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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
COMMISSION FILE NUMBER: 0-26980
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ARV ASSISTED LIVING, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 33-0160968
(STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OR ORGANIZATION)
245 FISCHER AVENUE, SUITE D-1 92626
COSTA MESA, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (714) 751-7400
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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COMMON STOCK, NO PAR VALUE AMERICAN STOCK EXCHANGE
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
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. Yes [X] No [ ]
As of March 25, 1999, the aggregate market value of the voting stock held
by non-affiliates of registrant was $25,309,832 (for purposes of calculating the
preceding amount only, all directors, executive officers and shareholders
holding 5% or greater of the registrant's Common Stock are assumed to be
affiliates). The number of shares of Common Stock of the registrant outstanding
as of March 25, 1999 was 15,873,498.
DOCUMENTS INCORPORATED BY REFERENCE:
Portion of Registrant's definitive Proxy Statement for its 1999 Annual
Meeting of Stockholders are incorporated by reference into Part III of this
report.
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ARV ASSISTED LIVING, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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PART I
Item 1: Business 1
Item 2: Properties 16
Item 3: Legal Proceedings 18
Item 4: Submission of Matters to a Vote of Security Holders 19
PART II
Item 5: Market for Registrant's Common Equity and Related Shareholder
Matters 20
Item 6: Selected Financial Data 21
Item 7: Management's Discussion and Analysis of Financial Condition and
Results of Operations 22
Item 7a: Quantitative and Qualitative Disclosures About Market Risk 30
Item 8: Financial Statements and Supplementary Data 30
Item 9: Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 30
PART III
Item 10: Directors and Executive Officers of the Registrant 31
Item 11: Executive Compensation 31
Item 12: Security Ownership of Certain Beneficial Owners and Management 31
Item 13: Certain Relationships and Related Transactions 31
PART IV
Item 14: Exhibits, Financial Statement Schedules, and Reports on Form 8-K 32
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PART I
ITEM 1. BUSINESS
GENERAL
ARV Assisted Living, Inc. ("ARV" or the "Company") is one of the largest
operators of licensed assisted living communities ("ALCs") in the United States.
We are a fully integrated provider of assisted living accommodations and
services that operates, acquires and develops ALCs. We have been continuously
involved in the housing business for more than 20 years. Our operating objective
is to provide high quality, personalized assisted living services to senior
residents in a cost-effective manner, while maintaining residents' independence,
dignity and quality of life. ALCs offer a combination of housing, personalized
support services and health care in a non-institutional setting. They are
designed to respond to the individual needs of elderly residents who require
assistance with certain activities of daily living, but who do not require the
intensive nursing care provided in a skilled nursing facility.
We implemented a plan to expand our operations through the acquisition
and development of new ALCs. To this end, we expanded our operations
through acquisitions in California, Ohio, Florida, Indiana, Michigan, Arizona
and Virginia, and have developed or are in the process of constructing new ALCs
in California, Florida, Texas, New Mexico, Indiana, Massachusetts, Nevada,
Colorado, Rhode Island and Connecticut. At December 31, 1998, we operated 63
ALCs containing 7,944 units. Of the 63 ALCs, we owned 16, leased 39, and managed
8. Subsequent to December 31, 1998, ARVP II, LLC a wholly owned subsidiary of
American Retirement Villas Properties II, of which we are managing general
partner and a majority limited partner, purchased four ALCs formerly leased by
the partnership. In addition, we have 7 ALCs under construction and development
that are expected to contain approximately 923 units.
Owned ALCs are owned by us directly, or by affiliated limited partnerships
or limited liability companies for which we serve as managing general partner or
member and community manager in which we have a majority ownership interest
("Affiliated Partnerships"). Leased ALCs are operated under long-term operating
leases for our own account or for Affiliated Partnerships in which we have a
majority ownership interest. Managed ALCs are operated by us on behalf of an
affiliated partnership (in which we do not have a majority ownership), joint
ventures or an unrelated third party. This blend of ownership
allowed us to fund our growth in a more balanced, efficient manner.
We have used lease and mortgage financing with health care real estate
investment trusts ("REITs"), private companies, commercial banks and a
convertible subordinated debt issuance to facilitate our growth strategy. We
intend to enhance our existing portfolio of assets by increasing the percentage
of communities that we own. We also plan to divest ALCs that do not meet our
financial objectives or geographic clustering strategy. Our primary geographic
focus is California. In December 1998, our Board of Directors decided to sell
the five owned ALCs located outside of California. As of March 18, 1999, we
entered into purchase and sale agreements for these properties for approximately
$32.3 million and on March 30, 1999, we completed the sale of three of five
properties, with the remaining two properties anticipated to close during the
second and third quarters of 1999.
We intend to continue our focus on "private-pay" residents, who pay for our
services from their own funds or through private insurance. Currently,
approximately 98% of our ALC revenue comes from private-pay residents, while the
remaining 2% of ALC revenue comes from residents participating in the
Supplemental Security Income ("SSI") program. Certain states have enacted
legislation enabling ALCs to receive Medicaid funding similar to funding
generally provided to skilled nursing facilities. However, we do not try to
attract residents with Medicaid funding since it is insufficient to cover the
cost of our accommodations and services.
Our ALCs provide residents with accommodations, basic care services and
assisted living services. Our residents average 85 years of age and often
require assistance with certain activities of daily living. We provide our
residents with private or semi-private rooms or suites, meals in a communal
setting, housekeeping, linen and laundry services, activities programs,
utilities, and transportation in a van or minibus. For an additional cost, we
also provide assisted living services to residents who require help with other
activities of daily living, such as bathing, grooming, dressing, personal
hygiene and escort services to meals and activities.
Further, each ALC offers a Wellness Program that arranges for professional
care providers to deliver certain health care services to our residents that our
ALCs are not licensed or equipped to provide. We formed a strategic alliance in
1998 with NovaCare, Inc. a nationwide provider of rehabilitation services, to
deliver physical rehabilitation services to our residents on-site. Also in 1998,
we
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formed a joint venture with Omnicare, Inc., a leading provider of network
pharmacy and related clinical information services, to help our communities
deliver pharmacy benefit services to residents who join the new Neighbor Network
program that we jointly operate with Omnicare.
Partnerships affiliated with us have acquired or developed market rate
senior apartments as well as affordable senior and multifamily apartment
communities, using the sale of tax credits under a federal low income housing
tax credit program (the "Federal Tax Credit Program" or the "Apartment Group")
to generate the equity funding for development. In December 1997, as part of our
strategic plan, we determined that the Apartment Group was not part of our core
business, and adopted a plan for disposing of the business, which included 17
apartment projects. During 1998, we entered into purchase and sale agreements
for the sale of 11 apartment projects. As of March 31, 1999, we have closed on
the sale of three of the 11 apartment projects, and have 8 of the apartment
projects under contract for sale for which we are awaiting consent to sell from
limited partners or lenders. The remaining 6 apartment projects are not
currently under contract; however, we plan to sell these projects by December
31, 1999.
THE ASSISTED LIVING MARKET
Assisted Living. Assisted living is a stage in the elder care continuum,
midway between home-based care for lower acuity residents and the more acute
level of care provided by skilled nursing facilities and acute care hospitals.
Assisted living represents a combination of housing, personalized support
services, and health care designed to respond to the individual needs of the
senior population who need help in activities of daily living, but do not need
the medical care provided in a skilled nursing facility.
We believe our assisted living business benefits from significant trends
affecting the long-term care industry. The first is an increase in the demand
for elder care resulting from the continued aging of the U.S. population, with
the average age of our residents falling within the fastest growing segment of
the U.S. population. While increasing numbers of Americans are living longer and
healthier lives, many gradually require increasing assistance with activities of
daily living, and are not able to continue to age in place at home. The second
trend is the effort to contain health care costs by the government, private
insurers and managed care organizations by limiting lengths of stay, services,
and reimbursement to patients in acute care hospitals and skilled nursing
facilities. Assisted living offers a cost-effective, long-term care alternative
while preserving a more independent lifestyle for seniors who do not need the
broader array of medical services that acute care hospitals and skilled nursing
facilities are required to provide. As of December 31, 1998, monthly revenue
generated by our ALCs on a same community basis averaged $1,903 per occupied
unit, compared with $1,738 per occupied unit as of December 31, 1997. (We define
"same community" as those communities which we owned or leased for a period of
five quarters or more as of December 31, 1998.) Other trends include increases
in the financial net worth of the elderly population, the number of individuals
living alone, and the number of women who work outside the home who are less
able to care for their elderly relatives. We believe these trends will result in
a growing demand for assisted living services and communities.
Aging Population. The primary consumers of long-term health care services
are persons over the age of 65. This group represents one of the fastest growing
segments of the population. According to U.S. Bureau of the Census data, the
segment of the population over 65 years of age is currently 13% of the total
population, or 34 million people. That number is projected to grow to 20% of the
total population, or 69 million people, by the year 2030. Additionally, the
number of people aged 85 and older, which comprises the largest percentage of
residents at long-term care facilities, is currently 3.7 million and is
projected to increase to 8.5 million by the year 2030.
Limitation on the Supply of Long-Term Care Facilities. The majority of
states in the U.S. have enacted Certificate of Need or similar legislation,
which generally limits the construction of skilled nursing facilities and the
addition of beds or services in existing skilled nursing facilities. High
construction costs, limitations on government reimbursement for the full cost of
construction, and start-up expenses also constrain growth in the supply of such
facilities. Such legislation benefits the assisted living industry by limiting
the supply of skilled nursing beds for the elderly. Cost factors are placing
pressure on skilled nursing facilities to shift their focus toward
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higher acuity care, which enables them to charge more. This contributes to a
shortage of lower acuity care and thereby increases the pool of potential
assisted living residents.
While Certificates of Need generally are not required for ALCs, except in a
few states, most states do require assisted living providers to license their
communities and comply with various regulations regarding building requirements
and operating procedures and regulations. States typically impose additional
requirements on ALCs over and above the standard congregate care requirements.
Further, the limited pool of experienced assisted living staff and management,
as well as the costs and start-up expenses to construct an ALC, provide an
additional barrier to entry into the assisted living business.
Cost Containment Pressures of Health Reform. In response to rapidly rising
health care costs, both government and private pay sources have adopted cost
containment measures that encourage reduced lengths of stay in hospitals and
skilled nursing facilities. The federal government has acted to curtail
increases in health care costs under Medicare by limiting acute care hospital
and skilled nursing facility reimbursement to pre-established fixed amounts.
Private insurers have also begun to limit reimbursement for medical services in
general to predetermined "reasonable" charges. Managed care organizations, such
as health maintenance organizations ("HMOs") and preferred provider
organizations ("PPOs") are reducing hospitalization costs by negotiating
discounted rates for hospital services and by monitoring and decreasing
hospitalization. We anticipate that both HMOs and PPOs increasingly may direct
patients away from higher cost nursing care facilities into less expensive ALCs.
These cost containment measures have produced a "push-down" effect. As the
number of patients being "pushed down" from acute care hospitals to skilled
nursing facilities increases, the demand for residential options such as ALCs to
serve patients who historically have been served by skilled nursing facilities
will also increase. In addition, skilled nursing facility operators are
continuing to focus on improving occupancy and expanding services (and fees) to
subacute patients requiring very high levels of nursing care. As the acuity
level of skilled nursing facility patients rises, the supply of nursing facility
beds will be filled by patients with higher acuity needs who pay higher fees.
This will provide opportunities for assisted living communities to increase
their occupancy and services to residents requiring lower levels of care than
patients in skilled nursing facilities generally receive.
OUR ASSISTED LIVING SERVICES
We provide services and care which are designed to meet the individual
needs of our residents. The services provided are designed to enhance both the
physical and mental wellbeing of seniors in each of our ALCs by promoting their
independence and dignity in a home-like setting. Our assisted living program
includes the following:
o Personalized Care Plan. The focus of our strategy is to meet the
specific needs of each resident. We customize our services beginning
with the admissions process; when the ALC's management staff, the
resident, the resident's family, and the resident's physician discuss
the resident's needs and develop a "personalized" care plan. If
recommended by the resident's physician, additional health care or
medical services may be provided at the community by a third party
home health care agency or other medical provider. The care plan is
reviewed and modified on a regular basis.
o Basic Service and Care Package. The basic service and care package at
our ALCs generally include:
- meals in a communal, "home-like" setting;
- housekeeping;
- linen and laundry service
- social and recreational programs;
- utilities; and
- transportation in a van or minibus.
Other care services can be provided under the basic package based upon
the individual's personalized health care plan. Our policy is to charge
base rents that are competitive with similar ALCs in the local market.
While the amount of the fee for the basic service package varies from
community to community, on a same community basis the average basic monthly
rate per unit was approximately $1,570 per month as of December 31, 1998,
compared with an average of $1,461 as of December 31, 1997.
o Additional Services. Our assisted living services program offers
additional levels of care beyond what is offered in the
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basic package. The level of care a resident receives is determined
through an assessment of a resident's physical and mental health which
is conducted by the community's assisted living director, with input
from other staff members. The six-tiered rate structure is based on a
point system. We assign points to the various care tasks required by
the resident, based on the amount of staff time and expertise needed
to accomplish the tasks. The point scale and pricing are part of the
admissions agreement between the community, the resident and the
resident's family. The community performs reassessments after the
initial 30 days and periodically throughout the resident's stay to
ensure that the level of care we provide corresponds to changes in a
resident's condition. The types of services included in the assessment
point calculation are:
- Medication management
- Assistance with dressing and grooming
- Assistance with showering
- Assistance with continence
- Escort services
- Status checks related to a recent hospitalization, illness,
history of falls, etc.
- Help with psychosocial needs, such as memory deficit or
depression
- Special nutritional needs and assistance with eating
In addition to the above services, we provide other levels of assistance to
residents at selected ALCs in order to meet individual needs, such as assistance
with diabetic care and monitoring, catheter, colostomy and ileosotomy care,
minor wound care needs and light to moderate transferring needs. Some of our
ALCs also operate memory loss units for residents with Alzheimer's disease and
related dementias. These units provide the attention and services required by
cognitively impaired residents to maintain a high quality of life in a secure
environment. Specially trained staffs provide personalized care and specialized
activity programs and medical directors oversee the medication regimens.
In addition to the base rent, we typically charge between $375 and $1,375
per month plus an additional $10 per point for higher levels of assisted living
services. Fee levels vary from community to community and we may charge
additional fees for other specialized assisted living services. We expect that
an increasing number of residents will use additional levels of services as they
age in our ALCs. Our internal growth plan is focused on increasing revenue by
continuing to improve our ability to provide residents with these services.
On a same community basis, the average monthly revenue per occupied unit
for both the basic service and the additional services increased to $1,793 from
$1,691 for the year ended December 31, 1998 and the nine-month period ended
December 31, 1997, respectively.
There can be no assurance that any ALC will be substantially occupied at
assumed rates at any time. In addition, we may only be able to lease up our ALCs
to full occupancy at rates below those assumed. If operating expenses increase,
local market conditions may limit the extent to which we may increase rates.
Because we must provide advance notice of rate increases, generally at least 30
days, rate increases may lag behind increases in operating expenses.
Wellness Program. We have implemented a Wellness Program for residents of
our communities designed to identify and respond to changes in a resident's
health or condition. Together with the resident and the resident's family and
physician, as appropriate, we design a solution to fit that resident's
particular needs. We monitor the physical and mental wellbeing of our residents,
usually at meals and other activities, and informally as the staff performs
services around the facility. Through the Wellness Program we work with:
o home health care agencies to provide services the community cannot
provide;
o physical and occupational therapists to provide services to residents
in need of such therapy; and
o long-term care pharmacies to facilitate cost-effective and reliable
ordering and distribution of medications.
We arrange for these services to be provided to residents as needed in
consultation with their physicians and families. At the present time, most of
our ALCs have a comprehensive Wellness Program.
GROWTH STRATEGIES
Overview. Our revised strategy to grow earnings and achieve profitability
is to increase our focus on operations and reduce the level of
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development and acquisition activity we historically pursued. To strengthen the
operations of our ALCs, we will focus on improving margins by increasing
occupancy rates, raising or maintaining pricing structures to ensure that our
rates are competitive with comparable facilities in our local markets, and
expanding the level and depth of our assisted living services. Although our pace
of development is expected to slow, we will continue efforts to cluster our
portfolio of ALCs within certain geographic areas through the development,
acquisition and divestiture of selected assets. By concentrating on a clustering
strategy we expect to increase the efficiency of our management and marketing
resources and to achieve broader economies of scale.
Our strategy is to target areas where there is a need for ALCs based on
demographics and market studies. In 1998, we acquired interests in 11 ALCs and
one skilled nursing facility from Hillsdale Group, L.P. and their affiliates,
and opened five newly constructed ALCs. The Hillsdale transaction substantially
increased our presence in Northern and Southern California. As of December 31,
1998, a substantial portion of our business and operations are conducted in
California, where 40 of the 63 ALCs we operated are located. We intend to
continue to make California the primary focus of our clustering strategy. In
addition to acquiring and developing ALCs through direct ownership and the use
of long-term leases, we may also divest ALCs that do not expand or enhance one
of our clusters or do not meet our financial objectives. In December 1998, our
Board of Directors decided to sell the five owned ALCs located outside of
California. As of March 18, 1999, we entered into purchase and sale agreements
for these properties for approximately $32.3 million and on March 30, 1999, we
completed the sale of three of five properties, with the remaining two
properties anticipated to close during the second and third quarters of 1999.
The market value of our properties and the income generated from ALCs we
own, manage or lease could be negatively affected by changes in local and
regional economic conditions and by acts of nature. A worsening of local
economic conditions could have a negative effect on our business.
Development. Our primary development strategy is to work with developers
and builders in clustered geographic areas of the U.S. Typically, regional
developers receive development or construction fees in connection with the
construction of the project. In all cases, we have the right to approve
acquisitions and all aspects of development including site selection, design,
plans and specifications, development budgets, choice of general contractor and
major subcontractors, and other significant criteria.
In developments financed through long-term operating leases, the financier
typically acquires the property when it is ready for construction. We perform
the development, either on our own or in conjunction with regional developers,
under a contractual arrangement with the owner. Concurrently, we enter into a
long-term operating lease that becomes effective when the ALC is completed. The
financier typically bears 100% of the budgeted development costs which may also
include our development or construction supervision fees. In most instances
where we provide development services, we bear the risk for cost overruns. We
typically incur up-front development costs in connection with the due diligence
and entitlement process, and architectural and engineering fees when we are
preparing the property for purchase by the financier at the beginning of
construction. Leases between us and a landlord entity are typically
interconnected. We are not entitled to exercise our right to renew one lease
with a particular lessor without exercising our right to renew all other leases;
and we will be required to maintain and rehabilitate all of the Leased ALCs with
any one landlord on a long-term basis.
In 1998, we pursued an additional development strategy by entering into our
first joint ventures ("LLCs") designed to help us finance development and
renovation projects and to mitigate the impact of start-up losses associated
with the opening of newly constructed ALCs. The joint ventures were formed to
finance and manage the substantial renovation of existing ALCs acquired in 1998
in the Hillsdale transaction and to construct four new communities on land sites
we own. Participants in the joint ventures with us are a third party investor
and a third party developer. The LLCs have contracted with the developer to
provide development services to perform the renovation and construction. We will
manage the properties operated by the joint venture for an amount equal to three
percent of gross revenues. We account for our investment in the joint ventures
using the equity method and losses incurred by the LLCs will be allocated
disproportionately to the joint venture partners based upon their assumption of
risk. We will have an option to purchase the joint venturers' interest in the
LLCs when the ALCs reach stabilization, at a purchase price that is the greater
of fair market value or an amount that generates a guaranteed rate of return on
the joint venturers' capital contribution. There can be no assurance that all of
the construction and renovation projects contemplated under the joint venture
agreement will be completed, or that we will pursue similar joint venture
agreements in the future.
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We plan to continue to develop new ALCs and currently have 7 development
projects in progress. Our ability to achieve our development plans will depend
upon a variety of factors, many of which are beyond our control. These and other
factors are detailed below. See "Risks Common to Our Assisted Living Operations
- -- Development and Construction Risks." These risks include the possibility that
we 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, licensing and other required governmental permits and
authorizations. Certain construction risks are beyond our control, including
strikes, bad weather, natural disasters, supply of materials and labor, and
other unknown contingencies that could cause the cost and timing of construction
to exceed estimates. In order to keep our internal costs to a minimum, we rely
on third party general contractors to construct new ALCs. Cash flow could be
reduced significantly if construction is not commenced or completed, or if there
are unpaid subcontractors or suppliers, or if required occupancy permits are not
issued in a timely manner. In addition, any property in construction is subject
to risks including construction defects, cost overruns, adverse weather
conditions, the discovery of geological or environmental hazards on the property
and changes in zoning restrictions or the method of applying such zoning
restrictions. The nature of licenses and approvals necessary for development and
construction, and the timing and likelihood for obtaining them, vary widely from
state to state, and from community to community within a state.
Acquisitions. In evaluating possible acquisitions, we consider:
o the location, construction quality, condition and design of the ALC;
o the current and projected cash flow of the community and its
anticipated ability to increase revenue through rent and occupancy
increases, additional assisted living services and management;
o whether we can acquire the community below replacement cost.
By developing and operating ALCs in 14 states, we have generated numerous
contacts to help us identify possible acquisitions in the early stage of the
sale process. Our sources for prospective acquisitions range from Affiliated
Partnerships to management's contacts with potential ALC sellers, to our local
and regional personnel who monitor the assisted living market in their area. In
certain cases we may also target additional third party management contracts.
However, we do not intend to continue our growth rate so that we focus greater
attention and resources on enhancing the profitability of our existing core
operations and on leasing up new developments at a faster rate.
Historically we have financed many of our acquisitions using equity and
debt and through direct long-term operating lease transactions with
institutional investors such as health care REITs, and may continue to do so in
the future. In long-term operating lease transactions, we typically arrange the
sale of the prospective assisted living community to a REIT or other
institutional investor while concurrently entering into a long-term operating
lease for the facility. Our initial cost is generally limited to a security
deposit that is typically provided through standby letters of credit.
Thereafter, we are obligated to make certain rental payments (which may include
an additional amount related to revenue of the community) for the term of the
lease. While we have financed a portion of our direct ownership of ALCs with
secured debt from REITs, we do not have any participation or sponsorship
interest in these entities. While we make our best estimates in projecting
lease-up costs and expenses as well as the achievement of rent stabilization,
our failure to generate sufficient revenue could result in an inability to meet
minimum rent obligations under our long-term operating leases.
Increase in Sales of Additional Assisted Living Services. We believe that
many custodial services provided in skilled nursing facilities are available at
approximately two-thirds of the cost in our ALCs. We believe that this
differential will enable us to attract additional residents. By increasing the
use of these services by our residents, we believe residents will be able to age
in place at our ALCs over a longer period of time, rather than having to
transfer to more expensive skilled nursing facilities until absolutely
necessary.
We seek to enhance and increase the amount and diversity of assisted living
services we provide through:
o the continued education of the senior community, and particularly the
residents and their families, concerning the cost-effectiveness of
receiving additional services in an assisted living community;
o the continued development and refinement of assisted living programs
designed to meet the needs of our residents as they age in place;
o the consistent delivery of quality services for residents.
EMPLOYEES
At March 24, 1999, we had approximately 3,400 employees.
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CAPITAL REQUIREMENTS
We entered into separate agreements with Health Care REIT, Inc., Meditrust,
Bank United of Texas and Imperial Bank to provide up to $210 million of
financing for acquisitions, development and general corporate purposes. At
December 31, 1998, $39.9 million of these commitments had been expended ($23.4
million for Leased ALCs, $8.8 million for mortgage financing of Owned ALCs, and
$7.7 million for the construction of an ALC owned by an Affiliated Partnership
which we guaranteed) and the remainder has expired.
In the past we provided standby letters of credit as security deposits with
most of our landlords. In December 1998, we provided cash in exchange for the
release of the standby letters of credit to our largest landlord, Nationwide
Health Properties, Inc. ("NHP"). For a period of time that is extended on a
month to month basis, NHP has granted a temporary reduction in some of the
security deposits totaling approximately $1.8 million. We anticipate funding the
temporary reduction during 1999.
At December 31, 1998, we have used $4.4 million of our line of credit with
Imperial Bank in the form of non-cash advances to provide letters of credit used
primarily as security deposits for leased ALCs. This line of credit is
collateralized by an owned ALC.
Our Board of Directors approved the refinancing of 11 communities that are
held by majority owned partnerships to:
o take advantage of lower fixed interest rates available at the time
through the commercial mortgage backed security market;
o provide a return of equity to the limited partners;
o borrow against the increased value of these properties; and
o finance the purchase of four ALCs that were previously operated under
long term operating leases.
In conjunction with this financing, we paid the lender approximately $1.7
million of fees for an interest rate lock and $0.2 for loan commitment and other
fees. The lender terminated the loan commitment and underlying interest rate
lock in October 1998 due to adverse market conditions. The lender returned $0.4
million of the interest rate lock fees in January 1999. We have included the
remaining $1.5 million of fees in interest expense in the accompanying
statements of income. We believe that we are entitled to a full and complete
return of the rate lock fees paid. We intend to pursue a return of all fees and
are investigating our legal alternatives to that end; however, there can be no
assurances that additional interest rate lock fees will be recovered.
We will be required from time to time to incur additional indebtedness or
issue additional debt or equity securities to finance our growth strategy,
including the acquisition and development of ALCs as well as other capital
expenditures and additional funds to meet increased working capital
requirements. We may finance future acquisitions and development through a
combination of our cash reserves, cash flow from operations, utilization of
current lines of credit, leasing of additional ALCs and ALCs in development,
sale/leaseback arrangements with respect to our Owned ALCs, and additional
indebtedness or public or private sales of debt securities or capital stock. We
have arranged financing of our ALCs under construction and development through
commitments from various health care REITs and other landlords and lenders. With
respect to these ALCs, our commitments for capital expenditures consist of
potential liability for cost overruns incurred during the construction of ALCs
and our obligation to fund start-up losses incurred in the operation of the ALCs
prior to the achievement of stabilized operations. While the amount of such
obligations are contingent on our ability to develop our ALCs within budget and
achieve profitable operations, the probable amount of these obligations cannot
be definitively quantified. Nonetheless, we believe that we have made adequate
provision for such obligations in our financing plan. There can be no assurance,
however, that funds will be available on terms favorable to us, that such funds
will be available when needed, or that we will have adequate cash available for
such requirements.
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TRANSACTIONS WITH PROMETHEUS ASSISTED LIVING
In July 1997, we entered into a Stock Purchase Agreement (the "Stock
Purchase Agreement"), by and among us, Lazard Freres Real Estate Investors LLC,
a New York limited liability company ("LFREI") and Prometheus Assisted Living
LLC, a Delaware limited liability company ("Prometheus").
Subject to the terms and conditions of the Stock Purchase Agreement, we
agreed to sell to Prometheus up to approximately 9.6 million shares (the
"Shares") of our Common Stock ("Common Stock") at a purchase price of $14.00 per
share (the "Transaction"), representing an aggregate investment of approximately
$135 million (the "Total Equity Commitment"). Proceeds from the sale of the
Shares were to be used by us to continue to implement our acquisition and
development plans, to repay debt, to strengthen systems and operations, and to
expand services. The Transaction was to be consummated in three phases:
o The initial closing was completed on July 23, 1997. At the Initial
Closing, we sold to Prometheus approximately 1.9 million Shares,
representing an aggregate investment of approximately $26.9 million.
The Shares sold to Prometheus in the Initial Closing represented
approximately 16.6% of the outstanding Common Stock (19.9% of the
outstanding Common Stock prior to issuance).
o At a second closing of the Transaction, we planned to sell to
Prometheus approximately 3.1 million Shares.
o Thereafter, at one or more subsequent closings, we planned from time
to time at our election to sell additional Shares to Prometheus at
$14.00 per share, in minimum increments of 715,000 shares, until the
Total Equity Commitment was invested. At such time as Prometheus
acquired all of the Shares under the Transaction, it would have owned
approximately 49.9% of the outstanding Common Stock.
In October 1997, we entered into an Amended and Restated Stock and Note
Purchase Agreement (the "Amended Stock and Note Purchase Agreement"), by and
among us, LFREI and Prometheus, amending and restating the original Stock
Purchase Agreement. Under the Amended Stock and Note Purchase Agreement,
Prometheus, no longer had the right or obligation to purchase the additional
shares of Common Stock contemplated by the Stock Purchase Agreement. Instead
Prometheus purchased $60,000,000 aggregate principal amount of our 6.75%
Convertible Subordinated Notes due 2007 (the "Prometheus Notes"). In connection
with the issuance of the Prometheus Notes, we executed a $60,000,000 note in
favor of Prometheus dated as of October 30, 1997 and entered into an indenture
dated as of October 30, 1997 (the "Indenture"), with The Chase Manhattan Bank,
N.A.
In December 1997, our Board approved the optional redemption of the
Prometheus Notes. Per the terms of the Prometheus Notes, the redemption was made
in our common stock. Including the 23.214% optional redemption premium and
accrued interest to date, the issuance amounted to approximately 4.3 million
shares. As a result, Prometheus acquired approximately 6.2 million of our common
shares, representing a 39.0% ownership stake in the Company.
On October 21, 1998, we announced that a "Termination Event", as defined in
the Amended and Restated Stock Purchase and Note Agreement, occurred on October
12, 1998, when Prometheus no longer beneficially owned our common stock having a
market value of at least $25 million. As a result of the Termination Event,
Prometheus' standstill obligations would have terminated on January 11, 1999.
However, on December 7, 1998, the Superior Court of the State of California,
County of Orange issued an order in favor of LFREI concluding that their
standstill obligations had terminated as of April 1998.
TENDER OFFER BY EMERITUS CORPORATION
On December 19, 1997, Emeritus Corporation ("Emeritus"), through its
wholly-owned subsidiary, EMAC Corp. ("EMAC"), commenced a tender offer (the
"Tender Offer") to purchase all outstanding shares of our common stock (the
"Common Stock"), together with the associated preferred stock purchase rights
(the "Rights") at a price of $17.50 per share, net to the seller in cash, upon
the terms and subject to the conditions set forth in the Offer to Purchase dated
December 19, 1997 (the "Offer"). The purpose of the tender offer was to acquire
control of, and the entire equity interest in, the Company. Previously, on
October 12, 1997, Emeritus proposed an acquisition of all of the outstanding
Common Stock for $16.50 per share in cash, also with conditions.
On November 23, 1997, Emeritus proposed its own slate of nominees (the
"Emeritus Nominees") for our Board of Directors and, on November 24, 1997, filed
preliminary proxy materials with the Securities and Exchange Commission (the
"Commission") indicating that Emeritus would be soliciting proxies to elect the
Emeritus Nominees.
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On December 9, 1997, Emeritus commenced litigation against us in Orange
County Superior Court in the State of California, asking the court, among other
things, to rescind the Prometheus transactions discussed above. Concurrently,
Emeritus sought a preliminary injunction to rescind the Prometheus transactions.
On January 5, 1998, we filed a recommendation statement with the Securities
and Exchange Commission on Schedule 14D-9 in which our Board of Directors
unanimously concluded that the Emeritus tender offer was inadequate and not in
our best interests and recommended that our shareholders reject the Emeritus
offer and not tender their shares pursuant to the Emeritus tender offer.
Our Board's determination, which was reached at meetings held on January 2,
1998 and January 5, 1998, was based on its belief that, in light of the
prospects of our business, the potential benefits of Prometheus' investment of
$86.9 million in the Company, our potential strategic alliance with a Prometheus
affiliate, Kapson Senior Quarters, Inc. ("Kapson"), and the other factors
described below, the Company's and our shareholders' interests would be best
served if we were to remain independent and pursue our business strategy.
In researching its determinations and recommendations, our Board considered
a number of factors, including, without limitation, the following:
o our Board's belief that the Emeritus Offer did not adequately reflect
the inherent value of the Company;
o our Board's continued belief that execution of our strategic plan
would produce greater long-term value for our shareholders and greater
benefits for our employees and customers;
o a presentation by Salomon Smith Barney ("SSB"), our financial
advisors, concerning the financial aspects of the Emeritus Offer, and
the opinion of SSB to the effect that, as of January 5, 1998, the
proposed consideration to be received by our shareholders was
inadequate;
o the numerous and significant conditions contained in Emeritus'
proposal, including:
- the valid tender of at least a majority of the total number of
outstanding shares on a fully diluted basis exclusive of any
Shares issuable upon conversion of our 6 3/4% Convertible
Subordinated Notes due 2006; - redemption of the Rights by the
Board;
- Emeritus and EMAC being satisfied, in their discretion, that EMAC
had obtained financing upon terms satisfactory to them in an
amount sufficient to consummate the offer, including the
redemption or refinancing of all outstanding debt and payment of
all fees and expenses;
- Emeritus and EMAC being satisfied, in their discretion, that the
Board had approved and recommended or would approve and recommend
a merger between us and EMAC;
- rescission of the December 5, 1997 Note Redemption of the
Prometheus Notes;
- EMAC being satisfied that all necessary consents and approvals,
including those from the landlords under our existing leases,
have been obtained on terms satisfactory to EMAC, in its
discretion; and
- that no material adverse change shall have occurred in the
operations or prospects of the Company or any of its subsidiaries
(the Board concluded that the defaults under our existing leases
that would result from EMAC's taking control of the Company would
constitute such a material adverse change); and
o the Board's concern that, in light of these numerous and significant
conditions, the offer was illusory in that Emeritus had no intention
of paying our shareholders $17.50 per share, but rather intended to
renegotiate with us for a lower price or a different form of
consideration.
On January 26, 1998, the California State Court denied, in its entirety,
Emeritus' request for a preliminary injunction to rescind the series of
transactions that culminated in the $86.9 million investment by Lazard, and
Emeritus' request to prevent Prometheus from voting the approximately 4.3
million shares it received in December 1997 when we redeemed the Prometheus
Notes.
At the Annual Meeting of Shareholders on January 28, 1998, the shareholders
voted in favor of our Board of Directors by a margin exceeding 5-to-1. According
to the Inspectors of Election, shareholders voted more than 10.5 million shares,
which represented approximately 85% of the approximately 12.4 million shares
voted, in favor of our directors.
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On January 30,1998, Emeritus announced that it had terminated the tender
offer. On April 23, 1998, the court entered a dismissal of the lawsuit without
prejudice Emeritus' request.
FACTORS AFFECTING FUTURE RESULTS AND FORWARD-LOOKING STATEMENTS
Our business, results of operations and financial condition are subject to
many risks, including those set forth below. Certain statements contained in
this report, including without limitation statements containing the words
"believes," "anticipates," "expects," and words of similar import, constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of the Company, or industry results, to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. We have made
forward-looking statements in this report concerning, among other things, the
impact of future acquisitions and developments, if any, and the level of future
capital expenditures. These statements are only predictions, however; actual
events or results may differ materially as a result of risks we face. These
risks include, but are not limited to, those items discussed below. Certain of
these factors are discussed in more detail elsewhere in this report, including
without limitation under the captions "Business" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations." Given these
uncertainties, we caution readers not to place undue reliance on such
forward-looking statements, which speak only as of the date of this report. We
disclaim any obligation to update any such factors or to publicly announce the
result of any revisions to any of the forward-looking statements contained here
to reflect future events or developments.
We have experienced rapid growth through the development and acquisition of
ALCs and by acquiring property for the development of new ALCs. Certain risks
are inherent with the execution of our growth strategies. These risks include,
but are not limited to:
o our ability to access capital necessary for operations, acquisition
and development;
o our ability to sustain and manage growth and to successfully integrate
new ALCs into our portfolio;
o governmental regulation;
o competition; and
o risks common to the assisted living industry.
HISTORY OF LOSSES
For the year ended December 31, 1998, the nine-month period ended December
31, 1997 and the year ended March 31, 1997, we had net losses of approximately
$46.0 million, $22.1 million, and $1.8 million, respectively. At December 31,
1998, our accumulated deficit was approximately $77.5 million.
Our net loss for the year ended December 31, 1998 primarily resulted from:
o start-up losses on newly developed ALCs;
o the impairment losses on properties held for sale and other operating
ALCs;
o legal expenses for and settlement of a lawsuit with LFREI and related
parties;
o costs incurred in our proxy fight and litigation with Emeritus;
o interest rate lock fees paid in connection with the failed refinance
of our majority-owned partnerships; and
o severance and other expenses related to changes in executive
management and layoffs.
Our loss for the nine months ended December 31, 1997, primarily resulted
from:
o establishing a provision related to the disposition of our
rehabilitation subsidiary, GeriCare, and the Apartment Group;
o costs incurred in our proxy fight with Emeritus;
o start-up losses on newly developed ALCs;
o severance expenses related to the retirement of three senior
executives; and
o the write-off of conversion costs after we determined that newly
purchased accounting software contained numerous application errors.
Our losses for the period ended March 31, 1997 primarily resulted from:
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o developing the Apartment Group assets financed through the Federal Tax
Credit Program;
o the provision for estimated future obligations of the Company for the
Apartment Group assets and certain allowances established for Medicare
reimbursement related to GeriCare;
o expanding our staffing and infrastructure to accommodate our
acquisition and development strategy;
o start-up losses on newly developed ALCs; and
o certain discontinued project costs.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations." We cannot provide assurance that the risks
associated with opening newly developed ALCs or assuming operations of acquired
ALCs can be managed to reduce or eliminate start-up losses; that other similar
costs and expenses or losses will not occur in the future. See "-- Indebtedness,
Lease and Other Obligations," "-- General Partner Liability and Status," and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations" and " Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
RAPID GROWTH
Management of Growth. We have experienced rapid growth over the past
several years. In order to maintain and improve operating results, we must
manage growth and expansion effectively. As we continue our expansion, it may
become more difficult to manage geographically dispersed operations and
effectively manage each ALC. Our ability to manage growth effectively requires
us to continue to expand our operational, financial and management information
systems and to continue to attract, train, motivate, manage and retain key
employees. To enable us to more effectively manage growth, we plan to slow the
pace of acquisitions and development beginning in 1999. See "-- Risks Common to
Our Assisted Living Operations." Our failure to effectively manage growth could
have a material adverse effect on operating results.
External Growth. We have entered into, and may continue to enter into, a
number of agreements to acquire properties for development and for the
acquisition of existing ALCs that are subject to certain conditions. We cannot
assure that one or more of such acquisitions will be completed, that we will be
able to find additional suitable properties and ALCs, or that we can obtain
financing to continue to acquire or develop ALCs and property on which to build
them. We expect to experience a slowdown in growth through acquisition of ALCs
due to shortages of suitable ALCs available at attractive prices, due to
limitations on obtaining financing, and due to our intention to manage growth
effectively as noted above. We also have acquired a number of properties to be
developed into ALCs, or have contracted to lease or manage ALCs being developed
by third-party developers. The development of ALCs is subject to a number of
risks, many of which are outside our control. We cannot provide assurance that
we will be able to complete our planned ALCs in the manner, for the amount, or
within the timeframe currently anticipated. Our ability to generate revenue when
anticipated could be affected by delays in the progress or completion of
development projects. See " -- Risks Common To Our Assisted Living Operations --
Development and Construction Risks."
COMPETITION
The health care industry is highly competitive and we expect that the
assisted living business, in particular, will become more competitive in the
future. Sources of competition include:
o family members providing care at home;
o numerous local, regional and national providers of assisted living and
long-term care whose facilities and services range from home-based
health care to skilled nursing facilities; and
o acute care hospitals.
In addition, we believe that as assisted living receives increased
attention among the public and insurance companies, new competitors focused on
assisted living will enter the market, including hospitality companies expanding
into the market. Some of our competitors operate on a not-for-profit basis or as
charitable organizations, while others have, or are capable of obtaining,
greater financial resources than those available to us.
We also expect to face increased competition for the acquisition and
development of ALCs. Some of our present and potential competitors are
significantly larger or have, or may obtain, greater financial resources than we
have. These forces could limit our ability to attract residents, attract
qualified personnel, expand our business, or increase the cost of future
acquisitions, each of which could have a material adverse effect on our
financial condition, results of operations and prospects.
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INDEBTEDNESS, LEASE AND OTHER OBLIGATIONS
We have financed, and may continue to finance, the acquisition and
development of ALCs through a combination of loans, leases and other
obligations. As of December 31, 1998, we had outstanding consolidated
indebtedness of $109.8 million, including $57.5 million of our 2006 Convertible
Notes, whose holders have the right to convert such notes into our common stock
at any time on or before the notes mature. In addition, at December 31, 1998, we
have $22.7 million in notes maturing within two years, including $20.0 million
related to properties held for sale. As a result, we will devote a portion of
our cash flow to debt service. There is a risk that we will not be able to
refinance our maturing note obligations on terms favorable to us, or that we
will not be able to generate sufficient cash flow from operations to make
required interest and principal payments.
At December 31, 1998, approximately $34.0 million of our indebtedness bore
interest at floating rates. We may incur indebtedness in the future that may
also bear interest at a floating rate, or be fixed at some time in the future.
Therefore, increases in prevailing interest rates could increase our interest
payment obligations and could have an adverse effect on our business, financial
condition and operating results. In addition, we have guaranteed mortgage and
construction debt for the benefit of Affiliated Partnerships of up to
approximately $55.7 million, including $53.5 million outstanding as of December
31, 1998, of which $36.9 million will become due and payable within the next two
years. This effectively subjects us to risks normally associated with leverage,
including:
o the risk that Affiliated Partnerships will not be able to refinance
this debt with permanent financing;
o an increased risk of partnership cash flow deficits; and
o the risk that if the economic performance of any mortgaged asset
declines, we will be obligated to make payments on the mortgage debt.
These risks could adversely affect our operating results and financial
condition. Because certain of the indebtedness that we guarantee bears interest
at rates which fluctuate with certain prevailing interest rates, increases in
such rates could increase our interest payment obligations and could have an
adverse effect on our operating results and financial condition.
In addition, as of December 31, 1998, we are a party to long-term operating
leases for certain of our Leased ALCs. These require minimum annual lease
payments aggregating $24.4 million for each of the years ended December 31, 1998
and 1999. These leases are non-cancelable, and typically have an initial term of
10 to 15 years.
We also have entered into guarantees (the "Tax Credit Guarantees") which
extend 15 years after project completion, relating to certain Apartment Group
assets financed under the Federal Tax Credit Program with respect to
o lien free construction;
o operating deficits; and
o obtaining and maintaining tax credit benefits to certain corporate
investors (see "-- Tax Credit Apartment Properties"), the obligations
under which, excluding potential penalties and interest factors, could
amount to an approximate limit of $78.4 million as of December 31,
1998. There can be no assurance that we will be able to negotiate a
settlement of these liabilities during the disposition of the
properties at terms favorable to us.
GENERAL PARTNER LIABILITY AND STATUS
We, directly or through our subsidiaries, are a general partner in 20
partnerships as of December 31, 1998. As a general partner we are liable for
partnership obligations such as partnership indebtedness (which totaled
approximately $103.4 million at December 31, 1998), potential liability for
construction defects, including those presently unknown or unobserved, and
unknown or future environmental liabilities. The cost of any such obligations or
claims, whether we bear part or all of the cost, could materially adversely
affect our operating results and financial condition.
We manage each affiliated partnership property according to a written
management contract. The managing general partner of the partnership may cancel
some contracts with 30 or 60 days notice. A majority in interest of limited
partners in each partnership may take action on such matters as the removal of
the general partners, the request for approval or disapproval of a sale of a
property owned by a partnership, or other actions affecting the properties or
the partnership. Where we are the general partner of the partnership,
termination of the contracts generally would require removal of the Company as
general partner by the vote of a majority of the holders of limited partner
interests. We would lose management fees if those contracts were terminated.
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We have funded and expect to fund amounts in our capacity as guarantor for
various obligations related to certain tax credit properties. See "--
Indebtedness, Lease and Other Obligations" and "Tax Credit Apartment
Properties."]
DEPENDENCE ON REIMBURSEMENT BY THIRD-PARTY PAYERS
GeriCare was a former subsidiary of the Company that specialized in
rehabilitative services, including speech, occupational and physical therapy.
Although we disposed of GeriCare in 1998, revenue received or earned before it
was disposed that directly or indirectly was billed to the Medicare program is
subject to statutory and regulatory changes, retroactive rate adjustments,
administrative rulings and funding restrictions. All could potentially limit or
reduce reimbursement levels for GeriCare's services.
Medicare reimbursed GeriCare monthly for services provided on a cost basis,
subject to certain adjustments. GeriCare submitted cost reports to the Health
Care Financing Administration ("HCFA") on an annual basis and was subject to
having amounts previously reimbursed adjusted retroactively. The result of a
retroactive reimbursement would be either a requirement to repay the amount
previously reimbursed or an adjustment downward in future reimbursements for
services rendered, or both. We have reviewed cost reports for GeriCare filed
prior to August 22, 1996, and have prepared cost reports that were filed as of
August 22, 1996 and thereafter. We have established an allowance for amounts
that we reasonably believe may be adjusted by HCFA, but there can be no
certainty that significant charges in addition to those provided for may be
denied, which could materially adversely affect our results of operations.
GOVERNMENT REGULATION
Assisted Living. Health care is subject to extensive regulation and
frequent regulatory change. Currently, no federal rules explicitly define or
regulate assisted living. A number of states also have not yet enacted specific
assisted living regulations. However, we are and will continue to be subject to
varying degrees of regulation and licensing by health or social service agencies
and other regulatory authorities in the various states and localities where we
operate or intend to operate. Changes in, or the adoption of, such laws and
regulations, or new interpretations of existing laws and regulations, could have
a significant effect on methods and costs of doing business, and on
reimbursement levels from governmental and other payers. In addition, the
President and Congress have proposed in the past, and may propose in future,
health care reforms that could impose additional regulations on the Company or
limit the amounts that we may charge for our services. We cannot assess the
ultimate timing and impact that any pending or future health care reform
proposals may have on the assisted living, home health care, skilled nursing or
health care industry in general. No assurance can be given that any such reform
will not have a material adverse effect on the business, financial condition or
results of operations of the Company.
SSI Payments. A portion of our revenue (approximately 2% of our assisted
living revenue) comes from residents who receive SSI payments. Revenue from
these residents is generally lower than the amounts we receive from our other
residents and could be subject to payment delay. We cannot assure that our
percentage of revenue received from SSI will not increase, or that the amounts
paid by SSI programs will not be further limited. In addition, if we were to
become a provider of services under the Medicaid program, we would be subject to
Medicaid regulations designed to limit fraud and abuse. Violations of these
regulations could result in civil and criminal penalties and exclusion from
participation in the Medicaid program.
RISKS COMMON TO OUR ASSISTED LIVING OPERATIONS
Staffing and Labor Costs. We compete with other providers of assisted
living and senior housing to attract and retain qualified personnel. We also
rely on the available labor pool of employees, and unemployment rates are low in
many areas where we operate. We make a genuine effort to remain competitive with
other companies in our industry. Therefore, if it is necessary for us to
increase pay and/or enhance benefits to maintain our competitive status in our
industry, our labor costs could rise. We cannot provide assurance that if our
labor costs do increase, they can be matched by corresponding increases in
rental, assisted living or management revenue.
Obtaining Residents and Maintaining Rates. As of December 31, 1998, the ALCs we
owned or operated had a combined occupancy rate of 83.7%. Newly developed ALCs
may take longer to lease up than anticipated, causing them to incur start-up
losses for longer periods of time. We may revise our construction schedules in
order to phase in start-up losses from newly developed ALCs. Occupancy may drop
in our existing ALCs, primarily due to:
o changes in the health of residents;
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o increased competition from other assisted living providers,
particularly those offering newer ALCs;
o the reassessment of residents' physical and cognitive state; and
o changes in management and staffing.
We cannot assure that, at any time, any ALC will be substantially occupied
at assumed rents. In addition, we may only achieve lease-up and full occupancy
at rental rates below those assumed. If operating expenses increase, local
rental market conditions may limit the extent to which we may increase prices.
The implementation of rate increases for residents of new acquisitions may lag
behind increases in operating expenses. In addition, if we fail to generate
sufficient revenue, we may be unable to meet minimum rent obligations under our
long-term operating leases and to make interest and principal payments on our
indebtedness.
General Real Estate Risks. The performance of our ALCs is influenced by
factors affecting real estate investments, including the general economic
climate. Other real estate risks include:
o an oversupply of, or a reduction in demand for, ALCs in a particular
market;
o the attractiveness of properties to residents;
o zoning, rent control, environmental quality regulations or other
regulatory restrictions;
o competition from other forms of housing;
o our ability to provide adequate maintenance and insurance; and
o our ability to control operating costs, including maintenance,
insurance premiums and real estate taxes.
At the time we acquire existing ALCs or open newly developed ALCs, we
prepare budgets for known or expected rehabilitation expenses. We may incur
unknown or unforeseen rehabilitation or lease-up expenses. Real estate
investments are also affected by such factors as applicable laws, including tax
laws, interest rates and the availability of financing. Real estate investments
are relatively illiquid and, therefore, limit our ability to vary our portfolio
promptly in response to changes in economic or other conditions. If we fail to
integrate or operate acquired or developed ALCs effectively, it may have a
material adverse effect on our business, financial condition and operating
results.
In addition, we currently lease ALCs from only four health care REITs. The
lease agreements with each REIT are interconnected in that we will not be
entitled to exercise our right to renew one lease with a particular landlord
without exercising our right to renew all other leases with that landlord. Also,
leases with each landlord contain certain cross default provisions. Therefore,
in order to exercise all lease renewal terms, we will be required to maintain
and rehabilitate the Leased ALCs on a long-term basis. We anticipate that
similar renewal and cross-default provisions will be included in leases with
other health care REITs or landlord.
Bond Financing. We have entered into four long-term leases of ALCs, the
acquisition and construction of which have been or are being financed by tax
exempt multi-unit housing revenue bonds. In order to meet the lease obligations
and to allow the landlord to continue to qualify for favorable tax treatment of
the interest payable on the bonds, the ALC must comply with certain federal
income tax requirements. These requirements principally pertain to the maximum
income level of a specified portion of the residents. Should we elect to execute
additional leases for ALCs to be constructed with bond financing, the same and
possibly additional restrictions are anticipated to be imposed. Failure to
satisfy these requirements will constitute an event of default under the leases,
thereby permitting the landlord to accelerate their termination. Failure to
obtain low-income residents in the sequence and time required could materially
affect the lease-up schedule and, therefore, cash flow from such ALCs.
Development and Construction Risks. As part of our growth strategy in 1999,
we are developing new ALCs. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Overview." Our ability to
achieve our development plans will depend upon a variety of factors, many of
which are beyond our control. The successful development of additional ALCs
involves a number of risks, including the possibility that we may be unable to
locate suitable sites at acceptable prices or may be delayed in or unable to
obtain necessary zoning, land use, building, occupancy, licensing and other
required governmental permits and authorizations. We may change development
schedules to meet staffing requirements and to allow a phase-in of start-up
losses inherent in the marketing and lease-up of new ALCs. Certain construction
risks are beyond our control, including strikes, bad weather, natural disasters,
supply of materials and labor, and other unknown contingencies which could cause
the cost and timing of construction to exceed estimates. If we do not start or
complete construction, or subcontractors or suppliers are not paid, or if
required occupancy permits are not issued in a timely manner, cash flow could be
significantly reduced. In addition, any property under construction is subject
to the risks of construction defects, cost overruns, bad weather conditions, the
discovery of geological or environmental hazards on the property, and changes in
zoning restrictions or the method of applying such zoning restrictions. The
nature of licenses and approvals necessary for development and construction, and
the timing and likelihood for obtaining them, varies
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widely from state to state and community to community.
Possible Environmental Liabilities. 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 costs of the removal or
remediation of certain hazardous or toxic substances. These include, without
limitation, asbestos-containing materials which could be located on, in or under
such property. Such laws and regulations often impose liability whether or not
the owner or operator knows of, or is responsible for, the presence of the
hazardous or toxic substances. When we acquire land for development or existing
facilities, we typically obtain environmental reports on the properties as part
of our due diligence in order to lessen our risk of exposure. Nonetheless, the
costs of any required remediation or removal of these substances could be
substantial. The owner's liability is generally not limited under such laws and
regulations and could exceed the value of the property 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 any entity that
arranges for the disposal of hazardous or toxic substances 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. When entering into leases
with health care REITs and other landlords of facilities, we typically enter
into environmental indemnity agreements in which we agree to indemnify the
landlord against all risk of environmental liability, both during the term of
the lease and beyond. In connection with the ownership or operation of our
properties or those of our Affiliated Partnerships, we could be liable for these
costs, as well as certain other costs, including governmental fines and injuries
to persons or properties.
Restrictions Imposed by Laws Benefiting Disabled Persons. Under the
Americans with Disabilities Act of 1990, all places of public accommodation are
required to meet certain federal requirements related to access and use by
disabled persons. A number of additional federal, state and local laws exist
that also may require us to modify existing and planned properties to allow
disabled persons to access the properties. We believe that our properties are
either substantially in compliance with present requirements or are exempt from
them, and we attempt to check for compliance in all ALCs we consider acquiring.
However, if required changes cost more than anticipated, or must be made sooner
than anticipated, we would incur additional costs. Further legislation may
impose additional burdens or restrictions related to access by disabled persons,
and the costs of compliance could be substantial.
Geographic Concentration. A substantial portion of our business and
operations are conducted in California, where 40 of our ALCs in operation or
under construction are located. Other regional concentrations of ALCs are in
Florida and the Midwest. We created regions to enable us to manage the ALCs more
cost-effectively. The market value of these properties and the income generated
from properties we manage or lease could be negatively affected by changes in
local and regional economic conditions, specific laws and the regulatory
environment in the states within those regions, and by acts of nature. We cannot
provide assurance that such geographic concentration will not have an adverse
impact on our business, financial condition, operating results and prospects.
Insurance. We believe that we maintain adequate insurance policies, based
on the nature and risks of our business, historical experience and industry
standards. Our business entails an inherent risk of liability. In recent years,
we and other assisted living providers have become subject to an increasing
number of lawsuits alleging negligence or related legal theories, which may
involve large claims and significant legal costs. From time to time we are
subject to such suits because of the nature of our business. We cannot assure
that claims will not arise that exceed our insurance coverage or are not covered
by it. A successful claim against us that is not covered by, or is in excess of
our insurance, could have a material adverse effect on our financial condition,
operating results or liquidity. Claims against us, regardless of their merit or
eventual outcome, may also have a material adverse effect on our ability to
attract residents or expand our business and would consume considerable
management time. We must renew our insurance policies annually and can provide
no assurance that we will be able to continue to obtain liability insurance
coverage in the future or that it will be available on acceptable terms.
CONFLICTS OF INTEREST
Certain of our current and former executive officers and Directors may have
an actual or potential conflict of interest with our interests. This conflict
may exist because of their investment in or involvement with entities providing
services, office space or guarantees to us, or to Company-sponsored
partnerships, or due to family ties with consultants offering services to us.
See "Certain Relationships and Related Transactions."
In addition, we are the managing general partner and communities manager
for Affiliated Partnerships owning or leasing 16 ALCs
15
<PAGE> 18
and various apartment communities. By serving in both capacities, we have
conflicts of interest because of our duty to act in the best interests of the
limited partners of those partnerships and our desire to maximize earnings for
our shareholders in the operation of those ALCs and apartment communities.
TAX CREDIT APARTMENT PROPERTIES
As part of our plan to dispose of the Apartment Group, we may be required
to fund:
o obligations under development deficit guarantees and operating deficit
guarantees;
o shortfalls in permanent loan financing to replace construction
financing on projects where permanent financing has not been
finalized; and
o adjustments if sufficient projected tax credits are not generated in
order to meet agreed-upon levels of tax credit benefits.
We have funded shortfalls through December 31, 1998, and have a remaining
provision of $5.6 million to fund estimated additional amounts due under such
arrangements.
ITEM 2. PROPERTIES
The following charts set forth, the location, number of units, acquisition
date and ownership for our communities as of December 31, 1998:
<TABLE>
<CAPTION>
MONTH PERCENT
COMMUNITY LOCATION UNITS ACQUIRED OWNERSHIP(a)
- --------- -------- ----- -------- -----------
<S> <C> <C> <C> <C>
LEASED
Amberwood FL 183 Jun-96 100.0%
Baypoint Village FL 231 Mar-96 100.0%
Bayside Landing CA 76 Jun-98 100.0%
Buena Vista Knolls CA 91 Feb-96 100.0%
Canterbury Woods MA 130 Jun-98 100.0%
Chateau San Juan CA 113 Dec-95 100.0%
Collier Park TX 159 Dec-96 100.0%
Eastlake Terrace IN 93 Apr-97 100.0%
El Camino Gardens CA 265 Jun-95 100.0%
Hacienda de Monterey CA 180 Apr-94 100.0%
Hillsdale Manor (c) CA 128 Jul-98 100.0%
Inn at Summit Ridge NV 72 Apr-97 100.0%
Inn at Willow Glen(b) CA 83 Aug-96 52.3%
Kinghaven Manor MI 143 Feb-95 100.0%
Lakes FL 154 Dec-98 100.0%
Lodge of Montgomery OH 214 Jan-97 100.0%
Mallard Cove OH 119 Feb-95 100.0%
Maria del Sol CA 124 Oct-95 100.0%
Northgate Park OH 124 Aug-96 100.0%
Rancho Park Villa CA 164 Oct-95 100.0%
Retirement Inn of Burlingame(b) CA 67 Aug-96 52.3%
Retirement Inn of Campbell(b) CA 71 Aug-96 52.3%
Retirement Inn of Fremont(b) CA 69 Aug-96 52.3%
Retirement Inn of Sunnyvale(b) CA 123 Aug-96 52.3%
Shorehaven Manor MI 120 Sep-96 100.0%
Sunlake Terrace NV 121 Feb-98 100.0%
Sutton Terrace NV 142 Dec-98 100.0%
Tamalpais Creek CA 120 Oct-95 100.0%
Tanglewood Trace IN 159 Jan-97 100.0%
Villa Bonita CA 130 Oct-95 100.0%
Villa Encinitas CA 117 Jun-95 100.0%
Villa at Palm Desert CA 77 Nov-95 100.0%
Villa de Palma CA 110 May-95 100.0%
</TABLE>
16
<PAGE> 19
<TABLE>
<S> <C> <C> <C> <C>
Villa del Obispo CA 95 May-95 100.0%
Villa del Rey CA 102 Jun-95 100.0%
Villa del Sol CA 91 Jun-95 100.0%
Vista del Rio NM 148 Jun-97 100.0%
Willow Glen Villa CA 187 May-98 100.0%
Woodside Village of Columbus OH 154 Feb-96 100.0%
-----
Total Leased 5,049
-----
OWNED
Acacia Villa(b) CA 65 Dec-95 89.5%
Amber Park OH 123 Jan-96 100.0%
Bella Vita FL 114 Apr-96 100.0%
Collwood Knolls(b) CA 113 Jan-96 95.5%
Covell Gardens CA 155 Mar-97 100.0%
Covina Villa(b) CA 63 Aug-96 52.3%
Gayton Terrace VA 94 Aug-96 100.0%
Golden Creek Inn CA 123 Apr-98 100.0%
Hillcrest Inn CA 138 Apr-98 100.0%
Montego Heights Lodge(b) CA 162 Aug-96 52.3%
Retirement Inn of Daly City(b) CA 94 Aug-96 52.3%
Retirement Inn of Fullerton(b) CA 67 Aug-96 52.3%
Valley View Lodge(b) CA 124 Aug-96 52.3%
Villa Colima(b) CA 93 Jun-96 60.5%
Woodside Village of Bedford OH 215 Jan-96 100.0%
Wyndham Lakes FL 246 Mar-96 100.0%
-----
Total Owned 1,989
-----
Total Leased and Owned 7,038
=====
MANAGED
Altenheim CA 136 Apr-98
Berkshire (d) CA 81 Nov-98
Bradford Square CA 92 Dec-90
Chandler Villas AZ 164 Sep-90
Encino Hills Terrace (d) CA 76 Nov-98
San Carlos Elms CA 85 Apr-98
Sterling Court CA 149 Apr-98
Villa Las Posas CA 123 Dec-97
-----
Total Managed 906
-----
Total 7,944
=====
</TABLE>
(a) Represents percentage ownership of Leased ALCs and Owned ALCs through
leasehold or fee ownership of the Company or an Affiliated
Partnership.
(b) Community managed by us, owned or leased by Affiliated Partnership in
which we have obtained a majority ownership interest.
(c) We also acquired 64 beds in a skilled nursing facility, which is
managed by a third party, as part of this ALC.
(d) Properties are owned by our unconsolidated joint ventures.
At December 31, 1998, we had the following projects under development and
construction and anticipate that the schedule set forth below can be met,
although there can be no assurance in this regard. Construction is subject to
numerous risks which could cause delays or the abandonment of a project or
projects. See "Risks Common to our Assisted Living Operations -- Development and
Construction Risks."
17
<PAGE> 20
<TABLE>
<CAPTION>
ANTICIPATED ANTICIPATED
LOCATION # OF UNITS OPENING DATE
-------- ---------- ------------
<S> <C> <C> <C>
Seville Terrace Summerlin, NV 125 First Quarter 2000
Lynnbrooke (b) Irvine, CA 140 First Quarter 2000
Bridgecreek (a) Danbury, CT 135 Second Quarter 2000
Bay Springs (b) Barrington, RI 126 Second Quarter 2000
Inn at Lakewood (b) Lakewood, CO 137 Second Quarter 2000
Laurel Ridge Highlands Ranch, CO 120 Fourth Quarter 2000
Rossmore House Los Angeles, CA 140 First Quarter 2001
---
Total units under development
and construction 923
===
</TABLE>
(a) We will manage this property for a third party.
(b) We will manage these properties for our unconsolidated joint ventures
with Vintage/ABR.
ITEM 3. LEGAL PROCEEDINGS
On September 27, 1996, American Retirement Villas Partners II, a California
limited partnership ("ARVP II") of which we are the managing general partner and
a majority limited partner, filed lawsuits in the Superior Court for the State
of California, County of Santa Clara, seeking declaratory judgment against the
landlords of the Retirement Inn of Campbell ("Campbell") and the Retirement Inn
of Sunnyvale ("Sunnyvale"). ARVP II leases the Campbell and Sunnyvale assisted
living communities under long-term leases. A dispute arose as to the amount of
rent due during the 10-year lease renewal periods, which commenced in August
1995 for Campbell and March 1996 for Sunnyvale. Two other communities we lease,
the Retirement Inn of Fremont and the Retirement Inn at Burlingame are owned by
entities, which are related to the entities that own the Campbell and Sunnyvale
communities. The parties have mutually negotiated the terms of a purchase
agreement involving the sale of the landlord's fee interest in four communities
to ARVP II and settlement of all claims. On March 2, 1999, ARVP II obtained
financing and, through its wholly owned subsidiary ARVP II, LLC, purchased the
landlord' interest in four ALCs (including Campbell and Sunnyvale) for
approximately $14.3 million, and the litigation has been dismissed.
On April 24, 1998, we were served with a lawsuit by Emeritus, which was
filed in the Superior Court of California, County of Orange, alleging that share
purchases on January 16, 1998 by Prometheus Assisted Living LLC triggered our
Shareholder Rights Agreement. Emeritus contends that due to the alleged
triggering event we are required to distribute one right per share of
outstanding Company stock and that each right is exercisable for approximately
9.56 shares at a total purchase price of $70 (or approximately $7.32 per share).
We believe that Emeritus' claims are meritless and we are contesting them
vigorously.
On May 12, 1998, we filed a lawsuit in the Superior Court for the State of
California, County of Orange, seeking to enjoin Kapson, a controlled affiliate
of LFREI, from acquiring Atria Communities ("Atria"), a then unaffiliated
competitor. Atria was also named as a defendant in the suit, as were three LFREI
representatives on our Board of Directors, Messrs. Kenneth M. Jacobs, Robert P.
Freeman and Murry N. Gunty. We alleged that LFREI was violating both its
contractual and fiduciary duties to us if it allowed Kapson to proceed with the
acquisition without first offering us the right to be the acquiring party and
then, if we declined, obtaining our permission to consummate this acquisition.
The lawsuit also sought to enforce rights we believed we obtained as part
of a strategic alliance with LFREI with respect to existing Kapson facilities.
When we previously consented to LFREI's acquisition of Kapson, the two companies
signed a letter agreement that was designed to make available to our
shareholders some of the potential benefits of the Kapson acquisition. Thus,
under its agreement, LFREI was obligated to negotiate in good faith with us to
identify commercially reasonable terms on which we will lease or manage the
existing Kapson facilities. However, since LFREI's acquisition of Kapson, we
alleged, LFREI had failed to negotiate in good faith. On July 30, 1998, our
compliant was amended to add Lazard Freres as a party and to include allegations
of fraud against Lazard, LFREI and Messrs. Kenneth M. Jacobs, Robert P. Freeman
and Murry N. Gunty.
On June 9, 1998, LFREI filed a cross-complaint against us, alleging that
our preliminary communications with several potential sources of capital to
assist us in financing the acquisition of Atria in the event that LFREI honored
our right of first offer or was ordered to do so by the court constituted an
early termination event under the Amended and Restated Stockholders Agreement
dated as of October 29, 1997, by and among LFREI, Prometheus Assisted Living LLC
and us (the "Amended Stockholders Agreement"). LFREI also contended that certain
standstill provisions under the Amended Stockholders Agreement have terminated.
18
<PAGE> 21
On August 14, 1998, the Judge in the trial ruled from the bench against us
and in favor of all defendants on LFREI's motion for judgment on all of our
causes of action.
On October 21, 1998, we announced that a Termination Event, as defined in
the Amended and Restated Stockholders Agreement, occurred on October 12, 1998,
when the price of our common stock dropped to a point where Prometheus no longer
beneficially owned our common stock having a market value of at least $25
million. As a result of the Termination Event, Prometheus' and LFREI's
standstill obligations would have terminated on January 11, 1999. However, on
December 7, 1998, the Superior Court of the State of California, County of
Orange issued an order in favor of LFREI's cross complaint concluding that their
standstill obligations terminated as of April 1998.
On December 18, 1998, Prometheus filed a lawsuit in the Delaware Chancery
Court against the Company and two of our directors, Howard G. Phanstiel and John
A. Booty. The lawsuit seeks a determination that our annual meeting of
stockholders held in June 1998 was invalid because we failed to reach a quorum
and that, accordingly, the election of the named individual directors was
invalid.
Since the nature of litigation is that results cannot be predicted with
certainty, there can be no assurance we will prevail in any of the foregoing
litigation actions.
We are from time to time subject to lawsuits and other matters in the
normal course of business. While we cannot predict the results with certainty,
we do not believe that any liability from any such lawsuits or other matters
will have a material effect on our financial position, results of operations, or
liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of our security holders during the
fourth quarter of 1998.
19
<PAGE> 22
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
Our Common Stock is listed and traded on the American Stock Exchange under
the symbol "SRS." Prior to October 13, 1997, our common stock was listed on the
NASDAQ National Market ("NASDAQ") under the symbol "ARVI." The following table
sets forth, for the periods indicated, the high and low closing prices for our
Common Stock.
<TABLE>
<CAPTION>
HIGH LOW
<S> <C> <C> <C>
FISCAL YEAR ENDED MARCH 31, 1997
First Quarter 4/1/96--6/30/96 $20.25 $15.50
Second Quarter 7/1/96--9/30/96 $17.00 $12.50
Third Quarter 10/1/96--12/31/96 $15.25 $10.06
Fourth Quarter 1/1/97--3/31/97 $11.63 $ 9.00
NINE-MONTH PERIOD ENDED DECEMBER 31, 1997
First Quarter 4/1/97--6/30/97 $11.63 $ 8.06
Second Quarter 7/1/97--9/30/97 $12.75 $10.25
Third Quarter 10/1/97--12/31/97 $16.88 $12.50
YEAR ENDED DECEMBER 31, 1998
First Quarter 1/1/98--3/31/98 $16.13 $12.88
Second Quarter 4/1/98--6/30/98 $14.63 $10.63
Third Quarter 7/1/98--9/30/98 $12.31 $ 6.38
Fourth Quarter 10/1/98--12/31/98 $ 6.75 $ 2.75
</TABLE>
We do not currently pay dividends on our Common Stock and do not anticipate
paying dividends in the foreseeable future. It is the present policy of our
Board of Directors to retain earnings, if any, to finance the expansion of our
business.
VOLATILITY OF STOCK PRICE
Sales of substantial amounts of shares of Common Stock in the public market
or the perception that those sales could occur could adversely affect the market
price of the Common Stock and our ability to raise additional funds in the
future in the capital markets. 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 shares of the Common Stock,
variations in our operating results, changes in our earnings estimates and/or
securities analysts, publicity regarding the industry or the Company and the
adoption of new statutes or regulations (or changes in the interpretation of
existing statutes or regulations) affecting the health care or real estate
industries in general or the assisted living industry 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 fluctuations may adversely affect the
market price of the shares of Common Stock.
CONTROL BY DIRECTORS AND EXECUTIVE OFFICERS; ANTI-TAKEOVER MEASURES
As of December 31, 1998, our Directors and executive officers and their
affiliates beneficially own approximately 54.4% our outstanding shares of Common
Stock (exclusive of unexercised options to purchase shares of Common Stock). As
a result, these shareholders, acting together, would be able to significantly
influence many matters requiring approval by our shareholders, including the
election of Directors. Our articles of incorporation provide for authorized but
unissued preferred stock, the terms of which may be fixed by our Board of
Directors. As a result of Delaware General Corporation Law relating to the
number of holders of Common Stock, our Board of Directors are classified and the
holders of Common Stock are not permitted to cumulate votes. Such provisions
could have the effect of delaying, deferring or preventing a change of control
of the Company.
20
<PAGE> 23
In May 1998, we adopted a shareholders rights plan, under Delaware law,
under which we have declared a dividend distribution of one Preferred Share
Purchase Right on each outstanding share of our common stock. Subject to limited
exceptions, the Rights will be exercisable if a person or group acquires 10% or
more of our stock or announces a tender offer for 10% of the common stock. When
exercisable, each Right will entitle its holder to purchase, at the Right's
then-current exercise price, a number of our common shares having a market value
at the time of twice the Right's exercisable price. If we are acquired in a
merger or other business combination transaction which has not been approved by
our Board of Directors, each Right (except the Rights held by the acquiring
person) will entitle its holder to purchase, at the Right's then-current
exercise price, a number of our common shares having a market value at that time
of twice the Right's exercise price. On October 21, 1998, we adopted an
amendment to our shareholders rights plan, whereby if LFREI or its affiliates
become the owner of 50 percent or more of our common stock, the rights of our
shareholders under the rights plan become exercisable.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data has been derived from our audited
consolidated financial statements as of December 31, 1998, and the year then
ended; December 31, 1997, and the nine-month period then ended; and for each of
the three fiscal years ended March 31, 1997. The data set forth below should be
read in conjunction with the consolidated financial statements and related notes
thereto included in Item 14, "Exhibits, Financial Statement Schedules and
Reports on Form 8-K -- Financial Statements," along with Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
NINE-MONTH
YEAR ENDED PERIOD ENDED FISCAL YEAR ENDED MARCH 31,
DECEMBER 31, DECEMBER 31, ---------------------------------------
1998 1997 1997 1996 1995
------------ ------------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
Assisted living community revenue $ 127,451 $ 76,887 $ 73,770 $ 25,479 $ 4,838
Management fees 1,116 388 1,141 2,536 3,463
--------- --------- --------- --------- ---------
Total revenue 128,567 77,275 74,911 28,015 8,301
--------- --------- --------- --------- ---------
Operating expenses:
Assisted living community operating expense 81,256 49,411 45,595 16,395 3,201
Assisted living community lease expense 26,628 15,773 12,872 6,644 814
General and administrative 27,058 17,595 9,097 7,705 9,179
Impairment loss 22,727 -- -- -- --
Depreciation and amortization 9,561 4,896 4,366 1,031 320
--------- --------- --------- --------- ---------
Total operating expenses 167,230 87,675 71,930 31,775 13,514
--------- --------- --------- --------- ---------
Income (loss) from operations (38,663) (10,400) 2,981 (3,760) (5,213)
--------- --------- --------- --------- ---------
Other income (expense):
Interest income 1,978 1,821 1,668 1,071 211
Other income, net 229 321 1,402 2,203 833
Gain (loss) on sale (674) 5,511 -- -- --
Interest expense (7,958) (4,568) (5,470) (1,362) (171)
--------- --------- --------- --------- ---------
Total other income (expense) (6,425) 3,085 (2,400) 1,912 873
--------- --------- --------- --------- ---------
Income (loss) from continuing operations before
income taxes (45,088) (7,315) 581 (1,848) (4,340)
Income tax expense (benefit) 54 484 297 233 (1,724)
--------- --------- --------- --------- ---------
Income (loss) from continuing operations before
minority interest in income of majority owned
entities, discontinued operations and
extraordinary item (45,142) (7,799) 284 (2,081) (2,616)
Minority interest in income of majority owned
entities 839 773 783 -- --
--------- --------- --------- --------- ---------
Loss from continuing operations (45,981) (8,572) (499) (2,081) (2,616)
Income (loss) from discontinued operations, net of
income tax -- (13,563) (889) 1,116 (383)
Early extinguishment of debt, net of income tax -- -- (386) -- --
--------- --------- --------- --------- ---------
Net loss (45,981) (22,135) (1,774) (965) (2,999)
Preferred dividends declared -- -- -- 351 398
--------- --------- --------- --------- ---------
Net loss available for common shares(1) $ (45,981) $ (22,135) $ (1,774) $ (1,316) $ (3,397)
========= ========= ========= ========= =========
Basic and diluted loss per common share:
Loss from continuing operations $ (2.90) $ (0.77) $ (.05) $ (.39) $ (.61)
Income (loss) from discontinued operations -- (1.21) (.10) .18 (.08)
</TABLE>
21
<PAGE> 24
<TABLE>
<S> <C> <C> <C> <C> <C>
Loss from extraordinary item -- -- (.04) -- --
--------- --------- --------- --------- ---------
Net loss $ (2.90) $ (1.98) $ (.19) $ (.21) $ (.69)
========= ========= ========= ========= =========
Weighted average common shares outstanding(1) 15,866 11,171 9,400 6,246 4,903
========= ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
--------------------- --------------------------------------
1998 1997 1997 1996 1995
-------- ------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
SELECTED OPERATING DATA:
Assisted living units owned or leased (end of
period) 7,038 5,880 5,599 3,277 445
Assisted living units managed (end of period) 906 379 256 1,289 2,803
Weighted average occupancy of assisted living units
(end of year) 84% 84% 87% 90% 92%
BALANCE SHEET DATA:
Working capital (deficit) $ 11,683 $ 75,279 $ 12,947 $ 10,014 $ (4,660)
Total assets 205,359 233,085 161,947 77,403 15,399
Long-term notes payable, excluding current portion 88,175 81,560 90,481 24,814 3,213
Series A Preferred Stock, convertible and
Redeemable -- -- -- 2,358 4,586
Total shareholders' equity (deficit) 65,687 111,435 51,374 39,947 (3,536)
</TABLE>
- ----------
(1) Net loss available for common shares reflects the effect of preferred stock
dividends. Weighted average common shares outstanding give effect to the 1
for 3.04 reverse stock split which occurred upon the completion of the IPO
Offering.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Selected Financial Data in Item 6 and the consolidated financial
statements included in this Annual Report on Form 10-K set forth certain data
with respect to our financial position, results of operations and cash flows
that should be read in conjunction with the following discussion and analysis.
OVERVIEW
We are a leading national provider of assisted and independent living
services for the elderly. As of December 31, 1998, we operated 63 ALCs
containing 7,944 units, including 39 Leased ALCs, 16 Owned ALCs and 8 Managed
ALCs. Additionally, we are in various stages of construction and development on
7 ALCs with an anticipated total of 923 units.
Since commencing operation of ALCs for our own account in April 1994, we
embarked upon an expansion strategy and achieved significant growth in revenue
resulting primarily from the acquisition of ALCs. We focused our growth efforts
on the acquisition and development of additional ALCs and expansion of services
to our residents as they "age in place." During 1998, we acquired interests in
11 ALCs and one skilled nursing facility from Hillsdale Group, LP and their
affiliates, and opened five newly constructed ALCs. The Hillsdale transaction
substantially increased our presence in Northern and Southern California. As of
December 31, 1998, a substantial portion of our business and operations are
conducted in California, where 40 of the 63 ALCs we operated were located. We
intend to continue to make California the primary focus of our clustering
strategy. However, we do not intend to continue our historic growth rate in
order to focus greater attention and resources on enhancing the profitability of
our existing core operations and on leasing up new developments at a faster
rate. In addition to acquiring and developing ALCs through direct ownership and
the use of long-term leases, we plan to divest ALCs that do not expand or
enhance one of our clusters or do not meet our financial objectives. In December
1998, our Board of Directors decided to sell the five owned ALCs and five land
sites located outside of California.
Newly opened ALCs are expected to incur operating losses until sufficient
occupancy levels and operating efficiencies are achieved. Based upon historical
experience, we believe that a typical community will achieve its targeted
occupancy levels 12 - 18 months from the commencement of operations.
Accordingly, we will require substantial amounts of liquidity to maintain the
operations of newly opened ALCs. If sufficient occupancy levels are not achieved
within reasonable periods, our results of operations, financial position and
liquidity could be materially and adversely impacted.
Effective March 23, 1999, Mr. Phanstiel's position as Chief Executive
Officer terminated and he resigned as a member of the Board of Directors. Mr.
Phanstiel will receive severance in the total amount of $1.0 million. The
severance payment will be made in equal installments over a twelve month
period, subject to certain acceleration provisions tied to the Company's
liquidity or a change in control event.
Effective March 17, 1999, Ms. Muldoon's position as Senior Vice President
and General Counsel terminated. Ms. Muldoon will receive severance in the total
amount of $185,000. The severance payment will be made in two installments, the
first on March 29, 1999 and the second tied to the occurrence of certain
events, but no later than May 31, 1999. Pursuant to a Consulting Agreement with
the Company, Ms. Muldoon will serve as Special Counsel for the President for a
period commencing on March 17, 1999, and terminating upon certain events but no
later than May 31, 1999.
Effective March 26, 1999, Douglas M. Pasquale, our President and Chief
Operating Officer, was named our Chief Executive Officer, and on March 30, 1999,
Abdo H. Khoury, our Vice President of Asset Strategy and Treasurer, was promoted
to Senior Vice President and Chief Financial Officer.
22
<PAGE> 25
EVENTS SUBSEQUENT TO DECEMBER 31, 1998
On March 2, 1999, ARVP II obtained financing and, through its wholly owned
subsidiary ARVP II, LLC, purchased the landlord' interest in four previously
leases ALCs for approximately $14.3 million.
As of March 18, 1999, we entered into purchase and sale agreements for
these properties for approximately $32.3 million and on March 30, 1999, we
completed the sale of three of five properties, with the remaining two
properties anticipated to close during the second and third quarters of 1999.
THE YEAR ENDED DECEMBER 31, 1998 COMPARED WITH THE NINE-MONTH PERIOD ENDED
DECEMBER 31, 1997
The following table sets forth a comparison of the year ended December 31,
1998 (the "1998 Year") and the nine-month period ended December 31, 1997 (the
"1997 Period").
<TABLE>
<CAPTION>
FOR THE NINE-
(DOLLARS IN MILLIONS) FOR THE YEAR MONTH PERIOD
ENDED ENDED
DECEMBER 31, DECEMBER 31, INCREASE/
1998 1997 (DECREASE)
------ ------ ------
<S> <C> <C> <C>
Revenue:
Assisted living community revenue $127.5 $ 76.9 65.8%
Management fees from affiliates and others 1.1 0.4 187.6%
------ ------ ------
Total revenue 128.6 77.3 66.4%
------ ------ ------
Operating expenses:
Assisted living community operating expense 81.3 49.4 64.4%
Assisted living community lease expense 26.6 15.8 68.8%
General and administrative 27.0 17.6 53.8%
Impairment loss 22.7 -- (100.0)%
Depreciation and amortization 9.6 4.9 95.3%
------ ------ ------
Total operating expenses 167.2 87.7 90.7%
------ ------ ------
Loss from operations (38.6) (10.4) 271.8%
------ ------ ------
Other income (expense):
Interest income 2.0 1.8 8.6%
Other income, net 0.2 0.3 (28.7)%
Gain (loss) on sale (0.7) 5.5 (112.2)%
Interest expense (8.0) (4.5) 74.2%
------ ------ ------
Total other income (expense) (6.5) 3.1 (308.3)%
------ ------ ------
Loss from continuing operations before income taxes (45.1) (7.3) 516.4%
Income tax expense 0.1 0.5 (88.8)%
------ ------ ------
Loss from continuing operations before minority
interest in income of majority owned entities and
discontinued operations (45.2) (7.8) 478.8%
Minority interest in income of majority owned entities 0.8 0.8 8.5%
------ ------ ------
Loss from continuing operations (46.0) (8.6) 436.4%
Loss from operations of discontinued operations -- (13.5) 100.0%
------ ------ ------
Net loss $(46.0) $(22.1) 107.7%
====== ====== ======
</TABLE>
The increase in assisted living community revenue is attributable to:
o the 1998 Year having 12 months as compared to 9 months in the 1997
Period;
o the acquisition of seven Owned and Leased ALCs during the 1998 Year;
o the opening of five Leased ALCs during the 1998 Year;
o the increase in average occupancy for all of our Owned and Leased ALCs
to 85.7% for the 1998 Year as compared with 83.8% for the 1997 Period;
o the increase in assisted living penetration to 43.5% for the 1998 Year
as compared with 37.8% for the 1997 Period; and
o the increase in average rate per occupied unit to $1,828 for the 1998
Year as compared with $1,679 for the 1997 Period.
Management fees from affiliates and others increased due to:
o the 1998 Year having 12 months as compared to 9 months in the 1997
Period; and
o the increased number of management contracts to seven in the 1998 Year
from three in the 1997 Period.
Assisted living community operating expense increased due to:
o the 1998 Year having 12 months as compared to 9 months in the 1997
Period;
o the acquisition of seven Owned and Leased ALCs during the 1998 Year;
23
<PAGE> 26
o the opening of five Leased ALCs during the 1998 Year;
o staffing requirements related to increased assisted living services
provided; and
o increased wages of staff.
The increase in assisted living community lease expense is primarily due
to:
o the 1998 Year having 12 months as compared to 9 months in the 1997
Period; and
o the acquisition of two Leased ALCs and the opening of five Leased ALCs
during the 1998 Year.
General and administrative expenses increased due to the following:
o the 1998 Year having 12 months as compared to 9 months in the 1997
Period;
o expenses incurred in connection with the lawsuits with Kapson, Atria
and LFREI;
o severance payments related to our changes in management personnel;
o investment banking fees; and
o additional staffing necessary to accommodate the increased operations
during the 1998 Year.
Depreciation and amortization expenses increased due to:
o the 1998 Year having 12 months as compared to 9 months in the 1997
Period; and
o the acquisition of seven Owned and Leased ALCs during the 1998 Year.
Interest income increased due to 12 months included in the 1998 Year as
compared to 9 months in the 1997 Period, offset by, lower average cash balances
carried by us during the 1998 Year as compared to the 1997 Period.
Other income remained constant for the 1998 Year as compared to the 1997
Period.
The impairment loss is due to:
o a $19.0 million write-down of five existing ALCs and five land sites
held for sale that had carrying values in excess of fair market value;
and
o a $3.7 million impairment loss on existing ALCs which had projected
future cash flows that were less than carrying value of the assets.
Interest expense increased due to:
o additional debt assumed in connection with the acquisition of two
Owned ALCs during the 1998 Year; and
o $1.5 million of interest rate lock and commitment fees incurred in
connection with the failed refinance of the majority owned entities
during the 1998 Year.
Minority interest in income of majority owned entities increased due to:
o the 1998 Year having 12 months as compared to 9 months in the 1997
Period;
o in the 1997 Period we allocated losses from a limited liability
corporation ("LLC") to the minority owner. We sold our interest in the
LLC in December 1997; offset by:
o interest rate lock and commitment fees paid by the majority owned
entities during the 1998 Year.
Loss from discontinued operations decreased as all expected future
operating costs for our discontinued operations were recorded in the 1997
Period. No additional costs have been incurred during the 1998 Year.
THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 COMPARED WITH THE FISCAL YEAR
ENDED MARCH 31, 1997
The following table sets forth a comparison of the nine-month period ended
December 31, 1997 (the "1997 Period") and the fiscal year ended March 31, 1997
("Fiscal 1997").
24
<PAGE> 27
<TABLE>
<CAPTION>
(DOLLARS IN MILLIONS) FOR THE
NINE-MONTH FOR THE
PERIOD ENDED FISCAL YEAR
DECEMBER 31, ENDED MARCH 31, INCREASE/
1997 1997 (DECREASE)
------ ------ ------
<S> <C> <C> <C>
Revenue:
Assisted living community revenue $ 76.9 $ 73.8 4.2%
Management fees from affiliates and others 0.4 1.1 (66.0)%
------ ------ ------
Total revenue 77.3 74.9 3.2%
------ ------ ------
Operating expenses:
Assisted living community operating expense 49.4 45.6 8.4%
Assisted living community lease expense 15.8 12.9 22.5%
General and administrative 17.6 9.1 93.4%
Depreciation and amortization 4.9 4.3 12.1%
------ ------ ------
Total operating expenses 87.7 71.9 21.9%
------ ------ ------
Income (loss) from operations (10.4) 3.0 (448.9)%
------ ------ ------
Other income (expense):
Interest income 1.8 1.7 9.2%
Other income, net 0.3 1.4 (77.1)%
Gain (loss) on sale 5.5 -- 100.0%
Interest expense (4.5) (5.5) (16.5)%
------ ------ ------
Total other income (expense) 3.1 (2.4) 228.5%
------ ------ ------
Income (loss) from continuing operations before income taxes (7.3) 0.6 (1359.0)%
Income tax expense 0.5 0.3 63.0%
------ ------ ------
Income (loss) from continuing operations before minority
interest in income of majority owned entities and
discontinued operations (7.8) 0.3 (2846.1)%
Minority interest in income of majority owned entities 0.8 0.8 (1.3)%
------ ------ ------
Loss from continuing operations (8.6) (0.5) 1617.8%
Loss from operations of discontinued operations (13.5) (0.9) 1425.6%
Loss from operations of discontinued operations -- (0.4) 100.0%
------ ------ ------
Net loss $(22.1) $ (1.8) 1147.7%
====== ====== ======
</TABLE>
The increase in assisted living community revenue is attributable to:
o the addition of 9 Owned ALCs and 11 Leased ALCs during Fiscal 1997
which were operated for only a portion of Fiscal 1997 as opposed to
the entire 1997 Period;
o the operations of three new Leased ALCs during the 1997 Period;
o the increase in assisted living penetration to 37.8% for the 1997
Period as compared with 35.9% for Fiscal 1997;
o the increase in average rate per occupied unit to $1,681 for the 1997
Period as compared with $1,527 for Fiscal 1997; offset by:
o the 1997 Period having 9 months as compared to 12 months in Fiscal
1997; and
o the decrease in average occupancy for all of our Owned and Leased ALCs
to 84.7% for the 1997 Period as compared with 87.1% for Fiscal 1997.
Management fees from affiliates and others decreased due to:
o the purchase of controlling interests in two affiliated partnerships,
in June and August 1996, that own or lease 11 ALCs which we previously
managed; and
o the 1997 Period having 9 months as compared to 12 months in Fiscal
1997.
Assisted living community operating expense increased due to:
o the addition of 9 Owned ALCs and 11 Leased ALCs during Fiscal 1997
which were operated for only a portion of Fiscal 1997 as opposed to
the entire 1997 Period ;
o the operations of three new Leased ALCs during the 1997 Period;
o staffing requirements related to increased assisted living services
provided;
o increased wages of staff; offset by:
o the 1997 Period having 9 months as compared to 12 months in Fiscal
1997.
The increase in assisted living community lease expense is primarily due to:
o the addition of 11 Leased ALCs during Fiscal 1997 which were operated
for only a portion of Fiscal 1997 as opposed to the entire 1997
Period;
o the operations of three new Leased ALCs during the 1997 Period; offset
by:
o the 1997 Period having 9 months as compared to 12 months in Fiscal
1997.
25
<PAGE> 28
General and administrative expenses increased due to the following:
o expenses incurred in connection with our successful proxy fight with
Emeritus during the 1997 Period;
o severance costs related to the retirement of three senior executives
during the 1997 Period;
o the write-off of certain costs incurred in the failed conversion of
our accounting system;
o costs incurred related to the development of our strategic plan; and
o additional staffing necessary to accommodate the increased operations
during the 1997 Period; offset by:
o the 1997 Period having 9 months as compared to 12 months in Fiscal
1997.
Depreciation and amortization expenses increased due to:
o the addition of 9 Owned ALCs and 11 Leased ALCs during Fiscal 1997
which were operated for only a portion of Fiscal 1997 as opposed to
the entire 1997 Period ;
o the operations of three new Leased ALCs during the 1997 Period; offset
by:
o the 1997 Period having 9 months as compared to 12 months in Fiscal
1997.
Interest income increased due to higher cash balances available for
investment during the 1997 Period offset by the 1997 Period having 9 months as
compared to 12 months in Fiscal 1997. The increase in cash was due to the
Prometheus Transactions.
Gain on sale represents the gain on the sale of our 50 percent interest in
two limited liability companies, which owned one ALC and one development site
during December 1997.
Interest expense decreased due to the 1997 Period having 9 months as
compared to 12 months in Fiscal 1997.
Minority interest in income of majority owned entities remained constant
between periods despite the 1997 Period having 9 months as compared to 12 months
in Fiscal 1997.
Losses from discontinued operations reflect the operations of GeriCare and
the Apartment Group, both of which we are currently in the process of disposing.
While developing the plan to dispose of these assets, we determined that the
fair value less selling costs of each was less than their current carrying cost.
In addition, it was determined that we will have to provide capital to fund
current operations and projected permanent financing deficits. During the 1997
Period, we provided $2.0 million and $8.6 million for the cost of disposing of
GeriCare and the Apartment Group, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Our unrestricted cash and cash equivalents balances were $11.9 million and
$102.8 million at December 31, 1998 and 1997, respectively.
Working capital decreased to $11.7 million as of December 31, 1998,
compared to working capital of $75.3 million at December 31, 1997, resulting
primarily from the acquisition of five owned, two leased ALCs and four
management contracts from the Hillsdale Group and its affiliates during 1998.
During the 1998 Year cash used in operations was $13.0 million compared to
$7.4 million during the 1997 Period and cash provided by operating activities of
$0.9 million in Fiscal 1997.
The cash used in operating activities during the 1998 Year was a result of:
o our net loss of $46.0 million;
o $3.4 million of cash used in operating activities of discontinued
operations; offset by:
o non-cash charges of:
- $22.7 million loss recorded for impairment of long-lived
assets;
- $9.6 million of depreciation and amortization expense;
- $0.8 million of minority interest in income of majority
owned entities;
- $0.7 million of losses recorded on properties sold to our
development joint ventures;
26
<PAGE> 29
- $0.6 million of provisions for doubtful accounts.
o $2.0 million increase in net liabilities.
The cash used in operating activities during the 1997 Period was a result
of:
o our net loss of $22.1 million;
o $4.3 million of cash used in operating activities of discontinued
operation;
o $5.5 million of non-cash gain from the sale of our 50% interest in two
LLCs; offset by:
o non-cash charges of:
- $13.6 million loss related to discontinued operations;
- $4.9 million of depreciation and amortization expense;
- $0.8 million of minority interest in income of majority
owned entities;
- $0.6 million of provisions for doubtful accounts.
o $4.6 million increase in net liabilities.
The cash provided by operating activities during Fiscal 1997 was a result
of:
o our net loss of $1.8 million;
o $2.7 million of cash used in operating activities of discontinued
operations;
o $1.3 million increase in net assets; offset by:
o non-cash charges of:
- $0.9 million loss recorded for reserves related to
discontinued operations;
- $4.4 million of depreciation and amortization expense;
- $0.8 million of minority interest in income of majority
owned entities;
- $0.4 million of extraordinary loss from early extinguishment
of debt;
- $0.2 million of provisions for doubtful accounts.
For the 1998 Year cash used in investing activities was $78.1 million as
compared with cash provided by investing activities of $11.9 million during the
1997 Period and cash used in investing activities of $59.3 million during Fiscal
1997.
The cash used in investing activities during the 1998 Year was a result of:
o $71.7 million related to the acquisition of five Owned ALCs, two
Leased ALCs and four management contracts;
o $12.3 million of purchases of property, furniture and equipment;
o $1.3 million of payments to increase cash security deposits on our
leased ALCs;
o $0.7 million for costs associated with development properties,
investments in joint ventures and a deposit related to the purchase of
additional ALCs; offset by:
o $7.2 million of net proceeds received from the sale of two Owned ALCs
and two land sites to our development joint ventures; and
o $0.7 million distribution received from our investment in Senior
Income Fund LP.
The cash provided by investing activities during the 1997 Period was a
result of:
o $24.2 million from the sale of our 50% interests in two LLCs;
o $3.6 million distributions received from our investment in Senior
Income Fund LP;
o $1.9 million of proceeds from the sale and leaseback of communities;
o $1.7 million release of restricted cash as collateral for letters of
credit pledged as security deposits of Leased ALCs; offset by:
o $18.6 million of purchases of property, furniture and equipment;
o $0.5 million for the purchase of units in Senior Income Fund LP;
o $0.3 million of payments to increase cash security deposits on our
leased ALCs; and
o $0.1 million for costs associated with development properties;
The cash used in investing activities during Fiscal 1997 was a result of:
o $73.9 million of purchases of property, furniture and equipment;
o $18.6 million of purchases of limited partnership units; offset by:
27
<PAGE> 30
o $29.1 million of proceeds from the sale/leaseback of four ALCs;
o $3.0 million release of restricted cash as collateral for letters of
credit pledged as security deposits of Leased ALCs;
o $0.9 million release of cash security deposits on our leased ALCs; and
o $0.2 million for a refund of costs associated with development
properties.
For the 1998 Year cash provided by financing activities was $0.2 million as
compared to $82.6 during the 1997 Period and $66.7 million during Fiscal 1997.
The cash provided by financing activities during the 1998 Year was a result
of:
o $4.4 million additional draw on a note payable;
o $0.2 million of proceeds received from issuance of common stock;
offset by:
o $2.6 million for issuance costs associated with our conversion of the
Prometheus Notes;
o $0.8 million of distributions paid to our minority partners in certain
majority owned entities;
o $0.7 million of repayments of notes payable;
o $0.3 million of payments for loan and line of credit fees.
The cash provided by financing activities during the 1997 Period was a
result of:
o $60.0 million proceeds from the issuance of the Prometheus Notes;
o $24.8 million of proceeds received from issuance of common stock, net
of issuance costs; offset by:
o $1.5 million of repayments of notes payable; and
o $0.7 million of distributions paid from our majority owned entities.
The cash provided by financing activities during Fiscal 1997 was a result
of:
o $55.2 million of proceeds from the issuance of the 2006 Notes, net of
issuance costs;
o $31.1 million of borrowings under notes payable;
o $0.7 million of proceeds received from issuance of common stock, net
of issuance costs; offset by:
o $18.6 million of repayments of notes payable and the redemption of the
1999 Notes; and
o $1.7 million of repurchases of convertible subordinated notes.
On June 24, 1996, we obtained a $35 million commitment from Bank United of
Texas for the construction or acquisition of ALCs. The terms of the commitment
provide for interest at 2.75% over the thirty day LIBOR rate. Of the commitment,
a $20 million sub-limit has been established for the construction of ALCs. As of
December 31, 1998, we had outstanding indebtedness of $8.8 million used as
mortgage financing of existing ALCs. Additionally, we had guaranteed a $7.7
million loan borrowed by an Affiliated Partnership for the construction of a new
ALC.
On September 10, 1996, we obtained a $10 million revolving line of credit
with Imperial Bank to be used for acquisition, development, the provision of
letters of credit and general corporate purposes. Advances under this line of
credit are priced at the Imperial Bank prime rate plus 0% to .5% or LIBOR plus
2.0% to 2.5% based upon our achievement of financial ratios. On November 10,
1998, Imperial amended the line of credit agreement to require that we provide
collateral for outstanding standby letter of credit obligations. In return for
this modification, Imperial removed all debt service covenants and reduced the
required minimum net worth and minimum current ratio requirements through June
30, 1999, the last quarterly measurement date under the existing line of credit
agreement. While there can be no assurances that we will be able to comply with
these reduced financial covenant requirements, we believe that we will be able
to comply with the modified covenants through maturity of the agreement. As of
December 31, 1998, we had used $4.4 million of this line of credit for the
provision of letters of credit used as Leased ALC security deposits. The line of
credit is collateralized by an owned ALC.
28
<PAGE> 31
We believe that our existing liquidity, ability to sell ALCs and land sites
which do not meet our financial objectives or geographic clustering strategy,
and ability to refinance certain Owned ALCs and investments will provide
adequate resources to meet our current operating and investing needs and support
our current growth plans for the next 12 months. We do not currently generate
sufficient cash from operations to fund recurring working capital requirements.
We will be required from time to time to incur additional indebtedness or issue
additional debt or equity securities to finance our growth strategy, including
the acquisition and development of ALCs as well as other capital expenditures
and to provide additional funds to meet increased working capital requirements.
YEAR 2000
General
We use computer programs that were written using two digits rather than
four to define the year. As a result, those programs may recognize a date using
"00" as the year 1900 rather than the year 2000. In the event this was to occur
with any of our computer programs, a system failure or miscalculation causing
disruptions of operations could occur. Such a failure could cause the temporary
inability to process transactions, send invoices or engage in similar normal
business activities. We have developed a comprehensive program to test and
modify our information technology to address the Year 2000 Issue. We believe
that our program is on schedule for completion by the end of 1999, and that
there will be no material impact on our business, results of operations,
financial position or liquidity as a result of Year 2000 Issues.
Program
Our program is focused on the following three main projects:
o information technology infrastructure - all of our hardware and
software systems;
o community maintenance - community specific systems, including alarms
(security, fire and emergency call), elevator, phone, HVAC, and other
systems; and
o third party suppliers/vendors.
For each component, we are addressing the Year 2000 Issues in the following
six phases:
o taking inventory of systems with potential Year 2000 Issues;
o assigning priorities to systems identified with Year 2000 Issues;
o assessing items which may have a material effect on our operations;
o testing items assessed as material;
o replacing or repairing material non-compliant items; and
o designing and implementing business continuation plans.
We have initiated communications with the third-party providers of certain
of our administrative services, as well as our significant suppliers of services
and products, to determine the extent to which we are vulnerable to those
parties' failures to remediate their own Year 2000 Issues. We completed our
evaluation of those suppliers during the third quarter of 1998. We do not
presently believe that third party Year 2000 issues will have a material adverse
effect on us. However, there can be no guarantee that the systems of other
companies on which our operations or systems rely will be remedied on a timely
basis or that a failure by another company to remediate its systems in a timely
manner would not have a material adverse effect on us.
Costs
We expect to successfully implement the changes necessary to address our
Year 2000 Issues, and do not believe that the cost of such actions will have a
material adverse effect on our financial position, results of operations or
liquidity. We anticipate that the cost of assessing the Year 2000 Issue will
range from $100,000 to $360,000. We are currently unable to assess the costs to
remediate any Year 2000 Issues that may result from the assessment.
29
<PAGE> 32
Risks
We believe that our Year 2000 program will be completed by the end of the
second quarter of 1999. Our program's schedule is based on a number of factors
and assumptions, such as:
o the accuracy and completeness of responses to our inquiries; and
o the availability of skilled personnel to complete the program.
Our program's schedule could be adversely impacted if any of the factors
and assumptions is incorrect. The failure to correct a material Year 2000 Issue
could result in an interruption in our normal business operations. There can be
no assurance, however, that there will not be delays in, or increased costs
associated with, the implementation of such changes, and our inability to
implement such changes could have a material adverse effect on our business,
operating results, and financial condition.
We intend to determine if contingency plans are needed for any aspect of
our business with respect to Year 2000 Issues (including most likely worst case
Year 2000 scenarios), and to create those contingency plans by the end of the
second quarter of 1999.
IMPACT OF INFLATION AND CHANGING PRICES
Operating revenue from ALCs we operate is the primary source of our
revenue. These ALCs are affected by rental rates which are highly dependent upon
market conditions and the competitive environments where the communities are
located. Employee compensation is the principal cost element of property
operations. Although there can be no assurance we will be able to continue to do
so, we have been able historically to offset the effects of inflation on
salaries and other operating expenses by increasing rental and assisted living
rates.
NEW ACCOUNTING PRONOUNCEMENTS
In April 1998, the Accounting Standards Executive Committee issued
Statement of Position ("SOP") No. 98-5, "Reporting on the Costs of Start-up
Activities," which is effective for fiscal years beginning after December 15,
1998. The SOP provides guidance on the financial reporting of start-up
activities and organizational costs. It requires costs of start-up activities
and organizational costs to be expensed when incurred and, upon adoption, the
write-off as a cumulative effect of a change in accounting principle of any
previously capitalized start-up or organizational costs. We plan to adopt the
provisions of SOP 98-5 in the first quarter of 1999. The carrying amounts of
capitalized start-up costs are approximately $1.3 million as of December 31,
1998.
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and
Related Information" ("SFAS 131"). This standard requires that a public business
enterprise report financial and descriptive information about its reportable
operating segments. Operating segments are components of an enterprise about
which separate financial information is available that is regularly evaluated by
the chief operating decision maker in deciding how to allocate resources and in
assessing performance. We evaluate performance and make resource allocation
decisions on a community by community basis. Accordingly, each community is
considered an "operating segment" under SFAS 131. However, SFAS 131 did not have
an impact on the financial statements because the communities have similar
economic characteristics, as defined by SFAS 131, and meet the criteria for
aggregation into one "reportable segment".
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks related to fluctuations in interest rates on
our notes payable. Currently, we do not utilize interest rate swaps. The purpose
of the following analysis is to provide a framework to understand our
sensitivity to hypothetical changes in interest rates as of December 31, 1998.
You should be aware that many of the statements contained in this section are
forward looking and should be read in conjunction with our disclosures under the
heading "Forward-Looking Statements."
For fixed rate debt, changes in interest rates generally affect the fair
market value of the debt instrument, but not our earnings or cash flows.
Conversely, for variable rate debt, changes in interest rates generally do not
impact fair market value of the debt instrument, but do affect our future
earnings and cash flows. We do not have an obligation to prepay fixed rate debt
prior to maturity, and as a result, interest rate risk and changes in fair
market value should not have a significant impact on the fixed rate debt until
we would be required to refinance such debt. Holding the variable rate debt
balance constant, each one percentage point increase in interest rates would
result in an increase in variable rate interest incurred for the coming year of
approximately $340,000.
The table below details the principal amount and the average interest rates
of notes payable in each category based upon the expected maturity dates. The
fair value estimates for notes payable are based upon future discounted cash
flows of similar type notes or quoted market prices for similar loans. The
carrying value of our variable rate debt approximates fair value due to the
frequency of re-pricing of this debt. Our fixed rate debt consists of
convertible subordinated notes payable and mortgage payables. The fixed rate
debt bears interest at rates that approximate current market value.
EXPECTED MATURITY DATA
<TABLE>
<CAPTION>
Fair
1999 2000 2001 2002 2003 Thereafter Total Value
-------- ------ ------ ------- ------ ---------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Fixed rate debt ....... $12,362 $ 459 $ 166 $ 179 $ 194 $62,522 $75,882 $75,882
Average interest rate .. 9.35% 9.04% 7.86% 7.86% 7.86% 6.84%
Variable rate debt ..... $ 9,307 $ 578 $ 602 $18,989 $ 234 $ 4,252 $33,962 $33,962
Average interest rate .. 8.30% 8.40% 8.39% 8.24% 8.50% 8.50%
</TABLE>
We do not believe that the future market rate risks related to the above
securities will have a material adverse impact on our financial position,
results of operation or liquidity.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and the Independent Auditors' Report
are listed at Item 14 and are included beginning on Page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
30
<PAGE> 33
ITEMS 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT,
EXECUTIVE COMPENSATION, SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT, AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by these Items is incorporated by reference to
our definitive Proxy Statement to be filed pursuant to Regulation 14A within
120 days after the end of our fiscal year covered by this Report.
31
<PAGE> 34
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of the report:
(1) Financial Statements. The following financial statements of the
Registrant and the Report of Independent Public Accountants therein are
filed as part of this Report on Form 10-K:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report F-1
Consolidated Balance Sheets F-2
Consolidated Statements of Operations F-3
Consolidated Statements of Shareholders' Equity F-4
Consolidated Statements of Cash Flows F-5
Notes to Consolidated Financial Statements F-7
</TABLE>
(2) Financial Statement Schedules. Schedule II-Valuation and Qualifying
Accounts. Other Financial Statement Schedules have been omitted because
the information required to be set forth therein is not applicable or
is shown in the financial statements or notes thereto.
(b) Reports on Form 8-K. We filed the following reports with the Securities and
Exchange Commission ("SEC") on Form 8-K during the quarter ended December
31, 1998:
(1) Our current report on Form 8-K filed with the SEC on December 10, 1998
reported under Item 5, concerning the ruling from the Superior Court of
the State of California in favor of LFREI on their cross-complaint
against us, concluding that the standstill obligations under the
stockholders agreement with us terminated as of April 1998.
(c) EXHIBITS: The following exhibits are filed as part of, or incorporated by
reference into this report on Form 10-K:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
2 Agreement and Plan of Merger, by and between ARV Assisted
Living, Inc. and ARV Delaware, Inc., incorporated by reference
to the Company's Proxy Statement for the 1997 Meeting of
Shareholders of ARV Assisted Living, Inc., filed with the
Securities and Exchange Commission on Schedule 14A on December
31, 1997.
3.1 Certificate of Incorporation of ARV Delaware, Inc.,
incorporated by reference to the Company's Proxy Statement for
the 1997 Meeting of Shareholders of ARV Assisted Living, Inc.,
filed with the Securities and Exchange Commission on Schedule
14A on December 31, 1997.
3.2 By-laws of ARV Delaware, Inc., as amended, incorporated by
reference to our 8-K filed October 21, 1998.
4.1 Rights Agreement, dated May 14, 1998, between ARV Assisted
Living Inc., and ChaseMellon Shareholder Services LLC which
includes the form of Certificate of Determination of the
Series D Junior Participating Preferred Stock of ARV Assisted
Living, Inc. as Exhibit A, the form of Right Certificate as
Exhibit B, and the Summary of Rights to Purchase Preferred
Shares as Exhibit C, incorporated by reference to our 10-Q
filed with the Securities and Exchange Commission on May 15,
1998.
4.2 First Amendment to the Right Agreement, dated October 21,
1998, by and between ARV Assisted Living Inc., and ChaseMellon
Shareholder Services LLC, incorporated by reference to our *-K
filed October 21, 1998.
10.1 Purchase and Sale Agreement by and between 270 Center
Associates, Limited Partnership and ARV Assisted Living, Inc.
dated as of February 12, 1998, incorporated by reference to
Exhibit 10.1 to our 8-K filed with the Securities and Exchange
Commission on May 11, 1998.
</TABLE>
32
<PAGE> 35
<TABLE>
<S> <C>
10.2 Amendment to Purchase and Sale Agreement by and between 270
Center Associated, Limited Partnership and ARV Assisted
Living, Inc. dated as of March 2, 1998, incorporated by
reference to Exhibit 10.2 to our 8-K filed with the Securities
and Exchange Commission on May 11, 1998.
10.3 Second Amendment to Purchase and Sale Agreement by and between
270 Center Associated, Limited Partnership and ARV Assisted
Living, Inc. dated as of April 10, 1998, incorporated by
reference to Exhibit 10.3 to our 8-K filed with the Securities
and Exchange Commission on May 11, 1998.
10.4 Purchase and Sale Agreement by and between TH Group, Inc. and
ARV Assisted Living, Inc. dated as of February 12, 1998,
incorporated by reference to Exhibit 10.4 to our 8-K filed
with the Securities and Exchange Commission on May 11, 1998.
10.5 Amendment to Purchase and Sale Agreement by and between TH
Group, Inc. and ARV Assisted Living, Inc. dated as of March 2,
1998, incorporated by reference to Exhibit 10.5 to our 8-K
filed with the Securities and Exchange Commission on May 11,
1998.
10.6 Second Amendment to Purchase and Sale Agreement by and between
TH Group, Inc. and ARV Assisted Living, Inc. dated as of April
10, 1998, incorporated by reference to Exhibit 10.6 to our 8-K
filed with the Securities and Exchange Commission on May 11,
1998.
10.7 Purchase and Sale Agreement by and between The Hillsdale
Group, LP and ARV Assisted Living, Inc. dated as of February
12, 1998, incorporated by reference to Exhibit 10.7 to our 8-K
filed with the Securities and Exchange Commission on May 11,
1998.
10.8 Amendment to Purchase and Sale Agreement by and between The
Hillsdale Group, LP and ARV Assisted Living, Inc. dated as of
March 2, 1998, incorporated by reference to Exhibit 10.8 to
our 8-K filed with the Securities and Exchange Commission on
May 11, 1998.
10.9 Second Amendment to Purchase and Sale Agreement by and between
The Hillsdale Group, LP and ARV Assisted Living, Inc. dated as
of April 6, 1998, incorporated by reference to Exhibit 10.9 to
our 8-K filed with the Securities and Exchange Commission on
May 11, 1998.
10.10 Executive Employment Agreement, dated December 5, 1997, by and
between ARV Assisted Living, Inc. and Howard G. Phanstiel,
incorporated by reference to our 10-Q filed with the
Securities and Exchange Commission on August 14, 1998.
10.11 Amendment to Executive Employment Agreement, effective
December 5, 1997, by and between ARV Assisted Living, Inc. and
Howard G. Phanstiel, incorporated by reference to our 10-Q
filed with the Securities and Exchange Commission on August
14, 1998.
10.12 Executive Employment Agreement, as amended, dated June 1,
1998, by and between ARV Assisted Living, Inc. and Douglas M.
Pasquale, incorporated by reference to our 10-Q filed with the
Securities and Exchange Commission on August 14, 1998.
10.13 Employment Agreement, as amended, dated June 15, 1998, by and
between ARV Assisted Living, Inc. and Patricia J. Gifford, MD,
incorporated by reference to our 10-Q filed with the
Securities and Exchange Commission on August 14, 1998.
10.11 Note dated as of October 30, 1997, by the Company in favor of
Prometheus, incorporated by reference to Exhibit 6 to the
Amendment No. 2 to Schedule 13D filed by Prometheus and LFREI
on November 7, 1997.
10.12 Letter Agreement dated October 29, 1997 by and among
Prometheus, LFREI and the Company, incorporated by reference
to Exhibit 7 to the Amendment No. 2 to Schedule 13D filed by
Prometheus and LFREI on November 7, 1997.
10.13 Stockholders' Voting Agreement dated as of October 29, 1997,
by and among Prometheus, LFREI and certain stockholders of the
Company, incorporated by reference to Exhibit 4 to the
Amendment No. 2 to Schedule 13D filed by Prometheus and LFREI
on November 7, 1997.
23 Consent of KPMG LLP.
27 Financial Data Schedule.
99.1 Complaint in ARV Assisted Living, Inc. v. Lazard Freres Real
Estate Investors LLC, et al., case no. 787788, incorporated by
reference to our 8-K filed with the Securities and Exchange
Commission on May 26, 1998.
</TABLE>
33
<PAGE> 36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
ARV ASSISTED LIVING, INC.
By: /s/ DOUGLAS M. PASQUALE
-------------------------------------
Douglas M. Pasquale
President and Chief Executive Officer
Date: March 31, 1999
Pursuant to the requirements of the Securities Act of 1934, as amended,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ DOUGLAS M. PASQUALE President and Chief Executive Officer March 31, 1999
- ---------------------------------------
Douglas M. Pasquale
/s/ ABDO H. KHOURY Senior Vice President and Chief March 31, 1999
- --------------------------------------- Financial Officer
Abdo Khoury
/s/ JOHN A. BOOTY Director March 31, 1999
- ---------------------------------------
John A. Booty
/s/ DAVID P. COLLINS Director March 31, 1999
- ---------------------------------------
David P. Collins
/s/ MAURICE J. DEWALD Director March 31, 1999
- ---------------------------------------
Maurice J. DeWald
/s/ ROBERT P. FREEMAN Director March 31, 1999
- ---------------------------------------
Robert P. Freeman
/s/ MURRY N. GUNTY Director March 31, 1999
- ---------------------------------------
Murry N. Gunty
/s/ KENNETH M. JACOBS Director March 31, 1999
- ---------------------------------------
Kenneth M. Jacobs
</TABLE>
34
<PAGE> 37
INDEPENDENT AUDITORS' REPORT
The Board of Directors
ARV Assisted Living, Inc.:
We have audited the accompanying consolidated balance sheets of ARV
Assisted Living, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, shareholders' equity and cash
flows for the year ended December 31, 1998, the nine-month period ended December
31, 1997 and the fiscal year ended March 31, 1997. In connection with our audits
of the consolidated financial statements, we have also audited the financial
statement schedule described in Item 14(a)(2). These consolidated financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule 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 ARV Assisted
Living, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for the year ended December 31, 1998,
the nine-month period ended December 31, 1997 and the fiscal year ended March
31, 1997, in conformity with generally accepted accounting principles. Also in
our opinion, the related financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
Orange County, California
March 31, 1999
F-1
<PAGE> 38
ARV ASSISTED LIVING, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 11,885 $ 102,776
Fees receivable and other amounts due from affiliates 757 211
Prepaids and other current assets 5,847 4,280
Properties held for sale, net 35,211 --
--------- ---------
Total current assets 53,710 107,267
Property, furniture and equipment 105,679 117,557
Goodwill, net 23,165 --
Other non-current assets 22,805 7,027
Net non-current assets from discontinued operations -- 1,234
--------- ---------
$ 205,359 $ 233,085
========= =========
Current liabilities:
Accounts payable $ 5,142 $ 6,696
Accrued liabilities 11,644 7,864
Notes payable, current portion 21,669 9,388
Accrued interest payable 1,677 1,482
Net current liabilities from discontinued operations 1,895 6,558
--------- ---------
Total current liabilities 42,027 31,988
Lease liabilities 1,346 565
Deferred revenue, less current portion 934 369
Notes payable, less current portion 88,175 81,560
--------- ---------
132,482 114,482
--------- ---------
Commitments and contingent liabilities
Minority interest in majority owned entities 7,190 7,168
Series A Preferred stock, convertible and redeemable; 2,000 shares
authorized, none issued or outstanding at December 31, 1998 and 1997 -- --
Shareholders' equity:
Preferred stock, no par value. 8,000 shares authorized, none issued
and outstanding -- --
Common stock, no par value. 100,000 shares authorized; 15,873 and
15,848 shares issued and outstanding at December 31, 1998 and 1997,
respectively 143,178 142,945
Accumulated deficit (77,491) (31,510)
--------- ---------
Total shareholders' equity 65,687 111,435
--------- ---------
$ 205,359 $ 233,085
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE> 39
ARV ASSISTED LIVING, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998, THE NINE-MONTH PERIOD ENDED
DECEMBER 31, 1997 AND THE FISCAL YEAR ENDED MARCH 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE-MONTH FISCAL YEAR
YEAR ENDED PERIOD ENDED ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1998 1997 1997
--------- --------- ---------
<S> <C> <C> <C>
Revenue:
Assisted living community revenue:
Rental revenue $ 103,402 $ 64,411 $ 63,475
Assisted living and other services 24,049 12,476 10,295
Management fees from others 374 -- --
Management fees from affiliates 742 388 1,141
--------- --------- ---------
Total revenue 128,567 77,275 74,911
--------- --------- ---------
Operating expenses:
Assisted living community operating expense 81,256 49,411 45,595
Assisted living community lease expense 26,628 15,773 12,872
General and administrative 27,058 17,595 9,097
Impairment loss 22,727 -- --
Depreciation and amortization 9,561 4,896 4,366
--------- --------- ---------
Total operating expenses 167,230 87,675 71,930
--------- --------- ---------
Income (loss) from operations (38,663) (10,400) 2,981
--------- --------- ---------
Other income (expense):
Interest income 1,978 1,821 1,668
Other income, net 229 321 1,402
Gain (loss) on sale of properties (674) 5,511 --
Interest expense (7,958) (4,568) (5,470)
--------- --------- ---------
Total other income (expense) (6,425) 3,085 (2,400)
--------- --------- ---------
Income (loss) from continuing operations before income
taxes (45,088) (7,315) 581
Income tax expense 54 484 297
--------- --------- ---------
Income (loss) from continuing operations before minority
interest in income of majority owned entities,
discontinued operations, and extraordinary item (45,142) (7,799) 284
Minority interest in income of majority owned entities 839 773 783
--------- --------- ---------
Loss from continuing operations (45,981) (8,572) (499)
Loss from operations of discontinued operations, net of
income tax expense (benefit) of $0, $1,580, and ($96) for the
year ended December 31, 1998, nine-month period ended
December 31, 1997 and the fiscal year ended March 31,
1997, respectively -- (13,563) (889)
Extraordinary loss from early extinguishment of debt, net
of income tax benefit of $231 -- -- (386)
--------- --------- ---------
Net loss $ (45,981) $ (22,135) $ (1,774)
========= ========= =========
Basic and diluted loss per common share:
Loss from continuing operations $ (2.90) $ (0.77) $ (.05)
Loss from discontinued operations -- (1.21) (.10)
Loss from extraordinary item -- -- (.04)
--------- --------- ---------
Net loss $ (2.90) $ (1.98) $ (.19)
========= ========= =========
Weighted average common shares outstanding 15,866 11,171 9,400
========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 40
ARV ASSISTED LIVING, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1998, THE NINE-MONTH PERIOD ENDED
DECEMBER 31, 1997 AND THE FISCAL YEAR ENDED MARCH 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK
--------------------------- ACCUMULATED
SHARES AMOUNT DEFICIT TOTAL
--------- --------- ------------ -----
<S> <C> <C> <C> <C>
Balance at March 31, 1996 8,309 $ 47,548 $ (7,601) $ 39,947
Issuance of common stock, net of issuance
costs of $1,572 1,346 13,201 -- 13,201
Net loss -- -- (1,774) (1,774)
--------- --------- --------- ---------
Balance at March 31, 1997 9,655 60,749 (9,375) 51,374
Issuance of common stock, net issuance cost
of $4,792 6,193 82,196 -- 82,196
Net loss -- -- (22,135) (22,135)
--------- --------- --------- ---------
Balance at December 31, 1997 15,848 142,945 (31,510) 111,435
Issuance of common stock 25 233 -- 233
Net loss -- -- (45,981) (45,981)
--------- --------- --------- ---------
Balance at December 31, 1998 15,873 $ 143,178 $ (77,491) $ 65,687
========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 41
ARV ASSISTED LIVING, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1998, THE NINE-MONTH PERIOD ENDED
DECEMBER 31, 1997 AND THE FISCAL YEAR ENDED MARCH 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE-MONTH FISCAL YEAR
YEAR ENDED PERIOD ENDED ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1998 1997 1997
-------- -------- --------
<S> <C> <C> <C>
Cash flows provided by (used in) operating activities:
Net loss $(45,981) $(22,135) $ (1,774)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Impairment losses 22,727 -- --
Loss from discontinued operations -- 13,563 889
Loss (gain) on sale of properties 674 (5,511) --
Extraordinary loss from early extinguishment of debt -- -- 386
Depreciation and amortization 9,561 4,896 4,366
Provision for doubtful accounts and discontinued project costs 644 597 163
Minority interest in income of majority owned entities 839 773 783
Other (35) (277) (90)
Changes in assets and liabilities, net of acquisitions:
(Increase) decrease in:
Fees receivable and other amounts due from affiliates (546) 300 (141)
Deferred tax asset -- 518 (290)
Prepaids and other assets (1,743) (63) (4,439)
Other non-current assets (1,382) -- --
Increase (decrease) in:
Accounts payable and accrued liabilities 4,734 4,329 2,438
Deferred revenue -- (166) (484)
Accrued interest payable 195 (459) 1,811
Lease concessions 781 565 --
Due to affiliates -- (40) (22)
-------- -------- --------
Net cash provided by (used in) operating activities of continuing
Operations (9,532) (3,110) 3,596
Net cash provided by (used in) operating activities of discontinued
Operations (3,429) (4,328) (2,681)
-------- -------- --------
Net cash provided by (used in) operating activities (12,961) (7,438) 915
-------- -------- --------
Cash flows provided by (used in) investing activities:
Acquisition of Hillsdale communities (71,709) -- --
Payments of deferred project costs (258) (128) 198
Increase in investments in real estate held for sale -- -- (3,769)
Additions to property, furniture and equipment (12,251) (18,619) (70,115)
(Increase) decrease in leased property security deposits (1,286) (282) 879
(Increase) decrease in restricted cash -- 1,706 3,003
Proceeds from sale and leaseback of communities -- 1,871 29,052
Purchase of limited partnership interests -- (524) (18,542)
Proceeds from sale of LLC interests -- 24,253 --
Proceeds from sale of communities to joint venture 7,249 -- --
Distributions received from limited partnership 660 3,570 --
Other (527) -- 41
-------- -------- --------
Net cash provided by (used in) investing activities (78,122) 11,847 (59,253)
-------- -------- --------
</TABLE>
F-5
<PAGE> 42
ARV ASSISTED LIVING, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998, THE NINE-MONTH PERIOD ENDED
DECEMBER 31, 1997 AND THE FISCAL YEAR ENDED MARCH 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE-MONTH FISCAL YEAR
YEAR ENDED PERIOD ENDED ENDED
DECEMBER 31, DECEMBER 31, MARCH 31,
1998 1997 1997
--------- --------- ---------
<S> <C> <C> <C>
Cash flows provided by financing activities:
Proceeds from issuance of common stock, net of issuance costs 233 24,806 739
Borrowings under notes payable 4,350 -- 31,081
Repayments of notes payable (704) (1,560) (18,633)
Proceeds from convertible subordinated notes, net of issuance costs -- 60,000 55,195
Distributions paid from majority owned entities (817) (688) --
Repurchase of convertible subordinated notes -- -- (1,689)
Payment of costs associated with the conversion of subordinated notes (2,610) -- --
Other (260) -- --
--------- --------- ---------
Net cash provided by financing activities 192 82,558 66,693
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents (90,891) 86,967 8,355
Cash and cash equivalents at beginning of period 102,776 15,809 7,454
--------- --------- ---------
Cash and cash equivalents at end of period $ 11,885 $ 102,776 $ 15,809
========= ========= =========
Supplemental schedule of cash flow information: Cash paid
during the year for:
Interest $ 9,097 $ 6,351 $ 4,481
========= ========= =========
Income taxes $ 54 $ 14 $ 671
========= ========= =========
Supplemental schedule of non-cash investing and financing
activities:
Assumption of debt in connection with the Hillsdale acquisition $ 15,250 $ -- $ --
Financing of leased property security deposits 2,625 -- --
Accrual of costs associated with the conversion of subordinated notes -- 2,610 --
Conversion of convertible subordinated notes to common stock -- 60,000 10,106
Minority interests in majority owned entities -- -- 7,141
Conversion of preferred stock to common stock -- -- 2,356
Acquisition of SynCare -- -- 485
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 43
ARV ASSISTED LIVING, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997 AND MARCH 31, 1997
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
ARV Assisted Living, Inc. and subsidiaries (the "Company") own, operate,
acquire and develop assisted living communities that provide housing to senior
citizens, some of whom require assistance with the activities of daily living
such as bathing, dressing and grooming.
At December 31, 1998, we operated 63 assisted living communities ("ALCs")
in 11 states including 16 which we own ("Owned ALCs"), 39 which we operate
pursuant to long-term operating leases ("Leased ALCs") and eight in which we
serves as the property manager ("Managed ALCs"). Forty of the ALCs are located
in California with other concentrations in Florida, Texas, the Midwest and the
Northeast. We also managed three senior apartment communities, and 17 affordable
senior and multifamily apartments (the "Apartment Group"), in 15 of which we
serve as the general partner. However, in December 1997, our Board of Directors
adopted a plan to the discontinue the operations of the Apartment Group.
Change in Fiscal Year
We changed our fiscal year end to December 31, from March 31, effective
with the period ending December 31, 1997.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. Subsidiaries, which include limited partnerships and
limited liability companies in which we have controlling interests, have been
consolidated into the financial statements. All significant intercompany
balances and transactions have been eliminated in consolidation.
Use of Estimates
In the preparation of our financial statements in conformity with generally
accepted accounting principles, we have made estimates and assumptions that
affect the following:
o reported amounts of assets and liabilities at the date of the
financial statements;
o disclosure of contingent assets and liabilities at the date of the
financial statements; and
o reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Stock-Based Compensation
During the fiscal year ended March 31, 1997, we adopted Statement of
Financial Accounting Standards 123 "Accounting for Stock-Based Compensation"
("SFAS 123"), which requires disclosure of the fair value and other
characteristics of stock options. We have chosen under the provisions of SFAS
123 to continue using the intrinsic-value method of accounting for employee
stock-based compensation in accordance with Accounting Principles Board Opinion
No. 25 "Accounting for Stock Issued to Employees" ("APB 25"). Consequently,
compensation related to stock options is measured as the difference between the
grant price and the fair market value of the underlying common shares at the
grant date. Generally, we issue options to employees with a grant price equal to
the market value of our common stock on the grant date. Accordingly, we have
recognized no compensation expense on our stock option plans for stock options
issued to employees.
Cash and Cash Equivalents
F-7
<PAGE> 44
For purposes of reporting cash flows, we consider all highly liquid
investments purchased with an original maturity of three months or less to be
cash equivalents.
Deferred Project Costs
Deferred project costs are payments incurred prior to the acquisition of
real property and are capitalized as incurred. These preacquisition costs
primarily include land acquisition, legal and architectural fees, feasibility
study costs and other direct costs associated with new ALC developments.
Deferred project costs are transferred to property, furniture and equipment upon
the successful acquisition of an assisted living community or site. If a project
is discontinued, any deferred project costs are expensed.
Property, Furniture and Equipment
Property, furniture and equipment are stated at cost less accumulated
depreciation which is charged to expense on a straight-line basis over the
estimated useful lives of the assets as follows:
<TABLE>
<S> <C>
Buildings and improvements 27.5 to 35 years
Furniture, fixtures and equipment 3 to 7 years
</TABLE>
Property, furniture and equipment consisted of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1998 1997
--------- ---------
<S> <C> <C>
Land $ 14,699 $ 14,712
Construction in progress 3,613 15,387
Buildings and improvements 84,094 82,180
Furniture, fixtures and equipment
14,612 13,746
--------- ---------
117,018 126,025
Accumulated depreciation (11,339) (8,468)
--------- ---------
$ 105,679 $ 117,557
========= =========
</TABLE>
Capitalized interest amounted to $1,004,000 for the year ended December 31,
1998, $1,065,000 for the nine-month period ended December 31, 1997 and $721,000
for the fiscal-year ended March 31, 1997.
Goodwill
Goodwill represents the excess of the purchase price of acquired assets
over the estimated fair value of the net tangible assets acquired. Goodwill is
amortized on a straight-line basis over 35 years.
Accounting for Long-Lived Assets
We review our long-lived assets for impairments when events or changes in
circumstances indicate that the carrying amount of the assets may not be
recoverable. In reviewing recoverability, we estimate the future cash flows
expected to result from using the assets and eventually disposing of them. If
the sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the asset, an impairment loss is
recognized based upon the asset's fair value.
In December 1998, our board of directors decided to sell five Owned ALCs
and five development land sites located outside of California, our primary
geographic focus. The fair value of the assets, based upon the offers we
received from potential buyers, is below the carrying amount of the assets. We
recorded an impairment loss of $19.0 million on these properties and classified
them as properties held for sale. Due to restrictions imposed by a landlord, we
are unable to convert the skilled nursing portion of an existing ALC to dementia
care. Because of this, the projected future cash flows from this ALC are less
than carrying value of the assets; therefore, we recorded a $2.9 million
impairment loss. Additionally, we recorded a $0.8 million impairment loss for
three Leased ALCs.
F-8
<PAGE> 45
Investments
We are the general partner in five limited partnerships, four of which are
consolidated, which operate ALCs and senior apartments (ownership interests
range from less than 1% to 89.5%). We are also a general partner in 15 tax
credit partnerships (ownership is generally less than 1%). We account for our
investment in one partnership where significant influence exists using the
equity method because we have less than a controlling interest. Other
investments in partnerships are accounted for using the cost method. Under the
terms of the partnership agreements, profits and losses are allocated to the
general and limited partners in specified ratios. We generally have unlimited
liability for obligations of certain partnerships in which we are the general
partner. Liabilities under these obligations have generally not been
significant. We have unlimited liability under separate guarantees and have
recorded significant provisions for these guarantees (see Note 3).
On January 31, 1997, we acquired a 12.8% limited partnership interest in
Senior Income Fund, L.P. ("Senior Income Fund") pursuant to a tender offer for
any and all outstanding limited partnership units in Senior Income Fund. The
partnership is a limited partnership that owned and operated four senior
residential properties. We account for our investment in Senior Income Fund
under the equity method. Effective October 1, 1997, we discontinued the
recognition of income related to this investment following Senior Income Fund's
announced plans to liquidate its assets and receipt of a substantial return of
capital.
In 1998, we pursued an additional development strategy by entering into our
first joint ventures ("LLCs") designed to help us finance development and
renovation projects and to mitigate the impact of start-up losses associated
with the opening of newly constructed ALCs. The joint ventures were formed to
finance and manage the substantial renovation of existing ALCs acquired in 1998
in the Hillsdale transaction and to construct four new communities on land sites
we own. Participants in the joint ventures with us are a third party investor
and a third party developer. The LLCs have contracted with the developer to
provide development services to perform the renovation and construction. We will
manage the properties operated by the joint venture for an amount equal to three
percent of gross revenues. We account for our investment in the joint ventures
on the equity method and losses incurred by the LLCs will be allocated
disproportionately to the joint venture partners based upon their assumption of
risk. We will have an option to purchase the joint venturer's interest in the
LLCs when the ALCs reach stabilization, at a purchase price that is the greater
of fair market value or an amount that generates a guaranteed internal rate of
return on the joint venturer's capital contribution.
Income Taxes
We account for income taxes the asset and liability method whereby deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. A valuation allowance is recorded to adjust net
deferred tax assets to the amount which management believes will more likely
than not be recoverable. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Revenue Recognition
We recognize rental and assisted living services revenue from owned and
leased communities on a monthly basis as earned. We receive fees for property
management and partnership administration services from managed communities.
Assisted Living Community Sale-Leaseback Transactions
Certain communities were sold subject to leaseback provisions. Leases were
structured to ensure they meet the provisions for operating lease treatment.
Gains were deferred and amortized into income over the lives of the leases.
Gain on Sale of LLC Interests
In December 1997, we sold our interest in two limited liability companies,
one of which owned a community in New York and the second of which owned a
parcel of land in New Jersey. As a result of this sale, we recognized a gain on
sale of approximately $5.5
F-9
<PAGE> 46
million during 1997.
Loss Per Share
In February 1997, the Financial Accounting Standards Board issued SFAS 128
"Earnings Per Share", which specifies the computation, presentation and
disclosure requirements for earnings per share ("EPS"). It replaces the
presentation of primary and fully diluted EPS with basic and diluted EPS. Basic
EPS excludes all dilution and is based upon the weighted average number of
common shares outstanding during the period. Diluted EPS reflects the potential
dilution that would occur if securities or other contracts to issue common stock
were exercised, or converted into common stock. The effect of potentially
dilutive securities was not included for any of the periods presented as the
effect was antidilutive. Potentially dilutive securities include convertible
notes and stock options which convert to 4,183,442, 4,250,546 and 1,085,002
shares of common stock for the year ended December 31, 1998, the nine month
period ended December 31, 1997 and the fiscal year ended March 31, 1997,
respectively. We adopted SFAS 128 during the final quarter of 1997.
The adoption of this statement did not have an impact on our financial
statements.
Recent Accounting Developments
In April 1998, the Accounting Standards Executive Committee issued
Statement of Position ("SOP") No. 98-5, "Reporting on the Costs of Start-up
Activities," which is effective for fiscal years beginning after December 15,
1998. The SOP provides guidance on the financial reporting of start-up
activities and organizational costs. It requires costs of start-up activities
and organizational costs to be expensed when incurred and, upon adoption, the
write-off as a cumulative effect of a change in accounting principle of any
previously capitalized start-up or organizational costs. We plan to adopt the
provisions of SOP 98-5 in the first quarter of 1999. The carrying amounts of
capitalized start-up costs are approximately $1.3 million as of December 31,
1998.
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and
Related Information ("SFAS 131"). This standard requires that a public business
enterprise report financial and descriptive information bout its reportable
operating segments. Operating segments are components of an enterprise about
which separate financial information is available that is regularly evaluated by
the chief operating decision maker in deciding how to allocate resources and in
assessing performance. We evaluate performance and make resource allocation
decisions on a community by community basis. Accordingly, each community is
considered an "operating segment" under SFAS 131. However, SFAS 131 did not have
an impact on the financial statements because the communities have similar
economic characteristics, as defined by SFAS 131, and meet the criteria for
aggregation into one "reportable segment".
Reclassifications
We have reclassified certain prior period amounts to conform to the
December 31, 1998 presentation.
(2) ACQUISITIONS
SynCare, Inc.
In August 1996, ARV Health Care, Inc. ("ARV Health Care"), our wholly owned
subsidiary, acquired all of the outstanding stock of SynCare, Inc., a California
corporation and its three wholly owned subsidiaries ("GeriCare"), in a stock for
stock merger valued at approximately $1.2 million. We recorded the acquisition
under the purchase method of accounting at the cost of approximately $1.2
million and recorded the assets and liabilities of the merged entity at their
estimated fair value. As part of the SynCare acquisition, we entered into a
Holdback Escrow Agreement (the "Agreement") with the former sole shareholders of
SynCare (the "Sellers"). Under the Agreement, one-half of the 85,146 shares
issued to Sellers as consideration for their stock in SynCare were delivered to
our General Counsel as escrowholder, defined as the "Buyer's Agent" in the
Agreement. Pursuant to the Agreement, Buyer's Agent retains possession of the
escrowed shares pending distribution of all or a portion of the shares to
Sellers on the first, second and third anniversaries of the closing date, as
determined by offsetting, as of each such anniversary, uncollected accounts
receivable listed on the closing balance sheet against the reserves established
on the closing balance sheet. It was a further condition to delivery of the
escrowed shares to Sellers that Sellers remain our full-time employees as of
each anniversary, without being terminated for cause prior to such anniversary
dates. Prior to the first anniversary of the closing date, both Sellers were
terminated for cause. Consequently, or accordingly, we have taken the position
that the undelivered shares are our property under the Agreement, and the matter
is in dispute between the parties. In December 1997, we concluded that the
operation of ARV Health Care was no longer part of our strategic plan or core
business and we discontinued the operations in March 1998 (see Note 3).
American Retirement Villas Properties II
In August 1996, we acquired a 51% controlling interest in American
Retirement Villas Properties II, a California limited partnership, which has
five Owned ALCs and five Leased ALCs totaling 941 units. The acquisition was
completed pursuant to a tender offer for limited partnership units not already
owned by the Company. We acquired additional limited partnership units that
increased our ownership to 52.3% at December 31, 1998.
F-10
<PAGE> 47
The following unaudited pro forma information presents a summary of the
consolidated results of operations as if the acquisition of American Retirement
Villas Properties II took place on April 1, 1996.
<TABLE>
<CAPTION>
(UNAUDITED)
FOR THE FISCAL YEAR ENDED
MARCH 31, 1997
-------------------------
(In thousands, except
per share amounts)
<S> <C>
Operating revenue $ 82,219
Operating expenses $ 78,482
Net loss $ (1,371)
Loss per common share $ (0.15)
</TABLE>
Villa Colima
In June 1996, we purchased an aggregate 18.6% limited partner interest for
$469,000 in San Gabriel Retirement Villa ("Villa Colima") for which we serve as
the general partner. Subsequently, we purchased an additional 19.0% for
$954,000. We acquired additional limited partnership units that increased our
ownership to 60.5% at December 31, 1998.
The following unaudited pro forma information presents a summary of
consolidated results of operations as if the acquisition of Villa Colima took
place on April 1, 1996.
<TABLE>
<CAPTION>
(UNAUDITED)
FOR THE FISCAL YEAR ENDED
MARCH 31, 1997
-------------------------
(In thousands, except
per share amounts)
<S> <C>
Operating revenue $ 75,299
Operating expenses $ 72,246
Net loss $ (1,749)
Loss per common share $ (0.19)
</TABLE>
Hillsdale Properties
In 1998 we purchased interests in 11 senior housing communities, including
a skilled nursing component in one community, all located in California, for
$83.5 million. The communities acquired are as follows:
<TABLE>
<CAPTION>
DATE
COMMUNITY LOCATION UNITS ACQUIRED
- --------- -------- ----- --------
<S> <C> <C> <C>
OWNED
Golden Creek Inn Irvine, CA 123 April 16, 1998
Hillcrest Inn Thousand Oaks, CA 137 April 16, 1998
Rossmore House Los Angeles, CA 157 May 4, 1998
The Berkshire Berkley, CA 81 May 12, 1998
Encino Hills Terrace Encino, CA 76 July 7, 1998
---
Total owned 574
---
LEASED
Willow Glen Villa San Jose, CA 188 May 18, 1998
Hillsdale Manor Retirement Center (a) San Mateo, CA 159 July 2, 1998
---
Total Owned 347
---
MANAGED
Sterling Court (b) San Mateo, CA 149 April 16, 1998
</TABLE>
F-11
<PAGE> 48
<TABLE>
<S> <C> <C> <C>
Palo Alto Commons Palo Alto, CA 143 April 16, 1998
San Carlos Retirement Center San Carlos, CA 85 April 16, 1998
The Altenheim Oakland, CA 138 April 16, 1998
---
Total Managed 515
---
Total 1,436
=====
</TABLE>
(a) Includes a skilled nursing center.
(b) In addition, we acquired a twenty percent (20%) general partnership
interest in WHW Associates, the fifty percent (50%) general partner of
Fifty Peninsula Partners, a California limited partnership, which owns
Sterling Court.
We accounted for the above transactions using the purchase method and paid
approximately $71.7 million of the purchase prices from cash on hand and assumed
$15.25 million of existing mortgage financing. The terms of the loans are as
follows:
o secured by Golden Creek Inn ($2.25 million) and Hillcrest Inn ($13.0
million);
o interest at LIBOR plus 2.50% (Golden Creek Inn) and LIBOR plus 2.25%
(Hillcrest Inn);
o monthly payments of interest only until August 1998 (Golden Creek Inn)
and October 1998 (Hillcrest Inn);
o thereafter, monthly payments of principal and interest based upon a
25-year amortization schedule; and
o outstanding balance of the loans plus all accrued and unpaid interest
is due and payable in 2002.
The purchase price paid in excess of the fair value of identifiable assets for
the owned, leased and managed communities acquired aggregated approximately
$23.6 million and is being amortized over the life of the related assets of 35
years.
The pro forma effect of the above acquisitions, assuming that the transactions
occurred on April 1, 1997, is as follows (dollars in thousands, except per share
amounts):
<TABLE>
<CAPTION>
(UNAUDITED)
FOR THE NINE-MONTH
FOR THE YEAR ENDED PERIOD ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- ------------------
(In thousands, except per share amounts)
<S> <C> <C>
Operating revenues $ 137,349 $ 93,992
Operating expenses $ 175,522 $ 102,960
Net loss $ (45,841) $ (21,636)
Loss per common share $ (2.89) $ (1.94)
</TABLE>
(3) DISCONTINUED OPERATIONS
In December 1997, our Board of Directors adopted a plan to discontinue the
operations of GeriCare, our therapy business, and the Apartment Group
(previously referred to as Tax Credit Properties). In March 1998, we reached an
agreement to form a strategic alliance with a national provider of physical
rehabilitation services. The alliance offers residents of ARV communities
rehabilitation and wellness care services and assists those residents to age in
place while us to exit the rehabilitation business. We are in negotiations with
lenders for certain of the Apartment Group's tax credit partnerships to resolve
outstanding issues which would increase the marketability of the partnerships
and are in discussions with several potential buyers of the Apartment Group's
assets. During 1998, we entered into purchase and sale agreements for the sale
of 11 apartment projects. As of March 31, 1999, we have closed on the sale of
three apartment projects, have 8 apartment projects under contract which we are
awaiting consent to sell from limited partners or lenders and 6 other apartment
projects that we plan to sell by December 31, 1999.
Accordingly, the results of these operations for the nine-month period
ended December 31, 1997, including provisions for impairments of the divisions
assets, future losses from operations, anticipated future operating deficit loan
funding and projected permanent loan financing deficits of $10.6 million, have
been segregated from continuing operations and reported separately in the
statement of operations. During the fiscal year ended March 31, 1997, we took a
$2.0 million charge related to our Apartment Group. Provisions for operating
deficit loan funding and permanent loan financing deficits are based on
management's estimates and include assumptions for occupancy, projected revenues
and expenses and timing until lease-up. Such estimates are revised as additional
information and operating history is available.
F-12
<PAGE> 49
The assets and liabilities of these operations have been reflected in the
balance sheet on a net basis, based substantially on the original current or
long-term classification of such assets and liabilities. We allocate interest to
discontinued operations based on average advances outstanding at our incremental
borrowing rate of 6.75%, 6.75% and 10% for the year ended December 31, 1998, the
nine months ended December 31, 1997 and the fiscal year ended March 31, 1997.
Operating results from discontinued operations are as follows (in
thousands):
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE NINE-MONTH PERIOD FOR THE FISCAL YEAR
DECEMBER 31, 1998 ENDED DECEMBER 31, 1997 ENDED MARCH 31, 1997
----------------- ----------------------- --------------------
<S> <C> <C> <C>
Revenue $ -- $ 7,129 $ 5,507
Costs and expenses -- 19,112 6,492
-------- --------
Loss before income taxes -- (11,983) (985)
Income tax provision (benefit) -- 1,580 (96)
---- -------- --------
Net loss $ -- $(13,563) $ (889)
==== ======== ========
</TABLE>
The components of net assets (liabilities) of discontinued operations
included in our consolidated balance sheets at December 31, 1998 and 1997 are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1997
------- -------
<S> <C> <C>
Current:
Cash $ 405 $ 132
Accounts receivable and other 4,378 3,171
Accounts payable and other (524) (1,460)
Accrued liabilities (6,154) (8,401)
------- -------
Net current liabilities from
discontinued operations (1,895) (6,558)
------- -------
Non-current assets -- 1,234
------- -------
Net liabilities from discontinued
operations $(1,895) $(5,324)
======= =======
</TABLE>
(4) NOTES PAYABLE
Notes payable consist of the following at December 31 (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Convertible subordinated notes due April 1, 2006 with interest at 6.75%
The notes require monthly semi-annual payments of interest and are
convertible to common stock at $18.57 per share. The notes, offered
in a maximum amount of $57,500, may be called by us beginning in
April 1999 at declining premiums starting at 110% of the principal
amount $ 57,500 $ 57,500
Notes payable, including notes payable to banks of
$6,140 and $6,305 at December 31, 1998, and 1997,
respectively, bearing interest at fixed rates
between 7.5% and 10.5%, payable in monthly
installments of principal and interest totaling
$155, collateralized by property, maturities
ranging from February 1999 through July
2035 18,217 18,456
</TABLE>
F-13
<PAGE> 50
<TABLE>
<S> <C> <C>
Notes payable to banks bearing interest at floating
rates of LIBOR (5.55% at December 31, 1998) plus
rates between 2.25% and 2.75% payable in monthly
installments of interest only collateralized by
Owned ALCs, maturities ranging from September 1999
through October 2002 28,289 8,750
Notes payable to banks, bearing interest at floating
rates between prime (7.75% at December 31, 1998)
plus rates between 1.0% through 2.0%, payable in
monthly installments of principal and interest
totaling $25 due March 2004, collateralized by an
ALC and our corporate headquarters 5,673 5,969
Other-- primarily capitalized equipment leases 165 273
-------- --------
109,844 90,948
Less amounts currently payable 21,669 9,388
-------- --------
$ 88,175 $ 81,560
======== ========
</TABLE>
The future annual principal payments of the notes payable at December 31,
1998 are as follows (in thousands):
<TABLE>
<S> <C>
1999 $ 21,669
2000 1,037
2001 768
2002 19,169
2003 427
Thereafter 66,774
--------
$109,844
========
</TABLE>
We called the previously issued convertible subordinated notes due in 1999
in the fiscal year ended March 31, 1997. Note holders who chose to redeem their
notes were paid a premium of 6.7% upon redemption, totaling $261,000.
Unamortized note issuance costs of $335,000 were expensed, resulting in the
extraordinary loss of $386,000, net of income tax benefit. Holders of
approximately $11.0 million of the notes converted the notes into 900,662 shares
of common stock.
On June 24, 1996, we obtained a $35 million commitment from Bank United for
the construction or acquisition of ALCs. The terms of the commitment provide for
interest at 2.75% over the thirty day LIBOR rate (5.55% at December 31, 1998).
Of the commitment, a $20 million sub-limit has been established for the
construction of ALCs. As of December 31, 1998 and 1997, we had outstanding
indebtedness of $8.8 million used as mortgage financing of existing ALCs.
Additionally, we had guaranteed a $7.7 million loan borrowed by an Affiliated
Partnership for the construction of a new ALC.
On September 10, 1996, we obtained a $10 million revolving line of credit
with Imperial Bank to be used for acquisition, development, the provision of
letters of credit and general corporate purposes. Advances under this line of
credit are priced at the Imperial Bank prime rate plus 0% to .5% or LIBOR plus
2.0% to 2.5% based upon our achievement of financial ratios. On November 10,
1998, Imperial amended the line of credit agreement to require that we provide
collateral for outstanding standby letter of credit obligations. In return for
this modification, Imperial removed all debt service covenants and reduced the
required minimum net worth and minimum current ratio requirements through June
30, 1999, the last quarterly measurement date under the existing line of credit
agreement. While there can be no assurances that we will be able to comply with
these reduced financial covenant requirements, we believe that we will be able
to comply with the modified covenants through maturity of the agreement. As of
December 31, 1998, we had used $4.4 million of this line of credit for the
provision of letters of credit used as Leased ALC security deposits. The line of
credit is collateralized by an owned ALC.
Our Board of Directors approved the refinancing of 11 communities that are
held by majority owned partnerships to:
o take advantage of lower fixed interest rates available at the time
through the commercial mortgage backed security market;
o provide a return of equity to the limited partners;
o borrow against the increased value of these properties; and
F-14
<PAGE> 51
o finance the purchase of four ALCs that were previously operated under
long term operating leases.
In conjunction with this financing, we paid the lender approximately $1.7
million of fees for an interest rate lock and $0.2 for loan commitment and other
fees. The lender terminated the loan commitment and underlying interest rate
lock in October 1998 due to adverse market conditions. The lender returned $0.4
million of the interest rate lock fees in January 1999. We have included the
remaining $1.5 million of fees in interest expense in the accompanying
statements of income. We believe that we are entitled to a full and complete
return of the rate lock fees paid. We intend to pursue a return of all fees and
are investigating our legal alternatives to that end; however, there can be no
assurances that additional interest rate lock fees will be recovered.
The various debt agreements contain restrictive covenants requiring us to
maintain certain financial ratios, including current ratio, working capital,
minimum net worth, debt-to-equity and debt service coverage, among others. At
December 31, 1998, we were not in compliance with minimum net worth, debt
service coverage ratios and cross default covenants. We have obtained waivers
for those debt covenants with which we were not in compliance. We believe that
several alternatives are available to remedy the default before the next
measurement date of June 30, 1999. Had we not obtained waivers, we would have
been in default on $8.8 million of mortgage debt and $7.7 million of
guaranteed debt.
(5) EMPLOYEE BENEFIT PLANS
ESOP
We have an Employee Stock Ownership Plan ("ESOP") which covers all of our
employees. Contributions to the ESOP are made at the discretion of our Board of
Directors. For the year ended December 31, 1998, the nine-month period ended
December 31, 1997 and the fiscal year ended March 31, 1997, we made no
contributions to the ESOP.
Savings Plan
Effective January 1, 1997, we established a savings plan (the "Savings
Plan") that qualifies as a deferred salary arrangement under Section 401(k) of
the Internal Revenue Code. Under the Savings Plan, participating employees who
are at least 21 years of age may defer a portion of their pretax earnings, up to
the Internal Revenue Service annual contribution limit. We match 25% of each
employee's contributions up to a maximum of 6% of the employee's earnings.
Employees are eligible to enroll at the first enrollment date following the
start of their employment (July 1 or January 1). We match employees'
contributions beginning on the first enrollment date following one year of
service or 1,000 hours of service. Our expense related to the Savings Plan was
approximately $195,000 and $129,000 for the year ended December 31, 1998 and the
nine-month period ended December 31, 1997, respectively.
(6) STOCK OPTIONS
We have elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees' ("APB 25") and related
interpretations in accounting for employee stock options. Under APB 25, because
the exercise price of our employee stock options usually equals the market price
of the underlying stock on the date of grant, no compensation expense is
recorded.
Effective October 1, 1995, we adopted the 1995 Stock Option and Incentive
Plan of ARV Assisted Living, Inc. (the Plan) for the benefit of our eligible
employees, consultants and directors. The Plan is two-tiered, one for the
benefit of key employees and consultants and one for the benefit of non-employee
directors. The maximum number of shares which may be issued under the Plan is
15% of the total outstanding shares at the end of the fiscal year. The number of
shares which may be issued for Incentive Stock Options is limited to 1,155,666
shares. As of December 31, 1998, there are 519,190 Incentive Stock Options
available for issuance. Options granted under the Plan vest over periods ranging
from one and one-half to five years from the date of the grant. At December 31,
1998, 141,350 of the options were eligible for exercise.
A summary of stock options at December 31, 1998 is as follows:
<TABLE>
<CAPTION>
SHARES SHARES UNDER
AVAILABLE OUTSTANDING PRICE PER
FOR GRANT OPTIONS SHARE
----------- ------------ --------------
<S> <C> <C> <C>
Authorization of shares 2,381,025 -- N/A
Options granted (2,350,400) 2,350,400 $4.75 - $16.25
</TABLE>
F-15
<PAGE> 52
<TABLE>
<S> <C> <C> <C>
Options exercised -- (25,000) $9.00 - $10.25
Options canceled 1,238,350 (1,238,350) $4.75 - $15.40
---------- ---------- --------------
Balance at December 31, 1998 1,268,975 1,087,050 $4.75 - $16.25
========== ========== ==============
</TABLE>
Pro forma information regarding net loss and net loss per share is required
by SFAS 123, which also requires that the information be determined as if we
have accounted for our employee stock options granted subsequent to December 31,
1994 under the fair value method of SFAS 123. The fair value for these options
was estimated at the date of grant using a Black-Scholes option pricing model
with a weighted-average expected life of the option of 7 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. Option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
our employee stock options have characteristics significantly different from
those of trade options, and because changes in subjective input assumptions can
materially affect the fair value estimate, actual fair values may differ from
those estimates.
The following represents the estimated fair value of options granted and
the assumptions used for calculation:
<TABLE>
<CAPTION>
NINE-MONTH
YEAR ENDED PERIOD ENDED FISCAL YEAR
DECEMBER 31, 1998 DECEMBER 31, 1997 ENDED MARCH 31, 1997
----------------- ----------------- --------------------
<S> <C> <C> <C>
Average estimated fair value per option at
grant date $ 11.81 $ 14.00 $ 11.21
Average exercise price per option granted $ 11.81 $ 14.07 $ 11.21
Expected Stock volatility 60% 53% 57%
Risk -- free interest rate 4.7% 5.7% 6.5%
Option term -- years 10 10 10
Stock dividend yield -- -- --
</TABLE>
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Our pro forma
information is as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
NINE-MONTH
YEAR ENDED PERIOD ENDED FISCAL YEAR
DECEMBER 31, 1998 DECEMBER 31, 1997 ENDED MARCH 31, 1997
----------------- ----------------- --------------------
<S> <C> <C> <C>
Pro forma net loss $(47,362) $ (23,865) $ (2,122)
Pro forma loss per share $ (2.99) $ (2.14) $ (.23)
</TABLE>
A summary of our stock option activity and related information for the year
ended December 31, 1998, the nine-month period ended December 31, 1997 and the
fiscal year ended March 31, 1997 is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
------------------------------------------------------------------ ----------------------------
1998 1997 1997
------------------------------ --------------------------------- ----------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
--------- ---------------- ---------- ---------------- -------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding-- beginning
of the year 1,038,002 $13.12 952,892 $12.82 775,782 $13.90
Granted 847,500 $11.81 259,500 $14.07 389,000 $11.21
Exercised (25,000) $9.33 -- -- -- --
Forfeited (773,452) $11.52 (174,390) $12.89 (211,390) $13.81
--------- -------- --------
Outstanding -- end
of year 1,087,050 $13.33 1,038,002 $13.12 952,892 $12.82
========= ========= =======
Exercisable at end of
year 141,350 $12.62 243,185 $13.69 132,393 $13.72
Weighted average fair
value of options
granted during the
year $11.81 $14.07 $11.21
====== ====== ======
</TABLE>
At December 31, 1998, options outstanding had a weighted average life of
8.69 years.
Subsequent to year-end, we granted approximately 75,000 additional options.
F-16
<PAGE> 53
(7) INCOME TAXES
The provision for income tax expense from continuing operations consists of
the following for the year ended December 31, 1998, the nine-month period ended
December 31, 1997 and the fiscal year ended March 31, 1997 (in thousands):
<TABLE>
<CAPTION>
For the Year Nine-month Fiscal year
Ended Period Ended Ended
December 31, December 31, March 31,
1998 1997 1997
------------ ------------ -------------
<S> <C> <C> <C>
Current:
Federal $-- $ (29) $ 364
State 54 (5) 64
----- ----- -----
Total current 54 (34) 428
----- ----- -----
Deferred:
Federal -- 440 (111)
State -- 78 (20)
----- ----- -----
Total deferred -- 518 (131)
----- ----- -----
$ 54 $ 484 $ 297
===== ===== =====
</TABLE>
We have Federal net operating loss carryovers of $36,417,000, which expire
in 2011 to 2018.
A reconciliation of income tax expense (benefit) related to income from
continuing operations at the Federal statutory rate of 34% our provision for
income taxes is as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
------------------------------ --------------
For the Year Nine-month Fiscal year
Ended Period Ended Ended
December 31, December 31, March 31,
1998 1997 1997
------------ ------------ -------------
<S> <C> <C> <C>
Income tax expense (benefit) at statutory
Rate $(15,330) $ (2,487) $ 198
State income tax expense, net of Federal
income taxes 36 48 29
Change in valuation allowance due to
change in assumptions at beginning of the
year -- 440 (219)
Change in valuation allowance due to
current year losses 15,000 3,878 709
Fully reserved tax benefits generated by
discontinued operations that will
benefit continuing operations in the future -- (1,133) --
Other 348 (262) (420)
-------- -------- --------
Total income tax expense $ 54 $ 484 $ 297
======== ======== ========
</TABLE>
Temporary differences giving rise to a significant amount of deferred tax
assets and liabilities from continuing operations at December 31, 1998 and 1997
are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
-------- --------
<S> <C> <C>
Deferred tax assets:
Deferred gain on sale $ 120 $ 140
Other partnership income 799 586
Net operating loss carryforwards 12,381 4,427
Write down of properties 9,044 --
Other 1,860 1,049
-------- --------
Gross deferred tax asset 24,204 6,202
Less valuation allowance (23,534) (5,844)
Deferred tax liabilities-- other (670) (358)
-------- --------
Net long-term deferred tax asset $ -- $ --
======== ========
</TABLE>
A valuation allowance is provided against net deferred tax assets when it
is more likely than not that some portion of the deferred tax asset will not be
realized. We have established a valuation allowance for the deferred tax asset
as, in our best estimate, it is not likely to be realized in the near term.
F-17
<PAGE> 54
(8) RELATED PARTY TRANSACTIONS
Fees and other amounts receivable from affiliates of $757,000 and $211,000
at December 31, 1998 and 1997, respectively, consist of receivables related to
management services we rendered and non-interest bearing expense advances to
various partnerships. Amounts due from affiliates are generally expected to be
repaid in subsequent years with cash from operations or from bank financing
obtained by the affiliates. Related management fee revenue from affiliates
totals $742,000, $388,000, and $1,141,000 during the year ended December 31,
1998, the nine-month period ended December 31, 1997 and the fiscal year ended
March 31, 1997, respectively.
We are reimbursed for certain expenses such as repair and maintenance,
supplies, payroll and retirement benefit expenses paid on behalf of Affiliated
Partnerships. During the year ended December 31, 1998, the nine-month period
ended December 31, 1997 and the fiscal year ended March 31, 1997, respectively,
the expenses incurred on behalf of affiliates and the related reimbursements
from these affiliates amounted to approximately $12.8 million, $8.6 million and
$7.1 million, respectively. We account for these reimbursements as a reduction
of the related expenses.
We lease office space under operating leases from affiliated entities which
expire between 2001 and 2003. Total rental expense related to these leases for
the year ended December 31, 1998, the nine-month period ended December 31, 1997
and the fiscal year ended March 31, 1997 was $163,000, $112,000 and $141,000,
respectively.
To address certain structural issues in connection with tax credit
partnerships, Pacific Demographics Corporation ("Pacific Demographics")
(formerly ARVTC, Inc.), was formed in August 1994 by Messrs. Booty, Collins and
Espley-Jones, as well as three other former officers, to provide certain
development services for these partnerships in exchange for cash and deferred
development fees generated by the tax credit partnerships. In order to lessen
potential conflicts of interest, in July 1995, our then principal shareholders,
who included but were not limited to Messrs. Booty, Collins and Espley-Jones
sold Pacific Demographics, Inc. to us for $100,000 in cash. In addition, they
formed a general partnership, Hunter Development ("Hunter"), and became
co-developers with Pacific Demographics and retained the right to receive 20% of
all developer fees up to a maximum of $850,000. Subsequently each of the general
partners of Hunter assigned his interest in Hunter to Redhill Development, LLC.
Of the maximum amount of $850,000 which could be distributed, $300,428 has been
distributed to date of which Messrs. Booty, Collins and Espley-Jones have
received $111,627, $65,714 and $37,153, respectively.
John A. Booty, our former President and current member of the Board of
Directors, provided us consulting services, between October 1996 and September
1997, for which we paid a varying sum not to exceed $30,000 per month for
development and acquisition consulting services. During the nine-month period
ended December 31, 1997 and the fiscal year ended March 31, 1997, Mr. Booty was
paid $175,000 and $180,000 for consulting services, respectively. No consulting
fees were paid to Mr. Booty during the year ended December 31, 1998.
We use the services of J&D Design, as well as others, for interior design
work at our communities. The principal of J&D Design is Joan Davidson, wife of
former Senior Vice President Eric Davidson and daughter-in-law of the former
Chairman, President and Chief Executive Officer, Gary Davidson. Services
provided by J&D Design include design work and the purchase of furniture,
fixtures and equipment ("FF&E") for developed ALCs and rehabilitation of
existing or newly acquired ALCs. We paid J&D Design approximately $560,000,
$755,000 and $431,000 for the year ended December 31, 1998, the nine-month
period ended December 31, 1997 and the fiscal year ended March 31, 1997,
respectively, a portion of which was for design services and a portion of which
was for reimbursement of costs for FF&E.
Mr. R. Bruce Andrews, a former member of our Board of Directors, is
President of Nationwide Health Properties, Inc. ("NHP"), a health care REIT. NHP
is the owner of 16 ALCs we lease. Of that number, leases for 13 ALCs were
entered into prior to November 29, 1995, the date Mr. Andrews became a Board
member, and leases for three ALCs were entered into during Mr. Andrews' tenure
as a board member. Aggregate lease payments under these leases were
approximately $11.3 million, $8.2 million and $10.3 million for the year ended
December 31, 1998, the nine-month period ended December 31, 1997 and the fiscal
year ended March 31, 1997, respectively.
John J. Rydzewski, a former member of our Board of Directors and
Compensation Committee, is a principal in the investment banking firm of
Benedetto, Gartland and Company, Inc. ("BG&C"). We retained BG&C to provide
advice concerning our investment in Senior Income Fund L.P., a Delaware limited
partnership owning four congregate care facilities in Southern California. We
paid
F-18
<PAGE> 55
BG&C approximately $206,000 during the fiscal year ended March 31, 1997. No
amounts were paid to BG&C during the year ended December 31, 1998 and the nine
month period ended December 31, 1997.
(9) SHAREHOLDERS' EQUITY
Sale of Shares to Prometheus
In July 1997, we sold approximately 1.9 million shares of our common stock
to Prometheus Assisted Living LLC ("Prometheus"), an affiliate of Lazard Freres
Real Estate Investors, LLC ("Lazard" or "LFREI") for $26.9 million. In October
1997, we issued $60 million of Convertible Subordinated Notes (the "Notes") to
Prometheus. The Notes were convertible into approximately 3.5 million shares of
our common stock at $17.25 per share. We had the option to call the Notes at any
time, and on December 5, 1997, the Board approved the redemption of the Notes.
Per the terms of the Notes, the redemption was made through issuance of our
common stock. Including a 23.214% optional redemption premium and accrued
interest to date, the issuance amounted to approximately 4.3 million shares. As
a result of these two transactions, we raised additional capital, net of costs,
of $82.2 million.
Warrants
At December 31, 1997, we had outstanding warrants issued to selling
brokerage firms in connection with our convertible subordinated notes which give
the holders the option to purchase an aggregate maximum of 116,152 shares of
common stock at $12.16 per share. These warrants were exercisable at any time at
the option of the holder within three years of the date of issuance, the latest
of which was July 31, 1995. As of December 31, 1998, warrants to purchase 28,415
shares of Common Stock were exercised and all other warrants are expired.
Shareholders Rights Plan
In May 1998, we adopted a shareholders rights plan under which we have
declared a dividend distribution of one Preferred Share Purchase Right on each
outstanding share of our common stock. Subject to limited exceptions, the Rights
will be exercisable if a person or group acquires 10% or more of our stock or
announces a tender offer for 10% of the common stock. When exercisable, each
Right (except the Rights held by the acquiring person) will entitle its holder
to purchase, at the Right's then-current exercise price, a number of our common
shares having a market value at the time of twice the Right's exercisable price.
If we are acquired in a merger or other business combination transaction which
has not been approved by our Board of Directors, each Right will entitle its
holder to purchase, at the Right's then-current exercise price, a number of the
acquiring company's common shares having a market value at that time of twice
the Right's exercise price. On October 21, 1998, we adopted an amendment to our
shareholders rights plan, whereby if LFREI or its affiliates becomes the owner
of 50 percent or more of our commons stock, the rights of our shareholders under
the rights plan become exercisable.
(10) REDEEMABLE PREFERRED STOCK
As of February 7, 1996, we exercised our right to redeem all outstanding
shares of the Series A 8% cumulative convertible redeemable preferred stock on
May 9, 1996. Preferred shareholders had the option of converting their shares
into Common Stock at any time prior to April 29, 1996. As of March 31, 1996,
48.6% of the shareholders had converted their Preferred Stock into 319,664
shares of Common Stock. During the fiscal year ended March 31, 1997, the balance
of the shareholders converted their preferred stock into 338,141 shares of
common stock.
(11) ASSISTED LIVING COMMUNITY LEASES
At December 31, 1998, we leased 39 ALCs. The ALC leases expire from 2006 to
2017, and contain two to three renewal options ranging from five to ten years.
During the fiscal year ended March 31, 1997, we sold four owned ALCs to a
subsidiary of Meditrust for proceeds of $29.1 million and simultaneously entered
into long-term operating leases. The minimum annual payments for these leases
are $2.9 million, subject to future increase as described below. The leases are
for terms of 15 years, with renewal options to extend under similar terms for
five years each. No gain was recognized on the transaction.
F-19
<PAGE> 56
Generally, leases for Leased ALCs owned by a common landlord contain cross
default provisions permitting the lessor to declare a default under all leases
in the event of default on one lease. The lease agreements with each landlord
are interconnected in that we will not be entitled to exercise our right to
renew one lease with a particular landlord without exercising our right to renew
all other leases with that landlord. Also, leases with each landlord contain
certain cross default provisions. Therefore, in order to exercise all lease
renewal terms, we will be required to maintain and rehabilitate the Leased ALCs
on a long-term basis. We anticipate that similar renewal and cross-default
provisions will be included in leases with other landlord.
Minimum lease payments required under assisted living community operating
leases in effect at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31: (IN THOUSANDS)
----------------------- -------------
<S> <C>
1999 $29,416
2000 29,434
2001 29,510
2002 29,695
2003 29,770
Thereafter 216,860
--------
$364,685
========
</TABLE>
Certain of the leases require the payment of additional rent based on a
percentage increase of gross revenues. Such amounts were not material. Leases
are subject to increase based upon changes in the consumer price index or gross
revenues, subject to certain limits, as defined in the individual lease
agreements.
(12) LIQUIDITY
We believe that our existing liquidity, ability to sell assisted living
communities and land sites which do not meet our financial objectives or
geographic clustering strategy, and ability to refinance certain assisted living
communities will provide adequate resources to meet our current operating and
investing needs and support our current growth plans for the next 12 months. We
do not currently generate sufficient cash from operations to fund recurring
working capital requirements. We will be required from time to time to incur
additional indebtedness or issue additional debt or equity securities to finance
our growth strategy, including the acquisition and development of assisted
living communities as well as other capital expenditures and to provide
additional funds to meet increased working capital requirements.
(13) COMMITMENTS AND CONTINGENT LIABILITIES
COMMITMENTS
We have guaranteed the indebtedness at December 31, 1998, of certain
affiliated partnerships as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Notes secured by real estate $29,749
Land and construction loans associated with the
development and construction of affordable housing
apartments $23,765
</TABLE>
The maximum aggregate amount of guaranteed indebtedness is $55.7 million at
December 31, 1998. We have guaranteed tax credits for certain partnerships in
the aggregate amount of $78.4 million, excluding interest, penalties or other
charges which might be assessed against the partners. We have provided
development and operating deficit guarantees for certain Affiliated
Partnerships. In December 1997, our Board of Directors adopted a plan to
discontinue operations of the Apartment Group. As of December 31, 1997, we
recorded an $8.6 million charge for development and operating deficit guarantees
and permanent loan shortfalls.
In our opinion, no claims may be currently asserted under any of the
aforementioned guarantees based on the terms of the respective agreements other
than those accrued.
In the past we provided standby letters of credit as security deposits with
most of our landlords. In December 1998, we provided cash in exchange for the
release of the standby letters of credit to our largest landlord, Nationwide
Health Properties, Inc. ("NHP"). For a period of time that is extended on a
month to month basis, NHP has granted a temporary reduction in some of the
security deposits totaling approximately $1.8 million. We anticipate funding the
temporary reduction during 1999.
At December 31, 1998, we have used $4.4 million of our line of credit with
Imperial Bank in the form of non-cash advances to provide letters of credit used
as security deposits for leased ALCs. This line of credit is collateralized by
an owned ALC.
At December 31, 1998, we leased office space under various operating leases
expiring from 2001 to 2003, some of which are from
F-20
<PAGE> 57
affiliated entities (see Note 8). Non-cancelable operating lease commitments for
office space at December 31, 1998 are:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31: (IN THOUSANDS)
- ----------------------- ---------------
<S> <C>
1999 $273
2000 283
2001 294
2002 305
2003 238
---
Total $1,393
======
</TABLE>
Rent expense for all leased office space amounted to $474,000, $257,000 and
$333,000 for the year ended December 31, 1998, the nine-month period ended
December 31, 1997 and the fiscal year ended March 31, 1997, respectively.
CONTINGENCIES
On September 27, 1996, American Retirement Villas Partners II, a California
limited partnership ("ARVP II") of which we are the managing general partner and
a majority limited partner, filed lawsuits in the Superior Court for the State
of California, County of Santa Clara, seeking declaratory judgment against the
landlords of the Retirement Inn of Campbell ("Campbell") and the Retirement Inn
of Sunnyvale ("Sunnyvale"). ARVP II leased the Campbell and Sunnyvale assisted
living communities under long-term leases. A dispute arose as to the amount of
rent due during the 10-year lease renewal periods, which commenced in August
1995 for Campbell and March 1996 for Sunnyvale. Two other communities leased by
ARVP II, the Retirement Inn of Fremont and the Retirement Inn at Burlingame are
owned by entities, which are related to the entities that own the Campbell and
Sunnyvale communities. The parties have mutually negotiated the terms of a
purchase agreement involving the sale of the landlord's fee interest in the four
communities to ARVP II and settlement of all claims. On March 2, 1999, through a
wholly owned subsidiary, ARVP II obtained financing and purchased, through its
wholly owned subsidiary, ARVP II, LLC, the landlords' interests in four
communities for approximately $14.3 million, and the litigation has been
dismissed.
On April 24, 1998, we were served with a lawsuit by Emeritus Corporation
("Emeritus'), which was filed in the Superior Court of California, County of
Orange, alleging that share purchases on January 16, 1998 by Prometheus Assisted
Living LLC triggered our Shareholder Rights Agreement. Emeritus contends that
due to the alleged triggering event we are required to distribute one right per
share of outstanding Company stock and that each right is exercisable for
approximately 9.56 shares at a total purchase price of $70 (or approximately
$7.32 per share). We believe that Emeritus' claims are meritless and we are
contesting them vigorously.
On May 12, 1998, we filed a lawsuit in the Superior Court for the State of
California, County of Orange, seeking to enjoin Kapson Senior Quarters Corp.
("Kapson"), a controlled affiliate of Lazard Freres Real Estate Investors LLC
("LFREI") from acquiring Atria Communities ("Atria"), a then unaffiliated
competitor. Atria was also named as a defendant in the suit, as were three LFREI
representatives on our Board of Directors, Messrs. Kenneth M. Jacobs, Robert P.
Freeman and Murry N. Gunty. We alleged that LFREI was violating both its
contractual and fiduciary duties to us if it allowed Kapson to proceed with the
acquisition without first offering us the right to be the acquiring party and
then, if we declined, obtaining our permission to consummate this acquisition.
The lawsuit also sought to enforce rights we believed we obtained as part
of a strategic alliance with LFREI with respect to existing Kapson facilities.
When we previously consented to LFREI's acquisition of Kapson, the two companies
signed a letter agreement that was designed to make available to our
shareholders some of the potential benefits of the Kapson acquisition. Thus,
under its agreement, LFREI was obligated to negotiate in good faith with us to
identify commercially reasonable terms on which we would lease or manage the
existing Kapson facilities. However, since LFREI's acquisition of Kapson, we
alleged, LFREI had failed to negotiate in good faith. On July 30, 1998, our
compliant was amended to add Lazard Freres as a party to include allegations of
fraud against Lazard, LFREI and Messrs. Kenneth M. Jacobs, Robert P. Freeman and
Murry N. Gunty.
On June 9, 1998, LFREI filed a cross-complaint against us, alleging that
our preliminary communications with several potential sources of capital to
assist us in financing the acquisition of Atria in the event that LFREI honored
our right of first offer or was ordered to do so by the court constituted an
early termination event under the Amended and Restated Stockholders Agreement
dated as of October 29, 1997, by and among LFREI, Prometheus and us (the
"Amended Stockholders Agreement"). LFREI also contended that certain standstill
provisions under the Amended Stockholders Agreement had terminated.
On August 14, 1998, the Judge in the trial ruled from the bench against us
and in favor of all defendants on LFREI's motion for
F-21
<PAGE> 58
judgment on all of our causes of action.
On October 21, 1998, we announced that a "Termination Event", as defined in
the Amended Stockholders Agreement, occurred on October 12, 1998, when
Prometheus no longer beneficially owned our common stock having a market value
of at least $25 million. As a result of the Termination Event, Prometheus' and
LFREI's standstill obligations would have terminated on January 11, 1999.
However, on December 7, 1998, the Superior Court of the State of California,
County of Orange issued an order in favor of LFREI concluding that their
standstill obligations terminated as of April 1998.
On December 18, 1998, Prometheus filed a lawsuit in the Delaware Chancery
Court against the Company and two of our directors, Howard G. Phanstiel and John
A. Booty. The lawsuit seeks a determination that our annual meeting of
stockholders held in June 1998 was invalid because we failed to reach a quorum
and that, accordingly, the election of the named individual directors was
invalid.
Since the nature of litigation is that results cannot be predicted with
certainty, there can be no assurance we will prevail in any of the foregoing
litigation actions.
We are from time to time subject to lawsuits and other matters in the
normal course of business. While we cannot predict the results with certainty,
we do not believe that any liability from any such lawsuits or other matters
will have a material effect on our financial position, results of operations, or
liquidity.
(14) DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of our financial instruments have been determined
using available market information and appropriate valuation methodologies.
However, considerable judgment is necessarily required to interpret market data
to develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts that could be realized in a
current market exchange. The use of different market assumptions or estimation
methodologies may have a material impact on the estimated fair value amounts.
The carrying amounts reported in the consolidated balance sheets for cash
and cash equivalents, fees receivable and other amounts due from affiliates and,
accounts payable, accrued liabilities and accrued interest payable, approximate
fair value due to the short-term nature of these instruments. The notes payable
bear interest at rates that approximate current market rates. Therefore, we
believe that the carrying value approximates fair value.
(15) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
-------------------------------------------------------------
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------- ------------ ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1998
<S> <C> <C> <C> <C>
Total revenue $ 35,249 $ 34,887 $ 31,104 $ 27,327
Loss from operations (29,046) (3,998) (2,951) (2,668)
Net loss (32,913) (5,608) (4,445) (3,015)
Basic and diluted loss per share (2.08) (0.35) (0.28) (0.19)
1997
Total revenue $ 26,730 $ 23,735 $ 24,810 $ 23,082
Income (loss) from operations (7,927) (2,769) 296 175
Net loss (17,250) (4,083) (802) (2,642)
Basic and diluted loss per share (1.35) (0.37) (0.08) (0.27)
</TABLE>
FINAL QUARTER TRANSACTIONS AND ADJUSTMENTS
In December 1998, our board of directors decided to sell five Owned
assisted living communities and five development land sites located outside of
California, our primary geographic focus. The fair value of the assets, based
upon the offers we received from potential buyers, is below the carrying amount
of the assets. We recorded an impairment loss of $19.0 million on these
properties and classified them as properties held for sale. The projected future
cash flows from four assisted living communities are less than carrying value of
the assets; therefore, we recorded a $3.7 million impairment loss. Additionally,
during the fourth quarter in the year ended December 31, 1998, we recorded an
accrual for litigation exposure related to our lawsuits with LFREI totaling $1.0
million and severance costs incurred in connection with the resignation of two
senior executives of $1.2 million.
In December 1997, our Board of Directors adopted a plan to discontinue the
operations of GeriCare (SynCare) and the Apartment Group. As part of the plan to
dispose of these assets, we recorded a provision of $10.6 million. Of that
provision, $8.6 million relates to amounts we expect to incur in funding
shortfalls in projected permanent financing on the assets of the Apartment Group
as well as anticipated operating losses to be incurred before disposal and the
write-down of certain assets. The remaining provision of $2.0 million relates to
anticipated operating losses on GeriCare, as well as the write-off of its
intangible assets.
The operating results for the final quarter in the nine-month period ended
December 31, 1997, include the expenses incurred in connection with our proxy
contest with Emeritus Corporation of $1.6 million, severance costs of $1.1
million incurred in connection with the retirement of two senior executives
which were approved by our Compensation Committee in December 1997, the
write-off of $1.1 million of costs incurred in connection with the accounting
software conversion, which was abandoned in February 1998 upon
F-22
<PAGE> 59
discovering numerous application errors in the software package it purchased,
and an impairment provision of $150,000 following Senior Income Fund's announced
plans to liquidate its assets and receipt of a substantial return of capital.
F-23
<PAGE> 60
(16) SUBSEQUENT EVENTS (UNAUDITED)
On March 2, 1999, ARVP II obtained financing and, through its wholly owned
subsidiary ARVP II, LLC, purchased the landlord's interest in four previously
leases communities for approximately $14.3 million.
As of March 18, 1999, we entered into purchase and sale agreements for the
sale of five owned ALCs located outside of California for approximately $32.3
million and on March 30, 1999, we completed the sale of three of five
communities, with the remaining two communities anticipated to close during the
second and third quarters of 1999.
F-24
<PAGE> 61
ARV ASSISTED LIVING, INC.
AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEAR ENDED DECEMBER 31, 1998, THE NINE-MONTH PERIOD ENDED
DECEMBER 31, 1997 AND THE FISCAL YEAR ENDED MARCH 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
DESCRIPTION BEGINNING OF YEAR ADDITIONS DEDUCTIONS END OF YEAR
- ----------- ----------------- --------- ---------- -----------
<S> <C> <C> <C> <C>
Allowance for Other Assets:
March 31, 1997 $ 65 $ 86 $ 38 $ 113
December 31, 1997 113 90 203 --
December 31, 1998 -- 376 68 308
Discontinued operations:
March 31, 1997 264 3,489 504 3,249
December 31, 1997 3,249 11,212 1,640 12,821
December 31, 1998 12,821 645 1,857 11,609
</TABLE>
See accompanying independent auditors' report.
F-25
<PAGE> 62
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
2 Agreement and Plan of Merger, by and between ARV Assisted
Living, Inc. and ARV Delaware, Inc., incorporated by reference
to the Company's Proxy Statement for the 1997 Meeting of
Shareholders of ARV Assisted Living, Inc., filed with the
Securities and Exchange Commission on Schedule 14A on December
31, 1997.
3.1 Certificate of Incorporation of ARV Delaware, Inc.,
incorporated by reference to the Company's Proxy Statement for
the 1997 Meeting of Shareholders of ARV Assisted Living, Inc.,
filed with the Securities and Exchange Commission on Schedule
14A on December 31, 1997.
3.2 By-laws of ARV Delaware, Inc., as amended, incorporated by
reference to our 8-K filed October 21, 1998.
4.1 Rights Agreement, dated May 14, 1998, between ARV Assisted
Living Inc., and ChaseMellon Shareholder Services LLC which
includes the form of Certificate of Determination of the
Series D Junior Participating Preferred Stock of ARV Assisted
Living, Inc. as Exhibit A, the form of Right Certificate as
Exhibit B, and the Summary of Rights to Purchase Preferred
Shares as Exhibit C, incorporated by reference to our 10-Q
filed with the Securities and Exchange Commission on May 15,
1998.
4.2 First Amendment to the Right Agreement, dated October 21,
1998, by and between ARV Assisted Living Inc., and ChaseMellon
Shareholder Services LLC, incorporated by reference to our *-K
filed October 21, 1998.
10.1 Purchase and Sale Agreement by and between 270 Center
Associates, Limited Partnership and ARV Assisted Living, Inc.
dated as of February 12, 1998, incorporated by reference to
Exhibit 10.1 to our 8-K filed with the Securities and Exchange
Commission on May 11, 1998.
</TABLE>
<PAGE> 63
<TABLE>
<S> <C>
10.2 Amendment to Purchase and Sale Agreement by and between 270
Center Associated, Limited Partnership and ARV Assisted
Living, Inc. dated as of March 2, 1998, incorporated by
reference to Exhibit 10.2 to our 8-K filed with the Securities
and Exchange Commission on May 11, 1998.
10.3 Second Amendment to Purchase and Sale Agreement by and between
270 Center Associated, Limited Partnership and ARV Assisted
Living, Inc. dated as of April 10, 1998, incorporated by
reference to Exhibit 10.3 to our 8-K filed with the Securities
and Exchange Commission on May 11, 1998.
10.4 Purchase and Sale Agreement by and between TH Group, Inc. and
ARV Assisted Living, Inc. dated as of February 12, 1998,
incorporated by reference to Exhibit 10.4 to our 8-K filed
with the Securities and Exchange Commission on May 11, 1998.
10.5 Amendment to Purchase and Sale Agreement by and between TH
Group, Inc. and ARV Assisted Living, Inc. dated as of March 2,
1998, incorporated by reference to Exhibit 10.5 to our 8-K
filed with the Securities and Exchange Commission on May 11,
1998.
10.6 Second Amendment to Purchase and Sale Agreement by and between
TH Group, Inc. and ARV Assisted Living, Inc. dated as of April
10, 1998, incorporated by reference to Exhibit 10.6 to our 8-K
filed with the Securities and Exchange Commission on May 11,
1998.
10.7 Purchase and Sale Agreement by and between The Hillsdale
Group, LP and ARV Assisted Living, Inc. dated as of February
12, 1998, incorporated by reference to Exhibit 10.7 to our 8-K
filed with the Securities and Exchange Commission on May 11,
1998.
10.8 Amendment to Purchase and Sale Agreement by and between The
Hillsdale Group, LP and ARV Assisted Living, Inc. dated as of
March 2, 1998, incorporated by reference to Exhibit 10.8 to
our 8-K filed with the Securities and Exchange Commission on
May 11, 1998.
10.9 Second Amendment to Purchase and Sale Agreement by and between
The Hillsdale Group, LP and ARV Assisted Living, Inc. dated as
of April 6, 1998, incorporated by reference to Exhibit 10.9 to
our 8-K filed with the Securities and Exchange Commission on
May 11, 1998.
10.10 Executive Employment Agreement, dated December 5, 1997, by and
between ARV Assisted Living, Inc. and Howard G. Phanstiel,
incorporated by reference to our 10-Q filed with the
Securities and Exchange Commission on August 14, 1998.
10.11 Amendment to Executive Employment Agreement, effective
December 5, 1997, by and between ARV Assisted Living, Inc. and
Howard G. Phanstiel, incorporated by reference to our 10-Q
filed with the Securities and Exchange Commission on August
14, 1998.
10.12 Executive Employment Agreement, as amended, dated June 1,
1998, by and between ARV Assisted Living, Inc. and Douglas M.
Pasquale, incorporated by reference to our 10-Q filed with the
Securities and Exchange Commission on August 14, 1998.
10.13 Employment Agreement, as amended, dated June 15, 1998, by and
between ARV Assisted Living, Inc. and Patricia J. Gifford, MD,
incorporated by reference to our 10-Q filed with the
Securities and Exchange Commission on August 14, 1998.
10.11 Note dated as of October 30, 1997, by the Company in favor of
Prometheus, incorporated by reference to Exhibit 6 to the
Amendment No. 2 to Schedule 13D filed by Prometheus and LFREI
on November 7, 1997.
10.12 Letter Agreement dated October 29, 1997 by and among
Prometheus, LFREI and the Company, incorporated by reference
to Exhibit 7 to the Amendment No. 2 to Schedule 13D filed by
Prometheus and LFREI on November 7, 1997.
10.13 Stockholders' Voting Agreement dated as of October 29, 1997,
by and among Prometheus, LFREI and certain stockholders of the
Company, incorporated by reference to Exhibit 4 to the
Amendment No. 2 to Schedule 13D filed by Prometheus and LFREI
on November 7, 1997.
23 Consent of KPMG LLP.
27 Financial Data Schedule.
99.1 Complaint in ARV Assisted Living, Inc. v. Lazard Freres Real
Estate Investors LLC, et al., case no. 787788, incorporated by
reference to our 8-K filed with the Securities and Exchange
Commission on May 26, 1998.
</TABLE>
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
ARV Assisted Living, Inc.:
We consent to incorporation by reference in the registration statement on Form
S-8 of ARV Assisted Living, Inc. and subsidiaries of our report dated March 31,
1999, relating to the consolidated balance sheets of ARV Assisted Living, Inc.
and subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of operations, shareholders' equity, and cash flows for the year
ended December 31, 1998, the nine-month period ended December 31, 1997 and the
year ended March 31, 1997 and all related schedules, which report appears in
the December 31, 1998, annual report on Form 10-K of ARV Assisted Living, Inc.
and subsidiaries.
/s/ KPMG LLP
Orange County, California
March 31, 1999
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