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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission file number:  1-14151

CLC HEALTHCARE, INC.
(Exact name of Registrant as specified in its charter)

Securities registered pursuant to Section 12(g) of the Act:  NONE

          Indicate by check mark whether the Company (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 Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

          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.  x

          Indicate by check mark whether the Company is an accelerated filer. 

          The aggregate market value of voting and non-voting stock held by non-affiliates of the Company was approximately $514,682 as of June 28, 2002 (the last business day of the Company’s most recently completed second fiscal quarter).

2,142,826
(Number of shares of common stock outstanding as of March 1, 2003)

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STATEMENT REGARDING FORWARD LOOKING DISCLOSURE

Certain information contained in this annual report includes statements that are not purely historical and are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, beliefs, intentions or strategies regarding the future.  All statements other than historical facts contained in this annual report are forward-looking statements.  These forward-looking statements involve a number of risks and uncertainties.  All forward-looking statements included in this annual report are based on information available to us on the date hereof, and we assume no obligation to update such forward-looking statements.  Although we believe that the assumptions and expectations reflected in such forward-looking statements are reasonable, no assurance can be given that such expectations will prove to have been correct.  The actual results achieved by us may differ materially from any forward-looking statements due to the risks and uncertainties of such statements.  

General

On February 6, 2002, the stockholders approved changing the name of our company to CLC Healthcare, Inc. (“CLC”) from LTC Healthcare, Inc.  CLC, a Nevada corporation, was incorporated on March 20, 1998 and began operations on March 25, 1998.  Our company was originally a preferred stock subsidiary of LTC Properties, Inc. (“LTC “), a real estate investment trust (“REIT”).  On September 30, 1998, concurrently with the conversion of all shares of company non-voting common stock held by LTC into voting common stock of our company, LTC completed the spin-off of our common stock through a taxable dividend to holders of LTC common stock, convertible subordinated debentures and Series C Preferred Stock.  See “Part II, Item 8 – FINANCIAL STATEMENTS - Note 3. Transactions with LTC Properties, Inc.” 

In accordance with “plain English” guidelines provided by the Securities and Exchange Commission, whenever we refer to “our company” or to “us”, or use the terms “we” or “our”, we are referring to CLC Healthcare, Inc. and its subsidiaries.

The principal business of our company is providing long-term healthcare services through the operation of nursing facilities.  As of March 1, 2003, our company operates twenty-five skilled nursing facilities with 2,584 licensed beds and a rehabilitation hospital with 74 licensed beds.  The facilities operated by us are located in six states and are collectively referred to herein as nursing facilities.  

Operations

Our company has one operating segment, nursing facility operations.  Nursing facility operations include revenues generated by providing long-term healthcare services in nursing facilities operated by us.  

Prior to September 1, 1999, our revenues consisted primarily of rental income from the ownership of long-term care facilities leased to third-party operators.  In August 1999, we acquired Generations Management Services, Inc. (“Generations”), a nursing facility management company.  For the period from August 20, 1999, to December 31, 1999, Generations managed the operations of nine nursing facilities for a third-party provider of long-term care under a fee based management agreement.  Eight of the facilities managed for the third-party provider were leased to the third-party by LTC and the remaining facility was leased to the third-party by our company.  The facility owned by us was closed throughout the term of the management agreement.  The third-party manager anticipated that our owned facility would be licensed and opened.  On December 31, 1999, the management agreement was terminated between Generations and the third-party provider.  A new at-risk management agreement was entered into between the third-party provider and our company effective January 1, 2000, for the eight facilities leased to the third-party provider from LTC. During 2000, two leases between LTC

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and the third-party provider were terminated and the facilities were leased directly to us from LTC.  Concurrently, the management agreement between our company and the third-party provider was terminated for the two facilities now leased directly from LTC.

On September 1, 1999, we entered into operating leases with LTC for the six remaining facilities and began operating the six nursing facilities.  In October 1999, we began operating twelve additional nursing facilities.  Eleven of the nursing facilities our company began operating in October 1999, were leased from LTC and the remaining facility was acquired by us.  We initially entered into management agreements with two third-party operators of long-term care facilities for the management of the twelve facilities.  Effective February 29, 2000, the management agreement with one of the third-party operators was terminated and we began operating nine of the facilities on March 1, 2000.  The management agreement for the remaining three facilities was terminated on March 31, 2000, and we began operating those facilities on April 1, 2000.

On January 1, 2000, our company began operating five facilities that were leased from LTC, and effective February 1, 2000, we began operating one facility that was leased from a third party.  In May of 2000, the facility owned by us that was formerly closed was opened.

In June 2000, LTC terminated the lease on a facility operated by our company.  Also, during 2000, LTC sold two facilities that were leased to us.  On August 9, 2000, the lease was terminated on one of the facilities sold and our company ceased operating the facility.  The lease was terminated on the second sold facility on September 30, 2000.

Effective January 1, 2001, our company and LTC agreed to terminate leases of four facilities containing a total of 603 licensed beds in four states.  These facilities were being operated by us under a short-term, at-risk management agreement with LTC during a transition period.

On March 1, 2001, our company began operating an additional facility not formerly operated by us under a short-term, at-risk management agreement with LTC.  On April 1, 2001, we began operating one additional nursing facility under an operating lease with LTC.  On April 24, 2001, we ceased operating and closed one nursing facility previously operated under a short-term, at-risk management agreement with LTC.  On May 25, 2001, we ceased operating and closed one nursing facility previously leased from LTC.  On June 20, 2001, we ceased operating and closed one nursing facility previously leased from LTC.  On July 24, 2001, our company ceased operating and closed one nursing facility previously operated under a short-term, at-risk management agreement with LTC.  On August 1, 2001, we ceased operating one nursing facility previously operated under a short-term, at-risk management agreement with LTC.  On September 17, 2001, our company ceased operating and closed one nursing facility previously operated under a short-term, at-risk management agreement with LTC.  On October 19, 2001, we ceased operating and closed one nursing facility previously leased from LTC.  On December 1, 2001, we began operating one additional nursing facility under an operating lease with an unrelated party. In December 2001, we began operating one nursing facility under an operating lease with LTC, which previously was under a short-term, at-risk management agreement with LTC. 

In February 2002, LTC sold two skilled nursing facilities in Illinois which had been leased to us to an unrelated third party.  We continued to operate these facilities under a short-term operations transfer agreement until the new owner obtained a license and regulatory approval.  On March 29, 2002, we ceased operating the two nursing facilities in Illinois.  We no longer operate in the state of Illinois.  Effective April 1, 2002, we de-licensed 24 beds in Kansas.  In June 2002, we purchased two nursing facilities in New Mexico from LTC.  Effective September 1, 2002, we de-licensed 29 beds in Iowa.    

As a result, as of March 1, 2003, our company operates twenty-five skilled nursing facilities with 2,584 licensed beds and a rehabilitation hospital with 74 licensed beds.  The facilities operated by us are located in six states and are collectively referred to herein as nursing facilities.  See “Relationship with LTC Properties, Inc.” below.

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Our company’s nursing facilities provide residents with routine care services, including daily dietary, social and recreational services, and pharmacy and medical supplies as well as restorative, rehabilitative and nursing care for people not requiring the more extensive and sophisticated treatment available at acute care hospitals.  Our nursing facilities also provide inpatient skilled nursing services and rehabilitative, restorative and transitional medical services to individuals with higher acuity medical conditions. We provide 24-hour nursing care in these nursing facilities by registered nurses, licensed practical nurses, and certified nurses’ aides.

We believe that the margins of our nursing facility operations can be improved through direct management by our company of the operations of the nursing facilities and by increasing resident census.  Our strategy is to improve resident census while providing comprehensive quality services to the residents of our nursing facilities within the reimbursement constraints imposed by third-party payors. 

Competition

The long-term care industry is highly competitive.  Our company’s nursing facilities generally operate in communities that are also served by similar nursing facilities operated by other operators. Some competing nursing facilities are located in buildings that are newer than those operated by us, provide services not offered by our nursing facilities or are operated by entities having greater financial and other resources and longer operating histories than ours.  In addition, some nursing facilities are operated by nonprofit organizations or government agencies supported by endowments, charitable contributions, tax revenues, and other resources not available to us.  Our company’s ability to compete with other operators of long-term care facilities is based on numerous factors, including our reputation for the quality and comprehensiveness of services provided; the commitment and expertise of our staff; the innovativeness of our treatment programs; local physician and hospital support; marketing programs; charges for services; family preferences and the physical appearance, location and condition of our nursing facilities.  There can be no assurance that we will not encounter increased competition in the future that would adversely affect our financial condition and results of operations.

Employees

As of March 1, 2003, our company had approximately 2,500 employees.

Investor Information

We do not currently maintain an Internet website.  We will provide, as soon as reasonably possible after these reports are filed with the Securities and Exchange Commission, at no charge and upon request, paper copies of our Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to reports filed pursuant to sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended.  Requests may be made in writing or by telephone at the address or telephone number listed on the cover of the Form 10-K.

Governmental Regulation

General.  Our company derives a substantial portion of its revenue from third-party payers, including the Medicare and Medicaid programs.  The Medicare program was enacted in 1965 to provide a nationwide federally funded health insurance program for the elderly and certain disabled persons.  The Medicaid program is a joint federal-state cooperative arrangement established for the purpose of enabling states to furnish medical assistance on behalf of aged, blind, or disabled individuals, and members of families with dependent children, whose income and resources are insufficient to meet the costs of necessary medical services. Within the Medicare and Medicaid statutory framework, there are substantial areas subject to administrative regulations and rulings, interpretation and discretion, which may affect payments made to providers under these programs.  The amounts of program payments received by us can be changed by legislative or regulatory actions and by determinations made by fiscal intermediaries and other payment agents acting on behalf of the programs.

Medicare PPS System and Related Legislation.  Medicare reimbursement for skilled nursing facilities is based on a prospective payment system (“PPS”) under which facilities are paid a federal per diem rate for virtually all

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covered services.  Payment is determined by Resource Utilization Groups (“RUGs”).  The PPS system, which was mandated by the Balanced Budget Act of 1997 (the “Balanced Budget Act”), was phased in starting with cost reporting periods beginning on or after July 1, 1998.  All of our nursing facilities were paid at the full federal rate beginning October 1, 2001.  PPS has resulted in more intense price competition and lower margins for our company.  There can be no assurance that our company will be able to operate at costs of services below the PPS reimbursement rates, or that the failure of our company to do so will not have a material adverse effect on our liquidity, financial condition, and results of operations. 

The Balanced Budget Refinement Act, enacted in November 1999 (“BBRA 1999”), and the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (“BIPA 2000”) sought to mitigate some of the reductions in reimbursement to skilled nursing facilities resulting from the Balanced Budget Act.  While many of the payment increases mandated by these two bills expired October 1, 2002, skilled nursing facilities (“SNFs”) continue to benefit from a BBRA 1999 provision (subsequently modified by BIPA 2000) that temporarily increases payments for certain high-acuity patients.  Specifically, the legislation temporarily increases the PPS per diem rates for certain specific patient acuity categories, beginning April 1, 2000, and ending when the Centers for Medicare & Medicaid Services (“CMS”), formerly the Health Care Financing Administration (“HCFA”), implements a refined RUG system that better accounts for medically-complex patients.  The Secretary did not implement such refinements in federal fiscal year 2003, and the Bush Administration has indicated that the refinements also will not be implemented in federal fiscal year 2004.

The Balanced Budget Act also instituted a consolidated billing requirement for skilled nursing facilities, which required facilities to submit Medicare claims to the fiscal intermediary for virtually all Medicare services that its residents receive, except for certain specifically excluded services.  The BBRA 1999 excluded additional items from the consolidated billing requirement. Moreover, BIPA 2000 limited consolidated billing requirements to items and services furnished to skilled nursing facility residents in a Medicare Part A covered stay and therapy services covered under Part B.  In other words, for residents not covered under a Part A stay, facilities may choose to bill for non-therapy Part B services and supplies, or they may elect to have suppliers continue to bill Medicare directly for these services.

Moreover, the Balanced Budget Act established: (1) a $1,500 per beneficiary annual cap for all outpatient physical therapy services and speech language pathology services; and (2) a $1,500 per beneficiary annual cap for all outpatient occupational therapy services.  The BBRA 1999 and BIPA 2000 suspended implementation of these caps through 2002.  While Congress did not extend the moratorium before it expired, CMS has announced that it will not begin enforcing the therapy caps until July 1, 2003, and that the caps are indexed for inflation, bringing the caps to $1,590.

Balanced Budget Act – Medicaid.  The Balanced Budget Act also repealed the Boren Amendment, which required state Medicaid programs to reimburse nursing facilities for the costs that are incurred by efficiently and economically operated nursing facilities.  Since repeal, many states have sought to lower their nursing facility payment rates, and several have succeeded.  It is unclear at this time the extent to which additional state Medicaid programs will adopt changes in their Medicaid reimbursement systems, or, if adopted and implemented, what affect such initiatives would have our company.  There can be no assurance that future changes in Medicaid reimbursement rates to nursing facilities will not have an adverse effect on our company.  Further, the Balanced Budget Act allows states to mandate enrollment in managed care systems without seeking approval from Health and Human Services (“HHS”) for waivers from certain Medicaid requirements as long as certain standards are met.  These managed care programs have historically exempted institutional care although some states have instituted pilot programs to provide such care under managed care programs.  Nevertheless, several states use capitated managed care financing for at least a portion of their long-term care programs. We are not able to predict whether any future states’ waiver provisions will change the Medicaid reimbursement systems for long-term care facilities from cost-based or fee-for-service to managed care negotiated or capitated rates or otherwise affect the level of payments to us.  Moreover, many states are facing significant budget shortfalls, and most states are taking steps to implement cost controls within their Medicaid programs.  Significant limits on the scope of

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services reimbursed and on rates of reimbursement under the Medicaid program could have a material adverse effect on our company’s liquidity, financial condition and results of operations.

On January 12, 2001, the Secretary of HHS issued final regulations to implement changes to the Medicaid “upper payment limit” requirements and additional restrictions were issued January 18, 2002.  The purpose of the rule is to stop states from using certain accounting techniques to inappropriately obtain extra federal Medicaid matching funds that are not necessarily spent on healthcare services for Medicaid beneficiaries.  Although the rule is being phased in over eight years to reduce the adverse impact on certain states, the rule eventually could result in decreased federal funding to state Medicaid programs, which, in turn, could prompt certain states to reduce Medicaid reimbursements to providers, including nursing facilities.

Future Legislative Changes.  We expect Congress and the states’ legislatures to continue to consider measures to reduce the growth in Medicare and Medicaid expenditures.  As noted previously, certain of the increases in Medicare reimbursement for skilled nursing facilities provided for under the Balanced Budget Refinement Act and the Benefits Improvement and Protection Act expired in October 2002. Congress has not enacted additional legislation to date to further extend these provisions.  No assurances can be given as to whether Congress will increase or decrease reimbursement in the future, the timing of any such action, or the form of relief, if any, that may be enacted.  In addition, the Medicare Payment Advisory Commission (“MedPAC”), an independent federal body established to advise Congress on issues affecting the Medicare program, reportedly will recommend in a March 2003 report that Congress adopt additional reductions in skilled nursing facility reimbursement. While the MedPAC recommendations are not binding on Congress, they may affect Congressional consideration of future Medicare reimbursement legislation.

Both the Medicare and Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy, intermediary determinations and governmental funding restrictions, all of which may materially increase or decrease the rate of program reimbursement to healthcare facilities.  We cannot predict at this time whether any additional measures will be adopted or if adopted and implemented, what effect such proposals would have on our company.  There can be no assurance that payments under state and federal governmental programs will remain at levels comparable to present levels or will be sufficient to cover the costs of patients eligible for reimbursement pursuant to the programs.

Certain states are currently evaluating various proposals to restructure healthcare delivery within their respective jurisdictions.  It is uncertain at this time what legislation of this type will ultimately be enacted and implemented or whether other changes in the administration or interpretation of governmental healthcare programs will occur. We anticipate that state legislatures will continue to review and assess various healthcare reform proposals and alternative healthcare systems and payment methodologies.  We are unable to predict the ultimate impact of any future state restructuring of the healthcare delivery system, but such changes could have a material adverse effect on our company’s liquidity, financial condition, and results of operations.

Licensure.  Our nursing facilities are subject to extensive state and local laws and regulations relating to licensure, conduct of operations, ownership of facilities, and services provided within the nursing facilities.  Our nursing facilities are subject to regulation and licensing by state and local health and social services agencies and other regulatory authorities.  In order to maintain its operating licenses, nursing facilities must comply with standards concerning medical care, equipment and hygiene.  Although regulatory requirements vary from state to state, these requirements generally address among other things: personnel education and training; staffing levels; patient records; facility services; quality of care provided; physical residence specifications; food and housekeeping services; and residents’ rights and responsibilities.  These nursing facilities are subject to periodic survey and inspection by governmental authorities.  Our nursing facilities are also subject to various state and local building codes and other ordinances, including zoning, and safety codes.

Certificate of Need.  Certificate of Need (“CON”) statutes and regulations control the development and expansion of healthcare services and facilities in certain states.  The CON process is intended to promote quality healthcare and to avoid the unnecessary duplication of services, equipment and facilities.  CON or similar laws

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generally require that approval be obtained from the designated state health planning agency for certain acquisitions and capital expenditures, and that such agency determine that a need exists prior to the expansion of existing facilities, construction of new facilities, addition of beds, acquisition of major items of equipment or introduction of new services.  Additionally, several states have instituted moratoria on new CONs or the approval of new beds.  CONs or other similar approvals may be required should we be able to do future acquisitions and/or expansions.  There can be no assurance that we will be able to obtain the CONs or other approvals necessary for any or all such projects.

Survey and Certification.  Long-term care facilities must comply with certain requirements to participate either as a skilled nursing facility under Medicare or a nursing facility under Medicaid.  Regulations promulgated pursuant to the Omnibus Budget Reconciliation Act of 1987 obligate facilities to demonstrate compliance with requirements relating to resident rights, resident assessment, quality of care, quality of life, physician services, nursing services, pharmacy services, dietary services, rehabilitation services, infection control, physical environment, and administration.  Regulations governing survey, certification, and enforcement procedures to be used by state and federal survey agencies to determine facilities’ level of compliance with the participation requirements for Medicare and Medicaid were adopted by CMS effective July 1, 1995.  These regulations require that surveys focus on resident outcomes.  They also state that all deviations from participation requirements will be considered deficiencies, but a facility may have certain minor deficiencies and be in substantial compliance with the regulations.  The regulations identify various remedies that may be imposed against facilities and specify the categories of deficiencies for which they will be applied.  These remedies include, but are not limited to: civil monetary penalties of up to $10,000 per day or “per instance”; facility closure and/or transfer of residents in emergencies; denial of payment for new or all admissions; directed plans of correction; and directed in-service training.  Failure to comply with applicable requirements for participation may also result in termination of the provider’s Medicare and Medicaid provider agreements.  Termination of nursing facilities’ Medicare or Medicaid provider agreements could have a material adverse effect on our company’s liquidity, financial condition, and results of operations.

The federal government has implemented several initiatives in recent years designed to improve the quality of care in nursing facilities and to reduce fraud in the Medicare program.  These initiatives include tougher enforcement measures by state surveying authorities, empowering specialized contractors to track down Medicare scams and program waste, and expanded use of “fraud fighters” by Medicare contractors.   Moreover, in April 2002, HHS announced a Nursing Home Quality Initiative pilot program for six states.  This pilot program was designed to provide consumers with comparative information about nursing facility quality measures. The initiative rated every nursing facility and skilled nursing facility operating in these states on specific quality of care indicators, including percentages of residents with infections, bedsores, and unplanned weight loss, among others. On April 24, 2002, HHS released initial quality data from nursing homes in the pilot program’s six states. The quality data, along with other information about individual nursing facilities, have been made available to the public through Medicare’s consumer web site, newspaper ads and a telephone help line. On November 12, 2002, HHS announced that the program is being launched nationwide. For the national project, HHS is using ten quality measures.  On November 13, 2002, CMS published advertisements in newspapers in every state that included a sampling of the quality data.  The complete listing is available on the CMS internet site.

Referral Restrictions and Fraud and Abuse.  The Medicare and Medicaid anti-kickback statute, 42 U.S.C. § 1320a-7b(b), prohibits the knowing and willful solicitation or receipt of any remuneration “in return for” referring an individual, or for recommending or arranging for the purchase, lease, or ordering, of any item or service for which payment may be made under Medicare or a state healthcare program.  In addition, the statute prohibits the offer or payment of remuneration “to induce” a person to refer an individual, or to recommend or arrange for the purchase, lease, or ordering of any item or service for which payment may be made under the Medicare or state healthcare programs.  The statute and the so-called safe harbor regulations establish numerous exceptions by defining conduct, which are not subject to prosecution or other enforcement remedies.  Violation of the anti-kickback statute could result in criminal conviction, as well as civil monetary penalties and exclusions.

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The Ethics in Patient Referrals Act (“Stark I”), effective January 1, 1992, generally prohibits physicians from referring Medicare patients to clinical laboratories for testing if the referring physician (or a member of the physician’s immediate family) has a “financial relationship,” through ownership or compensation, with the laboratory.  The Omnibus Budget Reconciliation Act of 1993 contains provisions commonly known as “Stark II” (“Stark II”) expanding Stark I by prohibiting physicians from referring Medicare and Medicaid patients to an entity with which a physician has a “financial relationship” for the furnishing of certain items set forth in a list of “designated health services,” including physical therapy, occupational therapy, home health services, and other services.  Subject to certain exceptions, if such a financial relationship exists, the entity is generally prohibited from claiming payment for such services under the Medicare or Medicaid programs, and civil monetary penalties may be assessed for each prohibited claim submitted.  On January 4, 2001, CMS released the first part of the Stark II final rule.  This final rule is divided into two phases.  Phase I focuses on the provisions related to prohibited referrals, the general exception to ownership and compensation arrangement prohibitions and the related definitions.  Most of Phase I of the rulemaking became effective January 4, 2002, one year after the date of its publication in the Federal Register.  Phase I of the final rule eases certain of the restrictions in the proposed rule, including the criteria for qualifying as a group practice.  The final rule also, among other things: conforms the supervision requirements to CMS coverage and payment policies for the specific services; clarifies the definitions of designated health services and indirect financial relationships; and creates new exceptions for indirect compensation arrangements and compensation of faculties in academic medical centers. Phase II of the final rule has not yet been released. Phase II will cover the remaining portions of the statute, including those pertaining to Medicaid.

Other provisions in the Social Security Act and in other federal and state laws authorize the imposition of penalties, including criminal and civil fines and exclusions from participation in Medicare and Medicaid, for false claims, improper billing and other offenses.

We are unable to predict the effect of future administrative or judicial interpretations of the laws discussed above, or whether other legislation or regulations on the federal or state level in any of these areas will be adopted, what form such legislation or regulations may take, or their impact on our company.  We endeavor to comply with applicable regulatory requirements, but there can be no assurance that statutory or regulatory changes, or subsequent administrative rulings or interpretations, will not require us to modify or restructure certain arrangements, or that we will not be required to expend significant amounts to maintain compliance.

Health Information Practices.  The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) mandates, among other things, the adoption of standards for the exchange of electronic health information in an effort to encourage overall administrative simplification and enhance the effectiveness and efficiency of the healthcare industry.  Among the standards that HHS will adopt pursuant to HIPAA are standards for the following:

Although HIPAA was intended ultimately to reduce administrative expenses and burdens faced within the healthcare industry, we believe the law could initially bring about significant and, in some cases, costly changes.  HHS has released three rules to date mandating the use of new standards with respect to certain healthcare transactions and health information. The first rule requires the use of uniform standards for common healthcare transactions, including healthcare claims information, plan eligibility, referral certification and authorization, claims status, plan enrollment and disenrollment, payment and remittance advice, plan premium payments and coordination of benefits.

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Second, HHS has released new standards relating to the privacy of individually identifiable health information. These standards not only require our compliance with rules governing the use and disclosure of protected health information, but they also require entities to impose those rules, by contract, on any business associate to whom such information is disclosed.

Third, on February 20, 2003, HHS issued final rules governing the security of health information. This rule specifies a series of administrative, technical, and physical security procedures covered entities must use to assure the confidentiality of electronic protected health information.

HHS finalized the new transaction standards on August 17, 2000, and covered entities originally were required to comply with the new standards by October 16, 2002.  Congress passed legislation in December 2001 that delayed the compliance date for one year (until October 16, 2003), but only for entities that submit a compliance plan to HHS by the original implementation deadline, which we have done.  On February 20, 2003, HHS published certain modifications to the final transaction standards, but these changes do not affect the October 16, 2003 compliance deadline. The privacy standards were issued on December 28, 2000, and, after certain delays, became effective April 14, 2001, with a compliance date of April 14, 2003. The security standards are effective April 21, 2003, with a compliance date of April 21, 2005, for most covered entities. Sanctions for failing to comply with HIPAA include criminal penalties and civil sanctions.

We are aware of and are evaluating the effects of HIPAA.  We cannot at this time estimate the cost of such compliance, nor estimate the cost of compliance with standards that have not yet been finalized.  The new and proposed health information standards are likely to have a significant effect on the manner in which we handle health data and communicate with payers.  However, based on our current knowledge, we cannot currently estimate the cost of compliance or if there will be a material adverse effect on our business, financial condition, or results of operations as a result of our experiencing increased costs for compliance.

Compliance Program.  On March 16, 2000, the Office of Inspector General of HHS (“OIG”) issued guidance to help nursing facilities design effective voluntary compliance programs to prevent fraud, waste, and abuse in health care programs, including Medicare and Medicaid.  The guidance, Compliance Program Guidance for Nursing Facilities, was published as a notice in the Federal Register. 

In May 2000, we voluntarily adopted a compliance program to assist us in complying with applicable government regulations.

Relationship with LTC Properties, Inc.

As of December 31, 2002, twenty-three of our nursing facilities with 2,511 licensed beds were leased from LTC.   The current leases for the twenty-three nursing facilities owned by LTC are under individual six-year leases, which expire on December 31, 2007, with aggregate annual base rents for 2002, 2003, 2004, 2005, 2006 and 2007 of $3,000,000, $4,000,000, $4,750,000, $5,350,000, $5,900,000, and $6,500,000, respectively.  The leases contain two five-year renewal options with increases of 2% annually.  These leases have a provision for acceleration should there be a change of control, as defined in the leases, of our company.  As of December 31, 2002, our company had unpaid rent related to these leases of $2,400,000.

See “Part II, Item 8. – FINANCIAL STATEMENTS – Note 1. – Basis of Presentation and Note 3. – Transactions with LTC Properties, Inc.”  Our company has sustained operating losses and net losses every year since inception, currently has no outside operating financing availability other than the line of credit with LTC discussed below and has recorded an actuarially based accrual for general and professional liability of $11,946,000 for the year ended December 31, 2002.  See below for discussion of our insurance coverage.  We have received a “going concern” opinion from our outside auditors.

LTC has discussed with our Board of Directors the possible transfer of some or all of the twenty-three LTC leased facilities to other operators and our independent directors agreed, at this time, to permit LTC to solicit other

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operators for these facilities.  LTC has committed that until June 30, 2003, and contingent on LTC reaching an agreement with another operator for any of these facilities, LTC would purchase from us the leasehold improvements, furniture, fixtures and equipment and pay us a mutually agreeable lease breakage fee for any facility leased to a new operator.  LTC has also agreed to give us a rent abatement retroactive to March 1, 2003 on any facility where LTC has entered into a new lease with a new operator.

Should these facilities be transferred to other operators, we would need to significantly restructure our company to reflect reduced operations.  At this time, we are unable to estimate the impact on our company from such potential reorganization.

Our Chief Executive Officer and Vice President of Taxes serve as the same officers of LTC.  Our President also serves as LTC’s Executive Vice President, Chief Investment Officer.  Prior to March 7, 2003, when she resigned, our Chief Financial Officer also served and still serves as Chief Financial Officer of LTC.  Our Chief Executive Officer, President and the former Chief Financial Officer  remain members of our Board of Directors.  LTC has provided these three directors and one outside director with indemnification agreements.   

In March 2002, LTC agreed to sell a wholly owned subsidiary, LTC-Fort Tucum, Inc. to us for a $500,000 note payable bearing no interest for one year and thereafter interest at 8% annually for two years.  We have certain rights to extend the note payable at its maturity.  We used LTC-Fort Tucum to acquire two nursing facilities in New Mexico, previously operated by Integrated Health Services, Inc., with a total of 97 beds, in a deed-in-lieu of foreclosure transaction.  These nursing facilities are financed with debt from a REMIC pool originated by LTC.  The total debt assumed by our company was $1,172,000 and we began operating the facilities on June 1, 2002.  As of December 31, 2002, these mortgage loans secured by the two nursing facilities has a total outstanding principal of $1,150,000, a weighted average interest rate of 12.6% and a maturity date of April 2015.

On June 23, 2000, LTC’s Board of Directors appointed our company as exclusive sales agent for all LTC’s identified nursing facilities for a period of one year and approved a commission agreement with us effective April 1, 2000.  Pursuant to the agreement, we received sales commissions of $1,600,000 in fiscal 2000. The exclusive sales agent agreement with LTC expired on March 31, 2001.

On November 21, 2001, we entered into a Securities Purchase Agreement with LTC pursuant to which, we sold to LTC 7.5% convertible subordinated debentures of Regent Assisted Living, Inc. (“Regent”) with a face value of $8,500,000 for a sales price of $7,800,000.  Our company had a carrying value of the debentures of $5,100,000 and recognized a gain on the sale of $2,700,000.  The sales price represented our estimated fair market value of the debentures.  The sales price of $7,800,000 was applied to reduce total indebtedness due to LTC.

In October 2001, Assisted Living Concepts, Inc., (“ALC”) filed for reorganization under Chapter 11 of the federal bankruptcy laws.  The filing was pre-negotiated with sufficient debt holders to allow ALC to reorganize its debt and equity and emerge from bankruptcy as of 12:01 a.m. on January 1, 2002.  The final order affirming the reorganization was made in December 2001, consequently we reflected the transaction as of December 31, 2001.  On December 17, 2001, Healthcare Holdings, Inc. (“Holdings”), a wholly owned subsidiary of our company, and LTC entered into an Assignment and Assumption Agreement (“Agreement”) whereby Holdings bought from LTC the right to receive common stock of ALC to be distributed pursuant to the First Amended Joint Plan of Reorganization of Assisted Living Concepts, Inc. and Carriage House Assisted Living, Inc. (“Plan”).  The Plan was confirmed at a hearing on December 5, 2001.

On December 31, 2001, Holdings issued a Promissory Note (“Note”) in accordance with the Agreement in the face amount of $7,000,000 in payment for the right to receive 1,238,076 shares of ALC common stock distributed pursuant to the Plan (approximately $5.65 per share).  CLC, the parent company of Holdings, did not guarantee the Note.  The price of the shares was determined by reference to Exhibit G, Volume II of II of ALC’s First Amended Joint Plan of Reorganization.  This Exhibit G reported that the projected stockholders’ equity of ALC upon emergence from bankruptcy to be $32,799,000 and to be $37,117,000 on December 31, 2002.  ALC issued 6,500,000 shares of new common stock at emergence, which results in a calculated valuation of $5.05 and $5.71 per

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share value as of January 1, 2002, and December 31, 2002, respectively. The Note is for a term of five years and bears interest at 5.0%, compounded annually and accruing to the principal balance plus interest at 2.0% on the original $7,000,000, payable in cash annually.  The Note is a full recourse obligation of Holdings and is secured by all of the assets owned now or in the future by Holdings and contains a provision for acceleration should there be a change of control of Holdings or our company.  At December 31, 2002, the Note had a principal balance of $7,350,000. 

Prior to ALC’s emergence from bankruptcy, Holdings owned $5,715,000 face value of ALC’s 5.625% convertible subordinated debentures and 30,847 shares of ALC’s common stock.  As a result of the Plan, Holdings received $1,382,000 of ALC’s new Senior Secured Notes bearing interest at 10.0% per annum, payable semi-annually in arrears; $534,000 of new Junior Secured Notes bearing interest payable in additional new Junior Secured Notes for three years at 8.0% per annum and thereafter payable in cash at 12.0% per annum, payable semi-annually in arrears and 214,250 shares of ALC common stock.   Additionally, Holdings received 468 shares of ALC common stock in exchange for the 30,847 shares owned prior to emergence.  During the year ended December 31, 2002, ALC repaid $157,000 of our Senior Secured Notes as a result of the sale of certain assets collateralizing those notes.  All of these securities are additional collateral for the Note and had a fair market value at December 31, 2002, of approximately $1,410,000.

Our company’s ownership of 1,452,794 shares of ALC’s common stock represents 22.35% of ALC’s total common stock outstanding.  This investment is accounted for under the provisions of APB No. 18. “The Equity Method of Accounting for Investments in Common Stock”.

On December 20, 2001, our company entered into an agreement to sell to LTC six skilled nursing facilities and four assisted living facilities.  The total sales price was $45,860,000 subject to mortgage debt of approximately $33,062,000 and minority interest of approximately $3,518,000.  We recognized a gain on the sale of the real estate properties of $11,679,000 and received proceeds of $9,285,000, which were applied to reduce total indebtedness due to LTC.  Two of the facilities sold to LTC were owned and operated by us.  The remaining eight facilities had been leased to third party operators and had rents of approximately $3,600,000 in 2001.  Additionally, in December 2001, LTC agreed to forgive approximately $1,401,000 in accrued interest related to the line of credit from LTC and approximately $3,000,000 in unpaid rent for 2001.  The forgiveness was granted to compensate our company for assuming operations and absorbing losses on certain nursing facilities that LTC and our company agreed should be, and subsequently were, closed.

Cumulatively, the above transactions reduced our indebtedness to LTC by approximately $21,485,000 during 2001 (not including the $7,000,000 Note).

All of the aforementioned transactions between our company and LTC were approved by the respective disinterested and/or independent members of the Board of Directors of each company.  All interested or non-independent Board members abstained from any such vote.

During 2001, we purchased from LTC 191,200 shares of our common stock for approximately $246,000, which was the market value of the stock on the date of trade.  These shares are included in treasury shares on our balance sheet.

LTC had provided our company with a $20,000,000 secured line of credit that bears interest at 10.0% and matures April 1, 2008.  Effective October 1, 2002, our company and LTC amended the secured line of credit extended by LTC to our company.  The amendment reduced the line from $20,000,000 to $10,000,000 and added certain restrictions to the use of funds drawn under the agreement.  The secured line of credit continues to bear interest at 10.0%, mature on April 1, 2008, and contain a provision for acceleration should there be a change of control our company.  As of December 31, 2002, $5,813,000 was outstanding under the secured line of credit.  For the year ended December 31, 2002, our company recorded $541,000 of interest expense related to the secured line of credit with LTC.  On March 17, 2003, we drew an additional $950,000 on the secured line of credit.

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At inception, our company and LTC entered into an administrative services agreement under, which, LTC would provide us management and administrative services.   In exchange for those services, we were required to pay LTC 25% of the aggregate amount of all wages, salaries, bonuses, and rent for its corporate offices paid by LTC each month.  The administrative services agreement had a term of ten years but could be terminated either by LTC or our company at any time upon 30 days’ prior written notice to the other party or upon a change of control of LTC.  The administrative services agreement was suspended with an effective date of January 1, 2000.  Pursuant to an intercompany agreement, our company has agreed not to engage in activities or make investments that involve real estate, unless it has first provided written notice to LTC of the material terms and conditions of such activities or investments, and LTC has determined not to pursue such activities or investments either by providing written notice to us rejecting the opportunity within ten days following the date of receipt of notice of the opportunity or by allowing such ten-day period to lapse.  Pursuant to the intercompany agreement, our company and LTC also agreed to notify each other of, and make available to each other, investment opportunities, which they develop or of which they become aware but are unable or unwilling to pursue.  We also agreed not to prepay or cause to be prepaid any of our mortgage loans originated by LTC which were securitized by LTC in REMIC transactions.  We no longer have any such debt covered by this agreement.  The intercompany agreement has a term of ten years and expires in 2008 but shall terminate earlier upon a change of control of LTC.

Our company and LTC have adopted policies and procedures to be followed by the Board of Directors of each company to limit the involvement of such officers and directors in conflict situations.  Such procedures include requiring the persons serving as directors of both companies to abstain from voting as directors with respect to matters that present a significant conflict of interest between the companies and will require approval of the disinterested directors of both companies with respect to the intercompany agreement and any administrative services agreement.  Whether or not a significant conflict of interest situation exists will be determined on a case-by-case basis depending on such factors as the dollar value of the matter, the degree of personal interest of any officers or directors in the matter and the likelihood that resolution of the matter has significant strategic, operational or financial implications for the business of our company and/or LTC.  The members of the Board of Directors of each company that do not have any potentially significant conflict of interest between the companies will determine whether a matter presents such a significant conflict.

Business Risk Factors

Potential investors should carefully consider the risks described below before making an investment decision in our company.  The risks and uncertainties described below are not the only ones facing our company and there may be additional risks that we do not presently know of or that we currently consider immaterial.  All of these risks could adversely affect our company’s business, financial condition, results of operations, and cash flows.

Going Concern. Management recognizes that the Company’s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to allow the Company to satisfy its obligations on a timely basis.  As a result of the Medicare program decreasing certain reimbursements as of October 1, 2002, the Company expects its revenues would decrease in 2003 by approximately $1,600,000 without a corresponding decrease in expenses.  Also, since August 18, 2001, the Company has been unable to obtain financially feasible insurance coverage for professional liability claims in the states of Texas and Florida.  At the same time, the Company has experienced an increase in the number of claims filed against the Company that would have generally been covered under such insurance.  Should any one or several of these claims develop into a significant obligation to the Company, the Company would not have the resources to pay such claim.

Currently, the Company is in discussions with LTC regarding the possible transfer of some or all of the twenty-three leased facilities to other operators.  These discussions include consideration LTC may be able to give the Company for leasehold improvements to the facilities as well as potential rent concessions.  See “Part II, Item 8 – FINANCIAL STATEMENTS - Note 1. Basis of Presentation and Note 3. – Transactions with LTC Properties, Inc.”

We have received a “going concern” opinion from our outside auditors. 

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Management would need to significantly reduce the amount of overhead of the Company should the Company and LTC agree to transfer some or all of the leased facilities to other operators.  At this time, the Company is unable to make an estimate of the cost or the potential savings of such a reorganization of the Company.

There can be no assurances that even with a restructuring of the Company’s overhead and reduction of facilities under lease, the Company will continue to be viable. 

Currently, the Company has no other external sources of financing and the Company has not received any other commitment with respect to any funds needed in the future.  The Company does not know when it could expect to be able to access capital markets or to seek other financing and there can be no assurance that it will be able to do so at all or in amounts or on terms acceptable to the Company. 

Some Potential Losses are not Covered by Insurance.    Our company is required, as the lessee of the properties we operate, to secure adequate comprehensive property and liability insurance. During 1999, and 2000, our company had purchased traditional occurrence-based indemnity insurance for our general, professional, and auto and workers compensation liabilities.  In addition, we had purchased traditional indemnity property insurance for the nursing facilities we operate. Since March 18, 2001, we have been able to purchase insurance coverage for general and professional liability on a claims-made basis in every state except for Texas and Florida.  We ceased all operations in Florida in August 2001.  All other coverage for property, autos and workers compensation is still in effect.  We have been advised by our insurance broker, that due to the regulatory and litigation environments in the state of Texas, there was no insurance company willing to provide acceptable coverage to our company. At this time our company and our broker are continuing to seek appropriate coverage for general and professional liability for operations in Texas.  Certain risks may, however, be uninsurable or not economically insurable and it is likely that our company will not have adequate funds to cover all contingencies.  There can be no assurance that we will be able to find acceptable coverage in the near future for Texas.  We have notified LTC, who is the owner of our leased properties in the state of Texas regarding this lapse in coverage.

The Healthcare Industry is Heavily Regulated by the Government.  Operators of nursing facilities are subject to extensive regulation by federal, state and local governments.  These laws and regulations are subject to frequent and substantial changes resulting from legislation, adoption of rules and regulations, and administrative and judicial interpretations of existing law.  These changes may have a dramatic effect on the definition of permissible or impermissible activities, the relative costs associated with doing business and the amount of reimbursement by both government and other third-party payers.  These changes may be applied retroactively.  The ultimate timing or effect of these changes cannot be predicted.  Our company’s failure to comply with such laws, requirements, and regulations could affect our ability to operate our nursing facilities.

Our Company Relies on Government and Third Party Reimbursement. A significant portion of our revenue is derived from government-funded reimbursement programs, such as Medicare and Medicaid.  Because of significant healthcare costs paid by such government programs, both federal and state governments have adopted and continue to consider various healthcare reform proposals to control healthcare costs.  In recent years, there have been fundamental changes in the Medicare program, which resulted in reduced levels of payment for a substantial portion of healthcare services.  In many instances, revenues from the Medicare and Medicaid programs are already insufficient to cover the actual costs incurred in providing care to those patients. Moreover, healthcare facilities have experienced increasing pressures from private payers attempting to control healthcare costs, and reimbursement from private payers has in many cases effectively been reduced to levels approaching those of government payers.

Governmental and public concern regarding healthcare costs may result in significant reductions in payment to healthcare facilities, and there can be no assurance that future payment rates for either governmental or private payers will be sufficient to cover cost increases in providing services to our residents.  Any changes in reimbursement policies, which reduce reimbursement to levels that are insufficient to cover the cost of providing patient care could adversely affect our revenues.

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Our Company’s Facilities are Subject to Licensing, Certification and Accreditation.  In addition to the requirements to be met by nursing facilities for participation in the Medicare and Medicaid programs, nursing facilities are subject to regulatory and licensing requirements of federal, state and local authorities.  The operator of each nursing facility is licensed annually by the board of health or other applicable agency in each state.  In granting and renewing licenses, regulatory agencies consider, among other things, the physical buildings and equipment, the qualifications of the administrative personnel and nursing staff, the quality of care and continuing compliance with the laws and regulations relating to the operation of the facilities.  State licensing of facilities is a prerequisite to certification under the Medicare and Medicaid programs.  In the ordinary course of business, operators receive notices of deficiencies for failure to comply with various regulatory requirements and take appropriate corrective and preventive actions. 

Failure to obtain licensure or loss of licensure would prevent a nursing facility from operating.  Failure to maintain certification in the Medicare and Medicaid programs would result in a loss of funding from those programs. Although accreditation is generally voluntary, loss of accreditation could result in a nursing facility not meeting eligibility requirements to participate in various reimbursement programs.  These events could adversely affect our company’s operations. 

In addition to licensing requirements, state and local laws may regulate expansion, including the addition of new beds or services or acquisition of medical equipment, and occasionally the contraction of health care facilities by requiring certificate of need or other similar approval programs.  States vary in their utilization of these programs. In addition, health care facilities are subject to the Americans with Disabilities Act and building and safety codes which govern access, physical design requirements for facilities, and building standards.

Nursing facilities are regulated primarily through state licensing and federal certification criteria established by federal law enacted as part of the Omnibus Budget Reconciliation Act of 1987.  Regulatory authorities and licensing standards vary from state to state, and in some instances from locality to locality.  These standards are constantly reviewed and revised.  Agencies periodically inspect nursing facilities, at which time deficiencies may be identified.  The nursing facilities must correct these deficiencies as a condition to continued licensing or certification and participation in government reimbursement programs, and may receive sanctions for noncompliance.  Depending on the nature of such deficiencies, remedies can be routine or costly, and sanctions can be modest or severe, up to revocation of a facility’s license or certification or closure of a nursing facility. Similarly, compliance with regulations that cover a broad range of areas such as patient’s rights, staff training, quality of life and quality of resident care may increase facility start-up and operating costs.

Regulations Have Been Adopted to Eliminate Fraud and Abuse.  There are various federal and state laws prohibiting fraud by healthcare providers, including criminal provisions, which prohibit filing false claims or making false statements to receive payment or certification under Medicare and Medicaid, or failing to refund overpayments or improper payments.  Violation of these federal provisions is a felony punishable by up to five years imprisonment and/or $25,000 fines.  Civil provisions prohibit the knowing filing of a false claim or the knowing use of false statements to obtain payment.  The penalties for such a violation are fines of not less than $5,500, nor more than $11,000, plus treble damages, for each claim filed.

There are also laws that govern referrals and financial relationships.  The federal Anti-Kickback Law prohibits, among other things, the offer, payment, solicitation, or receipt of any form of remuneration in return for, or to induce, the referral of Medicare and Medicaid patients.  A wide array of relationships and arrangements, including ownership interests in a company by persons who refer or who are in a position to refer patients, as well as personal services agreements, have under certain circumstances, been alleged or been found to violate these provisions.  In addition to the Anti-Kickback Statute, the federal government restricts certain financial relationships between physicians and other providers of healthcare services.

State and federal governments are devoting increasing attention and resources to anti-fraud initiatives against healthcare providers.  The HIPAA of 1996 and the BBA of 1997 expand the penalties for healthcare fraud, including broader provisions for the exclusion of providers from the Medicare and Medicaid programs.

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Although HIPAA was intended ultimately to reduce administrative expenses and burdens faced within the healthcare industry, we believe the law could initially bring about significant and, in some cases, costly changes.  HHS has released two rules to date mandating the use of new standards with respect to certain healthcare transactions and health information.  The first rule requires the use of uniform standards for common healthcare transactions, including healthcare claims information, plan eligibility, referral certification and authorization, claims status, plan enrollment and disenrollment, payment and remittance advice, plan premium payments, and coordination of benefits.

Second, HHS has released new standards relating to the privacy of individually identifiable health information. These standards not only require our compliance with rules governing the use and disclosure of protected health information, but they also require entities to impose those rules, by contract, on any business associate to whom such information is disclosed.

Third, on February 20, 2003, HHS issued final rules governing the security of health information. This rule specifies a series of administrative, technical, and physical security procedures covered entities must use to assure the confidentiality of electronic protected health information.

HHS finalized the new transaction standards on August 17, 2000, and covered entities, such as our company, originally were required to comply with the new standards by October 16, 2002.  Congress passed legislation in December 2001 that delayed the compliance date for one year (until October 16, 2003), but only for entities that submit a compliance plan to HHS by the original implementation deadline, which we have done.  On February 20, 2003, HHS published certain modifications to the final transaction standards, but these changes do not affect the October 16, 2003 compliance deadline. The privacy standards were issued on December 28, 2000, and, after certain delays, became effective April 14, 2001, with a compliance date of April 14, 2003. The security standards are effective April 21, 2003, with a compliance date of April 21, 2005 for most covered entities. Sanctions for failing to comply with HIPAA include criminal penalties and civil sanctions.

We are aware of and are evaluating the effect of HIPAA. We cannot at this time estimate the cost of such compliance, nor estimate the cost of compliance with standards that have not yet been finalized.  The new and proposed health information standards are likely to have a significant effect on the manner in which our company handle health data and communicate with payers.  However, based on our current knowledge, we cannot currently estimate the cost of compliance or if there will be a material adverse effect on our business, financial condition, or results of operations as a result of our company experiencing increased costs for compliance.

Congress and the States Have Enacted Healthcare Reform Measures.  The healthcare industry is facing various challenges, including increased government and private payer pressure on healthcare providers to control costs. While the Bush Administration has proposed expanded funding for Medicare prescription drug coverage, it has stated that it intends to offset the cost of this benefit in part from savings from “overpayments” to other Medicare providers.

The Balanced Budget Act enacted significant changes to the Medicare and Medicaid programs designed to “modernize” payment and health care delivery systems while achieving substantial budgetary savings.  In seeking to limit Medicare reimbursement for long-term care services, Congress established the prospective payment system for skilled nursing facility services to replace the cost-based reimbursement system.  SNFs needed to restructure their operations to accommodate the new Medicare prospective payment system.  Since the SNF PPS was enacted, several publicly held operators of long-term care facilities have filed for reorganization under Chapter 11 of the federal bankruptcy laws. While at least two of the long-term care operators have emerged from bankruptcy, there can be no assurances given that 2003 and future years will not include additional bankruptcies of skilled nursing facility companies. While BIPA 2000 contained provisions that mitigated, to a certain extent, the effects of the Balanced Budget Act, many of these changes expired in October 2002. If Congress fails to take timely action to provide additional relief, or if it actually decreases Medicare reimbursement, SNFs could experience significant losses in revenue.

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In addition, there are numerous initiatives at the federal and state levels for comprehensive reforms affecting the payment for and availability of healthcare services.  Congress and state legislatures can be expected to continue to review and assess alternative healthcare delivery systems and payment methodologies.  Changes in the law, new interpretations of existing laws, or changes in payment methodology may have a dramatic effect on the definition of permissible or impermissible activities, the relative costs associated with doing business and the amount of reimbursement by the government and other third-party payers.

In light of forthcoming regulations and continuing state Medicaid program reform and budget cuts, no assurance can be given that the implementation of such regulations and reform will not have a material adverse effect on our financial condition, or results of operations. 

Our Company’s Facilities Rely on Experienced Labor.  The healthcare industry has experienced a shortage of experienced nurses and therapists to staff nursing operations in the past.  Our company is currently experiencing a nursing and/or therapist shortage in certain nursing facilities where it competes with other operators for nursing and therapy personnel.  A shortage of nursing or therapist personnel could cause us to pay higher salaries and employ higher cost temporary personnel that could adversely affect our operations.

Our Company Leases Twenty-four of the Facilities it Operates.  See “Item 8. – FINANCIAL STATEMENTS – Note 3. – Transactions with LTC Properties, Inc.”  As of March 1, 2003, our company operates 23 facilities that are owned by LTC. The current leases for the nursing facilities owned by LTC are under individual six-year leases, which expire on December 31, 2007, with aggregate annual base rents for 2002, 2003, 2004, 2005, 2006 and 2007 of $3,000,000, $4,000,000, $4,750,000, $5,350,000, $5,900,000, and $6,500,000, respectively.  The leases contain two five-year renewal options with increases of 2.0% annually.  These leases have a provision for acceleration should there be a change of control, as defined in the leases, of our company.  Our company operates one other nursing facility under a long-term operating lease, which expires in 2007.  The economic performance of these nursing facilities’ operations can be affected by many factors including governmental regulation, economic conditions, and demand for health care services.  In the event our operations are adversely affected, we will continue to be liable for rent payments due under these leases.

Scheduled Debt Payments Could Adversely Affect Our Company’s Financial Condition.  We are subject to risks normally associated with debt financing, including the risks that it will be unable to refinance existing indebtedness  (which will not have been fully amortized at maturity) and that the terms of refinancing will not be as favorable as the terms of existing indebtedness.

Our Company Is Unable to Obtain External Sources of Capital.  Our company currently does not have access to third-party sources of capital other than our line of credit with LTC.  See “Relationship with LTC Properties, Inc.” above.

Certain of Our Company’s Executive Officers and Board Members have been or are also Executive Officers and
Board Members of LTC Properties.

Conflicts of Interest May Arise in Interpretations of Intercompany Agreements Between Our Company and LTC Properties. Our company and LTC entered into an intercompany agreement and an administrative services

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agreement on September 30, 1998. The administrative services agreement was suspended as of January 1, 2000. Because LTC owned nonvoting common stock of our company (representing approximately 99% of the outstanding shares of our common stock) at the time the agreements were entered into, such agreements were not negotiated at arms-length and may have included terms, which are not as favorable as would have been derived from arms-length negotiations.  Moreover, because our management has been and is largely the same as LTC’s  management, conflicts may have arisen with respect to the operation and effect of intercompany agreements and relationships, which could have an adverse effect on our company if not properly resolved.  Overlapping members of the board of directors and senior management of both companies may be presented with conflicts of interest with respect to matters affecting our company and LTC, such as the determination of which company may take advantage of potential business opportunities, decisions concerning the business focus of each company, potential competition between the business activities conducted, or sought to be conducted, by such companies, possible corporate transactions (such as acquisitions and leasing of facilities), and other strategic decisions affecting the future of such companies.

The following table sets forth certain information regarding the nursing facilities operated by our company as of March 1, 2003:

Our company is required, as the lessee of the properties we operate, to secure adequate comprehensive property and liability insurance. During 1999 and 2000, our company had purchased traditional occurrence-based indemnity insurance for our general, professional, and auto and workers compensation liabilities.  In addition, our company had purchased traditional indemnity property insurance for the nursing facilities it operates.  Since March 18, 2001, our company has been able to purchase insurance coverage for general and professional liability on a claims-made basis in every state except for Texas and Florida.  Our company ceased all operations in Florida in August 2001.  All other coverage for property, autos and workers compensation is still in effect.  Our company has been advised by its insurance broker that due to the regulatory and litigation environments in the state of Texas, there was no insurance company willing to provide financially feasible, acceptable coverage to our company. At this time our company and its broker are continuing to seek appropriate coverage for general and professional liability for operations in Texas.  Certain risks may, however, be uninsurable or not economically insurable and there can be no assurance our company will have adequate funds to cover all contingencies.   There can be no assurance that our company will be able to find acceptable coverage in the near future for Texas.  Our company has notified LTC, its landlord in the state of Texas regarding this lapse in coverage.  See “Item 8 – FINANCIAL STATEMENTS – Note 1. – Basis of Presentation.”  At December 31, 2002, and December 31, 2001, our company had a reserve for general and professional liability risks of $11,946,000 and $3,866,000, respectively.  These reserves include the company’s estimate, based on an actuarial

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analysis, of potential uninsured exposure in Texas and Florida and the company’s actuarial based estimate of exposure outside of the insured policy coverage. 

Our company is a party to various legal proceedings related to operations of its nursing facilities.  Our company analyzes all claims against it and vigorously defends those claims.  Our company attempts to resolve all claims in a manner that is in the best interest of our company.  Given the current litigation environment and unpredictability of jury trials, the existing claims could develop in a way which may present a material adverse affect on the Company’s financial position, results of operations or liquidity.  Based on our company’s insurance for those claims for which insurance exists and our company’s allowance for general and professional liability risk in an amount determined for reported claims and the incurred but not reported claims, management believes, at this time, that the existing claims may present a material adverse affect on our company’s financial position and such claims could have a material adverse effect on liquidity.  Such analysis and allowance is based on past experiences and estimates, while management, at this time, believes the provision for any loss is adequate, the ultimate liability may be in excess of or less than the amounts recorded.  

The Texas Health and Safety Code § 242.0372 requires as a condition of licensure for a nursing facility to maintain professional liability insurance.  The statute takes effect September 1, 2003, and requires that the coverage limits be in the minimum amount of $1,000,000 per occurrence and $3,000,000 aggregate; be written on a claims made basis; be issued by either an admitted insurer, the Texas Medical Liability Insurance Underwriting Association or an eligible surplus lines insurer.  Our company interprets the Texas Health and Safety Code coverage limits as per facility requirements and our company currently operates seven facilities in the state of Texas.  The Texas Legislature has entered into its 2003 session and it is expected to review this statute.

Currently, we have been unable to obtain financially feasible professional liability insurance coverage in the state of Texas.  Our company is unable at this point in time to determine if in the future it will be able to obtain professional liability insurance coverage, which meets the conditions of licensure effective September 1, 2003.

If the legislature does not repeal or amend the current professional liability insurance requirements as a condition of licensure, it is possible that the state could revoke the licenses of the facilities located in Texas and our company could no longer operate the facilities and we would be in default of its leases with LTC and as the landlord LTC, could impose all of its rights and remedies under the leases including the potential termination the leases (resulting in the loss to our company of the ability to operate the facilities) and assertion of leasehold damages against our company.

If our company were not able to obtain professional liability insurance coverage in the state of Texas and as a result could no longer operate its Texas facilities, it would have a material adverse effect on our company’s financial position, results of operations and liquidity.

Our company is subject to civil monetary penalties, admission restrictions and actions against the facilities’ licenses resulting from periodic surveys at our nursing facilities and facilities under management.  Penalties of approximately $1,038,000 have been asserted and are unresolved as of December 31, 2002, and we have pursued adjustments and appeals of these assessments.  Our policy is to accrue for these civil monetary penalties in the accounting period in which a loss is deemed to be probable and the amount is reasonably determinable, based on historical experience.  At December 31, 2002, we accrued approximately $702,000 for these potential penalties based on our experience.  Our company also is taking action to cure deficiencies and pursuing relief from any admission restrictions and other administrative actions.  It is the opinion of management that the ultimate resolution of these contingencies, to the extent not provided for, will not have a material effect on the financial condition of our company.

The state of Texas has amended regulation 19.2115, which now allows nursing facilities to ameliorate certain violations or improve services, excluding administrative services, using part or all of the money collected on the administrative penalty.  Our company is and intends to apply for amelioration of all previous and future administrative penalties, which meet the qualifications of the amended regulation 19.2115.

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None

Andre C. Dimitriadis has been the Chairman, Chief Executive Officer and Director of our company since its formation in 1998.  He was President from July 2000 to December 2001.  Mr. Dimitriadis founded LTC Properties, Inc. in 1992 and has been Chairman and Chief Executive Officer since its inception.  Mr. Dimitriadis is also a member of the Board of Magellan Health Services, Assisted Living Concepts, Inc. and Ribapharm, Inc.

Christopher T. Ishikawa has been the President and Chief Operating Officer since December 2001 and Executive Vice President and Chief Operating Officer from 1999 through November 2001 and a Director since 2000.  From our company’s formation in 1998 until 1999, he also served as Senior Vice President and Chief Investment Officer.  He has also served as LTC’s Executive Vice President and Chief Investment Officer since February 2001 and Senior Vice President and Chief Investment Officer since 1997.  Prior to that, he served as Vice President and Treasurer of LTC since April 1995.

Kimberly A. Daugherty has been General Counsel since November 2002.  Prior to that she served as Assistant General Counsel for Centers for Long Term Care, Inc. since October 2000.  Ms. Daugherty served as Legal Counsel for Cantex Healthcare Centers from 1998 to 1999 and Assistant Counsel-Operations of Horizon/CMS, Inc in 1997.

Andrew M. Kerr has been Chief Financial Officer since March of 2003.  He had served as Vice President and Controller since October 2000.  Prior to that, he served as Vice President and Corporate Controller for Specialty Healthcare Services from December 1997 through September 2000.  Prior to joining Specialty Healthcare Services, Mr. Kerr was Regional Chief Financial Officer for Transitional Hospitals Corporation from August 1995 to November 1997.  Mr. Kerr was elected to the Board in November 2001.

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