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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20459
FORM 10-K
(Mark One)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-13498
ASSISTED LIVING CONCEPTS, INC.
(Exact name of registrant as specified in its charter)
Nevada 93-1148702
(State or other jurisdiction (IRS EmployerIdentification No.)
ofincorporation or organization)
11835 N.E. Glenn Widing Drive, Building E
Portland, OR 97220-9057
(503) 252-6233
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
Securities Registered Pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
- ------------------- -----------------------
Common Stock, par value $.01 American Stock Exchange
6% Convertible Subordinated Debentures Due November
2002 American Stock Exchange
5.625% Convertible Subordinated Debentures Due May
2003 American Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act:
None.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for at least the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K: [_]
The Registrant had 17,171,077 shares of common stock, $.01 par value,
outstanding at May 31, 1999. The aggregate market value of the voting stock
held by non-affiliates of the registrant on such date was approximately $49.4
million.
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PART I
References in this report to "ALC," the "Company," "us" or "we" refer to
Assisted Living Concepts, Inc. and its subsidiaries.
ITEM 1. Business
Overview
We operate, own, lease and develop free-standing assisted living residences.
These residences are primarily located in small middle-market rural and
suburban communities with a population typically ranging from 10,000 to
40,000. As of June 30, 1999 we had operations or development activities in
five regions in 16 states.
We also provide personal care and support services and make available
routine nursing services (as permitted by applicable regulations) designed to
meet the health care needs of our residents. We believe that this combination
of residential, personal care, support and health care services provides a
cost-efficient alternative and affords an independent lifestyle for
individuals who do not require the broader array of medical services that
nursing facilities are required by law to provide.
We have experienced significant and rapid growth, primarily through the
development of assisted living residences and, to a much lesser extent,
through acquisitions of residences. When we completed our initial public
offering in November 1994 we had a base of five residences (137 units). As of
June 30, 1999, we had 175 assisted living residences in operation representing
an aggregate of 6,741 units. Of these residences, we owned 105 residences
(4,123 units) and leased 70 residences (2,620 units). For the three months
ended June 30, 1999, our 127 Stabilized Residences (those residences that had
been operating for twelve months prior to the beginning of the period or had
achieved 95.0% occupancy within the first twelve months of operations) had an
average occupancy rate of approximately 83.9% and an average monthly rental
rate of approximately $1,860 per unit. Our 175 residences in operation during
the three months ended June 30, 1999 had an average occupancy rate of
approximately 74.3% and an average monthly rental rate of approximately $1,881
per unit.
We are currently developing and, to a lesser extent, seeking to acquire
additional assisted living residences in Indiana, Michigan, New Jersey, Iowa,
Arizona, Georgia, and South Carolina. As of June 30, 1999, we had six
residences with 245 units that had received certificates of occupancy but were
not yet operating. In addition, we had four residences with 156 units that
were under construction as of the same date. We also owned land for
development of 10 sites, including three for expansion projects, where
construction had not yet commenced. We have significantly reduced our
development activity in 1999 in order to focus on stabilizing our current base
of operating residences. We wrote-off approximately $2.4 million in fiscal
year 1998 and $4.8 million through June 30, 1999 primarily associated with
sites which we will no longer seek to develop. For the twelve months ended
December 31, 1998, we commenced operations with respect to 57 residences
(2,297 units). We intend to commence operation on an additional 20 residences
(800 units) for the comparable period in 1999, 10 of which commenced operation
through June 30, 1999. In addition to the development and construction costs
incurred during 1998 with respect to these residences, we expect to incur up
to an additional $30.0 million in capital expenditures and related start-up
costs for the twelve months ended December 31, 1999, approximately $25.0
million of which had been incurred as of June 30, 1999.
We have significantly reduced development activity in order to focus on our
core business of operating our existing residences. The principal elements of
our business strategy are to:
. increase occupancy and improve operating efficiencies at our existing
base of residences;
. expand market penetration in existing markets;
. serve higher-acuity residents; and
. pursue strategic business alliances.
2
We anticipate that revenues at a majority of our residences will continue to
come from private pay sources. However, we believe that locating residences in
states with favorable regulatory and reimbursement climates should provide a
stable source of residents eligible for Medicaid reimbursement to the extent
that private pay residents are not available and, in addition, provide our
private pay residents with alternative sources of income when their private
funds are depleted and they become Medicaid eligible.
Assisted Living Concepts, Inc. is a Nevada corporation. Our principal
executive offices are located at 11835 N.E. Glenn Widing Drive, Building E,
Portland, Oregon 97220-9057, and our telephone number is (503) 252-6233.
Recent Developments
Restatement of Historical Financial Statements
On February 1, 1999, we announced that after consultation with our
independent auditors we would restate our financial statements for the fiscal
quarter ended June 30, 1997, the fiscal quarter ended September 30, 1997, the
fiscal year ended December 31, 1997, the fiscal quarter ended March 31, 1998,
the fiscal quarter ended June 30, 1998 and the fiscal quarter ended September
30, 1998. On March 31, 1999, we announced that the restatement would be more
extensive than we had previously believed, and might include periods prior to
the second quarter of 1997, including the fiscal year ended December 31, 1996.
After further consultation with our independent auditors, we determined to
restate our financial statements for the fiscal year ended December 31, 1996,
the fiscal year ended December 31, 1997 and each of the first three fiscal
quarters of the fiscal year ended December 31, 1998.
The restatement resulted primarily from:
. the earlier recognition of certain expenses that we previously
capitalized in connection with our development and financing activities;
. a modification in how we accounted for certain of our lease
arrangements;
. a modification in how we accounted for certain of our acquisitions and
joint venture agreements;
. the capitalization of fees we received during 1997 and 1998 that we
previously recorded as a reduction of expenses or other income;
. the elimination of an impairment write-down that we had previously
recorded on three of our residences;
. the elimination of certain accrued expenses previously recorded pursuant
to a change in accounting principle; and
. an increase in the amount of goodwill that we wrote-off in the second
quarter of 1998 relating to exiting our home health operations.
The overall effect of the restatement on net income and net income per share
in each of the periods subject to the restatement is illustrated in the
following table:
As previously reported As restated
--------------------------------- -----------------------
Net Income
(Loss) Per
Share Net Loss
--------------- Per Basic and
Period Net Income (Loss) Basic Diluted Net Loss Diluted Share
------ ----------------- ------ ------- -------- -------------
(in thousands, except per share data)
Year ended 12/31/96..... $ 149 $ 0.02 $ 0.01 $ (1,915) $(0.23)
Year ended 12/31/97..... $ 4,209 $ 0.35 $ 0.34 $ (2,479) $(0.21)
Quarter ended
3/31/98(1)............. $ 1,906 $ 0.12 $ 0.12 $ (784) $(0.05)
Quarter ended 6/30/98... $(4,378) $(0.28) $(0.28) $(11,831) $(0.75)
Quarter ended 9/30/98... $ 2,722 $ 0.16 $ 0.16 $ (720) $(0.04)
(1) Net income and net income per share, as previously reported for the
quarter ended March 31, 1998, do not reflect the cumulative effect of
the change in accounting principle which was adopted during the quarter
ended June 30, 1998, effective January 1, 1998.
3
Termination of Merger Agreement
On February 1, 1999, we agreed with American Retirement Corporation ("ARC")
to terminate our previously announced merger agreement, which had been entered
into during November 1998. We recorded a charge of approximately $1.1 million
in the fourth quarter of 1998, and $200,000 the first quarter of 1999 for
expenses incurred related to the terminated merger.
Securityholder Litigation
Since February 1, 1999 12 separate complaints, which have been consolidated
into one action, have been filed against us and certain of our officers and
directors on behalf of purchasers of our common stock, 6.0% Convertible
Subordinated Debentures (the "6.0% Debentures") and 5.625% Convertible
Subordinated Debentures (the "5.625% Debentures" and, together with the 6.0%
Debentures, the "Debentures") in the United States District Court for the
District of Oregon. On July 23, 1999, a consolidated complaint was filed in
connection with this litigation naming as additional defendants certain of our
directors that were not named previously, as well as our independent auditors
(solely in connection with our 1998 offering of 5.625% Debentures) and the
underwriters in connection with our October 1997 offering of 6.0% Debentures.
See Item 3 (Legal Proceedings) for information regarding this litigation.
Termination of Joint Venture Agreements
During fiscal years 1997 and 1998, we entered into joint venture agreements
with respect to the operation of certain start-up residences pursuant to which
90% of the operating risks and rewards related to such residences were
allocated to the joint venture partner, in which we had an interest. We
consolidated the operations of the joint venture agreements in our financial
statements. The joint venture partner reimbursed us for 90% of the start-up
losses of the joint venture residences incurred in the second quarter of 1997
and through the third quarter of 1998, and we recognized such reimbursements
as other income in our financial statements during such quarters. We have
determined to restate such loss reimbursements as loans, rather than other
income. We also have reflected amounts paid to repurchase the joint venture
partner's interest in the operations of the joint venture residences in excess
of reimbursed losses as interest and other expense.
During the first quarter of 1999, we negotiated with the joint venture
partner to acquire, for $3.8 million, all of such partner's remaining
interests in the operations of the remaining 17 residences subject to joint
venture agreements through the third quarter of 1998. The joint venture
partner did not reimburse us for any start-up losses, nor have we entered into
any new joint venture agreements with respect to the operation of start-up
residences, subsequent to the third quarter of 1998.
Management Changes
On March 16, 1999, our board of directors announced the appointment of Dr.
Keren Brown Wilson, our co-founder, as our President and Chief Executive
Officer. The board also announced the appointment of Leslie J. Mahon as Vice
President and Chief Operating Officer and James W. Cruckshank as Vice
President and Chief Financial Officer. As of March 16, 1999, we also entered
into a consulting agreement with William McBride, pursuant to which Mr.
McBride agreed to provide us with consulting services and to resign from his
position as our Chief Executive Officer, and amended Dr. Wilson's existing
employment agreement. The terms of these agreements are summarized in Item 11.
On March 31, 1999, we announced the resignation of Mr. McBride as Chairman
of the Board of Directors and the election by the board of Richard C. Ladd as
Interim Chairman. We also announced that Mr. McBride had decided not to seek
reelection to the board of directors at the next annual meeting.
In April 1999, we announced the increase in the number of board members from
five to six and the election by the board of Jill Krueger to serve as a
director and as chairman of our Audit Committee.
4
Amendments to Certain Leases
In March 1999, we amended 16 leases with a single lessor. Prior to the
amendment the leases were accounted for as financings due to our continuing
involvement in the residences in the form of a fair market value purchase
option. The amendments resulted in the reclassification of such leases from
financings to operating leases.
In June 1999, we amended all of our 37 leases with another lessor. These
amendments restructured provisions related to future minimum annual rent
increases, or "rent escalators," which prior to the amendments required us to
account for rent expense related to such leases on a straight-line basis. From
the date of the amendment forward, we will account for the amended leases on a
contractual cash payment basis and amortize the deferred rent balance as of
the date of the amendment over the remaining initial terms of the lease. Those
amendments also redefined the lease renewal option with respect to certain
leases and provided the lessor with the option to declare an event of default
in the event of a change of control under certain circumstances. In addition,
the amendments also provide us with the ability, subject to certain
conditions, to sublease or assign our leases with respect to two Washington
residences.
Write-off Related to Reduced Development Activity
As a result of a continued reduction in our new residence development
activities, we will incur write-offs of $1.3 million relating to previously
capitalized development costs during the first quarter of 1999 and an
additional $3.5 million in the second quarter of 1999. In the event that in
the future we do not complete and open residences planned for development, we
may incur similar write-offs. However, we have no present intention of
commencing further development activity beyond the 10 residences currently
included in construction in process as of June 30, 1999.
Amendment of Loan Agreements
During the third quarter of 1999, we amended certain loan agreements with
one of our creditors. Pursuant to the amendment, we agreed to provide $8.3
million of additional cash collateral in exchange for the forbearance or
waiver of certain possible defaults, including an amendment to certain
financial covenants. The amendment provides for the release of the additional
collateral upon the achievement of specified performance targets, provided
that we are in compliance with the other terms of the loan agreements.
Services
Our residences offer residents a supportive, "home-like" setting and
assistance with activities of daily living. Residents are individuals who, for
a variety of reasons, cannot live alone but do not typically need the 24-hour
skilled medical care provided in nursing facilities. We design services
provided to these residents to respond to their individual needs and to
improve their quality of life. This individualized assistance is available 24
hours a day, to meet both anticipated and unanticipated needs, including
routine health-related services, which are made available and are provided
according to the resident's individual needs and state regulatory
requirements. Available services include:
. General services, such as meals, laundry and housekeeping;
. Support services, such as assistance with medication, monitoring health
status and transportation; and
. Personal care, such as dressing, grooming and bathing.
We also provide or arrange access to additional services beyond basic
housing and related services, including physical therapy and pharmacy
services.
Although a typical package of basic services provided to a resident includes
meals, housekeeping, laundry and personal care, we do not have a standard
service package for all residents. Instead, we are able to accommodate the
changing needs of our residents through the use of individual service plans
and flexible staffing
5
patterns. Our multi-tiered rate structure for services is based upon the
acuity of, or level of services needed by, each resident. Supplemental and
specialized health-related services for those residents requiring 24-hour
supervision or more extensive assistance with activities of daily living are
provided by third-party providers who are reimbursed directly by the resident
or a third-party payor (such as Medicaid or long-term care insurance). We
assess the level of need of each resident regularly.
Operations
Each residence has an on-site program director who is responsible for the
overall day-to-day operation of the residence, including quality of care,
marketing, social services and financial performance. The program director is
assisted by professional and non-professional personnel, some of whom may be
independent providers or part-time personnel, including nurses, personal
service assistants, maintenance and kitchen personnel. The nursing hours vary
depending on the residents' needs. We consult with outside providers, such as
registered nurses, pharmacists, and dietitians, for purposes of medication
review, menu planning and responding to any special dietary needs of
residents. Personal service assistants who primarily are full-time employees
are responsible for personal care, dietary services, housekeeping and laundry
services. Maintenance services are performed by full and part-time employees.
We have established an infrastructure that includes five regional
operational managers who oversee the overall performance and finances of each
region, operations managers who oversee the day-to-day operations of up to 10
to 12 residences, and team leaders who provide peer support for up to three to
four residences. Presently, residence personnel also are supported by
corporate staff based at our headquarters. Corporate and regional personnel
work with the program directors to establish residence goals and strategies,
quality assurance oversight, development of Company policies and procedures,
government relations, marketing and sales, community relations, development
and implementation of new programs, cash management and treasury functions,
and human resource management.
Competition
The long-term care industry generally is highly competitive. We compete with
other assisted living providers, including an increasing number of hospitals
offering assisted living, and with numerous other companies providing similar
long-term care alternatives, such as home health agencies, life care at home,
community-based service programs, retirement communities and convalescent
centers. We expect that, as assisted living receives increased attention and
the number of states which include assisted living in their Medicaid programs
increases, competition will grow from new market entrants, including publicly
and privately held companies focusing primarily on assisted living. Nursing
facilities that provide long-term care services are also a potential source of
competition for us. Providers of assisted living residences compete for
residents primarily on the basis of quality of care, price, reputation,
physical appearance of the facilities, services offered, family preferences,
physician referrals and location. Some of our competitors operate on a not-
for-profit basis or as charitable organizations. Some of our competitors are
significantly larger than us and have, or may obtain, greater resources than
ours. While we generally believe that there is moderate competition for less
expensive segments of the private market and for Medicaid residents in small
communities, we have seen an increase in competition in certain of our
markets. Our major competitors are other long-term care facilities, including
assisted living facilities within the same geographic area as our residences
because our experience indicates that senior citizens who move into long-term
care communities frequently choose communities near their homes.
We believe that the rapid growth of the assisted living industry has
resulted in an oversupply of assisted living residences in certain of our
markets. Recently, we have experienced slower fill-up of Start-Up Residences
in these markets than expected, as well as declining occupancy in our
Stabilized Residences due to the increase in options available to potential
new residents when units are vacated. There can be no assurance that we will
be able to compete effectively in those markets where overbuilding exists, or
that future overbuilding in other markets where we have opened or plan to open
residences will not adversely affect our operations.
6
Funding
Assisted living residents or their families generally pay the cost of care
from their own financial resources. Depending on the nature of an individual's
health insurance program or long-term care insurance policy, the individual
may receive reimbursement for costs of care under an "assisted living,"
"custodial" or "alternative care benefit." Government payments for assisted
living have been limited. Some state and local governments offer subsidies for
rent or services for low-income elders. Others may provide subsidies in the
form of additional payments for those who receive Supplemental Security Income
(SSI). Medicaid provides coverage for certain financially or medically needy
persons, regardless of age, and is funded jointly by federal, state and local
governments. Medicaid contracts for assisted living vary from state to state.
Although a majority of our revenues come from private payors, the cost
structure of the residences has historically been, and is expected to continue
to be, sufficiently low so that the residences are able to operate profitably
if all of their revenues are derived through Medicaid contracts.
In 1981, the federal government approved a Medicaid waiver program called
Home and Community Based Care which was designed to permit states to develop
programs specific to the healthcare and housing needs of the low-income
elderly eligible for nursing home placement (a "Medicaid Waiver Program"). In
1986, Oregon became the first state to use federal funding for licensed
assisted living services through a Medicaid Waiver Program authorized by the
Health Care Financing Administration ("HCFA"). Under a Medicaid Waiver
Program, states apply to HCFA for a waiver to use Medicaid funds to support
community-based options for the low-income elderly who need long-term care.
These waivers permit states to reallocate a portion of Medicaid funding for
nursing facility care to other forms of care such as assisted living. In 1994,
the federal government implemented new regulations which empowered states to
further expand their Medicaid Waiver Programs and eliminated restrictions on
the amount of Medicaid funding states could allocate to community-based care,
such as assisted living. A limited number of states including Oregon, New
Jersey, Texas, Arizona, Nebraska, Florida and Washington currently have
operating Medicaid Waiver Programs that allow them to pay for assisted living
care. Without a Medicaid Waiver Program, states can only use federal Medicaid
funds for long-term care in nursing facilities.
During the years ended December 31, 1996, 1997 and 1998, direct payments
received from state Medicaid agencies accounted for approximately 12.4%, 11.1%
and 10.7%, respectively, of our revenue while the tenant-paid portion received
from Medicaid residents accounted for approximately 6.9%, 5.9% and 5.8%,
respectively, of our revenue during these periods. We expect in the future
that state Medicaid reimbursement programs will continue to constitute a
significant source of our revenue.
Government Regulation
Our assisted living residences are subject to certain state statutes, rules
and regulations, including those which provide for licensing requirements. In
order to qualify as a state licensed facility, our residences must comply with
regulations which address, among other things, staffing, physical design,
required services and resident characteristics. As of May 31, 1999, we had
obtained licenses in Oregon, Washington, Idaho, Nebraska, Texas, Arizona,
Iowa, Louisiana, Ohio, New Jersey, Pennsylvania, Florida, Michigan and South
Carolina. We are not subject to state licensure requirements in Indiana and we
expect that we will obtain licenses in other states as required. Our
residences are also subject to various local building codes and other
ordinances, including fire safety codes. These requirements vary from state to
state and are monitored to varying degrees by state agencies.
As a provider of services under the Medicaid program in the United States,
we are subject to Medicaid fraud and abuse laws, which prohibit any bribe,
kickback, rebate or remuneration of any kind in return for the referral of
Medicaid patients, or to induce the purchasing, leasing, ordering or arranging
of any goods or services to be paid for by Medicaid. Violations of these laws
may result in civil and criminal penalties and exclusions from participation
in the Medicaid program. The Inspector General of the Department of Health and
Human Services issued "safe harbor" regulations specifying certain business
practices, which are exempt from sanctions under
7
the fraud and abuse law. Several states in which we operate or intend to
operate have laws that prohibit certain direct or indirect payments or fee-
splitting arrangements between health care providers if such arrangements are
designed to induce or encourage the referral of patients to a particular
provider. We at all times attempt to comply with all applicable fraud and
abuse laws. There can be no assurance that administrative or judicial
interpretation of existing laws or regulations or enactments of new laws or
regulations will not have a material adverse effect on our results of
operations or financial condition.
Currently, the federal government does not regulate assisted living
residences as such. State standards required of assisted living providers are
less in comparison with those required of other licensed health care
operators. For instance, the states we initially targeted for
development/expansion typically do not set staffing ratios. Current Medicaid
regulations provide for comparatively flexible state control over the
licensure and regulation of assisted living residences. There can be no
assurance that federal regulations governing the operation of assisted living
residences will not be implemented in the future or that existing state
regulations will not be expanded.
Under the Americans with Disabilities Act of 1990, all places of public
accommodation are required to meet certain federal requirements related to
access and use by disabled persons. A number of additional federal, state and
local laws exist that also may require modifications to planned facilities to
create access to the properties by disabled persons. Although we believe that
our facilities currently under development are substantially in compliance
with, or are exempt from, present requirements, we will incur additional costs
if required changes involve a greater expenditure than anticipated or must be
made on a more accelerated basis than anticipated. Further legislation may
impose additional burdens or restrictions with respect to access by disabled
persons, the costs of compliance with which could be substantial.
Employees
As of May 31, 1999 we had 3,576 employees, of whom 1,506 were full-time
employees and 2,070 were part-time employees. None of our employees are
represented by any labor union. We believe that our labor relations are
generally good.
ITEM 2. Properties
The following chart sets forth, as of June 30, 1999 the location, number of
units, date of licensure, and ownership status of our residences. In addition,
the chart sets forth occupancy rates as of May 31, 1999.
Opening Occupancy (%)
Residence Units Date(1) Ownership(2) at 5/31/99
--------- ----- ------- ------------ -------------
Western Region
Idaho
Burley.............................. 35 08/97 Leased 68.6
Caldwell............................ 35 08/97 Leased 37.1
Garden City......................... 48 04/97 Owned 72.9
Hayden.............................. 39 11/96 Leased 94.9
Idaho Falls......................... 39 01/97 Owned 100.0
Moscow.............................. 35 04/97 Owned 65.7
Nampa............................... 39 02/97 Leased 66.7
Rexburg............................. 35 08/97 Owned 45.7
Twin Falls.......................... 39 09/97 Owned 51.3
---
Sub Total......................... 344
Oregon
Astoria............................. 28 08/96 Owned 89.3
Bend................................ 46 11/95 Owned 97.8
Brookings........................... 36 07/96 Owned 88.9
Canby............................... 25 12/90 Leased 100.0
8
Opening Occupancy (%)
Residence Units Date(1) Ownership(2) at 5/31/99
--------- ----- ------- ------------ -------------
Estacada............................ 30 01/97 Owned 96.7
Eugene.............................. 47 08/97 Leased 93.6
Hood River.......................... 30 10/95 Owned 96.7
Klamath Falls....................... 36 10/96 Leased 75.0
Lincoln City........................ 33 10/94 Owned 63.6
Madras.............................. 27 03/91 Owned 100.0
Myrtle Creek........................ 34 03/96 Leased 97.1
Newberg............................. 26 10/92 Leased 100.0
Newport............................. 36 06/96 Leased 88.9
Pendleton........................... 39 04/91 Leased 56.4
Prineville.......................... 30 10/95 Owned 100.0
Redmond............................. 37 03/95 Leased 89.2
Silverton........................... 30 07/95 Owned 100.0
Sutherlin........................... 30 01/97 Leased 100.0
Talent.............................. 36 10/97 Owned 100.0
---
Sub Total......................... 636
Washington
Battle Ground....................... 40 11/96 Leased 90.0
Bremerton........................... 39 05/97 Owned 64.1
Camas............................... 36 03/96 Leased 94.4
Enumclaw............................ 40 04/97 Owned 80.0
Ferndale............................ 39 10/98 Owned 46.2
Grandview........................... 36 02/96 Leased 80.6
Hoquiam............................. 40 07/97 Leased 97.5
Kelso............................... 40 08/96 Leased 95.0
Kennewick........................... 36 12/95 Leased 38.9
Port Orchard........................ 39 06/97 Owned 97.4
Port Townsend....................... 39 01/98 Owned 100.0
Spokane............................. 39 09/97 Owned 56.4
Sumner.............................. 48 03/98 Owned 87.5
Vancouver........................... 44 06/96 Leased 45.5
Walla Walla......................... 36 02/96 Leased 100.0
Yakima.............................. 48 07/98 Owned 79.2
---
Sub Total......................... 639
Midwest Region
Indiana
Bedford............................. 39 03/98 Owned 48.7
Bloomington......................... 39 01/98 Owned 71.8
Camby............................... 39 12/98 Owned 23.1
Elkheart............................ 39 09/97 Leased 89.7
Fort Wayne.......................... 39 06/98 Owned 25.6
Franklin............................ 39 05/98 Owned 59.0
Huntington.......................... 39 02/98 Owned 56.4
Jeffersonville...................... 39 03/99 Owned 20.5
Kendalville......................... 39 05/98 Owned 38.5
LaPorte............................. 39 10/98 Owned 46.2
Logansport.......................... 39 02/98 Owned 87.2
Madison............................. 39 10/97 Leased 89.7
Marion.............................. 39 03/98 Owned 25.6
Muncie.............................. 39 02/98 Owned 100.0
New Albany.......................... 39 05/98 Owned 56.4
New Castle.......................... 39 02/98 Owned 53.9
Seymour............................. 39 05/98 Owned 59.0
9
Opening Occupancy (%)
Residence Units Date(1) Ownership(2) at 5/31/99
--------- ----- ------- ------------ -------------
Shelbyville......................... 39 05/98 Owned 84.6
Warsaw.............................. 39 10/97 Owned 43.6
---
Sub Total......................... 741
Iowa
Atlantic............................ 30 09/98 Owned 60.0
Carroll............................. 35 01/99 Owned 34.3
Clarinda............................ 35 09/98 Owned 48.6
Council Bluff....................... 50 03/99 Owned 32.0
Denison............................. 35 05/98 Leased 48.6
---
Sub Total......................... 185
Michigan
Three Rivers........................ 39 04/99 Owned 12.8
Nebraska
Beatrice............................ 39 07/97 Leased 69.2
Blair............................... 30 07/98 Owned 60.0
Columbus............................ 39 06/98 Owned 100.0
Fremont............................. 39 05/98 Owned 97.4
Nebraska City....................... 30 06/98 Owned 96.7
Norfolk............................. 39 04/97 Leased 71.8
Seward.............................. 30 10/98 Owned 43.3
Wahoo............................... 39 06/97 Leased 64.1
York................................ 39 05/97 Leased 94.9
---
Sub Total......................... 324
Southeast Region
Florida
Quincy.............................. 39 04/99 Owned 20.5
Milton.............................. 39 06/99 Owned --
---
Sub Total......................... 78
Louisiana
Alexandria.......................... 47 07/98 Owned 57.5
Bunkie.............................. 39 01/99 Owned 25.6
Houma............................... 48 08/98 Owned 70.8
Ruston.............................. 39 01/99 Owned 25.6
---
Sub Total......................... 173
South Carolina
Aiken............................... 39 02/98 Owned 76.9
Clinton............................. 39 11/97 Leased 43.6
Goose Creek......................... 39 08/98 Owned 48.7
Greenwood........................... 39 05/98 Leased 18.0
James Island........................ 39 08/98 Owned 56.4
North Augusta....................... 39 10/98 Owned 23.1
Port Royal.......................... 39 09/98 Owned 51.3
Summerville......................... 39 02/98 Owned 82.1
---
Sub Total......................... 312
Texas
Athens.............................. 38 11/95 Leased 97.4
Carthage............................ 30 10/95 Leased 93.3
Gun Barrel City..................... 40 10/95 Leased 92.5
Henderson........................... 30 09/96 Leased 96.7
Jacksonville........................ 39 12/95 Leased 100.0
10
Opening Occupancy (%)
Residence Units Date(1) Ownership(2) at 5/31/99
--------- ----- ------- ------------ -------------
Longview............................ 30 09/95 Leased 96.7
Lufkin.............................. 39 05/96 Leased 97.4
Marshall............................ 40 07/95 Leased 100.0
Nacogdoches......................... 30 06/96 Leased 100.0
Paris Oaks.......................... 50 12/98 Owned 100.0
-----
Sub Total......................... 366
Southwest Region
Texas
Abilene............................. 38 10/96 Leased 86.8
Amarillo............................ 50 03/96 Leased 96.0
Beaumont............................ 50 04/96 Leased 92.0
Big Springs......................... 38 05/96 Leased 100.0
Bryan............................... 30 06/96 Leased 100.0
Canyon.............................. 30 06/96 Leased 93.3
Cleburne............................ 44 01/96 Owned 97.7
College Station..................... 39 10/96 Leased 100.0
Conroe.............................. 38 07/96 Leased 100.0
Denison............................. 30 01/96 Owned 86.7
Gainesville......................... 40 01/96 Leased 97.5
Greenville.......................... 40 11/95 Leased 75.0
Levelland........................... 30 01/96 Leased 100.0
Lubbock............................. 50 07/96 Leased 96.0
McKinney............................ 39 01/97 Owned 94.9
McKinney............................ 50 05/98 Owned 100.0
Mesquite............................ 50 07/96 Leased 90.0
Midland............................. 50 12/96 Owned 98.0
Mineral Wells....................... 30 07/96 Leased 96.7
Orange.............................. 36 03/96 Leased 100.0
Pampa............................... 36 08/96 Leased 100.0
Plainview........................... 36 07/96 Leased 100.0
Plano............................... 60 05/98 Owned 95.0
Port Arthur......................... 50 05/96 Owned 96.0
Rowlett............................. 36 10/96 Owned 100.0
Sherman............................. 39 10/95 Leased 97.4
Sulphur Springs..................... 30 01/96 Owned 100.0
Sweetwater.......................... 30 03/96 Leased 100.0
Temple.............................. 40 01/97 Leased 67.5
Wichita Falls....................... 50 10/96 Leased 64.0
-----
Sub Total......................... 1,209
Arizona
Apache Junction..................... 48 03/98 Owned 81.3
Bullhead City....................... 40 08/97 Leased 80.0
Lake Havasu......................... 36 04/97 Leased 58.3
Mesa................................ 50 01/98 Owned 72.00
Payson.............................. 39 10/98 Owned 84.6
Prescott Valley..................... 39 10/98 Owned 30.8
Surprise............................ 50 10/98 Owned 12.0
Yuma................................ 48 03/98 Owned 62.5
-----
Sub Total......................... 350
11
Opening Occupancy (%)
Residence Units Date(1) Ownership(2) at 5/31/99
--------- ----- ------- ------------ -------------
Northeast Region
New Jersey
Bridgeton........................... 39 03/98 Owned 87.2
Burlington.......................... 39 11/97 Owned 100.0
Egg Harbor.......................... 39 04/99 Owned 48.7
Glassboro........................... 39 03/97 Leased 100.0
Millville........................... 39 05/97 Leased 100.0
Pennsville.......................... 39 11/97 Owned 97.4
Rio Grande.......................... 39 11/97 Owned 94.9
Vineland............................ 39 01/97 Leased 97.4
-----
Sub Total......................... 312
Ohio
Bellefountaine...................... 35 03/97 Owned 80.0
Bucyrus............................. 35 01/97 Owned 94.3
Cambridge........................... 39 10/97 Owned 43.6
Celina.............................. 39 04/97 Owned 79.5
Defiance............................ 35 02/96 Owned 91.4
Findlay............................. 39 03/97 Owned 20.5
Fremont............................. 39 07/97 Leased 51.3
Greenville.......................... 39 02/97 Owned 79.5
Hillsboro........................... 39 03/98 Owned 53.9
Kenton.............................. 35 03/97 Owned 100.0
Lima................................ 39 06/97 Owned 56.4
Marion.............................. 39 04/97 Owned 48.7
Newark.............................. 39 10/97 Leased 92.3
Sandusky............................ 39 09/98 Owned 23.1
Tiffin.............................. 35 06/97 Leased 62.9
Troy................................ 39 03/97 Leased 94.9
Wheelersburg........................ 39 09/97 Leased 30.8
Zanesville.......................... 39 12/97 Owned 66.7
-----
Sub Total......................... 682
Pennsylvania
Butler.............................. 39 12/97 Owned 61.5
Hermitage........................... 39 03/98 Owned 100.0
Indiana............................. 39 03/98 Owned 43.6
Johnstown........................... 39 06/98 Owned 46.2
Latrobe............................. 39 12/97 Owned 89.7
Lower Burrell....................... 39 01/97 Owned 100.0
New Castle.......................... 39 04/98 Owned 71.8
Penn Hills.......................... 39 05/98 Owned 53.9
Uniontown........................... 39 06/98 Owned 56.4
-----
Sub Total......................... 351
-----
Grand Total....................... 6,741
=====
- --------
(1) Reflects the date operations commenced, typically the licensure date for
developed residences and the date of purchase for acquired residences.
(2) As of June 30, 1999, we owned 105 residences, 37 of which were subject to
permanent mortgage financing and 68 of which were unencumbered, and we
leased 70 residences pursuant to long-term operating leases. See Notes 5
and 8 to the consolidated financial statements included elsewhere herein.
12
We also lease in total approximately 28,000 square feet of office space for
the Corporate and Regional offices in Portland, Oregon; Glendale, Arizona;
Dallas, Texas; Omaha, Nebraska; and Dublin, Ohio.
Construction and Development Activities
We are developing additional residences or expanding existing residences in
Indiana, Florida, Michigan, Iowa, New Jersey and South Carolina. As of June
30, 1999, we had six residences with 245 units that had received certificates
of occupancy but were not yet operating. In addition, we had four residences
with 156 units that were under construction as of the same date. We also owned
land for development of nine sites, including three for expansion projects,
where construction had not yet commenced. We have significantly reduced our
development activity in 1999 in order to focus on stabilizing our current base
of operating residences.
We generally locate our residences in well-established residential
neighborhoods in smaller rural and suburban communities, where the population
typically ranges from 10,000 to 40,000 with a higher than average percentage
of middle aged or elderly individuals. To provide the appropriate level of
personal care efficiently and economically, and to ensure that residents are
not intimidated by residence size, we develop residences ranging in size from
30 to 50 residential units and containing approximately 16,000 to 32,000 total
square feet, with studio and one-bedroom units comprising an average of 320
square feet and 450 square feet, respectively, of private living space.
Historically, we have either retained outside developers to construct
residences or acquired newly constructed residences from developers under
"turn-key" agreements. Since the end of 1997 we have expanded almost entirely
through outside development. Because of the planned reduction of development
activities in 1999, we intend to conduct an increasing portion of such
development activities internally. Where we use outside developers, we approve
all aspects of development including, among other things, market feasibility,
site selection, plans and specifications, the proposed construction budget and
selection of the architect and general contractor. We estimate the average
construction time for a typical residence to be approximately five to nine
months, depending upon the number of units.
ITEM 3. Legal Proceedings
Securityholder Litigation
Since February 1, 1999, 12 separate complaints, which have since been
consolidated into one action, have been filed against us and certain of our
officers and directors in the United States District Court for the District of
Oregon. On July 23, 1999, a consolidated complaint was filed in connection
with this litigation. The consolidated complaint purports to be brought on
behalf of a class of purchasers of our common stock from July 28, 1997 through
March 31, 1999 and on behalf of a class of purchasers of our Debentures from
the date of issuance through March 31, 1999. The consolidated complaint
alleges violations of the federal securities laws and seeks unspecified
damages. It also names as additional defendants certain of our directors that
were not named previously, as well as our independent auditors (solely in
connection with our 1998 offering of 5.625% Debentures) and the underwriters
in connection with our 1997 offering of 6.0% Debentures. We cannot predict the
outcome of the foregoing litigation and currently are unable to evaluate the
likelihood of success or the range of possible loss. However, if the foregoing
consolidated action were determined adversely to us, such a determination
could have a material adverse effect on our financial condition, results of
operations, cash flow or liquidity.
Other Litigation
In addition to the matter referred to in the immediately preceding
paragraph, we are involved in various lawsuits and claims arising in the
normal course of business. In the opinion of our management, although the
outcomes of these other suits and claims are uncertain, in the aggregate such
other suits and claims should not have a material adverse effect on our
financial condition, results of operations, cash flow or liquidity.
ITEM 4. Submission of Matters to a Vote of Security Holders
Not applicable.
13
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Our Common Stock, par value $0.01 (the "Common Stock"), is listed on the
American Stock Exchange ("AMEX") under the symbol "ALF." The following table
sets forth the high and low closing sales prices of the Common Stock, as
reported by the AMEX, for the periods indicated.
1997 1998
------------- -------------
High Low High Low
------ ------ ------ ------
Years ended December 31:
1st Quarter.................................. $10.68 $ 7.13 $21.63 $17.50
2nd Quarter.................................. 14.50 9.88 21.38 14.13
3rd Quarter.................................. 19.75 13.25 18.00 12.44
4th Quarter.................................. 22.38 15.75 14.50 9.88
For the period from January 1, 1999 to April 15, 1999, the high and low
closing sales prices of the Common Stock, as reported by the AMEX was $14.50
and $2.88, respectively. On April 15, 1999, the AMEX halted trading in the
Common Stock.
As of May 31, 1999, we had approximately 80 holders of record of Common
Stock. We are unable to estimate the number of additional stockholders whose
shares are held for them in street name or nominee accounts.
Our current policy is to retain any earnings to finance the operations and
expansion of our business. In addition, certain outstanding indebtedness and
certain lease agreements restrict the payment of cash dividends. It is
anticipated that the terms of future debt financing may do so as well.
Therefore, the payment of any cash dividends on the Common Stock is unlikely
in the foreseeable future.
ITEM 6. Selected Financial Data
The following table presents selected historical condensed consolidated
financial data for us and our Predecessor. Our "Predecessor" consisted of:
Assisted Living Facilities, Inc., an S-Corporation; Madras Elder Care, a
partnership; and Lincoln City Partners, a partnership, which, prior to
December 31, 1994, owned the five residences operated by us in December 1994.
The consolidated statement of operations data of the Predecessor for the
eleven months ended November 30, 1994 and the consolidated statement of
operations data of the Company for the one month ended December 31, 1994 and
the year ended December 31, 1995, as well as the consolidated balance sheet
data at December 31, 1994, 1995 and 1996, are derived from our audited
consolidated financial statements and those of the Predecessor. The
consolidated statement of operations data for the years ended December 31,
1996, 1997 and 1998, as well as the consolidated balance sheet data at
December 31, 1997 and 1998, are derived from our consolidated financial
statements included elsewhere in this report which have been audited by KPMG
LLP, independent auditors. You should read the selected financial data below
in conjunction with our consolidated financial statements, including the
related notes, and the information in Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
14
Predecessor The Company
------------ ------------------------------------------------
Eleven One Month
Months Ended Ended Years Ended December 31,
November 30, December 31, -----------------------------------
1994 1994 1995 1996 1997 1998
------------ ------------ ------- ------- ------- --------
(in thousands, except per share data)
Consolidated Statements
of Operations Data:
Revenue................. $1,841 $ 212 $ 4,067 $21,022 $49,605 $ 89,384
Operating expenses:
Residence operating
expenses............. 1,127 125 2,779 14,055 31,591 57,443
Management Fees....... 93 -- -- -- -- --
Corporate general and
administrative....... -- 152 1,252 1,864 4,050 11,099
Building rentals...... -- 42 798 3,949 7,969 12,764
Depreciation and
amortization......... 105 13 296 1,094 3,683 6,339
Terminated merger
expense.............. -- -- -- -- -- 1,068
Site abandonment
costs................ -- -- -- -- -- 2,377
Write-off of impaired
assets............... -- -- -- -- -- 8,521
------ ------ ------- ------- ------- --------
Total operating
expenses........... 1,325 332 5,125 20,962 47,293 99,611
------ ------ ------- ------- ------- --------
Operating income
(loss)................. 516 (120) (1,058) 60 2,312 (10,227)
------ ------ ------- ------- ------- --------
Other income (expense):
Interest expense...... 297 8 96 1,146 4,946 11,039
Interest income....... (12) (64) (579) (455) (1,526) (3,869)
Loss on sale of
assets............... -- -- -- 854 1,250 651
Debenture conversion
costs................ -- -- -- 426 -- --
Other expenses........ -- -- -- 4 121 1,174
------ ------ ------- ------- ------- --------
Total other (income)
expenses........... 285 (56) (483) 1,975 4,791 8,995
------ ------ ------- ------- ------- --------
Income (loss) before
taxes and
cumulative effect of
change in
accounting principle... 231 (64) (575) (1,915) (2,479) (19,222)
Provision for income
taxes.................. 85 -- -- -- -- --
Cumulative effect of
change in
accounting principle... -- -- -- -- -- (1,523)
------ ------ ------- ------- ------- --------
Net income (loss)....... $ 146 $ (64) $ (575) $(1,915) $(2,479) $(20,745)
====== ====== ======= ======= ======= ========
Basic and diluted net
loss per common share:
Loss before cumulative
effect of change in
accounting
principle............ -- $(0.01) $ (0.10) $ (0.23) $ (0.21) $ (1.18)
Cumulative effect of
change in accounting
principle............ -- -- -- -- -- $ (0.09)
------ ------ ------- ------- ------- --------
Basic and diluted net
loss per common share.. -- $(0.01) $ (0.10) $ (0.23) $ (0.21) $ (1.27)
====== ====== ======= ======= ======= ========
Basic and diluted
weighted average common
shares outstanding..... -- 6,000 6,000 8,404 11,871 16,273
At December 31,
--------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
(in thousands)
Consolidated Balance Sheet Data:
Working capital.................. $13,122 $(5,320) $(27,141) $ 40,062 $ 43,856
Total assets..................... 17,903 53,546 147,223 324,367 414,669
Long-term debt, excluding current
portion......................... 1,101 24,553 49,663 157,700 266,286
Shareholders' equity............. 16,219 15,644 56,995 132,244 119,197
15
Quarterly Financial Data (Unaudited)
(in thousands except per share data)
1997 Quarterly Financial Data 1998 Quarterly Financial Data
----------------------------------------- ---------------------------------------------
1st 2nd 3rd 4th Year to 1st 2nd 3rd 4th Year to
Qtr Qtr Qtr Qtr Date Qtr Qtr Qtr Qtr Date
------ ------- ------- ------- ------- ------- -------- ------- ------- --------
Results of Operations
Revenue................. $9,479 $11,108 $12,765 $16,253 $49,605 $18,773 $ 21,353 $24,012 $25,246 $ 89,384
Operating income
(loss)................. 805 1,010 303 194 2,312 1,408 (8,609) 1,657 (4,684) (10,227)
Net income (loss) before
cumulative effect of
change in accounting
principle.............. 31 (74) (1,475) (961) (2,479) 739 (11,831) (720) (7,410) (19,222)
Change in accounting
principle.............. -- -- -- -- -- (1,523) -- -- -- (1,523)
Net income (loss)....... 31 (74) (1,475) (961) (2,479) (784) (11,831) (720) (7,410) (20,745)
Basic and diluted income
(loss) per share(1)
Income (loss) per common
share before cumulative
effect of change in
accounting principle... 0.00 (0.01) (0.13) (0.07) (0.21) 0.05 (0.75) (0.04) (0.43) (1.18)
Cumulative effect of
change in accounting
principle.............. -- -- -- -- -- (0.10) -- -- -- (0.09)
Loss per share.......... $ 0.00 $ (0.01) $ (0.13) $ (0.07) $ (0.21) $ (0.05) $ (0.75) $ (0.04) $ (0.43) $ (1.27)
Basic and diluted
weighted average common
shares outstanding..... 11,004 11,044 11,084 14,429 11,871 15,688 15,679 16,604 17,094 16,273
- --------
(1) Quarter net income (loss) per share amounts may not add to the full year
total due to rounding.
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Restatement
On February 1, 1999, we announced that after consultation with our
independent auditors, we would restate our financial statements for the fiscal
quarter ended June 30, 1997, the fiscal quarter ended September 30, 1997, the
fiscal year ended December 31, 1997, the fiscal quarter ended March 31, 1998,
the fiscal quarter ended June 30, 1998 and the fiscal quarter ended September
30, 1998. On March 31, 1999, we announced that the restatement would be more
extensive than we had previously believed, and might include periods prior to
the second quarter of 1997, including the fiscal year ended December 31, 1996.
After further consultation with our independent auditors, we determined to
restate our financial statements for the fiscal year ended December 31, 1996,
the fiscal year ended December 31, 1997 and each of the first three fiscal
quarters of the fiscal year ended December 31, 1998.
The restatement reduced the net income for the fiscal years ended December
31, 1996 and 1997 and for the nine months ended September 30, 1998 by $2.1
million, $6.7 million and $11.0 million, respectively. The cumulative effect
of the restatement reduced shareholders' equity by $19.7 million through
September 30, 1998. As a result of the restatement, we reported net losses of
$1.9 million, $2.5 million and $13.3 million for the fiscal years 1996 and
1997 and the nine months ended September 30, 1998, respectively, compared to
previously reported net income of $149,000, $4.2 million and a net loss of
$2.4 million, respectively. As a result of the restatement, the Company
reported net loss per diluted share of $0.23, $0.21 and $0.84 for the fiscal
years ended December 31, 1996 and 1997 and the nine months ended September 30,
1998, respectively, compared to previously reported net income of $0.03 and
$0.34, and net loss of $0.14, per diluted share, respectively. After the
restatement, the Company's cash position as of December 31, 1996 and 1997 and
as of September 30, 1998 was $2.1 million, $63.3 million and $79.6 million,
respectively, as compared to $2.1 million, $63.4 million and $79.8 million,
respectively, as previously reported. In addition, our working capital
position as of December 31, 1996 and 1997 and as of September 30, 1998 was
negative $27.1 million, positive $40.1 million and positive
16
$63.0 million, respectively, as compared to previously reported working
capital of negative $26.4 million, positive $41.0 million and positive $64.1
million, respectively.
The restatement resulted primarily from: (i) the earlier recognition of
certain expenses that we previously capitalized in association with our
development and financing activities; (ii) a modification in how we accounted
for certain of our lease arrangements; (iii) a modification in how we
accounted for certain of our acquisitions and our joint venture arrangements;
(iv) the capitalization of fees we received during 1997 and 1998 that we
previously recorded as a reduction of expenses or other income; (v) the
elimination of an impairment write-down that we had previously recorded on
three of our residences; (vi) the elimination of certain accrued expenses
previously recorded pursuant to a change in accounting principle and (vii) an
increase in the amount of goodwill that we wrote off in the second quarter of
1998 related to exiting our home health operations.
Overview
We operate free-standing assisted living residences, primarily in small
middle-market rural and suburban communities with a population typically
ranging from 10,000 to 40,000. We provide personal care and support services,
and make available routine nursing services (as permitted by applicable
regulations) designed to meet the personal and health care needs of our
residents. As of June 30, 1999, we had operations or development activities in
five regions (as defined by ALC) in 16 states.
We have experienced significant and rapid growth, primarily through the
development of assisted living residences and, to a lesser extent, through the
acquisition of assisted living residences. At the closing of our initial
public offering in November 1994, we began operating five residences (137
units) located in Oregon. As of June 30, 1999, we had received certificates of
occupancy on 181 residences (6,986 units), of which 175 residences (6,741
units) were included in operating results. Residences typically receive a
certificate of occupancy upon completion of construction. Residences are
included in operating results when they receive a license or its equivalent
from the state in which they are located. It may take several months to
receive a license after receiving a certificate of occupancy. Of the
residences included in our operating results, we owned 105 residences (4,121
units) and leased 70 residences (2,620 units).
We derive our revenues primarily from resident fees for the delivery of
assisted living services. Resident fees typically are paid monthly by
residents, their families, state Medicaid agencies or other responsible
parties. Resident fees include revenue derived from a multi-tiered rate
structure, which varies based on the level of care provided. Resident fees are
recognized as revenues when services are provided. Our operating expenses
include:
. residence operating expenses, such as staff payroll, food, property
taxes, utilities, insurance and other direct residence operating
expenses;
. general and administrative expenses consisting of corporate and regional
support functions such as legal, accounting and other administrative
expenses;
. building rentals; and
. depreciation and amortization.
Our operating results for the year ended December 31, 1998 were adversely
affected by several factors, including:
. write-offs in the second quarter and fourth quarter relating to our
decisions not to proceed with the development of certain sites which we
had acquired for development;
. a write-off in the second quarter relating to our decision to
discontinue the home health care business which we acquired in October
1997; and
. merger related expenses incurred during the fourth quarter related to
our proposed merger with ARC.
17
In addition, our results of operations were negatively impacted, commencing
in the fourth quarter of 1998, as a result of the diversion of management's
time and attention resulting from the proposed merger with ARC and its
subsequent termination, as well as from certain regulatory issues in
Washington and Oregon. These distractions continued into 1999 and, as such,
our operating results for the year ended December 31, 1998 are not necessarily
indicative of our future operating performance. With respect to our Stabilized
Residences (as defined below), we expect our operating margins to be
substantially lower in 1999 because our occupancy rates have declined and our
operating expenses have increased in those residences. This is partly due to
increased competition in certain markets for labor and residents and partly
due to the diversion of management's time and attention relating to the
matters described above, and also to a restatement of our financial statements
for certain prior periods and the securityholder litigation, both of which
commenced in February 1999. These factors have also resulted in slower fill-up
and increased operating expenses in our Start-Up Residences (as defined
below).
For the year ended December 31, 1998, we commenced operations in 57
additional residences, 53 of which were developed and four of which were
acquired. We intend to commence operation on an additional 20 residences
during the year ended December 31, 1999 (the "1999 Period"), 10 of which had
commenced operation through June 30, 1999. In addition to the development and
construction costs incurred during 1998 with respect to these residences, we
expect to incur up to an additional $30.0 million in capital expenditures and
related start-up costs for the twelve months ended December 31, 1999,
approximately $25.0 million of which had been incurred as of June 30, 1999. We
expect that Start-Up Residences will incur significant operating losses during
the fill-up period. As a result, our operating results will be adversely
affected by operating losses at certain residences, primarily Start-Up
Residences, which we expect will range from $3.5 million to $5.0 million
during 1999.
We believe that our current cash on hand and our working capital resources
will be sufficient to meet our capital needs for the next 12 to 18 months.
However, to provide us with additional capital, we may explore various
financing alternatives and/or commitments to engage in sale and leaseback
transactions. We currently do not have in place any of such loan or lease
commitments. As a result of the securityholder litigation, the restatement and
other factors, there can be no assurances that financing from any source will
be available in the future, or, if available, that such financing will be on
terms acceptable to us. See "Liquidity and Capital Resources" and "Risk
Factors--We may require additional financing."
Results of Operations
The following table sets forth, for periods presented, the number of total
residences and units operated, average occupancy rates and the sources of our
revenue. The portion of revenues received from state Medicaid agencies are
labeled as "Medicaid state portion" while the portion of our revenues that a
Medicaid-eligible resident must pay out of his or her own resources is labeled
"Medicaid resident portion."
Years Ended
December 31,
-------------------
Total Residences 1996 1997 1998
---------------- ----- ----- -----
Residences operated (end of period)..................... 60 109 165
Units operated (end of period).......................... 2,139 4,024 6,329
Average occupancy rate.................................. 76.7% 71.7% 72.3%
Sources of revenue:
Medicaid state portion................................ 12.4% 11.1% 10.7%
Medicaid resident portion............................. 6.9% 5.9% 5.8%
Private............................................... 80.7% 83.0% 83.5%
----- ----- -----
Total............................................... 100.0% 100.0% 100.0%
===== ===== =====
18
The following table sets forth, for the periods presented for Stabilized
Residences, the total number of residences and units operated, average
occupancy rates and the sources of our revenue. Stabilized Residences are
defined as those residences, which were operating for more than twelve months
prior to the beginning of the period or had achieved a 95% occupancy rate as
of the beginning of the reporting period.
Years Ended
December 31,
-------------------
Stabilized Residences 1996 1997 1998
--------------------- ----- ----- -----
Residences operated (end of period)..................... 7 32 65
Units operated (end of period).......................... 204 1,063 2,434
Average occupancy rate.................................. 96.5% 95.1% 93.9%
Sources of revenue:
Medicaid state portion................................ 19.9% 11.4% 14.5%
Medicaid resident portion............................. 11.5% 6.5% 8.2%
Private............................................... 68.6% 82.1% 77.3%
----- ----- -----
Total............................................... 100.0% 100.0% 100.0%
===== ===== =====
The following table sets forth, for the periods presented for Start-up
Residences, the total number of residences and units operated, average
occupancy rates and the sources of our revenue. Start-up Residences are
defined as those residences, which were operating for less than twelve months
prior to the beginning of the period or had not achieved a 95% occupancy rate
as of the beginning of the reporting period.
Years ended
December 31,
-------------------
Start-up Residences 1996 1997 1998
------------------- ----- ----- -----
Residences operated (end of period)..................... 53 77 100
Units operated (end of period).......................... 1,935 2,961 3,895
Average occupancy rate.................................. 73.0% 59.8% 55.7%
Sources of revenue:
Medicaid state portion................................ 9.8% 11.3% 7.1%
Medicaid resident portion............................. 5.3% 5.7% 3.4%
Private............................................... 84.9% 83.0% 89.5%
----- ----- -----
Total............................................... 100.0% 100.0% 100.0%
===== ===== =====
The following table sets forth, for the periods presented for Same Store
Residences, the total number of residences and units operated, average
occupancy rates and the sources of our revenue. Same Store Residences are
defined as those residences, which were operating throughout comparable
periods.
Years ended Years ended
December 31, December 31,
------------ ------------
Same Store Residences 1996 1997 1997 1998
--------------------- ----- ----- ----- -----
Residences operated (end of period).............. 19 19 59 59
Units operated (end of period)................... 595 605 2,104 2,157
Average occupancy rate........................... 90.0% 95.6% 86.9% 93.5%
Sources of revenue:
Medicaid state portion......................... 16.1% 13.8% 11.9% 15.1%
Medicaid resident portion...................... 9.1% 7.6% 6.5% 8.7%
Private........................................ 74.8% 78.6% 81.6% 76.2%
----- ----- ----- -----
Total........................................ 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
19
The following tables relating to Stabilized Residences, Start-up Residences
and Same Store Residences exclude the effects of corporate level expenses,
including general and administrative expenses and corporate level interest
expense. In addition, the following tables exclude the effect of the
capitalization of corporate and property level interest expense.
The following table sets forth, for the periods presented, the results of
operations for Stabilized Residences (in thousands).
Years ended December 31,
------------------------
Stabilized Residences 1996 1997 1998
--------------------- ------- ------- --------
Revenue..,,,,,,..................................... $4,084 $21,245 $46,260
Residence operating expenses........................ 2,422 12,255 27,456
------- ------ -------
Residence operating income.......................... 1,662 8,990 18,804
Building rentals.................................... 935 3,323 7,193
Depreciation and amortization....................... 138 945 1,777
------ ------- -------
Total other operating expenses...................... 1,073 4,268 8,970
------ ------- -------
Operating income.................................... $ 589 $ 4,722 $ 9,834
====== ======= =======
The following tables sets forth, for the periods presented, the results of
operations for Start-up Residences (in thousands).
Years ended December 31,
------------------------
Start-up Residences 1996 1997 1998
------------------- -------- ------- -------
Revenue............................................. $16,938 $27,164 $40,013
Residence operating expenses........................ 11,633 18,519 27,591
------- ------- -------
Residence operating income........................ 5,305 8,645 12,422
Building rentals.................................... 3,014 4,612 5,535
Depreciation and amortization....................... 956 2,010 4,063
------- ------- -------
Total other operating expenses.................... 3,970 6,622 9,598
------- ------- -------
Operating income................................ $ 1,335 $ 2,023 $ 2,824
======= ======= =======
The following table sets forth, for the periods presented, the results of
operations for the 19 Same Store Residences included in operating results for
all of fiscal years 1996 and 1997, and the 59 Same Store Residences included
in operating results for all of fiscal years 1997 and 1998 (in thousands).
Years ended Years ended
December 31, December 31,
--------------- ---------------
Same Store Residences 1996 1997 1997 1998
--------------------- ------- ------- ------- -------
Revenue..................................... $10,877 $12,397 $38,274 $42,002
Residence operating expenses................ 6,682 7,070 22,908 24,801
------- ------- ------- -------
Residence operating income................ 4,195 5,327 15,366 17,201
Building rentals............................ 2,374 2,440 5,635 6,375
Depreciation and amortization............... 543 461 2,280 1,647
------- ------- ------- -------
Total other operating expenses............ 2,917 2,901 7,915 8,022
------- ------- ------- -------
Operating income........................ $ 1,278 $ 2,426 $ 7,451 $ 9,179
======= ======= ======= =======
20
Year ended December 31, 1998 compared to year ended December 31, 1997
We incurred a net loss (after the cumulative effect of change in accounting
principle and other charges as described below) of $20.7 million, or $1.27 per
basic and diluted share, on revenue of $89.4 million for the year ended
December 31, 1998 (the "1998 Period") as compared to a net loss of $2.5
million, or $0.21 per basic and diluted share, on revenue of $49.6 million for
the year ended December 31, 1997 (the "1997 Period").
We had certificates of occupancy for 173 residences, 165 of which were
included in the operating results as of the end of the 1998 Period as compared
to 130 residences with certificates of occupancy, 109 of which were included
in the operating results as of the end of the 1997 Period. Of the residences
included in operating results as of the end of the 1998 Period, we owned 95
residences and leased 70 residences (54 of which were operating leases and 16
of which were accounted for as financings) as compared to 42 owned residences
and 67 leased residences (51 of which were operating leases and 16 of which
were accounted for as financings) as of the end of the 1997 Period.
Revenue. Revenue was $89.4 million for the 1998 Period as compared to $49.6
million for the 1997 Period, an increase of $39.8 million. Of this increase:
. $18.5 million or 46.5% related to the full year impact of the 49
residences (1,875 units) which opened during the 1997 Period;
. $15.7 million or 39.4% related to the opening of an additional 57
residences (2,297 units) during the 1998 Period;
. $3.7 million or 9.3% was attributable to the 59 Same Store Residences
(2,157 units); and
. the remaining $1.9 million or 4.8% related to our ancillary service
operation.
Revenue from the Same Store Residences was $42.0 million for the 1998 Period
as compared to $38.3 million for the 1997 Period, an increase of $3.7 million
or 9.7%. The increase in revenue for Same Store Residences was attributable to
a combination of an increase in average occupancy to 93.5% and average monthly
rental rate to $1,753 for the 1998 Period as compared to 86.9% and $1,720,
respectively, for the 1997 Period.
Of the $89.4 million in revenues reported for the 1998 Period:
. $46.3 million or 51.8% was attributable to Stabilized Residences;
. $40.0 million or 44.7% was attributable to Start-Up Residences; and
. $3.1 million or 3.5% was attributable to our ancillary service
operation.
As of the end of the 1998 Period, we had 65 Stabilized Residences (2,434
units) with an average occupancy of 93.9% and an average monthly rental rate
of $1,762 and we had 100 Start-Up Residences (3,895 units) with an average
occupancy of 55.7% and an average monthly rental rate of $1,934.
Residence Operating Expenses. Residence operating expenses were $57.4
million for the 1998 Period as compared to $31.6 million for the 1997 Period,
an increase of $25.8 million. Of this increase:
. $10.5 million or 40.7% related to the full year impact of the 49
residences (1,885 units) which opened during the 1997 Period;
. $11.8 million or 45.7% related to the opening of an additional 57
residences (2,297 units) during the 1998 Period;
. $1.9 million or 7.4% was attributable to the 59 Same Store Residences
(2,157 units); and
. the remaining $1.6 million or 6.2% related to expenses associated with
our ancillary service operation.
Residence operating expenses for the Same Store Residences were $24.8
million for the 1998 Period as compared to $22.9 million for the 1997 Period,
an increase of $1.9 million or 8.3%. This increase results from
21
the additional expenses incurred in connection with the increase in occupancy
at the Same Store Residences during the period.
Of the $57.4 million in residence operating expenses reported for the 1998
Period, $27.5 million or 47.9% was attributable to Stabilized Residences,
$27.6 million or 48.1% was attributable to Start-Up Residences and $2.3
million or 4.0% was attributable to our ancillary service operation.
Corporate General and Administrative. Corporate general and administrative
expenses as reported were $11.1 million for the 1998 Period as compared to
$4.1 million for the 1997 Period. Our corporate general and administrative
expenses before capitalized payroll costs were $12.9 million for the 1998
Period as compared to $5.9 million for the 1997 Period, an increase of $7.0
million. This increase results from additional investments in our corporate
and regional infrastructure to support the opening of new residences and the
on-going operation of our existing base of residences. Of the increase:
. $3.9 million or 56.0% related to increased payroll costs;
. $525,000 or 7.5% related to increased marketing expenses;
. $450,000 or 6.5% related to the increased corporate office rental
expense; and
. the remaining $2.1 million or 30.0% related to increased general
corporate expenses such as legal and travel related expenses.
We capitalized $1.8 million of payroll costs associated with the development
of new residences for each of the 1998 Period and the 1997 Period.
We expect to incur increased corporate general and administrative expenses
for the 1999 Period primarily as a result of:
. the increase in the number of regional offices from three to five;
. increased marketing and advertising expenses associated with residence
fill-up activities;
. an increase in professional fees associated with the restatement and
security-holder litigation;
. an increase in severance expense associated with management changes; and
. an increase in expenses associated with final operations of our home
health operations.
In addition, corporate general and administrative expenses as reported in
the 1999 Period are expected to increase as a result of the reduction in the
amount of capitalized payroll costs associated with development activities.
Building Rentals. Building rentals were $12.8 million for the 1998 Period as
compared to $8.0 million for the 1997 Period, an increase of $4.8 million. Of
the increase:
. $4.2 million was the result of the full year impact of the 26 operating
leases entered into during the 1997 Period;
. $400,000 related to the four leases entered into during the 1998 Period;
and
. the remainder of the increase was primarily driven by an increase in
expense on leases entered into prior to the 1997 Period offset by one
operating lease which was terminated during the 1998 Period.
As of the end of the 1998 Period we had 54 operating leases as compared to
51 operating leases as of the end of the 1997 Period.
Depreciation and Amortization. Depreciation and amortization was $6.3
million for the 1998 Period as compared to $3.7 million for the 1997 Period,
an increase of $2.6 million. Depreciation expense was $5.9 million
22
and amortization expense was $398,000 for the 1998 Period as compared to $2.9
million and $800,000, respectively, for the 1997 Period. The increase in
depreciation is the result of:
. the full year effect of depreciation on the 16 owned residences which
commenced operations during the 1997 Period;
. depreciation associated with the 53 owned residences that commenced
operations during the 1998 Period; and
. depreciation associated with the full year impact of seven residences
which were sold and leased back during the 1997 Period which were
accounted for as financings.
Amortization expense decreased as a result of the change in accounting for
certain costs incurred prior to opening new residences. Effective January 1,
1998, we adopted Statement of Position 98-5, Reporting on the Costs of Start-
Up Activities ("SOP 98-5"). See the discussion of cumulative effect of change
in accounting principle below.
Terminated Merger Expense. During the fourth quarter of the 1998 Period, we
recorded a $1.1 million charge relating to our terminated merger with ARC. On
February 1, 1999 we agreed with ARC to terminate our previously announced
merger agreement, which had been entered into during November 1998. We
incurred approximately $200,000 of additional merger related expenses during
the first quarter of 1999.
Site Abandonment Costs. As a result of our decision to reduce the number of
new residence openings during the 1999 Period and beyond, we wrote-off $2.4
million of capitalized costs during the 1998 Period relating to the
abandonment of 36 development sites. Of such costs, $1.0 million were written-
off during the second quarter and the remaining $1.4 million were written-off
during the fourth quarter 1998. We had not written-off any such costs prior to
1998.
As a result of a continued reduction in our new residence development
activities, we will incur write-offs of $1.3 million relating to previously
capitalized development costs during the first quarter of 1999 and an
additional $3.5 million in the second quarter of 1999. In the event that in
the future we do not complete and open residences planned for development, we
may incur similar write-offs. However, we have no present intention of
commencing further development activity beyond the 10 residences currently
included in construction in process as of June 30, 1999.
Write-Off of Impaired Assets and Related Expenses. In the 1998 Period, we
recorded an $8.5 million charge consisting of:
. $7.5 million write-off of unamortized goodwill resulting from the exit
from our home health operations;
. a $1.0 million provision for exit costs associated with closing such
home health care operation. During the fourth quarter of 1998, we
reduced the provision by $400,000 from $1.4 million as a result of a
change in the estimate for such exit costs.
Interest Expense. Interest expense was $11.0 million for the 1998 Period as
compared to $4.9 million for the 1997 Period. Gross interest expense for the
1998 Period was $17.0 million compared to $11.5 million for the 1997 Period, a
net increase of $5.5 million.
Interest expense increased by:
. $4.8 million due to the full year impact of interest expense related to
the October 1997 issuance of 6.0% Debentures;
. $3.6 million due to interest expense related to the April 1998 issuance
of 5.625% Debentures;
. $1.8 million related to the new mortgage financing entered into during
the 1998 Period;
23
. $750,000 related to the full year impact of seven residences which were
sold and leased back during the 1997 Period which were accounted for as
financings; and
. $475,000 related to interest expense associated with losses which were
reimbursed by the partner to our joint venture agreement (accounted for
as loans) incurred in connection with the operation of joint venture
residences (interest was calculated based on the average loan balance
using an imputed 20% interest rate, and other expense was calculated
based on a $10,000 administrative fee per residence).
This increase was offset by:
. a $5.5 million reduction associated with construction financing used to
fund development activity during the 1997 Period which was either repaid
or converted to leases prior to the 1998 Period; and
. a $400,000 reduction as a result of the redemption in August 1998 of the
7.0% Convertible Subordinated Debentures due 2005 (the "7.0%
Debentures").
We capitalized $6.0 million of interest expense for the 1998 Period compared
to $6.6 million for the 1997 Period. We expect a further reduction in the
amount of capitalized interest in the 1999 Period as a result of the reduction
in our development activities. As such, we expect reported interest expense in
the 1999 Period to increase.
Interest Income. Interest income was $3.9 million for the 1998 Period as
compared to $1.5 million for the 1997 Period, an increase of $2.4 million. The
increase is related to interest income earned on higher average cash balances
during the 1998 Period primarily resulting from the April 1998 offering of the
5.625% Debentures from which we received net proceeds of approximately $72.2
million.
Loss on Sale of Assets. Loss on sale of assets was $651,000 for the 1998
Period as compared to $1.3 million for the 1997 Period. Of the loss on sale of
assets recorded during the 1998 Period, $547,000 resulted from losses
pertaining primarily to additional capital costs incurred during the 1998
Period on sale and leaseback transactions completed in the 1997 Period and
$75,000 related to losses incurred in connection with terminating one
operating lease during the 1998 Period. The remainder of the loss on sale of
assets was attributable to losses incurred in connection with one sale and
leaseback transaction completed during the 1998 Period. We entered into four
sale and leaseback transactions during the 1998 Period as compared to 24 sale
and leaseback transactions during the 1997 Period.
Other Expenses. Other expense was $1.2 million for the 1998 Period as
compared to $121,000 for the 1997 Period. Other expenses during the 1998
Period included $907,000 of financing costs which were expensed during the
period. Of such amount, $614,000 related to financing costs which had been
previously capitalized and deferred in association with a future financing
commitment terminated during the fourth quarter 1998 and the remaining
$293,000 was associated with the termination of a swap agreement at the end of
the third quarter of the 1998 Period. In addition, other expenses during the
1998 Period included $210,000 of administrative fees incurred in connection
with our repurchase of the joint venture partner's interest in the operations
of 21 residences during the period.
Cumulative Effect of Change in Accounting Principle. We adopted AICPA
Statement of Position 98-5, Reporting on the Costs of Start-up Activities
("SOP 98-5") effective January 1, 1998. Under SOP 98-5, start-up costs
associated with the opening of new residences are expensed as incurred. We
recognized a charge of $1.5 million during the 1998 Period associated with
adopting such provision. Prior to the adoption of SOP 98-5, we capitalized
pre-opening costs on our balance sheet and amortized such costs over a 12-
month period.
Net Loss. As a result of the above, net loss (after the cumulative effect of
change in accounting principle and other charges as described above) was $20.7
million or $1.27 per basic and diluted share for the 1998 Period, compared to
$2.5 million, or $0.21 per basic and diluted share for the 1997 Period.
24
Year ended December 31, 1997 compared to year ended December 31, 1996
We incurred a net loss of $2.5 million, or $0.21 per basic and diluted
share, on revenue of $49.6 million for the year ended December 31, 1997 (the
"1997 Period") as compared to a net loss of $1.9 million, or $0.23 per basic
and diluted share, on revenues of $21.0 million for the year ended December
31, 1996 (the "1996 Period").
We had certificates of occupancy for 130 residences, 109 of which were
included in the operating results as of the end of the 1997 Period as compared
to 67 residences with certificates of occupancy, 60 of which were included in
the operating results as of the end of the 1996 Period. Of the residences
included in the operating results as of the end of the 1997 Period, we owned
42 residences and leased 67 residences (51 of which were operating leases and
16 of which were accounted for as financings) as compared to 26 owned
residences and 34 leased residences (25 of which were operating leases and
nine of which were accounted for as financings) as of the end of the 1996
Period.
Revenue. Revenue was $49.6 million for the 1997 Period as compared to $21.0
million for the 1996 Period, an increase of $28.6 million. Of this increase:
. $13.2 million or 46.2% related to the full year impact of the 41
residences (1,544 units) which opened during the 1996 Period;
. $12.7 million or 44.4% related to the opening of an additional 49
residences (1,875 units) during the 1997 Period;
. $1.5 million or 5.2% was attributable to the 19 Same Store Residences
(605 units); and
. the remaining $1.2 million or 4.2% related to ancillary revenues earned
in connection with the acquisition of Home and Community Care, Inc.
("HCI").
Revenue from the Same Store Residences was $12.4 million for the 1997 Period
as compared to $10.9 million for the 1996 Period, an increase of $1.5 million
or 13.8%. All of the increase in revenue for Same Store Residences was
attributable to an increase in average occupancy to 95.6% for the 1997 period
as compared to 90.0% for the 1996 period. The average monthly rental rate for
the Same Store Residences increased to $1,772 for the 1997 Period as compared
to $1,670 per month for the 1996 Period.
Of the $49.6 million in revenues reported for the 1997 Period:
. $21.2 million or 42.8% was attributable to Stabilized Residences;
. $27.2 million or 54.8% was attributable to Start-Up Residences; and
. $1.2 million or 2.4% was attributable to ancillary service operations.
As of the end of the 1997 Period, we had 32 Stabilized Residences (1,063
units) with an average occupancy of 95.1% and an average monthly rental rate
of $1,735 and we had 77 Start-Up Residences (2,961 units) with an average
occupancy of 59.8% and an average monthly rental rate of $1,782.
Residence Operating Expenses. Residence operating expenses were $31.6
million for the 1997 Period as compared to $14.1 million for the 1996 Period,
an increase of $17.5 million. Of this increase:
. $6.1 million or 34.9% related to the full year impact of the 41
residences (1,544 units) which opened during the 1996 Period;
. $10.2 million or 58.3% related to the opening of an additional 49
residences (1,885 units) during the 1997 Period;
. $388,000 or 2.2% was attributable to the 19 Same Store Residences (605
units); and
. the remaining $800,000 or 4.6% related to expenses associated with our
ancillary service operation.
Residence operating expenses for the Same Store Residences were $7.1 million
for the 1997 Period as compared to $6.7 million for the 1996 Period, an
increase of $388,000 or 5.8%. This increase results from the
25
additional expenses incurred in connection with the increase in occupancy at
the Same Store Residences during the period.
Of the $31.6 million in residence operating expenses reported for the 1997
Period, $12.3 million or 38.9% was attributable to Stabilized Residences,
$18.5 million or 58.6% was attributable to Start-Up Residences and $800,000 or
2.5% was attributable to our ancillary service operation.
Corporate General and Administrative. Corporate general and administrative
expenses were $4.1 million for the 1997 Period as compared to $1.9 million for
the 1996 Period. Our corporate general and administrative expenses before
capitalized payroll costs were $5.9 million for the 1997 Period as compared to
$3.0 million for the 1996 Period, an increase of $2.9 million. This increase
results from an additional investment in our corporate and regional
infrastructure to support the development and operation of new residences
including the expansion into new states.
We capitalized $1.8 million of payroll costs for the 1997 Period as compared
to $1.1 million for the 1996 Period resulting from an increase in development
activities.
Building Rentals. Building rentals were $8.0 million for the 1997 Period as
compared to $4.0 million for the 1996 Period, an increase of $4.0 million. Of
this increase, $1.3 million or 32.5% related to the full year impact of the 20
leases (four of which were repurchased) entered into during the 1996 Period
and the remaining $2.7 million or 67.5% related to the 26 leases entered into
during the 1997 Period. The nine leases entered into prior to the 1996 Period
remained relatively unchanged. As of the end of the 1997 Period we had 51
operating leases as compared to 25 operating leases as of the end of the 1996
Period.
Depreciation and Amortization. Depreciation and amortization was $3.7
million for the 1997 Period as compared to $1.1 million for the 1996 Period,
an increase of $2.6 million. Depreciation expense was $2.9 million and
amortization expense was $800,000 for the 1997 Period as compared to $805,000
and $289,000, respectively, for the 1996 Period. The increase in depreciation
is the result of:
. the full year effect of depreciation on the 26 owned residences which
commenced operations during the 1996 Period;
. depreciation associated with the 16 owned residences that commenced
operations during the 1997 Period; and
. depreciation associated with the sale and leaseback of seven residences
during the 1997 Period and nine residences during the 1996 Period which
were accounted for as financings.
Amortization expense increased as a result of the amortization of additional
pre-opening costs and goodwill.
Interest Expense. Interest expense was $4.9 million for the 1997 Period as
compared to $1.2 million for the 1996 Period. Gross interest expense for the
1997 Period was $11.5 million compared to $3.5 million for the 1996 Period, an
increase of $8.0 million. Of the increase:
. $5.3 million or 66.2% was due to construction financing used to fund
development activity during the 1997 Period;
. $1.5 million or 18.7% was related to the sale and leaseback of an
additional seven residences during the 1997 Period which were accounted
for as financings;
. $1.1 million or 13.8% was due to interest expense related to the October
1997 issuance of the 6.0% Debentures; and
. the remaining $100,000 or 1.3% was related to new mortgage financing
incurred during the 1997 Period.
26
We capitalized $6.6 million of interest expense for the 1997 Period compared
to $2.3 million for the 1996 Period. We completed the sale and leaseback of
seven residences during the 1997 Period and nine residences during the 1996
Period, which were accounted for as financings, and recorded building rental
payments as interest expense.
Interest Income. Interest income was $1.5 million for the 1997 Period as
compared to $455,000 for the 1996 Period, an increase of $1.1 million. The
increase is related to interest income earned on higher average cash balances
during the 1997 Period primarily resulting from the October 1997 offerings of
common stock and the 6.0% Debentures from which we received net proceeds of
approximately $155.0 million.
Loss on Sale of Assets. Loss on sale of assets was $1.3 million for the 1997
Period as compared to $854,000 (net of an $82,000 gain on the sale of land)
for the 1996 Period. Of the loss on sale of assets recorded during the 1997
Period, $650,000 or 52.0% resulted from losses incurred in connection with 10
sale and leaseback transactions entered into during the 1997 Period and the
remaining $600,000 or 48.0% resulted from losses resulting primarily from
additional capital costs incurred during the 1997 Period on sale and leaseback
transactions completed in the 1996 Period. We entered into 24 sale and
leaseback transactions during the 1997 Period as compared to 19 sale and
leaseback transactions (four of which were repurchased) during the 1996
Period.
Debenture Conversion Cost. In the third quarter of 1996, $6.1 million of the
$20.0 million of 7% Debentures were converted into 811,333 shares of our
common stock. We incurred a charge of $426,000 during the third quarter of the
1996 Period in connection with the conversion.
Net Loss. As a result of the above, net loss was $2.5 million or $0.21 per
basic and diluted share for the 1997 Period, compared to a net loss of $1.9
million, or $0.23 per basic and diluted share for the 1996 Period.
Liquidity and Capital Resources
We have historically financed our activities with the net proceeds from the
offerings of debt and equity securities, sale and leaseback financing, long-
term mortgage financing and cash flows from operations. At December 31, 1998,
we had $267.7 million of indebtedness outstanding, including $161.3 million of
convertible subordinated debentures. As of December 31, 1998, approximately
89% of our indebtedness bore interest at fixed rates, with a weighted average
interest rate of 6.9%. Our variable rate indebtedness carried an average rate
of 3.6% as of December 31, 1998. As of December 31, 1998, we had working
capital of $43.9 million as compared to $40.1 million as of December 31, 1997.
As of December 31, 1998, our unrestricted cash balance was $55.0 million as
compared to $63.4 million as of December 31, 1997.
Net cash provided by operating activities was $3.0 million for the year
ended December 31, 1998, as compared with $4.5 million provided by operating
activities for the year ended December 31, 1997 and $3.1 million used in
operating activities for the year ended December 31, 1996, respectively.
Net cash used in investing activities was $123.3 million for the year ended
December 31, 1998, as compared with $94.0 million and $82.3 million,
respectively, for the years ended December 31, 1997 and 1996. During the year
ended December 31, 1998, the primary uses of cash were:
. $118.0 million related to the development of new assisted living
residences in Arizona, Iowa, Indiana, Nebraska, New Jersey, Ohio,
Pennsylvania, South Carolina, Florida, Michigan and Washington;
. $11.4 million related to the acquisition of three residences in Texas
and one residence in Louisiana; and
. $4.0 million invested in marketable securities.
27
During the year ended December 31, 1998, we received proceeds of $8.1
million relating to the sale and leaseback of three residences and
restrictions on $2.0 million of funds held in trust were released. In
addition, we converted construction financing on one residence of
approximately $2.2 million into an operating lease through the completion of a
sale and leaseback transaction.
Net cash provided by financing activities was $112.0 million for the year
ended December 31, 1998, as compared with $150.6 million and $87.2 million,
respectively, for the years ended December 31, 1997 and 1996. In April 1998,
we completed the offering of $75.0 million of 5.625% Debentures due May 2003
realizing net proceeds of $72.2 million after discounts, commissions and other
expenses. The 5.625% Debentures are convertible at any time at or prior to
maturity, unless previously redeemed, at a conversion price of $26.184 per
common share, which equates to an aggregate of 2,864,345 shares of common
stock. In addition, for the year ended December 31, 1998, we received $49.0
million of proceeds from long-term mortgage financing, including,
. $35.8 million of fixed rate first mortgages secured by 15 assisted
living residences, with an average rate of 8.0% and
. $13.2 million of variable rate financing with Ohio Housing Finance
Agency secured seven residences.
Several of our leases and loan agreements contain restrictive covenants that
generally relate to the use, operation and disposition of the residences that
are leased or, in the case of loan agreements, serve as collateral for the
subject indebtedness. In addition, certain of our leases and loan agreements
contain cross-default provisions such that a default on one of those
instruments could cause us to be in default on one or more other instruments.
During the third quarter of 1999, we amended certain loan agreements with
one of our creditors. Pursuant to the amendment, we agreed to provide $8.3
million of additional cash collateral in exchange for the waiver of certain
possible defaults, including an amendment to certain financial covenants. In
August 1999, we restricted $8.3 million of cash balances as a result of such
amendment. The amendment also provides for the release of the additional
collateral upon the achievement of specified performance targets, provided
that we are in compliance with the other terms of the loan agreements.
For the twelve months ended December 31, 1998, we commenced operations with
respect to 57 residences (2,297 units), 53 of which were developed and four of
which were acquired. We intend to commence operation on an additional 20
residences (approximately 800 units) during the 1999 Period, 10 of which
commenced operation through June 30, 1999. In addition to the development and
construction costs incurred during 1998 with respect to these residences, we
expect to incur up to an additional $30.0 million in capital expenditures and
related start-up costs for the twelve months ended December 31, 1999,
approximately $25.0 million of which had been incurred as of June 30, 1999. We
expect that Start-Up Residences will incur significant operating losses during
the fill-up period. As a result, our operating income will be adversely
affected by operating losses at certain residences, primarily Start-Up
Residences, which we expect will range from $3.5 million to $5.0 million
during 1999.
During the first quarter of 1999, we made cash payments of approximately
$1.2 million related to severance arrangements and repurchases of restricted
stock.
We believe that our current cash on hand and working capital resources are
sufficient to meet our capital needs for the next 12 to 18 months. However, to
provide us with additional capital, we may explore various financing
alternatives and/or commitments to engage in sale and leaseback transactions.
We currently do not have in place any of such loan or lease commitments. As a
result of the securityholder litigation, the restatement and other factors,
there can be no assurances that financing from any source will be available in
the future, or, if available, that such financing will be available on terms
acceptable to us.
As of December 31, 1998, we had invested excess cash balances in short-term
certificates of deposit and highly liquid marketable debt securities.
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Inflation
We do not believe that inflation has materially adversely affected our
operations. We expect salary and wage increases for our skilled staff will
continue to be higher than average salary and wage increases, as is common in
the health care industry. We expect that we will be able to offset the effects
of inflation on salaries and other operating expenses by increases in rental
and service rates, subject to applicable restrictions with respect to services
that are provided to residents eligible for Medicaid reimbursement.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. SFAS No. 137, issued in June 1999, deferred the effective
date of SFAS No. 133 to all fiscal quarters of fiscal years beginning after
June 15, 2000. We do not expect the adoption of this statement to have a
material impact on our results of operations.
Year 2000
See discussion regarding year 2000 issues in Risk Factors.
29
RISK FACTORS
Set forth below are the risks that we believe are material. This report on
Form 10-K, including the risks discussed below, contains forward-looking
statements made pursuant to the safe harbor provisions of the Private
Securities Reform Act of 1995. Forward-looking statements involve known and
unknown risks, uncertainties and other factors that may cause our actual
results and future events to differ materially from those set forth or
contemplated in the forward-looking statements. Forward-looking statements
depend on assumptions, data or methods which may be incorrect or imprecise.
We face difficulties in stabilizing our operations following our rapid growth.
We have experienced rapid growth since 1994, which has placed significant
demands on our management resources. Our ability to stabilize operations and
manage our business following this growth requires us to continue to expand
our operational, financial and management information systems and to continue
to attract, train, motivate, manage and retain key employees. If we are unable
to manage this growth effectively, our business, financial condition and
results of operations could be adversely affected. Our ability to stabilize
operations and manage our business efficiently has been, and for the
foreseeable future will continue to be, adversely affected by the diversion of
management's time and attention to the pending securityholder litigation and
matters relating to the restatement of our financial statements for prior
reporting periods. See, "--We may incur significant costs and liability as a
result of our securityholder litigation," and "--We may be in technical
default under our loan and lease obligations."
We are highly leveraged; our loan and lease agreements contain financial
covenants
We are highly leveraged. We had total indebtedness, including short term
portion, of $267.7 million as of December 31, 1998 ($235.9 million as of June
30, 1999). In addition, we had shareholders' equity of $119.2 million as of
December 31, 1998 ($101.8 million as of June 30, 1999). The degree to which we
are leveraged could have important consequences, including:
. making it more difficult to satisfy our debt or lease obligations;
. increasing our vulnerability to general adverse economic and in