<PAGE> 1
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
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
-----------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES ACT
OF 1934
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 25,
1999 (BASED ON THE CLOSING PRICE OF SUCH SHARES ON THE NEW YORK STOCK EXCHANGE)
WAS $7,996,110. 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 25, 1999, 5,398,710 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 1999 ANNUAL MEETING OF STOCKHOLDERS.
<PAGE> 2
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 assisted
living facilities generally located in smaller rural and secondary markets in
the southeast United States and in Canada and pursue additional management
opportunities.
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> 3
MATERIAL CORPORATE DEVELOPMENTS.
Non-Recurring Charges
During the second and fourth quarters of 1998, the Company recorded various
non-recurring charges totaling $5.9 million. Information with respect to each
non-recurring charge is presented below:
<TABLE>
<CAPTION>
SECOND FOURTH
QUARTER QUARTER TOTAL
------------------------------------------
<S> <C> <C> <C>
MIS Conversion $ 968,000 $ 198,000 $1,166,000
Impaired Assets - 2,858,000 2,858,000
Legal and Contractual Settlements 282,000 994,000 1,276,000
Termination of Proposed Financing
and Acquisition Transactions 218,000 341,000 559,000
---------- ---------- ----------
$1,468,000 $4,391,000 $5,859,000
========== ========== ==========
</TABLE>
In connection with its decision to convert all management information systems
with respect to the Company's U.S. nursing homes, the Company abandoned much of
its existing software and eliminated much of its regional infrastructure in
favor of a more centralized accounting organization. The related second quarter
charge represents the costs associated with the write-off of capitalized
software costs ($553,000), the costs associated with the closing of certain
regional offices (primarily future lease commitments, $184,000), and the costs
of severance packages for affected personnel ($231,000). In the fourth quarter,
additional regional office closings were identified, and another charge of
$198,000 was recorded. All of these costs represent future cash requirements
except for the write-off of capitalized software costs. As of December 31,
1998, $382,000 remains unpaid.
As discussed in Note 6 of the Company's Consolidated Financial Statements, the
Company recorded a charge of $2.5 million for the estimated impairment of the
Company's investment in Texas Diversicare Limited Partnership ("TDLP") due to
the continuing funding of certain contractual cash flow requirements.
Approximately $1.3 million of this charge represents a valuation allowance
against advances made in 1998 in excess of the estimated fair value of the
Company's investment, while the remaining $1.2 million represents management's
estimate of additional future required funding. In addition, in the fourth
quarter of 1998, management identified two locations for which leases will not
be renewed and wrote off the impairment of certain long-lived assets with
respect to these locations ($358,000).
During the second and fourth quarters of 1998, the Company recorded costs
related to certain legal matters and contractual disputes that were settled
during the respective quarters. The largest of these settlements ($638,000)
related to claims submitted in the fourth quarter by the Company's most
significant lessor, Omega (See Notes 2 and 12 of the Company's Consolidated
Financial Statements), which have been settled.
3
<PAGE> 4
During the second and fourth quarters of 1998, the Company also wrote off costs
associated with terminated prospective financing and acquisition transactions,
each of which was abandoned in the respective quarter.
Current Debt Maturities
At December 31, 1998, $55.2 million of the Company's total debt of $63.6 million
was contractually due in 1999, meaning that it must be repaid or refinanced
during 1999. Because the Company has a commitment for $25.2 million, which it
expects to draw upon prior to May 31, 1999, that will refinance a portion of the
debt that is contractually due, only $30.1 million is classified as current in
the Company's balance sheet at December 31, 1998. These current maturities are
as follows: $11.1 million under the GMAC acquisition line, secured by four
nursing homes, due in December 1999; $1.2 million mortgage payable to a Canadian
bank, secured by one nursing home, due in December 1999; $4.3 million under the
working capital line of credit, due in December 1999 and $3.8 million under the
working capital overline, due in April 1999; $8.9 million of the original $34.1
million bridge loan due in July 1999; and miscellaneous current maturities of
$780,000. The Company expects to refinance the $11.1 million GMAC debt and the
$1.2 million Canadian mortgage with long-term fixed-rate debt with the existing
mortgage holders during the summer and fall of 1999. The Company plans to
utilize a $25.2 million commitment from GMAC for long-term financing to
significantly pay down the bridge loan prior to May 31, 1999, leaving a balance
of $8.9 million still due to the lending banks. The Company is currently
negotiating with the existing lenders to restructure a portion of this $8.9
million as longer-term debt and expects to repay a portion of the debt during
1999 through various means such as the sale of certain assets, refinancing
mortgage debt, and through cash generated from operations. The Company is also
currently negotiating with the existing lender to extend the maturities of the
working capital line and the working capital overline. The Company expects to
repay the miscellaneous current maturities of $780,000 with cash generated from
operations. See Note 8 of the Company's Consolidated Financial Statements for a
more detailed description of the Company's debt. The Company believes that it
will be successful in restructuring its debt as described in 1999.
Regulatory Issues
The Company's 1998 operating results were negatively affected by regulatory
issues in the State of Alabama. During the summer of 1997, two of the Company's
facilities in Mobile were decertified for 69 and 91 days, respectively, before
resurveys found them to be in compliance. In response to the regulatory problems
at the two Mobile facilities, the Company entered into a reorganization of its
regional and facility management and engaged nationally recognized consultants
to assist in achieving compliance, as well as local legal counsel familiar with
the Alabama regulatory environment. Although both of these facilities were
recertified for participation in the Medicare and Medicaid programs in 1997, the
Alabama regulatory issue continued to impact the Company's operations during the
first half of 1998 on two broad fronts: census declines and permanent cost
increases. The Company's response to the decertifications included permanent
staffing increases, which affected all of the Company's Alabama facilities. As
of December 31, 1998, one of the two
4
<PAGE> 5
decertified facilities had fully recovered to its historical census levels. The
other facility, though substantially improved, still had not fully recovered to
the historic census levels that it had experienced prior to its decertification
in 1997.
As a result of the lost revenues from census declines, the permanent cost
increases incurred in response to the Alabama survey issues and miscellaneous
other associated 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 $0.24 per share. Beginning in July of 1998, the Alabama
situation no longer had a significant negative financial impact on the
operations of the Company. Due to the nature of the Alabama Medicaid
reimbursement system, the Company began receiving an improved Medicaid
reimbursement rate that offset its higher staffing cost levels as of July 1,
1998.
During the latter half of 1998, the Company experienced further regulatory
issues with respect to certain other facilities:
- One of the Company's facilities in Arkansas was decertified from the
Medicare and Medicaid programs. This facility was recertified for
Medicaid participation within 30 days before the decertification had
a negative financial impact on operations, but the facility has not
yet been recertified for Medicare participation.
- The State of Florida imposed a moratorium on new admissions at a
facility during the last quarter of 1998. Additionally, the State
required that the facility increase its staffing during the last half
of 1998. The Company has taken corrective action at this facility and
has employed an external consultant to review the facility's systems
and procedures. The moratorium on admissions was lifted at the end of
January 1999.
- One other facility encountered potential survey problems during the
latter half of 1998, but this facility was not decentified or put on an
admission ban. However, the Company significantly slowed admissions
while corrective actions were being developed and implemented.
5
<PAGE> 6
Medicare Reimbursement Changes
During 1998, the Company began 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 1998, a portion of the
Company's facilities began the three-year transition from the cost reimbursement
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.
Management estimates that the ultimate impact of PPS on its revenues will be a
reduction of $12.0 to $13.0 million per year. Since PPS is still an evolving
process, the ultimate impact cannot be known with certainty. However, Management
presently believes that it can reduce its costs in response to PPS, as it is
currently structured, such that there will be 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 the Company's net income. SE has been eliminated in 1999
with the implementation of fee screens for Medicare Part B services.
Beginning in January 1998, 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 estimates the impact of
this change in 1998 to have been a reduction to after-tax operations of
$575,000, or $.11 per share. In 1999, cost reimbursement of Part B services has
been replaced by a system of fee screens that effectively limit the maximum fees
that may be charged for therapy services. The Company estimates that this will
further negatively impact operations although the negative effect on the
Company's operations cannot yet be reasonably estimated.
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, 1998, Advocat's portfolio includes 115 facilities composed of
63 nursing homes containing 7,182 licensed beds and 52 assisted living
facilities containing 4,755 units. In comparison, at December 31, 1997, the
Company operated 116 facilities composed of 65 nursing homes containing 7,341
licensed beds and 51 assisted living facilities containing 4,748 units. Within
this portfolio, 30 facilities are managed on behalf of other owners, 24 of which
are on behalf of unrelated owners and six in which the Company holds a minority
equity interest. The remaining facilities, consisting of 61 leased and 24 owned
facilities are operated for the Company's own account. In the United States, the
Company operates 52 nursing homes and 33 assisted living facilities, and in
Canada, the Company operates 11 nursing homes and 19 assisted living facilities.
6
<PAGE> 7
The Company's facilities provide a range of health care services to its
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. As of
December 31, 1998, 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 has current plans to begin operating facilities in
Virginia and the Canadian province of Manitoba in 1999.
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 1998 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 for all contracts.
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. PPS
is a direct result of the BBA. It requires that nursing homes transition to PPS
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 have resulted in and could lead to future
reductions in Medicare therapy cost reimbursement and Medicaid payment rates. To
date, the PPS has not had a material negative impact on the Company's
operations, since the reduction in revenues has, for the most part, been offset
by the Company's ability to take cost-saving measures. However, through December
31, 1998, not all the Company's nursing homes had begun their PPS phase-in, and
the Company is not able to predict with certainty the ultimate impact of the
prospective payment system on its future operations. Further, any reductions in
State or Federal spending for long-term
7
<PAGE> 8
health care could have an adverse effect on the operating 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 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.
8
<PAGE> 9
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 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.
9
<PAGE> 10
NURSING HOME AND ASSISTED LIVING FACILITY SERVICES
Operations. As of December 31, 1998, the Company operates 63 nursing homes with
7,182 licensed beds and 52 assisted living facilities with 4,755 units as set
forth below:
<TABLE>
<CAPTION>
United States Canada
------------------------------ ----------------------------
Facilities Licensed Beds Facilities Licensed Beds
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
Nursing Homes:
Owned.............................. 5 562 2 144
Leased............................. 37 4,158 0 0
Managed............................ 10 867 9 1,451
-- ----- -- -----
Total..................... 52 5,587 11 1,595
== ===== == =====
Assisted Living Facilities(1): Facilities Units Facilities Units
---------- ----- ---------- -----
Owned.............................. 14 1,050 3 218
Leased............................. 19 1,428 5 489
Joint Venture Managed.............. 0 0 6 865
Managed............................ 0 0 5 705
-- ----- -- -----
Total..................... 33 2,478 19 2,277
== ===== == =====
</TABLE>
- ----------------
(1) 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. Also includes seven facilities under development: one owned
with 79 units, two leased with 100 units and four to be managed with
486 units.
For the year ended December 31, 1998, the Company's net patient and resident
revenues were $201.3 million, or 98.1% of total net revenues. For the year ended
December 31, 1998, the Company's net revenues from the provision of management
services were $3.6 million, or 1.8% of the total net revenues. This management
fee revenue represented approximately 5% of the $71.7 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 operating segments.
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 owns an ancillary service supply business
through which it provides medical supplies and enteral
10
<PAGE> 11
nutritional support services directly to patients. In 1998, the Company entered
into a joint venture to provide institutional pharmacy services to the Company's
facilities as well as facilities owned by others. The Company continues to
explore opportunities to broaden its ancillary services. The Company's nursing
homes range in size from 48 to 247 licensed beds.
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 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 323
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 is considering
adding new services as appropriate including adult day care, medical
equipment rental, 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 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.
11
<PAGE> 12
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.
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 containing costs. 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.
Emphasize Development Joint Ventures in Canada. In 1998, the Company
entered into four Canadian joint ventures, each of which is developing a
new assisted living facility. The Company has a minority equity interest in
each development and has received a long-term contract to manage each
facility. Each of these facilities is scheduled to open during various
times in 1999.
Make Selective Acquisitions. The Company's senior management will
continue to evaluate selected acquisitions primarily through the lease of
additional 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.
Pursue Additional Opportunities for Management Agreements. Management
believes that the Company can attract additional management agreements in
Canada. Further, it is management's belief that the Company is a recognized
provider of quality care in Canada 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
12
<PAGE> 13
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.
The Company has established a task force to address the continuing impact of the
BBA. The task force will evaluate changes in the funding environment for
long-term care as these changes become known. The Company will attempt to
maximize the revenues available to it from governmental sources within the
changes that occur under the BBA.
MARKETING
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.
13
<PAGE> 14
DESCRIPTION OF MANAGEMENT SERVICES AND AGREEMENTS
Of the Company's 115 facilities, 30 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.
The Company's management fee is subordinated to debt payments at 17 facilities.
The Company participates in profits over its base management fee at 17
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 30 management contracts, two 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 two management
contracts are for a base fee with no profit participation, no subordination to
debt, no purchase options and no guarantees of debt.
14
<PAGE> 15
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 1998
-------------------- MANAGEMENT
YEAR U.S. CANADA FEES
---- ---- ------ ------------
<S> <C> <C> <C>
1999........................................ 0 4 375,000
2000........................................ 0 1 207,000
2001........................................ 6 0 -0-(1)
2002........................................ 0 1(2) -0-
2003........................................ 0 3(2) 65,000
2004........................................ 0 7 1,241,000
2005........................................ 0 2 501,000
2015........................................ 4 -- 1,013,000
-- --
Total.............................. 10 18
== ==
</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.
(2) These facilities had not begun full operations as of December 31, 1998.
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
these agreements will be renewed.
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,
------------------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Management Fees (1) $ 3,627 $ 3,886 $ 3,652
======= ======= =======
Net Revenues of Managed Facilities $71,670 $75,043 $72,076
======= ======= =======
Management Fees as a Percentage
of Net Facility Revenues 5.1% 5.2% 5.1%
======= ======= =======
</TABLE>
- -------------------
(1) 1996 amount is net of $0.5 million in non-recurring consulting fees.
DESCRIPTION OF LEASE AGREEMENTS
The Company leases 61 nursing homes and assisted living facilities, including 30
owned by Omega Healthcare Investors, Inc. ("Omega") (a real estate investment
trust), 11 owned by Counsel Corporation ("Counsel") (which owned or controlled
the Company's predecessor operations), 14 owned by members or affiliates of
Pierce and six owned by 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
15
<PAGE> 16
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 a series of agreements with Omega in 1994
ultimately resulting in the Company leasing a total of nine additional
facilities (the "1994 Omega Lease"). The 1994 Omega Lease provides for an
initial term of ten and one-half years expiring in May 2005 and allows 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, 1998, the patient and resident revenues from the Omega leased
facilities were $91.6 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 has notified Counsel of its intention to renew the lease on these
facilities. 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, 1998, the patient and resident revenues from the Counsel leased facilities
were $26.5 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 from Pierce Management Group ("Pierce"). 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
16
<PAGE> 17
maximum of 3.0%. Beginning at the fifth anniversary, the Company has a right to
purchase all 12 facilities as a group for their fair market value. An additional
lease, which expires in 2003, is with an affiliate of Pierce who is a current
employee of the Company. The remaining lease is a sublease that expires in 2017.
The Company has no purchase option with respect to either the 2003 lease or the
sublease. During the period ended December 31, 1998, the resident revenues from
the Pierce leased facilities were $13.9 million.
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, 1998:
<TABLE>
<CAPTION>
Assisted Living
Nursing Homes Centers
--------------------------- ------------------
Number Licensed Beds Number(1) Units
------ ------------- --------- -----
OPERATING LOCATIONS:
<S> <C> <C> <C> <C>
Alabama............................ 7 862 -- 52
Arkansas........................... 13 1,411 2 24
Florida............................ 8 800 -- --
Georgia............................ -- -- 1 56
Kentucky........................... 6 474 -- 4
North Carolina..................... -- -- 27 2,163
Ohio............................... 1 151 -- --
Tennessee.......................... 5 617 -- --
Texas.............................. 10 1,092 -- --
West Virginia...................... 2 180 -- --
Ontario............................ 11 1,595 12 1,310
British Columbia................... -- -- 3 460
---- ------ ---- ------
63 7,182 45 4,069
LOCATIONS UNDER DEVELOPMENT:
North Carolina..................... -- -- 1 79
South Carolina..................... -- -- 2 100
British Columbia................... -- -- 2 228
Ontario............................ -- -- 2 279
---- ------ ---- ------
Total..................... 63 7,182 52 4,755
==== ====== ==== ======
CLASSIFICATION:
Owned.............................. 7 706 17 1,302
Leased............................. 37 4,158 24 1,883
Joint Venture Managed.............. -- -- 6 865
Managed............................ 19 2,318 5 705
---- ------ ---- ------
Total..................... 63 7,182 52 4,755
==== ====== ==== ======
</TABLE>
- ------------------
(1) Facilities that provide both nursing care and assisted living services
are counted as nursing homes. There are two such facilities in Alabama
and one in Kentucky.
17
<PAGE> 18
ORGANIZATION
The Company's long-term care facilities are currently organized into nine
regions, seven in the United States and two 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, 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 which it owns, leases or manages. 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 CQI program used at all
locations was designed to meet accreditation standards and to exceed state and
federal government regulations.
18
<PAGE> 19
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 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.
19
<PAGE> 20
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 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 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 ("PPS") 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
20
<PAGE> 21
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, management
believes that it can reduce its costs in response to PPS, as it is presently
structured, such that there will be little or no impact on net income.
Although the Company was able to offset the vast majority of reductions in its
revenues due to Medicare PPS by realizing cost savings in 1998, PPS is still in
the process of being phased in and defined. Accordingly, there can be no
assurance that PPS will not ultimately have an adverse impact on the Company.
Management anticipates that the Company will incur a negative impact on
operations in 1999 due to the new fee screen for therapy services that is being
imposed as part of the BBA although the ultimate effect cannot yet be reasonably
estimated. Further, there can be no assurance that states in which the Company
operates will not enact further cost-saving measures in their Medicaid programs.
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, 1998, the Company derived
22.1% and 58.8% of its total patient and resident 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.
21
<PAGE> 22
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
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 quality and adequacy
of personnel, quality of medical care, record keeping, dietary services,
resident rights and the physical condition of the facility and the adequacy of
the equipment used therein. 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, one of the Company's facilities in Arkansas
was decertified from the Medicaid and Medicare programs in 1998. Although the
facility was recertified for participation in the Medicaid program within 30
days without significant adverse financial impact, it has not yet been
recertified to participate in Medicare and is not currently accepting Medicare
patients. A second facility, located in Florida, was subject to a
government-imposed moratorium on admissions and civil monetary penalties during
the last quarter of 1998. The Company is appealing the civil monetary penalties
and has taken aggressive action, including increasing its staffing, to correct
the deficiencies on which the moratorium was based. The moratorium was lifted at
the end of January 1999. 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,
22
<PAGE> 23
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 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)
1998 1997 1996
---------------------- ---------------------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
Medicaid (1) ....... $118,394 58.8% $ 99,396 55.8% $ 91,089 56.2%
Medicare ........... 44,490 22.1 44,974 25.2 41,566 25.7
Private Pay (1) .... 38,449 19.1 33,829 19.0 29,274 18.1
-------- ------ -------- ------ -------- ------
Total ....... $201,333 100.0% $178,199 100.0% $161,929 100.0%
======== ====== ======== ====== ======== ======
</TABLE>
- -------------------
(1) Includes assisted living facility revenues. The mix of Medicaid,
Medicare and private pay for nursing homes in 1998 was 61.0%, 25.8%,
and 13.2%, respectively.
23
<PAGE> 24
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,
----------------------------------------------------------
1998 1997 1996
----------------- ----------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Medicaid (1) ....... 1,747,844 72.1% 1,345,010 67.5% 1,253,342 69.1%
Medicare ........... 110,178 4.5 120,583 6.1 120,458 6.6
Private Pay (1) .... 566,834 23.4 525,016 26.4 440,130 24.3
--------- ----- --------- ----- --------- -----
Total ....... 2,424,856 100.0% 1,990,609 100.0% 1,813,930 100.0%
========= ===== ========= ===== ========= =====
</TABLE>
- -------------------
(1) Includes assisted living facility days. The mix of Medicaid, Medicare
and private pay for nursing homes in 1998 was 78.6%, 7.3%, and 14.1%,
respectively.
The above tables include net patient revenues and the patient days of the six
facilities comprising TDLP. 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.
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 $1.0 million and aggregate coverage limits of up to $3.0
million for its long-term care services. Through December 31, 1997, with respect
to a majority of its United States nursing homes, the Company was self-insured
for the first $25,000 per occurrence and $500,000 in the aggregate for
24
<PAGE> 25
such claims. Effective January 1, 1998, these self-insured per claim and
aggregate amounts increased to $250,000 and $2.5 million, respectively.
Effective February 1, 1999, the remaining United States nursing homes became
part of the $250,000/$2.5 million deductible program. In addition, the Company
maintains a $50.0 million 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 $10.0 million 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 $3.3
million ($5.0 million Canadian). In addition, the Company maintains an aggregate
umbrella liability policy of equal amount 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 $1.0 million and aggregate coverage limits of up to
$2.0 million. In addition, through January 31, 1999, TDLP maintained a $10.0
million aggregate umbrella liability policy for claims in excess of the
foregoing limits for these facilities. Effective February 1, 1999, TDLP became
insured locations under the Company's $50.0 million aggregate umbrella policy.
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. For the current policy
year, expected claims under this program are approximately $2.9 million, and the
Company has secured stop-loss insurance coverage for claims in excess of
approximately $3.6 million. Canadian employees are covered for worker's
compensation and supplemental health care as a result of the 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 a
non-subscriber to the Texas worker's compensation system and is, therefore,
completely self-insured for employee injuries with respect to its Texas
operations. 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 consultants 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
25
<PAGE> 26
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 28, 1999, the Company employed a total of approximately 5,210
individuals. Management believes that the Company's employee relations are good.
Approximately 210 of the Company's United States employees are represented by a
labor union and approximately 400 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 2,500
individuals, approximately 1,710 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.
ITEM 2. PROPERTIES
The Company owns 24 and leases 61 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, its regional office supporting the
Tennessee operations and the ancillary services supply 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 5,500 square feet of office space in
Kernersville, North Carolina, and its regional office with approximately 3,000
square feet of office space in Ashland, Kentucky. Lease periods on these
facilities generally range up to seven years, although the Kernersville lease
runs through 2022 including renewal options. Regional executives for Alabama,
Arkansas, Florida and Texas work from offices of under 1,000 square feet each.
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.
26
<PAGE> 27
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, 1998 through December 31, 1998) of the fiscal year
covered by this Annual Report on Form 10-K.
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 1997
and 1998:
<TABLE>
<CAPTION>
Period High Low
------ ---- ---
<S> <C> <C>
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
1998 1st Quarter 10 3/16 7 3/4
1998 2nd Quarter 10 5/16 6
1998 3rd Quarter 7 7/8 5 5/8
1998 4th Quarter 6 1/2 4 3/4
</TABLE>
The Company's Common Stock has been traded since May 10, 1994. On March 25,
1999, the closing price for the Common Stock was $3, as reported by the New York
Stock Exchange.
27
<PAGE> 28
On March 25, 1999, there were 205 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.
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 selected financial data of Advocat as of December 31, 1998,
1997, 1996, 1995 and 1994 and for the years ended December 31, 1998, 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 has been derived
from the pro forma financial data of Advocat.
28
<PAGE> 29
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
ADVOCAT ADVOCAT
------------------------------------------------- PRO FORMA
1998 1997 1996 1995 1994
--------- -------- -------- -------- --------
STATEMENT OF OPERATIONS DATA: (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
REVENUES:
Patient revenues ............... $ 166,529 $163,094 $153,582 $128,643 $ 92,228
Resident revenues .............. 34,804 15,105 8,347 7,477 7,098
Management fees ................ 3,627 3,886 4,152 3,618 3,583
Interest ....................... 192 158 156 227 177
--------- -------- -------- -------- --------
Net revenues ............. 205,152 182,243 166,237 139,965 103,086
--------- -------- -------- -------- --------
EXPENSES:
Operating ...................... 164,769 146,555 131,966 109,458 77,567
Lease .......................... 19,109 15,850 14,441 13,518 10,827
General and administrative ..... 10,969 9,636 8,578 7,806 6,409
Depreciation and amortization .. 3,838 2,823 2,285 1,516 1,230
Non-recurring charges .......... 5,859 -- -- -- --
Interest ....................... 5,425 2,672 1,591 777 484
--------- -------- -------- -------- --------
Total expenses ........... 209,969 177,536 158,861 133,075 96,517
--------- -------- -------- -------- --------
INCOME (LOSS) BEFORE
INCOME TAXES ................... $ (4,817) $ 4,707 $ 7,376 $ 6,890 $ 6,569
========= ======== ======== ======== ========
NET INCOME (LOSS) ................. $ (3,083) $ 3,013 $ 4,721 $ 4,410 $ 4,204
========= ======== ======== ======== ========
EARNINGS (LOSS) PER SHARE
Basic .......................... $ (.57) $ .56 $ .89 $ .84 $ .80
========= ======== ======== ======== ========
Diluted ........................ $ (.57) $ .56 $ .89 $ .82 $ .80
========= ======== ======== ======== ========
WEIGHTED AVERAGE SHARES
Basic .......................... 5,388 5,339 5,304 5,270 5,250
========= ======== ======== ======== ========
Diluted ........................ 5,388 5,373 5,330 5,381 5,275
========= ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------
ADVOCAT
----------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- ------- ------- -------
BALANCE SHEET DATA: (IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Working capital (deficit) ....... $(17,898) $ 13,849 $13,540 $ 6,726 $ 8,120
======== ======== ======= ======= =======
Total assets .................... $121,294 $114,961 $74,908 $59,031 $45,018
======== ======== ======= ======= =======
Long-term debt, excluding
current portion ............. $ 33,514 $ 58,373 $23,254 $11,063 $ 7,567
======== ======== ======= ======= =======
Shareholders' equity ............ $ 27,561 $ 30,733 $27,348 $22,437 $17,669
======== ======== ======= ======= =======
</TABLE>
29
<PAGE> 30
PRO FORMA SELECTED FINANCIAL DATA
(UNAUDITED)
The following unaudited pro forma consolidated income statement of Advocat for
the year ended December 31, 1994, has 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. This statement has been prepared
as if such transactions occurred on January 1. 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.
30
<PAGE> 31
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.
31
<PAGE> 32
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, 1998, Advocat's portfolio includes 115 facilities composed of
63 nursing homes containing 7,182 licensed beds and 52 assisted living
facilities containing 4,755 units. In comparison, at December 31, 1997, the
Company operated 116 facilities composed of 65 nursing homes containing 7,341
licensed beds and 51 assisted living facilities containing 4,748 units. Within
this portfolio, 30 facilities are managed on behalf of other owners, 24 of which
are on behalf of unrelated owners and 6 in which the Company holds a minority
equity interest. The remaining facilities, consisting of 61 leased and 24 owned
facilities are operated for the Company's own account. In the United States, the
Company operates 52 nursing homes and 33 assisted living facilities, and in
Canada, the Company operates 11 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 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 operations for the years
ended December 31, 1998, 1997, and 1996, and sets forth this data as a
percentage of revenues for the same years.
32
<PAGE> 33
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
($ IN THOUSANDS) 1998 1997 1996
---------------------- --------------------- --------------------
Revenues:
<S> <C> <C> <C> <C> <C> <C>
Patient revenues ..................... $ 166,529 81.2% $163,094 89.5% $153,582 92.4%
Resident revenues .................... 34,804 16.9 15,105 8.3 8,347 5.0
Management fees ...................... 3,627 1.8 3,886 2.1 4,152 2.5
Interest ............................. 192 0.1 158 0.1 156 0.1
--------- ----- -------- ----- -------- -----
Net revenues ....................... 205,152 100.0% 182,243 100.0% 166,237 100.0%
--------- ----- -------- ----- -------- -----
Expenses:
Operating ............................ 164,769 80.3 146,555 80.4 131,966 79.4
Lease ................................ 19,109 9.3 15,850 8.7 14,441 8.7
General and administrative ........... 10,969 5.3 9,636 5.3 8,578 5.1
Depreciation and amortization ........ 3,838 1.9 2,823 1.5 2,285 1.4
Non-recurring charges ................ 5,859 2.9 -0- 0.0 -0- 0.0
Interest ............................. 5,425 2.6 2,672 1.5 1,591 1.0
--------- ----- -------- ----- -------- -----
Total expenses ..................... 209,969 102.3 177,536 97.4 158,861 95.6
--------- ----- -------- ----- -------- -----
Income (loss) before income taxes ...... (4,817) (2.3) 4,707 2.6 7,376 4.4
Provision (benefit) for income taxes ... (1,734) (0.8) 1,694 0.9 2,655 1.6
--------- ----- -------- ----- -------- -----
Net income (loss) .................. $ (3,083) (1.5)% $ 3,013 1.7% $ 4,721 2.8%
========= ===== ======== ===== ======== =====
</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,
---------------------------
1998 1997 1996
------ ------ -----
<S> <C> <C> <C>
Licensed Nursing Home Beds:
Owned ............................................................................ 706 706 706
Leased ........................................................................... 4,158 4,158 4,295
Managed .......................................................................... 2,318 2,477 2,398
------ ------ -----
Total .......................................................................... 7,182 7,341 7,399
====== ====== =====
Assisted Living Units(1):
Owned ............................................................................ 1,302 1,314 125
Leased ........................................................................... 1,883 1,800 534
Managed(2) ....................................................................... 1,570 1,634 1,850
------ ------ -----
Total .......................................................................... 4,755 4,748 2,509
====== ====== =====
Total Beds/Units(1):
Owned ............................................................................ 2,008 2,020 831
Leased ........................................................................... 6,041 5,958 4,829
Managed(2) ....................................................................... 3,888 4,111 4,248
------ ------ -----
Total .......................................................................... 11,937 12,089 9,908
====== ====== =====
Facilities(1):
Owned ............................................................................ 24 25 8
Leased ........................................................................... 61 59 45
Managed(2) ....................................................................... 30 32 34
------ ------ -----
Total .......................................................................... 115 116 87
====== ====== =====
</TABLE>
- ---------------------
(1) Includes assisted living facilities under development for 1998 - one owned
with 79 units, two leased with 100 units and four to be managed with 486
units; for 1997, two owned with 139 units, one leased with 56 units and
one to be managed with 110 units.
(2) Includes six assisted living facilities with 865 units in which the
Company holds a minority equity interest.
33
<PAGE> 34
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Average Occupancy(1):
Leased/Owned(2) ................. 81.6% 83.0% 84.9%
Managed ......................... 95.6 96.3 97.1
------ ------ ------
Total ......................... 84.9% 86.7% 88.6%
====== ====== ======
</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 1996 through 1998:
<TABLE>
<CAPTION>
FACILITIES ADDED
---------------- BEDS/UNITS
PURCHASE LEASE ADDED
-------- ----- -----
<S> <C> <C> <C>
1998 0 0 0
1997 17 15 2,483
1996 4 1 410
</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 1998 and 1997. 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.
34
<PAGE> 35
NON-RECURRING CHARGES
During the second and fourth quarters of 1998, the Company recorded various
non-recurring charges totaling $5.9 million. Information with respect to each
non-recurring charge is presented below:
<TABLE>
<CAPTION>
SECOND FOURTH
QUARTER QUARTER TOTAL
--------------------------------------
<S> <C> <C> <C>
MIS Conversion $ 968,000 $ 198,000 $1,166,000
Impaired Assets - 2,858,000 2,858,000
Legal and Contractual Settlements 282,000 994,000 1,276,000
Termination of Proposed Financing
and Acquisition Transactions 218,000 341,000 559,000
--------------------------------------
$1,468,000 $4,391,000 $5,859,000
======================================
</TABLE>
In connection with its decision to convert all management information systems
with respect to the Company's U.S. nursing homes, the Company abandoned much of
its existing software and eliminated much of its regional infrastructure in
favor of a more centralized accounting organization. The related second quarter
charge represents the costs associated with the write-off of capitalized
software costs ($553,000), the costs associated with the closing of certain
regional offices (primarily future lease commitments, $184,000), and the costs
of severance packages for affected personnel ($231,000). In the fourth quarter,
additional regional office closings were identified, and another charge of
$198,000 was recorded. All of these costs represent future cash requirements
except for the write-off of capitalized software costs. As of December 31, 1998,
$382,000 remains unpaid.
The Company recorded a charge of $2.5 million for the estimated impairment of
the Company's investment in TDLP due to the continuing funding of certain
contractual cash flow requirements. Approximately $1.3 million of this charge
represents a valuation allowance against advances made in 1998 in excess of the
estimated fair value of the Company's investment, while the remaining $1.2
million represents management's estimate of additional future required funding.
In addition, in the fourth quarter of 1998, management identified two locations
for which leases will not be renewed and wrote off the impairment of certain
long-lived assets with respect to these locations ($358,000).
During the second and fourth quarters of 1998, the Company recorded costs
related to certain legal matters and contractual disputes that were settled
during the respective quarters. The largest of these settlements ($638,000)
related to claims submitted in the fourth quarter by the Company's most
significant lessor, Omega, which have been settled.
During the second and fourth quarters of 1998, the Company also wrote off costs
associated with terminated prospective financing and acquisition transactions,
each of which was abandoned in the respective quarter.
35
<PAGE> 36
REGULATORY ISSUES
The Company's 1998 operating results were negatively affected by regulatory
issues in the State of Alabama. During the summer of 1997, two of the Company's
facilities in Mobile were decertified for 69 and 91 days, respectively, before
resurveys found them to be in compliance. In response to the regulatory problems
at the two Mobile facilities, the Company entered into a reorganization of its
regional and facility management and engaged nationally recognized consultants
to assist in achieving compliance, as well as local legal counsel familiar with
the Alabama regulatory environment. Although both of these facilities were
recertified for participation in the Medicare and Medicaid programs in 1997, the
Alabama regulatory issue continued to impact the Company's operations during the
first half of 1998 on two broad fronts: census declines and permanent cost
increases. The Company's response to the decertifications included permanent
staffing increases, which affected all of the Company's Alabama facilities. As
of December 31, 1998, one of the two decertified facilities had fully recovered
to its historical census levels. The other facility, though substantially
improved, still had not fully recovered to the historic census levels that it
had experienced prior to its decertification in 1997.
As a result of the lost revenues from census declines, the permanent cost
increases incurred in response to the Alabama survey issues and miscellaneous
other associated 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 $0.24 per share. Beginning in July of 1998, the Alabama
situation no longer had a significant negative financial impact on the
operations of the Company. Due to the nature of the Alabama Medicaid
reimbursement system, the Company began receiving an improved Medicaid
reimbursement rate that offset its higher staffing cost levels as of July 1,
1998.
During the latter half of 1998, the Company experienced further regulatory
issues with respect to certain other facilities:
- One of the Company's facilities in Arkansas was decertified from the
Medicare and Medicaid programs. This facility was recertified for
Medicaid participation before the decertification had a negative
financial impact on operations, but the facility has not yet been
recertified for Medicare participation.
- The State of Florida imposed a moratorium on new admissions at a
facility during the last quarter of 1998. Additionally, the State
required that the facility increase its staffing during the last half
of 1998. The Company has taken corrective action at this facility and
has employed an external consultant to review the facility's systems
and procedures. The moratorium on admissions was lifted at the end of
January 1999.
- One other facility encountered potential survey problems during the
latter half of 1998, but this facility was not decertified or put on an
admission ban. However, the Company significantly slowed admissions
while corrective actions were being developed and implemented.
MEDICARE REIMBURSEMENT CHANGES
During 1998, the Company began 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 1998, a portion of the
Company's facilities began the three-year transition from the cost reimbursement
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.
Management estimates that the ultimate impact of PPS on its revenues will be a
reduction of $12.0 to $13.0
36
<PAGE> 37
million per year. Since PPS is still an evolving process, the ultimate impact
cannot be known with certainty. However, Management presently believes that it
can reduce its costs in response to PPS, as it is currently structured, such
that there will be 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 the Company's net income. SE has been eliminated in 1999 with
the implementation of fee screens for Medicare Part B services.
Beginning in January 1998, 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 estimates the impact of
this change in 1998 to have been a reduction to after-tax operations of
$575,000, or $.11 per share. In 1999, cost reimbursement of Part B services has
been replaced by a system of fee screens that effectively limit the maximum fees
that may be charged for therapy services. The Company estimates that this will
further negatively impact operations, although the ultimate impact cannot yet
be reasonably estimated.
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997
Revenues. Net revenues increased to $205.2 million in 1998 from $182.2 million
in 1997, an increase of $23.0 million, or 12.6%. Patient revenues increased to
$166.5 million in 1998 from $163.1 million in 1997, an increase of $3.4 million,
or 2.1%. Resident revenues increased $19.7 million, or 130.4%, of which $19.9
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 a
2.3% decline in patient days (approximately 45,000 days) among facilities in
operation for at least one year. Approximately 11,000 of this decline in patient
days is attributable to the facilities that experienced regulatory issues. As a
group, however, they recovered to post a modest gain in patient days in the
fourth quarter. 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 22.1% in 1998 from 25.2% in 1997 while Medicaid and similar programs
increased to 58.8% in 1998 from 55.8% in 1997.
Ancillary service revenues, prior to contractual allowances, increased to $58.0
million in 1998 from $57.0 million in 1997, an increase of $1.0 million or 1.7%.
The Company has emphasized expansion of ancillary services since its inception
in 1994. The modest increase in 1998 is consistent with the slower rate of
growth realized since 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. Because cost limits have
been 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 remain flat or begin
trending down in 1999. 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.
37
<PAGE> 38
Management fee revenues decreased by $258,000, or 6.7%, to $3.6 million. The
decrease is directly due to 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. Prior to the exchange adjustment, Canadian
management fees increased 1.2%.
Operating Expense. Operating expense increased to $164.8 million in
1998 from $146.6 million in 1997, an increase of $18.2 million, or 12.4%. Of
this increase, $12.3 million is attributable to the New Facilities. As a percent
of patient and resident revenues, operating expense decreased to 81.8% in 1998
from 82.2% in 1997. 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. With respect to facilities operated at least one year, the operating
expense percentage was 84.0%. The Company's operating costs relative to revenues
with respect to nursing homes has increased as occupancy has declined and
certain costs have increased in response to regulatory issues. The largest
component of operating expense is wages, which increased to $76.5 million in
1998 from $67.2 million in 1997, an increase of $9.3 million, or 13.8%. 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 $1.8 million, or
2.6%. The Company's wage increases are generally in line with inflation. With
respect to nursing home operations general insurance increased to $6.3 million
in 1998 from $3.9 million in 1997, an increase of $2.4 million, or 60.0%. The
1998 general insurance expense included a fourth quarter charge of $928,000,
based on development of claims, to increase the reserve for expected payments
under the Company's large deductible program. Bad debt expense increased to $2.4
million in 1998 from $2.0 million in 1997, an increase of $361,000, or 17.9%.
The 1998 expense included a charge of $875,000 to increase the allowance for bad
debts based on analysis completed in the fourth quarter.
Lease Expense. Lease expense increased to $19.1 million in 1998 from
$15.8 million in 1997, an increase of $3.3 million, or 20.6%. Of this increase,
$3.0 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 $11.0 million in 1998 from $9.6 million in 1997, an increase of
$1.4 million, or 13.8%. 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 and other regulatory issues. As a
percent of total net revenues, general and administrative expense remained flat
at 5.3% in 1998.
Depreciation and Amortization. Depreciation and amortization expenses increased
to $3.8 million in 1998 from $2.8 million in 1997, an increase of $1.0 million,
or 35.9%. This increase is primarily attributable to the New Facilities.
Interest Expense. Interest expense increased to $5.4 million in 1998
from $2.7 million in 1997, an increase of $2.7 million, or 103.0%. This increase
is primarily attributable to the New Facilities plus interest on additional
borrowings under the Company's credit lines.
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
$5.9 million, the Company lost $(4.8) million before income taxes as compared
with a profit of $4.7 million in 1997, a decrease of $9.5 million, or (202.3)%.
The effective combined federal, state and provincial income tax rate was 36.0%
in both 1998 and 1997. The net loss was $(3.1) million in 1998 as compared with
net income of $3.0 million in 1997, a decrease of $6.1 million, and basic
earnings (loss) per share was $(.57) as compared with $.56.
38
<PAGE> 39
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.
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 $67.2 million in
1997 from $59.2 million in 1996, an increase of $8.0 million, or 13.5%. Of this
increase, $4.8 million is attributable to the New Facilities. Wages with respect
to facilities in operation for
39
<PAGE> 40
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.
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.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had negative working capital of $(17.9)
million and the current ratio was 0.7, compared with $13.8 million and a current
ratio of 1.7 at December 31, 1997. The negative working capital results
primarily from the increase in the Company's current maturities of long-term
debt.
Net cash provided by operating activities totaled $4.1 million, $5.3 million and
$5.4 million in 1998, 1997 and 1996, 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 $8.1 million, $39.9 million and
$10.0 million in 1998, 1997 and 1996, respectively. The Company has used between
$2.4 million and $5.2 million for capital expenditures in each of the last three
calendar years ending December 31, 1998. Substantially all such expenditures
were for facility improvements and equipment, which were financed principally
through working capital. The 1998 additions were higher principally due to the
Company's conversion of its management information systems. For the year ended
December 31, 1999, the Company anticipates that capital expenditures for
improvements and equipment for its existing facility operations will be
approximately $3.9 million, including $1.3 million for non-routine projects.
There were no acquisitions completed in 1998. In 1997, the Company purchased 17
facilities for net cash consideration of $36.2 million. In 1996, the Company
purchased four facilities for net cash consideration of $7.2 million plus $1.6
million in assumed liabilities. In 1998, the Company invested
40
<PAGE> 41
in or advanced funds to joint ventures in the amount of $2.1 million. In
general, the Company has been appointed as manager of the joint venture
properties.
Net cash provided by financing activities totaled $3.7 million, $35.4 million
and $5.5 million in 1998, 1997 and 1996, respectively. The net cash provided
from financing activities primarily represents net proceeds from the issuance
and repayment of debt.
At December 31, 1998, the Company had total debt outstanding of $63.6 million,
of which $10.3 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 $19.2
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 December 31, 1998, the Company's average
interest rate on its indebtedness was 8.2%.
The $34.1 million Bridge Loan is contractually due in April, 1999. The Company
has a loan commitment of up to $25.25 million of three-year financing that
management plans to utilize to refinance a portion of the $34.1 million maturity
on a non-current basis; therefore, the $25.25 million (less current portion of
$132,000) has been classified as non-current in the accompanying consolidated
financial statements. The loan commitment of $25.25 million is available through
May 1999 for up to 80% of the value of the pledged assets, which management
estimates will support utilizing the entire commitment. In addition, the loan
commitment and subsequent loan is subject to certain financial covenants, which
management believes can be achieved. Management is negotiating with the lender
of its working capital line of credit to refinance the remaining $8.85 million
balance under the Bridge Loan in the refinancing of its working capital line of
credit discussed below.
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 December 31, 1998 and March 26, 1999, the Company
had drawn $4.3 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"). 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
April 14, 1999. As of December 31, 1998, the balance drawn under the Overline
totaled $3.8 million. As of March 26, 1999, the Company had drawn $2.7 million
under the Overline. Management is currently negotiating with this lender to
refinance the working capital line of credit, the Overline, and the expected
remaining balance of the Bridge Loan ($8.85 million) on a long-term basis, with
the remainder to be repaid with cash generated from the sale of certain assets,
from the refinancing of certain mortgaged properties, which management believes
may be further leveraged, and from cash generated from operations.
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 December 31, 1998, and March 25, 1999, 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.
41
<PAGE> 42
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, 1998, the Company was in compliance with the covenants or has been
granted a waiver as of December 31, 1998 in the event of non-compliance;
however, it is probable that the Company will not be in compliance with certain
covenants as of March 31, 1999.
At December 31, 1998, $55.2 million of the Company's total debt of $63.6 million
was current, meaning that it must be repaid or refinanced during 1999. Because
the Company has a commitment for $25.2 million, which it expects to draw upon
prior to May 31, 1999, that will refinance a portion of the debt that is
currently due, only $30.1 million is classified as current in the Company's
balance sheet at December 31, 1998. These current maturities are as follows:
$11.1 million under the GMAC acquisition line, secured by four nursing homes,
due in December 1999; $1.2 million mortgage payable to a Canadian bank, secured
by one nursing home, due in December 1999; $4.3 million under the working
capital line of credit, due in December 1999 and $3.8 million under the
Overline, due in April 1999; $8.9 million of the original $34.1 million Bridge
Loan due in July 1999; and miscellaneous current maturities of $780,000. The
Company expects to refinance the $11.1 million GMAC debt and the $1.2 million
Canadian mortgage with long-term fixed-rate debt with the existing mortgage
holders during the fall of 1999. The Company plans to utilize a $25.2 million
commitment from GMAC for long-term financing to significantly pay down the
Bridge Loan prior to May 31, 1999, leaving a balance of $8.9 million still due
to the lending banks. The Company is currently negotiating with the existing
lenders to restructure a portion of this $8.9 million as longer-term debt and
expects to repay a portion of the debt during 1999 through various means such as
the sale of certain assets, refinancing mortgage debt, and through cash
generated from operations. The Company is also currently negotiating with the
existing lender to extend the maturities of the working capital line and the
working capital overline. The Company expects to repay the miscellaneous current
maturities of $780,000 with cash generated from operations. The Company
believes that it will be successful in restructuring its debt as described in
1999.
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.
42
<PAGE> 43
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, 1998 and 1997, totaled $28.3 million and $27.2 million,
respectively, representing approximately 53 and 50 days in accounts receivable,
respectively. Accounts receivable from the provision of management services was
$387,000 and $716,000, respectively, at December 31, 1998 and 1997, representing
approximately 39 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.
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
("PPS") under the Medicare program during a three year "transition period,"
commencing with the first cost reporting period beginning on or after July 1,
1998. During 1998, 20 of the Company's facilities began the PPS transition. The
BBA also contains certain measures that have and could lead to further future
reductions in Medicare therapy cost reimbursement and Medicaid payment rates. As
facts are now known, management believes there will be little or no impact on
net operations from PPS, although both revenues and expenses are expected to be
reduced an estimated $12,000,000 to $13,000,000 from 1997 levels. With respect
to Medicare therapy allowable cost and fee reductions, the Company estimates
43
<PAGE> 44
that net operations was negatively impacted by approximately $575,000 after
taxes in 1998 and will be further negatively impacted in 1999, although the
ultimate effect cannot be reasonably estimated at this time. 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. Although
not material to the Company as a whole, 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 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 $409,000, which will be reported as the cumulative effect of a
change in accounting principle.
IMPACT OF THE YEAR 2000
To date, the Company's evaluation of its Year 2000 ("Y2K") preparedness has
focused on its internal information systems. Management has completed
the management information systems conversion with respect to its United States
nursing home operations. Included in the process of selecting hardware and
software, assurances were 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.
44
<PAGE> 45
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. The Company has received assurances from its
major vendors that they will not be adversely impacted by this issue. 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. Congress' General
Accounting Office ("GAO") has recently concluded that it is highly unlikely that
all Medicare systems will be compliant on time to ensure the delivery of
uninterrupted benefits and services into the year 2000. While the Company does
not receive payments directly from Medicare, the GAO statement could be
interpreted as applying to intermediaries from whom the Company does receive
payment. The Company intends to actively confirm the Y2K readiness status for
each of its intermediaries and other payors. However, the failure of the Company
or third parties to be fully Y2K compliant for essential systems and equipment
by January 1, 2000 could result in interruptions of normal business
transactions.
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 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.
In addition, Management has not completed its evaluation of 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 has reported to the Board of Directors on the Company's ability to
deal with Y2K issues. Management is mandated by the Board of Directors to
continue its evaluations of Y2K preparedness and to make periodic reports of its
assessments and plans. Contingency plans for the Company's Y2K related issues
continue to be developed, including identification of alternate suppliers and
vendors, alternate technologies, and manual systems. The Company is planning to
have contingency plans completed for essential systems and equipment by
September 1, 1999; however, given the nature of the potential problem with
vendors and payors, there can be no assurance that the Company will meet this
objective by such date or by January 1, 2000. The worst case result of assumed
non-compliance in any of several critical areas 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.
The foregoing Y2K disclosure is intended to be a "Year 2000 statement" as the
term is defined in the Year 2000 Information and Readiness Disclosure Act of
1998 (the "Year 2000 Act"), and, to the extent such disclosure relates to Y2K
processing of the Company or to products or services offered by the Company, it
is also intended to be the "Year 2000" readiness disclosure," as that term is
defined in the Year 2000 Act.
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, 1998. 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.
45
<PAGE> 46
These statements involve risks and uncertainties including, but not limited to,
changes in governmental reimbursement or regulation, health care reforms, the
increased cost of borrowing under the Company's credit agreements, covenant
waivers from the Company's lenders, possible amendments to the credit
agreements, the impact of future licensing surveys, 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 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.
46
<PAGE> 47
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Audited financial statements are contained on pages F-1 through F-35 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.
47
<PAGE> 48
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 1999 Annual Meeting of Shareholders.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning Executive Compensation is incorporated herein by
reference to the Company's definitive proxy materials for the Company's 1999
Annual Meeting of Shareholders.
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 1999 Annual Meeting of Shareholders.
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 1999 Annual Meeting of Shareholders.
48
<PAGE> 49
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
FINANCIAL STATEMENTS Pages
- -------------------- -----
<S> <C>
Report of Independent Public Accountants F-1
Consolidated Balance Sheets, December 31, 1998 and 1997 F-2
Consolidated Statements of Operations for the Years Ended December 31, 1998,
1997 and 1996 F-3
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Comprehensive Income for the Years Ended
December 31, 1998, 1997 and 1996 F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998,
1997 and 1996 F-6 to F-8
Notes to Consolidated Financial Statements, December 31, 1998,
1997, and 1996 F-9 to F-35
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.
49
<PAGE> 50
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
April 2, 1999
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) April 2, 1999
April 2, 1999
/s/ Mary Margaret Hamlett /s/ William C. O'Neil
- -------------------------------------------------- ------------------------
Mary Margaret Hamlett William C. O'Neil
Director Director
Executive Vice President, Chief April 2, 1999
Financial Officer, and Secretary
(Principal Financial and Accounting Officer)
April 2, 1999
/s/ Paul Richardson /s/ J. Bransford Wallace
- -------------------------------------------------- ------------------------
Paul Richardson J. Bransford Wallace
Director Director
April 2, 1999 April 2, 1999
50
<PAGE> 51
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Advocat Inc.:
We have audited the accompanying consolidated balance sheets of ADVOCAT INC. (a
Delaware Corporation) and subsidiaries as of December 31, 1998 and 1997 and the
related consolidated statements of operations, shareholders' equity,
comprehensive income and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Advocat Inc. and
subsidiaries as of December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Nashville, Tennessee
April 2, 1999
F - 1
<PAGE> 52
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
- ------------------------------------------- ------------- -------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,347,000 $ 2,673,000
Receivables, less allowance for doubtful
accounts of $2,650,000 and $2,702,000, 26,289,000 26,010,000
respectively
Income taxes receivable 800,000 380,000
Inventories 1,102,000 1,097,000
Prepaid expenses and other assets 1,528,000 1,640,000
Deferred income taxes 1,719,000 830,000
------------- -------------
Total current assets 33,785,000 32,630,000
------------- -------------
PROPERTY AND EQUIPMENT, AT COST 82,140,000 77,354,000
Less accumulated depreciation and
amortization (15,548,000) (12,149,000)
------------- -------------
Net property and equipment 66,592,000 65,205,000
------------- -------------
OTHER ASSETS:
Deferred tax benefit 6,338,000 5,460,000
Deferred financing and other costs, net 1,150,000 1,643,000
Assets held for sale or redevelopment 3,465,000 3,465,000
Investments in and receivables from joint 7,194,000 4,115,000
ventures
Other assets 2,770,000 2,443,000
------------- -------------
Total other assets 20,917,000 17,126,000
------------- -------------
$ 121,294,000 $ 114,961,000
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997
- ------------------------------------ ------------- -------------
CURRENT LIABILITIES:
Current portion of long-term debt $ 30,126,000 $ 762,000
Trade accounts payable 9,327,000 9,365,000
Accrued expenses:
Payroll and employee benefits 4,920,000 5,093,000
Interest 857,000 144,000
Self-insurance reserves 2,375,000 1,337,000
Other 2,413,000 1,540,000
------------- -------------
Total current liabilities 50,018,000 18,241,000
------------- -------------
NONCURRENT LIABILITIES:
Long-term debt, less current portion 33,514,000 58,373,000
Self-insurance reserves, less current 1,665,000 540,000
portion
Deferred gains with respect to leases, 3,293,000 3,562,000
net
Other 5,243,000 3,512,000
------------- -------------
Total noncurrent liabilities 43,715,000 65,987,000
------------- -------------
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, 5,399,000 and
5,377,000 shares issued and
outstanding, respectively 54,000 54,000
Paid-in capital 15,765,000 15,638,000
Retained earnings 11,742,000 15,041,000
------------- -------------
Total shareholders' equity 27,561,000 30,733,000
------------- -------------
$ 121,294,000 $ 114,961,000
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F - 2
<PAGE> 53
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996
------------- ------------ ------------
<S> <C> <C> <C>
REVENUES:
Patient revenues $ 166,529,000 $163,094,000 $153,582,000
Resident revenues 34,804,000 15,105,000 8,347,000
Management fees 3,627,000 3,886,000 4,152,000
Interest 192,000 158,000 156,000
------------- ------------ ------------
205,152,000 182,243,000 166,237,000
------------- ------------ ------------
EXPENSES:
Operating 164,769,000 146,555,000 131,966,000
Lease 19,109,000 15,850,000 14,441,000
General and administrative 10,969,000 9,636,000 8,578,000
Depreciation and amortization 3,838,000 2,823,000 2,285,000
Non-recurring charges 5,859,000 - -
Interest 5,425,000 2,672,000 1,591,000
------------- ------------ ------------
209,969,000 177,536,000 158,861,000
------------- ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES (4,817,000) 4,707,000 7,376,000
PROVISION (BENEFIT) FOR INCOME TAXES (1,734,000) 1,694,000 2,655,000
------------- ------------ ------------
NET INCOME (LOSS) $ (3,083,000) $ 3,013,000 $ 4,721,000
============= ============ ============
EARNINGS (LOSS) PER SHARE:
Basic $ (.57) $ .56 $ .89
------------- ------------ ------------
Diluted $ (.57) $ .56 $ .89
------------- ------------ ------------
WEIGHTED AVERAGE SHARES:
Basic 5,388,000 5,339,000 5,304,000
------------- ------------ ------------
Diluted 5,388,000 5,373,000 5,330,000
------------- ------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F - 3
<PAGE> 54
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, 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, net of tax - - - (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, net of tax - - - (184,000) (184,000)
--------- ------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 1997 5,377,000 54,000 15,638,000 15,041,000 30,733,000
Issuance of common stock 22,000 - 127,000 - 127,000
Net loss - - - (3,083,000) (3,083,000)
Translation loss, net of tax - - - (216,000) (216,000)
--------- ------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 1998 5,399,000 $54,000 $15,765,000 $ 11,742,000 $ 27,561,000
========= ======= =========== ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F - 4
<PAGE> 55
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996
------------- ------------ ------------
<S> <C> <C> <C>
NET INCOME (LOSS) $ (3,083,000) $ 3,013,000 $ 4,721,000
OTHER COMPREHENSIVE INCOME (LOSS):
Foreign currency translation
adjustments (338,000) (286,000) (28,000)
Income tax benefit 122,000 102,000 10,000
------------- ------------ ------------
(216,000) (184,000) (18,000)
------------- ------------ ------------
COMPREHENSIVE INCOME (LOSS) $ (3,299,000) $ 2,829,000 $ 4,703,000
============= ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F - 5
<PAGE> 56
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1998 1997 1996
----------- ------------ -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $(3,083,000) $ 3,013,000 $ 4,721,000
Items not involving cash:
Depreciation and amortization 3,838,000 2,861,000 2,285,000
Provision for doubtful accounts 2,306,000 2,029,000 1,745,000
Deferred income taxes (1,645,000) 2,131,000 778,000
Equity earnings in joint ventures (69,000) (53,000) (39,000)
Amortization of deferred credits (513,000) (1,022,000) (1,111,000)
Non-recurring charge write-off 1,630,000 -- --
Asset impairment provision 2,858,000 -- --
Changes in other non-cash items, net of acquisitions:
Receivables (4,306,000) (3,878,000) (6,037,000)
Inventories (5,000) (430,000) (159,000)
Prepaid expenses and other assets (273,000) (206,000) 48,000
Trade accounts payable and
accrued expenses 3,367,000 847,000 3,257,000
Other (36,000) 12,000 (133,000)
----------- ------------ -----------
Net cash provided by operating activities 4,069,000 5,304,000 5,355,000
----------- ------------ -----------
INVESTING ACTIVITIES:
Acquisitions, net of cash acquired -0- (36,151,000) (7,180,000)
Purchases of property and equipment, net (5,186,000) (2,710,000) (2,409,000)
Investment in TDLP (632,000) (655,000) -
Mortgage receivable, net 118,000 (307,000) (236,000)
Investment in joint ventures, net (2,086,000) 36,000 27,000
Deposits, pre-opening costs and other (577,000) (349,000) (258,000)
TDLP partnership distributions 307,000 201,000 97,000
----------- ------------ -----------
Net cash used in investing activities (8,056,000) (39,935,000) (9,959,000)
----------- ------------ -----------
</TABLE>
(continued)
F - 6
<PAGE> 57
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1998 1997 1996
----------- ------------ ------------
<S> <C> <C> <C>
FINANCING ACTIVITIES:
Proceeds from issuance of debt $ - $ 36,129,000 $ 18,688,000
Repayment of debt obligations (890,000) (730,000) (11,703,000)
Financing costs (207,000) (535,000) (386,000)
Net proceeds from bank lines of credit 5,674,000 3,000 4,531,000
Repayment of bank line of credit - - (4,130,000)
Lessor advances, net - 442,000 (523,000)
Proceeds from sale of common stock 127,000 556,000 208,000
Advances to TDLP (1,043,000) (503,000) (1,215,000)
----------- ------------ ------------
Net cash provided by financing activities 3,661,000 35,362,000 5,470,000
----------- ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (326,000) 731,000 866,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,673,000 1,942,000 1,076,000
----------- ------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,347,000 $ 2,673,000 $ 1,942,000
=========== ============ ============
SUPPLEMENTAL INFORMATION:
Cash payments of interest $ 5,016,000 $ 2,526,000 $ 1,572,000
=========== ============ ============
Cash payments of income taxes $ 330,000 $ 392,000 $ 665,000
=========== ============ ============
</TABLE>
(continued)
F - 7
<PAGE> 58
ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
NON-CASH TRANSACTIONS:
The Company assumed debt of $1,592,000 in connection with the acquisition of
facilities in 1996.
Foreign currency translation loss adjustments, net of tax, totaled $216,000,
$184,000 and $18,000 for 1998, 1997 and 1996, respectively.
The Company received net benefit plan deposits and earnings and recorded net
benefit plan liabilities of $443,000, $265,000 and $172,000 for 1998, 1997 and
1996, respectively.
The accompanying notes are an integral part of these consolidated financial
statements.
F - 8
<PAGE> 59
ADVOCAT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
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 its 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, 1998, the Company operates 115 facilities, consisting of 63 nursing
homes with 7,182 licensed beds and 52 assisted living facilities with
4,755 units. Within this portfolio, 30 facilities are managed on behalf
of other owners, 24 on behalf of unrelated owners and 6 in which the
Company holds a minority equity interest. The remaining facilities,
consisting of 61 leased and 24 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 - 9
<PAGE> 60
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
$54,618,000, $38,245,000 and $41,801,000 for 1998, 1997 and 1996,
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
76.0% of 1998 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 during 1999 and 2000.
LEASE EXPENSE
The Company operates 61 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"), 14 owned by members or affiliates of Pierce
Management Group ("Pierce") and six 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 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.
F - 10
<PAGE> 61
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 $2,306,000, $2,030,000 and $1,745,000 for 1998, 1997 and
1996, 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:
<TABLE>
<S> <C>
Buildings and leasehold improvements - 10 to 40 years
Furniture and equipment - 2 to 15 years
Vehicles - 5 years
</TABLE>
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 and
other long-lived assets in light of each property's or asset's cash
flow and estimated fair value.
F - 11
<PAGE> 62
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 certain of
these costs from cost-reimbursement programs over the five-year period
following incurrence.
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 consolidated statements of
operations, 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 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 operations
purposes) and respective year-end rates (for consolidated balance sheet
purposes). The cumulative foreign currency translation loss, net of
tax, included in retained earnings is $412,000 as of December 31, 1998.
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 - 12
<PAGE> 63
OTHER COMPREHENSIVE INCOME
The Company has adopted Statement of Financial Accounting Standards No.
130, Reporting on Comprehensive Income, which 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 as follows:
Foreign Currency Translation:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- --------
<S> <C> <C> <C>
Beginning balance $(196,000) $ (12,000) $ 6,000
Current period change, net of tax (216,000) (184,000) (18,000)
--------- --------- --------
Ending balance $(412,000) $(196,000) $(12,000)
========= ========= ========
</TABLE>
Positive amounts represent unrealized translation gains, and negative
amounts represent unrealized translation losses.
EARNINGS PER SHARE
The Company utilizes SFAS No. 128, "Earnings Per Share," for the
financial reporting of 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.
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, and the disclosed amounts 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 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 $409,000, which
will be reported as the cumulative effect of a change in accounting
principle.
F - 13
<PAGE> 64
RECLASSIFICATIONS
Certain amounts in the 1997 and 1996 financial statements have been
reclassified to conform with the 1998 presentation.
3. RECEIVABLES
Accounts receivable, before allowances, consists of the following
components:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1998 1997
--------------- ---------------
<S> <C> <C>
Medicare $ 10,809,000 $ 13,155,000
Medicaid and other non-federal programs 10,614,000 8,412,000
Other patient and resident receivables 6,868,000 5,608,000
Management fees - affiliates 354,000 375,000
Management fees 32,000 341,000
Other receivables and advances 262,000 821,000
--------------- ---------------
$ 28,939,000 $ 28,712,000
=============== ===============
</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. The Company's management
believes that all appropriate reserves have been provided for as of
December 31, 1998.
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 facilities 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. Rather than redevelop certain of the
properties as originally planned, the Company has since elected to sell
one facility with 60 units and is still evaluating plans for another
facility with 79 units.
F - 14
<PAGE> 65
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. The pro forma effect 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 $3,293,000 as of December 31, 1998.
Amortization of the deferred gain totaled $246,000 for each of the
years 1998, 1997 and 1996 and is included as a decrease to lease
expense in the accompanying consolidated statements of operations.
F - 15
<PAGE> 66
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 $2,572,000 as of December 31, 1998. 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 and an additional 2.6% in January 1999 for a cumulative
total of 22.6%. Total consideration for these purchases was $1,444,000.
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, 1998, the Company has provided working capital
funding and requirements under the cash flow guarantee to TDLP totaling
$4,285,000.
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 operations will continue to reflect the operations of the
facilities until the expiration of the Company's commitments with
respect to TDLP.
F - 16
<PAGE> 67
The Company continually evaluates the funding contingencies discussed
above in relation to the balance in the advance liability account, the
future wrap mortgage receivable collections, and the estimated fair
value of the related nursing homes. In accordance with SFAS No. 121,
the Company has previously recognized the advances receivable from TDLP
since the Company's recorded net assets with respect to TDLP were 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.
Based upon management's evaluation at December 31, 1998, the Company
has recognized a charge of $2,500,000 for the estimated impairment of
the Company's investment in TDLP.
The consolidated statements of operations include the recognition of
income and expenses from the TDLP homes since the sale. During 1998,
1997, and 1996, the consolidated statements of operations include TDLP
results of operations before taxes of $(287,000), $123,000 and $83,000,
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,
------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Land $ 4,595,000 $ 4,541,000
Buildings and leasehold improvements 58,194,000 56,688,000
Furniture, fixtures and equipment 19,351,000 16,125,000
----------- -----------
$82,140,000 $77,354,000
=========== ===========
</TABLE>
Substantially all of the Company's gross property and equipment is
security for debt obligations.
F - 17
<PAGE> 68
8. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------
1998 1997
-------------- --------------
<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 (8.37% at December 31, 1998);
balloon maturity in July 1999. $ 34,100,000 $ 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
(7.83% at December 31, 1998); 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 (8.12% at December 31, 1998); balloon maturities of $4,350,000
in December 1999 and $3,762,000 in April, 1999. 8,112,000 2,439,000
Mortgage payable to bank; secured by the six TDLP nursing homes; interest
and principal payable monthly, interest at 8.00%; matures in August
2001 2,572,000 3,245,000
</TABLE>
F - 18
<PAGE> 69
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1998 1997
------------ ------------
<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 $ 5,201,000 $ 5,650,000
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% (8.50% at December 31, 1998); balloon maturity in August
2001 2,393,000 2,411,000
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% (8.50% at
December 31, 1998); balloon maturity in August 2001 162,000 164,000
Promissory note payable to Omega - 26,000
------------ ------------
63,640,000 59,135,000
Less current portion (30,126,000) (762,000)
------------ ------------
$ 33,514,000 $ 58,373,000
============ ============
</TABLE>
Principal payments for the Company on long-term debt for the next five
years and thereafter beginning January 1, 1999, are as follows:
<TABLE>
<S> <C>
1999 $ 30,126,000
2000 1,058,000
2001 3,580,000
2002 25,125,000
2003 86,000
Thereafter 3,665,000
----------------
$ 63,640,000
================
</TABLE>
F - 19
<PAGE> 70
The $34,100,000 promissory note is contractually due in April, 1999.
The Company has a loan commitment of up to $25,250,000 of three-year
financing that management plans to utilize to refinance a portion of
the $34,100,000 maturity on a non-current basis; therefore, the
$25,250,000 (less current portion of $132,000) has been classified as
non-current in the accompanying consolidated financial statements. The
loan commitment of $25,250,000 is available through May 1999 for up to
80% of the value of the pledged assets, which management estimates will
support utilizing the entire commitment. In addition, the loan
commitment and subsequent loan is subject to certain financial
covenants, which management believes can be achieved. Management is
negotiating with the lender of its working capital line of credit to
refinance the remaining $8,850,000 balance under this promissory note
in the refinancing of its working capital line of credit discussed
below.
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, 1998, the
Company had drawn $4,350,000, had $5,650,000 of letters of credit
outstanding, and had no remaining borrowing capability under the
working capital line. The Company has received an increase from its
lenders in the working capital line of credit availability of
$4,000,000 (the "Overline"). The Overline is subject to the same terms
and conditions as the $10,000,000 working capital line of credit. The
Overline terminates and all outstanding borrowings are due in April,
1999. As of December 31, 1998, the balance drawn under the Overline
totaled $3,762,000. Management is currently negotiating with this
lender to refinance the working capital line of credit, the Overline,
and the expected remaining balance of the promissory note ($8,850,000)
on a long-term basis, with the remainder to be repaid with cash
generated from the sale of certain assets, from the refinancing of
certain mortgaged properties, which management believes may be further
leveraged, and from cash generated from operations.
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, 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. Management expects to refinance the $11,100,000
outstanding balance under this line of credit during 1999 on a
long-term basis with the existing mortgage holder.
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, 1998, the Company was in compliance
with the covenants or has been granted a waiver as of December 31, 1998
in the event of non-compliance; however, it is probable that the
Company will not be in compliance with certain covenants as of March
31, 1999.
At December 31, 1998, the classification of certain debt instruments as
current liabilities based upon their contractual maturities in 1999
results in negative working capital of $(17,898,000). As discussed
above, Management is pursuing various alternatives to potentially
refinance these debt instruments on a non-current basis.
F - 20
<PAGE> 71
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, as amended
December 7, 1998, 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 1998, 1,060,000 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 closing
market price on the day prior to 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 1998, 1997 and 1996, 22,000, 17,000 and 21,000 shares were issued
pursuant to this plan, respectively. The fair value of shares sold
under the plan was $6.87 in 1998 and $9.50 in both 1997 and 1996.
F - 21
<PAGE> 72
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,
--------------------------------------------------------
1998 1997 1996
-------------- ------------- -------------
<S> <C> <C> <C>
Net Income (Loss):
As reported $ (3,083,000) $ 3,013,000 $ 4,721,000
============== ============= =============
Pro forma $ (3,541,000) $ 2,813,000 $ 4,447,000
============== ============= =============
Basic Earnings (Loss) Per Share:
As reported $ (.57) $ .56 $ .89
============== ============= =============
Pro forma $ (.66) $ .53 $ .84
============== ============= =============
Diluted Earnings (Loss) Per Share:
As reported $ (.57) $ .56 $ .89
============== ============= =============
Pro forma $ (.66) $ .52 $ .83
============== ============= =============
</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 - 22
<PAGE> 73
Summarized activity of the stock option plans is presented below:
<TABLE>
<CAPTION>
SHARES
-------------------------- WEIGHTED
KEY PERSONNEL DIRECTOR AVERAGE
PLAN PLAN EXERCISE PRICE
------------- -------- --------------
<S> <C> <C> <C>
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
Issued 196,000 6,000 9.76
Exercised - - -
Expired or canceled (33,000) - 9.81
-------- -------- ------
Outstanding,
December 31, 1998 647,000 117,000 $ 9.71
======== ======== =======
Vested, December 31, 1998 506,000 106,000 $ 9.68
======== ======== ======
Available for future grants,
December 31, 1998 357,000 63,000
======== ========
</TABLE>
F - 23
<PAGE> 74
The outstanding options have exercise prices ranging from $5.56 to
$13.13 and have a weighted average remaining life of 7.5 years. The
weighted average fair value of options granted was $4.62, $4.20 and
$4.10 in 1998, 1997 and 1996, 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 1998, 1997 and 1996 grants: risk free interest
rates ranging from 5.0% to 5.7% for 1998, 5.7% to 6.2% for 1997 and
from 5.5% to 6.1% for 1996; no expected dividend yield for each of the
years; expected lives of five years for each of the years; and,
expected volatility of 44.4% for 1998, 37.2% for 1997 and 38.5% for
1996.
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
NET INCOME (LOSS)
(LOSS) SHARES PER SHARE
----------- --------- ---------
<S> <C> <C> <C>
Year ended December 31, 1998:
Basic earnings per share $(3,083,000) 5,388,000 $(.57)
----------- --------- ====
Employee stock purchase plan - -
Options - -
----------- ---------
Diluted earnings per share $(3,083,000) 5,388,000 $(.57)
=========== ========= =====
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
=========== ========= ====
</TABLE>
F - 24
<PAGE> 75
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 719,000, 352,000 and 320,000 for 1998, 1997 and 1996,
respectively.
11. INCOME TAXES
The provision (benefit) for income taxes is composed of the following
components:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Current payable (benefit):
Federal $ (577,000) $ (823,000) $1,498,000
State and province 488,000 386,000 379,000
----------- ----------- ----------
(89,000) (437,000) 1,877,000
----------- ----------- ----------
Deferred taxes:
Federal $(1,405,000) 1,941,000 621,000
State and province (240,000) 190,000 157,000
----------- ----------- ----------
(1,645,000) 2,131,000 778,000
----------- ----------- ----------
Provision (benefit) for
income taxes $(1,734,000) $ 1,694,000 $2,655,000
=========== =========== ==========
</TABLE>
A reconciliation of taxes computed at statutory income tax rates is as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Provision for federal income
taxes at statutory rates $(1,638,000) $ 1,600,000 $2,508,000
State and province income taxes,
net of benefit (193,000) 118,000 295,000
Other 97,000 (24,000) (148,000)
----------- ----------- ----------
Provision (benefit) for
income taxes $(1,734,000) $ 1,694,000 $2,655,000
=========== =========== ==========
</TABLE>
F - 25
<PAGE> 76
The net deferred tax assets and liabilities, at the respective income
tax rates are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Current deferred asset:
Accrued liabilities $ 1,719,000 $ 830,000
============ ============
Non-current deferred asset:
Net operating loss $ 1,222,000 $ -
Tax gain on sale transactions in excess of
recognized financial reporting gain 1,043,000 1,420,000
Tax goodwill and intangibles 9,170,000 10,217,000
Impairment of TDLP net assets 950,000 -
Other 323,000 251,000
------------ ------------
12,708,000 11,888,000
Less valuation allowance (5,500,000) (5,688,000)
------------ ------------
7,208,000 6,200,000
------------ ------------
Non-current deferred liability:
Deferred costs (136,000) (244,000)
Depreciation (734,000) (496,000)
------------ ------------
(870,000) (740,000)
------------ ------------
Net non-current deferred asset $ 6,338,000 $ 5,460,000
============ ============
</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 $188,000 in 1998 and
$221,000 in 1997. 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 - 26
<PAGE> 77
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, 1999, are as
follows:
1999............19,635,000
2000............20,148,000
2001............20,625,000
2002............21,106,000
2003............21,464,000
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 $19,109,000, $15,850,000
and $14,441,000, for 1998, 1997 and 1996, respectively.
One operating lease (expiring March 31, 1999) 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, 1998 or had received
a waiver in the event of non-compliance. 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, 1998. The Company is leasing the two
facilities mortgaged by these bonds.
F - 27
<PAGE> 78
Effective December 1, 1994, the Company entered into a series of
agreements with Omega and a third party ultimately resulting in the
Company leasing from Omega a total of nine additional nursing
facilities with a total of 805 beds. Through December 31, 1998, the
Company has executed formal lease agreements with respect to five of
the nine facilities. Formal lease agreements with respect to the
remaining four facilities were executed in March 1999. Prior to that
time, these four facilities were managed by the Company. Under the
management agreements, the Company was responsible for the operating
assets and liabilities of the facilities and received a management fee
equal to the net profits of the facilities. The Company accounted for
these four properties as operating leases in anticipation of the
completion of formal lease agreements. The initial lease period for all
nine facilities will expire in May 2005 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 through
September 2012 and two five-year renewal options. Beginning at the
fifth anniversary, the Company has a right to purchase all 12
facilities as a group for their fair market value. An additional
sublease, which expires in 2003, is with an affiliate of Pierce who is
a current employee of the Company. The remaining lease is a sublease
that expires in 2017.
F - 28
<PAGE> 79
SELF-INSURANCE MATTERS
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. Effective January 1998, the
Company substantially increased the self-insurance portion of its
liability with respect to its United States nursing home operations up
to $250,000 per occurrence and $2,500,000 in the aggregate per year.
For 1998, the Company expects to incur fully the aggregate deductible
amount. A reserve was established in anticipation of the settlement of
1998 claims, which may take up to four years from the date of the
injury event to reach final settlement. (See Note 13.) The ultimate
results of these claims and disputes are unknown at the present time,
but management is of the opinion that there would be no material
amounts in excess of liability coverages and established reserves.
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 a non-subscriber
to the Texas worker's compensation system and is, therefore, completely
self-insured for employee injuries 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, 1998. 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. In the current policy year, expected claims under this
program are approximately $2,900,000, and the Company has secured
stop-loss insurance coverage for claims in excess of approximately
$3,600,000. The Company provides reserves for the settlement of
outstanding self-insured health 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 $1,900,000. 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 - 29
<PAGE> 80
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. It is the Company's intention to terminate
the SERP in 1999.
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 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 were recertified for
participation in the Medicare and Medicaid programs in 1997.
During the latter half of 1998, the Company experienced further
regulatory issues with respect to certain facilities. One of the
Company's facilities in Arkansas was decertified from the Medicare and
Medicaid programs. This facility was recertified for Medicaid
participation before the decertification had a negative financial
impact on operations, but the facility has not yet been recertified for
Medicare participation. The State of Florida imposed a moratorium on
new admissions as well as civil monetary penalties upon a facility
during the last quarter of 1998. Additionally, the State required that
the facility increase its staffing during the last half of 1998. The
Company is appealing the civil monetary penalties. The moratorium on
admissions was lifted at the end of January 1999.
F - 30
<PAGE> 81
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 ("PPS") under the Medicare program during a
three year "transition period," commencing with the first cost
reporting period beginning on or after July 1, 1998. During 1998, 20 of
the Company's facilities began the PPS transition. The BBA also
contains certain measures that have and could lead to further future
reductions in Medicare therapy cost reimbursement and Medicaid payment
rates. As facts are now known, management believes the impact on net
operations from PPS will not be significant, although both revenues and
expenses are expected to be reduced from 1997 levels. With respect to
Medicare therapy allowable cost and fee reductions, the Company
estimates that net operations were negatively impacted in 1998 and will
be further negatively impacted in 1999 although the ultimate negative
impact on the Company's operations cannot be reasonably estimated.
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 was self-insured for the first $25,000 per occurrence and
$500,000 in the aggregate for such claims. Effective January 1, 1998,
these self-insured per claim and aggregate amounts increased to
$250,000 and $2,500,000, respectively. Effective February 1, 1999, the
remaining United States nursing homes become part of the
$250,000/$2,500,000 deductible program. 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 $3,267,000 ($5,000,000 Canadian). In addition, the Company
maintains an aggregate umbrella liability policy of equal amount for
claims in excess of the above limit for these facilities.
F - 31
<PAGE> 82
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, through January 31, 1999 TDLP
maintains a $10,000,000 aggregate umbrella liability policy for claims in
excess of the foregoing limits for these facilities. Effective February 1,
1999, TDLP became insured locations under the Company's $50,000,000
aggregate umbrella policy.
14. OPERATING SEGMENT INFORMATION
In June 1997, the Financial Accounting Standards Board issued Statement
No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which was adopted by the Company on January 1, 1998. The
Company has three reportable segments: U.S. nursing homes, U.S. assisted
living facilities, and Canadian operations, which consist of both nursing
home and assisted living services. Management evaluates each of these
segments independently due to the geographic, reimbursement, marketing,
and regulatory differences between the segments. The accounting policies
of these segments are the same as those described in the summary of
significant accounting policies described in Note 2. Management evaluates
performance based on profit or loss from operations before income taxes
not including nonrecurring gains and losses and foreign exchange gains and
losses. The following information is derived from the Company's segments'
internal financial statements and include information related to the
Company's unallocated corporate revenues and expenses:
<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Net revenues:
U.S. nursing homes $164,646,000 $161,683,000 $153,773,000
U.S. assisted living facilities 25,552,000 6,296,000 --
Canadian operations 14,950,000 14,248,000 12,440,000
Corporate 954,000 956,000 24,000
Eliminations (950,000) (940,000) --
------------ ------------ ------------
Total $205,152,000 $182,243,000 $166,237,000
============ ============ ============
Depreciation and amortization:
U.S. nursing homes $ 2,138,000 $ 2,095,000 $ 2,008,000
U.S. assisted living facilities 1,263,000 306,000 --
Canadian operations 347,000 298,000 185,000
Corporate 90,000 124,000 92,000
Eliminations -- -- --
------------ ------------ ------------
Total $ 3,838,000 $ 2,823,000 $ 2,285,000
============ ============ ============
</TABLE>
(continued)
F - 32
<PAGE> 83
<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Operating income (loss):
U.S. nursing homes $ (3,240,000) $ 4,264,000 $ 8,286,000
U.S. assisted living facilities 708,000 223,000 --
Canadian operations 1,912,000 1,889,000 1,617,000
Corporate (4,197,000) (1,669,000) (2,527,000)
Eliminations -- -- --
------------ ------------ --------------
Total $ (4,817,000) $ 4,707,000 $ 7,376,000
============ ============ ==============
Long-lived assets:
U.S. nursing homes $ 56,396,000 $ 54,315,000 $ 50,645,000
U.S. assisted living facilities 33,987,000 34,552,000 --
Canadian operations 10,536,000 9,337,000 6,735,000
Corporate 21,725,000 21,017,000 20,787,000
Eliminations (35,135,000) (36,890,000) (36,747,000)
------------ ------------ --------------
Total $ 87,509,000 $ 82,331,000 $ 41,420,000
============ ============ ==============
Total assets:
U.S. nursing homes $ 88,473,000 $ 82,997,000 $ 78,212,000
U.S. assisted living facilities 36,926,000 35,484,000 --
Canadian operations 13,718,000 14,327,000 10,605,000
Corporate 24,909,000 22,712,000 23,781,000
Eliminations (42,732,000) (40,559,000) (40,212,000)
------------ ------------ --------------
Total $121,294,000 $114,961,000 $ 72,386,000
============ ============ ==============
Capital expenditures:
U.S. nursing homes $ 4,043,000 $ 2,216,000 $ 2,164,000
U.S. assisted living facilities 688,000 59,000 --
Canadian operations 422,000 408,000 239,000
Corporate 33,000 27,000 6,000
Eliminations -- -- --
------------ ------------ -------------
Total $ 5,186,000 $ 2,710,000 $ 2,409,000
============ ============ =============
</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 $1,742,000, $1,814,000
and $1,656,000 for 1998, 1997 and 1996, respectively.
The Company has loaned one of the limited partnerships $1,050,000 and
$1,274,000 as of December 31, 1998 and 1997, 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.
F - 33
<PAGE> 84
Lease expense related to the facilities leased from Counsel totaled
$2,064,000, $2,091,000 and $2,078,000 for the years ended December 31,
1998, 1997 and 1996, respectively.
16. NON-RECURRING CHARGES
During the second and fourth quarters of 1998, the Company recorded
various non-recurring charges totaling $5,859,000. Information with
respect to each non-recurring charge is presented below:
<TABLE>
<CAPTION>
SECOND FOURTH
QUARTER QUARTER TOTAL
---------- ---------- ----------
<S> <C> <C> <C>
MIS Conversion $ 968,000 $ 198,000 $1,166,000
Impaired Assets -- 2,858,000 2,858,000
Legal and Contractual Settlements 282,000 994,000 1,276,000
Termination of Proposed Financing
and Acquisition Transactions 218,000 341,000 559,000
---------- ---------- ----------
$1,468,000 $4,391,000 $5,859,000
========== ========== ==========
</TABLE>
In connection with its decision to convert all management information
systems with respect to the Company's U.S. nursing homes, the Company
abandoned much of its existing software and eliminated much of its
regional infrastructure in favor of a more centralized accounting
organization. The related second quarter charge represents the costs
associated with the write-off of capitalized software costs ($553,000),
the costs associated with the closing of certain regional offices
(primarily future lease commitments, $184,000), and the costs of
severance packages for affected personnel ($231,000). In the fourth
quarter, additional regional office closings were identified, and
another charge of $198,000 was recorded. All of these costs represent
future cash requirements except for the write-off of capitalized
software costs. As of December 31, 1998, $382,000 remains unpaid.
As discussed in Note 6, the Company recorded a charge of $2,500,000 for
the estimated impairment of the Company's investment in TDLP due to the
continuing funding of certain contractual cash flow requirements.
Approximately $1,300,000 of this charge represents a valuation
allowance against advances made in 1998 in excess of the estimated fair
value of the Company's investment, while the remaining $1,200,000
represents management's estimate of additional future required funding.
In addition, in the fourth quarter of 1998, management identified two
locations for which leases will not be renewed and wrote off the
impairment of certain long-lived assets with respect to these locations
($358,000).
During the second and fourth quarters of 1998, the Company recorded
costs related to certain legal matters and contractual disputes that
were settled during the respective quarters. The largest of these
settlements ($638,000) related to claims submitted in the fourth
quarter by the Company's most significant lessor, Omega (See Notes 2
and 12), which have been settled.
During the second and fourth quarters of 1998, the Company also wrote
off costs associated with terminated prospective financing and
acquisition transactions, each of which was abandoned in the respective
quarter.
F - 34
<PAGE> 85
17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
QUARTER
-------------------------------------------------------------------------------
1998 FIRST SECOND THIRD FOURTH
-------------------------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Net revenues $51,493,000 $52,698,000 $51,305,000 $ 49,656,000
=========== =========== =========== ============
Net income (loss) $ 355,000(1) $ (337,000)(1)(2) $ 800,000 $ (3,901,000)(2)(3)
=========== =========== =========== ============
Basic and diluted earnings
(loss) per share $ .07(1) $ (.06)(1)(2) $ .15 $ (.72)(2)(3)
=========== =========== =========== ============
<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(1) $ 98,000(1)
=========== =========== =========== ===========
Basic and diluted earnings per
share $ .24 $ .25 $ .06(1) $ .02(1)
=========== =========== =========== ===========
</TABLE>
- ---------------
(1) Includes the negative impact of two nursing homes being decertified
from participation in the Medicare and Medicaid programs.
(2) Includes non-recurring charges primarily related to conversion of
management information systems as well as legal and contractual
settlements. (See Note 16.)
(3) Includes non-recurring charges primarily related to SFAS No. 121 asset
impairment. (See Note 16.)
F - 35
<PAGE> 86
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Advocat Inc.:
We have audited, in accordance with generally accepted auditing standards, the
consolidated financial statements of Advocat Inc., included in this Annual
Report on Form 10-K and have issued our report thereon dated April 2, 1999.
Our audit was made for the purpose of forming an opinion on those statements
taken as a whole. The financial statement schedule listed in the index under
Item 16(b) is the responsibility of the Company's management and is presented
for purposes of complying with the Securities and Exchange Commission's rules
and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic financial
statements, and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Nashville, Tennessee
April 2, 1999
S-1
<PAGE> 87
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,
1998:
Allowance
for doubtful
accounts $ 2,702 $ 2,306 $ - $ - $ 2,358 $ 2,650
=============================================================================================================
Year ended
December 31,
1997:
Allowance
for doubtful
accounts $ 2,524 $ 2,030 $ - $ - $ 1,852 $ 2,702
=============================================================================================================
Year ended
December 31,
1996:
Allowance
for doubtful
accounts $ 2,082 $ 1,745 $ - $ - $ 1,303 $ 2,524
=============================================================================================================
</TABLE>
- --------------------
(1) Amounts written off as uncollectible accounts, net of recoveries.
S-2
<PAGE> 88
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
2.1 Asset Purchase Agreement among the Company, Pierce Management Group
First Partnership and others dated July 23, 1997 (incorporated by
reference to Exhibit 2 to the Company's quarterly report on Form 10-Q
for the quarter ended June 30, 1997).
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 the Company's
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).
4.5 Amended and Restated Rights Agreement dated as of December 7, 1998
(incorporated by reference to Exhibit 1 to Form 8-A/A filed December 7,
1998).
10.1 Asset Contribution Agreement among Counsel Corporation and Certain of
its Direct and Indirect Subsidiaries dated May 10, 1994 (incorporated
by reference to Exhibit 10.1 to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1994).
10.2 Asset Contribution Agreement among Diversicare Inc. and Certain of its
Direct and Indirect Subsidiaries dated May 10, 1994 (incorporated by
reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1994).
10.3 1994 Incentive and Non-Qualified Stock Plan for Key Personnel
(incorporated by reference to Exhibit 10.3 to the Company's
Registration Statement No. 33-76150 on Form S-1).
</TABLE>
<PAGE> 89
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
10.4 1994 Non-Qualified Stock Option Plan for Directors (incorporated by
reference to Exhibit 10.4 to the Company's Registration Statement No.
33-76150 on Form S-1).
10.5 Master Agreement and Supplemental Executive Retirement Plan
(incorporated by reference to Exhibit 10.6 to the Company's
Registration Statement No. 33-76150 on Form S-1).
10.6 1994 Employee Stock Purchase Plan (incorporated by reference to Exhibit
10.7 to the Company's Registration Statement No. 33-76150 on Form S-1).
10.7 Form of Employment Agreements dated May 10, 1994, between the
Registrant and Dr. Birkett, Mr. Richardson and Ms. Hamlett
(incorporated by reference to Exhibit 10.8 to the Company's
Registration Statement No. 33-76150 on Form S-1).
10.8 Form of Director Indemnification Agreement (incorporated by reference
to Exhibit 10.8 to the Company's Registration Statement No. 33-76150 on
Form S-1).
10.9 Master Lease Agreement dated August 14, 1992, between Diversicare
Corporation of America and Omega Healthcare Investors, Inc.
(incorporated by reference to Exhibit 10.12 to the Company's
Registration Statement No. 33-76150 on Form S-1).
10.10 Consent, Assignment and Amendment Agreement between Diversicare
Corporation of America, Counsel Nursing Properties, Inc., Advocat Inc.,
Diversicare Leasing Corporation and Omega Healthcare Investors, Inc.
dated May 10, 1994 (incorporated by reference to Exhibit 10.10 to the
Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1994).
10.11 Advocat Inc. Guaranty in favor of Omega Healthcare Investors, Inc.
dated May 10, 1994 (incorporated by reference to Exhibit 10.11 to the
Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1994).
10.12 Consolidation, Modification and Renewal Note dated August 30, 1991, by
Diversicare Nursing Centers, Inc. to the order of Sovran Bank/Tennessee
(incorporated by reference to Exhibit 10.19 to the Company's
Registration Statement No. 33-76150 on Form S-1).
</TABLE>
2
<PAGE> 90
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
10.13 Wraparound Promissory Note dated August 30, 1991, by Texas Diversicare
Limited Partnership and Diversicare Nursing Centers, Inc. (incorporated
by reference to Exhibit 10.20 to the Company's Registration Statement
No. 33-76150 on Form S-1).
10.14 Management Agreement dated August 30, 1991, between Texas Diversicare
Limited Partnership and Diversicare Corporation of America, as assigned
effective October 1, 1991, to Diversicare Management, with consent of
Texas Diversicare Limited Partnership, as amended (incorporated by
reference to Exhibit 10.21 to the Company's Registration Statement No.
33-76150 on Form S-1).
10.15 Amended and Restated Limited Partnership Agreement dated August 30,
1991, among Diversicare General Partner, Inc., J. Scott Jackson and
each Limited Partner (incorporated by reference to Exhibit 10.22 to the
Company's Registration Statement No. 33-76150 on Form S-1).
10.16 Participation Agreement dated August 30, 1991, between Texas
Diversicare Limited Partnership and Diversicare Corporation of America
(incorporated by reference to Exhibit 10.23 to the Company's
Registration Statement No. 33-76150 on Form S-1).
10.17 Agreement of Purchase and Sale entered into August 30, 1991, among
Diversicare Corporation of America, Texas Diversicare Limited
Partnership' and Diversicare Corporation of America (incorporated by
reference to Exhibit 10.25 to the Company's Registration Statement No.
33-76150 on Form S-1).
10.18 Partnership Services Agreement entered into August 30, 1991, among
Texas Diversicare Limited Partnership, Diversicare Incorporated and
Counsel Property Corporation (incorporated by reference to Exhibit
10.26 to the Company's Registration Statement No. 33-76150 on Form
S-1).
10.19 Guaranteed Return Loan Security Agreement entered into August 30, 1991,
between Texas Diversicare Limited Partnership and Diversicare
Incorporated (incorporated by reference to Exhibit 10.27 to the
Company's Registration Statement No. 33-76150 on Form S-1).
10.20 Credit and Security Agreement dated October 12, 1994, between
NationsBank of Tennessee, N.A., the Company and the Company's
subsidiaries (incorporated by reference to Exhibit 10.20 to the
Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1994).
</TABLE>
3
<PAGE> 91
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
10.21 Promissory Note by Advocat Inc. to the order of Diversicare Inc. dated
May 10, 1994 (incorporated by reference to Exhibit 10.21 to the
Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1994).
10.22 Promissory Note by Advocat Inc. to the order of Counsel Nursing
Properties, Inc. dated May 10, 1994 (incorporated by reference to
Exhibit 10.22 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1994).
10.23 Demand Master Promissory Note by Advocat Inc. to the order of
Diversicare Corporation of America dated May 10, 1994 (incorporated by
reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1994).
10.24 Lease Agreement between Counsel Healthcare Assets Inc. and Counsel
Nursing Properties, Inc. dated May 10, 1994 (incorporated by reference
to Exhibit 10.24 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1994).
10.25 Lease Agreement between Counsel Healthcare Assets Inc. and Counsel
Nursing Properties, Inc. dated May 10, 1994 (incorporated by reference
to Exhibit 10.25 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1994).
10.26 Management and Guaranteed Return Loan Agreement dated as of November
30, 1985, between Diversicare VI Limited Partnership and Diversicare
Incorporated, an Ontario corporation, as amended, as assigned effective
October 1, 1991, to Diversicare Management Services Co., with consent
of Diversicare VI Limited Partnership (incorporated by reference to
Exhibit 10.34 to the Company's Registration Statement No. 33-76150 on
Form S-1).
10.27 Management Agreement dated August 24, 1981, between Americare
Corporation and Diversicare Corporation of America, as assigned to
Diversicare Management Services Co., with consent of Americare
Corporation (incorporated by reference to Exhibit 10.36 to the
Company's Registration Statement No. 33-76150 on Form S-1).
10.28 Management Agreement between Counsel Healthcare Assets, Inc., an
Ontario corporation and Counsel Nursing Properties, Inc. dated April
30, 1994, as assigned effective May 10, 1994, to Diversicare Canada
</TABLE>
4
<PAGE> 92
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
Management Services Co., Inc (incorporated by reference to Exhibit
10.28 to the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1994).
10.29 Lease Agreement between Spring Hill Medical, Inc. and First American
HealthCare, Inc. dated February 1, 1994 (incorporated by reference to
Exhibit 10.38 to the Company's Registration Statement No. 33-76150 on
Form S-1).
10.30 Lease Agreement, as amended, between Bryson Hill Associates of Alabama,
Inc. and Estates Nursing Homes, Inc. dated June 15, 1984, as assigned
effective May 10, 1994, to Diversicare Leasing Corp. (incorporated by
reference to Exhibit 10.39 to the Company's Registration Statement No.
33-76150 on Form S-1).
10.31 Lease Agreement between HealthCare Ventures and Wessex Care Corporation
dated October 23, 1989, as assigned effective May 10, 1994, to
Diversicare Leasing Corp. (incorporated by reference to Exhibit 10.40
to the Company's Registration Statement No. 33-76150 on Form S-1).
10.32 Lease Agreement between Osborne & Wilson Development Corp., Inc. and
Diversicare Corporation of America dated July 7, 1989, as assigned
effective May 10, 1994, to Diversicare Leasing Corp. (incorporated by
reference to Exhibit 10.41 to the Company's Registration Statement No.
33-76150 on Form S-1).
10.33 Florida Lease Agreement between Counsel Nursing Properties, Inc. and
Diversicare Leasing Corp. dated May 10, 1994 (incorporated by reference
to Exhibit 10.33 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1994).
10.34 Lease Agreement between Counsel Nursing Properties, Inc. and
Diversicare Leasing Corp. dated May 10, 1994 (incorporated by reference
to Exhibit 10.34 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1994).
10.35 Letter Agreement dated November 23, 1994, among Advocat Inc., Omega
Healthcare Investors, Inc., Sterling Health Care Centers, Inc. and E.B.
Lowman, II (incorporated by reference to Exhibit 10.36 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31,
1994).
</TABLE>
5
<PAGE> 93
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
10.36 Assignment and Assumption Agreement of Master Lease dated September 1,
1995, between Sterling Health Care Management, Inc., Diversicare
Leasing Corp. and Sterling Acquisition Corp (incorporated by reference
to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1995).
10.37 Master Lease dated December 1, 1994, between Sterling Health Care
Management, Inc. and Sterling Acquisition Corp (incorporated by
reference to Exhibit 10.2 to the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1995).
10.38 Assignment and Assumption Agreement of Master Sublease dated September
1, 1995, between Sterling Health Care Management, Inc., Diversicare
Leasing Corp. and O S Leasing Company (incorporated by reference to
Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1995).
10.39 Master Sublease dated December 1, 1994, between Sterling Health Care
Management, Inc. and O S Leasing Company (incorporated by reference to
Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1995).
10.41 Letter of Credit Agreement dated September 1, 1995, between Omega
Health Care Investors, Inc., Sterling Acquisition Corp., Sterling
Acquisition Corp II, O S Leasing Company and Diversicare Leasing Corp
(incorporated by reference to Exhibit 10.5 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended September 30, 1995).
10.42 Advocat Inc. Guaranty dated September 1, 1995, in favor of Omega Health
Care Investors, Inc., Sterling Acquisition Corp., Sterling Acquisition
Corp. II and O S Leasing Company (incorporated by reference to Exhibit
10.6 to the Company's Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 1995).
10.43 Management Agreement between Diversicare Management Services Co. and
Emerald-Cedar Hill, Inc. dated February 20, 1996 (incorporated by
reference to Exhibit 10.43 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995).
10.44 Management Agreement between Diversicare Management Services Co. and
Emerald-Golfcrest, Inc. dated February 20, 1996 (incorporated by
</TABLE>
6
<PAGE> 94
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
reference to Exhibit 10.44 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995).
10.45 Management Agreement between Diversicare Management Services Co. and
Emerald-Golfview, Inc. dated February 20, 1996 (incorporated by
reference to Exhibit 10.45 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995).
10.46 Management Agreement between Diversicare Management Services Co. and
Emerald-Southern Pines, Inc. dated February 20, 1996 (incorporated by
reference to Exhibit 10.46 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995).
10.47 Loan Agreement between Omega Healthcare Investors, Inc. and Diversicare
Leasing Corp., d/b/a Good Samaritan Nursing Home, dated February 20,
1996 (incorporated by reference to Exhibit 10.47 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31,
1995).
10.48 Short Term Note by Diversicare Leasing Corp. to Omega Healthcare
Investors, Inc. dated February 20, 1996 (incorporated by reference to
Exhibit 10.48 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995).
10.49 Advocat Inc. Guaranty in favor of Omega Healthcare Investors, Inc.
dated February 20, 1996 (incorporated by reference to Exhibit 10.49 to
the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
10.50 First Amendment to Credit and Security Agreement dated November 28,
1995, between NationsBank of Tennessee, N.A., Advocat Inc. and the
Subsidiaries (as defined) (incorporated by reference to Exhibit 10.50
to the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
10.51 Second Amendment to Credit and Security Agreement dated December 1,
1995, between NationsBank of Tennessee, N.A., Advocat Inc. and the
Subsidiaries (as defined) (incorporated by reference to Exhibit 10.51
to the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
</TABLE>
7
<PAGE> 95
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
10.52 Third Amendment to Credit and Security Agreement dated December 1,
1995, between NationsBank of Tennessee, N.A., Advocat Inc. and the
Subsidiaries (as defined) (incorporated by reference to Exhibit 10.52
to the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
10.53 Fourth Amendment to Credit and Security Agreement dated April 1, 1996,
between NationsBank of Tennessee, N.A., Advocat Inc. and the
Subsidiaries (as defined) (incorporated by reference to Exhibit 10.53
to the Company's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 1996).
10.54 Fifth Amendment to Credit and Security Agreement dated May 1, 1996,
between NationsBank of Tennessee, N.A., Advocat Inc. and the
Subsidiaries (as defined) (incorporated by reference to Exhibit 10.54
to the Company's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 1996).
10.55 Sixth Amendment to Credit and Security Agreement dated June 28, 1996,
between NationsBank of Tennessee, N.A., Advocat Inc. and the
Subsidiaries (as defined) (incorporated by reference to Exhibit 10.55
to the Company's Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 1996).
10.56 Seventh Amendment to Credit and Security Agreement dated September 1,
1996, between NationsBank of Tennessee, N.A., Advocat Inc. and the
Subsidiaries (as defined) (incorporated by reference to Exhibit 10.2 to
the Company's Quarterly Report on Form 10-Q for the quarterly period
ended September 30, 1996).
10.57 Eighth Amendment to Credit and Security Agreement dated November 1,
1996, between NationsBank of Tennessee, N.A., Advocat Inc. and the
Subsidiaries (as defined) (incorporated by reference to Exhibit 10.2 to
the Company's Quarterly Report on Form 10-Q for the quarterly period
ended September 30, 1996).
10.58 Master Credit and Security Agreement dated December 27, 1996, between
First American National Bank, GMAC-CM Commercial Mortgage Corporation,
Advocat Inc., Management Services Co. and the Subsidiaries (as defined)
(incorporated by reference to Exhibit 10.58 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1996).
</TABLE>
8
<PAGE> 96
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
10.59 Project Loan Agreement (Good Samaritan) dated December 27, 1996,
between GMAC-CM Commercial Mortgage Corporation Advocat Inc.,
Diversicare Management Services Co. and the Subsidiaries (as defined)
(incorporated by reference to Exhibit 10.59 to the Company's Annual
Report on Form for the fiscal year ended December 31, 1996).
10.60 Project Loan Agreement (Afton Oaks) dated December 27, 1996, between
GMAC-CM Commercial Mortgage Corporation, Advocat Inc., Diversicare
Management Services Co. and the Subsidiaries (as defined) (incorporated
by reference Exhibit 10.60 to the Company's Annual Report on Form for
the fiscal year ended December 31, 1996).
10.61 Project Loan Agreement (Pinedale) dated December 27, 1996, between
GMAC-CM Commercial Mortgage Corporation, Advocat Inc., Diversicare
Management Services Co. and the Subsidiaries (as defined) (incorporated
by reference Exhibit 10.61 to the Company's Annual Report on Form for
the fiscal year ended December 31, 1996).
10.62 Project Loan Agreement (Windsor House) dated December 27 1996, between
GMAC-CM Commercial Mortgage Corporation, Advocat Inc., Diversicare
Management Services Co. and Subsidiaries (as defined) (incorporated by
reference to Exhibit 10.62 to the Company's Annual Report on Form for
the fiscal year ended December 31, 1996).
10.63 Asset Purchase Agreement dated November 30, 1995, Williams Nursing
Homes Inc., d/b/a Afton Oaks Center, Lynn Mayers, Thomas E. Mayers, and
Diversicare Leasing Corp. (incorporated by reference to Exhibit 2.1 the
Company's Current Report on Form 8-K dated November 30, 1995).
10.64 Purchase Agreement between Diversicare Leasing Corporation and
Americare Corporation dated February 20, 1996 (incorporated by
reference to Exhibit 2.2 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995).
10.65 Amendment to 1994 Incentive and Non-Qualified Stock Plan for Key
Personnel (incorporated by reference to Exhibit A to the Company's
Schedule 14A filed March 31, 1997).
</TABLE>
9
<PAGE> 97
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
10.66 Amendment to 1994 Non-Qualified Stock Option Plan for Directors
(incorporated by reference to Exhibit A to the Company's Schedule 14A
filed April 19, 1996).
10.67 Amendment No. 3 Advocat Inc. 1994 Incentive and Nonqualified Stock
Option Plan For Key Personnel (incorporated by reference to Exhibit A
to the Company's Schedule 14A filed April 3, 1998).
10.67 Renewal and Modification Promissory Note dated March 31, 1998, between
the Company and AmSouth Bank.(incorporated by reference to Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 1998).
10.68 Renewal and Modification Promissory Note dated March 31, 1998, between
the Company and First American National Bank (incorporated by reference
to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1996).
10.69 Second Amendment to Loan and Negative Pledge Agreement dated March 31,
1998, between Diversicare Assisted Living Services NC, LLC and First
American National Bank, both individually and as Agent for AmSouth Bank
(incorporated by reference to Exhibit 10.2 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended September 30, 1996).
21 Subsidiaries of the Registrant.
23 Consent of Arthur Andersen LLP.
27 Financial Data Schedule (for SEC use only).
</TABLE>
10
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES
NAME OF CORPORATION STATE OF INCORPORATION
- ------------------- ----------------------
Advocat Ancillary Services, Inc. Tennessee
Advocat Distribution Services, Inc. Tennessee
Advocat Finance, Inc. Delaware
Diversicare Assisted Living Services, Inc. Tennessee
Diversicare Assisted Living Services NC, LLC Tennessee
Diversicare Canada Management Services Co., Inc. Ontario, Canada
Diversicare General Partner, Inc. Texas
Diversicare Leasing Corp. Tennessee
Diversicare Leasing Corp. of Alabama Alabama
Diversicare Management Services Co. Tennessee
First American Health Care, Inc. Alabama
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report included in this Annual Report on Form 10-K of Advocat Inc. and
Subsidiaries into the Company's previously filed Registration Statement File
Numbers 33-93940, 33-93946 and 33-93950.
ARTHUR ANDERSEN LLP
Nashville, Tennessee
April 2, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF ADVOCAT INC. AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH ANNUAL REPORT ON FORM 10-K DATED FROM THE
ANNUAL PERIOD ENDED DECEMBER 31, 1998
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,347
<SECURITIES> 0
<RECEIVABLES> 28,939
<ALLOWANCES> 2,650
<INVENTORY> 1,528
<CURRENT-ASSETS> 33,785
<PP&E> 82,140
<DEPRECIATION> 15,548
<TOTAL-ASSETS> 121,294
<CURRENT-LIABILITIES> 51,683
<BONDS> 0
0
0
<COMMON> 54
<OTHER-SE> 27,507
<TOTAL-LIABILITY-AND-EQUITY> 121,294
<SALES> 0
<TOTAL-REVENUES> 205,152
<CGS> 0
<TOTAL-COSTS> 209,969
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 2,306
<INTEREST-EXPENSE> 5,425
<INCOME-PRETAX> (4,817)
<INCOME-TAX> (1,734)
<INCOME-CONTINUING> (3,083)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,083)
<EPS-PRIMARY> (.57)
<EPS-DILUTED> (.57)
</TABLE>
