<PAGE> 1
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: SEPTEMBER 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 NOVEMBER 13, 1998)
<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
ADVOCAT INC.
INTERIM CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS AND UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------- --------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 1,871 $ 2,673
Receivables, less allowance for doubtful
accounts of $2,100 and $2,702,
respectively 27,925 26,010
Income taxes receivable 750 380
Inventories 1,045 1,097
Prepaid expenses and other assets 2,404 1,640
Deferred income taxes 880 830
-------- --------
Total current assets 34,875 32,630
-------- --------
PROPERTY AND EQUIPMENT, at cost 80,754 77,354
Less accumulated depreciation
and amortization (14,675) (12,149)
-------- --------
Net property and equipment 66,079 65,205
-------- --------
OTHER ASSETS:
Deferred tax benefit 4,980 5,460
Deferred financing and other costs, net 1,386 1,643
Other 12,887 10,023
-------- --------
Total other assets 19,253 17,126
-------- --------
$120,207 $114,961
======== ========
</TABLE>
(Continued)
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<PAGE> 3
ADVOCAT INC.
INTERIM CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS AND UNAUDITED)
(CONTINUED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------- --------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt $ 2,798 $ 762
Trade accounts payable 9,754 9,365
Accrued expenses:
Payroll and employee benefits 5,787 5,576
Other 4,631 3,078
-------- --------
Total current liabilities 22,970 18,781
-------- --------
NONCURRENT LIABILITIES:
Long-term debt, less current portion 59,404 58,373
Deferred gains with respect to leases, net 3,355 3,562
Other 3,018 3,512
-------- --------
Total noncurrent liabilities 65,777 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, 5,399,000 and 5,377,000 issued
and outstanding at September 30, 1998 and
December 31, 1997, respectively 54 54
Paid-in capital 15,765 15,638
Retained earnings 15,641 15,041
-------- --------
Total shareholders' equity 31,460 30,733
-------- --------
$120,207 $114,961
======== ========
</TABLE>
The accompanying notes are an integral part of these interim consolidated
balance sheets.
-3-
<PAGE> 4
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS, AND UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
------- ------- -------- --------
<S> <C> <C> <C> <C>
REVENUES:
Patient revenues $41,716 $40,566 $126,662 $122,030
Resident revenues 8,649 2,097 25,983 6,364
Management fees 896 952 2,708 2,826
Interest 44 42 143 116
------- ------- -------- --------
Net revenues 51,305 43,657 155,496 131,336
------- ------- -------- --------
EXPENSES:
Operating 40,163 36,139 123,546 105,072
Lease 4,816 3,577 14,379 11,192
General and administrative 2,703 2,328 8,159 7,046
Depreciation and amortization 1,024 667 2,818 2,000
Interest 1,349 458 3,848 1,471
Non-recurring charges -0- -0- 1,468 -0-
------- ------- -------- --------
Total expenses 50,055 43,169 154,218 126,781
------- ------- -------- --------
INCOME BEFORE INCOME TAXES 1,250 488 1,278 4,555
PROVISION FOR INCOME TAXES 450 176 460 1,640
------- ------- -------- --------
NET INCOME $ 800 $ 312 $ 818 $ 2,915
======= ======= ======== ========
EARNINGS PER SHARE:
Basic $ .15 $ .06 $ .15 $ .55
======= ======= ======== ========
Diluted $ .15 $ .06 $ .15 $ .54
======= ======= ======== ========
WEIGHTED AVERAGE SHARES:
Basic 5,399 5,350 5,384 5,327
======= ======= ======== ========
Diluted 5,403 5,442 5,395 5,370
======= ======= ======== ========
</TABLE>
The accompanying notes to interim financial statements are an integral part of
these interim consolidated financial statements.
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<PAGE> 5
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS AND UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
----- ----- ----- -------
<S> <C> <C> <C> <C>
NET INCOME $ 800 $ 312 $ 818 $ 2,915
----- ----- ----- -------
OTHER COMPREHENSIVE INCOME:
Foreign currency translation adjustments (216) -0- (341) (44)
Income tax benefit 78 -0- 123 16
----- ----- ----- -------
(138) -0- (218) (28)
----- ----- ----- -------
COMPREHENSIVE INCOME $ 662 $ 312 $ 600 $ 2,887
===== ===== ===== =======
</TABLE>
The accompanying notes are an integral part of these interim consolidated
financial statements.
-5-
<PAGE> 6
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS AND UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1998 1997
------- -------
<S> <C> <C>
CASH FLOWS (LOSS) FROM OPERATING ACTIVITIES:
Net income $ 818 $ 2,915
Adjustments to reconcile net income to net
cash provided from operating activities:
Depreciation and amortization 2,818 2,000
Provision for doubtful accounts 993 1,389
Equity earnings in joint ventures (50) (39)
Amortization of deferred credits (401) (791)
Deferred income taxes 553 1,565
Non-recurring charge write-off 1,028 -0-
Change in assets and liabilities:
Receivables, net (3,678) 520
Inventories 52 (374)
Prepaid expenses and other assets (959) (347)
Trade accounts payable and accrued expenses 2,168 (1,010)
Other 45 (9)
------- -------
Net cash provided from operating activities 3,387 5,819
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (3,857) (2,042)
Investment in TDLP (632) (655)
Mortgage receivable, net (305) (307)
Deposits, pre-opening and other costs (505) (463)
Investment in joint ventures, net (1,683) 40
TDLP partnership distributions 229 151
------- -------
Net cash used in investing activities (6,753) (3,276)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds (repayment) from bank line of credit 3,943 (1,380)
Repayment of debt obligations (571) (408)
Proceeds from sale of common stock 127 514
Advances to TDLP, net (867) (717)
Advances repaid by lessor, net -0- 442
Financing costs (68) (181)
------- -------
Net cash provided from (used in) financing activities $ 2,564 $(1,730)
------- -------
</TABLE>
(Continued)
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<PAGE> 7
ADVOCAT INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS AND UNAUDITED)
(CONTINUED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1998 1997
------- -------
<S> <C> <C>
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ (802) $ 813
CASH AND CASH EQUIVALENTS, beginning of period 2,673 1,942
------- -------
CASH AND CASH EQUIVALENTS, end of period $ 1,871 $ 2,755
======= =======
SUPPLEMENTAL INFORMATION:
Cash payments of interest $ 4,000 $ 1,472
======= =======
Cash payments of income taxes $ 827 $ 872
======= =======
</TABLE>
The Company received net benefit plan deposits and earnings and recorded benefit
plan liabilities of $209,000 and $64,000 in the nine month periods ended
September 30, 1998 and 1997, respectively.
The accompanying notes to interim financial statements are an integral part of
these interim consolidated financial statements.
-7-
<PAGE> 8
ADVOCAT INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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 10 states and in two Canadian
provinces.
As of September 30, 1998, the Company operates 115 facilities consisting of 63
nursing homes with 7,182 licensed beds and 52 assisted living facilities with
4,900 units. The Company owns seven nursing homes, leases 37 others and manages
19 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 32 assisted living facilities in the United States and 11
nursing homes and 20 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, 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 nine month periods ended
September 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 September 30, 1998, the results of operations for the three and nine
month periods ended September 30, 1998 and 1997, and the cash flows for the nine
month periods ended September 30, 1998 and 1997.
The results of operations for the three and nine month periods ended September
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. Certain amounts in the 1997 financial statements have been reclassified to
conform to the 1998 presentation.
-8-
<PAGE> 9
3. EARNINGS PER SHARE
Information with respect to the calculation of basic and diluted earnings per
share data follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30,
---------------------------- ---------------------------
1998 1997 1998 1997
-------------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net income (numerator) $ 800,000 $ 312,000 $ 818,000 $2,915,000
============== ========== ========== ==========
Basic average shares outstanding (denominator) 5,399,000 5,350,000 5,384,000 5,327,000
Employee stock purchase plan 4,000 2,000 10,000 10,000
Options -0- 90,000 1,000 33,000
-------------- ---------- ---------- ----------
Diluted average shares outstanding (denominator) 5,403,000 5,442,000 5,395,000 5,370,000
============== ========== ========== ==========
Basic earnings per share $ .15 $ .06 $ .15 $ .55
============== ========== ========== ==========
Diluted earnings per share $ .15 $ .06 $ .15 $ .54
============== ========== ========== ==========
</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 other comprehensive income balance
is presented below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30,
---------------------------- ---------------------------
1998 1997 1998 1997
-------------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Foreign currency items:
Beginning balance $ (276,000) $ (41,000) $ (196,000) $ (13,000)
Current-period change, net of income tax (138,000) 0 (218,000) (28,000)
-------------- ---------- ---------- ----------
Ending balance $ (414,000) $ (41,000) $ (414,000) $ (41,000)
============== ========== ========== ==========
</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 restructuring 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 included 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 the
write off of 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> 10
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 September 30, 1998, Advocat's portfolio includes 115 facilities composed
of 63 nursing homes containing 7,182 licensed beds and 52 assisted living
facilities containing 4,900 units. In comparison, at September 30, 1997, the
Company operated 86 facilities composed of 65 nursing homes containing 7,341
licensed beds and 21 assisted living facilities containing 2,406 units. As of
September 30, 1998, the Company owns seven nursing homes, leases 37 others and
manages the remaining 19 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 32 assisted living facilities, and in Canada, the Company
operates 11 nursing homes and 20 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> 11
RESULTS OF OPERATIONS
The following tables present the unaudited interim statements of income and
related data for the three and nine month periods ended September 30, 1998 and
1997.
<TABLE>
<CAPTION>
(IN THOUSANDS) THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------
1998 1997 CHANGE %
------- ------- ------- -----
<S> <C> <C> <C> <C>
REVENUES:
Patient revenues $41,716 $40,566 $ 1,150 2.8
Resident revenues 8,649 2,097 6,552 312.5
Management fees 896 952 (56) (5.8)
Interest 44 42 2 5.8
------- ------- ------- -----
Net revenues 51,305 43,657 7,648 17.5
------- ------- ------- -----
EXPENSES:
Operating 40,163 36,139 4,024 11.1
Lease 4,816 3,577 1,239 34.7
General and administrative 2,703 2,328 375 16.1
Depreciation and amortization 1,024 667 357 53.5
Interest 1,349 458 891 194.6
Non-recurring charges -0- -0- -0- 0
------- ------- ------- -----
Total expenses 50,055 43,169 6,886 16.0
------- ------- ------- -----
INCOME BEFORE INCOME TAXES 1,250 488 762 156.2
PROVISION FOR INCOME TAXES 450 176 274 156.2
------- ------- ------- -----
NET INCOME $ 800 $ 312 $ 488 156.2
======= ======= ======= =====
</TABLE>
<TABLE>
<CAPTION>
(IN THOUSANDS) NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------
1998 1997 CHANGE %
------- ------- ------- -----
<S> <C> <C> <C> <C>
REVENUES:
Patient revenues $126,662 $122,030 $ 4,632 3.8
Resident revenues 25,983 6,364 19,619 308.3
Management fees 2,708 2,826 (118) (4.2)
Interest 143 116 27 23.6
------- ------- ------- -----
Net revenues 155,496 131,336 24,160 18.4
------- ------- ------- -----
EXPENSES:
Operating 123,546 105,072 18,474 17.6
Lease 14,379 11,192 3,187 28.5
General and administrative 8,159 7,046 1,113 15.8
Depreciation and amortization 2,818 2,000 818 40.9
Interest 3,848 1,471 2,377 161.6
Non-recurring charges 1,468 -0- 1,468 N/A
------- ------- ------- -----
Total expenses 154,218 126,781 27,437 21.6
------- ------- ------- -----
INCOME BEFORE INCOME TAXES 1,278 4,555 (3,277) (72.0)
PROVISION FOR INCOME TAXES 460 1,640 (1,180) (72.0)
------- ------- ------- -----
NET INCOME $ 818 $ 2,915 $(2,097) (72.0)
======= ======= ======= =====
</TABLE>
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<PAGE> 12
PERCENTAGE OF NET REVENUES
(in thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30,
---------------------------- ---------------------------
1998 1997 1998 1997
------- ------- ------- -----
<S> <C> <C> <C> <C>
REVENUES:
Patient revenues 81.3% 92.9% 81.5% 92.9%
Resident revenues 16.9 4.8 16.7 4.8
Management fees 1.7 2.2 1.7 2.2
Interest 0.1 0.1 0.1 0.1
------- ------- ------- -----
Net revenues 100.0% 100.0% 100.0% 100.0%
------- ------- ------- -----
OPERATING EXPENSES:
Operating 78.3 82.8 79.5 80.0
Lease 9.4 8.2 9.3 8.5
General and administrative 5.3 5.3 5.2 5.4
Depreciation and amortization 2.0 1.5 1.8 1.5
Interest 2.6 1.1 2.5 1.1
Non-recurring charges 0.0 0.0 0.9 0.0
------- ------- ------- -----
Total expenses 97.6 98.9 99.2 96.5
------- ------- ------- -----
INCOME BEFORE INCOME TAXES 2.4 1.1 0.8 3.5
PROVISION FOR INCOME TAXES 0.8 0.4 0.3 1.3
------- ------- ------- -----
NET INCOME 1.6% 0.7% 0.5% 2.2%
======= ======= ======= =====
</TABLE>
GENERAL
Medicare Reimbursement Changes. The Company has begun to experience the impact
of Medicare cost limitations imposed by the Health Care Finance Administration
upon all providers of nursing home Medicare services. Beginning in July, a
portion of the Company's facilities began the three-year transition from the
cost reimbursed system to the prospective payment system ("PPS"). In general,
PPS provides a standard payment for Medicare Part A services to all providers
regardless of their costs. PPS creates an incentive for providers to reduce
their costs, and management has responded accordingly. The phase-in of PPS
begins for all providers at some point during the twelve-month period ending
June 30, 1999. Since PPS is still an evolving process, the ultimate impact is
not yet known. Management presently believes that it can manage its costs in
response to PPS, as it is currently structured, such that there is little or no
impact on net income. Management has also de-emphasized the provision of
Medicare services at certain locations.
Until a facility is fully transitioned into PPS, it is subject to salary
equivalency ("SE") limitations that became effective in April 1998. SE limits
the amount of allowable labor cost for the provision of certain services under
the cost reimbursement system. The short-term impact of SE has had a moderately
negative impact on net income. However, the Company believes that SE will become
less of a factor as PPS is implemented.
Beginning in January, the allowable costs for cost reimbursement components of
Medicare Part B services became subject to a limitation factor of 90% of actual
cost. For the Company, such revenues are primarily derived from reimbursement of
subcontracted therapy costs. Management
-12-
<PAGE> 13
estimates the impact of this change to be a reduction to pre-tax income of
$75,000 per month or $600,000 annually. As to net income, this equates to about
$.01 per share per month or $.12 annually. This change is expected to remain in
place and will not be impacted by the transition to PPS.
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 has abandoned much of its existing software and
has dismantled much of its regional infrastructure in favor of a centralized
accounting organization. This restructuring 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 included 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 the
write off of prospective financing arrangements or acquisitions, each of which
had been abandoned during the second quarter, and costs related to legal issues
that were settled during the second 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, 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'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 September 30, 1998, one of the
decertified facilities had fully recovered to its historical operating level.
The other facility, though improved, still had not fully recovered to the
historical operating level that had been experienced prior to the
decertification. The Company's response to the decertifications included
permanent staffing increases affecting all Alabama facilities.
-13-
<PAGE> 14
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 $.24 per share. Effective July 1, 1998, the Alabama
situation no longer has a negative financial impact on the operations of the
Company. Due to the nature of the Alabama reimbursement system, the Company
began receiving an improved Medicaid reimbursement rate relative to its higher
staffing cost levels effective July 1, 1998.
New Facilities. There have been no acquisitions in 1998. In the fourth quarter
of 1997, the Company acquired 17 assisted living facilities through purchase and
also 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.
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
facility operations.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH THREE MONTHS ENDED SEPTEMBER
30, 1997
Revenues. Net revenues increased to $51.3 million in 1998 from $43.7 million in
1997, an increase of $7.6 million, or 17.5%. Patient revenues increased to $41.7
million in 1998 from $40.6 million in 1997, an increase of $1.1 million, or
2.8%. Resident revenues increased to $8.6 million in 1998 from $2.1 million in
1997, an increase of $6.5 million, or 312.5%. This increase is entirely
attributable to the New Facilities. Overall, there was a 2.1% decline in patient
and resident days (approximately 10,000 days) among facilities in operation for
at least one year.
Revenue increases among nursing facilities were primarily due to inflationary
increases rather than from expanded services. The increase in patient revenues
was further restrained due to the impact of the Medicare reimbursement changes.
Although the Company experienced an increase year over year, patient revenues
actually declined as compared to the three months ended June 30, 1998.
Management anticipates that this trend will continue through the PPS transition
period. 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 20.4% in 1998 from 25.0% in 1997 while Medicaid
and similar programs increased to 62.4% in 1998 from 53.9% in 1997.
Ancillary service revenues, prior to contractual allowances, decreased to $8.8
million in 1998 from $14.2 million in 1997, a decrease of $5.4 million or 37.7%.
The 1998 decrease is primarily due to reduced revenues (and corresponding
reduced costs negotiated with the Company's therapy subcontractors) in response
to PPS and SE. Management expects reduction in year over year comparisons to
continue for the foreseeable future.
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<PAGE> 15
Operating Expense. Operating expense increased to $40.2 million in 1998 from
$36.2 million in 1997, an increase of $4.0 million, or 11.1%. Of this increase,
$4.1 million is attributable to the New Facilities. As a percent of patient and
resident revenues, operating expense decreased to 79.7% in 1998 from 84.7% in
1997. This decrease is attributable to the addition of the New Facilities and
the declining impact in the 1998 period of the 1997 decertification problems. As
a percent of resident revenues, operating expense of the New Facilities was
61.2%. All of the New Facilities are assisted living locations, which typically
have lower operating costs than do nursing homes. With respect to Alabama
operations over the past year, occupancy has substantially improved, higher
reimbursement began July 1, and non-recurring costs relative to addressing the
decertifications have been eliminated; this combination of factors yields a
substantial improvement in operating expense as a percent of patient and
resident revenues. The largest component of operating expense is wages, which
increased to $19.6 million in 1998 from $16.6 million in 1997, an increase of
$3.0 million, or 18.1%. Of this increase, $2.6 million is attributable to
the New Facilities. Wages with respect to facilities in operation for at least
one year increased $418,000, or 2.5%. The Company's wage increases are
generally in line with inflation. The Company experienced an increase of
$592,000, or 81.7%, in same facility general insurance compared to the 1997
period. Such insurance expense is anticipated to continue at higher levels for
the foreseeable future.
Lease Expense. Lease expense increased to $4.8 million in 1998 from $3.6 million
in 1997, an increase of $1.2 million, or 34.7%, 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 $376,000, or
16.1%. 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. Management estimates there were approximately
$235,000 of duplicate expenses incurred during the implementation of its new
management information system, which expenses will be eliminated upon completion
of the transition. As a percent of total net revenues, general and
administrative expense was 5.3% in 1998, the same as in the 1997 period.
Depreciation and Amortization. Depreciation and amortization expenses increased
to $1.0 million in 1998 from $667,000 in 1997, an increase of $357,000, or
53.5%. This increase is primarily attributable to the New Facilities.
Interest Expense. Interest expense increased to $1.3 million in 1998 from
$458,000 in 1997, an increase of $891,000, or 194.6%. This increase is primarily
attributable to financing associated with the New Facilities and increased
borrowing under the Company's working capital line of credit facility.
Income Before Income Taxes; Net Income; Earnings Per Share. As a result of the
above income before income taxes in 1998 was $1.2 million as compared with
$488,000 in 1997, an increase of $762,000, or 156.2%. The effective combined
federal, state and provincial income tax rate was 36.0% in both 1998 and 1997.
Net income was $800,000 in 1998 as compared with $312,000 in 1997, an increase
of $488,000, and basic earnings per share was $.15 as compared with $.06.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 1997
Revenues. Net revenues increased to $155.5 million in 1998 from $131.3 million
in 1997, an increase of $24.2 million, or 18.4%. Patient revenues increased to
$126.6 million in 1998 from $122.0 million in 1997, an increase of $4.6 million,
or 3.8%. Resident revenues increased to $26.0 million in 1998 from $6.4 million
in 1997, an increase of $19.6 million, or 308.3%. This increase is entirely
attributable to the New Facilities. Revenue increases among nursing facilities
operated at least one year were primarily
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<PAGE> 16
due to inflationary increases rather than from expanded services. These
increases were offset by reduced revenues from the advent of PPS, SE, and Part B
cost limitations and by foregone revenues with respect to occupancy declines in
the facilities that were decertified in 1997 and to one facility that was closed
in April 1997. Excluding the Alabama and closed facilities, there was a 3.1%
decline in patient and resident days (approximately 40,000 days) among
facilities in operation for at least one year. As a percent of patient and
resident revenues, Medicare decreased to 23.2% in 1998 from 26.3% in 1997 while
Medicaid and similar programs increased to 58.9% in 1998 from 54.4% in 1997.
Ancillary service revenues, prior to contractual allowances remained flat at
$42.9 million in 1998 as compared to the 1997 period. 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 Company
experienced an increase in ancillary service revenues in the first half of 1998,
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. The increase was offset beginning in July due to reduced revenues
(and corresponding reduced costs negotiated with the Company's therapy
subcontractors) in response to PPS and SE. Primarily due to its responses to
PPS, management anticipates that ancillary service revenues with respect to its
existing operations will continue the downward trend experienced beginning in
July 1998.
Operating Expense. Operating expense increased to $123.6 million in 1998 from
$105.1 million in 1997, an increase of $18.5 million, or 17.6%. Of this
increase, $12.3 million is attributable to the New Facilities. As a percent of
patient and resident revenues, operating expense decreased to 80.9% in 1998 from
81.8% in 1997. This decrease is attributable to the lessened impact of costs
associated with the Alabama decertifications and the addition of the New
Facilities. As a percent of resident revenues, operating expense of the New
Facilities was 61.8%. 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 $57.0 million in
1998 from $47.8 million in 1997, an increase of $9.2 million, or 19.3%. Of this
increase, $7.5 million is attributable to the New Facilities. Wages with respect
to facilities in operation for at least one year increased $1.7 million, or
3.5%. The Company's wage increases are generally in line with inflation. The
Company experienced an increase of $1.2 million, or 40.2%, in same facility
general insurance compared to the 1997 period. Such insurance is anticipated to
continue at higher levels for the foreseeable future.
Lease Expense. Lease expense increased to $14.4 million in 1998 from $11.2
million in 1997, an increase of $3.2 million, or 28.5%, which is primarily
attributable to the New Facilities.
General and Administrative Expense. General and administrative expense increased
to $8.2 million in 1998 from $7.1 million in 1997, an increase of $1.1 million,
or 15.8%. 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. Management estimates there were approximately
$296,000 of duplicate expenses incurred during the implementation of its new
management information system, which expenses will be eliminated upon completion
of the transition. 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 $2.8 million in 1998 from $2.0 million in 1997, an increase of $818,000, or
40.9%. This increase is primarily attributable to the New Facilities.
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<PAGE> 17
Interest Expense. Interest expense increased to $3.9 million in 1998 from $1.5
million in 1997, an increase of $2.4 million, or 161.6%. 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 $1.3 million in 1998 as compared with $4.6 million in 1997, a
decrease of $3.3 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
$818,000 in 1998 as compared with $2.9 million in 1997, a decrease of $2.1
million, and basic earnings per share was $.15 as compared with $.55.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998 and December 31, 1997, the Company's working capital was
$11.9 million and $13.8 million, respectively, and the current ratio was 1.5 and
1.7, respectively.
Net cash provided from operating activities totaled $3.4 million and $5.8
million in the nine month periods ended September 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 $6.8 million and $3.3 million the
nine month periods ended September 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 $6.0 million, including
$1.9 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 nine
months ended September 30, 1998, the Company had net investment expenditures of
$1.7 million relative to its joint venture activities. Management anticipates
additional investments of up to $900,000 will be required under its current
joint venture commitments over the next 12 months.
Net cash provided from (used in) financing activities totaled $2.6 million and
$(1.7 million) for the nine month periods ended September 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 the end of
1998. Along with the implementation of the
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<PAGE> 18
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 $550,000 related to this effort.
At September 30, 1998, the Company had total debt outstanding of $62.2 million,
of which $10.6 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 $17.5
million was drawn 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 September 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 September 30, and November 13, 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 $4.0 million. 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 September 30, 1998, the balance drawn under the Overline totaled $2.0
million. As of November 13, the Company had drawn $3.5 million under the
Overline.
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 September 30, 1998, and November 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 September 30, 1998 and
November 13, 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
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<PAGE> 19
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 September 30, 1998, the Company was in compliance with the
covenants or had received 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 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 September 30, 1998 and December 31, 1997, totaled $28.8 million
and $27.2 million, respectively, representing approximately 52 and 50 days in
accounts receivable, respectively. Accounts receivable from the provision of
management services was $520,000 and $716,000 respectively, at September 30,
1998 and December 31, 1997 representing approximately 53 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
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<PAGE> 20
2001. As of September 30, 1998, the Company has provided advances for working
capital funding and requirements under the cash flow guarantee to TDLP totaling
$4.1 million. As of September 30, 1998, the Company's recorded net assets and
amounts available from TDLP exceed the combined value of its interests in TDLP.
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.
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.
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 as well as manage its costs in relation to the revenues
available from the provision of services. 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.
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<PAGE> 21
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.
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
To date, the Company's evaluation of its Year 2000 ("Y2K") preparedness has
focused on its internal information systems. 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 December 31, 1998. Included in the process of selecting hardware
and software, assurances have been sought and received from the various vendors
that their products are Y2K compliant. The Company continues to evaluate other
information technology areas that may be affected including existing hardware
systems. 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 Y2K 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 Y2K compliance. According to testimony before a U.S. House of
Representatives subcommittee, the Department of Health and Human Services
("HHS") is far behind in remedying Y2K problems, which could delay payment of
claims to providers. HHS recently announced that of its 290 mission critical
systems, including Medicare payment systems, 45% are now Y2K compliant; however,
the internal HHS deadline for compliance is December 31, 1998. In addition to
Medicare, the Company has its payments processed via several paying agencies
that are unique to each state within which it operates. Paying agencies are only
one example of dependence of the Company on the Y2K preparedness of other
entities and vendors. Other examples include the normal flow of patient care and
nutritional supplies, utilities, communications, banking services and therapy
subcontractors. Just as with the Company's own systems, the failure of third
parties to remedy identified Y2K problems or the failure to address
unanticipated Y2K problems could have a material adverse effect on the Company's
business, financial condition and results of operations.
To date, the Company's evaluation of the Y2K preparedness of its critical
vendors and suppliers has not been centrally co-ordinated. Management has
mandated a formal completion of the process resulting in an evaluation status
by March 31, 1999. Until such work is completed, the Company cannot assess its
vulnerability to the Y2K preparedness of its vendors and suppliers. In the
absence of assurance, the worst case result of assumed non-compliance would
likely have a catastrophic impact on the Company's ability to deliver its
services to patients and residents in a safe manner and, consequently, on the
Company's results of operations.
In addition, the Company has not evaluated the risks of non-information
technology problems connected to Y2K. Risk exposure areas could include nurse
call systems, patient security and safety systems, HVAC systems and patient
care equipment. Management is also requiring a non-information technology Y2K
assessment status be completed by March 31, 1999.
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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 4. Submission of Matters to a Vote of Security Holders
None.
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.
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<PAGE> 23
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.
November 13, 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
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<PAGE> 24
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------
<S> <C> <C>
3.1 - Certificate of Incorporation of the Registrant
(incorporated by reference to Exhibit 3.1 to the
Company's Registration Statement No.33-76150 on Form
S-1).
3.2 - Bylaws of the Company (incorporated by reference to
Exhibit 3.2 to the Company's Registration Statement
No. 33-76150 on Form S-1).
3.3 - Amendment to Certificate of Incorporation dated
March 23, 1995 (incorporated by reference to Exhibit
A of Exhibit 1 to Form 8-A filed March 30, 1995).
4.1 - Form of Common Stock Certificate (incorporated by
reference to Exhibit 4 to the Company's Registration
Statement No. 33-76150 on Form S-1).
4.2 - Rights Agreement dated March 13, 1995, between the
Company and Third National Bank in Nashville
(incorporated by reference to Exhibit 1 to the Company's
Current Report on Form 8-K dated March 13, 1995).
4.3 - Summary of Shareholder Rights Plan adopted March 13,
1995 (incorporated by reference to Exhibit B of
Exhibit 1 to Form 8-A filed March 30, 1995).
4.4 - Rights Agreement of Advocat Inc. dated March 23,
1995 (incorporated by reference to Exhibit 1 to
Form 8-A filed March 30, 1995).
27 - Financial Data Schedule (for SEC use only).
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE INTERIM
CONSOLIDATED FINANCIAL STATEMENTS OF ADVOCAT INC. AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH QUARTERLY REPORT ON FORM 10-Q DATED FROM THE
QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,871
<SECURITIES> 0
<RECEIVABLES> 30,025
<ALLOWANCES> 2,100
<INVENTORY> 1,045
<CURRENT-ASSETS> 34,875
<PP&E> 80,754
<DEPRECIATION> 14,675
<TOTAL-ASSETS> 120,207
<CURRENT-LIABILITIES> 22,970
<BONDS> 0
0
0
<COMMON> 54
<OTHER-SE> 31,406
<TOTAL-LIABILITY-AND-EQUITY> 120,207
<SALES> 0
<TOTAL-REVENUES> 155,496
<CGS> 0
<TOTAL-COSTS> 154,218
<OTHER-EXPENSES> 993
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,468
<INCOME-PRETAX> 1,250
<INCOME-TAX> 450
<INCOME-CONTINUING> 800
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 800
<EPS-PRIMARY> .15
<EPS-DILUTED> .15
</TABLE>
