be applied retroactively, may
have a dramatic effect on:
. the definition of permissible or impermissible activities;
. the relative costs associated with doing business; and
. the amount of reimbursement by both government and other third-party
payors.
Congress and state legislatures, from time to time, consider and enact
various health care reform proposals. Congress and state legislatures can be
expected to continue to review and assess alternative health care delivery
systems and payment methodologies. Also, public debate of these issues can be
expected to continue in the future. We cannot predict the ultimate timing or
effect of legislative efforts or their impact on us. We cannot guarantee that
either the various states or the federal government will not impose additional
regulations upon our activities which might adversely affect our business,
financial condition, results of operations or prospects.
We face significant pressure to reduce our prices.
The health care services industry is currently experiencing market-driven
reforms from forces within and outside the industry pressuring health care and
related companies to reduce health care costs. These market-driven reforms are
resulting in industry-wide consolidation that is expected to increase the
downward pressure on health care service providers' margins, as larger buyer
and supplier groups exert pricing pressure on health care providers. We cannot
predict the ultimate timing or effect of these market-driven reforms. We
cannot guarantee that any of these reforms will not have a material adverse
effect on our financial condition, results of operations.
We may not be able to develop or acquire additional assisted living
residences.
Our ability to develop or acquire additional residences depends upon, among
other factors:
. our ability to obtain certificates of need, government licenses and
approvals;
. our ability to obtain financing; and
. the competitive environment for development and acquisitions.
The nature of such certificates of need, licenses and approvals and the
timing and likelihood of obtaining them vary widely from state to state,
depending upon the location of the residence, or its operation, and the type
of services to be provided. We depend upon these permits and authorizations to
construct and operate our residences. Any delay or inability to obtain such
permits could adversely affect our results of operations. We may also incur
construction costs that exceed our original estimates. We rely on third-party
general contractors to construct our new assisted living facilities. We cannot
guarantee that we will not experience difficulties in working with general
contractors and subcontractors, which could result in increased construction
costs and delays.
If we are unable to achieve our development plans, our business, financial
condition and results of operations could be adversely affected.
35
We may be liable for losses not covered by or in excess of our insurance.
The provision of health care services entails an inherent risk of liability.
In recent years, participants in the long-term care industry have been subject
to an increasing number of lawsuits alleging malpractice or related legal
theories. Many of these lawsuits involve large claims and significant defense
costs. In addition, we may be subject to claims alleging violations of federal
or state laws relating to safe working conditions, environmental matters and
the use and disposal of hazardous or potentially hazardous substances such as
medical waste. We currently maintain liability insurance intended to cover
such claims. We believe our insurance is in keeping with industry standards.
We cannot guarantee, however, that claims in excess of our insurance coverage
or claims not covered by our insurance coverage will not arise. A successful
claim against us not covered by, or in excess of, our insurance coverage could
have a material adverse effect upon our financial condition or results of
operations. Claims against us, regardless of their merit or eventual outcome,
may also have a material adverse effect upon our ability to attract residents
or expand our business and would require management to devote time to matters
unrelated to the operation of our business. In addition, we must renew our
insurance policies annually. We cannot guarantee that we will be able to
obtain liability insurance coverage in the future or that, if such coverage is
available, it will be available on acceptable terms.
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,
including, without limitation, asbestos-containing materials, 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 our 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 lease the property, or to borrow using
our property as collateral.
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, such
as asbestos-containing materials, 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 we hold or operate, or which we
acquire or operate in the future, could have an adverse effect on our
business, financial condition or results of operations.
Market conditions may decrease the value of our common stock.
The market price of our common stock may fluctuate significantly in response
to various factors and events, including:
. the liquidity of the market for our common stock;
. variations in our operating results; and
. new statutes or regulations or changes in the interpretation of existing
statutes or regulations affecting the health care industry generally or
assisted living residence businesses in particular.
In addition, the stock market in recent years has experienced broad price
and volume fluctuations that often have been unrelated to the operating
performance of particular companies. These market fluctuations also may
adversely affect the market price of our common stock.
On April 15, 1999, AMEX halted trading in our common stock. We are unable to
predict when trading in the common stock will resume.
36
We depend on senior management and skilled personnel.
We depend, and will continue to depend, upon the services of Dr. Wilson,
President, Chief Executive Officer and Vice Chairman of the Board of
Directors; Ms. Campbell, Senior Vice President, General Counsel and Secretary;
Ms. Gorshe, Senior Vice President of Community Relations; Mr. Mahon, Vice
President and Chief Operating Officer; Mr. Cruckshank, Vice President and
Chief Financial Officer; Ms. Maloney, Vice President, Controller and Chief
Accounting Officer; Mrs. Baldwin, Vice President of Operational Planning and
Strategy; and Mr. Parker, Vice President of Development.
We have entered into employment agreements with these officers as well as
other key personnel. We also depend upon our ability to attract and retain
management personnel who will be responsible for the day-to-day operations of
each residence. If we lose the services of any or all of our officers or we
are unable to attract additional management personnel in the future, our
business, financial condition or results of operations could be adversely
affected.
We could be adversely affected if our year 2000 problems are significant.
The year 2000 issue refers to a computer system's potential failure to
recognize dates on or beyond January 1, 2000 due to reading two digits, rather
than four, to define the applicable year. As a result, computer programs and
systems may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations. Our year 2000 readiness plan consists of:
. identify and assess year 2000 issues in our information and non-
information technology systems, including inquiring of third parties
with whom we do significant business, such as vendors and suppliers, as
to the state of their year 2000 readiness;
. repair or replace noncompliant information and non-information
technology systems;
. test and verify year 2000 readiness for previously non-compliant
systems; and
. compliance with state requirements related to disaster plan amendments.
We have identified year 2000 risks in the following areas:
. Our information technology systems might not be year 2000 compliant. We
have assessed our readiness in regard to year 2000 issues and believe
that all material hardware and software utilized in our operations and,
specifically, in our accounting systems, is year 2000 compliant. Despite
our efforts to identify and resolve year 2000 issues, we cannot
guarantee that all of our systems will be year 2000 compliant.
. Our non-information technology systems might not be year 2000
compliant. Our non-information technology systems are our building
management and life/safety systems, which include our emergency call
systems, electrical locking systems, fire alarm systems and fire alarm
monitoring systems. We have assessed our readiness of these systems in
regard to year 2000 issues. We are using four salaried employees, as
part of their normal course of business, to contact all manufacturers
and vendors and request that they verify in writing that each of their
systems is year 2000 compliant. Any systems identified as not in
compliance will be upgraded or replaced.
. We may have year 2000 issues with significant third parties. We are in
the process of obtaining year 2000 compliance letters and reports from
suppliers, banks, and other third party payors, including the federal
government. To date, no such payor has indicated an inability to
continue remittances in the normal course of business. However, most
such payors, including the federal government, are in the process of
evaluating and updating their internal systems and cannot yet assure us
that their systems are year 2000 compliant. We also face the risk that
vendors from which we purchase goods and services, such as utility
providers and our payroll provider, may have systems that are not year
2000 compliant. We plan to monitor the progress of our major vendors in
achieving year 2000 compliance.
37
We do not anticipate any major interruption in our business as a result of
year 2000 issues. Accordingly, we do not expect that Year 2000 issues will
have a material adverse effect upon our operations or prospects or that we
will incur any material expense associated with year 2000 compliance. However,
despite our efforts to identify and resolve year 2000 compliance problems, we
cannot guarantee that all of our systems or that of third parties on which we
rely will be year 2000 compliant. As a result our operations could be
interrupted or adversely affected.
In the worst case scenario, if our non-information technology systems
suffered year 2000 issues, we would implement our standard emergency operation
plan. This plan primarily includes incurring additional staffing. If we needed
to sustain this additional staffing for an extended period of time, it could
have a material adverse effect on our business and operations.
We have not established a contingency plan to address potential year 2000
noncompliance with respect to our information systems or those of our major
vendors. We are currently considering the extent to which such a plan is
necessary. Because we depend on systems outside our control, such as
telecommunications and power supplies, and because third party payors,
including the federal government, with whom we have relationships may not have
adequately addressed year 2000 issues, we cannot guarantee that we will not
face unexpected problems associated with year 2000 issues that may affect our
operations, business, and financial condition.
We anticipate that our future Year 2000 compliance expenditures will be less
than $25,000.
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 should not have a significant 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 $29.1 million
outstanding at December 31, 1998 with a weighted average interest rate of
3.7%. Assuming that our balance of variable rate debt remains constant at
$29.1 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 $290,000. 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 $290,000.
We are also exposed to market risks from fluctuations in interest rates and
the effects of those fluctuations on market values of our cash equivalent
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.
During 1998, we used an interest rate swap to fix the rate of interest on a
commitment for variable rate debt. Upon placement of debt subject to the
variable rate commitment, we terminated the interest rate swap on October 1,
1998. We do not currently have any derivative financial instruments in place
to manage interest costs, but that does not mean that we will not use them as
a means to manage interest rate risk in the future.
The Company does not use foreign currency exchange forward contracts or
commodity contracts and does not have foreign currency exposure.
38
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.
Not Applicable
39
PART III
ITEM 10. Directors and Executive Officers of the Company
General
We have provided below certain information regarding our directors and
executive officers:
Name Age(1) Position
---- ------ --------
Dr. Keren Brown Wilson(5)(6).. 51 President, Chief Executive Officer and
Vice Chairman of the Board of
Directors
Richard C. Ladd(2)(4)(6)...... 60 Chairman of the Board of Directors
Jill M. Krueger(2)(3)......... 39 Director
Bradley G. Razook(3)(5)....... 43 Director
Gloria J. Cavanaugh(2)(4)..... 56 Director
William McBride III(3)(5)..... 39 Director
Sandra Campbell............... 52 Senior Vice President, General Counsel
and Secretary
Nancy Gorshe.................. 48 Senior Vice President of Community
Relations
Leslie W. Mahon............... 51 Vice President and Chief Operating
Officer
James W. Cruckshank........... 44 Vice President and Chief Financial
Officer
Connie J. Baldwin............. 54 Vice President of Operational Strategy
and Planning
Paul B. Parker................ 33 Vice President of Development
M. Catherine Maloney.......... 36 Vice President, Controller and Chief
Accounting Officer
- --------
(1) As of May 31, 1999
(2) Member of the Audit Committee.
(3) Member of the Compensation Committee.
(4) Member of the Education, Training and Operations Committee.
(5) Member of the Legal Committee.
(6) Member of the Quality Assurance Committee.
Dr. Keren Brown Wilson is a co-founder of the Company and served as the
President/Chief Executive Officer of the Company from its formation in July
1994 until September 1997, and as President/Chief Operating Officer from
September 1997 until March 1999. She has served as Vice Chairman of our Board
of Directors since September 1997, and as President and Chief Executive
Officer since March 1999. From September 1997 until March 1999 Dr. Wilson
served as our Chief Operating Officer. Dr. Wilson has over twenty years of
experience in aging service delivery systems and has, for the past 17 years,
focused primarily on assisted living. From 1988 to September 1994, Dr. Wilson
was the President and sole director of Concepts in Community Living, Inc. a
corporation which specializes in the development and management of assisted
living residences. From 1992 to August 1994, Dr. Wilson was also President of
Sterling Management Company, a company which provided management services to
private (non-Medicaid) assisted living facilities in the state of Kansas. From
1986 to 1988, Dr. Wilson was a Senior Vice President at Milestone, Inc., an
assisted living development and management company. Prior to 1986, Dr. Wilson
was an owner and management agent for Park Place Living Center in Portland,
Oregon, and the Director of Research and Education for the Oregon Association
of Homes for the Aging in Portland, Oregon. Since 1983, Dr. Wilson has also
been an Associate Professor at the Institute for Aging at Portland State
University. In these capacities, Dr. Wilson was responsible for designing,
developing and managing the state of Oregon's first assisted living residence
along with the state's first Medicaid-eligible assisted living residence. She
currently serves as Vice Chair of the Assisted Living Federation of America
and is on the Board of Directors of the American Society on Aging and the IOM
Quality of LTC Committee.
Richard C. Ladd has served as Chairman of our Board of Directors since March
1999 and has been a director of the Company since September 1994. Since
September 1994, Mr. Ladd has been the President of Ladd
40
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.
Jill M. Krueger was elected to the Board of Directors in April 1999, and
presently serves as Chairman of our Audit Committee. Since 1996, Ms. Krueger
has served as President and Chief Executive Officer of Health Resources
Alliance, an organization designed to optimize market position and achieve
synergies which enable its 20 member organizations to prosper in a managed
care environment. From 1988 to 1996 Ms. Krueger was a partner at KPMG LLP
where she served as its Partner in charge of the firm's National Long Term
Care and Retirement Housing Practice.
Bradley G. Razook has been a director of the Company since August 1994. Mr.
Razook is currently President and Managing Director at Cohen & Steers Capital
Advisors, LLC. From July 1997 until February 1999, Mr. Razook served as
Managing Director and Head of Health Care Industry Group of Schroder & Co.,
Inc. From 1990 to July 1997, Mr. Razook was Executive Vice President of
National Westminster Bank PLC, New York Branch. Prior to being appointed
Executive Vice President, Mr. Razook held the position of Managing Director.
From 1985 to 1990, Mr. Razook was a First Vice President and counsel at Drexel
Burnham Lambert, Inc., an investment banking firm.
Gloria J. Cavanaugh was appointed as a director of the Company on September
7, 1997. Ms. Cavanaugh has been the executive director of the American Society
on Aging since 1975. From 1968 to 1975, she was Director of Continuing
Education at the Andrus Gerontology Center, University of Southern California.
Ms. Cavanaugh has almost thirty years experience developing and offering
educational programming on aging issues, including such areas as aging in
place/housing and assisted living. Ms. Cavanaugh serves on the Board of
Directors of Generations United, The National Alliance for Caregiving, The
National Policy and Resource Center on Women and Aging and the Center for
Assistive Technology, State University of New York at Buffalo.
William McBride III is a co-founder of the Company and has been a director
since its formation, and currently serves as a consultant to the Company. From
September 1997 until March 1999, Mr. McBride served as our Chief Executive
Officer and Chairman of our Board of Directors. From August 1992 to September
1997, Mr. McBride served as President and Chief Operating Officer of LTC
Properties, Inc. ("LTC"), a health care real estate investment trust
specializing in the long-term care industry, which was co-founded by Mr.
McBride in 1992. Prior to founding LTC, Mr. McBride was employed from April
1988 to July 1992 by Beverly Enterprises, Inc., an owner/operator of long-term
care facilities, retirement living facilities and pharmacies where he served
as Vice President, Controller and Chief Accounting Officer. From 1982 to 1988,
Mr. McBride was employed by the public accounting firm of Ernst & Young. Mr.
McBride served as a member of the board of directors of LTC from August 1992
to September 1997 and currently serves on the board of directors of Malan
Realty Investors, Inc.
Sandra Campbell joined the Company as Senior Vice President, General Counsel
and Secretary in January of 1998. Ms. Campbell has almost 20 years of
experience in practicing law in real property, secured transactions and
general business law. Prior to joining the Company she was a partner in the
law firm of Bullivant Houser Bailey where she was employed from April 1995 to
December 1998. From January 1992 to April 1995, Ms. Campbell served as Chief
Legal Counsel for First Fidelity Thrift & Loan Association.
James W. Cruckshank joined the Company as Vice President and Chief Financial
Officer in March of 1999 and brings with him over 20 years experience in
accounting and treasury. He served as the Corporate Controller and Assistant
Treasurer of Schnitzer Steel Industries, Inc., a public company in the
Portland area, from 1987 until March 1999. Prior to this assignment, Mr.
Cruckshank was an audit manager for Price Waterhouse.
41
Nancy Gorshe joined the Company as Vice President of Community Relations in
January of 1998 and has over twenty years of experience in the field of
geriatric health, community and long-term care and housing. Prior to joining
the Company, 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.
Leslie W. Mahon joined the Company as Vice President and Chief Operating
Officer in March of 1999 and his background includes 10 years experience in
the health care industry as the Chief Executive Officer of Lantis Enterprises,
Inc., a private company that operates 37 assisted living facilities in five
states.
Connie J. Baldwin has over twenty years of experience in designing and
implementing services to the elderly. Ms. Baldwin joined the Company in
February 1995 as Director of Operations and has served as the Vice President
of Operational Strategy and Planning since March 1999. From December 1993 to
January 1995, Ms. Baldwin was Executive Director for the Center for Developing
Older Adult Resources, a non-profit entity in Phoenix, Arizona. From September
1990 to December 1993, she was the Health Care Administrator for Managed Care
Systems, a division of the State of Arizona's Long-Term Care Medicaid Program.
In addition, Ms. Baldwin has held the position of Manager of Home and
Community Based Care in the State of Oregon with the Senior and Disabled
Services Department and was instrumental in the development of the State's
assisted living rules.
Paul B. Parker joined the Company in July 1998, and currently serves as Vice
President of Development. Mr. Parker has eight years experience in the
development and acquisition of assisted living facilities, health policy and
regulation as well as reimbursement. Prior to joining ALC, he served as Chief
Executive Officer of Supportive Housing Services, Inc. and President of LTC
Development Company. Both firms specialize in the development of assisted
living facilities.
M. Catherine Maloney joined the Company as Controller in June 1998, and
currently serves as Vice President, Controller, and Chief Accounting Officer.
Prior to joining the Company, Ms. Maloney was an Audit Manager with KPMG LLP.
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, 1998, each of our
officers, directors and 10% stockholders complied with all Section 16(a)
filing requirements applicable to them, except that:
. Sandra Campbell, Nancy Gorshe and Rhonda Marsh each filed a Form 3 more
than ten days after becoming an officer
. M. Catherine Maloney and Paul B. Parker each did not file a Form 3 after
becoming an officer
. Keren Brown Wilson filed a Form 4 more than ten days after the end of the
month in which she acquired 25,000 shares of common stock
. Form 4s have not been filed for
. any option grants during 1998 included in the table under the heading
"Option Grants in Last Fiscal Year" (except that 20,000 options granted
to Nancy Gorshe in January 1998 were included in the Form 3 filed by Ms.
Gorshe in March 1998)
. the option exercise included in the table under the heading "Aggregate
Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values"
42
. option grants of 7,500 shares to each director described under the
heading "Compensation of Directors"
. option grants of 30,000 shares and 40,000 shares, respectively, to M.
Catherine Maloney and Paul B. Parker
We have instituted procedures to ensure timely compliance in the future.
ITEM 11. Executive Compensation
We have set forth in the following table information concerning the
compensation paid during the fiscal year ended December 31, 1998 to our Chief
Executive Officer and each of our four other most highly compensated executive
officers (collectively, the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
Annual Compensation(1) Long-Term Compensation Awards
------------------------------- ----------------------------------
Restricted Securities
Name and Other Annual Stock Underlying All Other
Principal Position Year Salary Bonus(2) Compensation Awards(3) Options Compensation
------------------ ---- -------- -------- ------------ ---------- ---------- ------------
William McBride III(4).. 1998 $246,987 $100,000 -- -- -- --
Chief Executive 1997 -- -- -- $3,400,000 -- --
Officer and Chairman
Dr. Keren Brown Wilson.. 1998 $203,061 $100,000 -- -- -- --
Chief Operating 1997 200,000 -- -- $ 850,000 -- --
Officer, President, 1996 130,000 -- -- -- 15,000 --
Vice Chairman
Sandra Campbell(5)...... 1998 $141,644 $ 25,000 -- -- 15,000 --
Senior Vice President,
General Counsel and
Secretary
Nancy Gorshe(6)......... 1998 $101,263 -- -- -- 55,000 --
Vice President of
Community Relations
Rhonda S. Marsh(7)...... 1998 $105,513 -- -- -- 15,000 --
Vice President/ 1997 75,000 $ 14,569 -- -- 25,000 --
Treasurer, Chief 1996 62,382 -- -- -- 20,000 --
Accounting Officer
- --------
(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) Each of Mr. McBride and Dr. Wilson was paid a bonus of $100,000 related
to the execution of the ARC merger agreement. Payments made to each of
them subsequent to December 31, 1998 were reduced by $100,000 to reflect
repayment of these bonus payments.
(3) Restricted stock awards are valued in the table above at their fair market
value based on $17.00, the per share closing price of our Common Stock on
the American Stock Exchange on the date of the award. At December 31,
1998, Mr. McBride and Dr. Wilson held 200,000 and 50,000 shares,
respectively, of restricted stock valued at $2.6 million and $656,000,
respectively (calculated by multiplying the amount of restricted stock by
the closing market price of $13.125 on the last trading day of 1998). As
of March 15, 1999 Mr. McBride and Dr. Wilson agreed to forfeit the shares
of restricted stock held by each of them. See "Employment Agreements" and
"Consulting Agreement."
(4) Mr. McBride became Chief Executive Officer on October 3, 1997, but did
not begin receiving compensation until January 1, 1998. Subsequent to
December 31, 1998, Mr. McBride resigned as Chief Executive Officer.
(5) Ms. Campbell began her employment with us on December 31, 1997 and began
receiving compensation in January 1998.
43
(6) Ms. Gorshe began her employment with us in February 1998.
(7) Ms. Marsh resigned as an executive officer in February 1999.
We have provided in the following table information on stock options granted
during 1998 to the Named Executive Officers.
STOCK OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
-----------------------------------------
Potential
Realizable Value
at Assumed Annual
% of Total Rate of Stock
Number of Options Price
Securities Granted to Appreciation for
Underlying Employees Exercise Option Term(1)
Options in Fiscal Price Expiration -----------------
Name Granted Year ($/Sh) Date 5% 10%
---- ---------- ---------- -------- ---------- -------- --------
William McBride III..... -- -- -- -- -- --
Dr. Keren Brown Wilson.. -- -- -- -- -- --
Sandra Campbell......... 15,000 2.2% $14.50 11/08/08 $136,785 $346,639
Nancy Gorshe............ 20,000 3.0% $19.31 01/05/08 $242,879 $615,503
20,000 3.0% $16.75 07/27/08 $210,680 $533,904
15,000 2.2% $14.50 11/08/08 $136,785 $346,639
Rhonda S. Marsh......... 15,000 2.2% $14.50 11/08/08 $136,785 $346,639
- --------
(1) In accordance with rules of the Securities and Exchange Commission (the
"Commission"), shown are the gains or "option spreads" that would exist for
the respective options granted. These gains are based on the assumed rates
of annual compound stock price appreciation of 5% and 10% from the date the
option was granted over the full option term. These assumed annual compound
rates of stock price appreciation are mandated by the rules of the
Commission and do not represent our estimate or projection of future Common
Stock prices.
We have provided in the following table information with respect to the Named
Executive Officers concerning unexercised stock options held as of December 31,
1998.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
Value of
Number of Securities Unexercised In-
Underlying The-Money Options
Unexercised Options at Fiscal Year-
at Fiscal Year-End End(1)
Shares -------------------- ------------------
Acquired Value Exercisable/ Exercisable/
Name on Exercise Realized Unexercisable Unexercisable
---- ----------- -------- -------------------- ------------------
William McBride III..... -- -- 145,000/ 5,000 $1,176,225/$28,775
Keren Brown Wilson...... -- -- 210,000/ 5,000 $1,606,850/$28,725
Sandra Campbell......... -- -- 16,667/48,333 $ 0/$ 0
Nancy Gorshe............ -- -- 0/55,000 $ 0/$ 0
Rhonda S. Marsh......... 12,500 $102,188 29,167/38,333 $ 126,286/$38,302
- --------
(1) The closing trading price on the American Stock Exchange for the Common
Stock on December 31, 1998 was $13.125. As of April 15, 1999, the most
recent date on which the Common Stock was traded on the American Stock
Exchange, the closing trading price for the Common Stock was $2.875, and
the value of all of the exercisable and unexercisable options held by each
of the Named Executive Officers was $0.
Compensation of Directors
During 1998 each non-employee director received a fee of $12,000 per year for
services as a director, plus $500 for attendance in person at each meeting of
the Board of Directors or any committee meeting held on a day on which the
Board of Directors does not meet. For 1999, we increased the amount of
attendance fees to $1,000
44
for attendance in person, or $500 for attendance by telephone, at each meeting
of the Board of Directors or any committee meeting held on a day on which the
Board of Directors does not meet. In addition, we reimburse the directors for
travel expenses incurred in connection with their duties as our directors.
During 1998, we granted the non-employee directors non-qualified stock options
to purchase a total of 22,500 shares of Common Stock at $14.50 per share. Each
of the non-employee directors received options to purchase 7,500 shares. These
options vest ratably on each of November 5, 1999, 2000 and 2001.
Employment Agreements
William McBride and Keren Brown Wilson
We entered into employment agreements with Mr. McBride and Dr. Wilson in
October 1997, providing for Mr. McBride's services as Chief Executive Officer
and Dr. Wilson's services as President and Chief Operating Officer. Each
agreement provides for a four-year term with automatic extensions until the
date (if any) which is the fourth anniversary of our notice, or six months
after the employee's notice, of a desire to terminate the agreement.
Notwithstanding such "evergreen" provisions of each agreement, either
agreement may be terminated by us for cause or by the employee for "Good
Reason." The latter is defined in the agreements as
(1) material diminution of title, duties, or salary;
(2) reduction in benefit not generally applicable to senior executive
personnel; or
(3) a direction by the Board of Directors to report to any person or group
other than the Board of Directors.
Under the agreements, in the event of a termination of employment for any
reason other than cause, the employee will be entitled to the payment of an
amount equal to four times his or her annual salary. In the event of a
termination within one year of a change in control (as defined in the
agreement) for any reason other than the death or disability of the employee
or a termination by us for cause, Mr. McBride would be entitled to a
$4.0 million termination payment and Dr. Wilson would be entitled to a $3.0
million termination payment. The agreements also contain "gross-up" provisions
to compensate the employees in the event that any payment under such contracts
is subject to an excise tax imposed under Section 4999 of the Internal Revenue
Code. The employment agreements provide that Mr. McBride and Dr. Wilson are
entitled to compensation at an annual rate of $265,000 and $200,000,
respectively. Pursuant to the employment agreements, Mr. McBride and Dr.
Wilson were awarded, without cost to them, 200,000 and 50,000 shares of
"restricted stock," respectively, under our 1994 Amended and Restated Stock
Option Plan. The restricted stock agreements relating to the restricted stock
provide that the restrictions applicable to such shares lapse, and such shares
will no longer be subject to forfeiture in the event of termination of
employment, at the rate of 25% per year commencing on October 3, 2001, the
fourth anniversary of the date of award, subject to acceleration in the event
of a change in control. Dividends are payable on the restricted stock to the
extent paid on all other shares of Common Stock. The restricted stock does not
have voting rights.
In connection with their employment agreements, we agreed to indemnify Mr.
McBride and Dr. Wilson to the extent permitted under Nevada law against
liability and expenses incurred by them in any proceeding in which they are
involved due to their roles as officers or directors. The indemnity agreements
exclude certain claims from indemnification by us.
As discussed below, we have entered into a consulting agreement with Mr.
McBride, dated as of March 15, 1999, which provides for the termination of Mr.
McBride's employment agreement, the forfeiture of his $4.0 million termination
payment and the forfeiture of his restricted stock.
Effective as of March 15, 1999, we entered into an amendment with Dr. Wilson
to her employment agreement to provide that we will employ Dr. Wilson as
President and Chief Executive Officer. In addition, we paid Dr. Wilson a lump
sum cash payment of $187,500 (which was reduced to $87,000 to reflect
repayment of a $100,000 bonus paid in 1998 related to the execution of our
merger agreement with ARC) in consideration for Dr. Wilson's agreement to
forfeit her interest in 50,000 shares of restricted stock held by her and to
terminate the restricted stock agreement related to those shares.
45
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. The agreement provides for an initial two and
one-half-year term. If the agreement has not been terminated prior to the
expiration of the initial term, then the agreement is automatically extended
on a continuous basis. We may terminate the agreement by providing Ms.
Campbell with two and one-half years' prior notice of our intention to
terminate her employment, and Ms. Campbell may terminate the agreement by
providing us with four months prior notice of her intention to resign. In
addition, we may terminate the agreement at any time for "Cause" and Ms.
Campbell may terminate the agreement for "Good Reason" (each as defined in the
agreement), and the agreement automatically terminates upon Ms. Campbell's
death or permanent disability. If we terminate Ms. Campbell's employment other
than for Cause and without providing the notice referred to above, or if Ms.
Campbell terminates the agreement for Good Reason, then we must make a lump-
sum payment to Ms. Campbell equal to her then-annual salary plus $100,000. In
addition, if there is a Change in Control (as defined in the Agreement),
regardless of whether she remains in our employ, Ms. Campbell is entitled to
receive an additional amount equal to two times her then-annual salary plus
$100,000, and all options exercisable for common stock automatically vest and
become exercisable. The agreement provides that our President or Chief
Executive Officer will determine Ms. Campbell's annual compensation subject to
adjustment from time to time at the discretion of the Board of Directors. Ms.
Campbell's current salary is $150,000. In addition, Ms. Campbell received
options to purchase 50,000 shares of Common Stock, to become exercisable in
annual installments of 16,666 shares commencing December 31, 1998, at an
exercise price of $16.50, equal to the fair market value of the Common Stock
on the date of grant. The agreement includes an agreement to indemnify Ms.
Campbell to the extent permitted 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. The indemnity agreement excludes certain claims from
indemnification by us.
James W. Cruckshank
On March 15, 1999, we entered into an employment agreement with James W.
Cruckshank providing for Mr. Cruckshank's services as Vice President and Chief
Financial Officer. The agreement provides for an initial two-year term,
subject to automatic one-year extensions unless we notify Mr. Cruckshank
during the 90-day period ending on March 15 of each year that we wish to
terminate the agreement on March 15 of the following year. Notwithstanding
this "evergreen" provision, we may terminate the agreement at any time for
"Cause" (as defined in the agreement) and Mr. Cruckshank may resign at any
time upon 90 days' prior written notice to us. If we terminate Mr.
Cruckshank's employment without "Cause" and without offering Mr. Cruckshank
comparable employment (employment with us or an affiliated company that is not
materially different in level of responsibility, at the same or higher salary
level, with same or similar title or rank and within a 20-mile radius of the
location of his immediately prior position with us), then we must make a lump-
sum payment to Mr. Cruckshank in an amount equal to twice his then annual
salary. The agreement provides that our Chief Executive Officer will determine
Mr. Cruckshank's annual compensation subject to adjustment from time to time
at the discretion of the Board of Directors. Mr. Cruckshank's current salary
is $150,000. The agreement further provides that Mr. Cruckshank is subject to
confidential information restrictions for as long as Mr. Cruckshank possesses
any confidential information, and non-competition provisions until one year
after the termination of Mr. Cruckshank's employment. In addition, Mr.
Cruckshank received options to purchase 30,000 shares of Common Stock, to
become exercisable in annual installments of 10,000 shares commencing March
15, 2000, at an exercise price of $3.81, equal to the fair market value of
Common Stock on the date of grant.
Leslie Mahon
On March 15, 1999, we entered into an employment agreement with Leslie Mahon
providing for Mr. Mahon's services as Vice President and Chief Operating
Officer. The agreement provides for an initial two-year term, subject to
automatic one-year extensions unless we notify Mr. Mahon during the 90-day
period ending on March 15 of each year that we wish to terminate the agreement
on March 15 of the following year.
46
Notwithstanding this "evergreen" provision, we may terminate the agreement at
any time for "Cause" (as defined in the agreement) and Mr. Mahon may resign at
any time upon 90 days' prior written notice to us. If we terminate Mr. Mahon's
employment without "Cause" and without offering Mr. Mahon comparable
employment (employment with us or an affiliated company that is not materially
different in level of responsibility, at the same or higher salary level, with
same or similar title or rank and within a 20-mile radius of his immediately
prior position with us), then we must make a lump-sum payment to Mr. Mahon in
an amount equal to twice his then annual salary. The agreement provides that
our Chief Executive Officer will determine Mr. Mahon's annual compensation
subject to adjustment from time to time at the discretion of the Board of
Directors. Mr. Mahon's current salary is $175,000. The agreement further
provides that Mr. Mahon is subject to confidential information restrictions
for as long as Mr. Mahon possesses any confidential information, and non-
competition provisions until one year after the termination of Mr. Mahon's
employment. In addition, Mr. Mahon received options to purchase 30,000 shares
of Common Stock, to become exercisable in annual installments of 10,000 shares
commencing March 15, 2000, at an exercise price of $5.00, equal to the fair
market value of the Common Stock on the date of the grant.
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. The agreement provides for a two-year term. We may terminate the
agreement at any time for "Cause" (as defined in the agreement). If we
terminate Ms. Gorshe's employment without "Cause" and without offering Ms.
Gorshe comparable employment or if within one year following a Change of
Control (as defined in the agreement) we either terminate Ms. Gorshe without
cause or she voluntarily resigns (and we have not offered her comparable
employment in either case), then we must make a lump-sum payment to Ms. Gorshe
in an amount equal to twice her then annual salary. In addition, if we
terminate Ms. Gorshe within one year following a Change in Control, all Common
Stock options held by Ms. Gorshe will automatically become immediately
exercisable. The agreement provides that our President or Chief Executive
Officer will determine Ms. Gorshe's annual compensation subject to adjustment
from time to time at the discretion of the Board of Directors. Ms. Gorshe's
current salary is $125,000. The agreement further provides that Ms. Gorshe is
subject to confidential information, and non-competition provisions until one
year after the termination of Ms. Gorshe's employment. In addition, Ms. Gorshe
received options to purchase 20,000 shares of Common Stock, to become
exercisable in annual installments of 6,667 shares commencing on July 27,
1999, at an exercise price of $16.50, equal to the fair market value of the
Common Stock on the date of grant.
Consulting Agreement
As discussed above, we have previously entered into an employment agreement
with Mr. McBride pursuant to which Mr. McBride is entitled to certain payments
and benefits in the event of a termination of his employment with us under
certain circumstances. Effective as of March 15, 1999, we entered into a
consulting agreement with Mr. McBride which provides for the termination of
Mr. McBride's employment agreement and the extinguishment of our and Mr.
McBride's rights and obligations under that agreement. Pursuant to the
consulting
agreement, Mr. McBride agreed to provide consulting services to us and to
resign from his position as our Chief Executive Officer. The termination of
Mr. McBride's employment pursuant to the consulting agreement is by mutual
agreement and such termination will not be deemed either a resignation for
good reason or a termination of Mr. McBride for cause for purposes of his
employment agreement or otherwise, and the Board is not aware of any grounds
for terminating Mr. McBride for cause. Pursuant to the consulting agreement
Mr. McBride received a lump-sum cash termination payment of $490,000 (which
was reduced to $390,000 to reflect repayment of a $100,000 bonus paid in 1998
related to the execution of our merger agreement with ARC). In addition, we
paid Mr. McBride a lump sum cash payment of $750,000 in consideration for Mr.
McBride's agreement to forfeit his interest in 200,000 shares of restricted
stock held by him and to terminate the related restricted stock agreement.
47
Pursuant to the consulting agreement, Mr. McBride will provide consulting
services to us for a period of two years, on a basis of not more than forty
hours per month at a rate of $15,000 per month. During the consulting term,
Mr. McBride will also be entitled to participate in our medical insurance
plans at a cost equal to our cost of providing coverage. If we terminate the
consulting relationship without "Cause" (as defined in the consulting
agreement), Mr. McBride will be entitled to the balance of the cash amounts
which he would have received had the consulting relationship continued for the
remainder of the two year term. In addition, upon the occurrence of a "Change
in Control" of the Company (as defined in the consulting agreement), the
consulting relationship will automatically terminate and Mr. McBride will be
entitled to a lump-sum cash payment in an amount equal to the balance of the
cash amounts which he would have received had the consulting relationship
continued for the remainder of the two year term.
In addition, Mr. McBride has agreed that he will not disclose confidential
information belonging to us, and, for a period of two years following the
effectiveness of the consulting agreement, he will not compete with us or
solicit our employees. However, if the consulting relationship is terminated
as a result of a Change in Control of the Company, Mr. McBride's covenant not
to compete will automatically terminate. Pursuant to the consulting agreement,
we also reimbursed Mr. McBride for his attorneys fees incurred in the
negotiation and preparation of the consulting agreement in the amount of
approximately $8,000.
Mr. McBride's stock option agreements and indemnity agreement with us
survive the termination of his employment agreement.
Compensation Committee Interlocks and Insider Participation
As of May 31, 1999 the Compensation Committee was comprised of Mr. Razook,
Mr. McBride and Ms. Krueger.
During 1998 Mr. Razook, one of our directors, was Managing Director and Head
of the Health Care Industry Group of Schroder & Co. Inc. ("Schroders"), an
investment banking firm. During 1998 Schroders served as the initial purchaser
of our $75.0 million offering of 5.625% Debentures for which Schroders
received a customary commission. Also during 1998, Schroders provided
financial advisory services and delivered a fairness opinion in connection
with a proposed merger for which we paid Schroders a fee of $200,000. In March
1999, Mr. Razook became President and Managing Director at Cohen & Steers
Capital Advisors LLC ("C&S Advisors"). Pursuant to an agreement with C&S
Advisors, we anticipate that we will pay C&S Advisors up to $1.2 million in
1999 for financial advisory services plus customary fees and commissions in
the event that we are advised by C&S Advisors in connection with certain types
of transactions.
48
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
We have set forth in the following table information as of May 31, 1999 with
respect to the beneficial ownership of our Common Stock by:
(1) each person who is known by us to own beneficially more than 5% of its
Shares;
(2) each of our directors;
(3) each of the Named Executive Officers for the fiscal year ended December
31, 1998; and
(4) our directors and executive officers as a group.
Shares
Beneficially
Name and Address of Beneficial Owner(1) Owned(2) Percent of Class
--------------------------------------- ------------ ----------------
William McBride III......................... 504,000 2.9%
Dr. Keren Brown Wilson...................... 1,085,412 6.2%
Richard C. Ladd............................. 45,000 *
Bradley G. Razook........................... 34,000 *
170 Water Street, 20th Floor
New York, NY 10038
Gloria Cavanaugh............................ 10,000 *
Sandra Campbell(2).......................... 17,461 *
Nancy Gorshe(2)............................. 6,667 *
Rhonda Marsh................................ -- *
Dresdner Bank AG(4)......................... 1,786,300 10.3%
Jurgen-Ponto-Platz 1
60301 Frankfurt, Germany
Palisade Capital Management, L.L.C.(5)...... 1,368,955 7.9%
One Bridge Plaza, Suite 695
Fort Lee, NJ 07024
Wellington Management Company, LLP(6)....... 1,163,582 6.7%
75 State Street
Boston, MA 02109
The TCW Group, Inc.(8)...................... 1,076,675 6.2%
865 South Figueroa Street
Los Angeles, CA 90017
RH Capital Associates, LLC(7)............... 1,067,800 6.1%
55 Harristown Road
Glen Rock, NJ 07452
All directors and executive officers as a
group (13 persons)......................... 1,850,923 10.2%
- --------
* Less than 1%
(1) Except as otherwise noted below, the address of our directors and officers
is c/o Assisted Living Concepts, Inc., 11835 NE Glenn Widing Drive,
Portland, Oregon, 97220.
(2) Includes options to purchase 145,000 shares of Common Stock held by Mr.
McBride, 210,000 by Dr. Wilson, 45,000 by Mr. Ladd, 30,000 by Mr. Razook,
10,000 by Ms. Cavanaugh, 16,667 by Ms. Campbell, and 6,667 by Ms. Gorshe,
which are exercisable within 60 days of May 31, 1999.
(3) Includes 4,000 shares owned by Mr. Razook's children.
49
(4) Based on the Form 13G as filed on February 16, 1999.
(5) Based on the Form 13G as filed on February 9, 1999.
(6) Based on the Form 13G as filed on February 8, 1999.
(7) Based on the Form 13G as filed on February 10, 1999.
(8) Based on the Form 13G as filed on February 12, 1999. Such Form 13G
identifies Robert Day, 200 Park Avenue, Suite 2200, New York, NY 10166 as
a control person with respect to The TCW Group, Inc.
ITEM 13. Certain Relationships and Related Transactions
During 1998, Supportive Housing Services, Inc. ("SHS") provided services to
us for market feasibility analysis, site pre-acquisition services,
construction management oversight and building setup in conjunction with our
development activities. SHS was owned 80% by Dr. Wilson's spouse and 20% by
Paul Parker through June 30, 1998, and, as of July 1, 1998, owned 75% by Dr.
Wilson's spouse. SHS billed us approximately $3.9 million for such services in
1998, approximately $3.8 million (including $566,000 reflecting payment to CCL
(as defined below)) of which was paid as of December 31, 1998. As of May 31,
1999, we had incurred additional fees totaling $248,000 to SHS. In July 1999
we delivered 180 days' written notice terminating our agreement with SHS. We
expect to incur additional fees of approximately $240,000 for all remaining
services to be provided by SHS under the agreement.
In December 1997 we entered into a consulting services agreement with SHS
pursuant to which we provided SHS with consulting services in the assisted
living industry, including providing data on our facility prototypes,
facilitating the introduction of SHS to other potential customers and
providing market analysis on the assisted living industry. This consulting
agreement expired in September 1998. We received approximately $1.1 million in
fees and reimbursable expenses from SHS for such consulting services.
During 1998, Concepts in Community Living, Inc. ("CCL"), a company owned by
Dr. Wilson's spouse, provided feasibility studies and pre-development
consulting services to SHS and certain developers with respect to certain
assisted living residence sites we were developing and constructing. Both
directly and through these developers, we paid CCL approximately $566,000
indirectly through SHS for rendering such services in 1998. In June 1999 we
entered into a new agreement with CCL pursuant to which CCL will provide
market research, demographic review and competitor analysis in many of our
current and potential markets. We will pay CCL a retainer of $10,000 per
month, plus fees in excess of the retainer, if any, in connection with
specific projects that we authorize under the agreement.
We lease six residences from Assisted Living Facilities, Inc. Dr. Wilson's
spouse owns a 25% interest. During 1998, we paid Assisted Living Facilities,
Inc. rent of approximately $1.2 million. In addition, we leased one residence
from Oregon Heights Partners in 1998, in which Dr. Wilson's spouse owns
through CCL a 34% interest. Through September 30, 1998, we paid Oregon Heights
Partners approximately $195,000 in rent. The Oregon Heights Partners lease was
terminated in September 1998, effective October 1, 1998.
During 1998, Mr. McBride owned a $400,000 or 16.6% interest, and Dr.
Wilson's spouse owned a $200,000 or 8.3% interest, in Health Equity Investors
("HEI"). In the second quarter of 1997, we entered into joint venture
agreements with HEI to operate certain new assisted living residences that we
owned or leased. The joint venture concurrently entered into a non-cancelable
management agreement with us pursuant to which we managed the properties
operated by the joint venture for an amount equal to the greater of 8% of
gross revenues or $2,000 per month per residence. Through February 10, 1999,
we consolidated 100% of the revenues and expenses attributable to these
residences with our revenues and expenses, and HEI reimbursed us for 90.0% of
the start-up losses of the joint venture. We received loss reimbursements from
HEI of $4.7 million for the year ended December 31, 1998, and no loss
reimbursements in 1999. As of December 31, 1998, 17 residences owned or leased
by us were being operated by the joint venture.
50
On February 10, 1999, we purchased HEI's joint venture interest with respect
to the 17 properties then being operated by the joint venture for an aggregate
purchase price of approximately $3.8 million. HEI's investment with respect to
such properties was $3.2 million. As a result of such purchases, Mr. McBride
and Dr. Wilson's spouse received distributions of approximately $537,000 and
$269,000, respectively, in 1999.
In October 1997, we acquired Home and Community Care, Inc. ("HCI"). Certain
of our officers and directors were officers, directors or stockholders of HCI.
Mr. McBride and Dr. Wilson's spouse owned 13.9% and 4.7%, respectively, of
HCI's outstanding common stock at the time of acquisition, substantially all
of which was acquired in March 1997. The terms of the acquisition were
approved by a committee of independent directors. Pursuant to the HCI
acquisition agreement, during 1998, Mr. McBride and Dr. Wilson's spouse
received "earnout" payments from us of $174,000 and $70,000, respectively,
related to HCI sites we elected to develop. Additional "earnout" payments are
expected to be made under the HCI agreement in 1999.
In October 1997, we acquired Carriage House Assisted Living, Inc. ("Carriage
House"). Certain of our employees and directors collectively owned 23% of
Carriage House's stock at the time of acquisition. The terms of the
acquisition were approved by a committee of independent directors.
For information regarding certain other relationships and related
transactions, see Item 11 "Compensation Committee Interlocks and Insider
Participation."
51
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 November 18, 1998, we filed a report on Form 8-K announcing our entrance
into a definitive merger agreement and cross option agreement with American
Retirement Corporation. Subsequent to the year ended December 31, 1998, the
two companies mutually terminated such agreements, effective January 31, 1999.
52
ASSISTED LIVING CONCEPTS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
(Item 14(a))
Page
----
1. Financial Statements:
Independent Auditors' Report............................................ 54
Consolidated Balance Sheets, December 31, 1997 and 1998................. 55
Consolidated Statements of Operations, Years Ended December 31, 1996,
1997 and 1998.......................................................... 56
Consolidated Statements of Shareholders' Equity, Years Ended December
31, 1996, 1997 and 1998................................................ 57
Consolidated Statements of Cash Flows, Years Ended December 31, 1996,
1997 and 1998.......................................................... 58
Notes to Consolidated Financial Statements.............................. 59
2. Financial Statement Schedule:
Schedule II--Valuation and Qualifying Accounts.......................... 86
53
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
of Assisted Living Concepts, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Assisted
Living Concepts, Inc. and subsidiaries as of December 31, 1997 and 1998, and
the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1998. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the 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, 1997 and 1998, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1998, in conformity with generally
accepted accounting principles.
As discussed in note 13 to the consolidated financial statements, in 1998
the Company changed its method of accounting for pre-opening costs associated
with newly developed residences.
As discussed in note 20 to the consolidated financial statements, the
Company restated its financial statements as of and for the years ended
December 31, 1996 and 1997.
KPMG LLP
Portland, Oregon
September 10, 1999
54
ASSISTED LIVING CONCEPTS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
December 31,
------------------
1997 1998
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................ $ 63,269 $ 55,036
Funds held in trust (Note 3)............................. 1,956 --
Marketable securities, available for sale (Note 4)....... -- 4,000
Accounts receivable, net of allowance for doubtful
accounts of $79 at 1997 and $179 at 1998................ 2,185 5,127
Prepaid expenses......................................... 904 992
Other current assets (Note 7)............................ 3,579 4,472
-------- --------
Total current assets................................... 71,893 69,627
-------- --------
Property and equipment (Notes 2, 5, 6 and 8)............... 131,623 284,754
Construction in process (Note 6)........................... 102,025 51,304
-------- --------
Total property and equipment........................... 233,648 336,058
Less accumulated depreciation.......................... 3,370 9,133
-------- --------
Property and equipment--net............................ 230,278 326,925
-------- --------
Goodwill (Note 2).......................................... 12,447 5,371
Other assets (Notes 2, 5 and 8)............................ 9,749 12,746
-------- --------
Total assets........................................... $324,367 $414,669
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $ 1,859 $ 1,622
Construction payable..................................... 18,883 6,942
Accrued real estate taxes................................ 2,354 4,837
Other accrued expenses................................... 4,045 6,127
Other current liabilities (Note 7)....................... 2,368 4,857
Construction financing................................... 2,150 --
Current portion of long-term debt (Note 8)............... 172 1,386
-------- --------
Total current liabilities.............................. 31,831 25,771
-------- --------
Other liabilities (Notes 2 and 5).......................... 2,592 3,415
Long-term debt (Note 8).................................... 57,535 105,036
Convertible subordinated debentures (Note 9)............... 100,165 161,250
-------- --------
Total liabilities...................................... 192,123 295,472
-------- --------
Commitments and contingencies (Notes 5 and 19)
Shareholders' equity (Notes 8 and 17):
Preferred Stock, $.01 par value; 1,000,000 shares
authorized; None issued or outstanding.................. -- --
Common Stock, $.01 par value; 80,000,000 shares
authorized; issued and Outstanding 15,646,478 shares in
1997 and 17,344,143 shares in 1998...................... 156 173
Additional paid-in capital............................... 141,460 148,533
Unearned compensation expense............................ (4,100) (3,492)
Fair market value in excess of historical cost of
acquired net assets attributable to related party
transactions............................................ (239) (239)
Accumulated deficit...................................... (5,033) (25,778)
-------- --------
Total shareholders' equity............................. 132,244 119,197
-------- --------
Total liabilities and shareholders' equity............. $324,367 $414,669
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
55
ASSISTED LIVING CONCEPTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Years Ended December 31,
--------------------------
1996 1997 1998
------- ------- --------
Revenue........................................... $21,022 $49,605 $ 89,384
Operating expenses:
Residence operating expenses.................... 14,055 31,591 57,443
Corporate general and administrative............ 1,864 4,050 11,099
Building rentals................................ 1,137 2,691 11,308
Building rentals to related party (Notes 15 and
16)............................................ 2,812 5,278 1,456
Depreciation and amortization (Note 6).......... 1,094 3,683 6,339
Terminated merger expense (Note 12)............. -- -- 1,068
Site abandonment costs (Note 6)................. -- -- 2,377
Write-off of impaired assets and related
expenses (Note 11)............................. -- -- 8,521
------- ------- --------
Total operating expenses...................... 20,962 47,293 99,611
------- ------- --------
Operating income (loss)........................... 60 2,312 (10,227)
------- ------- --------
Other (income) expense:
Interest expense (Notes 8 and 9)................ 1,146 4,946 11,039
Interest income................................. (455) (1,526) (3,869)
Loss on sale of assets (Notes 5 and 16)......... 854 1,250 651
Debenture conversion costs (Note 9)............. 426 -- --
Other expenses (Notes 2, 8 and 16).............. 4 121 1,174
------- ------- --------
Total other (income) expense.................. 1,975 4,791 8,995
------- ------- --------
Net loss before cumulative effect of change in
accounting principle............................. (1,915) (2,479) (19,222)
Cumulative effect of change in accounting
principle (Note 13).............................. -- -- (1,523)
------- ------- --------
Net loss.......................................... $(1,915) $(2,479) $(20,745)
======= ======= ========
Basic and diluted net loss per common share:
Loss before cumulative effect of change in
accounting principle........................... $ (0.23) $ (0.21) $ (1.18)
Cumulative effect of change in accounting
principle...................................... -- -- (0.09)
------- ------- --------
Basic and diluted net loss per common share....... $ (0.23) $ (0.21) $ (1.27)
======= ======= ========
Basic and diluted weighted average common shares
outstanding...................................... 8,404 11,871 16,273
======= ======= ========
The accompanying notes are an integral part of these consolidated financial
statements.
56
ASSISTED LIVING CONCEPTS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Fair
Market
Value in
Common Stock Additional Unearned Excess of Total
-------------- Paid-In Compensation Historical Accumulated Shareholders'
Shares Amount Capital Expense Cost Deficit Equity
------ ------ ---------- ------------ ---------- ----------- -------------
Balance at December 31,
1995................... 6,000 $ 60 $ 16,462 $ -- $(239) $ (639) $ 15,644
Net proceeds from public
offering............... 4,192 42 37,299 -- -- -- 37,341
Exercise of employee
stock options.......... 28 -- 132 -- -- -- 132
Conversion of
subordinated
debentures............. 810 8 5,785 -- -- -- 5,793
Net loss................ -- -- -- -- -- (1,915) (1,915)
------ ---- -------- ------- ----- -------- --------
Balance at December 31,
1996................... 11,030 110 59,678 -- (239) (2,554) 56,995
Net proceeds from public
offering............... 4,140 42 72,086 -- -- -- 72,128
Shares issued for
acquisition............ 337 3 5,073 -- -- -- 5,076
Exercise of employee
stock options.......... 139 1 373 -- -- -- 374
Grant of restricted
stock (Note 17)........ -- -- 4,250 (4,250) -- -- --
Compensation expense
earned on restricted
stock (Note 17)........ -- -- -- 150 -- -- 150
Net loss................ -- -- -- -- -- (2,479) (2,479)
------ ---- -------- ------- ----- -------- --------
Balance at December 31,
1997................... 15,646 $156 $141,460 (4,100) $(239) $ (5,033) $132,244
Common stock
repurchased............ (529) (5) (7,057) -- -- -- (7,062)
Conversion of
subordinated
debentures............. 1,855 19 13,387 -- -- -- 13,406
Exercise of employee
stock options.......... 122 1 745 -- -- -- 746
Issuance of restricted
stock (Note 17)........ 250 2 (2) -- -- -- --
Compensation earned on
restricted stock
(Note 17).............. -- -- -- 608 -- -- 608
Net loss................ -- -- -- -- -- (20,745) (20,745)
------ ---- -------- ------- ----- -------- --------
Balance at December 31,
1998................... 17,344 $173 $148,533 $(3,492) $(239) $(25,778) $119,197
====== ==== ======== ======= ===== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
57
ASSISTED LIVING CONCEPTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended December 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
Operating activities:
Net loss..................................... $ (1,915) $ (2,479) $ (20,745)
Adjustment to reconcile net loss to net cash
(used in) provided by operating activities:
Depreciation and amortization.............. 1,094 3,683 6,339
Provision for doubtful accounts............ 33 23 359
Loss on sale of assets..................... 854 1,250 651
Compensation expense earned on restricted
stock..................................... -- 150 608
Write-off of impaired assets and related
expenses.................................. -- -- 8,521
Site abandonment costs..................... -- -- 2,377
Cumulative effect of change in accounting
principle................................. -- -- 1,523
Changes in assets and liabilities, excluding
effects of acquisitions:
Accounts receivable, net................... (627) (808) (3,302)
Prepaid expenses........................... (138) (530) (88)
Other current assets....................... (392) (3,039) (909)
Other assets............................... (1,554) (633) 1,314
Accounts payable........................... 866 (155) (237)
Accrued expenses........................... (2,508) 3,616 2,840
Other current liabilities.................. 196 1,824 2,922
Other liabilities.......................... 997 1,595 823
--------- --------- ---------
Net cash (used in) provided by operating
activities.................................. (3,094) 4,497 2,996
--------- --------- ---------
Investing activities:
Funds held in trust.......................... (8,515) 6,559 1,956
Investment in marketable securities.......... -- -- (4,000)
Proceeds from sale and leaseback
transactions................................ 41,385 51,671 8,113
Purchases of property and equipment.......... (122,169) (148,139) (117,972)
Acquisitions, net of cash, debt acquired and
issuance of common stock.................... -- (4,064) (11,366)
--------- --------- ---------
Net cash used in investing activities........ (89,299) (93,973) (123,269)
--------- --------- ---------
Financing activities:
Proceeds from construction financing......... 18,850 43,210 --
Repayments of construction financing......... -- (63,497) --
Proceeds from long-term debt................. 31,346 21,854 49,004
Payments on long-term debt................... (88) (5,516) (289)
Proceeds from issuance of common stock, net.. 37,473 72,502 746
Repurchase of common stock................... -- -- (7,062)
Debt issuance costs of offerings and long-
term debt................................... (418) (4,163) (5,359)
Proceeds from issuance of convertible
subordinated debentures..................... -- 86,250 75,000
--------- --------- ---------
Net cash provided by financing activities.... 87,163 150,640 112,040
--------- --------- ---------
Net increase (decrease) in cash and cash
equivalents................................. (5,230) 61,164 (8,233)
Cash and cash equivalents, beginning of
year........................................ 7,335 2,105 63,269
--------- --------- ---------
Cash and cash equivalents, end of year....... $ 2,105 $ 63,269 $ 55,036
========= ========= =========
Supplemental disclosure of cash flow
information (Note 18):
Cash payments for interest................. $ 3,218 $ 9,741 $ 16,480
Cash payments for income taxes............. -- 1,547 $ --
Non-cash transactions:
Increase (decrease) in construction payable
and property and equipment................ $ 8,752 $ 2,881 $ (11,941)
Conversion of subordinated debentures (net
of $509 of unamortized financing costs in
1998)..................................... 6,085 -- 13,406
Conversion of construction financing to
sale leaseback............................ -- -- 2,150
The accompanying notes are an integral part of these consolidated financial
statements.
58
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, operates and develops
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 designed to meet the needs of its residents. The
accompanying financial statements reflect the operating results of 60, 109 and
165 residences for the years ended 1996, 1997 and 1998, respectively.
Residences are included in operating results as of the first day of the month
following licensure.
On November 22, 1994, the Company sold 4,000,000 shares of common stock at
$4.625 per share in an initial public offering realizing net proceeds of
approximately $16.4 million after underwriter discounts, commissions and other
expenses.
In August 1995, the Company completed the offering of $20.0 million 7%
Convertible Subordinated Debentures ("7% Debentures") due August, 2005
realizing net proceeds of approximately $19.2 million after discounts,
commissions and other expenses. In September 1996, $6.1 million of the 7%
Debentures were converted into 811,333 shares of the Company's common stock
which resulted in $13.9 million of 7% Debentures outstanding. In August 1998,
the Company called for redemption all of the remaining $13.9 million of the 7%
Debentures. All of the 7% Debentures were converted into shares of the
Company's common stock, resulting in the issuance of 1,855,334 additional
shares of common stock.
In July 1996, the Company sold 4,192,500 shares of common stock at $9.50 per
share in a public offering realizing net proceeds of $37.3 million, after
underwriter discounts, commissions and other expenses.
In June 1997, the Company's Board of Directors declared a two for one stock
split on the Company's common stock. The record date for the stock split was
June 30, 1997 and the stock split occurred on July 10, 1997.
In addition, in June 1997 the Company's Board of Directors declared a
dividend distribution of one preferred share purchase right ("Preferred Share
Purchase Right") on each outstanding share of the Company's common stock. In
the event that a person or group of persons acquires or announces a tender
offer to acquire 15% or more of the common stock (the "Acquiring Person"), the
Preferred Stock Purchase Rights, subject to certain limited exceptions, will
entitle each shareholder (other than the Acquiring Person) to buy one
one-hundredth of a share of newly created Series A Junior Participating
Preferred Stock of the Company at an exercise price of $54 (after giving
effect to the stock split). The Company may redeem the rights at one cent per
right at any time before a person or group has acquired 15% or more of the
outstanding common stock. The record date for Preferred Share Purchase Right
distribution was June 30, 1997. The stock split occurred immediately prior to
the Preferred Share Purchase Right distribution.
In October 1997 the Company sold 4,140,000 shares of common stock at $18.50
per share in a public offering realizing net proceeds of $72.1 million, after
underwriter discounts, commissions and other expenses.
In October 1997, the Company completed the public offering of $86.3 million
of 6% Convertible Subordinated Debentures ("6% Debentures") due November 2002
realizing net proceeds of $82.9 million after underwriter discounts,
commissions and other expenses. The 6% Debentures are convertible at any time
at or prior to maturity, unless previously redeemed, at a conversion price of
$22.57 per common share, which equates to an aggregate of 3,821,444 shares of
the Company's common stock.
59
In April 1998, the Company completed the offering of $75.0 million of 5.625%
Convertible Subordinated Debentures ("5.625% Debentures") due May 2003
realizing net proceeds of $72.2 million after discounts, commissions and other
expenses. The 5.625% Debentures are convertible at any time at or prior to
maturity, unless previously redeemed, at a conversion price of $26.184 per
common share, which equates to an aggregate of 2,864,345 shares of the
Company's common stock.
Principles of Consolidation
The consolidated financial statements include the accounts of Assisted
Living Concepts Inc. and its wholly owned subsidiaries (the "Company"). All
significant intercompany balances and transactions have been eliminated in
consolidation.
Cash, Cash Equivalents and Marketable Securities
Cash and cash equivalents include cash on deposit and highly liquid
investments with maturities of three months or less at the date of purchase.
The Company's investments in cash equivalents are classified as held to
maturity and are stated at cost. 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 a component of
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 reevaluates 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 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.
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.
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:
Buildings..................................................... 40 years
Furniture and equipment....................................... 3 to 7 years
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 through the year ended December 31, 1998.
60
Interest and certain payroll costs incurred during construction periods are
capitalized as part of the building costs. Maintenance and repairs are charged
to expense as incurred, and significant betterments and improvements are
capitalized. Construction in process includes pre-acquisition costs and other
direct costs related to acquisition, development and construction of
residences. If a project is abandoned, any costs previously capitalized are
expensed.
Goodwill
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
are being amortized over periods ranging between 15 and 20 years on a
straight-line basis. Amortization of goodwill was $30,000, $128,000 and
$398,000, respectively, for the years ended December 31, 1996, 1997 and 1998.
Accumulated amortization of goodwill at December 31, 1997 and 1998 was
$188,000 and $278,000, respectively. Management maintains an impairment review
policy whereby the future economic benefit of the recorded balance is
substantiated at the end of each reporting period.
During the year ended December 31, 1998, the Company wrote-off all the
unamortized goodwill (approximately $7.5 million) associated with Pacesetter
Home Health Care, Inc. ("Pacesetter"), a wholly owned subsidiary of Home and
Community Care, Inc. The shut-down of Pacesetter operations was a result of a
change in the regulatory reimbursement environment during the quarter ended
June 30, 1998 (See Note 11).
Pre-Opening Costs
Prior to the adoption of AICPA Statement of Position 98-5, Reporting on the
Costs of Start-up Activities (SOP 98-5), pre-opening costs associated with
newly developed residences, prior to the commencement of their operations were
capitalized and amortized over 12 months. As a result of the Company's
adoption of SOP 98-5 (effective as of January 1, 1998), pre-opening costs are
expensed as incurred (See Note 13).
Deferred Financing Costs
Financing costs related to the issuance of debt are capitalized in 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.
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.
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. Management of the Company assesses the collectibility
of the accounts receivable periodically and records a provision for doubtful
accounts as considered necessary.
Classification of Expenses
All expenses (except interest, depreciation, amortization, residence
operating expenses) associated with corporate or support functions have been
classified as corporate general and administrative expense. All other expenses
incurred by the Company have been classified as residence operating expenses.
61
Comprehensive Income (Loss)
On January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for reporting and
presentation of comprehensive income and its components in a full set of
financial statements. Comprehensive income consists of net income (loss) and
several other items that current accounting standards require to be recognized
outside of net income (loss) and is presented in the consolidated statements
of shareholders' equity and comprehensive income. The Statement requires only
additional disclosures in the consolidated financial statements; it does not
affect the Company's financial position or net income (loss). There were no
unrealized gains (losses) on marketable securities for the years ended
December 31, 1997 or 1998. The Company had no items to be recognized in
comprehensive income (loss) outside net loss for the periods presented.
Net Income (Loss) Per Common Share
Basic earnings per share (EPS) is calculated using income (loss)
attributable to common shares (after deducting preferred dividends) 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 (after deducting preferred dividends and 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.
Vested options to purchase 382,000, 568,000 and 833,000 shares of common
stock were outstanding during the years ended December 31, 1996, 1997 and
1998, respectively. These options were excluded from the respective
computations of diluted loss per share, as their inclusion would be
antidilutive.
Also excluded from the computations of diluted loss per share, for the years
ended December 31, 1996, 1997 and 1998 were 1,855,333, 5,676,777 and 6,685,789
shares of common stock, respectively, issuable upon conversion of the
Company's convertible subordinated debentures (see Note 9) and 250,000 shares
of restricted stock for the year ended December 31, 1998 (see Note 20) as
their inclusion would be antidilutive.
Segment Reporting
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosure about Segments of an Enterprise and Related Information." This
SFAS 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.
This SFAS is effective for financial statements for periods beginning after
December 15, 1997 and, as such, was adopted by the Company in 1998. The
Company has no foreign operations, no customers which provide over 10 percent
of gross revenue, and has determined that it has only one operating segment.
Use of Estimates
Management of 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 generally accepted accounting principles. Actual results could
differ from those estimates.
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.
62
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable and
accounts payable 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. The carrying value of marketable debt securities and funds held
in trust approximates fair value because they bear interest at market rates.
The carrying amount of the Company's long-term debt and construction financing
approximate fair value as the interest rates approximate the current rates
available to the Company. The following table sets forth the carrying amount
and approximate fair value (based on quoted market values) of the Company's
subordinated debentures as of December 31, 1997 and 1998 (in thousands):
1997 1998
---------------- ----------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------- -------- -------
7% Debentures............................ $13,915 $36,596 -- --
6% Debentures............................ 86,250 93,581 $86,250 $71,156
5.625% Debentures........................ -- -- 75,000 58,500
Stock-based Compensation
In October 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-
Based Compensation," which provides an alternative to APB Opinion No. 25,
"Accounting for Stock Issued to Employee," in accounting for stock-based
compensation issued to employees. The Statement encourages, but does not
require financial reporting to reflect compensation expense for grants of
stock, stock options and other equity instruments to employees based on
changes in the fair value of the underlying stock. The Company continues to
apply the existing accounting rules contained in APB Option No. 25,
"Accounting for Stock Issued to Employees." While recognition of employee
stock-based compensation is not mandatory, SFAS 123 requires companies that
choose to continue applying the provisions of APB No. 25 to disclose pro forma
net income (loss) and earnings (loss) per share data (See Note 17).
The Non-Officer Stock Option Plan (the "Non-Officer Plan") is 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.
Concentration of Credit Risk
State Medicaid reimbursement programs constitute a significant source of
revenue for the Company. Adverse changes in general economic factors affecting
the health care industry or laws and regulatory environment, including
Medicaid reimbursement rates, could have a material adverse effect on the
Company's financial condition and results of operations. As of December 31,
1998, 23.1% of the Company's residences are in Texas, 11.0% are in Oregon,
10.4% in Ohio, 11.0% in Indiana and 9.2% in Washington. During the years ended
December 31, 1996, 1997 and 1998, direct payments received from state Medicaid
agencies accounted for approximately 12.4%, 11.1% and 10.7%, respectively, of
the Company's revenue while the tenant paid portion received from Medicaid
residents accounted for approximately 6.9%, 5.9% and 5.8%, 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. Acquisitions and Joint Venture
Acquisitions
Effective October 23, 1997, the Company acquired 98.8% of the outstanding
capital stock of Home and Community Care, Inc. ("HCI"). The Company had
acquired an initial 1.2% interest in HCI as a result of HCI's acquisition of
Pacesetter, a home health care agency in which the Company had made an
investment in November 1996. Several employees of the Company, including
members of the Board of Directors, owned
63
collectively approximately 40.0% of the outstanding common stock in HCI (See
Notes 15 and 16). In the second quarter of 1997 the Company signed a licensing
agreement with HCI, pursuant to which the Company agreed to allow HCI to use
certain of the Company's proprietary information and materials in connection
with the development of HCI's assisted living residences. During the second
quarter of 1997, the Company received $178,000 in fees from HCI and recorded
such fees as other income included in other income/expenses. The HCI purchase
was completed at a purchase price of approximately $4.0 million in cash (which
reflects approximately $5.3 million of cash paid net of (i) approximately
$250,000 in cash acquired, (ii) approximately $850,000 in fees from HCI for
services rendered during 1997, and (iii) $150,000 in dividends received from
HCI during 1997), and the assumption of approximately $6.6 million in
liabilities. HCI stockholders are entitled to receive certain "earnout"
payments over a two-year period based on the number of HCI's assisted living
residence sites, which the Company elects to complete. At the time of the
acquisition, HCI had 20 sites under development. For each completed residence,
HCI stockholders will receive an additional $7,500 per unit (approximately
$300,000 per residence) in cash. During the years ended December 31, 1997 and
1998, respectively, the Company paid earnout payments of $0 and $1.7 million,
respectively, and capitalized such payments in property and equipment.
The acquisition was accounted for as a purchase, and the operating results
of HCI have been included in the Company's consolidated financial statements
since the date of acquisition. The cost of the acquisition has been allocated
based on the estimated fair value of the net assets acquired of approximately
$3.4 million. The excess of the aggregate purchase price over the fair market
value of net assets acquired of approximately $7.5 million was recorded as
goodwill and amortized on a straight-line basis over 20 years.
During second quarter 1998 the Company announced a plan to exit all home
health business operations being conducted by Pacesetter. During the year
ended December 31, 1998, the Company incurred a $8.5 million charge to
earnings associated with exiting the Pacesetter operations. Such charge
consisted of (i) a $7.5 million write-off of all unamortized goodwill
associated with Pacesetter and (ii) a $1.0 million provision for exit costs
expected to be incurred during the phase out of the Pacesetter business.
During the fourth quarter 1998, the $1.0 million provision for exit costs was
reduced by $400,000 from $1.4 million as a result of a change in the estimate
for such exit costs. In addition, the Company incurred a $1.0 million charge
recorded as site abandonment expense during second quarter 1998 for previously
capitalized development costs relating to 11 sites acquired in the HCI
acquisition that it had determined not to develop (See Note 6 and Note 11).
Effective October 23, 1997, the Company acquired 90.1% of the outstanding
capital stock of Carriage House Assisted Living Inc. ("Carriage House").
Several employees of the Company, including members of the Board of Directors,
owned collectively approximately 23.0% of the outstanding common stock of
Carriage House (See Notes 15 and 16). The Company had acquired its initial
9.9% in Carriage House's outstanding capital stock during 1996. The purchase
was completed at a purchase price of $5.2 million with the exchange of
337,460 shares of Common Stock (based on a stock price of $15.41 per share)
for all of the outstanding common stock of Carriage House and the assumption
of approximately $3.2 million in liabilities.
The acquisition was accounted for as a purchase and the operating results of
Carriage House have been included in the Company's consolidated financial
statements since the acquisition date. The cost of the acquisition has been
allocated based on the estimated fair value of the net assets acquired of
approximately $3.4 million. The excess of the aggregate purchase price over
the fair market value of net assets acquired of approximately $4.7 million has
been recorded as goodwill and is being amortized on a straight-line basis over
20 years.
The following unaudited pro forma consolidated results of operations for the
Company for the year ended December 31, 1997 assume that HCI and Carriage
House acquisitions had occurred as of January 1, 1997 (in thousands, except
per share amounts):
(Unaudited) Total
----------- -------
Net revenue...................................................... $55,241
Net loss......................................................... (2,680)
Basic and diluted net loss per common share...................... $ (0.23)
64
The unaudited pro forma consolidated results of operations do not purport to
be indicative of the results that would have been reported if the acquisitions
had been completed as of the beginning of the periods presented, nor are they
indicative of future results of operations. The Company cannot predict whether
the consummation of the acquisitions described above will conform to the
assumptions used to prepare the unaudited pro forma consolidated results of
operations.
On April 30, 1998, the Company completed the acquisitions of two assisted
living residences in Plano and McKinney, Texas, having units of 66 and 50,
respectively. The residences were acquired for a total purchase price of
approximately $5.2 million. The acquisitions were accounted for as purchases
and the operating results of the facilities have been included in the
Company's consolidated financial statements since the acquisition date. The
cost of the acquisitions has been allocated based on the estimated fair value
of the net assets acquired of approximately $5.2 million. No goodwill was
recorded.
On July 1, 1998, the Company completed the acquisition of an assisted living
residence in Alexandria, Louisiana having 47 units. The residence was acquired
for a purchase price of approximately $2.8 million. The acquisition was
accounted for as a purchase and the operating results of the facility have
been included in the Company's consolidated financial statements since the
acquisition date. The cost of the acquisition has been allocated based on the
estimated fair value of the net assets acquired of approximately $2.8 million.
No goodwill was recorded.
On December 1, 1998, the Company completed the acquisition of an assisted
living residence in Paris, Texas, having 50 units. The residence was acquired
for a purchase price of approximately $3.4 million. The acquisition was
accounted for as a purchase and the operating results of the facility have
been included in the Company's consolidated financial statements since the
acquisition date. The cost of the acquisition has been allocated based on the
estimated fair value of the net assets acquired of approximately $3.0 million.
The excess of the aggregate purchase price over the fair market value of net
assets acquired is approximately $432,000 and has been recorded as goodwill
and is being amortized on a straight-line basis over 20 years.
The pro forma consolidated results of operations for the four facilities
acquired during 1998 are excluded, as they are not considered significant to
the Company's operations.
Joint Venture
During 1997, the Company entered into joint venture agreements with a joint
venture partner to operate certain new assisted living residences which
commenced operations during the second, third and fourth quarters of 1997. Of
the $2.3 million of total capital raised by the joint venture partner to
invest in such arrangements, the Company contributed $300,000 and recorded
such investment in other non-current assets. In addition, certain members of
management held interests in the joint venture partner (See Note 15). Pursuant
to the joint venture agreements, the Company entered into non-cancelable
management agreements under which the Company managed the residences operated
by the joint venture for an amount equal to the greater of 8% of gross
revenues or $2,000 per month per residence. The Company consolidated the
operations of the joint venture agreements in its consolidated financial
statements. The joint venture partner reimbursed the Company for 90.0% of the
start-up losses of the joint venture, and the Company recognized such
reimbursements as loans included in other liabilities. The Company also
reflected amounts paid to repurchase the joint venture partner's interest in
excess of reimbursed losses as interest and other expense. Interest was
calculated based on the average loan balance using an imputed 20.0% interest
rate and other expense was calculated based on a $10,000 administrative fee
per residence. The Company received loss reimbursements of $2.3 million and
$4.7 million for the years ended December 31, 1997 and 1998, respectively. The
Company did not repay any of these loans, and incurred interest expense of
$52,000 in connection with these loans, during the year ended December 31,
1997. The Company repaid $4.0 million of these loans in 1998, and incurred
interest and other expense of $687,000 in connection with these loans, for the
year ended December 31, 1998. As of December 31, 1998, 17 residences owned or
leased by the Company were being operated by the joint venture. During the
first quarter of 1999 the Company announced that it had negotiated with the
joint venture partner to purchase, for approximately $3.8 million, all of the
joint venture partner's interest in the remaining 17 residences subject to the
joint venture agreements (See Note 20).
65
3. Funds Held In Trust
During 1996, the Company issued $8.5 million in tax-exempt bonds to provide
permanent financing on five Washington residences. As of December 31, 1997,
four of the five properties had been completed and the Company had received
proceeds of $6.5 million. The remaining $2.0 million of proceeds was released
during the first quarter of 1998 once the remaining residence had been
completed and licensed.
4. Marketable Securities
At December 31, 1998 marketable securities, classified as available-for-
sale, are comprised of $3.4 million of U.S. government and agency debt
securities with a maturity of 2030 and $600,000 of state and municipal debt
securities with a maturity of 2025. These marketable securities have right to
call or prepayment provisions, which may affect the maturity. At December 31,
1998 the cost of these securities which was determined on a specific
identification basis, was equal to their estimated fair value, as such, there
were no realized or unrealized gains or losses.
5. Leases
A summary of leases that the Company has entered into since its inception is
as follows:
Number of
Sale and
Number of Leaseback Number of Sale Units under
Leased Residences Total and Leaseback Leases
Residences Accounted for Number of Residences Units under Accounted
("Oregon as Operating Operating Accounted for Operating for as
Leases") Leases Leases as Financings Leases Financings
---------- ------------- --------- -------------- ----------- -----------
Leases at December 31,
1994................... 4 -- 4 -- 114 --
Leases entered into
during 1995............ -- 5 5 -- 150 --
----- ----- ----- ----- ------ -----
Leases at December 31,
1995................... 4 5 9 -- 264 --
Leases entered into
during 1996............ 1 19 20 9 763 316
Residences repurchased
during 1996............ -- (4) (4) -- (146) --
----- ----- ----- ----- ------ -----
Leases at December 31,
1996................... 5 20 25 9 881 316
Leases entered into
during 1997............ 2 24 26 7 1,025 247
----- ----- ----- ----- ------ -----
Leases at December 31,
1997................... 7 44 51 16 1,906 563
Leases entered into
during 1998............ -- 4 4 -- 139 --
Lease expansions during
1998................... -- -- -- -- 47 10
Leases terminated during
1998................... (1) -- (1) -- (45) --
----- ----- ----- ----- ------ -----
Leases at December 31,
1998................... 6 48 54 16 2,047 573
===== ===== ===== ===== ====== =====
The Company has entered into agreements to lease six assisted living
residences in Oregon from Assisted Living Facilities, Inc., a related party
(the "Oregon Leases"). During 1998 the Company terminated a lease with Oregon
Heights Partners ("OHP"). 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 Assisted Living Facilities,
Inc., 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 8). 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, 1997 and 1998 were $176,000 and $126,000 respectively, which
are reflected in other assets.
During the years ended December 31, 1996, 1997 and 1998, the Company
completed the sale of 19, 24 and four residences under sale and leaseback
arrangements, respectively. The Company sold the residences for approximately
$41.4 million in 1996, $51.7 million in 1997 and $10.3 million in 1998, and
leased them back
66
over initial terms ranging from 12 to 20 years. During 1996, four of the 19
properties were repurchased for $7.8 million, in connection with a $50.2
million sale and leaseback commitment with LTC Properties, Inc. ("LTC") (See
Note 16). The properties were repurchased at a cost of $7.6 million plus a
$214,000 administrative fee. In addition, the Company assumed four leases
under sale and leaseback agreements that were acquired with the Carriage House
purchase that was completed in October of 1997.
The Company recognized losses of $936,000, $1.3 million and $651,000 on the
above sale and leaseback transactions for the years ended December 31, 1996,
1997 and 1998, respectively. The losses, net of a 1996 unrelated land sale
gain of $82,000, are presented in the Consolidated Statements of Operations as
net loss on sale of assets. Gains on sale and leaseback transactions of
$399,000, $1.1 million and $508,000 for the years ended December 31, 1996,
1997 and 1998 respectively, have been recorded as deferred income included in
other liabilities and are being amortized over the initial terms of the
corresponding leases. For the years ended December 31, 1996 and 1997, a
substantial portion of such gains and losses resulted from sale and leaseback
transactions with LTC (See Note 16).
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. The
Company was not in compliance with certain lease and loan covenants and has
obtained necessary waivers as a result of such non-compliance.
As of December 31, 1998, future minimum annual lease payments under
operating leases are as follows (in thousands):
1999................................ $ 16,139
2000................................ 16,103
2001................................ 16,099
2002................................ 16,102
2003................................ 16,123
Thereafter.......................... 108,990
--------
$189,556
========
During the years ended December 31, 1996 and 1997, respectively, the Company
entered into nine and seven sale and leaseback agreements, which are accounted
for as financings due to the Company's continuing involvement in the
properties in the form of a fair value purchase option which provides the
Company with the option to purchase the residence at fair market value at the
end of the initial lease term, ranging from 14 to 15 years. These financings
are included in long term debt and the related assets remain on the
consolidated balance sheets in property, plant and equipment (See Notes 6, 8
and 20).
6. Property and Equipment
As of December 31, 1997 and 1998, property and equipment, stated at cost,
consist of the following (in thousands):
1997 1998
-------- --------
Land...................................................... $ 7,924 $ 18,217
Buildings................................................. 119,649 256,904
Equipment................................................. 1,419 2,865
Furniture................................................. 2,631 6,768
-------- --------
Property and equipment.................................... 131,623 284,754
Construction in process................................... 102,025 51,304
-------- --------
Total property and equipment............................ 233,648 336,058
Less accumulated depreciation............................. 3,370 9,133
-------- --------
Property and equipment--net............................. $230,278 $326,925
======== ========
67
Land, buildings and certain furniture and equipment relating to 37
residences serve as collateral for long-term debt (See Note 8). Depreciation
expense was $805,000, $2.9 million, and $5.9 million, for the years ended
December 31, 1996, 1997 and 1998, respectively.
As of December 31, 1997 and 1998 construction in process consists of the
following (in thousands):
1997 1998
-------- -------
Land purchased and earnest deposits........................ $ 8,791 $ 4,217
Construction costs......................................... 80,325 37,883
Other costs................................................ 12,909 9,204
-------- -------
$102,025 $51,304
======== =======
During the years ended December 31, 1996, 1997 and 1998, the Company
capitalized interest costs of $2.3 million, $6.6 million and $6.0 million,
respectively, relating to financing of construction in process. In addition,
the Company capitalized payroll costs that are directly related to the
construction and development of the residences of $1.1 million, $1.8 million
and $1.8 million for the years ended December 31, 1996, 1997 and 1998,
respectively.
As a result of the Company's decision to reduce the number of new residence
openings during the year ending December 31, 1999 and beyond, the Company
wrote-off $2.4 million of capitalized costs during 1998 relating to the
abandonment of 36 development sites. Of such costs, $1.0 million were written-
off during the second quarter and the remaining $1.4 million were written-off
during the fourth quarter 1998. The Company had not written-off any of such
costs prior to 1998 (See Note 20).
The Company had certificates of occupancy for 173 residences, 165 of which
were included in the operating results as of December 31, 1998, as compared to
130 residences with certificates of occupancy, 109 of which were included in
the operating results as of December 31, 1997. Of the residences with
certificates of occupancy, the Company owned 103 residences and leased 70
residences (54 of which were operating leases and 16 of which were accounted
for as financings) as compared to 63 owned residences and 67 leased residences
(51 of which were operating leases and 16 of which were accounted for as
financings) as of December 31, 1997. At each of December 31, 1997 and 1998,
property and equipment included $31.4 million in land and buildings related to
sale and leaseback transactions accounted for as financings (See Note 16).
As of December 31, 1998, construction in process reflects: (i) 12 residences
(479 units) under construction ($21.9 million); (ii) eight residences (319
units) that have received a certificate of occupancy, but are pending
licensure ($23.5 million); (iii) one residence expansion (13 units)
($811,000); and (iv) other development costs ($5.1 million); (See Note 20).
The Company's 10 outstanding construction commitments were approximately
$15.0 million at December 31, 1998.
7. Resident Deposits
Pursuant to lease agreements, residents are required to provide security
deposits, and in certain cases, the last month's rent. As of December 31, 1997
and 1998, such deposits of $958,000 and $1.6 million, respectively have been
recorded as other current assets with a corresponding liability recorded in
other current liabilities. These funds are restricted as to use by the
Company.
68
8. Long-Term Debt
As of December 31, 1997 and 1998, long-term debt consists of the following
(in thousands):
1997 1998
------- --------
Trust Deed Notes, payable to the State of Oregon Housing
and Community Services Department (OHCS) through 2028..... $10,256 $ 10,155
Variable Rate Multifamily Revenue Bonds, payable to the
Washington State Housing Finance Commission Department
through 2028.............................................. 8,500 8,500
Variable Rate Demand Revenue Bonds, Series 1997 payable to
the Idaho Housing and Finance Association through 2017.... 7,350 7,350
Variable Rate Demand Revenue Bonds, Series A-1 and A-2
payable to the State of Ohio Housing Finance Agency
through 2018.............................................. -- 13,220
Finance lease obligations.................................. 31,488 31,488
Mortgages payable.......................................... -- 35,627
Capital lease obligations payable through 2002 with a
weighted average interest rate of 10.1%................... 113 82
------- --------
Total long-term debt....................................... $57,707 $106,422
Less current portion....................................... 172 1,386
------- --------
Long-term debt............................................. $57,535 $105,036
======= ========
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 11.80%.
The Variable Rate Multifamily Revenue Bonds are payable to the Washington
State Housing Finance Commission Department and at December 31, 1998 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 2001. The bonds had a weighted average interest rate of 3.69% during 1998.
The Variable Rate Demand Housing Revenue Bonds, Series 1997 are payable to
the State of Idaho Housing and Finance Association and at December 31, 1998
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 2002. The bonds had a weighted average interest rate of 3.56% during 1998.
In April 1998, the Company obtained $14.6 million in mortgage financing at a
fixed interest rate of 7.73% and secured by a mortgage encumbering each of
seven Texas residences. The mortgage is amortized with monthly payments of
$110,000 over 25 years with a balloon payment of $11.8 million due at maturity
in May 2008.
In July 1998, the Company obtained $12.7 million in Variable Rate Demand
Housing Revenue Bonds with the State of Ohio Housing Finance Agency ("OHFA")
and $530,000 in Taxable Variable Rate Demand Housing Revenue Bonds with OHFA.
The bonds 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 2003. The bonds had a weighted
average interest rate of 3.57% during 1998.
In July 1998, the Company obtained $6.6 million in mortgage financing at an
initial interest rate of 7.58% and secured by a mortgage encumbering each of
three Oregon residences. The interest rate increases 15 basis points per year
through maturity. The mortgage is amortized with monthly payments of $49,000
over 25 years with a balloon payment of $5.3 million due at maturity in August
2008.
In September 1998, the Company obtained $5.9 million in mortgage financing
at an interest rate of 8.79% and secured by one Pennsylvania residence and one
South Carolina residence. The mortgage is amortized with monthly payments of
$43,000 over 25 years with a balloon payment of $5.9 million due at maturity
in September 2008.
69
In November 1998, the Company obtained $8.7 million in mortgage financing at
a fixed interest rate of 8.65% and secured by a mortgage encumbering each of
three New Jersey residences. The mortgage is amortized with monthly payments
of $71,000 over 25 years with a balloon payment of $7.2 million due at
maturity in December 2008.
As of December 31, 1998, the following annual principal payments are
required (in thousands):
1999................................ $ 1,386
2000................................ 1,494
2001................................ 1,600
2002................................ 1,695
2003................................ 1,804
Thereafter.......................... 98,443
--------
Total............................. $106,422
========
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. The
Company was not in compliance with certain lease and loan covenants and has
obtained necessary waivers as a result of such non-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, which as of December
31, 1997 and 1998 was $136,000 and $286,000, 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 in the
amount of 3% of the original loan balance is required. This account had a
balance of $373,000, $351,000 and $240,000 as of December 31, 1996, 1997 and
1998, respectively, 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, 1996, 1997 and 1998, the Company was restricted from
paying dividends on $394,000, $860,000 and $1,659,000, respectively, of income
and retained earnings, 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.
During the years ended December 31, 1996 and 1997, the Company entered into
nine and seven sale and leaseback agreements, respectively, which are
accounted for as financings due to the Company's continued involvement in the
properties in the form of a fair value purchase option. As such, these
financings are included in long term debt and the related assets remain in the
consolidated balance sheet in property and equipment (See Notes 6 and 20).
During the fourth quarter of 1997, the Company entered into a $50.0 million
floating rate mortgage loan commitment with a commercial lender. During the
first quarter of 1998, the Company entered into a $25.0 million interest rate
swap in order to reduce its exposure with respect to such floating rate loan
commitment. The swap could be settled in cash on or before its effective date
of September 30, 1998. During the period the swap was outstanding, the Company
completed $21.2 million of financing under the mortgage
70
commitment. The Company elected to terminate the swap before its effective
date and paid $1.9 million in connection with settling the swap, recording
$1.6 million of such payment as deferred financing costs relating to the $21.2
million of financing completed during the term of the swap, and the remaining
$293,000 as other expense during the third quarter of 1998.
9. Convertible Subordinated Debentures
In August 1995, the Company completed the offering of $20.0 million of 7%
Debentures. The 7% Debentures were convertible at any time at or prior to
maturity, unless previously redeemed, at a conversion price of $7.50 per
common share.
In September 1996, $6.1 million of the 7% Debentures were converted into
811,333 shares of the Company's common stock which resulted in $13.9 million
of 7% Debentures remaining outstanding. The Company incurred a charge of
$426,000 in 1996 in connection with the conversion, which was included in
other expense. In August 1998, the Company called for redemption of all of the
remaining $13.9 million of the 7% Debentures. All of the 7% Debentures were
converted into shares of the Company's Common Stock, resulting in the issuance
of 1,855,334 additional shares of common stock.
In October 1997, the Company completed the offering of $86.3 million of 6%
Debentures. The 6% Debentures are convertible at any time at or prior to
maturity, unless previously redeemed, at a conversion price of $22.57 per
common share, which equates to an aggregate of 3,821,444 shares of the
Company's common stock and bear interest payable semi-annually on May 1 and
November 1 of each year, commencing May 1, 1998. The 6% Debentures are
unsecured and subordinated to all senior indebtedness of the Company. The 6%
Debentures are subject to redemption, as a whole or in part, at any time from
time to time commencing on or after November 15, 2000 at the Company's option
at a redemption price equal to 100% of the principal amount thereof, plus
accrued and unpaid interest to the redemption date.
In April 1998, the Company completed the private placement of $75.0 million
of 5.625% Debentures. The 5.625% Debentures are convertible at any time at or
prior to maturity, unless previously redeemed, at a conversion price of
$26.184 per common share, which equates to an aggregate of approximately
2,864,345 shares of the Company's common stock and bear interest payable
semiannually on May 1 and November 1 of each year, commencing November 1,
1998. The 5.625% Debentures are unsecured and subordinated to all senior
indebtedness of the Company. The 5.625% Debentures are subject to redemption,
as a whole or in part, at any time from time to time on or after May 15, 2001
at the Company's option at a redemption price equal to 100% of the principal
amount thereof, plus accrued and unpaid interest to the redemption date.
10. Stock Repurchase
During the year ended December 31, 1998, the Company purchased approximately
529,000 shares of its common stock for a total purchase price of approximately
$7.1 million in accordance with a stock repurchase plan initiated in May 1998.
The Board of Directors terminated the stock repurchase plan in November 1998.
11. Write-off of Impaired Assets and Related Expenses
In June 1998, the Company announced a plan to exit all home health business
operations being conducted by Pacesetter. The decision to exit Pacesetter's
operations was a result of certain laws becoming effective that adversely
affect the prospective payment system for home health care services. Based on
this decision, the Company recorded a $8.9 million charge to earnings during
the second quarter 1998. Such charge consisted of (i) a $7.5 million write-off
of all unamortized goodwill associated with Pacesetter and (ii) a $1.4 million
provision for estimated exit costs expected to be incurred during the phase
out period. Of this $1.4 million provision, $560,000 related to severance,
salaries and benefits incremental to the shut down effort; $720,000 related to
leases, equipment and related costs of closing offices; and $150,000 related
to travel and moving costs. During the fourth quarter 1998, the $1.4 million
provision for exit costs was reduced by $400,000 to $1.0 million as a result
of a change in the estimate for such exit costs. As of December 31, 1998,
approximately $760,000 of
71
this reserve had been utilized. The remaining reserve of approximately
$200,000 consists primarily of lease termination costs and severance costs for
one employee. Expenses related to Pacesetter's final operations of $430,000
for the six month period of June 1998 through December 1998 have been expensed
as incurred. The Company expects the phase out period to conclude during 1999.
12. Termination of Merger Agreement
On February 1, 1999, the Company agreed with American Retirement Corporation
("ARC") to terminate its previously announced merger agreement, which had been
entered into during November 1998. The Company recorded a charge of
approximately $1.1 million in the fourth quarter of 1998 for costs relating to
the terminated merger agreement (See Note 20).
13. Cumulative Effect of Change in Accounting Principle
Effective January 1, 1998, the Company adopted SOP 98-5, which requires that
pre-opening costs be expensed as incurred. In connection with such adoption,
$1.5 million of previously capitalized, unamortized pre-opening costs were
written off as of January 1, 1998 and presented in the accompanying 1998
statement of operations for fiscal year 1998 as the cumulative effect of a
change in accounting principle.
14. Income Taxes
The provision for income taxes differs from the amount of loss determined by
applying the applicable U.S. statutory federal rate to pretax loss as a result
of the following items at December 31:
1996 1997 1998
----- ----- -----
Statutory federal tax
rate................... (34.0)% (34.0)% (34.0)%
Non deductible stock
issuance costs......... 8.4 % -- % -- %
Non deductible
goodwill............... -- % -- % 12.4 %
Losses for which no
benefit is provided.... 25.5 % 34.6 % 21.5 %
Other................... 0.1 % (0.6)% 0.1 %
----- ----- -----
Effective tax rate...... -- % -- % -- %
===== ===== =====
An analysis of the significant components of deferred tax assets and
liabilities, consists of the following as of December 31 (in thousands):
1997 1998
-------- --------
Deferred tax assets:
Net operating loss carryforward...................... $ 4,408 $ 6,635
Deferred gain on sale and leaseback transactions..... 636 631
Debt financing recorded for books.................... 11,890 12,174
Other................................................ 1,332 6,837
Valuation allowance.................................... (2,848) (8,937)
Deferred tax liabilities:
Property and equipment, primarily due to
depreciation........................................ (3,014) (5,722)
Debt financing capitalized asset basis............... (11,363) (11,364)
Deferred operating costs............................. (702) --
Prepaid expenses..................................... (339) (254)
-------- --------
Net deferred tax asset (liability)................... $ -- $ --
======== ========
The valuation allowance for deferred tax assets as of December 31, 1997 and
1998 was $2.9 million and $8.9 million, respectively. The increase in the
total valuation allowance for the years ended December 31, 1996, 1997 and 1998
was $617,000, $2.0 million and $6.1 million, respectively.
72
As a result of the acquisitions discussed in Note 2, the Company acquired
net operating loss carryforwards for federal and state tax purposes
approximating $950,000 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 $358,000 to offset the
deferred tax asset related to the loss carryforwards. Additionally, any tax
benefit realized from the use of approximately $300,000 of the acquired
operating loss carryforwards will be applied to reduce goodwill.
At December 31, 1998, the Company had net operating loss carryforwards of
approximately $17.6 million available to reduce future taxable income. The
carryforwards expire at various dates beginning in the year 2009 through the
year 2019. Utilization of the carryforwards is subject to certain limitations
due to the change in ownership of the Company that occurred in connection with
the public stock offering during October 1997. As a result of the public stock
offering, utilization of approximately $9.5 million of the approximately $17.6
million of available net operating loss carryforwards is limited to
approximately $8.1 million per year.
The portion of the valuation allowance for deferred tax assets for which
subsequently recognized tax benefits will be applied directly to contributed
capital is $1.3 million as of December 31, 1998. This amount is attributable
to differences between financial and tax reporting of employee stock option
transactions.
15. Related Party Transactions
The Company leases six residences from Assisted Living Facilities, Inc. The
spouse of the Company's president owns a 25% interest in Assisted Living
Facilities, Inc. During the years ended December 31, 1996, 1997 and 1998, the
Company paid such entity aggregate lease deposits of $35,700, $31,500 and $0,
respectively, and aggregate rental payments of $912,000, $1.1 million and $1.2
million, respectively. In addition, in 1997 the Company leased one residence
from OHP in which the president's spouse owns an interest. The Company paid
OHP $50,000 in lease deposits in 1997 and $278,000 and $195,000 in rent
payments in 1997 and 1998, respectively. The lease with OHP was terminated in
September 1998, effective October 1, 1998.
In 1997, the Company contracted with Supportive Housing Services, Inc.
("SHS") to provide services to the Company for market feasibility analysis,
site pre-acquisition services and construction management oversight in
conjunction with the Company's development activities. SHS is owned 75% by the
president's spouse. The Company paid $480,000 and $3.8 million during the
years ended December 31, 1997 and 1998, respectively, for such development
services. The Company capitalized such payments as construction in process.
In addition, the Company and SHS entered into a consulting agreement whereby
the Company agreed to provide SHS with consulting services in the assisted
living industry, including providing data on the Company's facility
prototypes, facilitating the introduction to other potential customers and
providing market analysis on the assisted living industry. The Company
received fees for such services from SHS of $195,000 and $906,000 during the
years ended December 31, 1997 and 1998, respectively, and has recorded such
fees as a reduction of construction in process.
Commencing in 1995, the Company contracted with Concepts in Community
Living, Inc. ("CCL"), directly and through its developers, to perform
feasibility studies and pre-development consulting services for the developers
on the Company's behalf. CCL is owned 100% by the President's spouse. For the
years ended December 31, 1996, 1997 and 1998, the Company paid CCL for these
services fees of $623,000, $568,000 and $566,000, respectively, which were
capitalized in construction in process on the consolidated balance sheets.
The Company acquired HCI and Carriage House in October of 1997 (See Note 2).
Several employees of the Company, including members of the Board of Directors,
owned collectively 40.0% of the outstanding common stock in HCI and
approximately 23.0% of the outstanding common stock of Carriage House. In
addition, LTC held substantial interests in HCI and Carriage House prior to
their acquisition by the Company (See Note 16). Pursuant to the HCI
acquisition agreement, during 1998, Mr. McBride and Dr. Wilson's spouse
received "earnout" payments from the Company of $174,000 and $70,000,
respectively, related to HCI sites the Company elected to develop.
73
During 1997, the Company entered into joint venture agreements with a joint
venture partner to operate certain new assisted living residences which
commenced operations during the second, third and fourth quarters of 1997 (See
Notes 2 and 20). The Company, Mr. McBride, the Company's Chairman and Chief
Executive Officer, Dr. Wilson, the Company's President and Chief Operating
Officer, and Dr. Wilson's spouse each acquired interests in the joint venture
partner. During 1998, Mr. McBride owned a $400,000 or 16.6% interest, and
Dr. Wilson's spouse owned a $200,000 or 8.3% interest, in the joint venture.
During 1998 Mr. Razook, one of the Company's directors, was Managing
Director and Head of the Health Care Industry Group of Schroder & Co. Inc.
("Schroders") an investment banking firm. During 1998 Schroders served as the
initial purchaser of the Company's $75.0 million offering of 5.625% Debentures
for which Schroders received a customary commission. Also during 1998,
Schroders provided financial advisory services and delivered a fairness
opinion in connection with a proposed merger for which the Company paid
Schroders a fee of $200,000.
16. Transactions with LTC Properties, Inc.
During the period November 1994 to September 1997, two members of the
Company's Board of Directors served as executive officers and directors of
LTC. In September 1997, Mr. Dimitriadis resigned from the Company's Board of
Directors and Mr. McBride resigned as an executive officer and director of
LTC. The Company engaged in the following transactions with LTC since January
1, 1995.
Number of Sale
and Leaseback
Residences
Accounted for as Sales price
Operating Leases Number of units (in millions)
---------------- --------------- -------------
Leases at December 31,
1994....................... -- -- $ --
Leases entered into during
1995....................... 2 60 3.2
---- ------- -------
Leases at December 31,
1995....................... 2 60 3.2
Leases entered into during
1996....................... 16 591 34.1
Residences purchased during
1996....................... (4) (146) (7.6)
---- ------- -------
Leases at December 31,
1996....................... 14 505 29.7
Leases entered into during
1997....................... 21 832 52.7
---- ------- -------
Leases at December 31,
1997....................... 35 1,337 82.4
Leases entered into during
1998....................... 2 89 5.0
---- ------- -------
Leases at December 31,
1998....................... 37 1,426 $ 87.4
==== ======= =======
The Company incurred annual lease expense of $2.1 million, $4.3 million and
$9.1 million for the years ended December 31, 1996, 1997 and 1998,
respectively, pursuant to leases with LTC (See Notes 5 and 20). The Company
recognized losses of $656,000, $1.1 million and $504,000 on these sale and
leaseback transactions for the years ended December 31, 1996, 1997 and 1998,
respectively. For the same periods, the Company deferred gains of $384,000,
$951,000 and $55,000, respectively.
During 1995 the Company sold and leased back from LTC two residences for
$3.2 million with annual lease payments of $380,000. During 1996 the Company
sold and leased back 16 residences for $34.1 million with annual lease
payments of $3.3 million. Subsequently, the Company repurchased four of the 16
residences at a cost of $7.6 million plus a $214,000 administrative fee.
During 1997, the Company sold and leased back 21 residences for $52.7 million
with annual rent payments of $5.3 million. During 1998, the Company sold and
leased back two residences for $5.0 million with annual rent payments of
$447,000. As of December 31, 1998 the Company had sold and leased back 37
residences for $87.4 million with annual lease payments of $8.8 million.
74
During 1996 and 1997, the Company received from LTC $18.9 million and $43.2
million, respectively, of mortgage financing on eight and 19 residences,
respectively. As of December 31, 1997, the Company had repaid all of such
mortgage financing, except for one mortgage ($2.2 million) which was converted
to a sale and leaseback financing during the year ended December 31, 1998.
Interest was paid on a monthly basis ranging from 9.9% to 10.4% per annum. The
Company incurred $158,000, $5.4 million and $180,000 in interest expense
related to these mortgage financings during the years ended 1996, 1997 and
1998, respectively.
The Company acquired Carriage House in October 1997. LTC owned 9.9% of the
outstanding common stock of Carriage House (Notes 2 and 15). As a result, the
Company became the tenant on four assisted living residences leased by
Carriage House from LTC. These four leases are included in the table above and
the lease table in Note 5.
The Company acquired HCI in October of 1997. LTC owned 41.2% of the
outstanding common stock in HCI (See Notes 2 and 15).
During 1997, the Company contracted with LTC Development Services, Inc. to
provide services to the Company for market feasibility analysis, pre-
acquisition services and construction management oversight on several of the
residences under development. LTC Development Services, Inc. is owned 100% by
LTC. The Company paid approximately $415,000 for these services during 1997
and capitalized such fees and recorded them on the consolidated balance sheet
as construction in process. During 1998 LTC Development Services, Inc. did not
provide such services, and did not receive any such fees.
During the year ended December 31, 1996 the Company entered into a $50.2
million sale and leaseback financing commitment with LTC. This commitment was
renegotiated in November 1997 committing the Company to complete sale and
leaseback transactions with LTC with respect to nine residences during 1998.
In November 1997 the Company paid LTC $614,000 in connection with such
commitment and recorded such costs as deferred financing costs. In addition,
the Company entered into a commitment with LTC in October 1997 to complete
$50.0 million of sale and leaseback transactions by December 2000. Pursuant to
this commitment, the Company was obligated to pay a 2.0% fee on any unused
portion of the commitment as of the expiration date (or up to a maximum of
$1.0 million if none of the commitment were utilized). As a result of the
Carriage House acquisition in October 1997 the Company also became obligated
to enter into sale and leaseback arrangements with LTC by September 1998 with
respect to six Carriage House residences which were under development or
construction. In addition, HCI entered into a commitment with LTC in September
1997, which was assumed by the Company as part of the HCI acquisition, to
complete $50.0 million of sale and leaseback transactions by December 1999.
Pursuant to this commitment, the Company was obligated to pay a 2.0% fee on
any unused portion of the commitment as of the expiration date (or up to a
maximum of $1.0 million if none of the commitment were utilized).
During the second quarter of 1998, the Company determined that it would not
enter into sale and leaseback arrangements with LTC to the full extent of
certain of the sale and leaseback commitments, and recorded a $1.2 million
liability for expenses expected to be incurred in connection with this
determination. In December 1998, the Company and LTC terminated the
commitments referred to above at no cost to the Company, other than
approximately $200,000 of professional fees. As such, the Company reversed
$1.0 million of the previously recorded liability during the fourth quarter of
1998.
In December 1998, the Company determined that it would not utilize an
additional commitment to complete sale and leaseback transactions with LTC
with respect to nine residences which it had entered into during November
1997. As such, the Company wrote-off $614,000 of previously capitalized
deferred financing costs relating to such commitment.
17. Stock Option Plan and Restricted Stock
The Company has two Stock Option Plans (the "Plans") which provide for the
issuance of incentive and non-qualified stock options and restricted stock.
The Plans are administered by the Compensation Committee of the Board of
Directors which set the terms and provisions of options granted under the
Plans. Incentive options
75
may be granted only to officers or other full-time employees of the Company,
while non-qualified options may be granted to directors, officers or other
employees of the Company, or consultants who provide services to the Company.
The Amended and Restated 1994 Employee Stock Option Plan combines an
incentive and nonqualified stock option plan, a stock appreciation rights
("SAR") plan and a stock award plan (including restricted stock). The 1994
Plan is a long-term incentive compensation plan and is 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 may 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 equals the market price 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. Options typically vest three years from the date
of issuance and typically are exercisable within seven to nine years from the
date of vesting. Each option is exercisable in equal installments as
designated by the Compensation Committee or the Board at the option price
designated by the Compensation Committee; however, incentive options cannot be
less than the fair market value of the common stock on the date of grant. All
options are nontransferable and subject to adjustment by the Compensation
Committee upon changes in the Company's capitalization. The Board of
Directors, at its option, may discontinue or amend the 1994 Plan at any time.
During the year ended December 31, 1998, the Company's board of directors
adopted The Non-Executive Employee Equity Participation Plan of Assisted
Living Concepts, Inc. (the "Non-Officer Plan") pursuant to which up to 500,000
shares of Common Stock are issuable pursuant to non-qualified options granted
under the Non-Officer Plan. Officers, directors and significant employees of
the Company are not eligible to participate in the Non-Officer Plan; however,
consultants and non-executives are eligible.
In June 1998 the Company repriced 43,750 of options for eligible
participants to $16.75 per share. The Company recorded no compensation expense
as a result of the repricing.
The per share weighted-average fair value of each option grant is estimated
on the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for grants in 1996, 1997 and 1998,
respectively: dividend yield of zero percent, expected volatility of 36.67%,
39.81% and 45.12%, respectively, risk-free interest rate has been fixed at
6.69%, 5.66% and 5.56%, respectively based on the 10-year treasury rate and
expected life of 10 years.
The Company applies APB Opinion No. 25 in accounting for its Plan, and
accordingly, no compensation cost has been recognized for its stock options in
the financial statements. Had the Company determined compensation cost based
on the fair value at the grant date for its stock options under SFAS 123, the
Company's net income would have been reduced to the pro forma amounts
indicated below: (in thousands except per share data)
1996 1997 1998
------- ------- --------
Net loss as reported........................... $(1,915) $(2,479) $(20,745)
Net loss pro forma............................. (2,507) (3,928) (23,990)
Net loss per basic and diluted common share as
reported...................................... $ (0.23) $ (0.21) $ (1.27)
Pro forma net loss per basic and diluted common
share as reported............................. $ (0.30) $ (0.33) $ (1.47)
Pro forma net loss reflects only options granted in 1995 through 1998.
Therefore, the full impact of calculating compensation costs for stock options
under SFAS 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,
1995 is not considered. The resulting pro forma compensation costs may not be
representative of that expected in the future years.
76
A summary of the status of the Company's stock options as of December 31,
1996, 1997 and 1998 and changes during the years ended on those dates is
presented below:
1996 1997 1998
-------------------- -------------------- --------------------
Weighted- Weighted- Weighted-
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
--------- --------- --------- --------- --------- ---------
Options at beginning of
the year............... 806,068 $5.43 1,105,202 $ 6.15 1,629,967 $10.82
Granted................. 563,400 8.22 940,350 15.08 674,132 15.76
Exercised............... (28,170) 4.69 (139,770) 6.05 (121,606) 6.00
Canceled................ (236,096) 8.79 (275,815) 9.53 (315,324) 15.82
--------- ----- --------- ------ --------- ------
Options at end of the
year................... 1,105,202 $6.15 1,629,967 $10.82 1,867,169 $12.07
========= ===== ========= ====== ========= ======
Options exercisable at
end of year............ 381,988 567,756 833,465
Weighted-average fair
value of options
granted during the
year................... $ 4.99 $ 9.24 $ 10.22
The following table summarized information about fixed stock options
outstanding at December 31, 1998.
Options Outstanding Options Exercisable
--------------------------------------------- -------------------------------
Weighted-Average
Range of Number Remaining Weighted-Average Number Weighted-Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable at Exercise Price
---------------- ----------- ---------------- ---------------- -------------- ----------------
$ 4.63 to 5.75 268,701 5.03 $ 4.63 268,701 $4.63
$ 5.81 to 7.19 262,436 6.66 6.34 257,769 6.33
$ 8.12 to 9.00 157,376 7.51 7.44 97,295 7.42
$ 9.19 to 11.00 60,752 8.53 10.40 16,329 10.37
$11.31 to 14.13 92,416 9.58 13.03 5,167 12.97
$14.16 to 15.50 285,284 9.69 14.52 8,669 14.84
$15.68 to 17.07 631,369 9.00 16.55 173,190 16.50
$17.12 to 18.63 60,334 9.14 17.74 4,842 18.02
$18.87 to 20.50 38,751 9.04 19.50 1,503 19.89
$20.75 to 22.38 9,750 9.24 21.12 -- --
---------------- --------- ---- ------ ------- -----
$ 4.63 to $22.38 1,867,169 8.10 $12.07 833,465 $8.32
================ ========= ==== ====== ======= =====
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 vest in
three equal annual installments, commencing on the fourth anniversary of
grant. The Company has recorded the restricted stock as of the date of the
grant as unearned compensation expense of $4.3 million. This unearned
compensation expense has been reflected as a separate component of
shareholders' equity to be amortized as compensation expense over the seven
year vesting period. The Company recorded $150,000 and $608,000 of
compensation expense with respect to such award for the years ended December
31, 1997 and 1998, respectively. The Company recorded the issuance of the
restricted stock in 1998 upon issuance (See Note 20).
18. Non-cash Investing and Financing Activities
The following is a summary of non-cash investing and financing activities
related to acquisitions for the year ended December 31, 1997 (in thousands):
In October of 1997, the Company acquired all of the outstanding capital
stock of Carriage House as follows:
Fair value of assets acquired........................................ $8,279
Issuance of 337,460 shares of the Company's common stock............. 5,076
------
Liabilities assumed.................................................. $3,203
======
77
In October of 1997, the Company acquired all of the outstanding capital
stock of HCI as follows:
Fair value of assets acquired....................................... $11,877
Cash paid........................................................... 5,262
-------
Liabilities assumed................................................. $ 6,615
=======
19. Legal Proceedings
Shareholders Litigation
Since February 1, 1999, 12 separate complaints, which have since been
consolidated into one action, have been filed against the Company and certain
of its officers and directors in the United States District Court for the
District of Oregon. On July 23, 1999, a consolidated complaint was filed in
connection with this litigation. The consolidated complaint purports to be
brought on behalf of a class of purchasers of the Company's common stock from
July 28, 1997 through March 31, 1999 and on behalf of a class of purchasers of
the Company's 6.0% Debentures and 5.625% Debentures from the date of issuance
through March 31, 1999. The consolidated complaint alleges violations of the
federal securities laws and seeks unspecified damages. It also names as
additional defendants certain of the Company's directors that were not named
previously, as well as the Company's independent auditors (solely in
connection with the Company's 1998 offering of 5.625% Debentures) and the
underwriters in connection with the Company's 1997 offering of 6.0%
Debentures. The Company cannot predict the outcome of the any of the foregoing
lawsuits and currently is unable to evaluate the likelihood of its success or
the range of possible loss.
Other Litigation
In addition to the matter referred to in the immediately preceding
paragraph, the Company is involved in various lawsuits and claims arising in
the normal course of business. In the opinion of Management, although the
outcomes of these other suits and claims are uncertain, 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 or liquidity.
20. Subsequent Events
Restatement of Historical Financial Statements
On February 1, 1999, the Company announced that after consultation with its
independent auditors the Company would restate its financial statements for
the fiscal quarter ended June 30, 1997, the fiscal quarter ended September 30,
1997, the fiscal year ended December 31, 1997, the fiscal quarter ended March
31, 1998, the fiscal quarter ended June 30, 1998 and the fiscal quarter ended
September 30, 1998. On March 31, 1999, the Company announced that the
restatement would be more extensive than the Company had previously believed,
and might include periods prior to the second quarter of 1997, including the
fiscal year ended December 31, 1996. After further consultation with its
independent auditors, the Company determined to restate its consolidated
financial statements for the fiscal year ended December 31, 1996, the fiscal
year ended December 31, 1997, and the first three fiscal quarters of the
fiscal year ended December 31, 1998.
The restatement reduced the net income for the fiscal years ended December
31, 1996 and 1997 and for the nine months ended September 30, 1998 by $2.1
million, $6.7 million and $11.0 million, respectively. The cumulative effect
of the restatement reduced shareholders' equity by $19.7 million through
September 30, 1998. As a result of the restatement, the Company reported net
losses of $1.9 million, $2.5 million and $13.3 million for the fiscal years
1996 and 1997 and the nine months ended September 30, 1998 respectively,
compared to previously reported net income of $149,000 and $4.2 million, and
net loss of $2.4 million, respectively. The
78
Company reported net loss per diluted share of $0.23, $0.21 and $0.84 for the
fiscal years ended December 31, 1996 and 1997 and the nine months ended
September 30, 1998, respectively, compared to previously reported net income
per diluted share of $0.03 and $0.34 and net loss per diluted share of $0.14,
respectively. After the restatement, the Company's cash position as of
December 31, 1996 and 1997 and as of September 30, 1998 was $2.1 million,
$63.3 million and $79.6 million, respectively, as compared to $2.1 million,
$63.4 million and $79.8 million respectively, as previously reported. As a
result of the restatement, the Company's working capital position as of
December 31, 1996 and 1997 and as of September 30, 1998 was negative $27.1
million, positive $40.1 million and positive $63.0 million, respectively,
compared to previously reported working capital of negative $26.4 million,
positive $41.0 million and positive $64.1 million, respectively.
The restatement resulted primarily from: (i) the earlier recognition of
certain expenses which were previously capitalized in association with the
Company's development and financing activities; (ii) a modification in how the
Company accounted for certain lease arrangements; (iii) a modification in how
the Company accounted for certain of its acquisitions and its joint venture
arrangements; (iv) the capitalization of fees received by the Company
previously recognized as either a reduction of expenses or as other income;
(v) the elimination of an impairment write-down that the Company had
previously recorded on three of its residences; (vi) elimination of certain
accrued expenses previously recorded pursuant to a change in accounting
principle; and (vii) the increase in goodwill written off in the second
quarter of 1998 relating to exiting the Company's home health operation.
Termination of Merger Agreement
On February 1, 1999, the Company and ARC mutually agreed to terminate their
previously announced merger agreement, which had been entered into during
November 1998. The Company recorded a charge of approximately $1.1 million in
the fourth quarter 1998, and $200,000 in the first quarter of 1999, for
expenses relating to the terminated merger agreement.
Securityholder Litigation
Since February 1, 1999 12 separate complaints, which have since been
consolidated into one action, have been filed against the Company and certain
of its officers and directors in the United States District Court for the
District of Oregon. On July 23, 1999, a consolidated complaint was filed in
connection with this litigation. The consolidated complaint purports to be
brought on behalf of a class of purchasers of the Company's common stock from
July 28, 1997 through March 31, 1999 and on behalf of a class of purchasers of
the Company's 6.0% Debentures and 5.625% Debentures from the date of issuance
through March 31, 1999. The consolidated complaint alleges violations of the
federal securities laws and seeks unspecified damages. It also names as
additional defendants certain of the Company's directors that were not named
previously, as well as the Company's independent auditors (solely in
connection with the Company's 1998 offering of 5.625% Debentures) and the
underwriters in connection with the Company's 1997 offering of 6.0%
Debentures.
Termination of Joint Venture Agreements
On February 10, 1999, the Company announced with respect to certain joint
venture agreements that it had negotiated with the joint venture partner to
purchase, for approximately $3.8 million, all of the joint venture partner's
interests in the operation of the remaining 17 residences subject to the joint
venture agreements (See Note 2). As a result of such purchases, Mr. McBride
and Dr. Wilson's spouse received distributions of approximately $537,000 and
$269,000, respectively in 1999. The Company has no current intention of
entering into similar arrangements in the future.
Management Changes
On March 16, 1999, the Company's Board of Directors announced the
appointment of Dr. Keren Brown Wilson, a co-founder of the Company, as
President and Chief Executive Officer. The board also announced the
79
appointment of Leslie J. Mahon as Vice President and Chief Operating Officer
and James W. Cruckshank as Vice President and Chief Financial Officer.
Pursuant to an agreement (the "Consulting Agreement") between Mr. McBride and
the Company, Mr. McBride agreed to provide consulting services to the Company
and to resign from his position as the Company's Chief Executive Officer.
The Consulting Agreement provided for the payment to Mr. McBride a lump sum
cash termination payment of $490,000, which was reduced to $390,000 to reflect
repayment of a $100,000 bonus paid to Mr. McBride in 1998. In addition, the
Company agreed to pay Mr. McBride a lump sum cash payment of $750,000 in
consideration for Mr. McBride's agreement to forfeit his interest in 200,000
shares of restricted stock held by him and to terminate the agreement related
thereto. In addition, pursuant to the Consulting Agreement, Mr. McBride agreed
to forfeit a $4.0 million termination payment he would be entitled to receive
under certain circumstances, including upon a change of control. The Company
will record a charge of approximately $525,000 to corporate, general and
administrative expense in the first quarter of 1999 in connection with such
payments.
In March 1999, the Company entered into an amendment with Dr. Wilson to her
employment agreement to provide that the Company will employ Dr. Wilson as
President and Chief Executive Officer. In addition, the Company agreed to pay
Dr. Wilson a lump sum cash payment of $187,500 (which was reduced to $87,000
to reflect repayment of a $100,000 bonus paid in 1998) in consideration for
Dr. Wilson's agreement to forfeit her interest in 50,000 shares of restricted
stock held by her and to terminate the restricted stock agreement related to
those shares. The Company made the cash payment and cancelled the restricted
stock in June 1999.
Write-off Related to Development Activity
As a result of a continued reduction in the Company's new residence
development activities, the Company will incur write-offs of $1.3 million and
$3.5 million relating to previously capitalized development costs during the
first quarter and second quarter of 1999 respectively.
Agreement with CCL
In June 1999 the Company entered into a new agreement with CCL pursuant to
which CCL will provide market research, demographic review and competitor
analysis in many of the Company's current and potential markets. The Company
will pay CCL a retainer of $10,000 per month, plus fees in excess of the
retainer, if any, in connection with specific projects that the Company
authorizes under the agreement.
Amendment to Certain Loan and Lease Agreements
During the third quarter of 1999, the Company amended certain loan
agreements with one of its creditors. Pursuant to the amendment, the Company
agreed to provide $8.3 million of additional cash collateral in exchange for
the forbearance or waiver of certain possible defaults, including an amendment
to certain financial covenants. The amendment 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.
During 1996 and 1997 the Company entered into 16 sale and leaseback
transactions which contained purchase options entitling the Company to
purchase the properties at fair market value at the end of initial lease terms
ranging from 14 to 15 years. As a result of the purchase options the Company
accounted for these sale and leaseback transactions using the financing method
in SFAS No. 98, Accounting for Leases. In March 1999, the Company amended
these leases. The amendments eliminated the Company's purchase option;
therefore, the leases were reclassified as operating leases at that date. As a
result of the amendments, the Company recorded (i) the disposal of net
property and equipment in the amount of $30.0 million, (ii) the extinguishment
of long-term debt in the amount of $31.5 million and (iii) a deferred gain of
$1.5 million. The deferred gain will be included in other liabilities and
amortized over the remaining initial lease term as an offset to future rent
expense.
80
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 will account for the amended leases
on a contractual cash payment basis and amortize 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 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.
81
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
September 23, 1999 /s/ James W. Cruckshank
By: _________________________________
Name: James W. Cruckshank
Title: Vice President and Chief
Financial Officer
September 23, 1999 /s/ M. Catherine Maloney
By: _________________________________
Name: M. Catherine Maloney
Title: Vice President, Controller
and Chief Accounting Officer
82
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 Keren Brown Wilson or James W.
Cruckshank, 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.
Signature Title Date
--------- ----- ----
/s/ Keren Brown Wilson Vice Chairman, President and Chief September 23, 1999
------------------------
Keren Brown Wilson Executive Officer
/s/ James W. Cruckshank Vice President & Chief September 23, 1999
------------------------
James W. Cruckshank Financial Officer
/s/ M. Catherine Maloney Vice President/Controller & September 23, 1999
------------------------
M. Catherine Maloney Chief Accounting Officer
/s/ William McBride III Director September 23, 1999
------------------------
William McBride III
/s/ Gloria J. Cavanaugh Director September 23, 1999
------------------------
Gloria J. Cavanaugh
/s/ Richard C. Ladd Chairman of the Board & September 23, 1999
------------------------
Richard C. Ladd Director
/s/ Bradley G. Razook Director September 23, 1999
------------------------
Bradley G. Razook
/s/ Jill M. Krueger Director September 23, 1999
------------------------
Jill M. Krueger
83
ASSISTED LIVING CONCEPTS, INC. AND SUBSIDIARIES
Index to Exhibits
Exhibit
No. Description
------- -----------
3.1 Articles of Incorporation of the Company (Incorporated by reference to
the same titled exhibit to the Company's Registration Statement on
Form S-1, File No. 33-83938).
3.2 By laws of the Company (Incorporated by reference to the same titled
exhibit to the Company's Registration Statement on Form S-1, File No.
33-83938).
4.1 Indenture, dated as of October 2, 1997 by and between the Company and
Harris Trust and Savings Bank, as Trustee providing for Issuance of
Securities in Series. (Incorporated by reference to Exhibit 4.1 to
the Company's Report on Form 8-K, dated October 20, 1997, File No. 1-
13498).
4.2 Rights Agreement dated as of June 12, 1997, between Assisted Living
Concepts, Inc. and American Stock Transfer & Trust Company, as Rights
Agent, which includes the form of Certificate of Resolution
Establishing Designations, Preferences and Rights of Series A Junior
Participating Preferred Stock of Assisted Living Concepts Inc. as
Exhibit A, the form of Right Certificate as Exhibit B and the Summary
of Rights to Purchase Preferred Shares as Exhibit C (Incorporated by
reference to the same titled exhibit to the Company's Report on Form
8-K, dated July 24, 1997, File No. 1-83938).
4.3 Registration Rights Agreement, dated as of October 31, 1997, by and
between the Company and Carriage House Assisted Living, Inc.
(Incorporated by reference to the same titled exhibit to the
Company's Registration Statement on Form S-3, dated December 31,
1997, Registration No. 333-43521).
4.4 Indenture, dated as of April 13, 1998, by and between the Company and
Harris Trust and Savings Bank, as Trustee (Incorporated by reference
to the same titled exhibit to the Company's Registration Statement on
Form S-3, dated May 11, 1998, Registration No. 333-52297).
4.5 Registration Rights Agreement, dated as of April 7, 1998, by and
between the Company and Schroder & Co., Inc. (Incorporated by
reference to the same titled exhibit to the Company's Registration
Statement on Form S-3, dated May 11, 1998, Registration No. 333-
52297).
4.6 Form of Debenture (Incorporated by reference to the same titled
exhibit to the Company's Registration Statement on Form S-3, dated
May 11, 1998, Registration No. 333-52297).
10.1 Indemnification Agreement dated October 3, 1997 by and between the
Company and William McBride III. (Incorporated by reference to the
same titled exhibit to the Company's Report on Form 8-K, dated
October 20, 1997, File No. 1-13498).
10.2 Indemnification Agreement dated October 3, 1997 by and between the
Company and Keren Brown Wilson. (Incorporated by reference to the
same titled exhibit to the Company's Report on Form 8-K, dated
October 20, 1997, File No. 1-13498).
10.3 Amended and Restated 1994 Stock Option Plan of the Company
(Incorporated by reference to the same titled exhibit to the
Company's Report on Form 8-K, dated October 20, 1997, File
No. 1-13498).
10.4 Non-Executive Employee Equity Participation Plan of the Company
(Incorporated by reference to the same titled exhibit to the
Company's Registration Statement on Form S-8, dated July 13, 1998,
Registration No. 333-58953).
10.5 Deferred Compensation Plan of the Company.
10.6 Consulting Agreement, dated as of March 15, 1999, by and between the
Company and William McBride III.
10.7 Amended and Restated Employment Agreement, dated October 1999, as
amended as of March 15, 1999, by and between the Company and Keren
Brown Wilson.
84
Exhibit
No. Description
------- -----------
10.8 Employment Agreement, dated as of December 31, 1997, by and between
the Company and Sandra Campbell.
10.9 Employment Agreement, dated as of February 3, 1998, by and between the
Company and Nancy Gorshe.
10.10 Employment Agreement, dated as of March 15, 1999, by and between the
Company and James Cruckshank.
10.11 Employment Agreement, dated as of March 15, 1999, by and between the
Company and Leslie Mahon.
10.12 Merger Agreement dated as of October 4, 1997 by and between the
Company and Home and Community Care, Inc. (Incorporated by reference
to the same titled exhibit to the Company's Report on Form 8-K, dated
October 20, 1997, File No. 1-13498).
10.13 Joint Venture Agreement dated as of April 1, 1997 by and between the
Company and Health Equity Investors, LLC. (Incorporated by reference
to the same titled exhibit to the Company's Report on Form 8-K, dated
October 20, 1997, File No. 1-13498).
10.14 Reimbursement Agreement, dated as of November 1, 1996, between the
Company and U.S. Bank of Washington, National Association.
10.15 Reimbursement Agreement, dated as of July 1, 1997, between the Company
and United States National Bank of Oregon.
10.16 Reimbursement Agreement, dated as of July 1, 1998, between the Company
and U.S. Bank National Association.
10.17 Deed of Trust and Security Agreement, dated March 31, 1998, among DMG
Texas ALC, Partners, L.P., American Title Company of Houston and
Transatlantic Capital Company.
10.18 Mortgage and Security Agreement, dated November 12, 1998, between DMG
New Jersey ALC, Inc. and Transatlantic Capital Company.
10.19 Deed of Trust and Security Agreement, dated July 10, 1998, among DMG
Oregon ALC, Inc., Chicago Title Company and Transatlantic Capital
Company.
10.20 Loan Agreement, dated as of September 3, 1998, by and between MLD
Delaware Trust and the Company.
10.21 Loan Agreement, dated as of September 3, 1998, by and between MLD
Delaware Trust and the Company.
10.22 Amendment and Modification of Reimbursement Agreements, dated as of
August 18, 1999, by and between the Company and U.S. Bank National
Association.
12.1 Computation of Ratio of Earnings to Fixed Charges
23 Report on Schedule and Consent of KPMG LLP
27 Financial Data Schedule Article 5 of Regulation S-X
85
SCHEDULE II
ASSISTED LIVING CONCEPTS, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1996, 1997 and 1998
(in thousands)
Column A Column B Column C Column D Column E
-------- ---------- --------- ------------- ----------
Balance at Balance at
Beginning End of
Description of Year Additions Deductions(1) Year
----------- ---------- --------- ------------- ----------
Year ended December 31, 1996:
Valuation accounts deducted
from assets:
Allowance for doubtful
receivables................... $-- $ 33(2) $-- $ 33
---- ---- ---- ----
Year ended December 31, 1997:
Valuation accounts deducted
from assets:
Allowance for doubtful
receivables................... $ 33 $ 83(3) $ 37 $ 79
---- ---- ---- ----
Year ended December 31, 1998:
Valuation accounts deducted
from assets:
Allowance for doubtful
receivables................... $ 79 $359(2) $259 $179
---- ---- ---- ----
- --------
(1) Represents amounts written off.
(2) Charged to residence operating expenses.
(3) $23,000 of additions were charged to operating expenses, $60,000 of
additions were a result of an acquisition.
86