UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _____________________ to __________________
Commission file number: 333-34367
DIVERSIFIED SENIOR SERVICES, INC.
(Exact Name of Small Business Issuer as specified in its charter)
North Carolina 56-1973923
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
915 West Fourth Street, Winston-Salem, North Carolina 27101
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: 336-724-1000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
On which registered
Title of each class NASDAQ
Common Stock, no par value
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no
par value
Indicate 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__
As of February 28, 1998, the aggregate market value of the voting stock held by
non-affiliates of the registrant, based on the closing price, was approximately
$7,460,000.
As of March 30, 1998, the registrant had 3,300,000 shares of Common Stock
outstanding.
Registrant's revenues for the fiscal year ended December 31, 1997 were
$2,519,052.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [x]
Transitional Small Business Disclosure Format Yes ___ No X
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this report on Form 10-KSB is
incorporated by reference to the definitive Proxy Statement with respect to the
1998 Annual Meeting of Stockholders, which the Registrant intends to file with
the Securities and Exchange Commission no later than 120 days after the end of
the fiscal year convered by this report.
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
GENERAL
Diversified Senior Services, Inc. (the "Company" or "DSS") was founded
in May 1996 to develop and manage assisted living residences, to provide home
care services to the frail elderly and to manage low and moderate income
apartment complexes. Management believes that there is a growing demand for
assisted living residences developed for the low and moderate income frail
elderly, specifically in the Company's targeted areas of smaller cities and
towns of North Carolina and throughout the Southeast. Although the Company has
been operating for less than two years, through affiliates of the Company,
senior management has over 20 years of experience in developing and operating
housing specifically designed for this target population with a concentration in
Eastern North Carolina. The Company's two-year growth objective is to develop at
least 16 new assisted living residences, with a capacity of approximately 960
residents. The Company is in the early stages of its assisted living development
program, with two sites under contract, twelve sites optioned and eleven
positive feasibility studies completed as of March 15, 1998. The Company intends
for the majority of the projects it develops to be owned by or sold to qualified
non-profit organizations, with the Company retaining management contracts for
these projects. By transferring ownership of the properties to non-profit
organizations, the Company expects to be able to utilize tax-exempt bonds to
finance the majority of its facilities, while at the same time carrying little
real estate on its balance sheet. As of December 31, 1997, the Company managed
61 apartment complexes, consisting of approximately 2,269 rental units of low
and moderate income rent subsidized apartments, 31% of which are owned by
non-profit organizations and 57% of which are occupied by the elderly. As of
that date, the Company also provided approximately 1,400 hours of home care
services per month.
The Company was formed in May 1996 as a wholly owned subsidiary of
Taylor House Enterprises, Limited ("THE") and began operations in July 1996. THE
is a privately-held corporation controlled by the Company's senior management.
DSS was initially capitalized with $100 and its parent, THE, received 100 shares
of Common Stock. In July 1996, THE exchanged all of the stock of its wholly
owned subsidiary Residential Properties Management, Inc. ("RPM") for 2,277,678
shares of DSS. Effective June 30, 1997, THE returned 477,778 shares of Common
Stock to DSS which DSS retired leaving 1,800,000 shares of Common Stock issued
and outstanding. RPM, now a wholly owned subsidiary of the Company, manages
2,269 rental housing units located across four states: North Carolina, South
Carolina, West Virginia and Pennsylvania. The Company's management contracts
have initial terms of one to three years, with varying renewal provisions. Of
the 61 complexes managed by RPM, 37, or 61%, are controlled by affiliates and
24, or 39%, are controlled by third parties. Currently, apartment management
provides the majority of the Company's revenues.
The Company's home care activities are limited to providing personal care
services to the same population targeted for its assisted living residences. The
Company does not provide medical services and, as such, is not subject to the
regulatory burdens of that market, nor the attendant legal liabilities. The
Company utilizes its home care business for two primary purposes: (i) to provide
services to residents of its existing subsidized senior apartments; and (ii) to
establish operating procedures for delivery of personal care services at its
future assisted living residences.
BUSINESS STRATEGY
The Company's growth is expected to come primarily from developing and
managing assisted living residences. The Company expects its future assisted
living residences to serve as the foundation from which to provide a continuum
of care for low to moderate income senior citizens. The Company has already
developed and implemented its policies, procedures and operating systems for
providing personal care services and has hired its core staff for the personal
care division. Assisted living management is the combination of providing
personal care and real estate management services, both enterprises in which the
Company is already involved and in which the Company's senior management has
extensive experience. The Company has developed a 60-unit assisted living
prototype for development primarily in small to mid-sized communities with
populations of under 75,000, whose target resident will be a low to moderate
income frail, elderly individual. The Company is also developing a 30-unit
independent living prototype for smaller communities with approximately 600
individuals in the targeted population within the determined market area. The
targeted resident is a moderate income elderly individual. In addition, the
Company will continually review apartment management opportunities and may add
to its management portfolio.
Once the Company's assisted living residences have been developed, DSS will
be able to offer low and moderate income elderly individuals a continuum of
living arrangements spanning the course of many years; apartments managed
specifically for the needs of the elderly; home care services provided in such
apartment facilities if, and when, such individual may come to require such
assistance; and, finally, assisted living residences for that time when a
greater level of support may become necessary.
The Company expects to achieve its business objectives by implementing the
following strategies:
SELECTIVELY LOCATING ASSISTED LIVING RESIDENCES. During its initial phase
of development, the Company will locate some of its assisted living facilities
within close proximity to one of the Company's managed apartment complexes. Such
locations offer immediate benefits to the Company. Since over 57% of the
Company's apartments are occupied by low and moderate income elderly tenants,
when an elderly tenant needs to move into an assisted living residence, the
Company will be well positioned to be the provider of choice. In addition, since
over 31% of the Company's apartment complexes are owned by non-profit
organizations, the Company already has numerous relationships with regional
non-profit organizations, many of which are expected to become the ultimate
owners of the assisted living facilities. Lastly, the Company expects to be able
to utilize certain staff positions in both apartment complexes and assisted
living facilities, namely, maintenance staff and certain providers of personal
care, thus helping to control costs at both locations.
DEVELOPING ASSISTED LIVING FACILITIES SPECIFICALLY DESIGNED FOR LOW AND
MODERATE INCOME RESIDENTS. Each assisted living residence developed by the
Company will be designed, constructed and managed so as to be profitable with
only public pay residents, even while providing features typically found in
residences designed for the private pay population, such as private bedrooms,
personal lavatories and many diverse common areas located in various areas of
the residence. As such, for each private pay resident, for whom monthly fees are
typically $150 to $300 per month higher, the Company expects to generate
significantly greater profits. Most moderate income residents will typically
begin their residence as private pay individuals and will convert to public pay
only when such individual's personal resources are exhausted. Since the
Company's cost structure for its assisted living residences has been designed
based on complete occupancy by public pay residents, even when these changes
occur, the Company expects profitability at any given location to be maintained.
In addition, because many assisted living residences only accept residents who
have resources to cover a minimum time period, typically 18 months or longer,
the Company anticipates that demand for the Company's residences will be high
among the moderate income frail elderly who may not have the resources to cover
such an extended period of time.
ACCESSING FAVORABLE FINANCING. Because of management's extensive
experience working with non-profit organizations, particularly 501(c)(3)
organizations, the Company intends to use tax-exempt bonds to finance the
majority of its assisted living residences. This low-cost financing vehicle
provides the Company with a competitive cost advantage. The Company also
receives the added benefit of not carrying significant amounts of real estate on
its balance sheet, thus freeing up capital for new developments. In addition,
future earnings will not be charged with the associated depreciation and
amortization.
TRANSFERRING EXPERIENCE TO ASSISTED LIVING Residences. Assisted living is
the combination of providing senior housing with the provision of home care
services. The Company and its affiliates have extensive experience in developing
housing for low and moderate income seniors and disabled persons. Several of the
Company-managed apartment complexes currently provide regular activities,
communal meals, laundry facilities, and other amenities frequently associated
with assisted living. In addition, the Company currently provides home care
services to low and moderate income frail elderly. The home care services
provided by the Company include assistance with dressing, personal hygiene,
medication management, preparation of simple meals, assistance with mobility,
dental, hair and skin care and maintenance of a safe environment. These services
are identical to those required to be provided in an assisted living residences.
The Company's staff is experienced in providing and documenting these services,
assessing and developing individual care plans, maintaining client records,
regulatory compliance, quality assurance and Medicaid billing. Thus, the Company
believes it already possesses the personnel skills and management systems
required in providing assisted living.
JOINT VENTURES AND CONVERSIONS. Management anticipates growth opportunities
in addition to those provided by its own independent development activities. The
Company is developing alliances with local government agencies such as public
housing authorities dedicated to providing housing and services to the low
income elderly and disabled. The Company intends to explore joint ventures with
local agencies which provide assisted living to its targeted population. These
activities may include newly developed facilities as well as the conversion of
sections of existing subsidized senior housing to assisted living residences.
The Company is in the preliminary stages of developing newly constructed
assisted living with the housing authority of one North Carolina community and
exploring the conversion to assisted living of two residential floors in two
existing subsidized senior housing complexes. Management sees these joint
venture and conversion opportunities as a method of providing assisted living in
larger communities, as well as in the small to medium sized communities
currently targeted by the Company.
ORGANIZATION
The Company is organized into three divisions: (i) developing assisted
living facilities; (ii) managing assisted living facilities targeted to the low
and moderate income frail elderly residents and (iii) managing low and moderate
income, rent subsidized apartments, primarily for the elderly.
DEVELOPMENT DIVISION
The Company has designed a 60-unit prototype assisted living residence
for development primarily in communities with a population under 75,000 and a
30-unit prototype independent housing facility with services for development
primarily in smaller communities with approximately 600 individuals in the
targeted population within the determined market area. The targeted resident for
the 60-unit residence is a low-to-moderate income, frail elderly individual with
moderate income equaling the area median income, and low income beginning at
approximately 50% of median income. The target resident for the 30-unit
residence is a moderate income, elderly individual who wants the security and
convenience of non-personal care services (for example, meals, housekeeping,
linen service, 24-hour security and social interaction). Based on its own
industry surveys, the Company believes that there are currently few competitors
who have targeted the Company's demographic and regional market: the
low-to-moderate income frail elderly population of the Southeast, especially in
rural areas. The Company will target specific geographic areas where the only
existing competition is old style rest homes, home care and nursing homes.
The Company breaks down development of assisted living facilities into
three major phases as follows: (a) development consisting of town and site
selection, marketing and environmental studies, acquiring local permits,
obtaining financing and construction contracts (4 to 6 months); (b) construction
(9 to 12 months); and (c) fill-up (3 to 9 months). Once a project is completed,
obtaining and qualifying residents is generally not a problem because of the
existing demand for assisted living facilities. The Company intends to utilize
both corporate and on-site marketing teams and anticipates a period of 3 to 9
months to fill-up a location. With respect to the 60-unit prototype, management
anticipates some private pay residents, but intends to develop properties that
can be profitable with only public pay residents.
The Company's current plan anticipates that most facilities it
develops will be owned by qualified non-profit 501(c)(3)s. In management's
opinion, non-profit ownership offers the best overall financing available for
these facilities, while at the same time allowing the Company to keep its
balance sheet relatively free of real estate. The Company may own or lease some
of the properties to be developed, depending upon financing, investment and
marketing considerations. The Company anticipates construction and permanent
funding for the facilities would be tax-exempt bond financing, Federal Housing
Administration financing or a sale/lease back with a health care real estate
investment trust or other real estate holding entity. The Company expects to
combine two to four properties in a package for non-profit owners since bond
financing is more efficient with loan amounts of $7.5 million and above.
Therefore, the Company may own and operate completed properties until enough can
be packaged together for financing.
As of March 19, 1998, the Company had two sites under contract and
twelve sites optioned in the States of North Carolina and Virginia. Sites
located in eleven North Carolina communities have received favorable feasibility
analysis. The Company is in the process of obtaining feasibility analyses on the
remaining controlled sites. The Company intends to maintain a geographic focus
in North Carolina for its 60-unit prototype, developing approximately two to
four facilities at a time. The Company will focus on smaller communities in
North Carolina and Virginia for the 30-unit prototype which will not currently
qualify for public assistance. In the future, the Company will advance into
surrounding states, maintaining the same focus on small to mid-sized communities
with a relatively large low and moderate income elderly population with an
emphasis on developing newly constructed assisted living facilities. Initially,
the Company anticipates developing eight projects, in groups of four, per year
but intends to increase the number to 12 to 14 per year. The Company believes
the increased pace of development can be achieved with current staffing levels.
More importantly, management believe that such a heightened development pace
will bring greater economies of scale to project financings and that demand for
assisted living units among the low and moderate income population in the medium
sized markets that the Company is targeting will sustain that pace. Development
will be slightly staggered so that the Company will not be taking delivery of
all projects in the same month, but financing will typically be arranged in
packages of two to four properties. Turnkey costs, including all development
fees to the Company, for the 60-unit prototype are estimated to average
$2,581,000 for the first eight projects. In the initial phases of development,
the Company intends to locate some facilities near its existing subsidized
elderly apartments. Such location creates many cross-marketing opportunities for
the Company. However, management believes that its prototype assisted living
residences can be successfully developed independently.
The Company will enter into management contracts with non-profit owners
that provide for the development of newly constructed assisted living
residences. Once a potential site is located, feasibility and due diligence is
completed, the prospective non-profit owner will make a final commitment to the
site, subject to financing. In general, tax-exempt bond financing proceeds will
be used for both construction and permanent financing. In this situation, the
Company will assign its option to acquire a site to the non-profit for exercise,
and title in the property will go directly to the non-profit owner. The Company
will be entitled to a base development fee equal to 10% of total development
costs, less the development fee. The Company may receive an additional 5%
development fee for a total maximum fee of 15% of development costs, based on
achieving certain performance goals and cost efficiencies.
With respect to the assisted living projects currently in development,
management has completed all of the internal analysis necessary to bring each to
what is commonly called the mortgage package phase. For each project planned for
the initial stage of development, the Company has some form of site control
(actual ownership or an option to purchase), a schematic architectural plan and
an estimate from a proposed contractor, and the Company's own market study. With
respect to three of the sites, the Company has received a favorable feasibility
analysis from an independent market feasibility company and is in the process of
obtaining feasibility analyses on the remaining eight sites. In addition, if
required by the lender, the Company will also engage a third party appraiser.
The Company's approach to individual markets for potential development is
centered on senior management's long-term experience with mid-size and rural
markets. Consequently, senior managers of the Company perform the thorough
internal market analysis at the beginning of the site acquisition process. This
internal work is then carefully reassessed by a third party market study just
prior to entering into a formal commitment to the development, which typically
takes place when the site is acquired and construction commences. Management
believes that this approach provides the safest way to ensure a feasible
development in a timely and cost efficient manner.
Prior to the Company's final commitment to proceed with a site, the project
will typically have a designated non-profit owner committed to purchase the
facility when the necessary financing to fund the purchase is in place. The
purchase price will be the sum of the net proceeds of the financing DSS
arranges. The Company currently has relationships with several qualified
non-profits and intends to develop new ones with area hospitals as the Company
continues to grow. In all cases, the Company will have an option to purchase and
other safeguards to protect its long term interest in the properties.
As an alternative, the Company may consider more conventional
sale/leaseback arrangements with for-profit organizations. However, at this
time, management believes that for-profit organizations cannot compete with
financing alternatives available to non-profits. Management also believes that
developing assisted living residences for the low and moderate income frail
elderly for non-profits, as opposed to for-profit organizations, will be better
received by localities.
With respect to architectural plans, specifications and construction
contracts, the Company intends to negotiate guaranteed not-to-exceed contracts
and not to put the work out for bid. The architect currently retained by the
Company has extensive elderly housing and healthcare experience.
Developments will be staged to begin as previous developments reach
stabilized operations to maintain a pipeline of proposed projects with all
preliminary internal work done and land under option. The Company intends that a
few excess projects will always be in the pipeline because some proposed
projects will not prove feasible after final analysis.
In addition to the foregoing development activities in which the Company
will develop newly constructed assisted living residences for management by the
Company in communities of 75,000 or less, the Company intends to participate in
development activities as a joint venturer with local government agencies and
non-profit organizations dedicated to providing housing and services to the low
income elderly. As part of these activities, the Company may perform development
activities for the construction or rehabilitation of a facility on a fee basis
with the Company having no further participation in the operation of the
facility upon completion of construction. Likewise, the Company may enter into
agreements to manage an existing property on behalf of a government agency or
non-profit owner.
The Company currently manages several subsidized apartment complexes for
low and moderate income elderly individuals, which meet many of the physical
requirements of a licensed assisted living facility. That is, the facilities
have wide hallways, communal dining rooms, kitchens, laundry facilities,
activity rooms and other common areas available for use by residents. The
Company is currently working closely with its architect and the North Carolina
Division of Facility Services regarding the potential conversion of two floors
of existing apartment complexes to licensed assisted living residences.
Management believes that joint ventures and conversion opportunities provide an
attractive means of establishing a presence in larger communities with
populations in excess of 75,000, as well as in small to medium sized
communities.
ASSISTED LIVING MANAGEMENT DIVISION
All developed assisted living residences will be managed either under a
management contract, cancelable only under very specific conditions or pursuant
to a lease between the owner and a single purpose wholly-owned subsidiary of the
Company formed specifically for the project. The term of the management contract
or lease will be for a minimum of three years, rolling forward each year unless
notice of termination is given. In addition, the Company will have an option to
purchase any project and will receive a fee if the management agreement is
terminated without cause.
Management views assisted living operations as a combination of home care
services and real estate management services, both current operations of the
Company. Thus, this division will combine these two skills in buildings that the
Company will have developed and financed specifically for the low and moderate
income, public pay frail elderly market.
The assisted living operations division will begin full operation when the
first Company-developed assisted living residences come on line. However, with
respect to the home care component of assisted living, the Company has already
instituted a successful pilot program in which the Company is providing home
care services to low and moderate income frail elderly residents at some of the
apartment complexes that it manages as well as in private homes. These home care
services are funded by state Medicaid programs as well as private payors. The
home care services provided by the Company include assistance with dressing,
personal hygiene, medication management, preparation of simple meals, assistance
with mobility, dental, hair and skin care and maintenance of a safe environment.
The Company also has staff experienced in providing and documenting these
services, assessing and developing individual care plans, maintaining client
records, regulatory compliance, quality assurance and Medicaid billing. These
services are identical to those which the Company will be providing at its
assisted living residences. Through this pilot program the Company has
established the operating procedures which will be utilized in delivering home
care services at its assisted living residences. The Company has focused its
activities on having an exemplary operation with respect to client care,
documentation, policies and procedures and quality assurance. The Company had
its first on-site survey of its home care operations by the State of North
Carolina on May 16, 1997. The survey resulted in a deficiency-free finding by
the State. The State specifically complimented the Company's self-audit and
compliance procedures.
Until DSS reaches a certain level of assisted living units under
management, currently estimated to be approximately eight properties, this
division will, in part, be operated with personnel already providing home care
and apartment management services. There will, therefore, be some significant
operating savings to the Company as a whole. For example, with respect to real
estate management, the Company anticipates being able to share maintenance
personnel between assisted living residences and nearby apartment complexes that
the Company manages. The same overlap feature will apply to certified nurse's
aides and choreworkers who currently perform their duties in individual homes or
apartments and who can provide those same services in the assisted living
residences. However, key on-site personnel, such as the facility administrator,
will not be shared or assigned duties outside their respective property. Sharing
will take place at the service provider level only on an as-available basis.
Although the primary conduit for the Company's home care services in the
future will be its assisted living residences, the Company intends to continue
providing these services to individuals in apartments and private homes.
APARTMENT MANAGEMENT DIVISION
Affiliates of the Company have been in the business of developing and
managing senior housing for more than 20 years. Of the 61 complexes currently
managed by the Company, the Company controls 37 complexes, representing 1,351
units, either through the direct ownership of management rights or through
ownership by an affiliated entity. The remaining 24 complexes, representing 918
units, are owned by third parties. Approximately 31% of the complexes are owned
by non-profit organizations.
The Company manages apartments in North Carolina, South Carolina,
Pennsylvania and West Virginia. Generally the managed properties receive
government subsidies through favorable financing and/or direct rent
contributions under programs administered by Housing and Urban Development
("HUD") or Rural Development ("RD," formerly the Farmer's Home Administration).
Approximately 51% of the units under management are eligible for rent subsidies
under Housing Assistance Payment ("HAP") contracts. The treatment of HAP
contracts upon expiration is under review by the United States Congress. No
current HAP affecting the Company's managed properties is up for renewal until
1999. The effect of the expiration of an individual property's HAP without
renewal varies and depends on the HUD determined fair market rent for the
specific market area.
Management fees for government assisted housing are frequently higher than
fees for management of conventional apartments because of the added layers of
paperwork required to comply with government programs. The Company typically
receives a percentage of rent revenues ranging from 6% to 8% or a flat monthly
fee for occupied units. In addition, the Company receives a stated monthly
bookkeeping fee for all HUD properties it manages. The management agreements are
approved by the applicable government agency and are relatively standardized.
The initial term of a HUD management contract is two years with one-year
renewals thereafter. A typical RD management contract has a three-year term and
must be executed every three years. The Company's apartment management contracts
have initial terms of one to three years, with varying renewal provisions; the
Company's history of contract renewal has been excellent.
As discussed above, management anticipates modest savings in operating
costs for both the properties managed in the apartment management division and
those in the assisted living management division. Because many of the initial
assisted living residences will be in close proximity to existing apartment
complexes managed by the Company, management believes that through the sharing
of certain personnel, mostly maintenance and property staff, operating costs in
both divisions will be lowered. An additional, very important benefit from the
Company's experience managing low and moderate income elderly properties is that
it gives management excellent operating histories to use as comparisons for the
assisted living residences. However, perhaps most important for cross-marketing
purposes, through its apartment management division the Company has established
relationships with over a 1,000 low and moderate income elderly tenants. These
relationships give the Company a unique platform from which to develop its home
care and assisted living operations.
ASSISTED LIVING INDUSTRY
The Company believes that the assisted living industry is evolving as the
preferred alternative to meet the growing demands for a cost effective setting
for seniors who cannot live independently due to physical or cognitive frailties
but who do not require the more intensive medical attention provided by a
skilled nursing facility.
Generally, assisted living represents a combination of housing and 24-hour
per day personal support services designed to assist seniors with the activities
of daily living ("ADLs"), which include bathing, eating, personal hygiene,
grooming, ambulating and dressing. Certain assisted living facilities may offer
higher levels of personal assistance for residents with Alzheimer's disease or
other forms of dementia.
Assisted living facilities in North Carolina generally fall into three
types: downscale, dormitory and institutional style rest homes with shared
bathrooms; newly constructed, high fee, upscale, residential style facilities;
and traditional nursing homes with assisted living beds. The Company's prototype
residence is distinguishable from the traditional rest home or downscale
dormitory style in several respects. The Company's residences are residential in
style, provide suites with a private bath and two bedrooms, each with separate
entrance and temperature control, and provide spacious common areas that are
comparable to those in the upscale model. The Company's prototype follows the
high fee, upscale residential style in all aspects other than price.
The Company believes that a number of factors will allow assisted living
companies to continue as one of the fastest growing segments of senior care:
SUPPLY/DEMAND IMBALANCE. While the senior population is growing
significantly, the supply of skilled nursing beds per thousand is declining.
This imbalance may be attributed to a number of factors in addition to the aging
of the population. Many states, in an effort to maintain controls of Medicaid
expenditures on long-term care, have implemented more restrictive certificate of
need regulations or similar legislation that restricts the supply of licensed
skilled nursing facility beds. Additionally, acuity-based reimbursement systems
have encouraged skilled nursing facilities to focus on higher acuity patients.
The Company also believes that high construction costs and limits on government
reimbursement for the full cost of construction and start-up expenses will
constrain the growth and supply of traditional skilled nursing beds. These
factors, taken in combination, result in relatively fewer skilled nursing beds
available for the increasing number of seniors who require assistance with ADLs
but do not require 24-hour medical attention.
COST EFFECTIVENESS. The average annual cost for a patient in a skilled
nursing home can exceed $75,000 per year in certain markets. In contrast,
assisted living services are provided at a cost which is generally 30% to 50%
lower than skilled nursing facilities located in the same region.
DEMOGRAPHICS AND CHANGING FAMILY DYNAMICS. The target market for the
Company's services are persons generally 75 years and older, one of the fastest
growing segments of the U.S. population. According to the U.S. Census Bureau,
the portion of the U.S. population age 75 and older is expected to increase by
28.7%, from approximately 13.0 million in 1990 to approximately 16.8 million by
the year 2000, and the number of persons age 85 and older, as a segment of the
U.S. population, is expected to increase by 45%, from approximately 3.0 million
in 1990 to over 4.3 million by the year 2000. Furthermore, the number of persons
afflicted with Alzheimer's disease is also expected to grow in the coming years.
According to data published by the Alzheimer's Association, this group will grow
from the current 3.8 million people to 4.8 million, or an increase of 26.3%, by
the year 2000. As Alzheimer's disease and other forms of dementia are more
likely to occur as a person ages, the increasing life expectancy of seniors is
expected to result in a greater number of persons afflicted with Alzheimer's
disease and other forms of dementia in future years absent breakthroughs in
medical research.
CONSUMER PREFERENCE. The Company believes that assisted living is
increasingly becoming the setting preferred by prospective residents as well as
their families, who are often the decision makers for seniors. Assisted living
is a cost effective alternative to other types of facilities, offers seniors
greater independence and allows them to age in place in a residential setting.
COMPETITION
The assisted living industry is highly competitive, fragmented,
characterized by numerous small operators but also with large, public,
well-financed competitors. The scope of assisted living services varies
substantially from one operator to another and with the requirements of one
state to another. The Company believes that residential style assisted living
offers an attractive approach to providing residential and personal care
services for the elderly, particularly in light of (i) the increased emphasis by
both federal and state governments on containing costs; (ii) limitations imposed
in many states on the construction of additional skilled nursing facilities,
which have generally increased the level of care provided in such facilities and
forced less acute elderly to seek alternative care arrangements; and (iii) the
decreasing availability of family care. The primary consumers of assisted living
residences are persons over the age of 65.
The competition in managing subsidized housing for the elderly is
substantial with competition from numerous local, regional and national
companies, many of whom have greater financial resources than those of the
Company. There is increasing demand for such facilities due to the increasing
population of elderly in the United States but growth in this industry is
dependent upon the availability of government financing and subsidies which are
currently being restricted and undergoing reassessment and change. Many of the
current managers of such facilities are companies affiliated with the original
developers in the Company's geographic region. The Company does not anticipate
substantial near-term growth in this segment of its business and is not
dependent on such growth for future profitability. Management of the Company has
over twenty years experience in subsidized housing and extensive experience
interacting with governmental agencies, so the Company should be positioned to
take advantage of this business if and when conditions change.
REGULATORY MATTERS
The assisted living operations of the Company are subject to substantial
regulation by federal, state and local governmental agencies which vary among
the types of facilities and from state to state. Assisted living facilities are
generally subject to less regulation than other licensed health care providers
but more regulation than standard congregate care or independent living
facilities. However, the Company anticipates that additional regulations and
licensing requirements will likely be imposed by the states and the federal
government. Currently, North Carolina requires licenses to provide the assisted
living services provided by the Company but not a certificate of need. The North
Carolina legislature has enacted a twelve month moratorium on newly licensed
beds while licensure procedures are studied. The Company has received
confirmation from the Division of Facilities Services that its eleven feasible
sites are exempt from the moratorium. The Company's 30 unit housing with
services prototype will be subject to registration as a "housing with services"
facility but will not be required to be licensed. The purpose of the moratorium
is to study adult care homes in North Carolina to determine whether the existing
licensure procedures need to be modified. "Adult care homes" now include
everything from group homes to old style rest homes to new assisted living
facilities. It is anticipated that the moratorium will result in stricter
licensure procedures in North Carolina.
The licensing statutes typically establish physical plant specifications,
resident care policies and services, administration and staffing requirements,
financial requirements, emergency service procedures plus after construction
approval of the as-built building and the Company's operating policies and
procedures. The Company's facilities must also comply with the requirements of
the Americans With Disabilities Act and are subject to various local building
codes and other ordinances, including fire safety codes. The Company is a
provider of services under Medicaid programs and is subject to Medicaid
regulations designed to limit fraud and abuse, violations of which could result
in civil and criminal penalties and exclusion from participation in Medicaid
programs. The Company believes it is in substantial compliance with all
applicable regulatory requirements. No actions are pending against the Company
for non-compliance with any regulatory requirement.
The targeted residents for the Company's facilities are eligible for
several types of public funds in North Carolina. North Carolina's Division of
Special Assistance of the Department of Social Services pays a monthly maximum
of $893 for room and board. This payment is funded from the federal Supplemental
Security Income program ("SSI") and state supplements. In addition, the state
Medicaid program provides funds for personal care services. The State and County
are each responsible for half of the Medicaid payment. The amount available
depends on the services required. Finally, an allowance of 50 cents per day is
paid by Medicaid to fund medically related resident transportation.
Subsidized apartments are also subject to substantial regulations primarily
from HUD/FHA and the Rural Development Agency, as applicable. In most states,
subsidized apartments are also subject to state and local building and fire
codes.
Providers of personal care services in North Carolina must obtain a license
from the Department of Facility Services. There are different levels of
licensure depending on the nature of the services provided. A provider must
obtain a Certificate of Need ("CON") to participate in the Medicare-funded Home
Health Program, which generally entails the provision of skilled medical
services and therapies. No CON is required to participate in the Medicaid funded
personal care service ("PCS") program which is available to the low income
elderly in their place of residence nor the Community Access Program ("CAP")
which provides extensive personal care and related services for the low income
disabled. The Company participates in both the PCS and CAP programs. The
reimbursement rate is currently $11.92 per hour. Eligible participants in the
PCS program can receive up to a maximum of 80 hours of personal care services
each month. Services include assistance with the basic ADL's including bathing,
dressing, grooming, transfers, personal hygiene, assistance with medication
monitoring, maintaining a safe and clean environment, household management and
simple meal preparation. The Company's personal care revenues for 1996 and 1997
were funded 97% and 90%, respectively by the Medicaid PCS program.
EMPLOYEES
As of December 31, 1997, the Company had 140 employees, 43 of whom are
full-time. None of the Company's employees are subject to collective bargaining
agreements and none of the employees have been on strike in the past three
years.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company subleases 90% of the office and administrative building located
at 915 West Fourth Street, Winston-Salem, North Carolina from THE at a monthly
rent of $2,700 plus its share of property insurance and maintenance expenses.
There is no written sub-lease and the base lease between THE and an independent
third party has a remaining term of approximately two and one-half years.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION
Effective January 10, 1998, the Common Stock of the Company was listed on
the Nasdaq small cap market under the symbol "DISS." Accordingly, the Company's
Common Stock did not trade during the years ended December 31, 1996 and 1997.
HOLDERS OF RECORD
There were approximately eight shareholders of record of Common Stock as of
March 6, 1998. This number does not include beneficial owners holding shares
through nominees or "street" names. The Company believes that it has
approximately 500 beneficial holders of Common Stock.
DIVIDEND POLICY
The Company has not paid any cash dividends on its Common Stock since its
inception and does not currently anticipate paying dividends on its Common Stock
in the foreseeable future. Management intends to reinvest earnings, if any, in
the development and expansion of the Company's business. Any future declaration
of cash dividends will be at the discretion of the Board of Directors and will
depend upon the earnings, capital requirements and financial position of the
Company, general economic conditions and other pertinent factors.
RECENT SALES OF UNREGISTERED SECURITIES
The Company was formed in May 1996 as a wholly owned subsidiary of Taylor
House Enterprises, Limited and began operations in July 1996. The Company was
initially capitalized with $100 and its parent, Taylor House Enterprises,
Limited, received 100 shares of Common Stock. In July 1996, Taylor House
Enterprises, Limited exchanged all of the stock of its wholly owned subsidiary
Residential Property Management, Inc. for 2,277,678 shares of the Company.
Effective June 30, 1997, Taylor House Enterprises, Limited returned 477,778
shares of Common Stock to the Company which the Company retired leaving
1,800,000 shares of Common Stock issued and outstanding.
On September 24, 1997, the Board of Directors classified a series of
200,000 shares of convertible, preferred stock and authorized the issuance of
178,386 shares to Taylor House Enterprises, Limited to be exchanged for a note
payable to Taylor House Enterprises, Limited in the amount of $891,930 on
September 30, 1997. The preferred stock is nonvoting, is subordinate to the
Common Stock for payment of dividends, has a stated liquidation value of $5 per
share which is subordinate to a preferred distribution to holders of Common
Stock equal to $10 per share, may be converted to Common Stock at $6 per share
after September 30, 1999 and is not redeemable at the option of the holder.
<PAGE>
USE OF PROCEEDS FROM SALE OF COMMON STOCK
On January 14, 1998, the Company completed its public offering of 1,500,000
shares of Common Stock at $5.00 per share, for gross proceeds of $7,500,000.
Expenses of the offering totaled $1,175,821 for net proceeds of $6,324,179. The
Common Stock was sold pursuant to a Registration Statement (SEC file number
333-34367) which was declared effective on January 9, 1998. Pursuant to the
Registration Statement, the Company registered 1,500,000 shares of Common Stock,
150,000 Underwriter's Warrants and the underlying 150,000 shares of common
stock.
Strasbourger Pearson Tulcin Wolff Incorporated acted as the underwriter for
the sale of the Common Stock. The Company granted the underwriter warrants to
purchase 150,000 shares of common stock exercisable for four years, commencing
12 months after the closing of the offering, at an exercise price of $6.75.
The proceeds of the offering completed on January 14, 1998 were used as follows:
<TABLE>
<CAPTION>
<S> <C>
Gross proceeds (1,500,000 shares at $5.00 per share)................... $ 7,500,000
Offering expenses...................................................... (1,175,821)
--------------
Net proceeds from offering............................................. $ 6,324,179
==============
Use of proceeds:
Repayment of bank loan and accrued interest....................... (1,637,645)
Payment of deferred salaries...................................... (577,508)
Payment of deferred bonuses....................................... (24,582)
Other............................................................. (19,271)
Cash held for development......................................... (3,500,000)
Working capital................................................... (565,173)
--------------
Total proceeds used.................................................... $ 6,324,179
=============
Offering expenses incurred with respect to the offering are as follows:
Underwriter commission................................................. $ 750,000
Underwriter expense.................................................... 150,000
Printing and engraving expenses........................................ 55,595
Accounting fees and expenses........................................... 42,394
Legal fees and expenses................................................ 146,387
Filing fees and expenses............................................... 16,615
Transfer Agent......................................................... 3,500
Miscellaneous.......................................................... 11,330
-------------
Total......................................................... $ 1,175,821
=============
</TABLE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE DISCUSSION AND ANALYSIS BELOW SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS OF THE COMPANY AND THE NOTES TO FINANCIAL STATEMENTS.
OVERVIEW
Diversified Senior Services, Inc. ("DSS") was formed in May 1996 as a
wholly owned subsidiary of Taylor House Enterprises, Limited ("THE") and began
operations in July 1996. DSS was capitalized with $100 and its parent, THE,
received 100 shares of common stock. THE provided working capital to DSS during
its start-up phase. Upon formation, DSS agreed to take responsibility for
deferred salaries and bonuses for certain executives of THE for the period
January 1, 1996 through June 30, 1996.
In July 1996, THE exchanged all of the stock of its wholly owned subsidiary
Residential Properties Management, Inc. ("RPM") for 2,277,678 shares of DSS. RPM
was formed in March 1989 to manage government subsidized multi-family and
elderly residential rental apartments. Since July 1, 1996, the financial
statements of DSS are consolidated statements of DSS and RPM. Effective June 30,
1997, THE returned 477,778 shares of common stock to DSS which DSS retired
leaving 1,800,000 shares of common stock issued and outstanding. On January 14,
1998, DSS completed its initial public offering of 1,500,000 shares of common
stock at $5.00 per share for a total of $7,500,000.
The Company anticipates a moderate growth in the number of apartment units
managed and also expects that income will increase due to inflationary effects
on rents. All personnel located at the apartments who manage the apartments and
perform maintenance are employees of the Company. However, the apartments
reimburse the Company for the services of the on site personnel. The Company
anticipates a moderate growth in reimbursement income as a result of increases
in salaries of on site personnel and an increase in the number of apartment
complexes under management.
The Company began offering home care services in August 1996 at selected
apartment locations. Management anticipates that growth in home care service
income will continue at a moderate, controlled pace as it begins to offer these
services to elderly residents in other apartments that it manages. However,
management does not expect the income from these services to be material with
respect to the total income of the Company over the next several years.
Because the Company has not yet completed development of any assisted
living residences, it has not recognized any development fee income or
management fee income from its assisted living development activities. The
policy of the Company is to recognize development fee income when the
construction of the facility is completed and a certificate of occupancy is
issued. The Company expects to earn a fee of approximately $225,000 per facility
for its standard 60-unit facility. As of March 15, 1998, two sites are under
contract; twelve sites have been optioned and eleven positive feasibility
studies have been completed. The construction process is estimated to be nine to
twelve months. Once construction on an assisted living residence is completed,
the Company will begin to recognize management fee income for those properties.
Management believes that in the near future the development and management of
assisted living facilities will provide the vast majority of the Company's
revenues and profits.
All the operating expenses of the Company are related to the personnel
directly performing the management services and the corporate management staff.
Between 80% and 90% of the expenses are for salaries, benefits and payroll
taxes. The remaining expenses are administrative expenses that support the
activities of the personnel such as travel, rent, telephone and office expenses.
Since the Company's inception, the operating staff increases have been due
primarily to the entrance of the Company into the home care business. However,
the corporate staff has grown over that same period of time because of the need
to have adequate personnel in place to develop the assisted living residences.
Management expects that expenses associated with operating personnel will
continue to increase significantly as the Company expands, but management does
not expect to increase the number of corporate staff significantly during the
next several years.
The Company owns office furniture and computer equipment that is being
depreciated. The Company also owns management contract rights that were
purchased by RPM from an affiliate on January 1, 1996 and September 1, 1996.
Certain of these contracts are subject to amortization and are being amortized
over a seven-year period. The Company expects to extend the contracts upon
expiration at no additional cost to the Company.
DSS and RPM are both incorporated in North Carolina and, as C corporations,
file their federal income tax returns as part of a consolidated group with THE.
A provision for income tax benefit has been recorded in 1996 and 1997 since the
losses of DSS and RPM can be applied to income in the consolidated group. With
the completion of the public offering, DSS and RPM will cease filing tax returns
as part of the THE consolidated group and will file their own consolidated
federal return. DSS and RPM file separate state returns since North Carolina
income tax regulations do not permit filing consolidated returns.
RESULTS OF OPERATIONS
The Year Ended December 31, 1997 Compared to the Period from May 17, 1996
(Date of Inception) to December 31, 1996
INCOME
Total income increased $1,279,737, to $2,519,052 for the year ended
December 31, 1997 from $1,239,315 for the period from May 17, 1996 (Date of
Inception) to December 31, 1996. The increase in income was primarily due to
increases in management fee income, reimbursement income and home care fees.
MANAGEMENT FEES. Management fees increased $419,919, to $858,599 for 1997
from $438,680 for the period from May 17, 1996 to December 31, 1996. The
increase was a result of operating for a full year in 1997 compared to six
months in 1996. The Company managed fewer units in 1997 than in 1996.
REIMBURSEMENT INCOME. Reimbursement income increased $673,131, to
$1,454,969 for 1997 from $781,838 for the period May 17, 1996 to December 31,
1996. This increase was the net result of operating for a full year in 1997
compared to six months in 1996 and a decrease in the number of apartments
managed in 1997.
HOME CARE FEES. Home care fees increased $167,085, to $185,882 for 1997
from $18,797 for 1996. Home care operations began in August 1996.
EXPENSES
Total expenses increased $1,637,839, to $3,557,641 for the year ended
December 31, 1997 from $1,919,802 for the period from May 17, 1996 to December
31, 1996. The increase was due to increases in all expense items.
PERSONNEL EXPENSE. Personnel expense increased $1,261,241, to $2,912,629
for 1997 from $1,651,388 for 1996. The increase in personnel expense is
primarily due to operating for a full year in 1997 compared to 6 months in 1996.
However, certain executive salaries were incurred for the entire year in 1996
due to an arrangement with THE. Also, there was an increase in staffing due to
home care operations, but a reduction in staffing for apartment management. The
Company expects increases in personnel expense in future years due to increased
management activity.
ADMINISTRATION AND OTHER EXPENSES. Administration and other expenses
increased $271,648, to $447,370 in 1997 from $175,722 in 1996. The increase is
primarily due to operating for a full year in 1997 compared to six months in
1996. Further, administration expenses increased as a result of increased
operations in home care in 1997.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense increased $37,842, to $63,106 in 1997 from $25,264 in 1996. The increase
was due to operating for a full year in 1997 compared to six months in 1996 and
to an increase in intangible assets.
INTEREST EXPENSE. Interest expense increased $67,108, to $134,536 in 1997
from $67,428 in 1996. The increase was due to an increased amount borrowed from
the bank to fund operating deficits. Interest expense decreased in the fourth
quarter of 1997 due to THE accepting preferred stock in place of a note
payable on September 30, 1997.
<PAGE>
FINANCIAL CONDITION
DECEMBER 31, 1997 COMPARED TO DECEMBER 31, 1996
The Company had current assets of $643,311 on December 31, 1997 and
$217,825 on December 31, 1996. The primary assets in current assets are offering
expenses and accounts receivable. Offering expenses of $425,821 on December 31,
1997 are expenses incurred to prepare for the offering of 1,500,000 shares of
common stock completed January 14, 1998. After the completion of the offering,
these expenses were charged to equity. The Company had accounts receivable of
$92,878 on December 31, 1997 and $133,649 on December 31, 1996. The receivables
decreased primarily due to the collection of a single receivable of
approximately $35,000. The Company expects receivables to increase as the
Company increases management of apartment units and assisted living residences.
Furniture and equipment decreased to $56,487 at December 31, 1997 from
$88,451 at December 31, 1996 due to depreciation expense. Intangible assets
increased to $114,779 at December 31, 1997 from $89,927 at December 31, 1996 due
to increased organization costs related to the equity offering, net of
amortization expense.
Development costs increased to $241,433 at December 31, 1997 from
$132,350 at December 31, 1996 due to continuing development activities with
respect to assisted living residences. Development costs will either be recouped
with the successful completion of a facility or written off if a site is
determined not to be feasible.
Accounts receivable - affiliates, primarily fees receivable from
affiliated partnerships, increased to $310,407 at December 31, 1997 from
$233,616 at December 31, 1996. The increase is the net effect of transactions
between DSS and THE, including the tax benefit to THE of DSS's
operating losses.
Total liabilities increased $481,007, to $3,102,003 at December 31,
1997 from $2,620,996 at December 31, 1996 due to increases in accounts payable
and accrued expenses of $530,536, bank loan and accrued interest of $699,436,
deferred salaries and bonuses of $383,625, and a decrease in payables to
affiliates of $1,132,490. The increase in accounts payable and accrued expenses
was primarily due to the accrual of expenses for the equity offering. The
proceeds from the bank loan were used to finance the operating deficit for the
year and provide development working capital. Of the decrease in payables to
affiliates, $891,930 was the result of THE taking preferred stock as payment of
the note payable and $269,900 was the tax benefit realized by THE from the
utilization of DSS's losses.
Shareholder's deficit decreased from $1,858,827 at December 31, 1996
to $1,735,586 at December 31, 1997. The decrease was the result of the loss for
the year ended December 31, 1997 of $768,689, net of the increase in equity due
to the increase in preferred stock of $891,930.
Directly after the completion of the initial public offering on
January 14, 1998, DSS paid accrued offering expenses, paid off the bank loan
with accrued interest, paid certain deferred salaries and bonuses and invested
$3.5 million in cash equivalents available for development. The resulting
balance sheet (see Note 12 of the Notes to the Financial Statements) had assets
of $5,005,769, liabilities of $417,176 and equity of $4,588,593.
LIQUIDITY AND CAPITAL RESOURCES
The Company has operated, and expects to continue to operate, on a
negative cash flow basis due to start-up expenses and length of the development
cycle. Currently, the Company's primary cash requirements include covering
operating deficits and development expenses related to the development,
construction and fill-up of assisted living residences. The Company has relied
upon its parent, THE, and its bank lender to provide it with operating cash
until the initial public offering was completed January 14, 1998.
The net proceeds of the public offering were used to pay off the
outstanding balance under the bank line of credit, to provide $3.5 million in
development working capital for the assisted living projects and for general
corporate purposes. The Company anticipates that the net proceeds from the
public offering, together with construction funds available for each facility
will be sufficient to fund its operations for the next twelve months, if the
Company's future operations are consistent with management's expectations. The
Company may need additional financing thereafter. There can be no assurance that
the Company will be able to obtain financing on a favorable or timely basis. The
type, timing and terms of financing selected by the Company will depend on its
cash needs, the availability of other financing sources and the prevailing
conditions in the financial markets.
THE advanced funds to cover operating deficits for DSS and RPM in 1996
and 1997. In 1996, THE helped DSS secure a bank loan by providing collateral and
guaranteeing the loan. After the equity offering was completed and the bank loan
was repaid, THE will not offer either its collateral or its guarantee to DSS in
future bank financings.
INFLATION AND INTEREST RATES
Inflation has minimal impact on the daily operations of the Company.
Increases in salaries and administrative expenses are offset by increases in
management fees that are computed as a percentage of rent and resident service
fees. Increases in resident service fees may lag behind inflation since the
amount of the fee is based on a cost reimbursement by public sources. Except for
the lag time, however, the Company expects the reimbursement to keep pace with
inflation.
The primary concern regarding inflation is in interest rate
fluctuations. High interest rates would increase the cost of building new
facilities and could slow down the Company's development plans. Also, during a
period of rapid inflation, interest rates could become so expensive that it
would not be economical to use tax exempt bond financing for permanent
financing.
CERTAIN ACCOUNTING CONSIDERATIONS
SFAS NO. 123
In October 1995, FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). SFAS No. 123 establishes financial accounting
and reporting standards for stock-based employee compensation plans. Those plans
include all arrangements by which employees receive shares of stock or other
equity instruments of the employer or the employer incurs liabilities to
employees in amounts based on the price of the employer's stock. Examples are
stock purchase plans, stock options, restricted stock awards, and stock
appreciation rights. This statement also applies to transactions in which an
entity issues its equity instruments to acquire goods or services from
non-employees. Those transactions must be accounted for, or at least disclosed
in the case of stock options, based on the fair value of the consideration
received or the fair value of the equity instruments issued, whichever is more
reliably measurable. The accounting requirements of SFAS No. 123 are effective
for financial statements for fiscal years beginning after December 15, 1995, or
for an earlier fiscal year for which SFAS No. 123 is initially adopted for
recognizing compensation cost. The statement permits a company to choose either
a new fair value-based method or the current APB Opinion No. 25 intrinsic
value-based method of accounting for its stock-based compensation arrangements.
The Company adopted its Stock Incentive Plan effective January 1, 1997. On
February 11, 1998, 50,000 stock options were granted at an exercise price
ranging from $4.75 to $5.225, the market value of the shares at the date of
grant. The stock options are exercisable on July 1, 1998 and are 100% vested on
that date. The options expire five years after the date of grant, or February
10, 2003. In addition, a direct grant of 400 common shares was made to the
Company's outside directors.
ITEM 7. FINANCIAL STATEMENTS.
Reference is made to the Financial Statements, the reports thereon and
the notes thereto, commencing on page F-1 of this report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
ITEM 10. EXECUTIVE COMPENSATION.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
PART III information will be set forth in the Company's definitive proxy
statement for the Company's 1998 Annual Meeting of Stockholders.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT NO. DESCRIPTION
3.1 Articles of Incorporation of the Company (as amended).
Incorporated by reference to Exhibit 3.1 to Registration
Statement on Form SB-2 (File No. 333-34367).
3.1(a) Articles of Amendment filed October 6, 1997.
3.2 Bylaws of the Company, as amended Incorporated by reference
to Exhibit 3.2 to Registration Statement on Form SB-2 (File
No. 333-34367).
10.1 Employment Agreement dated as of January 1, 1997 between the
Company and William G. Benton, as amended. Incorporated by
reference to Exhibit 10.1 to Registration Statement on Form
SB-2 (File No. 333-34367).
10.2 Employment Agreement dated as of January 1, 1997 between the
Company and Susan L. Christiansen, as amended. Incorporated
by reference to Exhibit 10.2 to Registration Statement on
Form SB-2 (File No. 333-34367).
10.3 Employment Agreement dated as of January 1, 1997 between the
Company and G. L. Clark, Jr., as amended. Incorporated by
reference to Exhibit 10.3 to Registration Statement on Form
SB-2 (File No. 333-34367).
10.4 Lock-up agreements. Incorporated by reference to Exhibit
10.4 to Registration Statement on Form SB-2 (File No.
333-34367).
10.5 The Company's 1997 Stock Incentive Plan. Incorporated by
reference to Exhibit 10.5 to Registration Statement on Form
SB-2 (File No. 333-34367).
20 Independent Auditors' Report.
21 Subsidiaries of the Company.
23 Consent of The Daniel Professional Group, Inc.
27 Financial Data Schedule.
(b) Reports on Form 8-K.
None.
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
DIVERSIFIED SENIOR SERVICES, INC.
By: /S/ WILLIAM G. BENTON
William G. Benton,
Chairman of the Board and Chief
Executive Officer
Date: March 31, 1998
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
SIGNATURE TITLE DATE
/S/ WILLIAM G.BENTON Chairman of the Board March 31, 1998
- ---------------------- and Chief Executive
William G. Benton Officer
/S/ SUSAN L. CHRISTIANSEN Chief Operating March 31, 1998
- ------------------------- Officer and Director
Susan L. Christiansen
/S/ G.L. CLARK, JR. Chief Financial March 31, 1998
- -------------------- Officer, Treasurer
G.L. Clark, Jr. and Director
/S/ PERRY C. CRAVEN Director March 31, 1998
- ---------------------
Perry C. Craven
/S/ WALTER H. ETTINGER, JR. Director March 31, 1998
- ---------------------------
Walter H. Ettinger, Jr.
<PAGE>
<TABLE>
<CAPTION>
DIVERSIFIED SENIOR SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
1997 1996
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $78,156 $31,132
Accounts receivable--trade 92,878 133,649
Refundable income taxes 34,176 32,853
Offering expenses (Note 12) 425,821 -
Prepaid expenses 12,280 20,191
----------- ----------
643,311 217,825
Furniture and equipment, net (Note 3) 56,487 88,451
Intangible assets, net (Note 4) 114,779 89,927
Development costs 241,433 132,350
Accounts receivable--affiliates (Note 2) 310,407 233,616
------------ -------------
$1,366,417 $762,169
============ ==============
LIABILITIES
Current liabilities:
Accounts payable and accrued expenses $652,445 $122,009
Interest payable 33,070 6,587
Note payable--bank (Note 5) 1,604,575 931,622
Deferred salaries 577,508 292,906
------------- --------------
2,867,598 1,353,124
Deferred bonuses 234,405 135,382
Accounts payable--affiliates (Note 2) - 36,170
Note payable--affiliate (Notes 2 and 5) - 1,096,320
------------- -------------
3,102,003 2,620,996
------------- --------------
SHAREHOLDER'S DEFICIT
Preferred stock, no par, authorized 100,000,000 shares;
178,386 issued and outstanding at December 31,
1997 and -0- at December 31, 1996 891,930 -
Common stock, no par, authorized 100,000,000 shares;
1,800,000 shares issued and outstanding at
December 31, 1997 and 2,277,778 at
December 31, 1996 100 100
Deemed distribution (1,335,790) (1,335,790)
Accumulated deficit (1,291,826) (523,137)
-------------- -------------
(1,735,586) (1,858,827)
-------------- -------------
$1,366,417 $762,169
============== =============
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
<TABLE>
<CAPTION>
DIVERSIFIED SENIOR SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Year ended December 31, 1997 and for the Period from May
17, 1996 (Date of Inception) to December 31, 1996
1997 1996
Income:
<S> <C> <C>
Management fees 858,599 438,680
Reimbursement fees 1,454,969 781,838
Home care fees 185,882 18,797
Other 19,602 -
------------- -----------
2,519,052 1,239,315
============= ============
Expenses:
Personnel related 2,912,629 1,651,388
Administrative and other 447,370 175,722
Depreciation and amortization 63,106 25,264
------------ ------------
3,423,105 1,852,374
------------ -----------
Operating loss 904,053 613,059
Other expenses:
Interest expense 134,536 67,428
------------ -----------
Loss before income tax benefit 1,038,589 680,487
Income tax benefit (269,900) (88,000)
------------ ------------
Net loss $768,689 $592,487
============= ============
Net loss per common share $0.38 $0.32
============= ============
Weighted average shares outstanding 2,036,926 1,838,236
============= ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
<TABLE>
<CAPTION>
DIVERSIFIED SENIOR SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Year ended December 31, 1997 and for the Period from May
17, 1996 (Date of Inception) to December 31, 1996
1997 1996
Income:
<S> <C> <C>
Management fees 858,599 438,680
Reimbursement fees 1,454,969 781,838
Home care fees 185,882 18,797
Other 19,602 -
------------- -----------
2,519,052 1,239,315
============= ============
Expenses:
Personnel related 2,912,629 1,651,388
Administrative and other 447,370 175,722
Depreciation and amortization 63,106 25,264
------------ ------------
3,423,105 1,852,374
------------ -----------
Operating loss 904,053 613,059
Other expenses:
Interest expense 134,536 67,428
Loss before income tax benefit 1,038,589 680,487
Income tax benefit (269,900) (88,000)
------------- ------------
Net loss $768,689 $592,487
------------- ------------
Net loss per common share $0.38 $0.32
------------- ------------
Weighted average shares outstanding 2,036,926 1,838,236
=========== =============
The accompanying notes are an integral part of the financial statements.
</TABLE>
<TABLE>
<CAPTION>
DIVERSIFIED SENIOR SERVICES, INC. AND SUBSIDIARY
STATEMENTS OF CHANGES IN SHAREHOLDER'S DEFICIT
For the Year Ended December 31, 1997 and for the Period May 17,
1996 (Date of Inception) to December 31, 1996
Preferred Common Preferred Common Deemed Accumulated
Shares Shares Stock Stock Distribution Deficit Total
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, May 17, 1996 - - $ - $ - $ - $ - $ -
Issuance of common stock - 100 - 100 - - 100
Consolidation of subsidiary, July 1, 1996 - - (1,209,060) 69,350 (1,139,710)
Issuance of common stock - 2,277,678 - - - - -
Deemed distribution related to transfer
of assets and liabilities from affiliate - - - - (126,730) - (126,730)
Net loss for the period May 17, 1996
(Date of Inception) to December 31,
1996 - - - - - (592,487) (592,487)
-------- -------------- --------- -------- ----------- ----------- ----------
Balance, December 31, 1996 - 2,277,778 - 100 (1,335,790) (523,137) (1,858,827)
-------- -------------- --------- -------- ----------- ----------- ----------
Retirement of common stock,
June 30, 1997 - (477,778) - - - - -
Exchange note payable to affiliate for
preferred stock 178,836 - 891,930 - - - 891,930
Net loss for the year ended December 31,
1997 - - - - - (768,689) (768,689)
--------- ------------- --------- ------- ----------- ----------- ----------
Balance, December 31, 1997 178,836 1,800,000 $891,930 $100 $(1,335,790)$(1,291,826) $(1,735,586)
========= ============= ========== ======= ============ =========== ==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
<TABLE>
<CAPTION>
DIVERSIFIED SENIOR SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year ended December 31, 1997 and for the Period from May
17, 1996 (Date of Inception) to December 31, 1996
Increase (Decrease) in Cash and Cash Equivalents
1997 1996
Operating activities:
<S> <C> <C>
Net loss $(768,689) $(592,487)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization 63,106 25,264
Changes in operating assets and liabilities
Accounts receivable 5,521 (14,615)
Prepaid expenses 6,588 (11,930)
Accounts payable, trade 52,452 24,200
Accounts payable, affiliates (215,776) (30,173)
Interest payable 26,483 6,587
Deferred salaries and bonuses 383,625 428,288
----------- ----------
Total adjustments 321,999 427,621
Net cash used by operating activities (446,690) (164,866)
Investing activities:
Purchase of furniture and equipment (4,994) (2,903)
Development costs paid (104,256) (58,499)
Payment of organization costs - (9,586)
Other 35,250 (35,250)
------------ -----------
Net cash used by investing activities (74,000) (106,238)
------------ ------------
Financing activities:
Proceeds from borrowings 797,953 931,622
Offering expenses prepaid (127,664) -
Advances and repayments to affiliates 26,261 (668,991)
Advances and repayments from affiliates (127,836) 48,882
Payment of financing costs (1,000) (13,887)
Contribution of capital - 100
------------ ------------
Net cash provided by financing activities 567,714 297,726
------------ -------------
Net increase in cash 47,024 26,622
Cash and cash equivalents - beginning 31,132 -
Cash held by subsidiary at date of acquisition - 4,510
------------ ------------
Cash and cash equivalents - ending $78,156 $31,132
============ ============
Cash payments for interest $80,861 $7,862
============ ===========
Cash payments for taxes $ - $ -
============ ============
For supplemental schedule of non-cash investing and financing activities, see Note 2.
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
Diversified Senior Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 1997
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Diversified Senior Services, Inc. (the Company), a North Carolina corporation,
was formed on May 17, 1996, and began its operations on July 1, 1996. Through
January 14, 1998, the Company was a wholly-owned subsidiary of Taylor House
Enterprises (THE). On that date, the Company completed its initial public
offering whereby it issued 1,500,000 shares of common stock, as more fully
described in Note 11. The Company plans to use these proceeds to expand its
operations regarding the development and construction or acquisition and
refinancing of assisted living facilities and apartments for the elderly. DSS's
other business activity is providing personal care services (limited to
assistance with activities of daily living) to the low and moderate income
elderly. These individuals are primarily residents in low-income housing
projects managed by RPM (see below). Substantially all of these services are
reimbursed by Medicaid.
On July 1, 1996, DSS acquired all of the outstanding stock of Residential
Properties Management, Inc. (RPM) from THE. RPM was also a wholly-owned
subsidiary of THE. The transaction was accomplished by DSS issuing THE 2,277,678
of its common stock in exchange for all of RPM's common stock held by THE. RPM's
primary business activity is the management of government assisted [HUD and RD
(formerly FmHA)] low-income housing projects. RPM was formed in 1989 and manages
approximately 2,300 housing units in North Carolina, South Carolina, West
Virginia, and Pennsylvania for the owners of THE and for other third parties.
The following significant accounting policies have been followed in the
preparation of the Company's financial statements.
CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, RPM. All significant intercompany transactions
have been eliminated in consolidation.
CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers all highly
liquid investments purchased within three months of maturity to be cash
equivalents.
ACCOUNTS RECEIVABLE - TRADE
Accounts receivable - trade consists of management fees and reimbursements
for administrative services due from partnerships and other entities whose
properties are managed by RPM, and home care revenues which are due primarily
from Medicaid. The Company and its subsidiary provide services to customers
and clients on a noncollateralized basis.
FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost. Depreciation is determined using
the straight line method and is based on the estimated useful lives of the
related assets of three to five years. Expenditures for maintenance and
repairs which do not improve or extend the life of an asset are expensed as
incurred. Major renewals and betterments are charged to the property
accounts. Upon retirement or sale of an asset, its cost and related
accumulated depreciation are removed from the property accounts and any gain
or loss is recorded as income or expense.
INTANGIBLE ASSETS
Management contract rights represent the contractual rights purchased to
allow the Company to manage various apartment or housing projects and are
amortized on a straight line basis over the lives of the contracts, which
approximates seven years.
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Finance costs consist of expenses incurred for the bank line of credit, and
are amortized over the life of the loan.
Organization costs include expenses incurred in the initial organization of
the Company and prior to the initial public offering, and are amortized
ratably over sixty (60) months.
DEVELOPMENT COSTS
Development costs are expenses, including certain salaries, that are
capitalized during the development stage of new assisted living facilities.
If the Company retains the property after completion of construction, the
capitalized costs are included in the basis of the building and depreciated
over its useful life. If the building is sold after completion of
construction, the capitalized costs are included in the building basis and
are used to determine the gain or loss on sale. If the property is developed
for a third party owner, the costs are reimbursed upon the completion of
construction and sale of the facilities to the permanent owner of the real
estate. Costs for abandoned sites are written off when the sites are
considered not feasible.
NET INCOME (LOSS) PER SHARE
Net income (loss) per share is computed based on the weighted average number
of common shares outstanding for the period.
ADVERTISING
The costs of advertising and marketing programs are expensed as incurred.
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with generally accepted
accounting principles (GAAP) requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the
reporting period. Actual results could differ from those estimates.
INCOME TAXES
The Company is a C corporation and files its federal income tax return as a
part of a consolidated group with THE as the parent. Tax expense or benefit
is allocated based on net income or loss for each entity in the consolidated
group. North Carolina state income tax regulations do not permit filing of
consolidated income tax returns. Accordingly, the Company and its subsidiary
file separate state corporate income tax returns as described further in Note
9.
As a result of the initial public offering, the Company will no longer be
included in the consolidated group for federal income tax purposes effective
January 14, 1998.
The Company uses the asset and liability approach for financial accounting
and reporting for income taxes and deferred tax assets and liabilities. If it
is more likely than not that some portion or all of a deferred tax asset will
not be realized, a valuation allowance is recognized.
INCOME RECOGNITION
Management fee income is assessed as a percentage of rent collected at
apartments. Income is recognized monthly as rent collections are made.
Reimbursement income consists of amounts reimbursed or due to the Company
from properties managed for the services of management and maintenance
personnel employed by the Company.
Home care revenues are recognized at the time the service is provided.
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
PREFERRED STOCK
The Company's Articles of Incorporation provide authority for the issuance of
100,000,000 shares of preferred stock, no par value. On September 24, 1997,
the Board of Directors classified a series of 200,000 shares of convertible,
preferred stock as Series A preferred stock. The Series A preferred stock is
nonvoting, is subordinate to the common stock for payment of dividends, has a
stated liquidation value of $5 per share which is subordinate to a preferred
distribution to holders of common stock equal to $10 per share, may be
converted to common stock at $6 per share after September 30, 1999 and is not
redeemable at the option of the holder. Attributes or preferences have not
been established for the remaining unissued stock.
RECLASSIFICATION
Certain items in the financial statements for 1996 have been reclassified to
conform to the format presented in these financial statements.
NOTE 2: RELATED PARTY TRANSACTIONS
On July 1, 1996, the Company, a 100% owned subsidiary of THE, acquired 100% of
RPM from THE. RPM is a management company formed in 1989 to manage residential
apartments, many of which are subsidized through various Housing and Urban
Development ("HUD"), Rural Development ("RD"), and tax credit programs. The
acquisition was accomplished by the exchange of 2,277,678 shares of common stock
of DSS for 100% of the stock (100 shares) of RPM. No value was assigned to the
stock at the time of acquisition, as RPM had no positive book value at the date
of acquisition. The acquisition was treated as a combination of entities under
common control and the financial statements are presented on a basis similar to
a pooling of interests. The results of operations are included in the financial
statements of DSS from July 1, 1996 to December 31, 1996.
During 1996, RPM acquired certain assets in two transactions, consisting of
management contract rights, trade accounts receivable, land and furniture and
equipment from an affiliate, and assumed certain liabilities to THE. The
difference between the book value of the assets acquired, the reduction of the
amount due from affiliate and the liability assumed is recorded as a deemed
distribution in the equity section of the balance sheet. The assets acquired are
stated at the transferor's historical cost basis at date of transfer.
The non-cash transactions were accounted for as follows:
Management contracts $ 73,610
Land 70,536
Furniture and equipment 121,569
Accounts receivable 119,023
Reduction in receivable from affiliate (364,101)
Liability to THE (1,356,427)
----------
Deemed distribution $1,335,790
==========
Development costs totaling $50,000 were incurred by THE on behalf of the Company
during the period ended December 31, 1996.
RPM leases certain computer equipment from THE under operating lease agreements
expiring in 2003. These lease agreements are included in the lease information
disclosed in Note 10.
From time to time, the Company advances or borrows funds from the parent, THE,
or other related entities.
On September 30, 1997, the Company, in a non-cash transaction, issued 178,386
shares of preferred stock to the parent company in exchange for a note payable
to the parent in the amount of $891,930. The remaining amount of $76,554 was
reclassified to an account payable. The interest rate on this note was
NOTE 2: RELATED PARTY TRANSACTIONS - CONTINUED
8.25% per annum and interest expense of $27,191 was accrued for the nine months
ended September 30, 1997.
<TABLE>
<CAPTION>
The following schedule summarizes the related party activities for the year
ended December 31, 1997 and the period ended December 31, 1996.
Due (to) from Due (to) from Note
Affiliated Parent and Payable
Partnerships Subsidiaries Parent Total
<S> <C> <C> <C> <C>
Amounts due (to) from affiliates:
Amounts due to (from) RPM at
date of acquisition:
Management fees due from
related partnerships $257,673 $ - $ - $257,673
Advances due from affiliate - 50,441 - 50,441
Amounts due to related partnership (20,000) - - (20,000)
Amounts due to other related entities - (2,755) - (2,755)
Advances due to parent - (520,059) (1,114,116) (1,634,175)
------- ----------- ---------- ------------
237,673 (472,373) (1,114,116) (1,348,816)
Working capital advances to affiliate - 38,996 - 38,996
Receipts from related partnerships (4,057) - - (4,057)
Acquisition of management contract
rights from affiliate - (89,437) - (89,437)
Assumption of affiliate's liability to parent - (110,903) - (110,903)
Computer equipment lease
payment due parent - (4,848) - (4,848)
Working capital advances from parent - (44,825) - (44,825)
Accrued interest to parent - - (52,979) (52,979)
Repayments to parent - 559,220 70,775 629,995
Tax benefit of operating losses
due from parent - 88,000 - 88,000
------- ------- ------ ----------
Balance, December 31, 1996 $233,616 $(36,170) $(1,096,320) $ (898,874)
Repayment to affiliate - 33,415 - 33,415
Computer equipment lease
payment due parent - (5,333) - (5,333)
Rent due to parent - (21,600) - (21,600)
Accrued interest to parent - (27,191) - (27,191)
Repayments to parent - 90,771 127,836 218,607
Advances from parent - (150,447) - (150,447)
Exchange note for preferred stock - - 891,930 891,930
Reclassify remaining note to
account payable - (76,554) 76,554 -
Tax benefit of operating losses
due from parent - 269,900 - 269,900
------- ------- ---------- -------
Balance, December 31, 1997 $233,616 $76,791 $ - $310,407
======== ======= ========== ========
</TABLE>
NOTE 2: RELATED PARTY TRANSACTIONS - CONTINUED
There was no interest income received from related parties during the year ended
December 31, 1997 and the period ended December 31, 1996. Accounts payable to
related parties bear no interest and have no scheduled repayment terms.
Management fee income for the year ended December 31, 1997 and the period ended
December 31, 1996 includes $288,385 and $143,774, respectively, earned from
partnerships, a general partner of which is a beneficial shareholder of THE;
$26,237 of such income is included in trade accounts receivable at December 31,
1997 and $30,835 at December 31, 1996. In addition, the Company was reimbursed
for payments made through its central payroll system for payroll and related
expenses, by partnerships which are related through common ownership, of
$550,946 and $250,354, respectively, for the year ended December 31, 1997 and
for the period ended December 31, 1996.
NOTE 3: FURNITURE AND EQUIPMENT
The Company has furniture and equipment as follows:
1997 1996
Computer equipment $ 86,355 $84,679
Office furniture 43,112 39,794
-------- -------
129,467 124,473
Less accumulated depreciation 72,980 36,022
-------- -------
$ 56,487 $88,451
======== =======
Depreciation expense for the year ended December 31, 1997 was $36,958 and for
the period ended December 31, 1996 was $18,108.
NOTE 4: INTANGIBLE ASSETS
Intangible assets consist of the following:
1997 1996
---- ----
Management contract rights $ 73,610 $73,610
Finance costs 14,887 13,887
Organization costs 59,586 9,586
-------- -------
148,083 97,083
Less accumulated amortization 33,304 7,156
-------- -------
$114,779 $89,927
Amortization expense for the year ended December 31, 1997 was $26,148 and for
the period ended December 31, 1996 was $7,156.
<PAGE>
NOTE 5: NOTES PAYABLE
Notes payable consist of the following: 1997 1996
---- ----
Bank line of credit, bearing interest at prime (8.50% at December 31, 1997),
payable quarterly, originally maturing October 1997. The note is
guaranteed by THE, and 61,303 shares of Omega Healthcare Investors, Inc.
common stock owned by THE are pledged as collateral for the loan. In July
and October 1997, the Company modified its line of credit by increasing
the authorized amount to $1.6 million and extending the maturity date to
January 1998. The note was paid January 14,
1998. See Note 12. $1,604,575 $931,622
Note payable to THE, bearing interest at 8.25%,
payable 366 days after demand. - 1,096,320
------------ ----------
$1,604,575 $2,027,942
============= ==========
NOTE 6: FINANCIAL INSTRUMENTS
The Company's financial instruments include cash, note payable to a bank and
amounts due to and from affiliates. At December 31, 1997, the carrying values of
cash and the note payable approximated their fair values based on current market
prices and rates. It was not practicable to estimate the fair value of the
amounts due to and from affiliates as the repayment terms have not been
established and they are non-interest bearing.
NOTE 7: SAVINGS INCENTIVE PLAN
The Company participates in a defined contribution savings incentive plan
covering substantially all of its full time employees. The Company provided a
50% matching contribution to each employee participant for contributions up to
the first 5% of compensation. On January 1, 1996, the plan was amended to cover
substantially all employees of the controlled group of companies owned by THE.
The Company's contribution for the year ended December 31, 1997 and the period
ended December 31, 1996 was $21,465 and $11,613, respectively.
NOTE 8: STOCK INCENTIVE PLAN
Effective January 1, 1997, the Directors and shareholder adopted the Company's
1997 Stock Incentive Plan for 500,000 shares of common stock, which authorizes
the Board (or future committee) to issue stock options, stock appreciation
rights, restricted stock and deferred stock subject to the Plan and such other
terms as set by the board. At December 31, 1997, no grants had been made.
Separately from the Stock Incentive Plan, a maximum of 80,329 options at an
exercise price ranging from $2.50 to $5 per share have been granted to certain
officers of the Company in consideration for their deferral of certain cash
compensation.
As permitted by generally accepted accounting principles, the Company has
adopted APB Opinion No. 25 intrinsic value based method of accounting for its
stock-based compensation arrangements. The difference between the option price
and the fair price of the stock will be recorded as compensation expense on the
exercise date.
NOTE 9: PROVISION FOR INCOME TAXES
The components of income tax benefit are as follows for the year ended December
31, 1997 and for the period ended December 31, 1996:
12/31/97 12/31/96
Current taxes
refundable:
Federal $ (269,900) $ (88,000)
State - -
---------- ---------
(269,900) (88,000)
---------- ---------
Deferred tax expense
(benefit):
Deferred compensation (103,500) (95,900)
Start up costs 10,400 (57,200)
Generation of state loss carryforwards (61,500) (31,300)
All other changes (4,753) (1,812)
Increase in valuation allowance 159,353 186,212
---------- ---------
- -
---------- ---------
Income tax benefit $(269,900) $(88,000)
========== =========
As further described at Note 2, the income tax benefit is included in the
amounts due (to) from the parent company.
The actual income tax benefit attributable to loss from continuing operations
for the year ended December 31, 1997 and for the period ended December 31, 1996
differed from the amounts computed by applying the U.S. federal tax rate of 34
percent to loss before income tax benefit as a result of the following:
12/31/97 12/31/96
Computed "expected" tax benefit (353,100) (231,400)
Timing differences related to
deferred compensation 92,600 85,800
Start up costs capitalized
for tax purposes - 61,300
All other changes (9,400) (3,700)
---------- ----------
Income tax benefit $ (269,900) (88,000)
========== ==========
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying value of assets and liabilities for financial reporting
purposes and the amounts reported for income tax purposes. Significant
components of the Company's deferred income tax assets are as follows. There are
no significant deferred income tax liabilities.
12/31/97 12/31/96
Non-current deferred tax asset:
Deferred compensation 199,400 95,900
Start-up costs 46,800 57,200
State operating loss carryforwards 92,800 31,300
All others 6,565 1,812
---------- -----------
345,565 186,212
Valuation allowance (345,565) (186,212)
---------- -----------
Net deferred tax asset $ - $ -
========== ===========
NOTE 9: PROVISION FOR INCOME TAXES - CONTINUED
DSS and RPM had state loss carryforwards of $727,720 and $292,046 respectively
available at December 31, 1997 and $181,247 and $222,892 respectively, available
at December 31, 1996 to be applied against future state taxable income. The tax
loss carryforwards are subject to examination by taxing authorities and if not
previously utilized, expire December 31, 2002 and 2001.
From May 17, 1996 (Date of Inception) through January 13, 1998, the Company was
included in the consolidated federal return of the parent, THE; therefore, loss
carryforwards for federal purposes have been utilized. Effective January 14,
1998, DSS and RPM will file a consolidated federal return separate from THE.
NOTE 10: COMMITMENTS AND CONTINGENCIES
The Company has various operating leases for office space and equipment. Future
minimum lease payments of $130,016 are as follows for the years ending December
31:
1998 $36,406
1999 $31,096
2000 $26,270
2001 $22,427
2002 $13,139
Thereafter $ 678
Rent expense for the year ended December 31, 1997 and the period ended December
31, 1996 was $74,217 and $43,292, respectively. Beginning in May 1997, the
Company entered into a month-to-month sublease with THE, the parent, for office
space for its corporate headquarters with required monthly rent payments of
$2,700. In addition, RPM leases computer equipment from THE, with monthly
payments of $501.
NOTE 11: SUBSEQUENT EVENTS
On January 14, 1998, the Company completed its public offering of 1,500,000
shares of common stock at $5.00 per share, for gross proceeds of $7,500,000.
Expenses of the offering totaled $1,175,821 for net proceeds of $6,324,179. See
Note 12 for a pro forma balance sheet as if the Company completed the public
offering and paid certain loans and accrued expenses on December 31, 1997.
The Company granted the underwriter warrants to purchase 150,000 shares of
common stock exercisable for four years, commencing 12 months after the closing
of the offering, at an exercise price of $6.75.
In January, 1998, the Company formed a wholly-owned subsidiary, DSS Funding,
Inc. ("DSSF"), a North Carolina corporation, for the purpose of securing
permanent financing for the assisted living facilities which the Company
develops, as well as third party owners. The Company loaned DSSF $250,000
secured by a non-interest bearing note and will provide working capital for the
subsidiary.
On February 11, 1998, 50,000 stock options were granted at an exercise price
ranging from $4.75 to $5.225, the market value of the shares at the date of
grant. The stock options are exercisable on July 1, 1998 and are 100% vested on
that date. The options expire five years after the date of grant, or February
10, 2003. In addition, a direct grant of 400 common shares was made to the
Company's outside directors.
<PAGE>
NOTE 12: PRO FORMA CONSOLIDATED BALANCE SHEET
The following pro forma consolidated balance sheet is presented as if the
Company completed its public offering of 1,500,000 shares of common stock and
paid certain loans and accrued expenses on December 31, 1997.
<TABLE>
<CAPTION>
As Pro Forma As
STATED ADJUSTMENTS (1)ADJUSTED
ASSETS
Current assets:
<S> <C> <C> <C>
Cash and cash equivalents $ 78,156 $565,173 $643,329
Cash held for development - 3,500,000 3,500,000
Accounts receivable - trade 92,878 - 92,878
Refundable income taxes 34,176 - 34,176
Offering expenses 425,821 (425,821) -
Prepaid expenses 12,280 - 12,280
-------- -------- --------
643,311 3,639,352 4,282,663
Furniture and equipment, net 56,487 - 56,487
Intangible assets, net 114,779 - 114,779
Development costs 241,433 - 241,433
Accounts receivable - affiliates 310,407 - 310,407
-------- -------- --------
$1,366,417 $3,639,352 $5,005,769
============ ============ ============
LIABILITIES
Current liabilities:
Accounts payable and
accrued expenses $ 652,445 $ (445,092) $207,353
Interest payable 33,070 (33,070) -
Note payable - bank 1,604,575 (1,604,575) -
Deferred salaries 577,508 (577,508) -
-------- -------- -------
2,867,598 (2,660,245) 207,353
Deferred bonuses 234,405 (24,582) 209,823
-------- -------- --------
3,102,003 (2,684,827) 417,176
--------- ---------- --------
SHAREHOLDERS' EQUITY (DEFICIT)
Preferred stock 891,930 - 891,930
Common stock 100 6,324,179 6,324,279
Deemed distribution (1,335,790) - (1,335,790)
Accumulated deficit (1,291,826) - (1,291,826)
---------- -------- ----------
(1,735,586) 6,324,179 4,588,593
---------- --------- ---------
$1,366,417 $3,639,352 $5,005,769
========== ========== ==========
- -------------------------------
(1) Detailed below
</TABLE>
NOTE 12: PRO FORMA CONSOLIDATED BALANCE SHEET - CONTINUED
(1)The following gives the effect of the offering completed on January 14, 1998
and subsequent use of the proceeds:
Gross proceeds (1,500,000 shares at $5.00 per share) $7,500,000
Offering expenses (1,175,821)
----------
Net cash from offering 6,324,179
-----------
Use of proceeds:
Repayment of bank loan and accrued interest (1,637,645)
Payment of deferred salaries (577,508)
Payment of deferred bonuses (24,582)
Reclassification of offering expenses 425,821
Payment of accounts payable and accrued expenses (445,092)
Cash held for development (3,500,000)
-------------
(5,759,006)
Increase in cash and cash equivalents $ 565,173
=============
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
3.1 Articles of Incorporation of the Company (as amended).
Incorporated by reference to Exhibit 3.1 to Registration
Statement on Form SB-2 (File No. 333-34367).
3.1(a) Articles of Amendment filed October 6, 1997.
3.2 Bylaws of the Company, as amended Incorporated by reference
to Exhibit 3.2 to Registration Statement on Form SB-2 (File
No. 333-34367).
10.1 Employment Agreement dated as of January 1, 1997 between the
Company and William G. Benton, as amended. Incorporated by
reference to Exhibit 10.1 to Registration Statement on Form
SB-2 (File No. 333-34367).
10.2 Employment Agreement dated as of January 1, 1997 between the
Company and Susan L. Christiansen, as amended. Incorporated
by reference to Exhibit 10.2 to Registration Statement on
Form SB-2 (File No. 333-34367).
10.3 Employment Agreement dated as of January 1, 1997 between the
Company and G. L. Clark, Jr., as amended. Incorporated by
reference to Exhibit 10.3 to Registration Statement on Form
SB-2 (File No. 333-34367).
10.4 Lock-up agreements. Incorporated by reference to Exhibit
10.4 to Registration Statement on Form SB-2 (File No.
333-34367).
10.5 The Company's 1997 Stock Incentive Plan. Incorporated by
reference to Exhibit 10.5 to Registration Statement on Form
SB-2 (File No. 333-34367).
20 Independent Auditors' Report.
21 Subsidiaries of the Company.
23 Consent of The Daniel Professional Group, Inc.
27 Financial Data Schedule.
Exhibit 3.1(a)
Articles of Amendment
of
Diversified Senior Services, Inc.
The undersigned Corporation hereby submits these Articles of Amendment for
the purpose of Amending its Articles of Incorporation to fix the preferences,
limitations, and relative rights of a series of its shares:
A. The name of the corporation is Diversified Senior Services, Inc.
B. The following Amendment to the Articles of Incorporation of the
Corporation was duly adopted by the Board of Directors of the Corporation on the
23rd day of September, 1997;
The Corporation shall have the authority to issue a series of
preferred shares out of the 100,000,000 shares of preferred
stock authorized, which series shall consist of 200,000
shares, each of which shall have no par value per share, and
which shall be designated as Series A Preferred Stock. A
description of the powers, preferences and rights, and the
qualifications, limitations and restrictions of the Series A
Preferred Stock are as follows:
1. VOTING RIGHTS. The Series A Preferred Stock
shall be without voting rights except as
specifically required by law.
2. DIVIDENDS. The holders of the Series A Preferred
Stock shall be entitled to participate in dividends
on the same basis as holders of common stock;
provided, however, the payment of dividends to the
Series A Preferred Stock shall be subordinate to the
rights of the holders of Common Stock to receive any
dividend.
3. LIQUIDATION. Upon any liquidation, dissolution or
winding up of the Corporation, whether voluntary or
involuntary, liquidation of the assets of the
Corporation shall be accomplished
as follows:
(a) In the event of any liquidation, dissolution
or winding up of the Corporation, the
holders of Common Stock shall be entitled to
receive, on a pro rata basis, and in
preference to any distribution of any of the
assets or surplus funds of the Corporation
to the holders of the Series A Preferred
Stock, an amount (the "Common Stock
Preference Payment") equal to the sum of
$10.00 per share of Common Stock (subject to
appropriate adjustment for stock splits,
stock combinations, stock dividends,
reclassifications and similar events
affecting the Common Stock). After payment
of the Common Stock Preferred Payment,
holders of Series A Preferred Stock shall be
entitled to receive an amount equal to $5.00
per share of Series A Preferred Stock owned.
(b)Upon any liquidation, dissolution or
winding up of the Corporation, if the assets
of the Corporation available for
distribution to its shareholders shall be
insufficient to permit the payment in full
of the Common Stock Preference Payment, then
the assets available for distribution shall
be distributed among the holders of all
Common Stock ratably in proportion to the
number of shares of such Common Stock held
by each of them, and no distribution shall
be made to the holders of Series A Preferred
Stock.
(c) In the event the distribution provided
for by this Paragraph 3 is made to the
holders of Series A Preferred Stock upon any
liquidation, dissolution or winding up of
the Corporation, the Series A Preferred
Stock shall be retired and cancelled and the
holders thereof shall cease to have any
continuing interest in the Corporation in
their capacity as holders of Series A
Preferred Stock.
4. CONVERSION. Each share of Series A Preferred
Stock shall be convertible into such number of
fully paid and nonassessable shares of Common
Stock as is determined by dividing the
Conversion Value (as hereinafter defined) by the
Conversion Price (as hereinafter defined) in
effect at the time of the Conversion. The
Conversion Value shall equal at any time the
product obtained by multiplying the number of
shares of Series A Preferred Stock to be
converted by $5.00 (to be adjusted
proportionately in the event of any stock
dividend, stock split, combination or similar
event affecting the Series A Preferred Stock).
The Conversion Price shall be $6.00 per share of
Series A Preferred Stock. The holders of Series
A Preferred Stock shall be entitled to convert
their shares of Series A Preferred Stock into the
Corporation's Common Stock at any time upon notice
to the Corporation of the intent to convert; provided
however that in no event shall such conversion take
place within two years of the issue date of such
Series A Preferred Stock.
No fractional shares of Common Stock shall be issued
upon conversion of the Series A Preferred Stock. In
lieu of any fractional shares to which the holder
would otherwise be entitled, the Corporation shall
pay cash equal to such fraction multiplied by the
fair market value of one share of Common stock at the
time of conversion (which in the case of a public
offering, shall be equal to the price to the public
in such offering). Before any holder of Series A
Preferred Stock shall be entitled to convert the same
into shares of Common Stock, such holder shall
surrender the certificate or certificates therefor,
duly endorsed, at the office of the Corporation or of
any transfer agent of such Series A Preferred Stock
and shall give written notice by mail, postage
prepaid, to the Corporation at its principal
corporate office, of the election to convert the
same, and such conversion shall be deemed to have
been made immediately prior to the close of business
on the date of such surrender of the shares of Series
A Preferred Stock to be converted.
5. REDEMPTION. The Series A Preferred Stock shall not be subject to
redemption at the election of the holders of such stock.
This the 30th day of September, 1998.
DIVERSIFIED SENIOR SERVICES, INC.
By: /s/ Susan L. Christiansen
Title: President
Exhibit 20
The Daniel Professional Group, Inc.
Certified Public Accountants
4440 Silas Creek Parkway, Suite 200
Winston-Salem, NC 27104
910-768-3290
Fax 910-768-7666
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Diversified Senior Services, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheets of
Diversified Senior Services, Inc. and Subsidiary as of December 31, 1997 and
1996, and the related consolidated statements of operations, changes in
shareholder's deficit, and of cash flows for the year ended December 31, 1997
and for the period from May 17, 1996 to December 31, 1996. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform our audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As described in Note 11, the Company completed its initial public
offering on January 14, 1998.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of Diversified Senior Services, Inc. and Subsidiary as of December 31,
1997 and 1996, and the consolidated results of its operations and cash flows for
the periods indicated, in conformity with generally accepted accounting
principles.
/s/ The Daniel Professional Group, Inc.
The Daniel Professional Group, Inc.
February 24, 1998
Winston-Salem, North Carolina
principles.
EXHIBIT 21
SUBSIDIARIES
All subsidiaries are 100% owned by Diversified Senior Services, Inc., and
do business under their corporate names.
Residential Properties Management, Inc., a North Carolina corporation
DSS Funding, Inc., a North Carolina corporation
EXHIBIT 23
CONSENT OF THE DANIEL PROFESSIONAL GROUP, INC.
INDEPENDENT AUDITORS' CONSENT
To the Board of Directors and Shareholders
Diversified Senior Services, Inc.
We consent to the use in this Annual Report on Form 10-KSB our report dated
February 24, 1998 on the consolidated financial statements of Diversified Senior
Services, Inc. and subsidiary as of December 31, 1997 and for the year then
ended, and as of December 31, 1996 and for the period from May 17, 1996 to
December 31, 1996.
/s/ THE DANIEL PROFESSIONAL GROUP, INC.
THE DANIEL PROFESSIONAL GROUP, INC.
Winston-Salem, NC
March 27, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF DIVERSIFIED SENIOR SERVICES, INC. FOR THE TWELVE MONTHS
ENDED DECEMBER 31, 1997 AND FOR THE PERIOD FROM MAY 17, 1996 (DATE OF INCEPTION)
TO DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL SATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<PERIOD-START> MAY-17-1996
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 78
<SECURITIES> 0
<RECEIVABLES> 93
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 643
<PP&E> 129
<DEPRECIATION> 73
<TOTAL-ASSETS> 1,366
<CURRENT-LIABILITIES> 2,868
<BONDS> 0
0
892
<COMMON> 0
<OTHER-SE> (2,628)
<TOTAL-LIABILITY-AND-EQUITY> 1,366
<SALES> 2,519
<TOTAL-REVENUES> 2,519
<CGS> 3,423
<TOTAL-COSTS> 3,423
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 135
<INCOME-PRETAX> (1,039)
<INCOME-TAX> (270)
<INCOME-CONTINUING> (769)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (769)
<EPS-PRIMARY> (.38)
<EPS-DILUTED> (.38)
</TABLE>
