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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002

OR

FOR THE TRANSITION PERIOD FROM ___________ TO ___________

COMMISSION FILE NUMBER: 0-26980

          Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

The number of outstanding shares of the issuer’s Common Stock, no par value, as of October 20, 2002 was 17,459,689.

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.

ARV ASSISTED LIVING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS)

See accompanying notes to unaudited condensed consolidated financial statements.

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ARV ASSISTED LIVING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

See accompanying notes to unaudited condensed consolidated financial statements.

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ARV ASSISTED LIVING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS)

See accompanying notes to unaudited condensed consolidated financial statements.

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ARV ASSISTED LIVING, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 and 2001

(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements of ARV Assisted Living, Inc. and subsidiaries (“the Company” or “ARV”) are presented pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim reporting.  As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America (“GAAP”) can be condensed or omitted.  The Company has reclassified certain prior year data to conform to the 2002 presentation.

The consolidated financial statements include all normal and recurring adjustments that the Company considers necessary for the fair presentation of its financial position and operating results for the periods presented.  These are condensed consolidated financial statements.  To obtain a more detailed understanding of the Company’s results, you should also read the consolidated financial statements and notes in the Company’s Form 10-K for fiscal year ended December 31, 2001, which is on file with the SEC.

The results of operations can vary during each quarter of the year.  Therefore, the results and trends in these interim financial statements are not necessarily indicative of the results for the full year.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and its subsidiaries. Subsidiaries, which include limited partnerships and limited liability companies in which the Company has controlling interests, have been consolidated into the financial statements. In December 2001, the Company acquired approximately 9,667 limited partnership units in American Retirement Villas Properties III, L.P. (“ARVP III”) resulting in a total ownership interest of approximately 52%. The balance sheets at December 31, 2001 and September 30, 2002 include the accounts of ARVP III while the statement of operations includes the operations of ARVP III for the three and nine month periods ended September 30, 2002 only.  All significant intercompany balances and transactions have been eliminated in consolidation.

CONSOLIDATED PARTNERSHIPS

Included in the consolidated financial statements are partnerships in which the Company owns less than 80% but more than 50%. The following is a recap of the assets and liabilities of those partnerships as of September 30, 2002 and December 31, 2001:

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USE OF ESTIMATES

Actual results may differ from these estimates under different assumptions or conditions.

CASH AND EQUIVALENTS 

For purposes of reporting cash balances, the Company considers all highly-liquid investments purchased with an original maturity of three months or less to be cash equivalents.

IMPOUNDS

Impounds consist of cash deposits for property taxes, insurance and replacement reserves made by the Company to certain lenders in accordance with the loan agreements governing the loans encumbering the Company’s assisted living communities.

ADVERTISING

Advertising costs are expensed as incurred.

PROPERTY, FURNITURE AND EQUIPMENT

Property, furniture and equipment are stated at cost less accumulated depreciation which is charged to expense on a straight-line basis over the estimated useful lives of the assets as follows:

GOODWILL

Effective, January 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” which requires that the Company prospectively cease amortization of goodwill and instead conduct periodic tests of goodwill for impairment.  The Company has completed a transitional test for goodwill impairment and has determined that no goodwill impairment was indicated as of January 1, 2002.

The following table shows, on a pro-forma basis, what earnings and earnings per share would have been if the new accounting standards had been applied for the period indicated:

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INTANGIBLES

SFAS No. 141 “Business Combinations” and SFAS No.142 also require that the Company disclose the following information related to the Company’s intangible assets still subject to amortization.  The following table details the balances of the amortizable intangible assets as of September 30, 2002:

ACCOUNTING FOR LONG-LIVED ASSETS

The Company reviews its long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. In reviewing recoverability, the Company estimates the future cash flows expected to result from using the assets and eventually disposing of them. Cash flows are reviewed at the community level, which is the lowest level of identifiable cash flows. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized based upon the asset’s fair value. For long-lived assets held for sale, fair value is reduced for costs of sale.  

One land site that was previously held in property held for sale was sold during the quarter ended June 30, 2002.

INVESTMENTS IN REAL ESTATE ENTITIES

The Company serves as the general partner of five limited partnerships that operate assisted living communities (“ALCs”), four of which were consolidated for the entire 2001 year. The Company acquired a controlling interest in the fifth partnership in December 2001. The Company is also the general partner in two tax credit partnerships (ownership is less than 1%). The Company accounts for its investment in partnerships where it can exercise significant influence and owns more than 50% as consolidated entities.  Under the terms of the subject partnership agreements, profits and losses are allocated to the general and limited partners in specified ratios. With the exception of non-recourse mortgage debt, the Company, in its capacity as general partner, is liable for all obligations of the limited partnerships.  Liabilities under these obligations have generally not been significant. The Company is subject to liability under separate loan guarantees related to two of the partnership loans. Under Statement of Position No. 78-9, “Accounting for Investments in Real Estate Ventures,” the company records its obligations under these agreements as a component of the Company’s equity in the income or losses of these partnerships.

In 1998, the Company pursued an additional development strategy by entering into joint ventures (“LLCs”) designed to help us finance development and renovation projects and to mitigate the impact of start-up losses associated with the opening of newly constructed ALCs. The joint ventures were formed to finance and manage the substantial renovation of existing ALCs acquired in 1998 and to construct three new communities on land sites the Company owned. Participants in the joint ventures with us are a third-party investor and a third-party developer. The LLCs contracted with the developer to provide development services to perform the renovation and construction. The Company manages four of the properties operated by the joint ventures for a management fee equal to three percent of gross revenues. One property is managed by an unrelated third party. The Company accounts for its investment in the joint ventures using the equity method and losses incurred by the LLCs are allocated disproportionately to the LLC members based upon their assumption of risk.  Income generated by the LLCs is allocated based on the percentage of losses previously allocated until the original capital accounts are restored and then based on ownership percentages.  In 2000 and 2001, certain LLC members’ capital was reduced to zero, consequently, the losses from the joint venture were allocated to us based upon the Company’s capital or percentage interest. The Company has agreed to fund any operating deficits incurred in connection with the operation of the five joint venture projects up to an aggregate amount of $6.0 million for all of the development properties and $6.0 million for all of the renovation properties, subject to a $9.0 million cap. The advances, which are considered capital contributions to the LLCs, are non-interest bearing and will be repaid only if sufficient funds are available in accordance with the terms of the operating agreements of the respective LLCs. The operating deficit payment agreement will remain in effect from the commencement of operations of a project until the earlier to occur of 18 months after the project has achieved stabilization, the sale of the project to a third-party, or the purchase by the Company of the

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membership interests of the project owner. In March 2001, the two renovation projects reached stabilization and consequently in September 2002, ARV was no longer required to make operating deficit payments on these two projects. The cessation of operating deficit payments on two of the LLCs will be May 2003 and September 2003.  The remaining LLC has not reached stabilization thus no ending date can be computed as of September 30, 2002.  The Company’s current funding of operating deficits since inception in 1998 is $2.2 million. The LLC operating agreements grant the Company options to purchase the other members’ interest in the LLCs when the ALCs reach stabilization, at a purchase price that is the greater of fair market value or an amount that generates a guaranteed internal rate of return on the members capital contribution. In 2001, the Company declined to exercise the option to purchase two of the LLCs that had reached stabilization and in accordance with the LLCs’ operating agreement, the Company no longer serves as a manager of the two LLCs. In 2000 the Company determined that the value of certain of the LLCs was impaired based upon the Company’s review of the projected cash flows, accordingly, the Company wrote down its investment by $5.7 million, to reflect the fair value.

GENERAL INSURANCE LIABILITY

The Company utilizes third-party insurance for losses and liabilities associated with general and professional liability claims subject to established deductible levels on a per occurrence basis.  Losses up to these deductible levels are accrued based upon the Company’s and a third party’s actuarial study of the estimate of the aggregate liability for claims incurred based on Company experience.

REVENUE RECOGNITION

The Company recognizes rental, assisted living services and skilled nursing facility revenue from owned and leased communities on a monthly basis as earned. The Company receives fees for property management and partnership administration services from managed communities and recognizes such fees as earned.

ASSISTED LIVING COMMUNITY SALE-LEASEBACK TRANSACTIONS

Certain ALCs were sold subject to leaseback provisions under operating leases. Gains, where recorded, were deferred and amortized into income over the lives of the leases.

INCOME (LOSS) PER SHARE

Basic income (loss) per share are calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period.  Diluted income (loss) per share are computed similar to basic income (loss) per share except that the weighted average shares outstanding are increased to include additional shares from the assumed exercise of securities or other contracts to issue common stock, if dilutive.  The basic weighted average number of shares outstanding were 17,459,689 for the quarters and nine months ended September 30, 2002 and 2001.  The number of incremental diluted shares were 941,021 and 587,872 for the quarters ended September 30, 2002 and 2001, respectively.  For the nine months ended September 30, 2002 the number of incremental diluted shares were 733,889 and 238,400.  The number of anti-dilutive shares for the quarters and nine months ended September 30, 2002 and 2001 were 1,140,576 and 1,194,426, respectively.

NEW ACCOUNTING PRONOUNCEMENTS

The Company adopted SFAS No. 141 “Business Combinations”, SFAS No. 143 “Accounting for Asset Retirement Obligations”, and SFAS No. 144 “Accounting for the Impairment and Disposal of Long Lived Assets” on January 1, 2002. The adoption of SFAS Nos. 141, 143, and 144 did not have a material effect on the Company’s financial position, results of operations, or cash flows.

In addition, in April 2002, the Financial Accounting Standards Board issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.”  SFAS No. 145 rescinds the automatic treatment of gains or losses from extinguishment of debt as extraordinary unless they meet the criteria for extraordinary items as outlined in Accounting Principles Board Opinion No. 30, Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.  SFAS No. 145 also requires sale-leaseback accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions and makes various technical corrections to existing pronouncements.  The provisions of SFAS No. 145 related to the rescission of FASB Statement 4 are effective for fiscal years beginning after May 15, 2002, with early adoption encouraged.  All other provisions of SFAS No. 145 are effective for transactions occurring after May 15, 2002, with early adoption encouraged.  The only impact the Company

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expects from the adoption of SFAS No. 145 is the reclassification of prior year extraordinary gains and losses to other income, interest expense and income taxes.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”.  SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan.  Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operations, plant closing, or other exit or disposal activity.  SFAS No. 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged.  As the provisions of SFAS No. 146 are required to be applied prospectively after the adoption date, we cannot determine the potential effects that adoption of SFAS No. 146 will have on our condensed consolidated financial statements.

(2)  ACQUISITIONS

In December 2001, the Company purchased a controlling interest in ARVP III. ARVP III owns two ALCs, one located in Arizona with 164 units and one located in California with 123 units. The Company accounted for this transaction using the purchase method and paid approximately $4.1 million in cash for the units acquired.

     The following table summarizes the estimated fair or book value of the assets acquired and liabilities assumed at the date of acquisition:

The purchase price paid in excess of the book value of the net assets acquired required a $3.5 million step-up in basis. This step-up in basis is being depreciated over the remaining useful life of the underlying existing assets. The pro forma effect on the statements of operations for the acquisition as if it had been acquired as of January 1, 2001 is as follows:

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(3)  NOTES PAYABLE

Notes payable consist of the following at September 30, 2002 and December 31, 2001:

The future annual principal payments of the notes payable at September 30, 2002 are as follows:

On July 18, 2002, the Company completed the refinancing of two loans collateralized by two owned ALCs in an aggregate amount of $24.0 million. The loan proceeds were used to satisfy existing loans totaling $18.3 million, with maturities of $6.2 million in August 2002 and $12.1 million in March 2003.  The new loan matures in August 2004 and accrues interest at a rate of 30-day LIBOR plus 3.5%, with a minimum interest rate of 7%, payable monthly interest only payments through October 1, 2003 with principal and interest payments beginning November 1, 2003.

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In the quarter ended March 31, 2001, certain notes payable were refinanced and the prior debt extinguished, resulting in an extraordinary loss due to the remaining deferred financing costs that were written off at the time of the refinancing.  In the quarter ended June 30, 2001, $7.0 million of convertible subordinated notes were repurchased resulting in an extraordinary gain of $1.6 million offset in part by the write-off of loan issuance costs related to the $7.0 million convertible subordinated note.

The Company’s various debt and lease agreements contain restrictive covenants requiring us to maintain certain financial ratios, including current ratio, working capital, minimum net worth, and debt service coverage, among others. At September 30, 2002, the Company was in compliance with all such covenants or had obtained waivers.

(4)  LIQUIDITY

The Company believes that its existing liquidity, ability to sell assisted living communities and land sites which do not meet its financial objectives or geographic clustering strategy, and ability to refinance certain assisted living communities will provide adequate resources to meet current investing needs and support current growth plans for the next 12 months. The Company will be required from time to time to incur additional indebtedness or issue additional debt or equity securities to finance its growth strategy, including the acquisition of assisted living communities as well as other capital expenditures and to provide additional funds to meet increased working capital requirements.

(5) SHAREHOLDERS RIGHTS PLAN

In May 1998, we adopted a Rights Agreement which established a shareholders rights plan under which we have declared a dividend distribution of one Preferred Share Purchase Right on each outstanding share of our common stock. Subject to limited exceptions, the Rights will be exercisable if a person or group acquires 10% or , in the case of Lazard Freres Real Estate Investors, LLC ("Lazard" or "LFREI"), 50% or more of our stock or announces a tender offer for 10% or, in the case of LFREI, 50% or more of the common stock. When exercisable, each Right (except the Rights held by the acquiring person) will entitle its holder to purchase, at the Right's then-current exercise price, a number of our common shares having a market value at the time of twice the Right's exercisable price. If we are acquired in a merger or other business combination transaction which has not been approved by our Board of Directors, each Right will entitle its holder to purchase, at the Right's then-current exercise price, a number of the acquiring company's common shares having a market value at that time of twice the Right's exercise price.

On October 1, 2002, the Company amended its Rights Agreement dated May 14, 1998, and subsequently amended as of October 21, 1998 and April 24, 2000, in order to provide for the following: (i) to allow the board of directors under Section 23.1 of the Rights Agreement to redeem the Rights issued under the Rights Agreement at any time prior to the Distribution Date, as defined and to postpone the Distribution Date, as defined to allow additional time for negotiation; (ii) to grant the board of directors under Section 27.1 of the Rights Agreement the option to exercise its exchange rights even if a hostile bidder were to cause a Trigger Event, as defined by acquiring greater than 50% of the common shares outstanding of the Company; and (iii) to establish a procedure for registration of the common shares of the Company that would be issued if the Rights were issued and exercised.

(6)  COMMITMENTS AND CONTINGENT LIABILITIES

COMMITMENTS

The Company has guaranteed indebtedness at September 30, 2002 of certain unconsolidated affiliated partnerships for $3.5 million. Additionally the Company has guaranteed partnership indebtedness up to $3.7 million to the extent a lender suffers loss from: (i) the partnership’s failure to properly apply insurance proceeds, to deliver required books and records or to properly apply rents; (ii) fraud by the partnership; (iii) filing of bankruptcy by the partnership or the company; or (iv) environmental contamination of the secured properties.

The Company is the general partner of certain limited partnerships that in turn serve as the sole members of certain borrowing limited liability companies which had outstanding loan balances of $17.0 million at September 30, 2002. Although a member of a limited liability company is not personally liable for any contractual or other obligation of that entity, the Company delivered limited guaranties in connection with the loans. Due to the limited guaranties, the Company assumed liability for repayment of the loan indebtedness as a result of fraudulent or intentional misconduct regarding the mortgaged properties, an unconsented transfer of a mortgaged property, a change of control by borrower, or violation of hazardous materials covenants.  The Company also guaranteed up to $1.0 million of mortgage debt secured by an ALC and pledged its partnership interest in two of our consolidated partnerships through January 2004.

In the Company’s opinion, no claims may be currently asserted under any of the aforementioned guarantees based on the terms of the respective agreements other than those accrued.

CONTINGENCIES

The Company entered into four long-term leases of ALCs, the acquisition and construction of which have been or are being financed by tax exempt multi-unit housing revenue bonds. In order to meet the lease obligations and to allow the landlord to continue to qualify for favorable tax treatment of the interest payable on the bonds, the ALCs must comply with certain federal income tax requirements. These requirements principally pertain to the maximum income level of a specified portion of the residents. Should the Company elect to execute additional leases for ALCs to be constructed with bond financing, the same and possibly additional restrictions are anticipated to be imposed. Failure to satisfy these requirements will constitute an event of default under the leases, thereby permitting the landlord to accelerate their termination. Failure to obtain low-income residents in the sequence and time required could materially affect the lease-up schedule and, therefore, cash flow from such ALCs.

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LITIGATION

During 2001, four employees of an ALC owned by American Retirement Villas Properties II, a majority owned partnership, filed EEOC claims against the Company.  The claims have been submitted to binding arbitration.

On or about September 25, 2002, following delivery to the Company of an unsolicited letter from Prometheus Assisted Living LLC (“Prometheus”), an affiliate of Lazard Freres & Co. LLC, in which Prometheus stated that it had decided to propose a transaction to acquire for cash all of the outstanding shares of common stock of the Company not currently owned by Prometheus or its affiliates, (see note 7) four separate class action suits were filed in the court of Chancery of the State of Delaware against the Company and the Directors of the Company. The four suits, as well as a similar fifth class action suit filed in Orange County Superior Court in the State of California on October 1, 2002, were brought by individual shareholders on behalf of a putative class of all ARV shareholders asserting causes of action based upon alleged self dealing and breaches of fiduciary duties by the Company and its Directors in connection with the receipt of the Prometheus proposal letter. The Company and the Directors have retained counsel to defend the actions.

Other than as described above and other than the ordinary routine litigation that is incidental to, and arises in the normal course of, the business of the Company, there are no material legal proceedings pending against the Company.  While the Company cannot predict the results with certainty, it does not believe that any liability from any such lawsuits or other matters will have a material effect on its financial position, results of operations, or liquidity.

GENERAL LIABILITY INSURANCE

In order to protect itself against lawsuits and claims relating to general and professional liability, the Company currently maintains third party insurance policies in amounts and covering risks that are consistent with industry practice. Under the terms of such insurance policies, the Company’s coverage is provided subject to varying deductible levels and liability amounts. As the result of poor industry loss experience, a number of insurance carriers have stopped providing insurance coverage to the assisted living industry, and those remaining have drastically increased premiums and deductible amounts. Consistent with this trend, the Company’s general liability coverage is subject to significant deductible levels on a per occurrence basis for all states of operation, with materially higher deductible levels assessed for Texas and Florida, for the nine months ended December 31, 2001 and the three months ended March 31, 2002. For the six months ended September 30, 2002, the Company’s general liability deductible per occurrence has again been materially increased for all states of operation. Losses up to these deductible levels are accrued based upon the Company’s and a third party actuarial study of the estimate of the aggregate liability for claims incurred based on Company experience. As the result of these continuing increases in both deductible amounts and premiums, there can be no assurance that the Company will be able to obtain all desired insurance coverage in the future on commercially reasonable terms or at all.

(7)  RELATED PARTY TRANSACTIONS

On April 24, 2000, the Company entered into a Term Loan Agreement with LFSRI II Assisted Living LLC (“LFSRI”), an affiliate of Prometheus. Pursuant to the Term Loan Agreement, the Company could borrow up to $10,000,000 from LFSRI, subject to certain conditions, and the term of the loan could be extended by one year if no default occurred.  On April 24, 2002, for a fee of $250,000, the parties amended the existing $10.0 million term loan to: (i) increase the principal amount by $1.5 million to $11.5 million, (ii) decrease the interest rate to LIBOR plus 9.54% payable monthly and (iii) extend the maturity date to July, 1 2004, with principal payments of $1.5 million due on each July 1 until maturity.  The proceeds of $1.5 million were used to pay off the note payable to Prometheus of $1.5 million. In connection with the Term Loan Agreement, the Company issued to LFSRI a warrant to purchase up to 750,000 shares of the Company’s Common Stock at a price of $3.00 per share, subject to various adjustments, which is exercisable

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until April 24, 2005.  Also on April 24, 2000, the Company amended its Rights Agreement to prevent shares that Prometheus may be deemed to beneficially own by reason of LFSRI’s rights under the warrant from causing Prometheus to become an “Acquiring Person” and thus causing a triggering event under the Rights Agreement.

On September 23, 2002 we received an unsolicited letter from Prometheus, in which Prometheus stated that it has decided to propose a transaction to acquire for cash all of the outstanding shares of common stock of the Company not currently owned by Prometheus or its affiliates. Prometheus stated that it expects the price to be in the range of $3.25 to $3.60 per share in cash, subject to completion of confirmatory due diligence and negotiation of the terms of a mutually acceptable merger agreement. Prometheus further stated that following the completion of the transaction it intends to combine the Company with Atria, Inc. and Kapson Senior Quarters Corp. (also assisted living companies), subject to receipt of all necessary approvals and consents, but that its proposed acquisition of the remaining shares of the Company is not dependent on any subsequent transaction with Atria or Kapson. Prometheus also stated that it is not interested in selling its shares in the Company.

Prometheus currently owns approximately 43.5 percent of the outstanding shares of the Company, and owns warrants which, if exercised, would result in ownership of approximately 47.8 percent of the outstanding shares of the Company. Pursuant to the terms of certain agreements, Prometheus’ ability to purchase shares and engage in other transactions with the Company is subject to certain restrictions.

The Company’s board of directors has formed a special committee, consisting of two independent directors, to evaluate Prometheus’ proposal and to consider options that may be available to the Company. Cohen & Steers Capital Advisors LLC has been engaged to provide financial advice in connection with the proposal. There is no assurance that any definitive proposal will be forthcoming or that any definitive transaction will ultimately occur.

(8)     COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

(9)     SUBSEQUENT EVENTS

On October 28, 2002 we announced that we had received two unsolicited letters from third parties indicating interest in a transaction involving the outstanding shares of common stock of the Company.  Both potential bidders are proposing alternative transactions to that proposed by Prometheus, as described in Note (6), on terms that the letters suggest could be more favorable to the Company’s stockholders.  No firm offers have been received and no assurances can be given that such expressions of interest will lead to formal offers.  The Company has entered into standard confidentiality agreements to permit the potential bidders to conduct further due diligence as requested.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

FACTORS AFFECTING FUTURE RESULTS AND FORWARD-LOOKING STATEMENTS

This 10-Q report contains forward-looking statements, including statements regarding, among other items:

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These forward-looking statements are based on our expectations and are subject to a number of risks and uncertainties, some of which are beyond our control.  These risks and uncertainties include, but are not limited to:

Although the Company believes it has the resources required to achieve our objectives, actual results could differ materially from those anticipated by these forward-looking statements.  There can be no assurances that events anticipated by these forward-looking statements will in fact transpire as expected.

OVERVIEW

ARV Assisted Living, Inc. (“ARV” or the “Company”), originally incorporated in California in 1980 and subsequently merged into a Delaware corporation in 1998, is one of the largest operators of licensed assisted living communities (“ALCs”) in the United States. ARV is a fully integrated provider of assisted living accommodations and services that operates, acquires and develops ALCs. We have been involved in the senior housing business for more than 20 years. Our operating objective is to provide high quality, personalized assisted living services to senior residents in a cost-effective manner, while maintaining residents’ independence, dignity and quality of life. Our ALCs offer a combination of housing, personalized support services and assistance in activities of daily living in a non-institutional setting. Our ALCs are designed to respond to the individual needs of elderly residents who require assistance with certain activities of daily living, but who do not require the intensive nursing care provided in a skilled nursing facility.

As of September 30, 2002, we operated a total of 59 ALCs containing 6,863 units, 17 of which are owned by us, 33 that are leased by us and 9 that are managed by us. Owned ALCs (“Owned ALCs”) are owned by us directly, or by affiliated limited partnerships or limited liability companies for which we serve as managing general partner or member and community manager and in which we have a majority ownership interest (“Affiliated Partnerships”). Leased ALCs (“Leased ALCs”) are operated under long-term operating leases for our own account or for Affiliated Partnerships in which we have a majority ownership interest. Managed ALCs (“Managed ALCs”) are operated on behalf of joint ventures or an unrelated third-parties. We believe that this blend of ownership, leasehold and management interest in our ALCs allows us to fund our operations in a balanced, efficient manner.

Since commencing operation of ALCs we embarked upon an expansion strategy and achieved significant growth in revenue resulting primarily from the acquisition of ALCs. We focused our growth efforts on the acquisition and development of additional ALCs and expansion of services to our residents as they “age in place.”  In the last three years we have focused on improving the operations of our existing ALCs. In December 2001, we acquired two ALCs through acquiring a controlling interest in ARVP III, a California limited partnership described below. As of September 30, 2002, a substantial portion of our business and operations are conducted in California, where 39 of the 59 ALCs we operate are located. We intend to continue to make the western United States the primary focus of our clustering strategy. Our current attention and resources are focused on enhancing the profitability of our existing core operations. In addition, we plan to divest ALCs that do not expand or enhance one of our geographic clusters or do not meet our financial objectives.

In October 2001, we entered into four management contracts providing for the Company’s management of certain ALCs, two in Texas totaling 126 units and two in New Mexico totaling 92 units. In January 2002 we entered into a fifth management contract for a newly completed ALC that is in the lease-up stage in California.

On September 23, 2002 we received an unsolicited letter from Prometheus Assisted Living, LLC (“Prometheus”), an affiliate of Lazard Freres & Co. LLC, in which Prometheus stated that it has decided to propose a transaction to acquire for cash all of the outstanding shares of common stock of ARV not currently owned by Prometheus or its affiliates. Prometheus stated that it expects the price to be in the range of $3.25 to $3.60 per share in cash, subject to completion of confirmatory due diligence and negotiation of the terms of a

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mutually acceptable merger agreement. Prometheus further stated that following the completion of the transaction it intends to combine ARV with Atria, Inc. and Kapson Senior Quarters Corp. (also assisted living companies), subject to receipt of all necessary approvals and consents, but that its proposed acquisition of the remaining shares of the Company is not dependent on any subsequent transaction with Atria or Kapson. Prometheus also stated that it is not interested in selling its shares in the Company.

Prometheus currently owns approximately 43.5 percent of the outstanding shares of the Company, and owns warrants which, if exercised, would result in ownership of approximately 47.8 percent of the outstanding shares of the Company. Pursuant to the terms of certain agreements, Prometheus’ ability to purchase shares and engage in other transactions with the Company is subject to certain restrictions. The Company’s board of directors has formed a special committee, consisting of two independent directors, to evaluate Prometheus’ proposal and to consider options that may be available to the Company. Cohen & Steers Capital Advisors LLC has been engaged to provide financial advice in connection with the Prometheus’ proposal.

On October 28, 2002 the Company announced that we had received two unsolicited letters from third parties indicating interest in a transaction involving the outstanding shares of common stock of the Company.  Both potential bidders are proposing alternative transactions to that proposed by Prometheus, on terms that the letters suggest could be more favorable to the Company’s stockholders.  No firm offers have been received and no assurances can be given that such expressions of interest will lead to formal offers.  The Company has entered into standard confidentiality agreements to permit the potential bidders to conduct further due diligence as requested. There is no assurance that any definitive proposal will be forthcoming or that any definitive transaction will ultimately occur.

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH THREE MONTHS ENDED SEPTEMBER 30, 2001

     The following table sets forth a comparison of the three months ended September 30, 2002 (the “2002 Quarter”) and the three months ended September 30, 2001 (the “2001 Quarter”). The percentage increase (decrease) is based upon our Condensed Consolidated Statements of Operations and will not compute using the rounded amounts below.

Operating Results Before Income Tax Expense and Extraordinary Item
For the Three Months Ended September 30, 2002 and 2001
(Unaudited)

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Assisted living revenue increased $2.8 million or 7.6% to $38.7 million for the three months ended September 30, 2002 from $35.9 million for the three months ended September 30, 2001.  This increase was primarily due to:

Skilled nursing facility revenue increased $0.2 million or 46.5% to $0.7 million for the three months ended September 30, 2002 from $0.5 million for the three months ended September 30, 2001.  This increase was primarily due to an increase in the number of residents that are billed to Medicare.

Management fees remained relatively constant at $0.3 million for the quarter ended September 30, 2002 and for the quarter ended September 30, 2001. An increase in management fees from five new management contracts for the 2002 period versus the 2001 period were offset by the management fees from ARVP III included in the 2001 period which have been eliminated in the 2002 period as ARVP III became a consolidated entity as of December 14, 2001.

Assisted living community operating expenses increased $1.6 million or 6.8% from $22.2 million for the quarter ended September 30, 2001 to $23.8 million for the quarter ended September 30, 2002.  This increase was primarily due to the following: