-----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, UgJjxe9bEMBft3QY5MDAge+RTRppR7gqkxMiU1btyHXkssfXgGWwAPNgLeR8QkgH SO4cEiRD20P6AkGJGVK4Fg== 0000950144-00-004287.txt : 20000331 0000950144-00-004287.hdr.sgml : 20000331 ACCESSION NUMBER: 0000950144-00-004287 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADVOCAT INC CENTRAL INDEX KEY: 0000919956 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SKILLED NURSING CARE FACILITIES [8051] IRS NUMBER: 621559667 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-12996 FILM NUMBER: 588312 BUSINESS ADDRESS: STREET 1: 277 MALLORY STATION RD STREET 2: STE 130 CITY: FRANKLIN STATE: TN ZIP: 37067 BUSINESS PHONE: 6157717575 MAIL ADDRESS: STREET 1: 227 MALLORY STATION ROAD STREET 2: SUITE 130 CITY: FRANKLIN STATE: TN ZIP: 37064 10-K405 1 ADVOCAT INC. 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended DECEMBER 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934 [NO FEE REQUIRED] For the transition period from ______ to _____. Commission file number 1-12996 ADVOCAT INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 62-1559667 ------------------------------ ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 277 Mallory Station Road, Suite 130, Franklin, TN 37067 - ------------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (615) 771-7575 Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange On Title of Each Class Which Registered ------------------- ------------------------ Common Stock, par value $0.01 per share NASD OTC Toronto Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None. Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of Common Stock held by non-affiliates on March 23, 2000 (based on the closing price of such shares on the NASD OTC Market) was $1,176,309. For purposes of the foregoing calculation only, all directors, named executive officers and persons known to the Registrant to be holders of 5% or more of the Registrant's Common Stock have been deemed affiliates of the Registrant. On March 23, 2000, 5,491,693 shares of the registrant's $0.01 par value Common Stock were outstanding. Documents Incorporated by Reference: The following documents are incorporated by reference into Part III, Items 10, 11, 12, and 13 of this Form 10-K: The Registrant's definitive proxy materials for its 2000 annual meeting of stockholders. 2 PART I ITEM 1. BUSINESS FORWARD-LOOKING STATEMENTS. Certain statements made by or on behalf of Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company"), including those contained in this Annual Report on Form 10-K and elsewhere, are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties, including, but not limited to, changes in governmental reimbursement, government regulation and health care reforms, ability to expand operations through acquisition activities, both in finding suitable acquisitions and financing therefor, changing economic and market conditions and others. Actual results may differ materially from that expressed or implied in such forward-looking statements. See "Item 1 - Business - - Risk Factors." Such cautionary statements identify important factors that could cause the Company's actual results to materially differ from those projected in forward-looking statements. INTRODUCTORY SUMMARY. The Company provides long-term care services to nursing home patients and residents of assisted living facilities in 12 states, primarily in the Southeast, and three Canadian provinces. The Company completed its initial public offering in May 1994; however, its operational history can be traced to February 1980 through common senior management who were involved in different organizational structures. The Company's objective is to become the provider of choice of health care and related services to the elderly in the communities in which it operates. Advocat will continue to implement its operating strategy of (i) providing a broad range of cost-effective senior care services; (ii) forming strategic alliances with other health care providers to expand the Company's continuum of care; (iii) clustering its operations on a regional basis; and (iv) targeting non-urban markets, which management believes are under-served by long-term care providers. Key elements of the Company's growth strategy are to maximize revenue and profitability at existing facilities, make selective acquisitions of assisted living facilities generally located in smaller rural and secondary markets in the southeast United States and in Canada, and pursue additional management opportunities. The Company's principal executive offices are located at 277 Mallory Station Road, Suite 130, Franklin, Tennessee 37067. The Company's telephone number at that address is (615) 771-7575, and its facsimile number is (615) 771-7409. 2 3 MATERIAL CORPORATE DEVELOPMENTS. OPERATING LOSSES The Company has incurred losses during 1999 and 1998 and expects to continue to incur losses during 2000. The Company has a working capital deficit of $56.7 million as of December 31, 1999. Also, the Company has limited resources available to meet its operating, capital expenditure and debt service requirements during 2000. Given the events of default under the Company's working capital line of credit, there can be no assurance that the respective lender will continue to provide working capital advances. CURRENT DEBT MATURITIES AND FINANCIAL COVENANT NON-COMPLIANCE Certain of the Company's loan agreements contain various financial covenants, the most restrictive of which relate to net worth, cash flow, debt-to-equity ratio requirements, and limits on the payment of dividends to shareholders. As of December 31, 1999, the Company was not in compliance with the covenants. Cross-default or material adverse change provisions contained in the agreements allow the holders of substantially all of the Company's debt to demand immediate repayment. Although the non-compliance and resulting actions have not been formally or informally declared by lenders, the Company has not obtained waivers of the non-compliance. Based on regularly scheduled debt service requirements, the Company has a total of $27,195,000 of debt that must be repaid or refinanced within the next 12 months. However, as a result of the covenant noncompliance and other cross-default provisions, the Company has classified a total of $53,098,000 of debt as current liabilities as of December 31, 1999. The Company would not be able to repay the total amount of its indebtedness outstanding if the applicable lenders forced immediate repayment. At December 31, 1999, the Company had total debt outstanding of $60,925,000, of which $34,950,000 was principally mortgage debt bearing interest, generally at floating rates ranging from 6.3% to 8.6%. The Company also had outstanding a promissory note (the "Promissory Note") in the amount of $9,412,000 and a reducing demand loan to a Canadian bank in the amount of $1,038,000. The Company's remaining debt of $15,524,000 was drawn under the Company's lines of credit, consisting of a working capital line of credit and an acquisition line of credit. Most of the Company's debt is at floating interest rates, generally at a spread above the London Interbank Offered Rate ("LIBOR"). As of December 31, 1999, the Company's weighted average interest rate was 9.1%. On June 4, 1999, the Company obtained two loans totaling $25,250,000 (the "NC Loans"). The NC Loans are secured by the 13 owned assisted living facilities the Company operates in the state of North Carolina. The NC Loans mature in June 2002, bear interest at LIBOR plus 2.35%, and provide for principal amortization under a 25-year amortization schedule. The net proceeds available at closing, $24,688,000, was applied against the Company's indebtedness under the Promissory Note. As of December 31, 1999, the outstanding indebtedness under the NC Loans was $25,080,000 and the interest rate was 8.2%. The Promissory Note had an original indebtedness of $34,100,000. It was used to fund the purchase of the Company's North Carolina assisted living operations, which purchase closed on September 30, 1997. With the application of the net proceeds from the NC Loans, the balance of the Promissory Note was reduced to $9,412,000. Prior to the principal reduction, the Promissory Note had a maturity date of July 1, 1999, carried interest at LIBOR plus 3.0% and had a restriction against pledging the North Carolina assets as collateral with any other lender. With the reduction in the principal balance, the Company and its lenders agreed to modify the terms of the Promissory Note by extending the stated maturity date increasing the interest rate to 12.0% fixed and providing certain security interests to the lenders. The security interests include two non-operating properties 3 4 in North Carolina and the Company's limited partnership interests in Texas Diversicare Limited Partnership ("TDLP"). The Company has agreed to apply against the Promissory Note indebtedness any net proceeds realized from the sale of the collateral comprising the additional security interests. The Promissory Note was due February 28, 2000, and has not been not called. The Company and its lender are currently in negotiations with respect to the status of the Promissory Note. As of December 31, 1999, the Company had drawn $924,000, had $5,537,000 of letters of credit outstanding, and had $1,929,000 remaining borrowing capability under its working capital line of credit. The interest rate applicable at December 31, 1999, was 8.97%. The working capital line of credit matured February 28, 2000, and has not been called. A further extension of the existing agreement or a replacement working capital line of credit is currently being negotiated with the existing bank. Since early 1998, the Company's bank has provided additional line of credit availability (the "Overline"). Availability under the Overline began at $1,250,000 and was increased over time to a maximum level of $4,000,000. Subsequently, it was reduced to its current level of $3,500,000. Since April 14, 1999, the Overline has carried interest at 14.0% but was otherwise subject to the same terms and conditions as the Company's working capital line of credit. Maturity of the Overline had been scheduled for July 1, 1999. However, coincident with the changes with respect to the Promissory Note, the lender agreed to revised terms with respect to the Overline. These revisions, including availability reduction, extended the maturity date, provided for increased reporting responsibility to the lender and cooperation in the completion of an audit of the Company's accounts receivable if requested by the lender. In addition, the Company has provided, with respect to certain available assets, first and second collateral positions in favor of the lender. The Company's negotiations with its bank lender include the status of the Overline, which carried a formal maturity of February 28, 2000. The Overline has not been called by the respective lender. The acquisition line of credit of $40,000,000, less outstanding borrowings, was available to fund approved acquisitions through October 1999. The Company's obligations under the acquisition line are secured by the assets acquired with the draws under the acquisition line. Advances under the acquisition line bear interest, payable monthly, at LIBOR plus a defined spread with respect to each facility based upon its loan-to-value ratio and debt service coverage. Individual advances made under the acquisition line are due three years from the date of initial funding. As of December 31, 1999, the Company had $11,100,000 outstanding under the acquisition line, which amount was secured by four nursing homes. No further draws are available under the acquisition line of credit. Amounts outstanding under the acquisition line of credit had a scheduled maturity date of December 1, 1999; however, the lender has extended the maturity date to April 30, 2000. The Company and the lender are negotiating replacement long-term financing. In late 1999, the Company secured a credit agreement with a bank in support of its Canadian operations. The Company received a $1,038,000 ($1,500,000 Canadian) loan. This loan is a reducing demand loan with scheduled monthly payments aggregating $208,000 ($300,000 Canadian) annually. The loan carries interest at the lending bank's prime rate plus 0.25% and is secured by a general security agreement with respect to the Company's Canadian operations. The loan agreement includes a second facility for working capital loans up to $692,000 ($1,000,000 Canadian). The Company had no working capital draws outstanding under this facility at December 31, 1999. 4 5 Based on demand status or regularly scheduled debt service requirements (i.e., excluding any potential acceleration due to formal declaration of default by one or more of the Company's lenders), as of December 31, 1999, $27,195,000 of the Company's total debt $60,925,000 must be repaid or refinanced during the next 12 months. These scheduled maturities are as follows: $924,000 under the working capital line of credit, $3,500,000 under the Overline, and $9,412,000 under the Promissory Note, all three of which are currently due; $11,100,000 under the acquisition line of credit, which has been extended to April 30, 2000, as described above; $1,038,000 reducing demand loan to a Canadian Bank ($208,000 of which is scheduled in the absence of demand); and miscellaneous scheduled maturities over the next 12 months of $1,220,000. With respect to the Promissory Note, the working capital line of credit, and the Overline, the Company is currently negotiating with the existing lender to further restructure the terms, including further extension of their maturity dates. The Company expects to repay a portion of this debt through various means such as the sale of certain assets, refinancing mortgage debt, securing additional equity investment or through cash generated from operations. The Company expects to repay the reducing demand loan and miscellaneous current maturities of $1,220,000 with cash generated from operations. Management is hopeful that it will be successful in restructuring the Company's debt as described. However, there can be no assurance that the Company's restructuring efforts will be successful. The degree to which the Company is unsuccessful increases the likelihood of having to seek relief through other means including the possibility of relief under the United States Bankruptcy Code. At December 31, 1999, the classification of certain debt instruments as current liabilities, based upon their contractual maturities in 1999, results in negative working capital of $(56.7) million. As discussed above, management is pursuing various alternatives to extend or potentially refinance these debt instruments on a non-current basis. See also Notes 2 and 9 of the Company's Consolidated Financial Statements. Of the Company's 63 leased facilities, 30 are covered by a Master Lease and other leases with Omega Healthcare Investors, Inc. ("Omega"). Under the terms of the Master Lease, the Company must comply with certain covenants based on total shareholders' equity of the Company as defined. The Company was not in compliance with these covenants as of December 31, 1999. As a result of the non-compliance, Omega has the right to terminate all of its leases with the Company and seek recovery of any related financial losses, as well as other miscellaneous remedies. The Company has not obtained waivers of the non-compliance. The Company and Omega are currently in negotiations with respect to modification of the existing lease agreements. OPERATING LEASE NON-COMPLIANCE The Company is not in compliance with the financial covenants applicable to the lease agreements covering a majority of its United States nursing facilities. Under the agreements, the lessor has the right to terminate the lease agreements and seek recovery of any related financial losses as well as other remedies. The Company is currently in discussions with the respective lessor regarding a restructuring of the leases. HEALTH CARE INDUSTRY The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services and Medicare and Medicaid fraud and abuse. Health care law is a dynamic and rapidly evolving area of the law, and it has been the subject of increased legislative and regulatory scrutiny in recent years. Changes in these laws and regulations, such as reimbursement policies of Medicare and Medicaid programs as a result of budget cuts by federal and state governments or other legislative and regulatory actions, could have a material adverse effect on the Company's consolidated financial position, results of operations and cash flows. Future federal budget legislation and federal and state regulatory changes may negatively impact the Company. All of the Company's facilities are required to obtain annual licensure renewal and are subject to annual surveys and inspections in order to be certified for participation in the Medicare and Medicaid programs. In order to maintain their operator's license and their certification for participation in Medicare and Medicaid programs, the nursing facilities must meet certain detailed statutory and administrative requirements. These requirements relate to the condition of the facilities, the 5 6 adequacy and condition of the equipment used therein, the quality and adequacy of personnel, and the quality of medical care. Such requirements are subject to change. There can be no assurance that, in the future, the Company will be able to maintain such licenses for its facilities or that the Company will not be required to expend significant sums in order to do so. Recently, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of fraud and abuse statutes and regulations. Violations of these laws and regulations could result in expulsion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Management believes that the Company is in substantial compliance with fraud and abuse laws and regulations as well as other applicable government laws and regulations. However, compliance with such laws and regulations can be subject to future government review and interpretation as well as regulatory actions unknown or unasserted at this time. During 1997, the Company received separate notifications from the state of Alabama that, as a result of certain deficiencies noted upon periodic surveys of its two facilities in Mobile, the facilities would be decertified from participation in the Medicare and Medicaid programs and that licensure revocation could be pursued. The facilities were decertified for 69 and 91 days, respectively, before resurveys found them to be in compliance. Both of the facilities were recertified in 1998 for participation in the Medicare and Medicaid programs. During the latter half of 1998, the Company experienced further regulatory issues with respect to certain facilities. One of the Company's facilities in Arkansas was decertified from the Medicare and Medicaid programs. The facility was recertified for Medicaid participation before the decertification had a negative financial impact on operations; the Company is currently engaged in the application process to be recertified for Medicare participation. The State of Florida imposed a moratorium on new admissions as well as civil monetary penalties upon a facility during the last quarter of 1998. Additionally, the State required that the facility increase its staffing during the last half of 1998. The Company is appealing the civil monetary penalties. The moratorium on admissions was lifted at the end of January 1999. During 1999, the Company did not experience any facility decertifications. However, the Company did experience the increased regulatory scrutiny that has been exerted on the industry in the form of increased fines and penalties. MEDICARE REIMBURSEMENT CHANGES In 1999, the Company has continued to experience the impact of Medicare payment limitations imposed by the Health Care Finance Administration upon all providers of nursing home Medicare services, including implementation of a prospective payment system ("PPS"). The three-year phase-in of PPS began for all providers at some point during the year ending June 30, 1999. In general, PPS provides a standard payment for Medicare Part A services to all providers regardless of their current costs. PPS creates an incentive for providers to reduce their costs, and management has reduced operating expenses in 1999 in an effort to offset the revenue reductions resulting from PPS. 6 7 However, the Company's Medicare census has declined significantly as an indirect result of PPS and other reimbursement changes, which has resulted in a reduction in the amount of the Company's overhead absorbed by the Company's Medicare operations. Since PPS is still an evolving process, its ultimate impact cannot be known with certainty at this time. Cost restrictions placed on the provision of rehabilitation (ancillary) services have been significant. Beginning in January 1998, the allowable costs for cost reimbursement components of Medicare Part B services became subject to a limitation factor of 90.0% of actual cost. In 1999, the cost reimbursement system for rehabilitation services has been replaced by a system of fee screens that effectively limit reimbursement and place caps on the maximum fees that may be charged for therapy services. Historically, the Company subcontracted the provision of these therapy services. However, in response to the deep cuts in fees for service, the Company's therapy subcontractor exited the business. In June 1999, the Company began providing such services in house. The Company anticipates that this will further negatively impact operations, although the ultimate effect cannot yet be reasonably estimated. These changes with respect to Part B reimbursement have combined to cause a dramatic decrease in the Company's ancillary revenues and expenses. During 1997, the Federal government enacted the Balanced Budget Act of 1997 ("BBA"), which contains numerous Medicare and Medicaid cost-saving measures. The BBA requires that nursing homes transition to a prospective payment system ("PPS") under the Medicare program during a three-year "transition period," commencing with the first cost reporting period beginning on or after July 1, 1998. The BBA also contains certain measures that have and could lead to further future reductions in Medicare therapy reimbursement and Medicaid payment rates. To date, the major impact on the Company from PPS and other reimbursement changes has been systemic occupancy declines, which have reduced the amount of overhead absorbed under the Company's Medicare operations. These occupancy declines have resulted in part from the imposition of more conservative admission criteria and reductions in the average length of stay by patients. Both revenues and expenses have been reduced significantly from the levels prior to PPS. With respect to Medicare therapy allowable cost and fee reductions, the Company estimates that net operations was negatively impacted in both 1998 and 1999 and will continue to be negatively impacted beyond 1999 as a result of the changes brought about under BBA. These changes have affected the entire long-term care industry. They have resulted pursuant to the administrative implementation of the guidelines contained in the BBA. Under the BBA, Medicare expenditures by the Federal government have been cut approximately 20.0%. This has been a sudden, drastic blow to the industry. Other providers who relied more heavily on the provision of services to higher acuity patients have been impacted more severely than the Company. There have already been several major bankruptcy filings by nursing home companies. Without remediation, the long-term effect of the BBA on the industry is expected to be catastrophic. As the impact of these changes upon both providers and beneficiaries has become known, there has been growing 7 8 political awareness of a need to re-examine the drastic cuts that have been implemented. On November 29, 1999, President Clinton signed into law a budget agreement that restores over three years $2.7 billion in Medicare funding. The bill contains several components that become effective at various times over the three year period. As a result of the legislation, individual nursing facilities now have the option, for cost reporting years beginning after December 29, 1999, of continuing under the current PPS transition formula or adopting the full federal PPS per diem. In addition, the measure provides a two-year moratorium on the Part B therapy caps beginning January 1, 2000, and it also provides increases in the per diem rates for the care of certain groups of patients. The Company is continuing to evaluate the impact of the legislation on its operations. However, the ultimate impact on the Company's operations cannot be determined at this time. There are also ongoing discussions within Congress that may result in further legislative relief or the institution of administrative changes that would restore additional revenues to the U.S. nursing home industry. While such activity is positive, there is no expectation by management that the current round of legislative and administrative relief under consideration is sufficient to restore the economic viability that the industry needs. Current levels of or further reductions in government spending for long-term health care would continue to have an adverse effect on the operating results and cash flows of the Company. The Company will attempt to maximize the revenues available to it from governmental sources within the changes that have occurred and will continue to occur under the BBA. In addition, the Company will attempt to increase revenues from non-governmental sources, including expansion of its assisted living and Canadian operations to the extent capital is available to do so, if at all. BUSINESS. Advocat provides a broad range of long-term care services to the elderly including assisted living, skilled nursing and ancillary health care services. As of December 31, 1999, Advocat's portfolio includes 119 facilities composed of 65 nursing homes containing 7,307 licensed beds and 54 assisted living facilities containing 5,215 units. In comparison, at December 31, 1998, the Company operated 115 facilities composed of 63 nursing homes containing 7,182 licensed beds and 52 assisted living facilities containing 4,755 units. Within the current portfolio, 35 facilities are managed on behalf of other owners, 29 of which are on behalf of unrelated owners and six in which the Company holds a minority equity interest. The remaining facilities, consisting of 61 leased and 23 owned facilities, are operated for the Company's own account. In the United States, the Company operates 51 nursing homes and 33 assisted living facilities, and in Canada, the Company operates 14 nursing homes and 21 assisted living facilities. The Company's facilities provide a range of health care services to its residents. In addition to the nursing and social services usually provided in long-term care facilities, the Company offers a variety of rehabilitative, nutritional, respiratory, and other specialized ancillary services. As of December 31, 1999, the Company operates facilities in Alabama, Arkansas, Florida, Georgia, Kentucky, North Carolina, Ohio, South Carolina, Tennessee, Texas, Virginia, West Virginia, and the Canadian provinces of Ontario, British Columbia and Alberta. In January 2000, the Company began managing an assisted living facility in Nova Scotia in which it holds a minority equity interest. 8 9 The Company, in its role as owner, lessee, or manager, is responsible for the day-to-day operation of all operated facilities. These responsibilities include recruiting, hiring, and training all nursing and other personnel, and providing resident care, nutrition services, marketing, quality improvement, accounting, and data processing services for each facility. The lease agreements pertaining to the Company's 61 leased facilities are, in all but two cases, "triple net" leases, requiring the Company to maintain the premises, pay taxes and pay for all utilities. The leases typically provide for an initial term of 10 to 15 years with renewal options up to 10 years. The average remaining term of the Company's lease agreements, including renewal options, is approximately 14 years. As compensation for providing management services, the Company earns a management fee, which in 1999 averaged approximately 3.7% of the facilities' net patient revenues. Management fees with respect to four United States facilities were reduced in 1999 because of the failure to meet defined operational thresholds. Of the Company's 35 management agreements, 20 have more than five years remaining on their current terms, 12 have from one to three years remaining on their current terms and three have a current term expiring within one year, with an average remaining life of approximately five years for all contracts. INDUSTRY BACKGROUND. The long-term care industry encompasses a broad range of accommodations and health care and related services that are provided primarily to the elderly. As the need for assistance increases, the elderly can benefit from an assisted living facility, where nutritional, housekeeping and modest nursing or medical needs can be met. For those elderly in need of specialized support, rehabilitative, nutritional, respiratory or other treatments, nursing home health care is often required. The Company, through its assisted living facilities and nursing homes, is actively involved in the continuum of care and believes that it has, through its history of operating such facilities, developed the expertise required to serve the varied needs of its elderly residents. Since the enactment of the BBA in 1997, numerous changes affecting government funding levels of the nursing home industry have resulted. See "Item 1 - Material Corporate Developments - Medicare Reimbursement Changes." While the ultimate impact of the BBA is presently unknown, management believes there are a number of significant trends that will support the continued growth of the assisted living and nursing home segments of the long-term care industry, including: DEMOGRAPHIC TRENDS. The primary market for the Company's long-term health care services is comprised of persons aged 75 and older. This age group is one of the fastest growing segments of the United States population. According to United States Census Bureau information, this population segment will increase approximately 28.0% over the next 20 years. The population of seniors aged 85 and over is expected to increase approximately 68.0% over the next 20 years. As the number of persons aged 75 and over continues to grow, the Company believes that there will be corresponding increases in the number of persons who need skilled nursing care or who want to reside in an assisted living facility for assistance with activities of daily living. According to the United States General Accounting Office, there are approximately 6.5 million people aged 65 and older in the United States who needed assistance with daily activities, and the number of people needing such assistance is expected to double by the year 2020. 9 10 COST CONTAINMENT PRESSURES. In response to rapidly rising health care costs, governmental and other third-party payors have adopted cost-containment measures to reduce admissions and encourage reduced lengths of stays in hospitals and other acute care settings. The federal government had previously acted to curtail increases in health care costs under Medicare by limiting acute care hospital reimbursement for specific services to pre-established fixed amounts. Other third-party payors have begun to limit reimbursement for medical services in general to predetermined reasonable charges, and managed care organizations (such as health maintenance organizations) are attempting to limit hospitalization costs by negotiating for discounted rates for hospital and acute care services and by monitoring and reducing hospital use. In response, hospitals are discharging patients earlier and referring elderly patients, who may be too sick or frail to manage their lives without assistance, to nursing homes and assisted living facilities where the cost of providing care is typically lower than hospital care. In addition, third-party payors are increasingly becoming involved in determining the appropriate health care settings for their insureds or clients based primarily on cost and quality of care. INDUSTRY CONSOLIDATION. Although the long-term care market continues to be extremely fragmented, consolidations have occurred recently within the industry, driven in part by opportunities to leverage corporate overhead, expand into new markets or to enhance development pipelines through strategic acquisitions, with some companies attempting to achieve a critical mass and market concentration in order to provide leverage in dealing with managed-care companies that provide medical insurance for the elderly. Competitors of the Company desiring to provide more comprehensive care for the elderly are diversifying into home health care, rehabilitation, adult day care and assisted living services to provide the senior population with some measure of independence but with support for activities of daily living, often achieving this diversification through acquisitions of existing providers. LIMITED SUPPLY OF FACILITIES. Because of the aging of the population and limitations on the granting of Certificates of Need ("CONs") for new skilled nursing facilities, management believes that there will be a continuing demand for skilled nursing beds in the markets in which the Company competes. A majority of states in the United States have adopted CON or similar statutes generally requiring that, prior to the addition of new beds, the addition of new services, or the making of certain capital expenditures, a state agency must determine that a need exists for the new beds or the proposed activities. The Company believes that this CON process tends to restrict the supply and availability of licensed nursing facility beds. High construction costs, limitations on government reimbursement for the full costs of construction, and start-up expenses also act to constrain growth in the supply of such facilities. At the same time, nursing facility operators are continuing to focus on improving occupancy and expanding services to subacute patients requiring significantly higher levels of nursing care. As a result, the Company believes that there has been a decrease in the number of skilled nursing beds available to patients with lower acuity levels, as opposed to patients with physical or more acute disabilities, and that this trend should increase the demand for the Company's assisted living facilities. Management also believes there is currently a limited supply of assisted living units relative to the growing need for assisted living services in rural and secondary markets. Although states generally do not require CONs for assisted living facilities, some states may impose additional limitations on the supply of facilities. For example, North Carolina has imposed a moratorium on the addition of new beds unless the vacancy rate of the county is less than 15.0%. 10 11 REDUCED RELIANCE ON FAMILY CARE. Historically, the family has been the primary provider of care for seniors. Management of the Company believes that the increase in the percentage of women in the work force, the reduction of average family size, and the increased mobility in society will reduce the role of the family as the traditional care-giver for aging parents. Management believes that this trend will make it necessary for many seniors to look outside the family for assistance as they age. NURSING HOME AND ASSISTED LIVING FACILITY SERVICES. OPERATIONS. As of December 31, 1999, the Company operates 65 nursing homes with 7,307 licensed beds and 54 assisted living facilities with 5,215 units as set forth below:
United States Canada --------------------------- ---------------------------- Facilities Licensed Beds Facilities Licensed Beds ---------- ------------- ---------- ------------- Nursing Homes: Owned ........................ 5 562 2 144 Leased ....................... 36 4,007 0 0 Managed ...................... 10 867 12 1,727 ----- ----- ----- ----- Total ............... 51 5,436 14 1,871 ===== ===== ===== =====
Assisted Living Facilities(1): Facilities Units Facilities Units ---------- ------------- ---------- ------------- Owned ....................... 13 971 3 218 Leased ...................... 20 1,611 5 489 Joint Venture Managed ....... 0 0 6 865 Managed ..................... 0 0 7 1,061 ----- ----- ----- ----- Total .............. 33 2,582 21 2,633 ===== ===== ===== =====
(1) Facilities that provide both nursing care and assisted living services are counted as nursing homes although their units are classified as either nursing home beds or assisted living units. The Company operates three such facilities in the United States. For the year ended December 31, 1999, the Company's net patient and resident revenues were $178.9 million, or 98.2% of total net revenues. For the year ended December 31, 1999, the Company's net revenues from the provision of management services were $3.0 million, or 1.7% of the total net revenues. See Note 14 of the Company's Consolidated Financial Statements for more information on the Company's operating segments. NURSING HOME SERVICES. The nursing homes operated by the Company provide basic health care services, including room and board, nutrition services, recreational therapy, social services, housekeeping and laundry services and nursing services. In addition, the nursing homes dispense medications and otherwise follow care plans prescribed by the patients' physicians. In an effort to increase revenues by attracting patients with more complex health care needs, the Company also provides for the delivery of ancillary medical services at the nursing homes it operates. These specialty services include rehabilitation therapy services, such as speech pathology, audiology, and occupational, hospital-based respiratory, and physical therapies, which are provided through licensed 11 12 therapists and registered nurses, and the provision of medical supplies, nutritional support, infusion therapies, and related clinical services. The Company has historically contracted with third parties for a fee to assist in the provision of various ancillary services to the Company's patients. The Company owns an ancillary service supply business through which it provides medical supplies and enteral nutritional support services directly to patients. In 1998, the Company entered into a joint venture to provide institutional pharmacy services to certain of the Company's facilities as well as facilities owned by others. The Company continues to explore opportunities to broaden its ancillary services. The Company's nursing homes range in size from 48 to 247 licensed beds. ASSISTED LIVING FACILITY SERVICES. Services and accommodations at assisted living facilities include central dining facilities, recreational areas, social programs, housekeeping, laundry and maintenance service, emergency call systems, special features for handicapped persons and transportation to shopping and special events. The Company believes that assisted living services will continue to increase as an attractive alternative to nursing home care because a variety of supportive services and supervision can be obtained in a far more independent and less institutional setting. Generally, basic care and support services can be offered cheaper in an assisted living facility than either in a nursing home or through home health care assistance. On average, the Company provides 30 to 60 minutes of nursing care per resident per day in its Canadian assisted living facilities. The Company believes that the availability of health care services is an additional factor that makes assisted living an attractive alternative in Canada. The Company's assisted living facilities range in size from 12 to 323 units. OPERATING AND GROWTH STRATEGY. The Company's objective is to become the provider of choice of health care and related services to the elderly in the communities in which it operates. The Company intends to achieve this objective by seeking to: PROVIDE A BROAD RANGE OF COST-EFFECTIVE SERVICES. The Company's objective is to provide a variety of services in a broad continuum of care which will meet the ever changing needs of the elderly. The Company's expanded service offering currently includes assisted living, skilled nursing, comprehensive rehabilitation services and medical supply and nutritional support services. In addition, the Company is considering adding new services as appropriate including adult day care, medical equipment rental, and specialized recreational programs. By addressing varying levels of acuity, the Company is able to meet the needs of the elderly population it serves for a longer period of time and can establish a reputation as the provider of choice in a particular market. Furthermore, the Company believes it is able to deliver quality services cost-effectively, thereby expanding the elderly population base that can benefit from the Company's services, including those not otherwise able to afford private-pay assisted living services. FORM STRATEGIC ALLIANCES OR JOINT VENTURES WITH OTHER HEALTH CARE PROVIDERS. Through strategic alliances or joint ventures with other health care providers, the Company is able to offer additional services to its customers in a cost-effective, specialized manner. By entering into such agreements for services such as rehabilitation, the Company believes that it can continue to leverage the expertise of other providers in order to expand its continuum of care on a cost- 12 13 effective basis. In 1998, the Company entered into a joint venture to provide institutional pharmacy services with NCS HealthCare, a leading long-term care pharmacy services company. The Company expects to expand into other service areas as appropriate by establishing additional strategic alliances or joint ventures in the future. CLUSTER OPERATIONS ON A REGIONAL BASIS. The Company has developed regional concentrations of operations in order to achieve operating efficiencies, generate economies of scale and capitalize on marketing opportunities created by having multiple operations in a regional market area. Key elements of the Company's growth strategy are to: INCREASE REVENUES AND PROFITABILITY AT EXISTING FACILITIES. The Company's strategy includes increasing facility revenues and profitability levels through increasing occupancy levels and containing costs. The Company directs its marketing efforts locally in order to promote higher occupancy levels and improved payor and case mixes at its nursing homes and assisted living facilities. EMPHASIZE DEVELOPMENT JOINT VENTURES IN CANADA. During 1999 and 1998, the Company entered into five Canadian joint ventures, each of which has developed a new assisted living facility. The Company has a minority equity interest in each development and has received a long-term contract to manage each facility. Four of these facilities opened during 1999 and the fifth began operations in January 2000. MAKE SELECTIVE ACQUISITIONS. The Company's senior management will continue to evaluate selected acquisitions primarily through the lease of additional assisted living facilities, concentrating on rural and secondary markets in the southeast United States and Canada. Management believes that such markets are often under served by long-term care facilities and offer lower labor costs. The Company's goal is to use its expertise in operating long-term care facilities to increase the occupancy rates and lower the costs of these acquired facilities. In addition, where market conditions permit, the Company intends to expand the operations of acquired facilities by offering more services, in an effort to increase their profitability. PURSUE ADDITIONAL OPPORTUNITIES FOR MANAGEMENT AGREEMENTS. Management believes that the Company can attract additional management agreements in Canada. Further, it is management's belief that the Company is a recognized provider of quality care in Canada and has established financial and operational control systems, extensive reimbursement expertise, and access to purchasing economies. The Company has the ability to provide an array of services ranging from total operational management for passive investors in nursing homes and assisted living facilities to the provision of unbundled consulting services. In certain cases, the Company has the opportunity to share in the profits of a managed facility and/or has a right of first refusal or an option to purchase the managed facility. The Company has established a task force to address the continuing impact of the BBA. The task force will evaluate changes in the funding environment for long-term care as these changes become known. The Company will attempt to maximize the revenues available to it from governmental sources within the changes that occur under the BBA. 13 14 MARKETING. At a local level, the Company's sales and marketing efforts are designed to promote higher occupancy levels and optimal payor mix. Management believes that the long-term care industry is fundamentally a local industry in which both patients and residents and the referral sources for them are based in the immediate geographic area in which the facility is located. The Company's marketing plan emphasizes the role and performance of the administrator and social services director of each nursing home and the administrator of each assisted living facility, all of whom are responsible for contacting various referral sources such as doctors, hospitals, hospital discharge planners, churches, and various community organizations. Administrators are evaluated based on their ability to meet specific goals and performance standards that are tied to compensation incentives. The Company's regional managers and corporate staff assist local marketing personnel and administrators in establishing relationships and follow-up procedures with such referral sources. In addition to soliciting admissions from these sources, management emphasizes involvement in community affairs in order to promote a public awareness of the Company's nursing homes and assisted living facilities and their services. The Company also promotes effective customer relations and seeks feedback through family and employee surveys. The Company has an internally-developed marketing program that focuses on the identification and provision of services needed by the community. The program assists each facility administrator in analysis of local demographics and competition with a view toward complementary service development. The Company believes that the primary referral area in the long-term care industry generally lies within a five-to-fifteen-mile radius of each facility depending on population density; consequently, local marketing efforts are more beneficial than broad-based advertising techniques. DESCRIPTION OF MANAGEMENT SERVICES AND AGREEMENTS. Of the Company's 119 facilities, 35 are operated as managed facilities, where the Company's responsibilities include recruiting, hiring and training all nursing and other personnel, and providing quality assurance, resident care, nutrition services, marketing, accounting and data processing services. Services performed at the corporate level include group contract purchasing, employee training and development, quality assurance oversight, human resource management, assistance in obtaining third-party reimbursement, financial and accounting functions, policy and procedure development, system design and development and marketing support. The Company's financial reporting system monitors certain key data for each managed facility, such as payroll, admissions and discharges, cash collections, net patient care revenues, rental revenues, staffing trend analysis and measurement of operational data on a per patient basis. The Company's management fee is subordinated to debt payments at 17 facilities. The Company has the potential to earn incentive management fees over its base management fees at 26 facilities and is obligated to provide cash flow support at eight facilities. The Company receives a base management fee for the management of long-term care facilities ranging generally from 3.5% to 6.0% of the net revenues of each facility. Total management fees as a percentage of revenues were 3.9% in 1999. Management fees with respect to four United States facilities were reduced in 1999 because of the failure to meet defined operational thresholds. Other than certain corporate and regional overhead costs, the services provided at the facility are the facility owner's expense. The facility owner also is obligated to pay for all required capital expenditures. The Company generally is not required to advance funds to the owner. However, with respect to one management agreement covering two 14 15 facilities, the Company has advanced approximately $929,000; this advance carries 8.0% interest and is being repaid over the remaining life of the management agreement through December 2005. Additionally, the Company guarantees the cash flow of a second limited partnership that the Company manages. See Notes 6 and 16 of the Company's Consolidated Financial Statements for more information on these advances. In years prior to 1999, the Company has had several contracts to manage facilities during Canadian receivership or insolvency proceedings. Although these contracts are generally month-to-month, it has been the Company's experience that the duration of a receivership or insolvency management appointment typically ranges from six to twenty-four months. The number of such management appointments fluctuates as troubled facilities are added or are removed due to the disposition of the property by the receiver or owner. Such management contracts are generally for a base fee with no profit participation, no subordination to debt, no purchase options and no guarantees of debt. Based upon the initial term and any renewal terms over which the Company holds the option, the remaining Company's management contracts expire in the following years:
Number of Facilities 1999 -------------------------- Management Year U.S. Canada Fees ---- -------- --------- --------- 2000 ................... 0 3 264,000 2001 ................... 6(1) 1 48,000(1) 2002 ................... 0 3 293,000 2003 ................... 0 2 82,000 2004 ................... 0 14 1,423,000 2005 ................... 0 2 551,000 2015 ................... 4(2) 0 154,000 ----- --------- Total ......... 10 25 ===== =========
- ---------- (1) The operations of the six facilities of Texas Diversicare Limited Partnership ("TDLP") are included in the Company's consolidated operations. Accordingly, no management fees are recognized with respect to TDLP. See Note 6 of the Company's Consolidated Financial Statements for more information with respect to the Company's relationship with TDLP. (2) The management fees with respect to these facilities are subject to reduction because of the failure to meet defined operational thresholds. The Company's 1999 management fees were reduced $618,000 due to the operational results of these facilities. The Company currently anticipates that most of the management agreements coming due for renewal in 2000 will be renewed. However, there can be no assurance that any of these agreements will be renewed. 15 16 The following table summarizes the Company's net revenues derived from management services and the net revenues of the managed facilities during the years indicated (in thousands):
Year Ended December 31, ---------------------------------------------------------------- 1999 1998 1997 ------------- ------------- ------------- Management Fees $ 2,932 $ 3,627 $ 3,886 ============= ============= ============= Net Revenues of Managed Facilities $ 75,675 $ 71,670 $ 75,043 ============= ============= ============= Management Fees as a Percentage of Net Facility Revenues 3.9%(1) 5.1% 5.2% ============= ============= =============
- --------------- (1) In 1999, management fees were reduced due to the failure of four facilities to reach certain operational thresholds. Had these revenues been earned, the 1999 percentage would have been 4.5%. DESCRIPTION OF LEASE AGREEMENTS. The Company leases 61 nursing homes and assisted living facilities, including 30 owned by Omega, 11 owned by Counsel Corporation ("Counsel") (which owned or controlled the Company's predecessor operations), 13 owned by members or affiliates of Pierce and seven owned by others, three of which were added in 1999. All but two of the Company's leases are "triple-net," requiring the Company to maintain the premises, pay taxes, and pay for all utilities. The Company typically grants its lessor a security interest in the Company's personal property located at each leased facility to secure the Company's performance under the lease. The leases contain customary default and covenant provisions, generally requiring the Company to maintain a minimum net worth, expend specified sums per bed for capital expenditures, maintain certain financial and coverage ratios and prohibit the Company from operating any additional facilities within a certain radius of each leased facility. In addition, the Company is generally required to maintain comprehensive insurance covering the facilities it leases as well as personal and real property damage insurance and professional malpractice insurance. In all cases where mortgage indebtedness exists with respect to a leased facility, the Company's interest in the premises is subordinated to that of the lessor's mortgage lenders. OMEGA LEASES. The Company has a master lease with Omega Healthcare Investors Inc. ("Omega") covering 21 facilities (the "Master Lease"), which provides for an initial term of ten years through August 2002 and allows the Company one ten-year renewal option. The Master Lease provides for annual increases in the rent based upon inflation or a percentage of the increase in the net revenues of the facilities, whichever results in the greater increase in rent, up to a maximum increase equal to 5.0% of the prior year's rent. The Company entered into a series of agreements with Omega in 1994 that ultimately resulted in the Company leasing a total of nine additional facilities (the "1994 Omega Leases"). The 1994 Omega Leases provide for an initial term of ten and one-half years expiring in May 2005 and allow the Company two five-year renewal options. The rent with respect to these facilities is subject to increases under a formula similar to that of the Master Lease up to a maximum increase of 16 17 3.9% of the prior year's rent. During the year ended December 31, 1999, the patient and resident revenues from the Omega leased facilities were $69.6 million. A default with respect to any one facility would constitute a default with respect to all the facilities covered by the Master Lease or the 1994 Omega Leases, as applicable. The Company is currently not in compliance with the financial covenants applicable to the Master Lease and the 1994 Omega Leases. Under the agreements, Omega has the right to terminate the agreements and seek recovery of any related financial losses as well as other miscellaneous remedies. To date, Omega has not asserted any of its rights arising from the non-compliance. The Company is currently negotiating amendments to its agreements with Omega. COUNSEL LEASES. The Company leases five facilities from Counsel with a remaining term of approximately four years through April 2004. The Company leases three additional facilities from Counsel with an initial term of ten years through April 2004 and one ten-year renewal option. With respect to these eight facilities, the Company has the right of first refusal and a purchase option at the end of the respective lease terms. Additionally, the rent is fixed throughout the current terms. The Company leases three additional facilities from Counsel with a lease term through August 2002. These facilities are subject to a participating mortgage from Counsel in favor of Omega. At the end of the lease term, the Company has the right to purchase these facilities. In addition, the Company can require Counsel to transfer these facilities to Omega, at which time the Company has the right to lease these facilities from Omega in accordance with the terms of the Master Lease. Rent increases with respect to these three facilities are calculated under the same terms as applicable in the Omega Master Lease. During the year ended December 31, 1999, the patient and resident revenues from the Counsel leased facilities were $17.0 million. The Counsel leases provide that a default under any one of the leases constitutes a default under all of the leases. PIERCE LEASES. Effective October 1, 1997, the Company acquired leases with respect to 14 facilities from Pierce Management Group ("Pierce"). Of these leases, 12 are with the former principal owners of Pierce and have an initial term of 15 years and two five-year renewal options. Beginning at the third anniversary, annual rent increases are to be applied equal to the rate of inflation up to a maximum of 3.0%. Beginning at the fifth anniversary, the Company has a right to purchase all 12 facilities as a group for their fair market value. An additional lease, which expires in 2003, is with an affiliate of Pierce who is a current employee of the Company. The remaining lease is a sublease that expires in 2017. The Company has no purchase option with respect to either the 2003 lease or the sublease. During the period ended December 31, 1999, the resident revenues from the Pierce leased facilities were $14.1 million. 17 18 FACILITIES. The following table summarizes certain information with respect to the nursing homes and assisted living facilities owned, leased and managed by the Company as of December 31, 1999:
Assisted Living Nursing Homes Facilities -------------------------- ------------------------ Number Licensed Beds Number(1) Units ----- ------------- --------- ----- OPERATING LOCATIONS: Alabama .................. 6 711 -0- 52 Arkansas ................. 13 1,411 2 24 Florida .................. 8 800 -0- -0- Georgia .................. -0- -0- 1 52 Kentucky ................. 6 474 -0- 4 North Carolina ........... -0- -0- 28 2,241 Ohio ..................... 1 151 -0- -0- South Carolina ........... -0- -0- 1 99 Tennessee ................ 5 617 -0- -0- Texas .................... 10 1,092 -0- -0- Virginia ................. -0- -0- 1 110 West Virginia ............ 2 180 -0- -0- Ontario .................. 14 1,871 15 1,775 British Columbia ......... -0- -0- 5 688 Alberta .................. -0- -0- 1 170 ----- ----- ----- ----- 65 7,307 54 5,215 ===== ===== ===== ===== CLASSIFICATION: Owned .................... 7 706 16 1,216 Leased ................... 36 4,007 25 2,073 Joint Venture Managed .... -0- -0- 6 865 Managed .................. 22 2,594 7 1,061 ----- ----- ----- ----- Total ........... 65 7,307 54 5,215 ===== ===== ===== =====
- ---------- (1) Facilities that provide both nursing care and assisted living services are counted as nursing homes. The Company operates two such facilities in Alabama and one in Kentucky. 18 19 ORGANIZATION. The Company's long-term care facilities are currently organized into nine regions, seven in the United States and two in Canada, each of which is supervised by a regional vice president or manager. The regional vice president or manager is supported by nursing and human resource personnel, education coordinators and clerical personnel, all of whom are employed by the Company. The day-to-day operations of each owned, leased or managed nursing home is supervised by an on-site, licensed administrator. The administrator of each nursing home is supported by other professional personnel, including a medical director, who assists in the medical management of the facility, and a director of nursing, who supervises a staff of registered nurses, licensed practical nurses, and nurses aides. Other personnel include dietary staff, activities and social service staff, housekeeping, laundry and maintenance staff, and a business office staff. Each assisted living facility owned, leased or managed by the Company is supervised by an on-site administrator, who is supported by a director of resident care, a director of food services, a director of maintenance, an activities coordinator, dietary staff and housekeeping, laundry and maintenance staff. With respect to the managed facilities, the majority of the administrators are employed by the Company, and the Company is reimbursed for their salaries and benefits by the respective facilities. All other personnel at managed facilities are employed and paid by the owner of the nursing home or assisted living facility, not by the Company. All personnel at the leased or owned facilities, including the administrators, are employed by the Company. The Company has in place a Continuous Quality Improvement ("CQI") program, which is focused on training direct care givers. The Company conducts monthly audits to monitor adherence to the standards of care established by the CQI program at each facility which it owns, leases or manages. The facility administrator, with assistance from regional nursing personnel, is primarily responsible for adherence to the Company's quality improvement standards. In that regard, the annual operational objectives established by each facility administrator include specific objectives with respect to quality of care. Performance of these objectives is evaluated quarterly by the regional vice president or manager, and each facility administrator's incentive compensation is based, in part, on the achievement of the specified quality objectives. Issues regarding quality of care and resident care outcomes are addressed monthly by senior management. The Company also has established a quality improvement committee consisting of nursing representatives from each region. This committee periodically reviews the Company's quality improvement programs and, if so directed, conducts facility audits as required by the Company's executive committee. The Company and its predecessor have operated a medical advisory committee in Ontario for more than 13 years and has developed similar committees in some of the other jurisdictions in which it operates. It is the Company's view that these committees provide a vehicle for ensuring greater physician involvement in the operations of each facility with resulting improved focus on CQI and resident care plans. In addition, the Company has provided membership for all of its medical directors in the American Medical Directors Association. All of the nursing homes operated by the Company in Ontario have been accredited by the Canadian Council on Health Facilities Accreditation. The CQI program used at all locations was designed to meet accreditation standards and to exceed state and federal government regulations. 19 20 COMPETITION. The long-term care business is highly competitive. The Company faces direct competition for additional facilities and management agreements, and the facilities operated by the Company face competition for employees, patients, and residents. The Company plans to expand its business through the acquisition of additional leased long-term care facilities and through additional management agreements. The Company competes with a variety of other companies to acquire such facilities and to provide contract management services. Some of the Company's present and potential competitors for acquisitions and management agreements are significantly larger and have or may obtain greater financial and marketing resources. Competing companies may offer new or more modern facilities or new or different services that may be more attractive to patients, residents or facility owners than the services offered by the Company. The nursing homes and assisted living facilities that the Company operates compete with other facilities in their respective markets, including rehabilitation hospitals, other "skilled" or "intermediate" nursing homes and personal care residential facilities. In the few urban markets in which the Company operates, some of the long-term care providers with which the Company's operated facilities compete are significantly larger and have or may obtain greater financial and marketing resources than the Company's operated facilities. Some of these providers are not-for-profit organizations with access to sources of funds not available to the facilities operated by the Company. Construction of new long-term care facilities near the Company's existing operated facilities could adversely affect the Company's business. Management believes that the most important competitive factors in the long-term care business are: a facility's local reputation with referral sources, such as acute care hospitals, physicians, religious groups, other community organizations, managed care organizations, and a patient's family and friends; physical plant condition; the ability to identify and meet particular care needs in the community; the availability of qualified personnel to provide the requisite care; and the rates charged for services. There is limited, if any, price competition with respect to Medicaid and Medicare patients, since revenues for services to such patients are strictly controlled and are based on fixed rates and cost reimbursement principles. Although the degree of success with which the Company's operated facilities compete varies from location to location, management believes that its operated facilities generally compete effectively with respect to these factors. GOVERNMENT REGULATION AND REIMBURSEMENT. The Company's facilities are subject to compliance with numerous federal, state and local health care statutes and regulations. All nursing homes must be licensed by the states in which they operate and must meet the certification requirements of government-sponsored health insurance programs such as Medicare and Medicaid, in order to receive reimbursement from these programs. The Company's assisted living facilities in North Carolina are subject to similar state and local licensing requirements. REIMBURSEMENT. A significant portion of the Company's revenues is derived from government-sponsored health insurance programs. The nursing homes operated by the Company derive revenues under Medicaid, Medicare, the Ontario Government Operating Subsidy program and private pay sources. The United States assisted living facilities located in North Carolina derive revenues from Medicaid and similar programs as well as from private pay sources. Assisted living facilities in Canada derive virtually 20 21 all of their revenues from private pay sources. The Company employs specialists in reimbursement at the corporate level to monitor regulatory developments, to comply with all reporting requirements, and to maximize payments to its operated nursing homes. It is generally recognized that all government-funded programs have been and will continue to be under cost containment pressures, but the extent to which these pressures will affect the Company's future operations is unclear. MEDICARE AND MEDICAID. Medicare is a federally-funded and administered health insurance program for the aged and for certain chronically disabled individuals. Part A of the Medicare program covers inpatient hospital services and certain services furnished by other institutional providers such as skilled nursing facilities. Part B covers the services of doctors, suppliers of medical items, various types of outpatient services, and certain ancillary services of the type provided by long term and acute care facilities. Medicare payments under Part A and Part B are subject to certain caps and limitations, as provided in Medicare regulations. Medicare benefits are not available for intermediate and custodial levels of nursing home care, nor for a stay in an assisted living facility. Medicaid is a medical assistance program for the indigent, operated by individual states with financial participation by the federal government. Criteria for medical indigence vary somewhat from state to state, subject to federal guidelines. Available Medicaid benefits and rates of payment vary somewhat from state to state, subject to certain federal requirements. Basic long-term care services are provided to Medicaid beneficiaries, including nursing, dietary, housekeeping and laundry and restorative health care services, room and board, and medications. Previously, under legislation known as the Boren Amendment, federal law required that Medicaid programs pay to nursing home providers amounts adequate to enable them to meet government quality and safety standards. However, the Balanced Budget Act signed into law by President Clinton on August 5, 1997 (the "BBA"), repealed the Boren Amendment, and the BBA requires only that, for services and items furnished on or after October 1, 1997, a state Medicaid program must provide for a public process for determination of Medicaid rates of payment for nursing facility services. Under this process, proposed rates, the methodologies underlying the establishment of such rates and the justification for the proposed rates are published. This public process gives providers, beneficiaries and concerned state residents a reasonable opportunity for review and comment. At least four of the eight states in which the Company now operates are actively seeking ways to reduce Medicaid spending for nursing home care by such methods as capitated payments and substantial reductions in reimbursement rates. The BBA also requires that nursing homes transition to a prospective payment system ("PPS") under the Medicare program during a three-year transition period that began with the first cost reporting period beginning on or after July 1, 1998, and creates a managed care Medicare program called "Medicare + Choice." Medicare + Choice allows beneficiaries to participate either in the original Medicare fee-for-service program or to enroll in a managed care plan such as a health maintenance organization ("HMO"). Such managed care plans would allow the HMOs to enter into risk-based contracts with the Medicare program, and the Medicare HMOs could then contract with providers such as the Company for the provision of nursing home services. No assurance can be given that the Company's facilities will be successful in negotiating favorable contracts with Medicare HMOs. 21 22 Management estimates that the ultimate impact of PPS on Company revenues will be a reduction of $16.0 to $17.0 million per year. The Company's Medicare census has declined significantly as an indirect result of PPS and other reimbursement changes, which has resulted in a reduction in the amount of the Company's overhead absorbed by the Company's Medicare operations. Since PPS is still an evolving process, its ultimate impact cannot be known with certainty at this time. Reduction in health care spending has become a national priority in the United States, and the field of health care regulation and reimbursement is a rapidly evolving one. For the fiscal year ended December 31, 1999, the Company derived 14.2% and 66.3% of its total patient and resident revenues from the Medicare and Medicaid programs, respectively. Any health care reforms that significantly limit rates of reimbursement under these programs could, therefore, have a material adverse effect on the Company's profitability. The Company is unable to predict which reform proposals or reimbursement limitations will be adopted in the future or the effect such changes would have on its operations. In addition, private payors, including managed care payors, are increasingly demanding that providers accept discounted fees or assume all or a portion of the financial risk for the delivery of health care services. Such measures may include capitated payments, which can result in significant losses to health care providers if patients require expensive treatment not adequately covered by the capitated rate. ONTARIO GOVERNMENT OPERATING SUBSIDY PROGRAM. The Ontario Government Operating Subsidy program ("OGOS") regulates both the total charges allowed to be levied by a licensed nursing home and the maximum amount that the OGOS program will pay on behalf of nursing home residents. The maximum amounts that can be charged to residents for ward, semi-private and private accommodation are established each year by the Ontario Ministry of Health. Regardless of actual accommodation, at least 40% of the beds in each home must be filled at the ward rate. Generally, amounts received from residents should be sufficient to cover the accommodation costs of a nursing home, including food, laundry, housekeeping, property costs and administration. In addition, the Ontario government partially subsidizes each individual, and funds each nursing home for the approximate care requirements of its residents. This funding is based upon an annual assessment of the levels of care required in each home, from which "caps" are determined and funding provided on a retrospective basis. The Ontario government funds from 35.0% to 70.0% of a resident's charges, depending on the individual resident's income and type of accommodation. The Company receives payment directly from OGOS by virtue of its ownership of two nursing homes in Canada. Additionally, the Company earns management fees from Canadian nursing homes, which derive significant portions of their revenues from OGOS. SELF-REFERRAL AND ANTI-KICKBACK LEGISLATION. The health care industry is subject to state and federal laws which regulate the relationships of providers of health care services, physicians, and other clinicians. These laws impose restrictions on physician referrals to any entity with which they have a financial relationship. The Company believes that it is in compliance with these laws. Failure to comply with self-referral laws could subject the Company to a range of sanctions, including civil fines, possible exclusion from government reimbursement programs, and criminal prosecution. There are also federal and state laws making it illegal to offer anyone anything of value in return for referral of patients. These laws, generally known as "anti-kickback" laws, are broad and subject to varying interpretations. Given the lack 22 23 of clarity of these laws, there can be no absolute assurance that any health care provider, including the Company, will not be found in violation of the anti-kickback laws in any given factual situation. Strict sanctions, including exclusion from the Medicare and Medicaid programs and criminal penalties, may be imposed for violation of the anti-kickback laws. COMPLIANCE PROGRAM. During 1999, the Company instituted a formal compliance program. The program exists to promote a high standard of ethics and to promote adherence to a number of policies intended to avoid potential fraud and abuse. A corporate compliance officer oversees the program, which requires that he submit a formal report to the chief executive officer annually. LICENSURE AND CERTIFICATION. All the Company's nursing homes must be licensed by the state in which they are located in order to accept patients, regardless of payor source. In most states, nursing homes are subject to certificate of need laws, which require the Company to obtain government approval for the construction of new nursing homes or the addition of new licensed beds to existing homes. The Company's nursing homes must comply with detailed statutory and regulatory requirements in order to qualify for licensure, as well as for certification as a provider eligible to receive payments from the Medicare and Medicaid programs. Generally, the requirements for licensure and Medicare/Medicaid certification are similar and relate to quality and adequacy of personnel, quality of medical care, record keeping, dietary services, resident rights, and the physical condition of the facility and the adequacy of the equipment used therein. Each facility is subject to periodic inspections, known as "surveys" by health care regulators, to determine compliance with all applicable licensure and certification standards. If the survey concludes that there are deficiencies in compliance, the facility is subject to various sanctions, including but not limited to monetary fines and penalties, suspension of new admissions, and loss of licensure or certification. Generally, however, once a facility receives written notice of any compliance deficiencies, it submits a written plan of correction and is given a reasonable opportunity to correct the deficiencies. However, one of the Company's facilities in Arkansas was decertified from the Medicaid and Medicare programs in 1998. Although the facility was recertified for participation in the Medicaid program within 30 days without significant adverse financial impact, it has not yet been recertified to participate in Medicare and is not currently accepting Medicare patients. However, the Company is actively engaged in the application process for recertification. A second facility, located in Florida, was subject to a government-imposed moratorium on admissions and civil monetary penalties during the last quarter of 1998. The Company is appealing the civil monetary penalties and has taken aggressive action, including increasing its staffing, to correct the deficiencies on which the moratorium was based. The moratorium was lifted at the end of January 1999. See "Item 1 - Material Corporate Developments Health Care Industry." Privately owned nursing homes in Ontario are licensed by the Ministry of Health under the Ontario Nursing Homes Act. The legislation, together with program manuals, establishes the minimum standards that are required to be provided to the patients of the home, including staffing, space, nutrition and activities. Patients can only be admitted and subsidized if they require at least 1.5 hours per day of care, as determined by a physician. Retirement centers in Canada are generally regulated at the municipal government level in the areas of fire safety and public health and at the provincial level in the areas of employee safety, pay equity, and, in Ontario, rent control. Licensure and regulation of assisted living facilities varies considerably from state to state, although the trend is toward increased regulation in the United States. In North Carolina, the Company's facilities must pass annual surveys, and the state has established base-level requirements that must be maintained. 23 24 Such requirements include or relate to staffing ratios, space, food service, activities, sanitation, proper medical oversight, fire safety, resident assessments and employee training programs. In Canada, assisted living facilities are generally not required to be licensed and are subject to only minor regulations. PAYOR SOURCES. The Company classifies its revenues from patients and residents into three major categories: Medicaid, Medicare and private pay. In addition to traditional Medicaid revenues, the Company includes within the Medicaid classification revenues from other programs established to provide benefits to those in need of financial assistance in the securing of medical services. Examples include the OGOS and North Carolina state and county special assistance programs. Medicare revenues include revenues received under both Part A and Part B of the Medicare program. The Company classifies payments from individuals who pay directly for services without government assistance as private pay revenue. The private pay classification also includes revenues from commercial insurers, HMOs, and other charge-based payment sources. Veterans Administration payments are included in private pay and are made pursuant to renewable contracts negotiated with these payors. The following table sets forth net patient and resident revenues by payor source for the Company for the years presented:
Year ended December 31, ---------------------------------------------------------------------------------------- (Dollars in thousands) 1999 1998 1997 -------------------- --------------------- --------------------- Medicaid (1) ....... $118,571 66.3% $118,394 58.8% $ 99,396 55.8% Medicare ........... 25,461 14.2 44,490 22.1 44,974 25.2 Private Pay (1) .... 34,895 19.5 38,449 19.1 33,829 19.0 -------- -------- -------- -------- -------- -------- Total ....... $178,927 100.0% $201,333 100.0% $178,199 100.0% ======== ======== ======== ======== ======== ========
- ---------- (1) Includes assisted living facility revenues. The mix of Medicaid, Medicare and private pay for nursing homes in 1999 was 70.0%, 16.9%, and 13.1%, respectively. Patient and residential service is generally provided and charged in daily service units, commonly referred to as patient and resident days. The following table sets forth patient and resident days by payor source for the Company for the years presented:
Year ended December 31, ---------------------------------------------------------------------------------------- 1999 1998 1997 -------------------- --------------------- --------------------- Medicaid (1) ....... 1,708,335 71.7% 1,747,844 72.1% 1,345,010 67.5% Medicare ........... 82,571 3.5 110,178 4.5 120,583 6.1 Private Pay (1) .... 592,134 24.8 566,834 23.4 525,016 26.4 --------- -------- --------- -------- --------- -------- Total ....... 2,383,040 100.0% 2,424,856 100.0% 1,990,609 100.0% ========= ======== ========= ======== ========= ========
- ---------- (1) Includes assisted living facility days. The mix of Medicaid, Medicare and private pay for nursing homes in 1999 was 78.5%, 5.78%, and 15.8%, respectively. The above tables include net patient revenues and the patient days of the six facilities comprising TDLP. See Note 6 of the Company's Consolidated Financial Statements. 24 25 Consistent with the nursing home industry in general, changes in the mix of a facility's patient population among Medicaid, Medicare, and private pay can significantly affect the profitability of the facility's operations. For information about revenue, operating income (loss) and identifiable assets attributable to the Company's United States and Canadian operations, see Note 14 of the Company's Consolidated Financial Statements. SUPPLIES AND EQUIPMENT. The Company purchases drugs, solutions and other materials and leases certain equipment required in connection with the Company's business from many suppliers. The Company has not experienced, and management does not anticipate that the Company will experience, any significant difficulty in purchasing supplies or leasing equipment from current suppliers. In the event that such suppliers are unable or fail to sell supplies or lease equipment to the Company, management believes that other suppliers are available to adequately meet the Company's needs at comparable prices. National purchasing contracts are in place for all major supplies, such as food, linens, and medical supplies. These contracts assist in maintaining quality, consistency and efficient pricing. INSURANCE. The entire United States long-term care industry has seen a dramatic increase in personal injury/wrongful death claims based on alleged negligence by nursing homes and their employees in providing care to patients and residents. As a result, the Company has numerous liability claims and disputes outstanding for professional liability and other related issues. Professional liability insurance up to certain limits is carried by the Company and its subsidiaries for coverage of such claims. However, due to the increasing number of claims against the Company and throughout the long-term care industry, the Company's professional liability insurance premiums and deductible amounts have increased substantially during 1998 and 1999. Additional increases in premiums and deductibles will also occur for the policy year 2000. All of the Company's professional liability policies are currently on a claims made basis and are renewable annually. Prior to March 9, 2000, all of these policies were on an occurrence basis. The Company currently maintains general and professional liability insurance with coverage limits of $1,000,000 per medical incident, aggregate coverage limits of $3,000,000 per location and total aggregate policy coverage limits of $12,000,000 for its long-term care services. Through December 31, 1997, with respect to a majority of its United States nursing homes, the Company was self-insured for the first $25,000 per occurrence and $500,000 in the aggregate. Effective January 1, 1998, the Company substantially increased the self-insurance portion of its liability with respect to its United States nursing home operations up to $250,000 per occurrence and $2,500,000 in the aggregate per year. Effective February 1, 1999, all United States nursing homes became part of the $250,000/$2,500,000 deductible program, including the six TDLP facilities. For 1999 and 1998, the Company expects to ultimately fully incur the aggregate deductible amount. A reserve has been established in anticipation of the settlement of the 1999 and 1998 claims, which may take up to four years from the date of the injury event to reach final settlement. 25 26 Effective March 9, 2000, the self-insured per claim amount for all United States nursing homes increased to $500,000 per claim with no aggregate limit. The Company also maintains umbrella liability coverage of $15,000,000 per occurrence for all United States facilities. The assisted living operations acquired in the Pierce transaction are self-insured, with respect to each location, for the first $5,000 per occurrence and $25,000 in the aggregate. The Company also maintains a $10,000,000 aggregate umbrella liability policy for claims in excess of the foregoing limits for these assisted living operations. The Canadian facilities owned or leased by the Company maintain general and professional liability insurance with per claim coverage limits of up to $3,462,000 ($5,000,000 Canadian). The Company also maintains an aggregate umbrella policy for claims in excess of the above limit for these facilities. The ultimate results of the Company's professional liability claims and disputes are unknown at the present time. However, management is currently of the opinion that there would be no material amounts in excess of liability coverage and established reserves. The Company utilizes risk management consultants in the evaluation of its insurance programs, and management believes its current insurance coverage level is consistent with industry standards and is appropriate for the risk environment. The Company has established reserves that management believes are adequate to cover the self-insured risks of its insurance programs. There can be no assurance that the Company's insurance and reserves will be sufficient to cover any judgements, settlements or costs relating to any pending or future claims or legal proceedings (including any related judgements, settlements or costs) or that any such insurance will be available to the Company in the future on satisfactory terms, if at all. If the insurance and reserves carried by the Company are not sufficient to cover any judgements, settlements or costs relating to pending or future claims or legal proceedings, the Company's business and financial condition could be materially adversely affected. EMPLOYEES. As of February 15, 2000, the Company employed a total of approximately 5,150 individuals. Management believes that the Company's employee relations are good. Approximately 190 of the Company's United States employees are represented by a labor union and approximately 320 of the Company's Canadian employees are represented by various unions. With the exception of some administrators of managed facilities (whose salaries are reimbursed by the owners), the staff of the managed nursing homes and assisted living facilities are not employees of the Company. The Company's managed facilities employ approximately 3,160 individuals, approximately 2,130 of whom are Canadians represented by various unions. A major component of the Company's CQI program includes an employee empowerment selection, retention and recognition program. Administrators and managers of the Company include employee retention and turnover goals in the annual facility, regional and personal objectives. Although the Company believes it is able to employ sufficient nurses and therapists to provide its services, a shortage of health care professional personnel in any of the geographic areas in which the Company operates could affect the ability of the Company to recruit and retain qualified employees and could increase its operating costs. The Company competes with other health care providers for both professional and non-professional employees and with non-health care providers for non-professional employees. During 1999, the Company faced increased competition for workers due to tight labor markets in most of the areas in which the Company operates in the United States. 26 27 RISK FACTORS. This section summarizes certain risks, among others, that should be considered by stockholders and prospective investors in the Company. NON-COMPLIANCE WITH DEBT INSTRUMENTS AND LEASE AGREEMENTS. At December 31, 1999, the Company is in default of certain financial covenants under certain of its loan and lease agreements. Cross-default or material adverse change provisions contained in the agreements allow the holders of substantially all of the Company's debt and leases to demand immediate repayment or termination of the lease. The Company has not obtained waivers with respect to such defaults. As of December 31, 1999, the Company's total indebtedness was $60,925,000. The Company is currently in discussions with its senior bank lenders and its primary landlord with respect to their response to the foregoing. There can be no assurance that the bank lenders will not call the loans in default and demand the full repayment of the loans or that the landlords will not terminate one or more leases. If the credit agreements are called, the Company does not have sufficient assets to repay the entire outstanding balance under the credit agreements. In addition, the defaults under the credit and lease agreements may impair the Company's ability to finance, through its own cash flow or from additional financing, its future operations or pursue its business strategy and could make the Company more vulnerable to economic downturns, competitive and payor pricing pressures and adverse changes in government regulation. There can be no assurance that future cash flow from operations will be sufficient to cover debt obligations. Additional sources of funds may be required and there can be no assurance the Company will be able to obtain additional funds on acceptable terms, if at all. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." CROSS DEFAULTS UNDER CREDIT FACILITIES, LEASE AGREEMENTS, MANAGEMENT AGREEMENTS AND PARTICIPATING MORTGAGE. The Company's credit facility provides that a default under any of the Company's leases or management agreements constitutes a default under the credit facility unless waived by the Lender. Nineteen nursing homes and two assisted living facilities are leased by the Company pursuant to the Omega Master Lease agreement and an additional nine facilities under the 1994 Omega Leases, the terms of which provide that a default with respect to one facility is a default not only with respect to the entire Master Lease, the 1994 Omega Leases and each facility covered thereby, but also with respect to a participating mortgage secured by three additional nursing homes. The Company leases these nursing homes that are subject to the participating mortgage from Counsel Corporation ("Counsel"), a publicly-owned Canadian corporation. Counsel has agreed to indemnify Advocat in the event of a default by Counsel under such participating mortgage, except in the case where such default was caused by Advocat. A default under such participating mortgage or related documents is a default under the Master Lease. In addition to the three nursing homes previously discussed that the Company leases from Counsel, the Company leases eight facilities and manages eight facilities owned by Counsel or affiliates of Counsel. A default under any of the agreements with Counsel or its affiliates constitutes a default under all of the leases and management agreements with Counsel. Finally, four management contracts that cover two, four, six and seven nursing homes, respectively, provide that a default with respect to any facility under any one of the management contracts is a default with respect to all facilities under such management contract. 27 28 NO ASSURANCE OF GROWTH. The Company reported a net loss of $21.7 million for the year ended December 31, 1999 and a working capital deficit of $56.7 million at December 31, 1999. No assurance can be given that the Company will achieve profitable operations in the near term. There can be no assurance that the Company can increase growth in net revenues. The Company cannot assure that internally generated cash flows from earnings and existing cash balances will be sufficient to fund existing debt obligations or future capital and working capital requirements through fiscal year 2000. The price of the Company's Common Stock may fluctuate in response to quarterly variations in the Company's operating and financial results, announcements by the Company or other developments affecting the Company, as well as general economic and other external factors. THIRD-PARTY INDEBTEDNESS SECURED BY ASSETS LEASED OR MANAGED BY COMPANY. The Company, through leases and management agreements, operates facilities that secure the indebtedness of the owners of the facilities. As a result, the Company's leases at such facilities are subject to cancellation upon the default of these third-party owners under their credit agreements. In addition, the payment of management fees to the Company at these facilities is subordinated to the payment of the owners' debt obligations. To the extent that the owners of the Company's managed facilities experience financial difficulty or otherwise are unable to meet their obligations, the ability of the Company to receive management fees or continue as manager of such facility is jeopardized. DEPENDENCE ON REIMBURSEMENT BY THIRD-PARTY PAYORS. Government at both the federal and state levels has continued in its efforts to reduce, or at least limit the growth of, spending for health care services, including services provided by the Company. In August 5, 1997, President Clinton signed into law The Balanced Budget Act of 1997, which has negatively impacted the Company's net operations. Any additional reduction in either Medicare or Medicaid payments could adversely affect the Company. In addition, private payors, including managed care payors, increasingly are demanding that providers accept discounted fees or assume all or a portion of the financial risk for the delivery of health care services. Such measures may include capitated payments whereby the Company is responsible for providing, for a fixed fee, all services needed by certain patients. Capitated or flat-rate payments can result in significant losses if patients require expensive treatment not adequately covered by the payment rate. PPS is a flat-rate payment system as are the Medicaid programs of Arkansas, Texas and Kentucky. Substantially all of the Company's nursing home revenues, including management fees, are directly or indirectly dependent upon reimbursement from third-party payors, including the Medicare and Medicaid programs, the Ontario Government Operating Subsidy program, and private insurers. For the period ended December 31, 1999, approximately 66.3%, 14.2%, and 19.5% of the Company's patient and resident revenues were derived from Medicaid, Medicare and private pay sources. The net revenues and profitability of the Company are affected by the continuing efforts of all payors to contain or reduce the costs of health care. Efforts to impose reduced payments, greater discounts and more stringent cost controls by government and other payors are expected to continue. Any changes in reimbursement levels under Medicare, Medicaid or private pay programs and any changes in applicable government regulations could have a material adverse effect on the Company's net revenues and net income. The Company is unable to predict what reform proposals or reimbursement limitations will be adopted in the future or the effect such changes will have on its operations. No assurance can be given that such reforms will not have a material adverse effect on the Company. Changes in the mix of the Company's patients among Medicare, Medicaid and private pay categories and among different types of private pay sources may also affect the Company's net revenues and profitability. There can be no assurance that the Company will improve or continue to maintain its current payor or revenue mix. 28 29 GOVERNMENT REGULATION. The United States government, the Canadian government, and all states and provinces in which the Company operates regulate various aspects of its business. Various federal, state and provincial laws regulate relationships among providers of services, including employment or service contracts and investment relationships. The operation of long-term care facilities and the provision of services are also subject to extensive federal, state, provincial and local laws relating to, among other things, the adequacy of medical care, distribution of pharmaceuticals, equipment, personnel, operating policies, environmental compliance, ADA compliance, fire prevention and compliance with building codes. Long-term care facilities are also subject to periodic inspection to assure continued compliance with various standards and licensing requirements under state law, as well as with Medicare and Medicaid standards. The failure to obtain or renew any required regulatory approvals or licenses could adversely affect the Company's growth and could prevent it from offering its existing or additional services. In addition, health care is an area of extensive and frequent regulatory change. Changes in the laws or new interpretations of existing laws can have a significant effect on methods and costs of doing business and amounts of payments received from governmental and other payors. The Company's operations could be adversely affected by, among other things, regulatory developments such as mandatory increases in the scope and quality of care to be afforded patients and revisions in licensing and certification standards. The Company at all times attempts to comply with all applicable laws; however, there can be no assurance that administrative or judicial interpretation of existing laws or regulations will not have a material adverse effect on the Company's operations or financial condition. In order to receive Medicare and Medicaid reimbursement, the Company must be certified by Medicare and Medicaid. In 1995, the Federal Government promulgated new survey, certification and enforcement rules governing long-term care facilities participating in the Medicare and Medicaid programs, which impose significant new requirements on long-term care facilities. The breadth of the rules has created uncertainty over the manner in which the rules are implemented, the ability of any long-term care facility to comply with them and the effect of the rules on the Company. Facilities that are found not to be in compliance with the rules are subject to decertification from participating in the Medicare/Medicaid programs; termination of provider agreement; temporary management; denial of payment for new admissions; civil money penalties; closure of the facility or transfer of patients or both; and on-site state monitoring. In the ordinary course of its business, the Company receives notices of deficiencies for failure to comply with various regulatory requirements. The Company reviews such notices and takes appropriate corrective action. In most cases, the Company and the reviewing agency will agree upon the measures to be taken to bring the facility into compliance with regulatory requirements. During 1997 and 1998 certain of the Company's facilities in Alabama and Arkansas were decertified from the Medicare and Medicaid programs. Since then, one facility has been recertified, another is applying for recertification and the lease term expired on the third facility. There can be no assurance that the Company will not experience additional problems with maintaining the certification of its facilities. Failure to obtain and maintain Medicare and Medicaid certification at the Company's facilities will result in denial of Medicare and Medicaid payments which could result in a significant loss of revenue to the Company. SELF-REFERRAL AND ANTI-KICKBACK LEGISLATION. The health care industry is highly regulated at the state, provincial and federal levels. In the United States, various state and federal laws regulate the relationships between providers of health care services, physicians, and other clinicians. These laws impose restrictions on physician referrals for designated health services to entities with which they have financial relationships. These laws also prohibit the offering, payment, solicitation or receipt of any form of remuneration in return for the referral of Medicare or state health care program patients or patient 29 30 care opportunities for the purchase, lease or order of any item or service that is covered by the Medicare and Medicaid programs. There can be no assurance the Company's operations will not be subject to review, scrutiny, penalties or enforcement actions under these laws, or that these laws will not change in the future. Violations of these laws may result in substantial civil or criminal penalties for individuals or entities, including large civil monetary penalties and exclusion from participation in the Medicare or Medicaid programs. Such exclusions or penalties, if applied to the Company, could have a material adverse effect on the profitability of the Company. RELATIONSHIPS BETWEEN LONG-TERM CARE FACILITIES AND OTHER PROVIDERS. Relationships between long-term care facilities and other providers such as providers of physical therapy and other ancillary service providers have come under increased scrutiny by government and private payors. To the extent that the Company, any facility with which it does business, or any of their owners or directors have a financial relationship with each other or with other health care entities providing services to long-term care patients, such relationships could be subject to increased scrutiny. There can be no assurance that the Company's business operations and agreements with other providers of health care services will not be subject to change, review, penalties or enforcement actions under state and federal laws regarding self-referrals or fraud and abuse, or that these laws will not change in the future. LIQUIDITY. Effective at the close of business on November 9, 1999, the New York Stock Exchange de-listed the Company's Common Stock. As a result, beginning November 10, 1999, trading of the Company's Common Stock is conducted on the over-the-counter market ("OTC") or, on application by broker-dealers, in the NASD's Electronic Bulletin Board using the Company's current trading symbol, AVCA. In addition, in December 1999, the Company's market maker temporarily suspended trading of the Company's Common Stock on the OTC pending the Company's filing of certain amendments to the Company's quarterly reports on Form 10-Q. Although trading on the OTC has resumed, no assurance can be given that the Company's market maker will not suspend trading on the OTC again in the future, which could make it difficult for investors to complete transactions in the Company's Common Stock. As a result of the de-listing, the liquidity of the Company's Common Stock and its price have been adversely affected, which may limit the Company's ability to raise additional capital. LIABILITY AND INSURANCE. The provision of health care services involves an inherent risk of liability. In recent years, participants in the long-term care industry have become subject to an increasing number of lawsuits alleging malpractice or related legal theories, many of which involve large claims and significant defense costs. It is expected that the Company from time to time will be subject to such suits as a result of the nature of its business. The Company currently maintains liability insurance intended to cover such claims, however, it is self-insured with respect to the first $500,000 per occurrence and no aggregate limit on such claims. In addition, there can be no assurance that claims in excess of the Company's insurance coverage or claims not covered by the Company's insurance coverage (e.g., claims for punitive damages) will not arise. A successful claim against the Company in excess of the Company's insurance coverage could have a material adverse effect upon the Company and its financial condition. Claims against the Company, regardless of their merit or eventual outcome, may also have a material adverse effect upon the Company's ability to attract patients or residents or expand its business. In addition, the Company's insurance policies must be renewed annually. There can be no assurance that the Company will be able to obtain liability insurance coverage in the future on acceptable terms, if at all. 30 31 GUARANTEES AND OBLIGATIONS TO REDEEM CERTAIN PARTNERSHIP INTERESTS. A subsidiary of the Company has provided guarantees of certain cash flow deficiencies and quarterly return obligations of Diversicare VI Limited Partnership ("Diversicare VI"), which may obligate the subsidiary to make interest-free loans to Diversicare VI. Such cash flow obligations have never been called upon. The Company has also provided a cash flow guarantee to TDLP, which may obligate the Company to provide monthly interest-free loans to TDLP. In addition, the limited partners of TDLP have the right to cause the Company to repurchase up to 10.0% of their partnership units annually for five years (up to a maximum of 50.0% of the total partnership units outstanding) beginning in January 1996. To date, the Company has repurchased 22.6% of the partnership units. No units were presented for repurchase in January, 2000. It is a virtual certainty that the Company will be required to make additional loans to TDLP. It is less certain whether the Company will be called upon to repurchase up to 10.0% of additional partnership units in January 2001. The Company has reserved for these obligations, but there can be no assurance as to the aggregate dollar amount of the Company's obligations under the guarantees and redemption obligation, nor can there be any assurance that all or any portion of the loans made to Diversicare VI or TDLP will be repaid. COMPETITION. The long-term care industry generally, and the nursing home and assisted living center businesses particularly, are highly competitive. The Company faces direct competition for the acquisition or management of facilities. In turn, its facilities face competition for employees, patients and residents. Some of the Company's present and potential competitors are significantly larger and have or may obtain greater financial and marketing resources than those of the Company. Some hospitals that provide long-term care services are also a potential source of competition to the Company. In addition, the Company may encounter substantial competition from new market entrants. Consequently, there can be no assurance that the Company will not encounter increased competition in the future, which could limit its ability to attract patients or residents or expand its business, and could materially and adversely affect its business or decrease its market share. ANTI-TAKEOVER CONSIDERATIONS. The Company is authorized to issue up to 1,000,000 shares of preferred stock, the rights of which may be fixed by the Board of Directors without shareholder approval. In March 1995, the Board of Directors approved the adoption of a Shareholder Rights Plan (the "Plan"). The Plan is intended to encourage potential acquirors to negotiate with the Company's Board of Directors and to discourage coercive, discriminatory and unfair proposals. The Company's stock incentive plans provide for the acceleration of the vesting of options in the event of certain changes in control (as defined in such plans). The Company's Certificate of Incorporation (the "Certificate") provides for the classification of its Board of Directors into three classes, with each class of directors serving staggered terms of three years. The Company's Certificate requires the approval of two-thirds of the outstanding shares to amend certain provisions of the Certificate. Section 203 of the Delaware General Corporate Law restricts the ability of a Delaware corporation to engage in any business combination with an interested stockholder. Provisions in the executive officers' employment agreements provide for post-termination compensation, including payment of certain of the executive officers' salaries for up to 30 months, following certain changes in control. Certain changes in control of the Company also constitutes an event of default under the Company's bank credit facility. The foregoing matters and the Change in Control purchase feature of the Debentures described above may, together or separately, have the effect of discouraging or making more difficult an acquisition or change of control of the Company. 31 32 ITEM 2. PROPERTIES The Company owns 23 and leases 61 long-term care facilities. See "Item 1 - Description of Lease Agreements" and "- Facilities." The Company leases approximately 19,000 square feet of office space in Franklin, Tennessee, that houses the executive offices of the Company, centralized management support functions, and the ancillary services supply operations. In addition, the Company leases its regional office for Canadian operations with approximately 10,800 square feet of office space in Mississauga, Ontario, its regional office with approximately 5,500 square feet of office space in Kernersville, North Carolina, and its regional office with approximately 3,000 square feet of office space in Ashland, Kentucky. Lease periods on these facilities generally range up to seven years, although the Kernersville lease runs through 2022 including renewal options. Regional executives for Alabama, Arkansas, Florida and Texas work from offices of under 1,000 square feet each. Management believes that the Company's leased properties are adequate for its present needs and that suitable additional or replacement space will be available as required. ITEM 3. LEGAL PROCEEDINGS The provision of health care services entails an inherent risk of liability. In recent years, participants in the health care industry have become subject to an increasing number of lawsuits alleging malpractice, product liability, or related legal theories, many of which involve large claims and significant defense costs. It is expected that the Company from time to time will be subject to such suits as a result of the nature of its business. Further, as with all health care providers, the Company is potentially subject to the increased scrutiny of regulators for issues related to compliance with health care fraud and abuse laws. Although the Company is not a party to or subject to any material pending legal proceedings and carries liability insurance that Management believes meets industry standards, there can be no assurance that any pending or future legal proceedings (including any related judgments, settlements or costs) will not have a material adverse effect on the Company's business, reputation, or financial condition. See "Item 1 - Insurance." ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There have been no matters submitted to a vote of security holders during the fourth quarter (October 1, 1999 through December 31, 1999) of the fiscal year covered by this Annual Report on Form 10-K. 32 33 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS The Common Stock of the Company was listed on the New York Stock Exchange under the symbol "AVC" through November 9, 1999. Since that time, the Company's Common Stock has been traded on NASD's OTC Bulletin Board under the symbol "AVCA." The Company's Common Stock is also traded on the Toronto Stock Exchange under the symbol "AVCU." The following table sets forth the high and low prices of the common stock for each quarter in 1998 and 1999:
Period High Low ---------------- -------- ------- 1998 1st Quarter $10 3/16 $ 7 3/4 1998 2nd Quarter 10 5/16 6 1998 3rd Quarter 7 7/8 5 5/8 1998 4th Quarter 6 1/2 4 3/4 1999 1st Quarter 6 1/4 2 7/8 1999 2nd Quarter 2 5/16 1 3/8 1999 3rd Quarter 2 1/16 7/8 1999 4th Quarter 1 1/16 1/8
The Company's Common Stock has been traded since May 10, 1994. On March 23, 2000, the closing price for the Common Stock was $0.22, as reported by PCQuote.com. On March 23, 2000, there were 340 holders of record of the common stock. Most of the Company's shareholders have their holdings in the street name of their broker/dealer. The Company has not paid cash dividends on its Common Stock and anticipates that, for the foreseeable future, any earnings will be retained for use in its business and no cash dividends will be paid. The Company is currently prohibited from issuing dividends under certain debt instruments. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected financial data of Advocat as of December 31, 1999, 1998, 1997, 1996 and 1995 and for the years ended December 31, 1999, 1998, 1997, 1996 and 1995 have been derived from the audited financial statements of Advocat. 33 34
Year Ended December 31, ----------------------------------------------------------------------- 1999 1998 1997 1996 1995 --------- --------- --------- --------- --------- (in thousands, except per share amounts) STATEMENT OF OPERATIONS DATA: REVENUES: Patient revenues ............... $ 141,022 $ 166,529 $ 163,094 $ 153,582 $ 128,643 Resident revenues .............. 37,905 34,804 15,105 8,347 7,477 Management fees ................ 2,932 3,627 3,886 4,152 3,618 Interest ....................... 159 192 158 156 227 --------- --------- --------- --------- --------- Net revenues ............. 182,018 205,152 182,243 166,237 139,965 --------- --------- --------- --------- --------- EXPENSES: Operating ...................... 152,557 164,769 146,555 131,966 109,458 Lease .......................... 20,375 19,109 15,850 14,441 13,518 General and administrative ..... 11,753 10,969 9,636 8,578 7,806 Depreciation and amortization .. 4,516 3,838 2,823 2,285 1,516 Non-recurring charges .......... 500 5,859 -0- -0- -0- Interest ....................... 5,460 5,425 2,672 1,591 777 --------- --------- --------- --------- --------- Total expenses ........... 195,812 209,969 177,536 158,861 133,075 --------- --------- --------- --------- --------- INCOME (LOSS) BEFORE INCOME TAXES ................... $ (13,794) $ (4,817) $ 4,707 $ 7,376 $ 6,890 ========= ========= ========= ========= ========= NET INCOME (LOSS) ................. $ (21,676) $ (3,083) $ 3,013 $ 4,721 $ 4,410 ========= ========= ========= ========= ========= EARNINGS (LOSS) PER SHARE: Basic .......................... $ (3.98) $ (.57) $ .56 $ .89 $ .84 ========= ========= ========= ========= ========= Diluted ........................ $ (3.98) $ (.57) $ .56 $ .89 $ .82 ========= ========= ========= ========= ========= WEIGHTED AVERAGE SHARES: Basic .......................... 5,445 5,388 5,339 5,270 5,270 ========= ========= ========= ========= ========= Diluted .................. 5,445 5,388 5,373 5,381 5,381 ========= ========= ========= ========= =========
December 31, ----------------------------------------------------------------------- 1999 1998 1997 1996 1995 --------- --------- --------- --------- --------- (in thousands) BALANCE SHEET DATA: Working capital (deficit) ......... $ (56,699) $ 16,233 $ 14,389 $ 13,540 $ 6,726 ========= ========= ========= ========= ========= Total assets ...................... $ 96,185 $ 121,294 $ 114,961 $ 74,908 $ 59,031 ========= ========= ========= ========= ========= Long-term debt, excluding current portion ............... $ 7,827(1) $ 33,514 $ 58,373 $ 23,254 $ 11,063 ========= ========= ========= ========= ========= Shareholders' equity .............. $ 6,267 $ 27,561 $ 30,733 $ 27,348 $ 22,437 ========= ========= ========= ========= =========
- ---------- (1) Because of financial covenant non-compliance, the Company has classified as current $25,903 of debt with scheduled maturities that actually begin in 2001. In the absence of the non-compliance issues, the Company's long-term debt would have been $33,730. See "Item 1 - Material Corporate Developments - Current Debt Maturities and Financial Covenant Non-Compliance." 34 35 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company") provides long-term care services to nursing home patients and residents of assisted living facilities in 12 states, primarily in the Southeast, and three Canadian provinces. The Company completed its initial public offering in May 1994, however, its operational history can be traced to February 1980 through common senior management who were involved in different organizational structures. The Company's facilities provide a range of health care services to their patients and residents. In addition to the nursing, personal care and social services usually provided in long-term care facilities, the Company offers a variety of comprehensive rehabilitation services as well as medical supply and nutritional support services. As of December 31, 1999, Advocat's portfolio includes 119 facilities composed of 65 nursing homes containing 7,307 licensed beds and 54 assisted living facilities containing 5,215 units. In comparison, at December 31, 1998, the Company operated 115 facilities composed of 63 nursing homes containing 7,182 licensed beds and 52 assisted living facilities containing 4,755 units. Within the current portfolio, 35 facilities are managed on behalf of other owners, 29 of which are on behalf of unrelated owners and six in which the Company holds a minority equity interest. The remaining facilities, consisting of 61 leased and 23 owned facilities are operated for the Company's own account. In the United States, the Company operates 51 nursing homes and 33 assisted living facilities, and in Canada, the Company operates 14 nursing homes and 21 assisted living facilities. BASIS OF FINANCIAL STATEMENTS. The Company's patient and resident revenues consist of the fees charged for the care of patients in the nursing homes and residents of the assisted living facilities leased and owned by the Company. Management fee revenues consist of the fees charged to the owners of the facilities managed by the Company. The management fee revenues are based on the respective contractual terms of the Company's management agreements, which generally provide for management fees ranging from 3.5% to 6.0% of the net revenues of the managed facilities. As a result, the level of management fees is affected positively or negatively by the increase or decrease in the average occupancy level and the per diem rates of the managed facilities. The Company's operating expenses include the costs, other than lease, depreciation, amortization and interest expenses, incurred in the nursing homes and assisted living facilities owned and leased by the Company. The Company's general and administrative expenses consist of the costs of the corporate office and regional support functions, including the costs incurred in providing management services to other owners. The Company's depreciation, amortization and interest expenses include all such expenses incurred across the range of the Company's operations. 35 36 OPERATING DATA The following table presents the Advocat statements of operations for the years ended December 31, 1999, 1998 and 1997, and sets forth this data as a percentage of revenues for the same years.
Year Ended December 31, ---------------------------------------------------------------------------------- ($ in thousands) 1999 1998 1997 ----------------------- --------------------- ---------------------- Revenues: Patient revenues .................... $ 141,022 77.5% $ 166,529 81.2% $ 163,094 89.5% Resident revenues ................... 37,905 20.8 34,804 16.9 15,105 8.3 Management fees ..................... 2,932 1.6 3,627 1.8 3,886 2.1 Interest ............................ 159 0.1 192 0.1 158 0.1 --------- ------- --------- ------- --------- ------- Net revenues ...................... 182,018 100.0% 205,152 100.0% 182,243 100.0% --------- ------- --------- ------- --------- ------- Expenses: Operating ........................... 152,557 83.8 164,769 80.3 146,555 80.4 Lease ............................... 20,375 11.2 19,109 9.3 15,850 8.7 General and administrative .......... 11,753 6.5 10,969 5.3 9,636 5.3 Depreciation and amortization ....... 5,167 2.8 3,838 1.9 2,823 1.5 Non-recurring charges ............... 500 0.3 5,859 2.9 -0- 0.0 Interest ............................ 5,460 3.0 5,425 2.6 2,672 1.5 --------- ------- --------- ------- --------- ------- Total expenses .................... 195,812 107.6 209,969 102.3 177,536 97.4 --------- ------- --------- ------- --------- ------- Income (loss) before income taxes ..... (13,794) (7.6) (4,817) (2.3) 4,707 2.6 Provision (benefit) for income taxes .. 7,605 4.2 (1,734 (0.8) 1,694 0.9 --------- ------- --------- ------- --------- ------- Income (loss) before cumulative effect of change in accounting principle ........................... (21,399) (11.8) (3,083) (1.5) 3,013 1.7 Cumulative effect of change in accounting principle, net of tax .... (277) (0.2) -0- 0.0 -0- 0.0 --------- ------- --------- ------- --------- ------- Net income (loss) ..................... $ (21,676) (11.9)% $ (3,083) (1.5)% $ 3,013 1.7% ========= ======= ========= ======= ========= =======
The Company has incurred losses during 1999 and 1998 and expects to continue to incur losses during 2000. The Company has a working capital deficit of $56.7 million as of December 31, 1999. Also, the Company has limited resources available to meet its operating, capital expenditure and debt service requirements during 2000. Given that events of default under the Company's working capital line of credit, there can be no assurance that the respective lender will continue to provide working capital advances. 36 37 The following tables present data about the facilities operated by the Company as of the dates or for the years indicated:
December 31, ------------------------------ 1999 1998 1997 ------ ------ ------ Licensed Nursing Home Beds: Owned ...................... 706 706 706 Leased ..................... 4,007 4,158 4,158 Managed .................... 2,594 2,318 2,477 ------ ------ ------ Total .................... 7,307 7,182 7,341 ====== ====== ====== Assisted Living Units: Owned ...................... 1,216 1,302 1,314 Leased ..................... 2,073 1,883 1,800 Managed(1) ................. 1,926 1,570 1,634 ------ ------ ------ Total .................... 5,215 4,755 4,748 ====== ====== ====== Total Beds/Units: Owned ...................... 1,922 2,008 2,020 Leased ..................... 6,080 6,041 5,958 Managed(1) ................. 4,520 3,888 4,111 ------ ------ ------ Total .................... 12,522 11,937 12,089 ====== ====== ====== Facilities: Owned ...................... 23 24 25 Leased ..................... 61 61 59 Managed(1) ................. 35 30 32 ------ ------ ------ Total .................... 119 115 116 ====== ====== ======
- ---------- (1) Includes six assisted living facilities with 865 units in which the Company holds a minority equity interest.
Year Ended December 31, -------------------------------------- 1999 1998 1997 -------- -------- -------- Average Occupancy(1): Leased/Owned(2) ..................... 76.0% 81.6% 83.0% Managed ............................. 93.9 95.6 96.3 ----- -------- -------- Total ............................. 81.7% 84.9% 86.7% ===== ======== ========
- ---------- (1) Average occupancy excludes facilities under development or facilities managed during receivership or insolvency proceedings. (2) Includes the occupancy of the six facilities of TDLP, a limited partnership managed by the Company. 37 38 MEDICARE REIMBURSEMENT CHANGES During 1997, the Federal government enacted the Balanced Budget Act of 1997 ("BBA"), which contains numerous Medicare and Medicaid cost-saving measures. The BBA requires that nursing homes transition to a prospective payment system ("PPS") under the Medicare program during a three-year "transition period," which began for most of the Company's facilities on January 1, 1999. In general, PPS provides a standard payment for Medicare Part A services to all providers regardless of their current costs. PPS creates an incentive for providers to reduce their costs, and management has reduced operating expenses in 1999 in an effort to offset the revenue reductions resulting from PPS. Revenues and expenses have been reduced significantly from the levels prior to PPS. Cost restrictions placed on the provision of rehabilitation (ancillary) services as a result of the BBA have also been significant. Beginning in January 1998, the allowable costs for cost reimbursement components of Medicare Part B services became subject to a limitation factor of 90.0% of actual cost. In 1999, the cost reimbursement system for rehabilitation services has been replaced by a system of fee screens that effectively limit reimbursement and place caps on the maximum fees that may be charged for therapy services. Historically, the Company subcontracted the provision of these therapy services. However, in response to the deep cuts in fees for service, the Company's therapy subcontractor exited the business. In June 1999, the Company began providing such services in house. The Company anticipates that this will further negatively impact operations, although the ultimate effect cannot yet be reasonably estimated. These changes with respect to Part B reimbursement have combined to cause a dramatic decrease in the Company's ancillary revenues and expenses. To date, one of the major impacts on the Company from PPS and other BBA reimbursement changes has been the indirect impact of Medicare occupancy declines, which have reduced the amount of overhead absorbed under the Company's Medicare operations. With respect to Medicare therapy allowable cost and fee reductions, the Company estimates that net operations have been negatively impacted in both 1998 and 1999 and will continue to be negatively impacted beyond 1999 as a result of the changes brought about under BBA. However, since PPS and other various changes brought about by the BBA are still an evolving process, the ultimate impact of the BBA cannot be known with certainty at this time. These changes have affected the entire long-term care industry. They have resulted pursuant to the administrative implementation of the guidelines contained in the BBA. Under the BBA, Medicare expenditures by the Federal government have been cut approximately 20.0%. This has been a sudden, drastic blow to the industry. Other providers who relied more heavily on the provision of services to higher acuity patients have been impacted more severely than the Company. There have already been several major bankruptcy filings. Without remediation, the long-term effect on the industry is expected to be catastrophic. As the impact of these changes upon both providers and beneficiaries has become known, there has been growing political awareness of a need to re-examine the drastic cuts that have been implemented. On November 29, 1999, President Clinton signed into law a budget agreement that restores over three years $2.7 billion in Medicare funding. The bill contains several components that become effective at various times over the three-year period. As a result of the legislation, individual nursing facilities now have the option, for cost reporting years beginning after December 29, 1999, of continuing under the current PPS transition formula or adopting the full federal PPS per diem. In addition, the measure provides a two-year moratorium on the Part B therapy caps beginning January 1, 2000, and it also provides increases in the per diem rates for the care of certain groups of patients. The Company is continuing to evaluate the impact of the legislation on its operations. However, there is no expectation by management that the relief will be sufficient to restore the economic viability the industry needs. 38 39 While federal regulations do not provide states with grounds to curtail funding of their Medicaid cost reimbursement programs due to state budget deficiencies, states have nevertheless curtailed funding in such circumstances in the past. No assurance can be given that states will not do so in the future or that the future funding of Medicaid programs will remain at levels comparable to the present levels. The United States Supreme Court ruled in 1990 that healthcare providers could use the Boren Amendment to require states to comply with their legal obligation to adequately fund Medicaid programs. The BBA repeals the Boren Amendment and authorizes states to develop their own standards for setting payment rates. It requires each state to use a public process for establishing proposed rates whereby the methodologies and justifications used for setting such rates are available for public review and comment. This requires facilities to become more involved in the rate setting process since failure to do so may interfere with a facility's ability to challenge rates later. The Company will attempt to maximize the revenues available to it from governmental sources within the changes that have occurred and will continue to occur under the BBA. In addition, the Company will attempt to increase revenues from non-governmental sources, including expansion of its assisted living and Canadian operations to the extent capital is available to do so, if at all. However, current levels of or further reductions in government spending for long-term health care are expected to continue to have an adverse effect on the operating results and cash flows of the Company. NEW FACILITIES Since its inception as a public company in 1994, Advocat has sought to expand its operations through the acquisition of attractive properties via either purchase or lease. Management has conscientiously evaluated the acquisition opportunities that have been available to the Company in light of criteria that were established to help insure the long-term value of the acquisitions that have been completed. Effective October 1, 1997, the Company completed its most significant acquisition, 29 assisted living facilities from Pierce Management Group ("Pierce"). In the Pierce acquisition, the Company purchased 15 facilities (including two non-operating facilities) and leased 14 others. The Company holds the option to purchase 12 of the leased facilities for market value beginning at the fifth anniversary. With the Pierce acquisition, the Company, which has long been involved in the provision of assisted living services in its Canadian operations, established a foundation from which it hopes to expand its presence in the growing assisted living market in the United States. The following table summarizes the Company's acquisitions for 1997 through 1999:
Facilities Added ----------------------- Beds/Units Purchase Lease Added -------- ----- ----- 1999 0 3 324 1998 0 0 0 1997 15 15 2,344
These facilities are hereafter referred to collectively or in part as the "New Facilities." The contribution of the New Facilities to selected components of operations is noted separately where such contribution is significant within their first year of operations. 39 40 NON-RECURRING CHARGES In the third quarter of 1999, the Company recorded non-recurring charges of $500,000. In addition, during the second and fourth quarters of 1998, the Company recorded various non-recurring charges totaling $5.9 million. Summarized information with respect to each non-recurring charge is presented below:
1999 1998 ----------- ----------- Impaired Assets ...................... $ 500,000 $ 2,858,000 MIS Conversion ....................... -0- 1,166,000 Legal and Contractual Settlements .... -0- 1,276,000 Termination of Proposed Financing and Acquisition Transactions ..... -0- 559,000 ----------- ----------- $ 500,000 $ 5,859,000 =========== ===========
During the third quarter of 1999, the Company recorded a charge of $500,000 for the estimated impairment of the Company's investment in TDLP. The Company is obligated to support TDLP cash flow to defined levels through August 2001. The $500,000 charge represents management's estimate of additional future cash flow obligations beyond that which had been provided for in prior evaluations. During the fourth quarter of 1998, the Company recorded a charge of $2.5 million for the estimated impairment of the Company's investment in TDLP. Approximately $1.3 million of this charge represented a valuation allowance against advances made in 1998 in excess of the estimated fair value of the Company's investment, while the remaining $1.2 million represented management's estimate of additional future required cash flow obligations. In addition, in the fourth quarter of 1998, management identified two locations for which leases will not be renewed and wrote off the impairment of certain long-lived assets with respect to these locations ($358,000). During 1998, in connection with its decision to convert all management information systems with respect to the Company's U.S. nursing homes, the Company abandoned much of its existing software and eliminated much of its regional infrastructure in favor of a more centralized accounting organization. The related $1.2 million charge in 1998 represents the write-off of capitalized software costs, costs associated with the closing of certain regional offices and severance packages of affected personnel. During 1998, the Company recorded costs related to certain legal matters and contractual disputes that were settled, resulting in total charges of $1.3 million. During 1998, the Company also wrote off costs associated with terminated prospective financing and acquisition transactions. 40 41 YEAR ENDED DECEMBER 31, 1999 COMPARED WITH YEAR ENDED DECEMBER 31, 1998 REVENUES. Net revenues decreased to $182.0 million in 1999 from $205.2 million in 1998, a decrease of $23.2 million, or 11.3%. Resident revenues increased to $37.9 million in 1999 from $34.8 million in 1998, an increase of $3.1 million, or 8.9%. The increase in resident revenues is primarily attributable to three facilities the Company began operating late in the second quarter of 1999. Patient revenues decreased to $141.0 million in 1999 from $166.5 million in 1998, a decrease of $22.5 million, or 15.3%. This decrease in patient revenues is due primarily to the Medicare reimbursement changes brought about by the implementation of PPS and various other BBA initiatives. In addition, effective April 1, 1999, the Company ceased operating a facility it had previously leased; this facility provided $4.7 million in comparable revenues that were not repeated in 1999. Overall occupancy for leased/owned facilities declined from 81.6% in 1998 to 77.0% in 1999, which was primarily due to occupancy declines in the nursing home segment. There was a 3.3% decline in patient and resident days. A decline of approximately 102,000 patient days was partially offset by an approximately 23,000 increase in resident days. The terminated lease accounted for approximately 37,000 of the decline in patient days. As to payor types, there were declines of approximately 51,000, 28,000 and 23,000 days for Medicaid, Medicare and private pay patients, respectively, representing percentage declines of 4.3%, 25.1% and 9.2%, respectively. As a percent of patient and resident revenues, revenues generated from the Medicare program decreased to16.9% in 1999 from 22.1% in 1998 while Medicaid and similar programs increased to 70.0% in 1999 from 58.8% in 1998. Patient revenues also declined in 1999 compared to 1998 due to the recording of negative revenue adjustments resulting from reimbursement issues with several states. Two of the Company's Alabama facilities were decertified for a portion of 1997. As a result of the decertifications, the state retroactively recouped incentives that had previously been paid to these facilities with respect to 1996 and 1997. Although the Company believes that its efforts seeking restitution through the judicial system may ultimately prove successful, since such success is not assured, the incentive revenue was reversed in 1999. Additionally, certain patient claims by the Company's West Virginia facilities were denied in prior years by the third party intermediary. The Company has exhausted efforts to obtain approval for the claims and reversed these revenues during 1999. Finally, the Arkansas Medicaid system refused to pay to all nursing home operators a rate increase that had been both communicated to the Company and provided for in the state budget that would have covered a portion of both 1998 and 1999. Although the Company is not party to the action, litigation is being pursued seeking to force the payment of the budgeted increase. Because the prospects for collection are doubtful, the Company reversed this revenue that had been recognized over the last half of 1998 and the first half of 1999. Taken together, these reimbursement issues, along with miscellaneous other matters, accounted for approximately $2.0 million of the decline in patient revenues. Ancillary service revenues, prior to contractual allowances, decreased to $23.0 million in 1999 from $58.0 million in 1998, a decrease of $35.0 million, or 60.3%. The decrease is primarily attributable to reductions in revenue availability under Medicare and is consistent with the Company's expectations. Although the $1,500 per patient annual ceiling has now been lifted for a two year period on physical, speech and occupational therapy services, the impact of this relief is not expected to be sufficient to offset the substantial losses that have been incurred by the Company and the long-term care industry from the provision of therapy services. The Company anticipates that ancillary service revenues will remain flat or trend up only marginally during the next 12 months. The ultimate effect on the Company's operations cannot be predicted at this time because the extent and composition of the ancillary cost limitations are subject to change. 41 42 Management fee revenues declined to $2.9 million in 1999 from $3.6 million in 1998, a decline of $695,000, or 19.2%. The decrease is substantially due to reductions in management fees earned on four United States facilities due to the failure to achieve required operational thresholds. OPERATING EXPENSES. Operating expenses decreased to $152.6 million in 1999 from $164.8 million in 1998, a decrease of $12.2 million, or 7.4%. The decrease is primarily attributable to cost reductions implemented in response to the Medicare reimbursement changes (that is, reduced provision of therapy services and in the costs to provide them). Several significant expense increases, however, combined to offset the general decrease. The provision for doubtful accounts was $7.0 million in 1999 as compared with $2.4 million in 1998, an increase of $4.6 million. The increase in the provision for doubtful accounts in 1999 was the result of additional deterioration of past due amounts, increased write-offs for denied claims and additional reserves for potential uncollectible accounts receivable. The Company is self-insured for workers' compensation claims prior to May 1997. In connection therewith, the Company recognized a charge of $650,000 in 1999 to provide for the expected costs on claims related to this period that remain open. The expected costs have grown as the open cases continued to adversely develop in 1999. The Company also recognized a charge of $493,000 in 1999 to provide additional reserves for the self-insured portion of patient liability claims incurred prior to 1998, which claims have developed adversely in 1999 compared to previous evaluations. Finally, it is generally recognized that the regulatory environment in which nursing homes operate has become more restrictive. In 1999, the Company incurred approximately $400,000 in fines and penalties compared to $50,000 in the 1998 period. The largest component of operating expense is wages, which increased to $80.4 million in 1999 from $76.5 million in 1998, an increase of $3.9 million, or 5.0%. Savings from staff reductions in response to census declines have been offset by increases related to the provision of rehabilitation therapy as well as increased wage levels due to tight labor markets in most of the areas in which the Company operates in the United States. The Company's wage increases are generally in line with inflation. Approximately $4.1 million in operating expenses were not repeated in 1999 with respect to the facility whose lease terminated in 1999. As a percent of patient and resident revenues, operating expenses increased to 85.3% in 1999 from 81.8% in 1998. LEASE EXPENSE. Lease expense increased to $20.4 million in 1999 from $19.1 million in 1998, an increase of $1.3 million, or 6.6%. Of this increase, $494,000, or 2.6% is attributable to the three New Facilities. The increase was offset by $345,000 not repeated in 1999 due to the facility whose lease term expired April 1, 1999. Adjustments in the majority of the Company's lease agreements are generally tied to inflation. GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense increased to $11.8 million in 1999 from $11.0 million in 1998, an increase of $784,000, or 7.1%. As a percent of total net revenues, general and administrative expense increased to 6.5% in 1999 compared with 5.3% in 1998. The 1999 period includes a provision for $275,000 of severance benefits for the former Chief Financial Officer of the Company. INTEREST EXPENSE. Interest expense remained constant at $5.4 million during 1999 and 1998. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses increased to $5.1 million in 1999 from $3.8 million in 1998, an increase of $1.3 million, or 34.2%. The increase is primarily attributable to additional depreciable property placed in service during 1999 and 1998. 42 43 CHANGE IN ACCOUNTING PRINCIPLE. Effective January 1, 1999, the Company adopted Statement of Position ("SOP") 98-5, Reporting on the Costs of Start-Up Activities. SOP 98-5, issued by the Accounting Standards Executive Committee, requires that the cost of start-up activities be expensed as these costs are incurred. Start-up activities include one-time activities and organization costs. Upon adoption, the Company incurred a pre-tax charge to income of $433,000 ($277,000 net of tax), representing the write off of all previously deferred balances. This write off has been reported as the cumulative effect of a change in accounting principle in accordance with the provisions of SOP 98-5. INCOME (LOSS) BEFORE INCOME TAXES; NET INCOME (LOSS); EARNINGS (LOSS) PER SHARE. As a result of the above, the loss before income taxes and the cumulative effect of the change in accounting principle was $13.8 million in 1999 as compared with a loss of $4.8 million in 1998, a decrease of $9.0 million. The net loss after taxes and the cumulative effect of the change in accounting principle was $21.7 million in 1999 as compared with a net loss of $3.1 million in 1998, a decrease of $18.6 million. Excluding the effects of the increases and decreases discussed previously, the increased net loss in 1999 is also the result of a $7.6 million tax provision in 1999 compared to a $1.7 million tax benefit in 1998. The 1999 tax provision is the result of a $12.8 million increase in the Company's valuation allowance against the Company's deferred tax assets due to the uncertainty surrounding the realization of the future benefits of those deferred tax assets. Basic and diluted earnings per share were each a loss of $3.98 in 1999 as compared with each being a loss of $.57 for each in 1998. YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997 REVENUES. Net revenues increased to $205.2 million in 1998 from $182.2 million in 1997, an increase of $23.0 million, or 12.6%. Patient revenues increased to $166.5 million in 1998 from $163.1 million in 1997, an increase of $3.4 million, or 2.1%. Resident revenues increased $19.7 million, or 130.4%, of which $19.9 million is attributable to the New Facilities. Revenue increases among facilities operated at least one year were primarily due to inflationary increases rather than from expanded services. These increases were offset by a 2.3% decline in patient days (approximately 45,000 days) among facilities in operation for at least one year. Approximately 11,000 of this decline in patient days is attributable to the facilities that experienced regulatory issues. As a group, however, they recovered to post a modest gain in patient days in the fourth quarter. The Company anticipates it is likely that states and the federal government will continue to seek ways to retard the rate of growth in Medicaid program rates. As a percent of patient and resident revenues, Medicare decreased to 22.1% in 1998 from 25.2% in 1997 while Medicaid and similar programs increased to 58.8% in 1998 from 55.8% in 1997. Ancillary service revenues, prior to contractual allowances, increased to $58.0 million in 1998 from $57.0 million in 1997, an increase of $1.0 million or 1.7%. The Company has emphasized expansion of ancillary services since its inception in 1994. The modest increase in 1998 is consistent with the slower rate of growth realized since 1996. Management believes that the opportunities available for the expansion of ancillary services in its existing operations were essentially fully realized by the beginning of 1997. Because cost limits have been placed on ancillary services as part of the transition to the Medicare prospective payment system as well as other cost limitation provisions that have been announced or could occur, the Company anticipates that ancillary service revenues with respect to its existing operations will remain flat or begin trending down in 1999. The ultimate effect on the Company's operations cannot be predicted at this time because the extent and composition of the cost limitations are not yet certain. 43 44 Management fee revenues decreased by $258,000, or 6.7%, to $3.6 million. The decrease is directly due to the deterioration in the exchange value of the Canadian dollar versus the U.S. dollar. Most of the Company's management revenues are earned in Canada. Prior to the exchange adjustment, Canadian management fees increased 1.2%. OPERATING EXPENSE. Operating expense increased to $164.8 million in 1998 from $146.6 million in 1997, an increase of $18.2 million, or 12.4%. Of this increase, $12.3 million is attributable to the New Facilities. As a percent of patient and resident revenues, operating expense decreased to 81.8% in 1998 from 82.2% in 1997. As a percent of patient and resident revenues, operating expense of the New Facilities was 71.6%. Most of the New Facilities are assisted living locations, which typically have lower operating costs than do nursing homes. With respect to facilities operated at least one year, the operating expense percentage was 84.0%. The Company's operating costs relative to revenues with respect to nursing homes has increased as occupancy has declined and certain costs have increased in response to regulatory issues. The largest component of operating expense is wages, which increased to $76.5 million in 1998 from $67.2 million in 1997, an increase of $9.3 million, or 13.8%. Of this increase, $7.5 million is attributable to the New Facilities. Wages with respect to facilities in operation for at least one year increased $1.8 million, or 2.6%. The Company's wage increases are generally in line with inflation. With respect to nursing home operations, general insurance expense increased to $6.3 million in 1998 from $3.9 million in 1997, an increase of $2.4 million, or 60.0%. In 1998, general insurance expense included a fourth quarter charge of $928,000, based on development of claims, to increase the reserve for expected payments under the Company's large deductible program. Bad debt expense increased to $2.4 million in 1998 from $2.0 million in 1997, an increase of $361,000, or 17.9%. The 1998 expense included a charge of $875,000 to increase the allowance for bad debts based on analysis completed in the fourth quarter. LEASE EXPENSE. Lease expense increased to $19.1 million in 1998 from $15.8 million in 1997, an increase of $3.3 million, or 20.6%. Of this increase, $3.0 million is attributable to the New Facilities, and the remainder is primarily attributable to inflationary adjustments required under the terms of a majority of the Company's operating leases. GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense increased to $11.0 million in 1998 from $9.6 million in 1997, an increase of $1.4 million, or 13.8%. The increase in excess of inflation is primarily attributable to the expense of managing the New Facilities and structural costs associated with the Alabama decertifications and other regulatory issues. As a percent of total net revenues, general and administrative expense remained flat at 5.3% in 1998. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses increased to $3.8 million in 1998 from $2.8 million in 1997, an increase of $1.0 million, or 35.9%. This increase is primarily attributable to the New Facilities. INTEREST EXPENSE. Interest expense increased to $5.4 million in 1998 from $2.7 million in 1997, an increase of $2.7 million, or 103.0%. This increase is primarily attributable to the New Facilities plus interest on additional borrowings under the Company's credit lines. INCOME (LOSS) BEFORE INCOME TAXES; NET INCOME (LOSS); EARNINGS (LOSS) PER SHARE. As a result of the above, as well as the non-recurring charges of $5.9 million, the Company lost $(4.8) million before income taxes as compared with a profit of $4.7 million in 1997, a decrease of $9.5 million, or (202.3)%. The effective combined 44 45 federal, state and provincial income tax rate was 36.0% in both 1998 and 1997. The net loss was $(3.1) million in 1998 as compared with net income of $3.0 million in 1997, a decrease of $6.1 million, and basic earnings (loss) per share was $(.57) as compared with $.56. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1999, the Company had negative working capital of $56.7 million and the current ratio was 0.2, compared with negative working capital of $16.2 million and a current ratio of 0.7 at December 31, 1998. The increase in negative working capital as of December 31, 1999 results primarily from the increase in the Company's current maturities of long-term debt. The Company cannot assure that internally generated cash flows from earnings and existing cash balances will be sufficient to fund existing debt obligations or future capital and working capital requirements during 2000. The increase in current maturities is due to the Company's non-compliance with debt covenants in various debt agreements, including net worth, cash flow and debt-to-equity ratio requirements. Cross-default or material adverse change provisions contained in the agreements allow the holders of substantially all of the Company's debt to demand immediate repayment. The Company has not obtained waivers of the non-compliance. Based on regularly scheduled debt service requirements, the Company has a total of $27,195,000 of debt that must be repaid or refinanced within the next 12 months. However, as a result of the covenant noncompliance and other cross-default provisions, the Company has classified a total of $53,098,000 of debt as current liabilities as of December 31, 1999. The Company would not be able to repay this portion of its indebtedness if the applicable lenders demanded repayment. At December 31, 1999, the Company had total debt outstanding of $60,925,000, of which $34,950,000 was principally mortgage debt, bearing interest generally at floating rates ranging from 6.3% to 8.6%. The Company also had outstanding a promissory note payable to a bank in the amount of $9,412,000 and a reducing demand loan to a Canadian bank in the amount of $1,038,000. The Company's remaining debt of $15,524,000 was drawn under the Company's lines of credit, consisting of a working capital line of credit and an acquisition line of credit. Most of the Company's debt is at floating interest rates, generally at a spread above the London Interbank Offered Rate ("LIBOR"). As of December 31, 1999, the Company's weighted average interest rate was 9.1%. The $9,412,000 Promissory Note originally had a maturity date of July 1, 1999. During 1999, the Company and its lenders agreed to modify the terms of the promissory note by extending the stated maturity date to February 28, 2000, increasing the interest rate to 12.0% fixed and providing certain security interests to the lenders. As of December 31, 1999, the Company had drawn $924,000, had $5,537,000 of letters of credit outstanding, and had $1,939,000 remaining borrowing capability under its working capital line of credit. The working capital line of credit matured December 1, 1999, but was not called, and it carries a current extended maturity date of February 28, 2000. Since early 1998, the Company's bank lender has provided additional line of credit availability (the "Overline"). Availability under the Overline began at $1,250,000 and was increased over time to its maximum level of $4,000,000. Subsequently, the availability was reduced to its existing outstanding balance of $3,500,000. Since April 14, 1999, the Overline has carried interest at 14.0% but was otherwise subject to the same terms and conditions as the Company's working capital line of credit. Maturity of the Overline had been scheduled for July 1, 1999. However, coincident with the changes with respect to the $9,412,000 promissory note, the lender agreed to revised terms with respect to the Overline. These revisions, including availability reduction, extended the maturity date to February 28, 2000. 45 46 The promissory note, the working capital line of credit and the Overline are each held by the same lender. Each of these loans matured February 28, 2000. The Company is currently negotiating modifications to the status of these loans with the lender. As of December 31, 1999, the Company had $11,100,000 outstanding under an acquisition line of credit, which amount was secured by four nursing homes. No further draws are available under the acquisition line of credit. Amounts outstanding under the acquisition line of credit had a scheduled maturity date of December 1, 1999. However, the lender has extended the maturity date to April 30, 2000. Of the Company's 63 leased facilities, 30 are covered by a Master Lease and other leases with Omega Healthcare Investors, Inc. ("Omega"). Under the terms of the Master Lease, the Company must comply with certain covenants based on total shareholders' equity of the Company as defined. The Company was not in compliance with these covenants as of December 31, 1999. As a result of the non-compliance, Omega has the right to terminate all of its leases with the Company and seek recovery of any related financial losses, as well as other miscellaneous remedies. The Company has not obtained waivers of the non-compliance. The Company and Omega are currently in negotiations with respect to modification of the existing lease agreements. No assurance can be given that the Company will achieve profitable operations in the near term. There can be no assurance that the Company can increase growth in net revenues. The Company cannot assure that internally generated cash flows from earnings and existing cash balances will be sufficient to fund existing debt obligations on future capital and working capital requirements through fiscal year 2000. The Company is currently discussing potential restructuring, modification and refinancing alternatives with its lenders, primary lessor and potential investors. If the Company's lenders force immediate repayment, the Company would not be able to repay the related debt outstanding. The Company is unable to predict if it will be successful in reducing operating losses, in negotiating waivers, amendments, or refinancings of outstanding debt or lease commitments, or that the Company will be able to meet any amended financial covenants in the future. Any demands for repayment by lenders or the inability to obtain waivers or refinance the related debt would have a material adverse impact on the financial position, results of operations and cash flows of the Company. If the Company is unable to generate sufficient cash flow from its operations or successfully negotiate debt or lease amendments, it will explore a variety of other options, including but not limited to equity financing from outside investors, asset dispositions or relief under the United States Bankruptcy code. Net cash provided by operating activities totaled $9.2 million, $4.1 million and $5.3 million in 1999, 1998 and 1997, respectively. These amounts primarily represent the cash flows from net income plus changes in non-cash components of operations offset by working capital changes, particularly, increases in receivables. Net cash used in investing activities totaled $5.1 million, $8.1 million and $39.9 million in 1999, 1998 and 1997, respectively. The Company has used between $2.7 million and $5.2 million for capital expenditures in each of the last three calendar years ending December 31, 1998. Substantially all such expenditures were for facility improvements and equipment, which were financed principally through working capital. The 1998 additions were higher principally due to the Company's conversion of its management information systems. For the year ended December 31, 2000, the Company anticipates that capital expenditures for improvements and equipment for its existing facility operations will be approximately $3.2 million, including approximately $800,000 million for non-routine projects. There were no purchase acquisitions completed in 1999 or 1998. In 1997, the Company purchased 17 facilities for net cash consideration of $36.2 million. In 1999 and 1998, the Company invested in or advanced funds to joint ventures in the amount of $576,000 and $2.1 million, respectively. In general, the Company has been appointed as manager of the joint venture properties. Net cash provided by (used in) financing activities totaled $(4.6) million, $3.7 million and $35.4 million in 1999, 1998 and 1997, respectively. The net cash provided from financing activities primarily represents net proceeds from the issuance and repayment of debt. 46 47 RECEIVABLES The Company's operations could be adversely affected if it experiences significant delays in reimbursement of its labor and other costs from Medicare, Medicaid and other third-party revenue sources. The Company's future liquidity will continue to be dependent upon the relative amounts of current assets (principally cash, accounts receivable and inventories) and current liabilities (principally accounts payable and accrued expenses). In that regard, accounts receivable can have a significant impact on the Company's liquidity. Continued efforts by governmental and third-party payors to contain or reduce the acceleration of costs by monitoring reimbursement rates, by increasing medical review of bills for services or by negotiating reduced contract rates, as well as any delay by the Company in the processing of its invoices, could adversely affect the Company's liquidity and results of operations. Net accounts receivable attributable to the provision of patient and resident services at December 31, 1999 and 1998, totaled $15.8 million and $28.3 million, respectively, representing approximately 31 and 53 days in accounts receivable, respectively. Accounts receivable from the provision of management services was $412,000 and $387,000, respectively, at December 31, 1999 and 1998, representing approximately 42 and 39 days in accounts receivable, respectively. The allowance for bad debts was $5.0 million and $2.6 million at December 31, 1999 and 1998, respectively. The Company continually evaluates the adequacy of its bad debt reserves based on patient mix trends, agings of older balances, payment terms and delays with regard to third-party payors, collateral and deposit resources, as well as other factors. The Company continues to evaluate and implement additional procedures to strengthen its collection efforts and reduce the incidence of uncollectible accounts. HEALTH CARE INDUSTRY The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Changes in these laws and regulations, such as reimbursement policies of Medicare and Medicaid programs as a result of budget cuts by federal and state governments or other legislative and regulatory actions, could have a material adverse effect on the Company's consolidated financial position, results of operations, and cash flows. Future federal budget legislation and federal and state regulatory changes may negatively impact the Company. All of the Company's facilities are required to obtain annual licensure renewal and are subject to annual surveys and inspections in order to be certified for participation in the Medicare and Medicaid programs. In order to maintain their operator's license and their certification for participation in Medicare and Medicaid programs, the nursing facilities must meet certain statutory and administrative requirements. These requirements relate to the condition of the facilities, the adequacy and condition of the equipment used therein, the quality and adequacy of personnel, and the quality of medical care. Such requirements are subject to change. There can be no assurance that, in the future, the Company will be able to maintain such licenses for its facilities or that the Company will not be required to expend significant sums in order to do so. 47 48 Recently, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of fraud and abuse statutes and regulations. Violations of these laws and regulations could result in expulsion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Management believes that the Company is in compliance with fraud and abuse laws and regulations as well as other applicable government laws and regulations. Compliance with such laws and regulations can be subject to future government review and interpretation as well as regulatory actions unknown or unasserted at this time. During 1997 and 1998, the Company experienced certain adverse regulatory issues with respect to certain facilities, including decertifications from the Medicare and Medicaid programs. Although the Company did not experience any facility decertifications during 1999, the Company did experience the increased regulatory scrutiny that has been exerted on the industry in the form of increased fines and penalties. FOREIGN CURRENCY TRANSLATION The Company has obtained its financing primarily in U.S. dollars; however, it incurs revenues and expenses in Canadian dollars with respect to Canadian management activities and operations of the Company's eight Canadian retirement centers (three of which are owned) and two owned Canadian nursing homes. Although not material to the Company as a whole, if the currency exchange rate fluctuates, the Company may experience currency translation gains and losses with respect to the operations of these activities and the capital resources dedicated to their support. While such currency exchange rate fluctuations have not been material to the Company in the past, there can be no assurance that the Company will not be adversely affected by shifts in the currency exchange rates in the future. EXECUTIVE MANAGEMENT CHANGES Effective June 30, 1999, Mary Margaret Hamlett resigned as Executive Vice President, Chief Financial Officer and Secretary of the Company. Mr. Richard B. Vacek, Jr. replaced Ms. Hamlett in those capacities effective August 16, 1999. Ms. Hamlett also resigned as a Director of the Company coincident with her resignation as an employee of the Company. Effective January 28, 2000, Mr. Vacek resigned his position with the Company. Mr. James F. Mills, Jr., Vice President and Controller, replaced Mr. Vacek as Secretary and Acting Chief Financial Officer. In addition, Mr. Charles H. Rinne joined the Company effective June 28, 1999. Mr. Rinne is President and Chief Operating Officer of the Company. STOCK EXCHANGE On November 10, 1999, the Company's stock began being quoted on the NASD's OTC Bulletin Board under the symbol AVCA. Previously, the Company's common stock was traded on the New York Stock Exchange under the symbol AVC. The Company's common stock is also traded on the Toronto Stock Exchange under the symbol AVCU. 48 49 INFLATION Management does not believe that the Company's operations have been materially affected by inflation. The Company expects salary and wage increases for its skilled staff to continue to be higher than average salary and wage increases, as is common in the health care industry. To date, these increases as well as normal inflationary increases in other operating expenses have been adequately covered by revenue increases. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. SFAS No. 133, as amended by SFAS No. 137, "Deferral of the Effective Date of SFAS 133", is effective for fiscal quarters beginning after June 15, 2000. The impact of the adoption of SFAS No. 133 is not expected to have a material impact on the Company's results of operations or financial position. IMPACT OF THE YEAR 2000 The Company experienced the changeover to the year 2000 ("Y2K") without difficulty. In preparation for the potential of Y2K related problems, the Company established a Y2K compliance committee, which was responsible for identifying such problems and developing remedial or contingency plans to address them. Working closely with the Company's insurance carrier, the committee developed a formal, documented plan that was put into place. The costs of the Company's Y2K compliance program were not material. Although the Company experienced no catastrophic interruptions in its business in the changeover to the year 2000, it remains on alert for potential Y2K problems. To date, no problems have been noted with any of the Company's vendors. The greatest potential risk that remains is a delay in the liquidation of receivables from ntermediaries or other payors for services provided to patients and residents. Such delays are not expected, but they could yet occur. The foregoing Y2K disclosure is intended to be a "Year 2000 statement" as the term is defined in the Year 2000 Information and Readiness Disclosure Act of 1998 (the "Year 2000 Act"), and, to the extent such disclosure relates to Y2K processing of the Company or to products or services offered by the Company, it is also intended to be the "Year 2000 readiness disclosure," as that term is defined in the Year 2000 Act. FORWARD-LOOKING STATEMENTS The foregoing discussion and analysis provides information deemed by management to be relevant to an assessment and understanding of the Company's consolidated results of operations and its financial condition. It should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 1998. Certain statements made by or on behalf of the Company, including those contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere, are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties including, but not limited to, changes in governmental reimbursement or regulation, health care reforms, the increased cost of borrowing under the Company's credit agreements, 49 50 covenant waivers from the Company's lenders, possible amendments to the Company's credit agreements, the impact of future licensing surveys, the ability to execute on the Company's acquisition program, both in obtaining suitable acquisitions and financing therefor, changing economic conditions as well as others. Investors also should refer to the risks identified in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as risks identified in the Company's Form 10-K for the year ended December 31, 1998 for a discussion of various risk factors of the Company and that are inherent in the healthcare industry. Given these risks and uncertainties, the Company can give no assurances that these forward-looking statements will, in fact, transpire and, therefore, cautions investors not to place undue reliance on them. Actual results may differ materially from those described in such forward looking statements. Such cautionary statements identify important factors that could cause the Company's actual results to materially differ from those projected in forward-looking statements. In addition, the Company disclaims any intent or obligation to update these forward-looking statements. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Audited financial statements are contained on pages F-1 through F-33 of this Annual Report on Form 10-K and are incorporated herein by reference. Audited supplemental schedule data is contained on pages S-1 and S-2 of this Annual Report on Form 10-K and is incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 50 51 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information concerning Directors and Executive Officers of the Company is incorporated herein by reference to the Company's definitive proxy materials for the Company's 2000 Annual Meeting of Shareholders. ITEM 11. EXECUTIVE COMPENSATION Information concerning Executive Compensation is incorporated herein by reference to the Company's definitive proxy materials for the Company's 2000 Annual Meeting of Shareholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information concerning Security Ownership of Certain Beneficial Owners and Management is incorporated herein by reference to the Company's definitive proxy materials for the Company's 2000 Annual Meeting of Shareholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning Certain Relationships and Related Transactions is incorporated herein by reference to the Company's definitive proxy materials for the Company's 2000 Annual Meeting of Shareholders. 51 52 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. Financial statements and schedules of the Company and its subsidiaries required to be included in Part II, Item 8 are listed below.
Form 10-K Pages --------- FINANCIAL STATEMENTS Report of Independent Public Accountants F-1 Consolidated Balance Sheets, December 31, 1999 and 1998 F-2 Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998 and 1997 F-3 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1999, 1998 and 1997 F-4 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 1999, 1998 and 1997 F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997 F-6 to F-7 Notes to Consolidated Financial Statements, December 31, 1999, 1998 and 1997 F-8 to F-33 FINANCIAL STATEMENT SCHEDULE Report of Independent Public Accountants S-1 Schedule II - Valuation and Qualifying Accounts S-2
EXHIBITS The exhibits filed as part of this Report on Form 10-K are listed in the Exhibit Index immediately following the financial statement pages. REPORTS ON FORM 8-K None. 52 53 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ADVOCAT INC. /s/ Charles W. Birkett, M.D. - -------------------------------- Charles W. Birkett, M.D., Chairman of the Board March 30, 2000 /s/ James F. Mills, Jr. - -------------------------------- James F. Mills, Jr. Vice President and Controller, Acting Chief Financial Officer (Principal Financial and Accounting Officer) March 30, 2000 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Charles W. Birkett, M.D. /s/ William C. O'Neil - -------------------------------- -------------------------------- Charles W. Birkett, M.D. William C. O'Neil Chairman of the Board Director (Principal Executive Officer) March 30, 2000 March 30, 2000 /s/ Paul Richardson /s/ J. Bransford Wallace - -------------------------------- -------------------------------- Paul Richardson J. Bransford Wallace Director Director March 30, 2000 March 30, 2000 /s/ Edward G. Nelson - -------------------------------- Edward G. Nelson Director March 30, 2000 53 54 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1999 AND 1998 TOGETHER WITH REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS 55 INDEX TO FINANCIAL STATEMENTS Report of Independent Public Accountants F-1 Consolidated Balance Sheets F-2 Consolidated Statements of Operations F-3 Consolidated Statements of Shareholders' Equity F-4 Consolidated Statements of Comprehensive Income F-5 Consolidated Statements of Cash Flows F-6 Notes to Consolidated Financial Statements F-8 56 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Advocat Inc.: We have audited the accompanying consolidated balance sheets of ADVOCAT INC. (a Delaware Corporation) and subsidiaries as of December 31, 1999 and 1998 and the related consolidated statements of operations, comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of Advocat Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Advocat Inc. and subsidiaries as of December 31, 1999 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. The accompanying consolidated financial statements have been prepared assuming that Advocat Inc. will continue as a going concern. Advocat Inc. has incurred net losses in the years ended December 31, 1999 and 1998 and expects to incur losses in 2000. As discussed in Notes 2 and 9, Advocat Inc. is also not in compliance with certain debt covenants that allow the holders of substantially all of Advocat Inc.'s debt to demand immediate principal repayment. In addition, Advocat, Inc. has limited resources available to meet its operating, capital expenditure and debt service requirements during 2000. As discussed in Notes 2 and 13, Advocat Inc. is also not in compliance with the financial covenants applicable to the lease agreements covering a majority of its United States nursing facilities. These factors raise substantial doubt about Advocat Inc.'s ability to continue as a going concern. Management's plans in regard to these matters are described in Note 2. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset carrying amounts or the amounts and classification of liabilities that might result should the Company be unable to continue as a going concern. ARTHUR ANDERSEN LLP Nashville, Tennessee March 28, 2000 F-1 57 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1999 AND 1998
1999 1998 ------------- ------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,913,000 $ 2,347,000 Receivables, less allowance for doubtful accounts of 11,719,000 26,289,000 $4,958,000 and $2,650,000, respectively Income taxes receivable -- 800,000 Inventories 754,000 1,102,000 Prepaid expenses and other assets 813,000 1,528,000 Deferred income taxes -- 1,719,000 ------------- ------------- Total current assets 15,199,000 33,785,000 ------------- ------------- PROPERTY AND EQUIPMENT, AT COST 87,667,000 84,129,000 Less accumulated depreciation and amortization (19,015,000) (15,548,000) ------------- ------------- Net property and equipment 68,652,000 68,581,000 ------------- ------------- OTHER ASSETS: Deferred tax benefit -- 6,338,000 Deferred financing and other costs, net 939,000 1,150,000 Assets held for sale or redevelopment 1,476,000 1,476,000 Investments in and receivables from joint 8,126,000 7,194,000 ventures Other assets 1,793,000 2,770,000 Total other assets 12,334,000 18,928,000 ------------- ------------- $ 96,185,000 $ 121,294,000 ============= =============
1999 1998 ------------- ------------- LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt $ 53,098,000 $ 30,126,000 Trade accounts payable 7,984,000 9,327,000 Accrued expenses: Payroll and employee benefits 4,001,000 4,920,000 Interest 221,000 857,000 Current portion of self-insurance reserves 3,508,000 2,375,000 Other 3,086,000 2,413,000 ------------- ------------- Total current liabilities 71,898,000 50,018,000 ------------- ------------- NONCURRENT LIABILITIES: Long-term debt, less current portion 7,827,000 33,514,000 Self-insurance reserves, less current 2,268,000 1,665,000 portion Deferred gains with respect to 3,047,000 3,293,000 leases, net Other 4,878,000 5,243,000 ------------ ------------ Total noncurrent liabilities 18,020,000 43,715,000 ------------ ------------ COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Preferred stock, authorized 1,000,000 shares, $.10 par value, none issued and outstanding -- -- Common stock, authorized 20,000,000 shares, $.01 par value, 5,492,000 and 5,399,000 shares issued and outstanding, respectively 55,000 54,000 Paid-in capital 15,907,000 15,765,000 Retained earnings (accumulated deficit) (9,695,000) 11,742,000 ------------- ------------- Total shareholders' equity 6,267,000 27,561,000 ------------- ------------- $ 96,185,000 $ 121,294,000 ============= =============
The accompanying notes are an integral part of these consolidated balance sheets. F-2 58 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, ----------------------------------------------------- 1999 1998 1997 ------------- ------------- ------------- REVENUES: Patient revenues, net $ 141,022,000 $ 166,529,000 $ 163,094,000 Resident revenues 37,905,000 34,804,000 15,105,000 Management fees 2,932,000 3,627,000 3,886,000 Interest 159,000 192,000 158,000 ------------- ------------- ------------- 182,018,000 205,152,000 182,243,000 ------------- ------------- ------------- EXPENSES: Operating 152,557,000 164,769,000 146,555,000 Lease 20,375,000 19,109,000 15,850,000 General and administrative 11,753,000 10,969,000 9,636,000 Depreciation and amortization 5,167,000 3,838,000 2,823,000 Non-recurring charges 500,000 5,859,000 -- Interest 5,460,000 5,425,000 2,672,000 ------------- ------------- ------------- 195,812,000 209,969,000 177,536,000 ------------- ------------- ------------- INCOME (LOSS) BEFORE INCOME TAXES (13,794,000) (4,817,000) 4,707,000 PROVISION (BENEFIT) FOR INCOME TAXES 7,605,000 (1,734,000) 1,694,000 ------------- ------------- ------------- INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (21,399,000) (3,083,000) 3,013,000 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, NET OF TAX BENEFIT (277,000) -- -- ------------- ------------- ------------- NET INCOME (LOSS) $ (21,676,000) $ (3,083,000) $ 3,013,000 ============= ============= ============= EARNINGS (LOSS) PER SHARE: Basic $ (3.98) $ (.57) $ .56 ============= ============= ============= Diluted $ (3.98) $ (.57) $ .56 ============= ============= ============= WEIGHTED AVERAGE SHARES: Basic 5,445,000 5,388,000 5,339,000 ============= ============= ============= Diluted 5,445,000 5,388,000 5,373,000 ============= ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-3 59 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Retained Common Stock Earnings --------------------------- Paid-in Accumulated Shares Amount Capital (Deficit) Total --------- ------------ ------------ ------------ ------------ BALANCE, DECEMBER 31, 1996 5,316,000 $ 53,000 $ 15,083,000 $ 12,212,000 $ 27,348,000 Issuance of common stock 61,000 1,000 555,000 -- 556,000 Net income -- -- -- 3,013,000 3,013,000 Translation loss, net of tax -- -- -- (184,000) (184,000) --------- ------------ ------------ ------------ ------------ BALANCE, DECEMBER 31, 1997 5,377,000 54,000 15,638,000 15,041,000 30,733,000 Issuance of common stock 22,000 -- 127,000 -- 127,000 Net income -- -- -- (3,083,000) (3,083,000) Translation loss, net of tax -- -- -- (216,000) (216,000) --------- ------------ ------------ ------------ ------------ BALANCE, DECEMBER 31, 1998 5,399,000 54,000 15,765,000 11,742,000 27,561,000 Issuance of common stock 93,000 1,000 142,000 -- 143,000 Net loss -- -- -- (21,676,000) (21,676,000) Translation gain, net of tax -- -- -- 239,000 239,000 --------- ------------ ------------ ------------ ------------ BALANCE, DECEMBER 31, 1999 5,492,000 $ 55,000 $ 15,907,000 $ (9,695,000) $ 6,267,000 ========= ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-4 60 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year Ended December 31, -------------------------------------------------------- 1999 1998 1997 -------------- -------------- -------------- NET INCOME (LOSS) $ (21,676,000) $ (3,083,000) $ 3,013,000 OTHER COMPREHENSIVE INCOME (LOSS): Foreign currency translation adjustments 374,000 (338,000) (286,000) Income tax benefit (provision) (135,000) 122,000 102,000 -------------- -------------- -------------- 239,000 (216,000) (184,000) -------------- -------------- -------------- COMPREHENSIVE INCOME (LOSS) $ (21,437,000) $ (3,299,000) $ 2,829,000 ============== ============== ==============
The accompanying notes are an integral part of these consolidated financial statements. F-5 61 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, -------------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ OPERATING ACTIVITIES: Net income (loss) $(21,676,000) $ (3,083,000) $ 3,013,000 Items not involving cash: Depreciation and amortization 5,167,000 3,838,000 2,861,000 Provision for doubtful accounts 7,037,000 2,306,000 2,029,000 Deferred income taxes 7,923,000 (1,645,000) 2,131,000 Equity in (earnings) loss in joint ventures 177,000 (69,000) (53,000) Amortization of deferred balances 894,000 (513,000) (1,022,000) Non-recurring charge write-off -- 1,630,000 -- Asset impairment provision 500,000 2,858,000 -- Write-off pursuant to change in accounting principle 433,000 -- -- Changes in other non-cash items, net of acquisitions: Receivables, net 7,942,000 (4,306,000) (3,878,000) Inventories 348,000 (5,000) (430,000) Prepaid expenses and other assets 729,000 (273,000) (206,000) Trade accounts payable and accrued expenses (242,000) 3,367,000 847,000 Other (27,000) (36,000) 12,000 ------------ ------------ ------------ Net cash provided by operating activities 9,205,000 4,069,000 5,304,000 ------------ ------------ ------------ INVESTING ACTIVITIES: Acquisitions, net of cash acquired -- -- (36,151,000) Purchases of property and equipment, net (4,382,000) (5,186,000) (2,710,000) Investment in TDLP (160,000) (632,000) (655,000) Mortgages receivable, net 179,000 118,000 (307,000) Investments in and advances to joint ventures, net (576,000) (2,086,000) 36,000 Deposits, pre-opening costs and other (461,000) (577,000) (349,000) TDLP partnership distributions 345,000 307,000 201,000 ------------ ------------ ------------ Net cash used in investing activities (5,055,000) (8,056,000) (39,935,000) ------------ ------------ ------------
(continued) F-6 62 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Year Ended December 31, -------------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ FINANCING ACTIVITIES: Proceeds from issuance of debt $ 26,364,000 $ -- $ 36,129,000 Repayment of debt obligations (25,730,000) (890,000) (730,000) Financing costs (532,000) (207,000) (535,000) Net proceeds from repayment of bank line of credit (3,689,000) 5,674,000 3,000 Repayment of bank line of credit -- -- Lessor advances, net -- 442,000 Proceeds from sale of common stock 143,000 127,000 556,000 Advances to TDLP, net (1,305,000) (1,043,000) (503,000) Increases in lease obligations 165,000 -- -- ------------ ------------ ------------ Net cash provided by financing activities (4,584,000) 3,661,000 35,362,000 ------------ ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (434,000) (326,000) 731,000 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,347,000 2,673,000 1,942,000 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,913,000 $ 2,347,000 $ 2,673,000 ============ ============ ============ SUPPLEMENTAL INFORMATION: Cash payments of interest $ 6,095,000 $ 5,016,000 $ 2,526,000 ============ ============ ============ Cash payments (refunds) of income taxes, net $ (981,000) $ 330,000 $ 392,000 ============ ============ ============
NON-CASH TRANSACTIONS: During 1999, the Company's executive benefit plan was terminated. In connection therewith, the Company distributed net benefit plan deposits and relieved net benefit plan liabilities of $1,124,000. The Company received net benefit plan deposits and earnings and recorded net benefit plan liabilities of $443,000 and $265,000 for 1998 and 1997, respectively. The accompanying notes are an integral part of these consolidated financial statements. F-7 63 ADVOCAT INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 1. BACKGROUND Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company") provides long-term care services to nursing home patients and residents of assisted living facilities in 12 states, primarily in the Southeast, and three Canadian provinces. The Company's facilities provide a range of health care services to their patients and residents. In addition to the nursing, personal care and social services usually provided in long-term care facilities, the Company offers a variety of comprehensive rehabilitation services as well as medical supply and nutritional support services. As of December 31, 1999, the Company operates 119 facilities, consisting of 65 nursing homes with 7,307 licensed beds and 54 assisted living facilities with 5,215 units. Within the current portfolio, 35 facilities are managed on behalf of other owners, 29 on behalf of unrelated owners and 6 in which the Company holds a minority equity interest. The remaining facilities, consisting of 61 leased and 23 owned facilities, are operated for the Company's own account. In recent periods, the long-term health care environment has undergone substantial change with regards to reimbursement and other payor sources, compliance regulations, competition among other health care providers and relevant patient liability issues. The Company continually monitors these industry developments as well as other factors that affect its business. See Note 13 for further discussion of recent changes in the long-term health care industry and the related impact on the Operations of the Company. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATION The financial statements include the operations and accounts of Advocat and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Investments in entities in which the Company lacks control but has the ability to exercise significant influence over operating and financial policies are accounted for under the equity method. Investments in entities in which the Company lacks the ability to exercise significant influence are included in the consolidated financial statements at the cost of the Company's investment. BASIS OF ACCOUNTING The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has incurred net losses in the years ended December 31, 1999 and 1998. The Company has a working capital deficit of $56.7 million as of December 31, 1999. The Company expects to continue to incur losses in 2000. Also, the Company has limited resources available to meet its operating, capital expenditure and debt service requirements during 2000. In addition, the Company is currently not in compliance with certain debt covenants that F-8 64 allow the holders of substantially all of the Company's debt to demand immediate principal repayment. Although the Company does not anticipate that such demand will be made, the continued forbearance on the part of the Company's lenders cannot be assured at this time. Accordingly, the Company has classified the related debt principal amounts as current liabilities in the accompanying consolidated financial statements as of December 31, 1999. Given that events of default exist under the Company's working capital line of credit, there can be no assurance that the lender will continue to provide working capital advances. The Company is also not in compliance with the financial covenants applicable to the lease agreements covering a majority of its United States nursing facilities. Under the agreements, the lessor has the right to terminate the lease agreements and seek recovery of any related financial losses as well as other remedies. At a minimum, the Company's cash requirements over the next 12 months include funding operations, capital expenditures, scheduled debt service, and working capital requirements. No assurance can be given that the Company will have sufficient cash to meet its requirements for the next 12 months. The Company is currently discussing potential restructuring and refinancing alternatives with its lenders, primary lessor and potential investors. If the Company's lenders force immediate repayment, the Company would not be able to repay the related debt outstanding. The Company is unable to predict if it will be successful in reducing operating losses, in negotiating waivers, amendments, or refinancings of outstanding debt or lease commitments, or if the Company will be able to meet any amended financial covenants in the future. Any demands for repayment by lenders or the inability to obtain waivers or refinance the related debt would have a material adverse impact on the financial position, results of operations and cash flows of the Company. If the Company is unable to generate sufficient cash flow from its operations or successfully negotiate debt or lease amendments, it will explore a variety of other options, including but not limited to other sources of equity or debt financings, asset dispositions, or relief under the United States Bankruptcy code. These factors raise substantial doubt about the Company's ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset carrying amounts or the amounts and classification of liabilities that might result should the Company be unable to continue as a going concern. REVENUES PATIENT AND RESIDENT REVENUES - The fees charged by the Company to patients in its nursing homes and residents in its assisted living facilities include fees with respect to individuals receiving benefits under federal and state-funded cost reimbursement programs. These revenues are based on approved rates for each facility that are either based on current costs with retroactive settlements or prospective rates with no cost settlement. Amounts earned under federal and state programs with respect to nursing home patients are subject to review by the third-party payors. Final cost settlements, if any, are recorded when objectively determinable, generally within three years of the close of a reimbursement year depending upon the timing of appeals and third-party settlement reviews or audits. Contractual adjustments for revenues earned from federal and state programs amounted to $20,727,000, $54,618,000 and $38,245,000 for 1999, 1998 and 1997, respectively. MANAGEMENT FEES - Under its management agreements, the Company has responsibility for the day-to-day operation and management of each of its managed facilities. The Company typically receives a base management fee ranging generally from 3.5% to 6.0% of net revenues of each managed facility. Other than certain corporate and regional overhead costs, the services provided at the facility are at the facility owner's expense. The facility F-9 65 owner also is obligated to pay for all required capital expenditures. The Company generally is not required to advance funds to the owner. Other than with respect to facilities managed during insolvency or receivership situations, the Company's management fees are generally subordinated to the debt payments of the facilities it manages. In addition, the Company is generally eligible to receive incentives over and above its base management fees based on the profits at these facilities. Approximately 91.0% of 1999 management fee revenues were derived from agreements that expire beginning in 2001 through 2015. The remaining management agreements have remaining lives that expire or are cancelable at various times during 2000. LEASE EXPENSE The Company operates 61 long-term care facilities under operating leases, including 30 owned by Omega Healthcare Investors, Inc. ("Omega"), 11 owned by Counsel Corporation (together with its affiliates, "Counsel"), 13 owned by members or affiliates of Pierce Management Group ("Pierce") and seven owned by other parties. The Company's operating leases generally require the Company to pay stated rent, subject to increases based on changes in the Consumer Price Index or increases in the net revenues of the leased properties. The Company's leases are "triple-net," requiring the Company to maintain the premises, pay taxes, and pay for all utilities. The Company generally grants its lessor a security interest in the Company's personal property located at the leased facility. The leases generally require the Company to maintain a minimum tangible net worth and prohibit the Company from operating any additional facilities within a certain radius of each leased facility. The Company is generally required to maintain comprehensive insurance covering the facilities it leases as well as personal and real property damage insurance and professional malpractice insurance. The failure to pay rentals within a specified period or to comply with the required operating and financial covenants generally constitutes a default, which default, if uncured, permits the lessor to terminate the lease. The Company's interest in the premises is subordinated to that of the lessor's lenders. See Note 13 for discussion of the Company's non-compliance with the financial covenants applicable to lease agreements covering a majority of its United States nursing facilities. CLASSIFICATION OF EXPENSES The Company classifies all expenses (except interest, depreciation and amortization, and lease expenses) that are associated with its corporate and regional management support functions as general and administrative expenses. All other expenses (except interest, depreciation and amortization, and lease expenses) that are incurred by the Company at the facility level are classified as operating expenses. PROVISION FOR DOUBTFUL ACCOUNTS The Company includes provisions for doubtful accounts in operating expenses in its consolidated statements of operations. The provisions for doubtful accounts were $7,037,000, $2,306,000 and $2,030,000 for 1999, 1998 and 1997, respectively. F-10 66 PROPERTY AND EQUIPMENT Property and equipment are recorded at cost with depreciation being provided over the shorter of the remaining lease term (where applicable) or the assets' estimated useful lives on the straight-line basis as follows: Buildings and leasehold improvements - 10 to 40 years Furniture and equipment - 2 to 15 years Vehicles - 5 years Interest incurred during construction periods is capitalized as part of the building cost. Maintenance and repairs are charged against income as incurred, and major betterments and improvements are capitalized. Property and equipment obtained through purchase acquisitions are stated at their estimated fair value determined on the respective dates of acquisition. The Company utilizes Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of." In accordance with SFAS No. 121, the Company evaluates the carrying value of its properties in light of each property's projected cash flows from operations. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on deposit with banks and all highly liquid investments with original maturities of three months or less. INVENTORIES Inventory is recorded at the lower of cost or net realizable value, with cost being determined principally on the first-in, first-out basis. DEFERRED FINANCING AND OTHER COSTS Financing costs are amortized over the term of the related debt. Effective January 1, 1999, the Company adopted Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities." SOP 98-5 requires that the cost of start-up activities be expensed as they are incurred. Start-up activities include one-time activities and organization costs. As a result of adoption, the Company recorded a charge to income of $433,000 ($277,000 net of tax), which is reported as the cumulative effect of a change in accounting principle in the accompanying 1999 consolidated statement of operations. INCOME TAXES The Company utilizes SFAS No. 109, "Accounting for Income Taxes," for the financial reporting of income taxes, which generally requires the Company to record deferred income taxes for the differences between book and tax bases in its assets and liabilities. Income taxes have been provided for all items included in the statements of operations, regardless of the period when such items will be deductible for tax purposes. The principal temporary differences between financial and tax reporting arise from depreciation and from reserves that are not currently deductible, as well as the timing of the recognition of gains on sales of assets. See Note 12 for discussion of the 1999 write-off of deferred tax assets totaling $12,802,000, resulting in a 1999 tax provision of $7,605,000. F-11 67 DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value because of the short-term nature of these accounts. The carrying amount of the Company's debt approximates fair value because the interest rates approximate the current rates available to the Company and its individual facilities. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as in the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. FOREIGN OPERATIONS AND TRANSLATION POLICIES The results of the Canadian operations have been translated at the respective average rates (for purposes of the consolidated statements of operations) and respective year-end rates (for purposes of the consolidated balance sheets). OTHER COMPREHENSIVE INCOME The Company has adopted SFAS No. 130, "Reporting on Comprehensive Income," which requires the reporting of comprehensive income in addition to net income from operations. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. Information with respect to the accumulated other comprehensive income balance included in retained earnings is as follows: Foreign Currency Translation Unrealized Losses:
1999 1998 1997 --------- --------- --------- Beginning balance $(412,000) $(196,000) $ (12,000) Current period change, net of tax 239,000 (216,000) (184,000) --------- --------- --------- Ending balance $(173,000) $(412,000) $(196,000) ========= ========= =========
EARNINGS PER SHARE The Company utilizes SFAS No. 128, "Earnings Per Share," for the financial reporting of earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or otherwise resulted in the issuance of common stock that then shared in the earnings of the Company. The effect of the Company's potential dilutive securities (primarily stock options) was anti-dilutive in 1999 and 1998. F-12 68 RECLASSIFICATIONS Certain amounts in the 1998 and 1997 financial statements have been reclassified to conform with the 1999 presentation. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. SFAS No. 133, as amended by SFAS No. 137, "Deferral of the Effective Date of SFAS No. 133," is effective for fiscal quarters beginning after June 15, 2000. The impact of the adoptions of SFAS No. 133 is not expected to have a material impact on the Company's results of operations or financial position. 3. RECEIVABLES Accounts receivable, before allowances, consists of the following components:
December 31, ---------------------------- 1999 1998 ----------- ----------- Medicare $ 5,800,000 $10,809,000 Medicaid and other non-federal programs 5,716,000 10,614,000 Other patient and resident receivables 4,264,000 6,868,000 Management fees - affiliates 309,000 354,000 Management fees 103,000 32,000 Other receivables and advances 485,000 262,000 ----------- ----------- $16,677,000 $28,939,000 =========== ===========
The Company generally provides patient and resident services and manages health care facilities primarily located in the southeastern United States and three provinces in Canada. The Company provides credit for a substantial portion of its revenues and continually monitors the credit-worthiness and collectibility from its clients, including proper documentation of third-party coverage. The Company is subject to accounting losses from uncollectible receivables in excess of its reserves. F-13 69 4. ACQUISITIONS Effective October 1, 1997, the Company completed the acquisition or lease of 29 assisted living facilities from Pierce. The Company purchased 15 facilities with 1,093 units and entered into leases on the remaining 14 facilities with 1,209 units. The aggregate purchase price was approximately $34,148,000, which includes related costs of the acquisition. To fund the Pierce acquisition, the Company issued $34,100,000 in new debt. Rather than redevelop certain of the purchased properties as originally planned, the Company has since elected to sell two facilities with 139 units and is evaluating ongoing offers for the properties. In addition, the Company acquired two Canadian assisted living facilities on October 1, 1997. Immediately prior to the acquisitions, the Company had managed these facilities, which total 125 units, during receivership proceedings. The combined purchase price was approximately $2,317,000 ($3,200,000 Canadian), which was funded by internal sources and the issuance by the Company's principal Canadian lender of 10-year term loans totaling $2,029,000 ($2,800,000 Canadian). 5. SALE/LEASEBACK OF FACILITIES Effective August 14, 1992, the Company entered into an agreement with Omega whereby 21 of the Company's facilities were sold to Omega and leased back to the Company under a master lease agreement (the "Master Lease"). In addition, the Company entered into a participating mortgage (the "Participating Mortgage") with Omega on three other facilities. The net gain on the sale/leaseback was deferred in accordance with sale/leaseback accounting. The Company is amortizing the deferred gain over 20 years, which is the initial lease term and the renewal period. The net deferred gain totaled $3,047,000 as of December 31, 1999. Amortization of the deferred gain totaled $246,000 for each of 1999, 1998 and 1997 and is included as a decrease to lease expense in the accompanying consolidated statements of operations. 6. SALE OF TEXAS HOMES In 1991, the Company sold six of its Texas nursing homes to Texas Diversicare Limited Partnership ("TDLP") for a sales price of approximately $13,137,000. Total consideration for the sale in 1991 included a $7,500,000 wrap mortgage receivable from TDLP and $4,370,000 cash. Underlying the wrap mortgage receivable is a note payable to a bank by the Company of $1,895,000 as of December 31, 1999. The TDLP properties are collateral for this debt. Under a repurchase agreement, the Company has agreed to purchase up to 10.0% of the partnership units per year, beginning in January 1997 (up to a maximum of 50.0% of the total partnership units) through January 2001. The purchase of the partnership units is upon demand from the limited partners and the 10.0% maximum per year is not cumulative. The repurchase price is the original cash sales price per unit less certain amounts based on the depreciation from 1991 to the December 31 prior to the date of repurchase. No units were put to the Company for repurchase in January 2000. However, pursuant to its repurchase obligation, the Company has purchased a cumulative total of 22.6% through December 31, 1999. Total consideration for these purchases was F-14 70 $1,444,000. Units acquired pursuant to the repurchase agreement do not have voting rights with respect to any matters coming before the limited partners of TDLP. As part of the TDLP transaction, the Company has guaranteed certain cash flow requirements of TDLP for a ten-year period through August 2001. As of December 31, 1999, the Company has provided working capital funding and requirements under the cash flow guarantee to TDLP totaling $5,590,000. Because of the guaranteed financial requirements to the TDLP partners, the Company is accounting for this transaction under the leasing method of accounting under SFAS No. 66. Under this method, the Company has not recorded a sale of the assets. The cash received from TDLP was recorded as an advance liability, and the wrap mortgage receivable has not been reflected in the financial statements. The advance liability is adjusted throughout the year based on mortgage note payments and advances to or repayments from TDLP. In addition, the Company's consolidated statements of operations will continue to reflect the operations of the facilities until the expiration of the Company's commitments with respect to TDLP. The Company continually evaluates the funding contingencies discussed above in relation to its guarantees to TDLP, the balance in the advance liability account, the future wrap mortgage receivable collections, and the estimated fair value of the related nursing homes. The accounting treatment under SFAS No. 66 is applicable as long as the Company's recorded net assets with respect to TDLP are less than the total of the estimated fair value of the Company's investment in TDLP and the Company's interest in the wrap mortgage due from TDLP. Based upon management's evaluation, the Company has recorded a reserve of $3,000,000 for the estimated impairment of the Company's investment in TDLP. Of the total reserve, $500,000 was recognized in 1999 and $2,500,000 in 1998. The reserve has reduced the Company's net assets in TDLP to the estimated amount of cash to ultimately be realized by the Company from its investment in TDLP. The consolidated statements of operations include the recognition of income and expenses from the TDLP homes since the sale. During 1999, 1998 and 1997, the consolidated statements of operations include TDLP operating income (loss) before taxes of $(1,739,000), $(287,000) and $123,000, respectively, which have also been reflected as an adjustment of the advance liability account. 7. PROPERTY AND EQUIPMENT Property and equipment, at cost, consists of the following:
December 31, ---------------------------- 1999 1998 ----------- ----------- Land $ 5,172,000 $ 5,098,000 Buildings and leasehold improvements 61,863,000 59,629,000 Furniture, fixtures and equipment 20,632,000 19,402,000 ----------- ----------- $87,667,000 $84,129,000 =========== ===========
Substantially all of the Company's gross property and equipment is security for debt obligations. F-15 71 8. INVESTMENTS IN AND RECEIVABLES FROM JOINT VENTURES Investments in and receivables from joint ventures consist of the following: December 31, -------------------------- 1999 1998 ---------- ---------- Investments $3,567,000 $3,528,000 Receivables 4,148,000 3,666,000 Note receivable 411,000 -- ---------- ---------- $8,126,000 $7,194,000 ========== ========== The investments consist primarily of investments in joint ventures operating long-term care facilities in Canada and Texas. The investments are accounted for on the equity or cost method, as applicable. Receivables represent management fees receivable from TDLP. The note receivable represents a loan to a joint venture project located in Canada and is secured by a second mortgage on the facility. The note receivable accrues interest at 6% with the entire balance due in 2002. 9. LONG-TERM DEBT Long-term debt consists of the following:
December 31, ------------------------------- 1999 1998 ------------ ------------ Mortgages payable to a commercial finance company; secured by 13 assisted living properties; interest payable monthly at 2.35% above LIBOR (8.17% at December 31, 1999); balloon maturity in July 2002 $ 25,080,000 $ -- Acquisition line of credit payable to a commercial finance company; secured by four nursing homes; interest payable monthly at 2.75% above LIBOR (8.57% at December 31, 1999); balloon maturity in April 2000 11,100,000 11,100,000 Working capital line of credit payable to a bank; secured by certain accounts receivable and substantially all other Company assets; interest payable monthly at either 14.00% or 2.50% above LIBOR or the bank's Index rate (at December 31, 1999: $3,500,000 at 14.00% and $924,000 at 8.97%, respectively); matured on February 28, 2000; negotiations underway with lender 4,424,000 8,112,000
F-16 72
December 31, ------------------------------- 1999 1998 ------------ ------------ Promissory note payable to a bank secured by secondary interests in certain Company assets; interest payable monthly at 12.00%; matured on February 28, 2000; negotiations underway with lender; reduction refinanced in 1999 through issuance of mortgages payable $ 9,412,000 $ 34,100,000 Mortgage payable to a bank; secured by the six TDLP nursing homes; interest and principal payable monthly, interest at 8.00%; balloon maturity in August 2001 1,895,000 2,572,000 Mortgages payable to a Canadian bank; secured by two nursing homes and three assisted living facilities; interest and principal payable monthly; interest ranging from 6.34% to 7.89%; balloon maturities December 2004 through October 2007 5,421,000 5,201,000 Reducing demand loan payable to a Canadian bank; secured by pledgable security interest in Canadian operations; principal of approximately $17,000 and interest payable monthly; interest at bank prime rate plus 0.25% (6.50% at December 31, 1999); matures in December 2004 1,038,000 -- Mortgage payable to a bank; secured by one nursing home; interest and principal payable monthly; interest at the lending bank's base rate plus 0.75% (8.50% at December 31, 1999); balloon maturity in August 2001 2,396,000 2,393,000 Mortgages payable to two banks; secured by second interests in the nursing home referred to immediately above; interest and principal payable monthly; interest at the lead bank's base rate plus 0.75% (8.50% at December 31, 1999); balloon maturity in August 2001 159,000 162,000 ------------ ------------ 60,925,000 63,640,000 Less current portion (53,098,000) (30,126,000) ------------ ------------ $ 7,827,000 $ 33,514,000 ============ ============
F-17 73 Scheduled principal payments for the Company of long-term debt (assuming no accelerations by the lenders) for the next five years and thereafter beginning January 1, 2000, are as follows: 2000 $27,195,000 2001 4,152,000 2002 24,497,000 2003 129,000 2004 1,181,000 Thereafter 3,771,000 ----------- $60,925,000 =========== As of December 31, 1999, the Company's weighted average interest rate was 9.1%. Certain of the Company's loan agreements contain various financial covenants, the most restrictive of which relate to net worth, cash flow, debt-to-equity ratio requirements, and limits on the payment of dividends to shareholders. As of December 31, 1999, the Company was not in compliance with the covenants. Cross-default or material adverse change provisions contained in the agreements allow the holders of substantially all of the Company's debt to demand repayment. The Company has not obtained waivers of the non-compliance. Based on regularly scheduled debt service requirements, the Company has a total of $27,195,000 of debt that must be repaid or refinanced within the next 12 months. However, as a result of the covenant noncompliance and other cross-default provisions, the Company has classified a total of $53,098,000 of debt as current liabilities as of December 31, 1999. The Company would not be able to repay this portion of its indebtedness if the applicable lenders demanded repayment. Additionally, the Company does not currently have refinancing or other sources of funds available to service the current maturities in 2000. The promissory note payable to a bank had an original indebtedness of $34,100,000. It was used to fund the purchase of the Company's North Carolina assisted living operations, which purchase closed on September 30, 1997. With the application of the net proceeds from new mortgages payable in 1999, the balance of the promissory note was reduced to $9,412,000. Prior to the principal reduction, the promissory note had a maturity date of July 1, 1999, carried interest at LIBOR plus 3.0% and had a restriction against pledging the North Carolina assets as collateral with any other lender. With the reduction in the principal balance, the Company and its lenders agreed to modify the terms of the promissory note by extending the stated maturity date, increasing the interest rate to 12.0% fixed and providing certain security interests to the lenders. The security interests include two non-operating properties in North Carolina and the Company's limited partnership interests in TDLP, and the Company has agreed to apply against the promissory note indebtedness any net proceeds realized from the sale of the collateral comprising the additional security interests. The promissory note matured February 28, 2000, but has not been called due by the lender. The Company and the lender are currently negotiating alterations to the status of the promissory note. As of December 31, 1999, the Company had drawn $924,000, had $5,537,000 of letters of credit outstanding, and had $1,929,000 remaining borrowing capability under its working capital line of credit. The interest rate applicable at December 31, 1999, was 8.97%. The working capital line of credit matured December 1, 1999, but was not called, and it carries a current extended maturity date of February 28, 2000. A further extension of the existing agreement or a replacement working capital line of credit is currently being negotiated with the existing bank lender. F-18 74 Since early 1998, the Company's bank lender has provided additional line of credit availability (the "Overline"). Availability under the Overline began at $1,250,000 and was increased over time to its maximum level of $4,000,000. Subsequently, the availability was reduced to its existing outstanding balance of $3,500,000. Since April 14, 1999, the Overline has carried interest at 14.0% but was otherwise subject to the same terms and conditions as the Company's working capital line of credit. Maturity of the Overline had been scheduled for July 1, 1999. However, coincident with the changes with respect to the promissory note, the lender agreed to revised terms with respect to the Overline. These revisions extended the maturity date, provided for increased reporting responsibility to the lender, and cooperation, if requested by the lender, in the completion of an audit of the Company's accounts receivable. In addition, the Company has provided, with respect to certain available assets, first and second secured positions in certain assets in favor of the lender. The Overline matured on February 28, 2000, and it is included in the ongoing negotiations between the Company and the lender. Given that events of default under the Company's working capital line of credit, there can be no assurance that the respective lender will continue to provide working capital advances. The acquisition line of credit of $40,000,000, less outstanding borrowings, was available to fund approved acquisitions through October 1999. The Company's obligations under the acquisition line are secured by the assets acquired with the draws under the acquisition line. Individual advances made under the acquisition line are due three years from the date of initial funding. No further draws are available under the acquisition line of credit. Amounts outstanding under the acquisition line of credit had a scheduled maturity date of December 1, 1999. However, the lender has extended the maturity date to April 30, 2000. The Company and the lender are negotiating replacement long-term financing. In 1999, the Company secured a credit agreement with a bank to support its Canadian operations. The Company obtained a $1,038,000 ($1,500,000 Canadian) loan. This loan is a reducing demand loan with scheduled monthly payments aggregating $208,000 ($300,000 Canadian) annually. The loan agreement includes a second facility for working capital loans up to $692,000 ($1,000,000 Canadian). The Company had no working capital draws outstanding under this facility at December 31, 1999. With respect to the promissory note, the working capital line of credit, and the Overline, the Company is currently negotiating with the existing lender to further restructure the terms, including further extension of their maturity dates. The Company expects to repay a portion of this debt through various means such as the sale of certain assets, refinancing mortgage debt, securing additional equity investments, and through cash generated from operations. The Company expects to repay the $1,038,000 reducing demand loan and certain other miscellaneous current maturities of $1,220,000 with cash generated from operations. Management is hopeful that it will be successful in restructuring the Company's debt as described. However, there can be no assurance that the Company's restructuring efforts will be successful. F-19 75 10. SHAREHOLDERS' EQUITY AND STOCK PLANS SHAREHOLDERS' RIGHTS PLAN In 1995, the Company adopted a shareholders' rights plan (the "Plan"). The Plan is designed to protect the Company's shareholders from unfair or coercive takeover tactics. The rights under the Plan were effective for all shareholders of record at the close of business March 20, 1995, and thereafter and exist for a term of ten years. The Plan, as amended December 7, 1998, provides for one right with respect to each share of common stock. Each right entitles the holder to acquire, at a 50.0% discount from the then-current market, $100 worth of common stock of the Company or that of a non-approved acquiring company. The rights may be exercised only upon the occurrence of certain triggering events, including the acquisition of, or a tender offer for, 15.0% or more of the Company's common stock without the Company's prior approval. STOCK-BASED COMPENSATION PLANS In 1994, the Company adopted the 1994 Incentive and Nonqualified Stock Option Plan for Key Personnel (the "Key Personnel Plan"). Under the Key Personnel Plan, as amended in May 1998, 1,060,000 shares of common stock have been reserved for issuance upon exercise of options granted thereunder. In 1994, the Company adopted the 1994 Nonqualified Stock Option Plan for the Directors (the "Director Plan"). Under the Director Plan, as amended in May 1996, 190,000 shares of common stock have been reserved for issuance upon exercise of options granted thereunder. Under both plans, the option exercise price equals the stock's closing market price on the day prior to the grant date. The maximum term of any option granted pursuant to either the Key Personnel Plan or to the Director Plan is ten years. Options issued under either plan are one-third vested at the grant date with an additional one-third vesting on each of the next two anniversaries of the grant date. Shares subject to options granted under either plan that expire, terminate, or are canceled without having been exercised in full become available again for future grants. In 1994, the Company adopted the 1994 Employee Stock Purchase Plan and reserved 250,000 shares for issuance under the plan. Employees may purchase stock, subject to certain limitations, at 85% of the lower of the closing market price at the beginning or at the end of each plan year. The plan year begins July 1 and ends the following June 30. In July 1999, 1998 and 1997, there were 93,000, 22,000 and 17,000 shares, respectively, issued pursuant to this plan. The fair value of shares sold under the plan was $1.94, $6.87, and $9.50 in 1999, 1998 and 1997, respectively. The Company accounts for these plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," under which no compensation cost has been recognized. Had compensation cost for these F-20 76 plans been determined consistent with SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's net income (loss) and earnings (loss) per share would have been reduced to the following pro forma amounts:
Year Ended December 31, --------------------------------------------------- 1999 1998 1997 ------------- ------------- ------------- Net Income (Loss): As reported $ (21,676,000) $ (3,083,000) $ 3,013,000 ------------- ------------- ------------- Pro forma $ 22,705,000 $ (3,541,000) $ 2,813,000 ------------- ------------- ------------- Basic Earnings (Loss) Per Share: As reported $ (3.98) $ (.57) $ .56 ------------- ------------- ------------- Pro forma $ (4.17) $ (.66) $ .53 ------------- ------------- ------------- Diluted Earnings (Loss) Per Share: As reported $ (3.98) $ (.57) $ .56 ------------- ------------- ------------- Pro forma $ (4.17) $ (.66) $ .52 ------------- ------------- -------------
Because the provisions of SFAS No. 123 have not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. Summarized activity of the stock option plans is presented below:
Shares ----------------------- Key Weighted Personnel Director Average Plan Plan Exercise Price --------- -------- -------------- Outstanding, December 31, 1996 511,000 116,000 $ 9.71 Issued 39,000 21,000 9.88 Exercised (44,000) -- 9.67 Expired or canceled (22,000) (26,000) 10.19 ------- ------- -------- Outstanding, December 31, 1997 484,000 111,000 9.69 Issued 196,000 6,000 9.76 Expired or canceled (33,000) -- 9.81 ------- ------- -------- Outstanding, December 31, 1998 647,000 117,000 9.71 Issued 210,000 5,000 1.78 Expired or canceled (16,000) -- 9.56 ------- ------- -------- Outstanding, December 31, 1999 841,000 122,000 $ 7.94 ======= ======= ======== Vested, December 31, 1999 640,000 117,000 $ 8.94 ======= ======= ======== Available for future grants, December 31, 1999 163,000 58,000 ======= =======
F-21 77 The outstanding options have exercise prices ranging from $0.15 to $13.13 and have a weighted average remaining life of 5.1 years. The weighted average fair value of options granted was $1.78, $4.62 and $4.20 in 1999, 1998 and 1997, respectively. The fair value of each option is estimated on the grant date using the Black-Scholes option pricing model with the following weighted-average assumptions used for the 1999, 1998, and 1997 grants: risk free interest rates ranging from 5.9% to 6.5% for 1999, 5.0% to 5.7% for 1998 and from 5.7% to 6.2% for 1997; no expected dividend yield for each of the years; expected lives of five years for each of the years; and, expected volatility of 118.2% for 1999, 44.4% for 1998 and 7.2% for 1997. PREFERRED STOCK The Company is authorized to issue up to 1,000,000 shares of preferred stock. The Company's Board of Directors is authorized to establish the terms and rights of each series, including the voting powers, designations, preferences, and other special rights, qualifications, limitations, or restrictions thereof. 11. EARNINGS (LOSS) PER SHARE Information with respect to the calculation of basic and diluted (loss) earnings per share data is presented below:
Net Earnings Income (Loss) (Loss) Shares Per Share ------------- ------------ ------------ Year ended December 31, 1999: Basic earnings (loss) per share $(21,676,000) 5,445,000 $ (3.98) ============ Employee stock purchase plan -- -- Options -- -- ------------ ------------ Diluted earnings (loss) per share $(21,676,000) 5,445,000 $ (3.98) ============ ============ ============ Year ended December 31, 1998: Basic earnings (loss) per share $ (3,083,000) 5,388,000 $ (.57) ============ Employee stock purchase plan -- -- Options -- -- ------------ ------------ Diluted earnings (loss) per share $ (3,083,000) 5,388,000 $ (.57) ============ ============ ============ Year ended December 31, 1997: Basic earnings (loss) per share $ 3,013,000 5,339,000 $ .56 ============ Employee stock purchase plan -- 9,000 Options -- 25,000 ------------ ------------ Diluted earnings (loss) per share $ 3,013,000 5,373,000 $ .56 ============ ============ ============
F-22 78 For each period presented, the Company had options outstanding at prices in excess of the average market price of the Company's common stock. Such options were excluded from the computation because to include them would have been antidilutive. In addition, in years in which the Company reported a net loss, options that would have otherwise qualified for inclusion, were excluded from the computation of earnings per share because of anti-dilution. 12. INCOME TAXES The provision (benefit) for income tax is composed of the following components:
Year Ended December 31, -------------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Current payable (benefit): Federal $ (528,000) $ (557,000) $ (823,000) State and province 76,000 488,000 386,000 ------------ ------------ ------------ (452,000) (89,000) (437,000) ------------ ------------ ------------ Deferred taxes: Federal 5,952,000 (1,405,000) 1,941,000 State and province 2,105,000 (240,000) 190,000 ------------ ------------ ------------ 8,057,000 (1,645,000) 2,131,000 ------------ ------------ ------------ Provision (benefit) for income taxes $ 7,605,000 $ (1,734,000) $ 1,694,000 ============ ============ ============
A reconciliation of taxes computed at statutory income tax rates is as follows:
Year Ended December 31, -------------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Provision (benefit) for federal income taxes at statutory rates $ (4,837,000) $ (1,638,000) $ 1,600,000 Provision (benefit) for state and province income taxes at statutory rates (569,000) (193,000) 118,000 Increase in valuation allowance 12,802,000 -- -- Other 209,000 97,000 (24,000) ------------ ------------ ------------ Provision (benefit) for income taxes $ 7,605,000 $ (1,734,000) $ 1,694,000 ============ ============ ============
F-23 79 The net deferred tax assets and liabilities, at the respective income tax rates are as follows:
December 31, ------------------------------- 1999 1998 ------------ ------------ Current deferred asset: Accrued liabilities $ 2,641,000 $ 1,719,000 Less valuation allowance (2,641,000) -- ------------ ------------ Current deferred asset $ -- $ 1,719,000 ============ ============ Non-current deferred asset: Net operating loss $ 6,460,000 $ 1,222,000 Tax gain on sale transactions in excess of recognized financial reporting gain 1,114,000 1,043,000 Tax goodwill and intangibles 7,918,000 9,170,000 Impairment of TDLP net assets 1,140,000 950,000 Other -- 323,000 ------------ ------------ 16,632,000 12,708,000 Less valuation allowance (15,661,000) (5,500,000) ------------ ------------ 971,000 7,208,000 ------------ ------------ Non-current deferred liability: Deferred costs -- (136,000) ------------ ------------ Depreciation (971,000) (734,000) ------------ ------------ (971,000) (870,000) ------------ ------------ Net non-current deferred asset $ -- $ 6,338,000 ============ ============
Due to the uncertainty surrounding the realization of the future benefits of the deferred tax assets, the Company increased the valuation allowance by $12,802,000 during 1999. As a result, all deferred tax assets are fully reserved as of December 31, 1999. 13. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company is committed under long-term operating leases with various expiration dates and varying renewal options. Minimum annual rentals (exclusive of taxes, insurance, and maintenance costs) under these leases for the next five years beginning January 1, 2000, are as follows: 2000 $ 21,516,000 2001 22,063,000 2002 22,575,000 2003 22,942,000 2004 22,431,000 Thereafter 217,355,000 ------------ $328,882,000 ============ Under lease agreements with Omega, Counsel, Pierce and others, the Company's lease payments are subject to periodic annual escalations as described in Note 2. Total lease expense was $20,375,000, $19,109,000 and $15,850,000, for 1999, 1998 and 1997, respectively. F-24 80 OMEGA LEASES The Company's Master Lease with Omega covering 21 facilities provides for an initial term of ten years through August 2002 and allows the Company one ten-year renewal option. The Company issued a letter of credit in the amount of $3,800,000 in favor of Omega as security for its obligations under the Master Lease. First mortgage revenue bonds of $4,370,000 were assumed by Omega as of August 14, 1992. The Company remains secondarily liable for the debt service through maturity of these bonds. Omega has indemnified the Company for any losses suffered by the Company as a result of a default by Omega on the bonds. Omega has represented to the Company that the debt service on the bonds was current as of December 31, 1999. The Company is leasing from Omega the two facilities mortgaged by these bonds. Effective December 1, 1994, the Company entered into a series of agreements with Omega and a third party. Under the agreements, the Company leases a total of nine nursing facilities with a total of 805 beds. Through December 31, 1998, the Company had executed formal lease agreements with respect to five of the nine facilities. Formal lease agreements with respect to the remaining four facilities were executed in March 1999. Prior to the completion of the formal lease agreements, each of the nine facilities were managed by the Company. Under the management agreements, the Company was responsible for the operating assets and liabilities of the facilities and received a management fee equal to the net profits of the facilities. The Company accounted for these nine properties as operating leases in anticipation of the completion of formal lease agreements. The initial lease period for the nine facilities will be ten years with two five-year renewal options at the Company's option. The Company deposited $300,000 with Omega and issued a letter of credit in the amount of $1,150,000 in favor of Omega as security interests for its obligations under these leases. Under the terms of the Master Lease, the Company must comply with certain covenants based on total shareholders' equity of the Company as defined. The Company was not in compliance with these covenants as of December 31, 1999. As a result of the non-compliance, Omega has the right to terminate all of its leases with the Company and seek recovery of any related financial losses, among other things. The Company has not obtained waivers of the non-compliance. The Company and Omega are currently in negotiations with respect to modification of the existing lease agreements. COUNSEL LEASES The Company leases five facilities from Counsel with a remaining term expiring in April 2004. With respect to these facilities, the Company has a right of first refusal and a purchase option at the end of the lease term. The Company leases three additional facilities from Counsel with an initial term of ten years through April 2004 and one ten-year renewal option. With respect to these facilities, the Company has the right of first refusal and a purchase option at the end of the lease term. The Company leases three additional facilities from Counsel with a lease term through August 2002. At the end of the lease term, the Company has the right to purchase these facilities. In addition, the Company can require Counsel to transfer these facilities to Omega, at which time the Company has the right to lease these facilities from Omega in accordance with the terms of the Master Lease. F-25 81 PIERCE LEASES The Company acquired leases with respect to 14 facilities as part of the Pierce transaction. Of these leases, 12 are with the former principal owners of Pierce and have an initial term of 15 years through September 2012 and two five-year renewal options. Beginning at the fifth anniversary, the Company has a right to purchase all twelve facilities as a group for their fair market value. An additional sublease, which expires in 2003, is with an affiliate of Pierce who is a current employee of the Company. The remaining lease is a sublease that expires in 2017. INSURANCE MATTERS The entire United States long-term care industry has seen a dramatic increase in personal injury/wrongful death claims based on alleged negligence by nursing homes and their employees in providing care to patients and residents. As a result, the Company has numerous liability claims and disputes outstanding for professional liability and other related issues. Professional liability insurance up to certain limits is carried by the Company and its subsidiaries for coverage of such claims. However, due to the increasing number of claims against the Company and throughout the long-term care industry, the Company's professional liability insurance premiums and deductible amounts have increased substantially during 1998 and 1999. Additional increases in premiums and deductibles will also occur for the policy year 2000. As of March 9, 2000, all of the Company's professional liability policies are currently on a claims made basis and are renewable annually. Prior to March 9, 2000, all of these policies were on an occurrence basis. The Company currently maintains general and professional liability insurance with coverage limits of $1,000,000 per medical incident, aggregate coverage limits of $3,000,000 per location and total aggregate policy coverage limits of $12,000,000 for its long-term care services. Through December 31, 1997, with respect to a majority of its United States nursing homes, the Company was self-insured for the first $25,000 per occurrence and $500,000 in the aggregate. Effective January 1, 1998, the Company substantially increased the self-insurance portion of its liability with respect to its United States nursing home operations up to $250,000 per occurrence and $2,500,000 in the aggregate per year. Effective February 1, 1999, all United States nursing homes became part of the $250,000/$2,500,000 deductible program, including the six TDLP facilities. For 1999 and 1998, the Company expects to ultimately fully incur the aggregate deductible amount. A reserve has been established in anticipation of the settlement of the 1999 and 1998 claims, which may take up to four years from the date of the injury event to reach final settlement. Effective March 9, 2000, the self-insured per claim amount for all United States nursing homes increased to $500,000 per claim with no aggregate limit. The Company also maintains umbrella liability coverage of $15,000,000 per occurrence for all United States facilities. The assisted living operations acquired in the Pierce transaction are self-insured, with respect to each location, for the first $5,000 per occurrence and $25,000 in the aggregate. The Company also maintains a $10,000,000 aggregate umbrella liability policy for claims in excess of the foregoing limits for these assisted living operations. F-26 82 The Canadian facilities owned or leased by the Company maintain general and professional liability insurance with per claim coverage limits of up to $3,462,000 ($5,000,000 Canadian). The Company also maintains an aggregate umbrella policy for claims in excess of the above limit for these facilities. The ultimate results of the Company's professional liability claims and disputes are unknown at the present time. However, management is currently of the opinion that there would be no material amounts in excess of liability coverage and established reserves. With respect to workers' compensation insurance, substantially all of the Company's employees became covered under either an indemnity insurance plan or state-sponsored programs in May 1997. Prior to that time, the Company was self-insured for the first $250,000, on a per claim basis, for workers' compensation claims in a majority of its United States nursing facilities. The Company has been and remains a non-subscriber to the Texas workers' compensation system and is, therefore, completely self-insured for employee injuries with respect to its Texas operations. The Company has provided reserves for the settlement of outstanding self-insured claims at amounts believed to be adequate as of December 31, 1999. The differences between actual settlements and reserves are included in expense in the year finalized. The Company is self-insured for health insurance benefits for certain employees and dependents for amounts up to $125,000 per individual annually. In the current policy year, expected claims under this program are approximately $2,800,000, and the Company has secured stop-loss insurance coverage for claims in excess of approximately $3,700,000. The Company provides reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate. The differences between actual settlements and reserves are included in expense in the year finalized. EMPLOYMENT AGREEMENTS The Company has employment agreements with certain members of management that provide for the payment to these members of amounts up to 2.5 times their annual base salary in the event of a termination without cause, a constructive discharge (as defined), or upon a change in control of the Company (as defined). The maximum contingent liability under these agreements is approximately $2,000,000. In addition, upon the occurrence of any triggering event, certain executives may elect to require the Company to purchase options granted to them for a purchase price equal to the difference in the event that the fair market value of the Company's Common Stock at the date of termination exceeds the stated option exercise price. The terms of such agreements are from one to three years and automatically renew for one year if not terminated by the employee or the Company. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN The Company established a Supplemental Executive Retirement Plan (the "SERP") in 1994 to provide retirement benefits for certain officers and employees of the Company. Under the SERP, participants could defer up to 6.0% of his or her base pay, and the Company made matching contributions of 100.0% of the amount deferred by each participant. During 1999, the Company terminated the SERP plan, declared all contributions 100.0% vested and distributed the funds to the participants. F-27 83 HEALTH CARE INDUSTRY The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Changes in these laws and regulations, such as reimbursement policies of Medicare and Medicaid programs as a result of budget cuts by federal and state governments or other legislative and regulatory actions, could have a material adverse effect on the Company's consolidated financial position, results of operations, and cash flows. Future federal budget legislation and federal and state regulatory changes may negatively impact the Company. All of the Company's facilities are required to obtain annual licensure renewal and are subject to annual surveys and inspections in order to be certified for participation in the Medicare and Medicaid programs. In order to maintain their operator's license and their certification for participation in Medicare and Medicaid programs, the nursing facilities must meet certain statutory and administrative requirements. These requirements relate to the condition of the facilities, the adequacy and condition of the equipment used therein, the quality and adequacy of personnel, and the quality of medical care. Such requirements are subject to change. There can be no assurance that, in the future, the Company will be able to maintain such licenses for its facilities or that the Company will not be required to expend significant sums in order to do so. Recently, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of fraud and abuse statutes and regulations. Violations of these laws and regulations could result in expulsion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Management believes that the Company is in compliance with fraud and abuse laws and regulations as well as other applicable government laws and regulations. Compliance with such laws and regulations can be subject to future government review and interpretation as well as regulatory actions unknown or unasserted at this time. During 1997 and 1998, the Company experienced certain adverse regulatory issues with respect to certain facilities, including decertifications from the Medicare and Medicaid programs. Although the Company did not experience any facility decertifications in 1999, the Company did experience the increased regulatory scrutiny that has been exerted on the industry in the form of increased fines and penalties. During 1997, the Federal government enacted the Balanced Budget Act of 1997 ("BBA"), which contains numerous Medicare and Medicaid cost-saving measures. The BBA requires that nursing homes transition to a prospective payment system ("PPS") under the Medicare program during a three-year "transition period," commencing with the first cost reporting period beginning on or after July 1, 1998. The BBA also contains certain measures that have and could lead to further future reductions in Medicare therapy reimbursement and Medicaid payment rates. To date, the major impact on the Company from PPS and other reimbursement changes has been systemic occupancy declines, which have reduced the amount of overhead absorbed under the Company's Medicare operations. Revenues and expenses have both been reduced significantly from the levels prior to PPS. With respect to F-28 84 Medicare therapy allowable cost and fee reductions, the Company estimates that net operations was negatively impacted in both 1998 and 1999 and will continue to be negatively impacted beyond 1999 as a result of the changes brought about under the BBA. These changes have affected the entire long-term industry. They have resulted pursuant to the administrative implementation of the guidelines contained in the BBA. Under the BBA, Medicare expenditures by the Federal government have been cut approximately 20.0%. This has been a sudden, drastic blow to the industry. Other providers who relied more heavily on the provision of services to higher acuity patients have been impacted more severely than the Company. There have already been several major bankruptcy filings. Without remediation, the long-term effect on the industry is expected to be catastrophic. As the impact of these changes upon both providers and beneficiaries has become known, there has been growing political awareness of a need to re-examine the drastic cuts that have been implemented. On November 29, 1999, President Clinton signed into law a budget agreement that restores over three years $2.7 billion in Medicare funding. The bill contains several components that become effective at various times over the three year period. As a result of the legislation, individual nursing facilities now have the option, for cost reporting years beginning after December 29, 1999, of continuing under the current PPS transition formula or adopting the full federal PPS per diem. In addition, the measure provides a two-year moratorium on the Part B therapy caps beginning January 1, 2000, and it also provides increases in the per diems for the care of certain groups of patients. The Company is continuing to evaluate the impact of the legislation on its operations. However, the ultimate impact on the Company's operations cannot be reasonably estimated at this time. There is also movement that may result in further legislative relief or the institution of administrative changes that would restore additional revenues to the U.S. nursing home industry. While such activity is positive, there is no expectation by management that the current round of legislative and administrative relief under consideration is sufficient to restore the economic viability that the industry needs. Current levels of or further reductions in government spending for long-term health care would continue to have an adverse effect on the operating results and cash flows of the Company. The Company will attempt to maximize the revenues available to it from governmental sources within the changes that have occurred and will continue to occur under the BBA. In addition, the Company will attempt to increase revenues from non-governmental sources, including expansion of its assisted living and Canadian operations to the extent capital is available to do so, if at all. While federal regulations do not provide states with grounds to curtail funding of their Medicaid cost reimbursement programs due to state budget deficiencies, states have nevertheless curtailed funding in such circumstances in the past. No assurance can be given that states will not do so in the future or that the future funding of Medicaid programs will remain at levels comparable to the present levels. The United States Supreme Court ruled in 1990 that healthcare providers could use the Boren Amendment to require states to comply with their legal obligation to adequately fund Medicaid programs. The BBA repeals the Boren Amendment and authorizes states to develop their own standards for setting payment rates. It requires each state to use a public process for establishing proposed rates whereby the methodologies and justifications used for setting such rates are available for public review and comment. This requires facilities to become more involved in the rate setting process since failure to do so may interfere with a facility's ability to challenge rates later. F-29 85 14. OPERATING SEGMENT INFORMATION In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which was adopted by the Company on January 1, 1998. The Company has three reportable segments: U.S. nursing homes, U.S. assisted living facilities, and Canadian operations, which consist of both nursing home and assisted living services. Management evaluated each of these segments independently due to the geographic, reimbursement, marketing, and regulatory differences between the segments. The accounting policies of these segments are the same as those described in the summary of significant accounting policies described in Note 2. Management evaluates performance based on profit or loss from operations before income taxes not including non-recurring gains and losses and foreign translation gains and losses. The following information is derived from the Company's segments' internal financial statements and include information related to the Company's unallocated corporate revenues and expenses: F-30 86
1999 1998 1997 -------------- ------------- ------------- Net revenues: U.S. nursing homes $ 138,421,000 $ 164,646,000 $ 161,683,000 U.S. assisted living facilities 28,689,000 25,552,000 6,296,000 Canadian operations 15,029,000 14,950,000 14,248,000 Corporate (121,000) 4,000 16,000 ------------- ------------- ------------- Total $ 182,000,000 $ 205,152,000 $ 182,243,000 ============= ============= ============= Depreciation and amortization: U.S. nursing homes $ 2,645,000 $ 2,156,000 $ 2,113,000 U.S. assisted living facilities 1,808,000 1,263,000 306,000 Canadian operations 356,000 348,000 298,000 Corporate 78,000 71,000 106,000 ------------- ------------- ------------- Total $ 4,887,000 $ 3,838,000 $ 2,823,000 ============= ============= ============= Operating income (loss): U.S. nursing homes $ (12,314,000) $ (2,321,000) $ 5,185,000 U.S. assisted living facilities (684,000) 708,000 223,000 Canadian operations 1,726,000 1,912,000 1,889,000 Corporate (2,522,000) (5,116,000) (2,590,000) ------------- ------------- ------------- Total $ (13,794,000) $ (4,817,000) $ 4,707,000 ============= ============= ============= Long-lived assets: U.S. nursing homes $ 32,777,000 $ 41,072,000 $ 39,154,000 U.S. assisted living facilities 34,332,000 33,987,000 34,552,000 Canadian operations 12,933,000 10,536,000 9,337,000 Corporate 9,321,000 10,862,000 9,992,000 Eliminations (8,377,000) (8,948,000) (10,704,000) ------------- ------------- ------------- Total $ 80,986,000 $ 87,509,000 $ 82,331,000 ============= ============= ============= Total assets: U.S. nursing homes $ 55,796,000 $ 75,327,000 $ 68,918,000 U.S. assisted living facilities 36,568,000 36,926,000 36,067,000 Canadian operations 16,737,000 13,718,000 14,327,000 Corporate 18,712,000 11,869,000 11,688,000 Eliminations (31,628,000) (16,546,000) (16,039,000) ------------- ------------- ------------- Total $ 96,185,000 $ 121,294,000 $ 114,961,000 ============= ============= ============= Capital expenditures: U.S. nursing homes $ 1,341,000 $ 4,043,000 $ 2,216,000 U.S. assisted living facilities 937,000 688,000 59,000 Canadian operations 1,856,000 422,000 408,000 Corporate 248,000 33,000 27,000 ------------- ------------- ------------- Total $ 4,382,000 $ 5,186,000 $ 2,710,000 ============= ============= =============
F-31 87 15. RELATED PARTIES The Company commenced operations effective with an initial public offering of common stock in May 1994. The Company's predecessor operations were in companies owned or controlled by Counsel. From the Company's inception through November 1996, the Company had two Directors who are directors and key executives of Counsel. The Company provides management services for nine facilities owned by two Canadian limited partnerships. The president of the general partners of these partnerships is a director and key executive of Counsel, and Counsel leases seven of these facilities from one of the partnerships. Management fees from these facilities totaled $1,805,000, $1,742,000 and $1,814,000 for 1999, 1998 and 1997, respectively. The Company has loaned one of the limited partnerships $929,000 and $1,050,000 as of December 31, 1999 and 1998, respectively. The Company has received second, third and fourth mortgage security interests in the partnership's assets. The notes receivable bear interest at 8.0% and are being repaid over the life of the management contract through December 2005. Lease expense related to the facilities leased from Counsel totaled $2,132,000, $2,064,000 and $2,091,000 for the years ended December 31, 1999, 1998 and 1997, respectively. 16. NON-RECURRING CHARGES During the second and fourth quarters of 1998, the Company recorded various non-recurring charges totaling $5,859,000. In addition, in the third quarter of 1999, the Company recorded non-recurring charges of $500,000. Information with respect to each non-recurring charge is presented below:
1999 1998 ---------- ---------- Impaired Assets $ 500,000 $2,858,000 MIS Conversion -- 1,166,000 Legal and Contractual Settlements -- 1,276,000 Termination of Proposed Financing and Acquisition Transactions -- 559,000 ---------- ---------- $ 500,000 $5,859,000 ========== ==========
As discussed in Note 6, the Company has recorded total charges of $3,000,000 ($500,000 in the third quarter of 1999 and $2,500,000 in the fourth quarter of 1998) for the estimated impairment of the Company's investment in TDLP due to the continuing funding of certain contractual cash flow requirements. In addition, in the fourth quarter of 1998, management identified two locations for which leases would not be renewed and wrote off the impairment of certain long-lived assets with respect to these locations, $358,000. During 1998, in connection with its decision to convert all management information systems with respect to the Company's U.S. nursing homes, the Company abandoned much of its existing software and eliminated much of its regional infrastructure in favor of a more F-32 88 centralized accounting organization. The related $1,166,000 charge in 1998 represents the write-off of capitalized software costs, costs associated with the closing of certain regional offices and severance packages of affected personnel. During 1998, the Company recorded costs related to certain legal matters and contractual disputes that were settled, resulting in total charges of $1,276,000. During 1998, the Company also wrote off costs associated with terminated prospective financing and acquisition transactions. 17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Selected quarterly financial information for each of the quarters in the year ended December 31, 1999 and 1998 is as follows:
Quarter ---------------------------------------------------------------------------- 1999 First Second Third Fourth ---- ------------ ------------ ------------ ------------ Net revenues $ 46,712,000 $ 44,590,000 $ 44,500,000 $ 46,216,000 ============ ============ ============ ============ Net loss $ (983,000)(1) $ (2,606,000) $ (4,217,000)(2) $(13,870,000)(3) ============ ============ ============ ============ Basic and diluted loss per share $ (.18)(1) $ (.48) $ (.77)(2) $ (2.55)(3) ============ ============ ============ ============
Quarter ---------------------------------------------------------------------------- 1998 First Second Third Fourth ---- ------------ ------------ ------------ ------------ Net revenues $ 51,493,000 $ 52,698,000 $ 51,305,000 $ 49,656,000 ============ ============ ============ ============ Net income (loss) $ 355,000(4) $ (337,000)(4)(5) $ 800,000 $ (3,901,000)(2)(5) ============ ============ ============ ============ Basic and diluted earnings (loss) per share $ .07(4) $ (.06)(4)(5) $ .15 $ (.72)(2)(5) ============ ============ ============ ============
- ---------- (1) Includes the write off of certain deferred charges of $277,000, net of tax, due to mandated change in accounting principle. (See Note 2.) (2) Includes non-recurring charges primarily related to SFAS No. 121 asset impairment. (See Note 16.) (3) Includes the write-off of deferred tax assets totaling $12,802,000. (See Note 12). (4) Includes the negative impact resulting from the decertification of two nursing homes from participation in the Medicare and Medicaid programs. (5) Includes non-recurring charges primarily related to conversion of management information systems as well as legal and contractual settlements. (See Note 16.) F-33 89 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Advocat Inc.: We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Advocat Inc. and subsidiaries, included in this Annual Report on Form 10-K and have issued our report thereon dated March 21, 2000. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The financial statement schedule listed in the index under Item 16(b) is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements, and, in our opinion, fairly states in all material respect the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Nashville, Tennessee March 28, 2000 S-1 90 ADVOCAT INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
Column a Column B Column C Column D Column E - ----------- ------------ ------------------------------------------------ ------------- ------------ Additions ------------------------------------------------ Balance At Charged Balance Beginning to Charged At of Costs and to Other End of Description Period Expenses Accounts Other Deductions(1) Period - ----------- ------------ ------------ ------------ ------------ ------------- ------------ Year ended December 31, 1999: Allowance for doubtful accounts $ 2,650 $ 7,037 $ -- $ 100 $ (4,829) $ 4,958 ============ ============ ============ ============ ============ ============ Year ended December 31, 1998: Allowance for doubtful accounts $ 2,702 $ 2,306 $ -- $ -- $ (2,358) $ 2,650 ============ ============ ============ ============ ============ ============ Year ended December 31, 1997: Allowance for doubtful accounts $ 2,524 $ 2,030 $ -- $ -- $ (1,852) $ 2,702 ============ ============ ============ ============ ============ ============
- ---------- (1) Amounts written off as uncollectible accounts, net of recoveries. S-2 91
Exhibit Number Description of Exhibits ------ ----------------------- 2.1 Asset Purchase Agreement among the Company, Pierce Management Group First Partnership and others dated July 23, 1997 (incorporated by reference to Exhibit 2 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 1997). 3.1 Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement No. 33-76150 on Form S-1). 3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement No. 33-76150 on Form S-1). 3.3 Amendment to Certificate of Incorporation dated March 23, 1995 (incorporated by reference to Exhibit A of Exhibit 1 to the Company's Form 8-A filed March 30, 1995). 4.1 Form of Common Stock Certificate (incorporated by reference to Exhibit 4 to the Company's Registration Statement No. 33-76150 on Form S-1). 4.2 Rights Agreement dated March 13, 1995, between the Company and Third National Bank in Nashville (incorporated by reference to Exhibit 1 to the Company's Current Report on Form 8-K dated March 13, 1995). 4.3 Summary of Shareholder Rights Plan adopted March 13, 1995 (incorporated by reference to Exhibit B of Exhibit 1 to Form 8-A filed March 30, 1995). 4.4 Rights Agreement of Advocat Inc. dated March 23, 1995 (incorporated by reference to Exhibit 1 to Form 8-A filed March 30, 1995). 4.5 Amended and Restated Rights Agreement dated as of December 7, 1998 (incorporated by reference to Exhibit 1 to Form 8-A/A filed December 7, 1998). 10.1 Asset Contribution Agreement among Counsel Corporation and Certain of its Direct and Indirect Subsidiaries dated May 10, 1994 (incorporated by reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.2 Asset Contribution Agreement among Diversicare Inc. and Certain of its Direct and Indirect Subsidiaries dated May 10, 1994 (incorporated by reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).
92
Exhibit Number Description of Exhibits ------ ----------------------- 10.3 1994 Incentive and Non-Qualified Stock Plan for Key Personnel (incorporated by reference to Exhibit 10.3 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.4 1994 Non-Qualified Stock Option Plan for Directors (incorporated by reference to Exhibit 10.4 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.5 Master Agreement and Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.6 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.6 1994 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.7 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.7 Form of Employment Agreements dated May 10, 1994, between the Registrant and Dr. Birkett, Mr. Richardson and Ms. Hamlett (incorporated by reference to Exhibit 10.8 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.8 Form of Director Indemnification Agreement (incorporated by reference to Exhibit 10.8 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.9 Separation Agreement dated as of June 30, 1999, by and between Mary Margaret Hamlett and the Company (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999). 10.10 Employment Agreement dated June 28, 1999 by and between the Company and Charles H. Rinne (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999). 10.11 Employment Agreement dated June 28, 1999 by and between the Company and Richard Vacek (incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999. 10.12 Master Lease Agreement dated August 14, 1992, between Diversicare Corporation of America and Omega Healthcare Investors, Inc. (incorporated
2 93
Exhibit Number Description of Exhibits ------ ----------------------- by reference to Exhibit 10.12 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.13 Consent, Assignment and Amendment Agreement between Diversicare Corporation of America, Counsel Nursing Properties, Inc., Advocat Inc., Diversicare Leasing Corporation and Omega Healthcare Investors, Inc. dated May 10, 1994 (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.14 Advocat Inc. Guaranty in favor of Omega Healthcare Investors, Inc. dated May 10, 1994 (incorporated by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.15 Consolidation, Modification and Renewal Note dated August 30, 1991, by Diversicare Nursing Centers, Inc. to the order of Sovran Bank/Tennessee (incorporated by reference to Exhibit 10.19 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.16 Wraparound Promissory Note dated August 30, 1991, by Texas Diversicare Limited Partnership and Diversicare Nursing Centers, Inc. (incorporated by reference to Exhibit 10.20 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.17 Management Agreement dated August 30, 1991, between Texas Diversicare Limited Partnership and Diversicare Corporation of America, as assigned effective October 1, 1991, to Diversicare Management, with consent of Texas Diversicare Limited Partnership, as amended (incorporated by reference to Exhibit 10.21 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.18 Amended and Restated Limited Partnership Agreement dated August 30, 1991, among Diversicare General Partner, Inc., J. Scott Jackson and each Limited Partner (incorporated by reference to Exhibit 10.22 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.19 Participation Agreement dated August 30, 1991, between Texas Diversicare Limited Partnership and Diversicare Corporation of America (incorporated by reference to Exhibit 10.23 to the Company's Registration Statement No. 33-76150 on Form S-1).
3 94
Exhibit Number Description of Exhibits ------ ----------------------- 10.20 Agreement of Purchase and Sale entered into August 30, 1991, among Diversicare Corporation of America, Texas Diversicare Limited Partnership' and Diversicare Corporation of America (incorporated by reference to Exhibit 10.25 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.21 Partnership Services Agreement entered into August 30, 1991, among Texas Diversicare Limited Partnership, Diversicare Incorporated and Counsel Property Corporation (incorporated by reference to Exhibit 10.26 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.22 Guaranteed Return Loan Security Agreement entered into August 30, 1991, between Texas Diversicare Limited Partnership and Diversicare Incorporated (incorporated by reference to Exhibit 10.27 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.23 Credit and Security Agreement dated October 12, 1994, between NationsBank of Tennessee, N.A., the Company and the Company's subsidiaries (incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.24 Promissory Note by Advocat Inc. to the order of Diversicare Inc. dated May 10, 1994 (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.25 Promissory Note by Advocat Inc. to the order of Counsel Nursing Properties, Inc. dated May 10, 1994 (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.26 Demand Master Promissory Note by Advocat Inc. to the order of Diversicare Corporation of America dated May 10, 1994 (incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.27 Lease Agreement between Counsel Healthcare Assets Inc. and Counsel Nursing Properties, Inc. dated May 10, 1994 (incorporated by reference to Exhibit 10.24 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.28 Lease Agreement between Counsel Healthcare Assets Inc. and Counsel Nursing Properties, Inc. dated May 10, 1994 (incorporated by reference to
4 95
Exhibit Number Description of Exhibits ------ ----------------------- Exhibit 10.25 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.29 Management and Guaranteed Return Loan Agreement dated as of November 30, 1985, between Diversicare VI Limited Partnership and Diversicare Incorporated, an Ontario corporation, as amended, as assigned effective October 1, 1991, to Diversicare Management Services Co., with consent of Diversicare VI Limited Partnership (incorporated by reference to Exhibit 10.34 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.30 Management Agreement dated August 24, 1981, between Americare Corporation and Diversicare Corporation of America, as assigned to Diversicare Management Services Co., with consent of Americare Corporation (incorporated by reference to Exhibit 10.36 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.31 Management Agreement between Counsel Healthcare Assets, Inc., an Ontario corporation and Counsel Nursing Properties, Inc. dated April 30, 1994, as assigned effective May 10, 1994, to Diversicare Canada Management Services Co., Inc (incorporated by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.32 Lease Agreement between Spring Hill Medical, Inc. and First American HealthCare, Inc. dated February 1, 1994 (incorporated by reference to Exhibit 10.38 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.33 Lease Agreement, as amended, between Bryson Hill Associates of Alabama, Inc. and Estates Nursing Homes, Inc. dated June 15, 1984, as assigned effective May 10, 1994, to Diversicare Leasing Corp. (incorporated by reference to Exhibit 10.39 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.34 Lease Agreement between HealthCare Ventures and Wessex Care Corporation dated October 23, 1989, as assigned effective May 10, 1994, to Diversicare Leasing Corp. (incorporated by reference to Exhibit 10.40 to the Company's Registration Statement No. 33-76150 on Form S-1).
5 96
Exhibit Number Description of Exhibits ------ ----------------------- 10.35 Lease Agreement between Osborne & Wilson Development Corp., Inc. and Diversicare Corporation of America dated July 7, 1989, as assigned effective May 10, 1994, to Diversicare Leasing Corp. (incorporated by reference to Exhibit 10.41 to the Company's Registration Statement No. 33-76150 on Form S-1). 10.36 Florida Lease Agreement between Counsel Nursing Properties, Inc. and Diversicare Leasing Corp. dated May 10, 1994 (incorporated by reference to Exhibit 10.33 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.37 Lease Agreement between Counsel Nursing Properties, Inc. and Diversicare Leasing Corp. dated May 10, 1994 (incorporated by reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.38 Letter Agreement dated November 23, 1994, among Advocat Inc., Omega Healthcare Investors, Inc., Sterling Health Care Centers, Inc. and E.B. Lowman, II (incorporated by reference to Exhibit 10.36 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.39 Assignment and Assumption Agreement of Master Lease dated September 1, 1995, between Sterling Health Care Management, Inc., Diversicare Leasing Corp. and Sterling Acquisition Corp (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995). 10.40 Master Lease dated December 1, 1994, between Sterling Health Care Management, Inc. and Sterling Acquisition Corp (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995). 10.41 Assignment and Assumption Agreement of Master Sublease dated September 1, 1995, between Sterling Health Care Management, Inc., Diversicare Leasing Corp. and O S Leasing Company (incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995). 10.42 Master Sublease dated December 1, 1994, between Sterling Health Care Management, Inc. and O S Leasing Company (incorporated by reference to
6 97
Exhibit Number Description of Exhibits ------ ----------------------- Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995). 10.43 Letter of Credit Agreement dated September 1, 1995, between Omega Health Care Investors, Inc., Sterling Acquisition Corp., Sterling Acquisition Corp II, O S Leasing Company and Diversicare Leasing Corp (incorporated by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995). 10.44 Advocat Inc. Guaranty dated September 1, 1995, in favor of Omega Health Care Investors, Inc., Sterling Acquisition Corp., Sterling Acquisition Corp. II and O S Leasing Company (incorporated by reference to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995). 10.45 Management Agreement between Diversicare Management Services Co. and Emerald-Cedar Hill, Inc. dated February 20, 1996 (incorporated by reference to Exhibit 10.43 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.46 Management Agreement between Diversicare Management Services Co. and Emerald-Golfcrest, Inc. dated February 20, 1996 (incorporated by reference to Exhibit 10.44 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.47 Management Agreement between Diversicare Management Services Co. and Emerald-Golfview, Inc. dated February 20, 1996 (incorporated by reference to Exhibit 10.45 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.48 Management Agreement between Diversicare Management Services Co. and Emerald-Southern Pines, Inc. dated February 20, 1996 (incorporated by reference to Exhibit 10.46 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.49 Loan Agreement between Omega Healthcare Investors, Inc. and Diversicare Leasing Corp., d/b/a Good Samaritan Nursing Home, dated February 20, 1996 (incorporated by reference to Exhibit 10.47 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995).
7 98
Exhibit Number Description of Exhibits ------ ----------------------- 10.50 Short Term Note by Diversicare Leasing Corp. to Omega Healthcare Investors, Inc. dated February 20, 1996 (incorporated by reference to Exhibit 10.48 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.51 Advocat Inc. Guaranty in favor of Omega Healthcare Investors, Inc. dated February 20, 1996 (incorporated by reference to Exhibit 10.49 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.52 First Amendment to Credit and Security Agreement dated November 28, 1995, between NationsBank of Tennessee, N.A., Advocat Inc. and the Subsidiaries (as defined) (incorporated by reference to Exhibit 10.50 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.53 Second Amendment to Credit and Security Agreement dated December 1, 1995, between NationsBank of Tennessee, N.A., Advocat Inc. and the Subsidiaries (as defined) (incorporated by reference to Exhibit 10.51 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.54 Third Amendment to Credit and Security Agreement dated December 1, 1995, between NationsBank of Tennessee, N.A., Advocat Inc. and the Subsidiaries (as defined) (incorporated by reference to Exhibit 10.52 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.55 Fourth Amendment to Credit and Security Agreement dated April 1, 1996, between NationsBank of Tennessee, N.A., Advocat Inc. and the Subsidiaries (as defined) (incorporated by reference to Exhibit 10.53 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1996). 10.56 Fifth Amendment to Credit and Security Agreement dated May 1, 1996, between NationsBank of Tennessee, N.A., Advocat Inc. and the Subsidiaries (as defined) (incorporated by reference to Exhibit 10.54 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1996).
8 99
Exhibit Number Description of Exhibits ------ ----------------------- 10.57 Sixth Amendment to Credit and Security Agreement dated June 28, 1996, between NationsBank of Tennessee, N.A., Advocat IInc. and the Subsidiaries (as defined) (incorporated by reference to Exhibit 10.55 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996). 10.58 Seventh Amendment to Credit and Security Agreement dated September 1, 1996, between NationsBank of Tennessee, N.A., Advocat Inc. and the Subsidiaries (as defined) (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996). 10.59 Eighth Amendment to Credit and Security Agreement dated November 1, 1996, between NationsBank of Tennessee, N.A., Advocat Inc. and the Subsidiaries (as defined) (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996). 10.60 Master Credit and Security Agreement dated December 27, 1996, between First American National Bank, GMAC-CM Commercial Mortgage Corporation, Advocat Inc., Management Services Co. and the Subsidiaries (as defined) (incorporated by reference to Exhibit 10.58 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996). 10.61 Project Loan Agreement (Good Samaritan) dated December 27, 1996, between GMAC-CM Commercial Mortgage Corporation Advocat Inc., Diversicare Management Services Co. and the Subsidiaries (as defined) (incorporated by reference to Exhibit 10.59 to the Company's Annual Report on Form for the fiscal year ended December 31, 1996). 10.62 Project Loan Agreement (Afton Oaks) dated December 27, 1996between GMAC-CM Commercial Mortgage Corporation, Advocat Inc., Diversicare Management Services Co. and the Subsidiaries (as defined) (incorporated by reference Exhibit 10.60 to the Company's Annual Report on Form for the fiscal year ended December 31, 1996). 10.63 Project Loan Agreement (Pinedale) dated December 27, 1996, between GMAC-CM Commercial Mortgage Corporation, Advocat Inc., Diversicare Management Services Co. and the Subsidiaries (as defined) (incorporated by reference Exhibit 10.61 to the Company's Annual Report on Form for the fiscal year ended December 31, 1996).
9 100
Exhibit Number Description of Exhibits ------ ----------------------- 10.64 Project Loan Agreement (Windsor House) dated December 27 1996, between GMAC-CM Commercial Mortgage Corporation, Advocat Inc., Diversicare Management Services Co. and Subsidiaries (as defined) (incorporated by reference to Exhibit 10.62 to the Company's Annual Report on Form for the fiscal year ended December 31, 1996). 10.65 Asset Purchase Agreement dated November 30, 1995, Williams Nursing Homes Inc., d/b/a Afton Oaks Center, Lynn Mayers, Thomas E. Mayers, and Diversicare Leasing Corp. (incorporated by reference to Exhibit 2.1 the Company's Current Report on Form 8-K dated November 30, 1995). 10.66 Purchase Agreement between Diversicare Leasing Corporation and Americare Corporation dated February 20, 1996 (incorporated by reference to Exhibit 2.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.67 Amendment to 1994 Incentive and Non-Qualified Stock Plan for Key Personnel (incorporated by reference to Exhibit A to the Company's Schedule 14A filed March 31, 1997). 10.68 Amendment to 1994 Non-Qualified Stock Option Plan for Directors (incorporated by reference to Exhibit A to the Company's Schedule 14A filed April 19, 1996). 10.69 Amendment No. 3 Advocat Inc. 1994 Incentive and Nonqualified Stock Option Plan For Key Personnel (incorporated by reference to Exhibit A to the Company's Schedule 14A filed April 3, 1998). 10.70 Renewal and Modification Promissory Note dated March 31, 1998, between the Company and AmSouth Bank.(incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1998). 10.71 Renewal and Modification Promissory Note dated March 31, 1998, between the Company and First American National Bank (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996). 10.72 Second Amendment to Loan and Negative Pledge Agreement dated March 31, 1998, between Diversicare Assisted Living Services NC, LLC and First American National Bank, both individually and as Agent for AmSouth Bank
10 101
Exhibit Number Description of Exhibits ------ ----------------------- (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996). 10.73 Loan Agreement dated the 4th day of June, 1999, by and between Diversicare Assisted Living Services Nc II, LLC, a Delaware limited liability company and GMAC Commercial Mortgage Corporation, a California corporation (incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999). 10.74 Loan Agreement dated the 4th day of June, 1999, by and between Diversicare Assisted Living Services NC I, LLC, a Delaware limited liability company and GMAC Commercial Mortgage Corporation, a California corporation (incorporated by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999). 10.75 Fourth Amendment to Master Credit and Security Agreement dated as of April 14, 1999 (incorporated by reference to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999). 10.76 Form of Fifth Amendment to Master Credit and Security Agreement between Diversicare Management Services Co. and First American National Bank (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999). 10.77 Fourth Amendment to Loan and Negative Pledge Agreement dated October 1, 1999 between Diversicare Assisted Living Services NC, LLC. and First American National Bank along with AmSouth Bank (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999). 10.78 Line of Credit Note (Overline Facility) dated October 1, 1999 between Diversicare Management Services Co. and First American National Bank (incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999). 10.79 Fifth Amendment to Loan and Negative Pledge Agreement dated December 1, 1999 between Diversicare Assisted Living Services PC, LLC and First American National Bank along with AmSouth Bank (incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q/A for the quarter ended September 30, 1999).
11 102
Exhibit Number Description of Exhibits ------ ----------------------- 10.80 Sixth Amendment to Master Credit and Security Agreement dated December 1, 1999 between Diversicare Management Services Co. and First American National Bank along with GMAC Commercial Mortgage Company (incorporated by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q/A for the quarter ended September 30, 1999). 10.81 Amendments to Promissory Notes dated November 30, 1999 between Diversicare Management Services Co. and GMAC Commercial Mortgage Corporation. (Four amendments extending the term to April 30, 2000 on four notes totaling $11.1 million.)(incorporated by reference to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q/A for the quarter ended September 30, 1999). 21 Subsidiaries of the Registrant. 23 Consent of Arthur Andersen LLP. 27 Financial Data Schedule (for SEC use only).
12 EX-21 2 SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21 SUBSIDIARIES NAME OF CORPORATION STATE OF INCORPORATION - ------------------- ---------------------- Advocat Ancillary Services, Inc. Tennessee Advocat Distribution Services, Inc. Tennessee Advocat Finance, Inc. Delaware Diversicare Assisted Living Services, Inc. Tennessee Diversicare Assisted Living Services NC, LLC Tennessee Diversicare Assisted Living Services NC I, LLC Delaware Diversicare Assisted Living Services NC II, LLC Delaware Diversicare Canada Management Services Co., Inc. Ontario, Canada Diversicare General Partner, Inc. Texas Diversicare Leasing Corp. Tennessee Diversicare Leasing Corp. of Alabama Alabama Diversicare Management Services Co. Tennessee First American Health Care, Inc. Alabama Sterling Health Care Management, Inc. Kentucky 13 EX-23 3 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K of Advocat Inc. and subsidiaries into the Company's previously filed Registration Statement File Numbers 33-93940, 33-93946 and 33-93950. ARTHUR ANDERSEN LLP Nashville, Tennessee March 28, 2000 EX-27 4 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS OF ADVOCAT INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH ANNUAL REPORT ON FORM 10-K FOR THE ANNUAL PERIOD ENDED DECEMBER 31, 1999. 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 1,913 0 16,777 4,958 754 15,199 87,667 19,015 96,185 71,898 0 0 0 55 6,212 96,185 0 182,018 0 195,812 0 7,037 5,459 (13,794) 7,605 (21,399) 0 0 (277) (21,676) (3.98) (3.98)
-----END PRIVACY-ENHANCED MESSAGE-----