<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 27, 1998
REG. NO. 333-
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- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
AVC HOLDING CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 8051 58-2409489
(STATE OR OTHER (PRIMARY STANDARD (I.R.S.
JURISDICTION OF INDUSTRIAL EMPLOYERIDENTIFICATION
INCORPORATION OR CLASSIFICATION CODE NO.)
ORGANIZATION) NUMBER)
6600 PEACHTREE DUNWOODY ROAD
400 EMBASSY ROW, SUITE 410
ATLANTA, GEORGIA 30328
(770) 668-0142
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
----------------
FRANCIS J. CROSBY
PRESIDENT AND CHIEF EXECUTIVE OFFICER
6600 PEACHTREE DUNWOODY ROAD
400 EMBASSY ROW, SUITE 410
ATLANTA, GEORGIA 30328
(770) 668-0142
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
COPY TO:
RICHARD H. MILLER, ESQ.
POWELL, GOLDSTEIN, FRAZER & MURPHY LLP
SIXTEENTH FLOOR
191 PEACHTREE STREET N.E.
ATLANTA, GEORGIA 30303
(404) 572-6600
----------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective and all other
conditions to the Offer (defined hereafter) have been satisfied or waived.
If the securities being registered on this Form are offered in connection
with the formation of a holding company and there is compliance with General
Instruction G, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
TITLE OF EACH CLASS OF PROPOSED MAXIMUM PROPOSED MAXIMUM
SECURITIES TO BE AMOUNT TO BE OFFERING PRICE AGGREGATE AMOUNT OF
REGISTERED REGISTERED(1) PER SHARE(1)(2) OFFERING PRICE(2) REGISTRATION FEE
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $.01 par
value.................... 5,993,710 $7.50 $44,952,852 $13,262
</TABLE>
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(1) Represents the maximum amount of Common Stock, par value $.01 per share,
of AVC Holding Corp., a Delaware corporation ("Holding Co."), issuable
upon the consummation of the exchange offer for shares of Common Stock,
par value $.01 per share (the "Shares") of Advocat Inc., a Delaware
corporation (the "Company"), together with associated preferred stock
purchase rights. According to the Company's Form 10-Q for the period ended
June 30, 1998, as of August 12, 1998, there were issued and outstanding
5,398,710 Shares. Based on the foregoing and assuming that (i) no Shares
have been issued since August 12, 1998 and (ii) no options or Shares have
been issued other than the 595,000 options to purchase shares reported in
the Company's Form 10-K for the period ended December 31, 1997, the
maximum number of Shares to be received in exchange would be 5,993,710.
The actual number of Shares exchanged will depend on the facts that exist
on the date of the exchange. To the extent additional options or Shares
are issued, this Registration Statement shall be deemed to register a
corresponding number of shares of Holding Co.'s Common Stock without
changing the Proposed Aggregate Maximum Offering Price.
(2) Pursuant to Rules 457(f)(1) and 457(c) under the Securities Act of 1933,
as amended, and solely for the purposes of calculating the registration
fee, the registration fee was computed on the basis of $ 7.50 per Share,
the average of the high and low prices of Company Common Stock as reported
on the New York Stock Exchange on August 25, 1998.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OR UNTIL THIS REGISTRATION STATEMENT SHALL
BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SECTION 8(A), MAY DETERMINE.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED AUGUST 27, 1998
PROSPECTUS
OFFER TO EXCHANGE EACH OUTSTANDING SHARE OF COMMON STOCK
(including the associated preferred stock purchase rights)
OF
ADVOCAT INC.
FOR
$1.00 PER SHARE IN CASH
AND
ONE SHARE OF COMMON STOCK
OF
AVC HOLDING CORP.
(a newly formed holding company)
THE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 12:00 MIDNIGHT NEW YORK CITY
TIME ON SEPTEMBER , 1998, UNLESS EXTENDED. SHARES WHICH ARE TENDERED PURSUANT
TO THE OFFER MAY BE WITHDRAWN AT ANY TIME PRIOR TO THE EXPIRATION OF THE OFFER.
------------
SEE "RISK FACTORS" BEGINNING ON PAGE 11 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY HOLDERS OF SHARES IN CONNECTION WITH THE OFFER.
AVC Holding Corp., a Delaware corporation ("Holding Co."), hereby offers,
upon the terms and subject to the conditions set forth herein and in the
related Letter of Transmittal (collectively, the "Offer"), to exchange the
amount of $1.00 in cash and one (the "Exchange Ratio") share of common stock,
par value $.01 per share ("Holding Co. Common Stock"), of Holding Co. (the
"Consideration"), for each outstanding share of common stock, par value $.01
per share (each a "Share" and, collectively, the "Shares"), of Advocat Inc., a
Delaware corporation (the "Company"), together with the associated preferred
stock purchase rights (the "Rights") issued pursuant to the Rights Agreement,
dated as of March 13, 1995, as amended (the "Rights Agreement"), between the
Company and Third National Bank in Nashville, as Rights Agent, validly tendered
on or prior to the Expiration Date (as hereinafter defined) and not properly
withdrawn. Unless the context otherwise requires, all references to Shares
shall include the associated Rights, and all references to Rights shall include
all benefits that may inure to holders of the Rights pursuant to the Rights
Agreement.
On August 26, 1998, the last trading date preceding the filing of the
Registration Statement of which this Prospectus is a part, the closing price of
a Share on the New York Stock Exchange, Inc. (the "NYSE") Composite Tape was
$7-3/16. There is currently no public trading market for the shares of
Holding Co. Common Stock. Holding Co. intends to apply for the listing of the
Holding Co. Common Stock on either the NYSE, the American Stock Exchange or the
Nasdaq Stock Market.
Holding Co. intends, as promptly as practicable following consummation of the
Offer, to cause a wholly owned subsidiary of Holding Co. to be merged with the
Company (the "Merger" and, together with the Offer, the "Transactions"), and
each Share then outstanding will be converted into the right to receive the
Consideration.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------
THE DEALER MANAGER FOR THE OFFER IS
SCHRODER & CO. INC.
The date of this Prospectus is , 1998.
<PAGE>
[Graph of Advocat Inc. daily closing sale prices and trading volume on the NYSE
Composite Tape since May 10, 1994, the date of its initial public offering.]
[Bar Graph of the reported earnings per share of Advocat Inc. for each quarter
since June 1994]
<PAGE>
-----------------
Holding Co.'s obligation to exchange shares of Holding Co. Common Stock for
Shares pursuant to the Offer is conditioned upon, among other things: (i)
there being validly tendered prior to the expiration of the Offer and not
withdrawn a number of Shares which will constitute at least either (a) 66 2/3%
of the total outstanding Shares on a fully diluted basis as of the date the
Shares are accepted for exchange by Holding Co., if the Company's Board of
Directors has called or agreed to call a special meeting of stockholders
within sixty (60) days to vote on the Merger or (b) 90.1% of the total
outstanding Shares on a fully diluted basis as of the date the Shares are
accepted for exchange by Holding Co. (in either case, the "Minimum Tender
Condition"); (ii) the redemption of the Rights by the Board of Directors of
the Company or Holding Co. being otherwise satisfied that the Rights will not
be applicable to the acquisition of the Shares pursuant to the Offer or the
Merger (the "Rights Plan Condition"); and (iii) Holding Co. being satisfied
that Section 203 of the Delaware General Corporation Law will not be
applicable to the Offer and the Merger (the "Business Combination Statute
Condition"). The Minimum Tender Condition, the Rights Plan Condition, the
Business Combination Statute Condition and the other conditions set forth
under the caption "The Offer--Conditions of the Offer" are referred to
collectively as the "Offer Conditions."
-----------------
IMPORTANT
STOCKHOLDERS WILL BE REQUIRED TO TENDER ONE RIGHT FOR EACH SHARE TENDERED IN
ORDER TO EFFECT A VALID TENDER OF SHARES, UNLESS THE RIGHTS PLAN CONDITION HAS
BEEN SATISFIED OR WAIVED. UNLESS THE DISTRIBUTION DATE (AS DEFINED IN THE
RIGHTS AGREEMENT) OCCURS, A TENDER OF SHARES WILL CONSTITUTE A TENDER OF THE
ASSOCIATED RIGHTS.
ANY STOCKHOLDER DESIRING TO TENDER ALL OR ANY PORTION OF HIS OR HER SHARES
AND THE ASSOCIATED RIGHTS SHOULD EITHER (I) COMPLETE AND SIGN THE LETTER OF
TRANSMITTAL OR A FACSIMILE COPY THEREOF IN ACCORDANCE WITH THE INSTRUCTIONS IN
THE LETTER OF TRANSMITTAL, MAIL OR DELIVER THE LETTER OF TRANSMITTAL OR SUCH
FACSIMILE AND ANY OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT (AS
HEREINAFTER DEFINED), AND EITHER DELIVER THE CERTIFICATES FOR SUCH SHARES AND,
IF SEPARATE, CERTIFICATES FOR THE RIGHTS TO THE EXCHANGE AGENT ALONG WITH THE
LETTER OF TRANSMITTAL, DELIVER SUCH SHARES AND RIGHTS PURSUANT TO THE
PROCEDURES FOR BOOK-ENTRY TRANSFER SET FORTH HEREIN (IN THE CASE OF RIGHTS,
ONLY IF SUCH PROCEDURES ARE AVAILABLE), OR COMPLY WITH THE GUARANTEED DELIVERY
PROCEDURES SET FORTH HEREIN OR (II) REQUEST HIS OR HER BROKER, DEALER,
COMMERCIAL BANK, TRUST COMPANY OR OTHER NOMINEE TO EFFECT THE TRANSACTION FOR
HIM OR HER. A STOCKHOLDER HAVING SHARES AND RIGHTS REGISTERED IN THE NAME OF A
BROKER, DEALER, COMMERCIAL BANK, TRUST COMPANY OR OTHER NOMINEE MUST CONTACT
SUCH BROKER, DEALER, COMMERCIAL BANK, TRUST COMPANY OR OTHER NOMINEE IF HE OR
SHE DESIRES TO TENDER SUCH SHARES AND RIGHTS.
ANY STOCKHOLDER THAT DESIRES TO TENDER HIS OR HER SHARES AND WHOSE
CERTIFICATES FOR SUCH SHARES ARE NOT IMMEDIATELY AVAILABLE, OR WHO CANNOT
COMPLY WITH THE PROCEDURES FOR BOOK-ENTRY TRANSFER ON A TIMELY BASIS, OR WHO
CANNOT DELIVER ALL REQUIRED DOCUMENTS TO THE EXCHANGE AGENT PRIOR TO THE
EXPIRATION DATE, MAY TENDER SUCH SHARES BY FOLLOWING THE PROCEDURE FOR
GUARANTEED DELIVERY.
QUESTIONS AND REQUESTS FOR ASSISTANCE MAY BE DIRECTED TO THE INFORMATION
AGENT (AS HEREINAFTER DEFINED) OR TO THE DEALER MANAGER AT THEIR RESPECTIVE
ADDRESSES AND TELEPHONE NUMBERS SET FORTH ON THE BACK COVER OF THIS
PROSPECTUS. REQUESTS FOR ADDITIONAL COPIES OF THIS PROSPECTUS AND THE LETTER
OF TRANSMITTAL MAY BE DIRECTED TO THE INFORMATION AGENT OR TO BROKERS,
DEALERS, COMMERCIAL BANKS OR TRUST COMPANIES.
ii
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AVAILABLE INFORMATION..................................................... v
COMPANY INFORMATION....................................................... v
FORWARD-LOOKING STATEMENTS................................................ vii
PROSPECTUS SUMMARY........................................................ 1
Summary of Proposed Transactions........................................ 1
Parties Involved........................................................ 1
Overview of Events Culminating in the Offer............................. 2
Benefits of the Transactions............................................ 3
Management Following the Transactions................................... 3
Financing Commitments................................................... 4
Risk Factors............................................................ 5
The Offer............................................................... 5
Certain Federal Income Tax Consequences................................. 7
Effect of Offer on Market for Shares.................................... 7
Dissenters' Rights...................................................... 7
Comparison of Stockholder Rights........................................ 8
The Exchange Agent...................................................... 8
Requests for Assistance and Additional Copies........................... 8
Market Prices and Dividends............................................. 9
PER SHARE DATA............................................................ 10
RISK FACTORS.............................................................. 11
Risks Related to Business of the Company and Following the Transactions,
Holding Co. ........................................................... 11
Risks Relating to the Transactions...................................... 19
REASONS FOR THE OFFER..................................................... 22
Historical Challenges................................................... 22
Current Challenges...................................................... 23
Future Challenges....................................................... 24
Strategies to Address Current and Future Challenges..................... 24
BACKGROUND OF THE OFFER................................................... 26
THE OFFER................................................................. 28
General................................................................. 28
The Rights.............................................................. 29
Extension, Termination And Amendment.................................... 29
Exchange Of Shares; Delivery Of Holding Co. Common Stock And Cash
Consideration.......................................................... 30
Cash In Lieu Of Fractional Shares Of Holding Co. Common Stock........... 31
Withdrawal Rights....................................................... 31
Procedure For Tendering................................................. 32
Federal Income Tax Withholding And Backup Withholding................... 35
Certain Federal Income Tax Consequences................................. 36
Effect of Offer on Trading Market; Registration under the Exchange Act.. 37
Purpose Of The Offer; The Merger........................................ 38
Conditions Of The Offer................................................. 39
Source And Amount Of Funds.............................................. 43
Change in Control Provisions............................................ 43
Relationships With The Company.......................................... 44
Fees And Expenses....................................................... 45
Accounting Treatment.................................................... 45
Dissenters' Rights...................................................... 45
FINANCING COMMITMENTS..................................................... 47
Equity Financing........................................................ 47
Convertible Debt Financing.............................................. 47
Registration Rights..................................................... 48
</TABLE>
iii
<PAGE>
<TABLE>
<S> <C>
CERTAIN INFORMATION REGARDING THE COMPANY.................................. 48
CERTAIN INFORMATION REGARDING HOLDING CO. ................................. 48
General.................................................................. 48
Strategy................................................................. 48
Management............................................................... 48
Certain Relationships and Related Party Transactions..................... 50
Principal Stockholders................................................... 51
DESCRIPTION OF HOLDING CO. CAPITAL STOCK; COMPARISON OF STOCKHOLDER
RIGHTS.................................................................... 52
Summary.................................................................. 52
Common Stock............................................................. 52
Preferred Stock.......................................................... 53
Rights................................................................... 53
Antitakeover Effects of Provisions of the Certificate of Incorporation
and Bylaws.............................................................. 53
Delaware Takeover Statute................................................ 55
Limitations of Directors' Liability...................................... 56
Indemnification and Insurance............................................ 56
SELECTED HISTORICAL FINANCIAL DATA OF THE COMPANY.......................... 58
PRO FORMA CONDENSED COMBINED FINANCIAL DATA................................ 59
VALIDITY OF HOLDING CO. COMMON STOCK....................................... 66
EXPERTS.................................................................... 66
AUDITED BALANCE SHEET OF AVC HOLDING CORP. AS OF AUGUST 26, 1998........... F-1
</TABLE>
ANNEXES
<TABLE>
<S> <C>
Annex A: The Company's 1997 Form 10-K.......................................
Annex B: The Company's Annual Meeting Proxy Statement.......................
Annex C: The Company's First Quarter Form 10-Q..............................
Annex D: The Company's Second Quarter Form 10-Q.............................
</TABLE>
iv
<PAGE>
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). The reports, proxy
statements and other information filed by the Company with the Commission may
be inspected and copied at the Commission's public reference room located at
Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549,
and at the public reference facilities in the Commission's regional offices
located at: 7 World Trade Center, 13th Floor, New York, New York 10048, and
500 West Madison Street, Suite 400, Chicago, Illinois 60661. Copies of such
material may be obtained at prescribed rates by writing to the Commission,
Public Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549.
Holding Co. and the Company are electronic filers with the Commission, which
maintains a website containing reports, proxy and other information statements
at the following location: http://www.sec.gov. The Shares are listed on the
NYSE under the symbol "AVC". The periodic reports, proxy statements and other
information filed by the Company with the Commission may be inspected at the
offices of the NYSE, 20 Broad Street, New York, New York 10005. Holding Co.
intends to apply for the listing of the Holding Co. Common Stock on the NYSE,
the American Stock Exchange or the Nasdaq Stock Market, and register the
Holding Co. Common Stock under the Exchange Act effective as of completion of
the Offer. Future reports of Holding Co. filed pursuant to the Securities Act
of 1933, as amended (the "Securities Act"), or the Exchange Act may be
obtained from the Commission at the addresses set forth above or inspected at
the offices of the exchange upon which the Holding Co. Common Stock is listed.
This Prospectus does not contain all of the information set forth in the
Registration Statement on Form S-4 (the "Registration Statement") covering the
Holding Co. Common Stock offered hereby which has been filed with the
Commission. Reference is hereby made to the Registration Statement for further
information with respect to Holding Co., the Company and the securities
offered hereby. Statements contained herein concerning certain documents are
not necessarily complete and, in each instance, reference is made to the
copies of such documents filed as exhibits to the Registration Statement or
otherwise filed with the Commission. Each such statement is qualified in its
entirety by such reference.
Not later than the date of commencement of the Offer, Holding Co. will file
with the Commission a statement on Schedule 14D-1 pursuant to Rule 14d-3 under
the Exchange Act furnishing certain information with respect to the Offer.
Such schedule and any amendments thereto should be available for inspection
and copying as set forth above (except that such schedule and any amendments
thereto will not be available at the regional offices of the Commission).
COMPANY INFORMATION
The following documents filed with the Commission by the Company (File No.
1-4651) are included with this Prospectus as Annexes hereto:
Annex A: the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1997 (the "Company's 1997 Form 10-K"), except for the report of
the Company's independent accountants contained therein which is not included
herewith because the consent of the Company's independent accountants has not
yet been obtained;
Annex B: the Company's Proxy Statement for the Annual Meeting of
Stockholders held on May 15, 1998 (the "Company's Annual Meeting Proxy
Statement");
Annex C: the Company's Quarterly Report on Form 10-Q for the period ended
March 31, 1998 (the "Company's First Quarter Form 10-Q"); and
v
<PAGE>
Annex D: the Company's Quarterly Report on Form 10-Q for the period ended
June 30, 1998 (the "Company's Second Quarter Form 10-Q").
While Holding Co. has included information concerning the Company insofar as
it is known or reasonably available to Holding Co., the Company is not
affiliated with Holding Co. and the Company has not to date permitted access
by Holding Co. to the Company's books and records for the purpose of preparing
this Prospectus. Therefore, information concerning the Company which has not
been made public was not available to Holding Co. for the purpose of preparing
this Prospectus. Although Holding Co. has no knowledge that would indicate
that statements relating to the Company contained in this Prospectus
(including the Annexes hereto) in reliance upon publicly available information
are inaccurate or incomplete, Holding Co. was not involved in the preparation
of such information and statements and, for the foregoing reasons, is not in a
position to verify any such information or statements.
Pursuant to Rule 409 promulgated under the Securities Act and Rule 12b-21
promulgated under the Exchange Act, Holding Co. will request that the Company
and its independent public accountants provide to Holding Co. the information
required for complete disclosure concerning the business, operations,
financial condition and management of the Company. Holding Co. will provide
any and all information which it receives from the Company prior to the
expiration of the Offer and which Holding Co. deems material, reliable and
appropriate in a subsequently prepared amendment or supplement thereto and
will extend the Offer, in the manner set forth below under "The Offer--
Extension, Termination and Amendment," to ensure that five business days
remain for stockholders to determine whether to tender their Shares in the
Offer subsequent to the date of such amendment or supplement. An audit report
has been issued on the Company's year-end financial statements and is included
in the Company's public filings with the Commission. Holding Co. will request
the consent of the Company's independent public accountants to the inclusion
herein of the report of such independent public accountants on the financial
statements of the Company that are included or incorporated by reference
herein. However, the Company's independent public accountants have not granted
such consent to date. In the event such consent is ultimately obtained,
Holding Co. will promptly file such consent as an exhibit to the Registration
Statement of which this Prospectus is a part.
-----------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATION IN CONNECTION WITH THE OFFER OTHER THAN THOSE CONTAINED OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY HOLDING CO. OR BY THE DEALER MANAGER. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER OR A SOLICITATION TO ANY PERSON IN ANY JURISDICTION IN
WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL. THE OFFER IS NOT BEING MADE TO,
NOR WILL TENDERS BE ACCEPTED FROM OR ON BEHALF OF, HOLDERS OF SHARES IN ANY
JURISDICTION IN WHICH THE MAKING OR ACCEPTANCE THEREOF WOULD NOT BE IN
COMPLIANCE WITH THE LAWS OF SUCH JURISDICTION. HOWEVER, HOLDING CO. MAY, IN
ITS SOLE DISCRETION, TAKE SUCH ACTION, AS IT MAY DEEM NECESSARY TO MAKE THE
OFFER IN ANY SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY EXCHANGE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF HOLDING CO. OR THE COMPANY
SINCE THE DATE AS OF WHICH INFORMATION IS FURNISHED OR THE DATE HEREOF.
IN ANY JURISDICTION WHERE THE SECURITIES, BLUE SKY OR OTHER LAWS REQUIRE THE
OFFER TO BE MADE BY A LICENSED BROKER OR DEALER, THE OFFER SHALL BE DEEMED TO
BE MADE ON BEHALF OF HOLDING CO. BY SCHRODER & CO. INC., AS DEALER MANAGER, OR
ONE OR MORE OTHER REGISTERED BROKERS OR DEALERS LICENSED UNDER THE LAWS OF
SUCH JURISDICTION.
vi
<PAGE>
FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS CONTAINED IN THIS PROSPECTUS UNDER "SUMMARY," "REASONS
FOR THE OFFER," "BACKGROUND OF THE OFFER," AND "CERTAIN INFORMATION REGARDING
HOLDING CO.," IN ADDITION TO CERTAIN STATEMENTS CONTAINED ELSEWHERE IN THIS
PROSPECTUS OR INCORPORATED HEREIN BY REFERENCE, THAT ARE NOT STATEMENTS OF
HISTORICAL FACTS ARE PROSPECTIVE AND ARE THUS FORWARD-LOOKING STATEMENTS. SUCH
FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS REGARDING
HOLDING CO.'S OR THE COMPANY'S FUTURE FINANCIAL POSITION, RESULTS OF
OPERATIONS, BUSINESS STRATEGY (INCLUDING FUTURE DISPOSITIONS OF ASSETS AND
RESTRUCTURING OF OPERATIONS), BUDGETS, EXPECTED COST SAVINGS, PLANS AS TO
DIVIDENDS, AND PLANS AND OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS. SUCH
FORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS, UNCERTAINTIES AND OTHER
FACTORS WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM FUTURE
RESULTS EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. IMPORTANT
FACTORS ("CAUTIONARY STATEMENTS") THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THE INFORMATION SET FORTH IN ANY FORWARD-LOOKING STATEMENTS
ARE DISCLOSED UNDER "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. ALL
SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO HOLDING
CO. OR TO PERSONS ACTING ON ITS BEHALF ARE EXPRESSLY QUALIFIED IN THEIR
ENTIRETY BY THE CAUTIONARY STATEMENTS. HOLDING CO. WAS NOT INVOLVED IN THE
PREPARATION OF ANY FORWARD-LOOKING STATEMENTS RELATING TO THE COMPANY IN THIS
PROSPECTUS (INCLUDING THE ANNEXES HERETO) AND IS NOT IN A POSITION TO VERIFY
SUCH STATEMENTS AND TAKES NO RESPONSIBILITY THEREFOR.
vii
<PAGE>
PROSPECTUS SUMMARY
The information below is qualified in its entirety by the more detailed
information and financial statements appearing elsewhere in this Prospectus,
including the Annexes hereto. Stockholders are urged to read this Prospectus
and the attachments hereto in their entirety. As used in this Prospectus, the
terms "Holding Co." and the "Company" refer to AVC Holding Corp. and Advocat
Inc., respectively, and, unless the context otherwise requires, their
subsidiaries.
SUMMARY OF PROPOSED TRANSACTIONS
Holding Co. hereby offers to exchange $1.00 in cash and one share of Holding
Co. Common Stock (the "Consideration"), upon the terms and subject to the
conditions set forth herein and in the related Letter of Transmittal, for each
outstanding Share validly tendered on or prior to the Expiration Date and not
withdrawn. See "The Offer--General." Holding Co.'s obligation to exchange the
Consideration for Shares pursuant to the Offer is conditioned upon, among other
things, the satisfaction or, where permissible, waiver of each of the Offer
Conditions. See "The Offer--Conditions of the Offer." Holding Co. intends, as
promptly as practicable following consummation of the Offer, to cause a wholly-
owned subsidiary of Holding Co. to be merged with the Company and each Share
then outstanding will be converted into the right to receive the Consideration.
PARTIES INVOLVED
HOLDING CO. Holding Co. is a newly formed Delaware corporation organized for
the purpose of acquiring the Company as more fully set forth herein. Holding
Co.'s sole activities to date have been related to the Offer and the
transactions described herein. The principals of Holding Co. will include Essel
W. Bailey, Jr., Chairman, Francis J. Crosby, President and Chief Executive
Officer and John H. Stoddard, Executive Vice President and Chief Financial
Officer. See "Certain Information Regarding Holding Co.--Management" for
information regarding the directors and officers of Holding Co. in general and
Messrs. Bailey, Crosby and Stoddard in particular. Holding Co.'s mailing
address is 6600 Peachtree Dunwoody Road, 400 Embassy Row, Suite 410, Atlanta,
Georgia 30328 and its telephone number is (770) 668-0142.
THE COMPANY. The following information concerning the Company is based on the
Company's public filings with the Commission. See "Company Information." The
Company is a provider of long-term care services to the elderly. The Company
operates nursing homes and assisted living facilities in 11 states and in two
Canadian provinces. As of June 30, 1998, the Company operates 116 facilities
consisting of 64 nursing homes with 7,221 licensed beds and 52 assisted living
facilities with 4,980 units. The Company owns seven nursing homes, leases 37
others and manages 20 nursing homes. The Company owns 18 assisted living
facilities, leases 22 others and manages 12 assisted living facilities. The
Company operates facilities in Alabama, Arkansas, Florida, Georgia, Kentucky,
North Carolina, Ohio, South Carolina, Tennessee, Texas, West Virginia and the
Canadian provinces of Ontario and British Columbia. The Company's principal
executive offices are located at 277 Mallory Station Road, Suite 130, Franklin,
Tennessee 37067. The Company's telephone number at that address is (615) 771-
7575.
ESSEX HEALTHCARE CORPORATION. Essex Healthcare Corporation ("Essex") is a
Delaware company organized for the purpose of owning and operating nursing
homes. It was formed in August 1997 and is owned by Messrs. Crosby and
Stoddard, W. Blaine Sheffield and Omega Worldwide, Inc. ("OWWI"). Essex
operates 13 facilities in Ohio consisting of 1,323 licensed nursing home beds
and 75 assisted living units. Each of the Essex facilities in Ohio provides a
broad range of long-term care services and assisted living services to facility
residents. All of the properties are licensed providers in both the Medicare
and Medicaid programs.
1
<PAGE>
ATRIUM LIVING CENTERS, INC. Atrium Living Centers ("Atrium") is a wholly-
owned subsidiary of Essex, incorporated in Delaware in August 1997. Atrium
provides management services to the 13 Essex properties as well as 26 long-term
care facilities in Indiana and two facilities in Illinois. Both Essex and
Atrium maintain offices at 6600 Peachtree Dunwoody Road, 400 Embassy Row, Suite
410, Atlanta, Georgia 30328.
OMEGA WORLDWIDE, INC. OWWI provides investment advisory and management
services and holds equity and debt interests in companies engaged in providing
sale/leaseback and other capital financing to healthcare service providers
throughout the world. OWWI uses its extensive resources to identify, develop
and structure attractive opportunities to invest in healthcare real estate
ownership and finance on a global basis. OWWI's common stock is traded on the
Nasdaq National Market under the symbol "OWWI." OWWI also coordinates and
integrates its investment activity with Omega Healthcare Investors, Inc.
("OHI") so as to take advantage of investment opportunities which would not be
suitable for OHI due to its real estate investment trust ("REIT") status. OWWI
holds approximately 48% of the outstanding Essex common stock.
OMEGA HEALTHCARE INVESTORS, INC. OHI is a self-administered REIT which
invests primarily in income-producing healthcare facilities, principally long-
term care facilities located in the United States. OHI's common stock is traded
on the NYSE under the symbol "OHI." As of June 30, 1998, OHI's portfolio of
domestic investments consisted of 271 long-term care facilities, three medical
office buildings and two rehabilitation hospitals. OHI owns and leases 189
long-term facilities, three medical office buildings and two rehabilitation
hospitals and provides mortgages, including participating and convertible
participating mortgages, on 82 long-term healthcare facilities. The facilities
are located in 28 states and operated by 29 unaffiliated operators. OHI's gross
real estate investments at June 30, 1998 totaled $903.5 million. OHI holds
approximately 9% of the outstanding OWWI common stock.
OVERVIEW OF EVENTS CULMINATING IN THE OFFER
Since early February, Messrs. Essel W. Bailey, Jr. and Francis J. Crosby held
several meetings with Charles W. Birkett, M.D., Chairman of the Board of
Directors, Chief Executive Officer, President and Chief Operating Officer of
the Company, for the purpose of discussing various strategic proposals
including:
(i) a business combination of the Company and Essex in which the
stockholders of Essex would have received Shares of the Company, with a
concurrent $20.0 million to $40.0 million capital infusion by OWWI in
exchange for convertible debentures and equity issued by the Company; or
(ii) a leveraged recapitalization of the Company in which approximately 90%
of the Shares would have been repurchased for $11.00 per Share in cash
from the proceeds of an equity investment and other financing provided
by OWWI followed by a merger with Essex.
In conjunction with each of these transactions, it was proposed that OWWI and
Essex be granted the right to designate a majority of the Company's board of
directors in view of the amount of capital to be contributed to the Company or
Shares to be received in connection with a business combination. In either
transaction, it was proposed that Mr. Crosby would have been named Chief
Executive Officer and the management team of Essex would have been given senior
roles in the Company, while retaining the services of the existing management
team at its election.
2
<PAGE>
Every proposal suggested by Messrs. Crosby and Bailey was rejected--initially
by Dr. Birkett and, ultimately, on or about May 15, 1998, by the Company's
Board of Directors. As a result of the Company's repeated rejections of these
proposals and the Company's continuing operational and financial challenges,
Holding Co. has filed a Registration Statement with the Commission (which
includes this Prospectus) to provide the Company's stockholders an opportunity
to evaluate and, if appropriate, take action to obtain the benefits of the
Transactions. See "Background of the Offer."
BENEFITS OF THE TRANSACTIONS
Holding Co. believes that the benefits of the Transactions include the
following:
. IMMEDIATE CAPITAL INFUSION. As part of the proposed transaction, OWWI or
other investors identified by OWWI will provide Holding Co. up to $20.0
million of convertible subordinated debt financing, the proceeds of
which would be used to:
(i) partly repay and refinance the maturing $34.1 million Pierce
Acquisition bridge loan; see "Risk Factors--Ability to Pay Debt
Due in 1999";
(ii) partly repay and refinance the Company's $11.25 million working
capital line, which was fully drawn (including the $1.25 million
temporary "overline" increase) as of August 12, 1998;
(iii) finance capital expenditures for which the Company currently
lacks the needed funds; and
(iv) fund severance payments under existing employment agreements and
fees and expenses related to the Transactions.
. ENHANCED MANAGEMENT TEAM AND BOARD OF DIRECTORS. The depth and
capabilities of the Company's management team and Board of Directors
would be significantly augmented by the experienced Atrium management
team as well as by directors provided by OWWI with established track
records for creating stockholder value.
. STRATEGIC RELATIONSHIP. The proposed transaction would serve to
establish a strategic relationship with OWWI that would provide the
Company with access to, and disciplined financial and strategic analysis
of, potential acquisition, growth and financing opportunities not
otherwise available to the Company.
. GROWTH STRATEGY. Once recapitalized and the proposed management changes
have been instituted, the Company will be positioned as a viable
platform to participate actively in the on-going consolidation of the
long-term care industry.
MANAGEMENT FOLLOWING THE TRANSACTIONS
In connection with the Transactions, Holding Co. intends to enter into a
three-year management agreement (the "Management Agreement") with Atrium
pursuant to which Atrium will provide certain "central office" management
services to Holding Co. and the Company. The management services to be provided
to the Company would include strategic planning, executive leadership,
supervision of regional personnel and operations, and enterprise level (in
contrast to facility level) functions such as accounting, data processing,
investor relations, billing and accounts receivable monitoring. The Management
Agreement must be approved by a majority of the directors who do not serve as
officers or employees of Holding Co. or its subsidiaries and are not affiliates
or associates of Atrium, OWWI or OHI (the "Independent Directors").
It is contemplated that the management fee (the "Management Fee") payable to
Atrium during the first year under the Management Agreement will approximate
and be limited to the Company's current general and administrative expense run
rate. Thereafter, Atrium will receive a management fee equal to 6% of the
Company's revenues plus, if approved by the Independent Directors, performance-
related
3
<PAGE>
incentive fees to be negotiated. To the extent the Company is sold to a third
party during the term of the Management Agreement, Atrium will be entitled to a
one-time formula-based termination fee not to exceed $5.0 million. The
Management Agreement may be amended by the Independent Directors to include
additional functions and responsibilities and services to be provided pursuant
to the Management Agreement. See "Certain Information Regarding Holding Co.--
Management."
FINANCING COMMITMENTS
EQUITY FINANCING. In connection with the Transactions, OWWI has agreed to
purchase (the "Equity Financing") up to 819,476 newly issued shares of Holding
Co. Common Stock at a purchase price of $6.59 per share upon Holding Co.'s
acceptance of Shares tendered for exchange pursuant to the Offer. The purchase
price for the Holding Co. Common Stock equals the average closing sale price
for the Shares as reported on the NYSE Composite Tape for the 20 trading days
immediately preceding August 27, 1998, the filing date of the Registration
Statement of which this Prospectus is a part. See "Financing Commitments.
CONVERTIBLE DEBT FINANCING. In addition, OWWI has committed to purchase (the
"Convertible Financing") up to $5.0 million of convertible subordinated
debentures of the Company (the "Debentures") at the option of the Independent
Directors. Such commitment has been provided without any commitment fee or fees
for acceptance. Prior to commencing the Offer, Holding Co. will obtain
commitments for at least an additional $15.0 million of Convertible Financing
from OWWI or other investors identified by OWWI. Holding Co. and OWWI are
highly confident that such additional commitments will be obtained. See
"Financing Commitments." The terms of the Debentures must be approved by the
Independent Directors, but are expected to provide as follows:
ISSUE PRICE: 100% of principal amount.
DRAW ON COMMITMENT: Issuable at the option of the Independent Directors
at any time until the second anniversary of the
consummation of the Transactions.
INTEREST: 7% per annum, payable semi-annually in arrears.
MATURITY: Seventh anniversary of issuance.
CONVERSION: Convertible into Holding Co. Common Stock at a
conversion price of $8.07 per share, representing a
22.5% premium over the purchase price to be paid by
OWWI in the Equity Financing.
REDEMPTION: Non-redeemable until the third anniversary of
issuance. Thereafter, redeemable at the option of
Holding Co. at any time, in whole or in part at the
redemption price of 103% of face amount, together
with accrued and unpaid interest, and declining
annually thereafter as set forth herein.
RANKING: Subordinated to all Senior Indebtedness and pari
passu with all existing subordinated indebtedness.
4
<PAGE>
USE OF PROCEEDS: The proceeds of the Convertible Financing will be
used to:
(i) partly repay and refinance the maturing $34.1
million Pierce Acquisition bridge loan; see
"Risk Factors--Ability to Pay Debt Due in
1999";
(ii) partly repay and refinance the Company's
$11.25 million working capital line, which
was fully drawn (including the $1.25 million
temporary "overline" increase) as of August
12, 1998;
(iii) finance capital expenditures for which the
Company currently lacks the needed funds;
(iv) fund severance payments under existing
employment agreements and fees and expenses
related to the Transactions; and
(v) as otherwise determined to be appropriate by
the Independent Directors.
RISK FACTORS
See "Risk Factors" beginning on page 11 for a discussion of certain factors
that should be considered by stockholders in deciding whether to tender their
Shares to Holding Co. pursuant to the Offer, including both risk factors
relating to the Transactions as well as existing risks relating to the
Company's business and operations that will continue following the completion
of the Transactions.
THE OFFER
GENERAL. Holding Co. hereby offers, upon the terms and subject to the
conditions set forth herein and in the related Letter of Transmittal, to
exchange the Consideration for each outstanding Share validly tendered on or
prior to the Expiration Date (as defined below) and not withdrawn. The
Consideration consists of $1.00 in cash and one share of Holding Co. Common
Stock. The term "Expiration Date" shall mean 12:00 midnight, New York City
time, on September , 1998, unless and until Holding Co. extends the period of
time for which the Offer is open, in which event the term "Expiration Date"
shall mean the latest time and date at which the Offer, as so extended by
Holding Co., shall expire. See "The Offer--General."
RIGHTS. Stockholders will be required to tender one Right for each Share
tendered in order to effect a valid tender of Shares, unless the Rights Plan
Condition has been satisfied or waived. Unless the Distribution Date (as
defined in the Rights Agreement) occurs, a tender of Shares will constitute a
tender of the associated Rights. See "The Offer--The Rights."
CONDITIONS OF THE OFFER. Holding Co.'s obligation to exchange the
Consideration for Shares pursuant to the Offer is conditioned upon, among other
things, the satisfaction or, where permissible, waiver of each of the Offer
Conditions. See "The Offer--Conditions of the Offer." Subject to the applicable
rules and regulations of the Commission, Holding Co. expressly reserves the
right, in its sole discretion, at any time or from time to time, to delay
acceptance for exchange of, or, regardless of whether such Shares were
theretofore accepted for exchange, exchange any Shares pursuant to the Offer or
to amend or terminate the Offer and not accept for exchange or exchange any
Shares not theretofore accepted for exchange or exchanged upon the failure of
any of the Offer Conditions to be satisfied. Holding Co. reserves the absolute
right to waive any defect or irregularity in the tender of any Shares and to
waive any of the Offer Conditions (other than the condition related to the
effectiveness of the Registration Statement). Although Holding Co. reserves the
right to do so, Holding Co. does not currently intend to waive the Minimum
Tender Condition, the Rights Plan Condition or the Business Combination Statute
Condition. See "The Offer--Conditions of the Offer." Waiver or amendment of
certain conditions of the Offer may require an extension of the Offer.
5
<PAGE>
REGULATORY APPROVALS. The Transactions may be subject to various local,
state, U.S. federal, and Canadian provincial and federal requirements for
notice and/or review of the transaction, or the post-transaction review of the
operations, health care facilities and business of the Company. See "The
Offer--Regulatory Matters."
TIMING OF THE OFFER. The Offer is currently scheduled to expire at 12:00
midnight New York City time on September , 1998; however, it is Holding Co.'s
current intention to extend the Offer from time to time as necessary until all
conditions to the Offer have been satisfied or waived. See "The Offer--
Extension, Termination and Amendment" and "--Conditions of the Offer."
EXTENSION, TERMINATION AND AMENDMENT. Holding Co. expressly reserves the
right (but will not be obligated), in its sole discretion, at any time or from
time to time, and regardless of whether any of the events set forth in "The
Offer--Conditions of the Offer" shall have occurred or shall have been
determined by Holding Co. to have occurred, (i) to extend the period of time
during which the Offer is to remain open by giving oral or written notice of
such extension to the Exchange Agent, which extension will be announced no
later than 9:00 a.m., Eastern Time, on the next business day after the
previously scheduled Expiration Date, and (ii) to amend the Offer in any
respect (including, without limitation, by decreasing or increasing the
Consideration offered in the Offer to holders of Shares and/or by increasing or
decreasing the number of Shares being sought in the Offer) by giving oral or
written notice of such amendment to the Exchange Agent. The rights reserved by
Holding Co. in this paragraph are in addition to Holding Co.'s right to
terminate the Offer as described in "The Offer--Extension, Termination and
Amendment." There can be no assurance that Holding Co. will exercise its right
to extend the Offer. However, it is Holding Co.'s current intention to extend
the Offer until all Offer Conditions have been satisfied or waived. See "The
Offer--Extension, Termination and Amendment." During any such extension, all
Shares previously tendered and not withdrawn will remain subject to the Offer,
subject to the right of a tendering stockholder to withdraw his or her Shares.
See "The Offer--Withdrawal Rights."
EXCHANGE OF SHARES; DELIVERY OF HOLDING CO. COMMON STOCK AND CASH
CONSIDERATION. Upon the terms and subject to the conditions of the Offer
(including, if the Offer is extended or amended, the terms and conditions of
any such extension or amendment), Holding Co. will accept for exchange, and
will exchange, Shares validly tendered and not properly withdrawn as promptly
as practicable following the Expiration Date. See "The Offer--Exchange of
Shares; Delivery of Holding Co. Common Stock and Cash Consideration."
WITHDRAWAL RIGHTS. Tenders of Shares made pursuant to the Offer are
irrevocable, except that Shares tendered pursuant to the Offer may be withdrawn
at any time prior to the Expiration Date, and, unless theretofore accepted for
exchange and exchanged by Holding Co. for the Consideration pursuant to the
Offer, may also be withdrawn at any time after , 1998. See "The Offer--
Withdrawal Rights."
PROCEDURE FOR TENDERING SHARES. For a stockholder validly to tender Shares
pursuant to the Offer: (i) a properly completed and duly executed letter of
transmittal ("Letter of Transmittal") (or manually executed facsimile thereof),
together with any required signature guarantees, or an Agent's Message (as
defined herein) in connection with a book-entry transfer, and any other
required documents, must be transmitted to and received by the Exchange Agent
at one of its addresses set forth on the back cover of this Prospectus, and
either certificates for tendered Shares must be received by the Exchange Agent
at such address or such Shares must be tendered pursuant to the procedures for
book-entry transfer set forth under "The Offer--Procedure for Tendering" (and a
confirmation of receipt of such tender received), in each case, prior to the
Expiration Date; or (ii) such stockholder
6
<PAGE>
must comply with the guaranteed delivery procedure set forth under "The Offer--
Procedure for Tendering." Stockholders will be required to tender one Right for
each Share tendered in order to effect a valid tender of Shares, unless the
Rights Plan Condition has been satisfied or waived. Unless the Distribution
Date occurs, a tender of Shares will constitute a tender of the associated
Rights.
THE METHOD OF DELIVERY OF SHARE CERTIFICATES (AND RIGHTS CERTIFICATES, IF
APPLICABLE) AND ALL OTHER REQUIRED DOCUMENTS, INCLUDING DELIVERY THROUGH THE
BOOK-ENTRY TRANSFER FACILITY, IS AT THE OPTION AND RISK OF THE TENDERING
STOCKHOLDER, AND THE DELIVERY WILL BE DEEMED MADE ONLY WHEN ACTUALLY RECEIVED
BY THE EXCHANGE AGENT. IF DELIVERY IS BY MAIL, REGISTERED MAIL WITH RETURN
RECEIPT REQUESTED, PROPERLY INSURED, IS RECOMMENDED. IN ALL CASES, SUFFICIENT
TIME SHOULD BE ALLOWED TO ENSURE TIMELY DELIVERY.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The exchange of Shares for Holding Co. Common Stock and cash pursuant to the
Offer and the Merger will be a taxable transaction for U.S. federal income tax
purposes and may also be taxable under applicable state, local and foreign tax
laws. If the Board of Directors of the Company agrees to discuss a business
combination with Holding Co., the Offer and the Merger may be restructured to
be a partially tax-free merger for U.S. federal income tax purposes. ALL
COMPANY STOCKHOLDERS SHOULD CAREFULLY READ THE SUMMARY OF THE FEDERAL INCOME
TAX CONSEQUENCES OF THE OFFER AND THE MERGER UNDER "THE OFFER--CERTAIN FEDERAL
INCOME TAX CONSEQUENCES" AND ARE URGED TO CONSULT WITH THEIR OWN TAX ADVISORS
AS TO THE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES IN THEIR
PARTICULAR CIRCUMSTANCES.
EFFECT OF OFFER ON MARKET FOR SHARES
Prior to the Merger, the exchange of Shares for Holding Co. Common Stock
pursuant to the Offer will reduce the number of holders of Shares and the
number of Shares that might otherwise trade publicly and could adversely affect
the liquidity and market value of the remaining Shares held by stockholders who
do not exchange their Shares for Holding Co. Common Stock. Following the
acceptance of Shares tendered for exchange in the Offer and the Merger,
stockholders of the Company who tender their Shares for exchange will receive
in exchange therefor shares of Holding Co. Common Stock, which Holding Co.
expects to possess liquidity similar to the current liquidity of the Shares of
the Company, although no such assurance can be given. The consummation of the
Offer is conditioned upon the listing of the Holding Co. Common Stock on the
NYSE or other national securities exchange, or the Nasdaq Stock Market.
The Shares are listed on the NYSE. Depending on the number of Shares acquired
pursuant to the Offer, following consummation of the Offer, the Shares may no
longer meet the requirements of the NYSE for continued listing, and the Shares
may no longer constitute "margin securities" for purposes of the Federal
Reserve Board's margin regulations. In such event, Shares held by stockholders
who do not exchange their Shares for Holding Co. Common Stock could no longer
be used as collateral for margin loans made by brokers. See "The Offer--Effect
of Offer on Market for Shares; Registration under the Exchange Act."
DISSENTERS' RIGHTS
Holders of Shares do not have dissenters' rights as a result of the Offer
and, assuming the Shares remain listed on the NYSE or a similar market, will
not have dissenters' rights as a result of the Merger. However, in the event
the Merger is consummated and, if, on the date fixed to determine stockholders
entitled to vote on the Merger, the Shares are no longer listed on the NYSE,
other national securities exchange or the Nasdaq Stock Market or similar
market, holders of Shares will have certain rights
7
<PAGE>
pursuant to the provisions of Section 262 of the Delaware General Corporation
Law ("DGCL") to dissent and demand appraisal of their Shares. See "The Merger--
Dissenters' Rights."
COMPARISON OF STOCKHOLDER RIGHTS
As a consequence of the exchange of Shares for shares of Holding Co. Common
Stock in the Offer and the Merger, stockholders of the Company will become
stockholders of Holding Co. and their rights will be governed by Holding Co.'s
Certificate of Incorporation ("Holding Co.'s Certificate of Incorporation") and
Bylaws. Holding Co. intends for the material legal rights and characteristics
of the Holding Co. Common Stock to be identical to the greatest extent possible
to the existing legal rights and characteristics of the Shares of the Company,
except that Holding Co. has no present intention to implement a so-called
"poison pill" stockholder rights plan such as the plan contained in the
Company's Rights Agreement. Accordingly, Holding Co.'s Certificate of
Incorporation will be amended and restated prior to the consummation of the
Offer and the Merger into forms which are substantially similar in all material
respects to the Company's Certificate of Incorporation, as amended (the
"Company's Certificate of Incorporation"), and Bylaws. See "Description of
Holding Co. Capital Stock; Comparison of Stockholder Rights."
THE EXCHANGE AGENT
has been appointed exchange agent (the "Exchange Agent") in
connection with the Offer. The Letter of Transmittal (or facsimile copies
thereof) and certificates for Shares should be sent by each tendering
stockholder of Shares or his or her broker, dealer, bank or other nominee to
the Exchange Agent at one of the addresses set forth on the back cover of this
Prospectus.
REQUESTS FOR ASSISTANCE AND ADDITIONAL COPIES
Requests for information or assistance concerning the Offer may be directed
to the Dealer Manager or the Information Agent at their respective addresses
set forth on the back cover of this Prospectus. Requests for additional copies
of this Prospectus and the Letter of Transmittal should be directed to the
Information Agent.
8
<PAGE>
MARKET PRICES AND DIVIDENDS
The Shares are listed and principally traded on the NYSE (under the symbol
"AVC"). The following table sets forth, for the periods indicated, the high and
low sale prices per Share as reported on the NYSE Composite Tape.
<TABLE>
<CAPTION>
COMPANY SHARES
-----------------
HIGH LOW
-------- --------
<S> <C> <C>
1994
Second Quarter (from May 10, 1994)......................... $ 9.8750 $ 8.5000
Third Quarter.............................................. 11.3750 8.3750
Fourth Quarter............................................. 13.1250 10.0000
1995
First Quarter.............................................. 13.8750 11.3750
Second Quarter............................................. 12.6250 10.8750
Third Quarter.............................................. 13.0000 10.5000
Fourth Quarter............................................. 12.1250 9.5000
1996
First Quarter.............................................. 13.0000 9.3750
Second Quarter............................................. 11.1250 9.0000
Third Quarter.............................................. 10.0000 8.0000
Fourth Quarter............................................. 8.1250 6.0000
1997
First Quarter.............................................. 9.7500 7.3750
Second Quarter............................................. 11.3750 8.8750
Third Quarter.............................................. 12.3750 11.1250
Fourth Quarter............................................. 12.8750 7.5000
1998
First Quarter.............................................. 10.1250 7.7500
Second Quarter............................................. 10.1250 6.0625
Third Quarter (through August 26, 1998).................... 7.625 5.6250
</TABLE>
On August 26, 1998, the last full trading day prior to the filing of the
Registration Statement of which this Prospectus is a part, the reported high
and low sale prices and closing price per Share on the NYSE Composite Tape were
$7.5000, $7.1250 and $7.1875 respectively. The Company has not paid dividends
on the Shares.
On , 1998, the date of this Prospectus, the reported high and low sale
prices and closing price per Share on the NYSE Composite Tape were $ , $
and $ respectively.
STOCKHOLDERS ARE URGED TO OBTAIN CURRENT MARKET QUOTATIONS FOR THE SHARES.
9
<PAGE>
PER SHARE DATA
(UNAUDITED)
The following table sets forth certain historical and pro forma combined per
share data, giving effect to the Transactions on a reverse acquisition basis as
more fully described in the notes to the Pro Forma Condensed Consolidated
Financial Statements of the Company. The data should be read in conjunction
with the selected historical consolidated financial statements of the Company
and Holding Co. and notes thereto included within this Prospectus and in the
Annexes attached hereto. The pro forma condensed consolidated financial data is
not necessarily indicative of the operating results that would be achieved had
the Transactions been completed at the beginning of the periods presented and
should not be considered indicative of future operations.
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA COMBINED
-------------------------- --------------------------
YEAR ENDED SIX MONTHS YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED DECEMBER 31, ENDED
1997 JUNE 30, 1998 1997 JUNE 30, 1998
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
COMPANY PER SHARE DATA
Net income (loss) from
continuing
operations(1)
Basic................. $.56 $(.06) $.45 $ .14
Diluted............... .56 (.06) .45 .14
Book value at period
end(2)................. 5.72 5.68 4.15 4.12
</TABLE>
Holding Co. was incorporated under the laws of the State of Delaware on
August 18, 1998 for the purpose of acquiring the Company as more fully
described herein. As a result, per share information for Holding Co. with
respect to prior periods is not applicable.
- ----------
(1) The increase in the earnings per share data on a pro forma basis for the
six months ended June 30, 1998 as compared to historical six months ended
June 30, 1998 is attributable primarily to the elimination of the $1.5
million charge (classified by the Company as non-recurring) from the pro
forma presentation. Without the elimination of such charge, the pro forma
earnings per share for the six months ended June 30, 1998 would be $(.02)
on a basic and diluted basis.
(2) The reduction in pro forma book value per share is attributable to the
increase in shares outstanding, primarily as a result of the Equity
Financing, and a decrease in stockholder equity of approximately $5.4
million as a result of the payment of the $1.00 cash component of the
Consideration.
10
<PAGE>
RISK FACTORS
In addition to the other information in this Prospectus, the following are
certain factors that should be considered by holders of Shares in evaluating
the Offer and exchanging Shares for Holding Co. Common Stock.
RISKS RELATED TO BUSINESS OF THE COMPANY AND, FOLLOWING THE TRANSACTIONS,
HOLDING CO.
The following factors are existing risks to stockholders of the Company
relating to the Company's current business or the long-term care industry
generally, regardless of whether the Transactions are completed.
REGULATORY ISSUES. The Company's 1997 operating results were profoundly
affected by regulatory issues in the State of Alabama. During the summer of
1997, the Company received separate notifications from the State that, as a
result of certain deficiencies noted upon periodic surveys of its two
facilities in Mobile, the facilities would be decertified from participation
in the Medicare and Medicaid programs and that licensure revocation could be
pursued. The Company appealed the proceedings, noting that none of the
deficiencies were life-threatening, that the deficiencies noted did not
warrant the penalty imposed and that in the case of one of the facilities, it
was JCAHO accredited. The appeals were denied by the State agency, and as a
result, the facilities were decertified for 69 and 91 days, respectively,
before resurveys found them to be in compliance. Both of the facilities have
been recertified for participation in the Medicare and Medicaid programs.
Through June 30, 1998, the decertified facilities had only recovered
approximately two-thirds of the occupancy decline experienced in the
decertification. The Company previously announced that it expected the Alabama
operations to return to normal levels during the latter half of 1998. However,
there can be no assurance that either of the facilities will return to the
census and profitability levels experienced prior to the decertifications. See
"Item 1.--Business--Material Corporate Developments--Regulatory Issues" in the
Company's 1997 Form 10-K attached hereto as Annex A and "Item 2--Management's
Discussion and Analysis of Financial Condition and Results of Operations--
General--Regulatory Issues" in the Company's Second Quarter Form 10-Q attached
hereto as Annex D.
ABILITY TO PAY DEBT DUE IN 1999. The Company is obligated to make principal
payments of approximately $50 million in 1998 and 1999, including $34.1
million in or prior to July 1999 to repay the promissory note (the "Pierce
Bridge Loan") issued in connection with the acquisition or lease of 29
assisted living facilities from members or affiliates of Pierce Management
Group ("Pierce")(*). As of August 12, 1998, the Company had drawn the entire
balance available under both its $10.0 million working capital line of credit
(due December 1999) and $1.25 million "overline" increase in its working
capital line of credit (due January 15, 1999). Effective August 14, 1998, the
deadline for the filing of the Company's Second Quarter Form 10-Q, the Company
obtained an increase in its "overline" to $4.0 million. See "Item 2--
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" in the Company's Second Quarter
Form 10-Q. The Company has disclosed that it has a commitment of up to $30.0
million of long-term financing, although this commitment may not be drawn upon
so long as the $34.1 million Pierce Bridge Loan is outstanding. See "Item 1.--
Business--Material Corporate Development--Acquisitions and Related
Indebtedness" in the Company's 1997 Form 10-K attached hereto as Annex A. In
connection with the Transactions, OWWI is prepared to provide a capital
infusion to assist the Company in meeting its 1999 obligations if the proposed
terms of such financing are approved by the Independent Directors. See
"Financing Commitments." Although Holding Co. believes that the financing to
be provided by OWWI together with the other benefits the Transactions will
enhance the Company's efforts to obtain
- ----------
(*) The Pierce Bridge Loan was initially scheduled to mature January 1, 1999.
The Company's Second Quarter Form 10-Q states that the maturity of the
Pierce Bridge Loan was extended to July 1999. However, the exhibits filed
with the Company's Second Quarter Form 10-Q only provide for an extension
to APRIL 1, 1999.
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additional financing to refinance or repay its remaining indebtedness at or
prior to the maturity thereof, there can be no assurance that Holding Co. or
the Company will be able to obtain the required additional financing or, if
available, the terms thereof. See "Financing Commitments." THE COMPANY'S
PUBLIC FILINGS FAIL TO DEMONSTRATE SUFFICIENT CAPITAL RESOURCES TO FUND ITS
DEBT MATURING IN 1999 AS WELL AS ITS ANTICIPATED CAPITAL EXPENDITURES FOR
1998. IN THE EVENT THE TRANSACTIONS ARE NOT COMPLETED, HOLDING CO. BELIEVES
THE COMPANY MAY BE REQUIRED TO SEEK ADDITIONAL FINANCING FROM SOURCES THAT
HAVE NOT BEEN PUBLICLY IDENTIFIED.
GOVERNMENT REGULATION. As a lessee and manager of nursing homes and
retirement centers, the Company is, and after the consummation of the
Transactions, Holding Co. will be, subject to extensive U.S. federal, state
and local regulation and Canadian provincial regulation. In particular, the
operation of long-term care facilities and the provision of health care
services are subject to federal, state and local laws and Canadian provincial
laws relating to the adequacy of medical care, resident rights, equipment,
personnel, distribution of pharmaceuticals, operating policies, fire
prevention, rate-setting and compliance with building codes and environmental
and other laws. The facilities operated by the Company and, after the
consummation of the Transactions, by Holding Co., are subject to periodic
inspection and surveys by governmental and other regulatory authorities to
assure continued compliance with various standards and conditions of
participation and to provide for their continued licensing under state law and
certification under and participation in the Medicare and Medicaid programs
and participation in the Veterans Administration Program and other third party
payor arrangements. In the past, from time to time such facilities have
received statements of deficiencies from regulatory agencies and, in 1997, two
facilities in Mobile, Alabama, operated by the Company were decertified from
participation in the Medicare and Alabama Medicaid programs for 69 days and 91
days, respectively. Should the Company or Holding Co. receive any such
statements of deficiency after the consummation of the Transactions, Holding
Co. expects to implement plans of correction with respect to any such
statement to address any alleged deficiencies. While Holding Co. will endeavor
to comply with federal, state and local regulatory requirements for the
maintenance and operation of the Company's facilities if the Transactions are
completed, there can be no assurance that all facilities would always be
operated in full compliance with such requirements. The failure to obtain or
renew any required regulatory approvals, licenses or certifications could have
a materially adverse affect on the Company's and, after the consummation of
the Transactions, Holding Co.'s operations.
The Company is, and after the consummation of the Transactions, the Holding
Co. will be, subject to federal and state laws that govern financial and other
arrangements between health care providers. These laws prohibit certain direct
and indirect payments or fee-splitting arrangements between health care
providers that are designed to induce or encourage the referral of patients
to, or the recommendation of, a particular provider for medical products and
services. Such laws include the anti-kickback provisions of the federal
Medicare and Medicaid Patient and Program Protection Act of 1987 (the "Anti-
Kickback Law") and the expanded physician self-referral provisions of the
Omnibus Budget Reconciliation Act of 1993 (commonly referred to as "Stark
II"). The Anti-Kickback Law prohibits, among other things, the offer, payment,
solicitation or receipt of any form of remuneration in return for the
referral, or for arranging for the referral, of items or services paid for by
Medicare and Medicaid or other federal health care programs. Violation of this
statute is a felony punishable by up to five years imprisonment and/or $25,000
per violation in fines. In addition, violators are subject to civil money
penalties and exclusion from the Medicare, Medicaid and other federal health
care programs. Stark II prohibits, with limited exceptions, physicians from
making any Medicare or Medicaid referrals for certain "designated health
services" to any entity with which the physician has a "financial
relationship." Further, under some state laws there are prohibitions similar
to those found in the Anti-Kickback Law and Stark II. In addition to these
anti-kickback and self-referral prohibitions, there are various federal and
state laws prohibiting other types of fraud by health care providers,
including criminal provisions which prohibit filing false claims or making
false statements to receive payment or
12
<PAGE>
certification under Medicare or Medicaid. Civil provisions prohibit the
knowing filing of a false claim or the knowing use of false statements to
obtain payment; the penalties for a violation are fines of not less than
$5,000 nor more than $10,000 per violation, plus treble damages, for each
claim filed. These false claims statutes include the Federal False Claims Act,
which allows any person to bring a suit, known as a qui tam action, alleging
false or fraudulent Medicare and Medicaid claims or other violations of the
statute and to share in any amounts paid by the entity to the government in
fines or settlement. State and federal governments are devoting increasing
attention and resources to anti-fraud initiatives against healthcare
providers. The Health Insurance Portability and Accountability Act of 1996
(the "Accountability Act") and the Balanced Budget Act of 1997 (the "Balanced
Budget Act") expanded the scope and penalties for health care fraud, including
broader provisions for the exclusion of providers from the Medicare, Medicaid
and other federal health care programs.
Additionally, the Accountability Act granted expanded enforcement authority
to the U.S. Department of Health and Human Services ("HHS") and the U.S.
Department of Justice ("DOJ"), and provided enhanced resources to support the
activities and responsibilities of the Office of Inspector General ("OIG") and
DOJ. The Balanced Budget Act also includes numerous healthcare anti-fraud
provisions, including new civil monetary penalties for contracting with an
excluded provider; new surety bond and information disclosure requirements for
certain providers and supporters; expansion of the mandatory and permissive
exclusions added by the Accountability Act to any federal health care program
(other than the Federal Employees Health Benefits Program); and an expansion
to the ability of individuals to bring qui tam actions against health care
providers. In addition, many states have similar fraud and abuse provisions
and other laws that prohibit business corporations from providing, or holding
themselves out as providers of, medical care. These laws vary from state to
state and have seldom been interpreted by the courts or regulatory agencies.
There can be no assurance that substantial amounts will not be expended in
connection with the investigation or defense of any such matters, that
aggressive anti-fraud enforcement action will not adversely affect the
business of the Company and, after consummation of the Transactions, Holding
Co., or that federal and state fraud and abuse laws will ultimately be
interpreted in a matter consistent with the practices of, and business
transactions by the Company and, after consummation of the Transactions,
Holding Co. If the Company, and after consummation of the Transactions,
Holding Co. is found to be, or have been, in violation of any of the
aforementioned laws, criminal penalties, civil money penalties, and exclusion
from the Medicare, Medicaid and other federal health care programs could be
imposed, any of which could have a material adverse effect on the Company and,
after consummation of the Transactions, Holding Co.
Privately owned nursing homes in Ontario are licensed by the Ministry of
Health under the Ontario Nursing Home Act. This legislation, together with
program manuals, establishes the minimum standards that are required to be
provided to the patients of the home, including staffing, space, nutrition and
activities. Patients can only be admitted and subsidized if they require at
least 1 1/2 hours per day of care, as determined by a physician. Retirement
centers in Canada are generally regulated at the municipal government level in
the areas of fire safety and public health and at the provincial level in the
areas of employee safety, pay equity, and, in Ontario, rent control.
The Ontario Government Operating Subsidy program ("OGOS") regulates both the
total charges allowed to be levied by a licensed nursing home and the maximum
amount that the OGOS program will pay on behalf of nursing home residents. The
maximum amounts that can be charged to residents for ward, semi-private and
private accommodation are established each year by the Ontario Ministry of
Health. Regardless of actual accommodation, at least 40% of the beds in each
home must be filled at the ward rate. Generally, amounts received from
residents should be sufficient to cover the accommodation costs of a nursing
home, including food, laundry, housekeeping, property costs and
13
<PAGE>
administration. In addition, the Ontario government partially subsidizes each
individual, and funds each nursing home for the approximate care requirements
of its residents. This funding is based upon an annual assessment of the
levels of care required in each home, from which "caps" are determined and
funding provided on a retrospective basis. The Ontario government funds from
35% to 70% of a resident's charges, depending on the individual resident's
income and type of accommodation. The Company received payment directly from
OGOS by virtue of its ownership of two nursing homes in Canada. Additionally,
the Company earns management fees from Canadian nursing homes, which derive
significant portions of their revenues from OGOS. See "Item 1.--Business--
Government Regulation and Reimbursement" in the Company's 1997 Form 10-K
attached hereto as Annex A.
UNCERTAINTY ASSOCIATED WITH HEALTH CARE LEGISLATION. In addition to
extensive government health care regulation, there are numerous initiatives on
the federal and state levels for reforms affecting the payment for and
availability of health care services. The recently enacted Balanced Budget Act
seeks to achieve a balanced federal budget by, among other things, reducing
federal spending on the Medicare and Medicaid programs. The law contains
numerous changes in the methodology of Medicare payments to nursing homes and,
among other things, repeals the federal payment standard for Medicaid nursing
facilities and hospitals. There can be no assurance that these changes will
not adversely affect the Company and, after consummation of the Transactions,
Holding Co. See "--Risk Involved with Reimbursement by Third Party Payors." In
addition, there can be no assurance that currently proposed or future health
care legislation or other changes in the administration or interpretation of
governmental health care programs will not have an adverse effect on the
Company and, after consummation of the Transactions, Holding Co. Concern about
the potential effects of health care legislation and budget reduction measures
may contribute to the volatility of prices of securities of companies in
health care and related industries, including the Company, and after
consummation of the Transactions, Holding Co. See "Item 1.--Business
Government--Regulation and Reimbursement" in the Company's 1997 Form 10-K
attached hereto as Annex A.
RISK INVOLVED WITH REIMBURSEMENT BY THIRD PARTY PAYORS. For the year ended
December 31, 1997, the Company derived approximately 25.2% and 55.8% of its
net patient and resident revenues from Medicare and Medicaid, respectively. It
is expected that the Company and, after consummation of the Transactions,
Holding Co. will continue to derive a significant portion of its revenue from
such federal and state reimbursement programs. There can be no assurance that
the Company and, after consummation of the Transactions, Holding Co. will
achieve or improve this payor revenue mix in the future. Both governmental and
private payor sources have instituted cost containment measures designed to
limit payments made to health care providers. Most recently, the Balanced
Budget Act requires the establishment of a prospective payment system ("PPS")
for Medicare skilled nursing facilities under which facilities will be paid a
federal per diem rate for virtually all covered nursing facility services in
lieu of the current cost-based reimbursement rate. PPS will be phased in over
three cost reporting periods, starting with cost reporting periods beginning
on or after July 1, 1998. During the first three years, skilled nursing
facilities will be paid a per diem rate based on a blend of facility-specific
costs and federal costs. The blended rate for the first year of transition
will take 75% of the facility-specific per diem rate and 25% of the federal
per diem rate. In each subsequent transition year, the facility-specific per
diem rate component will decrease by 25% and the federal per diem rate
component will increase by 25%, ultimately resulting in a 100% federal per
diem rate. The facility-specific per diem rate is based upon a facility's 1995
cost report for routine, ancillary and capital services, updated using a
skilled nursing market basket index. The federal per diem rate is calculated
by the weighted average of each facility's standardized costs, based upon the
historical national average per diem for free-standing facilities. The rates
for such services were published as an interim final rule with comment period
in the Federal Register on May 12, 1998. The interim rule provided that the
Health Care Financing Administration ("HCFA") would accept comments until July
13, 1998, but the comment period has now been extended to September 11, 1998.
The payment rate will cover all
14
<PAGE>
routine, ancillary and capital costs and most nursing facility services,
including therapy services and certain covered drugs. Additionally, HCFA has
recently published in the Federal Register on August 11, 1998, a proposed rule
that would revise the procedures for granting exceptions to the cost limits
for skilled nursing facilities as well as remove the provisions allowing
reclassifications for all providers. Because the Balanced Budget Act mandates
the PPS for skilled nursing facilities, exceptions to the cost limits will no
longer be available to skilled nursing facilities with cost reporting periods
beginning on or after July 1, 1998, but fiscal intermediaries will continue to
process, beyond July 1, 1998, exception requests by skilled nursing facilities
for cost reporting periods prior to July 1, 1998. These changes will require
that the Company and, after consummation of the Transactions, Holding Co.,
manage the costs of its services effectively and efficiently as the transition
to PPS occurs. If it is unable to do so, the Company and, after consummation
of the Transactions, Holding Co., may experience a material adverse effect.
Also, delays in the reimbursement of health care providers by governmental and
state intermediary providers are possible as such agencies adjust to PPS and
could materially adversely affect the Company and, after consummation of the
Transactions, Holding Co.
The Balanced Budget Act also institutes consolidated billing for skilled
nursing facility services, under which payments for most non-physician Part B
services for beneficiaries no longer eligible for Part A skilled care will be
made to the facility, regardless of whether the item or service was furnished
by the facility, by others under arrangement, or under any other contracting
or consulting arrangement, effective for items or services furnished on or
after July 1, 1998. In a recent Medicare Program Memorandum (the "Program
Memorandum"), the Health Care Financing Administration ("HCFA") established a
transition period for skilled nursing facility consolidated billing. Under the
Program Memorandum, skilled nursing facilities are not obligated to begin
consolidated billing until January 1, 1999 except for Part A residents where
the skilled nursing facility begins on PPS before January 1, 1999. This is
because the PPS rate will include payment for the ancillary services subject
to consolidated billing.
Prior to the enactment of the Balanced Budget Act, federal law required
state Medicaid programs to reimburse nursing facilities for the costs that are
incurred by efficiently and economically operated providers in order to meet
quality and safety standards. The Balanced Budget Act repealed this payment
standard by repealing the so-called Boren Amendment, effective for services
provided on or after October 1, 1997, thereby granting states greater
flexibility in establishing payment rates. There can be no assurance that
budget constraints or other factors will not cause states to reduce Medicaid
reimbursement to nursing facilities or that payments to nursing facilities
will be made on a timely basis. Any such efforts to reduce Medicaid payment
rates or failure of states to meet their Medicaid obligations on a timely
basis would have a material adverse effect on the Company and, after
consummation of the Transactions, Holding Co.
In addition, several states have enacted or are considering various health
care reforms, including reforms through Medicaid managed care demonstration
projects. Several states in which the Company operates have applied for, or
received, approval from the HHS for waivers from certain Medicaid requirements
that were generally required for managed care projects. Although these
demonstration projects generally exempt institutional care, including long-
term care facilities, no assurance can be given that these waiver projects
ultimately will not change the reimbursement system for long-term care from
fee-for-service to managed care negotiated or capitated rates. Furthermore,
the Balanced Budget Act now allows states to mandate enrollment in managed
care systems without going through the federal waiver process as long as
certain standards are met. It is not possible to predict which reforms of
state health care systems will be adopted and the effect, if any, that the
reforms will have on the Company's and, after consummation of the
Transactions, Holding Co.'s, business. The business prospects of the Company
and, after the consummation of the Transactions, Holding Co., will be
significantly affected by general economic factors affecting many states'
health care industries and by the laws and regulatory environment in these
states, including Medicaid reimbursement rates.
15
<PAGE>
Government reimbursement programs are subject to additional statutory and
regulatory changes, retroactive rate adjustments, administrative rulings and
government funding restrictions, all of which could materially decrease the
rates paid to the Company, and after the Transactions, Holding Co., for its
future services or the services for which the Company or Holding Co. will be
able to seek reimbursement. Neither the Company nor Holding Co. can predict
whether any of these additional proposals will be adopted or, if adopted and
implemented, what effect such proposals would have on the Company and, after
consummation of the Transactions, Holding Co. There can be no assurance that
payments under state or federal governmental programs will remain at levels
comparable to present levels or will be sufficient to cover the costs
allocable to patients eligible for reimbursement pursuant to such programs,
particularly with respect to individual, state-administered Medicaid programs,
which generally provide lower reimbursement rates than does the Medicare
program and will have greater flexibility in establishing payment rates in the
future. In addition, there can be no assurance that the facilities operated by
and the services and supplies provided by the Company and, after consummation
of the Transactions, Holding Co., will meet or continue to meet the
requirements for participation in such programs. See "Item 1.--Business--Payor
Sources" in the Company's 1997 Form 10-K attached hereto as Annex A.
COMPETITION. The long-term care industry generally, and the nursing home and
retirement center business in particular, is highly competitive. The Company
competes and, after consummation of the Transactions, Holding Co. will
compete, with other providers on the basis of the breadth and quality of its
services, the quality of its facilities and, to a limited extent, price. The
Company and, after consummation of the Transactions, Holding Co. will also
compete with other providers in the acquisition and development of additional
facilities and businesses. These competitors include national, regional and
local operators of long-term care facilities, acute care hospitals and
rehabilitation hospitals, extended care centers, retirement centers, assisted
living facilities, community home health agencies and similar institutions,
some of which have significantly greater financial and other resources than
the Company and Holding Co. In addition, the Company competes, and after
consummation of the Transactions, Holding Co. will compete, with a number of
tax-exempt nonprofit organizations which can finance acquisitions and capital
expenditures on a tax-exempt basis or receive charitable contributions
unavailable to the Company or Holding Co. There can be no assurance that the
Company and, after consummation of the Transactions, Holding Co., will not
encounter increased competition which could adversely affect its business,
results of operations or financial condition. See "Item 1.--Business--
Competition" in the Company's 1997 Form 10-K attached hereto as Annex A.
LIABILITY AND INSURANCE. The provision of health care services entails an
inherent risk of liability. In recent years, participants in the long-term
care industry have become subject to an increasing number of lawsuits alleging
malpractice or related legal theories, many of which involve large claims and
result in the incurrence of significant damage awards and defense costs. It is
expected that the Company and after the consummation of the Transactions,
Holding Co., from time to time will be subject to such suits as a result of
the nature of their business. The Company currently maintains liability
insurance in amounts intended to cover such claims which it has stated it
believes is adequate based on the nature of the risks, the Company's
historical experience and industry standards. Holding Co. and Atrium intend to
evaluate the insurance policies, self-insured risks and insurance retentions
and the adequacy of any reserves established for such contingent liabilities
as well as the propriety of such positions in light of the Company's current
financial position. There can be no assurance, however, that the Company's
insurance is adequate or that claims in excess of such insurance or claims not
covered by insurance, such as claims for punitive damages, will not arise. A
successful claim against the Company not covered by, or in excess of, its
insurance policy limits could have a material adverse effect upon the
Company's and, after consummation of the Transactions, Holding Co.'s,
financial condition and results of operations. Claims against the Company or
Holding Co., regardless of their merit or eventual outcome, may also have a
material adverse effect upon the Company's and, after consummation of the
Transactions, Holding Co.'s, ability to attract or retain
16
<PAGE>
residents or patients or expand its business and may require management to
devote substantial time to matters unrelated to day-to-day operations. There
can be no assurance that Holding Co. will be able to obtain sufficient
liability insurance coverage in the future or that, if such insurance coverage
is available, it will be available on acceptable economic terms. See "Item 1--
Business--Insurance" in the Company's 1997 Form 10-K attached hereto as Annex
A.
THIRD-PARTY INDEBTEDNESS SECURED BY ASSETS LEASED BY COMPANY. As is
customary in the industry, the Company through its leasehold interests,
operates facilities that generally secure the indebtedness of the facilities'
owners. To the extent that the owners of the Company's leased facilities
experience financial difficulty or otherwise are unable to meet their
obligations, the ability of the Company to continue to operate such facilities
may be jeopardized, and the Company's and, after the consummation of the
Transactions, Holding Co.'s, financial condition and results of operation
could be materially adversely affected. See "--Subordination of Management
Fee" herein and see "Item 1.-- Business--Description of Lease Agreements" in
the Company's 1997 Form 10-K attached hereto as Annex A.
CROSS DEFAULTS UNDER LEASE AGREEMENTS AND MANAGEMENT CONTRACTS AND
PARTICIPATING MORTGAGE. Thirty long-term care facilities are leased by the
Company pursuant to agreements with OHI, the terms of which provide that a
default with respect to one facility is a default not only with respect to
each facility subject to a lease or management agreement with OHI, but also
with respect to a mortgage (the "Participating Mortgage") secured by four
additional nursing homes that are located in Florida. Counsel Corporation
("Counsel") has agreed to indemnify the Company in the event of default by
Counsel under the Participating Mortgage, except in the case where such
default was caused by the Company. A default by the Company under the lease or
related documents is a default by the Company under the master lease
agreement. In addition, other management contracts, and leases that cover
multiple nursing homes provide that a default by the Company with respect to
any facility under any one of the management contracts or leases is a default
by the Company with respect to all facilities under such management contract
and lease. Consequently, a default by the Company under any of the foregoing
agreements with respect to a particular facility may result in the termination
of the management contract or lease of not only that facility, but the
management contracts and leases covering the other facilities leased and
managed under such leases and management contracts. See "Item 1.--Business--
Description of Lease Agreements" in the Company's 1997 Form 10-K attached
hereto as Annex A.
SUBORDINATION OF MANAGEMENT FEES. As is customary in the industry, the
assets and operations of the facilities managed by the Company generally
secure the indebtedness of the facilities' owners, and the payment of
management fees to the Company at these facilities is subordinated to the
payment of the owners' debt obligations. To the extent that the owners of the
Company's managed facilities experience financial difficulty or otherwise are
unable to meet their obligations, the ability of the Company and, after the
consummation of the Transactions, Holding Co., to receive management fees or
continue as manager of such facility may be jeopardized. See "Item 1.--
Business--Description of Management Services and Agreements" in the Company's
1997 Form 10-K attached hereto as Annex A.
SHORT-TERM NATURE OF CERTAIN MANAGEMENT CONTRACTS. Holding Co. believes that
under certain circumstances the terms of management contracts with respect to
facilities, including four facilities managed during Canadian receivership or
insolvency proceedings, are subject to cancellation or termination prior to
December 31, 2000. See "Item 1.--Business--Description of Management Services
and Agreements" in the Company's 1997 Form 10-K attached hereto as Annex A.
AVAILABILITY OF SKILLED PERSONNEL AND OTHER LABOR. The Company depends upon
skilled personnel such as nurses as well as unskilled labor to staff its
facilities. In some areas in which the Company operates (particularly rural
areas) there is a labor shortage that could have a material
17
<PAGE>
adverse effect upon the Company's or Holding Co.'s ability to attract or
retain sufficient numbers of skilled personnel and the ability to attract or
retain sufficient numbers of unskilled labor at reasonable wages.
ABILITY TO ACQUIRE ADDITIONAL LONG-TERM CARE FACILITY OPERATIONS. Holding
Co. intends to expand its business through the selective acquisition of
additional long-term care facility operations. Holding Co.'s prospects for
growth are directly affected by its ability to acquire suitable long-term care
facility operations, which in turn will depend, among other things, upon its
ability to obtain financing, government licenses, certificates of need
("CONS") and approvals, and the competitive environment for acquisitions. The
nature of such licenses and approvals and the timing and likelihood of
obtaining them vary widely from state to state, depending upon the facility or
operation and the type of services proposed. Most states in which the Company
operates, and after the consummation of the Transactions the Holding Co. will
operate, have statutes that require a prior determination by the appropriate
state agency that a need exists for the addition or construction of new beds,
the addition of new services, the acquisition of certain medical equipment or
certain capital expenditures in excess of defined levels. These CON programs
are designed to avoid duplication of health care facilities. Some states also
require obtaining an exemption from CON review, or a reclassification of an
existing CON, for acquisitions of existing health care facilities.
Additionally, prior notification and approval may be required for a "change of
ownership," which can include the acquisition of stock, assets or by other
means, of an existing health care facility, either through the CON process or
the licensure process. Some states have instituted moratoria on new CONs for
nursing home bed and other services, or otherwise stated their intent to limit
approvals for new beds and such moratoria may affect the ability of the
Holding Co. to expand into or acquire operations in those states. In making
acquisitions, Holding Co. will compete with other providers, many of which
have greater financial resources than Holding Co. There can be no assurance
that suitable acquisitions will be identified, that acquisitions can be
consummated or that the acquired facility operations can be integrated
successfully into Holding Co.'s operations. The various risks associated with
Holding Co.'s acquisition of long-term care facility operations and
uncertainties regarding the profitability of such operations may affect
Holding Co.'s financial performance in any given period.
WORKERS' COMPENSATION INSURANCE. Canadian employees are covered for workers'
compensation as a result of the Company's participation in mandated insurance
programs administered by the individual provinces in which the Company
operates. U.S. workers' compensation coverage is effected through either an
indemnity insurance plan or state-sponsored programs. Texas does not require
mandatory workers' compensation for employee-related injuries; therefore, the
Company has elected to be a non-subscriber under the workers' compensation
laws of Texas. The Company, at its sole discretion, reviews each injury
incident and provides medical care and wage replacement appropriate to each
situation.
INSURANCE--RISK MANAGEMENT. The Company utilizes risk management experts in
the evaluation of its insurance programs, and management of the Company
believes its current insurance coverage level is consistent with industry
standards and is appropriate for the risk environment. The Company has
established reserves that management believes are adequate to cover self-
insured risks of its insurance programs. There can be no assurance that the
Company's insurance and reserves will be sufficient to cover any judgments,
settlements or costs relating to any pending or future claims or legal
proceedings (including any related judgments, settlements or costs) or that
any such insurance will be available to the Company in the future on
satisfactory terms, if at all. If the insurance and reserves carried by the
Company are not sufficient to cover any judgments, settlements or costs
relating to pending or future claims or legal proceedings, the Company's
business and financial condition could be materially adversely affected. See
"Item 1.--Business--Insurance" in the Company's 1997 Form 10-K attached hereto
as Annex A. Holding Co. and Atrium intend to evaluate the insurance policies,
self insured risks and insurance retentions and the adequacy of any reserves
18
<PAGE>
established for such contingent liabilities as well as the propriety of such
positions in light of the Company's current financial position.
FOREIGN CURRENCY TRANSLATION. The Company has obtained its financing
primarily in U.S. dollars; however, it incurs revenues and expenses in
Canadian dollars with respect to Canadian management activities and operations
of the Company's owned and leased facilities located in Canada. Therefore, if
the currency exchange rate fluctuates, the Company may experience currency
translation gains and losses with respect to the operations of these
activities and the capital resources dedicated to their support. While such
currency exchange rate fluctuations have not been material to the Company in
the past, there can be no assurance that the Company or Holding Co. will not
be adversely affected by shifts in the currency exchange rates in the future.
EFFECT OF CERTAIN ANTI-TAKEOVER PROVISIONS. Certain provisions of the
Company's Certificate of Incorporation and Bylaws and the Delaware General
Corporation Law (the "DGCL") may discourage certain transactions involving a
change of control. Holding Co. intends for the material legal rights and
characteristics of Holding Co. Common Stock to be identical to the greatest
extent possible to the existing legal rights and characteristics of the Shares
of the Company, except that Holding Co. has no present intention to implement
a so-called "poison pill" stockholder rights plan such as the plan contained
in the Company's Rights Agreement. Accordingly, Holding Co.'s Certificate of
Incorporation and Bylaws will be amended and restated prior to the
consummation of the Offer and the Merger into forms which are substantially
similar in all material respects (other than the identity of the initial
directors) to the Company's Certificate of Incorporation. As a result, the
market price of the Holding Co. Common Stock may not benefit from any premium
which might occur in anticipation of a threatened or actual change of control.
DIVIDEND POLICY. The Company and, following the Transactions, Holding Co.
intend to retain any earnings to finance the operations and expansion of its
business and not to pay dividends.
RISKS RELATING TO THE TRANSACTIONS
FIXED EXCHANGE RATIO. The Consideration includes one share of Holding Co.
Common Stock. This is a fixed exchange ratio and will not be adjusted in the
event of any increase or decrease in the market price of the Shares between
the date hereof and the Expiration Date. The value of Holding Co. Common Stock
issued in the Offer may be higher or lower than the market price of the Shares
on the date of this Prospectus. Such variations may be the result of changes
in or market assessments of the business, operations or prospects of the
Company and/or Holding Co., assessments of the likelihood that the Offer will
be consummated and the timing thereof, general market and economic conditions
or other factors. The Expiration Date will occur as soon as practicable
following the satisfaction or waiver (where permissible) of the conditions to
the Offer. Tendering stockholders of the Company are urged to obtain current
market quotations for the Shares. See "The Offer--Conditions of the Offer" and
"Market Prices and Dividends."
POTENTIAL INTEGRATION AND RESTRUCTURING COSTS. If the Transactions are
consummated, there exists a likelihood that one or more significant charges to
operations will be required as a result of rationalizing and integrating
operations. These costs may include severance and related employee benefit
costs, debt extinguishment costs, and costs associated with change of control
agreements, among others. To date, Holding Co.'s access to information related
to the Company has been limited to only publicly available information. In
addition, publicly available information does not contain sufficient details
related to existing severance plans, employee benefit agreements, change of
control costs, debt extinguishment provisions or other material contract
provisions to enable Holding Co. to quantify the costs associated with
business integration and rationalization actions that may be considered by
Holding Co.
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CHANGE IN CONTROL PROVISIONS. The Company has employment agreements with
certain members of management that provide for the payment to these members of
amounts up to 2.5 times their annual base salary in the event of a termination
without cause, a constructive discharge (as defined), or upon a change in
control of the Company (as defined). According to the Company's 1997 Form 10-
K, the maximum contingent liability under these agreements is approximately
$1.6 million. In addition, upon the occurrence of any triggering event,
certain executives may elect to require the Company to purchase options
granted to them for a purchase price equal to the difference between the fair
market value of the Company's common stock at the date of termination and the
stated option exercise price. The Company has established a Supplemental
Executive Retirement Plan (the "SERP") to provide retirement benefits for
officers and employees of the Company who have been designated for
participation by the President of the Company. If there is a change in control
of the Company as defined in the SERP, all participants shall be fully vested,
and each participant shall be entitled to receive his or her benefits under
the SERP upon termination of employment. To date, Holding Co. has not had
access to the materials that would permit Holding Co. to quantify payments
that may become due pursuant to the SERP.
Certain of the leases and related documents between the Company and OHI
provide for acceleration of the Company's obligations or an event of default
in the event of a change in control. OHI has agreed to consent to the
Transactions and waive any non-material defaults resulting solely therefrom.
The Company's lines of credit generally prohibit mergers involving the
Company and certain changes in senior management of the Company. Holding Co.
intends to negotiate with the lenders to waive any default resulting from the
Transactions or alternatively refinance the outstanding balance thereunder
through other lenders based on the financing commitments provided by OWWI and
improved prospects for the Company following the Transactions. No assurance
can be given at this time that Holding Co. will be able to obtain such waivers
from the existing lenders or refinance the balance outstanding under the
existing lines of credit on acceptable terms.
Other than documents filed by the Company with the Commission, Holding Co.
has not had access to, and therefore has not been able to review, any of the
documents governing any indebtedness of the Company or other material
contracts of the Company. Some or all of these documents may contain
provisions for acceleration of the Company's indebtedness or obligations upon
a change in control of the Company. In such event, Holding Co. may be required
to seek additional interim financing from OWWI or other sources.
RELATIONSHIP WITH ATRIUM AND OWWI. Holding Co. proposes to enter into a
management agreement with Atrium pursuant to which Atrium will provide
comprehensive "central office" management services to Holding Co. and the
Company. Francis J. Crosby, the President and Chief Executive Officer of
Holding Co., is the President and Chief Executive Officer of Atrium. John H.
Stoddard, the Executive Vice President and Chief Financial Officer of Holding
Co., is the Executive Vice President and Chief Financial Officer of Atrium. W.
Blaine Sheffield, the Vice President of Operations of Holding Co., is the Vice
President of Operations of Atrium. Messrs. Crosby, Stoddard and Sheffield will
devote the time they reasonably determine to be necessary to the business and
affairs of Holding Co., which will be less than full time since Atrium also
manages the business and operations of Essex and manages long-term care
facilities for others. The interests of the Holding Co. (and following the
Transactions, the Company) could conflict with the interests of Atrium and/or
Messrs. Crosby, Stoddard and Sheffield. Decisions with respect to matters
involving Holding Co. or the Company, on the one hand, and Atrium or Messrs.
Crosby, Stoddard or Sheffield, on the other, will be made by a majority of the
Independent Directors.
OWWI has agreed to purchase up to 819,476 shares of Holding Co. Common Stock
for a purchase price of $6.59 per share in connection with the completion of
the Offer to fund the expenses
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incurred in connection with the Transactions. The purchase price for the
Holding Co. Common Stock equals the average closing sale price for the Shares
as reported on the NYSE Composite Tape for the 20 trading days immediately
preceding August 27, 1998, the filing date of the Registration Statement of
which this Prospectus is a part. OWWI has also committed to purchase, at the
option of the Independent Directors of Holding Co. within two years of the
completion of the Offer, up to $5.0 million of Debentures, convertible into
Holding Co. Common Stock at a conversion price that would represent a premium
of at least 22.5% over the then current market price per share of Holding Co.
Common Stock. In addition, prior to commencing the Offer Holding Co. will
obtain commitments for an additional $15.0 million of Convertible Financing
from OWWI or other investors identified by OWWI. See "Financing Commitments."
Assuming (i) all the outstanding Shares are exchanged for Holding Co. Common
Stock in the Offer and (ii) the Independent Directors of Holding Co. call for
OWWI to purchase all 819,476 shares of Holding Co. Common Stock and all $5.0
million of Debentures as of the completion of the Offer, OWWI would
beneficially own approximately 21.0% of the outstanding Holding Co. Common
Stock on a pro forma basis, including the Holding Co. Common Stock issuable
upon conversion of $5.0 million principal amount of Debentures. Essel W.
Bailey, Jr. is a director nominee of Holding Co. and the Chairman, President
and Chief Executive Officer of OWWI. Decisions with respect to matters
involving Holding Co. or the Company, on the one hand, and OWWI or its
affiliates, on the other, will be made by a majority of the Independent
Directors.
The Company leases 30 long-term care facilities from OHI. For the year ended
December 31, 1997, the Company's patient and resident revenues from the
facilities leased from OHI were approximately $90.7 million, representing
49.8% of the Company's revenues for 1997. Four additional facilities leased by
the Company are subject to a participating mortgage in favor of OHI. Holding
Co. anticipates that OHI may provide additional financing to the Company
following the Transactions with the approval of the Independent Directors. The
interests of Holding Co. (and following the Transactions, the Company) could
conflict with the interests of OHI as a lessor and mortgagor to the Company.
See "--Cross Defaults under Lease Agreements and Participating Mortgage" and
see "Item 1.--Business--Description of Lease Agreements" in the Company's 1997
Form 10-K attached hereto as Annex A. Decisions with respect to matters
involving Holding Co. or the Company, on the one hand, and OHI or its
affiliates, on the other, will be made by a majority of the Independent
Directors.
ABSENCE OF PREVIOUS MARKET FOR COMMON STOCK; POSSIBLE VOLATILITY OF STOCK
PRICES. Prior to the completion of the Offer, there has been no public market
for the Holding Co. Common Stock, the American Stock Exchange, or the Nasdaq
Stock Market, there can be no assurance that an active trading market will
develop or be sustained after the Offering. After completion of the Offer, the
market price of the Holding Co. Common Stock could be subject to significant
fluctuations in response to various factors and events, including the depth
and liquidity of the market for the Holding Co. Common Stock, variations in
the Holding Co.'s operating results, litigation, new statutes or regulations
or changes in the interpretation of existing statutes or regulations affecting
the health care industry generally or long-term care businesses in particular
or changes in general market conditions.
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REASONS FOR THE OFFER
Holding Co. believes that the benefits of the Transactions include the
following:
. IMMEDIATE CAPITAL INFUSION. As part of the proposed transaction, OWWI or
other investors identified by OWWI will provide Holding Co. and its
affiliates up to $20.0 million of convertible debt financing, the
proceeds of which would be used to:
(i) partly repay and refinance the maturing $34.1 million Pierce
Acquisition bridge loan; see "Risk Factors--Ability to Pay Debt Due
in 1999";
(ii) partly repay and refinance the Company's $11.25 million working
capital line, which was fully drawn (including the $1.25 million
temporary "overline" increase) as of August 12, 1998;
(iii) finance capital expenditures for which the Company currently
lacks the needed funds; and
(iv) fund severance payments under existing employment agreements and
fees and expenses related to the Transactions.
. ENHANCED MANAGEMENT TEAM AND BOARD OF DIRECTORS. The depth and
capabilities of the Company's management team and Board of Directors
would be significantly augmented by the experienced Atrium management
team as well as by directors provided by OWWI with established track
records for creating stockholder value.
. STRATEGIC RELATIONSHIP. The proposed transaction would serve to establish
a strategic relationship with OWWI that would provide the Company with
access to, and disciplined financial and strategic analysis of, potential
acquisition, growth and financing opportunities not otherwise available
to the Company.
. GROWTH STRATEGY. Once recapitalized and the proposed management changes
have been instituted, the Company will be positioned as a viable platform
to participate actively in the on-going consolidation of the long-term
care industry.
HISTORICAL CHALLENGES
The Company encountered significant operating and financial issues during
1997 when two facilities located in Mobile, Alabama were decertified from
participation in the Medicare and Medicaid programs in Alabama for 69 days and
91 days, respectively. In the Company's 1997 Form 10-K, the Company states
that "[t]he Company's 1997 operating results were PROFOUNDLY affected by
regulatory issues in the State of Alabama." See "Item 1.--Business--Material
Corporate Developments--Regulatory Issues" in the Company's 1997 Form 10-K
attached hereto as Annex A (emphasis added).
Holding Co. believes that the issues encountered in Alabama were the result,
in part, of the failure to develop and implement appropriate internal systems
and controls to monitor the operations of the Company's various facilities and
to ensure compliance with increasingly stringent regulatory requirements
regarding quality of care. As a result of the Company's relatively small
operational platform, the consequences of the issues encountered in Alabama
were severe from an operating perspective and had a material adverse effect on
the Company's results of operations for the year ended December 31, 1997. The
Company further disclosed the following:
As a result of the lost revenues from the Medicare and Medicaid
programs (including charity care provided to continuing patients who
had been admitted under those programs), census declines and
expenditures incurred in response to the survey issues (including fines
and penalties), THE COMPANY EXPERIENCED AN ESTIMATED NEGATIVE IMPACT ON
1997 EARNINGS OF APPROXIMATELY $2.3 MILLION AFTER TAXES, OR
APPROXIMATELY $0.44 PER SHARE. The pre-tax impact of these events
[which total approximately $3,655,000] in the State of Alabama can be
quantified as follows:
--Lost revenue of $1.9 million, of which more than $950,000 represented
charity care for patients the Company elected not to discharge during
the decertification period
--Region-wide increases in staffing at all Alabama facilities with a
cost of more than $700,000
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--Direct costs relative to consultants, attorneys, and fines totaling
$580,000
--Other related expenses of approximately $475,000
See "Item 1.--Business--Material Corporate Developments--Regulatory Issues" in
the Company's 1997 Form 10-K attached hereto as Annex A (emphasis added).
CURRENT CHALLENGES
The Company's operational and management challenges have continued. In its
May 7, 1998 press release and related conference call with investors and
industry analysts announcing results for the quarter ended March 31, 1998, the
Company disclosed that:
.census levels in Alabama had not returned to historical levels as
anticipated;
. the Company had incurred for the first time a loss of $300,000 with
respect to its Tennessee operations; and
. the Company will likely incur a charge in 1998 of approximately $1.0 to
$1.5 million in connection with the closing of regional offices, the
relocation and reduction of accounting personnel and other costs
associated with the conversion to a new management information system.
See "Background."
In the Company's Second Quarter Form 10-Q, the Company reported a loss of
$.06 per Share for the second quarter of 1998 including a charge of $1.5
million classified by the Company as non- recurring. For the six months ended
June 30, 1998, the Company reported net revenues of $104.2 million reflecting
an increase of 18.8% over net revenues for the comparable prior year period.
Yet, net income for the six months ended June 30, 1998, before charges
classified as non-recurring, was $958,000, or $0.18 per Share, compared to net
income of $2.6 million, or $0.49 per Share for the same period in 1997. THUS
NET INCOME FOR THE FIRST SIX MONTHS IN 1998 HAS DECLINED BY MORE THAN 60% FROM
THE EARNINGS FOR THE COMPARABLE 1997 PERIOD DESPITE AN 18.8% INCREASE IN NET
REVENUES. The Company's Second Quarter Form 10-Q also discloses that:
. the previously decertified Alabama facilities had only recovered
approximately two-thirds of the occupancy decline experienced during
the decertification;
.the maturity of the $34.1 Pierce Bridge Loan was extended to July
1999(*);
. the Company had drawn the full amounts available under its $10.0
million working capital line of credit as well as the $1.25 million
temporary "overline" increase in its working capital line of credit
as of August 12, 1998;
. as of August 14, 1998 (the deadline for the timely filing of the
Company's Second Quarter Form 10-Q), the Company obtained a further
increase in the temporary "overline" to $4.0 million, with all
borrowings thereunder due January 15, 1999; and
. the Company anticipates capital expenditures during 1998 for
improvements and equipment of approximately $7.0 million (including
$2.9 million for "non-routine projects" and $1.5 million for
management information systems, as compared to $2.4 million to $3.0
million of capital expenditures in each of the three preceding
years).
The Company's operational challenges are compounded by the significant
amount of debt scheduled to mature in coming months. The Company is obligated
to make principal payments ofapproximately $50.0 million in 1998 and 1999,
including approximately $34.1 million in July 1999* to repay the Pierce Bridge
Loan. Borrowings under the Company's $10.0 million working capital line of
credit (which was fully drawn as of August 12, 1998) and $4.0 "overline"
increase are due in December 1999 and January 1999, respectively. THE
COMPANY'S PUBLIC FILINGS FAIL TO DEMONSTRATE SUFFICIENT CAPITAL RESOURCES TO
FUND ITS DEBT MATURING IN 1999 AS WELL AS ITS ANTICIPATED CAPITAL EXPENDITURES
FOR 1998. IN THE EVENT THE TRANSACTIONS ARE NOT COMPLETED, HOLDING CO.
BELIEVES THE COMPANY MAY BE REQUIRED TO SEEK ADDITIONAL FINANCING FROM SOURCES
THAT HAVE NOT BEEN PUBLICLY IDENTIFIED.
Holding Co. believes that the foregoing operational difficulties and highly
leveraged balance sheet have contributed to the substantial deterioration in
the price of the Shares. Through the Equity
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Financing and Convertible Financing, the Transactions would provide the
Company a much needed capital infusion to address upcoming debt maturities and
fund capital expenditures.
- ----------
(*) Notwithstanding the disclosure in the Company's Second Quarter Form 10-Q,
definitive documents filed as exhibits to the Company's Second Quarter
Form 10--Q provide for an extension of maturity only to APRIL 1, 1999.
FUTURE CHALLENGES
The long-term care market in the United States today is characterized by
dramatic changes in both the identity of the participants in the market as
well as the regulatory and reimbursement environment in which the various
participants operate. In addition to extensive government health care
regulation, there are numerous initiatives on the federal and state levels for
reforms affecting the payment for and availability of health care services.
The recently enacted Balanced Budget Act seeks to achieve a balanced federal
budget by, among other things, reducing federal spending on the Medicare and
Medicaid programs. The law contains numerous changes in the methodology of
Medicare payments to nursing homes and, among other things, repeals the
federal payment standard for Medicaid nursing facilities and hospitals.
Recently, additional initiatives seeking to ensure and, where appropriate,
improve the quality of care provided to patients through more frequent and
aggressive surveys of health care facilities have been announced. Holding Co.
believes that concern about the potential effects of health care legislation
and budget reduction measures as well as the recent intense scrutiny of the
industry in general coupled with the Company's recent regulatory and
continuing financial challenges in particular has contributed to the
significant decline in the price of the Shares from a high of $12.875 on
October 6, 1997 to a low of $5.625 on August 6, 1998. Holding Co. believes
that these factors may profoundly limit the Company's access to capital which
could, in turn, make it difficult for the Company to refinance the $34.1
million Pierce Bridge Loan and the temporary "overline" line of credit that
become due on or before July 1999.
Holding Co. does not believe that the Company's current portfolio of assets
constitutes a viable platform from which to conduct operations in a
competitive manner in light of the changing nature of the market in which the
Company competes. In addition, Holding Co. believes that the Company's current
management team would benefit from the focus and experience that could be
obtained by contracting with Atrium for the provision of certain services such
as those that would be provided pursuant to the proposed Management Agreement.
See "Certain Information Regarding Holding Co.--Management--Management
Agreement." Furthermore, the experience and vision provided by Atrium could
facilitate the Company's ability to address the challenges posed by certain
impending changes in regulatory and reimbursement environment applicable to
Medicare and Medicaid patients. The access to capital and growth opportunities
provided by OWWI would facilitate the development of a larger operational
platform that would enable the Company to benefit from enhanced economies of
scale that will become increasingly important under the prospective payment
reimbursement system.
Since January 1997, a number of transactions have occurred among
participants in the long-term care industry. Many of these transactions have
reflected a trend toward consolidating the markets secured by the various
providers as well as broadening the scope of ancillary services that these
providers can offer to patients in their respective facilities to facilitate
their ability to operate profitably under a prospective payment reimbursement
system.
STRATEGIES TO ADDRESS CURRENT AND FUTURE CHALLENGES
To compete effectively in the consolidating market requires that the
Company possess the management capability to develop and implement the systems
and procedures required to respond to the changing competitive and
reimbursement environment as well as managing the delivery of services in a
manner that meets an increasingly complex and rigorous array of regulatory
requirements. Furthermore, the Company must also have the ability to identify,
analyze, structure and finance appropriate acquisition, investment and other
growth opportunities. By leveraging the acquisition,
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financial and other strategic opportunities for growth that would be available
to the Company as a result of a strategic relationship with OWWI, the Company
would be able to expand its operational platform, attract "patient" equity
with a longer investment time horizon and restructure a portion of its balance
sheet on attractive terms, thereby reducing its potential exposure to adverse
financial consequences resulting from unforeseen disruptions that may be
encountered in the future as a result of the evolving regulatory, competitive
and reimbursement environment. Holding Co. believes that the Transactions will
also provide the Company with access to management services from Atrium that
will have an intense "turn-around" focus that is required to move the
Company's stagnant business in a positive direction.
Atrium intends to spend substantial time during the first year of operation
following the consummation of the Offer and the Merger analyzing the Company's
operations to evaluate the performance of each of the Company's facilities. In
addition, Atrium will evaluate the basis on which the Company currently
provides its ancillary services such as pharmaceutical supplies and services
and rehabilitation therapy with a view to determining whether such services
can be provided more efficiently to maximize the benefits inherent in the
prospective payment reimbursement methodology that is currently being phased
in as a result of the enactment of the Balanced Budget Act. Holding Co.
believes that Atrium's industry experience will also enable Atrium to provide
the Company with additional services not available internally at the Company
for a cost less than the cost the Company would incur if it were to undertake
to provide such services directly. As a result of Atrium's operating
experience and focused analysis of the Company's current operations, Holding
Co. also believes that Atrium will be able to implement appropriate internal
systems and procedures designed to address the requirements of the
increasingly complex regulatory environment to avoid a recurrence of issues
such as those encountered in Alabama in 1997 and will, as a consequence,
position the Company as a viable platform for growth.
In addition to the foregoing, OWWI will work through Atrium to provide the
Company with access to acquisition and other growth opportunities that would
not otherwise be available to the Company. OWWI possesses the financial
expertise to identify, analyze and structure acquisition opportunities that
will facilitate the Company's ability to build a larger platform of operations
over which to spread the anticipated increased costs associated with the
operation of a long-term care business under a prospective payment
reimbursement system. OWWI also has access to capital sources that will be
required to assist the Company both in the financing of future acquisition and
other growth opportunities as well as in its efforts to restructure its
current debt burden of approximately $50 million that matures in 1998 and
1999.
-----------------
HOLDING CO. BELIEVES THAT THE OFFER IS IN THE BEST INTERESTS OF THE
COMPANY'S STOCKHOLDERS BECAUSE, AMONG OTHER THINGS, THE CONSIDERATION WILL
ALLOW STOCKHOLDERS OF THE COMPANY TO REALIZE A CASH PAYMENT ON THEIR SHARES
IMMEDIATELY, WHILE CONTINUING, THROUGH THEIR OWNERSHIP OF HOLDING CO. COMMON
STOCK, TO PARTICIPATE IN THE FUTURE GROWTH OF THE COMPANY'S BUSINESS UNDER THE
DIRECTION OF A MANAGEMENT TEAM COMPRISED OF INDIVIDUALS AND ORGANIZATIONS WITH
ESTABLISHED RECORDS FOR PROFITABLE OPERATIONS AND BUILDING STOCKHOLDER VALUE.
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BACKGROUND OF THE OFFER
On February 13, 1998, Messrs. Bailey and Crosby met with Dr. Birkett for the
purpose of introducing Mr. Crosby to Dr. Birkett and providing an opportunity
for Dr. Birkett and Mr. Crosby to become familiar with the business and
operations of Essex and the Company, respectively. Following the initial
introductory meeting, Messrs. Crosby and Bailey met with Dr. Birkett to
provide detailed information on various alternatives to address and resolve
the strategic operational, financial and management challenges facing the
Company.
Mr. Crosby and Dr. Birkett met again on March 23, 1998 to discuss a variety
of matters including the Company's operations in Canada, key members of the
Company's management team, the status of the integration of the recently
acquired Pierce operations and a possible sale of the Company. During the
course of this meeting, Dr. Birkett stated that he believed that although the
Company's operational difficulties in Alabama had continued longer than he
initially anticipated, he believed such issues had been resolved. As a result,
Dr. Birkett believed that the Company's Board of Directors would not entertain
a cash offer to acquire the Company unless the offer contemplated a price of
at least $15.00 per Share. Mr. Crosby expressed doubt that a price of $15.00
per Share was economically viable given the Company's recent operating results
and likely future prospects.
Mr. Crosby suggested the possibility of engaging in a leveraged
recapitalization of the Company whereby a substantial portion of the Shares
would be acquired for cash at a premium over the then prevailing market price
and Essex would merge with the Company. Mr. Crosby noted that such a
transaction would have the added benefits of increasing the depth and
capabilities of the Company's management team while enabling the Company to
continue, to a limited extent, as a publicly traded entity, which would
facilitate its access to capital and provide additional flexibility in
structuring future acquisitions. Dr. Birkett asked Mr. Crosby to submit
further explanation and a specific proposal regarding such a transaction.
In April 1998, Dr. Birkett informed Mr. Crosby that the Company was
evaluating alternatives to refinance its $34.1 million Pierce Bridge Loan
scheduled to mature by January 1999 including a possible underwritten offering
of convertible debt securities. Dr. Birkett invited Messrs. Bailey and Crosby
to submit a proposal to provide financing to facilitate the Company's efforts
to refinance a portion of such indebtedness. In connection with the foregoing,
Messrs. Bailey and Crosby met with representatives of Schroder to analyze the
Company's operations, financial condition, recent operating results and likely
prospects and to evaluate the Company's financing requirements.
On April 23, 1998, Messrs. Bailey and Crosby met with Dr. Birkett to discuss
two alternative proposals. The first alternative contemplated a combination of
the Company and Essex in a stock-for-stock merger in which Essex stockholders
would receive Shares. Simultaneously with the proposed combination, OHI would
purchase up to $20.0 million of convertible subordinated debentures to be
issued by the Company. Messrs. Bailey and Crosby believed that the advantages
of this strategic alternative included, among others, (i) strengthening the
Company's base of facilities to attain "critical mass," (ii) entering a
complementary regional market, (iii) increasing the depth and capabilities of
the Company's senior management team, and (iv) providing access to additional
capital on attractive terms to finance growth.
The second strategic alternative contemplated a leveraged recapitalization
of the Company financed by an equity investment by OWWI, followed immediately
by a merger with Essex. In the leveraged recapitalization, approximately 90%
of the outstanding Shares would be repurchased for cash at an implied price of
approximately $11.00 per Share, which represented a premium of approximately
21% over the then prevailing price of the Shares as reported on the NYSE
Composite Tape. Messrs. Bailey and Crosby believed that in addition to the
advantages inherent in the first alternative, the advantages of the leveraged
recapitalization included (i) providing an opportunity for
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the Company's stockholders to receive a cash payment at a premium for a
significant percentage of their Shares, (ii) providing an infusion of new,
"patient" equity to support future growth, and (iii) enhancing short-term
operating flexibility by minimizing the Company's exposure to the pressures of
the public market.
Messrs. Bailey and Crosby indicated that both proposals were predicated on
their understanding (based on assurances previously given by Dr. Birkett) that
(i) the Company's management had resolved the operational issues that the
Company had encountered in 1997 resulting in the decertification of two of the
Company's facilities in Mobile, Alabama from participation in the Medicare and
Medicaid programs for 69 days and 91 days, respectively, (ii) the average
occupancy levels for the previously decertified Alabama facilities would
return to the 85%--90% range by late April or early May 1998, and (iii) the
Company's quarterly earnings would return to the level of approximately $0.22
to $0.24 per Share during the second quarter of 1998. Messrs. Bailey and
Crosby noted that as a result of a number of factors, primarily the issues
that had arisen in Alabama, the Company's quarterly earnings for the quarters
ended September 30, 1997 and December 31, 1997 had fallen to $0.06 and $0.02
per Share, respectively.
Dr. Birkett informed Messrs. Bailey and Crosby that their proposal regarding
a leveraged recapitalization at an implied price of approximately $11.00 per
Share was inadequate. Dr. Birkett stated his belief that a sale of the Company
was premature since the prevailing price for Shares did not reflect the fair
value of the Company. However, Dr. Birkett invited Messrs. Bailey and Crosby
to submit supplemental information regarding the terms upon which Atrium would
be willing to assist the Company in its efforts to refinance a portion of its
$34.1 million in outstanding indebtedness that was then scheduled to mature in
eight months.
On April 30, 1998, Mr. Crosby submitted a supplemental proposal to Dr.
Birkett that contemplated a combination of the Company and Essex (in which the
stockholders of Essex would receive Shares) and a simultaneous purchase by
OWWI of $20.0 million of 7% debentures that would be convertible into Shares
of the Company at a price of $11.50 per Share, representing a premium of 26%
over the then prevailing market price for the Shares of $9.125 as reported on
the NYSE Composite Tape. The proposed debentures were contemplated to be
unsecured obligations of the Company and would not be redeemable for three
years following issuance. In addition, OWWI would commit to purchase an
additional $20.0 million of such debentures at the Company's option at any
time during the one year period commencing 90 days following the completion of
the transaction. In connection with the foregoing, each of OWWI, on the one
hand, and the former stockholders of Essex, on the other hand, would have the
right to designate two members of the Company's seven-person Board of
Directors.
Following receipt of the April 30 proposal, Dr. Birkett informed Mr. Crosby
that he was not inclined to consider the proposal because the director
designation requirement would give OWWI and the former Essex stockholders the
ability to designate a majority of the Company's Board of Directors.
Subsequently, in a conference call with investors and industry analysts
immediately following the announcement on May 7, 1998 of the Company's
earnings of $0.07 per Share for the quarter ended March 31, 1998, the Company
disclosed that (i) the Company's Alabama operations had incurred a $500,000
loss, (ii) Alabama occupancy levels were not expected to return to historical
levels until the third quarter of 1998, rather than by April or early May 1998
as previously anticipated, (iii) the Company had incurred for the first time a
loss of approximately $300,000 relating to its operations in Tennessee, and
(iv) the Company would be incurring a charge of approximately $1.0 to $1.5
million in connection with the closing of regional offices, the relocation and
reduction of accounting personnel and other costs associated with the
conversion to a new management information system.
On or about May 11, 1998, Dr. Birkett contacted Mr. Crosby and informed him
that he would present the proposal to the Company's Board of Directors at the
Board meeting that was scheduled to be held immediately following the
completion of the Company's Annual Meeting of Stockholders on
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May 15, 1998. Following the May 15th meeting of the Company's Board of
Directors, Dr. Birkett contacted Mr. Crosby and informed him that the
Company's directors had determined that they were not interested in the
proposal because of the resulting change in a majority of the Company's Board
of Directors.
There has not been any further discussion between the Company and any of
Messrs. Crosby, Bailey, Atrium or OWWI since May 1998. However, as the
prevailing market price for the Shares declined and the Company's poor
financial performance and operational challenges continued, Holding Co.
retained Schroders, as financial advisors, and Powell, Goldstein, Frazer &
Murphy LLP, as legal advisors, to analyze alternatives pursuant to which
Holding Co. could either acquire the Company or otherwise acquire management
control over the Company's operations.
HOLDING CO.'S OBJECTIVE IS TO ESTABLISH A PLATFORM UPON WHICH TO BUILD AN
INTEGRATED LONG-TERM CARE NETWORK THROUGH SELECTED ACQUISITION OPPORTUNITIES.
HOLDING CO. BELIEVES THAT THE MUCH NEEDED CAPITAL INFUSION, ENHANCED
MANAGEMENT, ACCESS TO CAPITAL AND STRATEGIC INDUSTRY RELATIONSHIPS PROVIDED BY
THE TRANSACTIONS AND HOLDING CO.'S STRATEGIC RELATIONSHIP WITH OWWI WILL
SIGNIFICANTLY ENHANCE THE COMPANY'S ABILITY TO IDENTIFY, STRUCTURE, FINANCE
AND COMPLETE FUTURE ACQUISITIONS.
Holding Co. has determined not to pursue a cash purchase of the Company,
because Holding Co. believes its status as a public company following
completion of the Transactions will facilitate its ability to implement its
business plan since it will possess improved access to capital and enhanced
flexibility in structuring subsequent transactions.
THE OFFER
GENERAL
Holding Co. hereby offers, upon the terms and subject to the conditions set
forth herein and in the related Letter of Transmittal, to exchange the
Consideration for each outstanding Share validly tendered on or prior to the
Expiration Date and not withdrawn. The Consideration consists of $1.00 in cash
and one share of Holding Co. Common Stock. The Offer is currently scheduled to
expire at 12:00 midnight, New York City time on September , 1998; however, it
is Holding Co.'s current intention to extend the Offer from time to time as
necessary until all conditions to the Offer have been satisfied or waived. See
"--Extension, Termination and Amendment."
Tendering stockholders will not be obligated to pay any charges or expenses
of the Exchange Agent or any brokerage commissions. Except as set forth in the
instructions to the Letter of Transmittal, transfer taxes on the exchange of
Shares pursuant to the Offer will be paid by or on behalf of Holding Co.
The purpose of the Offer is to enable Holding Co. to obtain control of, and
ultimately the entire equity interest in, the Company. Holding Co. presently
intends, as soon as practicable after consummation of the Offer, to seek to
have the Company effect the Merger. In the Merger, each outstanding Share
(other than Shares owned by Holding Co. or any of its affiliates, Shares held
in the Company's treasury or by any subsidiary of the Company and Shares owned
by the Company's stockholders who perfect dissenters' rights under Delaware
law) would be converted into the right to receive the Consideration. See "The
Merger."
Holding Co.'s obligation to exchange the Consideration for Shares pursuant
to the Offer is conditioned on the satisfaction of the Minimum Tender
Condition, the Rights Plan Condition, the Business Combination Statutes
Condition, and the other conditions as set forth under "--Conditions of the
Offer."
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According to the Company's Second Quarter Form 10-Q, as of August 12, 1998,
there were 5,398,710 Shares outstanding. Holding Co. owns 1,250 Shares as of
the date hereof. Immediately following consummation of the Merger, and after
giving effect to the issuance of Holding Co. Common Stock in the Offer and the
Merger and to OWWI pursuant to the Equity Financing but not the Convertible
Financing current stockholders of the Company (other than Holding Co. or OWWI)
would own approximately 13% of the then outstanding shares of Holding Co.
Common Stock. If 66 2/3% of the Shares are purchased in the Offer, such
ownership percentage would be approximately 71% immediately following
consummation of the Offer and after giving effect to the issuance of Holding
Co. Common Stock in the Offer and the Equity Financing, and before giving
effect to the Merger and the Convertible Financing.
Holding Co. intends to request use of the Company's stockholder list and
security position listings for the purpose of communications with stockholders
and disseminating the Offer to holders of Shares. This Prospectus and the
related Letter of Transmittal and other relevant materials will be mailed to
record holders of Shares, and will be furnished to brokers, dealers,
commercial banks, trust companies and similar persons whose names, or the
names of whose nominees, appear on the stockholder list or, if applicable, who
are listed as participants in a clearing agency's security position listing
for subsequent transmittal to beneficial owners of Shares.
THE RIGHTS
No separate payment will be made by Holding Co. for the Rights pursuant to
the Offer. Stockholders will be required to tender one Right for each Share
tendered in order to effect a valid tender of Shares. The Rights are currently
evidenced by the certificates for the Shares and the tender by a stockholder
of his or her Shares prior to the Distribution Date will also constitute a
tender of the associated Rights. The "Distribution Date" is defined as the
earlier of the following dates (or such later date as may be determined by the
board of directors upon a majority of the continuing directors): (i) the close
of business on the tenth day following a public announcement that a person has
acquired beneficial ownership of 15% or more of the outstanding Shares (an
"Acquiring Person"); or (ii) the close of business on the tenth business day
(or such later date as the Board may determine prior to such time as any
person becomes an Acquiring Person) following the commencement of a tender
offer or exchange offer which would result in the person making the offer
becoming an Acquiring Person (irrespective of whether any Shares are actually
purchased pursuant to such offer). As soon as practicable after the Company
has notified the Rights Agent of the occurrence of the Distribution Date, the
Rights Agent will mail separate certificates evidencing the Rights to holders
of record of the Shares as of the close of business on the Distribution Date
and such separate Rights certificates alone will evidence the Rights. The
Distribution Date will occur on the tenth business day following the
commencement by Holding Co. of the Offer unless prior to such date the Board
of Directors of the Company determines to extend the Distribution Date to a
later date.
If the Distribution Date occurs and separate certificates representing the
Rights are distributed by the Company or the Rights Agent to holders of Shares
prior to the time that a holder's Shares are tendered pursuant to the Offer,
certificates representing a number of Rights equal to the number of Shares
tendered must be delivered to the Exchange Agent, or, if available, a Book-
Entry Confirmation (as defined in "--Procedure for Tendering" below) must be
received by the Exchange Agent with respect thereto, in order for such Shares
to be validly tendered. If a Distribution Date occurs and separate
certificates representing the Rights are not distributed prior to the time
Shares are tendered pursuant to the Offer, Rights may be tendered prior to the
stockholder receiving the certificates for Rights by use of the guaranteed
delivery procedure described under "--Procedure for Tendering" below.
EXTENSION, TERMINATION AND AMENDMENT
Holding Co. expressly reserves the right (but will not be obligated), in its
sole discretion, at any time or from time to time, and regardless of whether
any of the events set forth in "--Conditions of the
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Offer" shall have occurred or shall have been determined by Holding Co. to
have occurred, to extend the period of time during which the Offer is to
remain open by giving oral or written notice of such extension to the Exchange
Agent, which extension will be announced no later than 9:00 a.m., Eastern
Time, on the next business day after the previously scheduled Expiration Date.
There can be no assurance that Holding Co. will exercise its right to extend
the Offer. However, it is Holding Co.'s current intention to extend the Offer
until all conditions to the Offer have been satisfied or waived. During any
such extension, all Shares previously tendered and not withdrawn will remain
subject to the Offer, subject to the right of a tendering stockholder to
withdraw his or her Shares. See "--Withdrawal Rights."
Subject to the applicable rules and regulations of the Commission, Holding
Co. also reserves the right, in its sole discretion, at any time or from time
to time, (i) to delay acceptance for exchange of, or, regardless of whether
such Shares were theretofore accepted for exchange, exchange of any Shares
pursuant to the Offer, or to terminate the Offer and not accept for exchange
or exchange any Shares not theretofore accepted for exchange, or exchanged,
upon the failure of any of the conditions of the Offer to be satisfied, and
(ii) to waive any condition (other than the condition relating to the
effectiveness of the Registration Statement) or otherwise amend the Offer in
any respect, by giving oral or written notice of such delay, termination or
amendment to the Exchange Agent and by making a public announcement thereof.
Any such extension, termination, amendment or delay will be followed as
promptly as practicable by public announcement thereof, such announcement in
the case of an extension to be issued no later than 9:00 a.m., Eastern Time,
on the next business day after the previously scheduled Expiration Date.
Subject to applicable law (including Rules 14d-4(c) and 14d-6(d) under the
Exchange Act, which require that any material change in the information
published, sent or given to stockholders in connection with the Offer be
promptly disseminated to stockholders in a manner reasonably designed to
inform stockholders of such change) and without limiting the manner in which
Holding Co. may choose to make any public announcement, Holding Co. shall have
no obligation to publish, advertise or otherwise communicate any such public
announcement other than by making a release to the Dow Jones News Service.
Holding Co. confirms that if it makes a material change in the terms of the
Offer or the information concerning the Offer, or if it waives a material
condition of the Offer, Holding Co. will extend the Offer to the extent
required under the Exchange Act. If, prior to the Expiration Date, Holding Co.
shall increase or decrease the percentage of Shares being sought or the
consideration offered to holders of Shares, such increase or decrease will be
applicable to all holders whose Shares are accepted for exchange pursuant to
the Offer, and, if at the time notice of any such increase or decrease is
first published, sent or given to holders of Shares, the Offer is scheduled to
expire at any time earlier than the tenth business day from and including the
date that such notice is first so published, sent or given, the Offer will be
extended until the expiration of such ten business day period. For purposes of
the Offer, "business day" means any day other than a Saturday, Sunday or a
federal holiday and consists of the time period from 12:01 a.m. through 12:00
midnight, Eastern Time.
EXCHANGE OF SHARES; DELIVERY OF HOLDING CO. COMMON STOCK AND CASH
CONSIDERATION
Upon the terms and subject to the conditions of the Offer (including, if the
Offer is extended or amended, the terms and conditions of any such extension
or amendment), Holding Co. will accept for exchange, and will exchange, Shares
validly tendered and not properly withdrawn as promptly as practicable
following the Expiration Date. In addition, subject to applicable rules of the
Commission, Holding Co. expressly reserves the right to delay acceptance for
exchange or the exchange of Shares in order to comply with any applicable law.
In all cases, exchange of Shares tendered and accepted for exchange pursuant
to the Offer will be made only after timely receipt by the Exchange Agent of
certificates for such Shares (or a confirmation of a book-entry transfer of
such Shares in the Exchange Agent's account at The Depository Trust Company
(the "Book-Entry Transfer Facility")), a properly
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completed and duly executed Letter of Transmittal (or facsimile thereof) and
any other required documents.
For purposes of the Offer, Holding Co. will be deemed to have accepted for
exchange Shares validly tendered and not withdrawn as, if and when Holding Co.
gives oral or written notice to the Exchange Agent of its acceptance of the
tenders of such Shares pursuant to the Offer. Delivery of the Consideration in
exchange for Shares pursuant to the Offer, and cash in lieu of fractional
shares of Holding Co. Common Stock, will be made by the Exchange Agent as soon
as practicable after receipt of such notice. The Exchange Agent will act as
agent for tendering stockholders for the purpose of receiving the
Consideration and cash to be paid in lieu of fractional shares of Holding Co.
Common Stock from Holding Co. and transmitting the Consideration and cash to
tendering stockholders. Under no circumstances will interest with respect to
fractional shares be paid by Holding Co. by reason of any delay in making such
exchange.
If any tendered Shares are not accepted for exchange pursuant to the terms
and conditions of the Offer for any reason, or if certificates are submitted
for more Shares than are tendered or are exchanged, certificates for such
unexchanged Shares will be returned without expense to the tendering
stockholder or, in the case of Shares tendered by book-entry transfer of such
Shares into the Exchange Agent's account at the Book-Entry Transfer Facility
pursuant to the procedures set forth below under "--Procedure for Tendering,"
such Shares will be credited to an account maintained within the Book-Entry
Transfer Facility as soon as practicable following expiration or termination
of the Offer.
CASH IN LIEU OF FRACTIONAL SHARES OF HOLDING CO. COMMON STOCK
No certificates representing fractional shares of Holding Co. Common Stock
will be issued pursuant to the Offer. In lieu thereof, each tendering
stockholder who would otherwise be entitled to a fractional share of Holding
Co. Common Stock will receive cash in an amount equal to such fraction
(expressed as a decimal and rounded to the nearest 0.01 of a share) multiplied
by the closing price for shares of Holding Co. Common Stock on the NYSE
Composite Tape on the date such stockholder's Shares are accepted for exchange
by Holding Co.
WITHDRAWAL RIGHTS
Tenders of Shares made pursuant to the Offer are irrevocable, except that
Shares tendered pursuant to the Offer may be withdrawn pursuant to the
procedures set forth below at any time prior to the Expiration Date, and,
unless theretofore accepted for exchange and exchanged by Holding Co. for the
Consideration pursuant to the Offer, may also be withdrawn at any time after
, 1998.
For a withdrawal to be effective, a written, telegraphic, telex or facsimile
transmission notice of withdrawal must be timely received by the Exchange
Agent at one of its addresses set forth on the back cover of this Prospectus,
and must specify the name of the person having tendered the Shares to be
withdrawn, the number of Shares to be withdrawn and the name of the registered
holder, if different from that of the person who tendered such Shares.
The signature(s) on the notice of withdrawal must be guaranteed by a
financial institution (including most banks, savings and loan associations and
brokerage houses) which is a participant in the Securities Transfer Agents
Medallion Program, the New York Stock Exchange Medallion Signature Program or
the Stock Exchange Medallion Program (an "Eligible Institution") unless such
Shares have been tendered for the account of any Eligible Institution. If
Shares have been tendered pursuant to the procedures for book-entry tender as
set forth below under "--Procedure for Tendering," any notice of withdrawal
must specify the name and number of the account at the Book-Entry Transfer
Facility to be credited with the withdrawn Shares and must otherwise comply
with the Book-Entry Transfer Facility's
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procedures. If certificates have been delivered or otherwise identified to the
Exchange Agent, the name of the registered holder and the serial numbers of
the particular certificates evidencing the Shares withdrawn must also be
furnished to the Exchange Agent as aforesaid prior to the physical release of
such certificates.
All questions as to the form and validity (including time of receipt) of any
notice of withdrawal will be determined by Holding Co., in its sole
discretion, which determination shall be final and binding. Neither Holding
Co., the Exchange Agent, the Information Agent, the Dealer Manager nor any
other person will be under any duty to give notification of any defects or
irregularities in any notice of withdrawal or will incur any liability for
failure to give any such notification. Any Shares properly withdrawn will be
deemed not to have been validly tendered for purposes of the Offer. However,
withdrawn Shares may be retendered by following one of the procedures
described under "--Procedure for Tendering" at any time prior to the
Expiration Date.
A withdrawal of Shares shall also constitute a withdrawal of the associated
Rights. Rights may not be withdrawn unless the associated Shares are also
withdrawn.
PROCEDURE FOR TENDERING
For a stockholder validly to tender Shares pursuant to the Offer, (i) a
properly completed and duly exercised Letter of Transmittal (or manually
executed facsimile thereof), together with any required signature guarantees,
or an Agent's Message (as defined below) in connection with a book-entry
transfer, and any other required documents, must be transmitted to and
received by the Exchange Agent at one of its addresses set forth on the back
cover of this Prospectus and either certificates for tendered Shares must be
received by the Exchange Agent at such address or such Shares must be tendered
pursuant to the procedures for book-entry transfer set forth below (and a
confirmation of receipt of such tender received (such confirmation, a "Book-
Entry Confirmation")), in each case prior to the Expiration Date, or (ii) the
tendering stockholder must comply with the guaranteed delivery procedure set
forth below.
The term "Agent's Message" means a message, transmitted by the Book-Entry
Transfer Facility to, and received by, the Exchange Agent, and forming a part
of a Book-Entry Confirmation, which states that the Book-Entry Transfer
Facility has received an express acknowledgment from the participant in the
Book-Entry Transfer Facility tendering the Shares which are the subject of
such Book-Entry Confirmation, that such participant has received and agrees to
be bound by the terms of the Letter of Transmittal and that Holding Co. may
enforce such agreement against such participant.
Stockholders will be required to tender one Right for each Share tendered in
order to effect a valid tender of Shares, unless the Rights Plan Condition has
been satisfied or waived. Unless the Distribution Date occurs, a tender of
Shares will constitute a tender of the associated Rights. If the Distribution
Date occurs and separate certificates representing the Rights are distributed
by the Company or the Rights Agent to holders of Shares prior to the time a
holder's Shares are tendered pursuant to the Offer, certificates representing
a number of Rights equal to the number of Shares tendered must be delivered to
the Exchange Agent, or, if available, a Book-Entry Confirmation received by
the Exchange Agent with respect thereto, in order for such Shares to be
validly tendered. If the Distribution Date occurs and separate certificates
representing the Rights are not distributed prior to the time Shares are
tendered pursuant to the Offer, Rights may be tendered prior to a stockholder
receiving the certificates for Rights by use of the guaranteed delivery
procedure described below. If Rights certificates are distributed but are not
available to a stockholder prior to the time Shares are tendered pursuant to
the Offer, a tender of Shares constitutes an agreement by the tendering
stockholder to deliver to the Exchange Agent pursuant to the guaranteed
delivery procedure described below, prior to the expiration of the period to
be specified in the Notice of Guaranteed Delivery and the related Letter of
Transmittal for delivery of Rights certificates or a Book-Entry Confirmation
for
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Rights (the "Rights Delivery Period"), Rights certificates representing a
number of Rights equal to the number of Shares tendered. If Rights
certificates are distributed, Holding Co. will distribute a separate letter of
transmittal for such Rights certificates. If Rights certificates are tendered
separately from Shares, then a properly completed letter of transmittal for
Rights certificates (or manually executed facsimile thereof) must be submitted
with respect to such Rights. Holding Co. reserves the right to require that it
receive such Rights certificates (or a Book-Entry Confirmation with respect to
such Rights) prior to accepting Shares for exchange.
Nevertheless, Holding Co. will be entitled to accept for exchange Shares
tendered by a stockholder prior to receipt of the Rights certificates required
to be tendered with such Shares or a Book-Entry Confirmation for such Rights
and either (i) subject to complying with applicable rules and regulations of
the Commission, withhold payment for such Shares pending receipt of the Rights
certificates or a Book-Entry Confirmation for such Rights or (ii) exchange
Shares accepted for exchange pending receipt of the Rights certificates or a
Book-Entry Confirmation for such Rights in reliance upon the guaranteed
delivery procedure described below. In addition, after expiration of the
Rights Delivery Period, Holding Co. may instead elect to reject as invalid a
tender of Shares with respect to which Rights certificates or a Book-Entry
Confirmation for an equal number of Rights have not been received by the
Exchange Agent. Any determination by Holding Co. to make payment for Shares in
reliance upon such guaranteed delivery procedure or, after expiration of the
Rights Delivery Period, to reject a tender as invalid, shall be made, subject
to applicable law, in the sole and absolute discretion of Holding Co.
The Exchange Agent will establish an account with respect to the Shares at
the Book-Entry Transfer Facility for purposes of the Offer within two business
days after the date of the mailing of this Prospectus, and any financial
institution that is a participant in the Book-Entry Transfer Facility's
systems may make book-entry delivery of the Shares by causing the Book-Entry
Transfer Facility to transfer such Shares into the Exchange Agent's account in
accordance with the Book-Entry Transfer Facility's procedure for such
transfer. However, although delivery of Shares may be effected through book-
entry at the Book-Entry Transfer Facility, the Letter of Transmittal (or
facsimile thereof), with any required signature guarantees, or an Agent's
Message in connection with a book-entry transfer, and any other required
documents, must, in any case, be transmitted to and received by the Exchange
Agent at one or more of its addresses set forth on the back cover of this
Prospectus prior to the Expiration Date, or the guaranteed delivery procedure
described below must be complied with. No assurance can be given, however,
that book-entry delivery of Rights will be available. If book-entry delivery
is not available, a tendering stockholder will be required to tender Rights by
means of delivery of Rights certificates or pursuant to the guaranteed
delivery procedure set forth below.
Signatures on all Letters of Transmittal must be guaranteed by an Eligible
Institution, except in cases in which Shares are tendered (i) by a registered
holder of Shares (including any participant in the Book-Entry Transfer
Facility whose name appears on a security position listing as the owner of
Shares) who has not completed either the box entitled "Special Payment
Instructions" or the box entitled "Special Delivery Instructions" on the
Letter of Transmittal or (ii) for the account of an Eligible Institution.
If the certificates for Shares or Rights (if any) are registered in the name
of a person other than the signer of the Letter of Transmittal, or if
certificates for unexchanged Shares or Rights (if any) are to be issued to a
person other than the registered holder(s), the certificates must be endorsed
or accompanied by appropriate stock powers, in either case signed exactly as
the name or names of the registered owner or owners appear on the
certificates, with the signature(s) on the certificates or stock powers
guaranteed as aforesaid.
THE METHOD OF DELIVERY OF SHARE CERTIFICATES AND ALL OTHER REQUIRED
DOCUMENTS, INCLUDING DELIVERY THROUGH THE BOOK-ENTRY TRANSFER FACILITY, IS
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AT THE OPTION AND RISK OF THE TENDERING STOCKHOLDER, AND THE DELIVERY WILL BE
DEEMED MADE ONLY WHEN ACTUALLY RECEIVED BY THE EXCHANGE AGENT. IF DELIVERY IS
BY MAIL, REGISTERED MAIL WITH RETURN RECEIPT REQUESTED, PROPERLY INSURED, IS
RECOMMENDED. IN ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO ENSURE TIMELY
DELIVERY.
If a stockholder desires to tender Shares pursuant to the Offer and such
stockholder's certificates are not immediately available or such stockholder
cannot deliver the certificates and all other required documents to the
Exchange Agent prior to the Expiration Date or such stockholder cannot
complete the procedure for book-entry transfer on a timely basis, such Shares
may nevertheless be tendered, provided that all of the following conditions
are satisfied:
(a) such tenders are made by or through an Eligible Institution;
(b) a properly completed and duly executed Notice of Guaranteed Delivery,
substantially in the form made available by Holding Co., is received by the
Exchange Agent as provided below on or prior to the Expiration Date; and
(c) the certificates for all tendered Shares (or a confirmation of a
book-entry transfer of such securities into the Exchange Agent's account at
the Book-Entry Transfer Facility as described above), in proper form for
transfer, together with a properly completed and duly executed Letter of
Transmittal (or facsimile thereof), with any required signature guarantees
(or, in the case of a book-entry transfer, an Agent's Message) and all
other documents required by the Letter of Transmittal are received by the
Exchange Agent within three NYSE trading days after the date of execution
of such Notice of Guaranteed Delivery. The Notice of Guaranteed Delivery
may be delivered by hand or transmitted by telegram, telex, facsimile
transmission or mail to the Exchange Agent and must include a guarantee by
an Eligible Institution in the form set forth in such Notice.
In all cases, exchanges of Shares tendered and accepted for exchange
pursuant to the Offer will be made only after timely receipt by the Exchange
Agent of certificates for Shares (or timely confirmation of a book-entry
transfer of such securities into the Exchange Agent's account at the Book-
Entry Transfer Facility as described above), properly completed and duly
executed Letter(s) of Transmittal (or facsimile(s) thereof), or an Agent's
Message in connection with a book-entry transfer, and any other required
documents. Accordingly, tendering stockholders may be paid at different times
depending upon when certificates for Shares or confirmations of book-entry
transfers of such Shares are actually received by the Exchange Agent.
By executing a Letter of Transmittal as set forth above, the tendering
stockholder irrevocably appoints designees of Holding Co. as such
stockholder's attorneys-in-fact and proxies, each with full power of
substitution, to the full extent of such stockholder's rights with respect to
the Shares tendered by such stockholder and accepted for exchange by Holding
Co. and with respect to any and all other Shares and other securities issued
or issuable in respect of the Shares from and after the date of this
Prospectus. Such appointment is effective, and voting rights will be effected,
when and only to the extent that Holding Co. deposits the Consideration for
Shares tendered by such stockholder with the Exchange Agent. All such proxies
shall be considered coupled with an interest in the tendered Shares and
therefore shall not be revocable. Upon the effectiveness of such appointment,
all prior proxies given by such stockholder will be revoked, and no subsequent
proxies may be given (and, if given, will not be deemed effective). Holding
Co.'s designees will, with respect to the Shares for which the appointment is
effective, be empowered, among other things, to exercise all voting and other
rights of such stockholder as they, in their sole discretion, deem proper at
any annual, special or adjourned meeting of Company stockholders, by written
consent in lieu of any such meeting or otherwise. Holding Co. reserves the
right to require that, in order for Shares to be deemed validly tendered,
immediately upon Holding Co.'s exchange of such Shares, Holding Co. must be
able to exercise full voting rights with respect to such Shares.
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All questions as to the validity, form, eligibility (including time of
receipt) and acceptance for exchange of any tender of Shares will be
determined by Holding Co., in its sole discretion, which determination shall
be final and binding. Holding Co. reserves the absolute right to reject any
and all tenders of Shares determined by it not to be in proper form or the
acceptance of or exchange for which may, in the opinion of Holding Co.'s
counsel, be unlawful. Holding Co. also reserves the absolute right to waive
any of the conditions of the Offer (other than the condition relating to the
effectiveness of the Registration Statement), or any defect or irregularity in
the tender of any Shares. No tender of Shares will be deemed to have been
validly made until all defects and irregularities in such tender have been
cured or waived. Neither Holding Co., the Exchange Agent, the Information
Agent, the Dealer Manager nor any other person will be under any duty to give
notification of any defects or irregularities in the tender of any Shares or
will incur any liability for failure to give any such notification. Holding
Co.'s interpretation of the terms and conditions of the Offer (including the
Letter of Transmittal and instructions thereto) will be final and binding.
The tender of Shares pursuant to any of the procedures described above will
constitute a binding agreement between the tendering Company stockholder and
Holding Co. upon the terms and subject to the conditions of the Offer.
FEDERAL INCOME TAX WITHHOLDING AND BACKUP WITHHOLDING
To prevent backup U.S. federal income tax withholding equal to 31% of the
gross proceeds (i.e., Holding Co. Common Stock and cash) payable pursuant to
the Offer and the Merger, each stockholder who does not otherwise establish an
exemption from backup withholding must notify the Exchange Agent of such
stockholder's correct taxpayer identification number (or certify that such
taxpayer is awaiting a taxpayer identification number) and provide certain
other information by completing, under penalties of perjury, a Substitute Form
W-9 included in the Letter of Transmittal. Noncorporate foreign stockholders
should generally complete and sign a form W-8, Certificate of Foreign Status,
a copy of which may be obtained from the Exchange Agent, in order to avoid
backup withholding. As more fully described below, in the case of a foreign
stockholder, even if such stockholder has provided the required certification
to avoid backup withholding, the Exchange Agent will withhold 30% of certain
cash payments made pursuant to the Offer and the Merger unless a reduced rate
of withholding or an exemption from withholding is applicable.
The Exchange Agent will withhold U.S. federal income taxes equal to 30% of
the Holding Co. Cash payable to foreign stockholders in the Offer and the
Merger unless Holding Co. and the Exchange Agent determine that (i) a reduced
rate of withholding is available pursuant to a tax treaty or (ii) an exemption
from withholding is applicable because such gross cash proceeds are
effectively connected with the conduct of a trade or business within the
United States. For these purposes, a foreign stockholder is any stockholder
other than a United States Person (as defined below in "--Certain Federal
Income Tax Consequences"). In order to obtain a reduced rate of withholding
pursuant to a tax treaty, a foreign stockholder must deliver to the Exchange
Agent before any payment a properly completed and executed IRS Form 1001. In
order to obtain an exemption from withholding on the grounds that the gross
cash proceeds received from Holding Co. pursuant to the Offer and the Merger
are effectively connected with the conduct of a trade or business within the
United States, a foreign stockholder must deliver to the Exchange Agent before
any payment a properly completed and executed IRS Form 4224. Holding Co. and
the Exchange Agent will determine a stockholder's status as a foreign
stockholder and eligibility for a reduced rate of, or exemption from,
withholding by reference to any outstanding certificates or statements
concerning eligibility for a reduced rate of, or exemption from, withholding
(e.g., IRS Form 1001 or IRS Form 4224) unless facts and circumstances indicate
that such reliance thereon is not warranted. A foreign stockholder may be
eligible to obtain a refund of all or a portion of any tax withheld if such
stockholder meets the "substantially disproportionate" or "meaningful
reduction" tests of Section 302 of the Internal Revenue Code of 1986, as
amended (the "Code"), as
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modified and applied under Section 304 of the Code (see "--Certain Federal
Income Tax Consequences--Stockholders Owning Both Shares and Holding Co.
Common Stock"), or such stockholder is otherwise able to establish that no tax
or a reduced amount of tax is due. Backup withholding generally will not apply
to amounts subject to the 30% or a treaty-reduced rate of withholding.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The following summary describes the material anticipated U.S. federal income
tax consequences of the Offer and the Merger. This discussion does not address
all aspects of U.S. federal income taxation that may be relevant to a
particular investor in light of the investor's particular circumstances, and
may not apply to Company stockholders in special tax situations (such as
insurance companies, regulated investment companies, financial institutions,
dealers in securities, tax exempt organizations, persons who hold Shares as
part of a "straddle," "hedging" or "conversion" transaction or persons whose
functional currency (as defined in Section 985 of the Code) is not the United
States dollar) or to stockholders who acquired their Shares pursuant to the
exercise of employee stock options or warrants, or otherwise as compensation.
The summary also does not discuss the tax consequences to holders of Company
warrants or stock options, nor to persons who exercise dissenters' rights in
the Merger. The discussion below applies only to stockholders who hold their
Shares as capital assets, within the meaning of Section 1221 of the Code. This
discussion is based upon laws, regulations, rulings, administrative
pronouncements and decisions, all as in effect as of the date hereof and all
of which are subject to change (possibly with retroactive effect), and no
ruling has been or will be requested from the Internal Revenue Service on the
tax consequences of the Offer and the Merger.
The discussion below applies only to a United States Person. As used herein,
the term United States Person means (a) a citizen or resident of the United
States, (b) a corporation, partnership, or other entity created or organized
in or under the laws of the United States, any State or any political
subdivision thereof, (c) an estate the income of which is subject to U.S.
federal income taxation regardless of its source or (d) a trust, if a court
within the United States is able to exercise primary supervision over the
administration of the trust and one or more United States Persons have the
authority to control all substantial decisions of the trust.
TAX TREATMENT OF THE OFFER AND THE MERGER. The exchange of Shares for cash
and Holding Co. Common Stock pursuant to the Offer or the Merger (or both)
will be a taxable transaction for U.S. federal income tax purposes, and may
also be taxable under applicable state, local and foreign tax laws. Although,
as described below, the exchange of Shares in the Offer and the Merger is
likely to be governed in part by Section 304 of the Code, in general (subject
to the discussion below with respect to stockholders owning, directly or
constructively, stock in both the Company and Holding Co. other than the
Holding Co. Common Stock received in the Offer or the Merger (see "--
Stockholders Owning Both Shares and Holding Co. Common Stock," below)), for
U.S. federal income tax purposes, each stockholder will recognize capital gain
or loss equal to the difference between (x) the amount of cash and the fair
market value of the shares of Holding Co. Common Stock received and (y) the
stockholder's adjusted tax basis in the Shares exchanged therefor. Calculation
of gain or loss must be made separately for each block of Shares exchanged by
a stockholder. Any gain recognized will (in the case of individual
stockholders) be subject to reduced rates of taxation if the stockholder's
holding period for the Shares exceeds 12 months, subject to further reduction
in the case of Shares held for more than 18 months. The stockholder will have
a tax basis in the Holding Co. Common Stock received equal to the fair market
value thereof, and the stockholder's holding period for the Holding Co. Common
Stock will begin on the day following the date of the exchange.
TREATMENT OF DIVIDENDS TO CORPORATE STOCKHOLDERS. If, as is believed likely,
the Offer and the Merger are treated as a single integrated transaction for
U.S. federal income tax purposes, the portion of a shareholder's Shares
exchanged for cash attributable to Holding Co. (the "Holding Co. Cash") should
be treated as a deemed distribution in redemption of Holding Co. Common Stock
it owns or is considered to own pursuant to Section 304 of the Code. Holding
Co. Cash is equal to the cash exchanged in the Offer and the Merger, minus the
sum of any such cash attributable to cash held by
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the Company immediately prior to the Merger plus any increase in indebtedness
of the Company arising by virtue of the Merger. To the extent that Holding Co.
Cash received in exchange for Shares is treated as a dividend to a corporate
stockholder, such holder will be (i) eligible for a dividends received
deduction (subject to applicable limitations) and (ii) subject to the
"extraordinary dividend" provisions of the Code. Under recently enacted
legislation, any Holding Co. Cash which is treated as a dividend to a
corporate stockholder will constitute an extraordinary dividend, except as
otherwise provided in Treasury regulations which have yet to be promulgated.
Consequently, the nontaxed portion of the dividend would reduce a corporate
holder's adjusted tax basis in the Shares exchanged for Holding Co. Cash, but
not below zero, and would thereafter be taxable as a capital gain from the
sale or exchange of the Shares exchanged for Holding Co. Cash.
TAX TREATMENT IF OFFER AND MERGER ARE NOT INTEGRATED. In the unlikely event
that the Offer and the Merger were not treated as a single integrated
transaction for U.S. federal income tax purposes, both the Offer and the
Merger would be taxable transactions. The cash received in the Offer would be
subject to Section 304 of the Code, and the tax consequences to an individual
stockholder would depend on the application of the Section 302 Tests (as
described above) to such stockholder based on such stockholder's particular
facts and circumstances. The cash received in the Merger might also in part be
subject to Section 304 of the Code. However, any stockholder who tenders all
of its Shares in the Offer should recognize capital gain or loss.
RIGHTS. Because there is no specific binding authority dealing with
securities such as the Rights, it is unclear what the U.S. federal income tax
consequences are of the Rights becoming separately transferable apart from the
Shares, the redemption of the Rights, or the acquisition by Holding Co. of the
Rights. Company stockholders should consult their own tax advisors as to the
tax consequences of transactions with respect to the Rights.
THE FOREGOING DISCUSSION RELATES TO THE MATERIAL ANTICIPATED U.S. FEDERAL
INCOME TAX CONSEQUENCES OF THE OFFER AND THE MERGER. THE ANALYSIS CONTAINED
HEREIN DOES NOT ADDRESS STATE, LOCAL, OR FOREIGN TAX CONSEQUENCES OF THE OFFER
AND THE MERGER, OR ANY OTHER UNITED STATES TAX CONSEQUENCE OTHER THAN INCOME
TAX CONSEQUENCES (E.G., ESTATE OR GIFT TAX CONSEQUENCES), AND DOES NOT
CONSTITUTE TAX ADVICE TO ANY PARTICULAR COMPANY STOCKHOLDER. COMPANY
STOCKHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THE SPECIFIC TAX
CONSEQUENCES OF THE OFFER AND THE MERGER.
See "--Federal Income Tax Withholding and Backup Withholding" for
information regarding the application of U.S. federal income tax withholding
and backup withholding.
EFFECT OF OFFER ON TRADING MARKET; REGISTRATION UNDER THE EXCHANGE ACT
Between the completion of the Offer and the completion of the Merger, the
exchange of Shares pursuant to the Offer will reduce the number of holders of
Shares and the number of Shares that might otherwise trade publicly and could
adversely affect the liquidity and market value of the remaining Shares held
by stockholders of the Company who do not exchange their Shares for Holding
Co. Common Stock. Conversely, as a result of the issuance of Holding Co.
Common Stock in exchange for Shares pursuant to the Offer, Holding Co.
anticipates that the liquidity of Holding Co. Common Stock following the
Transactions will be similar to the liquidity of the Shares prior to the date
of this Prospectus.
SHARES OF THE COMPANY. The Shares are listed and principally traded on the
NYSE. Depending upon the number of Shares acquired pursuant to the Offer,
following consummation of the Offer, the Shares may no longer meet the
requirements of such securities exchanges for continued listing on the NYSE.
For example, published guidelines of the NYSE indicate that the NYSE would
consider delisting the outstanding Shares if, among other things: (i) the
number of publicly held Shares (exclusive of holdings of officers, directors
and members of their immediate families and other concentrated holdings of 10%
or more) should fall below 600,000; (ii) the number of record holders of 100
or more Shares should fall below 1,200; or (iii) the aggregate market value of
publicly held Shares should fall below $8 million.
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If the NYSE were to delist the Shares following the completion of the Offer,
the market for the Shares could be adversely affected. It is possible that the
Shares would be traded on other securities exchanges or in the over-the-
counter market following the completion of the Offer, and that price
quotations would be reported by such exchanges, through the Nasdaq Stock
Market or by other sources. The extent of the public market for the Shares
following the completion of the Offer and the availability of such quotations
would, however, depend upon the number of holders and/or the aggregate market
value of the Shares remaining at such time, the interest in maintaining a
market in the Shares on the part of securities firms, the possible termination
of registration of the Shares under the Exchange Act, as described below, and
other factors.
The Shares are presently "margin securities" under the regulations of the
Federal Reserve Board, which has the effect, among other things, of allowing
brokers to extend credit on the collateral of such Shares. Depending on
factors similar to those described above with respect to listing and market
quotations, following completion of the Offer the Shares may no longer
constitute "margin securities" for the purposes of the Federal Reserve Board's
margin regulations, in which event the Shares would be ineligible as
collateral for margin loans made by brokers. The Shares are currently
registered under the Exchange Act. Such registration may be terminated by the
Company upon application to the Commission if the outstanding Shares are not
listed on a national securities exchange and if there are fewer than 300
holders of record of Shares. Termination of registration of the Shares under
the Exchange Act would reduce the information required to be furnished by the
Company to its stockholders and to the Commission and would make certain
provisions of the Exchange Act, such as the short-swing profit recovery
provisions of Section 16(b) and the requirement of furnishing a proxy
statement in connection with stockholders' meetings pursuant to Section 14(a)
and the related requirement of furnishing an annual report to stockholders, no
longer applicable with respect to the Shares. Furthermore, the ability of
"affiliates" of the Company and persons holding "restricted securities" of the
Company to dispose of such securities pursuant to Rule 144 under the
Securities Act may be impaired or eliminated. If registration of the Shares
under the Exchange Act were terminated, the Shares would no longer be eligible
for the Nasdaq Stock Market reporting or for continued inclusion on the
Federal Reserve Board's list of "margin securities."
The Rights are registered under the Exchange Act and are listed on the NYSE,
but currently are attached to the outstanding Shares and are not separately
transferable. The Rights may become transferable apart from the Shares, unless
previously redeemed or unless the Rights Agreement is amended so as to make
the Offer not applicable to the Rights. If the Rights are not redeemed and the
Rights Agreement is not so amended so as to make the Offer inapplicable to the
Rights and Holding Co. waives the Rights Plan Condition, then the foregoing
discussion with respect to the effect of the Offer on the Shares would be
similarly applicable to the Rights (although the continued listing criteria
are different).
HOLDING CO. COMMON STOCK. Holding Co. intends to apply for the listing of
the Holding Co. Common Stock on either the NYSE, the American Stock Exchange
or the Nasdaq Stock Market and to register the Holding Co. Common Stock under
the Exchange Act effective as of the completion of the Offer. It is a
condition to the Offer that the Holding Co. Common Stock be authorized for
listing on either the NYSE, the American Stock Exchange or the Nasdaq Stock
Market.
PURPOSE OF THE OFFER; THE MERGER
The purpose of the Offer is to enable Holding Co. to obtain control of, and
ultimately the entire equity interest in, the Company.
The Offer, as the first step in the acquisition by Holding Co., is intended
to facilitate the acquisition of all of the Shares. Holding Co. presently
intends, following consummation of the Offer, to propose and seek to have the
Company effect the Merger. In the Merger, each outstanding share (other than
Shares owned by Holding Co. or any of its affiliates, Shares held in the
treasury of the Company or by any subsidiary of the Company and Shares owned
by the Company's stockholders who perfect
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dissenters' rights under Delaware law) would be converted into the right to
receive the Consideration. Assuming (i) the Minimum Tender Condition and the
other Offer Conditions are satisfied (or waived, as applicable), and (ii)
Holding Co. consummates the Offer, and (iii) the Board of Directors of the
Company approves the Merger and submits it for stockholder approval, Holding
Co. would have sufficient voting power to approve the Merger without the vote
of any other stockholders of the Company. If Holding Co. owns 90% or more of
the outstanding Shares, Holding Co. may be able to effect the Merger without
the consent of the Board of Directors or remaining stockholders of the Company
pursuant to Section 253 of the DGCL. See "Dissenter's Rights."
It is Holding Co.'s current intention to consummate the Offer as soon as the
conditions to the Offer are satisfied and to consummate the Merger as soon as
possible after successful completion of the Offer.
Holding Co. reserves the right to change the structure of the Merger to
provide for the merger of a subsidiary of Holding Co. into the Company or for
a merger of the Company into Holding Co. in the context of a negotiated
transaction with the Company.
CONDITIONS OF THE OFFER
MINIMUM TENDER CONDITION. The Offer is conditioned upon, among other things,
there being validly tendered prior to the expiration of the Offer and not
withdrawn prior to the Expiration Date a number of Shares which, together with
Shares owned by Holding Co. and its affiliates, will constitute at least
either (i) 66 2/3% of the total number of outstanding Shares on a fully
diluted basis (as though all options or other securities convertible into or
exercisable or exchangeable for Shares, other than the Rights, had been so
converted, exercised or exchanged) as of the date the Shares are accepted for
exchange by Holding Co. pursuant to the Offer if the Company's Board of
Directors has called or agreed to call a special meeting of stockholders
within sixty (60) days to vote on the Merger or (ii) 90.1% of the total
outstanding Shares on a fully diluted basis as of the date the Shares are
accepted for exchange by Holding Co. According to the Company's Second Quarter
Form 10-Q, as of August 12, 1998, there were 5,398,710 Shares outstanding, and
according to the Company's 1997 Form 10-K, as of December 31, 1997, options
covering an aggregate of 595,000 Shares were outstanding. As of the date of
this Prospectus, Holding Co. owned 1,250 Shares, or one-tenth of 1% of the
outstanding Shares. Based on the foregoing and assuming no additional Shares
have been or will be issued after August 12, 1998 (other than Shares issued
pursuant to the exercise of the outstanding stock options referred to above),
and no options, warrants or rights exercisable for, or securities convertible
into, Shares have been or will be issued after December 31, 1997, the Minimum
Tender Condition would be satisfied if, (i) at least 3,995,807 Shares were
validly tendered into and not withdrawn from the Offer and if the Company's
Board of Directors has called or agreed to call a special meeting of
stockholders within sixty (60) days to vote on the Merger; or (ii) at least
5,400,033 Shares were validly tendered into and not withdrawn from the Offer.
Holding Co. reserves the right (but shall not be obligated), subject to the
rules and regulations of the Commission, to waive or amend the Minimum Tender
Condition and to exchange fewer than such number of Shares as would satisfy
the Minimum Tender Condition pursuant to the Offer; provided, however, that,
in the event of such waiver or amendment, the Offer will expire no sooner than
ten business days from the date of such waiver or amendment.
RIGHTS PLAN CONDITION. The Offer is conditioned upon, among other things,
the satisfaction of the Rights Plan Condition. The Rights Plan Condition may
be satisfied in several ways, including by the Company's Board of Directors
(i) amending the Rights Agreement so that the Rights would not be triggered by
the Offer and the Merger or (ii) redeeming the Rights. For additional
information concerning the Rights Agreement, see "The Offer--The Rights" and
"Comparison of Rights of Holders of Shares and Holding Co. Common Stock."
BUSINESS COMBINATION STATUTE CONDITION. Section 203 of the DGCL provides
that, subject to certain exceptions specified therein, a corporation shall not
engage in any business combination with
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any "interested stockholder" for a three-year period following the date that
such stockholder becomes an interested stockholder unless certain conditions
are satisfied. One of the conditions includes prior approval by the board of
directors of either the transaction in which a person became an "interested
stockholder" or the "business combination."
Generally, Section 203 of the DGCL prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless (i) prior to the
date of the business combination, the transaction is approved by the board of
directors of the corporation, (ii) upon consummation of the transaction which
resulted in the stockholder becoming an interested stockholder, the interested
stockholder owns at least 85% of the outstanding voting stock, or (iii) on or
after such date the business combination is approved by the board and by the
affirmative vote of at least 66 2/3% of the outstanding voting stock which is
not owned by the interested stockholder. A "business combination" includes
mergers, asset sales and other transactions resulting in a financial benefit
to the stockholder. An "interested stockholder" is a person who, together with
affiliates and associates, owns (or if such stockholder is an affiliate or
associate, within three years, did own) 15% or more of the corporation's
voting stock.
REGULATORY APPROVAL CONDITION. The Offer is conditioned upon, among other
things, any regulatory approvals required to consummate the Offer (the
"Requisite Regulatory Approvals") having been obtained and remaining in full
force and effect, all statutory waiting periods in respect thereof having
expired and no such approval containing any conditions or restrictions which
the Board of Directors of Holding Co. determines will or reasonably could be
expected to materially impair the strategic and financial benefits expected to
result from the Offer (the "Regulatory Approval Condition"). Based on the
Company's public filings, these approvals may include the approval of certain
state healthcare regulatory agencies. Holding Co. will use its reasonable best
efforts to obtain the Requisite Regulatory Approvals. Although no assurances
can be given, Holding Co. anticipates that it will receive any Requisite
Regulatory Approvals on a timely basis.
Except as set forth above, based upon an examination of publicly available
information filed by the Company with the Commission and other publicly
available information with respect to the Company, Holding Co. is not aware of
(i) any license or regulatory permit which appears to be material to the
business of the Company and its subsidiaries taken as a whole, and which is
likely to be adversely affected by Holding Co.'s acquisition of Shares
pursuant to the Offer or (ii) any approval or other action by a state, federal
or foreign governmental, administrative or regulatory agency or authority
(each, a "Governmental Entity") that would be required prior to the
acquisition of Shares pursuant to the Offer. Holding Co. presently intends to
take such actions with respect to any approvals as will enable it to
consummate the Offer. In this regard, Holding Co. expressly reserves the right
to challenge the validity and applicability of any state, foreign or other
statutes or regulations purporting to require approval of the consummation of
the Offer.
There can be no assurance that any license, permit, approval or other
action, if needed, would be obtained, or would be obtained without substantial
conditions, or, if so obtained, when it would be obtained, or that adverse
consequences might not result to the Company, Holding Co. or their respective
businesses in the event of adverse regulatory action or inaction.
CERTAIN OTHER CONDITIONS OF THE OFFER. Notwithstanding any other provision
of the Offer and subject to any applicable rules and regulations of the
Commission, including Rule 14e-1(c) under the Exchange Act (relating to
Holding Co.'s obligation to exchange or return tendered Shares promptly after
the termination or withdrawal of the Offer), Holding Co. shall not be required
to accept for exchange or exchange any Shares, may postpone the acceptance for
exchange or exchange for tendered Shares and may, in its sole discretion,
terminate or amend the Offer as to any Shares not then exchanged if, at the
Expiration Date, the Minimum Tender Condition, the Rights Plan Condition,
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the Business Combination Statutes Condition and the Regulatory Approval
Condition shall not have been satisfied or, if legally permissible, waived, or
if on or after the date of this Prospectus and on or prior to the Expiration
Date:
(x) either of the following events shall not have occurred:
(a) The shares of Holding Co. Common Stock (and the accompanying Holding
Co. Rights) which shall be issued to the stockholders of the Company in the
Offer and the Merger shall have been authorized for listing on either the
NYSE, the American Stock Exchange or the Nasdaq Stock Market, subject to
official notice of issuance; or
(b) The Registration Statement shall have become effective under the
Securities Act, and no stop order suspending the effectiveness of the
Registration Statement shall have been issued and no proceedings for that
purpose shall have been initiated or threatened by the Commission; or
(y) any of the following conditions shall exist:
(a) there shall have been threatened or be pending any action or
proceeding before any court or Governmental Entity: (i) challenging or
seeking to restrain or prohibit, or seeking to impose voting, procedural,
price or other requirements, in addition to those required by federal
securities laws and the DGCL (each as in effect on the date of this Offer),
in connection with, the making of the Offer, the acceptance for exchange
of, or exchange for, any Shares by Holding Co. or any affiliate of Holding
Co. or the consummation by Holding Co. or any affiliate of Holding Co. of
the Merger or other business combination with the Company, or seeking to
obtain material damages in connection therewith; (ii) seeking to prohibit
or limit materially the ownership or operation by the Company, Holding Co.
or any of their subsidiaries of any material portion of the business or
assets of the Company, Holding Co. or any of their subsidiaries, or to
compel the Company, Holding Co. or any of their subsidiaries to dispose of
or hold separate any material portion of the business or assets of the
Company, Holding Co. or any of their subsidiaries; (iii) seeking to impose
limitations on the ability of Holding Co. or any affiliate of Holding Co.
to exercise effectively full rights of ownership of any Shares (including
the Rights associated with Shares), including, without limitation, the
right to vote any Shares acquired by Holding Co. pursuant to the Offer or
otherwise on all matters previously presented to the Company's
stockholders; (iv) seeking to require divestiture by Holding Co. or any of
Holding Co.'s affiliates of any Shares; (v) seeking any material diminution
in the benefits expected to be derived by Holding Co. or any affiliates of
Holding Co. as a result of the transactions contemplated by the Offer or
the Merger or any other similar business combination with the Company; (vi)
otherwise directly or indirectly relating to the Offer or which otherwise,
in the reasonable judgment of Holding Co., might materially adversely
affect the Company or any of its subsidiaries or Holding Co. or any
affiliate of Holding Co. or the value of the Shares; or (vii) which
otherwise, in the reasonable judgment of Holding Co., is reasonably likely
to have a material adverse effect on the business, operations (including,
without limitation, result of operations), condition (financial or
otherwise), assets, liabilities or prospects of the Company and its
subsidiaries taken as a whole (a "Material Adverse Effect") or on Holding
Co.;
(b) there shall have been any action taken, or any statute, rule,
regulation, legislation, interpretation, judgment, order or injunction
enacted, entered, enforced, or deemed applicable to (i) Holding Co., the
Company or any affiliate of Holding Co. or the Company or (ii) the Offer or
the Merger or other business combination by Holding Co. or any affiliate of
Holding Co. with the Company, by any legislative body, court, or
Governmental Entity, which, in the reasonable judgment of Holding Co., is
reasonably likely to result, directly or indirectly, in any of the
consequences referred to in clauses (i) through (vii) of paragraph (y)(a)
above;
(c) there shall have occurred any change, condition, event or development
which, individually or in the aggregate, has had or is reasonably likely to
have a Material Adverse Effect or Holding Co. shall have become aware of
any fact of which Holding Co. had no actual or constructive
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knowledge as of the date of this Offer which, individually or in the
aggregate, has had or is reasonably likely to have a Material Adverse
Effect;
(d) there shall have occurred (i) any general suspension of, or
limitation on prices for, trading in securities on any national securities
exchange or in the over-the-counter market in the United States, (ii) any
significant adverse change in interest rates, the financial markets or
major stock exchange indices in the United States or abroad or in the
market price of Shares, including without limitation any decline, measured
from the close of business on the day preceding the date of this
Prospectus, in the Russell 2000 Index by an amount in excess of 10%, (iii)
any change in the general political, market, economic, regulatory or
financial condition in the United States or abroad that could, in the
reasonable business judgment of Holding Co., have a Material Adverse
Effect, (iv) any material adverse change in United States currency exchange
rates or a suspension of, or limitation on, currency exchange markets, (v)
a declaration of a banking moratorium or any suspension of payments in
respect of banks in the United States, (vi) any limitation (whether or not
mandatory) by any government or Governmental Entity on, or other event
that, in the reasonable judgment of Holding Co., might affect the extension
of credit by banks or other lending institutions, (vii) a commencement of a
war or armed hostilities or other national or international calamity
directly or indirectly involving the United States or (viii) in the case of
any of the foregoing existing on the date of this Prospectus a material
acceleration or worsening thereof;
(e) The Company or any of its affiliates shall have, directly or
indirectly, (i) split, combined or otherwise changed, or authorized or
proposed a split, combination or other change of, the Shares or its
capitalization (other than by redemption of the Rights in accordance with
their terms as such terms have been publicly disclosed prior to the date of
this Offer), (ii) acquired or otherwise caused a reduction in the number
of, or authorized or proposed the acquisition or other reduction in the
number of, outstanding Shares or other securities (other than as
aforesaid), (iii) issued or sold, or authorized or proposed the issuance,
distribution or sale of, additional Shares (other than the issuance of
Shares under options granted prior to the date of this Offer, in accordance
with the terms of such options as such terms have been publicly disclosed
prior to the date of this Offer), shares of any other class of capital
stock, other voting securities or any securities convertible into, or
rights, warrants or options, conditional or otherwise, to acquire, any of
the foregoing, (iv) declared or paid, or proposed to declare or pay, any
dividend or other distribution, whether payable in cash, securities or
other property, on or with respect to any shares of capital stock of the
Company (other than in the event the Rights are redeemed, the price of
redemption thereof), (v) altered or proposed to alter any material term of
any outstanding security (including the Rights) other than to amend the
Rights Agreement to make the Rights inapplicable to the Offer and the
Merger, (vi) incurred any debt other than in the ordinary course of
business or any debt containing burdensome covenants, (vii) authorized,
recommended, proposed or entered into an agreement, arrangement or
understanding with respect to any merger, consolidation, liquidation,
dissolution, business combination, acquisition of assets, disposition of
assets, release or relinquishment of any material contractual or other
right of the Company or any of its subsidiaries or any comparable event not
in the ordinary course of business, (viii) authorized, recommended,
proposed or entered into, or announced its intention to authorize,
recommend, propose or enter into, any agreement, arrangement or
understanding with any person or group that in the reasonable judgment of
Holding Co. could adversely affect either the value of the Company or any
of its subsidiaries or other affiliates or the value of the Shares to
Holding Co. or any affiliate of Holding Co., (ix) entered into or amended
any employment, change in control, severance, executive compensation or
similar agreement, arrangement or plan with or for the benefit of any of
its employees, consultants or directors, or made grants or awards
thereunder, other than in the ordinary course of business or entered into
or amended any agreements, arrangements or plans so as to provide for
increased or accelerated benefits to any such person, (x) except as may be
required by law, taken any action to terminate or amend any employee
benefit plan (as defined in Section 3(3) of the Employee Retirement Income
Security Act of 1974, as amended) of the Company or any of its
subsidiaries,
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(xi) amended or authorized or proposed any amendment to the Company's
Certificate of Incorporation or Bylaws, or (xii) Holding Co. shall have
become aware that the Company or any of its subsidiaries shall have taken
any of the foregoing actions that was not disclosed in publicly available
filings prior to the date of this Offer;
(f) Holding Co. shall have reached an agreement or understanding with the
Company providing for termination of the Offer, or Holding Co. or any
affiliate of Holding Co. shall have entered into a definitive agreement or
announced an agreement in principle with the Company providing for a merger
or other business combination with the Company or the purchase of stock or
assets of the Company;
which, in the reasonable judgment of Holding Co. in any such case, and
regardless of the circumstances (including any action or inaction by Holding
Co. or any of its affiliates) giving rise to any such condition, makes it
inadvisable to proceed with such acceptance for payment.
The foregoing conditions are for the sole benefit of Holding Co. and may be
asserted by Holding Co. regardless of the circumstances giving rise to any
such condition or may be waived by Holding Co. in whole or in part at any time
and from time to time. The determination as to whether any condition has been
satisfied shall be in the reasonable judgment of Holding Co. and will be final
and binding on all parties. The failure by Holding Co. at any time to exercise
any of the foregoing rights shall not be deemed a waiver of any such right;
the waiver of any such right with respect to particular facts and
circumstances shall not be deemed a waiver with respect to any other facts and
circumstances; and each such right shall be deemed an ongoing right that may
be asserted at any time and from time to time. Notwithstanding the fact that
Holding Co. reserves the right to assert the failure of a condition following
acceptance for exchange but prior to exchange in order to delay exchange or
cancel its obligation to exchange properly tendered Shares, Holding Co. will
either promptly exchange such Shares or promptly return such Shares.
SOURCE AND AMOUNT OF FUNDS
Holding Co. estimates that the total amount of funds that will be required
to pay the cash component of the Consideration in the Transactions, severance
payments under existing employment agreements and fees and expenses related to
the Transactions will be approximately $10.4 million, excluding any amounts
required to finance outstanding debt or to provide working capital. See "--
Fees and Expenses" and "--Change of Control Provisions." OWWI or other
investors identified by OWWI will provide Holding Co. up to $25.4 million of
financing. See "Financing Commitments".
CHANGE IN CONTROL PROVISIONS
The Transactions are expected to constitute a change in control pursuant to
certain of the Company's contracts and compensation programs.
The Company has employment agreements with certain members of management
that provide for the payment to these members of amounts up to 2.5 times their
annual base salary in the event of a termination without cause, a constructive
discharge (as defined), or upon a change in control of the Company (as
defined). The maximum contingent liability under these agreements is
approximately $1.6 million. In addition, upon the occurrence of any triggering
event, certain executives may elect to require the Company to purchase options
granted to them for a purchase price equal to the difference between the fair
market value of the Company's common stock at the date of termination and the
stated option exercise price. The Company has established a Supplemental
Executive Retirement Plan (the "SERP") to provide retirement benefits for
officers and employees of the Company who have been designated for
participation by the President of the Company. If there is a change in control
of the Company as defined in the SERP, all participants would become fully
vested, and each participant would be entitled to receive his or her benefits
under the SERP upon termination of employment.
43
<PAGE>
Certain of the leases and related documents between the Company and OHI
provide for acceleration of the Company's obligations or an event of default
in the event of a change in control. OHI has agreed to consent to the
Transactions and waive any defaults resulting solely from the consummation of
the Transactions.
The Company's lines of credit generally prohibit mergers involving the
Company and certain changes in senior management of the Company. As of August
12, 1998, the Company had fully drawn all amounts available under its $10.0
million working capital line of credit and $1.25 million "overline" increase
in its working capital line and had announced the "overline" was further
increased to $4.0 million as of August 14, 1998. Holding Co. intends to
negotiate with the Company's lenders to waive any default resulting from the
Transactions or alternatively refinance the outstanding balance thereunder
through other lenders based on the financing commitments provided by OWWI and
improved prospects for the Company following the Transactions. No assurance
can be given at this time that Holding Co. will be able to obtain such waivers
from the existing lender or refinance the balance outstanding under the
existing lines of credit on acceptable terms.
Other than documents filed by the Company with the Commission, Holding Co.
has not had access to, and therefore has not been able to review, any of the
documents governing any indebtedness of the Company or other material
contracts of the Company. Some or all of these documents may contain
provisions for acceleration of the Company's indebtedness or obligations upon
a change in control of the Company. In such event, Holding Co. may be required
to seek additional interim financing from OWWI or other sources.
RELATIONSHIPS WITH THE COMPANY
Except as set forth below, neither Holding Co. nor, to the best of its
knowledge, any of its directors, director nominees, executive officers nor any
associate or majority-owned subsidiary of any of the foregoing, beneficially
owns or has a right to acquire any equity securities of the Company:
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
SHAREHOLDER OWNED AS OF AUGUST 26, 1998
----------- ---------------------------
<S> <C>
Holding Co...................................... 1,250
Essel W. Bailey, Jr............................. 1,000
John H. Stoddard................................ 1,000
W. Blaine Sheffield............................. 500
</TABLE>
Mr. Bailey's shares are held jointly with his spouse.
Other than the transfer of 1,250 Shares from Mr. Crosby to Holding Co. in
connection with the organization of Holding Co., neither Holding Co. nor, to
the best of its knowledge, any of the persons or entities referred to above,
nor any director, executive officer or subsidiary of any of the foregoing, has
effected any transaction in equity securities of the Company during the last
60 days.
Except as described in this Prospectus, neither Holding Co. nor, to the best
of its knowledge, any of its directors or executive officers has: (i) any
contract, arrangement, understanding or relationship with any other person
with respect to any securities of the Company, including, but not limited to,
any contract, arrangement, understanding or relationship concerning the
transfer or the voting of any such securities, joint ventures, loan or option
arrangements, puts or calls, guaranties of loans, guaranties against loss or
the giving or withholding of proxies; (ii) had any contacts or negotiations
with the Company or its affiliates concerning a merger, consolidation or
acquisition, a tender offer or other acquisition of securities, an election of
directors, or a sale or other transfer of a material amount of assets; or
(iii) has had any transaction with the Company or any of its executive
officers, directors or affiliates that would require disclosure under the
rules and regulations of the Commission applicable to the Offer.
44
<PAGE>
FEES AND EXPENSES
Schroders is acting as financial advisor to Holding Co. in connection with
the Transactions, and as Dealer Manager of the Offer, for which services
Holding Co. has agreed to pay a fee, which is contingent upon the consummation
of the Transactions, equal to 1% of the Transaction Value (as defined). For
purposes of the Schroders engagement, Transaction Value means the aggregate
market value of the outstanding Shares and outstanding common stock
equivalents (such as options) and gross debt of the Company immediately prior
to the completion of the Offer. Holding Co. has also agreed to reimburse
Schroders for its reasonable out-of-pocket expenses, including reasonable
attorneys' fees up to a specified maximum, and has agreed to indemnify
Schroders and certain related persons and entities against certain liabilities
and expenses in connection with its engagement, including certain liabilities
under the federal securities laws. OWWI has guaranteed Holding Co.'s
indemnification obligations to Schroders. In connection with the Schroders
engagement as financial advisor, officers and employees of Schroders may
communicate in person, by telephone or otherwise with a limited number of
institutions, brokers or other persons who are stockholders of the Company.
Schroder will not receive any fee for or in connection with such solicitation
activities by its officers and employees apart from the fees it is otherwise
entitled to receive as described above.
Holding Co. will pay the Exchange Agent reasonable and customary
compensation for its services in connection with the Offer, plus reimbursement
for out-of-pocket expenses, and will indemnify the Exchange Agent against
certain liabilities and expenses in connection therewith, including
liabilities under the federal securities laws.
Holding Co. has retained to act as Information Agent in connection
with the Offer. The Information Agent may contact holders of Shares by mail,
telephone, telex, telegraph and personal interviews and may request brokers,
dealers and other nominee stockholders to forward the Offer materials to
beneficial owners of Shares. The Information Agent will be paid reasonable and
customary compensation for such services, plus reimbursement of out-of-pocket
expenses, and Holding Co. will indemnify the Information Agent against certain
liabilities and expenses in connection with the Offer, including liabilities
under federal securities laws.
Holding Co. will not pay any fees or commissions to any broker or dealer or
other person for soliciting tenders of Shares pursuant to the Offer. Brokers,
dealers, commercial banks and trust companies will be reimbursed by Holding
Co. for customary mailing and handling expenses incurred by them in forwarding
material to their customers.
ACCOUNTING TREATMENT
The Offer and the Merger will be accounted for as a reverse acquisition as
the stockholders of the Company will own a majority of the shares of Holding
Co. upon completion of the Merger. Accordingly, for accounting purposes,
Holding Co. is treated as the acquired company and the Company is considered
to be the acquiring company. Under reverse acquisition accounting, the
purchase price is based on the market value of the Holding Co. Common Stock at
the date of acquisition as measured by the net carrying amount of the
Company's net assets. The cash portion of the Consideration will be accounted
for as a dividend by the combined company as measured by the net carrying
amount of the Company's net assets..
DISSENTERS' RIGHTS
The following discussion is not a complete statement of the law pertaining
to dissenters' rights under the DGCL and is qualified in its entirety by the
full text of Section 262 thereof.
Holders of Shares do not have dissenters' rights as a result of the Offer
and, assuming the Shares remain listed on the NYSE or a similar market, will
not have dissenters' rights as a result of the Merger. However, in the event
the Merger is consummated, and if, on the date fixed to determine stockholders
45
<PAGE>
entitled to vote on the Merger, the Shares are no longer listed on the NYSE, a
national securities exchange or the Nasdaq National Market or a similar
market, holders of Shares will have certain rights pursuant to the provisions
of Section 262 of the DGCL to dissent and to demand appraisal of their Shares.
Under Section 262, dissenting stockholders who comply with the applicable
statutory procedures would be entitled to receive a judicial determination of
the fair value of their Shares (exclusive of any element of value arising from
the accomplishment or expectation of the Merger) and to receive payment of
such fair value in cash, together with a fair rate of interest, if any. Any
such judicial determination of the fair value of Shares could be based upon
factors other than, or in addition to, the price per Share to be paid in the
Merger or the market value of the Shares. The value so determined could be
more or less than the price per Share to be paid in the Merger.
46
<PAGE>
FINANCING COMMITMENTS
EQUITY FINANCING
In connection with the Transactions, OWWI has agreed to the Equity Financing
at a purchase price of $6.59 per share upon Holding Co.'s acceptance of Shares
tendered for exchange pursuant to the Offer. The purchase price for the
Holding Co. Common Stock will equal the average closing sale price for the
Shares as reported on the NYSE Composite Tape for the 20 trading days
immediately preceding August 27, 1998, the filing date of the Registration
Statement of which this Prospectus is a part.
CONVERTIBLE DEBT FINANCING
In addition to the Equity Financing, OWWI has committed to the Convertible
Financing to purchase Debentures at the option of the Independent Directors.
Such commitment has been provided without any commitment fee or fees for
acceptance. Prior to commencing the Offer, Holding Co. will obtain commitments
for at least an additional $15.0 million of Convertible Financing from OWWI or
other investors identified by OWWI. Holding Co. and OWWI are highly confident
that such additional commitments will be obtained. The terms of the Debentures
must be approved by the Independent Directors, but are expected to provide as
follows:
<TABLE>
<C> <S>
ISSUE PRICE: 100% of principal amount.
DRAW ON COMMITMENT: Issuable at the option of the Independent Directors at
any time until the second anniversary of the completion
of the Offer.
INTEREST: 7% per annum, payable semi-annually in arrears.
MATURITY: Seventh anniversary of issuance.
CONVERSION: Convertible into Holding Co. Common Stock at a
conversion price of $8.07 per share, representing a
22.5% premium over the purchase price to be paid by OWWI
in the Equity Financing.
REDEMPTION: Non-redeemable until the third anniversary of issuance.
Thereafter, redeemable at the option of Holding Co. at
any time, in whole or in part, at the redemption prices
set forth on the following schedule, together with
accrued and unpaid interest:
</TABLE>
<TABLE>
REDEMPTION PRICE
REDEMPTION AS A PERCENTAGE
ON OR AFTER OF FACE AMOUNT
----------- ----------------
<S> <C>
Third Anniversary of Issuance........ 103%
Fourth Anniversary of Issuance....... 102%
Fifth Anniversary of Issuance........ 101%
Sixth Anniversary of Issuance........ 100%
</TABLE>
RANKING: Subordinated to all Senior Indebtedness and pari
passu with all existing subordinated indebtedness.
USE OF PROCEEDS: The proceeds of the Convertible Financing will be
used to:
(i) partly repay and refinance the maturing $34.1
million Pierce Acquisition bridge loan; see
"Risk Factors--Ability to Pay Debt Due in
1999";
(ii) partly repay and refinance the Company's
$11.25 million working capital line, which
was fully drawn (including the $1.25 million
temporary "overline" increase) as of August
12, 1998;
(iii) finance capital expenditures for which the
Company currently lacks the needed funds;
(iv) fund severance payments under existing
employment agreements and fees and expenses
related to the Transactions; and
(v) as otherwise determined to be appropriate by
the Independent Directors.
47
<PAGE>
REGISTRATION RIGHTS
In connection with the Equity Financing and Convertible Financing, Holding
Co. will agree to file at its expense up to two registration statements under
the Securities Act to register the sale of the Holding Co. Common Stock issued
in the Equity Financing or upon conversion of the Debentures issued in the
Convertible Financing upon the request of the holders of such Holding Co.
Common Stock received after the first anniversary of the Transactions. In
addition to the foregoing "demand registration rights," Holding Co. will also
be obligated to include such shares of Holding Co. Common Stock on certain
other registration statements filed by Holding Co.
CERTAIN INFORMATION REGARDING THE COMPANY
Publicly available information regarding the Company is contained in the
Company's 1997 Form 10-K included as Annex A hereto, the Company's Annual
Meeting Proxy Statement included as Annex B hereto, the Company's First
Quarter Form 10-Q included as Annex C hereto, and the Company's Second Quarter
Form 10-Q included as Annex D hereto.
CERTAIN INFORMATION REGARDING HOLDING CO.
GENERAL
Holding Co. is a newly formed corporation organized for the purpose of
acquiring the Company as more fully set forth herein. Holding Co.'s sole
activities to date have been related to the Offer and the transactions
described herein. Holding Co.'s mailing address is 6600 Peachtree Dunwoody
Road, 400 Embassy Row, Suite 410, Atlanta, Georgia 30328 and its telephone
number is (770) 668-0142. For information concerning the Company, see Annexes
A, B, C and D hereto.
STRATEGY
Holding Co. believes that the Company's present base of operations is
inadequate to enable the Company to participate in the emerging consolidation
trend occurring in the long-term care industry in the United States. In
addition, Holding Co. believes that the Company's management does not possess
the necessary experience to develop and implement the systems and procedures
required to effectively manage its existing portfolio of assets in the rapidly
changing regulatory and reimbursement environment for long-term care
providers.
Through a management contract with Atrium, Holding Co. would provide the
Company with access to a seasoned and proven team of operators who possess the
management skills to position the Company to address the increasingly complex
regulatory and reimbursement challenges. Furthermore, OWWI's equity investment
will provide the basis for a strategic partnership with OWWI, companies with
access to the financial resources required by the Company to refinance a
substantial portion of its significant indebtedness that matures by July 1999.
OWWI also will provide the Company with access to acquisition and other
strategic growth opportunities that would not otherwise be available to the
Company as well as the ability to analyze, structure and finance appropriate
opportunities to position the Company to build a large integrated network of
long-tem care facilities and emerge as a viable competitor in the rapidly
growing market for long-term care services. See "Reasons for the Offer--
Strategies to Address Current and Future Challenges."
MANAGEMENT
MANAGEMENT AGREEMENT. In connection with the Transactions, Holding Co.
intends to enter into the Management Agreement with Atrium pursuant to which
Atrium will provide certain "central office" management services to Holding
Co. and the Company following the Transactions during a three-year
48
<PAGE>
term. The management services to be provided to the Company would include
strategic planning, executive leadership, supervision of regional personnel
and operations, and enterprise level (in contrast to facility level) functions
such as accounting, data processing, investor relations, billing and accounts
receivable monitoring. Atrium expects to sub-contract with OWWI to provide the
board of directors of Holding Co. with analyses and recommendations regarding
financing alternatives as well as acquisition and investment opportunities.
The Management Agreement must be approved by a majority of Independent
Directors. It is contemplated that the Management Fee payable to Atrium during
the first year under the Management Agreement will equal the Company's General
and Administrative Expense for the most recent twelve months period prior to
the completion of the Transactions, less the amount of the Company's remaining
general and administrative expenses following the Transactions attributable to
activities that continue to be performed by the Company. It is anticipated
that the services to be provided by Atrium under the Management Agreement will
largely eliminate the need to incur significant central office General and
Administrative Expense other than (i) costs incurred in connection with its
status as a public company, such as public reporting, compliance and investor
relations, and (ii) field-based expenses, such as regional or facility-based
record-keeping and administrative expenses. Atrium would intend to develop,
with the assistance of the Independent Directors, a performance metric for the
Management Fee in the second and third years under the Management Agreement to
reward Atrium for developing enhanced economic activity such as an expanded
scope of operations conducted on a more profitable basis. In the event Atrium
and the Independent Directors are unable to agree on an appropriate
performance metric, the Management Fee for the second and third years will
equal 6% of Holding Co.'s annual consolidated revenues. In the event that the
Management Agreement is terminated by Holding Co. prior to the third
anniversary in connection with a change of control, Atrium will be entitled to
a termination fee equal to the LESSER of (i) 10% of the increase in the equity
value of the outstanding Holding Co. Common Stock at termination as compared
to the equity value of the outstanding Shares on August 26, 1998, as adjusted
to reflect changes in capitalization such as additional issuances of equity or
repurchases, or (ii) $5.0 million.
The Management Fee may be adjusted by the Independent Directors to reflect
additional functions and responsibilities of Atrium, including growth in
facilities of the Company, and the services provided pursuant to the
Management Agreement.
EXECUTIVE OFFICERS AND DIRECTORS.
The following table sets forth certain information regarding the directors
and executive officers of Holding Co. as well as persons who have agreed to
serve as directors or executive officers of Holding Co. as of the consummation
of the Offer.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Essel W. Bailey, Jr............ 53 Chairman of the Board*
Francis J. Crosby.............. 49 President, Chief Executive Officer
and Director
John H. Stoddard............... 56 Executive Vice President, Chief Financial
Officer and Director
W. Blaine Sheffield............ 51 Vice President of Operations
Patrick B. Long................ 58 Director*
John R. Moss................... 53 Director*
</TABLE>
[Additional Independent Directors to be named]
- ----------
*As of the consummation of the Offer.
49
<PAGE>
Mr. Bailey shall serve as the Chairman of the Board of Holding Co. upon
consummation of the Offer. Mr. Bailey is also a director of OWWI and has
served as its President and Chief Executive Officer since November 13, 1997.
Mr. Bailey has been President and Chief Executive Officer of OHI, as well as a
Director, since its formation in 1992 and Chairman of the Board since July
1995. It is anticipated that Mr. Bailey will spend a majority of his time on
the affairs of OHI. Prior to 1992, he was a Managing Director of Omega
Capital, a healthcare investment partnership, from 1986. Mr. Bailey is
formerly a Director of Evergreen Healthcare, Inc., which was a NYSE listed
company engaged in the operation of long-term healthcare facilities, and is
currently a Managing Director of Principal Healthcare Finance Ltd., a Jersey
company, and a Director of Vitalink Pharmacy Services, Inc., a NYSE listed
company and the fourth largest institutional pharmacy serving the long-term
care industry in the United States.
Mr. Crosby is the Chief Executive Officer, President and a director of
Holding Co. Mr. Crosby has served as the President of Essex and Atrium since
August 1997. Previously, Mr. Crosby served as the President of Atrium Living
Centers, Inc., a nursing home management company from 1988 to 1997, which was
a predecessor entity to Atrium.
Mr. Stoddard is the Executive Vice President, the Chief Financial Officer
and a director of Holding Co. He has served as the Executive Vice President
and Chief Financial Officer of Essex and Atrium since September 1997.
Previously, he served as the President of Qualicorp, Inc. and subsidiaries and
as the Managing General Partner of a series of limited partnerships which
owned nursing homes and medical office buildings from 1988 to 1997.
Mr. Sheffield is the Vice President of Operations of Holding Co. He has
served as the Executive Vice President of Operations of Atrium and Essex since
September 1997. From June 1997 until August 1997, Mr. Sheffield served as the
regional operations manager of Sunrise Healthcare Corp. From 1990 to 1997, Mr.
Sheffield served as the Executive Vice President of Operations of Atrium
Living Centers, Inc., which was a predecessor to Atrium.
Mr. Long has been Chief Executive Officer of Hill Advisors, Inc., a
management advisory firm since January 1, 1996. Prior thereto, he was Chief
Executive Officer of KMS Industries, Inc., a research and development company.
Mr. Long is also a director of Wayne Himmer Money Fund Trust and Wayne Himmer
Growth Fund Trust, which are both registered under the Investment Company Act
of 1940, as amended.
Mr. Moss has served as the Chief Executive Officer of Banaberry Healthcare
(UK) Ltd. since 1997. Previously, Mr. Moss served as a director of Exceler
Healthcare Ltd., a company wholly owned by Sun Healthcare Group, Inc.
EXECUTIVE COMPENSATION. Holding Co. was recently formed. None of Holding
Co.'s executive officers has received compensation from or on behalf of
Holding Co. since its formation. None of the executive officers will be direct
employees of Holding Co. The executive officers will provide services for
Holding Co. pursuant to the Management Agreement.
Holding Co. has not granted any options or other equity incentives to the
Holding Co. named executive officers.
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Holding Co. proposes to enter into the Management Agreement with Atrium. Mr.
Crosby, the President and Chief Executive Officer of Holding Co. is the
President and Chief Executive Officer of Atrium. Mr. Stoddard is the Executive
Vice President, Chief Financial Officer and a Director of Holding Company and
Atrium. Mr. Sheffield is the Vice President of Operations of Holding Co. and
Atrium. The
50
<PAGE>
interests of the Holding Co. (and following the Transactions, the Company)
could conflict with the interests of Atrium and/or Messrs. Crosby, Stoddard
and Sheffield. Decisions with respect to matters involving Holding Co. or the
Company, on the one hand, and Atrium or Messrs. Crosby, Stoddard or Sheffield,
on the other, will be made by a majority of the Independent Directors.
The Company has a master lease with OHI covering 21 facilities (the "Master
Lease"), which provides for an initial term of ten years through August 2002
and allows the Company one ten-year renewal option. The Master Lease provides
for annual increases in the rent based upon inflation or a percentage of the
increase in the net revenues of the facilities, whichever results in the
greater increase in rent, up to a maximum increase equal to 5.0% of the prior
year's rent. The Company entered into new agreements with OHI in 1994 with
respect to ten facilities (one of which was closed in April 1997). The Company
currently leases five of these facilities from OHI pursuant to a new master
lease agreement (the "1994 Omega Lease"). Pending the completion of a formal
lease, the remaining four facilities are managed by the Company pursuant to an
interim management agreement under which the Company is entitled to the net
profits of the facility. The Company classifies all four of these facilities
as leased facilities. The 1994 Omega Lease provides for an initial term of ten
years and provides the Company two five-year renewal options. The rent with
respect to these facilities is subject to increases under a formula similar to
that of the Master Lease up to a maximum increase of 3.9% of the prior year's
rent. During the year ended December 31, 1997, the patient and resident
revenues from the Omega leased facilities were approximately $90.7 million. A
default with respect to any one facility would constitute a default with
respect to all the facilities covered by the Master Lease of the 1994 Omega
Lease, as applicable. The Company leases four additional facilities from
Counsel Corporation ("Counsel") with a lease term through August 2002. These
facilities are subject to a participating mortgage from Counsel in favor of
OHI. At the end of the lease term, the Company has the right to purchase these
facilities. In addition, the Company can require Counsel to transfer these
facilities to OHI, at which time the Company has the right to lease these
facilities from OHI in accordance with the terms of the Master Lease. Rent
increases with respect to these facilities are calculated under the same terms
as applicable in the Master Lease. During the year ended December 31, 1997,
the patient and resident revenues from the Counsel leased facilities were
approximately $27.7 million. The Counsel leases provide that a default under
any one of the leases constitutes a default under all of the leases. Mr.
Bailey is a director of Holding Co. and the Chairman, President and Chief
Executive Officer of OHI and President and Chief Executive Officer and
Director of OWWI. Decisions with respect to matters involving Holding Co. or
the Company, on the one hand, and OWWI, OHI or their affiliates, on the other,
will be made by a majority of the Independent Directors.
PRINCIPAL STOCKHOLDERS
The following table sets forth the number of shares of Holding Co. Common
Stock and percentage of the outstanding Holding Co. Common Stock beneficially
owned as of August 26, 1998 and on a pro forma basis to reflect the
Transactions by (i) each of Holding Co.'s directors and director nominees,
(ii) each beneficial owner of 5% or more of the outstanding Holding Co. Common
Stock, and (iii) Holding Co.'s chief executive officer and other executive
officers. For information regarding principal stockholders of the Company who
may become principal stockholders of Holding Co. pursuant to the Transactions,
see "Stock Ownership of Directors, Executive Officers and Principal Holders"
in the Company's Annual Meeting Proxy Statement attached hereto as Annex B.
<TABLE>
<CAPTION>
HOLDING CO.
-----------------------------------
ACTUAL PRO FORMA
-------------- --------------------
SHARES PERCENT SHARES PERCENT
------ ------- ------- -------
<S> <C> <C> <C> <C>
Francis J. Crosby........................... 3,266 40 3,266 *
John H. Stoddard............................ 3,266 40 4,266 *
OWWI........................................ 1,633 20 820,726(/1/) 13.2%
W. Blaine Sheffield......................... -- -- 500 *
</TABLE>
51
<PAGE>
- ----------
* Less than 1%
(1) Includes 819,476 shares of Holding Co. Common Stock issuable in connection
with the Equity Financing. Excludes Holding Co. Common Stock issuable upon
the conversion of Debentures which OWWI has committed to purchase upon
request of Holding Co.'s Independent Directors. (See "Financing
Commitment").
DESCRIPTION OF HOLDING CO. CAPITAL STOCK;COMPARISON OF STOCKHOLDER RIGHTS
Pursuant to the Offer, stockholders of the Company whose Shares are
purchased in the Offer will receive Holding Co. Common Stock in exchange for
their Shares and will become stockholders of Holding Co., and their rights
will be governed by the Holding Co.'s Certificate of Incorporation and Bylaws.
Holding Co. intends for the material legal rights and characteristics of
Holding Co. Common Stock to be identical to the greatest extent possible to
the existing legal rights and characteristics of the Shares of the Company,
except that Holding Co. has no present intention to implement a so-called
"poison pill" stockholder rights plan such as the Company's Rights Agreement.
Accordingly, Holding Co.'s Certificate of Incorporation and Bylaws will be
amended and restated prior to the consummation of the Offer into forms which
are substantially similar in all material respects (other than identity of
initial directors) to the Company's Certificate of Incorporation and Bylaws.
The Holding Co.'s Certificate of Incorporation and Bylaws as proposed to be
amended and restated and in effect following consummation of the Offer and the
Merger are filed as exhibits to the Registration Statement of which this
Prospectus is a part and are described below.
The following summary does not purport to be a complete statement of the
rights of stockholders under Holding Co.'s Certificate of Incorporation,
Bylaws and other governing instruments and applicable law, as compared with
the rights of the Company's stockholders under the Company's Certificate of
Incorporation, Bylaws and other governing instruments and applicable law, or a
complete description of the specific provisions referred to herein. The
summary is qualified in its entirety by reference to the governing corporate
instruments of Holding Co. and the Company, respectively, to which
stockholders are referred. For information as to how these corporate
instruments may be obtained, see "Available Information."
SUMMARY
Immediately following the consummation of the Offer and the Merger, the
Holding Co.'s Certificate of Incorporation and Bylaws will be amended and
restated into forms which are based upon, and similar in all material respects
to, the Company's Certificate of Incorporation and Bylaws, except for the
designation of the initial directors of Holding Co.
Holding Co. is authorized to issue 20,000,000 shares of Holding Co. Common
Stock, par value $0.01 per share, and 1,000,000 shares of Serial Preferred
Stock, par value $0.10 per share (the "Holding Co. Preferred Stock"). As of
the date of this Prospectus, there were 8,165 shares of Holding Co. Common
Stock outstanding and no shares of Holding Co. Preferred Stock outstanding.
COMMON STOCK
Holders of the Holding Co. Common Stock are entitled to one vote per share
on all matters to be voted on by the shareholders. The Holding Co.'s
Certificate of Incorporation does not provide for cumulative voting and,
accordingly, the holders of a majority of the outstanding shares have the
power to elect all directors and to control the resolution of all issues put
to a vote of the shareholders. The quorum required at a shareholders' meeting
for consideration of any matter is a majority of the shares entitled to vote
on that matter, represented in person or by proxy. If a quorum is present, the
affirmative
52
<PAGE>
vote of a majority of the shares voting on the matter at the meeting is
required for shareholder approval.
The shares of Holding Co. Common Stock have the following rights, subject,
in each case, to the rights of the holders of any outstanding Holding Co.
Preferred Stock: (i) to receive dividends, if any, as may be declared and paid
from time to time by Holding Co.'s Board of Directors, in its discretion, from
funds legally available therefor, and (ii) upon liquidation, dissolution or
winding up of Holding Co., to receive pro rata all assets remaining available
for distribution. There are no preemptive or other subscription rights,
conversion rights, or redemption or sinking fund provisions with respect to
shares of the Holding Co. Common Stock. All shares of the Holding Co. Common
Stock outstanding upon consummation of the Offer will be validly issued, fully
paid and nonassessable.
PREFERRED STOCK
Holding Co.'s Board of Directors may authorize the issuance of up to
1,000,000 shares of Holding Co. Preferred Stock in one or more series, and may
fix by resolution, to the extent permitted by the DGCL, the terms and rights
of each such series, including the voting powers, full or limited, if any, of
the shares of such series and the designations, preferences, and relative,
participating, optional or other special rights, and qualifications,
limitations or restrictions thereof. The issuance of Holding Co. Preferred
Stock by action of Holding Co.'s Board of Directors could adversely affect the
voting power, dividend rights and other rights of holders of the Holding Co.
Common Stock. Issuance of a series of Holding Co. Preferred Stock could also,
depending on the terms of such series, either impede or facilitate the
completion of a merger, tender offer or other takeover attempt. Although
Holding Co.'s Board of Directors is required to make a determination as to the
best interests of the shareholders of Holding Co. when issuing Holding Co.
Preferred Stock, Holding Co.'s Board of Directors could act in a manner that
would discourage an acquisition attempt or other transaction that some, or a
majority, of the shareholders might believe to be in the best interests of
Holding Co. or in which shareholders might receive a premium for their stock
over the then prevailing market price. Although there are currently no plans
to issue shares of Holding Co. Preferred Stock, or rights to purchase such
shares, management believes that the availability of the Holding Co. Preferred
Stock will provide Holding Co. with increased flexibility in structuring
possible future financings and acquisitions and in meeting other corporate
needs that may arise. The authorized shares of Holding Co. Preferred Stock are
available for issuance without further action by Holding Co.'s shareholders,
unless such action is required by applicable law or the rules of any stock
exchange on which the Holding Co. Common Stock may then be listed.
RIGHTS
Holding Co. has no current plan or intention to implement a so-called
"poison pill" rights plan such as the Company's Rights Agreement.
ANTITAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF INCORPORATION AND
BYLAWS
GENERAL. Certain provisions of the Company's Certificate of Incorporation
and Bylaws could discourage potential acquisition proposals and could delay or
prevent a change in control of the Company. These provisions were intended to
enhance the likelihood of continuity and stability in the composition of the
Company's Board of Directors and in the policies formulated by the Company's
Board of Directors and to discourage certain types of transactions that may
involve an actual or threatened change of control of the Company. These
provisions are designed to reduce the vulnerability of the Company to an
unsolicited acquisition proposal and to discourage certain tactics that may be
used in proxy fights. Holding Co.'s Certificate of Incorporation and Bylaws
will contain similar provisions because Holding Co.'s Certificate of
Incorporation and Bylaws are based on those of the Company. Such provisions
may discourage third parties from making tender offers for shares of
53
<PAGE>
the Company or Holding Co. As a result, the market price of the shares of the
Company or Holding Co. may not benefit from any premium which might occur in
anticipation of a threatened or actual change in control. Such provisions also
may have the effect of preventing changes in the management of the Company or
Holding Co. For purposes of the following discussion, the term "Holding Co."
refers only to Holding Co. and not its subsidiaries.
BOARD OF DIRECTORS. Holding Co.'s Certificate of Incorporation and Bylaws
provide for Holding Co.'s Board of Directors to be divided into three classes,
as nearly equal in number as possible. The term of the Class 1 directors will
expire at the 1999 annual meeting of stockholders; the term of the Class 2
directors will expire at the 2000 annual meeting of stockholders; and the term
of the Class 3 directors will expire at the 2001 annual meeting of
stockholders (and in all cases when their respective successors are duly
elected and qualified). At each annual meeting of stockholders, successors to
the class of directors whose term expires at such meeting will be elected to
serve for three-year terms or until their successors are duly elected and
qualified. See "Management--Executive Officers and Directors."
Holding Co.'s Certificate of Incorporation and Bylaws provide that Holding
Co.'s Board of Directors shall consist of no less than three nor more than 15
members (except that such maximum number may be increased from time to time to
reflect the rights of holders of Holding Co. Preferred Stock) with the actual
number set from time to time to reflect the rights by resolution adopted by a
majority of the Board of Directors. Upon the closing of the Transactions,
Holding Co.'s Board of Directors will consist of members. Holding Co.'s
Certificate of Incorporation and the Bylaws provide that Holding Co.'s Board
of Directors is authorized to create additional directorships (up to the
maximum number permitted) and to elect additional directors thereto to serve
for the full term of the class of directors in which such directorship was
created. The provisions of the DGCL, Holding Co.'s Certificate of
Incorporation and the Bylaws relating to the removal of directors and the
filling of vacancies on Holding Co.'s Board of Directors will preclude a third
party from removing incumbent directors without cause and simultaneously
gaining control of Holding Co.'s Board of Directors by filling, with its own
nominees, the vacancies created by removal. These provisions also reduce the
power of stockholders generally, even those with a majority voting power in
Holding Co., to remove incumbent directors without cause and to fill vacancies
on Holding Co.'s Board of Directors.
STOCKHOLDER ACTION AND SPECIAL MEETINGS. Holding Co.'s Certificate of
Incorporation and Bylaws provide that any action of the common stockholders
must be effected at a duly called meeting and not by a consent in writing. The
Bylaws of Holding Co. do not permit stockholders of Holding Co. to call
special meetings of stockholders. A special meeting of stockholders may only
be called by the President or the Board of Directors of Holding Co.
ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER PROPOSALS AND DIRECTOR
NOMINATIONS. The Bylaws of Holding Co. establish an advance notice procedure
for the nomination, other than by or at the direction of Holding Co.'s Board
of Directors or a committee thereof, of candidates for election as directors
(the "Nomination Procedure") as well as for other stockholder proposals to be
considered at stockholders' meetings. Notice to Holding Co. from a stockholder
who proposes to nominate a person at a meeting for election as a director must
contain: (i) the name and residence address of the stockholder who intends to
make the nomination and the name, age and address of the nominee; (ii) the
principal occupation and business address of the nominee; (iii) the class and
number of shares held of record, beneficially and by proxy, by the stockholder
and the nominee as of the record date of such meeting (if such record date is
publicly available) and as of the date of such notice; and (iv) such other
information regarding each nominee proposed by such stockholder as would be
required to be included in a proxy statement or otherwise required pursuant to
Regulation 14A under the Exchange Act, including the consent of each nominee
to serve as a director of Holding Co. if so elected. The presiding officer of
the meeting may refuse to acknowledge the nomination of any person not made in
compliance with the Nomination Procedure. The purpose of requiring advance
notice is to afford
54
<PAGE>
Holding Co.'s Board of Directors an opportunity to consider the qualifications
of the proposed nominees or the merits of other stockholder proposals and, to
the extent deemed necessary or desirable by Holding Co.'s Board of Directors,
to inform stockholders about those matters. Although the advance notice
provisions do not give Holding Co.'s Board of Directors any power to approve
or disapprove of stockholder nominations or proposals for action by Holding
Co., they may have the effect of precluding a contest for the election of
directors or the consideration of stockholder proposals if the procedures
established by the Bylaws of Holding Co. are not followed and of discouraging
or deterring a third party from conducting a solicitation of proxies to elect
its own slate of directors or to approve its own proposals, without regard to
whether consideration of such nominees or proposals might be harmful or
beneficial to Holding Co. and its stockholders.
AMENDMENT OF THE CERTIFICATE OF INCORPORATION. Holding Co.'s Certificate of
Incorporation requires the affirmative vote of the holders of at least 66 2/3%
of the outstanding shares of Holding Co.'s capital stock entitled to vote
thereon and 66 2/3% of the members of Holding Co.'s Board of Directors in
order to amend certain of its provisions. These voting requirements will make
it more difficult for stockholders to make changes in Holding Co.'s
Certificate of Incorporation which would be designed to facilitate the
exercise of control over Holding Co. In addition, the requirement for approval
by at least a 66 2/3% stockholder vote will enable the holders of a minority
of the voting securities of Holding Co. to prevent the holders of a majority
or more of such securities from amending these provisions of Holding Co.'s
Certificate of Incorporation.
DELAWARE TAKEOVER STATUTE
Holding Co. is subject to Section 203 of the DGCL ("Section 203") which,
subject to certain exceptions, prohibits a Delaware corporation from engaging
in any business combination with an interested stockholder for a period of
three years following the date that such stockholder became an interested
stockholder, unless: (i) prior to such date, the board of directors of the
corporation approved either the business combination or the transaction which
resulted in the stockholder becoming an interested stockholder, (ii) upon
consummation of the transaction which resulted in the stockholder becoming an
interested stockholder, the interested stockholder owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced, excluding for purposes of determining the number of shares
outstanding at the time the transaction commenced, excluding for purposes of
determining the number of shares outstanding those shares owned (x) by persons
who are directors and also officers, and (y) by employee stock plans in which
employee participants do not have the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or
exchange offer, or (iii) on or subsequent to such date the business
combination is approved by the board of directors and authorized at an annual
or special meeting of stockholders, and not by written consent, by the
affirmative vote of at least 66 2/3% of the outstanding voting stock which is
not owned by the interested stockholder.
In general, Section 203 defines an interested stockholder as any entity or
person beneficially owning 15% or more of the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by such an entity or person. Section 203 defines business
combination to include: (i) any merger or consolidation involving the
corporation and the interested stockholder; (ii) any sale, transfer, pledge or
other disposition involving the interested stockholder of 10% or more of the
assets of the corporation; (iii) subject to certain exceptions, any
transaction which results in the issuance or transfer by the corporation of
any stock of the corporation to the interested stockholder; (iv) any
transaction involving the corporation which has the effect of increasing the
proportionate share of the stock of any class or series of the corporation
beneficially owned by the interested stockholder; or (b) the receipt by the
interested stockholder of the benefit of any loans, advances, guarantees,
pledges or other financial benefits provided by or through the corporation.
55
<PAGE>
LIMITATIONS OF DIRECTORS' LIABILITY
The DGCL permits corporations to limit or eliminate the personal liability
of directors to corporations and their stockholders for monetary damages for
breach of the directors' fiduciary duties of care. The duty of care requires
that, when acting on behalf of the corporation, directors must exercise
informed business judgment based on all material information reasonably
available to them. Absent the limitations now authorized by such legislation,
directors are accountable to corporations and their stockholders for monetary
damages for conduct constituting gross negligence in the exercise of their
fiduciary duties of care. Although the DGCL does not change the directors'
duties of care, it enables corporations to limit available relief to equitable
remedies such as injunction or rescission.
Holding Co.'s Certificate of Incorporation limits the liability of directors
(in their capacity as directors but not in their capacity as officers) to
Holding Co. or its stockholders to the fullest extent permitted by the DGCL,
as so amended. Specifically, no director of Holding Co. will be personally
liable for monetary damages for breach of the director's fiduciary duty as a
director, except for liability: (i) for any breach of the director's duty of
loyalty to Holding Co. or its stockholders; (ii) for acts or omissions not in
good faith or which involve intentional misconduct or a knowing violation of
law; (iii) under Section 174 of the DGCL, which relates to unlawful payments
of dividends or unlawful stock repurchases or redemptions; or (iv) for any
transaction from which the director derived an improper personal benefit. The
inclusion of this provision in Holding Co.'s Certificate of Incorporation may
have the effect of reducing the likelihood of derivative litigation against
directors, and may discourage or deter stockholders or management from
bringing a lawsuit against directors for breach of their duty of care, even
though such an action, if successful, might otherwise have benefited Holding
Co. and its stockholders.
INDEMNIFICATION AND INSURANCE
Under Holding Co.'s Certificate of Incorporation, and in accordance with
Section 145 of the DGCL, Holding Co. will indemnify any person who was or is a
party, or is threatened to be made a party, to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative
or investigative (other than a "derivative" action by or in the right of
Holding Co.) by reason of the fact that such person is or was a director or
officer of Holding Co., against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement in connection with such
action, suit or proceeding if such person acted in good faith and in a manner
such person reasonably believed to be in or not opposed to the best interests
of Holding Co., and, with respect to any criminal action or proceeding, had no
reasonable cause to believe was unlawful. A similar standard of care is
applicable in the case of derivative actions, except that indemnification only
extends to expenses (including attorneys' fees) incurred in connection with
the defense or settlement of such an action and then, where the person is
adjusted to be liable to Holding Co., only if and to the extent that the Court
of Chancery of the State of Delaware or the court in which such action was
brought determines that such person is fairly and reasonably entitled to such
indemnity and then only for such expenses as the court deems proper.
Holding Co.'s Certificate of Incorporation provides that Holding Co. will
pay for the expenses incurred by an indemnified director or officer in
defending the proceedings specified above in advance of their final
disposition, provided that, if the DGCL so requires, such person agrees to
reimburse Holding Co. if it is ultimately determined that such person is not
entitled to indemnification. Holding Co.'s Certificate of Incorporation so
provides that Holding Co. may, in its sole discretion, indemnify any person
who is or was one of its employees and agents or any person who is or was
serving at the request of Holding Co. as a director, officer, employee or
agent of another corporation, partnership, joint venture, trust or other
enterprise to the same degree as the foregoing indemnification of directors
and officers. In addition, Holding Co. may purchase and maintain insurance on
behalf of any person who is or was a director, officer, employee or agent of
Holding Co. or another corporation, partnership,
56
<PAGE>
joint venture, trust or other enterprise against any liability asserted
against and incurred by such person in such capacity, or arising out of the
person's status as such whether or not Holding Co. would have the power or
obligation to indemnify such person against such liability under the
provisions of the DGCL. Holding Co. will enter into an agreement with each of
its Directors providing for indemnification of such Directors and the
advancement of expenses to such Directors under certain conditions. Holding
Co. maintains insurance for the benefit of Holding Co.'s officers and
directors insuring such persons against certain liabilities, including
liabilities under the securities laws.
57
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA OF THE COMPANY
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table presents selected historical statement of income and
other financial data of the Company. The Company commenced operations
effective with an initial public offering of common stock in May 1994. The
Company's predecessor operations were in companies owned or controlled by
Counsel Corporation. The selected financial data of December 31, 1997, 1996,
1995 and 1994 and for the years ended December 31, 1997, 1996 and 1995 have
been derived from the Company's audited financial statements. The pro forma
selected financial data for 1994 and 1993 have been derived from the Company's
pro forma financial data included in the Company's 1997 Form 10-K. The
operating results for the six months ended June 30, 1998 have been derived
from the information in the Company's Second Quarter Form 10-Q and are not
necessarily indicative of the results that may be expected for the fiscal year
ending December 31, 1998. The Company's selected historical financial data
should be read in conjunction with, and are qualified in their entirety by
reference to, the historical financial statements (and related notes) of the
Company contained in the Company's 1997 Form 10-K included as Annex A hereto
(except for the report of the Company's independent accountants which is not
included herewith because the Company's independent accountants have not yet
granted such consent). See "Available Information."
<TABLE>
<CAPTION>
SIX MONTHS AS OF AND FOR THE FISCAL YEAR
ENDED JUNE 30, ENDED DECEMBER 31,
---------------- --------------------------------------------
(UNAUDITED) PRO FORMA
HISTORICAL (UNAUDITED)(1)
------------------------------------------- -----------------
1998 1997 1997 1996 1995 1994 1993
-------- ------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME
DATA:
Net revenues............ $104,191 $87,680 $182,243 $166,237 $139,965 $103,086 $91,770
Income Before Income
Taxes.................. $ 28 $ 4,067 $ 4,707 $ 7,376 $ 6,890 $ 6,569 5,153
Net Income.............. $ 18 $ 2,603 $ 3,013 $ 4,721 $ 4,410 $ 4,204 $ 3,298
Earnings per Share......
Basic.................. $ -- $ 0.49 $ 0.56 $ 0.89 $ 0.84 $ 0.80 $ 0.63
Diluted................ $ -- $ 0.49 $ 0.56 $ 0.89 $ 0.82 $ 0.80 $ 0.63
Weighted Average Shares
Basic.................. 5,377 5,316 5,339 5,304 5,270 5,250 5,250
Diluted................ 5,391 5,334 5,373 5,330 5,381 5,275 5,250
<CAPTION>
AS OF JUNE 30, AS OF DECEMBER 31,
---------------- --------------------------------------------
(UNAUDITED) PRO
HISTORICAL FORMA(1)
---------------------------------------------------- --------
1998 1997 1997 1996 1995 1994 1993
-------- ------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working Capital......... $ 12,067 $14,556 $ 13,849 $ 13,540 $ 6,726 $ 8,120 $ 993
Total Assets............ $118,922 $73,576 $114,961 $ 74,908 $ 59,031 $ 45,018 $53,150
Long-term Debt,
excluding Current
Portion................ $ 60,453 $22,863 $ 58,373 $ 23,254 $ 11,063 $ 7,567 $28,160
Shareholders' Equity.... $ 30,671 $29,923 $ 30,733 $ 27,348 $ 22,437 $ 17,669 $ 7,363
</TABLE>
- ----------
(1) The Company commenced operations effective with an initial public offering
of common stock in May 1994. The Company's predecessor operations were in
companies owned or controlled by Counsel Corporation (collectively, the
"Long-Term Care Business"). The pro forma selected financial data for 1994
and 1993 reflect: (i) transfer by the selling shareholders to the Company
of the outstanding stock of their wholly-owned subsidiaries possessing the
Long-Term Care Business in exchange for common stock of the Company and
the related tax and accounting effects; (ii) conversion of the 11
facilities owned by Counsel Corporation or an affiliate to operating
leases with the Company as lessee; (iii) terms of the revised operating
lease for one facility; (iv) exercise of the underwriters' over-allotment
option of 500,000 shares; and (v) certain expenses expected to be incurred
by the Company as a result of its initial public offering that were not
incurred by the Long-Term Care Business. The pro forma selected financial
data have been prepared as if such transactions occurred on January 1 of
each year. No pro forma information related to the Offer is contained in
the Selected Historical Financial Data presented.
58
<PAGE>
PRO FORMA CONDENSED COMBINED
FINANCIAL DATA
(UNAUDITED)
The following table presents pro forma condensed combined statement of
income and other financial data of Holding Co. and the Company. The
information is presented as if the Offer and the Merger of Holding Co. and the
Company occurred on January 1, 1997 with respect to financial data for twelve
months ended December 31, 1997 and January 1, 1998 with respect to financial
data for the six months ended June 30, 1998 for statement of income and
related data and on June 30, 1998 for balance sheet data. The pro forma data
assume that the Offer and the Merger are effected by the exchange of shares of
Holding Co. Common Stock and cash for Shares. The pro forma data assume
Holding Co. will exchange one share of Holding Co. Common Stock and $1.00 cash
for each Share, whereby 5,399,000 shares of Holding Co. Common Stock and
$5,399,000 of cash are issued in exchange for all outstanding Shares and
equivalent Shares, other than those owned by Holding Co. The Offer and the
Merger will be accounted for as a reverse acquisition, as the stockholders of
the Company will own a majority of the outstanding shares of Holding Co.
Common Stock upon completion of the transaction. Accordingly, for accounting
purposes, Holding Co. is treated as the acquired company and the Company is
considered to be the acquiring company. The cash portion of the Consideration
will be accounted for as a dividend by the combined company. Holding Co.'s
financial position and results of operations will not be included in the
Company's consolidated financial statements prior to the date the Merger is
consummated.
For accounting purposes, the Merger will be treated as a recapitalization of
the Company with the Company as acquires (reverse acquisition). Under a
reverse acquisition, the purchase price of Holding Co. is based on the fair
market value of Holding Co. Common Stock as measured by the net carrying
amount of the Company's net assets. The Consideration includes one share of
Holding Co. Common Stock. This is a fixed exchange ratio and will not be
adjusted in the event of any increase or decrease in the market price of the
Shares between the date hereof and the Expiration Date.
The pro forma condensed combined financial data are intended for
informational purposes, and do not purport to represent what the combined
entity's results of continuing operations or financial position would actually
have been had the Transactions in fact occurred at an earlier date, or project
the results for any future date or period. Upon consummation of the
Transactions, the actual financial position and results of operations of the
combined company may differ, perhaps significantly, from the pro forma amounts
reflected herein due to a variety of factors, including changes in operating
results between the date of the pro forma condensed combined financial data
and the date on which the Transactions are consummated and thereafter, as well
as the factors discussed under "Risk Factors."
The pro forma condensed combined financial data do not give effect to any
integration or restructuring costs that could result from the combination of
the companies. Any integration and rationalization of the operations of the
Company may include certain costs that in turn would result in a charge to
earnings of the combined company. Such a charge, which cannot now be
quantified fully, may be material and would be recognized in the period in
which such a restructuring occurs. These costs may include severance and
related employee benefit costs, debt extinguishment costs, and costs
associated with change of control agreements, among others. To date, Holding
Co.'s access to information related to the Company has been limited to
publicly available information. In addition, publicly available information
does not contain sufficient details related to the Company's severance plans,
employee benefit agreements, change of control costs or debt extinguishment
provisions to enable Holding Co. to quantify the costs associated with
business integration and rationalization actions that may be considered by
Holding Co.
59
<PAGE>
AVC HOLDING CORP.
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL
ADVOCAT HOLDING CO. PRO FORMA PRO FORMA
JUNE 30, 1998 AUGUST 26, 1998 ADJUSTMENTS(A) HOLDING CO.
------------- --------------- -------------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
ASSETS
Cash and cash
equivalents............ $ 1,649 $70 $ 1 (B) $ 1,720
Receivables, net........ 27,414 -- -- 27,414
Income taxes
receivable............. 280 -- -- 280
Inventories............. 1,063 -- -- 1,063
Prepaid expenses and
other assets........... 1,863 -- -- 1,863
Deferred income taxes... 1,330 -- -- 1,330
-------- --- ------- --------
Total current assets.. 33,599 70 1 33,670
-------- --- ------- --------
Property and equipment.. 83,193 -- -- 83,193
Accumulated depreciation
and amortization....... (13,759) -- -- (13,759)
-------- --- ------- --------
Net property and
equipment............ 69,434 -- -- 69,434
-------- --- ------- --------
Other assets:
Deferred tax benefit.. 5,366 -- -- 5,366
Deferred financing and
other costs, net..... 1,450 -- -- 1,450
Other................... 9,073 -- -- 9,073
-------- --- ------- --------
15,889 -- -- 15,889
-------- --- ------- --------
TOTAL ASSETS.......... $118,922 $70 $ 1 $118,993
======== === ======= ========
LIABILITIES
Current portion of long
term debt.............. $ 1,069 -- -- $ 1,069
Trade accounts payable.. 10,580 -- -- 10,580
Accrued expenses........ 9,883 -- -- 9,883
-------- --- ------- --------
Total current
liabilities.......... 21,532 -- -- 21,532
-------- --- ------- --------
Long term debt, less
curent portion......... 60,453 50 5,000 (C) 65,503
Deferred gains with
respect to leases,
net.................... 3,416 -- -- 3,416
Other................... 2,850 -- -- 2,850
-------- --- ------- --------
Total noncurrent
liabilities.......... 66,719 50 5,000 71,769
-------- --- ------- --------
TOTAL LIABILITIES..... 88,251 50 5,000 93,301
-------- --- ------- --------
SHAREHOLDERS' EQUITY:
Preferred stock......... -- -- -- --
Common stock............ 54 -- 8 (D) 62
Additional paid-in
capital................ 15,638 50 392 (D) 16,080
Subscriptions
receivable............. -- (30) -- (30)
Retained earnings....... 14,979 -- (5,399)(E) 9,580
-------- --- ------- --------
TOTAL SHAREHOLDERS'
EQUITY............... 30,671 20 (4,999) 25,692
-------- --- ------- --------
TOTAL LIABILITIES AND
SHAREHOLDERS'
EQUITY............... $118,922 $70 $ 1 $118,993
======== === ======= ========
</TABLE>
See Notes to Pro Forma Condensed Consolidated Balance Sheet
60
<PAGE>
AVC HOLDING CORP.
NOTES TO PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
For accounting purposes, the Merger will be treated as a recapitalization of
Advocat with Advocat as the acquirer (reverse acquisition). The pro forma
condensed consolidated balance sheet gives effect to the following adjustments:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
(A) Reflects (i) the distribution of $1.00 and exchange of one
share of Holding Co. Common Stock for each outstanding
share of Advocat, (ii) the purchase by OWWI of 819,000
shares of Holding Co. Common Stock for approximately $5.4
million and the sale of $5.0 million in Debentures to
OWWI, and (iii) the payment of approximately $5.0 million
in costs related to the Transactions.
</TABLE>
<TABLE>
<S> <C>
(B) Represents the following cash effects of the proposed
Transactions:
Sale of Debentures to OWWI....................................... $ 5,000
Sale of Holding Co. Common Stock to OWWI......................... 5,400
Cash distributions to stockholders of Advocat ................... (5,399)
Costs of the Offer and related transactions...................... (5,000)
-------
$ 1
=======
(C) Sale by Holding Co. of $5.0 million of Debentures to OWWI........ $ 5,000
=======
(D) Represents proceeds from the sale of 819,000 shares of Holding
Co. Common Stock for a total consideration of $5.4 million less
the costs of the Transactions:
Par value of shares sold......................................... $ 8
=======
Capital in excess of par value of shares sold.................... $ 5,392
Costs of the Offer and related transactions...................... (5,000)
-------
Additional paid in capital....................................... $ 392
=======
(E) Represents cash distributions of $1.00 per share to current
stockholders of Advocat pursuant to the Transactions............. $ 5,399
=======
</TABLE>
61
<PAGE>
AVC HOLDING CORP.
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL PRO FORMA PRO FORMA
ADVOCAT HOLDING CO. ADJUSTMENTS HOLDING CO.
---------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues:
Patient revenues.......... $163,094 -- -- $163,094
Resident revenues......... 15,105 -- -- 15,105
Management fees........... 3,886 -- -- 3,886
Interest.................. 158 -- -- 158
--------- ----- ------- ---------
Total................... 182,243 -- -- 182,243
--------- ----- ------- ---------
Expenses:
Operating................. 146,555 -- -- 146,555
Lease..................... 15,850 -- -- 15,850
General and
administrative........... 9,636 -- -- 9,636
Depreciation and
amortization............. 2,823 -- -- 2,823
Interest.................. 2,672 -- $ 354 (A) 3,026
--------- ----- ------- ---------
Total................... 177,536 -- 354 177,890
--------- ----- ------- ---------
Income before income taxes.. 4,707 -- (354) 4,353
Provision for income taxes: 1,694 -- (120)(B) 1,574
--------- ----- ------- ---------
Net income (loss)........... $ 3,013 $ -- $ (234) $ 2,779
========= ===== ======= =========
Basic earnings per share.... $ 0.56 $ 0.45
========= =========
Diluted earnings per share.. $ 0.56 $ 0.45
========= =========
Basic weighted shares
outstanding.............. 5,339,000 819,000(C) 6,158,000
Diluted weighted shares
outstanding.............. 5,373,000 819,000(C)(D) 6,192,000
</TABLE>
See Notes to Pro Forma Condensed Consolidated Statement of Income
62
<PAGE>
AVC HOLDING CORP.
NOTES TO PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997
(UNAUDITED)
The pro forma condensed consolidated statement of income gives effect to the
following adjustments:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
(A) Represents interest on (i) the $50,000 loan from OWWI to
Holding Co. at a rate of 8.5% per annum and (ii) the $5.0
million in Debentures at a rate of 7.0% per annum. $354
====
(B) Represents the tax effects related to additional interest
expense at Holding Co.'s federal statutory rate of 34.0%. $120
====
(C) Represents newly issued shares of Holding Co. Common Stock
purchased by OWWI.
(D) The conversion of the Debentures is assumed to be
antidilutive at date of issue for purposes of computing
diluted earnings per share.
</TABLE>
63
<PAGE>
AVC HOLDING CORP.
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE SIX MONTH PERIOD ENDED JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL PRO FORMA PRO FORMA
ADVOCAT HOLDING CO. ADJUSTMENTS HOLDING CO.
---------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues:
Patient revenues........ $ 84,946 -- -- $ 84,946
Resident revenues....... 17,334 -- -- 17,334
Management fees......... 1,812 -- -- 1,812
Interest................ 99 -- -- 99
--------- ----- ------- ---------
Total................. 104,191 -- -- 104,191
--------- ----- ------- ---------
Expenses:
Operating............... 83,383 -- -- 83,383
Lease................... 9,563 -- -- 9,563
General and
administrative......... 5,456 -- -- 5,456
Depreciation and
amortization........... 1,794 -- -- 1,794
Interest................ 2,499 -- $ 177 (A) 2,676
Non-recurring charge.... 1,468 -- (1,468)(B) --
--------- ----- ------- ---------
Total................. 104,163 -- (1,291) 102,872
--------- ----- ------- ---------
Income before income
taxes.................... 28 -- 1,291 1,319
Provision for income
taxes: 10 -- 439 (C) 449
--------- ----- ------- ---------
Net income (loss)......... $ 18 $ -- $ 852 $ 870
========= ===== ======= =========
Basic earnings per share.. $ 0.00 $ 0.14
========= =========
Diluted earnings per
share.................... $ 0.00 $ 0.14
========= =========
Basic weighted shares
outstanding.............. 5,377,000 819,000 (D) 6,196,000
Diluted weighted shares
outstanding.............. 5,391,000 819,000 (D)(E) 6,210,000
</TABLE>
See Notes to Pro Forma Condensed Consolidated Statement of Income
64
<PAGE>
AVC HOLDING CORP.
NOTES TO PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE SIX MONTH PERIOD ENDED JUNE 30, 1998
(UNAUDITED)
The pro forma condensed consolidated statement of income gives effect to the
following adjustments:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
(A) Represents interest on (i) the $50,000 loan from OWWI to
Holding Co. at a rate of 8.5% per annum and (ii) the $5.0
million in Debentures at a rate of 7.0% per annum........... $ 177
======
(B) Represents elimination of nonrecurring charges for pro forma
purposes.................................................... $1,468
======
(C) Represents the tax effects related to the additional
interest expense and the elimination of nonrecurring charges
at Holding Co.'s federal statutory rate of 34.0%............ $ 439
======
(D) Represents newly issued shares of Holding Co.'s Common Stock
purchased by OWWI
(E) The conversion of the Debentures is assumed to be
antidilutive at date of issue for purposes of computing
diluted earnings per share.
</TABLE>
65
<PAGE>
VALIDITY OF HOLDING CO. COMMON STOCK
The validity of the shares of Holding Co. Common Stock offered hereby will
be passed upon for Holding Co. by Powell, Goldstein, Frazer & Murphy LLP,
Atlanta, Georgia.
EXPERTS
The balance sheet of AVC Holding Corp. as of August 26, 1998 appearing in
this Prospectus and Registration Statement has been audited by Ernst & Young
LLP, independent auditors, as set forth in their report appearing elsewhere
herein, and is included in reliance upon such report given upon the authority
of such firm as experts in accounting and auditing.
66
<PAGE>
AUDITED BALANCE SHEET OF AVC HOLDING CORP.
AS OF AUGUST 26, 1998
REPORT OF INDEPENDENT AUDITORS
To the Shareholders
AVC Holding Corp.
We have audited the accompanying balance sheet of AVC Holding Corp. as of
August 26, 1998. This balance sheet is the responsibility of the Company's
management. Our responsibility is to express an opinion on this balance sheet
based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the balance sheet is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the balance sheet. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall balance sheet
presentation. We believe that our audit of the balance sheet provides a
reasonable basis for our opinion.
In our opinion, the balance sheet referred to above presents fairly, in all
material respects, the financial position of AVC Holding Corp. at August 26,
1998 in conformity with generally accepted accounting principles.
/s/ Ernst & Young llp
August 26, 1998
Chicago, Illinois
F-1
<PAGE>
AVC HOLDING CORP.
BALANCE SHEET
AUGUST 26, 1998
<TABLE>
<S> <C>
ASSETS
Cash.................................................................. $ 70,000
--------
TOTAL ASSETS...................................................... $ 70,000
========
LIABILITIES
Note payable.......................................................... $ 50,000
SHAREHOLDERS' EQUITY
Common stock $.01 par value:
Authorized 20,000 shares; issued and outstanding 8,165 shares....... 82
Additional paid-in capital............................................ 49,918
Subscriptions receivable.............................................. (30,000)
--------
TOTAL SHAREHOLDERS' EQUITY........................................ 20,000
--------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................ $ 70,000
========
</TABLE>
F-2
<PAGE>
AVC HOLDING CORP.
NOTES TO BALANCE SHEET
1. ORGANIZATION
AVC Holding Corp. ("Holding Co.") was incorporated on August 18, 1998 in the
state of Delaware. Upon incorporation, Holding Co. issued 8,165 shares of
common stock, par value $.01 per share ("Holding Co. Common Stock") in
exchange for $20,000 in cash and $30,000 in subscription notes receivable
which bear interest at a rate of 8.5% per annum and are due upon demand. The
terms of one note provide that a portion of the outstanding balance may be
satisfied via transfer to Holding Co. of 1,250 shares of common stock of
Advocat Inc. ("Advocat"), a Delaware corporation. Twenty percent of the
Company's initial shares were purchased by Omega Worldwide, Inc. ("OWWI") and
the remainder were purchased by officers of Holding Co. Holding Co. was formed
to offer (the "Offer") to exchange $1.00 in cash and one share of Holding Co.
Common Stock for each outstanding share of common stock, par value $.01 per
share, of Advocat.
2. NOTE PAYABLE AND FINANCING COMMITMENTS
Concurrent with its formation, Holding Co. obtained from OWWI a $50,000
unsecured loan at 8.5% per annum which matures September 30, 1999. In
connection with the Offer, Holding Co. will issue approximately 819,000 shares
of Holding Co. Common Stock to OWWI for approximately $5.4 million.
Additionally, Holding Co. currently intends to issue (and OWWI has committed
to purchase) up to $5.0 million of 7.0% convertible subordinated debentures
(the "Debentures"), and, prior to commencing the Offer, will obtain
commitments from OWWI or other investors identified by OWWI to purchase at
least an additional $15.0 million of the Debentures,subject to independent
director approval.
F-3
<PAGE>
ANNEX A
FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
-----------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES ACT OF
1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM ______ TO _____.
COMMISSION FILE NUMBER 1-12996
ADVOCAT INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 62-1559667
-------- ----------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
277 MALLORY STATION ROAD, SUITE 130, FRANKLIN, TN 37067
-------------------------------------------------- -----------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (615)771-7575
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
------------------- ------------------------
COMMON STOCK, PAR VALUE $0.01 PER SHARE NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE.
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO THE
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
--- ---
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. [X]
THE AGGREGATE MARKET VALUE OF COMMON STOCK HELD BY NON-AFFILIATES ON MARCH 23,
1998 (BASED ON THE CLOSING PRICE OF SUCH SHARES ON THE NEW YORK STOCK EXCHANGE)
WAS $25,179,807. FOR PURPOSES OF THE FOREGOING CALCULATION ONLY, ALL DIRECTORS,
NAMED EXECUTIVE OFFICERS AND PERSONS KNOWN TO THE REGISTRANT TO BE HOLDERS OF 5%
OR MORE OF THE REGISTRANT'S COMMON STOCK HAVE BEEN DEEMED AFFILIATES OF THE
REGISTRANT.
ON MARCH 23, 1998, 5,376,946 SHARES OF THE REGISTRANT'S $0.01 PAR VALUE COMMON
STOCK WERE OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE:
THE FOLLOWING DOCUMENTS ARE INCORPORATED BY REFERENCE INTO PART III, ITEMS 10,
11, 12, AND 13 OF THIS FORM 10-K: THE REGISTRANT'S DEFINITIVE PROXY MATERIALS
FOR ITS 1998 ANNUAL MEETING OF STOCKHOLDERS.
<PAGE>
PART I
ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS.
Certain statements made by or on behalf of Advocat Inc. (together with its
subsidiaries, "Advocat" or the "Company"), including those contained in this
Annual Report on Form 10-K and elsewhere, are forward-looking statements as
defined in the Private Securities Litigation Reform Act of 1995. These
statements involve risks and uncertainties, including, but not limited to,
changes in governmental reimbursement, government regulation and health care
reforms, ability to execute on the Company's acquisition program, both in
finding suitable acquisitions and financing therefor, changing economic and
market conditions, and others. Actual results may differ materially from that
expressed or implied in such forward-looking statements. The Company hereby
makes reference to items set forth under the heading "Risk Factors" in the
Company's Registration Statement on Form S-1, as amended (Registration No.
33-76150). Such cautionary statements identify important factors that could
cause the Company's actual results to materially differ from those projected in
forward-looking statements.
INTRODUCTORY SUMMARY.
The Company provides long-term care services to nursing home patients and
residents of assisted living facilities in 11 southeastern states and two
Canadian provinces. The Company completed its initial public offering in May
1994, however, its operational history can be traced to February 1980 through
common senior management who were involved in different organizational
structures.
The Company's objective is to become the leading provider of health care and
related services to the elderly in the communities in which it operates. Advocat
will continue to implement its operating strategy of (i) providing a broad range
of cost-effective senior care services; (ii) forming strategic alliances with
other health care providers to expand the Company's continuum of care; (iii)
clustering its operations on a regional basis; and (iv) targeting non-urban
markets, which management believes are underserved by long-term care providers.
Key elements of the Company's growth strategy are to increase revenue and
profitability at existing facilities, make selective acquisitions of nursing
homes and assisted living facilities generally located in smaller rural and
secondary markets in the southeast United States and in Canada, pursue
additional management opportunities and continue to offer current or expanded
ancillary services at its facilities.
The Company's principal executive offices are located at 277 Mallory Station
Road, Suite 130, Franklin, Tennessee 37067. The Company's telephone number at
that address is (615) 771-7575, and its facsimile number is (615) 771-7409.
2
<PAGE>
MATERIAL CORPORATE DEVELOPMENTS.
Acquisitions and Related Indebtedness
Effective October 1, 1997, the Company completed the acquisition or lease of 29
assisted living facilities from members or affiliates of Pierce Management Group
("Pierce"). The Company purchased 15 facilities with 1,093 units and entered
into leases on the remaining 14 facilities with 1,209 units. All of the Pierce
facilities are located in North Carolina. The aggregate purchase price was
approximately $34,148,000, which includes related costs of the acquisition.
To fund the Pierce acquisition, the Company issued $34,100,000 in new debt. The
debt issued in connection with the Pierce acquisition is a promissory note,
which is payable to two banks and is unsecured. However, the Company has agreed
not to pledge or otherwise encumber the assets acquired in the Pierce
acquisition or issue other debt without the banks' approval. The promissory note
bears floating interest in relation to the London Interbank Offered Rate
("LIBOR") and has a balloon maturity in January 1999.
The Company has a commitment of up to $30,000,000 of long-term financing under
which the Company may borrow and pledge the assets acquired in the Pierce
acquisition as collateral. Loans are available at up to 80% of the value of the
pledged assets. Interest, which would be at LIBOR plus a defined spread, would
be determined based upon the length of term selected (3, 10, or 20 years) and
the loan-to-value ratio. This commitment is available through November 1999.
However, the Company may not draw upon this commitment so long as the
$34,100,000 promissory note remains outstanding.
In addition, the Company acquired two Canadian assisted living facilities on
October 1, 1997. Immediately prior to the acquisitions, the Company had managed
these facilities, which total 125 units, during receivership proceedings. The
combined purchase price was approximately $2,317,000 ($3,200,000 Canadian),
which was funded by internal sources and the issuance by the Company's principal
Canadian lender of 10-year term loans totaling $2,029,000 ($2,800,000 Canadian).
Regulatory Issues
The Company's 1997 operating results were profoundly affected by regulatory
issues in the State of Alabama. During the summer, the Company received separate
notifications from the State that, as a result of certain deficiencies noted
upon periodic surveys of its two facilities in Mobile, the facilities would be
decertified from participation in the Medicare and Medicaid programs and that
licensure revocation could be pursued. The Company appealed the proceedings,
noting that none of the deficiencies were life-threatening, that the
deficiencies noted did not warrant the penalty imposed and that in the case of
one of the facilities, it was JCAHO accredited. The appeals were denied by the
State agency, and as a result, the facilities were decertified for 69 and 91
days, respectively, before resurveys found them to be in compliance. Both of the
facilities have been recertified for participation in the Medicare and Medicaid
programs. The Company expects the Alabama operations to return to normal levels
during the latter half of 1998. However, there can be no assurance that either
of the facilities will return to the census and profitability levels experienced
prior to the decertifications.
3
<PAGE>
In both cases, the State has stayed its proceedings to license revocation,
agreeing that the Company responded favorably toward the resolution of all
issues. Management believes that the aggressive measures taken by the State were
not warranted, particularly when the regulations prescribe a continuum of
intermediate penalties to be imposed before decertification. The Company has
aggressively pursued improved communications with the State and has reached
agreement with the State on methods of improved operations. The Company's
remaining five Alabama facilities have successfully passed their most recent
annual licensure surveys.
The Company, in response to the regulatory problems at the two Mobile
facilities, entered into a reorganization of its regional and facility
management, conducted in-depth reviews of all seven of the Company's Alabama
facilities, engaged nationally-recognized consultants to assist in achieving
compliance and engaged local legal counsel familiar with the Alabama regulations
and regulators. As a result of the lost revenues from the Medicare and Medicaid
programs (including charity care provided to continuing patients who had been
admitted under those programs), census declines and expenditures incurred in
response to the survey issues (including fines and penalties), the Company
experienced an estimated negative impact on 1997 earnings of approximately $2.3
million after taxes, or approximately $0.44 per share. The pre-tax impact of
these events in the State of Alabama can be quantified as follows:
- Lost revenue of $1.9 million of which more than $950,000 represented
charity care for patients the Company elected not to discharge during
the decertification period
- Region-wide increases in staffing at all Alabama facilities with a cost
of more than $700,000
- Direct costs relative to consultants, attorneys, and fines totaling
$580,000
- Other related expenses of approximately $475,000
BUSINESS.
Advocat provides a broad range of long-term care services to the elderly
including assisted living, skilled nursing and ancillary health care services.
As of December 31, 1997, Advocat's portfolio includes 116 facilities composed of
65 nursing homes containing 7,341 licensed beds and 51 assisted living
facilities containing 4,748 units. In comparison, at December 31, 1996, the
Company operated 87 facilities composed of 65 nursing homes containing, 7,399
licensed beds and 22 assisted living facilities containing 2,509 units. The
Company owns seven nursing homes, leases 37 others and manages the remaining 21
nursing homes. The Company owns 18 assisted living facilities, leases 22 others
and manages the remaining 11 assisted living facilities. In the United States,
the Company operates 52 nursing homes and 33 assisted living facilities, and in
Canada, the Company operates 13 nursing homes and 18 assisted living facilities.
The Company's facilities provide a range of health care services to their
residents. In addition to the nursing and social services usually provided in
long-term care facilities, the Company offers a variety of rehabilitative,
nutritional, respiratory, and other specialized ancillary services. The Company
operates facilities in Alabama, Arkansas, Florida, Georgia, Kentucky, North
Carolina, Ohio, South Carolina, Tennessee, Texas, West Virginia, and the
Canadian provinces of Ontario and British Columbia.
4
<PAGE>
The Company, in its role as owner, lessee, or manager, is responsible for the
day-to-day operation of all operated facilities. These responsibilities include
recruiting, hiring, and training all nursing and other personnel, and providing
resident care, nutrition services, marketing, quality improvement, accounting,
and data processing services for each facility. The lease agreements pertaining
to the Company's 59 leased facilities are, in all but two cases, "triple net"
leases, requiring the Company to maintain the premises, pay taxes and pay for
all utilities. The leases typically provide for an initial term of 10 to 15
years with renewal options up to 10 years. The average remaining term of the
Company's lease agreements, including renewal options, is approximately 15
years.
As compensation for providing management services, the Company earns a
management fee, which in 1997 averaged approximately 5% of the facilities' net
patient revenues. Of the Company's 32 management agreements, 14 have more than
five years remaining on their current terms, 10 have between two and four years
remaining on their current terms, and eight are month-to-month arrangements or
have a current term expiring within one year, with an average current maturity
of approximately five years.
INDUSTRY BACKGROUND
The long-term care industry encompasses a broad range of accommodations and
health care and related services that are provided primarily to the elderly. As
the need for assistance increases, the elderly can benefit from an assisted
living facility, where nutritional, housekeeping and modest nursing or medical
needs can be met. For those elderly in need of specialized support,
rehabilitative, nutritional, respiratory or other treatments, nursing home
health care is often required. The Company, through its assisted living
facilities and nursing homes, is actively involved in the continuum of care and
believes that it has, through its history of operating such facilities,
developed the expertise required to serve the varied needs of its elderly
residents.
During 1997, the Federal government enacted the Balanced Budget Act of 1997
("BBA"), which contains numerous Medicare and Medicaid cost-saving measures. The
BBA requires that nursing homes transition to a prospective payment system under
the Medicare program during a three year "transition period," commencing with
the first cost reporting period beginning on or after July 1, 1998. The BBA also
contains certain measures that could lead to future reductions in Medicare
therapy cost reimbursement and Medicaid payment rates. Given the recent
enactment of the BBA, the Company is unable to predict the ultimate impact of
the BBA on its future operations. However, any reductions in government spending
for long-term health care could have an adverse effect on the opening results
and cash flows of the Company. See "Item 1 - Government Regulation and
Reimbursement."
While the ultimate impact of the BBA is presently unknown, management believes
there are a number of significant trends that will support the continued growth
of the assisted living and nursing home segments of the long-term care industry,
including:
Demographic trends. The primary market for the Company's long-term
health care services is comprised of persons aged 75 and older. This age
group is one of the fastest growing segments of the United States
population. According to United States Census Bureau information, this
5
<PAGE>
population segment will increase approximately 28% over the next 20 years.
The population of seniors aged 85 and over is expected to increase
approximately 68% over the next 20 years. As the number of persons aged 75
and over continues to grow, the Company believes that there will be
corresponding increases in the number of persons who need skilled nursing
care or who want to reside in an assisted living facility for assistance
with activities of daily living. According to the United States General
Accounting Office, there are approximately 6.5 million people aged 65 and
older in the United States who needed assistance with daily activities, and
the number of people needing such assistance is expected to double by the
year 2020.
Cost containment pressures. In response to rapidly rising health care
costs, governmental and other third-party payors have adopted
cost-containment measures to reduce admissions and encourage reduced lengths
of stays in hospitals and other acute care settings. The federal government
had previously acted to curtail increases in health care costs under
Medicare by limiting acute care hospital reimbursement for specific services
to pre-established fixed amounts. Other third-party payors have begun to limit
reimbursement for medical services in general to predetermined reasonable
charges, and managed care organizations (such as health maintenance
organizations) are attempting to limit hospitalization costs by negotiating
for discounted rates for hospital and acute care services and by monitoring
and reducing hospital use. In response, hospitals are discharging patients
earlier and referring elderly patients, who may be too sick or frail to manage
their lives without assistance, to nursing homes and assisted living
facilities where the cost of providing care is typically lower than hospital
care. In addition, third-party payors are increasingly becoming involved in
determining the appropriate health care settings for their insureds or clients
based primarily on cost and quality of care.
Industry consolidation. Although the long-term care market continues to
be extremely fragmented, consolidations have occurred recently within the
industry, driven in part by opportunities to leverage corporate overhead,
expand into new markets or to enhance development pipelines through
strategic acquisitions, with some companies attempting to achieve a critical
mass and market concentration in order to provide leverage in dealing with
managed-care companies that provide medical insurance for the elderly.
Competitors of the Company desiring to provide more comprehensive care for
the elderly are diversifying into home health care, rehabilitation, adult
day care and assisted living services to provide the senior population with
some measure of independence but with support for activities of daily
living, often achieving this diversification through acquisitions of
existing providers.
Limited supply of facilities. Because of the aging of the population and
limitations on the granting of Certificates of Need ("CONs") for new skilled
nursing facilities, management believes that there will be a continuing
demand for skilled nursing beds in the markets in which the Company
competes. A majority of states in the United States have adopted CON or
similar statutes generally requiring that, prior to the addition of new
beds, the addition of new services, or the making of certain capital
expenditures, a state agency must determine that a need exists for the new
beds or the proposed activities. The Company believes that this CON process
tends to restrict the supply and availability of licensed nursing facility
beds. High construction costs, limitations on government reimbursement for
the full costs of construction, and start-up expenses also act to constrain
growth in the supply of such facilities. At the same time, nursing
facility
6
<PAGE>
operators are continuing to focus on improving occupancy and expanding
services to subacute patients requiring significantly higher levels of
nursing care. As a result, the Company believes that there has been a
decrease in the number of skilled nursing beds available to patients with
lower acuity levels, as opposed to patients with physical or more acute
disabilities, and that this trend should increase the demand for the
Company's assisted living facilities. Management also believes there is
currently a limited supply of assisted living units relative to the growing
need for assisted living services in rural and secondary markets. Although
states generally do not require CONs for assisted living facilities, some
states may impose additional limitations on the supply of facilities. For
example, North Carolina has imposed a moratorium on the addition of new beds
unless the vacancy rate of the county is less than 15.0%.
Reduced Reliance on Family Care. Historically, the family has been the
primary provider of care for seniors. Management of the Company believes
that the increase in the percentage of women in the work force, the
reduction of average family size, and the increased mobility in society will
reduce the role of the family as the traditional care-giver for aging
parents. Management believes that this trend will make it necessary for many
seniors to look outside the family for assistance as they age.
NURSING HOME AND ASSISTED LIVING FACILITY SERVICES
Operations. The Company currently operates 65 nursing homes with 7,341 licensed
beds and 51 assisted living facilities with 4,748 units as set forth below:
<TABLE>
<CAPTION>
U.S. Canada
-------------------------- --------------------------
Facilities Licensed Beds Facilities Licensed Beds
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
Nursing Homes:
Owned.................................................... 5 562 2 144
Leased(1)................................................ 37 4,158 0 0
Managed.................................................. 10 867 11 1,610
-- ----- -- -----
Total................................................... 52 5,587 13 1,754
== ===== == =====
Facilities Units Facilities Units
---------- ------------- ---------- -------------
Assisted Living Facilities(2):
Owned.................................................... 15 1,110 3 218
Leased................................................... 17 1,328 5 458
Managed.................................................. 1 56 10 1,578
-- ----- -- -----
Total................................................... 33 2,494 18 2,254
== ===== == =====
</TABLE>
- -------------
(1) Includes four nursing homes that the Company currently manages for net
profits under an interim agreement pending completion of a formal
lease.
(2) Facilities that provide both nursing care and assisted living services
are counted as nursing homes although their units are counted as assisted
living units. There are three such facilities in the United States and
one in Canada. Also includes four facilities under development: two owned
with 139 units, one leased with 56 units and one to be managed with 110
units.
7
<PAGE>
For the year ended December 31, 1997, the Company's net patient and resident
revenues were $178.2 million, or 97.8% of total net revenues. For the year ended
December 31, 1997, the Company's net revenues from the provision of management
services were $3.9 million, or 2.1% of the total net revenues. This management
fee revenue represented approximately 5% of the $75.0 million net revenues
earned by the owners or operators of the facilities under management. See Note
14 of the Company's Consolidated Financial Statements for more information on
the Company's geographic operations.
Nursing Home Services. The nursing homes operated by the Company provide basic
health care services, including room and board, nutrition services, recreational
therapy, social services, housekeeping and laundry services and nursing
services. In addition, the nursing homes dispense medications and otherwise
follow care plans prescribed by the patients' physicians. In an effort to
attract patients with more complex health care needs, the Company also provides
for the delivery of ancillary medical services at the nursing homes it operates.
These specialty services include rehabilitation therapy services, such as speech
pathology, audiology, and occupational, hospital-based respiratory, and physical
therapies, which are provided through licensed therapists and registered nurses,
and the provision of medical supplies, nutritional support, infusion therapies,
and related clinical services. The Company has historically contracted with
third parties for a fee to assist in the provision of various ancillary services
to the Company's patients. The Company has an ancillary service supply business
through which it provides medical supplies and enteral nutritional support
services directly to patients. The provision of ancillary services increased
dramatically from 1994 through 1996 as the Company's population of Medicare
patients increased. In 1997, the Company began expanding its sales of supplies
directly to the public and independent long-term care operators. In 1998, the
Company began selling enteral nutritional products in the rural communities in
which its facilities are located. The Company continues to explore opportunities
to broaden its ancillary services. The Company's nursing homes range in size
from 39 to 247 licensed beds.
In late 1996, the Company entered into a relationship with Prism, a diversified
health care company that specializes in the provision of comprehensive
post-acute health care services. Prism provides comprehensive rehabilitation
programs (physical, speech and occupational therapies) in the Company's United
States nursing facilities (concentrating in one vendor services that had
previously been dispersed among several). Through joint studies and development
projects, the Company and Prism are actively exploring ways to expand their
services to alternative markets. It is anticipated that these efforts could
include services to elderly clients in assisted living, home health care,
speciality unit care, or outpatient rehabilitation settings and could include
such services as traditional rehabilitation, fitness programs, medical alert
services, equipment rental, adult day care, home health care, or specialized
recreational programs.
Assisted Living Facility Services. Services and accommodations at assisted
living facilities include central dining facilities, recreational areas, social
programs, housekeeping, laundry and maintenance service, emergency call systems,
special features for handicapped persons and transportation to shopping and
special events. The Company believes that assisted living services will continue
to increase as an attractive alternative to nursing home care because a variety
of supportive services and supervision can be obtained in a far more independent
and less institutional setting. Generally, basic care and support services can
be offered cheaper in an assisted living facility than either in a nursing
8
<PAGE>
home or through home health care assistance. On average, the Company provides 30
to 60 minutes of nursing care per resident per day in its Canadian assisted
living facilities. The Company believes that the availability of health care
services is an additional factor that makes assisted living an attractive
alternative in Canada. The Company's assisted living facilities range in size
from 12 to 295 units.
OPERATING AND GROWTH STRATEGY
The Company's objective is to become the leading provider of health care and
related services to the elderly in the communities in which it operates. The
Company intends to achieve this objective by seeking to:
Provide a Broad Range of Cost-Effective Services. The Company's
objective is to provide a variety of services in a broad continuum of care
which will meet the ever changing needs of the elderly. The Company's
expanded service offering currently includes assisted living, skilled
nursing, comprehensive rehabilitation services and medical supply and
nutritional support services. In addition, the Company expects to add new
services as appropriate including adult day care, medical equipment rental,
home health care and specialized recreational programs. By addressing
varying levels of acuity, the Company is able to meet the needs of the
elderly population it serves for a longer period of time and can establish
a reputation as the provider of choice in a particular market. Furthermore,
the Company believes it is able to deliver quality services
cost-effectively, thereby expanding the elderly population base that can
benefit from the Company's services, including those not otherwise able to
afford private-pay assisted living services.
Form Strategic Alliances or Joint Ventures with Other Health Care
Providers. Through strategic alliances or joint ventures with other health
care providers, the Company is able to offer additional services to its
customers in a cost-effective, specialized manner. By entering into such
agreements for services such as rehabilitation, the Company believes that
it can continue to leverage the expertise of other providers in order to
expand its continuum of care on a cost-effective basis. In March 1998, the
Company entered into a joint venture to provide institutional pharmacy
services with NCS HealthCare, a leading long-term care pharmacy services
company. The Company expects to expand into other service areas as
appropriate by establishing additional strategic alliances or joint
ventures in the future.
Cluster Operations on a Regional Basis. The Company has developed
regional concentrations of operations in order to achieve operating
efficiencies, generate economies of scale and capitalize on marketing
opportunities created by having multiple operations in a regional market
area.
Target Non-Urban Underserved Markets. The Company believes there is
significant opportunity to enter non-urban markets, which are underserved
by senior care providers. The Company believes it can quickly and
effectively establish a presence as the leading provider of health care and
related services for the elderly in these markets as they typically have
less competition and more unsatisfied demand for the services the Company
provides.
9
<PAGE>
The key elements of the Company's growth strategy are to:
Increase Revenues and Profitability at Existing Facilities. The
Company's strategy includes increasing facility revenues and profitability
levels through increasing occupancy levels and improving payor mix,
containing costs and protecting or expanding ancillary services. The
Company directs its marketing efforts locally in order to promote higher
occupancy levels and improved payor and case mixes at its nursing homes and
assisted living facilities.
Make Selective Acquisitions. The Company's senior management will
continue to evaluate selected acquisitions through either the lease or
purchase of additional nursing homes and assisted living facilities,
concentrating on rural and secondary markets in the southeast United States
and Canada. Management believes that such markets are often underserved by
long-term care facilities and offer lower labor costs. The Company's goal
is to use its expertise in operating long-term care facilities to increase
the occupancy rates and lower the costs of these acquired facilities. In
addition, where market conditions permit, the Company intends to expand the
operations of acquired facilities by offering more services, in an effort
to increase their profitability.
The Company may also, from time to time, acquire the operations of
other health care providers in order to expand the range of services it can
offer as well as to increase the Company's presence in a particular market
area. For example, the Pierce acquisition significantly expands the
experience and scope of the assisted living component of the Company's
business in the United States. The Company expects to extend this
experience to certain of its existing markets, thereby broadening the range
of services it provides in each of the market areas it serves. In addition,
the Pierce acquisition substantially increases the density of the Company's
operations in the Southeast, which should enable the Company to achieve
economies of scale, operating efficiencies and increased name awareness.
Pursue Additional Opportunities for Management Agreements. Management
believes that the Company can attract additional management agreements.
Further, it is management's belief that the Company is a recognized
provider of quality care and has established financial and operational
control systems, extensive reimbursement expertise, and access to
purchasing economies. The Company has the ability to provide an array of
services ranging from total operational management for passive investors in
nursing homes and assisted living facilities to the provision of unbundled
consulting services. In certain cases, the Company has the opportunity to
share in the profits of a managed facility and/or has a right of first
refusal or an option to purchase the managed facility.
Expand Ancillary Services. The Company continues to develop strategic
alliances with leading health care providers to offer a broad range of
long-term care services to residents of the Company's facilities. Through
its arrangement with Prism, comprehensive rehabilitation programs
(physical, speech and occupational therapies) will be available in all of
the Company's United States nursing homes. Management of the Company is
exploring other opportunities to expand into a broad range of senior care
services. The Company owns a supply business through which it provides
medical supplies and enteral nutritional support services directly to
patients and is expanding its sales of supplies directly to the public and
independent long-term care operators.
10
<PAGE>
The Company has established a task force to address the impact of the BBA. As
they become known, the task force will evaluate changes in the funding
environment for long-term care. The Company will attempt to maximize the
revenues available to it from governmental sources within the changes that occur
under the BBA.
MARKETING
The Company's corporate sales and marketing efforts are designed to acquire
additional leased facilities and additional management contracts through
exhibiting at state and provincial long-term care conventions and through
relationships with bankers, receivers, business brokers and industry
consultants. At a local level, the Company's sales and marketing efforts are
designed to promote higher occupancy levels and optimal payor mix. Management
believes that the long-term care industry is fundamentally a local industry in
which both patients and residents and the referral sources for them are based in
the immediate geographic area in which the facility is located. The Company's
marketing plan emphasizes the role and performance of the administrator and
social services director of each nursing home and the administrator of each
assisted living facility, all of whom are responsible for contacting various
referral sources such as doctors, hospitals, hospital discharge planners,
churches, and various community organizations. Administrators are evaluated
based on their ability to meet specific goals and performance standards that are
tied to compensation incentives. The Company's regional managers and corporate
staff assist local marketing personnel and administrators in establishing
relationships and follow-up procedures with such referral sources. In addition
to soliciting admissions from these sources, management emphasizes involvement
in community affairs in order to promote a public awareness of the Company's
nursing homes and assisted living facilities and their services. The Company
also promotes effective customer relations and seeks feedback through family and
employee surveys.
The Company has an internally-developed marketing program that focuses on the
identification and provision of services needed by the community. The program
assists each facility administrator in analysis of local demographics and
competition with a view toward complementary service development. The Company
believes that the primary referral area in the long-term care industry generally
lies within a five-to-fifteen-mile radius of each facility depending on
population density; consequently, local marketing efforts are more beneficial
than broad-based advertising techniques.
DESCRIPTION OF MANAGEMENT SERVICES AND AGREEMENTS
Of the Company's 116 facilities, 32 are operated as managed facilities, where
the Company's responsibilities include recruiting, hiring and training all
nursing and other personnel, and providing quality assurance, resident care,
nutrition services, marketing, accounting and data processing services. Services
performed at the corporate level include group contract purchasing, employee
training and development, quality assurance oversight, human resource
management, assistance in obtaining third-party reimbursement, financial and
accounting functions, policy and procedure development, system design and
development and marketing support. The Company's financial reporting system
monitors certain key data for each managed facility, such as payroll, admissions
and discharges, cash collections, net patient care revenues, rental revenues,
staffing trend analysis and measurement of operational data on a per patient
basis.
11
<PAGE>
The Company's management fee is subordinated to debt payments at 18 facilities.
The Company has a right of first refusal or option to purchase one facility,
participates in profits over its base management fee at 16 facilities and is
obligated to provide cash flow support at eight facilities. The Company receives
a base management fee for the management of long-term care facilities ranging
generally from 3.5% to 6.0% of the net revenues of each facility. Other than
certain corporate and regional overhead costs, the services provided at the
facility are the facility owner's expense. The facility owner also is obligated
to pay for all required capital expenditures. The Company generally is not
required to advance funds to the owner. However, with respect to one management
agreement covering two facilities, the Company has advanced approximately $1.5
million; this advance carries 8.0% interest and is being repaid over the
remaining life of the management agreement. Additionally, the Company guarantees
the cash flow of a second limited partnership that the Company manages. See
Notes 6 and 15 of the Company's Consolidated Financial Statements for more
information on these advances.
Of the Company's 32 management contracts, four are contracts to manage
facilities during Canadian receivership or insolvency proceedings. Although
these contracts are generally month-to-month, it has been the Company's
experience that the duration of a receivership or insolvency management
appointment typically ranges from six to twenty-four months. The number of such
management appointments fluctuates as troubled facilities are added or are
removed due to the disposition of the property by the receiver or owner. These
four management contracts are for a base fee with no profit participation, no
subordination to debt, no purchase options and no guarantees of debt.
Based upon the initial term and any renewal terms over which the Company holds
the option, the remaining 28 contracts expire in the following years:
<TABLE>
<CAPTION>
NUMBER OF FACILITIES 1997
------------------- MANAGEMENT
YEAR U.S. CANADA FEES (000'S)
-------- --------- ------------
<S> <C> <C> <C>
1998......................... 1 3 $ 281,000
1999......................... 0 3 252,000
2000......................... 0 1 142,000
2001......................... 6 0 -0-(1)
2004......................... -- 8 1,297,000
2005......................... -- 2 517,000
2015......................... 4 -- 1,078,000
-- --
Total................... 11 17
== ==
</TABLE>
- ------------
(1) The operations of the six facilities of Texas Diversicare Limited
Partnership ("TDLP") are included in the Company's consolidated operations.
Accordingly, no management fees are recognized with respect to TDLP. See
Note 6 of the Company's Consolidated Financial Statements for more
information with respect to the Company's relationship with TDLP.
The Company currently anticipates that, except for the receivership or
insolvency agreements, most of the management agreements coming due for renewal
through 2001 will be renewed. However, there can be no assurance that any of
such agreements will be renewed.
12
<PAGE>
The following table summarizes the Company's net revenues derived from
management services and the net revenues of the managed facilities during the
years indicated (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Management Fees(1) $ 3,886 $ 3,652 $ 3,618
======= ======= =======
Net Revenues of Managed Facilities $75,043 $72,076 $75,359
======= ======= =======
Management Fees as a Percentage
of Net Facility Revenues 5.2% 5.1% 4.8%
======= ======= =======
</TABLE>
- -----------
(1) 1996 amount is net of $0.5 million in non-recurring consulting fees.
DESCRIPTION OF LEASE AGREEMENTS
The Company leases 59 nursing homes and assisted living facilities, of which 30
are leased from Omega Healthcare Investors, Inc. ("Omega") (a real estate
investment trust), 11 are leased from Counsel Corporation ("Counsel") (which
owned or controlled the Company's predecessor operations), 13 are leased from
members or affiliates of Pierce and five are leased from others. All but two of
the Company's leases are "triple-net," requiring the Company to maintain the
premises, pay taxes, and pay for all utilities. The Company typically grants its
lessor a security interest in the Company's personal property located at each
leased facility to secure the Company's performance under the lease. The leases
contain customary default and covenant provisions, generally requiring the
Company to maintain a minimum net worth, expend specified sums per bed for
capital expenditures, maintain certain financial and coverage ratios and
prohibit the Company from operating any additional facilities within a certain
radius of each leased facility. In addition, the Company is generally required
to maintain comprehensive insurance covering the facilities it leases as well as
personal and real property damage insurance and professional malpractice
insurance. In all cases where mortgage indebtedness exists with respect to a
leased facility, the Company's interest in the premises is subordinated to that
of the lessor's mortgage lenders.
Omega Leases. The Company has a master lease with Omega covering 21 facilities
(the "Master Lease"), which provides for an initial term of ten years through
August 2002 and allows the Company one ten-year renewal option. The Master Lease
provides for annual increases in the rent based upon inflation or a percentage
of the increase in the net revenues of the facilities, whichever results in the
greater increase in rent, up to a maximum increase equal to 5.0% of the prior
year's rent. The Company entered into new agreements with Omega in 1994 with
respect to ten facilities (one of which was closed in April 1997). The Company
currently leases five of these facilities from Omega pursuant to a new master
lease agreement (the "1994 Omega Lease"). Pending the completion of a formal
lease, the remaining four facilities are managed by the Company pursuant to an
interim
13
<PAGE>
management agreement under which the Company is entitled to the net profits of
the facility. The Company classifies all four of these facilities as leased
facilities. The 1994 Omega Lease provides for an initial term of ten years and
provides the Company two five-year renewal options. The rent with respect to
these facilities is subject to increases under a formula similar to that of the
Master Lease up to a maximum increase of 3.9% of the prior year's rent. During
the year ended December 31, 1997, the patient and resident revenues from the
Omega leased facilities were approximately $90.7 million. A default with respect
to any one facility would constitute a default with respect to all the
facilities covered by the Master Lease or the 1994 Omega Lease, as applicable.
Counsel Leases. The Company leases five facilities from Counsel with an initial
term of five years through April 1999 and one five-year renewal option. The
Company leases three additional facilities from Counsel with an initial term of
ten years through April 2004 and one ten-year renewal option. With respect to
these eight facilities, the Company has the right of first refusal and a
purchase option at the end of the respective lease terms. Additionally, the rent
is fixed throughout the initial terms. The Company leases three additional
facilities from Counsel with a lease term through August 2002. These facilities
are subject to a participating mortgage from Counsel in favor of Omega. At the
end of the lease term, the Company has the right to purchase these facilities.
In addition, the Company can require Counsel to transfer these facilities to
Omega, at which time the Company has the right to lease these facilities from
Omega in accordance with the terms of the Master Lease. Rent increases with
respect to these three facilities are calculated under the same terms as
applicable in the Omega Master Lease. During the year ended December 31, 1997,
the patient and resident revenues from the Counsel leased facilities were
approximately $27.7 million. The Counsel leases provide that a default under any
one of the leases constitutes a default under all of the leases.
Pierce Leases. Effective October 1, 1997, the Company acquired leases with
respect to 14 facilities as part of the Pierce transaction. Of these leases, 12
are with the former principal owners of Pierce and have an initial term of 15
years and two five-year renewal options. Beginning at the third anniversary,
annual rent increases are to be applied equal to the rate of inflation up to a
maximum of 3.0%. Beginning at the fifth anniversary, the Company has a right to
purchase all twelve facilities as a group for their fair market value. The
remaining two leases are subleases that expire in 2017 and 1998. With respect to
the latter sublease, the Company and the sublessor have agreed in principal to a
direct lease with a five-year term beginning concurrent with the expiration of
the sublease. The Company has no purchase option with respect to either
sublease. During the period beginning with the acquisition on October 1, 1997
and ending December 31, 1997, the resident revenues from the Pierce leased
facilities were approximately $3.4 million.
14
<PAGE>
FACILITIES.
The following table summarizes certain information with respect to the nursing
homes and assisted living facilities owned, leased and managed by the Company as
of December 31, 1997:
<TABLE>
<CAPTION>
Assisted Living
-----------------------------------------------------
Nursing Homes Centers
---------------------- ----------------------------
Number Licensed Beds Number(1) Units
------ ------------- ------- ---------------
<S> <C> <C> <C> <C>
OPERATING LOCATIONS:
Alabama......................................... 7 862 -- 52
Arkansas........................................ 13 1,411 2 24
Florida......................................... 8 800 -- --
Kentucky(2)..................................... 6 474 -- 4
North Carolina.................................. -- -- 27 2,163
Ohio............................................ 1 151 -- --
South Carolina.................................. -- -- 1 56
Tennessee....................................... 5 617 -- --
Texas........................................... 10 1,092 -- --
West Virginia(2)................................ 2 180 -- --
Ontario......................................... 13 1,754 14 1,684
British Columbia................................ -- -- 3 460
-- ----- -- -----
65 7,341 47 4,443
LOCATIONS UNDER DEVELOPMENT:
Georgia......................................... -- -- 1 56
North Carolina.................................. -- -- 2 139
British Columbia................................ -- -- 1 110
-- ----- -- -----
Total.......................................... 65 7,341 51 4,748
== ===== == =====
CLASSIFICATION:
Owned........................................... 7 706 18 1,328
Leased(2)....................................... 37 4,158 22 1,786
Managed......................................... 21 2,477 11 1,634
-- ----- -- -----
Total.......................................... 65 7,341 51 4,748
== ===== == =====
</TABLE>
- -----------
(1) Facilities that provide both nursing care and assisted living services
are counted as nursing homes. There are two such facilities in Alabama,
one in Kentucky and one in Canada.
(2) The Company manages two of the facilities in Kentucky and two of the
facilities in West Virginia for net profits under an interim agreement
pending completion of formal leases. All four of these facilities are
classified as leased facilities.
15
<PAGE>
The following table summarizes more detailed information regarding the nursing
homes and assisted living facilities owned, leased, or managed by the Company as
of December 31, 1997:
<TABLE>
<CAPTION>
NURSING HOMES:
AVERAGE
OCCUPANCY RATES(1)
LICENSED FOR THE YEAR ENDED
NURSING OWNED(O) DECEMBER 31,
HOME LEASED(L) --------------------------
FACILITY NAME LOCATION BEDS MANAGED(M) 1997 1996 1995
--------------------- -------- ------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
ALABAMA
Dauphin Health Care Facility....................... Mobile 151 L 89.3% 95.9% 95.2%
Westside Health Care Center........................ Huntsville 129 L 91.9 94.4 95.0
Lynwood Nursing Home............................... Mobile 127 L 76.8 92.8 96.4
Canterbury Health Care Facility ................... Phenix City 137 L 94.7 97.1 97.0
Windsor House ..................................... Huntsville 117 O 94.9 94.0 97.7
Northside Health Care.............................. Gadsden 115 L 94.3 97.5 97.0
Hartford Health Care............................... Hartford 86 O(2) 95.3 99.7 --
--- ---- ---- ----
Total - Alabama........................... 862 90.7% 95.5% 96.3%
--- ---- ---- ----
ARKANSAS
Ouachita Nursing & Rehabilitation Center........... Camden 142 L 86.7% 85.0% 83.4%
Pinedale Nursing & Rehabilitation Center........... Newport 130 O(2) 72.1 88.2 --
Sheridan Nursing & Rehabilitation Center........... Sheridan 121 L 76.2 91.5 93.9
Walnut Ridge Nursing & Rehabilitation Center....... Walnut Ridge 119 L 82.4 91.5 96.0
Rich Mountain Nursing & Rehabilitation Center...... Mena 115 L 77.4 89.8 89.8
Ash Flat Nursing & Rehabilitation Center........... Ash Flat 105 L 85.3 87.5 88.4
Faulkner Nursing & Rehabilitation Center........... Conway 105 L 75.1 75.9 74.5
Garland Nursing & Rehabilitation Center............ Hot Springs 105 L 68.3 74.8 78.9
Stillmeadow Nursing & Rehabilitation Center........ Malvern 104 L 65.7 73.6 83.2
Eureka Springs Nursing & Rehabilitation Center..... Eureka Springs 100 L 69.6 65.8 54.6
Des Arc Nursing & Rehabilitation Center............ Des Arc 98 L 58.1 61.6 66.1
Pocahontas Nursing & Rehabilitation Center......... Pocahontas 97 L 94.6 95.8 98.3
The Pines Nursing & Rehabilitation Center.......... Hot Springs 70 L 92.8 83.1 87.0
----- ---- ---- ----
Total - Arkansas.......................... 1,411 77.1% 81.9% 82.9%
----- ---- ---- ----
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
NURSING HOMES (CONTINUED):
AVERAGE
OCCUPANCY RATES(1)
LICENSED FOR THE YEAR ENDED
NURSING OWNED(O) DECEMBER 31,
HOME LEASED(L) --------------------------
FACILITY NAME LOCATION BEDS MANAGED(M) 1997 1996 1995
--------------------- -------- ------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
FLORIDA
Cedar Hills Nursing Center....................... Jacksonville 180 M 93.0% 93.1% 96.3%
Leesburg Nursing Center.......................... Leesburg 120 L(3) 82.6 85.7 91.5
Southern Pines Nursing Center.................... New Port Richey 120 M 92.8 96.0 93.8
DeSoto Manor Nursing Home........................ Arcadia 118 L(3) 85.7 90.0 90.5
Hardee Manor Care Center......................... Wauchula 79 L(3) 93.3 96.2 97.3
Golfcrest Nursing Home........................... Hollywood 67 M 91.8 91.1 93.7
Good Samaritan Nursing Home...................... St. Petersburg 60 O(4) 79.4 75.0 71.2
Golfview Nursing Home............................ St. Petersburg 56 M 82.2 83.0 86.1
Total - Florida......................... 800 88.5% 90.0% 91.6%
--- ---- ---- ----
KENTUCKY
Wurtland Health Care Center...................... Wurtland 126 L 94.4% 93.1% 94.9%
Carter Nursing & Rehabilitation Center........... Grayson 120 L 96.7 97.0 96.5
Boyd Nursing & Rehabilitation Center............. Ashland 60 L(5) 96.0 71.0 (6)
Elliott Nursing & Rehabilitation Center.......... Sandy Hook 60 L(5) 90.8 (6) --
South Shore Nursing & Rehabilitation Center...... South Shore 60 L 97.2 94.9 94.7
West Liberty Nursing & Rehabilitation Center..... West Liberty 48 L 97.4 94.2 96.8
--- ---- ---- ----
Total - Kentucky........................ 474 95.4% 84.8% 93.0%
--- ---- ---- ----
OHIO
Best Care........................................ Wheelersburg 151 L 94.6% 92.8% 94.1%
--- ---- ---- ----
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
NURSING HOMES (CONTINUED):
AVERAGE
OCCUPANCY RATES(1)
LICENSED FOR THE YEAR ENDED
NURSING OWNED(O) DECEMBER 31,
HOME LEASED(L) --------------------------
FACILITY NAME LOCATION BEDS MANAGED(M) 1997 1996 1995
--------------------- -------- ------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
TENNESSEE
Martin Health Care............................... Martin 150 L(3) 69.0% 75.4% 85.1%
Laurel Manor Health Care Facility................ New Tazewell 134 L 96.9 98.4 97.0
Mayfield Rehabilitation & Special Care Center.... Smyrna 125 L 86.9 85.3 95.9
Briarcliff Health Care Center.................... Oak Ridge 120 L(3) 92.7 94.1 92.5
Manor House of Dover............................. Dover 88 L 97.4 98.4 99.0
--- ---- ---- ----
Total - Tennessee....................... 617 87.3% 89.3% 93.3%
--- ---- ---- ----
TEXAS
South Park Rehabilitation & Nursing Center....... Corpus Christi 189 L(3) 62.7% 66.1% 66.5%
Aransas Pass Nursing & Rehabilitation Center..... Aransas Pass 170 L(3) 66.4 61.8 62.6
Afton Oaks Nursing & Rehabilitation Center....... Houston 169 O(7) 87.5 87.4 88.5
Hillside Nursing & Rehabilitation Center......... Beeville 120 L(3) 50.6 54.6 62.4
Chisolm Trail Nursing & Rehabilitation Center.... Lockhart 100 M(8) 68.2 80.6 74.8
Yorktown Nursing & Rehabilitation Center......... Yorktown 92 M(8) 69.9 71.5 82.3
Lampasas Nursing & Rehabilitation Center......... Lampasas 68 M(8) 68.6 84.9 92.6
Refugio Nursing & Rehabilitation Center.......... Refugio 64 M(8) 75.3 94.1 92.6
Goliad Nursing & Rehabilitation Center........... Goliad 60 M(8) 66.4 83.2 79.4
Hillcrest Manor Nursing & Rehabilitation Center.. Luling 60 M(8) 94.7 89.9 94.9
----- ---- ---- ----
Total - Texas........................... 1,092 70.0% 74.3% 74.4%
----- ---- ---- ----
WEST VIRGINIA
Boone Health Care Center......................... Danville 120 L(5) 75.4% 78.8% 75.8%
Laurel Nursing & Rehabilitation Center........... Big Otter 60 L(5) 80.4 (6) --
----- ---- ---- ----
Total - West Virginia................... 180 77.1% 78.8% 75.8%
----- ---- ---- ----
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
NURSING HOMES (CONTINUED):
AVERAGE
OCCUPANCY RATES(1)
LICENSED FOR THE YEAR ENDED
NURSING OWNED(O) DECEMBER 31,
HOME LEASED(L) --------------------------
FACILITY NAME LOCATION BEDS MANAGED(M) 1997 1996 1995
--------------------- -------- ------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
ONTARIO, CANADA
Chelsey Park Oxford.............................. London 247 M 99.0% 99.6% 99.6%
Chelsey Park..................................... Mississauga 237 M 97.8 98.0 98.3
Rockcliffe Nursing Home.......................... Scarborough 204 M 98.1 99.4 99.5
Cheltenham Nursing Home.......................... Willowdale 170 M 97.8 99.3 99.3
Altamont Nursing Home............................ West Hill 159 M 98.5 98.5 97.1
Tullamore Nursing Home........................... Brampton 159 M 99.0 99.0 98.9
Chelsey Park..................................... Streetsville 118 M 99.5 99.8 99.7
Tilbury Manor.................................... Tilbury 85 O 83.2 94.0 83.0
Oxford Regional Nursing Home..................... Ingersoll 80 M 99.9 99.9 99.9
St. Demetrius.................................... Weston 120 M 96.5 86.1 (9)
Knollcrest....................................... Milverton 77 M 94.6 95.4 95.7
Hardy Terrace.................................... Brampton 59 O(10) 97.6 85.8 --
Green Gables Manor............................... Stouffville 39 M(11) 94.3 -- --
----- ---- ---- ----
Total - Ontario, Canada................. 1,754 97.4%(12) 98.0%(12) 97.9%(12)
----- ---- ---- ----
Total - 65 Nursing Homes................ 7,341 86.1%(12) 87.9%(12) 89.6%(12)
===== ==== ==== ====
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
ASSISTED LIVING FACILITIES:
AVERAGE
OCCUPANCY RATES(1)
ASSISTED FOR THE YEAR ENDED
LIVING OWNED(O) DECEMBER 31,
CENTER LEASED(L) --------------------------
FACILITY NAME LOCATION UNITS MANAGED(M) 1997 1996 1995
--------------------- -------- ------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
NORTH CAROLINA
Christian Care of Winston-Salem.................. Winston-Salem 142 O 95.0% - -
Heritage Retirement of Wilson.................... Wilson 142 O 81.8 - -
Christian Care - Henderson....................... Henderson 129 L 64.9 - -
Heritage Retirement - Rocky Mount................ Rocky Mount 126 L 99.2 - -
New Bern Rest Home............................... New Bern 120 L(3) 71.6 - -
Pinewood Manor................................... Ahoskie 100 L(3) 92.9 - -
Christian Care - New Bern........................ New Bern 98 L(3) 93.4 - -
New River Country Center......................... Sparta 98 L(3) 57.7 - -
Edenton Prime Time............................... Edenton 94 L(3) 95.2 - -
Heritage Care of Clinton......................... Clinton 94 O 93.2 - -
Heritage Care - Elizabeth City................... Elizabeth City 94 L(3) 94.1 - -
Chatham Creek.................................... Cary 80 O 78.0 - -
Jacksonville Care Center......................... Jacksonville 80 L(3) 94.0 - -
Christian Care of Smithfield #2.................. Smithfield 79 O(13) N/A - -
Broman Rest Home................................. New Port 61 O 82.3 - -
Neilson's Rest Home.............................. Carikuba Beach 61 O 92.0 - -
Cateret Care..................................... Morehead City 60 O(13) N/A - -
Christian Care of Smithfield #1.................. Smithfield 60 O 98.2 - -
Clayton Restful Manor............................ Clayton 60 O 91.4 - -
Creekside Manor.................................. Kernersville 60 L(3) 98.2 - -
Heritage Care - Conover.......................... Conover 60 L(3) 88.5 - -
Heritage Care of Elkin........................... Elkin 60 L(3) 94.8 - -
Heritage Care of Seven Lakes..................... West End 60 O 96.8 - -
Kannapolis Village............................... Kannapolis 60 O 99.5 - -
Fremont Rest Center.............................. Fremont 50 L(3) 99.4 - -
Senters Rest Home................................ Fuquay Varina 50 O 80.5 - -
Branchwood Rest Home............................. Reidsville 43 O 87.6 - -
Suttons Rest Home................................ Goldsboro 41 O 92.0 - -
Carolina Rest Home............................... Roanoke Rapids 40 L(3) 99.4 - -
----- ----
Total - North Carolina.................. 2,302 87.9%
----- ----
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
ASSISTED LIVING FACILITIES (CONTINUED):
AVERAGE
OCCUPANCY RATES(1)
ASSISTED FOR THE YEAR ENDED
LIVING OWNED(O) DECEMBER 31,
CENTER LEASED(L) --------------------------
FACILITY NAME LOCATION UNITS MANAGED(M) 1997 1996 1995
--------------------- -------- ------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
CANADA
Chelsey Park Retirement Center............... London, Ontario 323 M 89.0% 94.3% 99.3%
Belmont Manor................................ Kitchener, Ontario 279 M 91.3 93.9 --
The Grenadier................................ Toronto, Ontario 250 M(14) 85.3 80.7 73.3
Hawthorn Park Condominiums................... Kelowna, BC 186 M N/A N/A N/A
Courtyard Gardens............................ Richmond, BC 139 M(14) 105.9 105.5 106.0
Hawthorn Park Retirement Community........... Kelowna, BC 135 L(3) 106.7 107.7 111.6
The Gilmore.................................. Richmond, BC 110 M(15) N/A -- --
Metcalfe Gardens............................. St. Thomas, Ontario 100 L(3) 92.3 88.9 91.9
Bruce Retirement Villa....................... Windsor, Ontario 96 M(11) 82.0 58.6 --
Cavendish Manor.............................. Niagara Falls Ontario 96 O(16) 90.7 82.7 80.9
The Richmond................................. Belleville, Ontario 88 M 96.6 88.2 80.6
Maple City Residence......................... Chatham, Ontario 85 L(3) 88.0 81.5 81.2
Erie Glen Manor.............................. Leamington, Ontario 82 L(3) 96.7 94.9 103.3
Waverley Mansion............................. London, Ontario 65 O(17) 75.9 69.1 --
Park Street Place............................ Dresden, Ontario 60 O(17) 92.8 66.0 --
Hudson Manor................................. Tilbury, Ontario 53 L(3) 86.7 79.0 83.8
Willoughby Manor............................. Niagara Falls, Ontario 51 M(11) 76.5 (6) --
Green Gables Manor(18)....................... Stouffville, Ontario 32 M(11) 57.8 -- --
Maynard Lodge................................ Toronto, Ontario 24 M(11) 95.7 -- --
----- ----- ----- -----
Total - Canada...................... 2,254 93.7%(12) 97.9%(12) 94.5%(12)
----- ----- ----- -----
ALABAMA
Canterbury Health Care Facility(18).......... Phenix City 35 L 26.8% 37.3% 66.5%
Windsor House(18)............................ Huntsville 17 O 65.4 85.7 47.4
----- ----- ----- -----
Total - Alabama..................... 52 39.4% 53.2% 60.3%
----- ----- ----- -----
ARKANSAS
Garland Village Apartments................... Hot Springs 12 L 101.4% 105.3% 91.4%
Pine Manor Apartments........................ Camden 12 L 107.6 100.9 91.9
----- ----- ----- ----
Total - Arkansas.................... 24 104.5% 103.1% 91.7%
----- ----- ----- ----
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
ASSISTED LIVING FACILITIES:
AVERAGE
OCCUPANCY RATES(1)
ASSISTED FOR THE YEAR ENDED
LIVING OWNED(O) DECEMBER 31,
CENTER LEASED(L) --------------------------
FACILITY NAME LOCATION UNITS MANAGED(M) 1997 1996 1995
--------------------- -------- ------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
GEORGIA
Plantation Manor................................ Thomasville 56 L(15) -- -- --
KENTUCKY
West Liberty Health Care Center(18)............. West Liberty 4 L 92.9% 84.4% 76.9%
SOUTH CAROLINA
Greenville Care................................. Greenville 56 M 74.1 53.6% --
------ ---- ---- ----
Total - 51 Assisted Living Facilities.. 4,748 91.7%(12) 92.4%(12) 95.8%(12)
====== ==== ==== ====
Total - 87 Facilities.................. 12,089 87.0%(12) 88.6%(12) 90.4%(12)
====== ==== ==== ====
</TABLE>
(1) The average occupancy is equal to the actual patient or resident days
during the period in which the Company operated the facility in the year
divided by the beds or units available for occupancy. If no percentage is
presented, the Company did not operate the facility. Available occupancy
of assisted living facilities is based on one person per unit.
(2) Facility purchased June 30, 1996.
(3) The Company holds an option to purchase these facilities.
(4) Facility purchased February 20, 1996; previously managed.
(5) The Company manages this facility for net profits under an interim
agreement pending completion of a formal lease.
(6) Facility opened during the year; occupancy statistics are excluded.
(7) Facility purchased November 30, 1995.
(8) The Company manages these facilities on behalf of TDLP, a limited
partnership of which the Company is the general partner. Because of
continuing potential financial obligations of the Company to the limited
partnership, the operations of these facilities are included in the
operations of the Company in accordance with generally accepted accounting
principles. See Note 6 of the Company's Consolidated Financial Statements
for a more detailed explanation of the Company's relationship with TDLP.
(9) Facility under development during the year.
(10) Facility purchased November 28, 1996.
(11) Managed during receivership or insolvency proceedings.
(12) Average occupancy for the group excludes facilities under development or
facilities managed during receivership or insolvency proceedings.
(13) Facility currently under evaluation for redevelopment.
(14) The Company holds a minority joint venture interest in this facility.
(15) Facility currently under development. Anticipated opening in 1998.
(16) Facility purchased December 31, 1995; previously managed.
(17) Facility purchased September 30, 1997, previously managed.
(18) These facilities are not included in the total number of assisted living
facilities since they are part of a nursing/assisted living facility
complex. Assisted living units are included in the count of retirement
units.
22
<PAGE>
ORGANIZATION
The Company's long-term care facilities are currently organized into ten
regions, seven in the United States and three in Canada, each of which is
supervised by a regional vice president or manager. The regional vice president
or manager is supported by nursing and human resource personnel, a regional
controller, education coordinators and clerical personnel, all of whom are
employed by the Company. The day-to-day operations of each owned, leased or
managed nursing home is supervised by an on-site, licensed administrator. The
administrator of each nursing home is supported by other professional personnel,
including a medical director, who assists in the medical management of the
facility, and a director of nursing, who supervises a staff of registered
nurses, licensed practical nurses, and nurses aides. Other personnel include
dietary staff, activities and social service staff, housekeeping, laundry and
maintenance staff, and a business office staff. Each assisted living facility
owned, leased or managed by the Company is supervised by an on-site
administrator, who is supported by a director of resident care, a director of
food services, a director of maintenance, an activities coordinator, dietary
staff and housekeeping, laundry and maintenance staff. With respect to the
managed facilities, the majority of the administrators are employed by the
Company, and the Company is reimbursed for their salaries and benefits by the
respective facilities. All other personnel at managed facilities are employed
and paid by the owner of the nursing home or assisted living facility, not by
the Company. All personnel at the leased or owned facilities, including the
administrators, are employed by the Company.
The Company has in place a Continuous Quality Improvement ("CQI") program, which
is focused on training direct care givers. The Company conducts monthly audits
to monitor adherence to the standards of care established by the CQI program at
each facility owned, leased or managed by the Company. The facility
administrator, with assistance from regional nursing personnel, is primarily
responsible for adherence to the Company's quality improvement standards. In
that regard, the annual operational objectives established by each facility
administrator include specific objectives with respect to quality of care.
Performance of these objectives is evaluated quarterly by the regional vice
president or manager, and each facility administrator's incentive compensation
is based, in part, on the achievement of the specified quality objectives.
Issues regarding quality of care and resident care outcomes are addressed
monthly by senior management. The Company also has established a quality
improvement committee consisting of nursing representatives from each region.
This committee periodically reviews the Company's quality improvement programs
and, if so directed, conducts facility audits as required by the Company's
executive committee. The Company and its predecessor have operated a medical
advisory committee in Ontario for more than 12 years and has developed similar
committees in some of the other jurisdictions in which it operates. It is the
Company's view that these committees provide a vehicle for ensuring greater
physician involvement in the operations of each facility with resulting improved
focus on CQI and resident care plans. In addition, the Company has provided
membership for all of its medical directors in the American Medical Directors
Association. All of the nursing homes operated by the Company in Ontario have
been accredited by the Canadian Council on Health Facilities Accreditation. The
Company is also in the process of seeking accreditation of each of its U.S.
nursing homes by the Joint Commission on the Accreditation of Healthcare
Organizations. The CQI program used at all locations was designed to meet
accreditation standards and to exceed state and federal government regulations.
23
<PAGE>
COMPETITION
The long-term care business is highly competitive. The Company faces direct
competition for additional facilities and management agreements, and the
facilities operated by the Company face competition for employees, patients, and
residents. The Company plans to expand its business through the acquisition of
additional owned or leased long-term care facilities and through additional
management agreements. The Company competes with a variety of other companies to
acquire such facilities and to provide contract management services. Some of the
Company's present and potential competitors for acquisitions and management
agreements are significantly larger and have or may obtain greater financial and
marketing resources. Competing companies may offer new or more modern facilities
or new or different services that may be more attractive to patients, residents
or facility owners than the services offered by the Company.
The nursing homes and assisted living facilities that the Company operates
compete with other facilities in their respective markets, including
rehabilitation hospitals, other "skilled" or "intermediate" nursing homes and
personal care residential facilities. In the few urban markets in which the
Company operates, some of the long-term care providers with which the Company's
operated facilities compete are significantly larger and have or may obtain
greater financial and marketing resources than the Company's operated
facilities. Some of these providers are not-for-profit organizations with access
to sources of funds not available to the facilities operated by the Company.
Construction of new long-term care facilities near the Company's existing
operated facilities could adversely affect the Company's business. Management
believes that the most important competitive factors in the long-term care
business are: a facility's local reputation with referral sources, such as acute
care hospitals, physicians, religious groups, other community organizations,
managed care organizations, and a patient's family and friends; physical plant
condition; the ability to identify and meet particular care needs in the
community; the availability of qualified personnel to provide the requisite
care; and the rates charged for services. There is limited, if any, price
competition with respect to Medicaid and Medicare patients, since revenues for
services to such patients are strictly controlled and are based on fixed rates
and cost reimbursement principles. Although the degree of success with which the
Company's operated facilities compete varies from location to location,
management believes that its operated facilities generally compete effectively
with respect to these factors.
GOVERNMENT REGULATION AND REIMBURSEMENT
The Company's facilities are subject to compliance with numerous federal, state
and local health care statutes and regulations. All nursing homes must be
licensed by the states in which they operate and must meet the certification
requirements of government-sponsored health insurance programs such as Medicare
and Medicaid, in order to receive reimbursement from these programs. The
Company's assisted living facilities in North Carolina are subject to similar
state and local licensing requirements.
Reimbursement. A significant portion of the Company's revenues is derived from
government- sponsored health insurance programs. The nursing homes operated by
the Company derive revenues under Medicaid, Medicare, the Ontario Government
Operating Subsidy program and private pay services. The United States assisted
living facilities derive revenues from Medicaid and similar
24
<PAGE>
programs as well as from private pay sources. Assisted living facilities in
Canada derive virtually all of their revenues from private pay sources. The
Company employs specialists in reimbursement at the regional and corporate level
to monitor regulatory developments, to comply with all reporting requirements,
and to maximize payments to its operated nursing homes. It is generally
recognized that all government-funded programs have been and will continue to be
under cost containment pressures, but the extent to which these pressures will
affect the Company's future operations is unclear.
Medicare and Medicaid. Medicare is a federally-funded and administered health
insurance program for the aged and for certain chronically disabled individuals.
Part A of the Medicare program covers inpatient hospital services and certain
services furnished by other institutional providers such as skilled nursing
facilities. Part B covers the services of doctors, suppliers of medical items,
various types of outpatient services, and certain ancillary services of the type
provided by long term and acute care facilities. Medicare payments under Part A
and Part B are subject to certain caps and limitations, as provided in Medicare
regulations. Medicare benefits are not available for intermediate and custodial
levels of nursing home care, nor for a stay in an assisted living facility.
Medicaid is a medical assistance program for the indigent, operated by
individual states with financial participation by the federal government.
Criteria for medical indigence vary somewhat from state to state, subject to
federal guidelines. Available Medicaid benefits and rates of payment vary
somewhat from state to state, subject to certain federal requirements. Basic
long-term care services are provided to Medicaid beneficiaries, including
nursing, dietary, housekeeping and laundry and restorative health care services,
room and board, and medications. Previously, under legislation known as the
Boren Amendment, federal law required that Medicaid programs pay to nursing home
providers amounts adequate to enable them to meet government quality and safety
standards. However, the Balanced Budget Act signed into law by President Clinton
on August 5, 1997 (the "BBA"), repealed the Boren Amendment, and the BBA
requires only that, for services and items furnished on or after October 1,
1997, a state Medicaid program must provide for a public process for
determination of Medicaid rates of payment for nursing facility services. Under
this process, proposed rates, the methodologies underlying the establishment of
such rates and the justification for the proposed rates are published. This
public process gives providers, beneficiaries and concerned state residents a
reasonable opportunity for review and comment. At least four of the eight states
in which the Company now operates are actively seeking ways to reduce Medicaid
spending for nursing home care by such methods as capitated payments and
substantial reductions in reimbursement rates.
The BBA also requires that nursing homes transition to a prospective payment
system under the Medicare program during a three-year transition period
commencing with the first cost reporting period beginning on or after July 1,
1998, and creates a managed care Medicare program called "Medicare + Choice."
Medicare + Choice allows beneficiaries to participate either in the original
Medicare fee-for-service program or to enroll in a managed care plan such as a
health maintenance organization ("HMO"). Such managed care plans would allow the
HMOs to enter into risk-based contracts with the Medicare program, and the
Medicare HMOs could then contract with providers such as the Company for the
provision of nursing home services. No assurance can be given that the Company's
facilities will be successful in negotiating favorable contracts with Medicare
HMOs. At this time, the Company is unable to predict the impact that the
Medicare prospective payment system will have on its operations.
25
<PAGE>
The BBA also contains certain measures that could lead to future reductions in
Medicare therapy cost reimbursement and Medicaid payment rates. Given the recent
enactment of the BBA, the Company is unable to predict the ultimate impact of
the BBA on its future operations. However, any reductions in government spending
for long-term health care could have an adverse effect on the operating results
and cash flows of the Company.
Reduction in health care spending has become a national priority in the United
States, and the field of health care regulation and reimbursement is a rapidly
evolving one. For the fiscal year ended December 31, 1997, the Company derived
25.2% and 55.8% of its total revenues from the Medicare and Medicaid programs,
respectively. Any health care reforms that significantly limit rates of
reimbursement under these programs could, therefore, have a material adverse
effect on the Company's profitability. The Company is unable to predict which
reform proposals or reimbursement limitations will be adopted in the future or
the effect such changes would have on its operations. In addition, private
payors, including managed care payors, are increasingly demanding that providers
accept discounted fees or assume all or a portion of the financial risk for the
delivery of health care services. Such measures may include capitated payments,
which can result in significant losses to health care providers if patients
require expensive treatment not adequately covered by the capitated rate.
Ontario Government Operating Subsidy Program. The Ontario Government Operating
Subsidy program ("OGOS") regulates both the total charges allowed to be levied
by a licensed nursing home and the maximum amount that the OGOS program will pay
on behalf of nursing home residents. The maximum amounts that can be charged to
residents for ward, semi-private and private accommodation are established each
year by the Ontario Ministry of Health. Regardless of actual accommodation, at
least 40% of the beds in each home must be filled at the ward rate. Generally,
amounts received from residents should be sufficient to cover the accommodation
costs of a nursing home, including food, laundry, housekeeping, property costs
and administration. In addition, the Ontario government partially subsidizes
each individual, and funds each nursing home for the approximate care
requirements of its residents. This funding is based upon an annual assessment
of the levels of care required in each home, from which "caps" are determined
and funding provided on a retrospective basis. The Ontario government funds from
35% to 70% of a resident's charges, depending on the individual resident's
income and type of accommodation. The Company receives payment directly from
OGOS by virtue of its ownership of two nursing homes in Canada. Additionally,
the Company earns management fees from Canadian nursing homes, which derive
significant portions of their revenues from OGOS.
Self-Referral and Anti-Kickback Legislation. The health care industry is subject
to state and federal laws which regulate the relationships of providers of
health care services, physicians, and other clinicians. These laws impose
restrictions on physician referrals to any entity with which they have a
financial relationship. The Company believes that it is in compliance with these
laws. Failure to comply with self-referral laws could subject the Company to a
range of sanctions, including civil fines, possible exclusion from government
reimbursement programs, and criminal prosecution. There are also federal and
state laws making it illegal to offer anyone anything of value in return for
referral of patients. These laws, generally known as "anti-kickback" laws, are
broad and subject to varying interpretations. Given the lack of clarity of these
laws, there can be no absolute assurance that any health care provider,
including the Company, will not be found in violation of the anti-kickback laws
26
<PAGE>
in any given factual situation. Strict sanctions, including exclusion from the
Medicare and Medicaid programs and criminal penalties, may be imposed for
violation of the anti-kickback laws.
Licensure and Certification. All the Company's nursing homes must be licensed by
the state in which they are located in order to accept patients, regardless of
payor source. In most states, nursing homes are subject to certificate of need
laws, which require the Company to obtain government approval for the
construction of new nursing homes or the addition of new licensed beds to
existing homes. The Company's nursing homes must comply with detailed statutory
and regulatory requirements in order to qualify for licensure, as well as for
certification as a provider eligible to receive payments from the Medicare and
Medicaid programs. Generally, the requirements for licensure and
Medicare/Medicaid certification are similar and relate to the physical condition
of the facility and the adequacy of the equipment used therein, quality and
adequacy of personnel, quality of medical care, record keeping, dietary
services, and resident rights. Each facility is subject to periodic inspections,
known as "surveys" by health care regulators, to determine compliance with all
applicable licensure and certification standards. If the survey concludes that
there are deficiencies in compliance, the facility is subject to various
sanctions, including but not limited to monetary fines and penalties, suspension
of new admissions, and loss of licensure or certification. Generally, however,
once a facility receives written notice of any compliance deficiencies, it
submits a written plan of correction and is given a reasonable opportunity to
correct the deficiencies. However, two of the Company's facilities located in
Mobile, Alabama, were decertified from the program for several months during
1997 as a result of deficiencies cited by state surveyors; these facilities have
now been brought back into compliance and recertified. See "Item 1 - Material
Corporate Developments - Regulatory Issues."
Privately owned nursing homes in Ontario are licensed by the Ministry of Health
under the Ontario Nursing Homes Act. The legislation, together with program
manuals, establishes the minimum standards that are required to be provided to
the patients of the home, including staffing, space, nutrition and activities.
Patients can only be admitted and subsidized if they require at least 1 1/2
hours per day of care, as determined by a physician. Retirement centers in
Canada are generally regulated at the municipal government level in the areas of
fire safety and public health and at the provincial level in the areas of
employee safety, pay equity, and, in Ontario, rent control.
Licensure and regulation of assisted living facilities varies considerably from
state to state, although the trend is toward increased regulation in the United
States. In North Carolina, the Company's facilities must pass annual surveys,
and the state has established base-level requirements that must be maintained.
Such requirements include or relate to staffing ratios, space, food service,
activities, sanitation, proper medical oversight, fire safety, resident
assessments and employee training programs. In Canada, assisted living
facilities are generally not required to be licensed and are subject to only
minor regulations.
PAYOR SOURCES.
The Company classifies its revenues from patients and residents into three major
categories: Medicaid, Medicare and private pay. In addition to traditional
Medicaid revenues, the Company includes within the Medicaid classification
revenues from other programs established to provide benefits to those in need of
financial assistance in the securing of medical services. Examples include the
OGOS and North Carolina state and county special assistance programs. Medicare
revenues
27
<PAGE>
include revenues received under both Part A and Part B of the Medicare program.
The Company classifies payments from individuals who pay directly for services
without government assistance as private pay revenue. The private pay
classification also includes revenues from commercial insurers, HMOs, and other
charge-based payment sources. Veterans Administration payments are included in
private pay and are made pursuant to renewable contracts negotiated with these
payors.
The following table sets forth net patient and resident revenues by payor source
for the Company for the years presented:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
(DOLLARS IN THOUSANDS)
1997 1996 1995
----------------- ----------------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Medicaid (1) $ 99,396 55.8% $ 91,089 56.2% $ 79,821 58.6%
Medicare 44,974 25.2 41,566 25.7 28,963 21.3
Private Pay (1) 33,829 19.0 29,274 18.1 27,336 20.1
--------- ----- --------- ----- --------- -----
Total $ 178,199 100.0% $ 161,929 100.0% $ 136,120 100.0%
========= ===== ========= ===== ========= =====
</TABLE>
- -----------------------
(1) Includes assisted living facility revenues. The mix of Medicaid, Medicare
and private pay for nursing homes in 1997 was 57.8%, 27.6%, and 14.6%,
respectively.
Patient and residential service is generally provided and charged in daily
service units, commonly referred to as patient and resident days. The following
table sets forth patient and resident days by payor source for the Company for
the years presented:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1997 1996 1995
----------------- ----------------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Medicaid (1) 1,345,010 67.5% 1,253,342 69.1% 1,160,593 69.1%
Medicare 120,583 6.1 120,458 6.6 102,777 6.1
Private Pay (1) 525,016 26.4 440,130 24.3 417,141 24.8
--------- ----- --------- ----- --------- -----
Total 1,990,609 100.0% 1,813,930 100.0% 1,680,511 100.0%
========= ===== ========= ===== ========= =====
</TABLE>
- -----------------------
(1) Includes assisted living facility days. The mix of Medicaid, Medicare and
private pay for nursing homes in 1997 was 75.2%, 7.6%, and 17.2%,
respectively.
The above tables include net patient revenues and the patient days of the six
facilities comprising Texas Diversicare Limited Partnership. See Note 6 of the
Company's Consolidated Financial Statements.
Consistent with the nursing home industry in general, changes in the mix of a
facility's patient population among Medicaid, Medicare, and private pay can
significantly affect the profitability of the facility's operations.
For information about revenue, operating income, and identifiable assets
attributable to the Company's United States and Canadian operations, see Note 14
of the Company's Consolidated Financial Statements.
28
<PAGE>
SUPPLIES AND EQUIPMENT
The Company purchases drugs, solutions and other materials and leases certain
equipment required in connection with the Company's business from many
suppliers. The Company has not experienced, and management does not anticipate
that the Company will experience, any significant difficulty in purchasing
supplies or leasing equipment from current suppliers. In the event that such
suppliers are unable or fail to sell supplies or lease equipment to the Company,
management believes that other suppliers are available to adequately meet the
Company's needs at comparable prices. National purchasing contracts are in place
for all major supplies, such as food, linens, and medical supplies. These
contracts assist in maintaining quality, consistency and efficient pricing.
INSURANCE
All of the Company's liability policies are on an occurrence basis and are
renewable annually. Each of the coverage limits and the self-insured risks
referred to in the following is measured on an annual basis.
The Company maintains general and professional liability insurance with per
claim coverage of $1,000,000 and aggregate coverage limits of up to $3,000,000
for its long-term care services. Through December 31, 1997, with respect to a
majority of its United States nursing homes, the Company is self-insured for the
first $25,000 per occurrence and $500,000 in the aggregate for such claims.
Effective January 1998, these self-insured per claim and aggregate amounts
increased to $250,000 and $2,500,000, respectively. In addition, the Company
maintains a $50,000,000 aggregate umbrella liability policy for claims in excess
of the foregoing limits for its nursing home operations. The assisted living
operations acquired in the Pierce transaction are self-insured, with respect to
each location, for the first $5,000 per occurrence and $25,000 in the aggregate.
In addition, the Company maintains a $10,000,000 aggregate umbrella liability
policy for claims in excess of the foregoing limits for these assisted living
operations.
The Canadian facilities owned or leased by the Company maintain general and
professional liability insurance with per claim coverage limits of up to
$1,398,000 ($2,000,000 Canadian). In addition, the Company maintains a
$2,097,000 ($3,000,000 Canadian) aggregate umbrella liability policy for claims
in excess of the above limit for these facilities. Canadian general and
professional liability insurance coverages are less than in the United States
due primarily to the lower incidence of liability litigation in Canada. The
facilities managed by the Company in Canada maintain similar coverages to those
outlined above. The Company is named as additional insured on the policies
maintained by the Canadian managed facilities. The six TDLP facilities maintain
general and professional liability insurance with per claim coverage of
$1,000,000 and aggregate coverage limits of up to $2,000,000. In addition, TDLP
maintains a $10,000,000 aggregate umbrella liability policy for claims in excess
of the foregoing limits for these facilities.
The Company is self-insured for health insurance benefits in amounts of up to
$75,000 per individual for certain of its United States employees who have
elected coverage under the Company's sponsored plan. This plan is also made
available to certain United States managed employees. Canadian employees are
covered for worker's compensation and supplemental health care as a result of
the
29
<PAGE>
Company's participation in mandated insurance programs administered by the
individual provinces in which the Company operates. With respect to its United
States workers' compensation risks, substantially all of the Company's employees
became covered under either an indemnity insurance plan or state-sponsored
programs in May 1997. Prior to that time, the Company was self-insured for the
first $250,000, on a per claim basis, for worker's compensation claims in a
majority of its United States nursing facilities. The Company has been and
remains completely self-insured for worker's compensation claims with respect to
its Texas operations. Texas does not require mandatory worker's compensation
coverage for employer related injuries, and the Company has elected to be a
non-subscriber under the worker's compensation laws in Texas. The Company, at
its sole discretion, reviews each injury incident and provides medical care and
wage replacement appropriate to each situation. Substantially all the risks of
worker's compensation claims under the high-deductible or self-insurance
programs are assumed by the Company, and, as such, the costs incurred are
comparable to those of a Company insured under a policy containing provisions
for retroactive premium adjustments to reflect past claims experience.
The Company utilizes risk management experts in the evaluation of its insurance
programs, and management believes its current insurance coverage level is
consistent with industry standards and is appropriate for the risk environment.
The Company has established reserves that management believes are adequate to
cover the self-insured risks of its insurance programs. There can be no
assurance that the Company's insurance and reserves will be sufficient to cover
any judgements, settlements or costs relating to any pending or future claims or
legal proceedings (including any related judgements, settlements or costs) or
that any such insurance will be available to the Company in the future on
satisfactory terms, if at all. If the insurance and reserves carried by the
Company are not sufficient to cover any judgements, settlements or costs
relating to pending or future claims or legal proceedings, the Company's
business and financial condition could be materially adversely affected.
EMPLOYEES
As of February 15, 1998, the Company employed a total of approximately 5,650
individuals. Management believes that the Company's employee relations are good.
Approximately 70 of the Company's United States employees are represented by a
labor union and approximately 370 of the Company's Canadian employees are
represented by various unions. With the exception of some administrators of
managed facilities (whose salaries are reimbursed by the owners), the staff of
the managed nursing homes and assisted living facilities are not employees of
the Company. The Company's managed facilities employ approximately 2,550
individuals, approximately 1,520 of whom are Canadians represented by various
unions.
A major component of the Company's CQI program includes an employee empowerment
selection, retention and recognition program. Administrators and managers of the
Company include employee retention and turnover goals in the annual facility,
regional and personal objectives.
Although the Company believes it is able to employ sufficient nurses and
therapists to provide its services, a shortage of health care professional
personnel in any of the geographic areas in which the Company operates could
affect the ability of the Company to recruit and retain qualified employees and
could increase its operating costs. The Company competes with other health care
providers for both professional and non-professional employees and with
non-health care providers for nonprofessional employees.
30
<PAGE>
ITEM 2. PROPERTIES
The Company owns 25 and leases 59 long-term care facilities. See "Item 1 -
Description of Lease Agreements" and "- Facilities." The Company leases
approximately 19,000 square feet of office space in Franklin, Tennessee, that
houses the executive offices of the Company and its regional office supporting
the Alabama and Tennessee operations. In addition, the Company leases its
regional office for Canadian operations with approximately 10,800 square feet of
office space in Mississauga, Ontario, its regional office with approximately
55,000 square feet of office space in Kernersville, North Carolina and its
regional offices, each with approximately 3,000 square feet of office space in
Clearwater, Florida; Little Rock, Arkansas; Corpus Christi, Texas; and Ashland,
Kentucky. Lease periods on these facilities generally range up to seven years,
although the Kernersville lease runs through 2022 including renewal options.
Management believes that the Company's leased properties are adequate for its
present needs and that suitable additional or replacement space will be
available as required.
ITEM 3. LEGAL PROCEEDINGS
The provision of health care services entails an inherent risk of liability. In
recent years, participants in the health care industry have become subject to an
increasing number of lawsuits alleging malpractice, product liability, or
related legal theories, many of which involve large claims and significant
defense costs. It is expected that the Company from time to time will be subject
to such suits as a result of the nature of its business. Further, as with all
health care providers, the Company is potentially subject to the increased
scrutiny of regulators for issues related to compliance with health care fraud
and abuse laws. Although the Company is not a party to or subject to any
material pending legal proceedings and carries liability insurance that
Management believes meets industry standards, there can be no assurance that any
pending or future legal proceedings (including any related judgments,
settlements or costs) will not have a material adverse effect on the Company's
business, reputation, or financial condition. See "Item 1 - Insurance."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There have been no matters submitted to a vote of security holders during the
fourth quarter (October 1, 1997 through December 31, 1997) of the fiscal year
covered by this Annual Report on Form 10-K.
31
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
The Common Stock of the Company is listed on the New York Stock Exchange under
the symbol "AVC." The following table sets forth the high and low prices of the
common stock as reported by the New York Stock Exchange for each quarter in 1996
and 1997:
<TABLE>
<CAPTION>
Period High Low
------ ---- ---
<S> <C> <C>
1996 1st Quarter $13 $ 8 1/2
1996 2nd Quarter 11 7/8 8 7/8
1996 3rd Quarter 10 3/8 7 7/8
1996 4th Quarter 8 1/4 5 7/8
1997 1st Quarter 9 5/8 7 1/4
1997 2nd Quarter 11 3/8 8 3/4
1997 3rd Quarter 12 7/16 11
1997 4th Quarter 12 15/16 7 1/2
</TABLE>
The Company's Common Stock has been traded since May 10, 1994. On March 23,
1998, the closing price for the Common Stock was $9 13/16, as reported by the
New York Stock Exchange.
On March 23, 1998, there were 175 holders of record of the common stock. Most
of the Company's shareholders have their holdings in the street name of their
broker/dealer. The total number of shareholders is believed to be approximately
1,700 individuals and entities.
The Company has not paid cash dividends on its Common Stock and anticipates
that, for the foreseeable future, any earnings will be retained for use in its
business and no cash dividends will be paid. The Company is currently prohibited
from issuing dividends under certain debt instruments.
32
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The Company commenced operations effective with an initial public offering of
common stock in May 1994. The Company's predecessor operations were in companies
owned or controlled by Counsel Corporation (collectively, the "Long-Term Care
Business"). The following table sets forth selected financial data of Advocat
and the Long-Term Care Business. The selected financial data of Advocat as of
December 31, 1997, 1996, 1995 and 1994 and for the years ended December 31,
1997, 1996 and 1995 have been derived from the audited financial statements of
Advocat. The selected unaudited pro forma financial data of Advocat for 1994 and
1993 have been derived from the pro forma financial data of Advocat. The
selected financial data of the Long-Term Care Business as of December 31, 1993
and for the year ended December 31, 1993 have been derived from the audited
combined financial statements of the Long-Term Care Business.
33
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
LONG-TERM
ADVOCAT CARE
ADVOCAT PRO FORMA BUSINESS
------------------------------ -------------------- --------
1997 1996 1995 1994 1993 1993
-------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA: (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
REVENUES:
Patient revenues................ $163,094 $153,582 $128,643 $ 92,228 $81,905 $81,905
Resident revenues............... 15,105 8,347 7,477 7,098 6,415 6,415
Management fees................. 3,886 4,152 3,618 3,583 3,234 3,234
Interest........................ 158 156 227 177 216 216
-------- -------- -------- -------- ------- -------
Net revenues.............. 182,243 166,237 139,965 103,086 91,770 91,770
-------- -------- -------- -------- ------- -------
EXPENSES:
Operating....................... 146,555 131,966 109,458 77,567 68,772 69,007
Lease........................... 15,850 14,441 13,518 10,827 10,379 8,174
General and administrative...... 9,636 8,578 7,806 6,409 5,968 5,432
Depreciation and amortization 2,823 2,285 1,516 1,230 1,005 2,512
Interest........................ 2,672 1,591 777 484 493 3,261
-------- -------- -------- -------- ------- -------
Total expenses............ 177,536 158,861 133,075 96,517 86,617 88,386
-------- -------- -------- -------- ------- -------
INCOME BEFORE
INCOME TAXES.................... $ 4,707 $ 7,376 $ 6,890 $ 6,569 $ 5,153 $ 3,384
======== ======== ======== ======== ======= =======
NET INCOME......................... $ 3,013 $ 4,721 $ 4,410 $ 4,204 $ 3,298 $ 2,098
======== ======== ======== ======== ======= =======
EARNINGS PER SHARE
Basic........................... $.56 $.89 $.84 $.80 $.63
======== ======== ======== ======== =======
Diluted......................... $.56 $.89 $.82 $.80 $.63
======== ======== ======== ======== =======
WEIGHTED AVERAGE SHARES
Basic........................... 5,339 5,304 5,270 5,250 5,250
======== ======== ======== ======== =======
Diluted......................... 5,373 5,330 5,381 5,275 5,250
======== ======== ======== ======== =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------
LONG-TERM
CARE
ADVOCAT BUSINESS
----------------------------------------- ---------
1997 1996 1995 1994 1993
-------- ------- -------- -------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA: (IN THOUSANDS)
Working capital................... $ 13,849 $13,540 $ 6,726 $ 8,120 $ 993
======== ======= ======= ======== =========
Total assets...................... $114,961 $74,908 $59,031 $45,018 $53,150
======== ======= ======= ======== =========
Long-term debt, excluding
current portion.................. $ 58,373 $23,254 $11,063 $ 7,567 $28,160
======== ======= ======= ======== =========
Shareholders' equity/Investment
by Counsel....................... $ 30,733 $27,348 $22,437 $17,669 $ 7,363
======== ======= ======= ======== =========
</TABLE>
34
<PAGE>
PRO FORMA SELECTED FINANCIAL DATA
(UNAUDITED)
The following unaudited pro forma consolidated income statements of Advocat for
the years ended December 31, 1994 and 1993, have been prepared to reflect: (i)
transfer by the selling shareholders to Advocat of the outstanding stock of
their wholly-owned subsidiaries possessing the Long-Term Care Business in
exchange for common stock of Advocat and the related tax and accounting effects;
(ii) conversion of the 11 facilities owned by Counsel Corporation or an
affiliate to operating leases with Advocat as lessee; (iii) terms of the revised
operating lease for one facility, entered into in February 1994; (iv) exercise
of the underwriters' over-allotment option of 500,000 shares of which one-half
of the proceeds remained with Advocat and the other half was used by Advocat to
retire the notes payable to the selling shareholders; and (v) certain expenses
expected to be incurred by Advocat as a result of its initial public offering
that were not incurred by the Long-Term Care Business. These statements have
been prepared as if such transactions occurred on January 1 of each year. The
unaudited pro forma consolidated financial information may not be indicative of
the future results of operations and what the actual results of operations would
have been had the transactions been consummated on such dates.
35
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED INCOME STATEMENT
YEAR ENDED DECEMBER 31, 1994
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
LONG-TERM
CARE BUSINESS ADVOCAT
------------- ----------------------------------------------
FOUR MONTHS EIGHT MONTHS TWELVE MONTHS
ENDED ENDED ENDED
APRIL 30, PRO FORMA DECEMBER 31, DECEMBER 31,
1994 ADJUSTMENTS 1994 1994
---------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Patient revenues................ $28,523 $ -0- $63,705 $ 92,228
Resident revenues............... 2,196 -0- 4,902 7,098
Management fees................. 1,100 -0- 2,483 3,583
Interest........................ 11 -0- 166 177
------- ----- ------- --------
Net revenues.............. 31,830 -0- 71,256 103,086
------- ----- ------- --------
EXPENSES:
Operating....................... 23,933 (39)(a) 53,673 77,567
Lease........................... 2,826 700 (a)(b) 7,301 10,827
General and administrative...... 1,981 155 (c) 4,273 6,409
Depreciation and amortization 904 (507)(b) 833 1,230
Interest........................ 1,023 (881)(b) 342 484
------- ----- ------- --------
Total expenses............ 30,667 (572) 66,422 96,517
------- ----- ------- --------
Income before income taxes...... 1,163 572 4,834 6,569
Provision for income taxes...... 442 183(d) 1,740 2,365
------- ----- ------- --------
PRO FORMA NET INCOME................ $ 721 $ 389 $ 3,094 $ 4,204
======= ===== ======= ========
PRO FORMA EARNINGS PER SHARE
Basic........................... $.80
========
Diluted......................... $.80
========
WEIGHTED AVERAGE SHARES (e)
Basic ............................ 5,250
========
Diluted .......................... 5,275
========
</TABLE>
- -----------
(a) Reflects the reduced operating expense of $39 and additional lease expense
of $12 in accordance with the terms of the revised lease for one facility,
entered into in February 1994, as if the terms of the revised lease had
been effective January 1, 1994.
(b) Reflects the effects of the conversion of certain owned facilities to
leasehold interests, including additional lease expense and reduced
interest, depreciation, and amortization expenses.
(c) Reflects the estimated additional corporate, administrative and public
financial reporting expenses which would have been incurred by Advocat if
it had operated as a separate public entity effective January 1, 1994.
(d) Reflects adjustments to the income tax provision due to additional pro
forma income before taxes.
(e) Based on the total number of shares sold to the public in the initial
public offering of Advocat stock on May 10, 1994, and the exercise of the
over-allotment option, as well as the impact of common stock equivalent
shares computed using the treasury stock method.
36
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED INCOME STATEMENT
YEAR ENDED DECEMBER 31, 1993
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
LONG-TERM ADVOCAT
CARE ---------------------------
BUSINESS ADJUSTMENTS PRO FORMA
--------- ----------- ---------
<S> <C> <C> <C>
REVENUES:
Patient revenues................ $81,905 $ -0- $81,905
Resident revenues............... 6,415 -0- 6,415
Management fees................. 3,234 -0- 3,234
Interest........................ 216 -0- 216
------- ------- -------
Net revenues.............. 91,770 -0- 91,770
------- ------- -------
EXPENSES:
Operating....................... 69,007 (235)(a) 68,772
Lease........................... 8,174 2,205 (a)(b) 10,379
General and administrative...... 5,432 536 (c) 5,968
Depreciation and amortization... 2,512 (1,507)(b) 1,005
Interest........................ 3,261 (2,768)(b) 493
------- ------- -------
Total expenses............ 88,386 (1,769) 86,617
------- ------- -------
Income before income taxes...... 3,384 1,769 5,153
Provision for income taxes...... 1,286 569 (d) 1,855
------- ------- -------
PRO FORMA NET INCOME................ $ 2,098 $ 1,200 $ 3,298
======= ======= =======
PRO FORMA EARNINGS PER SHARE
Basic........................... $.63
=======
Diluted......................... $.63
=======
WEIGHTED AVERAGE SHARES (e)
Basic ........................... 5,250
=======
Diluted ......................... 5,250
=======
</TABLE>
- -----------
(a) Reflects the reduced operating expense of $235 and lease expense of $143
in accordance with the terms of the revised lease for one facility,
entered into in February 1994, as if the terms of the revised lease had
been effective January 1, 1993.
(b) Reflects the effects of the conversion of certain owned facilities to
leasehold interest, including additional lease expense and reduced
interest, depreciation, and amortization expenses.
(c) Reflects the estimated additional corporate, administrative and public
financial reporting expenses which would have been incurred by Advocat if
it had operated as a separate public entity effective January 1, 1993.
(d) Reflects adjustments to the income tax provision at the statutory rate due
to additional pro forma income before taxes.
(e) Based on the total number of shares sold to the public in the initial
public offering of Advocat stock on May 10, 1994, and the exercise of the
over-allotment option.
37
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company")
provides long-term care services to nursing home patients and residents of
assisted living facilities in 11 Southeastern states and two Canadian provinces.
The Company completed its initial public offering in May 1994, however, its
operational history can be traced to February 1980 through common senior
management who were involved in different organizational structures.
The Company's facilities provide a range of health care services to their
patients and residents. In addition to the nursing, personal care and social
services usually provided in long-term care facilities, the Company, through
arrangements with third parties, offers a variety of comprehensive
rehabilitation services as well as medical supply and nutritional support
services.
As of December 31, 1997, Advocat's portfolio includes 116 facilities composed of
65 nursing homes containing 7,341 licensed beds and 51 assisted living
facilities containing 4,748 units. In comparison, at December 31, 1996, the
Company operated 87 facilities composed of 65 nursing homes containing 7,399
licensed beds and 22 assisted living facilities containing 2,509 units. The
Company owns seven nursing homes, leases 37 others and manages the remaining 21
nursing homes. The Company owns 18 assisted living facilities, leases 22 others
and manages the remaining 11 assisted living facilities. In the United States,
the Company operates 52 nursing homes and 33 assisted living facilities, and in
Canada, the Company operates 13 nursing homes and 18 assisted living facilities.
Basis of Financial Statements. The Company's patient and resident revenues
consist of the fees charged for the care of patients in the nursing homes and
residents of the assisted living facilities leased and owned by the Company.
Management fee revenues consist of the fees charged to the owners of the
facilities managed by the Company. The management fee revenues are based on the
respective contractual terms of the Company's management agreements, which
generally provide for management fees ranging from 3.5% to 6.0% of the net
revenues of the managed facilities. As a result, the level of management fees is
affected positively or negatively by the increase or decrease in the average
occupancy level and the per diem rates of the managed facilities. The Company's
operating expenses include the costs, other than lease, depreciation,
amortization and interest expenses, incurred in the nursing homes and assisted
living facilities owned and leased by the Company. The Company's general and
administrative expenses consist of the costs of the corporate office and
regional support functions, including the costs incurred in providing management
services to other owners. The Company's depreciation, amortization and interest
expenses include all such expenses incurred across the range of the Company's
operations.
OPERATING DATA
The following table presents the Advocat statements of income for the years
ended December 31, 1997, 1996 and 1995, and sets forth this data as a percentage
of revenues for the same years.
38
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1997 1996 1995
----------------- ----------------- ------------------
($ IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Patient revenues............................................. $163,094 89.5% $153,582 92.4% $128,643 91.9%
Resident revenues............................................ 15,105 8.3 8,347 5.0 7,477 5.3
Management fees.............................................. 3,886 2.1 4,152 2.5 3,618 2.6
Interest..................................................... 158 0.1 156 0.1 227 0.2
-------- ----- -------- ----- -------- -----
Net revenues............................................... 182,243 100.0% 166,237 100.0% 139,965 100.0%
-------- ----- -------- ----- -------- -----
Expenses:
Operating.................................................... 146,555 80.4 131,966 79.4 109,458 78.2
Lease........................................................ 15,850 8.7 14,441 8.7 13,518 9.7
General and administrative................................... 9,636 5.3 8,578 5.1 7,806 5.6
Depreciation and amortization................................ 2,823 1.5 2,285 1.4 1,516 1.1
Interest..................................................... 2,672 1.5 1,591 1.0 777 0.5
-------- ----- -------- ----- -------- -----
Total expenses............................................. 177,536 97.4 158,861 95.6 133,075 95.1
-------- ----- -------- ----- -------- -----
Income before income taxes..................................... 4,707 2.6 7,376 4.4 6,890 4.9
Provision for income taxes..................................... 1,694 0.9 2,655 1.6 2,480 1.8
-------- ----- -------- ----- -------- -----
Net income................................................. $ 3,013 1.7% $ 4,721 2.8% $ 4,410 3.1%
======== ===== ======== ===== ======== =====
</TABLE>
The following tables present data about the facilities operated by the Company
as of the dates or for the years indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Licensed Nursing Home Beds:
Owned........................................................ 706 706 371
Leased....................................................... 4,158 4,295 4,260
Managed...................................................... 2,477 2,398 2,693
----- ----- -----
Total...................................................... 7,341 7,399 7,324
===== ===== =====
Assisted Living Units(1):
Owned........................................................ 1,314 125 113
Leased....................................................... 1,800 534 534
Managed...................................................... 1,634 1,850 1,688
------ ----- -----
Total...................................................... 4,748 2,509 2,335
====== ===== =====
Total Beds/Units(1):
Owned........................................................ 2,020 831 484
Leased....................................................... 5,958 4,829 4,794
Managed...................................................... 4,111 4,248 4,381
------ ----- -----
Total...................................................... 12,089 9,908 9,659
====== ===== =====
Facilities(1):
Owned........................................................ 25 8 4
Leased....................................................... 59 45 45
Managed...................................................... 32 34 35
------ ----- ------
Total...................................................... 116 87 84
====== ===== ======
</TABLE>
- -----------
(1) For 1997, includes assisted living facilities under development: two owned
with 139 units, one leased with 56 units and one to be managed with 110
units.
39
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED
-------------------------------
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Average Occupancy(1):
Leased/Owned(2)............................................. 83.0% 84.9% 87.1%
Managed..................................................... 96.3 97.1 94.0
---- ---- ----
Total..................................................... 86.7% 88.6% 89.6%
==== ==== ====
</TABLE>
- -----------
(1) Average occupancy excludes facilities under development or facilities
managed during receivership or insolvency proceedings.
(2) Includes the occupancy of the six facilities of TDLP, a limited partnership
managed by the Company.
NEW FACILITIES
Since its inception as a public company in 1994, Advocat has sought to expand
its operations through the acquisition of attractive properties via either
purchase or lease. Management has conscientiously evaluated the acquisition
opportunities that have been available to the Company in light of criteria that
were established to help insure the long-term value of the acquisitions that
have been completed.
Effective October 1, 1997, the Company completed its most significant
acquisition, 29 assisted living facilities from Pierce Management Group
("Pierce"). In the Pierce acquisition, the Company purchased 15 facilities and
leased 14 others. The Company holds the option to purchase 12 of the leased
facilities for market value beginning at the fifth anniversary. With the Pierce
acquisition, the Company, which has long been involved in the provision of
assisted living services in its Canadian operations, established a foundation
from which it hopes to expand its presence in the growing assisted living market
in the United States.
The following table summarizes the Company's acquisitions for 1995 through 1997:
<TABLE>
<CAPTION>
FACILITIES ADDED
----------------------- BEDS/UNITS
PURCHASE LEASE ADDED
-------- ---------- ----------
<S> <C> <C> <C>
1997 17 15 2,483
1996 4 1 410
1995 2 2 325
</TABLE>
These facilities are hereafter referred to collectively or in part as the "New
Facilities." The acquisition of the New Facilities has added significantly to
the Company's volume of business in both 1997 and 1996. The contribution of the
New Facilities to selected components of operations is noted separately where
such contribution is significant within their first year of operations.
REGULATORY ISSUES
The Company's 1997 operating results were profoundly affected by regulatory
issues in the State of Alabama. During the summer, the Company received separate
notifications from the State that, as a result of certain deficiencies noted
upon periodic surveys of its two facilities in Mobile, the facilities would be
decertified from participation in the Medicare and Medicaid programs and that
licensure revocation could be pursued. The Company appealed the proceedings,
noting that none of the deficiencies were life-threatening, that the
deficiencies noted did not warrant the penalty imposed and that in the case of
one of the facilities, it was
40
<PAGE>
JCAHO accredited. The appeals were denied by the State agency, and as a result,
the facilities were decertified for 69 and 91 days, respectively, before
resurveys found them to be in compliance. Both of the facilities have been
recertified for participation in the Medicare and Medicaid programs. The Company
expects the Alabama operations to return to normal levels during the latter half
of 1998. However, there can be no assurance that either of the facilities will
return to the census and profitability levels experienced prior to the
decertifications.
In both cases, the State has stayed its proceedings to license revocation,
agreeing that the Company responded favorably toward the resolution of all
issues. Management believes that the aggressive measures taken by the State were
not warranted, particularly when the regulations prescribe a continuum of
intermediate penalties to be imposed before decertification. The Company has
aggressively pursued improved communications with the State and has reached
agreement with the State on methods of improved operations. The Company's
remaining five Alabama facilities have successfully passed their most recent
annual licensure surveys.
The Company, in response to the regulatory problems at the two Mobile
facilities, entered into a reorganization of its regional and facility
management, conducted in-depth reviews of all seven of the Company's Alabama
facilities, engaged nationally-recognized consultants to assist in achieving
compliance and engaged local legal counsel familiar with the Alabama regulations
and regulators. As a result of the lost revenues from the Medicare and Medicaid
programs (including charity care provided to continuing patients who had been
admitted under those programs), census declines and expenditures incurred in
response to the survey issues (including fines and penalties), the Company
experienced an estimated negative impact on 1997 earnings of approximately $2.3
million after taxes, or approximately $0.44 per share. The pre-tax impact of
these events in the State of Alabama can be quantified as follows:
- Lost revenue of $1.9 million of which more than $950,000 represented
charity care for patients the Company elected not to discharge during
the decertification period
- Region-wide increases in staffing at all Alabama facilities with a cost
of more than $700,000
- Direct costs relative to consultants, attorneys, and fines totaling
$580,000
- Other related expenses of approximately $475,000
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
Revenues. Net revenues increased to $182.2 million in 1997 from $166.2 million
in 1996, an increase of $16.0 million, or 9.6%. Patient revenues increased to
$163.1 million in 1997 from $153.6 million in 1996, an increase of $9.5 million,
or 6.2%, of which $5.2 million is attributable to the New Facilities. Resident
revenues increased $6.8 million, or 81.0%, of which $6.7 million is attributable
to the New Facilities. Revenue increases among facilities operated at least one
year were primarily due to inflationary increases rather than from expanded
services. These increases were offset by foregone revenues with respect to the
decertified facilities and to one facility that was closed in April 1997.
Excluding these facilities, there was a 0.7% decline in patient days
(approximately 11,000 days) among facilities in operation for at least one year.
While the recent increases in reimbursement rates received by the Company have
met or exceeded expectations, the Company anticipates it is likely that states
and the federal government will continue to seek ways to retard the rate of
growth in Medicaid program rates. As a percent of patient and resident revenues,
Medicare decreased to 25.2% in 1997 from 25.7% in 1996 while Medicaid and
similar programs decreased to 55.8% in 1997 from 56.3% in 1996.
41
<PAGE>
Ancillary service revenues, prior to contractual allowances, decreased to $57.0
million in 1997 from $57.7 million in 1996, a decrease of $682,000 or 1.2%. The
Company has emphasized expansion of ancillary services since its inception in
1994. However, the rate of growth began to decline in 1996. Management believes
that the opportunities available for the expansion of ancillary services in its
existing operations were essentially fully realized by the beginning of 1997.
Had it not been for the Alabama decertification and problems associated with the
transition from multiple therapy providers to one provider in a majority of its
nursing homes, ancillary revenues would have shown a slight increase in 1997.
Because cost limits are expected to be placed on ancillary services as part of
the transition to the Medicare prospective payment system as well as other cost
limitation provisions that have been announced or could occur, the Company
anticipates that ancillary service revenues with respect to its existing
operations will begin trending down in 1998. The ultimate effect on the
Company's operations cannot be predicted at this time because the extent and
composition of the cost limitations are not yet certain.
Management fee revenues decreased by $266,000, or 6.4%, to $3.9 million. The
decrease is primarily due to $500,000 in non-recurring consulting fees earned in
1996 with respect to the development of certain of the New Facilities. Excluding
these consulting fees, continuing management fee revenues increased $234,000, or
6.4%. This increase was in spite of the purchase of four facilities that were
formerly managed and the deterioration in the exchange value of the Canadian
dollar versus the U.S. dollar. Most of the Company's management revenues are
earned in Canada.
Operating Expense. Operating expense increased to $146.6 million in 1997 from
$132.0 million in 1996, an increase of $14.6 million, or 11.1%. Of this
increase, $8.5 million is attributable to the New Facilities. As a percent of
patient and resident revenues, operating expense increased to 82.2% in 1997 from
81.5% in 1996. This increase is primarily attributable to the costs associated
with the Alabama decertifications. With respect to facilities operated at least
one year and excluding the Alabama region, the operating expense percentage was
81.4%, representing a slight improvement over 1996; this group of facilities
experienced an increase of only 2.7% while net revenues increased 3.2%. As a
percent of patient and resident revenues, operating expense of the New
Facilities was 71.6%. Most of the New Facilities are assisted living locations,
which typically have lower operating costs than do nursing homes. The largest
component of operating expense is wages, which increased to $65.4 million in
1997 from $59.2 million in 1996, an increase of $6.2 million, or 10.5%. Of this
increase, $3.0 million is attributable to the New Facilities. Wages with respect
to facilities in operation for at least one year increased $3.2 million, or
5.3%. The Company's wage increases are generally in line with inflation,
however, the larger increase with respect to the same facility operations is due
primarily to a 16.7% increase in Alabama that arose principally from staffing
responses to the decertifications.
Lease Expense. Lease expense increased to $15.8 million in 1997 from $14.4
million in 1996, an increase of $1.4 million, or 9.8%. Of this increase, $1.1
million is attributable to the New Facilities, and the remainder is primarily
attributable to inflationary adjustments required under the terms of a majority
of the Company's operating leases.
General and Administrative Expense. General and administrative expense increased
to $9.6 million in 1997 from $8.6 million in 1996, an increase of $1.0 million,
or 12.3%. The increase in excess of inflation is primarily attributable to the
expense of managing the New Facilities and structural costs associated with the
Alabama decertifications. As a percent of total net revenues, general and
administrative expense increased to 5.3% in 1997 from 5.1% in 1996.
42
<PAGE>
Depreciation and Amortization. Depreciation and amortization expenses increased
to $2.8 million in 1997 from $2.3 million in 1996, an increase of $538,000, or
23.5%. This increase is primarily attributable to the New Facilities.
Interest Expense. Interest expense increased to $2.7 million in 1996 from $1.6
million in 1996, an increase of $1.1 million, or 67.9%. This increase is
primarily attributable to the New Facilities.
Income Before Income Taxes; Net Income; Earnings Per Share. As a result of the
above, income before income taxes was $4.7 million in 1997 as compared with $7.4
million in 1996, a decrease of $2.7 million, or 36.2%. The effective combined
federal, state and provincial income tax rate was 36.0% in both 1997 and 1996.
Net income was $3.0 million in 1997 as compared with $4.7 million in 1996, a
decrease of $1.7 million, and basic earnings per share was $.56 as compared with
$.89.
YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995
Revenues. Net revenues increased to $166.2 million in 1996 from $140.0 million
in 1995, an increase of $26.2 million, or 18.8%. Patient and resident revenues
increased to $161.9 million in 1996 from $136.1 million in 1995, an increase of
$25.8 million, or 19.0%. Of this increase, $14.7 million is attributable to the
New Facilities. Ancillary service revenues, prior to contractual allowances,
increased to $57.7 million in 1996 from $39.2 million in 1995, an increase of
$18.5 million or 47.2%. Of this increase, $4.3 million is attributable to the
New Facilities. The overall increase in ancillary revenues is reflective of the
Company's emphasis since 1994 on expanding ancillary services at existing
nursing home operations. The rate of growth in the provision of ancillary
services decreased throughout the year reaching 15.9% in the fourth quarter of
1996. The increase in patient and resident revenues is also impacted by normal
inflationary increases and a 1.9% decrease in patient and resident days
(approximately 31,000 days as adjusted for leap year) among the facilities
operating for at least one year. As a percent of net patient revenues, Medicare
increased to 25.7% in 1996 from 21.3% in 1995 while Medicaid decreased to 56.3%
in 1996 from 58.6% in 1995. Management fee revenues increased by $534,000, or
14.8%, to $4.2 million. The increase is primarily due to $500,000 in
non-recurring consulting fees earned with respect to the development of three of
the New Facilities.
Operating Expense. Operating expense increased to $132.0 million in 1996 from
$109.5 million in 1995, an increase of $22.5 million, or 20.6%. Of this
increase, $12.1 million is attributable to the New Facilities. As a percent of
patient and resident revenues, operating expense increased to 81.5% in 1996 from
80.4% in 1995. This increase is primarily attributable to the New Facilities and
the increase in the provision of ancillary services. As a percent of patient
revenues, operating expense of the New Facilities was 82.3%. This higher
percentage results because the New Facilities derive a higher percentage of
revenues from the provision of services to Medicaid patients than do the
Company's other locations. As ancillary services have increased, the supply
costs related to the provision of such services have increased correspondingly.
In addition, the Company's operating expenses have increased due to reduced
average census, efforts by states to curtail the growth in Medicaid programs,
difficulty in achieving expense reductions as occupancy levels declined in
certain homes, and an increase in the provision for bad debts of approximately
$800,000. Management has directed additional resources in an effort to improve
receivables management. Among facilities in operation for at least one year, the
Company has experienced increased general insurance costs of approximately
$836,000, which increases are expected to continue into 1997. Wages increased to
$59.2 million in 1996 from $51.5 million in 1995, an increase of $7.7 million,
or 15.1%. Of this increase, $5.8 million is attributable to the New Homes. A
portion
43
<PAGE>
of the remaining increase in wages is offset by reduced costs associated with
less utilization of temporary nursing services and reduced contracted
housekeeping and laundry services. The Company's wage increases are generally in
line with inflation.
Lease Expense. Lease expense increased to $14.4 million in 1996 from $13.5
million in 1995, an increase of $923,000, or 6.8%. Of this increase, $665,000 is
attributable to the New Facilities, and the remainder is primarily attributable
to inflationary adjustments required under the terms of a majority of the
Company's operating leases.
General and Administrative Expense. General and administrative expense increased
to $8.6 million in 1996 from $7.8 million in 1995, an increase of $772,000, or
9.9%. The increase in excess of inflation is primarily attributable to the
expense of new positions added to service the Company's expanded operations. As
a percent of total net revenues, general and administrative expense declined
from 5.6% in 1995 to 5.1% in 1996 reflective of spreading the Company's overhead
costs over a wider base of operations.
Depreciation and Amortization. Depreciation and amortization expenses increased
to $2.3 million in 1996 from $1.5 million in 1995, an increase of $769,000, or
50.7%. Approximately $555,000 of the increase is associated with the New
Facilities.
Interest Expense. Interest expense increased to $1.6 million in 1996 from
$777,000 in 1995, an increase of $814,000, or 104.8%. Approximately $749,000 of
the increase is attributable to indebtedness related to the New Facilities with
the remainder of the increase primarily attributable to increased borrowings
under the Company's working capital line of credit.
Income Before Income Taxes; Net Income; Earnings Per Share. As a result of the
above, income before income taxes was $7.4 million in 1996 as compared with $6.9
million in 1995, an increase of $486,000, or 7.1%. The effective combined
federal, state and provincial income tax rate was 36.0% in both 1996 and 1995.
Net income was $4.7 million in 1996 as compared with $4.4 million in 1995, an
increase of $311,000, and basic earnings per share was $.89 as compared with
$.84.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company's working capital was $13.8 million and the
current ratio was 1.7, compared with $13.5 million and a current ratio of 1.8 at
December 31, 1996.
Net cash provided by operating activities totaled $5.3 million, $5.4 million and
$2.3 million in 1997, 1996 and 1995, respectively. These amounts primarily
represent the cash flows from net income plus changes in non-cash components of
operations offset by working capital changes, particularly, increases in
receivables.
Net cash used in investing activities totaled $39.9 million, $10.0 million and
$9.8 million in 1997, 1996 and 1995, respectively. The Company has used between
$2.4 million and $3.0 million for capital expenditures in each of the last three
calendar years ending December 31, 1997. Substantially all such expenditures
were for facility improvements and equipment, which were financed principally
through working capital. For the year ended December 31, 1998, the Company
anticipates that capital expenditures for improvements and equipment for its
existing facility operations will be approximately $5.5 million, including $2.9
million for non-routine projects. In 1997, the Company purchased 17 facilities
for net cash consideration of $36.2 million. In 1996,
44
<PAGE>
the Company purchased four facilities for net cash consideration of $7.2 million
plus $1.6 million in assumed liabilities. In 1995, the Company purchased two
facilities for net cash consideration of $5.2 million plus assumption of a
seller note of $1.1 million.
Net cash provided by financing activities totaled $35.4 million, $5.5 million
and $5.4 million in 1997, 1996 and 1995, respectively. The net cash provided
from financing activities primarily represents net proceeds from the issuance
and repayment of debt.
At December 31, 1997, the Company had total debt outstanding of $59.1 million of
which $11.5 million was principally mortgage debt bearing interest at floating
rates ranging from 6.3% to 10.0%. The Company also had a promissory note
outstanding in the amount of $34.1 million, which was used to fund the Pierce
acquisition. The Company's remaining debt of $13.5 million was drawn under its
various credit lines. Most of the Company's debt is at floating interest rates,
generally at a spread above the London Interbank Offered Rate ("LIBOR"). At
December 31, 1997, the Company's average interest rate on its indebtedness was
8.1%.
The Company has both a working capital line of credit and an acquisition line of
credit. The working capital line of credit provides for working capital loans
and letters of credit aggregating up to the lesser of $10,000,000 or the
borrowing base, as defined. The Company's obligations under the working capital
line are secured by certain accounts receivable and substantially all other
Company assets. Advances under the working capital line bear interest payable
monthly at the Company's option of either LIBOR plus 2.50% or the bank's Index
rate. The working capital line terminates and all outstanding borrowings are due
in December 1999. As of December 31, 1997, the Company had drawn $2,439,000, had
$5,650,000 of letters of credit outstanding, and had $1,911,000 remaining
borrowing capability under the working capital line. As of March 10, 1998, the
draws totaled $2,909,000 and the Company had $1,411,000 remaining borrowing
capability under the working capital line. The Company has received a commitment
from the bank for an increase in its working capital line of credit availability
of $1,250,000. This additional line of credit is available through May 22, 1998
and contains terms mirroring the $10,000,000 working capital line of credit.
Through March 10, 1998, the Company had not drawn upon this increased
availability.
The acquisition line of credit of $40,000,000, less outstanding borrowings, is
available to fund approved acquisitions through October 1999. The Company's
obligations under the acquisition line are secured by the assets acquired with
the draws under the acquisition line. Advances under the acquisition line bear
interest, payable monthly, at LIBOR plus a defined spread with respect to each
facility based upon its loan-to-value ratio and debt service coverage.
Individual advances made under the acquisition line are due three years from the
date of initial funding. As of both December 31, 1997, and March 10, 1998, the
Company had drawn $11,100,000 under the acquisition line, which amount was
secured by four nursing homes, and had $28,900,000 available for future
acquisitions.
The promissory note, which is payable to two banks, is unsecured. However, the
Company has agreed not to pledge or otherwise encumber the assets acquired in
the Pierce acquisition or issue other debt without the banks' approval. The
promissory note bears floating interest in relation to LIBOR and has a balloon
maturity in January 1999.
The Company has a commitment of up to $30,000,000 of long-term financing under
which the Company may borrow and pledge the assets acquired in the Pierce
acquisition as collateral. Loans are available at up to 80% of the value of the
pledged assets. Interest, which would be at LIBOR plus a defined spread, would
be determined based upon the length of term selected (3, 10, or 20 years) and
the loan-to-value ratio. This
45
<PAGE>
commitment is available through November 1999. However, the Company may not draw
upon this commitment so long as the $34,100,000 promissory note remains
outstanding.
The Company's loan agreements contain various financial covenants, the most
restrictive of which relate to net worth, cash flow, debt to equity ratio
requirements, and limits on the payment of dividends to shareholders. As of
December 31, 1997, the Company was in compliance with the covenants or has been
granted waivers in the event of non-compliance.
Based upon the operations of the Company, management believes that available
cash and funds generated from operations, as well as amounts available through
its banking relationships, will be sufficient for the Company to satisfy its
capital expenditures, working capital, and debt requirements for the next twelve
months. The Company intends to satisfy the capital requirements for its
acquisition activities primarily through its acquisition line of credit
complemented as appropriate by various other possible means such as borrowings
from commercial lenders, seller-financed debt, issuance of additional debt,
financing obtained from sale and leaseback transactions and internally generated
cash from operations. On a longer-term basis, management believes the Company
will be able to satisfy the principal repayment requirements on its indebtedness
with a combination of funds generated from operations and from refinancings with
the existing or new commercial lenders or by accessing capital markets.
RECEIVABLES
The Company's operations could be adversely affected if it experiences
significant delays in reimbursement of its labor and other costs from Medicare,
Medicaid and other third-party revenue sources. The Company's future liquidity
will continue to be dependent upon the relative amounts of current assets
(principally cash, accounts receivable and inventories) and current liabilities
(principally accounts payable and accrued expenses). In that regard, accounts
receivable can have a significant impact on the Company's liquidity. Continued
efforts by governmental and third-party payors to contain or reduce the
acceleration of costs by monitoring reimbursement rates, by increasing medical
review of bills for services or by negotiating reduced contract rates, as well
as any delay by the Company in the processing of its invoices, could adversely
affect the Company's liquidity and results of operations.
Net accounts receivable attributable to the provision of patient and resident
services at December 31, 1997 and 1996, totaled $27.2 million and $25.4 million,
respectively, representing approximately 50 and 54 days in accounts receivable,
respectively. The increase in such accounts receivable is due primarily to the
general increase in revenues and to the addition of the New Facilities. Accounts
receivable from the provision of management services was $716,000 and $713,000,
respectively, at December 31, 1997 and 1996, representing approximately 62 and
66 days in accounts receivable, respectively.
The Company continually evaluates the adequacy of its bad debt reserves based on
patient mix trends, agings of older balances, payment terms and delays with
regard to third-party payors, collateral and deposit resources, as well as other
factors. The Company continues to evaluate and implement additional procedures
to strengthen its collection efforts and reduce the incidence of uncollectible
accounts.
Since 1991, the Company and its predecessor have included in their consolidated
operations the operations of the six facilities of Texas Diversicare Limited
Partnership ("TDLP"). The Company serves as the general partner of TDLP and has
several continuing obligations to TDLP, one of which includes cash flow support
through August 2001. As of December 31, 1997, the Company has provided advances
for working capital
46
<PAGE>
funding and requirements under the cash flow guarantee to TDLP totaling
$3,242,000. The Company will recognize the advances receivable from TDLP as long
as the total of the Company's recorded net assets in TDLP are less than the
estimated fair value of the Company's interests in TDLP. As of December 31,
1997, the Company's recorded net assets approximate the combined value of its
interests in TDLP. As a result, the ultimate realization of future advances to
TDLP may require reserves to be recorded by the Company to offset future
increases in the advances.
HEALTH CARE INDUSTRY
The health care industry is subject to numerous laws and regulations of federal,
state and local governments. These laws and regulations include, but are not
necessarily limited to, matters such as licensure, accreditation, government
healthcare program participation requirements, reimbursement for patient
services, and Medicare and Medicaid fraud and abuse. Recently, government
activity has increased with respect to investigations and allegations concerning
possible violations by health care providers of fraud and abuse statutes and
regulations. Violations of these laws and regulations could result in expulsion
from government health care programs together with the imposition of significant
fines and penalties as well as significant repayments for patient services
previously billed. Management believes that the Company is in compliance with
fraud and abuse laws and regulations as well as other applicable government laws
and regulations. Compliance with such laws and regulations can be subject to
future government review and interpretation as well as regulatory actions
unknown or unasserted at this time.
During 1997, the Federal government enacted the Balanced Budget Act of 1997
("BBA"), which contains numerous Medicare and Medicaid cost-saving measures. The
BBA requires that nursing homes transition to a prospective payment system under
the Medicare program during a three year "transition period," commencing with
the first cost reporting period beginning on or after July 1, 1998. The BBA also
contains certain measures that could lead to future reductions in Medicare
therapy cost reimbursement and Medicaid payment rates. Given the recent
enactment of the BBA, the Company is unable to predict the ultimate impact of
the BBA on its future operations. However, any reductions in government spending
for long-term health care could have an adverse effect on the operating results
and cash flows of the Company. The Company will attempt to maximize the revenues
available to it from governmental sources within the changes that will occur
under the BBA. In addition, the Company will attempt to increase
non-governmental revenues, including expansion of its assisted living
operations, in order to offset the loss of governmental revenues as a result of
the enactment of the BBA.
FOREIGN CURRENCY TRANSLATION
The Company has obtained its financing primarily in U.S. dollars; however, it
incurs revenues and expenses in Canadian dollars with respect to Canadian
management activities and operations of the Company's six Canadian retirement
centers (one of which is owned) and two owned Canadian nursing homes. Therefore,
if the currency exchange rate fluctuates, the Company may experience currency
translation gains and losses with respect to the operations of these activities
and the capital resources dedicated to their support. While such currency
exchange rate fluctuations have not been material to the Company in the past,
there can be no assurance that the Company will not be adversely affected by
shifts in the currency exchange rates in the future.
47
<PAGE>
INFLATION
Management does not believe that the Company's operations have been materially
affected by inflation. The Company expects salary and wage increases for its
skilled staff to continue to be higher than average salary and wage increases,
as is common in the health care industry. To date, these increases as well as
normal inflationary increases in other operating expenses have been adequately
covered by revenue increases.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued two statements, Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information." Each is effective for financial statement periods
beginning after December 15, 1997. SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components. SFAS No. 131
establishes standards for the way public companies report information about
operating segments in annual financial statements. SFAS No. 131 also requires
that public companies report selected information about operating segments in
interim financial reports issued to shareholders.
The Company will adopt the provisions of these statements in association with
its financial statements issued for the required periods. The Company does not
expect the adoption of these standards to have a material effect on the
Company's results of operations.
IMPACT OF THE YEAR 2000
The Company is continuing to assess its Year 2000 information systems issues.
Management is committed to ensuring that its information systems are compliant
with the advent of the Year 2000. To date, no issues of a material nature have
been identified, and the costs of ensuring compliance are not expected to have a
material impact on the Company's results of operations.
FORWARD-LOOKING STATEMENTS
Certain statements made by or on behalf of the Company, including those
contained in this "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and elsewhere, are forward-looking statements as
defined in the Private Securities Litigation Reform Act of 1995. These
statements involve risks and uncertainties, and actual results may differ
materially from that expressed or implied in such forward-looking statements.
The Company hereby makes reference to items set forth under the heading "Risk
Factors" in the Company's Registration Statement on Form S-1, as amended
(Registration No. 33-76150). Such cautionary statements identify important
factors that could cause the Company's actual results to materially differ from
those projected in forward-looking statements.
48
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Audited financial statements are contained on pages F-1 through F-32 of this
Annual Report on Form 10-K and are incorporated herein by reference. Audited
supplemental schedule data is contained on pages S-1 and S-2 of this Annual
Report on Form 10-K and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
49
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning Directors and Executive Officers of the Company is
incorporated herein by reference to the Company's definitive proxy materials for
the Company's 1998 Annual Meeting of Stockholders.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning Executive Compensation is incorporated herein by
reference to the Company's definitive proxy materials for the Company's 1998
Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning Security Ownership of Certain Beneficial Owners and
Management is incorporated herein by reference to the Company's definitive proxy
materials for the Company's 1998 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning Certain Relationships and Related Transactions is
incorporated herein by reference to the Company's definitive proxy materials for
the Company's 1998 Annual Meeting of Stockholders.
50
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
Financial statements and schedules of the Company and its subsidiaries required
to be included in Part II, Item 8 are listed below.
<TABLE>
<CAPTION>
Form 10-K
Pages
-----
<S> <C>
FINANCIAL STATEMENTS
Report of Independent Public Accountants F-1
Consolidated Balance Sheets, December 31, 1997 and 1996 F-2
Consolidated Statements of Income for the Years Ended December 31, 1997,
1996 and 1995 F-3
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Cash Flows for the Years Ended December 31,
1997, 1996 and 1995 F-5 to F-7
Notes to Consolidated Financial Statements, December 31, 1997,
1996, and 1995 F-8 to F-32
FINANCIAL STATEMENT SCHEDULE
Report of Independent Public Accountants S-1
Schedule II - Valuation and Qualifying Accounts S-2
</TABLE>
EXHIBITS
The exhibits filed as part of this Report on Form 10-K are listed in the Exhibit
Index immediately following the financial statement pages.
REPORTS ON FORM 8-K
None.
51
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
ADVOCAT INC.
/s/ Charles W. Birkett, M.D.
- ------------------------------------------------
Charles W. Birkett, M.D., Chairman of the Board
March 30, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ Charles W. Birkett, M.D. /s/ Edward G. Nelson
- ----------------------------------- -------------------------------------
Charles W. Birkett, M.D. Edward G. Nelson
Chairman of the Board Director
(Principal Executive Officer) March 30, 1998
March 30, 1998
/s/ Mary Margaret Hamlett /s/ William C. O'Neal
- ----------------------------------- -------------------------------------
Mary Margaret Hamlett William C. O'Neil
Director Director
Executive Vice President, Chief March 30, 1998
Financial Officer, and
Secretary (Principal
Financial and Accounting
Officer)
March 30, 1998
/s/ Paul Richardson /s/ J. Bransford Wallace
- ----------------------------------- -------------------------------------
Paul Richardson J. Bransford Wallace
Director Director
March 30, 1998 March 30, 1998
52
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
[INTENTIONALLY OMITTED]
S-1
<PAGE>
ADVOCAT INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Additions
Balance ---------------------------
at Charged Balance
Beginning to Charged at
of Costs and to Other Deductions End of
Description Period Expenses Accounts Other (1) Period
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Year ended December 31, 1997:
Allowance for doubtful
accounts $2,524 $2,029 $ - $ - $1,851 $2,702
====== ====== ======= ======= ====== ======
Year ended December 31, 1996:
Allowance for doubtful
accounts $2,082 $1,745 $ - $ - $1,303 $2,524
====== ====== ======= ======= ====== ======
Year ended December 31, 1995:
Allowance for doubtful
accounts $1,776 $ 967 $ - $ - $ 661 $2,082
====== ====== ======= ======= ====== ======
</TABLE>
- -------------
(1) Amounts written off as uncollectible accounts, net of recoveries.
S-2
<PAGE>
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1997 AND 1996
TOGETHER WITH REPORT OF
INDEPENDENT PUBLIC ACCOUNTANTS
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Public Accountants F-1
Consolidated Balance Sheets F-2
Consolidated Statements of Income F-3
Consolidated Statements of Shareholders' Equity F-4
Consolidated Statements of Cash Flows F-5
Notes to Consolidated Financial Statements F-8
</TABLE>
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
[INTENTIONALLY OMITTED]
F-1
<PAGE>
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
------ ------------ -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,673,000 $ 1,942,000
Receivables, less allowance for doubtful
accounts of $2,702,000 and $2,524,000,
respectively 26,010,000 24,946,000
Income taxes receivable 380,000 --
Inventories 1,097,000 667,000
Prepaid expenses and other assets 1,640,000 1,470,000
Deferred income taxes 830,000 1,941,000
------------ -----------
Total current assets 32,630,000 30,966,000
------------ -----------
PROPERTY AND EQUIPMENT, AT COST 80,819,000 41,445,000
Less accumulated depreciation and
amortization (12,149,000) (9,714,000)
------------ -----------
Net property and equipment 68,670,000 31,731,000
------------ -----------
OTHER ASSETS:
Deferred tax benefit 5,460,000 6,480,000
Deferred financing and other costs, net 1,643,000 1,021,000
Other assets 6,558,000 4,710,000
------------ -----------
Total other assets 13,661,000 12,211,000
------------ -----------
$114,961,000 $74,908,000
============ ===========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1996
-------------------------------------- ------------ -----------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt $ 762,000 $ 713,000
Trade accounts payable 9,365,000 7,715,000
Income taxes payable -- 906,000
Accrued expenses:
Payroll and employee benefits 5,576,000 4,670,000
Interest 144,000 36,000
Worker's compensation 978,000 1,678,000
Other 1,956,000 1,708,000
------------ -----------
Total current liabilities 18,781,000 17,426,000
------------ -----------
NONCURRENT LIABILITIES:
Long-term debt, less current
portion 58,373,000 23,254,000
Deferred gains with respect to leases, net 3,562,000 3,956,000
Other 3,512,000 2,924,000
------------ -----------
Total noncurrent liabilities 65,447,000 30,134,000
------------ -----------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, authorized
1,000,000 shares, $.10 par
value, none issued and
outstanding -- --
Common stock, authorized 20,000,000
shares, $.01 par value, 5,377,000 and
5,316,000 shares issued and
outstanding, respectively 54,000 53,000
Paid-in capital 15,638,000 15,083,000
Retained earnings 15,041,000 12,212,000
------------ -----------
Total shareholders' equity 30,733,000 27,348,000
------------ -----------
$114,961,000 $74,908,000
============ ===========
</TABLE>
The accompanying notes are an
integral part of these consolidated balance sheets.
F-2
<PAGE>
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES:
Patient revenues............................................... $163,094,000 $153,582,000 $128,643,000
Resident revenues.............................................. 15,105,000 8,347,000 7,477,000
Management fees................................................ 3,886,000 4,152,000 3,618,000
Interest....................................................... 158,000 156,000 227,000
------------ ------------ ------------
182,243,000 166,237,000 139,965,000
------------ ------------ ------------
EXPENSES:
Operating...................................................... 146,555,000 131,966,000 109,458,000
Lease.......................................................... 15,850,000 14,441,000 13,518,000
General and administrative..................................... 9,636,000 8,578,000 7,806,000
Depreciation and amortization.................................. 2,823,000 2,285,000 1,516,000
Interest....................................................... 2,672,000 1,591,000 777,000
------------ ------------ ------------
177,536,000 158,861,000 133,075,000
------------ ------------ ------------
INCOME BEFORE INCOME TAXES...................................... 4,707,000 7,376,000 6,890,000
PROVISION FOR INCOME TAXES...................................... 1,694,000 2,655,000 2,480,000
------------ ------------ ------------
NET INCOME...................................................... $ 3,013,000 $ 4,721,000 $ 4,410,000
============ ============ ============
EARNINGS PER SHARE:
Basic....................................................... $ .56 $ .89 $ .84
============ ============ ============
Diluted..................................................... $ .56 $ .89 $ .82
============ ============ ============
WEIGHTED AVERAGE SHARES:
Basic....................................................... 5,339,000 5,304,000 5,270,000
============ ============ ============
Diluted..................................................... 5,373,000 5,330,000 5,381,000
============ ============ ============
</TABLE>
The accompanying notes are an integral
part of these consolidated financial statements.
F-3
<PAGE>
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
-------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
----------- ------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1994.......... 5,250,000 $52,000 $14,567,000 $3,050,000 $17,669,000
Issuance of common stock........... 38,000 1,000 308,000 - 309,000
Net income......................... - - - 4,410,000 4,410,000
Translation gain................... - - - 49,000 49,000
----------- ------- ----------- ---------- -----------
BALANCE, DECEMBER 31, 1995.......... 5,288,000 53,000 14,875,000 7,509,000 22,437,000
Issuance of common stock........... 28,000 - 208,000 - 208,000
Net income......................... - - - 4,721,000 4,721,000
Translation loss................... - - - (18,000) (18,000)
--------- ------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1996.......... 5,316,000 53,000 15,083,000 12,212,000 27,348,000
Issuance of common stock........... 61,000 1,000 555,000 - 556,000
Net income......................... - - - 3,013,000 3,013,000
Translation loss................... - - - (184,000) (184,000)
--------- ------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1997.......... 5,377,000 $54,000 $15,638,000 $15,041,000 $30,733,000
========= ======= =========== =========== ===========
</TABLE>
The accompanying notes are an integral
part of these consolidated financial statements.
F-4
<PAGE>
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 3,013,000 $ 4,721,000 $4,410,000
Items not involving cash:
Depreciation and amortization 2,861,000 2,285,000 1,062,000
Provision for doubtful accounts 2,029,000 1,745,000 967,000
Deferred income taxes 2,131,000 778,000 1,165,000
Equity earnings in joint ventures (53,000) (39,000) (37,000)
Amortization of deferred credits (1,022,000) (1,111,000) (644,000)
Changes in other non-cash items, net of acquisitions:
Restricted cash -- -- 1,552,000
Receivables (3,878,000) (6,037,000) (8,085,000)
Inventories (430,000) (159,000) (68,000)
Prepaid expenses and other assets (206,000) 48,000 (1,057,000)
Trade accounts payable and
accrued expenses 847,000 3,257,000 3,019,000
Other 12,000 (133,000) 49,000
----------- ---------- ----------
Net cash provided by operating
activities 5,304,000 5,355,000 2,333,000
----------- ---------- ----------
INVESTING ACTIVITIES:
Acquisitions, net of cash acquired (36,151,000) (7,180,000) (5,153,000)
Purchases of property and equipment, net (2,710,000) (2,409,000) (2,988,000)
Investment in TDLP (655,000) -- --
Mortgage receivable, net (307,000) (236,000) (792,000)
Investment in joint venture, net 36,000 27,000 (233,000)
Deposits, pre-opening costs and other (349,000) (258,000) (734,000)
TDLP partnership distributions 201,000 97,000 87,000
----------- ---------- ----------
Net cash used in investing activities (39,935,000) (9,959,000) (9,813,000)
----------- ---------- ----------
</TABLE>
(continued)
F-5
<PAGE>
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1996 1995
----------- ------------ -----------
<S> <C> <C> <C>
FINANCING ACTIVITIES:
Proceeds from issuance of debt $36,129,000 $ 18,688,000 $ 4,309,000
Repayment of debt obligations (730,000) (11,703,000) (491,000)
Financing costs (535,000) (386,000) (90,000)
Net proceeds from bank lines of credit 3,000 4,531,000 2,035,000
Repayment of bank line of credit -- (4,130,000) --
Lessor advances, net 442,000 (523,000) 23,000
Proceeds from sale of common stock 556,000 208,000 309,000
Advances to TDLP (503,000) (1,215,000) (675,000)
----------- ------------ -----------
Net cash provided by financing activities 35,362,000 5,470,000 5,420,000
----------- ------------ -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 731,000 866,000 (2,060,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,942,000 1,076,000 3,136,000
----------- ------------ -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,673,000 $ 1,942,000 $ 1,076,000
=========== ============ ===========
SUPPLEMENTAL INFORMATION:
Cash payments of interest $ 2,526,000 $ 1,572,000 $ 765,000
=========== ============ ===========
Cash payments of income taxes $ 392,000 $ 665,000 $ 2,089,000
=========== ============ ===========
</TABLE>
(continued)
F-6
<PAGE>
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
NON-CASH TRANSACTIONS:
The Company assumed debt of $1,592,000 and $1,075,000 in connection with the
acquisition of facilities in 1996 and 1995, respectively.
Foreign currency translation (gain) loss adjustments totaled $184,000, $18,000
and ($49,000) for 1997, 1996 and 1995, respectively.
The Company received net benefit plan deposits and earnings and recorded net
benefit plan liabilities of $265,000, $172,000 and $164,000 for 1997, 1996 and
1995, respectively.
The accompanying notes are an integral
part of these consolidated financial statements.
F-7
<PAGE>
ADVOCAT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. BACKGROUND
Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company")
provides long-term care services to nursing home patients and residents of
assisted living facilities in 11 Southeastern states and two Canadian
provinces. The Company's facilities provide a range of health care
services to their patients and residents. In addition to the nursing,
personal care and social services usually provided in long-term care
facilities, the Company, through arrangements with third parties, offers a
variety of comprehensive rehabilitation services as well as medical supply
and nutritional support services. As of December 31, 1997, the Company
operates 116 facilities, consisting of 65 nursing homes with 7,341
licensed beds and 51 assisted living facilities with 4,748 units. Within
this portfolio, 32 facilities are managed on behalf of other owners while
the remaining facilities, consisting of 59 leased and 25 owned facilities,
are operated for the Company's own account.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The financial statements include the operations and accounts of Advocat
and its subsidiaries. Investments in 20% to 50% owned entities are
accounted for using the equity method. All significant intercompany
accounts and transactions have been eliminated in consolidation.
F-8
<PAGE>
REVENUE
PATIENT AND RESIDENT REVENUES - The fees charged by the Company to
patients in its nursing homes and residents in its assisted living
facilities include fees with respect to individuals receiving benefits
under federal- and state-funded cost reimbursement programs. These
revenues are based on approved rates for each facility that are either
based on current costs with retroactive settlements or prospective rates
with no cost settlement. Amounts earned under federal and state programs
with respect to nursing home patients are subject to review by the
third-party payors. Final cost settlements, if any, are recorded when
objectively determinable, generally within three years of the close of a
reimbursement year depending upon the timing of appeals and third-party
settlement reviews or audits. Contractual adjustments for revenues earned
from federal and state programs amounted to $38,245,000, $41,801,000 and
$30,815,000 for 1997, 1996 and 1995, respectively.
MANAGEMENT FEES - Under its management agreements, the Company has
responsibility for the day-to-day operation and management of each of its
managed facilities. The Company typically receives a base management fee
ranging generally from 3.5% to 6% of net revenues of each managed
facility. Other than certain corporate and regional overhead costs, the
services provided at the facility are at the facility owner's expense. The
facility owner also is obligated to pay for all required capital
expenditures. The Company generally is not required to advance funds to
the owner. Other than with respect to facilities managed during insolvency
or receivership situations, the Company's management fees are generally
subordinated to the debt payments of the facilities it manages. In
addition, the Company is generally eligible to receive incentives over and
above its base management fees based on the profits at these facilities.
Approximately 74% of 1997 management fee revenues were derived from
agreements that expire beginning in 2004 through 2015. The remaining
management agreements have remaining lives that expire or are cancelable
at various times from 1998 through 2000.
LEASE EXPENSE
The Company operates 59 long-term care facilities under operating leases,
including 30 owned by Omega Healthcare Investors, Inc. ("Omega"), 11 owned
by Counsel Corporation (together with its affiliates, "Counsel"), 13 owned
by members or affiliates of Pierce Management Group ("Pierce") and five
owned by other parties. The Company's operating leases generally require
the Company to pay stated rent, subject to increases based on changes in
the Consumer Price Index or increases in the net revenues of the leased
properties. The Company's leases are "triple-net," requiring the Company
to maintain the premises, pay taxes, and pay for all utilities. The
Company generally grants its lessor a security interest in the Company's
personal property located at the leased facility. The leases generally
require the Company to maintain a minimum tangible net worth and prohibit
the
F-9
<PAGE>
Company from operating any additional facilities within a certain radius
of each leased facility. The Company is generally required to maintain
comprehensive insurance covering the facilities it leases as well as
personal and real property damage insurance and professional malpractice
insurance. The failure to pay rentals within a specified period generally
constitutes a default, which default, if uncured, permits the lessor to
terminate the lease. The Company's interest in the premises is
subordinated to that of the lessor's lenders.
CLASSIFICATION OF EXPENSES
The Company classifies all expenses (except interest, depreciation and
amortization, and lease expenses) that are associated with its corporate
and regional office support functions as general and administrative
expenses. All other expenses (except interest, depreciation and
amortization, and lease expenses) that are incurred by the Company at the
facility level are classified as operating expenses.
PROVISION FOR DOUBTFUL ACCOUNTS
The Company includes provisions for doubtful accounts in operating
expenses in its statements of income. The provisions for doubtful accounts
were $2,029,000, $1,745,000 and $967,000 for 1997, 1996 and 1995,
respectively.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost with depreciation being
provided over the shorter of the remaining lease term (where applicable)
or the assets' estimated useful lives on the straight-line basis as
follows:
Buildings and leasehold improvements - 10 to 40 years
Furniture and equipment - 2 to 15 years
Vehicles - 5 years
Interest incurred during construction periods is capitalized as part of
the building cost. Maintenance and repairs are charged against income as
incurred, and major betterments and improvements are capitalized. Property
and equipment obtained through purchase acquisitions are stated at their
estimated fair value determined on the respective dates of acquisition.
The Company utilizes Statement of Financial Accounting Standards ("SFAS")
No. 121, "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to be Disposed of." In accordance with SFAS No. 121, the
Company evaluates the carrying value of its properties in light of each
property's operational profitability.
F-10
<PAGE>
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on deposit with banks and all
highly liquid investments with original maturities of three months or
less.
INVENTORIES
Inventory is recorded at the lower of cost or net realizable value, with
cost being determined principally on the first-in, first-out basis.
DEFERRED FINANCING AND OTHER COSTS
Financing costs are amortized over the term of the related debt. Start-up
costs incurred prior to the commencement of revenue recognition are
deferred and charged against operations over five years on a straight-line
basis. The Company is entitled to recover these costs from
cost-reimbursement programs over the five-year period following
incurrence. Financing costs are recoverable over the term of the related
indebtedness.
INCOME TAXES
The Company utilizes SFAS No. 109, "Accounting for Income Taxes," for the
financial reporting of income taxes, which generally requires the Company
to record deferred income taxes for the differences between book and tax
bases in its assets and liabilities. Income taxes have been provided for
all items included in the statements of income, regardless of the period
when such items will be deductible for tax purposes. The principal
temporary differences between financial and tax reporting arise from
depreciation and from reserves that are not currently deductible, as well
as the timing of the recognition of gains on sales of assets.
FOREIGN OPERATIONS AND TRANSLATION POLICIES
The results of the Canadian operations have been translated at the
respective average rates (for consolidated statements of income purposes)
and respective year-end rates (for consolidated balance sheet purposes).
The cumulative foreign currency translation loss included in retained
earnings is $196,000 as of December 31, 1997.
DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable,
accounts payable and benefit plan deposits approximate fair value because
of the short-term nature of these accounts and because they are invested
in accounts earning market rates of interest. The carrying amount of the
Company's debt approximates fair value because the interest rates
approximate the current rates available to the Company and its individual
facilities.
F-11
<PAGE>
EARNINGS PER SHARE
Effective with the issuance of these consolidated financial statements,
the Company has adopted SFAS No. 128, "Earnings Per Share," which
establishes standards for computing earnings per share. Basic earnings per
share excludes dilution and is computed by dividing income available to
common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or
otherwise resulted in the issuance of common stock that then shared in the
earnings of the Company. The requirements of SFAS No. 128 have been
applied to all periods presented, which includes restatement of prior
periods.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses, as well as in the disclosure of contingent assets
and liabilities. The Company uses estimates in the determination of the
allowance for doubtful accounts receivable, settlements under cost
reimbursement programs, self-insurance reserves, depreciation, taxes and
contingencies, among others. Actual results could differ from those
estimates.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued two statements, SFAS
No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." Each is
effective for financial statement periods beginning after December 15,
1997. SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components. SFAS No. 131 establishes
standards for the way public companies report information about operating
segments in annual financial statements. SFAS No. 131 also requires that
public companies report selected information about operating segments in
interim financial reports issued to shareholders.
The Company will adopt the provisions of these statements in association
with its financial statements issued for the required periods. The Company
does not expect the adoption of these standards to have a material effect
on the Company's results of operations.
RECLASSIFICATIONS
Certain amounts in the 1996 and 1995 financial statements have been
reclassified to conform with the 1997 presentation.
F-12
<PAGE>
3. RECEIVABLES
Accounts receivable, before allowances, consists of the following
components:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1996
------------------------
<S> <C> <C>
Medicare $13,155,000 $10,828,000
Medicaid and other non-federal programs 8,412,000 9,360,000
Other patient and resident receivables 5,608,000 5,238,000
Management fees - affiliates 375,000 262,000
Management fees 341,000 451,000
Other receivables and advances 821,000 1,331,000
----------- -----------
$28,712,000 $27,470,000
=========== ===========
</TABLE>
The Company generally provides patient and resident services and manages
health care facilities in the Southeastern region of the United States and
two provinces in Canada.
The Company provides credit for a substantial portion of its revenues and
continually monitors the credit-worthiness and collectibility from its
clients, including proper documentation of third-party coverage.
The Company is subject to accounting losses from uncollectible receivables
in excess of its reserves and from the realization of its long-term
assets. The Company's management believes that all appropriate reserves or
valuation allowances have been provided as of December 31, 1997.
4. ACQUISITIONS
Effective October 1, 1997, the Company completed the acquisition or lease
of 29 assisted living facilities from Pierce. The Company purchased 15
facilities with 1,093 units and entered into leases on the remaining 14
centers with 1,209 units. The aggregate purchase price was approximately
$34,148,000, which includes related costs of the acquisition. To fund the
Pierce acquisition, the Company issued $34,100,000 in new debt. The debt
issued in connection with the Pierce acquisition is due January 1, 1999.
The Company has a commitment for $30,000,000 in longer-term financing that
is available to partially repay the initial financing. In addition, the
Company is also evaluating other financing sources that are available.
While the mix among the alternatives is not yet certain, the Company
expects to refinance the initial financing under longer-term arrangements
during 1998.
F-13
<PAGE>
The following unaudited pro forma information assumes that the Pierce
acquisition described above took place as of January 1 of each applicable
year.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996
------------ ------------
<S> <C> <C>
Pro forma net revenues $201,397,000 $192,363,000
============ ============
Pro forma net income $ 3,409,000 $ 5,261,000
============ ============
Pro forma earnings per share:
Basic $ .64 $ .99
============ ============
Diluted $ .63 $ .99
============ ============
</TABLE>
In addition, the Company acquired two Canadian assisted living facilities
on October 1, 1997. Immediately prior to the acquisitions, the Company had
managed these facilities, which total 125 units, during receivership
proceedings. The combined purchase price was approximately $2,317,000
($3,200,000 Canadian), which was funded by internal sources and the
issuance by the Company's principal Canadian lender of 10-year term loans
totaling $2,029,000 ($2,800,000 Canadian). The pro forma effect on net
income of these acquisitions is not material.
In 1996, the Company purchased four facilities totaling 350 beds. The
aggregate purchase price of $8,802,000 was funded with cash of $693,000,
debt issued in the amount of $6,487,000 and assumed liabilities of
$1,622,000. In 1995, the Company purchased two facilities totaling 265
beds. The aggregate purchase price of $6,004,000 was funded with $726,000
cash, debt issued in the amount of $4,172,000, and assumed liabilities of
$1,106,000. The pro forma effect on net income of these acquisitions is
not material.
5. SALE/LEASEBACK OF FACILITIES
Effective August 14, 1992, the Company entered into an agreement with
Omega whereby 21 of the Company's facilities were sold to Omega and leased
back to the Company under a master lease agreement (the "Master Lease").
In addition, the Company entered into a participating mortgage (the
"Participating Mortgage") with Omega on three other facilities. The net
gain on the sale/leaseback was deferred in accordance with sale/leaseback
accounting. The Company is amortizing the deferred gain over 20 years,
which is the initial lease term and the renewal period. The net deferred
gain totaled $3,539,000 as of December 31, 1997. Amortization of the
deferred gain totaled $246,000 for each of 1997, 1996 and 1995 and is
included as a decrease to lease expense in the accompanying consolidated
statements of income.
F-14
<PAGE>
6. SALE OF TEXAS HOMES
In 1991, the Company sold six of its Texas nursing homes to Texas
Diversicare Limited Partnership ("TDLP") for a sales price of
approximately $13,137,000. Total consideration for the sale in 1991
included a $7,500,000 wrap mortgage receivable from TDLP and $4,370,000
cash. Underlying the wrap mortgage receivable is a note payable to a bank
by the Company of $3,245,000 as of December 31, 1997. The TDLP properties
are collateral for this debt.
Under a repurchase agreement, the Company has agreed to purchase up to
10.0% of the partnership units per year, beginning in January 1997 (up to
a maximum of 50.0% of the total partnership units) through January 2001.
The purchase of the partnership units is upon demand from the limited
partners and the 10.0% maximum per year is not cumulative. The repurchase
price is the original cash sales price per unit less certain amounts based
on the depreciation from 1991 to the December 31 prior to the date of
repurchase. Pursuant to its repurchase obligation, the Company purchased
10.0% of the partnership units in each of January 1997 and 1998 for a
total consideration of $1,281,000. Units acquired pursuant to the
repurchase agreement do not have voting rights with respect to any matters
coming before the limited partners of TDLP.
As part of the TDLP transaction, the Company has guaranteed certain cash
flow requirements of TDLP for a ten-year period through August 2001. As of
December 31, 1997, the Company has provided working capital funding and
requirements under the cash flow guarantee to TDLP totaling $3,242,000.
Because of the guaranteed financial requirements to the TDLP partners, the
Company is accounting for this transaction under the leasing method of
accounting under SFAS No. 66. Under this method, the Company has not
recorded a sale of the assets. The cash received from TDLP was recorded as
an advance liability, and the wrap mortgage receivable has not been
reflected in the financial statements. The advance liability is adjusted
throughout the year based on mortgage note payments and advances to or
repayments from TDLP. The Company's consolidated statements of income will
continue to reflect the operations of the facilities until the expiration
of the Company's commitments with respect to TDLP.
F-15
<PAGE>
The Company continually evaluates the funding contingencies discussed
above in relation to the balance in the advance liability account and
future wrap mortgage receivable collections. The Company will recognize
the advances receivable from TDLP as long as the Company's recorded net
assets with respect to TDLP are less than the total of the estimated fair
value of the Company's investment in TDLP and the Company's interest in
the wrap mortgage due from TDLP. As of December 31, 1997, the Company's
recorded assets related to TDLP approximate the estimated fair value of
the Company's TDLP investment and the unrecorded mortgage receivable. As a
result, the ultimate realization of future advances to TDLP may be
questionable and may require reserves to be recorded by the Company to
offset future increases in the advances.
The consolidated statements of income include the recognition of income
and expenses from the TDLP homes since the sale. During 1997, 1996, and
1995, the consolidated statements of income include TDLP results of
operations before taxes of $123,000, $83,000 and $260,000, respectively,
which have also been reflected as a reduction of the advance liability
account. These amounts represent the amortization of the balance of the
advance liability account in excess of the repurchase obligation amount.
7. PROPERTY AND EQUIPMENT
Property and equipment, at cost, consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1997 1996
---------- ------------
<S> <C> <C>
Land $ 4,714,000 $ 1,949,000
Buildings and leasehold improvements 59,495,000 28,154,000
Furniture, fixtures and equipment 16,610,000 11,342,000
----------- -----------
$80,819,000 $41,445,000
=========== ===========
</TABLE>
Substantially all of the Company's gross property and equipment is
security for debt obligations.
F-16
<PAGE>
8. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------
1997 1996
------------ --------------
<S> <C> <C>
Promissory note payable to two banks; unsecured, however,
the Company has agreed not to pledge or otherwise
encumber the assets acquired in the Pierce acquisition
or issue other debt without the banks' approval; interest payable
monthly at either 2.0% above the London Interbank Offered Rate
("LIBOR") or the lead bank's Index rate (7.94% at December 31, 1997);
balloon maturity in January 1999 $34,100,000 $ --
Acquisition line of credit payable to a commercial finance company;
secured by four nursing homes; interest payable monthly at 2.75%
above LIBOR (8.72% at December 31, 1997); balloon maturity in
December 1999 11,100,000 11,100,000
Working capital line of credit payable to a bank; secured by certain
accounts receivable and substantially all other Company assets;
interest payable monthly at either 2.50% above LIBOR or the bank's
Index rate (8.25% at December 31, 1997); balloon maturity in December 1999 2,439,000 2,436,000
Mortgage payable to bank; secured by the six TDLP nursing homes; interest
and principal payable monthly, interest at 8.0%; matures in August 2001 3,245,000 3,839,000
</TABLE>
F-17
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------
1997 1996
------------ --------------
<S> <C> <C>
Mortgages payable to a Canadian bank; secured by two
nursing homes and three assisted living facilities;
interest and principal payable monthly; interest
ranging from 6.34% to 10.00%; balloon maturities December 1999
through October 2007 $5,650,000 $3,905,000
Mortgage payable to a bank; secured by one nursing home; interest and
principal payable monthly; interest at the lending bank's base rate
plus 0.75% (9.25% at December 31, 1997); balloon maturity in August 2001 2,411,000 2,446,000
Mortgages payable to two banks; secured by second interests in the
nursing home referred to immediately above; interest and principal
payable monthly; interest at the lead bank's base rate plus 0.75%
(9.25% at December 31, 1997); balloon maturity in
August 2001 164,000 167,000
Promissory note payable to Omega; unsecured; interest and
principal payable quarterly; interest at 11.00%;
matures in April 1998 26,000 74,000
----------- -----------
59,135,000 23,967,000
Less current portion (762,000) (713,000)
----------- -----------
$58,373,000 $23,254,000
=========== ===========
</TABLE>
Principal payments for the Company on long-term debt for the next five
years and thereafter beginning January 1, 1998, are as follows:
<TABLE>
<S> <C>
1998 $ 762,000
1999 49,655,000
2000 845,000
2001 3,328,000
2002 531,000
Thereafter 4,014,000
-----------
$59,135,000
===========
</TABLE>
F-18
<PAGE>
The Company has both a working capital line of credit and an acquisition
line of credit. The working capital line of credit provides for working
capital loans and letters of credit aggregating up to the lesser of
$10,000,000 or the borrowing base, as defined. The Company's obligations
under the working capital line are secured by certain accounts receivable
and substantially all other Company assets. Advances under the working
capital line bear interest payable monthly at the Company's option of
either LIBOR plus 2.50% or the bank's Index rate. The working capital line
terminates and all outstanding borrowings are due in December 1999. As of
December 31, 1997, the Company had drawn $2,439,000, had $5,650,000 of
letters of credit outstanding, and had $1,911,000 remaining borrowing
capability under the working capital line. The Company has received a
commitment from the bank for an increase in its working capital line of
credit availability of $1,250,000. This additional line of credit is
available through May 22, 1998 and contains terms mirroring the
$10,000,000 working capital line of credit.
The acquisition line of credit of $40,000,000, less outstanding
borrowings, is available to fund approved acquisitions through October
1999. The Company's obligations under the acquisition line are secured by
the assets acquired with the draws under the acquisition line. Advances
under the acquisition line bear interest, payable monthly, at LIBOR plus a
defined spread with respect to each facility based upon its loan-to-value
ratio and debt service coverage. Individual advances made under the
acquisition line are due three years from the date of initial funding. As
of December 31, 1997, the Company had drawn $11,100,000 under the
acquisition line, which amount was secured by four nursing homes, and had
$28,900,000 available for future acquisitions.
The Company has a commitment of up to $30,000,000 of long-term financing
under which the Company may borrow and pledge the assets acquired in the
Pierce acquisition as collateral. Loans are available at up to 80% of the
value of the pledged assets. Interest, which would be at LIBOR plus a
defined spread, would be determined based upon the length of term selected
(3, 10, or 20 years) and the loan-to-value ratio. This commitment is
available through November 1999. However, the Company may not draw upon
this commitment so long as the $34,100,000 promissory note remains
outstanding.
The Company's loan agreements contain various financial covenants, the
most restrictive of which relate to net worth, cash flow, debt to equity
ratio requirements, and limits on the payment of dividends to
shareholders. As of December 31, 1997, the Company was in compliance with
the covenants or has been granted a waiver in the event of non-compliance.
F-19
<PAGE>
9. SHAREHOLDERS' EQUITY AND STOCK PLANS
SHAREHOLDERS' RIGHTS PLAN
In 1995, the Company adopted a shareholders' rights plan (the "Plan"). The
Plan is designed to protect the Company's shareholders from unfair or
coercive takeover tactics. The rights under the Plan were effective for
all shareholders of record at the close of business March 20, 1995, and
thereafter and exist for a term of ten years. The Plan provides for one
right with respect to each share of common stock. Each right entitles the
holder to acquire, at a 50% discount from the then-current market, $100
worth of common stock of the Company or that of a non-approved acquiring
company. The rights may be exercised only upon the occurrence of certain
triggering events, including the acquisition of, or a tender offer for,
15% or more of the Company's common stock without the Company's prior
approval.
STOCK-BASED COMPENSATION PLANS
In 1994, the Company adopted the 1994 Incentive and Nonqualified Stock
Option Plan for Key Personnel (the "Key Personnel Plan"). Under the Key
Personnel Plan, as amended in May 1997, 810,000 shares of common stock
have been reserved for issuance upon exercise of options granted
thereunder.
In 1994, the Company adopted the 1994 Nonqualified Stock Option Plan for
the Directors (the "Director Plan"). Under the Director Plan, as amended
in May 1996, 190,000 shares of common stock have been reserved for
issuance upon exercise of options granted thereunder.
Under both plans, the option exercise price equals the stock's market
price on the grant date. The maximum term of any option granted pursuant
to either the Key Personnel Plan or to the Director Plan is ten years.
Options issued under either plan are one-third vested at the grant date
with an additional one-third vesting on each of the next two anniversaries
of the grant date. Shares subject to options granted under either plan
that expire, terminate, or are canceled without having been exercised in
full become available again for future grants.
In 1994, the Company adopted the 1994 Employee Stock Purchase Plan and
reserved 250,000 shares for issuance under the plan. Employees may
purchase stock, subject to certain limitations, at 85% of the lower of the
closing market price at the beginning or at the end of each plan year. The
plan year begins July 1 and ends the following June 30. In July 1997, 1996
and 1995, 17,000, 21,000 and 23,000 shares were issued pursuant to this
plan, respectively. The fair value of shares sold under the plan was $9.50
in both 1997 and in 1996 and was $8.63 in 1995.
F-20
<PAGE>
The Company accounts for these plans under Accounting Principles Board
Opinion No. 25, under which no compensation cost has been recognized. Had
compensation cost for these plans been determined consistent with SFAS No.
123, the Company's net income and earnings per share would have been
reduced to the following pro forma amounts:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Net Income:
As reported $3,013,000 $4,721,000 $4,410,000
========== ========== ==========
Pro forma $2,813,000 $4,447,000 $4,302,000
========== ========== ==========
Basic Earnings Per Share:
As reported $ .56 $ .89 $ .84
========== ========== ==========
Pro forma $ .53 $ .84 $ .82
========== ========== ==========
Diluted Earnings Per Share:
As reported $ .56 $ .89 $ .82
========== ========== ==========
Pro forma $ .52 $ .83 $ .80
========== ========== ==========
</TABLE>
Because the provisions of SFAS No. 123 have not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
F-21
<PAGE>
Summarized activity of the stock option plans is presented below:
<TABLE>
<CAPTION>
SHARES WEIGHTED
------------------------------ AVERAGE
KEY PERSONNEL DIRECTOR EXERCISE
PLAN PLAN PRICE
------------------ -------- --------
<S> <C> <C> <C>
Outstanding,
December 31, 1994 409,000 128,000 $ 9.59
Issued 15,000 23,000 12.10
Exercised (5,000) (10,000) 9.50
Expired or canceled (6,000) (6,000) 9.50
------- ------- ------
Outstanding,
December 31, 1995 413,000 135,000 9.76
Issued 112,000 5,000 9.64
Exercised (7,000) -- 9.50
Expired or canceled (7,000) (24,000) 10.45
------- ------- ------
Outstanding,
December 31, 1996 511,000 116,000 9.71
Issued 39,000 21,000 9.88
Exercised (44,000) - 9.67
Expired or canceled (22,000) (26,000) 10.19
------- ------- ------
Outstanding,
December 31, 1997 484,000 111,000 $9.69
======= ======= =====
Vested, December 31, 1997 423,000 95,000 $9.67
======= ======= =====
Available for future grants,
December 31, 1997 270,000 69,000
======= =======
</TABLE>
F-22
<PAGE>
The outstanding options have exercise prices ranging from $7.13 to $13.13
and have a weighted average remaining life of 8.0 years. The weighted
average fair value of options granted was $4.20, $4.10 and $5.33 in 1997,
1996 and 1995, respectively.
The fair value of each option is estimated on the grant date using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for the 1997, 1996 and 1995 grants: risk free interest
rates ranging from 5.7% to 6.2% for 1997, from 5.5% to 6.1% for 1996 and
from 5.4% to 7.1% for 1995; no expected dividend yield for each of the
years; expected lives of five years for each of the years; and, expected
volatility of 37.2% for 1997 and 38.5% for both 1996 and 1995.
PREFERRED STOCK
The Company is authorized to issue up to 1,000,000 shares of preferred
stock. The Company's Board of Directors is authorized to establish the
terms and rights of each series, including the voting powers,
designations, preferences, and other special rights, qualifications,
limitations, or restrictions thereof.
10. EARNINGS PER SHARE
Information with respect to the calculation of basic and diluted earnings
per share data is presented below:
<TABLE>
<CAPTION>
EARNINGS
PER
NET INCOME SHARES SHARE
------------ --------- --------
<S> <C> <C> <C>
Year ended December 31, 1997:
Basic earnings per share $3,013,000 5,339,000 $.56
Employee stock purchase plan - 9,000
Options - 25,000
------------ ---------
Diluted earnings per share $3,013,000 5,373,000 $.56
============ ========= ========
Year ended December 31, 1996:
Basic earnings per share $4,721,000 5,304,000 $.89
Employee stock purchase plan - 11,000
Options - 15,000
------------ ---------
Diluted earnings per share $4,721,000 5,330,000 $.89
============ ========= ========
Year ended December 31, 1995:
Basic earnings per share $4,410,000 5,270,000 $.84
Employee stock purchase plan - 12,000
Options - 99,000
------------ ---------
Diluted earnings per share $4,410,000 5,381,000 $.82
============ ========= ========
</TABLE>
F-23
<PAGE>
For each period presented, the Company had options outstanding at prices
in excess of the average market price of the Company's common stock. Such
options were excluded from the computation because to include them would
have been antidilutive. The weighted average options excluded were
352,000, 320,000 and 26,000 for 1997, 1996 and 1995, respectively.
11. INCOME TAXES
The provision for income tax expense is composed of the following
components:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Current payable (benefit):
Federal $ (823,000) $1,498,000 $ 976,000
State and province 386,000 379,000 339,000
---------- ---------- ----------
(437,000) 1,877,000 1,315,000
---------- ---------- ----------
Deferred taxes:
Federal 1,941,000 621,000 865,000
State and province 190,000 157,000 300,000
---------- ---------- ----------
2,131,000 778,000 1,165,000
---------- ---------- ----------
Provision for income taxes $1,694,000 $2,655,000 $2,480,000
========== ========== ==========
</TABLE>
A reconciliation of taxes computed at statutory income tax rates is as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Provision for federal income
taxes at statutory rates
$1,600,000 $2,508,000 $2,343,000
State and province income taxes,
net of benefit 118,000 295,000 276,000
Other (24,000) (148,000) (139,000)
---------- ---------- ----------
Provision for income taxes $1,694,000 $2,655,000 $2,480,000
========== ========== ==========
</TABLE>
F-24
<PAGE>
The net deferred tax assets and liabilities, at the respective income tax
rates, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1996
---------- ----------
<S> <C> <C>
Current deferred asset:
Allowance for doubtful accounts $ -- $ 881,000
Accrued liabilities 830,000 1,060,000
----------- -----------
$ 830,000 $ 1,941,000
----------- -----------
Non-current deferred asset:
Tax gain on sale transactions in excess of
recognized financial reporting gain $ 1,420,000 $ 1,743,000
Tax goodwill and intangibles 10,217,000 11,084,000
Other 251,000 153,000
----------- -----------
11,888,000 12,980,000
Less valuation allowance (5,688,000) (5,909,000)
----------- -----------
6,200,000 7,071,000
----------- -----------
Non-current deferred liability:
Deferred costs (244,000) (325,000)
Depreciation (496,000) (266,000)
----------- -----------
(740,000) (591,000)
----------- -----------
Net non-current deferred asset $ 5,460,000 $ 6,480,000
=========== ===========
</TABLE>
The Company has recorded a valuation allowance with respect to the
deductibility of certain tax goodwill and intangibles. The valuation
allowance for deferred tax assets decreased $221,000 in 1997 and $281,000
in 1996. The changes are related to the amortization of tax goodwill. The
Company expects that such valuation allowances will be determined annually
based on any circumstances or events with the taxing authorities.
F-25
<PAGE>
12. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
The Company is committed under long-term operating leases with various
expiration dates and varying renewal options. Minimum annual rentals
(exclusive of taxes, insurance, and maintenance costs) under these leases
for the next five years beginning January 1, 1998, are as follows:
1998 $19,292,000
1999 19,881,000
2000 20,362,000
2001 20,846,000
2002 21,407,000
Under lease agreements with Omega, Counsel, Pierce and others, the
Company's lease payments are subject to periodic annual escalations as
described in Note 2. Total lease expense was $15,850,000, $14,441,000 and
$13,518,000, for 1997, 1996 and 1995, respectively.
One operating lease requires the Company to pay additional lease payments
in an amount equal to 60.0% of pretax facility profits, as defined.
OMEGA LEASES
The Company's Master Lease with Omega covering 21 facilities provides for
an initial term of ten years through August 2002 and allows the Company
one ten-year renewal option. The Company issued a letter of credit in the
amount of $3,800,000 in favor of Omega as security for its obligations
under the Master Lease. Under the terms of the Master Lease, the Company
must comply with certain covenants based on total shareholders' equity of
the Company as defined. The Company was in compliance with these covenants
as of December 31, 1997. First mortgage revenue bonds of $4,370,000 were
assumed by Omega as of August 14, 1992. The Company remains secondarily
liable for the debt service through maturity of these bonds. Omega has
indemnified the Company for any losses suffered by the Company as a result
of a default on the bonds. Omega has represented to the Company that the
debt service on the bonds was current as of December 31, 1997. The Company
is leasing the two facilities mortgaged by these bonds.
F-26
<PAGE>
Effective December 1, 1994, the Company entered into a series of
agreements with Omega and a third party. Under the agreements, the Company
will ultimately lease a total of nine nursing facilities with a total of
805 beds. The Company has executed formal lease agreements with respect to
five of the nine facilities. The remaining four facilities are currently
being managed by the Company. Under the management agreements, the Company
is responsible for the operating assets and liabilities of the facilities
and receives a management fee equal to the net profits of the facilities.
The Company is accounting for these properties as operating leases in
anticipation of the completion of formal lease agreements. The initial
lease period for the nine facilities will be ten years with two five-year
renewal options at the Company's option.
COUNSEL LEASES
The Company leases five facilities from Counsel with an initial term of
five years through April 1999 and one five-year renewal option. With
respect to these facilities, the Company has a right of first refusal and
a purchase option at the end of the lease term.
The Company leases three additional facilities from Counsel with an
initial term of ten years through April 2004 and one ten-year renewal
option. With respect to these facilities, the Company has the right of
first refusal and a purchase option at the end of the lease term.
The Company leases three additional facilities from Counsel with a lease
term through August 2002. At the end of the lease term, the Company has
the right to purchase these facilities. In addition, the Company can
require Counsel to transfer these facilities to Omega, at which time the
Company has the right to lease these facilities from Omega in accordance
with the terms of the Master Lease.
PIERCE LEASES
The Company acquired leases with respect to 14 facilities as part of the
Pierce transaction. Of these leases, 12 are with the former principal
owners of Pierce and have an initial term of 15 years and two five-year
renewal options. Beginning at the fifth anniversary, the Company has a
right to purchase all twelve facilities as a group for their fair market
value. The remaining two leases are subleases that expire in 2017 and
1998. With respect to the latter sublease, the Company and the sublessor
have agreed in principal to a direct lease with a five year term beginning
concurrent with the expiration of the sublease. The Company has no
purchase option with respect to either sublease.
F-27
<PAGE>
CONTINGENCIES
The Company has liability claims and disputes outstanding for professional
liability and other issues. Professional liability insurance up to certain
limits is carried by the Company and its subsidiaries for coverage of such
claims. (See Note 13.) The ultimate results of the litigation are unknown
at the present time, but management is of the opinion that there would be
no material amounts in excess of liability coverages.
With respect to worker's compensation, substantially all of the Company's
employees became covered under either an indemnity insurance plan or
state-sponsored programs in May 1997. Prior to that time, the Company was
self-insured for the first $250,000, on a per claim basis, for worker's
compensation claims in a majority of its United States nursing facilities.
The Company has been and remains completely self-insured for worker's
compensation claims with respect to its Texas operations. The Company has
provided reserves for the settlement of outstanding self-insured claims at
amounts believed to be adequate as of December 31, 1997. The differences
between actual settlements and reserves are included in expense in the
year finalized.
The Company is self-insured for health insurance benefits for certain
employees and dependents for amounts up to $75,000 per individual
annually. The Company provides reserves for the settlement of outstanding
self-insured claims at amounts believed to be adequate. The differences
between actual settlements and reserves are included in expense in the
year finalized.
EMPLOYMENT AGREEMENTS
The Company has employment agreements with certain members of management
that provide for the payment to these members of amounts up to 2.5 times
their annual base salary in the event of a termination without cause, a
constructive discharge (as defined), or upon a change in control of the
Company (as defined). The maximum contingent liability under these
agreements is approximately $1.6 million. In addition, upon the occurrence
of any triggering event, certain executives may elect to require the
Company to purchase options granted to them for a purchase price equal to
the difference between the fair market value of the Company's common stock
at the date of termination and the stated option exercise price. The terms
of such agreements are from one to three years and automatically renew for
one year if not terminated by the employee or the Company.
F-28
<PAGE>
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
The Company has established a Supplemental Executive Retirement Plan (the
"SERP") to provide retirement benefits for officers and employees of the
Company who have been designated for participation by the President of the
Company. Participants in the SERP will be eligible to receive benefits
thereunder after reaching normal retirement age which is defined in the
SERP as either (i) age 65, (ii) age 60 and ten years of service, or (iii)
age 55 and 15 years of service. Under the SERP, participants can defer up
to 6% of his or her base pay. The Company makes matching contributions of
100% of the amount deferred by each participant. Benefits under the SERP
become fully vested upon the participant reaching normal retirement age or
the participant's disability or death. In addition, if there is a change
in control of the Company as defined in the SERP, all participants shall
be fully vested, and each participant shall be entitled to receive his or
her benefits under the SERP upon termination of employment. The SERP trust
funds are at risk of loss. Should the Company become insolvent, its
creditors would be entitled to a claim to the funds superior to the claim
of SERP participants.
HEALTH CARE INDUSTRY
The health care industry is subject to numerous laws and regulations of
federal, state and local governments. These laws and regulations include,
but are not necessarily limited to, matters such as licensure,
accreditation, government health care program participation requirements,
reimbursement for patient services, and Medicare and Medicaid fraud and
abuse. Recently, government activity has increased with respect to
investigations and allegations concerning possible violations by health
care providers of fraud and abuse statutes and regulations. Violations of
these laws and regulations could result in expulsion from government
health care programs together with the imposition of significant fines and
penalties, as well as significant repayments for patient services
previously billed. Management believes that the Company is in compliance
with fraud and abuse laws and regulations as well as other applicable
government laws and regulations. Compliance with such laws and regulations
can be subject to future government review and interpretation as well as
regulatory actions unknown or unasserted at this time.
During the third quarter of 1997, the Company received separate
notifications from the state of Alabama that, as a result of certain
deficiencies noted upon periodic surveys of its facilities in Mobile, the
facilities would be decertified from participation in the Medicare and
Medicaid programs and that licensure revocation could be pursued. The
facilities were decertified for 69 and 91 days, respectively, before
resurveys found them to be in compliance. Both of the facilities have been
recertified for participation in the Medicare and Medicaid programs.
F-29
<PAGE>
During 1997, the Federal government enacted the Balanced Budget Act of
1997 ("BBA"), which contains numerous Medicare and Medicaid cost-saving
measures. The BBA requires that nursing homes transition to a prospective
payment system under the Medicare program during a three year "transition
period," commencing with the first cost reporting period beginning on or
after July 1, 1998. The BBA also contains certain measures that could lead
to future reductions in Medicare therapy cost reimbursement and Medicaid
payment rates. Given the recent enactment of the BBA, the Company is
unable to predict the ultimate impact of the BBA on its future operations.
However, any reductions in government spending for long-term health care
could have an adverse affect on the operating results and cash flows of
the Company. The Company will attempt to maximize the revenues available
to it from governmental sources within the changes that will occur under
the BBA. In addition, the Company will attempt to increase nongovernment
revenues, including expansion of its assisted living operations in order
to offset the loss of governmental revenues as a result of the enactment
of the BBA.
13. PROFESSIONAL LIABILITY INSURANCE
All of the Company's liability policies are on an occurrence basis and are
renewable annually. Each of the coverage limits and the self-insured risks
referred to in the following is measured on an annual basis.
The Company maintains general and professional liability insurance with
per claim coverage of $1,000,000 and aggregate coverage limits of up to
$3,000,000 for its long-term care services. Through December 31, 1997,
with respect to a majority of its United States nursing homes, the Company
is self-insured for the first $25,000 per occurrence and $500,000 in the
aggregate for such claims. Effective January 1998, these self-insured per
claim and aggregate amounts increased to $250,000 and $2,500,000,
respectively. In addition, the Company maintains a $50,000,000 aggregate
umbrella liability policy for claims in excess of the foregoing limits for
its nursing home operations. The assisted living operations acquired in
the Pierce transaction are self-insured, with respect to each location,
for the first $5,000 per occurrence and $25,000 in the aggregate. In
addition, the Company maintains a $10,000,000 aggregate umbrella liability
policy for claims in excess of the foregoing limits for these assisted
living operations.
The Canadian facilities owned or leased by the Company maintain general
and professional liability insurance with per claim coverage limits of up
to $1,398,000 ($2,000,000 Canadian). In addition, the Company maintains a
$2,097,000 ($3,000,000 Canadian) aggregate umbrella liability policy for
claims in excess of the above limit for these facilities.
F-30
<PAGE>
The six TDLP facilities maintain general and professional liability
insurance with per claim coverage of $1,000,000 and aggregate coverage
limits of up to $2,000,000. In addition, TDLP maintains a $10,000,000
aggregate umbrella liability policy for claims in excess of the foregoing
limits for these facilities.
14. GEOGRAPHIC OPERATIONS
Expenses incurred by the Company that are not directly traceable to either
of the Company's geographic segments (United States and Canada) have been
allocated to the applicable geographic region for which benefit the expense
was incurred. Information by geographic segment is presented below:
<TABLE>
<CAPTION>
UNITED STATES CANADA TOTAL
------------- ----------- ------------
<S> <C> <C> <C>
Year Ended December 31, 1997:
Net revenues $167,995,000 $14,248,000 $182,243,000
Income before taxes 2,818,000 1,889,000 4,707,000
Identifiable assets 100,644,000 14,317,000 114,961,000
Year Ended December 31, 1996:
Net revenues $153,797,000 $12,440,000 $166,237,000
Income before taxes 5,758,000 1,618,000 7,376,000
Identifiable assets 64,383,000 10,525,000 74,908,000
Year Ended December 31, 1995:
Net revenues $128,781,000 $11,184,000 $139,965,000
Income before taxes 5,228,000 1,662,000 6,890,000
Identifiable assets 52,780,000 6,251,000 59,031,000
</TABLE>
15. RELATED PARTIES
The Company commenced operations effective with an initial public offering
of common stock in May 1994. The Company's predecessor operations were in
companies owned or controlled by Counsel. From the Company's inception
through November 1996, the Company had two Directors who are directors and
key executives of Counsel. The Company provides management services for
nine facilities owned by two Canadian limited partnerships. The president
of the general partners of these partnerships is a director and key
executive of Counsel, and Counsel leases seven of these facilities from
one of the partnerships. Management fees from these facilities totaled
$1,814,000, $1,656,000 and $1,684,000 for 1997, 1996 and 1995,
respectively.
F-31
<PAGE>
The Company has loaned one of the limited partnerships $1,434,000 and
$1,028,000 as of December 31, 1997 and 1996, respectively. The Company has
received second, third and fourth mortgage security interests in the
partnership assets. The notes receivable bear interest at 8.0% and are
being repaid over the life of the management contract.
Lease expense related to the facilities leased from Counsel totaled
$2,091,000 $2,078,000 and $2,052,000 for the years ended December 31,
1997, 1996 and 1995, respectively.
16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
QUARTER
-----------------------------------------------------
1997 FIRST SECOND THIRD FOURTH
---- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net revenues $43,442,000 $44,237,000 $43,657,000 $50,907,000
=========== =========== =========== ===========
Net income $ 1,269,000 $ 1,334,000 $ 312,000 $ 98,000
=========== =========== =========== ===========
Basic and diluted earnings per
share $ .24 $ .25 $ .06 $ .02
=========== =========== =========== ===========
1996
----
Net revenues $39,533,000 $39,776,000 $42,646,000 $44,282,000
=========== =========== =========== ===========
Net income $ 900,000 $ 1,051,000 $ 1,271,000 $ 1,499,000
=========== =========== =========== ===========
Basic and diluted earnings per
share $ .17 $ .20 $ .24 $ .28
=========== =========== =========== ===========
</TABLE>
F-32
<PAGE>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
<PAGE>
ANNEX B
SCHEDULE 14A
(RULE 14A-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES
EXCHANGE ACT OF 1934 (AMENDMENT NO. )
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
<TABLE>
<S> <C>
[ ] Preliminary Proxy Statement [ ] Confidential, for Use of the Commission
Only (as permitted by Rule 14a-6(e)(2))
[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12
</TABLE>
Advocat, Inc.
- --------------------------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
(1) Title of each class of securities to which transaction applies:
(2) Aggregate number of securities to which transaction applies:
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (set forth the amount on which the
filing fee is calculated and state how it was determined):
(4) Proposed maximum aggregate value of transaction:
(5) Total fee paid:
[ ] Fee paid previously with preliminary materials:
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
(2) Form, Schedule or Registration Statement No.:
(3) Filing Party:
(4) Date Filed:
<PAGE>
ADVOCAT INC.
277 MALLORY STATION ROAD, SUITE 130
FRANKLIN, TENNESSEE 37067
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD ON MAY 15, 1998
Notice is hereby given that the Annual Meeting of Stockholders of
Advocat Inc. (the "Company") will be held at 1800 First American Center,
Nashville, Tennessee on May 15, 1998, at 9:00 a.m. Central Daylight Time, for
the following purposes:
1. To elect one Class 1 director to hold office for a three (3) year term
and until his successor is duly elected and qualified;
2. To amend the Company's 1994 Incentive and Nonqualified Stock Option
Plan for Key Personnel to increase the number of shares of Common Stock
reserved for issuance from 810,000 shares to 1,060,000 shares; and,
3. To transact such other business as may properly come before the meeting
or any adjournment thereof.
Stockholders of record at the close of business on March 23, 1998 will
be entitled to vote at the meeting.
The Company's Board of Directors urges all stockholders of record to
exercise their right to vote at the meeting personally or by proxy. Accordingly,
we are sending you the accompanying Proxy Statement and the enclosed proxy card.
Your attention is directed to the Proxy Statement accompanying this
notice for a statement regarding matters to be acted upon at the meeting.
By Order of the Board of Directors,
Mary Margaret Hamlett
Secretary
Franklin, Tennessee
March 30, 1998
YOUR REPRESENTATION AT THE ANNUAL MEETING OF STOCKHOLDERS IS IMPORTANT.
TO ENSURE YOUR REPRESENTATION, WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING,
PLEASE COMPLETE, DATE, SIGN AND RETURN THE ENCLOSED PROXY CARD. SHOULD YOU
DESIRE TO REVOKE YOUR PROXY, YOU MAY DO SO AT ANY TIME BEFORE IT IS VOTED IN THE
MANNER PROVIDED IN THE ACCOMPANYING PROXY STATEMENT.
<PAGE>
ADVOCAT INC.
PROXY STATEMENT
This Proxy Statement is furnished in connection with the solicitation
of proxies by the Board of Directors of Advocat Inc., a Delaware corporation,
with its principal offices at 277 Mallory Station Road, Suite 130, Franklin,
Tennessee 37067 (together with its subsidiaries, "Advocat" or the "Company"), to
be used at the Annual Meeting of Stockholders to be held on May 15, 1998, at
9:00 a.m. Central Daylight Time and at any adjournment thereof, for the purposes
set forth in the accompanying Notice of Annual Meeting of Stockholders. The
Proxy Statement and form of proxy are being mailed to stockholders on or about
March 31, 1998.
A stockholder who executes a proxy has the right to revoke the proxy at
any time before it is voted by giving written notice of revocation to the
Secretary of the Company, by executing a proxy bearing a later date, or by
attending the Annual Meeting of Stockholders and voting in person. Proxies will
be voted in accordance with instructions noted on the proxies. Unless otherwise
specifically instructed in the proxies, it is the intention of the persons named
in the proxy to vote all proxies received by them FOR THE ELECTION OF THE
NOMINEE NAMED HEREIN WHO IS STANDING FOR ELECTION AS A CLASS 1 DIRECTOR and FOR
THE AMENDMENT TO THE 1994 INCENTIVE AND NONQUALIFIED STOCK OPTION PLAN FOR KEY
PERSONNEL (THE "KEY PERSONNEL PLAN") TO INCREASE THE NUMBER OF SHARES OF COMMON
STOCK RESERVED FOR ISSUANCE FROM 810,000 TO 1,060,000 SHARES. Management does
not know of any other matters that will be presented for action at the Annual
Meeting of Stockholders. If any other matter does come before the meeting,
however, the persons appointed in the proxy will vote in accordance with their
best judgment on such matter.
The cost of this proxy solicitation will be borne by the Company. It is
contemplated that proxies will be solicited solely by mail. Banks, brokers and
other custodians will be requested to forward proxy soliciting materials to
their customers where appropriate, and the Company will reimburse such banks,
brokers, and custodians for their reasonable out-of-pocket expenses in sending
the proxy materials to beneficial owners of the Company's shares.
SUMMARY OF MATTERS TO BE CONSIDERED
At the Annual Meeting of Stockholders, the stockholders of the Company
will be asked to vote on (1) the election of one nominee to serve as a Class 1
director for a three-year term and until his successor is duly elected and
qualified (see "Proposal 1: Election of Director") and (2) the amendment of the
Key Personnel Plan to increase the number of shares of Common Stock reserved for
issuance thereunder from 810,000 shares to 1,060,000 shares (see "Proposal 2:
Amendment to 1994 Incentive and Nonqualified Stock Option Plan for Key Personnel
Increasing Shares Available for Grant").
1
<PAGE>
VOTING
Stockholders of record as of March 23, 1998 will be entitled to vote at
the annual meeting. At the close of business on that day, there were outstanding
5,376,946 shares of the Company's Common Stock, par value $.01 per share (the
"Common Stock"). Each share of Common Stock is entitled to one vote, which may
be given in person or by proxy authorized in writing. The Company has no other
classes of voting stock issued. The Company has the authority to issue shares of
preferred stock in one or more series, although no series of preferred stock has
been designated or issued.
To vote by proxy, a stockholder should complete, sign, date and return
the enclosed proxy to the Secretary of the Company. The Board of Directors urges
you to complete the proxy card whether or not you plan to attend the meeting. If
you attend the meeting in person, you may, if you wish, vote in person on all
matters brought before the meeting even if you have previously delivered your
proxy. Any stockholder who has given a proxy may revoke it any time prior to its
exercise by filing an instrument revoking it with the Secretary of the Company,
by duly executing a proxy bearing a later date, or by attending the meeting and
voting in person. The mere presence at the meeting of a stockholder who has
appointed a proxy will not revoke the appointment.
The director nominee will be elected by a plurality of the votes cast
by the holders of the Common Stock present or represented and entitled to vote
at the annual meeting. All other matters submitted to the stockholders will be
approved by the affirmative vote of a majority of the votes cast by the holders
of the Common Stock present or represented and entitled to vote at the Annual
Meeting of Stockholders. Abstentions and broker non-votes will not be counted as
affirmative votes, but will be counted for purposes of determining the presence
or absence of a quorum. Abstentions and broker non-votes have no legal effect on
the election of directors. On matters requiring majority vote for approval,
abstentions have the effect of negative votes.
2
<PAGE>
STOCK OWNERSHIP OF DIRECTORS,
EXECUTIVE OFFICERS AND PRINCIPAL HOLDERS
The table below sets forth, as of March 23, 1998, the number and
percentage of outstanding shares of the Company's Common Stock owned by all
persons known to the Company to be holders of 5% or more of such securities, by
all directors, by each of the executive officers named in the Summary
Compensation Table herein, and by all directors and executive officers of the
Company as a group. Unless otherwise indicated, all holdings are of record and
beneficial.
<TABLE>
<CAPTION>
NUMBER OF
SHARES PERCENTAGE
BENEFICIALLY SHARES OF TOTAL
NAME OWNED(1) OUTSTANDING(2)
- - ---- ------------ ---------------
<S> <C> <C>
Heartland Advisors, Inc. (3)....................... 814,800 15.2%
790 North Milwaukee Street
Milwaukee, WI 53202
The Goldman Sachs Group, L.P. (4).................. 814,000 15.1%
85 Broad Street
New York, NY 10004
Neuberger & Berman, LLC (5)........................ 454,223 8.4%
605 Third Avenue
New York, NY 10158-3698
Merrill Lynch & Co., Inc. (6)...................... 360,000 6.7%
World Financial Center, North Tower
250 Vesey Street
New York, NY 10281-1334
FMR Corp (7)....................................... 281,200 5.2%
82 Devonshire Street
Boston, MA 02109
Charles W. Birkett, M.D. (8)....................... 196,365 3.6%
Paul Richardson (9)................................ 165,617 3.0%
Mary Margaret Hamlett (10)......................... 110,646 2.0%
Edward G. Nelson (11).............................. 21,000 *
William C. O'Neil, Jr. (11)........................ 18,000 *
J. Bransford Wallace (12).......................... 10,333 *
All directors and executive officers
as a group (6 persons)(13)......................... 521,961 9.0%
</TABLE>
- - -----------------------
* less than 1%
3
<PAGE>
(1) Unless otherwise indicated, the persons or entities identified in this
table have sole voting and investment power with respect to all shares
shown as beneficially owned by them, subject to community property
laws, where applicable.
(2) The percentages shown are based on 5,376,946 shares of Common Stock
outstanding plus, as to each individual and group listed, the number of
shares of Common Stock deemed to be owned by such holder pursuant to
Rule 13d-3 under the Exchange Act, assuming exercise of options held by
such holder that are exercisable within 60 days of the date hereof.
(3) Information provided pursuant to a Schedule 13G/A filed by Heartland
Advisors, Inc. on or about January 23, 1998, which schedule indicates
beneficial ownership of 814,800 shares of Common Stock. The schedule
further indicates sole voting power on 812,600 shares and sole
dispositive power on all such shares.
(4) Information provided pursuant to a Schedule 13G/A filed by Goldman
Sachs & Co. and Goldman Sachs Group, L.P. on or about February 14,
1998, which schedule indicates beneficial ownership of 814,000 shares
of Common Stock. The schedule further indicates shared voting power on
650,700 shares and shared dispositive power on all such shares.
(5) Information provided pursuant to a Schedule 13G/A filed by Neuberger &
Berman, LLC on or about February 19, 1998, which schedule indicates
beneficial ownership of 454,223 shares of Common Stock. The schedule
further indicates sole voting power on 292,159 shares and shared
dispositive powers on all such shares.
(6) Information provided pursuant to a Schedule 13G/A filed by Merrill
Lynch & Co., Inc. on behalf of it and various of its subsidiaries on or
about January 13, 1998, which schedule indicates beneficial ownership
of 360,000 shares of Common Stock over all of which Merrill Lynch &
Co., Inc. has shared voting and dispositive powers. Merrill Lynch &
Co., Inc. and its various subsidiaries disclaim beneficial ownership.
(7) Information provided pursuant to a Schedule 13G filed by FMR Corp. on
or about February 10, 1998, which schedule indicates beneficial
ownership of 281,200 shares of Common Stock. The schedule further
indicates sole dispositive power on all such shares.
(8) Includes 85,000 and 50,000 shares purchasable upon exercise of options
at exercise prices of $9.50 and $9.75 per share, respectively, issued
under the Key Personnel Plan and 15,000, 1,000, 1,000, 667 and 333
shares purchasable upon exercise of options at exercise prices of
$9.50, $13.125, $11.125, $7.125 and $8.38125 per share, respectively
issued under the 1994 Nonqualified Stock Option Plan for Directors (the
"Director Plan").
(9) Includes 85,000 and 30,000 shares purchasable upon exercise of options
at exercise prices of $9.50 and $9.75 per share, respectively, issued
under the Key Personnel Plan and 15,000, 1,000, 1,000, 667 and 333
shares purchasable upon exercise of options at exercise prices of
$9.50, $13.125, $11.125, $7.125 and $8.38125 per share, respectively,
issued under the Director Plan.
(10) Includes 65,000 and 20,000 shares purchasable upon exercise of options
at exercise prices of $9.50 and $9.75 per share, respectively, issued
under the Key Personnel Plan and 15,000, 1,000, 1,000, 667 and 333
shares purchasable upon exercise of options at exercise prices of
$9.50, $13.125, $11.125, $7.125 and $8.38125 per share, respectively,
issued under the Director Plan.
(11) Includes 15,000, 1,000, 1,000, 667 and 333 shares purchasable upon
exercise of options at exercise prices of $9.50, $13.125, $11.125,
$7.125 and $8.38125 per share, respectively, issued under the Director
Plan.
(12) Includes 10,000 and 333 shares purchasable upon exercise of options at
an exercise price of $9.25 and $8.38125 per share issued under the
Director Plan. Mr. Wallace was elected to fill a vacancy on the Board
of Directors on February 24, 1997.
(13) Includes 301,666 and 90,000 shares purchasable upon exercise of options
issued under the Key Personnel Plan and the Director Plan,
respectively.
4
<PAGE>
EXECUTIVE OFFICERS
The following table sets forth, as of December 31, 1997, the Company's executive
officers:
<TABLE>
<CAPTION>
Name of Officer Age Officer Since Position with the Company
- - --------------- --- ------------- ------------------------
<S> <C> <C> <C>
Dr. Charles W. Birkett 61 Inception Chairman of the Board of Directors, Chief
Executive Officer, President and Chief
Operating Officer of the Company.
Paul Richardson 49 Inception Executive Vice President and a member of
the Board of Directors of the Company;
President and Chief Executive Officer of
the Company's Canadian operating
subsidiary.
Mary Margaret Hamlett 47 Inception Executive Vice President, Chief Financial
Officer, Secretary and a member of the
Board of Directors of the Company.
</TABLE>
Effective March 1, 1997, Mr. Richardson resigned as President and Chief
Operating Officer of the Company and was replaced in those capacities by Dr.
Birkett. Mr. Richardson continues in the employ of the Company as President and
Chief Executive Officer of the Company's Canadian operating subsidiary, and he
continues serving as a member of the Board of Directors.
EXECUTIVE COMPENSATION
The following table sets forth the compensation for the services in all
capacities to the Company for the three fiscal years ended December 31, 1997, of
the individual who served as the Company's chief executive officer during the
1997 fiscal year and of the other individuals who served the Company as
executive officers as of the end of the 1997 fiscal year.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
------------------------------------------- ------------------------------------------------------
Awards Payouts
---------------------- ------------------------------
Other Securities
Annual Restricted Underlying
Name and Principal Compensation Stock Options/ LTIP All Other
Position Year (1) Salary($) Bonus($) ($)(1) Awards($) SARs(#) Payouts($) Compensation($)(2)
-------- -------- --------- -------- ------------ ---------- ---------- ---------- ------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Dr. Charles W. Birkett 1997 275,625 -- -- -- 1,000 -- 19,697
Chairman of the Board 1996 262,500 82,687 -- -- 51,000 -- 16,290
of Directors, Chief 1995 250,000 -- -- -- 1,000 -- 15,432
Executive Officer,
President and Chief
Operating Officer
Paul Richardson 1997 105,847 11,012 -- -- 1,000 -- 5,236
Executive Vice President, 1996 183,750 51,450 -- -- 31,000 -- 5,351
Director and Chief 1995 175,000 -- -- -- 1,000 -- 5,374
Executive Officer of the
Company's Canadian
operating subsidiary
Mary Margaret Hamlett 1997 165,375 -- -- -- 1,000 -- 10,312
Executive Vice President, 1996 157,500 44,100 -- -- 21,000 -- 9,790
Chief Financial Officer, 1995 150,000 -- -- -- 1,000 -- 9,194
Secretary and Director
</TABLE>
(1) Perquisites for each executive officer are in amounts that do not
require disclosure.
(2) Includes matching contributions made by the Company under its
Supplemental Executive Retirement Plan (6% of salary), or in the case
of Paul Richardson, a Canadian citizen, a contribution made to Mr.
Richardson's Registered Retirement Savings Plan. The remaining amount
for each individual represents payments for life insurance premiums.
5
<PAGE>
EMPLOYMENT AGREEMENTS
On May 14, 1994, the Company entered into employment agreements with each
Dr. Birkett, Mr. Richardson and Ms. Hamlett (individually, an "Employment
Agreement" and collectively, the "Employment Agreements"). Dr. Birkett serves as
Chief Executive Officer and, since March 1, 1997, as President and Chief
Operating Officer of the Company; Mr. Richardson, through February 28, 1997,
served as President and Chief Operating Officer of the Company and, since March
1, 1997, as Executive Vice President of the Company and as President and Chief
Executive Officer of the Company's Canadian operating subsidiary; and, Ms.
Hamlett serves as Executive Vice President, Chief Financial Officer and
Secretary of the Company. The Employment Agreements for Dr. Birkett, Mr.
Richardson and Ms. Hamlett provide for a base annual salary of $250,000,
$175,000 and $150,000, respectively, which salaries are subject to change by the
Company's Compensation Committee. The base annual salaries of Dr. Birkett, Mr.
Richardson and Ms. Hamlett were increased to $275,625, $192,938 and $165,375,
respectively, effective January 1, 1997. Mr. Richardson's base annual salary was
reduced to $93,750 concurrent with the effective date of his new
responsibilities, March 1, 1997. The initial term of the Employment Agreement
for Dr. Birkett expired on the third anniversary of the date of execution
thereof. The initial term of the Employment Agreements for each of Ms. Hamlett
and Mr. Richardson expired on the second anniversary of the date of execution
thereof. The Employment Agreements renew automatically for one-year periods
unless 30 days notice is given by either the Company or the employee.
In addition, the Employment Agreements may be terminated by the Company
without cause at any time and by the employee as a result of "constructive
discharge" (e.g., a reduction in compensation or a material change in
responsibilities) or a "change in control" (e.g., certain tender offers,
mergers, sales of substantially all of the assets or sales of a majority of the
voting securities). In the event of a termination by the Company without cause,
at the election of the employee upon a constructive discharge or change in
control, or upon the Company giving notice of its intent not to renew his
Employment Agreement, Dr. Birkett shall be entitled to receive a lump sum
severance payment in an amount equal to 30 months of his monthly base salary. In
the event of a termination by the Company without cause, at the election of the
employee upon a constructive discharge or change in control or upon the Company
giving notice of its intent not to renew their respective Employment Agreements,
Mr. Richardson and Ms. Hamlett shall be entitled to receive a lump sum severance
payment in an amount equal to 24 months of his or her monthly base salary.
Furthermore, upon such termination, each employee may elect to require the
Company to repurchase options granted to him or her under the Key Personnel Plan
for a purchase price equal to the difference between the fair market value of
the Common Stock at the date of termination and the stated option exercise
price. In the event that an Employment Agreement is terminated earlier by the
Company for cause (as defined therein), or by the employee other than upon a
constructive discharge or a change in control, the employee shall not be
entitled to any compensation following the date of such termination other than
the pro rata amount of his or her then current base salary through such date.
Upon termination of employment, other than in the case of termination by the
Company without cause or at the election of the employee upon a constructive
discharge or upon a change in control, the terminated employee is prohibited
from competing with the Company for 12 months.
Although he resigned as President and Chief Operating Officer of the
Company effective March 1, 1997, Mr. Richardson continues to be employed by the
Company as Executive Vice President and as President and Chief Executive Officer
of the Company's Canadian operating subsidiary pursuant to his Employment
Agreement. (See "Executive Officers.") Mr. Richardson and the Company have
agreed to certain changes in the calculation of the amount he would receive
should he become eligible for a severance benefit: for 1998, Mr. Richardson's
severance benefit shall be 18 months at his monthly base salary prior to his
resignation as President and Chief Operating Officer (i.e., $275,625); and, for
1999 and thereafter, 24 months at his then current base salary.
6
<PAGE>
OPTION GRANTS
The table below provides information on grants of stock options pursuant to
the Key Personnel Plan and the Director Plan during the fiscal year ended
December 31, 1997, to the named executive officers reflected in the Summary
Compensation Table. The Company grants no stock appreciation rights.
OPTIONS/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------------------------------
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL RATES
PERCENT OF TOTAL OF STOCK PRICE APPRECIATION
NUMBER OF SECURITIES OPTIONS/SARS EXERCISE OR FOR OPTION TERM (1)
UNDERLYING OPTIONS/SARS GRANTED TO EMPLOYEES BASE PRICE EXPIRATION ---------------------------
NAME GRANTED (#) IN FISCAL YEAR ($/SH) DATE 5%($) 10%($)
---------------- ----------------------- -------------------- ----------- ---------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Dr. Charles W. Birkett 1,000(2) 2.41% 8.3125 12/31/07 5,228 13,248
Paul Richardson 1,000(2) 2.41% 8.3125 12/31/07 5,228 13,248
Mary Margaret Hamlett 1,000(2) 2.41% 8.3125 12/31/07 5,228 13,248
</TABLE>
- -------------------
(1) The dollar amounts under these columns result from calculations
assuming the indicated growth rates in accordance with Securities and
Exchange Commission regulations and are not intended to forecast the
actual appreciation of the Common Stock.
(2) Granted pursuant to automatic grants to directors under the Director
Plan.
7
<PAGE>
OPTION EXERCISES AND VALUES
The table below provides information as to exercises of options under the
Key Personnel Plan and the Director Plan by the named executive officers
reflected in the Summary Compensation Table and the year-end value of
unexercised options held by such officers. The Company grants no stock
appreciation rights.
AGGREGATED OPTIONS/SAR EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
Value of Unexercised
In-the-Money Options/
Shares Number of Securities Underlying Unexercised SARs at 1997 Fiscal
Acquired Value Options/SARs at 1997 Fiscal Year-End (#) Year-End ($)(1)
on Exercise Realized ------------------------------------------- -------------------------
Name (#) ($) Exercisable/Unexercisable Exercisable/Unexercisable
-------------------------- ----------- -------- ------------------------------------------- -------------------------
<S> <C> <C> <C> <C>
Dr. Charles W. Birkett -0- -0- 136,333 / 17,667 957 / 537
Paul Richardson -0- -0- 123,000 / 11,000 957 / 537
Mary Margaret Hamlett -0- -0- 96,333 / 7,667 957 / 537
</TABLE>
(1) Options are classified as "in-the-money" if the market value of the
underlying Common Stock exceeds the exercise price of the option. The
value of such in-the-money options is the difference between the option
exercise price and $8.50, the per-share market value of the underlying
Common Stock as of December 31, 1997. Such amounts may not necessarily
be realized. Actual values that may be realized, if any, upon the
exercise of options will be based on the per-share market price of the
Common Stock at the time of exercise and are thus dependent upon future
performance of the Common Stock.
8
<PAGE>
COMPENSATION COMMITTEE REPORT
Decisions on compensation of the Company's senior executives, except for
decisions related to awards under the Company's Director Plan, are made by the
Compensation Committee of the Company's Board of Directors. Each member of the
Compensation Committee is a non-employee director. It is the responsibility of
the Compensation Committee to assure the Board that the executive compensation
programs are reasonable and appropriate, meet their stated purpose and
effectively serve the needs of the Company's stockholders and the Company.
Pursuant to rules adopted by the Securities and Exchange Commission designed to
enhance disclosure of corporate policies toward executive compensation, set
forth below is a report submitted by directors Nelson and O'Neil in their
capacity as the Compensation Committee.
Compensation Philosophy and Policies for Executive Officers
The Company believes that the executive compensation program should
align the interests of stockholders and executives. The Company's primary
objective is to provide high quality patient care while maximizing stockholder
value. The Compensation Committee seeks to forge a strong link between the
Company's strategic business goals and its compensation goals.
The Company's executive compensation program is consistent with the
Company's overall philosophy for all management levels. The Company believes
that the more employees are aligned with the Company's strategic objectives, as
stated below, the greater the Company's success on both a short-term and
long-term basis.
The Company's executive compensation program has been designed to
support the overall Company strategy and objective of creating stockholder value
by:
- Emphasizing pay for performance by having a significant
portion of executive compensation "at risk."
- Directly aligning the interest of executives with the
long-term interest of stockholders by awarding stock options
at current market prices, which have value to the executives
only through stock appreciation over the long run.
- Providing compensation opportunities that attract and retain
talented and committed executives on a long-term basis.
- Appropriately balancing the Company's short-term and long-term
business, financial and strategic goals.
The Company's strategic goals are:
- Profitability: To maximize financial returns to its
stockholders, in the context of providing high quality
service.
- Quality: To achieve leadership in the provision of relevant
and high quality health services.
- Growth: To expand the operations of the Company in such a
manner as not to imperil the achievement of other objectives.
- Stability: To be seen as a desirable employer and a
responsible corporate citizen.
9
<PAGE>
Currently, the Company's executive compensation program is composed of
three components: base salary, annual cash incentive (i.e., bonus) and long-term
incentive opportunity through nonqualified stock options. When the Company or
the individual business units meet or exceed their respective annual operating
goals, the annual executive pay targets (i.e., base salary plus incentive) are
intended to be market competitive with similar U.S. public health care companies
having similar revenues.
Base Salary
The base salaries of the Company's executives are listed in the Summary
Compensation Table in this Proxy Statement and are evaluated annually. In
evaluating appropriate pay levels and salary increases for Company executives,
the Compensation Committee considers achievement of the Company's strategic
goals, level of responsibility, individual performance, internal equity and
external pay practices. Regarding external pay practices, the Compensation
Committee seeks to confirm base salaries for all executive officers at the
market rate, as determined from information gathered by the Company from an
independent compensation consulting firm and other outside sources.
Annual Incentives
Annual incentive (bonus) awards are designed to focus management
attention on key operational goals for the current fiscal year. The key
operational goals are specific to each executive's area of responsibility.
Specific weighting is assigned for identified financial, strategic and
management practices goals. At least 80% of the available bonus percentage for
each executive is tied to Company profitability, generally defined by
achievement of the annual budget as approved by the Board of Directors.
Company executives may earn a bonus of up to 35% of their annual base
salaries based upon achievement of their specific operational goals and
achievement by the Company or business unit of its financial targets. At the end
of the year, performance against these goals is determined on an arithmetic
scale with the pre-established weighting.
In February 1997, the Compensation Committee awarded 1996 bonuses of
$82,687, $51,450 and $44,100 to Dr. Birkett, Mr. Richardson and Ms. Hamlett,
respectively. These awards represented 31.5%, 28.0% and 28.0% of the respective
1996 base annual salary of each executive.
Long-Term Incentives
The Company's long-term incentive compensation program consists of
nonqualified stock options which are related to improvement in long-term
stockholder value. Stock option grants provide an incentive that focuses the
executive's attention on managing the Company from the perspective of an owner
with an equity stake in the business. These grants also focus operating
decisions on long-term results that benefit the Company and long-term
stockholders.
The option grants to executive officers offer the right to purchase
shares of Common Stock at their fair market value on the date of the grant.
These options will have value only if the Company's stock price increases. The
number of shares covered by each grant is intended to reflect the executive's
level of responsibility and past and anticipated contributions to the Company.
In 1997, the Compensation Committee did not award any grants under the
Key Personnel Plan to Dr. Birkett, Mr. Richardson or Ms. Hamlett.
10
<PAGE>
Chief Executive Officer Compensation
Securities and Exchange Commission regulations require corporate
compensation committees to disclose the bases for the compensation of a
corporation's chief executive officer relative to such corporation's
performance.
Dr. Birkett, the Company's Chief Executive Officer, is eligible to
participate in the same executive compensation plans that are available to the
other senior executive officers, which plans are described above. The
Compensation Committee's general approach in setting Dr. Birkett's annual
compensation is derived from the same considerations described above: to be
competitive with the compensation plans of other U.S. public health care
corporations of similar size while having a large percentage of his annual
incentive compensation based upon specific, corporate-wide operating performance
criteria.
Tax Regulation as to Limited Deductibility of Compensation
Section 162(m) of the Internal Revenue Code of 1986, as amended,
generally disallows a tax deduction to public companies for executive
compensation in excess of $1 million. It is not anticipated that the Company
will pay any of its executive officers compensation in excess of $1 million in
1998 and, accordingly, to date the Company has not adopted a policy in this
regard.
THE FOREGOING REPORT IS SUBMITTED BY ALL OF THE MEMBERS OF THE
COMPENSATION COMMITTEE OF THE COMPANY'S BOARD OF DIRECTORS, WHOSE MEMBERS ARE AS
FOLLOWS: EDWARD G. NELSON AND WILLIAM C. O'NEIL, JR.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based solely on the Company's review of the copies of Forms 3, 4 and 5
furnished to it and any amendments thereto, or written representations from
certain reporting persons that no Form 5's were required for such persons, the
Company believes that, during the 1997 fiscal year, its executive officers,
directors and greater than 10% stockholders complied with all applicable Section
16(a) filing requirements.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATIONS
The Company's Compensation Committee consists of directors Nelson and
O'Neil. Former director Morris A. Perlis, an affiliate of Counsel Corporation
(together with various of its subsidiaries, "Counsel"), served on the
Compensation Committee through May 1995. Former directors Silber and Sonshine
are officers and directors of Counsel and certain of its subsidiaries. Mr.
Silber and Mr. Sonshine resigned as Directors of the Company on November 26,
1996, at which time the size of the Board of Directors was reduced from eight to
six members.
COUNSEL CORPORATION RELATIONSHIP
Advocat was organized in 1994 with the transfer of the long-term care
business of Counsel and Diversicare Inc. ("Diversicare") to the Company. In an
initial public offering on May 10, 1994 (the "Offering"), 100% of the Company's
Common Stock was sold to the public. Following the Offering, neither Counsel nor
Diversicare retained any ownership interest in the Company. Various agreements
among the parties (the "Transfer Agreements") governed the Offering and the
transfer of certain assets of Counsel and Diversicare to the Company. The
Transfer Agreements and certain subsequent agreements and amendments continue to
govern various other matters between the Company and Counsel.
11
<PAGE>
Pursuant to the Transfer Agreements, the Company received the
outstanding capital stock of a Counsel subsidiary that held the general
partnership interest in a nursing home partnership managed by Advocat and
leasehold interests in all of the nursing homes and retirement centers then
owned or leased by Counsel. Eleven facilities owned by Counsel are now leased by
the Company under three separate leases as follows:
<TABLE>
<CAPTION>
Approximate
Number of Initial Base Rental
Facilities Location Lease Term Payment
---------- -------- ---------- -----------
<S> <C> <C> <C>
3 Florida through August 2002 $918,000/year*
3 Texas through May 2004 $205,000/year
5 Canada through May 1999 $970,000/year
</TABLE>
- -------------
* Subject to yearly increases not to exceed 5% of the prior year's rent.
Pursuant to the Transfer Agreements, Advocat received a management
agreement covering seven Canadian facilities affiliated with Counsel. The
management agreement is for a term of 10 years through April 2004, with base
management fees equal to approximately $700,000 per year (at the December 31,
1997 exchange rate) and an additional incentive management fee equal to 11.8% of
net operating income as defined. Management fees generated under this contract
in 1997 were approximately $1.3 million.
Pursuant to the Transfer Agreements, the Company received the leases and
all leasehold rights and obligations thereunder previously held by Counsel with
respect to 19 nursing homes and two assisted living facilities leased from Omega
Healthcare Investors, Inc. ("Omega") under a master lease. In connection
therewith, Advocat provided a replacement security deposit letter of credit in
the amount of $3.8 million in favor of Omega, assumed all future obligations
with respect to the master lease and agreed to indemnify Counsel and its
affiliates with respect to any obligations related to the master lease. The
Company also leases from Counsel three Florida facilities encumbered by a
participating mortgage in favor of Omega.
The Company owns all of the outstanding stock of Diversicare General
Partner, Inc. ("DGPI"), the corporate General partner of Texas Diversicare
Limited Partnership, a Texas limited partnership ("TDLP"), which owns six
nursing homes. At the time of the Offering, Counsel and various affiliates owned
approximately 31% of the limited partnership interests of TDLP. The Company also
received a mortgage on the TDLP properties of approximately $7.3 million, which
mortgage calls for monthly principal and interest payments of $73,500. The
mortgage balance at December 31, 1997 was $6,981,000.
The Company has provided a cash flow guarantee to TDLP in a Partnership
Services Agreement dated November 2, 1990 (the "TDLP Services Agreement"),
obligating the Company to provide monthly, interest-free loans to TDLP (the
"Cash Flow Loans") to the extent that 99% of Distributable Cash (as defined in
the TDLP Services Agreement) is less than the Guaranteed Monthly Return (as
defined in the TDLP Services Agreement). Any Cash Flow Loans made to TDLP will
be repaid to the extent that 99% of Distributable Cash exceeds the Guaranteed
Monthly Return. The obligation of the Company to TDLP under the cash flow
guarantee terminates on August 31, 2001 and any remaining amounts outstanding
under the Cash Flow Loans will be forgiven on that date. As of December 31,
1997, the outstanding amount of Cash Flow Loans was $3,242,000. Over the life of
TDLP through December 31, 1997, the Company and its predecessors have earned
management fees in the amount of approximately $3.1 million and have recognized
principal amounts under the mortgage in the amount of $519,000. These amounts
have been recorded as paid, and there have been corresponding increases to the
recorded advances to TDLP as a result. The Company considers such amounts
reversible to the extent they have been funded with advances to TDLP.
12
<PAGE>
Under TDLP's Amended and Restated Partnership Agreement dated August 30,
1991 (the "TDLP Partnership Agreement"), the limited partners of TDLP have the
right to cause DGPI to repurchase up to 10% of their partnership units annually
for five years (up to a maximum of 50% of the total partnership units
outstanding) beginning in January 1997 (the "Put Option"). The 10% maximum per
year is not cumulative. The purchase price for the partnership units is based on
the "Adjusted Net Unit Price" (as defined in the TDLP Partnership Agreement)
plus DGPI's assumption of a pro rata portion of the Cash Flow Loans and the
mortgage receivable. Units purchased by DGPI under the Put Option do not have
voting rights with respect to any matters coming before TDLP's limited partners.
Pursuant to its repurchase obligation under the Put Option, the Company
purchased 10% of the TDLP's partnershp units in both January 1998 and January
1997 for approximately $625,000 and $650,000 in cash, respectively, plus
assumption of pro rata portions of the Cash Flow Loans of $320,000 and $270,000,
respectively, and the mortgage receivable of approximately $700,000 and
$710,000, respectively. Because the total partnership units put to the Company
at each date were in excess of the 10% annual maximum, a pro rata reduction was
applied to the amount of units redeemed from each holder in accordance with the
terms of the Put Option. It is likely that the Company will be required to
repurchase additional partnership units annually over the next three years (and
assume additional amounts under the Cash Flow Loans and mortgage receivable) and
to made additional Cash Flow Loans.
Diversicare Canada Management Services Co., Inc., an indirect
wholly-owned subsidiary of the Company ("DCMS"), manages two facilities owned by
Diversicare VI, an affiliate of Diversicare, pursuant to a Management and
Guaranteed Return Loan Agreement dated as of November 30, 1985, as amended (the
"Guaranteed Return Loan Agreement"), which expires on December 31, 2005. In
connection with the Guaranteed Return Loan Agreement, DCMS loaned Diversicare VI
approximately $800,000 to repay indebtedness to Counsel and, additionally,
$750,000 to make expansions and improvements upon the two managed facilities.
These loans are secured by second, third and fourth mortgage security interests
in the assets of Diversicare VI. Each loan bears interest at 8% and is being
repaid over the life of the Guaranteed Return Loan Agreement. The balance due
from Diversicare VI with respect to these loans totaled approximately $1.4
million at December 31, 1997.
In addition, DCMS has guaranteed certain cash flow deficiencies and
quarterly return obligations of Diversicare VI through a guarantee period, which
expires on December 31, 2005 (the "Guaranteed Period"). Pursuant to its
guarantees, DCMS is obligated to make interest-free loans to Diversicare VI (the
"Cash Flow Deficiency Loans" and the "Guaranteed Return Loans") recoverable
during the Guaranteed Period. Any amounts outstanding under the Cash Flow
Deficiency Loans and the Guaranteed Return Loans remaining unpaid at the end of
the Guaranteed Period will be forgiven by DCMS. Through December 31, 1997, there
was no outstanding balance under either the Cash Flow Deficiency Loans or the
Guaranteed Return Loans. DCMS holds a security interest in certain distributable
cash in Diversicare VI to secure repayment of the Cash Flow Deficiency Loans and
Guaranteed Return Loans during the Guarantee Period.
Under the Guaranteed Return Loan Agreement, DCMS is entitled to receive
a management incentive fee through the Guarantee Period based on Diversicare
VI's distributable cash and proceeds of sales or refinancings, net of various
expenses and distributions. Pursuant to an Agreement with DCMS dated February 6,
1995, Counsel is entitled to receive 50% of DCMS's incentive management fees
payable under the Guaranteed Return Loan Agreement after payment to DCMS of
$107,000 Canadian (approximately $75,000 U.S.) per year. The Guaranteed Return
Loan Agreement generated revenues to DCMS for the year ended December 31, 1997
of approximately $517,000, including management incentive fees. During the
Guarantee Period, DCMS may not distribute to its shareholder (Diversicare
Leasing Corp., a wholly-owned subsidiary of Advocat) more than 25% of DCMS's
pre-tax profits.
Pursuant to the Transfer Agreements, the Company has been granted the
right to offset against payments owed from the Company to Counsel and Counsel
has been granted the right to offset against payments owned from Counsel to the
Company, up to $1.0 million Canadian (approximately $700,000 U.S.) per year to
the extent that either party does not receive the payment of the obligations
owned by either party to the other. The terms of the offset agreement provide
13
<PAGE>
that the party exercising offset rights will not be in default with respect to
its obligations to the other party to the extent such obligations are not paid
pursuant to the provisions of the offset. The obligations of the Company to
Counsel under the leases and management contracts between the Company and
Counsel provide that a default under one agreement constitutes a default under
each of the leases and management contracts.
In February 1996, Counsel made certain claims with respect to the leases
and management contracts to which it and the Company are a party. The Company's
Board of Directors created a special committee of Directors not affiliated with
management of the Company or Counsel to review such claims. During the year, the
special committee reviewed various documentation and met with representatives
from both the Company and Counsel. As a result of the work of the special
committee, Counsel voluntarily withdrew one of the two claims made against the
Company. In November 1996, Mr. Silber and Mr. Sonshine resigned from the Board
of Directors of the Company, and subsequently, the special committee concluded
its review of these matters. In February 1997, the remaining claim by Counsel
was submitted to the American Arbitration Association under the alternative
resolution dispute provisions of the original management contract.
In connection with an acquisition, effective October 1, 1997, the
Company entered into leases with or obtained subleases from the former principal
owners of Pierce Management Group with respect to 14 assisted living facilities,
an office building and a manager's home. These leases provide for annual
payments of approximately $4.0 million. Guy Pierce and A. Steve Pierce have
entered into a two-year employment agreement and a three-year consulting
agreement, respectively, with the Company.
CERTAIN TRANSACTIONS
For a discussion of the relationships between the Company and its
affiliates, directors, officers, and principal stockholders, please see "Stock
Ownership of Directors, Executive Officers and Principal Holders," "Executive
Officers," "Proposal 1: Election of Director," "Compensation Committee
Interlocks and Insider Participation" and "Counsel Corporation Relationship."
14
<PAGE>
STOCK PERFORMANCE GRAPH
The graph below compares the cumulative total return of the Company with
that of the S&P Smallcap 600 Index, a new peer group index and an old peer group
index. Cumulative return assumes $100 invested in the Company or respective
index on May 10, 1994 with dividend reinvestment through December 31, 1997. The
old peer group index is composed of four long-term care companies, including
Beverly Enterprises, Inc., Manor Care, Inc., National Healthcare, L.P., and
Paragon Health Network Inc. (the amalgamation of Living Centers of America, Inc.
and Arbor Health Care Co.). Because two of the members of the old peer group
combined in 1997, the Company deemed it appropriate to broaden the membership of
its peer group. The new peer group includes the four members of the old peer
group in addition to Health Care and Retirement Corporation, Integrated Health
Services, Inc., Mariner Health Group, Inc. and Sun Healthcare Group, Inc.
Normally, the graph would cover five years; however, information is
presented only since the Company's initial public offering date, May 10, 1994.
To date, the Company has not tied executive compensation to stock performance.
The future impact of stock performance on executive compensation, if any, will
be determined by the Compensation Committee and management.
<TABLE>
<CAPTION>
INDEX VALUES*
05/10/94 12/31/94 12/31/95 12/31/96 12/31/97
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
ADVOCAT INC. 100 138 117 76 89
S & P SMALLCAP 600 100 99 129 156 196
OLD PEER GROUP 100 106 115 132 175
NEW PEER GROUP 100 111 103 113 155
</TABLE>
* $100 INVESTED ON 05/10/94 IN STOCK OR ON 04/30/94 IN INDEX INCLUDING
REINVESTMENT OF DIVIDENDS. FISCAL YEAR ENDING DECEMBER 31. INDEX VALUES
PRODUCED BY RESEARCH DATA GROUP.
15
<PAGE>
PROPOSAL 1:
ELECTION OF DIRECTOR
All directors generally hold office for three-year terms and then until
their successors have been duly elected and qualified. The Board of Directors of
the Company is divided into three classes. The term of the Class 2 directors
will expire at the 1999 Annual Meeting of Stockholders; the term of the Class 3
directors will expire at the 2000 Annual Meeting of Stockholders; and the term
of the Class 1 director will expire at this Annual Meeting of Stockholders (and
in all cases when their respective successors are duly elected and qualified).
At each annual meeting, successors to the class of directors whose term expires
at such meeting will be elected to serve for a three-year term and until their
successors are duly elected and qualified.
Directors who are not officers, employees or consultants of the Company
(currently directors Nelson, O'Neil and Wallace) receive a director's fee of
$10,000 annually, $1,000 per board meeting attended and $500 per committee
meeting attended (except when held on the same day as board meetings). Directors
who are officers or employees of the Company or its affiliates have not been
compensated separately for services as a director.
The Board of Directors proposes that the one nominee indicated below be
elected as a Class 1 director to serve for a three-year term and until his
successor is duly elected and qualified. Mr. O'Neil is currently a Class 1
director. Should any nominee for the office of director become unable to accept
nomination or election, which is not anticipated, it is the intention of the
persons named in the proxy, unless otherwise specifically instructed in the
proxy, to vote for the election of such other person as the Board of Directors
may recommend.
16
<PAGE>
NOMINEE FOR ELECTION OF CLASS 1 DIRECTOR
<TABLE>
<CAPTION>
Director Principal Occupation
Name of Nominee Age Since Last Five Years
--------------- --- ----- ---------------
<S> <C> <C> <C>
William C. O'Neil, Jr. 63 Inception Member of the Board of Directors of the
Company; Chairman of ClinTrials Research
Inc., a contract research organization
("ClinTrials") from September 1989 to
present; President and Chief Executive Officer
of ClinTrials from September 1989 to
February 1, 1998; Director of ATRIX
Laboratories, Inc., a drug delivery company;
Director of American HealthCorp, a specialty
health care service company; Director of
Sigma Aldrich Corp., a manufacturer of
research chemicals; and Director of Central
Parking Systems, Inc., an operator of parking
facilities ("Central Parking").
</TABLE>
17
<PAGE>
CONTINUING DIRECTORS
<TABLE>
<CAPTION>
Director Principal Occupation
Name of Nominee Age Since Last Five Years
--------------- --- ----- ---------------
<S> <C> <C> <C>
CLASS 3 DIRECTORS:
Charles W. Birkett, M.D. 61 Inception Chief Executive Officer, President, Chief
Operating Officer and Chairman of the Board
of Directors of the Company; President, Chief
Executive Officer and a director of Diversicare
from September 1991 to May 1994; Director
of Counsel Corporation from 1983 to May
1994; Chairman of the Board of Directors and
Chief Executive Officer of Diversicare
Management Services Co. ("DMS") from
September 1991 to present; Chairman of the
Board of Directors and Chief Executive
Officer of Diversicare Leasing Corp ("DLC")
from May 1994 to present; and President of
Diversicare Incorporated ("DINC") from
February 1980 to May 1994.
Edward G. Nelson 66 Inception Member of the Board of Directors of the
Company; Chief Executive Officer and
President of Nelson Capital Corp., a merchant
banking firm, from January 1985 to present;
Director of Central Parking; Director of Berlitz
Interna-tional, Inc., a language services
company; Director of ClinTrials;
Trustee of Vanderbilt University.
Paul Richardson 49 Inception Executive Vice President and a Member of the
Board of Directors of the Company; President
and Chief Executive Officer of the Company's
Canadian operating subsidiary; President and
Chief Operating Officer of the Company from
May 1994 through February 1997; Executive
Vice President of Diversicare from September
1991 to May 1994; President of DMS from
November 1991 through February 1997;
President of DLC from May 1994 through
February 1997; Executive Vice President of
DINC from March 1991 to May 1994.
</TABLE>
18
<PAGE>
CONTINUING DIRECTORS
<TABLE>
<CAPTION>
Director Principal Occupation
Name of Nominee Age Since Last Five Years
--------------- --- ----- ---------------
<S> <C> <C> <C>
CLASS 2 DIRECTORS:
Mary Margaret Hamlett 47 Inception Executive Vice President, Chief Financial
Officer, and Secretary and a member of the
Board of Directors of the Company; Vice
President, Chief Financial Officer and
Accounting Officer, and Secretary of
Diversicare from September 1991 to May
1994; Vice President and Secretary of DMS
from May 1994 to present; Vice President and
Secretary of DLC from May 1994 to present;
and Vice President and Assistant Secretary of
Diversicare Corporation of America from June
1988 to May 1994.
J. Bransford Wallace 66 February 19 Member of the Board of Directors of the
Company; Chairman Emeritus of Willis
Corroon Corporation, an international provider
of insurance services, from April 1994 to
present; Chairman of Global Retail operations
and Director of Willis Corroon Group, PLC
from October 1990 to January 1994; Director
of NationsBank of Tennessee; founding
Chairman of the Quality Insurance Congress,
an organization emphasizing quality in the
insurance industry; and, Member of the Board
of ESC Strategic Funds, an investment strategy
organization.
</TABLE>
The Board of Directors currently has standing Audit, Executive and
Compensation Committees. The Board of Directors does not have a nominating
committee.
The Executive Committee presently is composed of three directors:
Birkett, Richardson and Nelson. The Delaware General Corporation Law and the
Company's Bylaws provide that the Board may designate such a committee from
their number to carry out the functions of the Board as permitted by law.
Between meetings of the Board, the Executive Committee may exercise all powers
of the Board. During 1997, the Executive Committee held no meetings and
unanimously adopted one written consent actions.
The Audit Committee presently is composed of two directors: Wallace and
O'Neil. Responsibilities of this committee include engagement of independent
auditors, review of audit fees, supervision of matters relating to audit
functions, and review and setting of internal policies and procedures regarding
audits, accounts and financial controls. During 1997, the Audit committee held
two meetings.
19
<PAGE>
The Compensation Committee presently is composed of two directors: Nelson
and O'Neil. Responsibilities of this committee include approval of remuneration
arrangements for executive officers of the Company, administration of the
Supplemental Executive Retirement Plan, review of compensation plans relating to
executive officers and directors, including benefits under the Company's
compensation plans, and general review of the Company's employee compensation
policies. During 1997, the Compensation Committee held one meeting and
unanimously adopted no written consent actions.
During the Company's fiscal year ended December 31, 1997, its Board of
Directors held four regular meetings and one special meeting and unanimously
adopted one written consent action. Each director named above, during the period
in which he or she served in 1997, attended meetings or executed written consent
actions with respect to at least 75% of the meetings and consent actions of the
Board of Directors and of the committees on which he or she served.
A plurality of the shares of Common Stock present or represented by proxy
at the Annual Meeting of Stockholders and entitled to be voted is required to
elect the nominee. THE BOARD OF DIRECTORS RECOMMENDS THAT ALL STOCKHOLDERS VOTE
"FOR" THE NOMINEE LISTED ABOVE.
20
<PAGE>
PROPOSAL 2:
AMENDMENT TO 1994 INCENTIVE AND NONQUALIFIED STOCK OPTION PLAN
FOR KEY PERSONNEL INCREASING SHARES AVAILABLE FOR GRANT
On March 3, 1994, the Company's Board of Directors and stockholders
approved the adoption of the 1994 Incentive and Nonqualified Stock Option Plan
for Key Personnel (the "Key Personnel Plan"), under which options to purchase
shares of the Company's Common Stock are available for grant to consultants,
advisors, directors and employees of the Company, providing an equity interest
in the Company and additional compensation based on appreciation of the value of
such stock.
During 1997, options to purchase 23,500 and 15,000 shares at exercise
prices of $9.25 and $12.125 per share, respectively, were granted under the Key
Personnel Plan to employees of the Company. Since December 31, 1997, through the
date of this proxy statement, no options were granted under the Key Personnel
Plan to employees of the Company. As of March 23, 1998, there were outstanding
under the Key Personnel Plan options to purchase 483,167 shares of Common Stock
with an aggregate market value of approximately $4,741,000 (based on the March
23, 1998 closing price of $9.8125 for the Company's Common Stock). The
outstanding options have expiration dates ranging from May 10, 2004 to October
1, 2007.
The Key Personnel Plan provides that the exercise price of an option must
not be less than the fair market value of the Common Stock on the trading day
next preceding the date of grant. Payment for shares of Common Stock to be
issued upon exercise of an option may be made either in cash, Common Stock or
any combination thereof, at the discretion of the option holder.
The maximum term of any option granted pursuant to the Key Personnel Plan
is 10 years. Options are non-transferable, other than by will, the laws of
descent and distribution or pursuant to certain domestic relations orders.
Shares subject to options granted under the Key Personnel Plan that expire,
terminate or are canceled without having been exercised in full become available
again for option grants.
The Key Personnel Plan is administered by the Board of Directors. The
Compensation Committee of the Board currently administers the plan. Subject to
certain limitations, the Board and its committee have the authority to determine
the recipients, as well as the exercise prices, exercise periods, length and
other terms of stock options granted pursuant to the Key Personnel Plan. In
making such determinations, the Board may take into account the nature of the
services rendered or to be rendered by option recipients, and their past,
present or potential contributions to the Company.
The number of shares of Common Stock that may be granted under the Key
Personnel Plan or under any outstanding options granted thereunder will be
proportionately adjusted, to the nearest whole share, in the event of any stock
dividend, stock split, share combination or similar recapitalization involving
the Common Stock or any spin-off, spin-out or other significant distribution of
the Company's assets to its stockholders for which the Company receives no
consideration.
Generally, no option may be exercised until the holder has been employed
by the Company or one of its subsidiaries continuously for at least three months
from the date of grant. In the event the option holder is terminated as an
employee by reason of disability or death, the holder or his or her
representative may exercise the option for a period of 12 months following such
termination unless the Board of Directors elects, in its sole discretion, to
extend the exercise period. If the employment of an option holder is terminated
for "cause," as defined in the Key Personnel
21
<PAGE>
Plan, the unexercised options expire. In the event the option holder is
terminated as an employee for any reason other than disability, death or cause,
the holder may exercise his or her option for a period of three months following
termination, unless extended by agreement of the Company.
In the event of a dissolution or sale of all or substantially all of the
assets of the Company, or a merger or consolidation in which the Company is not
the surviving corporation, each outstanding option will terminate, unless there
is an express assumption of the option by the surviving corporation. However, as
to any option which is to so terminate, each holder will have the right,
immediately prior to the dissolution, sale, merger or consolidation, to exercise
his or her options, in whole or in part.
Either nonqualified or incentive stock options may be granted under the
Key Personnel Plan. No federal income tax consequences occur to either the
Company or the optionee upon the Company's grant or issuance of a nonqualified
stock option. Upon an optionee's exercise of a nonqualified stock option, the
optionee will recognize ordinary income in an amount equal to the difference
between the fair market value of the Common Stock purchased pursuant to the
exercise of the option and the exercise price of the option. However, if the
Common Stock purchased upon exercise of the option is not transferable or is
subject to a substantial risk of forfeiture, then the optionee will not
recognize income until the stock becomes transferable or is no longer subject to
such a risk of forfeiture (unless the optionee makes an election under Internal
Revenue Code Section 83(b) to recognize the income in the year of exercise,
which election must be made within 30 days of the option exercise). The Company
will be entitled to a deduction in an amount equal to the ordinary income
recognized by the optionee in the year in which such income is recognized by the
optionee. Upon a subsequent disposition of the shares of Common Stock, the
optionee will recognize a capital gain to the extent the sales proceeds exceed
the optionee's cost of the shares plus the previously recognized ordinary
income.
Incentive stock options granted under the Key Personnel Plan are intended
to qualify for favorable tax treatment under Internal Revenue Code Section 422.
No individual may be granted incentive stock options under the Key Personnel
Plan exercisable for the first time during any calendar year and having an
aggregate fair market value in excess of $100,000. If the recipient of an
incentive stock option disposes of the underlying shares before the end of
certain holding periods (essentially the later of one year after the exercise
date or two years after the grant date), he or she will generally recognize
ordinary income in the year of disposition in an amount equal to the difference
between his or her purchase price and the fair market value of the Common Stock
on the exercise date. If a disposition does not occur until after the expiration
of the holding periods, the recipient will generally recognize a capital gain
equal to the excess of the disposition price over the price paid by the
recipient on the exercise date. The Company generally will not be entitled to
deduction if a participant disposes of stock received upon exercise of an
incentive stock option under the Key Personnel Plan prior to the expiration of
the holding periods.
As originally adopted, the Key Personnel Plan allowed for the purchase of
up to 460,000 shares of Common Stock; the Key Personnel Plan was amended in 1997
to allow for the purchase price of up to 810,000 shares of common stock. As of
March 23, 1998, 55,666 options have been exercised and options to purchase
483,167 shares of Common Stock remain outstanding. The Board of Directors
unanimously adopted a proposed amendment to the Company's Key Personnel Plan to
increase the number of shares of Common Stock reserved for issuance from 810,000
to 1,060,000 shares. The purpose of the amendment is to allow for grants of
options under the Key Personnel Plan to acquire additional shares. A copy of the
proposed amendment is attached hereto as Exhibit A.
The total number of shares issued and subject to issuance upon the
exercise of stock options granted pursuant to the Key Personnel Plan is less
than the current maximum number of shares available under the Key Personnel
Plan. No option grants are subject to stockholder approval of the proposed
amendment. Therefore, the benefits or amounts that will be received by the
Company's Directors, executive officers and other employees as a result of the
proposed amendment are not determinable.
22
<PAGE>
Through March 23, 1998, the following vested and unvested options have
been granted and are outstanding under the Key Personnel Plan: 135,000 to Dr.
Birkett; 115,000 to Mr. Richardson; 85,000 to Ms. Hamlett; or, 335,000 to all
current named executive officers as a group (including Mr. Richardson). In
addition, 149,167 options have been granted and are outstanding with respect to
all other employees, including officers who are not named executive officers, as
a group.
A majority of the shares of Common Stock present or represented by proxy
at the Annual Meeting of Stockholders and entitled to be voted is required to
amend the Key Personnel Plan. THE BOARD OF DIRECTORS HAS APPROVED THE AMENDMENT
TO THE KEY PERSONNEL PLAN AND RECOMMENDS THAT ALL STOCKHOLDERS VOTE IN FAVOR OF
THE AMENDMENT.
INDEPENDENT PUBLIC ACCOUNTANTS
The accounting firm of [INTENTIONALLY OMITTED] was appointed by the Board
of Directors to serve as the Company's Independent Public Accountants for the
fiscal year ended December 31, 1997. It is expected that [INTENTIONALLY OMITTED]
will be appointed to serve as the Company's auditor for the current fiscal year.
A representative of that firm will be present at the meeting with the
opportunity to make a statement if he so desires and to respond to questions.
DEADLINE FOR SUBMITTING STOCKHOLDERS PROPOSALS
Any proposal by a stockholder for consideration at the 1999 Annual
Meeting of Stockholders must be received by the Company's principal offices at
277 Mallory Station Road, Suite 130, Franklin, Tennessee 37067 no later than
November 29, 1998, if any such proposal is to be eligible for inclusion in the
Company's proxy materials for its 1999 annual meeting.
AVAILABILITY OF 10-K
Upon the written request of any record holder or beneficial owner of the
Common Stock entitled to vote at the annual meeting, the Company will provide
without charge, a copy of its Annual Report on Form 10-K for the year ending
December 31, 1997, including financial statements and financial statement
schedules, as filed with the Securities and Exchange Commission. The request
should be mailed to: Secretary, Advocat Inc., 277 Mallory Station Road, Suite
130, Franklin, Tennessee 37067. A request via facsimile may be submitted to
(615) 771-7409.
OTHER MATTERS
The management of the Company is not aware of any other matters to be
brought before the Annual Meeting of Stockholders. If other matters are duly
presented for action, it is the intention of the persons named in the enclosed
proxy to vote on such matters in accordance with their judgment.
EACH STOCKHOLDER IS URGED TO EXECUTE AND RETURN THE ENCLOSED PROXY
PROMPTLY. IN THE EVENT A STOCKHOLDER DECIDES TO ATTEND THE MEETING, HE MAY, IF
HE WISHES, REVOKE HIS PROXY AND VOTE HIS SHARES IN PERSON. IN ADDITION, A
STOCKHOLDER MAY REVOKE HIS PROXY AT ANY TIME BEFORE SUCH PROXY IS VOTED.
23
<PAGE>
EXHIBIT A
AMENDMENT NO. 3 TO
ADVOCAT INC.
1994 INCENTIVE AND NONQUALIFIED STOCK OPTION PLAN
FOR KEY PERSONNEL
Amendment No. 3 to Advocat Inc. (the "Corporation") 1994 Incentive and
Nonqualified Stock Option Plan for Key Personnel reflecting the increase of the
maximum number of shares reserved for issuance under the plan as approved by the
Stockholders of the Corporation by Stockholder vote at the Annual Meeting of
Stockholders held May 15, 1998. Capitalized terms used in the Amendment No. 3,
if not otherwise defined herein, shall have the respective meanings attributed
to such terms in the Plan.
The 1994 Incentive and Nonqualified Stock Option Plan for Key Personnel
is hereby amended by striking Paragraph 3 in its entirety and inserting the
following in lieu thereof:
3. Stock Subject to the Plan. There will be reserved for issuance upon
the exercise of Options 1,060,000 shares of Common Stock, which will be
authorized and unissued Common Stock. If an Option expires or terminates for any
reason without being exercised in full, the shares subject thereto which have
not been purchased will again be available for purposes of the Plan. The number
of shares as to which Options may be granted under the Plan will be
proportionately adjusted, to the nearest whole share, in the event of any stock
dividend, stock split, reorganization, merger, consolidation, share combination
or similar recapitalization involving the Common Stock or any spin-off, spin-out
or other significant distribution of assets of stockholders for which the
Corporation receives no consideration. In the event that there is an
insufficient number of authorized shares of Common Stock available to allow
exercise of the Options on the date of any grant hereunder, such Options will
not be exercisable until there are sufficient shares of Common Stock authorized
for issuance.
24
<PAGE>
Appendix A
PROXY ADVOCAT INC. PROXY
ANNUAL MEETING OF STOCKHOLDERS, MAY 15, 1998
THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS
The undersigned hereby appoints Dr. Charles W. Birkett and Ms. Mary Margaret
Hamlett, or either of them, as proxies, with power of substitution, to vote all
shares of the undersigned at the Annual Meeting of Stockholders of Advocat Inc.,
to be held on May 15, 1998, at 9:00 a.m. Central Daylight Time, at 1800 First
American Center, 315 Deaderick Street, Nashville, Tennessee, and at any
adjournments or postponements thereof, in accordance with the following
instructions:
(1) Election of Class 1 director -- William C. O'Neil
[ ] FOR the nominee listed [ ] WITHHOLD AUTHORITY to vote for the nominee
(2) To approve an amendment to the Company's 1994 Incentive and Nonqualified
Stock Option Plan for Key Personnel to increase the number of shares of
Common Stock reserved for issuance from 810,000 to 1,060,000.
(3) In their discretion, or such other matters as may properly come before the
meeting.
[ ] FOR DISCRETION [ ] AGAINST DISCRETION [ ] ABSTAIN
(Continued on reverse side)
THE SHARES REPRESENTED HEREBY WILL BE VOTED AS SPECIFIED. IF NO
SPECIFICATION IS MADE, THE SHARES WILL BE VOTED FOR THE NOMINEES IN THE ELECTION
OF DIRECTORS AND IN THE DISCRETION OF THE PROXIES ON SUCH OTHER MATTERS AS MAY
PROPERLY COME BEFORE THE MEETING.
PLEASE SIGN AND DATE BELOW AND RETURN PROMPTLY.
Dated: , 1998
-------------------------
--------------------------------
Dated: , 1998
-------------------------
--------------------------------
Signature(s) of shareholder(s)
should correspond exactly with
the name(s) printed hereon.
Joint owners should each sign
personally. Executors,
administrators, trustees, etc.,
should give full title and
authority.
<PAGE>
ANNEX C
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
CHECK ONE:
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 1998
--------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSACTION PERIOD FROM _________ TO _________.
COMMISSION FILE NO.: 1-12996
-------------
ADVOCAT INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 62-1559667
- ------------------------------- -------------------------------
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
277 MALLORY STATION ROAD, SUITE 130, FRANKLIN, TN 37067
- -------------------------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(615) 771-7575
- ------------------------------------------------------------------------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NONE
- -------------------------------------------------------------------------------
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT.)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
----- -----
5,376,946
- -------------------------------------------------------------------------------
(OUTSTANDING SHARES OF THE ISSUER'S COMMON STOCK AS OF MAY 13, 1998)
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
ADVOCAT INC.
INTERIM CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS AND UNAUDITED)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 3,375 $ 2,673
Receivables, less allowance for doubtful
accounts of $2,266 and $2,702,
respectively 25,829 26,010
Income taxes receivable 80 380
Inventories 1,110 1,097
Prepaid expenses and other assets 1,979 1,640
Deferred income taxes 1,105 830
-------- --------
Total current assets 33,478 32,630
-------- --------
PROPERTY AND EQUIPMENT, at cost 82,051 80,819
Less accumulated depreciation
and amortization (13,032) (12,149)
-------- --------
Net property and equipment 69,019 68,670
-------- --------
OTHER ASSETS:
Deferred tax benefit 5,367 5,460
Deferred financing and other costs, net 1,555 1,643
Other 8,338 6,558
-------- --------
Total other assets 15,259 13,661
-------- --------
$117,756 $114,961
======== ========
</TABLE>
-2-
<PAGE>
ADVOCAT INC.
INTERIM CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS AND UNAUDITED)
(CONTINUED)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
-------- -----------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt $ 764 $ 762
Trade accounts payable 11,020 9,365
Accrued expenses:
Payroll and employee benefits 5,309 5,576
Worker's compensation 828 978
Other 2,408 2,100
-------- --------
Total current liabilities 20,329 18,781
-------- --------
NONCURRENT LIABILITIES:
Long-term debt, less current portion 60,054 58,373
Deferred gains with respect to leases, net 3,478 3,562
Other 2,784 3,512
-------- --------
Total noncurrent liabilities 66,316 65,447
-------- --------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, authorized 1,000,000 shares,
$.10 par value, none issued and outstanding -0- -0-
Common stock, authorized 20,000,000 shares,
$.01 par value, 5,377,000 issued and outstanding at
March 31, 1998 and December 31, 1997, respectively 54 54
Paid-in capital 15,638 15,638
Retained earnings 15,419 15,041
-------- --------
Total shareholders' equity 31,111 30,733
-------- --------
$117,756 $114,961
======== ========
</TABLE>
The accompanying notes are an integral part of these interim consolidated
balance sheets.
-3-
<PAGE>
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS, AND UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1998 1997
------- -------
<S> <C> <C>
REVENUES:
Patient revenues $41,839 $40,314
Resident revenues 8,705 2,174
Management fees 906 918
Interest 43 36
------- -------
Net revenues 51,493 43,442
------- -------
EXPENSES:
Operating 41,252 34,074
Lease 4,754 3,871
General and administrative 2,726 2,312
Depreciation and amortization 962 661
Interest 1,245 542
------- -------
Total expenses 50,939 41,460
------- -------
INCOME BEFORE INCOME TAXES 554 1,982
PROVISION FOR INCOME TAXES 199 713
------- -------
NET INCOME $ 355 $ 1,269
======= =======
EARNINGS PER SHARE:
Basic $ .07 $ .24
======= =======
Diluted $ .07 $ .24
======= =======
WEIGHTED AVERAGE SHARES:
Basic 5,377 5,316
======= =======
Diluted 5,388 5,328
======= =======
</TABLE>
The accompanying notes are an integral part of these interim consolidated
financial statements.
-4-
<PAGE>
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS AND UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------
1998 1997
------------- --------------
<S> <C> <C>
NET INCOME $ 355 $1,269
----- ------
OTHER COMPREHENSIVE INCOME
Foreign currency translation adjustments 37 (53)
Income tax (expense) benefit (13) 19
----- ------
24 (34)
----- ------
COMPREHENSIVE INCOME $ 379 $1,235
===== ======
</TABLE>
The accompanying notes are an integral part of these interim consolidated
financial statements.
-5-
<PAGE>
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS AND UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended March 31,
---------------------------
1998 1997
---------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 355 $ 1,269
Items not involving cash:
Depreciation and amortization 962 661
Provision for doubtful accounts 446 251
Equity earnings in joint ventures (21) (6)
Amortization of deferred credits (170) (281)
Deferred income taxes (195) 2,077
Change in assets and liabilities:
Receivables, net 264 (641)
Inventories (13) (124)
Prepaid expenses and other assets (301) (182)
Trade accounts payable and accrued expenses 1,582 (1,910)
Other (4) (46)
------- -------
Net cash provided from operating activities 2,905 1,068
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (1,098) (521)
Investment in TDLP (625) (653)
Mortgage receivable, net (305) (219)
Deposits, pre-opening costs and other (350) (4)
Investment in joint ventures, net (764) 11
TDLP partnership distributions 75 50
------- -------
Net cash used in investing activities (3,067) (1,336)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from bank line of credit 1,830 -0-
Repayment of debt obligations (211) (170)
Advances (to) from TDLP, net (746) 167
Advances repaid from lessor, net -0- 339
Financing costs (9) (18)
------- -------
Net cash provided from financing activities 864 318
------- -------
</TABLE>
-6-
<PAGE>
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS AND UNAUDITED)
(CONTINUED)
<TABLE>
<CAPTION>
Three Months Ended March 31,
---------------------------
1998 1997
---------- -------------
<S> <C> <C>
INCREASE/DECREASE IN CASH AND CASH EQUIVALENTS $ 702 $ 50
CASH AND CASH EQUIVALENTS, beginning of period 2,673 1,942
------ ------
CASH AND CASH EQUIVALENTS, end of period $3,375 $1,992
====== ======
SUPPLEMENTAL INFORMATION:
Cash payments of interest $1,365 $ 551
====== ======
Cash payments of income taxes $ 278 $ 889
====== ======
</TABLE>
Advocat received net benefit plan deposits and earnings and recorded benefit
plan liabilities of $37,000 and $45,000 in the three month periods ended March
31, 1998 and 1997, respectively.
The accompanying notes are an integral part of these interim consolidated
financial statements.
-7-
<PAGE>
ADVOCAT INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998 AND 1997
1. BUSINESS
Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company") is a
leading provider of long-term care services to the elderly. The Company operates
nursing homes and assisted living facilities in 11 states and in two Canadian
provinces.
As of March 31, 1998, the Company operates 115 facilities consisting of 64
nursing homes with 7,221 licensed beds and 51 assisted living facilities with
4,880 units. The Company owns seven nursing homes, leases 37 others and manages
20 nursing homes. The Company owns 18 assisted living facilities, leases 22
others and manages 11 assisted living facilities. The Company operates 52
nursing homes and 33 assisted living facilities in the United States and 12
nursing homes and 18 assisted living facilities in Canada. The Company's
facilities provide a range of health care services to their patients and
residents. In addition to the nursing and social services usually provided in
the long-term care facilities, the Company offers a variety of comprehensive
rehabilitative, nutritional, respiratory and other specialized ancillary
services. The Company operates facilities in Alabama, Arkansas, Florida,
Georgia, Kentucky, North Carolina, Ohio, South Carolina, Tennessee, Texas, West
Virginia and the Canadian provinces of Ontario and British Columbia.
2. BASIS OF FINANCIAL STATEMENTS
The interim financial statements for the three month periods ended March 31,
1998 and 1997, included herein have been prepared by the Company, without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations. In the
opinion of management of the Company, the accompanying interim combined
financial statements reflect all adjustments (consisting of only normally
recurring accruals) necessary to present fairly the financial position at March
31, 1998 and the results of operations and the cash flows for the three month
periods ended March 31, 1998 and 1997.
The results of operations for the three month periods ended March 31, 1998 and
1997 are not necessarily indicative of the operating results for the entire
respective years. These interim financial statements should be read in
connection with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1997.
-8-
<PAGE>
3. EARNINGS PER SHARE
Information with respect to the calculation of basic and diluted earnings per
share data follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
Net income (numerator) $ 355,000 $1,269,000
========== ==========
Basic average shares outstanding (denominator) 5,377,000 5,316,000
Employee stock purchase plan 10,000 11,000
Options 1,000 1,000
---------- ----------
Diluted average shares outstanding (denominator) 5,388,000 5,328,000
========== ==========
Basic earnings per share $ .07 $ .24
========== ==========
Diluted earnings per share $ .07 $ .24
========== ==========
</TABLE>
4. OTHER COMPREHENSIVE INCOME
The Company has adopted Statement of Financial Accounting Standards ("SFAS")
No. 130, Reporting Comprehensive Income. SFAS No. 130 requires the reporting of
comprehensive income in addition to net income from operations. Comprehensive
income is a more inclusive financial reporting methodology that includes
disclosure of certain financial information that historically has not been
recognized in the calculation of net income.
Information with respect to the accumulated comprehensive income balance is
presented below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------
1998 1997
----------- -----------
<S> <C> <C>
Foreign currency items:
Beginning balance $(196) $ (13)
Current-period change, net of income tax 24 (34)
----- -----
Ending balance $(172) $ (47)
===== =====
</TABLE>
Positive amounts represent unrealized gains and negative amounts represent
unrealized losses.
-9-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Advocat (together with its subsidiaries, "Advocat" or the "Company") provides
long-term care services to nursing home patients and residents of assisted
living facilities in 11 Southeastern states and two Canadian provinces. The
Company completed its initial public offering in May 1994; however, its
operational history can be traced to February 1980 through common senior
management who were involved in different organizational structures.
The Company's facilities provide a range of health care services to their
patients and residents. In addition to the nursing, personal care and social
services usually provided in long-term care facilities, the Company, through
arrangements with third parties, offers a variety of comprehensive
rehabilitation services as well as medical supply and nutritional support
services.
As of March 31, 1998, Advocat's portfolio includes 115 facilities composed of 64
nursing homes containing 7,221 licensed beds and 51 assisted living facilities
containing 4,880 units. In comparison, at March 31, 1997, the Company operated
87 facilities composed of 65 nursing homes containing 7,449 licensed beds and 22
assisted living facilities containing 2,516 units. As of March 31, 1998, the
Company owns seven nursing homes, leases 37 others and manages the remaining 20
nursing homes. Additionally, the Company owns 18 assisted living facilities,
leases 22 others and manages the remaining 11 assisted living facilities. In the
United States, the Company operates 52 nursing homes and 33 assisted living
facilities, and in Canada, the Company operates 12 nursing homes and 18 assisted
living facilities.
Basis of Financial Statements. The Company's patient and resident revenues
consist of the fees charged for the care of patients in the nursing homes and
residents of the assisted living facilities owned and leased by the Company.
Management fee revenues consists of the fees charged to the owners of the
facilities managed by the Company. The management fee revenues are based on the
respective contractual terms of the Company's management agreements, which
generally provide for management fees ranging from 3.5% to 6.0% of the net
revenues of the managed facilities. As a result, the level of management fees is
affected positively or negatively by the increase or decrease in the average
occupancy level rates of the managed facilities. Management fees also include
consulting and development fee income. The Company's operating expenses include
the costs, other than lease, depreciation and amortization expenses, incurred in
the nursing homes and assisted living facilities owned and leased by the
Company. The Company's general and administrative expenses consist of the costs
of the corporate office and regional support functions, including the costs
incurred in providing management services to other owners. The Company's
depreciation, amortization and interest expenses include all such expenses
across the range of the Company's operations.
-10-
<PAGE>
RESULTS OF OPERATIONS
The following tables present the unaudited interim statements of income and
related data for the three months ended March 31, 1998 and 1997.
<TABLE>
<CAPTION>
(IN THOUSANDS) THREE MONTHS ENDED MARCH 31,
-----------------------------------------------
1998 1997 CHANGE %
------- -------- ----------- ------
<S> <C> <C> <C> <C>
REVENUES:
Patient revenues $41,839 $40,314 $ 1,525 3.8
Resident revenues 8,705 2,174 6,531 300.4
Management fees 906 918 (12) (1.3)
Interest 43 36 7 18.6
------- ------- -------
Net revenues 51,493 43,442 8,051 18.5
------- ------- -------
EXPENSES:
Operating 41,252 34,074 7,178 21.1
Lease 4,754 3,871 883 22.8
General and administrative 2,726 2,312 414 17.9
Depreciation and amortization 962 661 301 45.4
Interest 1,245 542 703 129.9
------- ------- -------
Total expenses 50,939 41,460 9,479 22.9
------- ------- -------
INCOME BEFORE INCOME TAXES 554 1,982 (1,428) (72.0)
PROVISION FOR INCOME TAXES 199 713 (514) (72.0)
------- ------- -------
NET INCOME $ 355 $ 1,269 $ (914) (72.0)
======= ======= =======
</TABLE>
PERCENTAGE OF NET REVENUES
<TABLE>
<CAPTION>
Three Months Ended March 31,
---------------------------
1998 1997
------------ -----------
<S> <C> <C>
REVENUES:
Patient revenues 81.2% 92.8%
Resident revenues 16.9 5.0
Management fees 1.8 2.1
Interest 0.1 0.1
----- -----
Net revenues 100.0% 100.0%
----- -----
OPERATING EXPENSES:
Operating 80.1 78.4
Lease 9.2 8.9
General and administrative 5.3 5.3
Depreciation and amortization 1.9 1.5
Interest 2.4 1.3
----- -----
Total expenses 98.9 95.4
----- -----
INCOME BEFORE INCOME TAXES 1.1 4.6
PROVISION FOR INCOME TAXES 0.4 1.7
----- -----
NET INCOME 0.7% 2.9%
===== =====
</TABLE>
-11-
<PAGE>
THREE MONTHS ENDED MARCH 31, 1998 COMPARED WITH THREE MONTHS ENDED MARCH 31,
1997
Regulatory Issues. The Company's operating results have been profoundly affected
by regulatory issues in the State of Alabama beginning in the third quarter of
1997. During the summer of 1997, the Company received notifications from the
Alabama Department of Public Health that, as a result of certain deficiencies
noted upon periodic surveys of its two facilities in Mobile, the facilities
would be decertified from participation in the Medicare and Medicaid programs
and that licensure revocation could be pursued. The Company appealed the
proceedings, noting that none of the deficiencies were life-threatening, that
the deficiencies noted did not warrant the penalty imposed and that in the case
of one of the facilities, it was JCAHO accredited. The appeals were denied by
the State agency, and as a result, the facilities were decertified for 69 and 91
days, respectively, before resurveys found them to be in compliance. Both of the
facilities have been recertified for participation in Medicare and Medicaid
programs and the State has stayed its license revocation proceedings with
respect to the two Alabama facilities, agreeing that the Company responded
favorably toward the resolution of all issues. The Company has aggressively
pursued improved communications with the State and has reached agreement with
the State on methods of improved operations. The Company's remaining five
Alabama facilities have successfully passed their most recent annual licensure
surveys.
The Company, in response to the regulatory problems at the two Mobile
facilities, entered into a reorganization of its regional and facility
management, conducted in-depth reviews of all seven of the Company's Alabama
facilities, engaged nationally recognized consultants to assist in achieving
compliance and engaged local legal counsel familiar with the Alabama regulatory
environment. Many of the costs associated with the decertifications were
non-recurring and limited to the latter half of 1997. However, the Company's
operations have continued to be impacted in 1998 on two broad fronts: census
declines and permanent cost increases. For the three months ended March 31,
1998, the decertified facilities had recovered approximately 15 percentage
points above the occupancy lows experienced during the decertification periods,
which is approximately half-way toward a full recovery of historical levels. It
is estimated that the revenue loss associated with the census decline in the
1998 period is approximately $522,000. The Company's response to the
decertifications included permanent staffing increases affecting all Alabama
facilities amounting to an increase of approximately $586,000 in 1998 over the
1997 period. Due to the nature of the Alabama reimbursement system, the Company
will not begin to realize an improved reimbursement rate relative to its higher
cost levels until July 1, 1998. The Company expects the Alabama operations to
return to normal levels during the latter half of 1998. However, there can be no
assurance that either of the facilities will return to the census and
profitability levels experienced prior to the decertification.
As a result of the lost revenues from the census declines, the permanent cost
increases incurred in response to the survey issues and miscellaneous other
costs, the Company experienced an estimated negative impact on 1998 earnings of
approximately $900,000 after income taxes, or approximately $0.17 per share.
-12-
<PAGE>
New Facilities. Since its inception as a public company in 1994, Advocat has
sought to expand its operations through the acquisition of attractive properties
via either purchase or lease. Management has conscientiously evaluated the
acquisition opportunities that have been available to the Company in light of
criteria that were established to help insure the long-term value of the
acquisitions that have been completed.
All of the Company's acquisition activity in 1997 was consummated in the fourth
quarter. The Company acquired 17 assisted living facilities through purchase and
acquired leases with respect to an additional 15 assisted living facilities.
These acquisitions added 2,483 units to the Company. The substantial portion of
these were acquired in the Pierce Group Acquisition: 29 assisted living
facilities, all located in North Carolina, with a total of 2,302 units. In the
Pierce Group Acquisition, the Company purchased 15 facilities and leased 14
others. The Company holds the option to purchase 12 of the leased facilities for
market value beginning at the fifth anniversary. With the Pierce Group
Acquisition, the Company, which has long been involved in the provision of
assisted living services in its Canadian operations, established a foundation
from which it hopes to expand its presence in the growing assisted living market
in the United States.
The acquired facilities are hereafter referred to collectively or in part as the
"New Facilities." The contribution of the New Facilities to selected components
of operations is noted separately where such contribution is significant within
their first year of operations. With the completion of the first year of
operations following acquisition or opening, a facility becomes part of same
store operations.
Revenues. Net revenues increased to $51.5 million in 1998 from $43.4 million in
1997, an increase of $8.1 million, or 18.5%. Patient revenues increased to $41.8
million in 1998 from $40.3 million in 1997, an increase of $1.5 million, or
3.8%. Resident revenues increased to $8.7 million in 1998 from $2.2 million in
1997, an increase of $6.5 million, or 300.4%. This increase is entirely
attributable to the New Facilities. Revenue increases among facilities operated
at least one year were primarily due to inflationary increases rather than from
expanded services. These increases were offset by foregone revenues with respect
to the decertified facilities and to one facility that was closed in April 1997.
Excluding these facilities, there was a 5.3% decline in patient and resident
days (approximately 24,000 days) among facilities in operation for at least one
year. While the recent increases in reimbursement rates received by the Company
have met or exceeded expectations, the Company anticipates it is likely that
state and federal governments will continue to seek ways to retard the rate of
growth in Medicaid program rates. As a percent of patient and resident revenues,
Medicare decreased to 25.8% in 1998 from 26.1% in 1997 while Medicaid and
similar programs increased to 55.4% in 1998 from 55.1% in 1997.
Ancillary service revenues, prior to contractual allowances, increased to $16.7
million in 1998 from $13.8 million in 1997, an increase of $2.9 million or
21.2%. The Company has emphasized expansion of ancillary services since its
inception in 1994. However, the rate of growth began to decline in 1996.
Management believes that the opportunities available for the expansion of
ancillary services in its existing operations were essentially fully realized by
the beginning of 1997. The 1998 increase is primarily due to benefits realized
from the transition to a single therapy provider in a majority of its nursing
homes and from an increase in sales to third parties. Because cost limits are
expected to be placed on ancillary services as part of the transition to the
-13-
<PAGE>
Medicare prospective payment system and because of other cost limitation
provisions that have been announced or could occur, the Company anticipates that
ancillary service revenues with respect to its existing operations will begin
trending down during 1998. The ultimate effect on the Company's operations
cannot be predicted at this time because the extent and composition of the cost
limitations are not yet certain.
Operating Expense. Operating expense increased to $41.3 million in 1998 from
$34.1 million in 1997, an increase of $7.2 million, or 21.1%. Of this increase,
$4.1 million is attributable to the New Facilities. As a percent of patient and
resident revenues, operating expense increased to 81.6% in 1998 from 80.2% in
1997. This increase is attributable to increased costs relative to revenues in
the nursing home segment. These increases include the costs associated with the
Alabama decertifications, increased provision for bad debts and increased
liability insurance costs. With respect to facilities operated at least one year
and excluding the Alabama region, the operating expense percentage was 83.4%. As
a percent of resident revenues, operating expense of the New Facilities was
61.9%. All of the New Facilities are assisted living locations, which typically
have lower operating costs than do nursing homes. The largest component of
operating expense is wages, which increased to $18.5 million in 1998 from $15.5
million in 1997, an increase of $3.0 million, or 19.7%. Of this increase, $2.4
million is attributable to the New Facilities. Wages with respect to facilities
in operation for at least one year increased $635,000, or 4.1%. The Company's
wage increases are generally in line with inflation, however, the larger
increase with respect to the same facility operations is due primarily to a
20.1% increase in Alabama that arose principally from staffing responses to the
decertifications.
Lease Expense. Lease expense increased to $4.8 million in 1998 from $3.9 million
in 1997, an increase of $883,000, or 22.8%, which is primarily attributable to
the New Facilities.
General and Administrative Expense. General and administrative expense increased
to $2.7 million in 1998 from $2.3 million in 1997, an increase of $414,000, or
17.9%. The increase in excess of inflation is primarily attributable to the
expense of managing the New Facilities and structural costs associated with the
Alabama decertifications. As a percent of total net revenues, general and
administrative expense was 5.3% in both 1998 and 1997.
Depreciation and Amortization. Depreciation and amortization expenses increased
to $962,000 in 1998 from $661,000 in 1997, an increase of $301,000, or 45.4%.
This increase is primarily attributable to the New Facilities.
Interest Expense. Interest expense increased to $1.2 million in 1998 from
$542,000 in 1997, an increase of $703,000, or 129.9%. This increase is primarily
attributable to financing associated with the New Facilities.
-14-
<PAGE>
Income Before Income Taxes; Net Income; Earnings Per Share. As a result of the
above, income before income taxes was $554,000 in 1998 as compared with $2.0
million in 1997, a decrease of $1.4 million, or 72.0%. The effective combined
federal, state and provincial income tax rate was 36.0% in both 1998 and 1997.
Net income was $355,000 in 1998 as compared with $1.3 million in 1997, a
decrease of $914,000, and basic and diluted earnings per share were each $.07 as
compared with $.24.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1998 and December 31, 1997, the Company's working capital was
$13.1 million and $13.8 million, respectively, and the current ratio was 1.6 and
1.7, respectively.
Net cash provided by operating activities totaled $2.9 million and $1.1 million
in the three month periods ended March 31, 1998 and 1997, respectively. These
amounts primarily represent the cash flows from net income plus changes in
non-cash components of operations and by working capital changes.
Net cash used by investing activities totaled $3.1 million and $1.3 million
for the three month periods ended March 31, 1998 and 1997, respectively. These
amounts primarily represent purchases of property, plant and equipment,
investments in joint ventures and additional investment in TDLP, a limited
partnership for which the Company serves as the general partner. The Company has
used between $2.4 million and $3.0 million for capital expenditures in each of
the last three calendar years ending December 31, 1997. Substantially all such
expenditures were for facility improvements and equipment, which were financed
principally through working capital. For the year ended December 31, 1998, the
Company anticipates that capital expenditures for improvements and equipment for
its existing facility operations will be approximately $5.5 million, including
$2.9 million for non-routine projects. The Company has announced its
participation in several joint ventures. The Company will be a minority partner
in four assisted living facilities to be developed in Canada. In addition, the
Company will participate in an institutional pharmacy joint venture with NCS
HealthCare, Inc. For the three months ended March 31, 1998, the Company had net
expenditures of $764,000 relative to its joint venture activities. Management
anticipates additional investments of up to $1.8 million will be required under
its current joint venture commitments over the next 12 months.
Net cash provided by financing activities totaled $864,000 and $318,000 for the
three month periods ended March 31, 1998 and 1997, respectively. The net cash
provided from financing activities primarily represents net proceeds from
issuance and repayment of debt and advances to or repayments from related
parties.
The Company has begun implementation of an integrated information management
system that will provide enhanced monitoring and tracking of all its operations.
Real-time information will be available to managers at all levels with respect
to clinical care planning, reimbursement, and financial control management. The
changes are under the direction of the Company's new Vice President and Chief
Information Officer. The conversion of all of the Company's nursing homes to
this sophisticated new information platform should be completed by November
1998. Along with the implementation of the new information system, Advocat will
be centralizing the accounting function for its nursing home operations. The
Company anticipates recording a one-time pre-tax accounting charge in the second
quarter of 1998 of approximately $1.0 to $1.5 million, representing the costs
associated with the closing of certain regional offices, the reduction of
accounting personnel, the write-off of certain capitalized software development
costs and other related costs.
At March 31, 1998, the Company had total debt outstanding of $60.8 million, of
which $11.3 million was principally mortgage debt bearing interest at floating
rates ranging from 6.3% to 10.0%. The Company also had outstanding a promissory
note (the "Bridge Loan") in the amount of $34.1 million, which was used to fund
the Pierce Group Acquisition. The Company's remaining debt of $15.4 million was
drawn under the Company's lines of credit. Most of the Company's debt is at
-15-
<PAGE>
floating interest rates, generally at a spread above the London Interbank
Offered Rate ("LIBOR"). At March 31, 1998, the Company's average interest rate
on its indebtedness was 8.1%.
The Company has a working capital line of credit and an acquisition line of
credit. The working capital line of credit provides for working capital loans
and letters of credit aggregating up to the lesser of $10.0 million or the
borrowing base, as defined. The Company's obligations under the working capital
line are secured by certain accounts receivable and substantially all other
Company assets. Advances under the working capital line bear interest payable
monthly at the Company's option of either LIBOR plus 2.50% or the bank's Index
rate. The working capital line terminates and all outstanding borrowings are due
in December 1999. As of March 31, 1998, the Company had drawn $4.27 million, had
$5.65 million of letters of credit outstanding, and had $81,000 remaining
borrowing capability under the working capital line of credit. As of May 13,
1998, the draws totaled $4.35 million and the Company had no remaining borrowing
capability under the original working capital line of credit. The Company has
received a temporary increase from its lenders in the working capital line of
credit availability of $1.25 million (the "Overline"). The Overline is subject
to the same terms and conditions as the $10.0 million working capital line of
credit. The Overline terminates and all outstanding borrowings are due on June
26, 1998. In April 1998, the Company borrowed and repaid $887,000 under the
Overline. As of May 13, 1998, the balance drawn under the Overline totaled
$597,000.
The acquisition line of credit of $40.0 million, less outstanding borrowings, is
available to fund approved acquisitions through October 1999. The Company's
obligations under the acquisition line are secured by the assets acquired with
the draws under the acquisition line. Advances under the acquisition line bear
interest, payable monthly, at LIBOR plus a defined spread with respect to each
facility based upon its loan-to-value ratio and debt service coverage.
Individual advances made under the acquisition line are due three years from the
date of initial funding. As of both March 31, 1998, and May 13, 1998, the
Company has drawn $11.1 million under the acquisition line, which amount was
secured by four nursing homes, and had $28.9 million available for future
acquisitions.
The Bridge Loan is unsecured. However, the Company has agreed not to pledge or
otherwise encumber the assets acquired in the Pierce Group Acquisition or issue
other debt without the banks' approval. As of both March 31, 1998 and May 13,
1998, the outstanding balance of the Bridge Loan was $34.1 million and the
interest rate was 8.0%. The Bridge Loan bears floating interest in relation to
LIBOR and has a balloon maturity in April 1999.
Prior to funding the Bridge Loan, the Company was required to obtain a
commitment for replacement financing. The Company satisfied this requirement by
obtaining a commitment for up to $30.0 million of long-term financing under
which the Company may borrow and pledge the assets acquired in the Pierce Group
Acquisition as collateral. Loans are available at up to 80.0% of the value of
the pledged assets. Interest, which would be at LIBOR plus a defined spread,
would be determined based upon the length of term selected (3, 10, or 20 years)
and the loan-to-value ratio. This commitment is available through November 1999.
However, the Company may not draw upon this commitment so long as the Bridge
Loan remains outstanding. In addition to this commitment, the Company is
exploring other alternatives for refinancing of the Bridge Loan.
-16-
<PAGE>
The Company's lines of credit and the Bridge Loan contain various financial
covenants, the most restrictive of which relate to net worth, cash flow, debt
to equity ratio requirements, and limits on the payment of dividends to
shareholders. As of March 31, 1998, the Company was in compliance with the
covenants.
Based upon the operations of the Company, management believes that available
cash and funds generated from operations, as well as amounts available through
its banking relationships, will be sufficient for the Company to satisfy its
capital expenditures, working capital, and debt requirements for the next twelve
months. The Company intends to satisfy the capital requirements for its
acquisition activities primarily through its acquisition line of credit
complemented as appropriate by various other possible means such as borrowings
from commercial lenders, seller-financed debt, issuance of additional debt,
financing obtained from sale and leaseback transactions and internally-generated
cash from operations. On a long-term basis, management believes the Company will
be able to satisfy the principal repayment requirements on its indebtedness with
a combination of funds generated from operations and from refinancings with the
existing or new commercial lenders or by accessing capital markets.
RECEIVABLES
The Company's operations could be adversely affected if it experiences
significant delays in reimbursement of its labor and other costs from Medicare,
Medicaid and other third-party revenue sources. The Company's future liquidity
will continue to be dependent upon the relative amounts of current assets
(principally cash, accounts receivable and inventories) and current liabilities
(principally accounts payable and accrued expenses). In that regard, accounts
receivable can have a significant impact on the Company's liquidity. Continued
efforts by governmental and third-party payors to contain or reduce the
acceleration of costs by monitoring reimbursement rates, by increasing medical
review of bills for services or by negotiating reduced contract rates, as well
as any delay by the Company in the processing of its invoices, could adversely
affect the Company's liquidity and results of operations.
Gross accounts receivable attributable to the provision of patient and resident
services at March 31, 1998 and December 31, 1997, totaled $26.7 million and
$27.2 million, respectively, representing approximately 49 and 50 days in
accounts receivable, respectively. Accounts receivable from the provision of
management services was $330,000 and $716,000 respectively, at March 31, 1998
and December 31, 1997 representing approximately 34 and 62 days in accounts
receivable, respectively.
The Company continually evaluates the adequacy of its bad debt reserves based on
patient mix trends, agings of older balances, payment terms and delays with
regard to third-party payors, collateral and deposit resources, as well as other
factors. The Company continues to evaluate and implement additional procedures
to strengthen its collection efforts and reduce the incidence of uncollectible
accounts.
-17-
<PAGE>
Since 1991, the Company and its predecessor have included in their consolidated
operations the operations of the six facilities of TDLP. The Company serves as
the general partner of TDLP and has several continuing obligations to TDLP, one
of which includes cash flow support through August 2001. As of March 31, 1998,
the Company has provided advances for working capital funding and requirements
under the cash flow guarantee to TDLP totaling $4.0 million. The Company will
recognize the advances receivable from TDLP as long as the total of the
Company's recorded net assets in TDLP are less than the estimated fair value of
the Company's interests in TDLP. As of March 31, 1998, the Company's recorded
net assets and amounts available from TDLP approximate the combined value of its
interests in TDLP. As a result, the ultimate realization of future advances to
TDLP may require reserves to be recorded by the Company to offset future
increases in the advances.
HEALTH CARE INDUSTRY
The health care industry is subject to numerous laws and regulations of federal,
state and local governments. These laws and regulations include, but are not
necessarily limited to, matters such as licensure, accreditation, government
health care program participation requirements, reimbursement for patient
services, and Medicare and Medicaid fraud and abuse. Recently, government
activity has increased with respect to investigations and allegations concerning
possible violations by health care providers of fraud and abuse statutes and
regulations. Violations of these laws and regulations could result in expulsion
from government health care programs together with the imposition of significant
fines and penalties as well as significant repayments for patient services
previously billed. Management believes that the Company is in compliance with
fraud and abuse laws and regulations as well as other applicable government laws
and regulations. Compliance with such laws and regulations can be subject to
future government review and interpretation as well as regulatory actions
unknown or unasserted at this time.
During 1997, the Federal government enacted the Balanced Budget Act of 1997 (the
"BBA"), which contains numerous Medicare and Medicaid cost-saving measures. The
BBA requires that nursing homes transition to a prospective payment system under
the Medicare program during a three year "transition period," commencing with
the first cost reporting period beginning on or after July 1, 1998. The BBA also
contains certain measures that could lead to future reductions in Medicare
therapy cost reimbursement and Medicaid payment rates. Given the recent
enactment of the BBA, the Company is unable to predict the ultimate impact of
the BBA on its future operations. However, any reductions in government spending
for long-term health care could have an adverse effect on the revenues and
results of operation of the Company. The Company will attempt to maximize the
revenues available to it from governmental sources within the changes that will
occur under the BBA. In addition, the Company will attempt to increase
non-governmental revenues, including expansion of its assisted living
operations, in order to offset the loss of governmental revenues as a result of
the enactment of the BBA.
-18-
<PAGE>
FOREIGN CURRENCY TRANSLATION
The Company has obtained its financing primarily in U.S. dollars; however, it
incurs revenues and expenses in Canadian dollars with respect to Canadian
management activities and operations of the Company's owned and leased
facilities located in Canada. Therefore, if the currency exchange rate
fluctuates, the Company may experience currency translation gains and losses
with respect to the operations of these activities and the capital resources
dedicated to their support. While such currency exchange rate fluctuations have
not been material to the Company in the past, there can be no assurance that the
Company will not be adversely affected by shifts in the currency exchange rates
in the future.
INFLATION
Management does not believe that the Company's operations have been materially
affected by inflation. The Company expects salary and wage increases for its
skilled staff to continue to be higher than average salary and wage increases,
as is common in the health care industry. To date, these increases as well as
normal inflationary increases in other operating expenses have been adequately
covered by revenue increases.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 is effective for financial
statement periods beginning after December 15, 1997. It establishes standards
for the way public companies report information about operating segments in
annual financial statements. SFAS No. 131 also requires that public companies
report selected information about operating segments in interim financial
reports issued to shareholders, although application to interim periods is not
required in the first year of adoption. The Company will adopt the provision of
this statement in association with its 1998 year-end financial statements. The
Company does not expect the adoption of this standard to have a material effect
on the Company's results of operations.
IMPACT OF THE YEAR 2000
The Company is currently reengineering its accounting and information systems.
Management anticipates that the systems conversion of the United States nursing
home operations will be completed by November 30, 1998. Included in the process
of selecting hardware and software, assurances have been sought and received
from the various vendors that their products are Year 2000 compliant. The
Company continues to evaluate other areas that may be affected. To date, no
issues of a material nature have been identified, and the costs of ensuring
compliance are not expected to have a material impact on the Company's results
of operations.
-19-
<PAGE>
FORWARD-LOOKING STATEMENTS
The foregoing discussion and analysis provides information deemed by Management
to be relevant to an assessment and understanding of the Company's consolidated
results of operations and its financial condition. It should be read in
conjunction with the Company's Annual Report on Form 10-K for the year ended
December 31, 1997. Certain statements made by or on behalf of the Company,
including those contained in this "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere, are
forward-looking statements as defined in the Private Securities Litigation
Reform Act of 1995. These statements involve risks and uncertainties including,
but not limited to, changes in governmental reimbursement or regulation, health
care reforms, the ability to execute on the Company's acquisition program, both
in obtaining suitable acquisitions and financing therefor, changing economic
conditions as well as others. Actual results may differ materially from those
expressed or implied in forward-looking statements. The Company hereby makes
reference to items set forth under the heading "Risk Factors" in the Company's
Registration Statement on Form S-1, as amended (Registration No. 33-76150). Such
cautionary statements identify important factors that could cause the Company's
actual results to materially differ from those projected in forward-looking
statements. In addition, the Company disclaims any intent or obligation to
update these forward-looking statements.
PART II -- OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) The exhibits filed as part of the report on Form 10-Q are listed in
the Exhibit Index immediately following the signature page.
(b) Reports on Form 8-K: None.
-20-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADVOCAT INC.
May 15, 1998
By: /s/ Mary Margaret Hamlett
-----------------------------------------
Mary Margaret Hamlett
Principal Financial Officer and Chief
Accounting Officer and An Officer Duly
Authorized to Sign on Behalf of the
Registrant
-21-
<PAGE>
ANNEX D
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
CHECK ONE:
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 1998
-------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSACTION PERIOD FROM TO .
--------- ----------
COMMISSION FILE NO.: 1-12996
-------
ADVOCAT INC.
------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 62-1559667
- ------------------------------- ---------------------------------
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
277 MALLORY STATION ROAD, SUITE 130, FRANKLIN, TN 37067
-------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(615) 771-7575
--------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NONE
- -------------------------------------------------------------------------------
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
REPORT.)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
--- ---
5,398,710
- -------------------------------------------------------------------------------
(OUTSTANDING SHARES OF THE ISSUER'S COMMON STOCK AS OF AUGUST 12, 1998)
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
ADVOCAT INC.
INTERIM CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS AND UNAUDITED)
JUNE 30, DECEMBER 31,
1998 1997
-------- --------
CURRENT ASSETS:
Cash and cash equivalents $ 1,649 $ 2,673
Receivables, less allowance for doubtful
accounts of $2,417 and $2,702,
respectively 27,414 26,010
Income taxes receivable 280 380
Inventories 1,063 1,097
Prepaid expenses and other assets 1,863 1,640
Deferred income taxes 1,330 830
-------- --------
Total current assets 33,599 32,630
-------- --------
PROPERTY AND EQUIPMENT, at cost 83,193 80,819
Less accumulated depreciation
and amortization (13,759) (12,149)
-------- --------
Net property and equipment 69,434 68,670
-------- --------
OTHER ASSETS:
Deferred tax benefit 5,366 5,460
Deferred financing and other costs, net 1,450 1,643
Other 9,073 6,558
-------- --------
Total other assets 15,889 13,661
-------- --------
$118,922 $114,961
======== ========
(Continued)
-2-
<PAGE>
<TABLE>
<CAPTION>
ADVOCAT INC.
INTERIM CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS AND UNAUDITED)
(CONTINUED)
JUNE 30, DECEMBER 31,
1998 1997
------- -------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt $ 1,069 $ 762
Trade accounts payable 10,580 9,365
Accrued expenses:
Payroll and employee benefits 5,470 5,576
Other 4,413 3,078
-------- --------
Total current liabilities 21,532 18,781
-------- --------
NONCURRENT LIABILITIES:
Long-term debt, less current portion 60,453 58,373
Deferred gains with respect to leases, net 3,416 3,562
Other 2,850 3,512
-------- --------
Total noncurrent liabilities 66,719 65,447
-------- --------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, authorized 1,000,000 shares,
$.10 par value, none issued and outstanding -0- -0-
Common stock, authorized 20,000,000 shares,
$.01 par value, 5,377,000 issued and outstanding at
June 30, 1998 and December 31, 1997, respectively 54 54
Paid-in capital 15,638 15,638
Retained earnings 14,979 15,041
-------- --------
Total shareholders' equity 30,671 30,733
-------- --------
$118,922 $114,961
======== ========
</TABLE>
The accompanying notes are an integral part of these interim consolidated
balance sheets.
-3-
<PAGE>
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS, AND UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
1998 1997 1998 1997
------- ------- -------- -------
<S> <C> <C> <C> <C>
REVENUES:
Patient revenues $43,108 $41,150 $ 84,946 $81,464
Resident revenues 8,629 2,093 17,334 4,267
Management fees 906 957 1,812 1,875
Interest 55 37 99 74
------- ------- -------- -------
Net revenues 52,698 44,237 104,191 87,680
------- ------- -------- -------
EXPENSES:
Operating 42,131 34,859 83,383 68,932
Lease 4,809 3,744 9,563 7,615
General and administrative 2,730 2,406 5,456 4,719
Depreciation and amortization 832 671 1,794 1,333
Interest 1,254 472 2,499 1,014
Non-recurring charges 1,468 -0- 1,468 -0-
------- ------- -------- -------
Total expenses 53,224 42,152 104,163 83,613
------- ------- -------- -------
INCOME (LOSS) BEFORE INCOME TAXES (526) 2,085 28 4,067
PROVISION (BENEFIT)FOR INCOME
TAXES (189) 751 10 1,464
------- ------- -------- -------
NET INCOME (LOSS) $ (337) $ 1,334 $ 18 $ 2,603
======= ======= ======== =======
EARNINGS (LOSS) PER SHARE:
Basic $ (.06) $ .25 $ .00 $ .49
======= ======= ======== =======
Diluted $ (.06) $ .25 $ .00 $ .49
======= ======= ======== =======
WEIGHTED AVERAGE SHARES:
Basic 5,377 5,316 5,377 5,316
======= ======= ======== =======
Diluted 5,377 5,339 5,391 5,334
======= ======= ======== =======
</TABLE>
The accompanying notes to interim financial statements are an integral part of
these interim consolidated financial statements.
-4-
<PAGE>
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS AND UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------- ------------------------
1998 1997 1998 1997
----- ------ ----- -----
<S> <C> <C> <C> <C>
NET INCOME (LOSS) $(337) $1,334 $ 18 $2,603
----- ------ ----- ------
OTHER COMPREHENSIVE INCOME:
Foreign currency translation adjustments (162) 9 (125) (44)
Income tax (expense) benefit 58 (3) 45 16
----- ------ ----- ------
(104) 6 (80) (28)
----- ------ ----- ------
COMPREHENSIVE INCOME (LOSS) $(441) $1,340 $ (62) $2,575
===== ====== ===== ======
</TABLE>
The accompanying notes are an integral part of these interim consolidated
financial statements.
-5-
<PAGE>
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS AND UNAUDITED)
SIX MONTHS ENDED JUNE 30,
-------------------------
1998 1997
------- -------
CASH FLOWS (LOSS) FROM OPERATING ACTIVITIES:
Net income $ 18 $ 2,603
Adjustments to reconcile net income to net
cash provided from operating activities:
Depreciation and amortization 1,795 1,333
Provision for doubtful accounts 786 856
Equity earnings in joint ventures (42) (21)
Amortization of deferred credits (278) (532)
Deferred income taxes (360) 2,261
Non-recurring change write off 1,028 -0-
Change in assets and liabilities:
Receivables, net (2,332) (2,130)
Inventories 34 (292)
Prepaid expenses and other assets (478) (228)
Trade accounts payable and accrued expenses 2,446 (515)
Other 47 (62)
------- -------
Net cash provided from operating activities 2,664 3,273
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (2,737) (1,193)
Investment in TDLP (632) (655)
Mortgage receivable, net (305) (307)
Deposits, pre-opening and other costs (435) (40)
Investment in joint ventures, net (1,345) 20
TDLP partnership distributions 152 99
------- -------
Net cash used in investing activities (5,302) (2,076)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt obligations (411) (335)
Net proceeds from bank line of credit 2,908 -0-
Advances to TDLP, net (815) (139)
Advances repaid by lessor, net -0- 442
Financing costs (68) (94)
------- -------
Net cash provided from (used in) financing
activities $ 1,614 $ (126)
------- -------
(Continued)
-6-
<PAGE>
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS AND UNAUDITED)
(CONTINUED)
SIX MONTHS ENDED JUNE 30,
-------------------------
1998 1997
------- ------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $(1,024) $1,071
CASH AND CASH EQUIVALENTS, beginning of period 2,673 1,942
------- ------
CASH AND CASH EQUIVALENTS, end of period $ 1,649 $3,013
======= ======
SUPPLEMENTAL INFORMATION:
Cash payments of interest $ 2,362 $1,014
======= ======
Cash payments of income taxes $ 637 $ 957
======= ======
The Company received net benefit plan deposits and earnings and recorded benefit
plan liabilities of $286,000 and $9,000 in the six month periods ended June 30,
1998 and 1997, respectively.
The accompanying notes to interim financial statements are an integral part of
these interim consolidated financial statements.
-7-
<PAGE>
ADVOCAT INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1997
1. BUSINESS
Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company") is a
leading provider of long-term care services to the elderly. The Company operates
nursing homes and assisted living facilities in 11 states and in two Canadian
provinces.
As of June 30, 1998, the Company operates 116 facilities consisting of 64
nursing homes with 7,221 licensed beds and 52 assisted living facilities with
4,980 units. The Company owns seven nursing homes, leases 37 others and manages
20 nursing homes. The Company owns 18 assisted living facilities, leases 22
others and manages 12 assisted living facilities. The Company operates 52
nursing homes and 33 assisted living facilities in the United States and 12
nursing homes and 19 assisted living facilities in Canada. The Company's
facilities provide a range of health care services to their patients and
residents. In addition to the nursing and social services usually provided in
the long-term care facilities, the Company offers a variety of comprehensive
rehabilitative, nutritional, respiratory and other specialized ancillary
services. The Company operates facilities in Alabama, Arkansas, Florida,
Georgia, Kentucky, North Carolina, Ohio, South Carolina, Tennessee, Texas, West
Virginia and the Canadian provinces of Ontario and British Columbia.
2. BASIS OF FINANCIAL STATEMENTS
The interim financial statements for the three and six month periods ended June
30, 1998 and 1997, included herein have been prepared by the Company, without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management of the Company, the accompanying
interim consolidated financial statements reflect all adjustments (consisting of
only normally recurring accruals) necessary to present fairly the financial
position at June 30, 1998, the results of operations for the three and six month
periods ended June 30, 1998 and 1997, and the cash flows for the six month
periods ended June 30, 1998 and 1997.
The results of operations for the three and six month periods ended June 30,
1998 and 1997 are not necessarily indicative of the operating results for the
entire respective years. These interim financial statements should be read in
connection with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1997.
-8-
<PAGE>
3. EARNINGS PER SHARE
Information with respect to the calculation of basic and diluted earnings per
share data follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net income (loss) (numerator) $ (337,000) $1,334,000 $ 18,000 $2,603,000
========== ========== ========== ==========
Basic average shares outstanding (denominator) 5,377,000 5,316,000 5,377,000 5,316,000
Employee stock purchase plan N/A(1) 15,000 13,000 14,000
Options N/A(1) 8,000 1,000 4,000
---------- ---------- ---------- ----------
Diluted average shares outstanding (denominator) 5,377,000 5,339,000 5,391,000 5,334,000
========== ========== ========== ==========
Basic earnings (loss) per share $ (.06) $ .25 $ .00 $ .49
========== ========== ========== ==========
Diluted earnings (loss) per share $ (.06) $ .25 $ .00 $ .49
========== ========== ========== ==========
</TABLE>
(1) Not applicable since inclusion would be anti-dilutive.
4. OTHER COMPREHENSIVE INCOME
The Company has adopted Statement of Financial Accounting Standards ("SFAS") No.
130, Reporting Comprehensive Income. SFAS No. 130 requires the reporting of
comprehensive income in addition to net income from operations. Comprehensive
income is a more inclusive financial reporting methodology that includes
disclosure of certain financial information that historically has not been
recognized in the calculation of net income.
Information with respect to the accumulated other comprehensive income balance
is presented below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Foreign currency items:
Beginning balance $(172) $ (47) $(196) $ (13)
Current-period change, net of income tax (104) 6 (80) (28)
----- ----- ----- -----
Ending balance $(276) $ (41) $(276) $ (41)
===== ===== ===== =====
</TABLE>
Positive amounts represent unrealized gains and negative amounts represent
unrealized losses.
5. NON-RECURRING CHARGES
During the quarter ended June 30, 1998, the Company recorded non-recurring
charges in the amount of $1.5 million. Of this amount, $1.0 million was a
restructuring charge related to the Company's management information systems
conversion with respect to its U.S. nursing homes. Pursuant to this conversion,
the Company will be abandoning much of its existing software and will be
dismantling much of its regional infrastructure in favor of a centralized
accounting organization. This charge represents the costs associated with the
closing of certain regional offices, severance packages for affected personnel,
the write-off of capitalized software costs, and other costs related to the
systems being replaced. This restructuring charge includes a provision for
approximately $380,000 of cash outlays expected to occur as the old systems are
phased out over the remainder of 1998. In addition to the restructuring charge,
the Company also recognized costs associated with prospective financing
arrangements or acquisitions, each of which had been abandoned during the
quarter, and costs related to legal issues that were settled during the quarter.
-9-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Advocat (together with its subsidiaries, "Advocat" or the "Company") provides
long-term care services to nursing home patients and residents of assisted
living facilities in 11 Southeastern states and two Canadian provinces. The
Company completed its initial public offering in May 1994; however, its
operational history can be traced to February 1980 through common senior
management who were involved in different organizational structures.
The Company's facilities provide a range of health care services to their
patients and residents. In addition to the nursing, personal care and social
services usually provided in long-term care facilities, the Company, through
arrangements with third parties, offers a variety of comprehensive
rehabilitation services as well as medical supply and nutritional support
services.
As of June 30, 1998, Advocat's portfolio includes 116 facilities composed of 64
nursing homes containing 7,221 licensed beds and 52 assisted living facilities
containing 4,980 units. In comparison, at June 30, 1997, the Company operated 87
facilities composed of 65 nursing homes containing 7,341 licensed beds and 22
assisted living facilities containing 2,470 units. As of June 30, 1998, the
Company owns seven nursing homes, leases 37 others and manages the remaining 20
nursing homes. Additionally, the Company owns 18 assisted living facilities,
leases 22 others and manages the remaining 12 assisted living facilities. In the
United States, the Company operates 52 nursing homes and 33 assisted living
facilities, and in Canada, the Company operates 12 nursing homes and 19 assisted
living facilities.
Basis of Financial Statements. The Company's patient and resident revenues
consist of the fees charged for the care of patients in the nursing homes and
residents of the assisted living facilities owned and leased by the Company.
Management fee revenues consists of the fees charged to the owners of the
facilities managed by the Company. The management fee revenues are based on the
respective contractual terms of the Company's management agreements, which
generally provide for management fees ranging from 3.5% to 6.0% of the net
revenues of the managed facilities. As a result, the level of management fees is
affected positively or negatively by the increase or decrease in the average
occupancy level rates of the managed facilities. Management fees also include
consulting and development fee income. The Company's operating expenses include
the costs, other than lease, depreciation and amortization expenses, incurred in
the nursing homes and assisted living facilities owned and leased by the
Company. The Company's general and administrative expenses consist of the costs
of the corporate office and regional support functions, including the costs
incurred in providing management services to other owners. The Company's
depreciation, amortization and interest expenses include all such expenses
across the range of the Company's operations.
-10-
<PAGE>
RESULTS OF OPERATIONS
The following tables present the unaudited interim statements of income and
related data for the three and six month periods ended June 30, 1998 and 1997.
<TABLE>
<CAPTION>
(IN THOUSANDS) THREE MONTHS ENDED JUNE 30,
-----------------------------------------------
1998 1997 CHANGE %
-------- ------- --------- ------
<S> <C> <C> <C> <C>
REVENUES:
Patient revenues $ 43,108 $41,150 $ 1,958 4.8
Resident revenues 8,629 2,093 6,536 312.2
Management fees 906 957 (51) (5.4)
Interest 55 37 18 48.3
-------- ------- -------
Net revenues 52,698 44,237 8,461 19.1
-------- ------- -------
EXPENSES:
Operating 42,131 34,859 7,272 20.9
Lease 4,809 3,744 1,065 28.4
General and administrative 2,730 2,406 324 13.4
Depreciation and amortization 832 671 161 24.0
Interest 1,254 472 782 165.7
Non-recurring charges 1,468 -0- 1,468 N/A
-------- ------- -------
Total expenses 53,224 42,152 11,072 26.3
-------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES (526) 2,085 (2,611) (125.2)
PROVISION (BENEFIT) FOR INCOME TAXES (189) 751 (940) (125.2)
-------- ------- -------
NET INCOME (LOSS) $ (337) $ 1,334 $(1,671) (125.2)
======== ======= =======
</TABLE>
<TABLE>
<CAPTION>
(IN THOUSANDS) SIX MONTHS ENDED JUNE 30,
-----------------------------------------------
1998 1997 CHANGE %
-------- ------- -------- ------
<S> <C> <C> <C> <C>
REVENUES:
Patient revenues $ 84,946 $81,464 $ 3,482 4.3
Resident revenues 17,334 4,267 13,067 306.2
Management fees 1,812 1,875 (63) (3.4)
Interest 99 74 25 33.6
-------- ------- -------
Net revenues 104,191 87,680 16,511 18.8
-------- ------- -------
EXPENSES:
Operating 83,383 68,932 14,451 21.0
Lease 9,563 7,615 1,948 25.6
General and administrative 5,456 4,719 737 15.6
Depreciation and amortization 1,794 1,333 461 34.7
Interest 2,499 1,014 1,485 146.6
Non-recurring charges 1,468 -0- 1,468 N/A
-------- ------- -------
Total expenses 104,163 83,613 20,550 24.6
-------- ------- -------
INCOME BEFORE INCOME TAXES 28 4,067 (4,039) (99.3)
PROVISION FOR INCOME TAXES 10 1,464 (1,454) (99.3)
-------- ------- -------
NET INCOME $ 18 $ 2,603 $(2,585) (99.3)
======== ======= =======
</TABLE>
-11-
<PAGE>
PERCENTAGE OF NET REVENUES
<TABLE>
<CAPTION>
(IN THOUSANDS) THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------- ---------------------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
REVENUES:
Patient revenues 81.8 % 93.0% 81.5% 92.9%
Resident revenues 16.4 4.7 16.7 4.9
Management fees 1.7 2.2 1.7 2.1
Interest 0.1 0.1 0.1 0.1
----- ----- ----- -----
Net revenues 100.0 % 100.0% 100.0% 100.0%
----- ----- ----- -----
OPERATING EXPENSES:
Operating 79.9 78.8 80.0 78.6
Lease 9.1 8.5 9.2 8.7
General and administrative 5.2 5.4 5.3 5.4
Depreciation and amortization 1.6 1.5 1.7 1.5
Interest 2.4 1.1 2.4 1.1
Non-recurring charges 2.8 0.0 1.4 0.0
----- ----- ----- -----
Total expenses 101.0 95.3 100.0 95.3
----- ----- ----- -----
INCOME (LOSS) BEFORE INCOME TAXES (1.0) 4.7 0.0 4.7
PROVISION (BENEFIT) FOR INCOME TAXES (0.4) 1.7 0.0 1.7
----- ----- ----- -----
NET INCOME (LOSS) (0.6)% 3.0% 0.0% 3.0%
===== ===== ===== =====
</TABLE>
GENERAL
Non-Recurring Charges. During the quarter ended June 30, 1998, the Company
recorded non-recurring charges in the amount of $1.5 million. Of this amount,
$1.0 million was a restructuring charge related to the Company's management
information systems conversion with respect to its U.S. nursing homes. Pursuant
to this conversion, the Company will be abandoning much of its existing software
and will be dismantling much of its regional infrastructure in favor of a
centralized accounting organization. This charge represents the costs associated
with the closing of certain regional offices, severance packages for affected
personnel, the write-off of capitalized software costs, and other costs related
to the systems being replaced. This restructuring charge includes a provision
for approximately $380,000 of cash outlays expected to occur as the old systems
are phased out over the remainder of 1998. In addition to the restructuring
charge, the Company also recognized costs associated with prospective financing
arrangements or acquisitions, each of which had been abandoned during the
quarter, and costs related to legal issues that were settled during the quarter.
Regulatory Issues. The Company's operating results have been profoundly affected
by regulatory issues in the State of Alabama beginning in the third quarter of
1997. During the summer of 1997, the Company received notifications from the
Alabama Department of Public Health that, as a result of certain deficiencies
noted upon periodic surveys of its two facilities in Mobile, the facilities
would be decertified from participation in the Medicare and Medicaid programs
and that licensure revocation could be pursued. The Company appealed the
proceedings, noting that none of the deficiencies were life-threatening, that
the deficiencies noted did not warrant the penalty imposed and that in the case
of one of the facilities, it was JCAHO accredited. The appeals were denied by
the State agency, and as a result,
-12-
<PAGE>
the facilities were decertified in 1997 for 69 and 91 days, respectively, before
resurveys found them to be in compliance. Both of the facilities have been
recertified for participation in Medicare and Medicaid programs and the State
has stayed its license revocation proceedings with respect to the two Alabama
facilities, agreeing that the Company responded favorably toward the resolution
of all issues. The Company has aggressively pursued improved communications with
the State and has reached agreement with the State addressing its concerns. The
Company's remaining five Alabama facilities have successfully passed their most
recent annual licensure surveys.
The Company, in response to the regulatory problems at the two Mobile
facilities, entered into a reorganization of its regional and facility
management, conducted in-depth reviews of all seven of the Company's Alabama
facilities, engaged nationally recognized consultants to assist in achieving
compliance and engaged local legal counsel familiar with the Alabama regulatory
environment. Many of the costs associated with the decertifications were
non-recurring and limited to the latter half of 1997. However, the Company's
operations have continued to be impacted in 1998 on two broad fronts: census
declines and permanent cost increases. Through June 30, 1998, the decertified
facilities had recovered approximately 2/3 of the occupancy decline experienced
at the lowest point of the decertification periods. The Company's response to
the decertifications included permanent staffing increases affecting all Alabama
facilities. Due to the nature of the Alabama reimbursement system, the Company
will not begin to realize an improved Medicaid reimbursement rate relative to
its higher staffing cost levels until July 1, 1998. The Company expects the
Alabama operations to return to normal levels during the latter half of 1998.
However, there can be no assurance that either of the facilities will return to
the census and profitability levels experienced prior to the decertification.
As a result of the lost revenues from census declines, the permanent cost
increases incurred in response to the survey issues and miscellaneous other
costs, the Company experienced an estimated negative impact on earnings for the
six months ended June 30, 1998 of approximately $1.3 million after income taxes,
or approximately $0.24 per share. Of this amount, approximately $400,000 after
income taxes, or approximately $.07 per share, was attributable to the three
months ended June 30, 1998.
New Facilities. Since its inception as a public company in 1994, Advocat has
sought to expand its operations through the acquisition of attractive properties
via either purchase or lease. Management has conscientiously evaluated the
acquisition opportunities that have been available to the Company in light of
criteria that were established to help insure the long-term value of the
acquisitions that have been completed.
There have been no acquisitions in 1998, and all of the Company's acquisition
activity in 1997 was consummated in the fourth quarter. The Company acquired 17
assisted living facilities through purchase and acquired leases with respect to
an additional 15 assisted living facilities. These acquisitions added 2,483
units to the Company. The substantial portion of these were acquired in the
Pierce Group Acquisition: 29 assisted living facilities, all located in North
Carolina, with a total of 2,302 units. In the Pierce Group Acquisition, the
Company purchased 15 facilities and leased 14 others. The Company holds the
option to purchase 12 of the leased facilities for market value beginning at the
fifth anniversary. With the Pierce Group Acquisition, the Company, which has
long been involved in the provision of assisted living services in its Canadian
operations, established a foundation from which it hopes to expand its presence
in the growing assisted living market in the United States.
-13-
<PAGE>
The acquired facilities are hereafter referred to collectively or in part as the
"New Facilities." The contribution of the New Facilities to selected components
of operations is noted separately where such contribution is significant within
their first year of operations. With the completion of the first year of
operations following acquisition or opening, a facility becomes part of same
store operations.
THREE MONTHS ENDED JUNE 30, 1998 COMPARED WITH THREE MONTHS ENDED JUNE 30, 1997
Revenues. Net revenues increased to $52.7 million in 1998 from $44.2 million in
1997, an increase of $8.5 million, or 19.1%. Patient revenues increased to $43.1
million in 1998 from $41.1 million in 1997, an increase of $2.0 million, or
4.8%. Resident revenues increased to $8.6 million in 1998 from $2.1 million in
1997, an increase of $6.5 million, or 312.2%. This increase is entirely
attributable to the New Facilities. Revenue increases among nursing facilities
operated at least one year were primarily due to inflationary increases rather
than from expanded services. These increases were offset by foregone revenues
with respect to occupancy declines in the facilities that had been decertified.
Excluding these facilities, there was a 2.3% decline in patient and resident
days (approximately 10,000 days) among facilities in operation for at least one
year. While the recent increases in reimbursement rates received by the Company
have met or exceeded expectations, the Company anticipates it is likely that
state and federal governments will continue to seek ways to retard the rate of
growth in Medicaid program rates. As a percent of patient and resident revenues,
Medicare decreased to 25.8% in 1998 from 27.9% in 1997 while Medicaid and
similar programs increased to 55.1% in 1998 from 54.3% in 1997.
Ancillary service revenues, prior to contractual allowances, increased to $17.2
million in 1998 from $14.9 million in 1997, an increase of $2.3 million or
15.6%. The Company has emphasized expansion of ancillary services since its
inception in 1994. However, the rate of growth began to decline in 1996.
Management believes that the opportunities available for the expansion of
ancillary services in its existing operations were essentially fully realized by
the beginning of 1997. The 1998 increase is primarily due to benefits realized
from the transition to a single therapy provider in a majority of its nursing
homes and from an increase in sales to third parties. Because cost limits are
expected to be placed on ancillary services as part of the transition to the
Medicare prospective payment system and because of other cost limitation
provisions that have been announced or could occur, the Company anticipates that
ancillary service revenues with respect to its existing operations will begin
trending down during the latter half of 1998. The ultimate effect on the
Company's operations cannot be predicted at this time because the extent and
composition of the cost limitations are not yet certain.
Operating Expense. Operating expense increased to $42.1 million in 1998 from
$34.8 million in 1997, an increase of $7.3 million, or 20.9%. Of this increase,
$4.1 million is attributable to the New Facilities. As a percent of patient and
resident revenues, operating expense increased to 81.4% in 1998 from 80.6% in
1997. This increase is attributable to increased costs relative to revenues in
the nursing home segment. These increases include the costs associated with the
structural changes made pursuant to the Alabama decertifications and increased
liability insurance costs. With respect to facilities operated at least one year
and excluding the Alabama region, the operating expense percentage was 83.5%. As
a percent of resident revenues, operating expense of the New Facilities was
62.3%. All of the New Facilities are assisted living locations, which typically
have lower operating costs than do nursing homes. The largest component of
operating expense is wages, which increased to $18.9 million in 1998 from $15.7
million in 1997, an increase of $3.2 million, or 20.2%. Of this increase, $2.5
million is attributable to the New Facilities. Wages with respect to facilities
in operation for at least one year increased $632,000, or 4.0%. The
-14-
<PAGE>
Company's wage increases are generally in line with inflation, however, the
larger increase with respect to the same facility operations is due primarily to
a 13.2% increase in Alabama that arose principally from staffing responses to
the decertifications.
Lease Expense. Lease expense increased to $4.8 million in 1998 from $3.7 million
in 1997, an increase of $1.1 million, or 28.4%, which is primarily attributable
to the New Facilities.
General and Administrative Expense. General and administrative expense increased
to $2.7 million in 1998 from $2.4 million in 1997, an increase of $324,000, or
13.4%. The increase in excess of inflation is primarily attributable to the
expense of managing the New Facilities and structural costs added in response to
the Alabama decertifications. As a percent of total net revenues, general and
administrative expense decreased to 5.2% in 1998 from 5.4% in 1997.
Depreciation and Amortization. Depreciation and amortization expenses increased
to $832,000 in 1998 from $671,000 in 1997, an increase of $161,000, or 24.0%.
This increase is primarily attributable to the New Facilities.
Interest Expense. Interest expense increased to $1.3 million in 1998 from
$547,000 in 1997, an increase of $782,000, or 65.7%. This increase is primarily
attributable to financing associated with the New Facilities.
Income (Loss) Before Income Taxes; Net Income (Loss); Earnings (Loss) Per Share.
As a result of the above, as well as the non-recurring charges of $1.5 million,
the Company lost $(526,000) before income taxes in 1998 as compared with a
profit of $2.1 million in 1997, a decrease of $2.6 million, or (125.2)%. The
effective combined federal, state and provincial income tax rate was 36.0% in
both 1998 and 1997. The net loss was $(337,000) in 1998 as compared with net
income of $1.3 million in 1997, a decrease of $1.5 million, and basic and
diluted earnings (loss) per share were each $(.06) as compared with $.25.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1997
Revenues. Net revenues increased to $104.2 million in 1998 from $87.7 million in
1997, an increase of $16.5 million, or 18.8%. Patient revenues increased to
$84.9 million in 1998 from $81.4 million in 1997, an increase of $3.5 million,
or 4.3%. Resident revenues increased to $17.3 million in 1998 from $4.3 million
in 1997, an increase of $13.1 million, or 306.2%. This increase is entirely
attributable to the New Facilities. Revenue increases among nursing facilities
operated at least one year were primarily due to inflationary increases rather
than from expanded services. These increases were offset by foregone revenues
with respect to occupancy declines in the facilities that had been decertified
and to one facility that was closed in April 1997. Excluding these facilities,
there was a 3.4% decline in patient and resident days (approximately 29,000
days) among facilities in operation for at least one year. While the recent
increases in reimbursement rates received by the Company have met or exceeded
expectations, the Company anticipates it is likely that state and federal
governments will continue to seek ways to retard the rate of growth in Medicaid
program rates. As a percent of patient and resident revenues, Medicare decreased
to 25.8% in 1998 from 27.0% in 1997 while Medicaid and similar programs
increased to 55.3% in 1998 from 54.7% in 1997.
Ancillary service revenues, prior to contractual allowances, increased to $34.0
million in 1998 from $28.7 million in 1997, an increase of $5.3 million or
18.3%. The Company has emphasized expansion
-15-
<PAGE>
of ancillary services since its inception in 1994. However, the rate of growth
began to decline in 1996. Management believes that the opportunities available
for the expansion of ancillary services in its existing operations were
essentially fully realized by the beginning of 1997. The 1998 increase is
primarily due to benefits realized from the transition to a single therapy
provider in a majority of its nursing homes and from an increase in sales to
third parties. Because cost limits are expected to be placed on ancillary
services as part of the transition to the Medicare prospective payment system
and because of other cost limitation provisions that have been announced or
could occur, the Company anticipates that ancillary service revenues with
respect to its existing operations will begin trending down during the latter
half of 1998. The ultimate effect on the Company's operations cannot be
predicted at this time because the extent and composition of the cost
limitations are not yet certain.
Operating Expense. Operating expense increased to $83.4 million in 1998 from
$68.9 million in 1997, an increase of $14.5 million, or 21.0%. Of this increase,
$8.2 million is attributable to the New Facilities. As a percent of patient and
resident revenues, operating expense increased to 81.5% in 1998 from 80.4% in
1997. This increase is attributable to increased costs relative to revenues in
the nursing home segment. These increases include the costs associated with the
Alabama decertifications and increased liability insurance costs. With respect
to facilities operated at least one year and excluding the Alabama region, the
operating expense percentage was 83.5%. As a percent of resident revenues,
operating expense of the New Facilities was 62.1%. All of the New Facilities are
assisted living locations, which typically have lower operating costs than do
nursing homes. The largest component of operating expense is wages, which
increased to $37.4 million in 1998 from $31.2 million in 1997, an increase of
$6.2 million, or 20.0%. Of this increase, $4.9 million is attributable to the
New Facilities. Wages with respect to facilities in operation for at least one
year increased $1.3 million, or 4.1%. The Company's wage increases are generally
in line with inflation, however, the larger increase with respect to the same
facility operations is due primarily to a 16.5% increase in Alabama that arose
principally from staffing responses to the decertifications.
Lease Expense. Lease expense increased to $9.6 million in 1998 from $7.6 million
in 1997, an increase of $2.0 million, or 25.6%, which is primarily attributable
to the New Facilities.
General and Administrative Expense. General and administrative expense increased
to $5.4 million in 1998 from $4.7 million in 1997, an increase of $737,000, or
15.6%. The increase in excess of inflation is primarily attributable to the
expense of managing the New Facilities and structural costs added in response to
the Alabama decertifications. As a percent of total net revenues, general and
administrative expense decreased to 5.3% in 1998 from 5.4% in 1997.
Depreciation and Amortization. Depreciation and amortization expenses increased
to $1.8 million in 1998 from $1.3 million in 1997, an increase of $462,000, or
34.7%. This increase is primarily attributable to the New Facilities.
Interest Expense. Interest expense increased to $2.5 million in 1998 from $1.0
million in 1997, an increase of $1.5 million, or 146.6%. This increase is
primarily attributable to financing associated with the New Facilities.
Income Before Income Taxes; Net Income; Earnings Per Share. As a result of the
above, as well as the non-recurring charges of $1.5 million, income before
income taxes was $28,000 in 1998 as compared with $4.1 million in 1997, a
decrease of $4.0 million, or (99.3)%. The effective combined federal, state and
provincial income tax rate was 36.0% in both 1998 and 1997. Net income was
$18,000 in 1998 as compared with
-16-
<PAGE>
$2.6 million in 1997, a decrease of $2.6 million, and basic and diluted earnings
per share were each $.00 as compared with $.49.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998 and December 31, 1997, the Company's working capital was $12.1
million and $13.8 million, respectively, and the current ratio was 1.6 and 1.7,
respectively.
Net cash provided from (used in) operating activities totaled $2.7 million and
$3.3 million in the six month periods ended June 30, 1998 and 1997,
respectively. These amounts primarily represent the cash flows from net income
plus changes in non-cash components of operations and by working capital
changes.
Net cash used in investing activities totaled $5.3 million and $2.1 million the
six month periods ended June 30, 1998 and 1997, respectively. These amounts
primarily represent purchases of property plant and equipment, investments in
joint ventures and additional investment in TDLP, a limited partnership for
which the Company serves as the general partner. The Company has used between
$2.4 million and $3.0 million for capital expenditures in each of the last three
calendar years ending December 31, 1997. Substantially all such expenditures
were for facility improvements and equipment, which were financed principally
through working capital. For the year ended December 31, 1998, the Company
anticipates that capital expenditures for improvements and equipment for its
existing facility operations will be approximately $7.0 million, including $2.9
million for non-routine projects and $1.5 million for management information
systems. The Company has announced its participation in several joint ventures.
The Company will be a minority partner in four assisted living facilities to be
developed in Canada. In addition, the Company has entered into an institutional
pharmacy joint venture with NCS HealthCare Inc. For the six months ended June
30, 1998, the Company had net expenditures of $1.3 million relative to its joint
venture activities. Management anticipates additional investments of up to $1.2
million will be required under its current joint venture commitments over the
next 12 months.
Net cash provided from (used in) financing activities totaled $1.6 million and
$(126,000) for the six month periods ended June 30, 1998 and 1997, respectively.
The net cash provided from or used in financing activities primarily represents
net proceeds from issuance and repayment of debt and advances to or repayments
from related parties.
The Company has begun implementation of an integrated information management
system that will provide enhanced monitoring and tracking of all its operations.
Real-time information will be available to managers at all levels with respect
to clinical care planning, reimbursement and financial control management. The
changes are under the direction of the Company's new Vice President and Chief
Information Officer. The conversion of all of the Company's U.S. nursing homes
to this sophisticated information platform should be completed by November 1998.
Along with the implementation of the new information system, Advocat will be
centralizing the accounting function for its U.S. nursing home operations. The
Company anticipates expenditures over the remainder of 1998 of up to $1.5
million related to this effort.
At June 30, 1998, the Company had total debt outstanding of $61.5 million, of
which $11.1 million was principally mortgage debt bearing interest at floating
rates ranging from 6.3% to 10.0%. The Company also had outstanding a promissory
note (the "Bridge Loan") in the amount of $34.1 million, which was used to fund
the Pierce Group Acquisition. The Company's remaining debt of $16.3 million was
drawn
-17-
<PAGE>
under the Company's lines of credit. Most of the Company's debt is at floating
interest rates, generally at a spread above the London Interbank Offered Rate
("LIBOR"). At June 30, 1998, the Company's average interest rate on its
indebtedness was 8.2%.
The Company has a working capital line of credit and an acquisition line of
credit. The working capital line of credit provides for working capital loans
and letters of credit aggregating up to the lesser of $10.0 million or the
borrowing base, as defined. The Company's obligations under the working capital
line are secured by certain accounts receivable and substantially all other
Company assets. Advances under the working capital line bear interest payable
monthly at the Company's option of either LIBOR plus 2.50% or the bank's Index
rate. The working capital line terminates and all outstanding borrowings are due
in December 1999. As of both June 30, and August 12, 1998, the Company had drawn
$4.35 million, had $5.65 million of letters of credit outstanding, and had no
remaining borrowing capability under the working capital line of credit. The
Company has received an increase from its lenders in the working capital line of
credit availability of $1.25 million (the "Overline"), which has been increased
to $4.0 million effective August 14, 1998. The Overline is subject to the same
terms and conditions as the $10.0 million working capital line of credit. The
Overline terminates and all outstanding borrowings are due January 15, 1999. As
of June 30, 1998, the balance drawn under the Overline totaled $310,000. As of
August 12, the Company had drawn the entire balance then available under the
Overline, $1.25 million.
The acquisition line of credit of $40.0 million, less outstanding borrowings, is
available to fund approved acquisitions through October 1999. The Company's
obligations under the acquisition line are secured by the assets acquired with
the draws under the acquisition line. Advances under the acquisition line bear
interest, payable monthly, at LIBOR plus a defined spread with respect to each
facility based upon its loan-to-value ratio and debt service coverage.
Individual advances made under the acquisition line are due three years from the
date of initial funding. As of both June 30, 1998, and August 12, 1998, the
Company has drawn $11.1 million under the acquisition line, which amount was
secured by four nursing homes, and had $28.9 million available for future
acquisitions.
The Bridge Loan is unsecured. However, the Company has agreed not to pledge or
otherwise encumber the assets acquired in the Pierce Group Acquisition or issue
other debt without the banks' approval. As of both June 30, 1998 and August 12,
1998, the outstanding balance of the Bridge Loan was $34.1 million and the
interest rate was 8.0%. The Bridge Loan, as amended, bears floating interest in
relation to LIBOR and has a balloon maturity in July 1999.
Prior to funding the Bridge Loan, the Company was required to obtain a
commitment for replacement financing. The Company satisfied this requirement by
obtaining a commitment for up to $30.0 million of long-term financing under
which the Company may borrow and pledge the assets acquired in the Pierce Group
Acquisition as collateral. Loans are available at up to 80.0% of the value of
the pledged assets. Interest, which would be at LIBOR plus a defined spread,
would be determined based upon the length of term selected (3, 10, or 20 years)
and the loan-to-value ratio. This commitment is available through November 1999.
However, the Company may not draw upon this commitment so long as the Bridge
Loan remains outstanding. In addition to this commitment, the Company is
exploring other alternatives for refinancing of the Bridge Loan.
The Company's lines of credit and the Bridge Loan contain various financial
covenants, the most restrictive of which relate to net worth, cash flow, debt to
equity ratio requirements, and limits on the payment of dividends to
shareholders. As of June 30, 1998, the Company was in compliance with the
covenants or had received waivers in the event of non-compliance.
-18-
<PAGE>
Based upon the operations of the Company, management believes that available
cash and funds generated from operations, as well as amounts available through
its banking relationships, will be sufficient for the Company to satisfy its
capital expenditures, working capital, and debt requirements for the next twelve
months. The Company intends to satisfy the capital requirements for its
acquisition activities primarily through its acquisition line of credit
complemented as appropriate by various other possible means such as borrowings
from commercial lenders, seller-financed debt, issuance of additional debt,
financing obtained from sale and leaseback transactions and internally-
generated cash from operations. On a long-term basis, management believes the
Company will be able to satisfy the principal repayment requirements on its
indebtedness with a combination of funds generated from operations and from
refinancings with the existing or new commercial lenders or by accessing capital
markets.
RECEIVABLES
The Company's operations could be adversely affected if it experiences
significant delays in reimbursement of its labor and other costs from Medicare,
Medicaid and other third-party revenue sources. The Company's future liquidity
will continue to be dependent upon the relative amounts of current assets
(principally cash, accounts receivable and inventories) and current liabilities
(principally accounts payable and accrued expenses). In that regard, accounts
receivable can have a significant impact on the Company's liquidity. Continued
efforts by governmental and third-party payors to contain or reduce the
acceleration of costs by monitoring reimbursement rates, by increasing medical
review of bills for services or by negotiating reduced contract rates, as well
as any delay by the Company in the processing of its invoices, could adversely
affect the Company's liquidity and results of operations.
Gross accounts receivable attributable to the provision of patient and resident
services at June 30, 1998 and December 31, 1997, totaled $28.8 million and $27.2
million, respectively, representing approximately 51 and 50 days in accounts
receivable, respectively. Accounts receivable from the provision of management
services was $320,000 and $716,000 respectively, at June 30, 1998 and December
31, 1997 representing approximately 32 and 62 days in accounts receivable,
respectively.
The Company continually evaluates the adequacy of its bad debt reserves based on
patient mix trends, agings of older balances, payment terms and delays with
regard to third-party payors, collateral and deposit resources, as well as other
factors. The Company continues to evaluate and implement additional procedures
to strengthen its collection efforts and reduce the incidence of uncollectible
accounts.
Since 1991, the Company and its predecessor have included in their consolidated
operations the operations of the six facilities of TDLP. The Company serves as
the general partner of TDLP and has several continuing obligations to TDLP, one
of which includes certain cash flow support through August 2001. As of June 30,
1998, the Company has provided advances for working capital funding and
requirements under the cash flow guarantee to TDLP totaling $4.1 million.
However, the Company is actively pursuing alternatives that could enhance its
prospects with respect to the realization of the TDLP advances in the long term.
As of June 30, 1998, the Company's recorded net assets and amounts available
from TDLP exceed the combined value of its interests in TDLP. In the event these
alternatives are not successful, the ultimate realization of existing or future
advances to TDLP may require reserves to be recorded by the Company to offset
future increases in the advances during the remainder of 1998.
-19-
<PAGE>
HEALTH CARE INDUSTRY
The health care industry is subject to numerous laws and regulations of federal,
state and local governments. These laws and regulations include, but are not
necessarily limited to, matters such as licensure, accreditation, government
health care program participation requirements, reimbursement for patient
services, and Medicare and Medicaid fraud and abuse. Recently, government
activity has increased with respect to investigations and allegations concerning
possible violations by health care providers of fraud and abuse statutes and
regulations. Violations of these laws and regulations could result in expulsion
from government health care programs together with the imposition of significant
fines and penalties as well as significant repayments for patient services
previously billed. Management believes that the Company is in compliance with
fraud and abuse laws and regulations as well as other applicable government laws
and regulations. Compliance with such laws and regulations can be subject to
future government review and interpretation as well as regulatory actions
unknown or unasserted at this time.
During 1997, the Federal government enacted the Balanced Budget Act of 1997 (the
"BBA"), which contains numerous Medicare and Medicaid cost-saving measures. The
BBA requires that nursing homes transition to a prospective payment system under
the Medicare program during a three year "transition period," commencing with
the first cost reporting period beginning on or after July 1, 1998. The BBA also
contains certain measures that could lead to future reductions in Medicare
therapy cost reimbursement and Medicaid payment rates. Given the recent
enactment of the BBA, the Company is unable to predict the ultimate impact of
the BBA on its future operations. However, any reductions in government spending
for long-term health care could have an adverse effect on the revenues and
results of operation of the Company. The Company will attempt to maximize the
revenues available to it from governmental sources within the changes that will
occur under the BBA. In addition, the Company will attempt to increase
non-governmental revenues, including expansion of its assisted living
operations, in order to offset the loss of governmental revenues as a result of
the enactment of the BBA.
FOREIGN CURRENCY TRANSLATION
The Company has obtained its financing primarily in U.S. dollars; however, it
incurs revenues and expenses in Canadian dollars with respect to Canadian
management activities and operations of the Company's owned and leased
facilities located in Canada. Therefore, if the currency exchange rate
fluctuates, the Company may experience currency translation gains and losses
with respect to the operations of these activities and the capital resources
dedicated to their support. While such currency exchange rate fluctuations have
not been material to the Company in the past, there can be no assurance that the
Company will not be adversely affected by shifts in the currency exchange rates
in the future.
INFLATION
Management does not believe that the Company's operations have been materially
affected by inflation. The Company expects salary and wage increases for its
skilled staff to continue to be higher than average salary and wage increases,
as is common in the health care industry. To date, these increases as well as
normal inflationary increases in other operating expenses have been adequately
covered by revenue increases.
-20-
<PAGE>
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 is effective for financial
statement periods beginning after December 15, 1997. It establishes standards
for the way public companies report information about operating segments in
annual financial statements. SFAS No. 131 also requires that public companies
report selected information about operating segments in interim financial
reports issued to shareholders, although application to interim periods is not
required in the first year of adoption. The Company will adopt the provision of
this statement in association with its 1998 year-end financial statements. The
Company does not expect the adoption of this standard to have a material effect
on the Company's results of operations.
The Accounting Standards Executive Committee has issued Statement of Position
(SOP) 98-5, Reporting on the Costs of Start-Up Activities. SOP 98-5 requires
that the cost of start-up activities be expensed as they are incurred. Start-up
activities include one-time activities and organization costs. The Company
anticipates adoption of the provisions of SOP 98-5 effective January 1, 1999.
Upon adoption, the Company anticipates a pre-tax charge to income of
approximately $300,000, which will be reported as the cumulative effect of a
change in accounting principal.
IMPACT OF THE YEAR 2000
The Company is currently reengineering its accounting and information systems.
Management anticipates that the systems conversion of the United States nursing
home operations will be completed by November 30, 1998. Included in the process
of selecting hardware and software, assurances have been sought and received
from the various vendors that their products are Year 2000 compliant. The
Company continues to evaluate other areas that may be affected. To date, no
issues of a material nature have been identified, and the costs of ensuring
compliance are not expected to have a material impact on the Company's results
of operations.
In addition, the Company has ongoing relationships with third-party payors,
suppliers, vendors, and others that may have computer systems with Year 2000
problems that the Company does not control. There can be no assurance that the
fiscal intermediaries and governmental agencies with which the Company
transacts business and who are responsible for payment to the Company under the
Medicare and Medicaid programs, as well as other payors, will not experience
significant problems with Year 2000 compliance. According to testimony before a
U.S. House of Representatives subcommittee, the Department of Health and Human
Services is far behind in remedying Year 2000 problems, which could delay
payment of claims to providers. The failure of third parties to remedy Year
2000 problems could have a material adverse effect on the Company's business,
financial condition and results of operations.
FORWARD-LOOKING STATEMENTS
The foregoing discussion and analysis provides information deemed by Management
to be relevant to an assessment and understanding of the Company's consolidated
results of operations and its financial condition. It should be read in
conjunction with the Company's Annual Report on Form 10-K for the year ended
December 31, 1997. Certain statements made by or on behalf of the Company,
including those contained in this "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere, are
forward-looking statements as defined in the Private Securities Litigation
Reform Act of 1995. These statements involve risks and uncertainties including,
but not limited to, changes in governmental reimbursement or regulation, health
care reforms, the ability to execute on the Company's acquisition program, both
in obtaining suitable acquisitions and financing therefor, changing economic
conditions as well as others. Actual results may differ materially from those
expressed or implied in forward-looking statements. The Company hereby makes
reference to items set forth under the heading "Risk Factors" in the Company's
Registration Statement on Form S-1, as amended (Registration No. 33-76150). Such
cautionary statements identify important factors that could cause the Company's
actual results to materially differ from those projected in forward-looking
statements. In addition, the Company disclaims any intent or obligation to
update these forward-looking statements.
-21-
<PAGE>
PART II -- OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
(a) The annual meeting of shareholders was held on May 15, 1998.
(c) Matters voted upon at the meeting:
- Election of Director:
William C. O'Neil, Jr.
----------------------
FOR 3,889,220
AGAINST -0-
WITHHELD 329,427
ABSTENTIONS -0-
NON-VOTING(1) 1,158,299
---------
ELIGIBLE SHARES 5,376,946
=========
(Continuing directors include Charles W. Birkett, M.D., Paul Richardson,
Mary Margaret Hamlett, Edward G. Nelson, and J. Bransford Wallace)
------------------
(1) Including broker non-votes.
- Proposal to amend the Company's 1994 Incentive and Nonqualified
Stock Option Plan for Key Personnel to increase the number of
shares of Common Stock reserved for issuance from 810,000 shares
to 1,060,000 shares.
FOR 2,386,926
AGAINST 1,819,607
WITHHELD -0-
ABSTENTIONS 12,114
NON-VOTING(1) 1,158,299
---------
ELIGIBLE SHARES 5,376,946
------------------
(1) Including broker non-votes.
Item 6. Exhibits and Reports on Form 8-K.
(a) The exhibits filed as part of the report on Form 10-Q are listed in
the Exhibit Index immediately following the signature page.
(b) Reports on Form 8-K: None.
-22-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADVOCAT INC.
August 14, 1998
By: /s/ Mary Margaret Hamlett
-----------------------------------------
Mary Margaret Hamlett
Principal Financial Officer and Chief
Accounting Officer and An Officer Duly
Authorized to Sign on Behalf of the
Registrant
-23-
<PAGE>
Manually signed facsimile copies of the Letter of Transmittal will be
accepted. The Letter of Transmittal, certificates for Shares and Rights and any
other required documents should be sent or delivered by each holder of Shares
or his or her broker, dealer, commercial bank, trust company or other nominee
to the Exchange Agent at one of its addresses set forth below.
THE EXCHANGE AGENT
[NAME]
By Mail: Facsimile Transmission: By Hand or Overnight
Courier:
(For Eligible
Institutions Only)
[ADDRESS]
[FAX] [ADDRESS]
For Information
Telephone:
[TEL]
Any questions or requests for assistance may be directed to the Information
Agent or the Dealer Manager at their respective telephone numbers and locations
listed below. Any requests for additional copies of this Prospectus, the Letter
of Transmittal and the Notice of Guaranteed Delivery may be directed to the
Information Agent. You may also contact your local broker, commercial bank,
trust company or nominee for assistance concerning the Offer.
THE INFORMATION AGENT FOR THE OFFER IS:
[NAME]
[ADDRESS]
Bankers and brokers call collect: _______________
All others call toll free: ______________________
THE DEALER MANAGER FOR THE OFFER IS:
SCHRODER & CO. INC.
787 SEVENTH AVENUE
EQUITABLE CENTER--5TH FLOOR
NEW YORK, NEW YORK 10019
(212) 492-6000
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Registrant is a Delaware corporation. Reference is made to Section 145
of the Delaware General Corporation Law (the "DGCL"), which provides that a
corporation may indemnify any person who was or is a party or is threatened to
be made a party to any threatened, pending or completed action or proceeding,
whether civil, criminal, administrative or investigative (other than an action
by or in the right of such corporation, by reason of the fact that such person
is or was a director, officer, employee or agent of the corporation, or is or
was serving at its request in such capacity of another corporation or business
organization against expenses (including attorney's fees), judgments, fines
and amounts paid in settlement actually and reasonably incurred by such person
in connection with such action, suit or proceeding if such person acted in
good faith and in a manner such person reasonably believed to be in or not
opposed to the best interest of the corporation and, with respect to any
criminal action or proceeding, had no reasonable cause to believe that such
person's conduct was unlawful. A Delaware corporation may indemnify officers
and directors in an action by or in the right of a corporation under the same
conditions, except that no indemnification is permitted without judicial
approval if the officer or director is adjudged to be liable to the
corporation. Where an officer or director is successful on the merits or
otherwise in the defense of any action referred to above, the corporation must
indemnify him or her against the expenses that he or she actually and
reasonably incurred.
The Registrant's Certificate of Incorporation provides that, to the fullest
extent permitted by the DGCL as the same exists or may hereafter be amended, a
director of Registrant shall not be liable to Registrant or its stockholders
for monetary damages for a breach of fiduciary duty as a director.
Section 145 further authorizes a corporation to purchase and maintain
insurance on behalf of any person who is or was a director, officer, employee
or agent of the corporation, or is or was serving at the request of the
corporation as a director, officer, employee or agent of another corporation
or enterprise, against any liability asserted against him and incurred by him
in any such capacity, arising out of his status as such, whether or not the
corporation would otherwise have the power to indemnify him under Section 145.
All of the Registrant's directors and officers are covered by insurance
policies maintained and held in effect by Registrant against certain
liabilities for actions taken in such capacities, including liabilities under
the Securities Act.
The Registrant may maintain at its expense a policy of insurance that
insures its directors and officers, subject to certain exclusions and
deductions as are usual in such insurance policies, against certain
liabilities which may be incurred in those capacities.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
3.1* Form of Amended and Restated Certificate of Incorporation of
Registrant
3.2* Form of Amended and Restated Bylaws of Registrant
4.1** Form of Common Stock Certificate of the Registrant
5.1** Opinion of Powell, Goldstein, Frazer & Murphy LLP regarding securities
being issued
8.1** Opinion of Powell, Goldstein, Frazer & Murphy LLP regarding tax
matters
23.1* Consent of Ernst & Young LLP, independent auditors
23.2** Consent of Powell, Goldstein, Frazer & Murphy LLP (contained in
Exhibit 5.1 and 8.1)
</TABLE>
II-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
24.1 Power of Attorney (included as part of the signature page on page II-4
hereto.)
27.1 Financial Data Schedule (for use of SEC only)
99.1** Form of Letter of Transmittal
99.2** Form of Notice of Guaranteed Delivery
99.3** Form of Letter to Brokers, Dealers, Commercial Banks, Trust Companies
and other Nominees
99.4** Form of Letter to Clients for Use by Brokers, Dealers, Commercial
Banks, Trust Companies and Other Nominees
99.5** Form of Guidelines for Certification of Taxpayer Identification Number
on Substitute Form W-9
99.6** Form of Summary Advertisement
</TABLE>
- ----------
* Filed herewith.
** To be filed by amendment.
(b) None
ITEM 22. UNDERTAKINGS
(a) The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act.
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the law or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20 percent change
in the maximum aggregate offering price set forth in the "Calculation
of Registration Fee" table in the effective registration statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the Registration Statement or
any material change to such information in the Registration Statement.
(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed to be a
new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
(3) To remove from registration by means of post-effective amendment any
of the securities being registered which remain unsold at the termination
of the offering.
The undersigned Registrant hereby undertakes to supply by means of a post-
effective amendment all information concerning a transaction, and the company
being acquired involved therein, that was not the subject of and included in
the Registration Statement when it became effective.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or
II-2
<PAGE>
otherwise, the Registrant has been advised that in the opinion of the
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim of
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
II-3
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT, THE REGISTRANT HAS DULY
CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED, IN THE CITY OF ATLANTA, STATE OF
GEORGIA, ON THE 27TH DAY OF AUGUST, 1998.
AVC Holding Corp.
/s/ Francis J. Crosby
By: _________________________________
Francis J. Crosby
President and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Francis J. Crosby with full power to act
without such person and in his name, place and stead, in any and all
capacities, to sign any or all further amendments or supplements (including
post-effective amendments) to this Form S-4 Registration Statement and to file
the same, with all exhibits thereto, and other documents in connection
therewith, with the Commission, granting unto said attorney-in-fact and agent
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully as to
all intents and purposes as he might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, or his substitutes,
may lawfully do or cause to be done by virtue thereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT, AS AMENDED, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED BELOW.
SIGNATURES TITLE DATE
/s/ Francis J. Crosby President, Chief August 27, 1998
- ------------------------------------- Executive Officer
FRANCIS J. CROSBY and Director
/s/ John Stoddard Executive Vice August 27, 1998
- ------------------------------------- President, Chief
JOHN STODDARD Financial Officer
and Director
II-4
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
3.1* Form of Amended and Restated Certificate of Incorporation of
Registrant
3.2* Form of Amended and Restated Bylaws of Registrant
4.1** Form of Common Stock Certificate of the Registrant
5.1** Opinion of Powell, Goldstein, Frazer & Murphy LLP regarding securities
being issued
8.1** Opinion of Powell, Goldstein, Frazer & Murphy LLP regarding tax
matters
23.1* Consent of Ernst & Young LLP, independent auditors
23.2** Consent of Powell, Goldstein, Frazer & Murphy LLP (contained in
Exhibit 5.1 and 8.1)
24.1 Power of Attorney (included as part of the signature page on page II-4
hereto.)
27.1 Financial Data Schedule (for use of SEC only)
99.1** Form of Letter of Transmittal
99.2** Form of Notice of Guaranteed Delivery
99.3** Form of Letter to Brokers, Dealers, Commercial Banks, Trust Companies
and other Nominees
99.4** Form of Letter to Clients for Use by Brokers, Dealers, Commercial
Banks, Trust Companies and Other Nominees
99.5** Form of Guidelines for Certification of Taxpayer Identification Number
on Substitute Form W-9
99.6** Form of Summary Advertisement
</TABLE>
- ----------
* Filed herewith.
** To be filed by amendment.
II-5
<PAGE>
Exhibit 3.1
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
AVC HOLDING CORP.
This Amended and Restated Certificate of Incorporation was duly adopted in
accordance with the provisions of Section 245 of the General Corporation Law of
the State of Delaware. The Certificate of Incorporation of the corporation is
hereby amended and restated to read in its entirety as follows:
FIRST: The name of the Corporation (hereinafter called the "Corporation")
-----
is AVC HOLDING CORP.
SECOND: The address, including street, number, city, and county, of the
------
registered office of the Corporation in the State of Delaware is 1013 Centre
Road, City of Wilmington 19805, County of New Castle; and the name of the
registered agent of the Corporation in the State of Delaware at such address is
Corporation Service Company.
THIRD: The nature of the business or purposes of the Corporation is to
-----
engage in any lawful act or activity for which corporations may be organized
under the Delaware General Corporation law.
FOURTH:
------
1. The number of shares of stock which the Corporation shall have the
authority to issue is twenty million (20,000,000) shares of Common Stock, having
a par value of $0.01 per share, which shares shall not be subject to any
preemptive rights, and one million (1,000,000) shares of preferred stock having
a par value of $0.10 per share.
2. Pursuant to Section 151 of the General Corporation Law of the State of
Delaware, a statement of the designations, powers, preferences and rights, and
the qualifications and restrictions thereof, in respect of each class of capital
stock is as follows:
A. PREFERRED STOCK
The Board of Directors is hereby expressly authorized at any time, and from
time to time, to provide for the issuance of shares of preferred stock in one or
more series, with such voting powers, full or limited, or no voting powers, and
with such designations, preferences and relative, participating, optional or
other rights, and qualifications or restrictions thereof, and shall be stated
and expressed in the resolution or resolutions providing for the issue thereof
adopted by a majority of the Board of Directors then in office and the
certificate of designations filed under the General Corporation Law of the State
of Delaware setting forth such resolution or
<PAGE>
resolutions, including (without limiting the generality thereof) the following
as to each such series:
(i) the designation of such series;
(ii) the dividends, if any, payable with respect to such series, the rates
or basis for determining such dividends, any conditions and dates
upon which such dividends shall be payable, the preferences, if any,
of such dividends over, or the relation of such dividends to, the
dividends payable on the Common Stock or any other series of
preferred stock, whether such dividends shall be noncumulative or
cumulative, and, if cumulative, the date or dates from which such
dividends shall be cumulative;
(iii) whether shares of such series shall be redeemable at the option of
the Board of Directors or the holder, or both, upon the happening of
a specified event and, if redeemable, whether for cash, property or
rights, including securities of the Corporation, the time, prices or
rates and any adjustment and other terms and conditions of such
redemption;
(iv) the terms and amount of any sinking, retirement or purchase fund
provided for the purchase or redemption of shares of such series;
(v) whether shares of such series shall be convertible into or
exchangeable for shares of Common Stock or any other series of
preferred stock, at the option of the Corporation or of the holder,
or both, or upon the happening of a specified event and, if provision
be made for such conversion or exchange, the terms, prices, rates,
adjustments and any other terms and conditions thereof;
(vi) the extent, if any, to which the holders of shares of such series
shall be entitled to vote with respect to the election of directors
or otherwise, including, without limitation, the extent, if any, to
which such holders shall be entitled, voting as a series or as a part
of a class, to elect one or more directors upon the happening of a
specified event or otherwise;
(vii) the restrictions if any, on the issue or reissue of shares of such
series or any other series;
(viii) the extent, if any, to which the holders of shares of such series
shall be entitled to preemptive rights; and
(ix) the rights of the holders of shares of such series upon the
liquidation of the Corporation or any distribution of its assets.
2
<PAGE>
B. COMMON STOCK
(i) Dividends and Distribution. No payment of dividends or distributions
--------------------------
shall be made to the holders of shares of Common Stock unless and until
the holders of shares of preferred stock receive any preferential
amounts to which they are entitled under this ARTICLE FOURTH or in the
resolution or resolutions providing for the issue of shares of
preferred stock. Subject to the limitation set forth in the preceding
sentence of this Paragraph (i) and except as otherwise provided by this
Certificate of Incorporation or in the resolution or resolutions
providing for the issue of shares of preferred stock, the holders of
shares of Common Stock shall be entitled to receive such dividends and
distributions as may be declared upon such shares of Common Stock, from
time to time by a resolution or resolutions adopted by the Board of
Directors.
(ii) Voting Rights. All holders of Common Stock shall be entitled to notice
-------------
of any stockholders' meeting. Subject to the provisions of any
applicable law and except as otherwise provided in this Certificate of
Incorporation or by the resolution or resolutions providing for the
issue of shares of preferred stock, all voting rights shall be vested
solely in the Common Stock. The holders or shares of Common Stock shall
be entitled to vote upon the election of directors and upon any other
matter submitted to the stockholders for a vote. Each share of common
stock issued and outstanding shall be entitled to one noncumulative
vote. A fraction of a share of Common Stock shall not be entitled to
any voting rights whatsoever.
(iii) Liquidation, Dissolution or Winding Up. Except as otherwise provided in
--------------------------------------
this Certificate of Incorporation and subject to the rights of holders,
if any, of preferred stock to receive preferential liquidation
distributions to which they are entitled under this ARTICLE FOURTH or
under the resolution or resolutions providing for the issue of shares
of preferred stock, in the event of any liquidation, dissolution or
winding up of the Corporation, whether voluntary or involuntary, after
payment or provision for payment of the debts and liabilities of the
Corporation, all assets of the Corporation shall be shared pro rata
among the holders of the Common Stock.
3. Except an otherwise provided in this Certificate of Incorporation
or by applicable law, the Corporation's capital stock, regardless of class, may
be issued for such consideration and for such corporate purposes as the Board of
Directors may from time to time determine by a resolution or resolutions adopted
by a majority of the Board of Directors then in office.
FIFTH: The name and the mailing address of the Board of Directors are
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as follows:
3
<PAGE>
Name Mailing Address
---- ---------------
Francis J. Crosby 6600 Peachtree Dunwoody Road
400 Embassy Row, Suite 410
Atlanta, Georgia 30328
John Stoddard 6600 Peachtree Dunwoody Road
400 Embassy Row, Suite 410
Atlanta, Georgia 30328
SIXTH: The Corporation shall have perpetual existence.
-----
SEVENTH: Whenever a compromise or arrangement in proposed between this
--------
Corporation and its creditors or any class of them, and/or between this
Corporation and its stockholders or any class of them, any court of equitable
jurisdiction within the State of Delaware may, on the application in a summary
way of this Corporation, or of any creditor or stockholder thereof or on the
application of any receiver or receivers appointed for this Corporation under
the provisions of (S)291 of Title 8 of the Delaware Code, or on the application
of trustees in dissolution or of any receiver or receivers appointed for this
Corporation under the provisions of (S)279 of Title 8 of the Delaware Code,
order a meeting of the creditors or class of creditors and/or of the
stockholders or class of stockholders of this Corporation, as the case may be,
to be summoned in such manner as the court directs. If a majority and number
representing three-fourths (3/4) in value of the creditors or class of creditors
and/or of the stockholders or class of stockholders of this Corporation, as the
case may be, agree to any compromise or arrangement and to any reorganization of
this Corporation as a consequence of such compromise or arrangement, the said
compromise or arrangement and the said reorganization shall, if sanctioned by
the court to which said application has been made, be binding an all the
creditors or class of creditors and/or on all the stockholders or class of
stockholders, of this Corporation, as the case may be, and also on this
Corporation.
EIGHTH:
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1. The management of the business and the conduct of the affairs of the
Corporation shall be vested in its Board of Directors.
2. The Board of Directors shall consist of not less than three nor more
than fifteen (15) persons, the exact numbers to be fixed from time to time by
the Board of Directors pursuant to a resolution adopted by a majority of
directors then in office, provided, however, that such maximum number may be
-----------------
increased from time to time to reflect the rights of holders of preferred stock
to elect directors in accordance with the terms of this Certificate of
Incorporation or of the resolution or resolutions adopted by a majority of the
Board of Directors then in office providing for the issue of shares of preferred
stock.
4
<PAGE>
3. The Board of Directors shall be divided into three classes, designated
Class 1, Class 2 and Class 3. Each class shall consist, as nearly as may be
possible, of one-third of the number of directors constituting the Board of
Directors. The term of office for Class 1 directors will first expire at the
annual meeting of stockholders for 1999; the term of office of Class 2 directors
will first expire at the annual meeting of stockholders for 2000; and the term
of office of Class 3 directors will first expire at the annual meeting of
stockholders for 2001, and in each case until their successors are duly elected
and qualified. At each annual meeting of stockholders commencing with the first
annual meeting of stockholders, successors to the class of directors whose terms
expire at the annual meeting of stockholders shall be elected by stockholders
for a three-year term and until their successors are duly elected and qualified.
Except as otherwise provided herein or in the Bylaws, increases in the size of
the Board of Directors shall be distributed among the classes so as to render
the class as nearly equal in size as possible. Whenever the holders of
preferred stock issued pursuant to this Certificate of Incorporation or the
resolution or resolutions adopted by a majority of the Board of Directors then
in office providing for the issue of shares of preferred stock shall have the
right, voting as a separate class, to elect directors, the election, term of
office, filling of vacancies and other terms of such directorships shall be
governed by the terms of this Certificate of Incorporation or such resolution or
resolutions, as the case may be, and such directorships shall not be divided
into serial classes or otherwise subject to this Section 3 unless expressly so
provided therein.
4. One or more directors or the entire Board of Directors of the
Corporation may be removed at any time for cause by the affirmative vote of the
holders of a majority of the outstanding shares of capital stock of the
Corporation entitled to vote generally in the election of directors (considered
for this purpose as one class).
5. Whenever the Corporation shall be authorized to issue only one class of
stock, each outstanding share shall entitle the holder thereof to notice of, and
the right to vote at, any meeting of stockholders. Whenever the Corporation
shall be authorized to issue more than one class of stock, no outstanding share
of any class of stock which is denied voting power under the provisions of this
Certificate of Incorporation shall entitle the holder thereof to the right to
vote at any meeting of stockholders except as otherwise provided by applicable
law provided, that no share of any such class which is otherwise denied voting
power shall entitle the holder thereof to vote upon the increase or decrease in
the number of authorized shares of said class.
NINTH: The personal liability of the directors of the Corporation is
------
hereby eliminated to the fullest extent permitted by paragraph (7) of clause (b)
of (S)102 of the Delaware General Corporation Law, as the same may be amended or
supplemented. The provisions of this ARTICLE NINTH are not intended to, and
shall not, limit, supersede or modify any other defense available to a director
under applicable law. Any repeal or modification of this ARTICLE NINTH by the
stockholders of the Corporation shall not adversely affect any right or
protection of a director of the Corporation existing at the time of such repeal
or modification.
TENTH:
-----
1. The Corporation shall, to the fullest extent permitted by (S)145 of the
Delaware General Corporation Law, as the same may be amended or supplemented
(but in the case of any
5
<PAGE>
such amendment or supplement, only to the extent that such amendment or
supplement permits the Corporation to provide broader indemnification rights
than said law permitted the Corporation to provide prior to such amendment or
supplement, indemnify any and all directors and officers whom it shall have
power to indemnify under said section from and against any and all of the
expenses, liabilities or other matters referred to in or covered by said
section, and the indemnification provided for herein shall continue as to a
person who has ceased to be a director or officer and shall inure to the benefit
of the heirs, executors and administrators of such person. The Corporation may,
in its sole discretion and to the fullest extent permitted by (S)145 of the
Delaware General Corporation Law, as the same may be amended or supplemented,
indemnify any and all employees and agents whom it shall have power to indemnify
under said section from and against any and all of the expenses, liabilities, or
other matters referred to in or covered by said section, and the Indemnification
provided for herein shall continue as to a person who has ceased to be an
employee or agent and shall inure to the benefit of the heirs, executors, and
administrators of such person.
2. The Corporation shall pay the expenses incurred in defending any
proceeding against a director or officer which is or may be subject to
indemnification pursuant to this ARTICLE TENTH in advance of final disposition
of such proceeding; provided, however, if the Delaware General Corporation Law
-------
so requires, that the payment of such expenses incurred by a director or officer
shall be made only upon receipt of an undertaking by the director or officer to
repay all amounts advanced if it should be ultimately determined that the
director or officer is not entitled to be indemnified under this ARTICLE TENTH
or otherwise. The Corporation may, in its sole discretion, advance expenses
incurred by its employees or agents to the same extent as expenses may be
advanced to its directors and officers hereunder.
3. The rights conferred on any person by this ARTICLE TENTH shall be
deemed contract rights and shall not be exclusive of any other rights which such
person may have or hereafter acquire under any statute, provision of this
Certificate of Incorporation or the Corporation's Bylaws, agreement, or vote of
stockholders or disinterested directors or otherwise.
4. The Corporation may purchase and maintain insurance to protect itself
and any other director, officer, employee or agent of the Corporation or any
corporation, partnership, joint venture, trust or other enterprise against any
liability, whether or not the Corporation would have the power to indemnify such
person under the Delaware General Corporation Law.
ELEVENTH:
--------
1. From time to time any of the provisions of this Certificate of
Incorporation may be amended, altered or repealed in accordance with the laws of
the State of Delaware at the time in force; provided, however, that the
-------- -------
affirmative vote of the holders of at least 66-2/3% of the outstanding shares of
the Corporation's capital stock entitled to vote thereon and 66-2/3% of the
members of the Board of Directors then holding office is required to amend those
provisions of this Certificate of Incorporation set forth in ARTICLES EIGHTH,
NINTH, TENTH, ELEVENTH, AND TWELFTH.
6
<PAGE>
2. The Corporation's Bylaws may be amended, added to or repealed by an
affirmative vote of at least 66-2/3% of either (i) the shares of the
Corporation's capital stock entitled to vote thereon, or (ii) the Board of
Directors.
TWELTH: Any action required or permitted to be taken by the holders of the
------
issued and outstanding capital stock of the Corporation may be of footed solely
at an annual or special meeting of stockholders duly called and held in
accordance with law and this Certificate of Incorporation, and not by the
consent in writing of such stockholders or any of them; provided, however, that
-------- -------
any holder of shares of preferred stock may exercise the special voting rights,
if any, of such shares to elect directors upon the occurrence of certain events
specified in this Certificate of Incorporation or in the resolution or
resolutions adopted by a majority of the Board of Directors then in office
providing for the issuance of such shares of preferred stock, in any manner now
or hereafter permitted by this Certificate of Incorporation or applicable law.
THIRTEENTH: The President of the Corporation may call special meetings of
-----------
stockholders.
IN WITNESS WHEREOF, the undersigned has executed this Amended and Restated
Certificate of Incorporation on this ___ day of __________, 1998.
Signed on __________, 1998.
AVC HOLDING CORP.
By:
--------------------------
Name:
---------------------
Title:
--------------------
ATTEST:
By:
--------------------------
Name:
---------------------
Title:
--------------------
7
<PAGE>
Exhibit 3.2
AMENDED AND RESTATED BYLAWS
OF
AVC HOLDING CORP.
ARTICLE I
MEETINGS OF STOCKHOLDERS
------------------------
1.1 Annual Meeting. The annual meeting of the stockholders shall be held,
--------------
at such place within or without the state of incorporation as may be designated
by the Board of Directors, on such date and at such time as shall be designated
each year by the Board of Directors and stated in the notice of the meeting. At
the annual meeting the stockholders shall elect directors by a plurality vote
and transact such other business as may properly be brought before the meeting.
1.2 Special Meetings. Special meetings of the stockholders may be called
----------------
by the President or a majority of the Board of Directors. The place of said
meetings shall be designated by the directors. The business transacted at
special meetings of the stockholders of the Corporation shall be confined to the
business stated in the notice given to the stockholders.
1.3 Notice of Stockholder Meetings. Written or printed notice of
------------------------------
stockholders meetings shall state the place, day, and hour of the meeting, and,
in the case of a special meeting, the purpose or purposes for which the meeting
is called and the person or persons calling the meeting; notice may be
communicated in person, by mall or private carrier or by other means of written
communication by or at the direction of the President, Secretary, officer, or
person calling the meeting to each stockholder entitled to vote at the meeting.
Such notice shall be delivered not less than ten (10) nor more than sixty (60)
days before the date of the meeting; provided, however, that any such notice may
-------- -------
be waived in writing, either prior to or subsequent to such meeting.
1.4 Advance Notice Requirements. The provisions of this Section 1.4 are in
---------------------------
addition to and do not waive, any standards in effect under applicable federal
or state law regarding stockholder proposals.
(a) At an annual or special meeting of stockholders, only such business
shall be conducted as shall have been properly brought before the meeting. To be
properly brought before a meeting, business must be (i) specified in the notice
of meeting (or any supplement thereto) given by or at the direction of the Board
of Directors or the President, (ii) otherwise properly brought before the
meeting by or at the direction of the Board of Directors or President, or (iii)
brought before the meeting by a stockholder in accordance with these Bylaws.
For business to be properly brought before an annual meeting by a stockholder,
the stockholder must have given
<PAGE>
timely notice thereof of in writing to the Secretary of the Corporation. To be
timely, a stockholder's notice must be delivered to or mailed and received at
the principal executive offices of the Corporation not less than sixty (60) nor
more than ninety (90) days prior to the meeting; provided, however, that in the
event that less than seventy (70) days notice or prior public disclosure of the
date of the meeting is given or made to stockholders, notice by the stockholder
to be timely must be so received not later than the close of business on the
tenth (10th) day following the day on which such notice of the meeting was
mailed or such public disclosure was made. A stockholder's notice shall set
forth as to each matter the stockholder proposes to bring before the meeting (i)
a brief description of the business desired to be brought before the meeting and
the reasons for conducting such business at the meeting, (ii) the name and
address, as they appear on the Corporation's books, of the stockholder proposing
such business, (iii) the class and number of shares which are beneficially owned
by the stockholder as of the record date of the meeting (if such record date is
publicly available) and as of the date of the notice, and (iv) any material
interest of the stockholder in such business. Notwithstanding anything in these
Bylaws to the contrary, no business shall be conducted at any annual or special
meeting except in accordance with the procedures set forth in this Section 1.4a.
The chairman of the meeting shall, if the facts warrant, determine that the
business was not properly brought before the meeting and in accordance with the
provisions of this Section 1.4(a), and if he shall so determine, he shall so
declare to the meeting and any such business not properly brought before the
meeting shall not be transacted.
(b) Notwithstanding anything to the contrary set forth in these Bylaws,
including the provisions of Section 1.4(a), only persons who are nominated in
accordance with the procedures set forth in this Section 1.4(b) shall be
eligible for election as directors. Nominations of persons for election to the
Board of Directors of the Corporation may be made at a meeting of stockholders
by or at the direction of the Board of Directors or by any stockholder of the
Corporation entitled to vote for the election of directors at the meeting who
complies with the notice procedures set forth in this Section 1.4(b). Such
nominations, other than those made by or at the direction of the Board of
Directors, shall be made pursuant to written notice timely made in writing to
the Secretary of the Corporation. To be timely, a stockholder's notice shall be
delivered to or mailed and received at the principal executive offices of the
Corporation within the time periods specified in Section 1.4(a). Such notice
shall set forth (i) as to each person whom the stockholder proposes to nominate
for election or re-election as a director (w) the name age, business address and
residence address of such person, (x) the principal occupation or employment of
such person (y) the class and number of shares of the Corporation which are
beneficially owned by such person as of the record date of such meeting (if such
record date is publicly available) and as of the date of such notice, and (z)
any other information relating to such person that is required to be disclosed
in solicitations of proxy for election of directors or is otherwise required
pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended
(including, without limitation, such person's written consent to being named in
the proxy statement as a nominee and to serve as a director if elected); and
(ii) as to the stockholder giving notice (y) the name and address, as they
appear on the Corporation's books, of such stockholder, and (z) the class and
number of shares of the Corporation which are beneficially owned by such
stockholder as of the record date of the meeting (if such record date is
publicly available) and as of the date of such notice. At the request of the
Board of Directors, any person nominated by the Board for election as a director
shall furnish to the Secretary of the Corporation
2
<PAGE>
that information required to be set forth in a stockholder's notice of
nomination that pertains to a nominee. No person shall be eligible for election
as a director unless nominated in accordance with the procedure set forth in
this Section 1.4(b). The chairman of the meeting shall, if the facts warrant,
determine that a nomination was not made in accordance with the procedures
prescribed by these Bylaws, and if he should so determine, he shall so declare
to the meeting and the defective nomination shall be disregarded.
1.5 Quorum Requirements. A majority of the shares entitled to vote,
-------------------
present in person or represented by proxy, shall constitute a quorum for the
transaction of business. A meeting may be adjourned despite the absence of a
quorum, and notice of an adjourned meeting need not be given if the time and
place to which the meeting is adjourned are announced at the meeting at which
the adjournment is taken. When a quorum is present at any meeting, a majority
in interest of the stock there represented shall decide any question brought
before such meeting, unless the question is one upon which, by express
provision of the Certificate of Incorporation or Bylaws or by the laws of
Delaware, a larger or different vote is required, in which case such express
provision shall govern the decision of such question.
1.6 Voting and Proxies. Every stockholder entitled to vote at a meeting
-------------------
may do so either in person or by proxy appointment made by an instrument in
writing subscribed by such stockholder which proxy shall be filed with the
secretary of the meeting before being voted. Such proxy shall entitle the
holders thereof to vote adjournment of such meeting, but shall not be valid
after the final adjournment thereof. No proxy shall be valid after the
expiration of three (3) years from the date of its execution, unless the said
instrument expressly provides for a longer period.
ARTICLE II
BOARD OF DIRECTORS
------------------
2.1 Qualification and Election. Directors need not be stockholders or
--------------------------
residents of this State, but must be of legal age. They shall be elected by a
plurality of the votes cast at the annual meetings of the stockholders or at a
special meeting of the stockholders called for that purpose. Each director
shall hold office until the expiration of the term for which he is elected, and
thereafter until his successor shall been elected and qualified.
2.2 Number. The Board of Directors shall consist of not less than three
------
(3) nor more than fifteen (15) persons, the exact numbers to be fixed from time
to time by the Board of Directors pursuant to a resolution adopted by a majority
of directors then in office; provided, however, that such maximum number may be
-------- --------
increased from time to time reflect the rights of holders of preferred stock to
elect directors in accordance with the terms of the Certificate of Incorporation
or of the resolution or resolutions adopted by a majority of the Board of
Directors then in office providing for the issue of shares of preferred stock.
2.3 Classes. The Board of Directors shall be divided into three classes,
-------
designated Class 1, Class 2 and Class 3. Each class shall consist, an nearly as
may be possible of one-third of the number of directors constituting the Board
of Directors. The term of office for Class I
3
<PAGE>
directors will first expire at the first annual meeting of stockholders; the
term of office of Class 2 directors will first expire at the second annual
meeting of stockholders; and the term of office of Class 3 directors will first
expire at the third annual meeting of stockholders, and in each case until their
successors are duly elected and qualified. At each annual meeting of
stockholders commencing with the first annual meeting of stockholders,
successors to the class of directors whose terms expire at the annual meeting of
stockholders shall be elected by stockholders for a three-year term and until
their successors are duly elected and qualified. Except as otherwise provided
herein or in the Certificate of Incorporation, increases in the size of the
Board of Directors shall be distributed among the classes so as to render the
class as nearly equal in size as practicable. Whenever the holders of preferred
stock issued pursuant to the Certificate of Incorporation or the resolution or
resolutions adopted by a majority of the Board of Directors then in office
providing for the issue of shares of preferred stock shall have the right,
voting as a separate class, to elect directors, the election, term of office,
filling of vacancies and other terms of such directorships shall be governed by
the terms of the Certificate of Incorporation or such resolution or resolutions,
as the case may be, and such directorships shall not be divided into serial
classes or otherwise subject to this Section 2.3 unless expressly so provided
therein.
2.4 Meetings. The annual meeting of the Board of Directors shall be held
--------
immediately after the adjournment of the annual meeting of the stockholders at
which time the officers of the Corporation shall be elected. The Board may also
designate more frequent intervals for regular meetings. Special meetings may be
called at any time by the Chairman of the Board, President, or any two
directors. Members of the Board of Directors may participate in a meeting of
the Board of Directors by means of conference telephone or similar
communications equipment by means of which all persons participating in the
meeting can hear each other, and participation in a meeting in such manner shall
constitute presence in person at such a meeting.
2.5 Notice of Directors' Meetings. The annual and all regular Board
-----------------------------
meetings may be hold without notice of the date, time, place or purpose of the
meeting. Special meetings shall be hold upon notice sent by any usual means of
communication not less than twenty-four (24) hours before the meeting noting the
date, time and place of the meeting. The notice need not describe the purposes
of the special meeting. Attendance by a director at a meeting or subsequent
execution or approval by a director of the minutes of a meeting or a consent
action shall constitute a waiver of any defects in notice of such meeting and/or
consent action.
2.6 Quorum and Vote. The presence of a majority of the directors shall
---------------
constitute a quorum for the transaction of business. A meeting may be adjourned
despite the absence of a quorum, and notice of an adjourned meeting need not be
given if the time and place to which the meeting is adjourned are fixed at the
meeting at which the adjournment is taken and if the period of adjournment does
not exceed thirty (30) days in any one adjournment. The vote of a majority of
the directors present at a meeting at which a quorum is present shall be the act
of the board, unless the vote of a greater number is required by the Certificate
of Incorporation, these Bylaws, or by the laws of Delaware.
2.7 Executive, Audit and other Committees. The Board of Directors. by a
-------------------------------------
resolution adopted by a majority of its members, may designate an executive
committee, consisting of two
4
<PAGE>
or more directors, an audit committee, a majority of the members of which shall
be independent directors, and other committees, consisting of two or more
persons, who may or may not be directors, and may delegate to such committee or
committees any and all such authority as it deems desirable, including the right
to delegate to an executive committee the power to exercise all the authority of
the Board of Directors in the management of the affairs and property of the
Corporation.
ARTICLE III
OFFICERS
--------
3.1 Number. The Corporation shall have a President, a Secretary, and such
------
other officers as the Board of Directors shall from time to time deem necessary.
Any two or more offices may be held by the same person, except the offices of
President and Secretary.
3.2 Election and Term. The officers shall be elected by, and shall hold
-----------------
office at the pleasure of, the Board of Directors.
3.3 Duties. All officers shall have such authority and perform such
------
duties in the management of the Corporation as are normally incident to their
offices and as the Board of Directors may from time to time provide.
ARTICLE IV
RESIGNATIONS, REMOVAL AND VACANCIES
-----------------------------------
4.1 Resignations. Any officer or director may resign at any time by
------------
giving written notice to the Chairman of the Board, the President or the
Secretary. Any such resignation shall take effect at the time specified
therein, or, if no time is specified, then upon its acceptance by the Board of
Directors.
4.2 Removal of Officers. Any officer or agent may be removed at any time
-------------------
with or without cause by the Board of Directors.
4.3 Removal of Directors. Any or all of the directors may be removed at
--------------------
any time for "cause" by the affirmative vote of the holders of a majority of the
outstanding shares of capital stock of the Corporation entitled to vote
generally in the election of directors (considered for this purpose as one
class). Cause, for purposes of these Bylaws, shall be: (i) any fraudulent or
dishonest act or activity by the director; or (ii) behavior materially
detrimental to the business of the Corporation.
5
<PAGE>
4.4 Vacancies. Newly created directorships resulting from an increase in
---------
the number of directors and vacancies occurring in any office or directorship
for any reason, including removal of an officer or director, may be filled by
the vote of a majority of the directors remaining in office, even if less then a
quorum exists; provided, however, that any vacancy created by removal of a
-------- -------
director pursuant to Section 4.3 may be filled by action of the stockholders
taken at the same meeting at which the vacancy was created, such action to be
taken upon the affirmative vote of the holders of not less than a majority of
the voting power of the outstanding capital stock of the Corporation entitled to
vote in the election of directors, voting as a single class.
ARTICLE V
CAPITAL STOCK
-------------
5.1 Stock Certificates. Every stockholder shall be entitled to a
------------------
certificate or certificates of capital stock of the Corporation in such form as
may be prescribed by the Board of Directors. Unless otherwise decided by the
Board, such certificates shall be signed by the President and the Secretary of
the Corporation, however, any or all of those signatures may be a facsimile.
The Corporation shall be entitled to treat the holder of record of any share or
shares of stock of the Corporation as the holder in fact thereof and,
accordingly, shall not be bound to recognize any equitable or other claim to or
interest in such share or shares on the part of any other person whether or not
it has actual or other notice thereof, except as provided by law.
5.2 Transfer Of Shares. Shares of stock may be transferred on the books
------------------
of the Corporation by delivery and surrender of the properly assigned
certificate, but subject to any restrictions on transfer imposed by either the
applicable securities laws or any stockholder agreement.
5.3 Loss, Theft or Destruction of Certificates. In the case of the loss,
------------------------------------------
theft, mutilation, or destruction of a certificate of stock, a duplicate
certificate may be issued upon such terms as the Board of Directors shall
prescribe.
ARTICLE VI
ACTION BY CONSENT
-----------------
6.1 Directors. Whenever the directors are required or permitted to take
---------
any action by vote, such action may be taken without a meeting on written
consent, setting forth the action so taken, signed by all the persons or
entities entitled to vote thereon, and such action shall be as valid and
effective as any action taken at a regular or special meeting of the directors.
6.2 Stockholders. Any action required or permitted to be taken by the
------------
holders of the issued and outstanding stock of the Corporation may be effected
solely at an annual or special meeting of stockholders duly called and held in
accordance with law, the Certificate of Incorporation and these Bylaws, and not
by the consent in writing of such stockholders or any of
6
<PAGE>
them; provided, however, that holders of shares of any series of the
-------- -------
Corporation's preferred stock may exercise the special voting rights, if any, of
such series to elect directors upon the occurrence of certain events specified
in the Certificate of Incorporation or in the resolution or resolutions adopted
by a majority of the Board of Directors then in office providing for issue of
any series of preferred stock pursuant to the Certificate of Incorporation, in
any manner now or hereafter permitted by the Certificate of Incorporation or the
General Corporation Law of the State of Delaware.
ARTICLE VII
AMENDMENT OF BYLAWS
-------------------
These Bylaws may be amended, added to or repealed by an affirmative vote
of at least 66-2/3% of either (1) the shares of the Corporation's capital stock
entitled to vote thereon, or (2) the Board of Directors.
ARTICLE VIII
FISCAL YEAR
-----------
The fiscal year for the Corporation shall be fixed from time to time by
the Board of Directors.
CERTIFICATION
I certify that these Amended and Restated Bylaws were adopted by the
stockholders of the Corporation on the ____ day of ____________, 1998.
------------------------------
John Stoddard
Secretary
7
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to the
use of our report dated August 26, 1998, with respect to the balance sheet of
AVC Holding Corp. included in the Registration Statement (Form S-4) and related
Prospectus for AVC Holding Corp. filed with the Securities and Exchange
Commission.
/s/ Ernst & Young LLP
Chicago, Illinois
August 27, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM AUDITED
BALANCE SHEET OF AVC HOLDING CORP. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> OTHER
<FISCAL-YEAR-END> AUG-26-1998
<PERIOD-START> AUG-26-1998
<PERIOD-END> AUG-26-1998
<CASH> 70,000
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 70,000
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 70,000
<CURRENT-LIABILITIES> 0
<BONDS> 50,000
0
0
<COMMON> 82
<OTHER-SE> 19,918
<TOTAL-LIABILITY-AND-EQUITY> 70,000
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 0
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
