<PAGE>
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20459
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 12 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition period from ___ to___
Commission file number 1-13498
ASSISTED LIVING CONCEPTS, INC.
(Exact name of registrant as specified in its charter)
NEVADA 93-1148702
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
9955 SE Washington, Suite 201
Portland, Oregon 97216
(Address of principle executive offices)
(503) 252-6233
(Registrant's telephone number, including area code)
Indicated by check mark whether Registrant (1) has filed all reports
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 Registrants was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
-- --
Shares of Registrant's common stock, $.01 par value, outstanding at November
14, - 15,630,184
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Page 1 of 26
<PAGE>
ASSISTED LIVING CONCEPTS, INC.
FORM 10-Q
SEPTEMBER 30, 1997
INDEX
-----
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION Page
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets of Assisted Living Concepts, Inc. and Subsidiary
as of September 30, 1997 and December 31, 1996....................................................... 3
Consolidated Statements of Operations of Assisted Living Concepts, Inc.
and Subsidiary for the three and nine months ended September 30, 1997
and September 30, 1996............................................................................... 4
Consolidated Statements of Cash Flows of Assisted Living Concepts, Inc. and
Subsidiary for the three and nine months ended September 30, 1997
and September 30, 1996............................................................................... 5
Notes to Consolidated Financial Statements........................................................... 6-8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................................... 9-16
</TABLE>
Page 2 of 26
<PAGE>
PART 1
ITEM 1 - FINANCIAL INFORMATION
ASSISTED LIVING CONCEPTS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(in thousands)
(Unaudited)
SEPTEMBER 30, DECEMBER 31,
ASSETS 1997 1996
-------------- --------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 5,437 $ 2,105
Investments 1,840 8,515
Accounts receivable 2,082 730
Other current assets 2,232 1,043
------------ ------------
Total current assets 11,591 12,393
------------ ------------
Property and equipment 87,912 59,574
Construction in process (Note 2) 70,854 53,458
------------ ------------
Total property and equipment 158,766 113,032
Less accumulated depreciation 1,840 674
------------ ------------
Property and equipment - net 156,926 112,358
Goodwill 341 362
Other assets 6,693 5,394
------------ ------------
Total assets $175,551 $130,507
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 6,096 $ 3,803
Construction payables 20,751 16,002
Construction financing (Note 2) 46,690 18,850
Current portion of long-term debt 115 110
------------ ------------
Total current liabilities 73,652 38,765
Mortgages payable 26,030 18,768
Convertible subordinated debt 13,915 13,915
------------ ------------
Total liabilities 113,597 71,448
------------ ------------
Shareholders' equity:
Preferred Stock, $.01 par value; 1,000,000 shares authorized;
none issued and outstanding
Common Stock, $.01 par value; 80,000,000 shares authorized;
11,083,842 and 11,030,500 shares issued and outstanding 111 110
Additional paid-in capital 59,945 59,678
Fair market value in excess of historical cost of acquired net assets
attributable to related party transactions (239) (239)
Retained Earnings (Accumulated deficit) 2,137 (490)
------------ ------------
Shareholders' equity 61,954 59,059
------------ ------------
Total liabilities and shareholders' equity $175,551 $130,507
============ ============
</TABLE>
The accompanying notes are an integral part of these Financial Statements.
Page 3 of 26
<PAGE>
ASSISTED LIVING CONCEPTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION> (Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Revenues $12,505 $5,171 $32,597 $11,663
Operating expenses:
Residence operating expenses 7,897 3,273 20,146 7,549
Corporate general and administrative 691 573 2,008 1,181
Building rentals 2,342 903 5,212 1,954
Building rentals - related party 353 259 1,052 703
Depreciation and amortization 801 204 2,009 588
------- ------ ------- -------
Total operating expenses 12,084 5,212 30,427 11,975
------- ------ ------- -------
Operating income (loss) 421 (41) 2,170 (312)
------- ------ ------- -------
Interest expense (245) (426) (653) (477)
Interest income 138 229 414 298
Other income 1,293 - 1,775 82
------- ------ ------- -------
Other income - net 1,186 (197) 1,536 (97)
------- ------ ------- -------
Income (loss) before taxes $ 1,607 $ (238) $ 3,706 $ (409)
Provision for income tax 611 - 1,079 -
------- ------ ------- -------
Net income (loss) $ 996 $ (238) $ 2,627 $ (409)
======= ====== ======= =======
Primary income (loss) per common share $ .09 $ (.02) $ .23 $ (.05)
======= ====== ======= =======
Fully-Diluted income (loss) per common share $ .09 $ (.02) $ .23 $ (.05)
======= ====== ======= =======
Primary common shares outstanding 11,600 10,530 11,566 7,532
Fully-Diluted common shares outstanding 13,502 10,530 13,487 7,532
</TABLE>
The accompanying notes are an integral part of these Financial Statements.
Page 4 of 26
<PAGE>
ASSISTED LIVING CONCEPTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION> (Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
--------- --------- -------- --------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 996 $ (238) $ 2,627 $ (409)
Adjustment to reconcile net income (loss) to net
cash provided by operating activities:
Gain on sale of asset - - (36) (82)
Depreciation and amortization 801 204 2,009 588
Changes in other non-cash items:
Accounts receivable (999) (268) (1,352) (584)
Other current assets (68) (362) (1,189) (597)
Other assets 146 (839) (22) (2,122)
Accounts payable and accrued expenses 798 2,273 2,293 (205)
--------- -------- -------- --------
Net cash provided by (used for) operating activities 1,674 770 4,330 (3,001)
--------- -------- -------- --------
INVESTING ACTIVITIES:
Funds held in trust 6,848 - 6,675 -
Proceeds from sale of land and residences 28,565 12,504 64,133 50,794
Purchases of property and equipment (48,817) (36,226) (110,227) (81,891)
--------- -------- -------- --------
Net cash used for investing activities (13,404) (23,722) (39,419) (7,375)
--------- -------- -------- --------
FINANCING ACTIVITIES:
Proceeds from short-term construction borrowings - - 43,210 -
Payoff of construction financing (5,220) - (15,370) -
Construction payables 6,668 - 4,749 -
Proceeds from long-term debt 7,350 - 7,350 5,865
Payments on long-term debt (28) (15) (83) (61)
Proceeds from issuance of common stock 194 37,096 267 37,219
Debt issuance costs (625) - (1,702) -
--------- -------- -------- --------
Net cash provided by financing activities 8,339 37,081 38,421 43,023
--------- -------- -------- --------
Net increase (decrease) in cash and cash equivalents (3,391) 14,129 3,332 8,925
Cash and cash equivalents, beginning of period 8,828 2,131 2,105 7,335
--------- -------- -------- --------
Cash and cash equivalents, end of period $ 5,437 $ 16,260 $ 5,437 16,260
======== ======== ======== ========
Supplemental disclosure of cash flow information: $ 5,090 $ 893 $ 1,823 $ 1,912
Cash payments for interest ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these Financial Statements.
Page 5 of 26
<PAGE>
ASSISTED LIVING CONCEPTS, INC.
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Assisted Living Concepts, Inc. ("the Company") owns, operates and develops
assisted living residences which provide housing to senior citizens who need
help with the activities of daily living such as bathing and dressing. The
Company provides personal care and support services and makes available routine
nursing services designed to meet the needs of its residents. As of September
30, 1997, the Company had received certificates of occupancy for 109 residences
of which 89 had commenced operations one of which is being operated through a
management agreement.
Basis of Presentation
These financial statements have been prepared without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission. The
accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiary. All significant intercompany accounts
and transactions have been eliminated in consolidation. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations. These condensed financial
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto included in the Company's annual report on Form 10-
K for the year ended December 31, 1996.
The financial information included herein reflects all adjustments (consisting
of normal recurring adjustments) which are, in the opinion of management,
necessary for a fair presentation of the results for interim periods. The
result of operations for the three and nine-month periods ended September 30,
1997 and 1996 are not necessarily indicative of the results to be expected for
the full year.
2. PROPERTY AND EQUIPMENT
Construction In Process
As of September 30, 1997 the Company had begun construction or had purchased
land to begin construction on 47 parcels of land ($70.9 million) which include
12 sites ($28.2 million) which have received certificates of occupancy but have
not yet received a license to operate. As of September 30, 1997, the Company
had also entered into agreements pursuant to which it may purchase, subject to
completion of due diligence and various other conditions, 26 additional sites.
Page 6 of 26
<PAGE>
ASSISTED LIVING CONCEPTS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. PROPERTY AND EQUIPMENT (CONTINUED)
As of September 30, 1997 the Company had capitalized all costs incurred in
connection with the development of these properties and, accordingly,
construction in process consisted of the following (in thousands):
<TABLE>
<S> <C>
Land purchased $ 8,395
Construction costs and architectural fees 49,597
Other costs, including interest, legal fees, building permits and other development
costs 12,862
-------
$70,854
=======
</TABLE>
During the quarter ended September 30, 1997, the Company capitalized $1.62
million of interest cost relative to financing of construction in process. Of
the 109 residences the Company had opened or had received certificates of
occupancy, 58 were leased (20 in the Northwest, 32 in the Southwest and 6 in the
East) and 50 were owned (20 in the Northwest, 8 in the Southwest and 22 in the
East) and one was being operated through a management agreement.
3. LEASES
During the quarter ended September 30, 1997, the Company completed the sale of
eleven residences (four in the Northwest, four in the East and three the
Southwest) under sale and leaseback arrangements. The Company sold the
residences for approximately $28.5 million which approximates cost, and leased
them back over initial terms ranging from 12 to 15 years. The residences were
leased back at an initial annual lease rate of approximately $2.8 million. In
addition, the Company entered into an operating lease to operate one residence
in the East.
4. SUBSEQUENT EVENTS
On October 24, 1997, the Company completed an underwritten public offerings of
4.14 million shares of common stock and $86.25 million in principal amount of
6.0% Convertible Subordinated Debentures. The Debentures are due November 1,
2002 and are convertible into common stock of the Company at $22.57 per share.
These offerings netted the Company $155 million after underwriters discounts and
expenses. The Company competed the acquisitions of Home and Community Care,
Inc. ("HCI") and Carriage House Assisted Living, Inc. ("Carriage House") with
the proceeds from the offerings and has repaid approximately $14.5 million of
loans which were used to develop seven Texas residences. The remaining proceeds
will be used primarily for the development and construction of additional
assisted living residences.
Page 7 of 26
<PAGE>
ACQUISITIONS
The acquisition of HCI was completed on October 23, 1997 for a purchase price of
$4.9 million in cash and the assumption of approximately $5.7 million in debt.
HCI stockholders are entitled to receive certain "earnout" payments over a two-
year period based on the number of HCI's assisted living residence sites which
ALC elects to complete. For each completed residence, HCI stockholders will
receive an additional $7,500 per unit (approximately $300,000 per residence) in
cash. HCI also has 39 assisted living residence sites (1,567 units) either
under construction or identified for possible development in five states. HCI
also operates three home health care agencies, one home health care branch
agency and one hospice agency and five home medical equipment offices primarily
in Texas. The HCI's home health agencies provide home care to residents in
eight of the Company's assisted living residences, as well as to persons living
in surrounding communities.
The acquisition of Carriage House was completed on October 31, 1997. The
Company exchanged 337,460 shares of common stock for all the stock of Carriage
House and assumed approximately $3.9 million in debt. Carriage House currently
operates 4 facilities with 156 units and has an additional 6 facilities with 198
units under construction. All units are located in Nebraska.
Page 8 of 26
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company operates, owns, leases and develops free-standing assisted living
residences, primarily in small middle-market rural and suburban communities with
a population typically ranging from 10,000 to 40,000. Currently the Company has
operations in Oregon, Washington, Idaho, Texas, Ohio, New Jersey and Arizona.
The Company also provides personal care and support services, and makes
available routine nursing services (as permitted by applicable regulations)
designed to meet the personal and health care needs of its residents.
The Company has experienced significant growth since the completion of its
initial public offering in November 1994, growing from a base of five residences
(137 units) primarily through the development of assisted living residences. As
of September 30, 1997 the Company owned, leased or managed a total of 109
operating assisted living residences representing an aggregate of 4,042 units.
Of these the Company owned 50 residences (1,882 units), leased 58 residences
(2,121 units) and managed one residence (39 units).
Operating results for the three and nine month periods ended September 30, 1997
include the operating results of 88 residences and the Company's corporate
overhead, and are not necessarily indicative of future operating financial
performance, as the Company intends to significantly expand its operating base
of residences through the end of 1997 and 1998. Based on the Company's
development schedule, the number of residences planned to open in 1997 ranges
from 50 to 60, of which 42 had been completed through September 30, 1997.
RESULTS OF OPERATIONS
The Company derives its revenues primarily from resident fees for the delivery
of assisted living services. Resident fees typically are paid monthly by
residents, their families, state Medicaid agencies or other responsible parties.
Resident fees include revenue derived from a multi-tiered rate structure which
varies based on the level of care required. Resident fees are recognized as
revenues when services are provided. Operating expenses include (i) residence
operating expenses, such as staff payroll, food, property taxes, utilities,
insurance and other direct residence operating expenses, (ii) general and
administrative expenses consisting of corporate and support functions such as
legal accounting and other administrative expenses, (iii) building rentals and
(iv) depreciation and amortization.
Page 9 of 26
<PAGE>
The following table sets forth, for the periods presented, the number of
residences and units operated, and the average occupancy rates and sources of
revenue for the three months ended September 30, 1997. The portion of revenues
received from state Medicaid agencies are labeled as "Medicaid state portion"
while the portion of the Company's revenues that a Medicaid-eligible resident
must pay out of his or her own resources is labeled "Medicaid resident portion".
<TABLE>
<CAPTION>
Three Months Ended September 30, 1997
Stabilized Start-up
Residences /(1)/ Residences /(2)/ Total /(3)/
--------------- --------------- ----------
<S> <C> <C> <C>
Residences operated (end of period) 49 39 88
Units operated 1,690 1,526 3,216
Average occupancy rate 94.2% 51.3% 74.4%
Sources of revenue:
Private 82.0% 84.7% 83.0%
Medicaid resident portion 6.5% 4.9% 5.9%
Medicaid state portion 11.5% 10.4% 11.1%
-------------- --------------- ----------
Total 100.0% 100.0% 100.0%
============== =============== ==========
- ---------------------
</TABLE>
(1) Stabilized residences are those residences that have been operating for
twelve months or have achieved a stabilized occupancy of 95% or more as of
the beginning of the quarter.
(2) Start-up residences are those residences that have not been operating for
twelve months and have not achieved a stabilized occupancy of 95% or more
as of the beginning of the quarter.
(3) The Company had received certificates of occupancy on 109 residences, of
which 95 had received licensure and 88 were fully operational, and one
residence which the Company manages.
COMPILATION OF STABILIZED AND START-UP RESIDENCES
THREE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
Stabilized Start-up Combined
Residences Residences Corporate Total
---------- ---------- --------- ------
<S> <C> <C> <C> <C>
Revenue $ 8,254 $ 4,251 $ - $ 12,505
Residence operating expense 4,785 3,112 - 7,897
---------- ---------- --------- --------
Residence operating income 3,469 1,139 - 4,608
Corporate overhead - - 691 691
Building rentals 1,786 908 1 2,695
Depreciation and amortization 256 514 31 801
---------- ---------- --------- --------
Total other operating expenses 2,042 1,422 723 4,187
---------- ---------- --------- --------
Operating income (loss) 1,427 (283) (723) 421
Interest expense (552) (916) 1,223 (245)
Interest income 1 2 135 138
Other income (expense) net - 790 503 1,293
---------- ---------- --------- --------
Income (loss) before taxes $ 876 $ (407) $ 1,138 $ 1,607
========== ========== ========= ========
Residences operated 49 39 88
Units operated 1,690 1,526 3,216
Average occupancy rate 94.2% 51.3% 74.4%
</TABLE>
Page 10 of 26
<PAGE>
RESULTS OF SAME RESIDENCES
THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
THREE THREE NINE NINE
MONTHS ENDED MONTHS ENDED MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
SAME STORE RESIDENCES 1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue $5,127 $4,573 $9,239 $7,977
Residence operating expense 2,917 2,791 5,190 4,819
---------- ------------ ------------ ------------
Residence operating income 2,210 1,782 4,049 3,158
Building rentals 1,012 1,012 1,692 1,628
Depreciation and amortization 181 156 336 333
---------- ------------ ------------ ------------
Other operating expenses 1,193 1,168 2,028 1,961
---------- ------------ ------------ ------------
Operating income 1,017 614 2,021 1,197
Other income (expense) net (330) (198) (595) (517)
---------- ------------ ------------ ------------
Income before taxes $ 687 $ 416 $1,426 $ 680
========== ============ ============ ============
Residences operating 31 31 19 19
Units operating 1,019 1,009 605 595
Average occupancy rate 95.8% 88.6% 95.8% 87.9%
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1996.
The company had net income of $996,000 or $.09 per share, on revenue of
$12.5 million for the three months ended September 30, 1997 compared to a net
loss of $238,000 or $.02 per share, on revenues of $5.2 million for the three
months ended September 30, 1996.
Revenues. For the three months ended September 30, 1997, revenues were $12.5
million compared to $5.2 million in the three months ended September 30, 1996,
an increase of $7.3 million or 140.4%. Of this increase, $6.8 million or 93.2%
related to the opening of an additional 57 operating residences (2,197 units)
since June 30, 1996. The remaining $554,000, or 6.8% of the increase was
attributable to the Same Store Residences. For the three months ended September
30, 1997, revenues for the Same Store Residences were $5.2 million as compared
to $4.6 million for the three months ended September 30, 1996, an increase of
13.0%. Substantially all of this increase was attributable to an increase in
average occupancy to 95.8% from 88.6%.
Residence operating expenses. For the three months ended September 30, 1997,
residence operating expenses were $7.9 million as compared to $3.3 million for
the three months ended September 30, 1996, an increase of $4.6 million or
139.4%. Of this increase, $4.5 million or 97.8% related to the opening of an
additional 57 operating residences (2,197 units) since June 30, 1996. The
remaining $126,000 or 2.2% of the increase was attributable to the Same Store
Residences. For the three months ended September 30, 1997, residence operating
expenses for the Same Store Residences were $2.9 million as compared to $2.8
million for the three months ended September 30, 1996, an increase of 3.6%.
This increase for the Same Store Residences was primarily attributable to higher
staffing levels required to accommodate higher occupancies at the residences.
Page 11 of 26
<PAGE>
Corporate, general and administrative. For the three months ended September 30,
1997, corporate, general and administrative expenses were $691,000 as compared
to $573,000 for the three months ended September 30, 1996, and increase of
$118,000 or 20.6%. This increase was primarily the result of additional
staffing needed to cover the increase in corporate activity as well as the
continued investment in the establishment of regional offices in Oregon, Texas
and Ohio.
Building rentals. Building rentals increased to $2.7 million in the three months
ended September 30, 1997 from $1.2 million for the three months ended September
30, 1996. This increase in building rentals is directly related to the increase
in the number of leases entered into by the Company between September 30, 1996
and September 30, 1997. The Company had 58 operating leases at September 30,
1997 compared to 31 at September 30, 1996. Building rentals for the 31 Same
Store Residences which operated for the entire period of 1997 and 1996 remained
relatively unchanged.
Depreciation and amortization. Depreciation and amortization expense was
$801,000 in the three months ended September 30, 1997 compared to $204,000 for
the three months ended September 30, 1996, an increase of $597,000, or 292.6%.
The increase in depreciation and amortization was directly related to the 57 new
residences that opened subsequent to June 30, 1996. Depreciation and
amortization expense for the 31 Same Store Residences which operated for the
entire third quarter of 1997 and 1996 increased slightly because the Company
purchased four residences which were previously leased.
Interest and other expense (income), net. Interest expense net of capitalized
interest was $245,000 for the three month period ended September 30, 1997
compared to $426,000 in the corresponding 1996 period, an increase of $181,000.
The Company's gross interest expense was $1.87 million for the three month
period ended September 30, 1997 compared to $944,000 for the three months ended
September 30, 1996, an increase of $926,000. The increase in interest expense
is due to temporary construction financing obtained for the expansion of
assisted living residences through development activity. Capitalized interest
for the three month period ended September 30, 1997 was $1.62 million compared
to $518,000 for the three months ended September 30, 1996, an increase of $1.1
million.
Interest income. Interest income was $138,000 for the three month period ended
September 30, 1997 compared to $229,000 for the three months ended September 30,
1996, a decrease of $91,000. The decrease in interest income is directly
related to the fluctuation in the amounts invested.
Other income. Other income was $1.3 million for the three month period ended
September 30, 1997 compared to $0 for the three months ended September 30, 1996,
an increase of $1.3 million. Approximately $790,000 of the other income for the
three months ended September 30, 1997 represents that portion of the net
operating losses of a joint venture (including management fees paid to the
Company) attributable to the Company's joint venture partner (See Risk Factors -
Anticipated Operating Losses of New Residences for further discussion.). The
remaining $503,000 related to development fees received by the Company.
Income (loss) before taxes. Income before taxes for the three months ended
September 30, 1997 was $1.6 million compared to a loss before taxes of $238,000
during the three months ended September 30, 1996, an increase of $1.8 million.
The Company's income before taxes has continued to increase as the number of
operating residences increases. As the Company has matured in certain of its
regions and occupancy has increased, the operating income of the residences has
been able to cover general corporate overhead plus provide additional income.
Page 12 of 26
<PAGE>
Provision for income tax. The Company's provision for income tax for the three
months ended September 30, 1997 was $611,000 compared to $0 during the three
months ended September 30, 1996. The Company has been utilizing its operating
loss carryforwards from previous periods to offset current income tax
provisions. As of June 30, 1997, the Company had extinguished its carryforwards
and in the future periods expects to experience a tax rate of approximately 38%.
Net income (loss). Net income for the three months ended September 30, 1997 was
$996,000 compared to a net loss of $238,000 during the three months ended
September 30, 1996. The Company has generated income due to the number of
residences operating as compared to the corresponding period in 1996. This has
been partially offset by the increase in corporate overhead, including
additional staffing, necessary to accommodate the Company's expansion plans.
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1996.
The Company had net income of $2.6 million or $.23 per share, on revenue of
$32.6 million for the nine months ended September 30, 1997, compared to a net
loss of $409,000 or $.05 per share, on revenues of $11.7 million for the nine
months ended September 30, 1996. The Company incurred a one-time charge of
$426,000 during the 1996 for the exchange of 811,332 shares of Common Stock on
$6.1 million of 7% Debentures. The Company's net income for 1996 prior to this
one-timer charge was $17,000 or $0.00 per share.
Revenues. For the nine months ended September 30, 1997, revenues were $32.6
million compared to $11.7 million for the nine months ended September 30, 1996,
an increase of $20.9 million or 178.6%. Of this increase, $19.6 million or 93.8%
related to the opening of an additional 69 residences (2,621 units) since
January 1, 1996. The remaining $1.3 million or 6.2% of the increase was
attributable to the Same Store Residences. For the nine months ended September
30, 1997, revenues for the Same Store Residences were 9.2 million as compared to
$7.9 million for the nine months ended September 30, 1997, an increase of 16.4%.
Substantially all of this increase was attributable to an increase in average
occupancy to 95.8% from 87.9%.
Residence operating expenses. For the nine months ended September 30, 1997,
residence operating expenses were $20.1 million as compared to $7.5 million for
the nine months ended September 30, 1996, an increase of $12.6 million. Of this
increase, $12.2 million or 96.8% related to the opening of an additional 69
residences (2,621 units) since January 1, 1996. The remaining $371,000 or 3.2%
of the increase was attributable to the Same Store Residences. For the nine
months ended September 30, 1997, residence operating expenses for the Same Store
Residences were $5.2 million as compared to $4.8 million for the nine months
ended September 30, 1996, an increase of 8.3%. This increase for the Same Store
Residences was primarily attributable to higher staffing levels required to
accommodate higher occupancies at the residences.
Corporate general and administrative. For the nine months ended September 30,
1997, corporate general and administrative expenses were $2.0 million as
compared to $1.2 million for the nine months ended September 30, 1996, an
increase of $800,000 or 66.7%. This increase was primarily the result of
additional staffing needed to cover the increase in corporate activity as well
as the continued investment in the establishment of regional offices in Oregon,
Texas and Ohio.
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Building rentals. Building rentals increased to $6.3 million in the nine months
ended September 30, 1997 from $2.7 million for the nine months ended September
30, 1996, an increase of $3.6 million or 133.3%. This increase in building
rentals is directly related to the increase in the number of leases entered into
by the Company between September 30, 1996 and September 30, 1997. The Company
had 58 operating leases at September 30, 1997 compared to 31 at September 30,
1996. Building rentals for the 19 residences which operated for the entire nine
months of 1997 and 1996 remained relatively unchanged.
Depreciation and amortization. Depreciation and amortization expense was $2.0
million for the nine months ended September 30, 1997 compared to $588,000 for
the nine months ended September 30, 1996, an increase of $1.4 million, or
240.1%. The increase in depreciation and amortization is directly related to the
69 new residences that opened subsequent to January 1, 1996. Depreciation and
amortization expense for the 19 residences which operated for the entire nine
month in 1997 and 1996, remained relatively unchanged.
Interest and other expense (income), net. Interest expense net of capitalized
interest was $653,000 for the nine month period ended September 30, 1997
compared to $477,000 for the nine months ended September 30, 1996, an increase
of $176,000. The Company's gross interest expense was $5.2 million for the nine
month period ended September 30, 1997 compared to $2.0 million for the nine
months ended September 30, 1996, an increase of $3.2 million. The increase in
interest expense is due to temporary construction financing obtained for the
expansion of our assisted living residences through development activity.
Capitalized interest for the nine month period ended September 30, 1997 was $4.6
million compared to $1.5 million for the nine months ended September 30, 1996,
an increase of $3.1 million.
Interest income. Interest income was $414,000 for the nine months ended
September 30, 1997 compared to $298,000 for the nine months ended September 30,
1996, an increase of $116,000. The increase in interest income is directly
related the fluctuation in the amounts invested.
Other income. Other income was $1.8 million for the nine months ended September
30, 1997 compared to $82,000 for the nine months ended September 30, 1996, an
increase of $1.7 million. Approximately $1.1 million of the $1.8 million in
other income for the nine months ended September 30, 1997 represents that
portion of the net operating losses of a joint venture (including management
fees paid to the Company) attributable to the Company's joint venture
partner (See Risk Factors - Anticipated Operating Losses of New Residences for
further discussion.). The remaining $700,000 related to development fees
received by the Company. The $82,000 for the nine months ended September 30,
1996 was from a gain on the sale of real property.
Income (loss) before taxes. Income before taxes for the nine months ended
September 30, 1997 was $3.7 million compared to a loss of $409,000 for the nine
months ended September 30, 1996, an increase of $4.1 million. The Company's
income before taxes has continued to increase as the number of operating
residences increases. As the Company has matured in certain of its regions and
occupancy has increased, the operating income of the residences has been able to
cover general corporate overhead plus provide additional income.
Provision for income tax. The Company's provision for income tax for the nine
months ended September 30, 1997 was $1.1 million compared to $0 for the nine
months ended September 30, 1996, an increase of $1.1 million. The Company has
been utilizing its operating loss carryforwards from previous periods to offset
current income tax provisions. As of June 30, 1997, the Company had extinguished
its carryforwards and in the future periods expects to experience a tax rate of
approximately 38%.
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Net income (loss). Net income for the nine months ended September 30, 1997 was
$2.6 million compared to net loss of $409,000 for the nine months ended
September 30, 1996, an increase of $3.0 million. The Company has generated
income due to the increased number of residences operating as compared to the
corresponding period in 1996. This has been partially offset by the increase in
corporate overhead, including additional staffing, necessary to accommodate the
Company's expansion plans.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1997, the Company had negative working capital of approximately
of $62.1 million. Included in this amount was approximately $20.8 million of
construction draws that the Company received for the September development
activity which was not payable until October 10. In addition the Company
completed the sale of two properties for $5.1 million subsequent to September
30, 1997. At September 30, 1997, the Company had $46.7 million of temporary
construction financing of which $32.2 million is currently outstanding. The
Company intends to repay or convert to leases the remaining $32.2 million of
temporary construction financing by the December 31, 1997. Excluding the
construction draws payable ($20.8 million) and temporary construction financing
($46.7 million), the Company has positive working capital of $5.4 million. On
October 24, 1997, the Company completed a public offering of 4.14 million in
common stock and $86.25 million in principal Convertible Subordinated Debentures
due 2002 which netted the Company $155.5 million after underwriters discounts
and expenses.
Net cash provided by operating activities was approximately $4.3 million during
the nine month period ended September 30, 1997. The primary source of funds was
from net income of $2.6 million and the add back of depreciation and
amortization of $2.0 million. Other operating type items netted to a use of cash
of $300,000. As of September 30, 1997, unrestricted cash balances were $5.4
million.
Net cash used in investing activities totaled $39.4 million during the nine
month period ended September 30, 1997. The primary use of cash was $110.2
million related to the development of new assisted living residences in Oregon,
Washington, Texas, New Jersey, Idaho, Ohio and Arizona. This was offset by
proceeds of $64.1 million related to the sale of 26 residences 25 which were
leased backed.
Net cash provided by financing activities totaled $38.4 million during the nine
month period ended September 30, 1997. The Company entered into 19 additional
construction financing loans which netted the Company $43.2 million, paid off
six construction loans for $15.4 million, experienced an increase in
construction draws of $4.7 million and incurred approximately $1.7 million in
debt issuance costs related to temporary construction financing and bond
issuance costs.
Capital expenditures for 1997 and 1998 are estimated to approximate $250.0
million to $300.0 million, related primarily for the development of additional
residences, of which approximately $110.2 million had been spent through
September 30, 1997. As of September 30, 1997, the Company has started
construction or had purchased land for development on 47 parcels of land in
Oregon, Washington, Texas, Ohio, Idaho, New Jersey and other states which
include 12 parcels that have received certificates of occupancy, but have not
yet received a license to operate. The Company has also entered into agreements
pursuant to which, it may purchase, subject to completion of due diligence and
various other conditions, 26 undeveloped sites. The Company expects these
developments to open through the third and fourth quarter of 1997 and the first
quarter of 1998. In addition, as of September 30, 1997, the Company had
outstanding $93 million in commitments from several health care REITs to finance
additional residences through sale and leaseback transactions. The Company also
anticipates being able to continue to utilize tax-exempt bond financing from
approximately $20.9 million from the states of Ohio, Idaho and Washington. In
addition, the Company subsequent to September 30, 1997, obtained a $50 million
commitment for mortgage financing.
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<PAGE>
The Company does not anticipate any significant capital expenditures within the
foreseeable future with respect to the residences developed in 1994, 1995, 1996
and those currently operating or those pending licensure as of September 30,
1997.
The Company expects that its cash on hand, the net proceeds from the common
stock offering and convertible debenture offering with cash flow from operations
and available REIT financing and mortgage financing, will be sufficient to meet
its operating requirements and to fund its anticipated growth for at least the
next 12 to 18 months. The Company expects to use a wide variety of financing
sources to fund its future growth, including public and private debt and equity,
conventional mortgage financing, unsecured bank financing, among other sources.
There can be no assurances that financing from such sources will be available in
the future, or if available that such financing will be available on terms
acceptable to the Company.
As of September 30, 1997, the Company had invested excess cash balances in
short-term certificates of deposit and U.S. Treasury securities. The Company
intends to satisfy future capital requirements for its development activities by
various means, including financing obtained from sale/leaseback transactions,
permanent mortgage financing and long-term state bond financing and to the
extent available, cash generated from operations.
RISK FACTORS
Except for the historical information contained herein, the matters discussed
herein are foreword looking statements. Such forward-looking statements involve
known and unknown risks, uncertainties and other factors that may cause the
actual results, performance or achievements of the Company to be materially
different from any future results, performance or achievements expressed or
implied by such forward-looking statements. The following discussion highlights
some of these risks and others are discussed elsewhere herein or in other
documents filed by the Company with the Securities and Exchange Commission.
ANTICIPATED OPERATING LOSSES OF NEW RESIDENCES. The Company anticipates that
each residence will have an operating loss (prior to depreciation, rent or
interest, if any) of $20,000 during the first three to four months of operation.
To the extent the Company sells a residence and leases it back or otherwise
finances it, the aggregate loss may increase by up to an additional $100,000.
The Company currently plans to open 50 to 60 residences in 1997, of which 42
were opened during the first nine months of 1997. The Company estimates that the
losses to be incurred during 1997 due to start-up residences could range from
$1.0 million to $3.2 million. The success of the Company's future operations is
directly tied to the expansion of its operational base. There can be no
assurance that the Company will not experience unforeseen expenses,
difficulties, complications and delays in connection with the expansion of its
operational base which could have a material adverse effect on the Company's
financial condition and results of operations.
In April 1997, in order to mitigate the impact of start-up losses associated
with the opening of newly constructed residences, the Company entered into a
joint venture agreement with a third party investor to operate certain new
assisted living residences owned and developed by the Company. Pursuant to the
joint venture agreement, the Company has acquired a 10% interest for $200,000
and the joint venture partner has acquired a 90% interest for $2.0 million in
the joint venture. The joint venture concurrently entered into a non-cancelable
management agreement with the Company pursuant to which the Company will manage
the properties operated by the joint venture for an amount equal to the greater
of 8% of gross revenues or $2,000 per month per property. As of September 30,
1997, eleven residences owned by the Company were being operated by the joint
venture. The revenues and expenses of the joint venture are consolidated with
Page 16 of 26
<PAGE>
those of the Company. In addition, the Company will recognize 10% of the losses
or profits, if any, of the joint venture, net of the effect of management fees
paid to the Company. The Company may seek to acquire the joint venture
partner's 90% interest in the future, but has no contractual right to purchase
such interest. While the use of such joint venture agreements is intended to
mitigate the impact on the Company of start-up losses associated the opening of
new residences or otherwise, the Company may, to the extent it does not acquire
the partner's interest, forgo a portion of future operating profits, if any,
from the residences operated by the joint venture. The Company expects it will,
from time to time, enter into additional partnering arrangements, which may be
similar to the current structure, for some of its future development projects.
There can be no assurance that the Company will be able to enter into any such
future arrangements or, if entered into, that such arrangements will achieve the
desired results.
Due to the completion of the recent common stock and convertible subordinated
debenture offerings and the completion of the acquisitions of Carriage House and
HCI, the Company expects to retain ownership of a greater number of its assisted
living residences as well as to accelerate its development program.
Historically, the Company has relied extensively on sale/leaseback financings
from REITs to finance its development efforts. The Company also expects to make
additional investments in its management infrastructure to further support its
growth strategy. While the Company believes that the resulting effects of the
recent completed offerings, the increased focus on asset ownership, its
accelerated development program and anticipated additions to its corporate
infrastructure will negatively impact its earnings prospects over the next 18 to
24 months, it believes that these measures will positively affect its long-term
prospects.
NO ASSURANCE AS TO ABILITY TO DEVELOP OR ACQUIRE ADDITIONAL ASSISTED LIVING
RESIDENCES. The Company's prospects for growth are directly affected by its
ability to develop and, to a lesser extent, acquire additional assisted living
residences. While the Company currently plans to open 60 to 70 residences in
1998, there can be no assurance that such residences will be completed. The
success of the Company's growth strategy will also depend upon, among other
factors, the Company's ability to obtain government licenses and approvals, the
Company's ability to obtain financing and the competitive environment for
development and acquisitions. The nature of such licenses and approvals and the
timing and likelihood of obtaining them vary widely from state to state,
depending upon the residence, or its operation, and the type of services to be
provided. The successful development of additional assisted living residences
will involve a number of risks, including the possibility that the Company may
be unable to locate suitable sites at acceptable prices or may be unable to
obtain, or may experience delays in obtaining, necessary zoning, land use,
building, occupancy, and other required governmental permits and authorizations.
The Company is dependent upon these permits and authorizations to construct and
operate its residences and any delay or inability to obtain such permits could
adversely affect the results of operations. The Company may also incur
construction costs that exceed original estimates, may not complete construction
projects on schedule and may experience competition in the search for suitable
development sites. The Company relies on third-party general contractors to
construct its new assisted living facilities. There can be no assurance that
the Company will not experience difficulties in working with general contractors
and subcontractors, which could result in increased construction costs and
delays. Further, facility development is subject to a number of contingencies
over which the Company will have little control and that may adversely affect
project cost and completion time, including shortages of, or the inability to
obtain, labor or materials, the inability of the general contractor or
subcontractors to perform under their contracts, strikes, adverse weather
conditions and changes in applicable laws or regulations or in the method of
applying such laws and regulations. Accordingly, if the Company is unable to
achieve its development plans, its business, financial condition and results of
operations could be adversely affected. There can be no assurance that the
Company will be successful in developing or acquiring any particular residence,
that the Company's rapid expansion will not adversely affect its operations or
that any residence developed or acquired by the Company will be
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<PAGE>
successful. The various risks associated with the Company's development or
acquisition of assisted living residences and uncertainties regarding the
profitability of such operations could have a material adverse effect on the
Company's financial condition and results of operations.
NEED FOR ADDITIONAL FINANCING TO FUND FUTURE DEVELOPMENT AND ACQUISITIONS. To
achieve its growth objectives, the Company will need to obtain sufficient
financial resources to fund its development, construction and acquisition
activities. The estimated cost to complete and fund start-up losses for the new
facilities that will be developed during the 15 months ended December 31, 1998
is between $190.0 million and $240.0 million; accordingly, the Company's future
growth will depend on its ability to obtain additional financing on acceptable
terms. The Company will, from time to time, seek additional funding through
public and/or private financing sources, including equity and/or debt financing.
If additional funds are raised by issuing equity securities, the Company's
stockholders may experience dilution. There can be no assurance that adequate
funding will be available as needed or on terms acceptable to the Company. A
lack of available funds may require the Company to delay or eliminate all or
some of its development projects and acquisition plans.
The Company's aggregate annual fixed debt and lease payment obligations as of
September 30, 1997 total approximately $19.7 million. These fixed payment
obligations will significantly increase as the Company pursues its development
plan. Failure to meet these obligations may results in the Company being in
default of its financing agreements and, as a consequence, the Company may lose
its ability to operate any individual residence or other residences which may be
cross-defaulted. There can no assurance that the Company will generate
sufficient cash flow to meet its current or future obligations. The Company has
not historically covered its fixed charges with earnings. In addition, the
Company anticipates, there is a risk that, upon completion of construction,
permanent financing for newly developed residences may not be available or may
be available only on terms that are unfavorable or unacceptable to the Company.
GEOGRAPHIC CONCENTRATION; DEPENDENCE ON STATE MEDICAID WAIVER PROGRAMS As of
September 30, 1997, approximately 33.9% of the Company's properties are located
in the State of Texas, approximately 18.3% are located in the State of Oregon,
14.7% are located in the State of Ohio and 11.0% are located in the State of
Washington; therefore, the Company is dependent on the economies of Texas,
Oregon, Ohio and Washington and, to a certain extent, on the continued funding
of state Medicaid waiver programs. The Company has operated residences in Oregon
since December 1994. During the three months and nine months ended September 30,
1997 and years ended 1996 and 1995, direct payments received from state Medicaid
agencies accounted for approximately 11.1%, 11.1%, 13.8% and 21.4%, respectively
of the Company's revenue while the tenant-paid portion of Medicaid residents
accounted for approximately 5.9%, 6.0%, 7.6% and 9.6% respectively, of the
Company's revenue during these periods. The Company expects that State Medicaid
reimbursement programs will constitute a significant source of revenue for the
Company. The Company intends to continue developing and operating assisted
living residences in other states. Adverse changes in general economic factors
affecting these states' respective health care industries or in these states'
laws and regulatory environment, including Medicaid reimbursement rates, could
have a material adverse effect on the Company's financial condition and results
of operations.
DEPENDENCE ON REIMBURSEMENT BY THIRD-PARTY PAYORS A portion of the Company's
revenues will be dependent upon reimbursement from third-party payors, including
state Medicaid programs and private insurers. For the three months and nine
months ended September 30, 1997, and the years ended December 31, 1996, 1995,
the Company received, as a percentage of total revenue, under Medicaid programs
11.1%, 11.1%, 13.8% and 21.4%, respectively. Furthermore, there can be no
assurance the Company's proportionate percentage of revenue received from
Medicaid programs will not increase. The revenues and profitability of the
Company will be affected by the continuing efforts of governmental
Page 18 of 26
<PAGE>
and private third-party payors to contain or reduce the costs of health care by
attempting to lower reimbursement rates, increasing case management review of
services and negotiating reduced contract pricing. In an attempt to reduce the
federal and certain state budget deficits, there have been, and management
expects that there will continue to be, a number of proposals to limit Medicaid
reimbursement in general. Adoption of any such proposals at either the federal
or the state level could have a material adverse effect on the Company's
business, financial condition, results of operations and prospects.
GOVERNMENT REGULATION. Federal and state governments regulate various aspects
of the Company's business. The development and operation of assisted living
facilities and the provision of health care services are subject to federal,
state and local licensure, certification and inspection laws that regulate,
among other matters, the number of licensed beds, the provision of services,
equipment, staffing (including professional licensing), operating policies and
procedures, fire prevention measures, environmental matters, resident
characteristics, physical design and compliance with building and safety codes.
Failure to comply with these laws and regulations could result in the denial of
reimbursement, the imposition of fines, suspension or decertification from the
Medicare and Medicaid program and, in extreme cases, the revocation of a
facility's license or closure of a facility. There can be no assurance that
federal, state, or local governments will not impose additional restrictions on
the Company's activities that could materially adversely affect the Company.
State and local laws regulating the Company's operations vary significantly
from one jurisdiction to another. In certain states in which the Company is
currently developing assisted living facilities, a certificate of need ("CON")
or other similar approval may be required for the acquisition or construction of
new facilities, the expansion of the number of licensed units or beds or
services, or the opening of a home health care agency or hospice. The Company
could be adversely affected by the failure or inability to obtain such approval,
changes in the standards applicable for such approval and possible delays and
expenses associated with obtaining such approval.
The Company's completed acquisition of HCI on October 23, 1997 includes HCI's
home health care and hospice operations. In addition to federal state
regulation of health care providers generally, home health care and hospice
operations are subject to federal and state laws covering the repackaging and
dispensing of drugs and regulating interstate motor-carrier transportation,
pharmacies, nursing services and certain types of home health agency and hospice
activities. Certain of HCI's employees are subject to state laws and
regulations governing the ethics and professional practice of, among others,
medicine, respiratory therapy, pharmacy and nursing. Home health care and
hospice operations are subject to periodic survey by governmental and private
accrediting entities to assure compliance with applicable state licensing,
Medicare and Medicaid certification and accreditation standards, as the case may
be. From time to time in the ordinary course of business, HCI, like other
health care companies, has received survey reports containing deficiencies for
alleged failure to comply with applicable requirements. HCI reviews such
reports and attempts to take appropriate corrective action. The failure to
effect such action or to obtain, renew or maintain any of the required
regulatory approvals, certifications or licenses could adversely affect HCI's
business, results of operations or financial condition and could prevent the
programs involved from offering products and services to patients.
Federal and state fraud and abuse laws, such as "anti-kickback" laws and
"self-referral" laws, govern certain financial arrangements among health care
providers and others who may be in a position to refer or recommend patients to
such providers. Although the Company has established policies and procedures
that it believes are sufficient to ensure that its facilities will operate in
substantial compliance with applicable regulatory requirements, there can be no
assurance that such fraud and abuse laws will be interpreted in a manner
consistent with the practices of the Company.
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<PAGE>
PRICING PRESSURES The health care services industry is currently experiencing
market-driven reforms from forces within and outside the industry that are
exerting pressure on health care and related companies to reduce health care
costs. These market-driven reforms are resulting in industry-wide consolidation
that is expected to increase the downward pressure on health care service
providers' margins, as larger buyer and supplier groups exert pricing pressure
on health care providers. The ultimate timing or effect of market-driven reforms
cannot be predicted. No assurance can be given that any such reforms will not
have a material adverse effect on the Company's business, results of operations,
financial condition and prospects.
HEALTH CARE REFORM Health care and related services is an area of extensive and
dynamic regulatory change. Changes in the law, new interpretations of existing
laws, or changes in payment methodology, may have a dramatic effect on the
definition of permissible or impermissible activities, the relative costs
associated with doing business and the amount of reimbursement by both
government and other third-party payors and may be applied retroactively.
The Balanced Budget Act of 1997 signed by President Clinton on August 5, 1997
(the "Act"), enacted significant changes to the Medicare and Medicaid programs
designed to modernize payment and health care delivery systems while achieving
substantial budgetary savings. In seeking to limit Medicare reimbursement for
home health services, Congress has established a prospective payment system to
replace the current cost-based reimbursement system. The cost based system
reimburses providers for reasonable direct and indirect allowable costs and
ancillary costs. Cost based reimbursement has been subject to limits fixed for
the particular geographic area served by a provider. The prospective payment
system will be implemented beginning in September 1999. In addition to
establishing new prospective payment systems, the Act eliminated certain
periodic interim payments advanced to home health agencies.
Under provisions of the Act, states will be provided additional flexibility in
managing their Medicaid programs while achieving in excess of $13 billion in
federal budgetary savings over five years. Among other things, the Act repealed
the Boren Amendment payment standard, which had required states to pay
"reasonable and adequate" payments to cover the costs of efficiently and
economically operated hospitals, nursing facilities and certain intermediate
care facilities. States, however, will be required to use a public notice and
comment process in determining rates for such facilities. States also will be
required to take into account during rate-setting procedures the situation of
facilities that serve a disproportionate number of low-income patients with
special needs. The Department of Health and Human Services is required to study
and report to congress within four years concerning the effect of state rate-
setting methodologies on access to and the quality of services provided to
medicaid beneficiaries.
The Act also provides the federal government with expanded enforcement powers
to combat waste, fraud and abuse in health care. In this regard, provisions of
the Act significantly expand the scope and coverage of civil monetary penalties
for violations of Medicare rules. Specific to home health services, the Act
established guidelines for the frequency and duration of home health services;
clarifying the definition of part-time or intermittent nursing care in order to
clarify the scope of the Medicare benefit and make it easier to identify
inappropriate services. The Act also requires home health agencies to bill for
services based on the location of service delivered rather than the location of
the agency, in an effort to limit high urban reimbursement rates for care
delivered in low-cost areas.
In addition, to the reforms enacted and considered by Congress from time to
time, state legislatures periodically consider various health care reform
proposals. Congress and state legislatures can be expected to continue to
review and assess alternative health care delivery systems and payment
Page 20 of 26
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methodologies and public debate of these issues can be expected to continue in
the future. The ultimate timing or effect of legislative efforts cannot be
predicted and may impact the Company in different ways. There can be no
assurances that either the states or the federal government will not impose
additional regulations upon the activities of the Company or HCI which might
adversely affect their businesses, the financial condition, results of
operations and prospects.
HOME HEALTH MEDICARE CERTIFICATION MORATORIUM AND SPECIFIC PROGRAM REFORM The
general accounting office ("GAO") reported to Congress in July 1997, that
federal regulators are failing to adequately police home health agencies,
resulting in extensive and expensive problems in Medicare's home-health program.
In response to the GAO report, the federal government announced on September 15,
1997, that home health care providers will be targeted in a growing federal
crackdown. The announced federal compliance program will institute a three-step
process in an effort to prevent unscrupulous operators from becoming Medicare
providers and significantly increase the level of scrutiny to which existing
companies in the program are subjected. The first step in this program was to
institute an immediate moratorium on the admission of new home health care
agencies to Medicare. During the moratorium on new providers, HCFA will develop
strict new conditions of participation. HCFA also will double the number of
audits of home health agencies it performs each year and increase substantially
the number of claims reviewed.
Under the new home health regulations to be proposed, HCFA will require
periodic recertification of home health agencies to determine if they meet the
beefed-up conditions of participation. As part of the re-certification process,
agencies will have to submit an independent audit of their records and
practices. If the provider does not meet the strict new enrollment
requirements, they will not be renewed as providers in Medicare. In addition,
home health agencies will be required to post surety bonds of at least $50,000
before they can enroll or re-enroll in Medicare. A related rule will require
new agencies to have enough funds on hand to operate for the first three to six
months.
To the extent the Company expands into home health care, the regulations to be
proposed by HCFA may require the restructuring of the operations of home heath
agencies to conform to the new Medicare conditions of participation ultimately
adopted. In addition, the Medicare moratorium on new home health care agencies
may require expansion to be achieved through acquisitions rather than through
the development of new agencies.
OPERATION RESTORE TRUST Under Operation Restore Trust ("ORT"), a two year
demonstration project, the Office of the Inspector General of the U.S.
Department of Health and Human Services (the "OIG"), in cooperation with other
federal and state agencies, has focused on the activities of home health
agencies, hospices, durable medical equipment suppliers and nursing homes in
certain states, including Texas, in which HCI currently operates. Because of
the success of ORT, the next phase of ORT has been expanded to numerous other
states and to additional health care providers including ancillary nursing home
services. The legislation adopted in 1996 expanding ORT also created a stable
source of funding for fraud control activities.
As part of ORT, hospice programs have been audited. According to public
reports, the OIG audits have focused on the hospice eligibility of long stay
patients (those who are in a hospice program for longer than 210 days). The
ultimate disposition of an OIG review and its possible impact on HCI cannot
currently be predicted and there can be no assurance that an OIG review will not
have a material adverse effect on the Company's business, results of operations
or financial condition.
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STAFFING AND LABOR COSTS The Company will compete with other providers of long-
term care with respect to attracting and retaining qualified personnel. The
Company will also be dependent upon the available labor pool of low-wage
employees. A shortage of nurses and/or trained personnel may require the
Company to enhance its wage and benefits package in order to compete. No
assurance can be given that the Company's labor costs will not increase, or
that, if they do increase, they can be matched by corresponding increases in
revenues.
COMPETITION The long-term care industry is highly competitive and the Company
expects that the assisted living business, in particular, will become more
competitive in the future. The Company will be competing with numerous other
companies providing similar long-term care alternatives, such as home health
agencies, life care at home, community-based service programs, retirement
communities and convalescent centers. The Company expects that as assisted
living receives increased attention and the number of states which include
assisted living in their Medicaid waiver programs increases, competition will
grow from new markets entrants, including publicly and privately held companies
focusing primarily on assisted living. Nursing facilities that provide long-
term care services are also a source of competition to the Company. Moreover,
in the implementation of the Company's expansion program, the Company expects to
face competition for development and acquisitions of assisted living residences.
Some of the Company's present and potential competitors are significantly larger
and have, or may obtain, greater financial resources than those of the Company.
Consequently, there can be no assurance that the Company will not encounter
increased competition in the future which could limit its ability to attract
residents or expand its business and could have a material adverse effect on the
Company's financial condition, results of operations and prospects.
DIFFICULTIES OF MANAGING RAPID GROWTH The Company expects that the number of
residences which it owns, leases or otherwise operates will increase
substantially as it pursues its growth strategy. This rapid growth will place
significant demands on the Company's management resources. The Company's
ability to manage its growth effectively will require it to continue to expand
its operational, financial and management information systems and to continue to
attract, train, motivate, manage and retain key employees. To the extent such
growth is attributable to acquisitions of existing facilities or businesses, the
Company's success will depend partly on its ability to integrate effectively
such facilities and businesses into the Company's management, information and
operating systems. If the Company is unable to manage its growth effectively,
its business, financial condition and results of operations could be adversely
affected.
DEPENDENCE ON SENIOR MANAGEMENT AND SKILLED PERSONNEL The Company depends, and
will continue to depend, upon the services of Mr. McBride, its Chief Executive
Officer, Dr. Wilson, its Chief Operating Officer and President, Connie Baldwin,
its Director of Operations and Stephen Gordon, its Chief Administrative Officer
and Chief Financial Officer and Rhonda S. Marsh, its Chief Accounting Officer.
The Company has entered into an employment agreements with Mr. McBride and Dr.
Wilson and has obtained a $500,000 key employee insurance policy covering Dr.
Wilson's life. The Company is also dependent upon its ability to attract and
retain management personnel who will be responsible for the day-to-day
operations of each residence. The loss of the services of any or all of such
officers or the Company's inability to attract additional management personnel
in the future could have a material adverse effect on the Company's financial
condition or results of operations.
Page 22 of 26
<PAGE>
LIABILITY AND INSURANCE The provision of health care services entails an
inherent risk of liability. In recent years, participants in the long-term care
industry have become subject to an increasing number of lawsuits alleging
malpractice or related legal theories, many of which involve large claims and
significant defense costs. The Company currently maintains liability insurance
intended to cover such claims and the Company believes that its insurance is in
keeping with industry standards. There can be no assurance, however, that
claims in excess of the Company's insurance coverage or claims not covered by
the Company insurance coverage (e.g., claims for punitive damages) will not
arise. A successful claim against the Company not covered by, or in excess of,
the Company's insurance coverage could have a material adverse effect upon the
Company's financial condition and results of operations. Claims against the
Company regardless of their merit or eventual outcome, may also have a material
adverse effect upon the Company's ability to attract residents or expand its
business and would require management to devote time to matters unrelated to the
operation of the Company's business. In addition, the Company's insurance
policies must be renewed annually. There can be no assurance that the Company
will be able to obtain liability insurance coverage in the future or that, if
such coverage is available, it will be available on acceptable terms.
ENVIRONMENTAL RISKS Under various federal, state and local environmental
laws, ordinances and regulations, a current or previous owner or operator of
real property may be held liable for the cost of removal or remediation of
certain hazardous or toxic substances, including, without limitation, asbestos-
containing materials, that could be located on, in or under such property. Such
laws and regulations often impose liability whether or not the owner or operator
knew of, or was responsible for, the presence of the hazardous or toxic
substances. The costs of any required remediation or removal of these
substances could be substantial and the liability of an owner or operator as the
any property is generally not limited under such laws and regulations and could
exceed the property's value and the aggregate assets of the owner or operator.
The presence of these substances or failure to remediate such substances
properly may also adversely affect the owner's ability to sell or rent the
property, or to borrow using the property as collateral. Under these laws and
regulations, an owner, operator or an entity that arranges for the disposal of
hazardous or toxic substances, such as asbestos-containing materials, at a
disposal site may also be liable for the costs of any required remediation or
removal of the hazardous or toxic substances at the disposal site. In
connection with the ownership or operation of its properties, the Company could
be liable for these costs, as well as certain other costs, including
governmental fines and injuries to persons or properties. As a result, the
presence, with or without the Company's knowledge, of hazardous or toxic
substances at any property held or operated by the Company, or acquired or
operated by the Company in the future, could have an adverse effect on the
Company's business, financial condition and results of operations.
Environmental audits performed on the Company's properties have not revealed any
significant environmental liability that management believes would have a
material adverse effect on the Company's business, financial condition or
results of operations. No assurance can be given that existing environmental
audits with respect to any other Company's properties reveal all environmental
liabilities.
POSSIBLE VOLATILITY OF STOCK PRICE The market price of the Common Stock could
be subject to significant fluctuations in response to various factors and
events, including the liquidity of the market for the Common Stock, variations
in the Company's operating results, new statutes or regulations or changes in
the interpretation of existing statutes or regulations affecting the health care
industry generally or assisted living residence businesses in particular. In
addition, the stock market in recent years has experienced broad price and
volume fluctuations that often have been unrelated to the operating performance
of particular companies. These market fluctuation also may adversely affect the
market price of the Common Stock.
Page 23 of 26
<PAGE>
DIVIDEND POLICY. The Company has never declared or paid any dividends on its
Common Stock. The Company expects to retain any earnings to finance the
operations and expansion of the Company's business. Certain Trust Deed Notes,
payable to the State of Oregon Housing and Community Service Department restrict
the payment of cash dividends in certain circumstances and it is anticipated
that the terms of future debt financings may do so as well. Therefore, the
payment of any cash dividends on the Common Stock is unlikely in the foreseeable
future.
Page 24 of 26
<PAGE>
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
Exhibit
Number
------
12 Computation of Fixed Charge to Earnings
27 Financial Data Schedule
(b) Reports on Form 8-K.
On July 24, 1997, the Company filed a report on Form 8-K
reporting a two-for-one stock split on the Company's common stock, and the
adoption by the Company's Board of Directors of a Stockholders Rights
Plan.
On October 2, 1997, the Company filed a report on Form 8-K
reporting the Company's plans to acquire Home and Community Care, Inc.,
the resignation of Mr. Andre Dimitriadis from the Board of Directors of
the Company as of September 8, 1997 and the election of Mr. William
McBride III as the Company's New Chief Executive and the election of Dr.
Keren Brown Wilson who has been the Chief Executive Officer and President
of the Company as the Chief Operating Officer, President and Vice Chairman
of the Company.
On October 6, 1997, the Company filed a report on Form 8-K of a
preliminary prospectus supplement to the prospectus dated October 2, 1997
for the proposed offering of 3,000,000 shares of the Company's common
stock and the concurrent offering of $50,000,000 of convertible
subordinated debentures due 2002.
On October 21, 1997, the Company filed a report on Form 8-K
containing certain material contracts.
Page 25 of 26
<PAGE>
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) the Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ASSISTED LIVING CONCEPTS, INC.
Registrant
November 14, 1997 By: /s/ STEPHEN GORDON
---------------------
Name: Stephen Gordon
Title: Chief Administrative Officer and CFO
November 14, 1997 By: /s/ RHONDA S. MARSH
----------------------
Name: Rhonda S. Marsh
Title: Chief Accounting Officer and
Controller
Page 26 of 26
<PAGE>
EXHIBIT 12.1
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Income before provision for income taxes $1,607 $ (238) $3,706 $ (409)
Add fixed charges
Interest expense including amortization
of debt issuance costs 245 426 653 477
------ ------ ------ ------
Earnings 1,852 188 4,359 68
====== ====== ====== ======
Fixed Charges
Interest expense including amortization
of debt issuance costs 245 426 653 477
Capitalized interest 1,620 518 4,600 3,100
------ ------ ------ ------
Total fixed charges $1,865 $ 944 $5,253 $3,577
====== ====== ====== ======
Ratio of earnings to fixed charges - - - -
Deficiency of Earnings to cover fixed charges (13) (756) (894) (3,509)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> JUL-01-1997 JAN-01-1997
<PERIOD-END> SEP-30-1997 SEP-30-1997
<CASH> 5,437 5,437
<SECURITIES> 1,840 1,840
<RECEIVABLES> 2,082 2,082
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 11,591 11,591
<PP&E> 158,766 158,766
<DEPRECIATION> 1,840 1,840
<TOTAL-ASSETS> 175,551 175,551
<CURRENT-LIABILITIES> 73,652 73,652
<BONDS> 39,945 39,945
0 0
0 0
<COMMON> 111 111
<OTHER-SE> 61,843 61,843
<TOTAL-LIABILITY-AND-EQUITY> 175,551 175,551
<SALES> 12,505 32,597
<TOTAL-REVENUES> 12,505 32,597
<CGS> 7,897 20,146
<TOTAL-COSTS> 7,897 20,146
<OTHER-EXPENSES> 4,187 10,281
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 245 653
<INCOME-PRETAX> 1,607 3,706
<INCOME-TAX> 611 1,079
<INCOME-CONTINUING> 996 2,627
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 996 2,627
<EPS-PRIMARY> .09 .23
<EPS-DILUTED> .09 .23
</TABLE>
