-----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, NAfwy8uTYfC+x84P+RTwBufIgJ+SmsGBwP/g8p0muf8RUsmIcdYMZNJFCFpvcE6t nGsTqEShjhyGETokpbY24g== 0000950144-01-004669.txt : 20010409 0000950144-01-004669.hdr.sgml : 20010409 ACCESSION NUMBER: 0000950144-01-004669 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 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: 1591772 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 g68202e10-k405.txt 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, 2000 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.)
37067 277 MALLORY STATION ROAD, SUITE 130, FRANKLIN, TN ----------- --------------------------------------------------- (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) 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
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 30, 2001 (BASED ON THE CLOSING PRICE OF SUCH SHARES ON THE NASD OTC MARKET) WAS $5,279,785. 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 30, 2001, 5,491,621 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, the increased cost or borrowing under the Company's credit agreements, covenant waivers from the Company's lenders, possible amendments to the Company's credit agreements, ability to control ultimate professional liability costs, the impact of future licensing surveys, changing economic conditions as well as others. Investors also should refer to the risks identified in Item 1 - Business - Risk Factors and "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of various risk factors of the Company and that are inherent in the health care 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. 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 four 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 elder care services; (ii) forming strategic alliances with other health care providers to expand the Company's continuum of care; and (iii) clustering its operations on a regional basis. Key elements of the Company's growth strategy are to increase revenue and profitability at existing facilities, emphasize development of joint ventures in Canada pursue additional management contract opportunities, pursue additional opportunities for ancillary distribution series and develop service bureau types of business, including senior employment agencies, senior vocational training sites and home care services with a non-capital intensive focus. 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. The Company's web site is located at IRINFO.COM/AVC. The information on the Company's web site does not constitute part of this Annual Report on Form 10-K. 2 3 MATERIAL CORPORATE DEVELOPMENTS. Professional Liability Insurance The entire long-term care profession in the United States has experienced a dramatic increase in claims related to alleged negligence in providing care to its patients - the Company is no exception in this regard. 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 cost of claims against the Company and throughout the long-term care industry, the Company's professional liability insurance premiums and deductible amounts increased substantially during 1999 and 2000. These substantial premium and deductible increases have also continued for the policy year 2001. As a result of the substantial premium and deductible increases for the 2001 policy year, effective March 9, 2001, the Company has obtained professional liability insurance coverage for its United States nursing homes that could be substantially less than the claims that could be incurred during the policy period from March 9, 2001 through March 9, 2002. For claims made after March 9, 2001, the Company maintains general and professional liability insurance with coverage limits of $2,000,000 per medical incident and total aggregate policy coverage limits of $3,000,000 for its long-term care services. The 2001 policy is on a claims made basis and the Company is self-insured for the first $50,000 per occurrence. The Company has recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $6,859,000 as of December 31, 2000. Based on its assessment of claims currently outstanding against the Company and estimates for claims incurred but not reported, management currently believes that there have been no incurred claims that are in excess of established reserves and related insurance coverage. However, the ultimate results of the Company's professional liability claims and disputes are unknown at the present time. Any future judgments or settlements above the Company's per occurrence, per location or umbrella coverage could have a material adverse impact on the Company's financial position, cash flows and results of operations. In addition, the ultimate payment of professional liability claims accrued as of December 31, 2000 and claims that could be incurred during 2001 could require cash resources during 2001 that would be in excess of the Company's available cash or other resources. These potential future payments could have a material adverse impact on the Company's financial position and cash flows. Failing reform in tort law, the profession in general, and the Company in specific will continue to be vulnerable to the unbridled actions of plaintiff's bar. Operating Losses The Company has incurred operating losses during the years ended December 31, 2000, 1999 and 1998 and has limited resources available to meet its operating, capital expenditure and debt service requirements during 2001. The Company has a working capital deficit of $60.1 million as of December 31, 2000. At a minimum, the Company's cash requirements during 2001 include funding 3 4 operations (including potential payments related to professional liability claims), capital expenditures, scheduled debt service, and working capital requirements. Current Debt Maturities and Financial Covenant Non-Compliance Certain of the Company's debt agreements contain various financial covenants, the most restrictive of which relate to current ratio requirements, tangible net worth, cash flow, net income (loss), and limits on the payment of dividends to shareholders. As of December 31, 2000, the Company was not in compliance with certain of these financial covenants. The Company has not obtained waivers of the noncompliance. Cross-default or material adverse change provisions contained in the debt agreements allow the holders of substantially all of the Company's debt to demand immediate repayment. The Company would not be able to repay this indebtedness if the applicable lenders demanded 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. 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. Based on regularly scheduled debt service requirements, the Company has a total of $5.1 million of debt that must be repaid or refinanced during 2001 and an additional $6.7 million that must be repaid or refinanced in January 2002. As a result of the covenant noncompliance and other cross-default provisions, the Company has classified a total of $61.2 million of debt as current liabilities as of December 31, 2000. An event of default under the Company's debt agreements could lead to actions by the lenders that could result in an event of default under the Company's lease agreements covering a majority of its United States nursing facilities. Should such a default occur in the related lease agreements, the lessor would have the right to terminate the lease agreements. The Company is currently discussing potential waiver, amendment and refinancing alternatives with its lenders. Of the total $5.1 million of scheduled debt maturities during 2001, the Company plans to repay $2.1 million from cash generated from operations and intends to refinance the remaining $3 million. The Company's management has implemented a plan to enhance revenues related to the operations of the Company's nursing homes and assisted living facilities. Management believes that revenues in future periods will increase as a result of increased occupancy rates resulting from an increased emphasis on attracting and retaining patients and residents. Management has implemented a plan to attempt to minimize future expense increases through the elimination of excess operating costs. 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 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. Settlement and Restructuring Agreement Through September 30, 2000, the Company leased 30 nursing homes from Omega Healthcare Investors, Inc. ("Omega") under various terms and lease agreements. On November 8, 2000, the Company entered into a 10-year restructured lease agreement (the "Settlement and Restructuring Agreement") with Omega. The Settlement and Restructuring Agreement, effective as of October 1, 2000, provides for reduced future lease costs under an amended lease agreement covering all nursing homes leased from Omega (the "Omega Master Lease"). The initial term of the Omega Master Lease is ten years, expiring September 30, 2010, with an additional ten-year renewal term at the option of the Company, assuming no defaults. Under the Settlement and Restructuring Agreement, Omega has agreed to waive all defaults under the previous Omega lease agreements. The Omega Master Lease requires the Company to fund capital expenditures related to the leased facilities totaling $1,000,000 during the first two years of the initial lease term. The Company is also required to fund annual capital expenditures equal to $325 per licensed bed over the initial lease term (annual required capital expenditures of $910,000). Total required capital expenditures over the initial lease term are $10,100,000. Upon expiration of the Omega Master Lease or in the event of a default under the Omega Master Lease, the Company is required to transfer all of the leasehold improvements, equipment, furniture and fixtures of the leased facilities to Omega. In the event that the Company does not transfer all 4 5 of the facility assets to Omega, the Company will be required to pay Omega $5,000,000 plus accrued interest at 11.00% from the effective date of the Settlement and Restructuring Agreement. The Company's management intends to transfer the facility assets to Omega at the end of the lease term; consequently, the Company has not recorded a liability for the potential $5,000,000 payment and has not recorded any interest expense related to the potential $5,000,000 payment. As settlement for outstanding lease payments owed to Omega for the period prior to the Settlement and Restructuring Agreement, Omega agreed to accept a $3,000,000 payment from the Company. The payment to Omega was funded through Omega's draw upon a then outstanding letter of credit from the Company's bank lender. Prior to the Settlement and Restructuring Agreement, the Company was required to provide letters of credit totaling $4,950,000 in favor of Omega as security for its obligations under the Omega Master Lease. Pursuant to the Settlement and Restructuring Agreement, Omega agreed to draw $3,000,000 on the outstanding letters of credit and to terminate the remaining $1,150,000 letters of credit. The $3,000,000 letter of credit draw was converted into a $3,000,000 non-interest-bearing promissory note payable to the bank lender (the "Non-Accrual Note"). The entire balance of the Non-Accrual Note is due on January 15, 2002. Prior to the maturity date of January 15, 2002, the Company is required to pay all surplus cash flow (as defined in the Non-Accrual Note agreement) to the lender to reduce the balance of the Non-Accrual Note. As partial payment for Omega entering into the Settlement and Restructuring Agreement, the Company agreed to issue Omega a subordinated note payable (the "Subordinated Note") in the amount of $1,700,000. Interest on the Subordinated Note accrues at an annual rate of 7.0% (beginning effective October 1, 2000) with any unpaid principal and interest becoming due on September 30, 2007. Payments of principal and interest on the Subordinated Note are subordinated to the payment in full of the Non-Accrual Note. As further payment for Omega entering into the Settlement and Restructuring Agreement, the Company agreed to issue Omega 393,658 shares of the Company's Series B Redeemable Convertible Preferred Stock. The Company's Series B Redeemable Convertible Preferred Stock has a stated value of $3,300,000 and carries an annual dividend rate of 7% of the stated value. The dividends accrue on a daily basis whether or not declared by the Company and compound quarterly. Dividend payments on the Series B Redeemable Convertible Preferred Stock are subordinated to the payment in full of the Non-Accrual Note. The Series B Redeemable Convertible Preferred Stock shares have preference in liquidation but do not have voting rights. The total redemption value is equal to the stated value plus any accrued but unpaid dividends. The liquidation preference value is equal to the redemption value. The holders of the Series B Redeemable Convertible Preferred Stock may convert their preferred shares and accrued dividends to common stock at their option at any time based on a conversion price per share of $4.67, subject to adjustment. Beginning on the earlier of a default under the Omega Master Lease agreement or September 30, 2007, Omega has the right to require the Company to redeem the Series B Redeemable Convertible Preferred Stock shares at the redemption price of $3,300,000 plus accrued and unpaid dividends. 5 6 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, quality of resident care, 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 resident care. Such requirements are both subjective and 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 exclusion 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. The Company is currently a defendant in two pending false claims actions as described below. On October 17, 2000, the Company was served with a civil complaint by the Florida Attorney General's office, in the case of State of Florida ex rel. Mindy Myers v. R. Brent Maggio, et al. In this case, the State of Florida has accused multiple defendants of violating Florida's False Claims Act. The Company, in its capacity as the manager of four nursing homes owned by Emerald Coast Healthcare, Inc. ("Emerald"), is named in the complaint, which accuses the Company of making illegal kickback payments to R. Brent Maggio, Emerald's sole shareholder, and fraudulently concealing such payments in the Medicaid cost reports filed by the nursing homes. The Company believes that it has meritorious defenses to this case, and intends to vigorously pursue these defenses in litigation. Currently, there are several motions by the Company seeking dismissal of this complaint that are pending before the trial court. Under the Federal False Claims Act, health care companies may be named as a defendant in an action which is filed under court seal, without being informed of this fact until the government has substantially completed its investigation. In such cases, there sometimes occurs a provision for "partial lifting of the seal," in which the trial court orders that the seal may be lifted for purposes of giving the named defendant the opportunity to informally present its defenses and discuss settlement prospects with the government. In cases in which the judge orders such a "partial lifting of the seal," the defendant becomes aware of the case but is precluded from discussing it publicly. Management is aware of one such case being filed in federal court against the Company regarding billing practices at one of its nursing homes. The Company has retained counsel to defend it in this case and, while cooperating with the government in its investigation of the matter, intends to vigorously pursue its defense of the case. Based on all information currently known, the Company currently does not believe that the claims being made in this case are material to the Company's financial condition, cash flows or results of operations. While the Company cannot currently predict with certainty the ultimate impact of either of the above cases on the Company's financial condition, cash flows or results of operations, an unfavorable outcome in any state or federal False Claims Act case could subject the Company to fines, penalties and damages. Moreover, the Company could be excluded from the Medicare, Medicaid or other federally-funded health care programs, which could have a material adverse impact on the Company's financial condition, cash flows or results of operations. During 1998, 1999 and 2000, the Company experienced certain adverse regulatory issues with respect to certain facilities, including decertifications from the Medicare and Medicaid programs during 1998 and 2000. The Company also continued to experience the increased regulatory scrutiny that has been exerted on the industry in the form of increased fines and penalties. 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," 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. Revenues and expenses have both been reduced significantly from the levels prior to PPS. With respect to Medicare therapy 6 7 allowable cost and fee reductions, the Company estimates that net operations were negatively impacted in both 1999 and 2000 and will continue to be negatively impacted beyond 2000 as a result of the changes brought about under the BBA. These changes have affected the entire long-term care profession. 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%. 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. During 1999, certain amendments to the BBA were enacted. Among the changes enacted during 1999 was the Balanced Budget Reform Act of 1999 ("BBRA"). The BBRA allowed providers the option, for cost reporting years beginning on January 1, 2000, of continuing under the current PPS transition formula or adopting the full federal PPS per diem. For facilities in which it is financially advisable to make this change, the Company is so doing. Effective between April 1 and October 31, 2000, the BBRA increased certain of the highest acuity Medicare reimbursement payment categories by 15%. Effective April 1, 2000, the BBRA also increased all other Medicare payment categories by 4%. The BBRA also enacted a two-year moratorium on the proposed Part B therapy caps beginning January 1, 2000. On December 15, 2000, the Medicare, Medicaid, and State Child Health Insurance Program Benefits Improvement and Protection Act of 2000 ("BIPA") was enacted to provide up to $35 billion in additional funding to the Medicare and Medicaid programs over the next five years. Under BIPA, the nursing component for each Medicare payment category will increase by 16.66% over the current rates for skilled nursing care for the period April 1, 2001 through September 30, 2002. BIPA also will provide some relief from scheduled reductions to the annual inflation adjustments to the Medicare payment rates through September 2001. Although the refinements resulting from the BBRA and BIPA have been well received by the U.S. nursing home industry, it is the Company's belief that the resulting revenue enhancements are insufficient compared to the losses sustained by the industry due to the BBA. There is additional legislative discussion that could result in further legislative relief or the institution of administrative changes that would restore additional revenues to the United States 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, 7 8 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 repealed 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. 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, 2000, Advocat's portfolio includes 120 facilities composed of 64 nursing homes containing 7,230 licensed beds and 56 assisted living facilities containing 5,425 units. In comparison, at December 31, 1999, the Company operated 119 facilities composed of 65 nursing homes containing 7,307 licensed beds and 54 assisted living facilities containing 5,215 units. Within the current portfolio, 36 facilities are managed on behalf of other owners, 29 of which are on behalf of unrelated owners and seven 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 13 nursing homes and 23 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, 2000, 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, Nova Scotia and Alberta. 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 17 years. 8 9 As compensation for providing management services, the Company earns a management fee, which in 2000 averaged approximately 4.5% of the facilities' net patient revenues. Of the Company's 36 management agreements, 8 have more than five years remaining on their current terms, 20 have from one to three years remaining on their current terms and 8 have a current term expiring within one year, with an average remaining life of approximately 3.9 years for all contracts. INDUSTRY BACKGROUND. The long-term care profession encompasses a broad range of non-institutional and institutional services. For those among the elderly requiring temporary or limited special services, a variety of home care options exist. As needs for assistance in acts of daily living develop, assisted living facilities become the most viable and cost effective option. For those among the elderly requiring much more intensive care, skilled nursing facility care becomes the only viable option. 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 on nursing homes 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. 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. 9 10 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. Limited Supply of Facilities. As the nation's elderly population continues to grow, life expectancy continues to expand, and as there continues to be limitations on granting Certificates of Need ("CON's") for new skilled nursing facilities, management believes that there will be continued demand for skilled nursing beds in the markets in which the Company operates. The majority of states have adopted CON, or similar statutes, requiring that prior to the addition of new skilled beds, any new services, or making certain capital expenditures, a state agency must determine that a need exists for the new beds or proposed activities. The Company believes that this CON process tends to restrict the supply and availability of licensed skilled nursing facility beds. High construction costs, limitations on state and Federal government reimbursement for the full costs of construction, and start-up expenses also act to restrict growth in the supply for such facilities. At the same time, skilled nursing facility operators are continuing to focus on improving occupancy and expanding services to include high acuity subacute patients, that require significantly higher levels of skilled nursing personnel and care. As a result, the Company believes that there has been a reduction in the number of available skilled nursing beds providing services to patients with lower acuity levels, as opposed to the higher reimbursed patients with physical, more acute medical or rehabilitation needs. With this continuing trend, there should a be corresponding increase in the demand for the Company's assisted living facilities. Management also believes there is currently a moderate supply of assisted living units relative to the growing demand for assisted living services in rural and secondary markets. Although many states do not require CON's for assisted living facilities, some states impose additional limitations on the supply of these facilities. For example, North Carolina has imposed a moratorium on any addition of new beds unless there is a demonstrated need based on several criteria, such as those items noted in the original language of the law stating that county vacancy rates are less than 15%, as well as other specific factors. 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. 10 11 NURSING HOME AND ASSISTED LIVING FACILITY SERVICES. Operations. As of December 31, 2000, the Company operates 64 nursing homes with 7,230 licensed beds and 56 assisted living facilities with 5,425 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 11 1,650 -- ----- -- ----- Total..................... 51 5,436 13 1,794 == ===== == ===== Facilities Units Facilities Units ---------- ----- ---------- ----- Assisted Living Facilities(1): Owned.............................. 13 964 3 215 Leased............................. 20 1,618 5 479 Joint Venture Managed.............. 0 0 7 1,062 Managed............................ 0 0 8 1,087 -- ----- -- ----- Total..................... 33 2,582 23 2,843 == ===== == =====
- --------- (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, 2000, the Company's net patient and resident revenues were $192.0 million, or 98.0% of total net revenues. For the year ended December 31, 2000, the Company's net revenues from the provision of management services were $3.9 million, or 2.0% 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 skilled nursing health care services, including room and board, nutrition services, recreational therapy, social services, and housekeeping and laundry 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 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. 11 12 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- effective basis. 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. 12 13 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 of 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. 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. Pursue Additional Opportunities for Ancillary Distribution Services. The Company is currently evaluating opportunities to expand distribution of its ancillary services product line to a retail customer base. The Company is pursuing a web-based distribution network with certain supplier/partners. Consider Divestiture of Selected Facilities. Management is currently evaluating certain facilities for possible divestiture. There are no agreements in place, nor can there be any assurance that any divestitures will occur, though the Company will evaluate any options that could improve liquidity and/or operating results. Develop Service Bureau Type Businesses. Management is evaluating the development of service bureau types of businesses, including senior employment agencies, senior vocational training sites, and home care services with a non-capital intensive focus. 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 13 14 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 120 facilities, 36 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 28 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 2.0% in 2000. Management fees with respect to four United States facilities were reduced in 1999 because of the failure to meet defined operational thresholds. In 2000, these facilities met the 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 facilities, the Company has advanced approximately $595,000; 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 5 and 12 of the Company's Consolidated Financial Statements for more information on these advances. 14 15 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 2000 --------------------- MANAGEMENT YEAR U.S. CANADA FEES ---- ---- ------ ---------- 2001........................................ 6(1) 2 148,000(1) 2002........................................ 0 4 414,000 2003........................................ 0 2 82,000 2004........................................ 0 14 1,520,000 2005........................................ 0 4 598,000 2015........................................ 4 0 964,000 -- --- Total.............................. 10 26 == ===
- --------- (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 5 of the Company's Consolidated Financial Statements for more information with respect to the Company's relationship with TDLP. The Company currently anticipates that all of the management agreements coming due for renewal in 2001 will be renewed, except for the management agreement for the TDLP homes, which expires August 31, 2001. The Company has informed TDLP that it will continue to manage the TDLP facilities on a month by month basis beginning September 1, 2001. However, there can be no assurance that any of these agreements will be renewed. The following table summarizes the Company's net revenues derived from management services and the net revenues of the managed facilities during the years indicated (in thousands):
YEAR ENDED DECEMBER 31, ----------------------------------------- 2000 1999 1998 ------- ------ ------- Management Fees............................ $ 3,863 $ 2,932 $ 3,627 ======= ======= ======= Net Revenues of Managed Facilities......... $84,857 $75,675 $71,670 ======= ======= ======= Management Fees as a Percentage of Net Facility Revenues................ 4.6% 3.9%(1) 5.1% === === ===
- --------- (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 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 15 16 leased properties. Certain of the leases require the Company to pay certain scheduled rent increases. 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. 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 lessors' mortgage lenders. Omega Leases. On November 8, 2000, the Company entered into a 10-year restructured lease agreement (the "Settlement and Restructuring Agreement") with Omega. The Settlement and Restructuring Agreement, effective as of October 1, 2000, provides for reduced future lease costs under an amended lease agreement covering all nursing homes leased from Omega (the "Omega Master Lease"). All of the accounts receivable, equipment, inventory and other assets of the facilities leased pursuant to the Omega Master Lease have been pledged as security under the Omega Master Lease. The initial term of the Omega Master Lease is ten years, expiring September 30, 2010, with an additional ten-year renewal term at the option of the Company, assuming no defaults. Lease payments of $10,875,000 and $11,030,000 are required during the first and second years, respectively, of the Omega Master Lease. During subsequent years, increases in the lease payments are equal to the lesser of two times the consumer price index or 3.0%. The Company is recording all scheduled rent increases, including the 3.0% rent increases, as additional lease expense on a straight-line basis over the initial lease term. The Omega Master Lease also requires the Company to fund capital expenditures related to the leased facilities totaling $1,000,000 during the first two years of the initial lease term. The Company is also required to fund annual capital expenditures equal to $325 per licensed bed over the initial lease term (annual required capital expenditures of $910,000). Total required capital expenditures over the initial lease term are $10,100,000. These required capital expenditures are being depreciated on a straight-line basis over the initial lease term beginning October 1, 2000. Upon expiration of the Omega Master Lease or in the event of a default under the Omega Master Lease, the Company is required to transfer all of the leasehold improvements, equipment, furniture and fixtures of the leased facilities to Omega. In the event that the Company does not transfer all of the facility assets to Omega, the Company will be required to pay Omega $5,000,000 plus accrued interest at 11.00% from the effective date of the Settlement and Restructuring Agreement. The Company's management intends to transfer the facility assets to Omega at the end of the lease term. As of December 31, 2000, the Company is not in compliance with certain debt covenants. Such events of default under the Company's debt agreements could lead to actions by the lenders that could result in an event of default under the Omega Master Lease. Should such a default occur in the Omega Master Lease, the lessor would have the right to terminate the lease agreements. Counsel Leases. The Company leases five facilities from Counsel with a remaining term expiring in 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 all of these facilities, the Company has a right of first refusal and a purchase option at the end of the lease term. 16 17 The Company leases three additional facilities from Counsel. Omega is Counsel's mortgage lender on the three facilities. Pursuant to the Settlement and Restructuring Agreement with Omega, Counsel is required to transfer one of the facilities to Omega in exchange for the outstanding mortgage balance, at which time the facility will be leased by the Company from Omega in accordance with the terms of the Omega Master Lease. The transfer of this facility is expected to occur during 2001. Also pursuant to the Settlement and Restructuring Agreement, the Company has the right to require Counsel to transfer the remaining two facilities to Omega in exchange for the related outstanding mortgage balances, at which time the facilities are expected to be sold. The Company has the ability to receive 20% of the sale proceeds upon the sale of the two facilities. The transfer and sale of these two facilities is expected to occur during 2001. Pierce Leases. During 1997, the Company acquired leases with respect to 14 assisted living facilities from Pierce. Of the 14 facilities currently leased from Pierce, 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 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 13 facilities as a group for their fair market value. An additional sublease, which expires in 2003, is with an affiliate of Pierce. The remaining lease is a sublease that expires in 2017. 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, 2000:
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 ....................... 13 1,794 14 1,617 British Columbia .............. -0- -0- 6 799 Alberta ....................... -0- -0- 2 230 Nova Scotia ................... -0- -0- 1 197 --- ----- --- ----- 64 7,230 56 5,425 === ===== === ===== CLASSIFICATION: Owned ......................... 7 706 16 1,179 Leased ........................ 36 4,007 25 2,097 Joint Venture Managed ......... -0- -0- 7 1,062 Managed ....................... 21 2,517 8 1,087 --- ----- --- ----- Total ................ 64 7,230 56 5,425 === ===== === =====
- --------- (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. 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 generally supported by nursing and human resource personnel, 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 18 19 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 identifying quality deficiencies and solutions to these self-identified deficiencies, as well as overseeing the initiation and effectiveness of interventions. 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 routinely 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. 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. 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 some of the services offered by the Company. 19 20 The nursing homes and assisted living facilities operated by the Company compete with other facilities in their respective markets, including rehabilitation hospitals, other "skilled" 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 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. 20 21 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 enacted during 1997 (the "BBA") repealed the Boren Amendment, and the BBA requires only that 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. Certain of the 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 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. Revenues and expenses have both been reduced significantly from the levels prior to PPS. The BBA has negatively impacted the entire long-term health care industry. During 1999 and 2000, certain amendments to the BBA have been enacted, including the Balanced Budget Reform Act of 1999 ("BBRA") and the Benefits Improvement and Protection Act of 2000 ("BIPA"). The BBRA has provided legislative relief in the form of increases in certain Medicare payment rates during 2000. The BIPA is expected to continue to provide additional increases in certain Medicare payment rates during 2001. Although the refinements resulting from the BBRA and BIPA have been well received by the United States nursing home industry, it is the Company's belief that the resulting revenue enhancements are still significantly less than the losses sustained by the industry due to the BBA. 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. 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, 2000, the Company derived 15.6% and 65.7% 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 21 22 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 of clarity of these laws, there can be no absolute assurance that any health care provider, including the Company, will not be found in violation of the anti-kickback laws in any given factual situation. Strict sanctions, including exclusion from the Medicare and Medicaid programs and criminal penalties, may be imposed for violation of the anti-kickback laws. Licensure and Certification. All the Company's nursing homes must be licensed by the state in which they are located in order to accept patients, regardless of payor source. In most states, nursing homes are subject to certificate of need laws, which require the Company to obtain government approval for the construction of new nursing homes or the addition of new licensed beds to existing homes. The Company's nursing homes must comply with detailed statutory and regulatory requirements in order to qualify for licensure, as well as for certification as a provider eligible to receive payments from the Medicare and Medicaid programs. Generally, the requirements for licensure and Medicare/Medicaid 22 23 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. The facility was subsequently recertified for participation in the Medicaid and Medicare programs. An additional leased facility, located in Texas, was decertified from the Medicaid and Medicare programs during 2000. The Company is actively engaged in the application and appeal process for recertification. The Company has elected to temporarily close the facility and relocate the facility's residents to another facility operated by the Company. 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. The Company is currently a defendant in two pending false claims actions as described below. On October 17, 2000, the Company was served with a civil complaint by the Florida Attorney General's office, in the case of State of Florida ex rel. Mindy Myers v. R. Brent Maggio, et al. In this case, the State of Florida has accused multiple defendants of violating Florida's False Claims Act. The Company, in its capacity as the manager of four nursing homes owned by Emerald Coast Healthcare, Inc. ("Emerald"), is named in the complaint, which accuses the Company of making illegal kickback payments to R. Brent Maggio, Emerald's sole shareholder, and fraudulently concealing such payments in the Medicaid cost reports filed by the nursing homes. The Company believes that it has meritorious defenses to this case, and intends to vigorously pursue these defenses in litigation. Currently, there are several motions by the Company seeking dismissal of this complaint that are pending before the trial court. Under the Federal False Claims Act, health care companies may be named as a defendant in an action which is filed under court seal, without being informed of this fact until the government has substantially completed its investigation. In such cases, there sometimes occurs a provision for "partial lifting of the seal," in which the trial court orders that the seal may be lifted for purposes of giving the named defendant the opportunity to informally present its defenses and discuss settlement prospects with the government. In cases in which the judge orders such a "partial lifting of the seal," the defendant becomes aware of the case but is precluded from discussing it publicly. Management is aware of one such case being filed in federal court against the Company regarding billing practices at one of its nursing homes. The Company has retained counsel to defend it in this case and, while cooperating with the government in its investigation of the matter, intends to vigorously pursue its defense of the case. Based on all Information currently known, the Company currently does not believe that the claims being made in this case are material to the Company's financial condition, cash flows or results of operations. While the Company cannot currently predict with certainty the ultimate impact of either of the above cases on the Company's financial condition, cash flows or results of operations, an unfavorable outcome in any state or federal False Claims Act case could subject the Company to fines, penalties and damages. Moreover, the Company could be excluded from the Medicare, Medicaid or other federally-funded health care programs, which could have a material adverse impact on the Company's financial condition, cash flows or results of operations. 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. 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. 23 24 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) 2000 1999 1998 --------------------- --------------------- --------------------- Medicaid (1) $126,193 65.7% $118,571 66.3% $118,394 58.8% Medicare 29,995 15.6 25,461 14.2 44,490 22.1 Private Pay (1) 35,772 18.7 34,895 19.5 38,449 19.1 -------- ----- -------- ----- -------- ----- Total $191,960 100.0% $178,927 100.0% $201,333 100.0% ======== ===== ======== ===== ======== =====
---------------------- (1) Includes assisted living facility revenues. The mix of Medicaid, Medicare and private pay for nursing homes in 2000 was 68.1%, 19.0%, and 12.9%, 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, ------------------------------------------------------------------------------------ 2000 1999 1998 ---------------------- ---------------------- ---------------------- Medicaid (1) 1,664,241 70.3% 1,708,335 71.7% 1,747,844 72.1% Medicare 91,943 3.9 82,571 3.5 110,178 4.5 Private Pay (1) 609,836 25.8 592,134 24.8 566,834 23.4 --------- ----- --------- ----- --------- ----- Total 2,366,020 100.0% 2,383,040 100.0% 2,424,856 100.0% ========= ===== ========= ===== ========= =====
---------------------- (1) Includes assisted living facility days. The mix of Medicaid, Medicare and private pay for nursing homes in 2000 was 77.5%, 6.6% and 15.9%, respectively. The above tables include net patient revenues and the patient days of the six facilities comprising TDLP. See Note 5 of the Company's Consolidated Financial Statements. Consistent with the nursing home industry in general, changes in the mix of a facility's patient population among Medicaid, Medicare, and private pay can significantly affect the profitability of the facility's operations. For information about revenue, operating income (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 24 25 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 long-term care profession in the United States has experienced a dramatic increase in claims related to alleged negligence in providing care to its patients - the Company is no exception in this regard. 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 cost of claims against the Company and throughout the long-term care industry, the Company's professional liability insurance premiums and deductible amounts increased substantially during 1999 and 2000. These substantial premium and deductible increases have also continued for the policy year 2001. As a result of the substantial premium and deductible increases for the 2001 policy year, effective March 9, 2001, the Company has obtained professional liability insurance coverage for its United States nursing homes that could be substantially less than the claims that could be incurred during the policy period from March 9, 2001 through March 9, 2002. For claims made after March 9, 2001, the Company maintains general and professional liability insurance with coverage limits of $2,000,000 per medical incident and total aggregate policy coverage limits of $3,000,000 for its long-term care services. The 2001 policy is on a claims made basis and the Company is self-insured for the first $50,000 per occurrence. For claims made during the period March 9, 2000 through March 9, 2001, the Company is self-insured for the first $500,000 per occurrence with no aggregate limit for the Company's United States nursing homes. The policy has coverage limits of $1,000,000 per occurrence, $3,000,000 per location and $12,000,00 in the aggregate. The Company also maintains umbrella coverage of $15,000,000 in the aggregate for claims made during the period March 9, 2000 through March 9, 2001. The Company provides reserves on an actuarial basis for known and expected claims incurred during the policy period. For all policy periods beginning on or after March 9, 2000, all of the Company's professional liability policies are on a claims made basis. Prior to March 9, 2000, all of these policies are on an occurrence basis. For the policy periods January 1, 1998 through February 1, 1999, the Company is self-insured for the first $250,000 per occurrence and $2,500,000 in the aggregate per year with respect to the majority of its United States nursing homes. 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 the policy years 2000 and 1999, the Company expects to ultimately fully incur the aggregate deductible amount and has established reserves based on this expectation. The Company's United States assisted living facilities are self-insured, with respect to each location, for the first $50,000 per occurrence. The Company also maintains a $15,000,000 aggregate umbrella liability policy for claims in excess of the foregoing limits for these assisted living operations. 25 26 In Canada, the Company's professional liability claims experience and associated costs has been dramatically less than that in the United States. The Canadian facilities owned or leased by the Company are self-insured for the first $3,000 ($5,000 Canadian) per occurrence. The Company's aggregate primary coverage limit with respect to Canadian operations is $1,335,000 ($2,000,000 Canadian). The Company also maintains a $3,338,000 ($5,000,000 Canadian) aggregate umbrella policy for claims in excess of the foregoing limits for these facilities. The Company has recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $6,859,000 as of December 31, 2000. Based on its assessment of claims currently outstanding against the Company and estimates for claims incurred but not reported, management currently believes that there have been no incurred claims that are in excess of established reserves and related insurance coverage. However, the ultimate results of the Company's professional liability claims and disputes are unknown at the present time. Any future judgments or settlements above the Company's per occurrence, per location or umbrella coverage could have a material adverse impact on the Company's financial position, cash flows and results of operations. In addition, the ultimate payment of professional liability claims accrued as of December 31, 2000 and claims that could be incurred during 2001 could require cash resources during 2001 that would be in excess of the Company's available cash or other resources. These potential future payments could have a material adverse impact on the Company's financial position and cash flows. 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, 2000. 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. The Company provides reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate. The liability for reported claims and estimates for incurred but unreported claims is $820,000 and $721,000 at December 31, 2000 and 1999, respectively. The differences between actual settlements and reserves are included in expense in the year finalized. EMPLOYEES. As of February 28, 2001, the Company employed a total of approximately 5,620 individuals. Management believes that the Company's employee relations are good. Approximately 156 of the Company's United States employees are represented by a labor union and approximately 405 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 26 27 managed facilities employ approximately 3,042 individuals, approximately 1,912 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 2000, 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. RISK FACTORS. This section summarizes certain risks, among others, that should be considered by stockholders and prospective investors in the Company. Professional Liability Insurance. The entire long-term profession in the United States has experienced a dramatic increase in claims related to alleged negligence in providing care to its patients - the Company is no exception in this regard. 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 cost of claims against the Company and throughout the long-term care industry, the Company's professional liability insurance premiums and deductible amounts increased substantially during 1999 and 2000. These substantial premium increases and deductible amounts have also continued for the policy year 2001. As a result of the substantial premium increases and deductible amounts for the 2001 policy year, effective March 9, 2001, the Company has obtained professional liability insurance coverage for its United States nursing homes that could be substantially less than the claims to be incurred during the policy period from March 9, 2001 through March 9, 2002. For claims made after March 9, 2001, the Company maintains general and professional liability insurance with coverage limits of $2,000,000 per medical incident and total aggregate policy coverage limits of $3,000,000 for its long-term care services. The 2001 policy is on a claims made basis and the Company is self-insured for the first $50,000 per occurrence. Based on its assessment of claims currently outstanding against the Company and estimates for claims incurred but not reported, management currently believes that there have been no incurred claims that are in excess of established reserves and related insurance coverage. However, the ultimate results of the Company's professional liability claims and disputes are unknown at the present time. Any future judgments or settlements above the Company's per occurrence, per location or umbrella coverage could have a material adverse impact on the Company's financial position, cash flows and results of operations. In addition, the ultimate payment of professional liability claims accrued as of December 31, 2000 and claims that could be incurred during 2001 could require cash resources during 2001 that would be in 27 28 excess of the Company's available cash or other resources. These potential future payments could have a material adverse impact on the Company's financial position and cash flows. Professional liability 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. Current Debt Maturities and Financial Covenant Non-Compliance. Certain of the Company's debt agreements contain various financial covenants, the most restrictive of which relate to current ratio requirements, tangible net worth, cash flow, net income (loss), and limits on the payment of dividends to shareholders. As of December 31, 2000, the Company was not in compliance with certain of these financial covenants. The Company has not obtained waivers of the noncompliance. Cross-default or material adverse change provisions contained in the debt agreements allow the holders of substantially all of the Company's debt to demand immediate repayment. The Company would not be able to repay this indebtedness if the applicable lenders demanded 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, 2000. 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. Based on regularly scheduled debt service requirements, the Company has a total of $5.1 million of debt that must be repaid or refinanced during 2001 and an additional $6.7 million that must be repaid or refinanced in January 2002. As a result of the covenant noncompliance and other cross-default provisions, the Company has classified a total of $61.2 million of debt as current liabilities as of December 31, 2000. An event of default under the Company's debt agreements could lead to actions by the lenders that could result in an event of default under the Company's lease agreements covering a majority of its United States nursing facilities. Should such a default occur in the related lease agreements, the lessor would have the right to terminate the lease agreements. The Company is currently discussing potential waiver, amendment and refinancing alternatives with its lenders. Of the total $5.1 million of scheduled debt maturities during 2001, the Company plans to repay $2.1 million from cash generated from operations and intends to refinance the remaining $3 million. The Company's management has implemented a plan to enhance revenues related to the operations of the Company's nursing homes and assisted living facilities. Management believes that revenues in future periods will increase as a result of increased occupancy rates resulting from an increased emphasis on attracting and retaining patients and residents. Management has implemented a plan to attempt to minimize future expense increases through the elimination of excess operating costs. 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 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. Cross-Defaults Under Debt, Lease and Management Agreements and Participating Mortgage. Cross-default provisions exist in a majority of the Company's debt agreements. In addition, certain of the Company's debt agreements provide that a default under any of the Company's leases or management agreements constitutes a default under the debt agreements. The Company's Master Operating Lease with Omega provides that a default with respect to one facility is a default not only with respect to the entire Master Operating Lease, 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 the Company in the event of a default by Counsel under such participating mortgage, except in the case where such default was caused by the Company. A default under such participating mortgage or related documents is a default under the Master Operating 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 contracts. 28 29 No Assurance of Growth. The Company reported a net loss of $3.8 million for the year ended December 31, 2000 and has a working capital deficit of $60.1 million at December 31, 2000. No assurance can be given that the Company will achieve profitable operations during 2001. 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 2001. 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. During 1997, the Balanced Budget Act ("BBA") was enacted which has negatively impacted the Company's net operations. 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. Revenues and expenses have both been reduced significantly from the levels prior to PPS. The BBA has negatively impacted the entire long-term health care industry. 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 year ended December 31, 2000, approximately 65.7%, 15.6%, and 18.7% 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 29 30 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. 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. 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. The Company is currently a defendant in two pending false claims actions as described below. On October 17, 2000, the Company was served with a civil complaint by the Florida Attorney General's office, in the case of State of Florida ex rel. Mindy Myers v. R. Brent Maggio, et al. In this case, the State of Florida has accused multiple defendants of violating Florida's False Claims Act. The Company, in its capacity as the manager of four nursing homes owned by Emerald Coast Healthcare, Inc. ("Emerald"), is named in the complaint, which accuses the Company of making illegal kickback payments to R. Brent Maggio, Emerald's sole shareholder, and fraudulently concealing such payments in the Medicaid cost reports filed by the nursing homes. The Company believes that it has meritorious defenses to this case, and intends to vigorously pursue these defenses in litigation. Currently, there are several motions by the Company seeking dismissal of this complaint that are pending before the trial court. Under the Federal False Claims Act, health care companies may be named as a defendant in an action which is filed under court seal, without being informed of this fact until the government has substantially completed its investigation. In such cases, there sometimes occurs a provision for "partial lifting of the seal," in which the trial court orders that the seal may be lifted for purposes of giving the named defendant the opportunity to informally present its defenses and discuss settlement prospects with the government. In cases in which the judge orders such a "partial lifting of the seal," the defendant becomes aware of the case but is precluded from discussing it publicly. Management is aware of one such case being filed in federal court against the Company regarding billing practices at one of its nursing homes. The Company has retained counsel to defend it in this case and, while cooperating with the government in its investigation of the matter, intends to vigorously pursue its defense of the case. Based on all information currently known, the Company currently does not believe that the claims being made in this case are material to the Company's financial condition, cash flows or results of operations. While the Company cannot currently predict with certainty the ultimate impact of either of the above cases of the Company's financial condition, cash flows or results of operations, an unfavorable outcome in any state or federal False Claims Act case could subject the Company to fines, penalties and damages. Moreover, the Company could be excluded from the Medicare, Medicaid or other federally-funded health care programs, which could have a material adverse impact on the Company's financial condition, cash flows or results of operations. In order to receive Medicare and Medicaid reimbursement, the Company must be certified by Medicare and Medicaid. In recent years, the Federal Government has promulgated numerous survey, certification and enforcement rules governing long-term care facilities participating in the Medicare and Medicaid programs, which impose significant 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 1998 and 2000, two of the Company's facilities in Arkansas and Texas were 30 31 decertified from the Medicare and Medicaid programs. Since then, one facility has been recertified and another is applying for recertification. 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 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. During 1999, the New York Stock Exchange de-listed the Company's Common Stock. Trading of the Company's Common Stock is currently 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. 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. Guarantees of Partnership Cash Flows. 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 Texas Diversicare Limited Partnership ("TDLP"), a partnership in which the Company holds 23.6% ownership as of December 31, 2000. The Company has guaranteed certain cash flow requirements of TDLP for a ten-year period expiring August 31, 2001. As of December 31, 2000, the Company has provided working capital funding and requirements under the cash flow guarantee to TDLP totaling $5,838,000. The cash flow guarantee obligates the Company to provide monthly interest-free loans to TDLP. It is a virtual certainty that the Company will be required to make additional loans to TDLP 31 32 through August 31, 2001. There is no 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 400,000 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"). In November 2000, the Company issued 393,658 shares of the Company's Series B Redeemable Convertible Preferred Stock to Omega in connection with the Settlement and Restructuring Agreement. 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. 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. 32 33 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. On October 17, 2000, the Company was served with a civil complaint by the Florida Attorney General's Office, in the case of State of Florida ex rel. Mindy Myers v. R. Brent Maggio, et al., Circuit Court Case No. 99-6080, Leon County, Florida. In this case, the State of Florida accused multiple defendants of violating Florida's False Claims Act (Florida Statutes Section 68,081, et seq.). The Company, in its capacity as the manager of four nursing homes owned by Emerald Coast Healthcare, Inc. ("Emerald"), is named in Counts III and IV of the complaint, which counts accuse the company of making illegal kickback payments to R. Brent Maggio, Emerald's sole shareholder, and fraudulently concealing such payments in the Medicaid cost reports filed by the nursing homes. The Company believes that it has meritorious defenses to this case, and intends to vigorously pursue these defenses in this litigation. Currently, there are several motions by the Company seeking dismissal of this complaint that are pending before the trial court. Under the Federal False Claims Act, 31 U.S.C. Section 3729, et seq., health care companies may be a named defendant in an action which is filed under court seal, without being informed of this fact until the government has substantially completed its investigation. In such cases, there sometimes occurs a provision for "partial lifting of the seal", in which the trial court orders that the seal may be lifted for purposes of giving the named defendant the opportunity to informally present its defenses and discuss settlement prospects with the government. In cases where the judge orders such a "partial lifting of the seal," the defendant becomes aware of the case but is precluded from discussing it publicly. Management is aware of one such case being filed in federal court against Diversicare regarding billing practices at one of its owned nursing homes. The company has retained healthcare counsel to defend it in this case and, while cooperating with the government in its investigation of the matter, intends to vigorously pursue its defense of the case. Based on all information currently known, the Company does not believe that the claims being made in this case are material to the Company's financial condition, cash flows or results of operations. While the Company cannot, at this time, predict with certainty the ultimate impact of either of the aforementioned cases on the Company's business or operating results, an unfavorable outcome in any state or Federal False Claims Act case could subject the Company to fines, penalties and damages. Moreover, the Company could be excluded from Medicare, Medicaid, and other federally-funded healthcare programs, which could have a material adverse effect on the Company's financial condition or results of operations. Although the Company 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, 2000 through December 31, 2000) of the fiscal year covered by this Annual Report on Form 10-K. 33 34 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 following table sets forth the high and low prices of the common stock for each quarter in 1999 and 2000:
Period High Low ------ ----- ----- 1999 1st Quarter $6.25 $2.88 1999 2nd Quarter 2.31 1.38 1999 3rd Quarter 2.06 .88 1999 4th Quarter 1.06 .13 2000 1st Quarter .40 .14 2000 2nd Quarter .40 .19 2000 3rd Quarter .50 .21 2000 4th Quarter 1.06 .17
The Company's Common Stock has been traded since May 10, 1994. On March 30, 2001, the closing price for the Common Stock was $1.00, as reported by PCQuote.com. On March 27, 2001, there were 1,805 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, 2000, 1999, 1998, 1997 and 1996 and for the years ended December 31, 2000, 1999, 1998, 1997 and 1996 have been derived from the audited financial statements of the Company. 34 35
YEAR ENDED DECEMBER 31, --------------------------------------------------------------------------- 2000 1999 1998 1997 1996 --------- --------- --------- -------- -------- STATEMENT OF OPERATIONS DATA: (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) REVENUES: Patient revenues $ 150,071 $ 141,022 $ 166,529 $163,094 $153,582 Resident revenues 41,889 37,905 34,804 15,105 8,347 Management fees 3,863 2,932 3,627 3,886 4,152 Interest 212 159 192 158 156 --------- --------- --------- -------- -------- Net revenues 196,035 182,018 205,152 182,243 166,237 --------- --------- --------- -------- -------- EXPENSES: Operating 153,719 152,557 164,769 146,555 131,966 Lease 20,563 20,375 19,109 15,850 14,441 General and administrative 12,136 11,753 10,969 9,636 8,578 Interest 6,073 5,460 5,425 2,672 1,591 Depreciation and amortization 5,603 5,167 3,838 2,823 2,285 Non-recurring charges 1,708 500 5,859 -0- -0- --------- --------- --------- -------- -------- Total expenses 199,802 195,812 209,969 177,536 158,861 --------- --------- --------- -------- -------- INCOME (LOSS) BEFORE INCOME TAXES $ (3,767) $ (13,794) $ (4,817) $ 4,707 $ 7,376 ========= ========= ========= ======== ======== NET INCOME (LOSS) $ (3,850) $ (21,676) $ (3,083) $ 3,013 $ 4,721 ========= ========= ========= ======== ======== EARNINGS (LOSS) PER SHARE: Basic $ (.70) $ (3.98) $ (.57) $ .56 $ .89 ========= ========= ========= ======== ======== Diluted $ (.70) $ (3.98) $ (.57) $ .56 $ .89 ========= ========= ========= ======== ======== WEIGHTED AVERAGE SHARES: Basic 5,492 5,445 5,388 5,339 5,270 ========= ========= ========= ======== ======== Diluted 5,492 5,445 5,388 5,373 5,381 ========= ========= ========= ======== ======== DECEMBER 31, --------------------------------------------------------------------------- 2000 1999 1998 1997 1996 --------- --------- --------- -------- -------- BALANCE SHEET DATA: (IN THOUSANDS) Working capital (deficit) $ (60,069) $ (56,699) $ 16,233 $ 14,389 $ 13,540 ========= ========= ========= ======== ======== Total assets $ 101,756 $ 96,185 $ 121,294 $114,961 $ 74,908 ========= ========= ========= ======== ======== Long-term debt, excluding current portion $ 5,016(1) $ 7,827(2) $ 33,514 $ 58,373 $ 23,254 ========= ========= ========= ======== ======== Shareholders' equity $ 2,142 $ 6,267 $ 27,561 $ 30,733 $ 27,348 ========= ========= ========= ======== ========
- ---------------------------- (1) Because of financial covenant non-compliance as of December 31, 2000, the Company classified $56,114 of debt as current with scheduled maturities that actually begin in 2002. In the absence of the non-compliance issues, the Company's long-term debt would have been $61,129. (2) Because of financial covenant non-compliance as of December 31, 1999, the Company classified $25,903 of debt as current 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. 35 36 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 four 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, 2000, Advocat's portfolio includes 120 facilities composed of 64 nursing homes containing 7,230 licensed beds and 56 assisted living facilities containing 5,425 units. In comparison, at December 31, 1999, the Company operated 119 facilities composed of 65 nursing homes containing 7,307 licensed beds and 54 assisted living facilities containing 5,215 units. Within the current portfolio, 36 facilities are managed on behalf of other owners, 29 of which are on behalf of unrelated owners and 7 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 13 nursing homes and 23 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. 36 37 OPERATING DATA The following table presents the Advocat statements of operations for the years ended December 31, 2000, 1999 and 1998, and sets forth this data as a percentage of revenues for the same years.
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------- ($ IN THOUSANDS) 2000 1999 1998 --------------------- --------------------- --------------------- Revenues: Patient revenues $ 150,071 76.5% $ 141,022 77.5% $ 166,529 81.2% Resident revenues 41,889 21.4 37,905 20.8 34,804 16.9 Management fees 3,863 2.0 2,932 1.6 3,627 1.8 Interest 212 0.1 159 0.1 192 0.1 --------- ----- --------- ----- --------- ----- Net revenues 196,035 100.0% 182,018 100.0% 205,152 100.0% --------- ----- --------- ----- --------- ----- Expenses:- Operating 153,719 78.4 152,557 83.8 164,769 80.3 Lease 20,563 10.5 20,375 11.2 19,109 9.3 General and administrative 12,136 6.2 11,753 6.5 10,969 5.3 Depreciation and amortization 5,603 2.9 5,167 2.8 3,838 1.9 Non-recurring charges 1,708 0.9 500 0.3 5,859 2.9 Interest 6,073 3.1 5,460 3.0 5,425 2.6 --------- ----- --------- ----- --------- ----- Total expenses 199,802 101.9 195,812 107.6 209,969 102.3 --------- ----- --------- ----- --------- ----- Loss before income taxes (3,767) (1.9) (13,794) (7.6) (4,817) (2.3) Provision (benefit) for income taxes 83 0.0 7,605 4.2 (1,734) (0.8) --------- ----- --------- ----- --------- ----- Loss before cumulative effect of change in accounting principle (3,850) (2.0) (21,399) (11.8) (3,083) (1.5) Cumulative effect of change in accounting principle, net of tax -0- 0.0 (277) (0.2) -0- 0.0 --------- ----- --------- ----- --------- ----- Net loss $ (3,850) (2.0)% $ (21,676) (11.9)% $ (3,083) (1.5)% ========= ===== ========= ===== ========= =====
The Company has incurred losses during 2000, 1999 and 1998. The Company has a working capital deficit of $60.1 million as of December 31, 2000. Also, the Company has limited resources available to meet its operating, capital expenditure and debt service requirements during 2001. Given that events of default exist under the Company's working capital line of credit, there can be no assurances that the respective lender will continue to provide working capital advances. 37 38 The following tables present data about the facilities operated by the Company as of the dates or for the years indicated:
DECEMBER 31, ------------------------------------- 2000 1999 1998 ------- ------- ------- Licensed Nursing Home Beds: Owned............................ 706 706 706 Leased........................... 4,007 4,007 4,158 Managed.......................... 2,517 2,594 2,318 ------- ------- ------- Total.......................... 7,230 7,307 7,182 ======= ======= ======= Assisted Living Units: Owned............................ 1,179 1,216 1,302 Leased........................... 2,097 2,073 1,883 Managed(1)....................... 2,149 1,926 1,570 ------- ------- ------- Total.......................... 5,425 5,215 4,755 ======= ======= ======= Total Beds/Units: Owned............................ 1,885 1,922 2,008 Leased........................... 6,104 6,080 6,041 Managed(1)....................... 4,666 4,520 3,888 ------- ------- ------- Total.......................... 12,655 12,522 11,937 ======= ======= ======= Facilities: Owned............................ 23 23 24 Leased........................... 61 61 61 Managed(1)....................... 36 35 30 ------- ------- ------- Total.......................... 120 119 115 ======= ======= =======
- --------------- (1) Includes, as of December 31, 2000, seven assisted living facilities with 1,062 units in which the Company holds a minority equity interest.
YEAR ENDED DECEMBER 31, ------------------------- 2000 1999 1998 ---- ---- ---- Average Occupancy(1): Leased/Owned(2).................................... 76.7% 76.0% 81.6% Managed............................................ 90.6 93.9 95.6 ---- ---- ---- Total....................................... 80.7% 81.7% 84.9% ==== ==== ====
- --------------- (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. 38 39 SETTLEMENT AND RESTRUCTURING AGREEMENT Effective October 1, 2000, the Company entered into agreements which modified existing debt and lease agreements as follows: Amendments to Omega Lease Agreements During 1998, 1999 and through September 30, 2000, the Company leased 30 nursing homes from Omega Healthcare Investors, Inc. ("Omega") under various terms and lease agreements. On November 8, 2000, the Company entered into a 10-year restructured lease agreement (the "Settlement and Restructuring Agreement") with Omega. The Settlement and Restructuring Agreement, effective as of October 1, 2000, provides for reduced future lease costs under an amended lease agreement covering all nursing homes leased from Omega (the "Omega Master Lease"). The initial term of the Omega Master Lease is ten years, expiring September 30, 2010, with an additional ten-year renewal term at the option of the Company, assuming no defaults. Under the Settlement and Restructuring Agreement, Omega has agreed to waive all defaults under the previous Omega lease agreements. Non-Accrual Note Payable As settlement for outstanding lease payments owed to Omega for the period prior to the Settlement and Restructuring Agreement, Omega agreed to accept a $3,000,000 payment from the Company. The payment to Omega was funded through Omega's draw upon a then outstanding letter of credit from the Company's bank lender. Prior to the Settlement and Restructuring Agreement, the Company was required to provide letters of credit totaling $4,950,000 in favor of Omega as security for its obligations under the Omega Master Lease. Pursuant to the Settlement and Restructuring Agreement, Omega agreed to draw $3,000,000 on the outstanding letters of credit and to terminate the remaining $1,950,000 letters of credit. The $3,000,000 letter of credit draw was converted into a $3,000,000 non-interest-bearing promissory note payable to the bank lender (the "Non-Accrual Note"). The entire balance of the Non-Accrual Note is due on January 15, 2002. Subordinated Note Payable As payment for Omega entering into the Settlement and Restructuring Agreement, the Company agreed to issue Omega a subordinated note payable (the "Subordinated Note") in the amount of $1,700,000. Interest on the Subordinated Note accrues at an annual rate of 7.0% (beginning effective October 1, 2000) with any unpaid principal and interest becoming due on September 30, 2007. Payments of principal and interest on the Subordinated Note are subordinated to the payment in full of the Non-Accrual Note. Series B Redeemable Convertible Preferred Stock As further payment for Omega entering into the Settlement and Restructuring Agreement, the Company agreed to issue Omega 393,658 shares of the Company's Series B Redeemable Convertible Preferred Stock. The Company's Series B Redeemable Convertible Preferred Stock has a stated value of $3,300,000 and carries an annual dividend rate of 7% of the stated value. The dividends accrue on a daily basis whether or not declared by the Company and compound quarterly. Dividend payments on the Series B Redeemable Convertible Preferred Stock are subordinated to the payment in full of the Non-Accrual Note. The Series 39 40 B Redeemable Convertible Preferred Stock shares have preference in liquidation but do not have voting rights. The total redemption value is equal to the stated value plus any accrued but unpaid dividends. The liquidation preference value is equal to the redemption value. The holders of the Series B Redeemable Convertible Preferred Stock may convert their preferred shares and accrued dividends to common stock at their option at any time based on a conversation price per share of $4.67, subject to adjustment. Beginning on the earlier of a default under the Omega Master Lease agreement or September 30, 2007, Omega has the right to require the Company to redeem the Series B Redeemable Convertible Preferred Stock shares at the redemption price of $3,300,000 plus accrued and unpaid dividends. At December 31, 2000, total accrued but unpaid dividends amounted to $58,000 ($.15 per share) and, accordingly, the aggregate redemption value on the Series B Redeemable Convertible Preferred Stock was $3,358,000 and the per share redemption value was approximately $8.53. Deferred Lease Costs During 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. In conjunction with this sale/leaseback, the Company entered into a participating mortgage with Omega on three other facilities. The net gain on the sale/leaseback was deferred in accordance with sale/leaseback accounting and was being amortized by the Company over the related lease term as a reduction in lease expense. As of September 30, 2000, the net deferred gain totaled $2,862,000. Pursuant to the amended Omega Master Lease and the issuance of the Subordinated Note and the Series B Redeemable Convertible Preferred Stock to Omega effective October 1, 2000, total deferred lease costs of $5,000,000 were recorded by the Company. The $2,862,000 of remaining deferred gain on the 1992 sale/lease-back has been reflected as a reduction of the $5,000,000 in new deferred lease costs, resulting in net deferred lease costs of $2,138,000 as of October 1, 2000. The net deferred lease costs are being amortized as lease expense over the initial ten-year term of the Omega Master Lease. As of December 31, 2000, net deferred lease costs totaled $2,085,000. 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," 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. Revenues and expenses have both 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 were negatively impacted in both 1999 and 2000 and will continue to be negatively impacted beyond 2000 as a result of the changes brought about under the BBA. These changes have affected the entire long-term care profession. 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%. 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. 40 41 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. During 1999, certain amendments to the BBA were enacted. Among the changes enacted during 1999 was the Balanced Budget Reform Act of 1999 ("BBRA"). The BBRA allowed providers the option, for cost reporting years beginning on January 1, 2000, of continuing under the current PPS transition formula or adopting the full federal PPS per diem. For facilities in which it is financially advisable to make this change, the Company is so doing. Effective between April 1 and October 31, 2000, the BBRA increased certain of the highest acuity Medicare reimbursement payment categories by 15%. Effective April 1, 2000, the BBRA also increased all other Medicare payment categories by 4%. The BBRA also enacted a two-year moratorium on the proposed Part B therapy caps beginning January 1, 2000. On December 15, 2000, the Medicare, Medicaid, and State Child Health Insurance Program Benefits Improvement and Protection Act of 2000 ("BIPA") was enacted to provide up to $35 billion in additional funding to the Medicare and Medicaid programs over the next five years. Under BIPA, the nursing component for each Medicare payment category will increase by 16.66% over the current rates for skilled nursing care for the period April 1, 2001 through September 30, 2002. BIPA also will provide some relief from scheduled reductions to the annual inflation adjustments to the Medicare payment rates through September 2001. Although the refinements resulting from the BBRA and BIPA have been well received by the United States nursing home industry, it is the Company's belief that the resulting revenue enhancements are insufficient compared to the losses sustained by the industry due to the BBA. There is additional legislative discussion that could result in further legislative relief or the institution of administrative changes that would restore additional revenues to the United States 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. PROFESSIONAL LIABILITY INSURANCE MATTERS The entire long-term profession in the United States has experienced a dramatic increase in claims related to alleged negligence in providing care to its patients - the Company is no exception in this regard. 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 cost of claims against the Company and throughout the long-term care industry, the Company's professional liability insurance premiums and deductible amounts increased substantially during 1999 and 2000. 41 42 These substantial premium and deductible increases have also continued for the policy year 2001. As a result of the substantial premium and deductible increases for the 2001 policy year, effective March 9, 2001, the Company has obtained professional liability insurance coverage for its United States nursing homes that could be substantially less than the claims that could be incurred during the policy period from March 9, 2001 through March 9, 2002. For claims made after March 9, 2001, the Company maintains general and professional liability insurance with coverage limits of $2,000,000 per medical incident and total aggregate policy coverage limits of $3,000,000 for its long-term care services. The 2001 policy is on a claims made basis and the Company is self-insured for the first $50,000 per occurrence. For claims made during the period March 9, 2000 through March 9, 2001, the Company is self-insured for the first $500,000 per occurrence with no aggregate limit for the Company's United States nursing homes. The policy has coverage limits of $1,000,000 per occurrence, $3,000,000 per location and $12 million in the aggregate. The Company also maintains umbrella coverage of $15 million in the aggregate for claims made during the period March 9, 2000 through March 9, 2001. The Company provides reserves on an actuarial basis for known and expected claims incurred during the policy period. For all policy periods beginning on or after March 9, 2000, all of the Company's professional liability policies are on a claims made basis. Prior to March 9, 2000, all of these policies are on an occurrence basis. For the policy periods January 1, 1998 through February 1, 1999, the Company is self-insured for the first $250,000 per occurrence and $2,500,000 in the aggregate per year with respect to the majority of its United States nursing homes. 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 the policy years 2000 and 1999, the Company expects to ultimately fully incur the aggregate deductible amount and has established reserves based on this expectation. The Company's United States assisted living facilities are self-insured, with respect to each location, for the first $50,000 per occurrence. The Company also maintains a $15,000,000 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 are self-insured for the first $3,000 ($5,000 Canadian) per occurrence. The Company's aggregate primary coverage limit with respect to Canadian operations is $1,335,000 ($2,000,000 Canadian). The Company also maintains a $3,338,000 ($5,000,000 Canadian) aggregate umbrella policy for claims in excess of the foregoing limits for these facilities. The Company has recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $6,859,000 and $4,393,000 at December 31, 2000 and 1999, respectively. Based on its assessment of claims currently outstanding against the Company and estimates for claims incurred but not reported, management currently believes that there have been no incurred claims that are in excess of established reserves and related insurance coverage. However, the ultimate results of the Company's professional liability claims and disputes are unknown at the present time. Any future judgments or settlements above the Company's per occurrence, per location or umbrella coverage could have a material adverse impact on the Company's financial position, cash flows and results of operations. In addition, the eventual payment of professional liability claims already incurred as of December 31, 2000 and claims that could be incurred during 2001 will require significant cash resources and could have a material adverse impact on the Company's financial position, cash flows and future results of operations. 42 43 NON-RECURRING CHARGES During the second, third and fourth quarters of 2000, the Company recorded non-recurring charges of $1,708,000. 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:
2000 1999 1999 ----------- --------- ----------- Legal and advisory fees incurred $ 1,708,000 $ -0- $ -0- in conjunction with amendment of lease and debt agreements Impaired Assets -0- 500,000 2,858,000 Information Systems Conversion -0- -0- 1,166,000 Legal and Contractual Settlements -0- -0- 1,276,000 Termination of Proposed Financing and Acquisition Transactions -0- -0- 559,000 ----------- --------- ----------- $ 1,708,000 $ 500,000 $ 5,859,000 =========== ========= ===========
As discussed above, the Company entered into a Settlement and Restructuring Agreement with Omega on November 8, 2000. The non-recurring charges recorded during 2000 represent legal and advisory fees incurred in conjunction with the Settlement and Restructuring Agreement and the related amendments to the Company's lease and debt agreements. 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 United States 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. 43 44 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. YEAR ENDED DECEMBER 31, 2000 COMPARED WITH YEAR ENDED DECEMBER 31, 1999 Revenues. Net revenues increased to $196.0 million in 2000 from $182.0 million in 1999, an increase of $14.0 million, or 7.7%. Patient revenues increased to $150.1 million in 2000 from $141.0 million in 1999, an increase of $9.1 million, or 6.4%. The increase in patient revenues is primarily attributed to increased Medicare utilization and PPS rate increases at several facilities which became effective in April 2000. In addition, several facilities in Tennessee received $1.3 million in retroactive Medicaid rate increases in August 2000. Partially offsetting these increases, the Company closed a facility in July 2000, transferring many of the residents to other Company facilities, resulting in reduced revenue by approximately $900,000 in 2000 as compared to 1999. The Company also recorded negative revenue adjustments in 1999 related to incentives which were retroactively recouped by the State of Alabama related to 1997 decertification issues and revenue that was reversed in the State of Arkansas which became uncertain. Overall occupancy for leased/owned nursing homes declined from 77.0% in 1999 to 73.4% in 2000, which was primarily due to Medicaid and private pay occupancy declines. As a percent of patient revenues for nursing homes, revenues generated from the Medicare program increased to 19.0% in 2000 from 16.9% in 1999 while Medicaid and similar programs decreased to 68.1% in 2000 from 70.0% in 1999. Resident revenues increased to $41.9 million in 2000 from $37.9 million in 1999, an increase of $4.0 million, or 10.5%. The increase in resident revenues is primarily attributable to three facilities the Company began operating in the second quarter of 1999 and rate increases related to the reimbursement of additional required personnel at the majority of the United States assisted living facilities. Ancillary service revenues, prior to contractual allowances, decreased to $22.1 million in 2000 from $23.0 million in 1999, a decrease of $900,000, or 3.9%. The decrease is primarily attributable to reductions in revenue availability under Medicare and is consistent with the Company's expectations. Management fee revenues increased to $3.9 million in 2000 from $2.9 million in 1999, an increase of $931,000, or 31.8%. The increase is due to revenue increases at facilities under management and an increase in the earned incentive management fees of approximately $800,000. The incentive management fees are earned based on the operating performance of the managed facilities. Management fees with respect to four United States facilities were less in 1999 than in 2000 because of the facilities' failure to meet operational thresholds. Operating Expenses. Operating expenses increased to $153.7 million in 2000 from $152.6 million in 1999, an increase of $1.1 million, or 0.7%. The Company continues to implement cost reductions in response to the Medicare reimbursement changes. As a percentage of patient and resident revenues, operating expense decreased to 80.1% in 2000, as compared to 85.3% in 1999. The largest component of operating expenses is wages, which increased from $80.5 million in 1999 to $83.5 million in 2000, an increase of $3.0 million, or 3.7%. Savings from staff reductions have been offset by increased wage levels due to tighter labor markets in most of the areas in which the Company operates. The Company's wage increases are generally in line with inflation. In addition, the Company increased staffing at the majority of its United States assisted living facilities to meet state regulatory requirements, resulting in increased wage expense of 44 45 approximately $975,000. The Company's professional liability costs for United States nursing homes, including insurance premiums and reserves for self-insured claims, increased from $5.6 million in 1999 to $8.4 million in 2000, an increase of $2.8 million, or 50%. As discussed above, this increase is due to the significantly increased costs of claims incurred by the industry in general and the Company's specific experience. The provision for doubtful accounts decreased from $7.0 million in 1999 to $2.8 million in 2000, a decrease of $4.2 million. In 1999, the Company determined that a substantial portion of its older receivables should be reserved. Lease Expense. Lease expense increased to $20.6 million in 2000 from $20.4 million in 1999, an increase of $0.2 million, or 1.0%. The majority of the Company's lease agreements include annual adjustments, generally tied to inflation. Partially offsetting these increases, effective October 1, 2000, the Company entered into an amended lease agreement with Omega, the primary lessor of the Company's facilities. The amended lease agreement resulted in reduced lease costs under the Omega Master Lease during the fourth quarter. The Company's minimum annual rental for 2001 is $20.5 million. General and Administrative Expense. General and administrative expense increased to $12.1 million in 2000 from $11.8 million in 1999, an increase of $383,000, or 3.3%. As a percent of total net revenues, general and administrative expense decreased to 6.2% in 2000 compared with 6.5% in 1999. The 1999 period includes a provision for severance benefits for the former Chief Financial Officer of the Company. Interest Expense. Interest expense increased to $6.1 million in 2000 from $5.5 million during 1999, an increase of $613,000, or 11.2%. This increase is primarily attributable to higher average interest rates during 2000. In addition, the Company's total average outstanding debt balance increased during 2000 as compared to 1999. Depreciation and Amortization. Depreciation and amortization expenses increased to $5.6 million in 2000 from $5.2 million in 1999, an increase of $436,000, or 8.4%. The increase is primarily attributable to additional depreciable property placed in service during 2000 and 1999. Loss Before Income Taxes; Net 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 $3.8 million in 2000 as compared with a loss of $13.8 million in 1999, a decreased loss of $10.0 million. The net loss after taxes and the cumulative effect of the change in accounting principle was $3.9 million in 2000 as compared with a net loss of $21.7 million in 1999, a decrease of $17.8 million. The net loss in 1999 includes a $7.6 million tax provision. 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 $.70 in 2000 as compared to each being a loss of $3.98 in 1999. 45 46 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 to 16.9% 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. 46 47 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. 47 48 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. LIQUIDITY AND CAPITAL RESOURCES At December 31, 2000, the Company had negative working capital of $60.1 million and the current ratio was 0.27, compared with negative working capital of $56.7 million and a current ratio of 0.21 at December 31, 1999. The Company has incurred losses during 2000, 1999 and 1998 and has limited resources available to meet its operating, capital expenditure and debt service requirements during 2001. Certain of the Company's debt agreements contain various financial covenants, the most restrictive of which relate to current ratio requirements, tangible net worth, cash flow, net income (loss), and limits on the payment of dividends to shareholders. As of December 31, 2000, the Company was not in compliance with certain of these financial covenants. The Company has not obtained waivers of the noncompliance. Cross-default or material adverse change provisions contained in the debt agreements allow the holders of substantially all of the Company's debt to demand immediate repayment. The Company would not be able to repay this indebtedness if the applicable lenders demanded 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. 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. Based on regularly scheduled debt service requirements, the Company has a total of $5.1 million of debt that must be repaid or refinanced during 2001 and an additional $6.7 million that must be repaid or refinanced in January 2002. As a result of the covenant noncompliance and other cross-default provisions, the Company has classified a total of $61.2 million of debt as current liabilities as of December 31, 2000. An event of default under the Company's debt agreements could lead to actions by the lenders that could result in an event of default under the Company's lease agreements covering a majority of its United States nursing facilities. Should such a default occur in the related lease agreements, the lessor would have the right to terminate the lease agreements. The Company is currently discussing potential waiver, amendment and refinancing alternatives with its lenders. Of the total $5.1 million of scheduled debt maturities during 2001, the Company plans to repay $2.1 million from cash generated from operations and intends to refinance the remaining $3 million. The Company's management has implemented a plan to enhance revenues related to the operations of the Company's nursing homes and assisted living facilities. management believes that revenues in future periods will increase as a result of increased occupancy rates resulting from an increased emphasis on attracting and retaining patients and residents. Management has implemented a plan to attempt to minimize future expense increases through the elimination of excess operating costs. 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 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. 48 49 At December 31, 2000, 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, 2000, the Company's weighted average interest rate was 9.1%. As of December 31, 2000, the Company had drawn $3,566,000 under its working capital line of credit. The total maximum outstanding balance of the working capital line of credit, including letters of credit outstanding, is $4,500,000. Of the total $4,500,000 of maximum availability, $1,000,000 is limited to certain maximum time period restrictions. There are certain additional restrictions based on certain borrowing base restrictions. As of December 31, 2000, the Company had $587,000 of letters of credit outstanding with the same bank lender, which further reduce the maximum available amount outstanding under the working capital line of credit. As of December 31, 2000, the Company had total additional borrowing availability of $778,000 under its working capital line of credit. The working capital line of credit matured during 2000. However, in conjunction with the Company's execution of the Settlement and Restructuring Agreement with Omega, the Company amended the terms of the working capital line of credit, extending the maturity through January 2004 and modifying the interest rate from LIBOR plus 2.50% to the bank's prime rate plus .50% (up to a maximum of 9.50%) effective October 1, 2000. As of December 31, 2000, the Company had $11,000,000 outstanding under an acquisition line of credit, which amount was secured by four nursing homes. Amounts outstanding under the acquisition line of credit matured during 2000 and were extended to February 2001. During March 2001, the Company refinanced the $11,000,000 acquisition line of credit. Of the total principal balance, $7,284,000 has been refinanced through the issuance of notes payable which extend the maturity through April 2006. The notes payable are secured by two nursing homes. The remaining $3,716,000 of the acquisition line of credit has been refinanced through the issuance of a note payable under terms that extend the maturity through January 1, 2002. The note payable is secured by one nursing home. Under the terms of the refinanced notes payable, interest and principal are payable monthly based on a 25-year amortization schedule, with interest accruing at a variable rate of LIBOR plus 3.50%. In conjunction with the Company's execution of the Settlement and Restructuring Agreement with Omega effective October 1, 2000, the Company refinanced a $3,499,000 working capital line of credit through the issuance of a promissory note payable to the Company's bank lender. The refinancing resulted in an extension of the maturity through September 2004 and a reduction of the interest rate from 14.00% to 9.50% effective October 1, 2000. Interest and principal on the promissory note payable are payable monthly based on a 25 year amortization schedule, with the entire remaining balance due in September 2004. Effective March 9, 2001, the Company has obtained professional liability insurance coverage that, based on historical claims experience, could be substantially less than the claims that could be incurred during 2001. The ultimate payments on professional liability claims accrued as of December 31, 2000 and claims that could 49 50 be incurred during 2001 could require cash resources during 2001 that would be in excess of the Company's available cash or other resources. Any future operating losses, demands for repayment by lenders, failure to refinance debt maturing during 2001 or payments of professional liability claims judgments in excess of insurance coverage 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 flows from its operations, unable to refinance or repay debt maturities during 2001, or unable to minimize the amount of future professional liability claims payments, it will explore a variety of other options, including but not limited to other sources of equity or debt financing, asset dispositions, or relief under the United States Bankruptcy code. Net cash provided by operating activities totaled $0.9 million, $9.2 million and $4.1 million in 2000, 1999 and 1998, 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 $2.7 million, $5.1 million and $8.1 million in 2000, 1999 and 1998, 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, 2000. 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, 2001, the Company anticipates that capital expenditures for improvements and equipment for its existing facility operations will be approximately $4.2 million, including approximately $1,000,000 for non-routine projects. There were no purchase acquisitions completed in 2000, 1999 or 1998. In 2000, 1999 and 1998, the Company invested in or advanced funds to joint ventures in the amount of $505,000, $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 $4.4 million, $(4.6) million and $3.7 million in 2000, 1999 and 1998, respectively. The net cash provided from financing activities primarily represents net proceeds from the issuance and repayment of debt. 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, 2000 and 1999, totaled $18.1 million and $15.8 million, respectively, representing approximately 34 and 31 days in accounts receivable, respectively. Accounts receivable from the provision of management services was $721,000 and $412,000, respectively, at December 31, 2000 and 1999, representing approximately 67 and 50 51 39 days in accounts receivable, respectively. The allowance for bad debts was $5.0 million at December 31, 2000 and 1999. 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, quality of resident care 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 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 resident care. Such requirements are subjective and 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. The Company is currently a defendant in two pending false claims actions as described below. On October 17, 2000, the Company was served with a civil complaint by the Florida Attorney General's office, in the case of State of Florida ex rel. Mindy Myers v. R. Brent Maggio, et al. In this case, the State of Florida has accused multiple defendants of violating Florida's False Claims Act. The Company, in its capacity as the manager of four nursing homes owned by Emerald Coast Healthcare, Inc. ("Emerald"), is named in the complaint, which accuses the Company of making illegal kickback payments to R. Brent Maggio, Emerald's sole shareholder, and fraudulently concealing such payments in the Medicaid cost reports filed by the nursing homes. The Company believes that it has meritorious defenses to this case, and intends to vigorously pursue these defenses in litigation. Currently, there are several motions by the Company seeking dismissal of this complaint that are pending before the trial court. Under the Federal False Claims Act, health care companies may be named as a defendant in an action which is filed under court seal, without being informed of this fact until the government has substantially completed its investigation. In such cases, there sometimes occurs a provision for "partial lifting of the seal," in which the trial court orders that the seal may be lifted for purposes of giving the named defendant the opportunity to informally present its defenses and discuss settlement prospects with the government. In cases in which the judge orders such a "partial lifting of the seal," the defendant becomes aware of the case but is precluded from discussing it publicly. Management is aware of one such case being filed in federal court against the Company regarding billing practices at one of its nursing homes. The Company has retained counsel to defend it in this case and, while cooperating with the government in its investigation of the matter, intends to vigorously pursue its defense of the case. Based on all information currently known, the Company currently does not believe that the claims being made in this case are material to the Company's financial condition, cash flows or results of operations. While the Company cannot currently predict with certainty the ultimate impact of either of the above cases on the Company's financial condition, cash flows or results of operations, an unfavorable outcome in any state or federal False Claims Act case could subject the Company to fines, penalties and damages. Moreover, the Company could be excluded from the Medicare, Medicaid or other federally-funded health care programs, which could have a material adverse impact on the Company's financial condition, cash flows or results of operations. During 1999 and 2000, the Company also experienced the increased regulatory scrutiny that has been exerted on the industry in the form of increased fines and penalties. During 1998, one of the Company's facilities in Arkansas was decertified from the Medicaid and Medicare programs. The facility was subsequently recertified for participation in the Medicaid and Medicare programs. An additional leased facility, located in Texas, was decertified from the Medicaid and Medicare programs during 2000. The Company is actively engaged in the application and appeal process for the recertification of this facility. 51 52 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 William R. Council, III joined the Company effective March 5, 2001 as Executive Vice President, Chief Financial Officer and Secretary. James F. Mills, Jr., the former Senior Vice President, Chief Financial Officer and Assistant Secretary left the Company effective March 31, 2001. 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. 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 From June 1998 through June 2000, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") and various amendments and interpretations. SFAS 133, as amended, establishes accounting and reporting standards requiring that any derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The Company will adopt SFAS 133, as amended, effective January 1, 2001. The impact of the adoption of SFAS 133 is not expected to have a material impact on the Company's financial position, results of operations or cash flows. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101") regarding revenue recognition in financial statements. SAB 101 was effective January 1, 2000 but implementation was delayed until the fourth quarter of 2000. The Company's implementation of SAB 52 53 101 in the fourth quarter did not have a material impact on its financial position, results of operations or cash flows on a quarterly or annual basis. 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, 2000. 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, government regulation and health care reforms, the increased cost of borrowing under the Company's credit agreements, covenant waivers from the Company's lenders, possible amendments to the Company's credit agreements, ability to control altimate professional liability costs, 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 Item 1 -- Business -- Risk Factors for a discussion of various risk factors of the Company and that are inherent in the health care 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-31 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. 53 54 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 2001 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 2001 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 2001 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 2001 Annual Meeting of Shareholders. 54 55 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 FINANCIAL STATEMENTS Pages ----------- Report of Independent Public Accountants F-1 Consolidated Balance Sheets as of December 31, 2000 and 1999 F-2 Consolidated Statements of Operations for the Years Ended December 31, 2000, 1999 and 1998 F-3 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2000, 1999 and 1998 F-4 Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2000, 1999 and 1998 F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 2000, 1999 and 1998 F-6 to F-7 Notes to Consolidated Financial Statements as of December 31, 2000, 1999 and 1998 F-8 to F-33 FINANCIAL STATEMENT SCHEDULES 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. 55 56 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ADVOCAT INC. /s/ Charles W. Birkett, M.D. - ----------------------------------------------- Charles W. Birkett, M.D., Chairman of the Board April 2, 2001 /s/ William R. Council, III - ----------------------------------------------- William R. Council, III Executive Vice President, Secretary (Principal Financial and Accounting Officer) April 2, 2001 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) April 2, 2001 April 2, 2001 /s/ Paul Richardson /s/ J. Bransford Wallace - ----------------------------------- ----------------------------------- Paul Richardson J. Bransford Wallace Director Director April 2, 2001 April 2, 2001 /s/ Edward G. Nelson - ----------------------------------- ----------------------------------- Edward G. Nelson Joseph F. Furlong, III Director Director April 2, 2001 56 57 INDEX TO CONSOLIDATED 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 (Loss) F-5 Consolidated Statements of Cash Flows F-6 Notes to Consolidated Financial Statements F-8
58 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, 2000 and 1999 and the related consolidated statements of operations, comprehensive income (loss), shareholders' equity and cash flows for each of the three years in the period ended December 31, 2000. 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, 2000 and 1999 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. The accompanying consolidated financial statements have been prepared assuming that Advocat Inc. (the "Company") will continue as a going concern. The Company has incurred operating losses in the years ended December 31, 2000, 1999 and 1998 and has limited resources available to meet its operating, capital expenditure and debt service requirements during 2001 and January 2002. Effective March 9, 2001, the Company has also obtained professional liability insurance coverage that, based on historical claims experience, could be substantially less than the claims that could be incurred during 2001. In addition, the ultimate payments on professional liability claims accrued as of December 31, 2000 and claims that could be incurred during 2001 could require cash resources during 2001 that would be in excess of the Company's available cash or other resources. The Company is also not in compliance with certain debt covenants that allow the holders of substantially all of the Company's debt to demand immediate repayment. Certain actions by the lenders could result in an event of default under the Company's lease agreements covering a majority of its United States nursing facilities. These matters raise substantial doubt about the Company'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 29, 2001 F-1 59 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2000 AND 1999
ASSETS 2000 1999 - ------------------------------------------- ------------- ------------ CURRENT ASSETS: Cash and cash equivalents $ 4,496,000 $ 1,913,000 Receivables, less allowance for doubtful accounts of $5,035,000 and $4,958,000, respectively 15,111,000 11,719,000 Inventories 633,000 754,000 Prepaid expenses and other current assets 2,100,000 813,000 ------------- ------------ Total current assets 22,340,000 15,199,000 ------------- ------------ PROPERTY AND EQUIPMENT, at cost 89,567,000 87,667,000 Less accumulated depreciation (24,418,000) (19,015,000) ------------- ------------ Property and equipment, net 65,149,000 68,652,000 ------------- ------------ OTHER ASSETS: Deferred financing and other costs, net 572,000 939,000 Deferred lease costs, net 2,085,000 -- Assets held for sale or redevelopment 1,476,000 1,476,000 Investments in and receivables from joint ventures 8,333,000 8,126,000 Other assets 1,801,000 1,793,000 ------------- ------------ Total other assets 14,267,000 12,334,000 ------------- ------------ $ 101,756,000 $ 96,185,000 ============= ============ LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------------- CURRENT LIABILITIES: Current portion of long-term debt $ 61,229,000 $ 53,098,000 Trade accounts payable 6,875,000 7,984,000 Accrued expenses: Payroll and employee benefits 5,241,000 4,001,000 Interest 232,000 221,000 Current portion of self-insurance reserves 4,445,000 3,508,000 Other current liabilities 4,387,000 3,086,000 ------------- ------------ Total current liabilities 82,409,000 71,898,000 ------------- ------------ NONCURRENT LIABILITIES: Long-term debt, less current portion 5,016,000 7,827,000 Self-insurance reserves, less current portion 3,586,000 2,268,000 Deferred gains with respect to leases, net -- 3,047,000 Other noncurrent liabilities 5,245,000 4,878,000 ------------- ------------ Total noncurrent liabilities 13,847,000 18,020,000 ------------- ------------ COMMITMENTS AND CONTINGENCIES SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK, authorized 600,000 shares, $.10 par value, 393,658 shares issued and outstanding at December 31, 2000, at redemption value 3,358,000 -- SHAREHOLDERS' EQUITY: Series A preferred stock, authorized 400,000 shares, $.10 par value, none issued and outstanding -- -- Common stock, authorized 20,000,000 shares, $.01 par value, 5,492,000 shares issued and outstanding 55,000 55,000 Paid-in capital 15,907,000 15,907,000 Accumulated deficit (13,820,000) (9,695,000) ------------- ------------ Total shareholders' equity 2,142,000 6,267,000 ------------- ------------ $ 101,756,000 $ 96,185,000 ============= ============
The accompanying notes are an integral part of these consolidated balance sheets. F-2 60 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, ------------------------------------------------------------- 2000 1999 1998 ------------- ------------- ------------- REVENUES: Patient revenues, net $ 150,071,000 $ 141,022,000 $ 166,529,000 Resident revenues 41,889,000 37,905,000 34,804,000 Management fees 3,863,000 2,932,000 3,627,000 Interest 212,000 159,000 192,000 ------------- ------------- ------------- 196,035,000 182,018,000 205,152,000 ------------- ------------- ------------- EXPENSES: Operating 153,719,000 152,557,000 164,769,000 Lease 20,563,000 20,375,000 19,109,000 General and administrative 12,136,000 11,753,000 10,969,000 Interest 6,073,000 5,460,000 5,425,000 Depreciation and amortization 5,603,000 5,167,000 3,838,000 Non-recurring charges 1,708,000 500,000 5,859,000 ------------- ------------- ------------- 199,802,000 195,812,000 209,969,000 ------------- ------------- ------------- LOSS BEFORE INCOME TAXES (3,767,000) (13,794,000) (4,817,000) PROVISION (BENEFIT) FOR INCOME TAXES 83,000 7,605,000 (1,734,000) ------------- ------------- ------------- LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (3,850,000) (21,399,000) (3,083,000) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, NET OF TAX BENEFIT -- (277,000) -- ------------- ------------- ------------- NET LOSS $ (3,850,000) $ (21,676,000) $ (3,083,000) ============= ============= ============= NET LOSS PER COMMON SHARE: Basic $ (.70) $ (3.98) $ (.57) ============= ============= ============= Diluted $ (.70) $ (3.98) $ (.57) ============= ============= ============= WEIGHTED AVERAGE SHARES: Basic 5,492,000 5,445,000 5,388,000 ============= ============= ============= Diluted 5,492,000 5,445,000 5,388,000 ============= ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-3 61 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Retained Common Stock Earnings ----------------------- Paid-in (Accumulated Shares Amount Capital Deficit) Total --------- -------- ------------ ------------- ------------- BALANCE, December 31, 1997 5,377,000 $ 54,000 $ 15,638,000 $ 15,041,000 $ 30,733,000 Issuance of common stock 22,000 -- 127,000 -- 127,000 Net loss -- -- -- (3,083,000) (3,083,000) Translation loss, net of tax -- -- -- (216,000) (216,000) --------- -------- ------------ ------------- ------------- BALANCE, December 31, 1998 5,399,000 54,000 15,765,000 11,742,000 27,561,000 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 Net loss -- -- -- (3,850,000) (3,850,000) Translation loss, net of tax -- -- -- (275,000) (275,000) --------- -------- ------------ ------------- ------------- BALANCE, DECEMBER 31, 2000 5,492,000 $ 55,000 $ 15,907,000 $ (13,820,000) $ 2,142,000 ========= ======== ============ ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-4 62 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Year Ended December 31, ------------------------------------------------------------- 2000 1999 1998 ------------- ------------- ------------- NET LOSS $ (3,850,000) $ (21,676,000) $ (3,083,000) OTHER COMPREHENSIVE INCOME (LOSS): Foreign currency translation adjustments (430,000) 374,000 (338,000) Income tax benefit (provision) 155,000 (135,000) 122,000 ------------- ------------- ------------- (275,000) 239,000 (216,000) ------------- ------------- ------------- COMPREHENSIVE LOSS $ (4,125,000) $ (21,437,000) $ (3,299,000) ============= ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-5 63 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, 2000 1999 1998 ------------- ------------- ------------- OPERATING ACTIVITIES: Net loss $ (3,850,000) $ (21,676,000) $ (3,083,000) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 5,603,000 5,167,000 3,838,000 Provision for doubtful accounts 2,881,000 7,037,000 2,306,000 Deferred income taxes -- 7,923,000 (1,645,000) Equity in (earnings) loss in joint ventures (43,000) 177,000 (69,000) Series B redeemable convertible preferred stock dividends 58,000 -- -- Amortization of deferred balances 195,000 894,000 (513,000) Lease cash payments in excess of financial reporting expense (345,000) -- -- Amortization of discount on non-interest- bearing promissory note 67,000 -- -- 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 assets and liabilities: Receivables, net (6,273,000) 7,942,000 (4,306,000) Inventories 121,000 348,000 (5,000) Prepaid expenses and other current assets (974,000) 729,000 (273,000) Trade accounts payable and accrued expenses 3,434,000 (242,000) 3,367,000 Other -- (27,000) (36,000) ------------- ------------- ------------- Net cash provided by operating activities 874,000 9,205,000 4,069,000 ------------- ------------- ------------- INVESTING ACTIVITIES: Purchases of property and equipment, net (2,381,000) (4,382,000) (5,186,000) Investment in TDLP -- (160,000) (632,000) Mortgages receivable, net 324,000 179,000 118,000 Investments in and advances to joint ventures, net (505,000) (576,000) (2,086,000) Deposits, pre-opening costs and other (332,000) (461,000) (577,000) TDLP partnership distributions 211,000 345,000 307,000 ------------- ------------- ------------- Net cash used in investing activities (2,683,000) (5,055,000) (8,056,000) ------------- ------------- -------------
(Continued) F-6 64 ADVOCAT INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Year Ended December 31, 2000 1999 1998 ------------- ------------- ----------- FINANCING ACTIVITIES: Proceeds from issuance of debt $ 3,000,000 $ 26,364,000 $ -- Repayment of debt obligations (1,453,000) (25,730,000) (890,000) Financing costs -- (532,000) (207,000) Net proceeds from (repayment of) bank line of credit 2,541,000 (3,689,000) 5,674,000 Proceeds from sale of common stock -- 143,000 127,000 Advances to (repayments from) TDLP, net 213,000 (1,305,000) (1,043,000) Increases in lease obligations 91,000 165,000 -- ------------- ------------- ------------- Net cash provided by (used in) financing activities 4,392,000 (4,584,000) 3,661,000 ------------- ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,583,000 (434,000) (326,000) CASH AND CASH EQUIVALENTS, beginning of period 1,913,000 2,347,000 2,673,000 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS, end of period $ 4,496,000 $ 1,913,000 $ 2,347,000 ============= ============= ============= SUPPLEMENTAL INFORMATION: Cash payments of interest $ 6,385,000 $ 6,095,000 $ 5,016,000 ============= ============= ============= Cash payments (refunds) of income taxes, net $ (183,000) $ (981,000) $ 330,000 ============= ============= =============
NON-CASH TRANSACTIONS: In exchange for certain concessions related to lease agreements during 2000, the Company issued Series B Redeemable Preferred Stock with a redemption value, excluding dividends, of $3,300,000 and a subordinated note payable of $1,700,000. 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 for 1998. The accompanying notes are an integral part of these consolidated financial statements. F-7 65 ADVOCAT INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 1. BACKGROUND Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company") provides long-term care services to nursing home patients and residents of assisted living facilities in 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, 2000, the Company operates 120 facilities, consisting of 64 nursing homes with 7,230 licensed beds and 56 assisted living facilities with 5,425 units. Within the current portfolio, 36 facilities are managed on behalf of other owners, of which 29 are managed on behalf of unrelated owners and 7 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 changes 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 12 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 consolidated 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 Advocat Inc. (the "Company") will continue as a going concern. The Company has incurred operating losses in the years ended December 31, 2000, 1999 and 1998 and has limited resources available to meet its operating, capital expenditure and debt service requirements during 2001 and January 2002. The Company has a net working capital deficit of $60.1 million as of December 31, 2000. The Company has $5.1 million of scheduled debt maturities during 2001 and an additional $6.7 million of scheduled debt maturities during January 2002. Effective March 9, 2001, the Company has also obtained professional liability insurance coverage that, based on historical claims experience, could be substantially less than the claims that could be incurred during 2001. The ultimate payments on professional liability claims accrued as of December 31, 2000 and claims that could be incurred during 2001 could require cash resources during 2001 that would be in excess of the Company's available cash or other resources. The Company is also not in compliance with certain debt covenants that allow the holders of substantially all of the Company's debt to demand immediate repayment. Although the F-8 66 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, 2000. 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. An event of default under the Company's debt agreements could lead to actions by the lenders that could result in an event of default under the Company's lease agreements covering a majority of its United States nursing facilities. Should such a default occur in the related lease agreements, the lessor would have the right to terminate the lease agreements. At a minimum, the Company's cash requirements during 2001 and January 2002 include funding operations (including potential payments related to professional liability claims), capital expenditures, scheduled debt service, and working capital requirements. No assurance can be given that the Company will have sufficient cash to meet these requirements. The Company is currently discussing potential waiver, amendment and refinancing alternatives with its lenders. If the Company's lenders force immediate repayment, the Company would not be able to repay the related debt outstanding. Of the total $5.1 million of scheduled debt maturities during 2001, the Company plans to repay $2.1 million from cash generated from operations and intends to refinance the remaining $3.0 million. The Company's management has implemented a plan to enhance revenues related to the operations of the Company's nursing homes and assisted living facilities. Management believes that revenues in future periods will increase as a result of increased occupancy rates resulting from an increased emphasis on attracting and retaining patients and residents. Management has implemented a plan to attempt to minimize future expense increases through the elimination of excess operating costs. Management will also attempt to minimize professional liability claims in future periods by vigorously defending itself against all such claims and through the additional supervision and training of staff employees. 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 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, the Company may have to 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. 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. In the opinion of management, adequate provision has been made for any adjustments that may result from such reviews. 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. During the years ended December 31, 2000 and 1998, the Company recorded $51,000 and $181,000 of net favorable estimated settlements from federal and state programs for periods prior to the beginning of fiscal 2000 and 1998, respectively. During 1999, the Company recorded $1,093,000 of net unfavorable estimated settlements from federal and state programs for periods prior to the beginning of fiscal 1999. F-9 67 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 owner is also 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 94.0% of 2000 management fee revenues were derived from agreements that expire beginning in 2002 through 2015. The remaining management agreements have remaining lives that expire or are cancelable at various times during 2001. The Company's management currently anticipates that most of these management agreements will be renewed during 2001. 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. Beginning October 1, 2001, the Company's Omega leases require the Company to pay certain scheduled rent increases. Such scheduled rent increases are recorded as additional lease expense on a straight-line basis over the term of the related leases. See Note 4 for discussion of the Company's amendments to the Omega leases during 2000. 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. 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 lessors' mortgage lenders. 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 $2,881,000, $7,037,000 and $2,306,000 for 2000, 1999 and 1998, respectively. F-10 68 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, fixtures 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 expensed 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. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of", the Company evaluates the recoverability of the carrying values of its properties on a property by property basis. On a quarterly basis, the Company reviews its properties for recoverability when events or circumstances, including significant physical changes in the property, significant adverse changes in general economic conditions, and significant deteriorations of the underlying cash flows of the property, indicate that the carrying amount of the property may not be recoverable. The need to recognize an impairment is based on estimated future cash flows from a property compared to the carrying value of that property. If recognition of an impairment is necessary, it is measured as the amount by which the carrying amount of the property exceeds the fair value of the property. 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 on a straight-line basis over the term of the related debt. The amortization is reflected as interest expense in the accompanying consolidated statements of operations. DEFERRED LEASE COSTS Deferred lease costs represent costs incurred in conjunction with the Company's restructuring of its Omega leases during 2000 (see Note 4). Deferred lease costs are amortized on a straight-line basis over the term of the related leases. ASSETS HELD FOR SALE OR REDEVELOPMENT Assets held for sale or redevelopment include two assisted living facilities located in North Carolina. The facilities were acquired during 1997 and the Company has since elected to sell the facilities. The Company is currently marketing the properties for sale. F-11 69 INCOME TAXES The Company utilizes SFAS No. 109, "Accounting for Income Taxes," for the financial reporting of income taxes, which generally requires the Company to record deferred income taxes for the differences between book and tax bases in its assets and liabilities. Income taxes have been provided for all items included in the consolidated statements of operations, regardless of the period when such items will be deductible for tax purposes. The principal temporary differences between financial and tax reporting arise from depreciation and from reserves that are not currently deductible, as well as the timing of the recognition of gains on sales of assets. DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of cash and cash equivalents, receivables, investments in and receivables from joint ventures, trade accounts payable, accrued expenses and self-insurance reserves 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 operations and the financial position 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). Translation gains and losses are reported as a component of accumulated other comprehensive (loss) in shareholders' equity. Accumulated foreign currency translation unrealized losses are as follows:
2000 1999 1998 ---------- ---------- ---------- Beginning balance $ (173,000) $ (412,000) $ (196,000) Current period change, net of tax (275,000) 239,000 (216,000) ---------- ---------- ---------- Ending balance $ (448,000) $ (173,000) $ (412,000) ========== ========== ==========
EARNINGS (LOSS) PER COMMON SHARE The Company utilizes SFAS No. 128, "Earnings Per Share," for the financial reporting of earnings (loss) per common share. Basic earnings (loss) per common 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 (loss) per common 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 and Series B Redeemable Convertible Preferred Stock) was anti-dilutive in 2000, 1999 and 1998. F-12 70 OTHER COMPREHENSIVE INCOME (LOSS) The Company has adopted SFAS No. 130, "Reporting on Comprehensive Income," which requires the reporting of comprehensive income (loss) in addition to net income (loss) from operations. All transactions representing comprehensive income (loss) are included in the consolidated statements of comprehensive income (loss). STOCK-BASED COMPENSATION The Company accounts for stock-based compensation arrangements under the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related interpretations. The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". As a result, no compensation cost has been recognized in the consolidated statements of operations for the Company's stock option plans. See Note 9 for additional disclosures about the Company's stock-based compensation plans. NEW ACCOUNTING PRONOUNCEMENTS From June 1998 through June 2000, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") and various amendments and interpretations. SFAS 133, as amended, establishes accounting and reporting standards requiring that any derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The Company will adopt SFAS 133, as amended, effective January 1, 2001. The impact of the adoption of SFAS 133 is not expected to have a material impact on the Company's financial position, results of operations or cash flows. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101") regarding revenue recognition in financial statements. SAB 101 was effective January 1, 2000 but implementation was delayed until the fourth quarter of 2000. The Company's implementation of SAB 101 in the fourth quarter did not have a material impact on its financial position, results of operations or cash flows on a quarterly or annual basis. 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. 3. RECEIVABLES Receivables, before the allowance for doubtful accounts, consist of the following components:
DECEMBER 31, --------------------------------- 2000 1999 ------------- ------------- Medicare $ 7,479,000 $ 5,800,000 Medicaid and other non-federal programs 6,356,000 5,716,000 Other patient and resident receivables 4,252,000 4,264,000 Management fees - affiliates 342,000 309,000 Management fees 379,000 103,000 Other receivables and advances 1,338,000 485,000 ------------- ------------- $ 20,146,000 $ 16,677,000 ============= =============
F-13 71 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. Substantially all receivables are provided as collateral on the Company's debt and lease obligations. 4. SETTLEMENT AND RESTRUCTURING AGREEMENT AMENDMENTS TO OMEGA LEASE AGREEMENTS During 1998, 1999 and through September 30, 2000, the Company leased 30 nursing homes from Omega under various terms and lease agreements. On November 8, 2000, the Company entered into a 10-year restructured lease agreement (the "Settlement and Restructuring Agreement") with Omega. The Settlement and Restructuring Agreement, effective as of October 1, 2000, provides for reduced future lease costs under an amended lease agreement covering all nursing homes leased from Omega (the "Omega Master Lease"). The initial term of the Omega Master Lease is ten years, expiring September 30, 2010, with an additional ten-year renewal term at the option of the Company, assuming no defaults. Under the Settlement and Restructuring Agreement, Omega has agreed to waive all defaults under the previous Omega lease agreements. See Note 12 for further discussion of the Omega lease agreements and required minimum capital expenditures over the initial lease term. NON-ACCRUAL NOTE PAYABLE As settlement for outstanding lease payments owed to Omega for the period prior to the Settlement and Restructuring Agreement, Omega agreed to accept a $3,000,000 payment from the Company. The payment to Omega was funded through Omega's draw upon a then outstanding letter of credit from the Company's bank lender. Prior to the Settlement and Restructuring Agreement, the Company was required to provide letters of credit totaling $4,950,000 in favor of Omega as security for its obligations under the Omega Master Lease. Pursuant to the Settlement and Restructuring Agreement, Omega agreed to draw $3,000,000 on the outstanding letters of credit and to terminate the remaining $1,950,000 letters of credit. The $3,000,000 letter of credit draw was converted into a $3,000,000 non-interest-bearing promissory note payable to the bank lender (the "Non-Accrual Note"). The entire balance of the Non-Accrual Note is due on January 15, 2002. See Note 7 for further discussion regarding the terms of the Non-Accrual Note. SUBORDINATED NOTE PAYABLE As payment for Omega entering into the Settlement and Restructuring Agreement, the Company agreed to issue Omega a subordinated note payable (the "Subordinated Note") in the amount of $1,700,000. Interest on the Subordinated Note accrues at an annual rate of 7.0% (beginning effective October 1, 2000) with any unpaid principal and interest becoming due on September 30, 2007. Payments of principal and interest on the Subordinated Note are subordinated to the payment in full of the Non-Accrual Note. SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK As further payment for Omega entering into the Settlement and Restructuring Agreement, the Company agreed to issue Omega 393,658 shares of the Company's Series B Redeemable Convertible Preferred Stock. The Company's Series B Redeemable Convertible Preferred Stock has a stated value of $3,300,000 and carries an annual dividend rate of 7% of the stated value. The dividends accrue on a daily basis whether or not declared by the Company and compound quarterly. Dividend payments on the Series B Redeemable Convertible Preferred Stock are subordinated to the payment in full of the Non-Accrual Note. The Series B Redeemable Convertible Preferred Stock shares have preference in F-14 72 liquidation but do not have voting rights. The total redemption value is equal to the stated value plus any accrued but unpaid dividends. The liquidation preference value is equal to the redemption value. The holders of the Series B Redeemable Convertible Preferred Stock may convert their preferred shares and accrued dividends to common stock at their option at any time based on a conversion price per share of $4.67, subject to adjustment. Beginning on the earlier of a default under the Omega Master Lease agreement or September 30, 2007, Omega has the right to require the Company to redeem the Series B Redeemable Convertible Preferred Stock shares at the redemption price of $3,300,000 plus accrued and unpaid dividends. At December 31, 2000, total accrued but unpaid dividends amounted to $58,000 ($.15 per share) and, accordingly, the aggregate redemption value on the Series B Redeemable Convertible Preferred Stock was $3,358,000 and the per share redemption value was approximately $8.53. Dividends on the Series B Redeemable Convertible Preferred Stock are reflected as interest expense in the accompanying consolidated statements of operations beginning October 1, 2000. DEFERRED LEASE COSTS During 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. In conjunction with this sale/leaseback, the Company entered into a participating mortgage with Omega on three other facilities. The net gain on the sale/leaseback was deferred in accordance with sale/leaseback accounting and was being amortized by the Company over the related lease term as a reduction in lease expense. As of September 30, 2000, the net deferred gain totaled $2,862,000. Pursuant to the amended Omega Master Lease and the issuance of the Subordinated Note and the Series B Redeemable Convertible Preferred Stock to Omega effective October 1, 2000, total deferred lease costs of $5,000,000 were recorded by the Company. The $2,862,000 of remaining deferred gain on the 1992 sale/leaseback has been reflected as a reduction of the $5,000,000 in new deferred lease costs, resulting in net deferred lease costs of $2,138,000 as of October 1, 2000. The net deferred lease costs are being amortized as lease expense over the initial ten-year term of the Omega Master Lease. AMENDMENTS TO DEBT AGREEMENTS In conjunction with the Company's execution of the Settlement and Restructuring Agreement with Omega, the Company also amended the terms of various debt agreements. See Note 7 for discussion of amendments to the Company's debt agreements. 5. 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 $1,161,000 as of December 31, 2000. The TDLP properties are collateral for this debt. Under a repurchase agreement, the Company has agreed to purchase up to 10.0% of the partnership units per year, beginning in January 1997 (up to a maximum of 50.0% of the total partnership units) through January 2001. The purchase of the partnership units is upon demand from the limited partners and the 10.0% maximum per year is not cumulative. The repurchase price is the original cash sales price per unit less certain amounts based on the depreciation from 1991 to the December 31 prior to the date of repurchase. Pursuant to its repurchase obligation, the Company has purchased a cumulative total of 22.6% through December 31, 2000. Additional units were put to the Company during January 2001, resulting in the purchase of an additional 10%. Total consideration for all of these purchases was F-15 73 $2,057,000. 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 expiring August 31, 2001. As of December 31, 2000, the Company has provided working capital funding and requirements under the cash flow guarantee to TDLP totaling $5,838,000. 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, "Accounting for Sales of Real Estate". Under this method, the Company has not recorded a sale of the assets. The cash received from TDLP has been recorded as an advance liability, and the wrap mortgage receivable has not been reflected in the Company's consolidated 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 on August 31, 2001. 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 was recognized 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 facilities since the sale. During 2000, 1999 and 1998, the consolidated statements of operations include losses of $1,461,000, $2,221,000 and $837,000, respectively, related to the operations of the TDLP facilities and the Company's guarantees under the TDLP partnership agreement. Beginning September 1, 2001, the Company's obligations to provide cash flow financing to TDLP will cease. As a result, the leasing method of accounting will no longer be appropriate. Instead, the Company's accounting will reflect its economic interest in the partnership, which consists of a mortgage receivable, a general partnership interest, a limited partnership interest and certain advances receivable. In addition, the Company currently serves as the manager of the nursing homes in the partnership, from which the Company is paid a management fee equal to 5% of net resident fees on a monthly basis. Additional management fees can be earned based on the net income of the partnership. This management agreement expires on August 31, 2001. The Company has informed TDLP that it will continue to manage the TDLP facilities on a month by month basis beginning September 1, 2001. The mortgage receivable currently matures on August 31, 2001. In order to satisfy this maturity, management believes the partnership would have to refinance the mortgage with an outside source of capital or sell the properties. If the partnership does not repay this note, the Company would have the ability to foreclose on the partnership assets. F-16 74 6. PROPERTY AND EQUIPMENT Property and equipment, at cost, consists of the following:
DECEMBER 31, -------------------------------- 2000 1999 ------------ ------------ Land $ 5,073,000 $ 5,172,000 Buildings and leasehold improvements 63,781,000 61,863,000 Furniture, fixtures and equipment 20,713,000 20,632,000 ------------ ------------ $ 89,567,000 $ 87,667,000 ============ ============
Substantially all of the Company's gross property and equipment are provided as collateral for debt obligations. 7. LONG-TERM DEBT Long-term debt consists of the following:
DECEMBER 31, 2000 1999 ------------- -------------- Mortgages payable to a commercial finance company; secured by 13 assisted living properties; interest payable monthly at 2.35% above LIBOR (8.91% at December 31, 2000); balloon maturity in July 2002. $ 24,777,000 $ 25,080,000 Acquisition line of credit payable to a commercial finance company; secured by four nursing homes; interest payable monthly at 3.00% above LIBOR (9.56% at December 31, 2000); refinanced during March 2001 with terms as noted below. 11,000,000 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 bank prime rate plus 0.50% up to a maximum of 9.50% (9.50% at December 31, 2000); matures in January 2004. 3,566,000 924,000 Promissory note payable to a bank; secured by certain accounts receivable and substantially all other Company assets; interest and principal payable monthly, interest at 9.50%; balloon maturity in January 2004. 3,499,000 3,500,000 Promissory note payable to a bank; secured by certain property, TDLP partnership interests, accounts receivable and substantially all other Company assets; interest and principal payable monthly, interest at 9.50%; balloon maturity in September 2004. 9,397,000 9,412,000
F-17 75
DECEMBER 31, 2000 1999 ------------ -------------- Promissory note payable to a bank; secured by certain accounts receivable and substantially all other Company assets; non-interest-bearing; balloon maturity in January 2002; balance is net of $278,000 debt discount as of December 31, 2000. $ 2,722,000 $ -- 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. 1,161,000 1,895,000 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. 5,125,000 5,421,000 Reducing demand loan payable to a Canadian bank; secured by a security interest in Canadian operations; principal and interest payable monthly; interest at bank prime rate plus 0.25% (7.75% at December 31, 2000); matures in December 2004. 801,000 1,038,000 Subordinated note payable to Omega; secured by accounts receivable and other assets of the facilities leased from Omega; interest at 7.00%; balloon maturity in September 2007. 1,700,000 -- 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% (9.25% at December 31, 2000); balloon maturity in August 2001. 2,339,000 2,396,000 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% (rates ranging from 9.25% to 10.25% at December 31, 2000); balloon maturities during July and August 2001. 158,000 159,000 ------------ -------------- 66,245,000 60,925,000 Less current portion (61,229,000) (53,098,000) ------------ -------------- $ 5,016,000 $ 7,827,000 ============ ==============
As of December 31, 2000, the Company's weighted average interest rate was 9.1%. F-18 76 Scheduled principal payments of long-term debt (assuming no accelerations by the lenders) for the next five years and thereafter beginning January 1, 2001 are as follows: 2001 $ 5,115,000 2002 31,224,000 2003 377,000 2004 17,253,000 2005 212,000 Thereafter 12,064,000 ------------ $ 66,245,000 ============
Cross-default provisions exist in a majority of the Company's debt agreements. In addition, certain of the Company's debt agreements provide that a default under certain of the Company's leases or management agreements constitutes a default under the debt agreements. Certain of the Company's debt agreements also contain various financial covenants, the most restrictive of which relate to current ratio requirements, tangible net worth, cash flow, net income (loss), and limits on the payment of dividends to shareholders. As of December 31, 2000, the Company was not in compliance with certain of these financial covenants. Cross-default or material adverse change provisions contained in the debt agreements allow the holders of substantially all of the Company's debt to demand repayment. The Company has not obtained waivers of the noncompliance. Based on regularly scheduled debt service requirements, the Company has a total of $5,115,000 of debt that must be repaid or refinanced during 2001 and an additional $6,700,000 that must be repaid or refinanced in January 2002. As a result of the covenant noncompliance and other cross-default provisions, the Company has classified a total of $61,229,000 of debt as current liabilities as of December 31, 2000. The Company would not be able to repay this indebtedness if the applicable lenders demanded repayment. Amounts outstanding under the $11,000,000 acquisition line of credit matured during 2000 and were extended to February 2001. During March 2001, the Company refinanced the $11,000,000 acquisition line of credit. Of the total principal balance, $7,284,000 has been refinanced through the issuance of notes payable which extend the maturity through April 2006. The notes payable are secured by two nursing homes. The remaining $3,716,000 of the acquisition line of credit has been refinanced through the issuance of a note payable under terms that extend the maturity through January 1, 2002. The note payable is secured by one nursing home. Under the terms of the refinanced notes payable, interest and principal are payable monthly based on a 25-year amortization schedule, with interest accruing at a variable rate of LIBOR plus 3.50%. As of December 31, 2000, the Company had drawn $3,566,000 under its working capital line of credit. The total maximum outstanding balance of the working capital line of credit, including letters of credit outstanding, is $4,500,000. Of the total $4,500,000 of maximum availability, $1,000,000 is limited to certain maximum time period restrictions. There are certain additional restrictions based on certain borrowing base restrictions. As of December 31, 2000, the Company had $587,000 of letters of credit outstanding with the same bank lender, which further reduce the maximum available amount outstanding under the working capital line of credit. As of December 31, 2000, the Company had total additional borrowing availability of $778,000 under its working capital line of credit. The working capital line of credit matured during 2000. However, in conjunction with the Company's execution of the Settlement and Restructuring Agreement with Omega, the Company amended the terms of the working capital line of credit, extending the maturity through January 2004 and modifying the interest rate from LIBOR plus 2.50% to the bank's prime rate plus .50% (up to a maximum of 9.50%) effective October 1, 2000. In conjunction with the Company's execution of the Settlement and Restructuring Agreement with Omega effective October 1, 2000, the Company refinanced a $3,499,000 working capital line of credit through the issuance of a promissory note payable to the Company's bank lender. The refinancing resulted in an extension of the maturity through September 2004 and a reduction of the interest rate from 14.00% to 9.50% effective October 1, 2000. Interest and principal on the promissory note payable are payable monthly based on a 25 year amortization schedule, with the entire remaining balance due in January 2004. F-19 77 The security interests on the $9,397,000 promissory note payable to a bank include two non-operating properties in North Carolina and the Company's limited partnership interests in TDLP. The Company has also 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 during 2000. However, in conjunction with the Company's execution of the Settlement and Restructuring Agreement with Omega, the Company amended the terms of the promissory note, extending the maturity through September 2004 and reducing the interest rate from 12.00% to 9.50% effective October 1, 2000. Interest and principal are payable monthly based on a 25 year amortization schedule, with the entire remaining balance due in September 2004. In conjunction with the Company's Settlement and Restructuring Agreement during 2000, the Company issued a $3,000,000 Non-Accrual Note (non-interest-bearing promissory note payable) to a bank. The Non-Accrual Note was recorded net of a discount of $345,000 as of October 1, 2000. The discount was calculated based on an interest rate of 9.5%, which approximated available interest rates. The debt discount is being amortized as interest expense over the term of the Non-Accrual Note. Prior to the maturity date of January 15, 2002, the Company is required to pay all surplus cash flow (as defined in the Non-Accrual Note agreement) to the lender to reduce the balance of the Non-Accrual Note. During 1999, the Company obtained a loan with a bank to support its Canadian operations. The loan has an outstanding balance of $801,000 as of December 31, 2000. This loan is a reducing demand loan with scheduled monthly payments aggregating $200,000 ($300,000 Canadian) annually. The loan agreement includes a second facility for working capital loans of up to $667,000 ($1,000,000 Canadian). The Company had no working capital draws outstanding under this facility at December 31, 2000. 8. INVESTMENTS IN AND RECEIVABLES FROM JOINT VENTURES Investments in and receivables from joint ventures consist of the following:
DECEMBER 31, -------------------------------- 2000 1999 ------------ ------------ Investments $ 3,275,000 $ 3,567,000 Receivables 4,689,000 4,148,000 Note receivable 369,000 411,000 ------------ ------------ $ 8,333,000 $ 8,126,000 ============ ============
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. F-20 78 9. SHAREHOLDERS' EQUITY AND STOCK PLANS SHAREHOLDERS' RIGHTS PLAN In 1995, the Company adopted a shareholders' rights plan (the "Plan"). The Plan is designed to protect the Company's shareholders from unfair or coercive takeover tactics. The rights under the Plan were effective for all shareholders of record at the close of business March 20, 1995, and thereafter and exist for a term of ten years. The Plan, as amended December 7, 1998, provides for one right with respect to each share of common stock. Each right entitles the holder to acquire, at a 50.0% 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 also 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 provisions of the plan provide for the deactivation of the plan upon the Company's stock price falling below $5.00 per common share. During 1999, the Company's stock price fell below $5.00 and the plan was deactivated pursuant to the plan provisions. During 1999 and 1998, there were 93,000 and 22,000 shares, respectively, issued pursuant to this plan. The fair value of shares sold under the plan was $0, $1.94 and $6.87 in 2000, 1999 and 1998, respectively. The Company accounts for these plans under APB No. 25, under which no compensation cost has been recognized. Had compensation cost for these plans been determined consistent with SFAS No. 123, the Company's net loss and earnings (loss) per share would have been reduced to the following pro forma amounts:
YEAR ENDED DECEMBER 31, -------------------------------------------------- 2000 1999 1998 ------------ ------------- ------------- Net Loss: As reported $ (3,850,000) $ (21,676,000) $ (3,083,000) ============ ============= ============= Pro forma $ (3,981,000) $ (22,705,000) $ (3,541,000) ============ ============= ============= Basic and Diluted Earnings (Loss) Per Share: As reported $ (.70) $ (3.98) $ (.57) ============ ============= ============= Pro forma $ (.72) $ (4.17) $ (.66) ============ ============= =============
F-21 79 The weighted average fair value of options granted was $0.11, $1.78 and $4.62 in 2000, 1999 and 1998, 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 2000, 1999 and 1998 grants: risk free interest rates of 5.7% for 2000, 6.2% for 1999 and 5.4% for 1998; no expected dividend yield for each of the years; expected lives of five years for each of the years; and, expected volatility of 90.0% for 2000, 118.2% for 1999 and 44.4% for 1998. For purposes of pro forma disclosures of net loss and earnings (loss) per share as required by SFAS No. 123, the estimated fair value of the options is amortized to expense over the options' vesting period. The following table summarizes information regarding stock options outstanding as of December 31, 2000:
WEIGHTED RANGE OF AVERAGE OPTIONS EXERCISE PRICES EXERCISE PRICES OUTSTANDING --------------- --------------- ----------- $5.60 to $13.13 $ 9.70 597,000 $0.15 to $1.88 $ 1.77 195,000 ---------- 792,000 ==========
As of December 31, 2000, the outstanding options have a weighted average remaining life of 4.3 years. Summarized activity of the stock option plans is presented below:
SHARES ------------------------------ WEIGHTED KEY PERSONNEL DIRECTOR AVERAGE PLAN PLAN EXERCISE PRICE ------------- --------- -------------- 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 Issued - 5,000 .15 Expired or canceled (156,000) (20,000) 8.68 ------------- -------- -------------- Outstanding, December 31, 2000 685,000 107,000 $ 7.72 ============= ======== ============== Vested, December 31, 2000 623,000 102,000 $ 8.30 ============= ======== ============== Available for future grants, December 31, 2000 163,000 58,000 ============= ========
SERIES A PREFERRED STOCK The Company is authorized to issue up to 400,000 shares of Series A 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. See Note 4 for discussion of the Company's issuance of Series B Redeemable Convertible Preferred Stock during 2000. F-22 80 10. EARNINGS (LOSS) PER SHARE Information with respect to the calculation of basic and diluted earnings ( loss) per share data is presented below:
NET LOSS PER COMMON NET LOSS SHARES SHARE ------------ --------- ------------- Year ended December 31, 2000: Basic and diluted loss per share $ (3,850,000) 5,492,000 $ (.70) ============ ========= ============= Year ended December 31, 1999: Basic and diluted loss per share $(21,676,000) 5,445,000 $ (3.98) ============ ========= ============= Year ended December 31, 1998: Basic and diluted loss per share $ (3,083,000) 5,388,000 $ (.57) ============ ========= =============
For each year presented, the Company had options outstanding at prices in excess of the average market price of the Company's common stock. As of December 31, 2000, the Company also had Series B Redeemable Convertible Preferred Stock outstanding. As the Company has reported net losses for all years presented, options and Series B Redeemable Convertible Preferred Stock that would have otherwise qualified for inclusion have been excluded from the computation of earnings per share because of anti-dilution. 11. INCOME TAXES The provision (benefit) for income tax is composed of the following components:
YEAR ENDED DECEMBER 31, ------------------------------------------------------ 2000 1999 1998 -------------- -------------- -------------- Current payable (benefit): Federal $ - $ (528,000) $ (577,000) State and province 83,000 76,000 488,000 -------------- -------------- -------------- 83,000 (452,000) (89,000) -------------- -------------- -------------- Deferred taxes: Federal - 5,952,000 (1,405,000) State and province - 2,105,000 (240,000) -------------- -------------- -------------- - 8,057,000 (1,645,000) -------------- -------------- -------------- Provision (benefit) for income taxes $ 83,000 $ 7,605,000 $ (1,734,000) ============== ============== ==============
F-23 81 A reconciliation of taxes computed at statutory income tax rates is as follows:
YEAR ENDED DECEMBER 31, ------------------------------------------------------ 2000 1999 1998 -------------- --------------- -------------- Benefit for federal income taxes at statutory rates $ (1,916,000) $ (5,422,000) $ (2,288,000) Provision for state and province income taxes at statutory rates 615,000 136,000 591,000 Increase in valuation allowance 1,058,000 12,802,000 - Other 326,000 89,000 (37,000) -------------- --------------- -------------- Provision (benefit) for income taxes $ 83,000 $ 7,605,000 $ (1,734,000) ============== =============== ==============
The net deferred tax assets and liabilities, at the respective income tax rates, are as follows:
DECEMBER 31, ------------------------------------ 2000 1999 --------------- --------------- Current deferred asset: Accrued liabilities $ 2,007,000 $ 1,759,000 Less valuation allowance (2,007,000) (1,759,000) --------------- --------------- $ - $ - =============== =============== Noncurrent deferred asset: Net operating loss $ 6,930,000 $ 6,460,000 Tax gain on sale transactions in excess of recognized financial reporting gain - 1,323,000 - Deferred lease costs 1,060,000 - Tax goodwill and intangibles 6,821,000 7,918,000 Allowance for doubtful accounts 503,000 - Investment in TDLP 907,000 931,000 Noncurrent self-insurance reserves 1,363,000 882,000 --------------- --------------- 17,584,000 17,514,000 Less valuation allowance (17,353,000) (16,543,000) --------------- --------------- 231,000 971,000 --------------- --------------- Noncurrent deferred liability: Depreciation (231,000) (971,000) --------------- --------------- (231,000) (971,000) --------------- --------------- $ - $ - =============== ===============
Due to the uncertainty surrounding the realization of the benefits of the Company's deferred tax assets, the Company has established a full valuation allowance against such tax assets as of December 31, 2000 and 1999. The Company increased the valuation allowance by $1,058,000 and $12,802,000 during 2000 and 1999, respectively. At December 31, 2000, the Company had $18,200,000 of net operating losses, which expire at various dates through 2021. F-24 82 12. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company is committed under long-term operating leases with various expiration dates and varying renewal options. Minimum annual rentals, including renewal option periods (exclusive of taxes, insurance, and maintenance costs) under these leases for the next five years beginning January 1, 2001, are as follows: 2001 $ 20,510,000 2002 20,914,000 2003 20,260,000 2004 19,977,000 2005 19,812,000 Thereafter 333,306,000 ---------------- $ 434,779,000 ================
Under lease agreements with Omega, Counsel, Pierce and others, the Company's lease payments are subject to periodic annual escalations as described below and in Note 2. Total lease expense was $20,563,000, $20,375,000 and $19,109,000, for 2000, 1999 and 1998, respectively. OMEGA LEASES As discussed in Note 4, effective October 1, 2000, the Company entered into a Settlement and Restructuring Agreement with Omega that amended the Omega Master Lease. The Omega Master Lease includes all facilities currently leased from Omega. All of the accounts receivable, equipment, inventory and other related assets of the facilities leased pursuant to the Omega Master Lease have been pledged as security under the Omega Master Lease. The initial term of the Omega Master Lease is ten years, expiring September 30, 2010, with an additional ten-year renewal term at the option of the Company, assuming no defaults. Lease payments of $10,875,000 and $11,030,000 are required during the first and second years, respectively, of the Omega Master Lease. During subsequent years, increases in the lease payments are equal to the lesser of two times the consumer price index or 3.0%. The Company is recording all scheduled rent increases, including the 3.0% rent increases, as additional lease expense on a straight-line basis over the initial lease term. The Omega Master Lease also requires the Company to fund capital expenditures related to the leased facilities totaling $1,000,000 during the first two years of the initial lease term. The Company is also required to fund annual capital expenditures equal to $325 per licensed bed over the initial lease term (annual required capital expenditures of $910,000). Total required capital expenditures over the initial lease term are $10,100,000. These required capital expenditures are being depreciated on a straight-line basis over the initial lease term beginning October 1, 2000. Upon expiration of the Omega Master Lease or in the event of a default under the Omega Master Lease, the Company is required to transfer all of the leasehold improvements, equipment, furniture and fixtures of the leased facilities to Omega. In the event that the Company does not transfer all of the facility assets to Omega, the Company will be required to pay Omega $5,000,000 plus accrued interest at 11.00% from the effective date of the Settlement and Restructuring Agreement. The Company's management intends to transfer the facility assets to Omega at the end of the lease term; consequently, the Company has not recorded a liability for the potential $5,000,000 payment and has not recorded any interest expense related to the potential $5,000,000 payment. The assets to be transferred to Omega are being depreciated on a straight-line basis over the initial lease term beginning October 1, 2000. F-25 83 With respect to two facilities leased by the Company from Omega, first mortgage revenue bonds of $4,370,000 were assumed by Omega during 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, 2000. As of December 31, 2000, the Company is not in compliance with certain debt covenants. Such events of default under the Company's debt agreements could lead to actions by the lenders that could result in an event of default under the Company's Omega Master Lease. Should such a default occur in the Omega Master Lease, the lessor would have the right to terminate the lease agreements. COUNSEL LEASES The Company leases three facilities from Counsel with an initial term of ten years through April 2004 and one ten-year renewal option. The Company leases five additional facilities from Counsel with a remaining term expiring in April 2004. With respect to all of 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. Omega is Counsel's mortgage lender on the three facilities. Pursuant to the Settlement and Restructuring Agreement with Omega, Counsel is required to transfer one of the facilities to Omega in exchange for the outstanding mortgage balance, at which time the facility will be leased by the Company from Omega in accordance with the terms of the Omega Master Lease. The transfer of this facility is expected to occur during 2001. Also pursuant to the Settlement and Restructuring Agreement, the Company has the right to require Counsel to transfer the remaining two facilities to Omega in exchange for the related outstanding mortgage balances, at which time the facilities are expected to be sold. The Company has the ability to receive 20% of the sale proceeds upon the sale of the two facilities. The transfer and sale of these two facilities is expected to occur during 2001. PIERCE LEASES During 1997, the Company acquired leases with respect to 14 assisted living facilities from Pierce. Of the 14 facilities currently leased from Pierce, 12 are with the former principal owners of Pierce and have an initial term of 15 years through September 2012 and two five-year renewal options. Beginning at the fifth anniversary, the Company has a right to purchase all 12 facilities as a group for their fair market value. An additional sublease, which expires in 2003, is with an affiliate of Pierce. 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 cost 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 1999 and 2000. These substantial premium increases have also continued for the policy year 2001. As a result of the substantial premium increases for the 2001 policy year, effective March 9, 2001, the Company has obtained professional liability insurance coverage for its United States nursing homes that, based on historical claims experience, could be substantially less than the claims that could be incurred. For claims made after March 9, 2001, the Company maintains general and professional liability insurance with coverage limits of $2,000,000 per medical incident and total aggregate policy coverage limits of $3,000,000 for its F-26 84 long-term care services. The 2001 policy is on a claims made basis and the Company is self-insured for the first $50,000 per occurrence. For claims made during the period March 9, 2000 through March 9, 2001, the Company is self-insured for the first $500,000 per occurrence with no aggregate limit for the Company's United States nursing homes. The policy has coverage limits of $1,000,000 per occurrence, $3,000,000 per location and $12,000,000 in the aggregate. The Company also maintains umbrella coverage of $15,000,000 in the aggregate for claims made during the period March 9, 2000 through March 9, 2001. The Company provides reserves on an actuarial basis for known and expected claims incurred during the policy period. For all policy periods beginning on or after March 9, 2000, all of the Company's professional liability policies are on a claims made basis. Prior to March 9, 2000, all of these policies are on an occurrence basis. For the policy periods January 1, 1998 through February 1, 1999, the Company is self-insured for the first $250,000 per occurrence and $2,500,000 in the aggregate per year with respect to the majority of its United States nursing homes. 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 the policy years 2000 and 1999, the Company expects to ultimately incur the full aggregate deductible amounts and has established reserves based on this expectation. The Company's United States assisted living facilities are self-insured, with respect to each location, for the first $50,000 per occurrence. The Company also maintains a $15,000,000 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 are self-insured for the first $3,000 ($5,000 Canadian) per occurrence. The Company's aggregate primary coverage limit with respect to Canadian operations is $1,335,000 ($2,000,000 Canadian). The Company also maintains a $3,338,000 ($5,000,000 Canadian) aggregate umbrella policy for claims in excess of the foregoing limits for these facilities. The Company has recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $6,859,000 and $4,393,000 at December 31, 2000 and 1999, respectively. Based on its assessment of claims currently outstanding against the Company and estimates for claims incurred but not reported, management currently believes that there have been no incurred claims that are in excess of established reserves and related insurance coverage. However, the ultimate results of the Company's professional liability claims and disputes are unknown at the present time. Any future judgments or settlements above the Company's per occurrence, per location or umbrella coverage could have a material adverse impact on the Company's financial position, cash flows and results of operations. Based on historical claims experience, the Company's professional liability insurance coverage for the period beginning March 9, 2001 could be substantially less than the claims to be incurred during 2001. The ultimate payments on professional liability claims accrued as of December 31, 2000 and claims that could be incurred during 2001 could require cash resources during 2001 that would be in excess of the Company's available cash or other resources. These potential future payments could have a material adverse impact on the Company's financial position and cash flows. 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 F-27 85 for the settlement of outstanding self-insured claims at amounts believed to be adequate as of December 31, 2000. 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. The Company provides reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate. The liability for reported claims and estimates for incurred but unreported claims is $820,000 and $721,000 at December 31, 2000 and 1999, respectively. 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 $2,081,000. 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 their 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. 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 financial position, results of operations and cash flows. Future federal budget legislation and federal and state regulatory changes may also 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 F-28 86 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. The Company is currently a defendant in two pending false claims actions as described below. On October 17, 2000, the Company was served with a civil complaint by the Florida Attorney General's office, in the case of State of Florida ex rel. Mindy Myers v. R. Brent Maggio, et al. In this case, the State of Florida has accused multiple defendants of violating Florida's False Claims Act. The Company, in its capacity as the manager of four nursing homes owned by Emerald Coast Healthcare, Inc. ("Emerald"), is named in the complaint, which accuses the Company of making illegal kickback payments to R. Brent Maggio, Emerald's sole shareholder, and fraudulently concealing such payments in the Medicaid cost reports filed by the nursing homes. The Company believes that it has meritorious defenses to this case, and intends to vigorously pursue these defenses in litigation. Currently, there are several motions by the Company seeking dismissal of this complaint that are pending before the trial court. Under the Federal False Claims Act, health care companies may be named as a defendant in an action which is filed under court seal, without being informed of this fact until the government has substantially completed its investigation. In such cases, there sometimes occurs a provision for "partial lifting of the seal," in which the trial court orders that the seal may be lifted for purposes of giving the named defendant the opportunity to informally present its defenses and discuss settlement prospects with the government. In cases in which the judge orders such a "partial lifting of the seal," the defendant becomes aware of the case but is precluded from discussing it publicly. Management is aware of one such case being filed in federal court against the Company regarding billing practices at one of its nursing homes. The Company has retained counsel to defend it in this case and, while cooperating with the government in its investigation of the matter, intends to vigorously pursue its defense of the case. Based on all information currently known, the Company currently does not believe that the claims being made in this case are material to the Company's financial condition, cash flows or results of operations. While the Company cannot currently predict with certainty the ultimate impact of either of the above cases on the Company's financial condition, cash flows or results of operations, an unfavorable outcome in any state or federal False Claims Act case could subject the Company to fines, penalties and damages. Moreover, the Company could be excluded from the Medicare, Medicaid or other federally-funded health care programs, which could have a material adverse impact on the Company's financial condition, cash flows or results of operations. MEDICARE REIMBURSEMENT 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. Revenues and expenses have both been reduced significantly from the levels prior to PPS. The BBA has negatively impacted the entire long-term health care industry. During 1999 and 2000, certain amendments to the BBA have been enacted, including the Balanced Budget Reform Act of 1999 ("BBRA") and the Benefits Improvement and Protection Act of 2000 ("BIPA"). The BBRA has provided legislative relief in the form of increases in certain Medicare payment rates during 2000. The BIPA is expected to continue to provide additional increases in certain Medicare payment rates during 2001. Although the refinements resulting from the BBRA and BIPA have been well received by the United States nursing home industry, it is the Company's belief that the resulting revenue enhancements are still significantly less than the losses sustained by the industry due to the BBA. Current levels of or further F-29 87 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 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. 13. 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. Counsel leases seven of these facilities from one of the partnerships. Management fees from these facilities totaled $1,828,000, $1,805,000 and $1,742,000 for 2000, 1999 and 1998, respectively. The Company has loaned one of the limited partnerships $595,000 and $929,000 as of December 31, 2000 and 1999, 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 $1,999,000, $2,132,000 and $2,064,000 for the years ended December 31, 2000, 1999 and 1998, respectively. 14. OPERATING SEGMENT INFORMATION SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," requires that public companies report financial and descriptive information about their operating segments. The Company has three reportable segments: United States nursing homes, United States assisted living facilities, and Canadian operations, which consist of both nursing home and assisted living services. Management evaluates each of these segments independently due to the geographic, reimbursement, marketing, and regulatory differences between the segments. The accounting policies of these segments are the same as those described in the summary of significant accounting policies described in Note 2. Management evaluates performance based on profit or loss from operations before income taxes not including non-recurring gains and losses and foreign currency 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:
2000 1999 1998 ---------------- ---------------- ---------------- Net revenues: U.S. nursing homes $ 147,527,000 $ 138,421,000 $ 164,646,000 U.S. assisted living facilities 32,455,000 28,689,000 25,552,000 Canadian operations 15,881,000 15,029,000 14,950,000 Corporate 172,000 (121,000) 4,000 ---------------- ---------------- ---------------- Total $ 196,035,000 $ 182,018,000 $ 205,152,000 ================ ================ ================ Depreciation and amortization: U.S. nursing homes $ 3,406,000 $ 2,925,000 $ 2,156,000 U.S. assisted living facilities 1,738,000 1,808,000 1,263,000 Canadian operations 389,000 356,000 348,000 Corporate 70,000 78,000 71,000 ---------------- ---------------- ---------------- Total $ 5,603,000 $ 5,167,000 $ 3,838,000 ================ ================ ================
F-30 88
2000 1999 1998 ---------------- ---------------- ---------------- Operating loss: U.S. nursing homes $ (848,000) $ (11,814,000) $ 1,041,000 U.S. assisted living facilities (541,000) (684,000) 708,000 Canadian operations 1,868,000 1,726,000 2,060,000 Corporate (2,538,000) (2,522,000) (2,767,000) ---------------- ---------------- ---------------- Total $ (2,059,000) $ (13,294,000) $ 1,042,000 ================ ================ ================ Long-lived assets: U.S. nursing homes $ 33,178,000 $ 32,777,000 $ 41,072,000 U.S. assisted living facilities 33,216,000 34,332,000 33,987,000 Canadian operations 12,164,000 12,933,000 10,536,000 Corporate 858,000 944,000 1,914,000 ---------------- ---------------- ---------------- Total $ 79,416,000 $ 80,986,000 $ 87,509,000 ================ ================ ================ Total assets: U.S. nursing homes $ 56,387,000 $ 55,796,000 $ 75,326,000 U.S. assisted living facilities 36,075,000 36,309,000 36,926,000 Canadian operations 17,154,000 16,738,000 13,718,000 Corporate 2,860,000 1,134,000 3,492,000 Eliminations (10,720,000) (13,792,000) (8,168,000) ---------------- ---------------- ---------------- Total $ 101,756,000 $ 96,185,000 $ 121,294,000 ================ ================ ================ Capital expenditures: U.S. nursing homes $ 1,273,000 $ 1,341,000 $ 4,043,000 U.S. assisted living facilities 774,000 937,000 688,000 Canadian operations 301,000 1,856,000 422,000 Corporate 33,000 248,000 33,000 ---------------- ---------------- ---------------- Total $ 2,381,000 $ 4,382,000 $ 5,186,000 ================ ================ ================
15. NON-RECURRING CHARGES The Company has recorded various non-recurring charges as presented below:
2000 1999 1998 ------------- ------------- ------------- Advisory, consulting and debt maturity extension fees incurred in conjunction with restructuring of lease and debt agreements $ 1,708,000 $ - $ - Impaired assets - 500,000 2,858,000 Information systems conversion - - 1,166,000 Legal and contractual settlements - - 1,276,000 Termination of proposed financing and acquisition transactions - - 559,000 ------------- ------------- ------------- $ 1,708,000 $ 500,000 $ 5,859,000 ============= ============= =============
F-31 89 As discussed in Note 4, the Company entered into a Settlement and Restructuring Agreement with Omega on November 8, 2000. In conjunction with and during the related negotiations of the Settlement and Restructuring Agreement, the Company also entered into various debt extension agreements. The non-recurring charges recorded during 2000 represent advisory, consulting and debt maturity extension fees incurred in conjunction with the Settlement and Restructuring Agreement. As discussed in Note 5, the Company has recorded total charges of $3,000,000 ($500,000 in 1999 and $2,500,000 in 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, during 1998, management identified two locations for which leases would not be renewed and recorded an impairment loss of $358,000 related to certain long-lived assets with respect to these locations. During 1998, in connection with its decision to convert all management information systems with respect to the Company's United States 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 $1,166,000 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. 16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Selected quarterly financial information for each of the quarters in the years ended December 31, 2000 and 1999 is as follows:
QUARTER ----------------------------------------------------------------------------- 2000 FIRST SECOND THIRD FOURTH ------------------------------- --------------- -------------- --------------- ------------------- Net revenues $ 47,338,000 $ 48,262,000 $ 50,301,000 $ 50,134,000 =============== ============== =============== =============== Net income (loss) $ 85,000 $ 73,000(1) $ 149,000(1)$ (4,157,000)(1)(2) =============== ============== =============== =============== Basic and diluted income (loss) per share $ .02 $ .01 $ .03 $ (.76)(1)(2) =============== ============== =============== ===============
-------------------- (1) Includes non-recurring charges totaling $1,708,000 related to the restructuring, amending and extension of the Company's lease and debt agreements (see Note 15). Of the total $1,708,000, $263,000 was recorded during the second quarter, $359,000 was recorded during the third quarter and $1,086,000 was recorded during the fourth quarter. (2) Includes a $1,500,000 charge recorded as a result of the unfavorable development of professional liability insurance claims during the fourth quarter (see Note 12). F-32 90
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) =============== ============== =============== ===============
--------------------------- (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 of $500,000 for the estimated impairment of the Company's investment in TDLP (see Notes 5 and 15). (3) Includes the write-off of deferred tax assets totaling $12,802,000 (see Note 11). F-33 91 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Advocat Inc.: We have audited, in accordance with auditing standards generally accepted in the United States, 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 29, 2001. 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 29, 2001 S-1 92 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 Deductions End of Description Period Expenses Accounts Other (1) Period - ------------------------------------------------------------------------------------------------ Year ended December 31, 2000: Allowance for doubtful accounts $4,958 $2,881 $ -- $ -- $(2,804) $5,035 ====== ====== ===== ===== ======= ====== 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 ====== ====== ===== ===== ======= ======
- ---------- (1) Amounts written off as uncollectible accounts, net of recoveries. S-2 93
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
94
Exhibit Number Description of Exhibits - ------ ----------------------- reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.3 1994 Incentive and Non-Qualified Stock Plan for Key Personnel (incorporated by reference to Exhibit 10.3 to the Company's Registration Statement No. 33-76150 on Form S-1). 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
95
Exhibit Number Description of Exhibits - ------ ----------------------- 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 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).
96
Exhibit Number Description of Exhibits - ------ ----------------------- 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). 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).
97
Exhibit Number Description of Exhibits - ------ ----------------------- 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 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
98
Exhibit Number Description of Exhibits - ------ ----------------------- 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). 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).
99
Exhibit Number Description of Exhibits - ------ ----------------------- 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 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).
100
Exhibit Number Description of Exhibits - ------ ----------------------- 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). 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).
101
Exhibit Number Description of Exhibits - ------ ----------------------- 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). 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)
102
Exhibit Number Description of Exhibits - ------ ----------------------- (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). 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).
103
Exhibit Number Description of Exhibits - ------ ----------------------- 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 (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
104
Exhibit Number Description of Exhibits - ------ ----------------------- (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). 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). 10.82 Employment Agreement dated January 1, 2000 by and between the Company and James F. Mills, Jr. (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2000). 21 Subsidiaries of the Registrant. 23 Consent of Arthur Andersen LLP.
EX-21 2 g68202ex21.txt SUBSIDIARIES 1 EXHIBIT 21 SUBSIDIARIES
NAME OF CORPORATION STATE OF INCORPORATION - ------------------- ---------------------- Advocat Ancillary Services, Inc. Tennessee Advocat Distribution Services, Inc. Tennessee Advocat Finance, Inc. Delaware Diversicare Assisted Living Services, Inc. Tennessee Diversicare Assisted Living Services NC, LLC Tennessee Diversicare Canada Management Services Co., Inc. Ontario, Canada Diversicare General Partner, Inc. Texas Diversicare Leasing Corp. Tennessee Diversicare Leasing Corp. of Alabama Alabama Diversicare Management Services Co. Tennessee First American Health Care, Inc. Alabama
EX-23 3 g68202ex23.txt CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS 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 29, 2001 -----END PRIVACY-ENHANCED MESSAGE-----