ASSISTED LIVING CONCEPTS INC - 10-K Annual Report

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

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FORM 10-K
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(MARK ONE)

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

OR

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

FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .

COMMISSION FILE NUMBER 1-13498

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

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

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for at least the past 90 days. Yes [X] No [ ]

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

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

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PART I

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

ITEM 1. BUSINESS

OVERVIEW

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

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

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

The principal elements of our business strategy are to:

- increase occupancy and improve operating efficiencies at our residences;

- reduce overhead costs where possible;

- establish necessary financing to meet maturing obligations; and

- increase rental and service revenue.

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

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

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

REORGANIZATION

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

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

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

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

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

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

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

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

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

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

MANAGEMENT CHANGES

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

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

SERVICES

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

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

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

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

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

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

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

OPERATIONS

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

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

COMPETITION

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

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

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

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

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

FUNDING

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

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

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

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

GOVERNMENT REGULATION

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

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

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

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

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

LIABILITY AND INSURANCE

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

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

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

EMPLOYEES

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

ITEM 2. PROPERTIES

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

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(1) Reflects the date we commenced operations.

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

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

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

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

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

ITEM 3. LEGAL PROCEEDINGS

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

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

- $40.25 million principal amount of Senior Secured Notes;

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

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

The New Notes are secured by 57 of our properties.

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

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

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Insurance Coverage Dispute

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

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

Other Litigation

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

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

Not applicable.

PART II

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

PREDECESSOR COMPANY

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

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

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

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

SUCCESSOR COMPANY

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

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

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

ITEM 6. SELECTED FINANCIAL DATA

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

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

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

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

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

(3) Based upon available units.

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

OVERVIEW

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

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

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

15

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

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

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

- building rentals; and

- depreciation and amortization.

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

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

REORGANIZATION

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

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

- $40.25 million principal amount of Senior Secured Notes;

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

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

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

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

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

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

16

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

FRESH-START REPORTING

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

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

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

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

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

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

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

18

RESULTS OF OPERATIONS

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

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

19

Other Data:

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

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

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

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

The principal elements of the increase include:

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

- $1.0 million related to increased utility costs;

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

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

These increases were offset by the following decreases:

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

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

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

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

20

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Other Data:

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

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

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

The increase includes:

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

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

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

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

The increase includes:

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

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

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

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

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

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

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

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

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

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

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

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

23

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

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

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

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

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

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

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

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

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

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

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

Interest expense decreased by:

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

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

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

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

24

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

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

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

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

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

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

LIQUIDITY AND CAPITAL RESOURCES

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

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

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

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

25

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

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

- $40.25 million principal amount of Senior Secured notes;

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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