-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HpfkTZvZgcaEFBawPX+gbe0KoExV3Yi/VRhJj7fgzUNqFnaBdtjEytTx3kzmpW8g 9hL08AXJWqv5o03spIc1ug== 0000950144-01-004461.txt : 20010409 0000950144-01-004461.hdr.sgml : 20010409 ACCESSION NUMBER: 0000950144-01-004461 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN RETIREMENT CORP CENTRAL INDEX KEY: 0000787784 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SKILLED NURSING CARE FACILITIES [8051] IRS NUMBER: 621674303 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13031 FILM NUMBER: 1588594 BUSINESS ADDRESS: STREET 1: 111 WESTWOOD PLACE STREET 2: SUITE 202 CITY: BRENTWOOD STATE: TN ZIP: 37027 BUSINESS PHONE: 6152212250 10-K 1 g68121e10-k.txt AMERICAN RETIREMENT CORPORATION 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2000 Commission file number 01-13031 American Retirement Corporation ------------------------------- (Exact Name of Registrant as Specified in its Charter) Tennessee 62-1674303 - --------- ---------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 111 Westwood Place, Suite 200, Brentwood, TN 37027 - -------------------------------------------- ----- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (615) 221-2250 Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered - ------------------- ----------------------------------------- Common Stock, par value $.01 per share ................................ NYSE 5 3/4% Convertible Subordinated Debentures due 2002 ................... NYSE Series A Preferred Stock Purchase Rights .............................. NYSE
Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to 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 the 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. [ ] As of March 19, 2001, 17,166,209 shares of the registrant's common stock were outstanding and the aggregate market value of such common stock held by non-affiliates was $43.4 million, based on the closing sale price of the common stock of $4.05 on the New York Stock Exchange on that date. For purposes of this calculation, shares held by non-affiliates excludes only those shares beneficially owned by officers, directors, and shareholders owning 10% or more of the outstanding common stock (and, in each case, their immediate family members and affiliates). DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement for use in connection with the Annual Meeting of Shareholders to be held on May 3, 2001 are incorporated by reference into Part III, items 10, 11, 12 and 13 of this Form 10-K. 2 CONTENTS:
PAGE ---- PART I 3 Item 1. Business 3 Item 2. Properties 14 Item 3. Legal Proceedings 17 Item 4. Submission of Matters to a Vote of Security Holders 17 PART II 18 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 18 Item 6. Selected Financial Data 18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 21 Item 7A. Quantitative and Qualitative Disclosure About Market Risk 36 Item 8. Financial Statements and Supplementary Data 36 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 68 PART III 68 Item 10. Directors and Executive Officers of the Registrant 68 Item 11. Executive Compensation 68 Item 12. Security Ownership of Certain Beneficial Owners and Management 68 Item 13. Certain Relationships and Related Transactions 68 PART IV 68 Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 68
2 3 PART I ITEM 1. BUSINESS THE COMPANY American Retirement Corporation, and its wholly-owned and majority owned subsidiaries (collectively referred to as the "Company"), is a national senior living and health care services provider offering a broad range of care and services to seniors, including independent living, assisted living, and skilled nursing services. Established in 1978, the Company currently operates 62 senior living communities in 15 states, with an aggregate capacity for approximately 14,500 residents. The Company owns 21 communities, leases 21 communities, and manages 20 communities pursuant to management agreements. The Company has experienced significant growth since the early 1990s through the acquisition and development of senior living communities in major metropolitan markets. The Company is developing these communities into Senior Living Networks that provide a continuum of housing and care for seniors, including independent living, assisted living, skilled nursing care and specialized care such as Alzheimer's and memory enhancement programs. The Company's strategy combines large continuing care retirement communities ("CCRCs") with stand-alone assisted living or skilled nursing residences as satellites to expand the continuum of housing and care into the market. The Company believes that this hub and satellite approach produces management efficiencies and market penetration by offering a range of senior living arrangements at various price and care levels. Although the Company operates its Senior Living Networks on a fully integrated basis, the Company's operations are divided into two business segments: (1) Retirement Centers and (2) Free-standing Assisted Living Communities ("Free-standing ALs"). The Retirement Centers are generally comprised of the Company's CCRCs and its independent living communities including those at which assisted living and/or nursing services are provided. Free-standing ALs are generally comprised of stand-alone assisted living communities that are not located on a Retirement Center campus, some of which also provide some skilled nursing and/or specialized care such as Alzheimer's and memory enhancement programs. Free-standing ALs are generally much smaller than Retirement Centers. Retirement Centers comprise 32 of the Company's 62 senior living communities, with capacity for approximately 11,700 residents, and generated 94% of the Company's total resident fees in 2000. The Company's operating philosophy was inspired by the vision of its founders, Dr. Thomas F. Frist, Sr. and Jack C. Massey, to enhance the lives of seniors by providing the highest quality of care and services in well-operated communities designed to improve and protect the quality of life, independence, personal freedom, privacy, spirit, and dignity of its residents. The Company's predecessor, American Retirement Communities, L.P. (the "Predecessor" or "ARCLP"), was formed in February 1995 through a combination of certain entities (the "Predecessor Entities") that owned, operated, or managed various senior living communities. Each of the Predecessor Entities was organized at the direction the Company. As a result of the combination, ARCLP issued partnership interests to the partners and shareholders of the Predecessor Entities in exchange for their limited partnership interests and stock in the Predecessor Entities, and thereby became the owner, directly or indirectly, of all of the assets of the Predecessor Entities. American Retirement Corporation was incorporated in February 1997 as a wholly-owned subsidiary of ARCLP in anticipation of the Reorganization (defined below) and the Company's initial public offering in May 1997 (the "IPO"). Simultaneously with the IPO, ARCLP was reorganized (the "Reorganization") with the result that all of its assets and liabilities were contributed to the Company in exchange for 7,812,500 shares of the Company's Common Stock and a promissory note in the original principal amount of approximately $21.9 million (the "Reorganization Note"). The Company issued 3,593,750 shares of Common Stock in the IPO, resulting in net proceeds of approximately $45.0 million. The Company used a portion of the net proceeds from the IPO to repay the Reorganization Note. 3 4 The Company acquired privately held Freedom Group Inc. ("FGI") and certain entities affiliated with FGI and its chairman, Mr. Robert Roskamp, in July 1998. The consideration paid at closing was approximately $43.0 million, including $23.2 million of cash and 1,370,000 shares of the Company's common stock valued at $19.8 million. As a result of the acquisition, the Company acquired three CCRCs and assumed the management of four additional CCRCs. The Company also acquired, for $4.0 million, options to purchase two of the managed CCRCs. The Company also entered into a development and management contract for, and acquired an option to purchase, one additional CCRC then under development. The transaction was accounted for as a purchase. On May 26, 2000, the Company assigned to an unrelated third party its option to acquire one of the managed properties. The third-party purchased the property and the Company simultaneously entered into a series of agreements with the third-party pursuant to which the Company leases and operates the retirement community. The Company chose to cancel one of the other purchase options, and received a full refund of its $2.0 million option payment during the third quarter of 2000. The parties to the management agreement for that community mutually agreed to terminate the management agreement in December 2000. CARE AND SERVICES PROGRAMS The Company provides a wide array of senior living and health care services at its communities, including independent living, assisted living and memory enhanced services (with special programs and living units for residents with Alzheimer's and other forms of dementia), and skilled nursing and sub-acute services. By offering a variety of services and involving the active participation of the resident and the resident's family and medical consultants, the Company is able to customize its service plans to meet the specific needs and desires of each resident. As a result, the Company believes that it is able to maximize customer satisfaction and avoid the high cost of delivering all services to every resident without regard to need, preference, or choice. Independent Living Services The Company provides independent living services to seniors who do not yet need assistance or support with the activities of daily life ("ADLs"), but who prefer the physical and psychological comfort of a residential community that offers health care and other services. Independent living services provided by the Company include daily meals, transportation, social and recreational activities, laundry, housekeeping, security, and health care monitoring. The Company also fosters the wellness of its residents by offering health screenings such as blood pressure checks, periodic special services (such as influenza inoculations), chronic disease management (such as diabetes with its attendant blood glucose monitoring), and dietary and similar programs, as well as ongoing exercise and fitness classes. Classes are given by health care professionals to keep residents informed about health and disease management. Subject to applicable government regulation, personal care and medical services are available to independent living residents. The Company's contracts with its independent living residents are generally for a term of one year and are terminable by the resident upon 60 days' notice. Certain of the Company's communities provide housing and health care services through entrance fee agreements with residents. Under these agreements, residents pay an entrance fee upon entering into a lifecare contract. The amount of the entrance fee varies depending on the resident's health care benefit election. These agreements obligate the Company to provide certain levels of future health care services to the resident for defined periods of care, in some cases for life. The agreements terminate when the resident leaves the community. A portion of the fee is refundable to the resident or the resident's estate upon termination of the agreement. The refundable amount is a long-term liability and is recorded by the Company as refundable portion of life estate fees, until termination of the agreement. The remainder of the fee is recorded as deferred life estate income and is amortized into revenue using the straight-line method over the estimated remaining life expectancy of the resident, based upon annually adjusted actuarial projections. Additionally, under these agreements the residents pay a monthly service fee which entitles them to the use of certain amenities and services. Residents may also elect to obtain additional services, which are paid for on a monthly basis or as the services are received. The Company recognizes these additional fees as revenue on a monthly basis when earned. The Company also provides housing to residents at certain communities under an entrance fee agreement providing that the entrance fee is refundable to the resident or the resident's estate contingent upon the occupancy of the unit by a succeeding 4 5 resident. The resident also shares in a specified percentage, typically 50%, of any appreciation in the entrance fee paid by the succeeding resident. The entrance fee is recorded by the Company as refundable portion of life estate fees and is amortized into revenue using the straight-line method over the remaining life of the building. Additionally, under these agreements the residents pay a monthly service fee, which entitles them to the use of certain amenities and services. They may also elect to obtain additional services, which are paid for on a monthly basis or as the services are received. The Company recognizes these additional fees as revenue on a monthly basis when earned. If a resident terminates the agreement, they are required to continue to pay their monthly service fee for the lesser of one year or until the unit is reoccupied. Assisted Living and Memory Enhanced Services The Company offers a wide range of assisted living care and services 24 hours per day, including personal care services, support services, and supplemental services. The residents utilizing the Company's assisted living services generally need assistance with some or all ADLs, but do not require the more acute medical care traditionally given in nursing homes. Upon admission, in consultation with the resident and the resident's family and medical consultants, each assisted living resident is assessed to determine his or her health status, including functional abilities and need for personal care services. Each resident also completes a lifestyles assessment to determine the resident's preferences. From these assessments, a care plan is developed for each resident to ensure that all staff members who render care meet the specific needs and preferences of each resident whenever possible. Each resident's care plan is reviewed periodically to determine when a change in care is needed. The Company has adopted a philosophy of assisted living care that allows a resident to maintain a dignified, independent lifestyle. Residents and their families are encouraged to be partners in their care and to take as much responsibility for their well being as possible. The basic types of assisted living services offered by the Company include: Personal Care Services which provide assistance with ADLs such as ambulation, bathing, dressing, eating, grooming, personal hygiene, monitoring or assistance with medications, and confusion management, Support Services such as meals, assistance with social and recreational activities, laundry services, general housekeeping, maintenance services and transportation services and Supplemental Services which include extra transportation services, extra laundry services, non-routine care services and special care services for residents with Alzheimer's and other forms of dementia. The Company maintains programs and special units at its assisted living communities for residents with Alzheimer's and other forms of dementia that provide the attention, care, and services needed to help those residents maintain a higher quality of life. Specialized services include assistance with ADLs, behavior management, and a lifeskills-based activities program, the goal of which is to provide a normalized environment that supports residents' remaining functional abilities. Whenever possible, residents assist with meals, laundry, and housekeeping. Special units for residents with Alzheimer's and other forms of dementia are located in a separate area of the community and have their own dining facilities, resident lounge areas, and specially trained staff. These special care areas are designed to allow residents the freedom to ambulate while safely keeping them within a secure area, with a minimum of disruption to other residents. Special nutritional programs are used to help ensure caloric intake is maintained by residents whose constant movement increases their caloric expenditure. Resident fees for these special units are dependent on the size of the unit, the design type, and the level of services provided. These assisted living and memory enhanced services are provided to the residents for monthly service fees. The Company recognizes these fees as revenue on a monthly basis when earned. If a resident terminates the agreement, they are required to continue to pay their monthly service fee for the thirty-day period for which they give notice. Skilled Nursing and Sub-Acute Services The Company provides traditional skilled nursing care by registered nurses, licensed practical nurses, and certified nursing aides. The Company also offers a range of sub-acute care services in certain of its communities. Sub-acute care is generally short-term, goal-oriented rehabilitation care intended for individuals who have a specific illness, injury, or disease, but who do not require many of the services provided in an acute care hospital. Sub-acute care is typically rendered immediately after, or in lieu of, acute hospitalization in order to treat such specific medical conditions. These skilled nursing and sub-acute services are provided to the individuals on a daily basis, as needed, and revenues are recognized when earned. 5 6 OPERATING SEGMENTS Although the Company operates its Senior Living Networks on a fully integrated basis, the Company's operations are divided into two operating segments, Retirement Centers and Free-standing ALs. The Retirement Centers are generally comprised of the Company's CCRCs and its independent living communities including those at which assisted living and/or nursing services are provided. Free-standing ALs are generally comprised of stand-alone assisted living communities that are not located on a Retirement Center campus, some of which also provide some skilled nursing and/or specialized care such as Alzheimer's and memory enhancement programs. Free-standing ALs are generally much smaller than Retirement Centers. Retirement Centers comprise 32 of the Company's 62 senior living communities, representing approximately 11,700 of the Company's 14,500 resident capacity, and generated 93% of the Company's total resident fees in 2000. During 2000, the portfolio of Free-standing ALs operated by the Company grew from 20 (four owned, three leased, and 13 Managed SPE Communities) to 30 (six owned, 12 leased, and 12 Managed SPE Communities); therefore the consolidated number of Free-standing ALs increased from seven to 18. A substantial majority of these Free-standing ALs have recently opened, and are unstabilized and are in the fill-up stage. As a result of the Company's substantial increase in Free-standing ALs, the Company determined to separate its operations in order to focus on separate management techniques and operating strategies for its two business-lines. Segregating the mature Retirement Centers from the unstabilized Free-standing ALs is indicative of how management views and analyzes the Company's operating activities. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations" and Note 18 of the Company's consolidated financial statements. MANAGED SPE COMMUNITIES During the late 1990s, the Company entered into a number of agreements with special purpose entities (SPEs) for the development and management of certain Free-standing ALs, ("Managed SPE Communities"). Under the terms of these agreements, the SPE's lease the assisted living communities from third-party lessors, which are primarily subsidiaries of financial institutions. The Company enters into agreements to manage the communities for the SPEs. Currently the Company manages 12 communities for those SPEs, six of which are affiliates of John Morris, a director of the Company. The agreements provide for the payment of management fees to the Company based on a percentage of each communities' gross revenues, and require the SPEs to fund all costs associated with the operations of the communities up to certain specified limits. The Company is responsible for paying operating costs that exceed the SPE funding limits and has guaranteed approximately $26.0 million of the mortgage financing for these communities. In the event that the Company funds any costs above the specified limits, the Company records these costs using a modified equity method of accounting. In 2000 and 1999, respectively, the Company recorded $2.2 million and $374,000 of funding costs as Equity in Losses of Managed SPE Communities. The Company has options to purchase or has rights of first refusal to acquire the leasehold interests in these Managed SPE Communities, but is under no obligation to do so. The Company acquired 13 of these leasehold interests and acquired one community during 2000. Two of the 13 leasehold interests and the one community acquired during 2000 opened during the first quarter of 2001, and one of the communities was subsequently leased to a third party during 2000. The Company is in discussions with the various SPEs to assume some or all of the remaining 12 communities that are currently managed by the Company. The aggregate development costs of the 12 communities was approximately $152 million, excluding the working capital to fund operations during their respective fill-up periods. Of the $152 million of total development costs, $41.5 million was provided by REIT lessors, $66 million was provided by first mortgage debt (guaranteed by the Company), and the balance of $44.5 million was provided by the Company in the form of notes receivable. If offered and accepted, the Company anticipates acquiring certain, and perhaps all, of those leasehold interests in Managed SPE Communities during 2001 and 2002. If all were acquired, the combined purchase price would be approximately $20.0 to $25.0 million. The timing of these leasehold acquisitions will depend on a variety of factors, including prevailing market conditions, the Company's financing plans, the availability of capital, alternative uses of capital, and general economic conditions. If the Company does not acquire these leasehold interests, the Company is still responsible for funding future operating losses which exceed specified limits. 6 7 During 2001, the Company expects to incur significant operating losses in connection with the stabilization of the recent 13 leasehold acquisitions. In addition, the Company anticipates incurring costs greater than those incurred during 2000 relating to its obligation to fund the Managed SPE Communities as a result of operating losses in excess of the limits for which the SPE's are responsible. These losses and funding obligations are likely to continue until these communities reach break-even occupancy. BUSINESS STRATEGY Since the early 1990's, the Company has grown significantly, primarily through acquisitions of Retirement Centers, expansions of existing communities, and development of Free-standing ALs. As a result of oversupply, significant pricing pressures and other adverse conditions affecting the assisted living industry, the Company has ceased developing new Free-standing ALs in order to focus on increasing the Company's revenues and cashflows, strengthening its balance sheet and improving the Company's operations. Set forth below are the key elements of the Company's current business strategy: Increase Revenues The Company intends to increase its revenues by improving occupancy levels at its communities, selective rate increases, expanding service offerings, and emphasizing sales and marketing efforts. The Company anticipates continued high-levels of occupancy at its Retirement Centers, which, as a whole, have maintained strong occupancy levels. The Company anticipates improving occupancy at its Retirement Centers, and intends to take advantage of the high occupancy trends through selective expansions. During 2000, the Company completed large expansions of two Retirement Centers, which are currently in the fill-up stages. Management continues to focus on maintaining and improving occupancy within these Retirement Centers. The Company's Free-standing ALs are largely unstablized and in the fill-up stage. Management believes that the Company's reputation for and commitment to a high quality of care, quality of support services offered, price of services, physical appearance, amenities associated with the communities, and location will attract new residents and increase occupancy. In addition, the Company believes that combining these services through the Senior Living Networks offers a range of senior living services, improving demand and thus improving occupancy. The Company anticipates the implementation of rate increases at its Retirement Centers in many markets. Some Retirement Center contracts stipulate a maximum allowable annual rate increase. Due to competitive pressures, the Company has less pricing flexibility at its Free-standing ALs and offers various discount programs as move-in incentives to facilitate the fill-up process. These incentive programs generally provide a certain discounted rate for a specified time period, typically six months, with the rate increasing to the standard rate subsequent to the discount period. The Company continually assesses contractual rate increase allowances, each communities' competitors' rates, areas of high demand, and cost inflations in order to improve profitability. The Company provides services that are complementary to senior living and health care services, including Alzheimer and memory enhanced services, as well as various types of therapy. These ancillary services do not constitute a significant portion of the Company's revenues, but management believes that the provision of ancillary services can be important in attracting new residents and preparing the Company for future changes in the senior living and health care industry. Management also anticipates that certain of these ancillary services, particularly therapy services, are likely to grow in the future and provide the Company with additional opportunities to increase revenues, as well as margins. The Company is actively involved in developing and maintaining business relationships and in exploring opportunities for improving occupancy and increasing margin. A cornerstone of the Company's culture is its incentive compensation system, which rewards managers who are able to meet budget, improve profitability and develop improved processes. The Company's marketing efforts are designed to expand its operations by developing lasting relationships with physicians, hospitals, and pharmacies, real estate developers and asset managers, and other sources of referrals. The Company encourages its managers 7 8 to pursue new opportunities at the local level while simultaneously selectively targeting key clients and projects at a regional level. Maintain Strict Cost Management and Achieve Operating Efficiencies In order to provide competitively priced services and enhance the Company's financial performance, the Company must contain costs. Managers are trained to analyze staffing and cost control issues, and each community is carefully tracked on a monthly basis to determine whether financial results are within budgeted and forecasted ranges. Because of the substantial performance-based components of their compensation, managers are continuously motivated to contain the costs of their operations. Because the Company's business is dependent, to some extent, on personal relationships, the Company provides its managers with a significant degree of autonomy in order to encourage prompt and effective responses to local market demands. In conjunction with this local operational authority, the Company provides, through its corporate office, services that typically are not readily available to independent operators such as management support, marketing and business expertise, training, and financial and information systems. The Company continues to seek ways to reduce costs and improve margins through efficiencies in management and marketing programs, strategic alliances, integration, and synergies. Consistent with past practices, the Company will continue to evaluate strategic alternatives that will provide efficiencies. Selective Dispositions The Company intends to selectively pursue dispositions of certain of its assets that are not located within its Senior Living Networks in an effort to reduce operating losses, control costs and raise capital. In addition, the Company will continue to identify and explore opportunities to expand its Retirement Centers and to provide the Company with additional capital through strategic joint ventures or alliances. ACQUISITIONS AND OTHER TRANSACTIONS On January 1, 2000, the Company acquired a health center at a CCRC in San Antonio, Texas for $4.5 million. The Company managed the health center prior to the acquisition. The health center has 141 total units, of which 124 are skilled nursing and 24 are assisted living. The health center is attached to a large independent living retirement center currently managed by the Company. On May 26, 2000, the Company entered into a long-term lease for a senior living community located in West Brandywine, Pennsylvania, which the Company had been managing pursuant to a management agreement entered into in conjunction with the FGI acquisition. In conjunction with the FGI acquisition, the Company acquired an option to purchase the community upon specified terms. On May 26, 2000, the Company assigned its purchase option to an unrelated third party, which exercised the option and purchased the property. The Company simultaneously entered into a series of agreements with this new owner to lease and operate the retirement community. As part of this transaction, the Company acquired for $1.0 million certain assets and liabilities from the previous owner of the community. In connection with this transaction, the Company is required to maintain $17.6 million of assets limited as to use, on which the Company receives the interest earned. The Company owned a 50% interest in a joint venture that was formed for the purpose of owning and operating two assisted living communities in Knoxville, Tennessee. The Company subsequently determined that this venture did not fit with the Company's Senior Living Network strategy. As of June 1, 2000, the parties dissolved the joint venture, with each party retaining one of the assisted living communities, along with the liabilities associated with that community. As a result of the dissolution, the Company recorded assets of $8.2 million, consisting primarily of land and buildings. The Company also assumed $8.2 million of liabilities, consisting primarily of a $7.9 million mortgage note payable. The Company has no further management responsibility for, or liability with respect to, the community that was retained by the other party. On July 24, 2000, the Company ceased operating an assisted living community located in Marietta, Georgia that the Company determined did not fit within the Company's Senior Living Network strategy. The Company leased the community to a third party, which assumed responsibility for the community's operations. The lease has a five-year term with a renewal option for an additional five years. 8 9 On December 18, 2000, the Company sold a community located in Westlake, Ohio and simultaneously leased the property back from the buyer. The community was originally acquired by the Company in October 1994 and has 302 units consisting of 246 independent living and 56 assisted living units. At the transaction date, the community had a net book basis of $13.2 million and was sold for approximately $26.0 million. The gain has been deferred and will be recognized into income over the life of the lease. The Company anticipates that a portion of the taxable gain from the transaction will be deferred by like-kind exchanges that the Company anticipates consummating in 2001. In conjunction with the lease, the Company has a right of first refusal to purchase the community. During the year, the Company acquired from various SPEs the assets and leasehold interests of 13 Managed SPE Communities and acquired one Managed SPE Community that the Company previously managed, in exchange for total payments of $14.3 million, net of cash received, which was recorded as leasehold acquisition costs. Two of the 13 leasehold interests and the one community acquired during 2000 opened during the first quarter of 2001, and one of the communities was subsequently leased to a third party during 2000. The Company also assumed certain liabilities in connection with these acquisitions. The costs of acquiring the leasehold interests are being amortized as lease expense on a straight-line basis over the remaining base terms of the respective leases. The assets and liabilities were recorded at cost, which approximates fair value. Four of these leasehold interests were acquired, for $6.2 million, from a SPE that is affiliated with John Morris, a director of the Company. One of the communities was subsequently leased to a third party during 2000. The Company manages six additional Free-standing ALs leased by affiliates of John Morris. In addition, the Company has advanced amounts for certain costs of these Managed SPE communities affiliated with Dr. Morris. At December 31, 2000, approximately $1.2 million was due to the Company from these affiliates. Such amounts are expected to be reimbursed through the future acquisition of the leasehold interests of these affiliates. GOVERNMENT REGULATION The senior living and health care industries are subject to extensive regulation and frequent regulatory change. At this time, no federal laws or regulations specifically regulate assisted or independent living residences. The Company's skilled nursing facilities and home health agencies are subject to federal certification requirements in order to participate in the Medicare and Medicaid programs. While a number of states have not yet enacted statutes or regulations specifically governing assisted living facilities, the Company's communities are subject to regulation, licensing, certificate of need ("CON") review, and permitting by state and local health and social service agencies and other regulatory authorities. While such requirements vary by state, they typically relate to staffing, physical design, required services, and resident characteristics. The Company's communities are also subject to various zoning restrictions, local building codes, and other ordinances, such as fire safety codes. The Company believes that such regulation will increase in the future, and that regulation of the assisted living industry is evolving and is likely to become more burdensome, although the Company is unable to predict the content of new regulations or their effect on its business. In the ordinary course of business, one or more of the Company's communities could be cited for operating or other deficiencies by regulatory authorities. In such cases, the appropriate corrective action would be taken. There are currently numerous legislative and regulatory initiatives at the state and Federal levels addressing patient privacy concerns. In particular, the Department of Health and Human Services ("DHHS") has released final privacy regulations implementing portions of the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). These regulations, which have an effective date of April 14, 2001, and a compliance date of April 14, 2003, restrict how health care providers use and disclose individually identifiable health information. Under HIPAA, DHHS also has proposed regulations governing electronically maintained or transmitted health-related information. Further, as required by HIPAA, DHHS has adopted final regulations establishing electronic data transmission standards that all health care providers must use when submitting or receiving certain health care transactions electronically. Compliance with these regulations is required by October 16, 2002. Failure to comply with regulations enacted under HIPAA could result in civil and criminal penalties. The Company will continue to remain subject to any Federal or state laws that are more restrictive than the privacy regulations issued under HIPAA. These statutes vary and could impose additional penalties. Management believes that the Company should be able 9 10 to replace or modify its systems and procedures to ensure compliance with HIPAA and other legislation or regulations. Management does not expect costs incurred with relation to HIPAA to have a material impact on the Company's operating results. The Balanced Budget Act ("BBA") of 1997 included sweeping changes to Medicare and Medicaid, significantly reducing rates of increase for payments to home health agencies and skilled nursing facilities. In 1999 and 2000, Congress enacted legislation that lessened the impact of the BBA. Under the BBA, beginning in the cost reporting years following January 10, 2001, skilled nursing facilities are no longer reimbursed under a cost based system, but will utilize a prospective payment system ("PPS") under which facilities are reimbursed on a per diem basis. Also, as required by the BBA, the DHHS implemented a PPS for home health care services for cost reporting periods beginning on and after October 1, 2000. Approximately 5.0%, 4.4%, and 4.7% of the Company's total revenues from continuing operations for the years ended December 31, 2000, 1999, and 1998, respectively, were attributable to Medicare, including Medicare-related private co-insurance and Medicaid. Federal and state anti-remuneration and self-referral laws, such as anti-kickback laws, govern certain financial arrangements among health care providers and others who may be in a position to refer or recommend patients to such providers. These laws prohibit, among other things, certain direct and indirect payments that are intended to induce the referral of patients to, the arranging for services by, or the recommending of, a particular provider of health care items or services, and have often been broadly interpreted to apply to certain contractual relationships between health care providers and sources of patient referrals. In addition, there are various Federal and state laws prohibiting other types of fraud and abuse by health care providers, including criminal and civil provisions that prohibit filing false claims or making false statements to receive payment or certification under Medicare or Medicaid and failing to refund overpayments or improper payments. Violation of these laws can result in loss of licensure, civil and criminal penalties, and exclusion of health care providers or suppliers from participation in Medicare, Medicaid, and other state and Federal reimbursement programs. There can be no assurance that such laws will be interpreted in a manner consistent with current or past practices of the Company. The Arizona Department of Insurance has notified the owner of the Company's managed community in Peoria, Arizona, that the owner is not currently in compliance with a net worth requirement imposed by Arizona law. While the compliance with this net worth requirement is technically the responsibility of the owner, in order to facilitate discussions with the Arizona Department of Insurance, the Company has provided the Department with a limited guaranty relating to the financial performance of the community, and has notified the Arizona DOI of the Company's intention to enter into a lease of the community, if the Company can reach acceptable terms with the owner. The Department has tentatively indicated that the proposed lease will result in the community's compliance with the applicable Arizona statute. While the Company and owner believe that the owner's noncompliance with the net worth requirement is only a technical violation of law and that the community is in a strong financial position, there can be no assurance that the State of Arizona will not enforce the law strictly or that the Company can successfully negotiate a lease with the owner of the community that is acceptable to both the Company and the Arizona DOI. A violation of this net worth requirement may, among other things, allow the Arizona Department of Insurance to take steps to appoint a receiver for the community. In addition, the Company is subject to various Federal, state, and local environmental laws and regulations. Such laws and regulations often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of hazardous or toxic substances. The costs of any required remediation or removal of these substances could be substantial and the liability of an owner or operator as to any property is generally not limited under such laws and regulations and could exceed the property's value and the aggregate assets of the owner or operator. The presence of these substances or failure to remediate such contamination properly may also adversely affect the owner's ability to sell or rent the property, or to borrow using the property as collateral. Under these laws and regulations, an owner, operator, or an entity that arranges for the disposal of hazardous or toxic substances, such as asbestos-containing materials, at a disposal site may also be liable for the costs of any required remediation or removal of the hazardous or toxic substances at the disposal site. In connection with the ownership or operation of its properties, the Company could be liable for these costs, as well as certain other costs, including governmental fines and injuries to persons or properties. 10 11 COMPETITION The senior living and health care services industry is highly competitive and the Company expects that all providers within the industry will become increasingly competitive in the future. During the mid- to late-1990's, a large number of assisted living units were developed and most have opened by 2000. This additional capacity has had the effect of increasing the time required to fill assisted living units in most markets and has resulted in significant pricing pressures in those markets. The Company believes that the primary competitive factors in the senior living and health care services industry are (i) reputation for and commitment to a high quality of care; (ii) quality of support services offered; (iii) price of services; (iv) physical appearance and amenities associated with the communities; and (v) location. The Company competes with other companies providing independent living, assisted living, skilled nursing, and other similar service and care alternatives, many of whom may have greater financial resources than the Company. In addition, the Company competes with many assisted living companies that are currently insolvent or that are likely to be insolvent in the future. These competitors may gain a competitive advantage over the Company as a result of the effect of bankruptcy or other insolvency proceedings. The Company believes it has a reputation as a leader in the industry and as a provider of high quality services. Because seniors tend to choose senior living communities near their homes or their families, the Company's principal competitors are other senior living and long-term care communities in the same local geographic areas as the Company's communities. The Company is one of the largest companies in the senior living health care industry and is not limited to a single geographic region. The Company's size has also allowed it to centralize administrative functions that give the decentralized managerial operations cost-efficient support. The Company also competes with other health care businesses with respect to attracting and retaining nurses, technicians, aides, and other high quality professional and non-professional employees and managers. The market for these professionals has become very competitive, with resulting pressure on salaries and compensation levels. However, the Company believes it is able to attract and retain quality managers through its reputation, and through its incentive compensation that directly rewards successful efforts and places a premium on profitable growth. INSURANCE The provision of personal and health care services entails an inherent risk of liability. In recent years, participants in the senior living and health care services industry have become subject to an increasing number of lawsuits alleging negligence or related legal theories, many of which involve large claims and result in the incurrence of significant defense costs. The Company currently maintains property, liability, and professional medical malpractice insurance policies for the Company's owned and certain of its managed communities under a master insurance program. Recently, the number of insurance companies willing to provide general liability and professional malpractice liability insurance for the nursing and assisted living industry has declined dramatically. The Company's previous liability policies expired on July 1, 2000, and, in order to renew its liability coverage, the Company was required to pay significantly higher premiums. In addition, the Company's new liability policies contain deductibles that are significantly higher than those the Company has historically maintained. As a result, beginning in the third quarter of 2000, the Company began to pay higher premiums and to establish higher reserves for potential liability claims. The Company believes this market condition is temporary, but is likely to persist for the foreseeable future. As a result, the Company is exploring alternatives to reduce its liability insurance costs and deductibles. The Company also has underlying and umbrella excess liability protection policies in the amount of at least $25.0 million in the aggregate. There can be no assurance that a claim in excess of the Company's insurance will not arise. A claim against the Company not covered by, or in excess of, the Company's insurance could have a material adverse effect upon the Company. In addition, the Company's insurance policies must be renewed annually. There can be no assurance that the Company will be able to obtain liability insurance in the future or that, if such insurance is available, it will be available on acceptable terms. ENVIRONMENTAL MATTERS Under various federal, state, and local environmental laws, ordinances, and regulations, a current or previous owner or operator of real estate may be required to investigate and clean up hazardous or toxic substances or petroleum product releases at such property, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean up costs. The Company is not aware of any environmental liability with respect to any of its owned, 11 12 leased, or managed communities that it believes would have a material adverse effect on the Company's business, financial condition, or results of operations. The Company believes that its communities are in compliance in all material respects with all federal, state, and local laws, ordinances, and regulations regarding hazardous or toxic substances or petroleum products. The Company has not been notified by any governmental authority, and is not otherwise aware of any material non-compliance, liability, or claim relating to hazardous or toxic substances or petroleum products in connection with any of the communities it currently operates. EMPLOYEES The Company employs approximately 7,600 persons. As of December 31, 2000, none of the Company's employees were represented by a labor union. However, subsequent to year-end, approximately 28 of 52 total employees at a Free-standing AL in Cleveland, Ohio voted to unionize. The Company believes that its relationship with its employees is good. EXECUTIVE OFFICERS The following table sets forth certain information concerning the executive officers of the Company.
NAME AGE POSITION - ---- --- -------- W. E. Sheriff 58 Chief Executive Officer Christopher J. Coates 50 President and Chief Operating Officer George T. Hicks 43 Executive Vice President - Finance, Chief Financial Officer H. Todd Kaestner 45 Executive Vice President - Corporate Development James T. Money 53 Executive Vice President - Senior Living Network Development Gregory B. Richard 47 Executive Vice President - Operations Ross C. Roadman 51 Senior Vice President - Strategic Planning and Investor Relations Terry Frisby 50 Senior Vice President - Human Resources Bryan D. Richardson 42 Vice President - Finance
W.E. SHERIFF has served as Chairman and Chief Executive Officer of the Company and its predecessors since April 1984. From 1973 to 1984, Mr. Sheriff served in various capacities for Ryder System, Inc., including as President and Chief Executive Officer of its Truckstops of America division. Mr. Sheriff also serves on the boards of various educational and charitable organizations and in varying capacities with several trade organizations, including as a member of the board of the National Association for Senior Living Industries. CHRISTOPHER J. COATES has served as President and Chief Operating Officer of the Company and its predecessors since January 1993 and as a director of the Company since January 1998. From 1988 to 1993, Mr. Coates served as Chairman of National Retirement Company, a senior living management company acquired by a subsidiary of the Company in 1992. From 1985 to 1988, Mr. Coates was senior director of the Retirement Housing Division of Radice Corporation, following that company's purchase in 1985 of National Retirement Consultants, a company formed by Mr. Coates. Mr. Coates is a former Chairman of the Board of Directors of the American Senior Housing Association. GEORGE T. HICKS has served as the Executive Vice President - Finance, Chief Financial Officer, Treasurer, and Secretary since September 1993. Mr. Hicks has served in various capacities for the Company's predecessors since 1985, including Vice President - Finance and Treasurer from November 1989 to September 1993. H. TODD KAESTNER has served as Executive Vice President - Corporate Development since September 1993. Mr. Kaestner has served in various capacities for the Company's predecessors since 1985, including Vice President - Development from 1988 to 1993 and Chief Financial Officer from 1985 to 1988. 12 13 JAMES T. MONEY has served as Executive Vice President - Senior Living Network Development since September 1993. Mr. Money has served in various capacities for the Company's predecessors since 1978, including Vice President - Development from 1985 to 1993. Mr. Money is a member of the board of directors and the executive committee of the National Association for Senior Living Industries. GREGORY B. RICHARD has served as Executive Vice President - Operations since January 2000. Mr. Richard was previously with a pediatric practice management company from May 1997 to May 1999 serving as President and Chief Executive Officer from October 1997 to May 1999. Prior to this Mr. Richard was with Rehability Corporation, a publicly traded outpatient physical rehabilitation service provider, from July 1986 to October 1996, serving as Senior Vice President of Operations and Chief Operating Officer from September 1992 to October 1996. ROSS C. ROADMAN has served as Senior Vice President - Strategic Planning and Investor Relations since May 1999. Previously, Mr. Roadman served in various capacities, since 1980, at Ryder System, Inc., including as Group Director of Investor and Community Relations, Assistant Treasurer, Division Controller, and Director of Planning. Before joining Ryder, he held positions with Ernst & Young and the International Monetary Fund. He serves on the boards of several educational and charitable organizations as well as being active in various professional organizations. TERRY L. FRISBY has served as Senior Vice President - Human Resources since January 1999. Mr Frisby served as Vice President - Corporate Culture and Compliance from July 1998 to January 1999. Prior to this Mr. Frisby was principal of a healthcare consulting business located in Nashville, Tennessee, from 1988 to 1998. Mr. Frisby serves on the Executive Council for Human Resources with the Assisted Living Federation of America. BRYAN D. RICHARDSON has served as Vice President - Finance since April 2000. Mr. Richardson was previously with a graphic arts company from 1984 to 1999 serving in various capacities, including Senior Vice President of Finance of a digital prepress division from May 1994 to October 1999, and Senior Vice President of Finance and Chief Financial Officer from 1989 to 1994. 13 14 ITEM 2. PROPERTIES The table below sets forth certain information with respect to the senior living communities currently operated by the Company. RETIREMENT CENTER
Resident Capacity(1) ------------------------------------------------- Commencement Community Location IL AL ME SN Total of Operations(2) --------- -------- ------------------------------------------------- ---------------- OWNED(3): Broadway Plaza Ft. Worth, TX 252 40 -- 122 414 Apr-92 Carriage Club of Charlotte Charlotte, NC 355 62 34 42 493 May-96 Carriage Club of Jacksonville Jacksonville, FL 292 60 -- -- 352 May-96 Freedom Plaza Sun City Center Sun City Center, FL 542 22 4 113 681 Jul-98 Freedom Village Holland Holland, MI 450 22 29 67 568 Jul-98 The Hampton at Post Oak Houston, TX 162 39 -- 56 257 Oct-94 Heritage Club Denver, CO 220 35 -- -- 255 Feb-95 Homewood at Corpus Christi Corpus Christi, TX 60 30 -- -- 90 May-97 Lake Seminole Square Seminole, FL 395 34 -- -- 429 Jul-98 Parklane West San Antonio, TX -- 17 -- 124 141 Jan-00 Parkplace Denver, CO 195 43 17 -- 255 Oct-94 Richmond Place Lexington, KY 206 60 17 -- 283 Apr-95 Santa Catalina Villas Tucson, AZ 217 70 15 42 344 Jun-94 The Summit at Westlake Hills Austin, TX 167 30 -- 90 287 Apr-92 Wilora Lake Lodge Charlotte, NC 142 43 -- -- 185 Dec-97 ----- ----- --- ----- ------ Subtotal 3,655 607 116 656 5,034 LEASED: Freedom Village Brandywine(4) Glenmore, PA 380 17 17 47 461 Jun-00 Holley Court Terrace(5) Oak Park, IL 179 17 -- -- 196 Jul-93 Homewood at Victoria(6) Victoria, TX 60 30 -- -- 90 May-97 Imperial Plaza(7) Richmond, VA 850 152 -- -- 1,002 Oct-97 Oakhurst Towers(8) Denver, CO 195 -- -- -- 195 Feb-99 Park Regency(9) Chandler, AZ 154 -- -- 66 220 Sep-98 Rossmoor Regency(10) Laguna Hills, CA 210 -- -- -- 210 May-98 Trinity Towers(11) Corpus Christi, TX 220 62 20 76 378 Jan-90 Westlake Village (12) Cleveland, OH 246 56 -- -- 302 Oct-94 ----- ----- --- ----- ------ Subtotal 2,494 334 37 189 3,054 MANAGED(13): Burcham Hills East Lansing, MI 138 99 -- 133 370 Nov-78 Freedom Plaza Arizona(14) Peoria, AZ 455 34 42 256 787 Jul-98 Freedom Square(15) Seminole, FL 497 107 69 192 865 Jul-98 Glenview at Pelican Bay Naples, FL 150 -- -- 35 185 Jul-98 Somerby at Jones Farm(16) Huntsville, AL 110 48 -- -- 158 Apr-99 Somerby at University Park(16) Birmingham, AL 148 105 15 -- 268 Apr-99 The Towers San Antonio, TX 505 -- -- -- 505 Oct-94 Williamsburg Landing Williamsburg, VA 360 45 15 58 478 Sep-85 ----- ----- --- ----- ------ Subtotal 2,363 438 141 674 3,616 ----- ----- --- ----- ------ Total Retirement Centers 8,512 1,379 294 1,519 11,704 ===== ===== === ===== ======
14 15 FREE-STANDING ASSISTED LIVING
Resident Capacity(1) ------------------------------------------- Commencement Community Location IL AL ME SN Total of Operations(2) --------- -------- -------------------------------------------- ---------------- OWNED(3): Homewood at Brookmont Terrace (17) Nashville, TN -- 57 34 -- 91 May-00 Homewood at Deane Hill Knoxville, TN -- 78 26 -- 104 Oct-98 Homewood at Flint (McLaren)(18) Flint, MI -- 80 34 -- 114 Apr-00 Homewood at Sun City Center(19) Sun City Center, FL -- 60 28 -- 88 Aug-99 Homewood at Tarpon Springs Tarpon Springs, FL -- 64 -- -- 64 Aug-97 Village of Homewood(20) Lady Lake, FL -- 32 13 -- 45 Apr-98 ----- ----- --- ----- ------ Subtotal -- 371 135 -- 506 LEASED: Bahia Oaks Lodge(21) Sarasota, FL 18 82 -- -- 100 Jun-98 Heritage Club at Greenwood Village(22) Denver, CO -- 75 15 90 180 Nov-99 Homewood at Bay Pines(11) St Petersburg, FL -- 80 -- -- 80 Jul-99 Homewood at Boca Raton(23) Boca Raton, FL -- 60 18 -- 78 Oct-00 Homewood at Lakeway(22) Austin, TX -- 66 15 -- 81 Sep-00 Homewood at Naples(22) Naples, FL -- 76 24 -- 100 Sep-00 Homewood at Pecan Park(23) Fort Worth, TX -- 80 17 -- 97 Aug-00 Homewood at Shavano Park(23) San Antonio, TX -- 62 17 -- 79 Jun-00 Hampton at Cypress Station(24) Houston, TX -- 81 19 -- 100 Feb-99 Hampton at Pearland(25) Houston, TX 15 52 15 -- 82 Feb-00 Hampton at Pinegate(25) Houston, TX -- 81 15 -- 96 May-00 Hampton at Spring Shadows(25) Houston, TX -- 54 16 -- 70 May-99 ----- ----- --- ----- ------ Subtotal 33 849 171 90 1,143 MANAGED(13): Hampton at Willowbrook(26) Houston, TX -- 66 -- -- 66 Jun-99 Hampton at Shadowlake(26) Houston, TX -- 78 17 -- 95 Apr-99 Heritage Club at Aurora(26) Aurora, CO -- 80 16 -- 96 Jun-99 Heritage Club at Lakewood(26) Lakewood, CO -- 78 14 -- 92 Apr-00 Homewood at Boynton Beach(27) Boynton Beach, FL -- 80 17 -- 97 Jan-00 Homewood at Cleveland Park(27) Greenville, SC -- 75 15 -- 90 Aug-00 Homewood at Coconut Creek(27) Coconut Creek, FL -- 80 18 -- 98 Feb-00 Homewood at Countryside(26) Safety Harbor, FL -- 57 26 -- 83 Oct-99 Homewood at Delray Beach(27) Delray Beach, FL -- 52 28 -- 80 Oct-00 Homewood at Richmond Heights(27) Cleveland, OH -- 78 17 -- 95 Feb-00 Homewood at Rockefeller Gardens(27) Cleveland, OH -- 105 34 -- 139 Dec-99 Summit at Northwest Hills(26) Austin, TX -- 106 16 -- 122 Aug-00 ----- ----- --- ----- ------ Subtotal -- 935 218 -- 1,153 ----- ----- --- ----- ------ Total Free-standing Assisted Living 33 2,155 524 90 2,802 ===== ===== === ===== ====== Grand Total 8,545 3,534 818 1,609 14,506 ===== ===== === ===== ======
15 16 - ----------------------- (1) Current resident capacity by care level and type: independent living residences (IL), assisted living residences (including areas dedicated to residents with Alzheimer's and other forms of dementia) (AL), memory enhanced (ME), and skilled nursing beds (SN). (2) Indicates the date on which the Company acquired each of its owned and leased communities, or commenced operating its managed communities. The Company operated certain of its communities pursuant to management agreements prior to acquiring the communities. (3) The Company's owned communities are subject to mortgage liens or serve as collateral for various financing arrangements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." (4) The Company entered into a lease for the community in 2000. The community was owned by an entity affiliated with Mr. Roskamp, a former director of the Company. Leased pursuant to an operating lease with an initial term of five years expiring September 30, 2005, with a renewal option of one year. (5) Leased pursuant to an operating lease with an initial term of ten years expiring December 31, 2006. The Company has a right of first refusal to purchase the community. (6) Leased pursuant to an operating lease expiring July 2011, with renewal options for up to two additional ten-year terms. (7) Leased pursuant to an operating lease expiring October 2017, with a seven-year renewal option. The Company also has an option to purchase the community at the expiration of the lease term. (8) Leased pursuant to a 14-year operating lease expiring February 2013 from a managed entity. The Company also has an option to purchase the community at the expiration of the lease term. (9) Leased pursuant to a five year operating lease expiring September 2003, with renewal options for up to two additional one-year terms. The Company also acquired an option to purchase the community at the expiration of the lease term. (10) Leased pursuant to a five-year operating lease expiring May 2003, with renewal options for up to five additional one-year terms. The Company also acquired an option to purchase the community at the expiration of the lease term. (11) Leased pursuant to an operating lease expiring November 2007, with renewal options for up to three additional ten-year terms. The Company has a right of first refusal to purchase the community. (12) During 2000, the Company sold the property and subsequently leased the property back from the buyer. Leased pursuant to a seven-year operating lease expiring December 31, 2007, with two renewal options of 13 and ten years. The sale-leaseback agreement also includes a right of first refusal for the Company. (13) Except as noted below, the Company's management agreements are generally for terms of three to five years, but may be canceled by the owner of the community, without cause, on three to six months' notice. Pursuant to the management agreements, the Company is generally responsible for providing management personnel, marketing, nursing, resident care and dietary services, accounting and data processing reports, and other services for these communities at the owner's expense and receives a monthly fee for its services based either on a contractually fixed amount or percentage of revenues or income. As noted below, certain of the communities managed by the Company are owned by affiliates of the Company. (14) Operated pursuant to a management agreement with a 20-year term, with two renewal options for additional ten-year terms, that provides for a management fee equal to all cash received by the community in excess of operating expenses, refunds of entry fees, capital expenditure reserves, debt service, and certain payments to the community's owners, including an entity affiliated with Mr. Roskamp, a former director of the Company. The Company is currently negotiating with the owner of this Community to convert its existing management agreement into a long-term operating lease. (15) Operated pursuant to a management agreement with a 20-year term, with two renewal options for additional ten-year terms, that provides for a management fee equal to all cash received by the community in excess of operating expenses, refunds of entry fees, capital expenditure reserves, debt service, and certain payments to the community's owner, Mr. Roskamp, a former director of the Company, and an entity affiliated with Mr. Roskamp. The Company has an option to purchase the community at a predetermined price. (16) The management agreements grant ARC options to purchase the communities upon achievement of stabilized occupancy at formula-derived prices. (17) Owned by a joint venture in which the Company owns a 51% interest. (18) Owned by a joint venture in which the Company owns a 37.5% interest. (19) Owned by a joint venture in which the Company owns a 50% interest. (20) Owned by a joint venture in which the Company owns a 61% interest. (21) Leased pursuant to a five-year operating lease (with five one-year renewal options) from an unaffiliated SPE that acquired the community from a general partnership of which Robert G. Roskamp, a former director of the Company, is a partner. The Company also acquired an option to purchase the community at the expiration of the lease term. (22) During the year, the Company acquired the assets and/or leasehold interests and assumed certain liabilities from an SPE affiliated with John Morris, a director of the Company. Leased pursuant to an operating lease expiring April 30, 2013, with renewal options for up to four additional ten-year terms. (23) During the year, the Company acquired the assets and/or leasehold interests and assumed certain liabilities from a managed SPE. Leased pursuant to an operating lease expiring July 1, 2007, with renewal options for up to two additional one-year terms. The Company also has an option to purchase the community at the expiration of the lease term. (24) During the year, the Company acquired the assets and/or leasehold interests and assumed certain liabilities from a managed SPE. Leased pursuant to an operating lease expiring April 1, 2012, with renewal options for up to three additional five-year terms. (25) During the year, the Company acquired the assets and/or leasehold interests and assumed certain liabilities from a managed SPE. Leased pursuant to an operating lease expiring June 24, 2012, with renewal options for up to four additional ten-year terms. (26) The communities are managed pursuant to management agreements that provide for the payment of management fees based on a percentage of gross revenues of each community and require the Company to fund operating losses above a specified amount. (27) The communities are owned by an unaffiliated third-party and leased by SPEs affiliated with John Morris, a director of the Company. The communities are managed pursuant to management agreements that provide for the payment of management fees based on a percentage of the gross revenues of each community and require the Company to fund operating losses above a specified amount. 16 17 ITEM 3. LEGAL PROCEEDINGS The ownership of property and provision of services related to the retirement industry entails an inherent risk of liability. Although the Company is engaged in routine litigation incidental to its business, there is no legal proceeding to which the Company is a party, which, in the opinion of management, will have a material adverse effect upon the Company's financial condition, results of operations, or liquidity. The Company carries liability insurance against certain types of claims that management believes meets industry standards; however, there can be no assurance that the Company will continue to maintain such insurance, or that any future legal proceedings (including any related judgments, settlements or costs) will not have a material adverse effect on the Company's financial condition, liquidity, or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 17 18 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock trades on the New York Stock Exchange under the symbol "ACR." The following table sets forth, for the periods indicated, the high and low sales prices for the Company Common Stock as reported on the NYSE.
Year Ended December 31, 2000 High Low ---------------------------------------------------------------------- First Quarter $ 8.750 $ 5.875 Second Quarter 8.625 5.125 Third Quarter 6.250 4.625 Fourth Quarter 7.000 3.010
Year Ended December 31, 1999 High Low ---------------------------------------------------------------------- First Quarter $17.938 $13.500 Second Quarter 17.750 11.875 Third Quarter 13.750 9.438 Fourth Quarter 9.813 4.313
As of March 19, 2001, there were 534 shareholders of record and approximately 1,860 persons or entities holding Common Stock in nominee name. It is the current policy of the Company's Board of Directors to retain all future earnings to finance the operation and expansion of the Company's business and repay debt obligations. Accordingly, the Company does not anticipate declaring or paying cash dividends on the Common Stock in the foreseeable future. The payment of cash dividends in the future will be at the sole discretion of the Company's Board of Directors and will depend on, among other things, the Company's earnings, operations, capital requirements, financial condition, restrictions in then existing financing agreements, and other factors deemed relevant by the Board of Directors. The Company did not sell any securities during the year ended December 31, 2000 without registration under the Securities Act of 1933, as amended. ITEM 6. SELECTED FINANCIAL DATA The selected financial data presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and notes thereto included elsewhere in this report. In February 1997, American Retirement Corporation was incorporated for purposes of effecting a reorganization of ARCLP and to complete an initial public offering (IPO). Pro forma earnings per share presented for the year ended December 31, 1997 and 1996 are based on the number of shares that would have been outstanding assuming the partners had been shareholders and is based on the 7,812,500 shares received as a result of the reorganization plus 1,562,500 shares representing the value of the $21.9 million promissory note at the IPO price of $14.00 per share. The pro forma adjustments reflected on the consolidated statements of operations for the year ended December 31, 1997 and 1996 provides for income taxes, at an effective tax rate of 36%, assuming ARCLP was subject to taxes and excludes the $3.0 million charge resulting from the difference between the accounting and tax bases of ARCLP's assets and liabilities at the time of the conversion from a limited partnership to a taxable corporation. 18 19
Predecessor ----------- Years Ended December 31, --------------------------------------------------------------------------- 2000 1999 1998 1997 1996 -------- -------- -------- ------- -------- STATEMENT OF OPERATIONS DATA: (in thousands, except per share data) Revenues: Resident and health care $200,805 $164,592 $130,036 $ 88,416 $ 71,409 Management and development services 5,309 10,678 12,321 1,765 1,739 -------- -------- -------- -------- -------- Total revenues 206,114 175,270 142,357 90,181 73,148 Operating expenses: Community operating expense 138,670 105,978 82,698 54,921 45,084 General and administrative 19,420 15,020 10,581 6,717 5,657 Lease expense, net 18,267 12,985 9,063 3,405 -- Depreciation and amortization 17,142 13,692 10,025 6,632 6,900 Asset impairments and contractual -- 12,536 -- -- -- losses Merger related costs -- -- 994 -- -- -------- -------- -------- -------- -------- Total operating expenses 193,499 160,211 113,361 71,675 57,641 -------- -------- -------- -------- -------- Operating income 12,615 15,059 28,996 18,506 15,507 -------- -------- -------- -------- -------- Other income (expense): Interest expense (36,517) (23,668) (17,924) (15,056) (12,160) Interest income 14,791 9,123 4,092 2,675 434 Gain on sale of assets 267 3,036 80 35 874 Equity in loss of managed SPE communities (2,234) (374) -- -- -- Other 872 (314) (242) (36) (86) -------- -------- -------- -------- -------- Other expense, net (22,821) (12,197) (13,994) (12,382) (10,938) -------- -------- -------- -------- -------- Income (loss) from continuing operations before income taxes, minority interest extraordinary item and cumulative effect of change in accounting principle (10,206) 2,862 15,002 6,124 4,569 Income tax expense (benefit) (3,523) 1,087 5,652 4,435 (920) -------- -------- -------- -------- -------- Income (loss) from continuing operations before minority interest, extraordinary item and cumulative effect of change in accounting principle (6,683) 1,775 9,350 1,689 5,489 Minority interest, net of tax 961 277 -- -- -- -------- -------- -------- -------- -------- Income (loss) from continuing operations before extraordinary item and cumulative effect of change in accounting principle (5,722) 2,052 9,350 1,689 5,489 Discontinued operations, net of tax: Income (loss) from home health operations -- -- (1,244) (155) 44 Write-off of home health assets -- -- (902) -- -- -------- -------- -------- -------- -------- Income (loss) before extraordinary item and cumulative effect of change in accounting principle (5,722) 2,052 7,204 1,534 5,533 Extraordinary item, net of tax (124) -- -- (6,334) (2,335) Cumulative effect of change in accounting for start-up costs, net of tax -- -- (304) -- -- -------- -------- -------- -------- -------- Net income (loss) (5,846) 2,052 6,900 (4,800) 3,198 Preferred return on special redeemable preferred limited partnership interests -- -- -- -- (1,104) -------- -------- -------- -------- -------- Net income (loss) available for distribution to partners and shareholders $ (5,846) $ 2,052 $ 6,900 $ (4,800) $ 2,094 ======== ======== ======== ======== ======== Distribution to partners, excluding preferred distributions $ -- $ -- $ -- $ 2,500 $ 6,035 ======== ======== ======== ======== ======== Cash earnings per common share(1) $ 0.67 $ 0.92 $ 1.21 $ 0.17 $ 0.96 ======== ======== ======== ======== ========
(1) Income (loss) before extraordinary item and cumulative effect of change in accounting principle, plus depreciation and amortization and asset impairment and contractual loss per diluted share. 19 20
Predecessor ----------- Years Ended December 31, ----------------------------------------------------------------------- 2000 1999 1998 1997 1996 ------- ------- ------- ------- ------- STATEMENT OF OPERATIONS DATA: (in thousands, except per share data) Pro forma earnings data: Income from continuing operations before income taxes and extraordinary item $ 6,124 $ 4,569 Pro forma income tax expense 2,210 1,644 ------- ------- Pro forma income from continuing operations before extraordinary item 3,914 2,925 Income (loss) from home health operations, net of pro forma tax (155) 27 ------- ------- Pro forma income before extraordinary item 3,759 2,952 Preferred return on special redeemable preferred limited partnership interests -- 1,104 ------- ------- Pro forma income before extraordinary item available for distribution to $ 3,759 $ 1,848 partners and shareholders ======= ======= EARNINGS (LOSS) PER SHARE: Basic earnings (loss) per share from continuing operations before extraordinary item and cumulative effect of change in accounting principle $ (0.34) $ 0.12 $ 0.67 ======= ======= ======= Basic earnings (loss) per share $ (0.34) $ 0.12 $ 0.49 ======= ======= ======= Pro forma basic earnings per share before extraordinary item available for distribution to partners and shareholders $ 0.36 $ 0.20 ======= ======= Weighted average basic shares outstanding 17,086 17,129 13,947 10,577 9,375 ======= ======= ======= ======= ======= Diluted earnings (loss) per share from continuing operations before extraordinary item and cumulative effect of change in accounting principle $ (0.34) $ 0.12 $ 0.66 ======= ======= ======= Diluted earnings (loss) per share $ (0.34) $ 0.12 $ 0.49 ======= ======= ======= Pro forma diluted earnings per share before extraordinary item available for distribution to partners and shareholders $ 0.35 $ 0.20 ======= ======= Weighted average diluted shares outstanding 17,086 17,177 14,074 10,675 9,375 ======= ======= ======= ======= =======
Predecessor ----------- At December 31, -------------------------------------------------------------------------- 2000 1999 1998 1997 1996 -------- -------- -------- -------- --------- (in thousands) BALANCE SHEET DATA: Cash and cash equivalents $ 19,850 $ 21,881 $ 20,400 $ 44,583 $ 3,222 Working capital (deficit) 14,280 23,590 25,804 47,744 (14,289) Land, buildings and equipment, net 473,062 431,560 388,404 229,898 213,124 Total assets 792,480 740,411 595,854 317,154 228,162 Long-term debt, including current portion 483,690 435,988 300,667 237,354 170,689 Refundable portion of life estate fees 44,739 43,386 48,805 -- -- Partners' and shareholders' equity 141,957 148,168 145,842 53,918 37,882
20 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company is a national senior living and health care services provider offering a broad range of care and services to seniors within a residential setting. The Company currently operates 62 senior living communities in 15 states with an aggregate capacity for approximately 14,500 residents. The Company currently owns 21 communities, leases 21 communities pursuant to long-term leases, and manages 20 communities pursuant to management agreements. At December 31, 2000, the Company's owned communities had a stabilized occupancy rate of 93%, its leased communities had a stabilized occupancy rate of 95%, and its managed communities had a stabilized occupancy rate of 89%. The Company defines a community or expansion thereof to be stabilized when that community or expansion has either achieved 95% occupancy or been open at least 12 months. The Company's long-term strategy is to develop and operate Senior Living Networks in major metropolitan regions. The Company portfolio of communities includes 32 large Retirement Centers and 30 Free-standing ALs, with capacity for approximately 11,700 and 2,800 residents, respectively. During 2000, the Company's Retirement Centers and Free-standing ALs generated 93% and 7% of total resident fees, respectively. Many of the Free-standing ALs are located within the same major metropolitan regions as the Retirement Centers and function as satellites to those Retirement Center hubs in order to form Senior Living Networks and expand the continuum of housing and care into the market. The Company believes that this hub and satellite approach produces management efficiencies and market penetration by offering a range of senior living arrangements at various price levels. During the late 1990s and 2000, the assisted living market has suffered from adverse market conditions including significant overcapacity in most markets, longer fill-up periods, price discounting and price pressures, and increasing labor and insurance costs. As a result, the Company ceased its development of Free-standing ALs in late 1999 in order to focus on improving the performance of its existing Retirement Centers, filling its Free-standing ALs, increasing the Company's cashflow and strengthening the Company's balance sheet. Although the Company abandoned its development program late in 1999, during 2000 the number of Free-standing ALs operated by the Company, or the Free-standing AL Portfolio, grew from 20 (four owned, three leased, and 13 Managed SPE Communities) to 30 (six owned, 12 leased, and 12 Managed SPE communities); therefore the consolidated Free-standing AL communities grew from seven to 18. Substantially all of these Free-standing ALs are in the fill-up stage and are generating losses. Management expects these losses to continue until the Free-standing ALs reach stabilized occupancy, which is estimated to be approximately 15 to 24 months after opening. The Company has recently completed the expansion of two of its existing Retirement Centers. In addition, the Company is formulating plans to develop or expand certain senior living communities, but does not intend to initiate the construction of these projects prior to finalizing acceptable financing arrangements or obtaining satisfactory equity financing through joint ventures or similar arrangements. RESULTS OF OPERATIONS The Company's total revenues from continuing operations are comprised of (i) resident and health care revenues and (ii) management and development services revenues, which include fees, net of reimbursements, for the development, marketing, and management of communities owned by third parties. The Company's resident and health care revenues are derived from four principal sources: (i) monthly service fees and ancillary revenues from independent and assisted living residents, representing 80.0%, 82.8%, and 83.7% of total resident and health care revenues for the years ended December 31, 2000, 1999, and 1998, respectively; (ii) per diem charges from nursing patients, representing 17.6%, 14.3%, and 14.2% of total resident and health care revenues for the years ended December 31, 2000, 1999, and 1998, respectively; and (iii) the amortization of non-refundable entrance fees over each resident's actuarially determined life expectancy (or building life for contingent refunds), representing 2.4%, 2.9%, and 2.1% of total resident and health care revenues for the years ended December 31, 2000, 1999, and 1998, respectively. Approximately 95.0%, 95.6%, and 95.3% of the Company's total revenues 21 22 for the years ended December 31, 2000, 1999, and 1998, respectively, were attributable to private pay sources, with the balance attributable to Medicare, including Medicare-related private co-insurance and Medicaid. Certain communities provide housing and health care services through entrance fee agreements with residents. Under these agreements, residents pay an entrance fee upon entering into a lifecare contract. The amount of the entrance fee varies depending on the resident's health care benefit election. These agreements obligate the Company to provide certain levels of future health care services to the resident for defined periods of care, in some cases for life. The agreement terminates when the unit is vacated. A portion of the fee is refundable to the resident or the resident's estate upon termination of the agreement. The refundable amount is recorded by the Company as refundable portion of life estate fees, a long-term liability, until termination of the agreement. The remainder of the fee is recorded as deferred life estate income and is amortized into revenue using the straight-line method over the estimated remaining life expectancy of the resident, based upon annually adjusted actuarial projections. Additionally, under these agreements the residents pay a monthly service fee which entitles them to the use of certain amenities and services. They may also elect to obtain additional services, which are paid for on a monthly basis or as the services are received. The Company recognizes these additional fees as revenue on a monthly basis when earned. The Company also provides housing to residents at certain communities under an entrance fee agreement whereby the entrance fee is fully refundable to the resident or the resident's estate contingent upon the occupation of the unit by the next resident. The resident also shares in a percentage, typically 50%, of any appreciation in the entrance fee from the succeeding resident. The entrance fee is recorded by the Company as refundable portion of life estate fees and is amortized into revenue using the straight-line method over the remaining life of the buildings. Additionally, under these agreements the residents pay a monthly service fee, which entitles them to the use of certain amenities and services. They may also elect to obtain additional services, which are paid for on a monthly basis or as the services are received. The Company recognizes these additional fees as revenue on a monthly basis when earned. If a resident terminates the agreement, they are required to continue to pay their monthly service fee for the lesser of one year or until the unit is reoccupied. The Company's management agreements are generally for terms of three to 20 years, but certain of such agreements may be canceled by the owner of the community, without cause, on three to six months' notice. Pursuant to the management agreements, the Company is generally responsible for providing management personnel, marketing, nursing, resident care and dietary services, accounting and data processing services, and other services for these communities at the owners' expense; and receives a monthly fee for its services based either on a contractually fixed amount or a percentage of revenues or income. Two of the Company's management agreements are for communities with aggregate resident capacity for approximately 1,650 residents and terms of twenty-years, with two ten-year renewals and include a purchase option for one of the communities. The management fee for these two agreements is equal to all cash received from these two communities in excess of operating and financing expenses and certain cash payments to the owner of the community. The Company's existing management agreements expire at various times through June 2018. The Company provides development services to owners of senior living communities. Fees for these services are based upon a percentage of the total construction costs of the community. Development services revenue is recognized under the percentage-of-completion method based upon the Company's costs of providing such services. The Company's operating expenses are comprised, in general, of (i) community operating expenses, which includes all operating expenses of the Company's owned or leased communities; (ii) lease expense; (iii) general and administrative expense, which includes all corporate office overhead; and (iv) depreciation and amortization expense. 22 23 SEGMENT RESULTS The Company's operations are divided into two segments: (1) Retirement Centers and (2) Free-standing ALs. The 32 Retirement Centers represent the large retirement communities that provide some or all of independent living, assisted living and skilled nursing care. A majority of the Retirement Centers are stabilized, including recent expansions, and averaged 94% occupancy during 2000. The portfolio of Free-standing ALs operated by the Company has increased from 20 (four owned, three leased, and 13 Managed SPE Communities) at December 31, 1999 to 30 (six owned, 12 leased, and 12 Managed SPE Communities) at December 31, 2000; therefore the consolidated number of Free-standing AL Communities increased from seven to 18. Substantially all of these are unstabilized and in the fill-up stage. The Company has been and continues to be focused on increasing and maintaining occupancy and controlling operating margin in all communities. The following table sets forth certain selected financial and operating data on an operating segment basis(1) (in thousands).
Total Total $ % Q1 Q2 Q3 Q4 2000 1999 Variance Variance -- -- -- -- ----- ----- -------- -------- Revenues: Retirement Centers $ 43,161 $ 45,172 $ 48,700 $ 50,572 $ 187,605 $ 159,531 28,074 17.6% Free-standing ALs 1,988 2,692 3,660 5,110 13,450 4,959 8,491 171.2% Corporate/Other 1,628 898 1,072 1,461 5,059 10,780 (5,721) (53.1)% ------------------------------------------------------------------------------------------------ Total $ 46,777 $ 48,762 $ 53,432 $ 57,143 $ 206,114 $ 175,270 30,844 17.6% ================================================================================================ NOI / Community EBITDAR:(2) Retirement Centers $ 15,254 $ 15,855 $ 16,547 $ 17,585 $ 65,241 $ 58,722 6,519 11.1% Free-standing ALs (64) (539) (1,132) (1,116) (2,851) 6 (2,857) n/a Corporate/Other (2,671) (3,476) (3,643) (4,576) (14,366) (4,456) (9,910) 222.4% ------------------------------------------------------------------------------------------------ Total $ 12,519 $ 11,840 $ 11,772 $ 11,893 $ 48,024 $ 54,272 (6,248) (11.5)% ================================================================================================ Total Assets: Retirement Centers $ 429,876 $ 451,106 $ 456,550 $ 445,020 $ 445,020 $ 426,331 18,689 4.4% Free-standing ALs 36,027 60,559 69,450 68,266 68,266 22,047 46,219 209.6% Corporate/Other 304,427 285,888 286,488 279,194 279,194 292,033 (12,639) (4.3)% ------------------------------------------------------------------------------------------------ Total $ 770,330 $ 797,553 $ 812,488 $ 792,480 $ 792,480 $ 740,411 52,269 7.1% ================================================================================================
(1) Selected financial and operating data does not include any inter-segment transactions or allocated costs. (2) Net Operating Income ("NOI"), or Community EBITDAR is defined as earnings before net interest expense, income tax expense (benefit), depreciation, amortization, rent, and other special charges related to asset write-offs and write-downs, equity in loss of Managed SPE Communities, other income (expense), minority interest, and extraordinary items. 23 24 YEAR ENDED DECEMBER 31, 2000 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1999 Revenues Total revenues were $206.1 million in 2000, compared to $175.3 million in 1999, representing an increase of $30.8 million, or 17.6%. Resident and health care revenues increased by $36.2 million, and management and development services revenue decreased by $5.4 million during the period. The increase in resident and health care revenue was primarily attributable to revenues derived from senior living communities acquired or leased after December 31, 1999. Management and development services revenue decreased as a percentage of total revenue to 2.6% from 6.1%, respectively. The decrease in management and development services revenue is primarily related to a decrease in development fees, as well as decreased management fees at certain properties as a result of lower sales of new units, which reduces the formula-based management fees. In late 1999, the Company discontinued new development of freestanding assisted living residences, for which the Company received development fees. The Company had a stabilized occupancy rate of 92% compared to 93% as of December 31, 2000 and 1999, respectively, and had a total occupancy rate of 83% compared to 86% as of December 31, 2000 and 1999, respectively. The decrease in the total occupancy rate is a result of new communities and expansions that have increased capacity from 13,600 as of December 31, 1999 to 14,500 as of December 31, 2000, many of which are in the fill-up stage. Retirement Center resident and health care revenues were $187.6 million in 2000, compared to $159.5 million in 1999, representing an increase of $28.1 million, or 17.6%. This increase was primarily attributable to increased average occupancies, as well as rate increases. Free-standing AL community resident and health care revenues increased from $5.0 million in 1999 to $13.5 million in 2000. This increase is largely related to the increase from seven to 18 consolidated Free-standing AL communities, as well as the fill-up and increased occupancy of these communities during the year. The $5.7 million reduction in Corporate and Other Revenues relates to the decreased management and development services revenues noted above. Community Operating Expense Community operating expense increased to $138.7 million in 2000, as compared to $106.0 million in 1999, representing an increase of $32.7 million, or 30.8%. The increase in community operating expenses was primarily attributable to expenses from expansions and communities acquired or leased after December 31, 1999. Additionally, this increase is the result of increased labor, insurance, facility and marketing costs at various new communities, as well as expansion of services provided within all communities. Community operating expense as a percentage of resident and health care revenues increased to 69.1% from 64.4% for the twelve months ended December 31, 2000 and 1999, respectively. The increase in community operating expense as a percentage of resident and health care revenues is primarily attributable to the acquisition of leasehold interests during the second half of 1999 and during 2000 of various Free-standing ALs that were Managed SPE Communities, which are in the fill-up stage. The Company anticipates that the fill-up of these communities will occur over the next 15 to 24 months. The Company expects community operating expense to remain at greater than historical levels as a percentage of resident and health care revenues as the Company anticipates additional acquisitions of leasehold interests of Managed SPE Communities. Retirement Center operating expenses were $122.4 million in 2000, compared to $100.8 million in 1999, representing an increase of $21.6 million, or 21.4%. This increase was primarily attributable to increased average occupancies, and reflects a slight reduction in gross margin from the prior year due to expansions. Free-standing ALs operating expenses increased from $5.0 million in 1999 to $16.3 million in 2000. This increase is largely related to the increase from seven to 18 consolidated free-standing AL communities, as well as the fill-up and increased occupancy of these communities during the year. General and Administrative General and administrative expense increased to $19.4 million for 2000, as compared to $15.0 million for 1999, representing an increase of $4.4 million, or 29.3%. The increase was primarily related to increases in salaries and benefits associated with the operation of an increased number of communities, as well as the overhead support costs associated with the Senior Living Networks in various geographic areas. In addition, over $968,000 of the increase relates to severance costs incurred in December 2000, as a result of the elimination of twelve positions. The Company anticipates that the elimination of these positions will result in annual savings of approximately $1.0 million. General and administrative expense as a percentage of total revenues increased to 9.4% compared to 8.6% for the twelve months ended December 31, 2000 and 1999, respectively. 24 25 EBITDAR (Community NOI) Retirement Center EBITDAR increased $6.5 million or 11.1%, from $58.7 million for 1999 to $65.2 million for 2000. This increase relates to continued improvement throughout the Retirement Centers, resulting from stabilized occupancy and increased capacity through expansions, rate increases, and improved control of overhead expense. Consolidated Free-standing AL EBITDAR decreased $2.9 million, from a positive $6,000 in 1999 to a $2.9 million loss in 2000. The 2000 loss resulted from the 13 leasehold interests and one community acquired during 2000. Two of the 13 leasehold interests and the one community acquired during 2000 opened during the first quarter of 2001, and one of the communities was subsequently leased to a third party during 2000. As the majority of these communities are unstabilized, the Company expects to continue to incur losses during this fill-up stage. Corporate and Other EBITDAR decreased $9.9 million from a $4.5 million loss in 1999 to a $14.3 million loss in 2000. This decrease in Corporate and Other EBITDAR resulted from the reduction in development and management fee revenues of $5.4 million, additional Corporate costs associated with corporate operations, human resources, financial services and overhead, assisted living management costs of $937,000, as well as severance costs of $968,000 related to terminated employees. Lease Expense Lease expense increased to $18.3 million for 2000, as compared to $13.0 million for 1999, representing an increase of $5.3 million, or 40.7%. This increase was attributable to leases entered into after December 31, 1999, including several acquisitions of leasehold interests. Depreciation and Amortization Depreciation and amortization expense increased to $17.1 million in 2000 from $13.7 million in 1999, representing an increase of $3.4 million, or 25.2%. The increases were primarily related to the increase in depreciable assets of approximately $47.5 million during the year. These assets relate primarily to the opening or acquisition of communities, including leasehold interests, and expansion of communities since December 31, 1999, as well as ongoing capital expenditures. Asset Impairment and Contractual Losses During the fourth quarter ended December 31, 1999, the Company announced that, due to a shift in its growth strategy from development to acquisitions of senior living communities, it would be abandoning certain development projects and reviewing others with regard to fit with its senior living network strategy. As a result, the Company recorded asset impairment and contractual loss charges of approximately $12.5 million during the quarter ended December 31, 1999. Other Income (Expense) Interest expense increased to $36.5 million in 2000 from $23.7 million in 1999, representing an increase of $12.8 million, or 54.3%. The increase in interest expense was primarily attributable to indebtedness incurred in connection with acquisitions and development activity, as well as increased interest rates. Interest expense, as a percentage of total revenues, increased to 17.7% for 2000 from 13.5% in 1999. Interest income increased to $14.8 million in 2000 from $9.1 million in 1999, representing an increase of $5.7 million, or 62.1%. The increase in interest income was primarily attributable to income generated from larger certificates of deposit and notes receivable balances associated with certain leasing transactions and management agreements. Equity in loss of Managed SPE Communities increased from $374,000 in 1999 to $2.2 million in 2000, representing an increase of $1.8 million. The increase in equity in loss of Managed SPE Communities relates to the significant fill-up losses that the Company is obligated to fund when operating deficits exceed specified limits. Income Tax Expense The provision for income taxes was a $3.5 million benefit compared to a $1.1 million expense for the twelve months ended December 31, 2000 and 1999, respectively. The Company's effective tax rate was 34.0% and 38.0% for the twelve months ended December 31, 2000 and 1999, respectively. Minority Interest in Losses of Consolidated Subsidiaries, Net of Tax Minority interest in losses of two consolidated subsidiaries, net of tax, for the twelve months ended December 31, 2000 was $961,000, representing an increase of $684,000 from $277,000 for 1999. The increase was primarily attributable to the losses of one of the communities which opened in May 2000. 25 26 Extraordinary Loss During the period ended December 31, 2000, the Company repaid a term note to a bank. As part of this transaction, the Company incurred a prepayment penalty of $124,000, net of income taxes, which was recorded as an extraordinary loss on the extinguishment of debt. Net Income (Loss) Based upon the factors noted above, the Company experienced a net loss of $5.8 million, or $.34 per dilutive share, compared to net income of $2.1 million, or $.12 per dilutive share, for the twelve months ended December 31, 2000 and 1999, respectively. YEAR ENDED DECEMBER 31, 1999 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1998 Revenues Total revenues were $175.3 million in 1999, compared to $142.4 million in 1998, representing an increase of $32.9 million, or 23.1%. Resident and health care revenues increased by $34.6 million, and management and development services revenue decreased by $1.6 million during the period. Approximately $28.0 million, or 80.9%, of the increase was attributable to new senior living communities acquired, leased or developed in 1999 and 1998, including $17.6 million from the FGI communities acquired in July 1998. The remaining increase of $3.4 million, or 9.8%, was attributable to increases in resident and health care revenues at the two communities with large expansions that opened in 1998. The decrease in management and development services revenue of $1.6 million, or 13.3%, was primarily related to the Company's decision to move to an acquisitions-oriented method of building its Senior Living Networks and, therefore, to discontinue new development of Free-standing ALs, for which the Company receives development fees. Community Operating Expense Community operating expense increased to $106.0 million in 1999, as compared to $82.7 million in 1998, representing an increase of $23.3 million, or 28.2%. Approximately $20.0 million, or 85.8%, of the increase was attributable to expenses from new leased or acquired senior living communities, including $11.4 million from the FGI communities acquired in July 1998. The remaining increase of $2.3 million, or 9.9%, was attributable to increases in operating expenses at the two communities with expansions that opened in 1998. Community operating expense as a percentage of resident and health care revenues increased to 64.4% for 1999 from 63.6% for 1998. This increase was attributable to labor cost increases at certain operating communities and startup losses at consolidating joint venture developments and community expansions. General and Administrative General and administrative expense increased to $15.0 million for 1999, as compared to $10.6 million for 1998, representing an increase of $4.4 million, or 42.0%. The increase was primarily related to the July 1998 FGI acquisition and other increases in corporate and regional staff to support increased operations. General and administrative expense as a percentage of total revenues was 8.6% for 1999 compared to 7.4% for 1998. Lease Expense Lease expense increased $3.9 million to $13.0 million for 1999, as compared to $9.1 million for 1998, primarily as a result of leases entered into for new senior living communities and increased lease costs at a community with an expansion that opened in late 1998. Depreciation and Amortization Depreciation and amortization expense increased to $13.7 million in 1999 from $10.0 million in 1998, representing an increase of $3.7 million, or 36.6%. The increase is primarily related to communities acquired during 1998 which had a full year of depreciation in 1999, depreciation related to recently completed expansions, and amortization of costs in excess of assets acquired in the July 1998 FGI transaction. Asset Impairment and Contractual Losses During the fourth quarter ended December 31, 1999, the Company announced that due to a shift in its growth strategy from development to acquisitions of senior living communities it would be abandoning certain development projects and reviewing others with regard to fit with its senior living network strategy. As a result, the Company recorded asset impairment and contractual loss charges of approximately $12.5 million during the quarter ended December 31, 1999. 26 27 Other Income (Expense) Interest expense increased to $23.7 million in 1999 from $17.9 million in 1998, representing an increase of $5.7 million, or 32.0%. The increase in interest expense was primarily attributable to indebtedness incurred in connection with development financing provided to third parties. Interest expense, as a percentage of total revenues, increased to 13.5% for 1999 from 12.6% in 1998. Interest income increased to $9.1 million in 1999 from $4.1 million in 1998, representing an increase of $5.0 million, or 122.9%. The increase in interest income was primarily attributable to income generated from increased certificates of deposit and notes receivable balances associated with certain leasing transactions and management agreements. Income Tax Expense Income tax expense related to continuing operations in 1999 was $1.1 million, or an effective rate of 38.0%, as compared to $5.7 million, or an effective rate of 37.7%, in 1998. Minority Interest in Losses of Consolidated Subsidiaries, Net of Tax Minority interest in losses of two consolidated subsidiaries, net of tax for the twelve months ended December 31, 1999 was $277,000. The loss was primarily attributable to communities in the fill-up stage. Net Income The Company experienced net income of $2.1 million, or $.12 per diluted share, compared to net income of $6.9 million, or $.49 per diluted share, for the period ended December 31, 1999 and 1998, respectively. The primary cause of the decrease was due to the shift in the Company's growth strategy away from development of senior living communities, resulting in the abandonment of certain development projects, and the consequent recording of asset impairment and contractual loss charges of approximately $12.5 million during the quarter ended December 31, 1999. LIQUIDITY AND CAPITAL RESOURCES Cashflow Net cash provided by operating activities was $6.4 million for the year ended December 31, 2000, as compared with $23.3 million and $23.4 million for the years ended December 31, 1999 and 1998, respectively. The Company's unrestricted cash balance was $19.8 million as of December 31, 2000, as compared to $21.9 and $20.4 million as of December 31, 1999 and 1998, respectively. Net cash used by investing activities was $40.1 million for the year ended December 31, 2000, as compared with $152.2 million and $151.1 million, respectively, for the years ended December 31, 1999 and 1998. During the year ended December 31, 2000, the Company made additions to land, buildings, and equipment, including construction activity, of $49.0 million, acquisitions of $6.4 million and leasehold acquisitions of $15.0 million, and purchased $3.6 million of assets limited as to use, received $26.5 million from sales of fixed assets, received reimbursement for advances to development projects of $3.7 million, and received refunds of deposits of $3.75 million from purchase options. Net cash provided by financing activities was $31.7 million for the year ended December 31, 2000, as compared with $130.4 million and $103.5 million, respectively, for the years ended December 31, 1999 and 1998, respectively. During 2000, the Company borrowed $89.5 million under long-term debt arrangements, made principal payments on its indebtedness of $49.9 million, and incurred $3.3 million of financing costs. In connection with certain lifecare communities, the Company also made principal payments and refunds under master trust agreements of $3.7 million. Financing Activity During the year ended December 31, 2000, the Company entered into various financing commitments including a secured term loan from a mortgage lender in the amount of $23.3 million, with interest payable at LIBOR plus 3%. Interest and principal are payable monthly, based on a twenty-five year amortization, with all remaining balances due in April 2003. The maturity date of the note may be extended to April 2005 upon satisfaction of certain conditions. 27 28 The Company also entered into a secured term loan with a finance company in the amount of $2.5 million, with interest payable at LIBOR plus 3 3/4%. Interest and principal are payable monthly, with interest only payments during the first year. The remaining balance on the note is due in full in April 2002, but can be extended to April 2003 based upon the satisfaction of certain conditions. The Company used a portion of the proceeds from these two loans to prepay a $14.3 million term note to a bank. As part of this transaction, the Company incurred a prepayment penalty of $124,000, net of income taxes, which was recorded as an extraordinary loss on extinguishment of debt during the first quarter of 2000. In connection with the expansion of a Retirement Center, the Company increased a mortgage note payable to a bank from $6.8 million to $11.4 million. Interest is payable monthly at LIBOR plus 2 1/4%, and the loan matures December 2, 2002. As of December 31, 2000, $11.1 million was outstanding on this note. The Company also entered into a mortgage note with an investment company in the amount of $12.0 million, which bears interest at 9.5%. Payments of principal and interest are payable monthly, with the note maturing in June 2025. The note is secured by certain land and buildings. As of December 31, 2000, $11.9 million was outstanding on this note. The Company assumed a mortgage note payable to a bank in the amount of $7.9 million as part of the dissolution of a joint venture in which the Company was a member. Interest and principal are payable monthly, with the note maturing in March 2006. Interest is paid at a fixed rate of the June 10, 1999 Treasury rate plus 2%, or 7.89%. The note is secured by certain land and buildings. As of December 31, 2000, $7.9 million was outstanding on this note. The Company entered into a construction loan with a mortgage lender in the amount of $10.3 million, with variable interest payable at LIBO plus 2%. Interest is payable monthly, with the principal maturing in September 2003. The maturity date of the note may be extended to September 2005 upon satisfaction of certain conditions. As of December 31, 2000, $9.3 million was outstanding on this note. The remaining $23.5 million of proceeds from issuance of long-term debt was from additional borrowings under existing credit facilities, primarily from a $100.0 million revolving line of credit, of which $91.1 million was outstanding at December 31, 2000. These funds were used primarily for construction or expansion of retirement communities, and expenditures for acquisitions of retirement communities and leasehold acquisitions. On December 18, 2000, the Company sold a community located in Westlake, Ohio for $25.4 million and subsequently leased the property back from the buyer. The Company used a portion of the proceeds from the sale to repay $17.0 million of a $50.0 million revolving line of credit. The Company expects that a portion of the taxable gain from the transaction will be deferred by like-kind exchanges, that the Company anticipates consummating during 2001. The Company expects that, upon completion of all like-kind exchanges, the transaction will result in net proceeds of approximately $5.7 million. In December 1999, the Company announced plans to buy back up to $1.5 million of its common stock to fund the Company's contributions to its employee benefit plans for 2000 and 2001. At December 31, 2000, the Company had purchased $1,198,000, or 211,400 shares of common stock, and considers the stock buy back program to be complete. The Company also announced, in March 2000, that the Board of Directors had authorized the repurchase, from time to time, of up to $30.0 million of the Company's 5 3/4% Convertible Debentures. The timing and amount of purchases of these debentures will depend upon prevailing market conditions, availability of capital, alternative uses of capital and other factors. As of December 31, 2000, the Company had not purchased any 5 3/4% Convertible Debentures. Purchases, if any, would be made primarily in the open market during 2001. Free-standing ALs and Managed SPE Communities The Company has a total of 30 Free-standing AL's. Since January 1, 1999, the Company has constructed and opened 22 Free-standing ALs, 12 of which opened during 2000. The Company has ceased development of new Free-standing ALs, and has only one free-standing assisted living community that is not in operation. The remaining Free-standing AL opened in the first 28 29 quarter of 2001. At December 31, 2000, the Company managed 12 of these Free-standing ALs for SPEs, including six SPEs which are affiliated with John Morris, a director of the Company. The Company is responsible for cumulative operating costs above specified limits for each of these Managed SPE Communities, which costs are recorded as equity in losses of Managed SPE Communities. Substantially all of the Company's Free-standing ALs, including Managed SPE Communities, are in the pre-stabilized fill-up stage. As a result, the Company expects its Free-standing AL portfolio (both consolidated Free-standing ALs and Managed SPE Communities) to continue to incur substantial losses throughout 2001. The Company believes that the losses to be incurred will decrease each successive quarter, primarily as a result of increased occupancy at these communities. The Company's consolidated results will include increased losses from Free-standing ALs in 2001 versus 2000, as a result of a full year of activity in 2001 for these communities opened during 2000, an increased number of Free-standing ALs which are included in consolidated results (as a result of acquiring various communities and leasehold interests during 2000 and 2001), and increased equity in losses of Managed SPE Communities (as cumulative operating costs exceed the limits for which the SPEs are responsible). The Company has options to purchase or has rights of first refusal to acquire the leasehold interests in these Managed SPE Communities, but is under no obligation to do so. The Company acquired 13 of these leasehold interests and acquired one community during 2000. Two of the 13 leasehold interests and the one community acquired during 2000 opened during the first quarter of 2001, and one of the communities was subsequently leased to a third party during 2000. The Company is in discussions with the various SPEs to assume some or all of the remaining 12 communities that are currently managed by the Company. The aggregate development costs of the 12 communities was approximately $152 million, excluding the working capital to fund operations during their respective fill-up periods. Of the $152 million of total development costs, $41.5 million was provided by REIT lessors, $66 million was provided by first mortgage debt (guaranteed by the Company), and the balance of $44.5 million was provided by the Company in the form of notes receivable. If offered and accepted, the Company anticipates acquiring certain, and perhaps all, of those leasehold interests in Managed SPE Communities during 2001 and 2002. If all were acquired, the combined purchase price would be approximately $20.0 to $25.0 million. The timing of these leasehold acquisitions will depend on a variety of factors, including prevailing market conditions, the Company's financing plans, the availability of capital, alternative uses of capital, and general economic conditions. If the Company does not acquire these leasehold interests, the Company is still responsible for funding future operating losses which exceed specified limits. Liquidity The Company has historically financed its activities with the net proceeds from public offerings of debt and equity, long-term mortgage borrowings, term and revolving credit facilities and cash flows from operations. At December 31, 2000, the Company had $483.7 million of indebtedness outstanding, including $138.0 million of Convertible Debentures, with fixed maturities ranging from May 2001 to April 2028 and was obligated to pay minimum rental obligations in 2001 of approximately $28.2 million under long-term operating leases. As of December 31, 2000, approximately 57.0% of the Company's indebtedness bore interest at fixed rates, with a weighted average interest rate of 6.94%. The Company's variable rate indebtedness carried an average rate of 7.76% as of December 31, 2000. As of December 31, 2000, the Company had working capital of $14.5 million. The Company's various credit facilities contain numerous financial covenants that require the Company to maintain certain prescribed debt service coverage, liquidity, net worth, capital expenditure reserves and occupancy levels. Effective as of September 30, 2000, the Company amended several of these financial covenants in order to remain in compliance therewith. Compliance with these covenants is dependent, among other things, upon improvements in the operations of the Company's Free-standing ALs. There can be no assurances that the Company will remain in compliance with those financial covenants or that its lenders will grant further amendments in the event of such non-compliance. Failure to maintain compliance with the financial covenants would have a significant adverse impact on the Company. 29 30 Most of the Company's owned communities are subject to mortgages. Each of the Company's debt agreements contains restrictive covenants that generally relate to the use, operation, and disposition of the communities that serve as collateral for the subject indebtedness, and prohibit the further encumbrance of such community or communities without the consent of the applicable lender. The Company does not believe the covenants relating to the use, operation, and disposition of its communities materially limit its operations. A significant amount of the Company's indebtedness is cross-defaulted. Any non-payment or other default with respect to such obligations (including non-compliance with a financial covenant) could cause lenders to cease funding and accelerate payment obligations or to foreclose upon the communities securing such indebtedness. Furthermore, because of cross-default and cross-collateralization provisions in certain of the Company's mortgages, debt instruments, and leases, a default by the Company on one of its payment obligations is likely to result in default or acceleration of a majority of the Company's other obligations. As part of its financing activities, the Company intends to consider selective dispositions of communities that do not fit within its senior living network strategy. The Company's ability to sell any such properties depends upon the market demand for property, the equity in the mortgaged property, and the general economic conditions of the senior living industry. The Company has several significant debt obligations which will mature in the next two years, including a $100.0 million revolving line-of-credit that matures on May 1, 2002 (of which $91.1 million is outstanding as of December 31, 2000), and $138.0 million of Convertible Debentures that mature on October 1, 2002. The Company must repay or refinance these debt instruments as they mature. The Company expects that its current cash and cash equivalents, cash flow from operations and borrowings available to it under existing credit arrangements will be sufficient to meet its operating requirements and to fund its start-up losses, and capital expenditure and debt service requirements during 2001. The Company's internally generated cash will not be sufficient to meet the obligations of debt instruments maturing in 2002. Due to adverse market conditions, the Company believes that it is unlikely that it will be able to raise capital in the public equity markets for the foreseeable future. Accordingly, the Company's ability to repay or refinance its maturing obligations will depend, in large part, upon its ability to renew existing credit facilities and arrangements or to obtain new credit facilities or arrangements on acceptable terms. The Company is also focusing on generating additional cash from incremental leverage, including possible combinations of senior and mezzanine financing. At the same time, the Company is examining other alternatives for raising capital, including the monetization of investments in certain of the stabilized communities. The Company has engaged in preliminary discussions with its existing lenders regarding the extension of certain of the Company's maturing credit facilities. The Company's ability to obtain new credit facilities and to repay or refinance its existing indebtednesses depends upon a number of factors, including the Company's financial condition and operating performance, the financial strength of the assets to be encumbered, general economic conditions, general conditions in the credit markets, mortgage interest rates and other factors. The Company's efforts to obtain new or replacement financing will be adversely affected by the condition of the assisted living market in general, the insolvency or weakened financial conditions of many assisted living competitors, a reduced number of lenders willing to finance assisted living or retirement companies and the fact that the Company is highly leveraged. However, based upon preliminary discussions with certain of the Company's existing and new lenders, coupled with banking relationships that the Company believes are positive, the Company believes it will be able to obtain new credit facilities and/or extensions of existing credit facilities necessary to allow it to meet all of its financial obligations and requirements for indebtedness that matures during 2001. There can be no assurances, however, that the Company will successfully negotiate and obtain adequate new credit facilities or extensions of its existing credit facilities, and if such financing is available, that the terms of any such financing will not impose significant burdens on the Company or be dilutive to the Company's existing shareholders. The Company's 5 3/4% Convertible Debentures in the principal amount of $138 million mature on October 1, 2002. It is unlikely that any of those debentures will be converted into the Company's common stock. Accordingly, the Company must repay or refinance those convertible debentures when they come due. The Company announced, in March 2000, that the Board of Directors had authorized the repurchase, from time to time, of up to $30.0 million of the Company's 5 3/4% Convertible Debentures. The timing and amount of purchases of these debentures will depend upon prevailing market conditions, availability of capital, alternative uses of capital and other factors. As of December 31, 2000, the Company had 30 31 not purchased any 5 3/4% Convertible Debentures. Purchases, if any, would be made primarily in the open market during 2001. In addition, the Company has engaged an investment advisor and is considering various capital raising and other alternatives to satisfy the Company's obligations in connection with the Convertible Debentures. There can be no assurance, however, that the Company will be able to refinance, extend or otherwise satisfy its obligations with respect to the Convertible Debentures prior to their maturity or classification as a current liability. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 established reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts. Under SFAS No. 133, the Company would recognize all derivatives as either assets or liabilities, measured at fair value, in the consolidated balance sheet. In July 1999, SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of Effective Date of FASB No. 133, An Amendment of FASB Statement No. 133" was issued deferring the effective date of SFAS 133 to fiscal years beginning after June 15, 2000. In June 2000, SFAS No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities, an Amendment of FASB Statement No. 133" was issued clarifying the accounting for derivatives under the new standard. SFAS 133 standardizes the accounting for derivative instruments. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, if so, on the reason for holding it. If certain conditions are met, entities may elect to designate a derivative instrument as a hedge of exposures to changes in fair values, cash flows, or foreign currencies. If the hedged exposure is a cash flow exposure, the effective portion of the gain or loss on the derivative instrument is reported initially as a component of other comprehensive income (outside earnings) and subsequently reclassified into earnings when the forecasted transaction affects earnings. Any amounts excluded from the assessment of hedge effectiveness as well as the ineffective portion of the gain or loss is reported in earnings immediately. During 1999 and 2000, the Company entered into two interest rate swap agreements as a hedge against certain long-term debt in order to manage interest rate risk. These swap agreements are designated and qualify as cash flow hedges under SFAS No. 133. The Company adopted SFAS No. 133 effective January 1, 2001. It is estimated that adoption of SFAS No. 133 will result in the Company recording a net transition adjustment loss of $1.1 million (net of related income tax of $570,000) in accumulated other comprehensive income at January 1, 2001. Further, the adoption of the Statement will result in the Company recognizing $266,000 of derivative instrument assets and $1.9 million of derivative instrument liabilities. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 establishes specific criterion for revenue recognition. In June 2000, the Securities and Exchange Commission issued SAB 101B, which amends the transition guidance for SAB 101. The SEC delayed the required implementation date of SAB 101 by issuing Staff Accounting Bulletins No. 101A, "Amendment: Revenue Recognition in Financial Statements" and 101B, "Second Amendment: Revenue Recognition in Financial Statements" in March and June 2000, respectively. As a result, SAB 101 was adopted by the Company in the fourth quarter of 2000, effective as of January 1, 2000. The Company's accounting policies are consistent with the requirements of SAB 101, so the implementation of SAB 101 did not have an impact on the Company's operating results. IMPACT OF INFLATION Inflation could affect the Company's future revenues and results of operations because of, among other things, the Company's dependence on senior residents, many of whom rely primarily on fixed incomes to pay for the Company's services. As a result, during inflationary periods, the Company may not be able to increase resident service fees to account fully for increased operating expenses. In structuring its fees, the Company attempts to anticipate inflation levels, but there can be no assurance that the Company will be able to anticipate fully or otherwise respond to any future inflationary pressures. 31 32 RISKS ASSOCIATED WITH FORWARD LOOKING STATEMENTS This Form 10-K contains certain forward-looking statements within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Those forward-looking statements include all statements that are not historical statements of fact and those regarding the intent, belief or expectations of the Company or its management including, but not limited to, the discussions of the Company's operating and growth strategy (including its development plans and possible acquisitions or dispositions), financing needs, projections of revenue, income or loss, capital expenditures, and future operations. Investors are cautioned that all forward-looking statements involve risks and uncertainties, including, without limitation, those set forth under the caption "Risk Factors" below and the Company's other filings with the Securities and Exchange Commission. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could prove to be inaccurate, and therefore, there can be no assurance that the forward-looking statements included in this Form 10-K will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved. The Company undertakes no obligation to publicly release any revisions to any forward-looking statements contained herein to reflect events and circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. RISK FACTORS Need to Refinance Certain Debt Instruments The Company has several significant debt obligations which will become due in the near future. These include, among others, a $100.0 million revolving line-of-credit which matures on May 1, 2002 (of which $91.1 million is outstanding as of December 31, 2000) and $138.0 million of convertible debentures which mature on October 1, 2002. The Company must repay or refinance these debt instruments as they become due. The Company's internally generated cash flow will not be sufficient to meet these obligations. Any non-payment or other default with respect to such obligations could cause lenders to cease funding and to accelerate payment obligations or to foreclose upon the communities securing such indebtedness. The Company may be forced to sell certain properties in order to satisfy these obligations. Furthermore, because of cross-default and cross-collateralization provisions in certain of the Company's mortgages, debt instruments, and leases, a default by the Company on one of its payment obligations is likely to result in default or acceleration of a majority of the Company's other obligations. The Company's ability to refinance these instruments depends upon a number of factors, including the Company's financial condition and operating performance, the financial strength of the assets to be encumbered, general economic conditions, general conditions in the credit markets, mortgage interest rates and other factors. The Company's efforts to obtain new or replacement financing may be adversely affected by the condition of the assisted living market in general, the insolvency or weakened financial conditions of many assisted living competitors, a reduced number of lenders willing to finance assisted living or retirement companies and the fact that the Company is highly leveraged. The Company's ability to sell the mortgaged property depends upon the level of mortgage interest rates, the equity in the mortgage property, market demand for property, general economic conditions and the availability of credit. There is no assurance that the Company will be able to refinance these obligations on a timely basis, and if such refinancing is available, whether the terms will be acceptable to the Company. This inability to repay or refinance these and other obligations would likely materially adversely affect the Company's business, results of operations, and financial condition. Losses from Free-standing ALs The Company has experienced significant losses and expects to continue to experience losses, associated with the fill-up of a large number of Free-standing ALs which were recently developed or acquired. Newly opened Free-standing ALs are expected to incur operating losses during a substantial portion of their first 15 to 24 months of operations, on average, until the communities achieve targeted occupancy levels. The Company expects to acquire additional leasehold interest of Managed SPE Communities during 2001 and 2002 which will result in additional losses. In addition to its consolidated Free-standing AL losses, the Company is responsible for funding operating costs for various Managed SPE Communities which exceed certain specified limits. In addition, the industry is experiencing significant competition and overcapacity in the Free-standing AL segment. There can be no assurance that these Free-standing ALs will be profitable in any future period, which may have a material adverse effect on the Company's financial condition, liquidity, or results of operations. 32 33 Substantial Debt and Operating Lease Payment Obligations At December 31, 2000, the Company had long-term debt, including current portion, of $483.7 million and was obligated to pay minimum rental obligations in 2001 of approximately $28.2 million under long-term operating leases. As a result, a substantial portion of the Company's cash flow will be devoted to debt service and lease payments. There can be no assurance that the Company will generate sufficient cash flows from operations to meet required interest, principal, and lease payments. Many of the Company's debt agreements and leases contain various financial and other restrictive covenants, which may restrict the Company's flexibility in operating its business. Any payment or other default with respect to such obligations could cause lenders to cease funding and accelerate payment obligations or to foreclose upon the communities securing such indebtedness or, in the case of an operating lease, could terminate the lease, with a consequent loss of income and asset value to the Company. Furthermore, because of cross-default and cross-collateralization provisions in certain of the Company's mortgages, debt instruments, and leases, a default by the Company on one of its payment obligations is likely to result in default or acceleration of a majority of the Company's other obligations. Consequently, such a default would adversely affect a significant number of the Company's other properties and, in turn, the Company's business, results of operations, and financial condition. Need for Additional Financing The Company's ability to sustain operating losses, maintain adequate levels of capital spending for its properties, and to otherwise meet its operating objectives will depend, in part, on its ability to obtain additional financing on acceptable terms from available financing sources. The Company's future debt instruments may include covenants restricting the Company's ability to incur additional debt, or otherwise restrict its operating flexibility. Moreover, raising additional funds through the issuance of equity securities would likely be dilutive to the ownership interests of existing shareholders and adversely affect the market price of the Company's common stock. There can be no assurance that the Company will be successful in securing additional financing or that adequate financing will be available and, if available, that the terms of any such financing will not impose significant burdens on the Company or be dilutive to the Company's existing shareholders. Highly Competitive Industry The senior living and health care services industry is highly competitive, and the Company expects that all providers within the industry will become increasingly competitive in the future. The Company competes with other companies providing independent living, assisted living, skilled nursing, and other similar service and care alternatives. Although the Company believes there is a need for senior living communities in the markets where the Company is operating and developing communities, the Company expects that competition will increase from existing competitors and new market entrants, some of whom may have substantially greater financial resources than the Company. In addition, some of the Company's competitors operate on a not-for-profit basis or as charitable organizations and have the ability to finance capital expenditures on a tax-exempt basis or through the receipt of charitable contributions, neither of which are readily available to the Company. The Company also competes with many assisted living companies that are currently insolvent or that are likely to be insolvent in the future. These competitors may gain a competitive advantage over the Company as a result of the effect of bankruptcy or other insolvency proceedings. Furthermore, the development of new senior living communities has exceeded the demand for such communities in certain of the markets in which the Company has or is developing senior living communities. An oversupply of such communities in certain of the Company's markets has caused the Company to experience decreased occupancy, significant downward pricing pressures and discounting, reduced operating margins, and lower profitability. There can be no assurance that the Company will not continue to encounter these conditions or that increased competition will not adversely affect its financial condition, liquidity, or results of operations. 33 34 Liability Insurance and Risks of Liability Claims The Company is subject to various legal proceedings and claims, which arise in the ordinary course of its business. The Company maintains property, general liability and professional malpractice insurance policies for the Company's owned and certain of its managed communities under a master insurance program. Recently, the number of insurance companies willing to provide general liability and professional malpractice liability insurance for the nursing and assisted living industry has declined dramatically. As a result, effective in the third quarter of 2000, the Company has incurred significantly higher liability costs and premiums. This change may impact the Company's ability to obtain and maintain insurance at a cost acceptable to the Company. A continued material increase in insurance costs due to industry trends could also adversely affect the operating earnings of the Company. The Company carries liability insurance against certain types of claims that management believes meets industry standards; however, there can be no assurance that the Company will continue to maintain such insurance, or that any future legal proceedings (including any related judgments, settlements or costs) will not have a material adverse effect on the Company's financial condition, liquidity, or results of operations. Community Management, Staffing, and Labor Costs The Company competes with other providers of senior living and health care services with respect to attracting and retaining qualified management personnel responsible for the day-to-day operations of each of the Company's communities and skilled technical personnel responsible for providing resident care. In certain markets, a shortage of nurses or trained personnel has required the Company to enhance its wage and benefits package in order to compete in the hiring and retention of such personnel or to hire more expensive temporary personnel. The Company will also be heavily dependent on the available labor pool of semi-skilled and unskilled employees in each of the markets in which it operates. The Company has experienced a competitive labor market, periodic shortages of qualified workers in certain markets, and increasing wage rates for many of these employees during the past year. The Company cannot be sure its labor costs will not increase, or that, if they do increase, they can be matched by corresponding increases in rates charged to residents. If the Company is unable to attract and retain qualified management and staff personnel, control its labor costs, or pass on increased labor costs to residents through rate increases, the Company's business, financial condition, and results of operations would be adversely affected. Exposure to Rising Interest Rates Future indebtedness, from commercial banks or otherwise, and lease obligations, including those related to REIT facilities, are expected to be based on interest rates prevailing at the time such debt and lease arrangements are obtained. As of December 31, 2000, the Company had $207.8 million of variable rate debt outstanding. The Company has entered into interest rate swap agreements with a major financial institution to manage its exposure of $53.0 million of debt. The swaps involve the receipt of a fixed interest rate payment in exchange for the payment of a variable rate interest payment without exchanging the notional principal amount. See "--Item 7A - Disclosure About Interest Rate Risk" for further description of the hedge transactions entered into by the Company. Increases in prevailing interest rates could increase the Company's interest or lease payment obligations and could have a material adverse effect on the Company's business, financial condition, and results of operations. Risks Associated With Lifecare Benefits Certain communities owned or operated by the Company are lifecare CCRCs that offer residents a limited lifecare benefit. Residents of these communities pay an upfront entrance fee upon occupancy, of which a portion is generally refundable, with an additional monthly service fee while living in the community. This limited lifecare benefit, is typically (a) a certain number of free days in the community's health center during the resident's lifetime, (b) a discounted rate for such services, or (c) a combination of the two. The lifecare benefit varies based upon the extent to which the resident's entrance fee is refundable. The pricing of entrance fees, refundability provisions, monthly service fees, and lifecare benefits are determined from actuarial projections of the expected morbidity and mortality of the resident population. In the event the entrance fees and monthly service payments established for the communities are not sufficient to cover the cost of lifecare benefits granted to residents, the results of operations and financial condition of the communities would be adversely affected. 34 35 Residents of the Company's lifecare CCRCs are guaranteed an independent living unit and nursing care at the community during their lifetime, even if the resident exhausts his or her financial resources and becomes unable to satisfy his or her obligations to the community. In addition, in the event a resident requires nursing care and there is insufficient capacity for the resident in the nursing facility at the community where the resident lives, the community must contract with a third party to provide such care. Although the Company screens potential residents to ensure that they have adequate assets, income, and reimbursements from government programs and third parties to pay their obligations to the communities during their lifetime, there can be no assurance that such assets, income, and reimbursements will be sufficient in all cases. To the extent that the financial resources of some of the residents are not sufficient to pay for the cost of facilities and services provided to them, or in the event that the communities must pay third parties to provide nursing care to residents of the communities, the Company's results of operations and financial condition would be adversely affected. Risks of Operations in Concentrated Geographic Areas Part of the Company's business strategy is to own, lease or manage senior living communities in concentrated geographic service areas. The Company has a large concentration of communities in Florida, Texas, and Colorado, among other areas. Accordingly, the Company's occupancy rates and operating results in certain of its communities may be adversely affected by a number of factors, including regional and local economic conditions, competitive conditions, applicable local laws and regulations, and general real estate market conditions, including the supply and proximity of other senior living communities. Dependence on Attracting Residents with Sufficient Resources to Pay Approximately 95.0% of the Company's total revenues for the year ended December 31, 2000 were attributable to private pay sources. For the same period, 5.0% of the Company's revenues were attributable to reimbursement from third-party payors, including Medicare and Medicaid. The Company expects to continue to rely primarily on the ability of residents to pay for the Company's services from their own or familial financial resources. Inflation, a change in general economic conditions or other circumstances that adversely affect the ability of seniors to pay for the Company's services could have a material adverse effect on the Company's business, financial condition, and results of operations. Government Regulation and the Burdens of Compliance Federal and state governments regulate various aspects of the Company's business. The development and operation of health care facilities and the provision of health care services are subject to federal, state, and local licensure, certification, and inspection laws that regulate, among other matters, the number of licensed beds, the provision of services, staffing levels, professional licensing, the distribution of pharmaceuticals, billing practices and policies, equipment, operating policies and procedures, fire prevention measures, environmental matters, and compliance with building and safety codes. Failure to comply with these laws and regulations could result in the denial of reimbursement, the imposition of fines, temporary suspension of admission of new patients, suspension or decertification from Medicare, Medicaid, or other state or Federal reimbursement programs, restrictions on the Company's ability to acquire new communities or expand existing communities, and, in extreme cases, the revocation of a community's license or closure of a community. While the Company endeavors to comply with all applicable regulatory requirements, from time to time certain of the Company's communities have been subject, like others in the industry, to various penalties as a result of deficiencies alleged by state survey agencies. There can be no assurance that the Company will not be subject to similar penalties in the future, or that federal, state, or local governments will not impose additional restrictions on the Company's activities that could materially adversely affect the Company's business, financial condition, or results of operations (see also - Item 1. Business - Government Regulation). 35 36 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Disclosure About Interest Rate Risk The Company is subject to market risk from exposure to changes in interest rates based on its financing, investing, and cash management activities. The Company utilizes a balanced mix of debt maturities along with both fixed-rate and variable-rate debt to manage its exposures to changes in interest rates. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." The Company has entered into two interest rate swap agreements with a major financial institution to manage its exposure. The swaps involve the receipt of a fixed interest rate payment in exchange for the payment of a variable rate interest payment without exchanging the notional principal amount. Receipts on the agreement are recorded as a reduction to interest expense. At December 31, 2000, the Company's outstanding principal under its existing swap agreements was $17.6 million and $35.2 million maturing December 10, 2024 and July 1, 2008, respectively. Under the agreements the Company receives fixed rates of 7.19% and 6.87%, respectively, and pays floating rates based upon LIBOR and a foreign currency index with a maximum rate through July 1, 2002 of 6.87% and 8.12% thereafter. During 2000, interest rates had risen. Interest rates have fallen in early 2001 and are expected to fall further in the first half of 2001. The Company does not expect changes in interest rates to have a material effect on income or cash flows in 2001, since the majority of the Company's debt has fixed rates. There can be no assurances, however, that interest rates will not significantly change and materially affect the Company. Additionally, the Company anticipates refinancing and/or renegotiating certain debt in 2001, which could result in higher interest rates in the future. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements - ----------------------------- Independent Auditors' Report 37 Consolidated Balance Sheets --- December 31, 2000 and 1999 38 Consolidated Statements of Operations --- Years ended December 31, 2000, 1999 and 1998 39 Consolidated Statements of Shareholders' Equity --- Years ended December 31, 2000, 1999 and 1998 41 Consolidated Statements of Cash Flows --- Years ended December 31, 2000, 1999 and 1998 42 Notes to Consolidated Financial Statements 44 Financial Statement Schedules 72
Schedule II - Valuation and Qualifying Accounts Schedule IV - Mortgage Loans on Real Estate All other schedules omitted are not required, inapplicable or the information required is furnished in the financial statements or notes therein. 36 37 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders American Retirement Corporation: We have audited the accompanying consolidated balance sheets of American Retirement Corporation and subsidiaries as of December 31, 2000 and 1999 and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2000. In connection with our audits of the consolidated financial statements, we have also audited the financial statement Schedule II - Valuation and Qualifying Accounts and financial statement Schedule IV - Mortgage Loans on Real Estate as of December 31, 2000 and for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 American Retirement Corporation and subsidiaries as of December 31, 2000 and 1999 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedules, 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 Nashville, Tennessee February 21, 2001 37 38 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
December 31 ---------------------------------- 2000 1999 -------- -------- ASSETS Current assets: Cash and cash equivalents $ 19,850 $ 21,881 Assets limited as to use 5,181 15,571 Accounts receivable, net 15,772 12,746 Advances for development projects 95 3,762 Inventory 1,079 950 Prepaid expenses 2,906 1,790 Deferred income taxes 332 758 Other current assets 5,513 5,727 -------- -------- Total current assets 50,728 63,185 Assets limited as to use, excluding amounts classified as current 73,785 60,855 Land, buildings and equipment, net 473,062 431,560 Notes receivable 90,707 97,236 Goodwill, net 37,503 38,524 Leasehold acquisition costs, net 16,103 978 Other assets 50,592 48,073 -------- -------- Total assets $792,480 $740,411 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 7,449 $ 10,173 Accounts payable 7,502 3,723 Accrued interest 3,980 4,140 Accrued payroll and benefits 3,916 3,144 Accrued property taxes 3,379 3,638 Other accrued expenses 4,981 4,898 Reserve for contractual losses -- 6,200 Other current liabilities 5,241 3,679 -------- -------- Total current liabilities 36,448 39,595 Long-term debt, excluding current portion 338,261 287,835 Convertible subordinated debentures 137,980 137,980 Refundable portion of life estate fees 44,739 43,386 Deferred life estate income 52,765 51,606 Tenant deposits 6,612 6,913 Deferred gain on sale-leaseback transactions 16,122 3,168 Deferred income taxes 13,079 15,236 Other long-term liabilities 4,517 6,524 -------- -------- Total liabilities 650,523 592,243 Commitments and contingencies (see notes) Shareholders' equity: Preferred stock, no par value; 5,000,000 shares authorized, no shares issued or outstanding -- -- Common stock, $.01 par value; 200,000,000 shares authorized, 17,065,395 and 17,138,235 shares issued and outstanding, respectively 171 171 Additional paid-in capital 145,079 145,444 Retained earnings (accumulated deficit) (3,293) 2,553 -------- -------- Total shareholders' equity 141,957 148,168 -------- -------- Total liabilities and shareholders' equity $792,480 $740,411 ======== ========
See accompanying notes to consolidated financial statements. 38 39 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share data)
Years ended December 31, ------------------------------------------ 2000 1999 1998 -------- -------- -------- Revenues: Resident and health care $200,805 $164,592 $130,036 Management and development services 5,309 10,678 12,321 -------- -------- -------- Total revenues 206,114 175,270 142,357 Operating expenses: Community operating expenses 138,670 105,978 82,698 General and administrative 19,420 15,020 10,581 Lease expense, net 18,267 12,985 9,063 Depreciation and amortization 17,142 13,692 10,025 Asset impairments and contractual losses -- 12,536 -- Merger related costs -- -- 994 -------- -------- -------- Total operating expenses 193,499 160,211 113,361 -------- -------- -------- Operating income 12,615 15,059 28,996 Other income (expense): Interest expense (36,517) (23,668) (17,924) Interest income 14,791 9,123 4,092 Gain on sale of assets 267 3,036 80 Equity in losses of managed special purpose entity communities (2,234) (374) -- Other 872 (314) (242) -------- -------- -------- Other expense, net (22,821) (12,197) (13,994) -------- -------- -------- Income (loss) from continuing operations before income taxes, minority interest, extraordinary item and cumulative effect of change in accounting principle (10,206) 2,862 15,002 Income tax (benefit) expense (3,523) 1,087 5,652 -------- -------- -------- Income (loss) from continuing operations before minority interest, extraordinary item and cumulative effect of change in accounting principle (6,683) 1,775 9,350 Minority interest in losses of consolidated subsidiaries, net of tax 961 277 -- -------- -------- -------- Income (loss) from continuing operations before extraordinary item and cumulative effect of change in accounting principle (5,722) 2,052 9,350 Discontinued operations: Loss from home health operations, net of tax -- -- (1,244) Write-off of home health assets, net of tax -- -- (902) -------- -------- -------- Income (loss) before extraordinary item and cumulative effect of change in accounting principle (5,722) 2,052 7,204 Extraordinary loss on extinguishment of debt, net of tax (124) -- -- -------- -------- -------- Income (loss) before cumulative effect of change in accounting principle (5,846) 2,052 7,204 Cumulative effect of change in accounting for start-up costs, net of tax -- -- (304) -------- -------- -------- Net income (loss) $ (5,846) $ 2,052 $ 6,900 ======== ======== ========
See accompanying notes to consolidated financial statements. 39 40 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - CONTINUED (in thousands, except share data)
Years ended December 31, -------------------------------- 2000 1999 1998 ------- -------- -------- Basic earnings (loss) per share: Basic earnings (loss) per share from continuing operations before extraordinary item and cumulative effect of change in accounting principle $ (0.34) $ 0.12 $ 0.67 Loss from home health operations, net of tax -- -- (0.09) Write-off of home health assets, net of tax -- -- (0.06) Extraordinary loss, net of tax (0.01) -- -- Cumulative effect of change in accounting principle, net of tax -- -- (0.02) ------- -------- -------- Basic earnings (loss) per share $ (0.34) $ 0.12 $ 0.49 ======= ======== ======== Diluted earnings (loss) per share: Diluted earnings (loss) per share from continuing operations before extraordinary item $ (0.34) $ 0.12 $ 0.66 Loss from home health operations, net of tax -- -- (0.09) Write-off of home health assets, net of tax -- -- (0.06) Extraordinary loss, net of tax (0.01) -- -- Cumulative effect of change in accounting principle, net of tax -- -- (0.02) ------- -------- -------- Diluted earnings (loss) per share $ (0.34) $ 0.12 $ 0.49 ======= ======== ======== Weighted average shares used for basic earnings (loss) per share data 17,086 17,129 13,947 Effect of dilutive common stock options -- 48 127 ------- -------- -------- Weighted average shares used for diluted earnings (loss) per share data 17,086 17,177 14,074 ======= ======== ========
See accompanying notes to consolidated financial statements. 40 41 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands, except share data)
Retained Common Stock Additional Earnings ----------------------- Paid-In (Accumulated Shares Amount Capital Deficit) Total ------------------------------------------------------------------ Balance at December 31, 1997 11,420,860 $114 $ 60,203 $(6,399) $ 53,918 Net income -- -- -- 6,900 6,900 Conversion of subordinated debentures 832 -- 20 -- 20 Issuance of common stock in FGI Transaction 1,370,000 14 19,765 -- 19,779 Net proceeds from public offering 4,297,500 43 64,762 -- 64,805 Issuance of common stock pursuant to employee stock purchase plan 16,190 -- 235 -- 235 Issuance of common stock pursuant to stock options exercised 13,003 -- 185 -- 185 ------------------------------------------------------------------ Balance at December 31, 1998 17,118,385 $171 $ 145,170 $ 501 $ 145,842 ------------------------------------------------------------------ Net income -- -- -- 2,052 2,052 Issuance of common stock pursuant to employee stock purchase plan 14,516 -- 199 -- 199 Issuance of common stock pursuant to stock options exercised 5,334 -- 75 -- 75 ------------------------------------------------------------------ Balance at December 31, 1999 17,138,235 $171 $ 145,444 $ 2,553 $ 148,168 ------------------------------------------------------------------ Net loss -- -- -- (5,846) (5,846) Issuance of common stock pursuant to employee stock purchase plan 66,067 -- 238 -- 238 Issuance of common stock pursuant to funding of employer 401k contribution 72,493 -- 595 -- 595 Repurchase of common stock pursuant to stock repurchase program (211,400) -- (1,198) -- (1,198) ------------------------------------------------------------------ Balance at December 31, 2000 17,065,395 $171 $ 145,079 $(3,293) $ 141,957 ==================================================================
See accompanying notes to consolidated financial statements. 41 42 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Years ended December 31, ------------------------------------------- 2000 1999 1998 -------- -------- -------- Cash flows from operating activities: Net income (loss) $ (5,846) $ 2,052 $ 6,900 Loss from discontinued operations, net of tax -- -- 1,244 Write-off of home health assets, net of tax -- -- 902 Cumulative effect of change in accounting principle, net of tax -- -- 304 Extraordinary loss on extinguishment of debt, net of tax 124 -- -- -------- -------- -------- Income (loss) from continuing operations (5,722) 2,052 9,350 Adjustments to reconcile income (loss) from continuing operations to net cash and cash equivalents provided by continuing operations: Asset impairments and contractual losses -- 12,536 -- Depreciation and amortization 17,142 13,692 10,025 Amortization of deferred entrance fee revenue (7,581) (6,945) (3,756) Amortization of deferred financing costs 2,174 1,342 754 Proceeds from terminated lifecare contracts 2,432 2,756 1,616 Proceeds from life estate sales, net of refunds 8,664 11,028 4,262 Deferred income tax (benefit) expense (1,731) (207) 3,923 Proceeds from (amortization of) deferred-gain on sale-leaseback transactions (452) (452) (453) Minority interest in losses of consolidated subsidiaries (961) (277) -- Losses from unconsolidated joint ventures 263 2,005 608 Gain on sale of assets (267) (3,036) (80) Proceeds from issuance of stock through employee 401k plan 595 -- -- Changes in assets and liabilities, net of effects from acquisitions: Accounts receivable (548) (1,588) (3,642) Inventory 45 (124) (95) Prepaid expenses (758) (163) (346) Other assets 1,165 (4,402) (2,195) Accounts payable 1,960 (2,820) 2,907 Accrued expenses and other current liabilities (7,591) 40 2,135 Tenant deposits (803) 48 496 Other liabilities (1,593) (2,179) (172) -------- -------- -------- Net cash and cash equivalents provided by continuing operations 6,433 23,306 25,337 Net cash and cash equivalents used in discontinued operations -- -- (1,941) -------- -------- -------- Net cash and cash equivalents provided by operating activities 6,433 23,306 23,396 Cash flows from investing activities: Additions to land, buildings and equipment (49,073) (59,221) (31,888) Expenditures for acquisitions, net of cash received (6,422) -- (37,358) Reimbursements from (advances for) development projects, net 3,667 7,374 (11,136) Investments in joint ventures (357) (1,763) (3,143) Contributions from minority owners 522 1,630 -- Receipts for purchase options 3,750 -- -- Purchases of other investments -- (10,177) (4,704) Proceeds from the maturity of marketable securities -- -- 132 Proceeds from the sale of assets 26,483 3,138 1,736 Other investing activities (338) (664) -- Changes in assets and liabilities, net of effects from acquisitions: Expenditures for leasehold acquisitions, net of cash received (14,972) -- -- Purchase of assets limited as to use (3,641) (13,643) (44,975) Receipts from (issuance of) notes receivable 244 (78,916) (19,731) -------- -------- -------- Net cash used by investing activities (40,137) (152,242) (151,067)
See accompanying notes to consolidated financial statements. 42 43 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED (in thousands)
Years ended December 31, ------------------------------------------- 2000 1999 1998 -------- -------- -------- Cash flows from financing activities: Net proceeds from public offerings -- -- 64,805 Proceeds from issuance of stock through employee stock purchase plan 238 199 235 Payments for common stock through stock repurchase program (1,198) -- -- Proceeds from exercise of stock options -- 75 185 Proceeds from the issuance of long-term debt 89,549 143,162 53,717 Principal payments on long-term debt (49,896) (5,341) (12,752) Principal reductions in master trust liability (3,727) (4,225) (2,625) Expenditures for financing costs (3,293) (3,453) (77) -------- -------- -------- Net cash provided by financing activities 31,673 130,417 103,488 -------- -------- -------- Net increase (decrease) in cash and cash equivalents (2,031) 1,481 (24,183) -------- -------- -------- Cash and cash equivalents at beginning of period 21,881 20,400 44,583 -------- -------- -------- Cash and cash equivalents at end of period $ 19,850 $ 21,881 $ 20,400 ======== ======== ========
Supplemental disclosure of cash flow information: Cash paid during the period for interest (including capitalized interest) $35,969 $24,591 $18,359 ======= ======= ======= Income taxes paid $ 211 $ 5,138 $ 249 ======= ======= =======
Supplemental disclosure of non-cash transactions: During the respective years, the Company acquired certain communities and entered into certain lease transactions. In conjunction with the transactions, assets and liabilities were assumed as follows: Current assets $ 939 $ -- $ 7,378 Costs in excess of net assets acquired -- -- 35,938 Land, buildings and other assets 14,202 -- 151,875 Current liabilities 768 -- 15,471 Long-term debt 7,951 -- 22,368 Other liabilities -- -- 74,793
During the year ended December 31, 2000, the Company funded its 401(k) contribution with 72,493 shares of its common stock at a fair market value of $595,000. During the year ended December 31, 1999, the Company sold certain land for $3.1 million in cash and the payment on a related note payable of $2.5 million for aggregate consideration of $5.6 million. During the year ended December 31, 1998, 1,370,000 shares of common stock were issued as partial consideration in the FGI transaction and 832 shares of common stock were issued upon the conversion of $20 of convertible subordinated debentures. 43 44 AMERICAN RETIREMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) ORGANIZATION AND PRESENTATION The accompanying financial statements as of and for the years ended December 31, 2000, 1999 and 1998 include the consolidated financial statements of American Retirement Corporation and its wholly-owned and majority owned subsidiaries (collectively referred to as the "Company"). All material intercompany transactions and balances have been eliminated in consolidation. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES The Company principally provides housing, health care, and other related services to senior residents through the operation and management of numerous senior living communities located throughout the United States. The communities provide a combination of independent living, assisted living and skilled nursing services. The Company is subject to competition from other senior living providers within its markets. The following is a summary of significant accounting policies. (a) Use of Estimates and Assumptions: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (b) Recognition of Revenue: The Company provides residents with housing and health care services through various types of agreements. The Company also receives fees for managing and developing senior living communities owned by others. The majority of the communities provide housing and health care services through annually renewable agreements with the residents. Under these agreements, the residents pay a monthly housing fee, which entitles them to the use of certain amenities and services. Residents may elect to obtain additional services, which are paid for on a monthly basis or as the services are received. The Company recognizes revenues under these agreements on a monthly basis when earned. Certain communities provide housing and health care services through entrance fee agreements with the residents. Under these agreements, residents pay a fee upon entering into a lifecare contract. The fee obligates the Company to provide certain levels of future health care services to the resident for life. The agreement terminates when the unit is vacated. A portion of the fee is refundable to the resident or the resident's estate upon termination of the agreement. The refundable amount is recorded by the Company as refundable portion of life estate fees, a long-term liability, until termination of the agreement. The remainder of the fee is recorded as deferred life estate income and is amortized into revenue using the straight-line method over the estimated remaining life expectancy of the resident, based upon annually adjusted actuarial projections. Additionally, under these agreements the residents pay a monthly service fee, which entitles them to the use of certain amenities and services. They may also elect to obtain additional services, which are paid for on a monthly basis or as the services are received. The Company recognizes these additional fees as revenue on a monthly basis when earned. The Company also provides housing to residents at certain communities under an entrance fee agreement whereby the entrance fee is fully refundable to the resident or the resident's estate contingent upon the occupation of the unit by the next resident. The resident also shares in a percentage, typically 50%, of any appreciation in the entrance fee from the succeeding resident. The entrance fee is recorded by the Company as refundable portion of life estate fees and is amortized into revenue using the straight-line method over the 44 45 remaining life of the buildings. Additionally, under these agreements the residents pay a monthly service fee, which entitles them to the use of certain amenities and services. They may also elect to obtain additional services, which are paid for on a monthly basis or as the services are received. The Company recognizes these additional fees as revenue on a monthly basis when earned. If a resident terminates the agreement, they are required to continue to pay their monthly service fee for the lesser of one year or until the unit is reoccupied. Resident and health care revenues are reported at the estimated net realizable amounts from residents, third-party payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. The Prospective Payment System (PPS), effective for the Company beginning January 1, 2000, eliminates the cost based reimbursement system, and communities are reimbursed on a per diem basis. Resident and health care revenues, primarily Medicare, subject to retroactive adjustments were 4.4%, and 4.7% of resident and health care revenues in 1999 and 1998, respectively. Management services revenue is recorded monthly as earned and relates to providing certain management and administrative support services under management agreements with the owners and lessees of senior living communities. Such fees are based on a percentage of revenues, income or cash flows of the managed community, or a negotiated fee per the management agreement. The Company provides development services to owners of senior living communities. Fees are based upon a percentage of the total construction costs of the community. Development services revenue is recognized under the percentage-of-completion method based upon the Company's costs of providing such services. (c) Cash and Cash Equivalents: For purposes of the Statements of Cash Flows, the Company considers highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. (d) Assets Limited as to Use: Assets limited as to use include assets held by lenders under loan agreements in escrow for property taxes and property improvements, operating reserves required by certain state licensing authorities, certificates of deposit, and U.S. Treasury obligations held as collateral for letters of credit or in conjunction with leasing activity or to support operating deficit agreements, and resident deposits. The Company classifies its U.S. Treasury obligations as held-to-maturity. Held-to-maturity securities are those securities in which the Company has the ability and the intent to hold the security until maturity. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Realized gains and losses from the sale of held-to-maturity securities are determined on a specific identification basis. A decline in the market value of any held-to-maturity security below cost that is deemed to be other than temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Premiums and discounts are amortized or accreted over the life of the related held-to-maturity security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned. (e) Inventory: Inventory consists of supplies and is stated at the lower of cost (first-in, first-out) or market. (f) Land, Buildings, and Equipment: Land, buildings, and equipment are recorded at cost and include interest capitalized on long-term construction projects during the construction period, as well as other costs directly related to the acquisition, development, and construction of the communities. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets. Buildings and improvements are depreciated over 15 to 40 years, and furniture, fixtures and equipment are depreciated over five to seven years. Leasehold improvements are amortized over the shorter of their useful life or remaining 45 46 base lease term. Construction in progress includes costs incurred related to the development and construction of senior living communities. If a project is abandoned, any costs previously capitalized and determined to be unrecoverable are expensed. (g) Notes Receivable: Notes receivable are recorded at cost, less any related allowance for impaired notes receivable. Management, considering current information and events regarding the borrowers' ability to repay their obligations, considers a note to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the note agreement. When a loan is considered to be impaired, the amount of the impairment is measured based on the present value of expected future cash flows discounted at the note's effective interest rate. Impairment losses are included in the allowance for doubtful accounts through a charge to bad debt expense. Cash receipts on impaired notes receivable are applied to reduce the principal amount of such notes until the principal has been recovered and are recognized as interest income, thereafter. (h) Goodwill: Goodwill is amortized on a straight-line basis over the expected periods to be benefited, generally 40 years. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the balance over its remaining life can be recovered through undiscounted future operating cash flows of the acquired operation. The amount of impairment, if any, is measured based on projected discounted future operating cash flows using a discount rate reflecting the risk of the acquired operations. The assessment of the recoverability will be impacted if estimated future operating cash flows are not achieved. Goodwill is net of accumulated amortization of $2.5 million and $1.5 million at December 31, 2000 and 1999, respectively. Amortization expense was $1.0 million, $1.0 million, and $486,000, for the years ended December 31, 2000, 1999, and 1998, respectively. (i) Other Assets: Other assets consist primarily of security deposits, unexercised purchase options, deferred financing costs (including convertible debenture offering costs), costs of acquiring lifecare contracts, deferred lifecare fee receivables, property held for sale, and investments in joint ventures. Deferred financing costs are being amortized using the straight-line method over the terms of the related debt agreements. Costs of acquiring initial lifecare contracts are amortized over the life expectancy of the initial residents of a lifecare community. Purchase options to acquire property are recorded at their cost and are applied to the cost of the property acquired. Nonrefundable purchase options are expensed when they expire or management determines that the option will not be exercised. (j) Investments in Joint Ventures: Investments in joint ventures includes the Company's investments organized to develop senior living communities. The Company is providing full development services related to, and has entered into management agreements to manage, the related communities. The Company accounts for its investments in 20-50% owned joint ventures under the equity method. At December 31, 2000 and 1999, the Company's investment and advances in joint ventures was approximately $3.1 million and $1.1 million, respectively. See Note 10. (k) Start-up Costs: On April 3, 1998, the AICPA Accounting Standards Executive Committee issued Statement of Position (SOP) No. 98-5, Reporting on the Costs of Start-up Activities. SOP No. 98-5 requires that costs incurred during start-up activities, including organization costs, be expensed as incurred. SOP No. 98-5 defines start-up activities broadly to include those one-time activities related to: opening a new facility; introducing a new product or service; conducting business in a new territory; conducting business with a new class of customer or beneficiary; initiating a new process in an existing facility; or commencing some new operation. Start-up activities also include activities related to organizing a new entity (costs of such activities are commonly referred to as organization costs). SOP No. 98-5 was effective January 1, 1999, however early application was permitted. Initial application of SOP No. 98-5 was required as of the beginning of the fiscal year in which it is first adopted, and restatement of previously issued financial statements is not permitted. Previously capitalized start-up costs were required to be written-off upon adoption of SOP No. 98-5. 46 47 The Company elected to adopt the provisions of SOP No. 98-5 in 1998. Accordingly, effective January 1, 1998, the Company recorded a cumulative effect of the change in accounting for start-up costs of $304,000, net of tax, in the consolidated statement of operations. Start-up costs subsequent to the adoption of SOP No. 98-5 are expensed as incurred. (l) Obligation to Provide Future Services: Under the terms of certain lifecare contracts, the Company is obligated to provide future services to its residents. The Company calculates the present value of the net cost of future services and use of facilities annually and compares that amount with the present value of future resident cash inflows. If the present value of the net cost of future services and use of facilities exceeds discounted future cash inflows, a liability will be recorded with a corresponding charge to income. As of December 31, 2000 and 1999, the Company did not have a liability associated with its obligation to provide future services and use of facilities. (m) Income Taxes: Income taxes are accounted for under the asset and liability method. 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 and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are recorded using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. 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. (n) Earnings per Share: Basic earnings per share ("EPS") is computed by dividing net income (loss) (numerator) by the weighted average number of common shares outstanding (denominator). The denominator used in computing diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. The effect from assumed conversion of the Company's convertible debentures would have been anti-dilutive in 2000, 1999 and 1998 and was therefore not included in the computation of diluted EPS. Antidilutive shares which were excluded from the diluted EPS calculation in 2000, 1999 and 1998 were 1,034,000, 1,796,000, and 235,000, respectively. See Note 21. (o) Stock-Based Compensation: The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company follows the requirements of the Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations including Financial Accounting Standards Board ("FASB") Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation, an Interpretation of APB Opinion No. 25" in accounting for stock-based compensation, and accordingly recognizes no compensation expense for stock option grants, but provides the pro forma disclosures required by the Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation". (p) Fair Value of Financial Instruments: The carrying amount of cash and cash equivalents approximates fair value because of the short-term nature of these accounts and because amounts are invested in accounts earning market rates of interest. The carrying value of assets limited as to use, accounts receivable, advances for development projects, tenant deposits, accounts payable, and refundable portion of life estate fees approximate their fair values because of the short-term nature of these accounts. The carrying value of notes receivable approximate their fair value because the notes earn interest at a variable rate based on LIBOR. The carrying value of debt approximates fair value as the interest rates approximate the current rates available to the Company. The fair value of the interest rate swaps is disclosed at Note 1(v). (q) Derivative Instruments: During 2000 and 1999, the Company entered into two interest rate swap agreements as a hedge against certain debt liabilities in order to reduce its exposure to market risks from changing interest rates. Notional amounts of the Company's two existing swap agreements were $17.8 million and $35.2 million maturing December 10, 2024 and July 31, 2008, respectively. Under the agreements the Company receives 47 48 fixed rates of 7.19% and 6.87%, respectively, and pays floating rates based upon LIBOR and a foreign currency index with a maximum rate through July 31, 2002 of 6.87% and 8.12% thereafter, respectively. Interest rate swap agreements are contracts that represent an exchange of interest payments and the underlying principal balances of the assets or liabilities are not affected. Net settlement amounts are reported as adjustments to interest income or interest expense. Gains and losses from the termination of interest rate swaps are deferred and amortized over the remaining lives of the designated balance sheet assets or liabilities, or immediately, if the item hedged does not remain outstanding. If the balance of the liability falls below that notional amount of the derivative, the excess portion of the derivative is marked-to-market with a corresponding effect on current earnings. (r) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of: Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets held for sale are reported at the lower of the carrying amount or the fair value less the costs to sell. (s) Comprehensive Income: The Company adopted SFAS No. 130, "Reporting Comprehensive Income" during the year ended December 31, 1998. The statement establishes standards for the reporting and display of comprehensive income and its components. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. During 2000, 1999 and 1998, the Company's only component of comprehensive income (loss) was net income (loss). (t) Segment Disclosures: During 1998, SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" became effective for the Company. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS No. 131 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 evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance. During 2000, the Company revised its staffing and internal reporting to manage and operate in two business segments. Prior to fiscal 2000, the Company operated as one business segment. See further disclosure in Note 18. (u) Reclassifications: Certain 1999 and 1998 amounts have been reclassified to conform with the 2000 presentation. (v) Recent Accounting Pronouncements: In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 established reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts. Under SFAS No. 133, the Company would recognize all derivatives as either assets or liabilities, measured at fair value, in the consolidated balance sheet. In July 1999, SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of Effective Date of FASB No. 133, An Amendment of FASB Statement No. 133" was issued deferring the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. In June 2000, SFAS No. 138 "Accounting for Certain Derivative Instruments and Certain 48 49 Hedging Activities, an Amendment of FASB Statement No. 133" was issued clarifying the accounting for derivatives under the new standard. SFAS 133 standardizes the accounting for derivative instruments. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, if so, on the reason for holding it. If certain conditions are met, entities may elect to designate a derivative instrument as a hedge of exposures to changes in fair values, cash flows, or foreign currencies. If the hedged exposure is a cash flow exposure, the effective portion of the gain or loss on the derivative instrument is reported initially as a component of other comprehensive income (outside earnings) and subsequently reclassified into earnings when the forecasted transaction affects earnings. Any amounts excluded from the assessment of hedge effectiveness as well as the ineffective portion of the gain or loss is reported in earnings immediately. During 1999 and 2000, the Company entered into two interest rate swap agreements as a hedge against certain long-term debt in order to manage interest rate risk. These swap agreements are designated and qualify as cash flow hedges under SFAS No. 133. The Company will adopt SFAS No. 133 on January 1, 2001. On adoption, the provisions of the Statement must be applied prospectively. It is estimated that adoption of SFAS No. 133 will result in the Company recording a net transition adjustment loss of $1.1 million (net of related income tax of $570,000 in accumulated other comprehensive income at January 1, 2001). Further, the adoption of the Statement will result in the Company recognizing $266,000 of derivative instrument assets and $1.9 million of derivative instrument liabilities. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 establishes specific criterion for revenue recognition. In June 2000, the Securities and Exchange Commission issued SAB 101B, which amends the transition guidance for SAB 101. The SEC delayed the required implementation date of SAB 101 by issuing Staff Accounting Bulletins No. 101A, "Amendment: Revenue Recognition in Financial Statements" and 101B, "Second Amendment: Revenue Recognition in Financial Statements" in March and June 2000, respectively. As a result, SAB 101 was adopted by the Company in the fourth quarter of fiscal 2000, effective as of January 1, 2000. The Company's accounting policies are consistent with the requirements of SAB 101, so the implementation of SAB 101 did not have an impact on the Company's operating results in 2000. (3) LIQUIDITY The Company's credit agreements contain restrictive covenants which include the maintenance of minimum tangible net worth, prescribed debt service coverage, liquidity, capital expenditure reserves and occupancy levels. Effective as of September 30, 2000, the Company amended several of these financial covenants in order to remain in compliance therewith. The Company is in compliance with its required financial covenants at December 31, 2000, as amended. Accordingly, the related debt is classified in accordance with the contractual maturity schedules. Future compliance with the financial covenants is largely dependent upon improvements in the operations of the Company's Free-standing ALs. Improvements in the Company's operations is also subject to various factors such as economic conditions, interest rate levels, competition for residents, increases in operating costs and various other factors, some of which are beyond the Company's control. Consequently, there can be no assurances that the Company will remain in compliance with those financial covenants. If the Company fails to meet the covenants, unless amended or waived, the lenders will have the right to cease funding and accelerate repayment of the debt, which would have a material adverse effect on the Company. The Company is highly leveraged and has a substantial amount of debt and lease obligations. At December 31, 2000, the debt maturities and minimum lease obligations in 2002 total $362 million. Internally generated cash will not be sufficient to meet the 2002 debt and minimum lease obligations. Furthermore, due to adverse market conditions and the market price of the Company's stock, the Company believes that it is unlikely that it will be able to raise capital in the public equity markets for the foreseeable future. Accordingly, the Company's ability to refinance its maturing obligations will depend, in large part, upon its ability to obtain new or replacement financing on acceptable terms. The Company is focusing on generating additional proceeds from incremental leverage. At the same time, the 49 50 Company is also examining other alternatives to obtain funding, including the monetization of certain stabilized communities. The Company has had preliminary discussions with its existing lenders regarding the extension of much of the Company's maturing indebtedness. There can be no assurances that the Company will be able to refinance, extend and obtain new financing. A significant amount of the Company's indebtedness is cross-defaulted. Any non-payment, other default with respect to such obligations, or failure to comply with the covenants of the debt agreements could cause lenders to cease funding, accelerate payment obligations or to foreclose upon the communities securing the indebtedness. Further, because of the cross-default and cross collateralization provisions in certain of the Company's mortgages, debt instruments and leases, a default by the Company on one of its payment obligations could result in default or acceleration of other obligations, which would have a material adverse effect on the Company. (4) ASSET IMPAIRMENTS AND CONTRACTUAL LOSSES During the fourth quarter ended December 31, 1999, the Company announced that due to a shift in its growth strategy from development to acquisitions of senior living communities it would be abandoning certain development projects and reviewing others with regard to fit with its senior living network strategy. The Company has two parcels of land upon which senior living communities were to be developed. In 1999, each property was in the early stage of development, with activity in process consisting primarily of securing the zoning permits, completing architectural drawings and site testing. As a result, the 1999 carrying values included capitalized costs for zoning, architect fees, and site testing that will not be realized upon sale of the parcels. Management intends to dispose of the land and recorded an impairment charge of approximately $800,000 in 1999 related to the parcels and classified the land as property held for sale. In December 2000, the Company sold one of these parcels. The Company continues marketing the other parcel. In 1999, the Company also decided not to complete the development and construction of three properties for which the Company provided development and construction services to third party owners of senior living communities. Pursuant to the terms of the construction agency agreements executed with the owners of those projects, the Company was in default as a result of its decision not to complete construction. The Company purchased the uncompleted property from the owners and forgave the construction financing to the owners in exchange for the uncompleted property. The Company owned the land for one of the projects and leased it to the owner. Management accrued an impairment loss for this property. The land is classified as property held for sale. The Company recorded a contractual loss of $6.2 million for its obligations under the construction agency agreements during the fourth quarter of 1999, which were paid in 2000. The Company also provided construction financing on the projects and recorded an impairment charge of $1.5 million in 1999 against the notes receivable that will not be collected. The Company typically has various development activities ongoing to locate future operating sites, research market demographics and competition, secure proper zoning and negotiate the acquisition of land. Direct third party costs for these activities are capitalized. Capitalized costs of approximately $600,000 related to sites that will not be developed based upon the shift in the Company's growth strategy toward acquisitions were written off during the fourth quarter of 1999. In 1999 the Company owned a 50% interest in a joint venture that was formed for the purpose of owning and operating two assisted living communities in Knoxville, Tennessee. The Company determined that this venture did not fit with the Company's Senior Living Network strategy. The Company had entered into an agreement in 1999 to dissolve the joint venture. The Company recorded an impairment charge of $3.2 million related to this joint venture, during the quarter ended December 31, 1999, as the fair market value of the net assets to be received upon dissolution were less than the carrying amount of the Company's equity investment and advances to the joint venture. As of June 1, 2000, the parties dissolved the joint venture, with each party retaining one of the assisted living communities, along with the liabilities associated with that community. As a result of the dissolution, the 50 51 Company recorded assets of $8.2 million, consisting primarily of land and buildings. The Company also assumed $8.2 million of liabilities, consisting primarily of a $7.9 million mortgage note payable. The Company has no further management responsibility for, or liability with respect to, the community that was retained by the other party. The Company has discovered that this property has several significant construction or design deficiencies that result in, among other things, inadequate water and condensation drainage and control. As a result of these construction issues, the Company has moved certain residents and initiated various inspections, air quality tests, and other procedures. The Company has also involved its outside counsel and its insurance carrier in these issues, and is in discussions with the construction contractors and the design participants of the project. The Company is not able to determine to what extent these issues will result in a negative impact on the results of this community or additional liabilities and costs to the Company. The Company abandoned a new software implementation project in the fourth quarter of 1999 and accordingly wrote off the capitalized third party costs incurred for licensing and consulting of approximately $200,000. As a result of the decisions noted above, the Company recorded total asset impairments and contractual loss charges of approximately $12.5 million during the quarter ended December 31, 1999. The pretax costs of $12.5 million include $5.8 million of asset write-offs and accruals of $6.7 million for contractual losses and other costs. The Company made cash payments of $5.9 million during 2000 related to these costs. An accrual of $811,000 remains at December 31, 2000. The Company anticipates expending the balance of these costs during 2001. (5) DISCONTINUED OPERATIONS During 1998, the Company suspended operations of certain of its home health care agencies pending either institution of prospective pay or major revisions to the United States interim payment system. During the quarter ended December 31, 1998, the Company determined that an acceptable reimbursement system will not be implemented in the near term and discontinued its home health care operations. The operating results and cash flows of the home health care division for the year ended December 31, 1998 have been reclassified to discontinued operations. The Company recorded losses from home health operations, net of tax, of $1.2 million for the year ended December 31, 1998. Additionally, during the quarter ended December 31, 1998, the Company recognized an after tax charge of $902,000, related primarily to the impairment of unamortized costs in excess of net assets acquired in home health care agency acquisitions. (6) ACQUISITION On July 14, 1998, the Company acquired privately-held Freedom Group, Inc. ("FGI") and certain entities affiliated with FGI and with Robert G. Roskamp, FGI's Chairman. The acquisition resulted in the ownership of three continuing care retirement communities ("CCRCs") and the management of four additional CCRCs. The Company also acquired options to purchase two of the managed CCRCs. Additionally, the Company entered into a development and management contract for, and acquired an option to purchase, one additional CCRC currently under development. The consideration paid at closing was approximately $43.0 million, including $23.2 million of cash and 1,370,000 shares of the Company's common stock valued at $19.8 million. The Company paid an additional $4.0 million for the purchase options and $1.5 million to enter into two of the management contracts. The transaction was accounted for as a purchase and the consolidated financial statements include the operations of the acquired entities effective July 1, 1998. The transaction resulted in goodwill of approximately $35.9 million. During 1999, the Company paid an additional $1.7 million to the former owners of FGI under a contingent arrangement within the 1998 acquisition agreement. Such amount was recorded as goodwill, which completed the FGI transaction. 51 52 The following unaudited condensed consolidated pro forma results of continuing operations assumes the above referenced acquisition had been consummated as of January 1, 1998.
(in thousands except share data): ----------------------------------------------------------------- Total revenues $159,801 Income from continuing operations before extraordinary item and cumulative effect of change in accounting principle $6,873 Diluted earnings per share $0.47 Weighted average diluted shares 14,747
(7) ASSETS LIMITED AS TO USE The composition of assets limited as to use at December 31, 2000 and 1999 is as follows (in thousands):
2000 1999 -------- -------- Held by trustee under agreement: U.S. Treasury obligations $ 17,630 $ -- Certificates of deposit 42,691 53,314 Cash and other short-term investments 18,645 23,112 -------- -------- 78,966 76,426 Less long-term investments 73,785 60,855 -------- -------- Short-term investments $ 5,181 $ 15,571 ======== ========
The $17.6 million of U.S. Treasury obligations related to a community leased on May 26, 2000. The Company receives and recognizes the interest income on these assets limited as to use. The certificates of deposit are pledged to the lessors of certain senior living communities as collateral to support the lessor's equity contributions. The Company receives and recognizes the interest income earned on these certificates of deposit. (8) LAND, BUILDINGS, AND EQUIPMENT A summary of land, buildings, and equipment is as follows (in thousands):
2000 1999 --------- --------- Land and improvements $ 46,534 $ 44,887 Land leased to others 15,406 17,022 Land held for development 9,762 9,762 Buildings and improvements 392,312 351,529 Furniture, fixtures, and equipment 30,677 25,740 Leasehold improvements 4,893 3,091 --------- --------- 499,584 452,031 Less accumulated depreciation and amortization (52,090) (39,752) Construction in progress 25,568 19,281 --------- --------- Total $ 473,062 $ 431,560 ========= =========
52 53 On December 18, 2000 the Company sold a community located in Westlake, Ohio and subsequently leased the property back from the buyer. At the transaction date, the community had a net book basis of $13.2 million and was sold for approximately $26.0 million. The gain has been deferred and will be recognized into income over the life of the lease, ending July 2007. Pursuant to the sale, the Company repaid the mortgage financing, $17.0 million, and has deposited the remaining proceeds with an escrow agent. The Company anticipates that a portion of the taxable gain from the transaction will be deferred by like-kind exchanges that the Company anticipates consummating during 2001, thus deferring a significant portion the taxable gain. In conjunction with the lease, the Company has the right of first refusal to purchase the community. The deferred gain recorded for financial reporting purposes could be subsequently reduced if a portion of the sales proceeds are used to purchase similar operating property. Depreciation expense was $15.0 million, $12.1 million, and $9.1 million for the years ended December 31, 2000, 1999, and 1998, respectively. The Company capitalized $1.4 million, $2.1 million, and $1.5 million of interest costs during 2000, 1999 and 1998, respectively. (9) NOTES RECEIVABLE The Company finances the cost of certain retirement communities owned by others that are being developed, leased or managed by the Company. The notes receivable generally earn interest at variable rates based on 200 basis points in excess of the 30 day LIBOR rate, which is recalculated monthly. Interest and principal are due monthly based on a 25 year amortization. The notes receivable mature from March 2005 through December 2005 and are secured by the related retirement communities. As discussed in Note 4, in 1999 the Company wrote off $1.5 million with a corresponding charge to earnings for notes receivable that will not be collected due to the default by the Company under certain construction agency agreements. No other notes receivable were impaired at December 31, 2000 or 1999. (10) OTHER ASSETS Other assets at December 31, 2000 and 1999 consist of the following (in thousands):
2000 1999 -------- -------- Security deposits $ 7,663 $ 6,957 Purchase options 17,376 21,126 Costs of acquiring lifecare contracts, net 3,080 3,326 Deferred lifecare fee receivables 4,303 4,002 Deferred financing costs, net of accumulated amortization 5,467 5,961 Investments and advances in unconsolidated entities 3,124 1,141 Property held for sale 5,423 2,900 Other 4,156 2,660 -------- -------- Total $ 50,592 $ 48,073 ======== ========
(11) LONG-TERM DEBT A summary of long-term debt is as follows:
2000 1999 ---------- ---------- (in thousands) Convertible debentures bearing interest at a fixed rate of 5.75%. Interest is due semi-annually on April 1 and October 1 through October 1, 2002, at which time all principal is due $ 137,980 $ 137,980
53 54
2000 1999 ---------- ---------- (in thousands) Revolving line of credit in the amount of $50.0 million bearing interest at the rate of LIBOR plus one hundred seventy-five basis points (8.63% - LIBOR index monthly at December 31, 2000). Interest only is paid monthly and the loan matures on December 31, 2002. The loan is secured by certain land and buildings 23,909 47,659 Revolving line of credit in the amount of $100.0 million bearing interest at the rate of LIBOR plus two hundred sixty basis points (9.22% at December 31, 2000). Interest only is paid monthly and the loan matures on May 1, 2002. The note is secured by certain land, buildings, equipment, and assignment of rents and leases 91,090 64,390 Mortgage note payable bearing interest at a fixed rate of 8.2%. Interest and principal is due monthly and the remaining principal and unpaid interest due at maturity on December 31, 2001. The loan was repaid in 2000 -- 14,300 Mortgage note payable bearing interest at a floating rate equal to two hundred twenty-five basis points in excess of the LIBOR rate recalculated each month (8.95% at December 31, 2000). Interest is due monthly with principal due at maturity on December 2, 2002 The loan is secured by certain land and buildings 11,138 6,750 Mortgage note payable bearing interest at a fixed rate of 8.2%. Interest is due monthly with principal and unpaid interest due at maturity on December 31, 2002. The loan is secured by certain land, buildings, equipment, and assignment of rents and leases 62,330 62,330 Mortgage note payable bearing interest at a floating rate equal to three hundred basis points in excess of the LIBOR rate (9.80% at December 31, 2000). Interest and principal, amortized over 25 years, is due monthly with balloon maturity on April 1, 2003. The loan is secured by certain land, buildings, equipment, and assignment of rents and leases 23,086 -- Mortgage note payable bearing interest at a fixed rate of 6.87%. Principal and interest of $262,747 is due monthly with remaining principal and unpaid interest due on July 31, 2008. The note is secured by certain land, buildings, equipment, and assignment of rents and leases 35,179 35,544 Mortgage note payable bearing interest at a fixed rate of 8.50%. Principal and interest of $144,956 is due monthly with remaining principal and unpaid interest due on December 10, 2024. The note is secured by certain land, buildings, equipment, and assignment of rents and leases 17,787 18,000
54 55
2000 1999 ---------- ---------- (in thousands) Mortgage note payable bearing interest at a fixed rate of 9.50% Principal and interest of $104,844 is due monthly with remaining principal and unpaid interest due on June 10, 2025. The note is secured by certain land, buildings, equipment, and assignment of rents and leases 11,940 -- Mortgage notes payable, generally payable monthly with interest rates ranging from 8.80% to 9.95% 28,910 20,521 Construction notes payable, generally payable monthly with interest rates ranging from 7.69% to 8.98% 24,184 11,413 Other long-term debt, generally payable monthly with interest rates ranging from 4.2% to 10.49% 16,157 17,101 ---------- ---------- Total long-term debt 483,690 435,988 Less current portion of long-term debt 7,449 10,173 ---------- ---------- Long-term debt, excluding current portion $ 476,241 $ 425,815 ========== ==========
The aggregate scheduled maturities of long-term debt at December 31, 2000 were as follows (in thousands): 2001 $ 7,449 2002 333,265 2003 33,019 2004 7,418 2005 7,461 Thereafter 95,078 -------- $483,690 ========
During 1997, the Company issued $138.0 million of 5 3/4% fixed rate convertible subordinated debentures due October 2002 in a public offering. The debentures are non-callable for three years and are convertible at any time by the holders into shares of the Company's common stock at a conversion price of $24.00 per share. The Company received proceeds of $134.2 million, net of offering costs, from the issuance of the debentures. The offering costs were capitalized as deferred financing costs and are being amortized using the straight-line method over the term of the debentures. During 1998, debentures totaling $20,000 were converted into 832 shares of common stock. The Company's various credit facilities, contain numerous financial covenants that require the Company to maintain certain prescribed debt service coverage, liquidity, net worth, capital expenditure reserves and occupancy levels. Effective as of September 30, 2000, the Company amended several of these financial covenants in order to remain in compliance therewith, resulting in a cost of $125,000 and an increase of twenty five basis points on the floating interest rate. Failure to maintain compliance with the financial covenants would have a significant adverse impact on the Company. Under the terms of various long-term debt agreements, the Company is required to maintain certain deposits with trustees. Such deposits are included in "assets limited as to use" in the financial statements. The Company's internally generated cash will not be sufficient to meet the obligations of maturing 2002 debt instruments. Furthermore, due to adverse market conditions and the market price of the Company's stock, the Company believes that it is unlikely that it will be able to raise capital in the public equity markets for the foreseeable future. Accordingly, the Company's ability to refinance its maturing obligations will depend, in large part, upon its ability to obtain new or replacement mortgage financing on acceptable terms. The Company is focusing on generating additional proceeds from incremental leverage, including possible combinations of senior and mezzanine financing. At the same time, the Company is also examining other alternatives for raising capital, including the opportunistic monetization of investments in certain of the stabilized communities. The Company has engaged in preliminary discussions with its existing lenders regarding the extension of much of the Company's 55 56 maturing indebtedness. Failure to meet the debt service requirements or debt covenants would have a significant adverse impact on the Company. (12) REFUNDABLE ENTRANCE FEES AND DEFERRED LIFE ESTATE INCOME Under certain of the Company's residency and health care agreements for its lifecare communities acquired pursuant to the FGI transaction, residents entered into a Master Trust Agreement whereby amounts were paid by the resident into a trust account. These funds were then made available to the related communities in the form of a non-interest bearing loan to provide permanent financing for the related communities and are collateralized by such land, buildings and equipment. As of December 31, 2000, the remaining obligation under the Master Trust Agreements is $47.3 million and is payable monthly based on a 40-year amortization of each residents' balance. The current installment due in 2001, and annually for the subsequent five-year period, is approximately $1.5 million. The annual obligation is reduced as individual residency agreements terminate. Upon termination of the resident's occupancy, the resident or the resident's estate receives a payment of the remaining loan balance from the trust and pays a lifecare fee to the community based on a formula in the residency and health care agreement, not to exceed a specified percentage of the resident's original amount paid to the trust. This lifecare fee is amortized by the Company into revenue on a straight-line basis over the estimated life expectancy of the resident beginning with the date of occupancy by the resident. The amortization of the lifecare fees is included in resident and health care revenue in the consolidated statement of operations. The Company reports the long-term obligation under the Master Trust Agreements as a refundable portion of life estate fees and deferred life estate income based on the applicable residency agreements. The obligation to the Master Trust is classified as follows at December 31, 2000 and 1999, respectively (in thousands):
Other Residency Master Trust Agreements Total ------------ --------------- ---------- At December 31, 2000: Other current liabilities $ 1,452 $ -- $ 1,452 Refundable portion of life estate fees 18,008 26,731 44,739 Deferred life estate income 27,791 24,974 52,765 ------------ --------------- ---------- $ 47,251 $ 51,705 $ 98,956 ============ =============== ========== Other Residency Master Trust Agreements Total ------------ --------------- ---------- At December 31, 1999: Other current liabilities $ 1,980 $ -- $ 1,980 Refundable portion of life estate fees 18,792 24,594 43,386 Deferred life estate income 29,359 22,247 51,606 ------------ --------------- ---------- $ 50,131 $ 46,841 $ 96,972 ============ =============== ==========
56 57 (13) SHAREHOLDERS' EQUITY On August 4, 1998, the Company completed a public offering of 4,500,000 shares of common stock, of which 4,297,500 were sold by the Company and 202,500 shares were sold by certain selling shareholders. Net proceeds to the Company were approximately $64.8 million, net of underwriting and issuance costs. The Company is authorized to establish and issue, from time to time, up to 5 million shares of no par value preferred stock, in one or more series, with such dividend rights, dividend rate, conversion rights, voting rights, rights and terms of redemption (including sinking fund provisions), redemption price or prices, and liquidation preference as authorized by the Board of Directors. At December 31, 2000, no preferred shares had been issued. On November 18, 1998, the Board of Directors of the Company declared a distribution of one stock purchase right (ARC Right) for each outstanding share of the Company's common stock, to shareholders of record at the close of business on December 7, 1998 and for each share of the Company's common stock issued thereafter. Each ARC Right entitles the holder, subject to the terms of the Rights Agreement, to purchase from the Company, one one-hundredth of a share (Unit) of ARC Series A Preferred Stock at a purchase price of $86.25 per Unit, subject to adjustment. The ARC Rights may cause substantial dilution to a person or group that attempts to acquire the Company on terms not approved by a majority of the Board of Directors. Thus, the ARC Rights are intended to encourage persons who may seek to acquire control of the Company to initiate such an acquisition through negotiations with the Company's Board of Directors. The ARC Rights attach to all certificates representing outstanding shares of Company common stock and no separate ARC Rights certificates will be distributed. The ARC Rights will separate from the common stock, and will be distributed, if certain persons acquire, obtain the right to acquire, or otherwise obtain beneficial ownership of 15% or more of the outstanding shares of the Company's common stock. If distributed, each holder of an ARC Right will thereafter have the right to receive, upon exercise, shares of Company common stock (or, in certain circumstances at the discretion of the Board of Directors, assets of the Company) having a value equal to two times the exercise price of the ARC Right. The ARC Rights are not exercisable until distributed and will expire at the close of business on November 18, 2008, unless earlier redeemed by the Company. The Board of Directors may redeem the ARC Rights in whole, but not in part, at a price of $.001 per ARC Right, payable, at the election of the Board of Directors, in cash or shares of Company common stock. Until an ARC Right is exercised, the holder will have no rights as a shareholder. A total of 2,000,000 shares of ARC Series A Preferred Stock have been reserved for issuance upon exercise of the ARC Rights, subject to adjustment. The Units of ARC Series A Preferred Stock that may be acquired upon exercise of the ARC Rights will be nonredeemable and subordinate to any other shares of preferred stock that may be issued by the Company. In December 1999, the Company announced plans to buy back up to $1.5 million of its common stock to fund the Company's contributions to its employee benefit plans for 2000 and 2001. As of December 31, 2000, the Company had purchased $1,198,000 or 211,400 shares of common stock and considers this buy back complete. The Company also announced, in March 2000, that the Board of Directors had authorized the repurchase, from time to time, of up to $30.0 million of the Company's 5 3/4% Convertible Debentures. The timing and amount of purchases of these debentures will depend upon prevailing market conditions, availability of capital, alternative uses of capital and other factors. As of December 31, 2000, the Company had not purchased any 5 3/4% Convertible Debentures. Purchases, if any, would be made primarily in the open market during 2001. 57 58 (14) STOCK-BASED COMPENSATION Stock Option Plan In 1997, the Company adopted a stock incentive plan (the "1997 Plan") providing for the grant of stock options, stock appreciation rights, restricted stock, and/or other stock-based awards. Pursuant to the 1997 Plan, as amended, 15% of the outstanding common stock, or 2,559,800 shares of common stock have been reserved and are available for issuance. The option exercise price and vesting provisions of such options are fixed when the option is granted. The options generally expire ten years from the date of grant and vest over a three-year period. The option exercise price is generally not less than the fair market value of a share of common stock on the date the option is granted. A summary of the Company's stock option activity, and related information for the years ended December 31, 2000, 1999 and 1998, respectively, is presented below (shares in thousands):
Average Exercise Options Shares Price ------------------------------------------------------------------------- Outstanding at December 31, 1997 780 $ 15.55 ------------------------------------------------------------------------- Granted 963 $ 16.93 Exercised (13) 14.00 Forfeited (240) 19.20 ------------------------------------------------------------------------- Outstanding at December 31, 1998 1,490 $ 15.86 ------------------------------------------------------------------------- Granted 1,018 $ 11.53 Exercised (5) 14.00 Forfeited (135) 16.47 ------------------------------------------------------------------------- Outstanding at December 31, 1999 2,368 $ 13.97 ------------------------------------------------------------------------- Granted 183 $ 6.10 Exercised -- -- Forfeited (1,791) 15.81 ------------------------------------------------------------------------- Outstanding at December 31, 2000 760 $ 7.52 =========================================================================
The following table summarizes information about stock options outstanding at December 31, 2000 (shares in thousands):
Weighted Average Range of Number Contractual Exercise Exercise Prices Outstanding Life (Years) Price --------------------------------------------------------------- $ 3.150 - 4.950 11 4.87 $ 4.46 $ 5.000 - 5.000 406 3.82 5.00 $ 5.010 - 14.000 285 5.59 9.32 $15.125 - 18.813 58 7.70 16.99 --------------------------------------------------------------- $ 3.150 - 18.813 760 5.08 $ 7.52 ---------------------------------------------------------------
There were 296,000 options exercisable at an average exercise price of $9.85 as of December 31, 2000. See Note 21. 58 59 The following table summarizes information about stock options outstanding at December 31, 1999 (shares in thousands):
Weighted Average Range of Number Contractual Exercise Exercise Prices Outstanding Life (Years) Price --------------------------------------------------------------- $ 5.000 - 13.188 458 9.81 $ 5.29 $14.000 - 14.000 496 7.42 14.00 $15.125 - 16.875 992 8.82 16.00 $17.375 - 23.000 422 8.93 18.51 --------------------------------------------------------------- $ 5.000 - 23.000 2,368 8.74 $13.97 ---------------------------------------------------------------
There were 623,000 options exercisable at an average exercise price of $15.35 as of December 31, 1999. As discussed in Note 2, the Company accounts for stock-based employee compensation in accordance with APB No. 25 and related interpretations including Financial Accounting Standards Board ("FASB") Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation, an Interpretation of APB No. 25" and related interpretations as permitted by SFAS No. 123. Accordingly, no compensation expense has been recognized for its stock option awards because the option grants are for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant. In accordance with SFAS No. 123, pro forma information regarding net income (loss) and earnings (loss) per share has been determined by the Company using the "Black-Scholes" option pricing model with the following weighted average assumptions for the years ended December 31, 2000, 1999 and 1998, respectively: 6.16%, 5.53% and 4.55% risk-free interest rate, 0% dividend yield, 60.6%, 76.4% and 39.7% volatility rate, and an expected life of the options equal to the remaining vesting period. The weighted average fair value of options granted during 2000, 1999 and 1998 was $2.77, $6.08, and $5.38, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands except per share amounts):
2000 1999 1998 ------------------------ ------------------------ ----------------------- As SFAS 123 As SFAS 123 As SFAS 123 Reported Pro Forma Reported Pro Forma Reported Pro Forma --------- --------- --------- --------- -------- --------- Net income (loss) $(5,846) $(6,665) $2,052 $ (419) $6,900 $5,559 Basic earnings (loss) per share $ (0.34) $ (0.39) $ 0.12 $(0.02) $ 0.49 $ 0.40 Diluted earnings (loss) per share $ (0.34) $ (0.39) $ 0.12 $(0.02) $ 0.49 $ 0.39
Stock Purchase Plan In 1997, the Company adopted an employee stock purchase plan ("ESPP") pursuant to which an aggregate of 138,792 shares remain authorized and available for issuance to employees at December 31, 2000. Under the ESPP, employees, including executive officers, who have been employed by the Company continuously for at least 90 days are eligible, subject to certain limitations, as of the first day of any option period (January 1 through June 30, or July 1 through December 31) (an "Option Period") to contribute on an after-tax basis up to 15% of their base pay per pay period through payroll deductions and/or a single lump sum contribution per Option Period to be used to purchase shares of common stock. On the last trading day of each Option Period (the "Exercise Date"), the amount contributed by each participant over the course of the Option Period will be used to purchase shares of common stock at a purchase price per share equal to the lesser of (a) 85% of the closing market price of the common stock on 59 60 the Exercise Date; or (b) 85% of the closing market price of the common stock on the first trading date of such Option Period. The ESPP is intended to qualify for favorable tax treatment under Section 423 of the Internal Revenue Code (Code). During 2000, 1999 and 1998, respectively, 66,067, 14,516 and 16,190 shares were issued pursuant to the ESPP at an average purchase price of $3.60, $9.34 and $14.52 per share, respectively. (15) RETIREMENT PLANS 401 (k) Plan Employees of the Company participate in a savings plan (the "401(k) Plan") which is qualified under Sections 401 (a) and 401(k) of the Code. To be eligible, an employee must have been employed by the Company for at least three months. The 401(k) Plan permits employees to make voluntary contributions up to specified limits. Additional contributions may be made by the Company at its discretion, which contributions vest ratably over a five-year period. The Company contributed $595,000, $115,000, and $521,000, for 2000, 1999, and 1998 respectively. Section 162 Plan The Company maintains a non-qualified deferred compensation plan (the "162 Plan") which allows employees who are "highly compensated" under IRS guidelines to make after-tax contributions to an investment account established in such employees' name. Additional contributions may be made by the Company at its discretion. All contributions to the 162 Plan are subject to the claims of the Company's creditors. Approximately 56 employees are eligible to participate in the 162 Plan. The Company contributed approximately $24,000 and $191,000 to the 162 Plan in 1999 and 1998, respectively. No contributions were made to the 162 Plan in 2000. (16) INCOME TAXES Total income tax expense (benefit) for the years ended December 31, 2000, 1999, and 1998 were attributable to the following (in thousands):
Years Ended December 31, --------------------------------- 2000 1999 1998 ------- ------ ------- Income (loss) from continuing operations $(3,523) $1,087 $ 5,652 Minority interest in losses of consolidated subsidiaries 589 170 -- Loss from home health operations -- -- (762) Write-off of home health assets -- -- (553) Extraordinary item (77) -- -- Cumulative effect of change in accounting principle -- -- (186) ------- ------ ------- Total income taxes (benefit) $(3,011) $1,257 $ 4,151 ======= ====== =======
The income tax expense (benefit), attributable to income (loss) from continuing operations before minority interest, extraordinary item and cumulative effect of change in accounting principle consists of the following (in thousands):
Years Ended December 31, ----------------------------------- 2000 1999 1998 ------- ------- ------- U.S. Federal: Current $(1,554) $ 1,375 $ 1,138 Deferred (1,525) (28) 3,925 ------- ------- ------- Total U.S. Federal (3,079) 1,347 5,063 ------- ------- -------
60 61
Years Ended December 31, ----------------------------------- 2000 1999 1998 ------- ------- ------- State: Current 274 89 591 Deferred (718) (179) (2) ------- ------- ------- Total State (444) (90) 589 ------- ------- ------- Total ($3,523) $ 1,257 $ 5,652 ======= ======= =======
The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2000 and 1999 are presented below (in thousands):
2000 1999 -------- -------- Deferred tax assets: Federal and state operating loss carryforwards $ 10,988 $ 3,734 AMT credit carryforward 478 2,000 Charitable contributions carryforward 6,653 6,653 Deferred gains on sale/leaseback transactions 5,337 1,183 Accrued expenses not deductible for tax 1,120 932 Intangible assets 700 549 Asset impairment charges and contractual losses on development 361 3,387 Other 308 295 -------- -------- Total gross deferred tax assets 25,945 18,733 Less valuation allowance (8,717) (7,554) -------- -------- Total deferred tax assets, net of valuation allowance 17,228 11,179 Deferred tax liabilities: Buildings and equipment 25,886 23,207 Deferred life estate revenue 1,403 1,016 Other 2,686 1,434 -------- -------- Total gross deferred tax liabilities 29,975 25,657 -------- -------- Net deferred tax liability $(12,747) $(14,478) ======== ========
The following table summarizes the significant differences between the U.S. Federal statutory tax rate and the Company's effective tax rate for financial statement purposes on income (loss) from continuing operations before income taxes, minority interest, extraordinary item and cumulative effect of change in accounting principle:
2000 1999 1998 ------- ------- ------- Statutory tax rate 35.0% 35.0% 35.0% Difference in book and tax goodwill amortization expense (1.4%) 4.0% -- State income taxes, net of Federal benefit 1.3% (1.8%) 2.5% Non-deductible expenses and other items (0.4%) 0.8% 0.2% ----- ----- ----- Total 34.5% 38.0% 37.7% ===== ===== =====
At December 31, 2000, the Company had unused federal net operating loss (NOL) carryforwards of approximately $20 million for regular tax purposes and $3 million for alternative minimum tax, which expire in 2011 through 2020. As of December 31, 2000 the Company had alternative minimum tax credit carryforwards of approximately $478,000. The Company also had an unused charitable contribution carryforward of approximately $19 million, which carried over from the acquisition of FGI. The charitable contribution carryover expires in 2002. 61 62 As of December 31, 2000, the Company carried a valuation allowance against deferred tax assets in the amount of $8.7 million. The net change in the total valuation allowance for the years ended December 31, 2000 and 1999 was an increase of $1.1 million. The increase in the valuation allowance during 2000 related to state net operating loss carryovers generated in 2000. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets related to deductible temporary differences is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The ultimate realization of deferred tax assets related to tax credit carryforwards is dependent upon the generation of future taxable income prior to the expiration of the carryforwards. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of projected future taxable income over the period in which the Company can utilize the charitable contribution carryforward, management believes that it is more likely than not that the tax benefit of the charitable contribution carryforward will not be fully realized prior to its expiration in 2002. Therefore, management has determined that a valuation allowance in the amount of $6.7 million should be applied against the charitable contribution carryforward. At such time as it becomes more likely than not that the benefit of the charitable contribution carryforward acquired will be realized, the goodwill recorded in the 1998 FGI acquisition will be reduced by an amount equal to the related tax benefit. Furthermore, management has determined that a valuation allowance in the amount of $2 million should be applied against certain state net operating loss carryovers. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced. (17) LEASEHOLD ACQUISITIONS AND SPECIAL PURPOSE ENTITIES (SPE) The Company has entered into various transactions with third parties for the development of certain Free-standing ALs. The Company generally has owned the land used for development purposes. The Company enters into a long-term ground lease with a special purpose entity, generally a subsidiary of a bank (the Owner). The Owner enters into a construction agreement with a lender. The Company is required to pledge to the Owners certificates of deposit as collateral to support the lessor's equity contribution commitment. At December 31, 2000, the Company has pledged certificates of deposit in the aggregate of $27.8 million, which are classified as non-current assets limited as to use. The Company receives the interest income earned on these certificates of deposit. Upon completion of the various development projects, the Owners of these senior living communities lease the properties to various other SPEs (the Lessee) under operating leases. The Company then enters into management agreements with the lessee's to manage the operations of the leased senior living communities. The management agreements provide for the payment of management fees to the Company based on a percentage of each communities' gross revenues and requires the Company to fund the lessee's operating deficits above specified amounts. During 2000 and 1999, the Company funded operating deficits of $2.2 million and $374,000, respectively. Such amounts are recorded as equity in losses of managed SPE communities on the accompanying Statements of Operation. The management agreements also provide the Company with purchase options or rights of first refusal to assume the lessee's leasehold interests in the leases at a formula price. During 2000, the Company assumed the leasehold interests of thirteen communities and acquired a community. Certain of these acquisitions were from a related party. This resulted in leasehold acquisition costs of $15.7 million during 2000, which are amortized over the remaining base term of the leases (generally ten to 15 years). Accumulated amortization was $547,000 as of December 31, 2000. See Note 20. At December 31, 2000, there were 12 assisted living communities leased by various lessee's. If offered and accepted, the Company anticipates acquiring certain, and perhaps all, of the leasehold interests, under its purchase options or rights of first refusal, in these 12 communities during 2001 and 2002. The combined purchase price would be approximately $20.0 to $25.0 million. Due to these leasehold acquisitions, the Company expects to incur significant operating losses until the communities achieve break-even occupancy levels. If the Company does not acquire these leasehold interest, it is still responsible for funding future operating losses which exceed specified limits. 62 63 (18) INDUSTRY SEGMENT INFORMATION The Company has significant operations principally in two industry segments: (1) Retirement Centers and (2) Free-Standing Assisted Living. Retirement Centers represent 32 of the senior living communities which provide a continuum of care services such as, independent living, assisted living and skilled nursing care. The Company currently operates 30 Free-Standing ALs. Free-standing ALs are generally comprised of stand-alone assisted living communities that are not located on a Retirement Center campus, some of which also provide some skilled nursing and/or specialized care such as Alzheimer's and memory enhancement programs. Free-standing ALs are generally much smaller than Retirement Centers. During fiscal year 2000, the Company realigned its management consistent with these segments. Prior to fiscal 2000, the Company operated in one segment. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance on EBITDAR, which is defined as earnings before net interest expense, income tax expense, depreciation, amortization, rent, and other special charges related to asset write-offs and write-downs, equity in loss of special purpose entities, other income (expense), minority interest, and extraordinary items. All prior year data has been reclassified to conform to the new segment alignment(1). The following is a summary of total revenues, EBITDAR, and total assets by segment for the years ended December 31, 2000 and 1999 (in thousands). It is impractical for the Company to report such segment information for fiscal 1998 as there was a limited number of Free-standing ALs in that period.
RETIREMENT FREE-STANDING CORPORATE / CENTERS ASSISTED LIVING OTHER TOTAL ---------- --------------- ----------- -------- FOR THE YEAR ENDED DECEMBER 31, 2000 Revenues $187,605 $ 13,450 $ 5,059 $206,114 NOI / Community EBITDAR(2) 65,241 (2,851) (14,366) 48,024 Lease Expense 18,267 Depreciation and Amortization 17,142 Operating Income (loss) 12,615 Total Assets 445,020 68,266 279,194 792,480 FOR THE YEAR ENDED DECEMBER 31, 1999 Revenues $159,531 $ 4,959 $ 10,780 $175,270 NOI / Community EBITDAR(2) 58,722 6 (4,456) 54,272 Lease Expense 12,985 Depreciation and Amortization 13,692 Asset Impairments and Contractual Losses 12,536 Operating Income (loss) 15,059 Total Assets 426,331 22,047 292,033 740,411
(1) Segment data does not include any inter-segment transactions or allocated costs. (2) EBITDAR is defined as earnings before net interest expense, income tax expense, depreciation, amortization, rent, and other special charges related to asset write-offs and write-downs, equity in loss of special purpose entities, other income (expense), minority interest, and extraordinary items. EBITDAR is commonly referred to by the Company as Net Operating Income or NOI. 63 64 (19) COMMITMENTS AND CONTINGENCIES The Company is subject to various legal proceedings and claims, which arise in the ordinary course of its business. In the opinion of management, the ultimate liability with respect to those proceedings and claims will not materially affect the financial position, operations, or liquidity of the Company. The Company maintains commercial insurance on a claims-made basis for medical malpractice liabilities. Management is unaware of any incidents which would result in a loss in excess of the Company's insurance coverage. The Company is self-insured for workers' compensation claims with excess loss coverage of $425,000 per individual claim and $1 million for aggregate claims. The Company utilizes a third party administrator to process and pay filed claims. The Company has accrued $547,000 to cover open claims not yet settled and incurred but not reported claims as of December 31, 2000. Management is of the opinion that such amounts are adequate to cover any such claims incurred but not reported as of December 31, 2000. At December 31, 2000, the Company had entered into operating leases for 21 of its senior living communities, its corporate offices, and a ground lease for a senior living community purchased during the year. The remaining base lease terms vary from two to 59 years. Certain of the leases provide for renewal and purchase options. Lease expense was $18.3 million, $13.0 million and $9.1 million for 2000, 1999, and 1998, respectively. Future minimum lease payments excluding residual guarantees under operating leases as of December 31, 2000 were as follows (in thousands):
2001 $ 28,249 2002 28,714 2003 26,308 2004 25,102 2005 29,400 Thereafter 181,109 -------- $318,882 ========
The Company's management agreements are generally for terms of three to 20 years, but certain of the agreements may be canceled by the owner of the community, without cause, on three to six months' notice. Pursuant to the management agreements, the Company is generally responsible for providing management personnel, marketing, nursing, resident care and dietary services, accounting and data processing services, and other services for these communities at the owner's expense and receives a monthly fee for its services based on either a contractually fixed amount, a percentage of revenues or income, or cash flows in excess of operating expenses and certain cash flows of the community. The Company's existing management agreements expire at various times through June 2018. In connection with the execution of management contracts pursuant to the FGI transaction, the Company assumed a debt guaranty on the mortgage debt of one of the managed communities. At December 31, 2000, $18.6 million was outstanding under the debt agreement. In addition, the Company has guaranteed mortgage debt of approximately $65.0 million of which $13.0 million relates to two leased Retirement Centers, $28.2 million relates to three of the Managed SPE Communities, $16.2 million relates to two of the acquired leasehold interests during 2000, one of which opened during the first quarter of 2001, and $7.6 million relates to a non-consolidated Managed SPE Community. The Company is currently providing development services for senior living communities owned by others. Under the terms of the development or management agreements, the Company receives a fixed fee of approximately 3.75% to 5% of the total construction costs of the communities. Such fees are recognized over the terms of the development agreements using the percentage-of-completion method. The Company recognized $901,000 and $5.9 million of development fee revenue during 2000 and 1999, respectively. The Company owns the land upon which 13 of these senior living communities are located, and has leased the land for terms of 50 years. 64 65 Federal and state governments regulate various aspects of the Company's business. The development and operation of health care facilities and the provision of health care services are subject to federal, state, and local licensure, certification, and inspection laws that regulate, among other matters, the number of licensed beds, the provision of services, the distribution of pharmaceuticals, billing practices and policies, equipment, staffing (including professional licensing), operating policies and procedures, fire prevention measures, environmental matters, and compliance with building and safety codes. Failure to comply with these laws and regulations could result in the denial of reimbursement, the imposition of fines, temporary suspension of admission of new patients, suspension or decertification from the Medicare programs, restrictions on the ability to acquire new facilities or expand existing facilities, and, in extreme cases, the revocation of a community's license or closure of a community. Except as noted below, management believes the Company was in compliance with such federal and state regulations at December 31, 2000. The Company manages a senior living community in Peoria, Arizona under a long-term management agreement with a third party owner. The Arizona Department of Insurance has notified the owner of the Company's managed community in Peoria, Arizona, that the owner is not currently in compliance with a net worth requirement imposed by Arizona law. While the compliance with this net worth requirement is technically the responsibility of the owner, in order to facilitate discussions with the Arizona Department of Insurance, the Company has provided the Department with a limited guaranty relating to the financial performance of the community, and has notified the Arizona DOI of the Company's intention to enter into a lease of the community, if the Company can reach acceptable terms with the owner. The Department has tentatively indicated that the proposed lease will result in the community's compliance with the applicable Arizona statute. There can be no assurance that the State of Arizona will not enforce the law strictly. A violation of this net worth requirement may, among other things, allow the Arizona Department of Insurance to take steps to appoint a receiver for the community. (20) RELATED PARTY TRANSACTIONS The Company agreed to develop ten assisted living residences for an unaffiliated third-party. Following completion of construction, the residences were leased to affiliates of John Morris, a director of the Company. During 2000, leasehold interests for four of these communities have been acquired by the Company for $6.2 million (see Note 17). One of the leasehold interests acquired was subsequently leased to a third party during 2000. The Company agreed to manage such residences pursuant to management agreements that provide for the payment of management fees to the Company based on a percentage of the gross revenues of each residence and require the Company to fund operating losses above a specified amount. The Company has agreements with similar terms with unaffiliated parties. During 2000 and 1999, the Company recognized $984,000 and $0 in operating losses related to the four leases acquired, and recognized $562,000 and $114,000 in 2000 and 1999, respectively, of management fees pursuant to the management agreements. In addition, the Company has advanced amounts for certain costs of these SPE affiliates of John Morris. At December 31, 2000, approximately $1.2 million was due to the Company from these affiliates. Such amounts are expected to be reimbursed through the future acquisition of the leasehold interests of these affiliates. As part of the FGI Transaction, the Company entered into a 20-year management agreement (with two ten-year renewal options) for a senior living community located in Peoria, Arizona, Freedom Plaza Limited Partnership (FPLP). Mr. Roskamp, a previous director of the Company, is a director of a charitable foundation that owns an interest in the community. Pursuant to the management agreement, the Company receives a management fee equal to all cash receipts from the community that is in excess of operating expenses, refunds of entrance fees, capital expenditure reserves, debt service, and certain payments to the community's owners. The Company recognized $972,000, $1.5 million, and $1.2 million of management fees in 2000, 1999, and 1998 respectively, pursuant to this agreement. At December 31, 2000 and 1999, the Company has receivables of $2.3 million and $1.5 million, respectively from FPLP. Such amounts are non-interest bearing. W.E. Sheriff, the Company's chairman and chief executive officer, owns 50% of Maybrook Realty, Inc., which in October 1999 acquired a 128-bed nursing center, Freedom Plaza Care Center (FPCC) in Peoria, Arizona. Maybrook 65 66 simultaneously leased the nursing center to FPLP, which, in turn, operates the nursing center as part of the Freedom Plaza retirement campus under the name FPCC. As described above, FPLP (including FPCC after October 1999) is managed by the Company pursuant to a management agreement providing the Company with a net cash flow management fee. The Company has guaranteed the payment and performance of FPLP's obligations under its lease with Maybrook. Mr. Sheriff has also agreed to indemnify the Company from any loss or liability that the Company incurs under the guaranty of such lease. The Company is serving as the developer of an expansion of the FPCC, which is nearing completion. Pursuant to the terms of its development agreement with Maybrook, the Company is to receive a development fee of $125,000. The Company recognized $78,125 of the development fee in 2000. Maybrook has also granted the Company an option to acquire the health center at a formula purchase price beginning in October 2009. In July 1998, the Company entered into a 20-year management agreement (with two ten-year renewal options) for a senior living community located in Seminole, Florida. In connection with the management agreement, the Company paid a $1.2 million fee to the owner of the community, which is a general partnership in which Mr. Roskamp, a previous director of the Company, owns a 98.0% interest, and assumed FGI's existing guaranty of approximately $18.6 million of the mortgage debt associated with the community. Pursuant to the management agreement, the Company will receive a management fee equal to all cash receipts from the community that is in excess of operating expenses, refunds of entrance fees, capital expenditure reserves, debt service, and certain payments to the community's owner. As part of the FGI transaction, the Company also acquired an option to purchase the community upon the occurrence of certain events (including the expiration of the agreement) for a formula purchase price. The Company recognized $519,000, $368,000, and $1.7 million of management fees in 2000, 1999, and 1998 respectively, pursuant to this agreement. At December 31, 2000 and 1999, the Company has receivables of $2.5 million and $1.2 million, respectively from this community. Such amounts are non-interest bearing. In July 1998, the Company entered into a three-year management agreement for a senior living community located in West Brandywine, Pennsylvania, that was owned by a partnership in which Mr. Roskamp, a previous director of the Company, owned a 70.0% interest. Pursuant to the management agreement, the Company received a management fee equal to 5.0% of the gross revenues of the community. The Company paid a non-refundable deposit of $2.0 million to acquire an option to purchase the community for a purchase price of $14.0 million, plus the assumption of certain specified liabilities. On May 26, 2000, the Company assigned its purchase option to a third party, which exercised the option and purchased the property. The Company subsequently entered into a series of agreements with this third party to lease and operate the retirement community. In connection with this transaction, the Company is required to maintain $17.4 million of assets limited as to use, on which the Company receives the interest. The Company also assumed FGI's remaining development obligations relating to the community. In return for its development services and costs associated therewith, the Company received a fee of $200,000 in 1998. Additionally, the Company recognized $212,000, $383,000, and $82,000 in management fees in 2000, 1999, and 1998 respectively, pursuant to this agreement. At December 31, 2000, the Company had a note payable of $888,000 to the lessor. Pursuant to the FGI Transaction, the Company also entered into an agreement to provide development services related to the development and construction of a senior living community in Sarasota, Florida that opened during 2000. The community is owned by a limited liability company in which Mr. Roskamp owns a 57.5% interest. The Company managed the community following its completion pursuant to a five-year management agreement that provides for a management fee equal to 5.0% of the gross revenues of the community. In consideration of the Company's payment of a $2.0 million fully-refundable deposit, the Company acquired an option to purchase the community for a price to be negotiated. During the third quarter of 2000, the Company chose to cancel the purchase option, the full $2.0 million deposit was refunded. The management agreement for this community was mutually terminated on December 31, 2000. The Company recognized $750,000, $900,000, and $450,000 of development fees in 2000, 1999, and 1998, respectively and $65,300 in management fees in 2000, from the agreement. 66 67 In connection with the FGI Transaction, Mr. Roskamp entered into a three-year consulting agreement with the Company that provides for annual payments of $150,000 to Mr. Roskamp through June 2001. (21) SUBSEQUENT EVENTS On January 4, 2001, the Company granted 1,120,000 incentive stock options, 236,700 of which were non-qualified. These options were granted with an exercise price of $3.10, the fair value of the shares at the date of grant. These grants are one-third vesting upon six months, 12 months and 15 months, and have an expiration of ten years. (22) QUARTERLY DATA (UNAUDITED) The following table presents unaudited quarterly operating results for each of the Company's last eight fiscal quarters. The Company believes that all necessary adjustments have been included in the amounts stated below to present fairly the quarterly results when read in conjunction with the consolidated financial statements. Results of operations for any particular quarter are not necessarily indicative of results of operations for a full year or predictive of future periods.
Year 2000 Quarter Ended Ended ---------------------------------------------------- Dec 31, Mar 31 June 30 Sept 30 Dec 31 2000 -------- -------- -------- -------- --------- (dollar amounts in thousands, except share data) STATEMENT OF OPERATIONS DATA: Total revenues $46,777 $ 48,762 $ 53,432 $ 57,143 $ 206,114 Net income (loss) 620 (652) (1,742) (4,072) (5,846) EARNINGS (LOSS) PER SHARE: Basic $ 0.04 $( 0.04) $( 0.10) $( 0.24) $( 0.34) Weighted average basic shares outstanding 17,138 17,146 17,024 17,037 17,086 Diluted $ 0.04 $( 0.04) $( 0.10) $( 0.24) $( 0.34) Weighted average diluted shares outstanding 17,249 17,146 17,024 17,037 17,086 Year 1999 Quarter Ended Ended ---------------------------------------------------- Dec 31, Mar 31 June 30 Sept 30 Dec 31 1999 -------- -------- -------- -------- --------- (dollar amounts in thousands, except share data) STATEMENT OF OPERATIONS DATA: Total revenues $43,595 $44,453 $44,362 $ 42,860 $175,270 Net income (loss) 3,395 3,431 2,079 (6,853) 2,052 EARNINGS (LOSS) PER SHARE: Basic $ 0.20 $ 0.20 $ 0.12 $( 0.40) $ 0.12 Weighted average basic shares outstanding 17,118 17,122 17,138 17,138 17,129 Diluted $ 0.20 $ 0.20 $ 0.12 $( 0.40) $ 0.12 Weighted average diluted shares outstanding 17,177 17,161 17,138 17,138 17,177
67 68 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item with respect to the directors of the Company is incorporated herein by reference to the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held May 3, 2001 to be filed with the Securities and Exchange Commission (the "SEC"). Pursuant to General Instruction G(3), certain information concerning the executive officers of the Company is included in Part I of this report under the caption "Executive Officers." ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated herein by reference to the section entitled "Executive Compensation" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held May 3, 2001 to be filed with the SEC. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated herein by reference to the section entitled "Security Ownership of Management and Certain Beneficial Owners" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held May 3, 2001 to be filed with the SEC. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference to the section entitled "Certain Transactions" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held May 3, 2001 to be filed with the SEC. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K Item 14. (a)(1) Financial Statements: See Item 8 (2) Financial Statement Schedules: See Item 8 (3) Exhibits required by item 601 of Regulation S-K are as follows:
Exhibit Number Description - ------- ----------------------------------------------------------------------- 2.1 Limited Partnership Agreement of American Retirement Communities, L.P. dated February 7, 1995, as amended April 1, 1995.(1) 2.2 Articles of Share Exchange between American Retirement Communities, L.P., and American Retirement Corporation, dated March 31, 1995.(1) 2.3 Reorganization Agreement, dated February 28, 1997.(1) 2.4 Agreement and Plan of Merger, dated as of May 29, 1998, by and among American Retirement Corporation, Freedom Group, Inc., and the shareholders of Freedom Group, Inc.(2)
68 69 2.5 Supplemental Agreement, dated July 14, 1998, among American Retirement Corporation, Freedom Group, Inc., Robert G. Roskamp, PHC, L.L.C., and The Edgar and Elsa Prince Foundation(3) 2.6 Amendment to Agreement and Plan of Merger, dated October 12, 1998, by and among American Retirement Corporation and each of the former shareholders of Freedom Group, Inc.(3) 3.1 Charter of the Registrant(1) 3.2 Articles of Amendment to the Charter of the Registrant(3) 3.3 Articles of Amendment to the Charter of the Registrant, dated May 12, 1999(10) 3.4 Bylaws of the Registrant, as amended(3) 4.1 Specimen Common Stock certificate(1) 4.2 Article 8 of the Registrant's Charter (included in Exhibit(3.1) 4.3 Form of Indenture between the Company and IBJ Schroder Bank and Trust Company, as Trustee, relating to the 5 3/4% Convertible Subordinated Debentures due 2002 of the Company.(4) 4.4 Rights Agreement, dated November 18, 1998, between American Retirement Corporation and American Stock Transfer and Trust Company.(5) 10.1 American Retirement Corporation 1997 Stock Incentive Plan, as amended(6) 10.2 American Retirement Corporation Employee Stock Purchase Plan(1) 10.3 First Amendment to Employee Stock Purchase Plan(8) 10.4 American Retirement Corporation 401(k) Retirement Plan(1) 10.5 Officers' Incentive Compensation Plan(1) 10.6 Registration Rights Policy(1) 10.7 Registration Rights Agreement, dated July 14, 1998, by and between American Retirement Corporation and Robert G. Roskamp, PHC, LLC, and the Edgar and Elsa Prince Foundation(7) 10.8 Shareholder Agreement, dated July 14, 1998, by and between American Retirement Corporation and Robert G. Roskamp(7) 10.9 Consulting Agreement, dated July 14, 1998, by and between American Retirement Corporation and Robert G. Roskamp(7) 10.10 Lease and Security Agreement, dated January 2, 1997, by and between Nationwide Health Properties, Inc. and American Retirement Communities, L.P.(4) 10.11 Lease and Security Agreement, dated January 2, 1997, by and between N.H. Texas Properties Limited Partnership and Trinity Towers Limited Partnership(4) 10.12 Amended and Restated Loan Agreement, dated December 21, 1994, between Carriage Club of Denver, L.P. and General Electric Capital Corporation(1) 10.13 Amended and Restated Promissory Note, dated December 21, 1994, between Carriage Club of Denver, L.P. and General Electric Capital Corporation(1) 10.14 Assumption, Consent and Loan Modification Agreement, dated February 9, 1995, by and among Carriage Club of Denver, L.P. and General Electric Capital Corporation(1) 10.15 Loan Agreement, dated October 31, 1995, by and between American Retirement Communities, L.P. and First Union National Bank of Tennessee, as amended(1) 10.16 Amended and Restated Promissory Note, dated October 31, 1995, by American Retirement Communities, L.P. and First Union National Bank of Tennessee, as amended(1) 10.17 Revolving Credit Promissory Note, dated October 31, 1995, by American Retirement Communities, L.P. and First Union National Bank of Tennessee, as amended.1 10.18 Standby Note, dated October 31, 1995, by American Retirement Communities, L.P. and First Union National Bank of North Carolina(1) 10.19 Reimbursement Agreement, dated October 31, 1995, by American Retirement Communities, L.P. and First Union National Bank of North Carolina(1) 10.20 Letter of Intent, dated April 3, 1997, by National Health Investors, Inc. to American Retirement Corporation(1) 10.21 Master Loan Agreement, dated December 23, 1996 between First American National Bank and American Retirement Communities, L.P.(1)
69 70 10.22 Letter of Intent, dated February 24, 1997, by National Health Investors, Inc. to American Retirement Corporation(1) 10.23 Deed of Lease, dated as of October 23, 1997, between Daniel U.S. Properties Limited Partnership, as Lessor, and ARC Imperial Plaza, Inc. as Lessee(8) 10.24 Loan Agreement, dated as of December 31, 1997, between General Electric Capital Corporation and Fort Austin Limited Partnership(8) 10.25 Promissory Note, dated December 31, 1997, by Fort Austin Limited Partnership to General Electric Capital Corporation in the original principal amount of $62,330,000(8) 10.26 Promissory Note, dated December 31, 1997, by Fort Austin Limited Partnership to General Electric Capital Corporation in the original principal amount of $50,000,000(8) 10.27 Fixed Rate Program Promissory Note Secured by Mortgage, dated July 9, 1998, by ARCLP-Charlotte, LLC to Heller Financial, Inc. in the original principal amount of $36,000,000(7) 10.28 Financing and Security Agreement, dated June 8, 1999, by and among ARC Capital Corporation II and Bank United, as Agent(9) 10.29 Loan Commitment, dated July 30, 1999, among American Retirement Corporation and Guaranty Federal Bank, F.S.B.(9) 10.30 Term Sheet, dated May 28, 1999, among Health Care REIT, Inc. and American Retirement Corporation(9) 10.31 Amended and Restated Financing and Security Agreement, dated February 11, 2000, by and among ARC Capital Corporation II and Bank United, as Agent(10) 10.32 Loan Agreement, dated March 23, 2000, by and between ARC Heritage Club, Inc. and GMAC Commercial Mortgage Corporation.(11) 10.33 Construction Loan Agreement, dated March 17, 2000 between Freedom Village of Sun City Center, Ltd. and Suntrust Bank, Tampa Bay(12) 10.34 Real Estate Mortgage and Security Agreement, dated May 8, 2000, between Lake Seminole Square Management Company, Inc., Freedom Group-Lake Seminole Square, Inc. and Aid Association for Lutherans(12) 10.35 Construction Loan Agreement, dated September 28, 2000 between ARC Scottsdale, LLC and Guaranty Federal Bank, F.S.B.(13) 10.36 First Amendment to Amended and Restated Financing and Security Agreement(13) 10.37 First Amendment to Amended and Restated Guaranty of Payment Agreement(13) 10.38 Lease Agreement by and between Cleveland Retirement Properties, LLC, and ARC Westlake Village, Inc., dated December 18, 2000 21 Subsidiaries of the Registrant 23 Consent of KPMG LLP
- -------------- 1 Incorporated by reference to the Registrant's Registration Statement on Form S-1 (Registration No. 333-23197). 2 Incorporated by reference to the Registrant's Current Report on Form 8-K, dated May 29, 1998. 3 Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. 4 Incorporated by reference to the Registrant's Registration Statement on Form S-1 (Registration No. 333-34339). 5 Incorporated by reference to the Registrant's Current Report on Form 8-K, dated November 24, 1998. 6 Incorporated by reference to the Registrant's Registration Statement on Form S-8 (Registration No. 333-94747) 7 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. 8 Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. 9 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999. 10 Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1999. 11 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2000. 12 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000. 13 Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000. (b) Reports on Form 8-K filed during the quarter ended December 31, 2000: None. 70 71 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AMERICAN RETIREMENT CORPORATION March 30, 2001 By: /s/ W.E. Sheriff ------------------------------------------- W.E. Sheriff Chairman and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - ----------------------------------------- ------------------------------------- -------------- /s/ W.E. Sheriff Chairman and March 30, 2001 - ----------------------------------------- W.E. Sheriff Chief Executive Officer (Principal Executive Officer) /s/ George T. Hicks Executive Vice President - Finance, March 30, 2001 - ----------------------------------------- George T. Hicks Chief Financial Officer (Principal Financial and Accounting Officer) /s/ H. Lee Barfield II Director March 30, 2001 - ----------------------------------------- H. Lee Barfield II /s/ Frank M. Bumstead Director March 30, 2001 - ----------------------------------------- Frank M. Bumstead /s/ Christopher Coates Director March 30, 2001 - ----------------------------------------- Christopher J. Coates /s/ Robin G. Costa Director March 30, 2001 - ----------------------------------------- Robin G. Costa /s/ Clarence Edmonds Director March 30, 2001 - ----------------------------------------- Clarence Edmonds /s/ John A. Morris, Jr., M.D. Director March 30, 2001 - ----------------------------------------- John A. Morris, Jr., M.D. /s/ Daniel K. O'Connell Director March 30, 2001 - ----------------------------------------- Daniel K. O'Connell /s/ Nadine C. Smith Director March 30, 2001 - ----------------------------------------- Nadine C. Smith /s/ Lawrence J. Steusser Director March 30, 2001 - ----------------------------------------- Lawrence J. Stuesser
71 72 American Retirement Corporation Schedule II - Valuation and Qualifying Accounts
Additions ---------------------- Balance at Charged to Charged to Balance at Beginning of costs and other End of Description Period expenses accounts Deductions Period - ------------------------------------------------------------------------------------------------ Allowance for Doubtful Accounts Year ended December 31, 1998 $ 248 $ 276 $ -- $ (282) $ 242 ========================================================= Year ended December 31, 1999 $ 242 $ 118 $ -- $ (123) $ 237 ========================================================= Year ended December 31, 2000 $ 237 $ 367 $ -- $ (182) $ 422 ========================================================= Deferred Tax Valuation Account Year ended December 31, 1998 $ -- $6,653(1) $ -- $ 6,653 ========================================================= Year ended December 31, 1999 $6,653 $ 901 $ -- $ -- $ 7,554 ========================================================= Year ended December 31, 2000 $7,554 $1,163 $ -- $ -- $ 8,717 ========================================================= Reserve for Contractual loss Year ended December 31, 1998 $ -- $ -- $ -- $ -- $ -- ========================================================= Year ended December 31, 1999 $ -- $6,200 $ -- $ -- $ 6,200 ========================================================= Year ended December 31, 2000 $6,200 $ -- $ -- $(5,389) $ 811 =========================================================
(1) Tax asset acquired in Freedom Group transaction for which management does not believe realization of the tax benefit is more likely than not. 72 73 American Retirement Corporation Schedule IV - Mortgage Loans on Real Estate
Principal amount Final Periodic Carrying of loans subject Interest Maturity Payment Face amount amount of to delinquent Description Rate Date Terms Prior liens of mortgages mortgages(3) principal or interest - ------------------------------------------------------------------------------------------------------------------------------------ First mortgage loan LIBOR+200 1-Oct-05 (1) -- 1,533 1,533 -- First mortgage loan LIBOR+200 1-Dec-09 (1) -- 18,235 18,235 -- First mortgage loan LIBOR+200 1-Jan-10 (1) -- 4,235 4,235 -- ====================================================================== -- 24,003 24,003 -- ---------------------------------------------------------------------- Construction loans LIBOR+300 1-Jul-07 (2) -- 9,128 9,128 -- Construction loans LIBOR+300 1-Jul-07 (2) -- 7,737 7,737 -- Construction loans LIBOR+300 1-Jul-07 (2) -- 1,588 1,588 -- Construction loans LIBOR+200 1-Apr-07 (2) -- 9,961 9,961 -- Construction loans LIBOR+300 1-Dec-09 (2) -- 9,764 9,764 -- Construction loans LIBOR+200 1-Feb-10 (2) -- 8,606 8,606 -- Construction loans LIBOR+200 1-Jan-07 (2) -- 10,264 10,264 -- Other construction loans -- 7,454 7,454 -- ---------------------------------------------------------------------- -- 64,502 64,502 -- ---------------------------------------------------------------------- $-- $ 88,505 $ 88,505 $-- ======================================================================
(1) Principal payment based upon a 25-year amortization schedule with outstanding principle due at maturity. (2) Interest only through completion of construction. Upon completion of construction principle payments will be based upon a 25-year amortization schedule with outstanding principle due at maturity. (3) The carrying amount of the mortgage aggregate cost for federal income tax purposes is $88,505. =========== Balance at December 31, 1997 $ -- =========== Additions during the period: New mortgage loans $ 19,759 Deductions during the period: Collections of principal (28) ----------------------- Balance at December 31, 1998 $ 19,731 =========== Additions during period: New mortgage loans 79,028 Deductions during period: Collections of principal (174) Write offs of impaired loans (1,349) ----------------------- Balance at December 31, 1999 $ 97,236 =========== Additions during period: New mortgage loans 23,084 Deductions during period: Collections of principal (31,815) ----------------------- Balance at December 31, 2000 $ 88,505 ===========
73 EX-10.38 2 g68121ex10-38.txt LEASE AGREEMENT DATED 12/18/00 1 EXHIBIT 10.38 Lease Agreement by and between CLEVELAND RETIREMENT PROPERTIES, LLC, a New York limited liability company as "Landlord" and ARC WESTLAKE VILLAGE, INC., a Tennessee corporation as "Tenant" Dated December 18, 2000 2 TABLE OF CONTENTS 1. TERM............................................................................. 2 1.1 TERM. ........................................................ 2 1.2 RENEWAL TERMS.................................................. 2 2. RENT............................................................................. 2 2.1 INITIAL TERM MINIMUM RENT...................................... 3 2.2 RENEWAL TERM MINIMUM RENT...................................... 4 2.3 ADDITIONAL RENT................................................ 8 2.4 PRORATION FOR PARTIAL PERIODS.................................. 9 2.5 ABSOLUTE NET LEASE............................................. 9 2.6 Special Lump Sum Payment; Termination Payment ................. 10 3. TAXES, ASSESSMENTS AND OTHER CHARGES............................................. 11 3.1 PAYMENT OF IMPOSITIONS......................................... 11 3.2 DEFINITION OF IMPOSITIONS...................................... 12 3.3 PRORATION...................................................... 13 3.4 RIGHT TO PROTEST............................................... 13 3.5 TAX BILLS...................................................... 13 3.6 OTHER CHARGES.................................................. 13 4. INSURANCE........................................................................ 14 4.1 GENERAL INSURANCE REQUIREMENTS................................. 14 4.2 PROPERTY INSURANCE............................................. 15 4.3 PUBLIC LIABILITY............................................... 16 4.4 BUSINESS INTERRUPTION INSURANCE................................ 17 4.5 BUILDER'S RISK INSURANCE....................................... 17 4.6 REPLACEMENT VALUE.............................................. 18 4.7 PERMITTED MORTGAGE LENDER'S INSURANCE REQUIREMENTS............. 18 4.8 PERMITTED MORTGAGE LENDER'S TAX AND INSURANCE ESCROWS.......... 19 5. USE, MAINTENANCE AND ALTERATION OF THE PREMISES.................................. 19 5.1 TENANT'S MAINTENANCE OBLIGATIONS............................... 19 5.2 REGULATORY COMPLIANCE.......................................... 20 5.3 PERMITTED USE.................................................. 21 5.4 NO LIENS....................................................... 21 5.5 ALTERATIONS BY TENANT.......................................... 21 5.6 CAPITAL EXPENDITURES ACCOUNT................................... 22 6. CONDITION AND TITLE OF PREMISES; RIGHT OF FIRST REFUSAL.......................... 25 6.1 CONDITION AND TITLE OF PREMISES................................ 25
i 3 6.2 RIGHT OF FIRST REFUSAL TO PURCHASE PREMISES.................... 26 6.3 TENANT'S TRANSFER RIGHTS SUBJECT TO BERKSHIRE LOAN DOCUMENTS... 31 7. LANDLORD AND TENANT PERSONAL PROPERTY............................................ 31 7.1 TENANT PERSONAL PROPERTY....................................... 31 7.2 REQUIREMENTS FOR TENANT PERSONAL PROPERTY...................... 31 7.3 COMPLIANCE WITH LAWS........................................... 33 7.4 RESIDENT TENANT LEASES......................................... 33 7.5 TRANSFER OF LICENSE, ETC....................................... 34 8. REPRESENTATIONS AND WARRANTIES................................................... 35 8.1 MUTUAL REPRESENTATIONS AND WARRANTIES.......................... 35 8.2 MUTUAL COVENANTS............................................... 35 8.3 NEGATIVE COVENANTS OF LANDLORD................................. 37 9. FINANCIAL, MANAGEMENT AND REGULATORY REPORTS..................................... 38 9.1 ANNUAL FINANCIAL STATEMENT..................................... 38 9.2 REGULATORY REPORTS............................................. 38 10. EVENTS OF DEFAULT AND LANDLORD'S REMEDIES........................................ 39 10.1 EVENTS OF DEFAULT.............................................. 39 10.2 REMEDIES....................................................... 41 10.3 RECEIVERSHIP................................................... 43 10.4 REMEDIES CUMULATIVE: NO WAIVER................................. 43 10.5 PERFORMANCE OF TENANT'S OBLIGATIONS BY LANDLORD................ 44 10.6 LATE PAYMENT CHARGE............................................ 45 11. DAMAGE BY FIRE OR OTHER CASUALTY................................................. 46 11.1 NOTICE OF CASUALTY............................................. 46 11.2 SUBSTANTIAL DESTRUCTION........................................ 47 11.3 PARTIAL DESTRUCTION............................................ 47 11.4 RESTORATION.................................................... 48 11.5 INSUFFICIENT PROCEEDS.......................................... 49 11.6 NOT TRUST FUNDS................................................ 49 11.7 LANDLORD'S INSPECTION.......................................... 49 11.8 LANDLORD'S COSTS............................................... 50 11.9 NO RENT ABATEMENT.............................................. 50 11.10 SURPLUS PROCEEDS............................................... 50 11.11 END OF TERM.................................................... 50 12. CONDEMNATION..................................................................... 51 12.1 TOTAL TAKING................................................... 51
ii 4 12.2 PARTIAL TAKING................................................. 51 12.3 CONDEMNATION PROCEEDS NOT TRUST FUNDS.......................... 52 13. PROVISIONS ON TERMINATION OF TERM................................................ 52 13.1 SURRENDER OF POSSESSION........................................ 52 13.2 REMOVAL OF PERSONAL PROPERTY................................... 52 13.3 TITLE TO PERSONAL PROPERTY NOT REMOVED......................... 53 13.4 MANAGEMENT OF PREMISES......................................... 53 13.5 CORRECTION OF DEFICIENCIES..................................... 53 14. NOTICES AND DEMANDS.............................................................. 54 15. RIGHT OF ENTRY: EXAMINATION OF RECORDS........................................... 55 16. QUIET ENJOYMENT.................................................................. 55 17. APPLICABLE LAW................................................................... 55 18. HAZARDOUS MATERIALS.............................................................. 55 18.1 HAZARDOUS MATERIAL COVENANTS................................... 55 18.2 TENANT NOTICES TO LANDLORD..................................... 56 18.3 PARTICIPATION IN HAZARDOUS MATERIALS CLAIMS.................... 56 18.4 ENVIRONMENTAL ACTIVITIES....................................... 57 18.5 HAZARDOUS MATERIALS INDEMNITY.................................. 57 18.6 HAZARDOUS MATERIALS............................................ 58 18.7 HAZARDOUS MATERIALS CLAIMS .................................... 58 18.8 HAZARDOUS MATERIALS LAWS....................................... 58 19. ASSIGNMENT AND SUBLETTING........................................................ 59 19.1 PROHIBITION ON ASSIGNMENT AND SUBLETTING....................... 59 19.2 REQUESTS FOR LANDLORD'S CONSENT TO ASSIGNMENT, SUBLEASE OR MANAGEMENT AGREEMENT .......................................... 60 19.3 ASSIGNMENT BY LANDLORD......................................... 61 19.4 ORDINARY COURSE SUBLEASES NOT REQUIRE CONSENT.................. 61 19.5 SUCCESSOR...................................................... 61 20. INDEMNIFICATION.................................................................. 61 20.1 TENANT'S INDEMNIFICATION....................................... 61 20.2 LIMITATION OF LANDLORD'S LIABILITY............................. 63 21. HOLDING OVER..................................................................... 64 21.1 SURRENDER...................................................... 64
iii 5 22. ESTOPPEL CERTIFICATES............................................................ 64 23. CONVEYANCE BY LANDLORD........................................................... 65 24. WAIVER OF JURY TRIAL............................................................. 65 25. ATTORNEYS' FEES.................................................................. 65 26. SEVERABILITY..................................................................... 66 27. COUNTERPARTS..................................................................... 66 28. BINDING EFFECT................................................................... 66 29. WAIVER AND SUBROGATION........................................................... 66 30. MEMORANDUM OF LEASE.............................................................. 67 31. INCORPORATION OF RECITALS AND ATTACHMENTS........................................ 66 32. TITLES AND HEADINGS.............................................................. 67 33. NATURE OF RELATIONSHIP; USURY SAVINGS CLAUSE..................................... 67 34. JOINT AND SEVERAL................................................................ 67 35. SURVIVAL OF REPRESENTATIONS, WARRANTIES AND COVENANTS............................ 67 36. INTERPRETATION................................................................... 67 37. ASSIGNMENT OF APPROVAL AND CONSENT RIGHTS........................................ 67 38. SUBORDINATION, NON-DISTURBANCE, AND ATTORNMENT................................... 68 39. ENTIRE AGREEMENT................................................................. 68
iv 6 EXHIBITS EXHIBIT A - LEGAL DESCRIPTION OF PREMISES EXHIBIT A-1 - PERMITTED EXCEPTIONS EXHIBIT B - LANDLORD PERSONAL PROPERTY EXHIBIT C - APPRAISAL PROCESS EXHIBIT D - ILLUSTRATION OF LEASE RENEWAL FACTOR EXHIBIT E - LANDLORD'S SINGLE PURPOSE ENTITY COVENANTS v 7 LEASE AGREEMENT THIS LEASE AGREEMENT ("Lease") is made and entered into as of the 18th day of December, 2000 by and between CLEVELAND RETIREMENT PROPERTIES, LLC, a New York limited liability company ("Landlord") having an address of c/o Robert J. Sant, 760 BROOKS AVENUE, ROCHESTER, NEW YORK 14619, and ARC WESTLAKE VILLAGE, INC., a Tennessee corporation ("Tenant"), having an address of American Retirement Corporation, 111 Westwood Place, Suite 412, Brentwood, Tennessee 37027. WITNESSETH: WHEREAS, Landlord has purchased from a subsidiary of American Retirement Corporation, a Tennessee corporation ("ARC"), certain real property, all improvements thereon (the "Improvements") and all appurtenances thereto, comprising a continuing care retirement community known as "Westlake Village", located in Westlake, Ohio and more specifically described in Exhibit "A" attached hereto, together with the furniture, machinery, equipment, appliances, fixtures, supplies and other personal property used in connection therewith as more specifically described on Exhibit "B" attached hereto ("LANDLORD PERSONAL PROPERTY"). The foregoing real and personal property owned by Landlord as described in this Recital shall be collectively referred to in this Lease as the "PREMISES"; WHEREAS, Landlord desires to lease the Premises to Tenant, and Tenant desires to lease the Premises from Landlord. 1 8 NOW THEREFORE, in consideration of the mutual covenants, conditions and agreements set forth herein, Landlord hereby leases and lets unto Tenant the Premises for the term and upon the conditions and provisions hereinafter set forth. 1. TERM. 1.1 TERM. The term of this Lease shall commence on December 18, 2000 (the "COMMENCEMENT DATE") and shall end on December 31, 2007 (the "INITIAL TERM") unless extended pursuant to Section 1.2 or earlier terminated in accordance with the provisions hereof. The Initial Term and all Renewal Terms are referred to collectively as the "TERM". (Each 12 month period commencing on the same day and month of the first day of the Initial Term shall be referred to herein as a "LEASE YEAR".) 1.2 RENEWAL TERMS. The Term may be extended for two (2) separate renewal terms (each a "RENEWAL TERM"), the first such Renewal Term being for a term of thirteen (13) years, and the second such Renewal Term being for a term of ten (10) years, upon the satisfaction of all of the following terms and conditions: 1.2.1 At least twelve (12) months prior to the end of the then current Term, Tenant shall have given Landlord written notice that Tenant desires to exercise its right to extend the then current Term for the succeeding Renewal Term. 1.2.2 This Lease shall be in full force and effect and Tenant shall not then be in material default of its obligations beyond any applicable periods of grace and/or notice and cure. 1.2.3 All other provisions of this Lease shall remain in full force and effect and shall continuously apply throughout the Renewal Term(s). 2 9 2. RENT. During the Initial Term and all Renewal Terms, minimum rent ("MINIMUM RENT") shall be paid by Tenant to Landlord at the address set forth in Section 14 of this Lease (except as otherwise provided in Section 2.1 below), without abatement, deduction or set-off, as follows: 2.1 INITIAL TERM MINIMUM RENT. During the Initial Term, the Minimum Rent (the "Initial Term Minimum Rent") shall be paid to Landlord by Tenant monthly in advance on the first business day of each month (except for the payment made on the date hereof for the period of December 18, 2000 through December 31, 2000), and shall be calculated as follows: 2.1.1 On the date hereof, Tenant has delivered to Landlord Minimum Rent in the amount of $81,755.26 representing prorated Minimum Rent for the month of December, 2000. 2.1.2 No Minimum Rent shall be due for January, 2001. 2.1.3 February, 2001 through June, 2001 - $133,818.88 per month. 2.1.4 July, 2001 through June, 2002 - $191,004.59 per month. 2.1.5 July, 2002 through June, 2003- $192,148.30 per month. 2.1.6 July, 2003 through June, 2004 - $193,292.01 per month. 2.1.7 July, 2004 through June, 2005 - $194,435.73 per month. 2.1.8 July, 2005 through June, 2006 - $195,579.44 per month. 2.1.9 July, 2006 through June, 2007 - $196,723.16 per month. 2.1.10 July, 2007 through end of Initial Term - $197,866.87 per month. 3 10 Notwithstanding anything to the contrary herein, any payment of principal and/or interest by Tenant to any Permitted Mortgage Lender as the same may become due and payable under the respective Permitted Mortgage Loan shall be deemed to be a credit in Tenant's favor against any Rent due hereunder. The term "PERMITTED MORTGAGE LOAN" shall mean any loan to Landlord from a Permitted Mortgage Lender that is secured by a valid mortgage lien on the Premises; provided that (i) the terms and conditions of such loan, and all of the documents relating to such loan, shall be commercially reasonable and customary, (ii) Tenant shall have consented to such documents and their terms and conditions in advance of such loan (which consent shall not be unreasonably withheld), (iii) the amount of such loan shall not, when aggregated with the outstanding principal amount of any other Permitted Mortgage Loans then in effect, exceed eighty percent (80%) of the Fair Market Value (as defined on Exhibit "C" attached hereto) of the Premises at the time that such loan is first made, and (iv) such loan is permitted by, and will not constitute a default under, any other Permitted Mortgage Loan. The Berkshire Loan (as hereinafter defined) shall be considered to be a Permitted Mortgage Loan, and all parties hereto agree that the terms and conditions of the Berkshire Loan, and all of the documents evidencing or securing the Berkshire Loan existing as of the commencement date of this Lease are "commercially reasonable and customary." "PERMITTED MORTGAGE LENDER" shall mean any commercial lending institution that generally engages in the business of making real estate loans, but shall not include any competitor of ARC. The Berkshire Lender (as hereinafter defined) shall be considered to be a Permitted Mortgage Lender. As used herein, "BERKSHIRE LOAN" refers to that certain $19,500,000 loan from Berkshire Mortgage Finance Limited Partnership, a 4 11 Massachusetts limited partnership together with its successors and assigns (the "BERKSHIRE LENDER") to Landlord, as evidenced by that certain Multifamily Note dated of even date herewith and payable to Berkshire Lender (the "BERKSHIRE NOTE"). 2.2 RENEWAL TERM MINIMUM RENT. The Minimum Rent for each Renewal Term shall be expressed as an annual amount but shall be payable in advance in equal monthly installments on the first business day of each calendar month. Such annual Minimum Rent shall be equal to the lesser of (a) the Twenty Percent Renewal Amount as defined and determined under Section 2.2.1, or (b) the Invested Capital Renewal Amount as defined and determined under Section 2.2.2. 2.2.1 The "Twenty Percent Renewal Amount" means an amount equal to an increase of twenty percent (20%) over the annual Minimum Rent for the Lease Year immediately preceding the expiration of the then expiring Term, subject, in certain circumstances, to the adjustments described in Sections 2.2.1.1 and 2.2.1.2 below. 2.2.1.1 For purposes of calculating the Twenty Percent Renewal Amount for the first Renewal Term, if there is a positive Rate Differential (as hereinafter defined), annual Minimum Rent for the Lease Year immediately preceding the expiration of the Initial Term shall be deemed to be increased by an amount equal to the Interest Rate Adjustment Amount (as hereinafter defined). As used herein, the term "INTEREST RATE ADJUSTMENT AMOUNT" shall mean an amount equal to the Rate Differential multiplied by the lesser of (i) the outstanding principal balance of the Berkshire Loan or the Permitted Mortgage Loan on the day preceding the expiration of the then expiring Term, or 5 12 (ii)( $17,857,765.79. As used herein, the term "RATE DIFFERENTIAL" shall mean the difference (if positive) between the Seven Year Note Rate (as hereinafter defined) at the expiration of the then expiring Term, less 5.24% (i.e., the Seven Year Note Rate as of the date hereof); provided, however, that the Rate Differential shall not under any circumstance exceed 1.54% for purposes of the calculation under this Section 2.2.1.1. As used herein, the term "SEVEN YEAR NOTE RATE" means the yield on seven year notes issued by the United States Treasury, as reasonably determined by Landlord and Tenant. 2.2.1.2 In the event that the Twenty Percent Renewal Amount was actually the determinative amount in establishing the Minimum Rent for the first Renewal Term (i.e., the Twenty Percent Renewal Amount was less than the Invested Capital Renewal Amount at the expiration of the Initial Term), then, for purposes of calculating the Twenty Percent Renewal Amount in connection with the establishment of the annual Minimum Rent for the second Renewal Term, annual Minimum Rent for the Lease Year immediately preceding the expiration of the expiring first Renewal Term shall be deemed to be increased by an amount equal to the Interest Rate Adjustment Amount. Notwithstanding the foregoing, for purposes of the calculations under this Section 2.2.1.2 the Rate Differential shall not exceed, and shall be limited to, the difference between 1.54%, less the Rate Differential calculated under Section 2.2.1.1 in connection with the determination of the annual Minimum Rent for the first Renewal Term (regardless of whether the Twenty Percent Renewal Amount was determinative). 6 13 2.2.2 The "Invested Capital Renewal Amount" shall equal ten percent (10%) of Landlord's Adjusted Investment Amount. As used herein, "LANDLORD'S ADJUSTED INVESTMENT AMOUNT" means $26,362,849.65, as increased, if applicable, by the Lease Renewal Factor. The LEASE RENEWAL FACTOR shall be determined as follows: 2.2.2.1 As promptly as practicable after the end of the Initial Term of this Lease (or the immediately preceding Renewal Term, as appropriate), Landlord shall compute the increase, if any, in the cost of living since the first day of the first Lease Year of the expiring term based upon the Consumer Price Index--United States (1982 = 100), All Urban Consumers (the "CPI"), published by the Bureau of Labor Statistics of the United States Department of Labor. 2.2.2.2 The CPI number for the month immediately preceding the first month of the first Lease Year of the expiring term shall be the "BASE CPI", and the corresponding CPI number for the last month of the expiring term in question shall be the "CURRENT CPI." 2.2.2.3 The "CPI INCREASE" shall equal (Current CPI/Base CPI) -1. 2.2.2.4 The CPI Increase shall be divided by two (2) to determine the "LEASE RATE ESCALATOR." 2.2.2.5 The Lease Renewal Factor shall equal the Lease Rate Escalator plus 1. Exhibit "D" hereto sets for a hypothetical, illustrative calculation of the Lease Renewal Factor. 2.2.2.6 Landlord shall, within a reasonable time after obtaining the appropriate data necessary for computing such increase, give Tenant notice of any 7 14 increase so determined, and Landlord's computation thereof shall be conclusive and binding (but shall not preclude any adjustment that may be required in the event of a published amendment of the CPI figures upon which the computation was based) unless Tenant shall, within 60 days after the giving of such notice, notify Landlord of any claimed error therein. 2.2.2.7 The Minimum Rent for each Renewal Term, as so determined, shall be due and payable to Landlord in equal monthly installments commencing with the first month of the Renewal Term in question (any retroactive payments then due being payable within five days after giving of such notice), and in the event of any subsequent redetermination of such amount the adjustment thus indicated shall be made promptly between Landlord and Tenant. 2.2.2.8 If publication of the CPI shall be discontinued, the parties shall thereafter accept comparable statistics on the cost of living for the City of Westlake, Ohio, as they shall be computed and published by an agency of the United States or by a responsible financial periodical of recognized authority then to be selected by the parties. In the event of (1) use of comparable statistics in place of the CPI as above mentioned, or (2) publication of the CPI figure at other than monthly intervals, there shall be made in the method of computation herein provided such revisions as the circumstances may require to carry out the intent of this Section. 2.2.3 MINIMUM RENT NOT TO DECREASE. Except as set forth in Section 2.2.4, in no event shall the Minimum Rent calculated for any Renewal Term decrease. 8 15 Notwithstanding anything to the contrary herein, subject to Section 2.2.4, in the event the Minimum Rent as so calculated in this Section 2.2 shall result in a decrease in the amount of Minimum Rent to be paid as compared to the immediately previous expiring term, then the Minimum Rent for the new Renewal Term shall be equal to the amount paid in the immediately previous expiring term. 2.3 ADDITIONAL RENT. In addition to Minimum Rent, Tenant shall pay as additional rent hereunder all other amounts, liabilities, obligations and Impositions (as hereinafter defined) which Tenant assumes or agrees to pay under this Lease and any fine, penalty, interest, charge and cost which may be added for nonpayment or late payment of such items (collectively the "Additional Rent"). The Minimum Rent and Additional Rent are referred to herein as "RENT". Landlord shall have all legal, equitable and contractual rights, powers and remedies provided either in this Lease or by statute or otherwise in the case of nonpayment of the Rent. 2.4 PRORATION FOR PARTIAL PERIODS. The Rent for any month during the Term that begins or ends on other than the first or last calendar day of such month shall be prorated based on actual days elapsed. 2.5 ABSOLUTE NET LEASE. 2.5.1 GENERALLY. All rent payments shall be absolutely net to the Landlord free of taxes (other than federal or state income, franchise and excise taxes calculated on the net income of Landlord), assessments, utility charges, operating expenses, refurnishings, insurance premiums or any other charge or expense in connection with the Premises. All expenses and charges, whether for upkeep, 9 16 maintenance, repair, refurnishing, refurbishing, restoration, replacement, insurance premiums, real estate or other property taxes, utilities, and other operating or other charges of a like nature or otherwise, shall be paid by Tenant. This provision is not in derogation of the specific provisions of this Lease, but in expansion thereof and as an indication of the general intention of the parties hereto. 2.5.2 SALES TAX. Tenant hereby agrees to pay any and all sales or use taxes (and any interest or penalties related thereto) at any time assessed by the State of Ohio (the "STATE") against Tenant, with respect to (i) Tenant's operation of business on the Premises, and (ii) this Lease, including any lease of personal property at any time entered into by and between Landlord and Tenant. 2.6 SPECIAL LUMP SUM PAYMENT; TERMINATION PAYMENT. In the event that Tenant does not exercise its first renewal option, and so long as Landlord is not in material default hereunder, Tenant shall pay to Landlord a single lump sum payment (the "SPECIAL PAYMENT") on the last day of the Initial Term in the amount of $1,222,720.00. Tenant shall also pay to Landlord a lump sum payment in an amount equal to $133,818.88 (the "TERMINATION PAYMENT") on the last day of the Initial Term unless Tenant exercises its first renewal option. If Tenant exercises its first renewal option, Tenant shall pay the Termination Payment to Landlord on the last day of the first Renewal Term unless Tenant exercises its second renewal option. If Tenant exercises its second renewal option, Tenant shall not be obligated to pay the Termination Payment to Landlord. 2.7 NO TERMINATION, ABATEMENT, ETC. Except as otherwise specifically provided in this Lease, Tenant shall remain bound by this Lease in accordance with its terms. 10 17 Tenant shall not, without the consent of Landlord, modify, surrender or terminate the Lease, nor seek nor be entitled to any abatement, deduction, deferment or reduction of Rent, or set-off against the Rent. Except as expressly provided in this Lease, the obligations of Landlord and Tenant shall not be affected by reason of (i) any damage to, or destruction of, the Premises or any part thereof from whatever cause or any Taking (as hereinafter defined) of the Premises or any part thereof; or (ii) the lawful or unlawful prohibition of, or restriction upon, Tenant's use of the Premises, or any part thereof, the interference with such use by any person, corporation, partnership or other entity, or by reason of eviction by paramount title. Except as otherwise specifically provided in this Lease, Tenant hereby specifically waives all rights, arising from any occurrence whatsoever, which may now or hereafter be conferred upon it by law to modify, surrender or terminate this Lease or quit or surrender the Premises or any portion thereof. 30 TAXES, ASSESSMENTS AND OTHER CHARGES: 3.1 PAYMENT OF IMPOSITIONS. Tenant shall pay, as Additional Rent, all Impositions that may be levied or become a lien on the Premises or any part thereof at any time (whether prior to or during the Term), without regard to prior ownership of said Premises, before any fine, penalty, interest, or cost is incurred; provided, however, Tenant may contest any Imposition in accordance with Section 3.4. Tenant shall deliver to Landlord [i] not more than 5 days after the due date of each Imposition, copies of the invoice for such Imposition and the check delivered for payment thereof; and [ii] not more than 30 days after the due date of each Imposition, a copy of the original receipt evidencing such payment or other proof of payment satisfactory to Landlord. Tenant's obligation to pay such Impositions shall be deemed absolutely fixed upon the date such Impositions become a lien upon the Premises or any part 11 18 thereof. Tenant, at its expense, shall prepare and file all tax returns and reports in respect of any Imposition as may be required by governmental authorities. Tenant shall be entitled to any refund due from any taxing authority if no Event of Default shall have occurred hereunder and be continuing. Landlord shall be entitled to any refund from any taxing authority if an Event of Default has occurred and is continuing. Landlord and Tenant shall, upon request of the other, provide such data as is maintained by the party to whom the request is made with respect to the Premises as may be necessary to prepare any required returns and reports. In the event governmental authorities classify any property covered by this Lease as personal property, Tenant shall file all personal property tax returns in such jurisdictions where it may legally so file. Landlord, to the extent it possesses the same, and Tenant, to the extent is possesses the same, will provide the other party, upon request, with cost and depreciation records necessary for filing returns for any property so classified as personal property. Where Landlord is legally required to file personal property tax returns, Tenant will be provided with copies of assessment notices indicating a value in excess of the reported value in sufficient time for Tenant to file a protest. Tenant shall reimburse Landlord for all personal property taxes paid by Landlord within 30 days after receipt of billings accompanied by copies of a bill therefor and payments thereof which identify the personal property with respect to which such payments are made. Impositions imposed in respect to the tax-fiscal period during which the Term terminates shall be adjusted and prorated between Landlord and Tenant, whether or not such Imposition is imposed before or after such termination, and Tenant's obligation to pay its prorated share thereof shall survive such termination. 12 19 3.2 DEFINITION OF IMPOSITIONS. "Impositions" means, collectively, [i] taxes, all real estate and personal property ad valorem, sales and use, business or occupation, single business, gross receipts, transaction privilege, rent or similar taxes; [ii] assessments (including without limitation, all assessments for public improvements or benefits, whether or not commenced or completed prior to the date hereof and whether or not to be completed with the Term); [iii] ground rents, water, sewer or other rents and charges, excises, tax levies, and fees (including without limitation, license, permit, inspection, authorization and similar fees); [iv] all taxes imposed on Tenant's operations of the Premises, including without limitation, employee withholding taxes, income taxes and intangible taxes; [v] all taxes imposed by the State or any governmental entity in the State with respect to the conveyance of the Premises by Landlord to Tenant or Tenant's designee, including without limitation, conveyance taxes and capital gains taxes; and [vi] all other governmental charges, in each case whether general or special, ordinary or extraordinary, or foreseen or unforeseen, of every character in respect of the Premises or any part thereof and/or the Rent (including all interest and penalties thereon due to any failure in payment by Tenant), which at any time prior to, during or in respect of the Term hereof may be assessed or imposed on or in respect of or be in a lien upon [a] Landlord or Landlord's interest in the Premises or any part thereof; [b] the Premises or any part thereof or any rent therefrom or any estate, right, title or interest therein; or [c] any occupancy, operation, use or possession of, or sales from, or activity conducted on, or in connection with the Premises or the leasing or use of the Premises or any part thereof. Notwithstanding anything herein to the contrary, Tenant shall not, however, be required to pay any tax based on, or calculated with reference to, Landlord's income or revenues by any governmental entity. 13 20 3.3 PRORATION. At the end of the Term all impositions shall be prorated unless Tenant or its assignee has exercised the right of first refusal pursuant to the terms of Section 6.2 hereof. 3.4 RIGHT TO PROTEST. Landlord and/or Tenant shall have the right, but not the obligation, to protest the amount or payment of any Impositions; provided that in the event of any protest by Tenant, Landlord shall not incur any expense because of any such protest, Tenant shall diligently and continuously prosecute any such protest and notwithstanding such protest Tenant shall pay any tax, assessment or other charge before the imposition of any penalty. 3.5 TAX BILLS. Landlord shall promptly forward to Tenant copies of all tax bills and payment receipts relating to the Impositions received by Landlord. 3.6 OTHER CHARGES. Tenant agrees to pay and discharge, punctually as and when the same shall become due and payable without penalty, all electricity, gas, garbage collection, cable television, telephone, water, sewer, and other utilities costs and all other charges, obligations or deposits assessed against the Premises during the Term. 40 INSURANCE. 4.1 GENERAL INSURANCE REQUIREMENTS. All insurance provided for in this Lease shall be maintained under valid and enforceable policies issued by insurers of recognized responsibility, approved to do business in the State having a general policyholders rating of not less than "A" and a financial rating of not less than "X" in the then most current Best's Insurance Report. Any and all policies of insurance required under this Lease shall name the Landlord and any Permitted Mortgage Lender as an additional named insured and shall be on an "occurrence" or "claims made" basis (at Tenant's election); provided, however, the proceeds of any business 14 21 interruption policy shall be payable to Tenant without relieving Tenant in any way of its obligation to pay Rent under this Lease. In addition, Landlord shall be shown as the loss payable beneficiary under the casualty insurance policy maintained by Tenant pursuant to Section 4.2. All policies of insurance required herein may be in the form of "blanket" or "umbrella" type policies which shall name the Landlord and Tenant as their interests may appear and allocate to the Premises the full amount of insurance required hereunder. Certificates from the insurers evidencing the existence of all policies of insurance required by this Lease and showing the interest of the Landlord shall be filed with the Landlord prior to the commencement of the Term and shall provide that the subject policy may not be canceled except upon not less than ten (10) days prior written notice to Landlord. Certificates from the insurers evidencing the existence of any renewal policies shall be deposited with Landlord upon renewal of the applicable policies. Any claims under any policies of insurance described in this Lease shall be adjudicated by and at the expense of the Tenant or of its insurance carrier, but shall be subject to joint control of Tenant and Landlord. 4.2 PROPERTY INSURANCE. At Tenant's expense, Tenant shall maintain in full force and effect a property insurance policy or policies insuring the Premises against the following: 4.2.1 Loss or damage commonly covered by a "Special Form" policy (also known as an "All Risk Policy") insuring against physical loss or damage to the Premises, including but not limited to, risk of loss from fire and other hazards, collapse, transit coverage, vandalism, malicious mischief, and any other risk as is normally covered under such a policy. The policy shall be in the amount of the Full Replacement Value (as 15 22 hereinafter defined) of the Premises and shall contain a deductible amount reasonably acceptable to Landlord and any Permitted Mortgage Lender (as hereinafter defined) in light of all applicable circumstances (including general industry conditions), but in no event shall Landlord require such deductible amount to be less than the deductible amount in effect immediately prior to the Commencement Date. Landlord shall be named as an additional insured. The policy shall include a stipulated value endorsement or agreed amount endorsement and endorsements for contingent liability for operations of building laws, demolition costs, and increased cost of construction. 4.2.2 If applicable, loss or damage by explosion of steam boilers, pressure vessels, or similar apparatus, now or hereafter installed on the Premises, in commercially reasonable amounts acceptable to Landlord. 4.2.3 Consequential loss of rents and income coverage insuring against all "Special Form" risk of physical loss or damage with limits and deductible amounts acceptable to Landlord covering risk of loss during the first 9 months of reconstruction, and containing an endorsement for extended period of indemnity of at least 6 months, and shall be written with a stipulated amount of coverage if available at a reasonable premium. 4.2.4 If the Premises is located, in whole or in part, in a federally designated 100-year flood plain area, flood insurance for all Improvements of every nature whatsoever now or hereafter situated on the Premises in an amount equal to the lesser of (i) the Full Replacement Value of the Improvements; or (ii) the maximum amount of 16 23 insurance available for the Improvements under all federal and private flood insurance programs. 4.2.5 Loss or damage caused by the breakage of plate glass in commercially reasonable amounts acceptable to Landlord. 4.2.6 Loss or damage commonly covered by blanket crime insurance including employee dishonesty, loss of money orders or paper currency, depositor's forgery, and loss of property of patients accepted by Tenant for safekeeping, in commercially reasonable amounts acceptable to the Landlord. 4.3 PUBLIC LIABILITY. At Tenant's expense, Tenant shall maintain liability insurance against the following: 4.3.1 Claims for personal injury or property damage commonly covered by comprehensive general liability insurance with endorsements for incidental malpractice, contractual, personal injury, owner's protective liability, voluntary medical payments, products and completed operations, broad form property damage, and extended bodily injury, with commercially reasonable amounts for bodily injury, property damage, and voluntary medical payments acceptable to Landlord, but with a combined single limit of not more than $5,000,000.00 per occurrence; provided, however, this amount shall be adjusted at the commencement of each Renewal Term according to reasonable and customary practices for similar businesses in similar locales. 4.3.2 Claims for personal injury and property damage commonly covered by comprehensive automobile liability insurance, covering all owned and non-owned automobiles, with commercially reasonable amounts for bodily injury, property damage, 17 24 and or automobile medical payments acceptable to Landlord, but with a combined single limit of not less than $3,000,000.00 per occurrence. 4.3.3 Claims for personal injury commonly covered by medical malpractice insurance in commercially reasonable amounts acceptable to Landlord. 4.3.4 Claims commonly covered by worker's compensation insurance for all persons employed by Tenant on the Premises. Such worker's compensation insurance shall be in accordance with the requirements of all applicable local, state, and federal law. 4.4 BUSINESS INTERRUPTION INSURANCE. Tenant shall maintain, at its expense, business interruption and extra expense insurance insuring a period of not less than three (3) months. 4.5 BUILDER'S RISK INSURANCE. In connection with any construction, Tenant shall maintain in full force and effect a builder's completed value risk policy ("Builder's Risk Policy") of insurance in a nonreporting form insuring against all "Special Form" risk of physical loss or damage to the Improvements, including but not limited to, risk of loss from fire and other hazards, collapse, transit coverage, vandalism, malicious mischief, theft, earthquake (if Premises is in earthquake zone 1 or 2) and sinkholes (if usually recommended in the area of the Premises). The Builder's Risk Policy shall include endorsements providing coverage for building materials and supplies and temporary premises. The Builder's Risk Policy shall be in the amount of the Full Replacement Value of the improvements on the Premises and shall contain a deductible amount acceptable to Landlord. Landlord shall be named as additional insured. The Builder's Risk Policy shall include an endorsement permitting initial occupancy. 18 25 4.6 REPLACEMENT VALUE. The term "FULL REPLACEMENT VALUE" means the actual replacement cost thereof from time to time including increased cost of construction endorsement, with no reductions or deductions. Tenant shall, in connection with each annual policy renewal, deliver to Landlord a redetermination of the full replacement value by the insurer or an endorsement indicating that the Premises is insured for its full replacement value. If Tenant makes any alterations to the Premises, Landlord may have such full replacement value redetermined at any time after such alterations are made, regardless of when the full replacement value was last determined. 4.7 PERMITTED MORTGAGE LENDER'S INSURANCE REQUIREMENTS. Notwithstanding anything to the contrary in this Lease, Tenant's obligations with respect to insurance as described in this Section 4 shall at all times be subject to any Permitted Mortgage Lender's insurance requirements as described in any of the documents evidencing a Permitted Mortgage Loan (the "PERMITTED MORTGAGE LOAN INSURANCE REQUIREMENTS"). Should the Permitted Mortgage Loan Insurance Requirements exceed the insurance requirements set forth in this Lease in any way, including without limitation, scope of coverage and coverage amounts, Tenant shall comply with terms of the Permitted Mortgage Loan Insurance Requirements to the extent that such requirements exceed Tenant's obligations in this Section 4. Absent acquiescence, waiver or amendment by any Permitted Mortgage Lender, failure of Tenant to so comply with the Permitted Mortgage Loan Insurance Requirements shall be an Event of Default under this Lease, and shall entitle Landlord to all of the remedies set forth in Section 10 of this Lease. 19 26 4.8 PERMITTED MORTGAGE LENDER'S TAX AND INSURANCE ESCROWS. Notwithstanding anything in this Lease to the contrary, in addition to all of Tenant's obligations with respect to taxes and insurance, as set forth in Sections 3 and 4 of this Lease, Tenant agrees to comply with any tax and/or insurance escrows required by any Permitted Mortgage Lender under any Permitted Mortgage Loans. Landlord and Tenant agree that Tenant's compliance with the tax and/or insurance escrows requirements of each Permitted Mortgage Loan shall, to the extent of any payment actually made into any Permitted Mortgage Loan escrow account, satisfy Tenant's requirements (a) with respect to the payment of Impositions, (b) relating to taxes, and associated with obtaining insurance under this Lease. 50 USE, MAINTENANCE AND ALTERATION OF THE PREMISES. 5.1 TENANT'S MAINTENANCE OBLIGATIONS. 5.1.1 Except as provided in Sections 11 and 12, Tenant will keep and maintain the Premises in good appearance, repair and condition and maintain proper housekeeping. Tenant shall make or cause to be made all repairs, interior and exterior, structural and nonstructural, ordinary and extraordinary, foreseen and unforeseen, necessary to keep the Premises in good and lawful order and condition. Tenant covenants and agrees that during the Term (i) it shall use, keep and operate the Premises in a careful, safe and proper manner; (ii) not commit or suffer waste thereon; (iii) not use or occupy the Premises for any unlawful purposes; (iv) not use or occupy the Premises or permit the same to be used or occupied, for any purpose or business deemed extrahazardous on account of fire or otherwise; (v) keep the Premises in such repair and condition as may be required by the local Board of Health, or other city, state or federal 20 27 authorities, free of all cost to Landlord; (vi) not permit any acts to be done which will cause the cancellation, invalidation, or suspension of any insurance policy; and (vii) permit Landlord and its agents to enter upon the Premises at all reasonable times upon reasonable notice to examine the condition thereof. 5.1.2 As part of Tenant's obligations under this Section 5.1, Tenant shall be responsible to maintain, repair and replace all Landlord Personal Property and all Tenant Personal Property (as defined in Section 7.1 below) in good and operable condition, consistent with prudent industry practice as applicable to the Retirement Care Facility (as defined in Section 5.2 below). 5.2 REGULATORY COMPLIANCE. 5.2.1 Tenant and the Premises shall comply in all material respects with all federal, state and local licensing and other laws and regulations applicable to the continuing care retirement community on the Premises (the "RETIREMENT CARE FACILITY") as well as with the certification requirements of Medicare and Medicaid (or any successor program) as currently exist or as are obtained by Tenant at a later date, as well as with the healthcare compliance covenants set forth on Exhibit "F" attached hereto. Further, Tenant shall not commit any act or omission that would in any way violate any certificate of occupancy affecting the Premises. Tenant shall deliver to Landlord complete copies of any material surveys, examinations, certification and licensure inspections, compliance certificates, and other similar reports issued to Tenant by any governmental agency within 10 days after Tenant's receipt of each item. 21 28 5.2.2 During the Term, all inspection fees, costs and charges associated with a change of any licensure or certification shall be borne solely by Tenant. Tenant shall at its sole cost make any additions or alterations to the Premises necessitated by, or imposed in connection with, a change of ownership inspection survey for the transfer of operation of the Premises from Tenant or Tenant's assignee or subtenant to Landlord or Landlord's designee at the expiration or earlier termination of the Term in accordance herewith. 5.3 PERMITTED USE. Tenant shall continuously use and occupy the Premises during the Term solely as a Retirement Care Facility or other senior housing, independent living, assisted living, skilled and intermediate nursing, subacute care, Alzheimer's care, and related uses, and no other use without Landlord's prior written consent. 5.4 NO LIENS. Tenant shall have no authority to permit or create a lien against the Premises, and Tenant shall post notices or file such documents as may be required to protect Landlord's interest in the Premises against liens. Tenant hereby agrees to defend, indemnify, and hold Landlord harmless from and against any mechanic's liens against the Premises by reason of work, labor, services or materials supplied or claimed to have been supplied on or to the Premises through or under Tenant. Tenant shall remove, bond-off, or otherwise obtain the release of any mechanic's lien filed against the Premises within 10 days after the filing thereof. Tenant shall pay all expenses in connection therewith, including without limitation, damages, interest, court costs and reasonable attorneys' fees. 5.5 ALTERATIONS BY TENANT. Tenant shall have the right of altering, improving, replacing, modifying or expanding the facilities, equipment or appliances in the 22 29 Premises from time to time as it may determine is desirable for the continuing and proper use and maintenance of the Premises under this Lease; provided, however, that any alterations, improvements, replacements, expansions or modifications to the Premises in excess of Five Hundred Thousand Dollars ($500,000) in any rolling twelve (12) month period shall require the prior written consent of the Landlord, which shall not be unreasonably withheld, conditioned, or delayed; provided, however, no such alterations, improvements, replacements, modifications or expansions shall result in a material diminution of value of the Premises or shall materially adversely affect the use and operation of the Premises upon completion. Any amounts funded by Tenant as necessitated by damage to the Premises by casualty or condemnation or in the nature of routine or ordinary course capital expenditures shall not be included in the foregoing calculation. The cost of all alterations, improvements, replacements, modifications, expansions or other purchases, covered by this Section 5.5 shall be borne solely and exclusively by Tenant and shall immediately become a part of the Premises and the property of the Landlord subject to the terms and conditions of this Lease. All work done in connection therewith shall be done in a good and workmanlike manner and in compliance with all existing codes and regulations pertaining to the Premises and shall comply with the requirements of insurance policies required under this Lease. In the event any items of the Premises have become inadequate, obsolete or worn out or require replacement (by direction of any regulatory body or otherwise), Tenant shall remove such items and exchange or replace the same at Tenant's sole cost and the same shall become part of the Premises and property of the Landlord. 5.6 CAPITAL EXPENDITURES ACCOUNT. At the commencement of the Initial Term, Landlord shall deposit in an interest bearing account maintained by Tenant (the "CAPITAL 23 30 EXPENDITURE ACCOUNT") the amount of $265,687.00 for the purpose of funding repairs, replacements and capital improvements to be made on the Premises from time to time. The Capital Expenditure Account shall be with Genesee Regional Bank, a New York State Chartered Commercial Bank ("GENESEE") for so long as, in the exercise of Tenant's reasonable discretion from time to time, Genesee has sufficient financial strength and stability to reasonably guaranty that funds deposited with it will not be subject to risk of loss. If at any time Tenant deems, in Tenant's reasonable discretion, that Genesee does not have sufficient financial strength and stability to reasonably guaranty that funds deposited with it will not be subject to risk of loss, Tenant shall have the right to move all or any portion of such funds to another financial institution or institutions selected jointly by Landlord and Tenant and to make subsequent Capital Expenditure Deposits (as hereinafter defined) thereto. Subject to Section 5.6.1 below, within sixty (60) days of the first day of the second Lease Year of the Initial Term, and sixty (60) days of the first day of each Lease Year thereafter, Tenant shall make additional deposits (the "Capital Expenditure Deposits") in the Capital Expenditure Account in an amount equal to 3% of Tenant's annual revenue generated from Tenant's ordinary course business operations at the Premises. Tenant may withdraw monies deposited in the Capital Expenditure Account for the purpose of making repairs, replacements and capital improvements on the Premises to be applied as follows: first, as required to comply with the provisions of this Lease and, second, as Tenant deems necessary or desirable. All such repairs, replacements and capital improvements funded by the Capital Expenditure Account shall be deemed to be a part of the Premises. 5.6.1 If Tenant's capital expenditures at the Premises in any Lease Year shall exceed the Capital Expenditure Deposit for said Lease Year (the "CAPITAL EXPENDITURE 24 31 DIFFERENCE"), Tenant shall fund the remaining cost of such Capital Expenditure Difference. Tenant shall receive a corresponding credit against future Capital Expenditure Deposits for the subsequent Lease Year (or Lease Years, if necessary to ensure that Tenant receives full credit for any Capital Expenditure Difference). 5.6.2 Any interest that accrues on the funds in the Capital Expenditure Deposit while in the Capital Expenditure Account shall at all times remain the property of Tenant, and Tenant shall have the right to withdraw any interest earned from time to time. 5.6.3 At the expiration of the Term, any funds remaining in the Capital Expenditure Account shall become the property of Landlord, other than the interest thereon, which shall remain Tenant's property. 5.6.4 Notwithstanding anything to the contrary herein, in the event that any Permitted Mortgage Loan requires similar capital expenditure deposits, any amounts so deposited by Tenant shall be a credit to Tenant against the Capital Expenditure Account requirements set forth herein. In no event shall Tenant be required to make any duplicate payments to the Capital Expenditure Account and/or any accounts for capital expenditures pursuant to any Permitted Mortgage Loan. 5.7 ASSIGNMENT OF DISBURSEMENTS. Landlord hereby assigns to Tenant all of Landlord's right to any disbursements (collectively, the "DISBURSEMENT ASSIGNMENT") under (a) that certain Completion/Repair and Security Agreement, of even date with the Berkshire Note, by and between Landlord and Berkshire Lender, and executed in conjunction with the Berkshire Loan, and (b) that certain Replacement Reserve and Security Agreement, of even date 25 32 with the Berkshire Note, by and between Landlord and Berkshire Lender, executed in conjunction with the Berkshire Loan. Tenant shall be entitled to direct disbursement from Berkshire Lender pursuant to the terms and conditions of each of said Completion/Repair and Security Agreement and said Replacement Reserve and Security Agreement. Tenant hereby assumes and agrees to perform all obligations of Landlord under the Completion/Repair and Security Agreement and the Replacement Reserve and Security Agreement. This Disbursement Assignment shall terminate concurrently with the expiration or sooner termination of this Lease; provided, however such termination shall not effect Tenant's right to such disbursement from Berkshire Lender for any reimbursable expenses (according to the terms and conditions of said Completion/Repair and Security Agreement and said Replacement Reserve and Security Agreement) incurred by Tenant during the Term of this Lease. 60 CONDITION AND TITLE OF PREMISES; RIGHT OF FIRST REFUSAL.. 6.1 CONDITION AND TITLE OF PREMISES. Tenant's affiliate, a subsidiary of ARC, previously owned the Premises, and Tenant has thoroughly investigated the Premises, has selected the Premises to its own specifications, and has concluded that no improvements or modifications to the Premises are required in order to operate the Premises for its intended use. Tenant accepts the Premises for use as A Retirement Care Facility under this Lease on an "AS IS, WHERE IS, WITH ALL FAULTS" basis and will assume all responsibility and cost for the correction of any observed or unobserved deficiencies or violations. In making its decision to enter into this Lease, Tenant has not relied on any representations or warranties, express or implied, of any kind from Landlord. Notwithstanding any other provision of this Lease to the contrary, Tenant accepts the Premises in their present condition, AS IS, WHERE IS, WITH 26 33 ALL FAULTS, and without any representations or warranties whatsoever, express or implied, including, without limitation, any express or implied representations or warranties as to the fitness, use, suitability, or condition of the Premises. LANDLORD MAKES NO WARRANTY OR REPRESENTATION, EXPRESS OR IMPLIED, IN RESPECT OF THE PREMISES OR ANY PART THEREOF, EITHER AS TO ITS FITNESS FOR USE, DESIGN OR CONDITION FOR ANY PARTICULAR USE OR PURPOSE OR OTHERWISE, OR AS TO QUALITY OF THE MATERIAL OR WORKMANSHIP THEREIN, LATENT OR PATENT, IT BEING AGREED THAT ALL SUCH RISKS ARE TO BE BORNE BY TENANT. Tenant hereby represents and warrants to Landlord that Tenant is thoroughly familiar with the Premises and the condition thereof, that Tenant is relying on Tenant's own personal knowledge of the condition of the Premises, that neither Landlord nor any person or entity acting or allegedly acting for or on behalf of Landlord or any other person or entity having or claiming any interest in the Premises has made any representations, warranties, agreements, statements, or expressions of opinions in any way or manner whatsoever related to, connected with, or concerning the Premises, the condition of the Premises, or any other fact or circumstance whatsoever on which Tenant is relying, and, to the maximum extent not prohibited by applicable law, Tenant hereby releases and discharges Landlord and all other persons and entities having or claiming any interest in the Premises from all liability, damages, costs, and expenses of every kind and nature whatsoever in any way or manner arising out of, connected with, related to, or emanating from the condition of the Premises at any time prior to or during the Term of this Lease. Tenant has examined the condition of title to the Premises prior to the execution and delivery of this Lease and has found the same to be satisfactory, including without limitation, all of the encumbrances 27 34 and other exceptions to title set forth more fully on Exhibit "A-1" (the "PERMITTED EXCEPTIONS"). 6.2 RIGHT OF FIRST REFUSAL TO PURCHASE PREMISES. 6.2.1 Tenant shall have the right of first refusal to purchase (a) the Premises at any time during the Term, and/or (b) Landlord's equity securities or equity interests at any time during the Term in which E. Phillip Saunders directly or indirectly controls Landlord ("LANDLORD'S EQUITY SECURITIES"), upon the terms and conditions set forth in this Section 6.2.; provided, however, Tenant shall not have the right to exercise its rights under this Section 6.2. if any Event of Default has occurred and is continuing as of any of the following dates: (i) the date on which Landlord delivers an Offering Notice to Tenant pursuant to Section 6.2.2(i), or (ii) the date of Tenant's delivery of an Exercise Notice pursuant to Section 6.2.2(ii), or (iii) or at the closing date established to consummate the purchase of the Premises or equity securities, as applicable, pursuant to Section 6.2.2(iii). 6.2.2 Subject to Section 6.2.1 above, if during the Term Landlord or any owner of Landlord's Equity Securities receives a bona fide offer to purchase the Premises, or any portion thereof, or all or any portion of Landlord's Equity Securities (the "OFFERED PROPERTY"), from any person or entity, Landlord and Tenant shall take the following steps prior to Landlord's acceptance of such offer: (1) Landlord shall give written notice to Tenant of its intention to accept such offer, which notice shall set forth the price, terms and conditions contained in 28 35 the offer to purchase the Offered Property which Landlord intends to accept ("OFFERING NOTICE"); (2) Within thirty (30) days after receipt of an Offering Notice, Tenant shall either (A) deliver to Landlord written notice that Tenant does not desire to purchase the Offered Property on the terms set forth in the Offering Notice, or (B) deliver to Landlord written notice of Tenant's desire to exercise its right to purchase the Offered Property on the terms set forth in the Offering Notice pursuant to this Section 6.2 ("EXERCISE NOTICE"); (3) If Tenant delivers an Exercise Notice within such thirty (30) day period, and if the Offered Property consists of all or any portion of the Premises, Landlord as seller and Tenant as buyer shall immediately open an escrow to consummate such purchase at a national title company selected by Landlord in its reasonable discretion on the following terms: (A) the form of such instructions to be then signed by Landlord and Tenant shall be such title company's standard sale escrow instructions and, notwithstanding anything set forth in the Offering Notice to the contrary, shall not provide for any representations or warranties by Landlord as seller or for any due diligence or other contingencies in favor of Tenant as buyer, (B) the purchase price shall be payable in cash by Tenant or on such other terms as are set forth in the Offering Notice with escrow to close on or before the date set forth in the Offering Notice, (C) transaction costs shall be paid as set forth in the Offering Notice, (D) at close, Landlord shall deliver title to the Offered Property subject only to those title exceptions shown on 29 36 Exhibit "A-1" (the Permitted Exceptions) attached hereto, (E) the sale escrow instructions shall provide for an earnest money deposit in the amount set forth in the Offering Notice and shall provide that such deposit may be retained by Landlord as liquidated damages in the event of any breach by Tenant of the terms of the escrow instructions (provided, however, such liquidated damages shall relate only to Landlord's damages by reason of a breach of the escrow instructions and shall in no way liquidate or limit Landlord's or Tenant's damages by reason of a breach of this Lease), and (F) the escrow instructions shall otherwise be in form and substance reasonably satisfactory to Landlord. If Tenant fails to close the escrow for any reason other than a breach by Landlord, then Landlord may elect to pursue all remedies available to Landlord against Tenant under the escrow instructions or under applicable law. (4) If Tenant delivers an Exercise Notice within such thirty (30) day period, and if the Offered Property consists of all or any portion of Landlord's Equity Securities, Landlord as seller and Tenant as buyer shall consummate the sale of landlord's Equity Securities according to the terms and conditions of the Offering Notice within sixty (60) days of Landlord's receipt of the Exercise Notice and Landlord shall cause its members (partners or shareholders) to sell, transfer and assign to Tenant or its designee all such membership (partnership or shareholder) interests, equity securities and other ownership interest in the Landlord, all of which shall be free and clear of all liens and encumbrances whatsoever, and Tenant or its designee shall pay to said members (partners or shareholders) the purchase price set forth in the Offering Notice (prorated among said parties in accordance with their respective ownership interests), and (c) the parties hereto 30 37 (and all members, partners or shareholders of Landlord) shall execute all securities purchase agreements, assignments and other documents that are reasonably necessary to consummate said transaction, which documents shall contain (x) indemnifications of such members (partners or shareholders) by Tenant for matters occurring after the closing, and (y) other representations and warranties that are reasonably and customary for a transactions of such size and nature. By entering into this Lease, Landlord represents and warrants that each owner of its equity securities (whether now or in the future) as agreed, or will agree, to be bound by the provisions of this Section 6.2.2. (5) If within the thirty (30) day period following Landlord's delivery of an Offering Notice, Tenant either delivers to Landlord the notice set forth in Section 6.2.2 (ii)(A) or falls to deliver either of the notices set forth in Section 6.2.2(ii), then for a period of six (6) months following the expiration of such fifteen (15) day period Landlord shall be free to sell the Offered Property on the terms set forth in the Offering Notice or on any other revised terms deemed appropriate by Landlord in its sole discretion; provided, however, if such other revised terms include a price that is below the price set forth in the Offering Notice, then prior to completing any sale on such revised terms Landlord shall notify Tenant of such revised offering terms. During the fifteen (15) business day period after receipt by Tenant of such notice, Tenant shall have the right (to be exercised if at all by Tenant's execution of escrow instructions and deposit of earnest money under Section 6.2.2 (iii) within such fifteen (15) business day period) to require that Landlord sell the Offered Property to Tenant on such revised offering terms. If Tenant fails to timely exercise its right as required by the preceding 31 38 proviso, Landlord shall be free to sell the Offered Property to a third party on the revised offering terms. (6) If at the end of the six (6) month period described in Section 6.2.1(iv), Landlord has not sold the Offered Property, then Landlord shall again be required to comply with the provisions of this Section 6.2 if Landlord desires to accept a third party offer to purchase the Offered Property. (7) If an escrow is opened pursuant to Section 6.2.2(iii) and such escrow fails to close by reason of Tenant's default, in addition to all of the other rights and remedies of Landlord with respect to such breach, Landlord shall thereafter be free to sell the Premises or any portion thereof to any Person on any terms whatsoever without being required to comply with this Section 6.2. (8) If Landlord has hypothecated its interest in the Premises, this Section 6.2 shall not apply to any judicial or non-judicial sale of the Premises in connection with any foreclosure action or proceeding by the lender. 6.3 TENANT'S TRANSFER RIGHTS SUBJECT TO BERKSHIRE LOAN DOCUMENTS. Notwithstanding anything in this Lease to the contrary, Tenant's right of first refusal, as set forth more fully in this Section 6, shall be subject to compliance with any applicable provisions of any document or agreement evidencing or relating to the Berkshire Loan (collectively, the "BERKSHIRE LOAN DOCUMENTS"), which shall control over any inconsistent provision in this Section 6. 70 LANDLORD AND TENANT PERSONAL PROPERTY. 32 39 7.1 TENANT PERSONAL PROPERTY. Tenant shall install, place, and use on the Premises such fixtures, furniture, equipment, inventory and other personal property in addition to Landlord Personal Property as may be required or as Tenant may, from time to time, deem necessary or useful to operate the Premises for its permitted purposes. All fixtures, furniture, equipment, inventory, and other personal property installed, placed, or used on the Premises which is owned by Tenant or leased by Tenant from third parties is hereinafter referred to as "TENANT PERSONAL PROPERTY." 7.2 REQUIREMENTS FOR TENANT PERSONAL PROPERTY. Tenant shall comply with all of the following requirements in connection with Tenant Personal Property: 7.2.1 Tenant shall, at Tenant's sole cost and expense, maintain, repair, and replace Tenant Personal Property. 7.2.2 Tenant shall, at Tenant's sole cost and expense, keep Tenant Personal Property insured against loss or damage by fire, vandalism and malicious mischief, sprinkler leakage, earthquake, and other physical loss perils commonly covered by fire and extended coverage, boiler and machinery, and difference in conditions insurance in an amount not less than 90% of the then full replacement cost thereof. Tenant shall use the proceeds from any such policy for the repair and replacement of Tenant Personal Property. The insurance shall meet the requirements of Section 4.1. 7.2.3 Tenant shall pay all taxes applicable to Tenant Personal Property. 7.2.4 Unless an Event of Default or any event which, with the giving of notice or lapse of time, or both, would constitute an Event of Default has occurred, Tenant may remove Tenant Personal Property from the Premises from time to time 33 40 provided that [i] the items removed are not required to operate the Premises for the permitted use hereunder (unless such items are being replaced by Tenant); and [ii] Tenant repairs any damage to the Premises resulting from the removal of Tenant Personal Property. 7.2.5 Upon the expiration of the Term, Landlord shall have the option to purchase the Tenant Personal Property for an amount equal to its depreciated value determined in accordance with GAAP (as hereinafter defined). If Landlord desires to exercise its option to purchase, Landlord shall notify Tenant at least ninety (90) days prior to the expiration of the Term. Landlord's option to purchase the Tenant Personal Property shall not include such property as bears the tradenames, trademarks or patents of ARC, Tenant, or any affiliate, successor or assign thereof or any rights in and to such tradenames, trademarks or patents (the "EXCLUDED PROPERTY"). If Landlord elects not to exercise Landlord's option to purchase Tenant Personal Property, Tenant shall remove Tenant Personal Property upon the termination or expiration of this Lease and shall repair any damage to the Premises resulting from the removal of the Tenant Personal Property. If Tenant fails to remove Tenant Personal Property within 30 days after request by Landlord, then Tenant shall be deemed to have abandoned the Tenant Personal Property, the Tenant Personal Property shall become the property of Landlord, and Landlord may remove, store and dispose of Tenant Personal Property. In such event, Tenant shall have no claim or right against Landlord for such property or the value thereof regardless of the disposition thereof by Landlord. Tenant shall pay Landlord, upon demand, all expenses incurred by Landlord in removing, storing, and disposing of 34 41 Tenant Personal Property and repairing any damage caused by such removal. Tenant's obligations hereunder shall survive the termination or expiration of this Lease. 7.3 COMPLIANCE WITH LAWS. Tenant shall comply with all legal requirements applicable to the Premises and keep all government authorizations in full force and effect. Tenant shall pay when due all taxes and governmental charges of every kind and nature that are assessed or imposed upon the Premises or Tenant's operation of the Premises at any time during the term of the Lease, including, without limitation, all income, franchise, capital stock, property, sales and use, business, intangible, employee withholding, and all taxes and charges relating to Tenant's business and operations. Tenant shall be solely responsible for compliance with all Legal Requirements, including the ADA, and Landlord shall have no responsibility for such compliance. 7.4 RESIDENT TENANT LEASES. During the Term, the lessor under all subleases with residents or patients of the Retirement Care Facility (the "RESIDENT TENANT LEASES") shall be Landlord. Tenant agrees to assign, or cause to be assigned, to Landlord all Resident Tenant Leases existing as of the Commencement Date. Throughout the Term, Tenant assumes and agrees to perform all of Landlord's obligations under the Resident Tenant Leases. Except to the extent actually caused by Landlord, Tenant agrees to keep and hold Landlord harmless of and from any loss, cost, damage, liability or expense arising under the Resident Tenant Leases during the Term, however arising. Landlord hereby grants Tenant a power of attorney to (a) enter into commercially reasonable Resident Tenant Leases on standard lease forms in the ordinary course of business on behalf of Landlord, (b) collect all rents and other sums due under any Resident Tenant Leases, and (c) perform all other activities required of lessor under the 35 42 Resident Tenant Leases or otherwise necessary in such capacity. This power of attorney is coupled with an interest, and shall only terminate upon the expiration or earlier termination of this Lease or upon any Event of Default by Tenant beyond any applicable notice, grace or cure periods. So long as this Lease remains in effect, and no Event of Default shall have occurred and be continuing beyond all applicable periods of grace and/or notice and cure, Landlord shall take no action as lessor under the Resident Tenant Leases. 7.4.1. If Tenant or its affiliate purchases the Property pursuant to either Section 6.2 or 6.3 of this Lease, Landlord shall assign all then existing Resident Tenant Leases to the purchaser simultaneous with transfer of the Property. 7.5 TRANSFER OF LICENSE, ETC.. If this Lease is terminated due to expiration of the Term, pursuant to an Event of Default or for any reason other than Tenant's purchase of the Premises, or if Tenant vacates the Premises without termination of this Lease, Tenant shall: 7.5.1 Execute, deliver and file all documents and statements reasonably requested by Landlord to effect the transfer of all licenses and government authorizations related to the Retirement Care Facility to Landlord or an entity designated by Landlord, subject to any required approval of governmental regulatory authorities, and Tenant shall provide to Landlord all information and records required by Landlord in connection with the transfer of the license and government authorizations. 7.5.2 Use commercial best efforts to cooperate with and facilitate transfer of the business and operations of the Retirement Care Facility to Landlord or its designee, without unreasonable disruption in operations. 80 REPRESENTATIONS AND WARRANTIES. 36 43 8.1 MUTUAL REPRESENTATIONS AND WARRANTIES. Landlord and Tenant do hereby each for itself represent and warrant to each other as follows: 8.1.1 DUE AUTHORIZATION AND EXECUTION. This Lease and all agreements, instruments and documents executed or to be executed in connection herewith by either Landlord or Tenant were duly authorized and shall be binding upon the party that executed and delivered the same. 8.1.2 DUE ORGANIZATION. Landlord and Tenant are duly organized, validly existing and in good standing under the laws of the State of their respective formations and are duly authorized and qualified to do all things required of the applicable party under this Lease within the State of Ohio. 8.1.3 NO BREACH OF OTHER AGREEMENTS. Neither this Lease nor any agreement, document or instrument executed or to be executed in connection herewith, violates the terms of any other agreement to which either Landlord or Tenant is a party where such violation would have a material adverse effect. 8.2 MUTUAL COVENANTS. Landlord and Tenant do hereby each for itself make the following covenants: 8.2.1 NO DEFAULT UNDER PERMITTED MORTGAGE LOAN. For so long as this Lease is in effect and any Permitted Mortgage Loan is outstanding, Tenant shall comply with the terms and conditions of the outstanding Permitted Mortgage Loan Documents; provided, however, Tenant shall not be required to take any action or otherwise cause compliance with or be deemed responsible for performance of such Permitted Mortgage Loan Documents as to any affirmative or negative obligation of 37 44 Landlord that does not relate to management or operation of the Premises, including, without limitation, accuracy and delivery of Landlord's financial statements, and the maintenance by Landlord of its good standing in any states required by such Permitted Mortgage Loan Documents. For so long as this Lease is in effect and any Permitted Mortgage Loan is outstanding, Landlord covenants and agrees to comply, or cause compliance, with the Permitted Mortgage Loan Documents with respect each affirmative or negative obligation of Landlord that does not relate solely to management or operation of the Premises, including, without limitation, accuracy and delivery of Landlord's financial statements, and the maintenance by Landlord of its good standing in any states required by such Permitted Mortgage Loan Documents. 8.2.2 NO AMENDMENT OF PERMITTED LOAN DOCUMENTS. Neither Landlord nor Tenant shall amend, alter, extend, renew or otherwise modify any document or agreement evidencing or relating to any Permitted Mortgage Loan without the prior written consent of the other party hereto, which may be denied by said party in its reasonable discretion. Any amendment of the Permitted Loan Documents without reasonable Tenant's consent shall not be binding on Tenant. 8.2.3 NO AMENDMENT OF LEASE WITHOUT MORTGAGE LENDER'S CONSENT. So long as the Berkshire Loan remains in effect, neither Landlord nor Tenant shall amend, modify, terminate or hypothecate this Lease without Berkshire Lender's prior written consent. 8.3 NEGATIVE COVENANTS OF LANDLORD. Landlord hereby makes the following covenants: 38 45 8.3.1 INCURRENCE OF INDEBTEDNESS. Landlord hereby agrees that it will not incur any indebtedness or obligation whatsoever with respect to the Premises, except a Permitted Mortgage Loan. 8.3.2 NO REMOVAL. During the Term, Landlord shall not take or remove any assets or items or personal property associated with, or comprising a portion of, the Premises, or associated or related to, the Premises without first obtaining the prior written consent of Tenant, which may be denied in Tenant's sole discretion. 8.3.3 NO OWNER ACTIONS. For so long as this Lease remains in effect, and Tenant shall not then be in material default of its obligations beyond any applicable periods of grace and/or notice and cure, Landlord shall take no action with respect to the business or operation of the Premises without Tenant's prior written consent, which may be denied by Tenant in its sole discretion. 8.3.4 NO OTHER ACTIVITIES; SINGLE PURPOSE ENTITY REQUIREMENTS. Landlord hereby agrees that it will not engage in any business activity other than those activities relating to the ownership of the Premises and performance of its obligations hereunder, and shall comply with the single purpose entity covenants and requirements set forth on Exhibit "E" attached hereto. 39 46 9. FINANCIAL, MANAGEMENT AND REGULATORY REPORTS. 9.1 ANNUAL FINANCIAL STATEMENT. Within one hundred twenty (120) days of the fiscal year end of Tenant, Tenant shall deliver to Landlord the annual financial statement of Tenant, with respect to Tenant's business operations on the Premises, prepared in accordance with generally accepted accounting principles consistently applied ("GAAP"), and audited by a certified public accounting firm reasonably acceptable to Landlord. Within forty-five (45) days after each fiscal quarter ends, Tenant shall deliver to Landlord unaudited financial statements of Tenant, with respect to Tenant's business operations on the Premises, prepared in accordance with GAAP. Notwithstanding any of the other terms of this Section 9.1, if Tenant be subject to any reporting requirements of the Securities and Exchange Commission (the "SEC") during the Term, Tenant shall concurrently deliver to Landlord such reports as are delivered to the SEC pursuant to applicable security laws. 9.2 REGULATORY REPORTS. In addition, Tenant shall within ten (10) business days of receipt thereof deliver to Landlord all federal, state and local licensing and reimbursement certification surveys, inspection and other reports received by Tenant as to the Premises or any portion thereof and the operation of business thereon, including, without limitation, state department of health licensing surveys, Medicare and Medicaid (and successor programs) certification surveys (if applicable) and life safety code reports. Within ten (10) business days of receipt thereof, Tenant shall give Landlord written notice of any violation of any federal, state or local licensing or reimbursement certification statute or regulation including without limitation Medicare and Medicaid or successor programs (if applicable to the Premises or any portion thereof), any suspension, termination or restriction placed upon Tenant or the 40 47 Premises or any portion thereof, the operation of business thereon or the ability to admit residents, or any violation of any other permit, approval or certification in connection with the Premises or any portion thereof or its business, by any federal, state or local authority including without limitation Medicare and Medicaid or successor programs if applicable to the Premises or any portion thereof. 10. EVENTS OF DEFAULT AND LANDLORD'S REMEDIES. 10.1 EVENTS OF DEFAULT. The occurrence of any of the following shall constitute an event of default on the part of Tenant hereunder ("EVENT OF DEFAULT"): 10.1.1 The failure to pay within ten (10) calendar days of (i) the date when due any Minimum Rent or Additional Rent, or (ii) the date when delinquent of any taxes or assessments required of Tenant under this Lease; provided, however, such ten (10) day cure periods shall not apply to late payments of P&I Rent so long as the Berkshire Loan is outstanding. 10.1.2 A material breach by the seller thereunder of any of the material representations, warranties or covenants in favor of Landlord as set forth in that certain Purchase Agreement of even date herewith, by and between Landlord, as purchaser, and a subsidiary of ARC, as seller (the "PURCHASE AGREEMENT"); 10.1.3 The appointment of a receiver, trustee, or liquidator for Tenant, or any of the property of Tenant, if within ten (10) business days of such appointment Tenant does not inform Landlord in writing that Tenant intends to cause such appointment to be discharged or Tenant does not thereafter diligently prosecute such discharge to completion within sixty (60) days after the date of such appointment; 41 48 10.1.4 The filing by Tenant of a voluntary petition under any federal bankruptcy law or under the law of any state to be adjudicated as bankrupt or for any arrangement or other debtor's relief, or in the alternative, if any such petition is involuntarily filed against Tenant by any other party and Tenant does not within ten (10) business days of any such filing inform Landlord in writing of the intent by Tenant to cause such petition to be dismissed, if Tenant does not thereafter diligently prosecute such dismissal, or if such filing is not dismissed within ninety (90) days after filing thereof; 10.1.5 The failure to make any monetary payment required by Tenant under this Lease not covered in Section 10.1.1 or the failure to perform or comply in any material respect with any other term or provision of this Lease not requiring the payment of money, including, without limitation, the failure to comply with the provisions hereof pertaining to the use, operation and maintenance of the Premises (or any portion thereof) or the breach of any representation or warranty of Tenant in this Lease; provided, however, if the default described in this Section 10.1.5 is curable it shall be deemed cured, if: (i) within ten (10) business days of Tenant's receipt of a notice of default from Landlord, Tenant gives Landlord notice of its intent to cure such default; and (ii) Tenant cures such default within thirty (30) days after such notice to Landlord, unless such default cannot with due diligence be cured within a period of thirty (30) days because of the nature of the default or delays beyond the control of Tenant, in which case such default shall not constitute an Event of Default if Tenant uses its best efforts to cure such 42 49 default by promptly commencing and diligently pursuing such cure to the completion thereof. 10.1.6 Tenant abandons or vacates the Premises or any material part thereof or ceases to do business or ceases to exist for any reason for any one or more days. 10.1.7 All notice and cure periods provided herein shall run concurrently with any notice or cure periods provided by applicable law. 10.1.8 Notwithstanding anything to the contrary in this Section 10.1., any act or omission of Tenant that causes an Event of Default under the Berkshire Loan Documents (as defined in the Berkshire Loan Documents) shall constitute an Event of Default hereunder. 10.2 REMEDIES. Upon the occurrence of an Event of Default and during the pendency thereof, Landlord may exercise all rights and remedies under this Lease and the laws of the State available to a lessor of real and personal property in the event of a default by its lessee. Without limiting the foregoing, Landlord shall have the right to do any of the following: 10.2.1 re-enter and take possession of the Premises without terminating the Lease, and lease the Premises for the account of Tenant, holding Tenant liable for all costs of the Landlord in reletting the Premises and for the difference in the amount received by such reletting and the amounts payable by Tenant under the Lease. 10.2.2 terminate this Lease, exclude Tenant from possession of the Premises and lease the Premises to others, holding Tenant liable for the difference in the amounts received from such reletting and the amounts payable by Tenant under the Lease. 43 50 10.2.3 re-enter the Premises and have, repossess and enjoy the Premises as if the Lease had not been made, and in such event, Tenant and its successors and assigns shall remain liable for any contingent or unliquidated obligations or sums owing at the time of such repossession. 10.2.4 have access to an inspect, examine and make copies of the books and records and any and all accounts, data an income tax and other returns of Tenant insofar as they pertain to the Premises. 10.2.5 accelerate all of the unpaid Rent hereunder so that the aggregate Rent for the unexpired term of this Lease becomes immediately due and payable. 10.2.6 take whatever action at law or in equity as may appear necessary or desirable to collect the Rent and other amounts payable under the Lease then due and thereafter to become due, or to enforce performance and observance of any obligations, agreements or covenants of Tenant under this Lease. 10.2.7 Before or after repossession of the Premises pursuant to Section 10.2.2, and whether or not this Lease has been terminated, Landlord shall have the right (but shall be under no obligation except to the extent required by applicable law) to relet any portion of the Premises to such tenant or tenants, for such term or terms (which may be greater or less than the remaining balance of the Term), for such rent, or such conditions (which may include concessions or free rent) and for such uses, as Landlord, in its absolute discretion, may determine, and Landlord may collect and receive any rents payable by reason of such reletting. Tenant agrees to pay Landlord, immediately upon demand, all reasonable expenses incurred by Landlord in obtaining possession and in 44 51 reletting any of the Premises, including fees, commissions and costs of attorneys, architects, agents and brokers; 10.3 RECEIVERSHIP. Tenant acknowledges that one of the rights and remedies available to Landlord under applicable law is to secure a court-appointed receiver to take possession of the Premises or any portion thereof, to collect the rents, issues, profits and income of the Premises or any portion thereof, and to manage the operation of the Premises or any portion thereof. Tenant further acknowledges that the revocation, suspension or material limitation of the certification of the Premises or any portion thereof for provider status under Medicare or Medicaid (or successor programs) as currently exist or as are obtained by Tenant at a later date and/or the revocation, suspension or material limitation of the license of the Premises or any portion thereof as A Retirement Care Facility under the laws of the State of Ohio will materially and irreparably impair the value of Landlord's investment in the Premises. Therefore, in the event of any such revocation, suspension or material limitation, and in addition to any other right or remedy of Landlord under this Lease, Tenant hereby consents to the appointment of such a receiver to enter upon and take possession of the Premises or any portion thereof, to manage the operation of the Premises or any portion thereof, to collect and disburse all rents, issues, profits and income generated thereby and to preserve or replace to the extent possible the licenses and provider certifications of the Premises required for the operation of the Retirement Care Facility or to otherwise substitute the licensee or provider thereof. The receiver shall be entitled to a reasonable fee for its services as a receiver. All such fees and other expenses of the receivership estate shall be added to the monthly rent due to Landlord under this Lease. Tenant 45 52 hereby irrevocably stipulates to the appointment of a receiver under such circumstances and for such purposes and agrees not to contest such appointment. 10.4 REMEDIES CUMULATIVE: NO WAIVER. No right or remedy herein conferred upon or reserved to Landlord is intended to be exclusive of any other right or remedy, and each and every right and remedy shall be cumulative and in addition to any other right or remedy given hereunder or now or hereafter existing at law or in equity. No failure of Landlord to insist at any time upon the strict performance of any provision of this Lease or to exercise any option, right, power or remedy contained in this Lease shall be construed as a waiver, modification or relinquishment thereof as to any similar or different breach (future or otherwise) by Tenant. A receipt by Landlord of any rent or other sum due hereunder (including any late charge) with knowledge of the breach of any provision contained in this Lease shall not be deemed a waiver of such breach, and no waiver by Landlord of any provision of this Lease shall be deemed to have been made unless expressed in a writing signed by Landlord. 10.5 PERFORMANCE OF TENANT'S OBLIGATIONS BY LANDLORD. Notwithstanding anything to the contrary, if Tenant at any time after applicable notice and cure periods shall fail to make any payment or perform any act on its part required to be made or performed under this Lease, then Landlord may, without waiving or releasing Tenant from any obligations or default of Tenant hereunder, make any such payment or perform any such act for the account and at the expense of Tenant, and may enter upon the Premises for the purpose of taking all such action thereon as may be reasonably necessary therefor. No such entry shall be deemed an eviction of Tenant. All reasonable sums so paid by Landlord and all necessary and incidental costs and expenses (including, without limitation, reasonable attorneys' fees and expenses) incurred in 46 53 connection with the performance of any such act by Landlord, together with interest at the rate of the Prime Rate as reported daily by the Wall Street Journal plus 2% (or if said interest rate is violative of any applicable statute or law, then the maximum interest rate allowable) from the date of the making of such payment or the incurring of such costs and expenses by Landlord, shall be payable by Tenant to Landlord on demand. 10.6 LATE PAYMENT CHARGE. Tenant acknowledges that any default in the payment of any installment of Rent payable hereunder will result in loss and additional expense to Landlord in servicing any indebtedness of Landlord secured by the Premises, handling such delinquent payments, and meeting its other financial obligations, and because such loss and additional expense is extremely difficult and impractical to ascertain, Tenant agrees that in the event any Rent payable to Landlord hereunder is not paid within 10 days after the due date, Tenant shall pay a late charge of 5% of the amount of the overdue payment as a reasonable estimate of such loss and expenses, unless applicable law requires a lesser charge, in which event the maximum rate permitted by such law may be charged by Landlord; provided that nothing herein shall extend the time for payment of Rent or the period for curing any default or constitute a waiver of such default, or limit Landlord's remedies in the event of any such default. Tenant further agrees to pay to Landlord interest on any P & I Rent not paid on the first day of each month at an annual rate of 7.31% calculated on the basis of a 360-day year to the extent permitted by applicable law until such P & I Rent installment is paid in full. 10.7 PERMITTED MORTGAGE LENDER'S RIGHT TO CURE. Notwithstanding any provision in the Lease to the contrary, no default in the performance of any of Landlord's obligations under the Lease that is of such a nature as to give Tenant a right to terminate the 47 54 Lease or to reduce the rent payable under the Lease or to any credit, reduction or offset against future rents shall entitle Tenant to exercise any such right, power or remedy unless and until notice of such default is given to Landlord and any Permitted Mortgage Lender and unless and until fifteen (15) days shall have elapsed following delivery of such notice by Tenant, during which period any Permitted Mortgage Lender shall have the right, but not the obligation, to remedy or cure such default; provided, however, that if such default cannot be cured within fifteen (15) days, then any Permitted Mortgage Lender shall have such longer period of time as may be reasonably necessary to cure such default so long as such Permitted Mortgage Lender pursues the cure of same with due diligence. 11. DAMAGE BY FIRE OR OTHER CASUALTY. 11.1 NOTICE OF CASUALTY. If the Premises shall be destroyed, in whole or in part, or damaged by fire, flood, windstorm or other casualty (a "CASUALTY"), Tenant shall give written notice thereof to the Landlord within one business day after the occurrence of the Casualty. Within 15 days after the occurrence of the Casually or as soon thereafter as such information is reasonably available to Tenant, Tenant shall provide the following information to Landlord: [i] the date of the Casualty; [ii] the nature of the Casualty; [iii] a description of the damage or destruction caused by the Casualty including the type of Premises damaged and the area of the Improvements damaged; [iv] a preliminary estimate of the cost to repair, rebuild, restore or replace the Premises; [v] a preliminary estimate of the schedule to complete the repair, rebuilding, restoration or replacement of the Premises; [vi] a description of the anticipated property insurance claim including the name of the insurer, the insurance coverage limits, the deductible amount, the expected settlement amount, and the expected settlement date; and [vii] a 48 55 description of the business interruption claim including the name of the insurer, the insurance coverage limits, the deductible amount, the expected settlement amount, and the expected settlement date. Within five days after request from Landlord, Tenant will provide Landlord with copies of all correspondence to the insurer and any other information reasonably requested by Landlord. 11.2 SUBSTANTIAL DESTRUCTION. 11.2.1 If the Improvements are substantially destroyed at any time other than during the final 18 months of the Initial Term or any Renewal Term, Tenant shall promptly rebuild and restore the Premises in accordance with Section 9.4 and Landlord shall make the insurance proceeds available to Tenant for such restoration. The term "substantially destroyed" means any casualty resulting in the loss of use of 50% or more of the licensed beds at the Retirement Care Facility. 11.2.2 If the Improvements are substantially destroyed during the final 18 months of the Initial Term or any Renewal Term, Landlord may elect to terminate the Lease at Landlord's option, and Landlord shall retain the insurance proceeds, except that Landlord shall not be entitled to so terminate this Lease nor to retain the insurance proceeds if Tenant (within 15 days after the applicable casualty) exercises its right to extend the term hereof for any remaining Renewal Term (if any). If Landlord elects to terminate, Landlord shall give notice ("TERMINATION NOTICE") to Tenant of its election to terminate this Lease within 30 days after receipt of Tenant's notice of the damage. If this 49 56 Lease is so terminated pursuant to the foregoing (and if Tenant has not renewed this Lease, as described above) this Lease shall terminate on the 15th day after delivery of the Termination Notice. If this Lease is so terminated, Tenant shall be liable to Landlord for all Rent and all other obligations accrued under this Lease through the effective date of termination. 11.3 PARTIAL DESTRUCTION. If the Premises is not substantially destroyed, then Tenant shall comply with the provisions of Section 11.4 and Landlord shall make the insurance proceeds available to Tenant for such restoration. 11.4 RESTORATION. Tenant shall promptly repair, rebuild, or restore the Premises, at Tenant's expense, so as to make the Premises at least equal in value to the Premises existing immediately prior to such occurrence and as nearly similar to it in character as is practicable and reasonable. Before beginning such repairs or rebuilding , or letting any contracts in connection with such repairs or rebuilding, Tenant will submit for Landlord's approval, which approval Landlord will not unreasonably withhold or delay, plans and specifications. Promptly after receiving Landlord's approval of the plans and specifications and receiving the proceeds of insurance, Tenant will begin such repairs or rebuilding and will prosecute the repairs and rebuilding to completion with diligence, subject, however, to strikes, lockouts, acts of God, embargoes, governmental restrictions, and other all causes beyond Tenant's reasonable control. Landlord will make available to Tenant the net proceeds of any fire or other casualty insurance paid to Landlord for such repair or rebuilding as the same progresses, after deduction of any costs of collection, including attorneys' fees. Payments will be made against properly certified 50 57 vouchers of a competent architect in charge of the work and approved by Landlord. Prior to commencing the repairing or rebuilding, Tenant shall deliver to Landlord for Landlord's approval a schedule setting forth the estimated monthly draws for such work. Landlord will contribute to such payments out of the insurance proceeds an amount equal to the proportion that the total net amount received by Landlord from insurers bears to the total estimated cost of the rebuilding or repairing, multiplied by the payment by Tenant on account of such work. Landlord may, however, withhold 10% from each payment until the work is completed and proof has been furnished to Landlord that no lien or liability has attached or will attach to the Premises or to Landlord in connection with such repairing or rebuilding. Upon the completion of rebuilding and the furnishing of such proof, the balance of the net proceeds of such insurance payable to Tenant on account of such repairing or rebuilding will be paid to Tenant. Tenant will obtain and deliver to Landlord a temporary or final certificate of occupancy before the Premises is reoccupied for any purpose. Tenant shall complete such repairs or rebuilding free and clear of mechanic's or other liens, and in accordance with the building codes and all applicable laws, ordinances, regulations, or orders of any state, municipal, or other public authority affecting the repairs or rebuilding, and also in accordance with all requirement s of the insurance rating organization, or similar body. Any remaining proceeds of insurance after such restoration will be disbursed to Tenant. 11.5 INSUFFICIENT PROCEEDS. If the proceeds of any insurance settlement are not sufficient to pay the costs of Tenant's repair, rebuilding or restoration under Section 11.4 in full, Tenant shall deposit with Landlord at Landlord's option, and within 10 days of Landlord's request, an amount sufficient in Landlord's reasonable judgment to complete such repair, 51 58 rebuilding or restoration. Tenant shall not, by reason of the deposit or payment, be entitled to any reimbursement from Landlord or diminution in or postponement of the payment of the Rent. 11.6 NOT TRUST FUNDS. Notwithstanding anything herein or at law or equity to the contrary, none of the insurance proceeds paid to Landlord as herein provided shall be deemed trust funds, and Landlord shall be entitled to dispose of such proceeds as provided in this Article 11. Tenant expressly assumes all risk of loss, including a decrease in the use, enjoyment or value, of the Premises from any casualty whatsoever, whether or not insurable or insured against. 11.7 LANDLORD'S INSPECTION. During the progress of such repairs or rebuilding, Landlord and its architects and engineers may, from time to time, inspect the Premises and will be furnished, if required by them, with copies of all plans, shop drawings, and specifications relating to such repairs or rebuilding. Tenant will keep all plans, shop drawings, and specifications at the building, and Landlord and its architects and engineers may examine them at al reasonable times. If, during such repairs or rebuilding are not being done in accordance with the approved plans and specifications, Landlord will give prompt notice in writing to Tenant, specifying in detail the particular deficiency, omission, or other respect in which Landlord claims such repairs or rebuilding do not accord with the approved plans and specification. Upon the receipt of any such notice, Tenant will cause corrections to be made to any deficiencies, omissions, or such other respect. Tenant's obligations to supply insurance, according to Article 4, will be applicable to any repairs or rebuilding under this section. 11.8 LANDLORD'S COSTS. Tenant shall, within 30 days after receipt of an invoice from Landlord, pay the reasonable costs, expenses, and fees of any architect or engineer 52 59 employed by Landlord to review any plans and specifications and to supervise and approve any construction, or for any services rendered by such architect or engineer to Landlord as contemplated by any of the provisions of this Lease, or for any services performed by Landlord's attorneys in connection therewith. 11.9 NO RENT ABATEMENT. Rent will not abate pending the repairs or rebuilding of the Premises. 11.10 SURPLUS PROCEEDS. If there remains any surplus of insurance proceeds after the completion of the repair or reconstruction of the Premises, such surplus shall belong to and be paid to Tenant. 11.11 END OF TERM. Notwithstanding any other provision of this Section 11, if the Premises are more than 30% destroyed (measured by square footage) by casualty during the last nine (9) months of the Initial Term or any Renewal Term, Tenant may terminate this Lease by written notice to Landlord delivered within thirty (30) days after the date of such casualty, in which event Landlord shall retain all insurance proceeds. 12. CONDEMNATION. 12.1 TOTAL TAKING. If, by exercise of the right of eminent domain or by conveyance made in response to the threat of the exercise of such right ("Taking"), the entire Premises is taken, or so much of the Premises is taken that the Premises cannot be used by Tenant for the purposes for which it was used immediately before the Taking, then this Lease will end on the earlier of the vesting of title to the Premises in the condemning authority or the taking of possession of the Premises by the condemning authority. All damages awarded for such Taking under the power of eminent domain shall be the property of the Landlord, whether 53 60 such damages shall be awarded as compensation for diminution in value of the leasehold or the fee of the Premises; provided, however, Tenant shall be entitled to any damages awarded for Tenant's relocation expenses. 12.2 PARTIAL TAKING. If, after a Taking, so much of the Premises remains that the Premises can be used for substantially the same purposes for which it was used immediately before the Taking, then [i] this Lease will end as to the part taken on the earlier of the vesting of title to the Premises in the condemning authority or the taking of possession of the Premises by the condemning authority; [ii] at its cost, Tenant shall restore so much of the Premises as remains to a sound architectural unit substantially suitable for the purposes for which it was used immediately before the Taking, using good workmanship and new materials; [iii] upon completion of the restoration, Landlord will pay Tenant the lesser of the net award made to Landlord on the account of the Taking (after deducting from the total award, attorneys', appraisers', and other fees and costs incurred in connection with the obtaining of the award and amounts paid to the holders of mortgages secured by the Premises), or Tenant's actual out-of-pocket costs of restoring the Premises; and [iv] Landlord shall be entitled to the balance of the net award. The restoration shall be completed in accordance with Section 11.4 and with such other provisions deemed to apply to condemnation instead of casualty. 12.3 CONDEMNATION PROCEEDS NOT TRUST FUNDS. Notwithstanding anything in this Lease or at law or equity to the contrary, none of the condemnation award paid to Landlord shall be deemed trust funds, and Landlord shall be entitled to dispose of such proceeds as provided in this Article 12. Tenant expressly assumes all risk of loss, including a decrease in the use, enjoyment, or value, of the Premises from any Condemnation. 54 61 13. PROVISIONS ON TERMINATION OF TERM. 13.1 SURRENDER OF POSSESSION. Tenant shall, on or before the last day of the Term, or upon earlier termination of this Lease (unless Tenant has purchased the Premises pursuant to Section 6.3), surrender to Landlord the Premises (including all resident charts and records along with appropriate resident consents) in good condition and repair, excepting only (i) any damage caused by condemnation pursuant to Section 12.1 above, or (ii) any damage caused by fire or other casualty resulting in the termination of the Lease pursuant to Section 11.4 above. 13.2 REMOVAL OF PERSONAL PROPERTY. Subject to Section 7.2.5. above, if Tenant is not then in default hereunder Tenant shall have the right in connection with the surrender of the Premises to remove from the Premises all Tenant Personal Property but not the Landlord Personal Property (including the Landlord Personal Property replaced by Tenant or required by the State or any other governmental entity to operate the Premises for the purpose set forth in Section 5.3 above). Any such removal shall be done in a workmanlike manner leaving the Premises in good and presentable condition and appearance, including repair of any damage caused by such removal. At the end of the Term or upon the earlier termination of this Lease, (unless Tenant has purchased the Premises pursuant to Section 6.2), Tenant shall return the Premises to Landlord with the Landlord Personal Property (or replacements thereof) in the same condition and utility as was delivered to Tenant at the commencement of the Term, reasonable and normal wear and tear excepted. 13.3 TITLE TO PERSONAL PROPERTY NOT REMOVED. Title to any of Tenant Personal Property which is not removed by Tenant upon the expiration of the Term shall, at 55 62 Landlord's election, vest in Landlord; provided, however, that Landlord may remove and dispose at Tenant's expense of any or all of such Tenant Personal Property which is not so removed by Tenant without obligation or accounting to the Tenant. 13.4 MANAGEMENT OF PREMISES. Upon the expiration or earlier termination of the Term (unless Tenant has purchased the Premises pursuant to Section 6.2), Landlord or its designee, upon written notice to Tenant, may elect to assume the responsibilities and obligations for the management and operation of the Premises and Tenant agrees to cooperate fully with Landlord or its designee to accomplish the transfer of such management and operation without interrupting the operation of the Premises. Tenant shall not commit any act or be remiss in the undertaking of any act that would jeopardize any licensure or certification of the facility, and Tenant shall comply with all requests for an orderly transfer of the Retirement Care Facility license, Medicare and Medicaid (or any successor program) certifications and possession at the time of any such surrender. Upon the expiration or earlier termination of the Term, Tenant shall promptly deliver copies of all of Tenant's books and records relating to the Premises and its operations to Landlord. 13.5 CORRECTION OF DEFICIENCIES. Upon termination or cancellation of this Lease, Tenant shall indemnify Landlord for any loss, damage, cost or expense incurred by Landlord to correct all deficiencies of a physical nature identified by the Ohio Department of Human Services, local health, fire and safety agencies or any other government agency or Medicare or Medicaid (or any successor program) providers in the course of the change of ownership inspection and audit. 56 63 14. NOTICES AND DEMANDS. All notices and demands, certificates, requests, consents, approvals, and other similar instruments under this Lease shall be in writing and shall be deemed to have been properly given upon actual receipt thereof or within three (3) business days of being placed in the United States certified or registered mail, return receipt requested, postage prepaid (a) if to Tenant, addressed to ARC Westlake Village, Inc., c/o American Retirement Corporation, 111 Westwood Place, Suite 412, Brentwood, Tennessee 37027, Attn: Chief Executive Officer, Fax No. (615) 221-2269 with a copy to Bass, Berry & Sims PLC, 315 Deaderick Street, Suite 2700, AmSouth Center, Nashville, Tennessee 37238, Attn: T. Andrew Smith, Esq., Fax No. (615) 742-2766 or at such other address as Tenant from time to time may have designated by written notice to Landlord and Mortgage Lender, (b) if to Landlord, addressed to CLEVELAND RETIREMENT PROPERTIES, LLC, 760 Brooks Avenue, Rochester, New York 14619 Attn: Joe Kuby, Fax No. 716-328-7374 with a copy to ROBERT J. SANT, 760 BROOKS AVENUE, ROCHESTER, NY 14619, Facsimile: (716) 328-0787, or at such address as Landlord may from time to time have designated by written notice to Mortgage Lender and Tenant, and (c) if to Mortgage Lender, addressed to BERKSHIRE MORTGAGE FINANCE LIMITED PARTNERSHIP, One Beacon Street, 14th Floor, Boston, Massachusetts 02108, Fax No. (617) 556-1507, or at such address as Mortgage Lender may from time to time have designated by written notice to Tenant Landlord. Refusal to accept delivery shall be deemed delivery. If Tenant is not an individual, notice may be made to any senior officer, general partner or principal thereof. 15. RIGHT OF ENTRY: EXAMINATION OF RECORDS. Landlord and its representative may enter the Premises at any reasonable time after reasonable notice to Tenant for the purpose of 57 64 inspecting the Premises for any reason including, without limitation, examination of records and/or Tenant's default under this Lease, or to exhibit the Premises for sale, lease or mortgage financing, or posting notices of default, or non-responsibility under any mechanic's or materialman's lien law or to otherwise inspect the Premises for compliance with the terms of this Lease. Any such entry shall not unreasonably interfere with residents, resident care, or any other of Tenant's operations. 16. QUIET ENJOYMENT. So long as there is no Event of Default which is existing and continuing by Tenant, Landlord covenants and agrees that Tenant shall peaceably and quietly have, hold and enjoy the Premises for the Term, free of any claim or other action of Landlord, or anyone claiming by through or under Landlord, not caused or created by Tenant (excepting, however, intrusion of Tenant's quiet enjoyment occasioned by condemnation or destruction of the property as referred to in Section 11 and 12 hereof). 17. APPLICABLE LAW. This Lease shall be governed by and construed in accordance with the internal laws of the State of Ohio without regard to the conflict of laws rules of such State. 18. HAZARDOUS MATERIALS. 18.1 HAZARDOUS MATERIAL COVENANTS. Tenant's use of the Premises shall comply in all material respects with all Hazardous Materials Laws. In the event any Environmental Activities occur or are suspected to have occurred in violation in any material respect of any Hazardous Materials Laws or if Tenant has received any Hazardous Materials Claim against the Premises, Tenant shall promptly obtain all permits and approvals necessary to remedy any such actual or suspected problem through the removal of Hazardous Materials or 58 65 otherwise, and upon Landlord's approval of the remediation plan, remedy any such problem to the satisfaction of Landlord, in accordance with all Hazardous Materials Laws and good business practices. 18.2 TENANT NOTICES TO LANDLORD. Tenant shall immediately advise Landlord in writing of: 18.2.1 any Environmental Activities in violation of any Hazardous Materials Laws, 18.2.2 any Hazardous Materials Claims against Tenant or the Premises, 18.2.3 any remedial action taken by Tenant in response to any Hazardous Materials Claims or any Hazardous Materials on, under or about the Premises in violation of any Hazardous Materials Laws, 18.2.4 Tenant's discovery of any occurrence or condition on or in the vicinity of the Premises that materially increase the risk that the Premises will be exposed to Hazardous Materials, 18.2.5 all communications to or from Tenant, any governmental authority or any other person relating to Hazardous Materials Laws or Hazardous Materials Claims with respect to the Premises, including copies thereof. 18.3 PARTICIPATION IN HAZARDOUS MATERIALS CLAIMS. Landlord shall have the right, at Tenant's sole cost and expense and with counsel chosen by Landlord, to join and participate in, as a party if it so elects, any legal proceedings or actions initiated in connection with any Hazardous Materials Claims. 59 66 18.4 ENVIRONMENTAL ACTIVITIES shall mean the use, generation, transportation, handling, discharge, production, treatment, storage, release or disposal of any Hazardous Materials at any time to or from the Premises or located on or present on or under the Premises. Nothing contained in the foregoing or elsewhere in this Section 18 is intended to, nor shall it, limit the liability of Tenant, if any, to Landlord with respect to any representation or warranty given by Tenant to Landlord with respect to Hazardous Materials or environmental matters generally as set forth in the Purchase Agreement. 18.5 HAZARDOUS MATERIALS INDEMNITY. Tenant agree to indemnify and hold Landlord and its officers, directors, members, agents, employees, affiliates and representatives harmless from and against any and all claims, demands, damages, losses, liens, liabilities, penalties, fines, lawsuits, actions, orders, judgments, investigations, regulatory proceedings and other proceedings, and all costs and expenses (including but not limited to attorney's and consultant's fees and expenses), incurred in connection therewith, arising directly or indirectly from or out of, or in any way connected with (a) the presence or alleged presence of any Hazardous Materials or underground storage tanks in, on or under the Premises occurring before or during the Term of this Lease; (b) any cleanup, removal and/or remedial proceeding, investigation, order or other action undertaken or required pursuant to any Hazardous Materials Law for violations or alleged violations accruing before or during the Term of this Lease, (c) any violation or alleged violation of any Hazardous Materials Law relating to the Premises, attributable to events occurring before or during the Term of this Lease; (d) any inaccuracy of the certifications, representations and warranties contained herein; or (e) any Hazardous Materials Claims asserted against Landlord. 60 67 18.6 HAZARDOUS MATERIALS shall mean (i) any petroleum products and/or by-products (including any fraction thereof), flammable substances, explosives, radioactive materials, hazardous or toxic wastes, substances or materials, known carcinogens or any other materials, contaminants or pollutants which pose a hazard to the Premises or to persons on or about the Premises or cause the Premises to be in violation of any Hazardous Materials Laws; (ii) asbestos in any form which is friable; (iii) urea formaldehyde in foam insulation or any other form; (iv) transformers or other equipment which contain dielectric fluid containing levels of polychlorinated biphenyls in excess of fifty (50) parts per million or any other more restrictive standard then prevailing; (v) medical wastes and biohazards; (vi) radon gas; and (vii) any other chemical, material or substance, exposure to which is prohibited, limited or regulated by any governmental authority or may or could pose a hazard to the health and safety of the occupants of the Premises or the owners and/or occupants of property adjacent to or surrounding the Premises. 18.7 HAZARDOUS MATERIALS CLAIMS shall mean any and all enforcement, clean-up, removal or other governmental or regulatory actions or orders threatened, instituted or completed pursuant to any Hazardous Material Laws, together with all claims made or threatened by any third party against the Premises, Landlord or Tenant relating to damage, contribution, cost recovery compensation, loss or injury resulting from any Hazardous Materials. 18.8 HAZARDOUS MATERIALS LAWS shall mean any laws, ordinances, regulations, rules, orders, guidelines or policies relating to the environment, health and safety, Environmental Activities, Hazardous Materials, air and water quality, waste disposal and other environmental 61 68 matters, if the failure to comply with the same does or would have a material adverse effect on the Premises or the operation thereof. 19. ASSIGNMENT AND SUBLETTING. 19.1 PROHIBITION ON ASSIGNMENT AND SUBLETTING. Tenant acknowledges that Landlord has entered into this Lease in reliance on the personal services and business expertise of Tenant. Tenant may not assign, sublet, mortgage, hypothecate, pledge, or transfer any interest in this Lease, or in the Premises, in whole or in part, without the prior written consent of Landlord, which Landlord may not unreasonably withhold, condition or delay. Notwithstanding the foregoing, Tenant may without Landlord's consent assign this Lease or sublet the Premises or any portion thereof to a Successor (as such term is defined below), to a wholly-owned, direct or indirect, subsidiary of Tenant ("Subsidiary"), or ARC provided that such Successor or Subsidiary fully assumes the obligations of Tenant and ARC is not released from its guaranty of this Lease. The following transactions will be deemed an assignment or sublease requiring Landlord's prior written consent: [i] an assignment by operation of law; [ii] an imposition (whether or not consensual) of a lien, mortgage, or encumbrance upon Tenant's interest in the Lease; and [iii] an arrangement (including, but not limited to, management agreements, concessions, licenses, and easements) which allows the use or occupancy or operation of all or part of the Premises by anyone other than Tenant. Landlord's consent to any assignment or sublease will not release Tenant from its payment and performance obligations under this Lease, but rather Tenant, and Tenant's assignee or sublessee will be jointly and severally liable for such payment and performance. An assignment or sublease without the prior written consent of 62 69 Landlord will be void at the Landlord's option. Landlord's consent to one assignment or sublease will not waive the requirement of its consent to any subsequent assignment or sublease. 19.2 REQUESTS FOR LANDLORD'S CONSENT TO ASSIGNMENT, SUBLEASE OR MANAGEMENT AGREEMENT. If Tenant requests Landlord's consent to a specific assignment, sublease, or management agreement, Tenant shall give Landlord [i] the name and address of the proposed assignee, subtenant or manager; [ii] a copy of the proposed assignment, sublease or management agreement; [iii] reasonably satisfactory information about the nature, business and business history of the proposed assignee, subtenant, or manager and its proposed use of the Premises; and [iv] banking, financial, and other credit information, and references about the proposed assignee, subtenant or manager reasonably sufficient to enable Landlord to determine the financial responsibility and character of the proposed assignee, subtenant or manager. Any assignment, sublease or management agreement shall contain provisions to the effect that [a] such assignment, sublease or management agreement is subject and subordinate to all of the terms and provisions of this Lease and to the rights of Landlord; [b] such assignment, sublease or management agreement may not be modified without the prior written consent of Landlord not to be unreasonably withheld or delayed; [c] if this Lease shall terminate before the expiration of such assignment, sublease or management agreement, the assignee, subtenant or manager hereunder will, at Landlord's option, attorn to Landlord and waive any right the assignee, subtenant or manager may have to terminate the assignment, sublease or management agreement or surrender possession thereunder as a result of the termination of this Lease; and [d] if the assignee, subtenant or manager receives a written notice from Landlord stating that Tenant is in default under this Lease, the assignee, subtenant or manager shall thereafter pay all rentals or 63 70 payments under the assignment, sublease or management agreement directly to Landlord until such default has been cured. 19.3 ASSIGNMENT BY LANDLORD. Landlord may not transfer, assign, mortgage, collaterally assign, or otherwise, directly or indirectly, dispose of Landlord's interest in this Lease or the Premises to a competitor of Tenant or ARC for so long as Tenant, ARC, or an affiliate of Tenant and/or ARC is tenant hereunder. 19.4 ORDINARY COURSE SUBLEASES NOT REQUIRE CONSENT. Notwithstanding anything to the contrary contained in Section 19, (i) a lease of a unit or bed to a resident of the Premises, (ii) a sublease of any space in the Premises to an entity that provides services to such residents, and (iii) a sublease of any space for uses ancillary to the Retirement Care Facility, so long as each is made in the ordinary course of Tenant's business shall not be deemed to be an assignment of the Lease, and shall not require Landlord's consent. 19.5 SUCCESSOR. As used herein, a "SUCCESSOR" is any entity which succeeds to materially all of the assets, operations and business of Tenant by merger or reorganization and which is controlled by the same person or persons as control Tenant prior to such merger or reorganization. 20. INDEMNIFICATION. 20.1 TENANT'S INDEMNIFICATION. Tenant hereby indemnifies and agrees to hold harmless Landlord, any successors or assigns of Landlord, and Landlord's and such successor's and assign's directors, officers, employees and agents from and against any and all demands, claims, causes of action, fines, penalties, damages (including consequential damages), losses, 64 71 liabilities (including strict liability), judgments, and expenses (including, without limitation, reasonable attorneys' fees, and court costs incurred in connection with or arising from [i] the use or occupancy of the Premises by Tenant or any persons claiming under Tenant; [ii] any activity, work, or thing done, or permitted or suffered by Tenant in or about the Premises; [iii] any acts, omissions, or negligence of Tenant or any person claiming under Tenant, or the contractors, agents, employees, invitees, or visitors of Tenant or any such person; [iv] any breach, violation, or nonperformance by Tenant or any person claiming under Tenant or the employees, agents, contractors, invitees, or visitors of Tenant or of any such person, of any term, covenant, or provision of this Lease or any law, ordinance, or governmental requirement of any kind including, without limitation, any failure to comply with any applicable requirements under the ADA; [v] any injury or damage to the person, property or business of Tenant, its employees, agents, contractors, invitees, visitors, or any other person entering upon the Premises; and [vi] any construction, alterations, changes or demolition of the Premises performed by or contracted for Tenant or its employees, agents or contractors, excluding, however, any claims and damages arising from Landlord's negligence or willful misconduct. If any action or proceeding is brought against Landlord, its employees, or agents by reason of any such claim, Tenant, upon notice from Landlord, will defend the claim at Tenant's expense with counsel reasonably satisfactory to Landlord. All amounts payable to Landlord under this section shall be payable on written demand and any such amounts which are not paid within 20 days after demand therefor by Landlord shall bear interest at the maximum permitted interest rate under applicable law. In case any action, suit or proceeding is brought against Tenant by reason of any such occurrence, Tenant shall use its best efforts to defend such action, suit or proceeding. Notwithstanding 65 72 anything in this Lease to the contrary, Tenant shall not indemnify or hold Landlord harmless, nor successors or assigns of Landlord, nor Landlord's and such successor's and assign's directors, officers, employees and agents from and against any and all demands, claims, causes of action, fines, penalties, damages (including consequential damages), losses, liabilities (including strict liability), judgments, and expenses (including, without limitation, reasonable attorneys' fees, and court costs) resulting from a breach of or default under this Lease, or negligence or misconduct on the part of Landlord, the successors and assigns of Landlord, and Landlord's and such successor's and assign's directors, officers, employees and agents. 20.1.1 NOTICE OF CLAIM. Landlord shall notify Tenant in writing of any claim or action brought against Landlord in which indemnity may be sought against Tenant pursuant to this section. Such notice shall be given in sufficient time to allow Tenant to defend or participate in such claim or action, but the failure to give such notice in sufficient time shall not constitute a defense hereunder nor in any way impair the obligations of Tenant under this section unless the failure to give such notice precludes Tenant's defense of any such action. 20.1.2 SURVIVAL OF COVENANTS. The covenants of Tenant contained in this section shall remain in full force and effect after the termination of this Agreement until the expiration of the period stated in the applicable statute of limitations during which a claim or cause of action may be brought and payment in full or the satisfaction of such claim or cause of action and of all expenses and charges incurred by Landlord relating to the enforcement of the provisions herein specified. 66 73 20.1.3 REIMBURSEMENT OF EXPENSES. Unless prohibited by law, Tenant hereby agrees to pay to Landlord all of the reasonable fees, charges and reasonable out-of-pocket expenses related to the Retirement Care Facility and requested hereby, or incurred by Landlord in enforcing the provisions of this Agreement. 20.2 LIMITATION OF LANDLORD'S LIABILITY. Landlord, its agents, and employees, will not be liable for any loss, injury, death, or damage (including consequential damages) to persons, property, or Tenant's business occasioned by theft, act of God, public enemy, injunction, riot, strike, insurrection, war, court order, requisition, order of governmental body or authority, fire, explosion, falling objects, stream, water, rain or snow, leak or flow of water (including water from the elevator system), rain or snow from the Premises or into the Premises or from the roof, street, subsurface or from any other place or by dampness or from the breakage, leakage, obstruction, or other defects of the pipes, sprinklers, wires, appliances, plumbing, air conditioning, or lighting fixtures of the Premises, or from construction, repair, or alteration of the Premises or from any acts or omissions of any other occupant or visitor of the Premises, or from any other cause beyond Landlord's control. 21. HOLDING OVER. Should Tenant, with or without the express or implied consent of Landlord, continue to hold and occupy the Premises after the expiration of the Term, such holding over beyond the Term and the acceptance or collection of Rent by the Landlord shall operate and be construed as creating a tenancy from month-to-month and not for any other term whatsoever. Said month-to-month tenancy may be terminated by Landlord by giving Tenant 10 days' written notice, and at any time thereafter Landlord may re-enter and take possession of the Premises. 67 74 21.1 SURRENDER. Except for [i] alterations made in accordance with the terms of this Lease; [ii] normal and reasonable wear and tear (subject to the obligation of Tenant to maintain the Premises in good order and repair during the Term); and [iii] damage and destruction not required to be repaired by Tenant, Tenant shall surrender and deliver up the Premises at the expiration or termination of the Term in as good order and condition as of the Commencement Date. 22. ESTOPPEL CERTIFICATES. Tenant shall, at any time upon not less than fifteen (15) days prior written request by Landlord, execute, acknowledge and deliver to Landlord or its designee a statement in writing, executed by an officer or general partner of Tenant, certifying that this Lease is unmodified and in full force and effect (or, if there have been any modifications, that this Lease is in full force and effect as modified, and setting forth such modifications), the dates to which Minimum Rent, Additional Rent and additional charges hereunder have been paid, certifying that no default by either Landlord or Tenant exists hereunder or specifying each such default and as to other matters as Landlord may reasonably request. 23. CONVEYANCE BY LANDLORD. If Landlord or any successor owner of the Premises shall convey the Premises in accordance with the terms hereof, Landlord or such successor owner shall thereupon be released from all future liabilities and obligations of Landlord under this Lease arising or accruing from and after the date of such conveyance or other transfer as to the Premises and all such future liabilities and obligations shall thereupon be binding upon the new owner. 68 75 24. WAIVER OF JURY TRIAL. Landlord and Tenant hereby waive any rights to trial by jury in any action, proceedings or counterclaim brought by either of the parties against the other in connection with any matter whatsoever arising out of or in any way connected with this Lease, including, without limitation, the relationship of Landlord and Tenant, Tenant's use and occupancy of the Premises, or any claim of injury or damage relating to the foregoing or the enforcement of any remedy hereunder. 25. ATTORNEYS' FEES. If Landlord or Tenant brings any action to interpret or enforce this Lease, or for damages for any alleged breach hereof, the prevailing party in any such action shall be entitled to reasonable attorneys' fees and costs as awarded by the court in addition to all other recovery, damages and costs. 26. SEVERABILITY. In the event any part or provision of the Lease shall be determined to be invalid or enforceable, the remaining portion of this Lease shall nevertheless continue in full force and effect. 27. COUNTERPARTS. This Lease may be executed in any number of counterparts, each of which shall be deemed an original, but all of which shall constitute one and the same agreement. 28. BINDING EFFECT. Subject to the provisions of Section 19 above, this Lease shall be binding upon and inure to the benefit of Landlord and Tenant and their respective heirs, personal representatives, successors in interest and assigns. 29. WAIVER AND SUBROGATION. Landlord and Tenant hereby waive to each other all rights of subrogation which any insurance carrier, or either of them, may have as to the Landlord 69 76 or Tenant by reason of any provision in any policy of insurance issued to Landlord or Tenant, provided such waiver does not thereby invalidate the policy of insurance. 30. MEMORANDUM OF LEASE. Landlord and Tenant shall, promptly upon the request of either, enter into a short form memorandum of the Lease, in form suitable for recording under the laws of the State of Ohio in which reference to this Lease shall be made. The party requesting such recordation shall pay all costs and expenses of preparing and recording such memorandum of this Lease. 31. INCORPORATION OF RECITALS AND ATTACHMENTS. The recitals and exhibits, schedules, addenda and other attachments to this Lease are hereby incorporated into this Lease and made a part hereof. 32. TITLES AND HEADINGS. The titles and headings of sections of this Lease are intended for convenience only and shall not in any way affect the meaning or construction of any provision of this Lease. 33. NATURE OF RELATIONSHIP; USURY SAVINGS CLAUSE. The parties intend that their relationship shall be that of lessor and lessee only. Nothing contained in this Lease shall be deemed or construed to constitute an extension of credit by Landlord to Tenant, nor shall this Lease be deemed to be a partnership or venture agreement between Landlord and Tenant. Notwithstanding the foregoing, in the event any payment made to Landlord hereunder is deemed to violate any applicable laws regarding usury, the portion of any payment deemed to be usurious shall be held by Landlord to pay the future obligations of Tenant as such obligations arise and, in the event Tenant discharges and performs all obligations hereunder, such funds will 70 77 be reimbursed to Tenant upon the expiration of the Term. No interest shall be paid on any such funds held by Landlord. 34. JOINT AND SEVERAL. If more than one person or entity is the Tenant hereunder, the liability and obligations of such persons or entities under this Lease shall be joint and several. 35. SURVIVAL OF REPRESENTATIONS, WARRANTIES AND COVENANTS. All of the obligations, representations, warranties and covenants of Tenant under this Lease shall survive the expiration or earlier termination of the Term. 36. INTERPRETATION. Both Landlord and Tenant have been represented by counsel and this Lease has been freely and fairly negotiated. Consequently, all provisions of this Lease shall be interpreted according to their fair meaning and shall not be strictly construed against any party. 37. ASSIGNMENT OF APPROVAL AND CONSENT RIGHTS. Intentionally omitted. 38. SUBORDINATION, NON-DISTURBANCE, AND ATTORNMENT. Upon written notice by Landlord to Tenant, this Lease shall be and become subject and subordinate to any and all mortgages or deeds of trust now existing, or that hereafter may secure Permitted Mortgage Loans, on the Premises, for the full amount of all advances made or to be made thereunder and without regard to the time or character of such advances, together with interest thereon, and subject to all the terms and provisions thereof. Notwithstanding the foregoing provisions with respect to subordination, such provisions shall not be effective unless the owner or holder of any such mortgage or deed of trust shall execute with Tenant a non-disturbance and attornment agreement under which said owner or holder shall agree to accept the attornment of Tenant and not disturb Tenant's right of possession hereunder upon foreclosure of any such mortgage or 71 78 deed of trust, if Tenant is not in default. Tenant hereby agrees to attorn to any person, firm or corporation purchasing or otherwise acquiring the Premises at any sale or other proceeding or pursuant to the exercise of any other rights, power or remedies under such mortgages or deeds of trust, as if such person, firm or corporation had been named as Landlord herein. Upon request of Landlord, Tenant agrees to execute and deliver an instrument suitable for recording subordinating Tenant's interest in the Premises to any such Permitted Mortgage Loan, subject to the provisions of this Section 38. 39. ENTIRE AGREEMENT. The entire understanding between the parties with respect to the transactions contemplated herein is set out in this Lease. This Lease supersedes and voids all prior proposals, letters and agreements, oral or written, with respect to the subject matter hereof. No modification or alteration of this Lease shall be effective unless evidenced by an instrument in writing and signed by all parties. [Signatures on following page(s).] Executed as of the date indicated above. TENANT: ARC WESTLAKE VILLAGE, INC. a Tennessee corporation By: -------------------------------- Title: ----------------------------- 72 79 LANDLORD: CLEVELAND RETIREMENT PROPERTIES, LLC, a New York limited liability company By: ------------------------------ Title: ---------------------------- 80 EXHIBIT "A" LEGAL DESCRIPTION OF PREMISES 81 EXHIBIT "A-1" PERMITTED EXCEPTIONS 82 EXHIBIT "B" Landlord Personal Property All furniture, furnishings, equipment, tools, machinery, fixtures, appliances and all other intangible and tangible personal property conveyed to Landlord pursuant to the Purchase Agreement. 83 EXHIBIT "C" Appraisal Process If Landlord and Tenant are unable to agree upon the Fair Market Value of the Premises within any relevant period provided in this Lease, each shall within ten (10) days after written demand by the other select one MAI Appraiser to participate in the determination of Fair Market Value. For all purposes under this Lease, the Fair Market Value of the Premises shall be based on the Fair Market Value of the Premises unencumbered by this Lease. Within ten (10) days of such selection, the MAI Appraisers so selected by Landlord and Tenant shall select a third MAI Appraiser. The three (3) selected MAI Appraisers shall each determine the Fair Market Value of the Premises within thirty (30) days of the selection of the third appraiser. To the extent consistent with sound appraisal practices as then existing at the time of any such appraisal, and if requested by Landlord, such appraisal, shall be made on a basis consistent with the basis on which the Premises was appraised at the time of its acquisition by Landlord. Each of Tenant and Landlord shall pay the fees and expenses of any MAI Appraiser which such party appoints pursuant to this Exhibit plus 50% of the cost of the third appraiser. In the event either Landlord or Tenant fails to select a MAI Appraiser within the time period set forth in the foregoing paragraph, the MAI Appraiser selected by the other party shall alone determine the Fair Market Value of the Premises in accordance with the provisions of this Exhibit and the Fair Market Value so determined shall be binding upon Landlord and Tenant. In the event the MAI Appraisers selected by Landlord and Tenant are unable to agree upon a third MAI Appraiser within the time period set forth in the first paragraph of this Exhibit, either Landlord or Tenant shall have the right to apply at their mutual expense to the presiding judge of the court of original trial jurisdiction in the county in which the Premises is located to name the third MAI Appraiser. Within five (5) days after completion of the third MAI Appraiser's appraisal, all three MAI Appraisers shall meet and a majority of the MAI Appraisers shall attempt to determine the Fair Market Value of the Premises. If a majority are unable to determine the Fair Market Value at such meeting, the three appraisals shall be added together and their total divided by three. The resulting quotient shall be the Fair Market Value of the Premises. If, however, either or both of the low appraisal or the high appraisal are more than ten percent (10%) lower or higher than the middle appraisal, any such lower or higher appraisal shall be disregarded. If only one appraisal is disregarded, the remaining two appraisals shall be added together and their total divided by two, and the resulting quotient shall be such Fair Market Value. If both the lower appraisal and higher appraisal are disregarded as provided herein, the middle appraisal shall be such Fair Market Value. In any event, the result of the foregoing appraisal process shall be final and binding. Landlord, Tenant will exercise their respective best efforts to expedite the appraisal process and will cooperate fully and with all deliberate speed with each other and with all 84 appraisers in order to allow the determination of Fair Market Value to be finally completed. Notwithstanding anything else in this Exhibit, if any appraiser appointed hereunder fails to complete his or her report within 60 days of his or her appointment, the Fair Market Value of the Premises will be determined by reference to the other report or reports completed within such period. "MAI APPRAISER" shall mean an appraiser licensed or otherwise qualified to do business in the State and who has substantial experience in performing appraisals of facilities similar to the Premises and is certified as a member of the American Institute of Real Estate Appraisers or certified as a SRPA by the Society of Real Estate Appraisers, or, if such organizations no longer exist or certify appraisers, such successor organization or such other organization as is approved by Landlord. 85 EXHIBIT "D" LEASE RENEWAL FACTOR For purposes of Section 2.2.2, the lease renewal factor shall be determined as follows: Assume: Base CPI = 240.0 Current CPI = 300.0 CPI Increase = ((300.0/240.0)-1) = 0.25 Lease Rate Escalator = 0.25/2 = .125 Lease Renewal Factor = .125 + 1 = 1.125 86 EXHIBIT "E" LANDLORD'S SINGLE PURPOSE ENTITY REQUIREMENTS A. Without limiting any other provision of this Lease, the following requirements are applicable to Landlord: 1. Landlord's purpose should be limited to owning the Premises. 2. Landlord shall be prohibited from engaging in any dissolution, liquidation, consolidation, merger, or asset sale, except as expressly permitted by this Lease. 3. The consent of all of the members of the Landlord shall be required in order to voluntarily: (a) file a bankruptcy or insolvency petition or otherwise institute insolvency proceedings; (b) dissolve, liquidate, consolidate, merge, or sell all or substantially all of the assets of the Landlord; (c) engage in any other business activity; and (d) amend Landlord's Operating Agreement or Articles of Organization. 4. Landlord agrees: (a) to maintain books and records and bank accounts separate from any other person or entity; (b) not to commingle assets or funds with those of any other person or entity; (c) to conduct its own business in its own name; (d) to maintain its assets in such a manner that it is not costly or difficult to segregate, identify or ascertain such assets; (e) to prepare separate tax returns and financial statements, or if part of a consolidated group, to be shown as a separate member of such group; (f) to pay its own liabilities out of its own funds; (g) to observe all limited liability company formalities; 87 (h) to transact all business with affiliates on an arm's-length basis and pursuant to enforceable agreements; (i) to pay the salaries of its own employees; (j) not to guarantee or become obligated for the debts of any other person or entity or hold out its credit as being available to satisfy the obligations of others or pay the debts or obligations of any other person or entity; (k) to allocate and charge fairly and reasonably any common employee or overhead shared with affiliates; (l) to use separate stationary, invoices, and checks; (m) not to pledge its assets for the benefit of any other person or entity. (n) to hold itself out to creditors and the public as a legal entity separate and distinct from any other person or entity. B. The above requirements are applicable so long as the Landlord is a limited liability company. If the entity structure of Landlord is different, Tenant shall formulate requirements that are specific to Landlord's actual entity structure, but similar in concept to the requirements set forth above. 88 EXHIBIT "F" TENANT'S HEALTHCARE COMPLIANCE COVENANTS I. Tenant hereby makes the following representations, warranties and covenants as of the date hereof and throughout the term of the Lease, which representations, warranties and covenants are in addition to those found within the body of the Lease: (a) Tenant is using and operating the Premises as a Retirement Care Facility (as modified from time to time with Landlord and any Permitted Mortgage Lender's consent, which consent shall not be unreasonably withheld, the "LICENSED USE"). The Retirement Care Facility has the number of beds/units set forth in the Berkshire Loan Documents. Tenant will comply in all material respects, with all applicable federal, state and local laws, regulations, quality and safety standards, accreditation standards and requirements of the applicable state department of health (each a "DOH") and all other applicable federal, state or local governmental authorities including those relating to the quality and adequacy of medical care, distribution of pharmaceuticals, rate setting, equipment, personnel, operating policies, additions to facilities and services and fee splitting. The Retirement Care Facility and any other assisted and/or independent senior housing and/or skilled nursing facilities which is owned, leased or operated by Tenant (a "FACILITY") shall be operated at all times in compliance in all material respects with such laws and requirements. Nothing in this subsection (a) or anywhere else in this Exhibit "F" to the contrary, Landlord acknowledges that pursuant to the Lease, Tenant is responsible for all of the covenants set forth in this Exhibit "F" (other than those pertaining to Landlord's own acts), and that performance of such covenants by ARC as guarantor (the "GUARANTOR") shall constitute performance by Tenant thereof. (b) All governmental licenses, permits, regulatory agreements or other approvals or agreements necessary or desirable for the Licensed Use of the Retirement Care Facility are held by Tenant, Guarantor or an affiliate of Tenant ("AFFILIATE") in the name of Lessee, Guarantor or Affiliate as required under applicable law and are in full force and effect, including a valid certificate of need ("CON") or similar certificate, license, or approval issued by the DOH for the requisite number of beds and units in the Retirement Care Facility, and a provider agreement or other required documentation of approved provider status for each provider payment or reimbursement program effecting the Retirement Care Facility, if applicable. All required permits, certificates, licenses and 89 governmental approvals necessary for operation of the Retirement Care Facility for the Licensed Use are listed on Schedule hereto (collectively, the "LICENSES"). So long as the Lease remains in effect, Tenant and Guarantor shall operate the Project or cause the Project to be operated in a manner such that the Licenses shall remain in full force and effect. (c) The Licenses for the Retirement Care Facility, including without limitation, if applicable, the CON: (i) May not be, and have not been, and will not be transferred to any location other than the Premises; (ii) Are not now and will not be pledged as collateral security for any other loan or indebtedness; and (iii) Are held free and will remain free from restrictions or known conflicts which would materially impair the use or operation of the Retirement Care Facility for the Licensed Use, and shall not be provisional, probationary or restricted in any way. II. None of Affiliate, Guarantor or Lessee shall: (i) Rescind, withdraw, revoke, amend, modify, supplement, or otherwise alter the nature, tenor or scope of the Licenses for the Retirement Care Facility; (ii) Amend or otherwise change the Retirement Care Facility's authorized units/beds capacity and/or the number of units/beds approved by the DOH; (iii) Replace or transfer all or any part of the Retirement Care Facility's units/beds to another site or location; or (iv) Voluntarily transfer or encourage the transfer of any resident of the Retirement Care Facility to any other Facility, unless such transfer is at the request of the resident or is for reasons relating to the health, required level of medical care or safety of the resident to be transferred. (e) If and when Tenant, Affiliate or Guarantor participates in any Medicare or Medicaid or other third party payor program with respect to the Retirement Care Facility, the Retirement Care Facility will remain in compliance with all requirements for participation in Medicare and Medicaid, including the Medicare and Medicaid Patient Protection Act of 1987, and other 90 federal or state third party payor programs. The Retirement Care Facility is and will remain in conformance in all material respects with all insurance, reimbursement and cost reporting requirements, and if applicable, has a current provider agreement which is in full force and effect under Medicare and Medicaid. (f) There is no, and during the term of the Lease shall be no, threatened, existing or pending revocation, suspension, termination, probation, restriction, limitation, or nonrenewal affecting Tenant, Guarantor, Affiliate or the Retirement Care Facility or any participation or provider agreement with any third-party payor, including Medicare, Medicaid, Blue Cross and/or Blue Shield, other and any other private commercial insurance managed care and employee assistance program (such programs, the "THIRD-PARTY PAYOR PROGRAMS") to which Tenant, Guarantor or Affiliate may presently be subject with respect to the Retirement Care Facility or any other Facility, or at any time hereafter is subject. All Medicaid, Medicare, and private insurance cost reports and financial reports submitted by Tenant, Affiliate or Guarantor, if any, are and will be materially accurate and complete and have not been and will not be misleading in any material respects. No cost reports for the Retirement Care Facility remain open or unsettled. Nothing in this subsection (f) shall be interpreted as requiring Tenant, Affiliate or Guarantor to participate in Medicare, Medicaid or any other federal or state health care programs; such participation shall be solely at the option of Tenant or Guarantor. (g) None of Tenant, Affiliate or Guarantor or the Retirement Care Facility is or will be the subject of any proceeding by any governmental agency, and no notice of any violation has been or will be issued by a governmental agency that would, directly or indirectly, or with the passage of time: (i) Have a material adverse impact on Tenant's or Guarantor's ability to accept and/or retain patients or operate the Retirement Care Facility for the Licensed Use or result in the imposition of a fine, a sanction, a lower rate certification or a lower reimbursement rate for services rendered to eligible patients; (ii) Modify, limit or annul or result in the transfer, suspension, revocation or imposition of probationary use of any of the Licenses; or (iii) If applicable, affect Tenant's or Guarantor's continued participation in the Medicaid or Medicare programs or any other of the Third-Party Payor Programs, or any successor programs thereto, at current rate certifications. 91 (h) The Retirement Care Facility and the use thereof complies and will continue to comply in all material respects with all applicable local, state and federal building codes, fire codes, health care, senior housing and other regulatory requirements (the "PHYSICAL PLANT STANDARDS"). (i) The Retirement Care Facility has not received a "Level A" (or equivalent) violation, and no statement of charges or deficiencies has been made or penalty enforcement action has been undertaken against the Retirement Care Facility, Tenant or Guarantor or against any officer, director, partner, member, stockholder or affiliate of Tenant or Guarantor by any governmental agency during the last three calendar years, and there have been no violations over the past three years which have threatened the Retirement Care Facility's, Tenant's, Affiliate's or Guarantor's certification for participation in Medicare or Medicaid, or the other Third-Party Payor Programs. (j) There are no current, pending or outstanding Medicaid, Medicare, or other Third-Party Payor Programs reimbursement audits or appeals pending at the Retirement Care Facility, and there are no years that are subject to audit. (k) There are no current or pending Medicaid, Medicare, or other Third-Party Payor Programs recoupment efforts at the Retirement Care Facility. Tenant, Affiliate and Guarantor are not participants in any federal program whereby any governmental agency may have the right to recover funds by reason of the advance of federal funds, including those authorized under the Hill-Burton Act (42 U.S.C. 291, et seq.). (l) Tenant will pledge its receivables as collateral security for any other loan or indebtedness. (m) All patient or resident records at the Retirement Care Facility, including patient or resident trust fund accounts, are true and correct in all material respects, and will remain true and correct in all material respects. (n) Tenant and Guarantor shall not, nor shall the Retirement Care Facility, other than in the normal course of business, change the terms of any of the Third-Party Payor Programs now or hereinafter in effect or their normal billing payment or reimbursement policies and procedures with respect thereto (including the amount and timing of finance charges, fees and write-offs). (o) Tenant and Guarantor shall at all times comply with all obligations under the contracts and leases with residents of the Retirement 92 Care Facility, and shall not commit or permit any default thereunder. Tenant hereby indemnifies and holds harmless Landlord and agrees to defend Landlord from and against (collectively, the "INDEMNIFIED CLAIMS") any (i) claims, proceedings or causes of action brought by any resident of the Retirement Care Facility, and (ii) loss, damage, cost or expense, including attorney's fees, incurred or suffered by Landlord as a result of any (x) breach by Tenant or Guarantor of any contract or lease with a resident of the Retirement Care Facility or (y) violation of any license or any federal, state or local law governing the Retirement Care Facility or the use, operation or maintenance thereof for the Licensed Use. EX-21 3 g68121ex21.txt SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT 1. ARC Air Force Village, L.P., a Tennessee limited partnership 2. ARC Bahia Oaks, Inc., a Tennessee corporation 3. ARC Boca Raton, Inc., a Tennessee corporation 4. ARC Brandywine Management, LLC, a Tennessee limited liability company 5. ARC Brandywine, LLC, a Tennessee limited liability company 6. ARC Capital Corporation II, Inc., a Tennessee corporation 7. ARC Capital Corporation, a Tennessee corporation 8. ARC Carriage Club of Jacksonville, Inc., a Tennessee corporation 9. ARC Castle Hills, Inc., a Tennessee corporation 10. ARC Castle Hills, L.P., a Tennessee limited partnership 11. ARC Charlotte, Inc., a Tennessee corporation 12. ARC Corpus Christi, Inc., a Tennessee corporation 13. ARC Cypress Station, L.P., a Tennessee limited partnership 14. ARC Deane Hill, LLC, a Tennessee limited liability company 15. ARC Flint, Inc., a Tennessee corporation 16. ARC Fort Austin Properties, Inc., a Tennessee corporation 17. ARC Freedom, Inc., a Tennessee corporation 18. ARC Greenwood Village, Inc., a Tennessee corporation 19. ARC Heritage Club, Inc., a Tennessee corporation 20. ARC Holland, Inc., a Tennessee corporation 21. ARC Holley Court Terrace, L.P., a Tennessee limited partnership 22. ARC Imperial Plaza, Inc., a Tennessee corporation 23. ARC Imperial Services, Inc., a Tennessee corporation 24. ARC Lady Lake, Inc., a Tennessee corporation 25. ARC Lakeway, L.P., a Tennessee limited partnership 26. ARC Lifemed, Inc., a Tennessee corporation 27. ARC Lowry, LLC, a Tennessee limited liability company 28. ARC Management Corporation, a Tennessee corporation 29. ARC Management, LLC, a Tennessee limited liability company 30. ARC Naples, LLC, a Tennessee limited liability company 31. ARC Oakhurst, Inc., a Tennessee corporation 32. ARC Park Regency, Inc., a Tennessee corporation 33. ARC Parklane, Inc., a Tennessee corporation 34. ARC Partners, Inc., a Florida corporation 35. ARC Pearland, L.P., a Tennessee limited partnership 36. ARC Pecan Park, L.P., a Tennessee limited partnership 37. ARC Pinegate, L.P., a Tennessee limited partnership 38. ARC Richmond Place, Inc., a Tennessee corporation 39. ARC Rossmoor, Inc., a Tennessee corporation 40. ARC San Antonio, Inc., a Tennessee corporation 41. ARC Santa Catalina, Inc., a Tennessee corporation 42. ARC SCC, Inc., a Tennessee corporation 43. ARC Scottsdale, LLC, a Tennessee limited liability company 44. ARC Seminole, Inc., a Tennessee corporation 45. ARC Services, L.P., a Tennessee limited partnership 46. ARC Shavano, L.P., a Tennessee limited partnership 47. ARC Spring Shadow, L.P., a Tennessee limited partnership 48. ARC Sun City Center Inc., a Tennessee corporation 49. ARC Sun City Golf Course, Inc., a Tennessee corporation 50. ARC Tarpon Springs, Inc., a Tennessee corporation 51. ARC Westlake Village, Inc., a Tennessee corporation 52. ARC Wilora Lake, Inc., a Tennessee corporation 53. ARCLP-Charlotte, LLC, a Tennessee limited liability company 54. Assisted Care of the Villages, a Florida general partnership 55. FALP Acquisition Company, LLC, a Tennessee limited liability company 56. FALP Holding Company, LLC, a Tennessee limited liability company 57. Flint Michigan Retirement Housing, LLC, a Tennessee limited liability company 58. Fort Austin Limited Partnership, a Texas limited partnership 59. Freedom Group Development Company, Inc., (d/b/a Freedom Development Corporation), a Tennessee corporation 60. Freedom Group Management Company, Inc., a Tennessee corporation 61. Freedom Group-Lake Seminole Square, Inc., a Tennessee corporation 62. Freedom Group-Naples Management Company, Inc., a Tennessee corporation 63. Freedom Village of Holland, a Michigan general partnership 64. Freedom Village of Sun City Center, Ltd., a Florida limited partnership 65. Homewood at Brookmont Terrace, LLC, a Tennessee limited liability company 66. Lake Seminole Square Management Company, Inc., a Tennessee corporation 67. Lebarc, L.P., a Tennessee limited partnership 68. Plaza Professional Pharmacy, Inc., a Virginia corporation 69. Trinity Towers Limited Partnership, a Tennessee limited partnership EX-23 4 g68121ex23.txt CONSENT OF KPMG LLP 1 EXHIBIT 23 ACCOUNTANTS' CONSENT The Board of Directors American Retirement Corporation We consent to incorporation by reference in the Registration Statement Nos. 333-28657, 333-66821, and 333-94747 on Form S-8 of American Retirement Corporation of our report dated February 21, 2001, relating to the consolidated balance sheets of American Retirement Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2000, and all related schedules, which report appears in the December 31, 2000 annual report on Form 10-K of American Retirement Corporation. /s/ KPMG LLP Nashville, Tennessee March 30, 2001 -----END PRIVACY-ENHANCED MESSAGE-----