<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Period Ended March 31, 1999
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: 0-20765
SUNRISE ASSISTED LIVING, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 54-1746596
(State or other jurisdiction of (I.R.S. Employer
incorporation of organization) Identification No.)
9401 LEE HIGHWAY, SUITE 300
FAIRFAX, VIRGINIA 22031
(Address of principal executive offices)
(703) 273-7500
(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 periods 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 May 3, 1999, there were 19,535,285 shares of the Registrant's Common
Stock outstanding.
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<PAGE> 2
SUNRISE ASSISTED LIVING, INC.
FORM 10-Q
MARCH 31, 1999
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 1999 and
December 31, 1998 3
Consolidated Statements of Operations for the three
months ended March 31, 1999 and 1998 4
Consolidated Statements of Cash Flows for the three
months ended March 31, 1999 and 1998 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosure About Market Risk 26
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
</TABLE>
2
<PAGE> 3
SUNRISE ASSISTED LIVING, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
----------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 38,889 $ 54,197
Accounts receivable, net 13,684 17,818
Notes receivable 13,892 754
Deferred income taxes 2,568 3,978
Prepaid expenses and other current assets 25,896 15,921
--------- ---------
Total current assets 94,929 92,668
Property and equipment, net 548,693 512,708
Notes receivable 37,472 34,919
Investments 28,070 28,329
Other assets 16,378 14,787
--------- ---------
Total assets $ 725,542 $ 683,411
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 2,574 $ 3,556
Accrued expenses and other current liabilities 14,817 14,049
Deferred revenue 3,026 3,722
Current maturities of long-term debt 1,817 1,768
--------- ---------
Total current liabilities 22,234 23,095
Long-term debt, less current maturities 459,219 426,558
Investments in unconsolidated assisted living facilities 1,229 1,003
Other long-term liabilities 2,959 3,194
--------- ---------
Total liabilities 485,641 453,850
Minority interests 3,097 1,906
Preferred stock, $0.01 par value, 10,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $0.01 par value, 60,000,000 shares authorized,
19,533,685 and 19,446,427 shares issued and outstanding
in 1999 and 1998 195 194
Additional paid-in capital 218,705 216,783
Retained earnings 17,904 10,678
--------- ---------
Total stockholders' equity 236,804 227,655
--------- ---------
Total liabilities and stockholders' equity $ 725,542 $ 683,411
========= =========
</TABLE>
Note: The balance sheet at December 31, 1998 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
See accompanying notes.
3
<PAGE> 4
SUNRISE ASSISTED LIVING, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months ended
March 31,
---------------------------------------------
1999 1998
------------ ---------------
(Unaudited)
<S> <C> <C>
Operating revenue:
Resident fees $ 44,318 $ 31,311
Management services income 4,958 3,112
Facility contract services 1,135 -
Realized gain on assisted living facilities 967 489
-------- --------
Total operating revenue 51,378 34,912
-------- --------
Operating expenses:
Facility operating 25,406 18,659
Facility contract services 1,028 -
Facility development and pre-rental 1,067 1,708
General and administrative 3,651 2,952
Depreciation and amortization 5,840 4,534
Facility lease 684 638
-------- --------
Total operating expenses 37,676 28,491
-------- --------
Income from operations 13,702 6,421
Other income (expense):
Interest income 2,586 1,733
Interest expense (6,706) (4,696)
-------- --------
Total other expense (4,120) (2,963)
Equity in (losses) earnings of unconsolidated
assisted living facilities (6) 176
Minority interests (191) (11)
-------- --------
Income before income taxes 9,385 3,623
Provision for income taxes (2,159) -
-------- --------
Net income $ 7,226 $ 3,623
======== ========
Net income per common share:
Basic $ 0.37 $ 0.19
======== ========
Diluted $ 0.35 $ 0.18
======== ========
</TABLE>
See accompanying notes.
4
<PAGE> 5
SUNRISE ASSISTED LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------------------
1999 1998
------------ ----------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 7,226 $ 3,623
Adjustments to reconcile net income to net cash
provided by operating activities:
Gain on sale of interests (70) (489)
Equity in losses (earnings) of unconsolidated
assisted living facilities 6 (176)
Minority interests 191 11
Provision for bad debts 191 271
Provision for deferred income taxes 1,410 -
Depreciation and amortization 5,840 4,534
Amortization of discount on investments (575) -
Amortization of premium on investments 6 -
Amortization of financing costs and discount on long-term debt 535 513
Changes in assets and liabilities:
(Increase) decrease:
Accounts receivable 3,957 (1,184)
Prepaid expenses and other current assets (7,331) 1,257
Other assets (2,035) (2,509)
Increase (decrease):
Accounts payable and accrued expenses 66 (3,249)
Deferred revenue (732) 299
Other liabilities (126) (445)
-------- --------
Net cash provided by operating activities 8,559 2,456
-------- --------
INVESTING ACTIVITIES
Investment in property and equipment (51,533) (29,828)
Increase in investment and notes receivable (12,385) (137)
Increase in restricted cash and cash equivalents (231) (355)
Contributions to investments in unconsolidated
assisted living facilities (145) (344)
Distributions from investment in unconsolidated
assisted living facilities 19 -
Proceeds from investments and notes receivable 5,133 -
-------- --------
Net cash used in investing activities (59,142) (30,664)
-------- --------
FINANCING ACTIVITIES
Additional borrowings under long-term debt 33,061 28
Repayment of long-term debt (456) (16,378)
Net proceeds from exercised options 1,923 3,308
Capital contribution from minority interest 1,000 -
Financing costs paid (253) (471)
-------- --------
Net cash provided by (used in) financing activities 35,275 (13,513)
-------- --------
Net decrease in cash and cash equivalents (15,308) (41,721)
Cash and cash equivalents at beginning of period 54,197 82,643
-------- --------
Cash and cash equivalents at end of period $ 38,889 $ 40,922
======== ========
</TABLE>
See accompanying notes.
5
<PAGE> 6
SUNRISE ASSISTED LIVING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements of Sunrise Assisted
Living, Inc. and subsidiaries (the "Company") are unaudited and include all
normal recurring adjustments which are, in the opinion of management,
necessary for a fair presentation of the results for the three-month periods
ended March 31, 1999 and 1998 pursuant to the instructions to Form 10-Q and
Article 10 of Regulation S-X. Certain information and footnote disclosures
normally included in the financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. These consolidated financial
statements should be read in conjunction with the Company's consolidated
financial statements and the notes thereto for the year ended December 31,
1998 included in the Company's 1998 Annual Report to Shareholders. Operating
results for the three-month period ended March 31, 1999 are not necessarily
indicative of the results that may be expected for the entire year ending
December 31, 1999.
Certain 1998 balances have been reclassified to conform with the 1999
presentation.
2. LONG-TERM DEBT
Long-term debt was $461.0 million at March 31, 1999 compared to $428.3
million at December 31, 1998.
On June 6, 1997, the Company issued and sold $150.0 million aggregate
principal amount of 5 1/2% convertible subordinated notes due 2002. The
convertible notes bear interest at 5 1/2% per annum, payable semiannually on
June 15 and December 15 of each year. The conversion price is $37.1875
(equivalent to a conversion rate of 26.89 shares per $1,000 principal amount
of the Notes). The convertible notes are redeemable at the option of the
Company commencing June 15, 2000, at specified premiums. The holders of the
convertible notes may require the Company to repurchase the convertible notes
upon a change of control of the Company.
The Company has an $86.0 million, excluding a $0.9 million discount,
multi-property mortgage, collateralized by a blanket first mortgage on all
assets of a subsidiary of the Company, consisting of 15 facilities. The
multi-property mortgage consists of two separate debt classes: Class A in the
amount of $65.0 million bears a fixed interest rate of 8.56% and is interest
only until the maturity date of May 31, 2001; and Class B in the amount of
$21.0 million bears a variable interest rate of LIBOR plus 1.75% and is
payable in installments through May 2001.
A subsidiary of the Company has a syndicated revolving credit facility for
$250.0 million. The facility is used for general corporate purposes, including
the continued construction and development of assisted living facilities. The
Company guarantees the repayment of all amounts outstanding under this credit
facility. The credit facility expires in December 2000, with the right to
extend, and is secured by cross-collateralized first mortgages on the real
property and improvements and first liens on all other assets of the
subsidiary. Advances under the facility bear interest at LIBOR plus 1.00% to
LIBOR plus 1.50%. There were $150.0 million of advances outstanding
6
<PAGE> 7
SUNRISE ASSISTED LIVING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
under this credit facility as of March 31, 1999. In May 1999, Sunrise obtained
a commitment to increase the credit facility to $400.0 million at an interest
rate of LIBOR plus 1.50%.
A subsidiary of the Company has received a commitment for a $32.1 million
revolving construction credit facility. The Company closed $32.1 million of
the total commitment. The credit facility provides for construction and
interim loans to finance the development of up to seven assisted living
facilities. The Company has agreed to guarantee the repayment of all amounts
outstanding under this credit facility. The credit facility is for a term of
five years and is secured by cross-collateralized first mortgages on the real
property and liens on receivables. Advances under the credit facility bear
variable interest rates based upon LIBOR plus 2.00% to LIBOR plus 2.35%. There
were $4.7 million of advances outstanding under this facility as of March 31,
1999.
A subsidiary of the Company has received a commitment for a $15.7 million
revolving construction credit facility. The credit facility provides for
construction and interim loans to finance the development of up to two
assisted living facilities. The Company guarantees the repayment of all
amounts outstanding under this credit facility. The credit facility is for a
term of three years and is secured by cross-collateralized first mortgages on
the real property and improvements and first liens on all other assets of the
subsidiary. Advances under the credit facility bear variable interest rates
based upon LIBOR plus 1.25% to LIBOR plus 1.75%. There were $8.0 million of
advances outstanding under this facility as of March 31, 1999.
As of March 31, 1999, the Company has various other debt outstanding
totaling approximately $63.2 million with interest rates ranging from 6.7% to
8.5%.
The Company has entered into a swap transaction whereby, effective during
the period June 18, 1998 through June 18, 2001, outstanding advances of up to
$19.0 million LIBOR floating rate debt bear interest at a fixed rate based on
a fixed LIBOR base rate of 7.30%. The Company has entered into another swap
transaction whereby, effective during the period August 20, 1997 through April
1, 2003, outstanding advances of up to $7.0 million under LIBOR floating rate
debt bear interest at a fixed LIBOR base rate of 7.14%.
In May 1999, the Company received a loan commitment from a new lender to
provide approximately $88.0 million secured by eight assisted living
properties. The loan will accrue interest at 7.14% and have a term of 10
years.
3. STOCK OPTION PLANS
The Company has stock option plans providing for the grant of incentive
and non-qualified stock options to employees, directors, consultants and
advisors for a fixed number of shares with an exercise price equal to the fair
market value of the shares at the date of grant. The Company accounts for
stock option grants in accordance with APB Opinion No. 25, Accounting for
Stock Issued to Employees and accordingly recognizes no compensation expense
for the stock option grants.
7
<PAGE> 8
SUNRISE ASSISTED LIVING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
A summary of the Company's stock option activity and related information
as of March 31, 1999, is presented below:
<TABLE>
<CAPTION>
Shares Weighted - Average
Fixed Options (000) Exercise Price
- ------------- ---------------------------------------
<S> <C> <C>
Outstanding - January 1, 1999 4,170 $24.93
Granted 191 37.62
Exercised (87) 22.03
Canceled (76) 31.38
=====
Outstanding - March 31, 1999 4,198 25.58
=====
Exercisable - March 31, 1999 1,112
=====
</TABLE>
The following table summarizes information about stock options outstanding
at March 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Number Average Average Number Average
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices (000) Contractual Life Price (000) Price
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 3.00 to 8.00 221 6.4 $ 5.53 138 $ 5.63
8.01 to 20.00 352 7.1 17.22 203 17.11
20.01 to 25.63 2,970 8.4 24.95 727 25.09
25.64 to 44.56 655 9.6 39.68 44 39.42
----- -----
4,198 1,112
===== =====
</TABLE>
4. COMMITMENTS AND CONTINGENCIES
The Company has entered into contracts to purchase and lease properties
for development of additional assisted living facilities. Total contracted
purchase price of these sites amounts to $87.3 million. The Company is
pursuing additional development opportunities and also plans to acquire
additional facilities as market conditions warrant.
8
<PAGE> 9
SUNRISE ASSISTED LIVING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
During the third quarter 1998, the Company completed the sale of two
assisted living communities for an aggregate purchase price of $29.3 million
in cash resulting in a $6.4 million gain from the transaction. To date, the
Company has recognized $2.5 million of the gain, of which $1.0 million was
recognized during the three months ended March 31, 1999. The remaining gain is
deferred, the recognition of which is contingent upon future events. For tax
purposes, the transaction was set up as a tax-free exchange. The Company will
continue operating the facilities under long-term operating agreements.
In May 1999, Sunrise entered into an agreement for the sale of two
assisted living facilities located in Columbia, Maryland and Norwood,
Massachusetts for an aggregate sales price of $27.9 million in cash. If the
sale is consummated, Sunrise will realize up to an approximate $11.3 million
gain from the transaction over a maximum of 12 quarters. For tax purposes, the
transaction will be treated as a tax-free exchange. Sunrise will continue
operating the facilities under long-term operating agreements. The transaction
is expected to close in the second quarter of 1999.
5. NET INCOME PER COMMON SHARE
The following table summarizes the computation of basic and diluted net
income per share amounts presented in the accompanying consolidated statements
of operations (in thousands, except per share data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------
1999 1998
------------------------
<S> <C> <C>
Numerator for basic and diluted net income
per share $ 7,226 $ 3,623
======= =======
Denominator:
Denominator for basic net income per
common share-weighted average shares 19,491 19,089
Effect of dilutive securities:
Employee stock options 1,052 1,392
Warrants - 30
------- -------
Denominator for diluted net income per common
share-weighted average shares plus assumed
conversions 20,543 20,511
------- -------
Basic net income per common share $ 0.37 $ 0.19
======= =======
Diluted net income per common share $ 0.35 $ 0.18
======= =======
</TABLE>
Shares issuable upon the conversion of convertible subordinated notes have
been excluded from the computation because the effect of their inclusion would
be anti-dilutive.
9
<PAGE> 10
SUNRISE ASSISTED LIVING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
6. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Included in prepaid expenses and other current assets are net receivables
from unconsolidated partnerships or limited liability companies of $17.6 million
and $11.8 million as of March 31, 1999 and December 31, 1998, respectively,
which relate primarily to development activities.
7. RELATED-PARTY TRANSACTIONS
The Company has entered into a joint venture arrangement with a third
party that is providing up to $55.3 million of the equity capital to develop up
to 22 projects in the United Kingdom and Canada. A director of the Company is a
general partner in the third party that is providing such equity capital.
Currently, the joint venture has one property under development in the United
Kingdom and two properties under development in Canada. The Company provides
management and development services to the joint venture on a contract-fee basis
with rights to acquire the assets in the future and has agreed to invest up to
$2.8 million of equity capital in the joint venture. As of March 31, 1999, the
third party has provided approximately $7.1 million and the Company has provided
$0.4 million of equity capital to the joint venture.
The Company has committed to provide a revolving credit arrangement of up
to approximately $3.4 million to a subsidiary of the joint venture. Interest on
advances made under the credit arrangement accrues at 12%. The outstanding
principal and unpaid accrued interest are due on November 4, 2001. At March 31,
1999, the outstanding principal balance and unpaid accrued interest under the
credit arrangement totaled approximately $3.5 million.
8. INFORMATION ABOUT THE COMPANY'S SEGMENTS
The Company primarily derives income from two types of services: (1)
resident services and (2) management services. Resident services are further
segmented into two stages of operations consisting of stabilized facilities and
lease-up facilities. Stabilized facilities represent owned facilities opened or
operated by the Company for at least 12 months, or that have achieved occupancy
percentages of 95% or above. Lease-up facilities represent those facilities
owned by the Company that are operating in their early stages but are not
considered stabilized. Management services include fees from long-term
management contracts or development contracts for facilities owned by
unconsolidated joint ventures and other third party owners.
10
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SUNRISE ASSISTED LIVING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Segment information is as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------
1999 1998
----------------------------
<S> <C> <C>
Operating Revenue:
Resident Services:
Stabilized $ 34,710 $ 20,211
Lease-up 9,608 11,100
Management services:
External 6,093 3,112
Internal 2,352 1,623
Other 967 489
Elimination of intersegment revenue (2,352) (1,623)
----------------------------
Total operating revenue 51,378 34,912
----------------------------
Operating expenses:
Resident Services:
Stabilized 21,122 13,180
Lease-up 6,636 7,102
Management services 4,856 3,257
Elimination of intersegment expenses (2,352) (1,623)
----------------------------
Total operating expenses 30,262 21,916
----------------------------
Segment operating income 21,116 12,996
Reconciliation to income before income taxes:
Facility pre-rental 410 918
General and administrative 480 485
Depreciation and amortization 5,840 4,534
Facility lease 684 638
----------------------------
Income from operations 13,702 6,421
Interest expense, net (4,120) (2,963)
Equity in (losses) earnings of unconsolidated assisted
living facilities (6) 176
Minority interests (191) (11)
----------------------------
Total consolidated income before income taxes $ 9,385 $ 3,623
============================
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
Assets: 1999 1998
- ------- ----------------------------
<S> <C> <C>
Stabilized facilities $ 310,962 $ 219,794
Lease-up facilities 23,999 89,552
Other segment assets 10,815 8,511
Corporate 379,766 365,554
============================
Total consolidated assets $ 725,542 $ 683,411
============================
</TABLE>
11
<PAGE> 12
SUNRISE ASSISTED LIVING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Other revenues for the three months ended March 31, 1999 and 1998 consist
of realized gains on the sale of assisted living facilities.
9. ACQUISITIONS
On October 18, 1998, the Company entered into a merger agreement to
acquire Karrington Health, Inc., a Columbus-based leading assisted living
provider, as amended on March 4, 1999. The Company plans to acquire Karrington
in a tax-free, stock-for-stock transaction valued at approximately $94.9
million. The transaction will be accounted for using the purchase method of
accounting.
Under the amended merger agreement, Karrington would become a wholly owned
subsidiary of the Company and each issued and outstanding Karrington common
share, other than shares for which dissenters' rights are exercised, would be
automatically converted into the right to receive 0.3333 of a share of the
Company's common stock. Subject to satisfaction of the conditions set forth in
the amended merger agreement, including approval of the amended merger agreement
by Karrington shareholders, the Company expects to consummate its acquisition of
Karrington during the second quarter of 1999.
Pursuant to the amended merger agreement, the Company has agreed to make
available to Karrington a fully secured line of credit in the principal amount
of up to $16.5 million. Sunrise advanced $13.1 million to Karrington under this
line of credit as of March 31, 1999. The note matures in January 2000 and
interest accrues at 10.0%.
12
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
information contained in the consolidated financial statements, including the
related notes, and other financial information appearing elsewhere in this
Form 10-Q. This management's discussion and analysis contains certain
forward-looking statements that involve risks and uncertainties. Sunrise's
actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including
development and construction risks, acquisition risks, licensing risks,
business conditions, risks of downturns in economic conditions generally,
satisfaction of closing conditions and availability of financing for
development and acquisitions. Some of these factors are discussed elsewhere in
this Form 10-Q and in Sunrise's 1998 Annual Report on Form 10-K. Unless the
context suggests otherwise, references herein to "Sunrise" mean Sunrise
Assisted Living, Inc. and its subsidiaries.
OVERVIEW
Sunrise is a provider of assisted living services for seniors. Sunrise
currently operates 82 facilities in 15 states with a capacity of approximately
7,100 residents, including 70 facilities owned by Sunrise or in which it has
ownership interests and 12 facilities managed for third parties. Sunrise also
operates two skilled nursing facilities owned by a third party.
Sunrise has continued to experience growth in operations over the 12
months ended March 31, 1999. During this period, Sunrise began operating an
additional 11 facilities owned by it and managing an additional three
facilities for independent third parties. Sunrise also entered into several
new development contracts during the 12 months ended March 31, 1999. As a
result, operating revenue increased substantially to $51.4 million for the
three months ended March 31, 1999 from $34.9 million for the three months
ended March 31, 1998. Net income increased by $3.6 million to $7.2 million for
the three months ended March 31, 1999, or $0.35 per share (diluted), from $3.6
million for the three months ended March 31, 1998, or $0.18 per share
(diluted). The increase in net income between the two periods was attributable
to the additional facilities operated in the three months ended March 31,
1999, increases in development contracts with independent third parties and
Sunrise's ability to control operating expenses during the expansion of
operations. Operating expenses decreased as a percentage of operating revenue
by 8.3% between the three months ended March 31, 1999 and 1998. See "Results
of Operations" for further discussion.
Sunrise's growth objectives include developing new Sunrise model assisted
living facilities and selectively acquiring existing facilities. Sunrise
currently has 22 facilities under construction with a resident capacity of
over 2,000. Sunrise also has entered into contracts to purchase 54 additional
development sites, 15 of which are zoned, and to lease three additional sites
under long-term ground leases. Sunrise is pursuing additional development
opportunities and also plans to acquire additional facilities as market
conditions warrant.
On October 18, 1998, Sunrise entered into a merger agreement to acquire
Karrington Health, Inc., a Columbus-based assisted living provider, as amended
on March 4, 1999. Sunrise plans to purchase Karrington in a tax-free,
stock-for-stock transaction valued at approximately $94.9 million. The
transaction will be accounted for using the purchase method of accounting.
Karrington owns or has ownership interests in 42 facilities, has an additional
eight facilities under
13
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
construction and has an additional eight development sites under contract.
Sunrise intends to sell 17 Karrington facilities within 12 months following
the merger. Most of these facilities are Karrington Cottage prototype models,
which consist of 20 units or less.
Under the amended merger agreement, Karrington would become a wholly owned
subsidiary of Sunrise and each issued and outstanding Karrington common share,
other than shares for which dissenters' rights are exercised, would be
automatically converted into the right to receive 0.3333 of a share of Sunrise
common stock. Subject to satisfaction of the conditions set forth in the
amended merger agreement, including approval of the amended merger agreement
by Karrington shareholders, Sunrise expects to consummate its acquisition of
Karrington during the second quarter of 1999.
In December 1998, Sunrise acquired four separate first trust mortgages
secured by Karrington properties for $22.4 million. In December 1998, Sunrise
also assigned its right to purchase six properties owned by Meditrust
Corporation and leased by Karrington to a trust owned and funded by financial
institutions. The trust purchased the six properties from Meditrust
Corporation for approximately $42.2 million. Simultaneously, Sunrise entered
into a leasing arrangement with the trust to lease the six properties.
Also in December 1998, Sunrise entered into development agreements with
Karrington. Under the agreements, Sunrise provides development and
construction services relating to three facilities until each facility
receives a certificate of occupancy.
In January 1999, Sunrise and Karrington entered into a management
consulting agreement and a management services agreement. Under the consulting
agreement, Sunrise agreed to assist Karrington in the management of its
assisted living facilities pending completion of the merger. Under the
management services agreement, Sunrise receives a management fee of 7% of the
revenues from the facilities to manage five of Karrington's facilities pending
completion of the merger. Both agreements are for a term of one year.
Sunrise initiated a previously-announced plan of selling selected real
estate assets, subject to market conditions, as a normal part of its
operations while retaining long-term management through operating agreements.
This strategy of selling selected real estate assets as a normal part of
operations should enable Sunrise to reduce debt, redeploy its capital into new
development projects and recognize gains on appreciated real estate. In
September 1998, Sunrise completed the sale of two assisted living facilities
located in Maryland that will result in the realization of up to a $6.4
million gain over a maximum of 15 quarters.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In May 1999, Sunrise entered into an agreement for the sale of two
assisted living facilities located in Columbia, Maryland and Norwood,
Massachusetts for an aggregate sales price of $27.9 million in cash. If the
sale is consummated, Sunrise will realize up to an approximate $11.3 million
gain from the transaction over a maximum of 12 quarters. For tax purposes, the
transaction will be treated as a tax-free exchange. Sunrise will continue
operating the facilities under long-term operating agreements. The transaction
is expected to close in the second quarter of 1999.
The Company has continued its efforts to explore international development
and acquisition possibilities in the United Kingdom and Canada and has entered
into a joint venture arrangement with a third party that is providing up to
$55.3 million of the equity capital to develop up to 22 projects. A director
of the Company is a general partner in the third party that is providing such
equity capital. Currently, the joint venture has one property under
development in the United Kingdom and two properties under development in
Canada. Sunrise provides management and development services to the joint
venture on a contract-fee basis with rights to acquire the assets in the
future and has agreed to invest up to $2.8 million of equity capital in the
joint venture. As of March 31, 1999, the third party has provided
approximately $7.1 million and Sunrise has provided $0.4 million of equity
capital to the joint venture.
In connection with the implementation of its growth plans, Sunrise made
significant investments in its infrastructure through the addition of
information technology in 1998 and 1997, as well as additions to headquarters
and regional staff. During 1999, Sunrise expects to continue to invest in
these areas to support both the growth of Sunrise and to provide enhancement
to some of its existing computer systems to make them year 2000 compliant.
See "Year 2000 Issues" for further discussion.
RESULTS OF OPERATIONS
Operating Revenue. Operating revenue for the three months ended March 31,
1999 increased 47.2% to $51.4 million from $34.9 million for the three months
ended March 31, 1998 due primarily to the growth in resident fees. Resident
fees, including community fees, for the three months ended March 31, 1999
increased $13.0 million, or 41.5%, to $44.3 million from $31.3 million for the
three months ended March 31, 1998. This increase was due primarily to the
inclusion for the three months ended March 31, 1999 of approximately $5.5
million of resident fees generated from the operations of assisted living
facilities open during the three months ended March 31, 1999 that were not
open during the three months ended March 31, 1998. The remaining increase in
resident fees was due primarily to an increase in the average daily resident
rate, excluding community fees, and the average resident occupancy for
facilities that were owned and operated by Sunrise during both periods.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Average resident occupancy for owned facilities operated by the Company
for at least 12 months or that have achieved stabilization of 95% or above,
increased to 95.6% for the three months ended March 31, 1999 compared to 92.9%
for the three months ended March 31, 1998. The occupancy rate excludes
facilities with temporary vacancies and resident relocations generally of
between three to six months due to renovations. The average daily resident
fee, excluding community fees, for these stabilized facilities increased to
$96 for the three months ended March 31, 1999 from $84 for the three months
ended March 31, 1998. The increase is due to the inclusion of additional
stabilized prototype facilities which have higher basic care rates, a general
increase in the basic care rate at other facilities, and an increase in the
number of residents receiving plus care and reminiscence care services.
Average resident occupancy for owned facilities in initial resident lease-up
increased to 66.9% for the three months ended March 31, 1999 from 60.1% for
the three months ended March 31, 1998. The average daily resident fee,
excluding community fees for these facilities increased to $113 for the three
months ended March 31, 1999 from $103 for the three months ended March 31,
1998.
Management services income represents fees from long-term contracts for
facilities owned by unconsolidated joint ventures and other third party owners
and includes management fees, which are generally in the range of 5% to 7% of
a managed facility's total operating revenue, for homes in operation and
development fees for site acquisition, development services, facility design
and construction management services. Management services income for the three
months ended March 31, 1999 increased to $5.0 million from $3.1 million for
the three months ended March 31, 1998. This increase resulted primarily from a
$1.9 million increase in development and management fees to $4.9 million for
the three months ended March 31, 1999 from $3.0 million for the three months
ended March 31, 1998 relating to the development and management of facilities
for unconsolidated joint ventures and third party owners. This increase is
primarily due to the increase in the number of development and management
contracts entered into after the first quarter of 1998. Sunrise had 34
development and management contracts as of March 31, 1999 and 18 development
and management contracts as of March 31, 1998.
During the three months ended March 31, 1999, Sunrise recognized a gain of
$1.0 million on the September 1998 sale of two assisted living communities.
During the three months ended March 31, 1998, Sunrise recognized a gain of
$0.5 million from the sale of its minority interest in a tenancy-in-common
that owned one facility.
Operating Expenses. Operating expenses for the three months ended March
31, 1999 increased by 32.2% to $37.7 million from $28.5 million for the three
months ended March 31, 1998. The increase in operating expenses for the three
months ended March 31, 1999 was attributable to increases in all of the
following areas: facility operating expenses, facility contract services,
general and administrative and depreciation and amortization.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Facility operating expenses for the three months ended March 31, 1999,
increased 36.2% to $25.4 million from $18.7 million for the three months ended
March 31, 1998. As a percentage of resident fees, facility operating expenses
for the three months ended March 31, 1999, decreased to 57.3% from 59.6% for
the three months ended March 31, 1998. Of the $6.7 million increase, $3.6
million was attributable to expenses from operations of additional assisted
living facilities open during the three months ended March 31, 1999 that were
not open during the same period in 1998 and $2.7 million was attributable to
facilities operated for a full quarter in 1999 that were initially opened in
the first quarter of 1998. The remaining balance of the increase was primarily
due to an increase in labor and general and administrative expense at
facilities that were operational for a full quarter in both periods.
Facility development and pre-rental expenses for the three months March
31, 1999, decreased 37.5% to $1.1 million from $1.7 million for the three
months ended March 31, 1998. The $0.6 million decrease in facility and
development expenses for the three months ended March 31, 1999 was primarily
related to a decrease in start-up costs due to facilities being in earlier
stages of development during the three months ended March 31, 1999 as compared
to facilities under development during the three months ended March 31, 1998.
General and administrative expenses for the three months ended March 31,
1999 increased 23.7% to $3.7 million from $3.0 million for the three months
ended March 31, 1998. As a percentage of operating revenue, general and
administrative expenses for the three months ended March 31, 1999 decreased to
7.1% from 8.5% for the three months ended March 31, 1998, reflecting the
higher operating revenue in the 1999 period. The $0.7 million increase in
general and administrative expenses for the three months ended March 31, 1999
was primarily related to labor costs, consisting of hiring and training
additional staff at the headquarters and regional offices.
Depreciation and amortization for the three months ended March 31, 1999
compared to the three months ended in March 31, 1998 increased $1.3 million,
or 28.8%, to $5.8 million from $4.5 million for the three months ended March
31, 1998 primarily due to a $1.2 million increase in depreciation expense. Of
the increase in depreciation expense, $0.7 million related to facilities open
during the three months ended March 31, 1999 that were not open during the
same period in 1998. The remaining increase was primarily due to additional
depreciation expense related to facilities opened during 1998.
Other Income (Expense). Interest income increased to $2.6 million for the
three months ended March 31, 1999 compared to $1.7 million for the three
months ended March 31, 1998. This increase was primarily due to an increase in
interest income from long-term investments and notes receivable, offset, in
part, by a decrease in funds available for investment. Interest expense
increased for the three months ended March 31, 1999 to $6.7 million from $4.7
million for the
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
three months ended March 31, 1998. Of this increase, $1.5 million was due to
interest on additional borrowings under one of Sunrise's credit facilities.
The remaining increase was primarily due to a decrease in capitalized interest
for the three months ended March 31, 1999 versus the three months ended March
31, 1998 due to a reduction in the average balance of funded project costs.
Provision for Income Taxes. The provision for income taxes was $2.2
million and zero for the three months ended March 31, 1999 and 1998,
respectively. Income tax for the three months ended March 31, 1999 includes
$3.6 million for federal and state income taxes. Utilization of
operations-related deferred tax benefits reduced Sunrise's federal and state
income taxes by $1.4 million for the three months ended March 31, 1999. As of
March 31, 1999, Sunrise had net operating loss carryforwards of approximately
$12.6 million available to offset future federal taxable income.
LIQUIDITY AND CAPITAL RESOURCES
To date, Sunrise has financed its operations from long-term borrowings,
equity offerings and cash generated from operations. At March 31, 1999,
Sunrise had $461.0 million of outstanding debt, excluding $40,000 notes
payable to an affiliate, at a weighted average interest rate of 6.5%. Of the
amount of outstanding debt, Sunrise had $260.0 million of fixed-rate debt,
excluding a $0.9 million loan discount, at a weighted average interest rate of
6.5%, and $201.9 million of variable rate debt at a weighted average interest
rate of 6.5%.
At March 31, 1999, Sunrise had approximately $38.9 million in unrestricted
cash and cash equivalents, including $18.2 million in high-quality short-term
investments (A1/P1 rated) and $72.7 million in net working capital and
currently has $135.2 million of unused lines of credit.
A subsidiary of Sunrise has a syndicated revolving credit facility for
$250.0 million. Sunrise guarantees the repayment of all amounts outstanding
under this credit facility. The credit facility expires in December 2000 and
includes two 12 month extension options, subject to the lender's approval. The
credit facility is secured by cross-collateralized first mortgages on the real
property and improvements and first liens on all other assets of the
subsidiary. Advances under the facility bear interest at LIBOR plus 1.00% to
LIBOR plus 1.50%. There were $150.0 million of advances outstanding under this
credit facility as of March 31, 1999. In May 1999, Sunrise obtained a
commitment to increase the credit facility to $400.0 million at an interest
rate of LIBOR plus 1.50%.
Other subsidiaries have revolving credit facilities totaling $47.8
million. The repayments of the amounts outstanding under these credit
facilities are also guaranteed by Sunrise. The credit facilities are secured
by real property and first liens on other assets. Advances under these
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
facilities bear interest at rates ranging from LIBOR plus 1.25% to LIBOR plus
2.35% and totaled $12.7 million as of March 31, 1999.
On June 6, 1997, Sunrise issued and sold $150.0 million aggregate
principal amount of 5 1/2% convertible subordinated notes due 2002. The
convertible notes bear interest at 5 1/2% per annum payable semiannually on
June 15 and December 15 of each year. The conversion price is $37.1875, which
is equivalent to a conversion rate of 26.89 shares per $1,000 principal amount
of the notes. The convertible notes are redeemable at the option of Sunrise
commencing June 15, 2000, at specified premiums. The holders of the
convertible notes may require Sunrise to repurchase the notes upon a change of
control of Sunrise, as defined in the convertible notes.
Sunrise has an $86.0 million, excluding a $0.9 million discount,
multi-property mortgage, collateralized by a blanket first mortgage on all
assets of a subsidiary of Sunrise, consisting of 15 facilities. The
multi-property mortgage consists of two separate debt classes: Class A in the
amount of $65.0 million bears a fixed interest rate of 8.56% and is interest
only until the maturity date of May 31, 2001; and Class B in the amount of
$21.0 million bears a variable interest rate of LIBOR plus 1.75% and is
payable in installments through May 2001.
As of March 31, 1999, Sunrise had various other debt outstanding totaling
approximately $63.2 million with interest rates ranging from 6.7% to 8.5%.
Sunrise has entered into a swap transaction whereby, effective during the
period June 18, 1998 through June 18, 2001, outstanding advances of up to
$19.0 million LIBOR floating rate debt bear interest at a fixed rate based on
a fixed LIBOR base rate of 7.30%. Sunrise has entered into another swap
transaction whereby, effective during the period August 20, 1997 through April
1, 2003, outstanding advances of up to $7.0 million under LIBOR floating rate
debt bear interest at a fixed LIBOR base rate of 7.14%. Sunrise recorded net
interest expense for the three months ended March 31, 1999 and 1998 in the
amounts of $132,000 and $12,000, respectively, for swap transactions.
There are various financial covenants and other restrictions in Sunrise's
debt instruments, including provisions which:
- require it to meet specified financial tests. For example, Sunrise's
$86.0 million multi-property mortgage, which is secured by 15 of its 67
facilities, requires that these facilities maintain a cash flow to
interest expense coverage ratio of at least 1.25 to 1. Sunrise's $250.0
million credit facility requires Sunrise to have a consolidated
tangible net worth of at least $185.3 million and to maintain a
consolidated minimum cash liquidity balance of at least $25.0 million.
These tests are administered on a monthly or quarterly basis, depending
on the covenant;
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
- require consent for changes in management or control of Sunrise. For
example, Sunrise's $250.0 million revolving credit facility requires
the lender's consent for any merger where Paul Klaassen or Teresa
Klaassen does not remain chairman of the board and chief executive
officer of Sunrise;
- restrict the ability of Sunrise subsidiaries to borrow additional
funds, dispose of assets or engage in mergers or other business
combinations without lender consent; and
- require that Sunrise maintain minimum occupancy levels at its
facilities to maintain designated levels of borrowings. For example,
Sunrise's $250.0 million credit facility requires that 85% occupancy be
achieved after 12 months for a newly opened facility and, following
this 12-month period, be maintained at or above that level.
In May 1999, the Company received a loan commitment from a new lender to
provide approximately $88.0 million secured by eight assisted living
properties. The loan will accrue interest at 7.14% and have a term of 10
years.
Working capital increased to $72.7 million at March 31, 1999 from $69.6
million at December 31, 1998, primarily due to a net increase in working
capital resulting from the sale of five facilities and an increase in notes
receivable from Karrington which became current in January 1999. The increase
was offset, in part, by a decrease in receivables related to management and
development contracts.
Sunrise has agreed to make available to Karrington a fully-secured line of
credit in the principal amount of up to $16.5 million. Sunrise advanced $13.0
million to Karrington under this line of credit as of March 31, 1999. The note
matures in January 2000 and interest accrues at 10.0%.
Sunrise has also committed to provide a revolving credit arrangement of
up to approximately $3.4 million to a subsidiary of a joint venture in the
United Kingdom. Interest on the outstanding principal amount accrues at 12%.
The arrangement expires on November 4, 2001. At March 31, 1999, the
outstanding principal balance and unpaid accrued interest under this credit
arrangement totaled approximately $3.5 million.
Net cash provided by operating activities for the three months ended
March 31, 1999 and 1998 was approximately $8.6 million and $2.5 million,
respectively, corresponding to the increased number of facilities operated by
Sunrise at March 31, 1999, compared to March 31, 1998.
During the three months ended March 31, 1999 and 1998, Sunrise used $59.1
million and $30.7 million, respectively, for investing activities. Investing
activities included investment in property and equipment in the amounts of
$51.5 million, which includes the purchase of one
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
assisted living facility, and $29.8 million for the three months ended March
31, 1999 and 1998, respectively, related to the construction of assisted
living facilities. For the three months ended March 31, 1999, Sunrise also
invested $12.4 million in notes receivable to facilitate the development of
assisted living facilities with third parties, offset by $5.1 million of
proceeds from investments and notes receivable.
Net cash provided by financing activities was $35.3 million for the three
months ended March 31, 1999 compared to $13.5 million net cash used in
financing activities for the three months ended March 31, 1998. Financing
activities for the three months ended March 31, 1999 included additional
borrowings of $33.1 million, offset, in part, by debt repayments of $0.5
million. Additional borrowings during the three months ended March 31, 1999
were primarily from one of Sunrise's credit facilities and were used to fund
Sunrise's continued development of assisted living facilities. During the
three months ended March 31, 1998, additional borrowings were $28,000 and debt
repayments were $16.4 million.
Sunrise currently estimates that the existing credit facilities, together
with existing working capital, financing commitments and financing expected to
be available, will be sufficient to fund facilities currently under
development. Additional financing will be required to complete additional
development and to refinance existing indebtedness. If the acquisition of
Karrington is completed, Sunrise estimates that it will cost between $261.0
million and $400.0 million to complete the 34 facilities the two companies
have under development. Sunrise expects that the cash flow from the combined
companies operations, together with borrowings under existing credit
facilities, will be sufficient to fund the needs of the combined entity for at
least six months following the merger. There can be no assurance that required
financing and refinancing will be available on acceptable terms.
The ability of Sunrise to achieve its development plans will depend upon a
variety of factors, many of which will be outside the control of Sunrise.
These factors include:
- obtaining zoning, land use, building, occupancy, licensing and other
required governmental permits for the construction of new facilities
without experiencing significant delays;
- completing construction of new facilities on budget and on schedule;
the ability to work with third-party contractors and subcontractors who
construct the facilities;
- shortages of labor or materials that could delay projects or make them
more expensive;
- adverse weather conditions that could delay projects;
- finding suitable sites for future development activities at acceptable
prices; and
- addressing changes in laws and regulations or how existing laws and
regulations are applied.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Sunrise cannot assure that it will not experience delays in completing
facilities under construction or in development or that it will be able to
identify suitable sites at acceptable prices for future development
activities. If it fails to achieve its development plans, its growth could
slow, which would adversely impact its revenues and results of operations.
Sunrise's growth plan includes the acquisition of assisted living
facilities or the companies operating assisted living facilities, such as
Karrington. The success of Sunrise's acquisitions will be determined by
numerous factors, including Sunrise's ability to identify suitable acquisition
candidates, competition for such acquisitions, the purchase price, the
financial performance of the facilities after acquisition and the ability of
Sunrise to integrate or operate acquired facilities effectively. Any failure
to do so may have a material adverse effect on Sunrise's business, financial
condition, revenues and earnings.
The long-term care industry is highly competitive and the assisted living
segment is becoming increasingly competitive. Sunrise competes with numerous
other companies that provide similar long-term care alternatives, such as home
health care agencies, facility-based service programs, retirement communities,
convalescent centers and other assisted living providers. Although some
competitors are significantly larger, there are no dominant companies in the
assisted living segment. In a recent industry report, it is estimated that
there are approximately 770,000 total assisted living beds currently
available, and that the 25 largest owners of assisted living properties, which
includes Sunrise, has 180,446 or only 23% of those currently available. The
largest individual owner has only 3% of the total assisted living beds
currently available. In general, regulatory and other barriers to competitive
entry in the assisted living industry are not substantial. In pursuing its
growth strategies, Sunrise has experienced and expects to continue to
experience increased competition in its efforts to develop and acquire
assisted living facilities. Some of the present and potential competitors of
Sunrise are significantly larger and have, or may obtain, greater financial
resources than Sunrise. Consequently, Sunrise cannot assure that it will not
encounter increased competition that could limit its ability to attract
residents or expand its business, which could have a material adverse effect
on its revenues and earnings.
Sunrise believes that some assisted living markets have become or are on
the verge of becoming overbuilt. As described above, regulation and other
barriers to entry into the assisted living industry are not substantial.
Consequently, the development of new assisted living facilities could outpace
demand. Overbuilding in Sunrise market areas could, therefore, cause Sunrise
to experience decreased occupancy, depressed margins or lower operating
results. Sunrise believes that each local market is different and Sunrise is
and will continue to react in a variety of ways, including selective price
discounting, to the specific competitive environment that exists in each
market.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In April 1998, the Accounting Standards Executive Committee issued
Statement of Position 98-5, Reporting on the Costs of Start-up Activities,
which is effective for fiscal years beginning after December 15, 1998. SOP
98-5 provides guidance on the financial reporting of start-up costs and
organization costs. It requires costs of start-up activities and organization
costs to be expensed as incurred. It is Sunrise's policy to capitalize certain
costs incurred to rent its facilities such as costs of model units, their
furnishings and "grand openings" in accordance with Statement of Financial
Accounting Standards No. 67, Accounting for Costs and Initial Rental Operation
of Real Estate Projects. Additionally, initial direct costs associated with
originating lease transactions are capitalized in accordance with Statement of
Financial Accounting Standards No. 91, Accounting for Nonrefundable Fees and
Costs Associated with Originating or Acquiring Loans and Initial Direct Costs
of Leases. Direct costs include employees' compensation and payroll-related
fringe benefits directly related to acquiring leases. All costs of Sunrise's
development and leasing activities which are not considered to be within the
scope of Statement 67 or Statement 91 are expensed as incurred. SOP 98-5
states that the guidance provided by Statement 67 and Statement 91 is not
affected by the provisions of SOP 98-5. The adoption of SOP 98-5 in January
1999 did not affect results of operations or the financial position of
Sunrise.
In June 1998, the Financial Accounting Standards Board issued Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities, which
is effective for all fiscal quarters of fiscal years beginning after June 15,
1999. Statement 133 standardizes the accounting for derivative instruments.
Sunrise participates in interest rate swap transactions, which would be
considered derivatives under Statement 133. Sunrise has not entered into any
other derivative transactions. To date, the net effect of the interest rate
swaps to Sunrise's results of operations has not been material. Therefore,
Statement 133 is not anticipated to affect results of operations or the
financial position of Sunrise.
IMPACT OF INFLATION
Resident fees from Company-owned assisted living facilities and management
services income from facilities operated by Sunrise for third parties are the
primary sources of revenue for Sunrise. These revenues are affected by daily
resident fee rates and facility occupancy rates. The rates charged for the
delivery of assisted living services are highly dependent upon local market
conditions and the competitive environment in which the facilities operate. In
addition, employee compensation expense is the principal cost element of
property operations. Employee compensation, including salary increases and the
hiring of additional staff to support Sunrise's growth initiatives, have
previously had a negative impact on operating margins and may again do so in
the foreseeable future.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Substantially all of Sunrise's resident agreements are for terms of one
year, but are terminable by the resident at any time upon 30 days' notice, and
allow, at the time of renewal, for adjustments in the daily fees payable, and
thus may enable Sunrise to seek increases in daily fees due to inflation or
other factors. Any increase would be subject to market and competitive
conditions and could result in a decrease in occupancy of Sunrise's
facilities. Sunrise believes, however, that the short-term nature of its
resident agreements generally serves to reduce the risk to Sunrise of the
adverse effect of inflation. There can be no assurance that resident fees will
increase or that costs will not increase due to inflation or other causes.
YEAR 2000 ISSUES
Impact of Year 2000. Some of the older computer programs utilized by
Sunrise were written using two digits rather than four to define the
applicable year. As a result, those computer programs have time-sensitive
software that recognize a date using "00" as the year 1900 rather than the
year 2000. This could cause a system failure or miscalculations causing
disruptions of operations, including a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
State of Readiness. Sunrise started to formulate a plan to address the
year 2000 issue in late 1996. Sunrise has given its vice president of
information technology specific responsibility for managing its year 2000
plan. This vice president leads a multi-disciplinary team to make Sunrise's
mission critical information technology systems and embedded systems year 2000
ready. Sunrise's plan for mission critical information technology systems
consists of four phases:
- inventory - identifying all mission critical information technology
systems and risk rating each according to its potential business
impact;
- assessment - identifying mission critical information technology
systems that use date functions and assessing them for year 2000
functionality;
- remediation - reprogramming, or replacing where necessary,
inventoried items to ensure they are year 2000 ready; and
- testing - including date testing and performing quality assurance
testing to ensure successful operation in the post-1999 environment.
Sunrise completed the inventory and assessment phases for substantially
all of its mission critical information technology systems by year-end 1997.
Sunrise's mission critical information technology systems are currently in the
remediation and testing phases. Mission critical information technology
systems implemented or updated that are year 2000 compliant include:
- the accounting general ledger system;
- the resident billing system;
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
- the cash disbursement or accounts payable system;
- the development or project cost system;
- the fixed asset system;
- the employee stock option system;
- payroll and human resource system; and
- substantially all software residing on Sunrise's home office and
facility desk-top and lap-top computers.
Sunrise plans to complete the remediation of substantially all of its
mission critical systems by mid-1999 and the testing of all of its mission
critical information technology systems by September 1999.
Sunrise is approximately 75% complete in its assessment of embedded
systems and expects to complete its assessment in June 1999, which includes
the additional Karrington communities. Sunrise's remaining steps will then
include testing selected embedded systems and remediating and testing systems
that exhibit year 2000 issues. Sunrise intends to focus its testing and
remediation efforts on select embedded systems at Sunrise's facilities, such
as telephone, elevator, security, HVAC and similar systems. Sunrise plans to
complete the assessment, remediation and testing of these systems by year-end
1999.
External Relationships. Sunrise also faces the risk that one or more of
its critical vendors will not be able to interact with Sunrise due to the
third party's inability to resolve its own year 2000 issues, including those
associated with its own external relationships. Sunrise has completed its
inventory of external relationships and is attempting to determine the overall
year 2000 readiness of its external relationships. In the case of mission
critical suppliers, such as banks, financial intermediaries, including stock
exchanges, telecommunications providers and other utilities, Sunrise is
engaged in discussions with the third parties and is attempting to obtain
detailed information as to those parties' year 2000 plans and state of
readiness. Sunrise, however, does not have sufficient information at the
current time to predict whether its external relationships with mission
critical suppliers will be year 2000 ready.
Year 2000 Costs. Sunrise estimates on a preliminary basis that the cost of
assessment, remediation, testing and certification of its internal systems
will range from approximately $500,000 to $1,500,000. The major components of
these costs are: consultants, new software and hardware, software upgrades and
travel expenses. Sunrise expects that these costs will be funded through
operating cash flows. This estimate is based on currently available
information. Sunrise's year 2000 costs may increase once it has determined the
year 2000 readiness of its vendors, customers and other third parties. In
addition, the availability and cost of consultants and other personnel trained
in this area and any future acquisitions may materially affect the estimated
costs.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
No Assurance that Sunrise Can Fully Implement Its Year 2000 Plan.
Sunrise's year 2000 issue involves significant risks. There can be no
assurance that Sunrise will succeed in fully implementing its year 2000 plan.
The following describes Sunrise's most reasonably likely worst-case scenario,
given current uncertainties. If Sunrise's remediated internal mission critical
information technology systems fail upon testing, or any software application
or embedded microprocessors central to Sunrise's operations are overlooked in
the assessment or implementation phases, Sunrise may incur significant
problems, including delays in billing its residents. If Sunrise's vendors or
suppliers fail to provide its facilities with necessary power,
telecommunications, transportation and financial services, equipment and
services, Sunrise will be unable to provide services to its residents. If any
of these uncertainties were to occur, Sunrise's business, revenues and results
of operations would be adversely affected. Sunrise is unable at this time to
assess the likelihood of these events occurring or the extent of the effect on
Sunrise.
Year 2000 Forward-Looking Statements. The foregoing year 2000 discussion
contains "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements, including
anticipated costs and the dates by which Sunrise expects to complete actions,
are based on management's best current estimates, which were derived utilizing
numerous assumptions about future events, including the continued availability
of resources, representations received from third parties and other factors.
However, there can be no guarantee that these estimates will be achieved, and
actual results could differ materially from those anticipated. Specific
factors that might cause material differences include the ability to identify
and remediate all relevant mission critical information technology and
non-mission critical information technology systems, results of year 2000
testing, adequate resolution of year 2000 issues by businesses and other third
parties who are service providers and suppliers of Sunrise, unanticipated
system costs, the adequacy of and ability to develop and implement contingency
plans and similar uncertainties. The "forward-looking statements" made in the
previous year 2000 discussion speak only as of the date on which the
statements are made. Sunrise undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which the statement is made or to reflect the occurrence of unanticipated
events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
Sunrise is exposed to market risks related to fluctuations in interest
rates on its notes receivable, investments and debt. The purpose of the
following analyses is to provide a framework to understand the Company's
sensitivity to hypothetical changes in interest rates as of March 31, 1999.
Sunrise has investments in notes receivable, bonds and mortgages loans.
Investments in notes receivable are primarily with joint venture arrangements
in which Sunrise has equity ownership percentages ranging from 9% to 15%.
Investments in bonds and mortgage loans are secured by the operating
properties subject to the debt and are with properties that are managed by
26
<PAGE> 27
Sunrise. The majority of the investments have fixed rates. One of the notes
has an adjustable rate. Sunrise utilizes a combination of debt and equity
financing to fund its development, construction and acquisition activities.
Sunrise seeks the financing at the most favorable terms available at the time.
When seeking debt financing, Sunrise uses a combination of variable and fixed
rate debt, which ever is more favorable, in management's judgment at the time
of financing.
Sunrise has used interest rate swaps to manage the interest rates on some
of its long-term borrowings. As of December 31, 1999, Sunrise had two interest
rate swap agreements which effectively establishes fixed rates of 7.3% on up
to $19.0 million of long-term debt until June 2001 and 7.0% on up to $7.0
million of long-term debt until April 2003. Sunrise does not utilize forward
or option contracts on foreign currencies or commodities, or other types of
derivative financial instruments.
For fixed rate debt, changes in interest rates generally affect the fair
market value, but not earnings or cash flows. Conversely, for variable rate
debt, changes in interest rates generally do not impact fair market value, but
do affect the future earnings and cash flows. Sunrise generally cannot prepay
fixed rate debt prior to maturity, therefore, interest rate risk and changes
in fair market value should not have a significant impact on the fixed rate
debt until Sunrise would be required to refinance such debt. Holding the
variable rate debt balance of $201.9 million at March 31, 1999 constant, each
one percentage point increase in interest rates would result in an increase in
interest expense for the coming year of approximately $2.0 million.
The table below details by category the principal amount, the average
interest rates and the estimated fair market value. Some of the mortgage loans
receivable and some items in the various categories of debt, excluding the
convertible debentures, require periodic principal payments prior to the final
maturity date. The fair value estimates for the mortgage loans receivable are
based on the estimates of management and on rates currently prevailing for
comparable loans. The fair market value estimates for debt securities are
based on discounting future cash flows utilizing current rates offered to
Sunrise for debt of the same type and remaining maturity. The fair market
value estimate of the convertible notes is based on the market value at March
31, 1999.
27
<PAGE> 28
<TABLE>
<CAPTION>
Estimated
Fair
Maturity Date Market
2000 2001 2002 2003 2004 Thereafter Value
---- ---- ---- ---- ---- ---------- -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Notes receivable
Fixed rate $ 15,273 $ 3,533 -- -- -- $ 500 $ 17,121
Average interest rate 10.0% 12.0% -- -- -- 10.0% --
Variable rate -- -- -- $31,254 -- -- $ 31,254
Average interest rate -- -- -- 9.9% -- -- --
Investments
Bonds -- -- -- -- -- $ 5,750 $ 5,750
Average interest rate -- -- -- -- -- 11.0% --
Mortgages -- -- -- -- -- $22,320 $ 22,320
Average interest rate -- -- -- -- -- 9.7% --
LIABILITIES
Debt
Fixed rate $ 905 $66,080 $ 22,214 $ 6,373 $ 354 $12,703 $ 108,319
Average interest rate 7.2% 8.5% 7.0% 7.2% 7.7% 7.1% --
Variable rate $158,836 $24,385 $ 4,733 $ 3,497 $10,411 -- $ 201,862
Average interest rate 6.4% 6.7% 7.3% 8.4% 6.7% -- --
Convertible notes -- -- $150,000 -- -- -- $ 161,250
Average interest rate -- -- 5.5% -- -- -- --
</TABLE>
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 26, 1999, Sunrise held its 1999 annual meeting of stockholders at
The Ritz-Carlton (Tysons Corner), 1700 Tysons Boulevard, McLean, Virginia. The
annual meeting was called for the following purposes: (1) to elect three
directors for terms of three years each; (2) to approve the 1999 Stock Option
Plan; and (3) to transact such other business as may properly come before the
annual meeting or any adjournments thereof.
The following table sets forth the names of the directors elected at the
annual meeting for new three year terms and the number of votes cast for and
withheld for each director:
<TABLE>
<CAPTION>
WITHHOLD
AUTHORITY
Directors FOR TO VOTE
--------- --- -------
<S> <C> <C>
Ronald V. Aprahamian 15,840,916 5,300
David G. Bradley 15,840,916 5,200
Teresa M. Klaassen 15,840,966 8,250
</TABLE>
The names of each of the other directors whose terms of offices continued
after the annual meeting are as follows: Thomas J. Donohue, Richard A.
Doppelt, David W. Faeder, Paul J. Klaassen, and Scott F. Meadow.
28
<PAGE> 29
The 1999 Stock Option Plan also was approved at the meeting. The vote
tabulation was as follows: 9,724,994 votes (69.3% of the total eligible votes
excluding broker-non-votes) were cast for approval of the 1999 Stock Option
Plan, 4,278,557 votes (30.5% of the total eligible votes excluding
broker-non-votes) were cast against such approval and 30,295 votes (0.2% of
the total eligible votes excluding broker-non-votes) were abstentions.
Broker non-votes totaled 1,812,370.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Exhibit Name
----------- ------------
<S> <C>
10.1 1999 Stock Option Plan
27 Financial Data Schedule, which is submitted
electronically to the Securities and Exchange Commission
for information only and is not filed.
</TABLE>
(b) REPORTS ON FORM 8-K
On March 5, 1999, Sunrise filed a Form 8-K with the Securities and
Exchange Commission announcing the date of its 1999 annual meeting of
stockholders.
On March 5, 1999, Sunrise filed a Form 8-K with the Securities and
Exchange Commission announcing it had entered into an amendment to the
Agreement of Merger, dated as of October 18, 1998, with Karrington Health,
Inc., an Ohio corporation, and Buckeye Merger Corporation, an Ohio corporation
and a newly-formed wholly owned subsidiary of Sunrise.
29
<PAGE> 30
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.
SUNRISE ASSISTED LIVING, INC.
(Registrant)
Date: May 13, 1999 /s/ Christian B. A. Slavin
------------------------------ ------------------------------------
Christian B. A. Slavin
Chief Financial Officer
Date: May 13, 1999 /s/ Larry E. Hulse
------------------------------ ------------------------------------
Larry E. Hulse
Chief Accounting Officer
30
<PAGE> 31
INDEX OF EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Exhibit Name Page
----------- ------------ ----
<S> <C> <C>
10.1 1999 Stock Option Plan
27 Financial Data Schedule, which
is submitted electronically to
the Securities and Exchange
Commission for information only
and is not filed.
</TABLE>
31
<PAGE> 1
EXHIBIT 10.1
SUNRISE ASSISTED LIVING, INC.
1999 STOCK OPTION PLAN
SUNRISE ASSISTED LIVING, INC., a Delaware corporation (the
"Corporation"), sets forth herein the terms of this 1999 Stock Option Plan (the
"Plan") as follows:
1. PURPOSE
The Plan is intended to advance the interests of the Corporation and
any subsidiary thereof within the meaning of Rule 405 of Regulation C under the
Securities Act of 1933, as amended (with the term "person" as used in such Rule
405 being defined as in Section 2(2) of such Act) (a "Subsidiary"), by providing
eligible individuals (as designated pursuant to SECTION 4 below) with incentives
to improve business results, by providing an opportunity to acquire or increase
a proprietary interest in the Corporation, which thereby will create a stronger
incentive to expend maximum effort for the growth and success of the Corporation
and its Subsidiaries, and will encourage such eligible individuals to continue
to serve the Corporation and its Subsidiaries, whether as an employee, as a
director, as a consultant or advisor or in some other capacity. To this end, the
Plan provides for the grant of stock options, as set out herein.
This Plan provides for the grant of stock options (each of which is
an "Option") in accordance with the terms of the Plan. An Option may be an
incentive stock option (an "ISO") intended to satisfy the applicable
requirements under Section 422 of the Internal Revenue Code of 1986, as amended
from time to time, or the corresponding provision of any subsequently-enacted
tax statute (the "Code"), or a nonqualified stock option (an "NSO"). An Option
is an NSO to the extent that the Option would exceed the limitations set forth
in SECTION 7 below. An Option is also an NSO if either (i) the Option is
specifically designated at the time of grant as an NSO or not being an ISO or
(ii) the Option does not otherwise satisfy the requirements of Code Section 422
at the time of grant. Each Option shall be evidenced by a written agreement
between the Corporation and the recipient individual that sets out the terms and
conditions of the grant as further described in SECTION 8.
2. ADMINISTRATION
(a) BOARD
The Plan shall be administered by the Board of Directors of the
Corporation (the "Board"), which shall have the full power and authority to take
all actions and to make all determinations required or provided for under the
Plan or any Option granted or Option Agreement (as defined in SECTION 8 below)
entered into hereunder and all such other actions and determinations not
inconsistent with the specific terms and provisions of the Plan deemed by the
Board to be necessary or appropriate to the administration of the Plan or any
Option granted or Option Agreement entered into hereunder. The interpretation
and construction by the Board of any provision of the Plan or of any Option
granted or Option Agreement entered into hereunder shall be final, binding and
conclusive.
<PAGE> 2
(b) ACTION BY COMMITTEE
The Board from time to time may appoint a Stock Option Committee
consisting of two or more members of the Board of Directors who, in the sole
discretion of the Board, may be the same Directors who serve on the Compensation
Committee, or may appoint the Compensation Committee to serve as the Stock
Option Committee (the "Committee"). The Board, in its sole discretion, may
provide that the role of the Committee shall be limited to making
recommendations to the Board concerning any determinations to be made and
actions to be taken by the Board pursuant to or with respect to the Plan, or the
Board may delegate to the Committee such powers and authorities related to the
administration of the Plan, as set forth in SECTION 2(a) above, as the Board
shall determine, consistent with the Restated Certificate of Incorporation and
By-Laws of the Corporation and applicable law. In the event that the Plan or any
Option granted or Option Agreement entered into hereunder provides for any
action to be taken by or determination to be made by the Board, such action may
be taken by or such determination may be made by the Committee if the power and
authority to do so has been delegated to the Committee by the Board as provided
for in this Section. Unless otherwise expressly determined by the Board, any
such action or determination by the Committee shall be final and conclusive.
(c) NO LIABILITY
No member of the Board or of the Committee shall be liable for any
action or determination made in good faith with respect to the Plan or any
Option granted or Option Agreement entered into hereunder.
3. STOCK
The stock that may be issued pursuant to Options under the Plan shall
be shares of common stock, par value $.01 per share, of the Corporation (the
"Stock"), which shares may be treasury shares or authorized but unissued shares.
The number of shares of Stock that may be issued pursuant to Options under the
Plan shall not exceed, in the aggregate, one million (1,000,000) shares. If any
Option expires, terminates, or is terminated or canceled for any reason prior to
exercise, the shares of Stock that were subject to the unexercised, forfeited,
terminated or canceled portion of such Option shall be available immediately for
future grants of Options under the Plan.
4. ELIGIBILITY
(a) DESIGNATED RECIPIENTS
Subject to the next sentence, Options may be granted under the Plan
to (i) any director, officer or employee of the Corporation or any Subsidiary as
the Board shall determine and designate from time to time or (ii) any consultant
or advisor providing bona fide services to the Corporation or any Subsidiary
(provided that such services must not be in connection with the offer or sale of
securities in a capital-raising transaction) whose participation in the Plan is
determined by the Board to be in the best interests of the Corporation and is so
designated by the Board. Options granted to a full-time employee of the
Corporation or a "subsidiary corporation" thereof within the meaning of Section
424(f) of the Code shall be either ISOs or NSOs, as determined in the sole
discretion of the Board, and Options granted to any other eligible individual
shall be NSOs.
A-2
<PAGE> 3
(b) SUCCESSIVE GRANTS
An individual may hold more than one Option, subject to such
restrictions as are provided herein.
5. EFFECTIVE DATE AND TERM OF THE PLAN
(a) EFFECTIVE DATE
The Plan shall be effective as of the date of adoption by the Board,
subject to approval of the Plan within one year of such effective date by the
affirmative vote of stockholders who hold more than fifty percent (50%) of the
combined voting power of the outstanding shares of voting stock of the
Corporation present or represented, and entitled to vote thereon at a duly
constituted stockholders' meeting, or by consent as permitted by law. Upon
approval of the Plan by the stockholders of the Corporation as set forth above,
however, all Options granted under the Plan on or after the effective date shall
be fully effective as if the stockholders of the Corporation had approved the
Plan on the Plan's effective date. If the stockholders fail to approve the Plan
within one year of such effective date, any Options granted hereunder shall be
null and void and of no effect.
(b) TERM
The Plan shall have no termination date, but no grant of an ISO may
occur after the date that is ten years after the effective date.
6. GRANT OF OPTIONS
(a) GENERAL
Subject to the terms and conditions of the Plan, the Board may, at
any time and from time to time, grant to such eligible individuals as the Board
may determine (each of the whom is an "Optionee"), Options to purchase such
number of shares of Stock on such terms and conditions as the Board may
determine, including any terms or conditions that may be necessary to qualify
such Options as ISOs under Section 422 of the Code. Such authority specifically
includes the authority, in order to effectuate the purposes of the Plan but
without amending the Plan, to modify grants to eligible individuals who are
foreign nationals or are individuals who are employed outside the United States
to recognize differences in local law, tax policy, or custom.
(b) LIMITATION ON GRANTS OF OPTIONS
The maximum number of shares subject to Options that can be granted
under the Plan to any executive officer of the Company or a Subsidiary, or to
any other person eligible for a grant of an Option under SECTION 4, is 500,000
shares during the first ten years after the effective date of the Plan and
200,000 shares per year thereafter (in each case, subject to adjustment as
provided in SECTION 16(a) hereof).
A-3
<PAGE> 4
7. LIMITATIONS ON INCENTIVE STOCK OPTIONS
(a) PRICE AND DOLLAR LIMITATIONS
An Option that is designated as being one that is intended to qualify
as an ISO shall qualify for treatment as an ISO only to the extent that the
aggregate fair market value (determined at the time the Option is granted) of
the Stock with respect to which all options that are intended to constitute
"incentive stock options," within the meaning of Code Section 422, are
exercisable for the first time by any Optionee during any calendar year (under
the Plan and all other plans of the Optionee's employer corporation and its
parent and subsidiary corporations within the meaning of Section 422(d) of the
Code) does not exceed $100,000.
(b) PARACHUTE LIMITATIONS
Notwithstanding any other provision of this Plan or of any other
agreement, contract, or understanding heretofore or hereafter entered into by
the Optionee with the Corporation, except an agreement, contract, or
understanding hereafter entered into that expressly modifies or excludes
application of this paragraph (an "Other Agreement"), and notwithstanding any
formal or informal plan or other arrangement for the direct or indirect
provision of compensation to the Optionee (including groups or classes of
participants or beneficiaries of which the Optionee is a member), whether or not
such compensation is deferred, is in cash, or is in the form of a benefit to or
for the Optionee (a "Benefit Arrangement"), if the Optionee is a "disqualified
individual," as defined in Section 280G(c) of the Code, any Option held by that
Optionee and any right to receive any payment or other benefit under this Plan
shall not become exercisable or vested (i) to the extent that such right to
exercise, vesting, payment, or benefit, taking into account all other rights,
payments, or benefits to or for the Optionee under this Plan, all Other
Agreements, and all Benefit Arrangements, would cause any payment or benefit to
the Optionee under this Plan to be considered a "parachute payment" within the
meaning of Section 280G(b)(2) of the Code as then in effect (a "Parachute
Payment") and (ii) if, as a result of receiving a Parachute Payment, the
aggregate after-tax amounts received by the Optionee from the Corporation under
this Plan, all Other Agreements, and all Benefit Arrangements would be less than
the maximum after-tax amount that could be received by him without causing any
such payment or benefit to be considered a Parachute Payment. In the event that
the receipt of any such right to exercise, vesting, payment, or benefit under
this Plan, in conjunction with all other rights, payments, or benefits to or for
the Optionee under any Other Agreement or any Benefit Arrangement would cause
the Optionee to be considered to have received a Parachute Payment under this
Plan that would have the effect of decreasing the after-tax amount received by
the Optionee as described in clause (ii) of the preceding sentence, then the
Optionee shall have the right, in the Optionee's sole discretion, to designate
those rights, payments, or benefits under this Plan, any Other Agreements, and
any Benefit Arrangements that should be reduced or eliminated so as to avoid
having the payment or benefit to the Optionee under this Plan be deemed to be a
Parachute Payment.
8. OPTION AGREEMENTS
All Options granted pursuant to the Plan shall be evidenced by
agreements ("Option Agreements"), to be executed by the Corporation and by the
Optionee, in such form or forms as the Board shall from time to time determine.
Option Agreements covering Options granted from time to time or at the same time
need not contain similar provisions; provided, however, that all such Option
Agreements shall comply with all terms of the Plan.
A-4
<PAGE> 5
9. OPTION PRICE
The purchase price of each share of the Stock subject to an Option
(the "Option Price") shall be fixed by the Board and stated in each Option
Agreement. The Option Price shall be not less than the greater of par value or
100 percent of the fair market value of a share of Stock on the date on which
the Option is granted (as determined in good faith by the Board); provided,
however, that in the event the Optionee would otherwise be ineligible to receive
an ISO by reason of the provisions of Sections 422(b)(6) and 424(d) of the Code
(relating to stock ownership of more than ten percent), the Option Price of an
Option that is intended to be an ISO shall not be less than the greater of par
value or 110 percent of the fair market value of a share of Stock at the time
such Option is granted. In the event that the Stock is listed on an established
national or regional stock exchange or The Nasdaq Stock Market, is admitted to
quotation on the National Association of Securities Dealers Automated Quotation
System, or is publicly traded in an established securities market, in
determining the fair market value of the Stock, the Board shall use the closing
price of the Stock on such exchange or system or in such market (the highest
such closing price if there is more than one such exchange or market) on the
trading date immediately before the Option is granted (or, if there is no such
closing price, then the Board shall use the mean between the highest bid and
lowest asked prices or between the high and low prices on such date), or, if no
sale of the Stock has been made on such day, on the next preceding day on which
any such sale shall have been made.
10. TERM AND EXERCISE OF OPTIONS
(a) TERM
Upon the expiration of ten years from the date on which an ISO is
granted or on such date prior thereto as may be fixed by the Board and stated in
the Option Agreement relating to such Option, that ISO shall be ineligible for
treatment as an "incentive stock option," as defined in Section 422 of the Code,
and shall be exercisable only as an NSO. In the event the Optionee otherwise
would be ineligible to receive an "incentive stock option" by reason of the
provisions of Sections 422(b)(6) and 424(d) of the Code (relating to stock
ownership of more than 10 percent), such ten year restriction on exercisability
as an ISO shall be read to impose a five year restriction on such
exercisability. If an Optionee shall terminate employment prior to the ten-year
or five-year limitation described in the immediately preceding sentences, any
outstanding ISO shall be ineligible for treatment as an "incentive stock
option," as defined in Section 422 of the Code, and shall be exercisable only as
an NSO, unless exercised within three months after such termination or, in the
case of termination on account of "permanent and total disability" (within the
meaning of Section 22(e)(3) of the Code), within one year after such
termination.
(b) OPTION PERIOD AND LIMITATIONS ON EXERCISE
Each Option granted under the Plan shall be exercisable, in whole or
in part, at any time and from time to time, over a period commencing on or after
the date of grant and, to the extent that the Board determines and sets forth a
termination date for such Option in the Option Agreement (including any
amendment thereto), ending upon the stated expiration or termination date. The
Board in its sole discretion may specify events or circumstances, including the
giving of notice, which will cause an Option to terminate as set forth in the
Option Agreement or in this Plan. No Option granted to a person who is required
to file reports under Section 16(a) of the Securities Exchange Act of 1934 (as
now in effect or as hereafter amended) shall be exercisable during the first six
months after the date of grant. Without limiting the foregoing but subject to
the terms and conditions of the Plan, the Board may in its sole discretion
provide that an Option may not be exercised in whole or in part for any period
or periods
A-5
<PAGE> 6
of time during which such Option is outstanding and may condition exercisability
(or vesting) of an Option upon the attainment of performance objectives, upon
continued service, upon certain events or transactions, or a combination of one
or more of such factors, or otherwise, as set forth in the Option Agreement.
Subject to the parachute payment restrictions under SECTION 7(b), however, the
Board, in its sole discretion, may rescind, modify, or waive any such limitation
or condition on the exercise of an Option contained in any Option Agreement, so
as to accelerate the time at which the Option may be exercised or extend the
period during which the Option may be exercised. Notwithstanding any other
provisions of the Plan, no Option granted to an Optionee under the Plan shall be
exercisable in whole or in part prior to the date on which the stockholders of
the Corporation approve the Plan, as provided in SECTION 5 above.
(c) METHOD OF EXERCISE
An Option that is exercisable hereunder may be exercised by delivery
to the Corporation on any business day, at the Corporation's principal office,
addressed to the attention of the President, of written notice of exercise,
which notice shall specify the number of shares with respect to which the Option
is being exercised and shall be accompanied by payment in full of the Option
Price of the shares for which the Option is being exercised. The minimum number
of shares of Stock with respect to which an Option may be exercised, in whole or
in part, at any time shall be the lesser of (i) 100 shares or such lesser number
set forth in the applicable Option Agreement and (ii) the maximum number of
shares available for purchase under the Option at the time of exercise. Payment
of the Option Price for the shares of Stock purchased pursuant to the exercise
of an Option shall be made (i) in cash or in cash equivalents; (ii) to the
extent permitted by applicable law and under the terms of the Option Agreement
with respect to such Option, through the tender to the Corporation of shares of
Stock, which shares shall be valued, for purposes of determining the extent to
which the Option Price has been paid thereby, at their fair market value
(determined in accordance with SECTION 9) on the date of exercise; (iii) to the
extent permitted by applicable law and under the terms of the Option Agreement
with respect to such Option, by the delivery of a promissory note of the person
exercising the Option to the Corporation on such terms as shall be set out in
such Option Agreement; (iv) to the extent permitted by applicable law and under
the terms of the Option Agreement with respect to such Option, by causing the
Corporation to withhold shares of Stock otherwise issuable pursuant to the
exercise of an Option equal in value to the Option Price or portion thereof to
be satisfied pursuant to this clause (iv); or (v) by a combination of the
methods described in (i), (ii), (iii), and (iv). An attempt to exercise any
Option granted hereunder other than as set forth above shall be invalid and of
no force and effect. Payment in full of the Option Price need not accompany the
written notice of exercise provided the notice directs that the Stock
certificate or certificates for the shares for which the Option is exercised be
delivered to a licensed broker acceptable to the Corporation as the agent for
the individual exercising the Option and, at the time such Stock certificate or
certificates are delivered, the broker tenders to the Corporation cash (or cash
equivalents acceptable to the Corporation) equal to the Option Price. Promptly
after the exercise of an Option and the payment in full of the Option Price of
the shares of Stock covered thereby, the individual exercising the Option shall
be entitled to the issuance of a Stock certificate or Stock certificates
evidencing his ownership of such shares. A separate Stock certificate or
separate Stock certificates shall be issued for any shares purchased pursuant to
the exercise of an Option that is an ISO, which certificate or certificates
shall not include any shares that were purchased pursuant to the exercise of an
Option that is an NSO. Unless otherwise stated in the applicable Option
Agreement, an individual holding or exercising an Option shall have none of the
rights of a stockholder (for example, the right to receive cash or stock
dividend payments attributable to the subject shares or to direct the voting of
the subject shares) until the shares of Stock covered thereby are fully paid and
issued to him. Except as provided in SECTION 16
A-6
<PAGE> 7
below, no adjustment shall be made for dividends or other rights for which the
record date is prior to the date of such issuance.
(d) DATE OF GRANT
The date of grant of an Option under this Plan shall be the date as
of which the Board approves the grant.
11. TRANSFERABILITY OF OPTIONS
During the lifetime of an Optionee, only such Optionee (or, in the
event of legal incapacity or incompetency, the guardian or legal representative
of the Optionee) may exercise the Option, except as otherwise specifically
permitted by this SECTION 11. No Option shall be assignable or transferable
other than by will or in accordance with the laws of descent and distribution;
provided, however, subject to the terms of the applicable Option Agreement, and
to the extent the transfer is in compliance with any applicable restrictions on
transfers, an Optionee may transfer an NSO to a family member of the Optionee
(defined as an individual who is related to the Optionee by blood or adoption)
or to a trust established and maintained for the benefit of the Optionee or a
family member of the Optionee (as determined under applicable state law and the
Code).
12. TERMINATION OF EMPLOYMENT OR OTHER RELATIONSHIP OF OPTIONEE
In the Board's sole discretion, the Board may include language in an
Option Agreement providing for the termination of any unexercised Option in
whole or in part upon or at any time after the termination of employment or
other relationship of the Optionee with the Corporation or a Subsidiary (whether
as an employee, a director, a consultant or advisor providing bona fide services
to the Corporation or a Subsidiary, or otherwise). Whether a leave of absence or
leave on military or government service shall constitute a termination of
employment or other relationship of the Optionee with the Corporation or a
Subsidiary for purposes of the Plan shall be determined by the Board, which
determination shall be final and conclusive.
13. USE OF PROCEEDS
The proceeds received by the Corporation from the sale of Stock
pursuant to the exercise of Options granted under the Plan shall constitute
general funds of the Corporation.
14. REQUIREMENTS OF LAW
The Corporation shall not be required to sell or issue any shares of
Stock under any Option if the sale or issuance of such shares would constitute a
violation by the Optionee, the individual exercising the Option, or the
Corporation of any provisions of any law or regulation of any governmental
authority, including without limitation any federal or state securities laws or
regulations. If at any time the Corporation shall determine, in its discretion,
that the listing, registration, or qualification of any shares subject to the
Option upon any securities exchange or under any state or federal law, or the
consent or approval of any government regulatory or self-regulatory body is
necessary or desirable as a condition of, or in connection with, the issuance or
purchase of shares, the Option may not be exercised in whole or in part unless
such listing, registration, qualification, consent, or approval shall have been
effected or obtained free of any conditions not acceptable to the Corporation,
and any delay caused thereby shall in no way affect the date of termination of
the Option. Specifically in connection with the
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<PAGE> 8
Securities Act of 1933 (as now in effect or as hereafter amended), upon the
exercise of any Option, unless a registration statement under such Act is in
effect with respect to the shares of Stock covered thereby, the Corporation
shall not be required to sell or issue such shares unless the Board has received
evidence satisfactory to it that the holder of such Option may acquire such
shares pursuant to an exemption from registration under such Act. Any
determination in this connection by the Board shall be final, binding, and
conclusive. The Corporation may, but shall in no event be obligated to, register
any securities covered hereby pursuant to the Securities Act of 1933 (as now in
effect or as hereafter amended). The Corporation shall not be obligated to take
any affirmative action in order to cause the exercisability or vesting of an
Option or to cause the exercise of an Option or the issuance of shares pursuant
thereto to comply with any law or regulation of any governmental authority. As
to any jurisdiction that expressly imposes the requirement that an Option shall
not be exercisable unless and until the shares of Stock covered by such Option
are registered or are subject to an available exemption from registration, the
exercise of such Option (under circumstances in which the laws of such
jurisdiction apply) shall be deemed conditioned upon the effectiveness of such
registration or the availability of such an exemption.
15. AMENDMENT AND TERMINATION OF THE PLAN
The Board may, at any time and from time to time, amend, suspend, or
terminate the Plan as to any shares of Stock as to which Options have not been
granted; provided, however, that any amendment by the Board which, if not
approved by the Corporation's stockholders, would cause the Plan to not comply
with Sections 162(m) or 422 of the Code shall not be effective unless approved
by the affirmative vote of stockholders who hold more than fifty percent (50%)
of the combined voting power of the outstanding shares of voting stock of the
Corporation present or represented, and entitled to vote thereon at a duly
constituted stockholders' meeting, or by consent as permitted by law. The
Corporation, however, may retain the right in an Option Agreement to convert an
ISO into an NSO. The Corporation may also retain the right in an Option
Agreement to cause a forfeiture of the shares of Stock or gain realized by a
holder of an Option (a) if the holder violates any agreement covering
non-competition with the Corporation or any Subsidiary or nondisclosure of
confidential information of the Corporation or any Subsidiary, (b) if the
holder's employment is terminated for cause or (c) if the Board determines that
the holder committed acts or omissions which would have been the basis for a
termination of holder's employment for cause had such acts or omissions been
discovered prior to termination of holder's employment. Furthermore, the
Corporation may, in the Option Agreement, retain the right to annul the grant of
an Option, if the holder of such grant was an employee of the Corporation or a
Subsidiary and the holder's employment is terminated for cause, as defined in
the applicable Option Agreement. Except as permitted under this SECTION 15 or
SECTION 16 hereof, no amendment, suspension, or termination of the Plan shall,
without the consent of the holder of the Option, alter or impair rights or
obligations under any Option theretofore granted under the Plan.
16. EFFECT OF CHANGES IN CAPITALIZATION
(a) CHANGES IN STOCK
If the number of outstanding shares of Stock is increased or
decreased or the shares of Stock are changed into or exchanged for a different
number or kind of shares or other securities of the Corporation on account of
any recapitalization, reclassification, stock split-up, combination of shares,
exchange of shares, stock dividend or other distribution payable in capital
stock, or other increase or decrease in such shares effected without receipt of
consideration by the Corporation, occurring after the effective date of the
Plan, the number and kind of shares for the acquisition of which Options may be
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<PAGE> 9
granted under the Plan, and the limitations on the maximum number of shares
subject to Options that can be granted to any individual under the Plan as set
forth in SECTION 6(b) hereof, shall be adjusted proportionately and accordingly
by the Corporation. In addition, the number and kind of shares for which Options
are outstanding shall be adjusted proportionately and accordingly so that the
proportionate interest of the holder of the Option immediately following such
event shall, to the extent practicable, be the same as immediately before such
event. Any such adjustment in outstanding Options shall not change the aggregate
Option Price payable with respect to shares that are subject to the unexercised
portion of the Option outstanding but shall include a corresponding
proportionate adjustment in the Option Price per share.
(b) REORGANIZATION IN WHICH THE CORPORATION IS THE SURVIVING CORPORATION
Subject to SUBSECTION ((c))(iv) hereof, if the Corporation shall be
the surviving corporation in any reorganization, merger, or consolidation of the
Corporation with one or more other corporations, any Option theretofore granted
pursuant to the Plan shall pertain to and apply to the securities to which a
holder of the number of shares of Stock subject to such Option would have been
entitled immediately following such reorganization, merger, or consolidation,
with a corresponding proportionate adjustment of the Option Price per share so
that the aggregate Option Price thereafter shall be the same as the aggregate
Option Price of the shares remaining subject to the Option immediately prior to
such reorganization, merger, or consolidation.
(c) DISSOLUTION, LIQUIDATION, SALE OF ASSETS,
REORGANIZATION IN WHICH THE CORPORATION IS NOT THE
SURVIVING CORPORATION, ETC.
The Plan and all Options outstanding hereunder shall terminate (i)
upon the dissolution or liquidation of the Corporation, or (ii) upon a merger,
consolidation, or reorganization of the Corporation with one or more other
corporations in which the Corporation is not the surviving corporation, or (iii)
upon a sale of substantially all of the assets of the Corporation to another
person or entity, or (iv) upon a merger, consolidation or reorganization (or
other transaction if so determined by the Board in its sole discretion) in which
the Corporation is the surviving corporation, that is approved by the Board and
that results in any person or entity (other than persons who are holders of
Stock of the Corporation at the time the Plan is approved by the stockholders
and other than an Affiliate) owning 80 percent or more of the combined voting
power of all classes of stock of the Corporation, except to the extent provision
is made in writing in connection with any such transaction covered by clauses
(i) through (iv) for the continuation of the Plan or the assumption of such
Options theretofore granted, or for the substitution for such Options of new
options covering the stock of a successor corporation, or a parent or subsidiary
thereof, with appropriate adjustments as to the number and kind of shares and
exercise prices, in which event the Plan and Options theretofore granted shall
continue in the manner and under the terms so provided. In the event of any such
termination of the Plan, each individual holding an Option shall have the right
(subject to the general limitations on exercise set forth in SECTION 10(b)
above), during such period occurring before such termination as the Board in its
sole discretion shall determine and designate, and in any event immediately
before the occurrence of such termination, to exercise such Option in whole or
in part, to the extent that such Option was otherwise exercisable at the time
such termination occurs, except that, by inclusion of appropriate language in an
Option Agreement, the Board may provide that the Option may be exercised before
termination without regard to any installment limitation or other condition on
exercise imposed pursuant to SECTION 10(b) above. The Corporation shall send
written notice of a transaction or event that will result in such a termination
to all individuals who hold Options not later than the time at which the
Corporation gives notice thereof to its stockholders.
A-9
<PAGE> 10
(d) ADJUSTMENTS
Adjustments under this SECTION 16 related to stock or securities of
the Corporation shall be made by the Board, whose determination in that respect
shall be final, binding, and conclusive. No fractional shares of Stock or units
of other securities shall be issued pursuant to any such adjustment, and any
fractions resulting from any such adjustment shall be eliminated in each case by
rounding downward to the nearest whole share or unit.
(e) NO LIMITATIONS ON CORPORATION
The grant of an Option pursuant to the Plan shall not affect or limit
in any way the right or power of the Corporation to make adjustments,
reclassifications, reorganizations, or changes of its capital or business
structure or to merge, consolidate, dissolve, or liquidate, or to sell or
transfer all or any part of its business or assets.
17. DISCLAIMER OF RIGHTS
No provision in the Plan or in any Option granted or Option Agreement
entered into pursuant to the Plan shall be construed to confer upon any
individual the right to remain in the employ or service of or to maintain a
relationship with the Corporation or any Subsidiary, or to interfere in any way
with any contractual or other right or authority of the Corporation or any
Subsidiary either to increase or decrease the compensation or other payments to
any individual at any time, or to terminate any employment or other relationship
between any individual and the Corporation or any Subsidiary. The obligation of
the Corporation to pay any benefits pursuant to this Plan shall be interpreted
as a contractual obligation to pay only those amounts described herein, in the
manner and under the conditions prescribed herein. The Plan shall in no way be
interpreted to require the Corporation to transfer any amounts to a third party
trustee or otherwise hold any amounts in trust or escrow for payment to any
participant or beneficiary under the terms of the Plan.
18. NONEXCLUSIVITY OF THE PLAN
Neither the adoption of the Plan nor the submission of the Plan to
the stockholders of the Corporation for approval shall be construed as creating
any limitations upon the right and authority of the Board to adopt such other
incentive compensation arrangements (which arrangements may be applicable either
generally to a class or classes of individuals or specifically to a particular
individual or particular individuals) as the Board in its discretion determines
desirable, including, without limitation, the granting of stock options
otherwise than under the Plan.
19. CAPTIONS
The use of captions in this Plan or any Option Agreement is for the
convenience of reference only and shall not affect the meaning of any provision
of the Plan or such Option Agreement.
20. DISQUALIFYING DISPOSITIONS
If Stock acquired by exercise of an ISO granted under this Plan is
disposed of within two years following the date of grant of the ISO or one year
following the transfer of the subject Stock to the Optionee (a "disqualifying
disposition"), the holder of the Stock shall, immediately prior to such
disqualifying disposition, notify the Corporation in writing of the date and
terms of such disposition and provide such other information regarding the
disposition as the Corporation may reasonably require.
A-10
<PAGE> 11
21. WITHHOLDING TAXES
The Corporation shall have the right to deduct from payments of any
kind otherwise due to an Optionee any Federal, state, or local taxes of any kind
required by law to be withheld with respect to any shares issued upon the
exercise of an Option under the Plan or in connection with the purchase of an
Option by the Corporation. At the time of exercise, the Optionee shall pay to
the Corporation any amount that the Corporation may reasonably determine to be
necessary to satisfy such withholding obligation. The Board in its sole
discretion may provide in the Option Agreement that, subject to the prior
approval of the Corporation, which may be withheld by the Corporation in its
sole discretion, the Optionee may elect to satisfy such obligations, in whole or
in part, (i) by causing the Corporation to withhold shares of Stock otherwise
issuable pursuant to the exercise of an Option or (ii) by delivering to the
Corporation shares of Stock already owned by the Optionee. The shares so
delivered or withheld shall have a fair market value equal to such withholding
obligations. The fair market value of the shares used to satisfy such
withholding obligation shall be determined by the Corporation as of the date
that the amount of tax to be withheld is to be determined. An Optionee who has
made an election pursuant to this SECTION 21 may only satisfy his or her
withholding obligation with shares of Stock that are not subject to any
repurchase, forfeiture, unfulfilled vesting, or other similar requirements.
22. OTHER PROVISIONS
Each Option granted under the Plan may be subject to, and the Option
Agreement relating to such Option may contain, such other terms and conditions
not inconsistent with the Plan as may be determined by the Board, in its sole
discretion. Notwithstanding the foregoing, each ISO granted under the Plan shall
include those terms and conditions that are necessary to qualify the ISO as an
"incentive stock option" within the meaning of Section 422 of the Code or the
regulations thereunder and shall not include any terms or conditions that are
inconsistent therewith.
23. NUMBER AND GENDER
With respect to words used in this Plan, the singular form shall
include the plural form, the masculine gender shall include the feminine gender,
etc., as the context requires.
24. SEVERABILITY
If any provision of the Plan or any Option Agreement shall be
determined to be illegal or unenforceable by any court of law in any
jurisdiction, the remaining provisions hereof and thereof shall be severable and
enforceable in accordance with their terms, and all provisions shall remain
enforceable in any other jurisdiction.
25. GOVERNING LAW
The validity and construction of this Plan and the instruments
evidencing the Options granted hereunder shall be governed by the laws of the
State of Delaware (excluding its choice of law rules).
* * *
A-11
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