<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
For the transition period from ___ to ___ .
Commission file number 0-28656
KARRINGTON HEALTH, INC.
(Exact name of registrant as specified in its charter)
OHIO 31-1461482
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
919 OLD HENDERSON ROAD
COLUMBUS, OHIO 43220
(Address of principle executive offices)
(614) 451-5151
(Registrant's telephone number, including area code)
Indicated by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- -----
Shares of Registrant's common shares, without par value, outstanding at
November 16, 1998 was 6,839,368.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
KARRINGTON HEALTH, INC.
AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
Item 1. Financial Statements
Consolidated Balance Sheets...........................................................3
Consolidated Statements of Operations
Three and Nine Months Ended September 30, 1998 and 1997...............................4
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1998 and 1997.........................................5
Notes to Consolidated Financial Statements..........................................6-9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................................10-15
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.....................................................16
Signature Page.......................................................................17
Note: Item 3 of Part I and Items 1 through 5 of Part II are omitted because they are not
applicable.
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION.
ITEM 1. FINANCIAL STATEMENTS.
KARRINGTON HEALTH, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
(UNAUDITED)
------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents ......................... $ 2,873,590 $ 4,370,488
Receivables:
Trade ........................................... 976,462 482,597
Due from REIT ................................... 2,540,051 4,330,981
Affiliates ...................................... 697,900 649,172
Land sold subject to put right .................... 2,100,000 --
Prepaid expenses .................................. 553,823 281,722
------------ ------------
Total current assets .......................... 9,741,826 10,114,960
Property and equipment - net ........................ 113,758,912 115,983,043
Cost in excess of net assets acquired - net ......... 8,136,689 8,231,073
Other assets - net .................................. 7,488,175 6,986,724
------------ ------------
Total assets .................................. $139,125,602 $141,315,800
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities .......... $ 3,581,857 $ 2,535,969
Construction payables ............................. 2,882,698 4,717,230
Notes payable-banks ............................... 5,000,000 6,000,000
Deposit on sale of land ........................... 2,100,000 --
Payroll and related taxes ......................... 1,111,089 1,080,884
Unearned resident fees ............................ 1,404,569 861,266
Interest payable .................................. 456,839 614,919
Current portion of long-term debt ................. 392,849 998,523
------------ ------------
Total current liabilities ..................... 16,929,901 16,808,791
Long-term debt, less current portion ................ 93,003,262 97,067,298
Deferred gain on sale/leasebacks .................... 9,307,425 --
Other long-term liabilities ......................... 1,730,050 440,169
Deferred income taxes ............................... 493,000 493,000
Minority interests .................................. 972,000 --
Shareholders' equity:
Common shares .................................... 33,501,855 33,484,712
Accumulated deficit .............................. (16,811,891) (6,978,170)
------------ ------------
Total shareholders' equity ..................... 16,689,964 26,506,542
------------ ------------
Total liabilities and shareholders' equity .... $139,125,602 $141,315,800
------------ ------------
------------ ------------
</TABLE>
SEE ACCOMPANYING NOTES.
3
<PAGE>
KARRINGTON HEALTH, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ----------------------------------
1998 1997 1998 1997
------------ ----------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Residence operations ......................... $ 9,325,579 $ 5,447,800 $ 23,293,959 $12,617,902
Development and management fees .............. 300,517 77,446 745,680 613,252
------------ ----------- ------------ ------------
Total revenues ........................... 9,626,096 5,525,246 24,039,639 13,231,154
Expenses:
Residence operations ......................... 7,965,643 4,190,287 18,934,230 9,364,082
General and administrative ................... 1,419,654 1,174,817 4,584,580 2,989,700
Rent expense ................................. 1,381,678 93,548 2,426,773 193,079
Depreciation and amortization ................ 1,375,587 783,753 3,613,717 1,765,233
Unusual charges .............................. -- 1,380,000 -- 1,380,000
------------ ----------- ------------ ------------
Total expenses ........................... 12,142,562 7,622,405 29,559,300 15,692,094
------------ ----------- ------------ ------------
Operating loss ................................. (2,516,466) (2,097,159) (5,519,661) (2,460,940)
Interest expense ............................... (1,415,932) (855,579) (4,072,190) (1,593,073)
Interest income ................................ 54,075 28,397 211,193 301,746
Equity in net loss of unconsolidated entities .. (112,717) (120,422) (453,063) (163,596)
------------ ----------- ------------ ------------
Loss before income taxes ....................... (3,991,040) (3,044,763) (9,833,721) (3,915,863)
Deferred income taxes .......................... -- 46,000 -- 190,000
------------ ----------- ------------ ------------
Net loss ....................................... $(3,991,040) $ (2,998,763) $(9,833,721) $(3,725,863)
------------ ----------- ------------ ------------
------------ ----------- ------------ ------------
Net loss per common share-basic and diluted $(0.58) $ (0.44) $ (1.44) $ (0.55)
Weighted average common shares outstanding ..... 6,839,400 6,837,400 6,838,000 6,777,000
</TABLE>
SEE ACCOMPANYING NOTES
4
<PAGE>
KARRINGTON HEALTH, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------------
1998 1997
------------- ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss ........................................................ $ (9,833,721) $ (3,725,863)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Depreciation and amortization ................................. 3,613,717 1,765,233
Provision for terminated projects and unusual charges ......... 775,000 1,380,000
Deferred income taxes ......................................... -- (190,000)
Equity in net loss of unconsolidated entities ................. 453,063 163,596
Change in operating assets and liabilities:
Accounts receivable ........................................ 2,125,249 (611,136)
Prepaid expenses ........................................... (272,101) (121,408)
Accounts payable and accrued liabilities ................... 2,129,197 1,610,596
Other liabilities .......................................... (49,359) 332,870
----------- ----------
Net cash (used in) provided by operating activities ........... (1,058,955) 603,888
INVESTING ACTIVITIES
Purchase of property and equipment .............................. (38,322,614) (28,788,179)
Proceeds from sale of property and equipment .................... 41,632,317 --
Decrease (increase) in restricted cash balances ................. (1,360,496) 749,372
Payments of pre-opening costs ................................... (2,284,020) (921,898)
Payments for organization costs and other ....................... (99,697) (710,312)
Acquisition of Kensington-net of cash acquired .................. -- (4,008,123)
----------- ----------
Net cash used in investing activities ......................... (434,510) (33,679,140)
FINANCING ACTIVITIES
Proceeds from (repayment of) notes payable ...................... (1,000,000) 15,500,000
Proceeds from mortgages ......................................... 28,789,338 9,783,424
Repayment of mortgages .......................................... (28,553,956) (199,662)
Proceeds from issuance of common shares ......................... 17,143 --
Minority interests equity contributions ......................... 972,000 --
Payment for financing fees ...................................... (427,958) (79,472)
Distributions from unconsolidated entity ........................ 200,000 225,000
----------- ----------
Net cash (used in) provided by financing activities ........... (3,433) 25,229,290
----------- ----------
Decrease in cash and cash equivalents ........................... (1,496,898) (7,845,932)
Cash and cash equivalents at beginning of period ................ 4,370,488 12,283,185
----------- ----------
Cash and cash equivalents at end of period ...................... $ 2,873,590 $ 4,437,253
----------- ----------
----------- ----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest .......................................... $ 4,565,922 $ 2,702,050
----------- ----------
----------- ----------
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
KARRINGTON HEALTH, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE UNAUDITED THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
1. BASIS OF PRESENTATION
The consolidated financial statements as of September 30, 1998 and for the
three and nine months ended September 30, 1998 and 1997 are unaudited;
however, in the opinion of management, all adjustments (consisting of normal
recurring items) necessary for a fair presentation of the consolidated
financial statements for these interim periods have been included. The
results for the interim period ended September 30, 1998 are not necessarily
indicative of the results to be obtained for the full fiscal year ending
December 31, 1998. Certain information and note disclosures which would
duplicate the disclosures normally included in annual financial statements
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission.
2. NET LOSS PER COMMON SHARE
In February 1997, the FASB issued Statement No. 128, "Earnings Per Share,"
which eliminates the presentation of primary earnings per share (EPS) and
requires the presentation of basic EPS, the principal difference being that
common stock equivalents are not considered in the computation of basic EPS.
It also requires dual presentation of basic and diluted EPS on the face of
the income statement for all entities with complex capital structures. The
Company was required to adopt Statement No. 128 for its year ended December
31, 1997.
The net loss per common share-basic and diluted for the three and nine months
ended September 30, 1998 and 1997 is computed based on the weighted average
number of shares outstanding during each period as the effect of including
any common share equivalents would be antidilutive. Common share equivalents
are comprised of outstanding stock options.
3. INVESTMENTS IN UNCONSOLIDATED ENTITIES
The Company and Catholic Health Initiatives ("CHI") have entered into joint
venture agreements to develop, own and operate eight assisted living
residences in Ohio, New Mexico, Nebraska and Colorado. Seven of the projects
are owned jointly by the Company and CHI, with the Company owning 20-50% of
the equity of each venture. The remaining project will be developed,
constructed and managed by the Company. As of September 30, 1998, the Company
has guaranteed $1 million of joint venture debt financing.
Effective January 1, 1998, the Company entered into a joint venture agreement
with a local hospital to operate an assisted living residence in Findlay,
Ohio, which opened on December 31, 1997. The joint venture is owned 50% by
the Company and is accounted for using the equity method of accounting.
6
<PAGE>
As of September 30, 1998, seven joint venture residences were open and one
joint venture residence was under construction. Five joint venture residences
were open at September 30, 1997. Summarized unaudited income statement
information of these joint ventures is presented below.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Residence revenues $ 2,862,784 $ 1,409,638 $ 7,816,703 $ 3,591,788
Expenses:
Operating expenses 2,200,973 1,313,533 6,213,240 3,103,814
Depreciation and amortization expense 481,882 285,664 1,506,107 675,798
Interest expense 587,797 290,409 1,724,877 651,509
----------- ----------- ----------- -----------
Total expenses 3,270,652 1,889,606 9,444,224 4,431,121
----------- ----------- ----------- -----------
Net loss $ (407,868) $ (479,968) $(1,627,521) $ (839,333)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
4. NOTES PAYABLE AND LONG-TERM OBLIGATIONS
In March 1997, the Company entered into a $5 million line of credit expiring
May 1999. At September 30, 1998, there was $5 million outstanding under this
agreement.
The Company entered into non-binding financing commitment letters with
Meditrust Mortgage Investments, Inc. ("MMI"), an affiliate of Meditrust (a
large healthcare REIT). Under the letters, MMI was to provide up to
approximately $100 million in financing for approximately 14 residences,
subject to various terms and conditions. The financings, which were to be
mortgage or lease financings, were entered into on a residence-by-residence
basis, and were for terms of up to 14 years (with two additional five-year
extension periods for the lease transactions). As of September 30, 1998, the
Company completed mortgage agreements for four residences totaling $22.4
million and six operating lease transactions totaling $46.2 million. See Note
6.
On April 30, 1997, the Company entered into a $27.6 million promissory note
in conjunction with its acquisition of Kensington. The amount outstanding
under the agreement was approximately $19.9 million as of September 30, 1998.
The Company anticipates that the remaining funds will be drawn down in two
phases prior to April 30, 1999, subject to certain Rochester, Minnesota
cottages achieving minimum debt service coverage ratios.
In September 1997, the Company entered into a $7.5 million promissory note
with JMAC, Inc. (JMAC), a 34% shareholder of the Company. Interest is payable
monthly and accrues at a bank's prime rate. The note expires on January 2,
2000. At September 30, 1998, $7.5 million was outstanding under this
agreement.
On October 17, 1997, the Company entered a $14 million construction loan
agreement for the development and construction of assisted living residences
in the State of Ohio. As of September 30, 1998, the Company has completed
mortgage agreements for three residences totaling $12.0 million. At September
30, 1998, the Company was in violation of certain covenants which the lender
has waived through September 30, 1999. Under the terms of the waiver, these
loans mature January 1, 2000.
In the second quarter of 1998, the Company sold six assisted living
residences for approximately
7
<PAGE>
$39.3 million and leased them back under a 20-year master lease agreement
which includes two ten-year renewal options. All six home leases will be
co-terminus and option periods must be exercised for all or none of the
residences. The transaction resulted in a gain of approximately $9.5 million,
which was deferred and is being amortized over the initial lease period. The
proceeds of the transaction were used to repay mortgage debt of $26.4 million
and short-term debt of $3.5 million. The balance of the proceeds was used for
development activities and working capital needs.
In April 1998, the Company entered into a $4 million construction mortgage
which expires on April 30, 1999 for the completion of five Karrington
Cottages. Interest is payable monthly and accrues at a rate of prime plus 1%.
In the third quarter of 1998, the Company sold two parcels of land in
California for a total of $3.5 million to a national assisted living operator
with operations on the West Coast. The net proceeds to the Company were $2.4
million after paying off a related note payable of approximately $1.1
million. The parties entered into a Put and Escrow Agreement related to one
of the parcels which states that if the buyer, after exercise of reasonable
diligence, is unable to obtain certain approvals on or before February 1,
1999, the buyer may exercise a "put" to require the Company to purchase the
property from the buyer. If the buyer should exercise the put, the purchase
price is $2,100,000 plus one-half (up to a maximum of $25,000) of the buyer's
out-of-pocket costs. The put terminates if the approvals are obtained prior
to February 1, 1999, and must be exercised by March 1, 1999. Until the put
option expires, the Company will report the $2,100,000 purchase price on its
balance sheet as "land sold subject to put right" and "deposit on sale of
land." The net proceeds were used to provide additional funds to support the
Company's working capital needs. If the buyer were to exercise its put
option, the Company's purchase price would be financed with the Sunrise
Assisted Living, Inc. line of credit discussed in Note 6.
5. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARD
In April 1998, the Accounting Standards Executive Committee issued SOP 98-5,
"Reporting on the Costs of Start-Up Activities" which requires that the costs
of start-up activities and organization costs be expensed as incurred. SOP
98-5 is effective for fiscal years beginning after December 15, 1998 with
earlier application encouraged. Management believes it will apply the
provisions of the SOP in the fourth quarter of 1998 or in the first quarter
of 1999. The application of SOP 98-5 will require the Company to write-off
all existing deferred preopening and organization costs (estimated to be $1.5
million at January 1, 1999) and expense all such items as incurred on a
prospective basis.
6. SUBSEQUENT EVENT
On October 19, 1998, the Company and Sunrise Assisted Living, Inc.
("Sunrise"), both leading providers of assisted living for seniors, announced
they have entered into a definitive agreement for Sunrise to acquire the
Company in a tax-free, stock-for-stock transaction valued at approximately
$89 million (based on the Sunrise closing price on October 16, 1998) and the
assumption of approximately $102 million in debt for a total purchase price
of approximately $191 million.
Under the merger agreement, the Company would become a wholly owned
subsidiary of Sunrise, and each issued and outstanding share of the Company's
common stock would be automatically converted into the right to receive a
number of shares of Sunrise common stock equal to the lesser of 0.3939 or the
number obtained by dividing $13 by the Average Trading Price of Sunrise
common stock, but in no event less than 0.3333. The Average Trading Price of
Sunrise common stock is defined to mean the
8
<PAGE>
average of the closing price of a share of Sunrise common stock as quoted on
Nasdaq National Market for the 10-day trading period ending three trading
days prior to the date of the Karrington shareholders' meeting held to
approve the merger agreement. Sunrise expects to account for the acquisition
of the Company using the purchase method of accounting.
Pursuant to the merger agreement, Sunrise has made available to the Company a
$10 million fully secured line of credit to be used for construction and
development activities and working capital which expires in November 1999.
After the merger, there will be approximately 21.9 million shares of Sunrise
common stock outstanding (using an exchange ratio of 0.3611) with a value
based on market prices at the time of the announcement of approximately $787
million. The combined company will operate 113 communities in 19 states with
a total resident capacity of approximately 8,400. It also will have an
additional 74 communities in various stages of development.
The acquisition has been approved by the Boards of Directors of both
companies and requires the approval of the shareholders of the Company. The
transaction also is subject to certain other customary conditions, including
regulatory approvals, and is expected to be completed during the first
quarter of 1999.
Sunrise also has entered into an agreement with Meditrust to acquire four
separate first trust mortgages secured by the Company's properties and six
assisted living properties currently leased to the Company ("the Meditrust
Interests") for approximately $63.7 million. Closing of the Sunrise
acquisition of the Meditrust Interests is scheduled to occur by December 2,
1998, subject to certain conditions such as examination of titles and
completion of transfer documents. Although the Company does not believe it is
in violation of any Meditrust covenants as of September 30, 1998, it is
probable that the Company would be in violation of certain Meditrust
covenants as of December 31, 1998 or in the first quarter of 1999 without an
infusion of equity.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of results of operations and financial condition
contains forward-looking information that involves risks and uncertainties.
The Company's actual results could differ materially from those anticipated.
Factors that could cause or contribute to such differences include, but are
not limited to, development activity and construction process risks,
availability of financing for development or construction, government
regulations, competition, and the challenge to manage rapid growth and
business expansion.
OVERVIEW
The Company is an operator and owner of licensed, assisted living residences
which provides quality, professional, personal and health-care services,
including an emphasis on Alzheimer's care, for individuals needing assistance
with activities of daily living. These activities include bathing, dressing,
meal preparation, housekeeping, taking medications, transportation, and other
activities that, because of the resident's condition, are difficult for
residents to accomplish in an independent living setting. The Company offers
its customers a dignified residential environment focused on quality of life.
The Company also provides development, support and management services to its
joint venture residences. As of September 30, 1998, the Company had 38
residences, including joint ventures, open in 10 states with a capacity of
2,116 residents. Five additional residences are under construction while four
others are complete and being readied for occupancy (these nine residences
have a capacity of 580 residents).
The Company derives its revenues primarily from: (i) resident fees for the
delivery of basic assisted living care services (79% of total revenues in
1998); (ii) resident fees for extended and special needs care services (9% of
total revenues in 1998) and (iii) community fee revenue (9% of total revenues
in 1998). Resident fees include revenue derived from basic assisted living
care, community fees, extended and special needs care and other sources.
Community fees are one-time fees generally payable by a resident upon
admission. Extended and special needs care are paid by residents who require
personal care in excess of services provided under the basic care program.]
The following table sets forth certain information regarding Karrington
residences as of September 30, 1998:
<TABLE>
<CAPTION>
COMPANY JOINTLY OWNED TOTAL
RESIDENCES RESIDENCES SYSTEM
----------------------------------- ----------------------------- -----------------------------
RESIDENCES UNITS BEDS RESIDENCES UNITS BEDS RESIDENCES UNITS BEDS
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Open 31 1,376 1,678 7 369 438 38 1,745 2,116
Under Construction 8 392 505 1 67 75 9 459 580
In Development:
Under Contract & Zoned 8 561 645 - - - 8 561 645
Under Contract & In Zoning 3 203 273 - - - 3 203 273
</TABLE>
10
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain data from the respective consolidated
statements of operations as a percentage of total revenues:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ --------------------------
1998 1997 1998 1997
-------------- ------------ ---------- ----------
<S> <C> <C> <C> <C>
Total revenues 100.0 % 100.0 % 100.0 % 100.0 %
Expenses:
Residence operations 82.8 75.8 78.8 70.8
General and administrative 14.7 21.3 19.1 22.6
Rent expense 14.4 1.7 10.1 1.5
Depreciation and amortization 14.2 14.2 15.0 13.3
Unusual charges - 25.0 - 10.4
-------------- ------------ ---------- ----------
Total expenses 126.1 138.0 123.0 118.6
-------------- ------------ ---------- ----------
Operating income (loss) (26.1) % (38.0) % (23.0) % (18.6) %
-------------- ------------ ---------- ----------
-------------- ------------ ---------- ----------
End of period (a):
Number of residences 31 20 31 20
Number of units 1,376 755 1,376 755
</TABLE>
(a) Excludes residences jointly owned by the Company accounted for by the
equity method.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997
Total revenue increased $4.1 million, or 74%, to $9.6 million in the third
quarter of 1998 from $5.5 million in the third quarter of 1997 primarily due
to the opening of new residences ($2.6 million) and the increased occupancy
of residences in the fill-up phase in 1997.
Average occupancy for the 14 stabilized residences for the three months ended
September 30, 1997 was 88%. For the three months ended September 30, 1998,
the average occupancy for 17 stabilized residences was 85%. Excluding an
older 66-unit hotel conversion acquired in the Kensington transaction which
averaged 67% occupancy and one Indianapolis location opened in March 1997
which averaged 49% occupancy, the remaining 15 stable residences averaged 89%
occupancy for the third quarter. The Company defines stabilized residences as
those residences (72 units or less) that have been operated by the Company
for 12 months or more as of the beginning of the period presented or that has
achieved occupancy of 95%.
Residence operating expenses increased $3.8 million, or 90%, to $8.0 million
in the third quarter of 1998 from $4.2 million in the third quarter of 1997.
As a percentage of residence operating revenues, residence operating expenses
increased from 77% in the third quarter of 1997 to 85% in the third quarter
of 1998 which resulted in a residence net operating income margin (NOI) of
23% in 1997 and 15% in 1998. The decrease in NOI resulted from start-up
losses associated with residences open less than one year (14 residences in
1998 vs. 6 residences in 1997).
General and administrative expenses increased $.2 million, or 21%, to $1.4
million in the third quarter of 1998 from $1.2 million in the third quarter
of 1997 primarily due an increase in uncapitalized construction and
development costs. The Company expects general and administrative expenses
will
11
<PAGE>
continue to decrease as a percentage of total revenues due to anticipated
economies of scale resulting from an increase in the number of open
residences.
Rent expense increased $1.3 million to $1.4 million in the third quarter of
1998 due to the opening of five leased residences in 1998 and the sale of six
residences pursuant to sale-leaseback transactions in the second quarter of
1998.
Depreciation and amortization increased $.6 million, or 76%, to $1.4 million
in the third quarter of 1998 from $0.8 million in the third quarter of 1997
primarily due to the opening of new residences ($.8 million) offset by lower
depreciation and amortization resulting from the sale of six residences
pursuant to sale-leaseback transactions in the second quarter of 1998.
Interest expense increased $.5 million, or 65%, to $1.4 million in the third
quarter of 1998 from $.9 million in the third quarter of 1997 primarily due
to the opening of new residences ($.4 million), a decrease in capitalized
interest ($.3 million) and a full quarter of interest expense for residences
which opened in the third quarter of 1997 ($.2 million), offset by lower
interest expense resulting from residences sold pursuant to sale-leaseback
transactions in the second quarter of 1998.
The equity in net loss of unconsolidated entities improved due to three joint
venture residences in the fill-up phase during the third quarter of 1998
compared to four joint venture residences in the fill-up phase during the
third quarter of 1997.
No deferred tax benefit was recorded in the third quarter of 1998 due to
limitations associated with the recognition of operating loss carryforwards
and other tax assets.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1997
Total revenue increased $10.8 million, or 82%, to $24.0 million in the first
nine months of 1998 from $13.2 million in the first nine months of 1997
primarily due to the opening of new residences ($4.2 million), the
acquisition of Kensington on April 30, 1997 ($3.6 million) and the increased
occupancy of residences in the fill-up phase in 1997.
Average occupancy for the stabilized residences for the nine months of 1997
was 89%. For the nine months ended September 30, 1998, the average occupancy
for 16 stabilized residences was 89%. Excluding an older 66-unit hotel
conversion acquired in the Kensington transaction which averaged 70% for the
first nine months of 1998, the remaining 15 stabilized residences averaged
92% occupancy.
Residence operating expenses increased $9.5 million, or 102%, to $18.9
million in the first nine months of 1998 from $9.4 million in the first nine
months of 1997. As a percentage of residence operating revenues, residence
operating expenses increased from 74% in the first nine months of 1997 to 81%
in the first nine months of 1998 which resulted in a residence NOI of 26% in
1997 and 19% in 1998. The decrease in NOI resulted from start-up losses
associated with residences open less than one year (15 residences in 1998 vs.
8 residences in 1997).
General and administrative expenses increased $1.6 million, or 53%, to $4.6
million in the first nine months of 1998 from $3.0 million in the first nine
months of 1997 primarily due to the acquisition of Kensington ($.2 million),
a provision for terminated projects of $.8 million (largely due to the
abandonment of one site and the third quarter sale of two additional sites)
and an increase in uncapitalized construction and development costs of $.5
million. The Company expects general and administrative expenses will
continue to decrease as a percentage of total revenues due to anticipated
12
<PAGE>
economies of scale resulting from an increase in the number of open
residences.
Rent expense increased $2.2 million to $2.4 million in the first nine months
of 1998 due to the opening of five leased residences in 1998 and the sale of
six residences pursuant to sale-leaseback transactions in the second quarter
of 1998.
Depreciation and amortization increased $1.8 million, or 105%, to $3.6
million in the first nine months of 1998 from $1.8 million in the first nine
months of 1997 primarily due to the opening of new residences ($1.4 million),
residences open for only a partial period in 1997 ($.5 million) and the
acquisition of Kensington, offset by lower depreciation and amortization
resulting from the sale of six residences pursuant to sale-leaseback
transactions in the second quarter of 1998.
Interest expense increased $2.5 million, or 156%, to $4.1 million in the
first nine months of 1998 from $1.6 million in the first nine months of 1997
primarily due to the opening of new residences and residences open for only a
partial period in 1997 ($1.3 million), the acquisition of Kensington ($.9
million), a decrease in capitalized interest ($.4 million) and the increased
use of the Company's lines of credit ($.4 million), offset by lower interest
expense resulting from residences sold pursuant to sale-leaseback
transactions in the second quarter of 1998.
The equity in net loss of unconsolidated entities increased due to four joint
venture residences in the fill-up phase during the first nine months of 1998
compared to two joint venture residences in the fill-up phase during the
first nine months of 1997.
No deferred tax benefit was recorded in the first nine months of 1998 due to
limitations associated with the recognition of operating loss carryforwards
and other tax assets.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its initial growth through a combination of mortgage
financing, sale/leasebacks, a development bond, subordinated borrowings from
JMAC and its affiliates, bank lines-of-credit, equity contributions and
proceeds from the initial public offering in 1996. The Company's mortgage and
construction mortgage financings mature in the next one to thirteen years,
bear interest at various fixed and fluctuating rates and are secured by
substantially all of the assets of the Company. The Company expects to
refinance such amounts as they mature.
On April 30, 1997, the Company entered into a $27.6 million promissory note
in conjunction with its acquisition of Kensington. The amount outstanding
under the agreement was approximately $19.9 million as of September 30, 1998.
The Company anticipates that the remaining funds will be drawn down in two
phases prior to April 30, 1999, subject to certain Rochester, Minnesota
cottage homes achieving minimum debt service coverage ratios.
On October 17, 1997, the Company entered a $14 million construction loan
agreement for the development and construction of assisted living residences
in the State of Ohio. As of September 30, 1998, the Company has completed
mortgage agreements for three residences totaling $12.0 million. At September
30, 1998, the Company was in violation of certain covenants which the lender
has waived through September 30, 1999. Under the terms of the waiver, these
loans mature January 1, 2000.
As of September 30, 1998, the Company had a line of credit totaling $5.0
million, all of which was outstanding, and had restricted cash of
approximately $2.5 million recorded in other assets on the consolidated
balance sheet.
13
<PAGE>
Pursuant to the merger agreement described in Note 6, Sunrise has made
available to the Company a $10 million fully secured line of credit to be
used for construction and development activities and working capital which
expires in November 1999.
The Company currently plans to open approximately 17 new Company and jointly
owned residences between September 30, 1998 and the second quarter of 2000.
The Company has opened 2 of these residences since September 30, 1998. In
addition, the Company has 4 cottage homes completed and being readied to
open, has 3 residences under construction and has obtained zoning approval
for the remaining 8 residences. The 17 planned openings do not include any
cottage homes beyond the 4 cottages completed and ready to open on the
Rochester, Minnesota campus. The Company is currently evaluating potential
and existing relationships with hospitals and clinics in order to evaluate
additional alternative, broader uses of its cottage model. As a result of
these evaluations, the Company's final plan for 1999 cottages will be
announced at a later date. The Company has been, and will continue to be,
dependent on third party financing for its acquisition and development
program. The Company estimates that newly developed residences will generally
range in cost from $5.0 to $11.0 million, with the development cycle taking
up to 24 months from site identification and zoning through construction and
residence opening. There can be no assurance that financing for the Company's
development program will be available to the Company on acceptable terms, if
at all. Moreover, to the extent the Company opens properties that do not
generate positive cash flow, the Company may be required to seek additional
capital for working capital and liquidity purposes.
The Company has existing financing in place in the form of loans or leases
for all residences which are currently completed and ready to open or under
construction. Additional financing will be required to develop and construct
the residences not currently under construction and to refinance certain
existing indebtedness. The Company has about $10.0 million invested in nine
projects staged for a construction start during 1998 and early 1999 that is
now awaiting construction or lease financing. Investments in future projects
will be limited until future financing commitments are obtained. In the
second quarter of 1998, the Company completed sale/leaseback transactions for
six residences generating approximately $13 million in net proceeds after
associated mortgage repayment. The Company is currently evaluating its
financing alternatives, including traditional mortgages, sale/leaseback
transactions and other forms of off-balance sheet financing.
The Company has funds available for working capital needs under project
financings currently in place. At this time, the Company expects to draw on
seven project mortgage and lease financings to support its working capital
needs in the fourth quarter of 1998 and first quarter of 1999.
In addition, the Company sold two parcels of land in California for a total
of $3.5 million to a national assisted living operator with operations on the
West Coast. The net proceeds to the Company were $2.4 million after paying
off a related note payable of approximately $1.1 million. The parties entered
into a Put and Escrow Agreement related to one of the parcels which states
that if the buyer, after exercise of reasonable diligence, is unable to
obtain certain approvals on or before February 1, 1999, the buyer may
exercise a "put" to require the Company to purchase the property from the
buyer. If the buyer should exercise the put, the purchase price is $2,100,000
plus one-half (up to a maximum of $25,000) of the buyer's out-of-pocket
costs. The put terminates if the approvals are obtained prior to February 1,
1999, and must be exercised by March 1, 1999. Until the put option expires,
the Company will report the $2,100,000 purchase price on its balance sheet as
"land sold subject to put right" and "deposit on sale of land." The net
proceeds were used to provide additional funds to support the Company's
working capital needs. If the buyer were to exercise its put option, the
Company's purchase price would be financed with the Sunrise line of credit
discussed in Note 6.
14
<PAGE>
The Company believes its existing financing commitments (including the
Sunrise line-of-credit), together with additional anticipated financing, will
be sufficient to fund its development, construction and working capital needs
into the first quarter of 1999.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARD
In April 1998, the Accounting Standards Executive Committee issued SOP 98-5,
"Reporting on the Costs of Start-Up Activities" which requires that the costs
of start-up activities and organization costs be expensed as incurred. SOP
98-5 is effective for fiscal years beginning after December 15, 1998 with
earlier application encouraged. Management believes it will apply the
provisions of the SOP in the fourth quarter of 1998 or in the first quarter
of 1999. The application of SOP 98-5 will require the Company to write-off
all existing deferred preopening and organization costs (estimated to be $1.5
million at January 1, 1999) and expense all such items as incurred on a
prospective basis.
IMPACT OF YEAR 2000
The Company has completed its review of the impact of the Y2K issue on its
information and financial systems and is in the process of spending about
$700,000 to upgrade hardware and software to be Year 2000 compliant. The
Company is implementing a Year 2000 compliant home administrative information
system which will provide better and faster information, particularly
regarding resident history, service needs, and associated billing. This
upgrade and implementation is expected to be completed beginning in the
fourth quarter of 1998 through the second quarter of 1999 and will be
financed from working capital and anticipated financing.
The Company is in the process of its review of all mechanical equipment
(i.e., telephone systems, elevators, security systems, HVAC systems,
vehicles, etc.) which shall be completed by the end of the fourth quarter of
1998. The Company believes its review is approximately 80% complete and
to-date has not identified any problems or issues which would require a
significant investment of time or capital.
The above effort should provide the Company with an internal solution to the
Y2K issue, but the Company remains cautious and continues to review external
issues that may impact the business or flow of funds. The Company's payroll
is processed by an independent third party that has assured the Company it
will be Year 2000 compliant. The Company will make contingent plans to resort
to manual operations if certain external interfaces fail. The Company is
continuing its review of Y2K issues.
15
<PAGE>
II. OTHER INFORMATION
Items 1 through 5 are not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit Number Description
-------------- -----------
<S> <C>
2 Agreement of merger dated as of October 18, 1998
incorporated by reference to exhibit 2.1 to
Registrant's report on Form 8K dated October 30,
1998.
27 Financial Data Schedule, which is submitted
electronically to the Securities and Exchange
Commission for information only and not filed.
</TABLE>
(b) Reports on Form 8-K
No reports on Form 8-K were filed for the three-month period ended September
30, 1998.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated November 16, 1998
KARRINGTON HEALTH, INC.
(Registrant)
/s/ RICHARD R. SLAGER
- -----------------------------
Richard R. Slager
Chief Executive Officer
/s/ THOMAS J. KLIMBACK
- -----------------------------
Thomas J. Klimback
Chief Financial Officer
17
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Number Description
- -------------- -----------
<S> <C>
2 Agreement of merger dated as of October 18, 1998
incorporated by reference to exhibit 2.1 to
Registrant's report on Form 8K dated October 30, 1998.
27 Financial Data Schedule, which is submitted
electronically to the Securities and Exchange
Commission for information only.
</TABLE>
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM KARRINGTON
HEALTH, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,873,590
<SECURITIES> 0
<RECEIVABLES> 4,214,413
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 9,741,826
<PP&E> 116,999,424
<DEPRECIATION> 3,240,512
<TOTAL-ASSETS> 139,125,602
<CURRENT-LIABILITIES> 16,929,901
<BONDS> 0
0
0
<COMMON> 33,501,855
<OTHER-SE> (16,811,891)
<TOTAL-LIABILITY-AND-EQUITY> 139,125,602
<SALES> 0
<TOTAL-REVENUES> 24,039,639
<CGS> 0
<TOTAL-COSTS> 18,924,027
<OTHER-EXPENSES> 10,877,143
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,072,190
<INCOME-PRETAX> (9,833,721)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,833,721)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,833,721)
<EPS-PRIMARY> (1.44)
<EPS-DILUTED> (1.44)
</TABLE>
