UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the period ended September 30, 1996
OR
[ ] Transition report pursuant to section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transaction period from ______ to ______
Commission file number: 1-14022
STERLING HOUSE CORPORATION
--------------------------
(Exact name of Registrant as specified in its charter)
KANSAS 48-1097141
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
453 S. WEBB ROAD, SUITE 500
WICHITA, KANSAS 67207
--------------------------
(Address of principal executive offices)
(316) 684-8300
-------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements
for the past 90 days.
YES X NO
As of November 1, 1996, there were 5,038,179 shares of the
Registrant's Common Stock outstanding.
<PAGE>
STERLING HOUSE CORPORATION
INDEX
PART 1. FINANCIAL INFORMATION
PAGE NO.
Item 1. Financial Statements:
Consolidated Balance Sheets at September 30, 3-4
1996 and December 31, 1995.
Consolidated Statements of Operations 5
for the three months and nine months
ended September 30, 1996 and 1995
Consolidated Statements of Cash Flows for 6
the nine months ended September 30, 1996
and 1995
Notes to Consolidated Financial Statements 7-9
Item 2. Management's Discussion and Analysis 10-20
of Financial Condition and Results of
Operations
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of 21
Security Holders
Item 6. Exhibits and Reports on Form 8-K 21-23
Signature Page 24
2
<PAGE>
<TABLE>
Sterling House Corporation
Consolidated Balance Sheets
Assets
(Unaudited)
<CAPTION>
September 30, 1996 December 31, 1995
___________________ _________________
<S> <C> <C>
Current assets:
Cash and cash equivalents $16,182,596 $17,396,355
Accounts receivable:
Construction due from REIT 16,655,582 ---
Trade 190,269 157,616
Affiliates 11,655 90,785
Other 141,648 309,652
Prerental costs (net of amortization) 1,143,926 242,285
Deferred income taxes 161,713 161,713
Principal and interest funds in trust 287,182 299,671
Other 259,436 283,274
----------- -----------
Total current assets 35,034,007 18,941,351
Property and equipment:
Land and improvements 2,124,482 3,714,642
Buildings 13,493,465 14,977,356
Vehicles and equipment 580,555 393,599
Furniture, fixtures and office equipment 1,605,308 1,273,480
Construction in progress 19,961,443 3,102,364
Leasehold rights and improvements 1,732,625 511,996
----------- -----------
39,497,878 23,973,437
----------- -----------
Less accumulated depreciation (727,328) (406,353)
----------- -----------
Net property and equipment 38,770,550 23,567,084
Other assets:
Deferred financing costs 1,537,240 ---
Deferred income taxes 447,901 447,901
Other 1,253,746 608,104
----------- -----------
Total other assets 3,238,887 1,056,005
----------- -----------
Total assets $77,043,444 $43,564,440
=========== ===========
</TABLE>
See accompanying notes.
3
<PAGE>
<TABLE>
Sterling House Corporation
Consolidated Balance Sheets
Liabilities and Stockholders' Equity
(Unaudited)
<CAPTION>
September 30, 1996 December 31, 1995
__________________ _________________
<S> <C> <C>
Current liabilities:
Short-term borrowings $ --- $ 6,726,428
Accounts payable 7,974,203 1,832,100
Accrued expenses:
Salaries and benefits 493,997 255,316
Interest 1,033,517 284,620
Other 964,447 133,584
Deferred income taxes 23,475 23,475
Unearned rent and refundable deposits 235,351 189,509
Current maturities of long-term debt
and bonds payable 206,966 277,966
----------- -----------
Total current liabilities 10,931,956 9,722,998
Bonds payable and long-term debt 4,651,335 6,561,808
Convertible debt 35,000,000 ---
Deferred income taxes 1,375,900 1,662,471
Deferred compensation 388,129 412,550
Other 28,217 ---
----------- -----------
Total liabilities 52,375,537 18,359,827
Stockholders' equity:
Preferred stock; no par value
20,000,000 shares authorized,
none issued and outstanding --- ---
Common stock; no par value; 75,000,000 shares
authorized, 5,038,179 and 5,035,000 shares
issued and outstanding, respectively 28,201,753 28,184,228
Accumulated deficit (3,533,846) (2,979,615)
----------- -----------
Total stockholders' equity 24,667,907 25,204,613
----------- -----------
Total liabilities and stockholders'
equity $77,043,444 $43,564,440
=========== ===========
</TABLE>
See accompanying notes.
4
<PAGE>
<TABLE>
Sterling House Corporation
Consolidated Statements of Operations
(Unaudited)
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1996 1995 1996 1995
________________________ _________________________
<S> <C> <C> <C> <C>
Revenues:
Residence rental $4,178,890 $390,560 $9,933,366 $687,764
Development fees affiliates: --- 67,699 --- 235,972
Initial franchise and royalty fees:
Affiliates 14,807 83,427 43,633 151,230
Other 46,570 7,366 98,267 85,477
Management and service fees:
Affiliates --- 95,520 --- 233,982
Other 12,527 56,266 65,493 111,675
Construction services:
Affiliates --- 85,243 --- 213,131
Other 46,887 198,900 110,010 497,306
--------- ---------- ---------- ----------
Total revenue 4,299,681 984,981 10,250,769 2,216,537
Operating expenses:
Residence operating expenses 2,906,799 270,067 6,703,358 472,329
General and administrative 708,356 463,650 1,899,639 1,281,045
Construction costs 16,839 182,239 45,084 544,305
Building rental 829,231 --- 1,944,754 ---
Depreciation and amortization 306,604 92,460 777,483 184,718
Equity in net loss from investments
in unconsolidated affiliates --- 87,196 --- 239,236
---------- ---------- ---------- ----------
Total operating expenses 4,767,829 1,095,612 11,370,318 2,721,633
Loss from operations (468,148) (110,631) (1,119,549) (505,096)
Other income (expenses):
Interest income 353,788 2,944 888,050 8,286
Interest expense (252,515) (115,874) (585,315) (192,095)
Minority interest in
loss of subsidiaries --- (15,316) --- (9,742)
Other (3,733) (1,653) (23,990) 12,241
---------- ---------- ---------- ----------
Total other income (expense) 97,540 (129,899) 278,745 (181,310)
---------- ---------- ---------- ----------
Loss before income taxes (370,608) (240,530) (840,804) (686,406)
---------- ---------- ---------- ----------
Benefit for income taxes 147,286 --- 286,571 ---
---------- ---------- ---------- ----------
Net loss $(223,322) $(240,530) $(554,233) $(686,406)
========== ========== ========= ==========
Net loss per common share $ (0.04) $ (0.11) $ (0.11) $ (0.30)
========== ========== ========= ==========
Weighted average number of shares
outstanding during the period 5,037,095 2,281,416 5,036,250 2,281,416
========== ========== ========= ==========
</TABLE>
See accompanying notes.
5
<PAGE>
<TABLE>
Sterling House Corporation
Consolidated Statements of Cash Flows
(Unaudited)
<CAPTION>
Nine months ended
September 30,
1996 1995
__________________________________
<S> <C> <C>
Operating activities
Net loss $(554,233) $(686,406)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 899,744 184,718
Amortized deferred financing costs 29,957 ---
Deferred income taxes (286,571) ---
Equity in net loss from investments in
unconsolidated affiliates --- 239,236
Minority interest in loss of subsidiaries --- 9,742
Gain on sale of assets --- (4,750)
Net change in operating assets and liabilities:
Accounts receivable 214,481 129,043
Prerental costs (1,272,106) (129,406)
Accrued expenses 1,278,321 49,567
Unearned rent and refundable deposits 45,842 65,585
Accounts payable (1,323,764) 522,405
Deferred compensation (24,421) ---
Other 404,520 (73,654)
----------- ---------
Net cash provided by (used in) operating activities (588,230) 306,080
Investing activities:
Purchase of property and equipment (44,638,106) (6,004,952)
Proceeds from sale/leaseback transactions 20,288,617 1,592,529
Proceeds from sale of property and equipment --- 7,500
Acquisition of Abilene, net of cash acquired --- (268,736)
Investment in unconsolidated affiliates --- (37,440)
Minority interest --- 42,246
Other (774,453) (7,857)
----------- ---------
Net cash used in investing activities (25,123,942) (4,676,710)
Financing Activities
Net change in line of credit --- 197,800
Proceeds from short-term borrowings 5,749,008 ---
Principal payments on short-term borrowings (12,475,436) (552,906)
Principal payments on bonds, long-term debt
and capital lease obligations (1,979,519) (160,099)
Convertible debt issued 35,000,000 ---
Proceeds from issuance of long-term debt --- 5,256,060
Expenditures for financing costs (1,602,000) (311,911)
Capital distributions to minority members --- (60,298)
Net change in bond reserve funds in trust (211,165) ---
Other 17,525 (104,045)
----------- ---------
Net cash provided by financing activities 24,498,413 4,264,601
----------- ---------
Net decrease in cash (1,213,759) (106,029)
Cash at beginning of period 17,396,355 585,089
----------- ---------
Cash at end of period $16,182,596 $479,060
=========== =========
</TABLE>
See accompanying notes.
6
<PAGE>
STERLING HOUSE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1) GENERAL
The accompanying unaudited interim financial statements of Sterling
House Corporation (the "Company") have been prepared pursuant to the rules
and regulations of the Securities and Exchange Commission (the "SEC").
Certain information and note disclosures normally included in annual
financial statements have been condensed or omitted pursuant to those rules
and regulations. In the opinion of management, all adjustments, consisting
of normal, recurring adjustments considered necessary for a fair
presentation, have been included. Although management believes that the
disclosures made are adequate to ensure that the information presented is
not misleading, it is suggested that these financial statements be read in
conjunction with the financial statements and notes thereto included in
the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995. The results of the three and nine months ended
September 30, 1996 and 1995 are not necessarily indicative of the results
of operations for the entire year.
2) ACCOUNTS RECEIVABLE
Construction due from REITs receivables represents receivables from
certain real estate investment trusts (the "REITs") for construction draws
on residences that are being constructed by the Company for the REITs and
leased to the Company. Such receivables represent unreimbursed
construction costs incurred by the Company during the construction phase.
These costs will be reimbursed to the Company by the REITs throughout
the construction phase of the residence, which is generally five to eight
months. At September 30, 1996 and December 31, 1995, the balances for
such receivables from the REITs totaled approximately $16,700,000 and $0,
respectively. Trade receivables include residence billings, franchise fees,
franchisee construction receivables, and other fee receivables which
totaled approximately $190,000 at September 30, 1996 and $158,000 at
December 31, 1995.
3) ACQUISITIONS AND DISPOSITION OF ASSETS
On February 29, 1996, the Company entered into a sale/leaseback
transaction with Health Care REIT, Inc. ("HCRI") for its Bartlesville,
Midwest City, Enid, Stillwater, and Shawnee, Oklahoma residences. The
Company received approximately $7,400,000 for the five residences which
had a book value at the date of the sale of approximately $7,600,000,
resulting in a $200,000 loss which is being deferred and amortized over the
initial term of the lease. The loss incurred in this transaction is due to
the step-up in the basis of the assets as a result of the Reorganization
7
<PAGE>
STERLING HOUSE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
3) ACQUISITIONS AND DISPOSITION OF ASSETS (CONT.)
Transaction as described in Management's Discussion and Analysis of
Financial Condition and Results of Operations on page 11 hereof. On April
18, 1996, the Company entered into another sale/leaseback transaction with
HCRI for its Oklahoma City SW and Chickasha, Oklahoma residences. The
Company received approximately $2,960,000 for the two residences resulting
in a gain of approximately $334,000 which is also being deferred and
amortized over the initial term of the lease. The terms of the transactions
are similar to those as described under "Sales/Leaseback Agreement," in
note 10 to the audited consolidated financial statements filed in the
Company's 1995 Annual Report on Form 10-K, and also as described in Item 7
- - Management's Discussion and Analysis of Financial Condition and Results
of Operations, filed in the Company's 1995 Annual Report on Form 10-K. The
annual lease expense to be borne by the Company under the terms of these
agreements will total approximately $992,000.
On March 26, 1996, the Company entered into an agreement with
Meditrust to lease three assisted living residences previously owned by
franchisees of the Company, as well as entering into sale/leaseback
transactions for two Company-owned residences located in Wichita, Kansas
and Bethany, Oklahoma. The total aggregate amount financed with Meditrust
for the five residences was approximately $7,500,000. Concurrently with
this transaction, the franchisees, Masters Associates, L.L.C., the owner of
the Derby, Kansas residence, Hays Assisted Living, L.L.C., the owner of the
Hays, Kansas residence, and Wellington Partners, L.L.C., the owner of the
Wellington, Kansas residence, contemporaneously sold all of their assets
(principly consisting of their real property, building, improvements,
furniture and equipment) to Meditrust. The Company has reported this
transaction on Forms 8-K dated March 26, 1996 (filed April 8, 1996) and 8-
K/A dated March 26, 1996 (filed June 10, 1996). The lease terms for this
agreement are similar to those described under Management's Discussion and
Analysis of Financial Condition and Results of Operations "Liquidity and
Capital Resources" reported herein. The annual lease expense to be
incurred by the Company under the terms of the agreement will total
approximately $952,000.
On July 31, 1996 the Company purchased, from High Plains Senior
Living, Inc. ("HPSLI"), the land, building, and other fixed assets of
Woodland Terrace, a 45 unit retirement and assisted living residence
located in Liberal, Kansas. The purchase was effective August 1, 1996 and
the purchase price of approximately $2,200,000 was paid in cash and
8
<PAGE>
STERLING HOUSE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
3) ACQUISITIONS AND DISPOSITION OF ASSETS (CONT.)
accounted for as a purchase. This acquisition was reported by the Company
on Forms 8-K dated August 1, 1996 (filed August 12, 1996) and 8-K/A dated
August 1, 1996 (filed October 15, 1996).
The following supplemental pro forma information presents the combined
results of operations of the Company and the franchised residences acquired
through the Meditrust transaction and the residence acquired from HPSLI as
though the acquisitions occurred at the beginning of the periods shown.
For the three months For the nine months
ended September 30, ended September 30,
____________________ ____________________
1996 1995 1996 1995
____ ____ ____ ____
Revenues $4,632,298 $1,326,341 $10,946,209 $2,981,468
Net Loss (386,761) (419,134) (667,893) (1,179,375)
Net loss per common share (0.08) (0.18) (0.13) (0.52)
Weighted average number
of shares of common
stock outstanding 5,037,905 2,281,416 5,036,250 2,281,416
These pro forma amounts represent the historical operating results of
the acquired residences combined with those of the Company with
appropriate adjustments which give effect to interest expense, depreciation
and amortization, lease expense and intercompany balances. These pro forma
amounts are not necessarily indicative of operating results which would
have occurred if the acquisitions had occurred at the beginning of the
periods presented.
4) CONVERTIBLE DEBT
On May 23, 1996, the Company sold at par $35,000,000 of 6.75%
convertible subordinated debentures due June 30, 2006. The debentures were
sold in a private placement to selected entities which qualified as either
"accredited investors" or as "qualified institutional buyers." The
debentures, noncallable for three years, are convertible into shares of
common stock of the Company at the conversion price of $22.42 per share,
which equates in aggregate to approximately 1,561,106 shares.
On November 1, 1996, the Company filed a Form S-3 Registration
Statement with the SEC with respect to the debentures and the common stock
issuable upon conversion of the debentures. The Company will not receive
any of the proceeds from the sale of debentures or the underlying common
stock.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION
GENERAL. Through the first nine months of 1996, the Company has
continued its efforts to expand its market share in the assisted living
residence segment of the long-term care industry through development,
construction, and acquisition of assisted living residences.
On May 23, 1996, the Company increased its funds available for
development, construction and acquisitions of assisted living residences
by selling at par $35,000,000 of 6.75% convertible subordinated
debentures due June 30, 2006 ("the Debentures"). The Debentures were sold
in a private placement to selected entities which qualified as either
"accredited investors" or as "qualified institutional buyers." The
debentures, noncallable for three years, are convertible into shares of
common stock of the Company at the conversion price of $22.42 per share,
which equates in aggregate to approximately 1,561,106 shares. The Company
intends to use the net proceeds of approximately $33,400,000 from the
Debentures for the development and construction, and to a lesser extent,
the acquisition of additional assisted living residences. On November 1,
1996, the Company filed a Form S-3 Registration Statement with the SEC with
respect to the debentures and the common stock issuable upon conversion of
the Debentures. The Company will not receive any of the proceeds from the
sale of the Debentures or the underlying common stock.
During the third quarter, the Company acquired the land, building, and
other fixed assets of Woodland Terrace, a 45 unit retirement and assisted
living residence located in Liberal, Kansas. This increased the number of
Sterling House operating residences in Kansas to 14 containing 422 units
and 1 additional residence containing 42 units under construction. The
Company began operations in the State of Texas in the second quarter of
1996 and has now begun operations in the State of Florida by opening the
Stuart and Vero Beach, Florida residences during the third quarter of 1996.
The Company continued to expand its operations by opening two more Texas
residences in Waxahachie and Texarkana, Texas and four Oklahoma residences
in Muskogee, Claremore, Oklahoma City and Ada, Oklahoma.
The acquisition and opening of the new residences brings the total
number of residences open and operating at September 30, 1996 to 50, of
which 41 are owned/leased by the Company and 9 are franchised or managed
residences.
The Company opened 8 residences containing 306 units during the three
months ended September 30, 1996 and 20 residences containing 726 units
during the nine months ended September 30, 1996.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION (CONT.)
GENERAL (CONT.)
The following table presents the number of owned/leased, managed or
franchised residences and the number of residences under construction and
under development, by state, as of September 30, 1996 and 1995.
<TABLE>
<CAPTION>
Owned/ Managed/ Under Under
Leased Franchised Construction Development
Residences by State: 1996 1995 1996 1995 1996 1995 1996 1995
---------- ----------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Kansas 14 10 8 9 1 0 0 0
Oklahoma 19 3 0 0 4 8 1 4
Texas 6 0 0 0 17 0 2 0
Florida 2 0 0 0 7 0 11 0
Colorado 0 0 1 0 0 0 7 0
Ohio 0 0 0 0 4 0 9 0
-- -- -- -- -- -- -- --
Total residences 41 13 9 9 33 8 30 4
== == == == == == == ==
Total units 1,372 384 346 315 1,309 268 1,294 136
===== === === === ===== === ===== ===
</TABLE>
The Company plans to finance its development and construction of new
residences primarily through the proceeds of the Debentures and through the
use of financing agreements involving the sale and immediate lease of the
land, building and equipment used at the residences.
In connection with the Company's initial public offering, filed on
Form S-1 dated October 26, 1995, the Company entered into a reorganization
transaction with various individuals, limited liability companies and
limited partnerships of which the Company owned majority or minority
interests, whereby the Company acquired all the stock of Sterling House of
Augusta, Inc. and all of the assets of such limited liability companies and
limited partnerships (Sterling House of Abilene, L.P., Sterling House of
Wichita, L.P., Sterling House of Bethany, L.L.C., Sterling Group, L.L.C.,
Scotia, L.L.C. and Corridor Properties, L.L.C.) (the "Reorganization
Transaction").
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION (CONT.)
GENERAL (CONT.)
The following table sets forth the number of residences and units
owned/leased or managed/franchised and the stabilized occupancy and private
pay percentages as of December 31, 1993, 1994, and 1995 and September 30,
1995 and 1996.
<TABLE>
<CAPTION>
December 31, September 30,
1993 1994 1995 1995 1996
____________________ _______________
<S> <C> <C> <C> <C> <C>
Residences (end of period)
Owned/Leased(1) 3 9 17 13 41
Managed/Franchised 1 6 10 9 9
-- -- -- -- --
Total 4 15 27 22 50
== == == == ==
Units (end of period)
Owned/Leased 73 250 516 384 1,372
Managed/Franchised 37 207 358 315 346
--- --- --- --- -----
Total 110 457 874 699 1,718
=== === === === =====
Stabilized Occupancy
Percentage (2) 100% 95% 96% 95% 96%
Units private pay 100% 100% 100% 100% 100%
Average monthly rent/unit(3) $1,355 $1,505 $1,618 $1,564 $1,629
</TABLE>
(1) Prior to the Reorganization Transaction, residences were owned by limited
partnerships, limited liability companies, or a corporation.
(2) Stabilized occupancy percentage represents the occupancy at the periods
presented and only includes those residences that have been operating in
excess of nine months or that have reached an occupancy rate of 95%
(Does not include Managed/Franchised units).
(3) Does not include community fees.
Except for the historical information contained herein, the matters
discussed in this Management's Discussion and Analysis of Financial
Condition and Results of Operations are forward looking statements that
involve risks and uncertainties that could cause actual results to differ
materially, including, without limitation, risks associated with the
Company's ability to develop, construct, acquire or franchise additional
assisted living residences in accordance with the Company's development
schedule, management of quarter to quarter results, and other risks
detailed from time to time in the Company's SEC reports. The risk factors
and information set forth in "Risk Factors" in the Company's S-1
Registration Statement dated October 26, 1995 and the Company's S-3
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION (CONT.)
GENERAL (CONT.)
Registration Statement dated November 1, 1996, along with the information
contained in the Company's 1995 Form 10-K, should be carefully considered
in the evaluation of the Company, its business and its investment value.
Updated information will be periodically provided by the Company as
required by the Securities Exchange Act of 1934.
RESULTS OF OPERATIONS
Three months ended September 30, 1996 and 1995
- ----------------------------------------------
REVENUES. Total revenue for the three months ended September 30,
1996 increased to $4,300,000 compared to $985,000 for the three months
ended September 30, 1995, an increase of $3,315,000 or 337%. This increase
was primarily attributable to an increase of $3,788,000 in residence
rentals as a result of the 330 rental units acquired in the Reorganization
Transaction and the 988 new rental units that have been developed or
acquired by the Company since September 30, 1995. Other revenues decreased
$473,000 from $594,000 during the third quarter of 1995 to $121,000 during
the third quarter of 1996. The overall decrease in other revenues is
primarily due to the Company's efforts in further developing Company owned
residences, primarily through new construction and acquisitions, and
placing less emphasis on revenue from developing, managing and constructing
franchise residences. The Company expects that franchise and royalty fees,
which have historically produced higher margins, will continue to decline
as a percentage of the Company's total revenue.
RESIDENCE OPERATING EXPENSES. Residence operating expense increased
to $2,907,000 for the three months ended September 30, 1996, compared to
$270,000 for the three months ended September 30, 1995, an increase of
$2,637,000 or 977%. The increase is attributable to the increase in
residences as described above. During the three month period ended
September 30, 1996, the Company has opened residences with an increased
number of rental units, resulting in higher operating expenses, primarily
property expenses, during the stabilization period of these residences.
Included in residence operating expenses are general and administrative
overhead charges for each residence equal to 2% of their residence rental
revenue and a $500 per month internal bookkeeping charge.
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION (CONT.)
RESULTS OF OPERATIONS (CONT.)
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses increased to $708,000 in the third quarter of 1996 from $464,000
during the same period last year, an increase of $244,000 or 53%. The
increase is primarily attributable to the increase in payroll costs and
associated costs relating to the expansion in the number of management and
support personnel to facilitate the Company's increase in residences and
growing development program. Other increases came in the areas of
marketing, advertising, professional fees, and other expenses related to
being a publicly traded company.
COST OF CONSTRUCTION SERVICES. Cost of construction services
decreased to $17,000 from $182,000 during the same period in 1995. The
decrease was attributable to a decrease in such services to franchisees.
BUILDING RENTALS. Building rental increased to $829,000 in the third
quarter of 1996, up from $0 during the same period in 1995. Such costs
reflect the operating leases entered into during the fourth quarter of 1995
and additional operating leases entered into during the first three
quarters of 1996. The Company had 5 residences under such operating
leases at the end of 1995, and entered into an additional 24 operating
leases during the first three quarters of 1996 making a total of 29
residences currently operating under an operating lease agreement.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization
increased to $307,000 for the three months ended September 30, 1996,
compared to $92,000 for the three months ended September 30, 1995, an
increase of $214,000 or 230%. This increase is primarily attributable to
the increase in prerental cost amortization during the current period.
Prerental cost amortization was $181,0000 for the three months ended
September 30, 1996, compared to $18,000 for the three months ended
September 30, 1995, an increase of $163,000. Prerental costs represent
preopening marketing, employee recruitment and training, and other start-up
expenditures necessary to prepare the residence for rent. These prerental
costs are amortized over a 12 month period commencing the month the
residence opens. Prerental costs (net of amortization) was approximately
$1,144,000 at September 30, 1996, compared to approximately $242,000 at
September 30, 1995, an increase of approximately $902,000 or 373%. The
increase in prerental costs is primarily attributable to two factors:
first, the Company opened 20 residences during the first nine months of
1996 compared to two residences opened in the first nine months of 1995, an
increase of 18 residences; second, the Company has experienced higher
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION (CONT.)
RESULTS OF OPERATIONS (CONT.)
prerental costs on a per residence basis as it has begun operations in the
markets of Florida and Texas. In the first nine months of 1996, the
Company incurred prerental costs averaging approximately $52,000 per
residence, which represents a significant increase over expenditures
incurred per residence during the same period in 1995. Management
anticipates that prerental costs per residence will continue to be higher
than the amounts incurred in 1995, as a result of the higher costs in the
new markets the Company is entering, and that the amortization of these
prerental costs will continue to impact the Company's results of
operations.
Depreciation and other amortization expense was $126,000 for the three
months ended September 30, 1996, compared to $74,000 for the three months
ended September 30, 1995, an increase of $42,000 or 70%. The increase is
attributable to the residences acquired in the Reorganization Transaction and
the depreciation related to the property and equipment acquired since
September 30, 1995.
EQUITY IN NET LOSS FROM INVESTMENTS IN UNCONSOLIDATED AFFILIATES.
Equity in net loss from investments in unconsolidated affiliates decreased
to $0 in the third quarter of 1996 from $87,000 during the third quarter of
1995. The Company's investments in its unconsolidated affiliates were
terminated on October 26, 1995, as the minority interests were acquired in
the Reorganization Transaction.
INTEREST INCOME. Interest income increased to $354,000 during the
third quarter of 1996 up from $3,000 during the third quarter of 1995. The
increase was attributable to the temporary investment of the remaining
public offering proceeds and the proceeds from the Debentures invested in
U.S. Treasury Securities.
INTEREST EXPENSE. Interest expense increased to $253,000 during the
third quarter of 1996, up from $116,000 during the third quarter of 1995.
The increase was attributable to the assumption of debt associated with the
residences acquired in the Reorganization Transaction and the interest
incurred relating to the Debentures.
INCOME TAXES. In the third quarter of 1996, the Company recorded a
tax benefit of $147,000 compared to $0 during the same period in 1995.
This benefit recognizes the effect of the residences acquired in the
Reorganization Transaction, whereby the Company accounted for the
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION(CONT.)
RESULTS OF OPERATIONS (CONT.)
acquisition under the purchase method of accounting, and, as required by
FAS 109, the basis differences between the allocated fair value for book
purposes and the assumed historical tax basis required the Company to
establish the necessary deferred tax liabilities for these temporary
differences. As such, the Company's deferred tax liability position
allowed the Company to recognize a tax benefit for the pre-tax operating
losses generated in the subsequent periods. During the third quarter of
1995, no tax benefit was received for the losses incurred because the
Company was in a net deferred tax asset position which required such
benefits to be reduced by valuation allowances.
Nine months ended September 30, 1996 and 1995
- ---------------------------------------------
REVENUES. The Company's total revenue for the nine months ended
September 30, 1996, was $10,251,000 compared to $2,217,000 for the same
period in 1995, an increase of $8,034,000 or 362%. This increase is
primarily attributable to an increase of $9,246,000 in residence rentals as
a result of the 330 rental units, acquired in the Reorganization
Transaction and the 988 new rental units, that have been developed and
acquired by the Company since September 30, 1995. The overall decrease in
other revenues is primarily due to the Company's efforts to rapidly develop
Company owned residences, primarily through new construction and
acquisitions, and the Company's decreasing emphasis on revenue from
developing, managing, and constructing franchise residences. The Company
expects that franchise and royalty fees, which have historically produced
higher margins, will continue to decline as a percentage of the Company's
total revenue.
RESIDENCE OPERATING EXPENSES. Residence operating expense increased
to $6,703,000 for the nine months ended September 30, 1996, compared to
$472,000 for the nine months ended September 30, 1995, an increase of
$6,231,000 or 1320%. The increase is attributable to the increase in
residences as described above. During the nine month period ended
September 30, 1996, the Company has opened residences with an increased
number of rental units, resulting in higher operating expenses, primarily
property expenses, during the stabilization period of these residences.
Included in residence operating expenses are general and administrative
overhead charges for each residence equal to 2% of their residence rental
revenue and a $500 per month internal bookkeeping charge.
16
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION (CONT.)
RESULTS OF OPERATIONS (CONT.)
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses increased to $1,900,000 in the first nine months of 1996 from
$1,281,000 during the same period last year, an increase of $619,000 or
48%. The increase is primarily attributable to the increase in payroll
costs and associated costs relating to the expansion in the number of
management and support personnel to facilitate the Company's increase in
residences and growing development program. Other increases came in the
areas of marketing, advertising, professional fees, and other expenses
related to being a publicly traded company.
COST OF CONSTRUCTION SERVICES. Cost of construction services
decreased to $45,000 from $544,000 during the same period in 1995. The
decrease is attributable to a decrease in such services to franchisees.
BUILDING RENTALS. Building rental increased to $1,945,000 in the
first nine months of 1996, up from $0 during the same period in 1995.
Such costs reflect the operating leases entered into during the third and
fourth quarters of 1995 and additional operating leases entered into during
the first nine months of 1996. The Company had 5 residences under such
operating leases at the end of 1995, and entered into an additional 24
operating leases during the first nine months of 1996, resulting in a total
of 29 residences currently operating under an operating lease agreement.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization
increased to $777,000 for the nine months ended September 30, 1996,
compared to $185,000 for the nine months ended September 30, 1995, an
increase of $592,000 or 320%. This increase is primarily attributable to
the increase in prerental cost amortization during the current period.
Prerental cost amortization was $370,000 for the nine months ended
September 30, 1996, compared to $27,000 for the nine months ended September
30, 1995, an increase of $343,000. Prerental costs represent preopening
marketing, employee recruitment and training, and other start-up
expenditures necessary to prepare the residence for rent. These prerental
costs are amortized over a 12 month period commencing in the month the
residence opens. Prerental costs net of amortization) was approximately
$1,144,000 at September 30, 1996, compared to approximately $242,000 at
September 30, 1995, an increase of approximately $902,000 or 373%. The
increase in prerental costs is primarily attributable to two factors. The
Company opened 20 residences during the first nine months of 1996 compared
to two residences opened in the first nine months of 1995, an increase of
18 residences. In addition, the Company has experienced higher prerental
17
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION (CONT.)
RESULTS OF OPERATIONS (CONT.)
costs on a per residence basis as it has begun operations in the markets of
Florida and In the first nine months of 1996, the Company incurred
prerental costs averaging approximately $52,000 per residence, which
represents a significant increase over expenditures incurred per residence
during the same period in 1995. Management anticipates that prerental
costs per residence will continue to be higher than the amounts incurred in
1995, as a result of the higher costs in the new markets the Company is
entering, and that the amortization of these prerental costs will continue
to impact the Company's results of operations.
Depreciation and other amortization expense was $407,000 for the nine
months ended September 30, 1996, compared to $158,000 for the nine months
ended September 30, 1995, an increase of $250,000 or 158%. The increase is
attributable to the residences acquired in the Reorganization Transaction
and the depreciation related to the property and equipment acquired since
September 30, 1995.
EQUITY IN NET LOSS FROM INVESTMENTS IN UNCONSOLIDATED AFFILIATES.
Equity in net loss from investments in unconsolidated affiliates decreased
to $0 in the first nine months of 1996 from $239,000 during the first nine
months of 1995. The Company's investments in its unconsolidated affiliates
were terminated on October 26, 1995, as the minority interests were
acquired in the Reorganization Transaction.
INTEREST INCOME. Interest income increased to $888,000 during the
first nine months of 1996 up from $8,000 during the first nine months of
1995. The increase is attributable to the temporary investment of the
remaining public offering proceeds and the proceeds from the Debentures
invested in U.S. Treasury Securities.
INTEREST EXPENSE. Interest expense increased to $585,000 during the
first nine months of 1996, up from $192,000 during the first nine months of
1995. The increase is attributable to the assumption of debt associated
with the residences acquired in the Reorganization Transaction and the
interest incurred relating to the Debentures.
INCOME TAXES. In the first nine months of 1996, the Company recorded
a tax benefit of $287,000 compared to $0 during the same period in 1995.
This benefit recognizes the effect of the residences acquired in the
Reorganization Transaction, whereby the Company accounted for the
acquisition under the purchase method of accounting, and, as required by
18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION (CONT.)
RESULT OF OPERATIONS (CONT.)
FAS 109, the basis differences between the allocated fair value for book
purposes and the assumed historical tax basis required the Company to
establish the necessary deferred tax liabilities for these temporary
differences. As such, the Company's deferred tax liability position
allowed the Company to recognize a tax benefit for the pre-tax operating
losses generated in the subsequent periods. During the first nine months
of 1995, no tax benefit was received for the losses incurred because the
Company was in a net deferred tax asset position which required such
benefits to be reduced by valuation allowances.
LIQUIDITY AND CAPITAL RESOURCES
Working capital at September 30, 1996 was approximately $24,102,000,
an increase of $14,884,000 from $9,218,000 at December 31, 1995. Net cash
used in operating activities totaled $588,000 which was primarily due to
the prerental costs and higher operating expenses during the stabilization
period associated with the development and opening of new residences. Net
cash used in investing activities was $25,124,000, resulting primarily from
the addition of $44,638,000 in property and equipment and offsetting
proceeds of $20,289,000 from sale/leaseback transactions during the first
nine months of 1996. Net cash provided from financing activities totaled
$24,498,000 which was primarily the result of paying off the debt
associated with the residences that were sold during the year and the net
proceeds of approximately $33,400,000 received from the issuance of the
Debentures.
The Company continues to utilize sale/leaseback transactions with
REITs as a primary source of financing the development, construction and,
to a lesser extent, acquisitions of assisted living residences. The
initial terms of the leases vary from 10 to 15 years and the rates vary
from 3.25% to 3.75% over the ten year U.S. Treasury Notes prevailing at the
time of each transaction. The minimum lease payments will increase each
year based on the increase in the Consumer Price Index from the previous
year. The Company entered into two additional agreements with REITs during
the third quarter of 1996. On August 13, 1996, the Company signed an
additional commitment with LTC Properties, Inc. for $20,000,000 of
additional sale/leaseback financing. The other commitment was signed on
September 25, 1996, with Nationwide Health Properties, Inc., ("NHP") for
$50,000,000 in sale/leaseback financing. The terms of both agreements are
similar to those described above. The commitment with NHP is contingent
upon the Company selling four residences to NHP by November 29, 1996. The
19
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION (CONT.)
LIQUIDITY AND CAPITAL RESOURCES (CONT.)
Company plans to make every effort necessary to accomplish this and
believes the residences will be sold by that date. On October 31, 1996,
the Company had commitments with four REITs to sell and leaseback assisted
living residences during the remainder of 1996 and through 1997. These
commitments totaled $172,800,000 in available sale/leaseback financing.
As of September 30, 1996, the Company had invested cash balances in
U.S. Treasury Securities. Capital expenditures are estimated to total
approximately $30,000,000 for the remaining months in 1996.
The Company believes that funds available from existing working
capital and sale/leaseback financing commitments, will provide adequate
capital to fund the Company's existing debt service and its development,
construction and, to a lessor extent, acquisition of additional assisted
living residences over the next 12 months, including, as a part of its
overall development plan, the 33 residences under construction and the 30
residences to be developed on the sites for which the Company has purchase
contracts. However, additional financing may be necessary in order to meet
the Company's development plan if such plan is modified or if certain
assumptions of the development plan prove to be inaccurate.
20
<PAGE>
PART II. OTHER INFORMATION
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's Annual Meeting of Stockholders held on May 24, 1996,
the following individuals were elected to the Board of Directors until the
1999 Annual Meeting of Stockholders:
Votes for Votes Withheld
--------- --------------
Diana M. Laing 4,470,706 100
Ronald L. Mercer 4,470,706 100
The terms of Dr. D. Ray Cook and Mr. Michael F. Bushee as Directors of
the Company continued after the meeting and will expire at the 1997 Annual
Meeting of Stockholders. The terms of Messrs. Timothy J. Buchanan and
Steven L. Vick as Directors of the Company continued after the meeting and
will expire at the 1998 Annual Meeting of Stockholders.
The following proposal was approved at the Company's Annual Meeting:
Affirmative Negative Votes
Votes Votes Withheld
----------- -------- --------
1. Ratify the appointment of
Ernst & Young LLP as
independent auditors for
the fiscal year ending
December 31, 1996. 4,470,506 300 0
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
See Index to Exhibits
B. Reports on Form 8-K
During the first three quarters of 1996, the Company filed the
following reports on Form 8-K:
(i) Current Report on Form 8-K/A dated March 26, 1996 (filed June 10,
1996) reporting information required to be reported under Item
7(a) Financial Statements, Pro Forma Financial Information and
Exhibits. The following financial statements of Sterling
Franchise Acquisition Group were filed:
21
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (CONT.)
Report of Independent Auditors
Combined Balance Sheets at December 31, 1994 and 1995
Combined Statements of Operations for the years ended
December 31, 1994 and 1995
Combined Statements of Members' Equity at December 31, 1994
and 1995
Combined Statements of Cash Flows for the years ended
December 31, 1994 and 1995
Notes to combined Financial Statements
The following Sterling House Corporation unaudited pro forma
financial information was filed:
Pro Forma Consolidated Balance Sheet at December 31, 1995
Pro Forma Consolidated Statement of Operations for the year
ended December 31, 1995
Notes to Pro Forma Consolidated Financial Statements
(ii) Current Report on Form 8-K dated May 23, 1996 (filed June 10,
1996), reporting that the Company sold at par $35,000,000 of
6.75% convertible subordinated debentures due June 30, 2006.
(iii) Current Report on Form 8-K dated August 1, 1996 (filed
August 12, 1996) reporting the acquisition of Woodland Terrace.
(iv) Current Report on Form 8-K/A dated August 1, 1996 (filed
October 15, 1996) reporting information required to be reported
under Item 7(a) Financial Statements, Pro Forma Financial
Information and Exhibits.
The following financial statements of High Plains Senior Living, Inc.
were filed:
Report of Independent Auditors
Balance Sheets as of December 31, 1995 and 1994 and
(Unaudited) as of June 30, 1996
Statements of Revenues, Expenses, and Changes in
Unrestricted Net Deficit for the Years Ended December 31,
1995 and 1994 and (Unaudited) for the Six Months Ended
June 30, 1996 and 1995
Statements of Cash Flows for the Years Ended December 31,
1995 and 1994 and (Unaudited) for the Six Months Ended
June 30, 1996 and 1995
Notes to Financial Statements
22
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (CONT.)
The following Sterling House Corporation unaudited pro forma
information was filed:
Pro Forma Consolidated Balance Sheet at June 30, 1996
Pro Forma Consolidated Statement of Operations for the Six
Months Ended June 30, 1996
Notes to Pro Forma Consolidated Financial Statements
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
Dated November 14, 1996
STERLING HOUSE CORPORATION
(Registrant)
/s/Timothy J. Buchanan
-----------------------
Timothy J. Buchanan
Chief Executive Officer
/s/R. Gail Knott
-----------------
R. Gail Knott
Chief Financial Officer
24
<PAGE>
STERLING HOUSE CORPORATION
INDEX TO EXHIBITS
Exhibit
Number Description
- --------------------------------------------------------------------------
10.1 Letter of Agreement, dated August 13, 1996, by and between Sterling
House Corporation and LTC Properties, Inc.
10.2 Letter of Agreement, dated September 25, 1996, by and between
Sterling House Corporation and Nationwide Health Properties, Inc.
10.3 Amendment to Letter of Agreement, dated November 12, 1996, by and
between Sterling House Corporation and Nationwide Health
Properties, Inc.
27 Financial Data Schedule, which is submitted electronically to the
Securities and Exchange Commission for information only and not
filed.
25
<PAGE>
EXHIBIT 10.1
August 13, 1996
Sterling House Corporation
453 S. Webb Rd. #500
Wichita KS 67207
Attention: Mr. Steven Vick, President
RE: AGREEMENT TO PURCHASE AND LEASE ASSISTED LIVING RESIDENCES
Dear Steven:
LTC Properties, Inc. ("LTC") is pleased to advise you that LTC
agrees, either itself or through its designee, and subject to the parameters
outlined in this letter and approval of LTC's Board of Directors, to enter
into a sale/leaseback transaction with Sterling House Corporation
("Sterling") with respect to a yet to be determined number of Properties
improved with assisted living facilities for a total purchase price of
$20 million.
As we have previously discussed, Sterling will sell and assign all
of its right, title and interest in and to all real and personal property and
fixtures comprising the Properties to LTC, and LTC or its designee will
purchase the Properties from Sterling and will lease the Properties back to
Sterling, all upon the following terms and conditions:
1. PURCHASE PRICE. LTC shall pay Sterling a total purchase price of
Twenty Million Dollars ($20,000,000.00).
The purchase price shall be paid in all cash at closing with respect to each
Property.
2. CONTINGENCIES.
(a) LTC's obligation to purchase the Properties and to
consummate the transactions contemplated in this commitment letter shall be
expressly contingent upon each of the following:
(I) the state of title to each of the Properties must
be acceptable to LTC in LTC's reasonable discretion, and LTC shall have
received an ALTA Owner's Policy of Title Insurance - Extended Coverage - for
each Property issued by Chicago Title Insurance Company showing the fee
interest in each Property vested in LTC subject only to those exceptions
specifically agreed to in writing by LTC, and containing those endorsements
reasonably required by LTC;
<PAGE>
Mr. Steven Vick, President
Sterling House Corporation
August 13, 1996
Page 2
(ii) LTC shall have received an ALTA/ACSM Land Title Survey of
each Property and the improvements located thereon prepared by a professional
land surveyor entirely satisfactory to LTC and dated after substantial
completion of the construction for the facility on each Property, which
survey shall be certified to LTC and Chicago Title Insurance Company with the
following language:
"This is to certify that this map or plat and the survey on which it is based
were made (i) in accordance with "Minimum Standard Detail Requirements for
ALTA/ACSM Land Title Surveys," jointly established and adopted by ALTA and
ACSM in 1992, and includes all items in Table A thereof; and (ii) pursuant to
the Accuracy Standards (as adopted by ALTA and ACSM and in effect on the date
of this certification) of an Urban Survey."
In addition, the record legal description of each Property must appear on the
survey of that Property, and any record easements or servitudes and covenants
affecting each Property must be plotted thereon;
(iii) LTC shall have received a Phase I environmental assessment
of each of the Properties in form and content, and performed by an
environmental consultant, entirely acceptable to LTC;
(iv) LTC shall have received a UCC lien search dated after the
date of substantial completion of the facility on each Property evidencing
that no liens exist as to the personal property located on each Property
other than those liens previously approved in writing by LTC;
(v) LTC shall be satisfied with the physical condition of the
assisted living facilities located on the Properties based on a physical
inspection of each Property by LTC;
(vi) LTC shall have received evidence acceptable to LTC that each
of the Properties is properly zoned for use as an assisted living facility;
(vii) LTC shall have received a corporate resolution of Sterling's
board of directors authorizing Sterling to entering into, deliver and perform
all of the documents and instruments necessary to effect the sale leaseback
transaction contemplated in this commitment letter;
<PAGE>
Mr. Steven Vick, President
Sterling House Corporation
August 13, 1996
Page 3
(viii) LTC shall have received a copy of the certificate of
occupancy with respect to each Property and a copy of Sterling's license to
operate the assisted living facility located on each Property as a fully-
licensed assisted living facility in the State of Oklahoma or Texas, as
applicable, and having not less than the numbers of units set forth for
each facility on page 1 hereof; and
(ix) LTC, at its option, shall have conducted with respect to
each Property, and be satisfied with the results of, such other standard due
diligence as is customarily performed by LTC in connection with the
acquisition of a fee interest in a property improved with an assisted living
facility.
3. TERM. Sterling and LTC contemplate that LTC will acquire each
of the Properties, and lease them back to Sterling, at such time as the
construction of the assisted living facility on each Property is completed,
the certificate of occupancy and operator's license with respect thereto
issued and all other pre-conditions to closing have been met with respect to
said Property. As a result, the parties anticipate that the Properties may
not all be acquired by LTC at one time, and Sterling's obligation to pay
Minimum Rent and other charges under each lease will commence concurrently
with LTC's acquisition of the Property to which the lease relates.
Notwithstanding the fact that Sterling's rental obligations under the leases
of the Properties may commence on different dates, it is LTC's specific
intention that the initial term of each lease will terminate on December 31,
2007. Sterling shall have two consecutive five-year options to extend the
term of ALL of the leases; that is, Sterling shall only have the option to
extend the term of any of the leases so long as Sterling exercises its option
to extend the term of all of the leases.
4. MINIMUM RENT. The initial annual Minimum Rent for the first year
of each lease shall be an amount equal to the total purchase price paid by
LTC (or its designee) for each Property (the "Purchase Price") multiplied by
a fraction, the numerator of which is 3.30 plus the interest rate on the ten-
year Treasury Security as of the second business day prior to closing, and
the denominator of which is 100. Sterling shall pay an amount equal to one-
twelfth (1/12) of the annual Minimum Rent applicable to each Property on the
first day of each and every month during the term of the leases without
demand, abatement, set-off or notice. Commencing on the first anniversary of
the rent commencement date for the first lease to commence (the "Anniversary
Date"), and continuing thereafter on each subsequent Anniversary Date during
the initial term and each option term of the leases, the Minimum Rent
applicable of the leases shall be increased by the same terms of the
Amendment to Lease dated June 25, 1996 (see copy attached).
<PAGE>
Mr. Steven Vick, President
Sterling House Corporation
August 13, 1996
Page 4
5. RENT DURING OPTION PERIODS. The initial Minimum Rent for each
of the option terms shall be the higher of: (i) the previous year's Minimum
Rent amount increased by two percent (2%); or (ii) the fair market value
rent as determined by independent appraisal process.
6. TRIPLE NET LEASE. Sterling shall be responsible for all costs
associated with the operation of the assisted living facilities located on
the Properties, including, but not limited to, property and other taxes,
utilities, insurance premiums and costs to maintain the assisted living
residences in good condition and repair, reasonable wear and tear excepted
(collectively "Additional Charges"). Taxes shall include any and all taxes
of any kind associated with the real or personal property constituting the
assisted living facilities, including, but not limited to, taxes attributable
to any period prior to acquisition of the Properties by LTC (or its designee)
with the exception of any transfer taxes owing in connection with any
subsequent transfer of any of the properties by LTC to a third party.
7. REPAIR AND MAINTENANCE. Sterling shall be responsible for
completing any and all work necessary to maintain each assisted living
facility located on the Properties as an assisted living residence in
good condition and repair, reasonable wear and tear excepted. In addition,
at Sterling's sole cost and expense, Sterling shall complete all
applications, give all notices and obtain and maintain all licenses, permits
and approvals necessary or desirable to allow Sterling to operate the
assisted living facilities located on the Properties in accordance with all
legal and regulatory requirements.
8. CROSS-DEFAULT. Each lease with respect to a Property shall be
cross-defaulted with each of the other leases of the Properties such that any
default under any one lease shall constitute a default under each other lease.
In the event that Sterling shall, for any reason whatsoever, fail to satisfy
all of the conditions precedent to LTC's obligations under this commitment
letter with respect to any one or more of the Properties, then, in addition
to, and not in lieu of, any and all other rights and remedies which LTC may
have under this commitment letter or otherwise at law or equity, LTC shall
have the right, among other things, to require Sterling to enter into a sale-
leaseback transaction with LTC with respect to one or more substitute
assisted living properties of like size, quality and location as the original
Properties, and the leases for the substitute properties shall be cross-
defaulted with the leases of each of the original Properties with respect to
which Sterling did satisfy the conditions precedent set forth herein, such
that, there shall be a total of not less than five (5) cross-defaulted leases
as a result of said substitutions.
<PAGE>
Mr. Steven Vick, President
Sterling House Corporation
August 13, 1996
Page 5
9. INDEMNITY. Sterling shall fully indemnify and hold LTC
harmless from and against any and all costs, losses, expenses, judgments,
claims, fees (including reasonable attorneys' fees and costs) or damages of
any kind or nature whatsoever arising from or relating to the assisted living
facilities located on the Properties and the operation thereof, including,
without limitation, all matters relating to (i) the presence of hazardous
substances located on the Properties, (ii) compliance with or failure to
comply with the provisions of the federal Americans with Disabilities Act,
(iii) compliance with or failure to comply with the provisions of the Fair
Housing Amendments Act of 1988; (iv) compliance with or failure to comply
with the provisions of Section 8 of the United States Housing Act of 1937, as
amended, and any and all other matters whatsoever relating to the Properties,
the assisted living facilities located thereon and the operation thereof.
Sterling's indemnification obligations set forth in this Paragraph shall
survive the expiration or termination for any reason of this commitment letter.
10. ASSIGNMENT AND SUBLETTING. Sterling shall not be entitled to
sublet or assign any one or more of the leases without the prior written
consent of LTC.
11. CLOSING COSTS. Concurrently with the closing of LTC's
purchase of each of the Properties, Sterling shall pay out of the proceeds of
the closing any and all closing costs in connection with the closing,
including but not limited to all of LTC's attorneys' fees (which shall be
Seventy-Five Thousand Dollars ($75,000.00) for the entire transaction
contemplated in this commitment letter) and attorneys' expenses, recording
fees, title fees, state and local transfer, mortgage or excise taxes in
connection with the transfer of title, LTC's out-of-pocket costs in
connection with the transaction and any and all other fees and costs in any
way associated with LTC's purchase of the fee interest in each Property, and
the leases between LTC and Sterling with respect to the Properties.
12. PHYSICAL INSPECTION. As a precondition to LTC's obligations
under this commitment letter, LTC shall have the right to conduct a physical
inspection of each assisted living facility on each Property, and LTC must be
satisfied with the physical condition of each of the Properties after
completion of the construction of the assisted living facilities thereon, in
LTC's reasonable discretion.
13. GOVERNING LAW. This commitment letter shall be governed by
and interpreted under the internal laws of the State of California without
resort to choice of law principles.
14. COMMITMENT FEE. Upon acceptance of this commitment, Sterling
shall pay a commitment fee to LTC in the sum of one and one-third percent
(1.333%) or Two Hundred Sixty Six Thousand, Six Hundred Sixty-Seven Dollars
($266,667.00) relating to the purchase and leaseback of the Properties, said
commitment fee amount to be paid at the acceptance of this commitment and to
be fully refunded after the closing of the $20 million transaction
<PAGE>
Mr. Steven Vick, President
Sterling House Corporation
August 13, 1996
Page 6
contemplated by this agreement. SINCE IT WOULD BE IMPRACTICAL AND EXTREMELY
DIFFICULT TO FIX THE ACTUAL DAMAGES WHICH WOULD BE SUFFERED BY LTC IN THE
EVENT STERLING FAILS FOR ANY REASON TO CLOSE THE TRANSACTION CONTEMPLATED IN
THIS COMMITMENT LETTER BY DECEMBER 31, 1997, THEN IN SUCH EVENT, BORROWER'S
DEPOSIT OF TWO HUNDRED SIXTY SIX THOUSAND, SIX HUNDRED SIXTY SEVEN DOLLARS
($266,667.00) SHALL BE RETAINED BY LTC AS LIQUIDATED DAMAGES FOR THE TIME,
EFFORT AND EXPENSES INCURRED BY LTC IN CONNECTION WITH THE TRANSACTION, AND
STERLING SHALL ALSO BE OBLIGATED TO PAY LTC'S COUNSEL LEGAL EXPENSES IN
CONNECTION WITH THE LOAN OF UP TO SEVENTY-FIVE THOUSAND DOLLARS ($75,000.00).
IN THE EVENT THAT LTC FAILS TO CLOSE THE TRANSACTION ACTION CONTEMPLATED
IN THIS COMMITMENT LETTER UPON TERMS CONSISTENT WITH THOSE PROVIDED HEREIN, AS
A SOLE RESULT OF LTC'S BREACH OF ITS OBLIGATIONS HEREUNDER, THE SOLE
OBLIGATION OF LTC SHALL BE TO REFUND THE TWO HUNDRED SIXTY SIX THOUSAND, SIX
HUNDRED SIXTY SEVEN DOLLARS ($266,667.00) COMMITMENT FEE, AND LTC SHALL
THEREAFTER HAVE NO FURTHER OBLIGATIONS OR LIABILITIES TO STERLING OF ANY KIND
OR NATURE WHATSOEVER.
initials: LTC Properties, Inc. ----- Sterling House Corporation ----
15. BORROWER'S ACCEPTANCE. Sterling must indicate its acceptance
of the terms and conditions of this commitment by affixing its signature
below. Unless LTC receives this accepted commitment in its Oxnard,
California office on or prior to the fifth (5th) business day following the
date of this letter, the terms hereof shall be null and void, and LTC shall
not have any obligations or liabilities to Sterling of any kind or nature
whatsoever. This commitment shall become effective only upon acceptance by
LTC evidenced by the affixation of LTC's signature hereto.
16. NO FINANCIAL RATIO COVENANTS. The leases of the Properties
shall not contain any covenants by Sterling regarding the existence or
maintenance of any financial ratios (e.g. cash flow coverage ratios, etc.)
with respect to the Properties or the assisted living facilities located
thereon.
17. FACSIMILE EXECUTION BINDING. The parties hereto specifically
agree that this commitment letter may be executed by facsimile, and that
facsimile signatures hereon shall be binding on the parties hereto as though
they were original signatures.
<PAGE>
Mr. Steven Vick, President
Sterling House Corporation
August 13, 1996
Page 7
18. SURVIVAL. Other than as specifically set forth above in
Paragraph 10 hereof, this commitment letter shall survive, and the covenants,
conditions and terms set forth herein shall continue, until the earlier of
(i) December 31, 1997, at which time this commitment letter shall expire
unless extended by a writing executed by both parties hereto, or (ii) the
date on which the sale of all of the Properties to LTC and the leases of all
of the Properties from LTC to Sterling has been consummated.
Please understand that, subject to the contingencies set forth above, this
letter constitutes the commitment of Sterling and LTC to enter into the sale-
leaseback transaction described herein on the terms set forth above.
Upon receipt of your original signature on this letter, LTC will
immediately instruct counsel to prepare draft documents to evidence the
transaction contemplated in this letter agreement.
Very truly yours,
LTC PROPERTIES, INC.,
a Maryland corporation
WILLIAM McBRIDE III,
President and Chief Operating Officer
READ AND AGREED:
STERLING HOUSE CORPORATION
By: --------------------------------------------
Its: ---------------------------------------------
<PAGE>
AMENDMENT TO LEASE
THIS AMENDMENT TO LEASE (this "Amendment") is made as of the -----
day of June, 1996, by and between KANSAS-LTC CORPORATION, formerly known as
Coronado Corporation, a Delaware corporation, herein called "Lessor," and
STERLING HOUSE CORPORATION, a Kansas corporation, herein called "Lessee,"
subject to the terms, conditions and contingencies set forth below.
RECITALS
A. Lessor and Lessee entered into that certain Lease, dated as of
December 22, 1995, whereby Original Lessor leased to Lessee that certain real
property located in Dodge City, Kansas, and the improvements located thereon
consisting of a 35-unit assisted living facility commonly known as the
"Sterling House," as more specifically described in the Lease.
B. Lessor and Lessee desire to amend the Lease subject to the
terms and conditions set forth herein.
NOW, THEREFORE, for good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, Lessor and Lessee agree as
follows:
1. ANNUAL ESCALATION OF MINIMUM RENT. Paragraph 3.1(c) of this
Lease is hereby deleted in its entirety and replaced with the following:
"(c) ANNUAL ESCALATION OF MINIMUM RENT. Commencing on
January 1, 1997 continuing on each subsequent January 1 during the Term, the
Minimum Rent (irrespective of any prorations made pursuant to Paragraph
3.1(a) of this Lease) shall increase to an amount equal to the Minimum Rent
for the immediately preceding Lease Year multiplied by a fraction, the
numerator of which shall be the C.P.I. (defined below) for January 1 of the
Lease Year then in effect, and the denominator of which shall be the C.P.I.
for January 1 of the immediately preceding Lease Year; provided, however,
that the product of said multiplication shall not result in an increase of
the Minimum Rent by more than two percent (2%) per year on a cumulative basis
("Annual Multiplier"). If, however, the Annual Multiplier is less than two
percent (2%) in any Lease Year (a "Less Than 2% Lease Year"), then at such
time as the Annual Multiplier is determined for subsequent Lease Years, the
Minimum Rent for each Less Than 2% Lease Year shall be retroactively
recalculated such that subsequent Annual Multipliers (whether less than or
greater than 2%) shall be first applied to increase the Annual Multiplier for
each Less Than 2% Lease Year to an amount up to, but not greater than, 2%,
with such recalculations to be made in chronological order beginning with the
earliest Less Than 2% Lease Year and continuing, so long as there is Annual
Multiplier remaining, until recalculations have been made with respect to all
Less Than 2% Lease Years. After each such recalculation has been made, the
shortfall in the Minimum Rent for the newly recalculated Less Than 2% Lease
Years shall be billed to Lessee and Lessee shall pay
-1-
<PAGE>
such shortfall amount to Lessor together with the next payment of Minimum
Rent otherwise coming due hereunder. Such recalculations and shortfall
billings shall be made in each Lease Year where there remain prior Less
Than 2% Lease Years which have not yet been recalculated to 2%. For purposes
of example only, if the initial Minimum Rent equals $939,120, and if (a) the
C.P.I. increased 1.5% as of January 1, 1997, the Minimum Rent would increase
to $953,207; (b) the C.P.I. increased 1.5% as of January 1, 1998, the Minimum
Rent as of January 1, 1998 would increase to $967,505; (c) the C.P.I.
increased 6% as of January 1, 1999, the Minimum Rent as of January 1, 1999
would increase to $996,602, which is the Minimum Rent increased by 2% per
year for three years (i.e. the average annual increases have been 3% (1.5% +
1.5% + 6% for three years, respectively) subject to the 2% annual
limitation), and the total shortfall amount to be billed to Lessee would be
$4,695 for Lease Year 1997 and $9,555 for Lease Year 1998. "C.P.I." shall
mean and refer to the Consumer Price Index of the Bureau of Labor Statistics
of the Department of Labor, U.S. Cities Average, All Items (1982-84=100);
provided that if compilation of the C.P.I. is discontinued or transferred to
any other governmental department or bureau, then the index most nearly the
same as the C.P.I. shall be used. If Lessor is unable to determine the
C.P.I. by January 1 of any Lease Year, Lessee shall continue to pay the
Minimum Rent at the rate paid for the immediately prior Lease Year, and once
the C.P.I. for January 1 of such Lease Year is published, the new Minimum
Rent (as increased by the Annual Multiplier) shall be effective retroactively
as of the first day of such Lease Year and the aggregate amount of any
additional Minimum Rent shall be paid by Lessee promptly after written notice
thereof from Lessor (but not later than the date of the next monthly
installment of Minimum Rent, unless the next installment falls due within
five (5) days after Lessor's notice, in which case not later than the date of
the second next monthly installment of Minimum Rent). No delay by Lessor in
providing notice of any such increase in Minimum Rent shall be deemed a
waiver of Lessor's right to increase the Minimum Rent as provided hereunder."
2. MISCELLANEOUS.
2.1 Except as set forth in this Amendment, the Lease (as
assigned) shall remain as originally stated and the terms and provisions of
the Lease (as assigned) are hereby ratified and affirmed.
-2-
<PAGE>
EXHIBIT 10.2
September 25, 1996
Mr. Steven L. Vick
President
Sterling Home Corporation
453 S. Webb Road, Suite 500
Wichita, KS 67207
Dear Steven:
The purpose of this letter is to propose that Nationwide Health Properties,
Inc. ("Nationwide") provide financing (the "Transaction" or "Transactions")
for approximately 25 completed assisted living facilities (collectively
"Properties" or individually "Property"). This financing would be in the
form of the acquisition/leases. Based on the information available to us and
subject to the conditions precedent contained in this letter, Nationwide is
prepared to enter into the Transaction under the following salient terms.
PRIOR APPROVAL
Each Property will be subject to prior approval by Nationwide in its sole
discretion as to site, land acquisition costs, plans, budget contracts, and
other customary matters as well as completion of due diligence procedures
satisfactory to Nationwide.
BUYER
Nationwide.
TENANT
Sterling House Corporation or its affiliates.
PURCHASE PRICE
Actual direct and indirect land and construction costs (excluding developers
profit) not to exceed approximately $50,000,000 in the aggregate.
GUARANTORS AND CROSS-DEFAULTS
Sterling House Corporation, all Properties.
LEASE TERM
Initial lease term to expire 12 years from closing the Transaction; 4
renewals of 10 years each at the option of Tenant.
TRANSACTION COSTS
Nationwide and Tenant will pay their respective ancillary transaction costs.
Nationwide will pay for environmental, survey, and site inspection, and its
own legal costs up to a reasonable level.
<PAGE>
Steven L. Vick
September 25, 1996
Page 2
COST ADVANCE
Upon acceptance of the terms of this proposal, Tenant will provide Nationwide
a Cost Advance of $25,000. Cost Advance will be credited to first month's
rent upon closing the Transaction. If Nationwide's board of directors does
not approve the transaction, Cost Advance will be refunded in full. If the
Transaction fails to close for any other reason, Cost Advance will be
refunded net of Nationwide's actual out-of-pocket costs incurred in
connection with the Transaction.
ACQUISITION FEE
A 1 1/4% Acquisition Fee will be paid to NHP at closing on all Transactions.
MINIMUM RENT
From site acquisition through completion, Prime; thereafter 325 basis points
over the 10-year Treasury rate determined as a 20-day average prior to closing.
ADDITIONAL RENT
Additional Rent equal to CPI increases.
RENT DEFERRAL
Rent for the first four months following completion will be deferred and
amortized over the initial lease term.
SECURITY DEPOSIT
Equal to 4 months Minimum Rent in cash or letter of credit from mutually
acceptable bank.
RENEWAL RENT
Fair market value as of renewal date times 10-year Treasury rate plus 300
basis points; total rent may not decrease from the prior year; renewals will
be "all-or-none."
TOTAL RENT
Total Rent defined as Minimum Rent plus Additional Rent. In no event will
Total Rent in any lease year be less than the Total Rent in the immediately
preceding lease year. In no event will the Total Rent increase over Total
Rent in the immediately preceding lease year by more than 1.5% in year 2, 2%
thereafter.
FINANCIAL COVENANTS
No affirmative financial covenants.
<PAGE>
Steven L. Vick
September 25, 1996
Page 3
CONDITIONS PRECEDENT
Satisfaction and fulfillment of conditions precedent customary and
appropriate for transactions of this type, including but not limited to:
Examination and acceptance of each Property by Nationwide;
Approval of each Property and each transaction by Nationwide's board of
directors;
Satisfaction of Nationwide with the material terms and conditions of all
necessary documents including, but not limited to, supporting documentation
such as trust agreements, partnership agreements, corporate charters, bylaws,
resolutions, certificates, security documents in addition to purchase
agreement(s) and lease(s), deed(s) of trust, note(s), mortgage(s), loan
agreement(s), and the execution, delivery and, where applicable, public
recordation, of all necessary documents;
No material adverse change;
Accuracy of representations and warranties;
Absence of default or other material breach;
Satisfaction of Nationwide with the final organization of and structure of
each Transaction, the Tenant, Guarantors, and title to respective assets;
Receipt and approval by Nationwide of then current financial statements of
the Property, Tenants, and Guarantors. Receipt and approval by Nationwide of
evidence satisfactory to Nationwide as to the due formation, power and
authority of Tenant, Borrowers, Guarantors, and other parties to each
transaction to participate on the transaction; the enforceability of all
documents and agreements contemplated hereunder; and the absence of material
actions, suits judgments, or proceedings;
Repayment of outstanding liens, encumbrances and debt on each Property and
satisfaction of Nationwide with unencumbered title thereon. Such title to be
insured by ALTA 1970 Form B extended coverage in amount equal to the Purchase
Price. Nationwide to receive surveys on each Property;
Receipt and approval by Nationwide of satisfactory evidence that each
Property has passed all inspections and has received all licenses, permits,
access approvals, certificates of need, provider agreements, Medicare,
Medicaid and third party payor agreements and other authorizations and
approvals as are needed for the operation of each Property as an
assisted/independent living facility, personal care facility, adult
congregate living facility as the case may be;
<PAGE>
Steven L. Vick
September 25, 1996
Page 4
Receipt and approval by Nationwide of satisfactory Phase 1 Environmental
Assessment Reports (or appropriate updates) prepared by qualified experts
approved by Nationwide showing no presence or potential presence of hazardous
materials in, on, under or around each Property;
Receipt by Nationwide of satisfactory certificates of compliance with
respect to all material obligations of Tenants, Borrowers and Guarantors as
are customary with transactions of this nature;
Receipt and approval by Nationwide of certificates of insurance satisfactory
to Nationwide naming Nationwide as additionally insured;
Receipt by Nationwide of representations and warranties customary and
appropriate for transactions of this nature.
This letter is not a commitment. Such a commitment can only be made by
Nationwide's board of directors, which has not reviewed the transaction. This
proposal is subject to Nationwide purchasing four Properties by November 15
and four Properties by January 15, 1997. This proposal is valid through
October 1, 1996. We look forward to working with you in the future.
Sincerely,
John J. Sheehan, Jr.
Vice President of Development
JJS/mp
- --------------------------------------- ---------------------------
Signature Date
Name (printed): ---------------------------------------------
Title: ----------------------------------------------------------
Company: ----------------------------------------------------
<PAGE>
EXHIBIT 10.3
Via Fax & Federal Express
Steven L. Vick, President
Sterling House Corporation
453 South Webb Road, Suite 500
Wichita, KS 67207
RE: Denton, TX; Paris, TX; Ennis, TX; Corsicana, TX; Mansfield,, TX;
Richland Hills, TX; Oklahoma City, Oklahoma; Broken Arrow, Oklahoma.
Dear Mr. Vick:
This letter will serve as an amendment to that certain correspondence dated
September 25, 1996 from John J. Sheehan, Jr. as it relates to the above-
referenced properties. Specifically, with respect to the acquisitions of the
Denton, Paris, Ennis and Corsicana properties, such acquisition deadline is
extended to November 29, 1996 and with respect to the properties in Broken
Arrow, Mansfield, Richland Hills and Oklahoma City, such acquisition deadline
is changed to December 31, 996. As you are aware, this amendment and change
of such acquisition deadlines apply only to the acquisition of these
properties, and any other future acquisitions and transactions remain subject
to the approvals and other conditions precedents set forth in the September 25,
1996 correspondence.
If these modifications meet with your approval, please so signify by signing
the acknowledgment below. If you have any questions, please contact me at
your earliest convenience.
Sincerely,
Gary E. Stark
Attorney for MLD Texas Trust
GES:pb u:\users\Gary\Vick.doc
cc: John J. Sheehan, Jr. (Via Fax)
Gail Knott (Via Fax 316-681-1517)
Howard Cordray (Via Fax 713-787-6175)
Agreed and Acknowledged:
Sterling House Corporation
By: _________________________
Steven L. Vick, President
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains information extracted form the consolidated
balance sheet and the consolidated statement of operations filed as part
of the quarterly report on Form 10-Q and is qaulified in its entirety by
reference to such quarterly report on Form 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 16,182,596
<SECURITIES> 0
<RECEIVABLES> 16,999,154
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 35,034,007
<PP&E> 39,497,878
<DEPRECIATION> (727,328)
<TOTAL-ASSETS> 77,043,444
<CURRENT-LIABILITIES> 10,931,956
<BONDS> 39,651,335
0
0
<COMMON> 28,201,753
<OTHER-SE> (3,533,846)
<TOTAL-LIABILITY-AND-EQUITY> 77,043,444
<SALES> 0
<TOTAL-REVENUES> 10,250,769
<CGS> 0
<TOTAL-COSTS> 11,370,318
<OTHER-EXPENSES> 278,745
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (840,804)
<INCOME-TAX> 286,571
<INCOME-CONTINUING> (554,233)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (554,233)
<EPS-PRIMARY> (.11)
<EPS-DILUTED> (.11)
</TABLE>
